Avenue State Bank v. Tourtelot

• Decision Date: 03 May 1974
• Docket Number: No. 74 C 259.,74 C 259.
• Citation: 379 F. Supp. 250
• Parties: AVENUE STATE BANK, Plaintiff, v. Joseph L. TOURTELOT et al., Defendants.
• Court: U.S. District Court — Northern District of Illinois

379 F. Supp. 250

AVENUE STATE BANK, Plaintiff, v. Joseph L. TOURTELOT et al., Defendants.

No. 74 C 259.

United States District Court, N. D. Illinois, E. D.

May 3, 1974.

Justin A. Stanley, Patrick W. O'Brien and Henry F. Field, Mayer, Brown & Platt, Chicago, Ill., for plaintiff.

Randall L. Mitchell and Nancy S. Whitten of Chapman and Cutler, Charles R. Kaufman, Victor Lewis and Allan E. Lapidus of Vedder, Price, Kaufman & Kammholz, Chicago, Ill., for defendants.

MEMORANDUM OPINION

MAROVITZ, District Judge.

Motion to Dismiss

I.

As the result of a meeting on April 14, 1973, plaintiff Avenue State Bank loaned defendant Travel Management Corporation $220,000, in exchange for the execution of a series of short-term notes (later consolidated) as evidence of the indebtedness, and the execution of certain security agreements. In attendance at the meeting were Carl Oberwortmann, President of the Bank; defendant Zimmerman, President and major stockholder of Travel Management; and defendant Tourtelot, director, creditor, and shareholder of Travel Management, as well as a director of the Oak Park Trust and Savings Bank, plaintiff's principal competitor in Oak Park, Illinois. The loan was needed immediately to pay off debts owing to the Air Traffic Conference, one of the suppliers of air transportation of Travel Management.

Plaintiff alleges that it agreed to loan the cash upon the false and fraudulent misrepresentations of defendants Tourtelot and Zimmerman that Travel had, as security, over one-half million dollars worth of accounts receivable which were clear of any prior liens, and were "solid" in that Travel had "paid out 90%" of the travel arrangements due with respect to them. Plaintiff alleges that, in fact, the accounts receivable were bogus, and that all of the assets of Travel were clouded by an asserted prior lien. Travel is insolvent, and none of the $220,000 indebtedness has been repaid.

Avenue is suing defendants in seven counts under Sections 12(2)¹ and 17(a)² of the Securities Act of 1933, as well as under the Illinois Securities Act and the common law.

Defendants contend that this ordinary commercial bank loan transaction does not constitute the "sale"³ of a "security" within the Securities Act of 1933, and in particular, is not within the purview of the jurisdictional sections, 15 U.S.C. §§ 77b(1) and 77b(3). Defendants move to dismiss the action for lack of subject matter jurisdiction. We agree with defendants' contentions and grant the motion to dismiss.

II.

As noted, the issue in this case is simply whether the borrowing of money in an ordinary commercial bank loan transaction by Travel Management Corporation from plaintiff Avenue State Bank and the giving of a promissory note to evidence the indebtedness, where the bank loan was used to pay off a debt owing to one of defendant's suppliers, constituted the "sale" of a "security" within the Securities Act of 1933. This issue is one of the most hotly contested and least clearly resolved questions in securities law today.

Professor Loss posed the question, and the two lines of argument, in his treatise:

When the borrower uses the mails or some facility of interstate commerce, and obtains a loan from the bank by means of fraud or misstatement, it is difficult to say whether the borrower has violated the anti-fraud provisions of the 1933 and 1934 Acts and whether he may be sued civilly under Section 12(2) of the 1933 Act. Under a literal reading the answer would seem to be yes. But again the definitions — of both "security" and "sale" — in Section 2 apply "unless the context otherwise requires." It might be argued that Congress would have been more explicit if it had intended to provide a federal civil remedy in the context of the ordinary promissory note. 1 Loss, Ch. 3A at 546.

