By responding to the Court's invitation to comment upon the matters thus far discussed, counsel will greatly aid the Court in arriving at an accurate assessment of the risks of unfair treatment to which their respective mortgages would be exposed in the event of particular levels of recovery in the Valuation Case. I should like also to invite further comments addressing the overall issue of whether, under the circumstances of this case, a Plan which does have that risk with respect to mortgages largely secured by conveyed assets is necessarily unfair or violative of the Absolute Priority Rule. These issues have, of course, already been addressed in a general way in the briefs and arguments of the parties, but I am inclined to believe that more sharply focused consideration would be desirable. The discussion which follows is intended to outline a possible approach to the problem, and to invite criticism of that approach.
Ordinarily, both in § 77 reorganizations and in other corporate reorganizations, the extent to which a particular claim is secured can be determined with finality as of the consummation date, because the value of the assets securing the claim can be determined as of that date. Because of the RRRA process, the value of Lehigh's conveyed assets simply cannot be determined at this time, and will not be known until the outcome of the Valuation Case. In the Penn Central proceeding, it was reasonable to assume that all mortgages were fully secured. With respect to this aspect of the two cases, therefore, the problem in the Penn Central case was confined to insuring that the ultimate Valuation Case award, whatever it might be, would be properly reflected in the securities of the new company and would be appropriately distributed. The Lehigh Valley case, on the other hand, presents the additional complication discussed above, namely, the need to determine the extent of security, notwithstanding the impossibility of determining with assurance what percentage of particular mortgages is actually secured.
There are various possible ways of dealing with this problem. One approach, adopted by the Trustee's Plan, is to treat as secured only that percentage of a mortgage which is most assuredly secured as of the consummation date; to treat the balance of the mortgage claim as unsecured; and to correct for any errors in the security determinations, if the actual Valuation Case award later establishes that the mortgage was better secured than was originally anticipated, by the issuance of intermediate debt securities payable from the additional proceeds of the Valuation Case.
Another approach, more or less represented by the Chemical and Fidelity proposals, is to attempt to provide a mechanism which would have the effect of retroactively determining, when the Valuation Case is concluded, the actual security coverage of each mortgage, and, without attempting to undo any intervening distributions under the Plan, thereafter treat each mortgage claim appropriately.
The Plan approach has the advantage of being more nearly consistent with traditional reorganization practice, in that it assigns security values as of consummation date. But it is vulnerable to the criticism that it disregards security values which everyone knows really exist at consummation date, because of the fortuitous circumstance that USRA placed an unrealistically low value on conveyed assets, and because it is impossible to determine how much real security value is being disregarded.
The objectors' proposals, on the other hand, are vulnerable to the criticism that they tend to treat potential security values, not clearly identifiable as of consummation date, virtually the same as security values known and ascertained as of that date. Moreover, there is room for argument that implementation of the objectors' proposals, particularly those of Fidelity, might result in impaired marketability of the securities of the reorganized company, because of the many complications and uncertainties involved.
Whatever approach is to be adopted, it is necessary to make certain that it is consistent with the implications of the Absolute Priority Rule. In this context, I am inclined to believe that this requires careful consideration of the passage of time and the running of interest. Everyone agrees that any reorganization plan for the Lehigh Valley will be akin to an orderly liquidation. To the extent that a claim is a secured claim, it bears interest to the date of payment. The security values recognized by the Plan are determined as of April 1, 1976. Interest on secured claims, for purposes of determining the amount of the claim, runs to July 1, 1978. If this were an actual liquidation (I. e., if the proceedings were to be dismissed, without a Plan, followed by a reasonably orderly liquidation), interest on the secured portion of each mortgage would run, at the contract rate, until the claims were paid. The contract interest accrued after the Plan cut-off date would have a priority claim, to the extent necessary, to any increase in the value of the conveyed assets securing each mortgage resulting from a Valuation Case award in excess of $ 20 million. Since under the Plan approximately 35% Of the secured portion of the various mortgages would be paid, over a relatively brief span of time, from the cash on hand and the ADP Program proceeds,
the remaining 65% May be viewed as being satisfied from a liquidation which will be completed only in the more distant future. The Plan takes account of this time delay by according the First Bonds a 7% Contingent interest rate which primes the principal and interest of the Second Bonds. It is also appropriate to point out that the conveyed assets securing each mortgage, at either the value used in the Plan or the value derived from the actual Valuation Case award (when that is known), will generate interest at the rate of 8% Compounded annually, by way of the Certificates of Value.
From the foregoing observations concerning the time delay and interest rates, it appears to follow that there is at least a difference in degree between presently ascertainable security value and the potential security value represented by the probability that the Valuation Case award will exceed $ 20 million base value. Is not the Plan provision giving the 7% Contingent interest on the First Bonds (which represent the known security value) priority over the principal and contingent interest on the Second Bonds (which represent the potential security value) a reasonably fair method of compensating the claims now known to be secured for the delay in payment and for the cut-off of contract interest on their claims, and of apportioning the benefit of the 8% Interest rate on the Certificates of Value? Stated otherwise, the question is whether the differential in access to Valuation Case proceeds between First and Second Bonds and their respective contingent interest is an appropriate way to recognize the difference between known security and potential security.
An Order will be entered inviting further comment and argument upon the issues referred to in the foregoing Opinion.
The primary purpose of this Appendix is to generate a comparison of the total dollars the CM and GCM bondholders will receive if the Plan is consummated as proposed and a $ 35 million Valuation Case recovery is obtained versus what the result would be if the marshalling analysis incorporated $ 35 million as the value of the conveyed assets and an award in that amount is obtained.
Part I consists of six steps resulting in the securities distribution which results from the incorporation of $ 35 million in the marshalling analysis. The method employed is not as detailed as that contained in the Trustee's submission. The increment in the value of the conveyed assets securing each mortgage if a $ 35 million recovery is obtained is calculated and assigned to each mortgage. Excess security is then determined and marshalled. Next, the GCM assets are allocated among the public holders and the Government issues. The resulting security coverages are applied as per the Plan to the 1978 claim and the distributions under the Plan calculated. The final aspect of Part I is a comparison of the Plan distributions with the distributions which result if $ 35 million is used in the marshalling analysis.
Part II calculates the payout under the Plan if an award of $ 35 million is received, and Part III does the same for the securities distribution if $ 35 million is used in the marshalling analysis.
Part II has four steps and a concluding summary of the payout. First, the contingent interest on the First Bonds is calculated. The contingent interest is then included in step 2 which relates the claims of the various securities to the base Valuation Case award necessary to satisfy the claims of the various securities. Next, the amount of the proceeds available from the $ 35 million base award are calculated, and the amount of the excess over the total claim of the Administrative Notes and the principal of the First Bonds is computed and assigned to the contingent interest claim of the First Bonds. Next, the funds available to pay contingent interest are assigned to each mortgage. This last step is a bit complicated because, if the Plan is consummated, early redemption of First Bonds would be by lot. Reflecting this fact in the analysis is not possible. Contingent interest is, therefore, assigned to each mortgage based on the percentage which the amount of First Bonds issued to each mortgage bears to the total amount of First Bonds issued. The total satisfaction is then determined by adding the cash paid on consummation, the full amount of the First Bonds issued to each mortgage, and the contingent interest assigned to each mortgage.
Part III follows the same method, but it is applied to the securities distribution based on the use of $ 35 million in the marshalling analysis.
Part IV is unrelated to the first three parts and contains the calculation of the implementation of the Chemical conversion formula if a $ 35 million base award is obtained.