The constitutional validity of the provisions in § 20 of the Act
to Regulate Commerce of February 4, 1887, c. 104, 24 Stat. 379, as
amended by the Hepburn Act of June 29, 1906, c. 3591, 34 Stat. 584,
giving the Interstate Commerce Commission authority to prescribe
the methods by which interstate carriers shall keep accounts, has
already been sustained by this Court.
Interstate Commerce
Commission v. Goodrich Transit Co., 224 U.
S. 194.
Page 231 U. S. 424
The authority conferred upon the Commerce Court by the Act of
June 18, 1910, c. 309, 36 Stat. 539 (Judicial Code, § 207), with
respect to enjoining or setting aside the order of the Interstate
Commerce Commission, like the authority previously exercised by the
federal circuit courts, was confined to determining whether there
had been violations of the Constitution, or of the power conferred
by statute, or an exercise of power so arbitrary as virtually to
transcend the authority conferred.
In enacting the Hepburn Act amending § 20 of the Act to Regulate
Commerce, Congress recognized the essential distinctions between
property accounts and operating accounts, and between capital and
earnings, and that, while prior to that time the practice of
different carriers varied, uniformity in regard to the keeping of
accounts was essential in the future for proper supervision and
regulation.
Interstate Commerce Commission v. Goodrich Transit Co.,
224 U. S. 194,
followed to the effect that there is no unconstitutional delegation
of legislative power by Congress to the Commission in giving it
authority to establish methods of accounts by the provisions of the
Hepburn Act amending § 20 of the Act to Regulate Commerce in that
respect.
The classification of accounts adopted by the Interstate
Commerce Commission in regard to additions and betterments and to
property and operating accounts are not so arbitrary or so entirely
at odds with fundamental principles of correct accounting as to
amount to an unconstitutional abuse of power.
In this case, the carrier was not deprived of any of its
property without due process of law because, under the Commission's
system of accounting, it was permitted to carry into its property
account only the excess of the full cost of improvements made off
the line after deducting the estimated replacement cost of the
abandoned portions of the track or because it was required to
charge to operating expenses the estimated cost of replacing the
abandoned sections.
Where, as in this case, all classes of stockholders of a carrier
whose dividends are affected by the method of charging betterments
and repairs are not before the Court, their rights cannot be
determined in a suit between the carrier and the Commission in
regard to such methods of accounts.
Semble that requiring stockholders to forego dividends
for a period so that the amount not divided be spent in bettering
the condition of the property, thus giving them greater security
for dividends in the future, does not amount to an unlawful taking
of property within the meaning of the Fifth Amendment.
A carrier is not relieved from complying with regulations
properly
Page 231 U. S. 425
made by the Interstate Commerce Commission because of agreements
previously entered into; whatever had been done was subject to
being displaced by the Commission under the powers conferred upon
it by Congress.
The power given to the Commission by § 20 of the Act to Regulate
Commerce, as amended by the Hepburn Act, to require the carrier to
keep accounts as prescribed by the Commission, does not impose
obligations upon the carrier as to the use of the proceeds of
bonds, but simply prevents such proceeds from being used in any
manner without the fact's appearing in the accounts.
Although the contention of the carrier that abandonments ought
to be charged to profit and loss, rather than to operating
expenses, may have weight, this Court will not reverse the order of
the Commission requiring them to be otherwise charged on the ground
that it was an abuse of power.
Where it appears that the Commission has acted fairly within the
grant of power constitutionally conferred upon it by Congress its
orders are not open to judicial review.
204 F. 641 affirmed.
This is an appeal from a decree of the Commerce Court dismissing
appellant's petition in an action brought to have certain,
regulations of the Interstate Commerce Commission relative to the
method of keeping the accounts of carriers declared invalid, and to
enjoin the enforcement thereof. 204 F. 641. The regulations are
contained in the "Classification of Expenditures for Additions and
Betterments of Steam Roads," effective July 1, 1909, and the First
Revised Issue thereof, effective July 1, 1910.
The facts as set forth in appellant's brief may be summarized as
follows:
Appellant is engaged in interstate commerce. Its main line is
about 786 miles in length, and extends from Kansas City to Port
Arthur, on the Gulf of Mexico, traversing the states of Missouri,
Kansas, Oklahoma, Arkansas, Louisiana, and Texas. The road was
built years ago, when the country was heavily timbered and sparsely
settled, and the traffic was correspondingly small. The traffic
would not
Page 231 U. S. 426
then support, nor could capital be obtained for, an expensively
constructed road, and in consonance with the general practice in
the development of the country, the road was built with rather
heavy ruling grades. But it was not defectively or improperly
constructed or located; it had substantially the same grades as
other roads then constructed in the West, and it was adequate to
serve the then-existing needs of the country. A railroad with heavy
grades is, of course, more cheaply constructed than a road of low
grades. And a road of heavy grades is generally adequate in a new
country, where the volume of traffic offered is small, the train
loads light, and the trains few.
The ruling maximum grade of appellant's line as originally
constructed was 1 percent, and in the mountain district as high as
1.35 percent. The evidence is undisputed that it was properly
located, well constructed, and ample for the needs of the country.
In the course of time, with the development of the country and the
resultant increase in traffic, whereby the limit of the road's
capacity was being approached, the conditions warranted and
rendered desirable such additions or improvements as would enlarge
the road's capacity and permit traffic to be moved more rapidly and
economically.
