In re Michigan Interstate Ry. Co., Inc.
| Decision Date | 17 June 1988 |
| Docket Number | Bankruptcy No. 84-01043-R. |
| Citation | 87 BR 921 |
| Parties | In re MICHIGAN INTERSTATE RAILWAY COMPANY, INC. d/b/a Ann Arbor Railroad System, Debtor. |
| Court | U.S. Bankruptcy Court — Eastern District of Michigan |
Patrick Hackett, Bloomfield Hills, Mich., for movant.
Daniel Gosch, Detroit, Mich., for respondent.
The law firm of Frasco, Hackett & Mills has filed a claim in the amount of $92,269.20, for legal fees and expenses. Attorney Patrick E. Hackett filed an additional claim in the amount of $3,279.00, for arbitration fees and expenses. Both claimants seek an equitable priority pursuant to 11 U.S.C. § 1171(b).1 The trustee has filed objections to claimants' requests for priority treatment; the trustee does not object to the amounts of the claims.
The claimants contend that because the following three criteria are met, their claims are entitled to priority:
(1) The claim represents a current operating expense, necessarily incurred.
(2) The claim was incurred within six months before the reorganization petition was filed.
(3) The 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 railroad's general credit.
In support of their assertion that these are the only criteria that they are required to fulfill in order for their claims to be given priority, the claimants cite Miltenberger v. Logansport C. & S.W. Ry. Co., 106 U.S. (16 Otto) 286, 1 S.Ct. 140, 27 L.Ed. 117 (1882); and In re Boston and Maine Corp., 634 F.2d 1359 (1st Cir.1980), cert. denied, 450 U.S. 982, 101 S.Ct. 1518, 67 L.Ed.2d 817 (1981).
The trustee agrees that these claims were incurred within the six months before the petition was filed. However, the trustee denies that the services resulting in the claims were current operating expenses, necessarily incurred. The trustee also denies that the services were delivered with the expectation that they would be paid for out of current operating revenues.
The trustee further contends that the claimants are required to establish one of two additional elements. If the claimants are seeking relief under the Six Months Rule, then they are required to establish the diversion of a fund of money to secured creditors, from which they might otherwise have been paid. In support, the trustee cites Fosdick v. Schall, 99 U.S. (9 Otto) 235, 25 L.Ed. 339 (1879); In re New York, New Haven and Hartford Railroad Co., 278 F.Supp. 592 (D.Conn.1967), aff'd, 405 F.2d 50 (2d Cir.1968), cert. denied, 394 U.S. 999, 89 S.Ct. 1592, 22 L.Ed.2d 776 (1969); In the Matter of Penn Central Transp. Co., 458 F.Supp. 1234 (E.D.Pa.1978), aff'd, 596 F.2d 1154 (3d Cir.1979); In re Penn Central Transp. Co., 467 F.2d 100 (3d Cir. 1972). Alternatively, if the claimants are seeking relief under the Necessity of Payment Rule, then they are required to establish that payment of these claims is necessary to maintain the railroad's business. In support, the trustee cites Miltenberger, above; and Gregg v. Metropolitan Trust Co., 197 U.S. 183, 25 S.Ct. 415, 49 L.Ed. 717 (1905). The parties appear to agree that if claimants are required to establish either of these elements, they are unable to do so.
Therefore, the three issues before the Court are:
(1) Did the services that resulted in these claims constitute current operating expenses, necessarily incurred?
(2) Did the claimants expect payment for these services out of current operating revenues?
(3) Are the claims required to establish either a diverted fund or necessity of payment?
In support of their contention that the legal and arbitration services represented in the claims at issue were necessary current operating expenses, the claimants submitted an affidavit from Patrick E. Hackett. This affidavit states:
The claimants also note that after the reorganization petition was filed, bills for identical and similar services have been paid as administrative services. This observation is supported in paragraphs 7 and 8 of the Hackett affidavit.
The trustee argues that the legal and arbitration services were not indispensable to the continued operation of the railroad, in the same way as fuel expenses, Burnham v. Bowen, 111 U.S. 776, 4 S.Ct. 675, 28 L.Ed. 596 (1884), or repair expenses, Johnson Fare Box Co. v. Doyle, 250 F.2d 656 (2d Cir.1958), cert. denied, 357 U.S. 938, 78 S.Ct. 1385, 2 L.Ed.2d 1551 (1958). See also Miltenberger v. Logansport C. & S.W. Ry. Co., above. The trustee's argument is not supported by an affidavit.
The Court concludes that the Hackett affidavit does establish that the legal and arbitration services were necessary to keep the railroad running. A fair portion of the legal services, and all of the arbitration services, were delivered in connection with the resolution of the railroad's dispute with the Michigan Department of Transportation over continued subsidy payments and other contractual obligations. It must be concluded that if these claimants had not performed those services, the subsidy payments would have ceased, to the great detriment of the railroad.
The other legal services were delivered in connection with other litigation, such as personal injury suits, collection actions, union contract disputes, and employee claims. The Court must likewise conclude that these services were also necessary to the continued operation of the railroad. In the current era, legal services are as indispensable to the operation of a railroad as fuel supplies and repair services. The importance of legal services, especially in a failing business2, is amply demonstrated in the bankruptcy priority given to post-petition expenses for legal services pursuant to 11 U.S.C. §§ 507(a)(1), 503(b)(3) and (4), and 330(a).
Accordingly, the Court concludes that the claimants have established that the services resulting in their claims were necessary to the continued operation of the railroad.
The claimants assert that when they delivered the services at issue, they expected payment from current operating revenues. This assertion is again supported in the Hackett affidavit:
The trustee notes that this element has been called "illusory." In re Boston and Maine Corp., 634 F.2d at 1379. Specifically, the trustee argues that when these claimants delivered services, they must have been relying upon the railroad's general credit rather than its operating revenues, because in the period before the filing, the railroad took longer and longer to pay its bills generally, and the claimants' bills in particular. In support, the trustee cites Lackawanna Iron & Coal Co. v. Farmers' Loan & Trust Co., 176 U.S. 298, 20 S.Ct. 363, 44 L.Ed. 475 (1900); Dictaphone Sales Corp. v. Powell, 77 F.2d 795 (4th Cir.1935); and In re New Hope and Ivyland Railroad Co., 353 F.Supp. 608 (E.D.Pa.1973). Again, the trustee's position is not supported by an affidavit.
In Southern Ry. v. Carnegie Steel Co., 176 U.S. 257, 20 S.Ct. 347, 44 L.Ed. 458 (1900), the Supreme Court indicated that in each case, this issue must be determined from a review of all relevant circumstances.
The Court concludes that the claimants have established that they delivered these services with the expectation that their payments would be made from revenues, and that the trustee's position lacks merit. As noted by the claimants, in the relevant pre-petition time period, the railroad had no credit at all upon which the claimants could have relied. The railroad's income consisted of customers' payments and the State's subsidy to cover expenses; however, even with the subsidy, the railroad lost large sums of money. Plainly, the claimants did not expect that their services were being delivered on the basis of the railroad's nonexistent credit; rather, they expected to be paid from ongoing receipts.
In its first statement of the Six Months Rule, the Supreme Court indicated that equity would allow a special priority for claims resulting from necessary pre-receivership expenses, when the railroad had diverted income from its current creditors to its mortgagees in an effort to avoid or delay foreclosure; the court noted that as a matter of practical reality, the mortgagees had impliedly agreed that current...
To continue reading
Request your trial