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Justia › US Law › US Case Law › US Supreme Court › Volume 318 › Group of Investors v. Milwaukee R. Co.
Group of Institutional Investors v.
Chicago, Milwaukee, St. Paul & Pacific Railroad Co.
they were therefore not entitled to participate in the reorganization, was sustained by the reasons and supporting data set forth in the Commission's report on the plan. P. 318 U. S. 536.
(a) The Commission is not required by the Act to formalize in findings the extensive data on which it relied in the exercise of its expert informed judgment. P. 318 U. S. 539.
(b) Nor was the Commission required to make a precise finding as to the value of the company's properties in order to eliminate the old stock from the plan. P. 318 U. S. 539.
(c) A finding as to the precise extent of the deficiency is not material or germane to the finding of "no value" prescribed by § 77(e). P. 318 U. S. 539.
(d) If it is established that there is no reasonable probability that the earning power of the road will be sufficient to pay prior claims of interest and principal and leave some surplus for the service of the stock, then the inclusion of the stock would violate the full priority rule, incorporated in § 77 by the phrase "fair and equitable." P. 318 U. S. 541.
2. The criteria employed by the Commission for determining the permissible capitalization of the reorganized company were in accord with the Act. P. 318 U. S. 539.
(a) Earning power is the primary criterion of value in reorganization proceedings under § 77. P. 318 U. S. 540.
(b) The limited extent to which § 77(e) provides that reproduction cost, original cost, and actual investment may be considered indicates that these factors are relevant, as in § 77B, only so far as they bear on earning power. P. 318 U. S. 541.
3. The evidence of changed circumstances since the Commission's approval of the plan was insufficient to require the District Court to return the plan to the Commission for reconsideration. P. 318 U. S. 543.
Earning power in war years is not a reliable criterion for the indefinite future. P. 318 U. S. 543.
4. The contention that the ratio of debt to stock in the reorganized company results in unfairness to junior interests is unsupported. P. 318 U. S. 544.
(a) The nature of the capital structure, as well as the amount of the capitalization, is for the determination of the Commission in its formulation of a plan which will be "compatible with the public interest." P. 318 U. S. 544.
of the business cycle, are by the Act reserved for the expert judgment of the Commission, which the courts must respect. P. 318 U. S. 545.
5. There is no justification in this case for further delay in effectuating the reorganization. P. 318 U. S. 545.
6. The effective date of a plan of reorganization under § 77 need not be the date of the filing of the petition. P. 318 U. S. 546.
Section 77 does not preclude the accrual of interest on secured claims after the date of the filing of the petition for reorganization.
7. The proposed modifications of the lease of the Terre Haute properties, with the alternative of rejection of the lease in the event of failure of acceptance of the modifications, were valid. P. 318 U. S. 549.
(a) The provisions of § 77 authorize the Commission (and the District Court), in approving a plan of reorganization, to condition acceptance of a lease on terms which are necessary or appropriate to keep the fixed charges within proper limits or to do equity between claims which arise under the lease and other claims against the debtor. P. 318 U. S. 550.
(b) The determination of the Commission and the District Court as to whether a lease should be rejected, or, if not, on what terms it should be accepted, ought not to be set aside upon review, except on a clear showing that the limits of discretion have been exceeded. P. 318 U. S. 551.
(c) The provision of the plan that the Terre Haute lease shall be rejected as of the date the District Court determines that the Terre Haute bondholders have not consented to the making of a new lease at a reduced rental is valid. P. 318 U. S. 551.
(d) In the event of rejection of the lease pursuant to a plan of reorganization, operation subsequent to the commencement of the proceedings and prior to the rejection need not be for the account of the lessor. P. 318 U. S. 552.
(e) When a lease is rejected pursuant to a plan, § 77(c)(6) may not be so applied as to give the lessor or its creditors a disproportionate claim against the estate. P. 318 U. S. 555.
8. The findings and conclusions of the Commission and the District Court with respect to the allocation of new securities to the holders of General Mortgage bonds, were adequate and proper. P. 318 U. S. 555.
(a) That system mortgages should be substituted for divisional ones was a determination which was peculiarly within the province of the Commission to make. P. 318 U. S. 558.
(b) The treatment of the General Mortgage bonds was not inequitable as compared with that accorded the 50-year bonds. P. 318 U. S. 562.
(c) The Commission and the District Court had before them sufficient data from which to determine the allocation of new securities as between holders of the General Mortgage bonds and holders of the 50-year bonds, and it cannot be said that an incorrect rule of law was applied in concluding that the plan was fair and equitable as between these two classes of bondholders. P. 318 U. S. 562.
(d) The determination by the Commission and the District Court that, so far as the holders of the General Mortgage and 50-year bonds were concerned, the requirements of the full priority rule were complied with is supported by the evidence. P. 318 U. S. 563.
(e) The treatment of the General Mortgage bonds, as compared with the Milwaukee & Northern First Mortgage bonds and Consolidated Mortgage bonds, was fair and equitable. P. 318 U. S. 563.
9. In order to give "full compensatory treatment" to senior claimants and to appropriate to the payment of their claims the "full value" of the property, it is not essential that a dollar valuation be made of each old security and of each new security. P. 318 U. S. 564.
(a) A requirement that dollar values be placed on what each security holder surrenders and on what he receives would create an illusion of certainty where none exists, and would place an impracticable burden on the whole reorganization process. P. 318 U. S. 565.
