As anticipated here earlier this week, Delta Air Lines commenced its inevitable chapter 11 reorganization case yesterday and was joined by fellow legacy carrier Northwest Airlines. Both chapter 11 cases were filed in New York City, which has become the preferred venue for big reorganization cases (or at least the preferred venue for the debtors’ attorneys).
With the filing of these cases, four of the U.S.’s seven largest airlines (by passenger traffic) are wallowing in Chapter 11 and more than half the capacity of the nation’s top dozen airlines are now under the jurisdiction of the Bankruptcy Courts. Although the liquidation of one or more of these debtor-carriers would likely improve the overall financial health of the airline industry, it’s difficult to put a big airline out of its misery.

The common thread behind all four big airlines currently in bankruptcy are that they are legacy carriers that have been unable to modify the structure of their finances and operations to remain profitable during this era of industry deregulation. The airline industry has faced a brutal business environment over the past five years, including high labor costs, increasing fuel prices and increased competition from low-cost carriers such as Southwest Airlines.
Although an effective way to convert excess debt to equity in a reorganized entity, a chapter 11 case is no guarantee that a reorganized airline will be successful. As noted here, substantial questions already exist whether the proposed reorganization plan in the United Airlines case will allow that airline to be profitable after bankruptcy, and several airlines have already filed chapter 22 cases (that is, chapter 11 twice), including US Airways and Houston-based Continental Airlines. Years ago, Eastern Air Lines and Pan American Airways were both liquidated in chapter 11 with other airlines buying their assets, while TWA was swallowed by American Airlines during TWA’s chapter 33 case.
Moreover, there is a developing line of thought — one that Larry Ribstein has frequently addressed on his blog — that there has not been enough contraction in the airline industry to make the industry profitable during this era of higher-than-expected fuel prices. Most airlines these days would be profitble if oil were selling at $35 a barrel, but the adjustment in the industry to oil prices almost double that price is delayed by chapter 11, which allows money-losing airlines such as United to continue operating and competing with non-bankrupt airlines that are attempting to restructure outside of bankruptcy. For example, Northwest would have gained market share and benefited greatly had United liquidated or become a much smaller airline, but United did not do so and has been operating in bankruptcy for almost three years now. Similarly, had US Airways bitten the dust rather than go into chapter 11, Delta would have been been able to gain market share and raise some prices on its East Coast routes, which might have allowed the company to parley that increased business into the changes necessary to stave off a bankruptcy case. Consequently, there is a real issue as to whether chapter 11 is really promoting the type of restructuring necessary to transform the airlines into a financially sound industry.
Delta has arranged over $2 billion in debtor-in-possession financing from a consortium of DIP lenders led by General Electric Co.’s commercial finance unit and Morgan Stanley. Interestingly, Northwest believes that it has sufficient liquidity to make a go of it in chapter 11 without DIP financing, although that may simply be a decision to avoid a fight with its current lenders, who have locked up virtually all of Northwest’s assets.
With US Airways about ready to emerge from its current chapter 11 case through a reorganization merger with America West, there has been some speculation in the markets that Delta and Northwest may pursue a similar merger while in chapter 11 with the assistance of private equity. The two airlines route networks do not overlap much and Delta’s trans-Atlantic flights would complement Northwest’s foreign routes. As with the US Airways-American West merger, absent fundamental changes in the way the two airlines operate, such a merger would likely be nothing more than a rearrangement of the deck chairs on the Titanic.