215 F.

2d 63

ZIRN et al.
v.
HANOVER BANK et al.
No. 259.
Docket 23000.

United States Court of Appeals, Second Circuit.

Argued June 7, 1954.
Decided July 2, 1954.

Proceedings for the reorganization, under Section 77 of the Bankruptcy

Act, 11 U.S.C.A. 205, of the debtor, New York, Ontario and Western
Railway Company, were commenced in 1937. During the 17 years the
reorganization proceedings have been pending, no plan of reorganization
has been approved by the Interstate Commerce Commission.
In 1945 and again in 1947, the Debtor's trustee obtained aid, in financing
the purchase of Diesel-electric locomotives, from the R. F. C. (i e.,
Reconstruction Finance Corporation) under the provisions of Section 4 of
the R. F. C. Act, 47 Stat. 5, as amended 15 U.S.C.A. 604, which
authorized the R. F. C., among other things, to assist railroads financially
by purchasing equipment trust certificates where such financial assistance
was not otherwise available on reasonable terms. Financial assistance to
the Debtor's trustee was effected by the purchase by the R. F. C. of all of
the trust certificates issued under two so-called Philadelphia plan type of
equipment trusts.
The first is embodied in a Lease and an Agreement, each dated as of May
1, 1945. This 1945 Equipment Trust covers 5 Diesel-electric freight
locomotives. Under the 1945 Equipment Trust, $1,695,000 principal
amount of trust certificates were issued, of which $918,000 principal
amount were outstanding and held by the R. F. C. at the date of entry of
the two orders appealed from.
The second equipment trust is embodied in a Lease and an Agreement,
each dated as of December 1, 1947. This 1947 Equipment Trust covers 5

Diesel-electric freight locomotives and 21 Diesel-electric switching

locomotives. Under the 1947 Equipment Trust, $2,600,000 principal
amount of trust certificates were issued, of which $1,795,000 principal
amount were outstanding and held by the R. F. C. at the date of entry of
the two orders appealed from.
Prior to the creation of each of the Equipment Trusts, the debtor's trustee
applied to the District Court in the debtor's reorganization proceedings for
authority to enter into the Lease and Agreement, to issue and sell the trust
certificates, and to assume the obligations with respect thereto, in order to
acquire the locomotives. Notice was duly given as directed by the District
Court, to all parties to the reorganization proceedings and to all creditors
and stockholders of the debtor. After a hearing, the District Court, without
objection from any party in interest, entered orders which approved the
form and provisions of the Lease and Agreement and authorized the
debtor's trustee to execute and deliver them.
Following the entry of each of these orders, title to the locomotives
covered by the respective Equipment Trusts was acquired by The Hanover
Bank, as Trustee, and the locomotives were leased to the debtor's trustee
upon the terms and provisions set forth in the respective Leases which
form a part of the Equipment Trusts. The Leases required the debtor's
trustee, among other things, to pay to the Equipment Trustee as rent on
each quarterly interest payment date an amount sufficient to pay the
interest on all certificates then outstanding and the principal of the
certificates maturing on such date.
Ever since 1949, the debtor's trustee has been in default in making such
principal payments. He has defaulted in the principal payments on each
quarterly interest payment date since August 1, 1949, in the case of the
1945 Equipment Trust certificates. By July 1, 1953, the principal amount
of 1945 certificates which had matured but had not been paid aggregated
$582,000. The debtor's trustee has defaulted in principal payments on
various quarterly interest payment dates since September 1, 1949 in the
case of the 1947 Equipment Trust certificates. By July 1, 1953, the
principal amount of 1947 certificates which had matured but had not been
paid aggregated $625,000. Interest at 3% per annum on all outstanding
certificates had been paid.
After the occurrence of the initial defaults, the Debtor's trustee on several
occasions negotiated with the R.F.C. concerning the refinancing of the
matured trust certificates. Tentative arrangements were worked out at
various times, but none of them ever was consummated. In fact, the

