In an apparent effort to abrogate labor contract obligations, Continental Airlines filed a petition for bankruptcy under Chapter 11 of the U.S. bankruptcy code.
On September 24, 1983, Continental Airlines, under the direction of company chairman Frank Lorenzo, filed a petition for bankruptcy under Chapter 11 of the bankruptcy code. Continental’s plunge into bankruptcy, leaving more than ten thousand travelers stranded at airports around the United States, was one of the most unusual applications of bankruptcy law in U.S. history. This unprecedented move was a surprise to many observers, given that Continental Airlines was the eighth-largest passenger airline in the United States and was solvent, with more than $58 million in cash and marketable securities.
In addition, pursuant to its perceived powers under Chapter 11, Continental unilaterally implemented drastic changes in wages, benefits, and work rules for employees. In response to these events, the Air Line Pilots Association,
The events that led to the drastic action of Continental Airlines went back several years. On October 24, 1978, President Jimmy Carter signed the Airline Deregulation Act.
During the more than forty years of airline industry regulation, the labor market and the process of collective bargaining in the industry became firmly entrenched. Collective bargaining traditionally operated as a form of labor market regulation that allowed unions to capture a portion of the monopoly profits generated by regulation of the product market. Following contract negotiations, most increases in labor costs were passed on to consumers in the form of higher regulated fare structures. Such an environment, although protective and stable for collective bargaining units, was gradually pricing the consumer out of the market. The Airline Deregulation Act of 1978 eliminated regulated pricing and thus presented a severe threat to the traditional economic power of certain airline unions. In the deregulated environment, numerous new service providers entered the airline industry. Many of the new entrants operated on a nonunion basis and therefore enjoyed significant cost advantages over older airlines because of lower wages, lower benefit costs, and less stringent work rules.
In an environment of competitive pricing (in some cases all-out price wars), increased competition for customers on highly profitable routes, and enormous collective bargaining obligations, the profit levels for established airline carriers began to change. Specifically, in the first half of 1983, the twelve largest trunk carriers posted $514 million in operating losses. In 1982, the eighteen largest airlines accumulated $651 million in losses from operations. Costs of labor for U.S. airlines increased significantly during this period. The average annual pay per employee rose from $39,373 for each of 316,000 employees in 1982 to $41,811 in the first quarter of 1983. Labor costs represented 37 percent of the total expenses of major and national carriers. The cost per employee rose 8.2 percent for the first six months of 1983 over the same period in 1982. In contrast, average annual employee compensation in the new entrant airlines, most of which were not unionized, was $22,000. Salaries and other labor costs represented only 18 percent of new entrants’ total expenses.
It was within this economic climate that Continental Airlines filed a petition for bankruptcy under Chapter 11 of the bankruptcy code. Three days after the filing, Continental emerged under court protection with a workforce and a route structure pared by two-thirds. The airline hired back four thousand employees from its original twelve thousand, cut pay scales by half, and in some cases doubled the number of required work hours.
Continental also began appealing to consumers in unprecedented ways. The airline offered tickets for $49 for any nonstop flight in its domestic route system. This promotion was effective only for the first four days after the airline resumed its flights. At the end of the initial four-day price promotion, the airline offered tickets at $75 for all flights. Effective October 15, 1983, fares would remain at $99 for Continental’s domestic route system.
The consumer response was tremendous. Passengers filled more than 60 percent of Continental’s seats, but canceled flights kept traffic and revenue below what the company had hoped for. To complicate matters, on October 1, four days after Continental resumed partial operations, Henry Duffy, president of the Air Line Pilots Association (ALPA), announced a strike. The pilots objected to a 50 percent pay cut, a 57 percent increase in flying time, and elimination of seniority rights and other protective work rules. The International Association of Machinists and Aerospace Workers (IAM) and the Union of Flight Attendants (UFA) also joined the strike effort.
