Petition — CITY OF CLEVELAND v. ROBERT W. MESERVE (Nos. 80-1196, 80-1182)
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IN THE
Supreme Court of the United States."
OcTOBER TERM, 1980.
CHESAPEAKE AND OHIO RAILWAY
COMPANY, ETAL.,
PETITIONERS,
Vv.
ROBERT W. MESERVE anpb
BENJAMIN H. LACY, TRUSTEES
OF THE BOSTON AND MAINE CORPORATION,
DEBTOR,
RESPONDENTS.
PETITION FOR A WRIT OF CERTIORARI TO THE UNITED STATES
COURT OF APPEALS FOR THE FIRST CIRCUIT.
-_
JOHN T. COLLINS, COUNSEL OF RECORD, ~
PauLA BONNELL, ,
SHERBURNE, Powers & NEEDHAM,
_ One Beacon Street,
Boston, Massachusetts 02108.
(617) 523-2700
Attorneys for Petitioners
Chesapeake and Ohio Railway Company,
Baltimore and Ohio Railroad Company,
and Western Maryland Railway
SELMAN TEER EM LED RATT TNT RNC ER AINA RL RTL DETA RINE PINT
ADDISON C. GETCHELL & SON, INC. - THE LAWYERS’ PRINTER - BOSTON
Questions Presented.
1. When the lending of railroad cars by one railroad to an-
other is required by federal law and the rate of compensation
for car loans is set without taking into account the risk of
non-payment in the event of bankruptcy of the borrower,
must a classification among creditors sufficient to assure pay-
ment be accorded to the car-lending railroad in the
reorganization of the car-borrowing railroad in order to avoid
an unconstitutional taking?
2. Should the First Circuit’s denial of a classification suffi-
cient to assure payment to railroad per diem claimants in a
railroad reorganization be reviewed by this Court because
that decision frustrates national transportation policy and
directly conflicts with Seventh Circuit decisions?
Parties.
Petitioners are the Chesapeake and Ohio Railway Com-
nany, the Baltimore and Ohio Railroad Company, and the
Western Maryland Railway.* Respondents are Robert W.
Meserve and Benjamin H. Lacy as Trustees of the Boston &
Maine Corporation, Debtor, a railroad in reorganization.
* The three Petitioners are all wholly-owned subsidiaries of the
CSX Corporation, a Virginia corporation. CSX also owns the
Seaboard Coastline Railroad Company and the Louisville and
Nashville Railroad Company.
°%
i
Table of Contents.
Opinions below
Jurisdiction
Constitutional provisions and statutes involved
Statement of the case
Reasons for granting the writ of certiorari
I. When federal law requires railroads to lend
freight cars to other railroads and the rate of
compensation for car loans is set without taking
into account the risk of non-payment in the event
of bankruptcy of the borrower, a classification
among creditors sufficient to assure payment
must be accorded to the car-lending railroad in
the reorganization of the car-borrowing railroad
in order to avoid an unconstitutional taking
A. Federal law required Petitioners, car-
owning railroads, to lend their cars to the
Boston & Maine at rates which had the
force of law
B. The per diem rates were intended to com-
pensate car-lending railroads for costs of
ownership and did not provide any profit
C. Petitioners, car-lending railroads, diligently
pursued their per diem claims against the
Boston & Maine, but its bankruptcy pre-
vented collection
D. Without inclusion of the risk of non-pay-
ment among the cost elements used to cal-
culate the per diem rate, priority for per
diem claims which will assure eventual full
payment is constitutionally required; other-
wise the car-lenders’ property will have
been taken without just compensation
E. The decision below conflicts with decisions
of this Court on the taking of property with-
out just compensation
wnN =
10
10
10
11
12
14
16
iti
F. The constitutionai issue will also be pre-
sented under the new Bankruptcy Act 19
Il. This Court’s review of the First Circuit’s denial
of a classification sufficient to assure payment to
railroad per diem claimants in a railroad reorgan-
ization is necessary to avoid frustration of na-
tional transportation policy and to resolve the
conflict between the First and Seventh Circuits 20
A. The decision below conflicts with Seventh
Circuit decisions 20
B. Railroad per diem claimants’ differences
from other creditors justify creation of a
separate classification for their claims 25
A priority which will assure payment in full
of per diem claims of car-owning railroads is
necessary to fulfill the purposes of car serv-
ice law 27
D. The important national interest in the con-
tinuing financial health of railroads furnish-
ing cars for the national pool requires a
priority in bankruptcy which will assure
eventual payment of outstanding per diem
O
balances 28
E. The rule articulated below will have adverse
consequences for the nation’s rail system 28
Conclusion 29
Appendix A Al
Appendix B Bl
Table of Authorities Cited.
CASES.
Agins v. City of Tiburon, 447 U.S. 255 (June 10, 1980) 19
Baltimore & Ohio R.R. v. New York, New Haven &
Hartford R.R., 196 F. Supp. 724 (S.D.N.Y. 1961) 7,13
Boston & Maine R.R. v. United States, 358 U.S. 68
(1958) 6
7%
iv
Boston and Maine R.R. v. United States, 162 F. Supp.
289 (D. Mass. 1958) 4,6, 11,12
Boston and Maine R.R. v. United States, 297 F. Supp.
615 (D. Mass.), aff'd, 396 U.S. 27 (1969), reh.
denied, 396 U.S. 1030 (1970) 8-9
Chicago, Burlington & Quincy R.R. v. New York,
Susquehanna & Western R.R., 297 I.C.C. 291
(1955) 6, 12
Chicago, Burlington & Quincy R.R. v. New York,
Susquehanna & Western R.R., 332 I.C.C. 176
(1968) (Per Diem Rates case) 2n.-3n., 8, 11, 12, 15, 22
Chicago, Milwaukee & St. Paul R.R. v. Wisconsin,
238 U.S. 491 (1915) 17,18
Chicago, Rock Island and Pacific Ry. v. United
States, 284 U.S. 80 (1931) 5, 11, 12, 17, 18
Delaware, Lackawanna v. Board of Public Utilities,
85 N.J.L. 28 (1913) 18
Incentive Per Diem Charges - 1968, 349 I.C.C. 303
(1975) 26, 27
In re Boston and Maine Corp., 456 F. Supp. 412
(D. Mass. 1978), aff'd, 600 F.2d 307 (1st Cir. 1979) 3-4
In re Boston & Maine Corp., 618 F.2d 137 (1st Cir.
Mar. 13, 1980) 22
In re Chicago, Milwaukee, St. Paul & Pacific R.R.,
632 F.2d 45 (7th Cir., Oct. 16, 1980) 20, 21n., 22, 24, 29
In re Chicago, Rock Island and Pacific R.R., 537
F.2d 906 (7th Cir. 1976), cert. denied sub. nom.
Gibbons v. Atchison, Topeka and Santa Fe Ry.,
429 U.S. 1092(1977) 18n., 20, 21n., 22, 24, 25, 27, 28, 29
In re Penn Central Transportation Co., 486 F.2d
519 (3d Cir. 1973), cert. denied sub. nom. Baker v.
Indiana Harbor Belt R.R., 415 U.S. 990(1974) 20n., 21n.,
23n., 24, 25
In re Penn Central Transportation Co., 553 F.2d
12 (3d Cir. 1977) 20n., 21n.
Investigation of Adequacy of Car Ownership, 323
I.C.C. 48 (1974) 14
Vv
Kaiser Aetna v. United States, 444 U.S. 164 (1979) 16,19
Missouri & Illinois Coal Co. v. Illinois Central R.R.,
22 I.C.C. 39 (1911) 10, 12
New Haven Inclusion Cases, 399 U.S. 392(1970) 26
Palmer v. Massachusetts, 308 U.S. 79 (1939) 23
Per Diem Rates case, see Chicago, Burlington &
Quincy R.R. v. New York, Susquehanna & Western
R.R., 332 L.C.C. 176 (1968) (above)
Per Diem Rules case, see Rules for Car-Hire
Settlement, 160 I.C.C. 369, 165 I.C.C. 495
(1930) (below)
Penn Central Transportation Co. v. City of New
York, 438 U.S. 104 (1978) 19
Rules for Car-Hire Settlement, 160 I.C.C. 369, 165
I.C.C. 495 (1930) (Per Diem Rules case) 5, 10, 11, 12, 15, 17
United States v. Allegheny-Ludlum Steel Corp., 406
U.S. 742 (1972) 10, 14, 19
United States v. Florida East Coast Ry., 410 U.S.
224 (1973) 14
CONSTITUTIONAL PROVISIONS AND STATUTES.
United States Constitution, Amendment V 2
Bankruptcy Act of 1978, 11 U.S.C. §§ 101 et seq. 19
§ 1166 19, 20, 29
Bankruptcy Act of 1898, as amended, 11 U.S.C.
§ 205 2, 25n., 26
§ 205(b) 3n.
§ 205(c) 23, 25, 27
§ 205(cX2) 2, Bl
§ 205(cX7) 2,3, 25, B2
Interstate Commerce Act,
49 U.S.C. §1 2, 5, 6, 10, 13, B2-B5
Rail Act, 45 U.S.C. § 791(bX4) 21n.
7
7%
vi
Railroad Revitalization and Regulatory Reform Act
of 1976, 45 U.S.C. §§ 801-854 28n.
28 U.S.C. § 1254(1) 2
ESCH Car Service Act, 40 Stat. 101, amended by
Transportation Act of 1920 (41 Stat. 456, 476) (see
In*-~state Commerce Act, § 1, above) 2,5
MISCELLANEOUS.
76 Cong. Rec. 5358 (March 1, 1933) (remarks of
Rep. LaGuardia) 23
‘Sax, Takings and the Police Power, 74 Yale L.J. 36
(1964) 19
Sax, Takings, Private Property and Public Rights,
81 Yale L.J. 149 (1971) 19
Stobaugh and Yergin, Energy Future, 87-91 (1979) 28n.
No.
IN THE
Supreme Court of the United States.
OcToBER TERM, 1980.
CHESAPEAKE AND OHIO RAILWAY
COMPANY, ET AL.,
PETITIONERS,
Vv.
ROBERT W. MESERVE anp
BENJAMIN H. LACY, TRUSTEES
OF THE BOSTON AND MAINE CORPORATION,
DEBTOR,
RESPONDENTS.
PETITION FOR A WRIT OF CERTIORARI TO THE UNITED STATES
COURT OF APPEALS FOR THE FIRST CIRCUIT.
Opinions Below.
The opinion of the Court of Appeals for the First Circuit, —
F.2d — (1st Cir. Oct. 6, 1980) appears in Appendix A (A1-
A47). It affirmed in part and reversed in part the United
States District Court for the District of Massachusetts deci-
sion reported at 468 F. Supp. 996 (D. Mass. 1979), which ap-
pears in Appendix A (A48-A68).
Jurisdiction.
The judgment of the Court of Appeals was entered October
6, 1980.! The appeal was from an order of the district court in
1 By Order dated December 31, 1980, Justice Brennan extended
the time within which Petitioners might file their petition for cer-
tiorari to and including January 15, 1981.
7.
railroad reorganization proceedings under Section 77 of the
Bankruptcy Act, 11 U.S.C. §205. Petitioners invoke this
Court’s jurisdiction to review that judgment by writ of cer-
tiorari under 28 U.S.C. §1254(1).
Constitutional Provisions and Statutes Involved.
United States Constitution, Amendment V:
. nor shall private property be taken for public use,
without just compensation.
In addition to the Fifth Amendment, this case involves Sec-
tion 77(cX2) & (7) of the former Bankruptcy Act, 11 U.S.C.
§205(cX2) & (7), and portions of the ESCH car service act
which constitute part of Section 1 in the former codification
of the Interstate Commerce Act, 49 U.S.C. §1. The relevant
p phs within that section are (4), (5), (10), (11), (14a),
and (17) as they stood prior to the October 17, 1978 enact-
ment of Pub. L. 95-473, 92 Stat. 1337, revising and recodify-
i de mma Commerce Act. They are set forth in Ap-
pe .
Statement of the Case.
Petitioners, the Chesapeake and Ohio Rail Company
(“the C&O”), the Baltimore and Ohio Rai Company
(‘the B&O’), and the Western Maryland Railway (‘‘the
Western Maryland’), seek a Writ of Certiorari to the Court
of Appeals for the First Circuit. By its judgment entered Oc-
tober 6, 1980, the court in Part I of its opinion upheld on
statutory and constitutional ——. the district court’s
denial to Petitioners of such a tion among creditors
of the Boston and Maine Corporation, Debtor, a railroad in
reorganization,” as would assure payment in full of their $1.4
million of per diem claims.* The court thereby affirmed classi-
? Herein called ‘‘the Boston & Maine,’ ’ whenever periods prior to
the bankruptcy petition are discussed, and “the Debtor” or “the
Trustees” (as appropriate) whenever the reorganization period is
* Petitioners’ claims cover the August 1, 1953 through
March 12, 1970. Petitioners ted with the Trustees that, if
paid at the rates set by the Interstate Commerce Commission
(“ICC’’) in Chicago, Burlington & Quincy R.R. v. New York Sus-
3
fication of per diem claimants along with general creditors in
ninth place among creditors and siackinihlers. and denied the
appeals of Petitioners and other similarly situated railroads
seeking classification sufficient to assure the ultimate pay-
ment in full of per diem claims.‘
The district court’s classification of creditors of the Boston
& Maine was made in response to the Trustees’ petition to fix
the division of creditors and stockholders. As a part of its
statutory duty under Section 77(cX7) of the Bankruptcy Act,
the district court decided that priority determinations are to
be governed by the bankruptcy goals of debtor rehabilitation
and equitable distribution of the debtor’s property among
creditors, and that national transportation policy as ar-
ticulated by ICC orders requiring payment of per diem did
not prevent the court’s assignment of per diem claimants,
along with general unsecured creditors, to the lowest
category among creditors. 468 F. Supp. at 999-1001. For all
practical purposes, classifying per diem claims in ninth place
denied full or even substantial payment of those claims. (Per
diem claims represent $8,582,000 of the total $143,973,380
claimed by creditors from Debtor’s estate.)
In a separate, earlier order, the reorganization court had
denied the car-owning railroads’ petition for immediate pay-
ment of their per diem claims. Jn re Boston and Maine Corp.,
quehanna & Western R.R., 332 1.C.C. 176 (1968), the per diem
charges sought by Petitioners for that period totalled
$1,385,108.42. Of this total, $763,196.56 is due the B&O;
Maryan and $196,537.06 is due the Western
By the decision below, appellants other than Petitioners were
denied such a classification as would assure payment in full of their
$7.2 million dollars of per diem claims.
* In part II of its opinion, which Petitioners do not question, the
Court of Appeals reversed in part the decision of the District Court
by determining that a separate class of creditors, with priority
suant to Section 77(b) of the former y Act, be
created for ‘‘six months” claims, including per diem charges and
other interline balances, widdls Nacnced tah glx mind period
preceding filing of the reorganization petition if they meet certain
tests.
7.
4
456 F. Supp. 412 (D. Mass. 1978). The Court of Appeals for
the First Circuit upheld that decision, 600 F.2d 307 (1st Cir.
1979) (“‘the immediate payment case’’).
When in its opinion below the Court of Appeals subsequent-
ly decided the appeal of the classification order, it adopted
the holdings in its earl’er immediate payment decision as
dispositive of statutory questions concerning the low priority
assigned to all per diem claims except six months claims. —
F.2d at —, (A7). In effect, by its 1980 decision, the First Cir-
cuit decided that a priority for per diem claims which would
assure eventual payment is not to be accorded for the same
reasons it had given a year earlier in denying immediate pay-
ment of per diem claims. It also decided that low priority for
per diem claims did not constitute an unconstitutional taking
of property from the car-owning railroads without just com-
pensation. — F.2d at —, (A7-A11).
The background of the present controversy is the history of
per diem charges and the law concerning their level and
method of payment. On November 15, 1977, Petitioners and
Respondents entered into a stipulation concerning this
history and also agreed about certain aspects of its relation to
the legal history of per diem charges, thus limiting by agree-
ment the issues presented to the courts below. A brief sum-
mary follows.
In the early days of railroading when a freight car reached
the end of the line which owned it, the goods were removed
from the car and reloaded in the car of the connecting
railroad. This gradually gave way to the more efficient
method of interchanging the car itself. Car lending eventual-
ly became mandatory when the ICC in 1911 ruled that a rail-
road could not refuse to permit its cars to pass onto the rails
of a connecting railroad.
The amount to be paid by one railroad for the use of the car
of another, the per diem rate, came to be determined contrac-
tually by the railroads in an cement signed by the
members of the organization which was the predecessor of
the Association of American Railroads (the AAR). The con-
tract included procedures for changing the rates from time to
time. Boston and Maine R.R. v. United States, 162 F. Supp.
289, 291 (D. Mass. 1958).
5
An elaborate set of rules established by the AAR for settl-
ing per diem interline payments was given the force of law
when in 1930 the ICC decided that all railroads must make
car hire settlements in accordance with the per diem rules of
the AAR, Rules for Car-Hire Settlement, 160 DLC. 369, 165
I.C.C. 495 (1930).5
In issuing that order, the ICC also issued its mandate that
“this order shall continue until further order of the Commis-
sion.”” The Supreme Court struck down certain portions of
the order but left the balance intact in Chicago, Rock Island
and Pacific Ry. v. United States, 284 U.S. 80 (1931). This ICC
order has never been revoked and was outstanding during all
periods in question.
