tion, worked out with the trustee and the parties, which was filed with the court. After hearings thereon the plan was approved by the court; two alternative plans proposed by other parties were opposed by the Commission and rejected by the court.

(e) In connection with the plan which he later approved, the judge raised certain legal and procedural questions and requested that the Commission and certain other parties submit their views. The plan provided for a gradual liquidation of the debtor's assets and the principal question raised by the judge was whether such a plan was permissible under the statute. The Commission expressed the view that such a plan is within the statutory definition of a plan of reorganization.

Activities with Regard to Allowances.

Every reorganization case ultimately presents the difficult problem of allowances to the various parties for services rendered and expenses incurred in the proceeding. In this matter the general practice of the Commission has been, initially, to make certain that the individual applications contain full information as to the nature and the extent of the services and expenses for which allowances are sought, that the necessary affidavits are submitted, and that adequate notice of the hearing on the applications is given to the security holders. A detailed study is then made by the Commission of the amount and kind of work performed by the different applicants. At the hearing on the applications, the Commission advises the judge with respect to its recommendations concerning the merits of the respective applications and the total charges with which the estate can be burdened, in light of its financial condition and related factors.

The Commission has been able to provide considerable assistance to the Federal courts in dealing with this problem. The Commission itself may not receive allowances from the estate for the services it renders, and is able to present a wholly disinterested, impartial view of the problem. It has sought to assist the courts in protecting reorganized companies from excessive charges while, at the same time. equitably allocating compensation on the basis of the claimants' contributions to the administration of the estate and the formulation of a plan. In this connection, it has been deemed important that unnecessary duplication of work shall not be compensated and that the aggregate of allowances shall not exceed an amount which the estate can afford to pay. With these objectives in mind, the Com mission may undertake to make specific recommendations to the courts as to the amount to be allowed in cases where the Commission has been a party throughout the proceeding and is thoroughly familiar with the activities of the various parties and all significant develop ments in the proceedings; in other cases, e. g., where it has entered the proceeding at an advanced stage, the Commission has undertaken at

least to advise the court generally as to whether it considers the requested amounts reasonable, moderately excessive, or exorbitant, and the reasons for these views.

PLANS OF REORGANIZATION UNDER CHAPTER X

The Act requires, as a condition to confirmation of a plan of reorganization, that the judge be satisfied that the plan is "fair and equitable, and feasible." The consummation of a plan which meets these requirements is, of course, the ultimate objective of any reorganization proceeding. The Commission's primary function under Chapter X is to aid the courts in the attainment of this objective.

In appraising the fairness of plans the Commission has consistently taken the position that, to be fair, plans must provide full compensatory treatment for claims and interests of creditors and stockholders according to the order of their legal and contractual priority, either in cash or new securities or both. The implications of this principle have been followed consistently by the Commission, and its position has been fully sustained by the decision of the Supreme Court in Case v. Los Angeles Lumber Products Co., Ltd., in which the principle was reiterated and given new vigor in its application to Chapter X proceedings.

The requirement of feasibility relates to economic soundness of the proposed financial structure. In a recent opinion, the Commission stated that the essence of feasibility "may be said to be that a plan is of such a character that it gives reasonable assurance that the reorganized enterprise will operate economically and efficiently, will be able to perform the purposes of its existence and will not so far as foreseeable result in the necessity for another reorganization with its attendant expense and injury to investors." In appraising the feasibility of plans the Commission has given consideration to such matters as the adequacy of working capital, the relationship of the funded debt or capital structure to property values, the ability of corporate earning power to meet interest and dividend charges, the effect of the proposed new capitalization upon the company's prospective credit, and the desirable objective that new securities shall not by their terms or otherwise be deceptive to subsequent purchasers.

Determination of Value.

