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ACQUISITION OF THE CALIFORNIA PACIFIC

Tendency to Monopoly Control

The first intimation that the Central Pacific Railroad was on its way to something like a monopoly control in the state of California is to be found in the negotiations for terminals on San Francisco Bay. But it was not long before more evidence came to light. Looking back with the advantage of knowledge of the company’s later history, it seems probable that the possibilities of monopoly control of the railway business of California were present to the owners of the Central Pacific as early as 1868. The task of securing such control was not, after all, so very great. California had few railroads in the sixties, and those which were in operation were small and unprosperous, and could be cheaply acquired.

Besides this, the topography of the state lent itself to schemes of conquest by a sharp separation of the interior valleys from each other and from the coast. It was not necessary to occupy the whole country, for an effective control over one valley could be maintained in spite of the fact that an adjacent valley was in hostile hands. Nor was there any public opinion in California at the time thoughtfully critical of monopoly, as such. The country was new. Theories covering the relations of large corporations to the consuming public had not been developed. People hated monopolies because monopolies meant high prices; but the very persons who were most likely to object to monopoly were also likely to seek positions of advantage for themselves when possible.

Under conditions like these, Stanford, Huntington, Hopkins, and Crocker were almost sure to attempt to dominate the railway system of the state as soon as they determined to make their connection with it more than temporary. This decision was made as the Central Pacific approached Ogden in 1868 and 1869. Had the associates been able to sell out before this time, it is likely that they would have done so. Indeed, it is credibly reported that 80 per cent of the stock of the Central Pacific was offered to D. O. Mills as late as 1873, for a price of $20,000,000,[151] and this was probably the last of several offers made to different parties.

The evidence seems to show, however, that by 1870 the Huntington group were inclined to remain in the railroad business. Strategically, the associates then occupied a very strong position. They possessed the only railroad line from California to the East. They dominated the Oakland water-front, and held important concessions in San Francisco. Branch lines, like long tentacles, stretched from Roseville north to Chico, on the way to the Oregon state line,[152] and from Lathrop south to Modesto, to be extended to Goshen by August 1, 1872.[153] By 1869 the Sacramento Valley Railroad, with its extension to Placerville, had been bought, and the California Central Railroad from Folsom to Marysville was under Central Pacific control. Even the budding project for a Southern Pacific Railroad had received the attention of Stanford and his associates. Indeed, the only really weak spots in the associates’ position were their failure fully to occupy the San Joaquin Valley, and the fact that they did not control the short line between Sacramento and San Francisco. We will, accordingly, consider the situation and the policy of the Huntington group in these respects.

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Map of California Railroad, about 1870.

Competition of California Pacific

The most direct railroad route from Sacramento to San Francisco is by way of Vallejo or Benicia, across the Straits of Carquinez, and along the eastern shore of San Francisco Bay. In 1865, after the Central Pacific had begun work in earnest, the California Pacific Railroad Company was incorporated to occupy this route from Sacramento as far as Vallejo. Contracts were let, though no material progress was made for two years. In 1867 the work was taken up with fresh energy, and in 1869 the road was finished between Vallejo and Sacramento, with a branch from Davisville to Marysville. The newly built Napa Valley Railroad from Adalanta, California, to Calistoga, was acquired at the same time. In 1870 the system reported 163 miles of road, of which 22 miles consisted of a ferry connection from Vallejo to the city of San Francisco.

It seems more probable that the California Pacific was originally intended as a connection for the Central Pacific than that it was built as a competitor with the larger road. This was satisfactory enough to the Central Pacific so long as this company terminated at Sacramento. But there is no manner of doubt that the California Pacific became a formidable competitor to the Central Pacific when the latter acquired its circuitous line to Oakland via Stockton. This was especially true with respect to the passenger business. The distance from Sacramento to San Francisco via Vallejo was 87 miles, via Stockton 137½ miles; the time via Vallejo was 3½ hours, via Stockton 5 hours. It appears that transcontinental passengers on Central Pacific trains often changed cars at Sacramento, sacrificing the balance of their through ticket and paying extra fare in order to save time.[154] Of the local passenger business between Sacramento and San Francisco, the California Pacific claimed three-fourths. How large a share of the freight went by the shorter line does not appear, but it must have been considerable, for Mr. Stubbs later estimated that the cost of operating the Benicia route could not have been more than 50 per cent of the cost of operating the Western Pacific,[155] and it is in evidence that the Central Pacific sent most of its freight via Benicia as soon as it obtained control of both lines.

