Opinion ID: 1485429
Heading Depth: 1
Heading Rank: 3

Heading: The Findings of the Commission.

Text: The Commission found that the registration statement was materially deficient in Items 13 and 39 in that it failed to name F. C. Hall as a promoter, and failed to reveal the profits realized by him from the sale of the leases acquired by the Trust; in Item 14 in affirmatively stating that the Trust intended to render quarterly reports, when in fact it had no such intention; in Item 17 in failing to disclose litigation pending at the time the registration statement became effective which might affect the value of the securities to be offered; in including in such registration statement engineering reports which were inaccurate, incomplete, and misleading; and in misstating in the prospectus the present revenues from the properties to be acquired by the Trust. Schedule A of the Act, 15 U.S.C.A. § 77aa, requires the registration statement to set forth the names and addresses of the promoters in the case of a business to be formed, or formed within two years prior to the filing of the registration statement. The registration statement did not set forth the name and address of Hall as a promoter. Brown, Diffie, and Shanks were trustees of the Southwest Trust. Prior to December 6, 1935, Hall agreed with Brown to convey certain oil and gas leases to the Southwest Trust and to advance the money for the acquisition of additional oil and gas leases in Texas. Brown and Diffie purchased several Texas leases with moneys advanced by Hall. Hall inspected only one of the leases. On December 6, 1935, Hall entered into a contract for the sale of the Oklahoma and Texas leases to the Southwest Trust for a consideration of $759,961.25, to be paid in six installments of $105,000 each on January, February, March, April, May, and June 25, 1936, respectively, and one installment of $129,961.25 on July 25, 1936. These leases cost Hall $535,654.59. The registration statement did not disclose the profit to be realized by him from the sale to the Southwest Trust. On December 6, 1935, the Southwest Trust executed an assignment of the contract to Brown, Diffie, Shanks, and Van Horn, [6] as trustees for a trust to be created on the following day under the name of Oklahoma-Texas Trust, for a consideration of $909,500, to be paid in six installments of $125,661 each on January, February, March, April, May, and June 25, 1936, respectively, and one installment of $155,534 on July 25, 1936. Out of such payments, Brown, Diffie, Van Horn and Shanks were required by the assignment to pay the installments provided for in the contract between Hall and the Southwest Trust. By the terms of the assignment the liability of the Trust and its trustees was limited to the proceeds received from the sale of participating units in the Trust. Hall testified that the Southwest Trust could cancel its contract with him at any time and suspend further payment of installments. In Cook on Corporations, 6th Ed., § 651, a promoter is defined as follows: A promoter is a person who brings about the incorporation and organization of a corporation. He brings together the persons who become interested in the enterprise, aids in procuring subscriptions, and sets in motion the machinery which leads to the formation of the corporation itself. See, also, Fletcher Cyc. Corporations, Perm. Ed., Vol. 1, § 189; Dickerman v. Northern Trust Co., 176 U.S. 181, 203, 20 S.Ct. 311, 44 L.Ed. 423; Luft v. Strobel, 322 Mo. 955, 19 S.W.2d 721. One may be a promoter notwithstanding he does not become connected as a shareholder with the company that is formed. [7] In Ex-Mission Land & Water Co. v. Flash, 97 Cal. 610, 32 P. 600, 604, the court said: The word `promoter' has no technical legal meaning, and applies to any person who takes an active part in inducing the formation of a company, whether he afterwards becomes connected with the company or not. We think it is a fair inference from the evidence that Hall, Brown, Diffie, and Shanks planned the formation of the Trust prior to December 6, 1935. The payment to Hall of the consideration for his contract of sale to the Southwest Trust was wholly contingent upon the payments to be made by the Trust under the terms of the assignment, which in turn was contingent upon a sale by the Trust of its participating units. Hall was an active participant in the entire plan. He advanced the money for the purchase of the leases. He entered into a contract for the sale of the leases to the Southwest Trust, which on the same day assigned the contract to the Trust to be formed. Under the arrangement, the Southwest Trust was under no binding obligation to make the payments to Hall. They were to be made directly by the trustees to Hall from the proceeds realized from the sale of participating units in the Trust. We conclude there was substantial evidence to sustain the finding that Hall was a promoter of the Trust. Item 14 of the registration statement called for the frequency, nature, and scope of reports to stockholders. The answer given in such statement was that quarterly reports showing receipts, expenditures, and disbursements for the preceding quarter would be given. Van Horn, one of the trustees, testified that they had no way of obtaining information for such reports because Hall, under the purchase contract, kept all the revenues from the property and paid all expenses, and that it was not our intention in answering that item in the registration statement that the reports would be made during the selling of the units. Item 14 calls for a statement of present intention. The evidence discloses such statement to be false. This was a misstatement of a fact. Donaldson v. Farwell, 93 U.S. 631, 633, 23 L.Ed. 993. The seriousness of the failure to make these quarterly statements during the period the units were being offered by the Trust to the public becomes more apparent when considered in the light of the misstatements respecting net income contained in the prospectus. In its prospectus the Trust stated that the present revenues from the properties to be