April 20, 1944; As Amended April 26, May 1, May 24, 1944.
Appeal from the District Court of the United States for the District of Delaware; Paul Leahy, Judge.
Before BIGGS, JONES, and McLAUGHLIN, Circuit Judges.
The appeal at bar presents for our determination the question of the meaning of the phrase "fair and equitable" contained in Section 11(e) of the Public Utility Holding Company Act of 1935, 15 U.S.C.A. § 79k(e). In view of the exhaustive opinion of the Commission,*fn1 those of its concurring and dissenting members and that of the District Court*fn2 it is unnecessary to include here an extended statement of facts for the questions before us are primarily those of law.
The United Light & Power Company, a solvent registered holding company, a Maryland corporation, is at the top of the United Light & Power Company system.*fn3 Immediately below "Power" is another registered holding company, the United Light & Railways Company. Most of the operating subsidiaries of the system are controlled by "Railways" and Power owns all of its common stock. The Commission has found that Power must be liquidated and dissolved in order to simplify the holding-company system as required by Section 11(b)(2) of the Act, 15 U.S.C.A. § 79k(b)(2). Power has three classes of stock; a class A common, a class B common, and a class A preferred stock, the last being entitled to cumulative dividends. No issue is presented by the present review as to the rights of the common stockholders visa-vis each other. It is unnecessary, therefore, to describe these stocks except to say that the B common carries all voting rights in the company. Power's charter provides that on the dissolution or liquidation of the corporation whether "voluntary or involuntary" the holders of the preferred stock "shall be entitled to receive out of the net assets of the corporation, whether capital or surplus, for each share of such stock, one hundred dollars and a sum of money equivalent to all cumulative dividends on such share, both accrued and in arrears (whether or not the same shall have been declared or earned) including the full dividend for the then current quarterly period before any payment is made to the holders of any stock other than the * * * [preferred] stock in accordance with their rights at the time of distribution."
It is conceded that upon dissolution or liquidation of Power the preferred stock would have a principal claim of $60,000,000*fn4 and that accumulated unpaid dividends, as of December 31, 1942, amounted to $38,700,000, a total of $98,700,000. Power's principal asset consists of common stock of Railways.*fn5 It is also conceded by all the parties that the value of Railways' common stock does not amount to $98,700,000.*fn6 Power and Railways none the less submitted to the Commission joint applications and declarations for the approval of a plan which provided that the common stock of Railways should be distributed to the preferred and common stockholders of Power in the respective ratios of 91.2% and 8.8% and that Power should then be dissolved. The Commission held a hearing on this plan and issued an opinion disapproving the proposed allocation of Railways stock as too generous to Power's common stockholders, but found, Commissioner Healy vigorously dissenting, that a distribution of 94.52% and 5.48% to Power's preferred and common stockholders respectively would be fair and equitable. The plan was modified to accord with the Commission's opinion, was then approved by the Commission and was brought on for hearing before the District Court for the District of Delaware as provided by Section 11(e) of the Act.*fn7 The court found that the plan was "fair and equitable" and entered an order approving it. The appeal at bar was taken by Otis & Co., a preferred stockholder, which had intervened in the proceedings before the District Court.
Certain apparent concessions made by the appellant disappear on examination. The Commission states in its brief that the only question which Otis & Co. has raised is the legal theory governing the allocations of the stock of Railways. This is not so in fact. In its brief the appellant "incorporates" and asserts the views of Commissioner Healy as set out in his dissenting opinion and those views cover almost every aspect of the case. The appellant therefore makes two major contentions which may be summed up as follows. First, it takes the position that the Commission is without authority to allocate to the common stockholders of Power any stock of Railways because the total value of that stock is insufficient to pay in kind the amount of the claims of the preferred stockholders of Power*fn8 as they will mature upon the liquidation of Power; that the phrase "fair and equitable"*fn9 being one of art, requires the application of the "absolute priority" rule of Case v. Los Angeles Lumber Co., 308 U.S. 106, 60 S. Ct. 1, 84 L. Ed. 110,*fn10 and forbids the giving of any interest whatsoever to the common stockholders of Power. In other words when the bourne or goal of liquidation or dissolution of Power is reached, says the appellant, the preferred stockholders' rights will mature and they will become entitled to all the common stock of Railways. Second, the appellant asserts that the allotment to Power's common stockholders of an interest of 5.48% cannot be justified by Railways' earnings, or by those of the system, by the present value of Railways stock or in any other way. This last contention necessarily involves some discussion on our part of Power's earnings as well as those of the system.
