McConnell v. Frank Howard Allen & Co.

• Citation: 574 F. Supp. 781
• Decision Date: 11 October 1983
• Docket Number: No. C-82-3349-MHP.,C-82-3349-MHP.
• Court: U.S. District Court — Northern District of California
• Parties: Gregory E. and Sherrill McCONNELL, Robert L. Morey, Dennis M. Burns, Beverly McDowell and Jo Ann Giunti, Plaintiffs, v. FRANK HOWARD ALLEN & CO., a California corporation, et al., Defendants.

574 F. Supp. 781

Gregory E. and Sherrill McCONNELL, Robert L. Morey, Dennis M. Burns, Beverly McDowell and Jo Ann Giunti, Plaintiffs, v. FRANK HOWARD ALLEN & CO., a California corporation, et al., Defendants.

No. C-82-3349-MHP.

United States District Court, N.D. California.

October 11, 1983.

Thomas J. LoSavio, Low, Ball & Lynch, San Francisco, Cal., Frank I. Mulberg, Mill Valley, Cal., for plaintiffs.

William S. Hochman, Bagshaw, Martinelli, Corrigan & Jordan, San Rafael, Cal., for Frank Howard Allen & Co.

Marshall W. Krause, Krause, Timan, Baskin, Shell & Grant, Larkspur, Cal., for Robert J. Eves, Eves Properties, Rancho Cordova Inv.

John C. MacKay, Rader, Rader & Goulart, Sacramento, Cal., for Creative Management.

Stephen A. Fraser, Sausalito, Cal., for Christine Hughes Ramberg.

M. Armon Cooper, Carol G. Perry, Lukens, St. Peter & Cooper, San Francisco, Cal., for Andrew Nickolatos.

John L. Hosack, Eugene J. Chiarelli, Tobin & Tobin, San Francisco, Cal., for 1st American Title Co. of Marin.

Stephen M. Kass, Richard G. Blair, Buchman, Kass, Morgan & Miller, Oakland, Cal., for Founders Title Co.

MEMORANDUM DECISION AND ORDER

PATEL, District Judge.

In the instant action, plaintiffs allege fifteen separate causes of action against a variety of defendants. Two of the claims assert violations of the federal securities laws, and the rest arise out of state law. Defendants have moved under Fed.R.Civ.P. 12(b)(1) to dismiss the complaint for lack of subject matter jurisdiction, or in the alternative for summary judgment, on the ground that plaintiffs did not purchase a security within the meaning of § 2(1) of the Securities Act of 1933, 15 U.S.C. § 77b(1), or § 3(a)(10) of the Securities Exchange Act of 1934, 15 U.S.C. § 78c(a)(10). Defendants have also moved for summary judgment on the federal claims on the ground that these actions are barred by the applicable statutes of limitations. Having carefully considered the papers submitted and the arguments of counsel, the court grants the motion with respect to plaintiffs' § 12(2) claim, 15 U.S.C. § 77l(2), and denies the rest.

I. Facts

The court need not recite the complex factual history of this case in detail. In short, agents of defendant Frank Howard Allen & Company ("FHA") began soliciting in April of 1978 for the sale of a group of eleven four-plex apartment buildings known as the "Camelot Apartments." Plaintiffs, who did not know one another at that time, all offered to purchase one or more of the four-plexes. Although many of the plaintiffs were told that they would receive individual deeds for each four-plex purchased, when the sale finally went through in August 1978, it was structured as a joint venture, not as individual purchases. Under the agreement, for each $12,000 contributed, plaintiffs purchased a one-eleventh undivided interest in the venture. Moreover, the agreement designated defendants Andrew Nickolatos and Christine Hughes as the managing partners of the venture and granted them exclusive management authority over its operations. Plaintiffs became non-managing general partners.

At the time of the sale, defendants told the plaintiffs that they were purchasing the apartment complex from defendant Robert Eves for $759,000. They did not inform the plaintiffs that Eves had purchased the property on the same date for $620,000 from its original owners, the Keiths. Shortly after the joint venture agreement was signed, Nickolatos and Hughes informed the plaintiffs that they would have to sign another agreement because the original joint venture agreement had not been properly notarized. Plaintiffs then signed a new superseding partnership agreement which formed the Rancho Cordova Investment Company ("RC Investment I").

In early January 1979, plaintiffs received a letter from Hughes stating that the investment was in good shape and that there should not be a negative cash flow. In May 1979, however, they received a second letter from Nickolatos informing them that because the property had been refinanced there was going to be a temporary negative cash flow. All of the plaintiffs expressed dissatisfaction with the cash flow problems.

