ORIGIN OF THE COMPLEXITY OF LIENS the case of railway bonds the reader of financial advertisements and circulars, who is not entirely familiar with the processes of cor poration financing, may not readily under stand how it comes about that a bond may be secured by a first mortgage on part of a rail road system and have a second mortgage or other junior lien on other parts of the system. Though the chapter in the first volume on "Financing an Expansion" contains the clue to the situation, it seems desirable to extend the explanation by presenting a concrete illustration of the building up of an assumed simple railway system showing the result in diversified liens.
Let us assume that at about the same time one group of men formed a corporation to build a line of railroad from X to Y, and another group of men formed another cor poration to build a line from X to R. One corporation, the X. Y. Railroad Company, financed its construction by an issue of $5, 000,000 X. Y. 20 year first mortgage 5's and $7,500,000 of common stock, and the other corporation, the X. R. Railroad Company similarly financed its construction by issuing $6,000,000 X. R. first mortgage 5's and $6,000,000 of common stock. Our earlier rail road mileage was built in just that way by different groups, in what would now seem small sections. No group had developed financial power enough to build or own a line from the Atlantic to Chicago.
The group in control of the X. Y. Railroad Company, we will suppose, now sees the de sirability of having a line from X. to Z. The mortgage securing the X. Y. first mortgage 5's is a blanket mortgage, and the group in control of X. Y. wants to be able to offer a first mortgage on the new mileage in order to finance it. So they incorporate the X. Z. Railroad Company and have the new corpora tion proceed to authorize $4,000,000 X. Z. first mortgage 5's. The X. Y. Railroad Com pany owns all the $5,000,000 of stock of the X. Z. Railroad Company.
Since the lien of the X. Z. first mortgage 5's has attached to the property, the manage ment of the X. Y. Railroad Company, as soon
as the construction of the X. Z. is completed, vote the stock of the X. Z. Railroad Company for a physical merger of the X. Z. property to make it an integral and directly owned part of the X. Y. property. The X. Y. Railroad Company is now taking all the assets of the X. Z. corporation and dissolving the tion; it will, therefore, assume the bonds of the X. Z. corporation, — that is, become the general obligor on and place its general credit back of the X. Z. first mortgage 5's, which, of course, continue to have their first mortgage lien on the line of railroad running from X. to Z. The X. Z. first mortgage 5's then become the X. Y. Railroad Company X. Z. Division first mortgage 5's. Since the mort gage securing the X. Y. Railroad Company first mortgage 5's is a blanket mortgage, stipulating that the lien of the mortgage shall extend to all future acquired property of the X. Y. corporation, now that the X. Y. Rail road Company has acquired the property of the X. Z. Railroad Company, the lien of the X. Y. first mortgage 5's will extend over the X. Z. line. The X. Y. Railroad Company, however, has acquired the X. Z. line subject to the existing first mortgage, and therefore has bought, to speak in legal terms, the equity of redemption in the property. So the lien of the X. Y. first mortgage 5's is a mortgage on this equity of redemption, or, as we say, a second mortgage on that part of the prop erty of the X. Y. Railroad Company which forms the X. Z. Division.
While all this has been going on, let us assume that another group of promoters in the city of M. has been projecting and build ing a line of railroad from M. to X. This is a much larger undertaking than any of those we have been considering. Its projectors capitalize the M. X. Railroad Company at $25,000,000 first mortgage 41's, $15,000,000 6 per cent preferred stock and $25,000,000 of common stock. The M. X. Railroad Com pang proves a profitable enterprise and in creases in financial strength.