The statutes of some States expressly pro vide that the purchasers of a railroad property at a foreclosure sale do not need formally to incorporate. Such States incorporate the business through the operation of the law by reason of the fact itself of the purchase under foreclosure. In the absence of such a statute, if the new corporation is not already formed by the time of the foreclosure, those in charge of the reorganization can effect the purchase and hold and operate the property as individ uals until the new corporation is formed and ready to take over the property.
A railroad corporation involves two distinct franchises, the franchise to operate the rail road and the franchise to be a corporation. It is not necessary to be a corporation in order to enjoy a franchise to operate, and the fact of being a corporation does not in itself give the right to operate. Sometimes the franchise to operate is expressly mortgaged and passes to the purchaser at the foreclosure sale. Though many States forbid the corpora tion to mortgage its franchise to operate, nevertheless on a foreclosure sale this fran chise passes to the purchaser. Many technical legal considerations revolve about this point, and we will not discuss it further here, but assume that the franchise to operate effec tively passes under the foreclosure.
The next matters in the process of reorgan ization center about the reorganization agree ment. These matters may be summarized as: — The financial plan.
The reorganization agreement.
The filing of the reorganization agreement with the de positories and advertising the filing.
Giving depositors an opportunity to withdraw.
Declaring the plan operative (or inoperative).
We have already mentioned the idea of the financial plan of cutting down fixed charges and providing the cash necessary to put through the reorganization. The big work of the reorganization comes in arranging a financial plan that will accomplish these re sults and at the same time be acceptable to a sufficient number of the parties in interest to enable it to be put through. We will reserve for the present a discussion of the principles and difficulties involved in drawing up this plan and assume that the reorganization committee has done the best it can. For at this point the various protective committees agree on a new committee which will go ahead and directly plan the details of the reorganization. Though it will, of course, represent principally the interests of the pro tective committee for the issue most con cerned, its duty will be to formulate a plan which will, if possible, win the adherence of the other protective committees.
The reorganization agreement provides for the consent of the various parties in inter est that the reorganization may be carried through under the financial plan proposed. Note that this is the second agreement which* the security-holder is asked to make. The first, the depository agreement, under which he was asked to deposit his securities with some trust company and constitute the pro tective committee his agents for taking steps toward a reorganization, we have already dis cussed. The reorganization agreement names the managers whom the reorganization com mittee has decided upon. They are likely to be one or more of the banking houses which have in the past handled the financing of the corporation, and which are therefore inter ested in having the reorganization as success ful as possible. The reorganization plan itself needs to win the adherence of the various protective committees, and the managers under it must be such as to meet with the approval of these committees.
Recall that each protective committee, in soliciting the adherence of the holders of securities of the issue for which they sought to act, designated some trust company or bank with which the holder was asked to de posit his security. Copies of the financial plan and agreement will be filed with each of these depositories. The fact of the filing will be advertised in the city of each depository bank or trust company. It is also customary for a committee to advertise in any cities in which the securities have been sold to any large amount and if any considerable amount of the securities has been sold abroad, a committee will advertise there also. Since the certificates of deposit the security-holders have received are negotiable, in the sense that the rights under them may be made to pass by delivery, the protective committee does not know just what individuals may consti tute the parties in interest at the particular moment. So this advertising is necessary to give notice of the situation. The reorganiza tion agreement will provide that security holders who have deposited their securities under the provisions of the protective com mittee's agreement may withdraw their se curities within a stated time, say twenty days, and that if they do not withdraw they will be presumed to have assented to the terms of the reorganization agreement. If they withdraw, they must, of course, surrender the certificates of deposit they received when they deposited their securities under the protective com mittee agreement. If they do not withdraw, these same certificates will continue to repre sent their interest in the reorganization agree ment. At this time another opportunity will be given to security-holders who have not already deposited their securities to come in and deposit. When they do so they will re ceive a certificate of deposit just like that of those who have already deposited. Naturally