(b) It is sufficient that each security holder, in the order of his priority, receives from that which is available for the satisfaction of his claim the equitable equivalent of the rights surrendered. P. 318 U. S. 565.
(c) Whether, in a given case, senior creditors have been made whole or received "full compensatory treatment" rests in the informed judgment of the Commission and the District Court on consideration of all relevant facts. P. 318 U. S. 566.
10. The provision in the plan of reorganization for an additions and betterments fund was proper. P. 318 U. S. 566.
11. The contention of the General Mortgage bondholders that, by reason of the after-acquired property clause in their mortgage, they have a first lien on so-called "pieces of lines east," the earnings from which were credited by the Commission to the 50-year bonds -- a claim made in both courts below but not determined -- should be resolved by the District Court. P. 318 U. S. 568.
(a) The objection cannot be treated as de minimis. Nor can it be concluded that the objection has been waived, or that the claim is frivolous. P. 318 U. S. 568.
(b) The determination of what assets are subject to the payment of the respective claims has a direct bearing on the fairness of the plan as between two groups of bondholders. P. 318 U. S. 569.
12. Since junior interests are participating in the plan, the Commission and the District Court should determine what the General Mortgage bonds should receive in addition to a face amount of inferior securities equal to the face amount of their old ones, as equitable compensation, qualitative or quantitative, for the loss of their senior rights. P. 318 U. S. 569.
13. The claims of the 50-year bonds as well as those of the General Mortgage bonds require that findings be made in respect of the matters referred to in paragraphs 11 and 12, supra, and final approval of the plan as it affects both groups is dependent thereon. P. 318 U. S. 571.
14. Whether earnings segregation, severance, or contributed traffic studies should be made is for the Commission initially to determine. This Court is unable to say that such studies are indispensable in this case. P. 318 U. S. 572.
15. The Commission's conclusion that no allowance should be made in the plan for interest on the Adjustment bonds subsequent to the date of the filing of the petition was justified. P. 318 U. S. 573.
124 F.2d 754 reversed in part.
Certiorari, 316 U.S. 659, to review the reversal of an order of the District Court, 36 F.Supp. 193, approving a plan formulated in proceedings under § 77 of the Bankruptcy Act for reorganization of the Chicago, Milwaukee, St. Paul & Pacific Railroad Company.
These cases are companion cases to Ecker v. Western Pacific R. Corp., ante, p. 318 U. S. 448, and are here on writs of certiorari to the Circuit Court of Appeals for the Seventh Circuit. They involve numerous questions relating to a plan of reorganization for the Chicago, Milwaukee, St. Paul & Pacific Railroad Co., formulated in proceedings under § 77 of the Bankruptcy Act. 49 Stat. 911, 11 U.S.C. § 205. The plan was approved by the Interstate Commerce Commission (239 I.C.C. 485, 240 I.C.C. 257) and certified to the District Court. After a hearing and the taking of additional evidence, the District Court approved the plan with certain minor modifications not material here. 36 F.Supp. 193. The Circuit Court of Appeals reversed the order of the District Court (124 F.2d 754) on the ground that the Commission did not make the findings required by Consolidated Rock Products Co. v. DuBois, 312 U. S. 510.
which were secured by a first lien on 286 miles of line north of Green Bay and by a second lien on the line south of that place. There is also in this group a $3,000,000 amount outstanding of First Mortgage 5s of Chicago, Milwaukee & Gary Ry. Co., with accrued and unpaid interest of $562,500. They were secured by a first lien on some 80 miles of portions of track around the Chicago district.
In addition, there is $301,000 principal amount of Bellingham Bay & British Columbia Railroad Co. First Mortgage bonds, owned by the debtor and pledged with the Reconstruction Finance Corporation as security for its loans. Furthermore, there are four bond issues of the Chicago, Terre Haute & Southeastern Ry. Co. and its subsidiaries. These are in the principal amount outstanding of $21,929,000, are secured by liens on lines and trackage rights in Indiana and Illinois, and carry either 4% or 5% interest. The debtor operates the lines of the Terre Haute under a 999-year lease executed in 1921 under which the lessee agreed to maintain and replace equipment, pay interest on and the principal of the lessor's bonds, and to pay specified annual expenses. [Footnote 2] The annual rental consists of interest on the Terre Haute bonds, taxes, and the expense of maintaining the corporate existence of the lessor.
unsecured claims and the claims which would then arise under the lease. The plan also calls for the establishment of an additions and betterments fund to which $2,500,000 annually would be paid. This annual charge is placed ahead of contingent interest. It is further provided that the board of directors may set aside certain additional amounts for that fund after the payment of full interest on the Series A General Mortgage bonds and the modified Terre Haute bonds. The plan thus authorizes a capitalization of $548,533,321 for the new company, [Footnote 6] the percentage of debt to total capitalization being 40.8. The annual charges ahead of dividends, including fixed and contingent interest, the mandatory payment to the additions and betterments fund, and the sinking fund, are approximately $12,532,528. When dividends on the new preferred stock are included, the annual charges ahead of dividends on the common stock are about $18,099,920.
