Texlon Corp., In re, 669

CourtUnited States Courts of Appeals. United States Court of Appeals (2nd Circuit)
Citation596 F.2d 1092,5 Bankr.Ct.Dec. 109
Docket NumberD,No. 669,669
Parties, Bankr. L. Rep. P 67,109 In re TEXLON CORPORATION, Bankrupt. William OTTE, as Trustee in Bankruptcy of Texlon Corporation, Plaintiff- Appellee, v. MANUFACTURERS HANOVER COMMERCIAL CORPORATION, Defendant-Appellant. ocket 78-5027.
Decision Date20 April 1979

Morton L. Gitter, New York City (Otterbourg, Steindler, Houston & Rosen, P. C., New York City), for plaintiff-appellee.

Michael S. Landes, New York City (Hahn, Hessen, Margolis & Ryan, New York City, Gilbert Backenroth, New York City, of counsel), for defendant-appellant.

Before FRIENDLY, SMITH and MANSFIELD, Circuit Judges.

FRIENDLY, Circuit Judge:

This appeal from an order of the District Court for the Southern District of New York concerns a controversy between Manufacturers Hanover Commercial Corporation (MHCC) and the trustee in bankruptcy of Texlon Corporation (Texlon), formerly a debtor in possession in a Chapter XI proceeding, which began early in 1975. It concerns a practice, euphemistically called "cross-collateralization", which, we are told, has been authorized not infrequently by bankruptcy judges in the Southern District of New York. What this term means is that in return for making new loans to a debtor in possession under Chapter XI, a financing institution obtains a security interest on all assets of the debtor, both those existing at the date of the order and those created in the course of the Chapter XI proceeding, not only for the new loans, the propriety of which is not contested, but for existing indebtedness to it. We must determine whether the bankruptcy court properly authorized such "cross-collateralization" in this case, and, if not, whether the trustee's challenge came too late. We uphold Judge Brieant in answering both questions in the negative.


The facts can be briefly stated: On November 1, 1974, Texlon filed a petition for an arrangement under Chapter XI of the Bankruptcy Act. The bankruptcy judge signed on the same day Ex parte an order continuing the debtor in possession, other orders routinely entered at the commencement of such proceedings and the order giving rise to this litigation (hereafter referred to as the financing order). This authorized Texlon to enter into a number of agreements with MHCC for the factoring of accounts on a nonrecourse basis and for advances in connection therewith and, in MHCC's discretion, additional advances up to $100,000 to be evidenced by certificates of indebtedness issued pursuant to § 344 of the Bankruptcy Act. Texlon gave MHCC a security interest in all of its inventory and equipment and in the equity in the accounts, not merely for amounts paid under the factoring agreement and for certificates of indebtedness, but also for preexisting debt held by MHCC. 1 The application represented that any delay in authorizing these arrangements would be prejudicial to Texlon's continued viability, that only immediate approval would enable it to continue in business, and that the need for the relief was urgent and could not await a creditors' committee meeting. On November 6 MHCC began purchasing the accounts receivable. On the same day counsel for the debtor sent a copy of all the November 1 orders to the firm of Otterbourg, Steindler, Houston & Rosen, P. C. which had represented an informal creditors' committee prior to Texlon's decision to file under Chapter XI. A week later MHCC made a $40,000 advance against a certificate of indebtedness.

A creditors' committee meeting was held on November 19, on notice to the 100 largest creditors. The meeting elected an unofficial creditors' committee for which Mr. Otte, the present trustee, acted as secretary. Counsel for Texlon informed the creditors of the terms of the financing order. The committee retained the Otterbourg firm as counsel, and elected Mr. Otte as "stand-by" trustee. Thereafter MHCC advanced a further $60,000 against a certificate of indebtedness and factored new receivables. On December 10 the unofficial committee was elected as the official committee and was later authorized to retain the Otterbourg firm as counsel.

Texlon continued to suffer heavy losses. On January 10, 1975, it was adjudicated a bankrupt under § 376(2) of the Bankruptcy Act, and Mr. Otte was appointed Trustee. By this time MHCC had made factoring advances of $567,000 in addition to the loan of $100,000. Texlon's assets were sufficient to repay these and leave a surplus of $267,000, 2 which MHCC contends to be applicable to pre-petition indebtedness, variously stated as $660,000 or $695,000. According to appellee, allowance of MHCC's claims would denude the estate of substantially all its assets.

