Opinion ID: 1060352
Heading Depth: 1
Heading Rank: 6

Heading: The Brewer Test as Applied to the Sale-Leaseback Program

Text: The first prong of the Brewer test requires that the offeree furnishes initial value. Participants in King and QCI's program bought a minimum of three pay telephones at $4995 per pay telephone. Participants never took possession of the phones, nor did participants pay taxes on the phones or choose locations for their phones. Furthermore, it is clear from promotional materials that QCI intended the program to quickly raise money for capital expenditures and expansion, without sacrificing equity in the company. King argues that, in the case of the sale of personal property, there must be an overpayment of fair value by the investor in order for there to be a finding of initial value. King bases his argument on Hawaii Market , in which participants in a private wholesale club scheme payed grossly inflated prices for consumer items in order to join the club and receive future commissions on sales. Rather than being a requirement for initial value, however, the presence of overpayment was simply how the Hawaii Market court distinguished the transaction from a simple purchase of merchandise. In this case, King's program requires little distinguishing from a sale of merchandise: purchasers never took possession of the pay telephones, and, furthermore, QCI was not in the business of selling pay telephones: QCI was in the business of providing discount long-distance telephone service. Thus, this Court finds that Prong 1, the furnishing of initial value, is satisfied.
The second prong of the Brewer test requires that a portion of the initial value be subject to the risks of the enterprise. As the Brewer court stated, this second prong adopts the concept of risk capital. Brewer, 932 S.W.2d at 13. The Brewer court explained that [u]nder the risk capital test the focus is ... on whether the promoter is relying on the investors for a substantial portion of the initial capital necessary to launch the enterprise. Id. at 11 (citing State v. Consumer Bus. Sys., Inc., 5 Or.App. 19, 482 P.2d 549, 555 (1971)). QCI was looking for a quick means of financing a $50 million expansion. The promotional materials clearly stated that [b]y going to private investors, QCI is able to raise expansion capital quickly without having to give up valuable equity. These promotional materials clearly reflect the risk capital concept: investors were sought out by King, they paid value, and in return they expected QCI to pay them a return on their investment. Furthermore, investors did not rely on their own pay telephones to produce an income; instead, investors were dependent on the profitability of the entire enterprise. King argues that this prong is not met because the lease provided for a fixed payment that was secured by a performance bond. However, it is clear from the record that potential investors were led to believe that the transaction was an investment. QCI promotional materials invited participants to join our growing QCI network and pledged that it is QCI's business policy to share the profits with our clients, by paying them a very high rate of return. The chancery court found that the performance bond was essentially worthless from the outset because it was guaranteed by an insurance company that was neither registered nor qualified to do business in Tennessee. King asks this Court to look only at the structure of the transaction, to focus on the provision of the lease securing payment by a performance bond, and to ignore the reality that the performance bond was worthless. To do so would exalt form over substance, something which, in the interest of protecting the investors of this state, this Court refuses to do. Thus, we find that the second prong of the Brewer test is met.
The third prong of the Brewer test is that the investor had a reasonable understanding that a valuable benefit of some kind, over and above initial value, will accrue as a result of the operation of the enterprise. Brewer, 932 S.W.2d at 11. The QCI promotional materials are relevant to determining the existence of this element. The materials contain several assurances that participants will receive a benefit: I assume you are interested [in this program] because you are fed up with 3% or 4% returns on your savings; or, maybe you are uncomfortable with risking your money in the stock market? Admin. R. at 64. QCI's Telephone Equipment Lease Agreement will give you an exceptional 18% return on your principal. This is what you will earn each year for a five year term. You will receive a check for $75.00 for 60 consecutive months for each unit purchased. Admin. R. at 68 (emphasis in original). King argues that the third prong of the Brewer test is lacking because QCI's obligation was fixed and was not dependent on the enterprise making a profit. However, the Hawaii Market court rightly noted that it is irrelevant to the protective policies of the securities laws that the inducements leading an investor to risk his initial investment are founded on the promises of fixed returns rather than a share of profits. Hawaii Market, 485 P.2d at 110. Participants in this sale-leaseback program clearly expected a benefit as the result of QCI's successful operation, and the third prong is thus satisfied.
The fourth and final prong of the Brewer test requires that the offeree does not receive the right to exercise practical and actual control over managerial decisions of the enterprise. Brewer, 932 S.W.2d at 11. King argues that since the purchaser has the right to terminate the relationship with QCI, the purchaser has the right to exercise ultimate control over the destiny of his or her phone. The State calls this right to terminate misleading: the agreement actually requires the payment of a potentially large early termination fee, and QCI limits the number of early terminations it must accept in any sixty-day period. Additionally, as the Commissioner points out, the right to terminate relates to liquidity. The right to terminate certainly is not the equivalent of exercising practical and actual control over managerial decisions. Participants in this sale-leaseback program had no right to exercise practical or actual managerial control. Participants never took possession of the pay telephones, and they had no control over the location or use of the telephones. Thus, we find that the participants did not receive the right to exercise practical and actual control over managerial decisions and that the fourth and final prong of the Brewer test is satisfied.