In re Chicago, Missouri & Western Ry. Co.

• Decision Date: 18 July 1989
• Docket Number: No. 88 C 8009.,88 C 8009.
• Citation: 109 BR 308
• Court: U.S. District Court — Northern District of Illinois
• Parties: In re CHICAGO, MISSOURI & WESTERN RAILWAY COMPANY, an Illinois corporation, Debtor. CITICORP NORTH AMERICA, INC. and Heller Financial, Inc., Appellants, v. Daniel R. MURRAY, Trustee, Appellee.

109 B.R. 308 (1989)

In re CHICAGO, MISSOURI & WESTERN RAILWAY COMPANY, an Illinois corporation, Debtor CITICORP NORTH AMERICA, INC. and Heller Financial, Inc., Appellants, v. Daniel R. MURRAY, Trustee, Appellee.

No. 88 C 8009.

United States District Court, N.D. Illinois, E.D.

July 18, 1989.

Neal Wolf, Ross & Hardies, Chicago, Ill., for appellants.

Douglas Cassling, Jenner & Block, Chicago, Ill., for appellee.

MEMORANDUM OPINION AND ORDER

ASPEN, District Judge:

Daniel R. Murray, the Trustee of the Debtor, the Chicago, Missouri & Western Railway Company ("CM & W" or "Railroad"), applied to the Bankruptcy Court for permission to borrow up to approximately $14 million from agencies of the State of Illinois. The Trustee proposed to secure these loans by granting the state agencies a lien on the CM & W's assets that was senior to the liens of other creditors. The CM & W's primary creditors, Citicorp North America, Inc. and Heller Financial, Inc. ("Lenders"), objected to these so-called "priming" or "super-priority" loans, but Chief Judge John D. Schwartz of this district's Bankruptcy Court allowed the Trustee's application over their objections. In re Chicago, Missouri & Western Railway Co., 90 B.R. 344 (Bankr.N.D.Ill.1988). The Lenders now appeal. For the reasons set forth below, we reverse the decision of the Bankruptcy Court.

Background

Chief Judge Schwartz wrote an extensive, thoughtful and thorough opinion to accompany his order. The Lenders have not appealed his findings of fact, so we will rely on the Chief Judge's account here. The CM & W, a subsidiary of the Venango River Corporation ("Venango"), owns and operates a 631-mile railroad running between Chicago and Kansas City by way of St. Louis. The CM & W purchased the railroad, along with certain trackage rights and other assets, from the Illinois Central Gulf Railroad Company in April 1987. In order to finance the purchase, Venango arranged an $86,650,000 loan from the Lenders. In addition, the Lenders provided a revolving credit agreement, in the initial amount of $5 million, to finance the Railroad's operations. Both loans were secured by a security interest in all of the CM & W's real, personal and mixed property. Both loans were also highly leveraged; Venango, the CM & W's parent, contributed no more than $55,000 in equity.

From the outset, the CM & W failed to meet its operating projections and consequently posted substantial losses. The Lenders subsequently increased the revolving credit agreement, but to no avail. On April 1, 1988, less than one year after starting, the CM & W filed its petition for a railroad reorganization under Subchapter IV of the Chapter 11 of the Bankruptcy Code. 11 U.S.C. §§ 1161-1174. At the time of the petition, the CM & W owed the Lenders over $107 million.

The Trustee Daniel R. Murray¹ found that the CM & W would soon be cashless unless it could obtain additional funding. Because the Lenders refused to advance any further money for operations, the Trustee was forced to look elsewhere. He had to look no farther than Springfield, where he found three state agencies willing to enter into five separate loan agreements. Chief Judge Schwartz summarized the five loans this way.

1-3. From the Illinois Department of Transportation ("IDOT"), three loans or grants. One loan in the amount of $1,661,290 would finance track rehabilitation and improvements on the Chicago to Springfield corridor ("Amtrak Loan"); the second in the amount of $860,000 would provide partial funding for improvements in the Carrollton District; and the third in the amount of $414,000 would fund the construction of the Girard Interchange.

4. A one million dollar loan from the Illinois Department of Commerce and Community Affairs ("DCCA") to be used for working capital, and to create or retain jobs; and

5. A $10,000,000.00 dollar loan from the Illinois Development and Finance Authority ("IDFA"), to maintain and improve fixed assets and preserve jobs for CM & W employees and shippers.

Chicago, Missouri, 90 B.R. at 364. We will not repeat here the details of the loans, which are set out in the Bankruptcy Court's opinion. See id. at 350-55. It suffices to note that certain of the loans, especially the IDOT loans, have relatively loose repayment provisions and might better be described as grants. Nonetheless, under some, if not all, of the loans, the state's lien has the potential of becoming senior to the Lenders' lien. That is, to use the language of the Bankruptcy Court, the state loans have the potential of priming the Lenders' lien.