Two methods of increasing the capacity of the road were
presented: one by double-tracking, the other by lowering the grades
and thus permitting traffic to be moved more rapidly. The road was
in active competition with powerful rivals operating in the same
general territory, among them the Southern Pacific, the Missouri,
Kansas & Texas, the Missouri Pacific, the St. Louis
Southwestern, the Texas & Pacific, the St. Louis & San
Francisco, the Atchison, Topeka & Sante Fe, and the Rock
Island. The character of the road as a trunk line, having a long
average haul and the prevalence of low-class traffic -- timber,
coal, oil, and like commodities -- necessarily entailed a low
average freight rate; its average rates per ton
Page 231 U. S. 427
per mile being lower than those of any of its competitors above
named.
Under these conditions, the management found that the most
desirable plan was to lower the grades of the road, and thus to
increase its capacity, procure economy in operation, and render
better service to the public. Two methods of reducing the grades at
various points along the line were presented: one by raising or
lowering the roadbed on the existing right of way, the other by the
construction of short sections of new road in substitution for
portions of the road in instances where the same result could be
thus obtained at less cost. The program of improvement
contemplated, therefore, not only many changes on the original
right of way, but also a number of changes by the substitution of
short sections of road on new ground where that method was more
economical.
The first six sections of the road where new locations were
utilized are covered by the petition herein. Other similar changes
are being made as the work proceeds, which will cover several
years, and is estimated to cost $3,000,000. The road at these six
points was in no way worn out, was fully maintained, and was
capable of performing for an indefinite term the function for which
it was originally constructed. All of these changes are being made
for the purpose of increasing the capacity of the line, of securing
economy in operation, and of rendering improved service to the
public.
At the six sections of the road in question, it was found by the
estimates of the engineers that the cost of securing the required
gradient upon the original roadbed would be $1,230,318.99, but that
the same result could be obtained by means of relocations upon
adjacent land for a net expenditure of $629,399.74.
The actual expenditure on these six new locations, as
ascertained on completion of the work (after the filing of the
petition), was $763,798, and the testimony shows
Page 231 U. S. 428
that, had the work been done on the original roadbed, the cost
would have been increased over the estimates in an equal or greater
proportion, the variation being due to increase in the cost of
labor, materials, etc. For present purposes, the figures set forth
in the petition are adopted.
The grade revisions at the six sections of line involved herein
having been completed by removing the tracks to adjacent parcels of
ground, which were procured and substituted for the original
parcels, the use of the latter parcels was, of course,
discontinued.
The expenditure required to improve the property by bringing it
to the desired grade of five-tenths of one percent being deemed a
capital expenditure, appellant's directors determined to finance
the work by applying to it the proceeds of a bond issue. It is
claimed to have been necessary to finance the improvements in this
way if they were to be made at all, because the appellant did not
have current earnings available for these improvements, and could
not have financed its program, involving the revision of about
forty-one percent of the entire line and an ultimate expenditure of
several million dollars, in any other way than by raising capital
for that purpose through the issuance of bonds.
Appellant, in order to raise funds for this and certain other
purposes, made an issue of bonds secured by a second mortgage on
its property. This way duly authorized by the directors and
stockholders in the month of June, 1909; a portion of the bonds was
sold and an initial sum of $1,250,000 thus obtained became
applicable to the improvements referred to in the petition and
other improvements in the grade. Additional bonds have since been
issued as the work has proceeded.
In 1907, appellant began the payment of dividends at the rate of
4% per annum upon its preferred stock, the total amount of which
was $21,000,000, and has continued to pay such dividends each year
until the present time.
Page 231 U. S. 429
These dividends are noncumulative, and are payable only out of
the earnings of the current year. The fact that appellant had paid
its dividends for several years was a factor in its credit.
Preferred dividends having been established, it is claimed that
their discontinuance would have affected the credit of the road so
seriously that it would have been unable except on prohibitive
terms to dispose of additional bonds as further money was required
from time to time during the progress of the work. It is further
claimed that appellant was able to finance its improvements only
out of the proceeds of a bond issue, and that it could not have
financed them at all except by adopting the economical method of
making a considerable part of the grade reductions by means of
changes off the line of the right of way.
Appellant, having paid the cost of the six improvements out of
its issue of bonds, was confronted with the regulations of the
Commission bearing on the method of recording the transaction in
its books of account. Except for those regulations, it is said that
the full cost of the improvements would have been charged to the
account of "Additions and Betterments," -- a subdivision of the
property accounts -- and credited to the proceeds of the bonds,
because that sum had been expended for additions and betterments,
and because the bonds had supplied the funds. In the balance sheet,
the "Assets" would have shown an increment of approximately
$629,399 under the subdivision of Additions and Betterments, and,
per contra, the "Liabilities" would have shown a
corresponding increase under the subdivision of "Bonds."
Under the regulations in question, it was found that, if the
improvements had been made on the original right of way, the
entries would have been made as above indicated. But, with respect
to improvements made off the right of way, different treatment was
prescribed. Here, the appellant was not permitted to carry into its
property
Page 231 U. S. 430
accounts the full cost of the improvement, but was required
first to deduct from the cost thereof the estimated replacement
cost of the portions of track no longer used, the difference only
being carried into the property accounts, and a sum equal to the
estimated cost of replacing the old sections of track being charged
to the operating expenses of that year.
The text of the Classification of Additions and Betterments
relative to revisions made on the original line is as follows:
"Grade Revisions. -- (Reducing of grades by cutting down summits
and raising sags without materially changing the alinement). -- The
amount to be charged to this account is the cost of additional
grading done, including as a portion of such cost the rent and cost
of operation of steam shovels and work trains, building temporary
tracks for steam shovels and grading outfits, tools, etc., used in
the work, raising or lowering existing bridges, increasing the
length of culverts and replacing riprap at culvert ends, changing
grade crossings for farm or country roads, highways, and streets,
including crossing gates, highway crossing alarms, and watch
houses."
