LATER DEVELOPMENTS IN THE UNION

PACIFIC MERGER CASE

SUMMARY

First attempt to dissolve the combination of the Harriman lines, 772. - Opinion of the Supreme Court, 773. — Second unmerging plan, 774.

Difficulties encountered in separating the Southern Pacific from the Central Pacific, 775. — Attitude of the Pacific Coast, 778. — The State Railroad Commission of California refuses to approve proposed leases and other contracts in California, 785. — Modified version of the second unmerging plan, 786. — Third plan successful, 787. — Distribution of Baltimore and Ohio Stock, 789. - Final outcome of the proceedings, 790.

In an article in this Journal for February, 1913, the writer discussed the decision of the Supreme Court in the Union Pacific Merger Case. Since that time there have been developments which justify mention. It will be recalled that the decree of the Supreme Court in the decision of December 2, 1912, called upon the Union Pacific to divest itself of the ownership of the Southern Pacific, altho it declared that nothing in the Court's instructions was to be construed as preventing the Union Pacific from retaining the Central Pacific property from Odgen to San Francisco. In response to this decision the Union Pacific immediately prepared to distribute its Southern Pacific holdings among its own individual stockholders. The action was in accordance with precedent in the Northern Securities, Standard Oil, and Powder cases, and there was some hope that it would be approved, in spite of the opposition of the Attorney-General. As it turned out, the

1 The Attorney-General desired that the shares be distributed among the holders of Southern Pacific stock as well as among holders of Union Pacific stock. Reporters'

hope was without foundation. When the matter was submitted to it in December, 1912, the Supreme Court curtly declared the plan inadmissible. "The ultimate determination of the affairs of a corporation," said the Court," rests with its stockholders and arises from their power to choose the governing board of directors. After such distribution as is now proposed, the stockholders of the Union Pacific Company may dominate and control not only the Union Pacific Company but the Southern Pacific Company as well."

This decision made it necessary to revise the original project completely. At the same time the insistence of the Attorney-General that the Southern Pacific should dispose of the Central Pacific made it seem advisable to avoid further litigation by including a transfer of the Central Pacific Railway to the Union Pacific in the dissolution plan. The step was taken reluctantly. It appears that the question was referred to eminent counsel, and that the Southern Pacific agreed to sell only when it had become convinced that the Central Pacific could not be retained, and on the assurance that the Attorney-General would bring pressure to bear upon the Union Pacific in order to compel that company to offer a satisfactory price.1 There is some reason to believe that the Union Pacific was more eager to buy than the Southern Pacific was to sell. Whatever the preference of the parties, the result of the negotiations appears in the second unmerging plan, approved by Southern and Union Pacific directors on February 6, 1913. This plan had also the sanction of the AttorneyGeneral.2 The Union Pacific now proposed to sell the

Transcript of Testimony in Application 409 before the State Railroad Commission of California, pp. 158-159, Sproule, referred to hereafter as "Transcript of Testimony." See also a statement by the Attorney-General in New York Journal of Commerce, December 19, 1912.

1 Transcript of Testimony, pp. 162-164, 195, Sproule; pp. 32-33, Lovett. New York Journal of Commerce, February 10, 1913.

1,266,500 shares of Southern Pacific stock in the treasury of the Oregon Short Line to stockholders both of the Southern Pacific and of the Union Pacific Companies. With the proceeds of $84,675,500 of this stock, less commissions and syndicate expenses, together with $14,065,441 in cash and $5,449,000 in Southern Pacific bonds, it offered to buy the 672,755 shares of Central Pacific common and the 174,000 shares of Central Pacific preferred owned by the Southern Pacific Company. The price suggested was therefore in the neighborhood of $104,000,000, which was approximately the cost at which the stock stood upon the Southern Pacific books. Judge Lovett has said that he never expected to give so much,' and in fact a price equivalent to $123 a share seems liberal in view of the quotations of other six per cent stocks at the time. The responsibility for the Central Pacific funded debt of approximately $200,000,000 was assumed by the Union Pacific. This occasioned no disturbance of outstanding securities, except in the case of the Central Pacific four per cent, 35-year European loan of 1911. Unfortunately, however, certain clauses in the indenture covering this issue caused a good deal of trouble. The loan was for 250,000,000 francs, and had been floated in France in March, 1911. It was guaranteed by the Southern Pacific and was secured further by collateral. In order to protect their clients the French bankers who handled the issue had

