Opinion
IP 01-0689-C-M/S
July 29, 2002
ORDER ON MOTION FOR JUDGMENT UPON THE PLEADINGS
This matter comes before the Court on a Federal Rule of Civil Procedure 12(c) motion by the counterdefendants Columbia Housing Partners SLP Corporation ("Columbia SLP"), Columbia Housing/PNC Institutional Fund II Limited Partnership ("Fund II"), and PNC Bank (collectively "Columbia Group"). Columbia Group requests that this Court dismiss Count IV of the Second Amended Counterclaim ("Counterclaim") filed by the counterplaintiffs Camby Housing Partners, LLC ("Camby LLC"), C. Salen Herke ("Herke"), Steven D. Shoup ("Shoup"), and Michele L. Wessler ("Wessler") (collectively "Camby Group") on the grounds that the terms of the partnership agreement between the parties renders that claim untenable.
Count IV of the Counterclaim is based upon Camby Group's belief that the partnership agreement it signed with Columbia Group in effect created a "security" interest, subject to the Indiana Securities Act. However, Columbia Group contends that Camby Group's interest cannot be considered a "security" under Indiana law because Camby Group was named as the "General Partner" in that agreement, rather than as a limited partner or investor. Columbia Group asserts that, because the partnership agreement with Camby Group specifies that Columbia Group is to take on certain management responsibilities for the joint venture, there is no set of facts which Camby Group could put forth to support its contention that its partnership interest was really a security interest under Indiana law.
The Court has considered the parties' arguments and, for the reasons discussed below, finds that Count IV of Camby Group's claim cannot be decided on the basis of the partnership agreement alone. Although Columbia Group points to a number of provisions in the partnership agreement which indicate that Camby Group was given responsibility for managing the joint venture, thus allegedly invalidating its claim that it was merely a (passive) investor in a "security" managed by others, Camby Group has pointed to a number of provisions in the agreement which seem to shift de facto control back to Columbia Group. Thus, there is a question of fact about how the partnership agreement really worked.
Moreover, Indiana law does not preclude a person who invests in a partnership from claiming a security interest in the investment merely because the partnership agreement refers to that person as a "managing" or "general partner." Rather, Indiana law takes a functional approach which requires an analysis of the actual role that the person plays in the performance of the partnership duties. Because Camby Group has alleged that, in fact, it did not have the type of control over partnership affairs usually associated with a general partner and because, for the purpose of this Rule 12(c) motion, the Court must assume that the facts are as Camby Group asserts, the Court finds that a dismissal upon the pleadings is not appropriate. Therefore, the Court DENIES Columbia Group's motion.
I. FACTUAL AND PROCEDURAL BACKGROUND
The relevant facts, as alleged or implied in the pleadings (and attached exhibits), when viewed in the light most favorable to Camby Group, are these:
The individual counterplaintiffs, Herke, Shoup, and Wessler, owned land on the west side of Indianapolis (along Camby Road) and were interested in developing that land. Counterclaim, ¶ 1. Beginning in the spring of 1998, representatives of PNC Bank began meeting with them to discuss the possibility of developing their land as a low-income apartment project (the "Project") of the type that would qualify for a low-income housing tax credit ("LIHTC"). Id., ¶ 3. PNC Bank represented that it and its affiliated companies had the special expertise necessary to advise the counterplaintiffs in such a project, describing itself as a "one-stop shop" for all aspects of LIHTC financing. Id., ¶¶ 3, 4.
Relying upon the professed expertise of PNC Bank and its affiliates, the counterplaintiffs agreed to have Columbia Group act on its behalf in developing the Project. Neither Columbia Group, nor any of its agents, disclosed to the individual counterplaintiffs the special risks entailed in pursuing an LIHTC project. Id., ¶ 9. These risks were well known to Columbia Group, as evidenced by the fact that two of the senior officers of Columbia SLP authored an article on the pitfalls of LIHTC financing entitled Tax Credit Investments Hide Minefield of Financial Risks, which was published in the November 3, 2000, issue of the American Banker. Id., ¶¶ 7,8 and Ex. 2.
In September of 1998, Columbia Group and Camby Group reached an agreement (the "Partnership Agreement") to form the United Partnership of Camby Crossing Apartments, L.P. (the "Partnership"), for the purpose of developing and operating an LIHTC housing complex on the counterplaintiffs' property. See Exhibit ("Ex.") E to the First Amended Complaint ("Complaint") for a complete copy of the Agreement. The Partnership Agreement and related financial documents were drafted by PNC Bank. Counterclaim, ¶ 15. The Agreement names Camby LLC as the "General Partner" with a capital contribution of $100, Columbia SLP as the "Special Limited Partner" with a capital contribution of $10, and Fund I (the predecessor to Fund II) as the "Investment Limited Partner" with an "agreed to capital contribution" of $2,002,900. Partnership Agreement § 1.3 and exhibit 3 as appended to that agreement.