debtor's trustee failed even to meet the deferred payments required under
the proposed refinancing arrangements. Finally, by letter dated May 14,
1953, the R. F. C. advised the debtor's trustee that it rescinded its previous
approval of proposed arrangements to refinance the Equipment Trust
certificates.
The rights and remedies given to the Equipment Trustee upon a default by
the debtor's trustee are typical of those found in any equipment trust issue.
The default provisions in the two Leases are substantially the same as are
the default provisions in the two Agreements.
The Leases provide that after a default by the debtor's trustee for thirty
days or more the Equipment Trustee may declare the Leases terminated
and may retake the equipment covered by the Leases and sell the same or
any part thereof at public or private sale, for cash or upon credit. The
proceeds of any such sale, after payment of the expenses of sale, are to be
applied to the payment of all sums required under the provisions of the
Leases and Agreements. If any deficiency then remains, the Equipment
Trustee is entitled to recover judgment against the debtor's trustee for such
deficiency. The Leases also provide that upon demand by the Equipment
Trustee, the debtor's trustee will deliver the locomotives covered by the
Leases to the Equipment Trustee at a point designated by the latter, or will
hold the locomotives for the Equipment Trustee until the latter shall have
sold them. It was agreed in the Leases that the performance of this
provision was of the essence of the contract and that upon application to
any court of equity, the Equipment Trustee should be entitled to a decree
against the debtor's trustee requiring the specific performance thereof.
The Agreements provide that upon a default by the debtor's trustee, the
Equipment Trustee may, and at the request of the holders of 20% in
principal amount of the trust certificates then outstanding, must declare
the principal of all of the trust certificates then outstanding to be due and
payable. Whether or not the principal of the trust certificates shall have
been declared due and payable, the Equipment Trustee, upon written
request of the holders of 20% in principal amount of the trust certificates
at the time outstanding, is required to take all steps for the performance
and enforcement of its rights and the rights of the holders of the trust
certificates, and to exercise one or more of the powers of entry, sale or
lease conferred upon the Equipment Trustee, or to take appropriate
judicial proceedings as the Equipment Trustee, being advised by counsel,
shall deem most expedient in the interests of the holders of the trust
certificates.

On July 1, 1953, the R. F. C., as the holder of all the outstanding trust
certificates, requested the Equipment Trustee to proceed promptly to take
all steps for the protection and enforcement of the rights of the Equipment
Trustee and of the R. F. C., as the holder of all such certificates as the
Equipment Trustee, being advised by counsel, should deem most
expedient in the interest of the R. F. C. as the holder of all such
certificates. On July 9, 1953, the Equipment Trustee, in accordance with
such request and acting pursuant to the terms of the two Equipment
Trusts, declared the principal of all of the 1945 Equipment Trust
certificates and 1947 Equipment Trust certificates then outstanding and
theretofore unmatured to be due and payable immediately.
Since the locomotives covered by the two Equipment Trusts were in the
possession and control of the District Court through the debtor's trustee
appointed by it, the Equipment Trustee filed a petition, verified July 17,
1953, in the reorganization proceedings, requesting that leave be granted
to it to enforce its rights and remedies pursuant to the two Equipment
Trusts, to institute and prosecute judicial proceedings to obtain possession
of the locomotives described in the 1945 and 1947 Leases, to sell the
same, applying the proceeds of sale in accordance with the Equipment
Trusts, and to obtain a judgment or judgments against the debtor's trustee
for any deficiency or deficiencies.
The debtor's trustee filed a cross-petition requesting the court to deny the
relief sought by the Equipment Trustee and to enjoin the Equipment
Trustee for a reasonable time from taking possession of the locomotives
covered by the two Equipment Trusts or commencing any suit against the
estate of the Debtor. A hearing was held on the petition of the Equipment
Trustee and the cross-petition of the debtor's trustee on July 29, 1953. At
the hearing the Equipment Trustee filed an answer to the cross-petition of
the debtor's trustee, and Henry I. Cohen, a bondholder who had intervened
in the reorganization proceedings and who is one of the appellants on this
appeal, filed an answer to the Equipment Trustee's petition. The debtor's
trustee and various other parties requested at the hearing that the debtor's
trustee be given time in which to negotiate with the R. F. C. in an attempt
to find some way to retain the locomotives covered by the two Equipment
Trusts. Acceding to their request and over the strenuous objection of
appellee, the District Court adjourned the hearing for 90 days.
Following such adjournment, the debtor's trustee entered into negotiations
with the R. F. C. As a result of such negotiations, the R. F. C. agreed to a
proposal by the debtor's trustee. In substance, the proposal was that upon
the entry by the District Court of an order granting to the Equipment

