CHAPTER II ERIE

    Early history—Reorganization—Wall Street struggles—Financial difficulties—Second reorganization—Development of coal business—Extension to Chicago—Grant & Ward—Financial readjustment—New York, Pennsylvania & Ohio—Third reorganization—Later history.

The New York & Erie Railroad was organized in 1833 in the hope of bringing to the southern tier of counties in New York State a prosperity equal to that which the Erie Canal had secured for the northern tier. It was to run from New York or some suitable point in its vicinity to Lake Erie. A six foot gauge was adopted, partly because the grades encountered were thought to require locomotives with more power than a narrower gauge could accommodate, and partly because it was wished to make the road independent of any connection which might lead trade away from the city of New York.88

The events of the early years may be briefly dealt with. Difficulty was experienced in getting subscriptions, and in 1836 the legislature granted a loan of $3,000,000. An assignment was made in 1842, due to the difficulty of getting the enterprise under way, which resulted in the release of the company from liability to the state on condition that it complete its line from the Hudson to Lake Erie by 1851. Stockholders were to exchange two shares of old for one share of new stock, and a first mortgage of $3,000,000 was authorized.89 In 1851 the line was completed to Dunkirk on Lake Erie, and the following year it reported a bonded indebtedness of $14,000,000, capital stock of $6,000,000, and floating debt to the amount of $3,080,000, or a total of $43,961 per mile of line; a high figure, but probably necessarily so in view of the difficult work to be performed. Although nominally completed, the troubles of the road were not over; and a precarious existence was maintained only by the placing of additional loans in 1852 and 1855, and by the aid of Daniel Drew on two distinct occasions. A war of rates with35 the New York Central aggravated the situation; heavy storms and ice floods in January, 1857, caused serious loss, and the panic of that year, with the ensuing depression, proved more than the road could stand. Proceedings were begun in 1859 by the trustees of the fourth mortgage, and in August a receiver was appointed.90 The wonder was that such action had been delayed so long. The income of the road had been so far short of meeting current expenses that claims for labor, supplies, rents, and unpaid taxes, and judgments rendered against the company before the receivers were appointed, had mounted up to $741,510; while not only had interest on three mortgages fallen due in April, May, and June, but the principal of the second mortgage, amounting to $4,000,000, had matured. The settlement of claims and the reorganization of the company were put in the hands of J. C. Bancroft Davis and Dudley S. Gregory. Since the earnings of the road were at so low an ebb, wisdom would have seemed to dictate some scaling of the charges to correspond. This did not enter into the views of the trustees; instead, they proposed to give preferred stock for all unsecured indebtedness, to extend the principal of the second mortgage coming due, to exchange old common stock for new, to levy an assessment of 2? per cent on both classes of new stock, and with the proceeds of the assessment to pay all coupons in arrears. Provision was made for the retirement of certain fourth mortgage bonds, and for a sale under foreclosure of that mortgage. By the arrangement no saving in fixed charges worth mentioning was secured; no sacrifice was demanded of bondholders; and, save for the payment of assessments and the (new) stock given for floating debt, the stockholder’s position was not made worse. The scheme was an easy and temporary means of escape from an embarrassing position. Before the reorganization the bonds outstanding had amounted to $18,006,000, the stock to $11,000,000, and the unsecured indebtedness to $8,504,000. After reorganization the totals were: indebtedness, $17,953,000, and stock, $19,911,000 (of which $8,911,000 preferred); or a capitalization of $67,728 per mile. The road was sold in 1862, and the Erie Railway took the place of the original New York & Erie Railroad Company.

With 1864 began the career of the Erie as a speculative Wall36 Street stock. Its large capitalization and the painful slowness with which its earnings grew kept the quotations of its shares normally at a low figure and invited speculation; while the location of its lines tempted more serious efforts to obtain control. Up to 1867 Daniel Drew was in power, while Commodore Vanderbilt spent his best efforts to drive him out; after that date Jay Gould and Jim Fisk became more and more prominent, and manipulated the Erie securities with enthusiastic regard to profits which they might derive both from the Erie Company itself and from operators who wished to speculate in its stock. In the course of the abundant litigation to which Gould’s methods gave rise, various receivers were appointed; but the orders of appointment were subsequently vacated, and the receiverships were nominal only. The details of the Wall Street struggles have little interest for us here.91 But the result is of importance. In the eight years from 1864 to 1872, when Gould was turned out of Erie by General Sickles and his English backers, the bonded indebtedness of the company increased from $17,822,900 to $26,395,000, and the common stock from $24,228,800 to $78,000,000; in the one case a growth of 48 per cent and in the other of 221 per cent, at a time when the mileage increased 53 per cent and the net earnings but 22 per cent.92 No more disgraceful record exists for any American railroad. The stock was not issued for the sake of improving the road, and it was subsequently shown that the road was not improved; but it was thrown upon the market at critical times in support of bear operations by the Erie managers, while portions of it, on at least one occasion, were bought back with the funds of the company to aid speculation for a rise. The result was to ruin the credit of the Erie, and to make it the favorite tool of cliques of gamblers. The increase in bonds occasioned an unmistakable increase in fixed charges, which rose from 20 per cent of gross earnings in 1864 to 25 per cent in 1871, 21 per cent in 1872, and 30 per cent in 1873, while the purchase of worthless bonds of subsidiary roads, such as the Boston, Hartford & Erie, lessened the assets without disclosing the real position to the casual observer.

In 1872 the control of Erie was taken from Gould through a vigorous campaign managed by General Daniel E. Sickles, and an37 “eminently respectable” board of directors was elected. Temporary relief was obtained from the use of $6,000,000, available from an issue of bonds previously approved,93 and dividends, first on the preferred and then on both preferred and common stock were declared. Unfortunately the dividends were not earned; and this fact, which was suspected from the previous record of the company and the marvel of its so early restoration to a dividend basis, was shown in the statements of ex-Auditor S. H. Dunan, who resigned in March, 1874, alleging that the accounts had been falsified to suit the company’s purposes, and that he was unwilling any longer to be a party thereto.94 Investigations conducted by representatives of English bondholders showed that in the three years ending in September, 1875, the profits of the road had been $1,008,775 instead of $5,352,673 as stated in the company’s accounts; and the severity of this finding was scarcely mitigated by the conclusion that in the opinion of the committee the dividends on the preferred stock at least were justified by the books.95 At the same time the report of Captain Tyler, another English representative, laid emphasis on the necessity for a change of gauge, a double track, improvements in gradient, fresh extensions and connections, and other similar matters.

