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Derailed by Bankruptcy: Life after the Reading Railroad

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What happened when the US government stopped investing in railroads and started investing in highways and air travel? By the late 1970s, six major eastern railroads had declared bankruptcy. Although he didn’t like trains, Howard H. Lewis became the primary lawyer for the Reading Railroad during its legendary bankruptcy case. Here, Lewis provides a frank account of the high-intensity litigation and courtroom battles over the US government’s proposal to form Conrail out of the six bankrupt railroads, which meant taking the Reading's property, leaving the railroad to prove its worth. After five grueling years, the case was ultimately settled for $186 million—three times the original offer from the US government—and Lewis became known as a champion defender of both the railroad industry and its assets.

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• Introduction

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Introduction

I am, by nature and inclination, lazy. Like many, I came to the practice of law with no great vocation but rather for its place as a refuge for the humanistically educated and verbally inclined. I had small talent and even less training. I graduated from Harvard Law School without distinction and accepted an offer from the firm for which I had clerked. After six and a half years, it became apparent to me that I needed to move on.

I was then hired by the law firm of Obermayer, Rebmann, Maxwell and Hippel in December 1969 and became a partner in 1972. I was appointed head of the Corporate Department in 1974. Under the firm’s culture, as department head I had the responsibility, or better the privilege, of assigning and supervising all corporate work as it developed, which meant I could keep the best and most lucrative work for myself while assigning the less rewarding cases to others. I had it made. Then there came the Reading.

For those of you who have forgotten your Monopoly, the Reading is, or was, a medium-sized bridge carrier centered around Reading, Pennsylvania, with lines extending south to Wilmington, Delaware, northwest to Newberry Junction (Williamsport), Pennsylvania, west to Harrisburg, Pennsylvania, northeast to Newark, New Jersey (in partnership with the Central Railroad of New Jersey), and east to Philadelphia and, in combination with Penn Central, Atlantic City.

 

1 The Age of Innocence

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1

The Age of Innocence

My first experience with the Reading was learning in 1971 that we at ORM&H would be counsel for it in its recently filed reorganization, and wasn’t that exciting? It didn’t really excite me. From what I casually learned about the case, it seemed to be a litigation, not a corporate matter, and I expected to have little if anything to do with it.

In the winter of 1972–1973, my mentor, Herbert A. Fogel, who was in charge of the Reading account, decided to ascend to the federal bench, and shortly thereafter my managing partner, William Fuchs, asked me to look into the representation to make sure that our client was being serviced adequately. I dutifully reported that I sensed some unhappiness in my short meetings with Reading’s staff and Drew Lewis, its active trustee, and that their affairs could stand some more hands-on legal representation. He turned to me and said, “OK, you’re it.”

“But Bill,” I replied, “I hate trains.”

 

2 The Gathering Storm

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2

The Gathering Storm

After the passage of the Rail Act in January of 1973, I decided it might be a good idea to read it. The act introduced an entirely new concept into American bankruptcy law: the idea of dual reorganization. Under it, the rail operations of the several railroads in bankruptcy in the region, defined as the northeast quadrant of the United States—namely, the Penn Central (much larger than the rest of the roads combined), the Reading, the Lehigh Valley, and the Central Railroad of New Jersey (all roughly the same size), the Ann Arbor and the Lehigh and Hudson River (much smaller), and later the Erie Lackawanna (smaller than Penn Central but much larger than Reading)—were to be split off from the remaining properties of the bankrupts and formed into a new government-controlled railroad called Conrail. The remaining properties were to continue in reorganization under Section 77, from which the creditors and possibly the stockholders would receive relief in the form of stock, cash, or new debt in many possible forms. The bankrupts would also be given interests in the new railroad in compensation and substitution for their transferred rail properties.

 

3 A Time of Waiting

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3

A Time of Waiting

Following the 1974 opinion came a time of waiting and regrouping during which nothing much happened of a formal nature until the government produced the Final System Plan as required by the Rail Act. During that period, however, we set about preparing for the oncoming deluge. One obvious question was who was going to try the case in the almost certain event that the government’s offer of compensation proved to be inadequate. I remember receiving a telephone call from Paul Duke, then head of Penn Central’s in-house legal department, asking what firm was going to try the Reading’s case and who would be the lead litigator. I replied, “Well, Paul, I guess we are and I am.”

There was a stunned silence. “Howard, I always thought of you more as a business lawyer. Have you had much litigation experience?”

“None whatever.”

“I see. Well, we’re going with the very distinguished firm of Covington and Burling in Washington with their superb Litigation Department.”

 

4 The Beginning

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4

The Beginning

Finally, in July of 1975, the government issued its Final System Plan, with a supplement issued in September. The plan followed a Preliminary System Plan dated February 20, 1975, which consisted of almost a thousand pages setting out in great detail the reconfiguration of the railroad system in the Northeast. In an effort to offer a sort of gesture toward maintaining competition in the industry, the Preliminary System Plan proposed a purchase by the Chessie of the Reading and the Erie. After considerable study on the part of the Chessie by a substantial team headed by one of its senior executives, James White, the Chessie declined the offer. That Chessie study became the foundation of our valuation claim in the case as it finally evolved.