Nickolatos and Hughes arranged to resell the property back to Eves in July 1979. However, they did not inform plaintiffs of the proposed resale until November 1979, at which time they requested plaintiffs to sign a third partnership agreement, Rancho Cordova Investment Company II ("RC Investment II"). This agreement was in effect a sale of the property to Eves in return for Eves' promise to pay $15,000 to plaintiffs for each $12,000 share they had purchased. Eves promised to purchase plaintiffs' interests within eighteen months after the signing of agreement. All of the plaintiffs agreed to the partnership/repurchase agreement.

Plaintiffs heard little else about their investment until January 1981, when two plaintiffs, Mr. and Mrs. McConnell, received a letter from Mr. Tacconelli. Tacconelli told them that he had purchased the property from Eves in August 1980 and that Eves had given him the McConnells' name. According to Tacconelli, Eves had told him that the plaintiffs had some interest in the property and that he would have to obtain their approval for an extension on a note due February 1, 1982. Shortly after this conversation, plaintiffs held their first investors' meeting and hired an attorney. They then began the process of unravelling what had happened to their investment. However, Hughes had moved to Oregon, and Nickolatos had disappeared. FHA and Eves refused to cooperate or answer their questions. Moreover, Eves did not honor his obligation to plaintiffs even on or after February 1, 1982, the date on which Tacconelli's note was due. Plaintiffs claim that February 1, 1982 was the date on which they discovered they had been defrauded.

II. Did Plaintiffs Purchase a Security?

A. Subject Matter Jurisdiction

Defendants have moved to dismiss this action for lack of subject matter jurisdiction under Fed.R.Civ.P. 12(b)(1). According to defendants, plaintiffs did not purchase a security within the meaning of the Securities Acts, and therefore since the sole basis for federal jurisdiction is plaintiffs' allegation that they did purchase a security, this case must be dismissed. Under Rule 12(b)(1), the court may consider matters outside the pleadings and resolve disputed issues of fact. This is because jurisdictional facts are questions for the court, rather than for the jury. However, it is well settled that a different rule obtains when the alleged jurisdictional basis is intertwined with an element of a federal cause of action. In such a case, the court should not determine the merits of plaintiffs' cause of action under the guise of determining jurisdictional facts. See Bell v. Hood, 327 U.S. 678, 66 S.Ct. 773, 90 L.Ed. 939 (1946). Rather, the court should assume jurisdiction and determine the merits unless "the alleged claim under the constitution or federal statutes clearly appears to be immaterial and made solely for the purpose of obtaining federal jurisdiction or where such claim is wholly insubstantial and frivolous." Id. at 682-83, 66 S.Ct. at 776. The courts have consistently applied this rule to motions to dismiss for lack of subject matter jurisdiction in securities actions where the claim is that the plaintiff did not purchase a security. See, e.g., Williamson v. Tucker, 645 F.2d 404, 415-17 (5th Cir.1981). As the court's discussion of defendants' summary judgment motion will demonstrate, plaintiffs' claim that they purchased securities within the meaning of the Securities Acts is not insubstantial or frivolous, either factually or legally. Accordingly, defendants' Rule 12(b)(1) motion is denied.

B. Summary Judgment

The analysis of whether an investment constitutes a security begins with SEC v. W.J. Howey Co., 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946), the celebrated citrus grove case. In Howey, the Court set forth the test for determining when an investment is a security under § 2(1), which defines a security as, inter alia, an investment contract. The Court stated:

an investment contract for purposes of the Securities Act means a contract, transaction or scheme whereby a person invests money in a common enterprise and is led to expect profits solely from the efforts of a promoter or third party.

328 U.S. at 298-99, 66 S.Ct. 1103. Subsequent cases have given a liberal reading to the requirement that the profits derive solely from the efforts of others. In SEC v. Glenn W. Turner Enterprises, Inc., 474 F.2d 476, 482 (9th Cir.1973), the Ninth Circuit set forth the proper standard:

whether the efforts made by those other than the investor are the undeniably significant ones, those essential managerial efforts which effect the failure or success of the enterprise.

Although not clearly articulated in their papers, defendants raise two distinct bases for their claim that plaintiffs' investments were not securities. Their first contention is that plaintiffs' investment was not an investment contract because the nature of the efforts which it was contemplated that defendants would perform were insignificant with regard to the venture's profitability. The second challenge is to the partnership form which the investment took.

1. Significance of Defendants' Efforts

The question raised by defendants' motion has been relatively unexamined by the courts. This challenge goes not to the nature of the investors' role in the venture, but rather to the importance of the third parties' actions in the overall profitability of the investment. There is persuasive authority for the position that if an investor in a real estate syndicate expects profits to come solely from the general appreciation of property values, then the investment is not a security. See Gordon v. Terry, 684 F.2d 736, 740 n. 4 (11th Cir.1982); I L. Loss, Securities Regulation at 491-92 (2d Ed.1961). See also McConathy v. Dal...