acquired by it approximated $20,000 per month after deducting the estimated operating costs. The evidence disclosed that the net income from such properties for the month of December, 1935, was $9,022.08, for January, 1936, $12,504.66, and for February, 1936, $8,920.37. Item 17 of the registration statement calls for a statement of all litigation pending, if any, that may materially affect the value of the security to be offered, describing briefly the origin, nature, and name of parties to such litigation. The Trust's answer to this question was None. Rule 37 of the Texas Railroad Commission reads as follows: No well shall hereafter be drilled for oil or gas at any point less than six hundred and sixty (660) feet from any drilling or completed well; and no well shall hereafter be drilled for oil or gas at any point less than three hundred and thirty (330) feet from any property or division line; provided, however, the Commission in order to prevent waste or to protect vested rights, or to protect any property against undue drainage by reason of the operation of the wells of any other operator, will, after hearing, grant exceptions permitting drilling within a less or shorter distance than hereinabove prescribed, upon application duly filed fully stating the facts, notice of such application and hearing having been first given to all adjacent lessees affected thereby; provided, that if all adjacent lessees affected thereby waive in writing, notice of hearing on or objection to the granting of said application, the Commission may proceed to determine such application without hearing; and, provided further that in cases of forced offsets the Commission may grant exceptions without waivers or hearing when it is evident that the wells desired are necessary to protect the properties on which it is proposed to drill them. See Brown v. Humble Oil & Refg. Co., 126 Tex. 296, 83 S.W.2d 935, 939, 940, 99 A.L.R. 1107. In the case last cited the court held that the action of the Railroad Commission in granting an exception under the proviso to Rule 37 must be based upon proof and must not be capricious or unreasonable, and that its action is subject to judicial review. [8] But the ruling of the Railroad Commission is presumed to be valid and will not be set aside unless it is clearly illegal, unreasonable, or arbitrary. [9] The Railroad Commission of Texas had granted two exception permits under the proviso to Rule 37 for the drilling of two wells on a five-acre lease in Texas belonging to the Trust. On the effective date of the registration statement, two suits were pending in the district court of Travis County, Texas, brought by adjoining landowners to enjoin the drilling of wells under the permits and to set aside the permits. The Trust was not a party to such suits, but the attorney for Hall, who examined the title to the lease, and Diffie, who negotiated the purchase of the lease, had knowledge of the pendency thereof. The suits were predicated upon allegations that the facts did not justify the granting of the permits. In one case, a plea in abatement had been sustained and the petition amended by leave of court. Counsel for the Trust assert that these suits are frivolous and without merit. This assertion is open to question, and whether it is correct cannot be determined with certainty until the litigation has been terminated. Should either of the suits be successful, the amount of oil recoverable from the lease will be substantially decreased and the value of the lease materially affected. The answer in the registration statement should have disclosed the pendency of this litigation. If the registrant believed it to be without merit, it could have so stated in its answer. One portion of an engineering report signed by Lon B. Turk and attached to the registration statement as an exhibit, deals with the Tuleta-Skinner-Harris lease. It was actually prepared by Turk's partner Richards upon information received by him from Snider, a geologist, who in turn received his information from one Dirks, an owner of the Tuleta Oil Company. Snider reported to Richards that the field was about exhausted unless pumping was resorted to, but this fact was not disclosed in the report. This report also stated that the allowable production since June, 1935, had been 35 barrels per day, whereas in fact, it was 22 barrels in November, 1935, and 20 barrels in January, 1936, and it did not disclose that the lease had failed to make its allowable during the period from August, 1935, to January, 1936, inclusive. The report further stated that there have been no wells completed in the shallower sand (Cole sand zone at 1100 feet above the Pettus sand) on this property. Prior to February 19, 1936, of the eight wells on the lease two had ceased to produce from the Pettus and had been plugged back to the Cole and were producing therefrom in small quantities. A portion of the report covered the Sunray-Fain County lease. Turk testified that after November 1, 1935, there were adverse developments on this lease which rendered his report inaccurate and too optimistic; that there was an encroachment of water; that several surrounding wells were producing water ranging as high as 55 per cent on November 1, 1935; that during November well No. 1 began cutting water; and that well No. 3 cut water and finally went dead in December, 1935. Brown and Diffie knew about the water development on this lease at the time the registration statement was filed. Sometime after the first of January they induced Hall to credit the purchase price with $50,000 on account of the water. This report further states that the Chatham-Lindsay lease will undoubtedly prove to be the outstanding fertile tract of the entire Oklahoma field. Prior to February 19, 1936, four of the eight wells surrounding this lease had ceased to produce and the other surrounding wells were declining in production. We conclude that the findings of the Commission were supported by substantial evidence and should be sustained and that the stop order was properly issued. The order is accordingly affirmed.