The Chessie’s rejection meant that the government’s reorganization was to lead to Conrail, which would include all property “used or useful in rail transportation.” It also invited an analysis of what precise property was in fact “used or useful”—what cars, locomotives, lines of railroad, yards, offices, etc.—a prospect that delighted the mass of lawyers assembled to represent either the government or the railroads in reorganization, now referred to collectively as the “transferors.” The fights that ensued ranged from the fundamental to the silly. A few examples may illustrate the problem.

 

5 The Plot Thickens

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5

The Plot Thickens

With conveyance now past, everything changed. No longer charged with the obligations of providing rail service, both freight and passenger, the company became an entirely different entity. Instead of some two thousand employees, there were three people—Bill Hesse as president, Lock Fogg as secretary and general counsel, and John Brennan as chief financial officer—plus a very small support staff. In addition, there were the two trustees, Drew Lewis and Joe Castle, who were part-time, and me as outside lawyer with my staff, by which I mean Jim. Instead of occupying a large Edwardian pseudo-Moorish building at Twelfth and Market Streets in Philadelphia, the company had a small suite of offices at Plymouth Meeting, Pennsylvania. Instead of operating a railroad, the company devoted its entire energies to getting value for its remaining assets, above all its claim for compensation for the taking of its rail property into Conrail.

The assets, other than its claim, were principally a small, profitable trucking company, which it sold, some miscellaneous pieces of real estate, and the Reading Terminal Market and adjoining property, whose fate had to await the removal of the commuter service from the terminal. This was to follow the completion of a commuter tunnel linking the Reading and Penn Central passenger service, now, postconveyance, the sole responsibility of SEPTA. Still, unlike the Penn Central, these nonrail assets of Reading were of minor importance, so our claim against the government dominated everything else.

 

6 Fear and Exhaustion

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6

Fear and Exhaustion

Prior to Reading, my workweek would consist of the normal five days plus a half day on Saturday. I’m not an early person, and would arrive at the office at about nine thirty, intentionally missing the early morning phone calls, which gave me the option of returning only the ones I wanted to. I usually didn’t leave until around six, getting home around seven thirty for drinks and dinner with my wife, Maxine (the kids, Rudy and Howard, often ate earlier, though we all ate together on the weekends). I took the usual holidays off: Christmas, Easter, Memorial Day, the Fourth of July, Labor Day, and even Thanksgiving, though for reasons peculiar to my family situation, that one was more a chore than a pleasure, involving two large family meals with too much food and too little real conversation. I was able to take, usually in two segments, about a month of vacation, which mattered more to me than weekends and holidays. Though not the most involved father in the world, I still enjoyed being with my kids, and my wife’s company was a constant pleasure.

 

7 Detailed Case Preparation

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7

Detailed Case Preparation

What, then, was the task that now consumed my life—what were the flesh and bone of the argument that I had to make? On the one hand, there was the government’s scrap case, with all its discounts and unfavorable adjustments, which led them to offer the sum of $32 million for the entire Reading system, including all the leased lines such as the North Penn. On the other was our argument for value as an operating railroad with respect to the Class A and B properties and as scrap for the Class C properties. I really did not have much hope for the OCLDD valuation of $230 million, as the court had made it fairly plain that this would only serve as a backup in the event that there was no other way to “fairly” value the properties. There existed limited attacks on the government’s scrap value, as described earlier, but this wasn’t going to get us very far. Therefore, it was necessary to stress the continued valuation argument with respect to the Class A and B properties.

 

8 The Times That Try Men’s Souls

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The Times That Try Men’s Souls

The meetings we had of counsel for all the transferors, where we sat around trying to feel each other out, did not occur in a vacuum. Prior to our getting together, the Special Court had made a strong suggestion as to what it did and did not wish to hear, and we had already had the two rounds of briefing and oral argument described above, one on the constitutional minimum value and the other on the unconstitutional erosion. It was clear at this point that if the public remained the buyer, the price it would have paid was limited; perhaps, as the court suggested, it might have paid original cost less depreciation and deterioration (OCLDD), but reconstruction new was out of the question. At any rate, our first line of attack had to be to value the operating properties as an operating profit-making enterprise, not as a public service, or, if valued as a public service, as a key ingredient in an overall rail transportation network. The net result of this conclusion led all but one of us to make up a hypothetical universe in which there were a number of buyers competing for our properties, and, with respect to a public buyer, a number of competitors to provide the service offered by the railroads.

