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In re Penn Central Transportation Co.

argued: August 18, 1987.


On Appeal from the United States District Court for the Easter District of Pennsylvania (BKY No. 70-347).

Gibbons, Chief Judge, and Weis and Sloviter, Circuit Judges.

Author: Gibbons


Gibbons, Chief Judge

The United States appeals from two district court orders which, in effect, rejected the government's request for reimbursement in the Penn Central reorganization proceedings. The government advanced an application for reimbursement pursuant to contracts entered into under section 215 of the Regional Rail Reorganization Act of 1973. 45 U.S.C. § 725 ("4R Act"). We will reverse.*fn1


In 1970, Penn Central Transportation Company filed a petition for reorganization. When neither Penn Central nor any other northeastern railroads could achieve an income-based reorganization in reorganization court, facing possible liquidation, Congress enacted the 4R Act, 45 U.S.C. §§ 701-797, creating a new railroad, Consolidated Rail Corporation ("Conrail"), to which Penn Central and other bankrupt railroads would convey their principal rail assets. The 4R Act also created the United States Railway Association ("USRA"), developing a Final System Plan designating those rail properties to be conveyed to Conrail. Congress, providing a means for keeping the railroad in operation during development of the Final System Plan, devised two funding mechanisms: (1) § 213, 45 U.S.C. § 723, and (2) § 215, 45 U.S.C. § 725.

Section 213 of the 4R Act, 45 U.S.C. § 723, as originally enacted, authorizes interim cash assistance in the form of cash grants to the bankrupt railroads, permitting them to continue their operations during the planning period. Congress also provided funds under section 215 of the 4R Act, 45 U.S.C. § 725, for rehabilitation of rail properties conveyed to Conrail. Section 215, as originally enacted, authorizes the Secretary of Transportation, together with the USRA's approval, to enter into agreements with the bankrupt railroads for improvement of rail properties transferred to Conrail. USRA loans, in the amount of $150 million, were provided to fund the improvement agreements. Conrail, upon conveyance of the property on April 1, 1976, we required by section 215 to assume the debt obligations and repay the Government. Conrail, however, was not required to compensate the railroads for such added value to the properties conveyed to Conrail as resulting from the rehabilitation financed by section 215 funds.

By late 1974, it was apparent, however, that the funds appropriated under section 213 for continuing operation were inadequate. In November, 1974, the Trustees met with representatives of the Department of Transportation ("DOT") to advise them that the section 213 grant funds could not stem Penn Central's impending cash crisis. The Trustees notified the government of their intention to reduce expenses by various self-help measures, including cut backs in maintenance. DOT objected to the Trustees' proposed self-help measures, concerned that Penn Central would implement cutbacks in maintenance programs which "might prove detrimental to the ability of Penn Central (or Conrail) to provide necessary transportation services." DOT letter to Trustees dated Jan. 10, 1975.

In early 1975, DOT proposed substantial amendments to sections 213 and 215 of the Rail Act. In response, Congress enacted the Regional Rail Reorganization Act Amendments of 1975, the primary purpose of which was to provide the funding necessary to ensure continued rail services pending conveyance to Conrail. Pub. L. 94-95, 89 Stat. 7. The total amount available for grants under section 213 was increased, with the clear understanding that the grants were to be given only as a last resort. Section 215 was amended to permit funds to be used not only for capital improvements, but also for "program maintenance." Although not defined, program maintenance was generally understood to encompass regular maintenance of track, equipment, or other facilities and rehabilitation projects which were included in the railroad's regular budgets and cash forecasts.

In addition, the 1975 amendments doubled the aggregate amounts which could be issued under section 215 from $150 million to $300 million. The amendments made no change in the repayment provision requiring Conrail to repay debt obligations made under section 215. The government retained discretion to forgive such obligations. Because of the inclusion of "program maintenance" under section 215, most section 215 expenditures were now not likely to increase the value of the conveyed properties. USRA was, therefore, required to decide what amount of section 215 expenditures would become Conrail's obligation and from what amount Conrail would be released.

Following the 1975 amendments, the government and bankrupt railroads entered into numerous section 215 agreements. A hearing was held on each agreement prior to the trustee's signing of the respective instruments. Further, the district court entered an order authorizing the Trustees to enter into each agreement. Among them were the four involved in this appeal: (1) DOT-RRRA-715 for the purchase of maintenance of way equipment; (2) DOT-RRRA-754 for the purchase of maintenance of way materials: (3) DOT-RRRA-775 for the installation of maintenance of way materials; and (4) DOT-RRRA-7515 for the performance of maintenance of equipment. (These four agreements are referred to collectively hereafter as "The section 215 agreements.") The section 215 agreements were funded in advance by the government, which provided the Trustees with an amount of cash sufficient to cover the estimated expenses under the contracts for the upcoming month. The Trustees deposited this cash into separate accounts and could withdraw funds as needed.

