Tung Chan v. HEI Res., Inc.

• Decision Date: 04 June 2020
• Docket Number: Court of Appeals No. 18CA1769
• Court: Colorado Court of Appeals
• Parties: TUNG CHAN, Securities Commissioner for the State of Colorado, Plaintiff-Appellee and Cross-Appellant, v. HEI RESOURCES, INC., f/k/a Heartland Energy, Inc.; Charles Reed Cagle; Brandon Davis; Heartland Energy Development Corporation ; John Schiffner; and James Pollak, Defendants-Appellants and Cross-Appellees.

490 P.3d 789

TUNG CHAN, Securities Commissioner for the State of Colorado, Plaintiff-Appellee and Cross-Appellant,

v.HEI RESOURCES, INC., f/k/a Heartland Energy, Inc.; Charles Reed Cagle; Brandon Davis; Heartland Energy Development Corporation ; John Schiffner; and James Pollak, Defendants-Appellants and Cross-Appellees.

Court of Appeals No. 18CA1769

Colorado Court of Appeals, Division V.

Announced June 4, 2020

Philip J. Weiser, Attorney General, Robert Finke, First Assistant Attorney General, Charles J. Kooyman, Senior Assistant Attorney General, Denver, Colorado, for Plaintiff-Appellee and Cross-Appellant

Thomas Law LLC, Jeffrey R. Thomas, Denver, Colorado for Defendants-Appellants and Cross-Appellees HEI Resources, Inc. and Charles Reed Cagle

Holland & Hart, LLP, Marcy G. Glenn, Denver, Colorado; Munck Wilson Mandala LLP, Shain A. Khoshbin, S. Wallace Dunwoody, Chase A. Cobern, Dallas, Texas; Munck Wilson Mandala LLP, Jennifer D. Jasper, Austin, Texas, for Defendants-Appellants Brand Davis and Heartland Energy Development Corporation

Law Offices of Otto K. Hilbert II, Otto K. Hilbert, II, Denver, Colorado, for Defendants-Appellants John Schiffner and James Pollak

Robinson Waters & O'Dorisio, P.C., Tracy L. Ashmore, Denver, Colorado, for Amicus Curiae National Federation of Independent Business

Ballard Spahr LLP, Theodore J. Hartl, Denver, Colorado; Kameron Hillstrom, Washington, D.C., for Amicus Curiae North American Securities Administrators Associations, Inc.

Opinion by JUDGE J. JONES

¶ 1 Plaintiff, Tung Chan, in his official capacity as Securities Commissioner for the State of Colorado, brought this enforcement action against defendants, HEI Resources, Inc. (HEI), f/k/a Heartland Energy, Inc.; Heartland Energy Development Corporation (HEDC); Charles Reed Cagle; Brandon Davis; John Schiffner; and James Pollack, for allegedly violating the Colorado Securities Act (CSA) in forming several oil and gas exploration and drilling joint ventures. The gist of the Commissioner's position is that, notwithstanding that the investors are designated general partners in the joint ventures, their interests are securities (specifically, investment contracts) under the CSA and defendants violated certain requirements of the CSA when offering those interests.

¶ 2 In 2013, following a partial summary judgment and a trial, the trial court found that the joint venture interests aren't investment contracts and therefore aren't securities under the CSA. The court reached that conclusion after applying the leading case in this field, Williamson v. Tucker , 645 F.2d 404 (5th Cir. 1981), which identifies three ways in which a party can overcome a strong presumption (the so-called " Williamson presumption") that a general partnership interest isn't an investment contract (the Williamson tests).¹

¶ 3 The Commissioner appealed, and a prior division of this court reversed and remanded. Rome v. HEI Res., Inc. , 2014 COA 160, 411 P.3d 851 ( HEI I ). The division concluded that the Williamson presumption doesn't apply in an action under the CSA and that the trial court erred by considering the partners' general, rather than venture-specific, business experience under the second Williamson test. The division remanded to the trial court

for redetermination of whether the joint venture interests are securities under the second and third Williamson factors and any other ‘catch-all’ economic realities, taking into consideration our rejection of the strong presumption that general partnership interests are not securities and our determination that the relevant measure of business experience is experience in the business of the venture.

Id. at ¶ 61.²

¶ 4 On remand, the trial court first determined that the general partners' interests are investment contracts under the second and third Williamson tests and "other economic realities." After taking additional evidence, the court later ruled that defendants had violated the CSA, enjoined them from engaging in securities-related activities in Colorado, and ordered certain defendants to pay restitution to the Commissioner.

