The opinion of the court was delivered by: JOHN A. NORDBERG
This action, filed on behalf of more than one thousand Plaintiffs, alleges that Cavanagh Communities Corp. ("Cavanagh Communities"), Cavanagh Land Sales Corp. ("Cavanagh Land Sales"), Joseph and Zola Klein ("the Kleins"), John Sgarlat, (collectively "the Cavanagh Defendants") and television personality Ed McMahon perpetrated a comprehensive land fraud scheme that defrauded Plaintiffs and other investors of millions of dollars. Plaintiffs' Seven Count Amended Complaint seeks remedies under the Securities Act of 1933, ch. 38, 48 Stat. 74 (codified as amended in scattered sections of 15 U.S.C. (1988)); the Securities Exchange Act of 1934, ch. 404, 48 Stat. 881 (codified as amended in scattered sections of 15 U.S.C. (1988)); the Interstate Land Sales Full Disclosure Act ("ILSFDA"), Pub. L. No. 90-448, 82 Stat. 590 (1968) (currently codified as amended at 15 U.S.C. §§ 1701-1720) (1988)); the Racketeer Influenced and Corrupt Organizations Act ("RICO"), ch. 96, 84 Stat. 941 (1970) (currently codified as amended at 15 U.S.C. §§ 1961-1968 (1988)); and the common law of fraud and contract.
Before the Court is Defendant McMahon's Renewed Motion to Dismiss and the Cavanagh Defendants' Motions to Dismiss and for Summary Judgment. For the following reasons, the Motions to Dismiss are granted in part and denied in part. The outstanding Motions for Summary Judgment are denied, without prejudice.
With the Court assuming as true all of the well pleaded allegations of Plaintiffs' Amended Complaint, and reasonable inferences therefrom, the facts of this case are as follows. In 1969, Cavanagh Communities acquired approximately 26,000 acres of land in central Florida, and commenced plans for the development of a community entitled Rotonda West. Joseph Klein was the original chairman of the board, chief operating officer, and largest stockholder of Cavanagh Communities, and was one of the driving forces in promoting Rotonda West. Zola Klein was an officer and director of Cavanagh Communities, and also was actively involved in promoting the project.
John Sgarlat was chairman of Cavanagh Communities at the time the original Complaint in this case was filed.
Cavanagh Land Sales was a wholly owned subsidiary of Cavanagh Communities which was used to market Rotonda West. Cavanagh Communities employed other subsidiaries, referred to here as the "Cape Corporations," in developing Rotonda West.
Employing a model constructed for a defunct project called "Rotonda East", the Kleins began marketing Rotonda West as an opportunity to acquire undeveloped land that would rapidly appreciate in value as a result of promised development. The project was to become a self-contained community, replete with homes, paved roads, canals, parks, golf courses and other facilities and was to be ringed with seven subdivisions promoted as "suburbs". As a result of their efforts, the promoters sold over one thousand lots. Many of those purchasers are Plaintiffs in this case.
Plaintiffs allege that the Kleins and the other Defendants induced them to purchase lots in Rotonda West by misrepresenting the actual value of the property and the ability of Cavanagh Communities and the Cape Corporations to develop and improve it. These Defendants artificially increased the price of Rotonda lots throughout the period of sales in order to deceive earlier purchasers into believing that their lots were appreciating in value, when, in fact, the lots were virtually worthless.
The terms of a given Plaintiff's investment in Rotonda West were governed by that Plaintiff's sales contract. The Plaintiffs' sales contracts provided for payment through monthly installments over approximately ten years coupled with annual interest rates of five percent to seven and a half percent. These contracts forbade purchasers to build on their property until all installments were paid. Until the purchase price and cost of improvements were fully paid, the developers retained title and possession of the lots. In addition, purchasers were required to grant Cavanagh Communities a right of first refusal on any resales. Plaintiffs who had not completed paying for their lots were prohibited from offering their property for resale without the express permission of Cavanagh Communities.
The concealment was further facilitated by the fact that approximately ninety-five percent of the lot sales were made to out-of-state investors who were not likely to visit the property and who depended on information from Defendants concerning the development of the property.
