Dunwoody Country Club of Atlanta, Inc. v. Fortson, 34446

• Decision Date: 27 February 1979
• Docket Number: No. 34446,34446
• Citation: 243 Ga. 236,253 S.E.2d 700
• Parties: , Blue Sky L. Rep. P 71,493 DUNWOODY COUNTRY CLUB OF ATLANTA, INC. v. FORTSON.
• Court: Georgia Supreme Court

Page 700

253 S.E.2d 700

243 Ga. 236, Blue Sky L. Rep. P 71,493

DUNWOODY COUNTRY CLUB OF ATLANTA, INC. v. FORTSON.

No. 34446.

Supreme Court of Georgia.

Argued Jan. 16, 1979.

Decided Feb. 27, 1979.

Fred A. Gilbert, Smith, Cohen, Ringel, Kohler & Martin, Robert D. Pannell, Marion Smith, II, Atlanta, for appellant.

Arthur K. Bolton, Atty. Gen., Michael R. Johnson, Asst. Atty. Gen., for appellee.

HALL, Justice.

Appellant Dunwoody Country Club sought a declaratory judgment that its redeemable membership certificates were not securities within the meaning of Code Ann. § 97-102(a)(16) or that Code Ann. § 97-102(a)(16) was unconstitutionally vague and overbroad. The trial court ruled that Dunwoody issued certificates of indebtedness which were securities and were subject to the registration requirements of Code Ann. § 97-105. We reverse.

Dunwoody Country Club is a non-profit corporation operated by its members through an elected board of governors. Dunwoody recently attempted to change its method of collecting fees. Previously, members paid a flat initiation fee; under the new system, the club assesses social members an initial fee of $1,200 and golfing members, $2,400. Each member receives a "redeemable membership certificate" of half the amount paid either $600 or $1,200. ¹ This certificate does not appreciate, bears no interest and cannot be assigned or pledged. When a member dies, moves away, or resigns his membership, Dunwoody redeems the membership certificate for its face value from a special fund established for that purpose.

The Securities Act provides that a "security" is: ". . . any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of indebtedness, investment certificate, certificate of interest or participation in any profit-sharing agreement, certificate of interest in oil, gas or other mineral rights, collateral trust certificates, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, limited partnership interest, or beneficial interest in profits or earnings, or any other instrument commonly known as security, including any certificate of interest or participation in, temporary or interim certificate for, receipt for, guaranty of, or warrant or right to subscribe to or purchase, any of the foregoing." Code Ann. § 97-102(a)(16). The court below classified the redeemable membership certificate as a "certificate of indebtedness" and held that the purchase of a membership was the sale of a security. We, however, reject a mechanistic approach which holds that an instrument is a security whenever it fits the literal statutory definition because "form should be disregarded for substance and the emphasis should be on economic reality." Ga. Market Centers v. Fortson, 225 Ga. 854, 858, 171 S.E.2d 620-623 (1969), quoting with approval, Tcherepnin v. Knight, 389 U.S. 332, 336, 88 S.Ct. 548, 19 L.Ed.2d 564 (1967).

The Supreme Court recently rejected a mechanistic approach to federal securities law in defining "stock." United Housing Foundation v. Forman, 421 U.S. 837, 95 S.Ct. 2081, 44 L.Ed.2d 621 (1975). "The focus of the (Securities) Acts is on the capital market of the enterprise system: the sale of securities to raise capital for profit-making purposes, the exchanges on which securities are traded, and the need for regulation to prevent fraud and to protect the interest of investors. Because securities transactions are economic in character Congress intended the application of these statutes to turn on the economic realities underlying a transaction, and not on the name appended thereto." Id. at 849, 95 S.Ct. at 2059.

