Appendix — Brooks v. St. Louis-San Francisco Railway Co.

Nee SE EM 2

App. A, p. 1

APPENDIX A

Section 73 of Bankruptcy Act (11 USCA See. 201)

ADDITIONAL JURISDICTION

In addition to the jurisdiction exercised in voluntary

and involuntary proceedings to adjudge persons bankrupt,

courts of bankruptey shall exercise original jurisdiction in

proceedings for the relief of debtors, as provided in sections

202, 203, and 205 of this chapter.

Excerpts from Section 77 of Bankruptcy Act

(11 USCA See. 205)

REORGANIZATION OF RAILROADS ENGAGED IN INTERSTATE

COMMERCE—PETITION FOR REORGANIZATION BY RAIL-

ROAD, SUBSIDIARY OR CREDITORS; VENUE; PROCEEDINGS

THEREON; JURISDICTION OF COURT OVER DEBTOR AND

PROPERTY ....

Plan of reorganization, contents; “securities”, “stock-

holders”, “creditors”, “claims” defined; suspension of statutes

of limitation.

(b) A plan of reorganization within the meaning of

this section (1) shall include provisions modifying or alter-

ing the rights of creditors generally, or of any class of

them, secured or unsecured, either through the issuance of

new securities of any character or otherwise; (2) may in-

clude provisions modifying or altering the rights of stock-

holders generally, or of any class of them, either through

the issuance of new securities of any character, or other-

wise; (3) may include, for the purpose of preserving such

interests of creditors and stockholders as are not otherwise

provided for, provisions for the issuance to any such cred-

itor or stockholder of options or warrants to receive, or

to subscribe for, securities of the reorganized company in

such amounts and upon such terms and conditions as may

be set forth in the plan; (4) shall provide for fixed charges

(including fixed interest on funded debt, interest on un-

funded debt, amortization of discount on funded debt, and

rent for leased railroads) in such amount that, after due

BI ha Nc a as

a

App. A, p. 2

consideration of the probable prospective earnings of the

property in light of its earnings experience and all other

relevant facts, there shall be adequate coverage of such

fixed charges by the probable earnings available for the

payment thereof; (5) shall provide adequate means for

the execution of the plan, which may include the transfer of

any interest in or control of all or any part of the property

of the debtor to another corporation or corporations, the

merger or consolidation of the debtor with another corpora-

tion or corporations, the retention of all or any part of the

property by the debtor, the sale of all or any part of the

property of the debtor either subject to or free from any

lien at not less than a fair upset price, the distribution of

all or any assets, or the proceeds derived from the sale

thereof, among those having an interest therein, the satis-

faction or modification of any liens, indentures, or other

similar interests, the curing or waiver of defaults, the ex-

tension of maturity dates of outstanding securities, the re-

duction in principal and/or rate of interest and alteration

of other terms of such securities, the amendment of the

charter of the debtor, and/or the issuance of securities of

either the debtor or any such other corporation or corpora-

tions for cash, or in exchange for existing securities, or in

satisfaction of claims or rights or for other appropriate

purposes; and may deal with all or any part of the prop-

erty of the debtor; may reject contracts of the debtor which

are executory in whole or in part, including unexpired

leases; and may include any other appropriate provisions

not inconsistent with this section.

The adoption of an executory contract or unexpired

lease by the trustee or trustees of a debtor shall not pre-

clude a rejection of such contract or lease in a plan of re-

organization approved hereunder, and any claim resulting

from such rejection shall not have priority over any other

claims against the debtor because such contract or lease had

heen previously adopted. The term ‘‘securities’’ shall in-

clude evidence of indebtedness either secured or unsecured,

bonds, stock, certificates of beneficial interest therein, certi-

ficates of beneficial interest in property, options, and war-

—_7_

App. A, p. 3

rants to receive, or to subseribe for, securities. The term

‘stockholders’? shall include the holders of voting-trust

certificates. The term ‘‘ereditors’’ shall include, for all

purposes of this section all holders of claims of whatever

character against the debtor or its property, whether or

not such claims would otherwise constitute provable claims

under this Aet, including the holder of a claim under a con-

tract executory in whole or in part including an unexpired :

lease, F

é

The term ‘*claims’’ includes debts, whether liquidated :

or unliquidated, securities (other than stock and option :

warrants to subscribe to stock), liens, or other interests of é

whatever character. For all purposes of this section un-

secured claims, which would have been entitled to priority

if a receiver in equity of the property of the debtor had

heen appointed by a Federal court on the day of the ap-

proval of the petition, shall be entitled to such priority

and the holders of such claims shall be treated as a separate

class or classes of creditors. In case an executory contract

or unexpired lease of property shall be rejected, or shall

not have been adopted by a trustee appointed under this

| section, or shall have been rejected by a receiver in equity

| in a proceeding pending prior to the institution of a pro-

ceeding under this section, or shall be rejected by any plan,

any person injured by such nonadoption or rejection shall

for all purposes of this section be deemed to be a creditor

of the debtor to the extent of the actual damage or injury

determined in accordance with principles obtaining in

equity proceedings. The provisions of section 96 of this 3

title shall apply to a proceeding under this section. For

all purposes of this section any creditor or stockholder may

act in person or by an attorney at law or by a duly au-

thorized agent or committee subject to the provisions of

subsection (p) of this section. The running of all statutes

of limitation shall be suspended during the pendency of a

proceeding under this section. :

PADI ° BIOWARE PRI PE

App. A, p. 4

Proceedings after approval of petition.

| ore

} 3 ge

The trustee or trustees so appointed, upon filing such

bond, shall have all the title and shall exercise, subject to

the control of the judge and consistently with the provisions

of this section, all of the powers of a trustee appointed pur-

suant to section 72 or any other section of this title, and, to

the extent not inconsistent with this section, if authorized

by the judge, the powers of a receiver in an equity proceed-

ing, and, subject to the control of the judge and the juris-

diction of the Commission as provided by chapter 1 of Title

49 as on August 27, 1935, or thereafter amended, the power

to operate the business of the debtor. Prior to the appoint-

ment of a trustee, the debtor on behalf of the court shall

continue in the possession of the property and shall oper-

ate the business thereof during such period, and shall have

all the title to the property and shall exercise all power con-

sistent with the provisions of this section subject at all

times to the control of the judge, and to such limitations,

restrictions, terms, and conditions as he may from time to

time impose and prescribe... .

(10) The judge may direct the debtor or the trustee

or trustees to keep such records and accounts, in addition to

the accounts prescribed by the Commission, as will permit

of such a segregation and allocation, as the necessities of

the case may require, of the earnings and expenses between

and to the divisions and parts of the railroad or other

property of the debtor which are separately subject to the

liens of the various mortgages or deeds of trust, or are

separately subject to lease, and may refer to the Commis-

sion for its recommendations after hearings thereon if the

parties shall so request and/or the Commission determine

necessary or desirable, as to the method or formula by

which such segregation and allocation shall be made; and

thereafter such segregation and allocation may be made at

the expense of the debtor’s estate. ...

App. A, p. 5

Court hearing after approval by Commission; acceptance

of plan by creditors and stockholders; confirmation of plan by

court; valuation of property.

(e) Upon the certification of a plan by the Commis-

sion to the court, the court shall give due notice to all par-

ties in interest 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 Commission, 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 approve the plan if satisfied that: (1) it complies with

the provision of subsection (b) of this section, if fair and

equitable, affords due recognition to the rights of each class

of creditors and stockholders, does not discriminate un-

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

will conform to the requirements of the law of the land re-

garding 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 ac-

quiring 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 Commission, and are within such maximum limits to

be subject to the approval of the judge; (3) the plan pro-

vides for the payment of all costs of administration and all

other allowances made or to be made by the judge, except

that allowances provided for in subsection (¢), 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

bes REP PET Re re eae IP ae?

a hac ae)

App. A, p. 6

opinion, stating his conclusions and the reason therefor,

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

the proceedings, or in his diseretion 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 Commission, it shall

proceed to a reconsideration of the proceedings under the

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

shall appreve 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 accordance

with the requirements of subsection (¢) of this seetion, 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 subinission 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

cash to such class of stockholders of an amount not less

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

ests 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 aeceptance: Pro-

vided 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 be adversely and ma-

terially affected by the plan, or that at the time of the find-

face

App. A, p.7

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

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

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

their interests. For the purpose of this section the ac-

ceptance or rejection by any creditor or stockholder shall be

in writing, executed by him or by his duly authorized at-

torney, committee, or representative. If the United States

of America, or any agency thereof, or any corporation

(other than the Reconstruction Finance Corporation) the

majority of the stock of which is owned by the United

States of America, is a creditor or stockholder, the inter-

ests 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 designate, is hereby authorized to act in

respect of the interests or claims of the United States or of

such ageney or other corporation. The expense of such

submission shall be certified by the Commission and shall

be borne by the debtor’s estate. The Comission shall

certify te the judge the results of such submission.

Upon receipt of such certification, the judge shall con-

firm the plan if satified that it has been accepted by or on

behalf of creditors of each class to which submission is re-

quired 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 the steckholders of each

class to which submission is required under this subsection

holding 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

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 statement of his

conclusions and his reasons therefor, and enter an order

in which he shall either dismiss the proceedings, or, in

his diseretion and on the motion of any party in inter-

est, refer the case back to the Commission for further

App. A, p. 8

proceedings, including the consideration of modifica-

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

event of such a reference back to the Commission, the pro-

ceedings 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 shall 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, aad 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.

Binding effect of confirmation; discharge of debtor from

liabilities; issuance of securities.

(f) Upon confirmation by the judge, the provisions

of the plan and of the order of confirmation shall, subject

to the right of judicial review, be binding upon the debtor,

all stockholders thereof, including those who have not, as

well as those who have, accepted it, and all crediters se-

cured or unsecured, whether or not adversely affected by

the plan, and whether or not their claims shall have been

filed, and if filed, whether or not approved, including cred-

itors who have not, as well as those who have accepted it.

Upon confirmation of the plan, the debtor and any other

corporation or corporations organized or to be organized

for the purpose of carrying out the plan, shall have full

power and authority to, and shall put into effect and carry

out the plan and the orders of the judge relative thereto,

under and subject to the supervision and the control of

the judge, the laws of any State or the decision or order of

—_

App. A, p. 9

any State authority to the contrary notwithstanding. The

property dealt with by the plan, when transferred and con-

veyed to the debtor or to the other corporation or corpora-

tions provided for by the plan, or when retained by the

debtor pursuant to the plan, shall be free and clear of all

claims of the debtor, its stockholders and creditors, and the

debtor shall be discharged from its debts and liabilities, ex-

cept such as may consistently with the provision of the plan

be reserved in the order confirming the plan or directing

such transfer and conveyance or retention, and the judge

may require the trustee or trustees appointed hereunder,

the debtor, any mortgagee, the trustee of any obligation of

the debtor, and all other proper and necessary parties, to

make any such transfer or conveyance, and may require

the debtor to join in any such transfer or conveyance made

by the trustee or trustees. Upon the termination of the

proceedings a final decree shall be entered discharging the

trustee or trustees, and making such provisions as may be

equitable, by way of injunction or otherwise, and closing

the case. Upon confirmation of a plan the Commission

shall, without further proceedings, grant authority for the

issue of any securities, assumption of obligations, transfer

of any property, sale, consolidation or merger of the

debtor’s property, or pooling of traffic, to the extent con-

templated by the plan and not inconsistent with the provi-

sions and purposes of chapter 1 of Title 49 as on August

27, 1935, or thereafter amended. . . .

Dismissal of proceedings because of undue delay in re-

organization.

(gz) If in the light of all the existing circumstances

there is undue delay in a reasonably expeditious reorganiza-

tion of the debtor, the judge, in his discretion, shall, on mo-

tion of any party in interest or on his own motion, after

hearing and after consideration of the recommendation of

the Commission, dismiss the proceedings. Upon the filing

of such an order of dismissal, all right, title, or interest of

the trustee or trustees shall vest by operation of law

in the debtor unless otherwise provided by such order. . . .

App, A, p. 10

Restraining or staying commencement or continuation of

proceedings against debtor; removal of causes; owners’ rights

to equipment leased or conditionally sold unaffected.

(j) In addition to the provisions of section 29 of this

title for the staying of pending suits against the debtor,

the judge may enjoin or stay the commencement or con-

tinuation of suits against the debtor until after final de-

cree; and may, upon notice and for cause shown, enjoin

or stay the commencement or continuance of any judicial

proceeding to enforce any lien upon the estate until after

Certified copy of order confirming plan or directing con-

veyance of property as evidence.

(k) <A certified copy of the final order confirming a

plan of reorganization, or of any other order or decree en-

tered in a proceeding under this section, shall be evidence

of the jurisdiction of the court, the regularity of the pro-

ceedings, and the fact that the order or decree was made.

A certified copy of an order directing the transfer and con-

veyance of the property dealt with by the plan as provided

in subsection (f) of this section, or as specified in an order

dismissing the proceedings as provided in subsection (i),

shall be evidence of the transfer and conveyance of title

accordingly, and if recorded shall impart the same notice

that a deed, if recorded, would impart.

Jurisdiction of court, duties of debtor and rights of cred-

itors same as in voluntary bankruptcy.

(1) In proceedings under this section and consistent

with the provisions thereof, the jurisdiction and powers of

the court, the duties of the debtor and the rights and liabili-

ties of creditors, and of all persons with respect to the

debtor and its property, shall be the same as if a voluntary

petition for adjudication had been filed and a decree of

adjudication had been entered on the day when the debtor’s

petition was filed. ...

tae by’

Wie

App. B, p. 1

APPENDIX B

Excerpts from Report No. 925 (Senate) 79th Congress

2nd Session, February 7, 1946.

Investigation of Trusteeships under Section 77 of the

Bankruptey Act and Railroad Equity Receiverships.

We apply italics for emphasis.

Pagings conform to the pagings of the report.

All tables have been condensed to apply only to St.

Louis-San Francisco Ry. Co.

(Page 5)

ADDITIONS AND IMPROVEMENTS TO THE TRANSPORTATION

PLANT OF THE RAILROADS

The investment per mile of road has increased

from approximately $80,000 per mile of road at the

end of Federal control to $111,352 at the beginning of

the calendar year 1942. This increase is in large part

attributable to expenditures for heavier rail, more and

improved signal systems, larger and more efficient

equipment and machinery, and in no small part to the

elimination of some 25,000 miles of the least efficient

lines, whose abandonment we had authorized as con-

sistent with public convenience and necessity (pp. 2-3).

(Page 6)

THE PHYSICAL PLANT DURING THE DEPRESSION YEARS

In the case of both the railroads in the hands of the

court and those whica have remained out of receivership

and bankruptey proceedings, heavy investments in im-

provements and additions as well as in maintenance, in the

war years, have now brought the railroad plant to a higher

level.

(Page 21)

REDUCTION OF DEBT

The Interstate Commerce Commission reported to

Congress:

a

App. B, p. 2

During the period January 1, 1932, to December

31, 1941, the funded debt of class I railroads was re-

duced from $10,850,944,438 to $10,565,084,210, a de-

crease of $285,860,228. Of this reduction, at least $111,-

115,727 was effected through reorganization (annual

report for 1942, p. 28).

At present, a large proportion of the outstanding

railroad bonds can be bought at large discounts. This

affords a most favorable opportunity to eliminate debt

and to cut fixed charges. The extent to which railroads

are now buying their own bonds is not currently re-

ported, but the indications are that substantial opera-

tions of this character are, and have lately been, in

progress (same, p. 29).

In our last annual report, we again discussed the

importance of debt reduction. We suggested that the

present favorable earnings be used as largely as is

practicable for that purpose. We are convinced that

both the public interest and the interest of carrier

shareholders will in the long run be served by that

policy (same).