Trustee the relief requested in its petition i. e., authorizing it to proceed

to enforce the rights and remedies given to it under the terms of the two
Equipment Trusts a stand-by agreement would be entered into between
the debtor's trustee and the R. F. C. By the terms of the stand-by
agreement, the R. F. C. agreed that, as the holder of all of the outstanding
trust certificates, it would instruct the Equipment Trustee not to take
possession of or sell the locomotives covered by the two Equipment
Trusts as long as the payments specified in the stand-by agreement were
made prior to the expiration of such agreement on June 24, 1954. The
payments which the debtor's trustee was required to make under the standby agreement were an initial principal payment of $185,000 and monthly
principal payments of $35,000, together with quarterly interest payments
at the rate of 3% per annum on the amount of trust certificates
outstanding. The payments under the stand-by agreement are in fact
somewhat less than those required under the Leases and Agreements.
At the adjourned hearing in the District Court held on October 28, 1953,
the debtor's trustee presented a petition, requesting permission to enter
into the stand-by agreement with the R. F. C. No further objection was
made at the hearing on October 28, 1953 to the granting to the Equipment
Trustee of the right to exercise its rights and remedies under the two
Equipment Trusts, and no objection was made at that hearing to
authorizing the debtor's trustee to enter into the proposed stand-by
agreement with the R. F. C., except that Samuel Zirn, a bondholder of the
debtor, one of the appellants, objected to the granting of the relief
requested in the two petitions.
As a result of the October 28 hearing, the District Court made and entered
Order No. 973, granting the relief requested by the Equipment Trustee in
its petition. The Court also made and entered Order No. 974-A approving
the stand-by agreement, which was executed by the debtor's trustee and
the R. F. C. on November 2, 1953.
Appellants Zirn and Cohen have appealed from Orders Nos. 973 and 974A.
Samuel Zirn, New York City, pro. per.
Nathaniel M. Sokolski, New York City, for Henry I. Cohen, BondholderAppellant.
Kelley, Drye, Newhall & Maginnes, New York City (Francis S. Bensel,
Hovey C. Clark and Leland J. Markley, New York City, of counsel), for
appellee, The Hanover Bank, as Trustee under the Equipment Trusts of

1945 and 1947.

Elbert N. Oakes, New York City, for appellee Ferdinand J. Sieghardt, as
Trustee of New York, Ontario and Western Railway Company.
Before CHASE, Chief Judge, and FRANK and HINCKS, Circuit Judges.
FRANK, Circuit Judge.

Appellants contend that Smith v. Hoboken R. R. Warehouse & S. S.

Connecting Co., 328 U.S. 123, 66 S.Ct. 947, 951, 90 L.Ed. 1123, is "decisive of
this appeal." There the debtor railroad, in reorganization-bankruptcy under
Section 77 of the Bankruptcy Act, was the lessee of a short-line railroad. The
lease, executed long before the bankruptcy, provided, in effect, that the lessor
had the power to terminate the lease and re-enter, if the lessee went into
bankruptcy-reorganization. The lessor-owner applied to the bankruptcy court
for permission to exercise this power, and that court made an order granting
such permission. The Supreme Court held the order erroneous for the following
reasons: (1) Under Section 77(b) of the Bankruptcy Act,1 a plan of
reorganization, which must be formulated by the Interstate Commerce
Commission, can modify or alter the rights of creditors of the debtor-railroad
and can cure or waive defaults of the debtor under a lease. Since forfeiture of
the lease might render a reorganization plan impossible, the forfeiture required
the approval of the Commission, and no such approval had been obtained. (2)
Section 1(18) of the Interstate Commerce Act2 provides that "no carrier by
railroad * * * shall abandon all or any portion of a line of railroad, or the
operation thereof, unless and until there shall first have been obtained from the
commission a certificate that the present or future public convenience and
necessity permit of such abandonment." "Discontinuance of operations by the
trustee", said the Supreme Court, "is abandonment of operations by a carrier
within the meaning of 1(18). And a certificate is required under 1(18),
whether the lessee or the lessor is abandoning operations."3 Therefore, absent
such a certificate, the order was improper.

We think the Smith decision inapposite here. In the first place, the provisions
of Section 77(b) have no application to the orders now before us. For, by an
amendment enacted in 1935, Congress added to Section 77(j)4 this sentence:
"The title of any owner, whether as trustee or otherwise, to rolling-stock
equipment leased or conditionally sold to the debtor, and any right of such
owner to take possession of such property in compliance with the provisions of
any such lease or conditional sale contract, shall not be affected by the
provisions of this section."