The per diem rules require that car hire reports be for-
warded from the car-using railroad to the car-owning rail-
road by the 10th day of the second month following that in
which the car is used (‘‘the forty day rule’’). Thus, if a car is
used in January, it must be reported by March 10th (Rule
11.1 (a)). The rules require that settlement of amounts accru-
ing for the use of cars shall be made monthly without regard
to reclaims pending (Rule 12). These rules have been appli-
— throughout the dispute among railroads as to the level
)
Many years before any dispute began between these par-
ties, Congress had, as part of the Interstate Commerce Act,
enacted the ESCH Car Service Act, 40 Stat. 101, which, as
amended by Transportation Act of 1920 (41 Stat. 456, 476)
became 49 U.S.C. §1, Par. (10) through Par. (17). It imposed
on every carrier subject to the Interstate Commerce Act the
duty to establish and enforce just and reasonable rules and
practices concerning car service, and declared every such un-
reasonable rule, regulation, or practice unlawful. At this
point, therefore, the per diem rates had a basis that was both
re ganas (the AAR Agreement) and statutory (49 U.S.C.
1).
‘The long dispute over the level of per diem charges be-
tween car-lending railroads, including the Petitioners, and
5 This case will hereinafter be referred to as the Per Diem Rules
case.
|
6
the Boston & Maine, together with other car-borrowing
railroads, in 1953 when the AAR decided to raise the
:
|
:
Maine R.R. v. United States, 162 F. Supp. 289, 292 (D. Mass.
sat te: i aati hey scar erste bo oe
with the ICC, alleging that the lesser charges which
ants had offered to pay were unjust, unreasonable, and non-
compensatory in violation of those paragraphs of Section 1 of
the Interstate Commerce Act which impose the duty on the
carriers to charge only what is reasonable and which declare
unreasonable charges to be unlawful. The car-owning roads
chose not to invoke Section 1(14Xa), which allows the ICC to
fix the charges. The complaint sought an order requiring all
railroads to pay the rates set by the AAR. It was the defend-
ants in that case, the Boston & Maine and the New Haven,
who by their answer asked the ICC to fix the lawful rate. The
ICC in Chicago, Burlington & Quincy R.R. v. New York, Sus-
quehanna & Western R.R., 297 1.C.C. 291 (1955) held that the
AAR per diem rates were not higher than was reasonable and
ordered all railroads to observe them. The Boston & Maine
sought judicial review of the ICC’s order in a three-judge
federal district court for the District of Massachusetts; Peti-
tioners were parties in the case. The court, in Boston and
Maine R.K. v. United States, 162 F. Supp. 289 (D. Mass.
1958), first found that Section 1(11) of the Interstate Com-
merce Act reruired just and reasonable levels of per diem and
that the ICC had wer to award damages for past or
present unreasonable . The court went on to hold that
the ICC had given inadequate consideration to fac-
tors in determining the fairness of the rate and the
matter to the ICC for further proceedings. An appea! was
<< v. United States, 358 U.S.
1 .
In response to the remand of the three-judge Court, the
ICC reopened the 1955 case and consolidated it with two
cases instituted under Section 1(14\Xa) of the Interstate Com-
merce Act. The proceedings before the ICC consumed a
decade, during which the Boston & Maine ccntinued to pay
7
Petitioners at pre-1953 rates. During this period, the Boston
& Maine and the Petitioners settled accounts at the scheduled
intervals set by the per diem rules, but the Boston & Maine
submitted its reports at the pre-1953 per diem figure, the
petitioning railroads drew drafts at the figures so reported
and, in addition, submitted statements setting forth the dif-
ference.
The Petitioners, along with other car-owning roads, acted
in a timely and diligent manner to preserve their rights while
awaiting the ICC’s decision. The C&O, on August 1, 1959, en-
tered into an agreement with the Boston & Maine in which
the latter agreed not to plead the statute of limitations until
90 days after final resolution (including court review) of the
per diem cas¢s before the ICC. The B&O and the Western
Maryland, in 1961, along with many other railroads, brought
suit in federal district court in the Southern District of New
York to recover per diem charges according to AAR agree-
ments. Baltimore & Ohio R.R. v. New York, New Haven &
Hartford R.R., 196 F. Supp. 724 (S.D. N.Y. 1961).®
* The court in that case did not rely on the contractual basis for
the rates but on the statutory requirement that the rates be ‘‘just
and reasonable”’ rates.
Although the suit was brought to recover per diem pur-
suant to the AAR Agreements, the court found that the defendants
had withdrawn from the AAR Agreement, 196 F. Supp. at 735, and
denied summary judgment based on contract. The court cited the
ESCH Car Service Act for the carrier’s duty to establish and en-
force just and reasonable rules and practices and the ICC’s role in
establishing and policing such rules. 196 F. Supp. at 728.
The court noted that under the contracts, both parties had the
right to invoke ICC jurisdiction and both had done so, the plaintiffs
by petition to the ICC to declare the rate of $2.40 reasonable;
defendants by answer, petitioning the ICC to find that rate
unreasonable and to fix a fair rate. 196 F. Supp. at 724. The court
found that the effective withdrawal from the agreement did not
mean defendants could “continue to use plaintiffs’ cars without
paying a reasonable rate’’(emphasis supplied), 196 F. Supp. at 735.
As to eighty-eight plaintiffs, including Petitioners the and
the Western Maryland, the court ordered partial judgment in
their favor as to liability and declared they were entitled to recover
per diem charges based on a rate to be found just, fair, reasonable,
8
When on January 17, 1968, the ICC finally issued its report
and order in the pending cases, Chicago Burlington Quincy
R.R. v. New York Susquehanna & Western R.R., 332 1.C.C.
176 (1968),’ it did two things:
1. It fixed® past rates by stating a series of rates which
it found to be fair and reasonable from 1953 to 1965 and
by setting a formula to determine rates from 1965 to
1969, and |
2. It fixed for the future new rates which included a
mileage factor for car use beginning August 1, 1969.
Following the ICC’s decision, the Boston & Maine (and the
New Haven) returned to the federal district court in the
District of Massachusetts seeking to enjoin and annul the
report and order of the ICC. The original case in that court
was reopened and consolidated with the new case. The three-
judge district court considered both the ICC’s action in fixing
specific rates for the past and in setting forth a system to
determine future rates. It sustained both aspects of the deci-
sion. The decision was upheld by the Supreme Court per
curiam on November 10, 1969. Rehearing was denied on
January 12, 1970. Boston and Maine R.R. v. United States,
297 F. Supp. 615 (D. Mass.), affirmed, 396 U.S. 27
and non-discriminatory by the ICC, of which the ICC was to advise
the court, for each month beginning with August, 1953, to be com-
puted with interest. Entry of a final money judgment in favor of all
plaintiffs, however, was stayed pending determination by the ICC
of the per diem rate controversy then pending.
It is incorrect to view as merely contractual the obligation of the
Boston & Maine to pay reasonable charges for the use of cars prior
to the effective date of the rates prescribed for the future in the
ICC’s decision in Chicago Burlington & Quincy R.R. v. New York,
Susquehanna & Western R.R., 332 1.C.C. 176 (1968). In the B&O
case, the court was concerned with what was fair and reasonable in
terms of cost to the railroad conferring the benefit (the statutory
test) rather than the value to the party benefited (the quantum
merit measure).
7 This case will hereinafter be referred to as the Per Diem Rate
case.
8 This is Judge Woodbury’s characterization in Boston and Maine
R.R. v. United States, 297 F. Supp. 615, 617 (D. Mass. 1969), a/-
firmed, 396 U.S. 27 (1969).
9
(1969), reh. denied, 396 U.S. 1030 (1970). The petition ror
reorganization of the Boston & Maine was filed two months
later.
When the petition for reorganization of the Boston &
Maine was filed in the District of Massachusetts on March 12,
1970, and the affairs of the Debtor first fell within the ex-
clusive jurisdiction of the reorganization court, the situation
was as follows: the Boston & Maine owed the B&O, the C&O
and the Western Maryland over $1,300,000 of per diem
charges; the ICC had set the rates by which these amounts
were calculated; the three-judge federal district court for the
District of Massachusetts had upheld the ICC’s decision; the
Supreme Court had affirmed; rehearing had been denied, and
the matter was ripe for the parties to go back into court in the
Southern District of New York for entry of an order com-
pleting the partial judgment in favor of Petitioners the B&O
and the Western Maryland (and other railroads) which the
court had entered on June 15, 1962. Petitioners would have
done so were it not for the exclusivity of the reorganization
court’s jurisdiction and its Order No. 2, dated March 18,
1970, enjoining the prosecution of all litigation in other
courts.
® In the context of a response to the referrals of the district
courts of Massachusetts and the Southern District of New York as
to those charges for car use prior to August, 1969, and in the con-
text of a prospective decree with respect to those charges for car
use after August 1, 1969.
10
Reasons for Granting the Writ of Certiorari.
I. WHEN FEDERAL LAW REQUIRES RAILROADS TO LEND FREIGHT
Cars TO OTHER RAILROADS AND THE RATE OF COMPENSATION
FOR Car Loans Is Set witHout TAKING INTO ACCOUNT THE
Risk OF NON-PAYMENT IN THE EVENT OF BANKRUPTCY OF THE
BoRROWER, A CLASSIFICATION AMONG CREDITORS SUFFICIENT
To ASSURE PAYMENT Must BE ACCORDED TO THE CAR-LENDING
RAILROAD IN THE REORGANIZATION OF THE CAR-BORROWING
RAILROAD IN ORDER TO AVOID AN UNCONSTITUTIONAL TAKING.
A. Federal Law Required Petitioners, Car-Owning Rail-
roads, to Lend Their Cars to the Respondent Debtor at
Rates which Had the Force of Law.
Since 1911, railroads have been required to interchange
cars and no railroad may refuse to lend its cars to another
railroad. Missouri & Illinois Coal Co. v. Illinois Central
R.R., 22 1.C.C. 39 (1911). This duty derives from §1, pars. (4),
(10) and (11) of the Interstate Commerce Act. Carriers are
praymatically powerless to prevent a car received by a con-
necting road being further interlined to a more distant road.
During the period for which Petitioners seek payment of per
diem charges, the loan of any per diem car was for an in-
definite period. United States v. Allegheny-Ludlum Steel
Corp., 406 U.S. 742, 745 (1972).%°
The car-owning roads did not voluntarily lend their cars
nor could they control the duration of the loan. It is the man-
datory nature of the car loans for which per diem claims are
made that distinguishes per diem claims from all other debts
treated by the reorganization court.
The Interstate Commerce Act provided not only for man-
datory car loan but also for the corresponding duty of car-
hire settlement, i.e., full and prompt reimbursement, Section
1, pars. (4), (5), (10) and (11). In 19380, in the Per Diem Rules
10 The validation of incentive per diem rates in Allegheny-Ludlum
eventually gave car-borrowing roads an economic incentive for
prompt car return, but even today the car-owning roads exercise
no direct control over car loans. During the periods for which Peti-
tioners seek per diem charges, the per diem rates did not include
any incentive element.
11
case, the ICC determined that per diem settlements must be
made at AAR rates, unless the ICC otherwise determined a
just and reasonable rate.
The courts have concurred in the ICC’s interpretation of
the Interstate Commerce Act and have emphasized that the
obligation to pay per diem charges and the entitlement to
receive them have the force of law. ‘“There is not and cannot
be any question that every railroad is entitled to be paid fair
and just compensation for the use of its freight cars by
another road.” Boston & Maine R.R. v. United States, 162 F.
Supp. 289, 295 (D. Mass. 1958). ‘The obligations imposed and
the benefits to be received [under the 1930 ICC order in the
Per Diem Rules case] are intended to be reciprocal, and put
subscribers and nonsubscribers [to the AAR agreement] upon
terms of equality.’’ Chicago, Rock Island, & Pacific Ry. v.
United States, 284 U.S. 80, 92 (1931).
B. The Per Diem Rates Were Intended to Compensate Car-
Lending Railroads for Costs of Ownership and Did Not
Provide Any Profit.
The ICC has interpreted the Interstate Commerce Act re-
quirement that railroads compensate each other for the man-
datory lending of cars by saying:
The owner of a car, required to release possession
thereof to another carrier . . ., may not be deprived of its
use without compensation. On the other hand, the car-
rier obtaining the use of the car is required to accept
possession for the purpose of continuing the transporta-
tion, and may not be required to pay therefor more than
the average cost it would have incurred as owner of the
car or by use of its own car. The two requirements can-
not be met except by calculation of the average owner-
ship burden based upon costs, measured with such ac-
curacy as is reasonably possible and distributed among
the car users and owners in a manner which can be found
most equitable to all .... [T]he “compensation” men-
tioned in section 1(14Xa) of the Act relating to “‘basic’’
per diem does not include any element of profit to the
owner of the car ....
Per Diem Rates case, 332 I.C.C. 176, 186 (1968). “It has long
been generally recognized that car hire, however established,
- =
12
should be enough reasonably to compensate the car owner for
its costs of ownership and no more.” Boston & Maine R.R. v.
United States, 162 F. Supp. 289, 295 (D. Mass. 1958) (three-
judge court). ,
The purpose of the compensatory level of per diem charges
and the prompt settlement rules is to enable American
railroad companies to operate their connecting lines so that
“they will constitute one national system.” Missouri and
Illinois Coal Co. v. IUinois Central R.R., 22 1.C.C. 39 (1911).
The list of cost elements to be included in the calculation of
the per diem rate has been generally agreed upon by the
courts and the ICC. Chicago, Rock Island & Pacific Ry. v.
United States, 284 U.S. 80, 97 (1931) (interest, depreciation,
insurance, taxes and other car-ownership costs); Boston &
Maine R.R. v. United States, 162 F. Supp. 289, 295 (D. Mass.
1958) (per diem should be enough, but no more than enough,
. cover the cost to the car owner of 1) repairs, 2) taxes, 3)
depreciation, 4) interest on investment, and 5) miscellaneous
expenses of ownership); Per Diem Rates case, 332 I.C.C. 176,
255 & 257-8 (1968) (repair and maintenance, taxes, and
capital investment); Chicago, Burlington & Quincy R.R. v.
New York, Susquehanna & Western R.R., 297 1.C.C. 291, 297
(1955) (noting that the McCrea Commission in 1910 adopted
the principle that the per diem charge should cover repairs,
taxes, depreciation, interest on investment, and
miscellaneous expense incidental to ownership. “This princi-
ple has been generally accepted as valid ever since ....”’);
Per Diem Rules case, 160 I1.C.C. 369, 378 (1930) (per diem to
reflect the average cost to the owner of freight car ownership
and maintenance, and embraces cost of repairs, taxes,
replacements, miscellaneous expenses, and interest on the in-
vestment). In none of the ICC or court cases has the risk of
non-payment ever been determined to be a cost element used in
formulating per diem rates.
C. Petitioners, Car-Lending Railroads, Diligenily Pursued
Their Per Diem Claims Against the Boston & Maine, But
Its Bankruptcy Prevented Collection.
The legal history recounted in the Statement of the Case
(pp. 2-9, supra) reveals that Petitioners, while continuing
13
to comply with the mandate of §1, par. (11) of the Interstate
Commerce Act to lend cars, promptly acted to enforce their
statutory right to receive just and reasonable compensation
for their cars. The complaint in the first ICC proceeding was
filed September 21, 1953, within two months of the Boston &
Maine’s notice that it would not pay the AAR $2.40 rate.
Petitioner the B&O was one of the complainants and the
Boston & Maine was named as a defendant. 297 I.C.C. at
292.11 Immediately upon the ICC’s entry of an order in that
case, the Boston and Maine sought to have the order set
aside; Petitioners contested that action as well (p. 6, supra).
The remand by the three-judge court to the ICC, some five
years after the initiation of legal action to recover the portion
of per diem rates which the Boston and Maine refused to pay,
confronted Petitioners with the prospect of further collection
delays. Petitioners again acted promptly and diligently to
preserve their rights, the C&O by obtaining a statute of
limitations waiver (p. 7, supra), the B&O and the Western
Maryland by bringing suit against the Boston & Maine (and
the New Haven) in the Scuthern District of New York. In
that case, where Petitioners the B&O and the Western
Maryland received partial judgment, the court said of the
litigation, then eight years old, “{Ijn fairness to plaintiffs
[who included the B&O and the Western Maryland, Peti-
tioners here], we cannot overlook the fact that, while they
were pursuing their remedy before the Commission in good
faith ... defendants’ shifting position before the Commission
lias resulted in much delay and wasted effort to the financial
detriment of plaintiffs whose cars the defendants continue to
use ....”’ Baltimore & Ohio R.R. v. New York, New Haven &
Hartford R.R., 196 F. Supp. 724, 739 (S.D. N.Y. 1961).
11 On the day when the complaint was filed, payment of the per
diem charge for the first car borrowed by the Boston & Maine after
its August 1, 1953 announcement that it would not pay the $2.40
rate would not yet have become due. Only what Justice Frank-
furter has called ‘the 20/20 vision of hindsight’’ makes believable
that seventeen years, three months and twenty-two days would be
ro before the course of litigation then commenced was con-
cluded.
|
14
The course pursued by the Boston & Maine in ceasing to
pay just and reasonable per diem and engaging in marathon
itigation to stave off legitimate collection efforts by the car-
owning roads frustrated the workings of the car interchange
and necessarily weakened the financial position of the car-
owning roads because it denied them current payments for
current expenses. This practice of underpayment, eventually
found by the ICC to violate the requirement of just,
reasonable and non-discriminatory rates, continued
throughout a period when there was a national railroad car
shortage. United States v. Allegheny-Ludlum Steel Corp., 406
U.S. 742 (1972); United States v. Florida East Coast Ry., 410
U.S. 224, 230 (1973); Investigation of Adequacy of Car
Ownership, 323 1.C.C. 48 (1974).
Allowing the postponement of prompt collection of per
diem charges through litigation to become non-payment
through the assignment by the bankruptcy court of last-
creditor priority to “ie ecoermag per diem claims
amounts to a taking of the property of the car-owning roads
in favor of other creditors, thus weakening the remaining
railroads at a time when railroads are of increasing impor-
tance to the nation.
