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IN RE PENN CENT. TRANSP. CO.

October 20, 1972

In the Matter of PENN CENTRAL TRANSPORTATION CO., Debtor. The FIDELITY BANK et al.
v.
PENN CENTRAL et al.



The opinion of the court was delivered by: FULLAM

OPINION AND ORDER NO. 980

FINDINGS OF FACT, DISCUSSION, CONCLUSIONS OF LAW AND ORDER

 Fidelity Bank, a minority shareholder of the New York & Harlem Railroad ("Harlem") has brought this action, derivatively on behalf of the Harlem, challenging the 1873 lease of the Harlem rail assets to the Debtor's predecessors. As amended by stipulation of counsel, the complaint makes the following assertions:

 Count 2-Neither the lease nor subsequent amendments were lawfully approved by the directors and shareholders of the Harlem, or by the appropriate regulatory agencies of the State of New York, hence the lease should be cancelled.

 Count 3-The lease should be terminated because of the Debtor's default.

 Count 4-This Court should enter a declaratory judgment, declaring that proceeds from the sales of properties covered by the lease may not be used by the Trustees for general railroad purposes, but should be escrowed for the account of the Harlem; and declaring that § 909 of the Business Corporation Law of the State of New York, McKinney's Consol.Laws, c. 4 is applicable to sales of the Harlem properties by the Trustees.

 The procedural history of this litigation is somewhat complicated. Fidelity brought suit in the state courts of New York, against the Harlem and its directors, raising many of the foregoing issues. Shortly thereafter, Fidelity petitioned this Court (Document No. 1945) for relief from the stay of suits provisions of Order No. 1 in these proceedings, in order to institute a suit against the Trustees in the New York State courts similar to the present action. By Order No. 456, Fidelity was granted leave to proceed with its suit against the Trustees in the Eastern District of Pennsylvania.

 The Trustees of the Debtor filed a petition seeking an injunction against the New York State action; in Order No. 478, Fidelity was temporarily enjoined from prosecuting that litigation. The present action in this Court was filed by Fidelity, and by Order No. 494, D.C. 335 F.Supp. 831, was consolidated into the reorganization proceedings. Finally, by Opinion and Order No. 496, D.C., 335 F.Supp. 832, I made the injunction under Order No. 478 permanent, but granted Fidelity the right to raise the same issues here.

 The Trustees then filed a motion to dismiss Counts 1, 2, and 3, on the ground that Rule 23.1 of the Federal Rules of Civil Procedure justified dismissal in the absence of any allegation that Fidelity owned any stock in the Harlem at the time of the wrongs complained of. Since it then appeared that, at least as to some of these counts, continuing wrongs were being alleged, and that the policies underlying Rule 23.1 would not be violated by permitting Fidelity to press its claims, the motion to dismiss was denied (Opinion and Order No. 476).

 Thereafter, the case proceeded to trial, non-jury, on a record consisting of stipulations of counsel, oral and documentary evidence followed by extensive oral argument. From this record, I now make the following

 FINDINGS OF FACT

 1. The Debtor is the successor in interest to a lease executed in 1873 for the term of 401 years between the New York Central & Hudson River Railroad Company (hereinafter the "Central") and the New York and Harlem Railroad Company. Said lease has been supplemented and amended by agreements dated May 15, 1882 (Supplemental Contract), October 5, 1898 (Second Supplemental Contract), and July 1, 1943 (Third Supplemental Contract.)

 2. At the time of the lease, the Harlem had outstanding bond issues secured by mortgages on the Harlem properties.

 3. The original lease covered substantially all of the Harlem's railroad property, associated personal property, and contractual rights, but excluded the Harlem's so-called street railroad in New York City, and real property south of 42nd Street in that City. The principal line subject to the lease was comprised of 132 miles of operating property from 42nd Street in New York City to Chatham Four Corners above New York City.

 5. The rental provisions required payment to the Harlem of $ 4 per share outstanding, or an 8% return per annum return on the par value of the Harlem stock. Certain tax liabilities of the Harlem were also assumed by the Central.

 6. The Central also agreed to pay interest on the mortgage obligations of the Harlem then outstanding, and to pay the principal of all mortgages except the Consolidated Mortgage which was to mature in 1900. As to the latter, the Central agreed to pay the principal if the Harlem did not do so. In the event the Central did pay the principal of the Consolidated Mortgage, the Harlem agreed that at the request of the Central the Harlem would issue bonds in like amount. The agreement also required the Harlem to issue new bonds when and if any refunding issue matured and was paid by the Central.

 7. The Central was granted a power of sale over the properties subject to the lease which were not necessary for the railroad operations, subject to an accounting for the proceeds at termination of the lease in due course or in the event of termination for default, with a set off for real property acquired by the Central from its own funds for operation of the Harlem lines. An equivalent provision covering personal property required that at termination the Central "deliver to [the Harlem] personal property of similar kind and equal in value."

 8. At the time the lease was executed the Central did not own any shares of the Harlem stock, but three of the directors of the Central served on the Harlem's 13-member board.

 9. The Harlem shareholders approved the 1873 lease on May 16, 1882, by a vote of 139,856 shares for and none against.

 10. In 1882, the parties executed a Supplemental Contract which provided that neither the directors nor shareholders of the lessee or lessor could effectuate any change in the first or second articles of the original lease, and that the rental reserved by the original lease was to be paid during the entire term.

 11. In 1882 the Central owned no stock of the Harlem, but six of the directors of the Central served on the Harlem 13-member board.

