RFC v. Denver & Rio Grand Western R. Co.
328 U.S. 495 (1946)

Annotate this Case

U.S. Supreme Court

RFC v. Denver & Rio Grand Western R. Co., 328 U.S. 495 (1946)

Reconstruction Finance Corporation v.

Denver & Rio Grande Western Railroad Co.

No. 278

Argued March 5, 6, 1946

Decided June 10, 1946*

328 U.S. 495

CERTIORARI TO THE CIRCUIT COURT OF APPEALS

FOR THE TENTH CIRCUIT

Syllabus

During lengthy proceedings for the reorganization of a railroad under § 77 of the Bankruptcy Act, it realized abnormally large earnings from war business. Most of these earnings were utilized to make capital improvements, and a large amount was held as free cash. Meanwhile, the claims of secured creditors were increased substantially

Page 328 U. S. 496

by the accumulation of interest and the position of holders of general mortgage bonds (the most junior lien holders) deteriorated 90%. The Interstate Commerce Commission approved a plan of reorganization which eliminated the claims of all existing stockholders and unsecured creditors, gave the holders of general mortgage bonds new common stock in face amount of 10% of their claims, and gave senior bondholders new securities (including about 88% of the new common stock) having an aggregate face value equal to 100% of their claims. This was based upon a determination that the aggregate of the securities in the plan represented the value of the properties for reorganization purposes, and that, through prospective earnings, there was adequate coverage for the charges. The large accumulation of free cash was not distributed. The plan was approved by the District Court and accepted by all creditors entitled to vote except the holders of general mortgage bonds. The District Court held that the latter's rejection of the plan was not "reasonably justified," and confirmed the plan.

Held:

1. The orders of the District Court approving and confirming the plan are affirmed. P. 328 U. S. 536.

2. Under § 77 of the Bankruptcy Act, the experience and judgment of the Commission must be relied upon for final determinations of value and of matters affecting the public interest, subject to judicial review to assure compliance with constitutional and statutory requirements. Ecker v. Western Pacific R. Co.,318 U. S. 448; Group of Investors v. Milwaukee R. Co.,318 U. S. 523. P. 328 U. S. 508.

3. The Courts are empowered to review the plan to determine whether the Commission has followed the statutory mandates of § 77(e) and had material evidence to support its conclusions. Id. P. 328 U. S. 509.

4. The congressional authorization for the Commission to eliminate valueless claims from participation in reorganization is a valid exercise of the federal bankruptcy power. Id. P. 328 U. S. 509.

5. The Commission's judgment that the earning prospect did not justify a greater capitalization than the one given is controlling. P. 328 U. S. 515.

6. It was not required to add, and would not be justified in adding, to the capitalized value the amount of expenditures for improvements made during the reorganization proceedings if, in the exercise of sound discretion, it felt that the reasonable prospective earnings of the road, after the improvements, did not justify it. P. 328 U. S. 515.

7. There was ample evidence to justify the valuation made by the Commission. Pp. 328 U. S. 512-516.

Page 328 U. S. 497

8. The valuation having been based on earnings, the segregation of the system earnings to each existing lien and the allocation of new securities representing the system value to each class of claimants, was in full accord with the principle that senior creditors are to retain their relative priority of position in a reorganization. P. 328 U. S. 517.

9. Junior claims can receive nothing until senior claims receive securities of a value equal to their indebtedness. P. 328 U. S. 517.

10. When the Commission made its allocations of securities, it did not find that the cash value of those awarded senior claimants equalled the face value of their claims, and it definitely had in mind that one thing that gave them compensation for the admission of junior claimants to participation in securities before the seniors obtained full cash payment was their chance to share in the unlimited dividends that might be earned and paid on the common stock in the "lush years," thus taking into account the abnormal earnings during the war. P. 328 U. S. 518.

11. The improved physical condition of the road through expenditures of the trustees for previously deferred maintenance, improvements, and new equipment necessarily entered into the Commission's valuation of the property. P. 328 U. S. 518.

12. That the creditors who received common stock to make them whole obtained with it an interest in all cash on hand or that might be accumulated was an important factor in the allocation of the new securities. Pp. 328 U. S. 518-519.

