Timmreck v. Munn

• Decision Date: 07 January 1977
• Docket Number: No. 76 C 2045.,76 C 2045.
• Citation: 433 F. Supp. 396
• Parties: Wendy TIMMRECK et al., Plaintiffs, v. Patrick MUNN et al., Defendants.
• Court: U.S. District Court — Northern District of Illinois

433 F. Supp. 396

Wendy TIMMRECK et al., Plaintiffs, v.Patrick MUNN et al., Defendants.

No. 76 C 2045.

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

January 7, 1977.

COPYRIGHT MATERIAL OMITTED

Thomas P. Young, Wotan, Muscarello & Crisanti, Elgin, Ill., for plaintiffs.

Robert H. Wheeler and Donald J. McLachlan, Isham, Lincoln & Beale, Chicago, Ill., for defendant 15 and American Standard, Inc.

Robert J. Oliver, Thomas E. Laughlin, Connolly, Oliver, Goddard, Coplan & Close, Rockford, Ill., for defendants 1, 2, 3, 7, 9, 10, 13, 14, Whetstone, W. L. Belvedere, Lorenz, Jr. and Taylor.

Kurt L. Schultz, Winston & Strawn, Chicago, Ill., for defendant Independence Mortgage Trust.

Patrick W. O'Brien, Alan R. Borlack, Mayer, Brown & Platt, Chicago, Ill., for defendant Continental Ill. Nat. Bank.

Leon J. Garrie, Los Angeles, Cal., for defendants 1, 2, 3, 7, 8, 10, 13, 14 and Whetstone.

MEMORANDUM OPINION

DECKER, District Judge.

I.Background of the Case

The 328 plaintiffs in this case allege that they have been defrauded in their purchases of lots in Candlewick Lake Subdivision during the years 1971 through 1973.They assert that they were led to believe by means of the defendants' advertising, financial statements, statement of record filed pursuant to the Interstate Land Sales Act, and other representations, that their undeveloped lots would be substantially improved and would greatly appreciate in value.They charge that these promises have not been kept and that the developers were undercapitalized and in fact lacked the funds to fulfill their obligations to complete the Candlewick Lake development.

The plaintiffs have brought a sixteen-count consolidated complaint against 23 defendants.These defendants include the Continental Illinois National Bank and Trust Company of Chicago ("Continental Bank"), which is alleged to have financed the project by purchasing the plaintiff's promissory notes secured by their mortgages.

The other defendants include developers, officials of the developers and other entities associated with the planning and financing of the Candlewick Lake project.Two defendants have been dismissed without prejudice by the plaintiffs, and one has filed an answer to the complaint.Three defendants are currently in corporate reorganization, and three individual defendants have not been located for service of process.

The Continental Bank has filed a motion to dismiss, and a separate motion to dismiss has been joined in by the remaining thirteen defendants.

Count I of the complaint asserts that the real estate purchase contracts made by the plaintiffs were investment contracts, and thus securities within the meaning of federal securities law, the 1933 Securities Act, the 1934 Securities Exchange ActandRule 10b-5.The plaintiffs allege that the defendants' representations induced them to make their "investments" and constituted a fraud covered by the securities laws.

Count II, which alleges that the defendants offered and sold securities without filing a registration statement as required by the 1933 Act, is conceded by the plaintiffs to be barred by the statute of limitations.

Count III is brought under the Interstate Land Sales Act, 15 U.S.C. § 1701 et seq., and alleges various misrepresentations and omitted essential statements in the statement of record filed by the developer with HUD, and in the representations made to the plaintiffs.

The remaining thirteen counts are pendent jurisdiction state statutory and common law claims.

II.Is the Sale of Securities Alleged in Count I?

As noted supra, Count I alleges fraud relating to the sales of securities, and charges violations of § 17(a) of the 1933 Act(15 U.S.C. § 77q), § 10(b) of the 1934 Act(15 U.S.C. § 78j) and of Rule 10b-5.The plaintiffs maintain that their real estate purchase contracts were investment contracts and note that the definition of "security" found in § 2(1) of the 1933 Act(15 U.S.C. § 77b) expressly includes "investment contracts".The defendants deny that this transaction is covered by securities law, and characterize it as a mere real estate transaction.

