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HEESE v. DEMATTEIS DEV. CORP.

July 15, 1976

William HEESE et al., Plaintiffs,
v.
DeMATTEIS DEVELOPMENT CORP. et al., Defendants



The opinion of the court was delivered by: PIERCE

PIERCE, District Judge.

 This is a civil action brought by the plaintiffs on behalf of a class of all of the original residents of a middle-income cooperative housing development consisting of one 20-story apartment house comprised of 351 apartment units. The apartment house, known as Scott Tower [hereinafter, the project], is located in the Borough of the Bronx in the City and State of New York. The complaint alleges that the project was financed, and built pursuant to the provisions of Article II of the New York State Private Housing Finance Law ("Limited-Profit Housing Companies Law", popularly known as the "Mitchell-Lama Act").

 Plaintiffs' complaint states seven causes of action against some or all of the defendant *fn1" arising out of the sale to the plaintiffs of shares in Scott Tower Housing Company (Scott Tower), the corporation which owns and operates the cooperative housing project. The jurisdiction of this Court is said to be based on the securities laws of the United States with respect to the first cause of action which charges the defendants with making numerous misrepresentations and omissions in the Information Bulletin by means of which the shares were sold, and on the Civil Rights Act, 42 U.S.C. §§ 1983 and 1988 and 28 U.S.C. § 1343, with respect to the fourth cause of action, which charges the defendants with having deprived the plaintiffs of rights and privileges secured to the plaintiffs by the Constitution and laws of the United States. The remaining causes of action assert claims on behalf of the class and derivative claims on behalf of Scott Tower based on New York State common and statutory law.

 The factual allegations of the plaintiffs' complaint are as follows:

 The plaintiffs in this action are resident shareholders of the project and were subscribers, together with all members of the class, of 94,250 shares on non-voting common stock of Scott Tower. The defendant DeMatteis Development Corp. (DeMatteis) sponsored the project which was to be owned by Scott Tower Housing Co. and constructed by the defendant Leon DeMatteis & Sons, Inc. (DeMatteis & Sons). The defendant Apartment Development and Management, Inc. (A.D.A.M.) was organized to sell the common stock of Scott Tower. The individual defendants were officers or directors of the various corporate defendants and the defendant Housing and Development Administration of the City of New York (HDA) *fn2" was, for the purposes of the Mitchell-Lama Act, the supervising agency of the Scott Tower cooperative development. As such it was charged with overseeing the construction, sale and management of the project. In performance of these functions the HDA is said to have approved the sponsorship application of DeMatteis, the construction contract entered into between DeMatteis & Sons and Scott Tower to build the housing development, and the sales agency agreement between A.D.A.M. and Scott Tower by which A.D.A.M. would market the shares in Scott Tower.

 Beginning prior to May 1965, the defendants published and circulated an Information Bulletin designed to induce the public to subscribe to the shares of Scott Tower. The Information Bulletin stated that the total estimated project cost of the development was $8,042,500; that $942,500 of this amount was to be provided by resident stockholder-subscribers through the purchase of stock; and that the balance was to be financed by a mortgage loan from the City of New York in the amount of $7,100,000, or in any lesser amount not in excess of 90% of the actual final project cost, whichever was less, and which mortgage loan was to be self-liquidating over a period of fifty years. The Information Bulletin also stated, inter alia, that the risk of completing the construction of the project within a stated lump-sum price was on the contractor, DeMatteis & Sons, and that any savings would accrue solely to Scott Tower.

 The complaint alleges that in reliance on the statements in the Information Bulletin, the plaintiffs subscribed to and paid for shares of the common stock of Scott Tower. However, it is alleged, the defendants' statements in the Information Bulletin were false in that, among other things, the defendants never intended that the risk of completing the construction within the lump-sum price would fall solely on DeMatteis & Sons or that savings in construction costs would accrue solely to Scott Tower. Further, the complaint charges, savings of over $1,000,000 were realized as a result of unauthorized deviation from the specifications and plans, and these savings accrued to the defendants alone. It is alleged, that by allowing the savings in construction costs to accrue to DeMatteis & Sons rather than to Scott Tower, the defendants caused construction costs to be accrued by Scott Tower, and transferred the risk of completing the construction within the projected lump-sum price to Scott Tower, all without notice to the then existing and prospective resident-stockholders of Scott Tower. It is alleged that the plaintiffs and all persons similarly situated have been damaged as a result of the foregoing in that, inter alia, they have paid and will be obliged to pay carrying charges greatly in excess of those which were represented in the Information Bulletin.

