Case Title: Andrews v. Browne

Citation: 

Docket Number: 071079

State: virginia

Court: Virginia Supreme Court

Date: 2008-06-06T00:00:00Z

Document:
Present:  All the Justices 
 
JOHN EDWARD ANDREWS 
 
v.  Record No. 071079  
OPINION BY JUSTICE DONALD W. LEMONS 
 
 
 
June 6, 2008 
MICHAEL S. BROWNE, ET AL. 
 
FROM THE CIRCUIT COURT OF PRINCE WILLIAM COUNTY 
Leroy F. Millette, Jr., Judge 
 
 
In this appeal, we consider whether a transaction in 
which 100% of the stock of a closely held corporation was 
transferred to a group of three purchasers is regulated by the 
Virginia Securities Act, Code § 13.1-501 et seq. 
I. 
 Facts and Proceedings Below 
 
Before August 31, 2004, Michael Browne ("Browne") and 
James Stein ("J. Stein") were the sole shareholders of the 
Manassas Health Club, Inc. ("MHCI").  MHCI operated a health 
club facility in Prince William County.  John Edward Andrews 
("Andrews"), a patron of MHCI, expressed an interest in buying 
MHCI from Browne and J. Stein.  Browne and J. Stein provided 
Andrews with a document entitled "Manassas Income & Expense 
Report" ("the Report"), containing financial information 
regarding the operations of MHCI.  The Report was prepared by 
Tina Stein ("T. Stein"), J. Stein's wife, who was responsible 
for MHCI’s bookkeeping. 
 
Relying on the information in the Report, Andrews, 
Christopher Pownall (an MHCI employee), and Richard Pownall 
(collectively "the Purchasers") decided to purchase MHCI.  
They entered into a "Stock Purchase Agreement" ("SPA") with 
Browne and J. Stein (collectively "the Sellers") under which 
they agreed to pay $500,000 in exchange for all 2,000 shares 
of MHCI stock.  The Purchasers also agreed to "assume all 
liabilities and obligations of the Corporation, including, but 
not limited to, leases, build out, and any outstanding bonds 
and payroll that was incurred by the Corporation prior to the 
date of closing, in the ordinary course of business," and to 
"indemnify Sellers against all liabilities and obligations 
related to the Corporation or this transaction except as 
described [in the SPA]."  The sale price was to be paid by 
transferring $200,000 cash to the Sellers at closing and a 
$300,000 note (the "Note") to the Sellers payable over 60 
months.  The SPA did not specify how the 2,000 shares were to 
be divided by the Purchasers.  The “stock certificates, 
documents, and monies” were to be “held in escrow by Lawrence 
E. Fischer, Attorney at Law[,] until conditions precedent to 
closing [were] fully satisfied and all the terms and 
conditions of the Note [had] been fulfilled in his sole 
discretion.” 
 
Under the SPA, the Purchasers retained the exclusive 
right to vote the stock as long as there were no breaches of 
the SPA.  The Purchasers agreed not to "sell, transfer, assign 
 
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for whatever reason, gift or transfer with or without 
consideration any shares of their stock in the Corporation to 
another individual or entity until such time as the aforesaid 
Note is satisfied in full, without first obtaining the written 
consent of the Sellers." 
 
The Sellers and Purchasers entered into the transaction 
on August 31, 2004.  After the transaction closed, Browne, J. 
Stein, and T. Stein gave Andrews a computer disc containing 
the income history of MHCI.  The defendants told Andrews the 
disc was “too damaged to be accessed.”  Andrews was able to 
access the disc, which contained different information than 
what was in the Report provided to him before the closing. 
In March 2005, Andrews, with the consent of the Sellers, 
bought Christopher Pownall’s and Richard Pownall’s interest in 
the MHCI stock.  Andrews was then the sole shareholder of 
MHCI. 
 
