FINAL SETTLEMENT OF THE CENTRAL PACIFIC INDEBTEDNESS TO THE GOVERNMENT
Refunding Proposals
It is the purpose of the present chapter to describe proposals for
the settlement of the government’s claims against the Central Pacific
Railroad which were made between 1878 and the date of maturity of the
subsidy bonds, and to explain in some detail the adjustment finally
arrived at in 1899.
Soon after it became apparent that the Thurman law would not provide
adequately for the retirement of the federal subsidy bonds at their
maturity, agitation began for other and more stringent arrangements.
As early as 1882, the Commissioner of Railroads suggested that the
indebtedness of the Pacific railroads be changed from a running
book account and that there be a settlement and actual delivery
of interest-bearing bonds for the amount found to be due upon a
convenient day, say July 1, 1883. On this day he proposed that the
companies should deliver to the government 100 redemption bonds, each
representing a hundredth part of the indebtedness. One bond was to fall
due thereafter every six months, and interest was to accrue as before
upon the unpaid bonds outstanding.[552]
Five years later the United States Pacific Railway Commission, in
an important report, recommended also that the net indebtedness of
the Central Pacific Railroad Company be ascertained as of a certain
date—this time as of July 1, 1888—and that arrangements be made to
fund the amount so determined into new railroad fifty-year 3 per cent
bonds, which should be made a lien upon all the property which the
Central Pacific owned or in which it had an interest.[553] Congress
was not ready, however, to refund the Pacific railroad debts upon the
terms proposed either by the Commissioner of Railroads or by this
special body of experts.
The next official report was that issued by a select committee to which
the United States Pacific Railway Commission report was referred. This
committee report was known as the Frye-Davis report, from the names of
the Senators who transmitted the sections dealing with the Union and
Central Pacific railroads, respectively. The committee was instructed
to, and did, personally examine the roads of the Union, Kansas,
Central, and Western Pacific Railroad companies, together with that
of the Central Branch Union Pacific. It further prepared a plan for
refunding the Pacific railroad debt.
So far as the Central Pacific was concerned, the committee proposed
that the company should pay its debt in seventy-five years from date,
with interest at 2 per cent. In view of the serious financial condition
of the company, and the alleged necessity of building several bridges
and some additional mileage in California, 1 per cent of the 2 per
cent was to be capitalized for ten years. During the first ten years
the company’s annual payment was thus to be from $600,000 to $650,000
per year; after that time it was to be about $1,400,000 annually.
The Frye-Davis committee therefore required a smaller payment and
contemplated a longer extension of time than did the United States
Pacific Railway Commission. Like its predecessor, it demanded from the
Central Pacific, as security, a mortgage on all the roads and property
of every name and description which the Central Pacific possessed,
including a mortgage on the whole road from four miles west of Ogden to
San José. This mortgage was to include the lease of the Central Pacific
to the Southern Pacific, and there was now inserted a provision that
the rental paid by the latter should never be less than the sums that
the bill called for from the Central Pacific, thus making the Southern
Pacific in effect a guarantor of the arrangement.[554]
Further Reports
In 1894 still another report was rendered, this time by James Reilly,
of Pennsylvania, from the House Committee on Pacific Railroads. The
report reviewed briefly the history of the relations between the
Pacific railroads and the government. It was opposed to foreclosure.
Instead, it suggested that the debt due to the United States be
calculated as of January 1, 1895, and be funded into railroad 3 per
cent bonds. The companies were then to begin paying on the debt at the
rate of one-half of 1 per cent semiannually, for a period of ten years,
commencing on the 1st of July, 1895. For the next period of ten years,
three-quarters of 1 per cent was to be paid; for the next period 1 per
cent; and so continuing that the railroad bonds, and therefore the
principal of the debt, should be wiped out in fifty years. Meanwhile
the railroads were to pay off their first mortgage bonds, leaving the
new funding bonds a prior lien upon the property of the companies,
including both the aided and the non-aided portions. Nothing was done
with this report except to submit it.[555]
As the period when the greater part of the subsidy bonds were to
mature approached, committee reports upon the Pacific railway debts
multiplied. On the 28th of January, the Committee on Pacific Railroads
submitted a long discussion through Senator Brice, of Ohio. The
committee was opposed to government operation and pessimistic about
the results of a foreclosure sale. It recommended that the subsidy
bonds be refunded for such a period and at such a rate of interest as
should enable the companies, under ordinary circumstances and business
conditions, to meet the current interest and a portion of the principal
of the debt each year.
Powers Bill
On April 25, 1896, Mr. Powers, of Vermont, in behalf of the House
Committee on Pacific Railroads, presented a bill and a report to
accompany it. The House committee now definitely proposed that the
Pacific railroad companies issue, and that the government accept,
bonds equal in amount to the whole balance due the United States, and
bearing interest at 2 per cent, payable semiannually. These bonds
were to be secured by second mortgages, which were to embrace not
only the subsidized parts of the Pacific railroads, but also all the
other railroads, terminals, lands, and equipments belonging to the
companies, to which the lien of the government did not then extend. It
was provided that the companies should make annual payments on account
of the principal of the bonds—smaller payments during the earlier, and
larger payments during the later years—in such fashion that the debt
would be repaid in about eighty-five years.