13. The senior creditors having accepted the plan as fair and equitable as between themselves, if the method and result of valuation are sound, the allocation of 10% of their claim in common stock to the junior creditors follows as a matter of computation. P. 328 U. S. 519.

14. The objection of a stockholder to a voting trust for future control of the debtor is ineffective, because the stockholder was eliminated from the reorganization by the valuation of the property and allocation of securities. P. 328 U. S. 520.

15. The Commission's action in fixing the effective date of the plan as January 1, 1943, was within its power. P. 328 U. S. 521.

16. Assuming that the courts may set aside a plan which was fair and equitable when adopted by the Commission merely on account of subsequent changes in economic conditions, they should not do so when the changes are of the kind that were envisaged and considered by the Commission in its deliberations upon, or explanations of, the plan. Pp. 328 U. S. 521-522.

17. It would be erroneous to assume that the senior bondholders were paid in full by the securities allotted to them without also

Page 328 U. S. 498

accepting the Commission's determination that the assets represented as of the effective date, and all subsequent earnings, were a part also of the common stock that was awarded to them, since the opportunity to participate in war earnings and in the accumulations of cash beyond operating fund needs was part of their compensation for their loss of position. Pp. 328 U. S. 522-524.

18. When common stock is issued in partial satisfaction of the claims of senior creditors and a reduction of senior capital takes place after the adoption of the plan by the use of anticipated earnings or existing cash, there can be no corresponding readjustment of junior participation; because assets in the balance sheet at the adoption of the plan and subsequent earnings are for the benefit of stockholders in the new company, the senior claimants, so that they may be compensated through these common stock advantages for their loss of payment in full in cash. Pp. 328 U. S. 524-525.

19. The settled rule in bankruptcy proceedings that a creditor secured by the property of others need not deduct the value of that collateral or its proceeds in proving his debt is applicable in proceedings under § 77. P. 328 U. S. 529.

20. A provision in a plan of reorganization that the trustee under a certain bond issue secured in part by a lien on stock owned by a third party shall be permitted to obtain the release of the equities in the stock and distribute it among the bondholders or to enforce its rights as pledgee of the stock and distribute the proceeds to the bondholders did not change or affect existing rights in the stock, and those rights remained subject to judicial determination. Therefore, it could not result in the holders of the bonds secured thereby receiving more than they were entitled to, nor deprive the holders of a junior lien on the stock of any of their rights, even though the Commission made no definite finding as to the value of the stock and the holders of the senior lien on the stock may have been fully compensated by other provisions of the plan. Pp. 328 U. S. 525-531.

21. The provisions of § 77(e) for confirmation of a plan of reorganization over the creditors' objection, if the reviewing court finds that it makes "adequate provision for fair and equitable treatment" of those rejecting it, that their rejection is not "reasonably justified" and that the plan complies with the requirements of the section, are within the bankruptcy powers of Congress. P. 328 U. S. 533.

22. The finding of the District Court that the plan made "adequate provision for fair and equitable treatment" of the dissenters, as of its effective date, was justified. P. 328 U. S. 533.

Page 328 U. S. 499

23. In view of the District Court's familiarity with the reorganization, this finding has especial weight with this Court. P. 328 U. S. 533.

24. The rejection of the plan by the holders of general mortgage bonds was not "reasonably justified" within the meaning of § 77(e). Pp. 328 U. S. 533-535.

25. It is the duty of the Commission to plan reorganizations with an eye to the public interest, as well as the private welfare of creditors and stockholders. P. 328 U. S. 535.

26. The public interest in an efficient transportation system justifies the Commission's requirements for reasonable maintenance and improvements of the properties and for a capitalization with fair prospects for dividends on all classes of securities. P. 328 U. S. 536.

150 F.2d 28, reversed.

The Interstate Commerce Commission approved a plan of reorganization of a railroad under § 77 of the Bankruptcy Act. 254 I.C.C. 349. The District Court approved it. C.C.H. Bankruptcy Law Service 54,562. All creditors entitled to vote accepted the plan except holders of the general mortgage bonds. The District Court held that the latter's rejection of the plan was not "reasonably justified," and confirmed the plan. 62 F.Supp. 384. The Circuit Court of Appeals reversed the District Court and remanded the reorganization proceedings to the Commission for further consideration. 150 F.2d 28. This Court granted certiorari. 326 U.S. 699. The judgment of the Circuit Court of Appeals is reversed; the orders of the District Court approving and confirming the plan are affirmed, and the cause is remanded to the District Court for further proceedings. P. 328 U. S. 536.

