429 F.

2d 348

Fed. Sec. L. Rep. P 92,625

M. P. GILBERT, M. J. Lebsack, and A. R. Lebsack and M. J.
Lebsack, a partnership d/b/a Lebsack Development
Company, Appellants,
v.
Richard P. NIXON, a/k/a R. P. NIXON, Appellee.
No. 68-68.

United States Court of Appeals, Tenth Circuit.

April 3, 1970, As Amended on Denial of Rehearing June 10, 1970.

Gerald Sawatzky, Wichita, Kan., for appellants.

Marvin E. Thompson, Russell, Kan., for appellee.
Before HILL, Circuit Judge, FAHY,* Senior Circuit Judge and
HOLLOWAY, Circuit Judge.
FAHY, Senior Circuit Judge.

In a suit filed in the United States District Court for the District of Kansas,
plaintiffs, now appellants, sought to recover from appellee, defendant in the
District Court, damages including some $190,000.00, alleged to be amounts
invested by them in the purchase from appellee of fractional interests in thirteen
oil and gas leases. Appellants base their claim on alleged violations by appellee
of the federal and Kansas securities statutes. After a lengthy trial without a jury
the court entered Findings of Fact and Conclusions of Law upon the basis of
which judgment was rendered for appellee in the main case. Appellants,
however, received a judgment in the sum of $5,657.11, representing their share
of certain discounts and oil payments for which appellee had not accounted. We
affirm that judgment for appellants. As to the judgment for appellee we affirm
in part, remand in part, and reverse in part, as to be explained.

Appellant M. J. Lebsack1 is a graduate petroleum engineer with offices in

Denver, Colorado, experienced in the purchase and sale of fractional working

interests in oil and gas properties in the mid-continent fields. His principal
activity since 1956 has been the supervision of the oil and gas investments of
appellants M. P. Gilbert and her husband, B. D. Gilbert, the manager of her
investments. Both Gilberts were residents of Connecticut. Appellee R. P. Nixon
is a graduate petroleum geologist generally engaged as a consulting geologist
and in drilling and operating wells on oil and gas leases in the mid-continent
fields. The transactions from which this suit arose began in May, 1960, but the
parties had been associated in similar ventures commencing in 1957. From
May, 1960, through February, 1963, the Gilberts, acting for purposes of this
decision through their agent Lebsack,2 purchased from appellee Nixon
fractional interests in sixteen oil and gas leases located in four Kansas Counties.
Thirteen of these fractional interests are the subject of this suit.
3

Nixon would acquire an oil and gas lease from a landowner. He would then
submit a proposal to Lebsack for the purchase by appellants of a fractional
working interest in the lease. Accompanying the proposal would be a
geological map derived from a base map of the area and upon prior drilling
activity as evidenced by available well completion cards. The geological map
represented Nixon's opinion of the sub-surface contours of the geological
formations giving a significant indication of possible productivity at the
proposed site. Nixon would also transmit to Lebsack production information on
nearby wells, his drilling plans, and his geological opinion as to the likelihood
of encountering oil. Lebsack would evaluate the proposal from the data
submitted by Nixon and, at times, from other available information. He then
sketched his own geological map and submitted this to the Gilberts along with
his evaluation of the Nixon proposal. They then advised Lebsack of their desire
to participate, and to what extent, and Lebsack would execute a letter agreement
in a form furnished by Nixon.3

The drilling, equipping and operating of the leases were supervised by Nixon.
Appellants were kept advised by Lebsack primarily on the basis of
communications between Nixon and Lebsack. Nixon billed Lebsack for
appellants' proportionate share of the drilling costs upon completion of the
drilling. If Nixon determined from drilling tests to install production equipment
the Gilberts were billed through Lebsack on a monthly basis for their fractional
share of operating costs. Fractional payments for oil produced were received by
appellants directly from the purchasing company.

Production casing was set and some production obtained or attempted from
wells on leases known as Bowlby, Ewing 'B', Ginther, Driscoll, Herber, and
Pendergast, all of which fractional interests were purchased by the Gilberts
under procedure conforming generally with that above outlined. The Driscoll,

Herber and Pendergast interests were soon abandoned as non-commercial. The

Bowlby, Ewing 'B' and Ginther leases, marginal producers, were sold at
appellants' loss. Purchases were also made by the Gilberts from appellee Nixon
of fractional interests in leases known as Steinert, Ewing 'A', Hlad, Brungardt
'C', Teeters, Snapp and Vogel. Wells on all these last named leases were
plugged and abandoned as dry holes.
6

Appellants' suit, filed in June, 1964, alleged violations of the Federal4 and
State5 Securities Acts and common law fraud,6 with respect to the interest
purchased by them in the thirteen oil and gas leases mentioned. The damages
claimed are roughly the amounts invested by appellants with appellee in
connection with the interests they purchased.7

The District Court held, in part, as follows: (1) the fractional interests were
'securities' within the meaning of 15 U.S.C. 77b(1);8 (2) offers or sales of
fractional interests in oil and gas leases to persons such as appellants,
knowledgable and experienced in such transactions, with whom the offeror had
a long standing association in other leases were 'transactions by an issuer not
involving any public offering,' 15 U.S.C. 77d(2), and thus were exempt from
the civil liability provisions of 15 U.S.C. 77l(1);9 (3) there is no need under 15
U.S.C. 77l(2) or K.S.A. 17-1268(a) for the seller of a fractional interest to state
every fact which, if known to the prospective purchaser, might tend to
influence his decision; (4) in cases where untrue statements were made or
where there were omissions to state facts, the statements or omissions were 'not
material, and also * * * defendant has sustained his burden of proof that he did
not know, and in the exercise of reasonable care could not have known, of such
untruth or omission.' Defining materiality the court stated (5):

