Holders of railroad bonds and notes: their rights and remedies

Front matter

HOLDERS OF RAILROAD BONDS AND NOTES

'THEIR RIGHTS AND RaiEDlES"

on iiiii

Preface

It is fairly safe to say that the great majority of the holders of railroad bonds and notes never read their securities nor the mortgage that secures them. It is only when the railroad company, whose securities they hold, becomes insolvent or defaults that they seek advice as to their rights. Then, quite generally, for the first time, they ask for a better understanding of the nature of their securities; of their rights as to the other creditors and the property of the road; of their probable relations with their trustee, the receiver, and the reorganization committee. The foreclosure and the receivership, that usually follow the insolvency of a railroad company, and the reorganization of the road, that is invariably attempted, present many situations that affect its security-holders, of which they should have at least a fair understanding.

Recent governmental investigations have pointed clearly to the extreme ignorance of the investing public as to their rights as holders of corporation securities. It is hoped that the information contained in these pages may help to a better understanding of the nature of railroad securities and of

PREFACE

the rights and remedies they confer on their holders, and that such knowledge may help to safeguard investments.

L. H.

New York, October, 1915.

LIST OF CHAPTERS

CHAPTER PAGE

I Introductory i

II Rights and Remedies with Relation to the Various

Kinds of Railroad Bonds and Notes 8

III Rights and Remedies with Relation to the Mortgage

or Deed of Trust 56

IV Rights and Remedies with Relation to the Trustee-

ship 1 16

V Rights and Remedies with Relation to Foreclosing the Mortgage or Otherwise Realizing on the Security 146

VI Rights and Remedies with Relation to the Receivership OF the Railroad Company 187

VII Rights and Remedies with Relation to the Assets of the Insolvent Railroad Company; Rights and Priorities of the Other Creditors 227

VIII Rights and Remedies with Relation to the Reorganization of the Railroad Company 335 vii

CONTENTS OF EACH CHAPTER I

PAGE

Introductory i

Three values of a railroad security — Market value — Intrinsic value — Legal value.

II Rights and Remedies with Relation to the Various Kinds of

General description of railroad bonds, notes and debentures; notes and bonds compared; power of railroad company to issue same; temporary bonds — Transfer of bonds — Difference between bondholders and stockholders — Bondholders are bound by the terms of the bond and mortgage — Validity of bonds; over-issue; defective issue; issue in excess or abuse of power; issue in violation of law or without power; secured by void mortgage — Many kinds of railroad bonds; classified generally as to form, security, purpose of issue, and mode of retirement; distinctions pointed out — Rights of bona fide holders of negotiable bonds or notes — Lost or stolen coupon bonds or notes, or coupons — Altered or mutilated bonds or notes or coupons — Coupon bonds and coupons — How transferred; clear or marked bonds; presumption of ownership — Effect on coupons when severed from their bonds or notes — Collection of coupons — Presentation of coupons for payment; dispensing with presentation; effect of non-presentation — Effect of payment on coupons; cancellation — Overdue coupons; effect on bonds — Interest on overdue coupons; attached and detached; rates of interest allowable — The security for the coupons; priorities and preferences — Rights of coupon holders as to each other; bona fide holders of coupons — Statute of limitations; as to bonds; as to coupons — Registered bonds; act of registration; effect thereof on principal and interest — Transfer of registered bonds; converting registered bonds into coupon bonds; payment of interest — Registration of coupon bonds as to principal only — Registration of both bond and coupons — Interchangeable or convertible bonds.

