argued as amended october 12 1977.: February 24, 1977.
ON APPEAL FROM ORDER No. 362 OF THE UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF PENNSYLVANIA.
Gibbons, Forman and Rosenn, Circuit Judges.
This is an appeal, taken pursuant to the Bankruptcy Act, 11 U.S.C. § 47, from Order No. 362 of the United States District Court for the Eastern District of Pennsylvania, entered in the Lehigh Valley Railroad reorganization proceedings. Order No. 362 denies the petition of Citibank, N.A., as Indenture Trustee of a certain mortgage bond issue on which Lehigh Valley is the obligor, for the sequestration of rent derived from the mortgaged property.*fn1
On July 24, 1970, the Lehigh Valley Railroad Company commenced proceedings in reorganization under Section 77 of the Bankruptcy Act, 11 U.S.C. § 205 (1964). On May 2, 1974, after a hearing, the District Court determined, as required by § 207(b) of the Regional Rail Reorganization Act of 1973, Pub. L. 93-236, 45 U.S.C. §§ 743, 744 ("the Rail Act"), that the Lehigh Valley Railroad is not independently reorganizable on an income basis under § 77 within a reasonable time. The District Court held a further hearing in June, and on July 1, 1974, entered its 180-day order, in which it determined that the Rail Act does not provide a process which would be fair and equitable to the estate of Lehigh Valley, and therefore, that the reorganization of its estate should not be carried out pursuant to the Rail Act.*fn2 The Special Court,*fn3 on September 30, 1974, reversed the District Court's 180-day order and directed reorganization to proceed under the Rail Act.*fn4 The Special Court's order directing reorganization under the Rail Act was affirmed by the Supreme Court in Regional Rail Reorganization Cases, 419 U.S. 102, 42 L. Ed. 2d 320, 95 S. Ct. 335 (1974).
In accordance with the provisions of § 77 and the Rail Act, the Trustee of the Estate of Lehigh Valley continued to operate a railroad system until April 1, 1976. As of April 1, 1976, the Lehigh Valley Trustee, pursuant to the Final System Plan of the United States Railway Association,*fn5 transferred a major portion of the railroad's properties to Consolidated Rail Corporation ("Conrail"). Conrail assumed the responsibility for operating this portion of Lehigh Valley's property and the Lehigh Valley Trustee has had no further obligation to operate ongoing railroad facilities since April 1, 1976.
Appellant, Citibank, N.A., is the successor Trustee under the Lehigh Valley Harbor Terminal Railway Company*fn6 First Mortgage Indenture, dated February 1, 1924, as supplemented, securing inter alia, the payment of principal, in excess of $4 million, and interest on the Lehigh Valley Railroad's 5% First Mortgage Gold Bonds due in 1984. The Bonds and the Indenture Agreement require Lehigh Valley to pay interest in respect of the Bonds semiannually on February 1 and August 1 of each year. Lehigh Valley has paid no interest on the Bonds since it commenced reorganization proceedings on July 24, 1970.
The Indenture Agreement grants to the appellant an interest in certain non-operating property of Lehigh Valley, known as the Claremont Terminal Property, as security to the Bondholders. The Indenture further provides*fn7 that if Lehigh Valley shall default in the payment of any installment of interest and such default shall continue for sixty days, appellant shall be entitled to collect all earnings, income and rents from the mortgaged property.
The Claremont Terminal Property is rail-served*fn8 industrial property which generates an annual income of almost $350,000.00 from fourteen leases to which it is subject. The income from the Claremont Terminal Property, representing approximately 76% of the total lease rentals derived from the holdings of the Debtor's Estate is being utilized by Lehigh Valley's Trustee to meet current expenses of administering the estate.
