A second bite of the appleStuart Gilson, Steven R. Fenster Professor of Business Administration and author of Creating Value through Corporate Restructuring: Case Studies in Bankruptcies, Buyouts, and Breakups
As United States equity markets and corporate balance sheets continue their remarkable comeback from the financial crisis that began in 2008, the recently announced merger between American Airlines and US Airways reminds us of the critical role that bankruptcy law, represented by Chapter 11 of the US Bankruptcy Code, has played in the ongoing economic recovery.
Like other recent large airline mergers that have helped domestic carriers compete more effectively in global markets, the American-US Airways combination was, in several important respects, made possible by Chapter 11 and the legal and financial tools it offers to companies in need. The deal still faces significant challenges, including integrating the two carriers' operations and unionized workforces. But working through this process and profitably growing the combined businesses are arguably much easier tasks when the merging parties are financially stronger. American's bankruptcy reorganization (as well as those of Continental, Delta, and United before it) highlights how Chapter 11 can help companies with fundamentally viable businesses become financially stronger and more competitive.
The Bankruptcy Code achieves this by giving companies a "safe harbor" while they restructure their liabilities, buying time for them to fix their businesses. When a company files a petition for Chapter 11 and becomes a "debtor in possession" (DIP), its assets and operations are protected by the "automatic stay," a legal injunction that prevents secured creditors from seizing their collateral—and without which the company might not be able to continue as a going concern.
While operating in Chapter 11, the company pays no interest on its pre-petition debts, freeing up cash that can be reinvested in the business. Moreover, any new money that the company borrows during bankruptcy must be repaid ahead of most other debts, which gives banks and other lenders a powerful economic incentive to lend to companies in Chapter 11. (Although American did not need such debtor-in-possession financing, United and Delta together raised almost $3.5 billion in DIP financing in their bankruptcies.)
Chapter 11 also allows a company to reject unprofitable leases and supply agreements or use the threat of such rejection as leverage to obtain financial concessions from lessors and other counterparties. For an airline that leases its planes, this can generate enormous cost savings. This ability to reject or renegotiate certain contracts also extends to collective bargaining agreements with organized labor. Thus, while in bankruptcy, American was able to negotiate new labor agreements with its three largest unions, generating what some expect will be hundreds of millions of dollars in additional annual cost savings.
Chapter 11 also provides an expedited process for selling assets, generating additional cash for the company and giving it more flexibility to restructure its operations. Under Section 363 of the Bankruptcy Code, assets can be sold by a court order, without requiring a full vote of creditors, and the winning bidder acquires the assets with the knowledge that they are "free and clear" of any unwanted liabilities. In 2001, American Airlines acquired the assets of bankrupt TWA using this approach.
Finally, getting a deal done in bankruptcy court can be much easier than attempting to restructure the company's assets and liabilities privately or in multiple non-bankruptcy courts. The American-US Airways deal is part of American's plan of reorganization and will have to be approved by its creditors and shareholders. However voting rules in Chapter 11 require only a majority of creditors to approve the plan, and when deadlocks do occur, the bankruptcy judge can "cram down" the plan to ensure fair and equitable terms if creditor objections are deemed unreasonable. Through the plan, whose final details are still being worked out, American will also be able to shed a significant amount of its debt, providing the new company with an added fresh start.
Of course, all this does not come without cost. American has been paying almost $20 million a month for legal and financial advice since it filed for bankruptcy. But for large companies (American had almost $25 billion in assets when it filed), the relative cost is arguably within reason when balanced against the value created in a successful reorganization.
Chapter 11 isn't perfect. Just as not every hospital patient is cured or every prison inmate rehabilitated, not every sick company that enters Chapter 11 emerges with all its problems solved. But Chapter 11 at least gives management the ability to preserve a viable business and create greater value than would be otherwise available for all the firm's stakeholders—in sharp contrast to other countries where "bankruptcy" automatically sentences companies to liquidation or is designed to protect the interests of select stakeholders.
By giving managers and entrepreneurs a "second bite at the apple" if they take reasonable risks that turn our poorly, Chapter 11 also encourages risk taking. This is the genius of the US system. Chapter 11 has already played a critical role in helping the economy recover from the financial crisis, and it will continue to be an important driver of national competitiveness in the future.
Merger's success depends on leadershipRosabeth M. Kanter, Ernest L. Arbuckle Professor of Business Administration and author of Supercorp: How Vanguard Companies Create Opportunity, Profits, Growth, and Social Good and the 2009 Harvard Business Review article "Mergers That Stick."
Investment bankers and lawyers still hold sway, and the regulators still must approve the merger of American Airlines and US Airways. But whether the deal provides the value the respective boards claim will soon become a matter of leadership: How the integration is conceived and led.
Having studied and consulted to numerous integration teams, I learned the M&A variant of Murphy's Law: Anything that can go wrong in merger integration probably will. So strong resilient teams focused on the future become the key asset. Competitors are ready to pounce on any misstep to win away customers, something that will become easier as American and US Airways are forced to give up landing slots on routes they once monopolized. People must come to know each other quickly across the legacy organizations and have a clear sense of the future. The top team must be ready to make people choices quickly and facilitate team-building. Otherwise uncertainty turns to passivity, and resentments are a drag on the work.
Top leaders must pay attention to the culture from the beginning, not as an afterthought once baggage handling and frequent flyer miles are running smoothly, and they must put dollars behind it. When a smaller Asian financial firm took over a larger, older bank that had to be bailed out by its government, a key part of the deal was equal representation of both on all integration task forces, but the smaller buyer went much further. The firm spent lavishly on retreats for large groups of managers and employees, discussing the strategy but also working toward "emotional integration," as they called it. While maintaining two banking systems—their equivalent of separate route networks and hubs—they created a group focused on the company of the future.
A new American Airlines combining US Airways is fortunate to have US Airways CEO Doug Parker at the helm, because he appears to understand not just the nuts and bolts of merging logistics systems but also the human process of ego suppression. This would be the second time his smaller airline has merged with (taken over, some would say) a larger one, and the second time he has let go of the identity of the enterprise he built. There is an instructive model in how Ivan Seidenberg, former CEO of Verizon, created today's Verizon out of two big mergers, with Bell Atlantic and GTE. In both cases, Seidenberg took a step backward to the number two position, before eventually moving up to CEO again.
This kind of signal from the top that egos and turf should be put aside in the interest of a great new entity is very hard to do without firm CEO signals. Everyone claims to seek a "merger of equals," but few really mean it, as people try to discern who is up and who is down. Mergers inevitably arouse competitive instincts—who is the conqueror and thus superior? Whose best practices are really better? One clue that the old AOL Time Warner wasn't going to be a long-lasting marriage (besides keeping all the previous names) was when staff at Time Inc. magazines refused to change their email addresses to AOL. Parker must make sure that the OneWorld Alliance slogan that includes American and a number of other airlines is truly reflected as "One American" inside the company.
In any merger, every function works on a different timetable, and some things can happen faster than others (for example, IT systems integration is notoriously slower than envisioned). Cultures and people change at their own pace. It's easy to change letterhead (although the ill-fated Pharmacia Upjohn combination labored over logos much too long when they should have been watching the business), but it takes much longer to solidify relationships. In Procter & Gamble's successful integration of Gillette, explicit attention was paid to helping people get to know each other casually and informally, and the much larger P&G adopted Gillette systems and promoted their people. They called it "the best of both worlds." That's a good concept for the new American to keep in mind as it strives to live up to "OneWorld."