For the year 1942 the Commission reported:

It is gratifying to report that more and more rail-

roads in a position to do so are voluntarily reducing

or taking steps looking toward the gradual reduc-

tion of their funded debt and the burden of fixed inter-

est charges. Some are using their surplus earnings to

retire a part of their funded debt or to purchase on

the open market their own outstanding securities or

those of their subsidiaries which they have guaranteed.

During the calendar year 1942 the funded debt of class

I railroads and their lessors, excluding companies in

receivership or trusteeship, was reduced by $324,375,-

299, or 3.71 percent. For the operating companies

alone the reduction was $282,026,921, or 3.84 percent,

and for lessors $42,348,378 or 3.02 percent (annual re-

port for 1943, p. 25).

—

App. B, p. 3

The Commission’s recent annual report states:

At the close of the year 1935 the amount of un-

matured funded debt, including equipment obligations,

of line-haul steam railways held by the public (that

portion not held by railways) was $11,341,000,000 as

compared with $9,312,000,000, as of December 31, 1944,

or a reduction in the 10-year period of $2,029,000,000

or 17.9 percent (annual report for 1945, pp. 19-20).

(Page 22)

The report published by the Association of American

Railroads in March 1944 and prepared for one of its com-

mittees, shows that the funded debt of railways of classes

I, Il, and IIT reached a peak of $11,880,000,000 in 1930 and

was gradually reduced thereafter, falling to $10,354,000,000

in 1942,, or a reduction in those 12 years of more than one

and one-half billion dollars (report, p. 10).

In addition it should be recalled, as noted above, that

a number of railways have in recent years been generally

making additions and betterments to their properties on

a cash basis and without following the usual practice of

selling securities to meet the cost of such additions and

betterments.

(Page 23)

On the basis of this estimate, the improvement in the

position of the carriers in the past 4 years may be totaled,

as follows:

Increase in net working capital (p. 3 of

Monthly Comment) .............. $1,125,667 ,235

Estimated increase due to the 2 tax pro-

visions, and profits of the closing 4

months for 1945, at least.......... 1,000,000,000

DR ah roe en wy kins 2,125,667,235

This amount constitutes almost one-fourth of the bond

debt of the carriers.

App. B, p. 4

This amount can be used to retire outstanding debt.

Very little is likely to be used for capital expenditures.

The carriers were polled by the Bureau of Transportation

Economics and Statistics of the Commission, and reported

that they were expected to spend $1,636,000,000 for road

and equipment in the 3 years following the end of the war

in Europe and Asia; they reported that they expected to

use little of their wartime and prewar earnings to finance

such expenditures. (Monthly Comment on Transportation

Statistics, December 10, 1945, pp. 1-2.)

REDUCTION IN INTEREST CHARGES AND RATE OF INTEREST

One of the most promising developments for the rail-

roads has been the substantial drop in the cost of money.

The United States Government led the way in financing

during World War II. The rate of interest for Liberty

bonds in World War I was 414 percent. In World War II,

the rate for long-term financing has been 214 percent, and

as low as 2 percent; the average cost of long- and short-

term financing for the Government has been below 2 per-

cent—this in spite of the fact that far larger sums have

been borrowed to finance World War II than World War

I. The money market is aggressively reducing the yield on

the 2- and 214-percent bonds; their market price is above

par, and on many days the increase in price has been the

full maximum amount permitted by Government regula-

tions.

Privately owned corporations have benefited from sim-

ilar reductions in the interest rate on their long-term

financing. There has been a large volume of refunding at

3 percent, 2% percent, 234 percent, and 214 percent.

(Page 25)

Interest rates on railroad debt are likely to continue

to decline, by reason of a second factor additional to the

general decline in interest levels. The large amount of sur

plus cash which the railroads possess means that a sub-

stantial portion of the outstanding railroad debt will be

App B, p. 5

retired. This means that the bonds remaining after such

retirement will be both better and scarcer. They will be

better because each remaining bon dis secured by more

collateral or mortgage value than before, and has access

to a larger proportion of the earnings than before. Many

of the remaining bonds will also be better because the re-

tirement process has raised their level of seniority. Re-

tirement of senior bonds converts the junior bonds below

them into first mortgage bonds; and so on down the hier-

archy of a company’s debt. The better the unretired por-

tion of a company’s bonds becomes the lower the rate of

interest which that company can require in the investment

market.

A similar result flows from the other factor already

mentioned, the reduced supply of railroad bonds and indeed

of all bonds.

The process of refunding to a lower level interest rate

will effect a financial change of magnitude for the rail-

roads ; the extent of the change is indicated by basic figures

published by the Western Railways and by the Eastern

Railroad Presidents Conference in the 1944 edition of A

Yearbook of Railroad Information (pp. 22, 42). These

figures show that the total funded debt of the class I rail-

ways in 1942 (the latest vear listed in those statistics) was

$10,354,041,681 and that the total interest in that year on

funded debt was $483,000,000. This constitutes an average

interest rate slightly in excess of 4.65 percent. A cut of

the average interest rate of 4 percent would effect a reduc-

tion in the annual interest charges of $68,336,000. A cut to

314 percent would reduce the annual interest charge $118,

513,000. A cut to 314 percent would reduce the charge by

$143,601,000. A cut to 3 percent would effect a reduction

in the annual interest charges of $168,689,000.

(Page 26)

On the subject of possible savings in interest charges,

this committee has received from the Interstate Commerce

Commission, in response to our request, data on 23 roads

App. B, p. 6

now in the hands of the Federal courts, or recently under-

going reorganization proceedings. Nine of the largest of

these companies are still in court hands, in receivership or

trusteeship; a tenth has emerged or is in the process of

emerging from court hands; their aggregate operated

mileage, as reported by the Commission (annual report for

1944, p. 146) is some 43,340 miles; if their interest charges

were reduced to 314 percent (the ‘‘lower level rate’’ or

average interest rate of the railway bond flotations be-

tween January 1, 1944, and June 30, 1945), those 10 sys-

tems would save about $30,205,000 per year. The amount

of such potential annual savings, and the percent by which

the 1944 total annual interest charges would be reduced

through such savings, are here given for each of the 10

companies:

Annual savings in

charges if interest Percentage of

Name of company on bonds were reduction of

reduced to lower present total

level rate interest charges

a” - * os s

St. Louis-SanFrancisco Ry. Co................. $3,094,386 26

Source: ICC, table VI, C. 8.

(Page 27)

The completion of the program of reducing the interest

rate paid by these and all other railways will constitute a

fundamental reorganization of their finances. It can pro-

duce financial changes adequate for the needs of the rail-

roads. The process, furthermore, is in contrast to the

drastic process usually involved in reorganizations in

equity receivership and under section 77 of the Bankruptcy

Act. It is a business process in contrast to a Government-

imposed process. It stems from the market place rather

than from governmental agencies. The possibility of ef-

fectuating such a program may well be regarded as one of

the greatest assets of the railroad industry.

App. B, p. 7

PAYMENT OF DEBT AND BACK INTEREST BY RAILROADS IN

RECEIVERSHIP AND IN SECTION 77 PROCEEDINGS

However, in a number of these railroads this process

could have been carried much further. A number of re-

ceivers and trustees have been inclined to hold cash and

cash equivalents in far larger amounts than were needed

or could be justified by sound business practice. It is neces-

sary to convert more rapidly from the theory and practice

in insolvency proceedings of withholding payment of

interest and retirement of bonds, to the sound business

practice of paying interest and retiring principal when

funds are available for those purposes. It is now clear

that the conversion to the normal process of paying inter-

est, past and current, and retirement of principal, can be

carried much further than has been the case up to the

present.

Sound railroad finance requires the prompt retire-

ment of debt through the use of the over-abundant funds

which are now being held by many of the receivers and

(Page 28)

trustees appointed by the Federal courts. It is true that

the receivers and trustees invest a portion of their large

surplus funds in short-term government obligations which

yield a fraction of 1 percent per year. However, the re-

ceivers and trustees are in a position to retire large

amounts of debt, bearing coupons of 4 to 6 percent. The

net loss to the railroads is, therefore, considerable—and

unnecessary. Jt is possible that some receivers and trustees

have found it difficult to use the surplus funds as fully as

they might have desired because they felt that this might

interfere with some pending plans of reorganization or with

negotiations among groups of security holders. However,

no such circumstances would seem to justify a departure

from the requirements of sound business practice which

should govern all such questions. The reorganization plans

are subject to revision, and even to abandonment, as experi-

ence demonstrates; legislation may affect their course also.

Pe eS Ser em

App. B, p. 8

Meantime unnecessary interest charges accrue, or are paid.

The industry can be greatly advantaged by using the sur-

plus funds without further delay, for reduction of debt.

Net interest Net amount of

rate which interest which

could have could have been

been saved saved, computed

‘ Z j : j Percent on an annual basis

St. Louis-San Francisco ...................0.0.0...... 3.83 $591,532

Source: ICC table VI, C 5 (8).

(Page 29)

The amount of surplus funds, available for reduction

of debt, is far larger today than it was at the end of 1944;

and the amount of interest charges which could be saved

if the surplus were energetically applied to retirement of

debt is far larger than in 1944. Reference has already been

made to the large cash accumulations of 1945, resulting

from the net income of that year, and the tax provisions

with respect to amortization and refund of 10 percent of

excess-profits taxes.

Reference was made above to the payment of inter-

est charges, both current and accured, by companies in the

hands of the courts. Large amounts have been paid by the

trustees and receivers, pursuant to court orders. Justice

to the bondholders required such action, and entitled them

to have such payments made larger, in order to clear up

all arrears, and to provide income to junior bondhelders,

where they have received no payments of interest, or rela-

tively small amounts of interest.

However, justice to the companies and their share-

holders makes some adjustment appropriate. The Recon-

struction Finance Corporation has already pointed to the

fair course, that of reducing the amount of interest de-

manded by it, from the full figure fixed in its notes, to a

lower rate made appropriate by financial conditions, usual-

ly for 6 percent to 4 percent; and, as we note later, this

process might even be carried further, in full recognition

of current money rates. Similarly, if these companies

PORT EE ETE OAL OI

App. B, p. 9

were no longer in the hands of the courts (and, as noted

later, there is only a technical basis, and often not even

such a basis, for continuing a number of them in the courts),

many of them could refund their outstanding bonds at con-

siderably lower rates of interest. It is desirable, until the

necessary steps can be taken to remove them from the

courts, to have such adjustment made, so as to eliminate

any suggestion that unfair advantage accrues to any set

of security holders by reason of artificial restrictions. On

the other hand, once such adjustment is made, it would

seem only fair to clear up, on that basis, all arrears to the

fullest extent permitted by the surplus funds.

The Bureau, of Transport Economics and Statisties of

the Interstate Commerce Commission has made a study

of the contrast between interest charges payable by roads

not in court hands and by roads in receivership or trustee-

ship. The fixed interest charges for the latter in 1944,

as compared with 1940, increased 4.1 percent, and for the

former decreased 12.5 percent (Monthly Comment. on

Transportation Statistics, March 7, 1945, p. 5). Jt does not

seem appropriate that in payments received and to be re-

received, roads in the hands of the courts should be sub-

jected to abnormal interest burdens, paying higher interest

than is paid by other roads.

While, of course, it is not suggested that any of the

parties have intended to bring about such a result, it is

nevertheless true that in its nature the result is akin to

one of the most widely criticized features of the small-loan

business of earlier days—the borrower who is in distress

is made to overpay; is, in effect, gouged. The artificial re-

straint on carriers subject to section 77 procedure, which

was evolved for conditions far different from those now

prevailing, should no longer be permitted to effect such un-

sound and unjustified disadvantage and damage to those

companies.

Companies which have any financial problems to solve

could advance the solution of their difficulties by reducing

their interest rates. The public in general will be benefited,

See TIE ee

2b YURI

mre

s

é

=

y

i

App. B, p. 10

as was indicated by the president of the American Short

Line Railroad Association at the hearings on S. 1253, as fol-

lows:

As a help in meeting such a situation we are sure

that a reduction in the cost for debt—in other words,

the cost of debt service—could in many cases serve a

very useful purpose, and entirely in the public inter-

est, without unfairness to a minority (pp. 121-122).

(Page 30)

Yet, the interests of the railroads in the custody of the

courts, and in the interests of the public as well, have been

retarded, not advanced. The companies which would be

most benefited by reduction of their interest rates are the

very companies which are being prevented from securing

a reduction.

In all such matters, the need is apparent for an ad-

vance in financial techniques comparable to the great ad-

vance made in railroad operating techniques. The former

have not kept pace with the latter; there is considerable

question whether there have been more than mere stirrings

or beginnings of improvement in dealing with financial

problems as required by sound business considerations. An

example is presented in data furnished by the Interstate

Commerce Commission in response to this committee’s re-

quest. The example relates to the Chicago & North West-

ern Railway Co. It was reorganized in June 1944. Reor-

ganization obviously offered an opportunity for adjusting

interest rates to current and oncoming interest levels.

Some $54,000,000 of reorganization bonds were issued in

July 1944, bearing interest rates of 4 percent. Within a few

months the directors of the reorganized company took the

necessary steps to bring about a refunding of those bonds,

by a new issue al 3 per cent—a saving of over half a million

dollars in interest charges per year (ICC table III). But

meantime the railroad had to pay the extra amount of

interest, and the charges for bankers’ and distributors’

| App. B, p. 11

commissions and profits had to come out of the pocket-

books of the railroad company and investors.

The financial staffs of the Government agencies, rail-

| road companies, committees, and other groups interested

in the general problem possess the ability to bring to bear

on this problem the same resourcefulness which engineer-

ing and similar experts and the operating managements and

employees of the railroads have used in the operation of

(Page 31)

the transportation plans. Indeed, the financial problems

are much simpler. One may be confident that once the er-

perts and interested parties are permitted to keep up, in

financial developments, with the practical men engaged

in railroad operation, the roads and the Nation, as well as

the investors themselves, will reap substantial benefits.

(Page 39)

The following data, dealing with eight major railroads

in the eustody of the bankruptcy courts, all but one still

there, are taken from the elaborate tables prepared by the

Interstate Commerce Commission.

For period from Jan. 1, 1941, to June 30, 1945—average per year

Number of

timesaver- Dollars earned per

age annual share of stock

Name of railroad company interest

charges Preferred Common

were stock stock

earned*

. . 7 . .

St. Louis-San Francisco................................ 1.99 7.04 34.53

* The accounting rules of the Commission provide for the deduction

of all taxes before considering the amount earned and available for pay-

ment of interest. In computing the number of times the annual interest

or fixed charges were earned, financial manuals consider earnings before

deduction of Federal income and excess-profits taxes, as well as after such

deductions. The Commission has stated that net income before such tax

deduction indicates certain earning power (annual report, 1944, pp. 7-8).

The comparison in this and later tables computes times earned on the

same basis for all companies.

Source: ICC, table VI C 1.

~ i

App. B, p. 12

(Page 44)

The net income figures for 1945 will not be comparable

with those for prior vears. A very large amount of amorti-

zation, in excess of normal depreciation rates, has been

deducted as an operating expense, in order to obtain bene-

fits under the tax law. Most of this deduction represents

a tax saving of 8514 percent of the amount deducted. The

total deducted by way of amortization probably runs into

hundreds of millions of dollars.

Part of this sum may be deducted as an expense in

preceding years, necessitating a revision of the back fig-

ures of net income for those vears as well.

The total cost of wartime facilities certified, so as to

be amortizable under the tax law, is believed to be about

one and one half billion dollars. If depreciated at the

normal rate, say, 3.41 pereent—a figure mentioned earlier

in this report—the amount of depreciation chargeable an-

nually as an operating expense would be about $51,100,000.

The actual figure would be somewhat less, since deprecia-

tion of roadways and structures is not charged as an oper-

ating expense, and part, though a smaller part, of the fa-

cilities under discussion were roadway and _ structures.