Whether representations or omissions of fact are material depends upon the

subject matter of the transaction and the relationship and knowledge of the
parties. Such representations or omissions are material when it relates to some
matter which is so substantial and important as to influence the party to whom it
is made and if the transaction would not have occurred in their absence; but
conversely, the representation or omission is immaterial if the transaction
would have occurred in the absence of such representations or omissions, or if
the representations or omissions causes no injury, or if they were mere
expressions of opinion.

The court also ruled that (6) any action plaintiffs may have remaining against
defendant, or conversely, would be an action for accounting and/or breach of
contract. Other findings and holdings of the court, to the extent deemed
necessary, are considered in relation to the subject to which directed in the

course of this opinion.

10

We agree with the District Court that the fractional interests in this suit were
securities within the meaning of 15 U.S.C. 77b(1) of the 1933 Act (as well as
15 U.S.C. 78c(10) of the 1934 Act and K.S.A. 17-1252(j)). Woodward v.
Wright, 266 F.2d 108 (10th Cir. 1959). We also agree with the District Court
that the fractional interests were 'transactions by an issuer not involving any
public offering,' see, 15 U.S.C. 77d(2), Woodward v. Wright, supra; Garfield v.
Strain, 320 F.2d 116 (10th Cir. 1963), and SEC v. Ralston Purina Co., 346 U.S.
119, 73 S.Ct. 981, 97 L.Ed. 1494 (1953), from which it follows that they were
exempt from the registration requirements of 15 U.S.C. 77e. Consequently,
there is no liability under the provisions of 15 U.S.C. 77l(1).

11

The statutory foundation upon which appellants rest their case is built primarily
upon Section 10(b), 15 U.S.C. 78j(b)10 of the Exchange Act of 1934 and Rule
10b-5, 17 C.F.R. 240.10B-5, issued thereunder, which provides in clause (2) as
follows:

12

It shall be unlawful for any person * * * (2) to make any untrue statement of a
material fact or to omit to state a material fact necessary in order to make the
statements made, in the light of the circumstances under which they were made,
not misleading * * * in connection with the purchase or sale of any security.

13

While appellants in their brief on appeal consider liability under Rule 10b-5 to
be 'most appropriate' they also pursue remedies under, and the trial court
appears to have based its decision upon, claimed violations of Section 12(2) of
the Securities Act of 1933, 15 U.S.C. 77l(2), which is comparable to Section
17-1268 of the Kansas Securities Act. Section 12(2) provides that a purchaser
may recover the consideration paid for a security, less the amount of any
income received therefrom, or damages if he no longer owns the security, if the
seller offers a prospectus which includes:

14

an untrue statement of a material fact or omits to state a material fact necessary

in order to make the statements, in the light of the circumstances under which
they were made, not misleading (the purchaser not knowing of such untruth or
omission), and who shall not sustain the burden of proof that he did not know,
and in the exercise of reasonable care could not have known, of such untruth or
omission.

15

We now consider whether the trial court, in denying recovery by appellants,

applied to the evidence the correct legal principles. We recognize that

purchasers of securities have an implied private action for damages under Rule
10b-511 in addition to a remedy under Section 12(2) and that the two provisions,
as interpreted, are not altogether consistent with each other.12 Had appellants
invoked Section 12(2) alone our task in formulating the proper legal standards
for recovery would have been simplified. We note, however, that a private
action under Rule 10b-5 originated in the need for a sellers remedy where none
had otherwise been provided.13 Once a remedy was implied for the seller, it
was extended to include the buyer even though relief was already available to
him under Section 12(2). Since in this case recovery is sought under both
provisions, we resolve any conflict between them in favor of Section 12(2),
where the statutory remedy is explicit.14
16

With the foregoing considerations in mind, we turn first to the requirement that
the alleged misrepresentations or omissions must be material. No conflict arises
in the definition of this term. In the leading case of List v. Fashion Park, Inc.,
340 F.2d 457, 462 (2d Cir.), cert. denied sub nom. List v. Lerner, 382 U.S. 811,
86 S.Ct. 23, 15 L.Ed.2d 60 (1965), the basic test of materiality under Section
10(b) and Rule 10b-5 is stated to be:

17

whether 'a reasonable man would attach importance (to the fact misrepresented)
in determining his choice of action in the transaction in question.' Restatement,
Torts, 538(2)(a).15 Rogen v. Ilikon Corp., 361 F.2d 260, 266 (1st Cir. 1966),
adopts the same definition but in terms of facts not disclosed. Likewise in
Kardon v. Nat'l Gypsum Co., 73 F.Supp. 798, 800 (E.D.Pa.1947), materiality is
said to be that 'which would materially affect the judgment of the other party to
the transaction,' and in SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 849 (2d
Cir. 1968), cert. denied sub nom., Coates & Kline v. SEC, 394 U.S. 976, 89
S.Ct. 1454, 22 L.Ed.2d 756 (1969), it was said that a material fact 'encompasses
any fact '* * * which in reasonable and objective contemplation might affect the
value of the corporation's stock or securities," quoting from Kohler v. Kohler
Co., 319 F.2d 634, 642 (7th Cir. 1963), and List v. Fashion Park, Inc., supra,
340 F.2d at 462. Materiality is similarly defined under Section 12(2), see
DeMarco v. Edens, 390 F.2d 836, 840 (2d Cir. 1968), and Johns Hopkins
University v. Hutton, 297 F.Supp. 1165, 1218 (D.Md.1968), where the test is
stated as 'matters as to which an average prudent investor ought reasonably to
be informed * * *.'

