Although, according to the letter of the mortgage contract, they are secured by specific pieces of property, yet, as a matter of fact, this separate security is worthless,-they must all stand together if the earning power of the road is to be maintained. This being the case, what bonds shall be disturbed, in what way shall their claim be reduced, and what compensation shall be given? Let us reverse the inquiry and ask what are the bonds which are not disturbed? In every reorganization we find some of these bonds. Take the Erie road, for example. It has five divisional mortgages made on portions of the line which lie within the State of New York. These mortgages have survived three reorganizations, not being disturbed by any of them. In the same way the Norfolk & Western, the Reading, and the Baltimore & Ohio each carried over certain issues of bonds without in any way disturbing them further than in some cases to change their name by exchanging them into other securities of equal value. These bonds are passed by in the reorganization for the reason that their interest, even in the worst years, has been fully earned. Divisional bonds of important branch roads and first mortgage bonds of larger systems, not to forget terminal bonds, do not suffer for the reason that there is no way to get at them. The property which secures them, such, for example, as a terminal or a connecting link in a trunk line, cannot be dispensed with. Should the holders of these bonds force a foreclosure, they would dissolve the entire system. Moreover, since their interest has been fully earned in the contribution of their security to the general earnings, the courts would undoubtedly protect them against any attempt to reduce the amount of the principal or interest. It is common, however, to find that branch lines have not earned the interest on the bonds, even when allowance has been made for their contribution to the traffic of the main line. In such cases, divisional bonds fare no better than junior liens. For example, in the Norfolk & Western reorganization of 1895, several branch

line issues were partially converted into preferred stock. It is only an absolute first lien that can feel secure in a reorganization. First mortgage consolidated bonds have not been so fortunate. Their lien is subject to divisional mortgages which may easily, in bad years, so diminish the net earnings as to cut into the interest on the general mortgage. The Reorganization Committee of the Atchison, in their circular of 1895, took the following position with reference to the general mortgage bonds:

"After making a careful estimate as to how much of the existing lines, if retained in the system, could, under the circumstances, be avoided, or, if these lines be left out, what amount the Atchison system would be able to earn without the auxiliary lines, the committee has arrived at the conclusion that it would not be safe to place upon the property a fixed charge of more than four per cent upon seventy-five per cent of the principal of the present general mortgage bonds."

The situation of holders of general mortgage bonds in a reorganization is exactly stated by the committee. The road cannot earn their interest. They cannot, in reason, refuse to consent to a reduction of their claim to fixed income. Suppose they should refuse, what can they do about it? The only alternative is to foreclose the mortgage. To do this they must raise enough cash to pay off all the prior liens, for their mortgage is spread over and is subordinate to a large number of claims superior to their own. This is practically impossible, so the only course is to submit or hold out for better terms. It is true that there is always the final resort to the courts, who may, at any time before the recording of the new securities, hold up the whole proceeding by injunction, and that will be done if it can be shown to the satisfaction of the court that any interest is being unjustly treated. Such interference, however, cannot, unless in cases of the most flagrant injustice, be secured by a minority. If a large majority of the bonds are deposited, the courts will usually refuse to interfere, holding that the

consent of the majority should be binding upon all. The contest over the Erie reorganization offers an illustration. A plan had been proposed which seemed unfair to the second mortgage bondholders. Nevertheless 80 per cent of these bonds had been deposited when a suit was brought in the New York Superior Court to enjoin the company from recording the mortgage. The court refused to grant the injunction on the ground that the consent of so large a majority of the parties in interest had made the plan already operative. The disturbance of first mortgage bonds was far more common in the early reorganizations, the reason being that their security at that time was much inferior to what it subsequently became. The first mortgage bonds of the Northern Pacific in 1876 were converted into preferred stock. The first mortgage bonds of the West Shore in 1885 were reduced in amount 50 per cent. The first mortgage consolidated bonds of the East Tennessee, Virginia & Georgia in 1885 were reduced 40 per cent. Arrangements even more unfavorable to bondholders were not uncommon in the early period, and indeed, generally speaking, the bondholders of weak roads must always make heavy concessions. For example, in 1873, the first mortgage bonds of the New York, Ontario & Western were converted into the common stock of the new company at par, and the second mortgage bondholders had to pay 20 per cent in cash for a similar privilege. In the reorganization of the Cincinnati, Wabash & Michigan, in 1880, the bonds received 70 per cent in stock. A method for dealing with bondholders, formerly in common use, was to require them to fund their interest in bonds of the same issue, or to convert it into inferior securities. In the reorganization of the Chesapeake & Ohio, in 1876, $15,000,000 of first mortgage bonds were issued in exchange for the bonds of the old company, with coupons payable for three years in preferred stock, and the second mortgage coupons were made payable for six years in preferred stock. The Erie reorganization plan of 1878

contained a similar provision. Absolute reductions of interest, without compensation in inferior securities, were also not uncommon. Witness the reduction of interest from 6 and 7 per cent to 5 per cent on the Eastern Division bonds. The position of the first mortgage bondholder, however, whether his security be a prior lien or consolidated mortgage, has steadily improved with the general increase in net earnings, and, as already remarked, in the later reorganizations he has been but slightly disturbed in comparison with the losses which he suffered in the period preceding 1893.

The reorganization committee, since they have no claim upon the first mortgage bonds, turn to the junior mortgages and the debenture and income bonds whose interest has not been fully earned. The former position of the junior bondholder was anomalous. He held a claim for a fixed rate of return which would not at all times be paid from the net earnings. This claim was nominally secured by property, but really by revenues-and a revenue inadequate to the payment of interest implies an impaired security. His bond, therefore, was no bond at all, because the distinguishing characteristic of a bond is the power which it gives to enforce its own payment by the sale of the property which secures it, and this it was not possible for the junior bondholder to do. He had, it may be, already discounted the greater risk of an inferior lien in the lower price paid for his bond, thus obtaining for 15 or 20 per cent less than the buyer of a first mortgage bond the same nominal claim to a fixed rate of return. As a matter of fact, the very discount at which the junior bonds were sold indicated that their interest was not fixed, but conditioned on earnings; in other words, that the bond was no bond at all, but rather a claim to a share in profits on practically the same basis as the stockholders. But, although a claimant upon profits, the junior bondholder acted as though his contract was in reality binding and his bond perfectly secured. As a result of his attitude onethird of the railway mileage of the United States has

been at one time in the hands of a receiver, thrown into actual bankruptcy, as though the junior bondholders were really able to enforce a full recognition of the claim upon properties which could not sell for the par value of the bonds outstanding against them. Then, when these bankrupt roads came to be reorganized, it was very soon found that something could not be made out of nothing, and the junior bondholders were obliged to accept the situation and reduce their claims to manageable limits. It has taken thirty years to drive this basal fact into the minds of investors-that a charge is not fixed when it is not at all times earned, and that when its earnings are insufficient to pay the interest on bonds the property can by no possibility sell for enough to pay their principal. The first step in the education of the bondholder was to give him income bonds in exchange for his second and third mortgage bonds, which were very common before 1880, but which have practically disappeared from the bond lists since that time.

It will be worth while to examine in some detail the terms and provisions of an income or debenture mortgage and to note the inconsistency which it involved. The form of an income mortgage contract was in general not different from other mortgages. The indenture was duly made out to a trustee to whom the railroad company acknowledged itself indebted in the sum of $1,000, which was to be paid at some distant date, place, time and manner of payment being carefully set down. Furthermore, the railroad company promises, I use the language of the Richmond & Danville debenture mortgage of 1883,

as interest upon the principal of this bond, such sum, not exceeding 6 per cent per annum, as shall remain out of net earnings of the company in each year, after paying the interest upon all bonds secured upon existing liens upon its property, the rental of all property now leased by the said company and its operating expenses. In its operating expenses shall be included expenditures made for the repair, renewal and improvement of its existing property, as well as