Whatever the precise amount, it is far less than the amount

of amortization actually deducted as an operating expense

for 1945 and two or more preceding years. The excess con-

stitutes an arbitrary understatement of the earnings of

those vears.

On the other hand, the book figures for net income of

postwar years will be higher to the extent that depreciation,

otherwise chargeable as an expense, will not be charged on

those installations for the many remaining years of their

life.

YEARS SUBSEQUENT TO 1945

In discussing business of the years subsequent of

1945, it is possible to make estimates of their probable earn-

ings or to limit discussion principally to those faets which

—

App. B, p. 13

are in the realm of certainty rather than in the realm of

forecast. We shall limit our own discussion primarily to

known facts and certainties with respect to the business

of the several years following 1945.

(1) One established fact is that large bodies of troops,

and large quantities of surplus goods released by the War

and Navy Departments and of war material will have to

be transported by our railroads.

As the Commission reported on November 2, 1945:

* * * the cessation of hostilities has not brought strictly

war demands to an end (annual report for 1945, p. 1).

(2) Another established fact is that the period of re-

conversion has already been under way for some months

and that there is a large pent-up demand for civilian goods

both on the part of returning members of the armed forces

and on the part of the civilian population.

In the 1945 edition of A Yearbook of Railroad Infor-

mation issued by the Western Railways and by the East-

ern Railroad Presidents Conference, this subject is dis-

cussed as follows:

World War II has ended. War production has

been cut back or terminated, but large quantities of

war materials in both theaters will be returned to the

United States and transported by rail to arsenals and

points of disposal. So long as large military forces

remain in the European and Pacific areas, there will

be a heavy movement of supplies and military person-

nel in both directions. Occupational forces also will

require food and supplies. China’s needs probably will

be substantial and there will be continued heavy relief

'

E

(Page 45)

shipments to the devastated countries in both theaters

of war. Demobilization, at the rate of 500,000 persons

a month, will demand considerable rail transportation.

Unlike other industries, the railroads have no re-

App. B, p. 14

conversion problem. Their plant in war is the same as

in peace. During the war, the railroad plant was able

to handle both military and civilian traffic. With the

decline in war traffic it is ready to move the increase in

traffic that will result from the resumption of civilian

production (p. 1).

(3) A third known fact of considerable importance is

provided by the carry-back provisions of the tax laws.

These constitute in effect a guaranty of minimum normal

earnings for the railroads for 1946.

On the subject of carry-backs and carry-overs under

the tax law, the Bureau of Transport Economies and Sta-

tistics of the Interstate Commerce Commission made some

valuable comments in its June 5, 1944, Monthly Comment

on Transportation Statistics. The Bureau said, in part:

(Page 47)

Excess-profits taxes of class I line-haul railways, year ended Dec. 31, 1944

Region and railway

e e e * e Amount

gg ERIN RON re TE Te $9,829,000

(Page 49)

While under the restraints and disabilities inherent

in control by bankruptcy courts, these railroad systems

have abundantly demonstrated their solvency. They have

overcome their financial difficulties to the point where

the facts of solvency are opposed to the forms of in-

solvency.

(Page 50)

UNPAID INTEREST CHARGES

There was some discussion at the hearings on the

question whether a court has the power to discharge a com-

pany from section 77 proceedings under such circum-

stances. The counsel for the savings banks confirmed the

chairman’s opinion, as follows:

* Report of trustee or trustees.

App. B, p. 15

Mr. Oliver. Mr. Chairman, you are exactly

right in saying that the courts have the inherent

right to dismiss proceedings, and Commissioner

Mahaffie tells me that that has been done in one

case of a small railroad (hearings, p 76). i ee

Reference to one such case was made in the Review

of Railway Operations in 1944 issued by the Bureau of

Railway Economics of the Association of American Rail-

roads (p. 26). The association’s report states:

** * the court discharged the debtor company

from trusteeship on a showing that its improved

financial condition made unnecessary the contin-

uation of such proceedings (p. 2).

(Page 51)

Some companies still in the hands of the courts are

not presently able to pay their past-due interest but could

have done so if their finances had been ordered in the

same manner as if they had not been under court control

in recent years. As a result of the action of the courts,

and of the receivers and trustees appointed by them, funds

which could have been used to pay past-due interest or to

retire principal obligations were employed for surplus

maintenance, or to purchase equipment for cash, or other-

wise for purposes which were in effect the substitutions

for paying off part of all the overdue interest.

In considering whether railroads which are wm the

hands of the Federal bankruptcy courts are now solvent,

one assumes that the bankruptcy courts should have been

desirous of so handling the affairs of these railroads as to

overcome any condition of bankruptcy and to restore them

to a condition of solvency; and it is assumed that to achieve

this desirable end, the bankruptcy courts should have de-

sired to conduct the affairs of the railroads as effectively

as the railroad companies themselves would have done if

they, instead of the bankruptcy courts, had been im control

of thetr properties during recent years.

—

somes. reas 7 a

Following this customary practice of railroad com-

panies, most of the important railroads whose properties

are at present in the hands of the bankruptcy courts, if

the companies had been in control of their own properties,

would by this time have been able to pay all interest they

owe for any past years right up to date. They would have

been able to do even more than this. They would in addi-

tion a large surplus amount of cash which they could

either keep in their treasuries or could have used to pay

and retire their bond issues and pay for some of the addi-

tions and betterments without any new financing what-

ever. This surplus amount which they could have so used

after paving all their interest right up to date aggregated,

on December 31, 1944, for seven important railroads, six

of them still in the control of the Federal bankruptcy

courts, approximately $317,000,000; as of the present time

the aggregate is far greater.

App. B, p. 16

(Page 52)

If these railroad companies had been in charge of

their own properties they could have undoubtedly refund-

ed some of their bond issues at lower interest rates. Had

this been done for the year 1944 alone, by a reduction in

interest rates to the lower level rate (the average interest

rate on bonds floated from January 1, 1944, to June 30,

1945), the surplus amount after paying all interest charges

up to date would have been $24,000,000 more or a total of

$341,000,000. The amount in the cash saving of each of the

above roads for 1 year alone would have been as follows:

* * * * *

Re, ER Be teeta senentersnssnanbtmnNicsraninsesnncawin Dikerinbsch mnAcebiienansenicsinn $3,094,386

Source: ICC table VI-C-8.

The ability of companies now in section 77 proceed-

ings to pay all their overdue interest, if they had been al-

lowed to follow the usual procedure of railroad companies

which are in charge of their own properties, may be further

studied by comparing the amount of matured unpaid inter-

est as of December 31, 1944, with four other items which ap-

pear in the data furnished to this committee by the Inter-

App. B, p. 17

state Commerce Commission. Those items show the amounts

expended by the courts out of the funds of the railroad

companies above listed, for additions and betterments dur-

ing the period of the bankruptcy proceedings, the amounts

similarly paid by the courts to reduce the long-term debt

of the companies, the increase in the net current assets

of the companies during the bankruptcy proceedings, and

the postwar refund of excess-profits taxes payable to these

companies as of December 31, 1944. The aggregate of these

four sums exceeds the total amount of matured unpaid

interest, as of December 31, 1944, by 63 percent.

(Page 53)

(In millions of dollars)

> * . *

St. Louis-San Francisco:

Matured unpaid interest at Dec. 31, 1944...........2-..------eeeeeeceeeeeeeees 96

Amounts expended by the courts during the bankruptcy

proceedings to Dec. 31, 1944..................c.csessscseseeeeeesenenessnensesnnsenenenes 54

Decrease in long-term debt during bankruptcy to Dec. 31, 1944... 34

Net current assets as of Dec. 31, 1944, in excess of net current

assets at close of year preceding bankruptcy..................................-- 24

Postwar refund of excess-profits taxes as of Dec. 31, 1944............. a8

Total of preceding 4 items................................c.cccecseseseesneeeereeenecnsenssensneeses 112

Source: ICC, tables VII and VIII.

Even if the companies in section 77 proceedings would

not have been able to pay all matured interest, their situa-

tion is nevertheless so good that it calls for a business

rather than a court solution. If they were not now in court

hands, it is unlikely that their present condition would lead

their managements or their creditors to go to court for

receivership or section 77 proceedings. Their affairs are in

good shape, their past-due interest is, relatively speaking,

sufficiently within the range of reasonable arrangement,

and their present surplus and prospects for surplus in the

next few years available to meet the remainder of the over-

due interest are sufficiently good. Furthermore, the very

fact, above noted, that bondholders of such companies have

been receiving interest at rates fixed years ago instead of

at the much lower level which the current money market

IEE NOUN A NTT 6 OAR

App. B, p. 18

ealls for, would, if taken into consideration, help consider-

ably in solving the present financial problems of those

roads by ordinary business adjustments rather than by

court proceedings. In the case of such companies, it is fair

to say that their insolvency is what might be called of a

technical nature rather than genuine insolvency.

(Page 54)

The following figures, furnished by the Commission,

demonstrate that in the case of seven major companies

the net current assets (the excess of current assets over

current liabilities) at the end of 1944 were 64 percent of

the interest in default at that time:

(In millions of dollars)

: - * -

St. Louis-San Francisco:

Matured unpaid interest at Dec. 31, 1944 a eterna Ca 96

UR, COIN, I OE e.g ainsi icine 25

Source: ICC, table VII.

A comparison of the amount of matured unpaid in-

terest with the cash on hand (including cash equivalents

in the form of short-term Government paper and the like)

is even more striking. The cash on hand at the end of 1944

exceeded the total amount of matured unpaid interest. The

figures, again in millions of dollars, are as follows:

(In millions of dollars)

+ a a a s

St. Louis-San Francisco:

Matured unpaid interest at Dec. 31, 1944.00... cece cetteeeeeteeeeeeeeeee 96

Cash and cash equivalents on hand at Dec. 31, 1944 40

Source: ICC, table VII.

The foregoing figures though impressive in themselves,

are less striking than will be the figures (still to be gathered

and published) as of the end of 1945. At the end of 1945

the net current assets, the cash on hand, and the income

(Page 55)

available for payment of interest will have greatly in-

creased by reason of the profits of the year 1945. In addi-

=

App. B, p.+19

tion, the net current assets and the cash on hand available

for paying matured unpaid interest will have vastly in-

creased by reason of the provisions of the tax law discussed

elsewhere in this report. Those tax provisions will prob-

ably enable the railroad industry to have net current as-

sets, as well as cash, greater than would otherwise have

been the ease, in the amount of $1,000,000,000, if not more.

Mention has been made of the cash which will be retained

by the companies under the amortization provisions of the

tax laws. In addition, there is the tax-refund provision.

Many of the companies still in the hands of the courts

(as well as many of the other railroad companies) received

from the Federal Government at the end of 1945 large

sums in the form of a refund of 10 percent excess-profits

taxes paid to the United States Treasury during the pres-

ent decade under section 210 of the Internal Revenue Code.

Seven railroad systems in court custody paid, in 1944 (the

year for which the separate figures for each company have

been published), about 14 percent of the industry’s $1,000,-

(00,000 excess-profits taxes.

In brief, the only basic obstacle to the release from

court, without any Commission proceedings or court re-

organization, of various major railroads now in court con-

trol is their unpaid, overdue interest; the companies, if they

could have used their funds, could have paid all this over-

due interest, but the courts and court-appointed trustees,

having control of the companies’ funds, used them in par

for other purposes; in any event, the earnings and the liquid

resources of these companies, together with favorable

money market conditions, would enable them to handle

the problem of overdue interest in a businesslike way—

if they were free from the section 77 proceedings and pro-

cedures which in fact tie their hands.

It is important to avoid the assumption that two quite

different conditions are in fact one and the same. A com-

pany’s temporary inability to pay tnterest charges ts not

synonymous with worthlessness of the company’s stock

App. B, p. 20

which, by definition of the Interstate Commerce Commis-

sion, means that the stock is a nonearner).

SECTION 77 PROCEEDINGS

Subsequent to the enactment of section 77 for railroad

reorganization and the entrance of a number of systems

into court custody under that statute, the theory was de-

veloped that companies in section 77 proceedings require

drastic reorganization; contrast was made with compan-

ies in proceedings under the Chandler and McLaughlin

Acts (eh. XV) which provide for mild reorganization.

Under the latter, stocks are not wiped out, whereas under

the administration of section 77 they are usually wiped

out. Thus, on the surface it might appear that companies

in section 77 proceedings are likely to be insolvent com-

panies, while those under chapter XV are solvent com-

panies.

Testimony at the hearings on S. 1253 indicates that

this is incorrect, and that the assumption is not justified

that companies in section 77 proceedings are inherently

weak and more in need of drastic reorganization than other

companies.

(Page 56)

In those years the statutory procedure was under sec-

tion 77. Chapter XV was not enacted until 1939; thereafter

major roads in need of statutory aid resorted to its pro-

cedure rather than to section 77. The need for such aid

usually arose out of the fact that a company’s bonds were

about to mature, or would mature within a year or two,

in a period when refunding was not available to it. This is

what forced the Baltimore & Ohio to resort to chapter XV;

testimony to this effect was given by the representative

of the insurance companies (hearings on §S. 1253, p 30).

The maturity dates of companies’ bonds, frequently re-

sponsible for decisions, both before and after 1939, to

seek statutory aid, were fixed many years earlier, when

the bonds were created. This coincidence, rather than in-

App. B, p. 21

herent weakness, brought various major roads under sec-

tion 77.

On this the following testimony was given by Mr. Pur-

cell, vice president and general counsel of the Chesa-

peake & Ohio Railway:

Most of the railroad bankruptey reorganization

proceedings have been caused by impending maturi-

ties of one or more bond issues during a period of de-

pressed earnings when railroad credit was inadequate

to permit of their refinancing. I look hack to 1937 when

the Nickel Plate Road was confronted with maturi-

ties of its Lake Erie & Western first mortgage bonds

and Nickel Plate first mortgage bonds. You will re-

eall that 1987 was a good year for railroad earnings.

Fortunately, Nickel Plate was able to refinance. Had

these bonds matured in 1938, a year later when rail-

road earnings were at a low ebb, Nickel Plate would

surely have gone into bankruptcy. Certainly its com-

mon stock, probably its preferred stock, and possibly

its outstanding unsecured notes would have been elim-

inated from any participation in a bankruptey reor-

ganization plan. Yet today the common is selling at

more than 50, the preferred at 130, and the unsecured

notes have been paid in full. What a vast difference

resulted from the pure coincidence that those who

decades ago caused the issuance of these bonds se-

lected a maturity date in 1937 rather than in 1938.

Similarly, we can all thank our lucky stars that

the Pere Marquette, about two-thirds of whose common

stock is owned by Chesapeake & Ohio, was not con-

fronted with maturities during the thirties when its

then outstanding high-interest bonds were selling at

very substantial discounts.

We look back today and are extremely thankful

that those particular bonds, by the rarest coincidence,

PREBLE A LEE OLO

an ra ee ee a te ee

App. B, p. 22

came due in 1937, because the Nickel Plate’s eredit in

1936 and prior years, and in 1938 and subsequent years,

was not such as would have made it possible to re-

finance those obligations in any year during the thir-

ties other than 1937.

(Page 57)

So that the Nickel Plate was saved from bank-

ruptey by the mere happenstance that someone, many

decades before, who had created that bond issue, caused

it to come due in 1937,

The misconception that the roads under section 77

procedure need that procedure, and in this respect are un-

like those which have had the benefit of the milder pro-

cedure of chapter XV, may be studied in the light of data

furnished to this committee by the Interstate Commerce

Commission. These data dispose conclusively of the view

that the former roads are essentially weaker than the lat-

ter or than their financial structures are fatally weak.