D. Without Inclusion of the Risk of Non-Payment among the
Cost Elements Used to Calculate the Per Diem Rate, Priori-
ty for Per Diem Claims Which Will Assure Eventual Full
Payment Is Constitutionally Required; Otherwise the Car-
Lenders’ Property Will Have ig wah Taken without Just
Compensation.
The decision below acknowledged that the extension of
credit implicit in the loan of equipment was mandatory, and
then proceeded as though an dane rates included a factor for
bad debts, equating per diem with ordinary commercial
debts. The court says, for example, that ‘failure to accord a
special priority in reorganization to per diem claims ... is
. a refusal ... to confer on per diem charges the special
advantage of freedom from one commercial risk, the risk of
becoming an unsecured claim in reorganization.”’ It also says:
Bad debt losses of the car-owning railroads in rail reor-
ganizations are simply elements of cost incident to the
es
15
massive system of interchanging freight cars, and unless
the system as a whole is shown to burden the car-owning
railroads unreasonably or arbitrarily or to deny them
overall reasonable compensation for the mandated loan
of — cars, there is no transgression of constitutional
right.
— F.2d at —, (All). The critical difference of per diem
charges from ordinary commercial charges is that commer-
cial creditors can set their prices to allow for the element of
cost represented by the risk of non-payment. Because the bad
debt element is a cost, but not one considered in determining
the per diem rates, pp. 11-12, supra, the decision below is
wrong in concluding that failure to accord priority to Peti-
tioners and other car-lending railroads does not take their
property without just compensation.
The twin assumptions on which per diem rates are founded
are that 1) per diem charges will be collected promptly in full,
and 2) they will be paid in all events. The railroads are neither
financial risk-takers nor profit makers in their car service
relationships as structured by the ICC, but involuntary
lenders who are to be invariably reimbursed for current
costs. To charge the Petitioners and other car-lending roads
with the cost of risks (no profit allowed as compensation for
taking them) is to flout the assumptions on which the per
diem system is predicated. To inflict on railroads not yet
bankrupt costs artificially postponed by roads on the verge of
bankruptcy until they were in reorganization subverts the
statutory purpose of just and reasonable compensation and
results in an unconstitutional taking.
The only risks which the per diem rate is set to include are
the risks that obsolete cars will not be used and that an over-
supply of cars will exist, recognized in the car-day divisor fac-
tor. See the Per Diem Rules case, 160 I.C.C. 369, 378 & 444
(1930) and the Per Diem Rates case, 332 I.C.C. 176, 226-30
(1968). Use of the car-day divisor assures that these costs of
car ownership will be s proportionally by car users.
There would be no need for a separate classification in bank-
ruptcy for per diem claims if contemporaneous payment for
the use of cars were universally observed or if the per diem
rate included an adequate facter for the cost of bad debts.
7%
16
Without car-lenders being able to stop car loans for non-
ayment of compensatory per diem charges and without a
bad debt factor, a classification sufficient to assure payment
of per diem claims is a constitutional necessity.
E. The Decision below Conflicts with Decisions of This Court
on the Taking of Property without Just Compensation.
The decision below that Petitioners’ claims may be so
classified as not to result in compensation at the statuto
just and reasonable rate for the Boston & Maine’s use of Peti-
tioners’ freight cars from 1953 through 1969 does not accord
with decisions of this Court concerning the Fifth Amendment
requirement that private property not be taken without just
compensation.
In Kaiser Aetna v. United States, 444 U.S. 164 (1979), a
compensable taking was found in a decision that a pond had
become a navigational water of the United States because
creation of a public right of access impaired the owners’
“right to exclude,” a property interest which the government
cannot take without compensation. There are other
resemblances of this case to Kaiser Aetna: first, the economic
impact of the regulation, see n.3, supra, 444 U.S. at 169 &
175; second, the interference with reasonable investment-
backed expectations fostered by ICC decisions and orders but
subverted by the decision below, id. at 175 & 179; and third,
the forced loan of cars without payment as a physical inva-
sion hp rty, id. at 180.”
Denial o signin f to per diem claims, given the statutory re-
quirement to lend cars, effects a taking of car-owning rail-
roads’ property because it gives a right of access to cars with-
out a corresponding obligation to pay. If car-lending roads
12 Three justices of this Court, in their dissenting opinion in
Kaiser Aetna, 444 U.S. 164, 180 (1979), noted the voluntary and
for-profit character of the Kuapa Pond developer’s actions (and
therefore, presumably, the foreseeability of effects of the
pond’s becoming navigable waters with public access). Here Peti-
tioners did not act voluntarily in lending their cars to the Boston &
Maine and recognition should be given to the governmentally com-
pelled character of acts for which the decision below would deprive
them of compensation.
17
were ordinary private owners free of statutory compulsion to
lend their cars, they would not have permitted the Boston &
Maine car use at below-cost rates. The combined effect of a
requirement to lend cars, a per diem rate set without con-
sideration of the risk of non-payment, and status as an or-
dinary unsecured creditor in reorganization'® is that the
government has transferred from car-owning railroads to
car-borrowing railroads a significant portion of the value of
car loans for the years 1953 to 1969. The impact of such a loss
on Petitioners, which remain among the principal car-
supplying railroads of the nation, is substantial. And under
the combination of compulsory car-lending and the denial
below of a creditor classification adequate to pay per diem
claims in full, car-lending railroads like Petitioners could not
avoid the loss.
Two earlier decisions of this Court about railroads further
buttress the analysis of low classification of per diem claims
as a taking without just compensation. Chicago, Rock Island
& Pacific Ry. v. United States, 284 U.S. 80 (1931) and
Chicago, Milwaukee & St. Paul R.R. v. Wisconsin, 238 U.S.
491 (1915).
In Chicago, Rock Island, two aspects of the ICC order in
the Per Diem Rules case were held to be unconstitutional as
taking the property of car-lending roads. These were the pro-
visions that granted the short lines two days free time for in-
terchanged loaded cars and relieved the short lines from any
car-hire charges whatsoever for coal cars received for return
loading with coal. 284 U.S. at 96, 98. The court held that con-
fiscation may result from the taking of the use of property
without compensation as well as from the taking of title. Al
regulation permitting the free use of property in the face o
an express finding that the owner is entitled to compensation
for such use cannot be regarded otherwise than as poh
and unreasonable.” Jd. at 97. If the short lines have insuf-
18 For at least $1,313,758.51 of the Petitioners’ total per diem
claims of $1,385,108.42.
The stipulation below separately states Petitioners’ claims from
August 1, 1969 through 12, 1970 as $71,322.91. The six
months’ claims (for the period tember 12, 1969 to March 12,
1970) would form the of the $71,322.91.
7s
_
18
ficient profits, said the court, that cannot be remedied ‘“‘by
confiscating for their benefit the use of cars of other
railroads.” Jd. at 97.
For the same reason, the financial ill health of the Boston &
Maine may not be remedied by affording it seventeen years’
use of cars at a less than compensatory rate. The decision
below treating per diem claims other than six months claims
as garden-variety unsecured debts penalizes the car-owning
roads for years of lawfully abiding by car-hire rules, and un-
justly enriches the secured creditors of the Boston & Maine
from the proceeds of the Boston & Maine’s noncompliance
with ICC orders applicable to aii railroads by their seventeen-
year failure to pay Petitioners just and reasonable car-hire.'4
See pp. 10-11, supra, pp. 25-27, infra.
The Boston & Maine had neither regulatory nor judicial
permission for paying a per diem rate of $2.00, a rate the ICC
ultimately found not to be just and reasonable compensation.
It is an affront to the regulatory compliance manifested by
Petitioners to hold that the appropriation of the value of Peti-
tioners’ cars by the Boston & Mame is not a taking. Compare
Chicago, Milwaukee & St. Paul R.R. v. Wisconsin, 238 U.S.
491 (1915) in which so minimal an intrusion as a state statute
forbidding an unused upper berth to be let down if the lower
berth is occupied as a limitation on the railroads’ free use
(and management of the use) of their property was held to be
a taking. It is precisely the limited management discretion
about its valuable property imposed by compulsory car-
lending in conjunction with last-place classification among
creditors which warrants reversal of Part I of the opinion
below. See also Delaware, Lackawanna v. Board of Public
Utilities, 85 N.J. L. 28 (1918) (requirement that railroad fur-
nish free transportation for state officials is an unconstitu-
tional taking).
14 On its face, the amount of Debtor’s per diem accounts with
Petitioners, n.3 supra, is signi t. The Seventh Circuit recog-
nized the precarious financial condition of many of the nation’s rail-
roads when it pointed out the ill effects of allowing railroads in re-
organization to shift Pe Ro gg vera per diem expense to car-
owning roads. In re Chicago, Rock Island and Pacific R.R., 537
F.2d 906 (7th Cir. 1976), cert. denied sub nom. Gibbons v. Atchison,
Topeka & Santa Fe Ry., 429 U.S. 1092 (1977).
19
\
No factor which might exclude Petitioners’ loss from the
category of a taking appears here. No “‘spillover” effects on
existing public interests were caused by Petitioners which
would justify non-compensation for the taking. See Sax, Tak-
ings, Private Property and Public Rights, 81 Yale L.J. 149
(1971); Sax, Takings and the Police Power, 74 Yale L.J. 36
(1964). Indeed, Petitioners were Lar aay to share their prop-
erty with a financially-troubled during an extended
riod for below-cost rates, thereby providing the public
nefit of continued operation of that . Alternate
uses of their cars which would have offered profits to Peti-
tioners were not possible. Compare Penn Central Transpor-
tation Co. v. City of New York, 438 U.S. 104 (1978).
Petitioners have lost ‘‘one of the most essential sticks in the
bundle of rights that are commonly characterized as property
—the right to exclude others,’”’ Kaiser Aetna v. United States,
444 U.S. 164, 176 (1979), and have now been denied compen-
sation for that loss. The result is to extinguish a fundamental
attribute of. property ownership and to frustrate the
statutorily-protected expectation of compensatory la goa
for involuntary car loan. They have been prevented from
choosing the best use of their property, see Agins v. City of
Tiburon, 447 U.S. 255, 262 (June 10, 1980). Other creditors
of the Boston & Maine, for no economically rational reason,
have become the beneficiaries of a denial of compensation to
Petitioners for their investment in cars throughout the period
of a national car sho . United States v. Allegheny-
Ludlum Steel Corp., 406 U.S. 742 (1972).
F. The Constitutional Issue Will Also Be Presented
Under the New Bankruptcy Act.
In 1978 when Congress passed the new Bankruptcy Act, 11
U.S.C. §§101 et seq., it provided that any ICC order which
would require the expenditure of funds from the bankrupt
estate would not be effective unless the court approved it. 11
U.S.C. §1166. In railroad reorganizations begun on or after
October 1, 1979, the a court would therefore
have discretion to provide for prompt — of pre-
reorganization per diem claims or to deny payment
altogether of pre-reorganization or even current per diem
7%
20
charges if the court decided debtor’s circumstances and equi-
ty among creditors required it.
Because discretion not to pay ICC-ordered per diem claims
is granted by §1166, the new act presents the prospect of the
same constitutional questions on takings being raised by per
diem claimants in reorganizations as are presented here. If
railroads compelled to furnish car service are denied payment
of per diem claims by courts supervising railroads in
reorganization under the new act, they—like Petitioners—
will have been deprived of the use and value of their property
without compensation therefor.
The Petitioners’ case therefore poses an important con-
stitutional issue which is likely to recur.
II. Tais Court’s REVIEW OF THE First Circurt’s DENIAL OF A
CLASSIFICATION SUFFICIENT TO ASSURE PAYMENT TO Ral_-
ROAD PER DieM CLAIMANTS IN A RAILROAD REORGANIZATION Is
NECESSARY TO AVOID FRUSTRATION OF NATIONAL TRANSPOR-
TATION POLICY AND TO RESOLVE THE CONFLICT BETWEEN THE
FIRST AND SEVENTH CIRCUITS.
A. The Decision below Conflicts with
Seventh Circuit Decisions.
The interpretation of the Bankruptcy Act and the In-
terstate Commerce Act made by the First Circuit below in
the Boston & Maine classification of creditors case differs
markedly from that made by the Seventh Circuit in decidi
In re Chicago, Rock Island and Pacific R.R., 537 F.2d 906
(7th Cir. 1976), cert. denied sub nom. Gibbons v. Atchison,
Topeka and Santa Fe Ry., 429 U.S. 1092 (1977) (Rock Island)
and In re Chicago, Milwaukee, St. Paul & Pacific R.R., 632
F.2d 45 (7th Cir. Oct. 16, 1980) (Milwaukee).** First Cir-
‘* Neither the First Circuit nor the Seventh Circuit view their
decisions as in conflict with the Third Circuit decisions
r diem claims against the Penn Central, In re Penn
Transportation Co, 486 F.2d 519 (3d Cir. 1973), cert. denied sub
nom. v. Indiana Harbor Belt R.R., 415 U.S. 990 (1974) (Penn
Central I) and In re Penn Central Transportation Co., 553 F.2d 12
(3d Cir. 1977) (Penn Central IT). The seventh Circuit, while denying
a conflict in reasoning or result with the Penn Central decisions,
21
cuit considered the bankruptcy goal of unified control over a
railroad debtor’s financial affairs more important than
transportation goals, whereas the Seventh Circuit held that
the requirements of transportation law superseded the
reorganization court’s authority.
The courts in the two circuits arrived at opposite results for
comparable issues. The per diem claims against the Boston &
Maine and against the Rock Island included both pre-
reorganization car use due befor. reorganization and ad
reorganization car use due during the reorganization.!® The
Seventh Circuit held that the trustees of the Rock Island
were required to defer to ICC authority by paying immediate-
537 F.2d at 913, recognized that its conclusion in Rock Island
“departs to some extent from the holding of the Third Circuit.” Jd.
at 912. The Third Circuit in Penn Central IT noted that all drafts
for payment of per diem accounts | ae pe prior to conveyance of
the Penn Central’s properties to ConRail had be zn paid, 553 F.2d
at 16, and distinguished post-conveyance per diem claims on the
basis of the termination of ICC authority upon conveyance to Con-
Rail which occurs under Section 601(b\4) of the Rail Act, 45 U.S.C.
§791(bX4). 553 F.2d at 15. The First Circuit, while finding per-
suasive the Third Circuit rationale for denying immediate payment
of per diem, admitted that the Penn Central cases were not in point
below because the Penn Central’s assets, unlike those of the
Boston & Maine, had been conveyed to ConRail. 600 F.2d at 311.
See — F.2d at —, (A7).
16 The Rock Island petition was filed March 17, 1975. At issue
were per diem claims for car use in January, February and March
of 1975, due respectively on March 10 (pre-petition), April 10 and
a 10 (post-petition). The court required all to be paid.
e Boston & Maine petition was filed March 12, 1970. At issue
were $8.6 million of per diem claims for car use from August of
1953 to January of 1970, all due pre-petition, and the claims for car
use in February and March of 1970, due respectively on April 10
and May 10 of 1970 (post-petition).
The Penn Central decisions were not comparable. In refusing
— of pre-reorganization claims due post-petition in its en
c decision in Penn Central I, 486 F.2d 519, the court’s attention
was not directed to ICC per diem rules and rates decisions. In its
subsequent panel decision in Penn Central IT, 553 F.2d 12, it held
that it could not overrule the earlier en banc decision, and con-
sideration of the administrative law of car service was therefore
not required. Jd. at 15, 17.
3
22
ly both categories of claims. The First Circuit allowed the
reorganization court to control the timing of payment and
classification of both. :
The Seventh Circuit fully disposed of per diem claims in a
single decision by granting them immediate — The
First Circuit required two decisions to complete the disposi-
tion of per diem claims: in June of 1979, it denied the car-
owning railroads’ demand for immediate payment of per
diem claims, 600 F.2d 307; in October of 1980, it decided that
the reorganization court could assign bottom-level classifica-
tion among creditors to per diem claimants.!”
In Milwaukee, the Seventh Circuit said its Rock Island deci-
sion “resolved a conflict of statutory authority” between the
two statutes “‘in favor of the power granted to the Interstate
Commerce Commission.” 632 F.2d at 45. It “held that a reor-
ganization court is without power to exempt a railroad from
compliance with the order of the Commission requiring
priority of payment of —— accrued to pre-reorganization
per diem accounts.” 632 F.2d at 47, characterizing Rock
Island. The Seventh Circuit distinguished per diem charges
from ordinary debts. Payment of per diem charges is re-
quired by ICC orders and represents statutorily required
cost-sharing cial pag to the car-owning roads; it must
be uniformly observed to achieve the national transportation
goals of equitable cost-sharing among railroads and adequate
national car supply. 537 F.2d at 911-912.
The courts in the First Circuit have explicitly repudiated
the Rock Island rule, both in the district court decision below,
468 F. Supp. at 1000, and in the Court of Appeals’ immediate
payment decision, 600 F.2d at 312. The Court of Appeals
ed the Seventh Circuit’s holding that the trustees of the
Rock Island were to pay pre-reorganization per diem claims
“‘a misconception about bankruptcy reorganization.” Id. at
312. It did not view ICC orders as limiting the reorganization
court’s discretion, id. at 313, because it interpreted the Per
Diem case as not fixing rates, and the Per Diem Rate case as
not being an exercise of the full ICC jurisdiction, 600 F.2d at
17 In the interim the court regarded the possibility of a priority
for per diem claims as still open. See In re Boston & Maine Corp.,
618 F.2d 137, 140 & 141 (1st Cir. Mar. 13, 1980).
|
23
309. It characterized the ICC’s action as “only ... a general
order applicable to all railroads.” 600 F.2d at 312. The opin-
ion below applied the reasoning of the per diem immediate
ae 27 i decision to the present classification case. — F.2d at
—, ( 7).
