How collective bargaining works, a survey of experience in leading American industries

MICROCOPY RESOLUTION TEST CHART (ANSI and ISO TEST CHART No. 2) is Zs 23 se (3.2 uA yz © i [le lz A APPLIED IMAGE Inc Owen's Bnibersity Course in Banking LESSONS X-XI ‘ Corporation Hi inane Copyright, Canada, 1914, by Queen’s University. —137— LESSON X. Tn solvency and Re organ ization. The anv advantaees of the cornorate org nization of industry have heen described in a previous Lesson. It was found thet the eorporation is best adapted to those enter- price: wh'ch meet a widesrread demand for their goods or sere viees: where the volume of business is fairly steady: and where profits may he expected to he reasonably uniform. Un der such eonditions eases of insolvenev should setdomn arise. But as such do oeenr it is Imnortant that we should under- stand the'r enuses and effect It ix well to distinenish betvrean two types of insolvency. The one mav be called “true.” the other “leral” insolvency. The fermer oceurs when the linhilities exceed the assets, Such insolvency may or may not lead to failure. Unless the obliga- nee it frequently hapnens that the cor- os 4 tions must be met ato poration can get out o they fall due. On the other hand, leeal insolvency occurs when a concern’s cash assets are not sufficient to meet its current obligations. The assets mav for exceed the liabilities. but if the latter cannot be met in cash as they fall due the concern becomes insolvent. Failure to psy debts as they mature leads to suspension of the business and finally to bankruptey, un- less some arrangement is effected with the creditors. its difficulties and mect its debts as Why insolvency occurs. In some inst: ‘solvency aay exist from the cornmencement of bisiness cause of the over-valuation of assets. When 4 pan “ey onitalized in this wav failure almost inevits ly foll: hrough some combination of circumstances earnings sl increase to an extent sufficient to carry the outstanding ob <ations in the shone of honds. and ta nay dividends unorn { le Again, some unforeseen accident may dest ro. the assets and compel a corporation to go into A port may lose its trade because of develonmen ing facilities elsewhere: a town may be sidetracked b wth of large wholesale centres elsewhere; a district n e its natural advantages through the exhaustion of the : ral re- sources upon which its prosperity depended; a disas 's fire may wipe out a whole town or city; or a thousand i one other factors may obtrude to destroy the value, in wh: or in part, of the assets of a corporation and compel its reor Za- tion or liquidation. In part, of course, these conting $ can be foreseen and provided against by applying the ciples of insurance and depreciation; but in other instanc . ee foresight or care can prevent the resultant decline in earnings and depreciation in the value of the fixed assets. Another cause of insolvency is bad management in carry- ing on the business. In some cases it would appear that the business is flourishing, whereas it is being carried on below cost. This may centinue for a number of years before it is discovered that the capital has been used up in large part for running expenses. It is necessary, therefore, that a searching analysis of a company’s affairs should be made frum time to time to discover the actual value of the fixed assets and the cost of conducting the enterprise. This is not difficult in the case of a trading concern, but it is a serious enterprise in the case of the railroads. It is doubtful whether the bene- fits received would be worth the very large costs involved in getting at the actual value of railway property. Recently various acts passed by the United States Congress provi‘‘e for an evaluation of American railway lines. It was forese:r that the cost would be heavy, but the outlays so far have exceeded the early estimates. A statement of what is being done in the work of getting at the value of the railways was recently made in Congress by Charles A. Prouty, for- merly a member of the Interstate Commerce Commission, but now in charge of the work of making an evaluation of the railroads. The following is a summary of Mr. Prouty’s report, taken from the New York “Journal of Commerce”: “Last year the railroad-valuers asked for $2,000.00. They now ask $3,000,000. As in all, about $2,400,000 has hereto- fore been appropriated, the total up to the end of the coming fiscal year on the basis stated would be $5,400,000. Work to- day is going on at the rate of $2,000,000 annually, but more rapid development is now called for. Mr. Prouty has given some interesting details as to the progress of this part of the work also, stating that of the $2,000,000 annual outlay over $500,000 is what may be called overhead expense, the bale~ce being for field work. Inasmuch as the field expense does not call for increased overhead charges in proportion as it enlarges in scope, the recommendation is made that more stress be placed on the field work. About 20,000 to 25,000 miles of line per annum are being examined at present, and it is desired to enlarge this to 50,000. If the latter rate should be obtained the field portion of the valuation work would be finished by four years from Jul, 1, 1915. At present eight parties are in the field doing the work in each of five districts into which the country is divided, or forty parties in all. With this staff about 2,000 miles a month, or 24,000 miles per an- num, can be covered. “Assuming that there are 250,000 miles of track in the United States and that the cost of valuation at the rate of | | | —129— 24,000 miles a year is $2,000,000, the total cost would he something li! ¢ $21,000,000. Something between $18,200,000 and $21,000,0000 would be the Government’s outlay—a very different figure from the three or four cnillions roughly esti- mated by some when the scheme was first projected. True, some estiinates still run as low as $16,400,000, but actual ex- perience gives the results just stated. “The expense io the government is only a part of the cost of the work. There has been much difference of opinion on this subject, but Mr. Prouty when questioned afforded some data. At first he was inclined slightly to depreciate the work of the rvads to so --ient, saying: ‘They are doing more talking than they ..:‘ rk up to the present time, but,’ he went on to say, ‘s*:). ©. them have done a good deal of work. The Boston & Mai; . «vad, for exaniple, which is poor and can not afford it, has been obliged to do a great deal of work, and is laying out a great deal of money.’ Asked what the valua- tion was costing the Boston & Maine, Mr. Prouty said, ‘oe hundred dollars a mile.’ This, moreover, would be the cost for the balance of the system. At this rate the cost to the railways of the United States for 250,000 miles would be $25.000,000. Mr. Prouty afforded a basis also for a different mode of estimate. It would, he sid. cost the Gov-rnment for its work ‘about half’ the outlay of the Bost n & Maine. If the cost to the Government is $20,000,000 for valuation, the cost to the roads would thus appear to be about $40,000,000.” Tt is doubtful whether the cost will justify the results obtained; but the case of the smaller corporations is some- v .at different, especially of the trading concerns. Here a t-ful calculation should be made from time to time to see t the assets of the company are not being dissipated in running expenses, the cause of failure in many a concern that seems to be prosperous and which, at all events, has been carrying on a large business. Causes of legal insolvency. The great mercantile agency Bradstreet’s, presents the following statistics on legal insol- vencies in Canada for the years 1911 and 1912. It should he noted that the fai'ures are a very small percentage of the large number of companies carrying on business in the Dominion: Failure due to— Number. Assets. Liabilities. 1912. 1911. 1912. 1911. 1912. 1911, Incompetence ..... 214 226 $1.121.328 $1.317,774 $ 2,815,349 $ 2,471,209 Inexperience ...... 67 41 204,761 93,032 435,468 200,851 Lack of capital.... 660 691 2,784,605 2,930,854 5,660,668 6,249,820 Unwise credits ... 17 12 148.524 62.250 204,744 130,244 Failure of others.. 12 16 77,967. 117,125 311,333 188,023 Extravagance Wéslecto 5.) —130— 29.460 172,871 308,000 65.510 417,900 183,610 33,699 780,504 377,384 78,598 1,081,139 23,800 123,600 53,600 406,486 133 349.802 469,883 1,271,129 1,300,757 tei cd B12 1401 $5,611,675 $6,420,331 $12,355,282 $13,086 046 It will be seen from an examination of “lack of capital” heads the ] competence.” As a rule, howe capital that causes insol a sufficient nercentage o assets. It inay be s 332,792 74,150 1,314,687 Competition Specific conditions. Speculation 39,538 659,019 ager must de his bills. ’ ill be unable to rn may be forced In Canada wholesalers and manufacturers have short- ened the period of commercial credit from four months to three. There are certain dates in the importance when settle many accounts have t himself in a ant as throwing light We quote from “The Toronto Globe” “The Fourth of March.” “Once the apex of the most critical period in the commer- cial year, and the settling day on the heavy contracts entered into by country merchants for the Christmas and winter trade, March 4 has lost some of its significance, but it still furnishes —131— one of the conclusive readings of the commercial barometer. The tendency of late has been to shorten the period of com- mercial notes from four months to three, and now the majority of these obligations mature on February 4. Payments upon that date this year were admittedly disappointing, a large per- centage of the country merchants, especially those in the West, requiring extensions and renewals. Although it will be several days before the character of the general response to the drafts sent out by the eastern manufacturing and distri- buting houses this week is known, there is evidence that the situation is improved, and that retail merchants throughout the country will be able to make more liberal remittances to the manufacturing centres than at any time since the war began. The credit men of large establishments, who occupy a particularly advantageous opportunity of judging trade condi- tions, are inclined to place the responsibility for tardy remit- tances of retailers, following upon the slow payment of accounts by customers, to a popular dread of drawing upon savings rather than to an inability upon the part of the ordinary debtor of the country merchant to pay. The credit men call this excessive devotion to savings the “hard-times microbe,” and current commercial statistics not only support their theory, but indicate that the spirit of economy is being as rigidly en- forced in corporate and in personal expenditure now as it was recklessly ignored a few years ago. “Trade statistics usually employed in estimating the pros- perity of business generally have been interpreted during the past few months as evidences of a semi-collapse of the buying power of the country. It is a question whether in jumping at this conclusion too much emphasis has not been placed upon the drastic reduction in the revenue of railroads, the heavy decrease shown in bank clearings, and the remarkable contraction in the volume of banking credits to the commercial community. Most of these changes were produced by an in- clination to save rather than an inability to spend. Savings entrusted to the banks are beginning to increase more sub- stantially than when the country was flushed with easily earned wealth. The gain in savings deposits in the chartered banks alone in January were $4,130,000, and at the end of that month they were $31,824,000 in excess of the same month of the year previous. At the end of January thrifty Canadians had in savings deposits in the chartered banks $666,960,000. This is the best test of the national credit position. It shows that the people as well as the lending institutions which have suc- cessively presented exhibits of great financial strength, based upon their possession of large amounts of unemployed capital, have been able to make preparations for any untoward con- tingency later on. —132— “Other commercial data indicate fields now being laid bare by the ine March sun is being reflect ings for the week “March 4 may have los red-letter date in the ot with the conclusions of the aterial. The important fact to underlying conditions may be such that