Series A and 20% in Series B General Mortgage bonds, and 20% in preferred stock. The same participation was afforded holders of the old General Mortgage bonds. The old 50-year bonds were to receive 15% of their claims in Series B General Mortgage bonds, 60% in preferred stock, and 25% in common stock. The Gary First Mortgage bonds were to receive 75% of the amount of their claims in new preferred stock and 25% in new common. The Convertible Adjustment bonds were allotted 1,749,492 shares of common stock for their claim upon the mortgaged assets of the debtor. The Commission noted that the allotment of stock, taken at $100 a share, would fail to satisfy the claim [Footnote 7] of those bondholders by $55,471,653. For that portion of their claim, the bondholders were permitted to participate with other unsecured creditors in the debtor's free assets. 55,000 shares of common stock were set aside as representing "a fair proportion of the equity of the new company for the unmortgaged assets of the debtor." Of these 55,000 shares, the Convertible Adjustment bondholders were allotted 39,163 shares. Unsecured creditors with claims amounting to $445,162, and the Terre Haute, in case of rejection of the lease, were allotted the balance -- or 15,837 shares. The Commission found that "the equity of the holders of the debtor's preferred stock and its common stock has no value," and that therefore they were not entitled to participation in the plan under the rule of Case v. Los Angeles Lumber Products Co., 308 U. S. 106. See § 77(e).
We need not stop to discuss the respective functions of the Commission and the District Court in respect to plans of reorganization under § 77. That matter has been fully explored in the Western Pacific case, ante, p. 318 U. S. 448. Against the background of the conclusions there reached, we come to the various objections to the plan, pressed on the courts below and renewed here.
Exclusion of the Stockholders. The objections of the debtor and the preferred stockholders are, in the main, that the findings of the Commission are inadequate; that it did not employ proper criteria in determining the capitalization of the new company and in concluding that there was no equity for the stockholders, and that, however proper the findings of the Commission on this phase of the case may have been when made, the earnings in 1940, 1941, and 1942 demonstrate that the earning power of the road exceeds that which the Commission found.
"reasonable margin above fixed charges operates not only to the advantage of the company in times of depressed earnings, but also to the benefit of the holders of contingent interest bonds and to the marketability of all classes of the securities."
"bear a proper relation to total capitalization, and such as to make the payment of contingent interest a probability and of dividends a reasonable prospect, at least on the preferred stock."
"these amounts are compared with the annual interest charges on the principal of the present debt, $23,739,000 a year, it is evident that the earning power of the system since the period of peak earnings (1928-1929) is entirely inadequate to cover the principal of the debt, disregarding more than $118,000,000 of unpaid interest."
"under all pertinent facts and considerations, the probabilities of the property's earning sufficient to pay dividends on any securities that could properly be represented by warrants issued under the plan are too remote to justify provision in the plan for such warrants,"
even though the warrants provided for their exercise on payment of cash.
Commission did exactly that. Its finding that the stock had no value was definite and explicit. To require it to go further and formalize in findings the numerous data on which it relied in the exercise of its expert informed judgment would be to alter the statutory scheme. Apart from the necessity of making a finding for the exclusion of stock or any class of creditors, as provided in § 77(e), the mandate which Congress gave the Commission by § 77(d) is merely to approve a plan "that will, in its opinion, meet with the requirements of subsections (b) and (e) of this section, and will be compatible with the public interest." Reasons which underlie the expert opinion which the Commission expresses on a plan of reorganization under § 77 need not be marshaled and labeled as findings in order to make intelligible the Commission's conclusion or ultimate finding or to make possible the performance on the part of the courts of the functions delegated to them. Here, as in other situations (Colorado v. United States, 271 U. S. 153, 271 U. S. 166-169; United States v. Louisiana, 290 U. S. 70, 290 U. S. 76-77; Florida v. United States, 292 U. S. 1, 292 U. S. 8-9), it is the conclusion or ultimate finding of the Commission, together with its reasons and supporting data, which are essential. Congress has required no more. Nor was it necessary for the Commission to make a precise finding as to the value of the road in order to eliminate the old stock from the plan. A finding as to the precise extent of the deficiency is not material or germane to the finding of "no value" prescribed by § 77(e).
and all other relevant facts. In determining such value, only such effect shall be given to the present cost of reproduction new and less depreciation and original cost of the property, and the actual investment therein, as may be required under the law of the land, in light of its earning power and all other relevant facts."
"criterion of earning capacity is the essential one if the enterprise is to be freed from the heavy hand of past errors, miscalculations, or disaster, and if the allocation of securities among the various claimants is to be fair and equitable."
Commissioner Eastman dissenting, Chicago, M. & St. P. Reorganization, 131 I.C.C. 673, 705. Only "meticulous regard for earning capacity" (Consolidated Rock Products Co. v. DuBois, supra, p. 312 U. S. 525) can afford the old security holders protection against a dilution of their priorities, and can give the new company some safeguards against the scourge of overcapitalization. Disregard of that method of valuation can only bring, as stated by Judge Evans for the court below, "a harvest of barren regrets." 124 F.2d p. 765. Certainly there is no constitutional reason why earning power may not be utilized as the criterion for determining value for reorganization purposes. And it is our view that Congress, when it passed § 77, made earning power the primary criterion. The limited extent to which § 77(e) provides that reproduction cost, original cost, and actual investment may be considered indicates that (apart from doubts concerning constitutional power to disregard them) such other valuations were not deemed relevant under § 77 any more than under § 77B "except as they may indirectly bear on earning capacity." Consolidated Rock Products Co. v. DuBois, supra, p. 312 U. S. 526. In this case, the Commission followed the statute. While it made earning power the primary criterion, it did not disregard the other valuations. It considered them and concluded, in substance, that they afforded no reasonable basis for believing that the probable earning power of the road was greater than what the Commission had found it to be by the use of other standards. The Commission need not do more.