Columbia SLP is wholly owned by PNC Financial Services Group. Id., ¶ 7. It was included in the partnership "to provide advice and assistance relating to the administration, management and direction of the business; to monitor the activities of the Project Manager . . .; to monitor the preparation of all financial and other reports required [by] the Partners; and to provide its Consent . . . with respect to certain operations of the Partnership." Partnership Agreement, §§ 1.3(d), 3.2(a). Fund I (subsequently, Fund II) was included to provide working capital, subject to various conditions precedent that Camby Group was required to meet. Agreement, §§ 3.2(b), 10.7(a). PNC Bank was to provide a "bridge loan" and serve as trustee to the initial bond offering. Counterclaim ¶ 13.
The parties anticipated that the Project would be financed in large part by tax-exempt bonds issued by the City of Indianapolis for a "maximum anticipated amount of $5,400,000." Partnership Agreement, Article II. In order to obtain these bonds, Camby Group was required to advance certain funds at the outset, which Columbia Group promised to return at the time the bond financing deal closed. Counterclaim, ¶ 20. However, the funds were not returned at closing. Id. In addition, the parties established a "bridge loan" to be provided by PNC "in the anticipated amount of $1,500,000," with "up to $600,000 [being] available upon the closing of the Bond Financing and the balance . . . available on a draw basis for construction costs after Bond Commencement." Partnership Agreement, Article II.
Apparently, the interest rates for the type of bond financing sought by the partners increased significantly between the time the Partnership Agreement was signed and the time that the bond deal closed. Counterclaim, ¶¶ 22, 23. As a result, Camby Group was required to pay approximately $867,000 to buy down the interest rate on the bonds in order to finance the Project. Counterclaim, ¶ 26(b). Columbia Group neglected to warn Camby Group, at the time the Partnership was formed, that this might happen, and failed to advise Camby Group to obtain insurance to protect against such an increase. Counterclaim, ¶¶ 9, 22, 23.
In the mean time, in December of 1999, Columbia SLP issued a "pre-development loan" to Camby LLC in the amount of $150,000. Complaint, Ex. A (the loan agreement), Ex. B (the promissory note), and Ex. D (the demand note). According to the promissory note, the loan was scheduled to mature on November 30, 2000. Complaint, Ex. B. The purpose of the loan was "solely to provide Borrowers [with] funds to allow the General Partner [Camby Group] to fulfill its obligations . . . to PNC." Complaint, Ex. A. The loan agreement stipulated that no portion of the loan may be used for any other purpose than to pay PNC Bank. Id. Herke, Shoup, and Wessler each personally guaranteed the loan. Complaint, Ex. C (the guaranty notes).
On January 18, 2001, Columbia SLP formally demanded repayment. Complaint, Ex. D. However, as of May 9, 2001, the loan still had not been repaid. Complaint, ¶ 11. At that time, the principal, together with the accrued interest, amounted to $165,162.22. Id.
In its claim against Camby Group, Columbia Group seeks to recover for the unpaid loan. Complaint, ¶¶ 6-12. In addition, Columbia Group alleges breach of the Partnership Agreement, Complaint ¶¶ 13-17, in that Camby Group failed "to perform various duties" which were "conditions precedent to [certain] obligations of the limited partners, including the obligation of Fund II to advance monies at various times." Complaint ¶ 14. Columbia Group further asserts that it was forced "to advance substantial sums" to third parties to keep the Project from defaulting, and that it "incurred [a] substantial . . . loss" in being unable to claim the intended tax credits as a result of Camby Group's failure to perform its duties. Id. All told, Columbia Group claims to have suffered $528,000 in damages from the breach of the Partnership Agreement. Id.
Camby Group, in turn, claims that Columbia Group breached the Partnership Agreement, in that Fund II reneged upon its obligation to provide capital for the Project. Counterclaim, ¶¶ 26(a), 30. Specifically, PNC Bank promised that certain cash advances made by Camby Group would be returned at the time the bond financing closed, but they were not. Counterclaim, ¶ 20. Instead, Camby Group was forced to contribute the additional $867,000 necessary to buy down the bond interest rates. Id., ¶¶ 19, 22. And, Camby Group was forced to borrow the additional $150,000 that is the subject of Columbia Group's Complaint. Id., ¶¶ 19, 26.
In addition, the Partnership Agreement prescribed that "the Partnership shall . . . pay a Development Fee of $772,000 to the Developer for services rendered in negotiating, coordinating and supervising the planning, architectural, engineering and construction services necessary for the construction of the Project." Partnership Agreement, § 6.8(b). Camby LLC was designated as the "Developer" of the Project. Counterclaim, ¶ 28. Therefore, Camby LLC was to receive $772,000 from the Partnership under the Agreement. At least $330,206 of that amount was designated to "be paid from the Third Installment of Capital Contributions of the Investment Limited Partner [Fund II]." Id. Camby Group alleges that Camby LLC performed all the conditions precedent for receiving these funds, but never received them. Counterclaim, ¶ 30.
Camby Group implies in its counterclaim that the entire $772,000 was to be paid by Fund II. Counterclaim, ¶ 29. But as far as the Court can tell, the remaining $441,794 is a "Deferred Development Fee" which need not be paid until January of 2008 "from the proceeds of the additional Capital Contribution made by the General Partner pursuant to Section 3.1." Partnership Agreement, § 6.8(b).