those to whom credit has been advanced cannot meet their obligations: and in that event it is essential that the business concerns of the country should be in a position to safeguard their own interests, As has been pointed out already, a concern may fail al- gh its assets far exceed its obligations, and although it may have a large and gr wing business yielding handsome profits. The cause of failu.. in this case is neglect to provide a sufficiently large working capital. A somewhat similar condition arises when a corporation is obliged to unduly increase its quick obligations to pay divi- dends that have been earned but not provided for. The profits that have been earned my have been put back into the busi- ness, and hence jt may be necessary to borrow money tem- porarily to pay the dividends. This is a dangerous practice. As has been already explained, dividends should be provided for in advance, so that it will never be necessary to endanger the corporation’s working capital. —1383— __ Corporations may face legal insolvency also through in- ability to renew medium-term notes or to refund long-term obligations when they become due. This may come about through an unfavorable conditon of the money markets when it is next to impossible to borrow on any terms. The sudden vency in Canada. In *he absence of a Dominion bankruptcy act, however, the several provinces have passed legislation— Voluntary Assignment Acts—providing the mechanism under which persons or partnerships may voluntarily go into liquida- tion and distribute their assets among their creditors. The greatest defect of this procedure is that after the assets are ment of his assets for the benefit of his creditors. Let us now consider the question of the liquidation of corporations, kee ping in mind that the Dominion Parliament has exclusive jurisdiction over questions of bankruptcy and insolvency. The Dominion Winding-up Act is an important piece of legislation covering the liquidation of incorporated companies. It applies to: All ccrporations incorporated by or under the authority of an Act of the Parliament of Canada, or by or under the —134— (b) Which are in liquidation or in process of being wound up, and, on petition of any of their shareholders or creditors, assignees or liquidators, ask to be brought under the provisions of this Act. In considering the application of the act, Canadian com- panies may be divided as follows: (1) Companies incorporated under general or special act of the Parliament of Canada; (2) companies incorporated under general or special acts of the Provinces before Confederation, which (a) if incorporated since Confederation should be incorporated under general or special acts of Parliament and (b) which if incorporated since Confederation should t.: incorporated under general or special acts of Provincial Legislatures; (3) banks, insurance com- panies, loan companies having a capital stock, and trading companies; (4) provincially incorporated companies. (1) and (2a) are within the provisions of the act whether insolvent or not; (2b), (3) and .4) which are within the description (3) are within the provisions of the act if they are insolvent or being wound up; and (4) which are not within the de- scription (3) are not within the provisions of the act. In connection with what has been said it should be ob- served that while Ontario has a Winding-up Act it applies only to companies that are not insolvent and that go into voluntary liquidation. The further cemment should be made that a company incorporated under the Ontario Companies Act and carrying on business in that province is “doing busi- ness in Canada.” So, too, is a foreign company, wherever it _May have been incorporated, that is carrying on its activities in this country. The courts of Canada are entitled to protect Canadian creditors of foreign corporations, to the extent that such corporations have assets in this country. Finally, it should be observed that the act does not apply to building companies that have no capital stock, or to railways or tele- graph companies. The determination of insolvency. A compaty may be declared insolvent under the act, among other reasons: (a) If it is unable to pay its debts when due. (b) If it calls a meeting of its creditors for the purpose ef compounding with them. (c) If it exhibits a statement showing its inability to meet its liabilities. (d) If it has otherwise acknowledged its insolvency. (e) If it assigns, removes or disposes of, or attempts to assign, remove or dispose of any of its property, with intent to defraud, defeat or delay its creditors at any time. A company is deemed to be unable to pay its debts as they become due when a creditor in a sum exceeding $200 —135— has made legal demand for payment; and the company has, for ninety days in the case of a bank, and for sixty days in all other cases, neglected to pay or secure or compound for the sum claimed. By a demand is meant, not a writ of summons, but a demand for immediate payment, reasonably certain in terms and not calculated to mislead. When a winding-up order will be granted. The court may grant a winding-up order: (a) Where a company’s charter has expired; or when the event, if any, has occurred upon the occurrence of which the charter provi?>s that-the company is to be dissolved. The order, in such cz-e, is made at the instance only of the com- pany or of a shareholder. (b) Where the company, at a special meeting of share- holders calle¢ “or .