It should be remembered also that in addition to its competition for local business, the California Pacific had ambitious plans in other directions. We know, for example, that it proposed an extension eastward via Beckwourth’s Pass to a connection with the Union Pacific, at or near Ogden. This line was to be built by the California Pacific Railroad Eastern Extension Company, incorporated at Sacramento in March, 1871, with a capital stock of $50,000,000.[156] Other reports credited it with an intention to enter the San Joaquin Valley;[157] while its influence in Sonoma, Marin and Napa counties was recognized. In short, by 1870 the California Pacific was not only important in respect to what it had actually accomplished, but it had in it the germ of a railroad system in no way inferior to that of the Central Pacific itself.

Rival’s Weakness

Unfortunately for the California Pacific, the company’s physical and financial position in 1871 did not measure up to the magnitude of its ambitions. Counsel for the Central Pacific in later years drew a vivid picture of the condition of the railroad in 1867 which probably contained more than a grain of truth. According to this account, the right-of-way of the California Pacific was unfenced, its sidings were few, and its stations were insufficient. The road-bed was almost wholly unballasted, and inadequately supplied with ties. Embankments were so narrow that the ends of the ties projected on both sides. The slope of the cuts was insufficient and upon the Napa branch the rails were fastened to the ties with wrought nails without heads which were bent back over the flanges of the rails after being partly driven, in order to hold the rails in position.[158]

On the other hand, in spite of the imperfect character of its construction, the California Pacific had paid large prices to contractors in its bonds and stock. In December, 1870, the company was compelled to borrow money to meet the January interest of 1871. By the following spring it was indebted to the extent of $8,450,000, of which $1,200,000 was floating debt, and had to prepare to meet an annual interest charge of $667,500. This was more than the company’s earnings could stand.

In 1871 the Central Pacific, taking advantage of the weakness of its rival, proceeded to the attack by arranging to construct a branch from Sacramento, by way of Davisville, to Vallejo. In pursuance of this arrangement it accumulated iron and ties, made surveys, and succeeded in effecting a contract with an organization known as the Bridge Company of the City of Sacramento, for the exclusive use of its bridge for their new enterprise.[159] The California Pacific was already suffering from the competition of river boats, and the construction of the new road would have ruined it. The pressing nature of the danger was appreciated by the managers of the road, and Milton S. Latham, director and treasurer of the California Pacific, and agent for the holders of three-fourths of the capital stock of that company, promptly opened negotiations with the Central Pacific, through Collis P. Huntington, for an adjustment of difficulties. This was precisely the situation which the Central Pacific desired to bring about.

Control of California Pacific Acquired

The agreement that resulted from the conditions described may probably be explained as an elaboration of the Central Pacific’s statement to Mr. Latham that the company was willing to buy the California Pacific but did not have the money. It took the form of the following consecutive transactions:

By agreement dated July 13, 1871, between Latham, Leland Stanford, and Mark Hopkins, Mr. Latham agreed to deliver 76,101 shares of the California Pacific Railroad Company, to assign three-fourths of the capital stock of the California Pacific Eastern Railroad Extension Company to the other parties to the contract, and to stipulate that the total indebtedness of the two companies named should not exceed $8,421,000. In consideration of this delivery, Stanford and Hopkins agreed to pay to Latham $1,579,000 in bonds of the California Pacific Railroad Company.

On August 9, 1871, Mr. Latham presented, and the directors of the California Pacific at a formal meeting approved, resolutions to the effect that the sum of $1,600,000 was necessary for the purpose of constructing and completing an additional track, and for strengthening the California Pacific embankments across the tule lands. The directors further voted that the money be borrowed, and the necessary bonds be issued. President Jackson then stated to the board that a contract had been made, and the execution of this contract was approved.

Under date of August 9, 1871, the California Pacific covenanted with Stanford, Hopkins, and Huntington for the construction referred to in the previous paragraph. The associates agreed

... to enlarge the embankment of the railroad of the said party of the second part, where embankment is required, and erect and widen the trestle work, where trestle work is required, from the bridge across the Sacramento River to Davisville, in the county of Yolo, in the State of California, and place thereon a good and sufficient superstructure, consisting of timber and ties and iron railroad thereon, so as to make an additional railroad track from said bridge to said Davisville, fully equal to the present railroad on the present embankment and to connect the same with proper switches with both the main track to Vallejo, and the track to Marysville of the railroads of the party of the second part. Said parties of the first part to furnish all the material for the said additional railroad track, and embankment, and trestle work, and to have the same completed and ready for use on or before the first day of January, in the year one thousand eight hundred and seventy-three.

In consideration of this construction, the California Pacific was to pay the associates 1,600 second mortgage California Pacific bonds.

