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South Carolina
JUDICIAL DEPARTMENT
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2010-04-01-01

 

STATE OF SOUTH CAROLINA ) IN THE COURT OF COMMON PLEAS
  )  
COUNTY OF CHARLESTON ) IN THE NINTH JUDICIAL CIRCUIT
     
JANE P. HUGGINS, as Personal Representative of the ESTATE OF CHARLES H. POWERS, SR., ) Civil Action No.:   2009-CP-10-3433
  )  
Plaintiff, )  
  ) ORDER
vs. )  
  )  
J.J.B. HILLIARD, W.L. LYONS, LLC f/k/a J.J.B. HILLIARD, W.L. LYONS, INC., d/b/a HILLIARD LYONS and JOHN A. JEFFORDS, INDIVIDUALLY, )
)
)
 
  )  
Defendants. )  

This matter came before the Court on March 23, 2010, upon motions to dismiss filed on behalf of Hilliard Lyons and John A. Jeffords pursuant to Rule 12(b)(6) of the South Carolina Rules of Civil Procedure.  William C. Cleveland and John C. Hawk appeared on behalf of the plaintiff; Robert E. Stepp and Tina Cundari appeared on behalf of Hilliard Lyons; and Julie Jeffords Moose appeared on behalf of John A. Jeffords.  After considering the motions and memoranda, as well as the oral argument of counsel, the Court grants the motions to dismiss. 

BACKGROUND

This is an action brought by the personal representative of an estate alleging that her father, the decedent, Charles H. Powers, Sr., a multi-millionaire, was misled into making a certain investment during his lifetime.  According to the complaint, on or about August 8, 2007, Powers invested $900,000 in a company in Charleston called Blackhawk Logistics, LLC.  Complaint ¶ 10.  In return, Powers received a promissory note and a 5% equity interest in Blackhawk.[1]  Id. 

The promissory note is a 3-year note that promises to pay Powers $900,000 on August 31, 2010, and monthly interest payments of 12% per annum.[2]  The note is secured by Blackhawk’s master lease and a life insurance policy on Jerry Ward, president of Blackhawk, exceeding $1,000,000, and naming Powers as the beneficiary of $900,000.  The note also contains a prepayment penalty of 2.5% of the principal balance.  In the event of default, the principal and overdue interest are payable on demand, and acquire interest at a rate of 18% per annum from the date of default until the date the default is waived or cured.  The note gives the holder full authority to enforce his rights in a court of law or equity. 

The 5% equity interest is reflected in the Blackhawk operating agreement that Powers signed as a “member.”  The agreement states that the “full and entire management of the business and affairs of the Company shall be vested in a Board of Managers . . . .”  The agreement also states that “[t]he Board of Manager(s) will be appointed on an annual basis by the Members.”  Additionally, the “profits and losses of the Company shall be allocated to the Members in accordance with their membership interests . . . .”

According to the complaint, Powers learned about Blackhawk Logistics from his long-time investment advisor and financial consultant, John A. Jeffords.  Complaint ¶¶ 6, 8.  At the time of the transaction described in the complaint, Jeffords was employed by Hilliard Lyons.  Complaint ¶ 6.  As an employee of Hilliard Lyons, Jeffords presented Powers with various investment opportunities, “some of which consisted of stocks for which Hilliard Lyons could provide brokerage services and some of which did not.”  Id. ¶¶ 5, 6.   

