FORMER PRESIDENT OF THE TRUST COMPANY SECTION, A. B. A., WHO HAS COMPLETED TWENTY YEARS OF CONTINUOUS SERVICE AS PRESIDENT OF THE GUARDIAN SAVINGS AND TRUST COMPANY OF CLEVELAND AND RECENTLY RESIGNED TO ACCEPT THE OFFICE OF CHAIRMAN OF THE BOARD. RAILROAD MORTGAGE TRUSTEESHIPS: 1918 MODEL AUTHORITY AND POWER OF TRUST COMPANIES AS TRUSTEE UNDER CORPORATE INDENTURES ROBERTS WALKER (EDITOR'S NOTE: The fiduciary duties and responsibilities which trust companies assume in acting as trustees under railroad or corporate mortgages have been the subject of a great deal of confused popular discussion. Among trust company authorities there is still lacking a definite agreement as to the extent of the obligations, which a corporate trustee should undertake. The discussion assumes a new phase as the result of a report submitted at the recent annual convention of the Investment Bankers' Association by the Committee on Railroad Securities. This Committee recommends two alternative provisions in railroad mortgages, namely (1) the election of a bondholder's trustee or permanent bondholders' committee with supervisory functions or (2) the separation of the functions of trustee, vesting supervisory and litigious duties in a selected committee of high standing and limiting the functions of the trust company, as trustee, to those of custody of securities, certification and other routine matters. Mr. Roberts Walker addresses himself, in the following article, to defense of the principle that trust companies are qualified and are properly within their sphere in assuming the broader functions of trusteeship and that the solution rests more immediately with strengthening and clarifying the form of the corporate mortgage.) .... be collected bis belongings and leaped upon the platform, crying 'Can I be of service? I'm a doctor.' "From the lamp-room I beard a wearied voice wailing. "Another Bloomin' Doctor!" " -KIPLING: My Sunday at Home Such, I imagine, will be the patient growl emitted by the average railroad manager, when he comes to read Part II of the "Report of the Committee on Railroad Securities" to the Investment Bankers' Association of America. Inter alia, it is proposed that a bondholders' representative shall supervise railway operations, in addition to the I. C. C., the P. S. C., the P. U. C., the Corp. Com., the legislators, the uplifters, and Clifford Thorne. "Another bloomin' doctor!" The railroad executives are today so circumscribed in the performance of their duties that a little more oversight will scarcely irritate them. They may not fix charges for services rendered. Wages have become a public and political question, to which the executives may apply a brake but which they cannot stop. Car service, passenger service, mail service and all the rest are controlled by external forces, not by the management. In all departments some vis major makes its influence felt. Further regulation, even though from a new point of view, will add nothing appreciable to existing burdens. So much for the railroad side. Now let's consider the trust company's position. Outline of Proposals The report is in the main so excellently conceived and worked out, that the fair-minded reader should read every word of it. Space limitations forbid quoting it in full, but a summary of the portions interesting to trust companies would run about thus: A weakness of railroad mortgages is that bondholders have no redress until an actual default and a receivership. To give the trustee more authority will not remedy this weakness. The committee suggests either (1) provision for election by bondholders of a permanent committee, not officers of the railroad, to employ an expert who shall watch the property and report evils, with power in the committee to act as the exigency may necessitate; or (2) the splitting up of the functions of the trustee into two sets of powers, vesting the supervisory and litigious functions (as distinguished from routine duties such as bond certification, custody of securities, etc.) in a committee of individuals of high standing. Then, follow suggestions for meetings of bondholders and the binding of the minority to votes taken by the majority (a usual British practice, but forbidden in some of the United States and requiring legislative authority in *Durkee vs. People (155 Ill. 354.) many of them); for bonding equipment and discontinuing the equipment trust device; and for sinking funds. All of this is admirably suggestive material. How Proposals Would Affect Trust Companies Literally construed, the recommendation is that the trust companies shall restrict themselves to the dull performance of static duties, and surrender any dynamic duties to a committee or an expert. Some trust companies would perhaps welcome such restriction. They might be glad to be out of the swirl of defaults and litigation, peacefully protecting a few pledged bonds and shares, and keeping in a fireproof vault a record of bonds authenticated. "Only this and