A prerequisite to the formulation of a fair and feasible plan of reorganization is the determination of the value of the debtor's enterprise for reorganization purposes. The Commission has consistently adhered to the position that, for reorganization purposes, the capitalization of reasonably prospective earnings is the most reliable method of valuation; that the value so found should be the controlling factor

308 U. S. 106.

In the Matter of Inland Power and Light Corporation, Holding Company Act Release No. 2042.

in arriving at an appropriate capital structure for the reorganized debtor and should provide the basis of allocation of new securities among the debtor's creditors and stockholders. The position which the Commission has consistently urged with respect to valuations was fully sustained by the decision of the United States Supreme Court in Consolidated Rock Products Co. v. DuBois, decided March 3, 1941, in which the Commission participated as amicus curiae. The Court's opinion, per Douglas, J., contained the following controlling statement on the problem of valuation in reorganization proceedings:

"In the second place, there is the question of the method of valuation. From this record it is apparent that little, if any, effort was made to value the whole enterprise by a capitalization of prospective earnings. The necessity for such an inquiry is emphasized by the poor earnings record of this enterprise in the past. Findings as to the earning capacity of an enterprise are essential to a determination of the feasibility as well as the fairness of a plan of reorganization. Whether or not the earnings may reasonably be expected to meet the interest and dividend requirements of the new securities is a sine qua non to a determination of the integrity and practicability of the new capital structure. It is also essential for satisfaction of the absolute priority rule of Case v. Los Angeles Lumber Products Co., supra. Unless meticulous regard for earning capacity be had, indefensible participation of junior securities in plans of reorganization may result.

"As Mr. Justice Holmes said in Galveston, Harrisburg & San Antonio Ry. Co. v. Texas, 210 U. S. 217, 226, 'the commercial value of property consists in the expectation of income from it.' And see Cleveland, Cincinnati, Chicago & St. Louis Ry. Co. v. Backus, 154 U. S. 439, 445. Such criterion is the appropriate one here, since we are dealing with the issue of solvency arising in connection with reorganization plans involving productive properties. It is plain that valuations for other purposes are not relevant to or helpful in a determination of that issue, except as they may indirectly bear on earning capacity. Temmer v. Denver Tramway Co., 18 F. (2d) 226, 229; New York Trust Co. v. Continental & Com mercial Trust & Sav. Bank, 26 F. (2d) 872, 874. The criterion of earning capacity is the essential one if the enterprise is to be freed from the heavy hand of past errors, miscalculations, or disaster, and if the allocation of securities among the various claimants is to be fair and equitable. In re Wickwire Spencer Steel Co., 12 F. Supp. 528, 533; 2 Bonbright, Valuation of Property, pp. 870-881, 884-893. Since its application requires a prediction as to what will occur in the future, an estimate, as distinguished from mathematical certitude, is all that can be made. But that estimate must be based on an informed judgment which embraces all facts relevant to future earning capacity and hence to present worth, including, of course, the nature and condition of the properties, the past earnings record, and all circumstances which indicate whether or not that record is a reliable criterion of future performance. A sum of values based on physical factors and assigned to separate units of the property without regard to the earning capacity of the whole enterprise is plainly inadequate. See Finletter, The Law of Bankruptcy Reorganization, pp. 557 et seq. But hardly more than that was done here. The Circuit Court of Appeals correctly left the matter of a formal appraisal to the discretion of the District Court. The extent and method of inquiry necessary for a valuation based on earning capacity are necessarily dependent on the facts of each case."

To illustrate various aspects of the fair and feasible plan which have arisen in cases in which the Commission was not required to file a for

mal advisory report and to indicate the position of the Commission with respect thereto, a number of examples are given below.

