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April 22, 1977

In the Matter of PENN CENTRAL TRANSPORTATION COMPANY, Debtor; In Re: Trustees' Proposed Compromise Of Personal Injury And Tax Claims

The opinion of the court was delivered by: FULLAM



 The Trustees of the Debtor have filed a proposed Plan of Reorganization. A major aspect of the Plan is the treatment accorded the very large highest priority administration claims of the United States. After extensive discussions, the United States and the Trustees agreed to a method for treating the Government's claims which adequately protects the interest of the United States, and also permits the Trustees to propose a plan now, rather than some undetermined number of years in the future. A condition of the agreement is that the Trustees offer to compromise certain tax and personal injury claims. *fn1" Before the Court are two petitions of the Trustees for authority to effectuate the compromise of those claims.

 The first petition seeks leave to pay, in cash, all personal injury claims which have thus far been liquidated, or which may hereafter be liquidated within a period of 180 days (or such further period as the Trustees, in their discretion, may authorize, or this Court may direct); claims in excess of $5,000 would be paid off in installments over a period of 18 months. It is estimated that approximately $11,952,830 would be required for this purpose, $3,460,124 immediately. *fn2"

 The second petition, which has engendered more controversy, seeks permission to extend to all state and local taxing authorities an offer to compromise all outstanding tax claims by paying, in cash, 50% of the unpaid taxes which have accrued since the filing of the reorganization petition. Each taxing authority would be completely free to refuse the settlement offer, in which case its claims would be dealt with in the Reorganization Plan. Since post-petition taxes aggregate approximately $340 million, the maximum amount of cash which might be required to carry out the compromise settlement program would be approximately $170 million.

 The cash needed immediately to carry out both proposals would be obtained primarily by transfers from certain existing escrow accounts, including a $50 million escrow account previously established in connection with matured trustees certificates, unrestricted funds of the estate, and accounts containing proceeds from sales of real and personal property. The deferred installments of the personal injury payments appear manageable from cash flow, as projected (for the most part, proceeds from future sales of property).

 In addition to the United States Government, most of the secured creditors have supported both petitions. Certain leased line and equivalent interests have expressed either approval of, or neutrality toward, the merits of the Trustees' proposals, but object to the proposed allocation of the burden as among the various possible sources of cash. The principal objections to the merits of both proposals were expressed by certain taxing entities, and by Amtrak.

 Briefly, a number of taxing authorities object to the payment of any personal injury claims unless all tax claims are first paid in full; and they object to the proposed tax compromise program on a variety of grounds. These objections, which will be discussed in detail in Part IV below, range from assertions that all taxes should be paid in cash immediately, and that the existing restraints against enforcement of tax liens should now be lifted, to the assertion that the compromise proposal unfairly discriminates between taxing authorities in the same category, or unfavorably discriminates against taxing authorities which are precluded by state law from agreeing to compromise settlements. In addition, many of the taxing authorities contend that the merits of the treatment of tax claims in the proposed Plan of Reorganization should be addressed at this time, so that the taxing authorities will be in a position to decide whether or not to accept the proposed compromise. Amtrak urges that the Trustees' proposals unfairly favor the taxing authorities and personal injury claimants.

 Hearings on both petitions were held on February 25, 1977. Because the relationship between the present petitions and the proposed Plan of Reorganization must be clearly understood, and because a large number of persons and entities legitimately concerned may not have a clear perception of the issues involved or of the context in which they arise, a complete and detailed analysis and discussion appears desirable, even at the risk of indulging in what those who have been intimately involved in these reorganization proceedings from the outset may consider repetition.

 I. The Background and Current Status of the Reorganization Proceedings

 Because the present petitions have their origin in the agreement between the United States and the Trustees, it is appropriate to review the course of these proceedings from the perspective of the United States involvement. It is fair to state that the role of the United States in the Debtor's reorganization is unprecedented. The Trustees' Reorganization Plan and the present petitions are at least as much a product of the involvement of the United States as of the underlying economic facts. The two primary legislative enactments through which the United States has participated in this case are the Emergency Rail Services Act of 1970 *fn3" and the Regional Rail Reorganization Act of 1973, as amended. *fn4"

 At the outset of the case, the Trustees were confronted with an unmanageable cash shortage which they were unable to alleviate through private-sector borrowing. In response to the imminent threat of cessation of rail operations, the Congress enacted the Emergency Rail Services Act of 1970. Under this Act, the Secretary of Transportation was authorized to guarantee trustees certificates. The guarantee permitted the Trustees to sell $100 million of trustees certificates in the private market. *fn5" In accordance with the Act, the trustees certificates were accorded the highest lien on the property of the estate. *fn6"

 Although there were some improvements in the financial results during the ensuing years, it became clear in 1973 that there could be no conventional reorganization, and that the Constitution required the termination of the Debtor's rail operations. Faced with this crisis, the Congress enacted the Regional Rail Reorganization Act, effective January 2, 1974. In broad outline, the RRRA was quite simple. A planning agency, USRA, was to analyze the operation of all bankrupt rail carriers in the Northeast and select from those lines a new system which would eventually be profitable; the selected lines were to be conveyed to a new for-profit company -- ConRail; and the bankrupt carriers were to be compensated for their property with stock of the new company. On April 1, 1976, Penn Central and the other bankrupt carriers conveyed their rail assets to ConRail, and ConRail has operated the properties since that time.

