Adena Exploration, Inc. v. Sylvan, 87-1429

Citation860 F.2d 1242
Decision Date16 November 1988
Docket NumberNo. 87-1429,87-1429
PartiesADENA EXPLORATION, INC., Plaintiff-Appellant, v. Dave SYLVAN, an Individual and as Trustee of the Dave R. Sylvan Revocable Trust, Defendant-Appellee.
CourtUnited States Courts of Appeals. United States Court of Appeals (5th Circuit)

Roger F. Claxton, John T. Mitchell, Kilgore & Kilgore, Dallas, Tex., for plaintiff-appellant.

D.L. Case, Retta A. Miller, Jackson, Walker, Winstead, Cantwell & Miller, Dallas, Tex., for defendant-appellee.

Rosalind C. Cohen, Eva Marie Carney, Washington, D.C., for amicus curiae S.E.C.

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

Before GARZA, HIGGINBOTHAM, and SMITH, Circuit Judges.

PATRICK E. HIGGINBOTHAM, Circuit Judge:

Plaintiff Adena Exploration, Inc., an oil company, appeals from a judgment and order of rescission in favor of defendant Dave Sylvan, urging that the district court erred in concluding that Adena's sale to Sylvan of an undivided fractional interest in oil and gas was a sale of a security under the federal securities laws. We affirm.

I

Adena mailed to prospective purchasers approximately twenty-five brochures, describing an opportunity to participate in exploration and drilling for oil and gas in Nacogdoches County, Texas. Sylvan received a copy of the brochure from another prospective investor, Penn Resources, and after his experts analyzed the data gathered by Penn, Sylvan decided to purchase a 25% interest. Penn purchased another 25% interest, and Adena retained a 50% interest. Sylvan executed a Participation Agreement subject to several modifications, which were accepted by Adena.

After one well-completion attempt, Sylvan and Penn met with Adena to discuss further plans. After this meeting, Sylvan met with Penn to discuss the fact that the leases covering 800 acres were subject to Pugh clauses 1 and that they suspected that Adena had been charging off certain overhead costs against the lease costs, thus effecting a "mark up." Penn and Sylvan each requested a credit of $12,250, and Sylvan later notified Adena that he was exercising his right to rescind.

Adena brought suit in Texas state court seeking approximately $200,000 from Sylvan under the Participation Agreement. Sylvan, an Oklahoma resident, removed the case to federal court on the basis of diversity, 2 and asserted as a defense that the agreement violated the Texas statute of frauds and federal securities laws. Sylvan sought rescission on the ground that Adena had failed to disclose material terms, including the fact that certain leases contained Pugh clauses and had certain lease expiration dates, omissions said to violate the anti-fraud provisions of the Securities Act of 1933. 3

The district court rejected Sylvan's defense under the Texas statute of frauds but found that the transaction involved a "security" and that Adena had made material misrepresentations with respect to lease expiration dates, the existence of Pugh clauses, and overhead charged to the venture. The court denied Adena recovery and granted Sylvan rescission on the ground that Adena had violated the federal securities laws.

Adena appeals from the district court's order of rescission. It does not challenge the district court's finding that it had made material misrepresentations but argues that the interest conveyed to Sylvan was not a security and thus that the federal securities laws are not applicable. Thus, the sole question before us is whether Sylvan's interest in Adena's oil and gas leases is a "security" as defined under the 1933 Act. 4

II

There is of course nothing novel about the suit now before us. Sophisticated purchasers of fractional undivided interests in oil and gas have sought--and obtained--rescission of their purchases pursuant to the 1933 Act for at least thirty years. See, e.g., Woodward v. Wright, 266 F.2d 108 (10th Cir.1959) (holding rescission remedy available to sophisticated, private purchasers of fractional undivided interest in oil and gas). The Securities and Exchange Commission has consistently espoused the view that any fractional undivided interest in oil and gas is subject to regulation under both the 1933 and 1934 Acts, and adheres to that position in an amicus brief filed in this case. S.E.C. Br. at 6-10; Securities Act Release No. 185 (June 20, 1934), 11 Fed.Reg. 10951. Commentators have long argued that the sale of a fractional undivided interest in oil and gas is the sale of a security. See Bloomenthal, SEC Aspects of Oil and Gas Financing, 7 Wyo.L.J. 49, 53 (1953) ("the sale of fractional undivided interests in the mineral rights, in the landowner's royalty, in an overriding royalty, or in a lease all involve the sale of [a] security").

