Act of 1864—Failure and reorganization—Extension into the Northwest—Villard and the Oregon & Transcontinental Company—Lack of prosperity—Refunding mortgage—Lease of Wisconsin Central—Financial difficulties—Receivership—Legal complications—Reorganization—Subsequent history.

The Northern Pacific Railroad Company was chartered in 1864, and failed in 1875 and in 1893. Besides these bankruptcies it has been in frequent financial difficulty, and on the whole furnishes an instructive chapter in a study of reorganizations.

The Act of July 2, 1864,542 empowered the Northern Pacific corporation to build a line from some point on Lake Superior, in the state of Minnesota or Wisconsin, westerly on a line north of the 45th degree of latitude, to a point near or at Portland, Oregon. It provided for organization on subscription for 20,000 shares out of an authorized capital of 1,000,000 shares with 10 per cent paid in, and granted forty alternate sections of public land per mile throughout the territories, and twenty alternate sections throughout the states across which the road should pass. This liberal donation was influenced in part by the fact that the value of lands in the Northwest was then low, and in part by the refusal of any money subsidy. The Government was to issue patents on the completion of stretches of twenty-five miles built in “good, substantial, and workmanlike manner,” and was to survey lands for forty miles on each side of the line543 as fast as the construction of the road should require. The company was to begin work within two years and was to finish the line within twelve years, and it was provided that in case of non-fulfilment of these conditions Congress could do “any and all acts and things which (might) be needful and necessary to insure a speedy completion of the road.” A section which gave trouble till264 amended forbade the issue of mortgage or construction bonds, or the making of a mortgage or lien upon the road in any way except by the consent of the Congress of the United States. The company was to obtain the consent of the legislature of any state before commencing construction through it, and finally the Act was to be void unless bona fide subscriptions of $2,000,000 to the stock, with 10 per cent paid in, should be obtained within two years.

A project so daring as the construction of a railroad through the unsettled Northwest not unnaturally found it difficult to obtain financial support. The capitalists who at first undertook the work were unable to carry it through.544 In 1869 and 1870 two developments occurred: the prohibition of bond issues contained in the act of incorporation was removed, and Jay Cooke became interested in the building of the road. Both facts were of far-reaching importance. Mr. Cooke was one of the foremost financiers of his time. He was a man of great personal energy, large fortune, and extensive personal following, and was admirably adapted to the promotion of the work in hand. The removal of the prohibition upon bond issues made it possible, with his support, to secure some funds from a mortgage issue and to allow construction to begin.

In 1869 Jay Cooke & Company were appointed financial agents of the Northern Pacific Railroad Company. On July 1, 1870, issues of $100,000,000 in 7.3 per cent first mortgage bonds and $100,000,000 in stock were authorized. The bonds were to be sold to the agents at 88; the bulk of the stock was to go to the agents as bonus or to the syndicate interested with them. The same parties agreed to raise $5,000,000 in cash within thirty days, in order to commence the building of the line. This made a fair start possible, and by May, 1873, over five hundred miles had been completed. The situation was nevertheless a difficult one because of the reluctance of capitalists to invest in the new first mortgage bonds. In 1870 extensive plans were made to interest the European markets, but all in vain because of the outbreak of the Franco-Prussian war. In America a similar campaign was not much more successful.545 The high price asked for265 the bonds,546 the uncertain nature of the enterprise, the not altogether ill-founded rumors of extravagance and mismanagement of the construction actually under way, the presidential election of 1872, all hindered rapid sales. Failure to sell bonds meant financial stringency for the Northern Pacific. Operating expenses were high, and the interest on outstanding indebtedness was considerable. On the other hand, earnings were very small. No through business could be secured till the completion of the road at least to the Snake River, and local traffic was yet to be developed. As a result, the company borrowed more and more from Jay Cooke & Co., and that firm soon found itself heavily involved.

On September 18, 1873, Jay Cooke & Co. closed its doors. The shock to the railroad was great. The quotations of first mortgage bonds dropped from par to about 11. For a time the company struggled on. In December, 1873, a funding of interest was carried through, whereby all coupons up to and including that of January 1, 1875, were made exchangeable for five-year 7 per cent coupon bonds, convertible into the company’s first mortgage bonds at par, and into the company’s lands at 25 per cent off from the regular prices.547 In April, 1874, settlement was made with Jay Cooke & Co. by the transfer of the railroad’s first mortgage bonds and other securities.548 These measures offered only temporary relief. Business was at a standstill throughout the country. Gross earnings for the year ending June 30, 1874, were reported to be $988,131, while $30,780,904 7.3 per cent bonds had been issued, and the floating debt stood at $777,335. The Northern Pacific was not only unable to meet its fixed charges, but was in default by a margin which it was hopeless to attempt to overcome. The original project had completely failed; and the only means of continuing the enterprise seemed to lie in a government guarantee of the railroad’s bonds, or in a reorganization so drastic as to sweep away fixed charges and to give the company a fresh start.

