Is

State Street Bank and Trust

(STT) - Get Report

trying to save United Airlines' pilots from themselves?

The pilots, fresh off negotiating $2.2 billion in wage cuts over the next five years with United parent

UAL

(UAL) - Get Report

, ordered State Street -- the trustee of its employee stock ownership plan, which owns 55% of UAL -- to halt sales of the carrier's battered stock. State Street, however, says it has to keep the best interest of the ESOP participants in mind, and that may not mean buying into an airline teetering on bankruptcy.

While the fate of the 11 million shares, 20% of the pilots' stake in UAL, remains up in the air, this peculiar standoff highlights the perilous state of affairs at the nation's No. 2 airline.

"This situation is extremely difficult," said Morningstar analyst Nicolas Owens, who recently dropped his rating on the company to no stars, because of the bankruptcy risk. "There are a whole lot of Catch-22s here. But the struggle between State Street and the employees just shows how tense this whole situation is."

Whose Stock Is It Anyway?

The genesis of today's conflict began in August, when UAL's ESOP committee gave State Street the fiduciary responsibility to make investment decisions on behalf of employees. State Street registered with the

Securities and Exchange Commission

to sell 11 million shares over a three-month span starting on Sept. 27. The trustee felt it would be a violation of ERISA, the law governing ESOPs, to keep the employee eggs in one basket, perhaps hoping to avoid the fate

Enron's

employees faced last year.

As it stands, United's ESOP, will lose everything if the company goes bankrupt. But after pilots last week agreed to cut costs and UAL renegotiated $500 million in debt, union leadership wants State Street to change course. Because pilots own a significant portion of United and have made great strides to ensure the company will be able to continue as a going concern, betting against the company's fortunes sends the wrong message.

"Our views in this regard are unequivocal: We do not want you to sell our ESOP stock, and you are doing so against our express request to the contrary," said Paul Whiteford, chairman of the union's master executive council, in a letter Wednesday demanding State Street stop selling and buy back what has been sold. "The ESOP unmistakably requires that all ESOP assets must be invested 'exclusively' in shares of UAL stock."

State Street isn't going to bow to the concerns of the labor unions, and it reiterated that it is in charge of the ESOP. "The UAL ESOP committee has appointed State Street the investment manager for the ESOP. State Street is required to follow the ERISA framework and focus on the best interests of the ESOP participants in their capacity as participants," said Dave Reilly, spokesman for State Street. "We're continuing to evaluate the situation on an ongoing basis."

Vote of Confidence, Odds on Bankruptcy

If the situation isn't resolved, some say the matter may end up in court. Meanwhile, industry watchers aren't sure what to make of it. "The fact that State Street is out there selling caused confusion in the market," said Kevin Mitchell, chairman of the Business Travel Coalition. "It was a major statement that said the likelihood of them going into bankruptcy was high."

The vote of confidence from the pilots helped push the stock higher in Wednesday's session, sending shares up 30 cents, or 6.7%, to $4.45. Over the past week, UAL shares have doubled as the company has made strides to shore up its $1.8 billion loan application to the Air Transportation Stabilization Board, which the company said it needs in order to avoid filing Chapter 11.

With Wednesday's news that the ATSB, which has been extremely hard on carriers looking for a handout, had also approved loan applications from

Frontier Air

(FRNT)

and

Aloha Airgroup

, the case for UAL looks improved. Add in the fact that the two largest carriers -- United and

AMR's

(AMR)

American -- are on the verge of bankruptcy, and the political pressure on the ATSB to approve the loan is growing.

"I don't see, politically, how they'll be allowed to go into bankruptcy," said Mitchell. "Under Chapter 11, United would get an instant price advantage over American. And then you could have the No. 1 and No. 2 airlines in bankruptcy at once."

But this isn't to say that UAL is a lock for the ATSB loan, or that UAL will get it in time to avoid bankruptcy. Even Mitchell, who thinks it likely UAL can avoid bankruptcy, warned that "if UAL doesn't have a decision

from the ATSB by the end of the month, there's an 85% chance they'll be bankrupt."

More Work to Do

And UAL still has some work to do, namely getting specific cost cuts from the four other labor unions sitting at the table. Of all the unions, pilots have been the quickest to offer cuts while flight attendants and machinists have been more reluctant. The ATSB has demanded that carriers show significant labor cost reductions in order to get a loan.

The ATSB has also demanded that companies show not only how the money will be used to improve operations, but also provide assurances that they'll be able to pay that loan back. In the case of

US Airways

and

America West

(AWA)

, both carriers give the government equity stakes in the company as collateral. But UAL's employee owners have been unwilling to go this route, which could be another potential sticking point.

Because employees own the company they're trying to save, they are now in an all-or-nothing situation. Selling UAL shares is out of the question, because it will be taken as a sign of no confidence. But if UAL does go bankrupt, employees really get the shaft. Not only have they lost everything, they forced State Street to go back into the open market and buy back shares at inflated prices -- throwing good money after bad.

As Owens put it: "The unions are betting on the horse they're riding on."