nothing more" might prove restful, if prosaic. And it might pay better than do present arrangements. The practice nowadays is to pay trust companies a small fee for authenticating bonds, and sometimes to pay a small annual sum for safekeeping of securities; but to expect the trust company to exert superhuman activity and prescience in time of trouble (the only time when most mortgages allow it to act at all), to wait forever and a day for its pay, and practically never to be rewarded adequately. The late John G. Johnson of Philadelphia, out of his long experience and unexcelled opportunity to judge of such matters, used to say that he had never heard of a trustee that was properly paid for the responsibilities imposed upon it by a railroad mortgage, and that he wondered why trust companies would accept such duties for such meager rewards. Perhaps many a one of them would be glad to become a sedentary bailee, allowing somebody else to be the vigilant representative of the bondholders. Enlargement of Trust Company Sphere But there are, I fancy, not a few institutions that would welcome, on proper terms, an enlargement of their sphere. To such, the formation of a separate committee will appear superfluous. Such a trust company will say, "Pay us properly, and we shall draw about us railroad experts as competent in their line as are our foreign exchange officers, our testamentary experts, our men at the loan desk." It is a characteristic of American trust companies that no new task deters them. Think of the wealth of new activities the past thirty years have brought! There is no reason, legal or otherwise, why the trust companies should not perform, if so minded, every function proposed to be exercised by the independent bondholders' committees. Nor are such functions today entirely novel: various mortgages require the trustee to call for more collateral when the margin gets low; the power to call bondholders' nieetings to act upon developments is found in many mortgages of British type; two recent 'Frisco mortgages require their trustees to exercise a detached scrutiny over earnings statements and resolutions, permitting the trustees to hire their own staff of experts to check figures or ascertain independently whether income bond interest has been earned and should be paid; and we are all familiar with annual duties like collecting sinking fund payments or obtaining balance sheets or insurance schedules. Need for Appositely Drafted Mortgages But it is nevertheless true that active duties, otherwise than in the event of default, are the exception and not the rule in corporate mortgages. The Committee on Railroad Securities urges that such duties be imposed. It seems to be making an illogical recommendation when it also urges a separate committee of trustees. There is no reason why the average trust company should not take on such duties. The real need is for appositely drafted mortgages, not for a separate committee of bondholders' representatives. In this respect the report is not convincing. It is all very well to charge somebody with new responsibilities, but it does not follow that such somebody cannot perfectly well be the trust company, trustee. Some Misconceptions In no carping spirit, let it be observed that only one member of the Committee on Railroad Securities, Mr. Blunt, is a trust company man. All the others are private bankers, except that Mr. Davis is of the National City Bank. Hence the committee's viewpoint was that of the salesman rather than of the trustee. Perhaps it was this circumstance that led to the inclusion of one or two statements that no trust company officer can allow to pass unchallenged. The report states: "One of the weak features of railroad mortgages brought to light by recent experience, is that the bondholder had no redress until there is a default under the mortgage and the property goes into the hands of a receiver. We do not believe it is practicable to attempt to remedy this weakness by giving the trustee more authority." Here are several questionable assertions. If the mortgage is weak, in that the bondholder has no redress prior to default, why not try the effect of strengthening the mortgage? Why search another remedy without first giving that one a fair test? Next, the statement, that it is impracticable to remedy the difficulty by giving the trustee more power, is at best only an opinion, and on its face a quite uncalculated and sweeping opinion. Such reason as is assigned for it is pretty slender support, viz.: "Too often, owing to the exigencies of the situation, the trustee has to bid competitively for the business without an opportunity to examine the indenture thoroughly before stating its fees, and the small payment it receives for its service does not warrant it in taking such responsibility." Trustee's Responsibilities The committee would have done well to consult a few trust officers or counsel for trust companies, before making that astonishing claim. The picture of