C. N. S. Enterprises, Inc. v. G. & G. Enterprises, Inc.

• Decision Date: 13 January 1975
• Docket Number: No. 73-2073,73-2073
• Citation: 508 F.2d 1354
• Parties: , Fed. Sec. L. Rep. P 94,938 C.N.S. ENTERPRISES, INC., et al., Plaintiffs-Appellants, v. G. & G. ENTERPRISES, INC., et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 1354

508 F.2d 1354

39 A.L.R.Fed. 343, Fed. Sec. L. Rep. P 94,938

C.N.S. ENTERPRISES, INC., et al., Plaintiffs-Appellants, v. G. & G. ENTERPRISES, INC., et al., Defendants-Appellees.

No. 73-2073.

United States Court of Appeals, Seventh Circuit.

Argued Nov. 12, 1974.

Decided Jan. 13, 1975.

Russell J. Hoover, Chicago, Ill., for plaintiffs-appellants.

Edmund P. Boland, Howard L. Fink, Zave H. Gussin, Chicago, Ill., for defendants-appellees.

Before CASTLE, Senior Circuit Judge, and STEVENS and SPRECHER, circuit judges.

SPRECHER, Circuit Judge.

The sole issue presented is whether promissory notes delivered to a bank for loans used to purchase the assets of a small business enterprise constitute 'securities' under the Securities Exchange Act of 1934, investing the maker of the notes with a jurisdictional basis for bringing suit in the federal courts.

I

According to the complaint, the 'Village Well' is a coin-operated laundry and dry cleaning business located in Justice, Illinois, which had been owned and operated by defendants Giselle Strausburger, Gladys Lucas and G. & G. Enterprises, Inc., in accordance with a license agreement from defendants Robert W. Casey and Kimlis Sales Company.

On January 20, 1972, the plaintiffs purchased the fixtures, merchandise, business and good will of the Village Well from Strausburger, Lucas and G. & G., having given Kimlis a promissory note for $5,000 as an earnest money deposit. As part of the transaction, the plaintiffs also (1) assumed a chattel mortgage in the amount of $73,515.26 on the fixtures, which mortgage was held by defendant National Bank of Austin, (2) gave the Austin Bank and 'evidence of indebtedness' in like amount, (3) borrowed an additional $20,000 from the Austin Bank evidenced by a note secured by a junior chattel mortgage, and (4) paid a portion of the non-specified purchase price to Strausburger, Lucas and G. & G.

Plaintiffs alleged that from September through December 1971, defendants Strausburger, Lucas and Casey represented orally and in writing that the monthly sales of the Village Well ranged from $4,500 to $5,500, that October 1971 sales were about $4,800, that November 1971 sales were $5,700, that December 1971 sales would exceed those of November and that defendants displayed to plaintiffs books and records purporting to reflect such sales. Plaintiffs further alleged that these representations were all false and that the books and records failed to reveal accurately the actual sales.

The plaintiffs operated the business for approximately four months, spending substantial sums in promoting the business, suffering financial losses and borrowing additional capital funds to carry on. On May 19, 1972, plaintiffs sent defendants a notice of rescission. Since May 28, the Village Well has been operated by Casey and Kimlis.

Plaintiffs sought rescission of all agreements with defendants, repayment of consideration paid and cancellation of obligations assumed. Plaintiffs relied exclusively for federal jurisdiction upon section 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. 78j) and Rule 10b-5 thereunder (17 C.F.R. 240.10b-5).

All six defendants filed motions to dismiss on the ground that the 1934 Act does not apply to this transaction and therefore that federal jurisdiction does not lie.

The district court denied all motions on May 2, 1973, but, on motion for reconsideration, vacated that order. On September 26, 1973, the motions by all defendants to dimsiss were granted 'for reasons stated in the record.' The record discloses that the court concluded that a 'commercial' note, particularly one not subjected to further trading, as distinguished from an 'investment' note, is not a security within the 1934 Act.

II

As we pointed out in Sanders v. John Nuveen & Co., Inc., 463 F.2d 1075, 1078 (7th Cir.), cert. denied, 409 U.S. 1009, 93 S.Ct. 443, 34 L.Ed.2d 302 (1972), the six basic federal securities acts each includes 'any note' within its definition of 'security.' ¹ However, the 1933 Act exempts from registration, but not from the antifraud provisions of that act, any note 'which arises out of a current transaction or the proceeds of which have been or are to be used for current transactions, and which has a maturity . . . not exceeding nine months.' ² The 1934 Act excludes from the definition of a 'security,' 'any note . . . which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited.' ³

In Sanders, we held that promissory notes with a maturity not exceeding nine months but offered to the public as an investment are 'securities' within the meaning of the 1934 Act despite the broad implications of the exception inasmuch as Congress obviously intended to protect such investors against fraud. 463 F.2d at 1079-1080. We said:

In other words, when Congress spoke of notes with a maturity not exceeding nine months, it meant commercial paper, not investment securities. When a prospective borrower approaches a bank for a loan and gives his note in consideration for it, the bank has purchased commercial paper. But a person who seeks to invest his money and receives a note in return for it has not purchased commercial paper in the usual sense. He has purchased a security investment.