Ix

X CONTENTS

III Page

Rights and Remedies with Relation to the Mortgage or

Deed of Trust 56

Purpose of the mortgage or deed of trust — General description of the mortgage — Power of railroad company to mortgage its property and its franchise to operate; opinion of counsel — The lien that the mortgage gives the bondholders; liens generally discussed — Recording the mortgage — Valid bonds as affected by defective mortgage; void bonds as affecting the mortgage — Defective mortgages; partly defective — Synopsis of railroad mortgages — (a) Parties to the mortgage; purposes of the mortgage — (b) Consents of stockholders, directors, public commissions to the issue and to the mortgage — (c) Amount of the issue; limitations; protection against over-issue; closed mortgages; open-end mortgages; open mortgages — (d) Description of the bonds of the issue- — (e) Direct obligations of the railroad (issuing) company; stockholders, directors, officers, protected from liability for the issue — (f) The property is transferred to the trustee to secure the issue, upon certain conditions, etc. — (g) The railroad company remains in possession of the mortgaged road and other property, except securities, and agrees to keep the same in good condition, etc. — (h) Insurance against loss by fire, etc. — (i) Description of the mortgaged property — (j) After-acquired property — (k) The railroad company agrees to preserve the lien of the mortgage — (1) Execution of all papers necessary to facilitate the trust; waiving redemption and exemption laws, etc. — (m) The rights, remedies, powers and liability of the trustee, etc.; trustee's certificate — (n) Provisions as to payment of principal and interest; free from all taxes; gold coin — (o) Priorities, if any, between principal and interest; canceling paid coupons — (p) Sinking fund arrangements — (q) Redeeming bonds or calling bonds in — (r) Payment of serial bonds; bonds issued in series — (s) Refunding plans — (t) Provisions for converting bonds into capital stock of the railroad company — (u) Re-possession by the railroad company of the road after receivership or possession by the trustee — (v) Remedies to enforce thp mortgage.

IV

Rights and Remedies with Relation to the Trusteeship . 116 Relation between bondholders and noteholders and their trustee generally — Reasons for trusteeship — Who are chosen as trustees — Courts hold trustees strictly to their duties — Liability of trustee to holders of bonds and notes secured by the mortgage; limitation of his liability; acts of representatives; losing rights against trustee; liability of

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PAGE

trustee to third persons; indemnity to trustee-rHolders of bonds and notes are bound by the official acts of their trustee — Remedies of holders of bonds and notes against their trustee; money damages; injunction; removal; compelling performance of certain acts — Co-trustees; majorit>'; liability of co-trustees for acts of each other; succession by continuing trustee — Trustee may not delegate to others the powers requiring his individual skill; details only may be delegated — Personal interest of the trustee in the mortgaged property forbidden when antagonistic to holders of the bonds and notes under the mortgage; purchase of trust property by trustee; remedies of bond and note holders; acceptance or rejection; waiving or losing remedies against trustee — Litigation is conducted by the trustee; holders of bonds and notes are then bound by the decisions of the courts; appearance by bondholders; indemnity and demand by a certain proportion of holders; when trustee loses right to litigate — Bondholders or noteholders may conduct litigation instead of trustee; one or more sues for all ; all then bound by decisions of the courts — Holders suing on individual holdings; recourse to security; provisions barring suits on individual holdings — Selection of the trustee; general scope of his powers — Duties of the trustee generally; duties before default by the railroad company; duties after such default; the remedies the trustee pursues — Discretion of the trustee in carrying out the details of the trusteeship — Trustee seeking advice of the court; advising with legal counsel; guided by the opinion of the holders under the mortgage; rights of majority of holders; rights of minority — Removal of trustee at option of holders; by the court; for cause — Resignation by trustee — Provisions for resignation by trustee; filling vacancies in the trusteeship — Compensation of the trustee; fixed by mortgage or agreement, or the court — Expenses of the trusteeship; compensation and expenses paid by the railroad company or out of the trust property; contribution by holders; expenditures for large or limited amounts, or for certain purposes; lien of trustee for compensation and expenditures.

V

Rights and Remedies with Relation to Foreclosing the Mortgage or Otherwise Realizing on the Security . 146

The three usual remedies to realize on the security — When the right to commence proceedings accrues; what constitutes a default; in interest; in principal — Reasons for postponing action by the trustee or the holders — Principal may fall due upon default in interest; when it does not; option of holders to declare principal due — Default may be waived; rights of trustee and of majority of the holders to xii CONTENTS

