in the united states bankruptcy court for the northern district
TRANSCRIPT
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IN THE UNITED STATES BANKRUPTCY COURTFOR THE NORTHERN DISTRICT OF ILLINOIS
EASTERN DIVISION
In re:
UAL CORPORATION, et al.,
Debtors.
))))))
Chapter 11
Case No. 02 B ______(Jointly Administered)
Honorable [___________]
INFORMATIONAL BRIEF OF UNITED AIR LINES, INC.
Dated: December 9, 2002
James H.M. Sprayregen, P.C.
Alexander Dimitrief, P.C.Andrew A. Kassof
KIRKLAND & ELLIS
200 East Randolph Drive
Chicago, Illinois 60601(312) 861-2000
Counsel for the Debtors
and Debtors-in Possession
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TABLE OF CONTENTS
Page
I. PRELIMINARY STATEMENT. .........................................................................................1
II. UNITED AIR LINES AND ITS CURRENT FINANCIAL CRISIS...................................4
A. Uniteds Operations. ................................................................................................... 4
B. The Employees of United. .......................................................................................... 4
C. Uniteds Revenues Have Collapsed............................................................................ 6
D. United Was Unable to Stop Burning Through Its Cash. ............................................ 8
III. THE LONG-TERM ROOTS OF UNITEDS FINANCIAL CRISIS. .................................9
A. The Airline Industry During the Regulatory Period. ................................................ 10
B. Deregulation and Its Effects on the Airline Industry and United Air Lines. ........... 12
C. The Struggles of the Industry from 1982 to 2000..................................................... 14
1. Airlines Have Tried Short-Term Initiatives to Curb Costs. .............................. 15
2. The Current Industry Paradigm Has Forced Numerous AirlinesOut of the Industry............................................................................................. 17
IV. UNITED ULTIMATELY PROVED UNABLE TO SUSTAIN ITS COSTSTRUCTURE. .....................................................................................................................19
A. United Reduced All of the Expenses That Were Within Its Control. ...................... 20
B. Increasing Labor Costs.............................................................................................. 22
1. ALPA. ................................................................................................................ 22
2. The IAM. ........................................................................................................... 22
3. The AFA. ........................................................................................................... 24
4. United Has Struggled With the Highest Labor Costs in the Industry. .............. 24
C. United Was Unable to Access the Capital Markets.................................................. 25
D. The Air Transportation Stabilization Board. ............................................................ 28
1. The Economic Recovery Plan. .......................................................................... 28
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2. The Enhanced Recovery Plan. ........................................................................... 29
3. Uniteds Unions Voted in Favor of the Coalitions Proposal. .......................... 30
4. The ATSB Decides Not to Approve Uniteds Application............................... 31
E. Uniteds Access to Its Proposed DIP Financing Is Conditioned onSubstantial Cost Reductions That Can Be Achieved Only if UnitedsEmployees Agree to Substantial Concessions. ......................................................... 32
1. The DIP Negotiations. ....................................................................................... 32
2. The DIP Facilities. ............................................................................................. 34
3. The DIP Covenants............................................................................................ 35
V. UNITED MUST RISE TO THE CHALLENGES OF A FUNDAMENTALLY
DIFFERENT COMPETITIVE LANDSCAPE. ..................................................................36
A. The Lingering Effects of September 11.................................................................... 36
B. Internet Shopping. ..................................................................................................... 37
C. Business Traffic Has Shrunk to Record Lows.......................................................... 38
D. The Increasingly Formidable Competition Posed by Low Cost Carriers. ............... 40
1. The Competitive Advantage. ............................................................................. 40
2. Expanding Presence. .......................................................................................... 42
3. Appealing to Business Travelers. ...................................................................... 43
4. The Impact on United. ....................................................................................... 43
VI. UNITEDS PLAN TO EMERGE FROM BANKRUPTCY AS A PROFITABLEAND FORMIDABLE COMPETITOR IN A CHANGED AIRLINE INDUSTRY..........45
A. Capitalizing on Uniteds Strong Market Position and Base of Assets
to Sell a Superior Product Across an Unrivaled Network. ....................................... 46
B. United Will Continue to Reduce Its Non-Labor Costs. ............................................ 47
1. Aircraft and Other Leases.................................................................................. 47
2. United Express Partners..................................................................................... 48
3. Other Revenue and Cost Initiatives................................................................... 48
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C. United Must Reduce Its Labor Costs. ....................................................................... 49
D. United and Its Unions Will Have to Take a Hard Look at Work Rules................... 53
E. United and Its Unions Must Work Together Constructively to Addressthe CBAs Restrictions on the Companys Ability to Generate Revenue,
Outsource Non-Core Activities and Furlough Employees. ...................................... 54
1. Regional Jets. ..................................................................................................... 55
2. Code Sharing. .................................................................................................... 57
3. Furlough Limitations. ........................................................................................ 58
4. Outsourcing Limitations. ................................................................................... 58
VII. UNITED IS NOT THE ONLY PRE-DEREGULATION CARRIER
STRUGGLING WITH THE INEVITABILITY OF TRANSFORMING ITSBUSINESS MODEL...........................................................................................................59
A. American Airlines. .................................................................................................... 60
B. Continental Airlines. ................................................................................................. 61
C. Delta Air Lines.......................................................................................................... 61
D. Northwest Airlines. ................................................................................................... 62
E. US Airways. .............................................................................................................. 62
VIII. CONCLUSION. ..................................................................................................................64
APPENDIXES
AFFIDAVITS SUBMITTED IN SUPPORT OF INFORMATIONAL BRIEFOF UNITED AIR LINES, INC.
Affidavit of Frederic F. Brace
Affidavit of Peter B. Kain
Affidavit of Daniel M. Kasper
Affidavit of Glenn F. Tilton
SOURCES CITED IN INFORMATIONAL BRIEFOF UNITED AIR LINES, INC. (Volumes 1 - 3)
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I. PRELIMINARY STATEMENT.
United Air Lines was determined to avoid this day. The reason it could not is
rooted in Economics 101: Uniteds costs are out of line with the Companys revenues, which
began to collapse in 2001. Indeed, the degree to which United and the other major network
carriers were already struggling with unaffordable cost structures before September 11 was laid
painfully bare by the tragedies of that day and their aftermath. Despite having the industrys best
work force, assets and route structure, United was unable to stop burning through its cash.
Uniteds revenues have plummeted mostly because Americans simply are not
flying as much as they used to, especially not on business trips at full fares. More of the
passengers who do continue to fly are opting for low cost carriers at the expense of United and
the other full-service carriers. The resulting price competition has been compounded by the
emergence of the Internet, which has made it easy for passengers to comparison shop for the
lowest available fares. All of this has reduced the value of differentiators among airlines other
than price. These shifts in the industry have hit United the hardest. The Companys passenger
revenues have plunged from $16.9 billion in 2000 to $13.8 billion in 2001 and a projected $11.8
billion for 2002.
In response, United did everything within its control to bring its costs into line
with the reduced revenue environment. The Company slashed costs in every aspect of its
operations except for safety delaying or canceling capital investments, reducing schedules,
downsizing the airline, cutting non-aircraft expenditures, bargaining for concessions from
vendors, furloughing employees, and eliminating scheduled pay increases for salaried and
management employees. But further cost reductions were needed. Before filing todays petition,
United sought savings from its unionized workforce in an amount and of a duration sufficient to
stave off bankruptcy. Yet, despite concessions agreed to by its unions, the capital markets and
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the Air Transportation Stabilization Board deemed Uniteds business plan to be insufficient to
address the Companys long-term issues, especially in a depressed revenue environment.
As a result, United was left with no alternative but to file todays petition for
bankruptcy.1 And now that United is in bankruptcy, its obligation to this Court and the
Companys stakeholders has become to reorganize into a viable airline that will be able to
compete in a chronic weak-yield environment.2 Against this backdrop, the harsh reality is that,
despite periodic boom years (such as during the late 1990s) in which every single variable
broke in the Companys favor, United has been unable to achieve sustained profitability. For
United to emerge from bankruptcy successfully, these proceedings will have to address Uniteds
collective bargaining agreements (CBAs) with its unionized employees because labor is by
far Uniteds largest cost, because Uniteds labor costs are now the highest in the industry, and
because the CBAs restrict Uniteds ability to reduce its costs and maximize its revenues in ways
that are no longer affordable. Moreover, the covenants set forth in Uniteds Debtor-In-
Possession financing require that the cost savings begin immediately.
To this end, the Company has already decided that the compensation of salaried
and management (SAM) employees at United will be reduced effective December 16, 2002,
the beginning of the Companys next pay period. The base compensation of the 36 officers at
United, including that of Chief Executive Officer Glenn Tilton, will be reduced by an average of
11 percent. Reductions in the salaries of non-officer SAM employees will be based on a
progressive scale pursuant to which employees with higher incremental incomes will be subject
to higher reductions. Reductions will start at 2.8 percent for employees earning less than
$30,000 per year and increase to an effective reduction of approximately 10.7 percent for the
highest paid non-officers.
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It bears immediate emphasis that, in calling this Courts attention to the
unaffordability of the Companys cost structure, United is not blaming any of its employees or
their union representatives for Uniteds current crisis. To the contrary, United could not be more
grateful to its employees and their unions leadership for their good-faith efforts and
unprecedented cooperation in trying to resolve Uniteds financial dilemma outside of
bankruptcy. At this juncture, however, the only conceivable way for United to reorganize into a
profitable and vibrant airline capable of providing stable employment will be to reduce its labor
and other costs dramatically, in part through changes to work rules that place United at an
extraordinary competitive disadvantage.
It also bears even further emphasis that, as before, Uniteds preferred course of
action would be to reach consensual agreements outside of the Section 1113 process with all of
its unions about the changes that must be made to the Companys CBAs. To this end, United has
already begun discussions with the leadership of its unions and stands ready to negotiate around
the clock. It is only if these negotiations prove unsuccessful in achieving a consensual
restructuring that, as a decidedly last choice, United will seek this Courts assistance pursuant to
Section 1113.
* * *
Section II of this Brief provides an overview of the immediate crisis that forced
United into bankruptcy. Section III chronicles the roots of Uniteds inability to control its costs.
Section IV details how United ultimately collapsed under the weight of an unsustainable cost
structure. Section V explains why, as taught by the experiences of carriers that have previously
succumbed to bankruptcy, short-term measures to address long-term structural problems at
United will no longer suffice. Section VI provides an overview of Uniteds plan to secure fair
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and equitable contributions from all of its stakeholders (including its management, suppliers,
vendors and lessors as well as its employees) to realign its costs with its revenues and thereby
ensure Uniteds long-term viability in a highly competitive industry. Section VII clarifies that
United will not be alone among airline carriers in seeking substantial concessions from unionized
employees as the industry heads into 2003.
II. UNITED AIR LINES AND ITS CURRENT FINANCIAL CRISIS.
A. Uniteds Operations.
Operating since 1926, United Air Lines is the worlds second largest airline.
Uniteds route network spans the United States, serving this countrys major business centers and
smaller cities both directly and through hubs in Chicago, Denver, Washington, D.C. (Dulles),
Los Angeles and San Francisco. Uniteds network also serves dozens of smaller communities
that would otherwise be left without airline service. In addition, United enjoys a strong share of
restricted international routes. In all, United transports approximately 200,000 passengers per
day on over 1,765 daily departures to 119 destinations in 26 different countries.3
The Company is also a long-time contributor to the United States government,
having committed 96 wide-body aircraft to the Civil Reserve Aircraft Fleet and providing
military and government engine maintenance.4 In these and many other respects, United serves
as a vital component of this nations transportation infrastructure and, in particular, plays an
indispensable role in maintaining the safety, efficiency, viability and competitiveness of U.S.
commercial aviation.
B. The Employees of United.
United employs approximately 83,000 people worldwide, including
approximately 77,000 employees in the United States and more than 19,000 in Illinois, 5 and also
indirectly supports thousands of additional jobs throughout the United States. 6 Uniteds
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employees are presently represented by six unions. Approximately 8,600 pilots are represented
by the Air Line Pilots Association (ALPA). About 20,000 flight attendants are represented by
the Association of Flight Attendants (AFA). More than 12,000 mechanics and related
employees are represented by District 141-M of the International Association of Machinists
(IAM). Nearly 25,000 customer service agents, and ramp and store employees are represented
by District 141 of the IAM. In addition, about 20 meteorologists are represented by the
Transportation Workers Union (TWU), approximately 180 dispatchers are represented by the
Professional Airline Flight Control Association (PAFCA) and roughly 425 engineers are
represented by the International Federation of Professional and Technical Employees (IFPTE).
Over the past 76 years, the men and women of United Air Lines have garnered the
loyalty of millions of passengers. At last count, 73 percent of Uniteds customers used the
airline as their primary carrier.7 And it is an enormous credit to the Companys employees that,
despite all of the industrys troubles, United has served its customers better than ever in 2002. In
October 2002, United ranked first in on-time arrivals at nearly 90 percent (up from ninth in
2001) and first in fewest flight cancellations. In all, Uniteds performance in October 2002 was
its best ever in all major categories.8
It is therefore not without irony that todays filing culminated the worst fifteen
months in Uniteds financial history. Uniteds tremendous base of assets enabled United for the
most part to compete despite its cost structure until 2001, which was already proving to be a
tough year for the industry before September 11.9 But the tragic events of that day exacerbated
the Companys problems in ways that United was unable to overcome.
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C. Uniteds Revenues Have Collapsed.
The number of passengers i dropped at unprecedented levels in 2001:
Exhibit 1. DROP IN INDUSTRY PASSENGERS, 2001.
The plunge in revenues for 2001 was even more unprecedented, as captured by Exhibit 2.
Revenue per Available Seat Mile (RASM), the amount of revenue an airline receives per each
unit (i.e., seat) of capacity it supplies to the market, ended up dropping by nearly 12 percent in
2001 and is on course to decline by as much as another 20 percent in 2002. 10
i The airline industry typically measures volume by revenue passenger miles or RPMs , with each RPMsignifying a mile flown by a paying customer. For example, a 1,000 mile flight carrying 100 passengers generates100,000 RPMs. In the same vein, available seat miles or ASMs measures the capacity that an airline provides
to the market. A 1,000 mile flight with 200 available seats represents 200,000 ASMs.
Notes: Revenue passenger miles for U.S. scheduled carriers. Partial year figures reflect change over same period in the previous year.Source: Air Transport Association.
-15%
-10%
-5%
0%
5%
10%
15%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
Jan-Aug2001
Sep01-Jul02
PercentChangeInRevenuePassengerMiles(Year
overPreviousYear)
1980-1981: Oilcrisis and U.S.
recession(-3.9% & -1.1%)
1991: Gulf war & U.S.recession (-2.3%) Jan-Aug 2001
(0.6%)
Sep 01 Jul 02(-12.7%)
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Exhibit 2. CHANGE IN INDUSTRY REVENUES , 1990 - 2001.
United has been hit the hardest.11 Revenue has remained low because
passengers have not returned as hoped, because of lower yields attributable to reduced demand
and promotions necessary to entice the flying public to return to the air and because of
increasingly formidable competition from low cost carriers like Southwest Airlines, American
Trans Air (ATA) and newcomer JetBlue.12
(30)%
(20)%
(10)%
0%
10%
20%
30%
YOY
% Change in
RASM
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
9/11 Disaster
Gulf War /Recession
Value
Pricing
Y2K
Source: ATA and UBS Warburg.
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Exhibit 3. UNITEDS OPERATING LOSSES .
-3,000
-2,500
-2,000
-1,500
-1,000
-500
0
500
1,000
1,500
2,000
2Q00 3Q00 4Q00 1Q01 2Q01 3Q01 4Q01 1Q02 2Q0 2 3Q02
Four Quarters Ending
UnitedTrailingFourQuartersOperatin
g
Income($M)
Source: U.S. DOT Form 41.Note: Includes grants received in 2001 under the Air Stabilization Act.
United ended up losing $1.4 billion in the second half of 2001 alone and an additional $1.7
billion in the first nine months of this year. 13 Never before has United experienced such a sharp
and sustained drop in revenue and profitability.
