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July 10, 1968

The NEW YORK, NEW HAVEN AND HARTFORD RAILROAD COMPANY, FIRST MORTGAGE 4% BONDHOLDERS' COMMITTEE, the Chase Manhattan Bank, N.A., as Trustee Under the General Income Mortgage of the New York, New Haven and Hartford Railroad Company, Manufacturers Hanover Trust Company, as Trustee of the First and Refunding Mortgage of the New York, New Haven and Hartford Railroad Company, United States Trust Company of New York, as Trustee Under the Harlem River Division Indenture of First Mortgage made by the New York, New Haven and Hartford Railroad Company, and Oscar Gruss & Son, Plaintiffs, Erie Lackawanna Railroad Company, Intervening Plaintiff,
UNITED STATES of America and Interstate Commerce Commission, Defendants, Pennsylvania New York Central Transportation Company, Richard Joyce Smith and William J. Kirk, Trustees of the Property of the New York, New Haven and Hartford Railroad Company, Debtor, State of New York, State of Connecticut, Commonwealth of Massachusetts, and State of Rhode Island, Intervening Defendants

The opinion of the court was delivered by: FRIENDLY

FRIENDLY, Circuit Judge:

For the fourth time this Court has before it an order of the Interstate Commerce Commission in the Penn-Central merger - this one relating to the terms for the inclusion of The New York, New Haven and Hartford Railroad Company (NH). *fn1" The principal decision under review is a Second Supplemental Report on Further Hearing, hereafter "the Report," 331 I.C.C. 643 (1967); *fn2" there is also a Third Supplemental Report on Reconsideration, I.C.C. (1968). In five consolidated actions holders of various NH bonds and trustees under NH bond indentures (all collectively referred to hereafter as "the bondholders") challenge the Commission's conclusion that a Purchase Agreement between the Pennsylvania and the Central on the one hand and the Trustees of NH on the other dated April 21, 1966, and an interim loan arrangement set out in the Report constitute "just and reasonable" and "equitable" terms within §§ 5(2)(b) and (2)(d) of the Interstate Commerce Act. Erie Lackawanna R.R. has intervened, under the broad provisions of 28 U.S.C. § 2323, to assert an unrelated claim - that the Commission erred in failing to set conditions to protect its interchange with NH at Maybrook, N.Y., similar to those prescribed for the benefit of the Central Railroad of New Jersey, the Reading and the Western Maryland. With some regret in view of the public urgency of effecting inclusion of NH in Penn-Central, we are constrained to vacate the order and remand for expeditious proceedings and further report by the Commission.

 We begin by noting the somewhat curious posture in which, so far as concerns the bondholders' actions, the case comes to us. Since 1961 NH has been in reorganization under § 77 of the Bankruptcy Act in the District of Connecticut under the supervision of Judge Anderson. The Commission's report approved the sale of NH to Penn-Central not only under § 5 of the Interstate Commerce Act but as a means for the execution of a plan of reorganization of NH under §§ 77(b)(5) and (d). The latter determination must be certified to the District Court for Connecticut, which may approve it only if that court finds the plan "fair and equitable," § 77(e), with review of its decision lying in the Court of Appeals. When the bondholders' actions were filed, the United States moved for dismissal on the ground that the reorganization court had exclusive jurisdiction. We denied the motion in a memorandum, the salient portions of which are reproduced in the margin. *fn3" We adhere to the view there expressed; unfortunate as the duplicitous system of review may be, we see no basis on which we can properly decline to exercise the jurisdiction conferred upon us by 28 U.S.C. §§ 1336(a) and 2321-25. Compare General Protective Committee for Holders of Option Warrants of United Corp. v. SEC, 346 U.S. 521, 74 S. Ct. 261, 98 L. Ed. 261 (1954); Phillips v. SEC, 388 F.2d 964, 969 (2 Cir. 1968).

