Full opinion text
CHESNUT, District Judge. The Seaboard Air Line Railway Company has been in receivership in this court for nearly thirteen years. Ancillary receivership proceedings have similarly been pending in the District Court of the United States for the Southern District of Florida. During this period several efforts have been made by the court to effect a plan of reorganization. In 1935 the court instructed the Receivers (Messrs. Legh R. Powell and Col. Henry W. Anderson) to prepare a plan for reorganization. Extended studies and tentative proposals were made by the Receivers but the then relatively poor earnings of the railroad caused the principal secured creditors to oppose further procedure along this line at that time; and the Receivers then were excused by the court from further activities in that respect. But on October 27, 1939 the court entered an order appointing Tazewell Taylor, Esq., a highly competent member of the Bar having had spécial experience in railroad matters and with the affairs of the particular railroad, to prepare and submit a plan of reorganization, after careful study and hearings of all parties in interest and development of all relevant evidence and other data pertaining to the subject. The appointment was made pursuant to Rule 53 of the Rules of Civil Procedure of the District Courts of the United States, 28 U.S.C.A. following section 723c. The master was given very full power and authority to hold hearings pursuant to notices, to receive evidence and to consider plans of reorganization submitted by any parties in interest. Somewhat similar orders with respect to the special master’s authority and procedure were passed in the ancillary Florida proceedings. After very full direct notice to all parties in interest who had appeared im the proceedings from time to time, and frequent published notices, special master Taylor conducted hearings, took evidence, received statistical studies over a period of more than three years, considered various plans of reorganization submitted by parties in interest and finally on July 20, 1943, submitted his report. This consists of a printed document of 283 large pages, to which are appended numerous tabulations and exhibits. After the receipt of the report, Judge Way entered an order notifying the parties in interest to file any objections or exceptions that they wished to make to said report, and setting the date for hearing the same on October 18, 1943. By reason of the subsequent illness of Judge Way (followed later by his most regrettable death) the case has been referred to the writer of this opinion for further judicial attention. On October 25, 1943, pursuant to further direct and published notices, all parties in interest were heard for a period of two weeks. At that time further evidence was submitted at a joint hearing held by the writer and United States District Judge Akerman of the Southern District of Florida, presiding Judge in the ancillary proceedings. At the adjournment of these hearings the court appointed a Conference Committee of certain representative secured creditors to consider and propose modifications of the plan of reorganization. This Committee, after further intensive study of the plan for a period of ten days and hearing certain interested parties obj ecting to the plan, submitted its report for substantial modification of the allocation of the new securities. A further hearing, after notice, has been held on these proposed modifications. The matter now stands for determination by the court with respect to the confirmation, rejection or modification of the plan submitted by the special master. The master’s printed report contains a table of contents which shows the vast scope of the studies made by him and his careful consideration of the extended evidence, oral and documentary, submitted at the hearings. It includes (1) the corporate history of the Seaboard Air Line Railway Company and its subsidiaries; (2) a general description of its property and assets; (3) its present debt and capital structure; (4) the properties to be dealt with in the reorganization; (5) data pertaining to its physical value and other capitalizable assets ; (6) the earnings experienced and forecast of the earnings; (7) the proposed capitalization of the new company; (8) classifications of creditors, security holders and stockholders; (9) claims not affected by the plan; (10) consideration of conflicting liens; (11) the amount of interest on past due instalments of interest; (12) studies incident to the allocation of the securities of the new company; (13) the proposed allocation of such securities; (14) consideration of certain other factors in the method of consummating the plan; and (15) method of putting the plan into effect. And finally, the ultimate conclusions of the special master with respect to the whole plan. Rule 53 of the F. R. C. P. deals with the procedure relating to appointments of special masters by the court. Subsection (e) (2) provides in part: “In an action to be tried without a jury the court shall accept the master’s findings of fact unless clearly erroneous. * * * The court after hearing may adopt the report or may modify it or may reject it in whole or in part or may receive further evidence or may recommit with instructions.” In passing upon the very numerous exceptions which have been filed to the master’s report, it will be impracticable in an opinion of any reasonable length to review in meticulous detail either each and all of the numerous exceptions, or to restate all the facts and figures with regard to the Railway Company which have been so fully considered and are treated at such length in the master’s printed report. It must be assumed, therefore, that the reader of this opinion is familiar with the main features of the report. An effort will be made here to simplify the statement of the rulings now to be made, as far as possible. A brief description of the Seaboard Air Line Railway Company will show the great complexity of the problem of its reorganization. Brief Description of the Seaboard System The present Seaboard Air Line Railway Company is the fourth corporation of the similar name. It is a consolidated corporation under the laws of Virginia, North Carolina, South Carolina, Georgia and Florida, and is also qualified to do business in Alabama. It was organized in 1915 and is the successor to three successive companies, each known as Seaboard Air Line Railway. It owns and operates more than 4,000 miles of railroad. The main stem of the Seaboard System extends from Richmond, Virginia, on the north, to Homestead on the east coast of Florida, and Naples on the west coast of Florida. From the main stem lines extend from Norlina, North Carolina, to Portsmouth, Virginia; from Hamlet to Wilmington, North Carolina, on the east and to Charlotte and Rutherfordton, North Carolina, and Atlanta and Birmingham on the west; from Savannah to Montgomery and from Jacksonville westwardly to Tallahassee and River Junction, Florida. There are numerous branch lines in Florida. Included in the more than 4,000 miles of railroad owned by the Seaboard are over 2,000 miles which are subject to ten separate underlying divisional mortgages. The total principal and unpaid interest on which (held by the public) as of January 1, 1943, amounted to $48,549,767.20. Subordinate to these underlying liens, but constituting first liens on certain portions of the whole railroad system are four general mortgages known as (1) first mortgage 4% bonds due April 1, 1950; (2) refunding mortgage 4% bonds due October 1, 1959; (3) first and consolidated mortgage 6% bonds, series A, due September 1, 1945, and (4) adjustment mortgage 5% bonds due October 1, 1949. These latter so-called adjustment mortgage 5% bonds are subordinate in lien to the refunding mortgage 4% bonds. The total principal and interest of these general mortgage bonds publicly held, aggregates $160,439,473.33. In addition there are $36,806,862.55 of Seaboard collateral trust obligations. The general unsecured claims against the Seaboard not entitled to priority of payment ahead of mortgage liens (as of August 1, 1942), principal and interest, amounted to $1,193,723.