Relative to changes off the original line, the regulation is as
follows:
"Changes of Line. -- (Construction of new lines for the purpose
of improving grade or alignment). -- The amount to be charged to
this account is the difference between the cost of the new line and
the cost of replacing in kind the line abandoned, exclusive of
right of way."
The General Instructions contained in the Classification
supplement these rules and prescribe charges to Operating Expenses
as follows:
"5. In case it becomes necessary directly in connection with
betterment or improvement work to abandon any property, the cost of
replacing the abandoned property in kind, plus the cost of removal,
but less the value of salvage, should be charged to the appropriate
accounts under Operating Expenses. In case, however, the amount
so
Page 231 U. S. 431
chargeable is large, and its inclusion in a carrier's operating
expenses for a single year would unduly burden the operating
expense accounts for that year, the carrier may, if so authorized
upon application to the Interstate Commerce Commission, charge such
cost to the Property Abandoned account provided in the Form of
General Balance Sheet statement, or to the reserve account
mentioned in paragraph 6."
"6. When property is abandoned and not replaced, the original
cost (estimated if not known) should be credited to the appropriate
Additions and Betterments Accounts and charged, less salvage, to
Profit and Loss Account, to which should also be charged all
incidental expenses directly connected with the abandonment. If so
authorized upon application to the Interstate Commerce Commission,
however, a carrier may set up depreciation accounts under
'Maintenance of Way and Structures' for the purpose of creating a
reserve to which (instead of Profit and Loss) should be charged the
original cost, less salvage, of the property (other than land or
equipment) abandoned, and all incidental expenses directly
connected with the abandonment."
These are the regulations as they appeared in the Classification
of 1909. In the First Revised Issue (1910), there were some slight
changes, but none now important.
To restrain the enforcement of the regulations so far as they
required or tended to require appellant to charge against its
earnings the estimated replacement value (less salvage) of the six
parcels of railroad line that was abandoned as an incident to grade
reduction as above set forth was the principal object of the
suit.
The petition sets forth the following as a second ground of
complaint. As a part of its program of improvements, appellant is
engaged in erecting a new and enlarged shop and terminal plant at
Shreveport, upon a different location from that of the existing
shop and terminal plant,
Page 231 U. S. 432
which latter are incidentally to be abandoned. It is claimed
that the present shop and equipment are not worn out or obsolete,
but are in good condition, and capable, with ordinary running
repairs, of performing for an indefinite time the functions for
which they were originally constructed. Appellant desires to charge
the estimated value of the abandoned shop and terminal plant,
amounting approximately to $100,000, against its accumulated
surplus as represented in its Profit and Loss Account. The
regulations of the Interstate Commerce Commission relative to
accounting, however, prohibit this charge, and require that the
estimated replacement cost (less salvage) of the existing shop and
terminal plant shall be charged to the Operating Expense Account.
An injunction against the enforcement of the regulations in this
regard also was prayed.
Page 231 U. S. 437
MR. JUSTICE PITNEY, after making the foregoing statement,
delivered the opinion of the Court.
The contention of appellant in the Commerce Court and in this
Court is that the regulations of the Interstate Commerce Commission
relative to the method of keeping the accounts of common carriers,
so far as they are here questioned, are unreasonable, beyond the
power or authority of either Congress or the Commission, and
violative of the Fifth Article of Amendments to the Constitution of
the United States as being a deprivation of property without due
process of law. It is claimed that the effect of enforcing the
regulations under the circumstances of the case is to reduce the
amount of net earnings applicable to dividends, and thereby cause
an irreparable loss to the
Page 231 U. S. 438
preferred stockholders, whose dividends are noncumulative, and
payable only out of the income of the current year; that the
property accounts become inaccurate because, while appellant has
actually expended something more than $600,000 in the improvement
of its property, and its bonded indebtedness has been in fact
increased by the like amount, the accounts will declare that for
this expenditure the company has obtained a net accretion to its
property of only a little over $200,000 ($629,399.74 less $386,484,
or $234,747.74); that the Operating Expense Accounts will be
improperly swollen by the inclusion therein of the sum of $386,484,
to the deception of the stockholders and the investing public and
the impairment of the financial credit of the company, and that,
under the requirements of the Commission, this sum of $386,484,
cannot be charged to and finally taken out of the proceeds of the
bonds, but must be charged to operating expenses, and thus taken
from operating revenue, because of which (as is claimed) this
amount, which has already been paid out of the proceeds of bonds,
must ultimately be restored in cash to the bond account, and
returned to the trustee or otherwise accounted for to the
bondholders. As to the Shreveport shop and terminal plant that are
to be abandoned, it is contended that it is unreasonable to require
the cost of abandonment to be charged to operating expenses, and
that this is a proper charge against the accumulated surplus, as
represented in the Profit and Loss Account.
The authority of the Commission rests upon § 20 of the "Act to
Regulate Commerce" (February 4, 1887, 24 Stat. 379, c. 104,
U.S.Comp.Stat. 1901, p. 3154, as amended by the Hepburn Act of June
29, 1906, 34 Stat. 584, c. 3591).
* The
constitutional
Page 231 U. S. 439
validity of this legislation was sustained in
Interstate
Commerce Commission v. Goodrich Transit Co., 224 U.
S. 194,
224 U. S. 211,
224 U. S.
214.
The authority conferred by Congress upon the Commerce Court (Act
of June 18, 1910, 36 Stat. 539, c. 309;
Page 231 U. S. 440
Judicial Code, § 207) with respect to enjoining or setting aside
the orders of the Commission, like the authority previously
exercised by the federal circuit courts, was confined to
determining whether there had been violations of the Constitution,
or of the power conferred by statute, or an exercise of power so
arbitrary as virtually to transcend the authority conferred.