 I. The Commission's Approach to the Valuation of NH.

 In determining fair and equitable terms for the sale of NH, the Commission was faced with a task far more difficult than the one it had just performed in setting terms for the acquisition of Erie-Lackawanna, D & H and B & M by the Norfolk & Western, see Erie-Lackawanna R.R. v. United States, supra, 279 F. Supp. at 337-340, 342-345; 389 U.S. at 523-526, 88 S. Ct. 602. Those three roads had, or were claimed to have, earning power. Here, because of the large and increasing losses of NH, the Commission properly found, 658, that "Past experience * * * furnishes no basis for valuing NH from an earnings standpoint except to emphasize the chronic deficit character of the operation which is likely to persist and render the operation a burden rather than an income producer." *fn4" A fair price for NH on the usual basis of capitalization of earnings would thus be negative or, at best, zero; on the other hand NH is conceded to have a very substantial liquidation value.

 The Commission discussed the valuation problem at several places. It began by noting, 656-58, that in the negotiations leading to the agreement between the acquiring railroads and the NH trustees "asset value was the primary determinant rather than earning power," and that the evidence before it "was directed largely toward showing asset values upon an assumed liquidation." After saying that "This approach had the appearance of satisfying" the provision in § 77(b)(5) that the means for execution of a plan or reorganization might include "the sale of all or any part of the property of the debtor either subject to or free from lien at not less than a fair upset price," it continued that "We do not look upon liquidation value as necessarily being the equivalent of 'a fair upset price'" since "liquidation contemplates a dismantling of the railroad and, therefore, an abandonment of the railroad's operations - eventualities hardly likely, in view of our findings in the prior reports herein that the services of NH are essential." It thought that "a fair upset price should be geared to the requirement that very large segments of the railroad, though probably not all, would have to be maintained in operation" through purchase by public agencies. The Report states that in such event "the pricing would be lower than a complete liquidation could produce" - without, however, elucidating on what basis NH could be required to sell property to public authorities for less than liquidation value. The Commission concluded this portion of the discussion by saying that "if the consideration to be paid is the equivalent of the liquidation value, it will exceed the fair upset price contemplated by section 77(b)(5)."

 After extensive discussion and findings as to the liquidation value of NH, the value to NH of the consideration under the Purchase Agreement, and the cost of the acquisition to Penn-Central, the Commission stated its summary and conclusions as follows, 697-98:

As detailed earlier, we have found the liquidation value of NH to be $125 million. We have also found that the value to NH of the consideration to be received is $125 million. It is evident, therefore, that the consideration is at least equivalent to the liquidation value and [it] will, therefore, be equitable to all parties having an interest in the NH estate to approve the transaction.
From the point of view of Penn-Central, we have found that the total cost to them of acquiring the assets is $159 million. In these circumstances, it would be unfair to Penn-Central to require them to pay a price greater than that agreed upon in the purchase agreement.
Penn-Central must assume a lossoperation which not merely lacks promise of foreseeable recovery, but in fact is plagued by an unrelenting erosion. Thus, they are faced with constantly diminishing going concern values. The cold, hard fact is that NH has been losing money for years and that unfortunate situation continues unarrested. As thorough as may be the analyses forecasting profitable operations for NH as a freight-only railroad, they are subject to the fulfillment of a number of conditions and the achievement of proposals as yet untested by experience. We cannot give such projections as much weight as the actual operating results of many years.

 The Commission's final words on the subject came in a portion of the opinion dealing with the Trustees' application under § 77. Here the Commission said, 724-25:

Although earning capacity is usually looked upon as the principal criterion in valuing railroad properties, due consideration may be accorded to other relevant factors, including original cost of the properties, cost of reproduction new, cost of reproduction depreciated, actual investment therein, severance or strategic value, contributed traffic, value of particular facilities, and the effect of potential operating economies. We have given due consideration to past, present and prospective earning power as well as to other relevant factors specified in section 77 (e), including reproduction and original costs, and, additionally we have considered the liquidation value of NH - finding that value to be $125 million, a figure comparable to the price in the purchase agreement. Moreover, the liquidation value of the NH properties in the context of the NH's present situation exceeds the fair upset price, and as indicated, under section 77(b)(5) all or any part of a debtor's property may be sold at not less than a fair upset price.
Those who have a valuable interest in the NH estate could not, under circumstances favorable to them in a liquidation, expect to effect a greater net return then would be accorded them under the plan we are approving herein for the sale of the assets to Penn-Central. All have had fair and ample opportunity to present evidence and argument on the question of valuation, and we find the record entirely adequate to make possible and to support findings as to that issue for all purposes of section 77 of the Bankruptcy Act as well as section 5(2) of the Interstate Commerce Act. Accordingly, the sale of NH assets to Penn-Central under the terms of our decision herein is consistent with section 77(b)(5) in that it provides an adequate means by which the trustees' plan can be executed. We also find that the consideration to be paid for the assets of NH constitutes just and adequate compensation. As we view the situation, the parties holding a present interest in NH will receive the economic equivalent of what is surrendered upon the sale of the NH assets.