-he purpose, has passed a resolution requir- the company to be wound up. Here again only the company or a shareholder may petition. (c) When a company is insolvent. in this case the peti- tioning creditor’s claim must be for at least two hundred dol- lars. If a shareholder petitions he must hold stock of the company to the amount at least of five hundred dollars. (d) When the capital stock of the company is impaired to the extent of twenty-five per cent., and when it is shown to the satisfaction of <he court that the lost capital will not likely be restored within the year. A shareholder only may petition, and he must hold at least five huxdred dollars of the company’s stock. (e) When the court is of the opinion that for any other reason it is just and equitable that the company should be wound up. A shareholder, qualified as above, alone can petition. Duties of liquidator. When the petition has been granted and the winding-up order given, a provisional liquidator is appointed who takes temporary possession of the company’s affairs and assets. A meeting of creditors, shareholders and contributories is then called to appoint a permanent liquidator and inspectors. It i: “e duty of the liquidator to make an inventory of the cc -ny’s assets, and to call in all claims against, and collect ali uebts due, the company. Under cer- tain conditions he is authorized to continue the company's business. When he has liquidated all assets he prepares a dividend sheet. If the sheet is not contested within a pre- scribed period he pays the dividend and obtains his discharge from the court. Many Canadian creditors lose large sums annu- ally because they are inclined to accept their losses —ie— without further question and write them off to “experience.” Too often they leave the details of arranging for liquidation proceedings to the large creditors. In some cases the latter do not properly safeguard their i:.terests, shirking individual trou- ble and responsibility. The result is that when the inspectors, solicitors and the liquidator have got through with the property there is little left to distribute. C.-editors need to be educated in this couniry to the need of taking energetic action to protect themselves agains! fraud in the first place, and the looting of the property in the second, by those who make a practice of disposing of insolvent estates, Principles of Reorganization. Reasons for reorganization. It must not be supposed that a corporation that gets into financial difficulties, whereby it is unable to meet its obligations, must necessarily go out of busi- ness. On the contrary it is often the case that the creditors gain most by consenting to some scheme of reorganization whereby the business is continued as a going concern. There are two general classes of reorganization; first, those that are necessary as the result of insolvency, and, sec- ond, those that are brought about to readjust the securities and hence the control of the property. In most cases, how- ever, financial difficulties of one kind or another have operated in bringing about the reorganization of corporations. We have already alluded to the advantages of reorganiza- tion in lieu of a simple sale of the property. Take a great railway system, for example, with a main line and numerous “feeders.” The parent company will own, in that case, the securities of a number of subsidiary companies, each of which in its turn will have junior and senior mortgages outstanding. The parent company may have deposited with a trust com- pany, as the basis of a collateral trust bond issue, the stocks and bonds of the subsidiary companies, which it holds. The parent company may also own several branch lines, with out- standing mortgages on each. In addition mortgages may have been placed on the terminals and on whatever real es- tate is held, as well as other property. Besides the bonds of all kinds outstanding there will be issues of common and pre- ferred stock and short-time notes; and in addition other lia- bilities will have to be met, includine accounts payable, bank loans and accrued wages. All this seems very complicated ; but as a matter of fact it is not half so complicated as are the obligations and relationships of many large industrial and rail- way corporations. Le Tere nena tte erp reese ere nee i ' —187— Yet, for all practical purposes, the railroad property is an indivisible unit. It would avail any group of creditors little or nothing to take possession of any particular branch line, terminal or other property. The value of the mortgaged line or terminal depends upon its relationship to the whole prop- erty as a going concern. The property, then, of most large corporations, and particularily of railroad corporations, is in- divisible. The various parts must be kept together if they are to retain their value. The question that arises in case of insolvency, then, is, How can the property be held together, and restored to its right position as a valuable profit-making business? Every bondholder and every stockholder is in- terested in getting at the right solution of that proble:n. Usually, the first thing that is done is to form commit- tees representing the various bonds that have been issued. As a rule these commiitees are dominated by men who hold or control large blocks of the several kinds of securities ovt- standing. In some cases banking houses which have under- written one or more of the bond issues come forward and offer to serve on the reorganization committees. Ordinarily it is not essential that the first mortgage bondholders should organize, as they are well protected, and can afford to let the other creditors first fight it out. Usually the stockholders do not organize as they have practically no voice in the condi- tions of reorganization. When the committees have all been formed they proceed to estimate the value of their various claims and the precedence of each. We have already considered in part why the bondholders as a whole, or as a class, do not foreclose and sell under their mortgage, or bid in the property for themselves. If the property were sold, each bond would be accepted at its par value. It should be observed, however, that it would be next tc impossible to sell a large corporation to an outsider for cash, because the amount involved would be too large. Be- sides, an outsider would prefer rather to buy the securities at a low price during the period of reorganization, and get control of the property in that way. And moreover, the first mortgage bondholders would get nothing more than principal and interest from such a sale, which, presumably, are well protected already. Those holding junior securities might gain something by foreciosure, although they might be forced to settle all claims that rank ahead of their own, in cash. The possibility of their taking such action, however, forces the reorganization commi.tce to treat their claims with respect. The first duty of the reorganization committee, therefore, ts to get at some working estimate of the relative value of the different classes of securities. The bonds of various descrip- tions—junior and senior mortgages, general mortgage bonds, —138— debenture bonds, ete.