Amicus Curiae Brief — Union Pacific Railroad v. Moritz

Supreme Court brief1988

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No. 88-93

Se eeeaEeEel van —_—_

SLER

IN THE —— tt”

Supreme Court of the Wuited States

OCTOBER TERM, 1988

UNION PACIFIC RAILROAD COMPANY, et al.,

Petitioners,

TERRY F. MORITZ, TRUSTEE OF

IOWA RAILROAD COMPANY,

Respondent.

On Petition for a Writ of Certiorzri to the

United States Court of Appeals

for the Seventh Circuit

BRIEF OF THE ASSOCIATION OF AMERICAN

RAILROADS AND THE AMERICAN SHORT LINE

RAILROAD ASSOCIATION AS AMICI CURIAE )

IN SUPPORT OF THE PETITION

THOMAS C. DORSEY J. THOMAS TIDD

The American Short Line KENNETH P. KOLSON *

Railroad Association Association of American

2000 Massachusetts Avenue, N.W. Railroads

Washington, D.C. 20001 50 F Street, N.W.

(202) 785-2250 Washington, D.C. 20001

(202) 639-2511

August 15, 1988 * Counsel of Record

WILSON - Epgs PRINTING Co., INC

. = 789-0096 - WASHINGTON, D.C. 20001

TABLE OF CONTENTS

ee I a I asics snc cceeccaiecans

INTEREST OF THE AMICI CURIAE

RPE SOUT PUMA, ie siccinrencscesnscennticsnsdeacccncsaics

ARGUMENT

I. The Court of Appeals Finding That the Interline

Freight Balances At Issue Constituted “General,

Unsecured Debts” of the Bankrupt Iowa Rail-

road is Totally Unsound as a Matter of Federal

Bankruptcy Law and Conflicts With Decisions

of the Third and Sixth Circuits That Properly

Treat Interline Freight Balances as Trust

Funds

A. Background—The Interline Freight Balance

RI el kere eres A Sabo Rie ons oe

B. The Third and Sixth Circuit Decisions Treat-

ing Interline Freight Balances as Trust

Funds in Railroad Bankruptcy Proceedings..

C. The Decision of the Seventh Circuit Below

Treating Interline Freight Balances as ‘‘Gen-

eral, Unsecured Debts” of the Bankrupt Con-

flicts with the Third and Sixth Circuit Deci-

sions and Will Create Serious Problems for

the Railroad Industry if Not Reversed .......

CRITI Sostecncdesstacie nent pcseceaibaneclinanancnaeinadgiticeecceniids

Page

TABLE OF AUTHORITIES

Cases Page

Atlantic Coast Line R. Co. v. Pennsylvania & Co.,

12 F.Supp. 720 (B.D. Pa. $086) 1.2: 24

Chase Vv. Committee of Interline R.Rs. (In re Ann

Arbor R.R. Co.), 623 F.2d 480 (6th Cir. 1980) .... passim

In re Lehigh and New England Ry. Co. (Appeal of

Central Jersey Indus., Inc.), 657 F.2d 570 (3rd

Che, TBR) ac ncccccsnvsecsaniniensidnnceeeeeaeaonee 20, 26

In re Penn Central Transp. Co., 486 F.2d 519 (3rd

Cir. 1973) (en banc), cert. denied, 415 U.S. 990

CIGG4) ....c eee passim

Southern Ry. Co. v. United States, 306 F.2d 119

(Sth Cir. 1008) nae 21

Statutes and Regulations

S USL. 4 eee 6

> Sie Tee S. . SOen renner EE Te TRA. 4, 7,13, 24

49 C.F.R. § 1201(A) (1-1) _...0.... eeu een we 2

Other Authorities

Restatement (Second) of Trusts (1957) .. 11

IN THE

Supreme Court of the Wuited States

OCTOBER TERM, 1988

No. 88-93

UNION PACIFIC RAILROAD COMPANY, et al.,

Petitioners,

TERRY F. MORITZ, TRUSTEE OF

IOWA RAILROAD COMPANY,

Respondent.

On Petition for a Writ of Certiorari to the

United States Court of Appeals

for the Seventh Circuit

BRIEF OF THE ASSOCIATION OF AMERICAN

RAILROADS AND THE AMERICAN SHORT LINE

RAILROAD ASSOCIATION AS AMICI CURIAE

IN SUPPORT OF THE PETITION

INTEREST OF THE AMICI CURIAE!

The Association of American Railroads (“AAR”) is

the trade association for the nation’s larger railroads.

1 All parties have consented to the filing of this brief pursuant to

Rule 36 of the Supreme Court rules. Letters signifying consent

have been filed with the Clerk.

Its membership includes essentially all Class I railroads *

and numerous non-Class I railroads. Its members account

for approximately 93 percent of the freight revenues of

all railroads in the United States. The American Short

Line Railroad Association is the trade association for

more than 300 small railroads, the vast majority of which

are Class III railroads. Both the AAR and the ASLRA

represent their member railroads before courts, agencies

and the Congress in matters of common concern.

