Allison v. Ticor Title Ins. Co.

• Decision Date: 10 August 1990
• Docket Number: No. 89-3589,89-3589
• Citation: 907 F.2d 645
• Parties: Fed. Sec. L. Rep. P 95,343 John D. ALLISON, et al., and Bayfield Electric Cooperative, et al., Plaintiffs-Appellees, v. TICOR TITLE INSURANCE COMPANY, Defendant-Appellant.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 645

907 F.2d 645

Fed. Sec. L. Rep. P 95,343

John D. ALLISON, et al., and Bayfield Electric Cooperative et al., Plaintiffs-Appellees, v. TICOR TITLE INSURANCE COMPANY, Defendant-Appellant.

No. 89-3589.

United States Court of Appeals Seventh Circuit.

Argued May 31, 1990.

Decided July 16, 1990.

Rehearing Denied Aug. 10, 1990.

Barry Levenstam, Jerold S. Solovy, Jenner & Block, Chicago, Ill., John Cotter, Alan Kildow, Larkin, Hoffman, Daly & Lindgren, Minneapolis, Minn., John Cates, Lawton & Cates, Madison, Wis., for plaintiffs-appellees.

Joshua G. Vincent, William J. Holloway, William Swindal, Hinshaw, Culbertson, Moelmann, Hoban & Fuller, Chicago, Ill., Thomas A. Lockyear, Bell, Metzner, Gierhart & Moore, Madison, Wis., for defendant-appellant.

Before WOOD, Jr., and EASTERBROOK, Circuit Judges, and ESCHBACH, Senior Circuit Judge.

EASTERBROOK, Circuit Judge.

Telemark Land Company built a recreational community in Cable, Wisconsin, near the Chequamegon National Forest. Including a lodge, houses, restaurants, ski trails, a fitness center, pools, tennis courts, a golf course, and convention facilities, the resort was designed for year-round occupancy. Telemark borrowed money for the construction, giving the lender a mortgage. It divided the lodge into 200 condominium "units" comprising leaseholds in particular rooms plus undivided 1/2% interests in the common areas of the lodge. Each lease runs for 52 years, with an option to renew for another 23. For between $27,000 and $29,500 per unit a purchaser obtained a right to occupancy and to participate in a rental arrangement: lessees could occupy their units when they pleased and ask the lodge to rent unoccupied units to guests. A rotation system ensured rough proportionality of returns.

The lodge opened in 1972. In 1978 Telemark and the lessees revised their arrangement. The lessees gave up the right to occupy particular units; all were put into a pool. Lessees were required to make reservations like anyone else and would not be assured of getting "their" units. Costs and revenues would be pooled, and the net disbursed pro rata. This arrangement, like the previous one--like the resort itself--was not entirely successful. Telemark Land Company and its affiliate Telemark Management Company filed for bankruptcy in 1981, unable to service the mortgage debt. By 1984 the lodge was rundown (it seems that the lessees did not fulfill their obligation to keep their units in tip-top shape, once they lost any sense that a unit was "theirs"), and business was off. Telemark's bankruptcy was converted that year from a Chapter 11 reorganization to a Chapter 7 liquidation.

Telemark's trustee in bankruptcy proposed to sell the lodge free of the leaseholds, on the ground that questions about the lessees' compliance with the repair obligations in their leases created a "genuine dispute" about the status of these leases. Such a procedure, authorized by 11 U.S.C. Sec. 363(f)(4), allows the buyer to take free of encumbrances but requires the bankruptcy court to resolve the dispute and pay the lessees from the proceeds of the sale if their claims are valid. Many of the lessees protested. Some of the protesters got in touch with Ticor Title Insurance Co., which had written title insurance on their units. The unit owners' association tried to organize a bid for the lodge. After several rounds of negotiation and attempts at compromise, the trustee issued an additional notice, again requesting the bankruptcy judge to authorize a sale of the lodge free of the leases. Among the grounds stated in the trustee's notice was that "all said [lessees] do not have an ownership or possessory leasehold interest in the premises ... but are merely either equity investors in the Telemark Lodge and/or mortgage holders on said equity investment."

Owners of 18 leaseholds promptly tendered the defense of this claim to Ticor, reasoning that the trustee was saying that they never obtained good title but had been "equity investors" all along. Ticor had insured them against any defect in the title conveyed by Telemark and any event that made title "unmarketable". Ticor denied coverage and refused to defend them. Ticor made it clear to all that it would neither defend nor indemnify the lessees. The bankruptcy judge authorized the trustee to sell the lodge clear of the leases but did not make specific findings about the nature of the "genuine dispute" that clouded the lessees' interests. The proceeds of the sale paid off the mortgage (then some $13 million) and the administrative expenses of the bankruptcy. From the residue, each lessee received $1,250.

