Searching over 5,500,000 cases.

Buy This Entire Record For $7.95

Official citation and/or docket number and footnotes (if any) for this case available with purchase.

Learn more about what you receive with purchase of this case.



March 9, 1978


The opinion of the court was delivered by: FULLAM



 The Trustees of the Penn Central Transportation Company, Debtor, have presented for approval a Plan of Reorganization for that company and 15 Secondary Debtors whose lines were a part of the Penn Central system. These related documents are generally referred to collectively in these proceedings as "the Plan." I have concluded that, subject to a few relatively minor adjustments, the Plan complies with all legal requirements, is feasible, fair and equitable, and should therefore be submitted to the vote of the participants. The Opinion which follows sets forth the reasons for those conclusions.

 The Opinion deals with a great many issues and the contentions of a large number of litigants. The reader will encounter certain recurring themes, because the same legal concepts, or the necessities of a certain set of circumstances, may have important, but slightly different, bearing upon the issues being decided in a variety of contexts. Every effort has been made to avoid unnecessary repetition, but in some instances reprise seemed preferable to constant cross-references.

 In anticipation of the hearings on the Plan, this Court extended an invitation to the Securities & Exchange Commission to review the proposed Plan and comment upon it. This was done because the traditional role of the Interstate Commerce Commission in railroad reorganization proceedings has been abrogated by statute, with respect to the Northeastern bankrupt railroads subject to the RRRA. The SEC graciously responded to the Court's invitation, and its Report has provided very valuable assistance to the Court and to the parties.

 The SEC Report has been particularly helpful with respect to feasibility issues and what may be referred to as the legitimacy of the new securities proposed to be issued pursuant to the Plan. I am satisfied that the SEC's valuations, and its conclusions concerning feasibility are sound. I incorporate herein the elaboration of these issues contained in the SEC Report, and have concluded that further discussion of feasibility and valuation issues in this Opinion would be superfluous.

 The excellent sketch of the pre-bankruptcy history of the Debtor which is included in the SEC Report has also made it unnecessary to repeat that material here.

 Because of the unavoidable length and complexity of the Opinion, I have provided at the outset a brief summary of the contents, for the benefit of those who are more interested in the decision of a particular issue than in the legal reasoning leading to that decision.


 The Opinion begins by explaining what a reorganization is, and how it occurs. This is followed by a review of the history of the Penn Central reorganization proceedings from June 21, 1970 to date. In combination, these opening sections of the Opinion point up the unique problems for this estate stemming from the implementation of the RRRA: the existence of huge amounts of unpaid administration claims against the estate, and the fact that the rail assets have been conveyed to ConRail but have not yet been paid for.

 Next, a summary of the Plan itself is provided. This section begins with an explanation of how the Plan attempts to deal with the uncertainties stemming from the RRRA-related problems. This is followed by a detailed description of the significant terms of the new securities to be issued under the Plan, and the proposed distribution of those securities. The section concludes with an explanation of the relationship between the Penn Central Plan and those of the Secondary Debtors.

 The next section contains a discussion of the compromise aspects of the Plan. The principal conclusions are that a reorganization plan may be achieved at this time without finally litigating all of the many disputed legal and factual issues; that it is permissible to incorporate in a reorganization plan compromise resolutions of disputed issues, regardless of whether the compromises are agreed upon by all of the affected parties, so long as the resolution is fair and reasonable, within the range of results which litigation could be expected to provide, and in the best interests of the affected parties. The major compromise settlements embodied in the Plan with the Federal Government, the secured bank group, and the New Haven Trustee are then discussed and approved.

 The following section contains a summary of the principal issues involved in the Valuation Case litigation before the Special Court, the status of that litigation, and its relationship to the provisions of the Plan.

 The balance of the Opinion deals with objections to various features of the Plan which have been expressed by the litigants. Section II-F deals with the claims of state and local taxing entities. In summary, the Court concludes that penalties should be disallowed, that tax claims need not be paid in full in cash; that the lien of tax claims against the rail assets conveyed to ConRail are not automatically transferred to the Debtor's retained assets; and that the Plan makes adequate provision for these claims.

 Section II-G deals with the Plan's provisions relating to the claims of secured creditors (Class J), and with a number of objections to that treatment. The conclusion is that the claims of secured creditors are properly classified in a single class, and are accorded fair and equitable treatment under the Plan. The various arguments of the so-called "super-secured" claimants (creditors whose claims are more than fully secured by retained assets) are discussed, and rejected for the most part; but the Court has concluded that slightly different treatment should be provided the claims of bondholders under four specified mortgages (Mohawk & Malone; Gold Bond; New York Central 6% Due 1990; Penn Central 61/2% Bonds due 1993). Specifically, their rights to redeem their preference stock are to have priority over the random-selection-by-lot redemptions for other Class J creditors.

 The Opinion then deals with various disputes concerning the manner in which retained assets have been allocated among various mortgages for purposes of establishing the correct allocations of A and B bonds under the Plan. The Court rejects most of the objections against the Plan but does require a slight revision in the allocation of retained assets to the R & I Mortgage in recognition of the denial of recourse against properties sold by the Debtor before bankruptcy and not released from the mortgage.

 The remaining objections of Class J creditors are discussed and overruled, with minor exceptions. The Court agrees with the contention of Girard Bank as Indenture Trustee of the Pennsylvania Railroad General Mortgage that the after-acquired property clause renders that mortgage a lien on certain disputed branch lines.

 Section II-H of the Opinion discusses the claims for priority under the so-called "six months" rule and under the "necessity of payment" doctrine. The conclusion is that the six months priority cannot be recognized in this proceeding, because there is no "current debt fund" and because there have been no diversions for the benefit of mortgagees. And the Court concludes that the "necessity of payment" doctrine does not apply at this time.

 Section II-I deals with claims for priority asserted by Bank Setoff claimants, the interline railroads, and claims for freight loss and damage. All of these claims for priority treatment are rejected.

 Finally, the Opinion deals with the contingent claims asserted by Amtrak and ConRail, and with certain miscellaneous claims of the Federal Government, and concludes that the Plan contains adequate provisions for these claims.



 1. Reorganization Process

 Federal bankruptcy law addresses the problems of financially embarrassed business debtors, and provides solutions which fall into two general categories: (1) liquidation, or "straight" bankruptcy, in which the assets of the debtor are sold and the proceeds distributed to its unsecured creditors in proportion to the amounts of their claims, whereupon all debts are discharged and the debtor can start anew *fn1" ; and (2) rehabilitation through reorganization of the enterprise *fn2" Generally speaking, if there is a reasonable prospect that the debtor can become successful, so that greater economic benefits would be realized by preserving it as a going concern than would be achieved through liquidation, then rehabilitation rather than liquidation is the correct choice.

 Railroads, however, are in a special category, both because the public interest requires that they continue to operate, and because dismantling and liquidating them would ordinarily be economically wasteful, and would be unlikely to provide as great a return to their creditors as would their preservation as operating units. Congress has therefore precluded railroads from availing themselves of the "straight" bankruptcy liquidation alternative, but instead has enacted the special provisions of § 77 of the Bankruptcy Act for the rehabilitation of railroad debtors *fn3" The Penn Central bankruptcy proceeding is a § 77 railroad reorganization proceeding.

 Assuming it makes economic sense to keep the enterprise going that is, assuming the value of its earning power is greater than the amount which would be produced by sale of its assets reorganization of the enterprise is feasible. Reorganization is achieved through the mechanism of a Plan *fn4" , which translates the value represented by the earning power of the enterprise into a new set of securities, and distributes these new securities appropriately among creditors and other claimants, in discharge of the debtor's obligations. Valuation of the enterprise involves at least two exercises of judgment: determining what the earning power of the enterprise realistically is (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 *fn5" 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 *fn6" , 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 *fn7"

 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. *fn8" And the labor-management issues were theoretically susceptible of resolution through the mechanisms provided by the Railway Labor Act. *fn9" 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. *fn10" 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. *fn11"

 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: *fn12"


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).

 The Trustees identified four conditions for viability: (1) elimination of losses on passenger service; (2) rationalization of freight plant through elimination or subsidy of uneconomic lines; (3) more flexible rate and division procedures; and (4) improved labor productivity. The Trustees properly observed with respect to these conditions:


It is appreciated that the conditions to Penn Central's viability are hard and introduce factors that go far beyond the normal boundaries of railroad reorganization proceedings under § 77. But in the firm opinion of the Trustees, nothing less has a chance.

  In September of 1971, the Trustees filed a further report. Progress had been made in improving the internal operations of the railroad, and the enactment of the Amtrak statute had resulted in a substantial diminution, but not elimination, of the estate's non-commuter passenger service losses *fn13" Between September of 1971 and January of 1972, the Trustees completed a series of economic studies, and in February of 1972, reported their conclusion that unless the conditions of viability were substantially met by the end of 1973, the estate could not be reorganized *fn14" On the positive side, the Trustees also reported that their studies indicated that there was within the 20,000 route miles of the Penn Central system a core freight railroad of about 11,000 miles which carried approximately 80% Of the traffic, and which would be a viable economic entity if certain labor practices were changed. However, the projected revenues of this core railroad would be inadequate to absorb the continuing losses under the Amtrak contract and from commuter operations. In sum, at the very early stages of the case the basic question was clearly drawn. Would the private and public institutions whose cooperation was essential to the attainment of the conditions of viability embrace the proposal for an 11,000-mile core railroad?

 On April 1, 1972, the Trustees filed a proposal for a Plan of Reorganization which spelled out in more specific terms the justification for and the method of implementing the core railroad concept *fn15" In October of 1972, the Trustees again reported their belief that the core railroad concept was appropriate but suggested increasing the size of the core to 15,000 miles *fn16" The reasons for this change were that reduction to the 11,000-mile core would not generate sufficient cash to pay the labor severance expenses which would flow from the concomitant reduction of the work force; and that the ICC's procedures for abandonment of rail lines would be inadequate to handle, within a reasonable time, the abandonment applications which would be necessary to reduce the system to the 11,000-mile core. The October 1972 report also contained an analysis by the Trustees of a variety of measures, short of outright nationalization, which would be necessary if the core system and the conditions of viability were not attained.

 In February of 1973, the Trustees again, eschewing nationalization, but apparently reconciled to the inevitability of delay before the conditions of viability could be achieved, concluded that plant improvement in the range of $ 600 to $ 800 million would be necessary and that the only source of this financing was the United States. Absent such capital investment even a sharply reduced freight system would not be viable *fn17"

 The dilemma facing the Trustees was that each day the estate operated, additional deferred charges were accruing. Time was expensive. High administration expenses gave rise to two concerns. First, the potential economic viability of any railroad which might emerge was diminished by each increase in high-priority obligations. Second, the continued accrual of administrative expenses would soon reach the point of being an unconstitutional impairment of the rights of the estate's creditors.

 During this early period this Court resolved virtually every question presented to it in such a way as to give the Trustees an opportunity to preserve the railroad. After all, that is the purpose of § 77. The problems came to a head in early 1973, as the April 1, 1973 deadline for the filing of a Plan of Reorganization approached. On March 6, 1973, I filed Memorandum and Order No. 1137, granting an extension of time for filing a Plan, but directing the Trustees, not later than July 1, 1973, to file either a Plan of Reorganization or their proposals for liquidating the enterprise. In the course of that Memorandum I made the following observations *fn18"


It has long been apparent that the particular problems of Penn Central cannot be completely divorced from problems of national transportation policy. Railroads are, after all, a regulated industry. However unappealing may be the notion that a regulated industry can become bankrupt, the Trustees' efforts to rehabilitate the Debtor are circumscribed by existing statutes and regulations. To the extent that these statutes and regulations, whether in the area of abandonment, tariffs, or resolution of labor disputes, preclude the exercise of self-help in achieving profitability, the legislative and executive branches of government must be looked to for solutions, if solutions are to be forthcoming.


And this is as it should be, for it is those branches of government which should determine whether the kind of railroad which could emerge from a private income-based reorganization would be consistent with long-range goals of national transportation policy. Such matters as how much rail transportation should be provided, how much competition among railroads is desirable in the Northeast, and the extent of public interest in maintaining rail service which cannot be operated profitably, are clearly beyond the province of the Trustees, the other parties to this reorganization, and this Court.


I take judicial notice of the fact that the legislative and executive branches are now addressing themselves to these problems. . . . It would obviously be premature, therefore, for this Court to make final determinations as to the future course of this reorganization proceeding on the basis of the existing legislative and regulatory framework. The legal and constitutional rights of the parties to this reorganization should be evaluated in the light of whatever changes Congress sees fit to enact.


By the same token, however, this Court cannot ignore the realities of the Debtor's situation. On the basis of the record to date, it appears highly doubtful that the Debtor could properly be permitted to continue to operate on its present basis beyond October 1, 1973.

 In July of 1973, the Trustees submitted a Plan of Reorganization which contemplated termination of rail operations and liquidation of rail properties unless arrangements were made with public authorities to assume interim losses. *fn19" That Plan contemplated that public agencies, and other carriers, would have preference in the bidding for the rail properties, and that service would be continued under interim operating agreements until ICC and Court approvals of any purchases could be obtained. Non-rail real estate was to be spun off into and managed by a new real estate company. Finally, after consummation of the sales of the rail property, the remaining rail assets would be conveyed to a real estate company. When and how the creditors would be compensated was left open. The Commission concluded, after extensive hearings, that the Trustee's Plan was not a "plan" within the meaning of § 77 because it did not provide concretely for the continuation of rail services. *fn20" The Commission specifically declined to take into account the evidence before the Commission relating to the unconstitutionality of continued loss operations, holding that that issue was exclusively for the courts. The Commission referred to the legislation then under preliminary consideration in the Congress as perhaps the appropriate solution to Penn Central's problem.

 In order to trace the efforts of the Congress to formulate a response to Penn Central's financial plight and that of the other bankrupts in the Northeast portion of the country, it is necessary to return to February of 1973. One step in the Trustees' efforts to achieve their conditions of viability was the implementation of far-reaching work rule changes which, after exhaustion of the Railway Labor Act procedures, were promulgated on February 8, 1973. The United Transportation Union immediately called a strike. With the trains at a standstill, Congress enacted Senate Joint Resolution 59 on the same day and the President signed the resolution into law on the next. As a result of this congressional action, the work rule changes were suspended and service resumed promptly. The Congress also directed the Department of Transportation to file a comprehensive report setting forth the Department's views "for the preservation of essential rail transportation services in the Northeast section of the country." The Department and the ICC filed reports on March 26, 1973, which by and large agreed that the conditions of viability set forth by the Trustees were correct, and recommended procedures for creating a new core freight system. However, both the Department and the Commission saw a broader need, the consolidation of the Northeast bankrupt carriers into one or more new rail systems.

