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In re Chicago Rapid Transit Co.

April 18, 1952


Author: Kerner

Before KERNER, DUFFY, and LINDLEY, Circuit Judges.

KERNER, Circuit Judge.

This appeal presents only one question, whether the District Court, during the course of a very complex public utility reorganization proceeding, may authorize the payment by the debtor of the sum of $1,125,000 to compromise mutual claims between the debtor and a former lessor solely on the basis of expediency and the desire to forestall further lengthy and expensive litigation, with no attempt at considering the relative merits of the conflicting claims of the parties. The disputed claims arose out of the operation by the debtor's trustees of the former lessor's lines for a period of ten years and eight months from the effective date of the disaffirmance of the lease by court order until sale and transfer of all the debtor's property to the Chicago Transit Authority. An unusual feature of the compromise offer is that it was not initiated by either of the disputing claimants - the trustee or the lessor, but instead was negotiated by some 40% of the bondholders of the debtor strictly as a "businessman's settlement" without any consideration of the merits.

The parties to this appeal are (1) a group of bondholders of the debtor, approximately 11% in amount, who contend that the amount authorized is grossly excessive and its allowance a clear abuse of discretion in the absence of any findings of fact on the merits; (2) the Securities and Exchange Commission (hereafter referred to as SEC) which supports the position of these objecting creditors and contends further that expediency alone is no basis for the settlement of the mutual claims here involved; (3) the lessor which asserts that the compromise is a fair one; and (4) the debtor's trustee who asserts that it should be affirmed by this court because there has been no showing of abuse of discretion on the part of the District Court in approving it.*fn1

The facts briefly stated are that in 1903 the Union Stockyards and Transit Company which then owned certain transit facilities in the City of Chicago including about three miles of right of way and tracks running east and west from near Lake Michigan to the Stockyards was required by city ordinance to elevate its trackage. Instead of putting this plan into effect by itself, Stockyards worked out a plan by which operations on the elevated trackage would be integrated with those of the South Side Elevated Company. Accordingly, there was created a new corporation, the Chicago Junction Railway Company, appellee here. It acquired the right of way of the Stockyards Company, and with the proceeds of a bond issue, elevated its structure and then leased it for fifty years to the South Side Company, a predecessor of the Chicago Rapid Transit Company, the debtor here, for an annual rental of $93,080, the amount required to pay the interest on the bond issue. The line as constructed was made up of two branches, the Kenwood branch, and the Stockyards branch, which were separated by some 1700 feet of track belonging to Rapid Transit at an east-west jog in the generally north-south main line tracks of that system. The line was thereafter operated as a part of the unified elevated transportation system, some portions of which were owned by Rapid Transit and others operated under lease. Junction has never owned any property except the leased premises.

In 1932 receivers were appointed for Rapid Transit; in 1937 a petition for reorganization under § 77B of the Bankruptcy Act 11 U.S.C.A. § 207, was approved. The trustees sought to negotiate a revision of the lease and reduction of the rental - it appears of record that such efforts were successful in the case of at least one other lessor of a heavily traveled main line, the $436,000 annual rental of which was reduced by 50%. Junction refused to reduce the rental, and the trustees, on a showing that the lease was unduly burdensome and that a substantial deficit resulted from the operation of the line, were granted leave to disaffirm, effective as of February 1, 1937. However, because the lessor was a public utility operated under the authority of the Illinois Commerce Commission, the trustees were directed to continue operating the line for the account of the lessor until the latter took over operations on its own account or until physical abandonment of the line was duly authorized. The order further provided that the trustees should file periodic accounts which should "follow substantially the method used by the trustee * * * [as to] the results of operations over the Junction branches during the years 1937 and 1938," and granted leave to Junction to file its claim for any injury it might suffer from the rejection of the lease. This order we affirmed. 7 Cir., 129 F.2d 1, certiorari denied, Chicago Junction R. Co. v. Sprague, 317 U.S. 683, 63 S. Ct. 205, 87 L. Ed. 547.

Pursuant to the leave granted, Junction filed its claim on September 30, 1941, in the amount of $434,373.33, for "reasonable rental value of the premises" from February 1, 1937 to October 1, 1941 - which amount is precisely the amount of the rent reserved by the rejected lease for the period of four years and eight months. The trustees filed objections. On September 26, 1941, they filed their account of operations for approximately the same period showing an operating deficit of $589,593. Periodic accounts were filed thereafter, all but one indicating deficits in varying amounts, and all objected to by Junction. A recapitulation of the accounts to July 31, 1946 indicated a balance due to Rapid Transit from Junction of $829,519.

The accounts and objections were referred to a master, and in September 1946 he reported that the wrong method of accounting had been followed. In this report the master criticized the trustees for failure to apply for leave to abandon, construing their inaction in this respect as an election which imposed upon them all the duties of a fiduciary to operate the lines for the benefit of Junction and charge them only with actual out-of-pocket costs on a "severance" basis instead of allocating revenues and expenses generally over the entire system as a unit. The master was also critical of what he called the trustees' resistance to the efforts of Junction to assume operation of its own lines as manifested by their refusal to permit Junction the use of the 1700 feet of Rapid Transit trackage which separate the two branches of the Junction line. On the basis of this "failure of the Trustees to promptly return the property and furnish temporary rental of facilities for Junction operations" the master found that the trustees were precluded from their claim of loss against Junction and that recovery thereon should be denied "if Trustees accounting is held proper."

