NORTH AM. FINANCIAL GROUP v. SMR ENTERPRISES

• Decision Date: 24 February 1984
• Docket Number: No. 83 C 3670.,83 C 3670.
• Citation: 583 F. Supp. 691
• Parties: NORTH AMERICAN FINANCIAL GROUP, LTD., Plaintiff, v. S.M.R. ENTERPRISES, INC., d/b/a Fantastic Sam's, and Sam M. Ross, Defendants.
• Court: U.S. District Court — Northern District of Illinois

583 F. Supp. 691

NORTH AMERICAN FINANCIAL GROUP, LTD., Plaintiff, v. S.M.R. ENTERPRISES, INC., d/b/a Fantastic Sam's, and Sam M. Ross, Defendants.

No. 83 C 3670.

United States District Court, N.D. Illinois, E.D.

February 24, 1984.

COPYRIGHT MATERIAL OMITTED

Carlo E. Poli, Engerman, Erlich, Jacobs & Berman, Chicago, Ill., for plaintiff.

George D. McCrary, Hester & McCrary, Bartlett, Tenn., David L. Schiavone, Wildman, Harrold, Allen & Dixon, Chicago, Ill., for defendants.

MEMORANDUM OPINION AND ORDER

WILLIAM T. HART, District Judge.

Plaintiff North American Financial Group, Ltd. ("North American"), brings a six count complaint against S.M.R. Enterprises, Inc., doing business as Fantastic Sam's ("Fantastic") and Sam Ross ("Ross"). North American is a Delaware corporation whose principal place of business is in Chicago, Illinois. Fantastic is a Tennessee corporation with its principal place of business in that state, and Ross is a citizen of Tennessee. Counts I and II are federal counts, brought respectively under section 17(a) of the Securities Act of 1933, as amended 15 U.S.C. §§ 77a et seq. ("1933 Act") and the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. §§ 1961 et seq. Counts III, IV, V and VI are based on Illinois statutory and common law: Illinois Franchise Disclosure Act, Ill.Rev.Stat. ch. 121½, §§ 701 et seq. ("Franchise Act"); fraud; quantum meruit; and specific performance of an oral contract. Jurisdiction is asserted through 28 U.S.C. § 1331 pursuant to 15 U.S.C. § 77v and 18 U.S.C. § 1961; and 28 U.S.C. § 1332.

FACTS

North American is engaged primarily in the business of raising venture capital and investing or loaning venture capital. It also engages in financial consulting. Fantastic is engaged in the business of franchising family hair care centers and centers which train franchisees to operate the hair care centers under the name of Fantastic Sam's. Ross, during the relevant period, was the president, director and principal shareholder of Fantastic.

The events giving rise to this lawsuit are curious. In the Fall of 1981, Ross contacted North American seeking capital for promotion of Fantastic's Chicago area franchise program. The capital supposedly was sought in the form of a loan to Ross rather than as a loan directly to Fantastic so that Fantastic's debt/equity ratio would be enhanced. North American refused to lend funds to Ross on that basis, allegedly because the result would mislead the Federal Trade Commission, Illinois Attorney General, potential franchisees and others. Nonetheless, North American agreed to explore other, "nonmisleading" funding methods for Fantastic.

In October of 1981, Gregory I. Kravitt ("Kravitt"), North American's president, met in Chicago with Ross. At this meeting and at a second meeting in January of 1982, Ross allegedly offered Kravitt a percentage of Fantastic stock, stock options and a chance to buy the Chicago area Fantastic franchise for $500,000.00 (collectively "Stage One deal").

During the negotiations which followed, North American claims that Ross intentionally misrepresented his past business ventures and successes expressly to induce North American into investing in Fantastic. The alleged misrepresentations include: that Ross had developed a motel and marina in Rockport, Massachusetts which later became a Holiday Inn; that Ross had opened a restaurant in Boston's financial district with a $60,000.00 loan from Shamut National Bank which restaurant later was sold for $250,000; that Ross had operated a successful real estate business in Green Bay, Wisconsin before relocating to Tennessee due to a heart condition; that Fantastic was Helene Curtis' second largest customer and that Helene Curtis was helping Fantastic to sell franchises, including offering to purchase Fantastic from Ross; and that if North American purchased the Chicago area Fantastic franchise it could easily sell individual franchises and realize annual income in the amount of $3,800,000.00. In North American's view most of the above are false rather than exaggerations or puffings.