The legislative history shows that Congress, recognizing the substantial

benefits to railroads which result from such equipment-agreements, desired to
remove any possible doubt stemming in part from Continental Illinois
National Bank & Trust Co. v. Chicago, Rock Island & Pacific Ry. Co., 294
U.S. 648, 55 S.Ct. 595, 79 L.Ed. 1110 as to the ability of owners of
equipment trust certificates promptly, on default, to repossess the equipment,
despite the pendency of bankruptcy-reorganization proceedings. See House
Report No. 1283, 74th Cong., 1st Session, dated June 21, 1935, accompanying
H.R. 8587, which reads in part (p. 4) as follows: "Under the present provisions
of section 77, there is doubt whether the trustee under the typical equipmenttrust agreement is entitled to the possession of the property insured by the terms
of the agreements, it having been urged in some of the pending cases that,
under the provisions of section 77, the equipment-trust arrangement must be
treated as an ordinary mortgage. If this were done, the investors in the trusts
would, consequently, be deprived of the preference intended to be preserved to
them by the terms of the agreements, which in form and substance are generally
in the nature of contracts of conditional sale. In view of the necessity of readily
financing purchases of equipment at a time when the development of the
transportation art is providing new forms of equipment, particularly in the
passenger field, of which, in interests of efficiency and economy, the carriers
should be able to avail themselves, and because after a depression the carriers
are usually required to make large expenditures for equipment in order to
accommodate the improved traffic, your committee is of the opinion that any
doubt should be removed with reference to the validity of the equipment trust as
a means of financing equipment purchases. Consequently H.R. 8507 carries an
amendment in subsection (j) under which the title of any owner to equipment
leased or conditionally sold to the debtor, and any right of such owner to take
possession of such property, shall not be adversely affected by the provisions of
the section." Senate Report No. 1336, 74th Cong., 1st Session, dated July 29,
1935, on S. 1634, which was the same as H.R. 8587, contained substantially the
same language. In the light of these Reports, we think that the words "this
section" in the amendment to 77(j) refers to Section 77 as a whole and not
merely to paragraph (j).

Moreover, significantly unlike the facts of the Smith case, here The Hanover
Bank sought to enforce contracts executed, by the bankruptcy trustee, after the
bankruptcy and by the express authority of the bankruptcy-reorganization court.
Whether the Smith-case doctrine would govern the lease of a railroad line
similarly executed, we need not now decide. But we think that doctrine cannot
apply to equipment-trust obligations which the bankruptcy court has
authorized.5

Nor, all else aside, is 49 U.S. C.A. 1(18) relevant here. The district court's
orders did not permit the railroad or the bankruptcy-trustee to abandon either
any part of its "line" or any "operation." To "abandon" in this context means,
we think, to give up permanently, not merely to suspend operations for lack of
physical equipment. No Commission approval is necessary where the cessation
of operations results, not from the volition of the railroad or its bankruptcytrustee, but from the exercise of the supervening rights, here recognized by the
Bankruptcy Act, of third persons. See, e. g., Town of Conway v. Atlantic Coast
Line R. Co., 4 Cir., 20 F.2d 250, 259-260.6 Especially in a case like this, if such
approval were required before equipment-trust certificate-holders could
recapture the equipment on default, the market for such certificates might well
dry up, and accordingly railroad reorganization trustees might often be unable
to procure needed equipment, with the consequence that suspension of
operations would often be accelerated rather than avoided.7

Affirmed.

Notes:
1

11 U.S.C.A. 205(b)

49 U.S.C.A. 1(18)

Section 77(o) of the Bankruptcy Act 11 U.S.C.A. 205(o) authorizes the

bankruptcy-trustee to sell or abandon lines or other property of the railroad
"only with the approval and authorization of the Commission when required by
the Interstate Commerce Act."

11 U.S.C.A. 205(j)

The foregoing discussion will serve to distinguish statements in the following

cases cited by appellants: Thompson v. Texas Mexican Ry. Co., 328 U.S. 134,
66 S.Ct. 937, 90 L.Ed. 1132; Palmer v. Commonwealth Massachusetts, 308 U.
S. 79, 60 S.Ct. 34, 84 L.Ed. 93; Ecker v. Western Pacific R. Corporation, 318
U. S. 448, 63 S.Ct. 692, 87 L.Ed. 892; Gardner v. State of New Jersey, 329 U.S.
565, 67 S.Ct. 467, 91 L.Ed. 504; Thompson v. State of Louisiana, 8 Cir., 98
F.2d 108; Van Schaick v. McCarthy, 10 Cir., 116 F.2d 987

There it was held that absence of I. C. C. approval constituted no defense in a

proceeding by a town to compel a railroad to remove a segment of its track,
thus severing its line

Cf. Chamber of Commerce of Demopolis v. Southern Railway Company, 206

I.C.C. 70 (failure of railroad, for lack of funds, to replace a wrecked bridge not
an illegal abandonment); Akron & B. B. R. Co., Abandonment of Operation,
239 I.C.C. 250, 254.
7

Although not the basis of our decision, we note the following in passing: (1)
That the railroad is still operating goes to show that the orders did not authorize
abandonment. (2) The bankruptcy-trustee stated that, if deprived of the dieselelectric locomotives, he can continue to operate by leasing steam locomotives
We are not to be understood as indicating that, considering this railroad's
prolonged grave financial condition and the failure to work out a reorganization
plan, the court below should not soon direct the bankruptcy trustee to seek
I.C.C. approval of abandonment of operation. Cf. Bankers Trust Co. v. Gebhart,
2 Cir., 195 F.2d 238, 240.