a mob of trust companies clamoring to accept a mortgage "sight unseen,". all underbidding each other, is not often beheld in actual experience. Nor does the writer recall, in some twenty years' experience on both sides of the fence, an instance where a trustee was "without opportunity to examine the.indenture thoroughly before stating its fees." extra The usual situation has been the submission of a proposed mortgage of wholly conventional provisions, and the charging therefor of wholly conventional fees. Confronted with duties, no trust company will have any difficulty, even under competitive bidding, in assessing a proper rate of recompense. If there has been a case where unusual duties were imposed, unobserved by the trustee, and where the trustee failed to perform them because it found it had not charged enough of a fee, the facts should be made known and that trust company should be court-martialed. I don't believe that such cases have been numerous. On the contrary, I have seen a number of cases where the trust company has taken up the burden and is still "holding the bag," with little or no hope of reward. If it were true that trust companies don't take responsibility because underpaid, the committee ought not to allow them to take any responsibility, passive or active, because of conspicuous unfitness. It was probably, however, the intention of the committee to say that routine duties and low pay were the usual thing in railroad mortgages, and hence that the practice prevailed of not inserting any active duties in such instruments. To that statement all of us could subscribe, and it gives the committee justification for deeming the trust companies worthy, as the committee does, of some few little responsibilities of the watch-dog variety. An Unwarranted Criticism Another statement reads as follows: "The functions which the trust company is now supposed to perform, but in the course of which it generally avoids any action requiring the exercise of discretion, and consequently fails to perform." This is another harsh accusation. The "functions" are defined thus: "Taking notice of defaults and enforcing the rights of bondholders, dealing with release of property and securities and substitution of securities, and calling the bondholders together in a meeting whenever consent by vote of a stipulated amount of the bonds is rendered necessary or desirable by reason of something out of the ordinary." It is difficult to answer this charge with becoming patience. If there is one thing a trustee does, it is to take notice of defaults. It makes the defaulter's life a burden. There is here, however, a difficulty of law and of policy, which the committee can't eradicate by cussing the trustee. Namely, there is no middle posi-> tion between (a) the existence of a default and (b) court proceedings. The bondholders often forbid the latter. On any default, other than non-payment of interest, they are advised that court proceedings will probably be futile. And they don't need to be told that court proceedings will damage the quotations on the bonds. So the trustee is rarely allowed to push proceedings except in case of a money default; and even then is often held back by the bondholders or their committee for some reason of policy. None of which is the fault of the trustee or of the mortgage. Let us again be broadminded, and assume that the committee meant that the situation requires some middle method, some Purgatory short of the Sheol of court proceedings, and some provision permitting the trustee to invoke Purgatory when Sheol is out of the question. The legal remedies are crude and unhandy tools. A mortgage provision giving a trustee an administrative grip on the situation would be a highly useful implement. "Release of Property" and "Substitution of As to duties relating to "release of property" and "substitution of securities," we cannot and do not believe that a trust company "avoids any action requiring the exercise of discretion and consequently fails to perform" them. Mortgages are ordinarily specific on these matters. The trustee exercises discretion, if any be reposed in it. Every trust company has, from discretionary motives, refused to execute more than one release. Just what the committee means to imply is an enigma. Recent mortgages allow the trustee to call for an impartial valuation before releasing property or substituting securities, and to act or not as the trustee may deem wise. Where such discretion is allowed to be exercised, the trust company exercises it. It does not avoid it. The matter of convening bondholders in meeting is relatively unfamiliar in American practice. If provided, any trust company would be delighted to employ this procedure. One of the greatest difficulties a trustee labors under is to try to imagine the course of conduct which unrepresented bondholders-who fail to respond to repeated letters or published notices-would like to have the trustee pursue. Provision for bondholders' meetings