 From March of 1973 to the end of that year, the Congress was engaged in the process of drafting and enacting legislation designed to remedy the Northeast rail crisis. On January 2, 1974, the Regional Rail Reorganization Act of 1973 (RRRA) became law. *fn21"

 The broad outline of the RRRA is relatively straightforward. The bankrupts would operate under the aegis of the Reorganization Courts for a further period, approximately 20 months, during which time the United States Railway Association (USRA), a new corporate entity created under the Act, could complete the task of planning the new rail system or systems, and deciding what portions of the Northeast bankrupts' rail facilities should be conveyed to Consolidated Rail Corporation (ConRail), the company which was to take over the system which USRA designed. The statute contemplates a system which, while not profitable immediately, would ultimately be a profitable private sector carrier. In return for the properties conveyed to ConRail, the bankrupts were to receive common stock and other securities of ConRail in amounts commensurate with the value of the properties conveyed. The Act also created the Special Court, a three-judge panel selected by the Judicial Panel on Multidistrict Litigation, to rule on the adequacy of USRA's valuation of the conveyed property and the value of the stock of ConRail which was given in return.

 Before a debtor in a § 77 reorganization could be subjected to the regimen of the RRRA, the presiding reorganization court had to find the debtor was not reorganizable under § 77, or, if it was, that the public interest would be best served by reorganization under the RRRA. With respect to Penn Central and a number of the Secondary Debtors, I concluded that they were not reorganizable under § 77. *fn22" As to certain other Secondary Debtors, I found that, although they were reorganizable under § 77, the public interest would best be served by their reorganization under the RRRA. *fn23" Shortly after these preliminary decisions were handed down, a three-judge court (of which I was a member) held the RRRA unconstitutional. *fn24" Although that Court found a number of the plaintiffs' key contentions premature, it concluded that the failure to provide a mechanism for compensating the estates for unconstitutional erosion between the time of the passage of the Act and the conveyance to ConRail rendered the Act unconstitutional.

 The next sequence of judicial review occurred pursuant to the RRRA. This Court found that the processes of the Act were not "fair and equitable," and an appeal was taken to the Special Court. *fn25" At about the same time the three-judge court's judgment was appealed directly to the United States Supreme Court.

 The Special Court reversed this Court's decision on the grounds that unconstitutional erosion of the estates, if any, would be compensable under the Tucker Act. *fn26" Shortly thereafter, the United States Supreme Court reversed the three-judge court's finding that the Act was unconstitutional. *fn27" The Supreme Court's two essential findings were (1) that the securities of ConRail were a constitutional medium of exchange for the properties conveyed, because the Tucker Act provided a remedy to satisfy any difference between the constitutional minimum value of the property conveyed and the value of the ConRail securities, and (2) that any unconstitutional erosion of the estates which occurred prior to the conveyance of the properties to ConRail could also be compensated under the Tucker Act. The upshot of all this was that the RRRA, as supplemented by the potential Tucker Act remedy, was held constitutional.

 The Preliminary System Plan was filed on February 27, 1975, and the Final System Plan on July 26, 1975. The end result of the planning process was that the service and trackage of the competing Northeast bankrupts was trimmed somewhat and consolidated into one system to be operated by ConRail.

 Throughout this period, the parties faced the problem of maintaining rail services until the conveyance date. There was almost constant litigation in the reorganization courts concerning the implementation of the § 213 grant program and the § 215 improvement program, the statutory mechanisms for providing cash necessary to continue rail operations. *fn28" That litigation aside, the Trustees and the respective Federal agencies joined in the cooperative effort to insure that the transfer of the Debtor's properties to ConRail went smoothly.

 Before the conveyance of the properties took place, however, Congress made a number of important amendments to the RRRA. Of primary importance to the consideration of the Plan are § 306 of the Act, which authorized the issuance of Certificates of Value, and the § 211(h) loan program. *fn29"

 Section 306 Certificates of Value are interest-bearing USRA securities backed by the full faith and credit of the United States, redeemable on December 31, 1987 (but potentially callable earlier). The certificates are a pledge of the United States to make up with cash any difference between the net liquidation value of the assets conveyed by Penn Central and the other Northeast bankrupts, and the value of ConRail's stock and other benefits conferred on the estates by the RRRA. Recourse to the Tucker Act would, however, be necessary if the Special Court should find that the constitutional minimum value of the assets conveyed exceeds the net liquidation value of the assets.

 As the conveyance date approached, it became clear to all that even after all funding provided under §§ 213 and 215 was exhausted, Penn Central's payables would far exceed its receivables as of the date of conveyance. The situation was potentially tantamount to a second bankruptcy, since ConRail was not to assume any liability for Penn Central's pre-conveyance obligations. And ConRail's operations might be adversely affected if the bills remained unpaid. Section 211(h) was enacted to remedy this situation. It created a mechanism by which ConRail borrowed from USRA in order to pay certain classes of the Debtor's payables. In turn, the estate was obligated to recognize as a current cost of administration the amount of § 211(h) funds expended by ConRail on the estate's behalf.

 On April 1, 1976, the Debtor's rail properties designated in the Final System Plan were conveyed to ConRail. Of the retained rail lines, some are being operated under RRRA-funded subsidy agreements with state and local governmental entities.

 As a consequence of all this, the Debtor's estate now consists of real estate and other investments not acquired by ConRail, plus the eventual right to receive ConRail securities (backed by USRA Certificates of Value) in exchange for the Debtor's rail assets conveyed to ConRail.


 1. Introduction

 The presence of huge amounts of unpaid administration claims (represented in large part by the claims of the United States Government, for which Congress has mandated the highest possible priority) and the unanswerable questions concerning the amount and timing of the receipt of the consideration for the rail properties conveyed to ConRail, have greatly compounded the difficulties inherent in fashioning a Plan of Reorganization of this magnitude. In my 1974 Opinion dealing with the so-called "180-day" issues under the RRRA, I had occasion to anticipate (but not resolve) these problems:


Another problem relating to valuation is the lack of any mechanism for establishing a relationship between the values to be assigned to the rail properties conveyed, and the valuation of the interests of secured creditors holding liens against those properties. There are several facets to that problem. In the first place, the timing is off. In determining whether a plan of reorganization is fair and equitable, it is necessary to determine the extent to which particular groups of creditors are secured, and the value of their respective securities, so as to be sure that they will receive equivalent value before any junior classes of claimants participate. Since the exchanges under RRRA would be between Conrail and the Debtor's estate, rather than the creditors, the problem of later recognition of the correct treatment of the creditors in a reorganization plan would be rendered quite difficult.


Moreover, the valuation of the property for sale to Conrail might very well not be on a basis which would permit rational allocation of the consideration on a segment-by-segment basis for purposes of later assigning lien values. And that difficulty would itself be greatly magnified by the fact that Conrail will presumably be made up of parts of various existing railroads, blended together in a smaller system designed to handle the traffic now being handled by several different railroads.


A further difficulty with the statute is the lack of precision in defining what "other benefits of the Act' are to be taken into account as part of the purchase price for the rail properties conveyed to Conrail.

 In re Penn Central Transp. Co. (180-Day Decision Under § 207(b)), 382 F. Supp. 856, 865 (E.D.Pa.1974). The Plan now before the Court is the product of the Trustees' Herculean and, in my judgment, successful, efforts to surmount these difficulties.

 The problems would be easily resolved if the value of the assets remaining in the Trustees' hands after the conveyance to ConRail were sufficient to satisfy all claims against the estate. Unfortunately, the facts are otherwise. The assets remaining on hand are valued at almost $ 1.85 billion, but the principal amount of all claims against the estate totals more than $ 3 billion. Therefore, any reorganization plan which is to be consummated before 1987 (the anticipated conclusion of the Valuation Case) must distribute securities based in part upon the anticipated proceeds from the Valuation Case, and must also take into account the correlative, albeit theoretical, risk that there will be no proceeds.

 The assets remaining after conveyance to ConRail fall into two principal categories: (1) Penn Central's ongoing, successfully operating, non-railroad business enterprises, principally consolidated in the Pennsylvania Company (Pennco); and (2) a variety of real estate and other investments. The key business judgment reflected in the Plan is that Pennco is a sound company with growth potential, and that it is in the best interests of all concerned to make Pennco the nucleus of the reorganized company. The soundness of this business judgment is amply supported in the evidentiary record, and is unquestioned.

 The Plan contemplates that most of the other assets (herein referred to collectively as the "retained assets") will be liquidated in an orderly fashion during the next 10 years pursuant to an Asset Disposition Program. This is a very detailed and carefully constructed plan of liquidation, and there is reasonable certainty as to the amount and timing of the fruits of that program.

 Pursuant to the conventional reorganization process outlined in Section II-A above, the first step is to arrive at a value for Pennco and the other retained assets. The next stop is to determine what claims are secured by those assets, and in what amount; this step includes applying marshalling principles. The final step is to establish a feasible capital structure and to design a fair and equitable scheme of distribution. It is at this final step that the Valuation Case must be taken into account.

 The Trustees have integrated the known values of Pennco and the retained assets with the unknown value of the proceeds from the Valuation Case in two ways: First, the various securities to be issued under the Plan are related primarily, and in some cases exclusively, to either the Asset Disposition proceeds, the value of the reorganized company, or the proceeds of the Valuation Case. Second, in determining an appropriate distribution scheme, the Trustees made two essential assumptions: (1) that the Debtor is solvent; and (2) that each secured creditor has a lien upon assets equal in value to the amount of his claim (principal and interest). If the Valuation Case should produce a very small recovery, the assumption of solvency would be incorrect, and the assumption of full security would be incorrect in many instances. But if a more favorable result is achieved in the Valuation Case litigation, both assumptions would be clearly correct. Since the record does not permit a finding of insolvency, and indeed it seems more probable than not that the estate is solvent, I am satisfied that the Trustees' assumptions represent the proper course of action.

 The Plan provides for the issuance of securities in various combinations designed to recognize the differing characteristics of each class of claims, and to achieve a fair and equitable distribution of both the known values and the risks and potential rewards of the Valuation Case litigation.

 The new securities to be issued under the Plan consist of four series of secured notes A through D; Series E unsecured notes; two series of general mortgage bonds A and B; preference stock; common stock; and certificates of beneficial interest (CBI). In addition, the reorganized company will assume the outstanding trustees certificates (due in 1986) which will have a first lien on all of its assets. *fn30" Administration claimants receive the secured notes or a combination of cash and secured notes; secured claimants receive the so-called "10-triple-30" package (10% Cash, 30% Mortgage bonds, 30% Preference stock, and 30% Common stock); unsecured creditors receive a combination of CBIs and common stock; and the Penn Central Company, the sole owner of the Debtor's stock, receives common stock (10% Of the total).

 Two of the securities, the Series B general mortgage bonds and the preference stock, are convertible to common stock under certain circumstances.

 The rights of the respective securities to cash from the Asset Disposition Program and other sources are rather complex. Therefore, in connection with the discussion of the securities, frequent reference will be made to the Trustees' 11-year cash forecast. 31 Having a reasonable estimate of when the securities are scheduled to be paid makes it easier to understand the complicated rights of each security in relation to the other securities issued under the Plan.

 2. New Securities and Their Distribution

 Series A Notes: These notes are an escape valve to be issued only if needed to pay approximately $ 56 million now due on the defaulted trustees certificates or to make scheduled principal payments on Series B notes. Cash is already on hand to pay the defaulted trustees certificates and cash flow should certainly be adequate to meet the payments on the Series B notes. There is, as the SEC Report has observed, therefore no need to consider the Series A notes in this analysis.

 Series B Notes: Approximately $ 350 million face amount of these notes are to be issued to satisfy the claims of the United States arising from its advances in that amount under § 211(h) of the RRRA. All interest on these notes is deferrable until December 31, 1987, when the principal and accrued interest are payable without any provision for extension. Interest will be compounded semi-annually at a rate slightly above the Treasury's cost for 10-year borrowings. The Trustees estimate the rate will be 71/2%. B notes will have a lien on the reorganized company's assets subject only to the lien of the 1986 trustees certificates and any outstanding Series A notes, and will also have a similar lien on the proceeds of the Valuation Case. Moreover, between 1978 and 1981 the outstanding principal of the Series B notes must be reduced by at least $ 80 million and under certain circumstances an additional, but limited, reduction of principal must be made. If the Valuation Case concludes before the B notes mature, the notes become payable to the extent that funds are available. The net effect of the Series B notes is to postpone payment of most of the priority claims of the United States Government until termination of the Valuation Case, permitting the use of cash and the proceeds from the Asset Disposition Program to satisfy the claims of other creditors.

 The Plan contains an important covenant which protects the B notes. Pennco may not dividend to the reorganized company more than 50% Of its consolidated net earnings. As a result, until the Series B notes are paid, there will be a substantial cash buildup in Pennco. This covenant insures the adequacy of the security which will be available to satisfy the Government first lien on the reorganized company.

 The cash flow forecast contemplates aggregate payments on B notes of $ 100 million by 1981 ($ 20 million more than the amount required). If this forecast is correct, at maturity the total outstanding obligation on the B notes will be $ 579 million, consisting of $ 249.8 million in principal and $ 329.2 million in accrued interest.

 Series C, D, and E Notes: These notes together with some cash, will be distributed to state and local tax authorities to satisfy pre- and post-petition taxes, including interest but excluding penalties, totaling $ 451.5 million. Forty-four percent of each tax claim will be paid within two years: 26.4% In cash at consummation, and 17.6% In Series D serial notes which mature during that period. The remaining 56% Of each claim will be paid with a combination of Series C-1 notes, and D term notes which mature in December of 1987. As will be more fully described below, under certain circumstances, the principal of the C-1 notes will be converted to either D term notes or E notes, or a combination of both.

   The original allocation of D term notes and C-1 notes depends on the extent to which the tax claims accrued on conveyed or retained property. Basically, tax claims are segregated into two classes: (1) real estate taxes assessed on conveyed property; and (2) real estate taxes assessed on retained property plus all other taxes. C-1 notes are distributed in an amount equal to 56% Of the total tax claim on conveyed property and D term notes are distributed in an amount equal to 56% Of the total tax claims attributable to retained property. By way of illustration, assume a tax claim of $ 40 on conveyed and $ 40 on retained assets with $ 10 in accrued interest on each. The tax claimant receives (subject to certain rounding principles) $ 26.40 in cash; $ 17.60 in Series D serial notes; $ 28 in C-1 notes; and $ 28 in D term notes. In the aggregate, $ 131.2 million in C-1 notes and $ 121.6 million in D term notes will be issued.