North American also complains that Ross omitted certain key information from the Stage One discussions: that Fantastic's need for capital fluctuated, such that no deal would be consummated unless capital was required when the transaction was mature and that unless North American sold 200 individual franchises within a two year period, its Chicago area franchise would be forfeited to Fantastic. North American further says that the defendants tendered faulty area franchise disclosure statements in violation of Illinois law.

North American alleges that it relied in good faith on the misrepresentations. As a result of its reliance, and the material omissions, North American says that it continued to negotiate with Ross, devoting substantial time and money in developing the Stage One deal, incurring travel and legal expenses and providing Fantastic with free investment counseling.

Stage One was aborted. It is unclear when North American actually learned of Ross' alleged business exaggerations and material misrepresentations or omissions. But, it is clear that North American did not back out of the deal. Rather, on July 20, 1982, Fantastic's agent George H. Carnall, II ("Carnall") withdrew the Stage One stock/franchise offer. The reason allegedly given was that Fantastic no longer needed the injection of capital which the proceeds of the area franchise would provide.

Instead of being relieved, North American apparently was disappointed. It considered alternative investment offers from Fantastic. The first such offer came on the very day that Carnall withdrew the Stage One deal. North American allegedly would have been permitted to purchase ten percent of Fantastic's stock for $250,000.00 and after one year could have purchased another 10 percent for another $250,000.00. That offer was followed about one month later with a second stock/franchise deal ("Stage Two deal"). Although the Court is unsure of its specifics, it seems that North American was offered the chance to buy 10 percent of Fantastic's stock for $50,000.00. That sum would be credited to North American for training, advertising and royalty expenses. Further, if North American accepted the Stage Two deal, it would have received an option to acquire 20 percent more of Fantastic's stock for $500,000.00.

Once again, North American claims it was duped into spending time and money in negotiations which it would not have had it known that the Stage Two deal also depended on whether Fantastic was capital-needy when all issues were resolved. North American also characterizes the Stage Two deal as fraught with material misrepresentations and omissions and violative of Illinois franchise law.

Stage Two was withdrawn by Ross, for reasons not expressed in the complaint. But, once again, a third offer allegedly was tendered during the withdrawal phone call. The "Stage Three" deal purportedly proposed that North American pay $50,000.00 for the Chicago area franchise, which sum would be applied as credit to North American for training, advertising and royalty expenses. North American "immediately accepted this third offer." Ross and Fantastic later refused to tender the Chicago area franchise arguing that no enforceable contract was made.

In support of a final, enforceable Stage Three deal, North American submits a copy of a trade journal advertisement. That advertisement invites persons eager to earn big profits as a Fantastic Sam's franchisee to contact, among others, "one of our regional offices ... George I. Kravitt, Fantastic Sam's of Illinois." Kravitt, of course, is president of North American.

If all the allegations made by North American are true, North American likely escaped being "clipped" by Fantastic. Surprisingly, however, North American seeks specific performance. It asks this Court to force Fantastic to sell it the Chicago area Fantastic franchise under the alleged terms of the Stage Three deal. North American also wants to recover the reasonable value of its efforts uselessly expended on Stages One and Two.

The defendants' general response to North American's complaint is that the facts describe only a garden variety business deal that could not be made. In their view, each side lost time and money—risks common in the volatile world of franchisors and venture capitalists. They specifically move to dismiss on various grounds.

1933 Securities Act

At least three separate challenges are raised to the claims brought as fraudulent violations of section 17(a) of the 1933 Act: (1) whether a withdrawn offer can trigger section 17(a) liability and, if so, whether either an "offeror" or a "security" exists here; (2) lack of standing because no sale of a security occurred; and (3) no compensable damage. Because the Court finds that North American has no standing to sue for a section 17(a) violation, the other proposed bases for dismissing the 1933 Act count are not considered.

The starting point for determining whether North American has standing to sue under section 17(a) of the 1933 Act is a comparison between the language of that section and the language of section 10(b) of the 1934 Securities Exchange Act, 15 U.S.C. § 78j(b) ("1934 Act"). The operative provisions of those antifraud sections of the 1933 and 1934 Acts are identical.

Section 17(a) of the 1933 Act, captioned "Fraudulent interstate transactions," provides in pertinent part

a. It shall be unlawful for any person in the offer or sale of any securities ...

(1) to employ any devise, scheme, or artifice to defraud, or

(2) to obtain money or property by means of any untrue statement of material fact or any omission to state a material fact ..., or

(3) to engage in any transaction, practice or course of business which operates or would operate as a fraud or deceit upon the purchaser.

15 U.S.C. § 77g. (emphasis added). Section 10(b) of the 1934...