Railroad Reorganization

by Stuart Daggett

The main difference between this and the English scheme lay in the treatment of the floating debt. It is improbable, however, that the substitute which this plan offered would have been sufficient, and that the preferred stock could have brought $66, at which price alone it would have covered the floating debt. Reading common stock was selling in the middle of the month at 16⅜; general mortgage 6s were bringing only 74¼, while debentures and convertible 7s were being quoted at 28 and 37 respectively.

In October a representative of the English bondholders arrived in Philadelphia for the purpose of examining into the condition of the company, and the following month agreed with the board of managers upon a reorganization committee to act in the United States. “The probabilities are,” said this gentleman (Mr. Thomas Wilde Powell), “that it will be found that the bondholders in London will be willing to do as they did in the case of the Erie, that is, fund a reasonable number of coupons ... for the purpose of setting at liberty a portion of the revenue to pay unfunded claims.”[169] The next move in the reorganization of the company came, however, not from this committee but from President Gowen, the man who had led the Reading into the purchase of coal lands, and who still remained in office in spite of the hostility shown toward him. His scheme comprised two parts: the first an issue of income bonds with which to pay off the floating debt (together with $5,000,000 mortgage bonds); the second a grand general mortgage to retire existing indebtedness. The plan in more detail was as follows:

(1) The company was to create $34,300,000 deferred income bonds, on which interest was to be deferred to a dividend of 6 per cent on the common stock. After this amount had been paid the bonds were to take all revenue up to 6 per cent and were then to rank pari passu with the common shares for further dividends. The debentures were to be issued at 30 per cent of their par value, or $15 per bond; and before selling or disposing of said bonds in the market the option of taking a pro rata share was to be first offered to the stockholders of the company.[170]

(2) A more permanent relief for the company was to be obtained from the proposal to issue a new long time or perpetual 5 per cent funding mortgage of $150,000,000, divided into two classes, A and B, of $75,000,000 each: class A having priority of lien and interest charge over class B. With this issue it was proposed, by purchase or exchange, to retire all outstanding indebtedness, and to acquire by purchase the securities of the companies owning the leased lines. It was estimated that $140,000,000 of the new issue would provide for all of this, the total interest on which would be $7,000,000, as against fixed charges for interest, sinking funds, and rentals, of $10,657,116, making an annual saving of $3,657,116.[171] Mr. Gowen did not expect to secure so large an annual reduction, owing to the impossibility of purchasing the higher securities and the probable appreciation in value of the lower ones; but he did expect to realize in all a saving of some $2,700,000.

In part this plan was commendable; in part it was inadequate, and in part it relied on a mere juggling with words. The proposal to unify all classes of indebtedness by a grand consolidated 5 per cent mortgage was a good one, both in the simplification of accounts which was to be expected, and in the reduction in fixed charges so far as this reduction went; but on the one hand a reduction of $2,700,000 in charges was too little for a company which had reported for that very year a deficit of $2,000,000, and on the other hand too little allowance was made for the difficulty of forcing securityholders without a foreclosure sale to submit to a definitive scaling down of their holdings, with not even a preferred stock to show for the sacrifice. In its handling of the floating debt, the plan was a second edition of Mr. Jones’s stock-selling scheme, with all the good points left out. What justification there could have been for calling securities, such as the deferred incomes, “bonds,” which were to be issued for no definite time, ranked even after the common stock for dividends, and were of such doubtful character that Mr. Gowen himself proposed to sell them for one-third of their face value, does not appear; unless it be that the lack of voting power, itself a disadvantage, entitled them to the more respected name. The deferred income bonds were a device for saddling the holders of the unsecured debt with a worthless certificate which they might be induced to accept because of its name, and to which not even the Reading stockholders could object. Furthermore, even if the creditors had been eager for this new issue, in itself it would not have been sufficient. The issue, if taken up, would have yielded $10,200,000. It was proposed besides to sell $5,000,000 of unissued general mortgage bonds, which, after the success of the deferred income bonds, it was presumed would sell at par. Income bonds and general mortgage together promised a total of $15,200,000, or more than $1,000,000 over cash requirements after commissions had been paid.[172]

However poor the prospect, there was no lack of syndicate guarantee. In November, 1880, a London syndicate agreed to deposit with an American bank, to be named by the company, the sum of $2,058,000, to be forfeited in case they failed to take at the issue price all deferred income bonds not taken by the shareholders. This syndicate further agreed that the company might retain, up to $1,000,000, out of the deposit money, whatever might be necessary to make up a second instalment of $4 on such neglected bonds.[173] Nothing was asked from the company in return except the chance to sell the bonds purchased at a premium. “As long as the bond- and shareholders find the money,” remarked the London Times, “there is nothing to be said. In all probability, however, these deferred bonds will become a medium for the very worst kind of gambling, and their chances for a dividend appear to us to be very small.”[174]

