FOR THE NORTHERN DISTRICT OF CALIFORNIA
EUREKA SOUTHERN RAILROAD No. 1-86-01976
ACQUIRING CORPORATION, No. 1-86-01977
Memorandum of Decision re Confirmation of Plan
Brian Whipple is the sole shareholder of the consolidated debtors. He is the sole objecting
party to a railroad reorganization plan proposed by the Trustee and supported by all creditors,
the counties of Mendocino and Humboldt, and the State of California. The plan meets all of
the requirements for confirmation with the possible exception of its treatment of Whipple's
rights. Thus, the sole issue before the court is whether the plan may be confirmed over
Whipple purchased the railroad in 1984, in an entirely leveraged transaction, for about $5
million. In late 1986, having completely failed to operate the railroad profitably or keep it
properly maintained, Whipple dumped the railroad into the hands of this court. For the last five
years, the railroad has been successfully operated by the court-appointed trustee, Jerry Gregg.
Gregg has proposed the plan of reorganization now before the court. Under the plan, the
railroad will be sold as a going concern to an entity committed to maintain its operations. The
purchase price will be approximately $5 million, which will be enough to pay all creditors in
full thanks to Southern Pacific Transportation Company, which has agreed to accept only $1
million on account of its $3.8 million claim and subordinate the balance.
It is undisputed that the profitability of the railroad is marginal and that the purchaser will
need to expend more than the purchase price on repairs and renovations just to keep the railroad
operational. Thus, the railroad is worth no more than the proposed $5 million as an operating
line. However, the railroad is worth more for scrap; if the tracks were torn out and sold, the
real estate sold to developers, and the equipment liquidated, about $7 million and possibly more
would be realized. This is the heart of Whipple's objection.
Whipple's objection has both a factual component and a legal component. Factually, he
argues that the railroad is worth so much as scrap that there would be enough money realized
to pay all creditors in full, with interest, and return a substantial dividend to him. Legally, he
argues that the court cannot confirm a plan which returns to him any less than he would receive
if the line were sold for scrap. The court does not find either argument persuasive.
Factually, there is no scenario which would truly result in Whipple seeing a dime. The plan
is only feasible because Southern Pacific is subordinating all of its claim in excess of $1
million. In a Chapter 7 liquidation, Whipple could receive a dividend only after all claims,
including late claims, were paid in full together with interest at the legal rate from the filing of
the petition. See section 726(a) of the Bankruptcy Code.
There are already some $7.6 million in claims in this case, with the possibility of more if
late claims surface, as they have a habit of doing when a significant dividend is available. The
average time for a liquidating trustee in this district to close even a modest asset case is two to
three years; it is inconceivable that a trustee could liquidate and distribute the debtor's estate in
this case in less than five years, especially considering the significant environmental problems
which would have to be addressed. The trustee, fearing personal liability, would not dare close
the estate until all environmental problems were addressed and the results inspected by the
Because of the necessary delays, it would take at least $14 million, and probably more, to
satisfy all the claims. In addition, there would be at least $250,000.00 in environmental costs
and $500,000.00 in additional administrative expenses involved in liquidating the estate.
Moreover, it is a well-established fact of bankruptcy life that liquidations always take longer,
are more expensive, and result in smaller dividends than originally estimated.
On the asset side, the Trustee has testified with substantial justification that the liquidation
value of the assets is $7 million or so. This figure is corroborated by a report introduced by
Whipple himself. The only contrary evidence is the testimony of a purported buyer that he is
willing to pay $8.2 million for the tracks, making the overall value of the assets about $10.7
million. However, the tracks are not in fact for sale today, and could not in fact be sold over
the objections of the parties without many years of litigation. Thus, the court disregards the
testimony of the purported buyer and fixes the liquidation value of the assets at $7 million. The
court notes that even at the inflated figures there would be nothing left for Whipple.
