Of the purchase price, enough must be paid in cash to pay off the outstanding receiver's certificates, the expenses of the court, and the amount required to be distributed to creditors or others who are not par ticipating in the reorganization. The balance, rep resenting the amount distributable to those who are participating, is payable either in securities of the new company or in securities of the old company which have been deposited under the reorganization agree ment, and which will be exchanged later for the new securities under the direction of the reorganization managers.
When the sale has taken place, all the non-partici pating stockholders and creditors have been elimi nated, and the property and business, now in the hands of the reorganization managers, or of the corn pang which they have formed, is free from all debt, except such as the new plan of capitalization provides. Nothing remains to be done in the reorganization, except to distribute the new securities in accordance with the reorganization agreement and place the man agers of the new company in charge.
14. How the new plan reduces the fixed charges.— The plan of reorganization must provide a reduction of the fixed charges to a point well below the estimated annual income. This is accomplished in one or more of several ways, of which the following are the prin cipal ones : 1. Reducing the amount of the fixed interest-bear ing debt by the substitution of capital stock or income bonds for a part of it 2. Reducing the interest rate upon the interest bearing debt, sometimes substituting a stock bonus as partial compensation 3. Disposing of certain unprofitable parts of the property or business.
When possible, the scheme of capitalization is sim plified under the reorganization, with fewer classes of securities and a liberal bond reserve to take care of renewals and extensions. Preferred stock is very often issued to take the place of junior lien bonds. It ordinarily bears six per cent interest and is cumula tive, so that the dividend upon it, if paid, will at least equal the interest which bondholders were formerly entitled to receive.
The chief feature of the reorganization, therefore, is a reduction all the way down the line of the lien upon earnings which the various claimants formerly had. Junior claimants frequently suffer reduction in both the amount and grade of their holdings. Cer tain preferred creditors, deriving no benefit from re organization, may retain their position undisturbed. It is only by this reduction in fixed charges and the provision of adequate new working capital that the bankers and the owners of the prior lien bonds of the old company are induced to join in the reorganiza tion, feeling that under the new plan there will be no necessity for another default. The par value of the new securities issued to the old bondholders probably will not be reduced, but may even be increased, in order to render more palatable the adulteration in their quality or lien. The investor's mind clings to par values, and the sense of loss in the matter of se curity is not felt so keenly if the total par value is not reduced.
The new stock has some speculative value, and this induces the old stockholders to come forward with assessments. Bondholders or other secured creditors cannot usually be subjected to assess ment.
Oftentimes property, which was formerly only leased by the corporation, is now taken over outright thru some compromise with the lessor, thus increasing the value of the equities of the new corporation. For instance, leased railroad equipment may bear the name of the lessee road and be in poor repair. The lessors
therefore are willing to compromise their claims and turn the equipment over to the reorganized lessee ab solutely.
15. Reorganizations in reorganiza tion of Canadian corporations in recent years has oc curred chiefly in connection with industrial amalga mations. Prior to 1912, during a very active period in Canadian development, a large number of amal gamations were executed, heavy capitalization being one of the outstanding features of this movement. Since then, the majority of these amalgamated com panies have had to be reorganized, resulting in many cases in pronounced reductions in the stock and bond holding of investors. One typical example may be cited. An industrial consolidation, with heavy cap italization, broke down in 1912. Action was taken by the directors and a bondholders' committee was appointed to save the company from complete dis aster. In submitting their reorganization scheme, this committee pointed out that it was evident from the operations of the company, that the original cap italization involving a fixed charge of $400,000, was excessive. The average earnings for a period of 3% years were not less than $250,000 and under normal conditions the company should exceed this. A plan of reorganization was submitted, suggesting the for mation of a new company. Under this plan, a dras tic cut was made in the bonds and share capital. The holder of $1,000 par value of bonds in the old com pany received $250 first mortgage bonds in the new company, $500 new 6 per cent preferred stock and $250 new common stock.
The reorganization plan is seen at a glance in the following table: Before After Reorganization Reorganization Common stock $ 8,125,000 $ 3,000,000 • Preferred stock 1,875,000 4,000,000 Bonds 8,000,000 3,000,000 $18,000,000 $10,000,000 The stock of the old company disappeared. The bondholders of the old company received $2,000,000 in common stock, $4,000,000 in preferred stock and $2,000,000 in bonds. To secure working capital the new company issued $1,000,000 in common stock and $1,000,000 in bonds.
The new company started operations on July 1912, and while early results were not remarkable, they later showed progressive improvement. Net profits for the first ten months of 1916 were $437,318, against $386,777 for the full year 1915, and $343,236 for the full year 1914, with a surplus after charges, greater than the combined surpluses of those two years. Indicated earnings in 1916 on the preferred stock were at a rate of 5 per cent.
When refinanced in 1912, the company was started with a substantial sum in cash for working capital, and the policy of the board was to maintain that posi tion. Surplus earnings went into improvements and betterments; but expenditure of that sort was kept within the bounds of earnings so available and there was no impairment of the company's financial liquid ity. Each of the successive statements issued since reorganization has shown the company in possession of about $450,000 to $500,000 cash and no debts other than ordinary trade accounts.
The company's strength in this respect and its gradual accumulation of a surplus, which on October 31, 1916, amounted to $450,369, or equal to about 11 per cent on the stock, allowed the directors in January, 1916, to declare a modest quarterly divi dend of 1 per cent on the $4,000,000 preferred stock of the company. This stock represented a 50 per cent equity in the bonds of the old company, rather than an original stock investment.