The new mortgage was to cover the property of the New York, Lake Erie & Western, including its leasehold of the New York, Pennsylvania & Ohio, and the capital stock of the Chicago & Erie Railroad.138 There was to be no assessment, no syndicate to raise money, and no voting trust.

This plan was advanced as adequate to restore the prosperity of the company. Examination will show its weakness. It comprised two measures of relief: first, reduction of interest by one per cent on the second consolidated bonds; second, the settlement of the floating debt. The first might be thought to have been the kernel of the plan, and the reduction in fixed charges the principal thing aimed at. That it was not is shown by the fact that so liberal were the new bond issues that the total fixed charges after reorganization were to be greater than those before. The floating debt which remained had arisen from lack of funds with which to make current and necessary improvements and repairs. This debt was the immediate cause of the failure of the company, and its cancellation was the real purpose of the plan. The method proposed was a forced levy upon bondholders, but the levy took, not the form of an assessment, but that of a subscription to new bonds on which payment of interest was to be as obligatory as any other charge. The operation differed, therefore, from an ordinary sale of securities in the more favorable selling price which it assured. It did little, however, to lighten the burden which had crushed the company. The only bright spot in the plan was the provision for future construction and improvement, which, though involving a still further increase in indebtedness, was justified because these improvements would serve not only to maintain but to make greater the earning powers of the company. Finally, it was the peculiar effect of this plan that it put the pressure imposed upon the wrong parties: the second consolidated and other junior bondholders were to be forced to subscribe to the new issue, when in fact it was the stockholders who should have been turned to, and whom it was consonant with no sound principle of finance to spare. Other matters come out in the objections raised by bondholders.

Opposition to the plan was vigorously headed by men like Kuhn, Loeb & Co., E. H. Harriman, August Belmont, Hallgarten, Peabody, Vermilye, and others.139 In England a meeting of dissentients was held and a committee was elected;140 in America the first formal action was the dispatch of a letter to the Erie managers by opposing bankers which is important enough to be quoted in full.

“Consultations and comparisons of views have recently taken place,” said these gentlemen, “between the owners and representatives of the second consolidated mortgage bonds and other bonds of your company, to whom the proposition as detailed in your circular of January 2 is not satisfactory.... Your plan seems unjust, inasmuch as it demands a permanent reduction of interest on the bonded indebtedness for which no adequate equivalent is offered, and it levies a forced contribution upon the bondholders through the demand for a subscription to new bonds at a price considerably over and above the market value these new bonds are likely to command, while the fixed charges proposed to be created appear to be considerably larger than, in the light of past earnings and experience, the property of the company can carry with safety.

“Instead of 5 per cent bonds, as provided in the published plan, 4 per cent bonds, in our opinion, should be issued, while for the interest to be surrendered the bondholders should receive an equivalent in interminable non-cumulative 4 per cent debentures, interest payable if earned; the holders of the debentures to have sufficient representation in the management to protect them.

“The floating debt should be liquidated from the proceeds of an adequate amount of new 4 per cent bonds (and debentures if desirable), which shall be offered to the shareholders and bondholders at a price rather below than above the probable market value of the new securities, and under the guarantee of an underwriting syndicate.

“Provision should also be made to obtain the conversion on fair terms of the reorganization prior lien bonds into the new bonds, so that it shall become practicable to secure the new 4 per cent bonds at once by a lien second only to the ‘Erie first consolidated 7 per cent bonds’; the new 4 per cent bonds to be issued under a general mortgage to an amount sufficient to provide for future additions and improvements, and with adequate provision for the taking up of the underlying bonds, and the issue of 4 per cent bonds in their stead.... Any plan now adopted for the readjustment of the finances of your company should seek, as its first object, to reduce the permanent charges so well within the earning capacity of the property as to make another default in the future an improbability.... We trust this communication will be received in the spirit in which it is submitted.”141

The directors refused to modify their plan, and the bankers, therefore, notified them of the election of a protective committee.142 On March 6 a meeting of stockholders approved the plan, and the same week Messrs. Drexel, Morgan & Co. gave notice that, having received deposits of a majority of each class of bonds, they had declared the plan operative as announced.143