On August 19, 1871, the Huntington group, now controlling a majority of the board of directors of the California Pacific, entered into an agreement with the California Pacific under which the Central Pacific undertook to pay the California Pacific $5,000 per month, to furnish the equipment for passenger business, and to guarantee the interest on 1,600 second mortgage bonds, while the California Pacific in return agreed to transport to or from San Francisco, passengers beginning or ending their trips on the Central Pacific or connecting roads, and to maintain its fare for other passengers at $4 between San Francisco and Sacramento. On September 1, 1871, the Central Pacific took full control of the California Pacific, and moved its offices from San Francisco to Sacramento.[160]

Motives Behind Transactions

Two explanations of these transactions are possible. Counsel for the Central Pacific, in 1886, maintained that the contracts fell into two distinct classes or groups. The California Pacific, according to this point of view, arranged for an additional track between Sacramento Bridge and Davisville, and for still more important enlargement in embankments and widening and erection of trestle work, by the transfer to defendants of second mortgage bonds. These bonds, it was alleged, though considerable in amount, had little value because of the desperate financial condition of the California Pacific. In the second place, the Central Pacific gave value to bonds which it held by a guaranty, and used them to buy a controlling interest in California Pacific stock. Of this, the minority stockholders of the corporation had no right to complain.

Counsel on the other side maintained that the essential feature of the whole transaction was the purchase of California Pacific stock, and that the various contracts merely supplied a method of buying this stock without paying for it. Starting, therefore, with the contract of July 13, they pointed out that the defendants agreed to purchase California Pacific stock from Latham with California Pacific bonds which were not yet in existence, stipulating for full control of the California Pacific before payment should be made, in order that they might obtain the purchase price from that company. When Latham announced that he was ready to deliver the stock, it became necessary for the defendants to secure about $1,600,000 in California Pacific bonds. These bonds could be legally issued only for new construction, hence the contract for a second track from Sacramento to Davisville. When issued, and in the hands of the defendants, it was necessary to have the Central Pacific’s guaranty. For this the Central Pacific required the California Pacific to enter into the traffic agreement of August 19, obtaining thus a full quid pro quo. The result was that the California Pacific furnished first the bonds and then a consideration for the Central Pacific’s guaranty, which together served to purchase the California Pacific stock.

Plausible Explanation

There were several circumstances which made this second version plausible. It seems extraordinary, for one thing, that a company in the straits to which the California Pacific was reduced should have issued bonds for double-tracking 13 miles of road.[161] If it be answered that the strengthening of the road against the immediate danger of flood was the real reason for the issue, then it was still extraordinary that the time limit for construction of the work should be set as it was, eighteen months away, on January 1, 1873. As a matter of fact, the section of the California Pacific across the tule lands was washed away before the associates got around to strengthening it. This made it impossible for Stanford, Huntington, and Hopkins, or the Contract and Finance Company, to which they had assigned their contract, to carry out the original agreement. Instead, Mr. Montague, chief engineer of the California Pacific, reported to his board that the cost of restoring the washed-out line would be equal to the cost of carrying out the original contract, and the board, on November 15, 1872, authorized the substitution of this work for that agreed on in the contract of August 9, 1871.

Owing to the subsequent destruction of the books of the Contract and Finance Company, there is no way of telling accurately what the cost of restoration actually was. The Contract and Finance Company finished the job, however, in six weeks after the work was actually commenced, and what information is available leads one to doubt if the expense was very great. Another circumstance which raises a question as to the good faith of the consideration offered for the 1,600 California Pacific bonds, is the coincidence that the par value of the bonds issued for construction was practically identical with the amount needed to pay for the 76,101 shares of stock sold by Latham to Stanford, Huntington, and Hopkins. Still another peculiar incident was that of the execution, contemporaneously with the main contract, of a supplementary agreement, under which the Stanford group agreed to pay Latham $250,000 in a six months’ note, besides the other consideration for California Pacific stock, if he would visit New York at once, obtain the consent of the stockholders whom he represented, and personally assume all the obligations of the California Pacific above the sum of $8,421,000 specified in the bond.

Whatever the true motives for the transaction described, the coincidence of the stock sale with the other transactions relieved the representatives of the California Pacific of any intense interest in the matter, and must inevitably have made them pliable as to terms. The directors present at the meeting of August 9, when the contract for the construction of the second track was approved, were Jackson, Hammond, Latham, Sullivan, and Atherton. Of these gentlemen, Hammond, Sullivan, and Atherton each held five shares only, transferred to their names to qualify them as directors; while the shares of Latham and Jackson were ready for transfer to Stanford, Huntington, and Hopkins. Hammond, vice-president of the company, as well as a director, subsequently said, referring to the contract for a second track: “I don’t recollect that I ever saw or knew what that contract was, until it was brought into the board.... This contract was made with a party who was purchasing the majority of the stock of that company, and whose interest would be to do that work in a workmanlike manner.” Certainly this was not a desirable point of view for a representative of the California Pacific to take.