D. United Was Unable to Stop Burning Through Its Cash.
As a consequence, United depleted its cash reserves at a rate unlike ever before in
its history. Uniteds operating cash burn (i.e., the amount by which operating cash
disbursements exceeds receipts)14 averaged more than $10 million per day over the fourth
quarter of 2001. Massive cost-cutting efforts reduced this amount to $7 million per day by
March 2002. And during the second quarter of 2002, United was able to reduce its operating
cash burn to less than $1 million per day. But with a stalled recovery in July 2002 came a nearly
$7 million operating cash burn during the third quarter. In November 2002, the Companys
revenues were higher than expected, but the Company still burned over $5 million a day.
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In the words of the Association of Flight Attendants, the mature segment of the industry,
including United, is vulnerable unless a sustainable balance of revenue and expense is found.15
A. The Airline Industry During the Regulatory Period.
Until 1978, the Civil Aeronautics Board (CAB) controlled virtually every
aspect of airline economics, determining whether to let new airlines enter the market, what routes
existing airlines could fly, and the fares that airlines could charge. 16 Competition from new
entrants generally did not exist because the CAB almost invariably refused to permit any new
airline to begin operations as a large passenger air carrier. 17
To ensure profitability, the CAB set higher fares on the more frequently traveled
routes (precisely the opposite of what would have been dictated by unregulated competition). In
the 1970s, for example, the CAB set prices to provide carriers with a twelve percent return if
they filled their planes to only fifty-five percent capacity. 18 Through formulas such as these that
allowed costs to dictate fares, the CAB in essence permitted the airlines to pass through cost
increases to customers.19
This insulation against cost-based competition enabled the airlines to pay
employees generous wages and benefits and to agree to inefficient work rules of the sort largely
unheard of in other industries.20 Because the CAB routinely passed on increased labor costs to
passengers at the next fare increase, management had little need (or incentive) to draw ha rd lines
in negotiations 21 with the large and well-organized unions that represented the vast majority of
employees at the major carriers notably the Air Line Pilots Association (ALPA), the
Association of Flight Attendants (AFA), the International Association of Machinists (IAM), and
the Transport Workers Union (TWU).22 The unions engaged in pattern plus bargaining with
each airline, advancing the increases they had received from their negotiations with the last
airline as the measuring stick for additional increases.23 This leapfrogging further reduced the
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airlines incentive to resist union demands because the companies knew their competitors would
undoubtedly accede to even greater demands in the near future. 24 As a result, airline unions
possesse[d] a high degree of relative bargaining power,25 and airlines got used to rubber-
stamping union demands.26
The upshot was a steady increase in wages and benefits throughout the regulation
period to levels well above what unionized employees could have earned outside of the airline
industry. ii Although pattern plus bargaining kept wage rates among airlines fairly close,27
unionized, [a]irline workers were among the highest paid in the American industry at the time
deregulation ended.28
Unions were also able to secure highly-restrictive work rules that required
airlines to hire more employees than necessary to run their operations. iii
Two of the more paradoxical work rules that came to life during this era remain in
place at United today. Minimum pay guarantees require United to pay pilots and flight
attendants a minimum amount each month, regardless of the amount of time the employees
actually worked. Vacation overrides enable pilots and flight attendants to stretch out vacations
by timing them to overlap with hand-picked, clustered flight schedules (known as IDs). 29
ii To be sure, airlines did not always agree to all union demands. Strikes were not unheard of in theregulatory era, and a Mutual Aid Pact (which provided struck airlines with a share of the additional profits earned by
competitors while the struck airlines stopped operating) enabled Northwest and a few other carriers to resist some oflabors more far-reaching requests. Michael A. Katz, The American Experience Under the Airline Deregulation Act
of 1978 An Airline Perspective, 6 Hofstra Lab. L. J. 87, 92 (1988); John M. Baitsell, Airline Industrial Relations342 - 46 (Harvard University 1966). Still, the airlines by and large lacked the incentive to risk disrupting their
operations (via blue flus or otherwise). Katz, 6 Hofstra Lab. L. J. at 92 - 93.
iii In his time-honored study of airline industrial relations, John Baitsell summarized this point for pilots,though his observations apply with as much force to all airline employee groups: In the area of scheduling the
strongest indication of a relative imbalance of power is the continual loss of pilot utilization that has been sufferedby airline management. Work rules have proliferated to the point where airlines are unable to obtain a reasonable
amount of flying from each pilot. Baitsell, Airlines Industrial Relations at 349.
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Overrides can turn a two-week vacation into a month away from work, at full pay and without
any penalty, as illustrated by the following December schedule for a United 747-400 captain:
Sun Mon Tues Wed Thurs Fri Sat
OFF 1 OFF 2 OFF 3 OFF 4 OFF 5 OFF 6 OFF 7
OFF 8 OFF 9 OFF 10 ID 11 ID 12 ID 13 ID 14
ID 15 ID 16VAC
VAC 17 VAC 18 VAC 19 VAC 20 VAC 21
VAC 22 VAC 23 VAC 24 ID 25
VAC
ID 26 ID 27 ID 28
ID 29 ID 30 OFF 31
In this real-world example, the pilot scheduled a vacation (VAC) from December 16 until
December 25. The pilot then bid for IDs from December 11 - 16 and December 25 - 30. The
pilot was not scheduled to work from December 1 - 10 or on December 31. By arranging for the
last and first days of his two IDs to overlap with the first and last days of his scheduled vacation
(on days 16 and 25), the pilot was able to take off all 12 days in the scheduled IDs (i.e., days 11 -
15 and 26 - 30). This creative scheduling enabled the pilot to parlay ten days of vacation time
into an entire month off from work with full pay.
B. Deregulation and Its Effects on the Airline Industry and United Air Lines.
The proponents of deregulation believed that, if freed from the shackles of
government, the airline industry would become more competitive, provide a better range of price
and service options and become more efficient. The swift passage of the Airline Deregulation
Act of 1978 thrust airlines into a competitive hotbed, freeing carriers to set fares and establish
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flight schedules based on market forces. But airlines also suddenly found themselves unable to
count on cover from regulators to pass on increased costs to consumers. 30 Instead, airlines
were forced almost overnight to make the transition to an environment in which financial
performance was driven by cost, price, and service.31
Nearly 200 new airlines flooded into the marketplace, 32 with upstarts such as
Peoples Express offering bargain-basement fares that enabled more people to fly than ever
before.33 These new competitive pressures forced the airlines to come up with a more efficient
way of using their fleets in order to compete for customers on the basis of low cost, convenient,
and attractive service.34
The larger carriers abandoned point-to-point service in favor of hub-
and-spoke networks.35 The words hub and spoke create a vivid image of how this system
works. A hub is a central airport through which flights are routed, and spokes are the routes that
planes fly out of the hub airport.36 The resulting network offered greater frequency of service
with its fleet of aircraft than had been possible with point-to-point service.37
United capitalized on its size, hub-and-spoke model and customer loyalty
programs to fend off competition from upstart airlines and outcompete long-standing rivals who
failed to adapt to the new environment.38 But creative marketing and changing route structures
alone were hardly sufficient. United and its competitors soon found it necessary to engage in
suicidal fare wars. Airlines slashed their on-board amenities as they sought to increase (or
preserve) market share by filling their planes at rock-bottom prices.39
But throughout all of these fundamental transformations of the industry, one
vestige of the regulatory era remained: Unions retained disproportionate bargaining power to
maintain regulation-sized labor costs, together with the ability to impose massive losses on
carriers if their demands were not met.40 In many respects, deregulations expansion of the
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industry strengthened the unions bargaining power. 41 Open entry into markets and the increased
overlap among competing airline route systems meant that a strike would likely be tantamount to
a death sentence.42 In short, aviation became deregulated only on one side: free competition for
revenue; costs largely immovable.43 Pre-deregulation carriers struggled mightily in what
ultimately proved to be a losing battle against cost structures that their shrinking yields could not
sustain.44
Exhibit 4. INDUSTRY REVENUES VERSUS COSTS, 1984 - 2002. iv
5.0
6.0
7.0
8.0
9.0
10.0
11.0
12.0
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
Q1-Q
3
Cents/ASM
RASM CASM
Sources: U.S. DOT Form 41, 2002 airline earnings reports and 10-Qs.Note: Carriers include American, United, Continental, Northwest, Delta, America West, and US Airways. Includes grantsreceived in 2001 under the Air Stabilization Act.