We shall consider first the more important of these

two criteria, the ability ef the roads in section 77 procedure

to earn their interest charges, as compared with those which

have proceeded under chapter XV. The number of times

that the annual interest charges are earned is a test not

only of the solvency of a railroad, but of the quality of

(Page 58)

its bonds; State laws apply this test to make sure that

only safe railroad bonds are purchased by insurance com-

panies, savings banks, and trustees for minors and others.

In the testimony before this committee, a vice president

of the Metropolitan Life Insurance Co., speaking in an-

other connection, used this test to indicate the inherent

soundness of the bonds of a temporarily distressed rail-

road company (hearings, p. 30).

The data furnished by the Commission at the request

1

App. B, p. 28

of this committee take a period of 514% years, January 1, f

1940, to June 30, 1945. In that period, the net earnings be- ;

fore interest and Federal income and excess-profits taxes t

were more than enough to pay the interest and taxes of E

those years, both in the case of roads under section 77 and '

those under chapter XV; in fact, the interest charges for }

many more years than those 514 years could have been :

paid out of those earnings. The number of times average

annual interest charges were earned per year during those

5'4 vears by roads which have proceeded under chapter XV

appears in the following table:

ENSURE fin ihe nka yer cs CREO ee ie be eRe RE 2.19

ES SN. Gir bo Wea a ena eS ee oa RRO 2.28

MONO 3 iy 29'c ya Sa kagewemk Maes eos 1.66

pe rer rer rT re serra eer 2.43

LO Peete eee Nee Con eee poe ee 1.95

The comparable figures for major roads under sec- 5

tion 77 proceedings are: f

Chicago, Milwaukee, St. Paul & Pacifie.............. 1.83 t

Chicago, Rock Island & Pacifie.......... ca eeatan von 3.21 ;

Denver & Rio Grande Western. ...........00:eeeeees 2.16 f

Gulf Coast Lines (5 years only)®.........00.0ceeeeee 3.90 i

by | Are Peeper ye Pa ee oe lO

New York, New Haven & Hartford............ pe oo Ee ¢

St. Louis-San Francisco (5 years only)*............ 1.86

St. Louis-Southwestern Railway System............. 6.98

Source: ICC table VI-C-1.

The average for the latter companies is 3.66, for the

former it is 2.52. Thus, both when compared individually

and collectively with the roads under chapter XV_ pro-

cedure, those which went into reorganization under section

77 prior to the enactment of chapter XV show up favorably ;

*Omits first half of 1945,

App. B, p. 24

collectively, they make a 68 percent better showing, on

this all important test.

The data furnished by the Commission, of earnings

per share during this same 514-year period, are as follows:

(Page 59)

The comparable figures for major companies under

section 77 procedure follow:

Earnings per share

.

St. Louis-San Francisco System (5 years only) :*

BIE TIIIIED 5a. ois scaneticnannthndlnsdiaetlonteneieminianiindagniebidpannlinceshhintiie $67.70

Source: ICC table ‘VEC.

Excess profits taxes in 1944—-per share of common stock

. . > . 7

St. Louis-San Francisco System:

ee Sk See Ce oiiikiniricnetnctnicneisiinntninndianamtiien $16.07

Source: ICC table VI-C-1; Monthly Comment, March 7, 1945, p. 3.

(Page 60)

The cereinge per share of common stock are here

given.

In the following list, three of the companies have al-

ready heen reorganized under section 77; the figures are

on the hasis, nat of the new capitalization, but of the

capitalization prior to reorganization, and show the earn-

ings on the shares wiped out under the reorganization plans.

Earnings per share of common stock of major railroads, 1941-44

(1) In Section 77 Proceedings

. . . . .

St. Louis-San Francisco System. sl FR ee

(Page 61)

These figures may be considered on various bases—

company by company, or average of the first 10 compared

with the average of the second 10, or geographicaliy.

Taking the averages, the section 77 roads show an av-

*Omits first half of 1945,

App. B, p. 25

erage of $59.09 per share, the roads not in any court pro-

ceeding show an average of $54.70 per share.

On a geographical basis, we may take the three sec-

tions in which major roads under section 77 proceedings

operate—northwest, southwest, and east and middle west.

These comparisons are important with respect to the

problem raised by forecasts which decree that companies

are insolvent, and that their stock is worthless. The ques-

tion is not whether the stocks of railroads in section 77 pro-

ceedings are worth less than at the time when they were

created, or are worth less than the stock of sound com-

panies which are not in any court or Commission reorgani-

zation proceeding, except as a comparison highlights the

essential solvency of the former companies and that their

shares have earning power and value. When a Govern-

ment decree wipes out the shares of stock of companies in

(Page 62)

section 77 proceedings, the decree is not that the shares are

worth less than those of other companies, but that they are

utterly worthless.

Comparison between the two groups of roads above

listed, those in section 77 and those which are not in any

reorganization, may also be made with respect to the ex-

cess profits they paid per share of common stock.

The comparison is even more revealing when each

group is taken as a whole. For the 10 roads not in reorgani-

zation listed above, the average of excess-profits taxes ac-

crued for 1944 was $23.31 per share of common stock. For

the 10 roads in section 77 proceedings, the average was

$34.35 per share of common stock. The roads in the hands

of the courts thus acerued an average of 46 percent more

excess-profits taxes per share of common stock than the

comparable roads not in court hands.

The share of the section 77 railroads above listed com-

pare favorably with the shares of the strong roads not

in court proceedings both as to net earnings per share

App. B, p. 26

after payment of taxes and deduction of all charges, and

as to earnings per share set aside for excess-profiits taxes,

The figures on excess-profits taxes per share. of com-

mon stock have a special bearing on the question whether

they are likely to have earnings in later years. As the Com-

mission reported to Congress in 1944, ‘‘the net income be-

fore deduction of income and profits taxes deserves at-

tention as indicating the earning power of a railroad with

the evisting rates, fares, expenses, and traffic volume”

(pp. 7-8). Since income taxes have not been greatly re-

duced, and excess-profits taxes have been eliminated, it

may be useful to limit a study of the per-share earnings for

1944 to consideration of the net income actually- earned,

and the excess-profits taxes per share. The figure for the

major roads in the section 77 groups follow: |

(Page 63)

1944 earnings per share of common stock

* . . * ~

St. Louis-San Francisco System:

I UII, I Nc ants ti Sch banssscnnvcsansesececanevtbacors eee et

MrmreU Gree SE GOT Tiana ssc ccc sesetserctsicecen un ARO

Aggregate of earnings set aside for excess-profits taxes,

I re ck ancient sinew 21,28

Source: ICC table VI-C-1; Monthly Comment, June 6, 1945, p. 6.

These figures are large; the earnings of the Companies

would have to drop to a very low point, and wold have

to stay that low, vear in and year out, before One could

say that the common shares of these companies ean have

no earnings at all in future vears.

The data presented above deal only with the. eommon

stocks. Even if there were a certainty that they could earn

nothing in the future, there would still be the question

whether the preferred shares could have no earnings in the

future; obviously, unless it can be demonstrated that the

preferred stock will have no earnings, it may not be as-

sumed that the companies are insolvent. Nine olf the ten

companies in the section 77 list above set out had jpreferred

App. B, p. 27

stock outstanding, and made large earnings per share of

preferred.

The comparisons above presented, with roads which

are not in reorganization proceedings, may be amplified

in one important particular. Those roads paid dividends in

a number of instances for each year of this decade, in other

cases for part of the period. Dividends were not paid dur-

ing the period on the stocks of the roads in section 77

proceedings.

This does not indicate that the one class of roads is

solvent and the other is insolvent, or that the shares of the

one have value, and the shares of the other are valueless.

In chapter XV proceedings, where the stock is saved and

is regarded as valuable and the companies are regarded as

solvent, limitations are placed on the payment of dividends.

Indeed, the fact that for a period of time dividends

were not paid only makes the assets of the companies

larger, and their shares more valuable.

(Page 64)

ADMINISTRATION OF SECTION 77 PROCEEDINGS BY THE

COMMISSION

With exceptions relating to a very small proportion

of the affected railroad stocks, most of the plans of re-

organization issued by the Interstate Commerce Commis-

sion in major cases arising under section 77 proceedings

(Page 65)

have treated the railroad systems under that section as

insolvent. The plans have proposed that the preferred and

common stocks of the companies be wiped out, on the

ground that the companies cannot earn enough in the fu-

ture to provide any yield or income on the stocks.

The issue which the Commission decided in these cases

was not whether there are earnings on the stocks of these

railroads at the present time; the decisions, as will appear

App. B, p. 28

shortly, were made in earlier years. If the issue were,

whether there are present earnings, the answer would be ob-

vious—there are big earnings on stocks—i. e., these stocks

now have a value—i. e., the railroads are not insolvent.

The issue the Commission considered in these cases

was whether the railroads would in the future earn any-

thing on their present stocks. That, in the Commission’s

opinion, was its duty under section 77—to fix, for the com-

panies under that section, a new capitalization based upon

its estimate of the future earnings of those companies.

The performance of such a duty confronted the Com-

mission with a dilemma, which makes clear the injustice

to any agency charged with such a duty. On the one hand,

if estimates of future earnings for purposes of new capital-

ization must be made, it is convenient to incline to the con-

servative if not the ultraconservative side; it is only nat-

ural to err in the direction of underestimating future good

news about earnings, rather than the opposite. On the

other hand, there is much to be said for the investors who

urge that their property should not be foreclosed, that esti-

mates made in 1939 and 1940 that the companies will not

he able to earn anything on their stock have already been

shown to be unduly low, and that in any event it is danger-

ous for anyone, particularly for a Government agency, to

destroy the property and investments of investors stmply

because the Government, no matter how well intentioned,

estimates that at some time in the future there may be no

mcome on those investments; the stockholders ask why

their securities, which are now, and for some years have

been, big money makers, should be now destroyed by Gov-

ernment fiat as presently worthless because a Government

agency estimates that at some time in the future these

securities will not be money makers.

The nature of such forecasting is indicated in one of

the Commission's decisions less than a year ago, when it

said: ‘**Any estimate of future traffie and earnings is, of

necessity, speculative’? (Baltimore & Ohio Railroad Debt

Adjustment, 261 I. C. 51, 81).

App. B, p. 29

What the Interstate Commerce Commission has felt

that it does in making the estimates which are the founda-

tion of its orders to wipe out stockholders was recently

explained by Commissioner Porter, the chairman of its

Finance Division, in testifying on H. R. 4779. The process

is one, to quote his testimony, of ‘‘making intelligent

quesses. For this purpose, we studied the past history that

was before us, we had the testimony of men who were re-

garded as in a position to make the most intelligent guess

as to what the future might hold. And starting from that

complete record up to the minute that it was submitted

to us, we tried to make up our minds as best we could on

that’’ (hearings, December 18, 1945.) The Commissioner

emphasized that the Commission looked to past years, and

(Page 66)

weighed in addition the testimony of men who were regard-

ed as experts in making their prediction as to what the

future might hold.

At the same time that the Commission recognized the

impossibility of making a forecast, it believed itself com-

pelled, under section 77, to make forecasts, and it was at

that very time engaged in proceedings to arrive at fore-

casts. Its forecasts were made in all important cases in

1939 and 1940, as indicated by Commissioner Mahaffie to

the committee considering H. R. 4779. In some of the cases

the plans were later revised, but the capitalization proposed

(Page 67)

by the Commission in 1939 and 1940 was not changed in

most of the larger cases, and if changed in any of them,

the change was minor. The Commission’s estimates of the

long future, on which its proposals of capitalization were

based were, so far as based on actual known earnings, made

in the light-of earnings to the end of 1937, and in a few

eases to the end of 1938 or possibly after looking at pre-

liminary figures for earnings in the first few months of

App. B, p. 30

1939; substantially speaking, when it fixed the capitaliza-

tion in the larger cases, it had before it the actual earn.

ings up to the close of 1938—the time when it frankly ad-

vised Congress of the impossibility of forecasting for the

long future.

The forecasts made in those years, with the resultant

proposals to eliminate 21% billion dollars of securities, and

to decree which security holders should be deprived of their

securities, could not, of course, have the benefit of knowl-

edge of fundamental changes of the near future. The hear-

ings on 8. 1253 treated of this fact, as follows:

The Chairman. Let me ask you this: Of course,

when the Interstate Commerce Commission set forth

their plans, they did not contemplate, or did not think

these railroads were going to have this windfall to

them on account of the war.

Mr. Hagerty. That is right.

Mr. Hagerty. The conditions were quite different

when the Interstate Commerce Commission approved

these plans * * * (hearings, pp. 34, 35).

In responsible quarters other than the Commission

the same difficulty of making such forecasts has been ex-

perienced. Thus, during the war period pessimism about

the future earnings of the railroads was based on various

assumptions about the future. It was assumed that the

railroads would in the future be subjected to a great in-

crease in taxes; this expression was made at a time when

the railroads were subject to 95 per cent excess-profits

tax, the highest in their history. In the very year when

such a future setback of their net income was being envis-

ioned, 47 percent of the total tax bill of the railroads was

due to the excess-profits tax—now eliminated; 21 percent

of their total tax bill was due to the Federal income tax—

now reduced in rate. In the following year these two Fed-

eral taxes were responsible for more than 70 percent of

the railroad industry’s total tax bill. A considerable por-

App. B, p. 31

tion of the balance of their taxes fluctuates, as does the

income tax, with the volume of their business, so that the

larger the amount of such taxes paid by the railroads,

the larger their net income (Statistics of Railways of Class

I, calendar years 1929 and 1936 to 1945, Statistical Sum-

mary No. 29, prepared by Association of American Rail-

roads, October 1945, at sheet 11).

Pessimism, similarly arising out of the inherent dif-

fieulty of prophesying, was based, in quarters outside the

Commission, on the assumption that the years after World

War II would resemble those immediately after World

War J. In the actual event, when World War II came to

an end, it was found that the assumption earlier made was

the exact contrary of the facts—the physical and financial

condition of the railroads today ts extraordinarily good,

compared with their extraordinarily bad condition in 1918

and for some tme thereafter.

Doubts about the future have also been based on the

assumption that there would be a great increase in op-

erating costs—though improvements and constantly in-

creasing efficiency now point in the opposite direction.

(Page 68)

A fourth example may be mentioned. It has been as-

sumed that reduced interest charges in the future sup-

port pessimistic prophecies about the future earnings of

roads whose fixed charges are decreased. Those who make

that assumption state that the less the interest charges,

the less the deductions from gross revenue, for income-tax

purposes, and thus the larger the income tax paid. Such

forecasting overlooks the fact that net income increases as

interest charges decrease, and would regard one of the

greatest blessings that the industry can look forward to,

as a disadvantage.

In short, others who have undertaken to forecast in

this field have had the same experience as the Commission

has had, in discharging the duty of forecasting which it

App. B, p. 32

believes has been imposed on it by Congress. This duty,

as demonstrated by the experience of others besides the

Commission, is one which should not be imposed on a Gov-

ernment agency, when the inevitable consequence of pes-

stmistic forecasts is the destruction of existing property

rights.

The Commission, in its forecasts, sought to be con-

servative (Western Pacific Railroad Company Reorgani-

zation, 230 I. C. C. 61, 87). It is, of course, conservative to

forecast one’s own future income pessimistically rather

than optimistically, when contemplating one’s future ex-

penditures for, say, luxuries. But there would appear to

be some justification for the view of junior security hold-

ers that, if the consequence of one’s forecast is to wipe out

another person’s investments, the forecast which is con-

servative in the eyes of the forecaster is radical in the eyes

of the investor—more than radical; it is destructive of his

property rights.

The soundness of the Commission’s warning to Con-

gress about the impossibility of forecasting future earn-

ings was demonstrated every year after it had issued its

conservative forecasts that the companies would not earn

anything on their stock, with the consequence that the

stocks of those companies must be destroyed. Since the

completion of its forecasts and orders to wipe out the

stocks of the major railroads in section 77, every one of

those railroads has earned large sums on its stock every

year (except two of the companies, which missed out in

1941 and only in that year).