Defeated in their appeal to the securityholders, the opposition turned to the courts. As a preliminary, they obtained an opinion from the well-known firm of Messrs. Evarts, Choate & Beaman, which held, first, that the Erie could not legally pay interest on the new bonds proposed until it had paid the interest on every one of the old second mortgage bonds, regardless of whether the latter was deposited with the reorganization committee; second, that if the old second mortgage bonds which were deposited as security for the new issue should be kept alive as proposed, the company would be increasing its obligations beyond the legal limit;144 and third, that much of the stock voted at the special meeting at which the new mortgage had been authorized was not really owned by the persons who had issued the proxies thereon as the law provided.145 Following the opinion, suit was commenced by Mr. Harriman in April for an injunction against the recording of the new mortgage, on the ground that the Drexel & Morgan proxies did not represent the actual stockholders, and in June by one John J. Emery to prevent the execution of the mortgage. Judge Ingraham in the Supreme Court Chambers denied an injunction, using in his opinion the following language: “While it is clear,” said he, “that there are certain obligations resting upon the majority to refrain from infringing the legal right of the minority, and that a court of equity will enforce and protect the rights of the minority, still, when the holder of a very small number of bonds or shares of stock seeks to enjoin a very large majority from carrying out a plan such majority deem to be for their benefit, I think the court should not interfere unless it plainly appears that some legal right of the minority is endangered.”146

What could not be accomplished by the hostile bankers was nevertheless to happen from the inherent weakness of the plan itself. It has been said that the new scheme involved an increase instead of a decrease in fixed charges. How this was to be met was not demonstrated; and already in June, 1894, it was necessary to announce that the coupons then due would not be paid for the present. In December matters were even worse, and a circular from Drexel, Morgan & Co. confessed the company’s inability to meet the coupons maturing. “Nevertheless,” the firm continued, “it seems to us inexpedient to treat the inability of the company to pay interest as an occasion for present foreclosure without giving a further chance to the company, especially as payment of bondholders’ subscriptions to the new bonds has not yet been called to provide the company with money necessary to pay the floating debt. It is, therefore, now proposed that the new bonds be issued with the coupons of June 1, 1894, and December, 1894, attached, but stamped as subject to a contract with the company which shall provide that they shall be paid as soon as practical out of the first net earnings over and above the railroad company’s requirements to meet interest and rentals accruing after December 1, 1894, except in case a default on later coupons shall give power of foreclosure, in which event the stamped coupons shall retain all their original rights.” The modification was assented to,147 but could not save the plan. Reluctantly the managers were forced to abandon it, and to consent to more radical propositions.

August 26, 1895, the new and final reorganization plan appeared. There were to be issued:

The first consolidated mortgage bonds were to be divided into prior lien bonds to the amount of $35,000,000, and general lien bonds to the amount of $140,000,000; the former to have priority of lien over the latter for both principal and interest. Both classes of bonds were to be secured by mortgage and pledge of all railroads and properties of every kind embraced in the reorganization as carried out and vested in the new company, and also all other properties which should be acquired thereafter by issue of any of the new bonds. Both issues were to bear interest at 4 per cent, except $29,435,000 of the general lien bonds, which were to bear 3 per cent for two years from July 1, 1896, and 4 per cent thereafter. The stock was to rank for dividends in the order given. Provision was made that no additional mortgage could be put upon the property to be acquired, and that no additional issue of first preferred stock could be made except with the consent in each instance of the holders of a majority of the whole amount of each class of preferred stock, given at a meeting of the stockholders called for that purpose; and with the consent of the stockholders of a majority of such part of the common stock as should be represented at such meeting, the holders of each class of stock voting separately; also that the amount of second preferred stock could not be increased except with like consent of the holders of a majority thereof, and a majority of such part of the common stock as should be represented at the meeting. All classes of stock were to be deposited in a voting trust until December 1, 1900, and until the expiration of such further period, if any, as should elapse before the Erie should in one year have paid 4 per cent cash dividends on the first preferred stock; though the voting trustees might terminate the trust earlier at their discretion.

Generally speaking, the prior lien bonds were relied on to pay the floating debt, to buy in the New York, Pennsylvania & Ohio, and to retire certain prior liens of the old company. The general lien bonds were reserved for undisturbed bonds, and, with the first preferred stock, exchanged for junior New York, Lake Erie & Western securities. The second preferred stock went for old preferred stock and income bonds, and the new common stock exchanged for old common.

