Southern Railway Company v. Flournoy

• Decision Date: 26 March 1962
• Docket Number: No. 8409.,8409.
• Citation: 301 F.2d 847
• Parties: SOUTHERN RAILWAY COMPANY, etc., et al., Appellants, v. Seaborn J. FLOURNOY, Trustee, Appellee. In the Matter of The ATLANTIC AND DANVILLE RAILWAY COMPANY, Debtor. In Proceedings for the Reorganization of a Railroad.
• Court: U.S. Court of Appeals — Fourth Circuit

301 F.2d 847 (1962)

SOUTHERN RAILWAY COMPANY, etc., et al., Appellants, v. Seaborn J. FLOURNOY, Trustee, Appellee In the Matter of The ATLANTIC AND DANVILLE RAILWAY COMPANY, Debtor. In Proceedings for the Reorganization of a Railroad.

No. 8409.

United States Court of Appeals Fourth Circuit.

Argued October 23, 1961.

Decided March 26, 1962.

COPYRIGHT MATERIAL OMITTED

W. R. C. Cocke, Norfolk, Va., and Thomas B. Gay, Richmond, Va., for Southern Ry. Co.

Russell T. Bradford, Norfolk, Va. (Denny, Valentine & Davenport, Richmond, Va., and Bradford & Guerry, Norfolk, Va., on brief), for Atlantic Coast Line R. R. Co. and Louisville and N.R. R. Co.

T. Howard Spainhour, Norfolk, Va., for Texaco, Inc.

Toy D. Savage, Jr., Norfolk, Va. (Thomas H. Willcox, Jr., and James Mann, Jr., Norfolk, Va., on brief), for National Bank of Commerce of Norfolk and Seaboard Citizens National Bank of Norfolk.

Thomas R. McNamara, Norfolk, Va. (Williams, Cocke, Worrell & Kelly, Norfolk, Va., and Jos. L. Kelly, Jr., Norfolk, Va., on brief), for Norfolk and W. Ry. Co. and Pennsylvania Railroad Co.

David M. Palley, New York City (L. S. Parsons, Jr., Norfolk, Va., on brief), for William Abrams, First Mortgage Bondholders and others similarly situated.

Before SOPER, BOREMAN and BRYAN, Circuit Judges.

ALBERT V. BRYAN, Circuit Judge.

Underlying mortgages of The Atlantic & Danville Railway Company — debtor in this reorganization proceeding^* — on the one hand, and unsecured accounts with other railroads and a fuel supplier, on the other hand, here vie for primacy of claim upon A. & D.'s mortgaged properties.

Resolution of the contentions is required to evaluate the possibility of reorganization. As the assets are not sufficient to satisfy all claims, the trustee has reported the debts of the railway with recommendations of preference. Exceptions were taken to the report and the decree of the District Court thereon. The correctness of the amounts of the debts listed is not disputed. The contestants — each maximizing its own realm of priority — respectively charge encroachment upon the mortgage security and over-extension of the mortgage lien.

The open accounts before us are for items furnished by connecting lines and by a single retailer of locomotive fuel. Superiority is asserted on the basis that the bills represent "business-operating" charges, that is, accounts for services, facilities and supplies absolutely necessary to the continued operation of A. & D. Admittedly the mortgages are valid, subsisting liens recorded long before incurrence of general creditors' claims.

The petition for reorganization was filed on January 19, 1960. At that time the railroad alleged its inability to meet its debts as they matured. Its financial condition proved to be roughly this: The first mortgage, dated July 1, 1949 and representing a refunded 3% debt, amounted to $2,007,800. Interest due thereon from July 1, 1949, to July 1, 1954 had been funded and deferred to July 1, 1999 by a supplemental indenture and amounted to $167,832. Subsequent interest in default since January 1, 1960 totalled $27,972. The second mortgage, also dated July 1, 1949 and evidencing a refunded 3% debt was in the sum of $1,143,750. Interest thereon from July 1, 1949 to July 1, 1954 aggregated $69,998 and had also been funded and deferred until July 1, 1999 by a supplemental indenture. Interest on the second mortgage was in default since January 1, 1960 and amounted to $11,666. Outstanding open accounts approximated $977,000. As of January 19, 1960 the railroad had cash in hand of only $49,146. Although the railroad has continued to operate since filing the petition, first under its own management and later under direction of the court trustee, its fiscal inadequacy continues.

It was suggested by one of the first mortgage bondholders that the railroad "is hopelessly insolvent and cannot be reorganized". He referred to the Trustee's Report No. 2 filed July 29, 1960 which averred that no plan of reorganization had been formulated though studies to that end would be assisted if submitted priorities could be ratified. The argument is that the railroad should at once be abandoned, and its assets sold and distributed to its creditors, implying also that at least consideration of priorities is premature and should await a decision of the practicability of any reorganization.