—are first evaluated, and their claims on the earnings and assets of the corporation determined. talized concerns the common stock will be wiped out absolute- ly. An effort is made to preserve something for the preferred stockholders, although as a rule they are requested to pay certain cash assessments to preserve their interest in the property. Why capital is needed. Cash will be needed at once to clear off the floating debt of the corporatio' Such debts may consist either of loans or medium-term notes secured by spe- cific pledge of property, or of unsecured obligations, such as accounts payable. Whether these debts are secured or not, they must be discharged, otherwise property essential to the must be secured, otherwise the corporation will at once get into new difficulties. And, finally, the reorganization commit- tee must see that the fixed charges are no yreatr than the minimum net earnings. There are thus four main objects of every reorganization: (a) the payment of the floating debt; (b) the providing of working capital; (c) the bringing of the property into a condition of efficiency; (d) and, lastly, the re- duction of fixed charges below minimum earnings. No reorganization policy that neglects these essentials, or any one of them, can hope to meet with suecess. A company that begins without suf- ficient working capital will at once find itself in difficulties and at a time when it is highly necessary to keep its credit good. On the other hand, if the minimum net earnings are not sufficient to meet fixed charges, a further reorganization must take place, which will do almost irreparable damage to the corporation’s position in the money markets of the country. Methods of raising capital. The first three of the objects mentioned above require cash in considerable amounts, be- cause a company that is approaching insolvency almost always lets its accounts payable accumulate, its working capital de- cline, and its Property to fall into disrepair. The reorganiza- tion committee, therefore, must first of all secure cash; and, Secondly, reduce its fixed charges. There are three obvious methods of raising money for these purposes: first, by the sale of some of the company’s Property; second, by the issue of new securities; third, by a n " SUEY eUTEpeEE Tre mercensee ET Te ee eit as —e —189— assessments on the security holders. The first two methods are, as a rule, not practicable of accomplishment, for such property as is non-essential to the business will be turned over to mortgagees; and in addition the company will have ex- hausted its borrowing powers. Of course, these conditions will not apply if the company is not insolvent, but has merely suffered a temporary setback. And, moreover, as has been said, even in cases of true insolvency cash is raised at times by the issue of receiver’s certificates. But the third method—the securing of cash by assess- ment—is generally followed. Naturally the heaviest assess- ments will fall on the common and preferred stockholders. What will be secured in this way will depend upon the value of the stock in the reorganized concern. But experience has shown that the stockholder will do better if he stays in the concern than if he forfeits or sells his shares. Sometimes the junior bondholders, although they are creditors, must pay a cash assessment also to help set the business on its feet. If the stockholders are asked to carry the whole burden of finding the cash the bondholders may be left with the prop- erty on their hands and thus have to carry the whole bu-- den themselves. Finally, it should be observed that, as a rule, the cash needed by a company is not all required at once, and the terms of payment of the assessment may be there- fore made fairly easy. Great care should be observed during the pro- cess of reorganization to do substantial justice to all concerned, not only in arranging for the new capitalization but in providing for cash require- ments. Asa rule the stockholders of a big concern have appointed men of conspicuous ability as di- rectors. It is necessary to preserve the connection of these men with the business, net only because of their ability but because of their knowledge of the concern’s affairs. The cash contributions, there- fore, should not be excessive; and, if necessary, the bondholders should help carry the burden. Reducing fixed charges. In arranging the reorganization three fixed charges, as a rule, must be dealt with: guarantees, rentals and interest. A reorganized company may make better terms with the holders of the guaranteed stock and bonds of subsidiary concerns and with the owners of leased property. This, as a matter of fact, is generally done. If the company is dissolved in the reorganization process, the new company is freed, of course, from the terms of the original contracts. But far more important in its effects on fixed charges is the substitution for the interest-bearing securities of the old corporation of dividend-paying securities of the new. Then again, old securities bearing a high rate of interest are con- verted into securities bearing a low rate of interest The result of this readjustment, if the reorganization is to prove Care must be taken, of course, to give the holders of the various class of securties the same relative protection and the junior bonds will be exchanged for the new general mort- gage bonds under conditions to be arranged. The second mortgage bonds, the branch line bonds, and the debenture bonds are then, as a rule, exchanged for general mortgage bonds. Let us suppose that there have been out- Standing $1,000,000 second mortgage bonds, $500,000 branch line bonds, and $1,500,000 debenture bonds, and that the new general mortgage bonds available for exchange are fixed, on the basis of lowest earning capacity, at $2,000,000. Suppose further that the committee has estimated the first-named issue on the basis of lowest earnings at 80 per cent. of their par value, and the second and third issues at 60 per cent. of their par