Condo-Hotel Litigation: The Lawsuit Boom Following The Burst Of Some Of The Riskiest Real Estate Investment Vehicles

Recently, the Wall Street Journal had a short but incisive item provocatively titled, Rooms With a Bubble View: Condo-Hotel Buyers See Investments Sour as the Market Weakens.  The article characterizes condo-hotels as “one of the most dangerous investments of them all,” and then briefly discusses some of the lawsuits being brought against condo hotel developers in places like Las Vegas, Singer Island and Clearwater.  (I previously wrote on the the lawsuit against the Resort at Singer Island here.)   The basis for all of these lawsuits is that the properties were marketed in such a way as to qualify as “securities” under federal and/or state law, but were not registered as a securities offering, thus entitling the buyers to a refund of their deposits.  If the allegations can be proven, then the remedy is potent indeed: as one attorney quoted in the Wall Street Journal article accurately states, “The rights of recovery are so much better if you can say it is a security.”  A version of the Wall Street Journal article also recently appeared in the Daytona Beach News-Journal, with additional discussion concerning an apparently struggling condo-hotel in Daytona Beach called Plaza Resort & Spa.

It is correct to hone in on securities laws as a potentially powerful weapon for purchasers of condo-hotels to seek rescission of their purchase agreements.  To a significant extent, however, the course that condo-hotel litigation will take — and how such cases will be viewed and ruled upon by courts — is difficult to predict.  Case law addressing the issue of the conditions under which a condo-hotel constitutes an offering of securities and should be registered as such is thin — in fact, non-existent, for all intents and purposes.  The most important guidance comes from a 1973 Release from the Securities and Exchange Commission (SEC) entitled Guidelines as to the Applicability of the Federal Securities Laws to Offers and Sales of Condominiums or Units in a Real Estate Development (SEC Release No. 33-5347).  A copy of the SEC Release can be found here.

The Release sets forth three broad factors, the presence of any one of which could render a condo-hotel as a securities offering, thus triggering the right of a buyer to seek rescission under securities law.  These factors are:

1. The condominiums, with any rental arrangement or other similar service, are offered and sold with emphasis on the economic benefits to the purchaser to be derived from the managerial efforts of the promoter, or a third party designated or arranged for by the promoter, from rental of the units.

2. The offering of participation in a rental pool arrangement; and

3. The offering of a rental or similar arrangement whereby the purchaser must hold his unit available for rental for any part of the year, must use an exclusive rental agent or is otherwise materially restricted in his occupancy or rental of his unit.

The Release itself contains some, but not a great deal of, elaboration concerning what these three factors mean in practice.  For example, a rental pool is defined as a rental system whereby “[t]he rents received and the expenses attributable to rental of all the units in the project are combined and the individual owner receives a ratable share of the rental proceeds regardless of whether his individual unit was actually rented.”  For more helpful detail, however, one must turn to the SEC “No-Action Letters” on the subject of what constitutes a security for regulatory purposes, and many of the key No-Action Letters affecting condo-hotels can be found on this page of the SEC website.  No-Action Letters are prepared by the SEC in response to formal requests from entities asking whether a given set of facts would trigger enforcement action by the agency.  The SEC’s position (i.e., whether or not it would recommend an enforcement action with respect to the proferred facts) is only binding as to the specific inquiry before it.  While No-Action Letters provide some guidance on how a court might rule if faced with similar or even identical issues, it is important to bear in mind that the SEC’s stated position as to a given set of facts would be persuasive, but not binding, upon a court.

Beyond the SEC Release and No-Action Letters, when it comes to legal analysis of the salient issues bearing on how securities law interacts with the offering of condo-hotels, nearly all of the analysis comes from developer-side attorneys seeking to advise their clients how to structure their projects so as to minimize the risk of coming under SEC scrutiny, or positing how local authorities can enact zoning regulations which lessen securities regulation hazards for condo-hotel developers.  For examples of articles in this vein, see here, here, and here.

