# Amicus Curiae Brief — Landreth Timber Co. v. Landreth

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Amicus Curiae Brief
- **Published:** January 1, 1985
- **Citation:** 471 U.S. 681

## Text

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No. 83-1961

Jn the Supreme Gourt of the Waited States

Octoser Term, 1984

LANDRETH TIMBER COMPANY, PETITIONER
v

IVAN K. LANDRETH, ET AL.

ON WRIT OF CERTIORARI TO THE UNITED STATES
COURT OF APPEALS FOR THE NINTH CIRCUIT

\

MOTION FOR LEAVE TO FILE BRIEF AMICUS CURIAE
and

BRIEF FOR ADVANCE ROSS CORPORATION AS
AMICUS CURIAE IN SUPPORT OF RESPONDENTS

Los A California 90071
213-626-3800

* Counsel of Record

PANDICK MIDWEST INC., * 454-7600

Yn the Supreme Court of the Waited States

OcToBER TERM, 1984

No. 83-1961

LANDRETH TIMBER COMPANY, PETITIONER

Vv.

IVAN K. LANDRETH, ET AL.

ON WRIT OF CERTIORARI TO THE UNITED STATES
COURT OF APPEALS FOR THE NINTH CIRCUIT

MOTION FOR LEAVE TO FILE BRIEF AMICUS CURIAE
and

BRIEF FOR ADVANCE ROSS CORPORATION AS
AMICUS CURIAE IN SUPPORT OF RESPONDENTS

Advance Ross Corporation, a Delaware corporation based
in Chicago, Illinois, respectfully moves pursuant to Rule 36.3 of
the Rules of this Court for leave to file a brief amicus curiae in
support of respondents. The consent of counsel for petitioner
and respondents has been requested but denied. Advance Ross
Corporation’s interest in this case, and its special perspective on
the issues presented, are briefly described in this motion.

In December 1982, Advance Ross Corporation (“Advance
Ross”) sold a wholly-owned subsidiary, AMI Industries
(“AMI”), to Algeran, Inc. (“Algeran”). That sale came in the
aftermath of a six-month period of negotiation, repeated on-site
inspections of AMI’s premises, a review of AMI’s receivables by
accountants, and a disclosure of non-public records and data

requested by Algeran. The parties embodied their purchase
agreement in a 64-page contract, which was negotiated by
experienced corporate lawyers and which contained extensive
warranties and covenants concerning the rights and obligations
of the purchaser and seller. Among those covenants and
warranties were specific promises concerning operations, assets,
liabilities, and the accuracy of financial information. See Add.,
infra, A-6 to A-24. The parties expressly agreed that any
disputes concerning the sale transaction or breaches of any
warranty or covenant were to be decided under California law
(id. at A-23), and that all such disputes were to be resolved by
arbitration rather than by judicial proceedings. Jd. at A-23 to
A-24, A-19 to A-20.

The purchase agreement between Advance Ross and Alge-
ran transferred control over AMI by conveying 97% of its stock.
The remainder of the shares were lost shares; the transferred
shares therefore represented all existing and identifiable stock.
Algeran paid Advance Ross the purchase price part in cash and
part in promissory notes secured by a pledge of AMI’s stock.
Immediately after the sale transaction, Algeran assumed control
of AMI, installed a new board of directors, and began to

manage the company as its own wholly-owned subsidiary
( Add., infra, A-1 to A-3, A-20).

Within two business days after the closing of the sale,
Algeran began to complain about alleged “nondisclosures” in
the sale negotiations and demanded a reduction in the purchase
price. Despite its unequivocal promise to arbitrate, Algeran
claimed a right to sue in federal court under the securities laws
by reason of this Court’s decision in Wilko v. Swan, 346 U.S.
427 (1953), which, it asserted, overrode the unambiguous
arbitration covenant.

Algeran then filed a complaint in the United States District
Court for the Central District of California, alleging various
purported nondisclosures in violation of the securities laws. A

lengthy period of discovery ensued. During that period of
discovery, Advance Ross uncovered proof that Algeran’s princi-
pals previously had purchased several other corporations and
had used litigation to coerce decreases in the purchase price.
Moreover, they reduced at least two of the corporations which
they purchased to worthless shells after acquisition. Appendix
in Support of Motion for Summary Judgment at 1-153.

Throughout the lengthy pretrial proceedings that resulted
from Algeran’s initiation of securities litigation and its refusal to
arbitrate, Algeran relied on the pendency of securities litigation
to delay foreclosure on the AMI stock which Advance Ross
held as collateral. Advance Ross therefore was forced to stand
by helplessly while its collateral dwindled in value due to
Algeran’s extraction of funds from AMI. Ultimately, both
Algeran and AMI filed bankruptcy petitions.

Algeran’s delaying tactics could have continued in-
definitely given the amount of time that it takes to resolve a
securities case in federal court. However, approximately a year
and a half after Algeran filed its securities complaint, the Ninth
Circuit decided the case of Landreth Timber Co. v. Landreth,
731 F.2d 1348 (9th Cir. 1984), which affirmed the sale of
business doctrine and which held that privately negotiated sales
of substantially all of the stock of a corporation are beyond the
scope of the federal securities laws.

Applying the Ninth Circuit’s decision in Landreth, the
district court dismissed Algeran’s securities law claims. After
dismissal of those securities law claims, Wilko v. Swan no
longer stood as an obstacle to arbitration and the district court
enforced the arbitration agreement. The court observed that
“arbitration may well be the speediest method of resolving the
claims in this case.” Add., infra, at A-3. Moreover, having
dismissed the securities law claims, the district court also
permitted Advance Ross to exercise its contractual rights as a
secured creditor—rights which had been hindered for over a
year and a half by Algeran’s initiation of securities litigation.

In view of these recent events, it is apparent that this
Court’s decision concerning the validity of the sale of business

iv

doctrine may have a substantial impact on the finai resolution
of the controversy between Algeran and Advance Ross. Ac-
cordingly, Advance Ross has a direct interest in the outcome of
this litigation.

In the Algeran litigation, as in the case now before this
Court, federal jurisdiction was premised on the assumption that
a privately negotiated sale of all of the stock of a corporation is
a “security” transaction subject to the federal securities laws.
As we demonstrate in this amicus brief, that assumption is
totally unfounded. This brief also demonstrates the far-
reaching importance of the sale of business doctrine and the
danger of “vexatious litigation” ( Blue Chip Stamps v. Manor
Drug Stores, 421 U.S. 723, 739 (1975)) which would follow
from a rejection of that doctrine. In particular, this brief
describes the injustice and waste that result from condoning
evasion of negotiated sale agreements by resort to securities
litigation. Superimposing securities law remedies would effec-
tively strip away contractual remedies negotiated by sophis-
ticated parties of equal bargaining power, and would nullify
express covenants to arbitrate which are essential to many sale
of business transactions.

In view of Advance Ross Corporation’s recent experience
with sale of business litigation, its views on the legal and policy
issues raised by this case should materially assist the Court and
provide a useful supplement to the presentation of respondents.

Respectfully submitted,

STEPHEN M. SHAPIRO

Mayer, Brown & Platt
231 South LaSalle Street
Chicago, Illinois 60604
312-782-0600

Counsel of Record for
Advance Ross Corporation

v

QUESTION PRESENTED

Whether a privately negotiated sale of business, which is
evidenced by a transfer of all of the stock of a closely-held
corporation and which is accompanied by the purchaser’s
assumption of control over all of the assets and operations of
the corporation, is in economic reality a sale of “securities”
within the meaning of the federal securities laws.

vi

TABLE OF CONTENTS

ARGUMENT:

The Federal Securities Laws Do Not Apply To
Privately Negotiated Sales Of All Of The Stock Of A
Corporation When The Stock Is Transferred As An
Incident Of An Unlimited Transfer Of Ownership
And Control Over The Business Enterprise...................

I.

This Court’s Recent Decisions Construing The
Term “Security” Strongly Support The Sale Of

The Legislative History Confirms That Congress
Did Not Intend To Treat Privately Negotiated
Sales Of Businesses As Securities Transactions ....

The Ninth Circuit’s Decision Finds Direct Sup-
port In The Established Principle That Sales Of
General Partnership Interests And Commercial
Notes Do Not Constitute Securities Transactions

The Ninth Circuit’s Decision Finds Direct Sup-
port In This Court’s Repeated Pronouncement
That The Federal Securities Laws Should Not
Be Construed Broadly To Supersede Traditional
State Law Remedies

The Sale of Business Doctrine Prevents Parties
From Breaching Their Contractual Obligations
And Deters Vexatious Litigation . “

15

18

21

22

PAGE

VI. No Persuasive Policy Argument Has Been Ad-
vanced For Rejecting The Sale Of Business

CONCLUSION ...0cccoccosccscsscsscrsccccsscsecsecocecsesecsecsessesseseeseess 30

ADDENDUM .........cccccccsscssscecscessercrseceencsnssenssencesssesssonseses A-l

TABLE OF AUTHORITIES

Cases:

AMFAC Mtg. Corp. v. Arizona Mall of Tempe, 583
TY Le | ene
American Bank & Trust Co. v. Wallace, 702 F.2d
EL CII cccsamnnensisenisnncntetreninnnintimennnesseen
Blue Chip Stamps v. Manor Drug Stores, 421 U.S.
Te

C.N.S. Enterprises, Inc. v. G.&G. Enterprises, Inc.,
508 F.2d 1354 (7th Cir. 1974), cert. denied, 423
U.S. 825 (1975).

Canfield v. Rapp & Son, Inc., 654 F.2d 459 (7th
Cir. 1981) ...

Chandler v. Kew, Inc., 691 F.2d 443 (10th Cir.
1977)

Chemical Bank v. Arthur faduem, 726 F. 2d 959
(2d Cir. 1984)

Christy v. Cambron, 710 F.2d 669 ( 10th Cir. 1983)

Condux v. Neldon, 404 N.E.2d 523 (Ill. App.
a

Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976) ..

Frederiksen v. Poloway, 637 F.2d 1147 (7th Cir.),
cert. denied, 451 U.S. 1017 (1981) ...........ccccccceeeee

Goodwin v. Elkins & Co., 730 F.2d 99 (3d Cir.
1984)

Grumman Allied Industries, Inc. vy. Rohr In-
dustries, Inc., 748 F.2d 729 (2d Cir. 1984)..........

Herman & MacLean v. Huddleston, No. 81-680 -

(Jan. 24, 1983)
International Brotherhood of Teamsters v. Daniel,
439 U.S. 551 (1979)

PAGE

23

10, 11, 12,
13, 22,

26

PAGE
Kaye v. Pawnee Constr. Co., 680 F.2d 1360 (11th
Ge Fe ennenen 6
King v. Winkler, 673 F.2d 342 ( 11th Cir. 1982) ..... 6
Landreth Timber Co. v. Landreth, 731 F.2d 1348

oo: | a iii, 3, 6
McGrath v. Zenith Radio Corp., 651 F.2d 458 (7th
Cir. ), cert. denied, 454 U.S. 835 (1981)............... 28
Marine Bank v. Weaver, 455 U.S. 551 (1982)........ 4, 13, 14,
15, 19,
20, 22,
26, 27,
29, 30
Odom v. Slavik, 703 F.2d 212 (6th Cir. 1983)......... 19
Piper v. Chris-Craft Industries, Inc., 430 U.S. |
fb , SR nen 22
Prima Paint Corp. v. Flood & Conklin Mfg. Co.,
En eee 25
Santa Fe Industries, Inc. v. Green, 430 U.S. 462
(fe 22
SEC v. Capital Gains Bureau, Inc., 375 U.S. 180
(1963) —
Sutter v. Groen, 687 F.2d 197 (7th Cir. 1982)......... 6, 17,27
United Housing Foundation, Inc. v. Forman, 421
ae ee COD etttcttntnntetemntntinneein 5, 7, 8, 9,
10, 15,
20, 21,
22, 24,
26, 29,
30
United States v. Naftalin, 441 U.S. 768 (1979)....... 18
Wilko v. Swan, 346 U.S. 427 (1953) ..........cccecceseees ii, iii, 23,
25

Williamson v. Tucker, 645 F.2d 404 (Sth Cir.),
cert. denied, 454 U.S. 897 (1981) .......c..ccccssesseeeees 19

PAGE
Statutes:

Securities Act of 1933, Section 2, 15 U.S.C. 77b....... 4
Securities Act of 1933, Section 12(2), 15 U.S.C.