Undisputed Control

The inevitable result of the various contracts and agreements which have been described was to place the Huntington group in undisputed control of the California Pacific. On August 10, 1871, Mr. Stanford was elected president vice Jackson, and on August 2, Mark Hopkins was elected treasurer vice Latham. The following year Hammond and Moses Hopkins took the positions of president and treasurer, respectively, while Stanford and Mark Hopkins and Collis P. Huntington were appointed general agents of the company, with large powers.

Once in control, Stanford and his associates proceeded to make the best use they could of the California Pacific in connection with other roads in their system. It does not appear that they felt any particular tenderness toward the enterprise. Most of the operating arrangements between the Central Pacific and the California Pacific were subsequently arranged by Mr. Towne for both parties, on terms favorable to the Central Pacific. It is on record that the California Pacific was allowed but $1 out of $16.75, the fare from Reno to San Francisco, for its haul from Sacramento to San Francisco, although the total distance was 240 miles, and the Sacramento-San Francisco haul amounted to 92 miles. Likewise, contracts were made with the Contract and Finance Company which were later complained of as extravagant. Special mention is made of lumber which was bought of the Contract and Finance Company at $30 a thousand when the market price was $18. Mr. Towne was asked in 1886:

Q. You say that you have done all that you could to increase the earnings of the California Pacific, do you?

A. Having a due regard for the other company; yes, sir.

Q. Did you make that qualification?

A. I do now.

Perhaps a policy of this sort was to be expected as the result of the conquest of a dangerous rival. Yet certain other arrangements between the Central Pacific and the California Pacific went beyond what one might have expected. It appears, for instance, that soon after the Stanford group obtained control of the last-named company, that portion of the contract of August 8, 1871, which provided for the payment of $5,000 monthly by the Central Pacific to the California Pacific, was eliminated. This elimination was said to have taken place by “mutual consent,” a meaningless phrase when the same men had charge of the negotiations for both sides.

Independent Security Holders

It has been charged, also, that Stanford and Huntington deliberately endeavored at this time to depress the value of California Pacific mortgage securities in order to induce independent holders to reduce their claims. In support of this contention there is evidence that very strong pressure was brought to bear upon independent security holders in 1874, and that as a result of this pressure the fixed charges of the California Pacific were reduced from $763,500 in 1875, to $303,500 in 1886. No part of this burden was borne by the second mortgage bonds held by Stanford, Huntington, Hopkins, and Crocker, nor was any assessment levied upon the company’s stock.

As a part of the campaign, during the period mentioned, wide publicity was given by the management of the California Pacific to financial difficulties, real or alleged, with which the company was confronted. Thus in June 1875, the board of directors confessed a judgment of $1,309,041.84 to one J. P. Haggin, assignee of certain claims of the Central Pacific, the Contract and Finance Company, and the associates, for advances previously made. Mr. Haggin had no interest in the matter, merely allowing the use of his name.[162] The following month, Vice-President Gray, of the California Pacific, made an extremely pessimistic report to his directors, declaring that the company’s deficit to date was $1,370,061.71, and that a large part of the outstanding bond issues of the company were represented by no construction that he was able to discover. On July 25, 1874, finally, a local capitalist named Michael Reese, acting in all probability on behalf of the associates, filed sensational charges against Mr. Latham, formerly general manager of the California Pacific, which called forth as sensational a reply.[163] These various activities roused holders of California Pacific Railroad Extension bonds to petition to have the California Pacific declared bankrupt, and drew forth a statement from the company, on the other hand, that it did not regard these bonds as constituting a valid legal claim upon it. The result was a compromise. The extension bondholders surrendered their 7 per cent bonds for a reduced amount in new 6 per cent securities, and the outstanding income bonds likewise exchanged their holdings for 3 per cent bonds. Both classes of bonds were guaranteed by the Central Pacific, and in consideration of the guaranty the California Pacific was leased to the Central Pacific on July 1, 1876, for 29 years, at a rental of $550,000 per year, plus three-fourths of the net earnings of the company above that amount. At a subsequent period in December, 1879, when the Central Pacific was about to turn a considerable volume of business over the short line by way of Benicia, the California Pacific gave up its right to payments over the $550,000 minimum in consideration of a fixed additional payment of $50,000 a year.[164]

By and large, the California Pacific proved a good investment for the larger company, especially after the Northern Railway had been built and a new route established between Oakland and Sacramento. The reason for its original acquisition was, nevertheless, in all probability, not the chance of a direct profit, but the advantage expected from a monopolistic control of the territory north of San Francisco Bay.