Camby Group also contends that Columbia Group breached the Partnership Agreement by failing to provide the expert advice about LIHTC projects which it promised, and by interfering with Camby Group's attempts to fulfill its obligations under the Partnership Agreement. Counterclaim, ¶ 26. In some instances, this interference took the form of withholding the consent necessary for Camby Group to perform said obligations. Id.
The parties dispute whether the intended role of Camby Group was to be more like an investor or more like a manager of the Project. The Partnership Agreement provides that Camby Group is the "General Partner," with Camby LLC, as its designated agent, responsible for performing all the duties ascribed to the General Partner. Partnership Agreement, §§ 1.3 (with attached Exhibit 3), and 6.10.
Section 6.1 then unequivocally states that the General Partner is "responsible for the management of the Partnership business." However, Section 6.2 is not so clear-cut. After first conferring upon the General Partner the same authority, rights, and powers that a general partner would have by law if there were no limited partners, Section 6.2 then states that those rights are limited by "Section 6.3 and other specific provisions contained" in the Partnership Agreement.
For example, Camby Group, through its agent Camby LLC, was granted the authority to bring, defend, or settle claims of or against the Partnership. Id., § 6.2(f). However, that authority was limited by the requirement that Camby Group may not settle any litigation in an amount exceeding $10,000 "without the Consent of the Investment Limited Partner and the Special Limited Partner." Id., § 6.3(h). As another example, Camby Group was granted the authority to deposit, withdraw, invest, pay, retain, and distribute Partnership funds in a manner consistent with the Agreement. Id., § 6.2(h). However, that authority was limited by prohibitions against selling or otherwise transferring any assets of the Partnership, and against borrowing any money except for the Bond Financing, the Bridge Loan, and small amounts of operating cash (not to exceed $10,000), "without the Consent of the Investment Limited Partner and the Special Limited Partner." Id., § 6.3(b),(d),(e).
From the start of the Project, the Partnership Agreement provided specific direction to Camby Group on how to conduct its business. In particular, Camby Group was required to hire Oakwood Construction Company of Michigan to build the apartment complex. Partnership Agreement, Article II ("Builder"). In addition, the Agreement conferred significant control over the financing and construction of the Project upon the Special Limited Partner (i.e. Columbia SLP). Specifically, Section 6.5(l) forbade the Developer and the General Partner from exceeding any "line item in connection with the construction of the Project . . . unless the Consent of the Special Limited Partner shall have been received thereto," and Section 6.5(j) required that all proposed documents in connection with the Bond Financing be "submit[ted] to the Special Limited Partner for its approval."
Once construction was completed, Camby Group was required to hire Flaherty Collins Real Estate Services of Indianapolis as the "Project Manager," responsible for "manag[ing], operat[ing], and maintain[ing] the Project on a day-to-day basis," and for "rent[ing] the apartment units in the Project in compliance with all of the regulations, requirements and restrictions of the Lender, the Agency and any other regulatory agency." Id., § 6.11. The Agreement further specified the financial terms of the contract that Camby Group was to sign with the Project Manager and then prohibited Camby Group from extending or renewing that contract without the approval of the Special Limited Partner. Id.
Although the Partnership Agreement does give the General Partner ongoing authority to terminate the Project Manager's contract with or without cause, it also requires that any new Project Manager be approved by the Special Limited Partner. Id. In addition, the Agreement requires the General Partner to grant the Special Limited Partner an irrevocable power of attorney to terminate the Project Management Agreement or take other action it "may deem to be necessary or appropriate in order to effectuate the provisions of this Section 6.11." Id.
At every point where the Partnership Agreement purports to grant the General Partner discretion, it also limits that discretion. For example, the Partnership Agreement charges Camby Group, as General Partner, with the duty to use its best efforts to maximize net revenue from the Project, but this is "subject [to an] overriding obligation to ensure the maximum availability of Tax Credits to the Partnership." Id., §§ 1.5, 6.5(b). The Partnership Agreement also charges Camby Group, as General Partner, with the duty to procure and maintain all policies of insurance, but this is subject to very specific requirements as to the kinds and amounts of insurance which must be carried. Id., § 6.5(c). The Partnership Agreement further charges Camby Group, as General Partner, with the duty to establish and maintain "reasonable reserves to provide for working capital needs, improvements, replacement, operating deficits and any other contingencies of the partnership," but again, the amount of money that must be set aside monthly for various purposes is specifically spelled out by the Partnership Agreement. Id., § 6.5(e).
Under the terms of the Partnership Agreement, the Special Limited Partner continues to exert control in other ways as well. The General Partner must submit an annual budget of capital expenditures to the Special Limited Partner for approval. Id., § 6.5(e)(1). Any subsequent disbursement which would exceed the amount budgeted must be approved by the Special Limited Partner. Id.
Section 10.3(a) ostensibly gives the General Partner the power to choose an accountant to handle the Partnership's taxes. Id., § 10.3. However, Section 10.3(b) grants the Special Limited Partner a power of attorney to "appoint replacement Accountants of its own choosing." Id.
