Opinion ID: 1058500
Heading Depth: 2
Heading Rank: 3

Heading: Sale of Business Doctrine

Text: 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 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, 105 S.Ct. 2308, 85 L.Ed.2d 708 (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, 105 S.Ct. 2297. 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, 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, 105 S.Ct. 2308 (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, 116 Hawai`i 187, 172 P.3d 499, 508-09 (2007); Banton v. Hackney, 557 So.2d 807, 824 (Ala.1989); Cohen v. William Goldberg & Co., Inc., 262 Ga. 606, 423 S.E.2d 231, 232-33 (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, 288 S.C. 309, 342 S.E.2d 406, 407 (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, 105 N.M. 366, 732 P.2d 1389, 1391 (Ct.App.1986); Doherty v. Kahn, 289 Ill.App.3d 544, 224 Ill.Dec. 602, 682 N.E.2d 163, 169-70 (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, 41 Cal.3d 714, 224 Cal.Rptr. 719, 715 P.2d 680, 694 n. 26 (1986) (quoting Tcherepnin, 389 U.S. at 336, 88 S.Ct. 548). 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. 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, 105 S.Ct. 2297. 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. Id. at 686-87, 105 S.Ct. 2297. 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, 105 S.Ct. 2308. Whether control has passed to the purchaser may not be determinable until a court has made a 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, 105 S.Ct. 2308. 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, 187 S.E. 447. 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.