The real position of the company at the time was shown but too well by the frequency of strikes upon its road. Thus in February, 1874, a strike of freight brakemen on the Susquehanna division broke out, caused principally by an order to discharge one of the brakemen from each freight crew, leaving only three on a train; and at the same time there was a strike of the switchmen on some of the divisions owing to a decrease in pay. In March occurred a serious strike among the employees of the road in Buffalo, mainly on account of irregularity and delay in payment of wages, and, finally, in April, there was trouble both in the Susquehanna shops and in the Jersey City freight yard over this same cause. The indications afforded by these troubles were borne out by the figures of the annual reports. The gross earnings of 1874 were $1,413,708 less than those of 1873,38 while the decrease in operating expenses was so slight as to reduce net earnings by nearly the same amount. If, now, there is deducted from the net earnings of the years 1871–3, inclusive, the sum which the London accountants declared to have been improperly reported as profits, there results an average of $4,175,699 net; or less than the net earnings for either 1864, 1865, or 1866, although the average charges for the years mentioned exceeded the average of the earlier period by $1,769,060 each year. These figures exclude the influence of the panic of 1873, which, as has been seen, caused a still further falling off in the earnings of the company. It was a time, moreover, when the Erie could not be content to sit still and wait, for competition was daily becoming more severe. By 1874 the Baltimore & Ohio, the New York Central, and the Pennsylvania had connections with Chicago, and the Erie was competing with them for business by means of traffic agreements with connecting lines. The next decade was to see the bitterest rate wars that the country has ever known; and the Erie, with its exceptional gauge and single track, was to compete with rivals of normal gauge, who were adding third and fourth tracks to the two which they already possessed. The one bright spot was the development of the coal traffic, which in 1874 formed the greatest item of the Erie’s tonnage, and was in a measure apart from the competition of other lines.

Suit was brought in July, 1874, for the appointment of a receiver. The complaint reviewed alleged improper acts of the management in declaring dividends, in buying Buffalo, New York & Erie stock and sundry coal lands, and in issuing the new $30,000,000 mortgage before mentioned.96 In October the Attorney-General of New York instituted suit on nominally the same grounds; not, as he explained, in the expectation that the appointment of a receiver would be required, but in order that this action might be taken if the conduct of the directors should make it necessary. Still other suits were begun before the year was out.

Meanwhile the management was changed. Whether or not Mr. Watson, who had been president since 1872, had done all humanly possible to set the Erie on its feet, his administration was not unnaturally in bad odor after the charges of Dunan and the report of the London accountants, to say nothing of the admittedly low39 earnings for the year 1874. An attempt was made to secure the very best man possible for the presidency, and to support him in necessary reforms, in the hope of some different results from those with which securityholders had become familiar. The man for the place was thought to be Mr. H. J. Jewett, a railroad man then in Congress from Ohio; and this gentleman was accordingly secured at an extremely liberal salary. Soon after his election a ten per cent cut in salaries was decreed, and an examination of the accounts of the stations along the line in behalf of the company was begun. It was too late, however, for the company. The business of the last of 1874 and first of 1875 was poor; floods in the spring damaged the property of the road, and rumors of a receivership were rife. On May 22 a private meeting of stockholders in New York passed resolutions to the effect that the borrowing of money by the sale of 7 per cent bonds at 40 cents on the dollar, and other means adopted by the Watson administration, would inevitably result in bankruptcy; that sound interest required that the money needed to pay interest should be raised by an assessment on the stockholders, and that the directors should be thereby requested to open books to examination, and to invite stockholders to contribute voluntarily a sum sufficient to keep the company from immediate failure.97 The proposal showed a proper spirit, but was impracticable. Four days later Mr. Jewett was appointed receiver on application of representatives of the Attorney-General and of the Railroad.98

This was the second receivership which the Erie had had to face, and the situation was materially worse than at the previous failure. According to the statement of President Jewett the funded indebtedness in May, 1875, amounted to $54,394,100, and the fixed charges to $5,059,828; while the net earnings for the previous nine months had decreased 13.4 per cent from the corresponding period for the previous year, and a serious deficit was in view. Temporary measures of relief had served but to drag the company further into the mire;99 and, most important of all, the causes for the existing difficulties40 were of a permanent nature, so that the future gave promise of still harder conditions than had existed in the past. What was needed was a reorganization which should undo the evil work of Gould, Fisk, Drew, and their associates, and which should secure the margin of surplus earnings which the reorganization of 1859–62 had failed to provide. Perhaps the chief difficulty lay in the fact that the men who were responsible for the increased capitalization were not at all those on whom the brunt of reconstruction would fall; for while the managers of the road had been Americans, the gullible investors had been Englishmen; and it was reported that much of the watered stock of the Gould régime had been unloaded on the English market.

Committees sprang up promptly. The most important of them were the English committees of bond- and stockholders, soon consolidated under the chairmanship of Sir Edward Watkin. On August 7, Sir Edward left England on a visit of inspection, accompanied by Mr. Morris, counsel for the bondholders. Conference with the board of directors and with President Jewett followed, and a provisional scheme of adjustment was decided upon. In his report to his English constituents Sir Edward outlined the results. Current indebtedness, said he, was $42,180,075; estimated net revenues for the year ending in June last were $3,715,609; operating expenses had been for that year 79 per cent, due largely to the cost imposed by exceptional gauge, while the chief lines with which the Erie competed showed proportions of only from 60 to 66 per cent. Out of fourteen branches only three showed a profit above rentals, and pay-rolls had ordinarily been months in arrears. These facts were familiar; the remedy proposed was unfortunately familiar as well. “Let it be hoped,” said this English financier, “that the bond- and stockholders will have the courage now to submit to a period of self-denial, and will consent to pay their debts and complete essential obligations out of available net profits, the bondholders receiving in place of cash such equitable obligations, realized out of surplus revenue in the future, as each, according to right of priority, may justly expect.”100 What could this have meant save an issue of stock or income bonds for coupons falling due, with the result of41 adding to the unwieldy capitalization of the road instead of reducing it as should have been done! For the rest, Sir Edward Watkin concluded with Mr. Jewett the following arrangement:

(1) Three nominees of the bond- and stockholders’ committee proposed by Watkin were to take seats in the Erie board;

(2) Mr. Morris was to be associated with counsel for the receiver and for the company, and was to be regarded and treated as one of the professional agents and officers of the undertaking;

(3) Mr. Jewett was to transmit a memorandum of his views on reorganization;

(4) Net earnings were to be retained for a while, and bondholders were to have a voice in their expenditure. Thus a vote was to be taken under the charge of the stock- and bondholders’ committee in London on the constitution of a committee of consultation, consisting of representatives of each class of bondholders and of preferred and ordinary stock, and that committee was to designate a special representative whose consent and approval were to be taken by Mr. Jewett in the expenditure of net earnings;

(5) Monthly reports of actual earnings and expenditures, together with reports from the president and receiver, were to be regularly transmitted to the office of the committee in London;

(6) Bond- and stockholders were to be urged to give power of attorney and proxies to Watkin, or to such other person or persons as the above representatives of the bond- and stockholders should designate;

(7) Any scheme of reorganization was to include a provision giving bondholders a voting power.

