Request By:
Mr. Jack D. Bunnell
Director
Division of Securities
Department of Banking and Securities
Frankfort, Kentucky 40601
Opinion
Opinion By: Robert F. Stephens, Attorney General; By: Charles W. Runyan, Assistant Deputy Attorney General
Your problem relates generally to the sale and registration of securities as covered in the regulatory function of the Division of Securities of the Department of Banking and Securities. See KRS Chapter 292.
The 1978 General Assembly amended KRS 292.380(3)(b) to read in pertinent part that:
". . . All securities delivered in escrow to the director or some other depository satisfactory to him prior to January 1, 1968 which have not previously been released shall be released from escrow and all securities delivered in escrow to the director or some other depository satisfactory to him subsequent to January 1, 1968 which have not previously been released shall be released from escrow no later than ten (10) years after the date of delivery into escrow. "
The amended provision provides for release by the director of securities or other depository of certain securities from escrow, covering securities so escrowed prior to and after January 1, 1968. The cause of your concern apparently lies in the fact that the legislative direction about release of the securities from escrow disregards the conditions of the escrow contracts.
You ask whether the application of the statute would be unconstitutional as an impairment of obligation of contract, considering public shareholders as third party beneficiaries.
Your description of the purpose of the escrow, in the period from January 1, 1961, to June 16, 1972, is helpful in noting the basic legislative purpose underlying the escrow provisions:
"The purpose of the escrow is to assure that the promoters who have been given stock for no consideration or much less than the public offering price will continue to exercise their best efforts in behalf of the company and, further, to prevent them from quickly disposing of their stock at a sizeable profit yet below the price paid by public investors thereby depressing the market price. For the protection of the purchasers of the public issue, the Division, as a matter of policy, generally required as a condition of registration that certain stock be delivered into escrow subject to the terms and conditions imposed by statute. The fact that escrow had been ordered by the Director along with an explanation of the rights and obligations imposed thereunder was then required to be included in the prospectus to be used in connection with the public offering. It is, therefore, reasonable to assume that some members of the investing public in evaluating their potential investment may have relied in part on the representations regarding escrow. " (Emphasis added).
The 1972 amendment of KRS 292.380(3) provided that the director may by rule or order determine the conditions of any escrow or impounding required. Although the decision of whether or not to impose escrow is discretionary with the director of the Division of Securities, once he elected to escrow, the conditions of the escrow were mandated by the statute prior to the 1972 amendment.
You point out that under the literal wording of KRS 292.380(3), as amended in 1978, persons owning stock held in escrow can, after a period of ten years, remove their stock from escrow irrespective of whether or not the terms of the escrow have been fullfilled and participate, for example, along with all other shareholders in the assets of the corporation should they choose to dissolve it. You contend that the statute so interpreted and applied might be unconstitutional because it involves an impairment of the obligation of contract, as treated in Article 1, § 10 of the United States Constitution and § 19, Kentucky Constitution, as relates to derivative rights of public shareholders.
Settled law provides that "the depositary is under a duty imposed by law not to deliver the escrow to anyone except upon strict compliance with the conditions imposed. " 28 Am.Jur.2d, Escrow, § 17, p. 25. In other words, "where a person assumes to and does act as the depositary in escrow, he is absolutely bound by the terms and conditions of the deposit and charged with a strict execution of the duties voluntarily assumed." Ibid., § 16, p. 24. The release-from-escrow provisions of the 1978 amendment literally suggest a disregard for conforming to the conditions of escrow.
In considering the history of the statute, it is at once evident that the legislature, in providing for the escrow-of-stock contracts, intended to equitably adjust the relationship of promoters to the public investors, the practical effect of which inures to the protection of the purchasers of the public issue as third party beneficiaries. It can be reasonably assumed that such public purchasers, or some of them, relied in part on the representations regarding escrow. Those members of the public so investing had a beneficial interest in the subject pre-existing contracts.
Now the question is: What constitutes impairment of obligations of contract under the constitutions?
"The obligation of a contract is impaired by a statute which alters its terms by imposing new conditions or dispensing with conditions, or which adds new duties, releases or lessens any part of the contract obligation, or substantially defeats its ends." (Emphasis added). 16 Am.Jur.2d, Constitutional Law, § 445, p. 794.
If by the legislative act the obligation of contract is in any degree impaired or weakened, or rendered less operative, the constitution is violated. Lapsley v. Brashears, 4 Litt. Ky. 47 (1823).
The clause [Art. 1, § 10, U.S. Const.] is clearly intended to protect benefits and rights of a party under contract. Stoneridge Apts., Co. v. Lindsay, [U.S.D. Ct. S.D. N.Y. - 1969] 303 F.Supp. 677, 679. The denial of a vested right under a contract, by a state constitution subsequently adopted, was held, in Permann v. Knife River Coal Mining Co., N.D., 180 N.W.2d 146 (1970), to impair the obligation of contract and was a deprivation of property without due process of law. The Supreme Court of South Carolina, in Henderson v. Evans, S.C., 232 S.E.2d 331 (1977), wrote at p. 333, that "A statutory construction which retroactively deprives a party from pursuing his rights pursuant to a legal contract is not only manifestly inequitable, it is an unconstitutional impairment of contractual obligations." "The underlying concern of Art. 1, § 10, forbidding impairment of contracts, is that a legislature or court will render invalid the rights and obligations which the parties agreed to in their contract." Evansville-Vanderburgh School Corp. v. Moll, Ind., 344 N.E.2d 831 (1976) 841.
The amendment to KRS 292.380 in 1978 came subsequent to pre-existing contracts of escrow, and thus comes within the range of subsequent legislation, which may impair contract. Munday v. Wisconsin T. Co., 64 L. Ed. 684 (1919).
Judge Thomas, for the Kentucky Court, recognized that the constitutional provision against impairment of contracts [§ 19, Ky. Const.] applies to those contracts made to the public and for the benefit of the public as well as to strictly private contracts. Cotton v. Walton-Verona Indep. G. School Dist., 295 Ky. 478, 174 S.W.2d 712 (1943) 716.
Under the foregoing analysis and authorities, it is our opinion that KRS 292.380(3) [as amended in 1978] is unconstitutional, since it mandates the release of escrowed securities involved in pre-existing escrow agreements without any regard whatsoever for the original conditions of the escrow agreements. This statute of disregard and alteration, we think, if applied, would constitute an impairment, under these federal and state constitutional sections, of the obligations of contract, since it would destroy the relative or derivative rights of public purchasers of securities, and would concomitantly nullify the historical purpose underlying the imposing of conditions in the escrow agreements.