In re Penn Central Transportation Co.

533 F.2d 1347

• Court: Court of Appeals for the Third Circuit
• Decided: March 3, 1976
• Docket: Nos. 75-1902, 75-2031 and 75-2151
• Status: Published

Opinions

OPINION OF THE COURT

HASTIE, Circuit Judge.

Two orders, No. 1884 and No. 1981, issued May 16, 1975 and August 4, 1975, by the District Court for the Eastern District of Pennsylvania in the Penn Central railroad reorganization and an order, No. 764 issued July 22, 1975, by the District Court for the District of New Jersey in the New Jersey Central railroad reorganization, have been appealed to this court. The three orders adjudicate similar controversies about the terms upon which the courts should require the trustees of the railroads in reorganization to accept federal financing of their operations. They have been consolidated for hearing and disposition.

These controversies have been generated by the Regional Rail Reorganization Act of 1973 (hereinafter, the Rail Act) 45 U.S.C. § 701. In that Act, Congress has provided for the organization and financing of a new corporation, Consolidated Railway Corp. (hereinafter, ConRail) that is to supply essential rail service after it shall purchase whatever property of the railroads now in reorganization may be needed for its operations. But Congress also recognized that the implementation of this plan would take time and that during the interim the trustees of the railroads in reorganization would have no choice but to continue to provide rail service at a substantial loss to the insolvent corporate estates. Accordingly, the 1973 Act and its 1975 amendments authorize interim federal financial aid to the trustees.¹ In dispute here are, the terms upon which aid is to be provided.

We begin with the appeals of the United States from the two judicial refusals to require the Penn Central trustees to accept federal financial aid upon terms proposed and insisted upon by the Federal Railroad Administrator (hereinafter, FRA), the responsible federal officer² who administers the federal financial assistance to railroads in reorganization that is authorized by sections 213 and 215 of the Rail Act.

Pending the conveyance of railroad properties to ConRail, section 215 provides for federal financing of interim maintenance and improvement of railroad properties and for government acquisition of “interests in such rail properties . . . or in purchase money obligations therefor”. The same section specifies that funds, not to exceed $300,000,000, for these purposes shall be obtained through obligations to be issued by the United States Railway Association and guaranteed by the United States. And in this connection it is expressly required that “the Corporation [ConRail] [shall] assume any such obligations” when it takes over the railroad service. There is a further provision that in the final system plan under which ConRail shall operate, the Secretary of Transportation may designate a portion of these obligations “from which ■ [ConRail] shall be released

The federal financing transactions proposed and in question here are, in the language of section 215, governmental acquisitions of “interests in . purchase money obligations” of the now bankrupt railroad. More particularly, the “obligations” are in essence long term conditional sale contracts under which Penn Central has acquired rolling stock and other essential equipment. Under section 215, FRÁ could, simply and without more, pay to equipment sellers whatever installments become due under Penn Central’s purchase money contracts. Beyond this, any mutually acceptable resultant obligation of the railroad to the United States can be defined by agreement between the parties.

In the present case, FRA and the Penn Central trustees have been unable to agree what obligation to the government, if any, the bankrupt estate should assume in return for the government’s payment of the railroad’s equipment obligations. FRA insisted upon agreement by the trustees that, upon payment of any installment of a purchase money contract, the United States Railway Association should acquire “the same rights as the original obligees under such equipment obligations” enjoyed before payment to them. However, the government would stipulate that as long as the trustees remain in possession of the equipment, they will be excused from the payment of interest or principal to the Railway Association. Nothing was to be said about the nature or extent of the rights against the Penn Central estate that would survive after ConRail’s acquisition of the equipment. The trustees refused to agree to these terms and FRA petitioned the reorganization court to order them to enter into the agreement as proposed. In Order No. 1844 of May 16,1975, the first of those from which these appeals have been taken, the court denied FRA’s petition. Thereafter, FRA and the trustees continued to negotiate about federal financing under section 215. These negotiations resulted in agreements, subsequently approved by the reorganization court, for the use of section 215 grants to pay for scheduled maintenance-of-way and maintenance-of-equipment expenditures that otherwise would have consumed about $144,000,000 of the railroad’s operating revenue. In these circumstances, the trustees were able to pay equipment obligation installments out of operating revenues as they matured through the month of July, 1975.

In the meantine FRA addressed a new petition to the reorganization court asking that the trustees be required to agree, under terms like those outlined above, to FRA purchases of other Penn Central equipment obligations that would mature during the months ahead. The district court’s decision on that petition, Order No. 1981, is the subject of the second appeal that will be considered in this opinion.

Because the trustees have now. paid out of operating income those installments of equipment operations that matured before August, 1975, and because financing of subsequently maturing obligations is the disputed matter on the second appeal, we hold that the first appeal, at our No. 75-1902, has been mooted by events subsequent to the district court’s order.

We turn now to Order No. 1981 and the appeal from it at our No. 75-2151. Order No. 1981 was entered on August 4, 1975, after FRA and the Penn Central trustees had presented differing forecasts of Penn Central’s anticipated deficit and need for additional financing in order to continue rail service through the second half of 1975 and until that time in 1976 when ConRail probably will take over the railroad operation. The parties also continued to disagree whether, in any event, the trustees should be required to accept the terms upon which FRA proposed to purchase monthly installments of equipment obligations.

The reorganization court adhered to its view, stated in its earlier Order No. 1884, that, on the proof before it, the trustees should not be required to accept FRA’s terms. But it also recognized that, on appeal, this court might disagree with its view. Moreover, if the trustees did not accept FRA’s proposal, they would be obliged to pay monthly installments of equipment obligations out of operating revenue, and they planned to continue to do so. Thus, the matter in dispute might again be mooted before we could decide an appeal from this second denial of an FRA petition.

Moved by these considerations, the reorganization court ordered the trustees to accept the terms of FRA’s proposal for government purchases of August and September installments of equipment obligations. But, over FRA’s objection, the court included a provision that gave the trustees the right to repay the government and thus discharge its debt before ConRail should take over this equipment and the operation of the railroad.³ Pursuant to this order the government paid August and September equipment obligation installments aggregating some $11,000,000.

On this appeal, the government asks that we reverse so much of Order No. 1981 as authorizes the trustees to discharge their debt by reimbursing the government. On the other hand, we are advised that the trustees have already tendered the government a check for $11,000,000 in full payment of the debt incurred in August and September, that the tender has been refused and that the trustees have set aside in a special account funds sufficient to cover the tendered payment.

Throughout this controversy FRA has complained and argued that the trustees and the reorganization court are frustrating FRA’s effort to respect a Congressional purpose, declared in section 101 of the Regional Rail Reorganization Act, to maintain essential rail service through “necessary Federal financial assistance at the lowest possible cost to the general taxpayer.” 45 U.S.C. § 701(b)(6). At least at first blush, therefore, it seems strange that the government should object to a judicial order that Penn Central trustees reimburse the government for expenditures it has made for Penn Central’s benefit. Indeed, the trustees’ tender of $11,000,000 to reimburse the government, as authorized by the reorganization court, seems a direct way of immediately minimizing any “cost to the general taxpayer” of financial assistance to Penn Central. Moreover, earlier in this reorganization, in connection with 1974 emergency government payments of Penn Central equipment loan installments the United States and the trustees had agreed that “the Trustees may . . . pay to the United States any amount which it has paid ” ⁴

In any event, the trustees’ repayment of the $11,000,000 obligation can possibly impose additional cost upon the general taxpayer only if the resultant depletion of Penn Central’s cash will necessitate an additional infusion of federal money to maintain service until ConRail shall take over. Unless that is the case, the government’s argument is not even colorable. •

We do not know, however, what the needs of the railroad operation are and will be, or what resources are and will be available to satisfy them during the remaining short period of Penn Central railroad service. All of the circumstances considered, we think the reorganization court should make a new current and final appraisal of the need for and effect of any repayment of equipment obligations during this period. To facilitate that process we add the following observations to what has already been said in this opinion.

We have pointed out that the equipment obligations are in the nature of long term installment contracts of conditional sale under which Penn Central purchased rolling stock and other equipment that the trustees now continue to use to provide rail service during reorganization. The trustees have had no choice but to assume these obligations. For, under section 77(j) of the Bankruptcy Act, a railroad reorganization proceeding does not affect the contractual right of a conditional seller of railroad equipment to repossess the equipment in case of default.

Since this equipment is in continuing use, it is depreciating apace. It follows that, in an accounting view, each payment of a matured installment on a railroad equipment obligation has three components: (1) interest on deferred purchase money, (2) a payment on the now depreciated part of the equipment’s original value and price, and (3) a remaining amount by which the value of the railroad’s equity in the equipment is increased. The present record indicates that the third of these components is only a minor fraction, probably less than 20 per cent of each of Penn Central’s 1975 purchase money installments. More than 80 per cent of each payment represents interest and depreciation, both elements of the cost of continuing to operate the railroad, as Congress has required in the public interest, after any prospect of successful reorganization on an income basis has disappeared.