Some decisions by the circuit courts of appeal contain language which seems to endorse a literal reading of the federal securities acts, at least in the area of notes. For example, the Fifth Circuit stated in Lehigh Valley Trust Co. v. Central Nat. Bank, 409 F.2d 989, 991-992 (1969), 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." A similar statement in SEC v. Continental Commodities Corp., 497 F.2d 516, 524 (5th Cir. 1974), was quoted with approval in the plurality opinion in Blau v. Redmond, 143 Ga.App. 897, 902, 240 S.E.2d 273 (1977). The Court of Appeals classified the instrument in Blau as either a note or certificate of indebtedness. The court then held that the instrument must be a security because as a note, it did not fit a statutory exemption and as a certificate of indebtedness, it had no exemptions. The Approach followed by the Court of Appeals does not tally with the actual approach used by the federal courts ² and is not, we believe, the correct way to proceed in deciding securities cases. Despite the language in the Lehigh Valley Trust and Continental Commodities cases to the contrary, the Fifth Circuit does not follow a literal approach. Instead, the Fifth Circuit has recognized a dichotomy between notes which represent investments and those which represent commercial transactions. The former but not the latter are subject to the securities acts. Reid v. Hughes, 578 F.2d 634 (1978); McClure v. First Nat. Bank of Lubbock, 497 F.2d 490, 493 (1974). That the note possesses the characteristics of a security, not the label "note," determines whether it is treated as a security. Compare Bellah v. First Nat. Bank, 495 F.2d 1109 (5th Cir. 1974) (renewal note for bank loan intended to aid borrowers in livestock business not a security) with SEC v. Continental Commodities Corp., 497 F.2d 516, Supra (notes issued in partial reimbursement to customers upon suspension of trading in commodities futures options were securities).

Although Georgia's blue sky law is not precisely identical to the federal securities laws, we approve the reasoning which has rejected a literal reading of the definitional section of the securities acts. Therefore, the label placed on the instrument by the parties or by the courts does not determine whether the instrument is a security. Instead, the characteristics of the instrument and the underlying economic reality are the significant factors for a court to consider in classifying an instrument as a security.

The Supreme Court in SEC v. W. J. Howey Co., 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946), characterized an investment contract as a security when "a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or third party . . ." Id. at 298-299, 66 S.Ct. at 1103. This test was reformulated in the more recent case, United Housing Foundation v. Forman, 421 U.S. 837, 95 S.Ct. 2051, 44 L.Ed.2d 621 (1975). "The touchstone (of a security) is the presence of an investment in a common venture premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others." Id. at 852, 95 S.Ct. at 2060. Although Howey involved an investment contract and United Housing Foundation, stock, both cases focus on those factors which distinguish "securities" from other instruments. The elements of the United Housing Foundation test are (1) an investment in a common venture, (2) a reasonable expectation of profits and (3) entrepreneurial or managerial efforts of someone other than the investor.

We assume for purposes of analysis that the redeemable membership certificate in this case is a certificate of indebtedness. The certificate of indebtedness does not, we believe, represent an "investment" within the meaning of the Securities Act because it does not meet the second element of the test the members of the Dunwoody Country Club had no expectation of profit from the certificate. Because the certificate bears no interest, cannot appreciate and cannot be pledged or assigned, Dunwoody attracts members solely through its social and recreational facilities and not through the prospect of financial returns on the initiation fees. Social and recreational opportunities do not represent the "profit" with which the Securities Act is concerned. The Supreme Court has stated that the "expectation of profits" means some form of Financial return. "By profits, the Court has meant either capital appreciation . . . or a participation in earnings resulting from the use of investors' funds, . . .. In such cases the investor is 'attracted solely by the prospect of a return' on his investment. (Cit. omitted.) By contrast, when a purchaser is motivated by a desire to use or consume the item purchased . . . the securities laws do not apply." United Housing v. Forman, 421 U.S. at 852-853, 95 S.Ct. at 2060, 2061. See also International Brotherhood of Teamsters v. Daniel, --- U.S. ----, 99 S.Ct. 790, 58 L.Ed.2d 808 (1979). Because members of Dunwoody Country Club are purchasing a social or recreational opportunity and not an investment opportunity, the redeemable membership certificate is not a security. Because no expectation of profits motivates the club member, we do not reach the other elements of the United Housing test.

The Commissioner has contended that under the "risk capital" test, identified by the Court of Appeals in Jaciewicki v. Gordarl Associates, 132 Ga.App. 888, 209 S.E.2d 693 (1974), the certificate is a security. Since Jaciewicki, this court has not had the occasion to examine the "risk capital" test. This test has received some approval since the legislature added a combined form of the "risk capital" and managerial efforts tests to the definition of security in Code Ann. § 97-102(a)(16). "The term investment contract shall include but is not limited to an investment which holds out the possibility of return on risk capital even though the investor's efforts are necessary to receive such return if (i) such return is dependent upon essential managerial or sales efforts of the issuer or its affiliates, and (ii) one of the inducements to invest is the promise of promotional or...