C. The Struggles of the Industry from 1982 to 2000.
Braniff Airways became the first casualty of deregulation in May 1982. v
Continental Airlines filed for bankruptcy in September 1983, but kept operating as it abrogated
iv Like revenues, which are generally measured according to RASMs, costs are typically measured andcompared by cost per available seat mile, or CASM. CASMs are ordinarily measured in cents and arecomputed as total operating costs divided by an airlines ASMs (available seat miles).
v Braniff resumed operat ions a year later with dramatically reduced labor costs agreed to by its unions. Butafter eking out meager profits for a few years, Braniff again succumbed to bankruptcy in 1989. The airline wasacquired out of bankruptcy and operated as a charter service for several years until shutting down for good in 1992.
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its labor contracts and endured a prolonged strike. Western Airlines and Republic Airlines both
faced financial crises which they ultimately resolved by merging with stronger partners (Delta
and Northwest, respectively). By 1992, the industry had suffered more than 150
bankruptcies, witnessed 50 mergers and, in the process, had lost all the profit it had made
since the Wright Brothers flight at Kitty Hawk, plus $1.5 billion more.45 Virtually every
airline hailing from the days of regulation has at some point found it necessary to cut costs in
order to cut fares or say good-bye to a franchise that had taken decades to build.46 But
controlling labor costs has been anything but easy in an industry with substantial union strength
and a labor relations environment characterized neither by cooperation nor trust.47
If anything, the industry consolidation bred by deregulation48 left carriers even
more vulnerable to crippling strikes. A smaller airline with several hundred pilots or mechanics
might be able to find enough replacements to continue operations. But a large airline like United
cannot even begin to replace more than eight thousand pilots, and thus has little choice but to
shut down during a strike, incurring millions of dollars of fixed costs every day without any
offsetting revenues. Indeed, on the one occasion that United did try to withstand a pilot strike in
1985, the results were disastrous.vi
1. Airlines Have Tried Short -Term Initiatives to Curb Costs.
Unable by and large to prevail at the bargaining table, airlines have sought to
control the cost of labor through means less conventional than simple wage reductions or work
vi Uniteds pi lots struck in response to the Companys desire to implement B-scale wages like those atAmerican. The strike cost the Company millions of dollars in operating revenue and cemented Americans position
as a lasting rival at Uniteds OHare hub. See Thomas Petzinger, Jr., Hard Landing 236-38 (Random House 1995).As Uniteds marketing chief said at the time, the strike was the worst thing to happen to the company in 50 years . .
. . Before the strike we were the greatest airline in the country, maybe the world. Afterward, we werent. Id. at238; see also James Ott & Raymond E. Neidl, Airline Odyssey: The Airline Industrys Turbulent Flight into the
Future 24-25 (McGraw-Hill 1995) (discussing the bitter consequences of the 1985 pilots strike for United).
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rule modifications.49 For example, in the early 1980s, American Airlines implemented a three-
tier wage structure pursuant to which new employees on the B-scale and C-scale50 were paid
lower salaries than incumbent members of the union. Eastern Airlines instituted a Variable
Earnings Plan (or VEP) pursuant to which the airlines employees agreed to condition a
percentage of their salaries on the airlines profitability. Easterns unions agreed that, if
Easterns earnings fell below a certain benchmark, members would receive 96.5 percent of their
full pay. 51 If profits exceeded the benchmark, members would receive 103.5 percent.52 And Pan
Am paid for its ninety-niner fare to anywhere in the United States by imposing an across-the-
board 10% wage cut, with a promise to snap back the unions pay three years later.53
Yet United arguably broke the most ground by creating the largest employee-
owned company in the United States in 1994. ALPA, the IAM and non-union employees were
awarded 55 percent ownership of Uniteds common stock, along with three out of twelve board
seats, in exchange for a six-year agreement involving pay-cuts and work rule concessions. 54 By
vesting the employees with a new stake as the largest owner of United, the ESOP sought to align
the interests of Uniteds pilots, mechanics, and other employees with those of the Company and
thereby ease the traditionally adversarial nature of the management-labor relationship.
None of these measures proved to have long-term success. Americans B-scale
and C-scale programs collapsed under the resentment of low-paid newcomers over receiving
unequal pay for equal work.55 At Eastern, a continuing deterioration in the airlines financial
performance fueled an antagonism between management and labor that ultimately led to the
carriers downfall. And although Uniteds ESOP yielded short-term cost reductions, it was back
to leapfrogging as usual as soon as the ALPA and IAM contracts became amendable in 2000.
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2. The Current Industry Paradigm Has Forced Numerous Airlines Outof the Industry.
Even before the tragic events of September 11, vicissitudes in the economy
caused those airlines with insufficient financial cushions to absorb steadily increasing labor costs
to vanish from the industry (some temporarily, others permanently).56 Nearly two hundred
airlines have filed for bankruptcy or otherwise exited the industry since Congress passed the
Deregulation Act of 1978.57 Among the casualties were several stalwarts of the airline industry.
For example, starting in 1980, Pan Am, desperately needing to raise cash, sold off
its most valuable assets at fire-sale prices, including its landmark building in New York, the
Intercontinental Hotel chain, and its prized signature routes to the Pacific, London, and Latin
America.58 This series of cash infusions enabled Pan Am to limp through another decade until
chronic losses ultimately forced a household name out of business. 59
Similarly, after suffering a net loss of more than $1 billion from 1980 through
1987,60 Eastern lost over $355 million in 1988 and another $225 million in the first quarter of
1989.61
Easterns above-industry labor costs contributed substantially to its deteriorating
financial condition.62 After a devastating strike by Easterns mechanics that was honored by the
airlines pilots, Eastern filed for Chapter 11 in March 1989.63 Continued labor unrest ultimately
forced Eastern to shut down its operations for good in January 1991. 64
Trans World Airlines (TWA) likewise suffered through years of losses
following deregulation. 65 Aided by employee concessions and a strong economy, TWA turned
its financial condition around in the late 1980s. 66 But losses from the Gulf War required further
concessions. This time, the unions refused, and [q]uick fix solutions such as selling off
profitable routes, properties, and equipment, as well as proposed mergers were not enough to
keep TWA out of Bankruptcy Court.67 In January 1992, TWA filed what would prove to be the
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first of three petitions for bankruptcy. In 2001, on the verge of liquidation, TWA was acquired
by American Airlines.
Continental is the only pre-deregulation airline to emerge from bankruptcy
successfully. In the early years of deregulation, the airline suffered losses exceeding $500
million that were caused primarily by Continentals inability to compete with new entrants
coming into the airline industry because its labor costs were significantly higher than the new
entrants.68 In September 1983, Continental filed its first petition for bankruptcy. Continental
imposed emergency work rules which reduced the salary and benefit packages of pilots by
nearly 50%,69
terminated its existing pension plans and rejected its collective bargaining
agreements (albeit under Section 365 instead of Section 1113, which was not to be enacted until
a year later).70
After exiting bankruptcy in June 1986, Continental again encountered serious
financial problems, and, in December 1990, filed a second petition for reorganization. 71 This
time around, Continental reached an agreement with its pilots on substantial reductions in the
pilots salaries and benefits.72 These concessions created a rippling effect that engendered
similar cost savings and concessions from Continentals other employee groups.73
Continentals mechanics agreed to an indefinite deferral of a scheduled pay increase, its flight
attendants agreed to a pay freeze and similar deferral of pay increases, and management and
other employees agreed to further concessions.74 Continental thus emerged from its second
bankruptcy in April 1993 with the lowest cost structure of any major network carrie r in the
industry. In fact, United estimates that, with Continentals labor cost structure, Uniteds annual
labor costs would be reduced by approximately $2 billion (or roughly 28 percent). 75
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To borrow a phrase from Tom Plaskett, the former President of Pan Am, it is a
national embarrassment that the only major network carrier to have succeeded in containing its
labor costs (at least until the next rounds of leapfrog bargaining) was able to do so only by
surviving two bankruptcies and a long strike. Indeed, Plaskett proved prophetic when he
lamented in 1991 that the circumstances leading to Pan Ams demise were not
something unique to Pan Am. Indeed, the result was theculmination of a long process and series of events that began in
1978. Thats when the drama really began. Thats when the old
script was thrown out the window and all of us in the airlineindustry were pushed out on stage together and told by our
government to improvise. Now, more than a decade later . . .
believe me, the show is far from over. . . . Whether you blame it onderegulation and excessive competition, recession, poor
management, recalcitrant unions, or just plain bad luck, the realityis that the U.S. airline industry is in terrible trouble.76
A decade later still, the show remains far from over.
IV. UNITED ULTIMATELY PROVED UNABLE TO SUSTAIN ITS COSTSTRUCTURE.
2000 capped several of the industrys best years, with the major carriers earning
more than $6.5 billion. 77 It was telling, however, that these profits reflected a net income margin
of only 2.3 percent for the industry and just 1.9 percent for United, 78 as compared to an average
net income margin of 8.5 percent for the 30 Dow Jones Industrials. vii In 2001, as industry
revenues plunged by nearly 12 percent,79 the major airlines lost $ 7.7 billion. This year, the
major network carriers are on pace to lose more than $8 billion. 80 The net losses of the Big 3
vii The 30 Dow Jones Industrials and their net income margins for 2000 were Alcoa (6.5%), AmericanExpress (11.9%), AT&T (4.7%), Boeing (4.1%), Caterpillar (5.2%), Citigroup (12.1%), Coca-Cola (10.6%), DuPont
(7.9%), Eastman Kodak (10.1%), Exxon Mobil (6.9%), General Electric (9.8%), General Motors (2.4%), Hewlett-Packard (7.3%), Home Depot (5.6%), Honeywell (6.6%), Intel (31.2%), IBM (9.2%), J.P. Morgan Chase (17.4%),
Johnson & Johnson ( 16.6%), McDonalds (13.9%), Merck (16.9%), Microsoft (41.0%), 3M (2.4%), Phillip Morris(10.6%), Procter & Gamble (8.9%), SBC Communications (15.5%), United Technologies (6.8%), Wal-Mart (3.3%)
and Walt Disney (4.8%).
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(American, United, and Delta) [have] reached depths in both absolute and relative terms
heretofore seen only in carriers destined to fail (Pan Am, in its final years, for example). 81
A. United Reduced All of the Expenses That Were Within Its Control.
When its revenues began to collapse, United started cutting costs in every aspect
of its business except for safety. 82 United vastly downsized its operations by reducing the
number of aircraft, slashing expenditures and furloughing roughly 20 percent of its employees.83
United also took a series of ever-escalating actions to try to staunch its financial bleeding:
September 2001 United cut daily flights. Prior to September 11, United
operated 2,400 daily flights. Shortly following the terrorist attacks, United
decreased this number by nearly 25 percent, down to 1,850 flights per day.84
September 19, 2001 United downsized its workforce. On September 19, 2001,
United announced furloughs of approximately 20,000 employees across all workgroups in the company, including over 1,500 non-union employees. The
Companys workforce reduction resulted in an overall savings of $374 million insalaries and related costs for the first six months of 2002, compared to the first six
months of 2001. United also reduced its number of management and salaried
employees by 23 percent.85
September 27, 2001 United suspended stock dividends. United suspended
dividends on its common stock.86
October 15, 2001 United again cut its number of daily flights. United cut its
flight schedule even further, down to 1,654 daily flights. 87
October 31, 2001 United retired aircraft. United grounded a total of 90 aircraftas part of the September capacity cuts, including the last of its Boeing 727-200
fleet and its entire 737-200 fleet. These were the oldest aircraft in Uniteds fleetand the most costly to operate and maintain. United also grounded 10 of its
largest aircraft, the B747-400.88
October 31, 2001 United turned to United Express. United transitioned sixcities previously served by Uniteds mainline jet service to its less costly United
Express regional jet service.89
November 16, 2001 United reduced new aircraft deliveries. During November
2001, United reduced planned new aircraft deliveries for 2002 and 2003 anddeferred deliveries of 43 out of 67 scheduled new aircraft. In 2003, United will
accept none of the 18 deliveries originally planned.90
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Fourth Quarter, 2001 United suspended airport construction plans. United
dropped or suspended a number of major airport construction plans. Theseprojects included over $1 billion for a new terminal at Dulles Airport, $313
million for a new terminal at JFK Airport in New York City and $51 million for a
stations operations center at OHare airport.91
Fourth Quarter, 2001 United obtained concessions from its vendors and
suppliers. United negotiated concessions from its vendors and suppliers, who
provide aircraft maintenance and parts, catering, and various services. Unitedsaved $80 million in price reductions or avoided price increases over 2001 and
2002, and will save more than $40 million annually from 2003 to 2005. Unitedalso saved approximately $320 million over 2001 and 2002 by canceling or
reducing the volume of orders.92
January 3, 2002 United closed reservation centers. In early January 2002,United closed five reservations centers, saving an estimated $30 million
annually.93
March 2002 United eliminated base commissions on ticket sales. In March
2002, United eliminated base commissions on tickets, a percentage fee that travelagents received on the sale of every ticket. The elimination of base commissions
will save approximately $200 million per year.94
April 1, 2002 United suspended wage increases for salaried and managementemployees. In April 2002, United cancelled a scheduled pay increase for its
salaried and management employees.95
October 21, 2002 United closed more reservation centers and transitionedmore stations to United Express. United announced that it will close three more
reservation centers on January 4, 2002. United also announced that it will convert
five more stations to United Express. United also closed a line at its Indianapolismaintenance center. These measures will generate an expected savings of $100
million per year.96
October 23, 2002 United closed international stations and shifted to smaller
aircraft on some international routes. United announced that it will close four
additional international stations in January 2003. United will also begin usingsmaller aircraft on a number of its international routes. These measures are
expected to save $120 million annually.97
November 8, 2002 Additional Furloughs. The Company announced that it will
furlough an additional 350 pilots and 2,700 flight attendants beginning in early2003.98
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B. Increasing Labor Costs.
Meanwhile, however, the Companys labor costs steadily increased at the most
rapid pace in the industry from 1998 - 2001:
Exhibit 5. INCREASE IN LABOR COSTS PERAVAILABLE SEAT MILE, 1998 - 2001.
26.0%
23.0%22.0%
13.0% 12.0%
5.0% 5.0%
0%
5%
10%
15%
20%
25%
30%
35%
United
American
Delta
Continental
Northwest
USAirways
Southwest
ChangeinLaborC
ostperASM:1998-2001
Source: U.S. DOT Form 41
1. ALPA.
Uniteds 8,600 pilots are represented by the Air Line Pilots Association. The
largest portion of the increase in Uniteds labor costs from 1998-2001 is attributable to the four-
year pilot contract to which the Company agreed in October 2000, when the revenue picture
remained bright. This contract immediately increased pilot wages (retroactive to the amendable
date of April 12, 2000) by a weighted average of 23 percent, with two subsequent weighted
average annual increases to date of 4.7 percent.99
2. The IAM.
Uniteds largest union is the International Association of Machinists. IAM 141
represents nearly 25,000 of Uniteds customer service agents and ramp and store employees,
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while IAM 141-M represents more than 12,000 mechanics and related employees. The IAM
agreements were open for re-negotiation at the time that September 11 struck. Although United
resisted huge increases, the IAM insisted upon leveling the playing field with the pilots by
securing its own industry-leading contracts before there could be any discussion of concessions.
In December 2001, President Bush convened a Presidential Emergency Board
(PEB) to forestall a strike. During these proceedings, the IAMs expert witness testified that
there is no innate right for any corporation to stay in business if it cant afford to pay all of its
factors of production at the rates that the market dictates.100 He went on to declare that it
will be the employees who have the most to gain and the most torisk with . . . the continuity of this company . . . . The publics
interest will be protected, because theres sufficient capacity in thisindustry to absorb United excess capacity, I should say. And
theres certainly ample precedent throughout the history of theairline and railroad industry to indicate that the public interest in
the world will not come to an end if there is a major consolidation.
But the employees interests must prevail.101
In January 2002, United reluctantly acceded to the PEBs recommendation to
increase the wages of its IAM-represented employees substantially, but on the understanding that
the parties would then negotiate concessions from those higher rates. In March 2002, United
agreed to a 25 percent base pay increase for mechanics and an 18 percent increase for utility
employees.102 Two months later, Uniteds IAM-represented public contact and ramp and store
employees received a 23 percent base pay increase.103 A substantial portion of these increases
was retroactive to July 12, 2000, the amendable date of the IAM contracts. Payment of the
retroactive increases is scheduled to be made in 8 quarterly installments beginning on December
15, 2002 and concluding on October 15, 2004.
