Voting Trusts: Like Cicadas, They’re Back Again – Greg E. Summy

The history is familiar even to the most casual observer of the railroad industry. Beginning after the end of World War II and continuing for the next 35 years, railroads were in a state of decline. As Ernest Hemingway’s character Mike Campbell famously stated in The Sun Also Rises, when asked about how he went bankrupt, he stated “Two ways . . . gradually and then suddenly.” The same was true for the railroads during these dark years.

After experiencing a couple of decades of parallel mergers,1 matters in the industry became desperate.2 Railroad bankruptcies, large and small, became commonplace. Track and roadbed conditions deteriorated. Purchases of new rolling stock were few and far between. The disastrous merger between two of the largest eastern railroads, the Pennsylvania and the New York Central into the Penn Central, fell into bankruptcy less than 30 months after its creation. As a result, the federal government created Conrail out of seven bankrupt eastern railroads, beginning operations on April 1, 1976.

Realizing that the railroad industry was vital to commerce in the United States, Congress threw the industry and the country a lifeline when it passed the Staggers Act of 1980. One of the stated purposes of the law was to “ensure the development and continuation of a sound railroad transportation system with effective competition among rail carriers and with other modes . . . .”3 As it turned out, however, the continuation of consolidation in the rail industry wasn’t finished, and in the two decades following the passage of Staggers, there were several railroad consolidations, including: • CSX, created from the combination of the

Chessie System, Seaboard Coast Lines and the “Family Lines”4; • Norfolk Southern, created from the merger of Norfolk & Western and the

Southern; • BNSF, created from the merger of

Burlington Northern and Santa Fe; • Union Pacific, created by UP’s acquisition of several fallen flags, including the Western Pacific, the Katy, Missouri

Pacific, Chicago & Northwestern and the

Southern Pacific (which previously had absorbed the Cotton Belt and the Rio

Grande); and • The Conrail Transaction, which was the division of Conrail between Norfolk

Southern and CSX, effective June 1, 1999. By 2000, only seven Class I railroads were left, with KCS being the smallest.5

As a reaction to the perceived consolidation of many significant railroads into a few larger ones, the Surface Transportation Board6 (“STB”) initiated a Notice of Proposed Rulemaking in the late 1990s, culminating in the promulgation of new regulations governing the STB’s approach to review of proposed mergers or acquisitions of control between the Class I railroads. STB Ex Parte No. 582 (Sub-No. 1), Major Rail Consolidation Procedures, 5 S.T.B. 539 (2001) (“Rulemaking”). The New Rules are found at 49 C.F.R. Part 1180. Differences between the New Rules and the rules previously in effect (“Old Rules”) are significant in certain respects, including the STB’s statement in the Rulemaking that any further merger proposals must “enhance, not merely preserve, competition, in order to secure our approval.”7 Interestingly, reacting to a Comment filed by KCS in the Rulemaking, the STB included the potential exception for a transaction involving KCS, stating that an applicant could request a waiver from the application of the New Rules for such a transaction, and if granted, the STB would review the consolidation application under the Old Rules. For purposes of this article, the key aspect of the Old Rules is that the application would be considered under an “adverse effect upon competition” standard, rather than the requirement under the New Rules that “merger applications should include provisions for enhanced competition.”8

The subject of voting trusts was also addressed in the STB’s Rulemaking, providing a specific procedural section governing the administrative review of requests for approval of a voting trust and requiring applicants to “demonstrate in a public filing that their contemplated use of a trust would not result in unlawful control and would be consistent with the public interest.”9

Considering all this history, we return to the present. Transportation Lawyers Association Rail Chair Jameson Rice presented an excellent lecture at the June 2021 Annual Conference entitled, The $33.7 Billion Question: Who will acquire Kansas City Southern and will it pass regulatory muster? Jameson thoroughly yet concisely outlined the battle for KCS, culminating with the richer bid of Canadian National (“CN”) winning the approval of the KCS Board of Directors over the competing offer of Canadian Pacific (“CP”).10 In anticipation that KCS would accept

Greg E. Summy*

its offer, CP quickly filed a request for approval of its voting trust and additionally requested that the STB apply the KCS exception and review the application under the Old Rules. When CN filed its request for a voting trust, CN did not request that its application be considered under the Old Rules and affirmatively stated that the New Rules should apply. Before the KCS Board rendered the filings in the CP docket moot, the STB approved use of the KCS exception and also approved the CP voting trust. As of this writing, however, the STB has not yet decided whether CN should be allowed to use a voting trust.