18

From the above we conclude that in the present case an omission or

misrepresentation of fact was material if, considering its full context, including
the subject matter and the relationship of the parties, the misrepresentation or
omission was of a fact which, considering appellants as reasonable or prudent
investors, would affect or influence them in determining whether to buy the

fractional interests.
19

The misrepresentation or omission must be misleading. This may appear from

its nature considered alone, or because it is not explained in a way to obviate its
otherwise misleading character.

20

The terms of Section 12(2) provide that knowledge of the truth on the part of
the person addressed also relieves the misrepresentation or omission of
materiality it otherwise might have had; and the buyer-plaintiff has the burden
of proving his excusable ignorance. Woodward v. Wright,supra, 266 F.2d at
116. On the other hand, the purchaser does not have to prove that he could not
have discovered the falsity upon reasonable investigation. Murphy v. Cady, 30
F.Supp. 466, 469 (D.Me.1939), aff'd sub nom. Cady v. Murphy, 113 F.2d 988
(1st Cir.), cert. denied, 311 U.S. 705, 61 S.Ct. 175, 85 L.Ed. 458 (1940); Dale
v. Rosenfeld, 229 F.2d 855, 858 (2d Cir. 1956); Johns Hopkins University v.
Hutton, supra, 297 F.Supp. at 1221.

21

Morever, reliance upon a material misrepresentation or omission is not a

condition for recovery under Section 12(2), Woodward v. Wright,supra, 266
F.2d at 116; DeMarco v. Edens, supra, 390 F.2d at 841; Johns Hopkins
University v. Hutton, supra, 297 F.Supp. at 1222. While the purchaser has been
required to prove his reliance in an action under 10b-5 by some courts, 16 we do
not place the burden on appellants in this case as we have decided that in such
circumstances the rules of Section 12(2) should prevail. We held in Woodward
v. Wright, supra, 266 F.2d at 116, that 'to say that purchaser reliance is a
prerequisite to seller liability is to import something into the statute which is
not there.' We do not think the result should be otherwise because appellants
sought recovery under 10b-5 as well as Section 12(2).

22

One is not to be held liable, however, because of his misleading

misrepresentation or omission of material fact, the truth of the matter being
unknown known to the purchaser, if the party responsible for the
misrepresentation or omission sustains the burden of proving that he did not
know, and in the exercise of reasonable care could not have known that it was a
misrepresentation or omission. Once again, as in the case of reliance, the
seller's burden of proving lack of scienter, made necessary by the specific
provisions of Section 12(2), see, Woodward v. Wright, supra, 266 F.2d at 116;
Wilko v. Swan, 346 U.S. 427, 431, 74 S.Ct. 182, 98 L.Ed. 168 (1953), should
not be affected in this case by different requirements in this regard under 10b5.17

23

The above we consider to be the basic standards to be applied in this case in

23

The above we consider to be the basic standards to be applied in this case in

determining injury and the consequent right to recover. It is seen that recovery
does not depend, as the trial court held, upon proof that 'the transaction would
not have occurred' absent the representation or omission or, conversely, 'would
have occurred' in its absence. We think this sine qua non is more favorable to
appellee than the law permits.18 However, the failure of the trial court to follow
the standard of materiality and related matters which we have described does
not necessarily require a remand with respect to all transactions involved, as we
shall see when we come to discuss separately those which require separate
treatment.

24

Before discussing the transactions requiring separate treatment we consider one

contention of appellants which applies to all thirteen fractionalinterest
transactions. The contention is that Nixon represented that all moneys invested
by appellants would be used for operations on the lease interests without
additional compensation to Nixon, that is, that billings would be at cost and all
discounts would be 'passed on.' Appellants contend, however, that Nixon as a
practice retained out of moneys invested by appellants substantial discounts,
ranging from 15% To 25%, granted by some of his suppliers, and that on some
of the leases he used old equipment for which he billed appellants at excessive
rates. These and other similar misrepresentations, it is claimed, materially
affected the entire course of dealings between the parties and in themselves
justify the return of the consideration paid by appellants for all thirteen lease
interests.

25

It is undeniable that the earlier of the 'letter contracts' included a provision that
appellants would be charged their proportionate part of 'any and all drilling
costs to the point of running production casing' and that the earlier billing
invoices sent by Nixon to Lebsack included a notation that all allowable
discounts would be 'passed on.' It is also true, as appellee confessed, followed
by a tender of restitution, that, though he did pass on to appellants the greater
part of the ordinary trade discounts, others growing out of special relationships
were not passed on. He has undertaken without contest in the litigation to
reimburse appellants for their proportionate share of the discounts of both
categories which were not passed on, though some disagreement appears as to
the amounts.19

26

The trial court, as we have said, entered judgment in favor of appellants in the
sum of $5,657.11 representing Nixon's confession of judgment as to the
withheld discounts,20 but declined to grant further relief, explaining in its
Memorandum Opinion:

27

Because of the partnership relationship between these parties the defendant is

27

Because of the partnership relationship between these parties the defendant is

required to pass on the discounts to his mining partners and has frankly done so
in his motion in confession of judgment.