In May, 1874, the first plan was tried. A bill was introduced into Congress providing that the company should be authorized to issue266 its 5 per cent thirty-year bonds for $50,000 per mile on its entire line, complete and incomplete, and that on completed sections of the road twenty miles long it should deliver its 7.3 per cent bonds at a rate of $50,000 per mile, receiving in return $40,000 of the 5 per cent bonds with interest but not principal guaranteed by the Government, which should hold the difference of $10,000 as a reserve fund. Holders of outstanding 7.3 per cent bonds were to have the right of exchanging their bonds for new 5s on the same terms.549 In return for the guarantee the railroad was to surrender to the United States Government its entire land grant, to be sold under the direction of the Secretary of the Interior, and to turn over semi-annually its entire net earnings. The Government was to have the right in addition to sell the Northern Pacific 5 per cent bonds whenever the combined yield of the land grant and the net earnings should not equal the interest guaranteed. Finally, Congress was to have power to fix fares, etc., provided that the government control did not impair the security of the bonds. In brief, the capitalists who had involved themselves in Northern Pacific affairs were ready to surrender their whole enterprise to the Government if the Government would carry it through. But Congress was so little willing to take the responsibility that the bill never came to a vote.

Early in 1875, while the application for government aid was still pending, the directors called a general meeting of the bondholders. When it assembled President Cass made a statement of the financial condition of the company. The outstanding debt, said he, was $30,441,300. Of the 7.3 per cent bonds issued as collateral for floating debt, mostly in 1875, there had been pledged $1,780,300 at the rate of from twenty-five to forty cents on the dollar. The interest on land warrants, bonds, and scrip given in funding of coupons amounted to $732,632. The floating debt was $634,758, of which $150,000 were arranged for settlement within a few days; and $250,000 were due to directors for money advanced to finish the Pacific section after the failure of Jay Cooke & Co. in 1873. The total net earnings to date had been $124,056, and the capital stock was $25,497,600. By this report it seems that some slight advance had been267 made since June, 1874, but in no measure which afforded any hope for the continued solvency of the company. Most instructive were the figures for the floating debt, which in less than five years had increased to a sum more than five times the net earnings for the whole period. After some discussion the bondholders elected a committee of seven to report at a future meeting. The committee recommended a receivership, the directors did not oppose, and on April 16 General Cass was appointed receiver, resigning his position as president to accept.

By this time hope of government aid had vanished, and no time was lost in accepting the alternative of a drastic reorganization. Late in May the bondholders’ committee reported a plan which was considered by the bondholders at subsequent meetings. The principle was simple, and the means sufficient. The company had earned .4 per cent on its funded debt:—ergo, the funded debt was to be swept away. Fixed charges had been heavy:—they were now to be completely removed. Scarcely less would have met the needs of the situation, but the merit in refusing to tinker and experiment was considerable. In more extended shape the plan was as follows: Reorganization was to be carried out through foreclosure, and a committee of six was appointed to take charge. All outstanding bonds were to be replaced by preferred stock, and all common stock was to be exchanged for new common stock. Floating debt was to be likewise exchanged for preferred stock, which was to be issued to the amount of $51,000,000 for the following purposes:

(a) To retire the principal of the outstanding 7.3 per cent bonds, and the interest to and including July 1, 1878, at 8 per cent, currency.

(b) To retire the land warrant bonds, principal and interest, to and including January 1, 1875.

(c) To pay the floating debt not protected under the existing orders of the court.

(d) Generally for the purpose of carrying the plan into effect.

Preferred stock was to have all rights and privileges of common stock, with the right to vote, and was to be entitled to 8 per cent out of net earnings before anything should be paid on the common, and to one-half the surplus after 8 per cent should have been declared268 on both preferred and common.550 It was to be convertible at par into any lands belonging to the company, or thereafter to belong to it, east of the Missouri River in the state of Minnesota or the territory of Dakota, until default should occur in some of the provisions of the new first mortgage bonds, and the proceeds of all sales of such land were to be used in extinguishing the stock. Common stock was to be issued to the amount of $49,000,000, and was to be given to old stockholders share for share. To provide the means to complete and to equip the road there were to be issued first mortgage bonds not to exceed an average of $25,000 per mile of road, actually completed and accepted by the President of the United States, to be secured by a first mortgage on the whole line of road, constructed or to be constructed, and on the equipment, property, lands, and franchises, including the franchise to be a corporation, subject only to the right of the holders of the preferred stock to convert their stock into lands. The principal was to be payable in forty years, and the interest and sinking fund might be made payable in gold. No other bonds were to be issued except on a vote of at least three-quarters of the preferred stock at a meeting specially held in reference thereto on thirty days’ notice. Subsequently it was resolved, and the resolution incorporated in the plan, that the holders of the common stock should have no voting power until on and after July 1, 1878, and that no assessment should be levied upon bondholders; but that the cost of purchase and the expense of foreclosure and other proceedings should be paid out of the assets and the income of the company.551