On February 2, 2007, Andrews filed a second amended 
complaint against the defendants, alleging that the Report 
prepared by T. Stein and provided to Andrews by Browne and J. 
Stein contained materially false information.  Specifically, 
Andrews alleged that the Report deliberately understated the 
expenses and overstated the income of MHCI.  Andrews also 
alleged that the defendants made various untrue statements of 
fact prior to the purchase regarding the number of members 
 
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MHCI had, MHCI's assets and debts, and whether MHCI's tax 
returns had been filed and its taxes paid when due.  Andrews 
alleged that if he had known these facts prior to the purchase 
of the MHCI stock, it would have "significantly impacted [his] 
deliberations on whether or not to purchase the corporation."  
Andrews sought judgment against Browne and J. Stein under Code 
§ 13.1-522 for making untrue statements of material fact and 
omitting material facts in furtherance of the sale of a 
security.  Andrews also sought judgment against all three 
defendants for actual fraud and common law civil conspiracy, 
and against Browne and J. Stein for breach of contract. 
 
The defendants moved for partial summary judgment 
concerning count one of Andrews' complaint in part on the 
grounds that Code § 13.1-522, a provision of the Virginia 
Securities Act, “is not intended to protect active purchasers 
of a business.”  After a hearing on defendants' motion for 
summary judgment, the trial court held that “the terms of the 
contract show [that the transaction was] a sale of business, 
and . . . that the Virginia Securities Act is not intended to 
protect the transaction herein under the facts and 
circumstances of this case.”  The trial court entered an order 
on March 16, 2007, granting partial summary judgment and 
dismissing count one of Andrews' complaint.  Andrews nonsuited 
his remaining claims pursuant to Code § 8.01-380.  Andrews 
 
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appeals the trial court's March 16, 2007 order granting 
partial summary judgment on four assignments of error: 
1.  The Court erred in its conclusion that the securities 
sold in this transaction did not have the traditional 
characteristics of stock. 
 
2.  The Court erred in determining that the “sale of 
business” doctrine was applicable to this stock transaction. 
 
3.  The Court erred by failing to apply the plain 
language of the Virginia Securities Act. 
 
4.  The Court erred by ignoring material facts in dispute 
and applied the incorrect standard for granting Summary 
Judgment. 
 
II. Analysis 
 
Whether the MHCI stock transferred in this case is a 
“security” within the meaning of the Virginia Securities Act 
is a mixed question of law and fact, which we review de novo.  
University of Va. Health Servs. Found. v. Morris, 275 Va. 319, 
332, 657 S.E.2d 512, 518 (2008). 
A. Similarity to Federal Securities Acts 
 
The Virginia Securities Act defines “security” as 
follows: 
“Security” means any note; stock; treasury 
stock; bond; debenture; evidence of 
indebtedness; certificate of interest or 
participation in any profit-sharing agreement; 
collateral trust certificate; preorganization 
certification of subscription; transferable 
share; investment contract; voting-trust 
certificate; certificate of deposit for a 
security; oil, gas or other mineral lease, 
right or royalty, or any interest therein; or, 
in general, any interest or instrument commonly 
 
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known as a “security,” or any certificate of 
interest or participation in, temporary or 
interim certificate for, guarantee of, or 
warrant or right to subscribe to or purchase, 
any of the foregoing. . . . 
Code § 13.1-501.  This definition of “security” derives almost 
verbatim from the definition of “security” in the federal 
Securities Act of 1933 (“1933 Act”).  George D. Gibson, The 
Virginia Corporation Law of 1956, 42 Va. L. Rev. 445, 483 
(1956).  The definition of “security” in the federal 
Securities Act of 1933, 15 U.S.C. § 77b(a)(1) (2000 & Supp. V 
2005), is “virtually identical” to the definition of 
“security” in the federal Securities Exchange Act of 1934 
(“1934 Act”), 15 U.S.C. § 78c(a)(10) (2000 & Supp. V 2005), 
and is treated as such for purposes of determining the scope 
of the term “security.”  Landreth Timber Co. v. Landreth, 471 
U.S. 681, 686 n.1 (1985). 
The Virginia Securities Act, the 1933 Act, and the 1934 
Act, are all intended to protect investors from fraud in the 
investment market.  See Gurley v. Documation, Inc., 674 F.2d 
253, 259 (4th Cir. 1982) (“Virginia’s blue sky law shares with 
§ 10(b) of the 1934 Act the central purpose of protecting 
investors from fraud in the securities markets.”).  “The 
primary purpose of the Acts of 1933 and 1934 was to eliminate 
serious abuses in a largely unregulated securities market.”  
 
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United Housing Found., Inc. v. Forman, 421 U.S. 837, 849 
(1975).  Similarly, 
[t]he object and purpose of [Virginia blue sky 
laws is] to suppress an existing and growing 
evil in this State.  The investment market was 
flooded with stocks of little or no value and 
promoters and stock salesmen, well versed in 
trade talk, preyed upon an unwary public by 
inducing it to purchase this character of 
stock. 
Virginia Brewing Co. v. Webber, 167 Va. 67, 71-72, 187 S.E. 
447, 449 (1936)) (interpreting the Securities Act of 1928, 
which was replaced by the current Virginia Securities Act in 
1956).  The Virginia Securities Act, the 1933 Act, and the 
1934 Act “achieve their ends in similar ways: the disclosure 
of material information concerning issuers of stock and the 
regulation of sellers of securities.”  Pollok v. Commonwealth, 
217 Va. 411, 413, 229 S.E.2d 858, 860 (1976).  In light of 
these parallels, we have previously held that the Virginia 
Securities Act should receive “similar construction” as the 
1933 and 1934 Acts.  Id.  When engaged in interpretation of a 
term used in the Virginia Securities Act, it is appropriate to 
look to the federal courts’ interpretation of the same term in 
the context of the 1933 and 1934 Acts.  See Tanner v. State 
Corp. Comm’n, 266 Va. 170, 172, 580 S.E.2d 850, 852 (2003). 
 
We have not previously addressed the use of the word 
“stock” as part of the definition of “security” in Code 
 
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§ 13.1-501.  We will therefore look to federal interpretation 
of the word “stock” as part of the definition of “security” in 
the 1933 and 1934 Acts. 
B. Federal “Economic Reality” Test 
 
Both the federal Acts and the Virginia Securities Act 
define “security” to include, “unless the context otherwise 
requires,” “any . . . stock.”  Code § 13.1-501, 15 U.S.C. 
§ 77b(a)(1), 15 U.S.C. § 78c(a)(10).  In interpreting the term 
“security” in the 1933 and 1934 Acts, the United States 
Supreme Court has repeatedly stated that “form should be 
disregarded for substance and the emphasis should be on 
economic reality.”  Tcherepnin v. Knight, 389 U.S. 332, 336 
(1967); see also Securities & Exch. Comm’n v. W.J. Howey Co., 
328 U.S. 293, 298 (1946). 
 
In the context of “stock,” the United States Supreme 
Court has rejected the suggestion that a transaction is 
regulated by the 1933 and 1934 Acts simply because the 
transaction is evidenced by the sale of an instrument called 
“stock.”  Forman, 421 U.S. at 848.  Noting that “[t]he 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,” the Court held that an instrument may 
 
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be “stock,” and therefore “within the letter of the [1933 and 
1934 Acts,] yet not within the [Acts] because not within 
[their] spirit, nor within the intention of [their] makers.”  
Id. at 849.  The Court further noted in Landreth that where an 
instrument called “stock” is exchanged, there “is no need 
. . . to look beyond the characteristics of the instrument to 
determine whether the Acts apply.”  471 U.S. at 690. 
 
Rather than apply a “plain language” approach to the 1933 
and 1934 Acts, the United States Supreme Court applies an 
“economic reality test.”  In Forman, the Court identified five 
common features of traditional stock: (1) the right to receive 
dividends contingent upon an apportionment of profits; (2) 
negotiability; (3) ability to be pledged or hypothecated; (4) 
conferring of voting rights in proportion to the number of 
shares owned; and (5) ability to appreciate in value.  421 
U.S. at 851.  The Court reasoned that in some instances, the 
use of the traditional name “stock” was likely to “lead a 
purchaser justifiably to assume that the federal securities 
laws apply.”  Id. at 850.  This is most likely when the 
instrument exchanged in the underlying transaction possessed 
some of the five common features of traditional stock.  Id. at 
851.  The touchstone of the analysis is “the presence of an 
investment in a common venture premised on a reasonable 
expectation of profits to be derived from the entrepreneurial 
 
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or managerial efforts of others.”  Id. at 852.  Under this 
test, if “the investor is ‘attracted [to a purchase] solely by 
the prospects of a return’ on his investment,” the underlying 
“stock” is more likely to be a security; the 1933 and 1934 Act 
would then apply.  Id. (quoting Howey, 328 U.S. at 300).  “By 
contrast, when a purchaser is motivated by a desire to use or 
consume the item purchased . . . the securities laws do not 
apply.”  Id. at 852-53. 
C. “Sale of Business” Doctrine 
 
Following the Supreme Court’s decision in Forman, some 
federal courts applied the Court’s reasoning from Forman to 
exclude from coverage under the 1933 and 1934 Acts 
transactions in which 100% of the stock of a business was 
sold.  See, e.g., Chandler v. KEW, Inc., 691 F.2d 443, 444 
(10th Cir. 1977) (holding that the federal securities law did 
not apply because the economic reality of the transaction was 
that the purchaser was receiving 100% of the stock of the 
company); Bula v. Mansfield, [1979 Transfer Binder] Fed. Sec. 
L. Rep. (CCH) ¶ 96,964 (D. Colo. May 13, 1977) (holding that 
the sale of “stock” does not transform the purchase of a 
business into a security transaction).  These courts declined 
to apply the 1933 and 1934 Acts when a purchaser sought to 
acquire a business in its entirety.  In such cases, the 
“stock” that was exchanged in the transaction was considered 
 
10
to be only a method of vesting ownership of the business, and 
was “passed incidentally as an indici[um] of ownership of the 
business assets.”  Frederiksen v. Poloway, 637 F.2d 1147, 
1151-52 (7th Cir. 1981).  This application of the “economic 
reality test” was ultimately referred to as the “sale of 
business” doctrine, providing that 
under certain circumstances, the transfer of 
100 percent of the stock of a corporation 
incident to the sale of an ongoing business to 
a purchaser who will manage or direct the 
management of the business does not constitute 
the sale of a security within the meaning of 
the federal securities laws. 
Irving P. Seldin, When Stock is Not a Security: The “Sale of 
Business” Doctrine Under the Federal Securities Laws, 37 Bus. 
Law. 637, 637-38 (1982). 
 
The United States Supreme Court rejected the “sale of 
business” doctrine in Landreth and its companion case, Gould 
v. Ruefenacht, 471 U.S. 701 (1985).  The Court reaffirmed its 
holding from Forman that “the fact that instruments bear the 
label ‘stock’ is not of itself sufficient to invoke the 
coverage of the Acts.”  Landreth, 471 U.S. at 686.  However, 
if an instrument is called “stock” and bears the usual 
characteristics of “stock” as identified in Forman, a 
purchaser would be justified in assuming that federal 
securities law applies.  Id.  Therefore, 
 
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where an instrument bears the label “stock” and 
possesses all the characteristics typically 
associated with stock, a court will not be 
required to look beyond the character of the 
instrument to the economic substance of the 
transaction to determine whether the stock is a 
“security” within the meaning of the [1933 and 
1934] Acts. 
Gould, 471 U.S. at 704 (citation omitted). 
 
Although the “sale of business” doctrine is no longer 
applicable under the federal Acts, there continues to be a 
split of authority among the states as to whether the doctrine 
should apply to individual state Securities Acts that define 
“security” to include “any . . . stock,” as the Virginia 
Securities Act does.  Some of the state courts that have 
followed Landreth have done so because they adopt the 
reasoning of the United States Supreme Court in that case.  
See Fong v. Oh, 172 P.3d 499, 508-09 (Haw. 2007); Banton v. 
Hackney, 557 So.2d 807, 824 (Ala. 1989); Cohen v. William 
Goldberg & Co., Inc., 423 S.E.2d 231, 232-33 (Ga. 1992).  Some 
courts have done so without explicitly agreeing with the 
Supreme Court’s reasoning, but because the language of the 
1933 and 1934 Acts is substantially similar to the wording of 
the particular state securities statute.  Barnes v. Sunderman, 
453 N.W.2d 793, 796 (N.D. 1990); Carver v. Blanford, 342 
 
12
S.E.2d 406, 407 (S.C. 1986).*  These courts apply the “stock 
characterization test” from Landreth. 
 
Some state courts that have not followed Landreth have 
done so because they have reasoned that their state 
legislatures have intended the state securities statutes to 
cover sales in the securities market, not commercial 
transactions when a closely held corporation is sold.  See 
White v. Solomon, 732 P.2d 1389, 1391 (N.M. Ct. App. 1986); 
Doherty v. Kahn, 682 N.E.2d 163, 169-70 (Ill. App. Ct. 1997); 
Anderson v. Heck, 554 So.2d 695, 700 (La. Ct. App. 1989).  
These states continue to apply the principle the United States 
Supreme Court applied in Forman, that “form should be 
disregarded for substance and the emphasis should be on 
economic reality.”  People v. Figueroa, 715 P.2d 680, 694 n.26 
(Cal. 1986) (quoting Tcherepnin, 389 U.S. at 336).  As such, 
these states apply the “sale of business” doctrine so that 
state securities laws do not apply to transactions in which 
100% of the stock of a closely held corporation is 
transferred. 
                     
* One state supreme court has followed Landreth while 
explicitly disagreeing with the decision.  In following 
Landreth, that court noted that “we are required to coordinate 
our interpretation of state securities laws with its federal 
equivalent” under a provision of the state securities statute.  
Kovatovich v. Barnett, 406 N.W.2d 516, 518 (Minn. 1987).   
 
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Like many of the states that have either chosen to follow 
Landreth or not to follow it, our state securities statute 
defines “security” to include, “unless the context otherwise 
requires,” “any . . . stock.”  Code § 13.1-501.  There are 
sound policy reasons for following Landreth and rejecting the 
“sale of business” doctrine.  As noted above, the definition 
of “security” in the Virginia Securities Act derives from the 
definition of “security” in the 1933 and 1934 Acts.  Gibson, 
42 Va. L. Rev. at 483.  The Virginia Securities Act and the 
federal Acts “achieve their ends in similar ways.”  Pollok, 
217 Va. at 413, 229 S.E.2d at 860.  We have previously held 
that the Virginia Securities Act should receive “similar 
construction” as the federal Acts.  Id.  It is therefore 
appropriate for the word “stock” as a part of the definition 
of “security” in the Virginia Securities Act to be interpreted 
in the same manner as the 1933 and 1934 Acts. 
 
As the United States Supreme Court noted in Landreth, the 
definition of “security” in the federal Acts is “quite broad.”  
471 U.S. at 686.  “The face of the definition shows that 
‘stock’ is considered to be a ‘security’ within the meaning of 
the Acts.”  Id.  Though bearing the label “stock” alone is not 
sufficient to invoke the coverage of the securities laws, the 
label does make it more likely that an investor purchasing 
“stock” would believe he was covered by the securities laws.  
 
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Id. at 686-87.  When the instrument purchased bears the label 
“stock” and possesses the characteristics of traditional 
stock, the purchaser is justified in assuming that the 
Virginia Securities Act applies.  In such a case, the Virginia 
Securities Act should apply, regardless of whether control of 
a business is changing hands.  
 
Additionally, application of the “sale of business” 
doctrine invites many practical difficulties in determining 
whether a transaction is regulated by the Virginia Securities 
Act.  The doctrine presumably applies whenever “control” of a 
business is sold.  Whether “control” has passed to the 
purchaser is often difficult to determine. 
Control . . . may not be determined simply by 
ascertaining what percentage of the company’s 
stock has been purchased.  To be sure, in many 
cases, acquisition of more than 50% of the 
voting stock of a corporation effects a 
transfer of operational control.  In other 
cases, however, even the ownership of more than 
50% may not result in effective control.  In 
still other cases, de facto operational control 
may be obtained by the acquisition of less than 
50%.  These seemingly inconsistent results stem 
from the fact that actual control may also 
depend on such variables as voting rights, veto 
rights, or requirements for a super-majority 
vote on issues pertinent to company management, 
such as may be required by state law or by the 
company’s certificate of incorporation or its 
bylaws.  
Gould, 471 U.S. at 705.  Whether “control” has passed to the 
purchaser may not be determinable until a court has made a 
 
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factual determination, which may follow “extensive discovery 
and litigation.”  Id.  The parties may therefore not know at 
the time of the transaction whether the transaction is 
regulated by the Virginia Securities Act. 
 
The determination of whether “control” has passed to a 
purchaser may also invite absurd results.  For example, 
a corporation’s stock could be determined to be 
a security . . . as to some purchasers but not 
others.  Likewise, if the same purchaser bought 
small amounts of stock through several 
different transactions, it is possible that the 
Acts would apply as to some of the transactions 
but not as to the one that gave him “control.” 
Id. at 705-06.  These potential results are inconsistent with 
the purpose of the Virginia Securities Act, to “protect[] 
investors from fraud in the securities markets.”  Gurley, 674 
F.2d at 259; see also Virginia Brewing Co., 167 Va. at 71-72.  
 
For the foregoing reasons, we hold that the “sale of 
business” doctrine does not apply in Virginia.  We therefore 
apply the Landreth “stock characterization” test to the 
transaction at issue in this case. 
D. Application of the “Stock Characterization” Test 
 
If an instrument “bears the label ‘stock’ and possesses 
all of the characteristics typically associated with stock,” 
it is a “security” within the meaning of the Virginia 
Securities Act.  Gould, 471 U.S. at 704.  As stated above, the 
characteristics typically associated with stock are: (1) the 
 
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right to receive dividends contingent upon an apportionment of 
profits; (2) negotiability; (3) ability to be pledged or 
hypothecated; (4) conferring of voting rights in proportion to 
the number of shares owned; and (5) ability to appreciate in 
value.  Forman, 421 U.S. at 851. 
 
The trial court erred in holding that the MHCI stock “did 
not have the indicia of traditional stock.”  First, there is 
no dispute that Andrews had a right to receive dividends 
contingent upon an apportionment of profits.  As the owner of 
the shares of MHCI “stock,” Andrews was entitled to receive 
dividends payable on that stock if any were ever paid. 
 
Second, the MHCI “stock” is negotiable.  Although the 
Purchasers agreed not to sell, transfer, assign, or gift their 
shares without the Sellers’ permission until the Note was 
satisfied, this was a limitation on the parties by agreement, 
not a limitation on the instruments themselves.  As previously 
noted, Andrews purchased Pownall’s shares of stock in MHCI.  
For the same reason, the MHCI “stock” has the ability to be 
pledged or hypothecated.  The parties’ agreement to hold the 
instruments in escrow until the Note was satisfied does not 
change the characteristics of the instruments. 
 
Similarly, the MHCI “stock” conferred voting rights on 
the Purchasers.  The parties placed a limitation in the SPA on 
the Purchasers’ right to vote, such that the Purchasers did 
 
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not retain the exclusive right to vote the shares if they 
breached the SPA.  Again, this is a limitation on the parties 
by the agreement, not a limitation on the instruments. 
 
Finally, it is not disputed that the MHCI “stock” had the 
ability to appreciate in the future if the value of the 
business increased.  Because the MHCI “stock” has all the 
characteristics of traditional stock as outlined in Forman and 
bears the label “stock,” we hold that it is a “security” 
within the meaning of Code § 13.1-501.  Therefore, the 
Virginia Securities Act applies to the sale of the MHCI stock 
in this case. 
III. Conclusion 
For the reasons stated, the judgment of the trial court 
will be reversed and the case remanded for further proceedings. 
Reversed and remanded.