then the inclusion of the stock would violate the full priority rule of Northern Pacific Ry. Co. v. Boyd, 228 U. S. 482 -- a rule of priority incorporated in § 77(e)(1), as in § 77B and Ch. X (Case v. Los Angeles Lumber Products Co., supra; Marine Harbor Properties, Inc. v. Manufacturer's Trust Co., 317 U. S. 78) through the phrase "fair and equitable." A valuation for reorganization purposes based on earning power requires, of course, an appraisal of many factors which cannot be reduced to a fixed formula. It entails a prediction of future events. Hence, "an estimate, as distinguished from mathematical certitude, is all that can be made." Consolidated Rock Products Co. v. DuBois, supra, p. 312 U. S. 526. But, recognizing the possible margin of error in any such prediction, we cannot say that the expert judgment of the Commission was erroneous when made, or that the District Court was not justified in affirming the finding of "no value."
1929, and 1930 were $30,671,000, $29,105,000, and $17,938,000, respectively, those for 1940 were $14,867,000, and, for 1941, $28,939,000. And they point out that the net for 1940 was almost as great as, and the net for 1941 was much in excess of, the estimated $15,894,000 of net earnings for the future normal year to which the Commission referred. They also point to the fact that, while that estimate indicated that 12 1/2% of gross would be left for fixed charges, that percentage for 1940 was 13%, and, for 1941, 20.6%.
"We know from past experience that the upswing in business which war brings is temporary, and likely to be followed by an aftermath in which conditions may be worse than before."
operation and the decrease in water and truck competition. In addition to the increase in tax rates, of which we cannot be unmindful, there is the likely increase of the total tax burden occasioned by the conversion of debt into stock. It is estimated by certain bondholders that, by reason of this fact, a full dividend could not be paid on the new preferred stock, and no dividend could be paid on the new common stock even on the basis of earnings as great as those for 1941. In view of these considerations, we cannot say that the junior interests have carried the burden which they properly have of showing that subsequent events make necessary a rejection of the Commission's plan.
"preservation of the transportation system and the stability of its credit, essential to its preservation, depend not alone upon the ability of individual carriers to meet their obligations, but upon the ability of all to attract the investment of funds in their securities."
"in such an amount that, after due 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."
H.Rep. No. 2177, 77th Cong., 2d Sess., p. 6. No case has been made out for further delay here.
Finally, it is argued on behalf of some of the stockholders that the effective date of a plan promulgated under § 77 must be the date of the filing of the petition, the theory being that § 77 does not permit the accrual of interest after that date. In Consolidated Rock Products Co. v. DuBois, we held that, under § 77B, interest on secured claims accrued to the effective date of the plan was entitled to the same priority as the principal. See 312 U.S. p. 312 U. S. 514, note 4, p. 312 U. S. 527, and cases cited. The definition of the terms "creditors" and "claims" was substantially the same under § 77B(b) as it is under § 77. We see no reason why the same result should not obtain here.
problem solely as one of rejection or affirmance of a lease. The Terre Haute bondholders were, in effect, given the option to take the Terre Haute lines back or to agree to a reduced rental. If the Commission had authority to determine the question of rejection in the manner indicated, and if it complied with the legal requirements for the exercise of that authority, the modifications which it proposed and which the District Court approved are valid. We think they are.
"a distress property controlled by a committee of Chicago bankers who wanted to liquidate and who had written the securities off the books of their banks as losses"
"the earning power of the Terre Haute is sufficient to cover all interest requirements, but this earning power is largely dependent on a continuation of the Milwaukee's coal traffic, together with the commercial coal traffic that accompanies it, and would be greatly diminished if such traffic ceased."
"could not be more than double the amount of the existing Terre Haute bonds, whereas the mileage represented by the general mortgage is about 18 times that of the Terre Haute, and, on the basis of the elements of value . . . for the lines covered by the general mortgage, about 17 times that of the Terre Haute properties."
"the best that we could devise in the public interest and as affording fair and equitable treatment to both the bondholders of the Terre Haute and those of the debtor."
approve that action without more specific findings. Just what findings it thought necessary, we do not know. The Terre Haute interests suggest that the deficiency was in the lack of any finding that the lease was burdensome. And they add that only leases found to be burdensome may be rejected, and that the evidence would not support any such finding, if made.
the issuance of new securities of any character or otherwise."
lease would be unjust from the viewpoint of other creditors. And we could not say that the Commission, exercising its expert judgment, and the District Court, affirming that judgment, were too generous in the offer which is made to the Terre Haute bondholders, or that they should have rejected the lease. We are not warranted in upsetting those determinations on review except on a clear showing that the limits of discretion have been exceeded. We cannot say that here.