The decision below raises an important issue of com-

mon concern to the railroad industry—to both large and

small rail carriers alike. At issue is the status under

federal bankruptcy law of “interline freight balances,”

which are essentially funds representing freight revenues

collected from shippers or consignees by one railroad par-

ticipant to an interline movement of freight (7.e., a move-

ment involving the interchange of freight between two

or more carriers) as collection agent for the other par-

ticipating carriers for their portion of the freight

charges. The district court in this case, relying on prior

decisions of the Third and Sixth Circuits holding such

interline balances to be trust funds, found that approxi-

mately $4 million in interline freight balances collected

by the Iowa and not settled at the time of the Iowa’s

bankruptcy petition were held in trust (to the extent

still in the possession of the Iowa) for the benefit of the

carriers who earned the freight revenues.* In the deci-

2 Under carrier classifications adopted by the Interstate Commerce

Commission, a Class I railroad is defined as a carrier with annual

operating revenues of $50 million or more. A Class II carrier has

annual operating revenues of less than $50 million but more than

$10 million. A Class III carrier has annual operating revenues of

$10 million or less. (The annua! revenue figures are adjusted for

inflation.) 49 C.F.R. § 1201(A)(1-1)(a)-(c).

3 Of the $4 million in interline freight balances at issue, $1.4

million was collected by the Iowa on behalf of petitioners; the

balance was collected on behalf of other railroads.

sion for which certiorari is sought, the Seventh Circuit,

finding that the requisites of a state law trust could not

be satisfied with respect to the interline freight balances

at issue, reversed the district court and held that the

interline freight balances at issue were merely “general,

unsecured debts of the Iowa” and that the revenues gen-

erated by such balances must accordingly be made avail-

able to all of the lowa’s general creditors.

If the decision of the Seventh Circuit is allowed to

stand, and the status of interline freight balances col-

lected by one railroad on behalf of another under estab-

lished industry practice is to be relegated to that of an

ordinary trade debt in railroad bankruptcy proceedings,

the potential adverse revenue impact upon the railroad

industry would be enormous. Of the approximately $26

billion earned by Class I railroads in 1987, approximately

54 percent, or $14 billion, constituted interline revenue

whose recovery would be placed in jeopardy in bankruptcy

proceedings by the decision of the court below. In addi-

tion, because the decision below strikes directly at estab-

lished industry practice with respect to the collection of

interline freight charges by a single carrier, it has the

potential to significantly and unnecessarily complicate

interline operations between carriers, particularly where

short line carriers (virtually all of whose earnings is de-

rived from interline operations) currently act as collec-

tion agent. The railroad industry submits that there is

neither warrant in law, equity nor policy to treat funds

earned by rail carriers in interline operations as prop-

erty of the collecting road in bankruptcy proceedings, and

such result should not be countenanced by this Court in

the interests of sound federal bankruptcy law applicable

to the rail industry.

Moreover, because the decision below conflicts with de-

cisions of the Third and Sixth Circuits with respect to

the status of interline freight balances in railroad bank-

ruptcy proceedings, the uncertainty and lack of national

uniformity fostered by the decision below provides strong

additional grounds for industry-wide concern. The AAR

and the ASLRA, on behalf of the railroad industry, there-

fore strongly support the petition for a writ of certiorari.

SUMMARY OF ARGUMENT

The national rail system is dependent on interline serv-

ice between connecting carriers for its very existence.

Rail carriers are in fact required by the Interstate Com-

merce Act to establish “through routes” with each other

to enable the interconnecting properties of independent

carriers to operate as a single, unified national rail net-

work. 49 U.S.C. 10705. In order to facilitate the efficient

movement of freight in interline service, the rail indus-

try has established specific procedures for the collection

and settlement of freight charges. Under those industry-

wide procedures, freight charges are collected from ship-

pers or consignees by either the origin or destination

carrier, which acts as the collection agent of the other

participating carriers for their portion of the freight

charges. Freight charges owed to participating carriers

by the collecting carriers for their portion of interline

movements (“interline freight balances”) are settled af-

ter the close of each month; a carrier with a net balance

to its credit may draw a “sight draft’’ upon the bank

account of a carrier with a net debit balance (the pay-

ment system required under the AAR’s rules and volun-

tarily subscribed to by approximately 250 smaller roads

or may request payment by direct billing (the “bill and

voucher” method) (the method used by approximately

230 smaller roads, including the Iowa Railroad at the

time of its bankruptcy).

Prior to the instant case, pursuant to the decisions of

the Third Circuit and the Sixth Circuit, interline freight

balances in the possession of a bankrupt carrier were

considered “trust” funds held by the bankrupt collecting

earrier for the benefit of the interline carriers who

earned the freight charges. In the instant case, the Sev-

enth Circuit found that interline freight balances settled

pursuant to the “bill and voucher” method were not held

in trust for the interline roads that earned the revenue

but were merely “general, unsecured debts” of the bank-

rupt.

In so holding, the Seventh Circuit rejected the specific

factors relied upon by the Third Circuit and Sixth Cir-

cuit in their determinations that the manifest intent of

the participants to the interline freight settlement system

was to establish a trust relationship rather than a debtor

creditor relationship for interline freight balances. The

Seventh Circuit also squarely rejected the holding of the

Sixth Circuit that interline freight balances should be

held to be trust funds as a matter of law because such

result was necessary to ensure the viability of the na-

tional rail system.

Because the decision of the Seventh Circuit directly

conflicts with the decisions of the Third and Sixth Cir-

cuits, review by this Court is necessary to ensure a uni-

form national rule for the treatment of interline freight

balances. Moreover, because the decision of the Seventh

Circuit has the potential to seriously disrupt interline

freight movements and place in jeopardy substantial rail

industry revenues, review by this Court is also necessary

in the interests of ensuring an efficient national rail

transportation system.