RE a vanes se 23
Securities Exchange Act of 1934, Section 3(c), 15
Ey Pe cnansmnsntnininanerieinninttndicninesbiiiebiintins 4
Miscellaneous:
J. Crane & A. Bromberg, Law Of Partnership
(1968) 19

Easley, Recent Developments In The Sale Of Busi-

ness Doctrine, 39 Business Lawyer 929 (1984)... 6,27
R. Jennings & H. Marsh, Securities Regulation (3d

ed. 1972) “ = at ae
Seldin, When Stock Is Not A Security: The Sale Of

Business Doctrine, 37 Business Lawyer 637

(1982) ae cuuininemenn 6
Thompson, The Shrinking Definition Of A Secu-

rity: Why Purchasing All Of A Company’s Stock

Is Not A Federal Security Transaction, 57

N.Y.U.L. Rev. 225 (1982). » O&@

Webster's International Dictionary (2d ed. 1934)... 5
77 Cong. Rec. ( 1933):

ee 15
ee 16
i eetreuntnianinemeiiniienee 16
p. 2918. : 16

H.R. Rep. No. 85, 73d Cong., Ist Sess. (1933)....... 16, 18
H.R. Rep. No. 1383, 73d Cong., 2d Sess. (1934)... 17
S. Rep. No. 47, 73d Cong., Ist Sess. (1933) ........... 16
S. Rep. No. 792, 73d Cong., 2d Sess. (1934) ......... 17

BRIEF FOR ADVANCE ROSS CORPORATION
AS AMICUS CURIAE

INTEREST OF THE AMICUS CURIAE

As explained in the foregoing motion for leave to file the
instant brief amicus curiae, Advance Ross Corporation has a
direct interest in the present case because it is now a defendant
in a suit which raises the validity of the sale of business doctrine
(see Add., infra, at A-1 to A-3).

STATEMENT

1. The sale of business involved in this case resulted from
three months of private negotiation between respondents, the
owners of a closely-held family corporation, and a representa-
tive of petitioner, a senior partner in a major law firm who was
experienced in corporate acGuisitions. J. App. 80-81, 264. Each
side to the negotiations was represented by counsel. Jd. at 171,
286. During the negotiations, the purchaser’s agents conducted
an extensive investigation of the acquired business—an inoper-
able sawmill then under reconstruction. In addition to person-
which analyzed the underlying assets, a certified public accoun-
tant who investigated the financic' condition of the business,
and a bank officer who examined th. operation of the business
before providing financuwg. Jd. at 84-86, 105-171, 217, 225-
247. The purchaser’s right ‘> conduct a “pre-acquisition audit
of the business and records of the company” (id. at 217)
encompassed every feature of the financial and business oper-
ations of the acquired entity, including confidential financial
information, relations with customers, equipment and in-
rate minute books, cash flow projections, and internal controls.
Id. at 84-86, 106-111, 115, 127, 139, 154, 225.

2

The negotiated purchase agreement, providing for pay-
ment in cash and notes over an extended period of time in
exchange for all of the stock of the acquired company, exceeded
60 pages in length. J. App. 206-274. The agreement contained
comprehensive inventories and appraisals of the “physical
assets” of the acquired company (id. at 210, 235-250), and a
host of specially negotiated “warranties” by the sellers relating
to assets, liabilities, and operations (id. at 208-213, 217-218,
227-233). In addition, the purchase agreement contained
specific provisions designed to remedy any inaccuracy in the
assurances and warranties made in the inducement of the
transaction. The agreement provided that all “representations
and warranties made by Sellers to Buyer * * * in this Agree-
ment or any document furnished or to be furnished by any of
them hereunder shall be true and correct in all material
respects” (id. at 215). It also prescribed a remedial mechanism
to deal with any breach of warranty or promise, including a
formula for computing damages to be paid (id. at 218-219).
Although the purchase agreement made repeated reference to
the “laws of the state of * * * incorporation” and the “Uniform
Commercial Code” (id. at 215-216), it nowhere referred to the
provisions of the federal securities laws. The record contains no
indication that the parties to the transaction expected the
federal securities laws to govern their respective rights and
obligations.

2. Following the closing of the sale transaction, the
acquiring corporation assumed complete control over the busi-
ness and operated it subject to its own managerial policies. The
sellers retained no interest in the business and all of the former
directors and officers resigned their positions. J. App. 183-186,
284-285. Moreover, prior to the closing, the purchaser selected
its own “general manager,” who supervised the day-to-day

3

operations of the company. /d. at 187-201. It is undisputed
that the sellers retained no control over the management of the
business and had no ability to direct its operations after the
closing.

Unfortunately, the purchaser did not succeed in operating
the business profitably, and, some months after the acquisition,
it accused the sellers of providing inaccurate information during
the sale negotiations. J. App. 90-94. The purchaser subse-
quently filed suit in the Superior Court for the State of
Washington, Landreth Timber Company v. Ivan K. Landreth,
Civ. No. 80-2-11740-8, a suit which alleged, inter alia, breach

’ of contract and warranty and common law deceit. The

purchaser also filed suit in federal district court, raising the
same allegations presented in state court and asserting jurisdic-
tion under the federal securities laws. J. App. 37-50.

3. The district court granted summary judgment and
dismissed the securities law complaint, concluding that Con-
gress never intended the federal securities laws to apply to
privately negotiated sales of an entire business. Pet. App. |2a-
20a. Looking to the “economic realities,” the district court
found that the transfer of stock certificates was merely in-
cidental to the consummation of a “commercial” transaction
(id. at 18a), and that the purchaser, who fully intended to own
and operate the business itself, did not expect to earn profits
“from the managerial or entrepreneurial efforts of others” ( id.
at 19a-20a. ).

The court of appeals unanimously affirmed. Pet. App. la-
10a. Speaking for the court, Chief Judge Browning explained
that the “underlying transaction involved the sale of an entire
business * * *. Following the transaction, [the purchaser] had
full control of the corporation, including the day-to-day oper-
ations of the mill and its employees. In ‘economic reality,’ the
underlying transaction was a sale of a lumber business and
* * * not an investment in a ‘security.’ Jd. at 9a.

4

INTRODUCTION AND SUMMARY OF ARGUMENT

The court of appeals correctly concluded that the “eco-
nomic reality” of the transaction in this case was a sale of
business and not an investment in securities. To treat the
transaction as a purchase of “securities” would exalt form over
substance. The purchaser in this case no more purchased
“securities” than the purchaser of a home or automobile
purchases a “deed of title” with his funds. The stock certificates
transferred in this case, like a deed of title, merely formalized
the transfer of ownership of the entire business enter-
prise—lock, stock and barrel. Because the purchaser here did
not invest in certificates symbolizing a pro rata interest in an
enterprise managed by others, and was in a position to
negotiate on a one-on-one basis for information and contractual
protection specially adapted to its needs, it did not engage in a
“security” transaction within the meaning of the federal secu-
rities laws.

The language used by Congress is, of course, the starting
point in any case of statutory interpretation. The definition of
“security” contained in both the Securities Act of 1933, 15
U.S.C. 77b, and the Securities Exchange Act of 1934, 15 U.S.C.
78c( a), provides that the term “security” shall include “stock”
— “unless the context otherwise requires.” As this Court held in
Marine Bank v. Weaver, 455 U.S. 551, 556 ( 1982), that express
caveat is an important restriction on the broad language used in
the definitional provisions: “The broad statutory definition is
preceded * * * by the statement that the terms mentioned are
not to be considered securities ‘if the context otherwise requires
*** .° [W]e are satisfied that Congress, in enacting the
securities laws, did not intend to provide a broad federal
remedy for all fraud.” The Court in Weaver then proceeded to
tions, both of which fit within the definitions prescribed by
Congress, but both of which, upon examination, were found to
be commercial in nature and beyond the scope of Congressional
intent.

5

That Congress did not mean to subsume privately nego-
tiated sales of entire businesses within the statutory definition of
a “security” sale is manifest from a consideration of the
meaning of the terms “stock” and “security” when Congress
enacted the federal securities laws. In this respect, it is
appropriate to examine contemporary dictionary definitions.
See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 199 nn. 20-21
(1976) (relying on Webster’s International Dictionary (2d ed.
(1934)). Webster's International Dictionary (2d ed. 1934)
establishes that the meaning of the term “stock” was “[s]hares
or holdings, collectively, in a corporate business enterprise
***” while the term “security” referred to “[a]n evidence of
debt or of property, as a bond [or] stock certificate, *** a
document giving the holder the right to demand and receive
property not in his possession.” Id. at pp. 2480, 2263 (emphasis
supplied). Thus, fifty years ago, the words “stock” and
“security” denoted precisely what they denote today: collective
holdings which symbolize the financial interest of investors in
the assets of a business enterprise not in their possession.

It is contrary to the “ordinary concept of a security”
transaction ( United Housing Foundation, Inc. v. Forman, 421
U.S. 837, 851 ( 1975)) to treat the sale of an entire business—in
which stock is transferred as a mere incident of a conveyance of
ownership and control—as a sale of “securities.” In such a
transaction, there is no “collective” investment in a venture
managed by others, but rather the transfer of an entire business,
including its physical assets, to be operated by the purchaser
alone. Certainly, the average person, giving the words used by
Congress their ordinary meaning, would not perceive this to be
an investment in securities as opposed to the outright purchase
of a business enterprise.

This view of the economic realities surrounding a sale of
business is particularly compelling in the present case, where
the purpose of the purchaser was not to acquire investment
securities but rather to obtain control of the physical assets of

6

the enterprise. As the purchaser’s representative explained (J.
App. 83): “I told defendant Landreth that we wanted to
purchase the operating assets and inventory of the sawmill from
Landreth Timber Company. I informed Mr. Landreth that I
was reluctant to purchase the corporate shares * * *.” The fact
that the transaction ultimately took the form of a stock transfer,
rather than an asset transfer, rested solely on tax considerations
that are irrelevant to the expectations of the parties regarding
the law that would govern a dispute such as this. Jd. at 83, 107.

The courts of appeals in four circuits have concluded that
the sale of a corporation, accompanied by a transfer of all of its
stock in a privately negotiated transaction, is a sale of business
and not a securities sale.’ That view is supported by the great
weight of academic scholarship.2 As we demonstrate in this
brief, that view also is compelled by this Court’s past decisions,
by the legislative history of the federal securities laws, by
principles of federalism, and by the compelling need to prevent
the federal securities laws from being used as instruments for
the infliction of fraud and the destruction of contractual rights.

‘See Landreth Timber Co. v. Landreth, 731 F.2d 1348, 1350-
1353 (%h Cir. 1984); Christy v. Cambron, 710 F.2d 669, 672 ( 10th
Cir. 1983); Sutter v. Groen, 687 F.2d 197, 199-204 (7th Cir. 1982):
Kaye v. Pawnee Constr. Co., 680 F.2d 1360, 1366 a. 2 (lth Cir. 1982);
King v. Winkler, 673 F.2d 342, 345-346 (llth Cir. 1982); Canfield v.
Rapp & Son, Inc., 654 F.2d 459, 463-466 ( 7th Cir. 1981); Frederiksen
v. Poloway, 637 F.2d 1147, 1150-1154 ( 7th Cir. 1981); and Chandler
v. Kew, Inc., 691 F.2d 443, 444 ( 10th Cir. 1977).

2 See, e.g, Easley, Recent Developments In The Sale Of Business
Doctrine, 39 Business Lawyer 929 ( 1984); Thompson, The Shrinking
Definition Of A Security: Why Purchasing All Of A Company's Stock Is
Not A Federal Security Transaction, $7 N.Y.U.L. Rev. 225 (1982);
Seldin, When Stock Is Not A Security: The Sale Of Business Doctrine,
37 Business Lawyer 637 ( 1982).

