American Bank & Trust Co. v. Wallace
| Decision Date | 16 December 1981 |
| Docket Number | Civ. A. No. 81-124. |
| Citation | 529 F. Supp. 258 |
| Parties | AMERICAN BANK & TRUST COMPANY, Plaintiff, v. Jan L. WALLACE, et al., Defendants. |
| Court | U.S. District Court — Eastern District of Kentucky |
J. Montjoy Trimble, Trimble & Henry, Anderson & Anderson, Lexington, Ky., for plaintiff.
William C. Shouse, Shouse & Burrus, Lexington, Ky., for defendants Jan L. Wallace, Wallace Leasing Co., Inc. and Anna L. Wallace.
R. David Lester, Stoll, Keenon & Park, Lexington, Ky., for defendant First Sec. Nat. Bank & Trust Co.
David A. Weinberg, P.S.C., Lexington, Ky., for defendants E. L. Wallace and Neda Wallace.
American Bank and Trust Company (American Bank), a Kentucky banking corporation, brought this action on July 7, 1981, against defendants Jan L. Wallace, E. L. Wallace, Ann Wallace, Neda H. Wallace (Wallaces), Jan Michael Wallace, Wallace Leasing Company, Inc., and First Security National Bank and Trust Company (First Security). The action stems from the circumstances surrounding a bank loan from American Bank to the Wallaces.
The complaint consists of four separate counts. Count I of the complaint seeks to recover for alleged violations of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. Section 78j (1934 Act), and Rule 10b-5, 17 C.F.R. Section 240.106-5, promulgated thereunder by the Securities and Exchange Commission. Count II of the complaint alleges violations of the Securities Act of 1933 (1933 Act). Count III of the complaint seeks damages for alleged violations of Section 17(a) of the 1933 Act, 15 U.S.C. Section 77q. Finally, Count IV alleges violation of the Kentucky securities statute, K.R.S. Section 292.320.
Jurisdiction is purportedly grounded upon Section 27 of the 1934 Act (15 U.S.C. 78aa), Section 22 of the 1933 Act (15 U.S.C. 77v), and principles of pendent jurisdiction.
The action is presently before the Court upon defendants'1 motion to dismiss the complaint upon the following grounds:
On October 6, 1981, the Court heard oral arguments of counsel. Plaintiff's counsel conceded that Count III of the complaint should be dismissed by the Court in light of this Court's ruling in Ingram Industries, Inc. v. Nowicki, 502 F.Supp. 1060 (E.D.Ky. 1980) which held that Section 17(a) of the 1933 Act did not provide a private right of action. Accordingly, counsel for both parties agreed that the dispositive remaining issue before the Court is whether the promissory note purchased by American Bank from the Wallaces constitutes a "security" within the ambit of the 1933 and 1934 Act.
On June 1, 1981, Jan L. Wallace contacted American Bank for the purpose of inducing American Bank to lend the Wallaces the sum of $300,000. Jan L. Wallace stated that the loan was to be used by him for the purpose of starting a new business venture. The new business was to be known as Wallace Leasing Company and would engage in the leasing of automobiles. He further stated that the loan would be repaid from proceeds to be derived from the sale of Budget Rent-A-Car, Lexington, Kentucky, and Budget Rent-A-Car, Knoxville, Tennessee, businesses which Jan L. Wallace owned or controlled.
Based upon these representations, American Bank, on June 3, 1981, loaned the Wallaces the principal amount of $300,000 in return for a promissory note executed by the Wallaces. (Exhibit A). Principal and interest were due thirty (30) days thereafter. The interest rate was fixed at one and three-fourth (1¾) percent above American Bank's prime rate.
Subsequently, American Bank received information that Jan L. Wallace and these companies that he either owned or controlled were engaged in the illegal and unlawful practices of "double floor planning" and "check kiting" and that a portion of the $300,000 would be used to pay off a loan from First Security to Wallace Motors. Jan L. Wallace failed to disclose this to American Bank during the loan negotiations.
