ways not unreasonably, it cannot be said that a corporation is acting unreasonably in adopting one policy or the other. This was pointed out by Mr. Justice Bradley when, in Union Pacific Railroad Company v. United States, 58 the Supreme Court was called upon to decide whether that company had acted unreasonably in so arranging its finances that it did not appear to be making such net earnings as by the terms thereof were to be applied to the reduction of certain of its bonds. "As a general proposition, net earnings are the excess of the gross earnings over the expenditures defrayed in producing them, aside from and exclusive of the expenditure of capital laid out in constructing and equipping the works themselves. It may often be difficult to draw a precise line between expenditures for construction and the ordinary expenses incident to operating and maintaining the road and works of a railroad company. Theoretically, the expenses chargeable to earnings include the general expenses of keeping up the organization of the company, and all expenses incurred in operating the works and keeping them in good condition and repair; while expenses chargeable to capital include those which are incurred in the original construction of the works, and in the subsequent enlargement and improvement thereof."59 356. Improvement of existing plant. It may fairly be said that it has been the American system of conducting public service companies to charge to maintenance, as an annual expense, betterments, replacements, improvements, and repairs The question is one of policy, which is usually left to the discretion of the directors. There is but little danger that any board will cause a very large or undue portion of their earnings to be absorbed in permanent improvements.60 The prac 58 99 U. S. 402, 25 L. ed. 274. 59 See also Metropolitan Trust Co. v. Houston & T. C. R. R. Co., 90 Fed. 683. 60 The Commission feels that rebuilding and strengthening bridges and trestles and laying heavier rails are expenses incident to increased tice will only extend to those which may be required, from time to time, by the gradual increase of the company's traffic, the dispatch of business, the public accommodation, and the general permanency and completeness of the works. When any important improvement is needed, such as an additional track, or any other matter which involves a large outlay of money, the owners of the road will hardly forego the entire suspension of dividends in order to raise the requisite funds for those purposes, but will rather take the ordinary course of issuing bonds or additional stock. But for making all ordinary improvements, as well as repairs, it may be better for the stockholders, and all those who are interested in the prosperity of the enterprise, that a portion of the earnings should be thus employed.61 In one sense, a railroad is never completed. There is never, or hardly ever, a time when something more cannot be done, and is not done, to render the most perfect road more complete than it was before. Moreover, this American system of maintenance of way from earnings has in practice proved itself far superior to the English system of issuing new securities for every sort of improvement, which accumulates fixed charges, and otherwise hampers the railway by excessive capitalization. § 357. Replacement considered as repair. In the leading case of Reagan v. Farmers' Loan & Trust Company,62 it was contended that the cost of new rails should be charged to construction, and not to expenses of operation; but Mr. Justice Brewer said: "Now, it goes without saying that, in the operation of every road, tonnage and are indicative of prosperity rather than distress. Memphis Freight Bureau v. L. & N. R. R. Co., 26 I. C. C. 402. 61 But, when the cost of what are clearly betterments, in contrast to maintenance, is charged to operating there is a constant wearing out of the rails, and a constant necessity for replacing old with new. The purchase of these rails may be called 'permanent improvements,' or by any other name; but they are what is necessary for keeping the road in serviceable condition. Indeed, in another part of the report, under the head of 'Renewals of rails and ties,' is stated the number of tons of 'New rails laid' on the main line. Other items therein are for fencing, grading, bridging, and culvert masonry, bridges and trestles, building, furniture, fixtures, &c. It being shown affirmatively that there were no extensions, it is obvious that these expenditures were those necessary for a proper carrying on of the business required of the company." 