the securities laws of the United States of America.
In December 1982, Bliss, acting as general partner of Aqua-Solar, purchased 5,684 solar water heating systems from Bliss in its individual corporate capacity for a total price of $20,841,352. The purchase price for each unit was $3,660 per system. Aqua-Solar paid Bliss $5,241,352 in cash, and gave Bliss a promissory note ("Purchase Note") in the amount of $ 15,600,000 bearing interest at 9% per annum. Bliss retained a security interest in the solar water heating systems and the limited partners' promissory notes were pledged to Bliss as security for the credit portion of the purchase price of the solar water heating systems.
The leasing arrangement worked as follows. The business plan for Aqua-Solar provided that Nationwide-Florida ("Nationwide") would serve as servicing agent for Aqua-Solar. Nationwide was a subsidiary of a Delaware corporation, Nationwide Power Corporation. Under a property management agreement with Aqua-Solar, Nationwide's duties were to obtain lessees for the solar water heating systems, install the systems, provide subsequent service for the systems as needed, and collect lease payments from the homeowners. In each case, the homeowner lessee of the solar water heating system was to make an initial rental pre-payment of $ 478.80 which represented rental payments for two years. After pre-payment the homeowner was to have use of the solar water heating system for two years before any additional rental payments became due. At the end of the two years, the homeowner would have the option of retaining the solar water heating system under lease at a beginning rental of $22.50 per month or cancelling the lease and returning the solar water heating system to the partnership. In 1983, Nationwide succeeded in leasing all 5,684 of the solar water heating systems purchased by Aqua-Solar from Bliss. Nationwide accordingly received from Aqua-Solar the agreed upon fee of $ 568,400 and a percentage of the lease payments as compensation for its services. In 1983, Bliss also made further payments to Nationwide of approximately $ 650 per system for obtaining the lessees and installing Aqua-Solar systems. During this time period, Bliss owned between 41.4 and 44.5% of Nationwide's stock.
During 1983, Bliss also organized other limited partnerships, including Bliss Partners '83, Ltd., Solar-Bliss '83, Ltd., and Bliss-Solar '83, Ltd. Each of these limited partnerships had the same business plan as Aqua-Solar, the same general partner, the same servicing agent, and the same form of investment. None of the partnership interests was registered with the SEC.
In December 1984, at the request of Nationwide, Aqua-Solar terminated its service agreement with Nationwide. Nationwide sought to terminate the agreement to act as Aqua-Solar's servicing agent because it wished to pursue a program of selling solar water heating units and found it unprofitable to service Aqua-Solar's water heating systems. At about the same time, Bliss acquired sole ownership of Nationwide from its Delaware parent corporation. Contemporaneously with the termination of the Nationwide service agreement, Aqua-Solar appointed Magnacard, Inc., to become Aqua-Solar's servicing agent. Magnacard was then 80% owned by Bliss. Magnacard is now known as Highlander International Corporation ("Highlander").
During early 1985, the two-year pre-paid rental periods for those persons who had leased the solar water heating systems from the partnership began to expire. Many homeowners elected to cancel leases at the end of the pre-paid rental period and return the solar water heating systems to the partnership. Others, although not initially cancelling their leases, soon ceased to pay rent, thereby terminating the leases. By December 31, 1985, 1,869 systems that had ceased to be leased during 1985 were returned to Bliss. Bliss, in turn, gave Aqua-Solar a credit of $4,924,815 on the partnership's Purchase Note. During 1986, and additional 3,315 Aqua-Solar systems ceased to be leased, leaving approximately 500 on lease.
At some point in late 1985, Bliss organized a corporation named Aqua-Solar Management Corporation. Aqua-Solar management had no assets or employees. Its president was Reinhard Mueller, who was also president of Bliss. At that same time, Bliss (having changed its name to Omni Equities, Inc.) purported to resign as general partner and purported to substitute Aqua-Solar Management as the new general partner of Aqua-Solar. The Aqua-Solar Partnership Agreement provided that a resignation and substitution of general partner required the consent of the limited partners. The limited partners did not consent to the substitution of general partner.