In one of the proceedings in which the Commission participated during the past fiscal year, the debtor's only asset, an apartment hotel, had an estimated value considerably less than the amount of the first mortgage bondholders' claims. Nevertheless, a plan of reorganization proposed by the debtor provided for participation by both second mortgage bondholders and stockholders. It was proposed that a loan would be obtained, part of the proceeds of which would be used for improvements and the remainder to be distributed to bondholders on the basis of approximately 28 cents on the dollar. The preferred stock of the reorganized company would be divided equally between the first mortgage bondholders and the second mortgagees, while the stockholders would retain their present interests. The Commission successfully opposed the plan on the ground that it was unfair in recognizing junior interests for which there was admittedly no equity. The Commission also was of the opinion that the plan was not feasible since the value of the assets was probably less than the amount of the proposed new mortgage; furthermore, it seemed extremely doubtful whether, even after rehabilitation, the earnings would be sufficient to pay interest and amortization charges. Subsequently, the trustee proposed a plan which provided for complete elimination of all interests junior to the first mortgage bondholders. Under the trustee's plan the bondholders would have received all of a new issue of preferred stock and 40 percent of the new common. The remainder of the common stock was to be sold for cash to an experienced hotel operator. Although the Commission did not object to the trustee's plan, it made several suggestions with respect to minor modifications, most of which were adopted. Subsequently the plan was accepted by the bondholders and confirmed by the court.

In another proceeding in which the Commission is participating, the debtor carries on, directly and through a number of wholly-owned subsidiaries, the business of subdividing and developing real estate, operating hotels, cottages, a water supply company, a lumber and supply company, and owning and leasing farm properties, dam sites, and other properties. The debtor has outstanding in excess of $800,000 principal amount of first mortgage bonds which are secured by certain of the debtor's properties and all of the outstanding shares of one of its subsidiaries. The debtor al-o owes approximately $250,000 to a bank secured by certain other properties of the debtor and the shares of another of the debtor's subsidiaries, viz., a hotel subsidiary. All of the preferred and common stock of the debtor is closely held by persons who are also creditors of the debtor.

The trustee filed a plan of reorganization. The main features of this plan provided for the continued existence of the debtor and the organization of a new corporation which was to acquire all of the assets pledged as security for the first mortgage bonds. All of the common stock of the new corporation was to be distributed to the bondholders. A new loan of approximately $195,000 was to be made by the bank to the new corporation, which loan was to be secured by a pledge of all of the bondholders' assets. Of the loan, $120,000 was to be used to purchase furniture and equipment from the hotel subsidiary and the balance was to be used to pay all reorganization expenses, outstanding trustee certificates, all claims requiring payment in cash, and unsecured obligations of the hotel subsidiary. The entire $120,000 secured by the hotel subsidiary upon the sale of the furniture to the new corporation was to be returned directly to the bank, $30,000 by way of payment of a note to the debtor pledged by the bank and the balance by virtue of the hotel subsidiary's guaranty of the bank loan.

After careful analysis of all available information, the Commission came to the conclusion that the plan, on its face, was unfair as well as lacking in feasibility. In the first place it was the belief of the Commission that the plan, in essence, operated to improve the status of the bank claim at the expense of the bondholders. It appeared that two of the directors of the debtor were also directors of the bank. Under the plan, the bondholders were required to accept equity secu rities in a new corporation and pledge all the assets of the new corporation to secure a new loan of $195,000 from the bank from which they were to receive no benefit and the necessity of which was not shown. Also, the bondholders were being foreclosed of any right to a deficiency claim against other assets of the debtor without any determination of the value of their security. The bank, on the other hand, which had a $250,000 claim against the debtor, secured by a small portion of the assets, would, upon consummation of the proposed plan, have a $325,000 claim, $195,000 of which would be secured by a first lien against all of the property which now secured the bonds, and the balance of $130,000 would be secured by all the property now securing its present $250,000 claim.

Also under the plan, the present stockholders were to receive all of the stock of the debtor without any determination that there was any equity over the secured claims. Further, it appeared that the stockholders had obtained possession of approximately two-thirds of the bonds, at least a substantial portion of which had been acquired under circumstances which might afford substantial grounds for the subordination of the claims of such bonds to the claims of the public bondholders. In the opinion of the Commission, approval of any plan as fair before this question had been fully explored was unwarranted.