Full opinion text
1GOE, District Judge. The Chicago, Rock Island and Pacific Railway Company, principal debtor in this proceeding, a railroad corporation organized under the laws of the States of Illinois and Iowa, filed its petition with this court on June 7, 19.33, alleging that it was unable to meet its debts as they matured and that it desired to effect a plan of reorganization under Section 77 of Chapter VILI of the Acts of Congress relating to Bankruptcy, 11 U.S.C.A. § 205. On the same day, the court approved the petition as properly filed under said Section 77. Thereafter, certain railroad corporations, subsidiaries of the principal debtor which owned all of the capital stock of each, filed similar petitions in the same proceeding, as follows: St. Paul and Kansas City Short Line Railroad Company, a corporation of the State of Iowa, and Rock Island, Arkansas and Louisiana Railroad Company, a corporation of Arkansas and Louisiana, on August 28, 1933; the Chicago, Rock Island and Gulf Railway Company, Choctaw, Oklahoma and Gulf Railroad Company, Rock Island, Stuttgart and Southern Railway Company, Rock Island Omaha Terminal Railway Company, Rock Island Memphis Terminal Railway Company and Peoria Terminal Company, on October 24, 1933. Each of said petitions stated that the respective petitioners were unable to meet their debts as they matured and desired to effect a plan of reorganization in connection with, or as a part of, the plan of reorganization of the principal debtor; said petitions were approved by the court as properly filed under the Act and in this proceeding. The principal debt- or was directed to continue in possession of and to operate the properties of said debtors, excepting the Chicago, Rock Island and Gulf Railway Company and Peoria Terminal Company, which were directed to continue in possession of and to operate their respective properties. On November 22, 1933, Frank O. Low-den, James E. Gorman and Joseph B. Fleming were appointed Trustees of the Estates of the several debtors, effective December 1, 1933; said appointment was made permanent by order entered December 28, 1933. After the death of James E. Gorman, the surviving Trustees were continued in office; after the death of Frank O. Lowden, Aaron Coition was appointed substitute Trustee by order of court entered April 19, 1943. Plans of reorganization were presented to the court as follows: By the Protective Committee representing the Rock Island, Arkansas and Louisiana Railroad Company First Mortgage Bonds, on June 9, 1936; by the principal debtor on July 15, 1936; and by the Protective Committee for the principal debtor’s First and Refunding Mortgage Bonds and Secured Series A Botids, on July 21, 1938. Said plans were likewise filed with the Interstate Commerce Commission. After extensive hearings and other proceedings before it, the Interstate Commerce Commission issued and approved a plan of reorganization of all said debtor companies by Report and Order dated October 31, 1940, and by Supplemental Report and Order dated July 31, 1941. To eliminate certain errors and inconsistencies in the approved plan, the Commission issued a further supplemental report and order on October 2, 1941, and, upon petition of various parties, a further supplemental report on April 6, 1942, setting forth the basis for allocations of new securities under the approved plan. On August 23, 1941, the court ordered all parties desiring to object to said plan of reorganization to file said objections and claims for equitable relief on or before September 30, 1941. Said objections and claims were set for hearing on Monday, October 13, 1941; a hearing was held accordingly. Testimony was heard on Monday and Tuesday; extensive arguments by counsel for various parlies in interest began on Wednesday morning and were concluded the following Friday afternoon. Thereafter, briefs were filed in support of their objections and claims by counsel representing those interested in the General Mortgage bonds, the Unsecured Convertible 4%% bonds, and the preferred and common stock of the principal debtor; the St. Paul & Kansas City Short Line First Mortgage bonds, the Rock Island, Arkansas & Louisiana First Mortgage bonds, the Little Rock & Hot Springs Western bonds, and the Burlington, Cedar Rapids & Northern Consolidated First Mortgage bonds. Later, briefs in support of the plan were filed by counsel representing those interested in the principal debtor’s First & Refunding Mortgage bonds, the Choctaw, Oklahoma & Gulf Railroad Company bonds and Choctaw & Memphis Railroad Company bonds, respectively, and by counsel for Reconstruction Finance Corporation. On March 29, 1943, the court entered an order permitting any party in interest to file by April 10 a statement setting forth whether, and if so in what respect, the plan of reorganization herein is inconsistent with the decisions given on March 15, 1943, by the Supreme Court-in the Chicago, Milwaukee, St. Paul and Pacific Railroad Company and the Western Pacific Railroad Corporation reorganization cases, and the extent to which this court has power to correct any such inconsistencies by virtue of the provisions of the plan of reorganization herein to the effect that the court may correct any defect, supply any omission or reconcile any such inconsistency in such manner and to such extent as may be necessary or expedient in order to carry out the plan effectively. In response thereto, numerous statements have been filed. The various lines of railway of the several debtors herein had been operated by the principal debtor, excepting those of the Chicago, Rock Island and Gulf Railway Company and Peoria Terminal Company, each of which was separately operated. This mode of operation has been continued by the Trustees, except that beginning September 1, 1939, the Trustees of the principal debtor leased and operated the properties of The Chicago, Rock Island and Gulf. The various mortgages of the several debtors herein, the lines of railway covered by the respective liens thereof, and the principal amount of bonds outstanding thereunder, are fully described in the aforesaid reports of the .Commission. In addition to mortgage bonds secured by liens on physical properties, the principal debtor has outstanding $39,813,600 principal amount of 4%% Bonds collaterally secured by $45,000,000 principal amount of its First & Refunding bonds; also collaterally secured 6% Notes, $13,718,700 principal amount, representing indebtedness to the Reconstruction Finance Corporation; various bank loans aggregating $3,811,006, collaterally secured; and an issue of unsecured Convertible 4%% Bonds, $32,228,-000 principal amount. In addition, there are outstanding various equipment trust certificates issued by the Trustees. As of January 1; 1942, the effective date of the plan, the total obligations thus represented amounted to $321,938,577, principal amount, or $429,738,085, principal plus interest accrued and unpaid. These figures include only bonds outstanding in the hands of the public; they do not include bonds constituting liens on the property of the Peoria Terminal Company, whose present corporate identity and separate operation are to be preserved. The plan contemplates that all of the properties of the several debtors (except Peoria Terminal Company) will be conveyed to and operated by the reorganized company which will issue new securities in lieu o'f those presently outstanding, with the exception