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Case study for "Pulling out of bankruptcy"
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Background
Since December 2002, when it filed for Chapter 11 bankruptcy protection, the UAL
Corporation, United Airlines' parent corporation, has been unable to operate normally. There
have been several obstacles for the firm in the two years since then, including severe competition
in a difficult economic climate, an underfunded pension plan of over $7.5 billion, and the
necessity to present a restructuring package that is acceptable to its creditors. As a response to
low-cost carriers like Southwest Airlines, JetBlue, and Frontier Airlines, UAL introduced a new
low-fare airline named Ted in February 2004. However, on June 17, 2004, the company's
restructuring plan failed when a request for government loan guarantees was denied by the Air
Transportation Stabilization Board (Bergstresser et al., 2005). A new business plan that is
acceptable to UAL's creditors must be developed soon if the airline is to emerge from
bankruptcy. The firm would need to make a decision about its pension plans: whether to keep
making payments or to stop making payments and try to renegotiate the pension's liabilities.
In addition, UAL was feeling the consequences of decreased air travel demand after the
terrorist events of September 11, 2001, as well as the rising cost of gasoline. It had to cancel
contracts for a number of planes, liquidate unused assets, and renegotiate worker pay to get the
bills down. An further major obstacle was UAL's pension fund, which had a deficit of $7.6
billion as of the end of 2003 and required contributions of $72 million by July 15, 2004 and
another $500 million by the end of the year.
Some tough choices have to be made quickly. Management's reform strategy was
rendered ineffective when the Air Transportation Stabilization Board denied UAL's request for
loan guarantees in June 2004. In order to compete with low-cost airlines, UAL introduced a new
3
low-fare carrier named Ted. Nonetheless, UAL still had pension fund problems and had to
determine whether to pay the necessary contributions or try to cancel its pension schemes.
Key Issues
When 2004 rolled around, UAL Corporation's biggest problem was getting the
corporation out of bankruptcy. Since its inception in December 2002, the firm has been operating
under Chapter 11 bankruptcy protection for almost 19 months (Bergstresser et al., 2005).
It was
necessary for the corporation to present a restructuring strategy that would be acceptable to the
firm's creditors while also addressing the firm's cost structure, competitiveness, and pension plan,
which was underfunded by more than $7.5 billion. The Air Transportation Stabilization Board's
government loan guarantees, which the business had previously rejected in June 2004, also
required a decision.
Company problems included a pension fund that was over $7.5 billion in the red. The
corporation had to make a decision between maintaining its current pension contribution levels
or stopping payments in an effort to restructure the pension's liabilities. UAL may have complied
with the law and made the needed payments, sought immediate termination of its pension
schemes, or continued discussions with its workers by not paying the required contributions.
The corporation also had to deal with the difficulty of introducing its new budget airline,
Ted, which was designed to go head-to-head with other low-cost carriers like Southwest, JetBlue,
and Frontier. Ted's successful introduction gave Tilton and UAL reason to believe that their
restructured airline could compete well (Bergstresser et al., 2005). Therefore, in 2004, the most
pressing concerns for UAL were how to start the new low-fare airline, Ted, and how to draft a
restructuring plan that creditors would approve.
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Risks
United Airlines (UAL) faces a wide variety of difficult risks as it emerges from
bankruptcy. The biggest threat to UAL's success is the possibility that it won't be able to
renegotiate labor contracts with its unions and get the salary and benefit reductions it needs to
lower costs and remain competitive in the airline sector. UAL cannot save enough money to stay
competitive and sustainable without these concessions.
The possibility of further increases in gasoline costs is another threat to UAL. Due to its
bankruptcy, UAL cannot access derivatives markets, making it unable to protect itself from rising
fuel prices by purchasing insurance.
UAL's pension liabilities might be a significant financial strain if certain assumptions
about future costs are incorrect. UAL must pay $72 million by July 15, 2004 and $500 million by
the end of the year to cover its unfunded pension liabilities of $7.6 billion. As a result of this
obligation, UAL may be forced to eliminate its pension programs, which would have devastating
effects on the company's current and former workers and retirees. Finally, UAL must deal with
the possibility that its creditors would reject its restructuring plan. If UAL's creditors don't agree
to the company's reorganization plan, the airline may be forced to file for Chapter 7 bankruptcy
and be liquidated.
Overall, UAL's endeavor to emerge from bankruptcy is fraught with many difficulties.
The possibility for fuel costs to rise, failure to reach an agreement on labor contracts, the
substantial financial weight of pension payments, and the possible rejection of the restructuring
plan by creditors are all factors that might affect the company's ability to go forward. UAL may
5
be compelled to file for Chapter 7 bankruptcy and dissolve if it is unable to address and mitigate
these threats.
Recommendation
Bankruptcy is likely to be a long and arduous procedure for UAL Corp. due to the
complexity of their current condition. The company's cost structure, competitiveness, and
pension liabilities must all be addressed for UAL to emerge from bankruptcy.
The first step for UAL to become more competitive in the airline sector is to renegotiate
its labor contracts with its unions and get the salary and benefit cutbacks needed to do so. In
order for UAL to survive in the face of rising competition, this is a necessary but challenging
step.
The second problem that needs fixing is UAL's unfunded pension commitments. UAL
has to put away $72 million by July 15, 2004 and another $500 million by the end of the year to
cover its $7.6 billion unfunded obligation. UAL may either comply with the law and pay the
necessary contributions, immediately seek to dissolve its pension schemes, or refuse to make the
necessary contributions and continue talks with its workers. UAL has to think carefully about all
of these alternatives to choose the one that will be best for the firm, its workers, and its creditors.
Third, UAL should keep pushing forward with the introduction of Ted, its new low-cost
airline meant to compete with Southwest Airlines, JetBlue, and Frontier Airlines. UAL has to do
everything it can to make sure the Ted launch goes well so that the firm can gain a competitive
advantage.
UAL must provide a plan for reorganization that will be approved by the airline's
creditors. If UAL's creditors don't agree with the company's planned reorganization, the airline
6
will have to make some tough choices. If this happens, UAL could have to file for Chapter 7
bankruptcy, which would be the end of the corporation.
UAL's cost structure, competitiveness, and pension commitments all need to be addressed
for the airline to effectively emerge from bankruptcy. UAL will need to adopt some tough
measures and take some risks if it wants to emerge from bankruptcy and keep competing in the
aviation market.
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References
Bergstresser, D., Froot, K. A., & Smart, D. R. (2005).
"UAL, 2004: Pulling Out of
Bankruptcy."
Harvard Business School Case 205-090.(Revised June 2006.)
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