Interstate Com. Comm. v. Illinois Central R. Co.,
215 U. S. 452,
215 U. S. 470;
Interstate Com. Comm. v. Union Pacific R. Co.,
222 U. S. 541,
222 U. S. 547;
Proctor & Gamble v. United States, 225 U.
S. 282,
225 U. S. 297;
Interstate Com. Comm. v. Baltimore & Ohio R. Co.,
225 U. S. 326,
225 U. S.
340.
As to the intent and meaning of § 20, it is first insisted that
the power conferred upon the Commission to prescribe the forms of
accounts, records, and memoranda to be kept by the carriers,
recognizes a distinction between the form and the substance, and
that, while the Commission, in order to obtain full and accurate
information concerning the affairs of each corporation, must have
power to require any reports, schedules, and accounts necessary to
show the true financial condition of each carrier, yet that the
grant must by fair interpretation, and, in order not to amount to
an unconstitutional delegation of legislative power, stop short of
the point where the regulation in its essence goes not to the form,
but to the substance, and involves interference with the internal
affairs of the corporation. We do not, however, think that any such
distinction between the form and the substance is admissible with
respect to the declared object of standardizing railroad accounts
and obtaining therefrom full and accurate information concerning
the affairs of the respective corporations. The very object of a
system of accounts is to display the pertinent financial operations
of the company, and throw light upon its present condition. If they
are to truly do this, the form must correspond with the substance.
In order that accounts may be standardized,
Page 231 U. S. 441
it is necessary that the accounts of the several carriers shall
be arranged under like headings or titles, and it is obviously
essential that charges and credits shall be allocated under the
proper headings -- the same with one carrier as with another.
Unless "Additions and Betterments," on the one hand, and "Operating
Expenses," on the other, are to indicate the same class of entries
upon the books of one carrier that they indicate upon the books of
other carriers, there is no possibility of standardization. So far
as such uniformity requirements control or tend to control the
conduct of the carrier in its capacity as a public servant engaged
in interstate commerce, they are within the authority
constitutionally conferred by Congress upon the Commission. There
is no direct interference with the internal affairs of the
corporation, and if any such interference indirectly results, it is
only such as is incidental to the lawful control of the carrier by
the federal authority, and to this the rights of stockholders and
bondholders alike are necessarily subject.
It is said, however, that the meaning of the term "operating
expenses" was well defined at the time of the passage of the Act of
1887, and that, during the period intervening between the beginning
of the work of the Commission thereunder and the passage of the
Hepburn Act in 1906, the term had never been construed to include
any charge for property abandoned in the course of improvements,
and that this settled construction, upon familiar principles, must
be deemed to have entered into the purpose of Congress when it
reenacted the language of § 20 in the latter year, and added to it
authority to the Commission to prescribe in its discretion the
forms of accounts and a prohibition against keeping any others than
those prescribed or approved by the Commission. But it will be
observed that § 20, as originally enacted, authorized the
Commission,
"in its discretion, for the purpose of enabling it the better to
carry out the purposes of this act,
Page 231 U. S. 442
[to] prescribe . . . a period of time within which all common
carriers subject to the provisions of this act shall have, as near
as may be, a uniform system of accounts, and the manner in which
such accounts shall be kept."
Congress, when it enacted the Hepburn Act in 1906, must have
known that the Commission had not as yet found occasion to enforce
this provision, and at the same time may be deemed to have
contemplated that the authority then for the first time conferred
upon the Commission to determine and prescribe the maximum rates to
be charged by the carriers for the services to be performed by them
furnished a new and more cogent reason for establishing a uniform
system of accounts.
The contention that the term "operating expenses" had a well
understood and defined meaning, either recognized at the time of
the passage of the Act of 1887 or established by the constant
practice of the Commission from that time until the Hepburn Act, so
that the use of the term in the latter act amounted to an express
limitation upon the grant of power to prescribe the forms of the
accounts, is not well founded. Congress, in authorizing the
Commission to prescribe a uniform system of accounts, recognized
that accounting systems were not then uniform, and, in reiterating
this authorization in 1906 and adding a prohibition against the
keeping of other accounts than those prescribed, manifested a
purpose to standardize and render uniform the accounts of the
different carriers with respect to matters that entered into
property and the improvements thereof, on the one hand, and the
current operations of the company, on the other. By the very terms
of § 20, Congress at least outlined the classification of the
carriers' accounts, for it required the annual reports to show
"the amount of capital stock issued, the amounts paid therefor,
and the manner of payment for the same . . . the surplus fund, if
any, . . . the funded and floating
Page 231 U. S. 443
debts, . . . the cost and value of the carrier's property,
franchises, and equipments; . . . the amounts expended for
improvements each year, how expended, and the character of such
improvements; the earnings and receipts from each branch of
business and from all sources; the operating and other expenses;
the balances of profit and loss, and a complete exhibit of the
financial operations of the carrier each year, including an annual
balance sheet."
By the same section, the Commission was authorized to require
these annual reports from all carriers subject to the act, and to
prescribe the manner in which the reports should be made, and for
this and other purposes to require carriers to have "as near as may
be, a uniform system of accounts, and [to prescribe] the manner in
which such accounts shall be kept."
Plainly the lawmaking body recognized the essential distinctions
between property accounts and operating accounts, between capital
and earnings; it recognized that the practice of different carriers
varied in respect to these matters, and that no system of
supervision and regulation would be complete without requiring the
accounts of all the carriers to speak a common language.
There is here no unconstitutional delegation of legislative
powers. The reasoning adopted in
Interstate Com. Comm. v.
