Matter of Reading Co., Bankruptcy No. 71-828.
| Decision Date | 21 May 1980 |
| Docket Number | Bankruptcy No. 71-828. |
| Citation | 24 BR 858 |
| Parties | In the Matter of READING COMPANY, Debtor. |
| Court | U.S. District Court — Eastern District of Pennsylvania |
Howard H. Lewis, James A. Sox, John J. Ehlinger, Jr., Philadelphia, Pa., for trustees.
John H. Broadley, U.S. Dept. of Justice, Washington, D.C., John J. Degnan, Atty. Gen., Douglas G. Sanborn, Deputy Atty. Gen., State of N.J., Trenton, N.J., Prince Altee Thomas, Asst. Atty. Gen., Com. Pa., Philadelphia, Pa., Robert W. Blanchette, Clifford W. Losh, Washington, D.C., G. Clarke Cummings, New York City, Edward C. Toole, Jr., Robert L. Pratter, James E. Howard, Philadelphia, Pa., Lawrence Z. Shiekman, Pepper, Hamilton & Scheetz, Brian S. North, Consolidated Rail Corporation, Philadelphia, Pa., Harry G. Silleck, Jr., New York City, David Berger, Daniel Berger, Philadelphia, Pa., for defendants.
Once the largest corporation in the world, the power and financial base of the Reading Company has eroded steadily since the demand for rail as a form of passenger and freight transportation diminished. Reading's income fell short of its expenses and finally, on November 23, 1971, it filed for reorganization under section 77 of the Bankruptcy Act, 11 U.S.C. § 205, thus becoming a part of the nation's rail crisis which eventually found seven other major railroads in the northeast and midwest seeking reorganization.
At the time of bankruptcy, Reading had a yearly operating income loss of $5.7 million and a net ordinary loss of $11.5 million. Order No. 1 stayed the payment of taxes, rents to leased lines, and proceedings by creditors against the railroad for suits stemming from the operation of trains. In 1972, the net operating loss increased to $12.1 million and the net ordinary loss to $20 million. In 1973, the situation slightly improved in that the net operating loss totaled $8.7 million and the net ordinary loss was $12.7 million. These gloomy financial statistics for Reading as well as the other bankrupt northeast and midwest railroads, coupled with the great public need for continuing rail service and the enormous inherent value of the railroads, provoked Congressional action to preserve an operating rail system.1
Intervention came by way of the Regional Rail Reorganization Act of 1973 (RRRA), 45 U.S.C. §§ 701-94. Essentially, the RRRA set up a plan for conveying the operating assets of the bankrupt railroads to a new corporation created by the Act, the Consolidated Rail Corporation (ConRail), 45 U.S.C. § 741-47. Pursuant to the RRRA the bankrupt railroads would continue to operate under their respective reorganization courts for twenty months. During that time, the newly formed United States Railway Association (USRA), see 45 U.S.C. § 711, was to plan which parts of the rail system were to be conveyed to ConRail. The bankrupt railroads were to receive ConRail securities2 in exchange for the conveyance of their operating rail assets. A three-judge "Special Court" was created to rule on the valuation of the conveyed property. See 45 U.S.C. §§ 719 and 743.
Before the Reading would be subject to the RRRA, I had to find that it was not reorganizable under section 77, or, if it was, that the public interest would be better served by reorganization under the RRRA rather than under section 77. See 45 U.S.C. § 717(b). I concluded that the Reading Company was not reorganizable on an income basis within a reasonable time under section 77 and thus, was eligible to be reorganized under the RRRA. In re Reading Company, 378 F.Supp. 474 (E.D.Pa.1974). As required for the RRRA to apply, 45 U.S.C. § 717(b), I also found that it provided a process which was "fair and equitable" to the Reading's estate. In re Reading Company, 378 F.Supp. at 481 (E.D.Pa.1974).
The USRA formulated a planning package for the conveyance to ConRail. A preliminary system plan was filed on February 27, 1975 and a final system plan on July 26, 1975. On April 1, 1976, the Reading's rail assets described in the final system plan were conveyed. The remainder of the estate then consisted of real property, a trucking company, some marine equipment, other investments, and the probable proceeds from the valuation case before the Special Court.