-

ARGUMENT

THE FEDERAL SECURITIES LAWS DO NOT APPLY TO
PRIVATELY NEGOTIATED SALES OF ALL OF THE
STOCK OF A CORPORATION WHEN THE STOCK IS
TRANSFERRED AS AN INCIDENT OF AN UNLIMITED
TRANSFER OF OWNERSHIP AND CONTROL OVER
THE BUSINESS ENTERPRISE

I. This Court’s Recent Decisions Construing The Term
“Security” Strongly Support The Sale Of Business
Doctrine

1. In their briefs in this Court, petitioner and the SEC
depend heavily on lower court decisions, and give grudging
mention to the three latest decisions of this Court defining the
term “security.” That is not surprising, since their theories are
irreconcilable with those recent decisions. Unlike petitioner
and the SEC, we begin with what this Court recently has said
on the subject at hand.

a. This Court enunciated the contemporary approach to
defining the term “security” in United Housing Foundation, Inc.
v. Forman, 421 U.S. 837 (1975). The plaintiffs in Forman
alleged that “shares of stock” in a housing cooperative were
investment securities subject to the federal securities laws.
Plaintiffs claimed that because the shares were denominated
“stock” and were purchased for value, they fell literally within
the statutory definition of the term “security” and also con-
stituted “investment contracts.” In words that are directly
applicable here, this Court rejected both contentions.

The Court began by observing generally that “stock” does
not “fall within the ordinary concept of a security” unless it is
sold “by those who seek the use of the money of others on the
promise of profits.” 421 U.S. at 848. Thus, the Court “re-
ject{ed] at the outset any suggestion that the present transac-
tion, evidenced by the sale of shares called ‘stock,’ must be
considered a security transaction simply because the statutory

definition of a security includes the words ‘any stock.’” Ibid.
Rather, in considering the scope of the term “stock,” the Court
found it essential to place “emphasis * * * on economic reality.”
Ibid. Stated otherwise, “[b]ecause securities transactions are
economic in character Congress intended the application of
these statutes to turn on the economic realities underlying a
transaction, and not on the name appended thereto.” Jd. at 849.
Viewing the economic realities underlying the purchase of stock
in Forman, this Court held that the plaintiffs, who sought to
acquire real estate “for their personal use,” were not, in fact,
“purchasing investment securities” even though the transaction
was evidenced by a sale of stock. Jd. at 851.

When the Court in Forman turned next to plaintiffs’ claim
that the certificates constituted “investment contracts,” it util-
ized the same “economic reality” test used in analyzing the
question whether the certificates were “stock,” emphasizing that
““we again must examine the substance —the economic realities
of the transaction— rather than the names that may have been
employed by the parties.” Jd. at 851-852. The economic
realities test required a careful analysis of whether “the scheme
involves an investment of money in a common enterprise with
profits to come solely from the efforts of others.” Jd. at 852.
“This test, in shorthand form, embodies the essential attributes
that run through ail of the Court’s decisions defining a security.
The touchstone is the presence of an investment in a common
venture premised on a reasonable expectation of profits to be
derived from the entrepreneurial or managerial efforts of
others.” Jbid. (emphasis supplied ).

Forman also announced the standard used to distinguish
between security transactions and commercial transactions:
“when a purchaser is motivated by a desire to use * * * the item
purchased — ‘to occupy the land or to develop it themselves’
* * * — the securities laws do not apply.” Jd. at 852-853. Even
though the purchasers in Forman had an economic motivation
for acquiring the stock in question, this Court found that “that

9

type of economic interest characterizes every form of com-
mercial dealing.” It added that “[{w ]hat distinguishes a security
transaction — and what is absent here — is an investment
where one parts with his money in the hope of receiving profits
from the efforts of others, and not where he purchases [an
asset] * * * for personal use.” Jd. at 858.

Thus, because the economic reality of the transaction at
issue in Forman was a purchase of property to be used by the
purchasers themselves — rather than payment of money to a
third party with the expectation of profit from the third party’s
entrepreneurial efforts — this Court declined to find a security
transaction despite the presence of certificates labelled “stock.”

b. Proper application of Forman in the present case is
clear. Here, as in Forman, the fact that stock certificates
changed hands is not dispositive. In construing the federal
securities laws, the Court must assess the economic reality of the
underlying transaction. Here, as in Forman, no one placed
money in the hands of others with the expectation of profit from
their managerial efforts and here, as in Forman, there was no
common venture. Quite to the contrary, the purchaser acquired
property to be used by itself. Unlike a true security transaction,
the purchaser here did not part with control over its investment.
The present transaction is no different from the countless other
transactions in our commercial world in which a purchaser
acquires property to be used for profit-making purposes and
obtains a transferable certificate to evidence its right of own-
ership.

What Forman recognizes, and what the court below also
recognized, is that documents evidencing an ownsrship interest
can be transferred in two fundamentally different contexts. In
the first situation, the purchaser obtains a document reflecting
its right of ownership at the same time that it obtains exclusive
possession of the underlying property. The document formal-
izes undivided ownership. Examples include purchases of real
estate or chattels in which cash is exchanged for a transferable

10

deed of title. By contrast, a security transaction arises when the
purchaser obtains a document representing a fractional equity
interest at the same time that he places capital in the hands of
managers who are expected to earn profits for investors at

large.

In this case, as in Forman, the acquiring party received
stock certificates merely to formalize its ownership of property
that it intended to manage itself. And here, as in Forman, the
certificates did not have the significant “characteristics” of
securities in the hands of investors (id. at 851). While ordinary
investors purchase stock to obtain “dividends contingent upon
an apportionment of profits” (ibid.), the certificates here were
acquired to serve the formal function of a bill of sale or deed of
title. The purchaser’s profits were not “contingent” on any
“apportionment of profits” by managers, but on its own
managerial efforts. Moreover, as in Forman, “voting rights”
and market “appreciat[ion]” had nothing to do with this stock
acquisition. Jbid. The purchaser acquired the sawmill not to
vote shares or speculate in the stock market, but to make money
cutting logs (J. App. 83).

It would be exalting form over economic substance to treat
a sale of business such as this as a sale of investment securities.
Here, the “stock * * * merely was passed incidentally as an
indici{um] of ownership of the business assets.” Frederiksen v.
Poloway, 637 F.2d 1147, 1151-1152 (7th Cir. 1981). Since a
sale of assets unquestionably would not be encompassed by the
securities laws, the form of the transaction (ordinarily dictated
by tax planning considerations) should not alter the result.

2. a. This Court’s unanimous decision in Jnternational
Brotherhood of Teamsters v. Daniel, 439 U.S.°551 (1979),

ll

provides additional compelling reasons for sustaining the sale
of business doctrine. In Daniel, the plaintiffs alleged that
participations in an involuntary, noncontributory pension plan
were securities. The financial interests in Daniel were part of
the compensation package which the plaintiffs received as
employees. The interests resembled interests in a commingled
mutual fund and were managed by professional fiduciaries. In
view of this, the plaintiffs in Daniel contended that the financial
interests constituted an “investment contract” or a “participa-
tion in a profit-sharing agreement,” both of which are contain-
ed in the definition of the term “security.” This Court rejected
both contentions.

Initially, the Court reiterated that the test “is whether the
scheme involves an investment of money in a common enter-
prise with profits to come solely from the efforts of others.” 439
U.S. at 558. That test is to be applied “in light of ‘the substance
— the economic realities of the transaction — rather than the
names that may have been employed by the parties.’” Jbid.
The Court declined to find “any broader meaning” in any of
the alternative definitions contained in the securities laws, since
the economic realities test “embodies the essential attributes
that run through ail of the Court’s decisions defining a secu-
rity.” Id. at 558 n. 11 (emphasis supplied ).

The Court in Daniel then turned to the question whether it
was realistic to view the plaintiffs’ acquisition of pension plan
interests as an investment in securities. The Court held that it
was not, explaining that “[i]n every decision of this Court
recognizing the presence of a ‘security’ under the Securities
Acts, the person found to have been an investor chose to give
up a specific consideration in return for a separable financial
interest with the characteristics of a security.” Jd. at 559. In
Daniel, by contrast, “the purported investment is a relatively
insignificant part of * * * [the] * * * total and indivisible * * *
package.” Id. at 560. The “package” received by the plaintiff-

12

employees, viewed as a whole, “is substantially devoid of
aspects resembling a security.” [bid.

In addition, the Court in Daniel found that the financial
benefits expected by the piaintiff-employees were not depend-
ent solely “on the efforts of the Fund’s managers.” Jd. at 562.
Rather, those financial benefits “would depend primarily on the
employee’s efforts to meet the vesting requirements.” Jbid.
Thus, the financial returns expected by the plaintiff-employees
came from their own efforts and not “from the entrepreneurial
or managerial efforts of others.” Jd. at 561.

Finally, this Court observed in Daniel that treating the
employees’ financial interests as securities was unnecessary to
protect their rights. The Court explained that other remedial
schemes, such as the Employee Retirement Income Security
Act, provided ample protection and were preferable to “the
indefinite and uncertain disclosure obligations imposed by the
antifraud provisions of the Securities Acts.” Jd. at 569. Thus,
extension of the federal securities laws to the transactions at
issue would “serve[ ] no general purpose.” Jd. at 570.

b. Daniel confirms that the court of appeals correctly
declined to expand the scope of the federal securities laws in
this case. Here, as in Daniel, it is completely unrealistic to
speak of petitioner’s acquisition of a business enterprise as a
purchase of “securities.” Petitioner clearly did not “give up a
specific consideration in return for a separable financial interest
with the characteristics of a security.” 439 U.S. 559. Unlike the
ordinary investor, who obtains only stock certificates and does
not obtain ownership and control of the underlying physical
assets, the purchaser here acquired a business operation in its
entirety.

In addition, here, as in Daniel, the profits expected by
petitioner were to come not from the managerial or entrepre-
neurial efforts of “others” (id. at 561), but rather from
petitioner’s own efforts (id. at 562). Finally, here, as in Daniel,
it is totally unnecessary to extend the “indefinite and uncertain

13

disclosure obligations imposed by the antifraud provisions of
the Securities Acts” (id. at 569) because there is an alternative
and superior remedial scheme. The parties have prescribed in
detail precisely how their rights and obligations are to be
measured in the 60-page sale agreement, which contains com-
prehensive and carefully negotiated covenants and warranties.
In this context, application of the federal securities laws would
“serve no general purpose.” Jd. at 570.

3. a. This Court’s unanimous decision in Marine Bank v.
Weaver, 455 U.S. 551 (1982), removes any remaining doubt
about the correctness of the decision of the court below. The
plaintiffs in that case alleged that sales of a “certificate of
deposit” and a “business agreement” constituted securities
transactions. The certificate of deposit contained a promise to
repay a sum certain plus interest, and fell literally within the
statutory definition of the term security, which embraces any
“note.” Likewise, the business agreement provided for a shar-
ing of profits from a commercial enterprise managed by other
persons. It therefore literally fell within the statutorv definition,

_ which embraces any “profit-sharing agreement” or “investment

contract.”

Applying the economic realities test, however, this Court
concluded that neither financial interest constituted a security.
In rejecting plaintiffs’ expansive arguments under the securities
laws, the Court warned that “we are satisfied that Congress
* * * did not intend to provide a broad federal remedy for all
fraud.” 455 U.S. at 556.

Turning to the certificate of deposit, the Court stated that
“(t]he definition of ‘security’ in the 1934 Act provides that an
instrument which seems to fall within the broad sweep of the
Act is not to be considered a security if the context otherwise
requires. It is unnecessary to subject issuers of bank certificates
of deposit to liability under the antifraud provisions of the
federal securities laws since the holders of bank certificates of

14

deposit are abundantly protected under [other applicable]
laws.” Id. at 558-559.