The complaint alleges that “[i]n the summer of 2007, Jeffords presented Powers with an opportunity to invest $1,000,000 in Blackhawk.”  Id. ¶ 8.  The complaint further alleges that “Powers initially resisted investing in Blackhawk, [but] Jeffords persuaded Powers that Blackhawk was a worthy investment.”  Id.  Jeffords allegedly told Powers that “if Powers made a $900,000 investment in Blackhawk, . . . Jeffords would invest $100,000 of his own funds in the venture.”  Id.  The complaint also alleges that Jeffords failed to tell Powers that Blackhawk owed Jeffords $250,000, and that Blackhawk agreed to give Jeffords an equity interest of up to 30% if Jeffords could find someone to invest $1,000,000 in the company.  Id. ¶ 9.  According to the operating agreement, however, Jeffords received a .5% equity interest in Blackhawk.  In addition, there are no allegations in the complaint that Hilliard Lyons or Jeffords received a profit or commission as a result of the transaction.[3]

Powers died in September 2007, about one month after the transaction.  See id. ¶ 1.  The complaint was filed on June 1, 2009.  The personal representative of the estate seeks to recover the money Powers invested in Blackhawk, less the money earned on the investment.  Id. ¶¶ 1, 16.    The complaint contains the following causes of action:  (1) violation of the South Carolina Uniform Securities Act (as to both defendants); (2) violation of the South Carolina Uniform Securities Act (as to Hilliard Lyons only); (3) negligent misrepresentation (as to both defendants); and (4) violation of the South Carolina Unfair Trade Practices Act (as to both defendants).  The estate has not sued Blackhawk, which is the entity liable under the note.

STANDARD

A defendant may move to dismiss a complaint for “failure to state facts sufficient to constitute a cause of action.”  Rule 12(b)(6), SCRCP.  “The question is whether, in the light most favorable to the plaintiff, and with every doubt resolved on his behalf, the complaint states any valid claim for relief.”  Plyer v. Burns, 373 S.C. 637, 645, 647 S.E.2d 188, 192 (2007) (quoting Stiles v. Onorato, 318 S.C. 297, 300, 457 S.E.2d 601, 602 (1995)).

“In considering a 12(b)(6) motion, the trial court must base its ruling solely upon the allegations set forth on the face of the complaint.”  Brazell v. Windsor, 384 S.C. 512, ___, 682 S.E.2d 824, 826 (2009).  The court may, however, consider documents outside the four corners of the complaint if the documents are “incorporated by reference in the complaint but not actually attached thereto . . . .”  Id.  This “prevents a plaintiff from benefitting from his own oversight or from surviving a motion to dismiss by intentionally omitting documents upon which [her] claims are based.”  Id. 

DISCUSSION

I. The first and second causes of action state a claim under the South Carolina Uniform Securities Act.

Defendants contend that the first and second causes of action should be dismissed because the financial transaction described in the complaint does not involve a security or the sale of a security by either defendant.  The Court disagrees.

The South Carolina Uniform Securities Act defines security as:

any note; stock; treasury stock; security future; bond; debenture; evidence of indebtedness; certificate of interest or participation in a profit-sharing agreement; collateral trust certificate; preorganization certificate or subscription; transferable share; investment contract; . . . .  The term:

. . .

(D) includes an investment in a common enterprise with the expectation of profits to be derived primarily from the efforts of a person other than the investor and a “common enterprise” means an enterprise in which the fortunes of the investor are interwoven with those of either the person offering the investment, a third party, or other investors; and

(E) “Investment contract” may include, among other contracts, an interest in a limited partnership and a limited liability company and shall include an investment in a viatical settlement or similar agreement.

S.C. Code Ann. § 35-1-102(29) (Supp. 2009).[4]

In determining whether a transaction involves the purchase or sale of a security, the court must examine the economic realities of the transaction.  Majors v. S.C. Sec. Comm’n, 373 S.C. 153, 644 S.E.2d 710 (2007) (analyzing whether the sale of tax lien certificates constitutes the sale of securities); Carver v. Blanford, 288 S.C. 309, 342 S.E.2d 406 (1986) (analyzing whether the sale of stock in a closely-held corporation constitutes the sale of securities); O’Quinn v. Beach Assocs., 272 S.C. 95, 249 S.E.2d 734 (1978) (analyzing whether the sale of condominium units constitutes the sale of securities); Garrett v. Snedigar, 293 S.C. 176, 181, 359 S.E.2d 283, 286 (Ct. App. 1987), overruled on other grounds, Olson v. Faculty House of Carolina, Inc., 354 S.C. 161, 580 S.E.2d 440 (2003), (analyzing whether a partnership interest constitutes a security).  For example, although a literal reading of the definition suggests that all notes are securities, case law says otherwise.  See Futura Dev. Corp. v. Centex Corp., 761 F.2d 33, 39 (1st Cir. 1985) (listing numerous federal court cases in which the court concluded that a promissory note was not a security); Crim v. E.F. Hutton, Inc., 298 S.C. 448, 450, 381 S.E.2d 492, 493 (1989) (holding that a promissory note was not a security).