On April 9, 1986, Bliss, assigned the Purchase Notes made by Aqua-Solar and the other Bliss partnerships, together with the notes made by Bumba and all the other limited partners to a wholly-owned subsidiary of Magnacard. The notes had a collective face value in excess of $ 10,000,000. In return for the assignment of the partner and Purchase Notes, Bliss received ten percent of Magnacard's stock, which increased Bliss' ownership of Magnacard from 80% to 90%.
In early May 1986, Bliss then sold its stock in Magnacard to another company for approximately $3,240,000. Thereafter, on May 15, 1986, Magnacard resigned as servicing agent for Aqua-Solar.
On June 12, 1986, Aqua-Solar Management (the "new" general partner) caused Aqua-Solar to sell to Magnacard all the remaining assets of Aqua-Solar, consisting of the solar heating systems still on lease, the outstanding leases, and the 3,315 solar heating systems returned by the lessees. Aqua-Solar received a credit of $ 1,000,000 against the Purchase Note that Bliss had assigned to Magnacard's subsidiary. Following the sale of the remaining assets of Aqua-Solar to Magnacard, Aqua-Solar Management notified the limited partners that the sale had been made and that, as a result, the partnership was terminated.
In July 1986, Asher, who is a director, president and chief operating officer of Magnacard, wrote letters on behalf of Magnacard to Bumba and the other limited partners stating that their notes were in arrears and demanding payment. In August, Asher again wrote to Bumba and the other limited partners demanding payment on the notes. In September, Magnacard then filed lawsuits in Florida seeking to collect payment on the notes. Those suits were subsequently dismissed for lack of personal jurisdiction over the defendants.
On August 15, 1988, Magnacard's subsidiary, to which the notes had originally been assigned, assigned the notes to Asher and Johnston in exchange for $50,000 and their note in the amount of $9,500,000. Asher and Johnston subsequently initiated this lawsuit to collect the balance outstanding on Bumba's partner note.
II. Findings of Fact and Conclusions of Law
There is no dispute that several of the elements for bringing a suit on a promissory note have been met. Thus, we find that 1) Bumba executed and delivered a promissory note, 2) the plaintiffs are the owners and holders of the promissory note executed by Bumba,
3) Bumba has failed to make payment when due, and 4) the balance of the note is due and payable as a result of Bumba's default. Our detailed findings and conclusions therefore center on two considerations: first, whether Bumba possesses any defenses that would relieve him of his obligation on the note, and second, whether the plaintiffs have proved the balance of the amount due on the note.
A. Defenses on the Note
By stipulation, Asher and Johnston have waived any claims of asserting holder in due course status on the note.
Since they are not holders in due course, the plaintiffs are subject to all defenses Bumba could have raised against Bliss, the original holder of the note. Ill. Rev. Stat. ch. 26, § 3-306(b). Bumba has asserted defenses based on both federal and state law.
1. Securities Law Violations
We shall first consider the plaintiffs' right to recover on the notes on light of the stipulation that the partnership interests in Aqua-Solar were securities as that term is defined in the Securities Act of 1933. As a matter of public policy, the law forbids an action to enforce the collection of the purchase price of a security sold in violation of the federal securities laws. This principle applies both to violations of the Securities Act of 1933 ("1933 Act"), General Life of Missouri Invest. Co. v. Shamburger, 546 F.2d 774, 783-85 (8th Cir. 1976), and violations of the Securities and Exchange Act of 1934 ("1934 Act"), Kaiser-Frazer Corp. v. Otis & Co., 195 F.2d 838, 843 (2d Cir.), cert. denied, 344 U.S. 856, 73 S. Ct. 89, 97 L. Ed. 664 (1952). Bumba contends that two violations of the securities laws occurred: the securities should have been registered, but were not, and the securities were sold through the use of false statements and omissions of material facts.