In addition to providing the government with the additional security
which came from extending the lien of its second mortgage bonds, the
Powers bill required, as one of the terms of the settlement, that the
lease of the Central Pacific Railroad to the Southern Pacific Company
should be so modified as to require, first, that the Southern Pacific
Company guarantee the full payment of the obligations imposed upon the
Central Pacific by the new legislation so long as it should remain
lessee of the property; and second, that if the Southern Pacific
Company should consent to the termination of the lease before the
maturity of all instalments payable under the act, it should in that
event guarantee the payment by the Central Pacific of all required
payments. In case of any abrogation or termination of the lease, the
principal of all bonds issued under the act was, at the option of the
President of the United States, immediately to mature.[556]
The Powers bill was debated in the House of Representatives from
January 7 to January 11, 1897. It was supported by the friends of the
railroad companies, doubtless because of the long period over which the
railroad debt was to be extended and the low rates of interest on the
refunding bonds. It was opposed by anti-railroad men, and by those who
thought the bargain a bad one for the government from a business point
of view, and it was finally defeated because Congress was unwilling to
extend the government loan at 2 per cent for eighty-five years until
more convinced of the necessity of compromise.[557]
Additional Schemes
Four days after the submission of the Powers report and its
accompanying bill, a report was presented to the Senate by Mr. Gear,
of Iowa, which recommended the passage of a substantially identical
statute.[558] Nothing was done with this report, nor with a suggestion
which Mr. Gear made in January that the whole matter be referred to a
commission to be appointed for the purpose.
The submission of the Gear report brings the account of the
negotiations for the settlement of the Pacific railroads’ indebtedness
down to the spring of 1897. Four Congressional committees had reported
up to this time. Of these, two had recommended that the subsidy bonds
be refunded at the rate of 3 per cent for fifty years, and two that
they be refunded at the rate of 2 per cent for seventy-five years or
more. All four had proposed an improvement of the government’s security
by extending the government lien to cover the non-aided portions of the
Pacific railroads, and in addition to this the Reilly bill had provided
that the government should secure a first lien upon the railroad
property in question by paying off the underlying bonds.
It would be possible to lengthen the list of suggestions for the
repayment of the subsidy bonds which were made during the eighties
and the nineties, by including schemes elaborated by other persons
than members of Congress and presented in other ways than through
formal reports of Congressional committees to the legislature. This
will not be done to any great extent because of limitations of time
and space. While, however, the greater part of outside comment upon
various pending refunding bills must be omitted, it is important to
remember that the discussion outside of Congress, especially during the
nineties, was quite as active as that within, and that it was conducted
with great bitterness of feeling and freedom of expression. Indeed, the
extreme contentions on either side are quite inadequately set forth in
the Congressional debates.
Railroad Proposals
The general railroad position with respect to the repayment of the
subsidy bonds was that the entire debt to the government should
be remitted.[559] Failing this, the companies contended that the
government should satisfy its claim by taking back a portion of the
railroad land grant. If the United States should be indisposed to
resume the land grant, then Mr. Stanford suggested that the government
should take up all the liens on the Central Pacific Railroad prior to
the subsidy bonds, and in lieu of them issue government bonds bearing
interest at the rate of 2 per cent. The saving to the company, due
to the reduction in the interest rate on first mortgage bonds from
6 to 2 per cent, would enable it to pay off its indebtedness to the
government, sufficient time being given and a moderate rate of interest
allowed.[560] In case even this settlement were rejected, it was
proposed that the government refund the subsidy bonds by a new issue,
running 100 or 125 years, and bearing interest at the rate of 2 per
cent.[561]
In opposition to the railroad proposals, western shippers, who
represented the extreme anti-railroad sentiment, violently objected to
a refunding bill of any description. It was the belief of California
men that a refunding bill would simply saddle the railroad debt upon
the shipping public. For the railroad would make the necessary annual
payments for interest and sinking fund from the proceeds of rates,
which would necessarily be paid by the shipper. As able a man as John
T. Doyle, of San Francisco, maintained, moreover, that refunding was
unnecessary, because it would be found that the assets of the Central
Pacific would be adequate on foreclosure sale to meet both its first
and its second mortgage obligations. In saying this, Mr. Doyle relied
upon the ability of the government to hold directors of the Central
Pacific personally liable for misappropriation of funds, as well as
upon alleged illegalities in the issue of first mortgage bonds, and
upon the chance that the courts would consider the San Francisco
terminals of the Western Pacific, together with other miscellaneous
property, subject to the lien of the government mortgage, although the
property was not “bond-aided” in a narrow sense.[562]
Pacific Coast Agitation
As an example of the feeling in the West concerning the policy of
refunding, particular reference may be made to expressions of opinion
in the city of San Francisco. In May, 1894, a mass meeting of citizens
of San Francisco elected a committee of three to proceed to Washington
and to oppose the funding of the debt of the Central Pacific Railroad
to the United States. In a memorial addressed to the Senate and House
of Representatives, and designed to oppose the Huntington scheme of a
long-time extension of the subsidy bonds at a low rate of interest,
this committee said:
In the name of the people of San Francisco, of California, and of the
whole Pacific Coast, we protest against the acceptance by Congress of
a plan which will keep more than $77,000,000 of the public’s money
from being paid to the United States Treasury, and which will secure
in their present wrongful possession of that sum, besides promoting
their other selfish and unpatriotic schemes, men who have for thirty
years been wrecking a railroad, defrauding the Government, corrupting
public morals, plundering and oppressing the people, and violating
every principle of business probity, of law, right, justice, and
public policy.