Holders of 98 leases then filed this diversity suit against Ticor to recover under their policies of title insurance. They maintained that the bankruptcy court must have concluded that they never acquired valid title, which had at all events become unmarketable. The district court conducted a jury trial, and the principal question put to the jury was whether the rotation and pooling agreements made the units "investment contracts" within the meaning of Sec. 2(1) of the Securities Act of 1933, 15 U.S.C. Sec. 77b(1), which would require registration or an exemption as a condition to their sale. See SEC v. W.J. Howey Co., 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946); SEC v. C.M. Joiner Leasing Corp., 320 U.S. 344, 64 S.Ct. 120, 88 L.Ed. 88 (1943). The premise of this question was that if the leases were unregistered securities, then the lessees did not get good title--or at least got unmarketable title. The jury concluded that the lease-plus-rental-pool was indeed an investment contract. After extended additional proceedings, the district judge entered judgment for some $2.6 million, representing the purchase price for each unit less the dividend received in bankruptcy.

The premise of the question put to the jury is that if the unit was an "investment contract", and thus a statutory "security", then the investors did not get good title. The premise is incorrect. Section 5 of the Securities Act, 15 U.S.C. Sec. 77e, forbids selling a security in interstate commerce without registration or an exemption, and Sec. 12, 15 U.S.C. Sec. 77l, provides that the purchaser of a security sold in violation of Sec. 5 may rescind the transaction. Nothing in either section implies that an unregistered sale does not pass title to the buyer. Section 12 gives the buyer a right to rescind the sale (a right to "put" the security to the seller within the period of limitations) without subtracting any entitlements under the law of property or contracts. Section 4(1) of the Act, 15 U.S.C. Sec. 77d(1), reinforces this by exempting from registration "transactions by any person other than an issuer, underwriter or dealer". The exemption does not depend on proof that every earlier sale in the chain was lawful. Section 5 (the registration requirement) applies to transactions; each sale must be registered or exempt. A violation does not stick to the instruments like tar. It is a personal offense by the seller, leaving the validity of the securities as contracts between issuer and purchaser unaffected. Future sales may proceed if an exemption is available. See Thomas Lee Hazen, 1 The Law of Securities Regulation Sec. 4.23 (2d ed. 1990) (discussing Sec. 4(1)).

Leaseholds coupled with financial pooling may be securities, but the addition of a rental pool does not make the leasehold less an interest in real property. See In re Owners of "SW 8" Real Estate, 513 F.2d 558, 562 (9th Cir.1975). Imagine what would have happened had Telemark sent letters to the lessees a day after the expiration of the one-year statute of limitations in Sec. 13, 15 U.S.C. Sec. 77m, informing them that because the combination of a lease and rental pool is a security, the lease is invalid, and the lessees' demands for occupancy (and a share in the receipts) would no longer be honored. It would take a state court but a few minutes to issue an injunction restoring the lessees' right of occupancy. Claims under their contract against the issuer are fully enforceable, and because of Sec. 4(1) their interests are freely transferrable. Any violation of Sec. 5 therefore does not negate the existence of title.

Perhaps the best argument for the lessees would be that their leaseholds are unmarketable because a subsequent purchaser could sue them under the securities laws, as in Hocking v. DuBois, 885 F.2d 1449 (9th Cir.1989) (in banc). We have grave doubts about the correctness of Hocking, a 6-5 decision that did not satisfactorily address the question how a unit owner who conveys only an interest in real property vends a "security" just because the proprietor of the condominium development offers a rental pool in which unit owners may participate if they choose. The proprietor conveys the full package and hence a "security" to the original owner, who cannot re-convey the same package (or for that matter stop the proprietor from offering a rental pool). Yet even if we were to follow Hocking the leases would not be "unmarketable". Liability in Hocking was based not on the unit owner's failure to register under Sec. 5 (something that Sec. 4(1) makes unnecessary) but on a claim that the unit owner defrauded the person to whom he sold. Hocking used the securities laws to transfer a claim of fraud from state to federal court without changing the nature of the liability. Rules against fraud are universal; an interest in land is not less "marketable" if, because of the securities laws, the victim has access to a federal forum in addition to a state court.

This conclusion does not save the day for Ticor, however, because of its failure to defend its insureds in the bankruptcy action. After the trustee proposed to extinguish the lessees' interests, 18 of them explicitly tendered the defense to Ticor, which refused. The trustee's notice put the existence of title into question, activating the obligation to defend. Ticor now...