In re Baltimore & O. R. Co. (63 F. Supp. 542, 1945)

CHESNUT, District Judge.

This petition for a railroad adjustment under Chapter XV of the Bankruptcy Act, 11 U.S.C.A. § 1200 et seq., is a sequel to In re Baltimore & Ohio Railroad Co., D. C., 29 F.Supp. 608, certiorari denied Getz v. Baltimore & O. R. Co., 309 U.S. 654, 60 S.Ct. 470, 84 L.Ed. 1003; Id., 309 U.S. 697, 60 S.Ct. 709, 84 L.Ed. 1036. In that earlier case this court (a three-judge court) approved the B and O’s 1938 plan for an adjustment of its securities under Chapter XV of the Bankruptcy Act then in force. That Act expired by limitation on July 31, 1940, but was re-enacted by the Act of October 16, 1942, c. 610, 56 Stat. 787, 11 U.S.C.A. (ss. 201 to end) §§ 1200-1255; but by its terms is limited in duration to November 1, 1945, except in respect of any proceeding thereunder theretofore filed.

The chief characteristic of the 1938 plan was an eight year moratorium for the payment of interest charges on certain of the Railroad’s bond issues. The dominant feature of this second plan is the extension of maturity dates for certain bond issues aggregating in principal amount $495,-799,164. The 1938 plan, after approval by the court, has proven successful in that it avoided a receivership and drastic reorganization of the Railroad under section 77 of the Bankruptcy Act, 11 U.S.C.A. § 205, and since 1941, all current and accumulated interest has been paid by the Railroad on all its securities; and in accordance with that plan, the Company has retired over $100,000,000 par value of its capital obligations with consequent reduction of over $5,500,000 of annual interest charges. One feature of the financial embarrassment of the Railroad in 1938 was its then existing obligation in the amount of $72,771,578.44 due to the Reconstruction Finance Corporation for loans previously made and maturing in 1939-1942, secured by a large amount of collateral, and a $50,000,000 note issue (of which the R.F.C. held $13,490,000), likewise maturing in 1939. One of the adjustments made by the 1938 plan was a five year extension of maturity of these obligations with the consent of the R.F.C., until November 8 and August 1, 1944 respectively. Although the 1938 plan was to be generally effective for eight years the R.F.C. was unwilling to postpone the maturity of the debts due to it for a longer period than five years. As the law then stood they could not extend beyond January 31, 1945. 49 Stat. 2, now amended, see 15 U.S.C.A. § 605m.

Particular consideration was given in the hearings on the 1938 plan to the possible or probable effect that these large 1944 maturities would have on the successful working out of the plan. It was realized that the obligations would have to be met either from excess earnings (which seemed improbable) or from successful refunding or otherwise; and the court concluded from the evidence submitted that there was a reasonable prospect for the successful refunding of the 1944 maturities through an anticipated increase in earnings with a consequent increase in market values of the securities (including $102,000,000 of B and O Refunding Bonds) constituting the collateral pledged for the loans. Prior to this second plan the B and O paid off all the $50,000,000 secured note issue, except the $13,490,000 held by the R.F.C. The latter was then consolidated with the other debts due the R.F.G, all secured by collateral.

The anticipated enhancement in value of the collateral did in fact occur to a very substantial extent. On June 15, 1938, the market value of the collateral was $52,000,-000; on November 15, 1939, shortly after the approval of the 1938 plan, it increased to $85,000,000; on September 17, 1944 (just before the date of announcement of this second plan) it had increased to $128,000,-000, and on September 6, 1945, it had increased to $172,000,000. But despite this substantial increase in market value the evidence in this case shows that it was not financially possible in 1944 for the Railroad to refund the indebtedness to the R.F.C.,' nor would it be possible even now, in the absence of the approval of the present plan, to refund the amount by sale to the public of notes secured by this collateral.

The reason lies in the nature of the collateral. The principal items of value were $102,000,000 of B and O Refunding Bonds and large amounts of the stocks of the Reading and Western Maryland Railroads, through which the B and O had vitally important operating arrangements. The sale of these stocks would have been disastrous to the B and O and very prejudicial to the holders of its securities affected by the present plan. The market value of these Refunding Bonds in 1939 was in the 30’s. It was anticipated that with the approval of the plan and the return of normal traffic conditions, the market value of these bonds would be greatly increased. But while there was some substantial appreciation the market value did not increase anything like so much as had been reasonably antiqipated despite substantial increased net earnings. This was apparently due to two factors: (1) the uncertainty as to whether the Railroad would be able to successfully refund its heavy maturities of about $300,000,000 to occur in 1944, 1948, 1950 and 1951, and (2) probably because the investing public had become more critical with respect to railroad securities by reason of the large number of railroads then in receivership or in process of reorganization in bankruptcy. This public attitude seems to have been induced largely by the policy of the Interstate Commerce Commission with respect to new capitalizations of railroads, in insisting that the ratio of fixed charges to net income should be much lower than had been customary in railroad financing in earlier years.

In this situation, after unsuccessful efforts to refund the 1944 maturities through public marketing, the management of the Railroad early in 1944 conferred with Mr. Jesse Jones, then Secretary of Commerce and Federal Loan Administrator and the former Chairman of the Reconstruction Finance Corporation, who had given special personal attention to railroad loans, and who still had supervisory authority in the R.F.C., to ascertain whether the R. F.C. would further extend the maturity of the 1944 obligations and if so, on what conditions. The Railroad was advised that 'no extension would be made unless it could successfully secure a substantial extension of maturities of its large bond issues, maturing in 1948, 1950 and 1951. Despite this previously expressed attitude of the R.F.C. it appears that some of the officers of the Railroad were uncertain whether the refusal to extend the 1944 maturities except on the conditions indicated, was final and unalterable. Thereupon arrangements were made for a formal conference with Mr. Jones upon the subject at his office in Washington on May 12, 1944. At that conference attended by Mr. Jones and other members or representatives of the R.F.C., Mr. White, president, Mr. Snodgrass, financial vice president, and Mr. Clay, General Solicitor, and several Directors of the B and O, Mr. Jones definitely and finally refused to further extend the loans except on the stated conditions. In consequence thereof the Railroad then proceeded to formulate the present adjustment plan, after conference with members of the legal staff of the R.F.C., and financial officers of some of the large institutional holders of B and O bonds.