The distribution was as follows: The old New York, Lake Erie & Western reorganization first lien and collateral bonds were paid off from the proceeds of the new prior lien bonds; the second consols received 75 per cent in new general lien bonds and 55 per cent in preferred stock; the funded coupon bonds of 1885 received 100 per cent in general lien bonds, 10 per cent in first preferred, and 10 per cent in second preferred stock; the income bonds 40 per cent in general liens and 60 per cent in first preferred stock; the New York, Lake Erie & Western preferred stock, on payment of assessment, 100 per cent in new common. For all other bonds included in the plan there were reserved general lien bonds in amounts usually equal to the par of the securities to be retired.

The cash requirements and the floating debt were as follows:

The necessity for retirement of the first lien and collateral bonds arose from the early maturity of the former, and from the fact that stocks and bonds of various Erie properties which it was desirous to consolidate with the new company were pledged for the latter. The wisdom of allowing for early construction and expenditure could not be denied; car trust payments were required to preserve the rolling stock, and the floating debt and receivers’ certificates called obviously for cash. Provision was made, first, by an assessment on the stock of $8 on preferred and $12 on common, with higher payments in case of delay, and estimated to yield $10,023,368; second, by a contribution from the New York, Pennsylvania & Ohio of $742,320; and third, by the sale of $15,000,000 prior lien bonds as indicated above. A syndicate of $25,000,000 was formed to subscribe to the prior liens, and to take the place of and succeed to all the rights of stockholders who should not deposit their stock and pay the assessment thereon.

With the settlement of cash requirements, unification of the Erie system was assured; “subject only to the undisturbed bonds and stock until retired by use of the bonds reserved for that purpose or the rentals corresponding thereto.” “The new bonds and stock will,” said the plan, “represent the ownership (either in fee or in possession of securities) approximately of:

—with valuable terminal facilities at Jersey City, Weehawken, Buffalo, etc., and also one-fifth ownership in the stock of the Chicago & Western Indiana Railroad Company. Also all the Erie coal properties, ... representing an aggregate of 10,000 acres of anthracite, of which about 9000 acres are held in fee, and 14,000 acres of bituminous, held under mining rights ... also the Union Steamboat Company, with its terminals and other properties in Buffalo, and its fleet of five lake steamers on which the Erie mainly depends for the lake and railway traffic,” etc.

Fixed charges under the plan were estimated at $7,850,000. Fixed charges in 1894 had been $9,400,000. For the first two years after reorganization, moreover, the charges were to be further reduced by $300,000 per annum, as the new general lien bonds were to bear only 3 per cent interest during that period; and an additional saving of $1,000,000 was looked for when the exchange of old bonds for new on the maturity of its existing prior issues should have been eventually completed. This sum of $7,850,000 the company was expected to have no difficulty in earning in view of the immediate expenditure of $5,337,208 for new construction, additions, and betterments, and the gradual distribution of the proceeds of $17,000,000 of general lien bonds to the same end. The compensation to Messrs. J. P. Morgan & Co. and Messrs. J. S. Morgan & Co. for their services as depositaries, and in carrying out the plan was put at $500,000 and expenses. Foreclosure was finally to take place and a new company was to be organized.

This plan differed from its abandoned predecessors in four important particulars, each of which was in its favor:

(1) It employed bonds and stock instead of bonds alone;

(2) It lowered instead of increased fixed charges;

(3) It procured cash from stockholders instead of from second consolidated mortgage bondholders; and

(4) It absorbed the New York, Pennsylvania & Ohio into the Erie system instead of continuing the lease thereof.

