Fargo Partners v. Dain Corporation, Civ. No. A3-75-47.

• Citation: 405 F. Supp. 739
• Decision Date: 31 December 1975
• Docket Number: Civ. No. A3-75-47.
• Parties: FARGO PARTNERS, a North Dakota Partnership, Plaintiff, v. DAIN CORPORATION et al., Defendants.
• Court: U.S. District Court — District of South Dakota

405 F. Supp. 739

FARGO PARTNERS, a North Dakota Partnership, Plaintiff, v. DAIN CORPORATION et al., Defendants.

Civ. No. A3-75-47.

United States District Court, D. North Dakota, Southeastern Division.

December 31, 1975.

Frank J. Magill, Nilles, Hansen, Selbo, Magill & Davies, Ltd., Fargo, N. D., for plaintiff.

E. T. Conmy, Jr., Conmy, Feste & Bossart, Ltd., Fargo, N. D., for Dain Corp. and Northwestern Nat. Bank; Lawrence C. Brown, Thomas L. Kimer, Faegre & Benson, Minneapolis, Minn., of counsel.

Jack G. Marcil, Tenneson, Serkland, Lundberg & Erickson, Fargo, N. D., for Viking Investment, Mark Q. Moore, Allen L. Moore and Howard B. Conkey, Jr. and Candletree; Morris, Mitchell, Larson, King, Stamper & Bold, Kansas City, Mo., of counsel.

MEMORANDUM AND ORDER

BENSON, Chief Judge.

This is an action alleging fraud and deceit in violation of the Federal Securities Act of 1933, the Federal Securities Exchange Act of 1934, and the rules and regulations promulgated thereunder. Upon a theory of pendent jurisdiction, Plaintiff also alleges a number of violations of state law. On motion of Defendant Dain Corporation, a Rule 12(d) preliminary hearing was held on the issue of subject matter jurisdiction. The issue presented is whether the transaction described in the Complaint involved the offer and sale of a security as that term is defined in 15 U.S.C. §§ 77b(1) and 78c.¹ If no "security" exists, the Court lacks jurisdiction of the subject matter. It is the finding of this Court that the transaction in question did not involve a security as that term has been defined by the Supreme Court. S. E. C. v. W. J. Howey Co., 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946); S. E. C. v. C. M. Joiner Leasing Corp., 320 U.S. 344, 64 S.Ct. 120, 88 L.Ed.2d 88 (1943). See also United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 95 S.Ct. 2051, 44 L.Ed.2d 621 (1975).

Plaintiff, Fargo Partners, is a partnership doing business in Fargo, North Dakota. Defendant Dain Corporation is a Minnesota corporation. Candletree is a partnership consisting of Mark Q. Moore, Allen L. Moore, and Howard B. Conkey, Jr., of Lawrence, Kansas. Viking Investment is a Kansas corporation and its officers are partners in Candletree.

Fargo Partners (hereinafter "Fargo") entered into an agreement with Candletree, whereby Fargo purchased an apartment development in Blue Springs, Missouri. Dain Corporation functioned in the role of broker. Specifically, Candletree conveyed by warranty deed and bill of sale the project to Fargo in return for a promissory note for $3,375,000.00, with interest. The note was secured by a trust deed and an assignment of rents, leases and profits. Pursuant to the agreement, Fargo has paid Candletree the sum of $265,650.00.

Viking Investment and the three individual partners of Candletree guaranteed Candletree's performance, and further agreed to indemnify Fargo and hold Fargo harmless from any costs, expenses or damages, including reasonable attorney fees caused by any default of Candletree.

As part of the transaction, Fargo signed a management agreement granting back to Candletree or its agents or representatives under its control, exclusive right to management of the property consisting of the apartment project with 248 dwelling units. This grantback, among other things, included Candletree's right to handle marketing for rent up; to offer for rental not only the dwelling units but any other concessions, including preparation for initial rent-up; to set up tenant selection policy; to show the premises to prospective tenants; to process applications for rental; to prepare dwelling leases and execute same in its own name; to collect, deposit and disburse security deposits; to collect rent, charges and other accounts receivable to be deposited in an account in its own name; to secure full compliance by each tenant with the terms of the lease; to comply with local codes; to investigate service requests of tenants; to make arrangements for utilities; and from said funds collected and deposited, make disbursement for wages, taxes, assessments and payments on debt service on the financing with any remaining balance not required for working capital purposes to be paid monthly to Fargo.