A railroad adjustment under Chapter XV is much preferable to more drastic reorganization under section 77 of the Bankruptcy Act, if the petitioner can meet the requirements of Chapter XV. One important advantage of the procedure under Chapter XV is that it is generally terminated one way or the other within a relatively short time of about a year after the formulation of the plan, as compared with the much longer periods of possibly five or even ten years not infrequently required under section 77. To comply with the conditions of Chapter XV the railroad must, after formulating the plan, first obtain the voluntary assents thereto of 25% in amount of the claims of affected creditors; and thereafter it must obtain the approval of the plan and the necessary authority for the issuance of new or modified securities by the Interstate Commerce Commission, all before the plan is submitted for approval by the three-judge court.

After these conditions have been met the railroad must secure assents to the plan, or any modification thereof made by the Commission as a condition of its approval, from creditors holding more than two-thirds of the aggregate amount of the claims affected, which two-thirds shall include at least a majority of the aggregate amount of the claims of each affected class; and thereafter it may file its petition for the approval of the plan by the court in the district where it has its principal office, averring in the petition that it is unable to meet its debts matured, or about to mature, and desires to carry out the plan of adjustment, and annexing thereto a copy of the order obtained from the Commission. Section 1213 provides for the convening of a three-judge court to act on the petition.

The petitioner in this case has complied with these conditions precedent. The three-judge court was duly convened and after two days’ hearing (July 10 and 11, 1945) held after notice thereof, at which much evidence was submitted, entered an order approving the petition as properly filed in good faith and setting the case for final hearing, after due notice to all parties in interest, on September 17, 1945; but giving leave for further consideration of the issue of good faith on the final hearing. The final hearing on the plan was held pursuant to notice (September 17-21) and the extended evidence submitted has been considered by the court.

The Baltimore and Ohio Railroad is the oldest railroad in the United States, having been chartered by the State of Maryland in 1827. It has been in continuous and generally successful operation for more than 100 years and by gradual growth and extension of operations from time to time is now one of the great railroad systems of the country. Its financial structure and the territorial extent of its operations were fully described in the prior case in this court. 29 F.Supp. 608. The system extends from New York through Philadelphia and Baltimore to Washington and thence westwardly through Pittsburgh and Cincinnati to St. Louis and to Chicago, with lateral branches to Cleveland and Buffalo. It operates more than 6,000 miles of road. The aggregate par value of its capitalization in bonds and stock, including subsidiaries, exceeds $1,000,000,000. Its continued successful operation is a matter of vital concern not only to the holders of hundreds of millions of its bonds, but also for the public interest and convenience.

The principal features of the adjustment plan now submitted, in addition to the refunding of the notes held by the R.F.C. in the amount of $82,393,114, consist in the extensions of the maturity of five of its large bond issues and in providing that a certain portion of fixed interest on some of the issues be made payable only contingently upon earnings sufficient therefor, but to be fully cumulative until finally fully paid. The plan contemplates that the security for existing obligations of the Company remain unchanged. The following schedule shows the aggregate amount of each class of all the claims affected by the plan and the proposed adjustment thereof:

The plan also contains carefully worded provisions for (1) the determination and allocation of available income for the payment of fixed charges and for contingent interest; (2) for creation of a capital fund for capital investments and better-ments; and (3) for sinking funds for the partial retirement of indebtedness; and (4) for certain restrictions on payments of dividends on the stock of the Company and (5) other miscellaneous provisions. If the plan is consummated the B and O will cancel $6,350,650 of several bond issues now in the treasury.

Section 1225 of Chapter XV of the Bankruptcy Act (which is set out in the margin) prescribes in detail the findings to be made by the special court as a condition to the approval of the plan. The more important of these findings in the instant case are (1) that the .plan has been approved by creditors affected thereby who hold more than three-fourths of the aggregate amount of the claims affected by the plan, including at least three-fifths of the aggregate amount of the claims of each affected class; (2) that the plan is fair and equitable as an adjustment and as such will afford due recognition to the rights of each class of creditors and stockholders and is fair to each class adversely affected; and (3) that the plan is feasible. This section also makes it the duty of the court in the findings to be made to scrutinize the facts independently (1) of the extent of acceptances of the plan and any lack of opposition thereto, and (2) of the fact that the Commission has authorized the issuance or modification of securities as proposed by the plan and (3) of the fact that the Commission has made such similar findings. It is further provided in the section that the court shall file an opinion setting forth its conclusions and the reasons therefor and shall enter a decree confirming the plan which shall be binding upon the petitioner and all creditors and security holders of the petitioner.

In the decree to be entered in this case there will be included the detailed findings of fact which we have made thus independently after consideration of the plan and the evidence in the case. In view of these separate findings, we find it unnecessary to here discuss in meticulous detail each and all of the findings and will, therefore, limit this opinion to our conclusions and the reasons therefor with regard to the fairness and feasibility of the plan generally, and to a discussion of certain matters which relate to the question of whether the plan is fair and equitable to the different classes of creditors affected and particularly to the holders of Convertible Bonds mentioned in the plan; and to certain modifications of the plan suggested by one or more of the intervenors in the case. We find the plan has been accepted by the holders of 81|% of all the securities affected and by more than three-fifths of each class, the percentages thereof ranging from 80,% to 67%.

