Draft:New Haven Inclusion Cases

The New Haven Inclusion Cases were cases decided by the United States Supreme Court in 1970, in which the court found that the interest of creditors in a failing railroad was subordinate to that of the public.

"Syllabus

When this Court sustained the Penn Central merger (389 U.S. 486), it upheld the action of the Interstate Commerce Commission (ICC) in conditioning its approval of the merger on inclusion as an operating entity of the New York, New Haven & Hartford R. Co. (New Haven), whose continued operation the ICC had found to be essential. Since 1961, the New Haven had been under reorganization proceedings under § 77 of the Bankruptcy Act, and was close to financial collapse. The basic issue in these cases concerns the propriety of the financial terms for the inclusion. The ICC had remitted the parties to negotiate the terms of the inclusion, and, after considering their appraisals issued its inclusion report, in which it concluded that the net liquidation value of New Haven's assets (after deducting liquidation expenses and making a discount to present worth on the basis of hypothesized receipts over the six-year period anticipated for liquidation) was $125,000,000, a figure that the ICC found "just and reasonable" as a condition of the merger under § 5 of the Interstate Commerce Act and "fair and equitable" as part of a plan of reorganization under § 77 of the Bankruptcy Act. The New Haven bondholders thereupon commenced litigation for review of the inclusion report (in its aspect as a condition of the merger) in the three-judge District Court for the Southern District of New York, which was called upon to review the order under § 5 of the Interstate Commerce Act. The ICC certified to the reorganization court in Connecticut the sale of New Haven's assets to Penn Central, and the New Haven bondholders filed their objections in that court. The bondholders' group and the United States each tried to avoid duplicate litigation -- the bondholders by an application in the three-judge court to enjoin the ICC's certification of its plan to the reorganization court (which was denied), and the United States by a motion to dismiss the complaints in the three-judge court (which was also denied). Each court, after hearings, concluded that New Haven's assets had been substantially undervalued, and remanded the case to the ICC. The ICC then revalued New Haven's assets at a higher figure than that first reached, which, after deductions for certain factors not previously considered ("the added deductions"), came to $140,600,000. In addition, the ICC directed Penn Central to pay $5,000,000 toward New Haven's interim operating expenses. The reorganization court ordered New Haven's assets transferred to Penn Central, which was done on December 31, 1968. The bondholders filed objections to the revised evaluation with the reorganization court, and brought actions against the United States and the ICC in the three-judge court. The reorganization court rejected the plan, though it accepted some of the ICC's determinations. The three-judge court sustained the plan with modifications. Though the two courts agreed on many substantial issues, the total evaluation reached by the reorganization court exceeded that reached by the three-judge court by $28,000,000. The bondholders appealed directly to this Court from the three-judge court's judgment, and this Court noted probable jurisdiction. The bondholders appealed to the Court of Appeals from the order of the reorganization court; the United States, the ICC, and Penn Central cross-appealed, and this Court granted certiorari in advance of judgment. The disputed items of valuation, plus one issue affecting the consideration given by Penn Central, are as follows: (1) Though the parties have agreed that New Haven, as Penn Central's partner in the development of the Grand Central Terminal Properties, is entitled to the capitalized value of 50% of the "excess income" from those properties, the bondholders claim that no recognition has been given to New Haven's right to have its share of basic Terminal income, used to defray its share of Terminal expenses, for purposes of determining the fair price Penn Central should pay.(2) The New Haven owned two large freight yards in the Bronx, which service important industrial enterprises in a 160-acre area and a vital municipal food market installation. The reorganization court ruled that the ICC had erred in rejecting an appraisal by a witness premised upon the yards' availability for continued industrial occupancy with existing trackage and electrical facilities, in favor of a lower appraisal based on his assumption that, on New Haven's liquidation, the yards would be stripped of those facilities, depressing the value of the land and necessitating substantial removal expenses. The three-judge court approved the ICC's valuation. (3) The reorganization court rejected, but the three-judge court approved, the added deductions, one made by the ICC in the net liquidation value as an adjustment for the assumed effect of a year's anticipated delay in securing a certificate of abandonment, the other that the ICC made on the basis of a hypothetical sale of all New Haven's land assets at a bulk discount. (4) The reorganization court found that the ICC had overstated the discount for the projected six-year liquidation. (5) The ICC ordered Penn Central to assume interim losses during the actual 1 l-month period from merger to inclusion to the extent of a ceiling of $5,000,000 (which constituted about 61% of the total loss). The reorganization court upheld the ICC and dismissed the bondholders' contention that Penn Central bear all operating losses. (6) The bondholders attack the ICC's order that New Haven transfer to Penn Central its ownership of stock, which the ICC found worthless, in two concerns. (7) The bondholders urge that Penn Central should pay an added amount to reflect New Haven's "going concern" value as a supplement to the liquidation value. (8) The New Haven received, in partial payment for the assets transferred to Penn Central, 950,000 shares of Penn Central common stock which were valued at $87.50 per share at the time of the valuation date used by the ICC, but which had declined to $63.38 as of the inclusion date. To remedy

"the unfairness [arising from] the fact that the purchaser is getting assets of sure present value, while the seller is asked to gamble on the future of Penn Central,"

the reorganization court provided for (and the three-judge court adopted) an "underwriting" formula under which Penn Central would be called upon to make up in cash the difference between the market price of Penn Central stock in 1978 and $87.50 per share, unless, before that time, the market price had attained $87.50 for a five-day period. The bondholders contend that this formula fails to cure the overvaluation. The bondholders also urge that the continued deficit operation of the New Haven from the inception of the reorganization proceeding in 1961 to the inclusion in Penn Central in 1968 resulted in their being deprived of property without just compensation in violation of the Fifth Amendment.

Held:

1. The three-judge court erred in not granting the Government's motion to dismiss to the extent of deferring to the reorganization court in proceedings ultimately involving only the price to be paid for the assets of the debtor's estate. Pp. 399 U. S. 419-430.

(a) The reorganization court, under § 77 of the Bankruptcy Act, and the ICC had full power over the debtor and its property, including the power to formulate and confirm a reorganization plan providing for sale of the debtor's property, and it would have disrupted that plan for the three-judge court to have enjoined certification of the plan by the ICC to the reorganization court. Pp. 399 U. S. 419-421.

(b) Though transfer of the New Haven assets was also a part of the merger under § 5 of the Interstate Commerce Act, and neither court had "complete" jurisdiction when the litigation started, the statutory interrelationship between § 5 and § 77 and the ability of the reorganization court to adjudicate all the inclusion issues made it advisable for the three-judge court to have yielded to the reorganization court, in which primary jurisdiction had vested. Pp. 399 U. S. 423-427.

(c) When the merger occurred and no question remained of Penn Central's obligation to assume the assets of New Haven, the jurisdiction of the reorganization court became "complete," and the three-judge court had virtually nothing to decide. Pp. 399 U. S. 427-428.

2. The reorganization court is empowered by Congress to review the plan to determine whether the ICC has followed the statutory mandate that the plan be "fair and equitable" and whether there was material evidence to support the agency's conclusion. Pp. 399 U. S. 431-435.

3. There was no error in the finding of the reorganization court that, under the contractual arrangements, only after Terminal income had been applied to meeting Terminal expenses would the residue be distributed to the two railroads, and thus the basic income could not be "freed up" from the obligation to meet Terminal expenses. Nor did that court err in concluding

that New Haven's access rights to the Terminal under the agreements were not entitled to recognition in evaluating New Haven's assets, since those rights were more than offset by New Haven's deficit operations which Penn Central assumed. Pp. 399 U. S. 438-451.

4. The ICC's adherence to the lower of an expert witness' two estimates of the valuation of the Bronx freight yards was clearly erroneous, as it was based on the premise that New Haven would dismantle the yards upon liquidation of the rest of the railroad even though Penn Central already had a link by which service to the yards would continue, and implied that a common carrier could deny service to industrial and public activities simply because ownership of adjoining trackage had changed hands. Pp. 399 U. S. 451-457.

5. The reorganization court did not err in disallowing the added deductions. Pp. 399 U. S. 457-473.

(a) The ICC should not have made a deduction for costs that New Haven would incur during the year's period anticipated to obtain approval for abandonment of train operations, since the valuation date (December 31, 1966) represented not the date on which New Haven would have sought a certificate of abandonment, but the date on which it would have commenced its six-year liquidation sale. Moreover, since the interested public bodies have not arranged to continue New Haven's transportation system during the long period New Haven has been in reorganization, there is no justification for assuming that, if confronted with an abandonment application, they would do so now, and that a delay would be necessary for the ICC to hear from those communities. Pp. 399 U. S. 459-466.

(b) The ICC's deduction from the estate's liquidation value, based on a hypothetical sale of all New Haven's land assets in bulk, was properly rejected by the reorganization court, as the ICC had concluded that only its power to compel the sale of the real estate to a single buyer for continued operation justified the bulk sale discount, and there is no evidence in the record that a bulk buyer would agree to take over New Haven properties for continued service at any price. Pp. 399 U. S. 468-473.

6. The adjustment made by the reorganization court in the ICC's erroneous computation of the discount to present values of New Haven's liquidation proceeds over the six-year liquidation period is affirmed as being substantially free from error. Pp. 399 U. S. 473-476.

7. The payment made by Penn Central for New Haven's interim operating losses between the effective date of the merger and the date of inclusion was in accordance with a formula devised by the ICC in its inclusion report that constituted a pragmatic compromise between the competing interests of the Penn Central and the bondholders. The reorganization court's acceptance of that disposition is affirmed. Pp. 399 U. S. 476-479.

8. The argument of the Bondholders Committee that the ICC erred in ordering the transfer to Penn Central of stocks that New Haven held in two concerns, which the ICC found were valueless, is foreclosed by res judicata, since the bondholders had not appealed the order of the reorganization court directing the transfer of New Haven assets. Pp. 399 U. S. 479-481.

9. The bondholders' contention that Penn Central should pay an added amount for New Haven's "going concern" value is without merit, being entirely at odds with the liquidation hypothesis on which appraisal of New Haven's assets was predicated. Pp. 399 U. S. 481-482.

10. The "underwriting plan" of the reorganization court added to the assessment of present worth of the Penn Central stock both a reasonable assurance of realization of such worth and the opportunity of additional gain, and, on the basis of the record before that court at the time of its order, the package constituted full compensation for the assets transferred to Penn Central. In view, however, of the impact of recent events, which make it possible that this aspect of the decree is not realistic, further proceedings will be needed to reassess the consideration that Penn Central must give in exchange for the New Haven properties. Pp. 399 U. S. 483-489.

11. The substantial losses to the bondholders that occurred during the course of the reorganization proceedings did not result in any unconstitutional taking of the property of the bondholders, whose rights are not absolute and who will be receiving the highest and best price for the debtor's assets as of the valuation date. Moreover, the bondholders did not petition the reorganization court to dismiss the proceedings, and thereby permit foreclosure on the mortgage liens, until well after the valuation date. Nor is the price Penn Central must pay unfair in view of the benefits that were anticipated from the merger. Pp. 399 U. S. 489-495."