Finally, Section 7.7 establishes that the Special Limited Partner may remove the General Partner for "fraud, bad faith, gross negligence or willful misconduct" (as determined solely by the Special Limited Partner), or for various other acts including any act which is in violation of the Partnership Agreement. Id., § 7.7(a)(1), (b). The Partnership Agreement then requires the General Partner to grant the Special Limited Partner an irrevocable power of attorney to remove the General Partner pursuant to any of the reasons listed in Section 7.7. Id., § 7.7(b).
II. STANDARDS A. Judgment on the Pleadings
Motions made pursuant to Federal Rule of Civil Procedure 12(c) are judged under the same standard as under Rule 12(b)(6) (failure to state a claim upon which relief can be granted). Northern Ind. Gun Outdoor Shows, Inc., v. City of South Bend, 163 F.3d 449, 452 (7th Cir. 1998). The Court must accept as true all well-pleaded allegations in Camby Group's complaint and all reasonable inferences therefrom. Gastineau v. Fleet Mortgage Corp., 137 F.3d 490, 493 (7th Cir. 1998). Dismissal is appropriate only if it appears beyond doubt that Camby Group can prove no set of facts, consistent with the allegations, that would entitle it to relief. Hentosh v. Herman M. Finch Univ. or Health Sciences, 167 F.3d 1170, 1173 (7th Cir. 1999).
The issue before the Court is a narrow one — not whether Camby Group is likely to prevail on Count IV, but only whether Camby Group's complaint is sufficient to entitle it to move the case forward and offer supporting evidence. Scheuer v. Rhodes, 416 U.S. 2323 (1974). Therefore, in moving for dismissal, Columbia Group may not challenge the factual basis for Camby Group's allegations. Rather, Columbia Group must show that, even if true, the allegations have no legal consequence. Gomez v. Illinois State Bd. of Ed., 811 F.2d 1030, 1039 (7th Cir. 1987).
Rule 12(c) further provides: "If . . . matters outside the pleading are presented to and not excluded by the court, the motion shall be treated as one for summary judgment and disposed of as provided in Rule 56." This is not discretionary. However, this rule must be read in conjunction with Federal Rule of Civil Procedure 10(c) which provides that "any written instrument which is an exhibit to a pleading is a part thereof for all purposes." Because Camby Group's Counterclaim subsumes within it the original Complaint by Columbia Group, to which the Counterclaim responds, the exhibits attached to Columbia Group's Complaint will also be considered part of the pleadings, to the extent that they are "referred to in [Camby Group's] complaint and [are] central to [Camby Group's] claim." Venture Associates Corp. v. Zenith Data Systems Corp., 987 F.2d 429, 431 (7th Cir. 1993).
B. Securities Law
"The word `security' is ordinarily used as a synonym for `investment'." Holloway v. Thompson, 42 N.E.2d 421, 424 (Ind.App. 1942). However, there is no precise legal definition. Id. The Indiana Code contains a long list of types of investments that might be considered securities, including "a note, stock, treasury stock, bond, debenture, evidence of indebtedness, an interest in a limited liability company or limited liability partnership, . . ., participation in a profit-sharing agreement, . . ., investment contract," and so forth. I.C. 23-2-1-1(k) (emphasis added). But the question is one of substance not form. Holloway, 42 N.E.2d at 424. "To determine whether an interest is a security, it must be examined in light of the purposes to be accomplished by its issuance and all surrounding circumstances." Id.
Federal law, based upon the Securities Acts of 1933 and 1934, also provides a list of types of investments that might be considered "securities", including "any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit sharing agreement, . . ., investment contract," and so forth. 15 U.S.C. § 77(b)(1).
The federal "definition" does not mention limited liability agreements, much less general partnerships. Id. However, in Williamson v. Tucker, the Fifth Circuit noted that it "has long been held" that a limited partnership agreement constitutes an investment contract. 645 F.2d 404, 423 (5th Cir. 1981). According to the Williamson Court, it follows that a general partnership interest may also be considered an investment contract if "some agreement among the partners places the controlling power in the hands of certain managing partners" and not others. Id.
This is consistent with the Supreme Court's holding that "Congress intended application of [the Securities Acts] to turn on the economic realities underlying a transaction and not on the name appended thereto." United Housing Foundation, Inc. v. Forman 421 U.S. 837, 849 (1975) (emphasis added). The "economic reality" test developed by the Supreme Court contains four elements: (1) an investment, (2) in a common venture or enterprise, (3) premised upon a reasonable expectation of profits, (4) to be derived from the entrepreneurial or managerial efforts of others. Id. at 852 (citing SEC v. W.J. Howey, 328 U.S. 293 (1946) for the formulation of the test).
This Court knows of no case in which an Indiana court has ruled on the question of whether a so-called general partner's interest in an enterprise can be considered a security under Indiana law. However, in two opinions dated September 20, 1993, the Indiana Securities Commissioner ("Commissioner") elaborated upon the circumstances under which an "investment contract" or a "limited liability interest" should be regarded as a security. See www.state.in.us/sos/securities/orpol.html (visited July 8, 2002) (hereinafter referred to as "Indiana Policy on Investment Contracts" and "Indiana Policy on Limited Liability Interests", respectively).
