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August 17, 1978


The opinion of the court was delivered by: FULLAM


On March 17, 1978, this Court approved, subject to certain modifications, the Plan of Reorganization proposed by the Penn Central Trustees and separate Plans for each of the 15 Secondary Debtors *fn1" (the 16 Plans will be referred to as the Plan). Order No. 3279 directed that a ballot, and a copy of the Plan, this Court's Opinion, the SEC's Advisory Report and supplement thereto, and other pertinent information be distributed to the parties entitled to vote on the Plan. By overwhelming majorities, all classes of creditors, save three classes of stock of the Pittsburgh, Fort Wayne & Chicago Railroad, accepted the Plan. For example, claimants holding $ 1.003 billion in Class J secured claims (99.4%) voted for acceptance, while claimants holding $ 5.570 million (.6%) voted to reject the Plan.

 A number of appeals have been taken from this Court's Approval Order, *fn2" briefing has been completed, and the Court of Appeals will hear oral argument some time during the week of October 16, 1978.


 1. Objections

 Under § 77(e) of the Bankruptcy Act, a plan which has been approved by the reorganization court and has received the required favorable vote of those entitled to vote should be confirmed, unless it is established that, in the interim, circumstances have changed in such a way as to undermine the basis of the court's earlier approval of the plan. Insurance Group Committee v. Denver, Rio Grande & Western R.R. Co., 329 U.S. 607, 67 S. Ct. 583, 91 L. Ed. 547 (1947). For the most part, those now objecting to confirmation of the Plan have merely restated the legal arguments previously rejected by this Court in its Approval Opinion. The one exception is Bankers Trust Company, as Indenture Trustee of the Consolidation Mortgage, which has, at least in a sense, asserted that circumstances have in fact changed.

 Bankers Trust originally objected to the way in which the Trustees were allocating retained asset security to the various mortgages, claiming that, as a result of crediting all of the value of the Harlem properties to the reversion, rather than assigning an appropriate value to the leasehold interests of the Debtor, the Consolidation Mortgage it represented was being shortchanged. Upon further analysis, the Trustees agreed, and made adjustments which had the effect of attributing some $ 29 million more in retained assets to the Consolidation Mortgage. Bankers Trust thereupon withdrew its objections, and supported the Plan during the approval proceedings, but expressly reserved the right to withdraw its support, and to oppose the Plan, if the Plan as finally approved by the Court accorded to any other mortgagees better treatment than the basic 10-triple-30 treatment proposed by the Trustees for all mortgages.

 As originally proposed, the Plan provided for only one class of preference stock. However, in approving the Plan, this Court directed that there be two series of preference stock, Series A and Series B, and that four designated mortgages should receive Series A preference stock, whereas all other bondholders are to receive Series B. Series A preference stock is to be redeemed before the Series B preference stock. It is this modification of the Plan in the Approval Opinion which Bankers Trust apparently relies upon as a "changed circumstance," justifying denial of confirmation.

 Although the Approval Opinion does not specifically deal with the possibility that the Consolidation Mortgage should be included within the group to receive Series A preference stock, it does discuss, and reject, the argument that the Lake Shore and Michigan Central Collaterals should be included in that group; and their claims to inclusion Vis-a-vis the Consolidation Mortgage are stronger. In other words, non-inclusion of the Consolidation Mortgage follows A fortiori from denial of that status to the Lake Shore & Michigan Central Collateral Mortgages.

 Under the 10-triple-30 distribution scheme as originally proposed, mortgages with retained asset coverages of 100% Receive the same package of securities (30% A Bonds; 30% Preference stock; 30% Common stock) and 10% In cash as mortgages with retained asset coverages of more than 100%. This fact led a number of Indenture Trustees to use the term "super secured" to describe the fact that their mortgages had retained asset coverages exceeding 100%. Three lines of argument were pressed by the super secureds in support of their contention that their mortgages were entitled to some form of better treatment under the Plan. The Approval Opinion discussed each of these arguments and rejected them.

 A number of super secureds which made this argument had no first liens on any retained assets. Their super secured status came about only because of the marshalling of asset values down from higher liens. This is true in the case of the Consolidation Mortgage. It has the third lien in a four-step sequential mortgage chain: First, the 013 Gold Bond Mortgage; second, the 014 Lake Shore & Michigan Central Collaterals; third, the 014 Consolidation Mortgage; and, fourth, the 015 R & I Mortgage. Any increase over the $ 29 million allocated by the Trustees to their leasehold interest in the Harlem would in the first instance be credited to the 013 Gold Bond Mortgage. For the purposes of considering whether the 10-triple-30 distribution is defective because it ignores retained assets in excess of 100%, it is necessary to look to first lien assets only. This is so because any other procedure results in a double count of the same retained asset values. For example, assume that there are three sequential liens each securing a claim of 100 units, and that there are 243 units of security. Lien 1 is 243% Secured. If lien 2 is entitled to better treatment on the theory that it has 143 units of security then lien 1 would no longer be over-secured. If both liens got better treatment, each would be relying on the same asset values. In the context of an argument focused on the "disparities" of treatment, it is the first lien which would have the full benefit of the excess security. *fn4" We are dealing here in Comparisons. If we compare two disparate piles of sand, we do not shovel sand from one pile to the other in the midst of the process. Under this analysis, the Consolidation Mortgage is in the same position as the Lake Shore Mortgage both have zero first lien retained asset coverage. Of course, the Consolidation Mortgage is not entitled to better treatment if others with higher retained asset coverages are not.