Given the impending wave of condo-hotel litigation that we can surely expect in the coming months owing to buyers looking to recover their deposit monies (and paralleling the tsunami of “plain vanilla” condo buyer lawsuits), the perspective from developer-side attorneys will surely be helpful for predicting what twists and turns such litigation might take.  But to get a true picture of what is on the horizon, it will be necessary to take a close and critical look at the relevant No-Action Letters as well as case law addressing the issue of what can constitute a security, generally speaking, in order to identify the pressure points which may exist for condo-hotel buyers (and their attorneys) to push in litigating rescission cases.  To fill the gap, I intend to make these issues a focus of my blog, in the weeks ahead, by providing condo-hotel securities law analysis alongside and in the same manner as my articles on the federal Interstate Land Sales Full Disclosure Act and Florida condominium law.

By Jared H. Beck, Esq.

This article does not constitute legal advice or the formation of an attorney-client relationship, and is not for re-publication without express permission of the author.

Mr. Beck has a law degree from Harvard Law School, and practices law in the courts of South Florida. His law firm, Beck & Lee Business Trial Lawyers in Miami, is dedicated to the practice of business and real estate litigation. A significant portion of Mr. Beck’s practice is devoted to issues arising under condominium and other real estate purchase agreements. He can be reached at 305-789-0072 or jared@beckandlee.com

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5 comments

  1. Property Investments Plans

    Really most of the real estate investor before investing on the property they should gather information about that property and then invest on the property investments, This will reduce the risk in real estate investments.

  2. Todd, condo hotel broker

    This kills me! People really have to be careful with a property offering, especially if they are looking to “flip.” It is such a dangerous assumption to think that the rental revenues will cover costs associated with condo hotel ownership, and any sales organization should know the dangers of implying such things. Now we are seeing rental revenue fall short in crashing markets like Las Vegas. Really they should be treated as second homes in great locations with rental revenue POTENTIAL. Next thing you know, people will be suing because their property didn’t appreciate. Phooey.

    As far as offering a condo hotel as a security, I doubt that will ever happen, it creates too many headaches for the developers. Not only would they have to hire a sales staff, but also licensed investment brokers as well.

  3. T Elaine

    States must take control and enforce the promotion and sales process of condominiums. We bought one based on presentation of an onsite rental program that all owners would pay the cost of running, whether they rented condo or not. Condos put in a pool and rotated for reservations (unless specific condo requested by renter. Found out units not build to the code which requires separate utilties (electric meter, electric box, hot water heater, etc.) for each condo unit. Net income to be made never materialized close to figures given. And HOA budget not even realistic…even when questioned told it’s solid…omitted a number of expenses. Onsite program was illegal and developers informed of this prior to sales, but continued to present unlicensed program, until most sold. Very few sales would have happened based on reality. Four owners filed lawsuits. Where are the local inspectors? Where is the endorcement of RE laws? Where is enforcement of Condo Act? Where is enforcement of anything???? Be careful when you buy out-of-state and don’t understand local “customs”.

  4. Stephen Duke

    Even the best structured condo-hotels are vulnerable to litigation because PEOPLE DO NOT READ THE AGREEMENTS THEY SIGN!!!

    I have seen this for myself. And, once a few people with disallusionment begin to throw up litigation, values and resales begin to decline.

    Disallusionmnet often results from expectations that are not aligned with the actual offering. If a developer does everything correctly and there are no projections or representation of income, there should not be any expectations raised. However, people too often fill in the blanks with their own imaginations.

    Perhaps reading isn’t all that is required. Developers are required to disclose all sorts of things in the “disclosure documents”, but they are specifically prohibited from disclosing anything related to what a buyer can expect from their purchase in terms of the hotel rental program. That unfortunately, leaves a big knowledge gap.

    I agree with the practice of selling real estate as such, and guiding potential purchasers to a (separate place) representative of the Hotel Operating Company to provide some details with respect to the Optional rental program. But, they should be clear about NOT raising expectations of income.

    SD

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