 Compensation of the estates with stock of the new company and the method of establishing the value of the properties conveyed to ConRail presented fundamental problems. The Act dealt with the procedural aspects by creating a new Special Court which was to decide issues relating to the value of the properties conveyed and the compensation paid. In the event that the value of the stock was less than the value of the properties conveyed, the Special Court was authorized to enter a deficiency judgment against ConRail. By definition, however, that deficiency judgment would be virtually valueless. Constitutional challenges to the Act based essentially on the fact that the deficiency judgment would be valueless were rejected by the Supreme Court on the theory that if a valueless deficiency judgment were to be entered, the estates would have a Tucker Act remedy against the United States for the shortfall. *fn7"

 In February of 1976, Congress amended the RRRA to provide that USRA was to issue to the bankrupt carriers certificates of value guaranteed by the Secretary of Treasury. *fn8" The certificates are redeemable on December 31, 1987, or such earlier time as USRA may determine. In general, the certificates of value are a promise by the United States to pay to the holders the net liquidation value of the holders' conveyed property as found by the Special Court, less the value of the ConRail stock and any dividends paid thereon, as of the redemption date, together with interest. The certificates of value, therefore, operate as a mechanism for reducing the likelihood that resort to the Tucker Act action in the Court of Claims will become necessary. It is important to note, however, that the certificates of value may or may not cover the compensation required by the Constitution, as determined by the Special Court; hence, an eventual Tucker Act action in the Court of Claims remains a possibility.

 Implementation of the RRRA presented another significant difficulty: continuation of rail operations from enactment date of the RRRA until conveyance of the properties to ConRail. Even with the deferral of local taxes, leased line rents, and other operating expenses, the revenue from the operations of the bankrupt Northeast carriers was inadequate to meet operating expenses. Congress dealt partially with this cash problem. Under § 215 of the Act, loans were made to the estates to do certain types of work which resulted in the upgrading of the carriers' property, and cash grants under § 213 were available to meet unavoidable cash deficiencies. The funds appropriated for §§ 213 and 215 were less than the aggregate need of the bankrupt carriers. Therefore, the Trustees of each carrier were required to "cash manage." What this meant was that as the conveyance date approached, the bankrupt's payables were not paid. Of course, the effect of this was to place the burden of continued operations on the private sector, vendors of services and supplies. Congress in turn addressed this problem by adding § 211(h) to the RRRA. *fn9" Under § 211(h), USRA was authorized to loan money to ConRail to pay certain of the Debtor's accounts payable. The estates are obliged to repay these § 211(h) expenditures, and ConRail and/or USRA hold highest priority administration claims against the estates for the unpaid balances of § 211(h) advances. The Trustees estimate that the estate's § 211(h) obligations will be approximately $290 million.

 In connection with the implementation of § 211(h) a dispute arose as to whether accrued vacation liabilities totaling approximately $60 million were obligations of the estate that should be paid by § 211(h) funds or obligations of ConRail as the successor employer. I held that ConRail was obligated to discharge the accrued vacation obligations. *fn10" While an appeal from that decision was pending, Congress amended the RRRA to provide that vacation pay was an obligation of the estate. *fn11" Arguably then, an additional $60 million will be added to the Trustees' § 211(h) obligations. Moreover, the Trustees have defaulted on $50 million in trustees certificates, and as a result the United States has honored its guarantee. *fn12" The total claim of the United States, which under the Emergency Rail Services Act and the RRRA is entitled to be accorded first priority of all claims, is therefore between $340 million and $400 million. Arguably, some portion of this might be set off or "netted" against an eventual Tucker Act claim; but as to the major share thereof, the § 211(h) advances, Congress has expressly proscribed setoffs.

 The cumulative impact of the Government's involvement in this case has created an extraordinary situation. All the estate's rail-related property and equipment has been conveyed to ConRail free and clear of liens. It is this property which was the security for the vast majority of the estate's secured creditors, including taxing authorities. Although stock in ConRail and certificates of value will be paid to the Trustees for the rail assets, no matter when the value is determined, it is possible that the stock of ConRail will not reach a value equal to the value of the conveyed property at any time prior to the 1987 redemption date. In addition, because of the priority status of the Government's claim, money now held in escrow for the benefit of bondholders and taxing authorities as well as any additional money received from future sales of property is not available for use in connection with a plan or otherwise to pay creditors. Finally, if the Court of Appeals were to reverse this Court's holding that escrow funds were not "cash or other current assets" for the purpose of § 211(h), the escrow funds would have to be used to satisfy the estate's § 211(h) obligations.