Consideration of Fairness of the Plan. In appraising the nature and effect of the plan with respect to whether it is fair and equitable, it is important to give due weight to certain financial and economic facts affecting railroad securities which have been emphasized in the experience of preceding years. The recent war has clearly demonstrated the vital importance of the continued efficient operation of the railroads in our national life; and they will continue to be necessary in times of peace. It is essential that they be continued in efficient management and operation as going concerns. It is highly important both to the holders of their securities and in the public interest that court receiverships or drastic reorganizations should be avoided if possible. If a railroad is unable to meet its debts as they mature, then, to keep them going concerns, receivership or reorganization is unavoidable unless there can be a successful adjustment under Chapter XV.

One lesson that has been learned in the recent past is that in the capitalization of a railroad its fixed charges for interest should be substantially less in amount than its average net earnings; and this has been the policy approved by the Interstate Commerce Commission in many of the railroad reorganizations under section 77 of the Bankruptcy Act. The Baltimore and Ohio Railroad has had a continuous growth for more than a century. Numerous extensions of its System have added greatly to its capital indebtedness and at the present time the aggregate amount of the latter is unfortunately large (about 60% of its total capitalization including its subsidiaries). However, its present financial embarrassment is not due to lack of earning capacity to meet all its interest charges but to. principal maturities which cannot be successfully refunded under oresent conditions in the absence of some further adjustment of its capital obligations'.

For more than fifty years all our interstate railroads have been subject to very firm governmental control administered principally by the Interstate Commerce Commission. Railroad rates for transportation of goods and passengers have for many years 'been fixed or controlled by the Commission at rates deemed reasonable but seldom affording more than a very moderate return on property devoted to the public service. It is practically impossible for railroads to carry to surplus from year to year sums sufficient in the accumulated aggregate to pay off in cash large sums of the maturing principal of capital indebtedness. Successful refunding thereof is ordinarily the only alternative to receivership or reorganization.

Another fact which must be realized by the holders of railroad securities is that the payment of interest to them is practically contingent upon the net earnings of the railroad. Legal redress for satisfaction of the debts due them through mortgage foreclosures almost inevitably results in very substantial loss, either in a long moratorium in the payment of interest, or in the total loss of income for many years, or in the impairment or reduction of their capital investments in case of receivership or drastic reorganization. On the other hand, especially under present financial and economic conditions, the time of maturity of the principal of their investments is much less important than the successful maintenance of payment of accruing interest from earnings. It is a well known financial fact that where the net earnings of the railroad are amply sufficient to meet all fixed charges, the márket price of railroad securities is generally sufficiently high to enable security holders to realize upon their investment even when originally made at high prices, by sale in the market. It is therefore obviously of advantage to them if the railroad can avoid receivership and continue to operate with sufficient net earnings.

Still another fact to be realized by investors is that net earnings depend very largely on good management. Unless the courts intervene through receivership or reorganization, management is elected and controlled by the stock interests in the railroad. They should have some incentive to maintain good management. The market prices for the stock and the prospect of dividends furnish this common incentive. While reasonable restrictions on the payment of dividends is thoroughly desirable, restrictions so drastic that they remove the incentive to good management impair the value of all the railroad securities. Conversely, it is a well known financial fact that where the common stocks of a railroad have substantial market value, this manifested public confidence in the railroad’s prosperity sympathetically tends to enhance the market value of its bonded indebtedness.

Against this background of economic and financial experience, a study of the main features of the present plan, and its particular impact on the several classes of affected securities, leads us to the conclusion that the plan as a whole is fair and equitable. There is much affirmative evidence in this case to this effect.

The plan does not reduce the principal amount of the capital debt or the obliga■tion of the Railroad for the full interest contracted for thereon, nor does it impair any of the present security for the several affected issues respectively. It merely postpones the maturities of the obligations for the principal, and possibly some of the interest thereon. With respect to the latter, it does not release the railroad from its absolute obligation eventually to pay all that has been contracted for, although some portion of the original contract rates is made contingent as to time of payment, dependent upon the sufficiency of current net income. Upon maturity of the principal as deferred or as accelerated unpaid contingent interest becomes a fixed obligation, and all currently deferred interest is fully cumulative.

The plan also provides a substantial sinking fund for the partial retirement of capital obligations. And to keep the railroad a going, and if desirable an expanding, concern, it provides for the setting apart from annual earnings a substantial “capital fund” for betterments, and if necessary and advisable (under restrictions) for the issuance of additional bonds for capital improvements, and also, under some rigid restrictions, for the issuance of temporary Emergency Bonds for similar purposes. Provision is also made in the modified indentures for refunding of many of the new bond issues to the extent not previously retired, through the sinking and other funds. These conditions make for flexibility and are reasonable assurance for the continued prosperity of the railroad as a going concern in meeting possible new conditions as they arise in the future.

A number of financial experts have submitted oral testimony in support of the fairness of the plan from the standpoint of the security holders. Among those who testified to this effect were Mr. Charles S. Garland, a member of the long established and well known banking firm of Alex. Br.own & Sons of Baltimore; Mr. John Stedman, vice president of the Prudential Insurance Company, whose Company holds over $7,000,000 par value of several of the affected bond issues and holds $540,000,000 of all railroad securities; Mr. Harry C. Hagerty, vice president of the Metropolitan Life Insurance Company which holds $28,000,000 of B and O Bonds, including substantial amounts of all the affected issues with the exception of the Convertibles, and also 6900 shares of B and O preferred stock; and Mr. Arthur Knies, a financial expert on railroad securities. It is also relevant to note that Moody’s well known rating manual has classified each of the affected classes of securities higher, if the plan is approved, than the rating which it previously has had. It is also, we think, quite significant to note the very substantial rise in market prices of each of the affected classes of securities since the announcement of the present plan. No doubt general conditions affecting all railroads are a considerable factor in this market rise; but it has been specially pronounced with respect to the B and O securities since the announcement of the present plan, and proportionately much greater than the average of similar increases for other railroads as shown by the well-known Dow-Jones statistics for second-grade securities. Thus on September 19, 1944 (the day before the public announcement of the plan) the market price for B and O 4’s was 88; on December 4, 1944, it was 95% and on July 12, 1945, it was 106. And there have been even greater proportionate market advances in other issues affected by the plan. The most pronounced and proportionate increase in market price has occurred in the case of the B and O Convertible Bonds which on September 19, 1944, was 37, but rose to 72% on July 12, 1945. Since then and doubtless consequent upon the termination of the war with Japan, there has been some slight market recession in all the affected issues. This very substantial rise in market prices of B and O securities is at least very weighty evidence that public confidence has been greatly increased in the continued prosperity of the B and O Railroad as a result of ■the announcement of the plan and of its progress toward being put into effect. It is, of course, not determinative of the fairness of the plan for this court and it has not been so regarded by us.