The Seventh Circuit viewed transportation policy as the
paramount consideration. Its concern for the unique situation
of railroad per diem claimants is manifested in its view of per
diem claimants as having a relation to railroads in reorganiza-
tion which resembles copartnership more than creditor-
debtor,!® of the ICC’s orders as compulsory, and of the
trustees’ obligation to rectify the pre-reorganization per diem
noncompliance prior to adopting a reorganization plan. To
the Seventh Circuit, payment of per diem claims (albeit a
monetary transaction) serves such an important function in
the overall car service regulatory scheme which links
railroads’ shared car use with uniformly enforced shared
financing, that it very properly regarded payment of per
diem charges as part of the operation of the railroad’s
business within the meaning of Section 77(c), 11 U.S.C.
§205(c). The Seventh Circuit decisions thereby fulfilled the
Congressional purpose of seeing that transportation policy is
not disturbed by treating railroads in reorganization dif-
ferently from solvent roads. See Palmer v. Massachusetts,
308 U.S. 79, 87 (1939); 76 Cong. Rec. 5358 (March 1, 1933)
(remarks of Rep. LaGuardia).
The First Circuit viewed unified control over all of the rail-
road debtor’s monetary transactions as the paramount goal
and was willing to read ICC orders and decisions very nar-
rowly in order to allow the reorganization court discretion
unfettered by ICC car service regulation. For the First Cir-
cuit, the monetary aspect of the per diem payments obscured
their function as an instrur-ent of federal planning for the
18 Even the Third Circuit tr gi short of equating the per diem
claimant’s status with that of an ordinary creditor merely
found the debtor-per diem claimant relationship to be “‘closer to
that of debtor-creditor than that of trustee-beneficiary.’”’ 486 F.2d
at 529.
This unique relationship must be given a conclusion commen-
surate with its beginnings.
7%
7%
24
nation’s rail car supply. It treated per diem claims as though
they were ordinary debts.
As Judge Adams suggested, concurring in Penn Central II,
the best application of both the Bankruptcy Act and the In-
terstate Commerce Act to per diem claims cases is one which
addresses the “practical problems confronting the railroad
industry today” in light of Congressional expressions of con-
cern ‘‘with the establishment and maintenance of a viable na-
tional rail system.” 486 F.2d at 531. Such an approach was
not taken below. The First Circuit opinion in the 1979 im-
mediate payment case reasoned that pre-reorganization per
diem claims should not be immediately paid because it
thought that even a direct ICC order should not override the
reorganization court’s discretion to defer pre-reorganization
per diem claims, given doubts about the ability of the debtor
to sustain an immediate multi-million dollar charge and still
continue to service the public. 600 F.2d at 312-313. However,
the laconic incorporation by reference below of the reasoning
in the 1979 decision to support the rather different decision
to affirm a last-place classification for per diem claimants, —
F.2d at —, (A7), lacked the thoughtful analysis of transporta-
tion consequences which the Seventh Circuit gave in Rock
Island and Milwaukee. It also ignored the fact that the ability
of the debtor to sustain the charge was not an issue in the
context of the classification of creditors.
Immediate payment might have adversely affected the
financial success of the reorganization, the viability of the
debtor railroad as an operating concern, the estate’s cash
flow, and the size of the total payment to be made to all
creditors. The classification decision is quite different; it is a
matter of allocating the burden of the debtor’s insolvency
among the several creditors. The question is which of the
creditors shall receive how much. Petitioning railroads
should not, in view of Congressional concern for fair cost-
sharing by the nation’s railways,!® be required to suffer seri-
ous financial losses as bottom-priority creditors while non-
railroad creditors benefit. The 1980 First Circuit decision be-
19 The National Transportation Policy, 54 Stat. 899, 49 U.S.C.
preceding §1.
25
low does not serve reorganization goals such as debtor stabili-
ty. The deferred payment allowed by the 1979 decision is not
inconsistent with assignment to per diem claims of a
classification sufficient to assure their eventual payment.
The conflict between the circuits begun by Rock Island and
the First Circuit’s immediate payment decision in 1979 is
perpetuated by the decision below and Milwaukee. This con-
tinued conflict necessitates review by this Court to resolve
the different interpretations of federal law by the First and
Seventh Circuits.
B. Railroad Per Diem Claimants’ Differences from Other
Creditors Justify Creation of a Separate Classification for
Their Claims.
The Bankruptcy Act requires the trustees of the Boston &
Maine to operate its business subject to the ICC’s jurisdic-
tion. When on March 12, 1970, the Boston & Maine filed its
petition for reorganization, Section 77(c) of the sernaeigo grid
Act,?° expressly provided that the trustees’ operation of the
railroad was subject to all orders of the ICC concerning
railroads:
The ... Trustees ... shall have ... subject to the con-
trol of the judge and the jurisdiction of the Commission
as provided by the Interstate Commerce Act ... the
power to operate the business of a debtor.
11 U.S.C. §205(c).
The Bankruptcy Act also provides in Section 77(cX7) that
the division of creditors ‘‘shall not provide separate classifica-
tion unless there be substantial differences in priorities,
claims, or interests.”” 11 U.S.C. §205(cX7). Per diem claims
differ substantially from ordinary debts, pp. 10-12, supra,
and under bankruptcy law alone there would be a rational
and equitable basis for differentiating them from other debts
20 Of the Bankruptcy Act of 1898, as amended, c.541, 30 Stat.
544, former 11 U.S.C. §205. On November 6, 1978 the Bankruptcy
Act of 1978 was enacted. Under Title IV of that Act (‘‘Transition’’),
railroad reorganizations like the Boston & Maine’s are governed by
former law, whereas railroad reorganizations filed October 1, 1979
or thereafter are governed by the new law. Pub. L. 95-598, Title I,
§401 .a), 92 Stat. 2549.
> Y
7%
26
because car loans are compulsory and per diem rates provide
no profits, pp. 10-12, supra.
Fairness and equity are the essence of a Section 77 pro-
ceeding. New Haven Inclusion Cases, 399 U.S. 392, 448
(1970). How to apply the statutory requirement that a plan of
railroad reorganization be fair and equitable in a given case
must depend on the unique facts of that case. Here the statu-
tory and regulatory assurance of payment for the mandatory
loan of cars used in revenue-producing service by the Boston
& Maine ys ye that compensatory payment be assured
regardless of intervening bankruptcy. The requirement in
the Bankruptcy Act of fairness here coincides with the re-
quirement of deference to ICC jurisdiction. Both require that
the dictates of car service law that payment for mandatory
car loans be equally mandatory must be carried out here.
The Interstate Commerce Act requirement of just and rea-
sonable compensation for car-hire is intended to spread the
cost of freight cars proportionately among all railroads, in-
cluding financially troubled and bankrupt roads. The ICC
made this clear when it was specifically asked to grant, and
refused, exceptions to the incentive per diem rates for less
solvent roads:
[TJhe position of the bankrupt and marginal railroads
had no merit because they sought, in effect, to require
the car-owning railroads to subsidize them ... [E]x-
—— these latter railroads would be added pressure
on non-bankrupt debit lines ....
Incentive Per Diem Charges—1968, 349 1.C.C. 303, 327
(1975). The ICC quoted with approval from the decision vy
the Administrative Law Judge:
“‘We now come to the bankrupt and marginal railroads
who seek exclusion because of their financial difficulty.
These carriers are part of the national system of rail-
roads and their obligation to provide shipping is not dif-
ferent from that of other companies .... The cir-
cumstances of the financially needy roads cannot be at-
tributed to the car-owning railr and it would be in-
equitable to require the car-owning railroads to subsidize
carriers who are in financial distress. Moreover, exempt-
ing these carriers from paying I.P.D. [incentive per
27
diem] would substantially increase the burden placed
upon the remaining debit I.P.D. lines.”’
349 I.C.C. at 328. Given the ICC’s conclusion that the public
interest in the continued financial health of the car-owning
lines required bankrupt and marginal carriers to pay full in-
centive per diem, the exemption of suck carriers from pay-
ment of any portion whatsoever of basic per diem would have
an even more damaging and unfai effect on Petitioners and
other car-owning railroads.
The duty to furnish cars and the requirement of prompt
and full payment for car service are two halves of a single
regulatory plan intended to provide fairly for the railroads’
joint burden of financing the national car fleet. To recognize
one while abrogating the other, as the decision below did, is
like substituting half a scissors or half a pair of tongs for the
whole tool.
Petitioners submit that the Rock Island view that trustees
of a bankrupt railroad are required to pay all of the railroad’s
outstanding per diem balances is the only interpretation of
the statutes which fairly disposes of their claims. The
deference to ICC jurisdiction required of the reorganization
court in Section 77(c) for the purpose of achieving uniform
application of transportation law to solvent and insolvent
railroads alike and also the fairness requirement of bankrupt-
cy law are violated by assigning per diem claims to the lowest
class of creditors’ claims.
C. A Priority Which Will Assure Payment in Full of Per
Diem Claims of Car-Owning Railroads Is Necessary to
Fulfill the Purposes of Car Service Law.
If per diem obligations of the Boston & Maine unpaid prior
to reorganization can be relieved of their compulsory
character and converted to ordinary unsecured claims by the
filing of the petition, the Boston & Maine will have shifted to
Petitioners a portion of their costs in contravention of the
ICC’s decision that even insolvent and marginal roads must
pay their fair share of freight car costs. The long period dur-
ing which the Boston & Maine was not in compliance with the
prompt and full payment requirement increased the unpaid
per diem claims of Petitioners while postponing the insol-
7%
7%
28
vency of the Boston & Maine. The necessary consequence for
Petitioners was an impairment of their incentive and ability
to buy new cars because they were not being fully reimbursed
for the cost of cars they already owned.
Petitioners have paid more than their fair share of the cost
of the national fleet of railroad freight cars and the Boston &
Maine has paid less. This disproportionate burdening of Peti-
tioners violates the Interstate Commerce Act.
D.T he Important National Interest in the Continuing
Financial Health of Railroads Furnishing Cars for the Na-
tional Pool Requires a Priority in Bankruptcy Which Will
ely Eventual Payment of Outstanding Per Diem
neces.
In summarizing the ICC’s position before it in Rock Island,
the Seventh Circuit noted that
deferred payment of per diem accounts will undermine a
finely balanced regulatory scheme, force other railroads
(some of which are themselves financially troubled) to
subsidize the Rock Island’s operations, and exacerbate
an already severe national rail car shortage.
537 F.2d at 910. If in the view of the expert agency, deferred
payment would have such effects, a fortiori, low classifica-
tion (and the consequent severe decrease in the amount of per
diem claims which Petitioners are likely to recover) would
financially weaken Petitioners and other affected railroads at
a time when Congress is funding railroad revitalization.”
E. The Rule Articulated below Will Have Adverse
Consequences for the Nation’s Rail System.
The prospect of losing substantial portions of shared car
financing from railroads which refuse to pay (or under the
new Bankruptcy Act from courts denying interline pay-
ments) and, in particular, Petitioners’ loss of substantial
21 Railroad Revitalization and tory Reform Act of 1976,
Pub. L. 94-210, 90 Stat. 31, 45 U.S.C. §§801-854. The railroads are
critically important to rt whatever coal will be used in the
nation’s energy future. See Stobaugh and Yergin, Energy Future,
87-91 (1979).
=>
29
sums endanger the financial stability of car-owning railroads.
While Congressional thinking as articulated in §1166 may
have changed future law, retroactive application of §1166 is
specifically prohibited by Congress.?2 The Interstate Com-
merce Act as interpreted by the ICC was the law applicable
during the period of Petitioners’ claims; that law represented
a Congressional decision to encourage an adequate car supply
and to allocate costs fairly among car-using railroads. The
domino effects of making railroad per diem creditors the last
creditors to be paid in railroad reorganizations were not in-
tended by that law.
Conclusion.
For all the reasons advanced above, a writ of certiorari
should issue to review the judgment and opinion of the Court
of Appeals for the First Circuit.
DATED: January 15, 1981
JOHN T. COLLINS, COUNSEL OF RECORD,
PAULA BONNELL,
SHERBURNE, POWERS & NEEDHAM,
One Beacon Street,
Boston, Massachusetts 02108.
(617) 523-2700
Attorneys for Petitioners
Chesapeake and Ohio Railway Company,
Baltimore and Ohio Railroad Company,
and Western Maryland Railway
22 Cases commenced under the former Act are, under the new
Act, to be governed throughout by the terms of the former Act.
Such cases include Rock Island, Milwaukee, and Boston & Maine.
The Seventh Circuit had made its Rock Island per diem decision be-
fore the enactment of the new act. In §1166 Congress chose not to
require future acquiescence by reorganization courts to ICC orders
as the Seventh Circuit had done, but it did allow courts the option
of permitting priority payment of per diem claims in future reor-
ganizations. Furthermore, Congress chose to leave standing the
prospective effects of Rock Island on reorganizations such as this
one which were begun at any time between November 6, 1978 and
October 1, 1979.
Al
Appendix A.
United States Court of Appeals
For the First Circuit
No. 79-1230
IN RE
BOSTON AND MAINE CORPORATION,
DEBTOR,
CHESAPEAKE AND OHIO RAILWAY COMPANY, ET AL.,
APPELLANTS.
No. 79-1231
IN RE
BOSTON AND MAINE CORPORATION,
DEBTOR,
MAINE CENTRAL RAILROAD COMPANY, ET AL.,
APPELLANTS.
No. 79-1234
IN RE
BOSTON AND MAINE CORPORATION,
DEBTOR,
PENN CENTRAL CORPORATION,
APPELLANT.
No. 79-1235
IN RE
BOSTON AND MAINE CORPORATION,
DEBTOR,
CANADIAN PACIFIC,
APPELLANT.
7%
A2
No. 79-1236
IN RE.
BOSTON AND MAINE CORPORATION,
DEBTOR,
EASTERN ASSOCIATED COAL CORPORATION,
APPELLANT.
APPEALS FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. Frank J. Murray, Judge]
Before
Kunzic,* Judge, U.S. Court of Claims
Bownss, Circuit Judge
Doouinc,** Senior District Judge
Entered October 6, 1980
John T. Collins, with whom Sherburne, Powers & Needham was
on brief, for Chesapeake and Ohio Railway Company, Baltimore
and Ohio Railway Company and Western Maryland Railway, ap-
pellants.
Paul B. Galvani, with whom Reed Witherby and Ropes & Gray
were on brief, for Maine Central Railroad Company and Portland
Terminal Company, Appellants.
George W. McLaughlin for Canadian Pacific, appellant.
Philip Burling, with whom Peter A. Fine and Foley, Hoag & Eliot
were on brief, for Eastern Associated Coal Corporation, appellant.
Robert M. Gargill, with whom Zdislaw W. Wieckowski, Choate,
Hall & Stewart, and Charles W. Mulcahy were on brief, for the
Trustees of the Boston and Maine Corporation, Debtor, appellees.
Joseph H.B. Edward, with whom Bingham, Dana & Gould was
on brief, for the First National Bank of Boston and Malcolm W. Hall
Successor Trustees, under First Mortgage Indenture Dated
December 1, 1919 of Boston and Maine Corporation, appellees.
‘ eo designation.
ei Eastern District of New York, sitting by designation.
A3
Doouine, D.J.
The present appeals' in this railroad reorganization case
challenge the district court's order, 468 F. Supp. 996 (D. Mass.
1979), determining the priorities of the creditors and
stockholders in the reorganization of the Boston and Maine
Corporation. Railroads which, as required by the Interstate
Commerce Act and the cases decided under it, have interlined
freight cars with the Boston & Maine appeal from the district
court’s refusal to accord their claims for per diem charges for
cars furnished in the periods August 1, 1953, to July 31, 1969,
and August 1, 1969, to March 12, 1970, such a priority in the
classification of creditors as would assure full payment of the
claims. The interlining railroads and Eastern Associated Coal
Corporation appeal also from the district court’s refusal to
establish a separate class of creditors, to be accorded priority
as “six months creditors,” for the railroads’ claims for per diem
car hire, car repair, loss and damage, and freight overcharges
for the six months preceding the filing of the involuntary peti-
tion against the Boston and Maine on March 12, 1970, and for
the Coal Corporation’s claim for diesel fuel furnished in the
same six months period.
' The appeals of the Committee of Interline Railroads and of
Trailer Train Co. have been withdrawn. No briefs have been sub-
mitted in support of the appeals of Penn Central Transportation
Company and Atchison, Topeka and Sante Fe Ry. The appeals of
the Chesapeake and Ohio Railway Company, et al., and of Cana-
dian Pacific present the issues concerning the classification of the per
diem claims of the interlining railroads for the period August 1,
1953, through July 31, 1969, as well as of the railroads’ claims for
per diem car hire, car repairs and loss and damage for the six months
preceding the date on which the involuntary petition was filed
against the Boston and Maine. The appeals of Maine Central
Railroad Company and Portland Terminal Company and of Eastern
Associated Coal Corporation relate to the classification of claims for
per diern car hire, freight loss and damage and overcharge, car
repairs, and diesel fuel for the six months preceding the filing of the
petition.
7%
A4
I
The railroads’ per diem claims, aggregating $8,582,000, are
described in Chief Judge Coffin’s opinion for this court, 600
F.2d 307 (1st Cir. 1979), affirming the district court's refusal,
456 F. Supp. 412 (D. Mass. 1978), to order immediate pay-
ment of the per diem charges before payment of all other
unsecured pre-reorganization claims.? On that appeal this
court rejected the contention that because the trustees’ opera-
tion of the Boston and Maine is subject to the jurisdiction of
the Interstate Commerce Commission, see former Bankruptcy
Act § 77(c)(2), 11 U.S.C. § 205(c)(2) (1976), and because the
ICC has ordered payment of specific per diem rates at specific
settlement times, neither the trustees nor the court have discre-
tion to defer payment of the pre-petition per diem charges.