Page 328 U. S. 500

MR. JUSTICE REED delivered the opinion of the Court.

The petitioners in these five cases are the owners of claims against the debtor, Denver & Rio Grande Western Railroad Company, or against secondary debtor, the Denver & Salt Lake Western Railroad Company. The respondents are the two debtors just named; City Bank Farmers Trust Company, Trustee under the General Mortgage of the principal debtor, and the Trustee of the Missouri Pacific Railroad Company, a large owner of common stock of the principal debtor.

The debtors sought reorganization in the District Court of the United States for the District of Colorado under Section 77 of the Bankruptcy Act, [Footnote 1] on November 1, 1935. The Interstate Commerce Commission approved the plan of reorganization under consideration in this review on June 14, 1943. [Footnote 2] The District Court approved the plan October

Page 328 U. S. 501

25, 1943. [Footnote 3] It was then submitted by the Commission to the creditors of the classes deemed entitled to vote for acceptance or rejection of the plan, and a certificate of the result filed in the District Court on July 15, 1944. All classes of voting creditors approved the plan, as required by Section 77 except the holders of the Denver's General Mortgage bonds. [Footnote 4] On November 1, the District Court held the rejection of the plan by the holders of the General Mortgage was not reasonably justified, [Footnote 5] and thereafter confirmed the plan on November 29, 1944. Section 77(e).

The plan provided for a reorganization as of January 1, 1943, by the Denver by adjustment of its liabilities to its assets with or without a consolidation with the Salt Lake and the Salt Lake Western to form a system. The stock of the latter road is held by the Denver. There are no bonds. As no ruling that we are asked or required to make turns upon whether the reorganization is with or without the suggested consolidation, we need not give further consideration to possible differences. In either case, creditors with secured claims against the reorganized roads or against their property were left undisturbed or allocated new securities of the new company, consisting of first mortgage and income bonds, preferred and common stock, in lots, in face amount of the secured claims except for the General Mortgage issue, that the Commission and District Court determined, through adoption of the plan, were fair and equitable in the light of the respective priorities, liens, and collateral of the various secured

Page 328 U. S. 502

claims. All of the securities were given a par value. Interest partly fixed and interest partly contingent on earnings was used to gain play in annual charges. The plan eliminated unsecured claims and allocated common stock in face amount of ten percent of their claim to General Mortgage bonds of the debtor. Its stockholders received nothing. It was determined that the aggregate of the securities in the plan represented the value of the properties for reorganization purposes, and that, through prospective earnings, there was adequate coverage for the charges. [Footnote 6]

Page 328 U. S. 503

Respondents sought review in separate appeals from the order of approval or the order of confirmation or both to the Circuit Court of Appeals for the Tenth Circuit. That court reversed the District Court on all appeals, and remanded the reorganization proceedings to the Interstate Commerce Commission for further consideration with the statement, 150 F.2d 28, 40,

"Nothing in this opinion shall prejudice or foreclose the rights of the parties to propose a new plan of reorganization or the power of the Commission to formulate, approve, and certify a new plan of reorganization in the light of any relevant facts presented to the Commission in any proceeding under 11 U.S.C. Sec. 205(d). "

Page 328 U. S. 504

By this remand, the Commission was empowered to proceed anew to consideration of the reorganization in all its phases, § 77(e), including those steps previously taken and approved by the opinion of the Circuit Court of Appeals.