1 According to Judge Lovett the Central Pacific was not likely to be as valuable to the Union Pacific as it had been to the Southern Pacific because the latter company would divert traffic to the Sunset Route. (Transcript of Testimony, pp. 50-52, Lovett.) Only the grant of certain preferential rights in California and the fact that the Southern Pacific stock owned by the Union Pacific was tied up pending settlement induced him to consent. (Transcript of Testimony, p. 62, Lovett.) Mr. Schlacks, Vice-President of the Western Pacific, on the other hand, thought the Central Pacific a bargain at $104,000,000. He asserted that this sum, after adding outstanding bonds and deducting treasury assets, yielded a price of about $100,000 per mile, which was about what the Western Pacific had cost to date. The Central Pacific, however, had larger facilities than the Western Pacific, better equipment, and a more fully developed territory. (Transcript of Testimony, pp. 317-318, Schlacks.)

stipulated that the Southern Pacific should not sell or pledge its holdings of stock in certain specified subsidiary companies, including the Central Pacific, during the life of the bonds, nor lease, sell or merge the properties named without their consent. Just one alternative was given: namely, that if the consent of the bankers was asked and refused, the Southern Pacific might after forty days declare the entire issue due and payable at the next interest date.1 When the Southern Pacific decided to sell the Central Pacific it found these clauses in the way. An issue of refunding bonds could not have been sold early in 1913 except at a heavy discount. In an attempt to secure the French bankers' consent to the separation of the Southern and the Central Pacific, the Union Pacific offered to give its own guarantee for the security of the European loan and to substitute Union Pacific for Southern Pacific collateral. When this proved insufficient, it proposed a lease of the Central Pacific to the Union Pacific, and for these reasons such a lease became a feature of the second unmerging plan.2

It was originally intended to pay for the Central Pacific stock by transferring to the Southern Pacific $84,675,500 of Southern Pacific stock held by the Union Pacific, along with the cash and bonds previously referred to. But the fact that the Southern Pacific was not permitted to purchase its own stock under its charter, nor reduce its capital except in the manner prescribed by Kentucky statutes, made the exchange impossible.3 The price at which the Southern Pacific stock was offered to stockholders was 98.67 plus accrued dividends, and the sale was underwritten at the same price by a syndicate

1 Article III, Sect. 3 of the indenture dated March 1, 1911.

? Transcript of Testimony, pp. 28-31, Lovett.

Ibid., p. 11, Lovett.

managed by Kühn, Loeb & Co.1 An essential feature of this plan was the grant of superior subscription rights to Southern Pacific stockholders. That is to say, the holder of every four shares of stock of the Union Pacific was given the right to subscribe for one Southern Pacific share, but the holder of every three shares of Southern Pacific stock was to have the right to subscribe for a similar amount. The preference thus accorded Southern Pacific stockholders was deliberately intended to diminish the influence of the Union Pacific in the Southern Pacific, by giving shareholders of the former a smaller holding of Southern Pacific stock than they would normally have acquired. On the assumption that all stockholders availed themselves of their subscription rights the stockholders of the Southern Pacific would have owned 71 per cent of its capital stock after the unmerging was completed, while those of the Union Pacific would have held only 29 per cent.

It was realized at once by those familiar with conditions in the West that the proposed separation of the Central Pacific from the Southern Pacific raised problems of unusual complexity. The two systems have been treated as a unit since very early days. They were originally financed by the same parties, have been operated as a unit in the same interest, have used the same equipment, and have drawn on the same funds for extensions and improvements. The accompanying map will show how hopelessly intertwined their mileage has become. The Central Pacific in all the years since it was first built has never entered San Francisco over its own rails, nor reached any port along the Pacific Coast such as San Diego, San Pedro, Santa Barbara, Monterey, or Santa Cruz. It does not even possess the short line from Sacramento to Oakland, but controls only a

1 Cf. Transcript of Testimony, p. 105, Lovett.