Even if the court had found that Whipple would get something on liquidation, it would
nonetheless disregard his objections. In a railroad case, where the plan proposes the continuing
operation of the line, a creditor or shareholder need not be paid a dividend equal to what he
would receive if there was a piecemeal liquidation.
In normal reorganization cases, the requirement that all parties receive as much through a
reorganization plan as they would under a liquidation is set forth in section 1129(a)(7) of the
Code. However, in railroad cases section 1129(a)(7) is expressly inapplicable pursuant to
section 1161. Instead, section 1173(a)(2) provides that each party must receive as much as he
would receive if all of the operating railroad lines
of the debtor were sold and the proceeds
distributed under Chapter 7. Thus, the test in a raiload case is the value of the operating lines
not the value of the rails as scrap.
Whipple has significantly misread the commentary at 5 Collier on Bankruptcy
paragraph 1173.02, as supporting his position. That commentary notes that any time
a potential buyer for the entire business as a going concern, the proper liquidation value for the
"best interests" test is the sale price for the entire operation and not the separate value of the
individual assets. Collier notes that the scrap value should only be considered when there is no
potential buyer for the operating rail line. In this case there are in fact two potential buyers who
desire to operate the line. The court may properly use the bids of potential purchasers to
establish the value of a railroad line as a going concern. In re Dakota Rail, Inc.
, -- F.2d -- (8th
Since section 1129(a)(7) is not applicable in this case and the requirements of section 1173
have been met, and since there are no interests junior to Whipple, the court may confirm the
plan over the objections of Whipple pursuant to section 1129(b)(2)(C) if the plan does not
discriminate unfairly and is fair and equitable as to Whipple. The court has no problem so
finding. Indeed, it would be patently unfair to allow Whipple, as the low man on the totem
pole, to thwart a reorganization desired by all other parties as well as the counties of Mendocino
and Humboldt and the State of California. Whipple purchased the railroad for no money down,
infused little or no new capital, and in short order unloaded the railroad on the bankruptcy court
on the brink of extinction. The idea of Whipple making a profit on his purchase and inept
operation of the railroad at the expense of all of the communities served by the rail line is
repugnant to every quitable instinct of the court.
In light of the court's factual findings, it is not necessary to address Whipple's constitutional
claims. However, the court notes that any infringement of Whipple's rights result not from
confirmation of the plan, but rather from the limitations placed on abandonment of a railroad
line by both bankruptcy and nonbankruptcy law. Since such restrictions have a valid public
interest purpose and do not reduce the value of the railroad to nothing, they do not violate the
Fifth Amendment. See Keystone Coal Assn.
, 480 U.S. 470, 485 (1987); Agins
, 447 U.S. 255, 260-61 (1980). The Fifth Amendment prohibition against taking
without compensation does not guarantee the most profitable use of property. Goldblatt
Town of Hempstead
, 369 U.S. 590, 592 (1962). Diminution in value, standing alone, does not
establish a taking. Penn Central Transportation Co.
v. City of New York
, 438 U.S. 104, 131
A fundamental principle of reorganization under the Bankruptcy Code is that properties are
valued under present conditions, not past markets or future hopes. Under present conditions,
the rails are not saleable as scrap. Therefore, Whipple has no right to have them valued as scrap
any more than the owner of real property zoned for agricultural use would have a right to have
his property valued as if zoned for development.
Moreover, Whipple is an experienced railroad man and had been an employee of Southern
Pacific during prior abandonment proceedings. He knew full well the many legal impediments
to piecemeal liquidation of a railroad line at the time he purchased the railroad; those
impediments, and the relevant provisions of the Bankruptcy Code, are the same today.
Valuation of the railroad as a going concern does not infringe on Whipple's rights, but merely
denies him a windfall at the expense of the communities served by the railroad.
For the foregoing reasons, Whipple's objections will be overruled and the plan will be
confirmed. Counsel for the Trustee shall submit an appropriate form of order forthwith.
Dated: November 9, 1991 _______________________