By 1975, Cavanagh Communities was promoting the Rotonda West project in twenty-seven cities located in sixteen states. The sales force used false and misleading slides, films, property reports and sales brochures to induce investors to purchase lots. These materials promised that Rotonda West, which was to include seven golf courses and club houses, a marina, thirty-two miles of canals, and extensive shopping, commercial and recreational facilities, would be completed by 1977. The "suburban" subdivisions surrounding Rotonda West were similarly promoted, with promised improvements to be completed between 1977 and 1981. The latest specified completion date for all improvements was January 1, 1983. Refunds were promised if the improvements were not made as planned. The overriding theme of these promotional activities was that the purchase of lots at the Rotonda project was a good investment, superior in kind to alternative investments such as bonds, insurance, savings or stocks. Much of the promotional literature was mailed to prospective purchasers.
Plaintiffs allege that in furtherance of the comprehensive scheme to defraud, Defendants also filed inaccurate reports with the Securities and Exchange Commission and several state regulatory agencies. These reports failed to disclose that Cavanagh Communities lacked certain permits and approvals, that flooding conditions existed at Rotonda, that governmental and environmental restrictions and prohibitions existed regarding development of the Rotonda property, and that prohibitive economic factors existed. At the time the original Complaint in this case was filed, on December 31, 1981, over ninety-five percent of the lots remained undeveloped and could not be accessed by conventional means because of flooding and other environmental hazards. Aside from one "core" community in the project, built as a showplace model and where approximately 700 families eventually resided, the Defendants neither developed the property in accordance with their original promises nor refunded any portion of Plaintiffs' installment payments.
The majority of the 22,000 unimproved lots in the Rotonda project were sold between 1969 and 1975. Prices ranged from $ 7,690 to $ 13,740 for "single-family homesites", and from $ 14,840 to $ 28,240 for "multiple family homesites". The comparable residential price ranges in the suburban subdivisions were from $ 4,540 to $ 11,390 for single-family sites, and from $ 9,840 to $ 61,890 for multiple-family sites.
Instrumental in the sales, Plaintiffs allege, were the activities of Ed McMahon. Hoping to parlay McMahon's television fame into lot sales, the Cavanagh Defendants hired him as the project's advertising spokesman. As compensation, McMahon received "approximately $ 500,000 in the form of cash payments, a home at Rotonda designed by a world famous architect, home furnishings, lots in the Rotonda West Cove area, and common stock of Cavanagh Communities." (Am. Compl. P 47.) In addition, McMahon was named an officer of Cavanagh Communities in November 1970.
McMahon agreed to the use of his likeness, name and statements attributed to him in sales brochures, company newspapers, magazines, letters, and other sales and promotional materials. Most important, according to Plaintiffs, was the use of a film narrated by McMahon at presentations for prospective purchasers. Under the terms of his contract with the developers, McMahon's approval was required before the developers could use any sales materials involving him. Throughout these materials, Plaintiffs allege, were a series of misrepresentations concerning the scope of McMahon's involvement in the project, the rise of Rotonda property values, and the project's ultimate potential for success. Plaintiffs allege, among other things, that the various promotional materials included untrue claims that McMahon was a substantial investor in Rotonda West and an active officer in Cavanagh Communities who participated in the determination of policies and the review of development plans.
In 1973 and 1974, disgruntled lot purchasers began sending McMahon letters complaining that the lots were not being developed as promised. McMahon began correspondence with Cavanagh Communities, requesting that the film he had narrated no longer be used for lot sales. Eventually, the developers agreed to pay McMahon at least an additional $ 100,000 in return for the continued use of his name and likeness on other sales materials.
Plaintiffs allege that Cavanagh Communities, "in conspiracy" with the Kleins, Cavanagh Land Sales and McMahon, distributed to Plaintiffs and other lot purchasers, either directly or through management agents, a stream of information designed to conceal the asserted land fraud. Plaintiffs cite a number of statements made by Defendants from 1972 to 1980. These statements include several made in the "The Rotonda Review", a company-published newspaper sent to lot owners through the date that the original Complaint was filed. Among the statements made in The Rotonda Review were discussions of a Federal Trade Commission investigation. These statements were issued in 1975 and included the claims that "the 'principal focus of the FTC appears to be towards projects other than Rotonda,'" and "'we are attempting to have the FTC clarify its position so that there can be no doubt that there are no serious objections concerning Rotonda.'" (Am. Compl. P 70.) Generally, Defendants' statements represented that progress on the completion of the project was continuing more or less as planned. Moreover, the company newspaper failed to inform the Plaintiffs that other lot purchasers had filed suit against the promoters for failure to fulfill their contractual obligations in the development of the project, and that the Rotonda property was decreasing in value.