  Both the D term and serial notes are general secured obligations of the reorganized company, carry a 7% Interest rate payable semi-annually, and have a claim to the Valuation Case proceeds subordinate to the B and C notes. Approximately $ 79.5 million in D serial notes will be issued, one-half payable on December 31 of 1978 and the remainder on December 31, 1979. Payment of the principal and interest of the D serial notes is to be from the asset disposition proceeds, subject only to the prior claim of the B notes. The maturity date of the $ 121.6 million in D term notes which are to be issued originally under the Plan is December 31, 1987, but if these notes are not redeemed on that date, they are automatically extended for five years with pro rata redemption in each year of the extension period. Between consummation and the redemption date, $ 85 million in interest will be paid on the D term notes.

  C notes will be issued in two series, C-1 and C-2. C-2 notes are reserved for Class G creditors. *fn32" Except for an important conversion provision applicable only to the C-1 notes, C-1 and C-2 notes have the same terms. Both series mature on December 31, 1987, and interest, which is deferred until maturity, accrues at 8% Compounded annually. Although the C notes are not general obligations of the reorganized company, the interest and principal of the C notes, in that order, have a claim against the Valuation Case proceeds subject only to prior claims of the B notes. Any portion of the interest or principal of the C notes which is not paid from Valuation Case proceeds is extinguished.

  There is, however, a rather complex conversion scheme which applies only to the principal of the C-1 notes which may remain outstanding after application of Valuation Case proceeds. Depending on the exact amount of the Valuation Case proceeds, the principal of the C-1 notes will convert to either D term notes, E notes, or a combination of both. The table below shows the treatment of principal and interest of C-1 notes for various amounts of 1987 Valuation Case proceeds and comparable 1976 base values.


   If the Valuation Case proceeds (1987) are between $ 447 million and $ 578 million, the allocation of D term notes and E notes is computed as follows: C-1 notes convert to E notes in an amount equal to the amount of B notes outstanding after application of the Valuation Case proceeds, and the balance of the C-1 notes convert to D term notes. By way of illustration, assuming $ 500 million in Valuation Case proceeds (1987), the balance due on B notes is $ 79 million and that amount of C-1 notes is converted to E notes with the remaining principal of the C-1 notes, $ 52.2 million ($ 131.2 million less $ 79 million), converted to D term notes.

  The integration of D term notes issued as a result of conversion of C-1 notes with the original D term notes requires some fine tuning. If the Valuation Case is concluded before December 31, 1987, and some or all of the C-1 notes are converted to D term notes, the conversion issue of D term notes will share Pari passu with the original D term notes and be subject to the automatic five-year extension. However, if the Valuation Case is concluded after December 31, 1987, but before December 31, 1991, the D term notes issued in conversion of C-1 notes will be payable in equal amounts so as to retire the entire conversion issue by the end of 1992. The last but, it is hoped, unnecessary provision of the conversion scheme is that if the Valuation Case is concluded on or after December 31, 1991, the principal of the C-1 notes is immediately payable in cash on the later of December 31, 1992, or the conclusion of the Valuation Case.

  Series E notes are fully subordinated unsecured obligations of the reorganized company which do not bear interest and mature on the later of December 31, 1993, or six years after the conclusion of the Valuation Case. In the event any E notes are outstanding on the maturity date, there is an automatic 10-year extension. E notes do have the benefit of a cumulative redemption covenant under which a maximum of $ 30 million a year in E notes may be retired. Payments will be made on the E notes only if cash is available, and then only to the extent the earnings of the reorganized company, subject to certain adjustments, exceeded $ 50 million in the previous year.

  General Mortgage Bonds: Two series of general mortgage bonds Series A and Series B are to be distributed in various combinations to secured creditors to satisfy 30% Of each secured creditor's claim. The mortgage bonds have the benefit of a complicated set of priorities as to the funds available to make principal and interest payments. For present purposes, all that need be noted is that the bonds are subordinate to the notes as to lien priority and cash availability, and as between the two series, the principal and interest of A bonds must be paid before Asset Disposition proceeds may be used to service the B bonds. Both series bear a 7% Per annum interest rate beginning on April 1, 1981, but if cash is not available, the interest is deferred and compounded semi-annually. The maturity date for the bonds is December 31, 1987, but if the Valuation Case is not concluded as of the maturity date, there is an automatic 10-year extension. With respect to the Valuation Case proceeds, the B bonds are paid first, but in the event that the Valuation Case proceeds are inadequate to satisfy the B bonds, any remaining amount of principal is converted into common stock at the same number of shares per thousand dollars as the unsecured creditors received per thousand dollars of claim (estimated to be 11.40 shares per thousand dollars). On the other hand, A bonds are general obligations of the reorganized company, and if the Valuation Case proceeds are inadequate to satisfy the A bonds, they must be paid either at maturity or pursuant to the terms of the automatic extension. The cash forecast indicates that A bonds will be retired easily from the Asset Disposition Program.

  Early redemption of the mortgage bonds is controlled by two separate provisions of the Plan. Mortgage bonds have a very high claim to Asset Disposition proceeds, and to the extent all prior claims to Asset Disposition proceeds are met in any given year, there will be mandatory early redemption of the mortgage bonds. However, the Plan puts a limit on the mandatory redemption feature by establishing the following maximum percentages of the total amount of mortgage bonds which may be redeemed as of any given year: 1978 33.34%; 1979 44.45%; 1980 55.56%; 1981-66.67%; 1982-77.78%; 1983-88.89%; 1984 100%. Because A bonds must be paid first, the actual A bond redemption limitation for 1978 is 55%, with an additional 18.3% Cumulatively thereafter until all the A bonds are redeemed. If the cash forecast is correct, $ 304.9 million of the $ 344 million in A bonds will be paid by 1980 and the remainder will be paid by 1983, and $ 25.1 million in B bonds will be paid in 1983 and most of the accruing B bond interest will be paid through 1987.

  Preference Stock: Secured creditors will receive non-dividend preference stock, computed at a ratio of 1 share per $ 20 of claim, for 30% Of their claim. Of the 30 million preference shares authorized, it is expected that 28.36 million will be issued to secured creditors. Each share will have two-thirds of a vote, and the aggregate preference shares will represent 45% Of the voting power of the reorganized company. Since secured creditors will also receive 12.73 million shares of common stock, which has one vote per share, the secured creditors as a class will have 75% Of the voting power.

  Beginning in 1981, annual redemption of 5% Of the preference stock at $ 20 per share is required if an income test is met. If the income test is met but cash is not available, the redemption obligation carries over. The cash forecast does not indicate that any preference stock will be redeemed. However, the forecast does show that the income test would permit redemption of $ 25.3 million of preference stock in 1981. Since no estimate of Pennco's earnings past 1981 is available, additional redemptions cannot be predicted. Unredeemed preference stock will have a claim against the proceeds of the Valuation Case subordinate to the Series B, C, and D notes and the Series B bonds. If the Valuation Case proceeds are not adequate to redeem the preference stock, preference stock automatically converts to common at a ratio of 1 share of common for each 6.5 of preference.

  Certificates of Beneficial Interest: It is estimated that $ 213.2 million in Certificates of Beneficial Interest will be issued to satisfy 30% Of the unsecured claims. The certificates are payable only out of the Valuation Case proceeds which are available after the satisfaction of the secured notes, general mortgage bonds and preference stock.

  Common Stock: Of the 40 million shares of common stock which are authorized under the Plan, 23.153 million are to be originally issued: Secured creditors 12,734,562 shares (55%); unsecured creditors 8,103,813 shares (35%); and Penn Central Company 2,315,375 shares (10%). However, due to the provisions of the Plan which preclude the issuance of fractional shares the stock issued on consummation will be somewhat less than the shares allocated to the class. The difference in shares between the full allocation and the amount issued will be sold to the public within one year, and the proceeds distributed to those who would have received the fractional shares. Conversion of the full amount of B bonds and preference stock would require issuance of 6.9 million additional shares of common. Any Valuation Case proceeds in excess of the amount necessary to satisfy Series B, C, and D notes, Series B mortgage bonds, preference stock, and certificates of beneficial interest, will of course benefit the common stockholders. Mr. Guest, the Trustees' investment advisor, has opined that the reorganized company may be able to pay modest dividends on the stock during the 1978-87 period and that it would be wise for the directors to declare such dividends.

   The first Board of Directors will be selected from persons representing the Institutional Investors, the PCTC Indenture Trustees, the secured banks, the New Haven Trustee, unsecured creditors, the Penn Central Company and two designated officers of the reorganized company. As the staggered terms expire, the shareholders will elect replacements. Beginning on the sixth anniversary of the consummation of the Plan all directors will be elected for one-year terms by cumulative voting. Thus, the voting shareholders will have substantial control over the choices to be made by the reorganized company.

  In sum, the Plan creates a set of securities which weave an intricate series of claims against the three asset groups. Cash and Asset Disposition Program proceeds are distributed to the United States, tax claimants, and secured creditors. Valuation Case proceeds are subject to the essentially same priority scheme, the United States, tax claimants, and the B bonds of secured creditors, and any remaining proceeds are available to satisfy the secured creditors preference stock, then the CBI's of the unsecured creditors, and ultimately the shareholders. The reorganized company is to be owned by the secured creditors, the unsecured creditors and Penn Central Company, but subject to all of the liens created by the Plan.

  3. Scope of the Plan

  The prior discussion has proceeded, for the purpose of clarity, as if there were only one debtor, Penn Central Transportation Company. This, of course, is not the case. Only about one-half of the rail lines of the Penn Central system were actually owned by Penn Central. The other half were leased to Penn Central under long-term leases by so-called leased line lessors. Fifteen of these lessor companies have filed § 77 petitions as part of the Penn Central proceedings and are referred to as the Secondary Debtors. For each of the Secondary Debtors, the Penn Central Trustees have proposed a Plan. Subject to a number of exceptions, the treatment of the bondholders of the Secondary Debtors is the same as that of the bondholders of Penn Central. Stockholders are, however, treated quite differently. The respective leases between Penn Central and the Secondary Debtors require Penn Central to pay as rent certain dividends to the public stockholders of the Secondary Debtors. For the purposes of the Plan, the annual stock dividend payment is capitalized at a rate of 10 and the resultant amount is treated as a secured claim which receives the same distribution as other secured creditors, the 10-triple-30 securities package. Implementation of the Penn Central and Secondary Debtor Plans would have the effect of placing control of the Secondary Debtor's assets, including their subsidiaries, in the reorganized company. The cash forecast assumes that all of the Secondary Debtors' Plans will be effectuated. A major purpose of proposing Plans for the Secondary Debtors at this time is to achieve a substantial simplification of the debt and equity structure of Penn Central and its related lessor companies. Consummation of all the Plans would eliminate more than 50 separate mortgages of Penn Central and the Secondary Debtors, and the outstanding stock of Penn Central Company and the Secondary Debtors. In sum, the Plan would replace the complex debt and equity structure of Penn Central and the Secondary Debtors with the comparatively streamlined and simple debt and equity structure of the reorganized company which is described above.

  There is another group of lessors which are not in bankruptcy. The Trustees originally appeared to be including these companies under the Plan and treating their debt and equity interests substantially the same as the Secondary Debtor bondholders and equity holders. Later, the Trustees clarified their position as being merely an offer by the Trustees to settle all outstanding accounts with the lessors on the terms mentioned. Failing prompt acceptance, settlement negotiations were to be initiated. To date, no such settlements have been presented to the Court. However, the cash forecast is predicated on the assumption that all of the non-bankrupt lessors accept the proposed settlements. Since the failure to accept the Trustees' settlement proposal reduces the assets available to the reorganized company but also reduces the amount of securities to be issued, it does not appear that feasibility of the Plan would be impaired by the failure of the non-bankrupts to join in the Plan. The Trustees have offered evidence that the feasibility of the Plan would not adversely be affected by the failure to have these matters resolved before consummation, and no one has challenged that conclusion. It should be noted, however, that the eventual resolution of the disputes between the reorganized company and the non-bankrupt lessors may be either more or less favorable to the Trustees than the terms of the Plan.


  In order to achieve this Plan, the Trustees have negotiated compromise settlements with the Federal Government; the group of banks holding the pledge of all of the stock of Pennco; the New Haven Trustee; and others. Unless these compromise settlement arrangements particularly those with the Federal Government and the bank group are approved as reasonable, there can be no Plan of Reorganization.

  Before discussing the reasonableness of each of the major compromise proposals, it is well to have clearly in view the legal standards which must govern the Court's judgment in the matter. It is firmly settled that a Plan may be approved which embodies compromise resolution of conflicting contentions, if the approval is based upon an informed evaluation of the strengths and weaknesses of the respective contentions, the likelihood, duration and expense of litigation which would otherwise be necessary, and the range of probable litigation results. Protective Committee for Independent Stockholders of TMT Trailer Ferry, Inc. v. Anderson, 390 U.S. 414, 88 S. Ct. 1157, 20 L. Ed. 2d 1 (1968). Where the Trustees and particular parties have in fact reached a compromise settlement of their conflicting contentions, those are the governing criteria.

  Essentially the same criteria are applicable in instances where no actual compromise agreement has been reached, but the Plan nevertheless resolves the dispute, I. e., where the Trustees have in effect proposed a compromise resolution of the controversy, and ask the Court to approve and implement it as being fair and reasonable.

  In both situations, approval of the suggested resolution of the controversy may substantially affect the interests of others who are not direct parties to the compromise, or to the negotiations and discussions which produced the agreed-upon or suggested solution. It is therefore necessary that all affected parties have an opportunity to be heard.

  A hypothetical example may be useful here. Assume creditor X asserts a claim for $ 1 million, but the Trustees contend that the estate's liability is only $ 500,000. Assume further that if creditor X is allowed more than $ 600,000 from the estate, there will not be enough left in the estate to pay creditor Y in full. The Trustees and creditor X agree to settle the claim for $ 750,000. Creditor Y is, of course, entitled to be heard on the fairness and reasonableness of the compromise. But if, after a full opportunity for all concerned to present both evidence and argument, the reorganization court is satisfied that the proposed compromise is fair and reasonable in light of the strengths and weaknesses of the contentions of creditor X, the Trustees, and creditor Y, the costs and delays litigation would involve, and the range of probable outcomes of litigation, the Court may approve a Plan which embodies that compromise resolution. The fact that creditor Y was not a party to the settlement, and did not participate in the negotiations which produced it, is immaterial. His rights are fully vindicated in the hearing process. The objective tests of fairness and reasonableness are controlling.