600 F.2d at 308. This court concluded that the ICC had not
exercised its statutory power, 49 U.S.C. § 1(14)(a) (1976), to
fix the rates for per ‘liem settlements for the period August 1,
1953, to August 1, 1969, and that, so far as concerned the
period after August 1, 1969, following the ICC’s entry of a per
diem rate order, the general power of the ICC to supervise the
trustees’ operation of the railroad did not outweigh the fun-
damental power of the reorganization court to set priorities for
payment of pre-reorganization claims, Bankruptcy Act
§§ 77(b), (c)(7), (I), and to schedule payment of such claims
consistent with the need to conserve assets for rehabilitation of
the debtor. 600 F.2d at 309-10. The court added that the 1968
ICC order that interlining railroads pay specific per diem
charges, Chicago, B. & Q. R.R. v. New York, S. & W. R.R.,
332 1.C.C. 176, 241, 333 (1968), was an order of general ap-
plication, and that, since non-payment of the per diem claims
violated no specific order directed to the reorganization
trustees, the remedial provisions of Section 1(17)(a) of the
* The district court decision recounts the sequence of proceedings
leading to the ICC’s fixing of per diem rates in 1968. See 456 F.
Supp. at 413 n.2.
A5
Interstate Commerce Act* could not be invoked. 600 F.2d at
312. The court observed that, fundamentally, the specific duty
to pay the per diem charges due for the pre-reorganization
period had been a duty of the railroad, and, after the filing of
the petition, those charges became claims against the debtor,
not claims against the trustees; the specific duty of the trustees,
as operators of the railroad, to pay per diems was limited to
the per diems incurred by the trustees in their operation of the
road.‘ The court rejected the contrary reasoning of In re
Chicago, R.I. & P.R.R., 537 F.2d 906 (7th Cir. 1976), cert.
denied, 429 U.S. 1092 (1977), and indicated agreement with
the result reached in In re Penn Central Transportation Co..,
486 F.2d 519 (3rd Cir. 1973), cert. denied, 415 U.S. 990
(1974), and which the Third Circuit reaffirmed in the dif-
ferent circumstances of In re Penn Central Transportation
Co., 553 F.2d 12 (3rd Cir. 1977). See 600 F.2d at 310-12.
On this appeal the interlining railroads argue, first, that
since the interlining of freight cars is mandatory under the In-
terstate Commerce Act, 49 U.S.C. §§ 1(4), (10), (11), (14),
(15), and (17), equity and considerations of national transpor-
tation policy unite to require that the roads receive just and
reasonable compensation for the compelled loan of freight
?19 U.S.C. § 1(17)(a) provides that if “any carrier, receiver, or
operating trustee” fails or refuses to comply with any order or direc-
tion of the ICC as to car service it shall be liable to stated
recoverable in a civil action brought by the United States. Citations
are to the Interstate Commerce Act, as amended, 49 U.S.C. § 1, et
seq. (1976). Parallel sections respecting car service are now
comprised in 49 U.S.C. § 11121, et seq.
* The court found in the terms of the Bankruptcy Reform Act
provision, 11 U.S.C. § 1166, a resolution of any supposed contradic-
tion between Section 77(c)(2) and Section 77 (1) in the requirement
that both the ICC and the reorganization court approve eee Renee
for both pre- and post-reorganization per diem charges. Con-
gress in adopting Section 1166 rejected a Senate provision requiring
So dihecs te ave be ca ceded Nelnaes onedi otier eamaetnne
terlining charges, including incentive per diems, for periods both
before and after the filing of the petition.
A6
cars; it is argued that the rail car fleet cannot be maintained at
the level essential to adequate rail service unless payment of
car hire is assured even in the case of the railroads that are in
reorganization. The argument is essentially that made on the
earlier appeal, and, so far as concerns the per diem claims for
the period 1953 to August 1, 1969, is disposed of by what was
then decided: the per diem claims for that sixteen year period
were not based on an ICC order fixing rates and ordering pay-
ment at those rates; the ICC in Chicago, B. & Q.R.R. v. New
York, S. & W.R.R., 332 1.C.C. 176, 183, 244-57 (1968),° did,
indeed, make findings as to the reasonableness of the rates
charged for the preceding fifteen years, but those findings, it
stated, were “of significance only as an aid to the courts in set-
tling the amount of damages in the pending lawsuits” (id. at
183).°
The unpaid per diem charges for car use during the period
August 1, 1969, to March 12, 1970, the date on which the
reorganization proceeding commenced, aggregated $564,000;
they were imposed at the rate determined by the order of the
ICC, Chicago, B. & Q. R.R. v. New York, S. & W. R.R.,
supra, 332 1.C.C. at 259: that order became final upon the
Supreme Court’s affirmance of the district court decisions
5 The background and course of the litigation are outlined in the
district court’s decision in the “immediate payment” case, In re
Boston & Maine Corp., 456 F. Supp. at 413 n.2.
*In the suit to recover from the Boston & Maine and other
railroads the difference between the amounts paid and the higher
charges fixed by the Association of American Railroads, the district
court deferred to the ICC’s determination of the reasonableness of
the AAR rates. Baltimore & O. R.R. v. N.Y., N.H. & H. R.R. Co.,
196 F. Supp. 724, 748-49 (S.D.N.Y. 1961). The ICC decision,
Chicago, B. & Q. R.R. v. New York, S.GW. R.R., 332 1.C.C. 176
(1968), fixing rates for the period commencing October 1, 1968, and
making findings on the reasonableness of the rates for the 1953-1968
, was sustained, Boston & M. R.R. v. United States, 297 F.
Supp. 615 (D. Mass.), and Union Pacific R.R. v. United States, 300
F. Supp. 318 (D. Neb.), both aff'd., without opinion, 396 U.S. 27
(1969).
7.
AT7
dismissing the railroads’ actions to set the order aside,’ and it
was made effective August 1, 1969. This court’s decision on
the earlier appeal is dispositive of all the contentions raised on
the present appeal as to this portion of the per diem claims ex-
cept the constitutional argument. While Chief Judge Coffin’s
opinion was occasioned by the “immediate payment” conten-
tion of the railroads, it dealt directly and necessarily with the
underlying issues of statutory interpretation and with the con-
tention that a priority in reorganization for per diem claims
would, by furnishing to the railroads an incentive for over-
coming the chronic shortage of freight cars, better serve the in-
terest of national transportation policy than would denying
the priority in the interest of preserving the public service
viability of bankrupt roads.
The railroads argue, on the constitutional issue, that since
Congress has mandated the interline loan of cars and the ICC
has fixed the per diem rates to be paid for the cars lent, deny-
ing to the car-owning railroads such a priority as will assure
payment of the per diem claims in reorganization effects a tak-
ing of their property without due process of law, an un-
constitutional taking akin to that found in Chicago, R.I., & P.
Ry. v. United States, 284 U.S. 80, 96-100 (1931); there a
divided court invalidated that part of the ICC order in Rules
for Car-hire Settlement, 160 1.C.C. 369, 386-395, 445 (1930),
that granted to the short line railroads two days of free time
for interchanged loaded cars and denied compensation
altogether in the case of cars received for return loading with
coal from mines customarily dependent upon connecting car-
riers for car supply. The Court put the decision on the ground
that, since the ICC had found that the owning roads were en-
titled to receive reasonable compensation in the form of a daily
rental for the use of their general-service freight cars when on
foreign lines, and that the $1 per car day charge then in effect
was such reasonable compensation, the ICC could not,
” See note 6.
7%
A8 —
without inconsistency, relieve one class of railroads of the duty
to pay that reasonable compensation: “The use of railroad pro-
perty is subject to public regulation, but a regulation which is
so arbitrary and unreasonable as to become an infringement
upon the right of ownership constitutes a violation of the due
process of law clause of the Fifth Amendment.” 284 U.S. at
or"
The rule, thus condemned by its very terms, effected at least
a partial denial of compensation for car use in every instance
of an interchange of cars between trunk line and short line.
However, the failure to accord a special priority in reorganiza-
tion to per diem claims neither denies an entitlement nor takes
either property or its use without compensation. It is rather a
refusal, on a ground of statutory policy, to confer on per diem
charges the special advantage of freedom from one commer-
cial risk, the risk of becoming an unsecured claim in
reorganization. Whatever might be the case if interchange of
cars was enforced in circumstances in which there was
certainty of non-payment, it is not the case that a scheme of
regulation that effects an appropriate public purpose may not,
without violation of constitutional principle, entail random
losses due to extrinsic factors. See Baltimore & O. R.R. v.
United States, 345 U.S. 146, 148 (1953) (carload rates
on certain kinds of fresh vegetables not violative of due process
merely because they are noncompensatory; so long as regula-
tions do not cause railroad to lose money on its overall business
“it is hard to think that it could successfully charge
® The railroads also cite Chicago, M. & St. P.R.R. v. Wisconsin,
238 U.S. 491 (1915), in which the Court invalidated a Wisconsin
law which provided that whenever a person engaged a lower berth
in a sleeping car and the upper berth in the same section was neither
engaged nor occupied, the upper berth should not be let down but
should remain closed until engaged or occupied. The divided court
held that the statute was not a reasonable exercise of state police
power but a taking of property without compensation. The statute,
like the short line rule, mandated a transfer of a value without com-
pensation in money or justifying social value.
A9
that its property was being taken for public use without just
compensation”);® Indiana Harbor Belt R.R. v. United States,
510 F.2d 644, 650 (7th Cir.) (ICC order requiring belt line to
move empty cars to repair shops without charge not an un-
constitutional taking of property without just compensation
absent a showing as to belt line’s overall operations), cert.
denied, 422 U.S. 1042 (1975); Western Air Lines, Inc. v. CAB,
495 F.2d 145, 152-153 (D.C. Cir. 1974) (Board’s denial
of operating certificate to carrier that sought to operate
only over profitable routes justified by consideration that
supra-competitive profits of a single carrier already serving the
route would enable it to undertake unprofitable local service
that required such subsidization).
The railroads’ contention must be considered strictly in
terms of the necessary impact of the rules for car-hire settle-
ment in the case of per diem claims against railroads in
reorganization. But no extension of credit to insolvent
railroads is inherent in the rules for car-hire settlement; the
Commission in Rules for Car-hire Settlement, supra,’
approved the rule of the “car service and per diem agreement”
among the subscribing railroads which required that the car
owner be furnished with a per diem statement within forty
days after the end of each calendar month giving the number
of days each car has been in the possession of the reporting
road; the Commission noted that customarily the car owner,
upon receipt of that information, drew on the using line for
the amount reported after deducting per diems, if any, owed
® Government of Guam v. FMC, 329 F.2d 251, 254 (D.C. Cir.
1964), and Pan American World Airways, Inc. v. CAB, 256 F.2d
711 (D.C. Cir. 1958), reach the same result on parallel facts.
Government of Guam spoke of the result as deriving from “the com-
pelling obligation of the carrier to render public service.”
'© An order giving effect to the findings of Rules for Car-hire Set-
tlement was entered in Rules for Car-hire Settlement, 165 1.C.C.
495 (1930), aff'd in part, reversed in part, Chicago, R.1. & P. Ry. v.
United States, 284 U.S. 80 (1931).
5%
— Ald
the other carrier. The accumulation of charges beyond the
forty days was the product of the interminable controversy
over rates, not a necessary consequence of interlining freight
cars; the modest credit term implicit in the car-hire settlement
rules could hardly be much shortened, and, given the impor-
tance of interchanging cars to the owning railroads’ earning of
freight revenue, the credit risk involved is not different from
that generally incident to the conduct of industrial and com-
mercial business. That some per diems of such short date may
go unpaid in some railroad reorganjzations, and that the loan
of cars is required by law, do not combine to show a taking
without just compensation. What must be shown to
demonstrate unconstitutionality, and is not shown, is that the
regulatory scheme as a whole, not excluding the incidence of
the loss in reorganization cases arising from the extensions of
credit required by the settlement rules, operates to take the
property of the car-owning roads without just compensation,
or is so unreasonable or arbitrary that it violates due process.
The interline car-service rules and practices have evolved
pragmatically in reasoned stages with but one only partly suc-
cessful constitutional challenge (Chicago, R.I. & P. Ry. v.
United States, supra) from the beginning position that a
railroad could refuse to send its cars beyond its line when there
was a car shortage since its first duty was to the business of its
line, Riddle, Dean & Co. v. Pittsburgh & Lake Erie R.R., 1
I.C.C. 374, 388 (1888); through the critical decision that local
traffic does not enjoy rights superior to through traffic and
that carriers must make reasonable rules and regulations with
respect to the operation of through routes and the exchange,
interchange and return of cars used on these routes, Missouri
¢ Illinois Coal Co. vy. Illinois Central R.R., 22 1.C.C. 39,
48-49 (1911); to the later comprehensive ICC review and im-
plementation of general car service standards in Rules for Car-
hire Settlement, supra, and the succession of ICC orders
of more recent years. In Chicago, B. & Q. R.R. v.
All
New York, S. & W. R.R., 332 1.C.C. 176 (1968),'! the Com-
mission, accepting the concept that car hire should be enough
reasonably to compensate the owner for its costs of ownership
and no more,'* concluded that per diem charges should con-
stitute no more than a sharing of cost, and should not include
any amount for the value of the use of a car. Id. at 186-87.'°
Bad debt losses of the car-owning railroads in rail
reorganizations are simply elements of cost incident to the
massive system of interchanging freight cars, and unless the
system as a whole is shown to burden the car-owning railroads
unreasonably or arbitrarily or to deny them overall reasonable
compensation for the mandated loan of their cars, there is no
transgression of constitutional right. No such showing was at-
tempted, nor is it suggested that it could be made.
II
The claims for which priority is asserted under the “Six
Months Rule” do not exceed $3,000,000 and include per diems
for the period commencing September 13, 1969; priority is also
claimed for the greater part of the same claims under the
“Necessity of Payment” rule, but for some $400,000 of claims
priority is sought under the Necessity of Payment rule only.
'! For the history of the ICC decision see note 6, supra.
'2 Boston & Maine R.R. v. United States, 162 F. Supp. 289, 295
o. Mass.), appeal dismissed, 358 U.S. 68 (1958), is to the same ef-
ect.
'3 More recent decisions have sustained further ICC action respec-
ting interchange of cars. United States v. Allegheny-Ludlum Steel
Corp., 406 U.S. 742 (1972), approved as reasonable under Section
1(14)(a) two car service rules promulgated in 1969 by the Commis-
sion which required freight cars, after being unloaded, to be
returned in the direction of the lines of the road owning the cars.
The Court, reviewing the car service history of the railroads, said
that, “The freight cars of the Nation thus became in essence a com-
mon pool, used by all roads.” Jd. at 743. And in Ann Arbor R.R. v.
United States, 368 F. Supp. 101, 112-13 (E.D. Pa. 1973), aff'd
without opinion, 419 U.S. 807 (1974), the courts sustained the Com-
mission's incentive per diem rules under the 1966 amendment to Sec-
tion 1(14)(a).
.
Al2
The district court held that to establish a priority under the Six
Months Rule the creditor had to show that its claim was for a
necessarily incurred current operating expense of the railroad,
that it accrued within the six months preceding the filing of
the reorganization petition, and that the goods or services
were furnished in the expectation of payment from current
railway operating revenues and not in reliance on the
railroad’s general credit, 468 F. Supp. at 1002. The court held
further that the creditor had to show that there existed a fund
in which qualifying six months claims would have a priority,
that is, a “current debt (or expense) fund” comprised of cur-
rent earnings of the six months period and during the
reorganization or, absent a surplus of such earnings, corpus of
the reorganization estate to the extent that such earnings have
been diverted to it for the benefit of the railroad’s
mortgagees.'* Id, at 1002-1005. The court concluded from the
evidence that, treating depreciation as properly deductible in
determining the amount of surplus earnings available for a
“current debt fund,” no surplus revenues had accrued either in
the six months preceding the filing of the reorganization peti-
tion or during the reorganization proceeding; that, in addi-
tion, contributions to railway operating income and to the
reduction of railway operating expenses had been made from
the proceeds of sales of mortgaged property and from sales of
scrap derived from mortgaged property; and that, finally,
even if the net railway operating deficit for the relevant
period, $42.5 million, were reduced by disallowing capital ex-
penditures for property and improvements of $12.9 million,
payments of pre-reorganization secured obligations of $5.6
4 The district court held that Six Months Rule creditors were not
entitled to a priority in unmortgaged assets; the court declined to
follow dicta indicating a contrary assumption in In re New York,
N.H. & H. R.R., 278 F. Supp. 592, 598 (D. Conn. 1967), aff'd, 405
F.2d 50 (2d Cir. " 1968), cert. ; tenia 394 U.S. 999 (1969), and in In
re Penn Central Transp. Co., 458 F. Supp. 1234, 1321 n. 81 (E.D.
Pa. 1978). 468 F. Supp. at 1007-08.
A13
million, and estimated six months claims of $3 million, there
would remain a net railway operating deficit of $21 million
and an adjusted deficit in income available for fixed charges of
$11.7 million. Id. at 1005-07. The district court rejected the
claim for priority under the “Necessity of Payment” rule on the
ground that the rule was not one of priority but of payment,
and that it is inapplicable where, as in the present case, no
creditor claiming under the rule had demanded payment of its
claim as a condition to providing goods or services to the deb-
tor, and the trustees never sought ‘authority to pay the claims.
Id. at 1008.
A
The Six Months Rule was recognized but not given precision
of definition in one sentence in Section 77(b) of the
Bankruptcy Act, 11 U.S.C. § 205(b) (1976):
For all purposes of this section unsecured claims, which
would have been entitled to priority if a receiver in equity
of the property of the debtor had been appointed by a
Federal court on the day of the approval of the petition,
shall be entitled to such priority and the holders of such
claims shall be treated as a separate class or classes of
creditors.
