Elson v. Geiger

• Decision Date: 20 November 1980
• Docket Number: Civ. A. No. 80-72893.
• Citation: 506 F. Supp. 238
• Parties: Harold ELSON, Thelma Elson, Seymour Grundy, Helen Grundy and Martin Figlen, Plaintiffs, v. Harold GEIGER, Seymour Techner, and Paul Feinberg, Jointly and Severally, Defendants.
• Court: U.S. District Court — Western District of Michigan

506 F. Supp. 238

Harold ELSON, Thelma Elson, Seymour Grundy, Helen Grundy and Martin Figlen, Plaintiffs, v. Harold GEIGER, Seymour Techner, and Paul Feinberg, Jointly and Severally, Defendants.

Civ. A. No. 80-72893.

United States District Court, E. D. Michigan, S. D.

November 20, 1980.

Julius Giarmarco, Paul Monicatti, Troy, Mich., for plaintiffs.

Howard Radner, Norman Sandles, Royce Baum, Jr., Southfield, Mich., for defendants.

MEMORANDUM OPINION AND ORDER

JULIAN ABELE COOK, Jr., District Judge.

On August 8, 1980, Plaintiffs filed their Complaint in the above-entitled cause, contending that a series of five transactions, which had been entered into in late 1977 and 1978, violated Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities and Exchange Act of 1934. Claiming pendent jurisdiction, Plaintiffs allege violations of the Michigan Uniform Securities Act, Mich.Comp.Laws §§ 451.501, 451.701, and 451.601(a), as well as common law fraud and breach of fiduciary duty.

This case is now before the Court on Motions to Dismiss by Defendants Techner and Feinberg. Defendant Geiger was served on September 2, 1980 but he has not entered an Appearance in this Court as of this date. The sole issue before this Court is whether the two loan participation agreements and the three sale and leaseback arrangements are "securities" within the meaning of Section 2(1) of the Securities Act of 1933 and Section 3(a)(10) of the Securities and Exchange Act of 1934.

On December 23, 1977, a joint venture, in which Plaintiffs collectively owned approximately a thirty percent interest, loaned $160,000.00 to a corporation which, in turn, executed a balloon mortgage on a parcel of realty that is located at 811 Young Street, Tonowanda, New York as collateral for the loan. Thereafter, the mortgaged property was sold to a partnership which (1) guaranteed the mortgage, and (2) leased the realty back to the corporation. The current lessee is bankrupt, but Plaintiffs still hold a guaranteed mortgage interest on the Tonowanda parcel.

On September 30, 1978, a second joint venture, in which Plaintiff, Harold Elson, contributed $10,000.00, loaned $145,000.00 to a second corporation which secured the loan with an equal mortgage on five parcels of land in Erie County, New York, and one parcel in Niagara County, New York. Two months later, the corporation sold the six parcels to a New York registered partnership in which Plaintiffs own an approximate thirty-one percent interest. The partnership guaranteed the mortgage. With regard to this transaction, Plaintiffs, as partners, still own an interest in the mortgage and in a portion of the underlying land parcels which are currently occupied by the bankrupt lessee.

In addition to the above-described loan agreements, Plaintiffs also participated in three sale and leaseback arrangements. As a ten percent partner in Pine Associates, a New York registered partnership, Plaintiff Figlen purchased gas stations and executed a lease thereon to the seller corporation which is now in bankruptcy. As eighteen and eight-tenths percent partners in Niagara Car Wash Associates, a New York registered partnership, Plaintiffs purchased property in Niagara, New York, with a similar leaseback provision to the same corporate seller. As associated individuals, Plaintiffs, Seymour Grundy and Helen Grundy, purchased twenty percent of ten parcels of real property in Erie and Cattaragus Counties, New York, with similar leaseback arrangements to the same corporate seller.

In summary, Plaintiffs claim that all of the above-described transactions are securities, while Defendants argue neither "investment contracts" nor "notes" are involved inasmuch as Plaintiffs either made fully collateralized loans or bought real property.

As Justice Powell stated in his concurring opinion in Blue Chips Stamps v. Manor Drug Stores, 421 U.S. 723, 756, 95 S.Ct. 1917, 1935, 44 L.Ed.2d 539 (1975), "The starting point in every case involving construction of a statute is the language itself."