"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."
or injury determined in accordance with principles obtaining in equity proceedings" does not "refer to any rule for the measure of damages in equity receiverships." 305 U.S. p. 305 U. S. 503. Furthermore, as we have noted, § 77(b) provides not only that a plan may reject unexpired leases, but also that it "may include any other appropriate provisions not inconsistent with this section." And § 77(b)(1), says that a plan "shall include provisions modifying or altering the rights of creditors generally." For the reasons which we have already stated, these provisions give the Commission and the District Court power to adjust the claims under the lease so as to do equity between the various classes of creditors. Deferment of the date as of which the lease shall be rejected is an appropriate exercise of that power. During the § 77 proceedings, the stipulated annual rental under the lease has been paid. In view of all the facts, no element of injustice to the lessor is apparent by reason of the deferment of the date as of which its damages, if any, will be measured.
at the end of a period to be fixed by the judge, to begin the operation of such line unless the judge, upon the petition of the lessor, shall decree after hearing that it would be impracticable and contrary to the public interest for the lessor to operate the said line, in which event it shall be the duty of the lessee to continue operation on or for the account of the lessor until the abandonment of such line is authorized by the Commission in accordance with the provisions of section 1 of the Interstate Commerce Act as amended."
is fair in comparison with the sacrifices which the other creditors make. The District Court agreed with the Commission that it would be inequitable to give the Terre Haute interests, in the event of a rejection, more than a return of the leased lines, an unsecured creditor's claim for damages, and the stipulated annual rental. We cannot say that that was not a fair equivalent of their claim. Nor can we say that their sacrifices, as compared with the sacrifices being made by the other Milwaukee creditors, are so great that they should receive an additional cash payment from the estate. Sec. 77(c)(6) and the doctrine of relation back are not to be considered separate and apart from the other provisions of the Act. The end product of this reorganization system is supposed to be a fair plan. When a lease is rejected pursuant to a plan, § 77(c)(6), may not be applied so as to give the lessor or its creditors a disproportionate claim against the estate.
General Mortgage Bonds. The objections of the corporate trustee and of a group of these bondholders are that the allocation of new securities under the plan violates their priority rights, that the findings of the Commission are inadequate to sustain that allocation of new securities, and that the additions and betterments fund impairs their priorities.
"Practical adjustments, rather than a rigid formula, are necessary. The method of effecting full compensation for senior claimants will vary from case to case."
Applying these principles here, we are of the view that, except as hereinafter noted, the findings and conclusions of the Commission and the District Court were adequate and proper.
"no means by which the exact present lien position of the general mortgage bonds or the 50-year bonds can be preserved except under a prohibitive mortgage structure."
"of great importance that a completely unified system be created through the reorganization, and that the capital structure be not complicated by numerous mortgages."
Such a determination is peculiarly one for the Commission under § 77. So far as the law is concerned, there is no obstacle to the substitution of system mortgages for divisional ones. We so held in Consolidated Rock Products Co. v. DuBois, supra, pp. 312 U. S. 530-531, indicating that the requirements of feasibility and practicability may often necessitate such a course. The same principles are applicable here.
So the problem for us on this phase of the case is whether, within the framework of the capital structure which has been designed, the allocation of new securities to the General Mortgage bonds was permissible within the rule of the Boyd and the Consolidated Rock Products cases. On this record, that entails primarily a consideration of the treatment accorded the General Mortgage bonds, on the one hand, and the Milwaukee & Northern bonds and the 50-year bonds, on the other.
are to receive 15% of their claims in Series B new General Mortgage bonds, 60% in new preferred stock, and 25% in common stock. If the criterion of earning power be given the weight which we think is necessary under this statutory system, the Milwaukee & Northern First Mortgage bonds are entitled to preferred treatment over the General Mortgage bonds and the Milwaukee & Northern Consolidated Bonds. On the basis of system earnings for 1936, the Commission noted that income available for the Milwaukee & Northern First Mortgage bonds was about three times interest charges, and for the General Mortgage bonds about 1.16. In the case of the Milwaukee & Northern Consolidated Mortgage bonds, the interest for the same period was earned about 1.2 times. Regard for the earning power of those respective units of property led to the preferred treatment of the Milwaukee & Northern First Mortgage bonds, and to the same offer's being made to the General Mortgage bonds as was made to the Milwaukee & Northern Consolidated Mortgage bonds. But the attack of the General Mortgage bonds is directed, in the main, to the participation accorded the 50-year bonds and to the inadequacy, as compared with them, of the treatment given the General Mortgage bonds.
some interest is apparently earned for the 50-year mortgage bonds under the present capital structure, but this reflects system operation, and does not demonstrate any earning power for the western lines."
"on the basis of $10,263,185 of system earnings available for fixed charges, approximately $2,000,000 of net income from the Terre Haute, and a deficit of $500,000 on the lines west."
"goes far toward resolving the doubts as to the accuracy or fairness of the allocation of earnings in favor of the 50-year bonds, without injustice to the general mortgage bonds."
validity, and any attempt at such a separation would, in the end, serve no purpose except to present an apparent certainty in the formulation of the plan which does not exist in fact."
levels. The question in each case is one for the informed discretion of the Commission and the District Court. We cannot say that that discretion has been abused here.