Another meeting, held in the Metropolitan Temple, in San Francisco,
on June 19, 1894, called on the state conventions of both parties to
introduce into their platform resolutions against the funding of the
debt of the Central Pacific Railroad Company to the United States at
the rate of 2 per cent per annum for one hundred years, at a rate of
4 per cent per annum for fifty years, or at any other percentage, or
during any other period. Under the leadership of the eccentric Adolph
Sutro, this meeting adopted an arraignment of the Southern Pacific
which was almost inarticulate in its denunciation. It was charged that:
This monopoly has spread a black cloud over the surface of the
State. It has manœuvred through a large number of corporations, of
which the Southern Pacific Company of Kentucky is now the center.
It has seduced and drawn into its service many prominent men, whose
Americanism and integrity were not equal to their brains. It has
antagonized the people, minimized immigration, choked enterprise, and,
in this unrelenting attack, has used the supposed representatives of
the people in each department of the government, Municipal, State,
and National. It has controlled legislation, executive action and the
administration of justice. It has discriminated in freights and fares
and, at every station on its many thousands of miles of railroad,
maintained a Custom House of its own.
This was followed on June 29 by a telegram, signed by Sutro and
addressed to Grover Cleveland, advising the President that history
would record him as the greatest benefactor of the American people if
he would recommend the foreclosure of the mortgages on the Pacific
railroads and the purchase of these railroads by the government at
foreclosure sale. It was Sutro’s idea that the government should hold
the transcontinental lines as a great national highway, and permit all
American railroads to run their locomotives and cars over it under
payment of tolls to be regulated by the Treasury Department.
During the summer of 1894 the _San Francisco Examiner_ circulated a
petition against the Reilly funding bill, to which, by September 20, it
was said that 194,663 names had been attached.[563] In January, 1895,
both the Colorado and the California legislatures adopted resolutions
opposing the refunding. In California there was not a dissenting vote.
The same month another mass meeting was held in San Francisco, and
in December, 1895, still another one followed, with the result that
a committee of fifty was appointed, and a recommendation sent to the
national government.
The San Francisco agitation in 1894 and 1895 was addressed to the
comparatively moderate provisions of the Reilly bill, proposing the
refunding of the government debt for fifty years at 3 per cent. In
1896, when the more liberal Powers bill was under discussion, the
agitation revived. At this time Mayor Sutro, of San Francisco, made
an unsuccessful attempt to persuade the people of Kentucky to repeal
the charter of the Southern Pacific Company. Although this particular
move met with no success, a state anti-funding convention was held at
the Metropolitan Temple in San Francisco on January 18, 1896, a new
committee was appointed, and a new memorial was framed.
This memorial reiterated and reinforced most of the arguments presented
in the memorial of the committee of fifty. It dwelt on the alleged
frauds of the Central Pacific and Southern Pacific companies, the
uncertainty as to the extent of the property of these corporations, and
as to the validity of certain liens against them. The whole matter,
the memorial urged, was distinctly one for judicial investigation.
It urged that the government let foreclosure take its course. The
Central Pacific should not be allowed to confirm possession of money it
might have stolen. It was sound policy, the memorial agreed, to make
sure that the company really had not enough to pay its debts, and to
this end to see that transferred, withdrawn, and stolen assets were
restored. Agitation along these same lines continued through 1896, and
in January of the following year the legislature adopted a resolution
opposing refunding and calling for foreclosure if necessary.[564]
Different Points of View
The fundamental difference between the sentiment in Congress in 1897
and that on the Pacific Coast was that the legislature at Washington
addressed itself to Pacific railroad legislation with the object
of recovering as much of the government’s advances to the Pacific
railroads as was possible under the circumstances. The gains sought
were primarily financial. In California, on the other hand, public
sentiment was more concerned with railroad service and railroad rates
than with finance. And this was a principal reason for the insistence
upon foreclosure and the equanimity with which government operation was
regarded. That the difference between the two points of view was not
more fully appreciated was doubtless because the necessity of shaping
its arguments so as to influence Congress led the Pacific Coast to
talk in terms of finance, even when they thought in terms of monopoly.
So much must be understood in order that the animus behind the San
Francisco agitation may be clear.
From the point of view of Congress, the weakness of the government’s
position in 1897 lay in the fact that its debt was secured by a second
mortgage, and a mortgage which covered, at that, only a portion of the
road. There seems to have been substantial unanimity of opinion among
official representatives of the government after 1882 and 1883, that
the bond-aided parts of the Pacific railroads would not bring at a
forced sale a sufficient price to cover both the first and the second
mortgage liens upon them. In fact, it was believed that if the Pacific
railroad property should be put up at foreclosure sale, no bidder would
appear except the Huntington-Stanford interest, and perhaps the Union
Pacific Railway. Under these circumstances the price obtained was sure
to be low, and it was not unlikely that the result of the sale would
be to leave the railroad in the hands of its original owners free from
all obligations to the government. “These very men whom you are now
scolding about,” said Mr. Powers, of Vermont, in 1897, “the very men
who own the terminals and own these connecting lines are the only ones
who can safely bid on the property, and probably they will be the only
bidders. They would get the property at their own figures.”[565]
Stockholders’ Liability
It is true that there were two possibilities that improved the
government’s position slightly. The first was found in the suggestion
that directors or stockholders of the Central Pacific might in some way
be held individually responsible for the debts of the company. If this
could be done, the great wealth of the Stanford-Huntington group made
the resource a substantial asset. It was pointed out by anti-railroad
men that the Central Pacific was a California corporation, and that
under California law each stockholder of a railroad corporation was
liable, in proportion to the stock owned and held by him, for all its
debts and liabilities. Moreover, the directors of the Central Pacific
were said to be liable as directors because of the diversion of Central
Pacific funds to the payment of dividends at a time when the company
owed the government and its first mortgage bondholders large sums
which it was unable to pay. In addition the directors were charged
with illegal use of Central Pacific money in the construction of the
Southern Pacific Railroad.