any one depositing his securities at this late date will be required to assume as large a proportion of the expense of the protective committee as if he had deposited at the very beginning. In fact, the protective commit tee's depository agreement probably limited the time within which the security-holder could deposit, but left it in the discretion of the committee to extend this time. It is so desirable that the committee control as many bonds as possible that this time limit is likely to be extended and perhaps extended again several times before finally further opportun ity is given to deposit after the filing of the reorganization agreement. The original de pository agreement may have provided that if a holder did not deposit within the time limited he could subsequently deposit only on the payment of a penalty. The penalty would be fixed at perhaps one per cent, or $10 a bond. The protective committee will adopt whatever policy as to depositing it thinks likely to give it most strength. But, of course, it would be unfair to the earlier depositors if people who came in subsequently were not obliged to bear their full proportionate share of the expenses. Filing the reorganization plan and agreement marks one of the critical times in the process of a reorganization. How many of the deposited bonds will be with drawn? How many bondholders who have stayed out heretofore will come in and deposit now that they know definitely the terms of reorganization? When the shift is over, will the result justify declaring the plan operative? Another situation now needs further ex planation. We have mentioned the appraisal of the property as helping the court to fix the proper upset price for the foreclosure sale. This is one of the delicate and critical matters of the procedure. Some of the bondholders will refuse to become parties to the reor ganization agreement. Their refusal to enter into this agreement cannot, however, deprive them of their rights as bondholders. The property must be sold at a definite price. The bondholders who become parties to the agree ment undertake to accept new securities, under such conditions as the agreement in dicates, in settlement of their rights under the foreclosure which they have entrusted to their protective committee. Let us assume that a sufficient number of bondholders join in the reorganization plan to make the man agers feel justified in declaring it operative. At the time of the foreclosure sale the man agers will have to be prepared to bid for the property, and the upset price will indicate the lowest price which will be accepted as a bid. Each bondholder is entitled, so far as the fore closure proceedings are concerned, to his pro portionate share of the price established at the sale of the property as the selling price. Those who have joined in the reorganization agreement, however, have cast their lot with the property or business itself, and to that end have given the reorganization managers the disposition of their interest in the proceeds of the foreclosure. Since this is the regular and normal thing, the procedure will provide for cutting out some of the motions that simply counteract each other. Let us assume, as ordinarily the case would be, that a property is being sold at the foreclosure subject to the underlying mortgages. We will also assume that the court has named $16,500,000 as the upset price, and that of this amount it will take $1,500,000 to provide for obligations of the receiver and other obligations which the court requires to be taken care of. This will leave $15,000,000 as that part of the proceeds which would be available to satisfy the general mortgage bondholders. We will assume that the mortgage secures an issue of $20,000,000. That is to say, at the price named the general mortgage bondholders are entitled to sev cents on the dollar of the par value of their bonds. If this entire amount of $16,500,000 were to be paid in cash at the foreclosure sale, it would mean that every general mortgage bondholder would get for each $1000 bond $750 in cash. Then those bondholders who want to stay by the prop erty and have come in under the reorganiza tion agreement would simply pay back the cash for the next securities provided for by the reorganization agreement. If the busi ness were ever put through in this way, it would mean probably that the reorganization managers had borrowed a large porportion of the amount required to be paid at the sale, and would repay the loan when they were paid back by the bondholders who had agreed to the reorganization plan. To require the reorganization managers, when purchasing the property under the foreclosure, to pay the full purchase price in cash, most of which they would have to borrow until the very money they paid was paid back to them on present ing the bonds which had been deposited with them, would greatly embarrass the process of reorganization. So, when the managers make their bid at the foreclosure sale and have the property awarded to them, they are per mitted to make payment in part with the bonds which have been deposited under the re organization agreement. That is to say, since every bondholder would have received sev enty-five cents on the dollar, if the foreclosure price were paid in cash, then the purchasers at the sale will be permitted to make pay ment in bonds which will be received in pay ment at the rate of seventy-five cents on the dollar.