Fundamental to any bankruptcy is the reality that all creditors cannot currently be fully paid in cash. Thus, principles of priority or structuring of creditors are used in a plan of reorganization so that preferred or senior creditors receive a proportionately better share than others.
The standards for approval of any priority system under a plan involve a determination that the creditors will be justly compensated in accordance with the fifth amendment, that pursuant to 11 U.S.C. § 205(e)(1) the plan is "fair and equitable" and affords "due recognition to the rights of each class of creditors and stockholders," and that the plan complies with the judicially created absolute priority rule.
Under the absolute priority rule, a plan is not "fair and equitable" unless it provides participation for claims and interests in complete recognition of their strict priorities, and unless the value of the debtor\'s assets supports the extent of the participation afforded each class of claims or interests included in the plan. Any arrangement by which a junior class receives values allocable to a senior class "comes within judicial denunciation." Beginning with the topmost class of claims against the debtor, each class in descending rank must receive full and complete compensation for the rights surrendered before the next class below may properly participate. (footnotes omitted)
In re Penn Central Transportation Co., 596 F.2d 1102, 1110 (3d Cir.1979) quoting 6A Collier on Bankruptcy ¶ 11.06, at 210-11 (14th ed. 1977).
Additionally, the reorganization court must conclude that the plan is feasible, that is, that the new corporation will have enough income to meet its expenses. 11 U.S.C. § 205(b)(4).
The present assets of the estate consist of approximately $25 million in cash, between $35 and $45 million in real estate and other investments not conveyed to ConRail,3 and a potential recovery in excess of $200 million from the valuation case. Under the Plan, many of these retained assets will be liquidated in a very detailed manner. The liabilities of the estate are estimated to be $165 million excluding the fees and expenses of the reorganization. Even though the amount of proceeds, if any, from the valuation case will not be determined for years, the trustees believe that the time is ripe for reorganizing the Reading estate. The retained assets and the problems relating to them are identified. An organization has been created to maximize the return on the retained investments and to liquidate as rapidly as possible retained assets which will not be used by the reorganized company. The Plan of Reorganization has been devised to establish a feasible capital structure and to propose a fair and equitable method of distribution. In this Plan, the estimated value of the corporation's retained assets is co-ordinated with the unknown value of the proceeds of the valuation case. This involves issuing securities based on the outcome of the valuation case, and satisfying various classes of creditors with combinations of cash and securities. The distribution of securities in lieu of cash satisfies the absolute priority rule. In re Penn Central Transportation Co., supra, 596 F.2d at 1110-11 (3d Cir.1979).
Generally, a reorganization plan must provide for the claims of administration (expenses of conducting ongoing operations during bankruptcy), secured claims, unsecured claims, and equity interests. However, it is only after satisfaction of the creditors' claims that the stockholders or equity interests are considered. The classification of claims is within the purview of section 77(c)(7) of the Bankruptcy Act, 11 U.S.C. § 205(c)(7) which provides in relevant part:
(7) The judge shall promptly determine and fix . . . for the purposes of the plan and its acceptance, after notice and hearing, the division of creditors and stockholders into classes according to the nature of their respective claims and interests. Such division shall not provide for separate classification unless there be substantial differences in priorities, claims, or interests.
The Reading Plan is structured around eight categories of claimants with various securities being issued to satisfy the debts in each category. The Class A claims include compensation for the trustees and their counsel and costs and expenses incurred in connection with the Plan and reorganization proceedings under sections 77(c)(2) and 77(c)(12). These claims have the highest priority and will be paid in cash at consummation or paid in the ordinary course of business.
Class B claims are those of the federal government arising from loans made to ConRail under section 211(h) of the RRRA for payment of Reading's administrative claims during the pre-conveyance post bankruptcy period and from trustees certificates issued to the United States. These claims will be paid by issuance and delivery of Series A administrative notes, having the highest priority.
Class C claimants include state and local taxing authorities which have not settled prior to the Plan's consummation. Their claims will be partially satisfied in cash and partially in Series B administrative notes which are contingent upon the Reading's receiving additional compensation for the valuation case.
Class D claims consist of other administrative claims which are not reorganization expenses paid at consummation. These debts will be settled in an administrative claims settlement program prior to consummation or will be paid in Series C administrative notes.
Class E claimants are railroads which provided materials and services to the Reading Company...
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