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3. The AFA.
Uniteds 20,000 flight attendants are represented by the Association of Flight
Attendants. In March 2002, Uniteds flight attendants received a 2 percent increase in base pay
as scheduled in their collective bargaining agreement and an additional 5.49 percent increase
through arbitration. 104
4. United Has Struggled With the Highest Labor Costs in the Industry.
As a result, United paid the highest labor costs (as measured by percentage of
operating revenue) in the industry in 2001.
Exhibit 6. LABOR COST AS A PERCENTAGE OF OPERATING REVENUE, 2001.
48.5%45.5% 44.6% 43.9% 42.7%
35.7% 35.1%
28.7%26.2%
22.9%
0%
10%
20%
30%
40%
50%
60%
United
USAirways
American
Delta
Northwest
Southwest
Continental
JetBlue
AirTran
Frontier
LaborCostas%o
fOperatingRevenue
Source: U.S. DOT Form 41.
And because these cost increases took hold in the midst of the most dramatic
revenue decline that United has confronted in its history, labor costs as a percentage of revenue
have now reached a historical high at United:
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Exhibit 7. UNITEDS LABOR COSTS AS A PROPORTION OF TOTAL OPERATING REVENUE.
33.5%
36.1% 36.5%
33.7%
36.5%35.5%
34.9%
36.5%37.3%
38.0% 37.7%
48.5%
20%
25%
30%
35%
40%
45%
50%
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
LaborCostsas%
ofOperatingRe
venue
Source: U.S. DOT Form 41.
C. United Was Unable to Access the Capital Markets.
The Companys problems biggest financial setback since September 11 may have
been the capital markets loss of confidence in United, as evidenced by the Companys inability
to access financing on reasonable terms outside of bankruptcy. Although ten other airlines were
able to access the public capital markets to secure over $8 billion of financing even in the wake
of September 11, United was shut out. And, despite having approached some 25 banks (ranging
from JP Morgan to Northern Trust) and other potential lenders (such as Boeing and Oasis
Leasing), United was rebuffed at nearly every turn. 105
Since September 11, the major credit agencies have downgraded United more
than any of its competitors by a total of 15 notches to junk.106
During much of the period since
September 11, Standard & Poors rated United as a CCC (as compared to a BB- for
American, five notches ahead of United, and an A for Southwest, thirteen notches ahead of
United), and Moodys rated United at Caa3 (as compared to a B1 for American, five notches
ahead of United, and a Baa1 for Southwest, eleven notches ahead of the Company). 107
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The degree to which investors have harbored reservations about risking money on
United is most forcefully captured by the investment communitys flight from the pre-
deregulation network carriers. In May 1999, Southwests market capitalization was only 28
percent of the combined market capitalization of the major network carriers. United stood in
third place.
Exhibit 8. MARKET CAPITALIZATION OF MAJOR CARRIERS IN MAY 1999.
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
45,000
Southwest Other Majors Other Low Cost Carriers
MarketCapitalizationofAirlin
es($M)
Note: Figures are as of market closing on 5/31/1999, with the exception of Frontier Airlines (market closing date of 6/18/1999).
Sources: Global Airline Alliances, Merrill Lynch, 6/2/1999; Yahoo Finance; Frontier Airlines 10-K.
American $11,864
Alaska $1,088
AirTran $307Frontier $270
US Airways $4,245
Delta $8,193
Northwest $2,702
Continental $2,339
United $8,374
America West $904
$10,785
$577
$39,708
As of mid-November 2002, however, Southwests market capitalization has
grown to more than double that of the major network carriers combined. Equally striking is
how the market capitalization of newcomer JetBlue exceeds that of all the major network carriers
and is six times bigger than Uniteds. United has fallen to ninth place, behind all of the other
network carriers.
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Exhibit 9. MARKET CAPITALIZATION OF MAJOR CARRIERS IN NOVEMBER 2002.
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
10,000
11,000
12,000
13,000
Southwest Other Majors Other Low Cost
Carriers
MarketCapitalizationofAirline
s($M)
Delta $1,344M
Northwest $616M
Continental $540MUnited $244M
Note: Figures are as of market closing on 11/12/2002.
JetBlue $1,535M
American $998M
Alaska $588M
AirTran $292M
Frontier $178M
US Airways $40M
America West $77M
$11,550
$2,005
$4,447
Unable to tap into new sources of capital, United exhausted all available sources
of liquidity:
United tapped out all of its credit lines, drawing down over one billion
dollars;
the Company received grants totaling $782 million from the ATSB after
September 11, 2001;
United received $590 million in tax refunds;
the Company sold all of its shares in Cendant Corporation, raising $330
million;
during the first quarter of 2002, United closed on a private debt financingthat raised $250 million on prohibitive terms that reflected the Companys
poor credit rating; and
during the third quarter of 2002, United engaged in a sale-leasebacktransaction that raised approximately $72 million.
As United burned through this $3 billion of additional capital, it became apparent that United
would require still additional financing.
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D. The Air Transportation Stabilization Board.
United made a final attempt to access the capital markets and avoid bankruptcy by
applying for loan guarantees from the Air Transportation Stabilization Board (ATSB), a new
agency created by the federal government after September 11, 2001 to provide loan guarantees to
airlines that could provide a reasonable assurance of being able to repay the loan. 108
1. The Economic Recovery Plan.
Of course, doubts about precisely this issue were the very reason private lenders
and the capital markets refused to extend United financing in the first place. To convince the
ATSB that it could repay the proposed loan, United needed to cut capacity, increase revenue, and
reduce its labor and non- labor costs. To this end, in the Spring of 2002, amidst what seemed to
be a rapidly-improving economic environment, the Company presented each union with an
Economic Recovery Plan (ERP) proposing to reduce wages immediately by between five and
ten percent, with snap backs to contract rates over the next three years. Uniteds initial
application to the ATSB, submitted on June 24, incorporated these proposed wage reductions.
With few exceptions, however, the unions opposed the ERP. ALPAs Master
Executive Council (MEC, the group that heads ALPA for a particular airline) agreed to submit
the ERP to its membership.109 The AFA resolved to reject the ERP and send a clear message to
both UAL and the UAL flight attendants that the AFA United MEC will not engage in
concessionary bargaining with United Air Lines.110 The IAM also refused to participate. 111
More bad news soon followed. The ATSB signaled that Uniteds proposed
business plan and labor cost reductions were insufficient in part because what had appeared to be
an industry recovery as of early 2002 was stalling. By July, Uniteds passenger unit revenue had
dropped 10 percent lower than the Companys earlier forecasts, causing a $1 billion decrease in
the Companys projected passenger revenues for the second half of 2002.
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2. The Enhanced Recovery Plan.
These developments prompted United to develop a far more comprehensive
recovery plan, known as the Enhanced Recovery Plan. Based on comments from the ATSB
staff, United determined that it would require approximately $2.5 billion in annual cost
reductions, with $1.5 billion of this amount having to come from labor. The Company presented
its proposal for $9 billion in total labor cost reductions over 6 years to the unions on August
28,112 and former CEO Jack Creighton set a deadline of September 15 to reach new labor
agreements.
Acknowledging the depth of Uniteds economic crisis,113
the Companys unions
formed a Union Coalition to develop a new plan that they believed would enable the Company
to obtain financing. 114 On September 25, 2002, the Coalition offered a plan to save $5 billion
over 5 years $500 million a year less than United had requested.115
United bargained for additional concessions, but without success. With large debt
repayments coming due in less than two months,116 United needed concrete agreements in place
right away to persuade the ATSB to approve its application. For this reason, United reluctantly
agreed to $5.8 billion in labor cost reductions that would be spread over 5 and one-half years
again, some $500 million per year less than United had originally sought. Of this total, $1.4
billion was again attributable to salaried employees and management, who were slotted for pay
cuts of 2.8 - 10.7 percent and to forego future increases.117
Proposed labor cost reductions were not the only elements of Uniteds new
business plan. United also proposed to reduce capacity in 2003 by 6 percent as compared to
2002 and defer deliveries of 25 aircraft scheduled for 2004 and 2005. This effort to rightsize
capacity resulted in an estimated $1.2 billion in profit improvements over the duration of the
business plan. (At the same time, the resulting furloughs of 6,000 employees reduced the total
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savings agreed to by Uniteds employees from $5.8 billion to $5.2 billion.) Moreover, a wide-
ranging series of revenue enhancements and cost savings in areas other than labor were to shore
up Uniteds bottom line by $7.7 billion. All told, over the next five and a half years, Uniteds
proposed business plan was to improve the Companys financial performance by $14.1 billion
from 2002 - 2008.
