Opinion
Nos. 34666 and 34667
Decided December 26, 1956.
Ohio Securities Act — Sale of "securities" — Test whether interest purchased a "security" or interest in realty — Purchaser's control over property or business venture acquired — Real estate improved with multiple residence units — Sale of individual units to individuals — Contracts not for sale of "securities," when.
1. In determining whether an interest is an investment contract or an interest in a real estate transaction, the principal test is the individual control which the purchaser has over the property or business venture in which he has acquired the interest. If the purchaser is to share in the gross proceeds or net profits of operations managed by the one who is disposing of the interest, the instrument evidencing the interest transferred is generally considered as an investment contract; but, if the purchaser of real property with others is to occupy the premises and conduct the enterprise, the instrument evidencing the interest is generally not an investment contract or security.
2. Where the owner of an improved real estate project made up of multiple residence units sells such undivided but specifically designated units to individual purchasers for personal occupancy by them, and where there is a provision in each contract of sale for title to the entire building project to be taken in the name of a corporation in which the unit owner is to have stock according to the value of his ownership in the project, for the co-operative management of the same, such contracts are for the sale of real estate and are not "securities" within the meaning of the Ohio Securities Act.
APPEALS from the Court of Appeals for Cuyahoga County.
These two criminal cases now in this court on appeal by reason of allowances of motions for leave to appeal were tried together in the Common Pleas Court of Cuyahoga County.
In cause No. 34666, the defendant, Hirsch Meyer Silberberg, was indicted and convicted on two counts of violation of the Ohio Securities Act, the first of which charged him with the sale of a security which was not registered or exempted and which transaction was not registered or exempted under Ohio law, and the second of which charged him with the sale of such security when he was not licensed to make the sale. In cause No. 34667, defendants, Hirsch Meyer Silberberg and The Euclid Green Development Company, were indicted and convicted on six similar counts involving three other sales.
A written instrument is referred to in each indictment and is a contract to sell for installment payments an undivided interest in real estate with an apartment building located thereon, granting to the purchaser the immediate right to occupy a specified unit in the building.
Two buildings are involved, a six-residential-unit terrace owned by Euclid Green Development Company and a two 15-unit brick building owned by Silberberg. In the former the units sold by the corporation were undivided 6/36 interests in the property described by metes and bounds, and the unit set aside for any purchaser was described by number. In the latter the units sold by Silberberg were undivided 3/58 interests in the property described by metes and bounds, and each unit set aside for a purchaser was described by number.
The contract in case No. 34667, which is similar to the one in case No. 34666 and which we will consider in this opinion, contains an acceleration clause maturing all installments, on the seller's election, in case of default of payment of any installment; covenants by the buyer to carry insurance in not less than $6,500 on the building and to pay all taxes and assessments; and default clauses giving the seller three alternative remedies, i.e., (1) to treat the contract as in force and sue for installments, (2) to treat the contract as void and re-enter, the buyer thenceforth being treated as a mere tenant at will liable to be proceeded against without notice to quit, and the seller being free to sell the property to others, or (3), after electing remedy (2), to apply the buyer's payments to damages suffered and sue him for any balance of damages. (The contract in case No. 34666 provides that payments are to be retained as stipulated damages.)
The contract also contains the following three paragraphs which form the basis for the claim of the state that the contract is a "security" within the meaning of the Ohio Securities Act:
"It is understood and agreed that the party of the first part shall incorporate a corporation at its own expense on or before June 1, 1959, capitalized at the sale price of said land and building thereon and to issue shares in said corporation in proportion to the value of the interest purchased by the party of the second part.
"It is understood and agreed that when said corporation has been duly formed, that the present owner will transfer by warranty deed with title guaranty at his own expense, all his right, title and interest, including the releasing of any dower right in said property to the said corporation; that taxes and assessments and insurance will be prorated as of the day of transfer to the corporation.
"It is further understood and agreed that these shares of stock will be delivered to the party of the second part when the principal sum, deposit, payments and all and any other conditions of this contract have been fully complied with and payment of same has been made in full."
The defendants were found guilty by the trial court as charged.