value. The second mortgage bondholders would then be offered $800 in new general mortgage bonds for each $1,000 of the old; and the bondholders of the second and third classes would be offered $600 of the new bond for each $1,000 of the old. As the values of the old issues and the amount of the new issue are based on lowest net earnings they must, of course, exactly correspond. Preferred stocks are given to bring the amount of their par holdings up to the old amount, often considerably more. This may greatly increase the capi- talization of the new concern; but at the same time it reduces fixed charges, the great object in view in conducting the re- organization. —i141— Mr. W. H. Lough, in “Corporation Finance,” sums up the principles and results of reorga :ization as follows: (a) The reorganization must remove the immediate causes of bankruptcy by providing cash and at the same time reducing fixed ch «ges. (b) The reduction of securities bearing fixed charges may well be, and usually is, accomplished by a great increase of dividend-paying securities. (c) In determining who shall stand the losses caused by the company’s insolvency, the reorganization committee will first rank the securities in the order of their safety and will then impose the losses in inverse order. ) In so doing the directors must of necessity consider primarily the ability of the security-holders to make trouble for or to wreck the reorganized company if their demands are not satisfied. (e) In raising necessary cash they will naturally impose the first and heaviest assessments on stockholders; but they must bear in mind that if they go beyond certain limits the stockholders will forfeit their shares rather than pay the assessments. 4 very careful study should be made of all the above conditions to determine the principles that should operate in effecting a successful reorgani- zation. Much capital has been lost in Canada and the United States through a failure to understand the underlying factors involved. If a successful policy of reorganization can be agreed upon it goes without saying that there will be a very great saving of property effected. A tyjical reorganization. Many examples of the reor- ganization of companies in Canada might be given, but one illustration must suffice. The following gives a brief outline of the career of the Amalgamated Asbestos Corporation, and admirably illustrats some of the important principles which have been discussed: The Amalgamated Asbestos Corporation, Limited. The year nineteen hundred and nine was a merger year in industrial and financial Canada, fifty-two companies combin- ing into ten amalgamations with a total capital of $195,500,000. Toronto and Montreal financiers promoted most of the enter- prises whose flotations were made largely in London, though some United States capital was contributed. The first large undertaking of the year was the organi- zation of the Amalgamated Asbestos Corporation, Limited, the prospectus appearing early ‘n Ayril. Its capital was as follows: ————— —142— Com. Stock. Pref, Stock. Bonds. Rate. Authorized ....... $8,125,000 $1,875,000 $15,000,000 5% REE ee a 8,125,000 1,875,000 7,500,000 ... Total authorized capital, $25,C00,000. The following companies enter -d the merger: Name. Capital. British Canadian Asbestos Company, Limited. .$1,000,000 King’s Asbestos Mines ..............eeeeeee 1,600,000 Beaver Asbestos Company .................. ,000 Standard Asbestos Company, Limited........ 150,000 Dominion Asbestos Company, Limited ....... 500,000 $3,500,000 The seven per cent. preferred stock was cumulative and convertible, share for share, into common stock at the option of the holder. One-half the bonds were issued, being under- written at par and carrying a bonus of 25 per cent. common and 25 per cent. preferred stock. Messrs. Cramp, Mitchell & Shober, of Philadelphia, were the syndicate managers, and financial arrangements were carried out by the Bank of Montreal and the Bank of Commerce. The prospectus declared that the company would com- mence business with no liabilities save its funded debt, with the properties fully paid for, and liquid assets and working capital of about $90%,100. The attention of readers was drawn to the fact that im- provements in selling and economies in operation would be introduced to increase largely the earnings of the company over those of the constituent companies operated individu lly, “thus assuring continued increase in surplus earnings, ap- plicable to payment of dividends on common stock.” The new company clairred to control about 70 per cent. of the total supply of asbest::- in the world. The organization meeting was held in Montreal on June 5, wher: the following officers were elected: E. B. Greenshields, Fresident, Montreal; Hon. Robert Mackay, Vice-President, “fontreal; Howard Ellery Mitchell, Second Vice-President, P!:‘ladelphia; and a board of twelve directors, four of whom were Canadians, seven Americans, and one from London, Eng. The consolidation resembled recent American mergers and was promoted largely by United States interests. The issue met with great success, entering the market in good shape, later settling back ten points, but soon recovering. In October the stock was listed on the exchange with trading in | | | —143-— preferred stock ranging between 90 and 91 and in common stock between 32 and 3214. When the flotation took place in 1909 one-half the bonds were issued, which were fully paid for by the underwriters who received the bonus of °% per cent. common and 25 per cent. preferred stock. The business of the first six months was very satisfac- tory. Earnings demonstrated the ability of the corporation to pay interest on bonds, dividends on preferred stock and a balance of 2 per cent. on common stock. The president’s circular to shareholders contained the following: ' “Under the initial period of operation the outnut did not increase greatly over the previous year, mines were operating separately. It is expected tha‘ company will reap advantages of specialization and « ation; also, that the output will reach a new record fig. und that prices will be higher than previously. The compa. ~ now has contracts aggregating upwerds of $3,500,000 on