That court approved the valuation of the debtor reached mainly by the use of present and prospective earnings. It held that the valuation adopted need not reflect necessarily the money spent for improvements during the trusteeship for reorganization. 150 F.2d at 35. The soundness of these conclusions is fully supported by the Western Pacific and Milwaukee cases. [Footnote 7] The Circuit Court further held that the Commission was justified in refusing to reopen the hearings just before the entry of its order of June 14, 1943, approving the plan, to hear evidence of the then existing economic conditions and the 1943 earnings of the debtor. [Footnote 8]

The reversal came from the Circuit Court's holding, contrary to the Commission and the District Court, that free cash in excess of operating capital needs and large earnings from war business after the date of the plan should be for the benefit of the General bondholders. 150 F.2d at 35-38. That court further held that decreases in debt by cash payments, with the consequent reduction of securities that were required to be issued under the plan to cover such debt claims, should inure to the benefit of the same General bondholders. 150 F.2d at 38, 39. The Circuit Court disagreed also with the treatment of certain collateral deposited behind the First Consolidated Mortgage of the Rio Grande Western Railway Company and secondarily behind other issues of the debtor. This is the Utah Fuel stock issue hereinafter discussed. These differences from the conclusions of the District Court led the

Page 328 U. S. 505

Circuit Court to hold that the General bondholders were "reasonably justified" in rejecting the plan, and that the District Court was without authority to confirm the plan over their veto. § 77(e).

Petitioners, on July 30, 1945, sought a writ of certiorari to reverse these rulings of the Circuit Court and, on account of the importance of the issues in the administration of railroad reorganization under Section 77, we granted their petition on October 8, 1945. 326 U.S. 699.

The briefs of all the parties here restate the questions presented in the petition for certiorari according to the emphasis the particular party places upon points of controversy. After a general consideration of the background of the plan and respondents' contentions to support the judgment besides the defenses applicable to petitioners' certiorari, we shall give attention to each of the just stated disagreements between the district and appellate court. This will cover the points under review.

The basic problems of railroad reorganization under Section 77 of the Bankruptcy Act have been so recently considered by this Court in the Western Pacific and Milwaukee cases that only a summary reference to their conclusions attacked by respondents need be made now. No new enactments have changed the law since those decisions on March 15, 1943. The complexities of the reorganization of a railroad with responsibility to the public and obligations to its security holders were recognized. The impossibility, without destruction of efficiency and values, of reversing the process of integration to restore the parts that now make up the whole of a system of their original operational function was understood. The various bond issues with different and often overlapping liens, with competing claims for allocation of earnings pending reorganization, presented hard problems for legislative solution. A fair, administratively practical, and lasting method was sought. By provisions for adjustment

Page 328 U. S. 506

of creditors' claims, Congress intended to avoid the delays, costs, and sacrifices of liquidation. [Footnote 9] The agencies employed

Page 328 U. S. 507

by Congress to accomplish reorganizations under Section 77 were the Interstate Commerce Commission and the

Page 328 U. S. 508

courts. The answer reached by Congress was that the experience and judgment of the Commission must be relied upon for final determinations of value and of matters affecting the public interest, subject to judicial review to assure compliance with Constitutional and statutory requirements. This was the interpretation of all members

Page 328 U. S. 509

of this Court from the language of the act and the evidence of Congressional purpose in the hearings, reports, and discussion. [Footnote 10] To the courts, Congress confided the power to review the plan to determine whether the Commission has followed the statutory mandates of subsection (e), 318 U.S. at 318 U. S. 477, and whether the Commission had material evidence to support its conclusions. 318 U.S. at 318 U. S. 477; concurring opinion at 318 U. S. 512; concurring opinion at 318 U. S. 725.

At this point, we restate our conclusion, reached in the former cases, that the Congressional authority to the Commission to eliminate valueless claims from participation in reorganization is a valid exercise of the federal bankruptcy power. Section 77 was directed at the relief of debtor railroads. Sec. 73, 47 Stat. 1467. Liquidation in depression periods meant that large portions of debts, as well as stock interests in the properties, would be irretrievably lost to their holders, while reorganization on a capitalization that estimated what normal income would support meant the salvage of sound values. We see no more constitutional impediment to the elimination of claims against railroad debtors by the Interstate Commerce Commission's determination of values with judicial review as to the sufficiency of the evidence and compliance with statutory standards than we do to their elimination by an accepted bid in a depression market. [Footnote 11] There is no occasion here to reexamine further these recent holdings of this Court in the Western Pacific and Milwaukee reorganizations.

