Tschetter v. Berven

• Decision Date: 17 January 2001
• Docket Number: No. 21500., No. 21474
• Citation: 2001 SD 11,621 N.W.2d 372
• Parties: Kim TSCHETTER, Marvis Tschetter, a/k/a Marvie Tschetter, Clarence Tschetter and Goldie Tschetter, Plaintiffs and Appellants, v. James L. BERVEN, William J. Folkerts, and Venerts Investment, Inc., a South Dakota Corporation, Defendants and Appellees.
• Court: South Dakota Supreme Court

621 N.W.2d 372

2001 SD 11

Kim TSCHETTER, Marvis Tschetter, a/k/a Marvie Tschetter, Clarence Tschetter and Goldie Tschetter, Plaintiffs and Appellants, v. James L. BERVEN, William J. Folkerts, and Venerts Investment, Inc., a South Dakota Corporation, Defendants and Appellees.

Nos. 21474, 21500.

Supreme Court of South Dakota.

Argued November 29, 2000.

Decided January 17, 2001.

Lee Schoenbeck, John W. Burke, Schoenbeck Law Office, Watertown, SD, Attorneys for plaintiffs and appellants.

Thomas K. Wilka of Hagen, Wilka & Archer, Sioux Falls, SD, Attorneys for defendants and appellees.

SABERS, Justice

[¶ 1.] Marvie and Kim Tschetter, Clarence and Goldie Tschetter (Tschetters) purchased units from Venerts Investment, Inc., James Berven, and William Folkerts (Venerts) in Huron Kitchen LLC, a limited liability company, (Huron LLC) the entity which would construct and own a Country Kitchen restaurant. Tschetters claimed that: 1.) these units constitute securities under South Dakota law, and that: 2.) Venerts breached their duty in failing to assess the suitability of Tschetters for investment in Huron LLC. The trial court denied Tschetters' motions for summary judgment and granted judgment to Venerts by dismissing Tschetters' claims as a matter of law. We affirm.

FACTS

[¶ 2.] In 1994, Venerts entered into an agreement with Country Hospitality Corporation (CHC) to develop several Country Kitchen restaurants over a period of years. Venerts contacted Marvie and Kim Tschetter after learning from the architect retained by Country Kitchen that Tschetters were interested in the investment. Venerts contacted Clarence and Goldie, Marvie's parents, after learning from Marvie that they were also interested. Venerts met with Tschetters and provided them a business plan which described the project.

[¶ 3.] After additional meetings with Venerts, Tschetters eventually invested in Huron LLC. Marvie and Kim purchased 6.750 units for $33,750.00, representing one ownership share of a total of eleven in Huron LLC. Clarence and Goldie purchased 13.5 units for $67,500, making them owners of two shares in Huron LLC. An operating agreement was entered into on April 4, 1995 and the Country Kitchen in Huron was opened in the fall of 1995.

[¶ 4.] Several months later, financing difficulties caused Tschetters and others to personally guarantee loans from First Madison Bank to Huron LLC. Nevertheless, the Country Kitchen continued to experience financial difficulties and closed November 1996. After the restaurant closed, First Madison Bank commenced an action against the personal guarantors, including Tschetters, to recover the monies loaned. Tschetters responded with cross-claims against Venerts for negligence and breach of South Dakota's Uniform Securities Act.

[¶ 5.] Tschetters moved for summary judgment asserting that: 1.) the units in the Huron LLC are "securities" under SDCL 47-31A-401(m); and 2.) Venerts owed a duty to determine the suitability of Tschetters to invest in Huron LLC. The trial court denied both motions. Tschetters appeal. Venerts filed a notice of review of: 3.) the trial court's decision denying the admissibility of evidence concerning settlement negotiations to prove Tschetters' role in Huron LLC.

STANDARD OF REVIEW

[¶ 6.] Our standard of review for summary judgment is well-established:

In reviewing a grant or denial of a summary judgment under SDCL 15-6-56, we must determine whether the moving party demonstrated the absence of any genuine issue of material fact and showed entitlement to judgment on the merits as a matter of law.

Kern v. City of Sioux Falls, 1997 SD 19, ¶ 4, 560 N.W.2d 236, 237. "The determination of whether a duty exists is a question of law for the court." Gilbert v. United Nat. Bank, 436 N.W.2d 23, 27 (S.D.1989). Similarly, "the construction of a statute and its application to the case at hand presents a question of law." Shevling v. Butte County Bd. of Comm'rs, 1999 SD 88, ¶ 12, 596 N.W.2d 728, 730. "Whether an instrument is a security is a question of law." Nutek Information Systems, Inc., v. Arizona Corporation Commission, 194 Ariz. 104, 977 P.2d 826, 829 (Ct.App.1998); see also Securities Exchange Commission v. W.J. Howey, Co., 328 U.S. 293, 297, 66 S.Ct. 1100, 90 L.Ed. 1244, 1249 (1946)

. "We review questions of law de novo." Hamerly v. City of Lennox Bd. of Adj., 1998 SD 43, ¶ 10, 578 N.W.2d 566, 568.