What is a voting trust? A voting trust is a vehicle that has been used frequently (according to CN) or perhaps rarely (according to the STB) wherein the shares of the target company will be conveyed into a trust. This practice allows the shareholders of the target company to be paid in accordance with the terms of the transaction between the acquiror and the target with the trustee essentially running the target company during the pendency of the STB approval process. If the transaction is approved, then the voting trust ends and the acquiror is in legal and actual control of the target. If the transaction isn’t approved, then the acquiror and the trustee will have to engage in a divestiture process for the shares of the target.

The CN/KCS merger is the first case to be filed under the New Rules. Several observations come to mind with respect to this transaction and any future transactions. 1. Every transaction is different, even though a party may say otherwise.

CN and CP have each tried to label their transaction as, colloquially, important, but not a big deal. CP is smaller than CN, and CP argues, in essence, that a CP/KCS transaction should not be viewed by customers, railroads or regulators as anything other than a classic end-to-end merger. For its part,

CN recognizes that KCS’s parallel line between Baton Rouge and New Orleans would have to be divested, but after that divestiture, the CN/KCS proposal is also nothing more than an end-to-end merger. Nevertheless, the STB has hinted that it views a CN/KCS merger as having a much greater impact on the railroad industry and shipping community than the CP/KCS proposal. Consider also that CN is significantly larger than

CP, and that a combined CN/KCS would be perceived to be a more powerful carrier than CP/KCS. 2. What do the New Rules really mean?

In the public comments leading up to the Rulemaking establishing the New

Rules, many parties expressed diverging views about whether “enhanced competition” was an appropriate standard, and if so, what exactly did it mean. Anecdotally, the New Rules have inhibited railroads from attempting a merger. With two large eastern railroads, two large western railroads, one large north-south railroad (CN) and the remaining two relatively small Class

I railroads, it would take a creative and unconventional mind to imagine how, for example, an east-west merger would enhance competition, unless the merging companies were willing to grant access over one’s tracks to others. Willingly allowing competitors to use your assets, even for a price, isn’t something that would seem to be immediately attractive. Perhaps railroads not involved in the CN/KCS transaction are interested in having someone else initiate the test case.

Also, might a party unhappy about an STB decision citing “not enough enhanced competition” be willing to take the STB to court about the

New Rules? The underlying statute governing the conditions of approval for mergers and control applications specifically states that “the Board shall consider at least . . . whether the proposed transaction would have an adverse effect on competition among rail carriers . . . .”11 The New Rules go further. In the Rulemaking announcing the New Rules, the STB justified the

“enhanced competition” requirement as being related to the standard in 49

U.S.C. 11324(c), which states that “[t] he Board shall approve and authorize a transaction under this section when it

finds the transaction is consistent with the public interest.” Following through on this observation, in the New Rules, 49 C.F.R. 1180.1(c) indicates that the Board believes that the “public benefits” component of the law includes the necessity for enhanced competition, and further concludes that due to the small number of Class I railroads that could be the subject of future mergers, any further consolidation in the industry is “likely to result in a number of anticompetitive effects.”12 Did this conclusion improperly veer from the underlying statute? An applicant whose transaction was denied by the STB might make such an argument. 3. Should consideration of a voting trust include an analysis of the underlying application for approval? It isn’t the same thing, but the argument for doing so is similar to the standards for injunctive relief—likelihood of success on the merits and significant harm if the relief (in this case, a voting trust) is not approved. CN has stated that it is not necessary to file the full application before approving a voting trust, but for good measure argues that the CN/ KCS transaction (and voting trust) is in the public interest. First, CN notes that the STB, and its predecessor the ICC, frequently approved voting trusts in railroad acquisitions so that railroads wishing to acquire another railroad could compete fairly with non-railroad acquirors that don’t have to go through the lengthy and complex STB approval process.13 If the STB inhibits the use of voting trusts, then, according to CN, a railroad wishing to sell would always prefer the quicker and easier transaction with a non-railroad. A differing view comes from opponents of the CN/KCS voting trust, such as the National Industrial Traffic League and The Fertilizer Institute. They argue that the public interest component should be considered in evaluating the voting trust; and since the underlying application and evidence hasn’t been filed, it’s too soon to determine if a voting trust is in the public interest. In essence, the implication is that a voting trust should

almost never be approved before the underlying case is decided. Perhaps this was what the STB was indicating when it established the New Rules.

Simply put, the approach of the New

Rules to voting trusts is a gamechanger that hasn’t been tested. CN’s arguments about approval of voting trusts in the past may be discounted by the

STB, based on establishment of the

New Rules. 4. What is the implication of the STB’s quick action on the CP voting trust?