Because of the potential priming effect of the state loan, the Trustee was required under 11 U.S.C. § 364(d) to seek permission from the Bankruptcy court before entering into them. The Lenders objected to all of the loans. Before ruling on the other loans, and upon an emergency request by the Trustee, the Court entered an order authorizing the Trustee to enter into the $1 million DCCA loan and to grant DCCA a senior lien on all the CM & W's assets, except its accounts receivable and certain post-petition assets. The Court expressly reserved the Lenders' objections to the Trustee's other applications to incur secured debt. The Lenders have not appealed the order authorizing the DCCA loan.

On August 24, 1988, after an eight-day hearing, the Court entered Findings of Fact and Conclusions of Law, a Memorandum Opinion and an Order granting the Trustee preliminary authorization to enter into IDOT and IDFA loans.² Because the state loans were super-priority loans, the Court looked to the two requirements of section 362(d)(1): that the trustee is unable to obtain credit without giving a senior or equal lien and that there is "adequate protection" of the interest of the creditor whose lien is displaced. The Court concluded that the first requirement was met, because CM & W's Trustee could not obtain credit without the priming liens. Chicago, Missouri, 90 B.R. at 360 (Conclusion No. 40). The Court then went on to consider the more difficult issue of "adequate protection," a matter that we will discuss at great length below. The court noted that the Lenders were undersecured — that is, the value of the collateral securing the loans to the CM & W is less than the amount due. See id. at 359 (Finding No. 134). The Trustee argued that despite the senior liens, the Lenders' interest would be adequately protected, because the operation of the CM & W, along with the improvements to be financed by the loans would increase the value of the Lenders' collateral by no less than the total cost of the loans. The Court, however, ultimately rejected this position.

Though this position is not without merit, it is speculative. Absent the public interest, the proposition does not, as a matter of law, satisfy the requirements of adequate protection of the Lenders\' interest in the collateral. (For example, if the Debtor were a private manufacturing corporation, the offer of adequate protection made by the Trustee would be inadequate).

Id. (Finding No. 133); see also id. at 36-61 (Conclusion No. 41).

Nonetheless, the court concluded that in a railroad reorganization case, the public interest plays a role in the consideration of priming loans and modifies the requirement of adequate protection. In light of the public interest in keeping the CM & W, the Court concluded that Lenders' interest was adequately protected and allowed the priming loans. It is the consideration of the public interest that the Lenders challenge on appeal, and that we will consider presently.

Standard of Appellate Review

The Lenders do not explicitly challenge the Bankruptcy Court's findings of fact, although they tell us they disagree with many of them. They do, however, challenge that court's conclusions of law. A Bankruptcy Court's conclusions of law are to be reviewed under a de novo standard. In re Hilligoss, 849 F.2d 280, 281 (7th Cir.1988); In re Excello Press, Inc., 90 B.R. 335, 337 (N.D.Ill.1988) (Aspen, J.).

The Bankruptcy Code

Section 364(d) of the Bankruptcy Code, 11 U.S.C. § 364(d), sets out the requirements for super-priority lending:

(d)(1) The court, after notice and a hearing, may authorize the obtaining of credit or the incurring of debt secured by a senior or equal lien on property of the estate that is subject to a lien only if —

(A) the trustee if unable to obtain such credit otherwise; and

(B) there is adequate protection of the interest of the holder of the lien on the property of the estate on which such senior or equal lien is proposed to be granted.

(2) In any hearing under this subsection, the trustee has the burden of proof on the issue of adequate protection.

In turn, section 361 defines, more or less, the concept of adequate protection:

When adequate protection is required under section 362 or 363, or 364, of this title of an interest of an entity in property, such adequate protection may be provided by —

(1) requiring the trustee to make a cash payment or periodic cash payments to such entity, to the extent that the stay under section 362 of this title, use, sale or lease under section 363 of this title, or any grant of a lien under section 364 of this title results in a decrease in the value of such entity\'s interest in such property;

(2) providing to such entity an additional or replacement lien to the extent that such stay, use, sale, lease, or grant results in a decrease in the value of such entity\'s interest in such property; or

(3) granting such other relief, other than entitling such entity to compensation allowable under section 503(b)(1) of this title as an administrative expense, as will result in the realization by such entity of the indubitable equivalent of such entity\'s interest in such property.

These provisions apply generally to the administration of bankruptcy cases. As may be observed, neither section 361 nor section 364(d) makes any mention of the public interest, and it seems clear that if the CM & W were a...