The Court also concluded that the profit sharing agreement
was beyond the scope of the securities laws. The Court
acknowledged that “the agreement gave the [purchasers] a
share in the profits of the slaughterhouse which would result
from the efforts of the [sellers].” Jd at 559. Nonetheless,
because the transaction was privately negotiated, it had none of
the characieristics commonly associated with a securities trans-
action. The instruments “found to constitute securities in prior
cases involved offers to a number of potential investors, not a
private transaction as in this case.” Jbid. The Court explained
that “[hJere, * * * the [sellers] distributed no prospectus to the
[purchasers] or to other potential investors, and the unique
agreement they negotiated was not designed to be traded
publicly.” Jd. at 560.

Finally, the Court observed that the plaintiffs in Marine
Bank were not mere passive investors who placed capital in the
hands of managers. It noted that “the [contractual] provision
that the [purchasers] could veto future loans gave them a
measure of control over the operation of the slaughterhouse not
characteristic of a security.” Jd at 560. Accordingly, “this
unique agreement, negotiated one-on-one by the parties, is not
a security.” bid.

b. The relevance of Marine Bank in present circumstances
is apparent. Here, as in Marine Bank, it is essential to look
beyond the language of the statutory definitions and to examine
the transactional “context.” That examination ‘stablishes that
resort to federal court remedies under the securities laws The
contractual warranty provisions in the purchase agreement are
enforceable under state law, not federal law.

In addition, this Court’s conclusion that the business
agreement in Marine Bank did not give rise to a security sale is

15

precisely applicable here. The agreement in Marine Bank
provided for a partial transfer of business pursu_nt to a joint
venture. The interest in the joint venture was not a security
because the plaintiffs obtained a “veto” power over certain
managerial decisions. In the present case, petitioner obtained
not only some role in management — it obtained a// manage-
rial power. Moreover, in this case, as in Marine Bank, the
privately negotiated agreement, calling for the transfer of assets
and stock, was unaccompanied by any element of public
distribution. It therefore follows that this “unique agreement,
negotiated one-on-one by the parties,” is beyond the scope of
the securities laws. Jd. at 560.

Il. The Legislative History Confirms That Congress Did
Not Intend To Treat Privately Negotiated Sales Of
Businesses As Securities Transactions

As this Court explained in Forman, supra, 421 U.S. at 849:

“The focus of the Acts is on the capital market of the
enterprise system: the sale of securities to raise capital for

profit-making purposes, the exchanges on which securities
are traded, and the need for regulation to prevent fraud
and to protect the interest of investors.”

Indeed, the only relevant statutory objective expressed in the
legislative history is protection of the financial interests of those
who buy or sell investment instruments — i.e., persons who
earn profits from the managerial efforts of others. See Thomp-
son, The Shrinking Definition Of A Security, supra, 57 N.Y.U.L.
Rev. at 241: “The securities laws are meant to protect those
who turn over their investments to third parties, not those who
manage their investments themselves.” As President Roosevelt
stated in his message to the House of Representatives in March
1933: “What we seek is a return to a clearer understanding of
the ancient truth that those who manage * * * corporations and
other agencies handling or using other people’s money are
trustees acting for others.” 77 Cong. Rec. 937 (1933). Thus,
the Securities Act of 1933 sought to protect public investors by

16

regulating fiduciaries who solicited their funds (H.R. Rep. No.
85, 73d Cong., Ist Sess. 5 (1933)):

“The character of civil liabilities imposed by this bill

See also id. at 9-10; S. Rep. No. 47, 73d Cong., Ist Sess. 5
(1933).

legislation (77 Cong. Rec. 2910, 2918 (1933)):

“We have, on the one hand, 18,000,000 passive citizens
having no actual contact with their companies; on the other
hand, a few hundred powerful aoe « directing and

controlling the destinies of the companies and the physical
properties which they own. The owners of these symbols
are entitled to know what the symbols represent. Those

Moreover, Congressman Rayburn left no doubt about his
understanding of the “ordinary concept of a security” (id. at
2917):

“Today the owner does not possess actual physical proper-

problems of those who both manage and own.

17

The legislative history of the Securities Exchange Act of
1934 shows the same concern for the plight of the dependent
investor. Congress intended to “regulate the stock exchanges
and the relationship of the investing public to corporations
which invite public investment.” H.R. Rep. No. 1383, 73d
Cong., 2d Sess. 2 (1934); accord, S. Rep. No. 792, 73d Cong.,
2d Sess. 5 (1934). See also H.R. Rep. No. 1383, supra, at 4-5:

“When corporations were small, when their managers
were intimately acquainted with their owners and when the
interests of management and ownership were substantially
identical, conditions did not require the regulation of
securities marke[t]s. *** * [A]s management became
divorced from ownership and came under the control of

banking groups, men forgot that they were dealing with
the savings of men and the making of profits became an

impersonal thing.”

Thus, as a “complex society so diffuses and differentiates the
f .neial interests of the ordinary citizen that he has to trust
others and cannot personally watch the managers of all his
interests * * *, it becomes a condition of the very stability of
that society that its rules of law and of business practice
recognize and protect that ordinary citizen’s dependent posi-
tion” (id. at 5).

In short, the legislative history distinguishes clearly be-
tween passive investors and managers, and identifies the former
as the “protected class.” Sutter v. Groen, 687 F.2d 197, 201
(7th Cir. 1982):

“The Committee’s report contains a chorus of references to
‘disastrous results to investors,” ‘tremendous losses to the
investing public,’ ‘losses incurred in speculative transac-
uons,’ ‘severe financial losses sus.ained by investors,’ ‘the

of the investor,’ and on and on in this vein.

There is not the slightest hint in the legislative history that
Congress intended to bring into federal court the claims of
businessmen who acquire entire corporations through privately
er to demand disclosure of relevant information, and who
prescribe by contract specific remedies for the protection of
their economic interests. Such an expansion of the scope of the
federal securities laws —with an accompanying displacement of
contractual remedies— would clash with Congress’ stated pur-
pose “to protect the public with the least possible interference
to honest business.” H.R. Rep. No. 85, 73d Cong., Ist Sess. 2
(1933).

This is not to say that only individual investors, and not
business firms, may invoke the federal securities laws. Business
firms frequently make investments, and when they do—wheth-
er they invest in securities traded on exchanges, over the
counter, or in face-to-face transactions— they may claim the
protection of the securities laws. See United States v. Naftalin,
441 U.S. 768 (1979). Common examples of such investments
include stock transactions by brokerage houses, or purchases of
debt securities by business firms seeking a return on surplus
cash. However, when either a natural person or a business firm
acquires all of the stock of a corporation by negotiated sale, not
for investment but as a means to obtain ownership and control
of the underlying physical assets, the transaction is commercial
in nature and beyond the purview of the federal securities laws.

Ill. The Ninth Circuit’s Decision Finds Direct Support In
The Established Principle That Sales Of General
Partnership Interests And Commercial Notes Do Not
Constitute Securities Transactions —

The decision of the Ninth Circuit finds direct and com-
pelling support in the law which governs other closely-related
types of economic transactions. For example, this Court has

19

recognized that a joint venture involving shared profits and
managerial responsibility is not a security, despite the literal
applicability of the statutory definition. See Marine Bank,
supra, 455 U.S. at 559-560. The reason is that the purchaser of
the joint venture interest has “a measure of control over the
operation of the [business enterprise] not characteristic of a
security.” Ibid.

The lower federal courts consistently have applied that
principle to hold that sales of general partnership interests,
which grant the purchaser a share of profits and some measure
of control over the business enterpnise, are beyond the scope of
the federal securities laws. See, ¢.g., Odom v. Slavik, 703 F.2d
212, 215-216 (6th Cir. 1983) (“The managerial powers vested
in general partners and the express right of inspection of
documents gives them the kind of leverage and ability to
protect themselves that takes them outside of the intended
scope of the "34 Act”); Williamson v. Tucker, 645 F.2d 404,
417-425 ( Sth Cir. 1981); Goodwin v. Elkins & Co., 730 F.2d 99,
102-108 (3d Cir. 1984).

The interests of general partners frequently are obtained
by making capital contributions and also are assignable for
value. See J. Crane & A. Bromberg, Law of Partnership, 130-
131, 239-240 (1968). Nonetheless, the securities laws do not
apply because “[p]artners are not passive investors who place
money in an enterprise with the expectation of deriving profits
solely from the efforts of others ***. Rather, they expect to
reap profits through their own active participation in the control
and management of the business.” R. Jennings & H. Marsh,
Securities Regulation 308 (3d ed. 1972).
investors, applies a fortiori to entrepreneurs who purchase a
business enterprise for themselves and operate it unilaterally.
To treat general partners and entrepreneurs differently would
create a serious anomaly under the federal securities laws and
would blink at economic reality.

20

It also is well established that instruments which are
securities when offered in an investment context cease to be
securities when transferred in a commercial context. In particu-
lar, this Court has recognized that an “unsecured note, the
terms of which were negotiated face-to-face, given to a bank in
return for a business loan, is not a security.” Marine Bank,
supra, 455 U.S. at 560 n. 10; accord, Forman, supra, 421 U.S. at
849 n. 14 (citing with approval C_N_S. Enterprises, Inc. v. G. &
G. Enterprises, Inc., 508 F.2d 1354 ( 7th Cir. 1974)). The lower
courts are in agreement on this issue. See, eg, AMFAC Corp.
v. Arizona Mail of Tempe, 583 F.2d 426, 433 ( 9th Cir. 1978);
American Bank & Trust Co. v. Wallace, 702 F.2d 93, 96-97
(6th Cir. 1983); Chemical Bank v. Arthur Andersen, 726 F.2d
930, 938-939 (2d Cir. 1984).

“Notes,” of course, are securities embraced by the literal
terms of the statutory definition when sold in an investment
concext. However, they cease to be securities when transferred
in a face-to-face, privately-negotiated commercial transaction.
This pnnapie strongly supports the sale of business doctrine.
As the court of appeals explained ( Pet. App. 8a-9a): “We see
no principled way to justify an analysis in which we determine
whether a note is a ‘security’ within the meaning of the Acts by
examuning the transaction in light of the statutory purpose, but
determine whether stock is a ‘security’ by examining only the
instrument and not the transaction ***. We therefore con-
clude that adherence to the pnincipie of construction adopted in
our ‘note’ cases requires adherence to the ‘sale-of-business’
exclusion from the Securities Acts of the purchase of 100% of
the stock of [a] closely-held corporation.” Stock certificates,
like notes, take countless forms and are transferred in many
different contexts. There is no reasonable basis for applying
different legal principles to them under the same statutory
definition.

In this case, both individually-negotiated promissory notes
and unregistered shares of stock changed hands in the same
sale of business (J. App. 206-207). Nobody would seriously

21

contend that the “notes” in this transaction were “securities”
merely because they fell within the literal terms of the statutory
definition. And it is equally unreasonable, in the context of this
purely commercial transaction, to so designate the shares of
stock, or to seize upon the label affixed to them as a pretext for
bootstrapping this state-law controversy into federal court.

IV. The Ninth Circuit’s Decision Finds Direct Support In
This Court’s Repeated Pronouncement That The
Federal Securities Laws Should Not Be Construed
Broadly To Supersede Traditional State Law Re-
medies

The parties to the sale of business contract in this case
specifically tailored their agreement to include warranties and
covenants prescribing their respective rights, which were
enforceable under state contract law. The very same claims
now asserted by petitioner in federal court also have been
asserted in a pending state law complaint. Such claims
traditionally have been relegated to state tribunals, and there is
no good reason why federal courts should hear such cases and

perm a totally unnecessary expansion of federal jurisdiction.‘

3 In this context, as in Forman, after-the-fact claims of “reliance”
on the federal securities laws are wholly unavailing. A party which
negotiates an agreement that prescribes detailed and comprehensive
contract remedies should not later be heard to argue that it was led
“justifiably to assume” that the federal securities laws would govern
those same disputes. Forman, supra, 421 U.S. at 850.

“State law remedies, including remedies based upon contract
and deceit, are specifically adapted and fully adequate to protect the
purchaser of a business enterprise, who can quickly identify defects in
assets or financial condition and invoke governing warranties and
covenants after obtaining control of the business. See page ii, supra.
See also SEC v. Capital Gains Bureau, Inc., 375 U.S. 180, 194-195
(1963), observing that common law “doctrines of fraud and deceit”
are specifically adapted to controversies concerning “tangible items of
wealth,” as opposed to “such intangibles as * * * securities.”