In these circumstances, the trustees and the reorganization court are properly concerned that, insofar as possible, interest and depreciation, that are costs of enforced continuing section 77 operation, be paid currently out of operating income so that the insolvent estate will not be burdened with an additional multi-million dollar deferred cost of administration.⁵ Although the Regional Rail Reorganization Act has supplemented and modified section 77 procedure to the extent necessary to accommodate the projected inauguration of rail service by a new corporate entity, the section 77 reorganization of Penn Central Transportation Company has not ended. The section 77 trustees and the reorganization court have not been relieved of their responsibility to consider and deal equitably with all claimants who have an interest in the Penn Central estate. True, the Supreme Court has determined that Penn Central creditors have an ultimate remedy under the Tucker Act for erosion losses the government has forced upon the bankrupt estate. Regional Rail Reorganization Act Cases, 1974, 419 U.S. 102, 95 S.Ct. 335, 42 L.Ed.2d 320. And the Court deemed that remedy constitutionally adequate. But the legitimate interests of Penn Central creditors are fairly and more fully served by additional measures calculated to prevent or minimize erosion losses and thus to avoid the long delays and practical uncertainties about recoupment that unavoidably will attend resort to a Tucker Act remedy.

In this case, the reorganization court was properly reluctant to approve any agreement that, as that court’s opinion characterized it, would “create additional high priority debt in order to finance loss operations of the railroad . . . [while] government planners are . . . seeking to devise a ‘Final System Plan’ . . . Unpersuaded that resort to this financing device was unavoidable, the court adopted the expedient of authorizing financing on the government’s terms for the time being, but requiring that the trustees be allowed to repay this high priority debt, leaving FRA and the trustees to find some other arrangement for supplying any unfilled cash requirements of the government imposed interim railroad operation.

FRA counters by arguing that any responsibility the reorganization trustees might normally have to safeguard the interests of creditors is legislatively overridden here by the Rail Act’s general declaration of Congressional purpose to provide “necessary Federal financial assistance [for essential rail service] at the lowest possible cost to the general taxpayer”. 45 U.S.C. § 701(b)(6). We read this language as an earnest entreaty to economize, addressed to those who are authorized to spend many millions, ultimately billions, of dollars in preserving and subsidizing essential rail service.⁶ Indeed, Congress seems to have spoken in contemplation of the high cost of financing the contemplated ConRail project, not merely the smaller cost of interim financing before the ConRail takeover. In any event, the legislative language does not even purport to be a directive to the judiciary. This is not to deny that a court asked to approve a proposed scheme of deficit financing under the Rail Act, should seriously consider, as the reorganization court has done here, the general concern of Congress to avoid unnecessary cost to the general taxpayer. But that is not the only proper and relevant consideration. A reorganization court must also be mindful that it is the government that has compelled the insolvent railroads to continue in the public interest to supply rail service,⁷ unavoidably consuming their dwindling assets in the process, and that it is the creditors of the railroad who are forced, for the time being at least, to bear the burden of that erosion. Fairness, beyond minimum constitutional requirement, to those thus harmed is also a legitimate consideration.

In our view, a reasonable accommodation of interests can and should be achieved. In late winter, 1976, the ConRail takeover of rail service is sufficiently imminent⁸ to permit a reliable forecast of both the expenditures that must be made before takeover and the resources that are or can be made available to the trustees to meet them. The picture of interim financing needs and potential under sections 213 and 215 for each and all of the insolvent railroad operations should now be clear and complete. Thus informed, the court can determine whether the money the trustees would use for repayment of equipment related debt to the United States is needed to finance the continuation of rail service until April.

To this end the reorganization court’s present blanket direction that the trustees shall repay their equipment debt to FRA will be vacated and the trustees will be required to justify whatever repayment they propose by showing to the satisfaction of the reorganization court that the funds needed to support the continuation of adequate Penn Central rail service until the ConRail takeover can and will be provided without the use of the money in question.

In dissent, Judge Gibbons expresses the view that the Regional Rail Reorganization Act has “stripped the reorganization courts of their powers of equitable oversight” over arrangements that may be made between FRA and the trustees for federal financing of ongoing section 77 operations. While our disagreement with that conclusion has already been expressed, the present posture of this case prevents the dispute over the originally proposed terms of federal financing from being a critical issue now. For the Penn Central trustees, as well as the New Jersey Central trustee, have executed the agreements for government financing of equipment loan installments on the terms proposed by FRA. The only question is whether and under what circumstances the trustees may reimburse the government before the ConRail takeover.