Appellant, as Indenture Trustee, petitioned the District Court to enter an order (a) impressing a trust upon the rents in the possession of the Debtor's Trustee derived from the Claremont Terminal Property and directing that such funds be deposited in an escrow account for the purpose of protecting the security of the Bondholders, and (b) sequestering future income derived from the Claremont Terminal Property and requiring the deposit of such funds in an escrow account for the benefit of the Bondholders. The District Court entered Order No. 362, without an opinion, denying appellant's petition on the ground that it "would impermissibly interfere with the formulation and implementation of a plan of reorganization for the Debtor's estate."*fn9
Appellant argues that Lehigh Valley's use of income derived from the Claremont Terminal Property, to pay for current expenses incurred by the Debtor's liquidation, constitutes an inequitable impairment of the Bondholders' security.
Section 77 of the Bankruptcy Act was enacted in 1933 to deal with the rights of creditors in railroads which were suffering severely from the effects of over-capitalization and the loss of revenue, among other things.*fn10 Under § 77 the debtors' trustees were given the responsibility for development of a reorganization plan, under supervision of the Interstate Commerce Commission, which would restructure the capitalization of the railroad but not its physical operations.*fn11 Prior to enactment of the Rail Act, the only orders that could be entered in a railroad reorganization under § 77(b) were an income-based reorganization or a dismissal.
Now, the federal district court with jurisdiction over the § 77 reorganization of each debtor railroad must determine whether to continue reorganization under § 77 or to seek reorganization under the Rail Act. In the instant case, the District Court determined that Lehigh Valley is not independently reorganizable on an income basis under § 77 within a reasonable time and thus ordered reorganization to proceed under the Rail Act.
Reorganization under the Rail Act, pursuant to the Final System Plan,*fn12 involves the transfer of a major portion of the railroad properties and the obligation to operate a railroad from Lehigh Valley's Trustee to Conrail. The principal purpose of this physical restructuring of the railroad "is to reorganize the regional rail structure, not to determine the rights and priorities of creditors and stockholders of the bankrupt railroad. These matters remain governed by § 77 of the Bankruptcy Act, which continues in effect except where specifically contradicted by the Rail Act."*fn13 Since the culmination of reorganization under the Final System Plan is the exchange of substantially all of Lehigh Valley's rail properties for Conrail stock, it is necessary to identify the statutory basis for the District Court's assumption of reorganization jurisdiction under § 77 after adoption of the Final System Plan.
Section 618(b) of the Railroad Revitalization and Regulatory Reform Act of 1976 (P.L. 94-210), amended the Rail Act by adding section 601(b)(4), 45 U.S.C. § 791 (b)(4). The amendment, which went into effect on February 5, 1976, reads:
"(4) The powers and duties of the Commission under section 205 of Title 11, with respect to a railroad in reorganization in the region which conveys all or substantially all of its designated rail properties to the Corporation or a subsidiary thereof, or to profitable railroads in the region, pursuant to the final system plan, and the requirement that plans of reorganization be filed with the Commission, shall cease upon the date of such conveyance. The powers and duties of the Commission under section 205 of Title 11 shall also so terminate, as of February 5, 1976, with respect to any railroad in reorganization under such section 205 of Title 11 but not subject to this chapter which (1) does not operate any line of railroad, and (2) has transferred all or substantially all of its rail properties to a railroad in reorganization in the region which was subject to this chapter prior to February 5, 1976. Thereafter, such powers and duties of the Commission shall be vested in the district court of the United States which has jurisdiction of the estate of any such railroad in reorganization at the time of such conveyance. Such court shall proceed to reorganize or liquidate such railroad in reorganization pursuant to such section 205 of Title 11 on such terms as the court deems just and reasonable, or pursuant to any other provisions of the Bankruptcy Act, if the court finds that such action would be in the best interests of such estate. This paragraph does not affect any obligation of any carrier by railroad subject to regulation under the Interstate Commerce Act. The powers and duties of the Commission under section 205 of Title 11 shall continue in effect only to the extent that the railroad in reorganization continues to operate any line of railroad."
It appears that this section explicitly authorizes the continuation of reorganization proceedings under Section 77, even where it is no longer possible to reorganize the debtor as a railroad. Thus, the District Court which has jurisdiction of the estate of a railroad in reorganization, which transfers all of its railroad properties, retains jurisdiction to "liquidate such railroad in reorganization pursuant to such section ." It is the duty of the reorganization court to decide whether the best interests of the ...