Chicago, M., St. P. and P. R. Co., Matter of

Decision Date02 January 1980
Docket Number79-1675,79-1683 and 79-1698,Nos. 79-1494,s. 79-1494
Citation611 F.2d 662
PartiesBankr. L. Rep. P 67,264 In the Matter of CHICAGO, MILWAUKEE, ST. PAUL AND PACIFIC RAILROAD COMPANY, Debtor, Consolidated Appeals of: Continental Illinois National Bank and Trust Company of Chicago, as indenture trustee; Harris Trust and Savings Bank, as indenture trustee; The First National Bank of Chicago, as indenture trustee; and Girard Bank, as indenture trustee, Chicago, Milwaukee, St. Paul and Pacific Railroad Company, as debtor, and Chicago Milwaukee Corporation, as shareholder, Stanley E. G. Hillman, as trustee.
CourtU.S. Court of Appeals — Seventh Circuit

Susan Getzendanner, Mayer, Brown & Platt, Chicago, Ill., for appellant.

John W. Rowe, Isham, Lincoln & Beale, Chicago, Ill., for trustee.

Henri F. Rush, Associate Gen. Counsel, ICC, Washington, D.C., Thomas J. Brewer, Special Asst. Atty. Gen., Seattle, Wash., William G. Mahoney, Washington, D.C., Douglas N. Owens, Asst. Atty. Gen., Olympia, Wash., for intervenors.

Before FAIRCHILD, Chief Judge, and SWYGERT * and TONE, Circuit Judges.

PER CURIAM.

These are appeals from orders of the district court in a railroad reorganization proceeding under Section 77 of the Bankruptcy Act, 11 U.S.C. § 205. 1 Two orders permitted the Reorganization Trustee, Stanley E. G. Hillman 2 (hereinafter Trustee) to borrow money in order to operate the railroad. A third order denied the request of the Trustee for an embargo suspending operations by the Trustee over a major portion of the lines operated by the Debtor railroad, the Chicago, Milwaukee, St. Paul & Pacific Railroad Company (hereinafter Milwaukee Road or Debtor). 3 The Trustee asks us to rule that the district court erred in concluding that it lacked the authority to authorize the requested embargo. The principal appellants on the borrowings issue are the Debtor Milwaukee Road; its principal shareholder, Chicago Milwaukee Corporation; and the railroad's creditors 4 (hereinafter Indenture Trustees). These appellants ask that the orders authorizing the borrowings be reversed. The district court's refusal to grant the embargo is supported by the ICC; the states of Washington Montana, and Illinois; and several organizations, including representatives of workers employed by the Milwaukee Road. The borrowings orders are supported by the Commission and the State of Montana.

I

The Milwaukee Road is a railroad carrier engaged in interstate commerce over 9,800 miles of rail lines in the midwestern and western portions of the United States. Following three years of financial losses totalling approximately $100,000,000, it filed, on December 19, 1977, a petition for reorganization pursuant to Section 77 of the Bankruptcy Act. The district court approved the petition and appointed the Trustee on February 13, 1978. During 1978, the Debtor sustained losses of $82,000,000. The Milwaukee Road's current average cash deficit is approximately $500,000 per working day. If the railroad continues to operate its entire system for all of 1979, its estimated losses will be $157,000,000 for the full year. There is no dispute about the poor condition of the tracks and equipment, for which over half a billion dollars in maintenance has been deferred.

Since his appointment, the Trustee made available over $100,000,000 from borrowings or deferred obligations to keep the railroad operating, while studying the possibility of reorganization. The railroad's estimated liquidation value is $832,000,000. Its debts amount to $420,000,000, not including labor protection claims to be determined by the ICC in the event of abandonment, which may amount to hundreds of millions of dollars. The district court found the obligations of the Debtor may exceed the liquidation value. Assisted by an independent analysis of the railroad's financial position and potential by Booz, Allen and Hamilton, a management consultant firm, the Trustee concluded that the entire railroad could not be successfully reorganized, but that there was a possibility of successful reorganization of a smaller segment (hereinafter Miles City Sub Core or MCSC) of 2,500 miles running from Louisville through Chicago, Milwaukee, and the Twin Cities to Miles City, Montana.