The entire series of forecasts in nine major cases, with

the conclusion that the stocks would have no earnings in

the future and must be destroyed, was completed by 1941;

most of the decisions were made in 1939 and 1940. The dates

follow:

. os . . *

St. Louis-San Francisco.................... July 6, 1940

Source: Hearings on H. R. 2857, p, 197.

App. B, p. 33

The earnings on the stock of these companies, in the

period after this series of forecasts was virtually com-

pleted (i. e., after 1940), were as follows (the figures were

furnished by the Commission in response to the request of

this committee) :

(Page 69)

Earnings on the stock (ordered by the Commission

to be wiped out), Jan. 1, 1941 to

June 30, 1945

St. Louis-San Francisco. ...........00.eeeeeee $36,321,158

Source: ICC table VI-C-1.

These are only the amounts of the recorded income.

The actual income was much larger. All but a small per-

centage of the cost of the wartime installations, though

deducted (for tax purposes) as an expense, was in fact

a capital addition to the property. The figures showing the

total for the nine systems listed abve have not yet been

compiled and published; a rough estimate would assign

15 percent of the total figure for the industry to those

companies (they operated about that percentage of the

raiload mileage; they paid that percentage of the indus-

try’s excess-profits taxes for 1944). On the basis of a total

expenditure of the industry for such installations in the

amount of 114 billion dollars, the unreported earnings on

the stock of the nine systems listed above, with respect

to the single item of amortization, would be approximately

225,000,000.

The actual income on the stock of those companies for

the years since the Commission’s no-earnings forecasts

must also take account of two other items—the refund of

10 percent of excess profits paid and any additions or bet-

terments charged as operating expenses.

It is perhaps not far from the mark to figure that the

actual earnings on the stocks of the nine systems since

App. B, p. 34

the Commission made its forecasts of no earnings on the

stocks are about $750,000,000.

These figures indicate that the valuations made some

years ago require revision, even if reorganizations are still

to be based on valuations, and valuations on forecasts.

When three-quarters of a billion dollars are added to the

assets, which prior to such addition, had been appraised

at a specified amount, that amount must be increased ac-

cordingly. Further, the very basis of the appraisal requires

modification, since it was based on a forecast of no earn-

ings on the stock, and business operations each year there-

after showed actual earnings on the stock.

On the question of changes subsequent to the Com-

mission’s making of an appraisal of value, the chairman of

this committee said at the hearings on S. 1253:

The Chairman. It seems to me that, when condi-

tions have changed to such an extent as T have in-

dicated, that railroad should have and does have the

inherent right to have those changed conditions recog-

nized (hearings, p. 76).

However, doubt has been expressed whether the In-

terstate Commerce Commission has the authority under

the statute to recall a plan of reorganization from the

courts, after it has been certified to them by the Commis-

sion. Doubt has been expressed whether the Commission

may even make representations to the district court to

(Page 70)

which a reorganization plan has been sent, stating that

changed conditions require modification of the plan in the

interest of justice. The Commission has resolved these

doubts against the exercise of such power by it, and, deem-

ing its authority strictly limited in this respect, has not

made necessary revisions of plans, no matter how impera-

tively required in the interest of justice, unless and until

the district courts have themselves found the plans to be

App. B, p. 35

unfair or unsound or have for any other reason returned

them to the Commission.

Such limitations obviously result in large difficulties

and injustices.

District and appellate courts should not be burdened

with proceedings to consider the fairness and soundness

of reorganization plans which the administrative commis-

sion may already know to be out of date. Furthermore, a

plan which is already out of date may nevertheless pass

the scrutiny of the courts because of deference for the

views of the administrative tribunal and out of ignorance

of the fact that members or staff of the Commission realize

that the plan pending in the courts is outmoded, and that

its effectuation would constitute a disregard of important

facts and of important considerations of justice. This is

apparently what happened in one railroad reorganization

which was consummated in 1944, and another in 1945, with

serious injustice to security holders who were wiped out

and with unjust enrichment of other security holders; in

each case a great increase in value of the securities had

taken place between the time of the Commission’s first

conclusion as to capitalization in reorganization, and the

time the district court finally approved that conclusion

and put into effect; these changes had demonstrated that

the holders of the securities wiped out under the plans ac-

tually had a genuine and valuable interest in the railroad

properties and were entitled to participate in the reorgant-

zations; since this fact, ascertainable subsequent to the

Commission’s decision, was disregarded, security holders

were unjustly subjected to forfeiture.

If, however, the Commission should be called upon to

revise its forecasts, it would be confronted by the same

difficulties as before.

Prudence calls for recognition of the wisdom of Com-

missioner Miller’s statement in one of the eases in which

the Commission was discharging the duty imposed on it

by Congress, the duty of making forecasts. The Commis-

;

‘

}

7

:

App. B, p. 36

sioner said: ‘‘We are not omniscient and cannot foresee

the future’’ (Chicago, Rock Island & Pacific Ry. Co. Re-

organization, 242 ICC 298 at 475).

The difficulty experienced by both the Commission

and others who have either been obliged or have ventured

to forecast for the long future, and the hazardous nature

of pessimistic forecasts in particular, are present today in

as full measure as before.

Any agency, governmental or nongovernmental, obliged

to make an estimate of future earnings, must answer many

questions which it is difficult to answer and on which, no

matter how earnest and informed the person or agency

may be, error cannot be eliminated. For example, to what

extent has the higher earning rate of the years 1940-45

affected the estimate which should be made for the years

thereafter? What will be the effect of the carry-back pro-

vis.ons of the present tax law? To what extent will future

earnings be benefited, by reason of recent surplus mainten-

ance, or by reason of current and recent underrecordings

of earnings? What dollars estimate shall be placed on post-

war consumer demands? What will be the effect of the

(Page 71)

elimination of excess-profits taxes? What will be the ef-

fect of the initial reduction just made in income-tax rates,

and what is the likelihood of future reductions?

Above all, what will be the future level of business of

the railroad industry? This is perhaps the most impor-

tant question of all.

It is only natural that forecasting should partake of

the mood of the period in which it is undertaken. This is

true, even in the case of the most expert and disinterested

forecasting. For example, it is interesting to compare the

pessimistic forecasts made at the end of the last decade

with the Commission’s statement to Congress early in the

same decade. In 1931, when the business depression had

run for only 2 years, the Commission stated:

ET rik RES OF Ms ee ne ee

App. B, p. 37

_* * * while the tide may be slow in turning, there

is no more reason for thinking that business will not

improve than there was in 1928 for thinking that de-

pressions were a thing of the past and that the coun-

try had entered an era of permanent prosperity. Too

much weight ought not to be attached, therefore, to

the present discouragement of investors. When rail-

road earnings take a sharp turn upward, as in due

time they will, railroad credit will also rise (annual

report for 1931, p. 115).

Reference has already been made to the statement in

the 1932 report of the Commission on the basis of which

it would appear that the railroads could make as large a

net income as in 1929 if their future volume of business

should be as much as one-half of the volume for the year

1944.

An additional question confronting individuals or

agencies which make estimates of the future earnings of

railroads is discussed in the concurring opinion of United

States Cireuit Judge Phillips in The Denver & Rio Grande

Western R. R. Co. et al. v. Insurance Group Committee

et al., on May 10, 1945, and in testimony received at hear-

ings on H. R. 4779, on December 26, 1945. The opinion of

the presiding judge, and the testimony on the bill, both

raise the question of effect on railroad revenues of a high

national income in the years ahead. As Commissioner

Mahaffie wrote to the House Judiciary subecominittee on

December 18, 1945, such a national income ‘‘ undoubtedly

has some relation to railroad revenues as a whole,’’ though

it cannot be conclusive with respect to the affairs of in-

dividual roads, other facts requiring consideration also.

Judge Phillips called attention to the effect of a greatly

increased postwar railroad traffie on the fortunes of the

road with whose reorganization under section 77 the court

of appeals was then dealing.

This new factor, together with other new factors which

have come to the front in the last 4 or 5 years, after the

Commission initially fixed its presently outstanding pro-

1 RRO GE NI TE ALI EPEC ONE OR ME ANE RY SL,

AEN TRS ER

mee

App. B, p. 38

posals of capitalization, add even greater emphasis to

the pronouncement of the Interstate Commerce Commis-

sion in its annual report to Congress in 1938. The Com-

mission said:

Every reasonable effort should be made to pro-

tect existing security holders, but not where their

securities have clearly lost all value (p. 21).

It is obviously difficult to reach the conclusion that

junior securities of the railroads have clearly lost all value.

To wipe them out is in effect to say, at a time when

these stocks are earning as much as the strongest rail-

roads earned in the most prosperous years, these stocks

must be wiped out because a Government agency, having

(Page 72)

made the most intelligent guess it could, has guessed that

they may not be able to earn anything at any time in the

future.

(Page 73)

EFFECT OF COURT ADMINISTRATION ON THE FINANCIAL

POSITION OF RAILROADS UNDER SECTION 77

An additional difficulty arises out of the fact that for

many policy purposes, court-appointed trustees have re-

placed the managements of companies which are in section

77 proceedings. In important respects the trustees and

the courts decide, by their action or inaction, the extent

of the earning power of those companies and their stocks.

In particular, the courts and the trustees they appointed

decide whether to cut and how much to cut, the interest

charges for which the companies are obligated; the man-

agements of the companies are deprived of this crucial

power. The subject calls for mention of the provision of

section 77 making mandatory the substitution of trustees

for managements.

Section 77 was amended in 1935. One of the amend-

ments required Federal courts to appoint trustees of the

EE

App. B, p. 39

railroad properties of companies under section 77. The

purpose of this provision was to have independent investi-

gation and correction of any abuses prior to the court

proceeding (H. Rep. No. 1283, 74th Cong., Ist sess., Pp. 4).

Such investigations have long since been completed. But

the statutory provision has continued. It has ousted the

managements of the roads up to the present time. Jn the

last few years, and now, active and aggressive manage-

ment was and is critically needed in order to enable the

roads to make the fullest use of present-day opportunities

to reform their financial structures, reduce their indebted-

(Page 74)

ness, and reduce the interest rates of their bonds and their

total interest charges. The Interstate Commerce Commis-

sion has for some years been urging the railroads to take

such action. Railroads not under section 77 have done so;

railroads under section 77 have done so to a very limited

extent, and their managements have been unable to move

at all in securing the very results which the Commission

has wisely and repeatedly urged.

A third difficulty is due to the fact that the sights of

the courts and trustees, as well as of some of the bondholder

groups not injured by the wiping out of the stock, were di-

rected to reorganizations having such consequences. Eyes

were closed to the abundant opportunities of correcting the

financial structures on @ business basis, without such dras-

tic consequences. Business conditions made possible the

accomplishment, by mild procedures, of the major objec-

tive of drastic reorganizations under section 77—the re-

duction of interest charges. Business conditions also made

possible the accomplishment, by resort to business methods,

of the secondary objective of drastic 77 reorganizations—

the reduction of outstanding capitalization, But section 77,

the control of the properties by trustees, and the concen-

tration on drastic reorganizations to the exclusion of solu-

tions made available by business developments have all

stood in the way.

App. B, p. 40

On the subject of business conditions which have laid

the foundation for a reduction of interest charges, the

Commission has frequently spoken and advised action by

the railroads. It will be sufficient to quote briefly from four

recent decisions by the Commission, calling attention to

the developments in the money market. It noted, on July

6. 1945, ‘‘the favorable market conditions now existing”

(L. & N. R. R. Co. Bonds, F. D. 14959). It authorized re-

fundings at reduced interest rates because the railroads

thereby effected ‘‘a saving in interest by taking advantage

of the present low interest rates’? (Arkansas & Memphis

Bridge & Terminal Co. Bonds, F. D. 14918, decided July

30, 1945). It repeated its references to ‘‘present favorable

market conditions’’ (e. g., Union Pacific Railroad Co.

Bonds, F. D. 15035, October 5, 1945; Lehigh & New England

Railroad Co. Bonds, F. D. 15071, October 31, 1945).

A perusal of recent decisions of the Commission shows

that a iarge number of railroads have taken advantage of

those conditions to reduce interest rates and thus total

interest charges. The reduction in total charges is, of

course, due in part to lowered interest rates, and in part

to reductions of debt. The Commission frequently calls

attention to the substantial results achieved, in a business _

way, by taking advantage of present conditions. For ex-

ample, in one of the cases noted above, the Commission

described the success of one large road in reducing its

annual interest charges, over a period of years, by 46 per-

cent (L. & N. Bonds, F. D. 14959). Examples were discussed

at the hearings on S. 1253; Great Northern, partly through

retirement of debt and partly through reduction in inter-

est rates, cut its interest charges more than one-half

(hearings on 8. 1253, p. 9).

Of course, the more powerful and strongest roads have

been availing themselves of the opportunity at hand; by

refunding operations they have reduced the interest they

pay on substantial portions of their debt, the reduction

being in a number of cases as large as 1 percent or 1%

_

App. B, p. 41

percent, and in some instances being even large, one case

late in 1945 showing a reduction of more than 2% percent.

(Page 75)

Rates have been reduced to 3 percent and even less (e. 9.,

G. N. Ry. Bonds, F. D. 15014, September 11, 1945; No. Pac.

Ry. Bonds, F. D. 15028, September 19, 1945; So. Pac. R.

Bonds, F. D. 15020, September 19, 1945; T. € P. Ry. Bonds,

F. D. 14958, July 19, 1945; Un. Pac. Bonds, F. D. 15035,

October 5, 1945; Penn, Ohio & Detroit R. Bonds, F. D. 15063,

October 17, 1945; Western Maryland Ry., F. D. 15080, Oc-

tober 24, 1945; Terminal R. R. Association of St. Louis,

F. D. 15070, October 26, 1945; N. Y. Connecting R., F. D.

15078, October 26, 1945; Leh igh & N. Eng. R. R., F. D. 15071,

October 31, 1945; Maine Central R. R., F. D. 15127, Decem-

ber 14, 1945; C. B. € Q., F. D. 15125, December 19, 1945).

Other companies, of smal! size and not to be classified

in the group which can command the lowest rates in the

money market, have been making comparable progress.

For example, one small road was able to refund notes at

a 214,-percent interest rate (Wichita Falls € Southern R. R.

Co. Notes, F. D. 14954, July 11, 1945). Denver Union Stock

Yards Co. refunded 334-percent obligations and issued an

additional amount all at 3 percent, the entire transaction

being effected with one of the large life-insurance compan-

ies (F. D. 15055, October 5, 1945). Texas City Terminal

Railway refunded an obligation which carried 4-percent

interest charges, with a 10-year installment note carrying

interest charges of 2% percent (F. D. 15135, December

18, 1945).

Railroads which were in difficulties in the 1930's but

escaped section 77 have already made great strides in the

direction of reorganizing their financial affairs in this

major respect. For example, the Missouri-Kansas-Texas

Railroad Co., one of the companies which, though in straits

during the depression, avoided section 77 proceedings, has

been able to benefit by the changed conditions of the money

market. This company has just effected a 2-year bank loan

App. B, p. 42

at 134-percent interest, with the approval of the ICC, and

is going to use the borrowed funds to retire debt on which

it had been paying much higher interest rates (Missouri-

Kansas-Texas Ry. Co. Bonds, F. D. 9660, decided by ICC

December 27, 1945).