Applying to this plan the same tests to which all other plans have been subjected, it appears that from the point of view of the corporation it left little to be desired. The general depression throughout269 the country and the needs of the Northern Pacific Railroad in particular were so great that for once, in the conflict of interests between the bondholders and the corporation, the latter had all the advantage on its side. As a matter of fact, had any attempt been made in this case, as so frequently in others of recent years, to unite in the exchange of new securities for old a bond and a stock as an equivalent for an outstanding bond, instead of giving stock only, the rate of interest on the new bond would necessarily have been so low as to deprive the combination of its attractiveness. That resource was not had to an income bond was perhaps due to the absence of English investment in the road. The wise course was the one pursued:—namely, to retire bonds with a fixed lien on earnings by stock which represented ownership in the enterprise, and which could claim dividends only when earned. The floating debt was not retired by an assessment but by new securities. This again, all things considered, was wise. The existing stock represented so little actual investment in the property that holders would doubtless have refused to pay an assessment, and would have surrendered their certificates instead; while it would have been both difficult to collect an assessment on the depreciated bonds, and hard to convince bondholders of the justice of a demand for such a contribution, so long as the stockholders were let off unscathed. On the other hand, whether or not an assessment would have yielded cash, the issue of stock for floating debt did not increase the fixed charges of the road, and was not, therefore, fundamentally unsound. Liberal provision was made for future capital requirements, and the only provision to which exception could have been taken was the limitation of bond issues to the moderate figure of $25,000 per mile except with the consent of three-quarters of the preferred stockholders. On the whole, the plan put the company fairly on its feet, presented it with all the work which had been accomplished, and bade it attempt again the project in which its failure had previously been so complete. The danger of future bankruptcy lay in this fact only: that a large section of the road was yet uncompleted, and through business was non-existent; that the Northwest was still unsettled, and the local business was small; in short, that so much was yet to be done that the company, with all the advantages which it now270 possessed, might fail again for the same reasons which had led it into bankruptcy before.

The plan was first reported on May 20,552 and was laid before the bondholders on the 30th of June. There was some protest that it proposed giving away the property of the bondholders, and the additional sections before mentioned, concerning the expenses of the reorganization and the voting power of the common stock were added. By August nearly two-thirds of the bondholders had assented.553 By May a decree of sale had been obtained, which was modified in August so as to give bondholders priority over claims of directors for advances made; and on August 12 all the property of the company, except the patented and certified lands,554 with all its rights, liberties, and franchises, was sold at public auction and bought in by a purchasing committee for $100,000.555 No upset price was set by the Court; and it was surmised that the bid was purposely made low in order to force non-assenting bondholders to accept the new stock. The new corporation was organized in October, 1875, by the election of Mr. Chas. B. Wright of Philadelphia as president, and with the denial of a petition to set aside the sale the reorganization may be said to have been concluded.

For fourteen years the company was now to be free from talk of further reorganization, and not until 1893 was there to be another receivership. During this time the mileage, owned or controlled, was to be made continuous from the Pacific coast to Chicago, and the Northern Pacific was to mount high among American railroads in its extent and in the volume of its business. In 1875 the completed mileage was, roughly, 550 miles of line; in 1893 it was 5431.92, and reached from Ashland, St. Paul, and Minneapolis on the east to Portland, Olympia, Tacoma, and Seattle on the west. In the former271 year the gross earnings were $414,722 and the net $97,478; in the latter the totals were $23,920,109 and $11,416,283. At the same time the fixed charges rose from nothing to $14,311,430, and the bonds outstanding to $133,545,500, besides $15,349,000 of bonds of subsidiary companies guaranteed. It appears, therefore, that the promoters were successful in raising funds for the completion of their enterprise, although their road suffered at first from the thin population of the Northwest and the lack of a through connection, and then from the competition of other transcontinental lines.

From the reorganization to 1879 very little was done in the way of new construction, owing to the general financial depression. Efforts to get the time allowed for completing the road extended failed, however, and it became necessary to resume in order to keep Congress contented and to avoid a forfeiture of the land grant. In 1878 a small loan was placed, and the following year one for a somewhat larger amount; and with the funds so secured construction was vigorously pushed. More liberal provision was made in 1880–1, when successful negotiations were carried through for the sale to a syndicate of $40,000,000 general mortgage 6 per cent railroad and land-grant bonds, to be issued at the rate of $25,000 per mile of finished road only, and to be secured by a mortgage on the entire property of the company except the lands east of the Missouri River, which were pledged for the redemption of the preferred stock. Provision was made for a reserve of these bonds sufficient to retire the prior issues before mentioned.556 Under the agreement the syndicate took $10,000,000 at once and had an option of taking $10,000,000 per year in each of the next three years. The reported price was 90 for the first $10,000,000 and 92? for the rest. As a matter of fact, the whole $40,000,000 had been turned over by the end of 1883, and though the effect on the company is seen in the increase in its bonded indebtedness from $3,881,884 in 1880 to $39,522,200 in 1883, and in its fixed charges from $334,482 to $2,478,939, it was meanwhile supplied with cash, and was enabled to advance toward the completion of the 1000 miles of line which remained unbuilt. The financial embarrassment which was felt in 1882, in spite of the syndicate contract, was due to an unforeseen cause. According to the272 statements of the company, it was felt necessary, in order to avoid waste of time and money, to build simultaneously from both ends of the line, and to start all the heavy work on the entire route at once. “This involved the shipment of millions of dollars’ worth of track material, motive power, and rolling stock to the Pacific coast many months before their actual use on the road; and on the line east of the Rocky Mountains very large expenditures of cash a long time before the works resulting from them could become parts of finished road.”557 The expenses were immediate;—the delivery of bonds to the syndicate could take place by the terms of the contract only after the completion of finished sections of road, so that great stringency easily occurred between. The trouble was only temporary, and was tided over with the help of the syndicate and of the Oregon & Transcontinental Company, a corporation of which we shall presently speak.

