In re Chicago, RI & P. Ry. Co., 6825

• Decision Date: 16 February 1940
• Docket Number: 6846,No. 6825,No. 6847.,6825,6847.
• Citation: 110 F.2d 395
• Parties: In re CHICAGO, R. I. & P. RY. CO. BLAINE et al. v. CHESTON et al.
• Court: U.S. Court of Appeals — Seventh Circuit

110 F.2d 395 (1940)

In re CHICAGO, R. I. & P. RY. CO. BLAINE et al. v. CHESTON et al.

Nos. 6825, 6846, No. 6847.

Circuit Court of Appeals, Seventh Circuit.

February 16, 1940.

Root, Clark, Buckner & Ballantine, of New York City (Wilkie Bushby and John J. Verdon, both of New York City, of counsel), for appellee Protective Committee for Chicago, R. I. & P. Ry. Co.'s First and Refunding Mortgage 4% Bonds and Secured 4½% Bonds, Series A.

Edward K. Hanlon, of New York City, and Tracy W. Buckingham, of Chicago, Ill., for appellants James G. Blaine, Vincent Cullen, and James R. Trowbridge, as Bondholders' Protective Committee for First Mortgage 4½% Gold Bonds of Rock Island, A. & L. R. Co.

M. L. Bell, of New York City, and W. F. Peter and Otis F. Glenn, both of Chicago, Ill., for appellees Frank O. Lowden, James E. Gorman, and Joseph B. Fleming, trustees.

Alexander & Green, of New York City, and Winston, Strawn & Shaw, of Chicago, Ill. (Edward W. Bourne and Clyde W. Sorrell, both of New York City, of counsel), for appellee Protective Committee for Chicago, R. I. & P. Ry. Co. General Mortgage Bonds.

Before SPARKS, MAJOR, and TREANOR, Circuit Judges.

SPARKS, Circuit Judge.

This controversy arose in proceedings for the reorganization of the principal debtor under section 77 of the Bankruptcy Act, 11 U.S.C.A. § 205. The appellants constitute the Protective Committee for the holders of 14% of the Rock Island, Arkansas & Louisiana Railroad Company (hereafter referred to as Rial) First Mortgage 4½% Gold Bonds, due March 1, 1934. The appellants had filed a petition for general relief, which was referred to a master. The order appealed from overruled appellants' objections to the report of the master which had recommended the denial of that petition.

The facts are complicated because there are several subsidiary corporations and many bond issues involved. The principal debtor filed its petition for reorganization on June 7, 1933, and it was approved on that date. Subsequently, petitions under section 77 were filed by five subsidiary corporations including Rial. The lines of all of these subsidiaries were operated by the principal debtor prior to June 7, 1933, under long term leases, and the stock of all was owned by it. Two other subsidiaries, all of whose stock was owned by the principal debtor and whose properties were operated by it prior to June 7, 1933, under leases terminable at will, also became subsidiary debtors. Two other subsidiaries, all of whose stock was owned by the principal debtor, also became subsidiary debtors. The properties of these last two companies, however, were not operated by the principal debtor under lease.

There are seven principal mortgage bond issues covering various parts of the principal debtor's system. Three of these cover properties owned by the principal debtor and the other four cover properties of three of the subsidiary lessors, including Rial.

On November 22, 1933, Lowden, Gorman and Fleming were appointed as temporary trustees of the estate of the principal debtor and also for all the subsidiary debtors. On December 28, 1933, this appointment was made permanent, and since their appointment they have operated all of the properties of the principal debtor's system, including the owned properties and the properties of the Rial and the other subsidiary lessors, as a unified system, as they were operated prior to the commencement of the reorganization proceedings. The trustees, however, have neither affirmed nor disaffirmed the Rial lease, nor the leases of any of the other subsidiary lessors. The time for making this determination was extended by the court until its further order, without objection from any of the parties. Prior to this time the protective committees of all the various bondholders had intervened.