of certain bond issues, relatively small in amount, which, with certain alterations in maturity dates and rates of interest, will remain undisturbed. The principal new securities in the form of debt obligations will be $30,917,060 par value of First Mortgage 4% Bonds, due January 1, 1992, and $80,000,000 par value of General Mortgage 4%% Income Bonds, due January 1, 2017. The liens of these new mortgages will extend, in order of rank, over the entire property of the reorganized company. The situation thus existing, where there are numerous mortgages, each constituting a lien on only a portion of the property to be acquired by the reorganized company, where the several bond issues thereunder bear different relationships to the value of the property securing the same, where the elements of value pertaining to the several mortgaged properties vary, and where the separate mortgages are to be replaced by. system mortgages, presents unusually difficult problems in the creation of a plan of reorganization which shall deal effectively and equitably with the claims of its different classes of creditors. Formula for Segregation of Revenues and Expenses to Mortgage Divisions. Subsection c, par. (10), of Section 77 of the Bankruptcy Act contains the following: “(10) The judge may direct the debt- or or the trustee or trustees to keep such records and accounts, in addition to the accounts prescribed by the Commission, as will permit of such a segregation and allocation, as the necessities of the case may require, of the earnings and expenses between and to the divisions and parts of the railroad or other property of the debtor which are separately subject to the liens of the various mortgages or deeds of trust, or are separately subject to lease, and may refer to the Commission for its recommendations after hearings thereon if the parties shall so request and/or the Commission determine necessary or desirable, as to the method or formula by which such segregation and allocation shall be made.” The formula with which we are concerned is an outgrowth or extension of an earlier formula prepared in 1934 by the General Auditor of the Trustees and a later modification thereof. The present formula was approved by the court (Order June 17, 1937, referred to as 106-A) and ordered to be applied for each six months’ period beginning January 1, 1936 and ending December 31, 1937. The results of iis applir cation to the two periods of the year 1936 were filed in the record of this proceeding. In order to make the results of application to the two 1937 periods available in due time for use in the reorganization proceedings before the Commission, an abridgement of the formula for 1937 was authorized by the court, (Order known as 106-B) and results thereunder were likewise obtained and filed in the record. Order 106-A provided that any party desiring to have the formula include any inter-mortgage division accounting for equipment or property under one mortgage and used in connection with one or more other mor 1 gage divisions might file and serve copies of the proposed provisions relating thereto and move for an appropriate order for a modification of the formula. The order likewise provided that any party might seek modification of the formula in any respect in which it apeared to be incomplete or to operate inequitably; and that nothing in said order should be deemed to require or contemplate that the results of the allocation of earnings and expenses should be the sole factor for consideration in determining the relative values of (he different mortgage divisions, or to exclude consideration of other relevant factors, such as contributed traffic, strategic position, prospective earnings, etc. The First & Refunding Mortgage Committee thereafter proposed additional provisions to the formula for charging mortgaged divisions and leased lines for the use of equipment and facilities which are subject to other mortgages or leases. This proposal was objected to by various parties. The questions involved were eventually decided by the Circuit Court of Appeals ; as a result of its decision (7 Cir., 108 F.2d 410), which held that the principle of making a charge for such use was proper and that the measure of the charge should be a fixed and uniform rate of return on the investment, the Commission fixed an annual rental of 4% on equipment and 4% on other facilities. The formula has been criticized both generally and specifically. The court is well aware that no formula can be devised which is free from assumptions, approximations and forecasts, some of which are miverifiable. The formula assumes that the various mortgage divisions are independent, separately operated railroads, and attempts to ascertain the revenues obtained and expenses' incurred by each. The Commission’s accounting classification governing operating expenses affords a reasonable and adequate basis for allocating expenses by divisions. Allocation of revenues presents more difficulty. Local freight and passenger revenues on traffic local to a mortgaged line are allocated directly to that line. Revenue from traffic moving jointly over two or more mortgaged lines is apportioned to each line on the basis of actual mileage as respects passenger traffic, and, with an exception to be hereafter noted, freight revenues are likewise so divided. The court is satisfied in the main that the formula is well devised for its purpose, and shall refer only to one or two details that seem to need mention. The principal criticism is with respect to the allocation of a minimum of 25% each to the originating and terminating lines of revenues from freight traffic handled jointly over two or more mortgaged lines. The criticism is not directed so much to the principle of an extra allowance to the line which originates or terminates the traffic, but rather to the method, i. e., the 25% minimum. Another method is known as the “constructive mileage block”. Each method has its origin in the practice in effect between independent carriers in dividing their joint-haul revenues. Once the assumption is made that these mortgage divisions are to be considered as independent carriers, it seems proper to adopt the further assumption that • divisions of revenue of inter-carrier traffic would follow customary practice. The 25% minimum is the general custom in Rock Island territory. The BCR&N Protective Committee claims that the 25% minimum operates to the disadvantage of that line because its hauls are sufficiently long that it receives no benefit from this provision. But it does not prove that a provision, correct in principle, becomes inapplicable because a particular line is unable, by reason of its own facts and circumstances, to take advantage of it. More pertinent to the subject is the statement of counsel for the Committee-that the BCR&N lines would have shown a deficit “no matter what kind of a formula we had”. (Tr. Oct. 15, 1941, p. 561.) Application of Formula. The Commission made certain adjustments in' both 1936 and 1937 earnings by mortgage divisions, as explained in its supplemental report of April 6, 1942. It uses the adjusted formula results in making allocations of the several classes of new securities. The Commission recognizes that there are various elements of value which are not necessarily reflected in earnings, and that a rigid adherence to the formula basis of distribution would, in certain instances, not recognize values for which new