Goodrich Transit Co., 224 U. S. 194,
224 U. S. 210,
etc., is controlling. And since, as just shown, uniformity in
accounting is dependent upon the adoption and enforcement of
precise classification, the authority to define the terms of the
classification necessarily follows. It amounts, after all, to no
more than laying down the general rules of action under which the
Commission shall proceed, and leaving it to the Commission to apply
those rules to particular situations and circumstances by the
establishment and enforcement of administrative regulations.
It is contended that the regulations of the Commission in
respect to the matters now under consideration are
Page 231 U. S. 444
so unreasonable and arbitrary as to constitute an abuse, rather
than an exercise, of the powers conferred by § 20, and consequently
that they ought to be set aside by judicial action. This is not on
the ground that the Commission did not proceed with due
deliberation and after proper inquiry. Respecting this, the record
abundantly shows that, in the year 1906 and shortly after the
passage of the Hepburn Act, the Commission undertook, and for
nearly three years prosecuted, a most thorough investigation into
the current practice of the principal railroad lines, procuring
reports and recommendations from experts and submitting tentative
plans for the classification of accounts to the executives of the
railroad lines and to a committee of accounts created by the
Association of American Railway Accounting Officers, which
association was made up of members representing practically every
important railroad in the country.
The present attack upon the classification as adopted is, and
must be, rested at bottom upon the contention that the regulations
embodied in it are so entirely at odds with fundamental principles
of correct accounting as intrinsically to manifest an abuse of
power.
There is evidence in the record that substantially the same
method of distributing charges for so-called "Additions and
Betterments" between the Property Accounts and the Operating
Accounts is and has long been pursued by important railroad
carriers, and has received the sanction of at least one recent
textbook writer -- Whitten, Valuation of Public Service
Corporations, §§ 450, 451, 458, etc. Nevertheless, it is insisted
with emphasis that property abandoned as an incident to permanent
improvements is not an operating expense, and, in effect, that no
matter what practice may be pursued by railroad accounting
officers, it cannot properly be treated as such.
We are thus brought back to the fundamental distinction between
(a) the property or capital accounts, designed
Page 231 U. S. 445
to represent the investment of the stockholders, and to show the
cost of the property as originally acquired, with subsequent
additions and improvements, these assets being balanced by the
liabilities, including the amount of the capital stock and of
bonded and other indebtedness, with net profits or surplus, whether
carried under the head of "profit and loss" or otherwise, and (b)
the operating accounts, designed to show, on the one side, gross
receipts or gross earnings for the year, and on the other side the
expenditures involved in producing those gross earnings and in
maintaining the property, the balance being the net earnings.
Since the regulation of the railroad carrier by the public
authority, and especially the fixing of the rates to be charged,
depend primarily upon two fundamental considerations, (a) the value
of the property that is employed in the public service and (b) the
current cost of carrying on that service, it is clear that the
maintenance of a proper line of distinction between property
accounts and operating accounts is essential to the execution by
the Interstate Commerce Commission of the supervisory and
regulatory powers conferred upon it by Congress.
Appellant contends,
inter alia, that, since the
original locations were necessary in the development of its
railroad line, and were abandoned only as an incident to the
improvement and development of the property, the cost thereof,
being, as it is termed, a part of the "cost of progress," should
remain in the property account, as representing a part of the
stockholders' present investment.
Support for this contention is sought in previous decisions of
this Court. In
Union Pacific R. Co. v. United States,
99 U. S. 402, a
decision that turned upon the meaning and effect of an Act of 1862
for aiding the construction of the railroad (12 Stat. 489, c. 120),
it was said at p.
99 U. S.
420:
"As a general proposition, net earnings are the excess of the
gross earnings over the expenditures defrayed
Page 231 U. S. 446
in producing them, aside from, and exclusive of, the expenditure
of capital laid out in constructing and equipping the works
themselves. It may often be difficult to draw a precise line
between expenditures for construction and the ordinary expenses
incident to operating and maintaining the road and works of a
railroad company. Theoretically, the expenses chargeable to
earnings include the general expenses of keeping up the
organization of the company, and all expenses incurred in operating
the works and keeping them in good condition and repair, whilst
expenses chargeable to capital include those which are incurred in
the original construction of the works, and in the subsequent
enlargement and improvement thereof."
In
Illinois Central R. Co. v. Interstate Commerce
Commission, 206 U. S. 441, the
Commission had held (206 U.S.
206 U. S. 449)
that, while repairs were properly chargeable to current operating
expenses, yet expenditures for improvements and equipment
"should not be taxed as part of the current or operating
expenses of a single year, but should be, so far as practicable and
so far as rates exacted from the public are concerned, projected
proportionately over the future."
And in this Court, it was said (p.
206 U. S.
462):
"It would seem as if expenditures for additions to construction
and equipment, as expenditures for original construction and
equipment, should be reimbursed by all of the traffic they
accommodate during the period of their duration, and that
improvements that will last many years should not be charged wholly
against the revenue of a single year."
And, after pointing out that the case of the Union Pacific
Railway Company in 99 U.S. had to do not with rates of
transportation or the like, but with the construction of the words
"net earnings" in an act of Congress, the Court, in pointing out
the difference between the position of the government in that case
and the position of a shipper of commodities in the case
sub
judice, said, with respect to the latter (p.
206 U. S.
463):
Page 231 U. S. 447
"His right is immediate. He may demand a service. He must pay a
toll, but a toll measured by the reasonable value of the service.
The elements of that value may be many and complex, not always
determinable, as we have seen, with mathematical accuracy; but, we
think, it is clear that instrumentalities which are to be used for
years should not be paid for by the revenues of a day or year, and
this is the principle of returns upon capital which exists in
durable shape."
