Petition — Barry v. American Financial Enterprises, Inc.

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Supreme Court, U, ee

FILED

8.0 .-6 66 - OCT 88 1980

MICHAEL RODAK, JR CLERK

In THE ae

Supreme Court of the United States

Octoser TrRM, 1980

In tHE Marrer or THe New York, New

Haven aNpD Hartrorp Rarroap Company,

Debtor,

Tomas B, Barry,

Petitioner,

AMERICAN FinanciAL Enrerprisss, Inc.,

Respondent.

PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

Metvyn I. Weiss

Counsel of Record

Ricuarp M. MEYER

One Pennsylvania Plaza

New York, New York 10119

Attorneys for Petitioner

(212) 594-5300

Of Counsel:

JEROME M. CoNnGRESS

Mriuperc Werss Bersuap & SPECTHRIE

Questions Presented

1. Did the court of appeals err in affirming the district

court’s approval of a Plan of Reorganization which

allowed over $32,000,000 in claims for post-bankruptcy

interest to certain secured creditors where that approval

was predicated upon a supposed exception to the gen-

eral rule and strong public policy enunciated by this

Court against the allowance of post-bankruptcy interest?

2. Where the district court structured a plan of reorgani-

zation by adjudicating litigated issues, did the court of

appeals err in treating the appeal as a settlement pro-

ceeding, substituting its discretion for the specific ad-

judications of the district court and making its own find-

ings concerning the propriety of the plan, including

findings concerning the risks of further litigation on

adjudicated questions of fact?

Parties in the Court of Appeals

The parties in the court of appeals are listed in the

caption of the opinion (A105-A106). By Order entered

October 1, 1980, the court of appeals substituted the re-

spondent herein for Richard Joyce Smith, Trustee, Law-

rence D. Iannotti, Successor Trustee, and Jacob D. Zeldes,

Successor Trustee (A124-A125).

TABLE OF CONTENTS

PAGE

Neen nn eens cnceumabbhbemosnesectins i

SE ih SETI AL CIA oe CORR SS ERT 1

EERIE RMA ee oe aT 2

I I se ackensndsahatninapoensinine Soiabs 2

I I I oo dcndtncnncccosannsonccss 2

Reasons For GRANTING THE WrIT—

It Is Important to Resolve the Confusion Among

the Circuits as to Whether This Court’s Policy

Against Allowing Post-Bankruptcy Interest Per-

mits an Exception for Interest on Consensual Se-

EE ce TERI a rahe BA STOR TOD 4

II. The Court of Appeals Departed From the Usual

and Proper Standards of Judicial Review ............ 10

i es. sscihonsacbicwhiaas 12

A> -ENDIx—

Statute—11 U.S.C. § 205(e) 2... eeeeeeeeeee Al

District Court Memorandum of Decision ................ A6

District Court Order Approving Plan of Reorgan-

ei ass ssennecesnanhsassossatonsnsnen A97

Annex to Order of District Court -........00000020222...... A100

District Court Supplemental Opinion .................... A103

Opinion of Court of Appeals ...0200200.20.20..ccc eee A105

Onder of Court of Appeals ........................................ A124

iii

TaBLE or AUTHORITIES

Cases: PAGE

City of New York v. Saper, 336 U.S. 328 (1949) ........ 4,5, 8

Coder v. Arts, 213 U.S. 223 (1909) ........ SO eo we 6, 6n

Consolidated Rock Products Co. v. DuBois, 312 U.S.

SU FRIED anciccdcinscaeccssassostiteabecresenpeiccsrcteertias-coanaalaaiianss sn

Group of Institutional Investors v. Chicago, 318 US.

ORB CODGBY aii sciiicapaistinicsrrnrncdtenenthoasstacdatenctatmdaiiiete 6n

In re Kingsboro Mortgage Corp., 514 F.2d 400 (2d

Circ SOE craic cctedln se cetditanonicanaiacnipnn eee, 7

In re Macomb Trailer Coach, Inc., 200 F.2d 611 (6th

Cir.) cert. denied sub nom. McInnis v. Weeks, 345

. GG ER eas isncccnesahcinvrssegerelinheciepeensimeeeancntetatnn 6

In re New York, New Haven and Hartford Railroad

Compuny. 304 F. Supp. 1121 (D. Conn. 1969) ......... . 8n

In re New York, New Haven and Hartford Railroad

Company, 304 F. Supp. 1136 (D. Conn. 1969) ............ 8n

In re Penn Central Transportation Co., 596 F.2d 1102

CBE Che, TIPU kasi ce iehe in eccick iecandialceibeh okednaatahallbcenian 11, 11n

Nicholas v. United States, 384 U.S. 678 (1966) 0... 4

Reading Company v. Brown, 391 U.S. 471 (1968) ........ 9

Sexton v. Dreyfus, 219 U.S. 339 (1911) ......0000000000.. 4

Sword Line, Inc. v. Industrial Commissioner of State

of New York, 212 F.2d 865 (2d Cir.), cert. denied,

S68 UR. GRO: COG iia heii keine. 6-7

TMT Trailer Ferry v. Anderson, 390 U.S. 414 (1968) 10

United States v. Bass, 271 F.2d 129 (9th Cir. 1959) ... 6

United States v. Harrington, 269 F.2d 719 (4th Cir.

SID scliessecicscescosssinicdissbiatattabableiashvtaiinicchaninaaittaaiaaediee aaa 5, 6n

Vanston Bondholders Protective Committee v. Green,

SSP: 5s. 368: (RONG ene 5, 6, 6n, 7

U.S. Code: PAGE

Te els 9 I OP Biciciadicsesethasthaecondecaphbatdsiabiidaeaeapastolenin 2,3

BT gqncnenmeenrne be Soebatine Wyse ORDER Teta 2

Legislatiwe Reports:

Report of the Commission On The Bankruptcy Laws

of the United States, Part I, House Doc. No. 93-137,

DOG CA, BOG PR. COG OD | isicntlctilisncsinlscssssitesafacctnceetcniien 9n

Miscellaneous:

Flanagan, Debtors File for Bankruptcy at a Record

Rate, Wall St. Jrnl., June 30, 1980 (Eastern Ed.) .... 9n

IN THE

Supreme Court of the United States

Ocroser Term, 1980

In THE Matter or THe New York, NEw

Haven anp Hartrorp Rarroap Company,

Debtor,

Tuomas B, Barry,

Petitioner,

AMERICAN Financia, Enterprises, Inc.,

Respondent.

PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

Thomas B. Barry hereby petitions that a writ of certio-

rari issue to review the judgment and opinion of the United

States Court of Appeals for the Second Circuit entered on

July 30, 1980.

Opinions Below

The opinion and supplemental opinion of the United

States District Court for the District of Connecticut are

not yet officially reported and are printed in the Appendix

at page A6-A96 and A103-A104. The opinion of the United

States Court of Appeals for the Second Circuit is not yet

officially reported and is printed in the Appendix at pages

A105-A123.

Jurisdiction

The Second Circuit’s judgment was entered on July 30,

1980 (A105). The jurisdiction of this Court .is invoked

under 28 U.S.C. §1254(1).

Statute Involved

The provisions of 11 U.S.C. § 205(e) are set forth in the

Appendix (A1-A5).

a Statement of the Case

The New York, New Haven and Hartford Railroad

Company originally filed for reorganization under Chapter

77 of the Bankruptcy Act in 1961. The ensuing proceed-

ings were presided over in the district court by Judge

Anderson until his death in 1978, and thereafter by Judge

Zampano. The competing claimants to the debtor’s assets—

found by the district court to have a value of $149.5 mil-

lion—are two classes: the First Mortgage Bondholders on

the one hand, and the Income Bondholders on the other.*

Despite the urging of the district court, the parties

were unable to resolve their differences and work out a

compromise. As a consequence, the district court “struc-

tured” a Plan of Reorganization, adjudicating all of the

claims advanced by the parties (A95). The principal

components of the district court’s decision are (1) its

finding that the present value of the assets of the New

Haven is $149.5 million (A87), and (2) its conclusion

* Administration and tax claims are to be paid in full in cash.

The debtor is insolvent, so that no equity resides in any of the

stockholders.

of law that the First Mortgage Bondholders are entitled

to over $32 million in post-bankruptcy interest (A91-A93).

The Plan of Reorganization structured by the District

Court provides for a reorganized debtor with an equity

capitalization consisting of one class of common stock.

Ninety-three percent of that stock is to be distributed to

the holders of the First Mortgage Bonds; seven percent

is given to the Income Bondholders (A101-A102). The First

Mortgage Bondholders will thus receive 100% of the

principal amount of their claims plus full post-bankruptcy

interest. The Income Bondholders on the other hand, will

receive only approximately 14% of the value of their claim

(A32, A93).

Pursuant to 11 U.S.C. § 205(e), the petitioner, the owner

of $310,000 of Income Bonds, filed a timely objection to

the Plan of Reorganization. The petitioner contended, and

contends here, that the Plan erroneously added to the

allowed claims of the First Mortgage Bondholders over

$32 million in post-bankruptcy interest. Without that

allowance, the Income Bondholders would be entitled to

receive 30% rather than 7% of the reorganized company.

The district court overruled the objections and approved

the Plan with minor revisions, adhering to its findings

of fact and conclusions of law. It did not treat the Plan as

a compromise plan (as, indeed, it was not), and thus made

no findings concerning the risks of litigation. Neverthe-

less, on appeal, the court of appeals affirmed without re-

ferring to the legal question of post-bankruptcy interest.

Instead, it held that its jurisdiction was “plenary” and ap-

proved the Plan as though it were a compromise in spite

of the district court’s contrary “determinations on the

merits” (A117).

REASONS FOR GRANTING THE WRIT

It Is Important to Resolve the Confusion Among the

Circuits as to Whether This Court’s Policy Against Al-

lowing Post-Bankruptcy Interest Permits an Exception

for Interest on Consensual Secured Claims.

Nearly 70 years ago, Mr. Justice Holmes, in Sexton v.

Dreyfus, 219 U.S. 339 (1911), pointed out that it was a

“fundamental principle” of bankruptcy law, reaching back

a century and a half, that post-petition interest was not

allowed in bankruptey or receivership proceedings. A

generation later, in City of New York v. Saper, 336 U.S.

328 (1949), Mr. Justice Jackson restated and reaffirmed

the vitality of that principle. The reasons underlying the

principle were stated by Mr. Justice Stewart in Nicholas

v. United States, 384 U.S. 678, 683-84 (1966) :

“We believe that the decisions of this Court in Sexton

and Saper reflect the broad equitable principle that

creditors should not be disadvantaged vis-a-vis one

another by legal delays attributable solely to the

time-consuming procedures inherent in the adminis-

tration of the bankruptcy laws. In the context of

interest-bearing debts, the equitable principle enun-

ciated in Sexton and Saper rests at bottom on an

awareness of the inequity that would result if, through

the continuing accumulation of interest in.the course

of subsequent bankruptcy proceedings, obligations

bearing relatively high rates of interest were per-

mitted to absorb the assets of a bankrupt estate whose

funds were already inadequate to pay the principal

of the debts owed by the estate.” (footnotes omitted)

Despite this seemingly categorical language, the courts

have permitted exceptions to the general rule against allow-

ing post-bankruptcy interest. In the present case, the dis-

trict court enumerated three such exceptions:

1. where the bankrupt ultimately proves to be solvent;

2. where the claimant’s security itself produces income

after the filing of the petition; and

3. where the value of the security exceeds the principal

and interest due (A89-A90).

The court found that neither of the first two exceptions is

applicable to this case (A90), and predicated its approval

of the »lan on the supposed third exception.

In City of New York v. Saper, supra, this Court recog-

nized the existence of the first two exceptions and no others.

The Court’s discussion strongly suggested that it would not

approve the exception upon which the plan below is predi-

cated, since it specifically recognized that, under the com-

mon law, the general rule that interest stopped running at

the date of bankruptcy “applied to mortgages as well as

unsecured debts.” 336 U.S. at pp. 330-31 n.7. In United

Stat s v. Harrington, 269 F.2d 719, 723 n.6 (4th Cir, 1959),

the court stated that “the Supreme Court does not appear

to have recognized any such general exception”, referring

to the alleged third exception at issue herein.

In formulating the third exception here, the lower court

relied upon Vanston Bondholders Protective Committee v.

Green, 329 U.S. 156 (1946). However, the lower court mis-

read Vanston. In Vanston, this Court (per Mr. Justice

Black) recognized the general rule of bankruptcy that in-

terest on the debtor’s obligations ceases to accrue at the

beginning of proceedings. 329 U.S. at 163. It did suggest

an exception (329 U.S. at 164):

“ .. But where an estate was ample to pay all cred-

itors and to pay interest even after the petition was

filed, equitable considerations were invoked to permit

payment of this additional] interest to the secured cred-

itor rather than to the debtor.”

The exception stated by this Court in Vanston is a far cry

from that formulated by the district court. The Court’s

exception permits the allowance of interest where the debt-

or’s estate is sufficient to pay all its creditors, so that cred-

itor’s rights may be fully satisfied before funds are returned

to the debtor or its stockholders.* But that is a long step

from saying that one creditor’s principal may be taken to

pay another creditor’s interest.

Nevertheless, the penumbral effects of decisions such as

Vanston and Coder v. Arts, 213 U.S. 223 (1909).** has left

confusion among the Circuits on the question whether this

Court’s policy with respect to post-bankruptcy interest per-

mits the alleged thi.d exception. E.g., United States v. Bass,

271 F.2d 129, 131 n.3 (9th Cir. 1959) (“there may be some

doubt whether the Supreme Court recognizes the third ex-

ception”) ; In re Macomb Trailer Coach, Inc., 200 F.2d 611,

613 (6th Cir.), cert. denied sub nom, McInnis v. Weeks, 345

U.S. 958 (1953), (“there is some difference of opinion

whether a third exception is recognized”). In Sword Line,

* Indeed, this is the rationale of Consolidated Rock Products

Co. v. DuBois, 312 U.S. 510 (1941), and Group of Institutional

Investors v. Chicago, 318 U.S 523 (1943), which involved the

rights of creditors as against stockholders.

**In Coder v. Arts, cited in Vanston, this Court affirmed the

allowance of post-bankruptcy interest to a mortgagee without any

discussion. As noted in United States v. Harrington, supra, 269

F.2d at 723, Coder was primarily concerned with whether or not

the particular mortgage involved was a fraudulent conveyance and

did not really address the issue as to whether or not the alleged

third exception exists.

Inc. v. Industrial Commissioner of State of New York, 212

F.2d 865 (2d Cir.), cert. denied, 348 U.S. 830 (1954), the

Second Circuit specifically indicated the need for a decision

by this Court resolving the uncertainty as to whether a

third exception existed:

“Since the Supreme Court has not yet settled the extent

and nature of these suggested exceptions, it may be

premature to base an extended argument upon their ex-

istence ; in pursuance of an overriding policy the Court

may ultimately think it is not desirable to allow any at

all.” 212 F.2. at 869. (emphasis added)

The pattern of uncertainty concerning the existence of

a third exception is further exemplified by subsequent de-

cisions in the Second Circuit. In In re Kingsboro Mortgage

Corp., 514 F.2d 400, 401 n.1 (2d Cir. 1975), the court sug-

gested that no third exception existed when it listed the

first two exceptions but did not acknowledge any third

exception. Nevertheless, here the district court utilized a

third exception as a basis for approving the plan of re-

organization. The court of appeals approved the district

court’s order despite the apparent inconsistency of that

order with the Second Circuit’s unwillingness to recognize

the third exception in Kingsboro, supra.

Unlike the Vanston exception, the third exception upon

which the plan of reorganization at bar is predicated makes

vast inroads upon the fundamental principle enunciated

by this Court that creditors should not normally be prej-

udiced by the continued running of interest beyond the

date of bankruptcy. The security interest of the First

Mortgage Bondholders extends to all of the property of

the debtor. Thus, application of the third exception could

have virtually eliminated the entire claim of the Income

Bondholders. This would occur as the accumulated interest

on the senior bonds increased to the point at which, when

added to the principal, it approached but did not quite

equal the value of the bankrupt estate. Indeed, had the

interest rate been slightly higher or the duration of the

proceedings slightly longer, this would have happened.

And as things now stand, the Income Bondholders receive

but a small fraction of their principal claim while the

First Mortgage Bondholders receive full principal and

interest.

Thus, the lower court’s formulated exception completely

erodes the substance and purpose of the fundamental

principle enunciated by this Court—that one creditor’s in-

terest should not invade another creditor’s principal. Par-

ticularly in view of the substantial fluctuation in interest

rates which have recently characterized the economy, and

which would render the relative treatment of creditors

especially inequitable (as in the present case), the Court

should not permit this unwarranted incursion to stand.*

This Court granted certiorari in City of New York v.

Saper, supra, to resolve the question of whether tax claims

against a bankrupt corporation ceased to bear interest as

of the date of bankruptcy because “the matter ... [was

one] of considerable practical importance in the adminis-

* The lower court’s error is compounded by the fact that it pur-

ported to follow the law of the case (A88), but failed to do so.

Judge Anderson had previously held “that the first mortgage

bondholders are entitled to an accrual of interest up to but not

beyond the effective date of the Plan” (In re New York, New

Haven and Hartford Railroad Company, 304 F. Supp. 1136, 1139

(D. Conn. 1969)). He specifically defined the effective date of the

Plan as being December 2, 1968 (304 F. Supp. at 1133 n. 17),

having in mind that lengthy and protracted proceedings would

follow. Judge Zampano apparently believed that the prior hold-

ing required the allowance of interest up until the effective date

of whatever plan was ultimately approved (A92).

tration of the Bankruptcy Act.” 336 U.S. at 329. In Read-

ing Company v. Brown, 391 U.S. 471, 475, 477 (1968),

certiorari was granted “because the issue is important in

the administration of the bankruptcy laws and is one of

first impression in this Court”, where the trustee had over-

looked the “decisive, statutory objective [of] fairness to

all persons having claims against an insolvent.” Here the

matter is also one of great practical importance since the

interest claims of secured creditors often represent very

substantial claims in bankruptcies and reorganizations.

