Group of Institutional Investors v. Chicago, Milwaukee, St. Paul & Pacific Railroad

Exclusion of the Stockholders. The objections of the debtor and the preferred stockholders are, in the main, that the findings of the Commission are inadequate; that it did not employ proper criteria in determining the capitalization of the new company and in concluding that there was no equity for the stockholders; and that, however proper the findings of the Commission on this phase of the cas,e may have been when made, the earnings in 1940, 1941, and 1942 demonstrate that the earning power of the road exceeds that which the Commission found.

In determining the permissible capitalization of the new company and the nature of its capital structure, the Commission made an extensive review of the properties, business, and earnings of the debtor. It reviewed freight and total revenues, passenger revenues and their trend, operating revenues and expenses, and maintenance and efficiency of operation for various periods ending in 1938. It gave consideration to estimated future taxes, emergency freight charges, and certain wage factors. It reviewed the amounts of income available for payment of interest in each of the years from 1921 to 1938. It considered the original cost of the properties, the cost of reproduction new, the cost of reproduction less depreciation, and the value for rate making purposes — each of which was substantially in excess of the capitalization which it authorized. It stated that its obligation was “to devise a plan that will serve as a basis for the company’s financial structure for the indefinite future.” It concluded that a

■ But it is urged that the Commission employed the incorrect criteria for determining the permissible capitalization of the new company. In this connection, reliance is placed on- § 77 (e), which provides in part that the “value of any property used in railroad operation shall be determined on a basis which will, give due- consideration to the earning power of the property, past, present, and prospec

The finding of the Commission, affirmed by the District Court under § 77 (e), that the stock had “no value” is supported by evidence. The issue involved in such a determination is whether there is a reasonable probability that the earning power of the road will be sufficient to pay prior claims of interest and principal and leave some surplus for the service of the stock. If it is established that there is no reasonable probability of such earning power,

The question of the increase in earnings since the Commission approved the plan raises of course different issues. As we have indicated in the Western Pacific case, the power of the District Court to receive additional evidence may aid it in determining whether changed circumstances require that the plan be referred back to the Commission for reconsideration. The hearings before the Commission were closed in 1938 and its report rendered in 1940. The hearings before the District Court were held in September 1940. It had before it the trustees’ annual reports for 1937, 1938 and 1939 and a statement of operating revenues and income available for fixed charges through the first half of 1940. Similar figures were before the Circuit Court of Appeals for most of 1941. The debtor and the preferred stockholders contend on the basis of those figures that the Commission’s conclusion that there is no evidence that a “recovery of the earning power of 1928-29 is reasonably probable” has been disproved by subsequent events. They argue that while the net earnings for 1928,

We agree with the Circuit Court of Appeals that no sufficient showing of changed circumstances has been made which requires the District Court to return the plan to the Commission for reconsideration. Late in 1939 the Commission had occasion to say, “We know from past experience that the upswing in business which war brings is temporary and likely to be followed by an aftermath in which conditions may be worse than before.” 53d Annual Report, p. 5. The record during the last World War is illuminating. It shows that the Milwaukee’s net operating income rose to almost $31,000,000 in 1916, exceeded $21,500,000 in 1917, dropped to about $4,000,000 in 1918 and to about $2,000,000 in 1919 and showed a deficit of over $14,000,000 in 1920. See Chicago, M. & St. P. Reorganization, 131 I. C. C. 673 , 715. As we have noted, the Commission conceived as its responsibility the devising of a plan which would serve “as a basis for the company’s financial structure for the indefinite future.” We cannot assume that the figures of war earnings could serve as a reliable criterion for that “indefinite future.” As some of the bondholders point out, the bulge of war earnings per se is unreliable for use as a norm unless history is to be ignored; and numerous other considerations, present here as in former periods, make them suspect as a standard for any reasonably likely future normal year. Among these are the great increase in taxes and in certain costs of