ARGUMENT

I. The Court of Appeals Finding That the Interline

Freight Balances At Issue Constituted “General, Un-

secured Debts” of the Bankrupt Iowa Railroad is

Totally Unsound as a Matter of Federal Bankruptcy

Law and Conflicts With Decisions of the Third and

Sixth Circuits That Properly Treat Interline Freight

Balances as Trust Funds

A. Background—The Interline Freight Balance System

The majority of the over $26 billion in revenue earned

by the railroad industry in 1987 (as a representative

year) was earned through interline operations, i.e., the

carriage of goods from origin to destination over the

lines of more than one carrier. These interline opera-

tions are the result of both practical necessity and stat-

utory obligation. The existing national rail network is

made up of thousands of miles of individual railroad

lines separately owned by hundreds of independent rail-

road companies. Although service over a single company’s

line can serve a multitude of origin and destination

points throughout the United States, true nationwide

service requires the cooperation and interchange of

freight between the nation’s carriers. Indeed, there cur-

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rently does not exist, and never has existed, a single rail-

road systen CaD ble oT serving hot} the A+ antic nd

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di iradie Il ne pudil interes O prescribe through

routes, joint classifications, joint rates .. ., the divisior

of joint rates, and the conditions under which those rout

must be operated” for interstate rail carriers. 49 U.S.C

10705(a)}(1). Such statutory requirements ensure

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a matter of law that the nation’s rail system acts as a

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of freight and render unnecessary the wasteful dupli

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Commission prescription). Rates for an interline move-

ment can also be established as the sum of individual

carrier rates applicable to the local line segments tra-

versed (7.e., the sum of “proportional” or “local” rates

separately established by the carrier participants and

which apply only to their individual line segments).

Regardless of whether interline rates are jointly set or

are the sum of combinations of individual rates, indus-

try-wide practice and procedure governing the collection

and settlement of interline freight charges provide for a

simplified mechanism whereby either the origin or desti-

nation carrier acts as agent of the other participating

carrier or carriers in collecting freight charges from the

shipper or consignee and in remitting to the other par-

ticipating roads the portion of the freight charges earned

by them. The industry’s collection and settlement pro-

cedure is designed to obviate the necessity of a shipper

or consignee making multiple payments to multiple roads

for a single shipment and concomitantly to facilitate the

prompt interchange of traffic between participants to

the literally tens of thousands of interline movements

that occur during each monthly settlement period.

The industry-wide “interline freight balance” settle-

ment procedure functions as follows. When a shipment

moves in interline service, a single carrier, either the

originating carrier (if it is a “prepaid”? shipment) or

the destination carrier (if it is a “collect”? shipment)

collects the freight charges from the shipper or consignee

on behalf of all carrier participants to the movement;

i.e., the originating or destination carrier acts as the

collection agent for the other participating roads with

respect to their share of the interline freight charges.

Regardless of which carrier collects the freight charges,

however, the destination road is responsible for prepar-

ing and settling the interline freight accounts.’ At the

5 The destination carrier is assigned the interline settlement

function because it alone is informed of the final routing of an inter-

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close of each month, the destination carrier, based on the

final “waybill” (or movement record) information for

each interline shipment, prepares an “abstract” of each

waybill and a summary of all waybill abstracts (“sum-

mary of interline accounts of freight received”) for the

month indicating the amounts owed to (or due from)

each carrier participant to an interline movement based

on the applicable revenue share and the amounts col-

lected (or to be collected) by that carrier. The interline

account summaries are exchanged between participants

to interline movements no later than the 14th working

day of the month after the freight movement is com-

pleted and the waybill information is available. Using

these statements, and offsetting the amounts shown, each

participating carrier calculates the monthly “interline

freight balance” resulting between it and each carrier

with which it interlined shipments.

The resulting interline freight balances are payable to

the carrier that earned the freight charges either through

“sight draft” or through direct billing. Under the “sight

draft” procedure, which is required under the AAR’s

accounting rules for AAR members and which is volun-

tarily subscribed to by approximately 250 smaller rail-

roads, a railroad with a net balance to its credit pre-

pares an electronic bank draft for the amount due (‘via

a micrcencoded card) and sends it to the debtor’s bank

which is authorized to pay the electronic draft in the

ordinary course of business. Under the direct billing

(“bill and voucher’’) method (which is used by approxi-

mately 230 smaller roads and which was used by the

Iowa Railroad at the time of its bankruptcy), a bill for

the amount due is prepared by the road with the net

balance in its favor and is forwarded for payment upon

receipt to the road with the net debit balance.

line movement, including the carriers participating in the move-

ment and each participant’s revenue share.

B. The Third and Sixth Circuit Decisions Treating

Interline Freight Balances as Trust Funds in Rail-

road Bankruptcy Proceedings

The status of outstanding interline freight balances

presents an issue of paramount importance in the con-

text of a railroad bankruptcy proceeding. Often, inter-

line freight balances in the possession of a bankrupt car-

rier at the time of a bankruptcy petition—particularly

a small origin or destination carrier (such as the Iowa

Railroad) that participates in only a small portion of

an interline movement yeu collects substantial sums due

other participating carriers—is targeted as the major

potential source of funds by the general creditors of the

bankrupt carrier, even though such funds have neither

been contributed by the general creditors themselves nor

represent freight revenues (nor other funds) generated

by the bankrupt carrier on its own behalf. Should these

funds representing outstanding freight charges collected

on behalf of other carriers be held to be general assets

of the bankrupt’s estate, the interline carriers who ac-

tually earned the funds and on whose behalf the funds

were actually collected would stand to lose virtually all

of the substantial interline revenue involved, to the bene-

fit of the general trade creditors of the bankrupt, who

would thereby gain an undeserved windfall.