Although the court is enjoined to consider the fairness of the plan independently of the percentages of acceptances by security holders, or lack of opposition therefrom, it is relevant to note how largely and widely the plan has been approved by the security holders of all affected classes. The holders of over 81% of the aggregate principal of all affected securities have affirmatively voted assent to the plan. Less than 1% have affirmatively dissented. Of the whole number of individual holders (less than 80,000), 39,-738 have voted for the plan and only 103 against it, a percentage of over 99% for the plan and less than one-third of 1% against the plan, of those voting on it. The percentages of assents to the plan by holders of the several affected classes range from 86% to over 67%, excluding the R.F.C. as holder of the securities pledged as collateral for its loan. It has fully assented to the plan. The only in-tervenors in this case as objectors to the plan are listed in the margin.

The Feasibility of the Plan. Section 1225 of the Act requires (among other things) as a condition of our approval, that we find that the plan meets the requirements of clause (2), sub. (c) of section 1210. As previously noted, section 1210 outlines the findings that must be made by the Interstate Commerce Commission and we are enjoined to make our findings independently of the Commission’s report. As previously indicated, we will make these findings in the decree in this case. We think it necessary in this connection to particularly discuss only those parts of the clause which relate to the findings of feasibility of the plan. To approve the plan it is necessary1 that it be found feasible, financially advisable, and not likely to be followed by the insolvency of the Railroad, or by need of further financial reorganization or adjustment; that it does not provide for fixed charges in an amount in excess of what will be adequately covered by the probable earnings available for the payment thereof; leaves adequate means for such future demands as may be requisite and is consistent with adequate maintenance of the property and consistent with proper performance by said railroad corporation of service to the public as a common carrier and will not impair its ability to perform such services. We have given careful consideration to the particular matter of the feasibility of the plan; that is, its probable success in the continuation of the Baltimore and Ohio Railroad as a going concern. We have thought it particularly important to do so in this case by reason of the fact that contrary to reasonable expectation there has been necessity for -this present plan as an aftermath of the 1938 plan. It has been said in opposition to the present plan that the 1938 plan failed, and therefore the Railroad should not be entitled now to further aid by the court’s approval of this present plan. But this criticism of the effect of the 1938 plan is superficial and literal rather than substantial. The 1938 plan has been highly successful in the interest both of the public and of the security holders in that the Railroad thereby escaped what otherwise would have been inevitable receivership or drastic reorganization. As a result of the plan the Railroad has been maintained as a going concern under private management, has proved its great worth to the public during the recent war, and since 1941 has fully met and paid all its fixed and contingent interest charges. It is true that the Railroad is again in need of financial adjustment under Chapter XV; but it seems clear on the evidence that its present embarrassment is due not at all to lack of earning capacity but to present inability to refund maturing principal obligations. The 1938 plan has been criticized because it did not foresee and successfully provide for this present situation. Of course as the event has proved, it would have been 'wiser if it had done so. But it should be Remembered that the B and O 1938 plan was the first case under Chapter XV. At the time it was a novel and bold venture for the railroad to obtain voluntary assents to the plan by the requisite percentage of its security holders affected thereby. It may be doubted whether the more comprehensive plan now proposed could have been successfully consummated. The plan has proven insufficient only in the one respect, that it did not include the extension of the maturities now provided for in this supplemental plan. We think the present plan should be considered on its intrinsic merits without prejudice resulting from the adverse comment that the 1938 plan was not sufficiently comprehensive.

So considered, we reach the con-elusion that the plan is financially advisable and feasible. So far as it is humanly possible to foresee the economic and financial conditions of the future, the adjustment now proposed is not likely to be followed by the insolvency of the Railroad or by the need of further reorganization or adjustment As already pointed out, the present embarrassment is not from lack of sufficient earning capacity to meet the current interest charges, but only inability to refund capital maturities. The current aggregate amount of all fixed charges and contingent interest payments including guaranteed dividends on leased lines stocks (as of August 31, 19*44) is less than $27,-000,000. By the present plan the annual fixed charges and guaranteed dividends on leased lines will be about $19,000,000, and the contingent current interest about $8,-000,000. The Baltimore- and Ohio income available for fixed charges, from 1921 to the present time, has been -annually substantially more than sufficient to meet all the present aggregate interest charges both fixed and contingent under the plan, with •the exception of the one year of 1938. In no year in this period, except 1932 and 1938, has the Income for charges been less than $28,000,000, and the average income for the whole period has been about $40,-000,000. From 1921 to- 1927 the average was over $46,000,000; from 1928 to 1934, over $42,000,000;. from 1935 to 1941, nearly $34,000,000, and from 1942 to 1944 inclusive, over $64,000;000_ In estimating future earnings we should of course disregard the high earnings during the war period; but even in the years of economic depression, -from 1935 to 1941, the average net income was nearly $34,000,000: We are also not unmindful that railway-operating expenses have been largely inicreased in the last two or three years by-reason of increase in wages and taxes, but it does not seem probable for the foiieseeable future that the net income will be less than $27,000,000; and even more improbable that it will be less than the total fixed charges under the plan of about $19,-000,000.

