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August 12, 1975

In the Matter of PENN CENTRAL TRANSPORTATION COMPANY, Debtor; In re Interim Financial Support; In Proceedings for the Reorganization of a Railroad

The opinion of the court was delivered by: FULLAM


 On August 4, 1975, I entered Order No. 1981, in response to a further petition by the Government seeking to compel the Trustees to agree to allow the Government to pay certain installments on equipment obligations, but with the liability of the Trustees for such payments merely deferred rather than satisfied. This Memorandum is intended to set forth the reasons for that Order.

 The first attempt by the Government to finance in this manner the operations of the Debtor, until the date of conveyance to Conrail under the provisions of the RRRA, occurred in May of 1974, when a small amount of § 213 funds were used for that purpose. At that time, § 215 funds were not, as a practical matter, available. The Government's proposal, which was agreed to by the Trustees upon the express understanding that this would not constitute a precedent or set a pattern, was approved by this Court in Order No. 1480. At that time, I expressed the view that the legal position of the objecting creditors was clearly correct, but held that the emergency then existing permitted no alternative, and that failure to approve the transaction would do greater harm to the creditors' interests than the Government's proposal.

 Thereafter, in connection with the application to Congress for additional funds to permit continued rail operation during 1975 and through March 1976, the Department of Transportation sought and obtained amendments to the RRRA, one of which authorizes the Secretary of Transportation (acting here through the Federal Rail Administrator) to enter into agreements with trustees of railroads in reorganization for the acquisition by the Administrator of, inter alia, "interests in" equipment obligations of such railroads.

 The Government thereupon sought to compel the Trustees to agree to the use of § 215 funds to make all of the installment payments on equipment obligations, pursuant to arrangements whereby the Debtor's liability for such payments would not be extinguished, but would merely be deferred until after the conveyance to Conrail. This would have had the effect of deferring an additional $62 million in administration expenses. In denying the Government's petition at that time, in Order No. 1884, I filed an Opinion pointing out that there was nothing in the RRRA, the 1975 amendments thereto, or the legislative history, to suggest that Congress intended to require such deferrals, and that the Government had not established that the creation of this new class of deferred priority debt was necessary. In the Matter of Penn Central Transportation Co. (In re Interim Financing of Operations), 395 F. Supp. 567 (E.D. Pa. 1975). I pointed out that there was no showing that remaining § 213 funds, together with other § 215 projects clearly contemplated by the statute, would be insufficient to assure continuation of rail service.

 The present petition of the Government seeks to establish that the proposed method of financing, which admittedly would seriously undermine the rights of creditors, is necessary, and can thus be approved by a § 77 reorganization court. A related argument appears to be that the proposed method of financing is "necessary" to the consummation of the Final System Plan pursuant to the RRRA, hence the normal standards of § 77 do not apply. It is necessary first to consider the competing financial projections that have been submitted by the parties. As the following analysis will show, the actual financial projections do not substantially conflict; the principal differences lie in the assumptions.

 I. Analysis of Forecasts

 In analyzing the figures submitted by the parties, it is important to note certain difficulties of interpretation stemming from the way the record was established. For example, the Government's presentation involved data derived from cash forecasts submitted by all of the bankrupt carriers, not just the Penn Central. But the reliability of the methods for deriving data from carriers other than Penn Central was not touched upon in the hearings. Second, the Penn Central figures which were used by the Government were based upon a May 1975 forecast. Everyone agrees that important changes have occurred since then, but interpolation of these events into the forecast by FRA and Penn Central were not consistent. Third, Penn Central used a July 17, 1975 forecast which differed somewhat from its earlier forecast. Fourth, the figures are for the period May 1975 through March 1976, but the Government's principal arguments relate to the closing figures at the end of February. Thus it was necessary to adjust the figures consistently to the closing February balances. Finally, some of the figures in a given forecast reflect actual results, and others reflect estimates of future results. For example, in the updated Penn Central forecast of July 17, actual expenses over budget for months of May and June are included, but there is no reduction in the forecast expenses for later months, even though these early expenditures may make it unnecessary to incur similar expenses in later months.