22

The availability of adequate state law remedies is an
additional and compelling reason for declining to adopt the
expansive construction urged by petitioner. See Santa Fe
Industries, Inc. v. Green, 430 U.S. 462, 477-480 (1977) ( declin-
ing to “bring within [the securities laws] a wide variety of
corporate conduct traditionally left to state regulation”). Green
held that undue “extension of the federal securities laws would
overlap and quite possibly interfere with state corporate law,”
and observed that “[a]bsent a clear indication of congressional
intent, we are reluctant to federalize the substantial portion of
the law of corporations that deals with transactions in secu-
rities * * *.” Green explicitly declined to extend the federal
securities laws “to ‘cover the corporate universe.’ Jd. at 479-
480. Accord, Piper v. Chris-Craft Industries, Inc., 430 U.S. 1,
40-41 (1977); Forman, supra, 471 U.S. at 859 n. 26; Blue Chip
Stamps v. Manor Drug Stores, 421 U.S. 723, 738 n. 9 (1975).5

As this Court admonished in Marine Bank, supra, it is
essential to bear in mind that Congress “did not intend to
provide a broad federal remedy for all fraud.” 455 U.S. at 556.
That admonition is relevant here, and weighs heavily against
creation of a new federal remedy that could serve “no general
purpose.” Daniel, supra, 439 U.S. at 570.

V. The Sale of Business Doctrine Prevents Parties From
Breaching Their Contractual Obligations And Deters
Vexatious Litigation

In resolving the question of interpretation presented in this
case, the Court should bear in mind the motivation for resorting
to securities litigation in sale of business controversies. The

SThe state law principles applicable to a sale of business
controversy place a burden of proving reasonable care on purchasers
alleging deception and give full effect to contractual remedies and
limitations on liability. See Grumman Allied Industries, Inc. v. Rohr
Industries, Inc., 748 F.2d 729, 730-740 (2d Cir. 1984). A federal
securities law remedy would run roughshod over these established
state law principles, as discussed immediately below.

23

securities laws are invoked because they confer a very substan-
tial advantage on the plaintiff. As this Court observed in Wilko
v. Swan, 346 U.S. 427, 435 (1953), “the Securities Act was
drafted with an eye to the disadvantages under which buyers
labor.” This Court’s decisions have accordingly construed the
securities laws liberally to minimize procedural and substantive
burdens recognized at common law. See, e.g., Herman &
MacLean v. Huddleston, No. 81-680 (Jan. 24, 1983), slip op.
13. The quest for liberal remedies is evident in petitioner’s
reliance on Section 12(2), 15 U.S.C. 77/ (2), of the Securities
Act of 1933. That provision permits the plaintiff to argue that
the burden of proof should be shifted from the plaintiff to the
defendant, who must establish that any omitied fact could not
have been discovered and disclosed through the exercise of
reasonable care. Compare note 5, supra.

While it is reasonable to suppose that Congress intended to
grant these liberal remedies to investors to overcome the
“disadvantages” described in Wilko, there is no reason to
suppose that Congress wished to favor one side rather than
another in a sale of business transaction. Certainly, wealthy
businessmen and sophisticated lawyers purchasing a corpo-
ration have no claim to special protection when compared to
the proprietors of a family-owned sawmill. In a case such as
this, each side of the controversy is in a position to bargain
effectively, and each side is free to contract —with the aid of
counsel—to secure precisely the protection which it requires.

Conferring special substantive and procedural advantages
on one party in a sale of business controversy is an invitation to
serious abuse. As this Court emphasized in Blue Chip Stamps v.
Manor Drug Stores, 421 U.S. 723, 739-743 (1975), “[t]here
has been widespread recognition that litigation under Rule 10b-
5 presents a danger of vexatiousness ***. [I]n the field of
federal securities laws governing disclosure of information even
a complaint which by objective standards may have very little
chance of success at trial has a settlement value to the plaintiff

24

out of any proportion to its prospect of success ***. The very
pendency of the law suit may frustrate or delay normal business
activity * * * .” The in terrorem threat of burdensome litigation
in federal court, with extensive discovery and only a limited
possibility of resolution by summary judgment, gives the plain-
tiff substantial leverage to coerce a settlement and thereby
reduce the purchase price. See pages i-iv, supra.

Federal court litigation under the securities laws permits
the plaintiff to ignore the sale contract, with its specific cov-
enants, warranties, procedures, and designation of governing
law. See Add., infra, at A-6 to A-24. It permits the plaintiff to
allege a host of “nondisclosures” after obtaining possession of
the business, and to contend that each such omitted fact
constituted a fraud, notwithstanding its own failure to carefully
investigate. In every commercial transaction of this magnitude
and complexity, it is possible to find some fact concerning the
operation of the transferred business which was not “dis-
closed,” particularly when the purchaser bargains for and
receives only certain information during its due diligence
investigation. Such a claim of nondisclosure permits the
plaintiff to insist upon a trial by jury to resolve factual issues of
“materiality” and “scienter,” while effectively nullifying cov-
enants providing that only specific warranties and representa-
tions are “of the essence.” See Add., infra, at A-23.

Recognition of a securities action in this context invites
other abuses. A liberal remedy in federal court encourages the
purchaser to over-extend itself in a leveraged acquisition, to
operate the newly-acquired company at great risk, and, if the
company does not prove to be profitable or if interest payments
cannot be met, to demand either a reduction in the purchase
price or rescission. See pages i-iv, supra; see also Condux v.
Neldon, 404 N.E.2d 523, 526, 530-531 (Ill. App. 1980), which
applied this Court’s decision in Forman and adopted the sale of
business doctrine:

25

“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 impru-
dently; 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. *****. The
[securities] laws, we reiterate, are a shield between the
promoter and the sucker, not a sword with which the
merely unskillful or unlucky businessman may oppress his
predecessors.”

Perhaps the most oppressive and unfair tactic which the
sale of business doctrine serves to prevent is the tactic of
renouncing an express agreement to arbitrate. Complex sale of
business controversies are ideally suited for arbitration. See
Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395
(1967). However, to the extent that a purchaser or seller in a
sale of business controversy files suit under the federal securities
laws, the unscrupulous plaintiff can contend (as in the Algeran
case) that the arbitration agreement is a nullity. See Wilko v.
Swan, supra, 346 U.S. at 438. See also pages i-iv, supra; Add.,
infra, at A-2 to A-3, A-23 to A-24.

It is no exaggeration to say that superimposing conflicting
securities law remedies upon contractual remedies negotiated
by the parties is a frontal assault on the principle of freedom of
contract which long has been applied to dealings between
sophisticated businessmen of equal bargaining power. Such a
result cannot be reconciled with this Court’s repeated declara-
tion that the securities laws should not be broadly construed to
permit “vexatious” litigation (Blue Chip Stamps, supra, 421
US. at 739). See Ernst & Ernst v. Hochfelder, 425 U.S. 185,
214-215 n. 33 (1976) (“the inexorable broadening of the class

26
of plaintiffs who may sue in this area” may “ultimately result in
more harm than good”).

VI. No Persuasive Policy Argument Has Been Advanced
For Rejecting The Sale Of Business Doctrine

The SEC, in a series of amicus curiae briefs filed in the

presented

No. 80-1562, at 8-10, 18-19, 25-26, and 26-29. In that brief, the SEC
that both a certificate $a and a profit sharing
were

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27

The Commission’s principal policy argument ( Br. 21-24) is
that the sale of business doctrine should be rejected because it
will precipitate the judiciary down a “slippery slope.” If sales of
100% of a company’s stock are not covered by the securities
laws, how will the judiciary grapple with cases involving sales
of 75% or 51%? The short and sufficient answer to that
argument is that the present case —involving a 100% stock sale
accompanied by an unlimited transfer of control— involves no
such complexities. The present case calls for a decision on its
own record.”

Beyond this, federal courts which have implemented this
Court’s “economic realities” test have experienced no difficulty
in applying it in other contexts. Thus, they have faithfully
adhered to the principle that “[e]Jach transaction must be
analyzed and evaluated on the basis of * * * the factual setting
as a whole.” Marine Bank, supra, 455 US. at 560 n. II.

Business Lawyer 929, 951-953, 966-975 ( 1984).

Judge Posner’s explanation of the practical aspects of
applying the “economic realities” test in such a case, as set forth
in Sutter v. Groen, 687 F.2d 197, 202 (7th Cir. 1982), is

28

especially pertinent: “We agree that the costs of administering
legal rules are a proper concern ***. But rarely will a net
saving in those costs be produced by expanding liability since
even if the legal standard will be simpler and therefore cheaper
to apply in each case, the number of potential cases in which it
will be applied will be greater.” Judge Posner added that even
if a mgid and literal approach to the definitional issue offered
“some net cost savings, we doubt they could justify expanding
liability to reach substantive evils far outside the scope of the
legislature’s concern.” Jbid.®

The legal issues raised in a sale of business case are no
more complex than those raised in the many other cases cited
by the SEC ( Br. 18 a. 18), which also require an examination

of thawanh » Ghats Aqndaundins

29

ic realities test, each type of security retains its special attributes
(e.g., stocks are equity investments, bonds are secured debt
investments, notes are unsecured debt investments, etc.) even
though every security has a common economic feature. Accord-
ingly, this Court need not hesitate to accept the sale of business
doctrine based on the erroneous assertion that such a ruling
would blur traditional differences between the categories of
securities enumerated by Congress.

The SEC also argues (Br. 12-13) that, because Congress
did not expressly state tha: privately ucgotiated transfers of
100% of a company’s stock are beyond the scope of the
securities laws, federal courts are powerless to examine the
economic realities of such transactions. This argument ignores
Congress’ unambiguous declaration that the secur'ties laws
should not be applied lit rally if the “context” indicates other-
wise. In Marine Bank, this Court held that the statutory
language refers to economic context, and not merely statutory
context. 455 U.S. at 555-560. In so holding, the Court followed
the SEC’s brief amicus curiae, which argued that “[t)he word
‘context,” which Congress deliberately selected, refers to the
surrounding factual circumstances” ( No. 80-1562 Amicus Br. at
8). As the SEC explained, “[i]f * * * the context of a given
transaction so requires a literal application of the statutory
definition should be subordinated to Congress’ underlying
intent. Effectuation of the intention of the legislature remains
the touchstone” (id at 9-10). Thus, a careful contextual
analysis, which includes “the interrelated conditions in which
something * * * occurs” (id. at 8 n. 8), is essential because “a
thing may be within the letter of the statute and yet not within
the statute, because not within its spirit * * *” (id. at 9).

The very purpose of this contextual approach is to avoid a
wooden construction that would extend the securities laws
beyond Congress’ intent and upset “the balance between state
and federal responsibility.” Forman, supra, 421 U.S. at 859 n.
26. This Court’s recent decisions establish that ngid literalism is

30

not appropriate in cases involving a “stock certificate” ( For-
man), <¢ a “long-term debt obligation,” “investment contract,”
or “certificate of * * * participation in any profit-sharing agree-
ment” (Marine Bank). In such instances, the Court uniformly
has required a analysis of economic reality. There is no
ground for departing from that standard here.

To be sure, “[t]here may be occasions when the use of
traditional names such as ‘stocks’ or ‘bonds’ will lead a
purchaser justifiably to assume that the federal securities laws
apply.” Forman, supra, 421 U.S. at 850. But this will follow
only if “the underlying transaction” embodies the economic
substance of a securities transaction. Jd at 851. Such an
assumption plainly is not justifiable when a sophisticated
purchaser negotiates for the acquisition of an entire business,
and bargains for and obtains specific covenants and warranties
to protect its financial interest under state law. In such a
situation, the justifiable expectation of both parties is that the
comprehensive sale agreement, enforceable under state law,
prescribes the rights and remedies of the parties. To permit one
party to cast aside that negotiated contract by resort to secu-
rities litigation in federal court would seriously undermine the
principle of freedom of contract—a principle which is of
nessmen and which Congress did not intend to disturb.