 The impression we derive from all this is that the Commission understandably avoided the hard decision whether a deficit ridden railroad could fairly be sold for less than its very substantial liquidation value by finding that under the Purchase Agreement liquidation value was received and thus the transaction was not unfair to NH. Since the validity of the latter inference would be indisputable, we shall first examine whether substantial evidence supported the Commission's finding of equivalence. If it did, we need go no further; if it did not, we must consider whether the Report can nevertheless be sustained.

 II. The Liquidation Value of NH.

 As indicated, the Commission made findings as to (1) the liquidation value of NH on December 31, 1966, (2) the value of the consideration payable by Penn Central, and (3) the cost of the acquisition to Penn Central. It found the first to be $128.9 million which it "rounded off" to around $125 million; the second to be $123.6 million which it again "rounded off" to around $125 million; and the third to around $159 million. In analyzing these findings, we shall endeavor to be ever mindful of the limited scope of our review, see Erie-Lackawanna R.R. v. United States, 279 F. Supp. at 337, and cases there cited, and of Mr. Justice Cardozo's warning, "An intelligent estimate of probable future values, * * * and even indeed of present ones, is at best an approximation. There is left in every case a reasonable margin of fluctuation and uncertainty." Dayton Power & Light Co. v. Public Utility Comm'n, 292 U.S. 290, 310, 54 S. Ct. 647, 657, 78 L. Ed. 1267 (1934).

 While we agree with the Government that in many instances the bondholders seek to have us substitute our judgment for the Commission's *fn5" and display a disturbing tendency to add apples to cucumbers by conceiving NH as operating and not operating at one and the same time, we nevertheless find the Commission's figures for liquidation value significantly too low and for value of consideration significantly too high. In this section of the opinion we shall discuss the former.

 (1) Failure to discount expenses of liquidation.

 We begin with what appears to be an obvious error by no means unsubstantial in amount. The Commission found that liquidation of NH would require time, which it assumed to be six years. It projected the receipts over this period and discounted them to present value, applying a factor of 6%. Recognizing that so large a program would entail substantial expenses including continued accrual of property taxes, it estimated these for each of the six years - a total of $58.23 million. However, it did not discount the expenses to present value. If future receipts are to be discounted to present value, as they properly should, future expenses must likewise be. The obligation to pay $1,000,000 six years hence no more entails a present cost of $1,000,000 than a right to receive $1,000,000 six years hence is an asset in that amount.

 The Report makes no attempt to explain its inconsistent treatment of the credit and debit sides of the ledger. The Commission's defense on brief is wholly unsatisfactory. It suggests that if a discount is to be applied to the liquidation expenses, a partially compensating downward adjustment should be made in the properties' assessed market value to reflect the fact that deferring tax payments by selling properties subject to tax liens depresses the sales price below the face value of the lien. The Trustees could, however, avoid this result simply by discharging the tax liens shortly before sale - under the contemplated liquidation schedule sufficient funds would be available for these and all other expenses. While it is difficult for us to determine the proper amount of the discount on the present record, it seems likely that, as the bondholders claim, this would be between $5 and $6 million. *fn6"

 (2) NH's interest in Grand Central Terminal (GCT) properties.