The Trustee moved on January 16, 1975 to modify the financing order "so as to provide that any equity in the collateral held by MHCC after satisfaction of the indebtedness due it under its Chapter XI factoring and other agreements, shall be applied for the benefit of all creditors pro rata, rather than in satisfaction of the unsecured portion of the pre-Chapter XI due MHCC from TEXLON." After proceedings unnecessary to detail and countless adjournments, Bankruptcy Judge Babitt denied the motion on November 11, 1977. He held that the financing order was "interdicted by the Act" and similar orders should not be entered in the future, both because the order gave pre-petition debt priority over that accorded post-petition Chapter XI creditors under § 64a(1), and also because it preferred the position of a pre-petition creditor over that of others in violation of § 70d(5). However, he declined to vacate the order because "(t)he elements of reliance on the order by MHCC, and the rights which vested because of such reliance, support this court's judgment that the order should be left in repose."

The trustee appealed to the district court. Agreeing with the bankruptcy judge that the "cross-collateralization" provision should not have been included in the financing order, although not clearly on the same grounds, Judge Brieant held that this was not the sort of case "where supervening equities attach in favor of a lender relying on a facially void order" since MHCC would be fully paid for all post-petition advances. Accordingly he reversed the order of the bankruptcy judge and directed that the Trustee's application be granted. On appeal MHCC argues that both the bankruptcy judge and the district judge were in error in holding that the Bankruptcy Act forbids "cross-collateralization" and that in any event the district judge erred by failing to recognize that the financing order had become final and non-appealable prior to the trustee's application.


We begin our discussion of the merits by agreeing with MHCC that the financing order did not run afoul of § 64a. Although, by virtue of § 302, § 64a applies in Chapter XI proceedings insofar as it is "not inconsistent with or in conflict with the provisions of" that Chapter, § 344 empowers the court to authorize a debtor in possession to issue:

certificates of indebtedness for cash, property, or other consideration approved by the court, upon such terms and conditions and with such security and priority in payment over existing obligations as in the particular case may be equitable.

It has long been the practice, both in equity receiverships and in reorganization proceedings under § 77, former § 77B, and Chapter X, for courts to authorize the issuance of certificates priming claims that would otherwise be entitled to prior payment. 3 Moreover the point at issue here is the creation not of a super-priority but of a secured interest, see 3A Collier, Supra, P 64.02(2). Compare White Chemical Co. v. Moradian, 417 F.2d 1015 (9 Cir. 1969). Indeed, it is common ground that, despite § 64a, the financing order is valid insofar as it created a new lien to secure the $100,000 of advances and any unpaid balance under the factoring agreement, even if enforcement of such a lien would deplete the funds from which priority claims could be paid.

We likewise agree with MHCC that, contrary to the views of the bankruptcy judge and the district judge, § 70d sheds no light on the problem here at issue.

The purpose of that subsection, enacted as part of the general revision of the Bankruptcy Act in 1938, was to protect certain transactions in the interval after the filing of an involuntary petition, which under §§ 1(4) and 1(13) initiates "bankruptcy", and "before adjudication or before a receiver takes possession of the property of the bankrupt, whichever first occurs." See 4B Collier, Supra, P 70.66(1); McLaughlin, Amendment of the Bankruptcy Act, 40 Harv.L.Rev. 583, 612-616 (1927), repeated by the author before Congress, Analysis of HR. 12889, 74th Cong. 2d Sess. 229-31 (1936), quoted in Bank of Marin v. England, 385 U.S. 99, 106-08, 87 S.Ct. 274, 17 L.Ed.2d 197 (1966) (dissenting opinion of Mr. Justice Harlan). After the substantive provisions of § 70d(1), (2) and (3), § 70d(5) provides that:

Except as otherwise provided in this subdivision and in subdivision g of section 21 of this title, no transfer by or in behalf of the bankrupt after the date of bankruptcy shall be valid against the trustee.

The bankruptcy judge found this to be "clear, peremptory language" invalidating the "cross-collateralization" here attempted. We find it rather to be irrelevant. In the first place, since under § 302, the date of adjudication is taken to be the date of Texlon's petition, the "time gap" to which § 70d is addressed does not exist. See In re Yellow Cab Company of Philadelphia, 4 Bankr Ct.Dec. 582, 585 (E.D.Pa.1978). Contrast Kass v. Doyle, 275 F.2d 258 (2 Cir. 1960) (applying § 70d to payment in interval between filing and approval of involuntary petition under Chapter X; pursuant to § 102, the Chapter X analog of § 302, the "date of adjudication" in a reorganization is taken to mean the date of Approval of the petition). ...

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