Railroad Reorganization

by Stuart Daggett

Even where no restrictions on future bond issues are imposed, it is highly advisable that some provision for future capital requirements be made, and that the management have at its disposal a fund of bonds issuable without the approval of stockholders in each case. It is probable, therefore, that some such provision would have been a feature of some, at least, of the reorganizations even had the restrictions described not made the clauses an imperative necessity; but if we may judge from the rather restricted basis on which we are here at work, the provisions would have been far less liberal than we have found to be the case. In 1895 the Union Pacific set aside $13,000,000 4 per cent bonds and $7,000,000 preferred stock to dispose of equipment obligations, and for reorganization and corporate uses. Of these, corporate uses were stated to be those which would be proper to the corporation thereafter, such as the issue of securities in extension of the property. This, of course, was quite inadequate. Similarly the Rock Island in 1902 and the Erie in 1875–7 provided for a certain issue of stock or bonds to be applied to future capital requirements. It is undoubtedly true that both the Erie and the Reading railroads were hampered by the lack of adequate provision of this nature; though as the main difficulty of each corporation was the continued existence of heavier charges than it could bear, an automatic increase of indebtedness would not have proved a solution of their troubles.

The essence of a voting trust is the deposit of stock in the hands of trustees (most frequently five in number). These trustees issue certificates in return. All dividends declared on the stock are paid over to holders of certificates, but all the voting power is exercised by the trustees so long as the trust endures. Of the reorganizations which we have described, ten reorganizations with foreclosure included five voting trusts and one proxy committee; eight reorganizations without foreclosure included two voting trusts; ten reorganizations before 1893 included two voting trusts (though a third was proposed for the Atchison in 1889); seven reorganizations in 1893–8 included five voting trusts and one proxy committee. The use of voting trusts has therefore become more general, denoting a realization of the dangers of fluctuating and speculative control at critical periods in a railroad’s history. This desire to secure conditions of stable control has been the dominant one in the cases under consideration. “In order to establish such control of the reorganized company for a series of years,” said the reorganization plan of the Baltimore & Ohio in 1898, “both classes of stock of the new company shall be vested in ... five voting trustees.” “The importance of vesting in the present creditor class the management of the properties until their productiveness is considerably increased ... is manifest,” said the syndicate reorganization plan of the Reading in 1886. It is of supreme importance that a reorganized company be well started on its way by men who have an interest in making the reorganization plan permanently successful, and that conservative direction be assured until danger of bankruptcy be past. For this reason we should expect the use of voting trusts to increase in direct relation to the seriousness of the difficulties experienced, and to the vividness with which the need for stability is felt. If we may generalize, and say that a railroad which cannot be reorganized without a foreclosure sale is usually in more desperate straits than one which can be saved by voluntary concessions, we have an explanation of the coincidence of foreclosures and voting trusts. The teachings of experience, which have shown both the usefulness of voting trusts as tools, and the necessity of a solution such as they offer, further explain the increased prominence of the trust in later years.

It is not true that voting trusts are always used for the purposes indicated. In 1892 certain stockholders of the Baltimore & Ohio agreed to deposit their certificates in a trust for one year and five months. The stock deposited amounted to $8,975,000 out of a total outstanding of $25,000,000, and a limit of $11,000,000 was set to the amount to be so placed, the object of the arrangement apparently being to increase the influence of the stockholders concerned by concentration of their holdings.[725] Again, in 1895, to take an outside example, the stock of the Oregon Railway & Navigation Company was placed in trust with the Central Trust Company in order better to protect the preferred stock. It was provided that during the continuance of the trust the Central Trust Company should vote all the stock: first, against any increase in the preferred stock unless the holders of all the voting trust certificates of both classes should give their unanimous consent at general meetings; second, against all propositions relating to the mortgaging, selling, or leasing of the railroad and telegraph lines of the company, or to the consolidation thereof, unless a majority of each class of certificates should consent; third, on all other questions as directed by the holders of a majority of the aggregate of all voting trust certificates of both classes represented at general meetings.[726] Further provisions gave to the preferred stock control of a majority of the board of directors. These instances are of interest; but the principal purpose of the voting trusts in the reorganizations which we have considered has been nevertheless the securing of stability of control for a definite period after the rehabilitation of the bankrupt companies.

The duration of the voting trust varies from company to company. The most usual provision is for five years. Frequently the voting trustees may terminate the trust earlier at their discretion, as in the case of the Baltimore & Ohio trust of 1898, the Richmond Terminal trust of 1894, or the Northern Pacific trust of 1896. Frequently, also, certain conditions must be fulfilled before termination. In the case of the Erie in 1895 no stock certificates were to be due or deliverable before December 1, 1900, nor until the expiration of such further period, if any, as should elapse before the Erie Railroad Company in one year should have paid 4 per cent cash dividend on the first preferred stock.[727] In the case of the Reading in 1896 4 per cent cash dividends on the first preferred stock were required for two consecutive years, and this delayed dissolution three years beyond the time originally contemplated.[728] The Richmond Terminal trust had provisions similar to those of the Erie.

The number of trustees also varies. The scheme proposed for the Atchison in 1889 contemplated a trust of seven; the Baltimore & Ohio in 1898 and the Richmond Terminal in 1894 provided for five; and the Erie in 1896 for three; but this point is not material. When the reorganization plan requires the consent of stockholders to an increase in the issue of securities the consent of holders of trust certificates is apt to be required on similar occasions during the existence of the trust. Thus the Northern Pacific agreement of 1896 forbade the trustees to increase the preferred stock or to issue any new mortgage, except with the consent of the holders of a majority of the whole amount of preferred stock trust certificates, and of the holders of a majority of the common stock trust certificates represented at the meeting.

This ends the present treatment of the subject of railroad reorganization. The results of the discussion may be briefly summed up as follows:

First. Reorganization is most frequently an attempt to extricate an embarrassed company from its difficulties.

Second. These difficulties can generally be traced either to an unrestricted freedom of capitalization, or to destructive competition.

Third. The shape in which trouble appears is likely to be that of a large floating debt or of excessive fixed charges; either or both of which may have brought the corporation to a critical condition some time before the actual collapse.

Fourth. The best practice favors the retirement of floating debt by assessments on securityholders, though sales of securities are sometimes resorted to, or a combination of sales and assessments is employed.