its books, and is work- ing to its limits in order to keep up to the demand.” About the middle of February, 1910, an advertisement appezred declaring that “perhaps the biggest public issue ever attempted by a Canadian industrial concern is that which will be announced in a few days by the Amalgamated Asbestos Corporation of $7,000,000 bonds, the offering to be made simul- taneously in London, New York, Philadelphia, Boston and Montreal and Toronto.” On February 21 the issue was announced. Messrs. Cramp, Mitel «"l and Shober took charge of the American, while Kileat and ..itken handled the English allotment. The bonds were divided into $500 and $1,000 and offered at 9214 flat. The London correspondent of the “Monetary Times’ wrote on March 9, 1910, as follows: “The Amalgamated Asbestos Corporation offered some $7,000,090 first mortgage thirty-year 5 per cent. sinking fi:nd Gold Coupon Bonds at 9214. The re- sult in London has been satisfactory, and a'though the pros- pectus has been criticised in some directions, the general re- ception has proved satisfactory.” On April 30, 1910, application was made to the London Stock Exchange to list Amalgamated Asbestos Corporaticn £2,017,000 fives. In the latter part of 1910 an issue «., “809,000 cf bonds was sold at 85. The business, however, showed sivns of f2/ing off, and at the ennual meeting in March, 1911, tie statement ex ‘ering the prc..ous seven months showed th: §u.ing ixi period the profits amounted to $195,424, while ve oad int ces. paid and accrued for the period amounted to $2 1,825, =e The following comment on the condition of the company was made by the “Monetary Times,” of March 11, 1911: “The report is one of the most discouraging that has been issued for some time in connection with a company of the magnitude of the Amalgamated Asbestos. The profits for the seven months were nearly $60,000 less than sufficient to meet the bond interest and dividends on preferred stock. It was doubt- less in anticipation of some such result that the directors de- cided to pass the preferred stock dividend last summer.” Mr. McDougall, the president, admitted that the year had been discouraging, but in addressing the shareholders, sounded a note of optimism, claiming that it was confidently expected poe the future had better things in store for Amalgamated sbestos. One of the most interesting statements made was that the $300,000 bond issue had been sold at 85 and that negotia- tions were nearly closed for the sale of $200,000 more at the same figure. Since no sales of bonds had been made recently in the open market at higher than around 70, the disposal of large blocks at 85 was evidence that financiers had more faith in the future of the company than had the investing public. But these hopes were soon dissipated and at a meeting on November 27, 1911, the directors resolved to default the bond interest due on December 1 following. The Royal Trust Com- pany was requested to call a meeting of the bondholders for the 25th of January, 1912. The balance sheet issued on Decemeber 31, 1911, showed that the profits for the year were $98,003, compared with $396,- 799 bond interst for the year. The profits were insufficient to meet even operating expenses, being $54,914 short of the sum required, so that with $396,799 bond interest not paid the deficit was $451,713. The following is a copy of the balance sheet of Decem- ber 31, 1911: Liabilities— pe ee ere ee $1,875,000 00 CRIN OOO oor 2 ote ce ee i 8,125,000 00 First Mortgage 5 per cent. bonds .......... 8,000,000 00 Accounts payable and pay rolls............ 87,452 18 PCAN RMR oe hae 328,840 13 Bond interest accrued .................8. 233,333 31 COUCINBORE WECIINE oo 5.5. 6.55 nk coaxinbae 118,640 00 PENNE oe oy aie ke eee ee ek 17,248 20 $18,785,513 82 — =~ ee a =~ —145— Assets— Property, plant improvements, etc........ $17,310,486 78 EMMOOUNG O08 BORGES |... css css oecccasacees 75,000 00 PPC I So oso 8 os a 693,665 01 MEVONICOM IGRI Site rere een aie re ee 172,689 03 Taxes, insurance prepaid ................ 14,1438 55 Accounts receivable ................000- 47,937 71 CARN oe ae noe tle oF Se OE 19,877 75 DONCIENGY. eee ose $ 396,799 07 Add bond interest for year... 396,799 07 re 451,713 99 $18,785,513 82 The president issued a brief circular announcing the de- fault of the bond interest. It claimed that the smallness of the profit was due in part to diminished production, which was only two-thirds of the effective production of the mills, the large mills being stopped most of the time. The British Canadian and the Beaver Mills, two out of five, produced prac- tically the entire output. The circular enumerated difficulties with which the com- pany had to contend. The system of grading was defective, dissatisfying critical buyers. Changes in machinery caused loss of time and money, and the prices of crude asbestos had abnormally declined. ; At the bondholders’ meeting in January, 1912, a commit- tee consisting of Messrsfi J. E. Alfred, Uzal H. McCarter and H. J. Fuller was named to enquire into and propose a solution of the company’s difficulties, and to report thereon at a meet- ing to be held four days later. The committee’s report called for a reorganization of the company with a reduced capitalization, so that the fixed charges would be so low that under no circumstances would the company at any time face a default. Briefly, the holder of $1,000 bond was to get in exchange a $250 bond; $500 in preferred stuck and $250 in common stock. Bondholders and old shareholders were invited to sub- scribe for $85,000 new 5 per cent. bonds on a basis of 85 for bonds, which carried 100 per cent. bonus of common stock. This was to provide new working capital. The new company known as the Asbestos Corporation of Canada, Limited, took over all the property, plants and assets of the defunct company. Its capitalization was as follows: Com. Stock. Pref. Stock. Bonds. Rate. Authorized ....... $3,000,000 $4,000,000 $5,000,000 5% FOQUOE FS5hi 8 ohcas 3,000,000 4,000,000 3,000,000 ... tae The bonds of the previous company amounted to $8,- 000,000. These were covered by an issue of $2,000,000 bonds, $4,000,000 preferred stock and $2,000,000 common stock. To provide working capital