The STB approved the CP voting trust and granted CP’s request for judging the case under the Old Rules in a matter of weeks after the request was filed, but it has been more cautious with respect to the CN/KCS proceeding. CN correctly notes that the language of the CN/KCS voting trust is substantially the same as the CP/KCS voting trust previously approved by the STB. But that argument misses the point made by the STB, which is that the underlying transaction will be evaluated under the New

Rules, not the Old Rules. The STB has concluded that its prompt action on the

CP/KCS case has no bearing on the CN/

KCS proceeding, because the underlying transactions are different, will be evaluated under different standards, and could result in different outcomes.14 5. Arguments for greater competition in the railroad industry. It’s clear that there will be policy headwinds for any merger of railroads. Consider the following: a. Department of Justice. DOJ is limited to advisory input in railroad mergers, as contrasted to its greater power for mergers involving other industries. DOJ believes that CN/KCS has greater competitive difficulties than CP/KCS, but goes further to say that even with the constraints in the language of the voting trust document, the unity of ownership interest diminishes incentives for the beneficial owner and the trustee to aggressively compete for traffic during the time the voting trust is in effect. Further, DOJ expresses concern about competition among railroads for moving the same commodities from different origins to the same destination. Pricing of transportation can often be a significant cost component of the delivered price of the commodity.

As such, even though a merger might be end-to-end on the map, there may be a diminution in competition if after the merger, the same railroad would serve both potential origins.15 Because of this and other subtleties, DOJ recommends not approving the voting trust at this time. b. President Biden’s Executive

Order. On July 9, 2021, President

Biden issued the Executive Order on Promoting Competition in the American Economy. While not specifically addressing railroad mergers except with respect to performance for passenger railroad trains, the order generally notes that the policy of the United States is to combat excessive concentration of industry. c. STB Chairman Martin Oberman’s statement with respect to the Executive Order. Chairman Oberman issued his own statement the same day as the executive order indicating his concern with “sufficient competition in the rail industry.”

In conclusion, the STB has executive (policy) duties, quasi-judicial (deciding complaints brought under applicable laws) duties, as well as duties that can turn into a mix of the two (such as railroad mergers). The STB must fulfill what it is authorized to do under its enabling legislation, but it does have discretion in how it does so. As a result, for railroad mergers, the STB has guardrails created by the law but also has to consider the public interest in making its decisions. All in all, it can make for an interesting ride for the parties and interested observers, and deciding the voting trust issue is just the first step. Open up the throttle but be prepared to drop it down a couple of notches. The track to completion of the deal could have some slow orders along the way.

1 A parallel merger is one between two railroads whose lines roughly serve the same markets. In the 1950s and 1960s, mergers like these were favored because excess capacity would be eliminated, and the surviving railroad would be stronger and better able to serve the public. 2 Gradually, then suddenly . . . 3 49 U.S.C. 10101(4). 4 The Louisville & Nashville was the best known of the Family Lines. 5 The six others are Union Pacific, BNSF, CSX, Norfolk Southern, Canadian National and Canadian Pacific. 6 The Surface Transportation Board (“STB”) is the independent federal agency charged with the economic regulation of railroads. 7 Rulemaking at 546. Perhaps not coincidentally, the last control application approved by the STB prior to establishment of the New Rules was the Conrail

Transaction, and in that case, Norfolk Southern and CSX touted as a benefit that many markets served solely by Conrail would, upon approval, have each railroad serving those markets. The phrase used by the parties was “inject competition” into the market. Very importantly, Conrail was a unique railroad, created out of seven bankrupted railroads, and was structured in such a way as to prevent what had formerly been destructive competition, and which would preserve railroad to markets in the Northeast. In the 20-plus years since its creation, Conrail had turned itself into a self-sustaining, profitable railroad, partially due to the

Staggers Act, partially due to an aggressive rationalization program, and partially due to the will of its employees. 8 49 C.F.R. 1180.1(c). 9 49 C.F.R. 1180.4(b)(4)(iv). 10 However, on August 10, 2021, The Wall Street Journal reported that CP was preparing to increase its bid for KCS to $300/share. This would still be less than CN’s bid.

11 U.S.C. 11324(b)(5). 12 Id. 13 49 U.S.C. 11321 through 11328 only apply to combinations involving rail carriers. Purchase of a railroad by a non-railroad doesn’t invoke the jurisdiction of the

STB. 14 The STB issued a press release on August 10, 2021, stating that it will issue a ruling on the CN/KCS voting trust by August 31, 2021. 15 Although DOJ very openly acknowledges product and geographic competition, the STB has consistently refused to recognize this competition with respect to rate cases. See EP No. 627, Market Dominance Determination—Product and Geographic Competition (decision date April 2, 2001).