[¶ 7.] 1. WHETHER THESE UNITS IN HURON LLC ARE SECURITIES UNDER SOUTH DAKOTA'S UNIFORM SECURITIES ACT.

[¶ 8.] This case presents a question of first impression in South Dakota. "We start with the proposition that statutes governing the registration and sale of securities are remedial in nature and are designed to protect the unwary buyer and thus should be liberally construed." Hofer v. General Discount Corp., 86 S.D. 133, 192 N.W.2d 718, 722 (1971). However, to receive this liberal construction Tschetters must establish that the units they purchased are securities.

[¶ 9.] In South Dakota, "security" is defined as:

any note; stock; treasury stock; bonds; debentures; evidence of indebtedness; certificate of interest or participation in any profit-sharing agreement; collateral-trust certificates; preorganization certificate or subscription; transferable shares; investment contracts; voting-trust certificates; certificate of deposit for a security; certificate of interest or participation in an oil, gas or mining title or lease or in payments out of production under such a title or lease; viatical settlement; or, in general, any interests or instrument commonly known as a security, or any certificate of interest or participation in, temporary or interim certificate for, receipt for guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing. Security does not include any insurance or endowment policy or annuity contract under which an insurance company promises to pay a fixed sum of money either in a lump sum or periodically for life or some other specified period.

SDCL 47-31A-401. Tschetters contend that the units they purchased in Huron LLC are "investment contracts" and therefore "securities" under SDCL 47-31A 401.¹ South Dakota's definition of "security" is substantially similar to the definition of "security" in the Securities Act of 1933 and the Securities Exchange Act of 1934. See Securities Act of 1933, 15 USCA 77(b)(1) (1997); Securities Exchange Act of 1934, 15 USCA 78(c)(a)(10) 1997. Therefore, we look to courts interpreting similar provisions for guidance.

[¶ 10.] "We must therefore begin where all analyses of investment contracts start, with Securities & Exchange Commission v. W.J. Howey Co., 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946)."² Williamson v. Tucker, 645 F.2d 404, 417 (5th Cir.1981) cert denied 454 U.S. 897, 102 S.Ct. 396, 70 L.Ed.2d 212 (1981). LLC membership interests constitute "securities" if they fulfill the criteria established by the United States Supreme Court in Howey. Keith v. Black Diamond Advisors, Inc., 48 FSupp 2d 326 (S.D.N.Y.1999); KFC Ventures, LLC v. Metaire Medical Equipment Leasing Corp., 2000 WL 726877, *2 (E.D.La.2000). The United States Supreme Court has stated that an "investment contract" is a "`security' when a person 1.) invests money 2.) in a `common enterprise' and 3.) is led to expect profits solely from the efforts of the promotor or a third party." Nutek, 977 P.2d at 830 (citing Howey, 328 U.S. at 301, 66 S.Ct. at 1100, 90 L.Ed. at 1244.)

[¶ 11.] The critical inquiry is the third prong of the Howey test-whether Tschetters were led to expect profits solely from the efforts of the promotor or a third party. We acknowledge, as other courts have done, that the use of the term "solely" is "not to be taken literally." Id. "Rather, the third prong is satisfied if `the efforts made by those other than the investor are the undeniably significant ones, those essential managerial efforts which effect the failure or success of the enterprise.'" Nutek, 977 P.2d at 830; citing SEC v. Glenn W. Turner Enters. Inc., 474 F.2d 476, 482 (9thCir.1973)

. The United States Supreme Court has also noted the definition of a security "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 in the promise of profits." Howey,

328 U.S. at 299,

66 S.Ct. at 1103,

90 L.Ed. at 1250.

[¶ 12.] The leading case interpreting the third prong of the Howey test is Williamson v. Tucker, 645 F.2d at 404. Williamson approaches this inquiry by recognizing that substance should take precedence over form. Id. at 422-23. The Williamson court set forth three factors to aid in this determination:

1. an agreement among the parties leaves so little power in the hands of the partner or venturer that the arrangement in fact distributes power as would a limited partnership; or

2. the partner or venturer is so inexperienced and unknowledgeable in business affairs that he is incapable of intelligently exercising his partnership or venture powers; or

3. the partner or venturer is so dependent on some unique entrepreneurial or managerial ability of the promoter or manager that he cannot replace the manager or the enterprise or otherwise exercise meaningful partnership or venture powers.

Id. at 424. These factors are not all-inclusive, and other considerations may come into play in each case. Id. at n. 5. In addition, we do not isolate these factors but consider them as a whole. Koch v. Hankins, 928 F.2d 1471, 1476-78 (9thCir.1991); Nutek, 977 P.2d at 831.

[¶ 13.] Based on the evidence in the record and South Dakota law, Tschetters had substantial rights and powers. South Dakota law vests the members of an LLC with management powers in proportion to their contribution of capital. SDCL 47-34-16. The members have the power to elect the managers of the LLC and set their responsibilities.

[¶ 14.] In addition, the Operating...