The plan was premised on a robust recovery of revenues by the industry. As its
base case, United projected 9.3 to 9.7 percent annual growth from 2003-2005 in revenue per
available seat mile. After several private lenders declined to loan any money to United based on
this business plan, United updated its application to the ATSB, pending the approval of the
Coalitions proposal by the membership of the unions. This application represented Uniteds last
shot to avoid bankruptcy.
3. Uniteds Unions Voted in Favor of the Coalitions Proposal.
The meteorologists represented by the Transport Union Workers were the first to
ratify the Coalition proposal on November 10, 2002. The pilots followed suit on November 18,
2002. The ramp, gate and customer service agents of IAM 141 signed on to the Coalition
framework on November 28, 2002.
On the same day, however, the mechanics of IAM 141-M appeared to deal a blow
to Uniteds ATSB application by narrowly rejecting the Coalitions proposal. Nevertheless, the
flight attendants ratified the Enhanced Recovery Plan on November 30, 2002. And, based on
their continued commitment to Uniteds future, the members of IAM 141-M were scheduled to
vote again on a slightly-modified proposal on December 5, 2002.
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4. The ATSB Decides Not to Approve Uniteds Application.
On December 4, 2002, however, the ATSB voted not to approve Uniteds
proposal.118 The ATSB flatly declared that Uniteds proposal had fallen short in trying to
address the fundamental challenges confronting United:
[The] business plan does not position the company to meet the
challenges of the current airline industry environment and toachieve long-term financial stability. The Board believes that,
even if the company were to receive the proceeds of a guaranteed
loan, there is a high probability that United would face anotherliquidity crisis within the next few years.119
The ATSB also faulted Uniteds business plan for being predicated upon a
significant near-term rebound in revenue.120 The ATSB observed that, in addition to being out
of step with industry and analyst forecasts, Uniteds revenue forecast does not make sufficient
allowance for the likely effects of continued expansion by low-cost carriers in Uniteds markets
as well as other potential structural changes affecting industry revenue.121
The ATSB went on to note that, even under more reasonable revenue forecasts,
United would not be able to support [its] cost structure as presented in the business plan:122
The Board notes that even with the benefit of Uniteds proposed
cost reduction initiatives, United would remain among the highestcost carriers in the industry. If competitors are successful in
achieving additional cost savings, Uniteds relative cost position
could weaken further.123
The ATSBs message was loud and clear: United cannot return to profitability
unless the Company joins forces with its employees and other stakeholders to revamp Uniteds
cost structure and business model.
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E. Uniteds Access to Its Proposed DIP Financing Is Conditioned on SubstantialCost Reductions That Can Be Achieved Only if Uniteds Employees Agree toSubstantial Concessions.
Because of its inability to access the capital markets and the uncertainty about the
ATSB application, United was forced to begin exploring options for obtaining a Debtor in
Possession (DIP) financing facility in connection with a Chapter 11 filing.
1. The DIP Negotiations.
To this end, United began preliminary negotiations with GE Capital Corporation
(GECC), JP Morgan Securities, Inc. (JP Morgan), and Citigroup in late September, 2002. 124
In consultation with their outside financial advisor, Rothschild Inc., United decided to initiate
discussions with these particular lenders (and subsequently Bank One, NA (Bank One) and the
CIT Group) because these lenders each possessed significant expertise in Debtor in Possession
Financing.125
Meetings with the potential debtor in possession lenders about DIP financing
continued through early October, 2002. During this time, United continued its efforts to obtain
out-of-court financing from these same lenders. By early October it became clear that these
lenders, like all the other lenders contacted by United, had no interest in making any out-of-court
loans to United.126
On October 15, 2002, United received a draft term sheet from GECC for a
proposed $2 billion debtor in possession loan. After receiving GECCs proposal, United
intensified their negotiations with JP Morgan and Citigroup in an effort to obtain the best
possible loan terms. Shortly thereafter, United began negotiations in earnest, on a parallel track,
with Bank One.127
Bank Ones status as a potential lender differed from the others in one critical
aspect. Bank Ones affiliate, First USA Bank, N.A. (First USA), is a party to a contract with
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UAL Loyalty Services, Inc. (ULS), whereby First USA issues co-branded credit cards with
United that allow cardholders to accrue mileage credit for travel awards redeemable through the
Mileage Plus program for purchases made with the credit cards (the First USA Agreement).
Pursuant to the First USA Agreement, First USA buys Mileage Plus miles from ULS that are
transferred to cardholders Mileage Plus accounts when purchases are made on the cardholders
First USA/United credit cards. The First USA Agreement provides ULS with a tremendous
source of revenue. Because of the existence of this unique collateral, Bank One was willing to
provide a larger initial debtor in possession loan than the other lenders. 128
By early November 2002, United was engaged in extensive and ongoing
negotiations with JP Morgan/Citigroup, and negotiations with Bank One were beginning to
intensify. In mid-November, United considered a revised proposal from GECC, so as to
continue their efforts to obtain the best possible loan terms. Given Uniteds projected cash burn
rate over the following several months, United and its financial advisers determined that the
Company needed immediate access to an $800 million facility and the potential to access an
additional several hundred million down the road. Unfortunately, no single lender was willing or
able to lend the necessary amount of money to United on any terms. Consequently, it became
apparent that a loan of sufficient size could only be obtained through a financing structure that
included all of the lenders being considered. Accordingly, United began negotiations with all
four lenders (and then subsequently the CIT Group) to arrange a multi-lender debtor in
possession financing facility or facilities.129
Throughout the negotiation process, the lenders questioned the achievability of
the Debtors revenue projections. Like the ATSB, the lenders considered the Debtors internal
financial projections to be aggressive, in light of the current revenue environment. The lenders
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collective reservations about the Debtors financial projections further necessitated a multi-
lender (or club) facility, whereby each lender would underwrite a portion of the loan, thereby
spreading the risk among the lenders. 130
In addition to questioning Uniteds revenue projections, the DIP lenders also
demanded significant additional cost concessions. The business plans upon which Uniteds
proposed DIP financing terms ultimately were based contain substantial cost reduction initiatives
far beyond those proposed to the ATSB. Indeed, absent Uniteds proposed significant additional
cost reductions, the DIP lenders would not have agreed in the first instance to provide the DIP
financing to United. But the DIP lenders did not simply take Uniteds word that the additional
cost savings would be achieved. Instead, as explained in more detail below, they erected
stringent financial covenants that require United to achieve the promised cost savings. If United
fails to do so, it will violate the DIP covenants and be subject to a default on the DIP loan.
Consequently, in order to maintain access the DIP facility (and ultimately to survive), United
must achieve these significant additional cost savings.