We would have quite a different problem if the District Court had failed to perform the functions which § 77(e) places upon it. But it cannot be said that there was any such failure here. The District Court satisfied itself that the principles of priority as applied to these facts were respected. See 36 F.Supp. pp. 202, 203, 211, 212. Since such a determination rests in the realm of judgment, rather than mathematics, there is an area for disagreement. But we are not performing the functions of the District Court under § 77(e). Our role on review is a limited one. It is not enough to reverse the District Court that we might have appraised the facts somewhat differently. If there is warrant for the action of the District Court, our task on review is at an end.
requires a comparison of the new securities allotted to him with the old securities which he exchanges to determine whether the new are the equitable equivalent of the old. But that determination cannot be made by the use of any mathematical formula. Whether, in a given case, senior creditors have been made whole or received "full compensatory treatment" rests in the informed judgment of the Commission and the District Court on consideration of all relevant facts.
The General Mortgage bondholders attack the additions and betterments fund on the ground that it is unlawful, and results in a dilution of their priority rights. They contend that § 77(b)(4) [Footnote 11] contemplates that the probable future earnings found to be available for fixed charges shall be used to pay those charges; that this provision of the plan reduces by $62,500,000 (the capitalized value of $2,500,000) the amount of new bonds available for the present underlying bonds; that additions and betterments are a capital charge, and that the income of the road pledged to the underlying bonds cannot be diverted for that purpose, at least without some compensating advantage given the underlying bonds; that the fund will enrich the junior interests at the expense of the bondholders; that the expenditures contemplated should be obtained from surplus earnings or from new capital raised under the open end First Mortgage.
betterments have varied in proportion to earnings available for interest. Ordinarily, with a rising trend in traffic and revenues, the carrier would need more or better facilities."
of subsections (b) and (e) of this section, and will be compatible with the public interest." And, in its report, the Commission is directed to "state fully the reasons for its conclusions." We do not see where the Commission failed to meet these requirements. The need for such a fund and its amount involve matters of policy. The determination that a particular fund should be constituted calls for the exercise of an expert informed judgment. The Commission clearly has power to require that such a fund be provided for in a plan of reorganization under § 77, whether or not the payments to it are properly included within the term "fixed charges" as used in § 77(b)(4). For such a fund, like the amount of capitalization and the nature of the capital structure, may be highly relevant to the financial integrity of the company which emerges from reorganization and to stability and efficiency of the transportation system.
net income of $170,100 in 1936. Nor can we conclude that the objection has been waived, or that the claim is frivolous. Here, as in the Consolidated Rock Products case, the "determination of what assets are subject to the payment of the respective claims" (312 U.S. p. 312 U. S. 520) has a direct bearing on the fairness of the plan as between two groups of bondholders. The District Court should resolve the dispute.
"If the value of the road justified the issuance of stock in exchange for old shares, the creditors were entitled to the benefit of that value, whether it was present or prospective, for dividends or only for purposes of control."
228 U.S. p. 228 U. S. 508. We adhere to that view. Unless that principle is respected, there will be serious invasions of the rights of senior claimants to the benefit of junior interests. The property of one group will be subtly appropriated to pay the claims of another while lip service is rendered the principles of priority.
Some argument is advanced that, under this plan, the General Mortgage bondholders do receive as against the junior interests compensatory treatment which is adequate to make up for the seniority rights which they are to surrender. Part of that is said to be in the control which they obtain. It is pointed out that the plan provides for a five-year voting trust in which the several groups of bondholders will be represented; that thereafter the plan protects their control by providing that the new preferred stock (all of which is to be issued to the Milwaukee & Northern Consolidated bonds, the Gary bonds, the General Mortgage bonds, and the 50-year bonds) will be entitled to cumulative to elect a majority of the board of directors during certain periods when full dividends on the preferred have not been paid, and that the exercise of the conversion rights of the Series B new General Mortgage bonds, allotted to these senior bondholders, would result in their acquisition of over 50% of both the preferred and common. It is also argued that compensatory treatment is to be found in the fact that the new General Mortgage bonds have sinking funds, and are cumulative up to three years of interest, and that the new preferred stock is participating.
But neither the Commission nor the District Court considered the problem. As we have indicated, the question whether senior creditors have received "full compensatory treatment" rests in the informed judgment of the Commission and the Court. A decision on that issue involves a consideration of the numerous investment features of the old and new securities and a financial analysis of many factors. Our task is ended if there is evidence to support that informed judgment. We are not equipped to exercise it in the first instance. Nor is it our function. Nor can we conclude that its omission in this instance was harmless. And minorities under § 77, like minorities under other reorganization sections of the Act (Case v. Los Angeles Lumber Products Co., supra, pp. 308 U. S. 114-115, 308 U. S. 128-129) cannot be deprived of the benefits of the statute by reason of a waiver, acquiescence, or approval by the other members of the class. Certainly we cannot say that the inclusion in the new securities to be received by the General Mortgage bonds of features normally common to them are adequate compensation for the lost seniority. Our conclusion on the point is that, since junior interests are participating in the plan, the Commission and the District Court should determine what the General Mortgage bonds should receive in addition to a face amount of inferior securities equal to the face amount of their old ones, as equitable compensation, qualitative or quantitative, for the loss of their senior rights.