-97. The par value of the outstanding' capital stock of the Seaboard Air Line Railway Company, preferred and common, aggregates $85,110,662.21. During the course of the receivership the Receivers have incurred obligations represented by, outstanding receivers’ equipment trust certificates in the amount of $13,531,000, and receivers’ certificates in the amount of $23,128,000, and other indebtedness, aggregating in all $38,412,882.37. The grand total of principal and interest of the secured debt in the hands of the public is $221,362,-460.25, on which there is unpaid interest amounting to $118,889,124.39, a total of principal and interest of $340,251,484.64, which is, of course, exclusive of capital stock. During the course of the receivership, principally in the last two years, the Receivers have purchased and acquired about $34,000,000 par value of outstanding receivers’ certificates, and other secured obligations of the System. Nearly all of the securities were acquired by the Receivers under orders of court to the effect that the application of the moneys therefor should be without prejudice to the claims of parties in interest with respect to the application of the moneys so used. And during the receivership the Receivers have also applied upwards of $50,-000,000 in betterments to the railroad system. In the special master’s plan for reorganization it is proposed that there shall be included into one unified railroad system (1) all the properties heretofore owned outright by Seaboard; (2) all wholly owned subsidiaries; (3) subsidiaries partly owned but with some outstanding debt or stock held by the public and (4) the leased lines. The several separate properties thus to be dealt with are subject in whole or in part to eighteen separate mortgages. The Seaboard Is Insolvent The special master found on ample and convincing evidence, that the Seaboard is insolvent according to both the equity and the bankruptcy definitions. In consequence he decided that the holders of the stock, both preferred and common, were not entitled to participate beneficially in the reorganization. He likewise found that the holders of the Adjustment 5% Bonds above mentioned would not be entitled to participate because the securities of the reorganized company properly allocable to the Refunding Mortgage 4% Bonds (to which the Adjustment 5% Bonds were subordinate) would be insufficient to satisfy the claims of the 4% Refunding bondholders. He also found that the unsecured debt above referred to was not entitled to participate in the reorganization because the new capitalization would be insufficient to fully satisfy the claims of the holders of the secured debt. He also found that the stock of the subsidiaries publicly held would not be entitled to participate because the new securities allocable to the debt of those companies were insufficient to satisfy the claims thereon in full. Two Outstanding Questions The result of these findings necessarily limited the problem of reorganization to two main questions (1) what would be a proper reduced capitalization for the reorganized company, and (2) what allocation of the new securities should be made among the numerous classes of secured creditors. There will now be outlined as simply as possible how the special master determined these two outstanding questions. The elaborate report of the special master shows with what great care he considered these questions in the light of the voluminous testimony and all relevant data. It also shows that he gave careful consideration to the statutory and case law applicable to railroad reorganizations, and particularly had in mind the important principles applied by the Supreme Court of the United States in the very recent cases of Ecker v. Western Pacific Corp., 318 U. S. 448, 63 S.Ct. 692 (hereinafter sometimes referred to as the Western Pacific case), and Group of Institutional Investors v. Chicago, Milwaukee, St. Paul & Pacific R. R. Co., 318 U.S. 523, 63 S.Ct. 727 (hereinafter sometimes referred to as the Milwaukee case). These cases dealt specifically with reorganizations under the bankruptcy statute, section 77, 11 U.S.C.A. § 205, but the principles thereof to a great extent are likewise applicable if the reorganization is through equity procedure and not under section 77. The special master also gave careful consideration to the practice and conclusions of the Interstate Commerce Commission in other railroad reorganizations. The New Capitalization With respect to the properly permissible capitalization of the reorganized company, the determination of the special master was principally based upon the earnings, history and prospects of the Railway. (See pp. 115 to 121 of the master’s, report). On page 118 will be found the following statistical compilation of (1) total Railway operating revenues; (2) net Railway operating income and (3) total gross income of the Railway for the 15-year period, 1926-1940. Total Net Average Railway Railway Total Mileage Operating Operating Other (Gross) Year Operated Revenues Income Income Income 1926 ................ 4,329 $71,274,835 $12,787,301 $1,853,541. $14,640,842 1927 ................ 4,487 63,268,934 10,673,994 2,268,636 12,942,630 1928 ................ 4,501 57,301,821 10,015,047 2,432,946 12,447,993 1929 ................ 4,493 58,205,713 10,934,232 1,229,580 12,163,812 1930 ................ 4,498 49,747,423 5,806,470 1,016,471 6,822,941 1931 ................ 4,482 42,366,632 . 2,580,798 489,132 3,069,930 1932 ................ 4,427 30,791,618 199,224 520,807 720,031 1933 ................ 4,359 31,626,026 2,620,546 490,818 3,111,364 1934 ................ 4,312 33,934,391 1,628,157 406,881 2,035,038 1935 ................ 4,311. 34,008,579 1,497,449 335,963 1,833,412 1936 ................ 4,311 38,423,314 3,527,374 368,074 3,895,448 1937 ............... 4,312 42,865,051 3,768,725 393,628 4,162,353 1938 ................ 4,321 40,086,098 ' 1,476,376 328,269 1,804,645 1939 ................ 4,330 44,252,278 3,615,172 350,686 3,965,858 1940 ................ 4,316 ' 48,596,779 4,432,931 329,027 4,761,958 5 yrs. average 1926-1930... ■ 39,959,745 10,043,409' 1,760,235 11,803,644 9 yrs. average 1931-1939... 37/594,887 2,323,758 409,362 2,733,120 14 yrs. average 1926-1939... 45,582,337 5,080,776 891,817 5,972,593 6 yrs. average 1934-^1939... 38,928,285 2,585,542 363,917 2,949,459 10 yrs. average 1931 — 1940... 38,695,077 2,534,675 401,329 2,936,004 15 yrs. average 1926-1040... . 45,783,299 5,037,587 854,297 5,891,884 5 yrs. average 1936 — 1940... 