1. Where the property of a railroad corporation, to be sold
under foreclosure, is so great as to render cooperation between
bondholders and stockholders essential in order to secure a bidder
and prevent undue sacrifice of their interests, they may enter into
a fair and open reorganization arrangement to that end. P.
271 U. S.
453.
2. But such arrangements are invalid if they recognize and
preserve the interests of stockholders at the expense of the prior
rights of the secured or unsecured creditors of the corporation.
Nor. Pac. Ry. v. Boyd, 228 U. S. 482.
Id.
3. A plan of reorganization, to bind the unsecured creditor,
must "give precedence to" --
i.e., recognize the superior
importance of -- the creditor's claim over any interest of the
stockholder in the old company. P.
271 U. S.
455.
4. Subject to the qualifications that the primary right of
unsecured creditors to the assets of the insolvent corporation,
remaining after lienholders are satisfied, must be adequately
protected, and that to each one of them must be given such
opportunity as the circumstances permit to secure the full
enjoyment of this preference, a plan of reorganization which offers
them securities of the same grade as those offered the
stockholders, but greater in amount, will be fair, and bind the
unsecured creditors if, in the opinion of the court, it tenders to
such creditors all that could be reasonably expected under all the
existing circumstances. P
271 U. S.
455.
5. Where the same grade of securities is offered both to
unsecured creditors and to stockholders, the difference being that
the stockholders are called upon to pay an assessment, or a
relatively greater assessment than that asked of creditors, it may
nevertheless
Page 271 U. S. 446
be fair and binding if the court is of the opinion that it
tenders them all that could reasonably be expected under all the
existing circumstances; but the prior rights of creditors, as above
pointed out, must be recognized, and assessments, whenever
demanded, must be adjusted to the purpose of according to the
creditor his full right of priority against the corporate assets as
far as possible in the existing circumstances. P.
271 U. S. 456.
Response to questions certified by the circuit court of appeals
on an appeal from a decree of the district court in a railway
foreclosure suit.
See 294 F. 32.
Page 271 U. S. 450
MR. JUSTICE McREYNOLDS delivered the opinion of the Court.
This cause is here on certificate from the United States Circuit
Court of Appeals, Eighth Circuit. Judicial Code, ยง 239. The
relevant facts and the submitted questions follow.
In a proceeding by creditors, the United States District Court,
Eastern District of Missouri, appointed a receiver for the
Missouri, Kansas & Texas Railway Company. Appellees asked
foreclosure of liens upon the whole property, and procured an order
of sale. According to a plan for purchase and reorganization, with
definite offers to lien creditors, unsecured creditors, and
stockholders, Blumenthal and another bid in the assets and then
assigned the rights so acquired to the Missouri-Kansas-Texas
Railroad Company, a newly organized Missouri corporation.
Pending entry of the final decree, appellants asserted
preferential rights. These were denied, and they were held to be
unsecured contract creditors.
Kansas City Terminal Ry. Co. v.
Central Union Trust Co., 294 F. 32. Thereupon they challenged
the reorganization plan as unfair to them and unduly preferential
to stockholders of the insolvent corporation. The trial court
overruled their objection, the matter went to the circuit court of
appeals, and it has asked for instruction.
The reorganization scheme required the issuance of four classes
of securities by the new company:
(1) Prior lien mortgage bonds (authorized, $250,000,000).
(2) Cumulative adjustment, or income, bonds (authorized,
$100,000,000), secured by mortgage as to principal.
(3) Preferred stock (authorized, $200,000,000).
(4) Common stock, without par value (authorized, 2,500,000
shares).
Specified amounts of each of these were reserved for future use
by the new company. Some of the prior lien
Page 271 U. S. 451
bonds bore interest at 4, some at 5, and some at 6 percent
New securities were offered to the holders of seventeen separate
issues of outstanding bonds of the old company and its various
subsidiaries, secured by mortgage, and one issue of notes, secured
by the pledge of mortgage bonds. In some cases, but not all, cash
was offered to holders of these secured claims in addition to the
new securities. Always the par amount of the new securities offered
(taking the new nonpar value common stock at $100 per share), plus
the cash offered, if any, equaled, but never exceeded, the
principal amount of the old securities in respect of which the
offer was made, plus interest to January 1, 1922.
