December 20, 2013 Utah Supreme Court Case Summaries

LEGACY RESOURCES, INC. v. LIBERTY PIONEER ENERGY SOURCE, INC., 2013 UT 76, No. 20120142 (December 20, 2013)

ISSUES: “Broker” defined, Securities

Justice Lee,

State and federal securities laws require a broker1 of securities to register and secure a license. See UTAH CODE § 61-1-3; 15 U.S.C. § 78o(a)(1). Noncompliance triggers certain statutory penal-ties, including the one at the center of this case: Utah Code section 61-1-22(8), which provides that “[a] person who has made or engaged in the performance of any contract in violation of this chapter . . . may not base a suit on the contract.”

At ¶ 1.

Legacy Resources, Inc. (Legacy) appeals from a decision dismissing its breach of contract and trade secret claims on summary judgment. The district court‘s decision rested on two key determinations: that Legacy violated the securities laws by acting as an unlicensed broker in recruiting investors on behalf of Liberty Pioneer Energy Source, Inc. (Liberty); and that its securities violations rendered its contracts unenforceable under Utah Code section 61-1-22(8).

At ¶ 2.

We affirm in part and reverse in part. After clarifying the definition of “broker” under Utah Code section 61-1-3, and rejecting the availability of the equitable defenses put forward by Legacy as a ground for circumventing Utah Code section 61-1-22(8), we hold that the undisputed facts sustain the conclusion that Legacy acted as an unlicensed broker and that such violation foreclosed the enforcement of one of its contracts. We also conclude, however, that another of Legacy‘s contracts was not implicated by its securities violation, and thus that its claim under that contract—and by extension its trade secret claim—should have survived summary judgment.

At ¶ 3.

We first address the propriety of the district court‘s grant of summary judgment on Legacy‘s breach of contract claims. We conclude that our securities laws precluded Legacy from enforcing the [Agency Agreement (“AA”)], but not the [Non-disclosure Agreement (“NDA”)]. And because the NDA imposes confidentiality obligations on Liberty—not tied to any commission payment entitlement—we hold that the district court‘s determination that Liberty was not obligated to pay commissions for use of Legacy‘s investor information on subsequent projects was also insufficient to sustain dismissal of the NDA claim. We accordingly take up—and ultimately reject—the district court‘s dismissal of Legacy‘s trade secret claim. . . . Thus, we affirm with respect to Legacy‘s claim for breach of the AA, but reverse with respect to its claims for breach of the NDA and on its trade secret claim.

At  ¶ 15.

Legacy challenges the dismissal of its breach of contract claims on four grounds. It (a) asserts that there are disputed questions of fact on the question whether it acted as a broker; (b) claims that equitable considerations sustain the enforceability of its contracts even assuming its status as a broker; (c) challenges the determination that the NDA required or was performed using illegal activity; and (d) disputes the construction of the NDA limiting its right to compensation to the CULA projects.

At ¶ 16.

We affirm the district court‘s determinations that Legacy acted as a broker and that the AA is unenforceable under our securities laws. We reverse the summary dismissal of the NDA claim, however, concluding that this agreement neither required nor was performed using illegal activity.

At ¶ 17.

“Broker” Defined

The threshold questions before us concern (1) the legal definition of “broker” under the securities laws and, (2) Legacy‘s status as such. In the district court, these issues were framed in terms of a so-called “finder‘s exception”—specifically, whether the law encompassed such an exception and whether Legacy qualified for it. We find the “finder‘s exception” question unhelpful—or at least more distracting than enlightening.

At ¶ 18.

The securities laws say nothing of finders, only of brokers. So the operative question is not whether Legacy qualifies for an exception as a finder, but only whether it is subject to regulation as a broker. Perhaps the notion of “finder” is meant only as the yin to the “broker‘s” yang—as a shorthand label for those actors whose activities do not quite qualify them for regulation under the securities laws. But if so it is entirely circular—and more confusing than helpful—to ask about finder status if all we really mean by that is non-broker status. It is simpler and more straightforward to proceed straight to the question whether a given actor qualifies as a broker, which, after all, is the controlling statutory term. . . .

At ¶ 19.