50-Year Bonds. The two points just discussed in relation to the General Mortgage bonds are equally applicable to the 50-year bonds. Final approval of the plan as it affects those two issues cannot be made until findings are made on those two matters.
be added in answer to their argument that the data before the Commission as to segregated earnings was too meager to warrant a permanent disruption of liens. They urge that the plan be remitted to the Commission, so that the earning power of the various component parts or mortgage divisions of the road may be determined in light of earnings segregation studies, severance studies, and contributed traffic studies. [Footnote 14] These are highly technical matters. See Meck & Masten, Railroad Leases and Reorganization, 49 Yale L.Journ. pp. 640-647. As stated above, we cannot say that the data as to earning power of the various divisions which was utilized by the Commission was inadequate. The earnings periods to be selected and the methods to be employed in allocating earnings among the various divisions are matters for the informed judgment of the Commission and the District Court. Whether earnings segregation, severance, or contributed traffic studies should be made is for the Commission initially to decide in light of the requirements of a particular case. We cannot say that those studies are so indispensable that they should be required here. Sec. 77(c)(10) provides that the judge "may direct" the debtor or trustees "to keep such records and accounts, in addition to the accounts prescribed by the Commission," as will permit such a segregation and allocation of earnings and expenses. That does not indicate that Congress felt that the suggested studies were always necessary.
kind which have been fully treated in other parts of this opinion, and need not be elaborated. But one point raised by the Adjustment bonds need be mentioned. As we have noted, the interest on these bonds accrued to December 31, 1938, is over $79,000,000. The Commission ruled that, in view of the insufficiency of the mortgaged assets to meet the claims of the Adjustment bonds and the inadequacy of the free assets to satisfy the deficiency, with interest, and the unsecured claims, with interest, no allowance should be made in the plan for interest on these bonds subsequent to the date of the filing of the petition. For reasons we have already stated, the conclusion of the Commission that the mortgaged assets were insufficient to meet the bonded indebtedness was supported by evidence. Since the distribution provided for these bonds on the basis of their mortgage securities is less than the principal amount of their claim, the limitation of their right to share the unmortgaged assets ratably with the unsecured creditors on the basis of principal and interest prior to bankruptcy only is justified under the rule of Ticonic National Bank v. Sprague, 303 U. S. 406.
We have considered all other objections to the plan, and find them without merit. But for the exceptions we have noted, we conclude that the District Court was justified in approving the plan, and that the Circuit Court of Appeals was in error in reversing that judgment. Accordingly, we reverse in part and affirm in part the judgment of the Circuit Court of Appeals, and direct that the cause be remanded to the District Court for proceedings in conformity with this opinion.
MR. JUSTICE JACKSON and MR. JUSTICE RUTLEDGE did not participate in the consideration or decision of these cases.
* Together with No. 12, Group of Institutional Investors et al. v. Union Trust Co. et al.; No. 13, Group of Institutional Investors et al. v. Abrams et al.; No. 14, Group of Institutional Investors et al. v. Orton et al.; No. 15, Group of Institutional Investors et al. v. Guaranty Trust Co. of New York et al.; No. 16, Group of Institutional Investors et al. v. Chicago, Terre Haute & Southeastern Ry. Co. et al.; No. 17, Group of Institutional Investors et al. v. United States Trust Co. of New York, Trustee; No. 18, Group of Institutional Investors et al. v. Trustees of Princeton University et al.; No.19, Group of Institutional Investors et al. v. Glines et al., and No. 32, Reconstruction Finance Corp. v. Chicago, Milwaukee, St. Paul & Pacific Railroad Co. et al., also on writs of certiorari, 316 U.S. 659, to the Circuit Court of Appeals for the Seventh Circuit.
Equipment obligations totalling $33,322,999 and a note of the trustees for $1,184,000 were undisturbed or extended.
The debtor also owns 97% of the stock of the Terre Haute which it acquired by purchase. The stock is entitled to 41,730 votes and the holders of certain Terre Haute bonds are entitled under the terms of the mortgage to 63,360 votes.
The bonds secured by this mortgage are unlimited in authorized principal amount, and, subject to limitations and restrictions specified in the mortgage, may be issued from time to time in different series at various interest rates, etc. as the board of directors and the Commission may approve. In addition to the amount of these bonds issued in the reorganization to security holders, it is contemplated that not exceeding $10,000,000 principal amount of them will be issued in the reorganization to provide for reorganization expenses, working capital, and additions and betterments.
The bonds secured by this mortgage are unlimited in authorized principal amount, and, subject to limitations and restrictions contained in the mortgage, may be issued from time to time in different series at various interest rates, etc., as the board of directors and the Commission may approve. Interest on any new series does not have priority over Series A or Series B. Bonds of Series B are convertible into common stock at the option of the holder at any time at the rate for each $1000 bond, of 10 shares of common stock. Both Series A and Series B are entitled to a sinking fund created by an annual payment out of available net income of an amount equal to 1/2 of 1% of the aggregate principal amount of Series A and Series B bonds authenticated and delivered.
The new preferred and new common stock are authorized in an unlimited amount. Additional amounts are issuable with approval of the Commission. The shares of preferred issuable in the reorganization are Series A. So long as any shares of Series A are outstanding, the consent of at least two-thirds in number of those shares is necessary for the issuance of any additional shares of preferred ranking either as to dividends or as to liquidation, in priority to or on a parity with the shares of Series A. The dividends on Series A of the preferred are noncumulative. B ut no dividends are payable on the common unless there shall have been paid or set apart for payment on the Series A preferred dividends at the rate of 5% per annum for the three consecutive income periods immediately preceding. Series A of the preferred participates with the common to the extent of $1 a share after dividends shall have been paid or set apart for the common at the rate of $3.50 a share. Series A preferred has voting rights and, voting cumulatively as a class, is entitled to elect a majority of the board until full 5% dividends shall have been paid on the Series A for three consecutive calendar years. Thereafter, each share of Series A votes equally with each share of common until full dividends have not been paid during three consecutive calendar years, in which event the Series A again becomes entitled to elect a majority of the board.