In essence, two principles expounded by the Supreme Court in securities cases—each of which suggests a different resolution to this problem — must be analyzed, balanced, and weighed. The first is that the Court has indicated that the words used in the definition of "security" are generic and should be given very broad meanings; Congress did not intend a strict construction of the word security. Tcherepnin v. Knight, 389 U.S. 332, 88 S.Ct. 548, 19 L.Ed.2d 564 (1967). The second principle is that one must consider context-over-text when examining the language of the statute; in searching for the meaning and scope of the word "security" in the Act, form should be disregarded for substance and the emphasis should be on economic reality. Tcherepnin v. Knight, 389 U.S. 336, 88 S.Ct. 548 (1967), citing SEC v. W. J. Howey Co., 328 U.S. 293, 298, 66 S.Ct. 1100, 90 L. Ed. 1244 (1946). And generally, while both these principles have been used to expand further and further that which might be considered a "security" for purposes of the Acts, it is clear that the required substance-over-form approach can, and in appropriate cases should, be used to exclude as well as include instruments within that definition. Comment, Commercial Notes and Definition of `Security' Under Securities Exchange Act of 1934: A Note is a Note is a Note?, 52 Neb.L.Rev. 478 at n. 51. Hereinafter, Commercial Notes. It is our belief, and we think that a close analysis and criticism of judicial precedents supports our view, that even a required broad interpretation of the definition of security should not include the type of ordinary bank transaction presented for our consideration here.

III.

The definition of "security" for purposes of the Securities Act of 1933 is found in 15 U.S.C. § 77b(1), which states in full:

When used in this subchapter, unless the context otherwise requires —

(1) 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 (emphasis added).

An analysis of the cases cited by plaintiff reveals that each has ignored the cardinal rule embodied in the statute itself that the definitions given are to be applied only if the context does not otherwise require. Surely Congress, by explicitly requiring the context-over-text method of construction, intended each question to be viewed as a matter of statutory interpretation, involving an analysis of the statute itself. Thus, the courts do not have discretion "to construe the word `security' as including certain types of notes but not others." Movielab, Inc. v. Berkey Photo, Inc., 321 F.Supp. 806, 809 (S.D.N.Y.1970). Rather, unless the "context" language of the statute is to be wrongly ignored altogether, it is manifest that Congress did in fact mean to say that some notes are securities while others are not. It is our premise that, viewing the intent of Congress, the context does require non-security treatment for the notes at suit herein.

Although there is no history on whether ordinary commercial notes are to be included in the definition of "security", the history of both the 1933 and 1934 Acts reveals a preoccupation with investment instruments. Commercial Notes, supra, at 486-487.

President Roosevelt's messages to Congress on both Acts indicate his concern with investments.⁴ Similarly, the concept of regulating investments permeates the Congressional reports on both Acts. The Senate Report accompanying the 1933 Act states:

The purpose of this bill is to protect the investing public and honest business. The basic policy is that of informing the investor of the facts concerning securities to be offered for sale in interstate and foreign commerce and providing protection against fraud and misrepresentation. S.Rep. No. 47, 73d Cong., 1st Sess. 1 (1933) (emphasis added).

The House report on the 1933 Act states that the definition of "security" is "in sufficiently broad and general terms so as to include within that definition the many types of instruments that in our commercial world fall within the ordinary concept of a security." H.Rep. No. 85, 73d Cong., 1st Sess. 11 (1933) (emphasis added). Similarly, the legislative history behind the 1934 Act also indicates an intent to control investment instruments without any concern over the ordinary commercial bank loan of the kind described herein.

The emphasis in all this legislative history on investment instruments indicates that Congress certainly was not concerned with regulating ordinary commercial notes. This emphasis was incorporated into law by inclusion of the required context-over-text method of statutory interpretation in the 1933 and 1934 Acts. And generally, it is the disregard of the statute's import in the cases which plaintiff cites which makes them unpersuasive as precedents.

In Lehigh Valley Trust Co. v. Central National Bank of Jacksonville, 409 F.2d 989 (5th Cir. 1969), the defendant bank had loaned as much money as banking law permits to a corporation on the verge of collapse. Because defendant sought to protect its prior loans, it marketed participation interests to other banks, including plaintiff, upon fraudulent misrepresentations. The court affirmed the jury verdict and held that the loan participation agreement was clearly within the statutory definition of a security, stating that the "definition of a security has been literally read by the judiciary to the extent that almost all notes are held to be securities." Lehigh, supra, at 991-992. We note, first, that this statement is an inaccurate summary of the views of the entire judiciary. Furthe...