In re New York, New Haven and Hartford Railroad Co.

• Decision Date: 28 August 1967
• Docket Number: No. 30226.,30226.
• Citation: 278 F. Supp. 592
• Court: U.S. District Court — District of Connecticut
• Parties: In the Matter of the NEW YORK, NEW HAVEN AND HARTFORD RAILROAD COMPANY, Debtor.

278 F. Supp. 592

In the Matter of the NEW YORK, NEW HAVEN AND HARTFORD RAILROAD COMPANY, Debtor.

No. 30226.

United States District Court D. Connecticut.

August 28, 1967.

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

James Wm. Moore of New Haven, Conn., counsel for the Trustees of the Property of the Principal Debtor.

Robert W. Blanchette, Gen. Counsel, and Seymour N. Weinstein of New Haven, Conn., for New Haven R. R.

Robert W. Kent, Breed, Abbott & Morgan, New York City, for 4% First Mortgage Bondholders Committee.

Davis Polk Wardwell Sunderland & Kiendl, by Donald N. Dirks, John E. Zuccotti, New York City, for Alco Products, Incorporated.

Simpson Thacher & Bartlett, by Horace J. McAfee, New York City, for Manufacturers Hanover Trust Co. and A. Frederick Keuthen, Trustees of the First and Refunding Mortgage.

John Hunt, Cravath, Swaine & Moore, New York City, for Bethlehem Steel Corp., Westinghouse Electric Corp. and Westinghouse Air Brake Co.

Jerome H. Shapiro, New York City, for The New York Central Railroad Co. and The Pittsburgh & Lake Erie Railroad Co.

Richard McLaren, Carter, Ledyard & Milburn, New York City, for United States Trust Co., Trustee of the Harlem River Division Bonds.

Wilkie Bushby, Dewey, Ballantine, Bushby, Palmer & Wood, New York City, for Chase Manhattan Bank, Trustee for the Debtor's General Income Mortgage.

Charles W. Dibbell, Stoddard, Persky, Eagan & Cobey, New Haven, Conn., for City Products Corporation.

Peter Wilkinson, Robert Berta, Marsh, Day & Calhoun, Bridgeport, Conn., for The Connecticut Coal Co. and Frank McGuire & Son.

John W. Barnett, William J. Egan, Wiggin & Dana, New Haven, Conn., for Humble Oil & Refining Co., Gulf Oil Corp., Shell Oil Corp., T.A.D. Jones & Co., C. W. Blakeslee & Sons, Inc., The United Illuminating Co., Western Union Telegraph Co., Diesel Service, Inc., The Kerite Company, The Fred B. Clark Corp., Arthur Andersen & Co., American Brake Shoe Co., and Wyatt, Inc.

MEMORANDUM OF DECISION ON PETITION BY SIX MONTHS CREDITORS FOR PRIORITY

ANDERSON, Circuit Judge.

Several unsecured creditors of the New York, New Haven & Hartford Railroad, the Debtor in reorganization, have asserted claims to a priority in the assets of the Debtor based on the so-called "six months rule". For the reasons set forth below, these claims are not entitled to be paid on a priority basis which would have to be satisfied from the corpus¹ of the mortgaged property of the Railroad. Since it appears extremely unlikely that any assets other than corpus will be available after satisfaction of all claims prior to those of the mortgagees, it is unnecessary to make any further determination regarding six months claims at this time.

The "six months rule" was developed in railroad equity receiverships during the late nineteenth century.² By 1900 the rule had been stated and applied with sufficient inconsistency to cause the Supreme Court to remark:

"It is apparent from an examination of the above cases that the decision in each one depended upon its special facts. This court has uniformly refrained from laying down any rule as absolutely controlling in every case * * *."