In light of this history, it would be most surprising if the security status of a fractional undivided interest in oil and gas remained an open question in this Circuit. And, indeed, the issue might fairly be thought settled by this Court's declaration in 1961: "That an assignment of a fractional undivided interest in oil and gas rights is a security within the definition of Section 2(1) of the Act is clearly and uncontrovertably established by decisions of the Supreme Court of the United States...." Moses v. Michael, 292 F.2d 614, 618 (5th Cir.1961). Accord, Nor-Tex Agencies, Inc. v. Jones, 482 F.2d 1093, 1098 (5th Cir.1973), cert. denied, 415 U.S. 977, 94 S.Ct. 1563, 39 L.Ed.2d 873 (1974) (following Moses ). See also Roe v. United States, 287 F.2d 435, 437 and 439 (5th Cir.1961) (distinguishing "fractional undivided interests in oil and gas" from "investment contracts," and citing, with approval, Judge Murrah's opinion in Woodward, 266 F.2d 108).

In total, at least five circuits and the Supreme Court have accepted or suggested, by express statement or by apparent implication, that a fractional undivided interest in oil and gas is a security. See Pinter v. Dahl, --- U.S. ----, 108 S.Ct. 2063, 100 L.Ed.2d 658 (1988) (applying securities laws to fractional undivided interests in oil and gas without commenting on the security status of such interests); Penturelli v. Spector, Cohen, Gadon & Rosen, 779 F.2d 160 (3d Cir.1985) (fractional undivided interests held to be securities); Moses v. Michael, 292 F.2d 614 (5th Cir.1961); Whittaker v. Wall, 226 F.2d 868 (8th Cir.1955) (upholding suit for rescission of sales of fractional undivided interests in oil and gas); Simon Oil Co., Ltd. v. Norman, 789 F.2d 780, 781 (9th Cir.1986) (commenting, with approval, upon the Third Circuit's "well-reasoned" opinion in Penturelli, although remanding for application of the "risk capital" approach); Woodward v. Wright, 266 F.2d 108 (10th Cir.1959). We have not found any circuit court decision denying security status to an instrument properly denominated a fractional undivided interest in oil and gas.

Appellants nonetheless assert that the sale of a newly 5 fractionalized undivided interest in oil and gas is sometimes not a security within the meaning of the Act. We have neither the authority nor the inclination to call into question the clearly articulated rule of this Court's earlier decisions in Moses and Nor-Tex. On the other hand, we are sensitive to the commercial significance of securities regulation, and are cognizant that this area of law is growing increasingly complex. We therefore examine now the security status of fractional undivided interests under the Securities and Exchange Acts in light of the major decisions construing those Acts. In so doing we reaffirm our pronouncements in Moses and Nor-Tex.

We begin with the statute itself. In determining whether Sylvan's interest in Adena's oil and gas leases is a "security," we look to the definition provided in Sec. 2(1) of the 1933 Act, which says that "unless the context otherwise requires," the term "security" means

any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, or, in general, any interest or instrument commonly known as a "security", or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing. 6

By this express language, the definition of "security" includes Sylvan's interest as a "fractional undivided interest in oil, gas, or other mineral rights."

Ordinarily, we do not look beyond the plain language of a statute; at the same time, however, we do not garrote congressional purpose with zealous literalism. Adena argues that a literalist approach is incompatible with Supreme Court case law and that we must inquire further than the express language of the statute. The Supreme Court, in S.E.C. v. C.M. Joiner Leasing Corp., 320 U.S. 344, 64 S.Ct. 120, 88 L.Ed. 88 (1943), spoke to the import of the statutory reference to "fractional undivided interests in oil and gas." The Court's comment upon the phrase guides our construction of the statute's meaning. The Court, speaking through Justice Jackson, said

Oil and gas rights posed a difficult problem to the legislative draftsmen. Such rights were notorious subjects of speculation and fraud, but leases and assignments were also indispensable instruments of legitimate oil exploration and production. To include leases and assignments by name might easily burden the oil industry by controls that were designed only for the traffic in securities. This was avoided by including specifically only that form of splitting up of mineral interest which had been most utilized for speculative purposes. We do not think the draftsmen thereby immunized other forms of contracts and offers which are proved as matter of fact to answer such terms as ...

