Doran v. Petroleum Management Corp.

• Decision Date: 20 January 1977
• Docket Number: No. 74-3972,74-3972
• Citation: 545 F.2d 893
• Parties: Fed. Sec. L. Rep. P 95,844 William H. DORAN, Jr., Plaintiff-Appellant, v. PETROLEUM MANAGEMENT CORP., Morton A. Sterling and O. W. Fauntleroy, Defendants-Appellees.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 893

545 F.2d 893

Fed. Sec. L. Rep. P 95,844

William H. DORAN, Jr., Plaintiff-Appellant, v. PETROLEUM MANAGEMENT CORP., Morton A. Sterling and O. W.

Fauntleroy, Defendants-Appellees.

No. 74-3972.

United States Court of Appeals,

Fifth Circuit.

Jan. 20, 1977.

Rehearing Denied March 4, 1977.

Robert L. Ramsey, Dallas, Tex., for plaintiff-appellant.

Pat S. Holloway, Dallas, Tex., for defendants-appellees.

Appeal from the United States District Court for the Northern District of Texas.

Before GOLDBERG, DYER and SIMPSON, Circuit Judges.

GOLDBERG, Circuit Judge:

In this case a sophisticated investor who purchased a limited partnership interest in an oil drilling venture seeks to rescind. The question raised is whether the sale was part of a private offering exempted by § 4(2) of the Securities Act of 1933, 15 U.S.C. § 77d(2) (1970), from the registration requirements of that Act. See Securities Act of 1933, §§ 5, 12(1), 15 U.S.C. §§ 77e, 77l (1). ¹ We hold that in the absence of findings of fact that each offeree had been furnished information about the issuer that a registration statement would have disclosed or that each offeree had effective access to such information, the district court erred in concluding that the offering was a private placement. Accordingly, we reverse and remand.

I. Facts

Prior to July 1970, Petroleum Management Corporation (PMC) organized a California limited partnership for the purpose of drilling and operating four wells in Wyoming. The limited partnership agreement provided for both "participants," whose capital contributions were to be used first to pay all intangible expenses incurred by the partnership, and "special participants," whose capital contributions were to be applied first to pay tangible drilling expenses. ²

PMC and Inter-Tech Resources, Inc., were initially the only "special participants" in the limited partnership. They were joined by four "participants." As found by the district court, PMC contacted only four other persons with respect to possible participation in the partnership. All but the plaintiff declined.

During the late summer of 1970, plaintiff William H. Doran, Jr., received a telephone call from a California securities broker previously known to him. The broker, Phillip Kendrick, advised Doran of the opportunity to become a "special participant" in the partnership. PMC then sent Doran the drilling logs and technical maps of the proposed drilling area. PMC informed Doran that two of the proposed four wells had already been completed. Doran agreed to become a "special participant" in the Wyoming drilling program. In consideration for his partnership share, Doran agreed to contribute $125,000 toward the partnership. Doran was to discharge this obligation by paying PMC $25,000 down and in addition assuming responsibility for the payment of a $113,643 note owed by PMC to Mid-Continent Supply Co. Doran's share in the production payments from the wells was to be used to make the installment payments on the Mid-Continent note.

Pursuant to this arrangement, on September 16, 1970, Doran executed a promissory note, already signed by the President and Vice President of PMC in their individual capacities, for $113,643 payable to Mid-Continent. On October 5, 1970, Doran mailed PMC a check for $25,000. He thereby became a "special participant" in the Wyoming drilling program.

On July 16, 1971, the balance on the note to Mid-Continent became due. The parties renegotiated the loan. A new note for $66,292.24 was executed by PMC, the two PMC officers, and Doran. Pursuant to a written agreement of February 9, 1971, however, Doran had agreed to hold PMC and its officers harmless for any liability arising from the Mid-Continent note. The July renegotiation did not alter Doran's obligation.

During 1970 and 1971, PMC periodically sent Doran production information on the completed wells of the limited partnership. Throughout this period, however, the wells were deliberately overproduced in violation of the production allowances established by the Wyoming Oil and Gas Conservation Commission. As a consequence, on November 16, 1971, the Commission ordered the partnership's wells sealed for a period of 338 days. On May 1, 1972, the Commission notified PMC that production from the wells could resume on August 9, 1972. After August 9, the wells yielded a production income level below that obtained prior to the Commission's order.

Following the cessation of production payments between November 1971 and August 1972 and the decreased yields thereafter, the Mid-Continent note upon which Doran was primarily liable went into default. Mid-Continent subsequently obtained a state court judgment against Doran, PMC, and the two signatory officers of PMC for $50,815.50 plus interest and attorney's fees.

