The opinion of the court was delivered by: GORBEY
On July 18, 1972, eleven minority shareholders of The Pittsburgh & Lake Erie Railroad Company (P&LE) filed a complaint which questioned two series of transactions between P&LE and the Penn Central Transportation Company (Penn Central), the holder of a majority of P&LE's stock. The transactions at issue are: first, the financing of rebuilt railroad cars, which were purchased by P&LE from Penn Central (car financing); and, second, a series of loans made by P&LE to Penn Central (loans). In the ten counts of the complaint, the P&LE directors are charged with violations of the Securities Exchange Act of 1934 (15 U.S.C. § 78a et seq., (1934 Act)), the Securities Act of 1933 (15 U.S.C. § 77a et seq. (1933 Act)), and state corporate law. The defendants have filed a motion for summary judgment and/or dismissal. The essential thrust of this motion is to determine the propriety of the federal forum for the resolution of these claims. The defendants have advanced six arguments, each of which is directed at one or more of the ten causes of action in the complaint.
First, defendants argue that the first four causes of action, which assert jurisdiction under the 1934 Act, should be dismissed with prejudice because the challenged transactions do not involve a security as defined by that Act. The first cause of action which deals with the car financing, states:
"Having depleted the cash of P&LE for the benefit of Penn Central, the individual defendants caused P&LE to enter into a conditional sales agreement at the rate of interest far in excess of the rate concurrently charged Penn Central by P&LE on the unsecured loans, and far in excess of the rate then prevailing for railroad equipment trust certificates of like quality."
It is the defendants' position that the installment sales contract is not a security as defined in the 1934 Act, thus the court is without jurisdiction. Section 3(a) (10) of the 1934 Act (15 U.S.C. § 78c(a) (10)) defines a security as follows:
"The term 'security ' means any note, stock, treasury stock, bond, debenture, certificate of interest or participation in a profit sharing agreement or in any oil, gas, or other mineral royalty or lease, any collateral-trust certificate, preorganization certificate or subscription, transferrable share, investment contract, voting-trust certificate, certificate of deposit, for a security, or in general, any instrument commonly known as a 'security '; or any certificate of interest or participation in, temporary or interim certificate for, receipt for, or warrant or right to subscribe to or purchase, any of the foregoing; but shall not include currency or any note, draft, bill of exchange, or banker's acceptance which has a maturity at the time of issuance of not exceeding nine months, exclusive of days grace, or any renewal thereof the maturity of which is likewise limited."
This definition does not appear to include the usual two-party conditional sales agreement in which one party delivers goods in exchange for the promise of the other to pay over a future period of time.
The transaction at issue, however, is slightly more complex. In addition to the buyer and seller, it involves a group of third parties whose sole function it is to provide the financing. The transaction also involves some individual nominal owners of the railroad cars and a bank which functions as an escrow agent. The ultimate effect of all the transactions was: (1) to transfer title to the railroad cars from Penn Central to P&LE; (2) to arrange for the payment of cash from the investors to the Penn Central; and (3) to provide for the investors to be repaid from the cash of the P&LE over an extended period of time. These objectives were accomplished by several documents, and a number of which form a part of the record for this motion for summary judgment. The documents include two conditional sales agreements (CSA) between the two sets of nominal owners and P&LE. The terms of these agreements provide, inter alia, that the nominal owners will transfer title to the railroad cars in exchange for the payment of a specified sum in twelve annual installments. Next, there are two assignments (assignments) in which the nominal owners assigned their right, title and interest in the CSA to the Bank in exchange for a nominal sum and other unspecified consideration. There is a third three-party agreement (agency agreement), executed by P&LE, Provident National Bank (the Bank) and the investors. In the agency agreement: the Bank agreed to deliver the cars to P&LE pursuant to the CSA; P&LE agreed to make payments, pursuant to the CSA, in twelve annual installments to the Bank; and the investors agreed to advance to the Bank, on two dates certain, the funds necessary to purchase the railroad cars. The Bank also agreed to issue a "certificate of interest" to each investor at the time of his payment and to disburse to the investor the principal and interest which it receives from P&LE. The certificates of interest (certificates) which were issued by the Bank as evidence of the investors' advances provide for the investors' repayment by reference to both the agency agreement and the CSA.
It is the plaintiffs' contention that these "certificates of interest" are a security within the meaning of the Act. In defining a security, the Act includes an "investment contract". The Supreme Court in dealing with the term "investment contract" in the 1933 Act noted:
SEC v. W.J. Howey Co., 328 U.S. 293 at 298, 66 S. Ct. 1100 at 1102, 90 L. Ed. 1244 (1946).
In this case, the investors have provided financing for the purchase of the cars in return for which they expect profits which result from P&LE's efforts. The 1934 Act has previously been held to reach those who supply financing in the form of a participation in a loan agreement. Lehigh Valley Trust Co. v. Central National Bank of Jacksonville, 409 F.2d 989 (5th Cir. 1969).
In viewing conditional sales agreements such as this which involve third parties whose only function is to provide financing, we must not let form take the place of substance. The role of the financiers is a passive one, and their interest is only to obtain a return on their investment. Whether their interest is evidenced by a separate document such as a note or is made part of a single contract, should not be controlling. Whether the document, it should be considered a security. Accordingly, we hold that the certificate of interest issued by the Bank to the investors is a security within the meaning of the 1934 Act. We therefore must reject the defendants' argument that the transactions involved in the first cause of action do not involve a security as defined by the 1934 Act.
It is the defendants' position that the loans which are the subjects of causes of action 2 through 4 are not a security because the notes which were issued to evidence the obligation had a maturity date of six months, and the 1934 Act definition of a security excludes notes which have a maturity at the time of issuance of not exceeding nine months.
Beginning December 20, 1968, P&LE changed its practice of short-term cash management. Prior to that time, it had invested cash in short-term commercial paper. On December 20, 1968, it began to loan its excess cash to Penn Central. The loans made at this time were evidenced by a receipt executed by Penn Central. At the time the loans were made, they had no definite maturity and were considered to be demand obligations by the treasurer of both companies.
On May 26, 1969, the Comptroller of Penn Central indicated that the borrowings would not be repaid within one year and should be classified as long-term investment advances to affiliated companies.
Beginning September 15, 1969, notes with a maturity of six months or less were executed as ...