PAGE

waive defaults of the railroad company — Redemption of mortgaged road by the railroad company and its re-possession — Possession and operation of the mortgaged road by the trustee; lease of the road; operation optional with trustee or holders; rights and liabilities of trustee while operating; income during this period; distribution of monies received by trustee; his duties while operating the road; expenses, contracts, repairs, supplies and help incidental to operation; contracts of the railroad company as aflfecting the trustee; liability of trustee for negligence of employees while operating — Trustee selling the mortgaged property to satisfy claims under his mortgage; exercise of this power may be within the discretion of trustee or controlled by holders; details of such sale — Foreclosure; outline of procedure — Foreclosure by trustee generally; may be controlled by holders; rights of majority of holders and of minority; foreclosure by holders instead of trustee — When foreclosure sale had — Entire road sold as one instead of in separate parcels; foreclosure for interest only; lease instead of sale; when divisions are separately mortgaged; mortgages on constituent roads of consolidated company — Combinations to purchase; reasons therefor; combinations of holders under the foreclosed mortgage with others; rights of non-participating holders — Persons barred from purchasing at the foreclosure sale; persons who may purchase — Rights of purchasers; title acquired; the franchise to operate; a distinction pointed out — Standing of purchaser at foreclosure sale — Liability, if any, of purchaser or new corporation for debts and contracts of the railroad company; for mortgages and other liens against the property; sale subject to or free of such mortgages or other liens; transferring liens to proceeds of sale — Purchasers as affected by debts, contracts, and certificates of the receiver — Effect of foreclosure on claims of general or unsecured creditors; on subsequent mortgages and other liens; on claims of the holders of the bonds or notes under the foreclosed mortgage; on prior mortgages or other liens; certain liens having priority; equity of redemption — Time and place of foreclosure sale; notice of sale; adjournment — Preventing, stopping or setting aside the sale; reasons therefor; losing rights by delay, by participation; effect of setting sale aside — Terms of sale; payment of bid by holders under the foreclosed mortgage.

VI Rights and Remedies with Relation to the Receivership of

THE Railroad Company 187

Receivership generally; outline of management and operation of road by receiver — Grounds for a receivership ; when appointed; default in interest or principal; in-

CONTENTS xiii

PAGE solvency; inadequate security; when income mortgaged; threatened waste of property; application by railroad company — Attitude of the courts toward receiverships of railroads; serving the interests of the public and the holders under the mortgage — Appointment is discretionary with the court; consent of the parties in interest; bond of the receiver — Effect of receivership on existing rights; mortgages or other liens how affected; attaching creditors; judgment creditors; suits against the receiver — Ancillary receiverships; road running through two or more States; appointment of same receiver in each jurisdiction; jurisdiction of the courts of each State; may appoint their own receiver — Receivership of parent road and of branch or subsidiary lines — Who is chosen as receiver; consent of parties in interest; qualifications of receiver — Receiver represents the court; subject only to its control — General powers and duties of receiver while operating the road; application to the court for instructions and authority; what the court generally allows the receiver to do — Discretion of the receiver in the management and operation of the road — Effect of the contracts of the insolvent road on the receiver; leased lines; leases of rolling stock; car trust agreements — Expenditures by the receiver — Expenditures for large amounts or for unusual purposes; making unusual contracts — Income during receivership; how applied; anticipatmg income — Receiver's certificates; only when absolutely necessary, unusual security; lien the court gives them; several issues; when payable; rate of interest; selling price; obligations of the receiver; their form and transifer; enforcing their payment; reasons for displacino- lien of holders of bonds and notes under their mortgage; notice to such holders; entitled to be heard — Official liability of the receiver; his personal liability — Liability of sureties on receiver's bond — Accounting by receiver — Removal of the receiver; his resignation — Compensation of the receiver; fixed by statute or the court; forfeiting compensation ; paid out of property or by contribution — Termination of the receivership.

VII

Rights and Remedies with Relation to the Assets of the Insolvent Railroad Company; Rights and Priorities

of the Other Creditors 227

General rules of distribution of the assets of the insolvent road; mortgages and other liens; secured and unsecured creditors — Income earned by the railroad company before its default; after default; income earned by the receiver — Distribution of income and proceeds of the mortgaged property when trustee takes possession, operates, or sells — Creditors of the railroad generally; what is meant