As the Northern Pacific pushed into the Northwest, and at the same time vigorously occupied itself in filling the gap between the ends of its main line, it came into contact with a combination of Northwestern companies known as the Oregon Railway & Navigation Company, of which Henry Villard was at the time in control. This corporation owned a line of steamboats running on the Willamette and Columbia rivers in Oregon, together with an ocean line connecting Portland and San Francisco.558 In connection with the water routes a narrow-gauge road had been built up the left bank of the Columbia River to a connection near the mouth of the Snake River with an existing narrow-gauge road to the town of Walla Walla in Southeastern Washington; and this narrow-gauge was being widened, in 1880, to standard. This was the very territory through which the Northern Pacific expected to make its connection with the Pacific coast; and in 1880 it had passed the Rocky Mountains and had reached the confluence of the Columbia and the Snake. On October 20, 1880, a contract was signed between the Northern Pacific and the Oregon Railway & Navigation Companies whereby the former, among other things, consented to a division of territory with the Snake and the Columbia rivers as the dividing-line; in return for which the latter agreed to complete a standard-gauge road within three years273 from the western end of the Northern Pacific, at the mouth of the Snake River, to Portland, and to grant the Northern Pacific the right, without the obligation, to run its own trains over it at a fixed charge per train mile. It will be remembered that the Northern Pacific was not at this time too easy in its finances, so that it was quite willing to secure connection with the coast without outlay of its own. Soon after the execution of the contract, however, the $40,000,000 loan earlier described was arranged for, and Mr. Villard feared that the road would build its own connection with Portland now that the means seemed to be at hand. To prevent it he conceived no less a plan than that of forming a new company which should purchase and hold a controlling interest in both the Northern Pacific and the Oregon Railway & Navigation Companies.559 This was done, and the new corporation, known as the Oregon & Transcontinental Company, for a long time played a prominent part in Northern Pacific affairs;560 aiding it in the construction of the main and branch lines, and time and again advancing money when the road was in straits.561

The formation of the Oregon & Transcontinental Company put Mr. Villard in control of the Northern Pacific. Mr. Villard’s financial strength in later years was due mainly to the support of German interests, notably the Deutsche Bank of Berlin; but his hold on the bank and on his followers was partly due to his real ability and resourcefulness, and partly to his confident predictions of results which sometimes he was but frequently was not able to attain. One of the company’s first acts after his appearance was the declaration of a scrip dividend upon the preferred stock. The question had been raised in the course of his fight for control, and he perhaps felt it incumbent upon himself to show the sincerity of his contentions; at any rate, the annual report for 1882 contained a statement that the surplus earnings since 1875 had been used for construction instead of being distributed as dividends, and that the sum of $4,667,490 was therefore properly due to the preferred stock. On the strength of this the directors resolved that a dividend274 of 11.1 per cent be declared, for which there were to be issued obligations of the company bearing 6 per cent interest, payable at the end of five years, but redeemable after one year at the pleasure of the company upon thirty days’ notice, in amounts of not less than 20 per cent to each holder. The policy thus initiated was plainly non-conservative and unsound. It may be true that as a general principle new construction should be paid for out of capital rather than out of income account, yet this is subject to qualifications; and the Northern Pacific had been and was in so precarious a condition that not a dollar of its resources could safely have been alienated. The sequel came in 1883 when the annual report admitted that there had been an excess of expenditures on account of construction and equipment of $7,986,508 over the cash receipts from the proceeds of the $40,000,000 general mortgage bonds, sales of preferred stock, and other sources;562 and when by October of the same year the deficit had been increased to $9,459,921, and a circular from President Villard stated the additional cash requirements to amount to $5,500,000.563

Relief had to be sought in an increase of indebtedness. On October 6, 1883, the directors authorized a second mortgage for $20,000,000 upon the property, subject to the consent of three-fourths of the preferred stock, and in a circular explained that they had accepted a proposition of Drexel, Morgan & Co., Winslow, Lanier & Co., and August Belmont & Co. to take $15,000,000 of the issue at 87?, less 5 per cent commission in bonds, with a six months’ option to take $3,000,000 more on the same terms. The stockholders assented,—they could do nothing else,—a suit for an injunction was denied, and the syndicate exercised its option. The result was an increase in bonds issued from $39,522,200 to $61,635,400, of which the greater part was accounted for by the new mortgage.