Under Utah law a broker is “a person engaged in the business of effecting transactions in securities for the account of others or for the person‘s own account.” UTAH CODE § 61-1-13(1)(c)(i). The federal definition is along the same lines. See 15 U.S.C. § 78c(a)(4)(A) (defining “broker” as “any person engaged in the business of effecting transactions in securities for the account of others”). The federal term has acquired a settled definition in the caselaw. We interpret the Utah statute to incorporate the same essential standard, both because our statute instructs us to “coordinate the interpretation and administration” of our securities law with “related federal regulation,” UTAH CODE § 61-1-27, and be-cause the text of our statute is generally in line with the federal standard. And we conclude that Legacy acted as a broker under these provisions under the undisputed facts in the record.

At ¶ 20.

This court has not yet interpreted the term “broker” in our securities laws. But there is a developed body of federal caselaw in this field. The federal law notion of “broker” looks to a range of factors or considerations. Those factors are sometimes framed in terms of “regular participation in securities transactions, employment with the issuer of the securities, payment by commission as opposed to salary, history of selling the securities of other issuers, [and] involvement in advi[sing] . . . investors and active[ly] recruit[ing]” them. S.E.C. v. George, 426 F.3d 786, 797 (6th Cir. 2005). Alternatively, the federal factors are sometimes ex-pressed in somewhat expanded terms of whether a person “1) is an employee of the issuer; 2) received commissions as opposed to a salary; 3) is selling, or previously sold, the securities of other issuers; 4) is involved in negotiations between the issuer and the investor; 5) makes valuations as to the merits of the investment or gives advice; and 6) is an active rather than passive finder of investors.” S.E.C. v. Martino, 255 F. Supp. 2d 268, 283 (S.D.N.Y. 2003) (internal quotation marks omitted).

At ¶ 21.

Federal law does not frame this list of factors as exhaustive, S.E.C. v. Benger, 697 F. Supp. 2d 932, 945 (N.D. Ill. 2010), or flag any one consideration as universally dispositive. But two factors are widely considered to be most strongly indicative of broker status. Kramer, 778 F. Supp. 2d at 1334.

At ¶ 22.

First,”[t]ransaction-based compensation,” i.e., payment on commission, is “one of the hallmarks of being a broker-dealer.” . . .

At ¶ 23.

Second, involvement “at key points in the chain [of] distribution” is a key indicator of broker activity. . . .  Thus, a person who participates in advertising for clients, and receives and possesses client funds and securities, is thought to be engaged in “brokerage” conduct under federal law. . . .

At ¶ 24.

We interpret our Utah statute in a manner encompassing similar considerations. . . .

At ¶ 25.

The key statutory terms—defining “broker” as “a person engaged in the business of effecting transactions in securities,” UTAH CODE § 61-1-13(1)(c)(i)—are in line with the above-quoted federal factors. A person who is “engaged” in something is “committed” or “employed, occupied, or busy.” THE AMERICAN HERITAGE DICTIONARY OF THE ENGLISH LANGUAGE 591 (5th ed. 2011). Engagement in a “business,” more-over, connotes active commitment to a regular or customary pursuit of a commercial activity, often for profit. And one who is engaged in the business of “effecting” a securities transaction is one who is involved in “bring[ing it] about; mak[ing it] happen, caus[ing] or accomplish[ing it].” Id. at 569.

At ¶ 26.

All of these words inform the meaning of the operative term “broker,” in a manner in line with the factors identified in the federal caselaw. . . .

At ¶ 27.

Thus, we interpret “broker” under Utah Code section 61-1-3 to incorporate the essential considerations set forth in federal law: A “broker” is one who is actively committed to or employed in the regular pursuit of bringing about a securities transaction, as evidenced by transaction-based compensation, the sale of securities of other issuers, involvement in negotiations between issuer and investor, advice or valuation of the merits of an investment, and active pursuit of investors.

At ¶ 28.

Under this standard, Legacy easily qualifies as a broker on the basis of the undisputed facts in the record. It is undisputed that Legacy (1) accepted transaction-based compensation; (2) pro-vided opinions regarding the merits of the project, calling it “a very low-risk deal with huge upside potential”; (3) actively recruited investors by emailing them marketing materials and/or traveling to meet with them; (4) participated in refining marketing materials; (5) answered investor questions about the project (including questions about geographical information related to the project); (6) offered to accompany investors to Liberty‘s offices to look at seismic data; (7) occasionally accepted payment and other documents from investors for eventual delivery to Liberty; and (8) remained the primary contact for the projects for some investors, even after they had invested. See supra ¶¶ 6–9.

