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In re Emergency Beacon Corp.

decided: November 23, 1981.

IN THE MATTER OF: EMERGENCY BEACON CORPORATION, DEBTOR, MONTCO, INC., APPELLANT,
v.
HARVEY S. BARR, APPELLEE



Appeal from an order of the United States District Court for the Southern District of New York, Mary Johnson Lowe, Judge, affirming an order of the Bankruptcy Court which vacated a prior authorization for issuance of a certificate of indebtedness to appellant. Affirmed.

Before Oakes and Kearse, Circuit Judges, and Re, Chief Judge.*fn*

Author: Kearse

Appellant Montco, Inc., appeals from an order of the United States District Court for the Southern District of New York, Mary Johnson Lowe, Judge, affirming an order of the bankruptcy court dated November 24, 1978 ("1978 Order"), that amended an order dated May 13, 1976 ("1976 Order"). The 1978 Order vacated so much of the 1976 Order as had authorized the debtor in possession, Emergency Beacon Corporation ("EBC" or "debtor"), to issue a certificate of indebtedness to Montco for $275,000. The effect of a certificate of indebtedness is to give its holder priority status over general creditors. See 8 Collier on Bankruptcy PP 6.40(7)-(7.2), at 971-75 (14th ed. 1978). The result of the 1978 Order was to deny Montco's claim for priority treatment based on the certificate. For the reasons below, we affirm.

Background

EBC was formed in 1968 by Stephen Glatzer and Rocco Scappatura to engage in the manufacture and sale of electronic equipment, primarily an emergency "S.O.S." transmitter that Glatzer invented and that is now required equipment in all aircraft. Glatzer and Scappatura were, respectively, president and vice president of EBC and each owned 28% of the corporation's stock. The two men subsequently had a falling out and in late 1974, Scappatura became president of EBC. Glatzer held no further executive position with EBC but agreed to provide consultative services for which Glatzer was to receive $100,000 per year for two years.

In the spring of 1975, EBC borrowed $275,000 from Montco at an interest rate of 24% per annum. The loan was secured by EBC's present and future accounts, contract rights, machinery, furniture, equipment, and inventory, and a second mortgage on its real estate.

Events Leading to the 1976 Order

On February 18, 1976, EBC filed a petition for an arrangement under Chapter XI of the Bankruptcy Act, 11 U.S.C. §§ 701-99 (1976). A creditors' committee was appointed with Glatzer as chairman, and appellee Harvey Barr was appointed stand-by trustee. In mid-March the debtor requested a special meeting of creditors to consider an offer that had been made to buy EBC's airplane. Montco timely filed an application stating that it did not object to the sale of the airplane, provided that Montco would receive the proceeds from the sale in partial reduction of its secured loans. A special meeting of creditors was convened on April 16, 1976, before Bankruptcy Judge Howard Schwartzberg. The sale of the plane was approved without objection, and the payment requested in Montco's application was approved on the condition that the proceeds from the sale would be held in escrow for up to thirty days to allow the creditors' committee to determine whether Montco's lien was valid.

Following the completion of this and other properly-noticed business before the court, counsel for the debtor stated that there was also a motion before the court for authority "to make payments of interest to Montco, Inc., to issue a certificate of indebtedness to Montco" pursuant to § 344 of the Bankruptcy Act, 11 U.S.C. § 744 (1976).*fn1 The court stated that any such motion would be held "in abeyance because that's going to be subject to question, also," and ruled that no action on the matter was to be taken at least during the thirty-day period during which the creditors' committee was entitled to challenge the validity of Montco's lien. Counsel for the creditors' committee asked what consideration was to be given for the requested "paying of security interest in all the debtor in possession assets." Counsel for the debtor responded that "(it's) a forebearance (sic ) of the secured creditor from foreclosing its security interest." The court immediately questioned this in light of Rule 11-44 of the Rules of Bankruptcy Procedure ("Bankruptcy Rules"), which provides that the filing of a Chapter XI petition effects an automatic stay of actions against the debtor and of enforcement of liens against it, and provides further that relief from the stay may be obtained from the bankruptcy court only "for cause shown."*fn2 Counsel for the debtor asserted that Montco's promise provided consideration notwithstanding Rule 11-44 because it assured forbearance not only from foreclosure on the security interest but also from institution of "an adversary proceeding to lift the statutory restraint on the foreclosure of this security interest." The court declined to rule on the request for a certificate of indebtedness to be issued for this kind of consideration. The court did state, however that if Montco's lien was valid it would be entitled to the requested interest payments, to which Montco's counsel responded, "That's all I ask."

On May 13, 1976, the thirtieth day after the hearing, the debtor's counsel submitted a proposed order to the bankruptcy court. The first paragraph of the proposed order authorized EBC to pay Montco the interest payments. The proposed order went on, however, to authorize the issuance to Montco of a certificate of indebtedness in the amount of $275,000, and stated that the certificate

shall be a lien upon all the property of the Debtor and Debtor-in-Possession, subject only to prior and valid liens of record, and shall have priority in payment over all obligations of the Debtor-in-Possession herein, subject only to the cost and expenses of administration.

There was no opposition to the proposed order and it was signed on the day it was submitted. This is the 1976 Order that was to be modified by the bankruptcy court in 1978.

The Undoing of the 1976 Order

Led by Scappatura, EBC continued in business as a debtor in possession until March 11, 1977, when an order was entered, with EBC's consent, adjudicating the corporation bankrupt and appointing Barr as trustee in bankruptcy. Shortly thereafter, at a meeting of EBC's shareholders, Glatzer was elected president and was authorized by the new management to reinstitute Chapter XI proceedings. The petition was filed and accepted on April 29, 1977, and the Chapter XI proceedings were reinstated as of that date. Barr, the trustee in bankruptcy, was retained as trustee in possession pursuant to § 342 of the Bankruptcy Act, 11 U.S.C. § 742 (1976) and Bankruptcy Rule 11-18(b). As trustee in possession, he ...


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