The trustees filed objections to the report of the master recommending the recasting of the accounts from February 1937 on the "severance or out-of-pocket" theory, which objections were overruled by the court, and the new accounting ordered. The trustees obtained leave to engage a new expert accountant to assist in the preparation of it. This account was filed on January 15, 1948. Meantime, on September 30, 1947, the trustee had turned over all Rapid Transit properties and operations to the Chicago Transit Authority which had been organized pursuant to Illinois statute, and on the day preceding Junction had filed a petition for the setting aside of a fund of $2,573,262.33 to be held pending final disposition of its claims against Rapid Transit, which amount, it stated, was a conservative estimate of the amounts due for the use of its property for the thirteen-year period from September 1934 through September 1947. This figure was based on the computations of an expert accountant engaged by Junction as to the value of the traffic of the two branches to the debtor estate for the period after February 1, 1937, plus the amount due for the preceding 29-month period. Since no evidence was heard as to any of these computations we have no way of knowing why these two branches whose operations had resulted in substantial deficits prior to February 1, 1937 became a bonanza thereafter resulting in earnings of over $2,000,000 for the entire period, although overall operations of the entire system resulted in a deficit for the ten-year period. It is admitted that traffic on all the lines increased during the war years, and that there was an operating profit of about $3,000,000 for certain years for the entire system, but even so, the overall result was a $212,000 deficit. Absent rejection of the lease, the rent thereon for the approximately 13-year period would have amounted to some $1,217,797.

Various hearings were had on the accounts and objections thereto. There is no question but that a peculiarly difficult problem of accounting was presented - the operation of solvent branch lines for the account of those lines by the debtor's trustees, utilizing the debtor's equipment and presumably its manpower for such operations, part of which were confined to travel only on the branch lines and the rest, as "feeder" operations to the main lines.*fn2 In their computations the trustees had divided through revenues on the basis of 60% to the debtor and 40% to Junction. The final accounting on the out-of-pocket basis for the ten-year and eight-month period rendered by the expert accountant engaged by the trustees at considerable expense to the estate of the debtor disclosed an indebtedness of $1,617,807 due from Junction to the debtor.

While the hearings were proceeding intermittently, a group of creditors holding about 40% of the certificates of interest which had been issued upon surrender of the various classes of mortgage bonds as a part of the reorganization plan began negotiations with Junction for the settlement of its claims. In May 1951, on the basis of a tentative agreement between these creditors and Junction to settle all mutual claims between the latter and the debtor by the payment of $1,125,000 to Junction, the matter came on for hearing before the master. The trustee had taken no part in these negotiations and originally refused to take any position on the matter. The principal proponent of the agreement on the part of the creditors testified that he regarded it strictly as a "businessman's settlement" made without any consideration of the merit or lack of merit of the Junction claim, but to be recommended only in the interest of ending the lengthy litigation and closing the estate. "We do not know the merits of this case. We do know * * * that if this thing is permitted to reach its judicial determination it will take some three years * * * and we think the great majority of bondholders will feel that a settlement at this time permitting the final and complete liquidation of this estate and the final liquidation distribution * * * will be preferable to awaiting the outcome of this litigation and the dissipation of the estate through further legal costs and running expenses."

Vigorous opposition to the proposed settlement was expressed by a group holding about 11% of the certificates of interest. Their position was that there was no authority for the payment of such a substantial sum without any consideration of the relative merits of the conflicting claims. The amount proposed was about 92% of what would have been due for rent under the lease which had been disaffirmed as too burdensome. A spokesman for the objectors called attention to the testimony of the trustee's expert that, while under the abandonment theory of accounting the thought there might be $1,617,809 due from Junction to the debtor, even giving every phase of the accounting the construction most favorable to Junction, there would still be due a balance of $412,000 from Junction. This spokesman conceded that it was possible that the settlement might be an equitable one, but thought that there should be a far more definite showing before the court should recommend it, and he also thought that the trustee should be prepared to make a statement as to his position on the proposed settlement and as to the possible duration and expense of continued litigation.

Following this hearing before the master on the settlement proposal and objections thereto, the matter was sent to the court for an order directing that notice of the proposal as supported by 40% of the security holders and opposed by 11% be sent to all security holders. This notice as ordered contained a brief statement by the master as to the proposed settlement agreement, the origin of the conflicting claims, the amounts claimed by each side - $238,813 by the trustee and $1,727,185 by Junction, with a further statement that Junction had filed its claim for $2,573,262 in the reorganization proceeding. It made it clear that the proposed settlement was made without reference to the merits of either side, solely in the interest of avoiding further lengthy and expensive litigation. Enclosed therewith was a letter of the trustee briefly outlining the history of the litigation and the conflicting claims but without any expression as to his views on the proposed settlement. Objections were to be filed by June 15 and the matter was rereferred to the master for further hearing and report. There were very few responses to the notice, hence the relative proportion of proponents and objectors remained about the same, with almost half of the security holders expressing no preference.

The master issued his report on July 6, 1951, recommending approval of the compromise settlement. Objections to the report were filed by the opposition security holders and by the SEC based on the excessiveness of the amount and, in effect, the impropriety of basing a settlement on expediency alone, without any regard to the merits of the respective claims, and the absence of sufficient showing that it was proper and for the best interests of the estate. Later, on motion of the SEC, the court directed the ...

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