Courts have used four different tests to analyze the economic realties of a transaction.  The first test is the commercial versus investment test.[5]  “Under this test, the court looks to see whether a transaction more closely resembles typical investment situations or typical mercantile or commercial transactions . . . .”  Futura, 761 F.2d at 40.  The test “focuses on the degree to which the plaintiff is dependent upon the expertise of others.”  Id.  Considerations under this test include: “the degree to which the profit on the note is in the hands of the maker rather than the payee; whether the object of the holder was to acquire an interest in the property or enterprise; whether the note was primarily commercial because it was serving as a ‘cash substitute’ for the purchase price; and whether the return on the note was predetermined or could reasonably be anticipated, or was subject to the managerial efforts of the maker.”  Id. at 41.   

The second test is the risk-capital test.  This test “focuses on whether the transaction more closely resembles a ‘loan’ or has the risk factors associated with ‘risk capital.’”  Id. at 40.  Six factors are considered when applying this test:  “the length of time between the note’s issuance and due date, whether there is collateral for the note, the form of the obligation, the circumstances of the issuance, the relationship between the amount borrowed and the size of the borrower’s business, and the contemplated use of the proceeds.” Id. 

The third test is the Howey test.[6]  This test is more commonly used to determine whether an investment contract exists, but has been used by the South Carolina Supreme Court and other courts to determine whether a note is security.[7]  The test requires: “(i) an investment of money, (ii) in a common enterprise, (iii) with an expectation of profits garnered solely from the efforts of others.”  Majors v. S.C. Sec. Comm’n, 373 S.C. 153, 164, 644 S.E.2d 710, 716 (2007).  The first prong is satisfied if “the investor . . . committed his assets to the enterprise in such a manner as to subject himself to financial loss.”  Id.  The second prong is satisfied if “the promoter’s gain is contingent on the investor’s gain . . . .”  Id. at 166, 644 S.E.2d at 717.  The third prong is satisfied if “the promoter’s efforts, not that of the investors, form the essential managerial efforts which affect the failure or success of the enterprise.”  Id. at 167, 644 S.E.2d at 718 (internal quotations omitted).   

The fourth test is the “family resemblance” test.[8]  Under the family resemblance test, a note is presumed to be a security unless it can be shown that the note bears a strong resemblance to one of the following: “the note delivered in consumer financing, the note secured by a mortgage on a home, the short-term note secured by a lien on a small business or some of its assets, the note evidence a ‘character’ loan to a bank customer, short-term notes secured by an assignment of accounts receivable, or a note which simply formalizes an open-account debt incurred in the ordinary course of business (particularly if, as in the case of the customer of a broker, it is collateralized).”  Reves, 494 U.S. at 65.  In determining whether a note resembles one of the above, four factors are considered. 

