Kansas City Southern Railway Company v. United States (231 U.S. 423)

[Syllabus from pages 423-425 intentionally omitted]

This is an appeal from a decree of the commerce court, dismissing appellant's petition in an action brought to have certain, regulations of the Interstate Commerce Commission relative to the method of keeping the accounts of carriers declared invalid, and to enjoin the enforcement thereof. 204 Fed. 641. The regulations are contained in the 'Classification of Expenditures for Additions and Betterments of Steam Roads,' effective July 1st, 1909, and the First Revised Issue thereof, effective July 1, 1910.

The facts as set forth in appellant's brief may be summarized as follows:

Appellant is engaged in interstate commerce. Its main line is about 786 miles in length, and extends from Kansas City to Port Arthur, on the Gulf of Mexico, traversing the states of Missouri, Kansas, Oklahoma, Arkansas, Louisiana, and Texas. The road was built years ago, when the country was heavily timbered and sparsely settled, and the traffic was correspondingly small. The traffic would not then support, nor could capital be obtained for, an expensively constructed road; and in consonance with the general practice in the development of the country, the road was built with rather heavy ruling grades. But it was not defectively or improperly constructed or located; it had substantially the same grades as other roads then constructed in the West; and it was adequate to serve the then-existing needs of the country. A railroad with heavy grades is, of course, more cheaply constructed than a road of low grades. And a road of heavy grades is generally adequate in a new country, where the volume of traffic offered is small, the train loads light, and the trains few.

The ruling maximum grade of appellant's line as originally constructed was 1 per cent; and in the mountain district as high as 1.35 per cent. The evidence is undisputed that it was properly located, well constructed, and ample for the needs of the country. In the course of time, with the development of the country, and the resultant increase in traffic, whereby the limit of the road's capacity was being approached, the conditions warranted and rendered desirable such additions or improvements as would enlarge the road's capacity, and permit traffic to be moved more rapidly and economically.

Two methods of increasing the capacity of the road were presented: one by doubletracking, the other by lowering the grades and thus permitting traffic to be moved more rapidly. The road was in active competition with powerful rivals operating in the same general territory; among them, the Southern Pacific, the Missouri, Kansas, & Texas, the Missouri Pacific, the St. Louis Southwestern, the Texas & Pacific, the St. Louis & San Francisco, the Atchison, Topeka, & Sante Fe, and the Rock Island. The character of the road as a trunk line, having a long average haul and the prevalence of low-class traffic,-timber, coal, oil, and like commodities, necessarily entailed a low average freight rate; its average rates per ton per mile being lower than those of any of its competitors above named.

Under these conditions the management found that the most desirable plan was to lower the grades of the road, and thus to increase its capacity, procure economy in operation, and render better service to the public. Two methods of reducing the grades at various points along the line were presented: one by raising or lowering the roadbed on the existing right of way; the other by the construction of short sections of new read in substitution for portions of the road, in instances where the same result could be thus obtained at less cost. The program of improvement contemplated, therefore, not only many changes on the original right of way, but also a number of changes by the substitution of short sections of road on new ground, where that method was more economical.

The first six sections of the road where new locations were utilized are covered by the petition herein. Other similar changes are being made as the work proceeds, which will cover several years, and is estimated to cost $3,000,000. The road at these six points was in no way worn out, was fully maintained, and was capable of performing for an indefinite term the function for which it was originally constructed. All of these changes are being made for the purpose of increasing the capacity of the line, of securing economy in operation, and of rendering improved service to the public.

At the six sections of the road in question it was found by the estimates of the engineers that the cost of securing the required gradient upon the original roadbed would be $1,230,318.99; but that the same result could be obtained by means of re-locations upon adjacent land for a net expenditure of $629,399.74.

The actual expenditure on these six new locations, as ascertained on completion of the work (after the filing of the petition), was $763,798; and the testimony shows that had the work been done on the original roadbed the cost would have been increased over the estimates in an equal or greater proportion; the variation being due to increase in the cost of labor, materials, etc. For present purposes, the figures set forth in the petition are adopted.

The grade revisions at the six sections of line involved herein having been completed by removing the tracks to adjacent parcels of ground, which were procured and substituted for the original parcels, the use of the latter parcels was, of course, discontinued.

The expenditure required to improve the property by bringing it to the desired grade of 5/10 of 1 per cent being deemed a capital expenditure, appellant's directors determined to finance the work by applying to it the proceeds of a bond issue. It is claimed to have been necessary to finance the improvements in this way if they were to be made at all, because the appellant did not have current earnings available for these improvements, and could not have financed its program, involving the revision of about 41 per cent of the entire line and an ultimate expenditure of several million dollars, in any other way than by raising capital for that purpose through the issuance of bonds.

Appellant, in order to raise funds for this and certain other purposes, made an issue of bonds secured by a second mortgage on its property. This way duly authorized by the directors and stockholders in the month of June, 1909; a portion of the bonds was sold and an initial sum of $1,250,000 thus obtained became applicable to the improvements referred to in the petition and other improvements in the grade. Additional bonds have since been issued as the work has proceeded.