On December 13, 1983, Lorenzo was in Houston’s bankruptcy court defending the decision to petition for bankruptcy under Chapter 11 of the bankruptcy code. A battery of lawyers representing the ALPA, IAM, and UFA attempted to prove that Continental had filed for bankruptcy in bad faith. It was within this environment that the fate of Continental Airlines and thousands of striking employees would be determined.
As of March 1, 1984, Continental Airlines had restored 75 percent of its capacity prior to the bankruptcy filing. By July 1, 1984, it had reached almost 95 percent of its earlier capacity. Such growth was attributed to a number of factors. First and foremost, the bargain fares the airline was offering filled more than 60 percent of its seats, a load factor ten points higher than those of rival airlines. In addition, because of the newly created rock-bottom labor costs, Continental was able to build up its operating funds, make payments on more than 40 percent of its debt obligations, give most employees raises during March of 1984, and still show a positive cash flow.
Continental’s restructured route system reduced the number of serviced cities from seventy-eight prior to the petition for bankruptcy to approximately forty-two during 1984. With almost all of its planes aloft, it was anticipated to break even with 60 to 65 percent of its seats filled at the new low prices. The airline predicted $30 million in pretax earnings on revenues of $1 billion in 1984. Analysts predicted a $60 million profit on revenues of $1.2 billion in 1985.
On January 17, 1984, the Houston bankruptcy judge had dismissed union charges that Continental had filed under Chapter 11 of the bankruptcy code only to abrogate its labor contracts. Filing for Chapter 11 under such conditions was illegal.
For a corporation to file for bankruptcy under Chapter 11 and still maintain operations and earn profits is extremely unusual, but Continental Airlines did just that. The following factors contributed to this unique combination of events. First, Continental was able to continue operations with a qualified labor force. Many members of the ALPA returned to work after the strike was called, and by January, 1984, more than five hundred members had crossed the picket lines and returned to work. In addition, Continental had recruited and hired three hundred new pilots, primarily from commuter and regional airline companies across the country.
Philip Bakes, Jr., Continental’s executive vice president, attributed the ALPA’s failure to a decline in organized labor’s leverage and a propensity of companies to operate during walkouts. Another reason for the weakened influence of the ALPA was poor communications between the union’s leaders and its member pilots. In addition, Continental staged a massive information campaign, with Lorenzo telephoning pilots each night to enlist their support. The ALPA was disorganized, so much so that the union’s chief negotiator was replaced soon after the strike began. The ALPA was also slow to respond to Lorenzo’s urgent demands for wage and benefit concessions as the company’s cash reserves began to dry up in late August, 1983. The union waited too long to soften its position in the bargaining process. In addition to pilots, Continental was able to hire qualified outside machinists and flight attendants. This activity weakened the positions for both IAM and UFA union memberships.
Another important factor contributing to this unusual bankruptcy situation was the bankruptcy code itself. In 1978, the U.S. bankruptcy code was changed to streamline the bankruptcy system. Court-appointed bankruptcy referees, who had limited jurisdiction, were replaced with 190 federal judges. These judges were given powers over all civil matters that could affect bankruptcy proceedings. In addition, the 1978 reform act set no hard-and-fast standard for voiding labor contracts in a bankruptcy proceeding. One of the questions was whether a company had to be on the brink of ruin before it could void a union pact. The U.S. Supreme Court held that a contract could be canceled if a federal bankruptcy judge agreed that such a step was necessary. Such was the case with Continental Airlines the bankruptcy judge agreed that the company’s situation warranted abrogating the union contracts in place. In addition, the code did not require insolvency as a condition for a reorganization filing. Again, such was the case with Continental’s filing for bankruptcy.
Could Continental’s filing for bankruptcy in 1983 be replicated? Probably not. In 1984, the U.S. Congress amended the bankruptcy code by adding section 1113, which regulated the rejection of collective bargaining agreements. Specifically, the code required as a prerequisite of the rejection of any collective bargaining agreement that an employer must engage in collective bargaining with its unions. The code required that an employer seeking rejection must make a proposal to the union, provide the union with information to evaluate the proposal, and engage in good-faith negotiations prior to rejection. In addition, if this bargaining is not successful, an employer must seek court approval before unilaterally changing a contract. With this amendment of the bankruptcy code, the type of swift, unilateral action undertaken by Continental Airlines became all but impossible. That is not to say that bankruptcies did not continue to occur in the airline industry; given the industry’s highly competitive nature and its susceptibility to international shocks, peaks, and valleys of passenger activity, in addition to upward swings in fuel prices, many airlines struggled in the final decades of the twentieth century.