By August 22, 1883, the gap in the Northern Pacific main line had been filled up, and on September 8 the formal opening occurred. The275 mileage in operation was then 2365, of which 1952.5 was main line and 412.8 branches, and the rapid construction of the last 1000 miles had done credit to most of those concerned. The total capitalization per mile was $59,304, of which less than one-third represented bonds; and though the following year this percentage was increased, the proportion of mortgage to total issues remained considerably under one-half. This showing was very favorable, and accounts for the success with which the Northern Pacific withstood the panic of 1884. With the completion of its through line, moreover, earnings increased so materially as to cover the interest on the new bonds; and though the road was never to enjoy a monopoly of transcontinental traffic, in February, 1883, it had concluded an agreement with the union Pacific concerning through rates and a division of territory, and a period of prosperity was hoped for. Meanwhile the Oregon & Transcontinental Company had been hard hit by the decline in Northern Pacific stock, due to the publication of the construction deficit. The straits of his company affected Mr. Villard; and in spite of the relief afforded by the Northern Pacific second mortgage he “became conscious that neither himself nor the Oregon & Transcontinental Company could be saved.”564 On January 4, 1884, the directors accepted his resignation, and soon after Robert Harris, then vice-president of the Erie, was elected to fill his place.565

The years immediately following the issue of the second mortgage and the completion of the road were not uneventful, although it is not necessary to describe them at length. The insolvency of the Oregon & Transcontinental, and continued disputes between it and the Northern Pacific over an adjustment of the two companies’ financial relations, made some other means of binding the Oregon Railway & Navigation with the Northern Pacific seem advisable, and a lease of the former company to the latter was discussed. In July, 1884, an arrangement was said to have been actually arrived at on the basis of a guarantee by the Northern Pacific of 6 per cent on the Navigation stock for two years, 7 per cent for three years, and 8 per cent in perpetuity; but the interest was very high, and an injunction helped to prevent a consummation at the time. In 1885276 the idea of a joint lease by the Northern Pacific and union Pacific railroad companies came to the front. The Oregon Railway & Navigation was serving as the Northwestern outlet for both of these roads, and such a contract would have greatly simplified the competitive situation, besides taking away from the Navigation Company the power to exact an excessive pro-rate because of its double connection.566 During the next few years negotiations were almost constantly in progress. In 1887, however, the Navigation Company was leased to the Oregon Short Line with a union Pacific guarantee; and upon the failure of renewed negotiations Mr. Villard, who was again in power, sold the Oregon & Transcontinental Company’s holdings of Oregon Railway & Navigation Company stock at a “satisfactory” price. This consummation was less unfavorable to the Northern Pacific because of its completion of a line of its own to the Pacific coast.567 From now on the Oregon & Transcontinental Company existed only as a means of obtaining financial assistance for the Northern Pacific, and for making more easy the control of that company’s stock.568

While these operations were going on the Northern Pacific once more found it advisable to increase its indebtedness, and added a third mortgage of $12,000,000 to the first and second mortgages which already have been described. Of the issue $8,000,000 were at once taken by a syndicate, and the $4,000,000 remaining were early disposed of to the same parties. The mortgage was said to be for the purpose of completing new work and for paying the floating debt; it also assisted in the redemption and refunding of the dividend scrip which had been issued to preferred stockholders in 1883; and the payment of $3,073,321 of this in cash, besides the extension of $1,567,500 more, now took place. The extended scrip was to be payable in 1907, to bear 6 per cent, and to be redeemable on277 thirty days’ notice on any interest day on or after 1892; and up to January 1, 1893, holders had the option of converting it into third mortgage bonds.569 The third mortgage itself required the consent of three-quarters of the preferred stockholders, but this there seems to have been little difficulty in securing.

The years 1886–9 saw also a considerable extension of branch and other construction. It was a time of great general activity. In another place the large additions to the Atchison system have been described; at the same time the union Pacific grew from a system of 5825.6 miles in 1886 to one of 6996 in 1889, adding over 1100 miles; the Chicago, Rock Island & Pacific increased from 1384.2 to 1592.7; the Chicago, Burlington & Quincy from 4036 to 5140.8; and the St. Paul, Minneapolis & Manitoba from 1509.4 to 3030.1. Meanwhile the Northern Pacific added 656.8 miles, or an average of 219 miles a year.570 In the far Northwest the great tunnel through the Cascade Mountains was nearly completed by May, 1888; and by the end of the following year a continuous line of road was in operation from Ashland, Wisconsin, to Portland, Oregon, which was of particular service in view of the difficulties with the Oregon Railway & Navigation Company, and was the reason for the willingness of the Northern Pacific to surrender control of that connection.571 In 1888, also, negotiations were carried on with the Canadian Government for an extension into Manitoba; and the same year the C?ur d’Alene Railroad & Navigation Company was purchased, comprising a steamship and narrow-gauge line in Northeastern Washington which extended through the mining region of the same name.572 Generally speaking, the Northern Pacific retained its character as a single-track transcontinental route with but few branches. Where it did expand was on the east, where it reached Duluth, Ashland, Superior, St. Paul, and Minneapolis, and on the west, where it joined Wallula, Portland, and Tacoma. The principal other branches278 were the ones mentioned: namely, those to Winnipeg, and to the mining districts in Montana and Washington.