 Thus, from the standpoint of the other creditors (including particularly the tax claimants) the Government's involvement in this case can be seen as achieving the goal of protecting continued rail operations by exacting a high price, namely, subordination of other secured claims to the massive new debt obligations of the Government, unavailability of liquid resources for use in carrying out a plan of reorganization which would satisfy the claims of creditors, and potential deferral of the time when a reorganization plan could sensibly be proposed. Indeed, many of the taxing authorities have stressed these arguments in the present proceeding.

 In apparent recognition of the potential unfairness inherent in the situation, Congress has authorized the Secretary of Transportation to permit the use of escrow funds for purposes other than payment of the priority claims of the Government, pursuant to a plan of reorganization which, in the judgment of the Secretary, provides adequate protection for the interests of the United States. *fn13" It was against this background that the negotiations between the United States and the Trustees have been carried out. In general terms, the Plan provides that instead of receiving cash, the United States will receive various interest-bearing securities secured by specified assets of the estate. The maturity dates of these securities vary, but would produce a result which the Trustees apparently find acceptable. The Secretary of Transportation has made the required finding that the proposed Plan, embodying this securities package, does adequately protect the interests of the United States. *fn14"

 II. The Proposed Plan

 A review of the broad outlines of the Plan of Reorganization proposed by the Trustees is helpful to an understanding of the issues now before the Court. But it must be emphasized that, until the hearings on the proposed Plan have been held, no question concerning the fairness and equity of the proposed Plan, or its feasibility, can be addressed. Thus, nothing which is said herein concerning the proposed Plan is intended to express any view as to the merits of the proposed Plan, nor should it be so understood.

 The proposed Plan contemplates a surviving corporation which would own and manage assets in three broad categories: (1) the claim arising from the conveyance of the railroad assets to ConRail (the "valuation case"); (2) retained assets, many of which are to be sold over time pursuant to an asset-disposition program; and (3) the earnings of profitable subsidiaries which are to be retained as going concerns (primarily the Pennsylvania Company or "Pennco"). Securities to be issued by the reorganized company are designed to reflect these differences, in terms of both the source and the timing of ultimate payment; and are to be distributed to the creditors in accordance with the nature and priority of their respective interests as classified in the Plan. The proposed distribution reflects certain proposed compromise adjustments of claims in addition to the Government compromise outlined above.

 This is not the place to comment upon the objections to the Plan which have been expressed to date, except to note that a list of the formal objections together with a brief one- or two-sentence description of each objection covers more than 50 closely typed pages. It is fair to assume that the interested parties are actively preparing for the forthcoming hearings by further studying both the Plan and the objections in order to identify and classify the genuinely disputed issues of fact and law which the Court will be called upon to resolve.

 From the standpoint of each class of creditors, the overriding issues presumably will be whether (1) the compromise with the United States has presented an opportunity which should not be lost; (2) the Trustees' Plan accords fair treatment; and (3) if not, in the creditors' judgment what modification to the Plan is necessary to achieve fair treatment.

 III. The Status of Tax Claims

 As of December 31, 1976, the Debtor's total unpaid liability for property taxes was $326,905,986.18, and for unpaid corporate taxes $54,276,289.91, making a total unpaid tax liability of $381,182,276.09. Of these amounts, $43,864,135.58 of property taxes and $1,923,839.21 of corporate taxes, for a total of $45,787,974.79, were regarded by the Trustees as constituting pre-bankruptcy obligations. Thus, according to the Trustees' records, $335,394,301.30 was the amount of unpaid post-bankruptcy tax liabilities as of December 31, 1976. The amounts stated do not reflect interest or penalties, nor does the present record permit a breakdown as between taxes assessed against properties conveyed to ConRail and properties retained by the Debtor, nor as between properties owned in fee by lessors and property owned in fee by the Debtor, nor as between properties which have been sold in the course of reorganization and properties still owned by the Debtor's estate.

 Until now, the straitened circumstances of the Debtor's estate have not permitted payment of tax liabilities. Although the Trustees have recently petitioned this Court for leave to pay taxes on a current basis for the year 1977 and thereafter, there are insufficient free resources available to permit any significant payments of overdue liabilities, unless the settlement with the Government is carried out.

 It is true that, at the present time, there are substantial amounts of money on deposit in various escrow accounts controlled by the Trustees, and that, to the extent that these funds were derived from sales of real property, various taxing authorities have liens against the funds in the amount of the unpaid taxes attributable to those particular properties. But substantially all of these funds ...

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