On the afternoon of June 4, 1981, American Bank officials questioned Wallace regarding the above unlawful practices. Jan L. Wallace reiterated his previous representations and denied the above allegations. Subsequently, the Wallaces defaulted on the note.
Plaintiff alleges that the representations made by Jan L. Wallace during the loan negotiations were "false, fraudulent, and untrue." Plaintiff further alleges that Jan L. Wallace was aided and abetted by and conspired with Wallace Motors, Jan Michael Wallace, Wallace Leasing, E. L. Wallace, Anna Wallace, Neda Wallace, and First Security to commit alleged violations of the 1933 and 1934 Act.
Originally, plaintiff sought damages in the amount of $300,000 dollars, together with interest at the rate of American Bank's prime plus 1¾% per annum from June 4, 1981. However, an amended complaint filed August 14, 1981, indicates that plaintiff now seeks damages in the mitigated sum of $159,408.29 together with interest "thereon after July 20, 1980 at the prime rate of American Bank plus 1¾% per annum."
The recent Sixth Circuit decision in Union Planters National Bank v. Commercial Credit, 651 F.2d 1174 (6th Cir. 1981), provides this Court with the necessary guidance to resolve the critical issue. For the reasons that follow, this Court concludes that the promissory note purchased by American Bank does not constitute a "security."
Section 3(a)(10) of the 1934 Act, 15 U.S.C. Section 78c(a)(10) provides:
Although the 1933 Act definition2 differs somewhat, both have been treated as "virtually identical." See Tcherepnin v. Knight, 389 U.S. 332, 335-36, 88 S.Ct. 548, 552-53, 19 L.Ed.2d 564 (1967); Union Planters National Bank, supra at 1180. A literal application of the definition would seem to be dispositive of the issue.3 A literal application, however, has been disapproved by the Supreme Court in United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 848, 95 S.Ct. 2051, 2058, 44 L.Ed.2d 621 (1975). See also McClure v. First National Bank of Lubbock, 497 F.2d 490, 493-94 (5th Cir. 1975).
Instead, the Supreme Court has focused on the legislative purpose4 behind the Acts and the economic realities underlying a transaction in developing a test, which in "`shorthand form'":
... embodies the essential attributes that run through all of the Court's decisions defining a security. The touchstone is (1) the presence of an investment (2) in a common venture (3) premised on a reasonable expectation of profits (4) to be derived from the entrepreneurial or managerial efforts of others.
As counsel for both sides correctly stated, the United States Courts of Appeals are split5 as to what mode of analysis is appropriate in determining which investment transaction the Securities Acts were meant to cover. The Sixth Circuit has adopted what has been commonly referred to as the "risk capital" test.6 The test, enunciated by the Ninth Circuit in Great Western Bank and Trust v. Kotz, 532 F.2d 1252, 1257 (9th Cir. 1976), has been confined primarily to loans used to capitalize an investor's business where the lender risks loss. AMFAC Mortgage Corp. v. Arizona Mall of Tempe, 583 F.2d 426 (9th Cir. 1978); Great Western Bank v. Kotz, supra; United California Bank v. THC Financial Corp., 557 F.2d 1351 (9th Cir. 1977).
The risk capital analysis focuses on six criteria:
As a general rule, "the longer one's money is held by another, the greater the risk of loss becomes for the one contributing the money." AMFAC Mortgage Corp., supra at 432. American Bank's money was not at risk for a very long time. The promissory note was due and payable 30 days after the date of execution. Such a short term duration is not indicative of an expenditure of risk capital.
Plaintiff's counsel states in his brief that the loan was not collateralized. If a lender is unsecured, then repayment of a loan is more dependent upon the efforts of the borrower. Although the Court is mindful that all facts are to be liberally construed in favor of the party opposing the motion to dismiss, Pessin v. Keeneland Association, 45 F.R.D. 10, 13 (E.D.Ky.1968), a reading of the amended complaint reveals that a portion of the $300,000 was collateralized. The amended complaint reads:
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