More than three years removed from predictions that the Sept. 11 attacks would usher in a major reshaping of the domestic airline industry, observers are still awaiting the big shakeout.

Faced with a looming capacity glut even before the terrorist attacks, many airline executives and industry consultants saw corporate failures as an inevitable consequence of the airline industry's rapid decline. Instead, only a handful of bit players have liquidated since 2001. And that's one reason why the industry as a whole has lost more than $30 billion during that span.

To many observers, the culprit is the nation's bankruptcy courts, which have sheltered UAL Corp.'s United Air Lines Inc. for nearly two years and have hosted US Airways Group Inc. twice since 2001. With Delta Air Lines Inc. still hovering at the court's entrance, nearly half of the domestic capacity could be under court protection by year's end.

Chapter 11 gives these airlines a chance to bring down costs and emerge better able to compete. But arguably, the bankruptcy system has also contributed to the industry's overcapacity, allowing entities with little chance of succeeding to remain in business.

Robert Crandall, former chairman and CEO of American Airlines Inc. parent AMR Corp., testified before the Senate Commerce Committee last month that bankruptcy law is to blame for much of the airline industry's woes. Crandall said that Chapter 11 allows "failed ventures" to operate long past their viability.

Bankruptcy statutes "have provided a way for unsuccessful competitors to gain cost advantages versus more successful ventures," Crandall said in prepared remarks. "They have functioned as a fail-safe for imprudent managements and unions and, by doing so, have perpetuated the existence of excess capacity which has deprived the industry of the ability to set prices at levels sufficient to recapture costs."

Struggling airlines have a negative impact on the entire industry. A wounded carrier will often discount ticket prices toward a goal of generating cash without consideration of turning a profit. Healthier companies in turn are forced to match those unprofitable fares, spiraling all of the airlines downward.

Airlines in Chapter 11 will often add frequencies on popular routes to squeeze out more revenue, even if those extra flights are only half full.

"In bankruptcy, cash is king, and profitability is an afterthought," one airline executive says. "That is difficult to fight."

The problem, according to bankruptcy attorney William J. Rochelle III, is that the bankruptcy system does not have any mechanism to decide when it is time to take the patient off of the respirator. "It is easier to guess when a human being is beyond redemption physically than to make that judgment concerning a company," says Rochelle, a partner with Fulbright & Jaworski LLP in New York. "There is no easy answer to the question of who should decide how and when to euthanize a troubled company."

Creditors and suppliers often have little motivation to force a company out of Chapter 11 protection. Suppliers often get shorter credit terms while the client is in bankruptcy, and aircraft financiers might have difficulty finding another company to take over a lease should they pull a plane from a troubled company.

"A creditor who is a continuing supplier has very good reason to want the company to hang on in Chapter 11," Rochelle says.

Aircraft financiers often have the greatest leverage among various kinds of creditors to put an airline out of business, since a company would be unable to generate revenue if it doesn't have planes to fly. Although aircraft financiers have been extremely accommodating to troubled airlines during the recent downturn, industry sources predict that an upswing in the economy could change some attitudes.

As airlines globally move to add capacity, these financiers will have more options to redeploy aircraft flown by bankrupt airlines. And some aircraft owners believe it is time to take a harder stand against the airlines even if it would mean taking a write-off on certain aircraft.

Payson Coleman, a partner with Pillsbury Winthrop LLP who works with aircraft financiers, says that some of his clients have come to the conclusion that a liquidation, though painful over the short term, would help to stabilize the industry over the long term. "If a large airline with a big fleet went belly up, it would take a long time for those jets to clear the market," Coleman says. "But do I hear people saying it would be a good thing for the industry? Yes, I do hear that a lot."

On the other hand, Robert M. Miller, a principal at New York-based investment bank and advisory firm Miller Mathis & Co. LLC, is skeptical that any financier would be willing to let a large airline liquidate. "I can't believe there is a single lender that is sanguine about having hundreds of planes coming on the market at once due to one of the majors going under," he says.

In the early 1990s, when the industry last faced a crisis, the market was able to absorb aircraft repossessed from the likes of Braniff, Pan Am and Eastern Airlines. "The situation today has changed," Miller says. "By keeping the airlines in business, the lenders are hoping for a brighter day."

While aircraft financiers have done their best to keep a stiff upper lip through this restructuring, labor has been pounded. The reasoning is simple economics. While most costs are generally the same at discounters and legacy airlines, wages typically are the variable that airlines say is the difference between who turns a profit on a route and who doesn't.

The givebacks have been substantial. Delta's pilots, for example, struck a deal in late October that would cut their pay by one-third and eliminate raises for five years in support of the company's transformation plan.

In addition to wages, airlines have targeted pensions in bankruptcies. US Airways dismantled its pilot pension plan during its first restructuring, and United is now contemplating a request to the courts to have its pension obligations dismissed.

Few would argue that some sort of labor cost reduction is not needed. But a growing number believe that some of the reason that labor has been hit so hard during the latest round of restructuring is that management has found it easier to cut employee contracts than to negotiate with the myriad of parties holding shares of leased jets and other heavy equipment.

"The popular wisdom is that this is all labor related," says H. Sean Mathis, Miller's partner at Miller Mathis. "Labor is certainly part of the problem, but it is only part of the problem."

Not everyone is ready to blame the current wave of bankruptcies for the troubles of the industry, which has largely failed to turn a profit in the 25 years since deregulation.

Marc E. Richards, a senior partner in the business reorganization and bankruptcy practice group of Blank Rome LLP in New York, argues that a bankruptcy courtroom is the appropriate venue for some of the issues faced by the airlines to be resolved in.

In fact, many creditors and labor groups would prefer to wait until a Chapter 11 filing to negotiate out of fear that a prefiling arrangement could be cut for a second time should the company eventually file. "No creditor wants to make the first deal," Richards, who represented creditor committees during the bankruptcies of Pan Am, TWA and Braniff, says. "They figure they might as well sit it out, let them go in and get a deal done inside of Chapter [11]."

Continental Airlines Inc., which has completed two court-assisted reorganizations since 1983 but which now stands as one of the healthiest legacy airlines, is an example of the danger of preventing an airline from completing the so-called "Chapter 22" of multiple filings. If Continental could eventually get its act together, managers of US Air might argue, then so too could their company.

And there are of course a number of issues beyond bankrupt competitors that are plaguing the industry. The most obvious is the rising cost of fuel, which has wreaked havoc on even the healthiest airlines this summer. Legacy carriers including American, Continental and Northwest Airlines Corp. would be holding up well if not for $50 per barrel crude prices, leading one analyst to lament after third-quarter earnings were released, "If they only flew gliders."

Aviation consultant Michael Boyd argues that it is fuel prices - not bankrupt competitors - that has led to the industry's current condition. He notes that despite predictions to the contrary, United has not dramatically lowered fares while under court protection.

He says that the failure of one of the large airlines would do little to solve the problem of crowded skies. "If US Air went out of business today, their flights between major markets, which is where the overcapacity is, would be replaced by other airlines within minutes," Boyd says. "There would still be the cutthroat competition in the markets where we have it today."

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