According to the Commissioner, the types of investment contracts to be considered securities include, but are not limited to those that meet either or both of (1) the economic reality test, or (2) the risk capital test. The former test mirrors the federal economic reality test described above. The latter test was developed in Hawaii v. Hawaii Market Center, 485 P.2d 105 (Haw. 1971), and holds that "any investment . . . in the risk capital of a venture . . . where the investor has no direct control over the investment or policy decisions of the venture" is a security. See Indiana Policy on Investment Contracts.
In assessing the "entrepreneurial or managerial efforts of others" for the economic reality test or the "direct control over the . . . policy decisions of the venture" for the risk capital test, the Indiana Securities Division focuses upon "whether the efforts made by those other than the investor are . . . essential [to] the failure or success of the enterprise." Id. (quoting SEC v. Glenn W. Turner Enters., Inc., 474 F.2d 476, 482 (9th Cir. 1973). A partnership interest is not excluded from consideration merely because the investor also makes some (minor) managerial contributions to the enterprise. Indiana Policy on Investment Contracts. Indiana law requires that "the anticipated profits be derived substantially from the efforts of others" (emphasis added); it does not require that they be derived solely therefrom. Id. Moreover, the Indiana Securities Division focuses on those managerial efforts which have the greatest impact upon the outcome of the venture, rather than those which take the most time or effort. Id. (citing Glenn Turner, 474 F.2d at 482-3; Forman, 421 U.S. at 852; and Sheets v. Dziabis, 738 F. Supp. 307, 311 (N.D.Ind. 1990). "[T]he unscrupulous promotor [sic] cannot avoid classification of an investment scheme as an investment contract simply by requiring the investor to furnish a modicum of physical labor." Indiana Policy on Investment Contracts.
The Indiana Securities Act itself mandates that its provisions be "liberally construed to the end that . . . [t]he practice or commission of fraud may be . . . prevented [and] . . . [d]isclosure of sufficient and reliable information . . . for the exercise of independent judgement [by] the persons involved may be assured." I.C. sec. 23-2-1-15(g). Thus, the Indiana Securities Division interprets the term "investment contract" broadly. Indiana Policy on Investment Contracts. This is consistent with the "canon of legislative construction that remedial legislation is to be interpreted broadly," Glenn Turner, 474 F.2d at 480, and the federal policy that the definition of security should be flexible so that it can be "adapted to the countless and variable schemes devised by those who seek to use [the] money of others on the promise of profits." Howey, 328 U.S. at 299.
Indiana law treats a partnership agreement as a form of investment contract. Indiana Policy on Limited Liability Interests. Thus, to determine whether a partnership interest is a security, the Indiana Securities Division applies the investment contract analysis discussed above. Id. In particular, a partnership interest will be considered a security under Indiana law if it meets either the economic reality test or the risk capital test. Id.
According to the Commissioner, most of the cases involving limited partnership interests raise "little or no question [about whether] there has been an investment in a common enterprise or venture with the expectation of a profit or benefit to the investor." Id. Therefore, "under either of the alternative investment contract definitions specified above, the . . . focus [will be] on the nature of the [limited partner's] right to participate in the management and operation of the venture." Id. The Commissioner further advises that the analogous principle applies to general partnerships as well. "[T]he . . . focus [should be] on the nature of the general partner's right to participate in the management of the enterprise." Id.
The Commissioner identified the Williamson case cited above (interpreting federal securities law) as the leading case with regard to this partnership issue.
Williamson recognized that . . . a general partnership interest may be a security in two ways. The first way is if the general partner [explicitly] relinquishes its statutory rights . . ., for example, [by] appointing a managing partner or designat[ing] a third-party such as the promoter to manage the partnership's affairs.
The second [way is] . . . if the general partner retain[s] management authority, [but] as a practical matter [cannot] exercise that authority in a meaningful way. . . . [This] most commonly arises . . . in a[n] enterprise which requires a special business expertise which the general partner lacks. In that situation, the general partner must rely on the expertise of some third-party, often the promoter, to manage and operate the business.
Indiana Policy on Limited Liability Interests (citing Williamson, 645 F.2d at 422-3).
