Court Denies American Airlines’ Motion to Reject CBAs; Provides Roadmap to Future Rejection

On August, 15, 2012, Bankruptcy Judge Sean H. Lane of the Southern District of New York denied American’s motion to reject its collective bargaining agreement with the Allied Pilots Association (“APA”) on narrow grounds.  The Court held that American had not demonstrated that its proposals to eliminate contractual restrictions on pilot furloughs and enter into essentially unlimited codesharing arrangements were necessary to its reorganization.

However, the court rejected the vast majority of the APA’s broader arguments, found that the CBA was “a burden that American is unable to maintain” and that American had met the standards for rejecting a CBA under section 1113 of the Bankruptcy Code.  Specifically, the court held that (i) American could reject the CBA even though a potential merger between American and US Airways may have resulted in fewer sacrifices by the APA; (ii) American’s business plan was a sufficient basis to reject the CBA; (iii) American’s proposal was fair and equitable; and (iv) American negotiated in good faith.  Accordingly, the court denied American’s motion without prejudice to remedying the furlough and codesharing shortcomings.

The decision follows the path recently taken by Judge Drain in the Hostess bankruptcy.  Both decisions denied the debtors’ motions to reject their CBAs on narrow grounds, but appear to leave the unions with few options going forward and may clear the way for the debtors to reject their respective CBAs.  Restructuring Review covered the Hostess opinion in greater detail HERE.

In response to Judge Lane’s decision, American submitted a revised proposal to the APA withdrawing its furlough proposal and modifying its codesharing requests.  Just two days after the Court entered its opinion, on August 17, American renewed its motion to reject the CBA, arguing that the modifications to its proposals satisfy the two concerns outlined in the court’s opinion.

Background

American filed for chapter 11 protection on November 29, 2011.  Among other factors, American attributed its financial troubles to high labor costs and poor employee productivity.  In 2003, American avoided bankruptcy by obtaining economic concessions from its unions, however, these concessions did not stem the tide of American’s losses.  On February 1, 2012, American unveiled a five-year business plan setting forth a comprehensive business model under which American would continue operating as a standalone airline.  Based on the business plan’s projections, American presented the pilots and its other unions with proposals seeking a 20% across the board reduction of labor costs from each union, which translated into approximately $1.25 billion in average annual reductions.  American also proposed to terminate its pension plans.  Subsequently, American submitted amended proposals that did not contemplate terminating the pension plans and provided instead that the plans would stop accruing new benefits.

On March 27, 2012, American filed a motion seeking authorization to reject the CBAs pursuant to section 1113 of the Bankruptcy Code.  Section 1113 of the Bankruptcy Code generally requires that to terminate or modify a collective bargaining agreement, a debtor must (i) make a proposal to the union (ii) that contains only those modifications necessary for a restructuring of the debtor and (iii) the union must refuse to accept those changes without good cause.  Restructuring Review discussed the requirements of section 1113 in detail HERE.

American argued that its proposals to the unions satisfied all of its obligations under section 1113 and that the unions’ rejection of the proposals did not constitute good cause.  After the motion was filed, American and the unions continued to negotiate.  Concurrently, the unions were also engaged in negotiations with US Airways, which resulted in term sheets that set forth proposed contractual terms if American and US Airways entered into a merger transaction.

In April and May, the court conducted a three-week trial at which the APA and American’s other unions – the Association of Professional Flight Attendants and the Transit Workers Union of America, AFL-CIO – presented evidence and raised multiple objections to the rejection motion.  After the trial’s conclusion, APFA and the TWU voted on and ultimately ratified new CBAs.  Accordingly, although the APFA vote was still pending when the court rendered its decision, the court focused solely on American’s motion to reject its CBA with the APA.

Was American’s Proposal Necessary to its Reorganization?

The APA advanced multiple objections contending that American’s proposal was not necessary for its reorganization.  The court divided these arguments into three categories:

1.         Blanket Objections to the Motion.  The APA advanced three principal blanket objections:

A.        The APA claimed that a merger between American and US Airways was inevitable given recent consolidation in the airline industry.  Because the term sheet provided by US Airways required the APA to accept fewer concessions, the APA argued that American was required to pursue a merger with US Airways before seeking to reject its CBAs pursuant to section 1113.

B         The APA alleged that American’s reliance on its business plan as the basis for its proposal to the union was inappropriate because the plan was a flawed extension of American’s previously introduced unsuccessful business plan.  The APA also questioned the assumptions and financial targets contained in the plan.

C.        American’s internal prepetition projections indicated that labor costs were currently, or would soon be, comparable to the industry standard.

