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JOHNSTON v. BUMBA

April 26, 1991

NEWMAN JOHNSTON III and PHILLIP C. ASHER, d/b/a Worldwide Collections, a general partnership, Plaintiffs,
v.
LINCOLN J. BUMBA, Defendant. NEWMAN JOHNSTON III and PHILLIP C. ASHER, d/b/a Worldwide Collections, a general partnership, Plaintiffs, v. JAMES DIIORIO and DOROTHY DIIORIO, Defendant. NEWMAN JOHNSTON III and PHILLIP C. ASHER, d/b/a Worldwide Collections, a general partnership, Plaintiffs, v. RALPH W. EWRY, JR., Defendant. NEWMAN JOHNSTON III and PHILLIP C. ASHER, d/b/a Worldwide Collections, a general partnership, Plaintiffs, v. ANTHONY J. ALBERT, Defendant. NEWMAN JOHNSTON III and PHILLIP C. ASHER, d/b/a Worldwide Collections, a general partnership, v. EUGENE ANDERSON, Defendant. NEWMAN JOHNSTON III and PHILLIP C. ASHER, d/b/a Worldwide Collections, a general partnership, Plaintiffs, v. JERRY BAUER, Defendant. NEWMAN JOHNSTON III and PHILLIP C. ASHER, d/b/a Worldwide Collections, a general partnership, Plaintiffs, v. MICHAEL R. BENNETT, Defendant. NEWMAN JOHNSTON III and PHILLIP C. ASHER, d/b/a Worldwide Collections, a general partnership, Plaintiffs, v. DANIEL R. LEE, Defendant. NEWMAN JOHNSTON III and PHILLIP C. ASHER, d/b/a Worldwide Collections, a general partnership, Plaintiffs, v. THOMAS J. WASHBURN, Defendant. NEWMAN JOHNSTON III and PHILLIP C. ASHER, d/b/a Worldwide Collections, a general partnership, Plaintiffs, v. CARMEN G. TUMINO, Defendant. NEWMAN JOHNSTON III and PHILLIP C. ASHER, d/b/a Worldwide Collections, a general partnership, Plaintiffs, v. RALPH RYDHOLM, Defendant. NEWMAN JOHNSTON III and PHILLIP C. ASHER, d/b/a Worldwide Collections, a general partnership, v. HAROLD K. RlDGWAY, Defendant. NEWMAN JOHNSTON III and PHILLIP C. ASHER, d/b/a Worldwide Collections, a general partnership, Plaintiffs, v. VINCENT A. PERNS, Defendant. NEWMAN JOHNSTON III and PHILLIP C. ASHER, d/b/a Worldwide Collections, a general partnership, Plaintiffs, v. FRED K. HALL, Defendant. NEWMAN JOHNSTON III and PHILLIP C. ASHER, d/b/a Worldwide Collections, a general partnership, Plaintiffs, v. CHARLES M. CARTER, Defendant. NEWMAN JOHNSTON III and PHILLIP C. ASHER, d/b/a Worldwide Collections, a general partnership, Plaintiffs, v. PHILIP D. KNELL, Defendant. NEWMAN JOHNSTON III and PHILLIP C. ASHER, d/b/a Worldwide Collections, a general partnership, Plaintiffs, v. CHARLES LEMASTER, Defendant. NEWMAN JOHNSTON III and PHILLIP C. ASHER, d/b/a Worldwide Collections, a general partnership, Plaintiffs, v. HARRY M. KROGH, Defendant


Marvin E. Aspen, United States District Judge.


The opinion of the court was delivered by: ASPEN

MARVIN E. ASPEN, UNITED STATES DISTRICT JUDGE

 This matter is presently before us for decision following a bench trial on case No. 88 C 10244. The plaintiffs, Newman Johnston, III, and Phillip Asher brought this suit seeking to collect on a promissory note which they allege was executed and delivered by the defendant, Lincoln J. Bumba, in connection with Bumba's acquisition of an interest in a limited partnership known as Aqua-Solar Associates Limited ("Aqua-Solar"). This case is essentially identical to 17 other suits brought by the plaintiffs against individuals who executed promissory notes in the venture. We have consolidated these cases and each of the defendants has agreed to be bound in each of their own suits by the disposition of Bumba's case at trial. Having reviewed all of the testimony, exhibits, and stipulations of the parties, and for the reasons stated in these findings and conclusions, we enter judgment in favor of Bumba and each of the defendants.

 I. Background Findings of Fact

 The following findings of fact are based on undisputed evidence and provide background for the further findings of fact and conclusions of law set forth in Section II. These facts set forth the basic chain of events and corporate history that give context to this dispute.

 The Aqua-Solar limited partnership was formed in 1982 by A.T. Bliss & Company, Inc. ("Bliss"). Bliss, now known as Omni Equities, Inc., is a Massachusetts Corporation and served as general partner, managing the business of Aqua-Solar. The business plan for Aqua-Solar was to purchase solar water heating systems and lease those systems to homeowners in Florida. The purpose of the partnership was to make a profit from the leasing of the solar water systems. It was also intended that the investors in Aqua-Solar would receive tax benefits, including investment tax credits and solar energy credits based on Aqua-Solar's acquisition of the solar water heating systems.

 During 1982, Bliss sold limited partnership interests in Aqua-Solar to Bumba and other investors. The Aqua-Solar offering began in March of 1982 and consisted of 185 units, at an investment of $ 150,000 per full unit and $75,000 per one-half unit. A full unit subscription required a cash payment of $37,500 and a promissory note for $ 112,500. A one-half unit subscription required a cash payment of $ 25,000 and a promissory note for $50,000. All of the promissory notes were made to the order of Aqua-Solar. The offering was completed on or about December 28, 1982. Ultimately, approximately 120 units were sold. Bumba purchased a full unit. The limited partnership interest purchased by Bumba was a security as that term is defined by 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.

 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%. *fn1" 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, *fn2" 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. *fn3" 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. *fn4" 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. *fn5"

 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; ...

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