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A.B.A. AUTO LEASE CORP. v. ADAM INDUS.

January 9, 1975

A.B.A. AUTO LEASE CORP. and ERNST INTERNATIONAL, INC.
v.
ADAM INDUSTRIES, INC., ADAM LEASING CORPORATION, KUTNER BUICK, INC. and JEROME S. KUTNER



The opinion of the court was delivered by: GORBEY

 GORBEY, District Judge.

 This action arises out of franchise agreements which were entered into between the plaintiffs and defendant, Adam Industries, Inc., for an automobile leasing franchise. Defendants have moved to dismiss on the grounds that the counts of the complaint based on violation of the federal securities law (i.e., counts 1 and 4) do not state cause of action under the federal securities laws.

 Defendants urge that the case is similar to the recent decision of the Third Circuit in Lino v. City Investing Co., 487 F.2d 689 (1973), where the court held that the franchise agreement in that case did not constitute an investment contract within the meaning of the Act. In the Lino case the Third Circuit rejected a strict interpretation of the classic definition of an investment contract which had come from the case of SEC v. W.J. Howey Co., 328 U.S. 293 at 298-99, 90 L. Ed. 1244, 66 S. Ct. 1100 (1946), which reads as follows:

 
". . . [An] investment contract for purposes of the Securities Act means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party . . ." (Emphasis added)

 In rejecting the strict interpretation, the Third Circuit adopted the reasoning of the Ninth Circuit in the case of SEC v. Glen W. Turner Enterprises, Inc., 474 F.2d 476 at 482 (9th Cir. 1973) and State v. Hawaii Market Center, Inc., 52 Haw. 642, 485 P.2d 105 (1971); stating 487 F.2d at page 692:

 
"We find these authorities persuasive. The reasoning of the Supreme Court, the Ninth Circuit, the S.E.C. and Supreme Court of Hawaii leads us to hold that an investment contract can exist where the investor is required to perform some duties, as long as they are nominal or limited and would have 'little direct effect upon receipt by the participant of the benefits promised by the promoters.' As the Ninth Circuit realized, to adopt a position similar to City Investing's would lead to easy evasion of the act 'by adding a requirement that the buyer contribute a modicum of effort.'" (citations omitted)

 Accordingly, we must, as it was done in the Lino case, "examine the substance and economic reality of this situation rather than the formal characteristics of the parties in interest." Under the license agreements in question, plaintiffs were required to promote the name and reputation of Adam, conduct the business in a reasonable manner suggested and approved by Adam, not commit any act which in the sole judgment of Adam is harmful to the name of Adam, advertise as approved by Adam, spend a specified amount in advertising in the first two months of operation, spend $50 per lease in advertising, comply with all requests for information made by Adam, maintain approved communications equipment and produce a specified number of leases in the first year. *fn1" Plaintiffs' rights under said agreement were to advertise as an authorized Adam leasing office in an exclusive area; to avail itself of the training provided by Adam; to receive the continuous guidance of Adam management, and the manuals, forms and price sheets provided by Adam, to attend regional seminars provided by Adam, to receive payment by Adam of a certain sum fixed by a schedule attached to the agreement for each lease produced and to have investigation, approval, inspection, titling, dunning and repossession and all other paper work to be done by Adam.

 As consideration for the license granted by Adam, plaintiffs paid $1. In addition, plaintiffs paid a specified sum for training, management and consulting. *fn2"

 Plaintiffs' primary argument is that the license agreements in question place all "essential managerial functions" with the defendants and under the test of SEC v. Glen W. Turner Enterprises, Inc., supra, adopted by the Third Circuit in Lino v. City Investing, Co., supra, the agreements in question were investment contracts and thus securities within the meaning of the Act. We do not agree.

 Plaintiffs point heavily to the allegation that the pricing structure was fixed by Adam and as a result of the prices set by Adam, the leases were not competitive in the local markets where plaintiffs operated, as a result plaintiffs lost substantial sums of money, primarily those paid to Adam under the agreement and expenses incurred in setting up their local offices. Here, it was intended that plaintiffs would open up an office as the authorized representative of Adam Leasing. *fn3" The plaintiffs were required to produce a certain number of leases under the agreement, and plaintiffs' success or failure was directly related to, among other things, its ability to produce prospective lessees.

 Plaintiffs' argument is, in essence, that since the defendants retained enough control over the business to also determine the success or failure of the venture, this agreement is an investment contract. We do not agree. Admittedly this is a close case and it appears defendants have attempted to retain the maximum control without having the license agreement deemed an investment contract. In the case at bar, plaintiffs were obviously required to expend their best efforts. They had to open an office. They admit in paragraphs 17 and 64 of the complaint that they were informed in the promotional material that they would be required to devote their full time to the business and do not allege that this was not so. Plaintiff A.B.A.'s claim for actual damages of "not less than $29,530.63 (including the $8,000 initial fee)" clearly indicates that plaintiff expended significant sums to set up and operate the business in addition to the monies paid to defendant under the agreement. Similarly, plaintiff Ernst claims actual damages of "not less than $23,919.76 (including the $5,000 initial fee)". ...


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