Id. at 1080.

In effect, we are now called upon to consider a situation which is the reverse of Sanders. In Sanders we applied a congressional-intent-revealed-in-context approach as against a literal-text-reading of 'any note (with) a maturity . . . of not exceeding nine months' as those words are used in the exemption portion of the security definition of the 1934 Act, in order to avoid the exemption in the case where the short-term notes were offered to the investing public intended by Congress to be protected. Here we are asked to give the same context-over-text consideration to 'any note' as those words are used in the security definition itself of the 1934 Act, in order to avoid federal jurisdiction of transactions claimed to fall beyond the protection intended by Congress in the enactment of the securities laws.

Analysis immediately reveals, however, much more serious differences between the two situations than the superficial analogy might lead one to believe. In Sanders, the effect of the contextual interpretation led to the non-application of an exemption and therefore to the inclusion of a kind of instrument within the protection of the 1934 Act. The effect of applying the same interpretation to the definition itself would lead to the exclusion of a type of instrument from the protection of the 1934 Act. When the Supreme Court has spoken of construing federal securities legislation 'not technically and restrictively, but flexibly to effectuate its remedial purposes,' ⁴ it has been speaking of expanding the reach of protection, not diminishing it; of increasing the types of covered documents and transactions, not of decreasing them; of avoiding more frauds, not less.

The inherent difficulty in purporting to find that Congress intended to limit the reach of federal jurisdiction exercised through securities legislation when it used the words 'any note' is therefore compounded by the fact that the Supreme Court was in the process of expanding that jurisdiction when it searched for and expounded the congressional intent behind the securities acts. Under these circumstances it is understandable that courts have been struggling to answer the question here: are the securities acts invoked every time a person borrows money from a bank and gives his promissory note in return?

III

In SEC v. C. M. Joiner Leasing Corp., 320 U.S. 344, 350-351, 64 S.Ct. 120, 123, 88 L.Ed. 88 (1943), the Supreme Court, after noting that the defendants had invoked the ejusdem generis rule and the expressio unius est exclusio alterius maxim in interpreting the definition of a security under the 1933 Act, said:

However, well these rules may serve at times to aid in deciphering legislative intent, they long have been subordinated to the doctrine that courts will construe the details of an act in conformity with its dominating general purpose, will read text in the light of context and will interpret the text so far as the meaning of the words fairly permits so as to carry out in particular cases the generally expressed legislative policy.

Id.

In SEC v. National Securities, Inc., 393 U.S. 453, 89 S.Ct. 564, 21 L.Ed.2d 668 (1969), the Court, citing Joiner, said:

The meaning of particular phrases must be determined in context . . .. Congress itself has cautioned that the same words may take on a different coloration is different sections of the securities law; both the 1933 and 1934 Acts preface their lists of general definitions with the phrase 'unless the context otherwise requires.' 1933 Act, 2, 48 Stat. 74, 15 U.S.C. 77b; 1934 Act, 3, 48 Stat. 882, 15 U.S.C. 78c.

Id. at 466, 89 S.Ct. at 571-572.

'Finally, we are reminded that, 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. SEC v. W. J. Howey Co., 328 U.S. 293, 298, 66 S.Ct. 1100, 1102, 90 L.Ed. 1244 (1946).' Tcherepnin v. Knight, 389 U.S. 332, 336, 88 S.Ct. 548, 553, 19 L.Ed.2d 564 (1967). See also, Milnarik v. M-S Commodities, Inc., 457 F.2d 274, 275-276 (7th Cir.), cert. denied, 409 U.S. 887, 93 S.Ct. 113, 34 L.Ed.2d 144 (1972).

Accordingly, we commence our analysis with the language of the statutes. ⁵ In the 1966 Act, the opening words of section 2 read (5 U.S.C. 77b):

Sec. 2. When used in this title, unless the context otherwise requires--

(1) the term 'security' means any note . . ..

The only difference in the 1934 Act is the immaterial one that nine other definitions intercede between the contextual proviso and the security definition (15 U.S.C. 78c):

Section 3. (a) When used in this title,...