In examining the contentions of petitioners as to the alleged errors of the Circuit Court of Appeals, we must

Page 328 U. S. 510

approach the problem in accordance with our reviewing authority under Section 77. That section embodies the method that Congress selected in 1933 [Footnote 12] and improved in 1935 [Footnote 13] to put the railroad transportation system of the county in order to meet its debts and perform its duties to the public after the hard years of the recent depression. Our constructions of the chief provisions of the section were handed down in March, 1943. Although the results of reorganizations under the section, as thus construed, have been criticized as unfortunate, and changes have been suggested, no different legislation has been enacted. [Footnote 14] Indeed,

Page 328 U. S. 511

a different method for reorganization, enacted in 1939 and designed to meet the requirements of railroads not in need of financial reorganization of the character provided by Section 77 but only of an opportunity for voluntary adjustments with their creditors, terminated on July 31, 1940, and a comparable provision made in 1942 was allowed to lapse on November 1, 1945. [Footnote 15] This situation leaves clear the duty of the agencies of the Government entrusted with the handling of reorganizations under Section 77, including this

Page 328 U. S. 512

Court, to administer its provisions according to their best understanding of the purposes of Congress as expressed in the words of Section 77 read in the light of the contemporaneous discussion in Congress. Changes in economic conditions cannot effect the powers of the reorganization agencies, even though such changes may require a reexamination into the present fairness of the former exercise of those powers.

Valuation. The Denver and Rio Grande Western, the principal debtor, is an important link in transcontinental transportation. [Footnote 16] The recent availability to the debtor of

Page 328 U. S. 513

the Moffett Tunnel and the Dotsero Cut-off (1934) improve its strategic position in the competition for "overhead" or "bridge traffic" -- that is, traffic that is consigned from and destined to points beyond its lines. The traffic originating or terminating on its lines is mixed in character, and varies with the general prosperity of the region.

The present Denver, the principal debtor, was organized in 1920. It succeeded the Denver & Rio Grande Railroad Company of 1908, which had, in its turn, acquired the property of the Rio Grande Western Railway Company, owning the western portion of the present debtor's lines, and of the Denver & Rio Grande Railroad Company of 1886, owning the eastern portion of the present debtor's lines. A connection between the two portions, Rio Grande Junction Railway, is under lease to the debtor, which, as lessee and a stockholder, guarantees the Junction bonds. Substantially all of the capital stocks of the Salt Lake and Salt Lake Western, and various other branch lines, are owned by the debtor. [Footnote 17] These corporate arrangements for the operations of the debtor have resulted in the assumption or creation by the debtor of the claims of the various issues, listed in note 6supra.

Just after these reorganization proceedings began, December 31, 1935, the debtor's report showed that its long-term debt was $120,541,000, and its current liabilities $24,990,901.63. It had current assets, including cash, $1,257,943.43, of $5,966,666.93. At the time the plan

Page 328 U. S. 514

became effective, December 31, 1942, the report showed long-term debt of $130,264,826.65 and current liabilities of $14, 172,575.50, and, in addition, deferred liabilities, chiefly matured interest in default. of $45,582,132.66. There were current assets, including cash, $10,850,149.96, of $20,983,652.54. As of December 31, 1944, these items were: long-term debt $129,358,337.79, current liabilities $20,539,637.83, and deferred liabilities $55,310,151.80. The current assets were $32,665,501.33, including $19,142,626.96 in cash.

During the period examined, the income of the system available for interest was found by the Commission at its lowest in 1936-1938. After adjustment, this was $2,893,255. 233 I.C.C. at 552. In 1941, there was $5,019,436. 254 I.C.C. at 10. When the present plan was approved by the Commission in June, 1943, the 1942 income available for interest was recognized, but the continuance of such earning power was thought to be negatived by any sound forecast. [Footnote 18] 254 I.C.C. at 356.