In considering the status of interline freight balances

in the context of railroad reorganization proceedings

under the federal bankruptcy laws, both the Third Cir-

cuit (In re Penn Central Transp. Co.) (“Penn Cen-

tral”), 486 F.2d 519 (8rd Cir. 1973) (en bane), cert.

denied, 415 U.S. 990 (1974)) and the Sixth Circuit

(Chase v. Committee of Interline R.R.s (In re Ann

Arbor R.R. Co.)) (“Ann Arbor’), 623 F.2d 480 (6th Cir.

1980) have squarely found that such balances are not

general assets of the collecting road that must be made

available to its general creditors in bankruptcy proceed-

ings but instead represent amounts held in trust by the

bankrupt collecting road for the benefit of the interline

carriers that earned (and are entitled to) the freight

charges constituting the balances. The grounds for the

Third and Sixth Circuit decisions are firmly predicated

in law, equity, and federal policy underlying the Inter-

state Commerce Act and the bankruptcy laws.

The landmark case with respect to the appropriate

treatment of “interline freight balances” as trust funds

in railroad bankruptcy proceedings is the en bane deci-

sion of the Third Circuit in Penn Central (both the

majority opinion and the concurring opinion of Judge

Adams). In Penn Central, the Third Circuit was faced

with the issue of ownership of approximately $15 million

in interline freight balances owed by the Penn Central to

interline carriers at the time of its bankruptcy petition

and for which sums the Penn Central declined to honor

sight drifts drawn on its account. The Third Circuit

majority, in analyzing the status of interline freight

balances under “common law trust principles” (486 F.2d

at 524), found that a trust relationship was indeed mani-

fested by the industry’s interline freight balance settle-

ment procedures.

The court, relying on the Restatement definition of a

“trust” as “a fiduciary relationship with respect to prop-

erty . . . which arises as a result of a manifestation of

an intention to create it,’ ® found that the facts and cir-

cumstances surrounding the industry’s interline freight

balance settlement procedures emphatically demonstrated

6 A trust is defined in Restatement (Second) of Trusts § 2 (1957)

as:

[A] fiduciary relationship with respect to property, subjecting

the person by whom the title to the property is held to equitable

duties to deal with the property for the benefit of another per-

son, which arises as a result of a manifestation of an intention

to create it.

an objective manifestation of intent to establish a trust

relationship with respect to interline freight balances.

In so concluding, the court found it significant that the

funds were collected by one railroad (Penn Central)

“aS an agent of money due and owing the other rail-

roads” (Id. at 523) and that there was no provision for

the payment of interest by the collecting carriers which

would ordinarily be the case in a debtor-creditor relation-

ship (Id.). The Court also found that the fact that the

Penn Central was permitted to commingle freight charges

collected on other interline railroads’ behalf with Penn

Central’s general revenues did not indicate the absence

of a trust relationship in the context of the “unique and

complex” interline railroad system. As stated by the

Third Circuit:

Commingling of monies has minimal significance

in the extraordinary operations of interline railroads.

That Penn Central is not, as a destination carrier, re-

quired by other carriers to immediately segregate

funds collected does not necessarily reflect any inten-

tion to establish a debtor-creditor relationship in the

face of the unique and complex interline railroad

system. Normal operation conditions with innumer-

able daily collections of various categories preclude

practically and economically any effective daily seg-

regation. Burlington Northern Railway alone has

more than 1300 stations from which waybills are is-

sued. This is not a simple situation of one party

receiving money clearly designated as payment for

services performed by another. When a carrier col-

lects funds for another railroad, it does not imme-

diately know what portion of the revenues collected

is to be allocated to other carriers.

.. . We recognize the enormous difficulties confront-

ing the destination carrier to correlate each of these

waybills with payments received on a monthly basis,

not to mention daily basis, and to segregate funds

received according to the waybills.

Id. at 525.

The court also noted that the “AAR [settlement] rules

merely serve to evidence the necessities of the situation.”

Id. As noted by the Court:

To accommodate the carriers in this exceedingly

voluminous and complicated accounting system, the

AAR rules require that the statements be rendered

only once each month and give the carriers 18 days

to prepare the abstracts of the interline freight ac-

counts after the end of the month in which the way-

bill is received.7 The rules also indicate the diffi-

culty in the segregation of collections. They require

that accounts may be drawn on the collecting carrier

after the specified period even though in some in-

stances the charges have not yet been collected from

the shippers.

Id.

“Accommodating and applying traditional common law

trust principles to the unique regulatory scheme and

accounting policies used by the nation’s railroads (Jd.

at 524),” the Third Circuit majority concluded “that

transportation and freight charges, when collected, are

held in trust” for the interline railroads (emphasis in

the original) and that the interlines are “entitled to have

their monies.” Jd. at 524. Such result, the court also

noted, was not only consistent with the “recognized trust

and pragmatic considerations” discussed in its decision,

but also “supports the congressional policy encouraging

interline rail transportation of freight . . . nationwide.”

Id. at 527.

