Rose v. Dobras

• Decision Date: 02 January 1981
• Docket Number: No. 2,CA-CIV,2
• Parties: , Blue Sky L. Rep. P 71,598 H. Barry ROSE, a married man, but dealing with his sole and separate property, Plaintiff/Appellant, v. Darryl B. DOBRAS, a married man, but dealing with his sole and separate property; Reesor and Nancy Woodling, husband and wife, Defendants/Appellees. 3655.
• Court: Arizona Court of Appeals

Page 887

624 P.2d 887

128 Ariz. 209, Blue Sky L. Rep. P 71,598

H. Barry ROSE, a married man, but dealing with his sole and separate property, Plaintiff/Appellant, v. Darryl B. DOBRAS, a married man, but dealing with his sole and separate property; Reesor and Nancy Woodling, husband and wife, Defendants/Appellees.

No. 2 CA-CIV 3655.

Court of Appeals of Arizona, Division 2.

Jan. 2, 1981.

Rehearing Denied Jan. 28, 1981.

Review Denied March 3, 1981.

Slutes, Browning, Zlaket & Sakrison, P. C. by D. Tom Slutes and Ronald E. Curry, Tucson, for plaintiff/appellant

Stompoly & Even, P. C. by John Patrick Lyons, Tucson, for defendants/appellees.

OPINION

HATHAWAY, Chief Judge.

Appellant (seller) brought suit against appellees (buyers) alleging failure to pay the fee for an orchard management agreement entered into between the parties. Buyers counterclaimed and filed a third-party complaint which was settled. At trial to the court without a jury, the counterclaim was limited to securities fraud and breach of the management agreement. Buyers' proposed findings and conclusions were adopted with some changes and judgment was granted buyers on their counterclaim and on seller's complaint.

The following issues are presented on this appeal:

1. Is the sale of a lease to over 14 acres of land with an option to lease more, entered concurrently with a sale of trees and a management agreement under which the seller/manager may be fired on 30-days' notice and under which the buyer has substantial oversight authority an "investment contract" or a "security?"

2. Does sufficient evidence support the findings of trial court that seller intentionally misstated or omitted material facts in connection with these transactions?

3. Did seller mismanage the orchard or breach the management agreement in any way?

4. Did the trial court err in granting rescission of the agreements under the theories of securities fraud and breach of contract and in failing to allow seller offsets in returning the parties to their prior positions?

5. Did the trial court err in failing to allow seller to allocate the money received as he saw fit when no allocation was made by buyers at time of payment and when insufficient consideration was provided by buyers to keep all agreements out of default?

6. Must the award of attorneys' fees to buyers be reversed with the reversal of the judgment on the issue of securities fraud?

On December 1, 1975, seller and Dobras entered into three agreements: A lease of over 14 acres of state-owned land in Cochise County, a "preliminary sales agreement" for apple trees and a "management agreement" covering the land and trees. On the same date, seller entered into three identical agreements with the Woodlings.

In 1970, seller acquired an assignment of a lease of a section of land in Cochise County near Pearce. He had earlier acquired title to 160 acres of land adjacent to the lease parcel. He planted apple trees and experimented with them. By 1975, the entire 160 acres of deeded land was planted and approximately one-half of the section of lease land was planted. The 160 acre parcel was used as the experimental part of the orchard. In 1975, seeking outside funds, the seller approached an investment brokerage firm with a proposition for individuals to invest or purchase interests in the apple orchard. He supplied information concerning the orchard. Eventually, buyers in this case were contacted. In various conversations with buyers, seller made certain representations concerning his ownership of an interest in the orchards, the use of sprinkler systems and their ability to protect the orchards, the availability of labor, the pH factor in the orchard soil, and the growth potential of the orchard's trees. Buyers, after examining the orchard and hiring an accountant and a lawyer to assist them, decided to proceed with the deal, and signed the various agreements. There was evidence that appellee Dobras traveled to Washington to make an independent investigation of the concept of apple orchards. However, he stayed in Washington only one day. Eventually, after the orchard failed to produce as per the expectations of the parties, seller sold all of his interest to a third party.

