Payable Accounting Corp. v. McKinley, 17589

Citation667 P.2d 15
Decision Date27 June 1983
Docket NumberNo. 17589,17589
PartiesBlue Sky L. Rep. P 71,830 PAYABLE ACCOUNTING CORPORATION, a Utah Corporation, Plaintiff and Respondent, v. Douglas McKINLEY, Director, Utah Securities Commission, Defendant and Appellant.
CourtSupreme Court of Utah

David L. Wilkinson, Charles A. Carlson, Salt Lake City, for defendant and appellant.

Gerald L. Turner, Salt Lake City, Eric W. Bjorklund, Murray, Wallace R. Bennett, Salt Lake City, for plaintiff and respondent.

STEWART, Justice:

This appeal is from a summary judgment in which the district court held that two contracts offered by Payable Accounting Corporation to clients and to investors are not securities as defined by the Utah Uniform Securities Act, U.C.A., 1953, § 61-1-13(12). We reverse.

The facts are not in dispute. Payable Accounting Corporation (PAC) serves commercial enterprises by managing their accounts payable and payrolls. To subscribe to this service, the enterprises are required to sign an agreement called a "client contract." Among other things, the contract provides that:

(1) Each month the client business must deposit funds equal to its payables and payroll for the month in a bank account controlled by the Universal Clearing House (UCH), a trust established by PAC.

(2) During the month, the client must inform PAC of its payables at least five business days before they fall due.

(3) PAC will pay the client's accounts payable as they fall due. If the client's funds fall short during the month, PAC agrees to make up the difference from its own funds.

(4) The contract lasts one year and is renewable. At the end of the year, PAC pays the client 6% interest on the monies transferred to UCH during the year.

(5) PAC may hypothecate the monies transferred to UCH by the clients.

PAC needs cash reserves to pay its clients' accounts payable when the clients' own funds fall short. PAC solicits these reserves from private investors, whom they call "undertakers." These investors sign an "investor contract." Among other things it provides that:

(1) The investor will commit to PAC a specified amount of cash, credit, or commodities which may be hypothecated.

(2) PAC may use the funds committed to pay the debts of PAC's clients.

(3) At the end of nine months, PAC agrees to return the principal amount committed. During the nine months, PAC pays a fixed monthly interest on the principal. The interest rate is negotiated between PAC and the investor and is specified in the agreement.

The investor also signs a "Commitment to Assume Debt," which sets forth the details of how his funds are to be committed to PAC.

The district court found that "PAC generates its own possible profits by an aggressive policy of taking trade discounts and through a realization of returns on available funds and credits before those funds are actually paid on client's behalf (i.e., the "float" period)." Because this is the only profit-generating method mentioned in the findings, we presume that it is also the method by which profits for the investors and clients are generated.

The contracts characterize PAC's operation as a "clearing house," and disavow the notion that lending or investing is actually taking place. The client contract states that "[i]t is understood that PAC and UCH are not lending institutions .... [They] are independent contractors, providing management and operations advice and ... clearing house services ..." The investor contract states that "[i]t is understood and agreed that [the undertaker] is not lending or investing the funds herein committed but that [the undertaker] is assuming the debt of PAC's clients."

In July, 1980 the Utah Securities Commission issued a stop order against PAC pursuant to U.C.A., 1953, § 61-1-12 and § 61-1-14(3) of the Utah Uniform Securities Act forbidding PAC from entering into any more client and investor contracts. In response, PAC brought this action against the Commission, seeking a declaratory judgment to rescind the stop order. On a motion for summary judgment, the district court held for PAC, ruling that the contracts are not securities. The Commission appeals.

As relevant here, U.C.A., 1953, § 61-1-13(12) of the Utah Uniform Securities Act defines securities as follows:

The word "security" means any note; stock; treasury stock; bond; debenture; evidence of indebtedness; certificate of interest or participation in any profit-sharing agreement; collateral-trust certificate; preorganization certificate or subscription; transferable share; investment contract; ... [Emphasis added.]