The concurring opinion of Judge Adams (joined by

Judge Weis) in Penn Central was even more emphatic

7 Effective January 1, 1983, AAR rules provide for forwarding of

the abstracts by the 12th working day (rather than the 18th

calendar day as formerly required) after the end of the month in

which the waybill is received. Similarly, the abstracts must be

received by the 14th working day after the end of the month

(rather than by the 20th calendar day as was formerly required).

with respect to the propriety of treating interline freight

balances as trust funds in railroad bankruptcy proceed-

ings. Treatment of such funds as property of the inter-

line railroads, Judge Adams found, is absolutely essential

to ensure the efficient functioning of the national rail

transportation network and such funds should be ac-

corded “trust”? status based on requirements of the na-

tional rail transportation system standing alone.* As

found by Judge Adams:

Congress has jong been concerned with the estab-

lishment and maintenance of a viable national rail

system. In part, this concern is manifested in legis-

lation tailored to encourage and facilitate ‘“‘inter-

line” rail transportation of freight and passengers

{statutory citations omitted]. To resort, as the ma-

jority does, primarily to “traditional common law

trust principle” to resolve this case is to overlook

these pertinent statutes. ...

* * *

There is no statutory compulsion for interconnect-

ing rail carriers to utilize any particular method of

collecting fares and freight charges for a through-

routed shipment. But, as a practical matter, only

one such method is feasible. That is for a single car-

rier—either the originating or the destination car-

rier—to collect the entire fare, and then remit to

interline carriers their pro rata portions. This ar-

rangement is apparently subscribed to by the entire

industry, and is incorporated in the rules of the As-

sociation of American Railroads. A departure from

this procedure—for example, insistence by each in-

terline carrier upon immediate payment by the

8 Judge Adams specifically agreed with the majority’s analysis

that a trust relationship had been established on the facts of Penn

Central. Id. at 532-33. The analysis set forth in his concurring

opinion was intended to obviate “the possibility that, in another

case, the absence of any of the traditional indicators of a trust

relationship” would require a contrary holding to the majority

decision. Id. —

shipper—might well undermine the entire system of

interline rail transportation. At a minimum, it

would greatly impede the smooth and efficient func-

tioning of the through route network.

id. at 531-532.

Judge Adams accordingly concluded that interline

freight balances should be considered a sui generis mat-

ter in railroad bankruptcy proceedings and that the pre-

ferred position of interline railroads with respect to such

funds should be guaranteed as a matter of federal bank-

ruptcy law without the necessity of a common law trust

analysis. As concluded by Judge Adams:

Rather than merely invoking the hoary principles

of trust law to settle this case, I would treat the prob-

lem of interline freight and passenger accounts as a

sui generis matter. Having perceived Congress’ in-

tent in creating and maintaining a viable interline

rail system, it would be appropriate to hold that,

even in the absence of anything formally resembling

a “trust,” the interlines are entitled to a preferred

position with resnect to freight and passenger rev-

enues owed them by a railroad in reorganization.

Td. at 533.

The reasoning of the Third Circuit in Penn Central, as

set forth in both the majority opinion and concurring

opinion of Judge Adams, was followed by the Sixth Cir-

cuit in the Ann Arbor case. In Ann Arbor, the issue

was identical to that raised in Penn Central: whether

pre-bankruptcy interline freight balances in the posses-

sion of a bankrupt carrier were the property of the in-

terline carriers on whose behalf the funds were collected

or were property of the bankrupt’s estate that must be

made available to the bankrupt’s general creditors. The

Sixth Circuit, specifically noting Judge Adams’ finding

that “the very existence of the national rail transporta-

tion system is dependent upon the interconnecting rail

service” (623 F.2d at 482), emphatically endorsed the

“trust” rule established in Penn Central:

We are persuaded by the reasoning of the court in

the Trust Funds Case [Penn Central] and the con-

curring opinion of Judge Adams in which Circuit

Judge Weis joined. .. . There was only temporary

commingling of the funds which accounts for the

reason that no res existed. . . . Furthermore, there

was no intent to establish any debtor-creditor rela-

tionship and no interest was payable on the com-

mingled funds. . . . Actually, no equities exist in

favor of the Trustee. We find no logic in the con-

tention that one bankrupt railroad may retain funds

belonging to another interline railroad, whether or

not in bankruptcy, which the collecting carrier was

required to pay under the established practice and

procedure required by the Interstate Commerce Com-

mission, the Regional Rail Reorganization Act and

the rules of the Association of American Railroads.

Id. at 482.

C. The Decision of the Seventh Circuit Below Treating

Interline Freight Balances as “General, Unsecured

Debts” of the Bankrupt Conflicts with the Third

and Sixth Circuit Decisions and Will Create Serious

Problems for the Railroad Industry if Not Reversed

In rejecting the claim of the Iowa Railroad Trustee

in the instant case that the approximately $1.4 million

in interline freight balances due the petitioning railroads

(and the approximately $2.6 million in interline freight

balances due other interlining railroads) should be treated

as mere unsecured debts of the Iowa rather than as trust

funds (to the extent still in the possession of the Iowa),°

*The district court found that approximately $2.8 million in

funds in the possession of the Iowa at the time of its bankruptcy

petition was attributable to freight charges collected by the Iowa

on behalf of interline carricrs. In addition, the district court

imposed a trust on certain locomectives and other assets of the Iowa

bettie

the district court below relied squarely on the Third

Circuit decision in Penn Central (particularly the con-

curring opinion of Judge Adams) and the Sixth Circuit

decision in Ann Arbor. The district court thus found

that Iowa Railroad “simply acted as a collection agent for

Union Pacific due to exigencies of the interline freight

revenue process” and that the “facts weigh against the

existence of a debtor/creditor relationship respecting

[Iowa] and these monies.” Pet. App. at 42a. The dis-

trict court further noted that the treatment of the in-

terline freight balances as trust funds should not be

solely dependent on whether the “traditional requisites

of a trust are present” but rather should turn on the fact

that the interlines should be held entitled to a preferred

position with respect to interline funds in the interest

ef ensuring the integrity of the interline rail system.