Nickel Plate, according to Mr. Pureell, vice president

and general counsel of Chesapeake & Ohio Railway, was

able to cut the debt and interest charges, since it was not

under section 77 procedure. He said:

The Nickel Plate, having escaped bankruptcy, was

able to devote its funds to retirement of its indebted-

ness, and just as soon as earnings permitted, the

Nickel Plate having somewhere in the neighborhood

of 145 million of bonded indebtedness outstanding, set

about to retire that indebtedness. And when it had

brought the debt down to about $100 million through

the application of excess earnings for the purpose, it

was able to refinance its high interest obligations, and

today it has two series of refunding mortgages out-

standing, one carrying 334 percent and the other 31,

pereent (hearings on S. 1253, p. 81).

Similarly, the Interstate Commerce Commission noted

in a recent report that Alleghany Corp., a holding com-

pany, had made excellent use of the opportunities afforded

by money conditions of recent times. First, it reduced the

interest rate on its indebtedness from 5 percent to 314 per-

cent; early in 1945 it arranged a large bank loan for a

period of a number of years at an interest rate of 214 per-

cent. Each borrowing at progressively lower rates, was

used to retire obligations incurred at higher rates of in-

terest (Chesapeake & Ohio Railway Company Purchase,

261 1. C. C. 239, 247).

Even trustees appointed by the courts to control rail-

roads in section 77 proceedings have participated in re-

(Page 76)

funding arrangements which reduced the interest rates

App. B, p. 43

paid by raidroads. This was done, not for the companies

in their control in section 77 proceedings, but for com-

panies controlled by those railroads. Thus, one company

owned by the Missouri Pacific, the St. Louis Southwestern

and the Rock Island, reduced its interest rate on a bond

issue from 5 percent to 234 percent, in a refunding opera-

tion: in the application to the Interstate Commerce Com-

mission to authorize this refunding, the court-appointed

trustees of the three railroads which jointly own the re-

funding company took part; the Commission was informed

that this refunding was undertaken ‘‘in order to effect a

saving in interest by taking advantage of the present low

interest rates’? (Arkansas & Memphis Railway Bridge &

Terminal Company Bonds, F. D. 14918, July 30, 1945).

In another recent case, a large bond issue (over $40,-

000,000) was refunded, reducing the interest coupon from

4 percent for the bulk of it, and from 33¢ percent for the

remainder, to 2% percent. The company which effected

the refunding is owned by 15 railroads, including 5 which

are in control of court-appointed trustees in section 77

proceedings—Missouri Pacifie, St. Louis Southwestern,

Rock Island, St. Louis-San Francisco, and Alton. The 15

proprietary railroads, 10 through their managements and 5

through court-appointed trustees, participated in the ap-

plication to the Commission, and guaranteed the new bonds;

each guaranteed one-sixteenth of the bond issue, except

the trustees of the Missouri Pacific, who in its behalf

guaranteed two-sixteenths (Terminal Railroad Association

of St. Louis Bonds, ¥. D. 15070, Oct. 26, 1945).

In another case, a railroad company owned by the

New Haven Railroad and the Pennsylvania Railroad re-

funded a bond issue of more than $25,000,000, reducing the

interest coupon from 314 percent to 27% percent; the

trustees of the New Haven, appointed by the court in sec-

tion 77 proceedings, joined the Pennsylvania management

in the ease, and both guaranteed the new bond issue (N. Y.

Connecting Railroad Company Bonds, F. D. 15078, Oct.

26, 1945). In another recent case, the reduction in interest

wal Soa a NO I

App. B, p. 44

rates was effected, without a guaranty by the three pro-

prietary roads, one of them the Missouri Pacific, con-

trolled by court-appointed trustees (J'exas City Terminal

Railway Notes, F. D. 15135, Dec. 18, 1945).

With the significant exception of one group of rail-

roads, the railroad industry has been making greater and

greater use of the opportunity at hand in recent years.

By September 30, 1942, the interest rate on over $1,000,-

000,000 of railroad debt had been cut more than 1 percent

(Annual Report of I. C. C., p. 27). The progress since then

has been large. New bonds issued in refunding operations

at reduced rates of interest are likely to be the subject

of further refundings at still lower rates of interest; bonds

issued in such operations during the latter part of 1945 are

already being prepared for further refunding, and the files

of the Commission now contain official notice that this

program is getting under way.

Every railroad which was in a position to do so has

been benefited by the improved money market conditions.

As the Interstate Commerce Commission reported to Con-

gress in 1943, railroads are alive to the opportunity ‘‘to

reduce the burden of fixed charges’’; the opportunity to

refund bond issues ‘‘at lower rates of interest’’ has already

been taken advantage of by—-

(Page 77)

most railroads in a position to do. It is gratifying to

report that more and more railroads in a position to

do so are voluntarily reducing * * * the burden of

fixed interest charges (annual report for 1945, p. 25).

Which railroads are in a position to make use of this

opportunity, and to give this gratification to all who are

interested in the health of the railroad industry? The

managements of those companies which had the good for-

tune to be free from heavy maturities in initial years or for

other reasons were able to avoid the section 77 procedure

have reduced their interest rates. Many companies which

WET PER AT EN LOR AE

App. B, p. 45

were under section 77 equally possess every facility for

naking use of this boon—except that the section 77 proceed-

ings tied their hands. These latter railroads have big cash

surpluses, they are big earners of profits, they operate in an

era in which other earners have reduced their interest rates

to as low as 3 percent or less. As the chairman of this

committee stated at the hearings on S. 1253, companies

in section 77 proceedings have been prevented from getting

“equality with other railroads”’ which have cut their i-

terest rates (hearings, p. 9). They could have worked out

their own reorganizations with their creditors if their man-

agements had heen free to manage their properties and

their financial affairs. Instead, however, some of their

creditors have enjoyed substantial windfalls by reason of

the inability of the managements to proceed with aggres-

sireness and dispatch in reorganizing their financial affairs

ona business basis, by business methods, and without resort

to the assistance or initial participation of Government

agencies. These creditors have been able to receive much

higher interest rates than have been justified by money

conditions of recent years and the present time.

It is not alone while railroad properties have been

in the control of the trustees under section 77 that the

managements of such companies have been unable to make

use of present-day money conditions. Even when the re-

organization machinery of section 77 is used and companies

are reorganized under that procedure, new bonds are

created in the reorganization process, and there ts an op-

portunity to fix the interest rates of the new bonds at

levels appropriate under present-day money conditions,

this is not done. Earlier in this report reference was made

to the case of one railroad (the Chicago & North Western)

in which some $54,000,000 of reorganization bonds were

issued at an interest rate of 4 percent when 3 percent would

have been far more appropriate. The result was that after

the reorganization was completed, the management of the

company had to go into the market and sustain the con-

siderable expense, which was wholly unnecessary, of re-

funding at a 3-percent rate (ICC table IIT).

PORES EN HOT St ATR IN a UMTS Ra ck ELLIE TPT A AS SMELT ELS PRINS AIF. SE ARTA,

App. B, p. 46

So far as some of the creditors are concerned, the wind-

fall they have been receiving at the expense of the com-

panies that are under section 77 and at the expense of their

stockholders is not deemed the only factor worthy of con-

sideration on their part. The representative of the savings

bank and security owners stated in the hearings on S. 1253:

* * * It seems to me it is better for us to take

what the property can produce temporarily, over a

period, than to go through this drastic reorganization

procedure provided by section 77 (p. 71).

Companies in section 77 proceedings have been at a

disadvantage in reducing their debt, as well as their in-

terest rates. Major companies in section 77 proceedings

have, and for several years have had, abundant funds for

(Page 78)

retiring debt. The Commission has urged all railroads to

use their excess funds for such purposes. The Commission

has indicated that one method is by purchasing of outstand-

ing bonds, on the bond market, at prices often below and

even far below par, with large savings to the railroad

companies (ICC Annual Report to Congress for 1943, p.

29). This opportunity was especially useful for companies

in need of reorganization, since their bonds were particu-

larly depressed in price.

Striking proof of the value of the method urged by the

Interstate Commerce Commission is to be found in the

data it furnished at the request of this committee. Three

important railroads which achieved reorganization under

the mild procedure of the Chandler and McLaughlin Acts

have had marked success in buying their own bonds prior

to maturity, at substantial discounts.

(Page 79)

Our committee asked for similar data with respect to

a number of roads in section 77 and equity-receivership

procedure. For each of the following 11 roads, the Com-

—_ AO NAAR EER SLO NRE TENS

App. B, p. 47

mission’s answer under the heading ‘‘ Amount of bonds

purchased”’ was ‘None.

These roads were in a position to save far more than

were the roads which went through the chapter XV_ pro-

cedure, and the roads which did not go into court or Com-

mission reorganization at all. The bonds of the companies

which were under section 77 or in equity receivership were

selling at far lower prices than the bonds of the other com-

panies; and, in addition, the bonds of the former carried a

number of matured, unpaid interest coupons which would

be included in the price paid; for example, a company not

undergoing court reorganization would buy for $485, as did

the Baltimore & Ohio, simply a $1,000 bond, without any

unpaid, matured coupons attached to it. But a road in

section 77 proceedings would buy, for the purchase price,

not only the $1,000 bond, but also a number of attached

matured, unpaid coupons, which might amount to $250 or

¢500 more. Thus the saving for the roads in section 77 pro-

ceedings and in equity receiverships would be greater than

in the case of the other roads, both because the market

price was lower and because the purchase included ma-

tured, unpaid interest coupons.

In some instances the courts have ordered the use of

surplus cash of railroad companies in their control to

pay off entire bond issues, or to make part payment of

bond issues, at 100 cents on the dollar. The trustees did

not use the surplus cash of the railroads to buy those bonds

in the market at less than 100 cents on the dollar, or to call

for tenders by bondholders. The result was that purchasers

of the bonds at less than 100 cents on the dollar, at a time

when the excess funds of the railroad companies enabled

the trustees themselves to make such purchases at less

than par, were able to turn in their bonds to the trustees

shortly afterward at 100 cents on the dollar. Several ex-

amples will serve to illustrate how the roads lost money

in this way.

ine tte. PAPE IAL I DELON RE PLS TEAR OL DRG 2 It ate TEES IED

App. B, p. 48

In October 1942 the trustees of St. Louis-San Francisco

Railway Co. petitioned the court which had appointed them,

to authorize them to pay in full, at 100 cents on the dollar,

mortgage bond issues on one of the divisions of this road

(the Kansas City, Memphis & Birmingham Railroad Co.

general and income bonds). The court gave the authority

to pay about $6,500,000 of these bonds, and they were paid

in November 1942 (ICC table VI-C-4 (1). Previously, in

1941, the bonds were the subject of trading on the Boston

Stock Exchange at prices ranging, for the general bonds,

from a low of 80 to a high of 874, and for the income

bonds, from a low of 74 to a high of 85. In 1942, to July 1,

the prices were a low of 83 and a high of 88 for the gen-

(Page 80)

eral bonds and a low of 18% to a high of 85 for the in-

come bonds (Moody’s Railroad Manual for 1942). Pur-

chasers who acquired these bonds in 1941 and 1942, when

the railroad had sufficient money to enable the trustees

to buy for it at those prices on the Boston Stock Exchange

and in the bond market outside that exchange, were able in

November 1942 to collect 100 cents on the dollar from the

trustees. Neither the company nor its management had

the power or liberty to use the funds of this railroad to buy

the bonds on the market, and apparently the trustees ap-

pointed by the court did not think they were ina position

to take such action.

(Page 82)

VI-C-5). For each of the years 1941 to 1945, inclusive,

data are presented with respect to bond issues of highest

mortgage rank now outstanding in the amount of $10,000,-

000 or over, and listed on the New York Stock Exchange;

figures were compiled showing the total of trading on that

exchange in each of the issues for each year, and the high

and low prices of each year (undeposited bonds and certifi-

RL TP RN A PENRO BLE WR LOD TONE LEE BIOL LE AAI

App. B, p. 49

cates of deposit for bonds are combined as one). Including

over-the-counter sales, the volume was, of course, far

greater than the figures here given.

(Page 83)

ad ° * * * Face or par

Sr. Lours-SAN FRANCISCO amount sold

Kansas City, Fort Scott & Excess-cash on New

Memphis refunding 4-per- at end York Stock High Low

cent bonds of 1936 of year Exchange price price

it. a Mee) ements & $10,959,727 $5,251,000 49% 32

FOOD... ccncccscapesconscassoenssenavesedensees : 12,952,445 9,717,000 691% 37%

FOES ccs cicnccccsscaissecssesecseseersacnonensess 13,897,429 10,193,000 91 61

FOEE cccinnccasoraccsccesssscccsnsonsssnnsaserse2- 15,454,650 5,291,000 90% 71%

eae CSE! a ea sida 5,412,000 9316 78

The prices at which purchasers bid up these bonds in

1945, and the volume of purchases at such prices, indicate

that the opportunity is no longer available to the companies

to purchase these bonds on the market or by eall for tenders,

with savings of the size available heretofore. It is evident

that investors now regard these bonds as prime invest-

ments: there can be little or no doubt that bonds of this

rank could be floated by the companies in the ordinary fi-

nancial channels. These facts constitute a tribute to the

soundness of the companies; ordinarily, as experts in this

financial field testified in the hearings on S. 1253, the

credit of companies in section 77 proceedings ts impaired,

and the prices of their bonds are considerably below their

true value (pp. 70, 116).

Though the earlier opportunity to purchase bonds of

topmost rank at the large discounts obtainable in prior

years has now been lost, the companies in section 77 pro-

ceedings can still reduce debt and effect substantial sav-

ings in so doing. Their second mortgage and similar bonds

are still selling at less than par, even though the interest

charges on these categories of bonds have been earned for

a number of years—as already noted, the interest charges

were earned two or more times per year, by many of the

major companies, for the past 5 years.

Se Os,

OMT EIS AE

RENIN ONE PM PENT

rss

4

i

é

3

¥

[

App. B, p. 50

Investors will undoubtedly continue to purchase these

bonds in large quantities, and at substantial discounts from

their par or face amount; this is demonstrated by figures

we here cite. The question which remains is whether the

companies will be permitted to avail themselves of this op-

portunity, or will be deprived, as heretofore, of the right

to reduce their indebtedness and to correct their financial

position, by this method.

(Page 85)

Face amount

of bonds sold

Face amount on New York

Fg aL ° of bonds Stock High Low

Sr. Louts-San Francisco outstanding Exchange price price

(1) Prior-lien 4-percent and

5-percent bonds of 1950. $117,448,597 00

ee ecenaneshaneintnsenenmeviien seinnmnentisesinnmn $26,625,000 16% 8%

Sa rteienapibcsiicries. inasntneniintaindnn 45,882,000 25% 10%

eg TN pinetniianiinpeinhinin 69,804,000 41% 18%

ee ecateitctiininnnniemiints enainmmnnanninnannan 64,585,000 54 32%

BaP ictinacnansscienienninnaiins ssnansenmnesnansone 61,489,000 71% 48

(2) Consolidated 4%-per-

cent bonds of 1978 ....... ae winnie wane ade

ey etsicmicindicwiieccnsedansinin: sanbsnnsniinnsannaaiin 33,328,000 16% 9%

Sn eee 46,426,000 23% 11%

1943. 72,809,000 39% 19%

ee icekacneaensensnmnnannininentss <innissinnieinmnentes 58,237,000 40% 2844

So crnsersisinccisateininantntnings sensi 55,936,000 51% 36%

Rarely, if ever, in the history of the railroad industry

has there been so valuable a conjunction of cireumstances—

low prices for buying in a company’s bonds and large

amounts of cash available for such purchases. Rarely, if

ever, has so invaluable an opportunity been lost, as it has

been lost, year after year, to the disadvantage of railroad

companies, helpless in the section 77 strait-jacket which had

been devised for other times and other needs.

The trustees in control of their affairs have not, of

course, had the same incentive as their managements and

owners to use the opportunity so constantly at hand. While

the trustees have listened to the views of interested security

App. B, p. 51

holders, they have given a greater degree of deference to

the spokesmen for bond interests than to the spokesmen for

the companies and thus of the industry.

