In the United States Bankruptcy Court for the Northern District

8/14/2019 In the United States Bankruptcy Court for the Northern District

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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

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In the United States Bankruptcy Court for the Northern District

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