  Ordinarily, if the only item in dispute is the correct amount of a claim, there would be no occasion for the Trustees to propose a compromise resolution which was not agreed to by the creditor directly involved; it would be simpler to have the claim summarily adjudicated pursuant to the program for proofs of claim. But when more complicated disputes arise, as they inevitably do in any complex reorganization case, what amounts to a compromise resolution of a dispute must often be proposed in the absence of actual agreement between the parties directly involved. The words uttered by the Supreme Court a century ago still ring true today:


Railroad mortgages . . . are peculiar in their character and affect peculiar interests. The amounts involved are generally large, and the rights of the parties oftentimes complicated and conflicting. It rarely happens that a foreclosure is carried through to the end without some concessions by some parties from their strict legal rights, in order to secure advantages that could not otherwise be attained, and which it is supposed will operate for the general good of all who are interested. This results almost as a matter of necessity from the peculiar circumstances which surround such litigation.

  Fosdick v. Schall, 99 U.S. 235, 252, 25 L. Ed. 339 (1878).

  The Plan now before the Court incorporates a host of compromises of various kinds. They include actual compromise settlement agreements; provisions of the Plan which carry out what the Trustees regard as a fair and reasonable adjustment of unresolved disputes; and underlying assumptions, concerning such matters as the Valuation Case, based upon judgments which have been arrived at through a process closely akin to compromise. The agreed-upon or proposed compromise settlements include disputes between the Trustees and particular claimants or classes of claimants regarding the amount or nature of the claims, and disputes between classes of creditors. Included in the former category is the important proposal that the complex relationships between Penn Central and the 15 Secondary Debtors be resolved by cancelling all mutual claims, paying off the public holders, and treating the Secondary Debtors' assets as assets of Penn Central. An illustration of the compromise resolution of a dispute between classes is the treatment of tax claims. In such cases, each party to the dispute receives less favorable treatment than would be appropriate if all disputed issues were resolved in its favor, but more favorable treatment than would be appropriate if it should litigate and lose.

  The distinction between settlement agreements and compromises which have not actually been agreed upon (a distinction which, as discussed above, is not crucial for present purposes) is sometimes difficult to draw. The compromises of the claims of the United States Government, the Pennco pledge dispute, the claims of the Secondary Debtors, and the claims of the New Haven Trustee have all been expressly agreed upon. On the other hand, there is not unanimous agreement by the taxing authorities concerning the treatment of state and local tax claims, although most such claimants who have participated actively in the Plan proceedings now support the Plan.

  The compromise-like assumptions related to the Valuation Case problem stem from the fact that neither the amount to be received by the estate in exchange for the rail properties conveyed to ConRail, nor the timing of its receipt, is now known. Thus, any Plan proposed before the Valuation Case litigation is concluded must take these uncertainties into account; the assumptions must be within the reasonable range of probable litigation results. As discussed in detail in Section II-B, the Plan deals with the uncertainties of the Valuation Case through the issuance of a mix of securities designed to reflect both the risks and the potential rewards of the Valuation Case.

  While each compromise settlement, compromise proposal and compromise-type assumption must be evaluated individually, the importance of viewing the Plan as a cohesive unit cannot be over-emphasized. All of the compromises are closely interrelated. In a very real sense, the Plan is the sum of all of its compromises. The fairness and equity of the treatment accorded to any class or member thereof must be evaluated in the context of the Plan as a whole.

   To recapitulate, a reorganization court unquestionably has the power to approve a plan which embodies compromise resolutions of disputed issues notwithstanding the objections of persons directly or indirectly affected by the compromises. This does not mean that legitimate contentions may be disregarded. Rather, they must be taken into account in determining whether the Plan does or does not provide fair and equitable treatment. The issue is not merely whether there are objections to a particular compromise, but whether the objections are persuasive. No one creditor or group of creditors can be permitted to insist upon litigating every contention to finality, if that very process would frustrate a reorganization which is in the best interests of all creditors.

  Perhaps the most striking feature of the Plan proceedings has been that, notwithstanding the welter of objections, counterproposals, charges and counter-charges, it appears that no one has consciously advocated abandoning the attempt to achieve a Plan of Reorganization at this time. And there is almost equally unanimous agreement on the proposition that retention of Pennco as the operating core of the reorganized company is essential. As an assessment of the economic realities of the situation, this business judgment is undoubtedly sound, as noted in the SEC Report. In view of the ramifications, intended or unintended, of some of the arguments presented, however, the Court must initially consider whether present approval of a Plan of Reorganization, with its attendant compromises, unfairly prejudices senior creditors whose claims might otherwise be more promptly satisfied. Arguably, if that were the case, the Plan should not be approved, no matter how globally beneficial it might be.

  At first blush, it would seem theoretically possible to simply liquidate all retained assets immediately, pay the proceeds to top-ranking claimants in descending order of priority, await the outcome of the Valuation Case, and then complete the liquidation process by distributing the proceeds as far down the priority ladder as they would reach. While this course of action would undoubtedly produce less total benefit for the creditors than would a Reorganization Plan, it would theoretically produce more immediate payment to the senior creditors whose claims are entitled to priority treatment.

  Upon analysis, however, it becomes immediately apparent that in the absence of compromise, even that simplistic and draconian result could not be achieved any more speedily than a Plan of Reorganization which provides greater benefits for all. The reason lies in the nature and complexity of the legal issues which, in the absence of compromise, would have to be litigated.

  In their evidentiary submission, the Trustees have spelled out in some detail the major sources of potential litigation. These include the disputes concerning the relative priority of governmental claims, state, local and federal; the validity of the Pennco pledge agreement; a host of issues concerning the coverages of various mortgages and the correct application of marshalling principles; and what is perhaps the most significant but least understood problem, unraveling the intricate relationships between the Debtor and the Secondary Debtors. And even if these disputes could be finally resolved through litigation by the early 1980s, as the Trustees assume, there is another aspect of the matter which the Trustees appear to have somewhat underestimated. All of these disputes are interrelated. Generally speaking, the highest-priority claims must be finally resolved before distribution to lower classes could begin. For that reason, until the highest-priority claims are known, it is virtually impossible to determine correctly the treatment which lower classes of claims should receive. It is unlikely, therefore, that litigation of all of these major disputes could efficiently be pursued simultaneously. Stated otherwise, if the litigation proceeded simultaneously, it might well be necessary, upon completion of one round of litigation, to commence an entirely new round of litigation in order to determine how the results of the first round of litigation should be implemented (either in a Plan of Reorganization, or in the hypothetical liquidation distributions).

   Until the validity and priority of the Government claims were finally determined through litigation, no distributions of any kind could be made. Until the issues surrounding the state and local tax claims were determined through litigation (Section II-F), distributions to bondholders would seem unlikely. Perhaps more importantly, until the amount of the recovery in the Valuation Case became known, it would be impossible intelligently to work through the problem of allocating unpaid administration claims among the various mortgages, rendering distribution impossible. And until the Secondary Debtor issues were resolved, those assets would not be available for Penn Central creditors.

  Thus, achieving a Plan at this time would expedite, rather than delay, distributions to senior claimants as well as junior claimants, and there is no valid reason for rejecting the obvious overall economic advantages reorganization would entail.

  The final, and equally obvious, point to be made is that there simply can be no reasonably prompt Reorganization Plan which does not embody compromise solutions of these litigable issues. The true choice, then, is among prompt achievement of a beneficial Plan which provides some immediate distributions to creditors and greater distributions in the long run, or holding matters in abeyance until all litigation, including the Valuation Case litigation, is concluded, and then attempting to achieve a Plan, or pursuing the economically wasteful course of a liquidation in which distributions to creditors would be withheld for many years. The choice is obvious.

  Therefore, the issue is not whether the Plan should be disapproved because it embodies compromises which are objected to, but whether the proposed compromises are fair and reasonable.


  1. United States Claims

  The principal compromise settlement agreement embodied in the Plan deals with the major claims of the Federal Government. These include $ 50 million, plus interest, due on trustees certificates in default since 1976, and approximately $ 350 million due or to become due under the § 211(h) program. In addition, the Government has guaranteed the balance of $ 50 million in trustees certificates, which fall due in 1986.

  On January 18, 1977, after hearing, I entered Order No. 2744, granting preliminary approval to the compromise arrangements which have now been embodied in the Plan. There were no significant objections to the proposed compromise at that time, and no actual objections to the terms of the compromise arrangements as such have been expressed at the present time. It is therefore unnecessary to spell out all of the details of the compromise agreement. The agreement resolves certain disputes between the Trustees and the Government concerning their respective rights and obligations under the § 211(h) program and the agency agreement with ConRail. For present purposes, the significant features are that payment of the $ 50 million in defaulted trustees certificates is deferred until the consummation date under the Plan, and all other claims are deferred until the conclusion of the Valuation Case; and the Government agrees to accept the distributions provided for in the Plan, and to support the Plan. Without such deferrals, there obviously could be no Plan of Reorganization, and no claims of other creditors could be paid until the Government's claims were satisfied in full.

  The Government reserved the right to withdraw from the settlement agreement unless certain conditions were met. The Trustees were required to agree to pay pre-bankruptcy personal injury claims in cash, and to extend to state and local taxing authorities a proposal for immediate compromise settlement of tax claims (see Orders Nos. 2921, 2922 and 2929); and it was stipulated that the Reorganization Plan must provide for full cash payment of all claims under $ 1,000. The Trustees agreed to the arrangements for financing the Government claims which are now set forth in the Plan, and also agreed, Inter alia, not to attempt to exercise a right of setoff based upon the estate's claims for unconstitutional erosion. The latter agreement was, of course, without prejudice to the Trustees' right to pursue those claims before the Special Court or elsewhere.

  I had no difficulty in approving this compromise settlement as reasonable when the issue was first before this Court, and my opinion remains the same. The primary reason is that there is no likelihood that a more favorable result could be achieved for the estate.

  No doubt there are many arguments which could be raised against the validity of the Government's claims, or at least against the super-priority they have been accorded by statute. *fn33"

  The range of possible litigation outcomes extends from full Government victory, the consequences of which are sketched above, and full victory for the estate, in which event conceivably the statutory prohibition against setoffs would be invalidated, and all of the Government's claims would be treated as part payment for the unconstitutional consequences of congressional treatment of the railroad, including the RRRA. Realistically, the likelihood of achieving that kind of result is not great, and the likelihood of achieving any favorable result of any kind within a reasonable span of time is simply non-existent. This was a negotiation in which the relative bargaining power of the adversaries was not exactly equal.

  Apart from the timing question, some brief further discussion of the merits of the issues is perhaps justified, in view of the widespread feelings on these matters among Penn Central's creditors and stockholders.

  I earlier expressed the view that requiring Penn Central to operate beyond October 1, 1973 would probably be unconstitutional. I followed very closely the development of the RRRA and, as one member of the three-judge court, agreed that it was unconstitutional in the absence of a Tucker Act remedy; and I further expressed the view that even a Tucker Act remedy would be too remote to satisfy constitutional requirements under these circumstances. The Supreme Court and the Special Court disagreed with this latter view. The RRRA, in tandem with the available Tucker Act remedy, is undoubtedly constitutional. The difficulty is that the statute as thereafter applied was quite different from the statute which was before the Supreme Court. It is conceivable that the consequences which, by amendment and other governmental actions and interpretations, have been permitted to flow from the present version of the statute, might not pass muster. But it must be recognized that constitutional challenges to governmental actions on the subject of bankruptcy have seldom been successful; the only authoritative judicial guidance as to the possible limitations of the bankruptcy power tends to include statements to the effect that whatever those limits may be, they have not been exceeded in the particular case under discussion.

  Parties unimpressed by the Government compromise must also be cognizant of the stark fact that, rightly or wrongly, bondholders and stockholders of railroad enterprises simply are not objects of sympathy in the legislative halls of this nation. Hence, even a successful assault upon the validity of the Government claims and their priority would very likely merely lead to further legislation which might generate a further round of litigation.

  Having said all of this, I hasten to add that I regard the compromise agreement with the Government as a generous one. It reflects a sincere effort on the part of the Government to rectify some of the rather harsh immediate consequences of the cash-flow crisis stemming from the conveyance. It has made possible the prompt payment of personal injury claims, and at least a beginning of payment of tax claims. Whatever may be the propriety of having required the Debtor to go deeper into debt in order to provide rail service to the public during the planning and implementation of the RRRA, there is undoubted merit in an agreement to postpone collection of that additional debt so that the company can reorganize.

  2. Settlement of Pennco Pledge Dispute

  During the period between the merger and the bankruptcy, the Debtor obtained much of its working capital by means of a short-term, revolving credit arrangement with a consortium of banks, for whom Citibank acted as agent. Plans to achieve long-term mortgage financing did not materialize, initially because of unfavorable market conditions, and later because of the Debtor's rapidly deteriorating financial condition.

  A few months before bankruptcy, the revolving credit arrangement was increased and modified. The Debtor pledged its Pennco stock to the Citibank group as collateral for a $ 300 million revolving credit authorization. Closing was held April 1, 1969. $ 200 million was drawn at the time of closing; of this amount, $ 100 million was used to satisfy the amount outstanding under the previous revolving credit arrangement. The entire $ 300 million was drawn down before bankruptcy.

  No payments have ever been made on account of this indebtedness. Treated as a fully secured claim, entitled to interest at the contract rate, the claim would now aggregate in excess of $ 470 million. It would be secured by the asset Pennco which is absolutely essential to the success of this reorganization.

  Early in the reorganization proceedings, various parties mounted a substantial challenge to the validity of the pledge of the Pennco stock. Those issues were fully litigated in connection with an earlier proposal for an amicable settlement between the Trustees and the bank group. When the proposed settlement agreement was rejected by this Court, See In re Penn Central Transp. Co., 358 F. Supp. 154 (E.D.Pa.1973) the impetus for prompt resolution of these disputes was removed. Since such matters are normally adjudicated in connection with the Plan proceedings, I was content to withhold decision in the matter, upon being advised that, for various reasons the interested parties preferred to have the pledge issues remain in abeyance. *fn34"

  The validity of the pledge was challenged by various parties, with varying degrees of intensity. The Trustees themselves remained neutral on the subject. Because many of the banks involved in the transaction were also Indenture Trustees for bondholders, it was necessary to appoint Special Representatives to look after the interests of the bondholders. These Special Representatives, and representatives of equity interests (commonly referred to as "the Robinson petitioners"), were the principal proponents of the view that the pledge was invalid, although they disagreed to some extent concerning the consequences which should flow from such invalidity.

  The facts giving rise to the challenge were these: Section 10 of the Clayton Act prohibits a railroad from selling its securities to any corporation having one or more directors who are also directors of the railroad, except pursuant to competitive bidding. Moreover, apart from the common director problem, transactions such as the revolving credit and pledge agreement require the approval of the ICC under Section 20a of the Interstate Commerce Act.