On the above resolutions Jewett, with his board, and Watkin, with his committee, agreed to co?perate.101 Under the circumstances the increased power given the bondholders was both a natural and a just demand, and it is probable that Mr. Jewett’s prompt acquiescence in it had something to do with Sir Edward’s advice to the securityholders “to rely on the honor, as I feel you may also upon the anxious labors and full experience of the President and Receiver.”

The report did not go uncriticised. It was pointed out, first, that a majority of English proprietors could not unhesitatingly share the confidence expressed in Mr. Jewett; second, that the first mortgage bondholders were well secured, and would surely refuse to fund42 their indebtedness; and third, that the payment of the floating debt, according to the Watkin plan, would simply create another debt of equal or greater amount due to the bondholders whose coupons were not paid. The only sound way, said a committee of bondholders in Dundee in a letter to the Watkin Committee, is resolutely to shun an accumulation of mortgage liabilities on the one hand, and on the other to give increased reality to the bonds and stocks of the company already existing as items in capital account, i. e. an assessment on the stock and a sweeping reduction in the interest on the bonds secured by the second mortgage:—the first mortgage bonds are in different case—they represent investment of cash instead of mere water, and even if foreclosure is difficult, they have beyond question an absolutely good security for the ultimate payment of both principal and interest.102

In September, 1875, a plan of reorganization was anonymously put forward as follows: Instead of assessment on the shareholders, it suggested the issue of 50 per cent more common stock; one new share for every two shares then existing. If a price of $25 per share could be obtained a total of $10,000,000 cash would be thereby secured. Besides the new stock issued bond- and preference-holders were to capitalize their interest for two years in bonds or shares bearing their present priorities. This funding should yield $8,000,000; and the $18,000,000 in all obtained was to be expended on the road over the next two years, during which period the new shares were to be paid up by half-yearly instalments. With the line furnished and equipped as proposed, continued this optimistic plan, the working expenses could be reduced from 79 per cent to 60 per cent, and the traffic within three years would be at least $24,000,000 per year, affording a net revenue of $9,600,000 per annum, sufficient to meet all bond and preference liabilities and to leave 3 per cent for the ordinary charges.103 The all sufficient criticism to this plan was that it required too great a combination of favorable circumstances to ensure its success. In some respects, however, it was not unlike the plan ultimately adopted.

Two months later appeared a plan by Mr. John C. Conybeare, an English bondholder, which was superior to the foregoing in that it proposed an assessment, and made some slight provision for an43 ultimate reduction in fixed charges. Mr. Conybeare proposed to assess preferred stock $11 and common stock $9. Payment of the assessment was not to be compulsory, but was to have the effect of giving to the stock which did pay a right to dividends before anything should be received by that which did not pay. Shares of the company by the plan would thus have ranked as follows:

(1) Preferred shares on which assessment had been paid, entitled to 7 per cent dividends before any other dividends were paid.

(2) Preferred shares on which no assessment had been paid, with rights inferior to the preferred A shares, but superior to the common shares.

(3) Common stock on which assessment had been paid, entitled to 4 per cent before further dividend on the common.

(4) Unprivileged, unassessed common stock which was to take what there was left.

In addition there was to be a pre-preference 8 per cent stock, ranking before all the above, which was to be issued to exchange in part for second preferred and convertible bonds. First consolidated bonds and sterling bonds of 1865 were to accept one or two per cent of their 7 per cent interest in bonds, secured perhaps by the coal property of the company, while the second consolidated and the convertible gold bonds were to receive 4 per cent in gold and 3 per cent in the new pre-preference stock as above. To the obvious possibility that the stockholders would refuse to pay an assessment the plan opposed no remedy. In this case the very moderate amount of interest funded would have been the only relief secured.104

These plans were, however, but preliminary to the elaborate Watkin scheme which appeared in December. The most prominent feature herein was, as previously indicated, the funding of coupons, both those past due and those to become due for a time into the future. Given net earnings sufficient to meet fixed charges, the postponement of interest by this plan would obviously have released revenue with which to make needed improvements on the road. This funding was to be, however, limited to the first consolidated 7s, convertible sterling 6s, second consolidated 7s, and convertible gold 7s; the six earlier issues were to be left untouched. One permanent reduction was also to be made, in that for the second44 mortgage and convertible 7s were to be given two classes of ninety-year gold bonds: the first for 60 per cent of the principal, with interest at 6 per cent, and payable in bonds of the same class from the dates of default until March, 1877, and thereafter in gold; the second for 40 per cent of the principal, carrying 4 per cent until 1881 and thereafter 5 per cent, payable only out of net earnings. To start the company on its way and to meet present obligations an assessment was proposed of three dollars on the preferred and six dollars on the common stock, in return for which 5 per cent income bonds were to be given; while finally the dividends on the preferred stock were to be reduced from 7 to 6 per cent, and foreclosure was contemplated, so that the opposition of an irreconcilable minority might be more easily overcome.105 According to the figures in the Watkin plan, the old and new capitalization and interest compared as follows:

The amount of capital stock was unchanged.
Total bonded indebtedness     Principal     Interest     ?
Before reorganization,     $54,394,100     $4,073,106     ?
After reorganization,     ?61,330,241     ?4,139,240     ?
Increase     ?$6,936,141     ?? $66,134     ?

Indebtedness on which interest was obligatory:
      Principal     Interest     ?
Before reorganization,     $54,394,100     $4,073,106     ?
After reorganization,     ?46,634,134     ?3,316,238     ?
Decrease     ?$7,759,966     ? $756,868     ?