28

It is the Court's opinion that the failure to pass on such discounts does not
constitute a representation as of the date of the letter agreements of a past or
existing fact. None of these discounts were, in the Court's opinion, material to
the plaintiffs' entering or accepting participation in any of the leasehold
projects.

29

The court did not reach the issue of the materiality of the excessive billings for
equipment as it determined that charges by appellee were at cost and fair
market value.

30

We agree with the court that Nixon's failure to pass on discounts did not
constitute a misrepresentation of a material fact warranting recovery of the total
amounts paid in connection with the thirteen leases, and hold the same to be
true with respect to the excessive billings. To hold otherwise would be in
substance to penalize appellee for wrongful conduct which was not
significantly related to the basis on which the transactions were consummated,
as Lebsack himself testified. Nor do we think Stevens v. Vowell, 343 F.2d 374
(10th Cir. 1965), relied upon by appellants, requires a different result, as that
case dealt with a quite different factual situation.

31

We do not find it necessary, however, in agreeing with the court on this portion
of the case to agree also with its characterization of the relationship of the
parties as joint venturers or mining partners. Whatever the source of Nixon's
obligation to return secret discounts he has confessed the judgment which has
been granted to appellants and there is no claim on appeal that the court erred
in doing so. Nor are we able to sustain the court's finding that appellants were
charged at fair market price for drilling equipment in light of the evidence in
the record of inflated and excessive billings far above market value. Thus our
decision favorable to appellee based on the Securities Act is without prejudice
to any claim appellants might assert for excessive charges.

32

Appellants acknowledge that aside from discounts and excessive billings, with
an exception to be stated, the evidence supports the court's findings favorable to
appellee with respect to the fractional interests known as Bowlby, Snapp, Hlad,
Vogel, Brungardt 'C', and Steinert. The exception is that the purchases of these
interests were influenced by misleading statements not directly concerning them
but by reports of the results of the Pendergast, Ewing 'B', Herber, Driscoll, and
Ginther leases. We shall separately consider these leases, and, also, Ewing 'A'

and Teeters, but dispose now of this exception to appellants' concession

regarding the six interests referred to. We conclude that appellants must
establish more than a general atmosphere of favorable but misleading reports in
order to recover their consideration for leases individually submitted on the
basis of data directly relating to them when there is found to be no direct
geological connection between the leases subject to false reports and those for
which recovery is sought. Such vague generalities do not amount to a showing
of materiality as we have defined the term. We thus affirm the trial court's
findings as to the fractional interests referred to as Bowlby, Snapp, Hlad, Vogel,
Brungardt 'C' and Steinert. This leaves for consideration those now to be
separately discussed.
33

Pendergast Lease-- NE/4 Section 27-19-15 Barton County, Kansas

34

The principal problem about this lease, which produced some oil but was
plugged in October, 1961, centers on the erroneous location of a dry hole on
the plat submitted by appellee, placing it one-half mile east of its actual
location. Appellants claim that if properly located on the plat it would have
required a substantial change in the location and depth of appellee's structural
subsea contour lines as drawn on a map sent to Lebsack, and would have
indicated that the proposed drill site was unfavorable. The court, however, on
the basis of all the testimony regarding this error found that his incorrect
location made the proposed site a less likely drilling venture than if the location
of the dry hole had been shown correctly. There was a difference of opinion
about this, with Lebsack in disagreement; but we think the court's conclusion is
not required to be disturbed under the standard of materiality we accept. True it
is that the testimony upon which the court relied conflicted with the opinion
which might have been reached on the basis of Mr. Lebsack's testimony, but on
the whole case, including the trial court's view of the relative merits of the
witnesses' testimony, we do not feel justified in disturbing the court's
conclusion. The evidence was strongly to the effect that the error was not
material. Accordingly we affirm the trial court's finding on this aspect of the
case.

35

Ewing 'A' Lease-- NE/4 Section 35-19-15, Barton County, Kansas

36

Ewing 'B' Lease-- SW/4 Section 36-19-15, Barton County, Kansas

37

Nixon submitted his prospectus for these leases September 12, 1961. In doing
so he represented that he 'recently completed a good Reagan Sand well in the
NW NE SE of Sec. 35' and that 'this well also has four Kansas City zones

behind the pipe.'21 Appellant Lebsack forwarded the material to the Gilbert
appellants September 14, 1961, stating that the foregoing representations were
the reason for recommending these two lease interests. The letter agreements
on the leases were accepted by Lebsack on October 4, 1961. As indicated on
the plat or geological map sent by Nixon to Lebsack, the Regan Sand well
referred to was a direct offset22 to both of the proposed locations on Ewing 'A'
and Ewing 'B.' The Ewing 'A' well never produced and was plugged as a dry
hole. The Ewing 'B' well produced oil, but accompanied by a high percentage
of water. Appellants sold their interest in the lease at a loss in a partition action.
38

The trial court found that the statement regarding the recent completion of a
good Reagan Sand well was true in that the well had an initial state tested
potential of 52.92 barrels of oil a day as of July 13, 1961. Aside from other
questionable representations relating to these leases,23 it appears from
uncontradicted testimony that on September 12, when the Ewing proposals
were submitted for appellants' consideration, production of the Reagan Sand
well had declined to approximately 10 barrels a day and therefore was not a
commercial well at that time.