42,844,/04 3,364,116 353,937 3,718,053 From this table it will be found that in this 15-year period the greatest annual total Railway operating revenues were in the year 1926 in the amount of $71,274,835, with total gross income of $14,640,842. The lowest annual figures were for the year 1932 (in the depth of the economic depression) when total Railway operating revenues were $30,791,618, and total gross income $720,031. In 1940 the total Railway operating revenues were $48,596,779, with total gross income of $4,761,958. For the ten years average, 1931 to 1940, the total gross income was $2,936,004. For the five years average, 1936 to 1940, the total gross income was $3,718,053. However, it is presently important to contrast with these figures what has occurred in the last three years. In 1941 the total Railway operating revenues were $64,729,178, with total gross income of $10,664,016; in 1942 the total Railway operating revenues were $110,467,787, with total gross income of $34,566,102. For 1943 it is estimated that the total Railway operating revenues will approximate $137,000,000, with estimated gross income before federal taxes and increased wages of about $50,000,000. It is, however, not possible at this time to determine with even approximate certainty what will be the net income for 1943 applicable to fixed charges in view of the uncertain amount of increased-federal taxes and expenses of operations owing to increased wages to employes. It is also recognized that the present greatly increased revenues are the result almost entirely of wartime activities which it is hoped, in the national interest, will not long continue; and upon resumption of normal activities it is reasonably to be anticipated that there will be a very great shrinkage in such Railway revenues, both total and net. In the new capitalization based on the earnings records and prospects, the master first considered that the proposed capitalization of the new company should be, in addition to $13,835,000 of undisturbed receivers’ equipment trust certificates, $40,-000,000 par value of first mortgage bonds, $45,000,000 pár value of income mortgage bonds, $15,000,000 of preferred stock and 850,000 shares (no par value) of common stock. However subsequently a large amount of receivers’ certificates were retired and in view of that and other considerations the master finally recommended the following new capitalization: Capitalization of the new company as finally recommended (As of January 1, 1944) To be assumed or issued on Title of Issue reorganization Annual charges, interest and dividends Rentals and mise, charges, undisturbed.... 8 110,000 Undistributed Receivers’ Equipment Trusts $ 11,870,000 336,000 First Mortgage Forty-Year 4% Bonds, Series A (distribution)............... 32,500,000 1,300,000 Total fixed interest debt............. 44,370,000 Total Annual fixed charges.......... 1.746.000 Capital Fund (Discretionary, not in excess of 3%% of Total Railway Operating Revenues or $1,625,000, whichever is greater) ............................. $1,625,000 Sinking Fund for First Mortgage Bonds Series A (1%).................... 325,000 Total Annual Charges prior to interest on Income Mtge. Bonds............ 3.696.000 Income Mortgage 50-year 4%% Bonds, Series A............................... $ 52,500,000 2,362,500 Sinking Fund for Income Mtge. Bonds, Series A ($262,500) ................. Total fixed and contingent debt....... 96,870,000 Total annual charges before dividends 6,058,500 Preferred stock 5% ($100 par value)...... 15,000,000 750,000 Total par value of securities.......... $111,870,000 Total annual charges against income through preferred stock dividends.. 6,808,500 Common Stock (shares of no par value).. 850,000 Total capitalization (common at $100) $196,870,000 From this it' appears that the total annual fixed charges of the reorganized railroad system will be only $1,746,000, and that, after the further deduction from net income of $1,625,000 annually for a discretionary capital fund and $325,000 as a sinking fund for the first mortgage bonds, the net earnings if sufficient thereafter will be applicable to the income mortgage bonds. Thus the total annual charges prior to interest on income mortgage bonds will be $3,696,000; and, if the net earnings are sufficient, the interest on the income mortgage bonds will be $2,363,500, making a total fixed and contingent debt in the principal amount of $96,870,000, with total annual charges before dividends in the amount of $6,058,500. If there are additional net earnings a 5% dividend 6n the preferred stock would be annually $750,-000, with any surplus of net earnings applicable to dividends on the common stock. Therefore if the annual net earnings exceed $7,000,000 it will be reasonably possible to pay some dividend on the new common stock. As the net earnings applicable to interest charges for 1941 were over $10,000,000, and for 1942 were over $34,000,000, and for 1943 will probably be 'comparatively large, it is a reasonable expectation that for the next year or two the net earnings of the Railroad will be sufficient to pay some dividend on the common stock, although it is fully realized that how long this prosperity will continue is wholly problematical at the present time. In the light of all the relevant data the new proposed capitalization would seem to be reasonably conservative, and to this extent in the public interest, although it is fully recognized that the capitalization of the new company is a matter now committed to the exclusive and plenary jurisdiction of the Interstate Commerce Commission under 49 U.S.C.A. § 20a. And therefore whether the reorganization of the Seaboard is to be consummated by equity or bankruptcy procedure, the new capitalization must necessarily first receive the approval of the Interstate Commerce Commission by formal proceedings applicable thereto. The proposed new capitalization is generally satisfactory to and has been expressly or at least impliedly approved by the representatives of all parties who have intervened in or otherwise participated -in' the proceedings here in court arising on the exceptions to the master’s report, with the exception of one holder of a substantial block of the present stock of the Railway Company who has contended that the present scale of earnings of the Railway Company justifies the beneficial inchtsion of stockholders in the reorganization. Full opportunity was offered by the court to this objector to present any additional evidence bearing on the solvency of the Seaboard, but no such new or additional evidence was presented. The temporary large earnings are so clearly due to special wartime causes that they cannot safely be made the basis for the new capitalization. I have therefore concluded that the exceptions to the master’s report on this ground must be overruled. For similar reasons the objections of certain owners of Adjustment 51% Bonds must also be overruled. Likewise exceptions by unsecured creditors are also overruled. Adjustment Mortgage 5% Bonds of 1949 The special master determined that the holders of this bond issue are not entitled to participate in the plan as the claims thereon had no value. The Fidelity Trust Company of Baltimore is the trustee of this bond issue, under mortgage dated October 1, 1909, which gave a lien immediately subordinate to the Refunding Mortgage 4’s. The trustee has asserted no claim for the bondholders and has not participated in the proceedings. The original issue of these bonds was in the principal amount of $25,000,000. Only $2,-500,000 are