Given the enormous number of bankruptcies over which

the Federal Courts preside, it is extremely important that

this Court resolve the confusion over a so-called third ex-

ception, the existence of which would severely undermine

the purposes of this Court’s declared policy.*

* Bankruptcy administration now constitutes one of the most

significant functions performed by the federal courts. 's 1973,

the Commission On The Bankruptcy Laws reported thai “The

most dramatic fact about bankruptcy administered under the pres-

ent Act is the rising tide of bankruptcies since World War II.”

Report of the Commission On The Bankruptcy Laws of the United

States, Part I, House Doe. No. 93-137, 93d Cong., 1st Sess., p. 2

(1973). From 10,000 cases commenced in fiscal 1946, the number

of new filings increased steadily to over 208,000 cases in fiscal

1967, and to approximately 355,000 filings in the year ended June

30, 1980. Idem; Flanagan, Debtors File for Bankruptcy at a Rec-

ord Rate, Wall St. Jrnl., June 30, 1980, p. 34 (Eastern Ed.).

These cases cannot be properly administered under the chaotic

jurisprudence laid down by the court of appeals.

Il.

The Court of Appeals Departed From the Usual and

Proper Standards of Judicial Review.

The court of appeals, considering the scope of its review

to be “plenary”, disregarded the adjudications of the dis-

trict court and treated the appeal as a de novo proceeding

to approve a plan of compromise (A117). If this approach

is sanctioned, it will wreak havoc with the system of ap-

pellate review.

It is a well accepted principle of appellate review that

findings of fact will be reversed only if they are clearly

erroneous, whereas conclusions of law cannot stand if in-

correct. The necessity for proper standards is no different

in bankruptcy proceedings; TMT Trailer Ferry v. Ander-

son, 390 U.S. 414, 434, 441 (1968) :

“Tt is essential ... that a reviewing court have some

basis for distinguishing between well-reasoned conclu-

sions arrived at after a comprehensive consideration

of all relevant factors, and mere boilerplate approval

phrased in appropriate language but unsupported by

evaluation of the facts or analysis of the law.

Since the determination of insolvency was not made

in accordance with the proper standards of valuation,

neither the approval nor the confirmation of the plan

can stand.”

Indeed, the importance of applying proper standards in

such proceedings is highlighted by the responsibility placed

upon the courts as the guardian of the absent parties, such

as the petitioner.

‘The necessity for following this accepted approach in the

present case is manifest. The district court conducted years

of hearings, considered extensive evidence, and compiled a

voluminous record (A36-A37, A72-A73, A112-A113). On

the other hand, the court of appeals “ranted an expedited

appeal and rendered its decision less than two months after

the docketing of the record. That decision turns upside-

down the established standards for appellate review. It

substitutes appellate factual findings for those of the dis-

trict court without finding them clearly erroneous; and it

ignores an egregiously incorrect conclusion of law. Specif-

ically, the district court found that the value of the debtor’s

estate was $149.5 million (A87). The court of appeals held

that it “need not ... determine” whether this finding was

erroneous; it sufficed that there existed other “plausible”

methods of valuation which might have been detrimental

to the Income Bondholders (A122).

The reliance of the court of appeals on the Penn Central

decision*® for the proposition of plenary review is com-

pletely misplaced. Indeed, Penn Central merely reiterates

the familiar proposition that findings of fact should not be

overturned unless clearly erroneous, but questions of law

must be decided in accordance with established jurispru-

dence.** In the present case, the district court’s legal con-

clusions were not in accordance with law. Its factual de-

*In re Penn Central Transportation Co., 596 F.2d 1102 (3d

Cir. 1979).

** 7d. at 1114-15:

“ . . These intimations, when coupled with the customary in-

junction that judicial findings of fact should not be over-

turned on appeal unless they are clearly erroneous, suggest

that on all factual issues our review should be highly defer-

ential. We think, however, that the issue of whether, viewing

the facts in the light most favorable to the Plan, a particular

legal theory is reasonably likely to succeed, is one on which

our review must necessarily be plenary.”

terminations could be reversed only if clearly eroneous.

Application of the correct legal standard to the findings of

the district court would have increased the Income Bond-

holders’ equity five-fold. Accordingly, the court of appeals

should have remanded the case to the district court in ac-

cordance with proper judicial procedure.

CONCLUSION

For the foregoing reasons, it is respectfully submitted

that this Court should grant the petition for a writ of

certiorari to review the judgment of the Court of Appeals

for the Second Circuit.

Respectfully submitted,

Metvyn I. Weiss

Ricuarp M. Meyer

One Pennsylvania Plaza

New York, New York 10119

Attorneys for Petitioner

Of Counsel:

JEROME M. ConGREsS

Mriperc Weiss Bersuap & SPEcTHRIE

APPENDIX

Statute—11 U.S.C. § 205(e)

Upon the certification of a plan by the Commission to the

court, the court shall give due notice to all parties in in-

terest of the time within which such parties may file with

the court their objections to such plan, and such parties

shall file, within such time as may be fixed in said notice,

detailed and specific objections in writing to the plan and

their claims for equitable treatment. The judge shall, after

notice in such manner as he may determine to the debtor,

its trustee or trustees, stockholders, creditors, and the Com-

mission, hear all parties in interest in support of, and in

opposition to, such objections to the plan and such claims

for equitable treatment. After such hearing, and without

any hearing if no objections are filed, the judge shall ap-

prove the plan if satisfied that: (1) It complies with the

provisions of subsection (b) 0” this section, is fair and equi-

table, affords due recogntion to the rights of each class of

creditors and stockholders, does not discriminate unfairly

in favor of any class of creditors or stockholders, and will

conform to the requirements of the law of the land regard-

ing the participation of the various classes of creditors and

stockholders; (2) the approximate amounts to be paid by

the debtor, or by any corporation or corporations acquiring

the debtor’s assets, for expenses and fees incident to the

reorganization, have been fully disclosed so far as they can

be ascertained at the date of such hearing, are reasonable,

are within such maximum limits as are fixed by the Com-

mission, and are within such maximum limits to be subject

to the approval of the judge; (3) the plan provides for the

payment of all costs of administration and all other allow-

ances made or to be made by the judge, except that al-

Statute—11 U.S.C. § 205(e)

lowances provided for in subsection (c), paragraph (12) of

this section, may be paid in securities provided for in the

plan if those entitled thereto will accept such payment, and

the judge is hereby given power to approve the same.

If the judge shall not approve the plan, he shall file an

opinion, stating his conclusions and the reasons therefor,

and he shall enter an order in which he may either dismiss

the proceedings, or in his discretion and on motion of any

party in interest refer the proceedings back to the Commis-

sion for further action, in which event he shall transmit to

the Commission a copy of any evidence received. If the

proceedings are referred back to the Commissien, it shall

proceed to a reconsideration of the proceedings under the

provisions of subsection (d) of this section. If the judge

shall approve the plan, he shall file an opinion, stating his

conclusions and the reasons therefor, and enter an order to

that effect, and shall send a certified copy of such opinion

and order to the Commission. The plan shall then be sub-

mitted by the Commission to the creditors of each class

whose claims have been filed and allowed in aecordance

with the requirements of subsection (c) of this section, and

to the stockholders of each class, and/or to the committees

or other representatives thereof, for acceptance or rejec-

tion, within such time as the Commission shall specify, to-

gether with the report or reports of the Commission thereon

or such a summarization thereof as the Commission may

approve, and the opinion and order of the judge: Provided,

That submission to any class of stockholders shall not be

necessary if the Commission shall have found, and the

judge shall have affirmed the finding, (a) that at the time

of the finding the corporation is insolvent, or that at the

time of the finding the equity of such class of stockholders

has no value, or that the plan provides for the payment in

Statute—11 U.S.C. § 205(e)

cash to such class of stockholders of an amount not less

than the value of their equity, if any, or (b) that the in-

terests of such class of stockholders will not be adversely

and materially affected by the plan, or (c) that the debtor

has pursuant to authorized corporate action accepted the

plan and its stockholders are bound by such acceptance:

Provided, further, That submission to any class of creditors

shall not be necessary if the Commission shall have found,

and the judge shall have affirmed the finding, that the in-

terests of such class of creditors will not be adversely and

materially affected by the plan, or that at the time of the

finding the interests of such class of creditors have no value,

or that the plan provides for the payment in cash to such

class of creditors of an amount not less than the value of

their interests. For the purpore of this section the accep-

tance or rejection by any creditor or stockholder shall be in

writing, executed by him or by his duly authorized attorney,

committee, or representative. If the United States of Amer-

ica, or any agency thereof, or any corporation (other than

the Reconstruction Finance Corporation) the majority of

the stock which is owned by the United States of America,

is a creditor or stockholder, the interests or claims thereof

shall be deemed to be affected by the plan, and the President

of the United States, or any officer or agency he may desig-

nate, is hereby authorized to act in respect of the interests

or claims of the United States or of such agency or other

corporation. The expense of such submission shall be certi-

fied by the Commission and shall be borne by the debtor’s

estate. The Commission shall certify to the judge the results

of such submission. .

Upon receipt of such certification, the judge shall confirm

the plan if satisfied that it has been accepted by or on behalf

of creditors of each class to which submission is required

Statute—11 U.S.C. § 205(e)

under this subsection holding more than two-thirds in

amount of the total of the allowed claims of such class

which have been reported in said submission as voting on

said plan, and by or on behalf of stockholders of each class

to which submission is required under this subsection hold-

ing more than two-thirds of the stock of such class which

has been reported in said submission as voting on said plan;

and that such acceptances have not been made or procured

by any means forbidden by law: Provided, That, if the plan

has not been so accepted by the creditors and stockholders,

the judge may nevertheless confirm the plan if he is satisfied

and finds, after hearing, that it makes adequate provision

for fair and equitable treatment for the interests or claims

of those rejecting it; that such rejection is not reasonably

justified in the light of the respective rights and interests

of those rejecting it and all the relevant facts; and that the

plan conforms to the requirements of clauses (1) to (3),

inclusive, of the first paragraph of this subsection (e):

Provided further, That if, in any reorganization proceeding

under this section, the United States is a creditor on claims

for taxes or customs duties (whether or not in the United

States has any other interest in, or claim against, the debtor,

as creditor or stockholder), no plan which does not provide

for the payment thereof shall be confirmed by the judge

except upon the acceptance, certified to the court, of a lesser

amount by the President of the United States or the officer

or agency designated by him pursuant to the provisions of

the preceding paragraph hereof: Provided further, That

if the President of the United States or such officer or

agency shall fail to accept or reject such lesser amount for

more than ninety days after receipt of writen notice so to

do from the court, accompanied by a certified copy of the

plan, the consent of the United States insofar as its claims

Statute—11 U.S.C. § 205(e)

for taxes or customs duties are concerned shall be conclu-

sively presumed, If the judge shall confirm the plan, he

shall enter an order and file an opinion with a statement of

his conclusions and his reasons therefor. If the judge shall

not confirm the plan, he shall file an opinion, with a state-

ment of his conclusions and his reasons therefor, and enter

an order in which he shall either dismiss the proceedings,

or, in his discretion and on the motion of any party in in-

terest, refer the case back to the Commission for further

proceedings, including the consideration of modifications

of the plan or the proposal of new plans. In the event of

such a reference back to the Commission, the proceedings

with respect to any modified or new plan shall be governed

by the provisions of this section in like manner as in an

original proceeding hereunder.

If it shall be necessary to determine the value of any

property for any purpose under this section, the Commis-

sion shal] determine such value and certify the same to the

court in its report on the plan. 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 prospective, and all other

relevant facts. In determining such value only such effect

shall be given to the present cost of reproduction new and

less depreciation and original cost of the property, and the

actual investment therein, as may be required under the

law of the land, in light of its earning power and all other

relevant facts.

Memorandum of Decision

UNITED STATES DISTRICT COURT

District or ConNECTICUT

In the Matter of

Tue New York, New Have. anp

Hartrorp Rarmroap Company,

Debtor.

In Proceedings for the Reorganization of a Railroad

No. 30226

TABLE oF CONTENTS

PAGE

I. History or tHe New Haven ReEorGANIZATION ........ 2

Il. AmenpeD Puan or REORGANIZATION OF THE NEW

B. CLASSIFICATION OF CLAIMS AND INTERESTS AND

TREATMENT PROVIDED .............-..0-ss0-cesese0e0 seth 17

Class A Claims ..............00-- CES AER CT 17

I eh ists sndsmensarennopaiionseevtontocs 17

Class C and Class F Clatms -.0..0.......21.0.-020-0-0-0++ 17

I a cscanesecnlvigibinanibozube 20

i ctcgnataesibetiiiliesonone 20

Memorandum of Decision

PAGE

TTI. Crass G anp Crass H CiarM ..0........ccceccececeeeeeseeeeees 21

A. Tue Parties’ VALUATION or THE New Haven

SPINE, cccicesscthiDaceppndecadsateideindtcagaitesillglapvanienecieshoneianhatinia 25

The Trustee’s Methodology .............000cc0000000000- 27

The First Mortgage Bondholders’ Method-

CONG cudisnsicrneseastiniigndenatdiaaladehsdvaedemmpapianbccn 41

The Income Bondholders’ Methodology ............ 49

B. Tue Court’s Ruuines on VALuaTION ...............- 52

GINGER sasieias secicissinyniinpnnceittiigipeianisensavelinaniineinseniGiadiadibniio 53

Fe. ID Sain aiceisinstetninsstapieteelaickel abibinlannnegl 53

EEN aE RUSS einen AE vee 64

C. Tue Court’s Runines on CuaIMs ............20000-0-+- 66

Se SCUUSIIR cciiteiiniiccrcicthnsinerttinmedicamainiilasl 73

Memorandum of Decision

[1] UNITED STATES DISTRICT COURT

District or CoNNECTICUT

In Proceedings for the Reorganization of » Railroad

No. 30226

In the Matter of

Tue New York, New Haven anv Hartrorp Rarroap

ComMPany,

Debtor.

MEMORANDUM OF DecIsIon

On July 7, 1961, the New York, New Haven & Hartford

Railroad Company (“New Haven”) filed a petition for re-

organization under Section 77 of the Bankruptcy Act, 11

U.S.C. § 205, in the United States District Court for the

District of Connecticut. At the time the New Haven was

a financially derailed and wrecked railroad. For the next

17 years, Chief Judge Robert P. Anderson, later Circuit

Judge, painstakingly presided over the reorganization pro-

ceedings with extraordinary skill, patience, common sense,

and perspicacity. The voluminous record discloses thou-

sands of pages of petitions, briefs, moving papers, exhibits,

transcripts of hearings, and other documents. Judge Ander-

son’s numerous decisions and orders speak eloquently of

his wise and effective judicial performance over the years

in salvage efforts of the New Haven, with the result that it

now emerges from the ruins with prospects of being a re-

markably healthy enterprise of substantial value.

By May 1978, Judge Anderson had set in motion the

£2] procedural steps necessary to reorganize the New

Memorandum of Decision

Haven and to terminate finally this complex and difficult

case. Unfortunately, he died on May 2, 1978, and the matter

was assigned to this Court for resolution.

I. History or tHe New Haven REorGANIZATION

In 1935 the New Haven first went into reorganization

under Section 77 of the Bankruptcy Act and emerged 12

years later with a capitalization in part of 1) $95,703,700

principal amount of series A first and refunding mortgage

bonds due July 1, 2007, bearing interest at the rate of 4

percent per annum, and 2) $87,881,500 principal amount of

general mortgage income series A bonds, due July 1, 2022,

bearing contingent interest at the rate of 41%4 percent per

annum.’ At the time, with some 1,500 miles of line extending

from Boston to New York, it was the largest railroad in

New England and the sixth largest in the Northeast region.’

After a few years of superficial prosperity, the financial

condition of the New Haven again deteriorated. By 1961,

with current liabilities exceeding current assets by over

$36,000,000 and losing cash at the annual rate of $18,000,000,

the company filed a petition for reorganization under Sec-

tion 77.2 Judge Anderson approved the petition and three

trustees were appointed to administer the rapidly declin-

ing railroad.‘

1 New York, N.H. & H.R.R. Reorganization, No. 10992 (1.C.C.

Sept. 17, 1947° (Supplemental Report of the Commission).

2 New Haven Inclusion Cases, 399 U.S. 392, 401 (1970).

37d., at 403.

‘The trustees were Richard Joyce Smith, William J. Kirk and

Harry W. Dorigan. Mr. Dorigan died in 1966; Mr. Kirk resigned

in 1969 and died in 1979; Mr. Smith has served as the sole trus-

tee since March 1, 1969.

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Memorandum of Decision

There were three possible courses of action for the par-

ties: 1) seek termination of the operations of the trans-

portation system and liquidation of the assets; 2) sell the

bankrupt railroad to other profitable carriers; or 3) merge

with a larger successful trunkline railroad.®

[3] Since it was immediately apparent that no other

railroad was interested in purchasing the debt-ridden New

Haven, Judge Anderson gave careful and thoughtful con-

sideration to the remaining options. Initially it appeared

that “the value of the property in the estate of the Debtor

as a going concern should exceed by far its value for pur-

poses of liquidation,” and, therefore, he approved continued

operations for the public good and in the interests of cred-

itors.© Through “life-sustaining transfusions of credit,” ?

the trustees maintained the system’s passenger and freight

lines.