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“Airlines in Turmoil.” BusinessWeek, October 10, 1983, 98-102. Addresses the labor woes, price wars, and bankruptcy threats in the U.S. airline industry. Discusses the issues involved in airline industry deregulation, including the impact of nonunion carriers competing with carriers with collective bargaining. -
Bernstein, Aaron. Grounded: Frank Lorenzo and the Destruction of Eastern Airlines. New York: Simon & Schuster, 1990. Provides a thorough chronology of Lorenzo’s career in the airline industry. Discussion spans Lorenzo’s beginnings as partner in Jet Capital Corporation through his acquisitions of Texas Air Corporation, Continental Airlines, and later Eastern Airlines. Highlights Lorenzo’s unique management style and philosophy. -
Bethune, Gordon, with Scott Huler. From Worst to First: Behind the Scenes of Continental’s Remarkable Comeback. New York: John Wiley & Sons, 1998. Bethune, who became chief executive officer of Continental Airlines in 1994, relates how he turned the business around. Includes discussion of the bankruptcy. -
Cifelli, Anna. “Management by Bankruptcy.” Fortune, October 31, 1983, 69-72. Addresses the apparent management strategy of fighting lawsuits and potential liabilities, breaking labor contracts, and avoiding tax obligations through bankruptcy proceedings. Corporations discussed include Manville, Continental Airlines, and Wilson Foods. -
Clifford, Mark. “A Struggle for Survival.” Financial World 152 (November 15, 1983): 13-18. Focuses on the turmoil within the airline industry. Explains the ramifications of deregulation within the industry and the fallout the industry experienced. Specific airlines discussed include AirCal, Aloha, Hawaiian, Muse, PSA, Southwest, and Continental. -
“Continental Is Coming Out a Winner.” BusinessWeek, January 30, 1984, 21. Discusses Continental’s apparent good fortune after filing for bankruptcy. Quotes Henry Duffy, president of the Air Line Pilots Association, conceding victory to the airline’s opposition to the union’s labor contract. -
Curtin, William J. “Airline Deregulation and Labor Relations.” Monthly Labor Review 109 (June, 1986): 29-30. Provides an excellent summary of the impact of deregulation on labor relations within the airline industry six years after the Airline Deregulation Act of 1978. -
Engel, Paul G. “Bankruptcy: A Refuge for All Reasons?” Industry Week 220 (March 5, 1984): 63-68. Presents an excellent discussion of the management strategy of using bankruptcy under the revised Bankruptcy Code of 1978 to avoid such financial difficulties as liability claims and rising labor costs. -
Petzinger, Thomas, Jr. Hard Landing: The Epic Contest for Power and Profits That Plunged the Airlines into Chaos. New York: Three Rivers Press, 1995. Business journalist provides a comprehensive account of the ups and downs of the airline industry from the 1930’s to the end of the twentieth century. Includes discussion of Continental’s bankruptcy. -
Rowan, Roy. “An Airline Boss Attacks Sky-High Wages.” Fortune, January 9, 1984, 66-73. Discusses the management strategy of Frank Lorenzo, chairman of Continental Airlines, in his decision to file for bankruptcy. Addresses the bitter relationship between Lorenzo and Continental’s labor unions and Lorenzo’s unyielding effort to reduce labor costs drastically. -
“Why Airline Pilots Are Becoming Street Fighters.” BusinessWeek, October 31, 1983, 127-131. Discusses the reaction of the ALPA to the sudden bankruptcy filing by Continental Airlines. Henry Duffy, ALPA’s president, discusses the demands for wage concessions from airline chief executives in an effort to cut collective bargaining obligations.
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