We first turn to the issue of whether the sale of the lease, coupled with the management agreement which the parties signed contemporaneously with the sales agreements, constitute an "investment contract" or a "security." The statutory definition of a security is found at A.R.S. Sec. 44-1801(13). It is substantially similar to the definitions found in the Securities Act of 1933 and the Securities Exchange Act of 1934. Federal interpretations are often looked to for guidance. Greenfield v. Cheek, 122 Ariz. 70, 593 P.2d 293 (App.1978), approved, 122 Ariz. 57, 593 P.2d 280 (1979). An "investment contract" is included within the definition of a security in Sec. 44-1801(13). In S.E.C. v. W. J. Howey Co., 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946), the supreme court set out the definition of an investment contract as any situation where (1) individuals are led to invest money (2) in a common enterprise (3) with the expectation that they will earn a profit solely through the efforts of others. In this case, there has clearly been an investment of money. Secondly, buyers' money has been invested in a common enterprise. Here, seller is involved in a common venture with each buyer, and there is more than one buyer. Vertical as well as horizontal commonality therefore exists. See Brodt v. Bache & Co., 595 F.2d 459 (9th Cir. 1978).

The key to whether an investment contract exists in this case is whether buyers entered into the agreements with the expectation that profits would come solely from the efforts of the seller. The trial court found this to be the case and made a specific finding that the transactions herein constitute an investment contract under our security laws. Seller, on appeal, contends that even though he had the right to manage and operate the orchard under the agreement, the fact that buyers had the power to cancel the agreement and actively inspect and control his operation of the orchard removes this transaction from the realm of a passive investment. In response, buyers argue that they were investing in only a part of the orchard, and that effective management by the seller of the overall orchard operation was necessary for them to make a profit.

In reviewing the evidence, we must keep in mind that the securities laws were designed to protect the public from speculative or fraudulent schemes of promoters. The supreme court has consistently construed the definition of "security" liberally. In searching for the meaning and scope of this term, form should be disregarded for substance and the emphasis should be on economic reality. Tcherepnin v. Knight, 389 U.S. 332, 88 S.Ct. 548, 19 L.Ed.2d 564 (1967). In S.E.C. v. Glenn W. Turner Enterprises, Inc., 474 F.2d 476 (9th Cir. 1973), cert. den. 414 U.S. 821, 94 S.Ct. 117, 38 L.Ed.2d 53 (1973), the court interpreted the third prong of the Howey test in a flexible and remedial fashion. Noting that strict interpretation of the requirement that profits be earned solely from the efforts of others has been subject to criticism, the court adopted a more realistic test:

"(W)hether the efforts made by those other than the investor are the undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise." Id. at 482.

After reviewing the evidence in light of this standard, we conclude that although buyers here had some powers of control over their portion of the orchard, the undeniably significant management efforts were those of the seller, and therefore the agreements herein constitute an "investment contract" under our securities laws.

Buyers clearly did not buy their leasehold interest in a portion of the orchard in order to take advantage of increases in its land value. Happy Investment Group v. Lakeworld Properties, Inc., 396 F.Supp. 175 (N.D.Cal.1975). Nor was their motivation for buying for purposes of "consumption," that is to occupy the land or develop it by their own efforts. Timmreck v. Munn, 433 F.Supp. 396 (N.D.Ill.1977). We consider the transactions to be similar to those in Blackwell v. Bentsen, 203 F.2d 690 (5th Cir. 1953), cert. dismissed 347 U.S. 925, 74 S.Ct. 528, 98 L.Ed. 1078 (1954), and S.E.C. v. Bailey, 41 F.Supp. 647 (S.D.Fla.1941). In Blackwell, a number of buyers purchased 20-acre units within a large citrus grove, entering into management agreements with the seller at the same time. While the seller's management company undertook full responsibility for harvesting and marketing the crops, the management contract contained provisions for a buyer to give directions as to the marketing of his crops. Further, the management contracts usually covered a period of one year, with an option to renew annually for up to five years. The Fifth Circuit, recognizing that few, if any, of the small tracts were purchased by citrus farmers who wished to cultivate them as a personal farming enterprise, held that despite having some degree of control over the management of their lots on the orchard, the buyers were in reality expecting profits solely through the efforts of the manager-seller. Therefore, the transactions amounted to an investment contract.

Seller contends the reasoning of the Eighth Circuit in Fargo Partners v. Dain Corp., 540 F.2d 912 (8th Cir. 1976), and Schultz v. Dain Corp., 568 F.2d 612 (8th Cir. 1978), must control here. In those cases, transactions in which the buyers purchased apartment developments, then immediately signed management agreements placing the seller or its agent in charge of managing the apartments, were held not to constitute investment contracts. In Fargo Partners, the court relied on the fact that the management agreement could be cancelled by the buyer upon 30-days' notice in reasoning that...