Despite spartan economies and a sizeable reduction in the

number of employees, staggering losses continued to mount

and it soon became obvious that no reorganization plan

that contemplated the New Haven as an independent oper-

ating business would be feasible.* Liquidation was deemed

5In re Penn Central Transportation Co., 458 F. Supp. 1234,

1248 (E.D. Pa. 1978), aff'd in part, modified and rev'd in part

596 F.2d 1102; aff'd in part, 596 F.2d 1127; appeal dismissed in

part, 596 F.2d 1155 (3 Cir.), cert. denied, 48 U.S.L.W. 3218 (US.

Oct. 2, 1979).

6 In re New York, N.H. & H.R.R., No. 30226 (D. Conn. Dee.

31, 1961) (Order No. 25, authorizing the trustees to borrow money

and issue certificates of indebtedness).

7 Id. (Mar. 5, 1962) (Order No. 81, authorizing trustees to lease

new commuter cars from the Port of New York Authority).

In re New York, N.H. & H.R.R., 281 F. Supp. 65, 66 (D. Conn.

1968).

All

Memorandum of Decision

detrimental to the public interest® and, therefore, merger

with a large, financially healthy railroad seemed to be the

most logical and promising means of sustaining the New

Haven’s transportation system.”

When the Pennsylvania Railroad and the New York

Central Railroad applied to the Interstate Commerce Com-

mission for permission to merge on March 9, 1962, the New

Haven trustees promptly sought inclusion in a merged

Penn-Central system, both by private negotiations and by

a petition to the Commission filed June 26, 1962.11 As noted

by Judge Anderson, the “inclusion of the New Haven in the

Penn-Central merger was the only salvation for the New

Haven as an operating railroad.” In re New York, N.H. &

H.R.R., 289 F. Supp. 451, 456 (D. Conn. 1968).

[4] On April 6, 1966, after more than four years of

deficit operations by the New Haven, the Commission ap-

proved the Penn-Central merger, subject to the condition

that the merged railroad would purchase essentially all of

the assets of the New Haven.” In addition, the Commission

directed that a plan for inclusion of the New Haven in the

Penn-Central system be filed by October 27, 1966, upon such

fair and equitable terms and conditions as the Commission

might determine, subject to the approval of the reorganiza-

9In re New York, N.H. & H.R.R., 304 F. Supp. 793, 800 (D.

Conn. 1969), aff’d in part, vacated in part sub nom., New Haven

Inclusion Cases, 399 U.S. 392 (1970).

10 In re New York, N.H. & H.R.R., 479 F.2d 8, 10 (2 Cir. 1978) ;

In re New York, N.H. & H.R.R., 289 F. Supp. 451, 456 (D. Conn.

1968).

11 New Haven Inclusion Cases, supra note 2, 399 U.S. at 408;

In re New York, N.H. & H.R.R., supra note 10, 479 F.2d at 10.

12 Pennsylvania R.R.—Merger—New York Central R.R., 327

I.C.C. 475, 524 (1966).

Al2

Memorandum of Decision

tion court."* On April 21, 1966, a Purchase Agreement was

executed between the New Haven trustees and representa-

tives of the merging railroads by which the Penn-Central

would acquire the properties of the New Haven for a

consideration consisting of cash, Penn-Central stocks and

bonds, and the assumption of certain of the New Haven’s

obligations."

In October 1966, the New Haven trustees filed with the

Commission a ‘two-step” plan of reorganization which pro-

vided for 1) the New Haven’s assets to be sold to the Penn-

Central, and 2) thereafter, a determination of fair and

equitable terms for the treatment of security holders. Cer-

tain creditor interests litigated and expenditure of the

assets of the New Haven to implement the plan and in 1967,

the Second Circuit ruled that the merits of the two-step

process should be postponed until the Commission certified

a plan to the reorganization court."®

On November 19, 1967, after an independent review, the

Commission concluded that $125 million was a fair and

equitable price for the sale of the New Haven’s assets under

the Purchase Agreement.’* This finding was promptly [5]

challenged by different classes of the New Haven’s bond-

holders which on January 23, 1968, commenced a series of

actions before a three-judge circuit court in the Southern

8 7d., at 553.

14 Tannottt v. Manufacturers Hanover Trust Co. (In re New

York, N.H. & H.R.R.), 567 F.2d 166, 168-69 (2 Cir.), cert. denied,

434 U.S. 833 (1977).

15 In re New York, N.H. & H.R.R., 378 F.2d 635 (2 Cir. 1967) :

see also New Haven Inclusion Cases, supra note 2, 399 U.S. at 431,

n. 47.

16 In re New York, N.H. & H.R.R., supra note 10, 479 F.2d at

11; see also Pennsylvania R.R.—Merger—New York Central R.R.,

331 I.C.C. 643 (1967).

Al3

Memorandum of Decision

District of New York to set aside the Commission’s order."

Shortly after the merger of the Pennsylvania and New York

Central railroads on February 1, 1968, the Commission cer-

tified Step I of the reorganization plan for the New Haven

—the sale of the New Haven’s assets to Penn-Central—to

the reorganization court.'* The New Haven bondholders,

pursuant to Section 77(e) of the Bankruptcy Act, responded

with objections to the plan and, thus, the identical question

concerning the price Penn-Central would have to pay the

New Haven was the subject of judicial review simultane-

ously in the reorganization court in this District and the

three-judge district court in New York. Subsequently, both

courts determined that the Commission had substantially

undervalued the New Haven’s assets to be conveyed and

remanded the issue to the Commission for further proceed-

ings. New York, N.H. d H.R.R., First Mortgage 4% Bond-

holders’ Committee v. United States, 289 F. Supp. 418 (S.D.

N.Y. 1968) ; In re New York, N.H. & H.R.R., supra, 289 F.

Supp. at 466.

On remand, the Commission held further hearings in ac-

cordance with the instructions of the two reviewing courts.

On December 2, 1968, it reported a revaluation of the New

Haven’s assets at $140 million and set January 1, 1969 as

the date for the transfer of the New Haven’s assets and

operations to Penn-Central. Pennsylvania R.R. — Merger

— New York Central R.R., 334 L.C.C. 25, 53, 74, 76 (“Fourth

Supplemental Report’).

[6] During this period Judge Anderson recognized that

the New Haven’s desperate financial problems were caus-

ing an irreversible erosion of the estate and that continued

expenses would soon reach the point of being an unconsti-

17 New Haven Inclusion Cases, supra note 2, 399 U.S. at 413.

18 Td.

Al4

Memorandum of Decision

tutional taking of the New Haven’s assets without just

compensation.'® Accordingly, on December 24, 1968, he

filed a memorandum of decision and order approving the

transfer of the New Haven’s assets to Penn Central as

the “first step” in the New Haven’s plan of reorganization.

He instructed the trustees to carry out the conveyance

and receive the consideration fixed by the Commission,

subject to a general reservation of jurisdiction to review

the plan of reorganization, including objections already

filed as to the amount of such consideration. He further

reiterated that “unless the transfer of the assets of the

New Haven and the operation of the transportation sys-

tem were taken over by the Penn Central by January 1,

1969, the trains of the New Haven would stop running.” *°

On December 31, 1968, the assets and operations were

transferred to the Penn Central. At the time of the trans-

fer the New Haven received from Penn Central 956,576

shares of Penn Central stock and about $63 million (cash,

bonds and assumption and/or forgiveness of indebtedness)

with the understanding that the total purchase price

Penn Central was to pay remained for future judicial de-

termination.”*

Another round of litigation brought by objecting bond-

holders before the reorganization court and a three-judge

[7] district court in New York followed, wherein post-

19In re New York, N.H. & H.R.R., supra note 9, 304 F. Supp.

at 796.

20 Td.; see also In re New York, N.H. & H.R.R., No. 30226 (D.

Conn. Dee. 24, 1968) (Memorandum of Decision on Inclusion and

Payment by January 1, 1969; Order No. 559, directing inclusion of

debtor in Penn Central Company).

*1ZIn re New York, N.H. & H.R.R., 330 F. Supp. 131, 139-40

(D. Conn. 1971), rev’d on other grounds, 457 F.2d 683 (2 Cir.

1972), cert. denied, 409 U.S. 890 (1973).

Al5

Memorandum of Decision

conveyance judicial review of the adequacy of the com-

pensation was sought.

On May 28, 1969, the reorganization court entered its

decision on Step I of the plan, In re New York, N.H. &

H.R.R., 304 F. Supp. 793 (D. Conn. 1969), aff'd in part,

vacated in part sub nom., New Haven Inclusion Cases, 399

U.S. 392 (1970), and in a separate opinion, filed July 28,

1969, it reviewed Step II of the plan, 304 F. Supp. 1121.

The findings and rulings in both decisions were incorpo-

rated in a single order, dated July 28, 1969, 304 F. Supp.

1136 (D. Conn. 1969), aff’d in part, vacated in part sub

nom., New Haven Inclusion Cases, 399 U.S. 392 (1970).

In his Step I Opinion, Judge Anderson determined the

Commission had erred in certain respects in its valuation

of the New Haven’s assets, and concluded that the price

to be paid by Penn Central was approximately $175 mil-

lion. Moreover, he structured an “underwriting” plan

designed to ensure that the New Haven would receive

the value of $87.50 per share of Penn Central’s common

stock, the intrinsic value ascribed to the shares by the

Commission, 304 F. Supp. at 809.

In his Step II Opinion, Judge Anderson addressed the

distributive elements of the plan of reorganization. This

opinion is, of course, highly significant as precedent be-

cause many of the same and/or related issues are now

pending before this Court for decision. Appellate review

of the plan of reorganization to date, culminating in the

New Haven Inclusion Cases, 399 U.S. 392 (1970), primarily

concerned Step I of the plan.”

[8] On June 18, 1969, the three-judge court entered its

opinion on the appropriate compensation to be paid by

*? Step II is further discussed in other sections of this opinion.

Al6

Memorandum of Decision

Penn Central to the New Haven. Although it agreed with

Judge Anderson on the need for the “underwriting,” it

disagreed with his valuation of the assets by over $28

million, and, in effect, sustained the Commission’s price

determinations.”*

The conflicting decisions of the two district courts were

then reviewed by the Supreme Court in expedited pro-

ceedings.” In the New Haven Inclusion Cases, supra, 399

U.S. 392, the Supreme Court held that the reorganization

court, as distinguished from the three-judge court, had

primary jurisdiction over the pricing question, and af-

firmed Judge Anderson’s evaluation of the New Haven’s

assets. This, however, did not terminate the issue. Eight

days before the Supreme Court’s decision, the Penn Cen-

tral filed a petition for reorganization under Section 77

of the Bankruptcy Act in the United States District Court

for the Eastern District of Pennsylvania. Recognizing

that Penn Central’s bankruptcy would substantially re-

duce the value of its securities, the Supreme Court de-

cided that a remand for “[{f]lurther proceedings before

the Commission and the appropriate federal courts [was]

necessary to determine the form that Penn Central’s con-

sideration to [the] New Haven should properly take and

the status of the New Haven estate as a shareholder or

creditor of Penn Central.” Jd. at 489.

On remand, in the light of Penn Central’s bankruptcy

and in order fully to compensate and secure the New

Haven estate for the balance remaining due, Judge Ander-

23 New York, N.H. & H.R.R., First Mortgage 4% Bondholders’

Committee v. United States, 305 F. Supp. 1049 (S.D.N.Y. 1969)

_ (Weinfeld, J. dissenting in part), vacated sub nom. New Haven

Inclusion Cases, 399 U.S. 392 (1970).

*4 In re New York, N.H. & H.R.R., supra note 10, 479 F.2d at 11.

Al7

Memorandum of Decision

son sought [9] to give the New Haven a secured-creditor

status by declaring an equitable lien on all the assets trans-

ferred by the New Haven to Penn Central, and imposing

a constructive trust on the New Haven’s share of the in-

come from the Grand Central properties.** On appeal, the

Second Circuit reversed on jurisdictional grounds and re-

manded the case directly to the Commission.** Later in

the Penn Central reorganization proceedings, for the pur-

pose of clarifying the status of the New Haven as a par-

ticipant in that case, Judge Fullam concluded that the

New Haven estate should be treated tentatively as hold-

ing “a lien, indeterminate in amount, and indeterminate

as to priority, upon all the real property and readily

identifiable tangible personal property (exclusive of roll-

ing stock) .. . conveyed to Penn Central.” *”

Thereafter, the reorganization of the New Haven was

largely entwined with the complex, unique and lengthy

reorganization of the Penn Central. The New Haven

trustee had asserted a secured claim in the total amount

of $208.5 million for the unpaid principal and interest,

arising from the inclusion in 1968 of the New Haven in

the Penn Central merger.

The collapse of the mighty Penn Central precipitated

a “rail transportation crisis seriously threatening the na-

tional welfare.” Regional Rail Reorganization Act Cases,

419 U.S. 102, 108 (1974). It soon became evident that a

successful reorganization of Penn Central could not be ac-

*6 In re New York, N.H. & H.R.R., supra note 21, 330 F. Supp.

at 142.

26 In re New York, N.H. & H.R.R., 457 F.2d 683, 691 (2 Cir.

1972) (Mansfield, J. concurring and dissenting), cert. denied, 409

U.S. 890 (1973).

*7In re Penn Central Transportation Co., 337 F. Supp. 779,

(E.D. Pa. 1971), cert. denied 409 U.S. 1012 (1972).

A18

Memorandum of Decision

complished wholly within the means provided by Section

77 of the Bankruptcy ‘ct and that congressional inter-

vention was necessary.”* Congress responded to the crisis

with the enactment of tue Regional Rail Reorganization

Act of [10] 1973 (RRRA), which became law on January

2, 1974.2 On December 16, 1974, the Supreme Court sus-

tained the Act against constitutional challenge.*® The pur-

pose and effect of the RRRA have been succinctly stated

by Judge Fullam as follows:

The broad outline of the RRRA is relatively straight-

forward. The bankrupts would operate under the aegis

of the Reorganization Courts for a further period,

approximately 20 months, during which time the United

States Railway Association (USRA), a new corporate

entity created under the Act, could complete the task

of planning the new rail system or systems, and decid-

ing what portions of the Northeast bankrupts’ rail fa-

cilities should be conveved to Consolidated Rail Cor-

poration (ConRail), the company which was to take

over the system which USRA designed. The statute

contemplates a system which, while not profitable im-

mediately, would ultimately be a profitable private

sector carrier. In return for the properties conveyed

to Conrail, the bankrupts were to receive common stock

and other securities of ConRail in amounts commen-

surate with the value of the properties conveyed. The

Act also created the Special Court, a three-judge panel

selected by the Judicial Panel on Multidistrict Litiga-

28 In re Penn Central Transportation Co., 596 F.2d 1127, 1133

(3 Cir. 1979).

2945 U.S.C. § 701, et seq.

8° Regional Rail Reorganization Act Cases, 419 U.S. 102 (1974).

A19

Memorandum of Decision

tion, to rule on the adequacy of USRA’s valuation of

the conveyed property and the value of the stock of

ConRail which was given in return.

In re Penn-Central Transportation Co., 458 F. Supp. 1234,

1252 (E.D. Pa. 1978), aff'd in part, modified and rev’d in

part, 596 F.2d 1102; aff'd in part, 596 F.2d 1127; appecl

dismissed in part, 596 F.2d 1155 (3 Cir.), cert. denied, 48

U.S.L.W. 3218 (U.S. Oct. 2, 1979).

On April 1, 1976, certain of Penn-Central’s rail properties

were conveyed to ConRail. Litigation, commonly referred

to as the “Valuation Case,” followed, with the focus pri-

marily directed to 1) the “net liquidation value” of the Penn-

Central properties conveyed to ConRail, and 2) the [11]

“compensable unconstitutional erosion, if any,” suffered

during the pre-conveyance period. See In re Valuation Pro-

ceedings, 439 F. Supp. 1351 (Special Ct. 1977) (Erosion

Opinion) and 445 F. Supp. 994 (Special Ct. 1977) (Valua-

tion Opinion). The main purpose of these two opinions

rendered by the Special Court is to establish guidelines for

the parties and the trial masters on the valuation issues.

The eventual outcome of the Valuation Case may have a

direct and significant effect on the payment of the debt

securities issued by the reorganized Penn-Central.*

The next sequence of relevant events involved efforts to

formulate a fair and equitable plan of reorganization of the

Penn-Central. As summarized by Judge Aldisert:

These efforts were focused on an attempt to construct

a plan that would take account of (1) the income-pro-

ducing continuing business owned and managed by

Pennco; (2) the cash to be generated through liquida-

317n re Penn Central Transportation Co., supra note 5, 458

F. Supp. at 1270-76.

A20

Memorandum of Decision

tion of non-essential remaining assets (the “asset dis-

position program”); and (3) the constitutionality as-

sured expectation that a significant award would be

made in the Valuation Case, understanding all the

while that both the time and the amount of the award

were unforeseeable. The alternative to such a plan, it

was believed, would be to embark on decades of litiga-

tion, with the concomitant waste of valuable and pro-

ductive assets and accrual of increasing claims. Any

plan, in order to be fair and equitable to the competing

claims against the estate, would also have to take into

-account a basic reality of this reorganization proceed-

ing: that the validity, priority or amount of virtually

every claim was under attack in one way or another.

In re Penn Central Transportation Co., 596 F.2d 1127, 1136

(3 Cir. 1979).