now outstanding in the hands of the public. In 1929 and 1930 the great majority of these, bonds were exchanged on a certain diminished basis for Consolidated 6’s. Ample opportunity appears to have been given to all bondholders to make this exchange at their option but the present outstanding $2,500,000 thereof failed to do so. No exceptions to the master’s report were filed by any bondholders of this group until after the time allowed therefor by the original order of court setting the case for hearing on October 18, 1943. But during the hearings in court beginning October 25, 1943, Mr. Paul Schmidt, of the lavr firm of Weinberg & Green of Baltimore, was .given leave to file exceptions on behalf of certain bondholders. It appears that a Committee for these bonds at one time during the receivership had been in existence but had long ceased to function. Opportunity was given to counsel for these exceptants to submit any evidence desired in support of the exceptions, but none was offered. However, a full brief has been submitted and carefully considered by the court. The points therein made, to the effect that these bonds are entitled to participate to some extent in the new capitalization, are (1) the management of the Seaboard Air Line Railway unfairly treated the bondholders by withdrawing the offer for exchange without adequate publicity; (2) in making the financial arrangements and subsequent mergers of the Railroad and new bond issues which gave unfair treatment to the Adjustment 5’s, and (3) that the present wartime earnings of the System are sufficient to justify their participation to some extent, the amount of which, however, is not specified. No evidence was submitted in support of these exceptions. I cannot find any legal or equitable basis in support of the exceptions. It is not disputed that the bonds have no lien except that wholly subordinate to the Refunding 4’s, arid it is also clear that the claim on the Refunding 4’s is not fully satisfied by the allocation of new securities. As will appear from the annexed tabulation showing the final allocation of new securities, the total claim, principal and interest, of the Refunding 4’s amounts to $36,127,360.36. The total par value of all new securities allotted to Refunding 4’s is only $18,760,186. While the Consolidated 6% mortgage is subsequent in point of time, and after the further and final consolidation of 1915, it is not shown that the Adjustment 5’s have any lien on the property, mostly collateral, securing the 6’s. With regard to the contention that the present large System earnings justified some recognition of the Adjustment 5’s, it is sufficient to say that there is certainly no evidence before the court from which it can be found that the Adjustment 5’s have a legal or equitable claim to any accumulated income as there is not a sufficient amount thereof to satisfy the claim of the Refunding 4’s, and indeed no mortgage foreclosure proceeding asking impounding of income has been filed by the trustee for the Adjustment 5’s. Allocation of New Securities The much more difficult problem of the reorganization is the allocation of the new securities to holders of secured indebtedness. The total principal .and interest of secured claims in the hands of the public adjusted to January 1, 1944, entitled to participate in the new securities amounts to $183,099,252.88 of principal, and $144,-780,897.33 of interest or a grand total of principal and interest in the amount of $325,546,816.88. The total new capitalization (taking the 850,000 shares of common stock at par of $100 per share) amounts to $196,870,000. It is obvious that the new capitalization, even if all the new securities are worth their respective pars (taking the common stock at $100 per share), does not greatly exceed 50% of the total secured debt. It is highly improbable that any of the new securities, with the possible exception of the first mortgage bonds, will have a realizable market value of par. The very reasonable estimate is that the new first mortgage bonds will have a market value of a little less than par; the income mortgage bonds 50, the preferred stock 25 or 30, and the common stock about 10 or 15 per share. Of course these are only estimates as it is impossible to predict with even approximate certainty future market conditions. It-is, however, entirely clear that (with the exception of a few classes of the secured debt arising from certain well secured underlying liens) the securities afforded by the new capitalization will be insufficient in value to fully satisfy the claims, principal and interest, of the secured creditors. It is inevitable, therefore, that some creditors must suffer capital losses or at least losses of much accumulated interest in the reorganization. The master’s report shows that he has very fully and carefully classified all the outstanding indebtedness and other claims against the Seaboard Railway Company. Only the secured debt is entitled to beneficial participation in the new securities. The chief problem is how they can be fairly, legally and justly allocated between the several classes of secured creditors. In approaching this major problem the master’s report shows that he has fully applied the dominant principles of law of full priority to prior liens, that is to say, a prior lien must be fully and fairly compensated in value in what is received therefor in the new securities, before subordinate liens can participate. However, this principle did not create the real difficulty in the allocation. It consisted rather in the apportionment to be properly made between holders of first liens by mortgage or otherwise on separate divisions of the whole railway mileage included in the reorganization, involving, as has been noted, (1) wholly owned mileage; (2) leased lines and (3) independently operated mileage. Much of the difficulty in the allocation consists in determining the fair equitable treatment to be accorded divisions of railroad mileage on which separate classes of secured creditors each have a first lien, especially in those cases where these divisions have had no net earnings but definite deficits in operation and therefore independently considered, have been operated at a loss and not at a profit. While there is little, if any, objection by these respective first lien holders to the new capitalization, practically all of them have objected to what they have considered an insufficient amount of new securities allotted to them respectively. And indeed this is the principal and main difficult problem in the whole of the master’s report. In considering this important feature of the reorganization plan, it is necessary to first clearly understand the principle of allocation adopted by the master. This has been fully explained by him in the text of his report, pp. 227 to 258, and the figures resulting from the principles adopted by him are set out in the numerous tabulations appended to the report. These tabulations are highly complex in detail, and have been made more complicated by the fact that the master first made a primary allocation of all the securities when there were outstanding receivers’ certificates in a large aggregate amount and when it was proposed that the total issue of first mortgage bonds should be greater than the amount finally recommended of $32,500,000. The retirement of some of the receivers’ certificates and the consequent reduction of the first mortgage