would be a most welcome relief. Popular Idea of Trusteeship One other assertion is this: "The present unsatisfactory situation is due to the fact that the trust companies are now supposed to exercise supervisory and discretionary power, although they are not compensated sufficiently to warrant them in taking any risk." "Supposed," by whom? Presumably the intention was to say that the popular idea is that a trustee is somehow responsible, while a. glance at the mortgage will show that the trustee usually has no supervisory or discretionary power, at least until defaults have ripened. The question of compensation has nothing to do with it. Paid or not, the average trust company would perform supervisory or discretionary powers, and would not shirk them. As an actual fact, mortgages usually provide and protect pay for the trustee, but fail to devolve upon it supervisory or discretionary powers of any consequence. That popular repute assigns such powers to trustees, when neither the documents nor courts of law do so, ought not to sway the committee on railroad securities. Summary of the Foregoing It is easy to agree with the committee that new and more vigorous oversight provisions might well be inserted in railroad mortgages. It is hard, on the other hand, to follow the committee's argument that something or anything in existing conditions would make it unwise to grant such powers to trust companies. On the contrary, the committee's own line of thought suggests the great desirability of putting new life into mortgages and, before going elsewhere, of calling upon the trust companies to execute these greater responsibilities and to become, for the first time, real vigilant day-today fiduciaries with keen weapons constantly at hand to prevent the mortgagor's derelictions. Equipment Trusts to be Discontinued One of the most effective passages in the report is the recommendation to abandon the use of equipment trust obligations, and instead issue bonds under refunding mortgages. The railroads are in such a plight that it is beside the mark to argue that equipment is poor security for long-term bonds. They must have equipment. A very junior mortgage is poorly secured at best, relatively speaking. Such a junior mortgage, without up-to-date equipment, is like a second or third mortgage on the fee title, but not the improvements, of a highly prosperous hotel. It can't be foreclosed, except at the risk of stirring up other liens and claims, nor sold without provision for them. Nor can the railroad be operated without equipment. The committee does not mention a very great embarrassment to trust companies and bondholders, inherent in this situation. I refer to the Kneeland case (136 U. S. 87) doctrine and its intendments. Often a trustee is delayed or deterred from foreclosing or from getting into a receivership litigation by this doctrine, the upshot of which is that the pledged property and income securing the bonds may be judicially subjected to equipment trust rentals as prior claims. This doctrine, while conceived in a most equitable temper, imposes heavy burdens on junior bondholders; and the more equipment trusts there are outstanding, the heavier the burdens may become. The answer is to give up equipment trust financing, and to make "general" or "refunding" mortgages complete in themselves, secured not only by a railroad but by all the working tools of a railroad. A Word on General Policy The committee's recommendations for sinking funds, for equipment financing and generally for more thorough and efficient provisions in railroad mortgages, are most timely. Let us assume, as many do, that Government Ownership is not far off. Should it come, bondholders will probably be in as good a position as their bonds and mortgage warrant, and no better. The Government would probably recognize and protect all provisions for the benefit of bondholders. Every consideration of prudence and foresight points to the importance of commencing, now, to better the conditions of bonds and mortgages. Every one of the committee's suggestions along these lines is worthy of close study and immediate action. Corporate Trust Holdings Because of the universal practice of corporations to employ trust companies in corporate fiduciary capacities it is estimated that practically the bulk of railroad indebtedness of the country in the form of bonds and notes amounting to $12,000,000,000 at the beginning of the year is covered by indentures conveyed to trust companies as trustees. The same holds true in large measure in regard to the $20,000,000,000 outstanding bonded indebtedness of industrial corporations. It is estimated that the value of corporate trusts and of securities handled by trust companies as registrar and transfer agents, custodians, fiscal agents, etc., is close to $75,000,000,000 or equal to threefourths of aggregate corporate indebtedness and capitalization. One New York trust company alone reports corporate trusts of $9,000, 000. |