In the fall of 1975 the Penn-Central trustees commenced

a series of meetings with creditor interests to work out a

consensual plan of reorganization, based necessarily on [12]

compromises of the many and varied claims in dispute. The

assets remaining after conveyance to Con-Rail fell into two

principal categories: 1) Penn-Central’s ongoing, success-

fully operating, non-railroad business, primarily consoli-

dated in the Pennsylvania Company (“Pennco’’); and 2) a

variety of real estate holdings and investments.”

During the following year, settlement proposals were

agreed upon by virtually all of the Penn-Central major

creditors, including the United States, the so-called “Friday

Group” (composed of representatives of a group of in-

surance companies known as the Institutional Investors

Group, the New Haven trustee, and a group of banks repre-

32 Td. at 1254-55.

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Memorandum of Decision

sented by Citibank), numerous state and local taxing au-

thorities, active unsecured creditors, Penn Central Company

(the sole stockholder of Penn-Central), and 15 leased lines

also in reorganization known as the “secondary debtors.” **

On December 17, 1976, the Penn-Central trustees filed a

plan of reorganization which embodied the agreement

reached on December 14, 1976, between the New Haven

trustee and the Chairman of the Penn-Central trustees. The

settlement proposed in the Penn-Central plan treated the

unpaid balance of the amount to be paid for the New Haven

assets transferred on December 31, 1968, as a debt obliga-

tion of the reorganized Penn-Central to be secured in the

amount of $121 million (the unpaid principal amount) and

unsecured in the amount of $53 million (a portion of the

interest claimed).** Ali securities previously received from

Penn-Central and then held by the New Haven were to be

cancelled. The total sum of [13] $174 million was in addi-

tion to the items of consideration (cash, assumption of

liabilities, and cancellation of indebtedness) previously paid

or credited under the inclusion agreement and which aggre-

gated approximately $53 million.

Inasmuch as all powers and duties of the ICC under

Section 77 of the Bankruptcy Act with respect to the New

Haven reorganization terminated as of February 5, 1976,

at which time all such powers and duties become vested in

the New Haven Reorganization Court by operation of § 618

(b) of the Railroad Revitalization and Regulatory Reform

Act of 1976, Pub, L. No. 94-210, 90° Stat. 31, February 5,

1976, the New Haven trustee petitioned the Court on Jan-

uary 7, 1977, for authority to settle the New Haven claim

337m re Penn Central Transportation Co., supra note 28, 596

F.2d at 1139.

847d., at 1138.

A22

Memorandum of Decision

against Penn Central Transportation Company on the terms

embodied in the Penn-Central reorganization plan. A hear-

ing on the petition was held on January 19, 1977, and by

Order No. 821, dated March 30, 1977, the New Haven trustee

was authorized “to take all such actions which he con-

sider[ed] necessary or appropriate in support of the pro-

posed settlement and Plan for Reorganization.”

After full and lengthy hearings, Judge Fullam approved

a plan of reorganization for the Penn-Central on March 17,

1978, specifically noting that the New Haven compromise

was “fair and reasonable” and “well within the range of

reasonably likely litigation possibilities.” In re Penn Cen-

tral Transportation Co., supra, 458 F. Supp. at 1270.

On May 1, 1978, the day before his death, Judge Anderson

issued Order No. 850 authorizing the New Haven trustee to

[14] vote in favor of the Penn-Central Plan. This order

constituted the final judicial step regarding approval of

Step I of the New Haven plan of reorganization.

The Penn Central Plan was consummated on October 24,

1978, and the New Haven trustee received the cash and

securities to which the New Haven estate was entitled:

$12.8 million in cash; $28.8 million principal amount of

Penn Central Series A Bonds; $7.5 million principal

amount of Penn Central Series B Bonds; 1,815,000 shares

of Penn Central Series B Preference Stock having a re-

demption value of $36.3 million; $15.9 million principal

amount of Penn Central Certificates of Beneficial Interest

(“CBI”) and 1,370,203 shares of Penn Central Common

Stock (representing about 6% of the total shares of Com-

mon Stock outstanding).

Prior to the receipt of the compensation from the Penn

Central, the New Haven trustee had filed Amendment No. 4

to the plan of reorganization of the New Haven (“Amended

A23

Memorandum of Decision

Plan”) on April 18, 1978, primarily directed toward Step

II, which had been held in abeyance pending a determina-

tion of New Haven’s interest in the reorganized Penn Cen-

tral. Hearings on Step II were conducted by this Court

commencing on October 12, 1978, and continuing through

July 12, 1979. Following the submission of briefs, final oral

arguments were heard during the week of November 19,

1979.

II. AMENDED PLAN or REORGANIZATION OF THE New Haven

As noted previously, definitive rulings with respect to

the treatment to be accorded security holders under [15]

Step II of the plan of reorganization were held in abeyance

pending the final determinations of the Step I issues. Those

determinations have been made and the consideration due

the New Haven from Penn Central has been paid. This

Court, therefore, now addresses the distributive elements

of the plan, incorporated in the trustee’s Amendment No. 4,

filed on April 18, 1978.°%° This necessarily includes con-

sideration of the distributive elements of the plans sub-

mitted by the other parties in this proceeding.

In deciding whether the provisions of the Amended Plan

are fair and equitable, the Court will discuss seriatim the

major features of the plan as set forth by the trustee, to-

gether with the objections, if any, of the parties, and rule

thereon.

6 The Amended Plan is a composite plan of reorganization re-

flecting the trustee’s plan of reorganization dated October 27, 1966,

as amended by Amendment No. 1 dated May 11, 1967, as amended

by Amendment No. 2 dated September 12, 1967, as amended by

Amendment No. 3 dated December 29, 1967, and as amended by

Amendment No. 4 dated April 18, 1978 (“Amended Plan”).

A24

Memorandum of Decision

A. Tue Reorcanizep CoMPANy

At the present time, the New Haven possesses cnly cash

and Penn Central securities. The Amended Plan contem-

plates that the New Haven will be reorganized to carry on

business as a closed-end, non-diversified management in-

vestment company under the Investment Company Act of

1940, as amended, 15 U.S.C. § 80a, e# seq., with an author-

ized equity capitalization consisting of 7,700,000 shares of

Class A Common Stock and 20,000,000 shares of New Com-

mon Stock of which the maximum number to be issued in

consummation of the Amended Plan will be approximately

7,700,000 and 6,600,000, respectively. There is no provision

for any long-term or short-term debt to be outstanding at

the consummation date except for Notes** and such debt as

may be incurred in consummation of the Plan in accordance

[16] with its terms.

On the consummation date of the Amended Plan, the

assets of the estate will be transferred to the reorganized

company which, in turn, will distribute cash and its securi-

ties in full satisfaction of all claims allowed against the

New Haven estate, in accordance with the provisions of

the approved Amended Plan. The transfer will effect a

discharge of all claims against the New Haven, except as

otherwise provided in the order confirming the Amended

Plan.

A reorganized New Haven has obvious merit particularly

in view of the substantial tax advantages and growth po-

tential of a new company. The parties to these proceedings

recognize that the gains to be derived from a reorganiza-

36 Inasmuch as the Court is ordering payments in cash for all

of the claimants for whom the Amended Plan provided partial

payment in Notes, the provisions for Notes should be deleted.

A25

Memorandum of Decision

tion of the New Haven far exceed the values for distribu-

tion under an immediate and straight liquidation and,

therefore, have offered no objection to this aspect of the

trustee’s Amended Plan.

Under these circumstances, the Court approves the con-

cept that the New Haven should continue as a reorganized

company, subject to the changes in the nature of the capital

structure required to comply with the Court’s rulings infra.

Whether the reorganized company will be formed by the

organization of a new corporation,*’ or by suitable changes

in the corporate papers of the present New Haven corpo-

ration, is left for future determination by this Court. In

either event, the Court will appoint the Board of Directors

of the reorganized company after considering suggestions

from interested persons.

[17] B. CwassiricaTion or CLAIMS AND INTERESTS

AND TREATMENT PROVIDED

Under the Amended Plan, the claims against the New

Haven are divided into ten classes: Classes A through

E represent post-bankruptcy or administration claims;

Classes F through J represent pre-bankruptcy claims.

Classes G and H are discussed in part III of this opinion.

Class A Claims

These claims consist of the costs and expenses incurred

and to be incurred in connection with the New Haven

reorganization proceedings. They include compensation

under Section 77(c)(2) (compensation for the trustee, his

37 Tn anticipation that this element of the Amended Plan would

be acceptable to the parties and the Court, the trustee formed a

new company, the “New Haven Corporation,”’ under the laws of

the State of Delaware on July 17, 1978.

A26

Memorandum of Decision

general counsel, and his special counsel), and under Sec-

tion 77(c)(12) (compensation for representatives of cred-

itor interests)."* The reserve of $5 million set aside by

38 Petitions have been filed on behalf of the trustee, his general

counsel, and certain of his special counsel for final compensation

under Section 77(¢c) (2) and are awaiting hearings to be scheduled

in the future.

The trustee requests $1,740,000, less the total amount of interim

fees received by him up to December 31, 1978, and further asks

that his final allowance for the period commencing January 1,

1979 and ending with his discharge, be fixed at $10,000 per month,

less the monthly interim fee allowed and paid to him during that

period. Between August 3, 1961 and November 30, 1979, Mr.

Smith received the sum of $943,180.00.

On behalf of the Estate of William J. Kirk, a former co-trustee

(see note 4, supra), Mr. Smith requests that a final fee of $300,000

be allowed in addition to the interim fees received by Mr. Kirk.

General counsel applies for an award ranging between $340,000

and $680,000 for the period ending August 3, 1978.

The firm of Sullivan and Worcester, special counsel to the trus-

tee, seeks $1,924,272 in addition to interim compensation paid or

to be paid. Between August 26, 1961 and December 13, 1979 this

firm has been paid the sum of $4,697,478.50. The trustee has filed

a Section 77(¢c)(12) petition in the Penn Central reorganization

court seeking reimbursement of $2,150,000 for legal expenses in-

curred by the New Haven which greatly benefited the reorganiza-

tion of the Penn Central.

The firm of Gratz, Tate, Spiegel, Ervin & Ruthrauff has also

filed a petition for final allowance as special counsel to the trustee

in the total amount of $98,861. This, too, is in addition to the fees

already allowed for services rendered to the New Haven.

On May 25, 1979, petitions were heard and are currently sub

judice with respect to the payment of contingent fees awarded by

Judge Anderson, In re New York, N.H. & H.R.R., 421 F. Supp.

249, 267, 272 (D. Conn. 1976), aff'd sub nom. Jannotti v. Manufac-

turers Hanover Trust Co., 567 F.2d 166 (2 Cir.), cert. denied, 434

U.S. 833 (1977), to the firm of Migdal, Tenney, Glass & Pollack,

counsel for the First Mortgage 4% Bondholders’ Committee, to

Manufacturers Hanover Trust Company for itself and for and on

account of the services of its attorneys Simpson, Thacher and

Bartlett, and to Chase Manhattan Bank, N. A., for and on account

of the services of its attorneys Dewey, Ballantine, Bushby, Palmer

& Wood. These contingent claims aggregate approximately

$1,400,000.

A27

Memorandum of Decision

the trustee for these claims is adequate for their payment

in cash by the reorganized company to the extent not paid

by the trustee prior to the consummation date.

Class B Claims

These claims were the sums due the United States as

the holder of Trustees’ Certificates which were extinguished

by the payments in full on November 8, 1978 and March

30, 1979, respectively, of $6.25 million unpaid principal

and $281,378 unpaid accrued interest. The provisions of

the Amended Plan with respect to Class B claims, there-

fore should be deleted.

Class C and Class F Claims

These classes refer to the claims of state and local au-

thorities for taxes and related charges. Class C is ap-

plicable to the post-bankruptcy period commencing July

7, 1961; Class F relates to the pre-bankruptcy accumula-

tion of [18] taxes and other charges. Section V of the

Amended Plan states in pertinent part:

5.3 Class C: These claims will be treated as being

equal to their principal amount, without penalties or

interest, and will be paid in cash on the Consummation

Date to the extent of 50% (together with such addi-

tional amount, if any, as will facilitate the issuance

of Notes in authorized denominations) and by the is-

suance and delivery of Notes in a principal amount

equal to the balance of the claims.

5.6 Class F: These claims (exclusive of penalties or

post-bankruptcy interest) including interest accrued

A28

Memorandum of Decision

for the Pre-Bankruptecy Period will be treated in the

same manner as Class C claims.

At the time the Amended Plan was filed, the contro-

versy over the computation and payment of the tax claims

loomed as a major source of complex and lengthy litiga-

tion. Second only in amount to the total claims of the two

system mortgages, the tax claims as listed on the books

of the New Haven represented a potential liability of over

$13 million due 347 taxing authorities. The major claim-

ants, led by the State of New York, asserted that post-

bankruptcy interest should be paid on all tax claims and

that tax claims, as “administration claims,” must be paid

in full and in cash upon consummation of the plan. If

valid, these contentions would have entitled local taxing

authorities from the State of New York alone, with the

principal amount of their tax claims at $5 million, to ob-

tain an additional sum of over $8 million in interest.

For reasons stated hereinafter, no useful purpose will

be served by reviewing the myriad legal arguments ad-

vanced by the tax claimants or the responses submitted

[19] by the trustee and other parties opposed to the tax

claimants’ position.*® Events occurring subsequent to April

*° The Court overrules the Income Bondholders trustee’s objec-

tion to payment of the remaining tax claimants in cash. He urges

that the Class C and Class F claims be treated as set forth in the

Amended Plan, i.e., 50% of the principal amount due on Con-

summation Date in cash, and the balance by the issuance of notes,

maturing in installments over a period of up to four years follow-

ing Consummation Date. The main reason advanced in support

of the objection is that the New Haven should preserve as much

of its cash reserves as possible to maximize the values in the

estate. However, the Court agrees with the New Haven trustee’s

position that the present cash position of the New Haven, well in

excess of $35 million, is more than sufficient to pay the remaining

A29

Memorandum of Decision

1978 have rendered these issues academic because no tax

claimant now remains that has legal standing to demand

more than the principal amount of its claim.

Concurring with Judge Anderson’s observation ten years

ago that “it may well be to the mutual advantage of [the]

tax claimants and the estate to negotiate settlements,” 304

F. Supp. at 1129, and in an effort to narrow the number

of litigable issues in these proceedings, this Court deter-

mined that as many as possible of the tax claimts’ dis-

putes with the New Haven should be settled. Accordingly,

in June 1978, the Court directed that a vigorous program

be commenced to reduce the number and dollar amount

of the tax claims. From that time on and continuing to

date, negotiations with tax claimants, on a case by case

basis, have been in progress with extraordinary success.

The overwhelming majority of the tax claims and related

charges, including those made by the City of New York,

State of New York, and the City of Providence, have been

resolved by payments ranging from 50% to 100% of their

respective principal amounts. No interest or penalty has

been allowed or paid on these claims.

Under these circumstances, settlement efforts with the

remaining tax claimants should continue up to the con-

summation date of the plan. Those tax claims which are

unresolved on the consummation date will be treated as

being equal to their principal amount, without penalties

or interest, and will be paid in full in cash on the con-

summation [20] date.

Paragraphs 5.3 and 5.6 of Section V of the Amended

Plan should be amended accordingly.

tax claims (less than $3 million) in cash without possible prej-

udice to the rights of other creditors or the financial status of the

estate.

A30

Memorandum of Decision

Class D Claims

These claims arise from the New Haven’s liability for

personal injury and wrongful death cases. Very few are

still pending, and the present reserve of $400,000 appears

adequate to cover immediate payments in cash of amounts

determined by adjudication or settlement up to the con-

summation date. Any claim that has not been so adjudi-

cated, determined or settled prior to the consummation

date will be assumed by the reorganized company and

thereafter paid in cash pursuant to an order of this Court

when such claim has been adjudicated or determined.

Paragraph 5.4 of Section V of the Amended Plan should

be amended to conform to this ruling.

Class E Claims

These claims are those not already specified in Classes

A through D but which are found by the Court to be en-

titled to be treated as administration claims. The total

exposure for Class E claims is approximately $1 million‘

and, therefore, when adjudicated or settled, they should be

paid in full in cash.

Paragraph 5.5 of Section V of the Amended Plan should

be amended accordingly.

Class I and Class J Claims

The New Haven estate is insolvent; therefore, the gen-

eral unsecured claims, designated as Class I, and the

stockholders’ interests, designated as Class J, have no

49 Certain consignees of perishable goods have filed a claim for

freight loss and damage during a period prior to December 31,

1968, in the amount of $610,000. The trustee disputes the claim.

seenne claims now pending, all of which are in contest, total

42.593.

A31

Memorandum of Decision

£21] equity and these unsecured, pre-reorganization claims

take nothing under the Amended Plan.

III. Cuass G anp Ciass H Ciaims

Class G claims are those of the First Mortgage Bond-

holders, whose bonds were issued under and secured by

the lien of the New Haven’s First and Refunding Mort-

gage, dated July 1, 1947, maturing July 1, 2007, and bear-

ing interest at the rate of 4% per annum. Class H claims

are those of the Income Mortgage Bondholders, whose

bonds were issued under and secured by the lien of the

New Haven’s General Income Mortgage, dated July 1,

1947, maturing July 1, 2002, and bearing interest at the

rate of 444% per annum.

The First Mortgage Bonds and Income Bonds them-

selves were originally reorganization securities, issued

when the New Haven emerged from an earlier Section 77

bankruptcy proceeding in 1947. In contrast to liens in

connection with specific acquisitions, these bonds are sys-

tem mortgages, secured by all the New Haven’s assets.