The net earnings for 1874–5 had been $3,715,609, and those from 1871–3 inclusive, with the deductions declared proper in the report of the London accountants, had averaged $4,175,699 each year, so that a safe margin seemed to intervene. The extent of the margin depended, however, on the fixed charges, such as rentals, over and above interest on the funded debt; and although it was proposed to cancel burdensome leases and contracts the actual leeway after 1880 was to be very small indeed. To speak briefly, the plan was definite but not sufficiently radical to meet conditions which were likely to arise. In counting upon the ability of the company to spare considerable sums from revenue for improvements during the next few years, it was leaning on a broken reed; in increasing the nominal45 amount of bonded indebtedness, it was making a step in the wrong direction; and by interposing additional claims on earnings while leaving the volume of stock the same, it took from the stockholders any very lively interest in the road’s future welfare. The plan was nevertheless accepted by the English securityholders, subject to such modifications as might afterwards be found desirable.106

The next step was to obtain the unanimous acceptance of this Watkin scheme. Messrs. Robert Fleming and O. G. Miller were accordingly sent to New York in February, 1876, to consult with the officers of the company and the securityholders in America. No very vigorous interest was taken on this side, but the Erie directors appointed a committee to confer with the English representatives, and discussions took place for something over a month. The committee criticised the plan proposed from the point of view of the stockholders; they maintained that it would destroy all their interest in the property unless they made further sacrifices, which they were unable to do, and suggested that the funding of from four to eight coupons by the first consolidated, gold convertible, and second consolidated bonds was all that would be needed to put the road in a prosperous condition, provide for steel rails, and for the narrowing of the gauge.107 This was so plainly inadequate that it is a matter of surprise that it was entertained by the English committee; and even they insisted that the stockholders agree to put a majority of the $86,000,000 of stock in the hands of the bondholders as a preliminary, and would do no more than lay the proposal before their constituents.

On their return home in April Messrs. Miller and Fleming stated that the essential conditions to a successful reorganization were:

(1) An effective control of the management by the real owners,—the bondholders;

(2) The restoration of the equilibrium between the compulsory interest charge on the mortgage debt and the minimum net earnings;

(3) A change of gauge from 6 ft. to 4 ft. 8? in.108

“The foreclosure scheme of the committee” (Watkin plan), said they, “is certainly the soundest plan and would doubtless be preferred by those shareholders who really care for the welfare of their property.” Then referring to the directors’ plan, “If it were possible to present to the bondholders the scheme of proceeding by46 amicable arrangement as practicable, and therefore as presenting a real alternative for their acceptance, we should suggest to you at the same time to lay the option before them. We feel, however, that that scheme can only be regarded as such an alternative when stockholders enough have signified their willingness to vest their shares in trustees on the footing of it, and so secure an effectual control to the bondholders for a certain period. We must, therefore, content ourselves for the present with suggesting that the committee should proceed with vigor in the direction of foreclosure, at the same time inviting the stockholders to signify their willingness to vest their stock in trustees as above mentioned.”109

The suggestion of the directors was the last alternative plan proposed, and from April, 1876, the only question was how to perfect and carry through the Watkin plan. As eventually put forward, this differed in a few points from its form as earlier announced. The fundamental principle was still the funding of coupons of the first and second consolidated and the convertible bonds. Of these the first consolidated mortgage and sterling 6 per cents were now to fund alternate coupons from September 1, 1875, to September 1, 1879, instead of funding all coupons to March 1, 1876, and receiving cash thereafter: and whereas in the earlier plan mortgage bonds of the same class had been given for funded interest, the later plan created special issues of funded coupon bonds, secured by deposit of the funded coupons, and bearing the same interest as the first consolidated bonds themselves. A more serious difference appeared in the treatment of the second mortgage and the gold convertibles. It will be remembered that it had been proposed in December, 1875, to exchange these for two classes of new bonds, of which 60 per cent were to bear interest at the rate of 6 per cent and 40 per cent were to consist of 4 per cent income bonds. The new plan did away with this permanent reduction in fixed charges. Instead, the second consolidated and convertible gold bonds funded alternate coupons from June 1, 1875, to December 1, 1879, and received a new 6 per cent bond for the principal of their holdings, and funded coupon 6 per cent bonds for the interest thus postponed; the new mortgage bonds not having the right of foreclosure until after default for six successive interest periods (3 years). The funded coupon bonds were47 to be funded at the existing rate of interest on the second consolidated and convertible bonds, i. e. 7 per cent, so that the reduction in interest was compensated for by the greater volume of securities given; and both classes of these coupon bonds were to bear lower interest at first than that to which they would ultimately attain. The assessment proposed in 1875 was retained in 1876, except that stockholders were given the choice of paying $6 on common and $3 on preferred stock and obtaining therefor income bonds, or of paying $4 on common and $2 on preferred and receiving nothing but new stock, dollar for dollar for their old.110 One-half of the shares of the new company (after foreclosure) were to be issued in the name of one or more sets of trustees, who were to hold them to vote on until a dividend had been paid on the preferred stock for three consecutive years. Provision was made for an issue of $2,500,000 in prior lien bonds, to take precedence of the remainder of the second consols, the proceeds to be applied to capital requirements. Voting power was conferred on the first and second consols, funded income bonds, prior lien bonds, and income bonds, in all about $57,000,000; one vote to every $100 of bonds.111 The property of the company was to be foreclosed by or under the direction of certain reconstruction trustees, for the choice of whom careful provisions were inserted.

Divested of all complications, what this reorganization plan proposed for the salvation of the property was the funding of the coupons on four classes of bonds from 1875 to 1879; the reduction of the interest to be paid on $25,000,000 second consolidated and convertible 7s one per cent per share; and the raising of a certain amount48 of cash by assessment upon the stockholders; while it dropped the one point of the earlier plan which might have given a key to the solution of the whole problem, viz. the exchange of mortgage and income bonds for the old second consolidated in the ratios respectively of 60 per cent and of 40 per cent. When we remember the desperate straits to which the company had been reduced, the permanent relief seems slight enough; and given the fact, which proved but too true, that the net earnings were to fall off until the road was little more than able to meet the alternate coupons which it was obliged to pay in cash, it appears to have been nothing at all. If we suppose no changes to have occurred in capital account between 1878 and 1883 save those provided for in the plan of reorganization itself, a comparison of the two periods would have stood as follows:
Before reorganization     Principal     Interest     ?
Sterling convertible 6s,     ?$4,457,714     ? $267,463     ?
First consolidated 7s,     ?12,076,000     ?? 845,320     ?
Convertible 7s,     ?10,000,000     ?? 700,000     ?
Second consolidated 7s,     ?15,000,000     ?1,050,000     ?
      $41,533,714     $2,862,783     ?
Old Mortgages,     ?13,155,500     ?? 921,062     ?
Guaranteed bonds, etc.,     ??6,003,360     ?? 449,411     ?
      $60,692,574     $4,233,256     ?
Rentals,           ?? 742,226     ?
            $4,975,482     ?
After December 1, 1883     Principal     Interest     ?
Consolidated 7s,     $20,005,794     $1,400,405     ?
Consolidated 6s,     ?33,516,666     ?2,011,000     ?
      $53,522,460     $3,411,405     ?
Old bonds,     ?13,155,500     ?? 921,062     ?
Guaranteed bonds, etc.,     ??6,003,360     ?? 449,411     ?
Rentals,           ?? 742,226     ?
      $72,681,320     $5,524,104     ?
Total before reorganization     ?60,692,574     ?4,975,482     ?
Increase,     $11,988,746     ? $548,622     ?