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by priority — Creditors on equal footing — Successive mortgages or other liens; waiving priorities — Closed mortgages; open-end mortgages; bonds in series; open mortgages — Numbered bonds — Over-issued bonds or notes — Re-issued, exchanged, and substituted bonds or notes- New mortgage before all bonds or notes under prior mortgage are put out — Operating expenses prior to receivership; nature of claims entitled to this preference; six months rule ; extent of preference ; reasons therefor ; funds affected by the preference — Claims for original construction — Mechanics' liens — Attachments and executions against property of the road — Preferred stock — Taxes, public assessments, governmental charges — Purchase money mortgages; conditional sales — Right of way claims — Judgments — Claims and judgments for injuries to persons or property — Priorities among interest coupons and claims for interest; between principal and interest — Notes; debentures or unsecured bonds — First lien bonds— First mortgage bonds; first mortgage trust bonds; first mortgage consolidated bonds; second, third, etc., mortgage bonds — Unification; general mortgage bonds; blanket mortgage bonds — Underlying liens — Refunding mortgage bonds — Bonds resulting from consolidation, merger, lease or control of property or stock of subsidiary companies — Collateral trust bonds; collateral trust notes; convertible collateral trust bonds or notes; participating or profit sharing bonds or notes; three plans for issuing collateral trust bonds — Bonds or notes of consolidated roads; of the constituent roads; Divisional bonds — Guaranteed bonds or notes — Stamped bonds — Assumed bonds — Terminal bonds — ^Bonds relating to development; development bonds — Extension bonds — Bonds to construction company — Car trust certificates or bonds — Equipment trust certificates or bonds — Equipment bonds — Bonds growing out of the reorganization or readjustment of the railroad company generally — Assented bonds — Prior lien bonds; preferential bonds — Extended bonds or notes — Scaling — Income bonds; debenture income bonds; mortgage income bonds; non-cumulative income bonds; cumulative income bonds; assented income bonds.

VIII Rights and Remedies with Relation to the Reorganization

OF the Railroad Company 335

Different forms of reorganizations; new charter; sale or lease of property; consolidation or merger; assessment of stockholders; bondholders waiving lien and accepting new securities; scaling; new management — Outline of procedure in reorganization — Attitude of courts toward reorganizations ; proposed reorganization must be fair —

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Rights of bondholders, generally, to participate in the reorganization; to receive notice and an opportunity to examine proposed agreement for reorganization — Rights of bondholders who do not join in the reorganization; rights upon withdrawal from agreement or abandonment of reorganization; reorganization of majority against objections of minority; provisions in mortgage empowering majority; interest of minority protected by courts — Bondholders may reorganize alone; or with other creditors or with stockholders, or both; interests of unsecured creditors protected; rights of stockholders of insolvent company; terms upon which they may acquire rights in new company — Synopsis of reorganization agreement — Becoming a party to the agreement; by signing; by deposit of securities; limitation of period; extension of period; penalty — Use of deposited bonds; how bonds deposited — Certificate of deposit; its transfer; its negotiability; rights of transferor and transferee; interest on bonds represented by certificates of deposit — Synopsis of the plan for reorganization — Filing the plan; giving notice thereof; reasonable opportunity to examine it; proposed changes; remedies when committee fails to file plan or give proper notice — How plan is formulated and submitted; when contained in agreement; discretion of committee to adopt plan ; submitting plan for assent or dissent; expressing assent or dissent; amount necessary to approve or reject; written assents or dissents; majority and minority rights on approval or rejection of plan — When plan takes effect; abandoning plan after adoption — Changes in the agreement or the plan; power of committee to make changes; uncontrolled power; limited to certain matters; material changes; submitting changes to parties; unauthorized changes; ratification or rejection; ratification by majority; changes by majority against objection of minority; provisions for majority control — Powers of committee defined by agreement; discretionary powers; positive instructions — Committee may employ representatives — Committee may construe, remedy, change, prepare, adopt, declare operative, abandon plan — Allowing parties to join in the reorganization; co-operation with other committees — Power of the committee over deposited bonds — Pursuing the remedies of the bondholders — Committee may acquire property; its powers with respect to same — Expenditures and debts by committee; expenses; may consent to receiver's certificates — Personnel of the committee — Individual interest of the committee — Duties of the committee; good faith; will of the majority; accounting; time within which to complete reorganization ; five years' provision — Personal liability of the committee; money damages; injunction; compelling performance of duties; declaring acts void; errors of judgment; limitation of liability;