Earnings during the trusteeship were used to improve the debtor railroad. When the vote was taken in 1944, the real estate and equipment account showed charges of $43,291,513 during the trusteeship. An estimated ten million of it was between the Commission's approval of the plan, June, 1943, and the Commission's certification on July 15, 1944, to the court of the vote by claimants. See 254 I.C.C. at 354 and 382 for explanation of new equipment program to meet the war situation. The retirements are said by the respondent trustee to have been about $13,000,000, leaving a net addition to capital account of $30,000,000. Respondents urge that, since capitalization

Page 328 U. S. 515

was not substantially increased by the Commission between 1938, when the first draft of a plan came from the Commission's staff, and 1943, the junior creditors got little or nothing for this investment. The improvements may have been wise or unwise. That question is not before us. Railroads, even in reorganizations, must make additions to take care of public needs or to lower operating costs. See 62 F.Supp. at 389. The senior bond interest continued to accumulate during this period. As the capitalization was not increased pari passu with the purchases, the holders of junior securities received less participation. The Commission did not consider that the earning prospect justified a greater capitalization than the one given, and we think its judgment controls the valuation. As was said by the Circuit Court of Appeals in In re Denver & R.G.W. R. Co., 150 F.2d at 38:

"Neither was the Commission compelled to, nor would it be justified in adding the amount of these expenditures to the capitalized value if, in the exercise of sound discretion, it felt that the reasonable prospective earnings of the road, after the improvements did not justify it. However, in the face of all this, after satisfying in full the claims of the senior bondholders, the plan of reorganization should have made sure that all excess current assets, as well as all excess war profits yet to accrue, would go to the General Bondholders."

The last sentence, we think, has the vice of overlooking the reason the Commission gave common stock to the Seniors. See discussion under Allocation of Securities.

We note also the contention that the possibility of a national income much higher and interest rates much lower than before World War II should affect valuation based on prospective earnings. Those factors, we think, were before the Commission when it made its earnings estimate.

Page 328 U. S. 516

The Commission reached its determination of a sound capital structure for the combined properties with these figures on earnings and investments before it. In addition, of course, the Commission had complete statistical information to guide it from its Bureau of Valuation and its other sections dealing with traffic, rates, earnings, interest, et cetera. The discussion by the Commission will be found in its printed volumes listed in note 2 Proceeding upon the principle accepted in the Western Pacific and Milwaukee cases, [Footnote 19] that capitalization based upon earnings is a permissible method of valuation in reorganization, the Commission fixed $155,173,127 as the sound capitalization. This capitalization, under the terms of the issues, with provisions for a capital fund and the sinking funds, carries annual charges at rates varying with the security of $6,211,250 before dividends on common. This present annual charge, plus, let us assume, five percent annually upon the common, $1,758,379, or a total of $7,969,629, is the basic figure to be applied, with adjustments for the variable factors, to earnings, past or prospective, available for interest and dividends as an aid to determine the fairness of the present valuation. Seenote 6 The decision was unanimous except for one Commissioner, who considered the valuation too high by ten percent. 254 I.C.C. at 379. There can be no doubt that, as of June, 1943, there was ample evidence to justify the valuation made by the Commission.

Allocation of Securities. Within the framework of that valuation, the Commission allotted the available securities to the claimants. Securities, including the common stock, were given a face value. The aggregate was too small to allow anything to former stockholders. [Footnote 20] Thus, they were eliminated from the reorganization. [Footnote 21] For the

Page 328 U. S. 517

holders of the General bonds, common stock was available to the amount of ten percent only of their claim. [Footnote 22] A glance at the proposed distribution in note 6 will show that the claimants did not receive all the new senior securities in the strict order of their old priorities

The value of a lien on a part of a railroad when the valuation is made from earnings cannot be fixed solely on a mileage basis. Nor is it practicable to issue new securities with a lien limited to the property that was covered by the old lien. There must be segregation of the system earnings to each existing lien and allocation of securities representing the system value to each class of claimants. This was done here as shown in the second table in note 6 [Footnote 23] Such a method is in full accord with the principle that senior creditors are to retain their relative priority of position in a reorganization. Group of Investors v. Milwaukee R. Co., 318 U.S. at 318 U. S. 561-564. Furthermore, junior claims can receive nothing until the senior claims receive securities of a worth or value equal to their indebtedness. 318 U.S. at 318 U. S. 483; 318 U.S. at 318 U. S. 569. The Generals are definitely junior. 233 I.C.C. at 524.