¶ 5 This time, both sides appeal — the Commissioner by way of cross-appeal.³ Though the parties raise a host of issues, we only need to address four raised by defendants: (1) whether the prior division erroneously departed from well-established federal securities law by rejecting the Williamson presumption; (2) whether the prior division erroneously held that the partners must have venture-specific experience under the second Williamson test; (3) whether the trial court improperly focused on whether the partners themselves could fill the role of the managing partner under the third Williamson test; and (4) whether the trial court erred by finding that the general partners' interests are investment contracts under "other economic realities."

¶ 6 For the reasons explained below, we agree with defendants that, contrary to the prior division's holding, the Williamson presumption applies when general partnership interests are alleged to be investment contracts under the CSA. We also agree with defendants, again contrary to the prior division's holding, that a collective lack of venture-specific experience isn't dispositive under the second Williamson test; it is relevant, but what ultimately matters is whether the partners have sufficient collective knowledge and experience to intelligently exercise their powers. And we conclude that under the third Williamson test the question isn't whether any of the general partners themselves could, if necessary, fill the role of the managing partner, but whether the managing partner is, considering the nature of the venture and the managing partner's knowledge and experience, essentially irreplaceable. These three conclusions are consistent with prevailing federal law applying corresponding federal statutes, which the General Assembly and the Colorado Supreme Court have expressly directed us to follow unless inconsistent with the purposes and provisions of the CSA. Lastly, we conclude that, although the three Williamson tests aren't exclusive, those tests account for economic realities, and the court should consider other economic realities only if they aren't adequately accounted for under the Williamson tests.

¶ 7 Accordingly, cognizant of our decision's whiplash effect, but nevertheless convinced that the prior division's decision is out of step with the applicable law, we reverse and remand to the trial court to determine, consistent with this opinion, whether the joint venture interests constitute investment contracts, based on the record developed to date.

I. Background

¶ 8 Much of the relevant background is recounted in HEI I . The following, however, should give the reader enough to understand how we got to where we are now.

A. Historical Facts

¶ 9 Beginning in 2004, defendants solicited thousands of, in the trial court's words, "wealthy, educated and sophisticated investors" nationwide by, in large part, cold-calling them and offering them interests in several oil and gas exploration and drilling joint ventures. If someone expressed interest in participating as a partner in a venture, they were sent an information package that included a "Confidential Information Memorandum" (CIM) and a "Joint Venture Agreement" (JVA).⁴ All parties acknowledge that, under the terms of the JVA, the joint ventures were organized as general partnerships under the Texas Revised Partnership Act, and that the partners ostensibly have significant management rights and responsibilities, such as the rights to call meetings, propose agenda items, access partnership records, receive business information, remove the managing partner, change the managing partner's powers, and otherwise actively run the business by majority vote. The JVA also says the partners are jointly and severally liable for any joint venture liabilities. The CIM delegates the venture's day-to-day operations to either HEI or HEDC as the initial "managing venturer."

B. Litigation

¶ 10 In 2009, the Commissioner filed a complaint against defendants, alleging that they had violated the CSA by employing unlicensed sales representatives to offer and sell unregistered securities.

¶ 11 The court granted summary judgment for defendants on the first Williamson test in 2011. Two years later, after a seven-day trial, the trial court found that the joint venture interests aren't investment contracts, and therefore aren't securities, under the CSA. Specifically, the court ruled that the Commissioner had failed to overcome the Williamson presumption by showing that those interests are investment contracts under the second and third Williamson tests.

¶ 12 On appeal, as previously discussed, a division of this court reversed and remanded. First, it concluded that the trial court erred by applying the Williamson presumption because Colorado hadn't adopted it. The division rejected the Williamson presumption, reasoning that (1) the presumption is inconsistent with the governing economic realities test; (2) how the presumption applies is unclear; (3) it is based on a policy judgment, which is for the General Assembly, not the courts, to make; and (4) it isn't necessary because the party claiming that the interests are securities ultimately bears the burdens of proof and persuasion anyway. Second, the division held that the trial court erred by considering the partners' experience in business affairs generally , rather than their "collective experience" specific to the oil and gas exploration and drilling business under the second Williamson test.

¶ 13 On remand, the trial court found that the joint venture interests are investment contracts because (1) the partners are incapable of intelligently exercising their partnership powers due to their relative collective inexperience with oil and gas exploration and drilling operations specifically (the second Williamson test); (2) the partners are dependent on HEI and HEDC's unique managerial...