securities should be allotted. Among such elements of value are strategic location, mortgaged properties not used in railway operation, pledge under one mortgage of bonds secured by another mortgage, proceeds of mortgaged property retired, value to the system of a line as a source of company material, etc. So-called “block allotments” of new securities were made to compensate for such values. The Commission’s procedure was, after determining the total amount of the securities to be issued by the reorganized company, first to subtract from the total amount of each class of new security, the amount of the block allotments to be made therefrom, and to allocate the residue on the basis of the earnings under the formula. Thus out of a total par value of $19,917,060 of new First Mortgage bonds, $7,793,312 are allotted in block; out of $80,000,000 new General Mortgage Income Bonds, $7,137,-281 are allotted in block; and out of $75,-000,000 par value of new preferred stock, $6,334,031 are allotted in block. Whatever method — block allotment, or otherwise — be used to compensate for values not measurable by earnings, such method must be applied in advance of the allocation of new securities according to relative earnings; this is so because the latter basis is stated in percentages and the base to which these percentages apply can be determined only after the non-percentage allotments have been determined. The objections to the formula relate principally to the use made of the results (or adjusted results) obtained thereby, rather than to its intrinsic features. The objections are diverse; the General Mortgage Committee complains because the Commission did not, as respects the General Mortgage bonds, allocate the new fixed interest securities or the new common stock upon the relative earnings of the several mortgage divisions as developed by the formula, notwithstanding the Commission had (as it is said) expressed its intention so to do, but instead applied formula results to the securities remaining after the block allot■ments. On the other hand, the BCR&N Committee contends that formula earnings furnish no gauge for allocation of new securities to a property which shows formula deficits. The Short Line Trustee, aside from objections to the block allotments, complains of some of the Commission’s adjustments of formula earnings, and to the alleged use, as a measure of its participation, of earnings of the “earning” lines exclusive of losses of deficit lines. General Mortgage Committee: The objection is that the Commission, after announcing that an allocation of new securities should be made, so far as practicable, according to the demonstrated current earning power of the different mortgage divisions, failed to do what it said it was doing. In other words, the Commission .did not so allocate the entire amount of the new fixed interest securities, but only the amount remaining after the block allotments. ' Whether the Commission’s acts are a departure from its announced intentions is not important; the court is concerned only with what was actually done. As the Committee’s brief says, in connection with another matter, “The function of the court is to pass upon the legal points in this case and to determine whether or .not the plan is ‘fair and equitable’.” The court finds nothing illegal in the principle of block allotments; whether the principle has been properly applied to specific instances requires inquiry into the question whether the values for which block allotments are made exist, and whether such allotments are fair compensation therefor. Burlington, Cedar Rapids & Northern Mortgage Committee: Since the formula showed the BCR&N to be a deficit line, allocation of new securities to its bondholders could not be determined by the formula; hence, the block allotment method was used. The Committee complains of the formula, however, and says that its unsoundness, as applied to the BCR&N, is the reason why that line shows such large deficits, and that these large deficits in turn caused its block allotments to be unfavorable. The complaint against the 25% minimum provision has already been noticed. Again, the formula is criticized because studies were not made, as between the several mortgage lines, of such matters as differences in operating advantage or disabilities, average length of hauls, proportion and relative cost of handling of originated or terminated traffic as compared to overhead traffic, or relative cost of handling of interchange traffic as compared to actual originated or terminated traffic, etc. Differences in operating advantages or disabilities are reflected in operating expenses, and hence in net earnings. But length of haul is not an omitted factor; on the contrary, it is the factor upon which operating line haul revenues are allocated, subject to the 25% minimum. As for the others mentioned, we may observe that to determine the relative cost of handling originated or terminated traffic, as compared to cost of handling overhead traffic, is well nigh impossible, considering that both classes of traffic are intermingled in common trains. The utility of trying to ascertain such relative costs may be doubted, considering the extent, to which a division of numerous small items would be involved, and that many such divisions would be sheer estimate. Also, ordinary experience justifies the belief that there is 110 great disparity between the two classes of costs, since originated or terminated traffic frequently requires no more or different handling at the point of origin or destination than does overhead traffic at its interchange points. It is claimed that the absence from the Commission’s reports of analysis or discussion of the formula itself indicates that the Commission did not scrutinize the formula to determine its basic soundness. In our opinion, the formula, which deals with the individual revenue and expense accounts contained in the Commission’s standard Accounting Classification, is sufficiently self-explanatory that whether or not it is basically sound can be determined from the terms and text of the formula itself. Some of the factors whose omission is complained of appear to be wholly irrelevant, e. g., that the BCR&N is preponderately an originating and terminating rather than an intermediate line, which tends to increase expenses, that it has operating disabilities due to climate, or that it has a number of branch lines with low traffic density and high operating ratios. These disadvantages are inherent in the property; they largely reflect themselves in net earnings, that is to say, in formula results. The 13CR&N bondholders are not entitled to an award of additional securities by reason of these disadvantages. The propriety of the adjustments which the Commission made in both the 1936 and 1937 formula earnings of the several mortgage divisions will be discussed later in connection with specific objections thereto. Block Allotments. The amount of the block allotments of Ihe several classes of securities and the reasons for which the same were made are set forth in the Commission’s supplemental report of April 6, 1942, and schedules at-I ached thereto. Certain of the block allotments of new First Mortgage bonds were made in respect of particular mortgage lines whose respective earnings have consistently exceeded interest requirements, although in varying degrees, during the years covered by formula studies. Chicago, Rock Island & Texas