Bankers, you can have your Jet and eat it too

The decline of Jet Airways’ business and the resulting distress to its creditors have elicited a sharply polarised response from observers. Some have supported the lead banker’s (in this case the State Bank of India) assertion that providing Jet with interim support increases the probability of a recovery while others have enthusiastically invoked Schumpeter’s creative destruction to espouse a dissolution of the troubled airline. Both the views are partially correct and are unable to completely grasp the economics of creative destruction and the strategic purpose of bankruptcy. 

Creative destruction does not mean the destruction of businesses with the attendant mass layoffs but the decimation of business practices that are no longer efficient. Similarly the bankruptcy process is not designed to liquidate the business but to allow it to restructure itself and realign its operations to market realities so as to minimise economic loss and maximise recovery for creditors. This is especially true for service businesses such as airlines. A firm derives its value from two sources. Its assets and its operations. In case of airlines (and other service businesses) the majority of the value is derived from operations and not from assets (since they don’t have much by way of assets if the fleet is leased). In the case of Jet, all its value is embedded in its operations and as such it is imperative for its operations to continue to preserve the remaining value for creditors. In this light, the SBI chief is correct in insisting on what is being painted as a bailout package for the airline to keep its operations afloat. 

Historically most major airline bankruptcies have resorted to what is called debtor-in-possession (DIP) financing to emerge from financial distress. Debtor in possession financing is a loan extended to a firm which is already in bankruptcy. The loan is used by the firm to restructure its operations and preserve or increase value for creditors. Understandably, such a loan prevails over claims from before the declaration of bankruptcy. Debtor in possession financing has been critical for the emergence of most major airlines from bankruptcy. American Airlines availed of $1.55 billion in DIP financing while in bankruptcy in 2013 and is now in robust health with creditor recoveries higher than 100 per cent. Similarly, Northwest Airlines used $1.355 billion in DIP financing before emerging from bankruptcy and then merging with Delta Airlines (which had used $2.5 billion in DIP financing to emerge from its own bankruptcy). 

Settle Down: By not dragging Jet to the NCLT process, bankers are robbing the company of an opportunity to overhaul its operations drastically and in a time-bound fashion to enhance value
Similarly, United Airlines had used $600 million in DIP financing to emerge from bankruptcy. Incidentally even in the capitalist America, the airways received $900 million in loan guarantees from the government while it was in bankruptcy in order to restructure its business. So the principle of using financing to restructure operations and preserve value for creditors is economically sound and the bankers are correct in trying to apply it to Jet Airways. 

What boggles the mind in case of the banker’s proposal for Jet is the insistence on not using the Insolvency and Bankruptcy Code (IBC) /and not taking it to the National Company Law Tribunal (NCLT). The key determinant of value and creditor recovery once a firm is economically bankrupt (which means that it can no longer pay what it owes in full) is the speed at which the operations are restructured and the new firm emerges from the ashes. In this context the time-bound NCLT process provides the right impetus both in terms of the time frame of restructuring and the degree of restructuring required to preserve the value of Jet Airways. By not dragging Jet to the NCLT process, the bankers are robbing the company of an opportunity to overhaul its operations drastically and in a time-bound fashion to enhance value. By providing financing without Jet being in NCLT, bankers run the risk that the restructuring will neither be timely nor deep enough and they will end up kicking the can down the road and creating a zombie airline. The case of Air India is a classic example of this half-hearted restructuring on the back of open-ended financial support from the government that is used in dribs and drabs to patch up operational inefficiency but never to eradicate it. 

This would still have been understandable had the IBC not allowed for DIP financing thereby necessitating the restructuring of operations outside the ambit of NCLT. But the IBC does allow for interim financing and it has been successfully used to restructure Alok Industries. If the bankers want to provide Jet with time and financing to recover its value, it is going to be more efficient and time-bound under NCLT than outside it. In this light the assertion of bankers that applying IBC on Jet will destroy value has been most puzzling. Earlier airline bankruptcies prove the opposite. Using interim financing under IBC is likely to resolve Jet’s woes faster and better. Yes dear banker, you can have your Jet and eat it too but only if you use IBC.
The author is a “probabilist” who researches and writes on behavioral finance and economics