 By far the largest item in dispute is the value of NH's interest in income derived from hotel and office buildings constructed on property acquired by the New York Central in connection with the construction of Grand Central Terminal (GCT) in New York City and the tracks leading to it. *fn7" Penn Central contends that, except for repayment of construction advances on the Waldorf Astoria Hotel, $1,110,258 as of December 31, 1966, NH's interest is simply to have the net proceeds of these properties devoted to the payment of terminal expenses; hence when NH ceases to operate its railroad, as it would in liquidation, its interest will end. The bondholders claim NH is entitled to a perpetual half interest in the net proceeds of the properties undiminished by terminal expenses, appraised at $113.5 million, less some $2 million representing the amount, capitalized on an 8% basis, of $160,179.22, which on their view of the Agreements, the NH is obliged to pay regardless of its use of the Terminal or a net figure of $111.5 million. The Commission valued NH's settlement prospects at $13 million by a process hereafter described. Since the facts with respect to the contracts and relations concerning the GCT properties are set forth in a painstaking report rendered to the District Court for Connecticut on June 18, 1968, by Hon. John Van Voorhis, retired Judge of the New York Court of Appeals, acting as special master, we can condense the recital here. While we have read Judge Van Voorhis' report, we have not relied upon it; our conclusions are our own.

 The NH's passenger tracks from the east run only as far as Woodlawn Junction in the Bronx, where they join those of the New York and Harlem Railroad (Harlem), since 1873 a leased line of the New York Central. NH in 1848 acquired trackage rights southward over the Harlem to the latter's terminal, then located at Fourth Avenue and 26th Street; in 1872 the Harlem granted NH and the Central use of the newly built Grand Central Depot. Legislation of 1903 and 1904 required that the tracks immediately north of 42nd Street be depressed below street level; this necessitated demolition of the old depot and construction of the present Terminal.

 By agreement of 1907 the Central leased to NH "the use" of the Terminal, not to exceed 50%, in common with the Central. The Terminal was defined as including land and improvements described in annexed schedules, these encompassing certain properties on or in the vicinity of Park Avenue between 42nd and 57th Streets. The Central was bound to acquire all necessary land and to construct the Terminal at its own expense. NH was to pay a proportion, based on car use, of four items: (i) $485,393.69 interest on the cost of construction of the former depot; (ii) interest, at the rate of 4 1/4% on the cost of the new Terminal; (iii) annual payments to the City of New York, insurance premiums, taxes and assessments relating to the new Terminal; *fn8" and (iv) the cost of maintaining and operating it. Section 14 of the lease provided that amounts owing from tenants and others should be collected by the Central, and that "all such rentals or other compensation so received, and not belonging exclusively to either Company, shall be credited to the fixed charges or to the cost of maintenance and operation of the said Railroad Terminal, as the same may be applicable."

 Shortly before 1913 it became apparent that large additional revenues could be generated by constructing buildings on land that had been acquired for the Terminal. Desiring "to express more fully the intent of the parties" as to the rights of NH and the Central "with respect to the construction, maintenance and use of such buildings and with respect to the rentals accruing from the leasing of such buildings or portions thereof," the two companies entered into a supplemental agreement in 1913. This added a long paragraph to the section of the 1907 agreement which had originally leased the "use" of the Terminal properties only for the express purpose of accommodating the passenger service of the NH. This new paragraph made it clear that the NH also had the right to participate in real estate development, stating that it was

"agreed that the use of the Railroad Terminal demised by this paragraph to the New Haven Company shall include the right on the part of the New Haven Company to join with the Central Company, in accordance with agreements relating thereto, made, or from time to time to be made, by and between the Central Company and the New Haven Company, in the construction, holding, maintenance and leasing of buildings * * * upon the land included within the Railroad Terminal."

 The 1913 Agreement further provided that, as to each building:

"toward the construction of which the New Haven Company shall furnish or contribute money, and until it is reimbursed therefor, the New Haven Company shall have and own an undivided interest which shall bear the same proportion to the entire building as the amount of money furnished or contributed by the New Haven Company, and for which it has not been reimbursed, bears from time to time to the entire cost for the construction of such building. At the time when the New Haven Company shall be fully reimbursed for all moneys furnished or contributed by it for or toward the ...

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