Unfortunately for the government, the United States Supreme Court
squarely refused to entertain the notion that Central Pacific
stockholders were individually liable for repayment of advances which
the United States had made to that company. Individual liability
depends upon express statutory prescription, and no word upon this
point was to be found in the federal laws of 1862 and of 1864. While
California railroad stockholders were undoubtedly personally liable to
some degree for the debts of California corporations, yet the state
law which established this liability was held not to apply to the debt
due to the United States. The terms of liability as regards this debt
were to be sought, according to the Supreme Court, in the Congressional
enactment, and there only. It was said that any other ruling would not
only lack solid legal foundation, but would have the unfortunate effect
of imposing a heavier burden upon stockholders of the Central Pacific
than upon those of the Union Pacific.[566]
Lien of Subsidy Bonds
A second possibility which might have strengthened the government’s
claim that the lien of the subsidy bonds might be held to extend to
the non-bond-aided portions of the Central Pacific as well as to
those portions for the construction of which the government had given
aid. This was also the contention of Mr. Doyle, of San Francisco.
The point was of the highest importance, because if it were denied,
the government possessed a mortgage upon only the trunk lines of the
Pacific railroads. It had no interest in, and could by foreclosure
secure no control over any branches, or over the principal terminals.
On the Central Pacific it could acquire by judicial sale only 860 miles
from a total of 1,360, and on the Union Pacific 1,532 miles from a
total of 7,944. The bond-aided portions of the Central Pacific reached
neither Oakland nor San Francisco.[567]
In order to understand the relation of the subsidy bonds to the
non-aided portions of the Central Pacific, it is necessary to refer for
a moment to the terms of the Pacific railroad legislation. The clauses
of the Act of 1862 which relate to the lien of the subsidy bonds of
the Central Pacific were to be found in Section 5 of that law. They
provided as follows, namely, that:
... the issue of said bonds and delivery to the company shall ipso
facto constitute a first mortgage on the whole line of the railroad
and telegraph, together with the rolling stock, fixtures and property
of every kind and description, and in consideration of which said
bonds may be issued; and on the refusal or failure of said company
to redeem said bonds, or any part of them, when required so to do by
the Secretary of the Treasury, in accordance with the provisions of
the act, the said road, with all the rights, functions, immunities,
and appurtenances thereunto belonging, and also all lands granted to
the said company by the United States, which, at the time of said
default, shall remain in the ownership of the said company, may be
taken possession of by the Secretary of the Treasury, for the use and
benefit of the United States.[568]
By the Act of July 2, 1864, the lien of the subsidy bonds was
subordinated to that of first mortgage bonds which the company was then
authorized to issue, but no other change in the underlying security was
made.[569]
The meaning of Section 5 of the Act of 1862, as amended, was considered
by the United States Supreme Court in 1878 in a case brought against
the Kansas Pacific Railway to recover 5 per cent of the net earnings
of the Kansas Pacific, payment of which was required by Section 6 of
the same act. In these matters the Kansas Pacific and the Central
Pacific were subject to the same requirements. It appeared that the
Kansas Pacific had received subsidy bonds for 393-15/16 miles of line,
from the Missouri River to the hundredth meridian, but had actually
constructed 637 miles, reaching as far west as Denver. The question
arose as to whether the company was responsible to the government for
5 per cent of its net earnings on the whole mileage, or only for 5
per cent on 393-15/16 miles. Upon this point the Supreme Court ruled
that “the subsidy bonds granted to the company, being granted only in
respect to the original road, terminating at the hundredth meridian,
are a lien on that portion only; and that the five per cent of the net
earnings is only demandable on the net earnings of said portion.”[570]
Provision in Thurman Law
The decision in the Kansas case clearly meant that the lien of the
subsidy bonds authorized by the Act of 1862 did not extend to the
non-bond-aided portions of the Central Pacific or to similar sections
of any of the other Pacific railroads. This appears to be a conclusive
answer to the later government argument, so far as the Act of 1862 is
concerned. The legislation of 1862 was, however, amended in 1878, as we
have seen in the previous chapter. Section 9 of the Thurman law read as
follows:
That all sums due to the United States from any of said companies
respectively, whether payable presently or not, and all sums required
to be paid to the United States or into the Treasury, or into said
sinking fund under this act, or under the acts hereinbefore referred
to, or otherwise, are hereby declared to be a lien upon all the
property, estate, rights, and franchises of every description granted
or conveyed by the United States to any of said companies respectively
or jointly, and also upon all the estate and property, real, personal,
and mixed, from whatever source derived, subject to any lawfully prior
or paramount mortgage lien, or claim thereon.[571]
A comparison of the Thurman law with the Act of 1862 shows that the
later law expressly extended the lien of the subsidy bonds to all
Pacific railroad property “from whatever source derived,” instead of
limiting the lien to property “in consideration of which said bonds
may be issued.” It does not appear that this change was particularly
considered in the debates on the Thurman bill. Mr. Thurman himself did
not mention Section 9 in his opening address, and while members of
the Senate discussed at length the power of Congress to alter, amend,
or repeal the Act of 1862, they usually had in mind the sinking fund
provisions of the Thurman law and not those relating to the lien of
the subsidy bonds. The exception to this statement is to be found in
a colloquy between Mr. Dawes, of Massachusetts, and Mr. Edmunds, of
Vermont. Mr. Dawes called attention on April 3 to the sweeping nature
of the amendment contained in Section 9. He was of the opinion that in
1862 Congress never undertook to put a mortgage on anything except that
which they granted to the railroad. Under the Thurman Act, however,
he understood that all subsequently acquired property was also to be
pledged, with the effect, Mr. Dawes added, that, among other results,
all payment of dividends would become illegal.