In the employment of bonds and stock instead of a simple issue of bonds, the Erie managers adopted what experience has shown to be the best method of dealing with the complicated situation arising from a great railroad default. The use of securities on which return was optional side by side with those on which return was obligatory tended both to protect the railroad company when earnings were low, and to benefit the recipients of the new securities when earnings were high. As worked out, it gave to the second consols and funded coupons a less return in the one case, and an equal or greater return in the other, than did the plan of 1894, and to the income bonds, though it offered no chance of equal gain, it at least promised a minimum below which payments should not fall. It further made a far nicer recognition of the relative priorities of different classes of old bonds possible, and whereas the previous plan had made the same demands on, and had given the same return to the second consols, the funded coupon bonds of 1885, and the income bonds, the new plan gave, as has been pointed out, to the first 75 percent in general lien bonds and 55 per cent in first preferred stock; to the second, 100 per cent in general lien bonds, 10 per cent in first preferred, and 10 per cent in second preferred; and to the third, 40 per cent in general liens and 60 per cent in first preferred stock. Income, coupon, and consolidated bonds benefited alike from the assessment upon the stock, which laid the burden of raising cash upon the owners of the road, where it most properly fell. No species of security was given for the assessment, not even common stock, with which the managers might well have been generous; although it must be remembered that the sale of $15,000,000 prior lien bonds for cash was part of the reorganization plan. It may be remarked that since, on July 2, 1895, the common stock was being offered at 10⅝, with no sales, and the preferred at 22½, and since the chance for dividends which the new stock was to enjoy was most remote, it was perhaps well that the syndicate guarantee of the payment of assessments had been obtained. Fixed charges by the new plan were lower, as a result of the liberal use of stock in the exchanges and the cancellation of floating debt as above; while the terms under which the outstanding New York, Pennsylvania & Ohio bonds were retired were the most drastic part of the scheme. In all, the total mortgage indebtedness of the Erie Company and its leased or controlled lines of $234,680,180 for January, 1896, was reduced to $137,704,100 by June 30 of that year.149

A weak point in the plan was, nevertheless, the small reduction in bonded indebtedness which it occasioned. Although, to repeat, the bonded indebtedness of the system was reduced from $234,680,180 to $137,704,100, the shrinkage was more apparent than real, since it consisted chiefly in the exchange of stock for New York, Pennsylvania & Ohio mortgage bonds, on which interest had not been paid by the Erie, and but seldom by the New York, Pennsylvania, & Ohio itself. These securities were slashed in most drastic fashion, particularly such of them as were inferior to the first mortgage. The amount of the reduction in the volume outstanding is indicated by the fact that for $5000 first mortgage New York, Pennsylvania & Ohio bonds were given $1000 Erie prior lien bonds, $500 Erie first preferred, $100 Erie second preferred, and $750 Erie common stock; and for $500 second mortgage, or for $1000 third mortgage, were given $100 Erie common stock. If, now, we exclude the New York, Pennsylvania & Ohio bonds from our consideration of the funded debt, we find the indebtedness of the Erie system on January 1, 1896, excluding the non-assumed New York, Pennsylvania & Ohio bonds to have been $121,399,431; and on June 30, excluding the new prior lien bonds used to exchange for these securities, to have been $123,304,100; or an increase through the reorganization of $1,904,669.150 Further, there was an accompanying increase in the capital stock of the combined companies, which did not, of course, involve an increase in fixed charges, but which increased the volume of securities outstanding.151 What the reduction in the capital of the New York, Pennsylvania & Ohio, joined with its amalgamation with the Erie system, did do was to lessen the burdens of that line to the parent company. For many years the Erie had engaged to operate the branch for 68 per cent and had paid 32 per cent of its gross earnings to the New York, Pennsylvania & Ohio, to be applied to payment or partial payment of interest on the excessive issues which were now retired. It was probably to be long before an operating ratio of 68 per cent could be successfully maintained; but the Erie after reorganization was obliged to turn over, not 32 per cent of gross earnings, but 4 per cent on the $14,400,000 prior lien bonds which had been given for New York, Pennsylvania & Ohio securities, or an amount of $576,000; which amounted to a reduction of the minimum rental of more than one-half, and of the sums actually paid of almost three-quarters.152

Turning again to fixed charges, we find them estimated, after the first two years, at $7,850,000. The average net earnings for the period 1887–94 had been $9,331,250. These earnings will not serve strictly as a basis for calculation, for from 1887 to 1892 they include an average of perhaps $750,000 derived from Lehigh Valley trackage payments and other sums now discontinued. With the deduction, therefore, of this amount from the net earnings of the period named, the average is reduced to $8,768,750; or $918,750 more than it was thought fixed charges would be. When it is considered that this $918,750 represented the sum available for dividends on $146,000,000 of outstanding Erie stock, it is plain that the over-capitalization of the company in 1895 was still very great.

