Contract Law - An Oral Buy Sell Agreement Is Upheld

The case captioned, Prignano v. Prignano, 2-09-0439, (Illinois Appellate Court, Second District) is significant in that it recognizes a vague oral buy-sell agreement between two brothers, one of whom had passed away.

George and Louis Prignano owned several businesses together. At some point they appear to have agreed the upon the death of either of them, the survivor would buy out the other's share of the business from his heirs, using the proceeds from three life insurance policies purchased for that purpose.

The brothers discussed the arrangement, purchased the insurance, but never formalized it with a written contract signed by both of them. The case is significant because George's widow, Nancy Prignano, met the burden of proving the existence of the agreement with testimony of third parties, the insurance policies and the draft buy-sell agreement. The Appellate Court affirmed a verdict in Ms. Prignano's favor, which essentially enforced the oral agreement. Louis obtained the entire business and George's widow, Nancy, obtained the insurance proceeds.

Comment: this case again shows the importance of documenting business relationships. All too often the undersigned learns of an "agreement" between two partners that was never documented. The agreement is often very difficult to prove up at a later date. Usually unsigned documents are not worth the paper they were printed on. The buy-sell area of the law is one in which timely legal advice is invaluable. Those who try to do it themselves inevitably suffer.

Read More

Securities Law - Recent Developments Concerning SEC v. Howey, 328 U.S. 293 (1946)

SEC v. Howey, 328 U.S. 293 (1946) is one of the most important cases interpreting the securities laws.

The Defendants offered "units of a citrus grove development coupled with a contract for cultivating, marketing and remitting the net proceeds to the investor."

The SEC sued and alleged that the Defendants had failed to register the unit offering. The Defendants responded that they were not offering securities - rather they were offering the right to engage in citrus farming.

The Supreme Court held that the units were "investment contracts" under the Securities Law. 15 U.S.C. Section 77b(a)(1). The Court defined the investment contract as "a contract, 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 third party, it being immaterial whether the shares in the enterprise are evidenced by formal certificates or by nominal interests in the physical assets employed in the enterprise." Id at 299.

The Supreme Court held that the interests in the citrus farm were investment contracts because the contracts were "an opportunity to contribute money and to share in the profits of a large citrus fruit enterprise managed and partly owned by respondents." Moreover, the purchasers were not seeking to own land. They hoped to obtain a return on their investment. As the Court noted, "all the elements of a profit-seeking business venture are present here. The investors provide capital and share in the earnings and profits; the promoters manager, control and operate the enterprise."

The holding of Howey is crucial to the operation of the Securities Laws. Without this holding, promoters could design investment contracts that would be exempted from regulation under the Act.

Recent Developments:

Two recent decisions have reaffirmed the long-standing principles set forth in Howey.

In Warfield v. Alaniz, 569 F.3d 1015 (9th Cir. 2009), the Ninth Circuit held that certain charitable gift annuities were investment contracts under the federal securities laws.

The promoter, Robert Dillie, sold charitable annuities that promised an investment return to investors during their lifetimes and gifts to charities when the passed away. The Foundation raised $55 million from investors. Unfortunately it was a Ponzi scheme and had no investments. Ultimately, the Foundation collapsed. A receiver was appointed to recover assets for the victims. The receiver filed a lawsuit seeking the return of commissions paid to agents who sold the charitable annuities. After a trial the District Court entered judgment in favor of the receiver and against the agents.

The agents appealed on the ground that the charitable annuities were not investment contract and, thus, not securities.

The Ninth Circuit rejected their arguments and affirmed the judgment. The Court held that the annuities were investment contracts because there was "(1) an investment of money (2) in a common enterprise (3) with an expectation of profits produced by the efforts of others."

The annuities were investments because the promoter promised a substantial return on the investment to the participants.

The second decision we will review is Liberty Property Trust v. Republic Properties Corporation, 577 F.3d 335 (D.C. Cir. 2009).