2.         Objections to Proposed Changes in Benefits to All Union Employees.  The APA argued that the assumptions underlying American’s calculation of its anticipated savings from changes to its current employee and retiree medical plans were incorrect because it failed to include potential savings due to higher deductibles and co-pays and utilized the incorrect discount rate.

3.         Objections to Proposed Changes Relevant Only to Pilots.  The APA argued that five specific aspects of American’s proposal were not necessary to its reorganization:

A.        Regional Jets.  American’s proposed expanded use of regional carriers to fly regional routes on American’s behalf exceeded the amount of regional jet usage envisioned under American’s business plan and would ultimately lead to reduced flights for APA members.

B.        Codesharing. American’s proposed use of essentially unlimited codesharing arrangements with other airlines (an arrangement that allows the use of American’s unique designation by other airlines) would effectively allow American to outsource its flights to other airlines with non-APA pilots.  Additionally, the proposal’s anticipated codesharing arrangements exceeded the contemplated use of such arrangements in American’s business plan.

C.        Furlough.  American’s proposal to eliminate all contractual provisions limiting pilot furloughs allowed five times more furloughs than what was contemplated under the business plan and would only yield annual savings of $300,000.

D.        Schedule Maximum.  American’s proposal to increase the maximum number of hours that a pilot could fly each month exceeded the industry standard.

E.         Sick Leave.  American’s proposal to pay pilots 60% of their hourly base rate after 36 hours of sick leave was unnecessary because the current CBA contained sufficient procedures to identify misuse of sick leave and would pressure pilots to fly when they are unwell and unable to fly.

The court rejected all of the blanket objections and objections to the proposed changes to all union employees.  Additionally, the court held that American’s proposed changes to the regional jet, schedule maximum and sick leave provisions were necessary to its reorganization.  However, the court found that although additional codesharing was necessary, American had not demonstrated that the essentially unlimited amount of codesharing it sought in its proposal was necessary.  Further, the court determined that American had not demonstrated that the proposed changes to the furlough policy were necessary.  Accordingly, the court denied the motion to reject the CBA, but granted American the ability to renew its motion if it remedied these two concerns.

Blanket Objections

The court began by noting that the focus of a section 1113 inquiry is on the debtor’s proposal, and debtors are not required to craft proposals that relied on the participation of a third party.  The court therefore held that American was not required to present the union with a proposal that relied on a potential merger with US Airways.  Moreover, the court found that the American-US Airways merger was speculative.  The two airlines had not discussed a possible merger and even if negotiations took place there was no guarantee that a deal could be completed.  Accordingly, American’s failure to consider a potential merger was not fatal to its proposal.  Additionally, the court held that requiring American to wait until it had pursued a possible merger before seeking to reject its CBAs was inconsistent with multiple subsections of section 1113 that require bankruptcy courts to consider section 1113 motions expeditiously.

The court also held that it was reasonable for American to rely on its business plan as a basis for its proposals, noting that in the context of an 1113 motion, debtors are not required to present a proposal containing all the details of its proposed reorganization.  Rather, the proposal must provide enough information to support the business plan’s projections – with the understanding that the ultimate plan of reorganization may differ.

Additionally, the court noted that under Second Circuit precedent, a debtor’s proposal could contain modifications over and above the bare minimum necessary for reorganization and still satisfy the necessity requirement of section 1113, so long as the proposal was necessary for the long-term viability of the debtor.  As a result, the court found that American had established that the business plan was a “reasonable stand-alone business strategy to serve as a basis for American’s section 1113 motion.”

Finally, the court rejected the APA’s argument that the proposed concessions were not necessary because of American’s prepetition assessments that its labor cost were comparable to other airlines.  The court found it “unsurprising” that American’s current projections that costs were too high differed from its prepetition view, noting that bankruptcy often alters management’s views of a company’s past policies and strategies.  The court held that American’s current outlook on labor costs was more reliable because it was underscored by the billions of dollars in losses suffered by American in recent years, as well as the APA’s own admission that the current status quo was unsustainable.

Proposals Affecting All Unions

Next, the court rejected the APA’s contentions that American’s assumptions regarding union medical plans underestimated the potential savings that would accrue to American due to higher deductibles, co-pays and out of pocket expenses assessed to employees.  The court found that American’s expert had based its assumptions on commonly accepted actuarial principles and gave little weight to the testimony on this issue by the APA’s expert, finding that the alternative estimates were not based on reliable methodology.  The court similarly found that American had utilized a reasonable discount rate to calculate the present value of the potential savings from the changes in medical plans because it was based on the actual rate of return on the medical plan’s assets.