To this criticism Senator Edmunds replied that the Act of 1862 already
subjected all the property of the Pacific railroads to the lien of the
subsidy bonds. It was the view of the Senator from Vermont that the
words “in consideration of which said bonds may be issued” did not
have the limiting effect in the Act of 1862 which Mr. Dawes ascribed
to them, but rather that they conveyed the idea, with other words in
the same clause, that the Secretary of the Treasury might from time to
time issue bonds of the United States in consideration of the fact,
which the law declared, that every particle of the property of the
Pacific companies, real and personal, franchises, tolls, and everything
else, were the security upon which the bonds were to be a lien.[572]
Subsequent discussion did not serve to clear up the differences in
interpretation brought out in the Congressional debate, but the later
decision of the Supreme Court showed that, in the principal matter at
issue, Mr. Dawes was right.
We may say with some confidence that the nature of the lien of the
second mortgage subsidy bonds of the United States depended, under the
Thurman Act, upon the power of Congress to alter, amend, and repeal the
terms of the Acts of 1862 and 1864 in respect to the security provided
for the government loan.
Court Decisions
Now on the question of the meaning of the “saving clause” in the Act of
1864, the courts had not in 1897, and still have not, satisfactorily
passed. That the clause did not authorize unlimited changes in the
provisions of existing legislation was evident. The majority of the
Supreme Court expressed the view in the sinking fund cases that the
reserved power could not be used to undo what had already been done
or to unmake contracts which had already been made, but that Congress
could provide for what should be done in the future, and might even
direct what preparation should be made for the due performance of
contracts already entered into.[573] Under this interpretation the
Supreme Court upheld the clauses in the Thurman law which required the
Pacific railroads to pay certain moneys into a sinking fund.
The same court in 1895 decided that a federal act which required
bond-aided railroads to operate their own telegraph lines was a
legitimate amendment of the clause of the Act of 1862 which authorized
these companies to enter into agreements with specified private
corporations for the rendering of telegraph service.[574]
Again, in Menotti v. Dillon (1897), the court approved an amendment
to the land-grant provisions of the Act of 1862 designed to quiet
litigation in land cases in California;[575] and in Union Pacific v.
Mason City and Fort Dodge, it sustained a law of 1871 which authorized
the Union Pacific to issue bonds for the construction of a bridge
across the Missouri River at Omaha, but required the company to permit
the trains of all railroads terminating at the Missouri River at Omaha
to use the new bridge up to a fair limit of its capacity and on payment
of a reasonable compensation.[576]
None of these cases, however, can fairly be taken as precedents for so
radical an alteration in a bargain made as would have been produced
by an extension of the lien of the subsidy bonds to non-aided portions
of the Pacific railroads. On this precise point the nearest approach
to a decision is found in a dictum growing out of litigation under
the Thurman law with respect to the proper handling of compensation
for government services. As explained in the previous chapter, the
government contended at one time that all compensation for services
rendered to the government by the Central Pacific Railroad should be
paid into a sinking fund for the eventual retirement of the subsidy
bonds or should be applied in liquidation of interest on these bonds,
whether these services were rendered on bond-aided or on non-bond-aided
portions of the company’s lines. When this contention reached the
Supreme Court it was rejected, on the ground that the Thurman Act,
properly interpreted, applied only to the bond-aided lines.
The court went on to remark, moreover, that the construction which the
government here sought to place upon the law would not only render the
second section of the Thurman Act a breach of faith on the part of the
United States, but would make it an invasion of the constitutional
rights of the railroad company.[577] This indicates that the court
would not have approved a law which clearly compelled the Central
Pacific to turn over to the government the compensation for the
transportation of government troops and supplies earned over sections
of its lines which had not received a subsidy in government bonds. If
this really represented the attitude of the court, then it seems still
more unlikely that an attempt to extend the lien of subsidy bonds to
these same non-bond-aided sections would have been sustained.
Critical Situation
It is reasonable to suppose that the repeated discussion of refunding
plans in Washington was due to the fact that Congress was of the
opinion that a rigid insistence by the government upon its legal
rights would result in a minimum rather than a maximum recovery from
the Pacific railroads. At the same time, the shrewder heads in the
legislature were perhaps hopeful that results might be obtained by
negotiation which could not be secured by legal proceedings. Hence the
refusal to approve of any specific plan for the settlement of the debt.
In the year 1897 the pending maturity of the United States subsidy
bonds made the situation too critical for action to be much further
delayed. On March 4, 1897, the 54th Congress and the second
administration of President Cleveland came to an end, and the
administration of President McKinley began. A special session of
Congress, called by the new President, convened on March 15. During
this session Mr. Gear introduced a bill for the appointment of a
commission to settle the debt of the Central Pacific and Western
Pacific railroads to the government.[578] This bill failed to pass.
