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In re Central Railroad Co.

decided: January 19, 1970.


Hastie, Chief Judge, and Van Dusen and Adams, Circuit Judges.

Author: Van Dusen


VAN DUSEN, Circuit Judge.

This is an appeal from a district court order of March 26, 1969, authorizing the Reorganization Trustee of the Central Railroad Company of New Jersey to pay for the removal of a damaged portion of the Newark Bay Drawbridge with funds drawn down from a special account held for the benefit of the Railroad's bondholders.*fn1

On March 22, 1967, the district court granted the petition of the Central Railroad Company of New Jersey for reorganization, pursuant to § 77 of the Bankruptcy Act, 11 U.S.C. § 205 (1964). On October 13, 1967, the court established Special Account No. 3 for the protection of the holders of The General Mortgage bonds, into which all proceeds from the disposition of real property subject to such mortgage, for amounts exceeding $10,000. were to be placed. Special Account No. 3 "is the account in which the Trustee deposits all proceeds of sale, salvage or other disposition of real property covered by the lien of the Debtor's General Mortgage (except items involving $10,000.00 or less in any one transaction), which proceeds are normally withdrawable by the Trustee to pay for needed additions and betterments to, or the purchase of, other real property, which would be or become subject to the lien of the General Mortgage."

The order challenged in this appeal authorized payment for the removal of a damaged span of the Newark Bay Drawbridge, which is the Railroad's only rail link between Bayonne -- Jersey City (parts of the Port of New York) and the remainder of its system. On May 19, 1966, the Steamship Washington collided with the Drawbridge, rendering both the north and south spans inoperative. Approximately $214,000. was expended by the Railroad to make the south span operative, and $49,000. was expended to support the north span which was left in a raised position; additional work on the south span at an estimated cost of $216,000. was deferred. In addition, because of the necessity to reroute its rail traffic while the south span was being repaired and the loss of revenue incurred during this period, the Railroad suffered $192,000. in consequential damages. On September 10, 1968, the court approved a settlement of $750,000., in full satisfaction of the Railroad's claims arising from the Washington's collision with the bridge.*fn2

Following the settlement it was determined that there was no further need for the north span and that the support to such span added after the collision was insufficient protection against the possibility of its collapse. If it continued to stand in its weakened condition, it would be a hazard to navigation on the river below and to the south span of the Drawbridge next to it. The Reorganization Trustee therefore advertised for bids for the removal of the damaged portion of the north span. The low bid was $385,000., an offer that was open to acceptance only until March 31, 1969. Related costs of the Railroad raised the total amount necessary for removal to $408,000. On January 21, 1969, the Reorganization Trustee petitioned the court for authority to accept the offer, the total cost of $408,000. to be drawn from Special Account No. 3.

The district court found that the expenditure would be for a "betterment to the economic and efficient operation of the railroad,"*fn3 since it was necessary for the preservation of the south span and to the continued operation of the Railroad. It also found specifically that (1) there was "an immediate and urgent need" for the removal of the damaged portion of the north span, (2) no sources other than Special Account No. 3 were available to meet this need, (3) reorganization of the Railroad was "probably feasible," and (4) the interests of the bondholders would not be prejudiced by granting the petition. Accordingly, the court authorized the Reorganization Trustee to enter into the contract for removal and to draw upon the funds in Special Account No. 3 for this purpose. No obligation to repay the $408,000. was imposed.*fn4

Under the Bankruptcy Act, the Reorganization Trustee is vested with the right to immediate possession of all the debtor's property. Bankruptcy Act § 257, 11 U.S.C. § 657 (1964). The incidents of this right, however, are not unlimited. The right of the trustee to the use of property to which a lien attaches, such as the funds in Special Account No. 3, to finance betterments was described by Judge Anderson in In re New York, New Haven & Hartford Railroad Co., No. 30226 (D.Conn., 12/7/61):

"The rule for a reorganization under Sec. 77 * * * is that in addition to finding that the funds are presently needed and cannot be obtained elsewhere the court need only conclude that reorganization is probably feasible, that the money drawn-down and expended for additions and betterments will materially contribute to the possibility of successful reorganization and to the continuation of the transportation plant, or a substantial part thereof, as a going concern, and that the interests of the bondholders are not thereby prejudiced." (Appellant's brief, at 28).

Similar factors are considered in Chapter X reorganizations, if the mortgaged property is to be expended to finance betterments. See, e.g., Harding v. Stichman, 240 F.2d 289 (2nd Cir. 1957); Reconstruction Fin. Corp. v. Kaplan, 185 F.2d 791 (1st Cir. 1950).

The funds taken from Special Account No. 3 in this case, however, were not expended for "additions or betterments."*fn5 They were expended to remove mortgaged property, not to replace or add to it. Certainly the expenditure inured to the benefit of the bondholders, since removal of the damaged portion of the Drawbridge protected the operative south span, thus insuring that the Railroad would not suffer another stoppage of service. And there is no doubt that the "going concern" value of the Railroad to the bondholders was greater than its liquidation value, had a stoppage of service prevented reorganization. But like insurance or any other expenditure that keeps the Railroad operating, this was an operating expense.*fn6 The crucial consideration in classifying an expenditure as being for an addition or betterment is whether such expenditure increases the value of mortgaged property by adding to the operational plant.*fn7 In this case, the Reorganization Trustee was authorized to draw $408,000. from the bondholders' account; the Indenture Trustee, representing the holders of the General Mortgage bonds, was given no substitute property in exchange and no property under lien was increased in value through physical additions thereto. The expenditure was not for "an addition or betterment."*fn8

The leading case in a situation where the trustee is authorized to draw down mortgaged funds to pay for operating expenses is In re Third Avenue Transit Corp., 198 F.2d 703 (2nd Cir. 1952). The Indenture Trustee appealed from an order authorizing the Reorganization Trustee to draw down $500,000. from the mortgaged funds account*fn9 for "working capital" in order "to continue operations." Id. at 705.*fn10 In return, the Indenture Trustee received from the Reorganization Trustee a certificate bearing 1 3/4% interest, the times and amounts of repayment to be settled by further court order on the application of either party. The Second Circuit established the test for such an order:

"The court's far more drastic power under Section 257 [to authorize the reorganization trustee to take possession of any or all property of the debtor], requires proof of the most extraordinary circumstances * * *. We believe that that power should never be exercised absent findings, based on the clearest evidence, not only that it is imperative to obtain the funds and that they cannot be obtained * * * through ordinary market channels * * * but also that there is a high degree of likelihood (a) that the debtor can be reorganized in accordance with the Act, within a reasonable time, and (b) that the secured creditors whose security is ...

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