CONCLUSION
The decision of the court of appeals should be affirmed.

A-l
UnrrTep States District Court

Central District of California

ALGERAN, INC.,
Plaintiff,
v.

ADVANCE ROSS CORP., et al.,
Defendants.

The Court, having heard argument from counsel on April
30, 1984, with respect to defendants’ motion for reconsidera-
tion, and having considered the points and authorities and
declarations submitted therewith,

HEREBY ORDERS that pursuant to Local Rule 7.16(a)
this is a proper motion for reconsideration as there is now a
material difference in law which did not exist at the time this
Court considered the original motion to dismiss. In reconsider-
_ ing the motion, the Court regards it as a motion for summary
judgment as there are matters outside of the pleadings which
have been submitted and considered by the Court.

After considering the Ninth Circuit’s recent decision in
Landreth Timber Co. v. Landreth, _._. F.2d —_. ( March 7,
1984) the Court grants summary judgment in favor of defend-
ants as to Counts I-IV. Although plaintiff and counter-
defendants argue that material questions of fact exist which
preclude summary judgment, the Court disagrees. The Court
finds that plaintiff's purchase of AMI was not a mere passive
investment and the plaintiffs were not so dependent upon the
existing AMI management for their profits that they could not
replace it or exercise ultimate control. See Gordon v. Terry, 684
F.2d 736 (llth Cir. 1982), reh’g. denied, 690 F.2d 907, cert.
denied, ___. U.S. —___ (1983).

The Court finds that Algeran, Inc., purchased AMI’s
existing management when it purchased AMI, and Advance

A-2

Ross Corp. had no control over AMI or its management after
the sale.

In denying the original motion to dismiss, the Court ruled
that as a matter of law the sale-of-business doctrine did not
apply in this Circuit. Since then, however, the Ninth Circuit has
adopted the doctrine in the Landreth case. The Court believes
that the application of Landreth to the undisputed facts of this
case requires summary judgment in favor of the defendants as
to the federal securities claims. Pursuant to Hamilton Jewelers
v. Department of Corporation, 37 Cal. App. 3d 330 (1974), the
Court grants summary judgment in fave. of defendants as to
the state securities claims.

The Court finds that the notes issued to defendants by
plaintiffs are not securities because they do not represent a
contribution of “risk capital subject to the entrepreneurial
efforts of others.” Amfac Manufacturing Corp. v. Arizona Mall
of Tempe, 583 F.2d 426, 432 (9th Cir. 1978).

The Court rejects plaintiffs claim that because it is in
bankruptcy it cannot be compelled to arbitrate its claims. This
is not the case in which a plaintiff/creditor is seeking to recover
a judgment from a defendant/debtor. Here, Algeran, Inc. is
the plaintiff seeking to rescind an agreement it entered into.
Defendants are simply defending on the claims. The Court
believes it would be manifestly unfair to allow plaintiff to use
the bankruptcy system as a shield but at the same time permit it
to use the federal courts as a sword. Plaintiff voluntarily chose
to file suit in federal court and must therefore expect to suffer
any possible adverse consequences by doing so. The Court
believes that Johnson v. England, 356 F.2d 44 (9th Cir. 1966)
and Braniff Airways, Inc. v. United Airlines, Inc. (In re Braniff
Airways, Inc.) 33 Bankr. 33 (Bankr. N.D. Tex. 1983) do not
compel a different result.

_ The Court further finds that defendants have not waived
their right to arbitration either because of filing a suit in Illinois

A-3

or in having undertaken some discovery. The Court further
believes that plaintiff and counterdefendants’ argument that
any possible stay will result in unnecessary delay, procedural
confusion and potential inconsistent results is incorrect. On the
contrary, the Court believes that arbitration may well be the
speediest method of resolving the claims in this case.

The Court orders that the remaining claims in the com-
plaint as well as other claims, i.e., counterclaims, be stayed
pending arbitration of the non-security claims in the complaint,
i.e., Counts V-VII. The Court believes that 98.04 of the
Agreement requires that these claims be arbitrated. The Court
reads 9 8.04 in conjunction with 7s 8.02 and 2.25 and con-
cludes that plaintiff's claims are disputes and controversies
relating to the interpretation of the contract. See Mediter-
ranean Enterprises, Inc. v. Sangyong Corp., 708 F.2d 1458 (9th
Cir. 1983).

As to the argument that there is an $800,000 0° simit of
recovery in the Agreement, the Court leaves it to the arbitrator
to interpret the Agreement.

IT IS FURTHER ORDERED that this case is removed
from the Court’s active caseload until further application by the
parties or Order of this Court.

IT IS FURTHER ORDERED that counsel are to file a
joint status report on a quarterly basis beginning on October |,
1984.

IT IS FURTHER ORDERED that defendants shall file
proposed Findings of Fact and Conclusions of Law and a
Judgment by May 29, 1984.

DATED: This 15th day of May, 1984.
/s/ Daviw V. KENYON

David V. Kenyon
United States District Judge

A-4

[EXCERPTS FROM]
AGREEMENT FOR SALE OF STOCK

This AGREEMENT FOR SALE OF STOCK is made and
entered into as of the 15th day of December, 1982, by and
between ADVANCE ROSS CORPORATION, a Delaware
corporation, its wholly owned subsidiary, AD ROSS CORPO-
RATION, a Delaware corporation (collectively referred to
herein as “Seller”), and ALGERAN, INC., a California corpo-
ration (“Buyer”), with respect to Seller’s shares of stock in AMI
INDUSTRIES, INC., a Colorado corporation (“Company”).

WHEREAS, Seller owns 406,786 shares (the “Shares”) of
the Company’s $0.50 par value Common Stock, representing
96.637 percent of the issued and outstanding shares of stock in
the Company, and

WHEREAS, Seller desires to sell, and Buyer desires to
purchase all of Seller’s Shares,

IT IS HEREBY AGREED:

ARTICLE I
AGREEMENT OF SALE AND PURCHASE

1.01 Sale of Stock. Seller agrees to sell and Buyer agrees
to purchase all of the Shares, as provided in this Agreement.

1.02 Purchase Price. In consideration for the sale of the
Shares, Buyer agrees to pay to Seller the sum of $8,000,000.00
(the “purchase price”). The purchase price was negotiated on
the basis of (a) total stockholder’s investment in the Company
as of June 30, 1982, as reflected in the Company’s June 30,
1982 consolidating balance sheet with Seller, plus (b) the
amount of the long-term debt owed by the Company to Seller
as of the June 30, 1982 consolidating balance sheet with Seller,
less (c) the current and long-term notes receivable from

A-5

Regent/Pearne. The total of the foregoing amounts on June
30, 1982 was $7,081,612.

1.03 Payment of Purchase Price. The purchase price shall
be paid in the following manner.

(a) At the Closing (as defined in Section 4.01 below)
Buyer shall pay the sum of $5,300,000.00

(b) At the Closing, Buyer shall deliver four promissory
notes (the “Notes”), executed by Buyer as maker and payable
to Seller or order. The Notes shall be in the following principal
amounts and maturity dates:

(i) $200,000.00 due one year after the Closing Date;
(ii) $350,000.00 due two years after the Closing Date;

(iti) $600,000.00 due three years after the Closing
Date; and

(iv) $1,550,000.00 due four years after the Closing
Date.

1.04 The Notes. Each of the Notes shall bear interest on
the unpaid principal balance at twelve percent (12%) per

annum, payable quarterly.
> > > ®

1.05 Security for the Notes. Payment of the Notes will be
secured pursuant to a Security and Pledge Agreement provid-
ing, among other things, * * * (i) that the security shall consist
of an assignment of Buyer’s interest in and to the oil and gas
revenues of its wholly-owned subsidiary, Algeran-Savage Cor-
poration (subordinate only to the rights of Union Bank) and a
pledge of the [AMI)} Shares.

A-6

ARTICLE II
WARRANTIES OF SELLER

Seller does hereby warrant and represent to Buyer as
follows:

2.01 Due Organization of the Company. The Company is
and will be at the Closing Date a corporation duly incorporated
and validly existing under the laws of the State of Colorado; is
and will be at the Closing Date in good standing under the laws
of the State of Colorado; is not and will not as of the Closing
Date be required to be qualified to do business in any other
State or jurisdiction where the failure to be qualified would
result in a liability for the Company in excess of $10,000.00; has
neither property nor employees in any state other than Colora-
do, except as described by name or other specific description
and address in SCHEDULE 2.01; has and will have at the
Closing Date all requisite corporate power and authority to own
its properties and carry on its business as now conducted; and
has and will have at the Closing Date received no notice that it
has not obtained all licenses, permits, or other authorizations,
nor failed to take any actions, required by applicable law or
governmental regulations in connection with its business as now
conducted.

2.02 Validity of Agreement. The execution and delivery of
this Agreement and consummation of the transactions con-
templated hereby will not violate any provision of any Articles
of Incorporation, By-Laws, agreement, mortgage, lien, lease,
instrument, order, judgment or decree to which the Seller or the
Company are a party or by which either of said entities are
bound, and shail not violate any other restriction of any kind or
character to which either of said entities are subject.

2.03 Financial Statements. Seller has delivered to Buyer

(a) Seller’s annual report for its year ended December 31,
1981; (b) Seller’s unaudited first quarter report for the period

A-7

ended March 31, 1982; and (c) the Company’s unaudited
balance sheet and consolidating statements of income for the
months ended June 30, 1982, July 31, 1982, August 31, 1982,
September 30, 1982 and October 31, 1982. A true and correct
copy of the Company’s consolidating balance sheet for the
month ended June 30, 1982 is attached hereto as SCHEDULE
2.03. All of the foregoing financial statements present fairly for
purposes of consolidation with Advance Ross Corporation's
financial statements the financial condition of the Company on
the dates thereof and the results of operations for said periods,
in conformity with generally accepted accounting principles
applied on a consistent basis, except (i) for the change in 1980
to the method of determining inventory costs as described in
Note B to the consolidated financial statements of Advance
Ross Corporation for the year ended December 31, 1981; and
(ii) that they do not give effect to certain adjustments and
reclassifications that will be made in the audited financial
statements of the Company referred to in Section 5.01(a) of
to in the foregoing clause (ii) will not reduce the Company's
total stockholder’s investment as shown in the Company’s June
30, 1982 financial statements. As of the Closing Date, the
amount of the Company's total stockholder’s investment plus
current and long term debts to Seller, less the current and long
term notes receivable from Regent/Pearne will total no less
than that shown on the June 30, 1982 financial statements
except that changes in the principal amount of intercompany
debt will be reflected in adjustments to the Note provided ~'
Section 1.03( b)( iv).

2.04 Patents, Copyrights, Trademarks, Tradenames, Ser-
vicemarks, Licenses, and Manufacturing Processes. The Com-
pany is the sole owner of the patents, patent applications,
inventions, disclosures, copyrights, trademarks, tradenames and
licenses listed and described in SCHEDULE 2.04. Except to

A-8

the extent, if any, set forth in SCHEDULE 2.04, such patents,
marks, tradenames and licenses are valid and in good standing,
are subject to no liens or charges and are not involved in any
interference, opposition or cancellation proceedings.

2.05 Real Property. SCHEDULE 2.05 contains a us.
all real property owned by the Company or in which the
Company has a leasehold or other interest. Such Schedule also
contains a substantially accurate legal descripuon of all such
real property, and a description of all claims, liens ard encum-
brances against the Company's interest in all such real property.

2.06 Title to Properties. The Company has good market-
able title to its properties and assets free and clear of all claims,
liens, and encumbrances except for those matters which are
disclosed in SCHEDULE 2.06.

2.07 Tax Returns. The Company, cither alone or in
conjunction with the filing of consolidated tax returns with
Seller, has timely filed or caused to be filed, and has paid or
accrued all taxes which have become due pursuant to such
returns, all federal, state and local tax returns for income taxes,
franchise taxes, sales and use taxes, withholding and all payroll
taxes, property taxes, and all other taxes of every kind what-
soever required by law to have been filed, and all such tax
returns are complete and accurate. For the purpose of the
preceding sentence, a return shall be deemed to be umely filed
if it is filed after the due date within any period allowed in an
extension granted by the taxing authority. All of the Seller's
and the Company’s estimated tax deposits required to be paid
prior to the Closing Date have been or will have been umely
paid.

