Lynn v. Caraway, Civ. A. No. 9435.

• Decision Date: 08 April 1966
• Docket Number: Civ. A. No. 9435.
• Citation: 252 F. Supp. 858
• Parties: Walston A. LYNN, J. T. Jordan, Maxcy C. Lynn and Houston B. Odom v. J. W. CARAWAY, Marvin L. Allison, and Carl W. Jones.
• Court: U.S. District Court — Western District of Louisiana

252 F. Supp. 858

Walston A. LYNN, J. T. Jordan, Maxcy C. Lynn and Houston B. Odom v. J. W. CARAWAY, Marvin L. Allison, and Carl W. Jones.

Civ. A. No. 9435.

United States District Court W. D. Louisiana, Shreveport Division.

April 8, 1966.

Jackson B. Davis, Robert J. Moffatt, Shreveport, La., for plaintiffs.

Marion K. Smith, Shreveport, La., Marvin L. Allison, in pro. per., L. E. Colvin, Colvin & Hunter, Mansfield, La., Wilburn V. Lunn, Lunn, Irion, Switzer, Trichel & Johnson, Shreveport, La., for defendants.

BEN C. DAWKINS, Jr., Chief Judge.

This action is brought by four individual plaintiffs, all citizens of South Carolina, against three individual defendants, citizens of Louisiana, alleging, in addition to diversity of citizenship, jurisdiction under the Securities Act of 1933.¹ The dispute has arisen over the assignment to plaintiffs of fractional undivided interests in a certain oil and gas lease, located within this district. Plaintiffs seek rescission of the assignment contract and the return of the price paid, some $33,530.00, plus interest, costs, and attorney's fees.

The claim is stated in two alternative theories, the first invoking the civil liabilities provisions of the Securities Act of 1933, particularly sections 5, 12 and 17. The second relies upon the general law of fraud, contained in the provisions of Louisiana Civil Code of 1870, articles 1847 and 2547.

The facts are not too complicated. In early 1962 the defendant Carl W. Jones was the owner of a fractional undivided portion of the 7/8 "working interest" in a certain oil and gas lease, known as the "Stevenson" lease, here in dispute. He was also designated operator of the lease, which contained over 500 acres on which four producing wells had been drilled. The defendant M. L. Allison was a local oil man, engaged in lease brokering as well as owning and operating oil leases and drilling wells. In the past Allison had bought and sold leases and portions of leases for Jones, as a lease broker.

In July, 1962, Allison was approached by Dr. Walston A. Lynn, one of the plaintiffs herein, who indicated an interest in making oil investments. Allison showed the "Stevenson" lease to Dr. Lynn and discussed a proposition whereby each of the plaintiffs would purchase fractional undivided interests in the lease. During his first sojourn in Louisiana to view the "Stevenson" lease, Dr. Lynn was introduced by Allison to defendant J. W. Caraway, who was president of a local bank in Mansfield, Louisiana.

After his return to South Carolina, Dr. Lynn, who by this time had interested his co-plaintiffs in the particular investment venture with Allison, instructed his banker, Robert E. Sibley, to telephone Caraway, with the view of checking up on Allison through banking channels, and to determine whether Allison was trustworthy and reliable and whether he owned the "Stevenson" lease. Probably as the result of a favorable impression created by Sibley's telephone call to Caraway on July 14, 1962, the plaintiffs became more enthusiastic about the investment. But it was only after a second visit to the lease site on July 23, 1962, by Dr. Lynn, and an actual inspection thereof by two of the other plaintiffs, that Allison received the sum of $33,530.00 from the four plaintiffs.

After Allison received a portion of the funds advanced by plaintiffs, he consummated his agreement with Jones, who had agreed to buy out his co-owners and sell the whole lease—that is, the 7/8 "working interest"—to Allison or his designees. Then, on July 31, 1962, a document evidencing an assignment from Jones of 3/8 of the 7/8 "working interest" to the plaintiffs and 5/8 of the 7/8 to defendant Caraway, as Allison's designee, was prepared and mailed to the plaintiffs.²

At the time of the assignment, and at all pertinent times, neither Jones nor Allison had registered the sales of these fractional undivided interests in oil rights as "securities" under the Securities Act of 1933.

When Dr. Lynn received the document evidencing the corrected assignment, noting that it came from Jones and not Allison, he stated he began to "smell a rat." He returned to Louisiana September 18, 1962, and discovered that Allison was in extreme financial difficulties, and was probably insolvent. He then employed counsel to advise him as to the proper course of conduct he should take with respect to Allison and his newly acquired lease interests.