 Next, some of the super secureds argued that in liquidation their mortgages would fare better than those with 100% Or less in retained asset coverage and therefore the Plan was not fair and equitable because the distribution scheme did not reflect the more favorable results on liquidation. In considering this argument, both first and second liens on retained assets were given weight and the full value of the Harlem lease was considered as at least potentially available to the Gold Bond, Lake Shore, Michigan Central, and Consolidation Mortgages. By and large, this argument was rejected because it was predicated on an over-simplified model based exclusively on "best case" assumptions. The principal liquidation scenario presented and rejected was that of the Lake Shore Collateral. It follows that the Consolidation Mortgage, which is subordinate to the Lake Shore Collateral, is in no better position.

 Finally, it was argued that the equitable equivalence doctrine was violated by the 10-triple-30 distribution. The main thrust of this argument was directed to the Trustees' assumption that the estate was solvent and that unsecured and equity interests may participate. The Plan also withstood this challenge. Obviously, the Consolidation Mortgage falls within that conclusion.

 It was only after consideration of these arguments that creation of two classes of preference stock was introduced. The detailed analysis of the super secureds' arguments led to the conclusion that within the class of those asserting super secured status there were such substantial differences in retained asset coverage that some form of better treatment of the most highly secureds might be appropriate. For example, the Mohawk & Malone and the Gold Bond Mortgages have first lien retained asset coverage of 275% And 243%, respectively. When this is compared with the retained asset coverage of other super secureds, for example, the Boston & Albany and the Michigan Central Collateral which have first lien retained asset coverages, respectively, of 115% And 116%, and with the retained asset coverages of the other mortgages, the magnitude of the difference is quite clear. That magnitude of the difference is relevant in and of itself, and also because the exceedingly high retained asset coverage makes it more likely there might be a sufficient cushion of retained assets to absorb administration claim assessments in liquidation. Because of the amount of the administration claims, no cushion would be provided by second lien asset values. Concededly, in drawing from the differences in retained asset coverages the conclusion that some better treatment was appropriate, the previously rejected arguments of the super secureds were in a sense partially adopted. The question posed, however, was significantly different: Did the substantial differences in the retained asset coverages of the various mortgages justify a modification of the Plan which did not do violence to the feasibility of the Plan but at the same time made the Plan more fair and equitable. The division of the preference stock into Series A and B is a modification which meets that specification, and the Plan, in my judgment, is made more fair and equitable by the recognition of the very high percentage of retained assets of the Mohawk & Malone and the Gold Bond Mortgages.

 Also included within the group of mortgages to receive Series A preference stock are two Collateral Trusts secured by the stock of the Pittsburgh & Lake Erie Railroad. The retained asset coverages of these Collateral Trusts are approximately 119% And 131%. Inclusion of these Collateral Trusts within the group to receive Series A preference stock was not based exclusively on the retained asset coverage. Rather, I also gave weight to the fact that these mortgages were secured by non-operating property. Irving Trust, the Indenture Trustee for the two Collateral Trusts, had argued that because the security was non-operating property these Collateral Trusts were entitled to treatment far superior to that accorded them by the 10-triple-30 distribution. I rejected that argument. On the other hand, in considering the secured bank settlement, weight was given to the nature of the security securing the secured bank's loan, the stock of Pennco. In the context of this Plan which incorporates a large number of compromises and seeks to avoid the ultimate litigation of a variety of complex and unanswered issues, it did not seem appropriate to recognize the potentially unique character of one creditor's security and not the others. Therefore, Irving Trust's Collateral Trusts were included within the group to receive Series A preference stock. Again, this modification for the benefit of the collateral trusts was possible without doing violence to the Plan.

 The Consolidation Mortgage's position is in no way similar to that of the Mohawk & Malone and Gold Bond Mortgages or the Collateral Trusts. Exclusion of the Consolidation Mortgage from the group of mortgages to receive Series A preference stock was Sub silentio previously determined in the Approval Opinion, and as the discussion makes clear, there is no merit in Bankers Trust's objection to confirmation.