It thus appears that this reorganization plan contemplated an immediate increase in the cumbrous capitalization of the company to the amount of nearly $12,000,000, and an eventual increase in fixed charges of over $500,000. It offered no reasonable assurance that the solvency of the company could be maintained under the49 average conditions existing in the past, and left no margin for contingencies of any kind. The trouble lay in the unwillingness of bondholders to sacrifice any part of their holdings to meet difficulties caused largely by inflation over which they had had no control. This reluctance was natural,—it should have been met, however, by the realization that the question was now of the future and not of the past, and that the best interests of the bondholders themselves demanded a reconstruction sufficiently radical to leave no doubt of the ability of the new company to pay its debts.

The plan adopted, foreclosure was in order, and suits which had been begun as early as 1875 were taken up and pushed. In November, 1877, a decree of foreclosure under the second consolidated mortgage was obtained, appointing a referee to conduct the sale, and providing for the sale of the road to representatives of the bondholders in case they made the highest bid. The opposition, which had not been able to prevent the approval of the plan, now appeared with a multiplicity of suits to prevent its consummation. In January, 1878, demands were made to secure a re-accounting from the receiver, and the reopening of an earlier suit of the people against the Erie which had been previously discontinued. On January 18 the postponement of the sale to March 25 was obtained. On January 19 a suit demanded the removal of Receiver Jewett, making sweeping charges of fraud; and on January 30, in still other proceedings, Mr. Jewett was arrested on a charge of perjury for swearing to incorrect statements in the annual report to the state engineer;—a culmination as disgraceful as it was absurd. In February a suit in Orange County, New York, demanded the removal of the receiver, and the appointment of a special receiver during the pendency of the action, with an injunction to prevent the sale of the road. In March a petition of one Isaac Fowler, a stockholder, for permission to examine the company’s books, was granted; argument was heard on the petition of James McHenry to intervene in the foreclosure suits and further to postpone the sale; the application of Albert Betz and others to be made parties was granted; and postponement of sale to April 24 obtained. Last of all, on April 23 and 24, arguments in behalf of John F. Brown and F. W. Isaacson were heard, asking for postponement to a still later date. The litigation availed nothing. Judge Potter in the Brown suit held that50 the courts could relieve against any injustice occasioned by the sale, and on April 24 the property of the Erie Railway was sold for $6,000,000 under foreclosure of the second consolidated mortgage.112 The new corporation formed to take over the railroad was called the New York, Lake Erie & Western Railroad Company, and had its articles of incorporation regularly filed at the office of the Secretary of State. Mr. Jewett was elected president. In May the receiver was discharged,113 and a new stage in the history of the road began.

For about seven years the Erie was to be free from the necessity for further reorganization. This result, unexpected from the nature of the adjustment of 1878, was due to the vigorous policy of Mr. Jewett, first, in developing the coal traffic for which the Erie was well located; second, in improving the condition of the road; and third, in securing connections with Chicago.

For some time the Erie had been a considerable carrier of coal and a large owner of coal lands as well. In 1877, the first year in which the figures were separated in the annual report, roughly 273,000,000 out of 1,113,000,000 ton miles reported, or something over one-quarter, were due to the carriage of coal; and $2,697,776 out of a total of $10,647,807 of the freight earnings came from that business. The lands owned by the company consisted of 8000 acres in fee, and large tracts in leasehold and mining rights in the anthracite territory in the northeast corner of Pennsylvania; together with 14,000 acres in fee and 13,000 acres of mining rights in the bituminous territory in the northwest portion of the state.114 Mr. Jewett felt that this property could be made of great value to the road, and it was under his administration as receiver that steps were taken to extend the holdings of bituminous land, and to control branch roads leading into the district. The result appeared in a remarkable extension of the company’s business. While the total freight ton mileage from 1878 to 1884 increased 103 per cent, the ton mileage of coal increased 190 per cent, or nearly tripled; and while the gross earnings on ordinary freight grew from $7,950,031 to $11,687,520, those51 on coal increased from $2,697,776 to $5,437,000. At the same time McKean County, directly north of the coal lands, and containing large tracts purchased by the Erie in the course of its other negotiations, turned out to be an abundant oil-producing district, and made the Bradford branch, which tapped it, Erie’s most valuable collateral property.115

It was partly because of the success of the policy in respect to coal lands that the Erie was enabled to spend large sums in the improvement of its road. In the six years from 1878 to 1883 the company put nearly $14,000,000 into improvements of the road, property and equipment, and of this about one-half was paid out of surplus earnings. In December, 1883, alone, $304,565 were spent, and in the three succeeding months nearly double that amount; making a total of nearly $1,000,000 in the four months previous to April, 1884. The money went toward reducing grades, straightening curves, increasing weight of rails, etc., including the completion of a third rail to Buffalo by which the serious disadvantage of an exceptional gauge was removed. Its result was seen in the decrease in the ratio of operating expenses from 75.13 in 1875 and 77.16 in 1876 to 64.78 in 1883; and in the rise of net earnings per ton mile from .251 cents to .261 cents, while the gross earnings per ton mile decreased from 1.209 cents to .780 cents. No policy which the Erie managers pursued met a more crying need, and none did so much toward maintaining the solvency of the company.