Meanwhile, the business fortunes of Cavanagh Communities took a turn for the worse. In February 1975, the Ford Motor Credit Company declared Cavanagh Communities in default on its guaranties of loans made to its subsidiaries, the Cape Corporations, for development of the core area of Rotonda. This caused Cavanagh Communities to file for reorganization under the bankruptcy laws later that month. In the course of the bankruptcy proceedings, Cavanagh Communities appointed the Deltona Corporation in 1976 to manage the properties. The Cavanagh subsidiaries, however, remained liable for any claims arising from the land-sale contracts, rather than the management company. The Deltona Corporation was succeeded as property manager in 1979 by Land Resources Corporation, which also did not assume liability for claims arising from the development of the project. These appointed managers continued sales activities, made improvements in the core areas of the development, collected payments and disseminated information to lot purchasers.
In 1978, Cavanagh Communities, the Kleins and Sgarlat, chairman of Cavanagh Communities at the time the original Complaint was filed, began planning the transition of Cavanagh Communities from land development into the casino and hotel business in Atlantic City, New Jersey. As part of this plan, Cavanagh Communities sold its Cape Corporations in 1980 to Rotonda Properties, Inc., a company formed in 1979. Plaintiffs claim that Rotonda Properties, Inc. had no assets, assumed no liability to develop the project, and was a sham intended to insulate Cavanagh Communities from its obligations to the lot purchasers. Cavanagh Communities subsequently changed its name to Royal International, Inc. and invested in Atlantic City properties.
Management of this case has been complicated by a number of factors: the difficulty of conducting litigation involving many hundreds of Plaintiffs; the number of allegations, overlapping theories of relief and the often unsettled state of the law concerning many of these theories; the inability of some of the Defendants to retain counsel, resulting in numerous defaults; and the Defendants' often divergent interests.
The Court has thus far made two rulings affecting this case's organization. Before ruling on the instant motions, the Court addressed Defendant McMahon's Motion for Summary Judgment and rejected his contention that further proceedings against him were barred by a covenant not to sue. Adams v. Cavanagh Communities Corp., 669 F. Supp. 870 (N.D. Ill. 1987). Additionally, the Court ruled that it would initially address issues that could be resolved on motion to dismiss, and would thereafter consider other issues in a subsequent revised motion, or motions, for summary judgment, if appropriate. In a further attempt to organize this case, the Court now briefly addresses several procedural issues presented by the instant motions.
A. Motions for Summary Judgment
In reliance on the Court's orders organizing this case, Plaintiffs have not made evidentiary submissions addressing Defendants' motions for summary judgment. In addition, with the passage of time and the further development in the legal principles governing this suit, the Defendants may wish to revise and update their summary judgment arguments. Accordingly, in the interest of simplifying the procedural difficulties of this case as much as possible, the Court now denies all of the Defendants' Motions for Summary Judgment, without prejudice to their bringing revised motions consistent with this Memorandum Opinion and Order.
B. Alleged Improper Solicitation
The Cavanagh Defendants have argued that this case must be dismissed under the Court's "inherent authority" to dismiss actions in which plaintiffs have been improperly solicited. However, the Court need not pass on that allegation in order to conclude that whatever its "inherent authority", the Court's ordering, at this time, a dismissal of the facially nonfrivolous Amended Complaint based on "improper solicitation" would be an abuse of the Court's discretion.
C. Fed. R. Civ. P. 12(b)(7)
The Cavanagh Defendants also argue that this case must be dismissed, pursuant to Fed. R. Civ. P. 12(b)(7), for failure to join indispensable parties under Fed. R. Civ. P. 19. The assertedly indispensable parties are a Cavanagh Communities subsidiary, Cape Cave Corporation, and two of Cavanagh Communities' former agents, Deltona Corporation and Land Resources Corporation. Based upon the current record, the Court is unpersuaded that the failure to join these parties mandates a dismissal under the rigorous standards of Rule 19.