2. The DIP Facilities.
After several weeks of intense, arms-length negotiations that included numerous
meetings among representatives of United and the various potential lenders, United successfully
negotiated two separate DIP facilities that met the Companys projected short- and long-term
capital needs. The DIP lenders committed to making the loans on the morning of December 8,
2002 and definitive term sheets reflecting the material terms of the facilities were agreed to
several hours later.131
The first facility is a stand-alone $300 million amortizing term loan issued by
Bank One, secured by, among other things, the revenue from the First USA Agreement (as
amended) (the Bank One DIP). This $300 million is immediately available to United upon the
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expiration without an appeal of the ten-day appeal period pursuant to Bankruptcy Rule 8002(a)
following Uniteds assumption of the First USA Agreement. Bank One demanded that this loan
be secured by the revenue stream from the First USA Agreement and that, as a condition to loan
funding, that ULS assume the First USA Agreement. 132
The second facility is a $1.2 billion loan from Bank One, JP Morgan, Citigroup,
and the CIT Group (the Club DIP). This facility makes available $500 million of initial capital
at the same time as the Bank One DIP, with the remaining $700 million becoming available upon
Uniteds achieving a specified level of EBITDAR (earnings before interest, taxes, depreciation,
amortization, and rent), as well as some additional cost reductions.133
3. The DIP Covenants.
As one might expect in view of the size of the DIP loan and the rate at which
United has been burning cash, the DIP lenders have taken numerous steps to protect their
interests. As is customary with DIP financings, the DIP lenders demanded much of the
Companys unsecured assets as collateral, including aircraft, spare parts, international route
authorities, and certain airport slots. But this collateral package, which was essentially the same
package offered by United to the ATSB, was not enough. 134
The DIP lenders expressed skepticism about Uniteds business plan. In their
view, regardless of the size of the DIP loan, Uniteds cost structure would preclude the Company
from achieving profitability. Based on this feedback, United went back to the DIP lenders with a
more conservative business plan that projected substantially less revenue growth. Based on the
revised plan, the lenders ultimately agreed to provide DIP financing for United. But before
doing so, the lenders insisted on significant loan covenants. 135
If United fails to achieve the financial targets (subject to a relatively small margin
of error) in the business plan upon which the DIP loans were based, United will breach the
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covenants and face a possible default on the loans. A default would allow the lenders to
foreclose on the collateral, which in turn would likely spell the end for United. Consequently,
United will need to achieve significant cost savings within the first few months of the bankruptcy
process to avoid defaulting on the DIP loans. Without substantial labor savings, United will not
be able to meet this threshold. In short, absent significant cost reductions in the immediate
future, United will not be able to access the capital that is required for a successful
reorganization. 136
V. UNITED MUST RISE TO THE CHALLENGES OF A FUNDAMENTALLYDIFFERENT COMPETITIVE LANDSCAPE.
Part of Uniteds decline may be attributable in part to the normal cycles in the
economy. But there can be little serious dispute that deeper issues have surfaced to cause a sea
change for United and the other major network carriers.137 Or, as the Chairman of the Business
Travel Coalition has put it, the major airlines cannot keep their heads in the sand saying
business travel is off because of the economy, period.138
A. The Lingering Effects of September 11.
First, the tragic events of September 11 continue to have a severe and sustained
effect on the airline industry. Passenger traffic has remained down. 139 Revenues have continued
to fall. Losses have continued to mount.viii Fear of terrorist attacks against American targets has
resulted in U.S. carriers losing share to foreign carriers on international routes. On Uniteds top
20 international routes, for example, the Company lost three points of market share to foreign
viii Recently filed 10-Qs reported the following losses at other major airlines through the first three quarters of2002: $22.6 million at Alaska Airlines, $161.4 million at America West, $2.77 billion at American Airlines, $342
million at Continental, $909 million at Delta, and $310 million at Northwest.
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carriers between July 2001 - July 2002. In short, the aftermath of September 11 has been far
more devastating and enduring than anything the airline industry has ever faced.140
B. Internet Shopping.
The ability to search the Internet for lower fares has increased the downward
pressure on the price being paid by Uniteds customers.141 The price transparency facilitated by
the Internet has transformed consumers into powerful comparison shoppers. 142 The resulting
price competition will continue to reduce Uniteds yields.143
Exhibit 10. PROPORTION OF REVENUE BOOKED VIA THE INTERNET
5.0%
9.0%
14.0%
22.0%*
18.0%*
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
22%
24%
1999 2000 2001 2002 2003
Percenta
geofAllAirlinePassengerRevenues
Note: *Estimates.Source: The Online Travel Marketplace 2001-2003: Forecasts, Business Models and Best Practices forProfitability, 2001, PhoCusWright.
Today, eighteen percent of all bookings now are made on the Internet, compared
to only five percent in 1999. 144 As more air travelers scour the Internet for the cheapest fares, 145
the resulting price transparency will continue to pressure airlines to lower their fares to win
and keep customers.146 This shift has accentuated the normal market pressure on carriers to
match the prices offered by their competitors.147
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C. Business Traffic Has Shrunk to Record Lows.
Businesses are discovering that they can make do with less commercial air travel.
Corporations are increasingly turning to ubiquitous technological substitutes to the commercial
air transportation product,148 especially video conferencing and web-based meetings. 149 A
recent survey found that 42 percent of business travelers had used teleconferencing as a
substitute for taking trips over the past year.150 In another survey last April of purchasing
executives from 184 corporations conducted by the Business Travel Coalition, 74 percent said
that least some of the travel cutbacks would be permanent.151 For these reasons, industry trade
press reports have suggested that emerging bandwidth technologies may make the business
traveler an endangered species.152
Business passengers also remain less eager to fly because of the increased time
required to clear security. An extra hour or two of security-related delays may not deter a family
from taking a three-week vacation, but may very well affect a business travelers decision
whether to fly between Chicago and New York in a single day to attend a three-hour meeting.
Industry surveys confirm that although 47 percent of leisure travelers are willing to arrive at
airports two hours before their flights, only 24 percent of business travelers are prepared to do
the same.153
As for employees who continue to travel on business, 68 percent of the companies
surveyed by the Business Travel Coalition plan to increase their companies use of low-fare
airlines.154
A considerable number of Uniteds corporate clients are flying fractional ownership
jets more frequently than ever before.155 And employees who continue to travel on United are
being required to work their schedules around the inflexibility of restricted (and, therefore, less
expensive) tickets.156 Businesses have also caught the Internet bug. 157 By some estimates, full-
fare traffic dropped by forty percent between mid-2000 and 2001, and this, of course, has sent
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shock waves through the industry.158 They continue to reverberate as of this filing. Since 1999,
the proportion of passengers purchasing premium fares (unrestricted fares typically used by
business travelers) at United has fallen even more dramatically. 159
Exhibit 11. PROPORTION OF DOMESTIC REVENUE FROM PREMIUM PASSENGERS.
41.0%
35.6%
21.9%19.8%
0%
4%
8%
12%
16%
20%
24%
28%
32%
36%
40%
44%
1999 2000 2001 2002
Proportion of Domestic Revenues from Premium Passengers
Notes: Data from second quarter of each year. Premium fares in clude first class, business class, and unrestricted coach.Source: U.S. DOT DB1A Database.
In 1999, 41 percent of Uniteds domestic passengers purchased unrestricted,
premium fares.160 Just two years later, that percentage had fallen by nearly 50 percent to
below 22 percent of domestic passengers.161 Likewise, the proportion of Uniteds domestic
revenues from premium passengers has fallen from 22.4 percent in 1999 to just 12.7 percent in
2001.162 This decline in high-fare business traffic appears to be both more severe and permanent
than those endured during previous downturns in the economy. 163 In the words of Darryl
Jenkins, director of George Washington Universitys Aviation Institute: Well never have as
much business travel as we saw in the late 1990s, and airlines are going to have to adjust to that
new reality.164
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D. The Increasingly Formidable Competition Posed by Low Cost Carriers.
Low cost carriers are smaller airlines that are able to charge lower fares by
operating on a high-volume, low cost business model. 165 Unlike major network carriers that fly
six or seven types of aircraft, low-cost carriers typically stick to one type of aircraft, thus
minimizing maintenance, operating and training costs.166 Low cost carriers also are able to hold
down their costs because they began their operations with many functions being outsourced and
minimal downtime between flights and have been able to preserve these competitive advantages
in their collective bargaining agreements.167 They also use less senior labor forces who are
entitled to less vacation, require less sick leave and are more accepting of flexible work rules that
allow for more efficient operations.168
1. The Competitive Advantage.
The primary cost disadvantage faced by the major network carriers is in labor,
where lower productivity, more-generous benefits, and higher average pay result in labor costs
some 50 percent higher than those of low-cost carriers.169 By way of example, Southwests cost
advantages over United have more than doubled since 1998:
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Exhibit 12. SOUTHWEST VS. UNITED UNIT COSTS
7.32 7.17
9.25
11.64
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
12.0
13.0
1998 2001
OperatingCostperASM(cents/mile)
Southwest United
Source: U.S. DOT Form 41. Includes grants received under the Air Stabilization Act.
1.93
4.47
Southwests advantages in labor costs have become especially pronounced:
Exhibit 13. SOUTHWEST VS UNITED