The same may be said of a comparable method of re-

ducing debt by the expenditure of smaller amounts than the

principal and accrued interest of bonds outstanding—a

public call for tenders. This can be done during chapter

XV proceedings and would be available during S. 1253 pro-

ceedings; it is also available to companies which, like the

Nickel Plate, proceeded without assistance of statutory

aids.

Another method of reducing debt, that of paying prin-

cipal and all unpaid coupons, is available under all the pro-

cedures, statutory and nonstatutory. It has been used

by court-appointed trustees in the section 77 proceedings ;

as noted earlier in this report, the use has been a hesitant

and unduly limited one, with the consequent piling up, for

vears, of additional interest charges on bonds which could

have been, but have not been, retired. This unnecessary

burden on the companies and thus on the railroad industry

was criticized at the hearings on S. 1253 (pp. 9, 13, 75, 103-

104).

(Page 86)

The third obstacle earlier mentioned, the assumption

that companies in section 77 proceedings cannot correct

their affairs, in whole or in part, by using their cash pru-

dently to reduce debt and cut interest rates, should of

course be removed.

In the long run, it will be helpful if the finances of these

companies can be restored promptly under mild procedure,

in accordance with business methods, and on the basis of

present-day money conditions and of the cash surpluses of

the companies.

In order to enable the companies to proceed with the

utmost dispatch in reducing their interest charges and their

4

outstanding debt, it is necessary to unshackle their manage-

ments.

App. B, p. 52

(Page 87)

CHANGES APPROPRIATE IN ADMINISTRATION OF RAILROADS

IN HANDS OF COURTS

(1) One of the most important changes which should

be made is the discharge from trusteeship or receivership of

those companies which are able to pay their overdue inter-

est, without court reorganization of their financial strue-

tures. To this end the courts and their trustees and re-

ceivers should bend their efforts, as would a company not

in the hands of the courts. The advantage would be one

both for bondholders and stockholders. Bondholders who

are now being offered reorganization securities and are be-

ing asked to agree to substantial changes in their contrac-

tual right to receive income on their bonds currently are

entitled to retain those rights, with the exception of the

change in the rate of interest which money conditions and

the money market necessitate.

(Page 88)

(5) The administration of reorganization can range

from the drastic to the mild. Jt can be geared to changed

conditions —and the changes in the affairs of companies

still in the hands of the courts today present a very differ-

ent reorganization problem from that in the 1930’s. In

consequence, the very approach made to that problem in the

years prior to the vast changes in the affairs of the com-

panies during this decade is today outmoded. The com-

panies themselves, by playing a larger and indeed the lead-

ing role, can bring about just results for both creditors and

stockholders. For solving their financial problems, the

companies possess opportunities they did not have until the

last 5 years and today have in greater abundance than at

any time in the abundant 1940's.

The opportunity to bring about reductions in interest

rates is something new in their affairs; it is a substitute for

+

drastic reorganization. The possession of large funds to re-

duce debt, and thus to eliminate interest charges on the debt

retired, and to provide the basis for still further reduction

of the interest rates on the balance of the debt, is of course

of inestimable importance. The reduction in debt and inter-

est charges, the record of high earnings, the easing of fi-

nancial difficulties, the conversion of what seemed in the

1930’s to be a mountainous task into one that is now rela-

tively simple of adjustment between creditors and stock-

holders—all these indicate the desirability of substituting a

business approach for the governmental approach, and the

methods of business adjustment for the methods of fore-

casting. This practical method, in place of the speculative

approach, will result in basic financial reorganizations of

large magnitude.

App. B, p. 53

Just as at the time of the enactment of section 77, so

when the pattern of reorganization method and reorganiza-

tion plan was set in the 1930’s by Government agencies

and security holders, present-day money market conditions,

interest rates, and cash positions of the companies had not

been foreseen. These basic changes require basic changes

in the part Government plays in the recasting of the fi-

nances of the companies, as well as changes in the spirit and

viewpoint of Government authorities when they deal with

this subject.

Above all, means can and should be devised to bridge

the chasm between Commission and courts. The latter,

together with the court-appointed trustees, can, as has

been noted, advance or defeat the use by the companies of

their present unparalleled opportunities to solve their re-

maining financial difficulties. At the same time, in a sep-

arate compartment, the Commission is forced to operate

on reorganization matters, virtually in a vacuum; so long

as the courts and the trustees slow up and virtually defeat

the reorganization which any competent management in

possession of its own properties could effect, the Com-

mission is put in a position where, if it has to prepare re-

App. B, p. 54

organization plans it is dealing with a situation which disre-

gards present-day realities. The courts and their trustees,

on the other hand, take the view that reorganization is not

to be initiated by them, but by the Commission—although

nothing in the statue forbids court or trustee action to al-

leviate and improve the financial affairs of the railroads,

even to the point of enabling solvent railroads to secure dis-

charge from court without any need for the Commission’s

operation of the reorganization machinery created by sec-

tion 77.

(Page 89)

The court-appointed trustees are under the obligation

to conduct the business affairs of the roads in such manner

as to vield the largest income consistent with adequate pro-

vision of transportation service to the public. In the course

of so doing, the cash resources may become sufficient to

enable a company to pay its unpaid interest obligations and

to be discharged from court, without any reorganization

at all, and thus without effectuating any plan prepared by

the Commission under the provisions of section 77.

Similarly, the trustees should so order the affairs of

these roads that they may be reorganized on a business

basis, as fully as if the managements had been in control of

their properties, without the custody of any court or trus-

tee. Even if this did not result in wholly solving the prob-

lem of matured unpaid interest, it should be solved in part,

as fully as possible. The remaining task for the Commis-

sion then becomes a relatively minor and mild one.

In dealing with such matters, the trustees need the

advice of the interested security holders. Their viewpoints

and their interests diverge. The bondholders should re-

ceive payment of overdue interest, with appropriate re-

ductions to conform to money-market conditions; insofar

as payment is not presently made in full, protection for pay-

ment of the balance should be provided—this is the accepted

EEE

App. B, p. 55

and practiced method for solving such problems, as is

shown by the experience in the major cases under the Chan-

dler and McLaughlin Acts. Section 77 is broad enough for

the purpose.

The adoption, in the respects mentioned, of a changed

attitude and a changed approach will give the bondholders

their due. But it will put a stop to the forfeiture of the

stockholders’ rights and will prevent the transfer of their

property rights without compensation to some of the

bondholders, additional to the principal and interest which

constitute the sole rights the bondholders can claim.

These railroad companies whose properties are still

in the hands of the courts and which cannot presently pay

all past interest, and the security holders of such com-

panies, should endeavor to pursue the same methods, to

bring about the same results, which have been successful

in cases not under section 77—methods not requiring the

assumption of a difficult burden which may be doomed to

failure, the burden of estimating the future earnings of the

railroad companies and more specifically the burden of

estimating those earnings in definite number of dollars. In

consequence, it would seem desirable that the caution which

various groups of security holders as well as the Inter-

state Commerce Commission have at times felt to be neces-

sary should be exercised once again in this field; that the

security holders and the governmental agencies involved

should once more stop, look, and observe the new develop-

ments in the finances and the affairs of the railroad in-

dustry and these railroad companies.

(Page 94)

The original enactment of section 77, the enactment of

the 1935 amendment, and the development of reorganiza-

tion procedures thereunder were effected at a time when

present-day money market conditions, interest rates and

cash positions of the companies had not been foreseen. Now

that it is realized that procedures developed under quite

a

App. B, p. 56

different conditions and for other purposes, in the ad-

ministration of a statute enacted when conditions were

wholly different from those of today, actually serve to de-

feat the very purpose Congress and the railroad interests

had in mind, it is essential that changes be made to meet

the needs and the opportunities of the railroads at the

present time.

ROI FEE Ties ET

—

App. C, p. 1

APPENDIX C

UNITED STATES CIRCUIT COURT OF APPEALS

Eientx Circuit

Nos. 13,105; 13,106; 13,107 St. Louis-San Francisco

Railway Matter, Appeals from the District Court of the

U.S. for the Eastern District of Missouri.

Before GARDNER, THOMAS and RIDDICK, Cir-

cuit Judges.

GARDNER, Circuit Judge, delivered the opinion of

the Court.

There are here three appeals, Nos. 13,105, 13,106 and

13,107, all from an order of the District Court approving

a plan or reorganization for the St. Louis-San Francisco

Railway Company. As these appeals raise substantially

the same questions and were consolidated for purpose of

presentation, they will be considered together. The plan

of reorganization reduced the capitalization of the Rail-

way Company from about $480,000,000.00 to about $247,-

000,000.00 The capitalization as so reduced is less than

the secured bonded indebtedness of the Railway Company

by over $110,000,000.00. The plan provides for the issuance

of new securities to go to the holders of the bonds. The

allocation and apportionment of these securities consist-

ing of first mortgage bonds, second mortgage bonds and

stock, among the secured creditors is not here material

because all the holders of the old bonds have accepted the

new plan. The old bonds were all secured by various mort-

gage liens on the property of the Railway Company. Under

the plan there is nothing apportioned to the unsecured

creditors nor to the stockholders.

The appellants are the Railway Company, represent-

ing its stockholders and unsecured creditors, and Lola

Brooks, Administratrix, and John E. Dikis, Administrator,

who are the owners of claims allowed in the proceedings in

the bankruptey court based upon judgments against the

TN IT EERE BF MAS TO CIE LIE NS Bee — o—_

ie

Railway Company on account of damages for personal in-

juries and death resulting from the negligence of the Rail-

way Company prior to the period of receivership and re-

organization proceedings.

App. C, p. 2

The debtor’s predecessor in interest was incorporated

in 1876 and went into reorganization in 1896. It was again

reorganized in 1916 at which time the debtor was organized

to take over the properties. The capital structure of the

debtor was a matter of adverse criticism by the Interstate

Commerce Commission as early as 1923. By 1932 its eredit

became exhausted, its taxes became delinquent and its fi-

nancial stability precarious. On its application for a Re-

construction Finance Corporation loan in 1932, the Com-

mission held that it was over-capitalized, and as a condition

to authorization of a Reconstruction Finance Corporation

loan the Commission required the debtor to agree to sub-

mit a plan for reduction of fixed charges. Such a plan

was proposed but did not become effective and receivers

were appointed November 1, 1932. On May 16, 1933, the

debtor filed its petition under Section 77 of the Bankruptey

Act. The 1932 plan was ultimately held inadequate to meet

debtor’s needs and thereaftei a new plan was proposed

by three bondholders’ committees. This plan, after wide

investigation and careful consideration by the Commission,

was submitted to the Court for its approval and it is from

the order entered November 16, 1944, approving that plan

that these appeals are prosecuted.

The substantial objection to the plan is that the new

capitalization is too low and that it should have been fixed

at an amount high enough to have satisfied all secured

claims and leave some equity to be allocated to the stock-

holders and unsecured creditors.

In the original brief filed on hebalf of the Railway

Company, its stockholders and unsecured creditors, the

questions at issue are stated substantially as follows: (1)

The Interstate Commerce Commission proceeeded on the

assumption that the rights and interests of the unsecured

creditors and the debtor in debtor’s assets were and are

aad PEIN RIESE RRL Re OE

App. C, p. 3

without value, such an assumption or finding being unfair,

inequitable, arbitrary and without support in the evidence ;

(2) that the burden of debt of the debtor as found or as-

sumed by the Commission was determined by the trial

court without correction and without any allocation of the

proceeds derived from the operation of the property dur-

ing reorganization, and such burden is grossly more than

warranted by the evidence or the applicable law; (3) that

if the earnings during reorganization period be properly

applied and the debtor’s earning power properly con-

sidered, there is no reasonable basis for a finding that

claims of unsecured creditors and the interest of the debtor

are without value.

In support of these contentions it is argued (1) that

it was beyond the power of the Commission to fix the total

new capitalization at an amount less than the total claims

of bondholders, and (2) that the total claims of the bond-

holders must be computed without regard to the interest

that has accumulated on their principal during the long

course of reorganization proceedings. In considering these

issues we must have in mind the province of the court as

distinguished from the province of the Interstate Commerce

Commission, as that question has been determined by con-

trolling decisions.

Ordinarily, the underlying necessity for the reorgan-

ization of a railroad company is that it can not support its

existing capitalization. Under the equity practice there was

no authority vested in the court to change or recapitalize

an overburdened railroad company, nor to pare down se-

cured debts without a sale of the security. With the adop-

tion of Section 77 of the Bankruptey Act, however, the

Interstate Commerce Commission was given the initial

power of determining the new capitalization of a reorgan-

ized railroad. The Act made it possible to eliminate the

foreclosure and sale under mortgages against the railway

property, and conferred upon the reorganization court the

power to determine the value of conflicting claims. The

Act also conferred upon the Interstate Commerce Commis-

App. C, p. 4

sion the duty and power of determining the new capitaliza-

tion. In the determination of this important question it is

necessary to ascertain the prospective earning power of

the Railway Company considered as a going concern.

While jurisdiction of the property of the Railway Company

and its management, maintenance and operation during the

process of reorganization is vested in the court, certain

matters were left to the determination of the Interstate

Commerce Commission, and its determination of those

questions if sustained by substantial evidence and not

violative of legal standards, is conclusive on the courts.

Ecker, et al. v. Western Pacific R. Corp., 318 U. S. 448:

Group of Investors v. Chicago, M. St. P. & P. R. Co., 318

U.S. 523.

Manifestly, if the value of the new securities does not

exceed the amount of the secured claims, then neither the

unsecured claims nor the stockholders can benefit by any

change in the apportionment of the new securities. The

general creditors and stockholders are confessedly junior

in all resepets to the claims of the bondholders. Louisville

Trust Co. v. Louisville, N. A. & C. R. Co., 174 U. S. 674:

Northern Pac. Ry. Co. v. Boyd, 228 U.S. 482; Case et al., v.

Los Angeles Lumber Products Co., 308 U. S. 106. In the

final analysis, the controlling if not the only question pre-

sented by these appeals is whether the action of the Com-

mission in determining the capitalization of the Railway

Company as represented by the new securities, approved

by the tral court, should be set aside in order to bring

about some allocation of the new securities to the general

ereditors and stockholders.

The Supreme Court, in Ecker v. Western Pacific R.

Corp., supra, and Group of Investors v. Chicago, M. St. P.

& P. R. Co., supra, has indicated the relative functions to

be performed by the Commission and the reorganizing

court. In the Eckert case it is said:

“These reorganizations require something more

than contests between adversary interests to pro-

duce plans which are fair and in the public interest.

—

a aan Se

App. C, p. 5

When the public interest, as distinguished from pri-

vate, bulks large in the problem, the solution is large-

ly a function of the legislative and administrative

agencies of government with their facilities and experi-

ence in investigating all aspects of the problem and

apprasing the general interest. Congress outlined the

course reorganization is to follow. It established

standards for administration and placed in the hands

of the Commission the primary responsibility for the f

development of a suitable plan. When examined to

learn the purpose of its enactment, Section 77 mani- ;

fests the intention of Congress to place reorganiza- f

tion under the leadership of the Commission, subject i

to a degree of participation by the court. ¢

rf

‘It is clear from the discussions and the statute

itself that there was recognition by everyone of the

advantages of utilizing the facilities of the Commis-

sion for investigation into the many-sided problems of

transportaton service, finance and public interest in-

volved in even minor railroad reorganizations and

utilizing the Commission’s experience in these fields

for the appraisals of values and the development of a

plan or reorganization, fair to the public, creditors and

stockholders. The resulting legislation was an at-

tempted balance between the power of the Commis-

sion and that of the court.’’

Serta

Again the court said:

‘‘The power of the court does not extend to par-

ticipation in all responsibilities of the Commission.