 A. FRA Projections

 Starting with the data submitted by Penn Central in May of 1975 and information presumably submitted around the same time by other carriers, the FRA projected a total cash deficit of $287.9 million for the period May 1975 through February 1976. Implementation of § 215 programs already under agreement totaling $245.6 million should reduce this deficit by $165.5 million. *fn1" This reduction is attributable to the fact that most § 215 programs provide funds for work originally included as expenses in the forecasts relied on by FRA. A shortfall of $122.4 million, therefore, remains. Of the $85.5 million § 213 funds available, *fn2" the FRA is prepared to commit $70.5 million, leaving a reserve of $15 million in § 213 funds. Thus, $51.9 million in projected deficits remain unsatisfied.

 On the assumption that no additional non-equipment financing of § 215 programs will be approved, the Government initiated proceedings before the various reorganization courts designed to secure relief which in one way or another would result in a partial reduction of the projected deficits. Petitions presently pending in other proceedings seek relief which would reduce the cash deficit by $10.7 million, and, if the relief requested in this petition is granted, there would be an additional reduction of $16.6 million. *fn3" The FRA would have $15 million in the § 213 reserve account and uncommitted § 215 funds available to meet the remaining deficit of $24.6 million. On its face, the situation presented to the FRA is indeed a difficult one, and, from FRA's perspective, the relief requested is quite reasonable. The validity of the FRA's projections is, however, subject to serious question.

 B. Penn Central's Projections

 A $23.2 to $25.7 million overstatement of Penn Central's cash deficit at the end of February 1976 is suggested by the Trustees' evidence. The FRA deliberately overstated the deficit by $13.9 million when it reduced from 4.5% to 3.5% the effective yield factor used by Penn Central to calculate the revenue attributable to the June tariff increase. While reduction to a 4% yield is now accepted by the Trustees, an increase from 4.1% to 5.2% in the effective yield from the April tariff increase is now projected by the Trustees to result in an aggregate increase of $10 million in revenue over its May forecast. Thus, there is a $23.9 million variance. FRA also increased the deficit to reflect a $12.9 million excess in the actual material purchases during May and June over the forecasted amounts. The Trustees contend that this is unrealistic for two reasons: the materials will be used for § 215 projects and therefore netted out and, in any event, a new managerial control system will permit the Trustees to limit future purchases and thereby bring the total material purchases through February within the May forecast. Finally, the Trustees estimate recent employee furloughs will save $1.4 million more than the $9.5 million assumed by the FRA. The total variance is $38.2 million. A negative adjustment to this amount is necessary to reflect the possibility of the repayment of a $15 million advance which was made by the FRA to make up for Amtrak's inability to meet its contractual obligations to the Trustees on schedule. If these factors are given full effect, the aggregate shortfall in February for all carriers would be $99.2 million instead of $122.4 million. Since the FRA made the same reductions in effective yield for the other carriers as it did for Penn Central, it would follow that an additional reduction in the shortfall is appropriate. The best that can be done on this record is to estimate the debt reduction would be between $2.59 million and $10.36 million. *fn4"

 Similar results are arrived at when Penn Central's July 17, 1975 forecast is utilized. $185.9 million is the projected deficit through February. This must be reduced by $145.2 million, FRA's projected cash impact of Penn Central's § 215 programs. In addition, $10 million more must be subtracted to reflect revenue attributable to the increase in the effective yield of the April tariff increase which was not included in the July 17 forecast. The net effect of this is to result in a $25.5 million smaller deficit than that shown by the Government. The chart below summarizes the various projections. A. FRA Projections (in millions) Penn Central Others Total Deficit May 1975 through Feb. 1976 ($201.6) ($86.3) ($287.9) Cash Impact § 215 145.2 20.3 165.6 Total (56.4) (66.0) (122.4) B. FRA Projection with Trustees' Adjustments (in millions) Deficit May 1975 through Feb. 1976 ($178.4) ($86.3) ($264.7) Cash Impact § 215 145.2 20.3 165.5 Total (33.2) (66.0) (99.2) C. FRA Projections for Other Carriers Combined with Trustees' July 17, 1975 Forecast (in millions) Deficit May 1975 through Feb. 1976 ($175.9) ($86.3) ($262.2) Cash Impact § 215 145.2 20.3 165.5 Total (30.7) (66.0) (96.7)


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