But it is suggested that the vice of the Commission’s plan is the formulation of a capital structure which as a result of conversion of debt into stock so increases the impact of mounting taxes on the company as to deprive junior interests of net earnings which would be available for distribution to them if the ratio of debt to stock were increased. Such a conversion of debt into stock is said to be entirely unnecessary to the formulation of a sound plan and results in unfairness to junior interests. The difficulty with that argument is that Congress has entrusted the Commission, not the courts, with the responsibility of formulating a plan of reorganization which “will be compatible with the public interest.” § 77 (d). The nature of the capital structure, as well as the amount of the capitalization, is a component of “the public interest.” For the “preservation of the transportation system and the stability of its credit essential to its preservation depend not alone upon the ability of individual carriers to meet their obligations, but upon the ability of all to attract the investment of funds in their securities.” See United States v. Chicago, M., St. P. & P. R. Co., 282 U. S. 311 , 337 (dissenting opinion). Furthermore, Congress

Finally, it is argued on behalf of some of the stockholders that the effective date of a plan promulgated under § 77 must be the date of the filing of the petition, the theory being that § 77 does not permit the accrual of interest after that date. In Consolidated Rock Products Co. v. Du Bois, we held that, under § 77B, interest on secured claims accrued to the effective date of the plan was entitled to the same priority as the principal. See 312 U. S. p. 514, note 4, p. 527, and cases cited. The definition of the terms “creditors” and “claims” was substantially the same under § 77B (b) as it is under § 77. We see no reason why the same result should not obtain here.

Treatment of the Terre Haute Bonds. The treatment accorded these bonds is attacked by the Terre Haute and representatives of its bondholders as well as by certain groups of Milwaukee bondholders. The Terre Haute interests contend, in the first place, that the plan contains no findings necessary for determining how the sacrifices required of these bondholders shall be distributed inter se. It is pointed out that the modifications proposed by the Commission for these four classes of bondholders are to be made regardless of the lien, security, interest or maturity of each and the earning power of the respective underlying properties. Hence it is argued that this phase of the plan is hot fair and equitable, since it does not even attempt to preserve the respective priorities of these bond issues. The short answer to that objection is that the Terre Haute properties have not been treated by the Commission or the District Court as a part of the properties of the debtor for reorganization purposes. Nor has any question been raised or argued here as to the power of the Commission or the District Court so to treat them. The Commission and the District Court considered the

In 1928 the Commission reviewed the history of the acquisition of this property. 131 I. C. C. 653 -660. It then said that the Terre Haute was “a distress property controlled by a committee of Chicago bankers who wanted to liquidate and who had written the securities off the books of their banks as losses” (pp. 657-658); that “the terms upon which the property was acquired were improvident and to that extent adversely affected the financial condition of the St. Paul” (p. 657); and that “the total financial burden as of June 30, 1925, which had fallen upon the income of the St. Paul as a result of this lease was nearly $11,000,000.” p.656. In its present report the Commission, after reviewing certain earnings data, concluded that “the earning power of the Terre Haute is sufficient to cover all interest requirements, but this earning power is largely dependent on a continuation of the Milwaukee’s coal traffic, together with the commercial coal traffic that accompanies it, and would be greatly diminished if such traffic ceased.” And it added; “The present arrangement is distinctly to the advantage of-the Terre Haute.” The Commission concluded, however, that a rejection of the lease would be to the “disadvantage” of both companies and that some means should be provided “for retaining the Terre Haute lines as a part of the system without unduly jeopardizing.a successful reorganization- of the Milwaukee.” - The Commission; ón the other hand, felt that .an. affirmance . would- be. inequitable; frqm

The argument of the Terre Haute interests that only burdensome leases may be rejected is based on certain statements of ours that burdensome leases may be rejected (Palmer v. Webster & Atlas National Bank, 312 U. S. 156 , 163; Philadelphia Co. v. Dipple, 312 U. S. 168 , 174) and on cases like American Brake Shoe & Foundry Co. v. New York Rys. Co., 278 F. 842 , 844, which hold that an equity receiver may not reject a lease when it does not appear that “in carrying out its affirmative obligations the estate suffers an actual loss as distinguished from the obtaining of a more profitable rental.” And an extended analysis of the operations under the lease is made to show that the lease is a valuable asset of the estate and that the debtor received a net financial benefit from it in recent years. We do not need to determine, however, what is the scope of the authority to reject leases under § 77, either by the trustees or pursuant to a plan of reorganization. For here we think that the proposed modifications of the lease contained in the plan were wholly justified. The Terre Haute bondholders are “creditors” of the debtor as defined in § 77 (b), for they are holders of “a claim under ... an unexpired lease.” See. 77 (b) (5) provides not only that the plan “may” contain provisions rejecting unexpired leases but also that it “may include any other appropriate provisions not inconsistent with this section.” It is also stated in subsection (b) (1) that a plan “shall include provisions modifying or altering the rights of creditors generally, or of any class of them, secured or unsecured, either through

