If, in their unrestricted discretion, the reorgan ization managers shall so determine, the pre ferred and common stock of the new company issued in the reorganization may be pledged as additional security for the prior lien bonds for five years, and for that purpose be vested in the corporate trustee under the prior lien mortgage by agreement made or approved by the reorgan ization managers, under which the voting power on the pledged shall be exercised by the corporate trustee under the prior lien mortgage as from time to time directed by the voting trustees, or, in the absence of such direction, or in case of default in the payment of any installment of interest on any prior lien bond, as directed by a majority of the corporate trustees under the prior lien mortgage, the adjustment mortgage and the income mortgage.
Now that we have considered the general procedure of a reorganization, let us take up the specific problem presented in the begin ning of our discussion, the reorganization of the X. Y. Railroad Company. We will assume that the divisional bonds shown in its capitali zation bear interest averaging five per cent for the $10,000,000. This makes fixed charges on account of : Divisional bonds, interest . $500,000 First and refunding 4t's, interest. 1,125,000 $1,625,000 The corporation has not defaulted on these obligations, its earnings are ample to provide for them, and no one at any time has thought of disturbing them in the reorganization. Besides the fixed charges the corporation is subject to an account of these undefaulted securities, the interest obligation on account of the securities in default amounts to: General mortgage 5's, interest $1,000,000 Collateral trust 5's, interest 250,000 $1,250,000 Or, total fixed charges of the system at the time of default were $2,875,000. Net earn ings at the time of default were, let us say, $2,750,000. The receiver has been able, dur ing the term of his operation of the prop erty, to increase the net, we will assume, by $50,000, and makes a showing at the time the reorganization plan is finally forMulated of net earnings of $2,850,000. Since he has in creased fixed charges by $30,000 through the issuance of $500,000 6 per cent receiver's cer tificates, the increase of $50,000 in net does not represent a real gain for the full amount of the increase.
The reorganization committee is confronted with the problem of two issues in default, each with a lien on separate pieces of property. It is important, however, in the interests of both pieces of property that the system be kept together, and in order to keep them together it is necessary that a plan be for mulated that will be just to both classes of security-holders. To form such a plan in
volved an examination into the relative merits of the two properties. It was found that at the time of the default the net earnings of the X. Y. system proper were $2,525,000. In terest on the issues secured on this property, the two underlying issues and the one in de fault, required $2,625,000. This made a de ficiency of earnings of this part of the system of $100,000, or a deficiency of 5 per cent on the amount required to meet the interest charge on the general 5's in default. Net earnings of the M. X. Railroad, the branch line, all of the bonds of which are deposited to secure the M. X. Railroad collateral 5's, amounted to $225,000. Interest requirements of the collateral 5's called for $250,000. This presented a deficiency in earnings of 10 per cent of the amount required to meet interest charges on account of this issue. Holders of the collateral 5's have the advantage, how ever, of not having any claim on the M. X. Railroad property ahead of theirs. We will assume that this and other considerations, such as the relative physical condition of the two properties and their relative impor tance to each other, led the reorganization committee to the conclusion that the general mortgage 5's and the branch line collateral trust 5's should stand on the same basis in the reorganization. Such a conclusion, of course, simplifies the problem of our reor ganization plan in providing equivalents for the securities which the new plan will displace.
We must now consider what success the reorganization committee has met with in getting deposits of the defaulting securities. Again we will simplify our computations by assuming that the same per cent of each of the issues refused to deposit, and place the amount at 5 per cent. So our reorganization committee had to consider $1,000,000 general mortgage 5's not deposited. 250,000 collateral 5's not deposited.
This becomes important, as we know, in relation to the upset price the court may name for the foreclosure sale, which determines the amount of cash the reorganization committee must provide for raising through its plan. The committee is able to make such proposals that neither the majority nor the minority of the holders of the collateral 5's are disposed seriously to press for a separate foreclosure. They recognize the essential importance of the properties remaining together and con tent themselves with exerting such pressure as they can to get better terms.