It is alleged that the anticipated profits would not be dependent on any efforts by Fargo as investors. The sale of the Blue Springs project was purportedly offered and consummated by the defendants through advertising, sales literature, promotional schemes, prospectuses, and other writings and oral representations emphasizing the economic benefits to Fargo to be derived from the management skills and efforts of Candletree, Viking and their agents or representatives whom they controlled. The plaintiff also alleges that when defendants were soliciting its purchase of this housing project, false representations were made concerning the expected returns from the venture via the United States mails. The issue raised by the Defendant, Dain, is whether this transaction is the purchase and sale of a "security". For the purpose of ruling on defendant's motion to dismiss, the Court assumes the truth of the plaintiff's allegations. See Spector v. L. Q. Motor Inns, Inc., 517 F.2d 278 (5th Cir. 1975).

Defendant Dain argues that the transaction is merely a sale of real estate which cannot be construed to involve the purchase or sale of a "security". Plaintiff finds the transaction more sophisticated. The purchase agreement and warranty deed together with the management contract incident to the investment which provided a complete grantback of management rights to Candletree allegedly constitute an investment contract within the purview of the federal securities law. It is further contended the profitability of the venture was solely dependent on the efforts of Candletree in exercising its limited duties under the management clause. Although the management offer was for a limited period of 36 months, there is no indication Fargo ever intended to use its own efforts to run the apartment project. Instead, plaintiff alleges it bought a "security" when it invested in the project. It is noted however that Fargo retained the right to terminate its management contract on thirty days notice.

The meaning of the word "security"² within the federal security law is found in S. E. C. v. C. M. Joiner Leasing Corp., 320 U.S. 344, 64 S.Ct. 120, 88 L.Ed. 88 (1943), and S. E. C. v. W. J. Howey Co., 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946). Both decisions dealt with investment contract securities, 15 U.S.C. § 78c(a)(10), the type which plaintiff alleges is involved here, and both set forth the basic proposition that an investment contract exists when a purchaser is led to invest money in a common enterprise with the expectation that profits would be collected solely through the efforts of others. The Supreme Court has stated that when interpreting the meaning of the word "security", "form should be disregarded for substance and the emphasis should be on economic reality." Tcherepnin v. Knight, 389 U.S. 332, 336, 88 S.Ct. 548, 553, 19 L.Ed.2d 564 (1967). The Court must consider the economic realities of the transaction. United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 851-852, 95 S.Ct. 2051, 44 L.Ed.2d 621 (1975). Not only is an investment contract determinable by the nature of what the sellers actually sell, but equally by

"what character the instrument is given . . . by the terms of the offer, the plan of distribution, and the economic inducements held out to the prospect. In the enforcement of an act such as this it is not inappropriate that promoters' offerings be judged as being what they were represented to be." S. E. C. v. C. M. Joiner Leasing Corp., 320 U.S. 344, 352-353, 64 S.Ct. 120, 124, 88 L.Ed. 88 (1943). (emphasis added).³

The Court has defined an investment contract more specifically as

"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." S. E. C. v. W. J. Howey & Co., 328 U.S. 293, 298-299, 66 S.Ct. 1100, 1103, 90 L.Ed. 1244 (1946).

In Howey, the Court of Appeals had concluded that an investment contract did not exist where the management and cultivation of citrus acreage was entrusted to the promoter, with the rate of the investor's return to be measured by the produce from the acreage he owned. The Court of Appeals found:

"Here it is quite clear that each purchaser looked for the income from his investment to the fruitage of his own grove and not to the fruitage of the groves as a whole. It is quite clear, too, that each purchaser's income was in no sense dependent upon the purchase or development of other tracts than his own except in the sense that as grove owners generally prospered, each owner of a grove would." (emphasis added). S. E. C. v. W. H. Howey & Co., 151 F.2d 714, 717 (5th Cir. 1945).

In reversing, the Supreme Court emphasized not whether profits were pooled, but rather the fact that the feasibility and success of the enterprise, in attracting individuals to invest, and in cultivating, harvesting and marketing the citrus products, rested on the availability of the Howey Company's management:

"Such persons have no desire to occupy the land or to develop it themselves; they are attracted solely by the prospects of a return on their investment. Indeed, individual development of the plots of land that are offered and sold would seldom be economically feasible due to their small size. Such tracts gain utility as citrus groves only when cultivated and developed as component parts of a larger area. A common enterprise managed by respondents or third parties with adequate personnel and equipment is therefore essential if the investors are to achieve their paramount aim of a return on their investments." (emphasis added). 328 U.S. at 300, 66 S.Ct. at 1103.

Applying the standard it created, the Court fo...