Coastal Finance Corp. v. Coastal Finance Corp. of North Providence

• Decision Date: 20 June 1978
• Docket Number: No. 77-7-A,77-7-A
• Citation: 387 A.2d 1373,120 R.I. 317
• Parties: COASTAL FINANCE CORP. v. COASTAL FINANCE CORP. OF NORTH PROVIDENCE. ppeal.
• Court: Rhode Island Supreme Court

Page 1373

387 A.2d 1373

120 R.I. 317

COASTAL FINANCE CORP. v.COASTAL FINANCE CORP. OF NORTH PROVIDENCE.

No. 77-7-Appeal.

Supreme Court of Rhode Island.

June 20, 1978.

[120 R.I. 327] Carroll, Kelly & Murphy, Dennis S. Baluch, Providence, for appellants Joseph E. Conneally and Helen J. Conneally.

John Quattrocchi, Jr., Vincent A. Ragosta, Providence, Louis J. Perez, Pawtucket, Francis Castrovillari, Cranston, for other appellant-investors.

Dick & Hague, William F. Hague, Jr., Providence, for appellee Walter E. Heller & Co.

OPINION

DORIS, Justice.

This civil matter arises out of receivership proceedings and concerns conflicting petitions to reclaim the assets of an insolvent corporation.After a hearing in the Superior Court, an order was entered granting the petition of Walter E. Heller and Company(Heller), a secured creditor, and denying the petition of certain holders of corporate notes and debentures (the investors).On appeal, the investors seek to set aside the claim of Heller and assert their own priority in the reclamation of corporate receivables.

Coastal Finance Corporation(Coastal), a small loan business and holding company owning several subsidiary corporations, was incorporated in Rhode Island in 1966.In an effort to generate an increase in funds for the corporation's lending operation, Coastal began to offer several series of subordinated debentures to the public in 1968 and 1969.The issue was to total $250,000, with the debentures carrying rates of interest of 7 percent or 8 percent per annum and reaching maturity generally in five years.The investors purchased these debentures at varying times and in a broad range of amounts.In 1972, Coastal entered into a financing arrangement with Heller, a large lending company, which became the sustenance of Coastal's operation.Heller, in return for its financing, received an interest rate of 6 percent above the prime interest rate and a security interest in all of Coastal's receivables.At the time of the agreement with Coastal, Heller filed a financing statement in the office of the Secretary of State in order to perfect its security interest as required by G.L.1956(1969 Reenactment)§§ 6A-9-302and6A-9-304.

In 1973 and 1974, when it appeared that most of the debentures were soon to become due, Coastal sent out letters to its investors asking them to exchange their debentures for corporate notes yielding 10 percent or 11 1/4 percent per year.Coastal had not been able to attain a profit in any year since its inception, and so offered this exchange at a high rate of interest to keep the investors' money in the corporation.Many of the debenture holders did acquire the notes, but Coastal continued to decline.In 1975, Coastal was petitioned into receivership.Subsequently, Heller filed a petition to reclaim all of Coastal's receivables from the permanent receiver in order to satisfy the debt owed to Heller by Coastal.The investors then filed a petition objecting to Heller's petition on several grounds largely consisting of allegations of fraud on the part of Coastal in obtaining their funds and illegality in the contract with Heller and requesting a hearing on the matter.A Superior Court justice sitting without a jury found that Heller had a valid contract with Coastal and could reclaim its security from the receiver.The investors were denied priority over Heller and ordered to file as general creditors.

The investors raise several interrelated issues on appeal.They allege that Coastal did not comply with either federal or state securities laws and made deceptive statements through its officers to unsophisticated investors to induce them to buy debentures and notes.The investors assert that the statutory violations and fraudulent behavior should have led the trial justice to impose a constructive trust on the assets available to the receiver for their benefit.Further, the investors contend that Heller's priority claim should have been set aside in their favor because Heller was not a good faith purchaser for value without knowledge of Coastal's fraud on the investors, or in the alternative, because Coastal lacked the proper corporate authority to make the contract with Heller.

In relation to the issue of Coastal's possible violations of federal and state securities statutes, the trial justice stated that even assuming there were such violations, the investors could not reach the available funds because Heller had intervened as a bona fide purchaser of Coastal's receivables.However, the investors argue that if Coastal was guilty of noncompliance, Heller's status would not here affect their right to priority of recovery because of the particular statutory remedy available to them.