39

Putting aside the issue of reliance, which in any event is supported by the
record, we hold that the misrepresentations were material under the standard we
have determined to be proper in this case. The record leaves no doubt that the
Reagan Sand well representation was used by Nixon as a selling point and
would have been considered as such by a reasonable and prudent investor. As
the representation was misleading at the time it was made, appellants are
entitled to recover their losses on the Ewing 'A' and Ewing 'B' leases. In so
concluding we fail to find support, in relation to these particular lease interests,
for the District Court's general conclusion that in all cases of material
misrepresentations, Nixon sustained his burden of proving lack of knowledge.
Nor is there any evidence that appellants were aware of the untruths or
omissions when the representations were made or when the leases were
purchased. We therefore find it unnecessary to remand this part of the case for
further findings by the District Court.

40

Teeters Lease-- NW/4 Section 1-20-15, Barton County, Kansas

41

In January 1962 Lebsack received a prospectus and a geological map

describing the Teeters lease. The map indicates that the proposed Teeters
drilling site was to be located as a direct southern offset to the Ewing 'B' lease
and within the same general structural formation as the Ewing 'A' well. In his
prospectus Nixon represented that '2 wells in the SE/4 of Sec. 35 have
recovered over 20,000 barrels.' The wells thus referred to include what was

described in relation to the Ewing 'A' and 'B' interests as a 'good Reagan Sand
well.' For this reason appellants claim our disposition of the Teeters lease
should follow that of the Ewing leases. The prospectus also points out that 'the
high well in the SW/4 of Sec. 36 was completed in December, 1961.' The
reference here is to the Ewing 'B' well, which appellants contend was
producing 90% Water at that time. It is said that this information was material
but was not disclosed by Nixon.
42

Lebsack accepted a letter agreement for the Teeters lease on March 22, 1962.
The well was drilled in April, 1962, but later was plugged as a dry hole. The
court found that the appellants knew or should have known as early as January
10, 1962, that the Ewing 'B' well was making salt water and that they received
further information to that effect about February 7 and March 7, 1962. The
court made no findings on the Reagan Sand well, as it had held, when
discussing the Ewing leases, that the well was a good well.

43

In our consideration of Ewing 'A' and Ewing 'B' we held that references to the
Reagan Sand well constituted material misrepresentations for which Nixon
should incur liability without a remand. The relation of this misrepresentation
to the Teeters lease, however, is not so clear as its relation to the Ewing leases.
We accordingly remand for reconsideration by the District Court the question
of possible recovery by appellants using the standards we have set forth in this
opinion, including that governing materiality. On remand the court might well
give consideration to the fact that in October, 1961, the Ewing 'A' well was
found to be dry. This was five months before the Teeters transaction, raising the
question whether the unreliability of the Reagan Sand well representations
might have been known to appellants when the Teeters interest was acquired.

44

We remand also for further findings by the District Court on the issue of salt
water production on Ewing 'B' as it relates to appellants' purchase of Teeters.
Appellants admit that at the time of the Teeters transaction they were aware of
the fact that the Ewing 'B' well was producing salt water, but it is claimed that
it is normal for good commercial wells to produce some salt water. A well that
produces 90% Water, on the other hand, is said by appellants to be a noncommercial well and it is alleged that Nixon should have disclosed this material
fact when he submitted proposals for the offsetting Teeters. A remand is
necessary to determine what information, in addition to that noted by the trial
court, was conveyed to Lebsack by Nixon by way, for example, of production
reports on Ewing 'B' which might have suggested to the appellants that Ewing
'B' was or was not commercial, and whether from all the information disclosed
to Lebsack prior to the Teeters transaction, the appellants should be charged
with knowledge of the high degree of salt water production. In making such a

determination the court should keep in mind that appellants cannot be charged
with the obligation to make independent investigations to verify the accuracy of
Nixon's representations. On the other hand, if the appellants were not led to
believe that the Ewing 'B' lease was commercial but instead were made aware
of salt water production, it is for the court to determine whether or not they had
sufficient knowledge to preclude recovery for material non-disclosures.
45

Herber Lease-- SE/4 Section 19-15-11, Russell County, Kansas

46

Nixon submitted a prospectus and a geological map for this lease in November,
1961, and a letter agreement was accepted by Lebsack in March, 1962. The
lease interest is geologically separated from those discussed previously. In his
map and prospectus Nixon pointed out that there were two producing wells
offsetting the proposed drill site to the southwest with subsea Lansing depths of
-1121 and -1128. It is appellants' position that in order for the Herber lease to
be a favorable purchase it would be necessary for the Lansing structure to
which the well was to be drilled to be similar to or higher than the producing
wells.24 There was a dry hole, which we assume, as appellants claim, was 'the
only structural control point'25 offsetting the proposed Herber site to the north,
and was shown by appellee to have a Lansing depth of -1128. Nixon's map thus
indicated that the Herber well would be drilled between the dry well to the
north and the two producers to the south, and that its Lansing depth would be
structurally higher than both. The fact was that the dry hole to the north had a
Lansing top of -1141 or -1144. The Herber well, when drilled, was found to
have a Lansing top of -1139 and was eventually plugged as a nonproducer.