bonds from $40,000,000 to $32,500,000, and the increase in the income mortgage bonds from $45,000,000 to $52,-500,000, required a secondary allocation. The primary allocation of first mortgage bonds is shown in table Vila, and the final allocation in table VHb. Similarly the primary and secondary allocations of income mortgage bonds are shown in tables Villa and VIHb and the initial and final allocations of preferred stock in tables IXa and IXb, and of the common stock in tables Xa and Xb. The final result of the primary and secondary allocations of the securities for each of the several classes of secured creditors is shown in table la, sheet 2. While these calculations, as has been said, are complex and at first blush quite confusing, there is no objection on that particular score to the master’s report. The figures themselves are not challenged and there is no complaint with respect to the fact that the master, largely for historical reasons, adopted the method of a primary and .secondary allocation. What is objected to by many of the separate classes of secured creditors is the principle which the master has applied in both the primary and secondary allocations, as applicable to the several divisions of the Railway System, in determining their quantitative participation in the several classes of the new securities. By reference to tables VII to X, there will be found the amount of first mortgage bonds, income mortgage bonds, and preferred and common stocks, allotted to each of the several railroad divisions. Here it is to be noted that primarily the particular Division is valued (but not at so many dollars) as an entity irrespective of the liens thereon. If the value of the Division is such that the total new securities allotted to it are of greater value than the principal and interest of the first liens thereon, the over-plus is awarded to the holder of the second or subordinate liens in their respective order. And there is no substantial complaint in this case that this full priority of treatment for prior liens has not been fully observed in the master’s report. To repeat, the real problem is to fairly determine what should be the proportionate shares of each of the railroad Divisions in the several classes of new securities. Referring to table la, sheet 2, there will be found in the left hand column the designation of particular railroad mortgage divisions by name (or other class of secured debt), and opposite the respective names are shown in column 1 the total principal and interest of claims thereon in the hands of the public, and then in subsequent columns the particular par values of first mortgage bonds, income mortgage bonds, preferred stock and common stocks allotted thereto, with total par value in column 7; and in subsequent columns the allotment is given for each $1,000 par value of indebtedness of the particular bond issue. We need not pause here to presently consider the particular treatment of receivers certificates and indebtedness to the Union Switch & Signal Company and the Pullman Standard Car Mfg. Co. (now acquired by the receivers) ; but for illustration we may take the case of the Carolina Central Railroad Co. 1st Consol. 4’s of 1949. These bonds are secured by a first mortgage lien on approximately 273 miles of railroad extending generally from Wilmington, N. C., to Rutherfordton, N. C. Of the ten underlying bond issues, it is one of the best secured with respect to amount of mortgage per mile of railroad and of net earnings. It naturally therefore has received favorable (by other secured creditors considered too favorable) treatment by the master. The principal and interest of this bond issue aggregated as of January 4, 1944, $4,017,620. It received in new first mortgage bonds $1,595,562 and $3,207,438 of income mortgage bonds; $1,-064,188 preferred stock and $4,418,340 of common stock, or a total par value of new securities of $10,285,526. But it is to be noted that in making this allocation the master considered that the new securities alone would not be worth par but should be taken at par for the first mortgage bonds, at $50 for the income mortgage bonds, at $25 for the preferred stock and $12.50 for the common stock. On this latter basis the new securities no more than equal the principal and interest of the bond issue. But the total allocation of new securities applicable to the Carolina Central Division as an entity, irrespective of the limited number of first mortgage bonds, shows a surplus applicable to this particular Division, with respect to the allocable common stock. By reference to table Xb, column 5, the amount of par value of common stock allocable to the Carolina Central Division was $6,032,622, of which amount (see column 6) $1,614,282 has been allotted as a surplus to junior lienors. Table la sheet 2 further shows that per $1,000 principal amount of this first mortgage bond issue of the Carolina Central the principal and interest amounted to $1,-340, and in the final allocation of new securities each of these bonds received an amount of new securities of a total par value of $3,428.51. Similarly table la, sheet 2, shows the aggregate of all new securities at par values awarded to the respective classes of secured creditors, both with respect to the whole issue of the particular securities outstanding and also with respect to the amount thereof per $1,-000 bond. As previously noted the most difficult problem in the reorganization plan lies in the relative valuations to be accorded respective railroad divisions. In discussing the same problem in the Milwaukee case, supra, the Supreme Court by Mr. Justice Douglas, 318 U.S. 561, 563, 63 S.Ct. pages 747, 748, said: “The problem in such a case is not a simple one. The contribution which each division makes to a system is not a mere matter of arithmetical computation. It involves the appraisal of many factors and the exercise of an informed judgment. Furthermore, an attempt to put precise dollar values on separate divisions of one operating unit would be quite illusory. As the Commission recently stated, ‘The properties comprise one operating unit; a complete separation of values would necessarily have to be based on extensive assumptions of unprovable validity; and any attempt at such a separation would in the end serve no purpose except to present an apparent certainty in the formulation of the plan which does not exist in fact.’ * * * Sec. 77 contains no formula for the making of such an allocation nor for the determination of the earning power of the entire system or parts thereof. The earnings period to be chosen, the methods to be employed in allocating system earnings to the various divisions are matters for the informed judgment of the Commission and the Court. * * * We are not dealing here merely with a first mortgage and a second mortgage on a certain piece of property. For each of the two groups of bondholders has a first lien on a part of the Milwaukee properties. * * * But where, as here, each group of bondholders is contributing to a new system mortgage separate properties from old divisional mortgages, it is necessary to fit each into the hierarchy of the new capital structure in such a way that each will retain in relation to the other the same position it formerly had in respect of assets and of earnings at various levels. If that is done, each has obtained new securities which are the equitable equivalent of its previous rights, and the full priority rule of the Boyd case [Northern Pacific R. Co. v. Boyd, 228 U.S. 482, 33 S.Ct. 554, 57 L. Ed. 931], as applied to the rights of creditors inter se, is satisfied. * * * No fixed rule supplies the method of bringing two divisional mortgages into a new capital structure so that each will retain in relation to the other the same position it formerly had in respect of assets and of earnings at various levels. The question in each case is one for the informed discretion of the Commission and the District Court.” Earlier in the same opinion, in particular discussion of permissible capitalization of the reorganized company, it was said: “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. Temmer v. Denver Tramway Co., 8 Cir., 18 F.2d 226, 229; New York Trust Co. v. Continental & Commercial Bank, 8 Cir., 26 F. 2d 872, 874. The reasons why it is the appropriate test are apparent. A basic requirement of any reorganization is the determination of a capitalization which makes it possible not only to respect the priorities of the various classes of claimants but also to give the new company a reasonable prospect for survival. * * * Certainly there is no constitutional reason why earning power may not be utilized as the criterion for determining value for reorganization purposes. And it is our view that Congress when it passed § 77 made earning power the primary criterion. The limited extent to which § 77 sub. e, provides that reproduction cost, original cost, and actual investment may be considered indicates that (apart from doubts concerning constitutional power to disregard them) such other valuations were not deemed relevant under § 77 any more than under § 77B ‘except as they may indirectly bear on earning capacity.’ * * * Consol. Rock Products Co. v. Dubois, supra, 312 U.S. [510], page 526, 61 S.Ct. [675] page 685, 85 L.Ed. 982. In this case the Commission followed the statute. While it made earning power the primary criterion, it did not disregard the other valuations. It considered them and concluded in substance that they afforded no reasonable basis for believing that the probable earning power of the road was greater than what the Commission had found it to be by the use of other standards.” So in this case the special master was quite correct, in valuing the several mortgage divisions for their relative participation in the new securities, in giving predominant weight to their respective earning capacities. However, he did not disregard other criteria of value, including cost of reconstruction new less depreciation, and the net value to the Railroad System of the freight contributions made by each of the lines to the System. (Traffic contributed by a separate division has reference to sums earned by the balance of the System on freight business forwarded from or received by each mortgaged or leased line.) He also considered what weight should fairly be given to the so-called “severance studies” with respect to the several Divisions. Principles of Allocation of New Securities In allocating the new securities to the several Divisions the special master proceeded on the following principle. In the primary allocation, the first mortgage bonds, other than those allotted on account of receivers’ indebtedness, investment securities, and cash on deposit with the trustees, were allotted on the basis of segregated, earnings average of the five-year period, 1936 to 1940, with certain adjustments. But the income mortgage bonds, other than those allotted on account of investment securities and the special allotment in a particular case, were allocated as to one-half thereof on the basis of segregated earnings, and the other half on the basis of the net value of freight contributions; with the exception that the $7,500,000 of such income bonds, resulting from the revision of the initially proposed capital structure as above explained, were allocated wholly on the basis of segregated earnings. The preferred and common stocks, other than the allotments thereof on account of investment securities, were allocated one-third on the basis of segregated earnings, one-third on the basis of the net contributions to freight traffic, and one-third on the basis of reconstruction cost new less depreciation. In the secondary allocation the first mortgage bonds which had been primarily allocated to receivers’ certificates and to some small bond issue acquired by the Receivers, were allocated on the basis of segregated earnings. Method of Determining Segregated Earnings The proper method of determining these “segregated earnings” of the respective mortgage Divisions, is factually a very difficult problem and much of the testimony before the master and before the court had relation to this particular problem. Its primary importance in the final results is shown in the figures on table II, annexed to the master’s report. In column 1, opposite the designation of the respective divisional mortgages, will be found a figure representing the total average annual gross income (that is, the total railway operating receipts less expenses plus other income, if any) for each of the mortgage Divisions. Other columns indicate adjustments by subtraction or addition made to the respective figures in column 1, and column 10 shows the adjusted net earnings of the respective Divisions. (The several adjustments are somewhat complex and detailed, but there has been no particular objection thereto insisted upon.) The total of column 10 represents the total of gross income of all the several Divisions which earned net income. But it will also be noted from column 1 that certain of the Divisions, including the Florida West Shore Railway, and Georgia & Alabama Railway, the Southbound Railroad, Naples, Seaboard & Gulf Railway Co., and among the Leased Lines the Seaboard-All Florida Lines, and the Georgia & Alabama Terminal Co., and the Tampa and Gulf Coast Railroad, the Durham & Northern Railway Co., and the Roanoke & Tar River Railroad Co., all had deficits instead of net earnings. And even after the adjustment of credits shown on table 2 all of these roads but one still had the net deficits shown in column 9. The aggregate of the deficits in column 9 is $1,231,178. The question as to the proper treatment of these deficits of particular lines will hereafter be further discussed. It is another real difficulty in the whole problem. To the extent that the new securities are allocated on the basis of segregated earnings, it will be noted that the amount allocated to each Division is represented by the proportion which its net earnings as adjusted and stated in column 10, bears to the aggregate net earnings of all the Divisions having net earnings, but without deducting from the latter the deficits of the Divisions having deficits. It will also be noted from table 2 that the original computation of net earnings of each Division was based on what is referred to as the “Kennedy Segregation Formula”. This requires further explanation. Formulas for Determining Segregated Earnings There is no uniformly recognized yardstick for the calculation of the net earnings of separate Divisions of a unified railroad system. The published traffic rates of the Interstate Commerce Commission do not make the segregation and in the case of a wholly solvent railroad there is no need of taking account of such segregated earnings. However, in the problem of reorganization some formula must be