On appeals to the Court of Appeals, the judgments of the Common Pleas Court were reversed, and final judgments were rendered for defendants.
Mr. Frank T. Cullitan, prosecuting attorney, and Mr. Frederick W. Frey, for appellant.
Messrs. Halle, Haber, Berick McNulty and Messrs. Klein Klein, for appellees.
The question here presented is whether the contracts entered into between the defendants and the purchasers are securities required to be registered under the Ohio Scurities Act, or are they exempt from such registration?
The courts have had difficulty in determining what constitutes a "security." As a rule they have preferred not to work out an all-inclusive definition, but have chosen to draw the lines of demarcation as the circumstances of each case present themselves.
In determining whether an interest is an investment contract or an interest in a real estate transaction, the principal test seems to be the individual control which the purchaser has over the property or business venture in which he has acquired the interest. If the purchaser is to share in the gross proceeds or net profits of operations managed by the one who is disposing of the interest, the instrument evidencing the interest transferred is generally held to be an investment contract. Thus in the case of State v. Ogden, 154 Minn. 425, 191 N.W. 916, wherein there were sales of fractional interests in a leasehold of 80 acres of oil lands, evidenced by instruments styled, "Statement and Purchase," the court held that the interests were investment contracts because the purchasers did not intend to become freeholders or land owners but expected rather to share in the profits of a corporation thereafter to be organized to take over the management of the property. See, also, Groby v. State, 109 Ohio St. 543, 143 N.E. 126; Securities and Exchange Comm. v. C.M. Joiner Leasing Corp., 320 U.S. 344, 88 L. Ed., 88, 64 S. Ct., 120; and Securities and Exchange Comm. v. W.J. Howey Co., 328 U.S. 293, 90 L. Ed., 1244, 66 S. Ct., 1100.
On the other hand, if the purchaser of real property with others is to occupy the premises and conduct the enterprise, the instrument evidencing his interest is generally not an investment contract or a security. For example, in the case of Hathaway v. Porter Royalty Pool, Inc., 296 Mich. 90, 295 N.W. 571, 299 N.W. 451, 138 A.L.R., 955, the owners of royalty interests in land, each owning a prescribed area, entered into a joint contract whereby each released a right to royalties in his own tract of land in return for an undivided interest in the royalties arising from the whole tract. The contract provided that a corporation was to be organized and stock issued to the signers in proportion to the acreage held by each owner. The court held that this contract did not violate the blue sky law of Michigan and pointed out that the purpose of the proposed corporation was not to carry on a business for profit but merely to hold the pooled rights for more convenient operation; and that no stock could be issued to any one except the freeholders of the undivided land joining in the project for its convenient operation. In the course of the opinion in that case, it is said:
"* * * the formation of the corporation pursuant to the agreement in no way changed the relationship of joint adventure between the parties; that the agreement for the use of the cororate medium was only a convenient method of carrying into effect the joint adventure, and was not a contract within the prohibition of the blue sky law; that the issuance of stock by the corporation to the pool members was not the sale of securities within the intendment of the statute." See, also, In re Estate of McCormick, 284 Ill. App. 543, 1 N.E.2d 769.
The case of Brothers v. McMahon, 351 Ill. App. 321, 115 N.E.2d 116, is in point. In that case, the purchaser of a housing unit in a co-operative apartment project brought suit against the seller to recover $1,600 paid, on the ground that the sale contract violated the Illinois Securities Act, which is quite similar to that of this state. The seller corporation was engaged in erecting and selling low-cost co-operatively owned houses in Chicago. Plaintiff, in response to an advertisement of the defendant owner, was advised that the corporation did not own title to the land in question but would acquire it and then transfer the interest in an undivided but specifically designated unit to the plaintiff. The price was $10,600, of which $1,600 was to be paid down and the balance out of the proceeds of a loan to be obtained on the unit. Provision was made in the contract for title to the entire building to be held either by a corporation or land trust. If title was taken by a corporation, plaintiff was to receive stock in such corporation for his proportionate share of the value of the entire building. If the title should be taken by a trust, plaintiff was to receive a corresponding beneficial interest. The seller company became bankrupt before it was able to complete the project and also violated its agreement by commingling funds with those of other projects. The action was against the officers of the seller corporation. Plaintiff claimed that the receipt issued to him, the prospectus of the project and the proposed trust agreement constituted "securities" within the Illinois blue sky law.
The trial court dismissed plaintiff's action, and on appeal the appellate court held:
"Receipt, prospectus describing a co-operative housing project similar to the type that was to be purchased, and a standard contract for the construction and purchase of a dwelling unit, including an agreement by the purchaser to agree with other purchasers who would reside in the same dwelling unit on either a corporation or a land-trust method of cooperative management of the unit, was a contract for the sale of real estate, and not a security within the meaning of the blue sky law."
It is stated in the opinion in that case:
"* * * The buyer agreed to execute an agreement with other purchasers who would reside in the same co-operative dwelling unit as would insure the entire dwelling unit would be managed on a co-operative basis. To achieve this it was contemplated that plaintiff would have stock in a corporation or a beneficial interest in a land trust. These alternatives were merely mechanical incidents to the basic contract which was for the sale of an interest in real estate. * * *
"* * *
"* * * Plaintiff was buying a unit in a building which was to be erected by the McMahon Corporation. He was not sharing in the profits of the corporation nor was he buying anything other than an interest in the real estate with other joint owners. The medium of a land trust or corporation was used for the convenience and protection of the parties who were to purchase an interest in the building. It is the common and usual method of handling such a transaction, which was co-operative in its nature."
Section 8624-2, General Code (Section 1707.01, Revised Code), a part of the Ohio Securities Act, provides in part as follows:
"(2) The term `security' shall mean any certificate or instrument which represents title to or interest in, or is secured by any lien or charge upon, the capital, assets, profits, property, or credit of any person (as that term is defined by subsection (4) of this section 2) or of any public or governmental body, subdivision or agency * * * but the provisions of this act shall not apply to bond investment companies or to the sale of real estate.
"The term `security' shall, for the purposes of this act, be deemed to include real estate not situated in this state and any interest in real estate not situated in this state." (Italics supplied.)
In the opinion of this court the provision of each of the contracts, here under consideration, to the effect that when the corporation was organized, the purchaser would transfer his interest in the property to the corporation and take stock in it to the value of the interest purchased, did not bring the transaction within the operation of the Ohio Securities Act. That provision was made necessary for the operation and management of the building as a whole after the interest of the original owner was entirely transferred to the owners of units in the building.
This court is in accord with the following statement of the Court of Appeals:
"The evidence in these cases clearly shows the buyers were buying an interest in an apartment building for the sole purpose of occupying the same as a home. That is the clear intent and purpose, as gleaned from the contract. Neither the evidence of the parties involved nor the contract itself shows any plan or scheme to invest in a profit-sharing venture. The buyers were to take possession of and occupy the property described in the contracts. This they have done and were occupying the premises at the time of trial.
"The purpose of an investment in a security is the hope of receiving an income as a return on such investment. There is nothing revealed by the record in these cases that shows such intent or purpose. The provisions in the contract for the formation of a corporation is incidental to the sale of an undivided interest in the real estate. The inclusion of these provisions for the formation of a corporation does not destroy the basic character of the instrument, nor invalidate the right of the purchaser as specifically set out in the contract, to demand a deed for his fractional part of the real estate upon payment of the purchase price. It is true the contract requires the seller to form a corporation, but does not require the buyer to subscribe to the stock or to surrender his deed to a fractional interest in exchange for the stock. The formation of the corporation is plainly a means for operating and maintaining the property as a whole as a co-operative venture. There is evidence in the record that a number of persons who held identical contracts in the same building have completed their payments and received deeds for their fractional interest. The purchasers were buying real estate and not shares in a corporation, and being contracts for the sale of real estate are exempt from registration."
The judgments of the Court of Appeals are affirmed.
Judgments affirmed.
ZIMMERMAN, STEWART, BELL and TAFT, JJ., concur.
WEYGANDT, C.J., and MATTHIAS, J., dissent.