Finally, the Terre Haute interests object to the provisions of the plan which state that the Terre Haute lease shall be rejected as of the date the District Court determines that the Terre Haute bondholders have not consented to the making of a new lease at a reduced rental. They contend that the lessor’s claim for damages for breach of the lease must be measured as of the date on which the proceeding was instituted. They further contend that, in the event of rejection of a lease, operation of the leased property subsequent to the commencement of the proceeding must be for the account of the lessor — the latter being liable for all losses and being entitled to any net earnings. On the first point they rely on § 77 (b), which provides that, in case an unexpired lease is rejected, “any person injured by such nonadoption or rejection shall for all purposes of this section be deemed to be a creditor of the debtor to the extent of the actual damage or injury determined in accordance with principles obtaining in equity proceedings.” It is argued that, since this Court held that that provision places leases “upon the same basis as executory contracts” (Connecticut Ry. Co. v. Palmer, 305 U. S. 493 , 502), the rule governing breaches of an executory contract (Pennsylvania Steel Co. v. New York City Ry. Co., 198 F. 721 , 744; Samuels v. E. F. Drew & Co., 292 F. 734 , 739) must be applied here. This Court stated in the Palmer case, however, that the provision in § 77 (b) which allows the lessor to prove his “actual dam

For similar reasons we conclude that, in event of rejection of the lease, operation subsequent to the commencement of the proceeding and prior to the rejection need not be for the account of the lessor so as to entitle it to any net earnings. As we have noted, the stipulated annual rental has been paid during the § 77 proceedings. The court order authorizing the payment of interest (which is part of the rental) stated that it should not be construed “to preclude or conclude the Debtor in respect of its right of election to disaffirm or discontinue” the lease. And § 77 (b) provides that the adoption of an unexpired lease by the trustees “shall not preclude a rejection” of it in a plan of reorganization. Furthermore, § 77 (c) (6) provides:

“If a lease of a line of railroad is rejected, and if the lessee, with the approval of the judge, shall elect no longer to operate the leased line, it shall be the duty of the lessor

at the end of a period to be fixed by the judge to begin the operation of such line, unless the judge, upon the petition of the lessor, shall decree after hearing that it would be impracticable and contrary to the public interest for the lessor to operate the said line, in which event it shall be the duty of the lessee to continue operation on or for the account of the lessor until the abandonment of such line is authorized by the Commission in accordance with the provisions of section 1 of the Interstate Commerce Act as amended.”

Sec. 77 (c) (6) contains no express provision that on rejection of a lease the operation of the property by the lessee shall be for the account of the lessor for the period prior to the rejection. But the Terre Haute interests seek to read into § 77 the doctrine of relation back so that in case of a rejection of the lease the lessee’s operation during the entire period of bankruptcy is for the account of the lessor, the latter being responsible for all losses and entitled to all the net earnings. That was the general rule governing railroad leases in equity receivership proceedings (See Meck, Railroad Leases and Reorganization, 49 Yale L. Journ. 1401, 1405-1407), at least where the receivers of the lessee made no payments of rent during the term of their possession. Pennsylvania Steel Co. v. New York City Ry. Co., supra, 730-732; American Brake Shoe & Foundry Co. v. New York Rys. Co., 282 F. 523 . And see United States Trust Co. v. Wabash Western Ry. Co., 150 U. S. 287 . And there is some authority for the view that the same result follows even though unconditional payments of rent have been made in the interim, the theory being that the receiver must “be held to have occupied from the beginning the same position that he ultimately assumes.” Westinghouse Electric & Mfg. Co. v. Brooklyn Rapid Transit Co., 6 F. 2d 547 , 549. But see Second Avenue R. Co. v. Robinson, 225 F. 734 . Cf. Sunflower Oil Co. v. Wilson, 142 U. S. 313 . But the rule was

General Mortgage Bonds. The objections of the corporate trustee and of a group of these bondholders are that the allocation of new securities under the plan violates their priority rights, that the findings of the Commission are inadequate to sustain that allocation of new securities, and that the additions and betterments fund impairs their priorities.

