Ecurities & Exch. Comm'n v. First Choice Mgmt. Servs., Inc.

• Decision Date: 01 May 2012
• Docket Number: No. 11–1702.,11–1702.
• Citation: 678 F.3d 538
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. FIRST CHOICE MANAGEMENT SERVICES, INC., et al., Defendants. SonCo Holdings, LLC, Intervenor–Appellant, v. Joseph D. Bradley, Receiver, and ALCO Oil & Gas Co., LLC, Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

678 F.3d 538

SECURITIES AND EXCHANGE COMMISSION, Plaintiff,

v.FIRST CHOICE MANAGEMENT SERVICES, INC., et al., Defendants.

SonCo Holdings, LLC, Intervenor–Appellant,

v.Joseph D. Bradley, Receiver, and ALCO Oil & Gas Co., LLC, Appellees.

No. 11–1702.

United States Court of Appeals,Seventh Circuit.

Argued Feb. 16, 2012.

Decided May 1, 2012.

Mark D. Cahn, Attorney, Securities and Exchange Commission, Office of the General Counsel, Washington, DC, Charles J. Kerstetter, Attorney, Securities and Exchange Commission, Chicago, IL, for Plaintiff.

Shawn F. Sullivan (argued), Attorney, South Bend, IN, for Defendants.

J. Michael Katz (argued), Attorney, Goodman Katz & Scheele, Highland, IN, for Appellee, ALCO Oil & Gas Company LLC.

Shawn F. Sullivan (argued), Attorney, South Bend, IN, for Appellee, Joseph D. Bradley.

Jacqueline S. Homann (argued), J. Thomas Vetne, Attorneys, Jones Obenchain, South Bend, IN, for Intervenor–Appellant.

Before POSNER, RIPPLE, and WILLIAMS, Circuit Judges.

POSNER, Circuit Judge.

This case, in the form in which it comes to us (an appeal from a contempt judgment against a company called SonCo Holdings), has a small head but a long tail. It began in 2000 as a suit by the SEC, filed in a federal district court in Indiana, charging fraud in violation of federal securities law. The court appointed a receiver, Joseph Bradley, to take charge of the defendant's assets and distribute them among the victims of the $31 million fraud. Bradley went hunting for the assets and found that some of them had been used to acquire oil and gas leases in Texas in the name of a sham corporation called Branson Energy Texas.

Some of these leases, referred to as the “Hull–Silk” leases, were in their “secondary term.” An oil and gas lease typically specifies two periods. In the first, the “primary term,” the lessee is required to produce oil (we omit “and gas,” to simplify) from the leased wells. If he fails to produce, the lease terminates and the wells revert to the lessor, except that the lessee can stave off reversion by paying an annual “delay rental,” provided he starts producing by the end of the primary term. In the secondary term, failure to produce (other than temporarily) triggers immediate reversion. Midwest Oil Corp. v. Winsauer, 159 Tex. 560, 323 S.W.2d 944, 946 (1959); Cobb v. Natural Gas Pipeline Co., 897 F.2d 1307, 1309 (5th Cir.1990); Owen L. Anderson et al., Hemingway Oil and Gas Law and Taxation §§ 6.2–6.3, pp. 217–23 (4th ed.2004). Thus, during the primary term, the lease is equivalent to an option.

Although the lessee is the producer in the sense that it is “his” oil that is flowing from the wells, Texas law distinguishes between the lessee of the wells and the operator, who extracts the minerals from them. The lessee receives the cash flow from the sale of the oil and pays the operator to extract it. Operators are regulated by the Texas Railroad Commission. The same person or firm can be both lessee and operator. ALCO Oil & Gas Co. was both the lessee and operator of the Hull–Silk leases when in 2002, after the SEC suit had been filed and the receiver had been appointed, it assigned the leases to “BET,” as the Branson corporation was known. ALCO remained the operator of the leases.

BET, remember, was a tool of the fraudsters, and its rights (and therefore the receiver's rights after he took over BET) in its properties, including the Hull–Silk leases, were contested. Among the entities that claimed to have valid legal interests in the leases was SonCo Holdings, which filed a claim (the precise nature of which is unclear, along with much else in this case) with the receiver in 2006. After protracted negotiations SonCo came to terms with the receiver in January 2010 and the district court entered an “agreed order” specifying the terms of settlement. The agreed order is the focus of this appeal because it is SonCo's violation of the order that precipitated the imposition of the sanction from which it appeals to us.

