Westchester Corp. v. Peat, Marwick, Mitchell & Co.

• Court: U.S. Court of Appeals — Fifth Circuit
• Writing for the Court: Before WISDOM, RONEY and HATCHETT; RONEY
• Citation: Westchester Corp. v. Peat, Marwick, Mitchell & Co., 626 F.2d 1212 (5th Cir. 1980)
• Decision Date: 01 October 1980
• Docket Number: No. 79-1340,79-1340
• Parties: Blue Sky L. Rep. P 71,599, Fed. Sec. L. Rep. P 97,647 WESTCHESTER CORPORATION and Glenn McMillan Developing Company, Plaintiffs-Appellants, v. PEAT, MARWICK, MITCHELL & COMPANY et al., Defendants-Appellees.

Page 1212

626 F.2d 1212

Blue Sky L. Rep. P 71,599, Fed. Sec. L. Rep. P 97,647

WESTCHESTER CORPORATION and Glenn McMillan Developing Company, Plaintiffs-Appellants, v. PEAT, MARWICK, MITCHELL & COMPANY et al., Defendants-Appellees.

No. 79-1340.

United States Court of Appeals Fifth Circuit.

Oct. 1, 1980.

John A. Townsend, Robert I. White, Houston, Tex., for plaintiffs-appellants.

James C. Slaughter, Houston, Tex., for defendants-appellees.

Appeal from the United States District Court for the Southern District of Texas.

Before WISDOM, RONEY and HATCHETT, Circuit Judges.

RONEY, Circuit Judge:

Brought as a securities fraud action asserting both federal and state claims, this case involves a real estate sales contract. The seller of the land asserts the defendant auditors misrepresented the purchaser's financial condition. Holding that the contract was not a "security" under either the federal or state statutes, and that pendent state common law negligence and fraud claims were barred by the statute of limitations, we affirm the summary judgment for defendants.

Because the question whether a real estate contract is a security turns on the facts, we set them forth in some detail in a light most favorable to plaintiffs, the parties opposing the motion for summary judgment. Adickes v. S.H. Kress & Co., 398 U.S. 144, 157, 90 S.Ct. 1598, 1608, 26 L.Ed.2d 142 (1970).

Facts

In the middle 1960s plaintiff Westchester Corp., a Texas firm, conceived a plan to develop a large residential tract in Harris County, Texas. Under the plan, plaintiff Glenn McMillan Developing Co. (McMillan), a Westchester subsidiary, would prepare blocks of property for the commencement of actual construction of residential units. In 1973, after development of some of the sections had been completed, McMillan entered into a sales contract with a subsidiary of National Equities, Inc., an unrelated construction company to whom lots had previously been conveyed. Under the agreement, McMillan would develop the remainder of the tract and transfer it in phases on a scheduled basis to the purchaser, which agreed to pay fixed sums in cash as the properties were transferred. After each phase of property was improved and conveyed, McMillan was to have no further interest in or responsibilities toward the property.

The one exception to cash payments related to phase III of the project, a flood plain where residential construction was deemed impractical. Transfer of this portion of the project was to be for a lesser sum per acre than for the developed acreage, and was to be paid on a deferred basis.

Plaintiff sellers required some assurance from National Equities that it had the financial capabilities to carry out the plan as contemplated, due to the substantial undertakings required of Westchester and McMillan. Westchester relied upon representations in the form of financial statements prepared by National Equities' auditor, defendant Peat, Marwick, Mitchell & Co. Those financial statements indicated National Equities had a net worth in excess of $27-million, an amount substantially in excess of National Equities' commitments under the contract.

Prior to June 1974, the first development phase was completed, for which McMillan received $1,274,000. On June 24, 1974, however, McMillan sued National Equities and its subsidiary in Texas state court, alleging breach of contract for refusing to close on another phase of the development. The suit sought termination and cancellation of the contract and liquidated damages. Counsel for plaintiffs explained at oral argument that termination and cancellation of the contract were sought instead of specific performance because of the prospect that National Equities would be financially unable to perform. In December of 1974, McMillan recovered judgment for $898,600 against National Equities and its subsidiary for the liquidated damages. The judgment was affirmed by the Court of Civil Appeals in NEI Corp. v. Glenn McMillan Developing Co., 550 S.W.2d 113 (Tex.Civ.App. Houston 1977), and was later settled for $550,000.