In December, 1897, the first regular session of the 55th Congress
convened. By this time the maturity of a large portion of the subsidy
bonds was distant only a few weeks. That is to say, the bonds issued to
the Central and Western Pacific railroads matured as follows:
January 16, 1895 $ 2,362,000
” 1, 1896 1,600,000
” 1, 1897 2,432,000
” 1, 1898 10,614,120
” 1, 1899 10,847,560
About $2,000,000 of these bonds were held in the sinking fund
established by the Thurman Act. These had naturally been canceled as
they fell due. On December 21, 1896, moreover, most of the remaining
bonds held by the government in the Central Pacific sinking fund had
been sold and the proceeds applied to maturing indebtedness.[579]
These resources, together with the credits in the Central Pacific bond
and interest account, had covered the demands upon the company up to
January 1, 1898. Meanwhile coupons on the first mortgage bonds had been
regularly paid, and arrangements had been made with first mortgage
bondholders to extend the maturity of each instalment until January
1, 1898, at which date first mortgage bonds of the Central Pacific
Railroad Company to the amount of $25,883,000 were to mature. First
mortgage bonds of the Western Pacific Railroad, aggregating $1,970,000,
matured on July 1, 1899. It was evident that all available Central
Pacific resources would be exhausted by the 1st of January, 1898.
Negotiations Initiated
In the face of what amounted to a real crisis, involving not only
the possibility of loss to the government, but also that of serious
financial injury to private interests connected with the Pacific
railroads, the initiative in seeking a compromise was now taken by the
banking firm of James Speyer and Company, of New York, through which
a large amount of Central Pacific securities had been marketed. Mr.
Speyer felt responsibility in the matter because so many of his clients
were involved. He later testified:
I think it naturally suggested itself to us as bankers, having sold
such a large amount of securities and the company being threatened
with bankruptcy, we naturally sat up nights thinking how we could
save it, because these bonds were all out, all over Europe, and stock
too; and we tried to find some means to work it out so that these
people would not lose their money. So that I think that originally
when this debt came nearer and nearer, when it got so that it
became a threatening thing to the Central Pacific security holders,
we naturally began to look around to see how we could stave off
receivership and bankruptcy.[580]
There were also certain strategic considerations which had weight
at this time. These affected the dominant interests in the Southern
Pacific particularly. In spite of the apparently indifferent attitude
of the Stanford-Huntington group, these gentlemen could not have been,
and were not, blind to the fact that a receivership for the Central
Pacific opened possibilities of disaster, not only for the Central
Pacific itself, but also for the Southern Pacific, in which their main
interest then lay. Such a receivership, if followed by a foreclosure
sale, would have wiped out the last vestiges of the Stanford-Huntington
stock holdings in the Central Pacific Railroad and would in all
probability have eliminated also the lease of the Central Pacific
to the Southern Pacific. This suggested the possibility of a severe
competition for Pacific Coast business, from which the Southern Pacific
could scarcely have escaped unscathed. The whole future control of the
railroad systems of the South West was clearly at stake.
It appears that Mr. Speyer took the matter up with Mr. Huntington,[581]
probably early in 1898. Mr. Huntington was receptive and the subject
was then discussed with representatives of the government. At an
early stage in the negotiations President McKinley was consulted. The
matter was one deemed of great importance to the government; in fact,
in January, 1898, the President directed the Attorney-General to give
immediate attention to the Pacific railroad debts, to take every means
necessary, and to spend as much money as should be needed in order to
enforce the government’s lien.[582] In later proceedings Mr. Griggs,
the Attorney-General, and Mr. Gage, Secretary of the Treasury, took an
active part. Mr. McKinley continued to follow the negotiations, and
was about as well informed as any of the others as to how matters were
getting on. Elihu Root was employed by the Attorney-General as special
counsel.[583] In short, the administration responded cordially to the
initiative of the railroad and banking group.
Government Commission
While negotiations were going on, Congress passed the Act of July 7,
1897. This act appointed the Secretary of the Treasury, the Secretary
of the Interior, and the Attorney-General a commission with full power
to settle the indebtedness to the government growing out of the issue
of bonds in aid of the Central Pacific and Western Pacific bond-aided
railroads. The commission was required to submit any settlement made
to the President for his approval, and it was forbidden to accept a
less sum in settlement of the debt due the United States than the full
amount of the principal and interest of the subsidy bonds. It was
empowered to grant an extension of time for repayment not exceeding ten
years, at a rate of interest not less than 3 per cent, and to accept
such security as might seem expedient.[584] So far as the commission
was concerned, this was Mr. Gear’s proposal of the previous year.
It seems probable that negotiations had already reached an advanced
stage before the Act of July 7 was passed. Mr. Griggs was later of
the impression that the act was drawn and passed to fit a tentative
agreement which had already been made.[585] If such were the case
the willingness of Congress to entrust the matter to the executive
branch of the government, after having once refused to do so, may be
explained. Possibly, also, the fact that the Union Pacific had been
sold at foreclosure on November 1, 1897, for $58,448,223.75, a sum
sufficient to cover the full amount of both first and second mortgage
bonds, had weight.[586]
The indebtedness of the Central and Western Pacific railroads to the
United States government as of February 1, 1899, was $58,812,715.48.