devised and applied, with necessary adjustments, by reason of special situations, in the allocation of new securities. Promptly after the initiation of the receivership of the Seaboard, followed by the filing of bills for foreclosure of certain of the mortgages on various segments of the System, the court ordered the Receivers to make segregation of the earnings and pursuant thereto the Receivers prepared a formula called the “General Formula” which undertook to provide the basis for the segregation of the revenues and expenses of various mortgage Divisions and Leased Lines comprising the System; but the court has never yet been asked to approve this or another formula until the present time. Drafts of this “General” formula were submitted from time to time to the organized representatives of security holders, and the results compiled thereunder for each of the years 1931 to 1940 were likewise currently distributed to such representatives. This General formula and its results are shown as exhibits in this case and discussed by the special master on page 215 of his report; and other formulas on succeeding pages. The general principle of the General formula is that freight revenues on traffic local to one line is allocated thereto. Where the freight revenue is applicable to two or more lines, the allocation is made as follows: An allowance of 10% of the total revenue on each shipment is credited to the line originating, terminating or interchanging a shipment, and a mileage pro rata is also allowed the originating, terminating or interchanging line in addition to the 10% allowance. There are also certain other allowances or adjustments made. Passenger revenue or traffic local to one line is allocated thereto, and the passenger revenue applicable to two or more lines is divided between the participating lines on an actual mileage basis. Operating expenses and other income debits and credits are allocated to lines of which or on behalf of which they were incurred. Sometimes they must he apportioned. With respect to routine expenses, such as crew wages, fuel and other supplies which constitute a large part of such expenses, the rate used is a train mileage pro rata. The formula provides for a rental charge for use of System equipment at the rate of 3%% per annum on the average depreciated book value of the equipment as of each year. This rental charge is allocated to the several Divisions. There are some variations in this procedure. In determining the net earnings the special master adopted in general this formula, but with important modifications made by Mr. Kennedy, testifying as an expert railroad engineer or statistician called as a witness on behalf of the general mortgage bondholders. He undertook to divide the income of the Seaboard System among the various mortgages and leased lines in such a manner as to show the earnings of each as a part of the Seaboard System. Where reports of revenues and expenses between the lines is required, the formula with minor exceptions is claimed to be uniform and in substantial accord with the formula approved by the Interstate Commerce Commission, Finance Docket 10992, N.Y. N.H. & H. Reorganization, 224 I.C.C. 723, 724. The Kennedy modifications of the general formula consist principally in adding “a constructive mileage block” to the actual road-haul mileage on the originating or terminating lines, and dividing the total revenue of each shipment in proportion to the sum of actual plus constructive mileage of each line to the total constructive and actual mileage over which the individual shipment moves. In accordance therewith “the mileage block used in allowing for terminal service was ascertained by finding the system cost of originating and terminating a car of freight or interchanging the same with another road by a method described in the formula”. The cost of interchanging a car of freight with another road was found equivalent to hauling a car of freight 16 miles. Similarly to each originating and terminating line a constructive block of 58 miles was added to the actual mileage of each shipment hauled. Under the Kennedy formula revenue for passengers hauled was apportioned on the basis of the actual mileage that each line hauled each passenger. While the master adopted the more significant features of the Kennedy formula, it is to be noted that he departed from it with respect to the treatment of passenger losses which he apportioned to all of the lines composing the System in relationship to the gross freight revenue on each line to the total of the System. “In applying this treatment, the net loss from passenger operations of each line divided by System net loss from passenger operations, gave the percentage of the individual line’s proportion of total net passenger loss. The revenues from freight operations of each line divided by the System revenues from freight operations gave the line’s percentage of the total System revenues from freight operations. In the event this percentage of revenues from freight operations was less than the percentage of net loss of the individual lines from passenger operations, the individual line was given credit for this difference to compensate it for the excess loss it had sustained in passenger operations, and, on the other hand, in the event the percentage of freight revenues was relatively higher, the individual line, by the same method, waSi charged with the difference in order to make its equitable contribution to the total loss sustained from the passenger operations.” See master’s report, pp. 242 to 245. Other formulas for determining segregated earnings were considered by the special master. The representatives of the underlying bonds submitted the so-called Wyer formula proposed by a railroad expert testifying for them. Both Messrs. Kennedy and Wyer also testified in the court hearings. In general the Wyer formula goes into more specific and particular treatment in many respects to determine the net earnings of each of the Divisions. Another formula considered by the special master was the “net ton mile” formula, the theory and practice under which was quite fully explained by Col. Henry W. Anderson of Richmond, Virginia, one of the Receivers in this case, himself a highly experienced railroad reorganization lawyer. As compared with the other formulas it has characteristic simplicity and realism as contrasted with many assumptions in other formulas. As stated by the master, “It is predicated upon the theory that the Railway System is a single integrated unit for rendering the public service required by law and that it is operated as a unit upon a System basis; that all Mortgage Lines Divisions or Leased Lines are interdependent, and contribute directly or indirectly to the net earnings of the System as a whole, and that each Mortgage Line Division or Leased Line constituting a part of the System is entitled to participate in the net earnings upon the basis of its relative aid or value to the service rendered to the public and for which the System receives payment from the public. The yardstick selected for determining the proper division of revenues and expenses is, in the case of freight revenue, the revenue net ton miles of freight carried, and, in the case of passengers, the revenue passenger miles of passengers carried. The relative value of the Mortgaged Lines Divisions or Leased Lines to the System is found in the number of revenue net ton miles