Opinion ID: 1483191
Heading Depth: 1
Heading Rank: 14

Heading: 2b Rise in Value.

Text: Under this heading we treat the contentions based upon the improved financial condition of Debtor resulting from the large increase in war-time earnings. These conditions have to do mainly with accumulated liquid assets, additions to property, tax refunds, decrease of liabilities and elimination of under-maintenance. The broad contention is that the combined effect of these elements is to show solvency of Debtor and so to raise the valuation by the Commission as to prove existence of an equity for the stockholders and, therefore, as to require remand to it for reconsideration in the light of this improved condition. The matter for consideration is not the direct effect of the increase of earnings, in and of itself, as a basis for estimating prospective earnings and, therefore, as a reason for revaluation (hereinbefore just examined) but it is the existing improved financial status of Debtor. The original report of the Commission stated system investment less depreciation (book value), as of December 31, 1939, to be $114,080,573 to which was added (at book value), as of December 31, 1940, cash and added supplies, investments in affiliated non-system companies and other items which brought the book value up to $122,604,969 as of the end of 1940. A valuation by the Commission's Bureau of Valuation, as of December 31, 1935, gave a reproduction cost less depreciation of $68,523,903 for road and equipment. A supplemental report of the Bureau showed deferred maintenance accumulation of $3,173,500  presumably as of December 31, 1935. As of January 1, 1938, the outstanding system interest bearing loan indebtedness was $70,045,250. [18] Interest was not being paid, except on $20,000,000 First Mortgage bond 4% certificates, $957,000 Equipment obligations, $315,000 Texarkana Union Station 5% trust certificates, $500,000 Gray's Point Terminal Railway 5% bonds, and $450,000 Shreveport Bridge and Terminal 5% bonds. In addition, interest due January 1, 1936, on Second Mortgage 4% certificates, $3,042,500, was authorized by court order February 7, 1941. Also, credits from the marshalling and distributing fund have offset interest on the Railroad Credit Corporation loan of $1,500,000. Thus interest had accumulated unpaid for several years upon $48,323,250 with exception of the one payment (authorized February 7, 1941) on Second Mortgage certificates. $23,882,250 of this indebtedness had fallen due in 1935 or 1936. As of December 31, 1941, the total interest in default was $13,862,823 which had been reduced, by December 31, 1944, to $10,056,493 (as shown by comparative general balance sheet attached to motion of Debtor). The total long term debts were $70,976,937 as of December 31, 1941, and $75,725,439.70 as of December 31, 1944 (as shown on such comparative general balance sheet; and see footnote 19). As of December 31, 1940 (Commission Report), material and supplies were $2,461,493; as of same date 1941, $3,386,233; as of same date 1944, $5,600. Current liabilities had increased from $8,531,344 as of December 31, 1941, to $29,389,478.90 as of December 31, 1944  omitting tax accruals, 1944 would show a decrease in other current liabilities from 1941 of $4,292,664 (as shown by above comparative general balance sheet). At the end of the years 1941 to 1944, inclusive, the cash and the liquid current assets of Debtor (comparative balance sheet) were as follows: 1941 1942 1943 1944 Cash $2,453,907 $ 4,815,634 $ 3,905,452 $1,368,775 Temporary Cash Investments 800,960 10,708,480 24,454,718 30,399,340 Expenditures for maintenance of way and structures and equipment (as shown on income account attached to motion of Debtor) were $7,827,778 for 1941, $8,842,565 for 1942, $11,624,200 for 1943 and $14,152,686 for 1944. The main arguments under this heading are presented by Debtor and by Pacific. While there are some differences in approach and in basic figures used by Debtor and by Pacific, we can dispose of the contention without discussing these differences as they have no vital effect. First, accent is placed upon the solvency of Debtor, as claimed to be shown by the above and related statistics from balance sheets of Debtor and elsewhere. By solvency they mean balance of assets over debts. Solvency in that sense is far from controlling in railway reorganization proceedings. The lack of solvency which justifies initiation of reorganization of railroads is inability to meet debts as they become due. The purpose of such proceedings is to produce a capital structure  as to amount and character  which will warrant continued ability, for a long period, to serve the public properly and to pay debts as they may mature and probably leave something for the new stock. Reconstruction Finance Corporation, et al. v. Denver & R. G. W. R. Co. et al., 66 S.Ct. 1282, In conclusion paragraph; Consolidated Rock Co. v. Du Bois, 312 U.S. 510, 525, 61 S.Ct. 675, 85 L.Ed. 982. The