* Defends plan to reject union contracts
* Unions picket outside courthouse
* Hearing expected to last a week (adds detail from union rally; adds detail from witness testimony)
By Nick Brown
NEW YORK, April 23 (Reuters) - American Airlines defended its plan to abandon its union contracts on Monday as its workers picketed outside a Manhattan court house, in the first day of a high-profile court battle over the bankrupt airline's labor deals.
The company's parent, AMR Corp, told a judge at a hearing on its request to abrogate its union contracts, that it cannot survive without major concessions.
Jack Gallagher, an attorney for AMR, said the company needs 20 percent across-the-board reductions in employee costs, half of which must come from employee benefits.
"It's not the unions' fault we're in bankruptcy, but it's not about whose fault it is," Gallagher said. "It's about the facts of our business."
AMR spends three times as much annually on medical benefits as the average lower-cost carrier, like Southwest Airlines , Gallagher said.
Hundreds of people, including lawyers and airline workers, filled a courtroom and two overflow rooms in U.S. Bankruptcy Court in Manhattan, while outside, hundreds of members of the Association of Professional Flight Attendants and Transport Workers Union, which represent AMR's flight attendants and ground workers, respectively, held a spirited rally.
Cordoned off by police, workers held signs and chanted for fairer work terms and against AMR's plan to cut about 13,000 union jobs.
The airline brought two of its expert witnesses to the stand on Monday, with more slated to testify later in the week.
Daniel Kasper, a Boston-based airline economics consultant, testified that deregulation in the airline industry has tied airlines' economic viability to a strong cost-structure.
Jerrold Glass, president of airline labor relations consultant F&H Solutions Group, said AMR's labor contracts are not as cost-effective as those of other major airlines.
AMR Chief Restructuring Officer Bev Goulet is among the witnesses slated to testify on Tuesday.
The hearing is expected to last about a week.
In order to succeed in its attempt to scrap labor contracts, AMR must convince Judge Sean Lane not only that it desperately needs labor concessions, but that its unions have unreasonably rejected prior attempts to negotiate those concessions. AMR filed for Chapter 11 bankruptcy in November, citing uncompetitive labor costs.
Judge Lane will not rule right away. After the hearing ends, the company and its unions will have another two weeks to negotiate. If new terms are still not reached, the unions will have a similar chance to present their case in court in May. A ruling from Lane would then be expected in June.
Regardless of how Lane rules, AMR must keep negotiating for a consensual deal with its unions. A ruling granting AMR's request to break its contracts would allow AMR to impose its own unilateral labor terms while those negotiations go on.
The Transport Workers Union, which represents seven work groups at American, will vote starting next week on the carrier's best and final contract offer, with results expected before unions testify in the hearing, three sources said. .
The Transport Workers Union represents 26,000 members.
Edgar James, a lawyer for the Allied Pilots' Association, which represents about 10,000 AMR pilots, argued at Monday's hearing that AMR's proposed business plan is unfair, in part because AMR has not done enough to explore possible merger or consolidation options.
"What everyone believes is going to occur is they're going to get out of this bankruptcy and consolidate with someone," yet the company has told the pilots' group it has not considered that option, James said.
In an unusual step in bankruptcy, the pilots', flight attendants' and ground workers' unions on Friday said they had struck a deal with US Airways Group Inc to support a potential merger between US Airways and AMR. They said a deal could save more than 6,000 jobs.
AMR has long shunned merger interest from US Airways, and on Monday, Chief Executive Tom Horton again shrugged off attention from US Airways in a letter to employees.
"I want you to know these developments in no way alter our course," he said. "We are making significant progress, and the court has granted us the exclusive right to pursue our plan of reorganization at least through the end of September and this may be extended further."
Jeff Brundage, senior vice president of human resources for AMR, said the US Air deal was "a creation of the unions and of US Air." "It's not real," Brundage said after Monday's hearing. "What's real is American's business plan, and this process."
At the rally, workers chanted "US Air" and carried signs declaring that American was trying to "Blame Labor Again" for its financial woes. The rally drew about 750 participants, TWU spokesman Jamie Horwitz said.
US Airways Chief Executive Doug Parker cautioned his employees on Friday that his company's agreement with AMR's unions does not mean a merger is in the works.
If the two airlines combine, it would create a carrier that rivals United Airlines and Delta Air Lines in size and scope.
The flight attendants' union, which represents 17,000 employees, said the US Airways plan would offer a pay increase of 2.5 percent initially and 1.5 percent a year for the next five years.
Gregg Overman, a spokesman for the pilots' association, declined to give details on the US Airways deal.
In March, US Airways gave a presentation to representatives of AMR's unsecured creditors and told them that a combination of the two airlines would create about $1.5 billion in synergies, according to people familiar with the matter.
The bankruptcy is In re AMR Corp et al, U.S. Bankruptcy Court, Southern District of New York, No. 11-15463. (Additional reporting by Kyle Peterson in Chicago; Editing by Martha Graybow, Tim Dobbyn and Carol Bishopric)