When the section 215 projects terminated, Penn Central had received approximately $212 million in section 215 funds for program maintenance. Pursuant to the section 215 contracts, Penn Central submitted final accountings of all funds deposited in, credited to, and disbursed from the separate accounts at the end of each section 215 project. Also pursuant to the contracts, the Defense Contract Audit Agency audited these accountings and concluded that Penn Central had received more than the $33.8 million stipulated under the agreements. Thereafter, the government made a formal demand of Penn Central for the return of these monies. After negotiation, spanning several years, the government reduced its $33.8 million claim to $22.3 million.

According to the government, the $22.3 million in disallowed costs is a result, inter alia, of Penn Central's excessive or double charges for transportation costs, charges for unauthorized work, failure to document claimed expenses and duplicate billings for authorized work.

In February, 1983, the government filed an Amended Petition for Payment seeking $22.3 million, but the parties reached an impasse. The government also invoked the binding arbitration procedures that are contained in two of the four section 215 agreements to resolve disputes arising under those contracts.*fn2 Penn Central answered, denying that it owed any money to the government. At the same time, Penn Central petitioned the district court for an order enjoining arbitration. Penn Central argued that, even if certain funds were not spent strictly in accordance with the provisions of the four contracts, the government could not recover any section 215 funds from Penn Central as a matter of law. Penn Central further argued that only the district court, not an arbitration panel, could decide the repayment claim.

On April 7, 1983, the district court temporarily stayed arbitration pending a ruling on the merits of Penn Central's petition. After discovery, briefing, and oral argument, on October 15, 1986 the district court issued Memorandum and Order No. 4292. The district court ruled that Penn Central did not have to return section 215 funds which were received pursuant to the agreements but not spent in accordance with the specific terms of those agreements if Penn Central could show that those funds were spent on projects within the general scope of section 215. The court held that the section 215 agreements could not be viewed and applied in isolation. To ignore the context in which the agreements arose would frustrate the intention of both the contracting parties and congressional intent. "The true purpose of the accounting and audit provisions of the contracts here was to ensure the government's money was properly spent for purposes authorized by § 215, and to ensure that [Penn Central] would not receive more than was actually necessary to sustain rail operations to the date of conveyance." Slip op. at 12.

Thus, the court ruled that if Penn Central could "prove that at least $22 million worth of genuinely section 215-eligible expenditures were made during the relevant pre-conveyance period, over and above the work specified in the contracts, the claims now being asserted by the government must be rejected." Slip op. at 13. Accordingly, Order No. 4292 ordered the government to state whether it disputed that Penn Central had spent at least $22.3 million on projects that were not approved under the section 215 agreements but which were within the general parameters of section 215.

The government appealed from Order No. 4292 (Appeal No. 86-1755) and filed a motion for certification of the order for appeal. 28 U.S.C. § 1292(b). The district court denied the government's request to certify Order No. 4292. Initially, the government advised the district court of an intent to contest Penn Central's assertion that at least $22 million were spent on projects which were eligible for section 215 funding. In February, 1987, Penn Central submitted evidence to the district court demonstrating such expenditures. In a letter dated March 16, 1987, however, the government stated an intention not the challenge Penn Central's expenditures. On May 11, 1987, the district court entered Order No. 4298, disallowing the government's claim against Penn Central. The government appealed from Order No. 4298 on May 19, 1987 (Appeal No. 87-1291). On June 1, 1987, both appeals were consolidated. The government challenges "the district court's ruling that federal funds spent without contractual authority need not be returned." Gvt's Brief at 5.


The government challenges the district court's decision on two grounds: a) that the government was foreclosed from enforcing the terms of the four contracts because it was not permitted to prove that funds paid to Penn Central were not spent in accordance with the contractual terms and b) that the district court improperly changed the terms of the contracts with the benefit of hindsight. The government quarrels, not so much that Penn Central received $212 million in section 215 funds, but that Penn Central did not give the Government $212 million worth of improvements on the rail properties which USRA determined were in greatest need of that work. The government's primary argument, then, is that the district court cannot disregard the agreements and legislation requiring section 215 funds to be expended in accordance with the terms of section 215 agreements only.

Conversely, Penn Central, which is no longer in reorganization and no longer a railroad, contends the district court did not alter the agreements but, rather, merely interpreted them in a permissible manner. Penn Central argues alternatively that even if the district court rewrote the section 215 agreements, it is still not liable for the $22.3 million spent on unauthorized program maintenance because: a) there was an implied-in-fact agreement between the government and Penn Central providing that the Trustees would continue, and the government would fund, Penn Central rail operations until the conveyance date; or b) under a theory of quasi-contract, return of ...

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