fact that the physical properties, including cash and liquid securities, may have a value beyond the total indebtedness is not controlling either at the beginning or during such reorganization proceedings. The only place for bettered conditions, after formation of a Plan by the Commission, is where such conditions have so altered the situation as to make the Plan inequitable to existing creditors or stockholders (Reconstruction Finance Corporation et al. v. Denver & R. G. W. R. Co. et al., 66 S.Ct. 1282. Solvency in the sense of balance of assets over liabilities has small bearing on such equity. The broad question is, do these changed conditions show such inequity in this Plan? These appellants start with a premise only partially, if at all, sustainable. That premise is that the Commission adopted, as the physical worth of the property, the valuation of $68,523,903 found by its Bureau of Valuation in 1935. That such valuation was one matter considered by the Commission in 1941 and 1942 may be accepted, since the Commission includes the figure in its report and declares therein that it considered all the data of record. However, it is clear that the moving consideration with the Commission was earnings  as it should have been. There is no direct suggestion in either of the reports of the Commission that such physical valuation in 1935 was regarded by the Commission as the physical valuation as of 1941 or 1942. That it did so is highly unlikely because there were many changes therein before the supplemental hearing closed in October, 1941. While the important matter is to what extent has the actual and potential earning power of Debtor been increased by this claimed improvement in physical value, yet it is not clear how much the physical value has been augmented  the balance sheets of Debtor, as of December 31, 1944, show current assets $43,566,776 and current liabilities of $29,389,479 or an asset balance of $14,177,297 which represents the accumulated operating profit for 4 years (1941-1944). That there is a pronounced increase in cash and liquid assets is clear. That the default in interest has been decreased from $13,862,823 in 1941 to $10,056,493 in 1944, or $3,806,330 is shown; but it appears also that the total Long Term Debt has increased, as to principal, comparing January 1, 1938 ($70,045,250) with December 31, 1944 ($75,725,439), or $5,680,189. [19] As to additions to property, all we have are the book figures with no information as to what these additions are or how they may affect earning power. As to tax refunds, appellant Pacific contends there will, according to Debtor's Income Accounts, be $744,073 excess profits tax refund bonds and post-war refund credits of $1,829,478 for 1943 and $2,302,054 which will come back to Debtor at the end of the second, third and fourth years after cessation of hostilities. Recognizing the present worth of such refunds is less than the above, Pacific estimates the total worth, as of January 1, 1945, to be $3,994,408. These appear as deferred assets. As to liabilities it appears that allowed claims plus accrued interest (as of August 31, 1942) were $84,178,418. Debtor argues these had been reduced to $79,990,584 by December 31, 1943, and Pacific figures $78,364,296 as of October 31, 1944. We are not able to verify these last two figures. From the Comparative General Balance Sheet attached to Debtor's motion, it would seem that the October 31, 1944, showing should be $78,831,306. [20] If our method of calculation is correct, the figure for December 31, 1944 (arrived at as in footnote 20), is $79,013,802. At any rate, the nonoperating indebtedness would seem to have been reduced approximately $5,000,000. As to elimination of under-maintenance. In the original report of the Commission it is stated that the supplemental report of the Bureau of Valuation shows that deferred maintenance amounting to $3,173,500 had accumulated. This supplemental report was approximately for December 31, 1935, which was the date for the valuation by the Bureau. At the same time, the Debtor made a survey of deferred maintenance and determined a slightly larger figure ($3,591,027). Colonel Green, Chief Operating Officer for Debtor, testified, before the Court, in October, 1942, that all deferred maintenance had been made up by January 1, 1942, and kept up to the time of his testifying. While a considerable portion of this deferred maintenance had to do with unproductive branch lines which were abandoned between the reports of the Commission and his testimony and although Colonel Green stated that no precise determination was made as to the deferred maintenance arising from these branch lines, yet he does testify that All of the maintenance which had accrued through these improvements and maintenance work which had been accomplished left us, at the end of 1941, with a better railroad than we ever had before, and with the equipment in better shape than it ever was in before, and because of that, we were able to handle the very heavy increase in traffic which we have had to handle since the 1st of January, 1942, and even in 1941. As to this matter the Court stated (53 F.Supp. at 930): the showing of restoration of undermaintenance does not relieve the doubt that the physical condition of the road may be adversely affected by inability to make proper replacements and repairs during wartime  the figures cited give no indication as to whether proper allowance for depreciation and maintenance has been made during recent years. Since routine monthly condition reports were filed by the Trustee sixty days afterward, the Court could have known, when the opinion was prepared, of the report for October, 1943. The total maintenance expenditure for the first ten months of 1943 were $9,014,013  more than for the entire year 1942 by $171,448. For the entire year 1943 and for 1944 the expenditures were $11,624,199 and $14,152,686, respectively. A table showing maintenance from 1930 to 1944, inclusive, is in the footnote. [21] The argument is that the testimony of Colonel Green establishes that deferred maintenance had been entirely overcome by January 1, 1942; that proper maintenance had been continued to the time of testimony (October, 1942); and the substantial increases in maintenance expenditures for all of 1942, for 1943 and for 1944 leave no room for belief that proper maintenance had not continued. There is much plausibility in this argument. However, there are certain known factors  the extent of which are not measured before us  which weaken and make uncertain the force of this position. Our additional industrial activity because of the war in Europe had favorably affected American railroads in 1941, as is shown by the definite  though not extravagant  increase in operating revenues, largely freight, of Debtor. After Pearl Harbor (December 7, 1941), the sudden and tremendous marshalling of our power during 1942 with vastly increasing momentum thereafter made a call upon our railroads almost unbelievable. Over 1941, Debtor's freight revenue sprang from $26,644,830 to $45,192,481 in 1942, $58,968,245 in 1943 and $66,524,757 in 1944. Similarly, passenger revenue increased from $662,443 in 1941 to $2,306,578 in 1942, $3,874,724 in 1943 and $4,339,826 in 1944. That every wheel which would turn was put into service and that equipment which in other times might have been laid by was put into service are things which every one knows. This tremendous burden was suddenly thrust on the carriers and the fact that they carried it is to their lasting credit. These heavy extra demands required as constant full use of all equipment as was possible in a great emergency. Obviously, the extent of use has a direct bearing on the need for maintenance. The measure suggested here is the dollar expenditure. In the Annual Report of the Commission (November 1, 1944) it is stated that: In terms of maintenance work performed, the effectiveness of current dollar expenditures has been substantially reduced by various factors, among which are generally higher costs of labor and materials; the payment of increased wages at overtime rates; the cost of uneconomical repairs to old equipment which must be retained in service because of inability to obtain replacements owing to priorities controls; the reduced efficiency of the maintenance labor resulting from the rapid turn-over and inexperience of the personnel, and the increased traffic density, resulting in greater loss of productive time due to passing trains. While these factors, considered individually, are indeterminate as to the extent of their influence, obviously they have reduced the effectiveness of the current year's expenditure when compared with that of prior years. [22] These factors of capacity usage requiring far beyond ordinary maintenance and of the decreased significance of dollar expenditure for maintenance, make entirely uncertain the effect of the much increased expenditures for 1942-1944, inclusive. As to additions to the property and as to elimination of under-maintenance, we regard the showing as to their existence as too uncertain to be of use in determination of whether the Plan should be remanded to the Commission. As to the existence of the cash and liquid assets, there is no doubt. As to the tax refunds, existence is certain but amount not. As to reduction in indebtedness there is question. As to current liabilities there has been large increase since 1941. As to long term debt, including interest in default and other deferred liabilities (not important comparatively and showing little change), the comparative general balance sheet, for 1941 to 1944, inclusive, shows $85,025,067 for December 31, 1941, $85,344,703 for same date 1942, $82,840,465 for 1943 and $85,971,302 for 1944. In this condition as to existence of these three elements, it is obvious that the matter of changed conditions as affecting the Plan boils down to the effect of a relatively large accumulation of cash and liquid