47

Whether there was actional misrepresentation or omission in connection with

appellants' decision to go forward with the purchase of this lease turns upon
whether Nixon should be held responsible for not discovering the correct depth
of the dry hole to the north of the Herber well and whether the misinformation
conveyed was material. The District Court found, with support in the evidence,
that Nixon had a well card from a reporting service which indicated that the
Lansing top was -1128 as he had represented to Lebsack on the map. The court
similarly found that when appellee submitted the proposal his base map of
Russell County showed the 'Lansing-Kansas City at the location of such dry
hole to be -1128, and defendant did not know the same to be -1141.' There is no
specific finding, however, that appellee could not reasonably have ascertained
that his representation about the dry hole was incorrect. We note that there is
evidence in the record that the correct information was known to the company
which drilled the Herber well and that if appellee had checked available sources
he could have discovered the correct top. Nixon testified that he had no reason
to doubt the accuracy of his information and thus did not verify it as he could

have. Despite the trial court's finding that in all instances appellee has sustained
the burden of proof that he did not know and in the exercise of reasonable care
could not have known, of any untruths or omissions, we remand for a specific
finding on this point in light of the foregoing, and if it is determined that Nixon
has not sustained his burden, whether his misrepresentations were material
under the standards we have held to be proper.
48

Driscoll Lease-- NE/4 Section 30-15-11, Russell County, Kansas

49

Nixon sent a prospectus and a map in connection with this lease on June 8,
1962. Reference was made to the Driscoll Pool to the south of the proposed
well together with the comment that 'I believe these wells to be on the edge of
the main structure as you can see from my subsurface plat.' There is no dispute
about these representations. However, the prospectus also stated that the
Driscoll lease is 'directly south of our Warta and Herber leases and appears to
have considerable merit.' Appellants' contention is that Nixon used the Herber
lease as a selling point at the very time he was giving appellants false reports on
the production of that lease. The trial court disagreed. It ruled that the
representations about the drilling results of Herber were true, but in any event,
the Driscoll lease 'was not an offsetting well to the Herber' and this fact made
any representations immaterial.

50

The evidence in the record does not appear to support the court's finding.
Lebsack testified that 'The information that we had on the Herber very
definitely induced me as to whether I would recommend to the Gilberts to
participate in the Driscoll.' The reference to Herber was to a report by appellee
May 15, 1962, prior to the Driscoll purchase date of July 19, 1962, that the
Herber well had a test of 30 barrels a day. During the trial Nixon was asked
whether he knew 'the plaintiffs were relying on an important and material
degree on the situation on the Herber and Warta leases in agreeing to purchase'
the Driscoll fractional interests. Appellee replied, 'They may have been relying
to some degree on this well, but the #1 Herber was a weak well from its outset
and we all knew it,' although he admitted that a 30 barrel well was not a weak
well and he could not specify any particular report sent to appellants after the
report of May 15 and before the purchase of Driscoll.

51

We have already held that appellants do not have the burden of proving reliance
as a condition of recovery. However, evidence of reliance, when presented,
does bear upon the issue of materiality if that reliance is determined to be
reasonable. See, SEC v. Texas Gulf Sulphur Co., supra, 401 F.2d at 849-851.
We think the trial court should not have ended its inquiry into materiality when
it found that the Driscoll and Herber wells are 'obviously located in separated

geological structures.' Accordingly we remand for the court to determine first

whether Nixon's failure to keep appellants informed on the progress of Herber
was, under the circumstances of the Driscoll sale, misleading, and if so,
whether the reliance upon the misleading reports was reasonable enough to
make them material.
Ginther Lease-- NE/4 Section 19-12-15
52

This interest was offered to appellee together with the Driscoll lease on June 8,
1962. The Ginther lease, as appellants' brief states, offset 'an excellent
producing lease called the Gibbs lease, on which defendant was operator and in
which Mrs. Gilbert (plaintiff) owned a small fractional interest.' Appellants
claim with respect to the lease that appellee failed to show on his contour map
an abandoned producer which was plugged an non-commercial after production
had been attempted for two years in 1959. The dry well was located 600 feet
east of the proposed Ginther site and 330 feet west of the productive Gibbs
lease. The trial court found as follows:

53

For full disclosure this information should have been shown for what it was
worth. The materiality of its omission is speculative and hence must be
considered immaterial in light of the information shown on the geological map
and in the prospectus at the time of its submission and in light of the
circumstances under which the parties determined to undertake the drilling of
the Ginther well, i.e., an abundance of producing wells in the area in adjoining
quarter sections, apparently probable and accurate contouring data, and the
existence of $2,000.00 dry hole money.

54

There is no testimony from which it can be found that appellee was not aware
of this abandoned well, or should not have been. Moreover the references to the
record contained in his brief cited in support of the trial court's finding of
immateriality do not necessarily support the court's position under the standard
of materiality to which we adhere. We therefore feel obliged to remand this part
of the case also for reconsideration under the test of materiality we have set out
in this opinion.