 There is another objection which warrants mention. Penn Central Company, the owner of the Debtor's stock, supported the Plan during the approval hearings and voted in favor of the Plan. Under the Plan, Penn Central Company receives 10% Of the reorganized company's new common stock. In connection with the hearing on confirmation, Penn Central Company supported confirmation and advocated prompt consummation as in the best interests of the shareholders of Penn Central Company.

 Shaffer's strategy appears to be carefully conceived. Ordinarily, this Court would have no jurisdiction to collaterally review an order of the Chapter XI court. On the other hand, the Chapter XI court's Order was entered on April 21, 1978, and no appeal was taken. Now the argument appears to be that this case must come to a standstill until Shaffer's Chapter XI litigation is completed. The simple answer is, however, that Penn Central Company's vote was authorized by the Chapter XI court and this Court accepts that vote as valid.

 Apparently, Shaffer also objects to confirmation of the Plan on the ground that it is not fair and equitable to Penn Central Company. No attempt has been made to suggest that there are any changed circumstances supporting Shaffer's contention. Rather, the objection is simply that the distribution to Penn Central Company is inadequate. Shaffer's objection to confirmation must be denied for two reasons: (1) he is not a shareholder of the Debtor as required by § 77(c)(13); and (2) there are no changed circumstances warranting reconsideration of the treatment of the Debtor's stock under the Plan.

 In the interests of clarity, it should be noted that Shaffer's complaints are permeated by misconceptions of the role of this Court and the realities of these proceedings. The Penn Central Company's Chapter XI plan is not and never has been before this Court. Therefore, the amount of the reorganized company's stock which is to be distributed pursuant to the Chapter XI plan of Penn Central Company in exchange for Penn Central Company shares is not within this Court's purview. The evils allegedly committed by the United States Government are not curable in this Court or through the Plan of Reorganization. The RRRA is constitutional and implementation of that statute is a matter for the Special Court. When these two aspects of Shaffer's submission are excised, the only remaining point is that if the Trustees obtain a Valuation Case judgment of $ 11 billion, or some other amount of that magnitude, the creditors who are giving up debt claims in exchange for common stock will receive a windfall.

 The $ 11 billion figure is taken from a letter authored by an attorney on the SEC staff who stated that the range of Valuation Case recoveries is $ 500 million to $ 11 billion. The Special Court's Opinions to date were extensively described in the Approval Opinion because they constituted part of the relevant context in which the Plan must be considered. The valuation theories which would generate a Valuation Case award approaching $ 11 billion have been resoundingly rejected by the Special Court.

"We should also advise the parties, in interest of their avoiding the expense incident to complex engineering studies, that we do not intend to consider estimates of reproduction costs, variations on that theme such as "assemblage value,' value of materials "in place,' trended original costs, gross liquidation value or societal values." In re Valuation Proceedings under §§ 303(c) and 303 of the Regional Rail Reorganization Act of 1973 (445 F. Supp. 994, 1031 (Special Ct.1977).

 The valuation theories adopted by the Special Court would seem to rule out any prospect of a "windfall" recovery.

 I pointed out in the Approval Opinion that "the immediate issue is whether the risks, uncertainties and possible benefits of the Valuation Case litigation, and the consequences of the RRRA process, are being fairly apportioned in the distributions proposed in the Plan." *fn5" The answer I gave was that "the allocations are fair and equitable." The correctness of that answer is demonstrated by considering what Penn Central Company's position would be in the absence of the Plan. The debt claims against the estate far exceed the value of the retained assets. Therefore, the Debtor's stock interests could receive at most only some form of contingent claim against the Valuation Case recovery. But if Penn Central Company received only a contingent claim, its stock would be worth pennies for many years to come. When the results of the Valuation Case became known, there would be some value to Penn Central Company's stock if, but only if, the recovery was high enough to pay off all other claimants. In contrast, under the Plan, Penn Central Company receives 10% Of the common stock of the reorganized company and thereby receives 10% Of the value of the ongoing business operations of the reorganized company and the potential increments in that value. Thus, in lieu of waiting a decade in which the Penn Central Company's stock would be worth little or nothing, the stockholders of Penn Central Company will own stock which has value. If they wish, they may still await the outcome of the Valuation Case, but they now have other choices as well.

 The Plan and the compromises which support it also provide other benefits to Penn Central Company. The certificates of value which are issued by the United States bear interest at 8% Compounded annually from April 1, 1976. But, under the Plan, interest on claims, as well as on the new securities, is handled quite differently. (1) The D Notes issued to taxing authorities will bear a 7% Interest rate. (2) In calculating the amount of secured creditors' accrued interest, interest accruals between April 1, 1976, and December 31, 1977, were booked at the contract rate applied only to principal, and the A and B Bonds, which are exchanged for 30% Of the secured claimants' claims, bear no interest between January 1, 1978, and April 1, 1981, but thereafter accrue interest at 7% Compounded semi-annually to the extent not paid. (3) Sixty percent of the secured claimants' claims are paid in ...

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