The Six Months Rule emerged out of the practice of in-
itiating railroad receiverships with an order appointing a
receiver and authorizing or directing him to pay from
operating receipts certain expenses incurred in the period im-
mediately preceding the receivership. Thus the 1867 receiver-
ship order in Gurney v. Atlantic & Great Western Ry., 58
N.Y. 358 (1874), directed the receiver to pay and discharge out
8 When first enacted in 1933, 47 Stat. 1474, the provision ap-
peared in Section 77(c), and the first part read:
For all —— of this section claims against a railroad cor-
poration ould have been entitled to priority over ex-
isting mortgages if a receiver .
The language of the 1978 Act, 11 U.S.C. § 1171(b), is the same in
substance as that of Section T1(b ).
i
?%
Al4
of the balance of receipts, after paying the expenses of main-
taining and operating the road, arrearages owing to laborers
and employees for work in connection with the railway and
such sums as were actually due for material and supplies fur-
nished for the use of the company’s railways. No general prin-
ciple, analogous to that in admiralty, was thought to give
priority to the last creditors who furnished necessary repairs
and supplies to a railroad. Galveston, H.dH. R.R. v.
Cowdrey, 78 U.S. (11 Wall.) 459, 480-82 (1871). As the court
said in Duncan v. Mobile & O.R.R., 8 F.Cas. 17, 19 (C.C.
S.D. Ala. 1876) (No. 4,137):
The fact that the floating debt was contracted in good
faith for the benefit of the railroad company’s property,
and therefore for the benefit of the bondholders, is true of
perhaps all such debts. But that does not give the floating
debt creditors any ground upon which to claim that their
debt should be paid first.
Nevertheless, receivership orders continued to authorize pay-
ment of wage and supply claims that accrued over various
periods, ranging up to eight months before receivership. E.g.
Skiddy v. Atlantic M. & O.R.R., 22 F. Cas. 274, 279-80
(C.C.E.D. Va. 1879) (No. 12,922) (reciting terms of 1876
receivership order); Taylor v. Philadelphia & Reading Co., 7
F. 377 (C.C.E.D. Pa. 1880) (reviewing terms of several pre-
Fosdick receivership orders). On the eve of Fosdick v. Schall,
99 U.S. 235 (1879), the practice of allowing payment for
operating expenses of the pre-receivership period was stated in
broad terms in Turner v. Indianapolis, B. & W. Ry., 24 F.
Cas: 366 (C.C.D. Ind., S.D. Ill. 1878) (No. 14,258); the court
observed that generally railroads were dilapidated when
receivership started, the first receipts were used to rehabilitate
the road, and the pre-receivership claims for labor and sup-
plies were paid by later order; the court emphasized that a
railway is a matter of public concern and that public as well as
private interests require its continued operation. The court
said that its experience
Al5:
. . . has satisfied it that practically, it would be well nigh
impossible, looking at things as they actually exist, to
operate the roads by receivers without some allowance
for claims of the character mentioned, existing at the time
of their appointment, and that the limitation already
stated [i.e., to six months, by analogy to the Illinois lien
statute] is not an unreasonable one, in view of all the cir-
cumstances.
24 F.Cas. at 367. But the court in Turner thought it desirable
that the bar obtain from the Supreme Court a decision enun-
ciating some just principle that might be a guide in such cases.
Fosdick v. Schall, one of three cases argued and decided
together,’ is said to have been decided “after a general invita-
tion had been extended to the members of the bar of [the
supreme] court interested in like cases, to present briefs on the
questions arising in that case.” See Atkins v. Petersburg R.R..,
2 F.Cas. 90, 92 (C.C.E.D. Va. 1879) (No. 604).
Fosdick v. Schall rejected a conditional vendor’s claim for
“rent” of gondola cars for the six months preceding and several
months following receivership for a number of very sufficient
reasons. But the Court sought to establish a basis in principle
for the payment of certain pre-receivership claims. The Court
commenced by saying that a court, asked by a mortgagee to
appoint a receiver in a mortgage foreclosure suit
. . . in the exercise of a sound judicial discretion, may, as
a condition of issuing the necessary order, impose such
terms in reference to the payment from the income dur-
ing the receivership of outstanding debts for labor, sup-
plies, equipment, or permanent improvement of the
mortgaged property as may, under the circumstances of
the particular case, appear to be reasonable.
© The two cases argued with Fosdick v. Schall did not deal with
the Six Months Rule, but followed Fosdick v. Schall in holding that
the lien of the railroad mortgage did not extend to cars, Fosdick v.
Car Company, 99 U.S. 256 (1879), or locomotives, Huidekoper v.
Locomotive Works, 99 U.S. 258 (1879), purchased under contracts
of conditional sale.
7%
Al6
99 U.S. at 251-52.'” Noting that a railroad foreclosure case is
rarely completed without concessions by the parties from their
strict legal rights, that much of railroad business is done on
credit, and that often debts for “labor, supplies, equipment
and improvements” are deferred so that bond interest may be
paid and disastrous foreclosure postponed, the Court con-
tinued:
In this way the daily and monthly earnings, which or-
dinarily should go to pay the daily and monthly expenses,
are kept from those to whom in equity they belong, and
used to pay the mortgage debt. The income out of which
the mortgagee is to be paid is the net income obtained by
deducting from the gross earnings what is required for
necessary operating and managing expenses, proper
equipment, and useful improvements. Every railroad
mortgagee in accepting his security impliedly agrees that
the current debts made in the ordinary course of business
shall be paid from current receipts before he has any
claim upon the income. If for the convenience of the mo-
ment something is taken from what may not improperly
be called the current debt fund, and put into that which
belongs to the mortgage creditors, it certainly is not
inequitable for the court, when asked by the mortgagees
to take possession of the future income and hold it for
their benefit, to require as a condition of such an order
that what is due from the earnings to the current debt
shall be paid by the court from the future current receipts
before anything derived from that source goes to the
mortgagees.
Id. at 252-53. Saying that if the mortgagee sought the extraor-
dinary equitable relief of receivership, it had to do equity in
order to get equity, the Court continued:
~ 1 The 1875 receivership order in the Fosdick foreclosure directed
the receiver to pay all debts due for labor and services rendered
within the g three months and all debts for “engines, iron,
wood, su , cars, or other purchased within said period
of three months for the use of the company.”
Al7
We think, also, that if no such order is made when the
receiver is appointed, and it appears in the progress of the
cause that bonded interest has been paid, additional
equipment provided, or lasting and valuable im-
provements made out of earnings which ought in equity
to have been employed to keep down debts for labor, sup-
plies, and the like, it is within the power of the court to
use the income of the receivership to discharge obliga-
tions which, but for the diversion of funds, would have
been paid in the ordinary course of business. This, not
because the creditors to whom such debts are due have in
law a lien upon the mortgaged property or the income,
but because, in a sense, the officers of the company are
trustees of the earnings for the benefit of the different
classes of creditors and the stockholders; and if they give
to one class of creditors that which properly belongs to
another, the court may, upon an adjustment of the ac-
counts, so use the income which comes into its own hands
as, if practicable, to restore the parties to their original
equitable rights. While, ordinarily, this power is
confined to the appropriation of the income of the
receivership and the proceeds of moneyed assets that have
been taken from the company, cases may arise where
equity will require the use of the proceeds of the sale of
the mortgaged property in the same way. Thus it often
happens that, in the course of the administration of the
cause, the court is called upon to take income which
would otherwise be applied to the payment of old debts
for current expenses, and use it to make permanent im-
provements on the fixed property, or to buy additional
equipment. In this way the value of the mortgaged pro-
perty is not unfrequently materially
increased . . . . Under such circumstances, it is easy to
see that there may sometimes be a propriety in paying
back to the income from the proceeds of the sale
Al8
what is thus again diverted from the current debt fund in
order to increase the value of the property sold. The same
may sometimes be true in respect to expenditures before
the receivership. No fixed and inflexible rule can be laid
down for the government of the courts in all cases.
Id, at 253-54. The Court emphasized that the power to com-
pensate for diversions from the “current debt fund” rests on
the fact that mortgage creditors have “got possession” of what
in equity belongs to all or some of the general creditors:
It follows that if there has been in reality no diversion,
there can be no restoration; and that the amount of
restoration should be made to depend upon the amount
of the diversion.
Fosdick’s principle, then, is one of mortgage law: that the
mortgagee’s interest attaches to net income, which arises only
after the payment from gross earnings for all necessary
operating and managing expenses, proper equipment, and
useful improvements, and that, in consequence, to the extent
that before or during receivership bonded interest has been
paid, additional equipment provided, or lasting and valuable
improvements in the mortgaged property have been made out
of earnings which ought in equity to have been used to pay
debts for labor, supplies and the like, the receivership court
can use receivership income or, in some cases, the proceeds of
sale of the mortgaged property, to pay the debts that, but for
the diversion of funds, would have been paid in the ordinary
course of business. Hale v. Frost, 99 U.S. 389 (1879), was
decided later in the same term on the authority of Fosdick but
without discussion; it approved the payment from net income
earned during the receivership of pre-receivership claims for
repair parts to equipment and for supplies furnished to the
railroad’s machinery department. The report is silent concern-
ing any “diversion” of earnings to the advantage of the
mortgagee before or during the receivership.
Atkins v. Petersburg R.R., supra, professed reliance on
_-
Al9
Fosdick, but approved the re-payment from income of the
receivership of an advance made before receivership to pay ar-
rears of wages in order to avert a strike. There was no
reference to “diversion.” The court said that:
. . . it would be difficult to draw a distinction between
the principles under which a court authorizes a receiver
to make necessary expenses for operating a railroad and
keeping it in a safe condition, and the principles em-
bodied in the language quoted from the opinion of the
supreme court, relating to sundry expenses of the railroad
companies incurred before the appointment of
receivers . . . . It is enough for us that no court has ever
refused to issue [receiver's] certificates when it was
necessary for repairing the road or keeping it agoing as a
safe road; and if it may authorize such expenditures by a
receiver, it may pay them if they have been made by the
company before the appointment of a receiver.
2 F. Cas. at 94. And in Taylor v. Philadelphia & Reading
R.R., supra, the court similarly cited Fosdick as justifying a
broad order permitting payment from income of claims for
“labor, materials, etc., furnished for the operation of the road
within five months” preceding receivership, 7 F. at 377-78,
and as authorizing the issuance of receiver’s certificates for the
amounts involved so that the receivers could defer payment in
case they found it necessary to apply earnings to protect
valuable investments of the railroad.
Miltenberger v. Logansport, C. & S.W. Ry., 106 U.S. 286
(1882), did not cite Fosdick. The critical issues in the case
related to the circuit court’s action in authorizing substantial
capital expenditures to be incurred, in giving them priority
over the first mortgage in a suit brought to foreclose the second
mortgage on the road, and in effecting payment for the capital
expenditures through first lien receiver's certificates
authorized and sold before the first mortgagees sought to
foreclose. The Court cited only Wallace v. Loomis, 97 U.S.
i.
A20
146 (1878), the cornerstone case on receiver's certificates, and
Barton v. Barbour, 104 U.S. 126, 136 (1881), which cited
Wallace v. Loomis for the general proposition that a court of
equity may and in most cases ought to authorize the receiver to
keep the road in repair and to manage and use it in the or-
dinary way until it can be sold to the best advantage of all in-
terested. Miltenberger approved the circuit court’s order
directing immediate payment of interline claims for materials,
repairs, and ticket and freight balances, some of which had ac-
crued more than ninety days preceding the receivership, and
charging the payments upon the earnings of the road “as with
a first lien prior to all incumbrances upon” the railroad. The
Court pointed out that the receiver’s petition for the order
stated that “payment of that class of claims was indispensable
to the business of the road, and that, unless the receiver was
authorized to provide for them at once, the business of the
road would suffer great detriment.” 106 U.S. at 311.'* The
Court said:
Many circumstances may exist which may make it
necessary and indispensable to the business of the road
and the preservation of the property, for the receiver to
pay pre-existing debts of certain classes out of the earn-
ings of the receivership, or even the corpus of the
property, under the order of the court, with a priority of
lien. Yet the discretion to do so should be exercised with
'® The master who passed on the claims “disallowed several items
in the receiver's accounts, claimed under the above heads, where the
claims were made on the ground that the creditors threatened not to
furnish any more supplies on credit unless they were paid the ar-
rears.” 106 U.S. at 311. The next sentence appears to refer to the
master’s action in disallowing the claims rather than to the receiver's
action in paying them. “His action, sanctioned by the court, in
allowing items within the scope of the orders of the court ap to
have been careful, discriminating and judicious, so far as « copied
can be arrived at from the record. It cannot be affirmed that no
items which accrued before the appointment of a receiver can be
allowed in any case.” Ibid.
A21
very great care. The payment of such debts stands, prima
facie, on a different basis from the payment of claims
arising under the receivership, while it may be brought
within the principle of the latter by special cir-
cumstances. It is easy to see that the payment of unpaid
debts for operating expenses, accrued within 90 days, due
by a railroad company suddenly deprived of the control
of its property, due to operatives in its employ, whose
cessation from work simultaneously is to be deprecated,
in the interests both of the property and of the public,
and the payment of limited amounts due to other and
connecting lines of road for materials and repairs, and for
unpaid ticket and freight balances, the outcome of in-
dispensable business relations, where a stoppage of the
continuance of such business relations would be a pro-
bable result, in case of non-payment, the general conse-
quence involving largely, also, the interests and accom-
modation of travel and traffic, may well place such
payments in the category of payments to preserve the
mortgaged property in a large sense, by maintaining the
good-will and integrity of the enterprise, and entitle them
to be made a first lien.
106 U.S. at 311-12. Miltenberger is concerned, not with the
“diversion” precept of Fosdick, but with the more general
authority of the receivership court to accord priority status to
pre-receivership claims in order to prevent the stoppage of a
business impressed with the public interest. The case em-
phasizes the power of the court to effect payment of pre-
receivership claims and the validity of the means it chooses to
effect payment; the analysis is not in terms of the property in-
terest of operating expense creditors in operating revenues and
the limitation of the mortgagee’s rights to net income, but it is
in terms of paying those pre-receivership expenses that are
brought within the principle of administrative expenses by
their relation to the continuance of the railroad business.
7%
A22
The cases in the Supreme Court involving payment of pre-
receivership operating expense claims which were decided in
the twenty-odd years between Miltenberger and Gregg v.
Metropolitan Trust Co., 197 U.S. 183 (1905), preserved the
“diversion” principle expressed in Fosdick without losing sight
of the separate Miltenberger approach. Union Trust v.
Souther, 107 U.S. 591 (1883), allowed a pre-receivership
supply claim on Fosdick “diversion” grounds; but the Court
noted also that the receivership court’s “right to impose terms
does not depend alone on whether current earnings have been
used to pay the mortgage debt, principal or interest instead of
current expenses” (107 U.S. at 594), citing Miltenberger, and
it indicated that the bondholders’ election, in their own in-
terest, to leave the loss-making company in possession to
operate the road after there had been a default entitling the
mortgage bondholders to take possession justified the court’s
use of receivership income to pay the expenses of pre-
receivership operation.'* Burnham v. Bowen, 111 U.S. 776
(1884), approved the payment of claims for coal furnished for
the railroad’s locomotives in the months preceding receiver-
ship. The Court emphasized that the bondholders permitted
the company to possess and manage the road after default and
observed that the “maintenance of the road and the prosecu-
tion of its business were essential to the preservation of the
security of the bondholders.” 111 U.S. at 780. In Burnham the
order appointing the receiver did not provide for the payment
of pre-receivership operating expenses; however, the Court
held that the use of receivership income to pay fixed charges on
certain railroad structures, increasing the bondholders’ security
'° Union Trust Co. v. Walker, 107 U.S. 596 (1883), decided with
Souther, held that a purchaser of claims of “six months” creditors
could enforce the claims, not because the creditors had a lien on the
property and income but “because in equity the earnings of the com-
pany constitute a fund for the payment of the which their
ar yy. sagan diaeaae fe -ndaaieraling 8 ought to be ap-
plied to the discharge of the mortgage debt.” 107 U.S. at 596.
A23
at the expense of the labor and supply creditors, was a “diver-
sion” within Fosdick. “So far as current-expense creditors are
concerned, the court should use the income of the receivership
in the way the company would have been bound in equity and
good conscience to use it if no change in the possession had
been made.” 111 U.S. at 782. The Court in Union Trust Co. v.
Illinois Midland Ry., 117 U.S. 434 (1886), was primarily con-
cerned, as in Miltenberger, with the validity and priority of
receiver's certificates, but it affirmed the grant of priority in
the corpus of the property over the bonds for wages due for the
six months preceding receivership. 117 U.S. at 464-65. To an
objection that the order appointing the receiver provided only
for payment of current operating expenses from current in-
come the Court answered that “the terms of these orders do
not impair or exclude the ample authority which the court
would otherwise have, and otherwise has, to order the claims
in question to be paid out of the property itself, with priority.”
Id. at 465. Virginia & A. Coal Co. v. Central Railroad &
Banking Co., 170 U.S. 355 (1898), affirmed a decree directing
that a debt for locomotive coal delivered in the months
preceding receivership be paid out of the current earnings in
the hands of the receiver; the Court relied on language from
Burnham v. Bowen, supra, and Miltenberger, as expressing an
“equitable doctrine” the “dominant feature” of which was
that a “superior equity” as against the mortgage bondholders,
in income earned before and after the receiver’s appointment,
arises in favor of materialmen who furnish supplies essentially
necessary to the continued operation of the railroad in the ex-
pectation of payment from current earnings. 170 U.S. at
367-68. The Court emphasized that, independently of the ex-
istence of any pre-receivership “diversion” of income, the
equity of the coal company for payment out of income
survived into the receivership, attached to the property in the
receiver's possession, and, if a surplus of income arose in the
receivership, entitled the coal company to demand that the
->
*%
A24
surplus be applied to payment of its claim. Jd, at 369. The ex-
istence of that surplus the court found implicit in the fact that
during receivership the road’s receivers “expended for bet-
terments on its railroad lines from the income of the roads dur-
ing the receivership a sum much larger than the entire claim”
of the coal company. Id. at 367-70. Southern Ry. v. Carnegie
Steel Co., 176 U.S. 257 (1900), affirmed a decree according
priority payment for rail furnished during a period in excess of
six months preceding receivership; the Court inferred that the
rail was furnished for ordinary safe maintenance of existing
lines;2° the Court found that current receipts that should have
been applied to payment of the steel company’s claim had
been applied during the receivership for the benefit of the
bondholders by paying interest, sinking fund, and car trust
debts and for construction and equipment.