The Circuit Court of Appeals was of the view that the plan could not be approved because of the absence of certain findings which it thought were necessitated by Consolidated Bock Products Co. v. Du Bois, supra. It concluded that the findings must include specific values of liens to be surrendered and specific values of securities given in exchange. In its view, this defect in the Commission’s reports permeated the whole plan except the finding of “no value” for the stock. As we have pointed out in the Western Pacific case, such a view misinterprets Consolidated Bock Products Co. v. Du Bois. In that case the District Court had found that the properties were

The objections of the General Mortgage bonds are that full compensation was not afforded them for the loss of

So the problem for us on this phase of the case is whether, within the framework of the capital structure which has been designed, the allocation of new securities to the General Mortgage bonds was permissible within the rule of the Boyd and the Consolidated Rock Products cases. On this record, that entails primarily a consideration of the treatment accorded the General Mortgage bonds, on the one hand, and the Milwaukee & Northern bonds and the 50-year bonds on the other.

As we have noted, the General Mortgage bonds are to receive 25% of their claims in new First Mortgage bonds, 35% in Series A and 20% in Series B, new General Mortgage bonds, and 20% in preferred stock. The same treatment is accorded the Milwaukee & Northern Consolidated Mortgage bonds. The Milwaukee & Northern First Mortgage bonds, however, are to receive 70% of their claims in new First Mortgage bonds and 30% in Series A new General Mortgage bonds. And the 50-year bonds

They point out that the Commission referred to the General Mortgage lines as “the heart of the system”; that the interest on these bonds has been earned, with the exception of a few years, since 1889; that the western lines securing the 50-year bonds are deficit lines. In that connection they refer to the Commission’s statement that the losses by the western lines were $142,591 in 1930 and $1,~ 540,808 in 1931, before payment of interest and that “on any reasonable basis of allocation between the lines west and the other parts of the system, the lines west cannot be expected to earn any sum for the payment of interest. In years when the system earnings approach $10,000,000,

The problem in such a case is not a simple one. The contribution which each division makes to a system is not a mere matter of arithmetical computation. It involves an appraisal of many factors and the exercise of an informed judgment. Furthermore, an attempt to put precise dollar values on separate divisions of one operating unit would be quite illusory. As the Commission recently stated, “The properties comprise one operating unit; a complete separation of values would necessarily have to be based on extensive assumptions of unprovable

We would have quite a different problem if the District Court had failed to perform the functions which § 77 (e) places upon it. But it cannot be said that there was any such failure here. The District Court satisfied itself that the principles of priority as applied to these facts were respected. See 36 F. Supp. pp. 202-203, 211-212. Since such a determination rests in the realm of judgment rather than mathematics, there is an area for disagreement. But we are not performing the functions of the District Court under § 77 (e). Our role on review is a limited one. It is not enough to reverse the District Court that we might have appraised the facts somewhat differently. If there is warrant for the action of the District Court, our task on review is at an end.

That leads to a question much discussed in this case, as in the Western Pacific case, as to the nature and extent of the findings necessary under § 77 in order to approve a plan as “fair and equitable.” As we have said, the finding of the Commission, affirmed by the District Court, that the stock had “no value” was warranted. Furthermore, the Commission’s determination of the permissible capitalization of the new company was sufficient as a finding of the maximum reorganization values which might be distributed among the various classes of security holders. But it has been argued here, as in the Western Pacific case, that a dollar valuation must be made of each old security and of each new security in order to give “full compensatory treatment” to senior claimants and to appropriate to the payment of their claims the “full value” of the property, in accord with the principles of Consolidated Rock Products Co. v. Du Bois, supra, p. 529 . The rule in equity receivership cases that the creditors

There are, however, two objections made by the General Mortgage bonds which we think have merit. The first of these relates to the dispute as to the so-called “pieces of lines east.” The General Mortgage bonds contend here, as they did before the Commission, that they have a first lien on those properties by reason of the after-acquired property clause in their mortgage. The Commission credited the 50-year bonds with the earnings from those properties, indicating, however, that the propriety of doing so was doubtful in absence of a judicial determination of the question. Some of the General Mortgage bonds objected to that allocation before the District Court. The District Court, however, did not undertake to resolve the dispute. These General Mortgage bondholders likewise raised the point before the Circuit Court of Appeals. But it was not considered there. The objection has been renewed here but has not been argued on the merits. We can hardly treat the matter as de minimis, as there is evidence that these properties had a