Pet. App. at 43a-44a. As concluded by the district

court:

There is simply no sensible argument that can be

made that these interline freight revenues are prop-

erty of IRRC. Principles of common sense and ele-

mental justice require that the railroad which earned

this money be declared to be its owner. Union Pa-

cific should not be relegated to the status of a mere

general creditor hoping to share some small portion

of the money it earned with its capital and its labor.

Rather, Union Pacific is entitled to be treated as a

beneficiary with respect to these interline freight

revenues which I hold are trust funds in the hands

of IRRC.

Pet. App. at 44a.

In reversing the district court in its decision below,

the Seventh Circuit rejected the lewer court’s reliance

on “principles of common sense and elemental justice”

and emphasized that the rights of the interline railroads

that were purchased with interline freight revenues. Pet. App. at

40a, 49a.

to the freight balances at issue “turns on property rights,

not notions of equity” (Pet. App. at 4a)."” The Seventh

Cireuit then found that the interline railroads had “three

possible sources of property rights: federal statutory

law, federal interests sufficiently strong to demand crea-

tion of federal common law, and state law” (Pet. App.

9a)."" After finding that neither the Interstate Com-

merce Act nor regulations of the Interstate Commerce

Commission specifically required the treatment of inter-

line freight balances as trust funds (Pet. App. 10a-1la),

the Seventh Circuit turned its attention to whether the

federal interests at stake warranted the treament of

interline freight balances as trust funds as Judge Adams’

concurring opinion in Penn Central and the Sixth Cir-

cuit in Ann Arbor had found.

Based on its independent assessment regarding the

economic interests at stake and the potential impact upon

the national rail system of failing to accord connecting

carriers a property right in interline freight balances

earned through their interline operations, the Seventh

Circuit expressly rejected the conclusions reached by the

Third and Sixth Circuit opinions that “the federal inter-

est in a unified national rail system required interline

balances to be treated as trust funds.” Pet. App. 9a. In

so doing, the Seventh Circuit found it “at most a ques-

tion of convenience” should failure to treat interline

10'The Seventh Circuit also found that the interline railroads

had no special equitable claim to the interline balances at issue on

the ground that the trade creditors of the Iowa, just as the inter-

line carriers, “contributed essential ingredients of the movement

of the freight and earned their right to payment.” Pet. App. at 4a.

The Seventh Circuit found that no provision of the Bank-

ruptcy Code (which was overhauled in 1978 subsequent to the Penn

Central decision) specifically dealt with the status of interline

freight balances. The Seventh Circuit therefore found that whether

such balances constituted trust funds must accordingly be deter-

mined by the governing law in existence prior to the 1978 Bank-

ruptcy Code. Pet. App. 4a-9a.

balances as trust funds lead railroads to bill customers

separately (Pet. App. 12a) and further noted that the

interline carriers’ risk of nonpayment was “small” and

could be protected against without separate billing. As

found by the Seventh Circuit:

Railroads need security, not complete assurance.

The system of interline balances assures payment of

most debts automatically: the Iowa “pays” the Union

Pacific by providing transportation services when the

Union Pacific is the originating carrier. Only the

nets become debts. The risk railroads take is a cor-

respondingly small portion of their revenues.

Railroads have ways to deal with the risk of de-

fault by collecting carriers on the balances remain-

ing after the automatically setoffs. One is to scrutin-

ize the credit-worthiness of their trading partners,

just as firms ordinarily do. . . . Collecting carriers

with shaky finances may be required to post bonds,

secure letters of credit, or find other ways to assure

that they turn over receipts to the railroads that

provide part of the transportation. The economy

teems with such devices. .. .

Pet. App. at 13a. The Seventh Circuit also noted that

there are other industries which rely upon interline trans-

fers (e.g., the airline industry and the motor carrier

industry! and that “in none of these businesses are sums

paid to the originating carrier treated as trust funds for

the subsequent carriers.” Pet. App. 14a.”

With respect to whether the requisites of an express

or implied trust relationship were established by the

12 The Seventh Circuit specifically noted that, unlike rail carriers,

no statute requires air carriers to enter into interline agreements

with other air carriers. Pet. App. 14a. The Seventh Circuit failed

to note, however, that unlike rail carriers, who are required to

enter into through arrangements with other rail carriers, a motor

carrier of property may refuse to enter into a through arrange-

ment with a motor carrier that is delinquent in its interline settle-

ments. 49 U.S.C. 10705(h).

interline freight settlement procedures used by the Iowa

and its connecting lines in the instant case, the Seventh

Circuit found that the issue was a question of state law

rather than “general common law” (‘which the court

deemed consistent with the Third Circuit’s analysis in

Penn Central)". The Seventh Circuit, however, in re-

sorting to the identical analysis under the Restatement

trust principles as made by the Third Circuit in Penn

Central, found that no trust relationship could be im-

plied because, unlike the facts in Penn Central, the Iowa

paid by the “bill and voucher” methed rather than

through the use of sight drafts. As found by the Seventh

Circuit:

We are sympathetic to the contention that the

AAR’s accounting rules, coupled with the system of

sight drafts that give creditor lines effective domin-

ion over the funds, is the practical equivalent of a

declaration of trust. The trouble from the interline

creditors’ perspective is that the Iowa did not par-

ticipate in the AAR’s system for more than a few

months. During the period at issue in this case it

used the bill-and-voucher system, under which inter-

line railroads had no more control over payment than

did the Iowa’s suppliers of diesel fuel.