The Defendants have objected that the Amended Complaint fails to plead fraud with the particularity required by Fed. R. Civ. P. 9(b). After carefully considering the allegations of the sixty-four page Amended Complaint, the Court concludes that Plaintiffs' allegations of fraud are minimally sufficient to withstand a Rule 9(b) motion to dismiss.
In order to satisfy the particularity requirements of Rule 9(b), a plaintiff must describe the contents of the allegedly false representations, their time, their place, the identity of the party or parties making the misrepresentations, and the consequences of the alleged fraud. Midwest Grinding Co. v. Spitz, 716 F. Supp. 1087, 1092 (N.D. Ill. 1989), aff'd, 976 F.2d 1016 (7th Cir. 1992). Here, Plaintiffs allegations push the limits of these requirements. However, Plaintiffs are not required to plead evidence. The Amended Complaint contains quoted material from the sales film in which Defendant McMahon made several representations about the Rotonda project. (Am. Compl. PP 49(a) - 49(j).) Plaintiffs also allege fraud in several other quoted passages. (Am. Compl. PP 53(a) - 53(x).) Additionally, Plaintiffs list several omissions that they claim are material, (Am. Compl. PP 55(a) - 55(dd)), several quoted passages made at a 1975 meeting, (Am. Compl. PP 60(a) - 60(c)), and several specific statements said to constitute fraudulent concealment, (Am. Compl. PP 70(a) - 70(h) & (a) - (g)). Although the Amended Complaint does not contain allegations regarding how each and every one of the more than one thousand Plaintiffs was defrauded, it is apparent that each Plaintiff is relying on one or more of the statements alleged in the Amended Complaint. Given the great undertaking necessary to plead each of the Midwest Grinding factors for each of the Plaintiffs, the Court finds that Plaintiffs have satisfied their pleading requirements.
E. Standard for Motions to Dismiss
Defendants move to dismiss several of Plaintiffs' claims for failure to state a claim, pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure. Defendants also argue that Plaintiffs' claims are time-barred due to their failure to satisfy the relevant statute of limitations.
The purpose of a Rule 12(b)(6) motion is to test the legal sufficiency of a complaint. See Barkman v. Wabash, Inc., 674 F. Supp. 623 (N.D. Ill. 1991). In order to survive a motion to dismiss, a complaint must allege sufficient facts to outline a cause of action. Davis v. Frapolly, 747 F. Supp. 451 (N.D. Ill. 1989). The complaint "must state either direct or inferential allegations concerning all of the material elements necessary for recovery under the relevant legal theory." Carl Sandburg Village Condominium Ass'n No. 1 v. First Condominium Dev. Corp., 758 F.2d 203, 207 (7th Cir. 1985).
The Court must accept as true all facts alleged in the complaint and reasonable inferences based on those facts. Bane v. Ferguson, 890 F.2d 11, 13 (7th Cir. 1989). However, the Court need not accept as true conclusory legal allegations. Coronet Ins. Co. v. Seyfarth, 665 F. Supp. 661, 665 (N.D. Ill. 1987). Furthermore, the Court need not strain to find inferences from the complaint's allegations. P & P Mktg., Inc. v. Ditton, 746 F. Supp. 1354, 1357 (N.D. Ill. 1990). When evaluating the legal sufficiency of a plaintiff's factual allegations, courts are held to a strict standard. A motion to dismiss may be granted only if "it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46, 2 L. Ed. 2d 80, 78 S. Ct. 99 (1957).
As statutes of limitations form bases for affirmative defenses, plaintiffs are not required to allege facts demonstrating the timeliness of their suit. See Tregenza v. Great Am. Communications Co., 12 F.3d 717, 718 (7th Cir. 1993) (stating this conclusion in a Rule 10b-5 case). Unless a plaintiff pleads facts that show his case is time-barred, see id., a statute of limitations defense is best addressed on a motion for summary judgment. Here, the Court has indicated to the parties that a motion for summary judgment on the statute of limitations arguments may be necessary. However, on the current record, the Court can resolve several legal issues. The Court therefore proceeds with an analysis of those issues.
IV. PLAINTIFFS' SECURITIES CLAIMS
In Count Two of the Amended Complaint, Plaintiffs claim that the Defendants have violated section 10(b) of the 1934 Act, Rule 10b-5, and section 17(a) of the 1933 Act. Defendants argue that, while there is an implied private right of action under the 1934 Act and Rule 10b-5, there is no such right of action under the 1933 Act and section 17(a). Under Schlifke v. Seafirst Corp., 866 F.2d 935, 942-43 (7th Cir. 1989), that argument must be accepted, especially when a plaintiff's complaint already attempts to state a claim under Rule 10b-5. It is now clear that a majority of courts have refused to imply a right of action under section 17(a). Id.