First, courts “examine the transaction to assess the motivations that would prompt a reasonable seller and buyer to enter into it.”  Id. at 66.  “If the seller’s purpose is to raise money for the general use of a business enterprise or to finance substantial investments and the buyer is interested primarily in the profit the note is expected to generate, the instrument is likely to be a ‘security.’”  Id.  “If the note is exchanged to facilitate the purchase and sale of a minor asset or consumer good, to correct for the seller’s cash-flow difficulties, or to advance some other commercial or consumer purpose, on the other hand, the note is less sensibly described as a ‘security.’”  Id.  Second, courts “examine the ‘plan of distribution’ of the instrument, . . . to determine whether it is an instrument in which there is ‘common trading for speculation or investment.”  Id.  Notes “offered and sold to a broad segment of the public” is all that is “necessary to establish the requisite ‘common trading’ in an instrument.”  Id. at 68.  Third, courts “examine the reasonable expectations of the investing public . . . .”  Id. at 66.  Fourth, courts “examine whether some factor such as the existence of another regulatory scheme significantly reduces the risk of the instrument, thereby rendering application of the Securities Act unnecessary.”  Id. at 67.

In large measure the transaction in this case resembles a loan which would be exempt from coverage under the Securities Act under any of these tests.  Powers gave Blackhawk $900,000 and in return received a 3-year promissory note which promised to repay him the entire amount.  In the meantime, Powers was to receive fixed monthly interest payments of 12% of the principal per annum.  The return on the note was predetermined and was not subject to the managerial efforts of others.  The note provided for the same payment for the same interest rate over the same period of time.  The rate of return was not tied to the success or failure of Blackhawk.  If Blackhawk increased in value, the rate on the interest payments remained the same, and the principal was still due in 3 years.  If the company went bankrupt, the note remained enforceable as written.  Powers was entitled to repayment regardless of whether Blackhawk was successful.  Given the terms of the note, there could be no expectation of profits or of the note increasing in value.

Additionally, the note was secured by an interest in a master lease and a $1,000,000 life insurance policy on Jerry Ward (president of Blackhawk), with Powers as the named beneficiary of $900,000, which made the investment even more secure, more like a loan, and less like risk-capital.  Powers was not dependent on the expertise of others.  Powers made a deal in which he controlled his return by negotiating the interest rate.  The money he received was locked-in by the terms of the note and was secured by the assets of the company.  There were harsh financial repercussions in the event of default.  There was a penalty for prepayment.  This was not an investment in the corporation or its managers, but a calculated loan with a less risky, more secure profit stream.  It was a tailor-made transaction that was not offered or sold to a broad segment of the public.  It was not dependent on securities laws for enforcement.  In short, a note of the type presented in this case would traditionally not be considered a security.

However, the note does not stand alone. The equity interest that Powers received in Blackhawk changes the economic reality of the transaction.  The purchase of an equity interest in an LLC may constitute a security, S.C. Code Ann. § 35-1-102(29), and I find the equity interest in this case as pled may constitute a security. Defendants argue Powers did not pay any money for the equity interest and therefore there was no purchase or sale of an equity interest, i.e., all of the money that Powers paid is reflected in and guaranteed by the promissory note. However, that assumes a fact not in evidence – that the equity interest was gratuitous. That is inconsistent with the Plaintiff's complaint, and cannot therefore be considered at this point. As pled, the note and equity interest are intertwined and do not stand alone.

Therefore, the Defendants' motions to dismiss the first and second causes of action are dismissed. 

II. The third cause of action for negligent misrepresentation is dismissed.

Defendants contend that the claim for negligent misrepresentation should be dismissed because it is rooted in fraud and deceit and therefore does not survive death.  The Court agrees. 

The survivability statute states that “[c]auses of action for and in respect to any and all injuries . . . and any and all injuries to the person or to personal property shall survive both to and against the personal or real representative, as the case may be, of a deceased person . . ., any law or rule to the contrary notwithstanding.”  S.C. Code Ann. § 15-5-90 (2005).  Although the language in the statute “is broad and ostensibly appears to include almost every conceivable cause of action, . . . South Carolina case law has continued to recognize a common law exception regarding causes of action for fraud or deceit.”  Ferguson v. Charleston Lincoln Mercury, Inc., 349 S.C. 558, 565, 564 S.E.2d 94, 97 (2002).  “The fraud exception to survivability is not limited only to a cause of action titled ‘fraud.’”  Brailsford v. Brailsford, 380 S.C. 443, 450, 669 S.E.2d 342, 345 (Ct. App. 2008).  This is illustrated in Ferguson.