Southern Railway Co. v. Carnegie Steel Co., 176 U.S. 257, 284-285, 20 S.Ct. 347, 358, 44 L.Ed. 458 (1900). With one exception,³ the principal decisions on the six months rule since 1900 have been made by lower federal courts,⁴ and these decisions have hardly clarified the situation. One court recently commented:

"The researches of counsel supplemented by such research as has been at my command have not resulted in the discovery of any principle which would account for all of the decisions or even enough of the decisions so that one might say that there was a principle behind them."⁵

In re Third Avenue Transit Corporation, 138 F.Supp. 623, 625 (S.D.N.Y.1955), aff'd per curiam, 230 F.2d 425, (2 Cir. 1956). In construing the rule at the present time, ambiguities must generally be resolved against those claiming the benefit of the rule:

"The so-called six months' priority rule is an invasion of the established contract rights of lienholders. As an invasion the rule should be strictly contained within narrow confines and limited to the purposes which brought it into being."

Johnson Fare Box Company v. Doyle, 250 F.2d 656, 657 (2 Cir.), cert. denied 357 U.S. 938, 78 S.Ct. 1385, 2 L.Ed.2d 1551 (1958).⁶

In broad terms the six months rule provides that claims for labor, supplies and material furnished to the debtor-railroad shortly before reorganization shall to a certain extent be afforded a priority in the debtor's assets. It has been generally held that certain requirements must be met in order for the rule to apply:

(1) The claim must have accrued within a reasonably short period prior to reorganization (usually six months). Southern Railway Co. v. Carnegie Steel Co., supra, 176 U.S. at 292, 20 S.Ct. 347.

(2) The claim must be for a current expense in the ordinary operation of the railroad necessarily incurred to keep it running. Burnham v. Bowen, 111 U.S. 776, 780, 4 S.Ct. 675, 28 L.Ed. 596 (1884).

(3) The claimant, when furnishing labor, supplies, or material, must have relied on the railroad's current earnings for payment of his claim, and not on the railroad's general credit. Southern Railway Co. v. Carnegie Steel Co., supra 176 U.S. at 285, 20 S.Ct. 347.

Guaranty Trust Co. v. Albia Coal Co., 36 F.2d 34 (8 Cir. 1929); FitzGibbon, The Present Status of the Six Months' Rule, 34 Colum.L.Rev. 230, 235-236 (1934).⁷

The Supreme Court's first statement of the rule, Fosdick v. Schall, 99 U.S. 235, 25 L.Ed. 339 (1879), remains as clear as anything thereafter handed down:⁸

"The business of all railroad companies is done to a greater or less extent on credit. This credit is longer or shorter, as the necessities of the case require; and when companies become pecuniarily embarrassed, it frequently happens that debts for labor, supplies, equipment and improvements are permitted to accumulate, in order that bonded interest may be paid and a disastrous foreclosure postponed, if not altogether avoided. In this way the daily and monthly earnings, which ordinarily 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 the current receipts before he has any claim upon the income. If for the convenience of the moment 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 * * *

If it appears in the progress of the cause that bonded interest has been paid, additional equipment provided, or lasting and valuable improvements made out of earnings which ought in equity to have been employed to keep down debts for labor, supplies and the like, it is within the power of the court to use the income of the receivership to discharge obligations which, but for the diversion of funds, would have been paid in the ordinary course of business."

* * * * * *

"The power rests upon the fact, that in the administration of the affairs of the company the mortgage creditors have got possession of that which in equity belonged to the whole or a part of the general creditors. Whatever is done, therefore, must be with a view to a restoration by the mortgage creditors of that which they have thus inequitably obtained. 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." Emphasis added.

99 U.S. at 254, 25 L.Ed. 339. The rationale of the rule as stated in Fosdick v. Schall is an equitable distribution of the railroad's operating revenues, to which the Court says the mortgagees "impliedly agree".⁹ 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.¹⁰

The two basic questions raised by the claims presently made are: (1) does the financial history of the New Haven Railroad from January 1, 1961, show that there is presently, in the words of the Fosdick case, "a current debt fund" (later referred to as "a current expense fund") out of which the petitioning six months creditors would be entitled to a priority payment; and (2) from what assets, if any, of the Debtor's estate may these priority payments be made?

Such a fund may arise out of one or more of the following: (a) current earnings in the sense of surplus earnings during the six months period and during the reorganization itself; (b) unmortgaged assets of the debtor; and (c) income diverted during the six months period or during the reorganization for the benefit of the mortgagees.

Although most of the Supreme Court cases have used the terms "current receipts" or "current earnings" as a source of this fund, several lower federal courts have used the word "income"....