The expressions quoted were properly employed with respect to
the questions then presented for decision. As expressions of the
general principle, we see no occasion now to qualify them. In both
cases, it was recognized that, in so complicated a matter as the
construction, maintenance, and operation of a railroad line, it is
difficult to define, and perhaps more difficult to consistently
apply, a precise distinction between capital and expense accounts,
and, while the propriety of distributing improvement costs over a
series of years was recognized, the impossibility of scientific
accuracy in that regard was acknowledged. The question now is
whether the regulations of the Commission under attack do violence
to these general principles -- rather, it is whether those
regulations are so clearly contrary to these and other applicable
principles that they should be set aside as being in excess of the
powers conferred by Congress upon the Commission.
We are unable to see that there is substantial inconsistency
with principle, much less gross violation thereof. The contention
of the appellant that property, originally acquired because
necessary in the construction of the road, and afterwards abandoned
only because rendered unnecessary by the improvement and
development of the property, should remain in the property account
as a part of the stockholders' investment, will be found, upon
analysis, to rest upon the unwarrantable assumption that all
capital expenditures result in permanent accretions to the
Page 231 U. S. 448
property of the company. This in effect ignores depreciation --
an inevitable fact which no system of accounts can properly ignore.
A more complete depreciation than that which is represented by a
part of the original plant that through destruction or obsolescence
has actually perished as useful property it would be difficult to
imagine. The fact that the original investment was necessary in
order that the second investment might be made is not a conclusive
test. Reference is made to the cost of the scaffolding used in the
erection of a house, and discarded when the house is completed, and
to the cost of the paper that goes to the wastebasket rather than
to the printer, in the preparation of a literary composition; but
these are fanciful analogies, and do not assist us here, where the
real question is not how shall original cost be ascertained, but,
how shall subsequent depreciation in value be reckoned and
accounted for?
In
Knoxville v. Knoxville Water Co., 212 U. S.
1, this Court had to do with a similar element of
depreciation, and, after pointing out that such a plant as was
there in question begins to depreciate in value from the moment of
its use, and that, before coming to the question of profit at all,
the company was entitled to earn a sufficient sum annually to
provide not only for current repairs, but for making good the
depreciation and replacing the parts of the property when they
should come to the end of their life, the Court proceeded to say
(p.
212 U. S.
14):
"If, however, a company fails to perform this plain duty and to
exact sufficient returns to keep the investment unimpaired, whether
this is the result of unwarranted dividends upon overissues of
securities or of omission to exact proper prices for the output,
the fault is its own. When, therefore, a public regulation of its
prices comes under question, the true value of the property then
employed for the purpose of earning a return cannot be enhanced by
a consideration of the errors in management which have been
committed in the past. "
Page 231 U. S. 449
And since one of the manifest objects of Congress in authorizing
the supervision and standardization of carriers' accounts, as is
done in § 20 of the Interstate Commerce Act, was to enable the
Commissioners to intelligently perform their duties respecting the
regulation of carriers' rates for the services performed, and since
it is settled that the property investment which is to be taken
into consideration as one of the elements in fixing such rates is
the property then in use (
Smyth v. Ames, 169 U.
S. 466,
169 U. S. 546;
San Diego Land & Town Co. v. National City,
174 U. S. 739,
174 U. S. 757;
San Diego Land & Town Co. v. Jasper, 189 U.
S. 439,
189 U. S. 442;
Willcox v. Consolidated Gas Co., 212 U. S.
19,
212 U. S. 41;
Minnesota Rate Cases, 230 U. S. 352,
230 U. S. 434,
230 U. S. 454,
230 U. S.
458), it is obvious that, so far as the regulations of
the Commission now under consideration discard the "cost of
progress" theory, they need no further vindication.
It is insisted that, if the appellant, having expended in round
figures $600,000, secured by the sale of bonds for improvements,
can be compelled to charge $400,000 of that amount to the operating
expense of one year, or to distribute it among the operating
expenses of a series of years, and if it be forbidden to keep any
other record representing the transaction, it will have in its
possession no kind of record from which it can report accurately
either the cost of its property or the cost of improvements or its
operating expenses. This, we think, is a misapprehension of the
effect of the regulations. They do not require appellant to falsify
its books or to change in any way the evidential character of the
original entries. The source of the money, and the disposition made
of it as expended, may and should be correctly shown. The
regulations do require that the contemporaneous abandonment of
other property be likewise shown, and the replacement cost, less
salvage, charged to the appropriate accounts under operating
expenses. This, if observed, of course, results
Page 231 U. S. 450
in enforcing a prescribed distinction between capital expense
and operating expense. It does not require that the record of the
expenditure be obliterated, but it does, of course, affect the
results as they work out upon the balance sheet. If this be fairly
done, there is no transmutation of new property into operating
expenses, but only an insistence upon the requirement that new
property added shall not alone be the measure of the accretion to
the property account, and that the depletion attributable to
contemporaneous abandonment of other property shall likewise be
reflected upon the books.
Stress is laid upon the fact that, if the grade reductions in
question had been made upon the line of the original right of way,
even though made at double the expense, the cost would have gone
into "additions and betterments," and would have stood as a
permanent increment of assets in the property account, while, with
respect to similar improvements made off the line of the original
right of way, appellant is not permitted to carry into the property
account the full cost of the improvement, but must first deduct
therefrom the estimated replacement cost (less salvage) of the
portions of track no longer used, charging this to the account of
operating expenses.
So far as the comparative expense of the different modes of
improvement is concerned, little need be said. The accounting
regulations do not seek to control railroad companies in the
exercise of their discretion respecting what shall be done and how
it shall be done, but only to systematize their accounts with
respect to whatever is done. It is to be presumed that boards of
directors will select that method of accomplishing a needed grade
revision that shall be preferable from the engineering standpoint
and suited to the financial condition and prospects of the company,
not that they will adopt an inferior or more costly method of
improvement because of the accounting requirements.