In spite of its moderation the Northern Pacific was not over-prosperous. Its passenger earnings remained small, being scarcely greater in 1888 than they had been in 1884; and while its freight earnings increased from $7,867,367 in 1884 to $10,426,245 in 1888, and to $15,600,320 in 1889, this was so far offset by increased operating expenses that the increase in net earnings from both passengers and freight was only $2,223,194. Construction meanwhile caused an increase in funded indebtedness outstanding of $15,202,000, to say nothing of $20,981,000 of branch-line bonds which the road by 1889 had guaranteed; and the floating debt began to grow uncomfortably large.573 At the same time, if Mr. Villard is to be believed, officials in charge of the operation of the road were eager for appropriations for the improvement of the track, the replacement of wooden by metal bridges, additional motive power and rolling stock, enlargement of terminal facilities, and the purchase and construction of new lines. The truth was that the problem of getting the road built had been more important than that of how it was to be built; so that much work had been done in a hasty and imperfect manner which it was now advisable to renew.

Since, then, there was need for additional capital, while it was unsafe to increase the fixed charges of the road, the managers felt called upon to devise a scheme whereby these circumstances should both, at least in appearance, be met. Their solution was the proposal of a large refunding mortgage to retire as soon as possible existing mortgages, and to provide a balance which could be spent upon the line. If, they argued, bondholders could be induced to accept new 4 per cent or even 5 per cent bonds in exchange for their 6 per cent securities, the road would be free to issue new additional bonds until the margin of charges so obtained should have been taken up. The plan was worthy of its ingenious promoter, Mr. Villard, and will be criticised in the proper place.

279 On September 19, 1889, the managers issued a circular to the preferred stockholders. “In the opinion of the Directors,” said they, “the time has come to make new financial provision on a liberal scale for the growing needs of the Company.” Then followed a statement of gross earnings. “A further corresponding increase may be expected in the present fiscal year, which will bring the gross earnings up to $23,000,000 or $24,000,000.... But the Company could not in the past, and will not be able hereafter, to take full advantage of this auspicious situation without further large investments of capital. Secondly.—The prosperity of the road attracts competition.... The Company must be prepared to build additional feeders wherever and whenever the local developments warrant, and the danger of hostile occupancy appears.... Another strong [motive] lies in the Company’s ownership of a large land grant, the benefits of which cannot be fully realized without the promotion of settlements through the construction of branch lines. The Board is also of opinion that the time has come to make such provision, that the Company may take advantage of its high credit to effect a reduction of fixed charges.”574

It was proposed to issue a $160,000,000 one hundred-year consolidated mortgage, bearing interest not to exceed 5 per cent, to cover the entire Northern Pacific Railroad, together with its equipment, land grant, branch lines, and securities of branch lines. This was to be applied as follows:
For the retirement of $77,430,000 outstanding first, second, and third mortgage bonds     $75,000,000          ?
For the retirement of the existing $26,000,000 branch bonds     26,000,000          ?
For additional branches at a rate per mile not over $30,000     20,000,000          ?
For enlargement of terminals and stations, additional rolling stock, betterments and renewals, and other expenses not properly chargeable to operating expenses     20,000,000          ?
For premiums on bonds exchanged     10,000,000          ?
For general purposes     9,000,000575     ?

Only a portion of these securities was, therefore, to be issued at once. The provision for enlargement of terminals, etc., was likely to call for early issues, as might a portion of that reserved for280 new branches and for general purposes. It was expected that a certain amount of branch-line bonds could be retired without much delay. On the whole, the bonds immediately put forth were not expected to exceed $15,000,000; though there was nothing in the plan to prevent a greater issue. The interest rate was “not to exceed 5 per cent.” That this wording was deliberately adopted is shown by the terms of the mortgage, which expressly gave to the company the power to issue the new bonds, from time to time, bearing such a rate of interest as the managers might think advisable up to 5 per cent. It was understood that the issue was to be in three classes, one of $57,000,000 to bear 5 per cent, one of $23,000,000 to bear 4? per cent, and one of $80,000,000 to bear 4 per cent; and on this basis it was thought that fixed charges would be reduced $2,000,000, to which would have to be added interest on bonds issued in excess of those previously outstanding.576 The reserve of $10,000,000 for premiums shows that in the opinion of the directors the offer of substantially more than par in new bonds was necessary in order to induce exchanges of old bonds for new. To prevent careless use of this reserve it was provided that the $10,000,000 in bonds could be used to pay premiums only upon the affirmative vote of at least nine members (out of thirteen) of the board, and when in the opinion of the trustees, expressed in writing, a saving of interest to the company could be effected.

