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May 12, 1972

In the Matter of PENN CENTRAL TRANSPORTATION COMPANY, Debtor. In re Purchase of maintenance of way equipment through MANOR REAL ESTATE CO.

Fullam, District Judge.

The opinion of the court was delivered by: FULLAM

FULLAM, District Judge.

 The Debtor desired to finance these purchases, but for various reasons, including, apparently, certain potential obstacles represented by "after-acquired property" clauses in its various railroad mortgages, the Debtor arranged to channel these purchases, and the related financing, through its wholly-owned subsidiary, Manor Real Estate Company ("Manor").

 The mechanics of these arrangements were somewhat complicated. Manor placed orders for the equipment, in its own name. It was contemplated that the Debtor would advance to Manor the cash necessary to complete the purchases; thereafter, upon acquisition of the equipment, Manor would sell the equipment to the Debtor under conditional sales contracts, and would then assign its rights under the conditional sales contracts to a lender. The money received by Manor from the lender as consideration for the assignments would then be returned to the Debtor in repayment of the cash advances.

 All of this maintenance equipment has been delivered to the Debtor and placed in service. However, for obvious reasons, the proposed financing arrangements have not been feasible. The Trustees have filed a petition (Document No. 1331) seeking authorization, in effect, to complete all of these purchases by payment in cash. This petition is opposed, in part, by Girard Trust Bank and Morgan Guaranty Trust Company, indenture trustees under certain railroad mortgages.

 Any attempt to sort out and dispose of the various legal issues involved must begin with a statement of the factual situation as it existed when the Debtor went into bankruptcy on June 21, 1970. As of that date, the Debtor had advanced $404,700 to Manor; Manor had ordered all of the equipment and had obligated itself to pay for it; some of the equipment had been delivered to the Debtor (the balance was delivered shortly after bankruptcy); and none of the permanent financing had been carried out. After bankruptcy, the Debtor made further payments for some of this equipment, including some equipment which had been delivered before bankruptcy, and some which was delivered after bankruptcy; these payments were made without obtaining Court approval.

 After the initial hearing in this matter, I concluded that it would unquestionably be proper to authorize payment by the Trustees for all equipment delivered after bankruptcy, on the theory that, irrespective of the prior arrangements, the Trustees should be authorized to procure and pay for this equipment, which was essential to the continued operation of the railroad. Accordingly, Order No. 431 authorized expenditures (including ratification of previous expenditures) totalling $418,806, representing the full price of all equipment delivered post-bankruptcy. The issues relating to equipment which was delivered to the Debtor before bankruptcy must now be determined.

 With respect to the equipment delivered before bankruptcy, the position of the indenture trustees may be summarized as follows: this equipment was in the possession and control of the Debtor on the date of bankruptcy; therefore, under provisions of Order No. 1, neither Manor nor the original suppliers, nor anyone else, can repossess the equipment or interfere with Debtor's possession thereof. The Debtor has a claim against Manor for the sums advanced. Manor is entitled to file a proof of claim for any damages it may sustain, or may already have sustained, either by reason of the Debtor's failure to advance additional sums as agreed, the Debtor's failure to complete the conditional sales financing, or the Debtor's use of equipment, to which Manor holds title. Payments which were made without Court authorization should be restored. And any attempt by the Trustees to pay for the equipment would be improper since it would amount to preferential treatment of Manor.

 The Trustees of the Debtor, on the other hand, argue that matters of form should not be permitted to obscure the substance of the transaction. In reality, they point out, Manor was acting as merely a financial conduit for the Debtor throughout the entire transaction. Manor was a wholly-owned subsidiary of the Debtor, and provided its services gratuitously, with no prospect of any benefit to itself. To adopt the indenture trustees' position would be to require the Trustees of the Debtor to manipulate a controlled subsidiary in such a way as to perpetrate a fraud upon the creditors of Manor.

 To recapitulate, the present situation is as follows:

 1. Prior to bankruptcy, the Debtor advanced $440,707 to Manor, and Manor paid this money over to suppliers of the maintenance equipment. The Trustees request that the "advance" be cancelled, and that title to the equipment thus purchased be transferred to the Trustees.

 2. After bankruptcy, as a result of procedural confusion precipitated by the bankruptcy, the Debtor's estate has made payments totalling $650,000 on account of the purchase of equipment which was delivered before bankruptcy. The Trustees seek ratification of these expenditures, and vesting of title to this equipment in the Trustees.

 3. In addition, equipment costing $570,150 was delivered before bankruptcy and has not yet been paid for. The Trustees seek authorization to pay for this ...

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