The term "security" is defined in the Securities Act of 1933, 15 U.S.C. 77b(1), as follows:

The term "security" means any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation of 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.

The Securities Exchange Act of 1934, 15 U.S.C. 78c(a)(10), provides:

The term "security" means any note, stock, treasury stock, bond debenture, certificate of interest or participation in any profit-sharing agreement or in any oil, gas, or other mineral royalty or lease, any collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit, for a security, or in general, any instrument commonly known as a "security"; or any certificate of interest or participation in, temporary or interim certificate for, receipt for, or warrant or right to subscribe to or purchase, any of the foregoing; but shall not include currency or any note, draft, bill of exchange, or banker's acceptance 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.

In Tcherepnin v. Knight, 389 U.S. 332, 335-336, 88 S.Ct. 548, 552-553, 19 L.Ed.2d 564 (1967), the Supreme Court determined that these definitions are "virtually identical."

Since neither "loan participation agreements" nor "sale and leasebacks" are explicitly included in the definitions provided, the Court must now examine the catch-all phrase, "investment contract."

There are two tests which may be applied to define the term "investment contract;" to wit, the Howey test and the "modern test."¹

The Howey test, last cited in International Brotherhood of Teamsters v. Daniel, 439 U.S. 551, 558, 99 S.Ct. 790, 796, 58 L.Ed.2d 808 (1979), is "whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others." The Supreme Court in SEC v. Howey Co., 328 U.S. 293, 298-99, 66 S.Ct. 1100, 1102-03, 90 L.Ed. 1244 (1946) held:

An investment contract for purposes of the Securities Act means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party ...

Although the Howey test has been generally unaltered since 1946, United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 851-52, 95 S.Ct. 2051, 2060, 44 L.Ed.2d 621 (1975) added a caveat that "the substance — the economic realities of the transaction — rather than the names that may have been employed by the parties'" controls.

Thus, in determining whether the transactions complained of involved "securities," the Court must now determine whether Plaintiffs invested money which was "premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others," United Housing Foundation, Inc. v. Forman, 421 U.S. at 847-48, 95 S.Ct. at 2057-58, or whether they were loaning money with the hope that the borrower would remain solvent in order to repay the principal with interest.

The commercial loan/investment dichotomy is explained in C.N.S. Enterprises Inc. v. G & G Enterprises, Inc., 508 F.2d 1354 (7th Cir.), cert. denied, 423 U.S. 825, 96 S.Ct. 38, 46 L.Ed.2d 40 (1975), where the Court noted that every money lender places his money at risk in anticipation of a "profit" through interest payments; however, in order to come under the aegis of the Federal Securities Act, it must be shown that the instant lender is distinguishable from "every lender" and warrants the special protection which is offered by the Acts.

The cases that have been offered by the parties are instructive, but not controlling.²

In the case at bar, Plaintiffs, in concert with an optical center's employee pension trust and a retirement profit sharing trust, made fully secured loans to corporations. While it is true that "profits" may take the form of fixed interest in some circumstances, S.E.C. v. Lake Havasu Estates, 340 F.Supp. 1318 (D.C.Minn.1972) (residential/resort complex development with active management by developer), accord, Los Angeles Trust Deed & Mortgage Exchange v. S.E.C., 285 F.2d 162 (9th Cir. 1960), cert. denied, 366 U.S. 919, 81 S.Ct. 1095, 6 L.Ed.2d 241 (1961), additional factors must exist before the Court can say the Howey test is met. No such factors are present here, particularly in light of the fact that the mortgages were personally guaranteed or assumed by the subsequent land purchaser. Plaintiffs argue that (1) the "higher than market" interest rate, (2) the pre-execution understanding that the property would be resold, and (3) the fact that the mortgagor only paid interest during the first three years of the term and retained the right to extend the due date are factors which satisfy the Howey standard.³ The Court disagrees. While the repayment of the mortgage may have depended on the solvency of the borrower, this is not the same as depending on entrepreneurial efforts.

With regard to the three land purchases and subsequent leasebacks, the Court must ask again whether Plaintiffs were buying land or buying a reasonable expectation of profits from entrepreneurial efforts of others.

The simplest case where a land purchase may be recharacterized as a security...