First Mortgage bonds (pledged under the principal debtor’s General Mortgage) are given $2,102,100 thereof, being equal to the full amount of principal and accrued interest to January 1, 1942. Chicago, Rock Island & Gulf Main Line bonds (pledged under the principal debtor’s First & Refunding Mortgage) are given $2,611,840 principal amount of First Mortgage Bonds and $2,611,840 principal amount of new General Mortgage Income bonds, in respect of the full principal and accrued interest to January 1, 1942. Choctaw & Memphis First Mortgage bonds are left undisturbed and the principal thereof, $3,524,000 together with $1,-409,600 of new First Mortgage bonds to be issued in respect of the accrued and unpaid interest thereon to January 1, 1942, may be considered as a block allotment. Choctaw, Oklahoma & Gulf bondholders are given a block allotment of $550,000 principal amount of First Mortgage bonds on account of oil royalties received by the Railway Trustees from leases on mortgaged lands and cash representing partial proceeds of sale of abandoned facilities at Ardmore, Oklahoma, which were subject to the CO&G Mortgage; additionally, $150,000 par value of new General Mortgage bonds were similarly allotted on account of the sale of said facilities. Rock Island Arkansas & Louisiana bondholders arc given a block allotment of $750,-000 par value of General Mortgage Income Bonds by reason of the importance of that line as a source of company material and on account of severance value; in further recognition of these elements of value, those bonds receive $650,000 par value of new Preferred Stock. The Reconstruction Finance Corporation is given a block allotment of $1,119,772 principal amount of First Mortgage Bonds, $1,684,941 principal amount of General Mortgage Income Bonds and $832,781 par value of new Preferred Stock, in recognition of its interest as pledgee of $6,927,000 face amount of Chicago, Rock Island and Gulf Extension First Mortgage Bonds. Burlington, Cedar Rapids & Northern bonds receive $1,940,500 of new General Mortgage Income bonds, of which $1,100,-000 are given to bonds outstanding in the hands of the public, and $840,500 are given to the First & Refunding bondholders on account of pledges of BCR&N bonds under that mortgage. Additionally, BCR&N bonds receive new Preferred Stock in the amount of $4,851,250, of which $2,750,000 is given to bonds outstanding in the hands of the public and $2,101,250 to the First & Refunding bondholders. Some of the less controverted issues may be disposed of first. The oil royalties received from leases of CO&G lands are not reflected in the railroad earnings .dealt with by the formula. The CO&G bondholders are entitled to the royalties or their equivalent. The block allotment represents the latter. Unlike the ordinary case of railroad abandonments, which are occasioned' by reason of operating losses, the terminal properties at Ardmore, Oklahoma, which were sold for continued operation to another road for $250,000, had a going-concern value. The terminals, which were no longer needed for Rock Island System operation, were an asset of value to the CO&G estate; compensation in lieu of cash, in the form of $100,000 principal amount of First Mortgage Bonds and $150,-000 of General Mortgage Income bonds, is proper. It is an element of value of the Rock Island, Arkansas & Louisiana line that it affords a practical source for company materials, such as ties and other lumber products; the cost of transporting these materials, as compared with tariff rates of a foreign line, is less and the recurrent savings will inure to the benefit of the reorganized company. This item, whether considered directly or as a part of severance value, should be recognized; and the court considers that recognition, in the form of block allotments, is proper. Whether the Commission’s allotments of $750,000 principal amount of General Mortgage Income bonds and $650,000 par value of new preferred stock, are a fair measure will be considered in connection with the RIA&L objections generally. The Commission appears to have arrived at the amount of the block allotment of First Mortgage bonds, $1,119,772, to Reconstruction Finance Corporation, on the basis of the segregated earnings of the Gulf Extension Mortgage Division. The adjusted 1936-1937 income of said lines was 4.3% of the system total; the block allotment constitutes approximately 3.03% of the total new fixed income debt, issued or to be assumed, or approximately 3.62% of the total new First Mortgage bonds. See also Chicago R. I. & P. Reorganization, 247 I.C.C. 533, at page 561. But unless the entire fixed interest debt, or the entire amount of First Mortgage bonds, is to be distributed on the basis of proportionate earnings, it is difficult to understand the reason for this apparent preferential treatment. The Commission states that the amount of new securities allocated on account of the Gulf Extension bonds “on further consideration of the entire record, reflects with substantial accuracy the relative value of the Gulf Extension bonds”. The record contains evidence that the Extension Mortgage lines have value as a source of fuel oil for the system (I.C.C.Tr.2854) and have a severance value (ibid, 2844). While the Commission’s finding on this subject might well have been more specific, the court believes the amount of the several new securities allotted is supported by evidence of record, and is not disposed to disturb it. The allotments to the mortgaged lines above mentioned, whose earnings exceeded interest requirements, are sharply controverted. The court has already stated that it finds nothing illegal in the principle of block allotments. Subsection e of Section 77 provides that values shall be determined on the basis which gives due consideration to earning power “and all other relevant facts”. The question, therefore, is whether the facts on account of which the Commission made the block allotments are relevant, and, if so, whether the Commission gave them due consideration. Choctaw & Memphis Bonds: The undisturbed bonds, together with the new First Mortgage bonds representing all unpaid interest up to January 1, 1942, totaling $4,933,600, may be considered in the category of a block allocation of an equal amount of First Mortgage bonds. Certain objectors claim that it is wholly immaterial, as a basis of distribution of new securities, that interest on any existing mortgage has been earned in the past; that there is no relation between the existing Rock Island debt of about $400,000,000 and the new debt proposed by the Commission; and that to employ one method for distributing securities for lines that do not earn all of the interest requirements on their bonded indebtedness and another method for lines which earn more than the interest requirements on their bonded indebtedness, means that securities are not being distributed on the basis of the values of the lines but upon the basis of their bonded indebtedness. These objections bring forward the question, What is the subject-matter of reorganization? Obviously, it is not the lines of railway which are being reorganized, but the debtor’s financial structure. F'air and equitable treatment of creditors must be in accordance with the respective values of their credits. That value is created not only by the value of the property which stands as security, but depends also on the size of the debt as compared to the value of the security. Otherwise, in