(based upon past performance, present circumstances, and supportable predictions of future events), and establishing the appropriate capitalization rate for converting the predicted future earnings into present value.
The design of the capital structure of the reorganized enterprise must be such that the debtor's earnings will support the new capital structure. The reorganized company must be reasonably likely to be able to comply with the requirements of the securities issued. That is, it must be reasonable to suppose that the reorganized company will be able to meet when due the payments required by the new debt securities, and that it will have sufficient earnings to enable it to pay dividends and grow, so that its equity securities will have value.
By definition, if the Debtor were able to pay off its existing debt obligations according to their terms, it would not be in bankruptcy. Thus, the new securities provided for in a reorganization plan inevitably represent substantial alterations in the rights of creditors and other claimants.
In a straight liquidation proceeding, the assets would be sold and the cash divided among the unsecured creditors, subject to priorities established by statute. All claims would be discharged, even though the proceeds from the sale of the Debtor's assets proved insufficient to pay all claims in full, or even left many claims unpaid altogether. By the same token, in a reorganization proceeding we are dealing with a finite quantity of values (the total value of the ongoing enterprise, represented by the new securities, or cash plus new securities) to be distributed among creditors and other claimants. The essential requirement is that the distribution be fair and equitable, and in accordance with the absolute priority rule.
Under the absolute priority rule, all claims against the estate must be classified and ranked in accordance with the system of priorities established by law. The claims in each class must receive the fair equivalent of the rights lost through discharge, if there is to be any distribution to claimants of lesser rank. This does not mean that senior claimants must be paid in cash before junior claimants participate, nor does it mean that distributions to junior claimants must be made at later times than to senior claimants. But what is required is that the distributions to senior claimants must have value which is substantially equivalent to the value of the claim being surrendered, before claims of lower rank can be recognized.
Generally speaking, there are four classes of claims: claims of administration (I. e., the costs and expenses incurred in conducting operations during bankruptcy), secured claims, unsecured claims, and equity interests. To the extent that a secured claim is not fully secured (that is, to the extent the assets securing the claim are worth less than the amount of the claim), it is treated as an unsecured claim. If the total amount of the claims against the estate exceed the total value of the estate, the estate is insolvent, albeit still reorganizable, and equity interests cannot be permitted to participate under the plan.
A § 77 Plan of Reorganization must be submitted to the Court for approval
If approved as fair and equitable, and as complying with all legal requirements, the Plan must then be submitted to the vote of all who are entitled to participate in the Plan. If the vote is favorable
, the Plan is then confirmed by the Court, and carried out. If one or more classes of participants reject the Plan, the Court will review the matter in light of the results of the voting, but the Court is empowered to confirm the Plan notwithstanding the negative vote, in the absence of changed circumstances, if it deems that course appropriate.
If the Court initially disapproves the Plan, it is not submitted to vote; the Court may require that a new Plan be submitted, or may dismiss the proceedings
The Penn Central Plan is now before the Court for approval. The Court is required to decide whether the Plan conforms to legal requirements, whether it is feasible and whether it is fair and equitable.
2. History of the Penn Central Reorganization
The Penn Central reorganization differs from the "normal' railroad reorganizations of the past in many ways. The immediately apparent difference, of course, is the magnitude of the enterprise and the complexity of its financial structure; but these are only matters of degree. The really important differences in kind have become manifest during the course of the proceedings, and require some explanation, as a prelude to our examination of the proposed Reorganization Plan.
If a bankrupt railroad can be sufficiently revitalized so that it becomes income-producing again, it can be reorganized. In previous railroad reorganizations, the question whether the enterprise could be restored to profitability depended upon changes in the economic climate, or changes within the control of management (E. g., cost reductions, increases in efficiency, etc.). The successful reorganizations of the past were generally achieved because a combination of changed economic circumstances and management improvements provided sufficient net income to support a scaled-down and stretched-out debt structure.
In instances where it proved impossible to achieve profitability, there were several alternatives. Merger into larger, profitable, railroads could sometimes provide a solution to the problem. Or, preservation of essential rail service could be achieved by selling major portions of the bankrupt railroad to other, profitable, carriers, and the remaining assets could be liquidated. Or, in rare instances, the bankrupt railroad could simply be shut down and liquidated, with only temporary and localized adverse consequences to the public.
In the case of Penn Central, however, it early became apparent that profitability could not be restored by means within the control of the Trustees or of this Court. Very substantial changes in the regulatory climate, both procedural and substantive, were required, and sweeping changes in work rules and other aspects of labor-management relations bearing upon productivity. Some of these changes could theoretically have been brought about without further legislation by Congress. For example, greater flexibility in rate-making, more expeditious and more equitable divisions proceedings, and expedited proceedings for abandonment of unprofitable lines, were theoretically attainable through the actions of regulatory agencies.
And the labor-management issues were theoretically susceptible of resolution through the mechanisms provided by the Railway Labor Act.
But the changes needed here would have ramifications far beyond the Penn Central system itself; important issues of national transportation policy were at stake. Hence, as a practical matter, congressional action was essential.
Thus, in the case of Penn Central, restoration of profitability which would render reorganization feasible was dependent upon governmental action. And many of the alternatives to independent reorganization which had provided acceptable solutions in other railroad reorganizations were simply not available to Penn Central because of its size, the magnitude of its problems, and the importance of its rail service to the nation's economy. For example, merger with another railroad was out of the question, and cessation of operations was unthinkable.
The other major distinction between the Penn Central reorganization and earlier reorganizations, namely, the accumulation of huge amounts of unpaid administration expenses, is a product of the passage of time before legislative action occurred, and the nature of the legislative actions taken.
The historical review which follows shows how these problems developed, and puts in chronological perspective the genesis of the proposed Plan of Reorganization.
From the first day of the Penn Central reorganization, June 21, 1970, the full powers of § 77 were brought to bear. Pursuant to various Orders of this Court, the Trustees suspended all tax payments, leased line rents, and debt service, and all creditors' actions against the estate were stayed.
Notwithstanding the substantial reduction in expenses which resulted from these actions, there was inadequate cash available to continue operations. A federal guarantee provided $ 100 million from the issuance of trustees certificates and the entire amount was used to pay operating expenses during the early months of the case.
While the immediate cash shortage problem was working its way to resolution, the Trustees endeavored to cut costs and increase demand for the Debtor's services. They made some progress and predicted additional progress. Yet, on February 10, 1971, the Trustees reported to the Court:
Penn Central is presently locked by circumstances beyond its managerial control into a situation which had best be recognized Now as completely precluding viability unless certain constraints are removed, or other arrangements are made to compensate for their effects. (Emphasis in original).