  The transactions were structured as loans made by a small number of "lender banks"; but these lenders would then simultaneously assign part of the transactions to a large number of "participating banks". While there may be some dispute as to the extent to which the banks regarded these arrangements as legally binding among themselves, it is clear that the proposed participants were informed by Citibank from time to time as to the status of the negotiations, and that the identity of the participating banks and the amounts of their respective participations were known to Penn Central when the credit agreement was signed.

  A couple of months before the final revolving credit arrangement became effective, a director of one of the lender banks was nominated to the Penn Central Board, and was actually elected a few days before the closing, although he did not attend any directors meetings until after the closing. There was uncontradicted evidence to the effect that he was not aware of the pending loan transaction, and that the bank was not aware of his impending Penn Central directorship. He did not disclose his bank directorship to the railroad, because he misunderstood the questionnaire the railroad required him to fill out, and was not aware of the possible conflict.

  In addition to this problem, it developed that five of the participating banks, who participated in the transaction to the extent of $ 57 million, had directors in common with the railroad throughout the relevant period. The parties were all aware of these interlocks, but assumed that they posed no problem because the participating banks were one step removed from the transactions between the Debtor and the lender banks; there were no direct negotiations or dealings between Debtor and the participating banks.

  The arguments in support of the challenge may be summarized as follows: There was a clear, albeit unintentional, violation of § 10 with respect to one bank, and a violation of at least the spirit of the statute with respect to five additional banks. The Court should not countenance this transparent attempt to circumvent the competitive bidding requirements of § 10. Moreover, the failure to disclose any of these infirmities to the ICC amounted to a fraud against that agency, rendering its approval of the transaction nugatory. And, as a separate matter, the failure of the parties to disclose to the ICC the existence of "compensating balance" arrangements between the various banks and the Debtor (I. e., "gentlemen's agreements" to maintain deposits at specified levels the participating banks) further undercut the legitimacy of the transaction.

  On behalf of the banks, the following arguments were presented: This was not a sale of "securities" subject to § 10. In any event, a transaction of this magnitude is not realistically susceptible to competitive bidding, hence Congress could not have intended that § 10 should be applied in this context. The terms of the loan transaction were unduly favorable to the railroad. The railroad obtained the full benefit of the loan transaction, and should now be required to comply with its terms. The banks had nothing to do with the proceedings whereby the approval of the ICC was obtained. Obtaining the approval of the ICC was clearly the responsibility of the railroad; it would be unthinkable to permit the railroad to avoid a $ 300 million obligation by reason of irregularities in its application to the ICC. Moreover, there were no such irregularities; the structuring of the direct transaction was appropriate; the ICC must have been aware of the common practice of using the "participation" device, and certainly was aware of the universal practice of compensating balances. The compensating balance arrangements were standard, were not lived up to by the railroad, and resulted in no detriment to the railroad. None of the parties was aware of the technical violation of § 20a in the one case, and the vast majority of the participating banks were not even aware of the interlocks which necessitated the participation arrangement. None of the interlock banks participated in any way in the negotiation of the terms of the credit agreement.

  Having thus summarized the contentions of the parties with respect to liability issues, I now summarize briefly the range of possible litigation results. Assuming that the debt obligations issued by the Debtor pursuant to the revolving credit arrangement were "securities" within the meaning of § 10 (an easy assumption), and that the magnitude of the transaction and arguable ineffectiveness of competitive bidding do not exempt this transaction from application of the statute, it might nevertheless be concluded that the role of the participating banks does not amount to a violation of the statute, and that the technical violation should be simply ignored. Or, it might be held that the criminal penalties provided by § 10 of the Clayton Act and § 20a of the Interstate Commerce Act are exclusive, and that there is no civil liability apart from that specified in § 20a. Section 20a(11) provides that securities issued without ICC approval are void, but that securities issued in accordance with the terms and conditions of an authorization shall not be rendered void because of the failure to comply with any provision of this section. The ICC did authorize the transaction. Its decision has not been challenged (and, arguably, could not be challenged in this Court); hence the securities are valid and enforceable. Acceptance of any of these arguments would fully vindicate the pledge.

  If it were concluded that the Clayton Act was violated, and that a civil remedy should be fashioned, the remedy might include cancellation of the obligation; cancellation of the obligation, leaving the banks to an unsecured pre-bankruptcy claim for unjust enrichment; depriving the banks of the fruits of the transaction which occurred in technical violation of the Act, I. e., either voiding their secured position in its entirety, or voiding their secured position to the extent of $ 100 million (the amount by which previously unsecured obligations were satisfied from the initial proceeds and thus converted into secured obligations): invalidating only the notes held by the conflicted lender; invalidating only the notes held by conflicted participants; invalidating the notes held by the conflicted banks and Citibank; treating the claims of the conflicted lender bank, and/or the conflicted participating banks, and/or Citibank, as unsecured, but treating the remaining claim as secured; reducing the aggregate amount of the claim by offsetting provable damages; or a combination of the foregoing.

  If offsetting damages were held to be the appropriate remedy, the burden of proof would be of particular importance. It might be held that, in the absence of evidence that more favorable loan terms could have been obtained elsewhere, and in the absence of evidence that the railroad suffered any loss by reason of the "compensating balances," no damages are recoverable. Or it might be permissible to presume damages in these circumstances. A middle ground might be to conclude that, since the purpose of the competitive bidding requirement is to prevent harm to the railroad from unduly generous terms, and since the entire transaction was intentionally structured so as to avoid the competitive bidding requirements of which all concerned were well aware, the proper remedy would be to preclude recovery for any interest in excess of the prime rate at that time.

  A further issue, not involved in the earlier litigation, is the extent to which the bank's claim is secured. That is, assuming the pledge is fully valid, does the amount of the claim now exceed the value of the Pennco stock? If it does, then part of the claim should be treated as unsecured; but by the same token, this would strengthen the banks' argument that they should be permitted to foreclose on the pledge, and that the administration claims, including the Government's priority claims, may not invade their interest in Pennco.

  The proposed Plan embodies a compromise resolution of all of these issues. The banks' total claim is fixed at $ 440 million. The banks further give up any rights they may have to assert a secured position by reason of the cash held on deposit when the bankruptcy petition was filed, or any priority arising from this Court's injunction against setoffs. With respect to the $ 440 million claim, the banks would receive the same treatment as other secured creditors. That is, the claim would be recognized as fully secured, but allocated as between retained and conveyed assets (61% Retained, 39% Conveyed).

   I have no difficulty in concluding that the proposed compromise is fair. It is noteworthy that the compromise is accepted by the Special Representatives, as well as by the Robinson petitioners. The latter, of course, would have standing only if the $ 300 million obligation were to be voided in its entirety; that is, equity interests are affected by the totality of the debt recognized, and not by distinctions between secured and unsecured.

  Because the pledge issues were fully litigated, and indeed were the subject of a lengthy adjudication prepared (but not filed) by this Court, the task of evaluating the compromise in light of the probable litigation results, at least at the district court level, is uniquely straightforward. Because the parties have resolved their differences, I do not propose to set forth in this Opinion the conclusions previously reached. It is sufficient to state that I regard it as extremely unlikely that the final outcome of the litigation would be total cancellation of the indebtedness, or total disregard of the pledge; that it would be improper simply to ignore the statutory requirements; and that the most likely outcome of litigation would have been some form of modified treatment in the Plan of Reorganization. In short, I am satisfied that the Plan provisions represent an entirely acceptable compromise of the various disputes.

  3. New Haven Trustee Claims

  The New Haven Trustee asserted a secured claim in the total amount of $ 208.5 million (Library Doc. J-20.1) stemming from the inclusion of the New Haven in the Penn Central merger on December 31, 1968. The price to be paid by Penn Central for the New Haven properties was finally adjudicated by the Supreme Court shortly after Penn Central filed its reorganization petition. New Haven Inclusion Cases, 399 U.S. 392, 90 S. Ct. 2054, 26 L. Ed. 2d 691 (1970). The consideration was to have been principally composed of Penn Central common stock, but the New Haven reorganization court had included an underwriting provision embodying a guarantee by Penn Central that the stock would be worth $ 87.50 per share. No express lien was created to support that guarantee, but in view of Penn Central's bankruptcy, the Supreme Court remanded the case for reconsideration of "the form that Penn Central's consideration to New Haven should properly take and the status of the New Haven estate as a shareholder or creditor of Penn Central." 399 U.S. at 489, 90 S. Ct. at 2108.

  The New Haven reorganization Court imposed an "equitable lien" upon all of the former New Haven assets in the hands of Penn Central, because of what it regarded as the compelling equities of the situation. This decision was later vacated on appeal for lack of jurisdiction. In light of that litigation, and for the purpose of clarifying the status of the New Haven as a participant in the Penn Central reorganization proceedings, I concluded that the New Haven estate should be treated tentatively as holding "a lien, indeterminate in amount, and indeterminate as to priority, upon all of the real property and readily identifiable tangible personal property (exclusive of rolling stock) . . . conveyed to Penn Central" by the New Haven Trustee. In re Penn Central Transp. Co., 337 F. Supp. 779, 791 (E.D.Pa.1971). The New Haven Trustee also holds $ 34,025,800 of Penn Central Divisional First Mortgage Bonds secured by the properties previously owned by the New Haven, and the New Haven Trustee has also asserted various claims based upon alleged misrepresentation or fraud on the part of Penn Central's pre-bankruptcy management (Library Docs. J-20.28-29).

  The extent to which any or all of these claims, even if secured claims, are secured by retained assets, is a further subject of controversy. They are at least secured by retained assets to the extent of slightly more than $ 48 million and, depending upon how certain disputes concerning the New Haven's relationship to the Park Avenue properties might be resolved, may be secured by retained assets to the extent of an additional $ 86 million.

   Under the settlement agreement, all of these disputes are resolved by according to the New Haven Trustee a secured claim in the sum of $ 121 million and an unsecured claim in the sum of $ 53 million. The settlement is well within the range of reasonably likely litigation possibilities, and the litigation would obviously be lengthy and expensive. It is significant that no one has expressed any objection to the settlement arrangement. I conclude it is fair and reasonable, and should be incorporated in the Plan.


  1. Status of the Valuation Case

  Pursuant to the RRRA, the Final System Plan prepared by USRA designated the properties to be conveyed to ConRail and set forth USRA's findings concerning the value of the conveyed properties and the consideration to be given in exchange. The Valuation Case is simply a De novo adversary proceeding *fn35" in which the Special Court will decide whether the terms of the exchange proposed by USRA meet the constitutional minimum standards of fairness and equity and, if not, what the terms should be to comply with that standard.

  For purposes of this Opinion, it suffices to review briefly what some of the major issues are, and what decisions have thus far been expressed by the Special Court. This limited review is essential to a clear understanding of the securities distributions proposed on the Plan, and is included only for that reason. Nothing in this Opinion should be interpreted as expressing or suggesting the views of this Court as to the merits of the Valuation Case litigation.

  USRA based its initial findings in the Final System Plan upon the premise that the net liquidation value of the conveyed properties was the appropriate standard for compensation. Its definition of net liquidation value was rather complex, *fn36" but in essence was based on two assumptions (1) that in the absence of the RRRA most of the Debtor's rail properties would have been sold to other carriers, and (2) the prices paid would have been established by the ICC at the levels which would have prevailed if there were no rail service in the Northeast at the time of the sale. On that premise, USRA assumed that the estate would be required to dismantle all rail-related physical structures and return the property to the condition it was in before dedication to rail service. For example, it assumed that all bridges and roadway electrification facilities would be removed, and all tunnels plugged. Thus, with the exception of rolling stock and salvageable rail and ties, all of the conveyed assets, in USRA's view, were to be valued at their prices for non-rail use.

  USRA then constructed a Master Liquidation Plan hypothesizing that liquidation would have proceeded at the following pace: Year 1 18%; year 2 21%; year 3 18%; year 4 13%; year 5 10%; year 6 6%; year 7 2%; and subsequent years 10%. This projected rate of liquidation conformed to USRA's estimates of the time necessary to dismantle structures and otherwise prepare the properties for sale, and incorporated the prediction that the estate would wish to avoid saturating the market. By deducting the estimated expenses which would be incurred in the dismantling and liquidation process, USRA arrived at a net amount of proceeds to be received. The next step was to establish the date upon which such liquidation would have begun. USRA concluded that liquidation could not have commenced until after federal and state regulatory approvals were received, and fixed that date as January 1, 1979. On the assumption that the proceeds would be received over a period of more than seven years, commencing January 1, 1979, USRA then applied discount rates in order to reduce the future liquidation proceeds to their 1976 values. Applying these discounts (16% For land and 13% For other property) reduced the net proceeds by 57%. The end result of USRA's net liquidation analysis was that the appropriate value of Penn Central's conveyed assets was $ 485 million.

  Section 303(b)(4) of the RRRA requires that "other benefits" to the estate from the exchange are to be considered in fixing the constitutional minimum standard. The statute does not define the term "other benefits." USRA set the value of "other benefits" to the Penn Central estate at $ 527 million. *fn37" Thus, when the Valuation Case litigation began, USRA's findings in the Final System Plan, if accepted by the Special Court, would have meant that the Penn Central estate should receive no recovery in that litigation.

  After the Final System Plan was published, but before the conveyance, Congress enacted the Railroad Revitalization and Regulatory Reform Act of 1976, amending the RRRA. The statute now provides for Certificates of Value, which are new securities issued by USRA and backed by the full faith and credit of the United States, as a partial guarantee of the value of the ConRail securities the estates are to receive in exchange for their properties. Moreover, the amended statute requires the Special Court to make findings as to the amount, if any, of compensable unconstitutional erosion incurred by the estates and as to the net liquidation value of the conveyed properties. Compensable unconstitutional erosion is relevant in two contexts. The Special Court must take the amount of compensable unconstitutional erosion into account in determining whether the exchange meets the constitutional minimum standard of fairness and equity, and must include that amount, if any, in computing the redemption value of the Certificates of Value. The Certificates of Value represent an obligation on the part of the United States Government to pay in cash, not later than 1987, an amount equal to the net liquidation value of the assets, less "other benefits," plus compensable unconstitutional erosion, plus interest on the sum thus calculated, at the rate of 8% Compounded annually, less the aggregate of the actual value of the ConRail securities on the date of redemption and any dividends which may have been paid thereon.

  The Special Court has rendered two decisions addressing the major legal issues upon which the eventual outcome of the litigation will probably depend. The first of these concerns the meaning of "compensable unconstitutional erosion" In re Valuation Proceedings under §§ 303(c) and 306 of the Regional Rail Reorganization Act of 1973, 439 F. Supp. 1351 (Special Ct.1977) (Erosion Opinion) ; and the second concerns the definition of "net liquidation value" and "constitutional minimum value." In re Valuation Proceedings Under §§ 303(c) and 306 of the Regional Rail Reorganization Act of 1973, 445 F. Supp. 994 (Special Court, 1977) (Valuation Opinion). The purpose of both opinions is to establish a framework of ground rules to guide the parties in their trial preparations, and to guide the masters who are to conduct the evidentiary hearings. For that reason, neither opinion purports to represent the final and unalterable views of the Special Court on these issues, but it would be reasonable to assume that any party seeking reconsideration would bear a significant burden of persuasion. Both decisions are, of course, subject to eventual review by the Supreme Court.