reorganization, a small bond issue of $10,000 on a specific property would be entitled to no more per bond than if the issue were $10,000,000 instead. It is undoubtedly true, as claimed by the objectors, that the holders and pledgees of Choctaw & Memphis bonds (as well as of CRI & Texas and CRT & Gulf Main Line bonds) receive more favorable treatment than if they had the same proportionate interests in larger liens. They should, under the facts of record. The size of the bond issue, the nature and extent of the mortgaged property and other such factors affecting value, may be supposed to have influenced the buyer in his choice of securities in which to invest his money. The Commission and the Court must take the facts as they exist and not consider hypothetical “proportionate interests in larger liens”. It is next argued that the formula is erroneous in treating the Choctaw & Memphis line as a “separate mortgage division”. Objectors claim that the entire CO&G line constitutes a single mortgage division as between those who are interested in that property and those who are interested in the remainder of the system. Section 77, subsection c, par. (10), provides for the segregation and allocation “of the earnings and expenses between and to the divisions and parts of the railroad or other property of the debtor which are separately subject to the liens of the various mortgages or deeds of trust, or are separately subject to lease”. The C&M line is certainly a division or part of the railroad of the debtor, Choctaw, Oklahoma & Gulf. Is it any the less a “part” of the entity which is comprised of the aggregate lines of the several debtors herein? Under the authority of subsection (a), the CO&G and the other subsidiary debtors filed their petitions in the same proceeding instituted by the principal debtor, praying that they be allowed to effect a reorganization in connection with, or as a part of, the reorganization of the principal debtor. The court interprets the above-quoted language of the statute to refer to the unified proceeding and as authorizing a segregation and allocation of earnings and expenses on that basis. Otherwise, a formula would have little or no utility as an index to the distribution of the securities of a reorganized company which is to become owner of all the properties. Chicago, Rock Island & Texas bonds and CRI& Gulf Main Line bonds: The first of these lines earned more than its bond interest requirements during the formula period, and its bonds received a block allotment of $2,102,100 of First Mortgage bonds, equal to full principal and interest to January 1, 1942. The excess of earnings over interest requirements was credited to the CRI& Gulf Main Line bonds which constitute a second lien on the CRI &T properties. This credit, together with the earnings of the line upon which the CRI& Gulf Main Line Mortgage constitutes a first lien, aggregates a sum in excess of the Main Line Mortgage interest requirements, and therefore the Main Line bondholders receive a block allotment in full of principal and accrued interest to January 1, 1942, one-half in First Mortgage bonds and one-half in Income Mortgage bonds. The carry-over principle has been applied by the Commission, and is similarly criticised, where no block allocations of new securities are involved. The excess earnings of the Choctaw & Memphis line, for example, are carried over to the CO&G whose mortgage constitutes a second-mortgage lien thereon, with the result that the CO&G deficit of $165,299, based on adjusted formula results, becomes $83,594 income by virtue of receiving $248,893 excess of C&M income. This “carry-over” of excess income is declared by objectors to be fallacious in that it makes the value of a line of railway and the total amount of securities distributable to it dependent upon the number, amount and character of the different liens upon it. But again we point out that it is'not the lines of railway which are being reorganized, but the correlative rights. and liabilities of the creditors and the debtor. Cases may exist where the value of a mortgage derives principally from its second-lien upon certain properties rather than its first-lien upon other property. The second mortgage-interest of the CO&G bondholders in the C&M line, and the second-mortgage interest of the CRI& Gulf Main Line bondholders in the Chicago, Rock Island & Texas Line, are additionally valuable to whatever extent there is an excess of earnings necessary to pay first mortgage interest, or excess value of assets over the amount required to discharge the principal. If that excess exists, it belongs to the second-mortgage bondholders and adds value to their bonds. The court deems' it entirely proper that such value should be recognized and given effect to; otherwise, the second mortgage bonds would be-deprived of an element of their value. For the reasons stated, the court concludes that the carry-over principle and its application are proper.-' The block allotments to the BCR&N bondholders are made upon a different ground and the propriety thereof will be dealt with in connection with the BCR&N objections generally. Distribution of Income Bonds and Preferred Stock. Under the plan, the new General Mortgage Income bonds are allocated to each issue outstanding in the hands of the public and to secured claims, based on estimated allocation of earnings during what is termed a prospective normal year. After making adjustments, similar to those made for the formula earnings, and after deducting the interest on the several allotments of new First Mortgage Bonds to each mortgage division, the remaining earnings were used to determine the proportionate allotments to each mortgage division of the Income Bonds remaining after the block allotments previously referred to herein. The new preferred stock is allocated to each present bond issue outstanding in the hands of the public and to secured claims, based on estimated earnings sufficient, after prior charges, to cover preferred stock dividends. Similar adjustments in estimated income, and similar methods of distribution, to those used in connection with the allocations of First Mortgage bonds and of Income Bonds, were used. Apportionments of the adjusted prospective normal year earnings to the several mortgage divisions are different from the apportionments-of the 1936 and 1937 earnings resulting from the application of the formula. For example, the General Mortgage Division has 52.21% of the average total income for the formula years and has 63% of the total adjusted income for the prospective normal year. The method employed was to distribute among the various mortgage divisions the gross earnings of the normal year in proportion of their respective gross earnings during the formula years. Next, the operating expenses to be incurred by the several mortgage divisions in making their gross earnings were estimated, and the net income of each such division arrived at accordingly. The validity of the results thus obtained is assailed on the ground that there is no basis for assuming that the increased gross revenues of the normal year (estimated at $100,000,000) will result from proportion■ate increases in the gross earnings of each mortgage division, or that the expenses of each mortgage division will increase proportionately as its gross rises. Section 77 speaks of prospective earnings as one of the facts relevant to value. The estimate of prospective $100,000,000 of system gross revenues is not criticised; as does any forecast, it involves assumptions and the application of judgment. It was made by a disinterested and competent expert at the request of the management. The estimated net system earnings for the normal year are subject to the same observations. The court believes that such estimates for the system as a whole represent the approximate limit of what is practical in this regard and that an attempt to estimate gross earnings and attendant operating expenses by separate mortgage divisions would .involve such an amount of conjecture and unverifiable assumption as to make the results of doubtful value. Operating expenses particularly are subject to a variety of influences, some of which cannot be foreseen even at relatively short range. With respect to the contention that gross revenues and operating expenses do not increase pari passu, it may be observed that while this is generally true, still the factors which present a steady relationship are common to any line and may be expected to operate uniformly upon the basic conditions inherent in each line. The point to which an increase in gross revenues is not accompanied by proportionate increased expenses, or the point beyond which the increase in gross causes an appreciable increase in the expenses, is not necessarily dependent upon whether the line is one of light or heavy traffic density, since there are too many other factors involved, particularly when the several lines are operated as a single system. The court is of the opinion that the estimates of prospective income are supported by the evidence, that the basis of allocations thereof to the several mortgage divisions is logical and reasonable, and that the method of distributing the new Income Mortgage bonds and new Preferred Stock produces fair and equitable results. Objections of Debtor Corporations and of Stockholders. In its Report of October 31, 1940 (242 I.C.C. 298, at page 438) the Commission stated: “From a consideration of the record, including the elements of value referred to, the past, present, and prospective earnings of the system, we conclude and find that, in these circumstances, the equities of both classes of stockholders have no value.” Its Order provided: “The equity of the holders of the debtor’s preferred and common stock having been found to be of no value, such stockholders shall not be entitled to participate in the plan.” In its Supplemental Report of July 31, 1941, the Commission approved a new capitalization of approximately $368,000,000 and stated that this amount “represents a fair estimate of the value of the system’s assets for purposes of capitalization”. It added, ‘“Pile secured and unsecured claims against the Rock Island must be satisfied in full before stockholders may participate in the plan of reorganization. Since it is clear on the basis of the above valuation that the creditors cannot he satisfied in full, the equity of the Rock Island stockholders has no value.” The total claims of creditors as of January 1, 1942 aggregated in excess of $430,-000,000. The debtor complains that the $368,000,000 value of system assets for purposes of capitalization, is arbitrary and is not supported by any statement of reasons therefor. The Supplemental Report of July 31, 1941 states that the value and resulting capitalization of $368,000,000 “is supported by the data on elements of value, earnings, additional investments being made in equipment, and other evidence of record”. The Report states that the increase of $17,000,000 over the capitalization of $351,000,000 approved in the original report of October 31, 1940, results from the “further consideration” which the Commission gave to the subject. The fact that no new evidence was submitted in the interim does not indicate that the increase, or indeed the entire amount, is arbitrarily arrived at. The purpose of the Act in allowing petitions to be filed within 60 days and giving the Commission power to modify any plan which it has approved, is obviously to enable the Commission to give further consideration to the facts of record. That it has done so is no cause for complaint. The courts have many times stated that the fixing of a value is not a matter of formula, but of informed judgment based on the relevant facts. The court believes that the Commission has stated as fully as is reasonably possible the reasons for its conclusions in fixing the value of the systern’s assets for purposes of capitalization; obviously, it cannot state its mental processes, and is not required to do so. Chicago, B. & Q. R. Co. v. Babcock, 204 U.S. 585, 27 S.Ct. 326, 51 L.Ed. 636. The debtor contends that the Commission has no power, undei Section 77, to reduce the total capitalization of the debtor company. In Consolidated Rock Products Co. v. DuBois, 312 U.S. 510, 61 S.Ct. 675, 85 L.Ed. 982, the Supreme Court held that the new capital structure may be revolutionary and need not be patterned after the existing structure. This principle applies in Section 77 proceedings. In re Chicago, M. St. P. & P. R. Co., 7 Cir., 124 F.2d 754, 763; Group of Inst’l. Investors v. Chicago, M. St. P. & P. R. R. Co., 318 U.S. 523, 63 S.Ct. 727, 738, 87 L.Ed. -. In that case, the total maximum permissible capitalization of the reorganized company was fixed at $548,333,321 as contrasted with a capitalization (exclusive of no par common stock) in excess of $625,-000,000. The amount of capital which has been invested in the property of the debtors and the so-called physical values . of the properties are not controlling, although either or both may be useful in fixing the amount which should not be exceeded. But within the limits so indicated, the earning capacity of the property is the proper guide not only for determining the amount of interest-bearing obligations but of preferred and common stock as well, for it would be against the public interest to have outstanding in the hands of the public stock upon which there is no reasonable prospect of any return. A sound reorganization implies a substantial relationship between earning power and capitalization. The provisions of subsection b, par. (4), relative to adequate coverage of fixed charges by the probable earnings available for the payment thereof, are intended as a standard for guidance in determining what-proportion of the total capitalization shall consist of fixed interest indebtedness; it does not mean that probability of earnings may be disregarded in providing for contingent interest obligations or stock. In determining the capitalization of the reorganized company, the Commission must follow the standards prescribed for it in administering the provisions of Section 20a of the Interstate Commerce Act, 49 U.S.C.A. § 20a, one of which is that the issuance or assumption of securities of a carrier by railroad must be compatible with the public interest; it would be an anomalous situation if the law were otherwise. The debtors contend that since railroad property is devoted to a public use and its earnings subject to governmental regulation, a consideration of such earnings as a measure of value in a reorganization case is improper. This court is well aware that in a case where the validity of the governmental regulation is in issue, earning power cannot be made the criterion of value upon which the fairness of the return is to be computed. But this is not such a case. The rates, fares and charges are