The meaning of the term "security" as used in § 61-1-13(12) has not been previously addressed by this Court. However, we are not without substantial guidance in the area. Section 61-1-13(12) is taken from the Securities Act of 1933, 15 U.S.C. § 77(b)(1) (1976), and the Securities Exchange Act of 1934, 15 U.S.C. § 78c(a)(10) (1976). 1 Because most state blue sky laws and the federal securities acts are similar, states frequently rely on federal case law in interpreting state security acts. See, e.g., Suave v. K.C., Inc., 91 Wash.2d 698, 591 P.2d 1207 (1979); American Mutual Reinsurance Co. v. Calvert Fire Insurance Co., 52 Ill.App.3d 922, 9 Ill.Dec. 670, 367 N.E.2d 104 (1977).

At the outset we note that securities laws are remedial in nature and should be broadly and liberally construed to give effect to the legislative purpose. See Tcherepnin v. Knight, 389 U.S. 332, 336, 88 S.Ct. 548, 553, 19 L.Ed.2d 564 (1967); S.E.C. v. W.J. Howey Co., 328 U.S. 293, 299, 66 S.Ct. 1100, 1103, 90 L.Ed. 1244 (1946). The federal securities acts were adopted and designed to restore investors' confidence in the financial markets, 2 as was the Utah Act. 3

The United States Supreme Court has construed the term "investment contract" broadly to include more than just stocks and bonds. In S.E.C. v. C.M. Joiner Leasing Corp., 320 U.S. 344, 351, 64 S.Ct. 120, 124, 88 L.Ed. 88 (1943), the Court stated:

[T]he reach of the [Securities] Act does not stop with the obvious and commonplace. Novel, uncommon, or irregular devices, whatever they appear to be, are also reached if it be proved as matter of fact that they were widely offered or dealt in under terms or courses of dealing which establish their character in commerce as "investment contracts," or as "any interest or instrument commonly known as a 'security.' "

In S.E.C. v. W.J. Howey Co., 328 U.S. 293, 299, 66 S.Ct. 1100, 1103, 90 L.Ed. 1244 (1946), the Court stated that the concept of an investment contract "embodies a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits." And in Tcherepnin v. Knight, 389 U.S. 332, 336, 88 S.Ct. 548, 553, 19 L.Ed.2d 564 (1967), the Court stated that "in searching for the meaning and scope of the word 'security' in the [Securities] Act, form should be disregarded for substance and the emphasis should be on economic reality." The Utah act was intended to have similar flexibility and to place substance over form. Accordingly, we are not bound by the labels used by PAC to characterize its contracts. We look instead to the substance of those contracts.

The Supreme Court first defined the term "investment contract" in S.E.C. v. W.J. Howey Co., supra, in the context of contracts for the sale and cultivation of citrus trees. The contracts were sold by two sister Florida citrus companies, who used the money from the contract sales to finance their citrus growing operation. The contract buyers were patrons of a nearby resort hotel who, during their stay, were given tours of the citrus tree groves and an opportunity to "purchase" some of the trees. Although the contract buyers were formally the title owners of the trees, they took no part in the management of the trees. Almost all signed a service agreement which gave to the citrus companies the cultivation and harvesting rights. In return the tree owners were paid a yearly percentage of the harvest profits based on the number of trees they had purchased.

The Court held that the citrus contracts were securities. The Court's definition of an "investment contract" in Howey is applicable here:

[A]n investment contract ... 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 ....

328 U.S. at 298-99, 66 S.Ct. at 1103. This test was based in part on language from a state case, State v. Gopher Tire & Rubber Co., 146 Minn. 52, 56, 177 N.W. 937, 938 (1920), which described an investment contract as "[t]he placing of capital or laying out of money in a way intended to secure income or profit from its employment."

Both federal and state securities cases after Howey have widely relied on its definition of an investment contract. Although the test can hardly be mechanically applied if we are to remain true to the fundamental policies underlying our act, the definition has proven useful in deciding, in a wide variety of situations, what constitutes an investment contract. 4 Schemes that have been held to qualify as investment contracts include sale or assignment of mineral leases; contracts for the sale, lease or management of income-producing property such as fur-bearing animals and oyster beds; contracts for the resale of goods, merchandise, or other property; contracts evidencing shares or interest in certain partnerships or associations; contracts evidencing shares or interests in investment pools; and variable annuity or insurance contracts. See 69 Am.Jur.2d Securities Regulation--Federal, §§ 26-34 (1973); 69 Am.Jur.2d Securities Regulation--State, §§ 27, 28 (1973); 47 A.L.R.3d 1375 (1973).

In most of these schemes, the profits received by investors are, as in Howey, proportionately related to the profits of the business as a whole, or are otherwise...

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