Under the accounting classifications of the Interstate Commerce Commission, accounts of a railroad system operated as such are required to be kept only for the entire system, and reflect the results of its operations as a whole. Special operating revenue and expense accounts, as a rule, are not required to be maintained for the individual mortgaged or leased lines of a system. N. Y. N. H. and Hartford Railroad Company Reorganization, 224 I.C.C. 723. This method was pursued by the System prior to the institution of reorganization proceedings, and it was followed by the trustees after their appointment in the manner following. It was obvious that the revenues and expenses of the mortgaged and leased divisions of the System could not be ascertained except through the application to such unified operations of a formula designed to allocate the revenues and expenses to the respective divisions, as contemplated under section 77(c) (10) of the Bankruptcy Act. It was under this section that the District Court attempted in its sequestration order to establish separate accounts. By this order it directed the trustees to keep records and accounts showing separately the earnings of the respective divisions in accordance with a formula for the determination and allocation of the earnings of the respective divisions.

Pursuant to this order a formula for such purpose was proposed by the trustees, and applied to the operations of the System for the year ending May 31, 1934. This formula, however, was not approved by any of the parties or by the court. Its application for the year incurred a cost of approximately $84,000, and the trustees in November, 1934, petitioned the court for permission to discontinue it until further order, on the ground that there was no immediate necessity for its use. Neither the appellants nor any of the other parties made any objections to its discontinuance, and the order was granted.

No further steps were taken for the approval of a formula until the middle of 1937, when the Protective Committee for two of the bond issues of the debtor filed a petition in which they sought to adopt an earnings and expense formula. An order was had on this petition at which appellants were represented and offered no objection. As a result, the court entered an order which approved a specific and detailed formula for the allocation of the earnings and expenses of the respective divisions of the System, subject to certain terms and conditions. This is the only formula in effect in these proceedings and no motion was ever made by appellants to modify it in any respect, unless appellants' present petition for general relief should be considered as such.

On July 19, 1937, appellants filed their petition for general relief in which they noted that the principal debtor had defaulted in the payment of rent to Rial since March 1, 1933, and that no interest had been paid on the bonds since that date, and that there was a default in payment on the principal on their maturity date of March 1, 1934. By this petition they sought relief from the practice of the trustees in bankruptcy of commingling the revenues and earnings of Rial with those of the principal debtor, and making expenditure for the operating expenses and for the benefit of and improvements upon the properties of the principal debtor, without regard to the rights of the Rial bondholders. They sought, among other things, to obtain directions requiring the trustees in bankruptcy to prepare and keep separate accounts, to segregate to the assets and properties of Rial from the assets and properties of the principal debtor, to pay $3,000,000 as rental of the Rial lines, to pay interest on the bonds of Rial, and otherwise to pay for its property which, they alleged, was being used for the benefit of others. In the alternative they asked for the removal of the trustees and the appointment of an independent trustee for Rial.

It is obvious that all of appellants' grievances were primarily based on the fact that the trustees had made no payments to the Rial bondholders either by way of rent, bond interest, or earnings. It may be said, however, that the trustees had made no payments to any of the other lessors or mortgagees of the System except for the payment, in the early part of these proceedings, of two semi-annual interest coupons on both the General Mortgage Bonds and the Choctaw and Memphis Bonds. In the first instance, the two interest payments were made on the debtor's bonds at the solicitation of all other committees. This was done because it was hoped that these 4% bonds, having a long maturity, could be kept out of default. The interest payments on the Choctaw Bonds were made pursuant to a court order on petition and on notice to all of the parties interested. The record discloses no objection to any of these payments.

The many issues tendered in appellants' petition have been narrowed to three here. They first contend that the District Court and the special master erred in preventing them from proving as a matter of fact that the Rial was earning the interest charges on its bonds. As proof of this fact they offered in evidence certain exhibits which they claim would have demonstrated that the Rial lines were amply able to service the bonds issued under its mortgage. These exhibits consisted of memoranda and calculations prepared by employees of the trustees of the principal debtor and related to the Rial mortgage lines and other lines adjacent thereto. They represented estimates with respect to the revenues and expenses, the contributed revenues and the credits for transportation of company materials of a section of the System comprised of the Rial and certain adjacent lines. These estimates were calculated on bases in many respects different from those set forth in the formula. No effort was made to produce as witnesses those who had prepared the estimates. The master refused admission as against the General Mortgage Committee and the First and Refunding Mortgage Committee on the ground that these two committees were entitled to have the witnesses produced, after appellants' counsel had declined to...