Subsequently this action was brought in behalf of all four South Carolina investors seeking rescission of the assignment and return of the price paid. It will be necessary to discuss each of plaintiffs' theories of the case generally and particularly with respect to each of the three defendants.

The financing of the development of oil and gas properties has been as correspondingly peculiar as the technical character of the industry to traditional legal and economic notions. The typical exploitation of oil and gas reservoirs has been by the large oil company which leases large amounts of acreage for their operation even prior to the making of geologic and geophysical estimates. The large company's activities are better suited to the task as the company will usually be a well organized and well financed corporation. But in the less typical, but nonetheless usual, situation an individual or small company will hold oil leases, with the expectation of self-development. Therefore, to assist the small operator in his enterprise, the practice of dividing the ownership rights in the leasehold itself has come into wide usage, in order to raise the necessary funds.

The lessor-landowner receives, in addition to a cash bonus, and in some cases a fixed periodic rental payment for the right not to drill immediately, a further promise by the lessee to pay a percentage, usually one-eighth, of the oil and gas actually produced. The lessee's seven-eighths is termed the "working interest." While the large company, with adequate financing, may retain the whole of the "working interest," the small operator may be able to raise needed funds only through the sale of fractional undivided interests in his lease rights, with the commensurate promise to the purchaser to share in the production. Without this facility to raise money the small oil operator would likely be relegated to incorporation, and the sale of shares in his company, an often cumbersome and unsatisfactory manner of raising funds. At the same time, it must be remembered that an investment in an oil venture is often speculative in direct proportion to the chance that oil underlies the particular plot of ground.

The possibility of abuses in such a system of financing is obvious. With the evil in mind, the remedy embodied in the Securities Act of 1933 was designed "to provide full and fair disclosure of the character of the securities sold in interstate commerce and through the mails and to prevent fraud in the sale thereof." In keeping with this broad purpose the Act defined, in section 2(1), the term "security" as meaning, among other things, "any * * * fractional undivided interest in oil, gas, or other mineral rights * * *." The principle underpinning the statutory provision appears to be that no matter what the form or the terminology used, if the interest conveyed does not contemplate operation of the lease or drilling of wells by the purchaser, and does hold out to the purchaser an expectation of profit from the operation of others, the interest is probably a "security" under the Act.³ Perhaps as a limiting feature, the 1934 amendments supplied a special definition of the term "issuer" with respect to these fractional undivided interests, providing that "issuer" means "the owner of any such right or of any interest in such right (whether whole or fractional) who creates fractional interests therein for the purpose of public offering." Section 2(4).

It therefore follows that not every transaction involving the sale of a fractional undivided interest in oil, gas, or other mineral rights is necessarily the sale of a "security" under the Act. It is only that interest which is created by subdivision of a portion of the owner's interest for the purpose of a public offering for sale which is reached by the Act. Thus if the seller transfers the whole of what he owns, there can be no creation of the interests by him, as "issuer," such as would be counted "securities" within the meaning of the Act. Graham v. Clark, 332 F.2d 155 (6 Cir. 1964); Roe v. United States, 287 F.2d 435 (5 Cir.1961), cert. denied 368 U.S. 824, 82 S.Ct. 43, 7 L.Ed.2d 29. See also Woodward v. Wright, 266 F.2d 108 (10 Cir.1959).

The legislative purpose behind such a distinction was well stated in S. E. C. v. C. M. Joiner Leasing Corp., 320 U.S. 344, 352, 64 S.Ct. 120, 124, 88 L.Ed. 88 (1943):

"Oil and gas rights posed a difficult problem to the legislative draftsmen. Such rights were notorious subjects of speculation and fraud, but leases and assignments were also indispensable instruments of legitimate oil exploration and production. To include leases and assignments by name might easily burden the oil industry by controls that were designed only for the traffic in securities. This was avoided by including specifically only that form of splitting up of mineral interests which had been most utilized for speculative purposes." (Emphasis added.)

The Securities Act of 1933 affords protection to the investing public by requiring the filing with the S. E. C. of a registration statement containing material facts bearing upon the investment merit of securities which are publicly offered or sold through the use of the mails or through the instrumentalities of interstate commerce. Thus section 5 provides in part:

"(a) Unless a registration statement is in effect as to a security, it shall be unlawful for any person, directly or indirectly—

"(1) to make use of any means or instruments of transportation or communication in interstate commerce or of the mails

...