Circuit court decisions, influenced by Miltenberger, clearly
went beyond the Fosdick principle. E.g., Dow v. Memphis &
L. R.R., 20 F. 260, 267 (C.C.E.D. Ark. 1884); Blair v. St.
Louis, H. & K. R.R., 22 F. 471, 472-73 (C.C.E.D. Mo.
1884). One case, in the Fourth Circuit Court of Appeals,
in which Chief Justice Fuller wrote for the court, allowed
the payment from the proceeds of the foreclosure sale of
the road of interline claims for freight and freight balances
that accrued before the appointment of the receiver. Finance
Co. v. Charleston, C. & C. R.R., 62 F. 205 (4th Cir. 1894).
There were no surplus earnings before or during the receiver-
ship, nor had there been any diversion of income. The court
relied on the broad terms of the order appointing
* A claim for extraordinary quantities of rails furnished before
the receivership but outside the ordinary course of business, and for
construction rather than repair, was not accorded priority.
Lackawanna Iron & Coal Co. v. Farmers’ Loan & Trust Co., 176
U.S. 298, 315-16 (1900); Hale v. Frost, supra, disapproved priority
payment for pre-receivership supplies furnished to the road's con-
struction department while approving such payment for repair parts
and for supplies so furnished to the road’s machinery department.
A25
the receiver, saying that it could not be construed as limited to ’
payment out of current earnings, “especially in view of the
condition of the road.” 62 F. at 208. Emphasizing that the
payment of such debts was related to the interest in preserving
and disposing of the property as a going concern, and to the in-
terest in the road’s discharging its public duty, the court said
that
.. such indebtedness may be given priority, not-
withstanding there may have been no diversion of in-
come, or that the order for payment was not made at the
time, and as a condition, of the receiver's appointment,
the necessity and propriety of making it depending upon
the facts and circumstances of the particular case, and
the character of the claims.
62 F. at 208.
The Supreme Court did not sweep so broadly. St. Louis, A.
& T. H. R.R. v. Cleveland, C.C. & I. Ry., 125 U.S. 658
(1888), acknowledged the authority of Fosdick, but it refused
to accord priority over the mortgage to a claim for the rental of
a leased line. The Court said that the lessor would have to
show that the rent arrearage had arisen “by the diversion and
misappropriation of the fund that ought to have been applied
to its payment to the use and benefit of the mortgage bond-
holders.” 125 U.S. at 674. To the extent that the Court im-
pliedly required a showing of diversion before the receiver-
ship, it appears to be repudiated in Virginia & A. Coal Co. v.
Central Railroad & Banking Co., supra, 170 U.S. at 365, 369.
Kneeland v. American Loan & Trust Co., 136 U.S. 89 (1890),
was a case in which there were no surplus earnings before or
during the receivership, no receipts were diverted to pay mort-
gage interest or to improve the road, and the foreclosure sale
realized only a fraction of the mortgage debt; the Court held
that an unpaid conditional vendor of rolling stock, whose cars
were ordered returned to him before the foreclosure sale,
would not be granted a priority claim for the reasonable
?%
A26
rental value of the cars used during the four months of their
use by a receiver appointed upon a judgment creditor's bill,
but that such a priority would be accorded to the claims for
reasonable rent for use of the cars by a successor receiver ap-
pointed at the end of the four months upon the mortgage
trustee’s foreclosure bill. The Court was critical of “an idea”
which “seems to have obtained that a court appointing a
receiver acquires power to give such preference [that is,
preference over mortgage debts] to any general and unsecured
claims.” 136 U.S. at 97. But in the same year the Court in
Morgan’s L. & T. R.R. & S.S. Co. v. Texas Central Ry., 137
U.S. 171, 197 (1890), although denying priority to the claim
before it, broadly restated both the Fosdick principle and that
of Miltenberger. And Kneeland v. Bass Foundry & Machine
Works, 140 U.S. 592 (1891), distinguished Kneeland v.
American Loan & Trust Co., supra, on its facts and as relating
to a contract to buy rolling stock in which the vendor reserved
title and reclaimed the rolling stock;*' the Court in Bass Foun-
dry affirmed an order for payment of claims for supplies fur-
nished during the four month period for which the earlier
Kneeland decision had rejected the reasonable rental value
claim; the Court relied on Fosdick and Miltenberger and on
Union Trust Co. v. Souther, supra. Thomas v. Western Car
Co., 149 U.S. 95 (1893), again rejected a car vendor’s claim for
a reasonable rental for the pre-receivership months and cited
Kneeland v. American Loan & Trust Co., but it put the deci-
sion in large part on the ground that the terms of the contract
for the cars demonstrated that the vendor relied on the
security of the cars themselves and not on the interposition
of a court of equity. 149 U.S. at 112. Similarly,
s nip ome & A. Coal Co. v. Central Railroad & Banking Co.,
supra, nguished Kneeland v. American Loan & Trust Co.on
essentially the same ground. 170 U.S. at 370-71.
* Virginia & A. Coal Co. v. Central Railroad & Banking Co.
supra, treated Thomas as decided on the ground that the car com-
pany relied on the responsibility of the railroad company and not on
the interposition of a court of equity. 170 U.S. at 371-72.
7%
A27
Penn v. Calhoun, 121 U.S. 251 (1887), and, later, Lacka-
wanna Iron & Coal Co. v. Farmers’ Loan & Trust Co., 176
U.S. 298 (1900), rejected priority claims where, in the first
case, the creditor took as security bonds of the railroad for
twice the amount of the claim, and, in the second, the creditor
had taken collateral security for part of the debt and had ex-
tended and renewed long terms of credit; in neither case could
it be found that the creditor relied on the railroad’s current
earnings for payment.
Gregg v. Metropolitan Trust Co., 197 U.S. 183 (1905), dealt
with Gregg’s claim for railroad ties delivered to the railroad in
the month preceding the receivership; they were used prin-
cipally during the receivership to maintain the railroad as a
going concern, and the claim for payment was admittedly for
a necessary operating expense incurred to keep and use the
railroad and preserve the property in fit and safe condition.
There had been no diversion of income by which the mort-
gagee had profited, or otherwise, and, the Court concluded,
the circumstances affecting the claim were not “special.” The
Court said that the claim could not be charged on the corpus
of the fund unless there was
. . a general rule that such claims for supplies are
entitled to precedence over a lien expressly created by a
mortgage recorded before the contracts for supplies were
made.
197 U.S. at 186-87. The Court said that
. . we are of opinion, for reasons that need no further
statement, Kneeland v. American Loan & Trust Co., 136
U.S. 89, 97, that the general rule is the other way, and
has been recognized as being the other way by this court.
197 U.S. at 187. Of the allowance of pre-receivership claims in
Miltenberger, the supplier's principal reliance, the Court said:
The grourd of such allowance as was made was not
merely that the supplies were necessary for the preserva-
tion of the road, but that the payment was necessary to
the business of the road — a very different proposition.
7%
A28
Ibid. Other cases were distinguished as related to the special
principle of Miltenberger, or as involving diversion of earn-
ings, and cases like Union Trust Co. v. Souther. supra, where
the receivership order authorized payment of six months
claims for labor and supplies out of income, were explained as
standing
. . on the special theory which has been developed with
regard to income, and afford no authority for a charge on
the body of the fund.
Id. at 188. The cases the Court cited as developing the “special
theory” with regard to income are Fosdick, Burnham v.
Bowen, supra, Morgan's L. & T. R.R. & S.S. Co. v. Texas
Central Ry., supra, Virginia & A. Coal Co. v. Central
Railroad & Banking Co., supra, and Southern Ry. v. Carnegie
Steel Co., supra. The Court added:
It is agreed that the petitioner may have a claim against
surplus earnings, if any, in the hands of the receiver, but
that question is not before us here.
Ibid. The original receivership order in Gregg authorized the
receiver to pay material and supply claims which accrued not
more than six months before the receivership. Of this provision
the Court said:
But even if any words in the order authorized a charge on
the corpus in order to pay claims like that of the peti-
tioner, or a payment of them except from income, cer-
tainly there are nore requiring it, or going beyond giving
authority to the receiver if, for instance, he thought
payments of previous debts necessary to the continued
operation of the road.
Id. at 188-89.
Gregg is the last extended opinion on the Six Months Rule,
and on the Necessity of Payment rule in the Supreme Court.”
*3 Baker v. Gold Seal Liquors, Inc., 417 U.S. 467, 471 n. 5 (1974),
refers to the priority language of Section 77(b), to Gregg as to that
priority, and to St. Louis & S.F.R.R. v. Spiller, 274 U.S.
A29
The dissent clearly states the more inclusive principle that the
Court’s majority seemed to reject:
And that principle has its cudation in the public in-
terests. A railroad, from its nature and public respon-
sibilities, must be kept a going concern. This is the
supreme necessity, and affords the test of the equity in-
voked for the claims for supplies. It cannot depend upon
diversion of income or upon the existence of income. It
cannot be confined to debts contracted during the
receivership. It may extend to debts contracted before the
appointment of the receiver. But recognizing that there
must be some limitation of time, the courts have fixed six
months as the period within which preferential claims
may accrue. And there is no infringement of the rights of
mortgagees. Their interests are served, as those of the
public are, by keeping the railroad in operation. Tlie
limitations of the rule dependent upon the conditions
under which supplies are furnished are expressed in
Virginia & Alabama Coal Co. v. Central Railroad &
Banking Co., 170 U.S. 355, and in Southern Ry. Co. v.
Carnegie Steel Co., 176 U.S. 257.
Id. at 196.
Carbon Fuel Co. v. Chicago, C. & L.R.R., 202 F. 172 (7th
Cir. 1912), a case in which there was neither surplus earnings
nor any diversion of income, interpreted Gregg as limiting
Miltenberger to the cases in which not the supply or service
furnished to the railroad but payment by the receiver is essen-
tial to the continuance of the business of the railroad. See, to
the same effect, Taylor v. Delaware & E.R.R., 213
304, 311 (1927), as stating the general six months limitation on
Fosdick claims. New York Dock Co. v. S.S. Poznan, 274 U.S. 117,
121 (1927), stated the Fosdick principle as requiring payment for
supplies furnished before receivership where the debtor's or
receiver's use of them “has produced the earnings;” the Court con-
sidered the result to flow from the courts’ self-imposed duty to re-
quire that, before distribution, expenses that have contributed to the
preservation or creation of the fund in its custody should be paid.
A30
F. 622, 624 (2d Cir. 1914), Moore v. Donahoo, 217 F. 177,
180-83 (9th Cir. 1914), cert. denied, 235 U.S. (1915), Chicago
¢> A.R.R. v. United States & Mexican Trust Co., 225 F. 940,
945 (8th Cir. 1915), and Crane Co. v. Fidelity Trust Co., 238
F. 693, 695-96 (9th Cir. 1916), cert. denied, 244 U.S. 658
(1917).
Pennsylvania Steel Co. v. New York City Ry., 216 F. 458,
470 (2d Cir. 1914), however, referred to Gregg as the “most
striking example of the uncertainty which surrounds the whole
subject.” The Court allowed pre-receivership supply claims
against unmortgaged assets of the railway in the absence of
any “current debt fund.” The court said:
If the preference is properly rested on public policy we do
not see how it can be restricted to current earnings. Such
claimants should be preferred over all general creditors,
and if current earnings are not sufficient to secure the
preference it should be extended to the company’s un-
mortgaged assets.
216 F. at 471. Johnson Fare Box Co. v. Doyle, 250 F.2d 656,
657 (2d Cir.), cert. denied, 357 U.S. 938 (1958), paraphrased
with apparent approval, a district court’s assertion™ that it is
very difficult to discover any principle which would account
for all the decisions, and that the only generality obtainable
from the cases is that the decision in each depended on its
special facts.
Southern Ry. v. Flournoy, 301 F.2d 847 (4th Cir. 1962), re-
jected the theory that Gregg severly limited Miltenberger, 301
F.2d at 852, and emphasized that, from Miltenberger for-
ward, “public concern with the continued operation of the
railroad has been a factor supporting the priority accorded
*% In re Third Avenue Transit Corp., 138 F. Supp. 623 (S.D. N.Y.
1955), aff'd on opinion below, 230 F.2d 425 (2d Cir. 1956). Third
Avenue Transit treated pre-receivership ating expense claims as
enjoying priority only in net income of the railroad and of the
receiver.
A31_
general creditors.” Id. at 853.*° The court accorded interline
traffic balances and other interline accounts a priority in cor-
pus over the mortgage bondholders. The court treated the
time limitation, generally six months, as preventing operating
claims from undermining the mortgage through secret liens.
Ibid.
In re New York, N.H. & H. R.3R., 278 F. Supp. 592 (D.
Conn. 1967), aff'd, 405 F.2d 50 (2d Cir. 1968), cert. denied,
394 U.S. 999 (1969) (“New Haven”), saw the Six Months Rule
as one that over the years had been inconsistently stated and
applied in decisions that lacked any harmonizing principle, so
that “ambiguities must generally be resolved against those
claiming the benefit of the rule.” 278 F. Supp. at 595-96. The
rule of Fosdick was summarized:
Revenues accruing from operations should be paid first to
the operations creditors whose materials and services
made those revenues possible; and only after all such
operational claims have been paid, should the balance be
available for the benefit of the mortgagees. If any
operating revenues do improperly get into the hands of
the mortgagees, equity requires that those revenues be
restored to the operations creditors by the mortgagees
yielding them a priority. (Footnote omitted.)
278 F. Supp. at 597-98. The “surplus earnings” element of the
“current debt” or “expense” fund of Fosdick the court defined
as the sum of all operating revenues accrued during the six
months period and during reorganization and which have ac-
tually been received or taken over by the trustee less deprecia-
tion and all operating expenses that have actually
** The court noted its earlier statement in Virginia Passenger &
Power Co. v. Lane Bros., 174 F. 513, 516 (4th Cir. 1909), that in
certain cases preferential payments have been allowed out of corpus.
“One of the foundations of the principle is that the public interest re-
quires that a railroad must be a ‘going concern.’ It does not de-
pend, therefore, upon the diversion, or even upon the existence of
income.”
A32
been paid, or are payable by the trustee, or which constitute
administrative expenses.” Id. at 599. {n New Haven the court
found neither “surplus earnings,” as it defined them, nor “in-
come available for fixed charges,” nor unmortgaged assets, nor
any diversion to the mortgagees’ advantage of current
revenues to which the operations creditors were entitled, since
neither the depreciation allowances nor payments on equip-
ment trust and conditional sales obligations could be con-
sidered such diversions. Id. at 600-05. The court concluded
that the six months creditors could not be accorded a priority
in corpus over the mortgage bondholders. The court con-
sidered that Flournoy had confused and merged the Six
Months Rule and the Necessity of Payment rule, “first enun-
ciated in Miltenberger,” by making necessity of payment a re-
quirement of the Six Months Rule and eliminating diversion as
a requirement of corpus invasion,” directly contrary to Gregg.
Id. at 602 n. 15. The court, on the supposed authority of
Gregg, reduced Miltenberger to the case in which immediate
payment is necessary to avert a threat to continued operation
of the road, and characterized as “absurd” reliance on the
Necessity of Payment rule by creditors whose claims had gone
unpaid during six years of operation in reorganization. Id. at
602-03 n. 15.?”
In re Tennessee Central Ry., 316 F. Supp. 1103 (M.D.
Tenn. 1970), vacated on other grounds, 463 F.2d 73 (6th
Cir.), cert. denied, 409 U.S. 893 (1972), accorded a
*° The court differentiated its treatment of the six months earn-
ings (“gross operating income” taken over and collected by the
trustee less expense items payable on the date the petition was filed
which the trustee was required to pay) from the scheme referred to
in Guaranty Trust Co. v. Albia Coal Co., 36 F.2d 34, 36 (8th Cir.
1929), that is, “gross operating income taken over or collected by the
receiver less taxes accrued.” 278 F. Supp. at 599.
*” The Court of Appeals affirmed, 405 F.2d 50 (2d Cir. 1968),
saying that the “current expense fund” for six months claims “is to be
computed by deducting operating expenses and depreciation from
current revenues.” 405 F.2d at 52.
*?
A33
priority over mortgage bonds to claims for interline freight
balances; the court found that the extensions of credit that the
balances reflected averted a complete shutdown of the
railroad’s operation and facilitated the sale of the railroad to
three other carriers which continued to operate it. The court
relied in part on the special character of interline freight
balances as collections for which the road had to account to
connecting carriers, 316 F. Supp. at 1110, and ultimately on
the circumstance that the connecting carriers’ extension of
credit preserved the cczpus of the mortgaged railroad by main-
taining it as a “going concern” and enabled the area formerly
served by the railroad to enjoy continued rail services. Id. at
1111. The court argued that Gregg seemed to indicate that,
where special circumstances or equities favored six months
claimants, their claims might be allowed a priority in assets
even in the absence of a diversion of income to the secured
creditors’ benefit. Ibid.