In December Mr. Gowen’s plan received the approval of the American committee and of the board of managers of the company. Bondholders were in no way injured by the worthlessness of the deferred income bonds, and only the most far-sighted could be expected to have demanded a larger reduction in their claims. The same month a meeting of London bond- and shareholders passed unanimously a resolution expressing confidence in President Gowen, and adopting his scheme.[175] Opposition came from the influential London banking firm of McCalmont Bros., and the struggle centred about the annual election set for January 10, 1881. The last of November or first of December President Gowen issued a circular in which he said: “As I am about to visit Europe on business of the company, and as it is possible that I may not return until the first week in January, I think it proper to call your attention to the fact that it is highly important that all shareholders who can possibly do so should attend the annual meeting in Philadelphia on the second Monday in January. An effort will undoubtedly be made at the next election to control the management of the company in the interest of rival lines, and if the effort is successful the future of the Philadelphia & Reading Railroad Company will be little, if any, better than that of the Philadelphia & Erie Railroad Company, or of the Northern Central Railroad Company.”[176] In Europe, or, more strictly speaking, in London, Gowen busied himself in placing his deferred income bonds, with apparently a very considerable measure of success. As to the result of the coming election he professed absolute confidence. It made little difference, said he, which way the McCalmonts decided to vote their shares. He could be elected without any English votes at all, and with the backing of the English bondholders who had resolved to support him, the matter was not at all in doubt.[177] On January 4, six days before the date set for the election, Gowen actually issued a prospectus for his new income and mortgage loans, and cabled to Vice-President Keim that he was satisfied that he could dispose of the general mortgage A bonds at 110 and the general mortgage B bonds at par.[178]

Meanwhile in America both parties had recourse to the courts: the McCalmonts, to prevent the issue of the deferred income bonds, and the friends of Mr. Gowen to get the election postponed in order to give the president time to return from Europe. The latter suit was the first decided. Judge McKennan, of the United States Circuit Court, refused to grant an order, but unofficially advised postponement. The board of managers therefore withdrew the notice of the annual meeting, and on January 12 voted to postpone it indefinitely. Counsel for the McCalmonts then made application to the Court of Common Pleas in Philadelphia for a mandamus to compel the board to call a meeting. They obtained a peremptory mandamus on January 24, but accepted the date of March 14 as satisfactory, and forbore further proceedings.

The matter of the deferred income bonds was complicated by a full and complete authorization which Mr. Gowen had before obtained from the Circuit Court for the issue of his bonds. The request of the McCalmonts was twofold: the court was prayed to revoke the previous decree, and to enjoin any further action in the negotiation or consummation of the said scheme; or, failing this, to direct the officers of the company and the receivers to refrain from the issue of the bonds until the form thereof should have been settled by the said court, and also until deposit with the receivers should have been made of the $2,058,000 provided as a guarantee.[179] The first request sought a prohibition of the issue; the second attempted to delay the negotiation of the bonds until the annual election should have passed and the McCalmonts should have had a chance to obtain control. The immediate result was the transference to Philadelphia of the $2,058,000 guaranteed, from its place of deposit in London. In February the McCalmonts obtained a revocation of the original grant of authority for the deferred income bonds, a continuance of the suit for a preliminary injunction, and an order restraining the respondents from “making any agreement or ordering any act by which the Philadelphia & Reading Railroad Company [might] be definitely bound touching the deferred bond plan or the proposed mortgage loan of $150,000,000.”[180]

In January the Coal & Iron Company quietly held its annual election, and chose Mr. Gowen president. As the time for the postponed election of the Railroad Company came round, the activity of both sides became intense. Both Gowen, who was still in London, and the McCalmonts issued calls for proxies. The former appealed to the shareholders to save the property from passing into the hands of the Pennsylvania Central Railroad Company, which he said was believed to be the ruling power behind the McCalmont litigation. The latter objected vigorously to this charge, and pointed out that the Reading managers held only 16,500 shares of the company’s stock, and that some of them had barely enough to qualify them for the positions which they held.[181] The McCalmonts, furthermore, applied to the courts for an injunction to prevent Gowen from voting on the shares pledged as collateral for the floating debt. They maintained with some justification that these shares could not legally be voted, and that it was particularly illegal for the president to use them to elect himself.[182]