(a). Registration and Exemption
It is undisputed that the securities sold in this case were not registered, and with respect to the offerings at issue, interstate transportation or communication in the mails was used in connection with the sale or offer of sale. These facts establish a prima facie violation of Section 5 of the 1933 Act, 15 U.S.C. § 77e, which requires registration of such securities. SEC v. Continental Tobacco Co., 463 F.2d 137, 155-56 (5th Cir. 1972). In order to overcome an ultimate finding of a violation and establish a threshold right to recover on the note, the plaintiffs have the burden of proving that the partnership interests were exempt from registration by law. SEC v. Ralston Purina Co., 346 U.S. 119, 126, 73 S. Ct. 981, 985, 97 L. Ed. 1494 (1953). Accordingly, we must consider whether the plaintiffs have established the requisite exemption.
The parties agree that the only potentially applicable basis for exemption from registration under the 1933 Act is the exemption for sales "not involving a public offering," 15 U.S.C. § 77d(2), known in other words as the private offering exemption. In his post-trial brief, Bumba first points out that plaintiffs stipulated in the pre-trial order that the partnership interest sold to Bumba "was sold in a public offering." See Pre-Trial Order Statement of Uncontested Facts at para. 1. Thus, at the outset the matter would appear to have been decided. We have difficulty accepting that stipulation as dispositive of the issue, however, since the parties' actions at trial belied their words in the pre-trial order. At trial the parties proceeded as if the public offering question were at issue. Bumba never raised a relevance objection to evidence adduced by the plaintiffs to show that the transaction with Bumba was not part of a public offering, and indeed, Bumba dedicated a significant amount time at trial in adducing his own evidence to establish that the Aqua-Solar offering was in fact a public offering.
Thus, on the question of public offering, it is evident that the stipulation, even if it was intended to mean what Bumba says it does, had been abandoned at trial. Accordingly, we shall consider and decide whether the Aqua-Solar offering was a public offering subject to registration under the securities laws.
In making that determination, we first address Bumba's contention that the Aqua-Solar offering should be considered along with the offering of three other limited partnerships -- Bliss Partners, Solar-Bliss, and Bliss-Solar -- as constituting a single integrated offering. 17 C.F.R. § 230.502(a); SEC v. Murphy, 626 F.2d 633, 645-46 (9th Cir. 1980) (series of sales of cable television limited partnership interests held to be single offering). The SEC has set out five factors commonly used in determining whether apparently separate offerings should be treated as one integrated offering:
(a) whether the offerings are part of single plan of financing; (b) whether the offerings involve issuance of the same class of securities; (c) whether the offerings are made at or about the same time; (d) whether the same kind of consideration is to be received; and (e) whether the offerings are made for the same general purposes.
Securities Act Release No. 4552 (Nov. 6, 1962), reprinted in Note at 17 C.F.R. § 230.502. See also Murphy, 626 F.2d at 645.
Factors (b) through (e) clearly have been met in this case. Each partnership was engaged in the same business in the same market. Each partnership had the same general partner and the same servicing agent. For each partnership, the method of offering and the form of investment were the same. The offering memoranda distributed by Bliss to offerees for each of the partnerships were substantially identical and the payment for each partnership interest involved a combination of cash and promissory note. With respect to timing, the interests in the four partnerships were sold during the twelve-month period December 1982 to December 1983, during which the offering of each partnership commenced within six months of the closing of the prior partnership.
The plaintiffs nevertheless maintain, however, that Bumba has specifically failed to satisfy criterion (a) -- that the sales be part of a single plan of financing. The plaintiffs rely solely on an allegation that there was no cross collateralization or use of funds of one partnership by a different partnership. The plaintiffs, however, have failed to indicate any place in the record that provides the evidentiary support for that allegation. Even assuming there is factual support for plaintiffs' position, we do not believe that the lack of cross collateralization weighs against a finding of integration in this case, given the overall structure of the partnerships as a common business venture. In essence, the venture did involve a single plan of financing, even if the funds ultimately obtained were allocated toward the serial purchase of distinct lots of solar water heating units. Accordingly, we conclude that the offerings should be considered a single integrated offering.