The Commission did not make a finding that the cash value of the securities awarded the senior claimants as of the effective date of the plan equalled the face of the claims. It did, however, carefully state its reasons for concluding that the compensation "flowing under the plan to the various classes of bondholders for the rights surrendered by them" was adequate in the light of the full priority rule. 254 I.C.C. at 360. For those classes, other than the Junior Generals, that received common stock, the Commission said that the possibility of "unlimited dividends on common stock" was a factor in offsetting

Page 328 U. S. 518

loss of position. [Footnote 24] Thus, it is clear that, when the Commission made its allocations, it had definitely in mind that one thing that gave the senior creditors compensation for the admission of junior claimants to participation in securities before the seniors obtained full cash payment was their chance to share in the unlimited dividends that might be earned and paid on the common stock to have a part in the "lush years." It should be noted that income applicable to dividends was at its highest in 1942, prior to the approval of the plan by the Commission in June, 1943. Therefore the abnormal earnings of 1942 were in the Commission's contemplation when it spoke of the opportunities for "unlimited dividends." Its discussion of the plan assumed that 1943 available earnings might be as large. 254 I.C.C. at 355.

The improved physical condition of the road through expenditures of the trustees for previously deferred maintenance, improvements, and new equipment was before the Commission, and necessarily entered into their valuation of the property. 233 I.C.C. 531.

There is another important factor, corollary to stock ownership, to be noted in the Commission's allocation of these securities. This factor is that the creditors who received common stock to make them whole obtained with

Page 328 U. S. 519

that common stock an interest in all cash on hand or all cash that might be accumulated. Of course, the Commission thoroughly understood this. In fact, it referred to the ten million plus of cash on hand as of January 1, 1943. 254 I.C.C. 353. Immediately following this reference is a full discussion of the cash needs of the road for the year 1943, including additions, betterments, and new equipment, and the amount which it was estimated would be in the treasury at the end of the year. That was $15,600,000. This cash would be reflected in the value of the common stock. The petitioner states that the highest when-issued Stock Exchange price in 1945 for the common stock was $31 1/2, par $100. See Commercial and Financial Chronicle, May 13, 1946, p. 2618, where the common is quoted at 29 bid, 31 asked. Cash, material, and supplies, as well as all other assets and all liabilities of the debtor, were represented by the securities. If there is more cash on hand than needed for taxes, expenses, and proper improvements, it is at the disposal of the common stockholders. If money was used to pay indebtedness, there would be a corresponding reduction in the capital structure. Therefore, the plan provided, 254 I.C.C. at 286:

"The new company shall be deemed to have come into possession of the properties as of the effective date of the plan."

". . . The capitalization of the new company, as of January 1, 1943, after consummation of the plan, . . . shall consist substantially of the following securities, excluding those to be pledged, the amounts stated being subject to reduction to the extent, if any, that matured interest proposed to be funded in the plan is paid, and as equipment obligations or other liabilities are paid or reduced. . . ."

It is accepted by the senior claimants that the plan is fair and equitable as between themselves. If our conclusion that the method and result of valuation

Page 328 U. S. 520

is sound, the allocation of ten percent of their claim in common stock to the Generals follows as a matter of computation.

It would also follow that the objection of a stockholder, the Missouri Pacific Railroad Company, through its Trustee in reorganization, to a voting trust for future control of the debtor would be ineffective, because this stockholder is eliminated from the reorganization by the valuation of the property and allocation of securities. For the Commission's reasons for creating a voting trust, see 233 I.C.C. at 581, 254 I.C.C. at 33, 35, 367.

Cash and War Earnings. The Circuit Court of Appeals was of the view that war earnings were of "very little value in estimating the probable future earnings of this property in the peace economy which is to come," and that the Commission was well within its right in appraising them lightly. 150 F.2d at 34. This was after the seventeen million earnings of the top year, 1942. The appellate court agreed, too, that excess current assets should not be capitalized, and that improvements made during the trusteeship for reorganization had been considered by the Commission and District Court in fixing their valuation by past and prospective earnings. 150 F.2d at 35. The appellate court then made the following ruling:

"The Senior Bondholders were paid in full. They received all the new securities and most of the common stock. Ninety percent of the General Bondholders' claims were wiped out. They received only a small amount of common stock, ten percent of their total claim. Adequate operating funds are essential to the operation of a railroad. The Senior Bondholders were entitled to receive in addition to the full amount of their claims, working capital sufficient for proper and efficient operation of the railroad. But anything in excess of what was reasonably necessary for this purpose constituted assets of the insolvent

Page 328 U. S. 521

corporation which belonged to the remaining creditors."