Pet. App. at 19a-20a."*

3 In Penn Central, however, the Third Circuit looked to “tradi-

tional common law trust principles” as a matter of federal law to

determine whether a trust relationship existed. 486 F.2d at 524:

see also, In re Lehigh and New England Ry. Co. (Appeal of Central

Jersey Indus., Inc.), 657 F.2d 570, 576 (3d Cir. 1981) (noting that

issues involving the settlement of interline freight accounts “im-

plicate wholly national concerns and therefore should be governed

by federal law’).

The Seventh Circuit also noted that “when billed, [the Iowa]

paid slowly (60-90 day delays were common)” and that other rail-

roads apparently did not protest the slow payment. Pet. App. at

20a. The Seventh Circuit, however, viewed these facts as illustra-

tive of the “bill and voucher” system rather than as outcome-

determinative in themselves (i.¢e., as demonstrating “laches”): its

A te a

The Seventh Circuit also rejected the possibility that a

“constructive trust” existed, finding no “unjust enrich-

ment” on behalf of the lowa’s trade creditors. As found

by the court:

There could be a decent claim of unjust enrichment

if we had to decide whether the Iowa’s stockholders

or the interline railroads should get the money re-

maining in the Iowa’s coffers; it would unjustly en-

rich the stockholders to receive this money. But that

is not the problem. The question is whether the in-

terline railroads get all of the money and the sup-

pliers of diesel fuel (and tort creditors) none, or

whether all creditors share the inadequate funds... .

All of the Iowa’s creditors have supplied valuable

goods and services; all have been stiffed. No case of

which we are aware employs the idea of the “con-

structive trust” to settle priorities among bona fide

business suppliers. . . .

Pet. App. at 22a.

As is apparent, the Seventh Circuit decision directly

conflicts with the reasoning and conclusions of the Third

and Sixth Cireuits with respect to the trust status of

interline freight balances and in so doing turns estab-

decision denies trust status to all interline freight balances settled

under the “bill and voucher” method regardless of the regularity of

the settlement period. Indeed, the per se treatment accorded the

“bill and voucher” settlement method is highlighted by the Seventh

Cireuit’s reference in its decision to Southern Ry. v. United States,

306 F.2d 119 (5th Cir. 1962). Pet. App. at 20a. In Southern Ry., a

case cited by the Penn Central majority as supporting its trust

analysis (486 F.2d at 525-26), the Fifth Circuit in fact agreed with

the petitioning interline railroad that the interline freight balances

at issue “acquire[d] a ‘trust’ character” when collected and mingled

(306 F.2d at 125), but found, apparently on a laches theory, that

because the carrier had waited for over a year to demand payment,

the interline balance claim was not “entitled to preference” over-

certain tax claims. /d. In contradistinction to Southern Ry, the

Seventh Circuit in the instant case denied “trust” status to the

interline balances at issue ab initio.

lished law, policy and equitable considerations on their

head. In addition, the Seventh Circuit’s attempt to be-

little the impact of its decision on the railroad industry

is totally unsound.

First, although the Seventh Circuit attempts to dis-

tinguish its holding on the ground that the “bili and

voucher” settlement method was used in the instant case

rather than the “sight draft’? method employed in Penn

Central, the purported distinction between the two cases

is essentially makeweight. There is no escaping the fact

that, rather than predicating the existence of a common

law trust relationship on the facts that the Iowa Rail-

road was acting as “an agent of money due and owing

the other railroads;” that no interest was charged the

Iowa on funds collected and retained for other railroads

as would imply a debtor/creditor relationship; and that

the Iowa could not as a practical matter be expected to

segregate the freight charges collected on behalf of other

railroads in the context of the interline railroad system

(factors which the Third Circuit expressly relied upon in

finding a trust relationship (468 F.2d at 523)), the

Seventh Circuit instead seeks to impose, at a minimum,

the additional general requirement that the interline

railroads be concomitantly provided “effective dominion”

over ithe interline freight balances before a trust relation-

ship’may be implied. Such requirement, which assigns

to unprotected status the over $46 million per month in

net interline revenue payable to Class I railroads through

the “bill and voucher” settlement method, simply can-

not be squared with either the rationale used by the

Penn Central majority or with general trust principles.

There is absolutely no requirement under established

trust principles that a trust relationship be predicated

on a finding that the beneficiary of a trust possess “effec-

tive dominion” over the funds held in trust. Indeed, as

the Third Circuit majority decision itself notes, Penn

Central never in fact parted with ultimate dominion over

inert tis ss

the interline funds it collected: Penn Central stopped

payment on the sight drafts drawn by the other interline

carriers when presented. The Seventh Circuit’s reason-

ing, as well as its effective dismissal of the other support-

ing grounds relied upon by the Penn Central majority in

finding a trust relationship, thus strike at the very

foundation of the Penn Centrel decision and cast in un-

certain light not only the status of interline freight

balances settled under the “bill and voucher” method, but

also those settled under the “sight draft’ system (the

“trust” status of which the court, although terming it-

self “sympathetic”, effectively reopened as an unsettled

question.

Second, with respect to the policy issues presented, the

Seventh Circuit, rather than finding that interline freight

balances should be treated as trust funds in the interests

of ensuring the viability of the unitary national rail sys-

tem as the concurring opinion of Judge Adams in Penn

Central and the Sixth Circuit decision in Ann Arbor

held, expressly found that such policy considerations were

insufficient to require the imposition of a trust relation-

ship as a matter of federal common law. In so holding,

as the Seventh Circuit itself specifically notes, it is in

direct conflict with the opinions cited. Pet. App. at 9a,

13a.