Curiously, Columbia Group asserts that "Indiana's definition of `security' is functionally equivalent to the federal definition," citing American Fletcher Mortgage Co., Inc. v. U.S. Steel Credit Corp., 635 F.2d 1247, 1253 (7th Cir. 1980) (incorrectly) for that proposition. Columbia Group then argues that federal law holds that "general partnership interests, like [Camby's], are not `securities,'" citing Williamson. Columbia Group's Brief at 6-7. But, according to the Commissioner, Williamson stands for the proposition that general partnership interests may be considered security interests, under the right circumstances. Thus, to uphold Columbia Group's argument, the Court would have to find that: (a) Indiana is bound by federal law, but (b) the Commissioner has misinterpreted Williamson. The Court respectfully declines to do so. In the first place, this Court prefers to avoid ruling on controversial matters of state law. In the second place, the Court finds that the Commissioner's interpretation of federal law in the Williamson case is essentially correct. In the third place, the Indiana definition of `security' is somewhat broader than the federal definition, as demonstrated by B T Distributors, Inc. v. Riehle 366 N.E.2d 178 (Ind. 1977). In Riehle, the Indiana Supreme Court held that a stock transaction for the sale of an entire business was subject to the Indiana Securities Act. By contrast, the sale of an entire business cannot be considered the sale of a security under federal law because it does not meet the economic reality test. The Buyer is not engaged in a joint venture with the Seller. And, the Buyer does not anticipate that its profits will be derived from the entrepreneurial or managerial efforts of the Seller. Although federal courts in Sheets v. Dziabis, 738 F. Supp. 307, 311 (N.D.Ind. 1990), and Canfield v. Rapp Son, Inc., 654 F.2d 459, 463 (7th Cir. 1981), have stated that the Indiana definition is functionally equivalent to the federal one, the only Indiana court to comment on this issue has pointed out that such a holding does not square with Riehle. Wisconics Engineering, Inc. v. Fisher, 466 N.E.2d 745, 760-1. (Ind.App. 1984). Therefore, this Court will refrain from proliferating the notion that the two laws are equivalent.
On the other hand, the Indiana Securities Act specifically excludes from consideration any (limited) partnership interest in which the partner is actively engaged in the management of the enterprise. A "security" does not include "an interest in a . . . limited liability partnership if the person claiming that the interest is not a security can prove that all of the members of the . . . limited liability partnership are actively engaged in the management of the . . . partnership." I.C. 23-2-1-1(k)(3). It is significant to note that this statutory provision places the burdens of production and persuasion on Columbia Group, the party claiming that the Partnership interest is not a security.
III. DISCUSSION A. Jurisdiction
Columbia SLP is an Oregon corporation whose principal place of business is Portland, Oregon. First Amended Complaint, ¶ 1. Fund II is a limited partnership. Id., ¶ 2. Its general partner, Columbia/PNC Fund II, Inc., is a Massachusetts corporation and has its principal place of business in Oregon. Id. Its limited partners are PNC Bank, a United States corporation with principal place of business in Pennsylvania; Federal National Mortgage Association, a United States corporation with principal place of business in Virginia; West Coast Bank, an Oregon corporation with principal place of business in Oregon; Heller Affordable Housing, Inc., a Delaware corporation with principal place of business in Illinois; and Xilinx, Inc., a Delaware corporation with principal place of business in California. Id.
Camby LLC is a limited liability company. Id., ¶ 3. Herke, Shoup, and Wessler are citizens of Indiana. Id. The alleged damages exceed $75,000. Therefore, this Court has diversity jurisdiction, pursuant to 28 U.S.C. § 1332.
B. The Partnership as a Security Interest
This Court has no reason to doubt that both the Indiana Policy on Investment Contracts and the Indiana Policy on Limited Liability Interests, discussed above, present an accurate analysis of the current state of the law in Indiana with regard to the question of whether a partnership interest may be considered a security. That being so, the Court finds that Columbia Group's motion to dismiss has no merit.
It is true that the Partnership Agreement between Camby Group and Columbia Group plainly states that Camby Group is the "general partner" in their joint enterprise. It also is true that a general partner normally is expected to play a prominent role in the management of the enterprise and not to rely primarily upon the knowledge and efforts of others to make that enterprise profitable.
However, the mere fact that Camby Group was designated as "general partner" does not mean that Camby Group functioned as one. Nor does the fact that Camby Group (freely) accepted the "general partner" mantel when it signed the Partnership Agreement preclude it from arguing now that its partnership interest was, in reality, limited. According to both the express language of the Indiana Securities Law and the interpretation provided by the Commissioner, the policy objective of preventing fraud in the sale of securities outweighs any contrary consideration that the parties should be free to define their respective partnership roles entirely as they wish. Indeed, in the Policy on Limited Liability Interests, the Commissioner explicitly endorsed the holding of Williamson to the effect that a so-called general partner may be found to be a de facto limited partner if either: (a) an agreement between the parties sufficiently limits the management prerogatives of said partner to the point that said partner does not exercise substantial control over the enterprise, or (b) the special expertise of the promoter, or of another so-called limited partner, renders that party the de facto managing partner.
Thus, the narrow question before this Court is whether there is any set of facts which Camby Group could prove, consistent with the pleadings and associated exhibits, that would establish that it satisfied either criterion (a) or (b) above. The Court finds that there are plausible facts which would enable Camby Group to meet both criteria. Therefore, dismissal of Camby Group's claim at this time is inappropriate.
The Court recognizes that Indiana law may not require that a proof be structured along the lines of criterion (a) or (b). As discussed in the standards section above, these criteria are rooted in the economic reality test and the risk capital test, both of which have been endorsed by the Commissioner as a sufficient but not necessarily exclusive means to prove that an investment is a security. Based upon the facts of this case, however, the Court need not consider other possible criteria.