Not the least important part of the plan was that designed to gain the preferred stockholders’ approval. It will be remembered that by the terms of the reorganization of 1875 the consent of three-quarters of these stockholders was necessary to validate any mortgage after the first mortgage then proposed. The increase in indebtedness now suggested threatened to postpone indefinitely dividends on the preferred, and could not be expected to be welcome. In consequence, the directors offered three distinct inducements: first, a promise of a distribution to the preferred stockholders of sums which had been taken from earnings and spent on the property to date; second, a promise of early and regular dividends in the future; third, a preferential right of subscription to the new bonds. By resolution of August 21, 1889, they therefore definitely declared in favor of the281 distribution of a sum equal to the earnings which should be found to have been applied in earlier years to the capital requirements of the property. An investigation was made, the amount was officially declared to be $2,844,430, and an equivalent amount of new bonds at 85 was set aside to cover it. For the future Mr. Villard and his associates announced a determination to begin dividends at the rate of 4 per cent, the first to be paid January 1, 1890; and declared that thereafter dividends would be paid out of the current net earnings, or, if these should be insufficient, out of a reserve fund until the net earnings should justify a larger distribution. Finally, it was provided that the common and preferred stockholders should be given the privilege of subscribing to the new bonds at 85 to the extent of 15 per cent of their holdings. That these concessions attracted attention was shown by the action of the preferred stockholders in calling for an actual distribution as soon as possible of the amounts deducted from earnings in past years. On October 17, 1889, they passed a resolution recommending to the incoming board of directors “to take into consideration the distribution of the whole amount due to the Preferred Stock, under the plan of reorganization, as soon as the Company shall be financially in a proper position to do so;”577 and again the following year they resolved “that the incoming Board of Directors be ... requested to set apart the additional earnings in ... consolidated bonds ... and to (consider) the question of either increasing the ... dividend above 4 per cent or of declaring an extra dividend to the preferred stock.”578

All things considered it is improbable that the refunding plan could have been put through without the promise of dividends to the preferred stock, but it remains unfortunate that such promises had to be made. The money which had been put into the road had been of necessity so invested to preserve the solvency of the company. In a sense it had increased earning power, but not all expenditures which affect earnings may be charged to capital. In the first place, if earnings are below fixed charges, or are constantly tending to fall282 below, sums put into the property merely assist the company to keep its head above water, and are not a sound basis for an increase in indebtedness; and in the second place expenditures which serve to preserve earnings may not be charged to capital account, even when the method of preservation is the construction of branch lines, and still less when the method is the improvement of the existing plant. If, then, as was the case, the earnings claimed by the preferred stockholders had gone to preserve the solvency of the company, and to defend it against competition, the arguments of these stockholders in 1889 did not hold good.

As for the plan itself, it was simply a method for providing new capital, and should be judged as such. Its refunding provisions were mainly misleading. It proposed to secure a reduction in fixed charges by the exchange of bonds bearing 5 per cent or less for bonds bearing 6 per cent, but how the reduction was to be accomplished was not clear. The maturity of the bonds to be retired was remote, and the assured reduction was therefore also remote. The first mortgage had been issued in 1881, and ran for forty years; the second dated from 1882 and was to mature after fifty years; and the third, which had been issued only the year before, was not redeemable until 1937. The Missouri division and Pend d’Oreille mortgages matured somewhat earlier,579 but had nevertheless a considerable time to run. The mortgage issues would therefore not soon fall in of themselves. Secondly, bondholders would evidently not consent voluntarily to surrender old unexpired bonds without such a premium in new bonds as would make their annual return approximately the same. Something they might concede in view of the more remote maturity of the new issue and the somewhat more inclusive character of its mortgage lien, but not enough to create any considerable saving.580 The new issues for improvement of the road, moreover, involved an increase in the annual interest payments; which we must not, perhaps, condemn offhand, for the raising of capital was in some measure forced upon the company, but which is important in considering the railroad’s financial condition and prospects. The fact was that the Northern Pacific was not self-supporting; it had been obliged283 to issue $20,867,000 bonds of its own and to guarantee $20,981,000 besides, between 1884 and 1889, in order to secure an advance of $2,462,288 in annual net income during a period of rapidly increasing prosperity; and it was now obliged to increase this indebtedness in the attempt to maintain its solvency for the future.

