August 23, 2019

Colorado Court of Appeals: Economic Realities Test Determines When General Partnership Interests Constitute Securities

The Colorado Court of Appeals issued its opinion in Rome, Acting Securities Commissioner for the State of Colorado v. HEI Resources, Inc. on Thursday, November 20, 2014.

Partnership Interests as Securities Under the Colorado Securities Act—Strong Presumption Test Under Williamson.

Rome, Acting Securities Commissioner for the State of Colorado (commissioner), appealed from a judgment dismissing his enforcement action against defendants. Two of the defendants, HEI Resources, Inc. (HEI) and Heartland Energy Development Corporation (HEDC), had their principal place of business in Colorado. In 2009, the commissioner filed a complaint alleging that defendants violated the Colorado Securities Act (Act) by using unlicensed sales representatives to offer and sell unregistered securities.

The allegations were premised on defendants’ formation and operation of several joint ventures in oil and gas exploration and drilling. To capitalize the ventures, defendants solicited investors by cold-calling thousands of people across the country. If an individual was interested, defendants sent an information package that included a Confidential Information Memorandum (CIM) and a Joint Venture Agreement (JVA). The JVA provided for the formation of a joint venture, organized as a general partnership under the Texas Revised Partnership Act.

HEI or HEDC was named as the initial managing venture. Although the JVA gave the venturers authority to remove the managing venturer by a majority vote and to vote on other issues, the commissioner alleged that any theoretical control by the venturers was illusory. The commissioner argued that the substance of the transaction was an investment contract under which the venturers invested money with the expectation that defendants’ efforts would return a profit.

The trial court granted summary judgment motions filed by defendants. It held the commissioner was collaterally estopped (due to a 2002 cease and desist action) from arguing that, based on the plain language of the JVAs, the joint venture interests were securities. It also ruled that, as a matter of law, the commissioner could not establish that the interests were securities. Based on its summary judgment orders, the subsequent trial was limited to the commissioner trying to prove that the interests were securities based on the knowledge and experience of the partners or venturers or under other economic realities surrounding their offer and sale. The court ruled in favor of defendants.

On appeal, the commissioner argued it was error to apply a strong presumption that general partnership or joint venture interests are not securities and to conclude that the relevant experience of the venturers is their general business experience. Only transactions that involve a “security” fall under the scope of the Act. Courts are to look to the “economic realities” of the transaction.

In what the Court of Appeals saw as a matter of first impression in Colorado, it held that Colorado courts should not apply the “strong presumption” that interests in joint ventures or general partnerships are not securities. Because the trial court applied the strong presumption, the Court vacated the judgment and remanded the case for reconsideration.

The Court found that the inquiry is to be based on the knowledge of the nature of the underlying venture. The Court clarified that this is not a requirement that every investor have specific experience related to the underlying venture. Therefore, this issue must also be reconsidered on remand.

Summary and full case available here, courtesy of The Colorado Lawyer.

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