55

It will be seen from the foregoing that we affirm the District Court in its
decision insofar as appellants rest their appeal upon their broad claims of
misrepresentation regarding excessive charges, discounts, and misleading
atmosphere caused by allegedly false reports. We also affirm the District
Court's money judgment based on appellee's confession of liability for
restitution of appellants' share of discounts and oil credits. With regard to the

lease interests individually considered in this opinion we affirm the District

Court's denial of recovery of appellants' losses on the Pendergast lease but
reverse and award judgment in favor of appellants for the amounts found as
their loss with respect to the Ewing 'A' and 'B' fractional interests. We remand
for reconsideration by the District Court the issues of recovery or not by
appellants with respect to the amounts claimed as a consequence of their
purchase of fractional interests in the leases known as Teeters, Herber, Driscoll
and Ginther.
56

While we have attached considerable emphasis in our opinion to the standard of

materiality to be applied to the transactions to be reconsidered on the remand,
the trial court when applying the standard governing materiality which we
adopt is not precluded in determining the issue of recovery from applying other
criteria laid down in our opinion and found by the trial court to be applicable to
the particular transaction.

57

It is so ordered.

Of the United States Court of Appeals for the District of Columbia Circuit,
sitting by designation

The suit was filed by M. P. Gilbert and M. J. Lebsack, anf by A. R. Lebsack

and M. J. Lebsack, a partnership doing business as Lebsack Development
Company. While Mrs. (M. P.) Gilbert is the real party in interest so far as the
record reveals, all of the original plaintiffs have filed a notice of appeal and will
be referred to herein collectively as appellants. We do not understand that the
Lebsacks, however, individually or as a partnership, assert any rights or sums
involved in this appeal separate from those asserted on behalf of M. P. Gilbert,
wife of B. D. Gilbert who acted as her agent. If they do the adjustment between
appellants must be resolved by the District Court on the remand. Moreover, we
hold for purposes of the transactions involved in this case that Lebsack was an
agent of the Gilbert appellants, and we base our decision on submissions made
by appellee to the Gilberts through Lebsack, except where the nature of such
submissions might have been materially altered by independent submissions,
representations, or omissions by Lebsack

See, note 1, supra

An example of the letter agreement is the following:

'Mr. M. J. Lebsack, #9 Lee Building, 2133 South Bellaire, Denver 22,

Colorado. Re: Ewing 'B' Prospect, SW/4 Sec. 36-19S-15W, Barton County,
Kansas.
Dear Mr. Lebsack: This is to reduce to writing, our agreement whereby I agree
to assign 5/8ths working interest in the SW/4 Section 36, Township 19 South,
Range 15 West, Barton County, Kansas. This Lease is subject to a 1/32 of
7/8ths overriding royalty to Mr. Galen Ewing.
You agree to participate in the drilling of an oil and gas test in the NW SW SW
of Section 36, T19S, R15W. On the first hole only, you will be charged for
5/7ths of any and all drilling costs to the point of running production casing.
You will also be charged 5/7ths of $480.00 which covers the initial lease
bonus, title opinion and any and all charges and expenses pertinent to the
acquisition of these leases. *363.
If this sets forth our agreement in this respect, please signify by signing the
attached copy and returning it to my office.
Very truly yours, (s) R. P. Nixon
RPN:rm
Accepted: This 4th day of October, 1961.
Milton J. Lebsack By (s) M. J. Lebsack'
4

Securities Act of 1933, 15 U.S.C. 77l(1), 77l(2), 77q; Securities Exchange Act
of 1934, 15 U.S.C. 78j and 17 C.F.R. 240.10b-5. The District Court's ruling that
Section 77q and K.S.A. 17-1253, note 5, infra, cannot be the basis of an action
for civil liability was not appealed by appellants

Kansas Securities Act, K.S.A. 17-1253 and 17-1268

Appellants do not contest the District Court's determination that they failed to
prove a case of common law fraud. Their arguments in this court relate solely to
Nixon's liability under the securities acts, notes 4 and 5, supra

The net consideration or expense paid by the appellants for their fractional
interests in each of the thirteen leasehold drilling ventures in issue, and the
combined expenditures of all, were claimed as follows:

Lease Name
Pendergast
Ewing "A"
Ewing "B"
Teeters

Amount
$ 16,659.58
13,041.47
7,519.42
10,483.07

Herber
Driscoll
Bowlby
Ginther
Hlad
Brungardt "C"
Snapp
Vogel
Steinert
Total.....

22,586.76
21,243.85
17,740.80
20,098.17
10,151.26
10,598.50
10,214.64
14,010.85
15,484.83
----------$189,833.20

See also, 15 U.S.C. 78c(10); K.S.A. 17-1252(j)

See also, K.S.A. 17-1262(m); 17-1268(a)

10

Section 78j provides:

It shall be unlawful for any person, directly or indirectly, by the use of any
means or instrumentality of interstate commerce or of the mails * * * (b) To
use or employ, in connection with the purchase or sale of any security
registered on a national securities exchange or any security not so registered,
any manipulative or deceptive device or contrivance in contravention of such
rules and regulations as the Commission may prescribe as necessary or
appropriate in the public interest or for the protection of investors.
That Nixon used means of communication in interstate commerce and of the
mails, a jurisdictional prerequisite to liability under both Section 10 of the 1934
Act and Section 12(2) of the 1933 Act, is not disputed.

