A state-backed turnaround fund may seek to put Japan Airlines Corp through bankruptcy court as part of a restructuring of the struggling carrier, two sources with knowledge of the matter said.

JAL applied in October to the Enterprise Turnaround Initiative Corp of Japan, a fund established this year to help revive firms with state-guaranteed loans. The ETIC will decide whether to support JAL as early as next month.

The ETIC has discussed with JAL's creditors the possibility of using a Chapter 11-style bankruptcy procedure along with making fresh loans and investment, but has not ruled out a restructuring outside of bankruptcy court, the two sources said.

Government officials have said a court-led reorganization was a possibility but the state is at the same time wary of the potential disruption to air travel. JAL is Asia's largest carrier by revenue and handles more than half of air traffic in Japan.

A bankruptcy could also complicate talks with American Airlines and Delta Air Lines, which are courting JAL with rival offers of investment to gain access to its network in Asia and closer ties on U.S.-Japan routes.

If JAL really were to file for bankruptcy, that would cause chaos, said Kotaro Toriumi, an airline analyst and professor at Josai International University. At this moment I think the chance of a JAL bankruptcy is still quite small.

In addition to ongoing talks with creditors, the ETIC met with JAL over the weekend and explained that bankruptcy was being considered as an option, the two sources said, speaking on condition of anonymity given the sensitivity of the matter.

The ETIC and JAL declined to comment.

The chances of bankruptcy appeared to increase last week when Finance Minister Hirohisa Fujii said the state would not back any more loans to JAL, raising the risk it could run out of cash amid a slump in travel demand.

JAL was saddled with 1.5 trillion yen in total liabilities as of the end of September. At that level its bankruptcy would be the 6th biggest ever in Japan, ranking just below the 2001 collapse of retailer Mycal.

If JAL were allowed to go into a court-led reorganization just as it is right now it would trigger major social confusion, said one of the sources. There would be uproar over mileage, planes would be grounded, clients would suspend transactions.

LONG TIME

JAL's main creditors include the state-owned Development Bank of Japan and the country's top three private banks -- Mitsubishi UFJ Financial Group, Mizuho Financial Group, and Sumitomo Mitsui Financial Group.

The ETIC is considering a plan that would involve JAL filing for reorganization under the Corporate Rehabilitation Law, a process similar to Chapter 11 in the United States but that can prove lengthy, sometimes taking several years to complete.

Worried about the risk to JAL's operations during that period, the ETIC is mulling ways to accelerate the process. This could include seeking approval to opt out of some of the normal processes usually required, one of the sources said.

At the same time the ETIC would provide JAL financing, either in the form of loans or investments, by drawing on the 1.6 trillion yen in state-guaranteed money available to it in the current fiscal year to March.

Investors appeared unfazed by news of a possible court-led restructuring. The news was reported earlier on Monday by Kyodo news and the Nikkei business daily, while Reuters reported last week that the ETIC had not ruled out bankruptcy.

JAL's stock fell 1 percent to 96 yen, versus a 1.3 percent gain in the benchmark Nikkei average.

The market consensus seems to be they will never let JAL go bust, and the impact of JAL's problems on the overall economy has already largely been factored in, said Hiroaki Kuramochi, chief equity marketing officer at Tokai Tokyo Securities.

JAL's stock has already lost more than half its value this year while the spread on its 5-year credit default swaps, which are used as insurance against bankruptcy, are quoted at distressed levels above 2,300 basis points.

The news could nevertheless give pause to American Airlines and Delta, which have been fighting a heated public relations battle to pitch themselves as the ideal partner to help JAL rebuild itself.

American has said that it and other members of the Oneworld airline alliance along with private equity fund TPG are willing to invest $1.1 billion in JAL to prevent it from defecting from Oneworld to Delta and the rival Skyteam group.

Delta is offering a $1 billion financial aid package, half in equity, and has said it would consider investing in JAL even if it were put through bankruptcy court.

Both have said they would apply for anti-trust immunity to cooperate more closely with JAL on pricing and scheduling under a recently agreed open skies pact between the U.S. and Japan.

JAL has said it will make a decision on which overseas partner it will choose by early January.

(Additional reporting by Mariko Katsumura and Aiko Hayashi; Editing by Michael Watson and Joseph Radford)

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