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■who affected by limitation ; liability to third persons ; liability for acts of co-members ; accounting and discharge — Purchase of property of insolvent road by bondholders or committee; using bonds in payment; payment of costs in cash; how bid paid when purchased by others; committee using own money; failure to complete purchase; deficiency on resale — Parties to the agreement are bound by all proper acts of the committee; rule when committee acts wrongfully; ratification of unauthorized acts; remedies for wrongful acts — Parties to the agreement are bound by its terms; must deposit bonds; must pay share of expenses, etc.; when such expenses are not paid; parties avoiding liability under agreement; abandonment — Withdrawing from agreement; surrendering certificates; payment of expenses and charges; return of securities; limitation of time — Termination of the agreement; by completing reorganization; committee may terminate: court may declare agreement abandoned; rights of parties when agreement and proceedings terminated by the court or the committee — Expenses of reorganization; charged against deposited securities; payment as condition of right to receive securities of the new corporation— The new corporation ; distinct legal body from old corporation; succeeding to franchises; name of new corporation ; distinction between franchises to operate the road and franchise to exist as a corporation — New corporation bound to issue stock, bonds, etc., according to plan or agreement for reorganization; rights of parties to securities of new corporation; when such securities must issue; five years' provision; voting trust — New corporation may take property free from all liens against it; may take same subject to such liens, or some of them; other debts and contracts of the old corporation — New corporation not liable for contracts or debts of the receiver; exceptions.

HOLDERS OF RAILROAD BONDS

AND NOTES : THEIR RIGHTS

AND REMEDIES

Chapter I Introductory

Three values of a railroad security.

Generally speaking, a railroad security may be said to have three values. It has a market value, the price at which it can be bought and sold (probably) in the market. It has an intrinsic value, depending upon the solvency of the issuing company and the property or security behind it. It has a legal value, founded upon the rights and remedies its ownership confers to enforce its payment and which entitles it by reason of its legal lien or standing to be paid out of certain property of the road or out of all its property, as the case may be, before other creditors or other classes of creditors receive anything.

Market value.

The market value of a railroad security does not depend always upon its actual, intrinsic value alone, i. e., upon the property and its foreclosure value, pledged as security, and the other liens, prior and junior, against such property; but it is affected, quite often, and sometimes quite materially, by extraneous influences, among them the temper of the times ; the state of the money market; the quoted price; whether or not it has a broad and ready market and is a legal investment for trust funds or savings banks ; its form, whether easy of negotiation and how quickly it can be converted into cash; when it matures; its rate of interest and the income it produces at the price; whether or not it is listed on the stock exchanges ; the personnel of the board of directors of the railroad company; the prevalent reports, true or false, of the state of the finances and affairs of the road ; the effect of recent legislation or expected legislation; recent decisions of the higher courts ; pending litigation that affects the road; events and reports of political significance, local, state, national or international.

Intrinsic value.

To determine the intrinsic value of a railroad security, inquiry is directed by experts to the credit and standing of the issuing company; the condition of its finances ; the nature of its franchises ; the property mortgaged as security and its physical condition; what the prior and later liens against this property are; the company's entire property generally; the contracts and leases by which the road is bound or has

INTRODUCTORY 3

the advantage of; what the entire outstanding bonded indebtedness of the company is and how it is secured ; whether the bonded indebtedness of the issuing company is in excess of the actual or foreclosure value of the road as near as it can be judged; whether the proportion of the bonded indebtedness to the capital stock of the road is proper; the topography of the country over which the road is laid; the geographical position of the road and whether it commands a strategic position; whether it serves a needed purpose; its future prospects; whether the territory and termini served can be reasonably expected to maintain the road; whether the population in the territory and points served is increasing or decreasing; the character of the traffic, whether it is limited to certain industries or is general and diversified; what rival lines are in competition; whether the road is likely to be absorbed by a larger one and the possibility of its securities being made valueless upon the market before the absorption; the personal character and efficiency of the company's management ; its policies; its aggressiveness or conservativeness ; whether or not the business of the road is being conducted along conservative lines ; whether or not those in control have other interests that conflict with the best interests of the company ; the amount of business the road is doing; its permanent earning power; the proportion that the capitalization of the road per mile bears to the earning capacity per mile; whether the gross earnings have been maintained from year to year; whether the ratio of the operating expenses per mile is reasonably proportioned to the gross earnings per mile and that this proportion has been maintained from year to year; that the fixed charges are for proper purposes and are kept to the minimum and are not out of proportion to the gross earnings; and in addition such other matters as the particular issue under consideration calls for.