Of these eighteen outstanding issues, five were offered new
prior lien bonds and cash; one was offered new prior lien bonds;
five were offered new prior lien bonds and new adjustment bonds;
three were offered new prior lien bonds, new adjustment bonds, and
new preferred stock; one was offered new adjustment bonds and new
preferred stock; three were offered new adjustment bonds, new
preferred stock, and new common stock.
In all cases, the new prior lien bonds and the new adjustment
bonds (whether offered to secured creditors, unsecured creditors,
or stockholders) were to bear interest from January 1, 1922.
As to stockholders and unsecured creditors, it was provided: (1)
Preferred stockholders might receive $14 in prior lien bonds
(bearing 6 percent), $6 in adjustment bonds, and one share of
common stock in the new company, upon payment of $20 for each $100
share of old stock. (2) Common stockholders might receive $17,50 in
6 percent prior lien mortgage bonds, $7.50 in adjustment bonds, and
one share of common stock, upon payment of $25 for each $100 share
of old stock. (3) Unsecured creditors were given the choice of two
plans:
Page 271 U. S. 452
(a) One-third of a share of preferred stock, $100 par value, and
two-thirds of a share of common stock without par value, for each
$100 of their claims, plus interest to January 1, 1922 (whereas the
receiver was appointed and took possession of the property
September 27, 1915, foreclosure decree was entered June 30, 1922,
offer to creditors was dated July 15, 1922, foreclosure sale was
had December 13, 1922, order confirming the sale was entered
February 9, 1923, and order approving the master's deed conveying
the property to the new company was entered on March 10, 1923); (b)
$14 in prior lien mortgage 6 percent bonds, $6 in adjustment
mortgage bonds, and one share of common stock, upon payment of $18
for each $100 of their claims.
Appellants maintained below that
Northern Pacific Railway
Co. v. Boyd, 228 U. S. 482, and
Louisville Trust Co. v. Louisville Railway Co.,
174 U. S. 674,
require that an offer in a reorganization plan, in order to be fair
and binding upon him, must preserve
"to the creditor his relative priority over the stockholder. It
is not sufficient that he should get a little more than the
stockholder. His entire claim must take precedence over any part of
the interest of a stockholder. It is not sufficient that he be
offered securities of the same grade as the stockholder, but a
trifle more in amount, or that the stockholder's right to
participate be conditioned upon the payment of an assessment."
The questions:
"I. Is a plan of reorganization of a railway company sufficient
as to unsecured creditors, and binding upon them, which does not
give precedence to the entire claim of the creditor over any part
or interest of a stockholder in the old company?"
"II. Is such a plan fair and binding upon such creditors even
though they be offered securities of the same grade as the
stockholders, the difference being only in the
Page 271 U. S. 453
greater amount offered the creditors, provided the court shall
be of the opinion that the offer tenders to such creditors all that
could reasonably be expected under all of the existing
circumstances?"
"III. Is such offer as to such creditors fair and binding if it
consists only of the same grade of securities as offered the
stockholders, the difference being that the right of the
stockholders to participate is conditioned upon the payment of an
assessment or the payment of a relatively greater assessment than
that asked of such creditors, provided the court shall be of the
opinion that the offer tenders to such creditor all that could
reasonably be expected under all of the existing
circumstances?"
These questions lack precision, and the accompanying statement
of facts fails to reveal the detail of the situation with desirable
clearness. There is nothing to show the amount or character of the
insolvent company's outstanding securities, or the amount of the
unsecured indebtedness, or the probable value of the equity in the
property beyond secured debts, or the amount of money deemed
necessary to insure successful operation of the new company. The
questions therefore must be defined and answered with certain
qualifications.
Chicago, etc., Railroad Co. v.
Howard, 7 Wall. 392,
Louisville Trust Co. v.
Louisville Railway Co., 174 U. S. 674, and
Northern Pacific Railway Co. v. Boyd, 228 U.
S. 482, gave much consideration to the general
principles which must control the present cause. These were applied
in
Kansas City, etc., Railway Co. v. Guardian Trust Co.,
240 U. S. 166, and
Pierce v. United States, 255 U. S. 398.