The Plaintiffs brought claims under the securities laws against the Defendant Republic that marketed certain limited partnership units.

The two main defendants controlled the defendant and, in exchange for limited partnership units, transferred a valuable contract to the limited partnership. Later, as a result of a scandal, that contract was terminated by city of West Palm beach. The limited partnership interests became worthless.

The Defendants argued that the limited partnership interests were not investment contracts because they were on both sides of the transaction (they owned the Defendant and some of the limited partnership interests.) The court held that the limited partnership interests were securities because two of the defendants "expected to profit from the efforts of [others]." The two defendants lacked sufficient control over the limited partnership, so they were clearly trying to profit from the work of other people.

In sum, the Howey decision remains good law and is as relevant today as it was in 1946.

Edward X. Clinton, Jr.

Read More

Does Illinois Permit Lawsuits By Those Who Merely "Hold" Securities?

The United States Supreme Court in Blue Chip Stamps v. Manor Drugstores, 421 U.S. 723 (1975) held that investors injured by fraud may recover under the Federal Securities Law only if the deceit caused them to purchase or sell securities. In the Blue Chips case, the Supreme Court stated that states may supply the remedy when Federal Law does not. California has done so. It authorizes “holder actions” which are suits by investors who contend that the fraud caused them to hold their shares when they would have sold them had they known the truth. See, Small v. Fritz Companies, Inc., 30 Cal. 4th 167 (2003).

Plaintiff, Anderson, the holder of about 95,000 shares of Aon Corporation claimed in a U.S. District Court case that he would have sold his stock in Aon if he known earlier of fraud by the Company. When the financial information was discovered the stock dropped from about $69.00 a share to about $14 a share. Anderson’s claim was under the Illinois Securities Law and the District Judge held that the Illinois law supplies the rule of decision. Securities law in Illinois tracks federal law when the statutes use the same language, see Tirapelli v. Advanced Equities, Inc., 351 Ill.App. 3d 450, 455, 813 N.E. 2d 1138, 1142 (2004), which means that Illinois may follow the purchaser-seller rule of Blue Chip Stamps. The District Court concluded that the Plaintiff does not have a claim under Illinois law.

The Seventh Circuit in Anderson v. Aon Corporation, No. 09-1144 decided July 26, 2010, after sorting out various procedural maneuvers by plaintiff, in effect held that it was not clear if Illinois will permit holder actions, but it reversed the District Court that had dismissed Plaintiff’s complaint and remanded so that Plaintiff could pursue his claim.

Does Plaintiff have a holder claim under Illinois law? The final determination of this issue will await a trial.

Read More

Contract Law - Illinois Court Rejects Impossibility of Performance Defense

The case captioned, YPI 180 N. LaSalle Owner, LLC, v. 180 N. LaSalle II, LLC, 1-09-1797, provides an interesting discussion of the impossibility of performance doctrine.

The Plaintiff was an assignee of a contract to purchase real estate. It argued that the 2008 financial crisis following the failure of Lehman Brothers made it impossible to obtain financing and therefore it was excused from performance.

The Court, like the trial court, rejected the rescission claim. The court noted that "Rescission is an equitable remedy that seeks to restore the contracting parties to their precontract positions." Opinion at 5.

The Court noted that "impossibility of performance as a ground for rescission of a contract refers to those factual situations where the purposes for which the contract was made have, on the one side, become impossible to perform." See 30 R. Lord, Williston on Contracts, Section 77:95 (2004). The court noted that the impossibility defense is limited "to the destruction of the means of performance by an Act of God, vis major, or by law" and that performance should only be excused in extreme circumstances. Seaboard Lumber Co. v. United States, 308 F.3d 1283, 1294 (Fed. Cir. 2002); Kel Kim Corp. v. Central Markets, Inc., 70 N.Y.2d 900, 902, 519 N.E. 2d 295, 296 (1987). More importantly, "where a contingency that causes the impossibility might have been anticipated or guarded against in the contract, it must be provided for by the terms of the contract or else impossibility does not excuse performance.