These figures were reached by adding thirty years’ interest at 6 per
cent to the original loan of $27,855,680, and by deducting accumulated
credits resulting either from the deposits in the sinking fund
established by the Thurman law, or from the operation of the bond and
interest account originating in the Acts of 1862 and 1864. Comparison
of the figure of $58,812,715.48 with the slightly larger amount given
in the previous chapter as of June 30, 1897, will show that during the
intervening nineteen months the net amount of indebtedness had slightly
decreased.
Plan of Settlement
In view of the impending maturity of large quantities of subsidy bonds,
the first essential point in the negotiations between Mr. Speyer and
the government was necessarily that more time should be allowed the
Central Pacific for the payment of its debt. It was agreed that at
least certain portions might be extended for as long as ten years.
Mr. Speyer was of the opinion that, given this extension, the Central
Pacific could repay its debt in full—a striking contrast to the former
statements of Central Pacific Railroad men. By paying the debt in full
was meant paying with interest on all delayed balances.[587]
In order to cover the matters just referred to, Mr. Speyer agreed in
1898 that the indebtedness of the Central Pacific to the government
should be refunded into twenty notes of the railroad company, falling
due one every six months, beginning August 1, 1899, and ending February
1, 1909. The notes were to carry interest at 3 per cent per annum,
payable semiannually. Taken by itself, this offer was the most liberal
that the railroad company had ever made. Yet it represented up to this
point only a promise, without security. In order to provide security,
Mr. Speyer proposed an additional arrangement, in two parts.
By the first part of the additional agreement, Speyer and Company
undertook to purchase the four Central Pacific notes earliest in point
of maturity, and to pay the face value thereof as soon as received
from the government. This obligation of a reputable banking house to
pay the substantial sum of $11,762,543.12 was a valuable thing in
itself, and materially increased the attractiveness of the whole plan
from the government’s point of view. In consideration for its advance,
Speyer and Company received new first mortgage bonds of the Central
Pacific Railroad, of an issue presently to be described. By the second
part of the same arrangement, each note remaining in the hands of the
government was to be secured by deposit of first refunding 4 per cent
gold bonds of the Central Pacific equal in amount to the face of the
note.[588]
It will, however, be asked how, in view of the outstanding
capitalization of the Central Pacific, it was possible to offer a
first mortgage security as collateral for the refunding notes. This
was provided for by the further reorganization of the Central Pacific,
and by the issue in particular of two new classes of bonds, of which
the first was to be a 4 per cent, and the second a 3½ per cent issue,
having a first and second mortgage lien, respectively, upon all
property of which the Central Pacific was possessed.
Reorganization Proposal
On February 1, 1899, the outstanding debt of the Central Pacific
Railroad consisted of the following issues:
Central Pacific Railroad of California, first mortgage
bonds $25,881,000
Western Pacific Railroad Company, first mortgage
bonds 2,735,000
Central Pacific Railroad Company (San Joaquin
Valley branch), first mortgage bonds 6,080,000
Central Pacific Railroad Company, land bonds 2,134,000
Central Pacific Railroad Company, 50-year 6 per
cent bonds 56,000
Central Pacific Railroad Company, 50-year 5 per
cent bonds 10,245,000
California and Oregon Railroad Company, and
Central Pacific Railroad Company, successor,
first mortgage bonds 10,340,000
———————————
Total $57,471,000
Under the proposed reorganization plan, the aggregate of $57,471,000
of securities listed was to be retired in exchange for $51,253,500
in new 4 per cent bonds, $13,695,000 in new 3½ per cent bonds, and
$1,987,383.70 in cash. Generally speaking, the outstanding first
mortgage bonds were offered par in new fours, with a slight bonus in
new 3½ per cents. Junior mortgages received 50 per cent in new fours,
and from 70 to 90 per cent in new 3½ per cent securities. After the
retirement of outstanding first mortgages, the 4 per cent bond issue
was then to be increased further by the amount necessary to provide
the government with the collateral stipulated for in the negotiations.
Thus the government was set on a par with outstanding first mortgage
bondholders.
Here, however, was a real difficulty. It was plain that while the old
first mortgage bondholders might consent to the retirement of the
issues which they held by exchange for new bonds, on the terms stated,
they would yet hesitate to allow the inflation of the first mortgage
issue by putting out $58,000,000 first mortgage bonds over and above
the amount of their holdings in order to satisfy a government claim
hitherto secured only by a second mortgage lien. It must be remembered
that the reorganization was a voluntary one, requiring for its success
the free consent of all parties. Some additional considertion had
to be offered at this point in order to satisfy first mortgage
bondholders. It was at this juncture that the Southern Pacific Company
stepped in, with a guaranty on both the new 4 per cent and the new 3½
per cent issues. The additional security provided by this guaranty
was without doubt an element contributing strongly to the successful
carrying out of the proposed exchanges. At the same time the guaranty
was received with favor by the government, because it increased the
government’s security as well as that possessed by former bondholders.
In subsequent years there was dispute as to how far the government
relied on the Southern Pacific guaranty as an essential element in the
security provided for the ultimate repayment of the government loan.