and revenue passenger miles that the special line carries in relation to the other lines of the System, except that equipment rent credits and certain other income are allocated on the basis of ownership or other basis.” If this formula were applied it would eliminate the troublesome question of the treatment of deficits of certain Division Lines in this case, and would furnish a determination of relative values on the realistic conception of what service each Division actually renders in the System as a whole. It is perhaps regrettable that-none of the interested parties in this case advocate, but on the contrary, all oppose the application of the net ton mile formula. The experts in this case (other than Col. Anderson) object to the application of the formula on the grounds principally that it does not take into account the comparatively high operating expenses of particular Divisions owing to grades and other physical conditions, and gives no credit to Lines which it is said or assumed, carry an alleged higher remunerative class of traffic. To the latter objection Col. Anderson points out that all rates for passenger traffic are fixed by the Interstate Commerce Commission and all freight traffic rates are likewise fixed by the Commission. Presumably they are all fixed on a reasonable basis and there is no certain knowledge by any one that there is intrinsically more profit in the carriage of one class of freight than of another. For instance, the freight rate for perishable commodities is much higher than for coal or pig iron, but the expenses of carriage in refrigeration and other care are also much higher. The special master obviously had to make a choice of some formula for the calculation of net earnings. His report shows that it was not arbitrarily made but resulted from his best judgment on consideration of all the relevant data. It must be remembered here that there is no rule of law which prescribed the criteria for the determination of earnings of separate railroad divisions in one system. The master concluded from the relevant facts that the formula he adopted and applied was the one most equitable and fair in the particular situation. I cannot say that his conclusion in this respect was clearly erroneous despite the fact that, if the matter had been one of original impression with the court, I would have been much disposed to adopt and apply the net ton mile formula. However, the cii cumstauces of this particular reorganization seem to render the adoption of this formula impracticable. To adopt it would necessitate a complete revision of the allocation of new securities and the statistical data to be compiled would require a further delay which should be avoided if possible. None of the parties interested in the reorganization, with one possible exception, had advocated it. Nor has it ever heretofore, so far as the court is advised, been actually applied in any of the numerous prior railroad reorganizations either in equity or the more recent ones under section 77. In re Chicago, R. I. & P. Ry. Co., D.C., 50 F. Supp. 835, 862, its applicability was briefly discussed by District Judge Igoe with the following comment: “The court is of opinion that the relative net ton miles of the different mortgage divisions are not an indication of relative values because they take no account of the character of the traffic or of the income derived therefrom.” The Result of the First Court Hearings As a result of two weeks’ hearings on exceptions to the plan, it appeared that the general attitude of the interested parties was that the plan as a whole was fair and equitable, with the qualification urged by a number of different classes of the secured creditors that they were respectively not given sufficient amounts of the new securities. That is to say, nearly all of them approved the plan in general for others, but not for themselves in its practical results. The major conflict was between the underlying bonds and the general mortgage bonds. There was also a particular complaint by the representatives of the Division known as the Seaboard Air Line Railway — Atlanta Birmingham 1st 4% bondholders of ’33 that the test period of five years (1936 to 1940) adopted by the master was wrong in principle as applied to the Atlanta Birmingham Line, and that the test period for it should have been only the year 1939. The representatives of a minority amount of the Georgia & Alabama Railway 1st Con. 5’s of ’45 also objected to the allocation to that Division principally on the ground that they were not given any first mortgage bonds or other junior securities allocable on the basis of a proportion of net earnings. This was because for the five-year period the average of the net earnings of that road showed a deficit of $126,078. In only one of these years (1936) did this Division show any net earnings. Counsel for the Tampa Northern (a leased line) bondholders objected to the treatment given that Line by reason of its special situation in that it had on hand in cash and clearly available credits from receivership operations a sum aggregating more than the principal and accumulated interest on the whole outstanding bond issue. A representative of the publicly held preferred stock of the Georgia, Florida & Alabama Division (another leased line) also objected to the plan on the ground that no provision had been made for its preferred stock. Counsel for the Committee representing the majority of most of the underlying bonds objected to the allocation as made by the master’s report on several grounds. One was that the master should have adopted the Wyer formula rather than the Kennedy formula; another that the test period for determining earnings should more properly have been the year 1939 alone rather than the five-year period of 1936 to 1940; but the principal objection was in the manner of treatment of deficits of Divisions which did not have average net earnings for the test period. In this respect the contention is that the deficits of the non-profit Divisions should not in effect be pro rated over the other underlying Divisions having net earnings thus diminishing their average net earnings, but such deficits should have been absorbed by the net earnings otherwise applicable to the general mortgage Divisions. The practical importance of this contention will appear from a study of table II filed with the master’s report, to which reference has previously been made. In column 10 there is stated, opposite each Division, the amount of the adjusted net earnings of that Division. The total of the column is $3,237,904. But it will be noted that from this column there has been omitted the deficits incurred attributable to eight of the Divisions which aggregate $1,231,178. In calculating the proportion of the whole net earnings ($2,006,726) for each Division as a basis for the allocation of new securities, the master has disregarded these deficits. The mathematical result is that the holders of underlying bonds on Divisions having net earnings receive a smaller proportion of the new securities (to the extent the allocation is based on earnings) than they would have received if the deficits of the non-earning Lines had been deducted from the aggregate earnings of the earning Divisions. A simple example will suffice. By reference to table II it is found the adjusted earnings of the Carolina Central Division are about $200,000. The aggregate of all the earnings of