Page 231 U. S. 451
The distinction drawn between grade improvements "off the line"
and those made "on the line" rests upon the view that the
discarding of sections of the original line of road is a loss or
depreciation that, in correct accounting, should be taken out of
the property account. If this is to be done, its value must be
charged, directly or indirectly, as an expense incident to the
operation of the road. Whether it should be charged against the
accumulated profits of previous years, as reflected in the Profit
and Loss Account, or against the profits of present and future
years may depend upon circumstances. The theory upon which the
Commission has acted in formulating its regulations is fairly
stated in its brief herein as follows: the abandonment of property
incident to grade revision is "depreciation," and such depreciation
is of two kinds -- (1) that which is not replaced in kind and (2)
that which is replaced by improved materials, track, or equipment.
If a trunk line of road has a branch extending into a territory not
served by its main line, and, finding the branch unprofitable,
abandons it, taking up the track without constructing any
substitute to serve the same territory, the abandoned branch ceases
to be an earning instrumentality; the stockholders can thereafter
derive no profit from it; it has served its purpose, and only past
operations have benefited from it. So far as the profits of past
operations have not been distributed to the stockholders, they are
represented in the Profit and Loss Account, and therefore such an
abandonment or depreciation is properly chargeable to that account
unless a special depreciation account has been established in
anticipation of such abandonments, and for such an account,
provision is made in the regulations. The other kind of
depreciation is the result of changes attributable to the
inadequacy of the existing property to meet the demands of the
future. The road or the structures have to be replaced with
stronger or more efficient instrumentalities. Abandonments
Page 231 U. S. 452
occasioned by changes of this character are therefore chargeable
to future earnings for the reason that the improved condition of
the road is not only designed to meet the demands of the future,
but presumably will result in economics of operation, and so the
resulting benefits will be reaped by those who hold the stock of
the company in the present and in the future. The railroad company
may, if it sees fit, anticipate general depreciations and make
provision for them by establishing a reserve for the purpose; but
if no such provision has been made, the abandonment should be taken
care of by charging them to present or future operating expense. In
case, however, the amount is so large that its inclusion in a
carrier's operating expenses for a single year would unduly burden
the operating expense account for that year, the carrier may, if so
authorized by the Commission, distribute the cost throughout a
series of years.
A statement of the theory is sufficient to show that the
regulation is not arbitrary in the sense of being without
reasonable basis. And there is evidence to show that the Commission
was warranted in adopting it, as sustained by expert opinion and
approved by experience.
One of the reasons for the distinction made in accounting
between improvements made on, and those made off, the old right of
way is that, in the former case, the improvements show themselves
in the physical structures, and can be inventoried and appraised by
witnesses; the deepening of cuts and increasing of fills, while
involving some abandonments (and these under the regulations are to
be taken out of the operating account), yet in the main are visible
upon the ground and capable of mensuration and appraisement. To the
suggestion that cuts filled up and embankments reduced would not be
thus manifest, it is sufficient to say that, if such cases occur,
they must be most extraordinary. When a railroad is originally
constructed, cuts and fills are made to overcome natural
Page 231 U. S. 453
inequalities of surface; if any undue grades are permitted to
remain, it is usually because, for reasons of economy, cuts have
been made less deep and fills less high than otherwise they would
have been made. Therefore grade revisions upon the line of the
original right of way are normally required for the purpose of
removing summits in cuts and raising sags in fills, not
vice
versa.
It is said that the effect of the regulations, if complied with,
is to deprive the preferred stockholders of a considerable part of
the noncumulative dividends from the net earnings of the company to
which they would otherwise be entitled. The preferred stockholders,
as such, are not before the court, and this is not a proper
occasion for determining their rights. Supposing, however, that the
enforcement of the accounting system does require them to forego
their current dividends, we do not concede that this amounts to an
unlawful taking of their property. Assuming (as, of course, we
must) that the management of the company has acted prudently in
making these extensive improvements within a short time, instead of
distributing them throughout a series of years, and without
providing in advance any fund applicable to them, still it must be
presumed that the improvements are necessary to the general welfare
of the company, and will result in its increased prosperity, and
therefore make better the assurance of dividends for the preferred
stockholders in the future.
But, aside from that, the Interstate Commerce Act deals with the
carrier in its capacity as a servant of the public, and as a
distinct entity, amenable to the legitimate regulation of Congress
and the Commission. If in this aspect the carrier is not
unwarrantably injured or deprived of its property by the exercise
of the regulatory powers, the operation of such regulations cannot
be restrained on the ground of agreements made by the stockholders
amongst themselves for apportioning profits to one or the
Page 231 U. S. 454
other class of stockholders. To admit this might materially
hamper the federal control over interstate carriers, and evidently
would tend to render impracticable the standardization of methods
of accounting.
Much stress is laid upon the situation that results from the
circumstance that (as is claimed) these regulations were
promulgated after appellant had mortgaged its property and issued
bonds for financing the improvements in question. It is not
contended that the regulations impair the rights of either party
under the mortgage. The contention is that the company had the
right to finance the full cost of the improvements out of the
proceeds of a bond issue, and that the regulations amount in effect
to a veto upon the action of the directors in this respect.
Supposing this to be true, we are unable to perceive that the
appellant is thereby relieved from compliance with the regulations.
Whatever was done about authorizing the improvements and financing
the cost from the bond issue was done subject to being displaced by
the exercise of the powers conferred upon the Interstate Commerce
Commission by the Act of 1906. The regulations do not affect the
administration of the borrowed money. It was borrowed
inter
alia specifically for use in "reducing grades to one-half of
one percent on three full operating divisions, aggregating 41
percent of the total length of the line." And, by the mortgage,
appellant covenanted to use the bonds and the proceeds thereof in
calling in and redeeming an outstanding loan, "and for the general
improvement of its property." In short, so far as appears, there is
nothing in the regulations to prevent the appellant from devoting
the money strictly to the purposes for which it was borrowed,
although they do prevent the keeping of the accounts in such manner
as to make it appear that the book value of the company's assets is
enhanced to the full extent of the moneys disbursed in the
improvements.