11

Fischman v. Raytheon Mfg. Co., 188 F.2d 783 (2d Cir. 1951); Ellis v. Carter,
291 F.2d 270 (9th Cir. 1961); Stevens v. Vowell, 343 F.2d 374 (10th Cir.
1965); Jordan Bldg. Corp. v. Doyle, O'Connor & Co., 401 F.2d 47 (7th Cir.
1968)

12

See, e.g., Trussell v. United Under-writers, Ltd., 228 F.Supp. 757

(D.Col.1964); Weber v. C.M.P. Corp., 242 F.Supp. 321 (S.D.N.Y.1965); Drake
v. Thor Power Tool Co., 282 F.Supp. 94 (N.D.Ill.1967); 'Negligent
Misrepresentations under Rule 10b-5,' 32 U.Chi.L.Rev. 824 (1965)

13

Kardon v. Nat'l Gypsum Co., 69 F.Supp. 512 (E.D.Pa.1946); Ellis v. Carter,

note 11, supra

14

In reaching this conclusion we do not mean to say that buyers never have an
action under 10b-5 independent of Section 12(2)

15

Cf. Mills v. Electric Auto-Lite Co., 396 U.S. 375, 90 S.Ct. 616, 24 L.Ed.2d 593
(1970), where the Court, construing a private cause of action under Rule 14a-9,
15 U.S.C. 78n(a) of the proxy rules held that a finding of materiality:
indubitably embodies a conclusion that the defect was of such a character that it
might have been considered important by a reasonable shareholder who was in
the process of deciding how to vote.

16

See, List v. Fashion Park, Inc., supra, 340 F.2d at 462-463; Janigan v. Taylor,
344 F.2d 781, 785-786 (1st Cir.), cert. denied, 382 U.S. 879, 86 S.Ct. 163, 15
L.Ed.2d 1260 (1965); Myzel v. Fields, 386 F.2d 718, 735 (8th Cir. 1967), cert.
denied, 390 U.S. 951, 88 S.Ct. 1043, 19 L.Ed.2d 1143 (1968); Trussell v.
United Underwriters, Ltd., supra, 228 F.Supp. at 773; Contra, Vine v.
Beneficial Finance Co., 374 F.2d 627, 635 (2d Cir.), cert. denied, 389 U.S. 970,
88 S.Ct. 463, 19 L.Ed.2d 463 (1967). Cf., Mills v. Electric Auto-Lite Co., note
15, supra, holding under the proxy rules that the requirement of materiality is
sufficient and need not be supplemented by proof of actual reliance

17

Compare Fischman v. Raytheon Mfg. Co., supra, 188 F.2d at 786, with Royal
Air Properties, Inc. v. Smith, 312 F.2d 210, 212 (9th Cir. 1962), and SEC v.
Texas Gulf Sulphur Co., supra, 401 F.2d at 854-855; see, also, Stevens v.
Vowell, supra, 343 F.2d at 379; Globus v. Law Research Service, Inc., 418
F.2d 1276, 1290-1291 (2d Cir. 1969)

18

The trial court did not distinguish materiality from reliance. That the two
concepts are distinguishable was fully explained in List v. Fashion Park, Inc.,
supra, 340 F.2d at 462-463. Whether or not reliance is to be equated with
causation, see 'Civil Liability under Section 10b and Rule 10b-5', 74 Yale L.J.
658 (1965) when liability rests upon 10b-5 alone, we have held that the
requirement of reliance is not appropriate when relief is properly subject to the
provisions of Section 12(2)

19

The court found that the amounts billed to appellee coincided with the invoices,
which, the court also found, were the normal charges for the services rendered

20

The amount of the judgment also included an oil credit of $378.06 which Nixon
admitted to be due the appellants

21

The 'Reagan Sand,' according to the testimony of Lebsack, is a topical name

given to a geological zone so located that it is usually the last opportunity for
reaching oil and gas
The 'Kansas City zone' is a formation underlying the Lansing Limestone. Both
zones were frequently referred to by the parties as the 'Lansing-Kansas City.'

These geological formations are structurally higher than the Reagan Sand and,
insofar as the leases under discussion are concerned, represent an area where
oil and gas can normally be expected to be found. The record reveals, however,
some uncertainty as to the meaning of 'zones behind the pipe' although the term
appears to indicate a potential area of productivity.
22

Although the term 'offset' may have other meanings in different contexts, as
used in this case it describes a well or proposed drilling site which is in the
same oil producing formation as another well or site

23

The trial court made no findings with respect to the representation that there
were 'four Kansas City zones behind the pipe.' However, we find it unnecessary
in the resolution of this part of the case to discuss the matter further. Nor do we
need consider other matters such as appellants' claim that Nixon's map showed
a producer offsetting the Ewing 'B' well which, unknown to appellants, was
producing a high percentage of water

24

The record indicates that oil is usually found in a dome-like structure and the
taller the dome, the more likely it is that oil can be successfully produced. Thus
appellants' assumption that the Herber lease, to be an attractive prospect, must
have a Lansing Limestone dome top at least as high as the offsetting producers,
has support in the record

25

Geological formations, including in this case oil producing domes, are

estimated primarily through the use of depths of previously drilled wells, which
are called 'control points.'