On October 16, 1972, Doran filed this suit in federal district court seeking damages for breach of contract, rescission of the contract based on violations of the Securities Acts of 1933 and 1934, and a judgment declaring the defendants liable for payment of the state judgment obtained by Mid-Continent. ³

The court below found that the offer and sale of the "special participant" interest was a private offering because Doran was a sophisticated investor who did not need the protection of the Securities Acts. The court also found that there was no evidence that PMC, its officers, or Kendrick made any misrepresentation or omissions of material facts to Doran. Finally, the court found that the overproduction of the wells was not a breach of the partnership agreement, but in any event there was no evidence that Doran suffered any losses as a result of the overproduction. The court concluded that all relief requested by Doran should be denied. Doran filed this appeal.

II. The Private Offering Exemption

No registration statement was filed with any federal or state regulatory body in connection with the defendants' offering of securities. ⁴ Along with two other factors that we may take as established that the defendants sold or offered to sell these securities, and that the defendants used interstate transportation or communication in connection with the sale or offer of sale the plaintiff thus states a prima facie case for a violation of the federal securities laws. See Hill York Corp. v. American International Franchises, Inc., 448 F.2d 680, 686 (5th Cir. 1971). ⁵

The defendants do not contest the existence of the elements of plaintiff's prima facie case but raise an affirmative defense that the relevant transactions came within the exemption from registration found in § 4(2), 15 U.S.C. § 77d(2). Specifically, they contend that the offering of securities was not a public offering. The defendants, who of course bear the burden of proving this affirmative defense, must therefore show that the offering was private. See SEC v. Ralston Purina Co., 346 U.S. 119, 126, 73 S.Ct. 981, 985, 97 L.Ed. 1494 (1953); Hill York Corp. v. American International Franchises, Inc., supra, 448 F.2d at 690; Lively v. Hirschfeld, 440 F.2d 631, 632 (10th Cir. 1971); United States v. Custer Channel Wing Corp., 376 F.2d 675, 678 (4th Cir.), cert. denied, 389 U.S. 850, 88 S.Ct. 38, 19 L.Ed.2d 119 (1967).

This court has in the past identified four factors relevant to whether an offering qualifies for the exemption. The consideration of these factors, along with the policies embodied in the 1933 Act, structure the inquiry. Hill York Corp. v. American International Franchises, Inc., supra, 448 F.2d at 687-88; Henderson v. Hayden, Stone Inc., 461 F.2d 1069, 1071 (5th Cir. 1972); SEC v. Continental Tobacco Co. of South Carolina,463 F.2d 137, 158 (5th Cir. 1972); see also Woolf v. S. D. Cohn & Co.,515 F.2d 591, 609 (5th Cir. 1975), vacated on other grounds, 426 U.S. 944, 96 S.Ct. 3161, 49 L.Ed.2d 1181 (1976). The relevant factors include the number of offerees and their relationship to each other and the issuer, the number of units offered, the size of the offering, and the manner of the offering. Consideration of these factors need not exhaust the inquiry, nor is one factor's weighing heavily in favor of the private status of the offering sufficient to ensure the availability of the exemption. Rather, these factors serve as guideposts to the court in attempting to determine whether subjecting the offering to registration requirements would further the purposes of the 1933 Act.

The term, "private offering," is not defined in the Securities Act of 1933. The scope of the § 4(2) private offering exemption must therefore be determined by reference to the legislative purposes of the Act. In SEC v. Ralston Purina Co., supra, the SEC had sought to enjoin a corporation's offer of unregistered stock to its employees, and the Court grappled with the corporation's defense that the offering came within the private placement exemption. The Court began by looking to the statutory purpose:

Since exempt transactions are those as to which "there is no practical need for . . . (the bill's) application," the applicability of (§ 4(2)) should turn on whether the particular class of persons affected need the protection of the Act. An offering to those who are shown to be able to fend for themselves is a transaction "not involving any public offering."

346 U.S. at 124, 73 S.Ct. at 984. According to the Court, the purpose of the Act was "to protect investors by promoting full disclosure of information thought necessary to informed investment decisions." Id. at 124, 73 S.Ct. at 984. It therefore followed that "the exemption question turns on the knowledge of the offerees." Id. at 126-27, 73 S.Ct. at 985. That formulation remains the touchstone of the inquiry into the scope of the private offering exemption. It is most nearly reflected in the first of the four factors: the number of offerees and their relationship to each other and to the issuer.

In the case at bar, the defendants may have demonstrated the presence of the latter three...