At ¶ 29.

Legacy suggests that only the first two items11 weigh in favor of broker status and that the facts in this case, as presented, “are insufficient to establish that a person acted as a broker (or a broker-dealer) as a matter of law.” We disagree with both assertions.

At ¶ 30.

All of the activities listed above—and not just the first two—illustrate that Legacy was involved in the securities transactions at issue “at key points in the chain of distribution.” . . . Legacy‘s interaction with investors ranged from initial contact straight through to document execution and ultimate payment. Legacy did more than “merely act[] as a finder in bringing together the parties to transactions involving the purchase and sale of securities.” Cornhusker, 2006 WL 2620985, at *6 (internal quotation marks omitted). In its meetings and correspondence with potential investors, Legacy sought to influence investors‘ decisions, both directly, by offering opinion, marketing material, and other information, and indirectly, by providing input and feedback on CULA marketing materials. In this way, Legacy did not simply introduce investors to Liberty‘s marketing agent who in turn lobbied for an investment; it functioned, at least in a limited way, as Liberty‘s marketing agent. . . . It also functioned as the go-between for Liberty and potential investors by procuring answers from Liberty to specific questions posed by investors, accepting documents and checks from investors for delivery to Liberty, and acting as the primary contact person with investors about CULA even after they invested. See supra ¶¶ 6–7.

At ¶ 31.

Legacy‘s efforts were geared toward effecting an investment, not just initiating a business contact. It was, after all, only after an actual investment was made that Legacy received a com-mission, the mark of a salesman with a personal stake in the out-come. Together, all of these actions are sufficient to sustain the district court‘s conclusion that Legacy acted as a broker.

At ¶ 32.

Equitable Considerations

In Legacy‘s view, both state and federal law allow courts to consider “additional and equitable factors”—specifically, waiver, estoppel, and in pari delicto-type defenses—before they invalidate a contract based on violations of the securities laws. We disagree. Whether or not such an inquiry is permissible under federal law (a question we need not and do not reach), our state statute leaves no room for the equitable inquiry advanced by Legacy.

At ¶ 37.

The governing Utah statute unequivocally prohibits an un-licensed broker from enforcing a contract performed in violation of our securities laws. See UTAH CODE § 61-1-22(8) (“A person who has . . . engaged in the performance of any contract in violation of this chapter . . . may not base a suit on the contract.”). The broad, categorical terms of this provision leave no room for “equitable considerations” preventing Liberty from invoking its protections.

At ¶ 38.

Granted, the “ordinary circumstance[]” for foreclosing the enforceability of a contract under Utah Code section 61-1-22(8) involves “a violator of the securities laws on the one hand and an ‘innocent party‘ on the other.” Infra ¶ 63. But we find no basis in our statute for limiting the terms of this section to that ordinary circumstance. The statutory bar on enforcement is unconditional and categorical. Without exception, this provision renders any “person” engaged in the performance of “any contract in violation of this chapter” unable to “base a suit on the contract.” UTAH CODE § 61-1-22(8). And when the code proceeds to specify defenses, it fails to include any reference to estoppel, waiver, or in pari delicto. See id. § 61-1-22(3), (4), (7)(a). The closest our securities law comes to addressing these principles is in the waiver provision in section 61-1-22(9). And, as noted, that provision rejects the notion of an implied waiver by expressly foreclosing an express one.

At ¶ 43.

That conclusion is not altered by Utah Code section 61-1-22(10). That provision clarifies that the rights and remedies pre-scribed by statute “are in addition to any other rights or remedies that may exist at law or in equity.” (Emphasis added). But that says only that our statute does not preempt additional common law rights and remedies. The equitable defenses identified by Legacy are not additional rights or remedies; they are defenses foreclosed by the express terms of the code.

At ¶ 45.

Thus, Legacy has presented no persuasive ground for its continued enforcement of the AA. Because Legacy acted as an unlicensed broker when it performed its duties under the AA, that contract was performed in violation of state securities laws and Legacy is barred from enforcing it.

At ¶ 47.

Enforceability of the NDA

Legacy asserts that the same cannot be said of the NDA. It claims that nothing about the NDA or Legacy‘s performance of it violated securities laws. We agree.

At ¶ 48.

Under the NDA, the parties agreed “not to circumvent, avoid, bypass, or obviate the other party directly or indirectly to avoid payment of fees in any transaction pending, or in the future.” They also agreed to “keep totally confidential any and all information that is disclosed by the other party and not [to] disclose to any other person or entity any such information.” Neither of those obligations, on their face, run afoul of the securities laws. And nothing in Legacy‘s performance implicated securities violations either, as neither maintaining confidentiality nor refraining from circumventing payment of fees is an activity that made Legacy look more like a broker. See supra ¶¶ 22–25 (listing factors that are indicative of broker status). The NDA and the obligations im-posed therein certainly facilitated the parties‘ relationship, but they did not contribute to Legacy‘s broker status.

At ¶ 49.

Liberty insists that Legacy “acted as a broker regardless of the contract under which it now seeks compensation,” and that it “seeks compensation for those illegal services pursuant to an un-enforceable contract, whether that compensation is pursuant to the AA, the NDA, or a combination of both agreements.” But Legacy‘s acts as an unlicensed broker under one contract cannot render every other contract it enters into unenforceable. The question is whether the NDA was “made” or performed in violation of the securities laws, UTAH CODE § 61-1-22(8), not whether that contract is related to others that were. And the NDA implicates no securities violations. It in no way calls for brokering activity, so it cannot be seen as a component of the unlawful brokerage relationship between Legacy and Liberty through Legacy‘s performance of the AA.

At ¶ 50.

Liberty also challenges the NDA‘s legality on the ground that it is really just a part of the AA—a contract we find unenforceable. See supra ¶ 17. We are unpersuaded. The AA and the NDA are separate agreements supported by separate consideration. And because the NDA was neither made nor performed in violation of the securities laws, there is no statutory basis for deeming it unenforceable.

At ¶ 51.

We thus reverse the district court‘s determination that the NDA is unenforceable under Utah Code section 61-1-22(8).

At ¶ 52.

With that breach of contract claim still in play, the district court‘s ground for dismissing Legacy‘s trade secret claim vanishes. The district court determined that because the AA and the NDA are unenforceable, there was no basis for protecting Legacy‘s contacts as a trade secret under the Uniform Trade Secrets Act. See UTAH CODE § 13-24-2(4) (defining ―trade secret‖). That premise no longer holds. Because we agree with the district court‘s assessment that “whether the contacts supplied by Legacy to Liberty constitute a trade secret raises issues of material fact,” summary judgment is not appropriate on Legacy‘s trade secret claim. We accordingly reverse on this point, reinstating the trade secret claim.

At ¶ 57.

Finally, we address Legacy‘s claim that the district court erred in failing to consider and rule on its request for a continuance and additional discovery. We hold that any such error in this regard was harmless. . . .

At ¶ 58.

Justice Durham, Concurring,

I concur in the majority opinion except for the analysis in section II.B.1, but I nevertheless concur in the result.

At ¶ 62.

I am unpersuaded by the majority‘s assertion that Liberty‘s mere status as an issuer automatically qualifies it for membership in the class of persons the securities statute was designed to protect. I think this is a fact-dependent inquiry, not merely a structural one. I see no indication in the statute as a whole or any of its provisions that it was de-signed or intended to protect parties who themselves were engaged in violations and/or were responsible for securing or facilitating the violations they subsequently pose as a bar to liability.

At ¶ 64.

The majority rejects the possibility that common law equitable considerations might have any relevance to our construction of the statute. I find this position incompatible with the statutory language itself, which in Utah Code section 61-1-22(10) provides that “[t]he rights and remedies provided by this chapter are in addition to any other rights or remedies that may exist at law or in equity.” We are thus construing a statute that explicitly references equity and the common law. This is even more reason to follow “virtually all other [federal] courts” that have held that equitable considerations should be taken into account before deter-mining a contract is unenforceable under a similar unenforceability provision in the federal securities act. . . .

At ¶ 65.

Notwithstanding my disagreement with the majority‘s interpretation of the statute, I concur in the result of its opinion on the contract claim. The opinion does not reach the question of whether the agency agreement covered all future oil and gas projects (as Legacy contends) or whether it was limited to the first two CULA projects (as Liberty contends). Having examined the agreement, I conclude that it clearly references the CULA projects and is limited to them. Therefore, even assuming that there may be facts supporting Legacy‘s equitable claims, no recovery would be available under its terms.

At ¶ 66.