The opinion of the court was delivered by: FULLAM
In 1962, the Pennsylvania Railroad (predecessor to Penn Central Transportation Company) acquired ownership of 97.3% of the common stock of the Lehigh Valley Railroad Company. In 1966, when the merger between the Pennsylvania Railroad and the New York Central was under consideration by the Interstate Commerce Commission, the possible adverse effects of the proposed merger upon the Lehigh Valley (and the public interest in the competitive rail service provided by Lehigh Valley) were a cause of concern. In its April 6, 1966 report, Pennsylvania Railroad Company -- Merger -- New York Central Railroad Company, Finance Docket 21989, ICC Finance Reports, Vol. 327, p. 475, et seq., approving the merger, the Commission imposed certain conditions pertaining to the relationship between Penn Central and Lehigh Valley. Condition No. 13 (327 ICC Reports at p. 555) required both companies to negotiate in good faith with the Norfolk & Western Railway Company for a proposed merger of the Lehigh Valley into the N&W. Condition No. 14 (ibid) contained the following provisions:
"14. Until otherwise relieved by this Commission, [Penn Central] shall retain its stock and other holdings to the degree now maintained in Lehigh Valley Railroad Company and render such support, financial and otherwise, as the Commission, from time to time, may determine necessary to keep such railroad operational. . . ."
Condition 14 further provided, in essence, that if after 10 years, Lehigh Valley had not been merged into the N&W or the Chesapeake & Ohio Railway Company, the Commission would consider the desirability of ordering the inclusion of the Lehigh Valley into the Penn Central "upon such terms as may be found just and reasonable and such action shall be binding upon [Penn Central]."
The ICC order embracing the conditions set forth above followed a Hearing Examiner's report which, after discussing the possible desirability of merging Lehigh Valley into the N&W and the C&O/B&O, stated as follows (ibid p. 942):
"In the event, however, that despite its best efforts, neither alternative is accomplished within ten years from the date of consummation or such additional time as the Commission may determine necessary, it is our conclusion that the merged company should be required to merge the franchises and properties of LV into its system operations, and that during the interim the merged company shall be required to maintain its present stock interests to the degree of its present holdings in LV and provide such support, financial or otherwise, as the Commission may from time to time deem advisable.
"With respect to the latter conditions, as previously indicated, LV depends largely upon the support of PRR for its traffic . . . We do not mean to infer that the former shall assume the existing debt structure of the latter nor support its uneconomical operations which may exist or come into being during the interim. We believe that such support as may be necessary to keep LV operational should be required, especially if a causal relationship between its condition and the operations resulting from this merger are established. . . ."
By consummating the merger on February 1, 1968, Penn Central accepted the merger conditions imposed by the Commission.
In the normal course of operations of the two railroads, more money becomes due and owing from the Lehigh Valley to the Penn Central than vice-versa. While the amounts of these "interline balances"
fluctuate from month to month, they average approximately $400,000 per month (at present, about $380,000). Both before and after the merger, Lehigh Valley was often unable to meets its obligations to Penn Central. Penn Central's accounting department also performed the accounting services for Lehigh Valley, and the two companies had a common treasurer. Penn Central made no attempt to collect the amounts due. Indeed, on one occasion, when Lehigh Valley was unable to redeem certain of its bonds falling due, Penn Central purchased the outstanding bonds at face value on the maturity date.
Penn Central entered reorganization under the Bankruptcy Act on June 21, 1970. Lehigh Valley followed on July 24, 1970. As of July 31, 1970, Lehigh Valley owed Penn Central $16,387,647.10 for unpaid interline balances, the earliest of which had remained unpaid since April of 1967.
During reorganization, the Penn Central Trustees have consistently taken the position that, whatever might be the status of the pre-reorganization balances, post-reorganization interline balances should be paid on a current basis, as administration expenses. Until recently, the Lehigh Valley Trustees have not contended otherwise, but for the most part have been unable to pay substantial amounts because of the chronic lack of cash. Various payments on account have been made, and various attempts to resolve the matter have been pursued.
In 1972, the two sets of trustees submitted to this Court for approval a proposed settlement agreement, under the terms of which Lehigh Valley would acknowledge the interline obligation to Penn Central as an administration claim, would pay amounts accruing thereafter on a current basis, and would make certain installment payments on the arrearages. At the hearing, the creditors of both railroads objected. Penn Central's creditors asserted that, to the extent that Lehigh Valley might be unable to meet its interline payments to Penn Central, the deficiency should be prorated among all of Lehigh Valley's interline creditors, rather than leave Penn Central as the only interline railroad not receiving full payment from Lehigh Valley. The objections of the Lehigh Valley creditors were based on one or more of the following contentions: that, in view of merger condition No. 14, Lehigh Valley was not obligated to pay Penn Central at all; Lehigh Valley Trustees might have a claim against Penn Central for diversion of traffic or other actions adversely affecting the financial condition of Lehigh Valley; and, in any event, if there was an obligation on the part of Lehigh Valley to pay the interline balances, that obligation should be subordinated to the rights of the secured prebankruptcy creditors of the Lehigh Valley.
By the time of the hearing on the proposed settlement agreement, the occurrence of tropical storm Agnes had caused all concerned to recognize that the Lehigh Valley Trustees would not be able to carry out that part of the proposed settlement agreement relating to payments on a current basis. Disposition of the proposed settlement agreement was deferred to await developments.
In 1973, the Lehigh Valley Trustees petitioned for authorization to cease all rail operations unless adequate federal assistance were in the offing by September. Disposition of that petition was likewise ...