In our opinion -the plan contains provisions sufficiently flexible to meet such future financing as may be requisite- In addition to the sinking fund for the .partial retirement of bonds, it provides that upon maturity the outstanding bonds may be refunded, and also provides a minimum capital fund of $5,000,000 annually (after payment of fixed interest) for capital betterments, and provides for the issuance of additional bonds to finance 75% of additions to property covered by several of the respective new mortgages, and, in addition, a limited amount of Emergency Bonds to finance up to 100% of the cost of similar betterments.

Objections to the Plan. The objections to the plan as a whole do not attack its feasibility but only the alleged lack of necessity for any plan at all at this time. The attack is focused on the basic requirement of the remedial Act that the petitioner is unable to meet its maturing debts. It is contended that the proceeding has not been filed in good faith because the Railroad is in fact able to meet its maturing debts or at least could have done so by proper financial management. More specifically, it is stated that the refusal of the R. F. C. to extend its secured loans, by refunding or otherwise, except on the condition of the approval of the plan, is not due to the independent judgment of the R. F. C. but was inspired by the officers of the B and O and is therefore really collusive.

In purported support of this main contention it is said (1) that in soliciting assents to the plan the petitioner made misrepresentations of fact; (2) that it has wasted funds otherwise available to meet the 1944 maturities in the amount of $30,-000,000 in the over maintenance o.f the Railroad; (3) that it unnecessarily carries in its working capital many millions of dollars that could be made available to meet indebtedness and (4) that it has improvidently used about $31,500,000 in the retirement of capital obligations maturing after 1944 which should properly have been applied on account of 1944 maturities. These particular contentions are advanced as circumstances tending to show bad faith in connection with the more specific and direct charge of collusion above mentioned. We will discuss these particular charges separately. Some of them need only brief comment.

We find no material misrepresentations of fact in the letters of the president of the Railroad, inviting assents to the plan. The criticism of the wording objected to seems to be to be based only on the objector’s personal interpretation of the language and is more argumentative than factual. The B and O was actively soliciting assents to the plan and the intervenor, Mr. Randolph Phillips, was likewise actively urging the Convertible Bondholders to express dissent. In the course of the correspondence some unnecessary personal criticism was made by the B and O regarding Mr. Phillips. One statement was that “Randolph Phillips attempted to defeat the 1938 plan. If he had been successful, your bonds might have been wiped out and your road might be in bankruptcy today”. Mr. Phillips’ principal activity is that of a railroad economist of long experience. He particularly complains that this statement was a misinterpretation of his participation in the hearings on the 1938 plan, and asks that the statement as to his position then should be corrected. The court’s understanding of Mr. Phillips’ attitude toward the 1938 plan is stated in 29 F.Supp. at page 627. As will there appear, he considered the 1938 plan defective because it did not make sufficient provision for what might happen in the event of the inability of the B and O to meet the 1944 maturities. He states that he was not attacking the 1938 plan as a whole but endeavoring to improve it to avoid the contingency which the B and O now says confronts it. His present position, however, it clearly stated in his testimony and brief. It is that he opposes the whole of the present plan on the ground that the contingency which he anticipated in 1939 did not in fact occur in 1944 in that, as he contends, the Railroad was able to meet its maturing indebtedness in that year.

The contention that the Railroad has been intentionally over maintained (“gold plated”) is based only on a statistical comparison (prepared by the objector) of the average maintenance expense ratio of the B and O and other railroads for 1929, compared with the ratios for 1943 and 1944, which show that the B and O ratio is higher for these latter years than for 1929, and apparently higher now than for other railroads. But the respective periods are not fairly comparable by reason of differing prevailing conditions. What is overlooked is the higher taxes and cost of labor and materials in the later period. But apart from this there is a very simple explanation .of the increased maintenance ratio in the latter period as explained by Mr. A. C. Clarke, Chief Engineer of the Railroad, and Mr. Roy White, its president. The higher expense in the latter years is due to much deferred maintenance which had been accumulated over the depression years, the effect of which was very pronounced in the case of the B and O. The objector submitted no factual evidence based on inspection by experts that ¡there was over maintenance of the B and O System.

Mr. Phillips contends that the B and O is presently carrying in its balance sheet an unnecessarily large working capital, and that about $40,000,000 could be withdrawn from it to pay on account of the 1944 maturities. We are not impressed with the soundness of this contention. Without 'here analyzing in detail ¡the several items of current assets and current liabilities, we are satisfied from the testimony of the B and O’s financial vice president and from other evidence in the record, that no substantial cash sum could fairly be presently withdrawn from current assets to apply on the 1944 maturities. The question is not whether the available current assets could be used to pay debts in liquidation, but whether the working capital as a whole, necessarily excluding the large item of materials and supplies, is more than ‘reasonably adequate for the B and O System as a going concern, doing presently a volume of $380,000,000 of business annually, operating in 13 States and having 128 bank accounts. The testimony of Mr. Snodgrass, the B and O’s financial vice president, analyzing the April 1945 balance sheet, was to the effect that the available cash for current .payments was only about $16,000,000, while he thought $20,000,000 was reasonably required. The later balance sheet of July 1945 is not very greatly different in its figures. We do not find that the working capital is unreasonably large. The contention to the contrary is largely based on comparison of the much smaller amount of working capital maintained by the B and O in prior years. It was one of the features of ¡the 1938 plan that the then inadequate working capital might be increased by about $10,000,000.