Of course, Columbia Group argues that the provisions of the Partnership Agreement are unambiguous. "[I]t is undeniable from the Partnership Agreement that Camby, as General Partner, agreed to assume and actually assumed substantial authority and control over the day-to-day operations of the [P]roject, during construction and lease-up until the present." Brief in Support of Motion on the Pleadings at 3.
Before proceeding to the substance of this argument, however, the Court notes that it is logically unsupportable as stated. A mere piece of paper, such as the Partnership Agreement, cannot render it "undeniable" that "Camby . . . actually assumed substantial authority . . . over . . . the [P]roject," Nevertheless, the Court agrees that if the Partnership Agreement were truly unambiguous in granting Camby Group primary authority, it would be hard to explain how Columbia Group could have usurped that authority without expressly violating the management terms of the Partnership Agreement, something which Camby Group does not allege.
Therefore, hyperbole aside, Columbia Group's real point seems to be that Camby Group cannot possibly meet criterion (a). To that end, Columbia Group points to certain terms of the Agreement which, taken out of context, appear to grant Camby Group unambiguous authority:
1. Camby Group, as the General Partner, is responsible for the management of the Partnership business.
2. Camby Group possesses all rights and powers generally conferred by law upon a general partner.
3. Camby Group possesses the authority to bring, defend, or settle any lawsuit on behalf of the Partnership.
4. Camby Group possesses the authority to invest, pay, retain, and distribute Partnership funds.
5. Camby Group is charged with the duty to use its best efforts to maximize net cash flow.
6. Camby Group is responsible for procuring and maintaining all policies of insurance required of the Partnership.
7. Camby Group is responsible for establishing and maintaining reasonable reserves to provide for the working capital needs and any other contingencies of the Partnership.
Brief in Support of Motion on the Pleadings at 4-5.
However, this recitation of terms of the Agreement is disingenuous because, as noted in the fact section above, every one of these rights and powers is also strictly limited. The Partnership Agreement gives rights and then takes them away. For example, Camby Group does not have the right to settle a lawsuit for more than $10,000. Camby Group's true overriding concern must be to maximize tax credits, not rental income or net revenue. And, the amount and method of establishing reserve funds, as well as the way those funds must be spent, are strictly prescribed by the Agreement, with any discretion on the part of the General Partner being subject to the express approval of the Limited Partners.
Indeed, viewed in its entirety, the Agreement does not state that Camby Group has the rights and powers ordinarily conferred by law upon a general partner; it says that Camby Group has the rights and powers of a general partner, "[s]ubject to Section 6.3 and other specific provisions contained herein." Partnership Agreement § 6.2 (Powers). The question is how extensive the limitations are. Columbia Group asserts that Camby Group was "obligated to exercise substantial control and authority over the day-to-day operations of the [P]artnership." Brief in Support of Motion on the Pleadings at 7. But the Court finds that the Partnership Agreement is ambiguous on this point. Once the limitations are taken into account, there is a question of fact as to whether Camby Group had substantial control over the day-to-day operations of the Partnership.
Moreover, determining who controls the day-to-day operations is not the proper focus of this inquiry. Looking at the facts in the light most favorable to Camby Group, the specific examples of "day-to-day" control alleged by Columbia Group primarily refer to certain mundane bureaucratic work that Camby Group performed for the Partnership. But the fundamental question under Indiana law is: who, under the Partnership Agreement, was granted control of those managerial efforts most likely to affect the overall success of the venture? Did Camby Group have the power to exercise the kind of "substantial control over [it]s investment [necessary] to protect" its own interests from predation by Columbia Group? Williamson, 645 F.2d at 424.
The facts seem to suggest that Camby Group did not. The Partnership Agreement specified who the Builder of the apartment complex was to be and who the Project Manager was to be. The Project Manager, and not the General Partner, was given responsibility for "manag[ing], operat[ing], and maintain[ing] the Project on a day-to-day basis," and for "rent[ing] the apartment units in the Project in compliance with all of the regulations, requirements and restrictions of the Lender, the Agency and any other regulatory agency." Id., § 6.11.
Because, according to the pleadings, Columbia Group wrote the Partnership Agreement, it is not unreasonable to infer that Columbia Group chose the Builder and the Project Manager without consulting Camby Group. Furthermore, Columbia Group dictated the most important terms of the management contract that Camby Group was required to sign with the Project Manager, and reserved for itself an irrevocable power of attorney to replace the Project Manager without consulting Camby Group. In addition, it is undisputed that the Partnership Agreement gave Columbia Group control over the process of arranging the special bond financing that was necessary for the Project to be successful.
It seems clear to this Court (and the parties have not argued otherwise) that the building, financing, and managing of the apartment complex comprise most, if not all, of the vital functions necessary for the success of the enterprise. Therefore, the Court finds that the substantial powers reserved for Columbia Group in the Partnership Agreement are more than enough to raise a question of fact as to whether the profits anticipated from the joint venture were to be derived substantially from the efforts of Columbia Group, rather than Camby Group.