 This action is now before the Court for consideration of the defendants' motions to dismiss the complaint. Specifically, the defendants have argued that the plaintiffs' claims under the federal securities laws must be dismissed because the shares of stock in question are not securities within the meaning of those laws; that the plaintiffs' civil rights claims must be dismissed either because they are not well-pleaded or because they have failed to state a claim; and that the plaintiffs' pendent claims must be dismissed under the authority of United Mine Workers v. Gibbs, 383 U.S. 715, 86 S. Ct. 1130, 16 L. Ed. 2d 218 (1966). The defendant HDA has asserted the additional defense that it is not a "person" within the meaning of 42 U.S.C. § 1983 and therefore cannot be sued under that statute. These claims will be considered in turn.

 Securities Act Claims. The threshold question with respect to the plaintiffs' securities law claims is whether this case is controlled by the Supreme Court's decision in United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 95 S. Ct. 2051, 44 L. Ed. 2d 621 (1975) and by the subsequent decision of the United States Court of Appeals for the Second Circuit in Grenader v. Spitz, 537 F.2d 612 (2d Cir. 1976). For the reasons which follow, the Court concludes that these cases are controlling and that the plaintiffs' federal securities law claims must be dismissed.

 In Forman, the Supreme Court held that transactions in which the purchaser of shares in a state-subsidized and supervised non-profit housing cooperative acquired the right to lease an apartment in the cooperative were not purchases of securities within the contemplation of the federal securities laws. The Court held that the shares themselves were not "securities" as defined by those statutes, specifically rejecting the socalled "literal approach" which would have them classified as securities simply because they were described as "stock" in the offering statement. The Court also rejected the contention that the shares were "investment contracts" holding that, despite the existence of certain potential sources of income which might have inured to the benefit of the shareholders, the economic realities of the transactions in question were such that the test for what constitutes an investment contract, as set forth in SEC v. W. J. Howey Co., 328 U.S. 293, 66 S. Ct. 1100, 90 L. Ed. 1244 (1946), had not been met. The Court stated that:

 
"There is no doubt that purchasers in this housing cooperative sought to obtain a decent home at an attractive price. But that type of economic interest characterizes every form of commercial dealing. What distinguishes a security transaction -- and what is absent here -- is an investment where one parts with his money in the hope of receiving profits from the efforts of others, and not where he purchases a commodity for personal consumption or living quarters for personal use." United Housing Foundation, Inc. v. Forman, supra, 421 U.S. at 858, 95 S. Ct. at 2063.

 In attempting to distinguish Forman from the instant case, the plaintiffs have argued that Forman was not a broad decision applying to all shares of stock in cooperative housing projects, but rather, was a narrow ruling which should be limited to the facts of that case. Such a view cannot be sustained in this Circuit after the decision in Grenader v. Spitz, supra. There, the Second Circuit declined to read Forman narrowly and held that a sale of stock in a privately-owned and operated New York City apartment house cooperative was not a sale of a security within the meaning of the federal securities laws. Following the reasoning of the Forman decision, the Court stated that the reality of the transaction in question was that "The tenants were seeking a place to live and whether their residence be in a publicly or privately financed cooperative residence has no legal significance . . .." At 617.

 Whatever merit might have attached to the plaintiffs' arguments that Forman should not control here because the developer in this case was seeking a profit from the enterprise and that the "risk-capital" theory of the California Supreme Court *fn3" should be applied in this case because of the lack of public guarantees to support the purchasers' investment, these arguments cannot survive the Second Circuit's extension of Forman to a private cooperative development, unsupported by state funds. Likewise, with respect to the potential sources of income from project-related stores and services, there are no allegations here that any Scott Tower resident was induced to purchase shares because he hoped to receive profits from these sources. See Grenader v. Spitz, supra at 617. Rather, it appears that here, as in Grenader, the tenants were seeking primarily a place to live. As for the plaintiffs' contention that their claim differs from that in Forman because they are claiming not only that they have been forced to pay higher carrying charges, but also that they have been deprived of the actual equity in which they invested -- that is, housing in suitable condition -- this contention may distinguish the type of injury claimed here from that in Forman but it does not distinguish the nature of the underlying transaction.

 The Court concludes, for the reasons stated, that to the extent that the plaintiffs' claims here rely on the federal securities laws, those claims are controlled by Forman and Grenader. ...


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