The position of the Commission cannot be stated as briefly. It has found that "The assets of Power are * * * of insufficient value to satisfy the stated liquidation preference of the preferred stock in the amount of $100 per share for 600,000 shares, plus arrearages of $38,700,000, or a total of $98,700,000 as of December 31, 1942." The Commission points out that Railways' balance sheets indicate a pro forma book value of $77,954,874 for Railways' common stock on a corporate basis and $81,554,330 on a pro forma consolidated basis and states categorically that the "present book values of assets pro forma are clearly insufficient to cover the liquidation preferences of Power's preferred stock. Similarly, on the basis of a capitalization of reasonably anticipated earnings of the enterprise we are unable to find an over-all value for the assets which approaches $98,700,000." The Commission finds that, "If the amount of the liquidation preference of the preferred stock ($100 per share plus accumulated dividends) is controlling, our inquiry must perforce be ended at this point in a decision that the preferred stock is entitled to all the assets of the corporation to the exclusion of the common."
How then can the Commission reach the conclusion, in view of the Los Angeles Lumber Co. case, that Power's common stockholders may receive an interest of 5.48%? This question may be answered as follows. The Commission asserts that while the type of liquidation contemplated in the case at bar is "involuntary" it is of a type that could not have been foreseen by the draftsman of Power's charter or by the investors in its stock. Next, it points out that in the Los Angeles Lumber Co. case and in Northern Pacific Railway Co. v. Boyd, 228 U.S. 482, 33 S. Ct. 554, 57 L. Ed. 931, financial disaster had overtaken or threatened to overtake the corporate enterprises and that, therefore, reorganization securities had to be distributed among creditors and other claimants according to their contractual rights, determined as in liquidation; that in contrast Power is a company virtually without debt or financial embarrassments; that its existence is proscribed by the Public Utility Act of 1935, 15 U.S.C.A.§ 79 et seq., and because of this fact Power's stockholders are prevented from maintaining their interests in a going concern; that for these reasons the "stockholders affected should be given participations according to their contractual or other rights determined as though in a continuing enterprise, and that the process of compliance with the statute should not be permitted to mature liquidation preferences * * * [and that] the measure of participation allowed should compensate for the substantive rights of security holders as they would exist apart from the reorganization * * * ". The Commission states that in giving effect to the congressional mandate it should not allow the fact of liquidation " * * * to add value to one class of securities at the expense of another class." The Commission concludes that "Where simplification of a system is to be attained through elimination of an unnecessary corporate entity, it is our opinion that the 'fair and equitable' standard does not require us to consider liquidation rights as having matured, and as the sole measure of participation for the preferred stockholders; and it should be immaterial whether the simplification process takes the form of recapitalization, merger or distribution of the assets of a holding company in liquidation. In other words, the 'fair and equitable' standard requires the same recognition of substantive rights irrespective of the method employed in a particular case for obtaining the objectives of Section 11(b)(2)."
The Commission then asserts that " * * * if a class of preferred stock has a measurable interest in an enterprise absent the maturing of liquidation preferences and a proportionately greater interest upon the maturity thereof, it would not be fair or equitable under the statute to give recognition to the greater interest at the expense and to the detriment of the common stock. And conversely, if the common stock has a measurable interest apart from the maturing of liquidation preferences, we must not sanction the destruction of that interest through the operation of the statutory mandate." Referring specifically to the intent of Congress the Commission finds " * * * that the techniques employed under Section 11 should be those necessary to remove the holding-companies' concentration of economic power over operating utilities and * * * benefit investors generally by giving them more direct interests in the operating properties and earnings to the extent that their holding-company securities represent any real equity therein." The Commission concludes, therefore, that it must judge " * * * the fairness of the plan according to legitimate investment values existing apart from the duty of liquidation imposed by the statute." and that the liquidation preference enters into the question of what is fair and equitable only as " * * * one of the bundle of rights belonging to the preferred stock and affecting its normal value."; that preferences may not be permitted to operate so as to be conclusive in the division of assets between the preferred and common stocks to "accelerate the arrearages and translate them into matured claims at their full face amount, so as to entitle the preferred stock not only to all the assets but also in perpetuity to the entire earning power of those assets," a result which would enrich the preferred at the expense of the common. Fair and equitable compensation will be given to all of the claimants, asserts the Commission, "if their rights are measured not in terms of the situation created by the statute but rather in terms of the situation terminated by it - i.e., as though no liquidation were to take place."; that only in this way can each class of stock be accorded " * * * its proportionate share of the benefits to be gained from the elimination of a useless and expensive corporate entity and from the receipt of a security representing a more direct investment in the underlying assets and earnings of the system."
As to valuation the Commission states that " * * * it is unnecessary to arrive at any specific over-all value for the enterprise or for the preferred and common stocks of Power.", but that it is required "to examine into the respective existing interests of the preferred and common stockholders in the earnings of the enterprise."; that the valuation of the respective interests of preferred and common stockholders cannot be "an exact science" under the circumstances of the case at bar and that the best it can do is to determine " * * * what assumptions are necessary to arrive at the allocation, and ascertain whether such assumptions fall within the permissible limits of reasonableness."
The Commission then embarks upon a discussion of the corporate and consolidated net income per books applicable to the preferred and common stock of Power, the preferred dividend requirements and the balance of consolidated net income applicable to Power's common stock from the period from 1929 through 1942. A tabulation is attached to the Commission's opinion and we have reproduced this below.*fn11 The tabulation shows that Power's corporate income has not met the dividend requirements of the preferred stock since 1932 but that the consolidated (system) earnings for the same period produced a net balance applicable to the common stock. The Commission points out, however, that it has not been advisable in the past to pass up any substantial part of consolidated earnings to Railways or to Power and that these earnings have fluctuated widely over the fourteen-year period covered by the tabulation. But it is apparent none the less, that consolidated earnings during the ten years from 1932 through 1941 have come close to equalling the preferred dividend requirements. Also set out in the Commission's opinion is another table, reproduced in part in the footnote below.*fn12 This tabulation shows the comparative consolidated net income applicable to Railways common stock for the years 1937 through 1942. This includes a statement of earnings for 1942, based on nine months' actual operations and three months' estimated operations. The table shows that consolidated earnings applicable to the common stock of Railways, subject to certain adjustments which need not be set out here, averaged in excess of $6,000,000 for the five year period from 1937-41 inclusive and about $6,184,000 for the six year period from 1937-42.
Having before it the contents of these tables as well as evidence offered by one of Power's officers as to management's estimates of future earnings the Commission stated, "For the purpose of determining the existing rights of the preferred and common stocks in the enterprise, we have assumed earnings of $6,185,000, the average adjusted consolidated income applicable to Railways' common stock for the period 1937-42. However, it must be pointed out that in view of the actual earnings experience and the intangible factors discussed, this figure must be regarded as a very liberal assumption as to earning power." If the $6,185,000 annual consolidated earning figure be adopted, it will, as the Commission points out, require approximately fifteen years for the preferred dividend arrearages to be paid in full, even if all consolidated net earnings be applied to the payment of current and accumulated preferred dividends. In this connection the Commission stated, " * * * it is recognized that at best the interest of the common stock in earnings is remote. Particularly is this true since, as a practical matter, all consolidated earnings would not be available for disbursement to the preferred and common stockholders. The remoteness of the common stock's participation is also demonstrated by the fact that actual earnings have fluctuated substantially and have never in the past ten years exceeded the figure we are assuming except in 1942." The Commission then concluded, as we have stated, that it could not find that the proposal to allocate 8.8% of Railways stock to Power's common "falls within the permissible limits of reasonableness for a situation of this kind", but found upon consideration of all the circumstances that the " * * * common stock is nevertheless entitled to some participation.", and that " * * * a participation for the common of approximately 5%, while representing the maximum, would not exceed the permissible limits of fairness, and to secure our approval the plan must be modified to reduce the common stockholders' participation accordingly."*fn13
We have quoted at length from the findings and opinion of the Commission because the principles involved in the case at bar are of great public importance and it is necessary for the purposes of this opinion to show the basis of the Commission's decision. It will be observed that the theory of priorities first elucidated by the Commission in Community Power & Light Co.*fn14 and developed further in Federal Water Service Corp.*fn15 has been modified at least by inference by the Commission's decision in the case at bar.*fn16 There seems to be an unmistakable implication in Federal Water Service Corporation that contractual priorities of preferred stock, no matter how matured, when matured must be respected. This issue, however, was not squarely before the Commission in Federal Water Service Corporation since liquidation was not contemplated. It should be noted that the Commission in the instant case contends that it has in fact applied the "fair and equitable" standard prescribed by Section 11(e) and has not ...