In re Penn Central Transp. Co., 458 F. Supp. 1234, 1319-28
(E.D. Pa. 1978), relied principally on New Haven as a distilla-
tion of a large number of earlier cases; the “current debt
fund,” the court said, included surplus income of the six
months preceding reorganization as well as for the reorganiza-
tion period, inclusive of non-rail income customarily made
available to support rail operations; generally accepted
railroad accounting principles were held applicable, deprecia-
tion being deducted from operating revenues in computing the
“current expense fund.” The deficit in Penn Central’s income
for the six months period and during reorganization exceeded
the depreciation for the same period by very much more than
the aggregate of the six months claims; since there was no
earnings component for the Fosdick “current debt fund,” and
capital improvements for the same period (nearly four times
the amount of the six months claims) were far less than the
depreciation for the period, the court concluded that there
-.
A34
was neither enhancement of property nor “diversion.” 458 F.
Supp. at 1325. The court rejected Flournoy as “discredited”
and as impermissibly combining the six months and necessity
rules, and treated the Necessity of Payment rule as stating the
circumstance in which a court couid justify entry of an order
auth ‘izing payment of a pre-reorganization creditor who in-
vokea the sanction of refusal to furnish further supplies or ser-
vices as a means of obtaining payment of his old claim.” Jd. at
1326-27.
B.
The persistence of the Six Months Rule and the persistence
of two distinct attitudes toward it, the one receptive and
* The trustee evidently argued that $770 million spent on capital
improvement should not be considered in the “diversion” calcula-
tion because the expenditure did not exceed the increase in deprecia-
tion reserve through charges to income in the period. The six months
creditors apparently argued that this was “double dipping,” taking
depreciation into account twice, once to compute surplus
and a second time to absorb the capital expenditures’ effect as a
diversion to the advantage of the mortgage bondholders. The court
so to meet the argument with the statement that, if the amount
of ation charged had actually been t to make good the
depreciation, that outlay “would not have enhanced the
assets at the expense of the six months claimants.” 458 F.
Supp. at 1375. That, however, is, logically, a restatement of the
conclusion that depreciation should be ducted in computing the
earnings component of the Fosdick “curnent debt fund.” The court
met the argument directly by concludi~>< that even adding back the
tion did not produce Fosdick surplus earnings, leaving the
capital expenditures in large part unexplained, however. Ibid.
* The court said that In re Penn Central Transp. Co., 467 F.2d
100 (3d Cir. 1972), correctly stated the Necessity of Payment doc-
trine. The appellate court summarized the Necessity of Payment
rule, an “exception to the normal deferment of payment of pre-
reorganization claims until their disposition can be made part of a
plan of tion,” as permitting immediate payment where
creditors net aay Su vines Oe aenbertel Sinentian te She wentaet
of the business unti! their pre-reorganization claims are paid. 467
F.2d at 102 n.1. The s:ppellate court intimated that a reorganization
court might well have power to compel a continuance of a service
ee re ee ee
Id. at 102.
A35
expansive, the other insistent upon its limitations and narrow
sphere of operation, suggest the co-existence of two essentially
different principles, neither of which limits the operation of
the other, and both of which may operate in the same
reorganization to embrace many of the same claims. The
Fosdick rule is one of equitable restitution; in receivership the
mortgagee must restore to operating creditors revenues
diverted to the mortgagee’s advantage; the lien of the mort-
gage extends to railroad revenue or income only when posses-
sion of the road and its income is demanded, pursuant to the
mortgage terms after default, Fosdick, supra, 99 U.S. at 253;
Gilman v. Illino’s and Mississippi Telegraph Co., 91 U.S. 603,
617 (1876); Galveston, H. & H. R.R. v. Cowdrey, supra, 78
U.S. (11 Wall.) at 482-83, and the lien reaches only what re-
mains of revenue after payment of all current operating ex-
penses. Burnham v. Bowen, supra, 111 U.S. at 782-83. The
receivership furnishes the occasion and judicial means of effec-
ting the equitable restitution, but mortgage law, not the
special principles governing the administration of railroad
receiverships, is the source of the right to restitution.
The second rule, elaborated and applied in Miltenberger, is
peculiarly a principle of railroad receivership law, reflecting
the view that a “railroad is authorized to be constructed more
for the public good to be subserved, than for private
gain.... It is...a matter of public right by. which the
courts, when they take possession of the property, authorize
the receiver . . . in whose charge it is placed to carry on in the
usual way those active operations for which it was designed
and constructed, so that the public may not receive detriment
by the non-user of the franchises.” Barton v. Barbour, 104
U.S. 126, 135 (1881). Miltenberger, relied on Wallace v.
Loomis, supra, 97 U.S. at 162-63, for the authority to issue
receiver's certificates superior to the first mortgage lien to
finance the payment of pre-receivership operating expenses,
administrative expenses of the receiver and costs of new
A36
construction, and relied on Barton v. Barbour for the public
interest justification for continued operation of the ~ailroad as
a going business. 106 U.S. at 309-12. The Court said that pay-
ment of pre-receivership debts
. . where a stoppage of the continuance of such business
relations would be a probable result, in case of non-
payment, the general consequence involving largely,
also, the interests and accommodation of travel and traf-
fic, may well place such payments in the category of
payments to preserve the mortgaged property in a large
sense, by maintaining the good-will and integrity of the
enterprise, and entitle them to be made a first lien.
Id. at 312. The Court’s rationale excludes the inference that
only those creditors are entitled to priority of payment who de-
mand immediate payment as a condition of continuing to sup-
ply a service or commodity of which they are monopolists.*°
The Court was defining the classes of claims payment of which
was indispensable to the business of the road and which,
“unless the receiver was authorized to provide for them at
once, the business of the road would suffer great detriment.”
Id. at 311. The Court’s depiction of the disastrous conse-
quences of failing to pay labor claims — a work stoppage®! —
or interline claims — a stoppage of traffic interchange — is
directed to restricting the class of claims entitled to priority of
payment to claims for those goods and services that are
% As noted above, footnote 18, the special master disallowed
“several items” where the claimants threatened “not to furnish any
more supplies on credit unless they were paid the arrears.” 106 U.S.
at 311.
3! In Skiddy v. Atlantic, M. & O. R.R., supra, 22 F.Cas. at
281-82, the court, acting on such a ground, dire:ted the receiver to
pay eight months back wages to employees only who con-
tinued in employment; claims of the remaining employees and
claims for materials supplied under contracts made on the eve of
receivership were denied priority. The district judge who joined in
the Skiddy opinion evidently regarded it as overruled in its latter
aspect by Fosdick. Atkins v. Petersburg R.R., supra, 2 F. Cas. at 92.
A37
indispensable to the continued performance of the transporta-
tion service. The point is to single out the pre-receivership ex-
penses the payment of which although it — prima facie —
may stand on a different principle from that governing pay-
ment of administrative expenses, “may be brought within the
principle of the latter by special circumstances.” Ibid. The test
is not whether the claimant has the naked power to exert
economic duress, but whether the expenses have the
characteristics of those that the receiver pays from revenue as
expenses of administration or pays out of the proceeds of the
sale of first lien receiver’s certificates. E.g., Boston ¢ Maine
Corp. Trustee’s Competitive Bidding Exemption, 347 1.C.C.
234, 235 (1971). (Sale of certificates “for meeting payroll and
other expenses which, if not met, would preclude continued
provision of essential railroad transportation services.”) An
early district court decision, authorizing the issuance of
receiver's certificates, summed up the principle:
It is enough for us that no court has ever refused to issue
[receiver's] certificates when it was necessary for repair-
ing the road or keeping it agoing as a safe road; and if it
may authorize such expenditures by a receiver, it may
pay them if they have been made by the company before
the appointment of a receiver. |
Atkins v. Petersburg R.R., supra, 2 F. Cas. at 94.
Sore decisions have, very evidently, read Gregg as reducing
Miltenberger to a Necessity of Payment holding in the starkest
economic duress form,** but Gregg is, rather, circumspect in
32 With one exception, later cases in the Supreme Court that cited
Miltenberger relied also on the equitable restitution principle of
Fosdick. Virginia & Alabama Coal Co. v. Central Railroad & Bank-
ing Co., supra, 170 U.S. at 365-66; Illinois Midland Ry., supra, 117
U.S. at 456-58; Union Trust Co. v. Souther, supra, 107 U.S. at 594.
The exception is Kneeland v. Bass Foundry & Machine Works,
supra, 140 U.S. at 596-97, where the claim was ordered paid out of
corpus because the supplies covered by the claim “had been
reponenr phewehnscapse soaks (ap aug tbs hg and had gone into
the general property by the mortgage” and “contributed to
the preservation of the p during the receivership.” Neither a
surplus of earnings nor a diversion was involved.
A38
its treatment of Miltenberger; it preserves the ambiguity of the
Miltenberger language without explaining or applying it, and
declines to find that Gregg’s facts presented special cir-
cumstances warranting priority. The Supreme Court has since
cited Miltenberger for the principle that claims with equities
superior to the mortgagee’s “may be accorded priority in pay-
ment although they arose prior to the receivership.” Carpenter
v. Wabash Ry., 309 U.S. 23, 28 (1940).
The criterion of priority to have intrinsic validity must be
found in the nature of the claim and in the nature of the
reorganization. If the claim is for a service or supply indispen-
sable to the maintenance and operation of the railroad, and if
the railroad continues to operate while in reorganization, the
real difficulty is in finding a ground on which a court can
fairly deny payment of a pre-reorganization expense claim in-
distinguishable from current administration expenses that are
being paid and indistinguishable from kindred operating ex-
penses that were incurred in the ordinary course of business by
the railroad company in the months preceding reorganization
and were paid by the railroad before reorganization or were
paid thereafter by the trustees as liabilities arising out of the
operation of the railroad. If a claim has the generally accepted
characteristics of a six months claim, as stated in the district
court’s opinion, 468 F.Supp. at 1002, that is, (1) it represents
a current operating expense necessarily incurred, (2) was in-
curred within six months before the reorganization petition
was filed, and (3) the goods or services were delivered in the
expectation that they would be paid for out of current
operating revenues of the railroad, and not in reliance on the
road’s general credit,** it will inevitably be for an expense in-
distinguishable from and essentially contemporaneous with
*° To the same effect are In re Penn Central Transp. Co., supra,
458 F. Supp. at 1321; In re New York, N.H. & H. R.R., supra, 278
F. Supp. at 596; Guaranty Trust Co. v. Albia Coal Co., supra, 36
F.2d at 35.
A39
expenses paid by the railroad before reorganization, and will
be indistinguishable from currently paid administration ex-
penses. The singularity of the claim will not be either in the
goods or services which it represents, nor in their contribution
to the railroad’s service to the public, nor in their contribution
to the preservation of the fabric of the railroad, but only in the
fact that it will, of course, not be paid. No principle marks
current expenses paid in ordinary course on the eve of
reorganization as preferences, but denial of an equivalent
right to priority payment for expenses of the same kind
likewise incurred on the eve of reorganization introduces an
inequality of treatment that finds no justification either in the
principles on which businesses are continued in operation dur-
ing receivership, or in the mortgagee’s lien interest. The
desideratum is equality of treatment for the current operating
expenses of a railroad enterprise the operations of which have
continued without interruption of service, revenues and ex-
penses. That equality is readily achieved by recognizing ad-
ministration expenses as extending backward to the period
preceding reorganization to the extent necessary to assure that
there is continuity in the payment of indispensable operating
expenses without reference to the date the petition is filed so
long as the current expenses of the pre-reorganization period
that are brought forward for payment conform to the strict
standard established for administration expenses of the current
operating class, and are not so dated as to forbid the conclu-
sion that they are in fact current. The inequity in treatment
arising out of the accidental circumstance of non-payment
before the filing of the petition is eliminated.
The hostility to “six months” claims evident in Gregg,
supra, 197 U.S. at 186-87 and New Haven, supra, 278 F.
Supp. at 596,% is no doubt in some part a product of the
* In contrast is the support for a broad gags 0 principle ap-
proach successively evident ir Finance Co. v. Charleston C. & C.
R.R., supra, 62 F. at 208, the dissent in Gregg, supra,
i
7%
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uncertain limits of the class of claims: six months is not an in-
flexible time limit, and each case “must depend largely upon
its special facts,” Southern Ry. v. Carnegie Steel Co., supra,
176 U.S. at 292; the “surplus earnings” and the quantum of
“diversion” relevant under Fosdick are puzzling concepts, id.
at 294-95; In re Penn Central Transp. Co., supra, 278 F.
Supp. at 598-601; reliance on the general credit of the railroad
seems an illusory concept, Lackawanna Iron & Coal Co. v.
Farmers’ Loan & Trust Co., 176 U.S. 298, 316-17 (1900)
(security taken upon renewal of notes given for rail); Southern
Ry. v. Carnegie Steel Co., supra, 176 U.S. at 292 (if first notes
given for rail contemplated payment from current earnings,
seller “lost no equity merely by renewing the notes”); Penn v.
Calhoun, 121 U.S. 251, 252 (1887) (bank took bonds of
railroad to secure repayment of loan). But the definition of the
class has been left to the courts by the Congress,** and when
197 U.S. at 196, and Flournoy, supra, 301 F.2d at 851-52. The
paragraph by which Chief Justice Waite introduced the discussion
of priorities in Fosdick, supra, 99 U.S. at 251-52, is more easily
referred to the broad receivership principle later elaborated in
Miltenberger than to the narrow principle of equitable restitution
that the following paragraphs of the opinion outline.
35 The Commission on the Bankruptcy Laws of the United States,
Report, H.R. Doc. No. 93-137, 93d Cong., Ist Sess. (1973),
reprinted in King, Klee and Levin, Collier on Bankruptcy (15th
Ed.), Appendix, Vol. 2, Part I, p. 270, recommended retaining the
“so-called six-month priority rule according to creditors who sup-
plied necessities to the debtor within six months prior to the filing of
the petition the status of administrative expense claimants.” The
Commission’s recommended bill, in the “Confirmation of Plan” sec-
tion (9-503), included a requirement that the plan provide “for pay-
ment of all allowed claims for current operating expenses
pcg: spe ser ceva. Joey eee gamege meer ag eg pasate
ing of the petition.” Id., Part I, p. 288. The Senate in 1978 would
have followed the Commission recommendation to provide that
“traditionally accorded” priority (S. Rep. No. 95-989, 95th Cong.,
2d Sess. 135-36, reprinted in [1978] U.S. Code Cong. & Ad. News
5921-22), and S. 2266, 95th Cong., Ist Sess. § 1173(a) (9) (1978), re-
quired that the “Plan” include a provision for payment in cash of all
Sr ee ee ee eee
preceding the filing of the petition. House Bill, H.R. 8200,
A4l1
the time comes to determine membership in the class® it will
be for the reorganization court to determine what claims
belong in the class because they represent indebtedness for or-
dinary and necessary current operating expenses indispensable
to continued rail service of the kinds being paid currently as
expenses of administration; whether the non-payment reflects
an intentional extension of credit to the railroad, or the in-
tervention of the reorganization petition before expiration of
the ordinary billing and payment period, or some non-
contractual indulgence or inadvertence on the part of the
claimant, or deferment of payment on the part of the railroad;
and whether, if the transaction giving rise to the claim had any
credit term, it was compatible with a general expectation of
payment from current receipts or indicated reliance on the
railroad’s general credit. In any event, it must be concluded
that the class of creditors entitled to the priority contemplated
by Section 77(b), 11 U.S.C. § 205(b) (1976), is not limited to
participation in the current debt (expense) fund defined in
terms of Fosdick equitable restitution, but extends to par-
ticipation in reorganization railway operating revenues essen-
tially on the same basis as administration expenses incurred
during the reorganization period.
C.
Where payment for pre-reorganization services and supplies
is claimed on the ground that the expenses are within
95th Cong., Ist Sess. (1977), which in substance proposed to con-
tinue, as Section 1170(b), the language of former Section 77(b), and
H.R. Rep. No. 95-595, 95th Cong., Ist Sess. 424, reprinted in [1978]
U.S. Code Cong. & Ad. News 6380, stated that “As under current
law, the courts will determine the precise contours of the priority
zed by this subsection in each case.” The provision enacted as
. 11 U.S.C. § 1171(b) follows the House Bill and substantially con-
tinues the language of Section 77(b).
% Since the district court disposed of the six months claims on the
ground that there was no current debt fund, 468 F. Supp. at 1003,
and no diversion, id. at 1004-06, and did not designate a priority
classification for six months creditors, id. at 1008, the court did not
refine its definition of the class, id. at 1002, nor set out the limita-
tions on membership in such a class.
oh
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A42
the principle governing the priority accorded to administra-
tion claims, questions respecting the existence of a current ex-
pense or debt fund, that is, of surplus earnings or net income,
are not directly involved; the controlling considerations are
those taken into account in authorizing administration ex-
penses.
However, if payment is claimed under the Fosdick princi-
ple, the existence of a current debt fund must be
demonstrated. The district court’s analysis of the financial
data, 468 F. Supp. at 1002-04, 1005-07, establishes that there
were no surplus revenues but a deficit in operating income and
income available for fixed charges in the period from
September 13, 1969, to July 31, 1978, and that the operating
deficit exceeded the amounts arguably expended to the mort-
gagee’s advantage. However, in its analysis the district court
defined the earnings (deficit) component of the current ex-
pense fund as comprising revenues less operating expenses and
depreciation, id. at 1003; the court rejected the argument that
providing an allowance for depreciation out of revenue
enhanced the mortgaged assets and so was a diversion, id. at
1006-07; it indicated approval of the New Haven view that
depreciation reflects the consumption of the railroad property
through use, and that the depreciation allowance is com-
parable to expenditures made merely to preserve and not to in-
crease the mortgaged assets. Ibid. See New Haven, supra, 278
F. Supp. at 604; In re Penn Central Transportation Co.,
supra, 458 F. Supp. at 1324-25; note 28, supra.
Certainly the depreciation of income producing property,
the exha
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