Between 1889 and the end of 1892 business increased, and net earnings at first gained more rapidly than did fixed charges. Mr. Villard was again supreme in the management, and actively directed financial operations until his departure for Europe in 1890. The most important operation conducted was the lease of the Wisconsin Central, whereby the eastern terminus of the Northern Pacific system was transferred from St. Paul and Minneapolis to Chicago. The directors who were elected with Mr. Villard in 1887 controlled the Wisconsin Central and the Terminal Company, which had been formed to secure an entrance for that road into the Lake city.581 Perhaps because of this financial interest, the conviction seems to have crept over them that the Northern Pacific would do well to make connection with the trunk lines at Chicago, instead of stopping further west; and they brought the subject up in 1889, and again in 1890. On July 1, 1889, a traffic contract went into effect, under which the Northern Pacific obtained the use of the Wisconsin Central lines in consideration of the business which it should turn over to them. Certain provisions imposed on both roads a share of the operating expenses whenever the proportion of operating expenses to gross earnings was greater than 65 per cent, and which gave both a profit whenever the proportion fell below this level. The Wisconsin Central retained entire and absolute control of its own property, except that the Northern Pacific was to share in the profits of the subsidiary Terminal Company whenever these profits should be more than $800,000.582 This was considered unsatisfactory, because284 the Northern Pacific had no control of the Central’s operation; and on April 1 of the following year a new contract gave to the former a lease of all the lines owned and controlled by the Wisconsin Central Company and the Wisconsin Central Railroad Company between St. Paul and Chicago for 999 years; including terminal facilities at Chicago held by the Chicago & Northern Pacific Railroad Company, a subsidiary corporation.583 “It was deemed by the Board,” said the annual report, “as of the utmost importance that your road should have access to the city of Chicago by a line in its own ownership and possessed with terminal facilities which it could control and have possession of. The whole subject was most carefully considered by the Board, and the contracts and leases were adopted after deliberate and careful consideration.”584 The advantage of this lease to the Wisconsin Central lay in the large volume of traffic which the arrangement secured to it; that to the Northern Pacific was more doubtful. Connection with Chicago was desirable, but it was to prove difficult to operate the Wisconsin Central for 65 per cent, and the acquisition was to arouse the hostility of all the other roads between Chicago and St. Paul. We shall see that the lease was presently given up and that the attempt to make Chicago the eastern terminus was for the time abandoned.

The year 1891 was a good one, but during the following twelve months the situation changed for the worse. Most noteworthy was an increase in fixed charges of over $2,000,000, due in part to an increase in the funded indebtedness, but more largely to an increase in rentals paid. This increase brought charges above total net income, and shows how serious the position of the company had become. In fact, the company’s repeated issues of bonds had failed so completely to put it in a stable position that in but three of the285 nine years from 1884 to 1892 was a surplus greater than $500,000 above fixed payments secured, while the operations of two of these same years resulted in a deficit.

The first admission by directors that the road was in difficulty consisted in the passing of the preferred stock dividend for March 31, 1892. That this action did not deprive the holders of all return was due to the previous conversion of the consols formerly reserved into a trust for ten years on which to draw whenever the road should be unable to pay the usual dividends. The directors therefore added to their declaration of suspension a resolution that the “time, manner, and method of the distribution of so many of the $3,347,000 of consolidated bonds set aside for the benefit of the preferred stockholders as may be necessary to supply the deficiency, if any, in this or any subsequent fiscal year, between the amount of net earnings and 4 per cent on the preferred stock, be submitted to preferred stockholders at the annual meeting in October next.”585 Not unnaturally stockholders were alarmed. At the annual meeting in October an investigating committee was appointed,586 and proceeded to a careful examination of the property accompanied by certain officers of the road. The committee was not friendly to the management. Its preliminary report announced that the physical condition of the system was good, but its later criticism of the company’s financial condition was severe. In the words of the London Standard “there has been no such scathing arraignment of Directors since the exposures of the Erie Railway.” The committee stated that the bad condition of the property was due to the reckless financial methods of the directors.286 It alleged that officers had held dual positions, and had subordinated the interests of the Northern Pacific Company to those of the Wisconsin Central, relieving themselves at the expense of the former road. It commented upon the unprofitable character of certain of the other branches. The floating debt, it maintained, had been financed by Mr. Villard personally at double the current rates of interest, and it recommended litigation in default of some assurance that the policy of the company should be changed.587 In reply the directors issued a lengthy statement taking up the charges in detail. The policy of building branch lines, said they, was imperatively necessary in order to develop business. Although some of the branches had not earned their fixed charges, yet, if they had been credited with 60 per cent of the gross earnings on business which they had brought to the main line, they would have shown a good profit. The policy of branch-line construction had met with the unanimous approval of successive boards of directors, and had been ratified by the stockholders in 1886; and in this connection the reply defended specifically the acquisition of the Wisconsin Central and other lines. The carrying of the floating debt by officials interested in the property, instead of being subject to criticism and censure, was entitled to the highest commendation.588

It is difficult to pass with justice upon the conflicting contentions above outlined. However, writing in 1905, long after his retirement from Northern Pacific affairs, Mr. Villard expressed himself as follows: “In 1891 Mr. Villard ... made ... his last official tour of inspection of the main line and principal branches of the Northern Pacific.... The most alarming impression of all made upon him was the revelation of the weight of the load that had been put upon the company by the purchase and construction of the longer branch lines in Montana and Washington, which he then discovered for the first time. There was the Missoula branch to the C?ur d’Alene mines; the C?ur d’Alene Railway & Navigation, a mixed system of steamboats and rail lines; the Seattle, Lake Shore & Eastern; and the roads built into Westernmost Washington; representing a total287 investment in cash and bonds of not far from $30,000,000, which together hardly earned operating expenses. The acquisition and building of these disappointing lines had in a few years absorbed the large amount of consolidated bonds set aside for construction purposes, which had been assumed to be sufficient ............