Indeed, the Seventh Circuit’s attempts to dismiss the

overriding policy arguments supporting the imposition

of a trust relationship as a matter of federal common

law not only create an express conflict in the circuits on

the issue, but also serve to clearly indicate the deficiencies

of the Seventh Circuit’s reasoning. It is simply incompre-

hensible for the Seventh Circuit to have concluded, as it

did, that the absence of a system of unitary billing for

interline movements “is at most a question of conven-

ience.” Pet. App. at 12a. The sheer volume of additional

paperwork that would be required, as well as the neces-

sity of each carrier ensuring the actual payment to it of

“pre-paid” charges at each junction point involved, has

the potential to create not only complexity, but also havoc

in interline scheduling. In fact, the Seventh Circuit does

not even so much suggest in its opinion how the national

rail system, which is effectively unique in that its “very

existence . . . is dependent upon the interconnecting rail

service (Ann Arbor, 623 F.2d at 482)” could even begin

to function efficiently should all carrier participants to

an interline movement insist on separate billing. Indeed,

as other courts who have examined the issue have cor-

rectly concluded, the unitary billing system for interline

freight accounts presents a “convenience so great as to

be imperative... .” Atlantic Coast Line R. Co. v. Penn-

sylvania & Co., 12 F. Supp. 720 (E.D. Pa. 1935), quoted

in Penn Central (Adams, concurring), 486 F.2d at 532,

2%,

In addition, the Seventh Circuit’s suggestions for al-

ternative “security” arrangements that could be adopted

by carriers for interline freight balances in the absence

of trust treatment of such funds is similarly short-

sighted. At bottom, all such arrangements must reflect

the absolute statutory requirement that rail carriers, un-

like air or motor carriers, must deal with connecting

earriers in establishing through routes (49 U.S.C. 10705

(a)(1)) and that an individual carrier cannot simply

insist on particular “security” arrangement that it deems

most beneficial to its interests: a recalcitrant carrier can

effectively insist on separate billing based on its statutory

right to participate in a through movement. In the ab-

sence of the imposition of a trust relationship between

the collecting carrier and the other interline participants,

therefore, the system for settlement of interline freight

balances would likely be far more complex—and poten-

tially far less efficient—than the system currently in

place.

Finally, the Seventh Circuit’s conclusion that there

would be no “unjust enrichment” should interline freight

1 2p MOS

balances in the possession of the Iowa be made available

for the benefit of the Iowa’s general creditors—and there-

fore no predicate upon which the court could impose a

“constructive” trust on behalf of the interline carriers

that earned the revenues—totally reverses the equities

presented. The Iowa Railroad and its connecting car-

riers do not lose their status as wholly independent car-

riers incurring wholly distinct commercial obligations for

their respective portions of the interline freight move-

ments performed on behalf of shippers. There simply is

no basis whatsoever—particularly an equitable one as

the Seventh Circuit found—for considering that a gen-

eral creditor of the Iowa—who only supplied the Iowa

with fuel and equipment—would have an equal claim to

interline funds earned by the Iowa’s connecting carriers

—for which the connecting carriers expended their own

fuel and resources and to which they would indisputably

be legally entitled in the absence of the Iowa’s bank-

ruptcy—for the settlement of the Jowa’s debts. The gen-

eral creditors have no more “equitable” claim to interline

freight balances in the hands of a bankrupt carrier at the

time of its bankruptcy petition than they would if they

attempted to obtain such funds after settlement directly

from the interline roads who earned them—a claim of

“equitable” entitlement that can only be viewed as out-

rageous.

Indeed, the Seventh Circuit’s position regarding the

equities of according trust status to interline freight

balances has been flatly rejected by both the Third and

Sixth Circuits. As found by the Penn Central majority:

The AAR interline accounting system is in essence

. a system by which one railroad collects monies

owed by shippers to both itself and other railroads.

The monies collected belong only in part to the col-

lecting railroad; as to monies owed other railroads,

the collecting railroad serves merely as a receiving

and transmitting agent. A common sense interpre-

tation of this system would indicate that funds col-

lected by one railroad for and in behalf of another

railroad are held in trust by the collecting railroad

until the monies are transmitted... .

486 F.2d at 523-24. As also flatly concluded by the Sixth

Circuit in Ann Arbor in rejecting the Trustee’s argu-

ment that pre-bankruptcy interline freight balances should

be made available to the bankrupt’s general creditors:

“TN]o equities exist in favor of the Trustee... .” 482

F.2d at 482.

Because the Seventh Circuit’s denial of trust status to

interline freight balances collected by one railroad on

behalf of another is contrary to sound considerations of

law, policy and equity, departs from settled practice and

has the potential to cause serious disruption to the ef-

ficient functioning of the national rail system, the Sev-

enth Circuit’s decision warrants reversal by this Court.

In addition, because the decision below directly conflicts

with decisions of the Third and Sixth Circuits treating

interline freight balances as trust funds as a matter of

federal law, review by this Court is necessary to ensure

a uniform federal rule regarding the status of interline

freight balances. As specifically found by the Third Cir-

cuit, “i]t is manifest that uniformity is required in the

manner and means by which interline freight accounts

are balanced.” In re Lehigh and N. E. Ry. Co., 657

F.2d 570, 575 (8rd Cir. 1981).

CONCLUSION

For the foregoing reasons the Court should grant the

petition for certiorari.

Respectfully submitted,