We accept those opinions as authoritative, and it now may be
announced as settled doctrine that, where the value of corporate
property to be sold under foreclosure is so great as to render
cooperation between bondholders and stockholders essential in order
to secure a bidder and
Page 271 U. S. 454
prevent undue sacrifice of their interests, they may enter into
a fair and open arrangement to that end. But
"no such proceedings can be rightfully carried to consummation
which recognize and preserve any interest in the stockholders
without also recognizing and preserving the interests not merely of
the mortgagee, but of every creditor of the corporation. In other
words, if the bondholder wishes to foreclose and exclude inferior
lienholders, or general unsecured creditors and stockholders, he
may do so; but a foreclosure which attempts to preserve any
interest or right of the mortgagor in the property after the sale
must necessarily secure and preserve the prior rights of general
creditors thereof. This is based upon the familiar rule that the
stockholder's interest in the property is subordinate to the rights
of creditors, first of secured and then of unsecured creditors. And
any arrangement of the parties by which the subordinate rights and
interests of the stockholders are attempted to be secured at the
expense of the prior rights of either class of creditors comes
within judicial denunciation."
Louisville Trust Co. v. Louisville Railway Co.,
174 U. S. 683,
174 U. S.
684.
This doctrine is the "fixed principle" according to which
Northern Pacific Railway Co. v. Boyd, 228
U. S. 507, declares the character of reorganization
agreements must be determined, and to it there should be rigid
adherence. But, as that opinion states, this does not require the
impossible, and make it necessary always to pay unsecured creditors
in cash before stockholders may retain any interest whatever in the
reorganized company. By way of illustration, it further pointed out
that such creditors can be protected "by the issuance, on equitable
terms, of income bonds or preferred stock." And we now add that,
when necessary, they may be protected through other arrangements
which distinctly recognize their equitable right to be preferred to
stockholders against the full value of all property belonging to
the debtor corporation, and afford each of them
Page 271 U. S. 455
fair opportunity, measured by the existing circumstances, to
avail himself of this right.
Unsecured creditors of insolvent corporations are entitled to
the benefit of the values which remain after lienholders are
satisfied, whether this is present or prospective, for dividends or
only for purposes of control. But reasonable adjustments should be
encouraged. Practically, it is impossible to sell the property of a
great railroad for cash, and generally the interests of all
parties, including the public, are best served by cooperation
between bondholders and stockholders. If creditors decline a fair
offer based upon the principles above stated, they are left to
protect themselves. After such refusal, they cannot attack the
reorganization in a court of equity.
Northern Pacific Railway
Co. v. Boyd, 228 U. S.
508.
Question I, if interpreted strictly and according to the
ordinary meaning of the words employed, must be answered in the
negative. We assume that to "give precedence" implies recognition
of superior importance. As above stated, to the extent of their
debts creditors are entitled to priority over stockholders against
all the property of an insolvent corporation. But it does not
follow that, in every reorganization, the securities offered to
general creditors must be superior in rank or grade to any which
stockholders may obtain. It is not impossible to accord to the
creditor his superior rights in other ways. Generally, additional
funds will be essential to the success of the undertaking, and it
may be impossible to obtain them unless stockholders are permitted
to contribute and retain an interest sufficiently valuable to move
them. In such or similar cases, the chancellor may exercise an
informed discretion concerning the practical adjustment of the
several rights.
Question II is answered in the affirmative, with the
qualifications which follow. The primary right of unsecured
creditors to the assets of an insolvent corporation
Page 271 U. S. 456
remaining after lienholders are satisfied must be adequately
protected, and to each one of them there must be given such
opportunity as the circumstances permit to secure the full
enjoyment of this preference.
Question III is also answered in the affirmative, subject to the
following qualification. No offer is fair which does not recognize
the prior rights of creditors, as above pointed out; but
circumstances may justify an offer of different amounts of the same
grade of securities to both creditors and stockholders. Whenever
assessments are demanded, they must be adjusted with the purpose of
according to the creditor his full right of priority against the
corporate assets, so far as possible in the existing
circumstances.