Valuation is a function limited to the Commission,

without the necessity of approval by the court. * * *

“The function of valuation thus left to the Com-

mission is the determination of the worth of the prop-

erty valued, whether stated in dollars, in securities or

otherwise. One of the primary objects of the bill was

the elimination of obstructive litigation on the issue

of valuation to that position as seemed to the drafts-

App. C, p. 6

men legally possible. Judicial reexamination was not

considered desirable. None of the findings required

of the judge under subsection (e) relate specifically

to valuation. Congress apparently intended to leave

the determination of valuation ‘of any property for

any purpose under this section’ to the Commission.’’

Again it is said:

‘‘Another restriction on court action is that the

determination as to whether the plan is ‘compatible

with the public interest’ rests, as valuation does, with

the Commission. * * *

‘“** * Capitalization is an essential factor bearing

on an efficient transportation system for shipper, in-

vestor and consumer, The development of the capi-

talization of the reorganized company which is ent-

trusted solely to the Commission under the require-

iment that the plan be compatible with the public inter-

est is that relating to the total amount of issuable se-

curities and the quality of the securities to be issued.

So long as legal standards are followed, the judgment

of the Commission on such capitalization is final.’’

(Italics supplied)

Again the court said:

*‘Assuming at this point that the Commission’s

valuation is sound and reached by allowable methods,

a matter discussed later in this opinion at page 477,

we hold that the elimination of the claims of stock-

holders and creditors which are valueless from par-

ticipation in the reorganization is in accordance with

valid provisions of Section 77 (e).’’

In Massachusetts Mutual Lfe Ins. Co. v. Securities &

Exchange Commission, 151 F., 2d 424, we said:

‘*Since there is a ‘rational basis’ in fact for the

finding of the Commission and no ‘clear-cut’ error of

law by either Commission or court, we are not in-

clined to disturb the conclusion * * *,’’

AIRTEL NS EIEN PGRN Ales mE. Det sa

App. C, p. 7

To the same effect see: Archer v. Securities & Ex-

change Commission, 8 Cir., 133 F. 2d 795; Board of Trade

v, United States, 314 U. S. 534.

It is clear that the Commission has the power to limit

total capitalization and its finding on the question of re-

organization value is not subject to review. It is urged,

however, that the Commission arbitrarily assume a value,

and complaint is made that the Commission did not, in

words at least, find or fix the value of the property in-

volved. In view of the very extensive investigation by

the Commission of every element or factor having any con-

ceivable bearing on the question of future earning capacity,

including the condition and nature of the physical prop-

erties, the past earnings record and all circumstances

which bear upon the question of future earnings or value,

it can not reasonably be said that the Commission assume

anything.

The Supreme Court, in Group of Investors v. Milwau-

kee R. Co., supra, speaking of the work of the Commission

as reflected by the record in that case, said:

‘It reviewed freight and total revenues, passenger

revenues and their trend, operating revenues and ex-

penses, and maintenance and efficiency of operation

for various periods ending in 1938. It gave considera-

tion to estimated future taxes, emergency freight

charges, and certain wage factors. It reviewed the

amounts of income available for payment of interest

in each of the years from 1921 to 1938. It considered

the original cost of the properties, the cost of repro-

duction now, the cost of reproduction less deprecia-

tion, and the value for rate making purposes—each of

which was substantially in excess of the capitalization

which it authorized.’’

The investigation made by the Commission in the in-

stant case has been as searching and as thorough as that re-

ferred to in the Milwaukee case. Here, as in the Milwaukee

and Western Pacific cases, the Commission based its de-

snepee PERT St

Seer

PAA oath “OR PR

App. C, p. 8

termination as to the capitalization largely upon the earn-

ing capacity of the railroad, and in the Milwaukee case the

court said:

‘Certainly there is no constitutional reason why

earning power may not be utilized as the criterion for

determining value for reorganization purposes.”’

For reorganization purposes the value depends upon

its earning capacity. ‘* * * * the commercial value of prop-

erty consists in the expectation of income from it * * *,”’

Galveston, H. € 8. A. R. Co. v. Texas, 210 U. S. 217. As

said by the Supreme Court in Consolidated Rock Product

Co. v. DuBois, 312 U. 8. 510,

**The criterion of earning capacity is the essential

one if the enterprise is to be freed from the heavy

hand of past errors, miscaleulations or disaster, and

if the allocation of securities among the various ele-

ments is to be fair and equitable.’’

These authorities dispose of appellants’ contention

that the original cost of reproduction should govern re-

organization value. The determination by the Commission

of the aggregate amount of securities that may be issued

is in effect a finding of total value for reorganization pur-

poses. The Commission, as has already been observed, had

before it and considered every element or factor affecting

value, including the evidence as to the original cost of re-

production of the physical properties. It held extended

hearings at various times between July, 1933, and Febru-

ary, 1944, and a perusal of the record makes apposite

what is said by the court below:

“The extent of the record on these questions is

appalling and it is difficult for the court to under-

stand how anyone could contend that the Commission

has omitted to go into every phase of the debtor’s

existence.”’

The trial court, in referring to the work and findings

of the Commission, further said:

App. C, p. 9

‘*The Commission has * * * gone exhaustively into

the history of the debtor corporation, including the

development of its physical and financial structure

and that of its subsidiaries; into the characteristics of

its properties and their condition and improvements;

into the traffic experience, year by vear, by commodi-

ties and revenue tons carried, and by flow of traffic

over various parts of the system, and by the prospect

for the future; into operating revenues for each year

since 1915 by classes and compared by ratios to the

total in the preceding year; into expenses and oper-

ating ratios since 1915, both maintenance and improve-

ment, and into taxation; into the net earnings avail-

able for interest since the debtor has been in exist-

ence; and elaborately into the elements of physical

value.”’

In the appeals of Brooks and Dikis, the same con-

tentions are urged as in the appeal of the debtor, but they

make some further contentions with reference to the Com-

mission’s findings. It is said that the Commission over-

looked certain wnmortgaged assets, namely, the cash on

hand at the time of the receivership, November 1, 1932, and

the cash thereafter collected by the receivers before the

order segregating income for the benefit of bondholders,

and it is urged that they should share in the cash assets on

a parity with bondholders. As compared with the claims

of bondholders, their claims are so small that their share

would be negligible, if indeed not infinitesimal. The Com-

mission found that the mortgage liens covered the entire

system and that the greater part of the cash at least was

subject to the lien of the various mortgages. Each of the

mortgages covers all income. The trustees under the mort-

gages made proper demand for the income, and the court,

by an order entered March 10, 1933, appointing receivers,

directed the trustees to hold the mortgaged property, in-

cluding the rents, issues and profits thereof. The bank-

ruptey court thereafter confirmed and adopted this order.

The lien of the mortgages related back to the inception of

the proceedings and was entitled to preference over the

App. C, p. 10

competing claims of general creditors. In Mortgage Loan

Co. v. Livingston, 45 F. 2d 28, we said:

“So here, the receiver, while not appointed in

a separate suit instituted by the mortgages, was

functioning on behalf of all creditors with due regard

to priorities of claims and liens on the property of the

bankrupt.’’

See, also: In re Wakey, 7 Cir., 50 F. 2d 869; Central

Hanover Bank & Tr. Co. v. Philadelphia & Reading Goal

& Tron Co., 3 Cir., 99 F. 2d 642.

Any equitable interest which Brooks and Dikis may

assert in the mortgaged property is subject to the payment

of the bonds, as the existence of a junior lien does not un-

settle the rights of the senior claimants. Louisville Tr. Co.

v. Louisville, N. A. & C. R. Co., supra; Case et al v. Los

Angeles Lumber Products Co., supra.

It is also urged by Brooks and Dikis that they were

in fact not general creditors, but entitled to some pref-

erential treatment. True, they may have liens in the states

in which their judgments were entered but these liens are

subject to pre-existing liens and certainly junior to the lien

of the bondholders. It is also urged that they were entitled

to priority of payment under the equity rule allowing pri-

ority to those who furnish material for the operation of a

railroad within a limited time before receivership. Pro-

ceedings to determine that question seem to be pending

and we do not believe a plan of reorganization should

embody an adjudication or classification of individual

claims, and we express no opinion on the question.

Again, it is urged that there are current assets of

the value of $50,000,000.00 which should be available to pay

debts. From the current assets on hand the court ordered

payment of the 1945 interest, and manifestly, the Railway

Company as a going concern can not, even for the purpose

of paying creditors, be left stranded for want of operating

funds. These so-called funds on hand belonged to the Rail-

way Company and while they may tend to enhance some-

App. C, p. 11

what the value of the new stock and bonds, these stocks and

bonds are held by those who have preferred claims and if

the funds could be taken from the company for the purpose

of paying debts they should be applied upon the remaining

unsatisfied preferred claims of the bondholders, so that

no possible benefit could inure to the stockholders or un-

secured creditors. The finding of the Commission as to the

amount due on the preferred claims is challenged and it is

argued that the bondholders were not entitled to interest

from the time of the initiation of the reorganization pro-

ceedings. The argument, however, overlooks the fact that

the property in reorganization was all subject to the mort-

gage liens and these mortgages cover not only the pay-

ment of the principal but also the payment of interest.

Interest on secured claims to the effective date of the

plan is entitled to the same priority as the principal. Con-

solidated Rock Products Co, v. DuBois, supra; Ecker v.

Western Pacific R. Corp., supra; Case v. Los Angeles Lum-

ber Products Co., supra; Louisville Joint Stock Land Bank

v. Radford, 295 U. S. 555; American Iron & Steel Mfg.

Co. v. Seaboard Air Line Railway, 233 U. 8. 261; Group of

Investors v. Milwaukee R. Co., supra. The time as of which

the claims of creditors should be computed was fixed as

January 1, 1944. From that time the interest on the se-

curities will be the new rate, but up to that time it will be

computed on the old securities at the contract rate. This

determination, we think, is reasonable and equitable and

violative of no legal principle.

In a reply brief filed by the debtor subsequent to

oral argument on leave of court, it is suggested that the

decision of this ease be held until it is determined whether

there will be an order of confirmation brought to this court

on appeal, and that such an appeal should be considered

before we decide the issues in the present appeal. We can

see no justification for further delay. We need not here an-

ticipate what questions for review might be presented on

such an appeal further than to observe that Section 77 pro-

vides that when a plan is approved by the Commsision and

App. C, p. 12

the District Court, it shall then be submitted to the se-

curity holders whose interests are of value and are affected

by the plan, and after vote by them it shall come again to

the District Court to be confirmed. If the plan is accepted

by more than two-thirds of those voting in each class to

which submission is required, then the District Court, we

think, will not again consider the merits of the plan. If

the plan has been accepted and the acceptance has been

properly obtained it will then be confirmed. In the instant

case, the plan has already been accepted by more than

two-thirds of those voting in each class to which the sub-

mission was required. Certainly, in those circumstances

there should be no further delay in this proceeding which

has already been pending for more than twelve years.

As the order appealed form is sustained by substantial

evidence and the Commission in reaching its determination

has applied proper standards as declared by controlling de-

cisions of the Supreme Court, it is affirmed.

App. D, p. 1

APPENDIX D

Remarks of Judge Evans of the Seventh Circuit in Rock

Island Reorganization, No. 8930.

JUDGE EVANS: One point which gives me some

anxiety is that in the Supreme Court it was said valuation

was a matter of income, in the St. Paul case didn’t think

that the question of valuation was to be determined by an

appraisal of the property, but by the income.

MR. BROWN: Yes, your Honor.

JUDGE EVANS: That income has changed so radi-

cally from the time that valuation was first fixed that it is

hard to assume that the valuation was correct.

MR. BROWN: Yes, that is perfectly true. But, in the

Milwaukee decision there was some war earnings. But, no

one contends that the Rock Island earnings of the last

three or four years are going to be earnings on which a

permanent plan should be based.

JUDGE EVANS: That might be, but it did show, ap-

parently, and lots of people have rather indicated that

they believe that increased or swollen income will be, in

part, carried on through because of what has taken place

in railroad management, in equipment, and so forth, dur-

ing the last ten years; in other words, valuation based upon

income. While railroad income during the war would be

greater than in peace, probably, that income will be larger

than the amount upon which the original valuation was

based.

MR. BROWN: I don’t think there is anything in the

record in this ease, I am sure there is nothing in the

record in this ease, hearing this appeal on its full merits

and full record upon which this Court could determine

whether the Rock Island earnings for the next three years,

or the next one year, can be expected to continue. The

record that will come to your Honors on this full appeal

will be only historical earnings.

JUDGE EVANS: We may be bound by judicial prece-

App. D, p. 2

dent, which is quite strong in your favor, in the St. Paul

case. But, where they tried to get in was when the plan

went back from the District Court to the Commission and

the Commission says only the questions that caused the

Court not to approve, only those questions will be con-

sidered—in other words, then was the time, probably, if

the Interstate Commerce Commission was desirous of do-

ing complete justice and ascertaining, or checking on it-

self: Did we make the correct finding of the value of this

railroad?—when to our great surprise and to the great

surprise of everybody else, something happened, to wit,

war, and the revenues just doubled. If you start with a

value that is going to be determined on the basis of reve-

nues and something happens that causes revenues to

double, then it comes back—‘‘ Well, how about it?’’ And:

‘*No, we won’t go back of it, we will stick by what we

said.’’ Is that entirely right?

MR. BROWN: If we follow that line of thought, it is

impossible for me to say, or understand how the Rock

Island can be reorganized within less than ten years from

now.

JUDGE EVANS: Maybe so, but there is also the

thought that if it takes ten years to get it right it is pretty

nearly right to do it.

I had quite a little part in the St. Paul Railroad, and it

was always shocking to think that there should be such an

absolute denial of any right for any stockholder, notwith-

standing that money was just rolling into the St. Paul and

the North Western Railroad, but notwithstanding that, it

was decided, ‘‘ You are out.’’ That don’t set very well on

your conscience. If you did it wrong, it is about time you

correct it.

Of course, we don’t want any longer reorganization

of this railroad than is necessary. But, there was quite a

big difference between the first one and the last one, at-

tributable to a difference in revenue, due to, we will say,

primarily to war, but not entirely. There has been a tre-

——

App. D, p. 3

mendous change in operation and management, and so

forth, of railroads. No man can ride on a railroad and not

see it and not have it outlined to him. It is not alone the

convenience and the amount of tons of freight hauled by

one engine, but the cost per mile of hauling is startling. It

has all taken place, it seems to me, in the last ten or fif-

teen years. It is truly remarkable it had to be a period of

depression, and almost a loss of all railroads, that they

should wake up and go after the business as they should ;

have done long before, instead of merely figuring on re-

financing that has been the mistake of the railroads.

MR. BROWN: I am in full agreement with the last

portion of your remarks. My difficulty comes from my be-

lief that this Court was right when it indicated that See-

tion 77 did not contemplate an indefinite nursing receiver-

ship. I don’t believe it contemplates a holding of the rail-

road under the umbrella of the chancellor while we see

whether the next ten years will continue the remarkable

war earnings, or whether we will see something other than

that. You cannot predict future earnings on the earnings

of the Rock Island in the last few years.

JUDGE EVANS: If I remember correctly, Justice

Sutherland wrote the opinion in the Rock Island case, and

we both commented on the delay in these reorganizations,

and we thought about two years ought to be long enough

to reorganize, and it has been twelve years, and we haven’t

got it yet.

MR. BROWN: I think the parties thought so, too.

JUDGE EVANS: I also realize that in ten years [

have never seen such a change in railroad operation and

railroad revenue: I never had my confidence in my judg-

ment of valuation so shaken as it was when the returns

began to come in from railroad operation during the war

period, when previously common and preferred stocks were

wiped out with a sweep of the hand, and in the next year

they made enough so that that stock that was wiped out

could have received 10 cents on the dollar and still have

something left in the treasury.