Sometime the debtor is able to successfully reduce its liability and returns to profitability but quite often it returns to seek the court's protection again and sometime the end result is liquidation.
Under Chapter 11 protections, the debtor gets an automatic protection from all creditors. The unsecured creditors cannot lay a claim on assets and secured creditors are also prevented from foreclosing on their collateral. A Chapter-11 company also gets the advantage of discarding or renegotiating union agreements, ability to freeze or cut wages and benefits and restructures its staffing requirement. Retirement and pension plans can also be reviewed or the company can transfer its pension obligations to the Federal Pension Benefit Guaranty Corporation.
The reorganization is carried out by the bankruptcy and the court appointed trustee. The trustee appoints committee(s) to represent the creditor's interests and work out a plan for reorganization of the company. The reorganization plan must be approved by the bankruptcy court and also by the creditors and stockholders. However even if the creditors reject the plan, the court can still approve the plan if it feels that creditors and stockholders are adequately safeguarded under it. Normally the company management continues to implement the plan while the court appointed committee act as co-manager. However, if the court feels that the business is grossly mismanaged it may appoint a trustee to operate the business in the reorganization phase.
OTHER TYPES OF BANKRUPTCIES
Bankruptcies other than liquidation (Chapter 7) and reorganization (Chapter 11) are also covered in 'Title 11 of the United States Code'. These cover farmer and individuals as well as municipalities facing severe financial problems. These chapters are not relevant to the present discussions and will not be discussed further.
MODIFICATIONS TO THE BANKRUPTCY LAWS
The bankruptcy laws have been designed to give every opportunity to businesses and individuals to get back on their feet. The cost of allowing a company to go bankrupt is much higher than the cost of allowing the business to reorganize itself. The creditors can expect higher return of their money from a restructured business than in the case the business is allowed to go bankrupt. The cost in terms of services land employment opportunities lost is also substantial.
The lawmakers expected that reorganized business would continue to provide jobs, satisfy creditors claim and produce a return for its owners. For this reason, Chapter11 provided considerable concessions to the businesses [Rodgers, 1999]. The Congress has realized that some of the provisions of reorganization are being misused in all categories. The laws are therefore being tightened to remove loopholes.
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 passed in April 2005 became law on October 17, 2005. This law modifies Chapter 7 provisions to discourage consumer bankruptcy filing. Changes have also been made to Chapter 11 provisions [Jones, 2005]. Major amendments to Chapter 7 provisions include:
18 months time limit for debtors to submit their own organization plan after they file for bankruptcy
Time for releasing leases reduced, this time forces the company to decide quickly which locations they wish to continue to operate and which locations they want to close.
Limit how much companies pay to retain essential employees.
Bankruptcy judge can order a trustee to restructure committee to better represent creditors' interests.
Requirements applicable to large businesses have been applied on small businesses too.
The Bankruptcy Abuse Prevention act shows that the possibility of misuse is well recognized and laws are being tightened to prevent misuse of Bankruptcy Act.
THE 'GOOD' OLD DAYS OF REGULATION
Civil Aeronautics Board (CAB) formed in 1938 managed the air transport in United States. The board set the routes, schedules and fares. It also ensured that the operating airlines had a reasonable rate of return. The bureaucratic set up dragged any attempt to modify the airline business for years. The operating airlines recognized that they did not have to please their customers but the CAB to be profitable. The last Chairman of CAB appointed to bring changes to airline operating regulation observed that "rather than sustain air travel, CAB in fact acted to inhibit growth and encourage inefficient practices" [Wikipedia' 2005].
The guaranteed acceptable 'rate of return' to the airlines promoted inefficiency in airline operating practices. The airlines accepted huge pay claims from the unions, allowed restrictive operating practices, which determined how many hours' pilots, technicians and other workers will be expected to work. The lucrative retirement pension and health plans also added to the operating costs. Major airlines supported this system but passengers and the taxpayers who had to pay the ever-increasing costs did not like the system. Kahn [Wikipedia' 2005] argued that "removing regulation would help foster a new efficient equilibrium price, quality and quantity of air service; that long haul fares would drop, barriers to entry of new airlines would drop and airlines will be able to deploy air crafts suitable to the traffic load on different routes." Eventually pressure of consumer interest resulted in the Air Lines Deregulation Act of 1978, which phased out CAB controls on routes and prices and also the CAB.
THE AIRLINE DEREGULATION ACT
The Airline Deregulation Act (ADA) became law on Oct 28, 1978. The purpose of the act included:
Reliance on competition in air transport services
Encouragement of air service through secondary or satellite airports
Avoidance of policies, which allow air carriers to increase prices, reduce services or exclude competition
Encouraging formation of new airlines
Encouraging existing airlines to provide new air services and encouragement of small air carriers and Giving highest priority to Air Safety.
The ADA changed the shape of air transport in USA forever. The CAB in the transition period was expected to have no role in setting the airfares, liberalize establishment of new airlines, authorize international carriers to offer domestic services, justify blocking a request for new routes, authorize interstate carriers to enter into joint fare and through service agreements and encourage hiring of employees of another carrier terminated due to reorganization. The CAB was expected to handover charge of its remaining responsibilities to the Department of Transport (DOT) and dissolve itself after the transition period [Wikipedia' 2005].
IMPACT OF DEREGULATION
The deregulation has opened the competition in air travel industry. The old large airlines of the pre-deregulation period, which carried the legacy of inefficient and uncompetitive practices, were highly troubled by the new changes. The inexperience airlines, which sprung up after the deregulation, also had a rough time and many of these new airlines also went bankrupt. In the 27 years prior to deregulation no airline in U.S. went bankrupt, during the last 27 years (since deregulation), 160 airlines have come and gone [Morris, 2005]. The rate of companies seeking Chapter 11 protection is 10 times higher than the other industrial sectors.
The legacy carriers were forced to compete and countered union disputes in reforming their policies to be in line with the competition. In 2005 almost all major airlines are either in Chapter 11 protection or appear to be heading that way. At present Delta, Northwest, United and U.S. Air, Hawaii and numerous other smaller airlines are under Chapter 11 protection.
Deregulation reduced the airfare in a large number of cases. A 1990 survey indicated that between 1978 and 1990 the airfare declined by 30% in inflation adjusted terms. It has been estimated that passengers saved $100 billions in airfares during this period [Siddiqi, 2005].
The hub and spoke route system became common after deregulation. This route system used was adopted by major airlines. The hubs were used as the main airports. Airlines, their subsidiaries or partner airlines ran trips from other cities to these hubs. Smaller aircrafts are often used to feed the hub resulting in more flights and better plane occupancy. The airlines found that operating from a central Hub and running flights from other cities to the hub improved fleet utilization, increased passenger traffic and filled more seats.
New entrepreneurs enter the airline industry, some of these airlines used highly unconventional methods and to attract passengers. People's Express an airline formed after deregulation used low salary, staff that could do multiple jobs for airline operations; passengers were expected to pay for their in-flight meals and also for the checked-in baggage. This allowed People's Express to offer fares, which were comparable to bus service. Larger airlines had to compete with these shoestring budget airlines and had to reduce their fares to remain in business. Better service of large airline coupled with lower fares forced Peoples Express and other similar airlines out of business.
In order to stay in business and drive competitors out of business, airlines resorted to very low airfares and in many cases affected themselves financially to an extent that some of the bankruptcies and takeover in the following years can be credited to predatory pricing of airfares.
In the wake of 1978 ADA, turbulence in the industry was only to be…