To continue reading

Request your trial
8 cases
  • Schaffer Family Investors, LLC v. Sonnier
    • United States
    • U.S. District Court — Central District of California
    • August 13, 2015
    ...in oil or minerals. See, e.g. , Nolfi v. Ohio Kentucky Oil Corp. , 675 F.3d 538, 546 (6th Cir.2012) ; Adena Exploration, Inc. v. Sylvan , 860 F.2d 1242, 1249 (5th Cir.1988) ; Penturelli v. Spector, Cohen, Gadon & Rosen, Attorneys at Law , 779 F.2d 160, 167 (3d Cir.1985). In Simon Oil Co. v.......
  • Lenau v. Co-Exprise, Inc.
    • United States
    • Pennsylvania Superior Court
    • September 23, 2014
    ...is created for the purpose of sale, the conveyance of the interest is the sale of the security.” Adena Exploration, Inc. v. Sylvan, 860 F.2d 1242, 1246 (5th Cir.1988).The statutory definition of a security includes both relatively specific categories, composed of “instruments whose names al......
  • Holloway v. Peat, Marwick, Mitchell & Co.
    • United States
    • U.S. Court of Appeals — Tenth Circuit
    • July 11, 1989
    ...Penturelli v. Spector, Cohen, Gadon & Rosen, 779 F.2d 160, 167 (3d Cir.1985) (citation omitted); accord Adena Exploration, Inc. v. Sylvan, 860 F.2d 1242, 1248 (5th Cir.1988). Here, both the passbook savings certificates and thrift certificates are essentially debt instruments, representing ......
  • Nolfi v. Ohio Kentucky Oil Corp.
    • United States
    • U.S. Court of Appeals — Sixth Circuit
    • April 4, 2012
    ...interest in oil and gas is a security under the statute, while no circuit has held otherwise. See Adena Exploration Inc. v. Sylvan, 860 F.2d 1242, 1244–45 (5th Cir.1988) (listing cases holding the same and noting that no circuit has held otherwise).5 If the OKO investments are fractional un......
  • Request a trial to view additional results
4 books & journal articles
  • Securities fraud.
    • United States
    • American Criminal Law Review Vol. 45 No. 2, March 2008
    • March 22, 2008
    ...constituted "notes" within the meaning of the securities acts under the "family resemblance" test); Adena Exploration, Inc. v. Sylvan, 860 F.2d 1242, 1249 (5th Cir. 1988) (holding that economic reality test does not apply to undivided oil and gas interests that fall "squarely within" the de......
  • Securities fraud.
    • United States
    • American Criminal Law Review Vol. 42 No. 2, March 2005
    • March 22, 2005
    ...and "security," because economic realities of transaction suggested the plan was not a security); Adena Exploration, Inc. v. Sylvan, 860 F.2d 1242, 1249 (5th Cir. 1988) (holding that economic reality test does not apply to undivided oil and gas interests that fall "squarely within" the defi......
  • Securities fraud.
    • United States
    • American Criminal Law Review Vol. 44 No. 2, March 2007
    • March 22, 2007
    ...and "security," because economic realities of transaction suggested the plan was not a security); Adena Exploration, Inc. v. Sylvan, 860 F.2d 1242, 1249 (5th Cir. 1988) (holding that economic reality test does not apply to undivided oil and gas interests that fall "squarely within" the defi......
  • Securities fraud.
    • United States
    • American Criminal Law Review Vol. 46 No. 2, March 2009
    • March 22, 2009
    ...constituted "notes" within the meaning of the securities acts under the family resemblance test); Adena Exploration, Inc. v. Sylvan, 860 F.2d 1242, 1249 (5th Cir. 1988) (holding that economic reality test does not apply to undivided oil and gas interests that fall "squarely within" the defi......

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT