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Condux v. Neldon

OPINION FILED APRIL 23, 1980.

GERALD E. CONDUX ET AL., PLAINTIFFS-APPELLANTS,

v.

FRANK S. NELDON, DEFENDANT-APPELLEE.



APPEAL from the Circuit Court of Cook County; the Hon. DONALD J. O'BRIEN, Judge, presiding.

MR. JUSTICE SIMON DELIVERED THE OPINION OF THE COURT:

When is a sale of stock not a sale of securities? When it is the sale of a business.

The defendant owned all the stock of Blue Island Gun Shop, Inc., a retail business. For $186,000, he sold it all to the two plaintiffs, who took over the business and operated it for 2 1/2 years. Dissatisfied with the results, they sued to rescind the sale, claiming it was a sale of unregistered securities, in violation of the Illinois Securities Law of 1953 (Ill. Rev. Stat. 1973, ch. 121 1/2, pars. 137.1 through 137.19) (the Act). The circuit court dismissed the complaint for failure to state a cause of action. We affirm.

If such a sale were concluded today, it would be exempt from registration under section 4(O) of the Act (Ill. Rev. Stat. 1977, ch. 121 1/2, par. 137.4(O)), because the plaintiffs, after the sale, owned 50 percent or more of the stock of the corporation. Because that provision was enacted after this sale, the defendant concedes it has no application to this case.

Previous opinions have ruled against similarly opportunistic plaintiffs by calling forth another exemption, section 4(G) (Ill. Rev. Stat. 1977, ch. 121 1/2, par. 137.4(G)). That provision allows sale of unregistered securities to a few dozen people, provided certain information about the sale is filed within 30 days thereafter. It has been held that where a plaintiff was an officer or director at the time of the sale (Stevens v. Crystal Lake Transportation Sales, Inc. (1975), 30 Ill. App.3d 745, 332 N.E.2d 727) or as a result of the sale (James v. Erlinder Manufacturing Co. (1979), 80 Ill. App.3d 4, 398 N.E.2d 1225), the responsibility for filing on behalf of the corporation was as much his as the defendant's, and that the plaintiff should therefore not recover.

In this case, however, the corporation itself sold no stock and would not be liable if the sale violated the Act. Where the corporation has no duty to file, we do not see how its officers and directors can be held to any such duty derivatively. And the parties have not argued, or even mentioned, the 4(G) theory, here or below.

In any event, the 4(G) theory strikes us as an evasive technicality. We prefer to address the more fundamental issue, the only one the parties have presented. Is the sale of all the stock in a corporation to a single buyer or a small group of affiliated buyers a "sale of securities"? Is it the sort of sale the securities laws were intended to cover? We hold that it is usually not.

In commercial substance, the plaintiffs bought a gun shop. The sale was consummated in the form of a sale of stock, not assets; but that is only a matter of form. The plaintiffs insist that form is all-important, that the defendant agreed to the form and is stuck with all it entails. But "[i]n determining whether an instrument is a security within the meaning of the statute, the courts> look to the substance of the transaction, to the relationship between the parties; these elements will control as against the form of the instrument. Form is disregarded for substance and emphasis is placed on the economic reality." Polikoff v. Levy (1965), 55 Ill. App.2d 229, 234, 204 N.E.2d 807; accord, Tcherepnin v. Knight (1967), 389 U.S. 332, 336, 19 L.Ed.2d 564, 569, 88 S.Ct. 548, 553.

There are good reasons for this rule. The plaintiffs cannot claim to have relied on a right of rescission when they first bought the stock, for had they known then that the sale was covered by the Act and that the shares were not registered, they would now be barred by the 6-month limitation rule of section 13(B) of the Act (Ill. Rev. Stat. 1973, ch. 121 1/2, par. 137.13(B)). Any rights the plaintiffs now claim are for them a windfall. Conversely, it seems doubtful that the defendant anticipated or could have been induced to agree to the obligations the plaintiffs now seek to impose; for this defendant, the securities laws are a trap. The law does not favor windfalls or traps. The rescission provision of the Act is a penalty, designed to compel promoters to register their stock. But had the parties anticipated the present conflict, the seller could have insisted on structuring the transaction differently. This would probably have been possible. Applying the securities laws according to form will not, therefore, afford future buyers the protection of those laws, but will only drive sales into other, presumably less convenient, forms. The laws will function only as traps, or in those rare cases where the stock format, despite the burden imposed by the Act, is, fortuitously, still the least unattractive course.

Apart from our reluctance to promulgate a rule so easily evaded, Polikoff v. Levy and numerous other cases setting forth the same view show that there is no good reason for extending the protection of the Act to the present plaintiffs, since they fail what is generally known as the Howey test, or the passive investor test.

"Both the Illinois and the federal courts> have emphasized that a security within the meaning of the acts is a contract, transaction or scheme whereby one person invests his money in a common enterprise on the theory that he expects to receive profits solely from the efforts of others. Sire Plan Portfolios, Inc. v. Carpentier, 8 Ill App 2d 354, 132 N.E.2d 78; S.E.C. v. Howey Co., 328 U.S. 293; Hammer v. Sanders, 8 Ill.2d 414, 134 N.E.2d 509; S.E.C. v. Bailey, 41 F. Supp. 647. The reason for excluding from the scope of the securities laws those transactions in which the profits do not come solely from the efforts of others is clear. In such situations, the member of the enterprise pools his money with that of others in the group; he has an equal right of control over the project and the opportunity and right to know what is going on. Because of this, the protection of the full disclosure offered by registration is not needed as it is in cases involving a nonparticipating investor." Polikoff v. Levy (1965), 55 Ill. App.2d 229, 234, 204 N.E.2d 807, 809.

The rights the plaintiffs claim would be manifestly open to abuse. A buyer, once in control of the corporation, would find it to his advantage to gamble with it, to take abnormal risks, knowing that any profits will be his while any losses can be unloaded onto the seller. The buyer would have an incentive to manage his business imprudently; the helpless seller, who thought he was disposing of his business, would find himself indefinitely dependent on its fortunes, now at the mercy of a buyer of unknown skill and honesty, over whom the seller has no control. The seller, in fact, would be in the sort of position the securities laws attempt to protect buyers against.

To apply the securities laws to this case would be to try to cure an evil that does not even exist here, by means doomed to failure, at the expense of appalling injustice to the seller and probable damage to the economy at large. We do not believe this is what the legislature intended.

"Since 1919, the clearly indicated purpose of the Illinois securities laws has been `to furnish information, to protect credulity and ignorance from deception * * * prevent fraudulent and deceitful sales of securities * * *' (Stewart v. Brady (1921), 300 Ill. 425, 439, 133 N.E. 310; see also Martin v. Orvis Bros. & Co. (1974), 25 Ill. App.3d 238, 244, 323 N.E.2d 73), and `to protect innocent persons who may be induced to invest their money in speculative enterprises over which they have no control.' Meihsner v. Runyon (1960), 23 Ill. App.2d 446, 456, 163 N.E.2d 236.

`[T]he Securities Law serves a useful purpose and should be construed liberally in this light; however, it is intended to function as a shield for the innocent and not a sword for the investor who, because of the speculative nature of the venture or his own poor business judgment, fails to reap the expected return on his investment.' Burke v. Zipco Oil Co. (1974), 19 Ill. App.3d 909, 913, 312 N.E.2d 339." James v. Erlinder Manufacturing Co. (1979), 80 Ill. App.3d 4, 9, 398 N.E.2d 1225, 1228.

The plaintiffs cannot rebut these arguments. Essentially, their position is that there is no room for interpretation, no place for considerations of justice or the policies behind the Act. We are, rather, to enforce the Act rigidly, either because it is so clear on its face that we can and must apply it literally, or because precedent requires this. The meaning of the ...


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