The order required SonCo to pay the receiver $580,000 for an assignment of the Hull–Silk leases, and this part of the order was carried out. (SonCo actually paid the receiver $600,000 for the leases, the additional $20,000 being a penalty for delay, and we'll use the larger figure rather than $580,000.) But there was more to the order, because the settlement was tripartite, the third party to it being ALCO, the operator of the Hull–Silk wells. The wells had been unproductive, in part because of freeze orders entered by the district court to prevent the dissipation of BET's assets. Reversion of the leases to the lessor (or lessors—we don't know whether there was more than one), because they were in their secondary term yet not producing, had been staved off only by an order by the district court. But as the operator of the leases ALCO had been compelled to post a $250,000 cash bond with the Texas Railroad Commission to assure payment of any costs that the Commission might impose on ALCO for failing as the operator of the wells to take proper measures to conserve oil and gas and prevent or remedy environmental damage from its operations. See Texas Natural Resources Code §§ 91.103, .104, .1041, .1042, .105, .142. ALCO could get its $250,000 back only if it was replaced as operator and the new operator posted an equivalent bond that would replace ALCO's.

The reason the receiver was interested in ALCO's operation of the leased wells—and the reason therefore for ALCO's inclusion in the agreed order—was that the $250,000 for ALCO's bond had come in part from the defrauded investors; for remember that ALCO had been hired as the operator by BET, though there is no suggestion of wrongdoing by ALCO. Regarding ALCO's bond the agreed order therefore provided that “SonCo shall obtain a bond ... that shall replace Alco's bond so that Alco and the Receiver may obtain the release of its bond paid for with defrauded investor funds ” (emphasis added). Thus the $250,000 would not stop with ALCO if it ceased to be the operator of the wells—not all $250,000 at any rate; some (we haven't been told how much) would be added to the receiver's assets because it had come from victims of the fraud.

ALCO was desperate to relinquish its position as operator because it anticipated mounting liabilities to the Texas Railroad Commission and perhaps other entities, with little prospect of offsetting revenues. The agreed order as we just saw required SonCo to replace ALCO's $250,000 bond with its own bond. The order also, according to the receiver's, ALCO's, and the district judge's interpretation, required SonCo to replace ALCO as operator, making SonCo both the lessee, and thus owner of the oil, and the operator of the wells. The replacement would require the permission of the Texas Railroad Commission but the grant of that permission was expected to be pro forma, provided that SonCo demonstrated, presumably by posting the replacement bond, its financial ability to shoulder the costs, referred to earlier, of conservation and of curing environmental violations. Texas Natural Resources Code § 91.107; cf. id. § 52 .026.

But more than a year after the agreed order was issued, SonCo still had failed to post the bond that would replace ALCO's bond; it had sent the Commission a cashier's check for $250,000 but had timed it to arrive on the last business day prior to the extended deadline set by the district judge. And it had failed to obtain the Commission's authorization to operate the wells. It had applied for that authorization too at the last minute, and the application was incomplete; it was a fair inference that SonCo never actually intended to become the operator. (Since the authorization to operate the wells was never given, presumably the $250,000 check for an operator's bond was never cashed.)

On motion by the receiver and ALCO, the judge held SonCo in contempt of the agreed order and as a sanction ordered it to return the Hull–Silk leases to the receiver. But the judge allowed the receiver to keep the $600,000 that SonCo had paid him for the leases. The judge also awarded the receiver and ALCO more than $22,000 in attorneys' fees, an award not challenged in this appeal.

SonCo returned the leases as ordered to the receiver, who assigned them to another company, Wilson Operating Company, which is unconnected with any of the parties. Wilson in turn assigned them to still another unrelated party.

Because the receiver no longer has the leases, he and ALCO argue that SonCo's appeal is moot. Reversing the contempt judgment, they argue, would mean returning the Hull–Silk leases to SonCo, and the receiver cannot do that because he no longer has them; Wilson's assignee has them. True, SonCo has filed a lis pendens in a Texas court against the leases. It hopes the lis pendens will enable it to wrest them back from the current lessee (Wilson's assignee). If valid, the lis pendens is constructive notice that SonCo is litigating the receiver's, and hence Wilson's, claim to be empowered to assign the leases. Texas Water Rights Commission v. Crow Iron Works, 582 S.W.2d 768, 771 (Tex.1979). “A filed lis pendens is constructive notice of the underlying lawsuit, and a prospective buyer is on notice that he acquires any interest subject to the outcome of the pending litigation.” World Savings Bank, F.S.B. v. Gantt, 246 S.W.3d 299, 303 (Tex.App.2008). But the lis pendens was mentioned for the first time in SonCo's reply brief, and is discussed there for all of three sentences. The receiver has said nothing about it. Its bearing on the appeal is opaque. We ignore it.

The argument that the appeal is moot because there is no way (ignoring the effect of the lis pendens) to revest SonCo with the leases interprets SonCo's challenge to the contempt judgment too narrowly. SonCo argues that it didn't violate the agreed order, and therefore should not have been sanctioned. It would (or says it would) prefer to have the oil leases back,...