It is uncontroverted that the lien of the Income Bonds is

in all respects junior to the lien, on the same collateral,

of the First Mortgage Bonds. Thus, the First Mortgage

Bondholders must receive full compensation for the amount

allowed of their claim, and thereafter the Income Bond-

holders receive payment of their claim, but only to the

extent that the assets of the New Haven estate exceed the

senior claim. If nothing remains after the payment to the

first system bondholders, the second system bondholders

take nothing. If there is a surplus of assets, the Income

Bondholders participate in the plan or reorganization and

are secured in such amount, beyond [22] which they are

unsecured and are entitled to no payment.

A32

Memorandum of Decision

Under the Amended Plan, the trustee computes the

First Mortgage Bondholders’ allowable claim as follows:

$76,819,900 as the principal amount due, with accrual of

simple interest at the contract rate of 4% per annum

until the effective date of the plan, i.e., the date on which

the Court enters an order approving a plan of reorgani-

zation for the New Haven.*’ This interest now approxi-

mates $58,895,251. Thus, the trustee recognizes the total

claim in Class G to be about $135.7 million.”

The claims in Class H are fixed in the Amended Plan

in the aggregate amount of $59,877,493, with no further

accrual of interest.

In light of his estimated reorganization value for the

New Haven of between $120 million and $150 million, and

his estimated equity value for the reorganized New Haven

of approximately $140 million, the trustee proposes that

a fair and equitable distribution of the securities of the

reorganized New Haven as between the two system bond-

holders is as follows:

1) 7,681,990 shares of the preferred convertible Class A

Common Stock, representing one share for each $10 of

principal, to the holders of First Mortgage Bonds, in

satisfaction of the principal amount of their claim.

‘1 As filed on April 18, 1978, the trustee’s Amended Plan pro-

vided for accrual of simple interest on the First Mortgage Bonds,

at the contract rate of 4%, to September 30, 1978, his estimate of

a possible effective date of the Amended Plan.

*2 At the contract rate of 4%, simple interest on the principal

amount of the claim of the First Mortgage Bondholders accrues

in the amount of $256,066 per month. Such an accrual of interest

would require the issuance to the bondholders of 25,606.6 shares

of New Common Stock of the reorganized company for each month

between October 1, 1978 and the last day of the month in which

the effective date occurs.

A33

Memorandum of Decision

2) $5,889,525 shares of the New Common Stock repre-

senting one share for each $10 of interest, to the holders of

First Mortgage Bonds, in satisfaction of the interest ac-

crued to the effective date of the plan, i.e., February 14,

1980.

[23] 3) 1,055,110 shares of New Common Stock to holders

of Income Bonds, in satisfaction of the allowable portion

of their claim for principal and accrued interest to 1960.

In practical effect, assuming full conversion of Class A

Common into New Common, the relative distribution of

equity in the reorganized company under the Amended Plan

is 93.1% to the First Mortgage Bondholders and 6.9% to

the Income Bondholders.

Both the First Mortgage Bondholders* and the Income

Bondholders strenuously oppose these features of the

Amended Plan, and have submitted their own proposals

for the Court’s consideration. As might be expected, each

of their plans—based on divergent factual and legal ap-

proaches to the issues concerning the valuation of the assets

of the New Haven and the calculation of the allowable por-

tion of their respective claims—differs significantly with

respect to the proper distribution of the securities of the

reorganized New Haven vis-a-vis the two system mortgages.

In sum, the First Mortgage Bondholders argue that: 1)

the net asset value of the New Haven estate is less than

$76 million; 2) their total claim, including interest running

to the consummation date rather than the effective date of

the approved plan of reorganization, is in excess of $130

million; 3) the Court, therefore, must conclude there is no

equity whatever for the Income Bondhclders; and 4) there

48The “First Mortgage Bondholders” should be understood to

mean the Successor Trustee under the Debtor’s First and Re-

funding Mortgage and the First Mortgage 4% Bondholders’ Com-

mittee. °

A34

Memorandum of Decision

should be a single class of equity security in the reorgan-

ized New Haven, all of which should be distributed to the

holders of the First Mortgage Bonds,

The Income Bondholders, on the other hand, contend [24]

that 1) the New Haven’s reorganization value is in the

range of $174.5 million to $245.8 million; 2) the allowable

claim of the First Mortgage Bondholders for principal and

interest should be fixed at $101,154,737 ; 3) the Income Mort-

gage Bondholders’ claim aggregates $79,832,047 of principal

and interest; 4) with certain limitations on redemption

rights, all the Class A Common Stock (approximately 10.1

million shares of the reorganized New Haven) should issue

to the First Mortgage Bondholders, pro rata, on the basis

of 100 shares for each $1,000 of principal and 100 shares

for each $1,000 of interest, in full satisfaciion of their

claims; 5) all the New Common Stock (aproximately 7.9

million shares) should issue to the Income Mortgage Bond-

holders, pro rata, on the basis of 100 shares for each $1,000

of principal and 100 shares for each $1,000 of interest;

6) until the conclusion of the Valuation Case, the reorgan-

ized New Haven’s holdings of Penn-Central’s Common

Stock and CBI must be retained; and 7) the reorganized

New Haven cannot be voluntarily dissolved or liquidated,

except with the prior approval of the holders of at least

60% of the outstanding shares of Class A Common Stock

and New Common Stock.

These competing and conflicting proposals advanced by

the trustee and the two-system bondholders fashion the

major legal and factual questions presented for rulings in

these proceedings.

Under Section 77(e) of the Bankruptcy Act, the primary

duty of the Court is to approve a legal plan of reorganiza-

tion of the New Haven which is fair and equitable, and

A35

Memorandum of Decision

affords due recognition to the rights of each class of cred-

itors. [25] See, e.g., Group of Institutional Investors v,

Chicago, M., St. P. & P.R.R., 318 U.S. 528, 539-40 (1943)

(“Institutional Investors’); Case v. Los Angeles Lumber

Products Co., 308 U.S, 106, 114 (1939) ; In re Penn Central

Transportation Co., 596 F.2d 1155, 1164 (3 Cir.), cert.

denied, 48 U.S.L.W. 3218 (U.S. Oct. 2, 1979).

An application of those standards in the context of the

present proceedings requires the Court to 1) value the New

Haven estate; 2) determine the allowable claims against

the estate; and 3) establish the treatment to be accorded

these claims under the plan to ensure that creditors will

receive full and equitable compensation in exchange for

their prior claims. Institutional Investors, supra, 318 U.S.

at 566; Consolidated Rock Products Co. v. DuBois, 312 U.S,

510, 529-30 (1941) (“Consolidated Rock”); In re Penn Cen-

tral Transportation Co., 596 F.2d 1102, 1110 (8 Cir. 1979) ;

see also T'r. Brief at 22; FB Brief at 13, 26; IB Brief at

14.4,“4

A. Tue Parties’ VALUATION or THE New Haven Estate

A valuation of the assets of the New Haven is a necessary

prerequisite to the design of a fair and equitable plan of

reorganization for the enterprise. Once that valuation is

ascertained, it is then translated into a new set of securities

of the reorganized New Haven which, in turn, is distributed

to creditors in accordance with the absolute priority rule.

As Collier explains:

‘4 Citations to the briefs of the parties with respect to the

Amended Plan will be abbreviated as follows: the trustee’s brief

and reply brief will be Tr. Brief and T'r. Reply Brief, respectively ;

the briefs of the First Mortgage Bondholders will be /B Bricf and

FB Reply Brief; and the briefs of the Income Bondholders will be

IB Brief and IB Reply Brief.

A36

Memorandum of Decision

If the court is to pass upon the proposed distribution

of the debtor’s assets, the classes of creditors and stock-

holders to be granted participation, the allocation of

new securities or other compensation, the allocation of

voting control, and the like, as well as upon the sound-

ness of the proposed [26] capital structure of the re-

habilitated enterprise with regard to its ability to meet

future charges and to furnish an adequate return to

creditors, the court obviously must have before it a

complete and reliable evaluation of the debtor’s assets.

Absent the requisite valuation data, the court is in no

position to exercise the informed judgment required of

it in assessing the fairness, equity and feasibility of a

plan, either upon approval or confirmation thereof.

6A Collier on Bankruptcy, 11.05 at 184-85 (1977) ; see also

Consolidated Rock, supra, 312 U.S, at 524 (a determination

of the value of the debtor’s assets is required so that criteria

will be available to determine an appropriate allocation of

new securities between bondholders and stockholders).

The main controversy in this case focuses on the proper

methodology to be applied by the Court in valuing -the -

assets of the New Haven, which consist solely of cash and

Penn-Central securities. The parties urge acceptance of

the valuation procedures for the securities which best con-

form to their views of the applicable law and which, coinci-

dentally, establish the most favorable standing with respect

to their own cause. In support of their positions, the parties

have submitted considerable evidence by way of affidavits,

expert testimony, exhibits, moving papers, and briefs, Each

of the varied and conflicting opinions of the experts was the

subject of extensive and, at times, exhaustive cross-exam-

ination; hardly a material representation on valuation sub-

A37

Memorandum of Decision

m.‘ved by one party went unchallenged by another party.

The voluminous record in the proceedings speaks eloquently

of the tireless efforts of counsel on behalf of their clients.

[27] The Trustee’s Methodology

The trustee contends that, for reorganization purposes,

the Court is required to measure the worth of the New

Haven by evaluating its earning power as a going concern.

Under this methodology, the securities held by the New

Haven must be appraised by estimating their “intrinsic”

or “reorganization” value, rather than by reference to their

current market value. He finds support for his position

in the rulings of leading cases involving the reorganization

of debtors and from his analyses of certain claimed factual

circumstances unique to this particular reorganization.

In Consolidated Rock, the Supreme Court stated: “Find-

ings as to the earning capacity of an enterprise are essen-

tial to a determination of the feasibility as well as the fair-

ness of a plan of reorganization.” 312 U.S. at 510. Later

in Institutional Investors the Court again emphasized that

in a Section 77 proceeding, earning power was the primary

criterion and, therefore, “(t]he basic question in a valua-

tion for reorganization purposes is how much the enter-

prise in all probability can earn.” 318 U.S. at 540, 541.

Since this determination by nature “requires a prediction

as to what will occur in the future, an estimate, as distin-

guished from mathematical certitude, is all that can be

made.” Consolidated Rock, supra, 312 U.S. at 526; see also

Dudley v. Mealey, 147 F.2d 268, 270 (2 Cir.), cert. denied,

325 U.S. 873 (1945). While definitive dollar values on the

whole or on specific parts of the debtor’s’ estate may be

neither expected nor required, the reorganization court can-

not, of course, resort to guesswork or conjecture. [28] It

A38

Memorandum of Decision

is incumbent upon the court to exercise a wise informed

judgment based on reasonable foreseeable factors to assure

that creditors receive “full compensatory treatment.” Pro-

tective Committee for Independent Stockholders of TMT

Ferry, Inc. v. Anderson, 390 U.S. 414, 452 (1968) (“TMT

Trailer’); Ecker v. Western Pacific R.R., 318 U.S. 448,

487 (1943).

According to the trustee, these legal principles are espe-

cially suitable for application to the unusual facts and

circumstances in the reorganization sub judice. He argues

that the current market value of the Penn Central securi-

ties is not a reliable indicator of the worth of the New

Haven’s holdings because the investing public’s perception

of the true value of the securities has been distorted by

various factors.

First, the Penn Central has just recently emerged from

a lengthy and complex reorganization and the “stigma of

bankruptcy” necessarily results in a serious depression in

the market value of its securities. As explained by Mr.

William S. Nydorf, one of the trustee’s experts:

Any securities newly issued as a consequence of a

bankruptcy reorganization are likely to be subject to

substantial investor prejudice and must undergo a

period of market seasoning before their relative at-

tractiveness as an investing medium can be fully ap-

praised. This is particularly important in the case of

Penn Central, certainly one of the most spectacular

and complex bankruptcies in the United States’ finan-

cial history.

Affidavit of William S. Nydorf With Respect to the

Amended Plan of Reorganization for the Debtor at 12

(“Nydorf Ajfidavit”). Second, the market place is unable

A39

Memorandum of Decision

to make sound business judgments concerning Penn Central

at this time because of the major legal complexities of the

Valuation [29] Case. The Valuation Case is unique and at

present has an indeterminable value; therefore, its un-

certainty may adversely affect the market values of all the

securities of Penn Central which are directly or indirectly

tied to the ultimate receipt of the award in that case.

Third, the Penn Central securities at this time lack

“seasoning” and “stability” because they are generally in

the hands of large institutions and have not been suffi-

ciently traded over a long period of time to reflect their

true value. Finally, the trustee contends that the investing

public’s lack of knowledge about and confidence in certain

features peculiar to Penn Central—the results and timing

of the Asset Disposition Program, its unusual capital

structure and debt cascades, its new management—make

it highly unlikely that the market place has correctly ap-

praised the value of the securities.

Utilizing the intrinsic value concept for the securities

held by the New Haven, the trustee concludes that, with the

cash on hand, the value of the New Haven estate for re-

organization purposes is within a range of $120 million to

$150 million, and that the value of the equity of the re-

organized New Haven is commensurate with this value.

At the high end, this valuation would provide compensa-

tion to the First Mortgage Bondholders to the full extent

of their claim, as computed by the trustee, i.e., approx-

imately $135.7 million ($76,819,000 in principal plus

$58,895,251 in interest to date), as well as affording a

present equity in the estate for the Income Bondholders.

In practical effect, the Amended Plan affords the First

Mortgage Bondholders [30] 93.1%, and the Income Bond-

holders 6.9%, of the reorganized New Haven.

A40

Memorandum of Decision

This is a significant modification of the treatment ac-

corded the Income Bondholders in the plan of reorganiza-

tion submitted to Judge Anderson in 1968. In ruling on

that plan, Judge Anderson required that the First Mortgage

Bondholders’ claim of $101,154,737 (principal amount of

$76,819,900 plus post-bankruptcy interest of $24,334,837

from January 1, 1961 to December 2, 1968, the effective date

of the plan) be satisfied by the issuance to them of common

stock of the reorganized New Haven. When taken together

with the Penn Central underwriting required by him, this

would satisfy the First Mortgage Bondholders’ total claim.*®

The holders of Income Bonds were to receive warrants to

buy common stock at a price of $50 per share, which could

only be exercised under certain specified conditions.

The more favorable treatment proposed in the Amended

Plan for the second level bondholders is due to the trustee’s

analyses of the improved financial condition and stability

of the New Haven since 1969, and his desire to provide the

parties with a basic framework for a “compromise” or “con-

sensual” plan of reorganization.“

45 In re New York, N.H. & H.R.R., supra note 9, 304 F. Supp.

at 809.

46Qn numerous occasions throughout these proceedings, this

Court urged the parties to resolve their differences and agree upon

a “eonsensual” plan. The Court recognized that an amicable set-

tlement would be difficult; there were vast disparities between the

two system bondholders in their respective views of the merits of

the case, both legally and factually. A full victory for the First

Mortgage Bondholders would result in their complete ownership

of the reorganized New Haven; a full victory for the Income Bond-

holders would give them a substantial equity in the new company,

with a surplus remaining. Thus, it was apparent that only by long

and diligent negotiations, in a spirit of cooperation and due re-

spect for each other’s position, could these creditors produce a

consensual plan.

In addition, unlike the strategy employed in the Penn Central

reorganization where the representatives of all the principal

A41

Memorandum of Decision

The main components of the trustee’s valuation are: 1)

the cash assets; 2) an estimate of the intrinsic worth of the

Penn-Central securities held by the New Haven; and 3) a

recognition of the real, but presently unquantifiable, values

of certain tax attributes and corporate opportunities avail-

able to the reorganized New Haven.

Cash: At the present time, the cash assets of the [31]

New Haven are approximately $36.5 million. In addition,

the trustee treats as the equivalent of cash for valuation

purposes his claim in the amount of $2.15 million for reim-

bursement of fees and costs in the Penn-Central reorganiza-

tion proceedings under Section 77(c)(12) which is sub

judice.

Value of the Securities: The trustee did not personally

undertake the task of determining the present value of the

Penn-Central securities owned by the New Haven; rather,

he relied on the analysis developed by his expert, Mr. Ny-

dorf. In addition, he retained another expert, Mr. Thomas

creditors were convened to deliberate before a definitive plan was

submitted to Judge Fullam, here a plan was filed by the trustee

without consultation with or input from the representatives of the

bondholders upon whom a consensual plan was completely depen-

dent. To negotiate from positions already fixed in a document

filed for the Court’s approval and publicly reported, might well

inhibit any meaningful “give and take” by these representatives

because of their understandable reluctance to deviate to any great

degree from the allocations presumably “cast in concrete” in the

eyes of their numerous bondholders.

Despite these serious stumbling blocks, the Court was convinced

that a compromise could be reached. Among other obvious benefits,

millions of dollars would be saved by the estate and years of con-

tinued litigation would be avoided. The failure to draft a con-

sensual plan is all the more disturbing because after several

lengthy settlement conferences to which the Court was not privy,

the parties reported that an amicable agreement was at hand and

only a “few details” had to be worked out. Unfortunately, these

details proyed fatal to a resolution of the issues.

A42

Memorandum of Decision

K. Dewey, Jr., to make an independent valuation in order to

obtain a second opinion.

The valuation methodologies of both experts embodied

studies of the two separate aspects of the Penn-Central

enterprise: 1) its ongoing non-railroad businesses, princi-

pally consolidated in the Pennsylvania Company (“Penn-

co”); and 2) its “discontinued businesses” which are in-

volved in the Asset Disposition Program and the Valuation

Case.

