UPSET PRICES IN CORPORATE REORGANIZATION

THE

HE uncertainties, delay, and heavy expense involved in corporate reorganization, particularly where dissension arises among the security holders, would seem to indicate a defect in our law of corporations. The right of the majority of the stockholders of a corporation to control the corporate policy is, obviously, one of the salient reasons for the wide adoption of the corporate form in business; yet, conveniences of financing have brought about a change in the organization of corporations to which the law has not yet adjusted itself. The theory of the law is that the ownership of a corporation is vested in its stockholders; the truth is that to-day the substantial ownership of most large corporations, particularly public, service corporations, because of the lower cost of financing through the sale of bonds, is held not by the stockholders but by the bondholders. Most public utility bonds, as well as the secured obligations of many private corporations, are issued without any intent of being repaid; the money obtained therefrom is considered part of the capital invested.1 Bondholders, unlike stockholders, stand in the position of tenants in common; in theory the consent of all the bondholders, not merely of a majority, is required before any action can be taken. So, whenever a corporation encounters difficulties, and the control of the corporation passes out of the hands of the stockholders, whose equity in the property has faded away, into the hands of the owners of the property, the bondholders, there is no convenient or facile procedure no means of majority control whereby the interests of the bondholders, or of other creditors, can be adjusted. Hence the confusion and litigation which accompanies a hostile reorganization.

Indeed, a corporate reorganization is looked upon commonly as a catastrophe; few recognize it as a natural phase of corporate growth. It has been estimated that fifty per cent of our American corporations have passed through some form of reorganization

1 See Wilds v. St. Louis, etc. R., 7 N. E. 290, 293, 102 N. Y. 410 (1886).

in the last twenty years.2 Corporate reorganizations, of course, are usually caused by insolvency; but not infrequently a sound enterprise, earning an adequate return, will be hampered by an unsound financial structure involving excessive fixed charges, such as bond interest; or again, the difficulty of refunding a matured bonded indebtedness during a time of financial stringency, or the urgent need of additional capital for improvements, or the weight of an unfunded debt, will make a reorganization necessary. Reorganization, in brief, must be viewed as a normal phase of corporate life; the frequency of reorganizations makes it necessary for the law to provide a facile procedure; and the basis of such procedure must be fair majority control. It is the purpose of the writer to indicate how this right of the majority to control during corporate reorganizations, under the guidance of the court, can be conveniently secured without the violation of any constitutional rights, thus removing many of the present uncertainties, and much of the delay and cost of corporate reorganizations; and also to show how the authorities, throughout the various phases of corporate reorganization, are slowly recognizing this right of fair majority control.

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The English procedure of "Arrangements" such is the apt term used approaches closely the desired procedure. The control of the majority over the minority, during the reorganization of public service corporations, is fully established by Act of Parliament. Formerly an Act was passed for each reorganization, and that is the practice in Canada to-day;3 a general statute in England, however, provides for all such situations, leaving it to the courts to pass upon the fairness of the reorganization plan instead of Parliament itself. Lord Cairns has tersely described the purpose of this act as follows:

2 United States District Judge Hough, of the Southern District of New York, as quoted by Paul D. Cravath in "Reorganization of Corporations," STETSON, LYNDE, et al., SOME LEGAL PHASES OF CORPORATE FINANCING, REORGANIZATION AND REGULATION, 154.

3 Canada Southern Ry. v. Gebhard, 109 U. S. 527, 534 (1883). See Jones v. Canada, etc. Ry., 46 U. C. Q. B. 250, 261 (1881), where Osler, J., said, in discussing such statutes, Legislation of this kind, of which, be it said, our books are full." See also,

JONES, CORPORAte Bonds and Mortgages, 3 ed., § 617.

Railway Companies Act, 1867, 30 & 31 Vict. c. 127.

"Hitherto such companies, if they desired to raise further capital to meet their engagements, have been forced to go to Parliament for a special Act, enabling them to offer such advantages by way of preference or priority to persons furnishing new capital as would lead to its being obtained. And Parliament, in dealing with such applications, has been in the habit of considering how far the arrangements proposed as to such new capital were assented to or dissented from by those who might be considered as the proprietors of the existing capital of the company, either as shareholders or bondholders. The object of the present Act . . . appears to be to dispense with a special application to Parliament of the kind I have described, and to give a Parliamentary sanction to a scheme filed in the Court of Chancery, and confirmed by that Court, and assented to by certain majorities of shareholders and of holders of debentures and securities ejusdem generis." 5

Under the English Act, the directors of a corporation in difficulty file a scheme of arrangement with the Chancery Division of the High Court. The filing of the scheme gives the court jurisdiction to enjoin actions against the Company. The assent in writing of three-fourths in value of any class of security holders, other than common stockholders, binds the minority members of each class; in the case of common stockholders the assent of the corporation at a special meeting is sufficient. The court ascertains whether a majority in each class has assented, and whether the scheme is fair and just to all concerned; if the court approves, the scheme is enrolled and becomes effective as an Act of Parliament. After enrollment no appeal is possible, although the court may in its discretion delay enrollment to allow an appeal. Similar procedure is provided for in the case of most private corporations under the Companies Acts.8

An English debenture upon a railroad's properties, or upon the property of any public utility, differs, it is true, from the ordinary American bond issue in that the rights of the security holders are limited solely to the returns from the property after the fashion

9

5 Cambrian Railways Company's Scheme, L. R. 3 Ch. App. 278, 294 (1868). Railway Companies Act, 1867, 30 & 31, Vict. c. 127, §§ 6-22. See also 2 LINDLEY ON COMPANIES, 6 ed., 1261; HAMILTON'S COMPANY LAW, 3 ed., 525.

7 Devon & Somerset Ry. Co., L. R. 6 Eq. Cas. 615 (1868).

8 Companies Act, § 120, 8 Edw. 7, c. 69. See also HAMILTON'S COMPANY Law,

3 ed., 527.

• Bowen v. Brecon, etc. Ry., L. R. 3 Eq. Cas. 541, 547 (1867).

of a "Welsh Mortgage" or the "vivium vadium" of Lord Coke; 10 but that does not affect a comparison with the English procedure of "arrangements." The public utility, under a debenture, to use the often-quoted phrase of the English courts, is viewed “as a fruit-bearing tree, the produce of which is the fund dedicated by the contract to secure and pay the debt;"" or, as the English courts also state it, the "living and going concern thus created by the Legislature must not, under a contract pledging it, as security, be destroyed, broken up, or annihilated." 12 In brief, a debenture holder cannot destroy the usefulness of the property to the public in order to get payment of his obligation. This same rule applies in America. A public utility is charged with an obligation to the public; its property is dedicated to the public use, and the owner thereof, or the holder of any lien thereon, cannot so change the nature or condition of the property as to interfere with the public's rights.13 Thus in substance there is no difference between an American bond or an English debenture, and the situation in each case during reorganization is comparable.

The method of "Arrangements" in force in England, thus recognizes the two fundamental necessities of all reorganizations: first, a means of forcing the minority to abide by a plan of reorganization acceptable to the majority; second, a method of de

10 See 4 KENT. COM., 6 ed., 137.

11 Lord Cairns in Gardner v. London, Chatham & Dover Ry. Co., L. R. 2 Ch. App. Cas. 201, 217 (1867). See also Marshall v. South Staffordshire, etc. Co., [1895] L. R. 2 Ch. D. 36.

12 Gardner v. London, Chatham & Dover Ry. Co., supra.

13 Munn v. Illinois, 94 U. S. 113, p. 126 (1876). The question as to whether or not one voluntarily engaging in a public service can voluntarily withdraw on due notice to the public is not entirely settled in America. In Munn v. Illinois at page 126 this right to withdraw was recognized; see also Weems Steamboat Co. v. Peoples Co., 214 U. S. 345, 356 (1909). Yet, as a practical question, a utility, needed by the public will not be allowed to cease serving the public, and this rule now insisted upon by State Regulatory Bodies probably will be finally accepted by the courts. Moreover, a utility must give adequate service; a partial withdrawal resulting in inadequate service or a temporary cessation of service will not be allowed. San Antonio St. Ry. Co. v. Texas, 90 Tex. 520, 39 S. W. 926 (1897). The public has an established right in every reorganization, Central Trust Co. v. Missouri K. & T. Ry. Co., 246 Fed. 154, 156 (1917); and, even assuming that the bondholders could acquire the ownership of a property and completely terminate its continuance in the public ice, yet they could not by reason of their position as creditors or owners, impair its usefulness so long as it continued in the public service. Thus the powers and security of holders of American public utility bonds is actually no greater than that of holders of English debentures despite frequent assertions to the contrary.

serv

termining, preferably by the decree of the Chancellor, that the plan is not fraudulent or unduly oppressive as to minority interests. In America, although such procedure would not be a violation of the due process clause of the Federal Constitution, as to the rights of the minority, since it can be viewed as a form of bankruptcy or insolvency procedure, nevertheless, the contract rights of the minority would be impaired. The Supreme Court of the United States has so viewed the English procedure:

"Unless, as is the case in the States of the United States, the passage of laws impairing the obligation of contracts is forbidden, we see no good reason why such provision may not be made in respect to existing as well as prospective obligations. The nature of securities of this class is such that the right of legislative supervision for the good of all, unless restrained by some constitutional prohibition, seems almost necessarily to form one of their ingredients, and when insolvency is threatened, and the interests of the public as well as creditors, are imperilled by the financial embarrassments of the corporation, a reasonable 'scheme or arrangement' may, in our opinion, as well be legalized as an ordinary 'composition in bankruptcy."" 14

Because of this constitutional difficulty, reorganizations in America require a foreclosure sale under the mortgage or trust deed securing the bonds. Thus the procedure adopted unfortunately is that of the winding up of a business, or a complete change of ownership - a flat contradiction of the real purpose of a reorganization, which is simply an "arrangement" whereby a new financial structure can be established.15 Such a foreclosure sale, in short, is a device rather than a fact. A new purchaser with sufficient means to buy the property outright and pay off the bondholders practically never appears; the old security holders must be the purchasers under the foreclosure sale.16 Consent decrees are entered by the court if all the bondholders reach an agreement; and, as will be pointed out later, the courts, recognizing such consent decrees of sale to be merely devices to facilitate reorganization, rather than the adjudication of rights, do not hesitate to set aside such decrees, often with startling results. For convenience, outstanding bonds may be paid to the master under the foreclosure 14 Canada Southern Ry. Co. v. Gebhard, 109 U. S. 527, 535 (1883).

15 Canada Southern Ry. Co. v. Gebhard, supra. See 4 COOK ON CORPORATIONS, 7 ed., § 889, pp. 3496, 3498.

16 Investment Registry Limited v. Chicago & M. E. R. Co., 212 Fed. 594, 609 (1913).