With these comments it is necessary to leave the plan. It was far the best that had ever been applied to the rehabilitation of Erie’s affairs; it was discriminating in its nature, and, thanks to the increasing prosperity of the last eleven years, it has been fortunate in its results. In August, 1895, a decree of foreclosure was signed in the city of New York, and the following November the property was sold under the second consolidated mortgage, and purchased by the reorganization committee for $20,000,000.153

Since 1895 the Erie has shared in the prosperity of the country. Its ton mileage has increased from 3,939,679,175 in 1897 to 6,275,629,877 in 1907; its gross earnings have grown from $31,497,031 to $53,914,827; and its net earnings, which had hovered for so many years near or below the level of fixed charges, have now soared away above. Under these circumstances it is but natural that large sums should have been applied to improvements. Between December 1, 1895, and June 30, 1907, $12,732,486 were spent in the purchase of land, in yards, stations, and buildings, in reducing grades, relocating tracks, and in other ways, and charged to capital; $36,511,046 were spent for new equipment, and charged to capital; and $8,625,307 were taken from income for equipment and improvements of various sorts. These expenditures have had a most gratifying result. The average train load has grown from 224.74 tons in 1895 to 471.67 in 1907, although coal now constitutes a smaller proportion of the freight; and the average revenue per train mile has more than doubled, in face of a revenue per ton mile which has only slightly increased. In 1907 the Erie’s ton mileage was 59 per cent greater than in 1897, and its passenger mileage was 73 per cent greater, but the expense of conducting transportation had increased but 27 per cent. Instead of freight cars with an average capacity of 22½ tons the company now uses cars which average 34 tons. Instead of locomotives which on the average could exert a tractive force of only 24,500 pounds as late as 1901, it has now engines which average 31,000. Freight train mileage is 2,600,000 less than it was in 1896, and passenger train mileage has only slightly increased.

And yet, with all this prosperity, it cannot be said that the Erie enjoys an assured position. In 1907 it had to pay out 89 per cent of the largest income which it had ever received for operating expenses, fixed charges, and taxes. Of its net income of about $6,000,000 the modest dividends of 4 per cent on its first and second preferred stock absorb some $2,500,000, and the widespread financial difficulties of 1907 have led its management to declare the dividends for that year payable in scrip and not in cash. And although the present period of reaction dates back but a little way the company has been already obliged to the issue of short term notes.

In matters of railroad policy the Erie has accordingly been conservative. In 1898 it acquired control of the New York, Susquehanna & Western, from New York City to Wilkesbarre in northeast Pennsylvania. Three years later it bought the entire stock of the Pennsylvania Coal Company in order to protect its tonnage, and, as the directors expressed it, for other reasons which seemed good; and in 1901 also it bought an interest in the Lehigh Valley. The most sensational episode which has occurred has been the purchase and subsequent release of the Cincinnati, Hamilton & Dayton. It seems that in 1905 Mr. J. P. Morgan bought a majority of a syndicate’s holdings in Cincinnati, Hamilton & Dayton stock, amounting to a majority of the total issue; a purchase which carried control of the Pere Marquette and of the Chicago, Cincinnati & Louisville, or of a total system of 3675 miles. This stock Mr. Morgan turned over to the Erie at a price reported to be $160 a share. From a traffic point of view the deal seemed likely to strengthen the Erie’s position in Ohio, Indiana, and Michigan, while more than doubling the mileage of its system. Because of the financial condition of the new companies, however, the purchase was decidedly unwise; and, after an investigation, Mr. Morgan’s offer to take the road off the Erie’s hands was gladly accepted. On December 4, 1905, Mr. Judson Harmon was appointed receiver of the Cincinnati, Hamilton & Dayton and of the Pere Marquette, and the reorganization of these properties is just being completed.

At present the Erie is operating 2169 miles of road as against 2166 in 1896. Its earnings have greatly increased, its capitalization has grown in less proportion,154 but it has not yet a sufficient margin of surplus earnings to meet a decline in prosperity without serious misgivings. Dividends on its first preferred stock have been paid since 1901, and on its second preferred since 1905. The common stock cannot expect a dividend in any period which can be foreseen.