"We think it is apparent from the record that there were current assets on hand consisting of cash and securities in excess of what was needed for the efficient operation of the road. As pointed out, the working capital of the the debtor had increased from a deficit of $9,727,230 as of December 31, 1935, to a surplus of $12,125,863.50 as of December 31, 1944. While these increased net earnings are due in large part to the war, and will not continue after the end of the war, and may therefore be disregarded in setting up the capitalized structure based upon prospective earnings, we cannot disregard the fact that these huge surpluses actually exist. Their existence is an accomplished fact. It is also obvious that surpluses will continue to pile up for a reasonable time yet to come. We think any plan which fails to take this into account and which gives the Senior Bondholders their claims in full by substantially delivering the road to them, and gives them the surplus cash actually on hand and further enables them to receive in addition the excess war profits which are reasonably sure to come, is inherently inequitable and unfair so long as there are classes of creditors whose claims are not fully satisfied."

In our judgment this holding is erroneous.

The effective date of the plan was fixed by the Commission as January 1, 1943. This was in its power. [Footnote 25] The allocation of the securities took into consideration the interest of the secured claims to that date. Any gain or any loss after that time was a benefit or an injury to the new common stockholders, and then sometimes to security holders in positions senior to them. Assuming that the courts, as courts with equity powers in a bankruptcy matter,

Page 328 U. S. 522

might set aside a plan, fair and equitable when adopted by the Commission, merely on account of subsequent changes in economic conditions of the region or the nation, [Footnote 26] it should not be done when the changes are of the kind that were envisaged and considered by the Commission in its deliberations upon or explanations of the plan.

We have pointed out in the section of this opinion dealing with the allocations of the securities that a part of the compensation to senior claimants for their loss of position was the opportunity to participate in war earnings. This was understood by the District Court [Footnote 27] and the Commission. [Footnote 28] Accumulations of cash beyond operating fund needs are in the same category. In dealing with the problem, the Commission noted that a five percent dividend on the authorized common would require an income available for interest and dividends of $7,969,629. The Trustee for General bonds claims no such earnings between 1929 and 1942. Even before the transportation difficulties of 1946, it was obvious that the Commission's judgment was being confirmed by events. Seenote 18supra. [Footnote 29]

Page 328 U. S. 523

The error of the Circuit Court in its holding set out above lies in its assumption that the senior bondholders were paid in full by the securities allotted to them without also accepting the determination of the Commission that the assets represented as of January 1, 1943, and all

Page 328 U. S. 524

subsequent earnings were a part also of the common stock that was awarded the senior bondholders.

Decreases in Senior Debt. The plan provides for securities to take the place of the Rio Grande Junction's first 5's in the face amount of $2,758,333 and for the assumption by the reorganized road of $5,758,000 equipment obligations. All of these securities are senior to the Generals. The Denver purchased the Junctions and paid $1,218,000 on the Equipments. This reduced the necessary capitalization by that aggregate sum. The Circuit Court of Appeals was of the opinion that "The value behind these securities in no wise belonged to the Senior Bondholders, because they had been paid in full." 150 F.2d at 39. This ruling, we conclude, was erroneous for the same basic reason that we held the cash and war earnings belong to the owners of the common stock.

We called attention, supra, page 328 U. S. 519, to the authority granted the District Court to reduce the capitalization of the new company as interest due on January 1, 1943, or equipment obligations or other liabilities were paid. The District Court acted on this authority and, in its approval of the plan, said of the Junctions, "They may be canceled or they may be utilized under the plan in acquisition of new securities which will become an asset of the reorganized company." C.C.H., Bankruptcy Law Service Decisions 1942-1945,

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