Page 231 U. S. 455
When it is said that the amount of $386,484, which, under the
requirements of the Commission, must be charged to operating
expenses must for that reason be ultimately restored in cash to the
bond account and returned to the trustee, or otherwise accounted
for to the bondholders, this does not mean that any obligation of
that kind is imposed upon appellant by the classification. We are
not referred to anything in the classification, in the provisions
of the mortgage, or in the law that imposes any such duty. What is
meant (as we presume) is that, if the operating expenses are
increased and the operating revenue decreased by the amount
mentioned, in accordance with the regulations, and the payment of
dividends should nevertheless continue, the books would make it
appear that the dividends were paid not from earnings, but from the
proceeds of the bonds. In other words, the regulations of the
Commission prevent the proceeds of the bond issue from being used,
in whole or in part, to maintain dividend payments without that
fact's appearing upon the accounts, and, since it is improbable
that appellant would be willing to have the accounts bear such an
interpretation, it is probable that the proceeds of the bonds will
not be employed for dividend purposes, and unless required for
further improvements, may as well be returned to the trustee for
the bondholders. Since one of the very purposes of establishing the
accounting system is to deter the payment of dividends out of
capital, the criticism, upon analysis, bears its own
refutation.
The same may be said of the argument that enforcement of the
regulations will impair the credit of appellant by diminishing
apparent earnings, preventing continuance of dividends upon
preferred stock and keeping down the aggregate value of "assets"
upon the property accounts. Presumably the regulations have a
tendency to place the accounting system upon a sound basis in these
respects, and to accomplish this was one of the legitimate
Page 231 U. S. 456
objects at which Congress aimed in the enactment of § 20 of the
Interstate Commerce Act.
It is further insisted that even the theory upon which the
accounting regulations rest does not, when analyzed, justify a
charge of abandoned property to operating expenses, but at most a
charge to profit and loss. The suggestion apparently has force;
but, upon consideration, we are unable to see that it furnishes
ground for judicial interference with the course pursued by the
Commission. Except for the contention (already disposed of) that
the value of the abandoned parcels should be permanently carried in
the property account as part of the cost of progress, it is and
must be conceded that, sooner or later, it must be charged against
the operating revenue, either past or future, if the integrity of
the property accounts is to be maintained, and it becomes a
question of policy whether it should be charged
in solido
to profit and loss (an account presumptively representative of past
accumulations) or to the operating accounts of the present and
future. If abandoned property is not charged off in one way or the
other, it remains as a permanent inflation of the property
accounts, and tends to produce, directly or indirectly, a
declaration of dividends out of capital. If it be charged off to
the surplus account, it tends to prevent the declaration of
dividends based upon a supposed accumulation of past earnings. If
charged to operating expenses of the current and future years, it
has a tendency to prevent the declaration of dividends from current
earnings until the amount of the depreciation shall have been made
up out of the earnings.
But, did we agree with appellant that the abandonments ought to
be charged to surplus or to profit and loss, rather than to
operating expenses, we still should not deem this a sufficient
ground to declare that the Commission had abused its power. So long
as it acts fairly and reasonably within the grant of power
constitutionally conferred
Page 231 U. S. 457
by Congress, its orders are not open to judicial review.
What has been said respecting the enforced disposition of the
charges for property abandoned in grade revision applies as well to
the abandonment of the present shop and terminal plant at
Shreveport.
Decree affirmed.
*
"SEC. 20. That the Commission is hereby authorized to require
annual reports from all common carriers subject to the provisions
of this Act, and from the owners of all railroads engaged in
interstate commerce as defined in this Act, to prescribe the manner
in which such reports shall be made, and to require from such
carriers specific answers to all question upon which the Commission
may need information. Such annual reports shall show in detail the
amount of capital stock issued, the amounts paid therefor, and the
manner of payment for the same; the dividends paid, the surplus
fund, if any, and the number of stockholders; the funded and
floating debts and the interest paid thereon; the cost and value of
the carrier's property, franchises, and equipments; . . . the
amounts expended for improvements each year, how expended, and the
character of such improvements; the earnings and receipts from each
branch of business and from all sources; the operating and other
expenses; the balances of profit and loss, and a complete exhibit
of the financial operations of the carrier each year, including an
annual balance sheet. Such reports shall also contain such
information in relation to rates or regulations concerning fares or
freights, or agreements, arrangements, or contracts affecting the
same as the Commission may require, and the Commission may, in its
discretion, for the purpose of enabling it the better to carry out
the purposes of this Act, prescribe a period of time within which
all common carriers subject to the provisions of this Act shall
have, as near as may be, a uniform system of accounts, and the
manner in which such accounts shall be kept."
"
* * * *"
The Commission may, in its discretion, prescribe the forms of
any and all accounts, records, and memoranda to be kept by carriers
subject to the provisions of this Act, including the accounts,
records, and memoranda of the movement of traffic as well as the
receipts and expenditures of moneys. The Commission shall at all
times have access to all accounts, records, and memoranda kept by
carriers subject to this Act, and it shall be unlawful for such
carriers to keep any other accounts, records, or memoranda than
those prescribed or approved by the Commission, and it may employ
special agents or examiners, who shall have authority under the
order of the Commission to inspect and examine any and all
accounts, records, and memoranda kept by such carriers. This
provision shall apply to receivers of carriers and operating
trustees.