 12. The Harlem shareholders approved the 1882 Supplemental Contract on May 16, 1882, by a vote of 139,856 shares for and none against.

 13. On June 1, 1897, the Harlem 3 1/2 % Gold Mortgage was executed securing a bond issue not to exceed $ 12 million maturing in the year 2000. The Gold Bond issue was for the purpose of refunding the Harlem's 7% Consolidated Mortgage, which was to mature on May 1, 1900.

 14. A dispute and litigation arose between the Central and the Harlem over who would benefit from the 50% reduction in interest costs ($ 420,000 per annum) occasioned by the 3 1/2 % Gold Bond rate versus the 7% rate on the consolidated bonds which were refunded by the Gold Bond issue.

 15. The Second Supplementary Contract was executed on October 5, 1898, in settlement of the litigation instituted by the Central, pursuant to which:

 
a. The Central litigation was terminated;
 
b. The rental payment per share was increased by $ 1 per annum, thereby raising the return at the par value of each share to 10%;
 
c. Central agreed to tender the funds to pay the Consolidated Mortgage at maturity, and in turn the Harlem agreed to issue to the Central bonds under the Gold Bond Mortgage equal to Central payments;
 
d. The original lease obligation to pay the Harlem's funded debt was modified to reflect an unconditional obligation on the part of the Central to pay the Consolidated Mortgage and any refunding mortgage or mortgages.

 16. In 1898 the Central owned no stock of the Harlem, but seven of the directors of the Central also served on the Harlem's 13-member board.

 17. The Harlem shareholders approved the Second Supplemental Contract (1898) on October 5, 1898, by a vote of 145,519 shares for and 11,042 against.

 18. In 1943, a dispute and ensuing litigation arose concerning the Central's obligations under the original lease to pay income and excess profit taxes of the Harlem. The Central contended that any such payments made on behalf of the Harlem were to be subtracted pro rata from the $ 5 per annum dividend rental. In 1942, said payments on behalf of the Harlem were $ 330,630.

 19. The Third Supplemental Contract to the original lease as theretofore amended was executed as a means of amicably settling this dispute. Under the Third Supplemental Contract:

 a. The Central terminated its litigation;

 b. The Harlem agreed to issue $ 7,800,000 in principal amount of Second Mortgage Bonds to be purchased by the Central;

 c. $ 2,500,000 of the purchase price of the bonds were to be turned over by the Harlem to the mortgage trustee of the Harlem Gold Bond Mortgage to be used as a sinking fund to retire but not cancel Harlem Gold Bonds. The mortgage trustee was to receive interest on the retired bonds;

 d. The remaining $ 5,300,000 in purchase price was waived by the Harlem in consideration of the Central's release of all claims for past due tax payments, cancellation of certain Harlem debts arising from operation of the street railroad during the 1920's, and the costs incurred by the Central in the bond issue and associated formalities;

 e. The $ 7,800,000 in principal amount of Harlem bonds acquired by the Central were to be used for an exchange offer to the non-Central shareholders of the Harlem on a basis of $ 125 principal amount of 4% bonds for each share of Central stock;

 f. 4% on $ 125 returned $ 5 per annum to the holder, the equivalent of the return to the stock under the rental provision of the lease as modified;

 g. The Second Mortgage was specified as constituting, for the purpose of the lease as modified, a refunding of the Harlem Gold Bond Mortgage, and, hence, the Harlem Gold Bond Mortgage could not be refunded again;

 h. Central agreed to pay the interest and principal of the Second Mortgage bonds; and

 i. The lease was modified to require payment of the $ 5 per annum per share only to non-Central shareholders of the Harlem. The Central's Harlem stock had been pledged as security for the Central's Refunding and Improvement Mortgage of 1913. The lease provided that suspension of rental payments to the Central as shareholder would not apply if the R&I mortgage trustee was not required under the mortgage to turn over stock dividends on pledged stock to the Central.

 20. By 1943, the Central owned 23,119 shares of the Harlem's 26,879 outstanding preferred and 114,321 of the 173,121 outstanding common.

 21. Eight of the Harlem's 13 directors in 1943 also served on the board of the Central.

 22. The Harlem shareholders approved the Third Supplemental Contract (1943) on August 5, 1943, by a vote of 174,525 for and 2,951 against.

 23. Outside independent counsel was retained to act as counsel to the Harlem relating to the 1943 dispute, and they recommended acceptance of the agreement by the Harlem.

 24. The Central and Harlem submitted in support of their petition under § 20(a) and § 5(2) of the Interstate Commerce Act, the Third Supplemental Contract and Second Mortgage along with summaries of the terms of said contract and mortgage.

 26. The documents recite that about 90 sales or exchanges of property to third parties or to condemning authorities took place in the period 1876 to 1953.

 27. The documents further recite that in most instances the proceeds were delivered to the Harlem and then transferred to the Central for application toward additions and betterments to the Harlem line. The total consideration received aggregated $ 1,875,129.39.

 28. On July 1, 1970, a $ 2.50 semi-annual rental dividend came due, and on January 1, 1971, a second semi-annual dividend came due.

 29. The directors of the Harlem at the time the reorganization petition was filed and thereafter were employees of the Debtor.

 30. An officer of the Harlem made formal demand on the Trustees for payment of the rental dividends mentioned in Finding No. 28, on March 29, 1971.

 31. The two rental dividend payments mentioned in Finding No. 28 were paid by the Trustees on April 30, 1971. Neither payments were within ...


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