63 Upon the whole every liberty possible should be given the companies to improve their properties out of current earnings; and it is only when it is plain that outright new construction is being entered upon that the companies should be obliged to issue new securities to provide capital. For as long as the company has a continuous policy that, as improvements are needed in each year, they shall be provided for out of annual earnings, the maintenance of such a policy will roughly from year to year throw a fair share upon each year which gets the benefits of the work done in other years. § 358. Permanent improvements should not be annual charge. However it may be in doubtful cases, where continual replacements, going on from year to year, may not unreasonably be considered as equivalent to annual charges to repair account, it is obvious that permanent improvements should not be charged as annual expenditures in the year in which they are constructed, but should be carried to capital account. The United States Supreme Court 64 63 Acc. Southern Pac. Co. v. Railroad Comrs., 78 Fed. 236. 64 Illinois C. R. R. Co. v. Interstate Com. Comm., 206 U. S. 441, 51 L. ed. 1127, 27 Sup. Ct. 700. was perhaps speaking within limits when it held that the Commission was not acting unreasonably in disallowing, as operating expenses of the Illinois Central Railroad, expenditures for real estate, right of way, tunnels, bridges, and other strictly permanent improvements; and also for equipment such as locomotives and cars. The Commission had expressed the opinion that such expenditures should not be charged to a single year, but should be, so far as practicable, projected proportionally over the future. And this view Mr. Justice McKenna, speaking for the court, adopted. "It would seem," he said, "as if expenditures for additions to construction and equipment, as expenditures for original construction and equipment, should be reimbursed by all of the traffic they accommodate during the period of their duration, and that improvements that will last many years should not be charged wholly against the revenue of a single year." 1965 § 359. New construction should be charged to capital. The rule will be generally conceded that outright new construction should be charged to capital and should not therefore be admitted as an annual expense of operation. As Mr. Justice Carter of the Florida court recently put it in a case 66 where the railroad, in complaining of the rates put in force by a commission, alleged that its total receipts would not now be sufficient to recoup it for its "costs of operation" and its "cost of constructing:" "The use of the words 'reasonable cost of constructing' renders the pleading very ambiguous. The reasonable cost of construction is to be considered in determining the fair value of the company's property, which is an element entering into the question of reasonableness of the rate; but the cost of construction is not to be deducted from 65 Permanent improvements and betterments are not properly chargeable against the earnings for the year. Louisville & N. C. & C. Rates, 26 I. C. C. 20. 66 State ex rel. v. Seaboard A. L. Ry. Co., 48 Fla. 129, 37 So. 314. See Erie v. Erie Gas & C. Co., 78 Kans. 348, 97 Pac. 468. the earnings under the proposed rates in ascertaining if those rates are reasonable; for under such a rule the public would be compelled to pay for constructing the road without being entitled to its ownership." So in estimating the net profits of a gas company it was held that operating expenses would not include "expenditures for new wells, mains, or other permanent improvements or betterments."67 $ 360. New construction not an operating expense. The rule, therefore, is that outright new construction should be charged to capital, and should not, therefore, be charged in as an annual expense of operation. It is hardly more unjustifiable to charge a shipper by sea the cost of the vessel than to charge a shipper by rail in a given year the cost of a new terminal freight station. This general problem was discussed with discrimination in one of the earlier investigations by the Commission,68 an extract from which follows: "Within recent years this railroad, in common with many others in the United States, has been extensively improved. Grades have been eliminated, curves reduced, wood bridges replaced with those of iron and stone, station buildings rebuilt, equipment of all kinds greatly added to. All this has been rendered necessary, partly by increase in traffic and partly by the desire to handle this traffic in the cheapest possible manner; and it adds very materially to the value and the earning capacity of the property. Now, in so far as these outlays are reasonably necessary to keep the property 67 In one of the latest cases on this point in the State courts it is held that the earnings of a railroad company applied to the purchase of additional equipment, extension of its lines, and other improvements, must be regarded as a part of the net earnings, and are not properly chargeable to operating expenses. Coal & Coke Ry. Co. v. Cenley, 67 W. Va. 129, 67 S. E. 613. See Nashua & L. R. R. v. Boston & L. R. R., 136 U. S. 356, 34 L. ed. 363, 10 Sup. Ct. 1004. 68 Re Advances in Freight Rates, 9 I. C. C. Rep. 382. See also The St. Paul & P. S. Accounts, 29 I. C. C. 508, pointing out the impropriety of putting items plainly belonging to maintenance into capital, thereby making a better showing in income. |