Curiously enough, the fact of the guaranty was not mentioned in the
original agreement of February 1, 1899, between the Central Pacific and
the government, nor was it referred to in the report dated February
15, 1899, which the commissioners appointed to settle the Central
Pacific indebtedness made to Congress, nor in the clauses of the
refunding mortgage itself. But the testimony of all concerned is that
the guaranty was understood to be a vital part of the agreement, and
Attorney-General Griggs later went so far as to say that the Central
Pacific bonds without the guaranty would not have been acceptable.[589]
When the bonds to which the government was entitled were delivered to
the United States Treasury Department, they had indorsed on them in
proper form the guaranty of the Southern Pacific Company.
Treatment of Stockholders
In addition to the promises for settlement of the government debt,
mention should be made of the allowance made to Central Pacific
stockholders in the reorganization plan, and of the provision for cash
requirements.
Some provision for cash requirements is a necessary part of any
reorganization plan. In the case of the Central Pacific and Western
Pacific, the cash requirements consisted of $11,762,543.12, which were
needed to take up the first four notes issued to the government, and
of $9,657,556.88 for new equipment, improvements, and other purposes
of the new company, including expenses, commissions, compensation,
and similar items incident to the reorganization. Speyer and Company,
it will be recalled, had agreed to purchase the first four maturing
notes issued to the government. The inclusion of the amount paid for
these notes as a cash requirement of the Central Pacific was due to the
fact that the money paid by the bankers for this purpose was regarded
merely as a loan by the bankers to the railroad company. In all, the
sum which it was necessary to raise amounted to $21,420,100. This money
was raised by the sale to Speyer and Company, on behalf of a syndicate,
of portions of the new 4 per cent and 3½ per cent issues aggregating
$12,995,500, and by the issue of $12,000,000 of new preferred stock to
the Southern Pacific in exchange for a like amount of that company’s
4 per cent bonds. In addition, the Southern Pacific agreed to take
up $8,000,000 additional preferred stock of the Central Pacific, as
issued, upon the same terms.
As for the common stock of the Central Pacific Railroad, this was
exchanged, dollar for dollar, for stock of the Central Pacific
Railway Company (new corporation). Such an exchange was the best that
stockholders could hope for. At the same time the Southern Pacific,
here too, became a factor in the operation, by offering to issue its
own stock, dollar for dollar, in exchange for the new stock of the
Central Pacific Railway and to add thereto a bonus in the shape of
Southern Pacific 4 per cent bonds to the extent of 25 per cent of the
new stock issue.
Examination of the elaborate arrangements between the Central Pacific,
the government, and the Southern Pacific in 1899 shows that the
last-named company participated in the reorganization plan which has
been described to the following extent:
It became guarantor in respect of a bond issue
(new 4 per cent first mortgage) of $100,000,000
It became guarantor in respect of a bond issue
(new 3½ per cent second mortgage) of 25,000,000
It issued its own bonds for the purchase of
$12,000,000 of the preferred stock of the new
company, in the amount of 12,000,000
It agreed as and when required to purchase the
remaining $8,000,000 of the preferred stock
of the new company with bonds in the
amount of 8,000,000
It agreed to issue its bonds as part payment in
the purchase of $67,275,500 of the common
stock of the new Central Pacific Railway in
the amount of 16,819,000
It issued its own stock in partial payment for
$67,275,500 of the common stock of the new
Central Pacific Railway Company in the
amount of 67,275,500
————————————
Making a total of assumed liabilities of $229,094,500
This was a very substantial contribution for any third party to
make to the success of a Central Pacific reorganization plan. True,
the Southern Pacific received Central Pacific stock for its cash
advance, but the value of this stock at the time was slight. The real
consideration which counted with the Southern Pacific was the control
of the Central Pacific system.
Execution of Agreement
In carrying out the proposed plan the commission named in the Act of
July 7, 1897, reported to Congress under date of February 15, 1899,
that an agreement had been reached, and that the subsidy bonds were
to be refunded into twenty notes of $2,940,635.78 each. On March 3,
1899, Congress authorized the Secretary of the Treasury to sell the
first four notes in order that the agreement with Speyer and Company
might be carried out.[590] These notes were already in the Secretary’s
hands. They were duly purchased by the bankers named on March 10 of
the same year. During the summer of 1899, the Central Pacific Railway
was incorporated to succeed the former railroad company, and the
various issues called for by the reorganization plan were put forth. On
February 1, 1909, the last of the refunding notes matured and was duly
paid. The divorce of the Central and Western Pacific companies from the
government was complete.
To anyone who has followed the long drawn-out discussions between the
Central Pacific and the government, the speed with which the final
settlement was made and the favorable terms which the government
secured come as a distinct surprise. Not once during the twenty years
following the passage of the Thurman Act had it been suggested that the
Central Pacific could meet principal and interest of the government
loan on condition only that it be granted an average extension of
five years on its indebtedness with interest at 3 per cent on delayed
payments. The result was properly regarded as a triumph for the
administration.
In a measure, also, the settlement justifies in a general way the
entire policy of the administration with respect to the issue of
subsidy bonds to the Central and Western Pacific Railroad companies.
These subsidy bonds were issued originally for a well-considered
purpose. The purpose was accomplished, and repayment of the loan was
secured without important delay. From a business point of view the
operation was therefore a distinct success. Doubtless there were
disadvantages connected with the policy. Such were the many disputes
between railroad and government, which hampered the railroad in its
later development, and occupied the time and energy of public men.
Such, also, was the apparent consent which the government yielded
to the permanent consolidation of the Central and Southern Pacific
companies by its acceptance of the reorganization of 1899. The final
price paid by the public was larger than is sometimes appreciated. But
the final gain was also very large.