Here, Plaintiff's claim was rejected because it was foreseeable that a commercial lender might not provide the required financing to complete the real estate purchase.

Comment: this is a novel and creative attempt by the plaintiff's lawyer to rescind a real estate contract, but it did not convince the trial court or the Illinois Appellate Court. As the court noted, if the inability to obtain commercial financing, standing alone, were sufficient to excuse performance...., then the law binding contractual parties to their agreements would be of no consequence." The Court is correct, the Plaintiff could have negotiated for a financing contingency in the contract, but apparently failed to do so. Opinion at 10.

Edward X. Clinton, Jr.

Read More

Contract Law - Seventh Circuit Blocks An Attempt to Hold Shareholders Liable For Corporate Debts

On August 2, 2010, the Seventh Circuit issued an opinion (written by Judge Easterbrook) in the case captioned Fusion Capital Fund II, LLC v. Richard Ham and Carla Aufdenamp, 09-3723, reversing a decision by Judge Shadur, holding that corporate shareholders could be liable for the corporation's debts.

The Plaintiff sought to collect a debt incurred by a corporation directly from the corporation's shareholders. The debt arose as a result of an ill-fated merger transaction.

Millenium Holding corporation was insolvent. However, it had previously gone public and its stock was tradeable. Another company, Sutura, Inc., sought to go public by merging into Millenium. As the Court noted, "Sutura wanted to go public without all the fuss and bother (and expense) of a registration statement and the release of audited financials." As a part of the merger agreement, Millenium agreed to raise $15 million in new capital. Later, Plaintiff Fusion and Millenium signed a contract and agreed to provide the $15 million.

When the merger with Sutura failed to close, Fusion "wrote to Millenium that the money would not be forthcoming." Sutura then terminated the merger agreement.
Fusion prevailed in contract litigation and later sued in the Northern District of Illinois to collect its legal fees incurred.

Fusion brought its claim against Ham and Aufdenkamp, Millenium's controlling shareholders. The District Court held that the Ham and Aufdenkamp were personally liable for the debt under Nevada law. The District Court ruled that Ham and Aufdenkamp became the "alter ego" of the corporation because (a) they influenced and governed it; (b) there was a "unity of interest" between the shareholders and the corporation; and (c) "adherence to the corporate fiction of a separate entity would sanction fraud or promote manifest injustice." Opinion at 4.

The Seventh Circuit agreed with the analysis with respect to the first two elements of the alter ego test. However, there was no fraud because Fusion was well aware - when it entered into the contract - that Millenium had no assets and was insolvent.

The Court reasoned that Fusion should have been aware that it could never enforce its contract (for the payment of legal fees) because Millenium was broke.

"When Millenium signed a contract promising to reimburse Fusion's legal expenses if litigation ensued, Fusion knew beyond a doubt that Millenium would be unable to keep that promise - unless the merger closed. Someone who wants to protect himself against the possibility that a thinly capitalized corporation will be unable to pay its debts asks the investors for a guaranty. It is feckless to do business with a corporation such as Millenium without one. Yet Fusion did not get a guaranty but also did not even ask for one....A business such as Fusion that neglects to arrange for payment if the worst comes to pass is not well positioned to seek judicial aid....Fusion wants to be protected from this asymemetry [the risk that Millenium would not be able to pay], but to get this protection Fusion should have negotiated for a guaranty and refused to deal if the Hams would not give one."

The Court distinguished the situation where the debtor is solvent when the contract is signed, but later siphons off its assets to avoid payment.

Comment: This is a thoughtful opinion that takes the polar opposite view of the District Court. It is a reminder to lawyers that anything can happen on appeal and that the underlying economics of a transaction are often far more persuasive than case citations and three-factor tests.

Edward X. Clinton, Jr.

Read More