  Judge Friendly's opinion for the Special Court in the Erosion Opinion expresses the view that "unconstitutional erosion arises only when a losing business has been required to continue to operate against its will for more than a reasonable period," and that the term "against its will" means "that some identifiable agency of government having power to do so should have thwarted its desires (to cease operations)." 439 F. Supp. 1351 at 1356.

   There are two kinds of erosion to be considered. Financial erosion refers to the creation of claims against the Debtor's estate which prime the claims of pre-bankruptcy creditors, both secured and unsecured; and physical erosion refers to the reduction in value of the physical assets, depletion of cash, etc. As the Special Court noted, the transferors' erosion claims are of great magnitude. For example, the Penn Central asserts that its claim for compensable unconstitutional erosion is approximately $ 900 million.

  The Special Court fixed the date for the commencement of potential unconstitutional erosion at February 9, 1973, the date on which the President signed the Senate Joint Resolution which revoked the Trustees' work rule changes and mandated continued operation of the railroad. That was also the date on which Congress directed the Secretary of Transportation to devise a plan for the preservation of rail service in the Northeast; the Special Court regarded this direction to the Secretary of Transportation as an event which rendered futile any later applications for abandonment authority.

  Establishing the February 9, 1973 date would have validated most of Penn Central's $ 900 million claim for unconstitutional erosion, except for the fact that the Special Court further concluded that, because of regulatory delays, Penn Central would not actually have been able to terminate rail operations until April 1, 1976. However, the Special Court added a caveat to this latter conclusion, namely, that the Trustees were free to try to prove that they could actually have terminated rail operations over some or all of the Penn Central system earlier than April 1, 1976.

  The net effect of the Erosion Opinion, therefore, would seem to be that, unless the Trustees can persuade the Special Court that the ICC would have approved abandonment of portions of the system earlier than April 1, 1976, or that the federal courts would not have permitted abandonment proceedings to drag on for 38 months in the circumstances then prevailing, *fn38" there will be no award for pre-conveyance erosion.

  Be that as it may, the Erosion Opinion does make clear the Special Court's view that that 38-month period "cannot be taken into account a second time in determining when the proceeds of sales would come into hand." 439 F. Supp. at 1366 n.28. Thus, it would seem that, apart from any other flaws in the Master Liquidation Plan embodied in USRA's Final System Plan, a major portion of its projected "other benefits" would be eliminated, and its projected 57% Net discount of the liquidation proceeds would be substantially reduced.

  It now appears, however, that USRA is completely revising its Master Liquidation Plan (now designated a "retrieval model"), and is also reassessing all aspects of its real estate valuation effort and re-calculating all of its estimates of sales of scrap. *fn39" In short, it appears that USRA will attempt to substitute its new theory of valuation the retrieval model and apply to that model data other than that used in the Final System Plan. At the present time, the results of these revisions are not available, and whether they will survive the adversary proceedings before the Special Court is a matter of conjecture.

  In its October 12, 1977 Valuation Opinion, the Special Court did not reveal its views on the "other benefits" issue. It should also be noted that USRA has apparently revised its approach to the "other benefits" issues by eliminating the 1976-1978 administration claims component but adding many other items. As noted by the Special Court, "all these claims are hotly disputed by the transferors." 445 F. Supp. at 1043.

  The Valuation Opinion did provide some guidance to the parties on the valuation issues. The Court rejected USRA's contention that net liquidation value may be determined only on the assumption that all sales would be for non-rail use, and thus enabled the transferors to show what the properties would have sold for to other railroads. On the other hand, the Court excluded from consideration hypothetical sales to, or condemnations by, the United States Government, and also ruled out several of the more generous valuation theories espoused by the transferors (reproduction cost less depreciation, social value, etc.), and essentially concluded that fair market value and net liquidation value were synonymous.

  While permitting the governmental parties to continue to assert that scrap value (the so-called "trash can" theory) is equivalent to net liquidation value, the Court also had this to say:


While the cases previously reviewed (which used valuation approaches other than market value) do not carry the weight the transferors would give them, we cannot be wholly insensitive to the views that seem to underlie them. The courts rejected market value as the measure of just compensation in circumstances which made that measure suspect.


Circumstances peculiar to this case make market value particularly hard to prove. The transferors face serious difficulties in proving alternative scenario sales (sales to profitable railroads or public entities other than the United States), and the amounts that would have been obtained from those sales. These difficulties are increased by the chilling effect, not disputed by the Government, that serious discussion of the Rail Act had on the prospect of such sales. The discussion and enactment of the Act eliminated any incentive other parties might have had to negotiate purchases.


This does not mean that we should reject the role of market value in determining just compensation. Nor, however, should we bind a notion as fundamental as just compensation by the sterile logic of provable market value if a manifestly unfair result is produced. We may have such a situation here. It seems incredible that these 19,000 miles of railway and freight and passenger terminals, together with the equity in rolling stock, were worth only $ 685 million, the sum arrived at in the revised (Master Liquidation Plan) of March 1, 1976. It is nearly as unbelievable as the zero award in PATH. Of course, the revision of (Master Liquidation Plan) now in progress or attacks on it by the transferors may considerably augment this figure. It may also be that the transferors will succeed in showing a higher value by proving the potential salability of some of the property for rail use. The Government parties might be well advised not to be overly finical in their attitude toward such proof.


It suffices now to note that if the transferors should not be able to establish a figure for (net liquidation value), which would square with our notions of what constitutes "just compensation,' we may be obliged to consider some other method to arrive at (constitutional minimum value). This would not be to deny the thesis of the Government that value to the taker should not be considered. However, if the unique circumstances of this case make it impossible to establish a market value which constitutes just compensation, it may be necessary to resort to some other rule.


If it should prove impossible to establish a market value which constitutes just compensation, the basis that now seems to us most deserving of serious consideration whether as the sole basis or as one to be considered along with (net liquidation value) we need not now determine is a basis related to original cost. In contrast to most condemnations, the property is not being converted to new uses; ConRail is being substituted for the transferors. In other words, ConRail has been put in roughly the same position it would have occupied had it made the transferors' original investment when they did and depreciated it at the proper rate. Thus, a figure related to original cost may have some relevance to the value of what is being transferred. We use the phrase "related to' since not only must allowance be made for depreciation, but a further deduction might be justified to reflect physical deterioration beyond the point provided by the normal depreciation allowances but not constituting (compensable unconstitutional erosion). ConRail is being substituted as the operator of a deteriorated railroad. Since ConRail must pay for the deterioration when it rehabilitates the property, the Government should benefit through a deduction in its purchase price (except insofar as the deterioration constitutes (compensable unconstitutional erosion)).

  At 1029.

  To summarize, then, the governmental parties can take heart from the scrap value possibility and the exclusion of reproduction cost and social values, as well as from the exclusion of hypothetical sales to the Government as influencing fair market value; and the transferors can derive encouragement from the Court's apparent skepticism toward USRA's valuation figures, and from the references to depreciated original cost as a measure of value.

  2. Relationship of the Valuation Case to the Plan Distributions

  The ultimate outcome of the Valuation Case litigation will be based upon an objective application of legal and constitutional principles, without regard to the question of how various classes of creditors of Penn Central would be affected by a greater or lesser recovery. *fn40" Any discussion of the potential impact of various possible levels of recovery in the Valuation Case upon the likelihood of redemption of the various securities to be issued under the Plan involves a risk that it will be misunderstood as indicating what a satisfactory conclusion of the Valuation Case litigation would be. That is not my function, and it certainly is not my intention. But I believe that at least a general understanding of the relationship between the Valuation Case litigation and the Plan distributions is necessary to an evaluation of the fairness and equity of the proposed distributions in order to ascertain whether the Plan does or does not fairly allocate the risks and potential benefits that the Valuation Case entails.

  The Plan contemplates that a substantial portion of the securities to be issued will be redeemed between consummation date and 1987, primarily from the proceeds of the Asset Disposition Program. The outcome of the Valuation Case will have no bearing upon those redemptions, and it is therefore appropriate for present purposes to consider only the securities which will remain outstanding in 1987. It is reasonable to suppose that by 1987, the principal amount of debt-type securities still outstanding will be approximately $ 1.487 billion, and that accrued but unpaid interest on those securities which are interest-bearing will aggregate approximately $ 481.3 million, for a total of $ 1.969 billion. Unless the net recovery from the Valuation Case is sufficient to pay off those securities, the Valuation Case will contribute nothing to the value of the common stock of the reorganized company. This does not mean that the common stock would have no value, but merely that its value would be dependent primarily upon the fortunes of Pennco.

  At the risk of belaboring the obvious, it should also be pointed out that 90% Of the common stock of the reorganized company is used to pay the claims of Penn Central's creditors; that is, a Valuation Case recovery sufficient to redeem the $ 1.969 billion in debt-type securities of the reorganized company would not translate into payment in full of Penn Central's creditors.

  What level of Valuation Case recovery would be sufficient to provide for the redemption of that amount of debt-type securities by 1987? In attempting to answer that question, several factors must be kept in mind. The Certificates of Value, which will be the primary source of the cash to redeem these securities, bear interest at the rate of 8% Compounded annually, from and after April 1, 1976. The base amount of the CVs (I. e., the 1976 amount upon which interest is to be calculated) is geared to the outcome of the Valuation Case. While the base amount of the Certificates of Value therefore cannot be determined until the Valuation Case litigation is concluded, if that litigation terminates before 1987, USRA would have the right to pay off on the Certificates of Value before 1987. *fn41"

  The Series B notes and Series C notes accrue interest, the Series D term notes and A and B bonds will not accrue interest if paid currently, preference stock and CBIs are non-interest-bearing. The rates of interest on some securities which accrue interest differ from the interest rate specified for the Certificates of Value. For that reason, payment of the Certificates of Value before 1987 would not have precisely the same consequences as would payment in 1987. By the same token, 1976 base values of the Certificates of Value would not translate into as large an amount of cash if the CVs are paid off earlier.

  Subject to the foregoing variables, and assuming the cash forecast is accurate, it can be stated that a net recovery from the Valuation Case (I. e., 1976 base value of the Certificates of Value) in the amount of approximately $ 797 million, with interest thereon compounded annually at the rate of 8%, should produce enough money to redeem the remaining Series B notes, Series C notes, Series D notes, B bonds, preference stock and Certificates of Beneficial Interest (CBI), if the Certificates of Value are paid in 1987.

  In view of the nature of some of the objections originally pressed, for example, by state and local tax claimants, it may be helpful to illustrate how Valuation Case recoveries at lower levels would affect redemption of the various classes of securities:


   It is difficult to quantify the impact of recoveries above the $ 797.1 million (1976 base value) level upon the value of the common stock of the reorganized company. The excess over what would be required to redeem the debt securities listed above would belong to the reorganized company and should have the effect of improving the quality of its securities, including common stock; but it would be somewhat misleading to suggest that any such recovery would increase the market value of the common stock dollar-for-dollar, or that it would necessarily be paid to the shareholders in dividends. About all that can be said on the subject at this juncture is that modest amounts recovered in excess of the amount needed to redeem the debt securities would presumably have little effect upon the value of the common stock; that recoveries at substantially higher levels would significantly enhance the value of the common stock; *fn42" and that the "reasonable range of litigation possibilities" in the Valuation Case is broad enough to encompass either eventuality.


  1. Description of Claims

  Claims for unpaid taxes, asserted by various state and local taxing entities, total approximately $ 523 million, including interest to December 31, 1977. Approximately $ 73.3 million of this amount represents taxes which accrued before the bankruptcy petition was filed; the balance of $ 449.7 million represents unpaid taxes which accrued during reorganization, June 21, 1970 through December 31, 1976. All taxes accruing after January 1, 1977 are being paid on a current basis. Of the $ 523 million total, approximately $ 300 million is attributable to properties which were conveyed to ConRail free and clear of all liens and encumbrances; the balance of $ 223 million represents taxes assessed against retained assets. (In discussing the securities distributed to tax claimants, Section II-B, the total claim there referred to of $ 451.5 million was net of claims satisfied under the Alternative Settlement Program.)

  These taxes are imposed under the local laws of the 17 American jurisdictions in which the Debtor conducted rail operations. These laws vary greatly, and there are corresponding variations in the precise characteristics of various tax claims. The totals set forth above include general corporate taxes and similar levies, as well as real estate taxes. Real estate taxes may be levied on a parcel-by-parcel basis, countywide, or even statewide. In some jurisdictions, they represent a general In personam claim against the Debtor, as well as a charge against specific property, whereas in other jurisdictions they are solely In rem. Some jurisdictions exempt transportation property, others do not. There may also be procedural differences affecting such matters as whether or not a particular tax lien has been perfected.

  For purposes of discussion, all of these variations may be ignored. It will be assumed that all claims for taxes related to the pre-bankruptcy period constitute valid liens against all of the physical assets of the Debtor, and that this lien is superior to the claims of general creditors, and at least arguably superior to the claims of all other pre-bankruptcy lien-holders except the Federal Government.

  The post-bankruptcy taxes, on the other hand, are claims of administration. As such, they have priority over all pre-bankruptcy claims. The very existence of unpaid administrative claims of this magnitude ($ 449.7 million in unpaid taxes, plus about $ 350 million in unpaid operating expenses, represented by the Government's § 211(h) claims) is striking proof of the uniqueness of this reorganization, and of the corresponding novelty of the problems involved.

  In ordinary corporate reorganizations, the continued operation of the Debtor while reorganization planning is taking place is conducted primarily for the benefit of its creditors. Any debtor which cannot even meet its current operating expenses while being temporarily relieved of the burden of pre-bankruptcy debt is not likely to remain in reorganization very long; it will be liquidated. Hence, the possibility of any significant amount of post-petition taxes remaining unpaid does not ordinarily arise.

  Railroad reorganizations differ from ordinary corporate reorganizations because of the public interest in continued rail service. Bankruptcy liquidation is not available to railroads. A railroad debtor simply must continue to operate, without regard to the interests or desires of its creditors, at least until such time as the constitutional rights of secured creditors under the Brooks-Scanlon line of cases are clearly in jeopardy. Here again, however, inability to generate sufficient revenue to pay taxes accelerates the triggering of Brooks-Scanlon rights. *fn43"

  With the enactment of the RRRA and the decision of the Supreme Court in the Regional Rail Reorganization Act Cases, 419 U.S. 102, 95 S. Ct. 335, 42 L. Ed. 2d 320 (1974), it was made clear that, in the case of the Northeastern railroads, including Penn Central, Brooks-Scanlon rights could be violated in the short run, so long as ultimate vindication of constitutional rights was assured.