a further issue of $1,000,000 of bonds, together with $1,000,000 common stock was made. The “Monetary Times” criticized the insolvent company in plain terms. It said: “The bondholders’ values have depreciated 75 per cent. The stocks thrown in as a sop are of a remote value. We have yet to learn that any other supposedly business-like corpora- tion has ever run its affairs in a way which has ultimately entailed the absorption of three-quarters of the bondholders’ securities in order to square matters. That fact alone is suf- ficient to damn in the eyes of British and foreign investors, any further offering of the promoters of thr Amalgamated As- bestos Corporation. The bondholders’ committee has appar- ently deemed it necessary to plaster their report with excuses. The results of operation, they claim, have been materially af- fected by difficulties in obtaining practical management and a general demoralization in the market for asbestos.” The kernel of the whole thing lay in the original excessive capitalization involving a fixed charge of $400,000 per year. Besides, the company was inefficiently managed and had to face the cut-throat competition of a rival company, the Black Lake Asbestos Company, organized a few weeks after the Amalgamated. Had the promoters of the merger gained pos- session of the Black Lake properties the disaster might have been avoided, but after all the genesis of the matter was the unreasonable overcapitalization which permitted the company barely three years of unhappy existence. Neither of the companies could weather the storms of competition. The market was too limited and for several years prior to 1911 the annual output of asbestos had exceeded the sales. Price-cutting was resorted to and the Amalgamated Asbestos Corporation was reorganized as above; the Black Lake Company, defaulting its bond interest in February, 1912, was reorganized, first, under the name of The Black Lake Con- solidated Asbestos Company, and then under The Black Lake Asbestos and Chrome Company, Limited. The first statement of the Asbestos Company of Canada, covering the seven months between incorporation and Decem- ber 31, 1912, showed a net profit over operating expenses and bond interest of $68,082.31. Three of the five plants were in operation, the condition of the market not warranting full production. The annual statement issued on December 31, 1913, while not inspiring, showed a big increase in profits over the previous year. In 1911 the actual loss was $64,614, while the present eT —147— statement shows a profit from operation of $270,982, an amount sufficient to meet bond interest of $148,750, to allow $67,416 for renewals and betterments, and to leave $54,765 to be carried forward to surplus account. The general manager, Mr. J. D. Sharpe, said the unfilled orders on hand amounted to $1,278,386, and contracts for deliv- ery during 1914, were sufficient to keep the properties in full operation during the year, and that the physical condition of the properties was better at the present time than at any other period during the past three years. Altogether the report was satisfactory; and it would ap- pear that the future of the company will in time permit the payment of dividends on the preference stock, and remedy the faults of the position created when the original merger was formed in 1909. Questions for Review. 1. What is meant by “insolvency”? What are the causes of “true” insolvency ? of “legal” insolvency ? 2. Analyze Bradstreet’s table of insolvencies in Canada and show the percentage of failures from each cause. 3. What are the difficulties involved in making periodic evaluations of the assets of industrial concerns? of railroads? 4. What effect have ordinary trade conditions on the solvency of a business? What is the importance of periods of trade settlements in Canada’s industrial life? - 5. State the main provisions of the Dominion Winding-up ct; P & When may a company be declared insolvent under that ct? 7. Do we need a general bankruptcy act in Canada? Under the B. N. A. Act where lies the authority over ques- tions of bankruptcy and insolvency in Caneda? 8. How can a corporation fail when its assets are greater than its liabilities? 9. What general committees are appointed when a com- pany is reorganized? State the relative strength of the dif- ferent classes of bondholders; of the stockholders. 10. Why must the stockholders and the junior bond- holders provide the necessary cash to begin business? In what proportion should the cash be provided by each class? 11. What are the chief principles that should he followed in providing for a successful reorganization? k i t t ' ¥ if ag 12. Why must fixed interest charges be reduced? To what extent should dividends replace interest charges? 13. How are the difficulties of exchanging securities for each type of security outstanding settled? 14. Give the history of any reorganization in Canada with which you are familiar. Questions for Written Answer. 15. What kinds of companies can be liquidated or reor- ganized under the Dominion Winding-up Act? What proof will be accepted for legal insolvency? 16. State the principles according to which the different types of securities are exchanged for new securities. 17. To what extent should the stockholders be provided for in the reorganization of - company ? 18. Bring up any difficuiiies. LTT Ltt TLE nttenteeteeTNantiiis ansttien=nntniseeseeaeenanetsnsernenasetenntetennencwennnenee~~! recente ners ats errant —i6— LESSON XI. Manipulation of Corporations by Officers, Directors and Stockholders. The corporate organization of industry is undoubtedly the most economic and efficient method of conducting business that has ever been devised. Nevetheless, there are obvious draw- backs in the system, not the least of which is the compera- tive ease with which officers and directors may use the capital of others for their own advantage. Of course, we do not mean to say that dishonesty occupies any important place in the organization of business either in Canada or the United States; yet from time to time fraudulent and unfair, not to say unsound, methods do come to light which shake the con- fidence of the public in the integrity of those in control