Without weighing the merits of these assertions, the court is of the opinion that the question of priorities is neither premature nor moot. Nothing found in the Bankruptcy Act, 11 U.S.C.A. § 1 et seq. or the Interstate Commerce Act, 49 U.S.C.A. § 1 et seq. forbids ascertainment of the order of liens in advance of a plan. The trustee testified in the hearings following submission of Report No. 2 that he did not feel the railroad could be run as an independent line. He inclined to the view that it might be profitable as a division of a larger system. Regimenting the liens, we think, would be helpful to a consideration of this possibility as well as of any plan of reorganization later proposed. It would be of aid, too, in the event of sale of the railroad's properties.

The statute, § 77 b, 11 U.S.C.A. § 205(b), directs that determination of the several issues here be made upon principles employed in the administration of equity receiverships:

"For all purposes of this section unsecured claims, which would have been entitled to priority if a receiver in equity of the property of the debtor had been appointed by a Federal court on the day of the approval of the petition, shall be entitled to such priority and the holders of such claims shall be treated as a separate class or classes of creditors. * *"

The expositive decisional law incorporated into the statute for fixing priorities as between general creditors and mortgages against the receivership properties lays down this fundamental principle: the mortgage is a paramount and exclusive lien upon the property therein conveyed as against a later unsecured or otherwise junior claim save for an exceptional and supreme equity. Kneeland v. American Loan & Trust Co., 136 U.S. 89, 97, 10 S.Ct. 950, 34 L.Ed. 379 (1890). The equity warranting deference of the mortgages to a general creditor must embrace the following elements:

(1) The account must cover an expense immediate to the continuance of railroad operation, not merely to its preservation: it must be a business-operating account; Virginia & Alabama Coal Co. v. Central R. & Banking Co., 170 U.S. 355, 368, 18 S.Ct. 657, 42 L.Ed. 1068 (1898);

(2) The account must have arisen within a reasonable time anterior to the institution of the trusteeship, generally established as 6 months; St. Louis & S. F.R. R. v. Spiller, 274 U.S. 304, 311, 47 S.Ct. 635, 74 L.Ed. 304 (1927);

(3) The claim must represent a debt contracted with the intention of the parties that current earnings would respond thereto, not simply a charge upon the general credit of the road; Southern Ry. v. Carnegie Steel Co., 176 U.S. 257, 296, 20 S.Ct. 347, 44 L.Ed. 458 (1900);

(4) The account must first have been given preference in any current debt fund over non-operating debts and mortgage payments; Fosdick v. Schall, 99 U.S. 235, 254, 25 L.Ed. 339 (1878); and

(5) There must have been such a pressing necessity for payment of the account that it was reasonably probable that nonpayment would result in suspension of the railroad's operations. Gregg v. Metropolitan Trust Co., 197 U.S. 183, 25 S.Ct. 415, 49 L.Ed. 717 (1905); Miltenberger v. Logansport Ry., 106 U.S. 286, 1 S.Ct. 140, 27 L.Ed. 117 (1882); Moore v. Donahoo, 217 F. 177, 182 (9 Cir. 1914).

While this sovereign equity prevails also as between general creditor and general creditor, and between general creditor and mortgagee, in the disbursement of earnings, it is now discussed in the graver context of general creditor versus the corpus of the mortgage security.

In this connection it has been said that until the existence of earnings and other immediate funds for that purpose — "current debt fund" — is ascertained, no ruling can be made on the issues before us. No such fund has been discovered and the mortgage trustees aver the complexities and expense of its determination would be prohibitive. Establishment of priorities is not thereby precluded, however. Regardless of who has the burden of proving the fund, we may proceed nevertheless in view of the conclusion we reach. If such funds later appear, they can be taken into account in settlement of general claims before resort is had to mortgage corpus.

The mortgagees — trustees and bondholders — concede the doctrine of priorities herein outlined only insofar as it governs priority among general creditors. They concede it partial force, too, as between mortgagees and business-operating creditors; they insist that the latter's preference avails only to the extent a diversion of earnings — from the general creditors for the benefit of the mortgagees — can be demonstrated.

But we think income diversion to mortgage is not the sine qua non of corpus invasion where there are found — as special circumstances — all elements constituting the pre-eminent equity. Some precedents are to the contrary. Others, admittedly, expound the principle only by way of obiter, since in their facts prior diversion or receivership income was sufficient to render unnecessary direct expropriation of corpus to a general creditor. Throughout them, however, runs the acknowledgment that, in special circumstances as heretofore set out, the general creditor partakes of liened capital assets ahead of the mortgagee.

We deraign the surmounting equity previously noted from the opinions of the Supreme Court framing it, and interstitial decisions of lower courts further applying it, in the absence of diversion. These cases develop the requisites of the priority whereby a business-operating general account overtops a mortgage lien. Initially, in Miltenberger v. Logansport Ry., supr...