2.08 Capitalization. The Company is authorized to issue
two classes of stock, consisting of 2,000,000 shares of common

A-9

stock having a par value of $0.50 per share and 1,000,000
shares of preferred stock having a par value of $1.00 per share.
There are 420,944 common shares outstanding, and no more
are presently issued and outstanding. No preferred shares have
beén issued. Seller owns, beneficially and of record, free and
clear of all liens charges, claims, equities, restrictions, or
encumbrances 406,786 common shares, representing 96.637%
of the outstanding and issued shares of the Company. There
are no options or warrants outstanding to acquire any of the
Shares nor any of the authorized but unissued shares of stock in
the Company, and the Company is not subject to any agree-
ment. express or implied, which would require it to issue any
additional shares of stock. Seller has no knowledge indicating
that any of the outstanding shares of the Company were not
duiy and validly issued in compliance with all applicable laws
and regulations or that they are not fully paid and nonasses-
sable. Seller has full right, power and authority to sell the
Shares to Buyer as provided in this Agreement. Prior to Seller’s
acquisition of the Shares, the Company’s shares were publicly
traded and the Company was required to file reports pursuant
to the Securities Exchange Act of 1934 (the “Act”), as
amended. Seller has caused the ompany to take such actions
as were necessary to terminate the Company's reporting
requirements under the Act, and the Company is not now and
will not as of the Closing Date, be a reporting compa. under
the Act.

2.09 Litigation. Except as set forth in SCHEDULE 2.09,
neither Seller nor the Company has been served with any
summons, complaint, or notice to arbitrate, and none of Seller’s
officers nor the Company's officers have any knowledge of any
suit or action ( equitable, legal or admunistrative ), arbitration or
other proceeding (including any formal or informal govern-
mental investigation), pending o: threatened in any way in-
volving the Company or which relates to the Company's
properties, business, assets, or prospects, or with respect to

A-10

which the Company, Seller, any of Seller’s officers or any of the
Company’s officers has knowledge whereby as a result of the
judgment or decision therein the Company may become legally
obligated to discharge all or part of the judgment.

2.10 Buildings and Equipment. All buildings and equip-
ment used or occupied by the Company are in good repair and
operating condition, and Seller has no knowledge indicating
that any such buildings or equipment fail to conform with all
applicable ordinances, regulations and zoning laws.

2.11 Material Contracts. Except as listed in SCHEDULE
2.11, the Company is not a party to any written or oral: (a)
contract for the employment of any officer or individual
employee; (b) contract for the purchase of materials, supplies,
services, machinery, or equipment involving payment by the
Company of more than $10,000 in each case, or more than
$25,000 in the aggregate with any one contracting party; (c)
contract continuing over a period of more than one year from
the date hereof; (d) material contract not terminable on thirty
(30) days’ notice or less without liability on the part of the
Company, (¢) material distributor, sales agency, or advertising
contract, or contract for the sale of its products or services; (f)
lease; (g) material contract with any subcontractor; (h) stock

tract” excludes purchase or sale contracts involving less than
$10,000.00, individually. True and complete copies of all
contracts listed in SCHEDULE 2.11 requested by Buyer shall
be delivered to Buyer upon demand.

A-11

2.12 insurance Policies. Attached hereto as SCHEDULE
2.12 is a list of the insurance policies and bonds owned by the

Company.

2.13 Liabilities. The Company does not have any liabi-
lities of a kind generally described on a balance sheet (in-
cluding notes thereio) in accoraance with generally accepted
accounting principles, whether accrued, absolute, contingent, or
otherwise, and whether due or to become due, known or
unknown, except (a) Liabilities set forth on the October 31,
1982 financial statement and (b) Liabilities that have been
incurred in the ordinary course of business of the Company
since October 31, 1982; or (c) Liabilities disclosed on SCHED-
ULE 2.13.

2.14 Power to Enter Into Agreement. This Agreement has
been approved by resolution of Seller's Board of Directors, and
no remaining corporate action or third party action is required
to make this Agreement binding upon Seller.

2.15 Accounts Receivable. The accounts receivable as
shown on the October 31, 1982 financial statement and that will
exist as of the Closing Date, have arisen, or will have arisen, out
of materials furnished or services performed. Seller has no
knowledge indicating that any such accounts receivable will not
be collectible in full on or before November 30, 1983.

2.16 Inventory. The inventory on hand as of the Closing
Date is not and will not be obsolete or unusable in any maternal
respect as of the Closing Date, and is saleable in the ordinary
course of the business of the Company, subject to the under-
standing that Buyer and Seller agree that a reserve of
$450,000.00 is adequate for all obsolete and unusabie inventory
that may be on hand as of the Closing Date. All finished goods
comply with normal commercial standards in the rail and air
line industries, as the case may be, and with all applicable laws,

A-12

rules and regulations pertaining to the Company's anticipated
use of such finished goods.

2.17 Pension and Profit Sharing Plans.

(a) Hourly Employees Pension Plan. The Company has
heretofore established the AMI Industnes Inc. Hourly Employ-
ees’ Retirement Plan (the “Hourly Plan”) for its hourly

purpose of funding benefits under the Hourly Pian. True and
correct copies of the Hourly Plan and Hourly Trust as of the
date hereof are attached hereto as SCHEDULE 2.17(a). Prior
to the Closing Date, the Company shall have accrued contnbu-
tions to the Hourly Trust through the Closing Date in accord-
ance with the amounts described in the actuarial valuation
report prepared by the Plan's actuaries, Reed-Ramsey, Inc., for
the 1982 Plan Year.

2.18 Labor Problems. Since December 31, 1976, the
Company has never sufferec a material work stoppage, and no
work stoppage is presently threatened. Attached hereto as
SCHEDULE 2.18(a) is a list of outstanding written labor
grievances as of the date hereof and, as of the date hereof, there
are no other material written labor grievances involving any
labor unions representing any of the employees of the Com-
pany. Attached hereto as SCHEDULE 2.18(b) is a list of all
labor organizations or associauons of employees with which the
Company has any written or oral contract with or commitments
or liabiliues to, along with a copy of any written contract and a
statement describing any oral contract or commitment.

2.19 Customers and Suppliers. Attached hereto as
SCHEDULE 2.19 is a list of (a) the ten largest customers of the

A-13

Company (in dollar volume for the fiscal year ended December
31, 1981 and for the current fiscal year through October 31,
1982); and (b) the ten largest suppliers of the Company (in
dollar volume for the fiscal year ended December 31, 1981 and
for the current fiscal year through October 31, 1982); and (c)
any current sole-source supplier of significant goods or services
to the business of the Company (other than electricity, gas,
telephone or water) with respect to which their unavailability
would at the Closing Date, have a maternal adverse effect upon
the Company's business. Neither Seller nor the Company has
any information or knowledge which indicate that any of the
customers or suppliers listed in Schedule 2.19 will cease to do
business with the Company or will reduce the volume of their
business with the Company in a way which would have a
material adverse effect upon the Company's business.

2.20 Subsidiary Corporations. Except as set forth on
SCHEDULE 2.20, the Company does not own, directly or
indirectly, any interest in any corporation, business trust, joint
stock company, or other business organization or associavon.
The Company is not a general partner of any partnership or a
party to any joint venture.

2.21 Dividends. The Company has not since June 30, 1982
declared or paid or made any payment of a dividend or other
distribution to its shareholders or purchased, redeemed, or
otherwise acquired or disposed of any share of its stock; e~d the
Company has not, except in the ordinary course of business or
except as specifically permitted by this Agreement, paid or
discharged any outstanding indebtedness.

2.22 Closing Statements. Seller shall deliver wo the Buyer
on or before the Closing a true and complete list, as of the date
hereof and certified by the Company's chief financial officer,
showing: (a) the names of all persons whose compensation for
the Company for the fiscal year ending December 31, 1982 will
equal or exceed $35,000.00; (b) the name of each bank in

A-14

which the Company has an account or safe deposit box and the
names and identification of all persons authorized tw draw
thereon or to have access thereto; and (c) the name of all
persons, if any, holding tax or other powers of attorney from
the Company and a summary statement of the terms thereof.

2.23 Conduct of Company's Business Prior to Closing.
Between October 31, 1982 and the Closing Date, except with
the pnor wntten consent of Buyer, Seller shall have caused the
Company. (a) To conduct its business only im the ordinary and
usual course; (b) To not change the character of its business or
undertake any new business; (c) To not enter into any employ-
ment contracts; (d) To not sell any of its assets except in the
ordinary course of business and for good and sufficent consid-
eration; (¢) To not amend, terminate or change any material
contracts listed in SCHEDULE 2.11; (f) To not sell or issue any
stock, bonds or other securities or rights therein; (g) To not
meur any obliganon or liability except in the ordinary course of
business; (h) To not make any payment to Seller, except to pay
mterest or principal on the imtercorporate debt referred to at
Section 1.03}(a)(i), above or to pay the regular, periodic
management fee as paid or accrued to the Closing Date: (i) To
not mortgage, pledge or subject to lien or encumbrance any of
its assets, tangible or intangible; ()) To not make any contnbu-
tion or incur any indebtedness under the Hourly Plan, the
Salaried Plan or the Thrift Flan except to the extent provided
herein, and to not make any amendments to or changes in the
Hourly Plan, Hourly Trust, Thrift Plan or Thrift Trust.

2.24 Warrenty of Product. The Company has provided
purchasers of its finished goods with various product war-
ranties. Such warranties are individually negotiated, and the
Company does sot have any one form of warranty that has
been provided with respect to more than ten percent of its sales
im any calendar year, other than as described in SCHEDULE
2.24 The Company's financial statements present fully and
fairly the Company's expenses and obligations related to

A-15

product warranties in conformity with generally accepted ac-
counting principles applied on a consistent basis.

ARTICLE IV
CLOSING

4.01 Time and Place of Closing. This transaction shall
close (“the Closing”) at such location in Los Angeles County,
California as Buyer shall designate, or, if Buyer consents, at
such other location as Buyer and Seller shall mutually agree.
The Closing shall take place on December 15, 1982 at 10:00
A.M. (the “Closing Date”).

4.02 Documents Delivered by Seller to Buyer at the
Closing. At the Closing, Seller shall deliver the following
documents to Buyer:

(a) A stock certificate or certificates representing all of
the Shares, duly endorsed for transfer to Buyer;

(b) The statement of Ernst & Whinney as required by
Section 1.03(a)(i), above;

(c) Seller’s written release of the Company from any
debts or claims, including specifically the intercorporate
debt, but excluding the Company’s obligations with respect
to corporate income taxes as provided in Section 2.07
above, whether accrued, absolute, contingent or otherwise,
and whether due or to become due, known or unknown, in
form and substance satisfactory to Buyer and its counsel;

A-16

(d) A certificate from the Secretary of State of the
State of Colorado dated no earlier than November 30,
1982 that the Company is in good standing in such state;

(e) An opinion of Daniel P. Edwards, Esq. in form
and substance satisfactory to buyer and its counsel to the
effect that the warranties and representations contained in
Sections 2.01, 2.02, 2.04, 2.05, 2.06, 2.08, 2.09, 2.11, 2.18,
the last sentence of 2.19, 2.20 and 2.25 of this Agreement
are true and correct to the best of said counsel’s knowledge
and further to the effect that: (a) the Company has been
duly incorporated and is validly existing, in good standing,
under the laws of the state of Colorado, has all requisite
corvorate power and authority to own its properties and
carry on its business as conducted on the date of the
Closing, and as of such date has all licenses, permits, or
other authorizations, and has taken all actions required by
applicable law or governmental regulations in connection
with its business as then conducted; (b) the Company has
authorized and outstanding capital stock as set forth in
Paragraph 2.08 and all shares of its outstanding capital
stock have been duly and validly authorized and issued
and are fully paid and nonassessable; (c) except as may be
set forth in SCHEDULE 2.09 hereof, such counsel does not
know (after reasonable investigation) of any litigation,
proceedings, or governmental investigation or labor dis-
pute pending or threatened against or relating to the
Company; (d) such counsel does not know or have reason
to know ( after reasonable investigation ) that there are any
defects in or encumbrances upon the title of the Company
to its property and assets and leaseholds which would
violate the representations in Article II of this Agreement;
and (¢) as to such other lega| matters as Buyer may
reasonably require.

