Inside Delta vs. Mesa: Court Ruling Tells a Tale of Overbilling and Confusion

Last week I mentioned how Delta (DAL) had won its lawsuit allowing the airline to terminate its contract with Mesa Air Group's (MESAQ) Freedom Airlines subsidiary to fly 22 Embraer regional jets under the Delta Connection brand. Now that I've had the chance to read through the 78-page ruling, it's a much more interesting story than I first thought. The ruling tells a tale of confusion and overbilling that really makes Mesa look incompetent at best and devious at worst. But this isn't completely one-sided. Delta looks like a disorganized mess that isn't paying enough attention to its costs. Oh boy.

First, some background. Delta entered into a 2005 agreement that allowed Mesa to operate up to thirty six 50-seat Embraer 145s under the Delta Connection brand. Originally, Mesa operated the airplanes primarily in and out of Orlando, but eventually, most of them were moved to New York/JFK. A key piece of the contract required Mesa to operate 95 percent of scheduled flights within four hours of schedule. If Mesa failed to meet that bar for any 3 months during a 6 month period, Delta could walk away.

You can guess where this is going. Delta cut ties with Mesa after the airline failed to meet the 95 percent threshold in October 2007, December 2007, and February 2008. Mesa fought back through a "variety of legal theories: equitable estoppel; oral modification and mutual departure; waiver; and breach of the express and implied duty of good faith." The airline claimed that Delta had asked the airline to cancel all those flights (Delta-caused), so Mesa shouldn't be held accountable. Initially, the judge in the case agreed and issued a preliminary injunction against Delta.

This sounds reasonable on the surface. It's common practice for the branded airlines to ask regionals to start canceling when the weather is bad and airport capacity is restricted. That's a common issue in JFK for sure, so it seems likely. But should those numbers have been excluded from the calculation? Though the judge originally felt that way, he changed his mind after getting all the facts.

The case boiled down to whether or not there had been an amended agreement between Delta and Mesa to include those flights Delta asked Mesa to cancel as well as those flights which operated more than four hours late in the "completion factor" (percent of scheduled flights that operate) calculation. The original agreement did not call for that, but flying out of Orlando didn't create much of a problem. It was only after the move to JFK that this became an issue.

According to Freedom chief operating officer Jorn Bates, he came to an agreement with Delta's Courtney Boyd in March 2007 that would count Delta-caused cancellations and four hour delays as completed. Boyd denied it. The "agreement" was never put into writing, so it was hard to figure out if it actually even existed.

What followed was a fairly lengthy process of examining document after document. In the end, the judge determined that Jorn's testimony was not credible and that while he claimed that he had come to an oral agreement with Delta, that wasn't actually the case. How did the judge get to this conclusion? He looked at the evidence at hand.

For example, in the summer of 2007, Mesa asked Delta to lower its performance goals. That wouldn't have been necessary had the two airlines agreed to amend the agreement already. There were also presentations from the top at Mesa showing that the airline expected to be judged on "Total Completion Factor." There were all kinds of discrepancies regarding who knew what and when that only clouded the issue further.

To make things even worse, Mesa never even bothered to try to take credit for the Delta-caused cancellations until September 2007, months after the agreement was supposedly made. But in September, the difference was important. Mesa received a bonus every time it surpassed a 97.9 percent completion factor. In September, that number was 97.7, but if you added the Delta-caused cancels back in, it jumped to 98.0. Mesa billed for the bonus in September and thanks to Delta's sloppy billing practices -- or so Courtney called them -- the bill was approved and sent on its way.

This is where Delta starts to look bad. This chain of events paints a picture of an airline with a lot of turnover and not much knowledge of how to handle these things. The data wasn't double-checked against independent sources and, according to Courtney, the groups within the airline were "not communicating well." Delta basically relied on Mesa to handle this properly. It didn't.

By February 2008, Delta's finance team was finally getting suspicious and repeatedly asked Bud Tyler, Mesa's director of contract-revenue management, for clarification on how these numbers were being determined. Bud never responded and in fact, internal documents show him saying "the less said the better at this moment."

Meanwhile, the overbilling was adding up. From June through December 2007, Mesa overbilled Delta by more than $3 million. That's how we ended up in court.

Now that the case has been decided, the damage is not just the loss of an important contract for Mesa. It also has to repay Delta the $3 million for which it overbilled. That's not the kind of news you want to receive as an airline in bankruptcy. That being said, it's certainly the portrait of an airline in trouble.