Some argument is advanced that under this plan the General Mortgage bondholders do receive as against the junior interests compensatory treatment which is adequate to make up for the seniority rights which they are to surrender. Part of that is said to be in the control which they obtain. It is pointed out that the plan provides for a five year voting trust in which the several groups of bondholders will be represented; that thereafter the plan protects their control by providing that the new preferred stock (all of which is to be issued to the Milwaukee & Northern Consolidated bonds, the Gary bonds, the General Mortgage bonds, and the 50-year bonds) will be entitled to cumulative voting to elect a majority of the board of directors during certain periods when full dividends on the preferred have not been paid; and that the exercise of the conversion rights of the Series B new General Mortgage bonds, allotted to these senior bondholders, would result in their acquisition of over 50% of both the preferred and common. It is also argued that compensatory treatment is to be found in the fact that the new General Mortgage bonds have sinking funds and are cumulative up to three years of interest, and that the new preferred stock is participating.

50-Year Bonds. The two points just discussed in relation to the General Mortgage bonds are equally applicable to the 50-year bonds. Final approval of the plan as it affects those' two issues cannot be made until findings are made on those two matters.

The 50-year bonds raise other objections. We have already considered their major objections in other connections, and they need not he repeated. But a word should

The plan formulated by the Commission seems to me to be a straddle between these two alternatives. The holders of bonds secured by mortgages on the Terre Haute property are, in some aspects, treated as if they were mortgage creditors of the debtor. In other aspects, Terre Haute is treated as an arm’s length creditor with whom a bargain must be struck. The vice of this seems apparent on this record. Whereas each class of mortgage creditors of the debtor is afforded a participation in the securities and probable earnings of the new company in purported compliance with the rule of the Case and Rock Products decisions, and whereas the Commission recognizes the difference in the nature of the lien and security of the three issues of mortgage bonds of Terre Haute, in the plan they are all treated alike and not accorded positions corresponding to their respective liens and priorities. The excuse for this is that the Commissión is dealing with a lease and fixing a rental to be paid to an outside lessor. On the other hand, the concept of dealing with a lessor, as I read the record, moved the Commission to propose to the lessor what it thought would be an attractive offer in order to persuade the lessor to accept a new lease. In this aspect, the Commission, as I think, made the bondholders of Terre Haute, treated as a class, a proposition which gives them an inordinately superior position to that accorded the holders of General Mortgage bonds, and produces a serious discrimination against the latter.

I refer to these circumstances merely to reinforce what I have said above to the effect that it is evident Congress did not provide for any such treatment of the rights accruing under an unexpired lease. I am of opinion, therefore, that, as a matter of law, the plan adopted by the Commission does not conform to the standards set up by § 77, and particularly by subsection (b).

In conformity with what I have said in Ecker v. Western Pacific R. Corp., I think the duty rested upon the district judge to sustain the objections of General Mortgage bondholders, because I cannot find hi the facts stated by the Interstate Commerce Commission and those proved before the District Court any reasonable justification for the allocation made to them as against that made to the holders of bonds secured by the Milwaukee & Northern Consolidated Mortgage and the Fifty Year Mortgage, or for the treatment accorded them in comparison to that accorded Terre Haute’s bondholders. The opinion of the Court treats this question as, in effect, lying within the sound discretion of the district judge and refuses to review his action on the ground that it is not evident he abused that discretion. I am of the view that, unless we are to recant what we have heretofore said, the rule of law as to the maintenance of the respective positions of lienors must be enforced. Of course, that rule must be applied in the light of the facts of each ease, but I do not think the district judge may abdicate the duty of examining those facts and correcting what is shown to be a clear infraction of the rule. Neither the judge nor the Commission need essay to value the property under each mortgage, or the securities to be allocated to the mortgagees under it, in dollars and cents. Substantial equivalence satisfies the requirement of “fairness and equity” in its legal sense as used in this setting. The court should, of course, give weight to what the Commission has found,