The project of controlling a line of their own to Chicago was brought actively to the attention of the Erie managers by the danger of being cut off from a connection with that city. The original line of the Erie had run to Dunkirk on Lake Erie, from which a branch to Buffalo had soon been built. For western traffic the Erie had had to rely largely on the Atlantic & Great Western (later the New York, Pennsylvania & Ohio), which connected with the main line at Salamanca, New York, and extended by 1884 west to Dayton, Ohio. In 1857 the Erie first leased this property. Placed in receivers’ hands in 1869, the Atlantic & Great Western was re-leased to the Erie on January 1, 1870; sold July 1, 1871, it was again leased to the Erie in May, 1874, only to enter upon a new receivership on December 9 of that year. The persistent attempt to control the road52 showed the value which the Erie placed upon it, and in fact it was invaluable as a link in a prospective line to the West. Even while the leases were in force, however, the Erie lacked that connection of its own with Chicago which seemed necessary to make it a successful competitor for trunk-line business. In 1882 it was forwarding passengers over not less than five different routes, over no one of which could it feel assured of the continuance of contracts of a favorable nature. In 1881 Mr. Jewett relieved the situation by acquiring control of the franchise of the Chicago & Atlantic Railway, extending from Marion, Ohio, on the line of the New York, Pennsylvania & Ohio towards Chicago, and soon after he entered into a contract with certain private parties for construction of the road. In 1883 he executed a new lease of the New York, Pennsylvania & Ohio, which he hoped would secure for the Erie permanent control of the property, and about the same time (1882) he purchased a controlling interest in the stock of the Cincinnati, Hamilton & Dayton, which extended the Erie system to the important city of Cincinnati. These operations put the Erie upon a footing which was secure so long as the obligations which they entailed could be met, and showed a broad-minded appreciation of strategic necessities. The terms of the arrangement with the Chicago & Atlantic were as follows: For the construction of the road the Erie agreed to give to the directors the entire proceeds of the mortgage bonds of that branch ($6,500,000), and its entire capital stock ($10,000,000); making an aggregate of $61,710 per mile of line. The proceeds were, however, to be deposited with the president of the New York, Lake Erie & Western in trust, together with certain subsidies which had been voted by the counties and townships along the line, and upon him was to devolve the duty of seeing to the proper application thereof; and besides this, 90 per cent of the stock was to be deposited and an irrevocable proxy given thereon for the thirty years’ life of the bonds.116 The obligation which the Erie assumed amounted in practice to guaranteeing that the road should be constructed for the sum provided, and that interest on the bonds should be paid. In leasing the New York, Pennsylvania & Ohio the Erie involved itself more heavily. As lessee it agreed to pay the minimum sum of $1,757,055 yearly (the net earnings of 1882); the actual rental to be 32 per cent of all gross earnings53 up to $6,000,000 and 50 per cent of all gross earnings above $6,000,000, until the average of the whole rental should be raised to 35 per cent, or until the gross earnings should be $7,200,000. If 32 per cent of the gross earnings should ever be less than the $1,757,055 to be paid yearly, then the deficiency was to be made up, without interest, out of the excess in any subsequent year. Out of the rental the New York, Pennsylvania & Ohio was to pay the interest on its prior lien bonds, the rentals of its leased lines, the expenses of maintaining its organization in Europe and America, and for five years a sum of $260,000 each year to the car trust.117 Finally, in purchasing the Cincinnati, Hamilton & Dayton, the Erie gave to the holders of the $2,000,000 of stock which it bought beneficial certificates to the amount of $1,500,000, on which it agreed to make good any failure of the Cincinnati company to pay 6 per cent per annum.

But though the Erie managers did their best with the conditions which they were called upon to face, they were unable to hold the company up under the enormous capitalization and heavy charges left by the reorganization of 1874–8, at a time when rate wars were sapping its resources, and when contracts which it was being forced to make were entailing an annual loss.118 In spite of the declaration of sufficient dividends on the comparatively small amount of preferred stock to terminate the voting trust, it is certain that for most of the years from 1874 to 1884 the solvency of the road was a precarious matter, and that there never was a time when any considerable falling off in earnings or any severe shock to its credit would not have driven it to the wall.

Such a shock was preparing in the early months of 1884. For some weeks before the last of April there had been a tendency for the quotations of Erie securities to fall; no reason was assigned, but it was hinted that default might be made in the payment of the June interest on the second consols, and that a receivership was not unlikely. This weakness was accompanied, and perhaps accentuated,54 by a strike of the brakemen on the New York, Pennsylvania & Ohio in consequence of an order reducing the number of brakemen on each train from three to two. The truth of the matter came out in May, when the failure of the Wall Street firm of Grant & Ward both precipitated a stock exchange panic and laid bare the straits to which the company had been reduced. Investigation showed that a large floating debt had been piling up for four principal purposes: First, advances to the Chicago & Atlantic Railroad; second, advances for coal mines; third, advances for improvements on the Hudson River at Weehawken; fourth, equipment instalments.119 Attempts to raise funds to cover the debt had resulted in the negotiation of promissory short time notes with the firm of Grant & Ward, for which $2,500,000 of Chicago & Atlantic second mortgage bonds had been deposited as security. The company had been attracted to Grant & Ward by their offer to purchase and dispose of Chicago & Atlantic bonds at a price 15 per cent above that offered by any other parties;120 and had trusted so implicitly in their integrity as to deposit notes and collateral for its short time loans detached and independent, one from the other, so that Grant & Ward were able to, and did, fraudulently raise money upon them to an amount much larger than the advances they had made. The losses entailed by the transaction were serious, and the blow to Erie’s credit was even more severe. The floating debt which had been so hard to carry became doubly menacing now that the possibility of further short time loans was practically cut off; and to cap the climax, the earnings for the first half of the year 1884 showed an unusually large decrease with the cessation of the fall business. Under these circumstances it was the part of wisdom to take advantage of every loophole of escape, and the peculiar provisions of the second consolidated mortgage, denying to these bonds the right of immediate foreclosure in case of default, were turned to for relief. It will be remembered that by the terms of the reorganization of 1878 no right of action was to accrue to the second mortgage bondholders until on each of six successive due dates of coupons (three years) some interest secured by the second indenture should be in default. This being the case the Erie directors decided to pass the June interest on these bonds. “As a general rule,” said they in a circular, “the business55 and earnings of the company are much less for the first half than for the last half of the year. The falling off in earnings for the first six months of the previous year has been unusually large. The coupons of the second consolidated mortgage bonds are due and payable on the first of June prox.... Under ordinary circumstances the board might at the present as on the former occasions provide to some extent for the deficit of the first six months, relying on the usual increase in earnings of the last half of the year, but in the present depressed condition of the business of the country and of the earnings of this company, as well as of others, the board does not feel at liberty to deal with anything but the business and earnings as now ascertained, and therefore deems it wise to accept the provisions of the mortgage as the lawful rule for their government in the existing emergency....”121

However necessary the action, the bondholders of the company could not have been expected to receive it quietly; and naturally again, the indignation was intense among the English securityholders, to whom, more than to any one else, the existing situation was due. In June, 1884, a meeting of stockholders of the company was held in London, at which much complaint was made of the fall in value of the securities of the company, and an inquiry into the management was demanded. A committee was appointed, and two of its members, Messrs. Powell and Westlake, landed in New York July 15, with protestations of a friendly spirit toward all concerned. The situation was not encouraging. The day before their arrival President Jewett had offered his resignation, and the directors were busy selecting his successor; a large floating debt was demanding most vigorous attention, and confidence in the company was at a low ebb. Beyond a doubt the raising of a large amount of cash, $4,000,000 to $5,000,000, was a pressing necessity, and the English representatives were anxious to make it plain that at least a fair share of this should come from American as well as from English bondholders. Force of circumstances compelled them to give assurance that the money would be raised, and this done, Mr. John King accepted the position which Mr. Jewett professed himself ready to resign. Pending the annual election Mr. King took the position of Assistant to the President.

56 On their return to London Messrs. Powell and Westlake reported the floating debt to be as follows:
Unpaid coupons, June 1, 1884,     $1,007,922     ?
Balance of actual and early maturing liabilities other than the June 1 coupons over and above cash in hand and money assets considered good and available,     $4,447,316     ?