  The period of time covered by the post-bankruptcy taxes in this case extends from June 21, 1970 to December 31, 1976. During the first part of this period, from the filing of the bankruptcy petition until early 1973, the Trustees were attempting a private sector reorganization. This was based upon the assumption that substantial changes in the regulatory and labor relations climate, which the appropriate governmental authorities were being urged to effectuate, would take place within a reasonable time. During the second part of the period, from the Spring of 1973 until the end of that year, Congress was addressing itself to a possible legislative solution. The third phase covers the period required for implementation of the RRRA.

  There was never any cash available for the payment of taxes during any of these phases. Operations until 1973 were made possible only because the Government guaranteed the Trustees' borrowings under trustees certificates, in the sum of $ 100 million. During the third phase, there would not have been even enough cash to meet payroll, if the Federal Government had not provided cash grants and loans to keep the railroad going. Unfortunately for the tax claimants, however, Congress did not see fit to provide cash for the payment of taxes; moreover, Congress insisted that the funds advanced (the Government's § 211(h) claim) would have the highest possible priority, both in lien and in payment, and would thus have priority over claims for post-petition taxes.

  The impact of these developments upon the status of the claims for state and local taxes, and upon the relationship between those claims and the claims of other creditors, cannot be overemphasized. Because continuation of loss operations was mandated, the amount of unpaid tax claims and other unpaid administration claims was greatly increased, probably by more than half a billion dollars in the aggregate. At the same time, the rights which such claims would have on liquidation (which is the standard for assigning "value" to all claims in the present context) were significantly altered; moreover, the nature and extent of this alteration could well provide the grist for many years of litigation.

  While the hypothetical liquidation rights of tax claimants in the absence of the RRRA are of only academic interest, a brief review of that scenario provides a useful contrast. Presumably, any such wholesale liquidation of the Debtor's assets for the purpose of paying off its creditors would have been conducted on an orderly basis, under Court supervision, and thus would not have produced immediate cash payments for all. Nevertheless, it is reasonable to assume that, disregarding possible challenges to the amount and validity of particular tax claims, all tax claims would have been satisfied within a reasonable time, either by cash payments from sales of assets, or by acquisition of liened parcels through tax sale proceedings. The probability that in many instances mortgagees or other junior lienholders would pay or compromise tax claims to protect their own liquidation rights should not be overlooked.

  The liquidation rights of the tax claimants in the present circumstances are quite different. In the first place, the properties against which roughly three-fifths of the tax claims are assessed have been conveyed to ConRail free and clear of all liens, including tax claims. With respect to pre-petition taxes, this means that the liens are transferred to the proceeds to be derived from the Valuation Case; but realization from that source is deferred and uncertain. With respect to post-petition taxes, the problem is one of the proper allocation of administration expenses. That is, it cannot be assumed that post-petition taxes, even though they are administration claims, would be satisfied promptly by retained assets, in the event of liquidation. Assuming the validity of the Government's super-priority, the tax claims would not have access to cash or other liquid assets, and could not be satisfied from sales of retained assets without doing violence to mortgage liens upon retained assets. The notion that tax claims generated by conveyed assets would automatically be transferred to, and prime existing mortgages on, retained assets is one which would not likely be accepted by mortgagees without a struggle.

  The mortgagees would have substantial arguments to present. Implementation of the Rail Act has made this proceeding more nearly like a standard Chapter X proceeding than it was before; and under Chapter X, the rights of secured creditors cannot be altered without their consent. Moreover, equitable principles would be applicable, even on liquidation; and pro rata allocation of administration expenses is equitable.

  A second set of problems stemming from implementation of the RRRA has to do with ascertaining the appropriate amounts of tax claims. The values assigned to the conveyed properties in the Final System Plan (FSP) are only about 50% Of the assessments upon which the tax claims are based. While no one takes these FSP valuations at face value, and indeed they have been referred to by the Special Court in its most recent Opinion as seemingly "incredible." See In re Valuation Proceedings under §§ 303(c) and 306 of the Regional Rail Reorganization Act of 1973, Misc. No. 76-1, 445 F. Supp. 994 at 1029 (Special Ct., Oct. 12, 1977), a persuasive argument can be made that, at the very least, final determination of the proper amounts of tax claims against conveyed property should await resolution of the valuation issues by the Special Court. Section 64(a)(4) of the Bankruptcy Act provides, in straight bankruptcy proceedings,


that no order shall be made for the payment of a tax assessed against any property of the bankrupt in excess of the value of the interest of the bankrupt estate therein as determined by the court.

  While not directly applicable in railroad reorganizations under § 77 or to ordinary reorganization under Chapter X, it does provide guidelines which the reorganization court may look to in exercising its equitable authority. Section 2(a)(2A) of the Bankruptcy Act gives the reorganization court jurisdiction to "hear and determine . . . any question arising as to the amount or legality of any unpaid tax . . . "; this statute has been interpreted as conveying broad authority over tax assessments. See Amarillo v. Eakens, 399 F.2d 541 (5th Cir. 1968), Cert. denied, 393 U.S. 1051, 89 S. Ct. 688, 21 L. Ed. 2d 692 (1969).

  A third problem area has to do with the direct impact of the RRRA implementation upon the nature of the administration claim represented by state and local taxes. It can be argued that, in prescribing the § 211(h) program, Congress effectively brought about a de facto classification of administration claims, by providing interim financing for claims which were required to be paid if rail operations were to continue, on the one hand, and failing to provide such financing for administration claims, such as taxes, non-payment of which would not result in cessation of rail service. *fn44"

  In short, by (a) mandating continuance of loss operations until April 1, 1976, (b) providing cash loans and grants in the amounts necessary to prevent shutdown, but not for the payment of taxes, and (c) providing super-priority for the claims of the Federal Government, Congress seems to have gone a long way toward neutralizing the administration claim status of the post-petition tax claims, rendering them, at least arguably, not very different from claims for pre-bankruptcy taxes.

  A final problem area attributable to implementation of the RRRA is less serious, but nevertheless significant enough to require brief mention. The arduous task of drafting the more than 2,000 conveyancing documents has not yet been completed; indeed, only a few of such documents have yet been recorded. The Court is advised that the entire process will not be completed for several months. Apparently, there will be a separate deed for each county, with separate attachments containing detailed descriptions of what is included in, and what is excepted from, the conveyance. The task of actually collecting tax claims through foreclosure proceedings, in the event of liquidation, would no doubt be rendered more difficult and complicated by virtue of the need to reconcile these conveyancing documents with tax parcel records in order to obtain accurate information about the property remaining available for tax sale.

  2. Treatment of State and Local Tax Claims Under the Plan

  The Plan treats all state and local tax claims alike, without distinction between pre- and post-bankruptcy status. The amount of each claim includes the principal claim plus interest to December 31, 1977, exclusive of penalties. Of this amount, 44% Would be paid in cash (26.4% On consummation date, 8.8% On December 31, 1978, and 8.8% On December 31, 1979). The deferred portion of these cash payments (I. e., 17.6%) would bear interest at the rate of 7% Per annum, from the consummation date, and would be evidenced by Series D serial notes bearing appropriate maturities.

  The remaining 56% Of each claim would be satisfied with Series C-1 notes or Series D term notes, depending upon whether the claim relates to conveyed or retained assets. For purposes of this allocation, all general corporate and similar tax claims would be treated as claims against retained assets; only real estate taxes would be assigned to the "conveyed asset" category.

  The Series D term notes are general obligations of the reorganized company, and bear interest at the rate of 7% Per annum payable semi-annually. They are secured obligations, having a lien on substantially all of the assets of the reorganized company. With respect to retained assets, their position is second only to the claims of the Federal Government; with respect to the Valuation Case proceeds, their position is junior only to the claims of the Federal Government, and the Series C notes. Like all of the other secured notes, the Series D notes may be redeemed at any time. If not sooner paid, the Series D term notes originally issued will mature not later than December 31, 1987, but that maturity date may be extended up to five years if the Valuation Case proceeds prove insufficient to pay them off in full. Under certain circumstances, Series C-1 notes may later be converted into Series D term notes; any Series D term notes later issued for that purpose will mature with the original D notes.

  The deferred portion (56%) of tax claims attributable to conveyed assets would be satisfied by the issuance of Series C-1 notes. These are not general obligations of the reorganized company, but have the first claim, after the Federal Government claim, to the proceeds of the Valuation Case. Series C notes bear interest at the rate of 8%, compounded annually. The proceeds of the Valuation Case would be credited first to interest, then to principal. At the conclusion of the Valuation Case, the principal amount (but not interest) of any unpaid Series C-1 notes would automatically be converted into Series D term notes, described above, unless some of the Series B notes (representing claims of the Federal Government) remained unpaid, in which case, that amount would be converted into Series E notes. Series E notes would be general obligations of the reorganized company, but would not bear interest. They would mature December 31, 1993, or six years after conclusion of the Valuation Case, whichever was later; and this maturity might be extended for an additional 10 years. In any year in which the consolidated net earnings of the reorganized company exceeded $ 50 million, the company would be required to redeem up to $ 30 million in Series E notes. On liquidation, Series E notes would be junior to all other debt obligations.

  These complex provisions are designed to ensure that the balance of all taxes attributable to retained assets will be paid fairly promptly from the Asset Disposition Program if possible, from the Valuation Case if necessary, and, as to both principal and interest, by the reorganized company in any event; and that the balance of taxes attributable to conveyed property will be paid from the Valuation Case, that interest to the end of the Valuation Case will be paid first, and that any remaining principal will be paid by the reorganized company, and that interest will be paid also, unless the outcome of the Valuation Case is disastrous.

  3. The Alternative Settlement Program

  Independently of the Plan of Reorganization, pursuant to arrangements between the Federal Government and the Trustees, which were approved by this Court in Orders Nos. 2922 and 2929, any taxing entity which wishes to do so is at liberty to accept, in full settlement of its tax claims, either 44% Of the principal amount of all taxes, or 50% Of post-bankruptcy taxes, whichever is greater. Moreover, under this program individual tax claims aggregating less than $ 10,000 (or which the claimant is willing to compromise for $ 10,000) would be paid in full. Claimants accepting the compromise would not, of course, share in the distributions under the Plan; but, on the other hand, they would be paid immediately, without regard to the final outcome of the Plan proceedings.

  4. Objections to the Plan by State and Local Tax Claimants

  As originally proposed, the Plan accorded less favorable treatment to tax claimants than does the Plan now before the Court. A great many objections were filed on behalf of taxing entities, and these objections were extensively briefed and argued. Thereafter, the Trustees modified the Plan, so that it now stands as outlined above. At the hearing on this modified Plan, most of the objecting tax claimants withdrew their objections, and now support the Plan. A few tax claimants, most notably the State of New York and the City of Jersey City, continue to press the objections initially asserted by themselves or others; and it is reasonable to suppose that other tax claimants, who did not participate in either hearing, may still be dissatisfied with the Plan. It is therefore necessary to deal with all of the objections which have been expressed, at least to the extent that they have not plainly been rendered moot by the changes in the Plan.

  a. Exclusion of Penalties

  A few of the taxing entities originally asserted that their claims should include not only principal and interest, but also statutory penalties. It is not clear that this objection is being pressed by any of the present objectors. In any event, it is without merit.

  The lack of merit in this contention is clearest with respect to pre-bankruptcy taxes. Section 57(j) of the Bankruptcy Act expressly provides


debts owing . . . to any state or any subdivision thereof as a penalty or forfeiture shall not be allowed.

  This section is applicable to reorganizations under § 77. In re Tennessee Central Ry., 316 F. Supp. 1103, 1116 (M.D.Tenn.1970), Vacated, 463 F.2d 73 (6th Cir.), Cert. denied, 409 U.S. 893, 93 S. Ct. 119, 34 L. Ed. 2d 150 (1972); and See In re N.Y., N.H. & H. R.R., 304 F. Supp. 1121, 1135 (D.Conn.1969).

  I am satisfied that the same result is applicable to post-reorganization taxes as well. The purpose of penalties is punitive. United States v. Childs, 266 U.S. 304, 307, 69 L. Ed. 299, 45 S. Ct. 110 (1924). In deferring the payment of state and local taxes during reorganization in the present case, the Trustees were acting pursuant to an express Order of this Court, duly affirmed on appeal. In re Penn Central Transp. Co., 325 F. Supp. 294 (E.D.Pa.1970), Aff'd, 452 F.2d 1107 (3d Cir. 1971), Cert. denied, 406 U.S. 944, 92 S. Ct. 2040, 32 L. Ed. 2d 331 (1972). To hold that the estate should be punished for continuing to provide rail service despite its lack of funds, and for complying with an Order of this Court, would be the height of injustice.

  Penalties may be imposed for blameworthy failures to comply with legal requirements which impose no insurmountable burden upon the estate. In the case of Boteler v. Ingels, 308 U.S. 57, 60 S. Ct. 29, 84 L. Ed. 78 (1939), a trustee who willfully failed to pay a motor vehicle license tax was held properly subject to a penalty. And in Nicholas v. United States, 384 U.S. 678, 86 S. Ct. 1674, 16 L. Ed. 2d 853 (1966), a penalty was upheld for a trustee's failure to file required federal tax returns. But I have not been made aware of any case in which the imposition of penalties was upheld in circumstances remotely resembling the present case.

  It is argued that the Act of June 18, 1934, 28 U.S.C. § 960, mandates a different conclusion. It provides:


Any officers and agents conducting any business under authority of a United States court shall be subject to all Federal, State and local taxes applicable to such business to the same extent as if it were conducted by an individual or corporation.

  This statute, which was intended to lay to rest the notion that court-appointed trustees and receivers were exempt from taxes, simply does not address the question of the collectability of post-bankruptcy penalties.

  In my view, recognition of the full amount of state and local tax claims, plus interest, but excluding penalties, reflects the balance between federal and state interests which Congress, in the exercise of its bankruptcy and commerce powers, intended to strike.

  b. Payment in Full in Cash

  Section 77(e) of the Bankruptcy Act, provides that a plan may be approved if, Inter alia,


(3) the plan provides for the payment of all costs of administration and all other allowances made or to be made by the judge, except that allowances provided for in section (c) paragraph (12) of this section may be paid in securities provided for in the plan if those entitled thereto will accept such payment, and the judge is hereby given power to approve the same.