assets with an accumulation of a substantial tax refund. This situation is not new to the Commission (see the New Haven reorganization, 254 I.C.C. 405; Milwaukee, 257 I.C.C. 223; the Rock Island, 257 I.C.C. 265, also 257 I.C.C. 307, and the Missouri Pacific, 257 I.C.C. 479) and has been denied. Of course, our determination is not to be governed by what the Commission might or might not do on a remand to it. Also, our problem is not whether these actual and potential funds might make an increased valuation and capitalization better than those of the Plan. It is whether, if the Commission had before it all that has come in to the record before the District Court and before us, it would be arbitrary for it to adhere to its present Plan. That these much improved conditions as to cash, liquid assets and potential tax refunds might alter the picture as seen by the Commission at the time of its reports seems true. However, that they must do so because otherwise the sight of the Commission would have to be declared arbitrary, we think is not true. In the foregoing adverse determinations that the Commission did not act arbitrarily in its valuation for capitalization at the time it acted and that subsequent changed conditions have not made that valuation arbitrary, we have not considered any effect of two matters thereon. These three appeals are for stockholders. Before stockholders can participate, all of the creditors must be cared for in full. The Act provides for elimination of stockholders and even of junior creditors where the valuation does not exceed senior indebtedness. The decisions preserve the full right to priority of senior creditors. Reconstruction Finance Corporation et al. v. Denver, R. G. W. R. R. Co. et al., supra; Ecker v. Western Pacific Railroad Corporation, 318 U.S. 448, 63 S.Ct. 692, 87 L.Ed. 892; Group of Institutional Investors v. Chicago M., St. P. & P. R. Co., 318 U.S. 523, 63 S.Ct. 727, 87 L.Ed. 959; Consolidated Rock Products Co. v. DuBois, 312 U.S. 510, 61 S.Ct. 675, 85 L.Ed. 982; Case v. Los Angeles Lumber Products Co., 308 U.S. 106, 60 S.Ct. 1, 84 L.Ed. 110; Kansas City Terminal Railway Co. v. Central Union Trust Co., 271 U.S. 445, 46 S.Ct. 549, 70 L.Ed. 1028; Northern Pacific Ry. Co. v. Boyd, 228 U.S. 482, 33 S.Ct. 554, 57 L.Ed. 931. The two matters have to do with this legal rule as applied to the factual situation. The first of these is that the Plan left unprovided for $8,304,118 of junior indebtedness. This amount seems to be made up of the portions of General and Refunding bonds. Stephenville bonds and Central Arkansas bonds not fully covered by allotments of common stock in the Plan with accrued interest thereon to January 1, 1942  the effective date of the Plan. The second is that arising from the character of securities pledged back of the bank and of the Reconstruction Finance Corporation loans  the last loan having been taken over and now owned by the Pacific. The principal amounts of these loans were, at the time of the Plan, Chase National Bank $3,500,000, Mississippi Valley Trust Company $1,000,000 and Reconstruction Finance Corporation $17,882,250  a total of $22,382,250. Back of the Chase note are pledged $4,921,500 General and Refunding Mortgage bonds and $98,000 First Mortgage 4% bonds of Southern Illinois and Missouri Bridge Company. Back of the Mississippi Valley note are pledged $1,405,500 General and Refunding Mortgage bonds and $28,000 S. I. & M. Bridge Company bonds. Back of the R.F.C. loan are pledged $23,903,000 General and Refunding bonds and $474,000 S. I. & M. Bridge Company bonds. A total security of $30,830,000 for all three loans. The participation in the Plan allowed these three creditors seems to be based on the value of pledged security rather than face of loans plus accrued interest. But be this as it may, in the calculations of indebtedness of Debtor these three appellants use the face of the loans plus accrued interest. [23] In so far as these debts enter the valuation estimates of these appellants it would seem they have thus undervalued these loans by the difference between principal with accrued interest thereon and security with accrued interest thereon  a difference as to principal of $8,447,750. As of October 31, 1944, Pacific calculates the principal and interest on these three obligations as totaling $27,901,003. Appellee Chase National Bank states principal and interest of the pledged General and Refunding bonds then to be $39,802,933  a difference of $11,901,930. This difference is allowable to these creditors under In re Chicago & N. W. Ry. Co., 7 Cir., 126 F.2d 351, certiorari denied Chicago & N. W. R. Co. v. Mutual Sav. Bank Group Committee, 318 U.S. 793, 63 S.Ct. 987, 87 L.Ed. 1158 and In the Matter of New York, N. H. & H. R. Co., 2 Cir., 147 F.2d 40, 47, 48, certiorari denied Commonwealth of Massachusetts v. New York, N. H. & H. R. Co., 325 U.S. 884, 65 S.Ct. 1577, 89 L.Ed. 1999. The effect of these two matters is to accentuate our determination.