A-17

(f) An opinion of Messrs. Mayer, Brown & Platt in
form and substance satisfactory to Buyer and its counsel to
the effect that the warranties and representations contained
in Sections 2.02, 2.09, 2.14, and 2.17 of this Agreement as
they pertain to Seller are true and correct to the best of said
counsel’s knowledge, and further to the effect that: (a)
Seller has complete and unrestricted power under its
Articles of Incorporation and By-Laws to sell, convey,
assign, transfer, and deliver to Buyer the Shares to be sold
by Seller under this agreement; (b) this Agreement is the
valid and binding obligation of Seller and is enforceable
against Seller in accordance with its terms and conditions,
and will not conflict with, or result (immediately or upon
the giving of notice and/or upon the passage of a period of
time) in a breach of, any of the terms of any indenture,
mortgage, deed of trust, or other agreement, instrument or
understanding to which Seller is a party or by which it is or
may be bound, or constitute a default thereunder, or result
in the creation or imposition of any lien, charge, or
encumbrance, or give to others any interest or right in the
Shares or in any of the properties or other assets of the
Company; and (c) as to such other legal matters as Buyer
may reasonably require; and

(g) Such other documents as may otherwise be
required by this Agreement.

4.03 Documents to be Delivered by Buyer to Seller. Buyer

shall deliver or cause delivery of the following to Seller at the
Closing:

(a) The cash required by Section 1.03(a), above;
(b) The Notes required by Section 1.03(b), above;

(c) The Security and Pledge Agreement required by
Section 1.05, above;

(d) Assignments of Buyer’s interest in and to the oil
and gas revenues of Buyer’s wholly-owned subsidiry,

A-18

Algeran-Savage corporation, subordinate to the rghts of
Union Bank, as security under the Security and Pledge
Agreement,

(e) A stock certificate or certificates representing all of
the Shares, with stock powers executed in blank, as security
under the Security and Pledge Agreement; and

(f) An opinion of STERN & MILLER, a Professional
Corporation, in form and substance satisfactory to Seller
and its counsel to the effect that the warranties and
representations contained in Sections 3.01 and 3.02 of this
Agreement are true and correct to the best of said counsel’s
knowledge, and further to the effect that: (a) such counsel
does not know (after reasonable investigation) of any
litigation or proceeding pending or threatened against
Buyer, except as set forth on SCHEDULE 3.04; (b) this
Agreement is the valid and binding obligation of Buyer
and is enforceable against Buyer in accordance with its
terms and conditions, and will not conflict with, or result
(immediately or upon the giving of notice and/or upon the
passage of a period of time) in a breach of, any of the
terms of any indenture, mortgage, deed of trust, or other
agreement, instrument or understanding to which Buyer is
a party or by which it is or may be bound, or constitute a
default thereunder; and (c) as to such other legal matters
as Seller may reasonably require.

ARTICLE V
ADDITIONAL COVENANTS OF SELLER
5.01 Books and Records—Cooperation and Assistance

(a) Preparation of Audited Financial Statements. Seller's
independent auditors, Ernst & Whinney ( the “ Auditors”), have
examined and issued their opinion on Advance Ross Corpo-
ration’s consolidated financial statements for each of the three

A-19

years in the period ended December 31, 1981 which include the
financial statements of the Company. Within forty-five days
after the Closing Date, Seller shall deliver to Buyer audited
balance sheets of the Company as of December 31, 1980 and
December 31, 1981 and statements of operation and changes in
financial position for each of the three years in the period ended
December 31, 1981 prepared in accordance with generally
accepted accounting principles applied on a consistent basis
except for the change, in 1980, in the method of determining
inventory costs as described in Note B to the consolidated
financial statements of Advance Ross Corporation for the year
ended December 31, 1981. Such audit will be performed by
Ernst & Whinney, whose fees and costs for such professional
services shall be paid by Buyer or the Company, as Buyer shall
choose.

(b) Preservation of and Access to Books and Records.
Except to the extent that Seller shall transfer any of such books
and records to Buyer as hereinafter provided, Seller shall, for a
period of at least ten (10) years after the Closing Date,
preserve or cause to be preserved all books and records in its
possession or control (including, without limitation, books and
records in the possession or control of Seller’s attorneys and
accountants ) pertaining to the Company, and Seller shall make
them available to Buyer or its authorized representatives at all
copies and extracts therefrom for any proper purpose; and
Seller shall permit Buyer to remove such books and records in
connection with any proceedings, claims or actions which may
be brought against Buyer or the Company in any judicial or
formal or informal administrative proceeding or before any
arbitration tribunal in connection with the Company.

§.03 Indemnification. If and to the extent that Buyer is
damaged in an amount in excess of $25,000.00 in the aggregate,

A-20

net of reimbursement by insurance or other third parties, by
reason of a breach or breaches of any warranty, representation
or covenant of Seller, including the existence of any tax
deficiency, or any losses with respect to any claims described in
SCHEDULE 2.09, Seller shail forthwith pay or credit to Buyer
the amount of damages caused by said breach or breaches cf
warranty to the extent that the aggregate of such damages
exceed said $25,000.00. Seller shall indemnify, defend and
hold Buyer and the Company harmiess from and against any
assessment, claim, lien or liability for taxes asserted against
Buyer or the Company for any period prior to the Closing Date
or for taxes of the Seller's consolidated group for any period
prior to December 31, 1982. As a condition precedent to the
right to enforce its right of indemnification, buyer is hereby
required to give written notice of any claim of breach of

shall not have any liability to buyer for breach of warranty: (a)
For any matter other than tax deficiencies unless a written claim
is filed with Seller on or before December 31, 1984; and (b)

5.04 Accuracy of Representations and Warranties. The
representations and warranties set forth in ARTICLE II hereof
shall be true and correct in all respects at and as of the Closing
Date.

5.07 Change of Board.of Directors. At the Closing, Seller
shall take such steps as are reasonably necessary to cause all
members of the Board of Directors of the Company to be

comprised of persons designated in writing by Buyer.

A-21

ARTICLE VI
ADDITIONAL COVENANTS OF BUYER

Buyer hereby agrees:

6.01 Indemnity from Claims of Brokers. Buyer warrants
and represents that it has not engaged any broker or finder in
that no person other than said Robert Berner has made any
claim against it for any finder’s fee. Buyer 1s solely responsible
for any broker's or finder’s fee payable to said Robert Berner,
and Buyer agrees to indemnify and hold Seller harmless against
or in respect of any commissions or brokerage fees incurred or
alleged to be incurred pursuant to any alleged arrangements
with Buyer.

6.06 Accuracy of Representations and Warranties. The
representations and warranties set forth in ARTICLE II hereof
shall be true and correct in all respects at and as of the Closing
Date.

6.08 Absence of Material Changes. Between the date of
the July 31, 1982 financial statements and the Closing Date,
there shall have been no material adverse change in the
financial position of the Buyer.

ARTICLE VII
Propucts LIABILITY

7.01 Seller’s Indemnification. Seller agrees to ina -mnify,
defend and hold Buyer and the Company harmless from and
against any products liability or similar claim or action relaung
to finished goods of the Company which were manufactured

A-22

prior to the Closing Date, including all costs, expenses and
attorneys’ fees in connection with the defense of any such action
or claim.

7.02 Buyer’s Indemnification. Buyer agrees to indemnify,
defend and hold Seller harmless from and against any products
liability or similar claim or action relating to finished goods of
the Company which are manufactured after the Closing Date,
including all costs, expenses and attorneys’ fees in connection
with the defense of any such action or claim.

ARTICLE VIII
MISCELLANEOUS MATTERS

8.01 Notices. Any notice, request, instruction, or other
document deemed by either party to be necessary or desirable
to be given to the other party shall be in writing and shall be
mailed by registered or certified mail, postage prepaid, with
return receipt requested, addressed as follows:

TO SELLER: Mr. Harve A. Ferrill, President
ADVANCE ROSS CORPORATION

111 West Monroe Street
Chicago, Illinois 60603

with a copy to: H Nixon, Esq.
MAYER, BROWN & PLATT
231 South LaSalle Street

Chicago, Illinois 60604

A-23

TO BUYER: Mr. Robert W. Miller, Chairman
ALGERAN, INC.
890 South Arroyo Parkway
Pasadena, California 91105

with a copy to: Michael D. Miller, Esq.
STERN & MILLER, a
Professional Corporation
606 Wilshire Boulevard, Suite 706
Santa Monica, California 90401

TO COMPANY: Mr. Tom Carlsen
Chief Financial Officer
AMI INDUSTRIES, INC.
3265 North Nevada
Colorado Springs, Colorado 80907

8.02 Entire Agreement. This Agreement contains the
entire agreement between the parties hereto and supersedes any
and all prior agreements, arrangements, or understandings
between the parties relating to this Agreement. No oral
understandings, statements, promises or inducements contrary
to the terms of this Agreement exist. No representations,
warranties, covenants or conditions, express or implied, wheth-
er by statute or otherwise other thaa as set forth herein, have
been made by any party hereto. No waiver of any term,
provision or condition of this Agreement, whether by conduct
or otherwise, in any one or more instances shall be deemed to
be or construed as a further or continuing waiver of any such
term, provision, or condition or any other term, provision or
condition of this Agreement. This Agreement cannot be
changed or terminated orally.

8.03 Applicable Law. This Agreement shall be governed
by, and construed and enforced in accordance with, and subject
to, the laws of the State of California.

8.04 Arbitration of Disputes. In the event any controversy
or claim as to matters arising out of this Agreement cannot be
settled by the parties or their legal representatives, such con-

A-24 A-25
IN WITNESS WHEREOF, the parties hereto set their

troversy or claim shall be settled by arbitration in accordance hands on the day and year first above written.

with the then current rules of the American Arbitration Associ-
ation and judgment upon the award may be entered in any

court having jurisdiction thereof. SELLER: ADVANCE ROSS CORPORATION
,
8.05 Binding on Successors. All of the terms, provisions By__/s/ H \. Ferrill
and conditions of this Agreement shall be binding upon and
' Harve A. Ferrill
inure to the benefit of the parties hereto and their successors in ;
' ; President
interest of every kind and nature whatsoever.
8.06 Survival of Representations. All representations, AD ROSS CORPORATION
warranties, agreements and covenants made by the parties
hereto in this Agreement or pursuant hereto shall be deemed to By__/s/ Harve A. Fernill _
have been made for the purpose of inducing the other party to Executive Vice President

enter into this Agreement, and shall survive the Closing and
remain operative thereafter to and through December 31, 1984
but all representations, warranties, agreements and covenants BUYER: ALGERAN, INC.

of Seller contained in Section 2.07 concerning taxes shall By__/s/ Robert R. S

remain operative until the applicable statute of limitations y Robert R. S

- concerning the assessment and collection of taxes has expired. ” be —

8.07 Titles. The titles of the articles and sections of this
Agreement are for convenience of reference only and are not to
be considered in construing this Agreement. ~ [Schedules and Exhibits Omitted ]

8.08 Counterparts. This Agreement may be executed in
one or more counterparts, each of which shall be deemed an
original and all of which taken together shall constitute one and
the same document.

8.09 Exhibits and Schedules. To the extent that any
exhibits or schedules have not previously been delivered to
Buyer or Seller, Buyer and Seller agree to deliver such exhibits
and schedules at the Closing. With respect to any exhibits or
schedules delivered by either Buyer or Seller prior to the
Closing, Buyer or Seller, as the case may be, shall provide the
other with a certificate which represents, warrants and cov-
enants that there have been no changes in or to such exhibits or
schedules except as disclosed in the certificate.

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385012_0783%3A07. Public record. Not legal advice.