We now turn to the public offering/private offering question. Following Ralston, courts have cited four factors as providing useful guidelines for determining whether an offering of securities is public or private: 1) the number of the offerees and their relationship to the issuer; 2) the number of units offered; 3) the size of the offering; and 4) the manner of the offering. See, e.g., Mary S. Krech Trust v. Lakes Apartments, 642 F.2d 98, 101 (5th Cir. 1981); Continental Tobacco Co., 463 F.2d 137. Since the evolution of these guidelines, the Securities and Exchange Commission, under Congressional authority, has promulgated "safe harbor" rules in order to provide objective standards upon which businessmen may rely in raising capital under the private offering exemption found in 15 U.S.C. § 77d(2). Rule 146, issued by the Commission in 1974, was in effect at the time of the Aqua-Solar offering and therefore pertained to that transaction. 17 C.F.R. § 230.146. Soon after the Aqua-Solar offering, the Commission issued Regulation D, which replaced Rule 146 and thus governed the subsequent Bliss offerings. These standards appear to have refined, rather than abrogated, the judicial guidelines. Indeed, after the promulgation of the safe harbor rules, courts have considered and applied them in conjunction with the former precedential considerations. See, e.g., Krech Trust, 642 F.2d at 100-01; Murphy, 626 F.2d at 644-48.
We shall, however, primarily refer to the safe harbor rules, since they provide the more detailed framework for analyzing the availability of a private offering exemption. Where appropriate we shall look to the precedential considerations for further guidance. In addition, we observe that both Rule 146 and Regulation D set forth essentially similar criteria. Thus, we shall discuss our findings with reference to Rule 146. To the extent any difference between the two regulations materially impacts on our findings we shall so indicate.
The question of compliance requires an extended discussion of our findings only with respect to four of the Rule 146 criteria as to which there is a substantial factual dispute. Bumba contends that plaintiffs have failed to establish 1) that the partnership interests were not sold as part of a general solicitation, 17 C.F.R. § 230.146(c); 2) that none of the partnership interests was sold to any person who lacked the knowledge and the experience to evaluate the risk or was unable to bear the economic risk of the investment, 17 C.F.R. § 230.146(d); 3) that the sale of the partnership interests satisfied the "35 purchaser" limitation, 17 C.F.R. § 230.146(g); and 4) that the offerees and purchasers had access to the kind of information required under 17 C.F.R. § 230.146(e).
1) Burden of proof
The party claiming a private offering exemption from registration must show that it is met not only with respect to each purchaser, but also with respect to each offeree. Murphy, 626 F.2d at 645. Such proof must be "explicit, exact, and not built on conclusory statements" of the plaintiffs. Continental Tobacco, 463 F.2d at 156. We reject plaintiffs' contention that these evidentiary requirements do not apply with respect to proof of compliance with Section 146 or Regulation D. We see no reason why the evidentiary burden established by the cases we have cited should not also apply to proof of compliance with the later promulgated Sections 146 and Regulation D. Those regulations serve essentially as codified refinements to the private exemption considerations developed by caselaw following Ralston. The significance of the evidentiary burden imposed by these cases is not based on the particular bases for exemption under Section 4(2), but on how the seller must prove that the relevant standards were met. We do find, however, that the promulgation of Regulation D requires an adjustment in the evidentiary standard, since certain of the Regulation D standards pertain only to the ultimate purchaser, and not to any offerees. Accordingly, with respect to the three Bliss offerings subject to Regulation D, where relevant, the plaintiffs must show only that the criteria were met with respect to each purchaser.
We further observe that the bottom line issue when considering the availability of the private offering defense is whether the particular class of persons affected needed the protection of the act. Ralston, 346 U.S. at 125, 73 S. Ct. at 984; Krech Trust, 642 F.2d 98. Thus, while the purpose of Rule 146 and Regulation D is "to provide objective standards upon which businessmen may rely in raising capital under the 4(2) exemption, 15 U.S.C. § 77d(2), . . . failure to satisfy all of conditions of the Rule does not raise the presumption that the offering cannot be exempt." Krech Trust, 642 F.2d at 102. Ultimately, the question whether an offering is public or private is a question of fact which must be resolved in light of the particular circumstances. Id. at 101.
2) General solicitation
Under Rule 146(c), an exemption is not available if a security is sold
by means of any form of general solicitation or general advertising, including but not limited to the following: