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IN RE PENN CENT. TRANSP. CO.

May 10, 1972

In the Matter of PENN CENTRAL TRANSPORTATION COMPANY, Debtor. In re Petition of NEW YORK STATE URBAN DEVELOPMENT CORP.

Fullam, District Judge.


The opinion of the court was delivered by: FULLAM

FULLAM, District Judge.

 In December of 1969, the Debtor conveyed to UDC, by quitclaim deed, a large tract of land in Niagara Falls, New York. The property was subject to three railroad mortgages, which will be referred to herein as the Hudson River Mortgages. UDC made settlement, and paid the full purchase price, in reliance upon an indemnity letter from the Debtor, in which it was represented that the Debtor had requested, and expected to obtain, releases of the property from the three mortgages. After settlement, UDC proceeded to make substantial improvements to the property, and has committed additional millions of dollars for the construction of housing units. However, to date, no releases from the mortgages have been issued by the indenture trustees.

 The Hudson River Mortgages contained provisions, typical in railroad financing, authorizing the Debtor to sell off real property no longer needed in the operation of the railroad, so long as the proceeds were devoted to "additions and betterments" to the remaining property subject to the liens of the mortgages. The property sold was to be released from the liens of the mortgages upon delivery to the indenture trustees of either the proceeds of the sale, or adequate documentation certifying that additions and betterments to remaining property subject to the mortgage had been made in an amount at least equal to the sale price. It was the customary practice, as between the Debtor and the indenture trustees of its various mortgages that, if the proceeds of sale were deposited with the indenture trustees, the proceeds would routinely be released upon receipt of certification of additions and betterments; or, that certification of additions and betterments would be accepted in lieu of deposit of the proceeds; and in either case, the property sold would routinely be released from the liens of the mortgages.

 With respect to the Hudson River Mortgages, there is a factual dispute in the record as to whether, as contended by the Trustees of the Debtor, the Debtor was entitled to credit for additions and betterments no matter when they were made; or, as contended by the indenture trustees, only "fresh" additions and betterments, made after the sale in question, could be used by the Debtor in obtaining releases. It is unnecessary to resolve this dispute, since it is clear that the Debtor has certified an adequate amount of additions and betterments which occurred after the sale to UDC. *fn2"

 UDC's petition seeks relief in the alternative: either (1) an order declaring that the Debtor's estate is subject to a constructive trust in favor of UDC in the amount of the purchase price paid for the property by UDC, and directing immediate payment (presumably, in order to enable UDC to pay this sum to the indenture trustees in exchange for releases of the mortgages); or (2) an order of specific performance, directing the indenture trustees to execute and deliver releases of the mortgages in exchange for the tendered certifications of additions and betterments. The latter claim for relief is asserted, apparently, on the theory that UDC is a third party beneficiary, pro tanto, of the indenture trustees' obligations to the Debtor under the provisions of the mortgages.

 The Trustees of the Debtor have joined in UDC's request for relief to the extent that they seek an order directing the indenture trustees to issue releases; pursuant to Order No. 422, the Trustees' response to UDC's petition is treated as a petition by the Trustees of the Debtor to compel the indenture trustees to execute and deliver the required releases.

 The indenture trustees assert that this Court lacks jurisdiction to grant any of the relief requested by either UDC or the Trustees. Alternatively, they contend that they cannot be required to furnish releases except in exchange for a cash deposit in the appropriate amount, and that the appropriate amount would be the present value of the property sold, as improved by UDC, rather than the original sale price.

 In order to determine the proper extent of this Court's jurisdiction, it is first necessary to analyze the various claims asserted, and the precise legal relationship between the parties.

 The basic problem -- sales of individual parcels of property subject to blanket mortgages, and failure on the part of the seller-mortgagor to pay for and obtain releases from the blanket mortgages -- is not a new one. For example, similar situations arise with unfortunate frequency in residential subdivision financing. See Storke and Sears, Transfer of Mortgaged Property, 38 Corn. L. Rev. 185 (1953). Ultimately, the resolution of these problems, at least in part, derives from the application of the doctrine of marshalling. See Glenn, Mortgages, paras. 289-299.1 (1943); Osborn, Mortgages, paras. 286-92 (1970 ed.); 4 Pomeroy, Equity Jurisprudence, para. 1224.3 (5th ed. 1941). Briefly stated, the doctrine of marshalling confers upon the grantee in such situation an equitable right to require the mortgagee to seek satisfaction of the underlying obligation from the mortgagor's remaining properties which are subject to the blanket mortgage, before resorting to the premises conveyed. This equitable right on the part of the grantee is, of course, independent of and in addition to its rights against the grantor-mortgagor.

 Thus, in the present case, UDC has valid claims against the Debtor arising by virtue of the indemnification agreement, and also has the right to insist that there be no execution against UDC's property unless and until all other property of the Debtor subject to the mortgages has been exhausted.

 Moreover, the peculiar nature of railroad mortgages gives rise to additional rights and obligations. By their very nature, railroad mortgages are intended to constitute liens upon operating railroad properties. Railroad mortgage financing necessarily contemplates a greater degree of flexibility and fluidity than is characteristic of ordinary mortgage financing. It is in the best interest of the mortgagees, as well as the mortgagors, that property no longer needed in the operation of the railroad be disposed of, and the proceeds reinvested in additional useful property, or in improvements. It is not ...


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