At the time the trustee’s experts prepared their valua-

tions, Pennco’s operating subsidiaries were:

(a) Arvida (100% owned), a developer of residen-

tial, resort and other properties in Florida and Geor-

gia ;

(b) Buckeye Pipe Line Company (100% owned), a

common carrier of petroleum products in Northeastern

and Midwestern United States; its sister company,

Buckeye Petro Fuels Company, markets fuel oil, gaso-

line, and propane gas;

amusement parks and a wax museum;

[32] (d) Edington Oil Company (80% owned), a

petroleum refiner that also manufactures and markets

petroleum products;

(e) Clearfield Bituminous Coal Corp. (100% owned),

a coal mining company ; and

(f) Pennrec (100% owned), an owner of amusement

parks.

Subsequent to the experts’ calculations on value, Pennco

acquired the remaining minority interests in both Edging-

A43

Memorandum of Decision

ton Oil Company and Great Southwest, and purchased Wil-

liams Energy, a marketer of propane gas in over 25 states.

In addition, after the closing arguments in these proceed-

ings, Penn Central merged with another operating com-

pany, Marathon Manufacturing Company, which is one of

the world’s largest manufacturers of offshore drilling rigs.

In addition to valuing these income producing continuing

businesses owned and operated by Pennco, the experts

deemed it crucial to their methodologies to consider the

cash that would be generated by the Asset Disposition

Program (“ADP”) and the anticipated range of awards

likely to be received in the Valuation Case.

The ADP is a detailed plan pursuant to which most of the

assets of Penn Central and its subsidiaries, except Pennco

and the Valuation Case, will be liquidated in an orderly and

systematic fashion prior to December 31, 1987. In re Penn

Central Transportation Co., supra, 458 F’. Supp. at 1255.

As previously noted, the Valuation Case evolved from

the dispute between the parties over the valuation of the

Penn Central’s rail assets which were transferred to Con-

rail in 1976 under the provisions of the RRRA. The novel

and [33] complex litigation presently pending before the

Special Court, for a determination of the fair, equitable

and constitutional terms of exchange, will undoubtedly take

years to resolve unless a settlement is negotiated.

For the reasons discussed at length by Judge Fullam,

458 F. Supp. at 1270-76, and the Third Circuit, 596 F.2d at

1164-66, it is clear that the ultimate outcome of the Valua-

tion Case will have a direct and substantial effect upon the

Penn Central’s ability to redeem a large number of its

debt-type securities (Series B Notes, Series C Notes,

Series D Notes, Series B Bonds, Preference Stock, and

CBI). Any “spillover” from the award, i.e., the amount of

A44

Memorandum of Decision

recovery in excess of that required to retire all the Penn

Central securities senior to the Common Stock, would pre-

sumably enhance the value of the Common Stock. Any in-

crease in the value of the Common Stock, of course, neces-

sarily depends on the size of the spillover and the timing

of its payment.

In the instant proceeding, the trustee and the experts

recognize that an assessment of the award, or range of

awards, must be considered in the valuation of the Penn

Central’s securities held by the New Haven, particularly

with respect to the 6% block of Common Stock owned by

the estate.

Mr. Nydorf valued the New Haven’s securities as of

September 30, 1978, the date he assumed would be the

effective date of the Amended Plan and the time at which

the interest accruing on the First Mortgage Bonds would

cease.

His evaluation proceeded on three basic premises which

he determined to be valid:

[34] 1. The projections concerning the amounts and

timing of the sales under the ADP should be accepted;

2. The appropriate range of values for Penn Cen-

tral was between $662.3 million (the SEC’s $600 mil-

lion evaluation of Penn Central as of January 1, 1978,

adjusted to reflect retained earnings for the first nine

months of 1978) and $1 billion (based on Mr. Dewey’s

valuation of Penn Central of $969 million as of De-

cember 31, 1978); and

3. The Valuation Case would produce a recovery

of not less than $500 million as of April 1, 1976, plus

compound interest at 8% to date of payment.

Nydorf Affidavit at 6-9.

A45

Memorandum of Decision

He then assigned a value to the Penn Central securities

held by the New Haven which would be redeemed by the

cash flow of the reorganized Penn Central, namely, all

the Series A Bonds and a portion of the Series B Bonds.

He assumed that the New Haven would receive $46,069,000

(including the $12,826,000 initial cash payment) in the

ten-year period 1978 to 1987, which discounted at appro-

priate rates,’ would have a present worth (September

30, 1978) of $41,531,000.‘

‘7 Mr. Nydorf applied a discount rate of 8%, which is “ap-

plicable to high grade debt obligations,” on the Series A Bonds

because of the “minimal risk that the projected receipts would be

as forecast.” A one percent additional discount was applied to

the projected payments on the Series B Bonds because the “pay-

ments are junior to the claims of the Series A Bonds to Asset Dis-

position Proceeds and thus bear the risk of any shortfalls in the

Asset Disposition Program and would become dependent for pay-

ment of these amounts upon the Valuation Case Proceeds.”

Nydorf Affidavit at 13-14.

48 Exhibit 1

Estimatep Receipts oF CasH By New Haven?

PuRSUANT TO PENN CENTRAL PLAN

($000 omitted)

Mortgage Bonds

Date or Year Cash Series A Series B Total

At Consummation $12,826 — — $12,026

1978 — $13,706 — 13,706

1979 — 3,648 — 3,648

1980 — 8,158 — 8,158

1981 —_— 778 $ 336 1,114

1982 — 1,832 336 2,168

1983 —_ 1,104 1,664 2,768

1984 — — 474 474

1985 — — 474 474

1986 — — 397 397

1987 — — 336 336

Total $12,826 $29 226 $4,017 $46,069

(continued on next page)

A46

Memorandum of Decision

He also valued the securities held by the New Haven

which would not be redeemed by the cash flow of the

reorganized Penn Central, namely, the remaining Series

B Bonds in the amount of $6,878,000 (including interest),

the Series B Preference Stock, and the CBI. All these

securities would be retired if the basic award from the

Valuation Case was at least $887.4 million (April 1, 1976),

for a total recovery of $2.1 billion (December 31, 1987).

The New Haven would receive $59,078,000 from this re-

covery, which discounted,**® has a present value (September

30, 1978) of $23,981,000.°°

48 (continued )

Present Value at 9/30/78?

Mortgage Bonds

Date or Year Cash Series A Series B Total

At Consummation $12,826 — —- $12,826

1978 — $13,445 — 13,445

1979 — 3,313 — 3,313

1980 — 6,861 — 6,861

1981 — 606 $ 254 860

1982 — 1,321 233 1,554

1983 — 737 1,058 1,795

1984 — — 277 277

1985 —_— — 254 254

1986 — — 195 195

1987 — — 151 151

Total $12,826 $26,283 $2,422 $41,531

(1) Based upon November, 1977 Penn Central projection.

(2) At discount rates of 8% for the Series “A” Bond receipts

and 9% for the Series “B” Bond receipts.

(3) Adjusted to reflect assumed earnings at the rate of 8% per

annum for the interim between 1/1/79 and 9/30/78.

Nydorf Affidavit Exhibit 1

49 Based upon “estimates of the likelihood of achieving such re-

coveries,” Mr. Nydorf adopted a discount rate of 10% for the Pref-

erence Stock, i.e., a premium of 25% over the basic 8% rate

applicable to the Series B Bond proceeds, and a discount rate of

12% for the CBI payments, i.e., a premium of 50% over the rate

attributable to the Series B Bonds proceeds. Nydorf Affidavit at 17.

5° Footnote fifty appears on page A47.

A47

Memorandum of Decision

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A48

Memorandum of Decision

[35] Thus, as of September 30, 1978, Mr. Nydorf con-

cluded that the value of the securities senior to the Com-

mon Stock, together with cash payments received, was

$65.5 million.

To this, he added a range of values for the New Haven’s

interest in the equity of the reorganized Penn Central,

i.e., the New Haven’s 6% block of Penn Central Common

Stock, based on the range between the values placed on

Penn Central by the SEC, as updated, of $662.3 million

and by Mr. Dewey of $969 million, rounded off to $1 bil-

lion. The value of the 6% block would, therefore, be

between $39.7 million and $60 million.

The next factor Mr, Nydorf considered was the enhance-

ment of the Common Stock from any Valuation Case spill-

over. He opined that the base award would probably be

within the range of $1 billion to $2.5 billion. Using in-

creasing discount rates for various segments of the range

of assumed awards," he calculated that a base award of

$1.4 billion (using Mr. Dewey’s valuation of Penn Cen-

tral)** or a base award of $2.25 billion (using the SEC’s

valuation of Penn Central) would be necessary to justify

the trustee’s allocations between the two system bond-

holders as set forth in his Amended Plan.

Because “the Valuation Case awards required to make

the allocations [in the trustee’s Amended Plan] fair on a

figure basis are well within the range of possible awards,”

Mr. Nydorf concluded that the Amended Plan was fair,

equitable and feasible. Nydorf Affidavit at 22.

51 Footnote fifty-one appears on page A49.,

52 Footnote fifty-two appears on page A50.

53 Footnote fifty-three appears on page A51.

A49

Memorandum of Decision

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A50

Memorandum of Decision

52°

EXHIBIT 5

Analysis of Relative Values of New Haven 4's and 44's Assuming Various Valuation Case

Awards and 7, FE. Dewey, Jr., Value for Reorganized P.C, Comon Exclusive of Valuation Case

($000,000 omitted)

Awards Req. to hag

Undiluted Fully Dil.

Based Upon Assumed Valuation Case Awards Of Allocation Allocation

$1,000 $1,250 = $1,500 = $1,750 += $2,000 = #2,250 = $2,500 = 1,362.8 ~—- 1,345.6

Val. Award at 8% Compound Int.—

12/81/87 $2,470.2 $3,087.7 $3,705.58 $4,322.8 $4,940.4 $5,057.90 $6,175.5 $1,365.2 $3,328.8

Amt. Req. through CBI's 2,191.9 2,191.9 2,191.9 2,191.9 2,191.9 2,191.9 2,191.9 2,191.9 2,191.9

Avail, for Common at 12/31/87 from

V.C, 276.3 895.8 1,511.4 2,130.9 2,746.5 3,166.8 3,983.6 1,171.1 1,131.9

Discounted value of Common at

10/1/78 (A) 101.5 278.9 437.2 552.4 637.6 697.6 7387.7 355.0 $45.0

T. E. ioe Jr. valuation of Common ‘1,000.0 —-1,000,0 1,000.0 1,000.0 1,000.0 1,000.0 —- 1,000.0 ~—- 1,000.0 1,000.0

Value of Reorganized P.C, Common—

10/1/78 1,11.6 1,278.9 1,487.2 1,662.4 1,617.6 1,677.6 1,737.7 1,355.0 1,845.0

Effect Upon N.H, Plan

— P.C, package at 10/1/78 (B)

12.8 12.8 12.8 12.8 12.8 12.8 is 12.8 12.8

“A” Bond roceipts 26.3 26.8 26.8 26.3 26.3 26.3 6.3 26.8 26.8

“B” Bond recei 5.8 5.8 5.8 5.8 5.8 5.8 5.8 5.8 5.8

Preference Stoe 15,0 15.0 15.0 15.0 15.0 15.0 15.0 15.0 15.0

OBI's 5.6 5.6 5.6 5.6 5.6 5.6 5.6 5.6 5.6

Common-—-6% participation 66.1 76.7. 86,2 97.1 98,8 101.4 104.1 80.8

Total 131.6 142.8 151.7 158.6 163.8 167.4 19.8 146.2

Less Est. shortfall in other assets

with respect to other liabilities 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0

Balance available to 4's and 44's— ‘

value of new common—fully diluted 126.6 187.2 146.7 153.6 158.8 162.4 hay 164.8 141.8 141.2

Less PA of 4's 76.8 76,8 76.8 76.8 76.8 76,8 76.8 . 76.8

Balance—value of new common—

undiluted basis 49.6 50.4 69.9 76.8 82.0 85.6 88,0 65.0 181.8

Interest claim—4's 54.5 54.5 54.5 54.5 54.5 545 54.5, 54.5

Balance for 4144's (4,7) 5.9 15.4 22.3 37.5 a1 Po 9.9

Value of 16.2% int. in new common

Neogene y 8,1 9,8 11.3 12.4 13,8 13.9 14.3 10.5

Value of 7% int. in new common

(fully diluted) 8.0 9.6 10.8 10,8 11 114 11.5 9.9 9.9

(A) At graduated rates of discount based upon application of 1.2% (99%) to each successive

#250 of assumed Valuation Case award above $500 million,

(B) See Exhibits 1 and 2, 9/17/78

Nydorf Affidavit Exhibit 5

A51

Memorandum of Decision

EXHIBIT 4

Analysis of Relative Values of New Haven 4's and 44's Assuming Various Valuation

Case Awards and SEC Value for Reorganized PC Common Exclusive of Valuation Case

Val. Award at 8% Compound Int.—

12/31/87

Amt, Req. through CBI’s—12/31/87

Avail for Common at 12/31/87 from

Discounted Value of Common at

10/1/78 (A)

SEC value of Common adjusted to

10/1/78

Value of Common adjusted to 10/1/78

Effect Upon N.H. Plan

— hed P.O, package at 10/1/78 (B)

“A” Bond receipts

“B” Bond receipts

Preference Stoc

CBI's

Common—6% participation

Total

Less Est, shortfall in other assets with

respect to other liabilities

Balance available to 4's and 414's—

value of new common—fully diluted

Less PA of 4's

Balance—value of new common—

undiluted basis

Interest claim—4's

Balance for 44's

Value of 16.2% int. in new common

(undiluted)

Value of 7% int. in new common

(fully diluted)

(A) At graduated rates of discount based upon application of 1.2

#250 of assumed Valuation Case Awar

(B) See Exhibits 1 and 2.

Nudorf Affidavit Exhibit 4

* Durin

to Mr.

on the exhibits for the purposes for which they are being refer

($000,000 omitted)

Awards Req. to

Undiluted Da.

Based Upon Assumed Valuation Case Awards Of Allocation Allocation

$1,000 $1,250 $1,500 $1,750 $2,000 $2,250 $2,500 $2,220.6 $2,158.9

$2,470.2 $3,007.7 $3,706.3 $4,322.8 $4,940.4 $5,067.9 $6,175.5 $6,507.5 404.6

2,191.9 2,191.9 2,191.9 2,191.9 2,191.9 2,191.9 2191.9 2191.9 2,191.9

278.3 095.8 1,511.4 2,110.9 2,748.5 3,166.0 3,961.6 3,316.6 3,212.7

101.5 278.9 417.2 5524 637.6 697.6 737.7 692.7 692.7

662.3 662.3 662.3 662.3 662.3 662.3 662.3 662.3 662.3

“T0005 T2147 “T2309 “TID “Tas 3% “Te

12.8 12.0 12.8 12.8 12.8 12.8 12.8 12.8 12.8

26.3 26.3 26.3 26.3 26.3 26.3 26.3 26.3 26.3

5.8 5.8 5.8 5.8 5.8 58 5.8 58 ‘a8

15.0 15.0 15.0 15.0 15.0 15.0 15.0 15.0 15.0

5.6 5.6 5.6 5.6 5.6 5.6 56 5.6 5.6

45.8 56.5 66.0 72.9 78.0 51.6 84.0 81.1 80.7

5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0

106.38 117.0 126.5 133.4 138.5 142.1 144.5 M412

76.8 76.8 76.8 76.8 76.8 76.8 76.8 70.8)

29.5 40,2 49.7 56.6 61.7 65.3 67,7 65.0 131.3

54.5 54.5 54.5 54.5 54.5 M5 M5 ‘45

(28.0) ~ (14.8) (4.8) | 7.2 10.8 11.2

4.8 6.5 8.1 9.2 10.0 10.6 11.0 10.5

74 8.2 8.9 9.8 9.7 9.9 10,1 9.9 99

(8%) to each successive

above $500 million.

9/17/78

the course of the testimony regarding the above reproduced tables, which were exhibits

dort's affidavit, certain corrections, not reflected — were mude but have no effect

to here.

A52

Memorandum of Decision

“ir. Dewey valued the assets of the New Haven as of

December 31, 1978. In doing so, he assumed that the pro-

ceeds from the ADP would be realized as projected by the

[36] Penn Central trustees, and that the recovery from

the Valuation Case would be not less than $500 million,

plus compound interest at 8% from April 1, 1976 to date

of payment.

He was of the opinion, however, that the two previous

studies evaluating the constituent businesses of Penn Cen-

tral, i.e., the SEC’s and Kuhn Loeb’s reports, were effec-

tively outdated. He, therefore, valued the individual com-

ponents of the Penn Central’s continuing businesses as of

December 31, 1978. His findings may be summarized as

follows:

Arvida Corporation ......... piciaaalitreodincseds $300,000,000°

Buckeye Pipe Line Company ................ 160,000,000°*

Great Southwest Corporation .............. 100,000,000°*

Edgington Oil Company, Ine. .............. 70,000,000°"

Clearfield Bituminous Coal Corp. ...... 25,000,000°*

PUIG ccntaaaree 20,000,000°°

Tax Loss Carryforwards

TOTS TRTOUMM LOGE oncipciccsincsicencedsecsvenss 160,000,000%°

Corporate Administrative

Expenses 1979 through 1982 ............ (20,000,000) *

Non-Penneo Future Coal Royalties .... 80,000,000%

Subsidized Rail Rentals ...........0............ 26,000,000°*

Real Estate Unsold at

PRONTO BE, BIIEE Sivccccccnensnsencsdsscetess.- 36,000,000°*

1983-1987 Tax Deductions .................... 12,000,000°*

I ss scceictinenbntaetavetennleeadeasnlioeie $969,000,000

547n valuing Arvida, Mr. Dewey began with a November 14,

1976 appraisal for its real estate and operating properties of $221

A53

Memorandum of Decision é

million. He then posited that Arvida’s other assets were approx-

imately equal to its liabilities and, therefore, no adjustment to the

appraisal was necessary for either of those two items. Then, based

upon growth in land values in the general location of Arvida’s

holdings, coupled with its ability to maintain its inventories of

properties and its other investments, he determined that an annual

growth rate of 15% for the two years following the appraisal

would be reasonable. Applying that growth rate to the appraisal

value, he determined Arvida’s worth to be $292 million. He then

rounded this value up to $300 million to take into account what he

described as the company’s superior management, “the unique-

ness of [its] position and record and the current attraction of

properties of this type.” Affidavit of Thomas EF. Dewey, Jr. With

Respect to Amended Plan of Reorganization Dated April 18, 1978

at 12-13.