Several sections of the Securities Act of 1933,15 U.S.C. § 77a et seq.(1970), are pertinent to this issue.The investors claim that Coastal violated § 77e, which prohibits communications relating to sales of securities through the use of the mails or any means of interstate commerce unless a registration statement is filed with the Securities and Exchange Commission(the SEC).Coastal did not register its securities with the SEC and did use the mails in connection with the sales of the debentures and notes.Further, Coastal advertised the sale of the debentures in a newspaper with interstate circulation.Therefore, the investors invoke § 77l (1) defining the civil liability of one who violates § 77e as the amount paid for the security with interest, less any income received.They contend that the remedy here intended is rescission and restitution of the funds, even if they have been transferred into the hands of a third party.The case which the investors cite to support their position, Deckert v. Independence Shares Corp., 311 U.S. 282, 61 S.Ct. 229, 85 L.Ed. 189(1940), is not dispositive of the issue but does seem to indicate that tracing of funds under § 77l is possible and equitable.

However, the opinion of this court is that the sales of securities by Coastal were exempt from registration with the SEC according to § 77c(a)(11).This section exempts an intrastate issuance of securities by a company incorporated by and doing business within the state from regulation under most of the provisions of the federal statute.Here, Coastal's securities were in fact sold only to residents of Rhode Island, and the newspaper advertisement offering the debentures clearly stated that they would be sold only to Rhode Island residents.The use of the mails and other interstate facilities for an issuance which is exempt under § 77c(a)(11) is not a violation of the statute.SeeHillsborough Inv. Corp. v. Securities & Exch. Comm'n, 276 F.2d 665(1st Cir.1960); 1 Loss, Securities Regulation 602 (2d ed. 1961).Section 77e prohibiting such use and § 77l (1) prescribing the remedy for violation of § 77e must be read as integral with the exemption provisions of the statute.SeeNorthrop v. duPont, 210 Va. 709, 173 S.E.2d 839(1970);1 Loss, supra at 182.

Although Coastal's securities were exempt as intrastate issuances, the antifraud provisions of § 77l (2) still apply to the sales, according to the explicit language of that section.¹SeePawgan v. Silverstein, 265 F.Supp. 898(S.D.N.Y.1967).Therefore, the investors might be entitled to the rescission and restitution remedy if they could prove that Coastal's officers had misled them through material misstatements concerning the offering which were communicated either orally or through the instruments of interstate commerce.

Accordingly, the investors testified at trial that Coastal's officers had represented to them that the debentures were insured, and some alleged that they had been told that the Federal Deposit Insurance Corporation guaranteed the debentures.Further, the investors stated that at the time Coastal offered the notes in exchange for the debentures, Coastal's officers reassured them that Coastal was in excellent financial condition and expected to continue doing well.However, the trial justice indicated in his order that he did not believe that the weight of the evidence supported the investors' allegations of fraudulent or misleading behavior on the part of Coastal either generally or as to individuals.It is well settled that the findings of a trial justice sitting without a jury will not be disturbed on appeal unless the trial justice was clearly wrong or has overlooked or misconceived material evidence.Salo Landscape & Constr. Co. v. Liberty Elec. Co., R.I., 376 A.2d 1379(1977);Raheb v. Lemenski, 115 R.I. 576, 350 A.2d 397(1976);Agar Supply Co. v. David-Hodosh Co., 115 R.I. 80, 340 A.2d 140(1975).The investors have failed to show error on the part of the trial justice in this respect, and so we must find that the investors are not entitled to relief under § 77l (2).

Further, any action under § 77l (2) concerning the debentures would be barred by the limitation period set out in § 77m.²Only the representations relating to the notes could have been called into question under § 77l (2) at this time.

The investors next argue that Coastal violated the Rhode Island securities laws and that rescission and restitution ought to be available to them as a remedy under state law as it is under federal law.The trial justice did not find it necessary to make conclusive findings on the matter of Coastal's specific violations of the Rhode Island statute, but it does appear that Coastal was responsible for some noncompliance.

First, Coastal included in its advertisements for the sale of the debentures a statement to the effect that it had complied with...