“All the purposes, the expenditures on which have caused the floating debt,” said they, “seem to us to have been in themselves wise and politic, but the piling up of a large floating debt for even the best of purposes is always more or less imprudent and dangerous. The company’s credit might have borne the strain of the panic, but it was broken down by the Grant & Ward disaster, and the funding of its floating debt is now indispensable.... We have suggested to the president and directors, and now recommend to the committee that an effort should be made without delay to raise a permanent loan on the securities available for a total of $5,000,000.”122 This, it will be observed, was the old remedy. Inability to meet current expenses was to be removed by capitalizing the debts which this inability had caused.

The year 1885 was taken up with suits brought against the Erie by certain of its branch lines. In February the directors of the Buffalo & Southwestern Company brought suit to recover $345,000 interest defaulted during the previous January. The complaint alleged that the Erie was insolvent, and asked that it be restrained from using the gross receipts of the road until the default should have been made good. The Erie paid the back interest, but in July, after another default, an injunction was obtained forbidding it to divert any part of the earnings received or to be received from this property. It was recited that on May 24, 1881, the Buffalo & Southwestern had been leased to the Erie for 35 per cent of the gross earnings, subject to certain deductions; that the Erie had delayed payment of the rental due in January, 1885, and had refused to pay that due in July, 1885, but that it was still receiving the gross earnings of the plaintiffs’ road, and had applied these to the payment of its debts other than the rentals of this road.123 In November, after57 the Erie’s other troubles were settled, the litigation was terminated by an agreement to reduce the Buffalo & Southwestern rental from 35 per cent to 27? per cent. Other suits arose, directly or indirectly, because of the control which Mr. Jewett maintained as trustee of the stock of the Chicago & Atlantic and the Cincinnati, Hamilton & Dayton railways even after his resignation from the Erie Company. On the one hand President King was anxious to repossess himself of these important branches for the Erie, and on the other Mr. Jewett was not disinclined to do what damage he could to the managers who had succeeded in supplanting him. In the matter of the Chicago & Atlantic Mr. Jewett gained the first victory in a temporary injunction forbidding the Erie to divert traffic from this line contrary to contract. This injunction was soon, however, substantially vacated, and President King in his turn obtained a decision that Jewett had been made trustee of the Chicago & Atlantic simply because he had been at the time vice-president of the New York, Lake Erie & Western Railroad Company and could be relied upon to control the road as the western outlet of the Erie. A receiver was subsequently appointed and the road reorganized as the Chicago & Erie Railroad Company, the Erie agreeing to guarantee payment of its first mortgage bonds, and receiving in return the $100,000 of capital stock and $5,000,000 in income bonds, besides $2,000,000 first mortgage bonds which were in part payment of old advances.124 In his action concerning the Cincinnati, Hamilton & Dayton President King was less successful; and Mr. Jewett was sustained in his refusal to deliver proxies for the stock held to the larger company. The result was to turn the Erie to the Big Four, upon which, instead of upon the Dayton road, the management was for some time to rely for an entrance into Cincinnati.

During these various contests the suggestions of the English committee were not lost to view, and in the latter part of 1885 they crystallized into definite propositions. The floating debt then consisted of two parts: first, the defaulted coupons on the second consolidated bonds; and second, the current liabilities accumulated for the purposes before described. The relief proposed was likewise in58 two parts, and involved the issue of a 5 per cent mortgage, secured by deposit of the second consolidated coupons maturing and to mature in June and December, 1884, June, 1885, and June, 1886, and a 6 per cent mortgage upon the property of the Long Dock Company, comprising the valuable terminals of the Erie at Jersey City.125 The funding of the coupon issue proved simplicity itself; the funded coupons were exchanged for bonds of the new gold mortgage, which were to be redeemable at 105 at the pleasure of the company.126 By the end of 1886 these bonds had been accepted by the holders of $32,982,500 of the outstanding $33,597,400 of the second consols, and $3,957,900 of them had been issued. Dealing with the Long Dock Company was slightly complicated by the fact that 8000 shares of that company were pledged as part security for the issue of Erie collateral bonds. To free them $800,000 in cash were deposited with the trustee of the mortgage, which were in turn employed by him to pay off $727,000 of the 6 per cent collateral bonds, thus reducing the interest charge on that issue $43,620 per annum. This done, the Long Dock Company extended the lease of its property and franchises to the Erie to 1935 at a rental of $480,000 per annum, and contemporaneously therewith placed a consolidated mortgage upon its property to secure $7,500,000 of 50-year 6 per cent gold bonds; of which $3,000,000 were reserved to retire existing indebtedness, and the proceeds of $4,500,000 were paid to the Erie for the cancellation of its floating debt. The total result was to increase fixed charges by $270,000 of interest at 6 per cent on the Long Dock bonds, and by $197,895 on $3,957,900 of the new funded 5s, less the reduction of $43,620 on cancelled collateral bonds; leaving a net increase of $424,275.127 For its ingenuity the scheme was to be admired; from any other point of view it was to be condemned as another example of that borrowing to pay interest which had brought the Erie to its existing straits. The incapacity of the creditors of the company to realize that continued borrowing of money to pay current obligations was only to ensure repeated bankruptcy seemed complete.

59 After this new “salvation,” the Erie started once more on its laborious attempt to pay interest on its outstanding bonds. From 1887 to 1892 the business increased somewhat, and despite a decrease in the average receipts per ton mile128 a gain of about $4,700,000 in gross earnings was secured; from which is to be deducted an increase of $310,996 in fixed charges, and of $4,076,111 in operating expenses.

The prohibition of pooling in 1887 affected the company unfavorably. Previous to the passage of the Interstate Commerce Act the other lines had been paying it an annual average of $42,500 on west-bound business from New York for shortages under the operation of the trunk-line pool, besides about $88,000 annually on east-bound dead freight and $19,770 on live stock. These payments ceased when the Act was passed, although a differential on west-bound traffic was subsequently allowed.129 But the leakage which was most apparent lay in the large rental and heavy operating cost of the New York, Pennsylvania & Ohio. It will be remembered that the Erie had leased that road for 32 per cent of the gross earnings when earnings were $6,000,000 or under, and 50 per cent when they should be above that figure. In 1887 this was amended so as to provide that for every increase of $100,000 over $6,000,000 in the gross earnings the Erie should pay to the lessor an additional one-tenth of one per cent of such gross earnings until the gross earnings should be $7,250,000, and the rental 33? per cent, after which the percentage was not to increase.130 Under the old lease the Erie had guaranteed to carry over the line 50 per cent of all its east-bound and 65 per cent of all its west-bound through traffic—under the new lease, these maxima were increased to 55 per cent and 70 per cent; but even this failed to make the branch road pay. Its grades were high, its equipment and sidings were limited, its cost of operation was well above 68 per cent; and the increase in tonnage provided for emphasized each and every disadvantage. Up to 1893 the results of operations were as follows:

60
            Loss     Profit     ?
First 5 months to Sept. 30,     1883           $199,540     ?
Twelve months ending Sept. 30,     1884     ? $270,281     ?
      1885     ?? 239,820     ?
      1886           ??51,322     ?
      1887           ??91,965     ?
      1888     ?? 343,911     ?
      1889     ?? 331,134     ?
      1890           ??77,376     ?
      1891     ??? 19,586     ?
      1892     ?? 425,888     ?
      1893     ?? 197,106     ?
            $1,827,726     $420,203     ?
Net loss,           ?1,407,523     ?

