CONDOMINIUM HOTELS, CONVERTED HOTEL/APARTMENT condos, resort condos, and even exclusive-occupancy luxury passenger ships are some of the ventures attracting real estate investors today. At the outset, it is necessary to distinguish among other real estate ventures, e.g., cooperatives (co-ops), or tenancy-in-common (TIC) interests. Cooperatives are single, non-profit corporations with the corporation, rather than shareholders, holding title to the property. Shareholders have a proprietary lease to their units, in addition to shares in the corporation. Conversely, condo owners have a fee simple in their interest. (1) With TICs, the title is held by a separate legal entity, e.g., a corporation, partnership or limited liability company (LLC). (2) On Jan. 14, 2009, the Securities and Exchange Commission (SEC) responded to a "no action request," holding TICs to be securities. (3) However, this article will discuss more traditional condo interests in hotels and apartments where relevant law is yet to be settled.
Unfortunately every deal is not as good as it may first appear to be. In a weak economy, real estate purchasers increasingly seek ways to void purchases, as deals become less attractive because of factors such as falling prices or costlier financing. One recent pretext to void such purchases is to claim securities fraud. If the real estate venture in question is a security, a purchaser can claim that the seller should have registered it as such under state or federal securities law, unless an exemption applies. If the seller did not do so, the purchaser may be able to void a now-undesirable deal by claiming securities fraud. Moreover, the person controlling the selling company and those involved in the sale may be personally liable.
It is often more difficult than one might suppose to determine whether something is a security. Not only are stocks and bonds securities, but many other things are as well. For example, a company in Florida once sold parts of orange groves mainly to out-of-state investors. Another company proposed to nurse the trees and sell the fruit for a share of the proceeds. In Securities and Exchange Commission v. W. J. Howey Co., (4) the United States Supreme Court found that the companies had offered and sold securities in the form of an "investment contract."
While investment contracts do not exist in the real world, this was the name the court coined for a transaction that it deemed should be considered a security. It also devised a formula for determining when these transactions exist. Since the Howey case, courts have found investment contracts involving all kinds of things, including contracts for raising earthworms, cutting demo records and even certain real estate sales involving resort condominiums. (5) This article will addresses the characteristics of a security under the Howey test, and analyze how this might apply to various real estate transactions, e.g., those involving condominium hotels.
The Uniform Securities Act, which has been adopted by a majority of states, is modeled after Section 2(1) of the Securities Act of 1933 ("the Act"). (6) Thus, state judges following the Uniform Act often refer to federal securities cases even when analyzing state cases. Accordingly, several federal securities cases involving real estate transactions will be addressed in this article, as well as Securities and Exchange Release No. 33-5347, (7) which concerns criteria for whether the offering of condominiums or similar units will be considered securities. Finally some recent lawsuits will be discussed.
ANALYSIS OF A SECURITY
Is it Called Stock?
It appears that one of the most self-evident cases for coverage by the Act is where the instrument is called a stock. Sections 2(1) of the 1933 Act and 3(a) (10) of the Securities Exchange Act of 1934 define a "security" to include "stock" and some other instruments. (8) …