REORGANIZATIONS We have contemplated the original issuance of securities at the time of organization and such additions as may be made from time to time to supply the funds for increases in the capital account required by an expansion of the business. We have also considered such changes as may result through the redemption of outstanding secur ities, either for sinking-fund purposes, or to allow their replacement by a larger issue with the same lien, or to absorb a surplus for which the corporation has no other immediate use. We have indicated the change which may result from the issuance of a convertible se curity through the conversion of part or all of an issue of bonds into stock or through the conversion of part or all of an issue of pre ferred stock into common stock. All such changes in the capitalization of a corpora tion come about in the ordinary course of the financial management of the business. We have still to consider extraordinary changes which may take place in the financial plan of an enterprise.
Such extraordinary changes may come r about as a result of insolvency or may take place without insolvency. They may be made to remedy some existing defect in the financial structure or to meet some new and unforeseen requirement of the business. If they are made as a result of insolvency, they may accompany foreclosure proceedings or be accomplished without foreclosure. When they accompany foreclosure we say the cor poration has gone through a "reorganiza tion." If the change in the plan of capitaliza tion takes place as a result of insolvency without foreclosure, we may say that the cor poration has undergone a "readjustment of the capital account." In the event that it has become desirable to make a rear rangement of the corporation's finances, al though it continues as an entirely solvent or, indeed, it may be, an exceptionally pros perous concern, — in that event we will speak of the rearrangement of finances as a "re capitalization." Let us first take up a matter of reorganiza tion. We will assume a railroad corporation, the X. Y. Railroad Company, capitalized as follows: — We will assume that the corporation has committed some default in its obligations to its general mortgage bondholders which en titles them to foreclose on the property under their mortgage. The bankers who financed the corporation may stipulate, and the cor poration may agree, that breaches of various agreements on the part of the corporation shall constitute defaults entitling the bond holders to foreclose under their mortgage. Of course, the default regularly leading to foreclosure is a failure to pay either principal or interest when it falls due. The mortgage regularly stipulates that a failure to pay in terest shall make the principal due and pay able.
We will assume, then, that the manage ment of our corporation foresees that it will not be able to pay the interest falling due on its 5 per cent general mortgage bonds at the next interest period. The earnings of the corporation are sufficient to continue the payment of interest on the first and refunding 41's and on the underlying divisional bonds. We have to consider the $5,000,000 of collat eral bonds secured by the deposit of all the stock and bonds of a branch line. The earn ings of the branch line have fallen to a point where the net is not sufficient to meet the in terest charge on account of the collateral bonds secured by the deposit of the branch line securities. So far as the claim of these collateral bonds against the issuing corpora tion is concerned, they are, of course, a general obligation merely and junior to the general mortgage 5's. The interest date on these bonds is, let us say, a month later than that of the general mortgage 5's, and the failure to pay this interest when it falls due will nat urally follow the failure to meet the interest charge of the general mortgage issue.
Directors and officers of the corporation consult with the bankers who have done its financing and they decide to be ready to apply for a receivership. That the receiver ship should be foreseen and planned for under such guidance is usually in the best interests of all the people who have any concern about the property. Such managers of affairs are best equipped to proceed along a well-de fined line of action and to harmonize the conflicting interests. We will refer to them as "the management." If the various inter ests should be permitted to proceed at hap hazard, they would cause a much greater delay in reaching a settlement and largely increase the total losses. Usually it is desir able that the receiver be appointed by a federal court. It is especially important that the federal court should assume control of the property if it is a line of railroad running through or into more than one State. For the purpose of getting a federal receivership counsel for the management, looking forward to the anticipated default, will prepare a creditors' bill in which bondholders or other creditors, living in some State other than the State in which the corporation is incorporated will appear as the petitioners for the receiv ership. The fact that the petitioners are citizens of a different State from that in which the corporation is incorporated gives the necessary diversity of citizenship to en able the federal court to take jurisdiction and appoint a receiver.