It thus appears that the terms of the amended lease were in reality more onerous than the contract which they succeeded, and that whatever the value of the branch as a feeder, its operation involved large and fairly regular deductions from the net income of the parent line. Emphasis on these facts was laid in the annual reports, and frequent demands were made that the New York, Pennsylvania & Ohio bring its road up to the standard of like connections of through trunk lines. Meanwhile improvements were imperative on the Erie’s own lines: new equipment was needed, new rails and new motive power, and at the same time surplus earnings were somewhat less. The directors adopted the expedient of allowing current liabilities to accumulate, and put $8,496,572 into the road from October 1, 1884, to September 30, 1892, of which $3,351,977 represented surplus earnings, $2,375,400 increase in bonded indebtedness, and the balance floating debt. In the matter of traffic policy they paid particular attention to the coal business, which, however, lost ground as compared with other freight, and to the local business, which it was the policy of the management to encourage. In 1890 the board declared that “the time had arrived when extraordinary expenditure for improvements and the necessities of the property were no longer necessary.”131 In 1891 3 per cent on the preferred stock was paid, the first dividend since 1884.132

From 1887 to 1893, with all its struggles, the Erie was continually61 on the verge of failure. The capitalization in 1892 was at the enormous total of $163,607,485 on an operated mileage of 1698 miles, while fixed charges were $4993 per mile, and the available net revenue but $4830.133 Given, with this condition, a gross floating debt which amounted in 1892 to $9,163,166, and represented in a large measure the inability of the company to make necessary repairs, no further explanation is needed for the bankruptcy which soon took place.

Early in 1893 rumors were current that the Erie might be thrown into the hands of a receiver. The reports were vigorously denied, but on July 25, nevertheless, on application of the company itself, Judge Lacombe appointed President John King and Mr. J. G. McCullough as receivers of the property. The measure was taken to avoid the sacrifice of collaterals deposited. “Within the last few weeks,” said President King, “during the severe money stringency the floating debt of the Erie ... became impossible of renewal, and in order not to sacrifice the best interests of the company it was decided to place the road in receivers’ hands, and preserve the system intact, and preserve and develop the transportation business for the company.”134 The action occasioned no surprise, and there was even a disposition to praise the management for having preserved the solvency of the company. “The company was bankrupt de facto when it passed to its new control,” says Mott, and “that the time when it must become bankrupt de jure was held off so long was a striking demonstration of the tact and resourcefulness which the new régime had been able to bring to bear in the management of the company’s unpromising affairs, and in judicious shifting and manipulating of the heavy burdens Erie bore upon its chafed and weary shoulders.”135 What a receivership meant was a new opportunity to put the company upon a genuinely sound foundation, by providing new capital to pay off the floating debt and to allow for future additions and improvements, and by getting fixed charges to a point well within the road’s capacity to earn. We shall see what use was made of the chance.

The matter of reorganization was set about at once. On January 1 a plan appeared, prepared, at least nominally, by a special62 committee chosen by the directors,136 and backed by the well-known firms of Drexel, Morgan & Co. of New York and J. S. Morgan & Co. of London.137 By its terms no mortgage senior to the second consolidated mortgage was to be disturbed save the first mortgage, which matured in 1897. The bonds to be dealt with were thus reduced to $41,481,048, besides which provision had to be made for the floating debt and for future capital requirements. The plan proposed to authorize a blanket mortgage of $70,000,000 at 5 per cent, of which $33,597,000 were to exchange at par for the 6 per cent second consolidated bonds and funded coupons thereof, $4,031,400 to exchange for the funded coupon bonds of 1885, and $508,008 for the income bonds. Of the balance, $6,512,800 were to be reserved to settle with the old first lien and collateral trust bonds, $15,915,208 to supply capital requirements in the future, and $9,915,208 to be offered for subscription in order to pay the floating debt. The new management did not conceive that these last bonds could be sold to advantage in the general market, but imposed as a condition of the exchanges as above that second consols, funded coupon, and income bonds should subscribe at 90 to the extent of 25 per cent of their holdings; hoping that the grant of the right of immediate foreclosure upon default would induce the second consols to come in. Both these consols and the funded coupon bonds of 1885, it may be remarked, were to be kept alive and deposited with the trustee for the protection of the new bonds. Stated in tabular form the distribution of securities was to be as follows:
To acquire the existing second consols,     $33,597,400     ?
To acquire the funded coupons of 1885,     4,031,400     ?
To acquire the income bonds,     508,008     ?
For subscription as above,     9,915,208     ?
To acquire the old reorganization first lien and collateral trust bonds,     6,512,800     ?
To be expended for construction, equipment, etc., not to exceed $100,000 in any year, except that $500,000 might be used to acquire existing car trusts,     15,435,184     ?
Total,     $70,000,000     ?

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 & Erie63 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 first64 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 property65 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 to66 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:

$175,000,000 first consolidated mortgage 100-year gold bonds;

??30,000,000 first preferred 4 per cent non-cumulative stock;

??16,000,000 second preferred 4 per cent non-cumulative stock;

?100,000,000 common stock.

The first consolidated mortgage bonds were to be divided into prior lien bonds to the amount of $35,000,000, and general lien67 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 second68 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:
Floating debt, receivers’ certificates, etc.,     $11,500,000     ?
Collateral trust bonds (Erie), at 110,     3,678,400     ?
Reorganization first lien bonds (Erie),     2,500,000     ?
Early construction and expenditures,     5,337,288     ?
Car trusts for three years,     2,000,000     ?
      $25,015,688     ?

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:

69
N. Y., L. E. & W. proper,     ?538 miles     ?
N. Y., P. & O.,     ?600     ?
Chicago & Erie,     ?250     ?
N. Y., L. E. & W. Auxiliary Companies,     ?550     ?
Total,     1938 miles148     ?

—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

70 (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 10?, with no sales, and the preferred at 22?, 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 outstanding71 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 which72 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’s73 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 22? 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 second74 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.