Accordingly, with respect to Plaintiffs' section 17(a) allegations, Defendants' Motion to Dismiss is granted.
B. Existence of a "Security"
Plaintiffs' securities claims, based on Rule 10b-5 and section 12(2), require the demonstration of the existence of a security. Defendants contend that the Amended Complaint fails to do so.
The Securities Act of 1933 defines "security":
The term "security" means any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, or, in general, any interest or instrument commonly known as a "security", or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.
15 U.S.C. § 77b(1) (1988). The definition contained in the 1934 Act, see 15 U.S.C. § 78c(a)(10) (1988), while worded somewhat differently from the 1933 Act definition, is construed as though it were identical. See Tcherepnin v. Knight, 389 U.S. 332, 335-36, 19 L. Ed. 2d 564, 88 S. Ct. 548 (1967); Secon Serv. Sys. Inc. v. St. Joseph Bank & Trust Co., 855 F.2d 406, 411 n.5 (7th Cir. 1988). Plaintiffs claim that their agreements to purchase property in the Rotonda project are "investment contracts", (see Am. Compl. P 54; Pls' Mem. in Opp'n to Def. McMahon's Renewed Mot. to Dismiss at 35-36), within the broad definitions of "security" in the 1933 and 1934 Acts. See 15 U.S.C. § 77b(1) (1988) (including "investment contracts" within the definition of a security); 15 U.S.C. § 78c (a)(10) (1988) (same).
Neither the 1933 act nor the 1934 act defines what is an "investment contract". In the seminal case of SEC v. W. J. Howey Co., 328 U.S. 293, 90 L. Ed. 1244, 66 S. Ct. 1100 (1946), the Supreme Court attempted to define the term. An investment contract, for the purposes of the federal securities acts, is a "transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party." Id. at 301.
In Howey, the Supreme Court held that a contract to sell property in a citrus grove, accompanied by an agreement for the property's promoters to continue harvesting and developing the property, was held to be an "investment contract", and therefore a security. The Howey investors purchased narrow, unseparated strips of land containing orange trees. The land was collectively managed and serviced by the plan's promoters and the profits were distributed based on the investors' allocable share of the land owned. Because the Howey scheme satisfied the Court's newly declared test, the investment instruments in that case were deemed "investment contracts".
The Circuit Courts are split on the standard for demonstrating a "common enterprise". See Mordaunt v. Incomco, 469 U.S. 1115, 83 L. Ed. 2d 793, 105 S. Ct. 801 (1985) (White, J., dissenting from denial of writ of certiorari). According to the Fifth Circuit, commonality is established through "promoter dominance", meaning "whether the fortunes of the investments collectively" are "essentially dependent upon promoter expertise." See SEC v. Continental Commodities Corp., 497 F.2d 516, 522 & n.12 (5th Cir. 1974); SEC v. Koscot Interplanetary, Inc., 497 F.2d 473 (5th Cir. 1974). In contrast with the Fifth Circuit rule, which is often called "vertical commonality", the Seventh, Sixth, and Third Circuits require a different test, called "horizontal commonality". See Stenger v. R.H. Love Galleries, Inc., 741 F.2d 144, 146 (7th Cir. 1984); Hart v. Pulte Homes of Michigan Corp., 735 F.2d 1001, 1004 (6th Cir. 1984); Salcer v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 682 F.2d 459, 460 (3d Cir. 1982).
Generally, horizontal commonality exists when multiple investors pool their investments and receive pro rata profits. Stenger, 741 F.2d at 146; Hirk v. Agri-Research Council, Inc., 561 F.2d 96, 100-01 (7th Cir. 1977); Milnarik v. M-S Commodities, Inc., 457 F.2d 274 (7th Cir.), cert. denied, 409 U.S. 887, 34 L. Ed. 2d 144, 93 S. Ct. 113 (1972); see also Secon Serv. Sys. v. St. Joseph Bank & Trust, 855 F.2d 406, 411 (7th Cir. 1988) (stating that ...