The average investor has neither the opportunity to get at these facts nor the experience in the various branches of expert knowledge necessary to understand or judge them. These matters should be and are examined into by financial and engineering experts upon whose opinion the bankers depend when underwriting or purchasing an issue, and it is upon the recommendations of the latter as to the intrinsic value of the security that the intending investor usually and necessarily relies.

Legal value.

The legal value of a railroad security is the foundation of both its market and intrinsic values. For its legal rank as a security, its rights to priority in payment over the other indebtednesses of the company, its form and negotiability, and such special rights and privileges that may be peculiar to that issue, affect its market value and enter materially into a consideration of its intrinsic value.

INTRODUCTORY 5

While the railroad company is paying interest regularly and there is no apparent reason for concern, the legal rights and remedies that the security may carry with it are not given much thought. Then the price at which it may be bought or sold and the ready market that it may have are alone considered. But when the railroad company falls into insolvency then the safety of tl:ie security is thought of. And in the usual struggle among its creditors over its assets, those rights that enable the holders of its securities to obtain payment in full in preference to or priority over other creditors or other classes of creditors become of prime importance. It is this that constitutes the legal value of a railroad security and upon which its market and intrinsic values depend.

In adjusting the affairs of an insolvent railroad corporation, the court usually finds itself confronted with claims of many kinds and with many classes of creditors. In the unraveling of the entangled mesh each strand must be given its position.

Usually it will be found that the insolvent road is a system consisting of a number of branch lines operated under leases or by subsidiary companies. These subsidiary companies are invariably controlled by the main or parent company by means of a controlling interest in their capital stocks or by ownership of their properties. The financing of these extensions, branch, subsidiary, divisional and leased lines, and of the main or parent road, results in many issues of notes and bonds and other forms and kinds of securities. And it is not unusual that the insolvency of a railroad will find creditors holding bonds secured by underlying liens against all or certain portions of the property of the road issued by constituent companies before consolidation or representing the original mortgages upon the road, followed by first, second, general, blanket or unified mortgages on the entire system; collateral trust bonds issued by the parent company and secured by a deposit of the stocks and bonds from its own treasury or the securities of its subsidiary companies ; also bonds resulting from an attempt at readjustment or reorganization, such as extended bonds, prior lien bonds, adjustment bonds, income bonds, etc.; outstanding notes or debentures that are not secured; car trust certificates or equipment bonds may cover the rolling stock and equipment of the road; terminals may have been mortgaged to secure an issue of bonds or notes ; some of the creditors may have outstanding attachments against the road, or may have reduced their claims to judgments; interest on preferred stock may have been made a lien on the property of the road or some parts of it; certain claims for labor and materials may be entitled to preference as operating expenses or under statutes; claims for injuries to persons or property caused in the operation of the road before the receivership may be given a preference by the statutes of some of the States; mechanics' liens

INTRODUCTORY 7

may be charged against t±ie property of the road And, further, should a receiver be appointed he may, under order of the court, issue receiver's certificates, which may be given a lien prior to and a preference over mortgages and other liens then against the property of the road. Also the claims for the expenses of the receivership and of the operation of the road by him, and the expenses of the trusteeship, and the costs and expenses of the litigation are given a priority in payment over all the preceding claims. And the debts for taxes and other governmental charges are usually entitled to a preference over all others.

The relative rights and standings of these different securities and claims, their priorities and preferences, and the order in which each shares in the assets of the railroad company, constitute their legal values, and it is the purpose of these pages to discuss and to analyze each security or claim against the road that will in any way affect the rights or the remedies of the holders of the outstanding bonds and notes, and show the reason for the standing, priority or preference accorded it.

Chapter II

RIGHTS AND REMEDIES WITH RELATION TO THE VARIOUS KINDS OF RAILROAD BONDS AND NOTES