already fixed. They are one of the conditions under which the business is conducted and they have their effect upon the ultimate financial results as do any of the other factors which affect the revenues or expenses, such as taxes, compliance with safety appliance laws and other police regulations, climate, the nature of the territory served, etc. The resulting income is the product of all these composite forces; the Commission and the court must take that product as an ultimate fact. Furthermore, the debtors’ attempted distinction between property devoted to the public use and ordinary commercial or industrial property is unsound; the earnings of the latter class are subject to and affected by governmental regulation, as witness the Wages-Hours Act, 29 U.S.C.A. § 201 et seq. corporate excise taxes, workmen’s compensation statutes, and the like. If the debtor has in mind a value beyond that produced by earning power, the answer is that such value is not appropriate in a proceeding such as this. As the Supreme Court said in the Milwaukee case: “The basic question in a valuation for reorganization purposes is how much the enterprise in all probability can earn. Earning power was the primary test in former railroad reorganizations under equity receivership proceedings. * * * The reasons why it is the appropriate test are apparent.” The debtors likewise complain of the Commission’s estimate of the earning power of the property. From the facts of record, we cannot agree that the earnings of the pre-depression years are a fair measure of prospective earning power. The Commission estimated that $96,210,000 of total operating revenues would be reached by the year 1941 and that $11,000,-000 thereof would be available for interest and dividends. 242 I.C.C. 435, 437. However, elsewhere the Commission states that the $11,000,000 earnings of a prospective normal year were used to measure the total amount of fixed and contingent interest obligations (ibid. 438). But whether the estimated $11,000,000 is intended to represent earnings available for interest and dhddends, as the debtor contends, and not merely the interest requirements, and whether an estimate of $11,000,000 net income from a gross of $96,000,000 is unduly low, the court is of opinion that the errors, if such they be, are not sufficiently large that their correction would benefit the stockholders. It is true that in 1941 the actual gross revenues were $96,962,498 and that there remained therefrom a balance of $18,149,929 available for interest and, dividends. But there was no income tax liability for 1941 by reason of allowable deductions for carry-over losses. These losses would not be available to the reorganized company; had the plan been in effect during 1941, the $18,149,929, would be sharply reduced and this would be the case even if the provisions of the 1942 Revenue Law relating to income tax liability of a reorganized railroad had then been in effect. Also, operating conditions were unusual in that the increased volume of traffic, mostly freight, could be handled with greater concentration, thereby permitting locomotives to haul more nearly their full tonnage capacity. This is shown by the fact that despite a slight decrease under 1940 in revenues per ton and per mile, revenues per freight (rain mile increased 50.6 cents. Average haul per ton of revenue freight increased as well as the number, of tons per loaded car mile. These favorable conditions resulted largely from the National Defense program at home and war conditions abroad; in normal times it may well be doubted whether operations can he carried on in such fashion that $96,000,000 of earnings will produce as much as $18,352,967 even aftei giving consideration to the abilities of the present management and economies from capital expenditures during trusteeship. Even with a fair degree of optimism, the fact remains that there would be still unsatisfied claims of creditors of over $89,000,000 which must be taken care of before the stockholders can participate. The $32,» 228,000 principal amount of the unsecured Convertible Bonds will receive new common stock allotted at the rate of 4% shares for each $1,000 thereof, and will receive nothing on account of $12,568,920 accrued and unpaid interest; general claims receive 13/30 of 1 share of common stock for each $100 principal amount of claim. Indeed, except for the General Mortgage bonds, there is no class of mortgage security which will receive 100% of the total amount due thereon in aggregate par value of new securities. It is plain that full satisfaction of the creditors’ claims is impossible; and short of that satisfaction, there can be nothing given to the stockholders. The debtors point out that over $50,000,-000 has been spent in additions and betterments to the property during the trusteeship; they complain that this money could have been used to reduce the claims of creditors by paying interest on the secured indebtedness and that the junior interests, including stockholders, should be given credit for the money thus spent in improving the property. The court is unable to agree. The debtors’ claim takes no account of property retirements made during the same period, which were unusually large and exceeded the amount spent for improvements. The debtors’ claim is necessarily without merit unless it is based upon the proposition that said expenditures resulted in a net increase in the value of the mortgaged properties. This premise is untrue because of the property retirements. Finally, the debtors allege that the Commission has no power to fix the effective date of the plan at January 1, 1942, but that it must he made effective as of the date on which the petition was approved, June 7, 1933. The debtors’ concern arises from the accrual of interest on the secured claims during the interval, amounting to approximately $14,000,000 a year. That point has been determined adversely to the debtor by the Supreme Court in Group of Inst’l. Investors v. Chicago, M. St. P. & P. R. Co., supra. The debtors make reference, however, to subsection (Í) of Section 77, which provides that in the proceedings thereunder: “The rights and liabilities of creditors, and of all persons with respect to the debtor and its property, shall be the same as if a voluntary petition for adjudication had been filed and a decree of adjudication had been entered on the day when the debtor’s petition was filed.” This does not mean that the money-measure of the rights and liabilities must be taken as of the date on which the petition is filed and approved. The right to receive interest is different from the amount of money which may be realized therefrom. The language simply means that the creditors’ rights shall be neither increased nor diminished, but shall continue to operate according to their terms. The debtors object to certain features of the plan which, it is alleged, operate adversely upon the creditors; we do not notice these since the creditors are entitled to speak for themselves. Also, objection is made that certain creditors — Reconstruction Finance Corporation and the Banks— are too well treated, in that their claims are provided for on the basis of their collateral. The court agrees with what was said on this point in the case of Chicago & North Western Railway Company, D.C., 35 F.Supp. 230, 242. The debtors object that the plan does not take into account the impact of federal excess profits taxes and income taxes on