55 With respect to Buckeye Pipe Line Company, Mr. Dewey

adopted a Kuhn Loeb valuation which was based on a forecast

of Buckeye’s future operations. Finding that in fact, in Mr.

Dewey’s opinion, Buckeye was running close to forecasts, the

Kuhn Loeb valuation of $155 million as of December 31, 1977

was rounded off to $160 million to reflect its reinvestment of earn-

ings during 1978.

56 As a starting point for his valuation of Great Southwest, Mr.

Dewey used a figure of $82 million, which was based on an out-

standing offer by Penneo to minority share holders of Great

Southwest of $19 a share. That figure was then adjusted upward

to $100 million, approximately 20%, to reflect what he viewed

as a reasonable premium for acquiring the shares of the entire

company, its excellent position in the industry, and its superior

management and earnings performance in the recent past.

57In his analysis of Edgington Oil Company, Mr. Dewey first

considered the book value of the company as of June 30, 1978

which was $56 million. To value Pennco’s 80% holding, he eal-

culated that the book value of the whole company would be $70

million at year-end using projected earnings for 1978 of $27 mil-

lion. As a multiple of earnings, the $70 million is a little more

than three times 80% of earnings as projected for 1978, and, is a

premium of approximately 25% over 80% of the book value. In

Mr. Dewey’s opinion, a multiple of earnings in that range or a

premium over book in that range would be conservative in view

of the competitive position of the company in the market. He,

therefore, valued the 80% holding at $70 million.

58 In this instance, Mr. Dewey agreed with the value of $22.8

million placed on the Clearfield Bituminous Coal Corp. by Kuhn

A54

Memorandum of Decision

Loeb as of December 31, 1977. The operations were running close

to the forecast of the Penn Central trustees so the only adjustment

Mr. Dewey made to the Kuhn Loeb value was an increase to $25

million which, in his opinion, was justified by inflation and by

increased core drillings in 1978.

5°In valuing Pennree, Mr. Dewey took its book value of $23

million as of June 30, 1978, and discounted it to $20 million. While

Pennree at the time was not a profitable company, Mr. Dewey

justified the slight discount on the basis of an operating profit be-

fore interest and debt expenses of approximately $1 million during

the first six months of 1978, the size of the market in the area of its

major operating asset, Great Adventure, and on the abilities of

management, e

6°Mr, Dewey anticipated continuing acquisitions by the re-

organized Penn Central would utilize substantial tax loss carry-

forwards which could be offset against increased earnings. As he

explained :

These valuations have been made in accordance with stan-

dard financial practice, which assumes full taxation. Assum-

ing, then, that these present earnings, estimated at more than

$90 million for 1978, continue, I can add to the Pennco valua-

tion the value of future tax loss carryforwards, as of December

31, 1978. Again, I will use the SEC methodology, which is to

run through 1982 (the year of expiration of the pre-1978 tax

losses) and then use a lump sum for succeeding years. As-

suming that pre-tax earnings average $100 million for the

years 1979 through 1982, the value, discounted at 8% from

the middle of each year, of being relieved of a 48% corporate

income tax during the period 1979-1982 would be approx-

imately $160 million.

Dewey Affidavit at 17.

61 Having taken credit for four further years of tax loss carry-

forwards (see note 60, supra), Mr. Dewey recognized he had to

take into account the expenses of continuing Pennco as an operat-

ing entity. Corporate administrative expense was $2.3 million for

the first six months of 1978, therefore, he assumed an annual

figure of $5 million or a total of $20 million for the years 1979

through 1982.

6° For a valuation of the non-Pennco future coal royalties, the

subsidized rail rentals and the unsold real estate on December 31,

1987, and Mr. Dewey accepted the numbers set forth in the SEC

analysis, and discounted the figures to December 31, 1978 at 8%

per annum.

A55

Memorandum of Decision

Having determined the worth of the ongoing businesses

and other assets of the reorganized Penn Central, Mr.

Dewey then proceeded to value the securities owned by the

New Haven. Using a series of ascending discount rates,**

he projected that present values of the cash flows [37]

anticipated to be received upon redemption of the Series A

Bonds, Series B Bonds, Series B Preference Stock, and

CBI, to be $56.12 million. To this, he added the values rep-

resented by the 6% block of Penn Central’s Common Stock

of $58.14 million, and the cash on hand of $13.07 million.

After deducting certain claims senior to the bondholders,

he concluded that the equity of the New Haven for re-

organization purposes was $118.3 million, excluding con-

sideration of any spillover value for the Common Stock

from the Valuation Case."

Mr. Dewey next considered the extent to which the value

of $118.3 million would be increased by Valuation Case base

awards between $1 billion and $2.5 billion, a range of re-

coveries he believed to be reasonably probable. Based on

®3 See note 62, supra.

64 See note 62, supra.

65 Mr. Dewey valued the 1983-1987 tax deductions, less reorga-

nized Penn Central’s corporate expenses in excess of $10 million

annually, at approximately $12 million.

66 No discount was applied to the cash and the Common Stock

attributable to the ongoing business. Payments on Series A Bonds

after 1978 were discounted at 8%, as the average rate for high-

grade obligations. Series B Bonds receipts were discounted at

8.5%, to reflect the junior status of these securities with respect

to the ADP and the longer average life of the issue. The Prefer-

ence Stock was considered a more speculative security so Mr.

Dewey applied an 11% rate of discount; a 13% rate was used for

the CBI, junior securities to the Preference Stock with a no fall-

back basis.

67 Footnote sixty-seven appears on page A56,

6§ Footnote sixty-eight appears on page A57.

A56

Memorandum of Decision

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A58

Memorandum of Decision

this analysis he ascertained that a base award of approx-

imately $1.4 billion would be the “break-even” point for

the allocations between the two system bondholders under

the Amended Plan.

Under these circumstances, he concluded that the

Amended Plan was fair, equitable and feasible.

Intangible Values: The third salient element in the trus-

tee’s methodology is a recognition of the real, but presently

unquantifiable, values inhering in the New Haven estate be-

cause of the tax attributes of the reorganized New Haven,

and its other corporate opportunities, which he describes

as its attractiveness as a candidate for merger and the

“block” value of its Penn Central Common Stock.

The trustee is of the opinion that several tax rulings re-

ceived by the New Haven confer important tax benefits

[38] on the estate and its bondholders. The principal tax

benefits derive from the ruling that the New Haven has a

high tax basis for its Penn Central securities (other than

the CBI).

When conveyed to Penn Central in late 1968, the New

Haven’s operating assets had a basis for tax purposes of

about $300 million. In private letter rulings issued Sep-

tember 24, 1970, and May 14, 1979, the Internal Revenue

Service (IRS) determined that: 1) the transactions of con-

veyance between the New Haven and the Penn Central in

1968 was a tax-free exchange under 4 374 of the Internal

Revenue Code; 2) the New Haven did not recognize a tax

loss in 1968; and 3) the New Haven’s tax basis in its Penn

Central securities will be the same as the basis of the

assets conveyed to Penn Central in 1968, reduced by cash

and the value of the liabilities assumed, indebtedness can-

celled, and other property received.

A59

Memorandum of Decision

Under the ruling letters from the IRS, the basis of the

property conveyed to» Penn Central in 1968, reduced as

aforementioned, is to be allocated among the Series A and

Series B Bonds, the Preference Stock, and the Common

Stock in proportion to the fair market value of each. This

allocation results in a tax basis for the Preference Stock

well in excess of its liquidation or redemption value and a

basis for the Bonds well in excess of their principal amount.

Thus, any disposition of the Preference Stock or the Bonds

will result in a tax loss. In addition, the Common Stock

has a tax basis substantially higher than its current market

value.

[39] Under these rulings, the trustee predicts that tax

savings are available and may be realized in several ways.

For example, because the market value of the Series A and

Series B Bonds, Preference Stock, and Common Stock are

considerably less than the basis allocated to them, the sales

or exchanges of these securities would generate large

capital losses. Such transactions could be timed to offset

capital gains on other investments or to reduce or eliminate

current earnings and profits of the reorganized New Haven.

Elimination of earnings and profits could benefit the equity

owners of the reorganized New Haven as well as the com-

pany, itself. Under § 301 of the Code, so long as the new

company had neither current nor accumulated earnings

and profits, distributions to its equity owners would be

deemed first to be returns of capital (non-taxable) until the

owners have recovered their own respective tax bases, and

then as capital gains. The trustee believes that by careful

and appropriate timing of the sales or exchanges of the

Penn Central securities, the reorganized New Haven would

be able for a considerable time in the future to create

ordinary and capital losses sufficient to insure it would

A60

Memorandum of Decision

have no current earnings, so that the equity owners would

be able to utilize the tax benefits.

With respect to the Series A and Series B Bonds, the

trustee expects the reorganized New Haven would make use

of the bonds’ high bases other than by a sale for capital

losses. Redemption of these bonds for less than their bases

results in an ordinary loss in the year of redemption. [40]

Losses incurred because of redemptions before consumma-

tion could be carried forward for the following seven years.

Also, under a ruling issued to the Penn Central trustees,

holders of Series A and Series B Bonds can amortize antic-

ipated losses resulting from future redemptions over the

term of the bonds. Under this ruling, the reorganized New

Haven could, in the trustee’s view, expect at least some

ordinary loss in each year through 1987, unless all the

bonds are redeemed before then.

In addition the trustee is of the opinion that maximiza-

tion of operating losses could have potential additional

benefits. There would exist the possibility of what the trus-

tees terms “merchandising” its losses if certain carefully

structured transactions between the reorganized New

Have. and a “partner” looking to shelter some of its in-

come were accomplished.

Although the trustee considers these tax attributes are

valuable assets in the New Haven estate, he does not

quantify them.

The trustee further believes that the “block” character

of the New Haven’s 6% holding of Common Stock (one of

the largest single blocks of voting and equity ownership in

the reorganized Penn Central) warrants an additional

“plus value” which he does not quantify.

Thus, the trustee concludes that a reorganization value

for the New Haven is between $120 million and $150 mil-

A61

Memorandum of Decision

lion, based on his appraisals of the cash on hand, the

Nydorf valuation of the securities, and a recognition of the

real, but unquantifiable, intangible attributes inherent [41]

in the New Haven. The floor estimate of $120 million gives

little if any recognition to a spillover value from the Val-

uation Case; the ceiling figure of $150 million assumes a

recovery on the lower end of the scale of possible recoveries

insofar as a spillover is concerned.

The First Mortgage Bondholders’ Methodology

In marked contrast to the trustee’s position, the basic

argument of the First Mortgage Bondholders is that fair

market value, almost wholly derived from market price,

constitutes the primary criterion for determining the re-

organization value of the New Haven. They argue that it

is logical and practical for the Court to calculate the net

asset value of the New Haven and the reorganized com-

pany mathematically by reference to the opinion of in-

vestors in the open market because, except for cash, the

estate consists solely of marketable securities.

While recognizing the intrinsic value concept in prin-

ciple, they contend it is inapplicable as employed by the

trustee because there is and has been broad, active, arid

orderly sales of the Penn Central securities over an ex-

tended period of time which establishes the marketplace as

the primary and most reliable indicator of value.

Reliance is placed on a series of cases which they con-

strue to require the Court to find, as a matter of law, that

the present market value of the New Haven securities is

the equivalent of their value for reorganization purposes.

They cite E.J. duPont de Nemours & Co. v. Collins, 432

U.S. 46 (1977), in which the Supreme Court referred to

the SEC’s expertise in merger cases and sustained the

A62

Memorandum of Decision

agency’s method [42] of valuing a closed-end investment

company by the market price of the underlying securities

it owned. Also discussed is Seaboard World Airlines, Inc.

v. Tiger International, Inc., 600 F.2d 355, 361-62 (2 Cir.

1979), wherein the Second Circuit stated that “in a free

and actively traded market, absent compelling reasons to

believe otherwise, the market price of [stock] is held to

take account of asset value as well as the other economic,

political, and financial factors that determine ‘value.’ ”

Central States Electric Corp. v. Austrian, 183 F.2d 879

(4 Cir. 1950), cert. denied, 340 U.S. 917 (1951), is claimed

to be a parallel case. There, in a Chapter X reorganiza-

tion of a closed-end investment company, the plan of re-

organization provided for the collapse of the “pyramid” of

various companies into a single investment company. The

stock of the reorganized company was to be issued first to

bondholders for their claim, with interest,.'and then to

senior preferred shareholders, with accrued dividends, on

the basis of the underlying net asset value of the new in-

vestment company as of the effective date of the plan. The

common stockholders, who were eliminated from receiving

shares of the reorganized company, challenged the valua-

tion method approved by the reorganization court and the

SEC because “the assets of the corporation were not valued

at ‘going concern’ value to include such matters as prob-

able enhancement in values of securities held, increase in

dividends, investment of amounts now held in cash and

government bonds, restoration of ‘leverage’ through the

borrowing of money and the earnings of skilled manage-

ment in the purchase and sale of securities.” Jd. at 884.

The Fourth Circuit rejected these contentions, [43] con-

cluding:

A63

Memorandum of Decision

[Wle agree with it [the SEC] that the proper method

of valuing the assets of an investment company such

as this is not prospective earnings, as in the case of

a manufacturing or railroad corporation, but the pres-

ently realizable market value of the securities on hand.

Id.; see also Mills v. Electric Auto-Lite Co., 552 F.2d 1239,

1247 (7 Cir.), cert. denied, 434 U.S. 922 (1977) (“[WJhen

market value is available and reliable, other factors should

not be utilized in determining whether the terms of the

merger were fair.”) ; Amerada Hess Corp. v. Commissioner,

517 F.2d 75, 84 (3 Cir.), cert. denied, 423 U.S. 1037 (1975)

(“The better view is that the market does provide the best

evidence of the value notwithstanding a depressed state,

or even a large scale manipulation of the market as a

whole.”); In re Equity Funding Corp. of America, 416 F.

Supp. 132, 144 (C.D. Cal. 1975) (The market value of assets

such as stocks and bonds “is the appropriate measure of

their value for reorganization purposes, since the value de-

termined by investors in the marketplace is the best in-

dicator of the present value of the future earnings of the

assets.”).

In support of their position that the average market

price is the primary determinant of reoganization value,

as a factual matter, the First Mortgage Bondholders rely

principally on the testimony of their expert, Mr. Stanley

S. Shuman.

Based on his study of the market, his research, and his

conferences with other experts, he determined that the

market generally was stable and orderly, and that for Penn

Central securities it was active, free and orderly. He there-

fore concluded that the New Haven, which is the [44]

holder of only cash and marketable securities and is not

A64

Memorandum of Decision

an operating company, should be valued by aggregating its

cash and the fair market value of its securities, He de-

fined fair market value as “the price at which willing and

informed buyers, and willing and informed sellers, acting

under no compulsion, will trade.”

However, Mr. Shuman did not accept the market prices

of the securities at face value. After an evaluation of the

trading prices and the yield of each Penn Central security,

he tested the market’s conclusions by comparing the yield

and quality of each security to comparable securities trad-

ing in the open market.

The following table summarizes Mr. Shuman’s findings

concerning the fair market value of the New Haven estate,

as of the end of February 1979, net of claims senior to the

First Mortgage Bonds:

2 RESHME RTT PRE Liter ND PAS SEN NRO RIN $17,426,677

Penn Central securities:

PI IR I Nica a nes tchettasbbcnedicenoveveiie 12,377,250

I Br I ie iecectennesptcerevesnsnveneninls 3,532,500

Series B Preference Stock .................... 9,755,625

Certificates of Beneficial Interest .......... 2,007,375

A 23,978,552

Recovery of New Haven Legal

Expenses from Penn Central ................ 2,150,000

TEE "s ectdlaksaconeubiunsiciebieguamendacaandlias $71,227,979

His valuation methodology with respect to each of the

securities is as follows:

Series A Bonds: These Bonds are traded on the New

York Stock Exchange. Prior to December 13, 1978, they

traded at a range between 87 and 801%. Thereafter, the

trading range was between 78% and 70%, with the closing

A65

Memorandum of Decision

price for February 28, 1979 at 7254. He believed the de-

cline after December 13, 1978 was due to the drawings

[45] for redemption of a portion of the Bonds in December

1978. Total volume of sales was $1,281,000 for December

1978, $1,802,000 for January 1979, and $870,000 for Febru-

ary 1979. Based on the foregoing, he concluded that

$727 4% per $1000 Bond was a reasonable market price for

the Bonds.

Mr. Shuman then sought to establish comparability by

assigning a “rating’’ for the Series A Bonds. Because

neither Standard & Poor’s nor Moody’s had ratings for

the Penn Central debt-type securities, Mr. Shuman studied

the relevant characteristics of the Bonds and concluded

that they would receive a rating no higher than “A” ® if

classified by Moody’s.