 

9 The Rail Use Case: Ours and the Government’s

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The Rail Use Case: Ours and the Government’s

It was essentially the transferors’ burden to demonstrate the value of their properties in continued rail service. The government’s primary contention, by contrast, was that absent Congressional action expressed in the Rail Act, the railroads in the Northeast would simply have disappeared, replaced by trucks on a much expanded highway system, ships on an enhanced intercoastal waterway, increased air freight, and I guess snowshoes. The government believed its role was counterpunching, that is, demonstrating that our contention would not have worked and that our properties would be largely ignored by profitable roads, or at best bought for a pittance no greater than what they would have yielded in liquidation for nonrail use.

My approach of beginning at the end of the case by imagining oral argument had the advantage of focusing my mind and the work product it developed, so that I didn’t range over a mass of fact and speculation trying to find the compelling argument emerging from the jumble like weeds sprouting in a yard. Admittedly, it had the disadvantage of limiting inquiry, so that I might well overlook a big piece of evidence which a less structured, more open investigation might have revealed. The truth is, however, I really had no choice, since the timetable set by the court effectively precluded any kind of full-range inquiry given the limited resources available to me and my own physical capacity.

 

10 The Government’s Case

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The Government’s Case

The government’s case came in two parts. The first, developed to considerable extent in the Final System Plan, was an argument that the country could, if necessary, do without railroads in the Northeast altogether. We thought this contention patently absurd. Indeed, during his examination, one of the government’s key witnesses, Edson L. Tennyson of the Pennsylvania Department of Transportation, blurted out in exasperation, “Who’s kidding whom? You simply can’t move ore, coal, or grain in the Northeast by land except by rail.” We then set about disproving the government’s assertion by specific examples.

The second prong of the government’s attack was to concede, arguendo, that rail service was indispensable, but to insist that the bankrupt railroads were such hopeless losers that the public, state and local governments and authorities, and the profitable western roads would pay next to nothing for the properties, certainly no more or just a little more than they were worth in liquidation for nonrail use. Their value then would be what the government contended in the Final System Plan. The fundamental thrust of our argument that the government brought the disaster on the railroads was aimed at countering this contention. According to us, if only the government ceased its interference through both regulation and cross-subsidy, the railroads would return to profitability.

 

11 End Game

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End Game

In the fall of 1980, as we finished the cross-examination of the government’s witnesses, we all turned to writing our briefs, though I, and I think many others, had already started drafting portions of what we wanted to present. Since the court had heard no testimony and had not been given the written evidence, let alone the discovery and cross-examination transcripts, both our cases and the government’s consisted entirely of these briefs and the excerpts of evidence each side wanted to present in the form of appendices. Our briefs were due on January 12, 1981, and the government’s some six weeks later. In the midst of the frenzied assembly of the summary of six years of intense work which consisted of the careful sifting and organizing of the mass of evidence and forming it so that it told a coherent story, two cataclysmic events occurred.

First, Ronald Reagan was elected president, and Drew told us all that he was quitting as trustee to become secretary of transportation. In short, he was switching from being our leader to leading the opposition. The problems of conflict of interest—of how we could get an unbiased hearing before the court or even the appearance of an unbiased hearing—appalled me. I tried as much as I could, since we were never really intimate, to urge him to take another post. “How about Commerce,” I said. “You have an extraordinary record as a business doctor, a fixer of troubled companies. Or how about Treasury—you at least can read a balance sheet, which is more than many of your predecessors could do.”

 

• Epilogue

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Epilogue

They’re all dead now, mostly. The three judges of the Special Court; Joe Castle, after typically ignoring his doctor’s order not to visit his daughter in Denver because of the altitude; Lock Fogg and Bill Hesse in the fullness of their years, fully vindicated as to the value of their railroad. Grant and Tom—Grant from too much alcohol over a long period of time, Tom from a surplus of cigarettes. Bill Dimeling and Jim Sox, way too young. Of the list of the fallen, two deaths affected me the most.

The first was Henry Friendly’s. When I read of his suicide in March of 1986, I found myself sobbing uncontrollably, which was totally inexplicable since I never really knew him at all, not even to exchange as little as a civil greeting: “Good morning, Mr. Lewis.” “Good morning, Your Honor.” Our “relationship” consisted of my attempts to answer his unending stream of highly intelligent and provocative questions and make as clear and convincing as possible our arguments for the valuation of what I now felt to be my railroad, in view of my contribution to a legal proceeding he created, structured, and managed in order to solve one of the most complicated and novel legal problems ever to exist in American jurisprudence. In the course of the five years we were together (longer than many marriages), I became persuaded that he epitomized the best of my profession: extraordinary intelligence; a determination to work harder than anyone should; a willingness, indeed eagerness, to explore all the issues in the case; an ability to control the litigation so that it moved at an extraordinary pace without giving anyone cause to complain that they had not been heard; and of course, total honesty and integrity. The most vivid memory I have of him now is posthumous. Several years after Friendly’s death and several years before his own, I entertained John Wisdom following a talk he gave at my request at the Historical Society of Pennsylvania, when he told me the following story in private: On the night he took the suicidal overdose of pills, Friendly wrote a number of letters. The one he wrote to Wisdom went something like this:

 

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