The dissenting opinion points out the probability that the government will recoup part of its investment in Penn Central equipment loans by way of reduction of the price ConRail would otherwise have to pay the Penn Central estate for that equipment. This circumstance is relied upon as an indication that we should not permit repayment now. But repayment in full now must be more advantageous to the general taxpayer than some partial recoupment that may be realized later when it is determined how much ConRail must pay for the Penn Central rolling stock. The dollar value of the possible future benefit to ConRail could not exceed, probably would be much less than, the amount of the equipment installments which the trustees propose to repay now. And to the general taxpayer, for whose financial burden Congress has expressed concern, the certainty of present repayment in full to the federal financing agency that rendered assistance can hardly be less beneficial than a prospective accrual of a part, or even all of that sum, for the future benefit of another corporation that is dependent upon the government for much of its financing.

There is nothing in the Regional Rail Reorganization Act that prohibits or discourages reorganization trustees from reimbursing the government for financing railroad operations. The dissenting opinion points out that section 215(b) empowers the Secretary of Transportation to prescribe “reasonable terms and conditions” upon which financial assistance will be provided. But we do not believe refusal to accept repayment is comprehended by this language. To us it seems a proper function of the reorganization court to determine whether such reimbursement will be fair to the interested parties and can be accomplished without jeopardizing the service which the trustees must continue to provide, probably until about April 1. To dispose of this case we think it is sufficient to indicate the considerations that should influence that determination and to instruct the district courts to make a new adjudication of each reimbursement proposal before the contemplated April 1 transfer of property and operating responsibility to Con-Rail.

In the New Jersey Central railroad reorganization, the reorganization court was persuaded that a government purchase of the railroad’s equipment obligation installments in the amount of $223,698.51, on terms essentially like those originally rejected by the Penn Central court, was necessary to enable the trustee to continue rail service until the ConRail takeover. As in the Penn Central case, the resultant debt to the government is a high priority claim that has been deferred.

The New Jersey Central trustee now argue.s that there neither was nor is justifying need for this type of financing to the disadvantage of creditors. Here too, we think that, whatever financial predictions may have been reasonable last summer, the imminence of the ConRail takeover now permits a much better informed determination whether this debt need be left unpaid in March, 1976. To that end we will affirm Order No. 764, but the trustee shall be permitted to show the reorganization court, if he can and will, that resources at hand or about to become available are sufficient to permit repayment of the debt in question without jeopardizing the continuity of rail service.

At our No. 75-1902, the appeal will be dismissed because of mootness.

At our No. 75-2151, the order of the reorganization court will be modified to require that the trustee show, in conformity with this opinion, that current resources, considered in the light of operating needs, justify each proposed payment of the equipment debt to the government.

At our No. 75-2031, the order of the reorganization court will be affirmed and also supplemented by leave granted to the trustee to show, in conformity with this opinion, that current resources, considered in the light of operating needs justify payment of some or all of the equipment debt to the government. Each party to bear its own costs.

Our mandate shall issue forthwith.

1 . See sections 213 and 215 of the 1973 Act, 45 U.S.C. §§ 723, 725, as amended by Pub.L. 94-5, approved February 28, 1975.

2 . The Federal Railroad Administrator is the delegate of the statutory authority and responsibility of the Secretary of Transportation for providing and administering federal financing needed to assure continuation of rail service pending the transfer of railroad property and operating responsibility to ConRail.

3 . In a subsequent Order No. 2100 the Court has permitted government purchases of installments becoming due in November, 1975, and thereafter, subject, however, to the trustees’ right to repurchase before the ConRail takeover.

4 . The text of that agreement is set out in In the Matter of Penn Central Transportation Co., E.D.Pa.1974, 373 F.Supp. 185, 189.

5 . The reorganization court points out that it has been able to avoid deferral of administration expenses other than taxes and interline obligations.

6 . Since funds for section 215 financing come not from federal tax collections but from borrowings by United States Railway Association, and ConRail is required to assume these obligations, the risk to the general taxpayer, though real and a matter of proper concern, is only that of a guarantor.

7 . See section 304(f) of the Rail Act, 45 U.S.C. § 744(f).

8 . April 1, 1976, appears to be the target date.