Proposals Specific to the APA

Finally, the court addressed the APA’s objections to specific aspects of American’s proposal to the APA.  The court rejected the APA’s objection that American’s proposal to expand its ability to subcontract regional jet routes was not necessary to its reorganization.  The court found that American’s proposed use of regional jets was “very much in line with the projected need” described in the business plan and that American’s need for flexibility to keep pace with changing market needs justified the amount of regional jet usage in the proposal.  Similarly, the court found that the revised maximum amount that pilots would be allowed to fly was in line with industry standards and that American’s proposal to curtail the use of sick leave was designed to bring American’s sick leave costs in line with its peers.

The court acknowledged that American required additional flexibility in its codesharing agreements, however, the proposal’s codesharing provisions exceeded the goals and arrangements set forth in the business plan and thus American had not demonstrated that “essentially unlimited” codesharing was necessary to achieve successful reorganization.  Similarly, the court held that American’s proposal would effectively eliminate all restrictions on pilot furloughs and the business plan only contemplated an increase in furloughs.  Additionally, the court found that American had not demonstrated that unrestricted furloughs were standard in the airline industry or would result in significant cost savings.  Accordingly, the court held that unlimited codesharing and unrestricted furloughs were not necessary to American’s reorganization.

Was American’s Proposal Fair and Equitable?

Section 1113(b)(1)(A) requires a debtor’s proposal to treat all affected parties “fairly and equitably.”  Generally, a debtor can satisfy this requirement by demonstrating that the proposal treats the union fairly compared to the burden imposed on other stakeholders.  The APA argued that the proposal was not fair and equitable because (i) American had improperly valued the savings associated with changing the pilots’ maximum scheduled flying time; (ii) American had not considered an additional $21 million of lost pilot wages that would likely result from the increased use of regional jets; and (iii) the proposal did not take into account the concessions that the APA had agreed to in 2003 to help American avoid bankruptcy.

The court rejected these arguments finding that American’s approach to valuing projected savings from changes in flying time was generally consistent with the valuations utilized in previous airline bankruptcy cases.  The additional $21 million of lost wages was speculative.  Finally, the court acknowledged the APA’s 2003 sacrifices, but found that American’s proposal sought similar across the board concessions from all of its unions.  As a result, the court held that the proposed uniform cuts to all of the unions was fair and equitable.

Did American Bargain in Good Faith?

Section 1113(b)(2) requires a debtor to negotiate in good faith after making a proposal to its unions.  The APA argued that American did not negotiate in good faith.  In support of this contention, the APA stated that American (i) did not change its “ask” from the original proposal; (ii) refused to negotiate over specific terms such as sick leave and maximum flying time; and (iii) requested concessions over and above those requested by American in its prepetition negotiations with the APA.  The court held that although American did not make many changes to its proposal during negotiations, it did make some changes that satisfied the good faith requirement.  Most notably, the court held that American’s decision to freeze its pension plans instead of outright termination was “particularly significant.” Accordingly, even though the total dollar amount of concessions remained unchanged, and some provisions in the proposal were non-negotiable, American’s willingness to modify its position on the pension plans demonstrated that American was negotiating in good faith.  The court also held that comparisons to prepetition negotiations were inappropriate because “those proposals were designed to be acceptable to the unions, as opposed to fully addressing the company’s financial issues.”

In summary, the court found that American’s proposal generally satisfied the section 1113 requirements and that “rejection of the [CBA] is necessary for American to successfully reorganize.” However, the court found that the proposed changes to the furlough and codesharing provisions were not justified.

American’s Renewed Motion

On August 17, American filed a renewed motion to reject the CBA.  In its filings, American stated that under a modified proposal it had submitted to the APA, it withdrew entirely its prior proposals on furloughs and limited its proposed ability to enter into new codesharing arrangements with new partners whose total air seat miles was 50% or less than American’s air seat miles.  American argued that these changes satisfy the court’s concerns and it should therefore be allowed to reject the CBA.  A hearing on the renewed motion is scheduled for September 4.

Conclusion

Although the court denied American’s motion to reject the CBA, it did so on very narrow grounds (limited only to two specific problems with the proposed terms).  The court’s analysis  provided the APA with only a small window of opportunity to negotiate some settlement.  American’s swift response to the decision appears to be an indication that it intends to reject the CBA.  The court’s decision also had an immediate impact on American’s negotiations with its flight attendants’ union.  In a communication to its members, APFA characterized the decision as a “blistering indictment of the labor unions” and urged its members to ratify American’s proposal.

Judge Lane followed a very similar course to that pursued by Judge Drain in the recent Hostess decision denying Hostess’ efforts to reject its CBAs with the International Brotherhood of Teamsters, but making clear that the Debtors had met the standards for termination of a CBA, except with respect to certain specific issues.  Judges in the Southern District of New York have laid out a road map for debtors to terminate or modify CBAs under section 1113 of the Bankruptcy Code, but Debtors will need to ensure that all aspects of the proposed plan are necessary for reorganization.

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