The Trustee's petition to borrow $15,000,000 from the proceeds of sales of mortgaged assets held as security by the Indenture Trustees to operate the entire railroad system for the month of May was granted by the district court on May 4, 1979. The further petitions of the Trustee to embargo traffic on about 70% Of the rail lines operated by Debtor and to authorize priority loans of $20,000,000 to operate the Miles City Sub Core were heard by Special Master Milton H. Gray, appointed by the district court on May 10, 1979. The Special Master recommended approval of the embargo petition as consistent with the public interest and applicable statutes and further recommended approval of the $20,000,000 borrowings to operate the Miles City Sub Core. On consideration of the Master's report, the district court on June 1, 1979 indicated that the embargo proposal "would promote the public interest" but nevertheless rejected the proposal as a discontinuance of rail service, governed by the provisions of 49 U.S.C. §§ 10903-05, and a plan of reorganization, governed by 11 U.S.C. § 205. A discontinuance of rail service or a plan of reorganization would require approval by the Commission before being allowed to take effect. If the embargo had been ordered, the ICC stated that it was prepared, under 49 U.S.C. § 11125, to direct other carriers to render service to shippers affected by the embargo. The ICC's directive would have provided railroad service for over 99% Of the traffic in the territory subject to the embargo for up to 240 days. The trustee suggested that the embargo would not be detrimental to the public interest during the period of directed service because there would be no material reduction of service.

On June 19, 1979, the district court ordered the Trustee to issue trustee certificates in the total amount of $20,000,000 to continue service on the entire railroad. Addressing the fact that this borrowing would take priority over the rights of all existing creditors, the court indicated that "(w)e cannot find that the pending borrowing of an additional $20,000,000 will not erode the Indenture Trustee's security, but we do conclude as a matter of law that this will not unconstitutionally impair their contractual rights." The court further ordered the Trustee to immediately commence proceedings before the ICC to abandon the Milwaukee Road's entire rail system and to file a plan of reorganization of the Milwaukee Road with the district court. 5

II

We must first review the two orders authorizing borrowing upon terms which give the obligations priority over all other debts. Because of the dire financial condition of the Milwaukee Road, such priority borrowings in the form of trustee certificates are the only feasible sources of funds (except for the possibility of government subsidy). Bankruptcy Act Section 77(c)(3), 11 U.S.C. § 205(c)(3), permits the reorganization court to "authorize the trustee . . . to issue certificates . . . for such lawful purposes and upon such terms and conditions and with such security and such priority in payments over existing obligations, secured or unsecured, . . . as might in an equity receivership be lawful."

The problem presented here is to define the criteria that should govern the propriety of the district court's authorization of the priority borrowings under this provision. Appellants ask us to adopt a strict three-prong test for approval of issuance of trustee certificates. That test, cited in opinions of several circuits, requires a showing by the trustee that

(a) it is imperative to obtain the funds and they cannot be obtained from other sources,

(b) creditors will not be injured, and

(c) there is a high degree of likelihood that the Debtor can be reorganized within a reasonable time.

See In re Erie Lackawanna Railway Co., 563 F.2d 784 (6th Cir. 1977); In re Penn Central Transportation Co., 494 F.2d 270 (3d Cir.), Cert. denied sub nom. United States v. Bankers Trust Co., 419 U.S. 883, 95 S.Ct. 147, 42 L.Ed.2d 122 (1974) (hereinafter Columbus Option); In re Third Avenue Transit Corp., 198 F.2d 703 (2d Cir. 1952). We considered this test in a prior case and observed that even the circuits which formulated it have not applied it consistently and we determined that it is too restrictive. In In re Chicago, Rock Island & Pacific Railroad Co., 545 F.2d 1087 (7th Cir. 1976) (hereinafter Rock Island ), we stated:

The Third Avenue/Columbus Option test goes too far. It may force further deterioration of a debtor's situation by preventing interim borrowing which might otherwise be necessary and profitable. This may prevent reorganization altogether, resulting in liquidation with consequent detriment to both unsecured creditors and the public. The standard allows measures such as those taken in the instant case only in the most limited circumstances. We believe the Fifth Amendment does not require such a strict test.

545 F.2d at 1090.

Following our pronouncement in Rock Island, we are of the view that a more flexible, discretionary approach should be taken with respect to the financial straits of the Milwaukee Road.

Aside from the question whether the statute can be interpreted to permit the borrowings, the Indenture Trustees contend that the priority borrowings result in an uncompensated taking of the property of the Debtor and of the security creditors. To force a railroad to continue operations indefinitely at a loss in order that the public may be served is a violation of the Fifth Amendment rights of those who have a security interest in the enterprise. Brooks-Scanlon Co. v. Railroad Commission, 251 U.S. 396, ...

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