In 1907, appellant began the payment of dividends at the rate of 4 per cent per annum upon its preferred stock, the total amount of which was $21,000,000, and has continued to pay such dividends each year until the present time. These dividends are noncumulative and are payable only out of the earnings of the current year. The fact that appellant had paid its dividends for several years was a factor in its credit. Preferred dividends having been established, it is claimed that their discontinuance would have affected the credit of the road so seriously that it would have been unable except on prohibitive terms to dispose of additional bonds as further money was required from time to time during the progress of the work. It is further claimed that appellant was able to finance its improvements only out of the proceeds of a bond issue; and that it could not have financed them at all except by adopting the economical method of making a considerable part of the grade reductions by means of changes off the line of the right of way.

Appellant, having paid the cost of the six improvements out of its issue of bonds, was confronted with the regulations of the Commission bearing on the method of recording the transaction in its books of account. Except for those regulations, it is said that the full cost of the improvements would have been charged to the account of 'Additions and Betterments,'-a subdivision of the property accounts,-and credited to the proceeds of the bonds, because that sum had been expended for additions and betterments, and because the bonds had supplied the funds. In the balance sheet the 'Assets' would have shown an increment of approximately $629,399 under the subdivision of Additions and Betterments, and, per contra, the 'Liabilities' would have shown a corresponding increase under the subdivision of 'Bonds.'

Under the regulations in question, it was found that if the improvements had been made on the original right of way, the entries would have been made as above indicated. But, with respect to improvements made off the right of way, different treatment was prescribed. Here the appellant was not permitted to carry into its property accounts the full cost of the improvement, but was required first to deduct from the cost thereof the estimated replacement cost of the portions of track no longer used, the difference only being carried into the property accounts, and a sum equal to the estimated cost of replacing the old sections of track being charged to the operating expenses of that year.

The text of the Classification of Additions and Betterments relative to revisions made on the original line is as follows: 'Grade Revisions.-(Reducing of grades by cutting down summits and raising sags without materially changing the alinement).-The amount to be charged to this account is the cost of additional grading done, including as a portion of such cost the rent and cost of operation of steam shovels and work trains; building temporary tracks for steam shovels and grading outfits; tools, etc., used in the work; raising or lowering existing bridges; increasing the length of culverts and replacing riprap at culvert ends; changing grade crossings for farm or country roads, highways, and streets, including crossing gates, highway crossing alarms, and watch houses.'

Relative to changes off the original line the regulation is as follows: 'Changes of Line.-(Construction of new lines for the purpose of improving grade or alinement).-The amount to be charged to this account is the difference between the cost of the new line and the cost of replacing in kind the line abandoned, exclusive of right of way.'

The General Instructions contained in the Classification supplement these rules and prescribe charges to Operating Expenses as follows:

'5. In case it becomes necessary directly in connection with betterment or improvement work to abandon any property, the cost of replacing the abandoned property in kind, plus the cost of removal, but less the value of salvage, should be charged to the appropriate accounts under Operating Expenses. In case, however, the amount so chargeable is large, and its inclusion in a carrier's operating expenses for a single year would unduly burden the operating expense accounts for that year, the carrier may, if so authorized upon application to the Interstate Commerce Commission, charge such cost to the Property Abandoned account provided in the Form of General Balance Sheet Statement, or to the reserve account mentioned in paragraph 6.

'6. When property is abandoned and not replaced, the original cost (estimated, if not known) should be credited to the appropriate Additions and Betterments Accounts and charged, less salvage, to Profit and Loss Account, to which should also be charged all incidental expenses directly connected with the abandonment. If so authorized upon application to the Interstate Commerce Commission, however, a carrier may set up depreciation accounts under 'Maintenance of Way and Structures,' for the purpose of creating a reserve to which (instead of Profit and Loss) should be charged the original cost, less salvage, of the property (other than land or equipment) abandoned, and all incidental expenses directly connected with the abandonment.'

These are the regulations as they appeared in the Classification of 1909. In the First Revised Issue (1910) there were some slight changes, but none now important.

To restrain the enforcement of the regulations so far as they required or tended to require appellant to charge against its earnings the estimated replacement value (less salvage) of the six parcels of railroad line that was abandoned as an incident to grade reduction as above set forth was the principal object of the suit.

The petition sets forth the following as a second ground of complaint. As a part of its program of improvements, appellant is engaged in erecting a new and enlarged shop and terminal plant at Shreveport, upon a different location from that of the existing shop and terminal plant, which latter are incidentally to be abandoned. It is claimed that the present shop and equipment are not worn out or obsolete, but are in good condition, and capable, with ordinary running repairs, of performing for an indefinite time the functions for which they were originally constructed. Appellant desires to charge the estimated value of the abandoned shop and terminal plant, amounting approximately to $100,000, against its accumulated surplus as represented in its Profit and Loss Account. The regulations of the Interstate Commerce Commission relative to accounting, however, prohibit this charge, and require that the estimated replacement cost (less salvage) of the existing shop and terminal plant shall be charged to the Operating Expense Account. An injunction against the enforcement of the regulations in this regard also was prayed.

Messrs. Samuel Untermyer, Walter C. Noyes, Arthur M. Wickwire, and Irwin Untermyer for appellant.

[Argument of Counsel from pages 432-434 intentionally omitted]

Assistant Attorney General Denison and Mr. Thurlow M. Gordon, Special Assistant to the Attorney General, for the United States.

Statement by Mr. Justice Pitney:

[Argument of Counsel from pages 434-436 intentionally omitted]

Mr. Charles W. Needham for the Interstate Commerce Commission.

Mr. Justice Pitney, after making the foregoing statement, delivered the opinion of the court: