Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-ca10-88-01194/USCOURTS-ca10-88-01194-0/pdf.json

Nature of Suit Code: 850
Nature of Suit: Securities, Commodities, Exchange
Cause of Action: 

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UNITED STATES COURT OF APPEALS 

FOR THE TENTH CIRCUIT 

AUG B 1;99 

ROBERT L. HOECKER 

Clerk 

STEVE U. BLASER; 0. JAY CALL and 

SANDRA CALL, his wife; KENNETH PAUL 

COLLEDGE and JOANNE COLLEDGE, his wife; 

DENNIS LEE CROCKETT and TERI CROCKETT, 

h i s wife; KELVYN H. CULLIMORE and 

KAY CULLIMORE, his wife; EDWARD A. 

DALTON, JR. and MERNA DALTON, his wife; ) 

GRAHAM DODD and APRIL E. DODD, his wife;) 

DWIGHT HOWARD EGAN and LESLIE EGAN, ) 

h i s wife; R. JOHN EYRE; J. RAY FISHER ) 

a nd KATHLEEN J. FISHER, his wife; ) 

J OHN L. FORRESTER, JR. and PATRICIA A. ) 

FORRESTER, his wife; JOHN L. ) 

FORRESTER, III; CHRISTIANE. HANSEN ) 

a nd CINDY HANSEN, his wife; MICHAEL C. ) 

J OHNSEN and JOLYNN JOHNSEN, his wife; ) 

DAVIDE. JONES and SHAWN JONES, ) 

his wife; JEDD P. JONES and JACKIE I. ) 

J ONES, his wife; DANIEL w. MARCUM; ) 

MARVIN MILLS; THOMAS G. OSBORNE; ) 

W. TRUMAN RIGBY and MAE RIGBY, ) 

his wife; DONALD LEWIS SMITH and ) 

FAYE SMITH, his wife; MARDEN SPENCER ) 

and JANENE SPENCER, his wife, ) 

Plaintiffs-Appellants, 

v . 

GATE CITY MORTGAGE COMPANY, a North 

Dak ota corporation; GATE CITY FEDERAL 

SAVINGS AND LOAN ASSOCIATION, a 

Federally chartered savings and loan 

association; 

Defendants-Appellees, 

and 

KILBURN VACATION-HOMESHARE, 

I NCORPORATED, now known as 

BAJ AN RESORTS, INC., a Delaware 

c orporation; JAMES D. CLARK; 

VAUGHN R. COOK; and VAUGHN COOK AND 

ASSOCIATES, INC., a Utah corporation, 

Defendants. 

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No. 88-1194 

(D.C. No. C-84-2077W) 

( D. Utah) 

Appellate Case: 88-1194 Document: 01019974333 Date Filed: 08/08/1989 Page: 1 
ORDER AND JUDGMENT* 

Before MOORE, SETH, and TACHA, Circuit Judges. 

The plaintiffs appeal from orders of the district court 

dismissing their complaint and denying their motion for leave to 

fil e a second amended complaint in an action brought under the 

f ederal securities laws. We must decide on appeal whether the 

f a c ts alleged in the complaint are sufficient to support a finding 

tha t the transactions forming the basis of the complaint involved 

securities as they are defined in the relevant provisions of the 

fe d e ral securities laws, 15 U.S.C. §§ 77(b)(l), 78c(a)(l0), and 

whe t her the district court abused its discretion in denying the 

plaintiffs leave to file a second amended complaint. We affirm. 

I. 

The plaintiffs allege the following relevant facts in their 

complaint. 1 Kilburn Vacation- Homeshare, Inc. (Kilburn) and Vaughn 

Cook and Associates, Inc. (Cook) entered i nto a joint venture 

agr eement to develop and construct homes on property located in 

Utah. These homes were to be later marketed as timeshare 

properties. 

* This order and judgment has no precedential value and shall 

not be cited, or used by any court within the Tenth Circuit, 

e x cept for purposes of establishing the doctrines of the law of 

the case, res judicata, or collateral estoppel. 10th Cir. R. 

36. 3 . 

1 The district court's ruling was based on the plaintiffs' 

first amended complaint, and our discussion refers only to this 

d ocument. 

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Appellate Case: 88-1194 Document: 01019974333 Date Filed: 08/08/1989 Page: 2 
Kilburn and Cook negotiated a complex financing arrangement 

with Gate City Mortgage Company to fund their project. According 

to t his arrangement, Cook solicited the plaintiffs to act as 

str awmen "investors" by executing promissory notes in favor of 

Ga t e City Mortgage for approximately $200,000 for each parcel of 

property. Gate City Mortgage then disbursed the funds to Kilburn. 

At the loan closing, Kilburn transferred title to individual lots 

to t he plaintiffs, who in turn signed deeds of trust on the 

property to secure the loans, and then conveyed the property back 

to Ki lburn. 2 

According to this plan, Kilburn and Cook essentially were to 

receive the use of the plaintiffs' credit in order to obtain 

financing for their development project. In return for the use of 

the plaintiffs' credit, Kilburn agreed to pay up to $3,000 for 

e a c h loan transaction, assume all responsibility for repayment of 

the loans, provide the plaintiffs with written releases from all 

o b l igations under the promissory notes, and indemnify the 

plaintiffs from any liability that they might incur. The 

a s sumption of the notes and the execution of the releases were 

expected to occur soon after the loan closing. The plaintiffs 

s pecifically alleged that they e xpected to have no risk under the 

fi nancing plan. 

Kilburn paid all installments on the notes for two years, 

during which time the plaintiffs were assured that Kilburn had 

assumed the notes and that the releases had been issued. In fact, 

2 These conveyances have never been recorded. The plaintiffs 

ar e therefore presently the record owners of the property. 

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Appellate Case: 88-1194 Document: 01019974333 Date Filed: 08/08/1989 Page: 3 
Kilburn had not applied to assume the notes and Gate City Mortgage 

had not issued releases. Gate City Mortgage had discovered after 

the l oan closing that its affiliate, Gate City Federal Savings & 

Loan , would not purchase the promissory notes if Kilburn assumed 

them and if the releases were given. Gate City Mortgage never 

communicated with the plaintiffs during this time. 

In the spring of 1984, Kilburn stopped making payments on the 

no tes and thereafter filed for bankruptcy. In June 1984, Gate 

City Mortgage sent the plaintiffs a notice of default and demand 

fo r payment. Gate City Mortgage later filed foreclosure 

p r o ceedings in state court. 

The plaintiffs filed this action in federal court alleging 

t hat Gate City Mortgage violated the federal securities laws and 

f u r ther asserting several pendent state law claims. The district 

c ou r t determined that the complaint failed to plead facts to 

support a finding of the purchase or sale of a "security" as 

d efined in section 2(1) of the Securities Act of 1933, 15 U.S.C. 

§ 77(b)(l), and section 3(a)(l0) of the Securities Exchange Act of 

1 9 34, 15 U.S.C. § 78c(a)(l0), and therefore dismissed the action 

for lack of federal jurisdiction. 

II. 

In reviewing the dismissal of the complaint, we follow the 

a ccepted rule that "a complaint should not be dismissed unless 'it 

a ppears beyond doubt that the plaintiff can prove no set of facts 

in support of his claim which would entitle him to relief. 111 

McLain v. Real Estate Bd., 444 U.S. 232, 246 (1980) (quoting 

Conl ey v. Gibson, 355 U.S. 41, 45-46 (1957)). The plaintiffs 

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Appellate Case: 88-1194 Document: 01019974333 Date Filed: 08/08/1989 Page: 4 
contend that the combination of the promissory notes, the deeds of 

trust, the oral agreement that the notes would be assumed by 

Kilburn, and the agreement that they would be released from all 

obligations constitutes an "investment contract" under the federal 

securities laws. We agree with the district court that no 

investment contract is present here. 

The Supreme Court has established the following test to 

determine whether an investment contract is present: "[A] n 

investment contract for purposes of the Securities Act means a 

contract, transaction or scheme whereby a person invests his money 

in a common enterprise and is led to expect profits solely from 

the efforts of the promoter or a third party . " SEC v. W. J. 

Howey Co., 328 U.S. 293, 298-99 (1946). We agree with the 

district court that these elements have not been met in this case. 

Under the terms of the agreement, the plaintiffs clearly did 

not intend to be involved in a common enterprise with the 

defendants. Their sole function was to lend their credit for the 

purpose of obtaining financing, and but for Kilburn's breach of 

the agreement to provide releases from liability in exchange for 

reconveying the property, they would not have had any ownership in 

the development venture. Further, there was no expectation of 

profit to be derived solely from the efforts of others, as the 

only profit contemplated by the agreement was the payment of up to 

$3000 for lending their credit in each transaction. 

The fact that the defendants and Kilburn did not perform 

their part of the bargain may give rise to a cause of action under 

state law, but this fact does not transform the transaction into a 

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Appellate Case: 88-1194 Document: 01019974333 Date Filed: 08/08/1989 Page: 5 
security. When the plaintiffs did not expect any profits, but 

were instead promised a specific payment and release of all 

o bligations, no reliance on another's managerial efforts or 

professional skill was anticipated. The agreement left nothing to 

c hance other than the possibility that the Gate City Mortgage, 

Kilburn, and Cook would not honor their promises. The expected 

benefits were not to be derived from the efforts of Kilburn in 

managing the joint venture project, but were to be derived from 

t he good faith compliance with the terms of the agreement. 

Failure to comply with the terms of the agreement, which exposed 

t he plaintiffs to loss, did not render the agreement a security. 

III. 

The plaintiffs also assert that the district court abused its 

discretion in refusing to allow them to file a second amended 

complaint alleging that the transactions forming the basis for 

the i r complaint involved an "oral note" or "evidence of 

indebtedness." Assuming that the transactions here could be 

c haracterized as involving an "oral note" or "evidence of 

indebtedness," we nevertheless find that the district court did 

not abuse its discretion in refusing to allow an amended 

complaint. 

Although the terms "note" and "evidence of indebtedness" are 

foun d within the literal language of the statutory definition of a 

secur ity, see 15 U.S.C. § 77(b)(l), it is well settled that the 

literal language does not govern whether such instruments are 

securities. See Holloway v. Peat, Marwick, Mitchell & Co., Nos. - --

87 - 1 486, -1490, slip. op. at 9-13 (10th Cir. July 11, 1989). This 

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Appellate Case: 88-1194 Document: 01019974333 Date Filed: 08/08/1989 Page: 6 
circuit utilizes the commercial/investment test in determining 

whether notes or similar debt instruments fall within the 

definition of a security. Id. at 12-13. Under the commercial/ 

investment test, we distinguish investment notes, which are 

securities, from commercial notes, which are not securities, by 

evaluating the context of the issuing transaction. See id. "'The 

test accords with the exalting of economic reality over form, and 

seeks to protect investors.'" Id. at 13 (quoting Zabriskie v. 

Lewis, 507 F.2d 546, 551 (10th Cir. 1974)). 

Examining the economic reality of the transactions 

contemplated by the agreements here, we find that the plaintiffs 

were essentially sureties in commercial lending transactions. 

According to the agreement, each of the plaintiffs effectively 

sold the use of $200,000 of their credit to Kilburn in exchange 

for payment of up to $3,000 plus promises to be released from 

liability on their notes and to be indemnified from any loss. 

Thus , even if such promises could be characterized as "oral notes" 

or "evidence of indebtedness," such promises could not be deemed 

secu rities because they were clearly made in the context of a 

commercial, rather than an investment, transaction. When, as 

here, it is apparent that the complaint as amended would be 

subj ect to dismissal, the district court did not abuse its 

discretion in denying leave to amend. See Mountain View Pharmacy 

v. Abbott Laboratories, 630 F.2d 1383, 1389 (10th Cir. 1980) (Fed. 

R. Civ. P. 15(a) requirement that leave to amend be "freely given" 

not violated when futility of amendment is apparent). 

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Appellate Case: 88-1194 Document: 01019974333 Date Filed: 08/08/1989 Page: 7 
The judgment of the United States District Court for the 

District of Utah is AFFIRMED. 

ENTERED FOR THE COURT 

PER CURIAM 

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