In Ferguson, the South Carolina Supreme Court held that a cause of action arising under the South Carolina Regulation of Manufacturers, Distributors, and Dealers Act could not be brought in a representative capacity because the action was based upon a theory of fraud and deceit.  Id.  The court reasoned that “[a]t the core of [the decedent’s] complaint was the allegation that [the car dealership] misled him into paying more for the car than he should have paid, and concealed the overcharge either through intentionally deceptive acts or through grossly negligent disclosure practices.”[9]  Id.  As a result, the cause of action did not survive death.  Id.  349 S.C. at 565, 564 S.E.2d at 97-98.

At the core of Plaintiff’s complaint in the case at hand is the allegation that her father was misled during his lifetime.  Plaintiff contends Jeffords failed to tell Powers that Blackhawk owed Jeffords $250,000, and that Blackhawk agreed to give Jeffords as much as a 30% ownership interest if he could find someone to invest $1 million.  Such allegations are based in fraud and deceit and do not survive death.  This conclusion makes sense because it is unclear how Plaintiff would be able to prove what Powers knew or whether the information that Jeffords allegedly failed to tell Powers would have made a difference to Powers. 

Additionally, the complaint fails to allege facts supporting a claim for negligent misrepresentation.  “To establish liability for negligent misrepresentation, the plaintiff must show (1) the defendant made a false representation to the plaintiff; (2) the defendant had a pecuniary interest in making the representation; (3) the defendant owed a duty of care to see that he communicated truthful information to the plaintiff; (4) the defendant breached that duty by failing to exercise due care; (5) the plaintiff justifiably relied on the representation; and (6) the plaintiff suffered a pecuniary loss as the proximate result of his reliance upon the representation.”  Sauner v. Pub. Serv. Auth. of S.C., 354 S.C. 397, 407, 581 S.E.2d 161, 166 (2003) (internal quotations omittted).

The complaint does not identify any false representation that was made to the estate, nor does it identify any duty that Defendants owed the estate.  Further, the complaint does not allege that the estate relied on any such representation or suffered a pecuniary loss as a result.  The loss complained of stems from the breach of the note, and not from the alleged misrepresentations. 

For these reasons, the cause of action for negligent misrepresentation is dismissed.

III. The fourth cause of action for violation of the South Carolina Unfair Trade Practices Act is dismissed.

Finally, Defendants contend that the claim for violation of the South Carolina Unfair Trade Practices Act should be dismissed because it cannot be brought in a representative capacity.  The Court agrees.

The Unfair Trade Practices Act states:

Any person who suffers any ascertainable loss of money or property, real or personal, as a result of the use or employment by another person of an unfair or deceptive method, act or practice declared unlawful by § 39-5-20 may bring an action individually, but not in a representative capacity, to recover actual damages.     

S.C. Code Ann. § 39-5-140 (1985) (emphasis added).

Based on the plain language of the Act, courts have held that the personal representative of an estate does not have standing to bring a claim under the Act.  Wogan v. Kunze, 366 S.C. 583, 609, 623 S.E.2d 107, 121 (Ct. App. 2005); Faircloth v. Jackie Fine Arts, Inc., 682 F. Supp. 837 (D.S.C. 1988), reversed in part on other grounds, Faircloth v. Finesod, 938 F.2d 513 (4th Cir. 1991).

The plaintiff in this case is Jane P. Huggins as personal representative of the estate of Charles H. Powers, Sr.  Because Plaintiff is suing in a representative capacity, she cannot state a claim for violation of the Unfair Trade Practices Act.  Even if Plaintiff could state a claim in her capacity as personal representative, the complaint fails to identify any unfair or deceptive acts that have been directed to the estate.  See Wright v. Craft, 372 S.C. 1, 23, 640 S.E.2d 486, 498 (Ct. App. 2006) (outlining the elements for a claim of unfair trade practices).  There are no allegations that Defendants harmed the estate, and the estate has not suffered monetary or property loss because of Defendants.  The estate still has the note.  Whether the note is being breached is a different issue than whether unfair or deceptive conduct was aimed at the decedent during his lifetime. 