Interpretation of the securities laws is governed by two conflicting judicial concerns.Since the Acts were devised to protect the public from speculative or fraudulent schemes advanced by promoters, they must be construed liberally as remedial statutes.S. E. C. v. Glenn W. Turner Ent., Inc.,474 F.2d 476(9th Cir.1973).

The Supreme Court has held that the term "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."S. E. C. v. Howey Co.,328 U.S. 293, 299, 66 S.Ct. 1100, 1103, 90 L.Ed. 1244(1946).

The Court had earlier stressed that "novel, uncommon, or irregular devices, whatever they may appear to be, are also reached under this definition".S. E. C. v. Joiner Corp.,320 U.S. 344, 351, 64 S.Ct. 120, 124, 88 L.Ed. 88(1943).In essence, "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).Most recently the Court in United Housing Foundation, Inc. v. Forman,421 U.S. 837, 851, 95 S.Ct. 2051, 44 L.Ed.2d 621(1975), again emphasized that trial courts must look to the "substance" of the transaction.

But while the securities laws must be utilized with flexibility to remedy the protean forms of investment fraud, the court is also mindful that these laws cannot be utilized as catch-all solution for business fraud and other economic torts.Previously this court has commented that "the word `security' is not a judicial philosopher's stone for the conjuration of federal cases."Lincoln National Bank v. Lampe,414 F.Supp. 1270, 1280(N.D.Ill.1976).

Thus, the court must carefully match the allegations of the instant complaint against the well-established standard for investment contracts first articulated by the Supreme Court in Howey, supra, and recently reiterated in Forman, supra,421 U.S. at 852, 95 S.Ct. 2051.

"The test is whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.If that test be satisfied, it is immaterial whether the enterprise is speculative or non-speculative or whether there is a sale of property with or without intrinsic value."Howey, supra,328 U.S. at 301, 66 S.Ct. at 1104.

The plaintiffs in this case assert that the lots they purchased were vacant and substantially undeveloped.They maintain that the lots were not worth the purchase price without the substantial improvements which the defendants are said to have promised.These improvements and amenities are listed in detail in paragraph 36 of the complaint.The complaint maintains that these representations were made in maps, brochures and other written and oral representations.

The plaintiffs, therefore, argue that the excess purchase price over the current value represented a common fund which would be used by the defendants to make improvements which would substantially increase the value of the individual lots.This is said to constitute a common enterprise dependent upon the efforts of the defendants, and thus fall within the definition of an investment contract.

The defendants respond by contending that the plaintiffs have all acknowledged that no such representations of future improvements influenced their agreement to purchase their lots.This is based on the inclusion in the standard real estate contracts signed by the defendants of certain language in paragraph 11 that "buyer acknowledges that no representations or warranties oral or written, have been made by Seller which are not set forth in this Contract."

Defendants then rely upon the decision of Judge McMillen in Bubula, et al. v. The Grand Bahama Development Co., Ltd.,No. 73 C 3131(N.D.Ill.6/27/74), for the proposition that "alleged oral misrepresentation cannot transform a document into a security to bring it within the jurisdiction of this court if the document itself does not satisfy the definition of the statute and the case law."

In Bubula it seems that the plaintiffs asserted that the real estate purchases were securities upon the basis of a clause providing for a small "service" charge for maintenance and other minor improvements, and other oral and written representations "about the nature and value of the land".The court apparently viewed the former as insufficient to establish a common enterprise with profits solely from the efforts of the defendants.And while Judge McMillen did give some emphasis to the fact that the latter representations were specifically excluded from the purchase agreement, it is clear that mere generalizations about the "nature and value" of the property could not suffice to transform a routine real estate transaction into an investment.

To the extent that some of the language in Bubula intimates that a contractual clause disclaiming prior representations bars the court from considering such promises in assessing the deal as a securities transaction, this court must dissent.

In S. E. C. v. Joiner Corp., supra,the Supreme Court stated that

"the test for an investment contract is what character the instrument is given in commerce by the terms of the offer, the plan of distribution, and the economic inducements held out to the prospect."320 U.S. at 352-53, 64 S.Ct. at 124.

The Court did not limit the analysis to the four corners of the final contract completing the transaction.Rather the "terms of the offer", the "plan" and the "economic inducements" must all be considered.As noted above, securities analysis requires inquiry into the substance of the transaction, and emphasis upon economic reality rather than mere form.

Just as the Court will not permit language denominating an interest as...