  The objectors argue that post-bankruptcy taxes are "costs of administration," and that the Plan cannot be approved unless it provides for their payment in cash. In my view, however, the quoted language does not mean that every item of operating expenses incurred in conducting business operations during bankruptcy is a "cost of administration." That section deals with "costs of administration and All other allowances made or to be made by the judge." Applying the familiar Ejusdem generis maxim, I believe that the quoted language refers only to the costs incurred in the reorganization process itself, which must be allowed by the judge, and not with the ordinary business expenses of the Debtor.

  In equity receiverships, which preceded § 77, taxes were regarded as an expense of operation, to be paid with other expenses, Michigan v. Michigan Trust Co., 286 U.S. 334, 52 S. Ct. 512, 76 L. Ed. 1136 (1932); Southern Ry. v. United States, 306 F.2d 119, 127 (5th Cir. 1962), but after receivers' expenses, Id.; 2 Clark on Receivers § 627, at 1052-53 (3d ed. 1939).

  The Supreme Court has held that there must be flexibility in the manner in which tax claims are satisfied. See, e.g., Gardner v. New Jersey, 329 U.S. 565, 574, 67 S. Ct. 467, 91 L. Ed. 504 (1947). In the New Haven reorganization, a plan was approved which did not provide for the payment of post-petition taxes in cash. In re N.Y., N.H. & H. R.R., 304 F. Supp. 1121, 1134 (D.Conn.1969).

  I recognize that my colleague, Chief Judge Whipple in In re Central R.R. of N.J., 425 F. Supp. 1055 (D.N.J.1977), Appeal docketed, No. 77-1960 (3d Cir., July 25, 1977) (CNJ case) has expressed the view that post-petition taxes must be paid in cash in full. Because of the peculiar features of the "plan" under consideration in that case (administration claims were to be paid in ConRail stock, while the accompanying Certificates of Value and all other assets of the estate would have gone to junior creditors), it is doubtful that the New Jersey court intended its "cash only" holding to be absolute and universal, or that it fully considered all of the possible ramifications of such a sweeping declaration.

  Section 77B(b)(3), the predecessor of Chapter X, formerly required that costs of administration be paid "in cash." Chapter X requires merely that "costs and expenses of administration" be paid. Even under § 77B(b)(3), however, the cash requirement was not regarded as an absolute. Thus, in In re Parker-Young Co., 15 F. Supp. 965 (D.N.H.1936), it was held that, so long as there was assurance of eventual payment, securities could be used. In In re Janson Steel & Iron Co., 47 F. Supp. 652 (E.D.Pa.1942), a plan was approved which contemplated payment of administration expenses, including taxes, 10% In cash, and 60% Within five years. The case of In re New Era Housing Corp., 117 F.2d 569 (3d Cir. 1941), relied upon in the CNJ case, did not require that administration claims be paid in cash. The court merely held


that such allowances as are made in a 77B proceeding must be paid at the time of reorganization either in cash or by the delivery of securities which themselves evidence an indebtedness or obligation of or interest in the reorganized company.

  117 F.2d at 572. Under present Chapter X, of course, the "in cash" requirement has been eliminated.

  I am satisfied that approval of this Plan need not be withheld merely because it does not provide for payment of state and local tax claims in cash, or provide for full payment immediately. I therefore proceed to consider whether the Plan should be approved as fair and equitable in its treatment of these tax claims.

  5. Fairness to Tax Claimants

  As noted earlier in this Opinion (II-B-1 Supra ), reorganization of the Debtor has obvious advantages over liquidation in that, by reason of the growth potential of Pennco and other circumstances, reorganization will undoubtedly produce a greater total of values for distribution than would liquidation. That conclusion is of less importance to senior creditors (such as the tax claimants) who are to receive debt securities, than it is to creditors scheduled to receive some equity participation, or to junior creditors whose claims might be lost altogether in a liquidation proceeding. But the tax claimants, too, have an interest in the continuation of the business enterprises constituting the Debtor's estate.

  To the extent that tax claims can properly be relegated to the proceeds of the Valuation Case (and this is clearly true with respect to taxes in jurisdictions where only an In rem remedy is available, with respect to about $ 42 million of pre-reorganization taxes, and, as discussed above, quite possibly true with respect to three-fifths of the post-petition taxes) tax claimants have a vital stake in the continuation of the business enterprise consisting of the conduct of the Valuation Case litigation. This is not just the low-threshold interest in seeing to it that the recovery is adequate to pay off tax claims, but also to make sure that the results of the valuation process do not provide reasons for challenge to the underlying tax assessments. In a more general sense, the taxing entities have an interest in avoiding the economic upheavals which would accompany liquidation of so vast an enterprise, and in the preservation of rateables. While these factors are not susceptible to precise measurement, and are much less pronounced now that possible cessation of rail services has been removed from the equation, these intangible benefits of reorganization as opposed to liquidation are nevertheless real.

  In short, it would be inaccurate to characterize this as a situation in which tax claims are being deferred in order to produce a reorganization which will only benefit others.

  Nevertheless, this Plan cannot be approved by the Court if the proposed treatment of tax claims in relation to other claims does not accurately reflect their relative priority. This requires an analysis of how tax claims would fare on liquidation, compared to other claims. As discussed above in Subsection 1, Description of Tax Claims, this analysis is complicated perhaps obfuscated would be a better word by reason of the interposition of the RRRA.

  Unless the tax claimants could succeed in challenging the super-priority asserted by the Federal Government, they could not expect to have access to the cash or other liquid assets of the Debtor's estate. No basis for such a challenge has been suggested, except on constitutional grounds. Granted that such a constitutional attack might have merit (although other creditors would undoubtedly assert that they have stronger constitutional arguments than do the tax claimants), the tax claimants could hardly anticipate a prompt victory. It is apparent, therefore, that the tax claimants are primary beneficiaries of the Government compromise embodied in the Plan. In essence, 44% Of their total claims will be accorded better treatment than the higher-ranking claims of the Federal Government.

  I am also satisfied that the Plan treats tax claims fairly in comparison to the treatment of the claims of pre-bankruptcy secured creditors. It must be remembered that the absolute priority rule does not require sequential distributions (I. e., cash payment in full to senior creditors before any distribution is made to junior creditors), but merely that the values represented by the higher-ranking claims are fully satisfied by the values distributed under the Plan. Those related sets of values are properly reflected in this Plan. The tax claimants receive a much greater percentage in cash and receive all debt securities, with no equity participation. Unlike the secured creditors (Class J), the tax claimants are virtually insulated from entrepreneurial risks.

  Because of the undesirability of now predicting what the Valuation Case will produce, the Trustees have presented a Plan which would "fly" even if there should be no recovery at all in the Valuation Case. By virtue of the recent modifications to the Plan, tax claims are, for the most part, protected against even that dire eventuality. It is possible to conjure up a series of catastrophes which would jeopardize payment of a portion of the principal of the tax claims against conveyed assets (disregard of constitutional limitations by the courts, resulting in a near-zero recovery in the Valuation Case, coupled with bankruptcy of the reorganized company after piling up huge amounts of new debt), but assessments of the fairness of reorganization plans must be based upon real-world assumptions. It is virtually certain that all tax claims will be paid in full by the end of the Valuation Case.

  In considering the relative treatment of tax claims and the claims of Class J creditors, it must be emphasized that the compromise with the Government, which makes possible the payment in cash of 44% Of all tax claims at or shortly after consummation, is itself dependent upon concessions made by Class J creditors with respect to the Pennco pledge and the uses of Pennco income. It must also be remembered that the Plan removes all questions concerning the amount, validity, and collectability of all tax claims, a not insignificant concession. And the tax claimants, like other parties to the reorganization proceeding, would be relieved of the burdens of protracted litigation of a multiplicity of issues.

  To summarize, I have concluded that the proposed treatment of tax claims is fair and equitable.

  6. Objections of Taxing Entities in the State of Ohio

  Representatives of taxing entities in the State of Ohio, while they now strongly support the Plan, have again raised the contention that Order No. 3012, which requires current payment of all taxes accruing after January 1, 1977, should be broadened to require the Trustees to pay Ohio taxes for the year 1976. This contention is relevant to the Plan proceedings only insofar as granting the request would remove 1976 taxes from Plan treatment, and have them paid on a current basis in cash. These contentions were previously rejected. Order No. 3012 was affirmed on appeal, In re Penn Central Transp. Co., No. 77-2063, 573 F.2d 1302 (3d Cir., filed Mar. 1, 1978). Moreover, it is appropriate to point out that the problem arises because of the manner in which Ohio taxes are levied and billed. Although this peculiarity somewhat defers, for Ohio taxing entities, the benefits of the Order No. 3012 payment program, the Plan's treatment of pre-bankruptcy taxes in precisely the same fashion as post-bankruptcy taxes confers a somewhat greater benefit upon Ohio taxing entities than those in other states. On balance, I believe the Ohio districts are being fairly treated.


  1. The Distribution to Class J Creditors

  Pre-bankruptcy secured creditors are classified in Class J. Included within this class are the holders of bonds issued under the various mortgages of Penn Central and the Secondary Debtors, certain public shareholders of the Secondary Debtors, the New Haven Trustee, and the secured bank group (whose claims are secured by a pledge of the Pennco stock). *fn45" Excluding claims held by Penn Central and its subsidiaries, the claims of secured creditors of Class J aggregate $ 1,910,729,000. Of this amount, $ 1,418,733,000 is attributable to the Penn Central system, and $ 491,996,000 is attributable to the Secondary Debtors.

  In a conventional, going-concern, reorganization a first step is to determine the extent to which creditors claiming secured status are in fact secured. That portion of the claim which is in excess of the value of the assets securing the claim is then treated as unsecured for the purposes of the Plan. Because the Penn Central estate has been partitioned into "conveyed" and "retained" assets, and because the value of the conveyed assets (in the sense of the benefits they will provide to the reorganized company), cannot now be determined, the conventional analysis cannot be fully carried out in this case. *fn46" Instead, the Plan treats all secured creditors as fully secured, both as to principal and accrued interest. But because the value of the retained assets (I. e., what they can be expected to contribute to the reorganized company, and when this contribution will be realized) can now be determined, claims secured by retained assets receive somewhat different treatment in the Plan than do claims secured by conveyed assets. In short, all secured creditors are treated as fully secured, but the distributions under the Plan vary in ways intended to reflect the differences in the nature of the assets securing the claims.

  With few exceptions, Class J claimants receive what is referred to as a 10-triple-30 security package: 10% Of the total claim in cash; 30% In preference stock; 30% In common stock; and the remaining 30% In general mortgage bonds allocated between A and B bonds according to the proportion in which the claim is secured by retained assets. For example, if a mortgage is 60%-Secured by retained assets, the distribution per $ 1,000 of claim would be as follows: $ 100 in cash, $ 180 in A bonds, $ 120 in B bonds, 15 shares of preference stock, and 6.7 shares of common stock. *fn47"

  The allocations of A and B bonds proposed in the Plan are based upon the Trustees' determinations of asset values, and their analysis of the impact of a hypothetical application of marshalling principles. *fn48" In general, the Trustees identified the assets available, estimated the present and future marketability of the assets, and then appraised the value of the asset for sale within a particular time frame. The resulting values were then credited to the appropriate mortgages. Values in excess of the full amount of the senior claim were marshalled down to junior lienholders, if any, or treated as unencumbered. The net result of the process is a determination of the amount of retained assets available to each mortgage or other secured obligation. Table I-A below shows the distribution of securities to Class J creditors under the Plans of Penn Central and the Secondary Debtors. Distributions to equity interests of the Secondary Debtors are shown on Table I-B. Also included on both are the proposed distributions to holders of interests in certain non-bankrupt leased lines. (See Section II-B-3 Supra.) For convenience, the distributions shown are those which result from the adjustments in the retained asset analysis required by this Opinion. TABLE I-A DISTRIBUTION TO CLASS J CREDITORS UNDER APPROVED PLAN (Dollars in Thousands) Mort- Year Claim gage of # Issue Rate Maturity Principal Interest Total Penn Central Transp. Co. 027 Boston & Albany Imp. 4-1/4% 1978 $ 2,270 $ 1,232 $ 3,952 001 Carthage & Adirondack 1st 4% 1981 799 255 1,054 053 Kanawha & Michigan 1st 4% 1990 1,539 479 2,018 008 Lake Shore & Michigan So. Gold 3-1/2% 1997 43,357 11,536 54,893 011 Mohawk & Malone 1st 4% 1991 1,489 478 1,967 012 Mohawk & Malone Consolidated 3-1/2% 2002 2,794 777 3,571 065 New Jersey Junction 1st 4% 1986 1,178 373 1,551 017 New York & Putnam 1st 4% 1993 1,574 498 2,072 014 NYC & Hudson River Consolidation Series A 4% 1998 62,785 20,022 82,807 Lake Shore Collateral 3-1/2% 1998 15,505 4,310 19,815 Michigan Central Collateral 3-1/2% 1998 17,101 4,755 21,856 013 NYC & Hudson River --Gold 3-1/2% 1997 75,762 21,243 97,005 015 NYC & Hudson River R&I Series A 4-1/2% 2013 92,658 32,693 125,351 Series C 5% 2013 63,966 25,153 89,119 301 NY, NH, Hartford HR Div. 1st 4-1/4% 1973 8,014(1) 3,506 11,520 211 P.R.R. General Series D 4-1/4% 1981 43,641 14,451 58,092 Series E 4-1/4% 1984 36,143 12,317 48,460 Series F 3-1/8% 1985 43,029 10,764 53,793 Series G 3% 1985 42,002 9,660 51,661 019 Surgis, Goshen & St. Louis 3% 1989 4 1 5 078 West Shore 1st 4% 2361 33,017 10,627 43,644 Total Mortgage Bonds 589,077 185,130 774,207 Collateral Trust Bonds New York Central Bonds 5-1/4% 1980 173 75 248 New York Central Bonds 5-3/4% 1980 454 213 667 New York Central Bonds 6% 1980 18,298 8,669 26,967 New York Central Notes 5% 1974 16,900 7,352 24,252 New York Central Bonds 6% 1990 7,180 306 7,486 P.C. Bonds 6-1/2% 1993 7,642 353 7,995 Total Collateral Trust Bonds 50,647 16,968 67,615 109 Chicago River and Indiana (3) 12,056 2,287 14,343 Total Mortgage & Coll. Trust Bonds 651,780 204,385 856,165 New Haven Claim Not Applicable 121,000 Claims of Secured Bank Creditors 300,000 140,000 440,000 Total Penn Central Trans. Co. $951,780 $344,385 $1,417,165


© 1992-2004 VersusLaw Inc.

Buy This Entire Record For $7.95

Official citation and/or docket number and footnotes (if any) for this case available with purchase.

Learn more about what you receive with purchase of this case.