Each share of common stock carries one vote. Approximately 514,221 shares are reserved for the conversion of Series B General Mortgage bonds.
The Commission computed the amount of the claim by taking the principal and interest to June 29, 1935, the date of the filing of the petition. That amount was $230,420,853. As we discuss hereafter, it concluded that no allowance should be made in the plan for interest on these bonds subsequent to the date of the filing of the petition in view of the insufficiency of the mortgaged assets to meet the claims and the apparent inadequacy of the free assets to satisfy the deficiency with interest.
"shall have found, and the judge shall have affirmed the finding, . . . that, at the time of the finding, the equity of such class of stockholders has no value."
Respecting the new Ch. XV of the Bankruptcy Act, P.L. 747, 77th Cong., 2d Sess., c. 610, which provides for certain voluntary adjustments of obligations of railroads.
The lien of the 50-year bonds is, of course, subject to the First & Refunding Mortgage bonds all held by the Reconstruction Finance Corporation as security for its loan. But in view of the adequacy of that security, the Circuit Court of Appeals recognized that, as a practical matter, the 50-year bonds were to be considered as having a first lien on the western lines.
"shall provide for fixed charges (including fixed interest on funded debt, interest on unfunded debt, amortization of discount on funded debt, and rent for leased railroads) in such an amount that . . . there shall be adequate coverage of such fixed charges by the probable earnings available for the payment thereof."
Order of June 8, 1942, effective January 1, 1943.
This objection obviously would not run to a participation by junior creditors in unmortgaged assets -- against which, in this case, 55,000 shares of common stock were reserved. Of those, the Adjustment bonds were allotted 39,163 shares. But, as we have noted, the Adjustment bonds were also allotted 1,749,492 shares of new common for their claim upon the mortgaged assets of the debtor.
Although the 50-year bonds and the debtor raised this point before the Commission as early as February, 1938, and the 50-year bonds raised it again when they filed their objections to the plan in the District Court, neither of them attempted to submit any such studies either in the hearings before the Commission or in the hearings before the District Court more than two years later.
This case presents two questions on which I feel compelled to express my views. I have set forth in Ecker v. Western Pacific Railroad Corp., ante, p. 318 U. S. 448, what I consider the respective functions of the Interstate Commerce Commission and the district judge in respect of a plan of reorganization formulated under § 77. It follows from what I there said that I agree with the opinion of the Court except as herein noted.
The two matters as to which I disagree are the provisions of the plan respecting the lease of Chicago, Terre Haute & Southeastern Railway Company and the allocation of securities to the holders of General Mortgage bonds.
nor did it intend to put the Commission in a position of bargaining with such a lessor for a new base.
The plan formulated by the Commission seems to me to be a straddle between these two alternatives. The holders of bonds secured by mortgages on the Terre Haute property are in some aspects treated as if they were mortgage creditors of the debtor. In other aspects, Terre Haute is treated as an arm's length creditor with whom a bargain must be struck. The vice of this seems apparent on this record. Whereas each class of mortgage creditors of the debtor is afforded a participation in the securities and probable earnings of the new company in purported compliance with the rule of the Case and Rock Products decisions, and whereas the Commission recognizes the difference in the nature of the lien and security of the three issues of mortgage bonds of Terre Haute, in the plan, they are all treated alike, and not accorded positions corresponding to their respective liens and priorities. The excuse for this is that the Commission is dealing with a lease and fixing a rental to be paid to an outside lessor. On the other hand, the concept of dealing with a lessor, as I read the record, moved the Commission to propose to the lessor what it thought would be an attractive offer in order to persuade the lessor to accept a new lease. In this aspect, the Commission, as I think, made the bondholders of Terre Haute, treated as a class, a proposition which gives them an inordinately superior position to that accorded the holders of General Mortgage bonds, and produces a serious discrimination against the latter.
I refer to these circumstances merely to reinforce what I have said above to the effect that it is evident Congress did not provide for any such treatment of the rights accruing under an unexpired lease. I am of opinion therefore that, as a matter of law, the plan adopted by the Commission does not conform to the standards set up by § 77 and particularly by subsection (b).
2. Upon the facts set forth in the Commission's report, I think it clear that the award of securities in the new corporation to the holders of General Mortgage bonds does not comply with the rule of absolute priority announced in the Boyd and Rock Products cases. If this is true, the plan violates subsection (e).
and its reasons for its allocation, but I think that, if the district judge had, in this case, exercised the duty which lay upon him, he would have held that there was no substantial foundation for the Commission's treatment of general mortgage bondholders, and would have been bound, therefore, to disapprove the plan. As he did not perform that duty, I think that, unless the right to come to this court is vain, we have the duty to correct his action. I should therefore reverse the decree below.
Sec. 77(c)(2); Palmer v. Webster and Atlas National Bank, 312 U. S. 156, 312 U. S. 163.

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