the proposed capital structure. Under revenue laws in effect at the time the plan was certified, the reorganized company, if a new corporation, would be entitled to a relatively low invested capital, and this might result in large excess profits taxes. The plan was also assailed on the ground that the new capitalization consisted of such a small proportion of funded debt that interest deductions for income tax purposes will be correspondingly low and permit a disproportionate share of income to be taxed. The first objection has been removed by the provisions of the 1942 Revenue Act. The court does not believe that the plan should be disturbed by reason of the second objection; to increase the amount of interest-bearing obligations might endanger the long-range financial stability of the reorganized company. In any event, the tax burden will fall upon the future owners of the property, and not upon the present debtors or their stockholders. General Mortgage Bonds. This bond issue totals $99,981,000 principal amount, of which $38,400,000 are pledged as security under the First & Refunding Mortgage. They are secured by a direct first lien on approximately 3,060 miles of railroad and a considerable amount of rolling stock; they constitute a collateral lien on the line of the Chicago, Rock Island and Texas Railway through pledge of the latter company’s First Mortgage bonds, $1,365,000 principal amount. The mortgage is also secured by a lien on various trackage-right contracts totaling 187.25 miles and by the leasehold interest of the principal debtor in Peoria & Bureau Valley Railroad. v The principal objections of the General Mortgage interests relate to the Commission’s methods of distribution of the new securities. The contentions relating to the block allotments and the correct determination of what parts of the System comprise “mortgage divisions” for the purposes of allocating new securities have already been discussed and disposed of. One phase of the “mortgage division” argument has reference to the line subject to the BCR&N Mortgage, on which the First & Refunding Mortgage is a second lien. It is contended that the BCR&N lines are an integral part of the “First & Refunding Division,” as a result of which the BCR&N deficits should be subtracted from the earnings of those lines upon which the First & Refunding Mortgage is a first mortgage and the remainder used as the basis of allocation of new securities to the First and Refunding bondholders. The court finds no merit in this contention; the carry-over principle applied to the excess earnings of Choctaw & Memphis, Chicago, Rock Island & Texas and Chicago, Rock Island & Gulf Main Line bonds, is not germane here. Those lines had earnings in excess of first mortgage interest requirements and the excess earnings were applied to the interest requirements of the second mortgages. But it does not follow that where a line does not have earnings sufficient to meet its first mortgage interest requirements in whole or in part, the second mortgage bondholders are to be charged accordingly. A mortgage is a contract;, if the mortgagor company is unable to fulfill its obligations,' the mortgagee may be-disappointed in the result; but his right to receive earnings, if any, has no correlative obligation to make up deficits. The First & Refunding bondholders do not— and under the facts here, should not — receive new securities by reason of their second mortgage on the BCR&N lines; but that second mortgage does not and should not operate to diminish their rights with respect to other lines which stand as. a separate and independent security. But it is claimed that by treating the BCR&N as a separate mortgage division, the Commission has thereby used earnings of the General Mortgage lines to meet the expense of operations over the BCR&N lines. To understand this objection, it is necessary to state more particularly what the Commission did, as shown by Schedule A to its Supplemental Report of April 6, 1942. The average adjusted income of the system for the formula years 1936 and 1937 was $4,101,087; that sum is the composite result of the earnings and the deficits, as the case may be, of the several divisions. The total average income of the lines which had earnings amounted to $5,483,-596; the total average income of the lines which participate in the initial distribution of new first mortgage bonds is $4,337,163 which includes $1,127,341 of First & Refunding Mortgage Division earnings. Of said total, the $2,261,416 earnings of the General Mortgage Division amount to 52.21%. If the BCR&N average deficit of $1,110,127 were subtracted from the first & Refunding Mortgage Division earnings, the total would be correspondingly reduced to $3,221,035, of which the General Mortgage Division earnings would be 70%. Thus, the claim is made that the earnings of the General Mortgage Division were, in effect, unlawfully diverted permanently to pay for the operation of the BCR&N lines. The court has already rejected the hypothesis upon which this contention rests. The Commission did not charge the deficit of the BCR&N, or the deficit of any other line, against any mortgage, division; the lines or mortgage divisions which participate in the initial distribution of new first mortgage bonds do so in the proportion that the earnings of each bear to the total earnings of such lines. The court finds nothing improper in this method. It is next urged that the plan discriminates against the General Mortgage bonds in consequence of the treatment of those bonds as compared with the First & Refunding bonds and with the claims of the bank creditors. The General Mortgage bonds outstanding in the hands of the public, together with accrued and unpaid interest thereon to January 1, 1942, total $81,286,920; they are allotted $81,286,920 principal amount of new securities, of which $20,714,220 consists of common stock (taken at $100 per share). The Commission holds that these bonds receive “full satisfaction”. The Banks receive securities whose par value (including common stock at $100 per share) aggregates approximately 2% times the principal and accrued interest on their notes. The Commission arrived at this result by allocating the new securities to the Banks on the basis of their collateral. The General Mortgage Committee asserts that it is an absurd result that it should take 2% times as large an amount of the same new securities to satisfy the claims of the Banks as is required to satisfy the General Mortgage Bonds; that, in consequence, either the General Mortgage Bonds have not received full satisfaction or the Banks receive more than full satisfaction. The court is of the opinion that this contention fails to give effect to the legal rights of a pledgee of securities to secure a note of Ihc same obligor. The securities held by the Banks are obligations of the principal debtor, either as mortgagor or guarantor. The subject is fully discussed in the Chicago & North Western Reorganization case, 35 F.Supp. 230, 242, 24-3; affirmed 7 Cir., 126 F.2d 351. An attempt is made to distinguish the Chicago & North Western case, based upon the following language in the District Court’s opinion: “In this case it is not clear whether the First and Refunding Mortgage Bonds are fully secured. It is clear that there are some unmortgaged assets in which unsecured creditors are entitled to participate pari passu with any unsecured portion of 1he claims of mortgage bondholder