CONCLUSION

For these reasons, the Court denies the Defendants' motions to dismiss the First and Second causes of action, and grants the Defendants' motions to dismiss the Third and Fourth causes of action.

AND IT IS SO ORDERED.

  _________________________________
Roger M. Young, Sr.
Circuit Court Judge

Charleston, South Carolina
April 1, 2010                   


[1] The note and operating agreement, which reflect the 5% equity interest, are referred to throughout the complaint and were provided to the Court for purposes of deciding the motions to dismiss. 

[2] In another part of the note, the maturity date is listed as July 31, 2010.

[3] At the hearing before this Court, counsel for Jeffords stated that Jeffords was acting outside the course and scope of his employment at the time of the transaction. However, the Plaintiff alleges in her complaint that he was acting within the course and scope of his employment, and at this stage this Court must deem that allegation as true.

[4] This definition is similar to the definition found in the federal Securities Act of 1933, 15 U.S.C. § 77b(1), and the Securities Exchange Act of 1934, 15 U.S.C. § 78(a).  Because the definitions in the state and federal acts are similar, South Carolina courts look to federal courts for guidance when interpreting the state act.  See Majors v. S.C. Sec. Comm’n, 373 S.C. 153, 644 S.E.2d 710 (2007) (“In construing the state act, we may look for guidance to cases construing its federal counterpart”); McGaha v. Mosley, 283 S.C. 268, 273, 322 S.E.2d 461, 464 (Ct. App. 1984) (“In construing the South Carolina Uniform Securities Act, our courts look for guidance to cases interpreting the federal statute.”). 

[5] This test has been applied by a federal district court in South Carolina.  S.C. Nat’l Bank v. Darmstadter, 622 F. Supp. 226, 229 (D.S.C. 1985), aff’d, 1986 WL 18613 (4th Cir. 1986) (unpublished decision). 

[6] The test comes from Sec. & Exch. Comm’n v. Howey, 328 U.S. 293 (1946).

[7]  See Crim v. E.F. Hutton, Inc., 298 S.C. 448, 450, 381 S.E.2d 492, 493 (1989) (holding that a promissory note was not a security because it was not “an investment in a common venture premised on a reasonable expectation of profits to be derived from the entrepreneurial and managerial efforts of others”).  See also Lawler v. Gilliam, 569 F.2d 1283, 1287 (4th Cir. 1978) (explaining that the touchstone to whether a note is a security “is the presence of an investment in a common venture premised on a reasonable expectation of profits to be derived from the entrepreneurial efforts of others”) (quoting United Hous. Found., Inc. v. Forman, 421 U.S. 837, 852 (1975)).  

[8] This test has been adopted by the United States Supreme Court.  Reves v. Ernst & Young, 494 U.S. 56, 60 (1990).  This test has also been referred to as the “literal approach” because it interprets the language of the securities acts as requiring courts to presume that a note is a security unless the context requires otherwise.  Futura Dev. Corp. v. Centex Corp., 761 F.2d 33, 39 (1st Cir. 1985). 

[9] The Dealers Act defines fraud as including “a misrepresentation in any manner, whether intentionally false or due to gross negligence, of a material fact; a promise or representation not made honestly and in good faith; and an intentional failure to disclose a material fact.”  Ferguson, 349 S.C. at 564, 564 S.E.2d at 97.  The supreme court later regarded this act as “arguably expanding the definition of fraud to include actions that would not normally amount to fraud.”  Tilley v. Pacesetter Corp., 355 S.C. 361, 378, 585 S.E.2d 292, 300 (2003)