On April 16, 1975, the Wall Street Journal reported National Equities "announced the resignation of it president and plans for an $11 million write-off." According to the Journal, the write-off was to be "reflected in the company's financial statement for the year ended March 21." The Journal reported in its April 28 editions that Peat, Marwick had withdrawn its certification from the National Equities financial report for fiscal 1974, and added that National Equities revealed "it was experiencing 'operating difficulties' and that its creditors were requiring immediate or accelerated repayment." These two articles were followed by a June 7 report in The Houston Post that National Equities was then experiencing operating difficulties, which a National Equities official blamed on " 'less than efficient management practices.' " The official also stated, " 'Texas lenders aren't willing to work with our company because of an auditing problem, which we are trying to get worked out.' "

During the pendency of the state court suit for liquidated damages, Westchester officials became aware of National Equities' deteriorating financial condition, and in January 1976 acquired 100 shares of National Equities stock in order to receive regular reports of National Equities' finances. Some time after April 29, 1976, Westchester received a copy of National Equities' annual report, which had been filed with the Securities and Exchange Commission for the fiscal year ending March 31, 1975. National Equities restated its financial statement in the report for the fiscal year ending March 31, 1974, and further revealed that Peat, Marwick had been dismissed as its auditor because of certain audit deficiencies. In explaining the financial statement adjustment, the company said the 1974 adjustments may have related back to earlier years. National Equities had also been named, along with Peat, Marwick, as a defendant in two actions commenced in federal courts in Ohio and New York, alleging various violations of the federal securities acts and the issuance of false and misleading financial statements. On December 2, 1975, National Equities and others brought suit in New York state court against Peat, Marwick alleging breach of contract and negligence in connection with its audit of National Equities' financial statements for the fiscal year ending March 31, 1974.

The suit at bar, not commenced until November 29, 1977, was brought against Peat, Marwick, a partnership with offices in Texas, and several of its partners. The district court, without findings or opinion, "concluded that all of the assertions of defendants' motion for summary judgment are meritorious," and entered judgment for defendants.

We have thoroughly reviewed the record and determined there are grounds upon which the district court's judgment may be sustained on each of plaintiffs' claims. See Jaffke v. Dunham, 352 U.S. 280, 281, 77 S.Ct. 307, 308, 1 L.Ed.2d 314 (1957); Gay Student Services v. Texas A & M University, 612 F.2d 160, 163 (5th Cir. 1980).

Federal Securities Claim

Plaintiffs alleged defendant, in the preparation of National Equities' financial statements, violated section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C.A. § 78j(b), and rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5 (1979). The key to recovery under these sections is the purchase or sale of a "security." National Bank of Commerce v. All American Assurance Co., 583 F.2d 1295, 1298 (5th Cir. 1978).

Plaintiffs assert the real estate contract is a "security." A real estate contract is not listed as a security in section 3(a)(10) of the Securities Exchange Act, 15 U.S.C.A. § 78c(a)(10), which defines a security for purposes of the Act. Investment contracts are listed as securities, however, and flexible principles applied to the definition require the real estate contract to be treated as a security if it has the essential elements of an investment contract, the economic reality being the basis for determination. Tcherepnin v. Knight, 389 U.S. 332, 336, 88 S.Ct. 548, 553, 19 L.Ed.2d 564 (1967). The Supreme Court has established three elements that bring an instrument under the definition of investment contract: (1) investment, (2) common enterprise, and (3) expectation of profit derived solely from the efforts of others. SEC v. W.J. Howey Co., 328 U.S. 293, 298-99, 66 S.Ct. 1100, 1102-03, 90 L.Ed. 1244 (1946). This definition under the Securities Act of 1933 can be treated as the same in the context of this case. United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 847 n. 12, 95 S.Ct. 2051, 2058 n. 12, 44 L.Ed.2d 621 (1975).

This Circuit has required all three Howey elements to be present for a land contract to constitute a security. Cameron v. Outdoor Resorts of America, Inc., 608 F.2d 187, 192-93 (5th Cir. 1979), modified on rehearing on other grounds, 611 F.2d 105 (1980). Contrary to plaintiffs' argument, the Howey test has not been met on the facts of this case.

First, there is no "common enterprise," since the fortunes of the investors are not " 'interwoven with and dependent upon the efforts and success of those seeking the investment or of third parties.' " SEC v. Koscot Interplanetary, Inc., 497 F.2d 473, 478 (5th Cir. 1974) (quoting SEC v. Glenn W. Turner Enterprises, Inc., 474 F.2d 476, 482 n. 7 (9th Cir.), cert. denied, 414 U.S. 821, 94 S.Ct. 117, 38 L.Ed.2d 53 (1973)). The contract in this case simply provided that the purchaser was to pay fixed sums at fixed intervals for phases of developed property as available for conveyance from the sellers. Under the contract, if a phase was not completed, the purchaser had no obligation. After conveyance of the tracts, the sellers' interest and responsibilities were to cease. This is not the kind of symbiotic relationship where "the fortunes of all investors are inextricably tied to the efficacy" of...