The 1938 plan, Art. VI, provided for a substantial sinking fund to be applied to the retirement of $100,000,000 of aggregate principal amount of obligations without designating the particular bonds to be so retired, but expressly providing that the Company “may purchase bonds or obligations of any issue or issues eligible for acquisition under the preceding provisions of this Article VI in the open market or by call for tenders or otherwise at not exceeding the redemption price”. In accordance therewith the Railroad has now retired over $100,000,000 of its capital indebtedness at a cost of about $67,000,000. Of this latter amount approximately $31,500,-000 was applied to the retirement of capital obligations aggregating approximately $66,000,000 maturing subsequent to November 8, 1944. A large part of the debt so retired consisted of B and O Refunding Bonds which were purchased and retired by the Railroad at a very heavy discount. The application of funds to the retirement of debts maturing after 1944 resulted in decreasing fixed charges by $2,500,000 more than if all the available funds had been applied to the retirement of earlier maturities. And the evidence shows that this application of that available cash has received the express approval of some of the Railroad’s most important creditors as sound and advisable financing. Even if all the cash available for debt retirement had been applied solely to the retirement of obligations maturing prior to 1945 there would have remained owing on the 1944 maturities approximately $51,000,000.

We come now to the principal attack on the plan. It is the charge that it is not proposed in good faith, because the R. F. C. would have extended the loans maturing in 1944 if the officers of the B and O had really wanted that done. Some color was given to this contention by the resignation of Mr. Cassius M. Clay, General Solicitor (assistant to the General Counsel) of the B and O, made public on the eve of the final hearing of this case on September 17, 1945. In his letter of resignation he criticized the plan to which he said he had long been opposed. The position taken by Mr. Qay requires fuller comment, which will be later made. It is bound up with the whole question whether the present position of the R. F. C. is an independently taken one based only on the financial conditions applicable to the case, or whether it is the result of inspiration and collusion with officers and directors of the Railroad to create an only simulated or “synthetic” financial embarrassment for the purposes of this case. This is a question of fact to be determined on the evidence.

Bearing on this issue, we have heard and considered the testimony orally given in open court and subject to cross-examination of all the principal persons now living having any knowledge of the subject, including Mr. Roy White, president of the B and O Railroad; Mr. R. L. Snodgrass, its financial vice president largely in charge of the present plan; Mr. Stewart McDonald, Chairman of the Road’s Executive Committee ; Messrs. Traphagen and Cheston, other members of the Board, and of Mr. Jones, former Chairman, and Senator Charles Henderson, present Chairman, of the R.F.C. All of these witnesses emphatically refute the suggestion that the past or present attitude of the R.F.C. was inspired or stimulated by the officers of the B and O. With equal clarity they assert that the position taken and maintained represents the independent judgment of the members of the R.F.C. acting in the interests of the United States as a large creditor of the B and O, and having due regard to the interests of the public and of the security holders of the B and O. There is no sufficient evidence in the case to warrant a rejection of the testimony of these reputable witnesses whose general credibility is in no way attacked and their evidence not impaired by cross-examination. And we find nothing in the nature of the case inconsistent with this definitely asserted position taken by the R.F.C.

Apart from the uncontradicted testimony the financial situation then existing is indisputable. The Railroad had no financial means to meet the 1944 maturities other than the collateral pledged therefor. Unsuccessful efforts had been made to refund the debt by public financing. The sale of the collateral would have had very disastrous effects on the B and O System and its earning power. Even if, by greater pressure or persuasiveness, the R.F.C. could have been induced to extend the loan for a few years more, the financial problem would have recurred with greater intensity) in 1948 when the even much larger maturities come on. It seems improbable that they could have been successfully refunded with the outstanding menace of the unrefunded R.F.C. maturities of $80,000,000 or more. The evidence given by Mr. Jones is very clear, definite and explicit that it was this condition that actuated him and through him the R.F.C. in insisting, as a condition to substantial extension of the 1944 maturities, that the later maturities should first be substantially extended. The dominant fact in the case is that the R.F.C. did take this position.

As we have stated, it was a feature of the 1938 plan that the $50,000,000 secured notes of which the R.F.C. held $13,490,000, and the indebtedness of $72,771,578 to the R.F.C. should be extended to mature in 1944. In 1939, when the 1938 plan was considered by the court, Mr. Daniel Willard was the president and Mr. George M. Shriver the senior vice president of the B and O. It is not now disputed that these two highly respected and long experienced railroad officials testified to their belief in entire good faith and on grounds which seemed reasonable, that in the working out of the 1938 plan the B and O would be able to meet these 1944 maturities aggregating about $122,000,000. It was thought that the reasonably expected increase in the market values of the collateral pledged for these loans and the general improvement of the Railroad’s finances' would enable the Road to successfully refund them or otherwise meet the problem. As we have seen, this enhancement of the market values of the collateral has been realized to a considerable extent but not sufficiently to make it possible for the Road to refund the present obligation to the R.F.C. by the sale of new securities to the public secured by the same collateral, without the postponement of maturities of other and soon maturing bond issues. And the evidence is clear that the R.F.C. early in 1944, took the position that it would not extend the loans unless there was a comprehensive plan for the postponement of these maturities. A substantial reason for the position taken by the R.F.C. was that an extension of the loan was inadvisable in the interests of the creditor by reason of the uncertainty whether the B and O could successfully refund the heavy maturities of its senior mortgage bonds due July 1, 1948, and in 1950 and 1951, aggregating over $200,000,000 of principal. If they could not be successfully refunded, receivership or reorganization was highly probable. On the other hand, with them substantially extended, it was the judgment of the R.F.C. that a new bond issue, in the amount of the principal then due to it, secured by the collateral and bearing 4% interest, could be readily sold to the public. In this situation the present plan emerged which provides for such refunding, and the R.F.C. has agreed to accept the new 4% bonds at par and accrued interest in the principal amount of the obligation as payment in full.