He then examined bonds with comparable ratings to test

the market price of the Series A Bonds. He reviewed the

asset coverages, current yields and the yield-to-maturity

of comparably rated bonds and found that the yield-to-

maturity of the Series A Bonds, on a number of assump-

tions as to payment, was greater than that of the other

bonds reviewed. He attributed this difference to the Series

A Bonds’ low asset coverage, the size of senior claims, the

lack of current interest payments, and the possibility of

an extended maturity. After making an adjustment to

average market price because he believed that newly re-

leased material information concerning the Bonds had not

been fully digested by investors, he decided that market

6* Bonds which are rated A possess many favorable investment

attributes and are to be considered as upper medium grade obliga-

tions. Factors giving security to principal and interest are con-

sidered adequate but elements may be present which suggest a

susceptibility to impairment sometime in the future.

A66

Memorandum of Decision

price could not be accepted as the primary indicator of

value at the time he made his valuation.

Based on these factors, Mr. Shuman determined that a

market price of $750 reflected the fair market value for

[46] the Series A Bond and, therefore, the total value

fur the New Haven’s holdings of these securities was

$12,377,250.

Series B Bonds: Trading on a “when-issued” basis for

these Bonds commenced on the New York Stock Exchange

on November 14, 1978. Through December 20, 1978, they

traded in the range of $50 144 to $46 1%. Regular trading

of the Bonds began December 22, 1978, at a price of $48 14.

Thereafter, until March 1979, the Bonds traded in the range

of 481% to $45. Daily volume for February 1979 averaged

$26,277 principal amount and totalled $473,000 for the

month.

Establishing con parability in the same fashion as he

did for the Series A Bonds, Mr. Shuman decided the Series

B Bonds would be rated no higher than “Ba” ” by Moody’s,

and that a $471 market price valuation per Bond would be

proper. The New Haven’s holdings, therefore, amounted to

$3,532,500.

Series B Preference Stock: During the period Novem-

ber 14, 1978 and December 20, 1978, when the Series B

Preference Stock was sold on a when-issued basis, it traded

in the range of $6 % to $5. After regular trading of this

Stock began on December 21, 1978, it sold in the range of

7° Bonds rated Ba are judged to have speculative elements; their

future cannot be considered as well assured. Often the protection

of interest and principal payments may be very moderate and

thereby not well safeguarded during both good and bad times over

Se a Uncertainty of position characterizes bonds in this

, class.

A67

Memorandum of Decision

$6 3% to $5 through February 1979. An aggregate of

692,800 shares of the Stock was traded in February 1979.

Following the same procedure for determining compara-

bility as he did for the Bonds, Mr. Shuman believed that

the Stock would be classified no higher than “B”™ and

probably “Caa.” ™

Based on his analysis he accepted the market price of

[47] $5 % per share for the Stock as its fair market value.

Because the New Haven own 1,815,000 shares of this Stock,

the estate’s holdings amounted to $9,755,625.

CBI: These securities are not traded on a national secu-

rities exchange; as a result, volume figures are difficult to

obtain. However, they are traded over-the-counter and bid

prices are available. The average bid price of the CBI dur-

ing the month of February 1979 was $12 % per $100 face

value of a certificate.

Mr. Shuman determined that the CBI would be “unrated”

or would be classified no higher than “C”™ by Moody’s

and, upon comparison with other similar securities, he con-

cluded that the average market price demonstrated fair

market value, and that New Haven’s ownership of

$15,900,000 face amount of CBI was worth $2,007,375.

Common Stock: The Common Stock traded on a when-

issued basis in the over-the-counter market through No-

7 Bonds which are rated B generally lack characteristics of the

desirable investment. Assurance of interest and principal pay-

ments or of maintenance of other terms of the contract over any

long period of time may be small.

72 Bonds which are rated Caa are of poor standing. Such issues

may be in default or there may be present elements of danger with

respect to principal or interest.

78 Bonds which are rated C are the lowest rated class of bonds

and issues so rated can be regarded as having extremely poor

prospects of ever attaining any real investment standing.

A68

Memorandum of Decision

vember 13, 1978, closing at $17 34. During the period No-

vember 14, 1978 through December 13, 1978, of when-issued

trading on the New York Stock Exchange, it sold in the

range of $19 14% to $16 14. After regular trading started on

December 14, 1978, it sold in the range of $18 14 to $13 %

through February 1979. In the latter month, 1,534,300

shares were traded.

Based on his studies, Mr. Shuman determined that the

Common Stock should be valued at the market price of

$17.50 per share for the following main reasons:

1) The market for the securities was seasoned,

broad, free and orderly;

[48] 2) The quality and quantity of information

was more than adequate for investors to make sound

judgments concerning the value of the Common Stock,

including appraisals of the range of recoveries in the

Valuation Case;

3) The market price reflects investors’ valuations of

the risks and rewards of the ADP and of the Penn

Central’s tax attributes; and

4) The hypothetical liquidation value of Penn Cen-

tral would be $405.1 million resulting in a liquidation

value of $17.50 per share of Common Stock.

Thus under Mr. Shuman’s analyses, as of late February

1979, the fair market value of the New Haven’s 1,370,203

shares of Common Stock was $23,978,552.

To further sustain the validity of the market value meth-

odology, the First Mortgage Bondholders rely on the testi-

mony of two additional experts, Mr. Martin J. Whitman,

a professor at the Yale School of Organization and Man-

agement, and Mr. James J. Maguire, a registered specialist

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Memorandum of Decision

at the New York Stock Exchange in the trading of the

Common Stock and Preference Stock of the Penn Central.

Both men testified that the market was stable and orderly

and that these securities were seasoned. Mr. Whitman fur-

ther concluded that the market was an appropriate in-

dicator of the values of the Penn Central securities.

In their brief, submitted months following Mr. Shuman’s

testimony, the First Mortgage Bondholders “update” their

estimate of the net asset value of the New Haven available

to satisfy their claim (after payment of senior claims) to

[49] reflect the later market prices for the securities dur-

ing the period July 16, 1979 to August 15, 1979:

Market Value

Asset Per Security Total

Series A Bonds $80.49 /$100" $13,283,265

Series B Bonds $58.34/$100 4,375,500

Preference B Stock $ 5.65/share 10,254,750

CBI $14.95/$100 2,378,640

Common Stock $18.75/share 25,691,306

Cash (as of 6/30/79) 18,825,000

The Net Asset Value Available to

Satisfy First Mortgage Bondholders $74,808,461

™ During the closing arguments, the First Mortgage Bond-

holders introduced tables to update the market prices of the

various Penn Central securities held by the New Haven estate

reflected in exhibits VI, XI, XIV, XVII and XIX of Mr. Shuman’s

affidavit. Using the table introduced to supplement exhibit VI,

which was the market prices of the Series A Bonds from Mar. 1,

1979 to Nov. 9, 1979, the average price of those bonds for the

period July 16, 1979 to August 15, 1979 should have been

$83.69/100. That would yield a total of $13,812,350 as the value

of the New Haven’s Series A Bonds.

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Memorandum of Decision

The Income Bondholders’ Methodology

The Income Bondholders and their experts contend, as

does the trustee and his experts, that intrinsic value rather

than market price is the appropriate measure of value for

the securities.

As explained by Mr. Walter Breslav, Jr., the Income

Bondholders’ lead expert, the market prices of the Penn

Central securities must be assumed to be substantially

below their intrinsic value for the following reasons: 1)

the securities of a once-distressed company emerging from

a lengthy reorganization are subject to substantial investor

prejudice; 2) the market generally undervalues a litigated

claim, such as the Valuation Case, as an asset; 3) the abil-

ities of the management of Penn Central are as yet un-

proven; 4) holders of large numbers of the securities are

banks and insurance companies which are under a

“pressure” to sell the securities and, therefore cannot be

considered to be “voluntary” sellers in the open market;

and 5) investors do not possess sufficient knowledge con-

cerning Penn Central’s complex capital structure to ap-

praise accurately the real value of its securities. Amended

[50] Affidavit of Walter Breslav, Jr., dated March 29, 1979

at 5-15.

Mr. Breslav agreed with Mr. Dewey’s valuations of the

Penn Central securities and found them fair and accurate.

He adopted Mr. Dewey’s calculations and, with an adjust-

ment made for the redemption of a portion of the Series

A Bonds in 1978, he arrived at a valuation of $97.9 million

as his initial determination of the value of the securities.

Mr. Dewey’s assessments, however, assumed an $887 mil-

lion base award in the Valuation Case, which was $113 mil-

lion less than what Mr. Breslav expected as the minimum

recovery. Mr. Breslav, therefore, concluded that $4.7 mil-

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Memorandum of Decision

lion more was available for the Common Stock, and that

$102.6 million was the value of the Penn Central securities

based on a minimum Valuation Case award of $1 billion.

Mr. Breslav used two different approaches in appraising

the tax attributes for which he relied in part on the testi-

mony of a tax expert, Mr. Samuel Braunstein. First, Mr.

Breslav assumed that the IRS rulings that the transfer of

the New Haven’s rail assets to Penn Central in 1968 was

nontaxable would be accepted by the management of the

reorganized New Haven; and second, he considered the tax

effects if the management of the reorganized New Haven

did not follow the IRS rulings but treated the transfer of

the New Haven’s rail assets to Penn Central as a 1978

closed transaction and taxable.

Assuming an almost full utilization of the tax benefits

available under the IRS rulings, Mr. Breslav calculated

that net operating losses would be over $77 million and

capital losses of over $100 million would exist. He cal-

culated [51] that the intrinsic value of these potential tax

attributes was $47.8 million, after applying at 20% discount

to allow for the possibility that the values could not be

completely realized.

Based on the alternative assumption that the transfer of

assets to Penn Central in 1968 was a taxable transaction

giving rise to an ordinary loss deduction, he concluded

that the intrinsic value of the tax attributes would be

$56.2 million, after applying at 20% discount to the present

gross value of $70.2 million for various uncertainties,

Mr. Breslav also testified that another quantifiable ele-

ment of intrinsic value for the New Haven assets was the

block value inherent in its holdings of approximately 6%

of the Penn Central Common Stock. He was persuaded

that a premium of at least $5.8 million, 10% over the value

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Memorandum of Decision

of the Common Stock as found by Mr. Dewey, would be

paid if an acquirer sought to gain control over the reorgan-

ized Penn Central through the New Haven’s large block

of voting and equity ownership. With a 20% discount for

risk applied, the net intrinsic value for the block premium

is $4.6 million.

Mr. Breslav also considered the values attributable to

the Common Stock from recoveries in the Valuation Case

from $1 billion to $2.5 billion. He concluded that the dis-

counted present value of the New Haven’s share of these

proceeds can range as high as $63.2 million.

Finally, Mr. Breslav recognized a real, but unquantifi-

able, value in terms of benefits that could be anticipated as

a result of a merger of the reorganized New Haven with

another corporation, such as providing a more effective

[52] and economical operation or combining assets to pro-

vide a strong capital base for future developments.

The Income Bondholders also rely on the evidence pre-

sented by Mr. Peter C. Morse, a financial expert. Mr.

Morse discussed the various effects upon the two system

bondholders under the various plans of reorganization be-

fore the Court. He testified that in his view the reorgani-

zation value of the New Haven is in the range of $174.5

million to $246 million, that the trustee’s Amended Plan

was not fair and equitable, and that the Income Bond-

holders’ proposed plan of reorganization was the only one

feasible and equitable.

B. Tre Covrr’s Rutines on VALvaATIon

The disputed issues of fact and law relating to the ap-

plicable methodology for the valuation of the assets of

the New Haven have been fully litigated in a trial on the

merits. The validity of every opinion expressed on the

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Memorandum of Decision

subject was contested to the minutest detail. After a care-

ful review and consideration of the extensive evidence and

voluminous briefs, the Court is of the opinion that no

party’s valuation procedures can be accepted in toto as the

basis for a fair, equitable and feasible plan of reorganiza-

tion.

In determining the value of the New Haven estate for

reorganization purposes, the Court will consider and value

each of the categories of assets considered by the parties

and their experts: 1) cash and cash equivalents; 2) the

Penn Central securities; and 3) various intangibles, such

as tax attributes and block premiums, which are inherent

in the reorganized New Haven.

[53] Cash: At the present time the cash held by the

trustee is $36.7 million. It is reasonable to expect favor-

able consideration of the trustee’s’ claim for $2.15 million

for reimbursement for attorneys’ fees and expenses paid

by him in the Penn Central reorganization proceedings.

The Court, therefore, will treat the amount of this claim

as a cash equivalent asset of the estate.

The Securities: The fair market value concept has defi-

nite facial attraction. Its application results in precise

calculations, mathematically ascertained, which are not

only expressible in monetary terms but are realizable in

actual dollars at the present time, Such exact measurement

of the worth of New Haven’s securities would have the

ostensible imprimatur of the scientific method and would

evoke a sense of definitiveness to these proceedings. Final-

ity certainly would be welcomed after 18 years of uncer-

tainty and of protracted, complicated, and expensive liti-

gation. But, however tempting the easier route to resolu-

tion may be, the Court finds that it cannot equate ease

with equity nor fairness with market value.

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Memorandum of Decision

This is not to say that the market prices of the securities

are to be ignored or summarily dismissed as irrelevant.

The design of a fair and equitable plan of reorganization

first necessitates a valuation of the assets of the New

Heven to ensure that the distribution of the securities of

the reorganized New Haven will conform to the absolute

priority rule. See, e.g., TMT Trailer, supra, 390 U.S. at

448-50; Consolidated Rock, supra, 312 U.S. at 527; Case v.

Los Angeles Lumber Products Co., supra, 308 U.S. at 115-

19; 6A Collier, supra, § 11.06. Obviously, if the Court errs

by not accepting the market value approach [54] advo-

cated by the First Mortgage Bondholders, they will, indeed,

receive less on distribution than their entitlement. On the

other hand, a wooden application of the market price

methodology, if erroneous, would deprive the Income Bond-

holders of a position of equity, rightfully theirs, in the

reorganized New Haven.

Though significantly different in theory and by defini-

tion,”® the Conrt does not view the market price and in-

trinsic value methodologies to be necessarily antithetical,

irreconcilable approaches to valuation. If the investing

public is well informed, and the securities are seasoned and

trading actively in a stable market, it seems apparent that

market price should approximate the intrinsic value of the

securities. If so, the marketplace should be the principal,

if not the exclusive, indicator of value. However, the pres-

75 Fair market value has been generally defined as the price at

which property would change hands between a willing buyer and

a willing seller, neither being under any compulsion to buy or to

sell and both having reasonable knowledge of the relevant facts.

Intrinsic value, as it has been used in these proceedings with

respect to securities, is that value which is justified by the facts,

including assets, earnings and dividends, capitalized earnings and

discounted cash flow.

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Memorandum of Decision

ence of special circumstances, which would unduly distort

the investors’ appraisals of the fair and real value of the

securities, requires that the trier assess criteria other than

market prices to gauge the worth of an enterprise for re-

organization purposes,

These legal principles are not antagonistic to the stan-

dards enunciated in the case authorities heavily relied on

by the First Mortguye Bondholders, In E.J. duPont de

Nemours & Co. v. Collins, supra, the Supreme Court ac-

cepted the SEC’s valuations in a merger case based on

market value, but only after expressly noting that the

transaction involved “an exchange of equivalents,” 432

U.S. at 51, and that the value of the securities being sur-

rendered was basically their “real value.” Jd. at 54. The

Second [55] Circuit in Seaboard World Airlines, Inc, v.

Tiger International, Inc., supra, stressed that in a takeover

situation the market value approach was the appropriate

measure of “going concern” value, “absent compelling rea-

sons to believe otherwise.” 600 F.2d at 361 (emphasis

added). Similarly, in Mills v. Electric Auto-Lite Co.,

supra, the court asserted that “when market value is avail-

able and reliable,” it should be used to assess the value of

ongoing enterprises in the context of a merger. 552 F.2d at

1247 (emphasis added). The holding in In re Equity Fund-

ing Corp., supra, also confirms that market value is the

appropriate measure of assets for reorganization purposes

if it adequately recognizes “relevant risks and market fac-

tors.” 416 F. Supp. at 144. Finally, the market price test

was approved as the fundamental valuation criterion “in

the absence of special circumstances” in Central States

Elec. Corp. v. Austrian, supra, 183 F.2d at 884."

It is significant to point out that Mr. Shuman’s testimony

indicated that his analysis would not support the conclusion that

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Memorandum of Decision

In the instant case, the Court finds that the market in

general is somewhat unsettled because of the social, polit-

ical, and economic stresses current on the domestic and

international scenes. Yet, it is neither in disarray nor in a

panic state which in and of itself would warrant a rejection

of the investors’ perceptions of the value of securities.

More specifically, the transactions involving Penn Central

securities during the past year have been in a volume am-

ple to indicate steady and positive investors’ interest,

On balance, however, there are sufficient features, pecu-

liar to the securities held by the New Haven, which [56]

sustain the conclusion that the market has underrated these

securities, and will continue to do so for some time in the

future. The stigma of bankruptcy alone is a factor that

will seriously depress the market value of a company’s

securities. In its discussion of the contention that the

market can be expected irrationally to undervalue the

securi'::s of a company emerging from a lengthy reorga-

nization, the Third Circuit stated:

That argument has considerable force when the se-

curities in issue represent equity in, or long term

interest bearing obligations of, a reorganized debtor.

In such cases, the market value of the security will

depend upon the investing publie’s perception of the

future prospects of the enterprise. That perception

may well be unduly distorted by the recently concluded

reorganization and the prospect of lean years for the

at a future point in time one could simply refer to the market

quotations to determine the value of the New Haven’s holdings of

Penn Central se

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