Still, the Court wishes to emphasize the subtle nature of this question. It is not enough for Camby Group to argue that it delegated its authority as General Partner to Columbia Group, to the Builder, or to the Project Manager. Id. at 423. The mere delegation of duties does not give rise to the sort of dependence on others that is required by the economic reality test. Id. The question is one of ultimate authority. Id. at 424. Camby Group alleges that, according to the Agreement, it did not have the right to control the essential management decisions in the first place. If so, then its investment should be classified as a security under Indiana law.
On the other hand, Columbia Group argues that Camby Group was actively engaged in management decisions from the start, and therefore had the ability to protect its own investment interest without resort to the special protection of Indiana Securities Law. For example, Columbia Group notes that Camby Group had the power to fire the Project Manager with or without cause. That would seem to indicate ultimate control, or at least a share of ultimate control. But the Court has already noted that the Partnership Agreement does not grant Camby Group the correlative right to hire a replacement Project Manager without Columbia Group's approval. By contrast, the Agreement gives Columbia Group both the power to fire any Project Manager that it deems unsatisfactory and the power to hire a replacement, with or without Camby Group's approval. Thus, the Court finds that the Partnership Agreement is ambiguous about ultimate control. Further fact-finding about the intent of the parties and their actual practice in implementing the Agreement would seem to be necessary.
Moreover, as noted in the standards section above, the burden does not lie with Camby Group to prove that it did not have substantial control. The burden lies with Columbia Group to prove that Camby Group did have substantial control. The mere recitation of certain terms from the Partnership Agreement, which disguise rather than shed light upon the strong management role that Columbia SLP played in the Partnership, is simply not enough to meet that burden.
In addition, Camby Group has presented the outline of an alternative argument that is also recognized by Indiana law. Camby Group alleges in its complaint that it relied, from the start, upon Columbia Group's special expertise with respect to LIHTC projects. According to Camby Group, Columbia Group initially proposed the idea of an LIHTC project and then offered its own services as an expert in implementing the Project. A plausible inference is that Camby Group found itself dependent upon Columbia Group in the manner described in criterion (b) above. Arguably, Camby Group did not know enough about LIHTC projects to make the critical management decisions necessary for the enterprise to succeed.
The Court does not mean to suggest by this that constructing an apartment complex for rental purposes, in and of itself, would have forced Camby Group to rely exclusively upon Columbia Group for key management decisions. However, constructing a low income housing complex that meets the eligibility requirements for special financing and special tax breaks, arguably, may have required the kind of special expertise which the Commissioner was talking about in criterion (b). Indeed, Columbia SLP seems to have been added to the Partnership only for the purpose of providing such special expertise.
In their briefs, the parties did not address this alternative basis for finding that the Partnership Agreement created a security interest. But Camby Group did allege in its pleading that, as a practical matter, it had to look to Columbia Group for substantial guidance in the process of developing the LIHTC Project, to the point of effectively relinquishing its general partner status. Without more information, the Court cannot say that there is no set of facts which could support that claim.
IV. CONCLUSION
The purpose of securities laws is to provide statutory protection for those who invest in certain business enterprises but do not retain sufficient control over their investment to protect themselves against fraud and other unfair business practices. In asserting that Count IV of Camby's Counterclaim should be dismissed based upon the pleadings, Columbia Group is claiming that it is "undeniable" that Camby Group did, in fact, retain sufficient control over the Partnership to protect its own interest. The "proof" offered by Columbia Group is that the Partnership Agreement (which is part of the evidentiary record) states that Camby Group is the General Partner of the enterprise, "responsible for the management of the Partnership business." Partnership Agreement § 6.1.
However, Indiana Securities Law, as interpreted by Indiana's Securities Commissioner, provides that a party formally designated as a "general partner" may nevertheless claim that it holds a security interest if: (a) the partnership agreement sufficiently limits the party's management prerogatives to the point that it cannot exercise substantial control over the enterprise, or (b) the special expertise of the promoter, or of some other "limited partner," renders that party the de facto managing partner. The former criterion is derived from the federal economic reality test, as explained by the U.S. Supreme Court in Howey and Forman. The latter is derived from the Fifth Circuit's interpretation of federal law in Williamson.
In response to Columbia Group's argument that certain terms of the Partnership Agreement clearly show that Camby Group was the true General Partner, Camby Group has pointed to numerous other terms of the Partnership Agreement that strictly limit its prerogative to make the kind of decisions that are vital to the success of the enterprise. Thus, there are questions of fact that must be resolved in order to determine, in reality, who had ultimate control over the Partnership.
Furthermore, Camby Group has alleged that it relied, from the Project's inception, upon Columbia Group's special expertise in the area of LIHTC housing. Columbia Group has not denied that it provided such expertise, nor has it presented evidence that Camby Group was not dependent upon that expertise in the sense intended by Indiana Securities Law. That creates a question of fact as to whether Camby Group's interest in the Partnership meets criterion (b) for establishing a security interest.
Therefore, the Court DENIES Columbia Group's motion for Judgment Upon the Pleadings with regard to Count IV of Camby Group's Counterclaim.