Now we return to the letter of resignation by and the testimony of Mr. Clay. In 1941 he joined the legal staff of the B and O on the invitation of Mr. George M. Shriver, then its senior vice president. For some years theretofore he had been a member of the legal staff of the R.F.C. and had been actively engaged for it as a creditor in various railroad reorganizations. His chief work for the B and O was in matters before the Interstate Commerce Commission. Mr. Snodgrass, who is now the financial vice president of the B and O, had also been a member of the legal staff of the R.F.C. for some years before he was invited by Mr. White (president of the B and O and successor to Mr. Willard) to take the position rendered vacant by the regrettable death of Mr. Shriver. Mr. Snodgrass had also been engaged in railroad reorganization cases when with the R.F.C. When Mr. Snodgrass first assumed this position in 1942, he was told by Mr. White that his principal activity at once must be to consider plans to meet the approaching large maturities of 1944 and later years. As a result of this assignment it is' Mr. Snodgrass and not Mr. Clay who has been in principal charge of the present plan after the failure of active efforts by the former to meet the maturities by refunding. It appears that when Mr. Clay was first advised of the reported refusal of Mr. Jones to extend the 1944 maturities, and the probable necessity for a second plan under Chapter XV, he expressed skepticism about the genuineness of Mr. Jones’ refusal and doubts about the necessity for the plan. Apparently in consequence of this the Railroad sought the opinion of outside legal advice which was subsequently received from Mr. Dulles of the New York firm of Sullivan & Cromwell. The opinion was to the effect that the proposed Chapter XV proceeding would of course vitally depend upon the real position taken by the R.F.C. It was in consequence of this that the conference already referred to of May 12, 1944, was held with Mr. Jones and his associates in Washington, and Mr. Clay, in view of his previously expressed opinion, was invited to participate in the conference. He says that he was “shocked” when Mr. Jones firmly refused to modify the previously announced conditions for the requested extension.

Mr. Clay as a witness in the case was examined and cross-examined at great length. His testimony shows a considerable qualification of the briefer statements made in his letter of resignation. While he stated in his letter that he had regarded the plan as an unsound one, as a witness he said he did not question “the intrinsic financial soundness of the plan” and that he was “not questioning the good faith of any of the officers and directors of the B and O who became such after the time of the 1938 plan”. We have carefully considered the whole of his testimony. In short summary we find that while Mr. Qay’s own good faith as to his position need not be questioned, his expressed opinion that the plan was unnecessary and therefore not in good faith, was based on his own personal view and was not supported by the evidence or exhibits in the case. His personal opinion seems to have been based in his experience while associated with the R.F.C. that Mr. Jones was very reluctant to force any railroad into receivership or court reorganization, and on especially what he referred to as his understanding that there was a “gentlemen’s agreement” at the time of the 1938 plan that the R.F.C. loans, then extended to mature in 1944, would again be renewed at maturity. There is no evidence in this case to show that there was such an “agreement”. Mr. Qay appeared at the court hearings on the 1938 plan as counsel for the R.F.C. It is not contended that he or any one else made any commitment, express or implied, to that effect at that time. Mr. Willard and Mr. Shriver who, it is suggested, would have been the officers of the B and O to have had such an agreement with Mr. Jones, are now deceased. Mr. Jones as a witness in this case emphatically denied that there was any such agreement or understanding, and categorically stated that there was no discussion between himself and Mr. Shriver or Mr. Willard about the extension of the loans beyond 1944.

The evidence is fully convincing that the Railroad was unable to meet its maturing obligations of about $82,000,000 due to the R.F.C. on August 1 and November 8, 1944, either from available cash or by refunding the loan; nor could it obtain a voluntary extension of the loan by the R.F.C. except on the condition of postponement of its principal obligations maturing in 1948, 1950 and 1951 in the amount of $218,832,350. But the question may still be asked whether the loan could not have been met by the sale of the pledged collateral either in 1944 or at the present time, especially in view of the fact that the market value of this collateral had increased on September 17, 1944 (just before the date of announcement of this second plan) to $128,000,000; and on September 6, 1945, it had increased to $172,000,000. The evidence in the case persuades us that despite the apparent ample excess value of the collateral, this method of relief was not practically available to the Railroad. In the first place, the present large increase in market value of the collateral is due to the prospect of the success of this plan; and the failure of the plan would inevitably substantially impair public confidence in the future prosperity of the Railroad with the consequent substantial decrease in the market value of the collateral. A more important answer to the suggested possibility lies in the nature of the collateral itself. A list of this collateral appears in the Appendix to the report of the Interstate Commerce Commission filed with the petition in this case. The principal items of value in the long list of this collateral are about $102,000,000 par value of the B and O Refunding Bonds which are affected by the plan. These pledged Refunding Bonds have never been issued or sold to the public but their issuance was approved by the Interstate Commerce Commission for the purpose of this pledge. They are now selling in the 70’s but if the plan is not approved the market price would doubtless be very considerably less and their sale at a very heavy discount would result in a large increase in the Railroad’s outstanding capital obligations and interest charges. Other important items in the list of collateral are very substantial holdings by the B and O of stocks of the Reading Company and the Western Maryland Railway, and the Southwestern Construction Company. It is of the utmost importance to the integrity of the B and O System that these stocks be held by the B and O. Their holding is highly important as the basis for important railroad operating arrangements between the B and O and the Western Maryland and Reading Railroads, and the Southern Railway. Freight originating or received on the B and O lines in the west is' routed into New England through interchange by the B and O with the Western Maryland and Reading; and the B and O’s access from Philadelphia to New York is through operating arrangements with the Reading. It would be utterly disastrous to the unity of the B and O System and would entail a very great impairment of its earning capacity if, in consequence of the sale of these stocks, the operating arrangements now in force should be terminated. A serious threat of the sale of these items of collateral would almost inevitably necessitate a drastic reorganization proceeding under section 77 of the Bankruptcy Act to preserve if possible the integrity of the B and O System. See Continental Illinois Nat. Bank & Trust Co. v. Chicago, Rock Island & P. R. Co., 294 U.S. 648, 55 S.Ct. 595, 79 L.Ed. 1110. It is the very purpose of this present proceeding to avoid this disaster which would certainly cause great loss to the holders of securities affected by the present plan.

Looking at the broad and beneficial purpose of Chapter XV, we think the condition therein that the Railroad must show its inability to pay its debts as they mature should not be so narrowly and strictly construed as to deny approval of the petition in this case on the possibility that the R.C.F. could realize on its loan by sale of collateral which might so seriously affect the integrity of the B and O System as a going concern. (It was stated in the Report of the Committee on the Judiciary of the House of Representatives of May 27, 1942 (Report No. 2177, 77th Congress, 2nd Session) in respect to the proposed legislation which became the Act of October 16, 1942, that the purpose of the Bill was' to enable railroads which are not insolvent and which are fundamentally sound as transportation systems but are handicapped financially by maturing obligations to enter into agreements with their creditors and security holders for the postponement or modification of obligations so as to avoid the drastic overhauling of their capital structures provided for in section 77. This purpose would be defeated if such a railroad could not take advantage of the Act without disposing of collateral that would greatly impair its' usefulness and efficiency as a going concern. Such a sale of collateral by creditors might be enjoined in a proceeding under section 77 of the Bankruptcy Act. Continental, etc., Bank & Trust Co. v. Chicago R. I. & P. R. Co., 294 U.S. 648, 55 S.Ct. 595, 79 L.Ed. 1110; but see also 15 U.S.C.A., s. 605, last sentence). And it may be added that despite the present apparent margin of value in the collateral for the secured loans, it is by no means certain that collateral of this type would be readily marketable in bulk at its' present quoted prices. Present market prices have been largely influenced by the progress of the plan. If it fails a substantial recession in the present prices is clearly indicated.

Is the plan fair to all affected classes? We have determined that the plan as a whole, as a substantial recapitalization of the petitioner, is intrinsically sound and financially feasible. Section 1225 of the Act requires as a further condition of approval, that the plan must be fair and equitable and as such will “(a) afford due recognition to the rights of each class of creditors and stockholders and fair consideration to each class adversely affected, and (b) will conform to the law of the land regarding the participation of the various classes of creditors and stockholders.”

In our opinion the plan does conform to legal standards and requirements. There is no reduction of the amount of the contractual obligations of the B and O for either principal or interest, and no impairment of the security therefor. The only change is postponement of maturity of principal, and the time of payment of interest made contingent upon earnings, but fully cumulative until finally paid. Such changes are not uncommon features in railroad reorganizations or adjustments. In quality they are similar to those made in the B and O 1938 plan.

We will now s'ee whether it is fair to the several classes inter sese. In the first place, it is to be noted that the plan affects nearly all of the petitioner’s present funded debt. The main features of the plan are the extension of the maturities of the several classes and changing a certain amount of now fixed interest to contingent interest, reducing about one-third of the present fixed interest to contingent interest. With the exception of the interest on the Refunding Bonds, all the interest made contingent is presently unsecured interest. Some of the interest now both fixed and secured on Refunding Bonds is' made contingent but payable from available income prior to the contingent interest which is unsecured.

The eight classes affected by the plan may, for convenient comparison as to their respective treatments, be grouped into four classes: (1) R.F.C. as holder of secured notes; (2) holders of prior lien bonds, that is, First Mortgage 4’s, First Mortgage 5’s, Southwestern Division 5’s, Pittsburgh, Lake Erie & West Va. Bonds, Toledo-Cincinnati 4’s; (3) holders of junior lien bonds, that is, Refunding and General Mortgage 5’s and 6’s, and (4) holders' of unsecured obligations, that is, Convertible 4%’s.

By the plan each of these classes is required to make certain concessions or, if you please, sacrifices in the recapitalization It is clear, we think, that the aggregate of the respective sacrifices to the plan as a whole greatly improves the position of the Railroad and adds' to the prospect of its long continued prosperity as a going concern. In this bettered position of the entity each of the affected classes participates and is itself bettered at least in public estimation as reflected in Moody’s Rate Manual. On this branch of the case the particular inquiry is whether the sacrifices which each class has made to the whole is reasonably in proportion to its present position. In our opinion the answer is — Yes.

Each of the four classes' (except the Refunding Bonds) agrees to an extension of maturity — 20 years for class 1; 25 to 30 years for class 2; 50 years for class 4. The extended maturities are fairly evenly spaced. Class 1 also yielded a reduction in interest rate under the 1938 plan which is continued under the present plan. Presently unsecured fixed interest of some of the class (2) bonds yields from fixed interest position to that of contingent interest; class (3) yields a portion of its fixed and secured interest to contingent interest, the latter payable, however, prior to the unsecured contingent interest. Class (4) yields its position of unsecured fixed interest to that of contingent. The preferred and common stocks of the Railroad are also, of course, affected by the plan. The modification of the maturities and change from fixed to contingent interest of some of the bond issues is an advantage to the stock; but the features of the plan which provide for the application of available income to a capital fund and to the substantial sinking fund and other limitations upon dividends are, of course, restrictions upon the stocks.

With respect to the impact of the plan as a whole upon the several classes, it is obviously unnecessary to consider class 1, the R.F.C., because it had fully assented to the plan. Nor is it necessary to especially discuss the fairness of the plan to the senior bond issues in class' 2. It appears to us, on the face of the plan, that it is equitable to them inter sese, and there has been nothing of importance called to our attention to the contrary. As to the class 3, Refunding Bonds, there is no active opposition to the plan as a whole or contention that it is unfair to them. The report of the Interstate Commerce Commission deals