Resort Condominiums and the Federal Securities Laws
| Publication year | 1989 |
| Pages | 229 |
1989, February, Pg. 229. Resort Condominiums and the Federal Securities Laws
Colorado's recessed economy has resulted in a glut of unsold resort condominiums, forcing some developers to promote resort condominiums in ways that were unneccesary when Colorado's economy was growing vigorously. To promote the benefits of owning resort condominiums, developers often provide a variety of services to purchasers, including acting as rental agents.
One popular rental opportunity promoted by developers is the condominium rental pool. In a typical rental pool arrangement, all rental income and expenses of operating the condominium units are pooled and the net proceeds are divided equally among the participants on a pro rata basis, regardless of the extent to which each unit is actually rented during the rental period. Often overlooked by developers is the application of the federal securities laws to the sale of these and similar arrangements.(fn1)
If the sale of the condominium is found to involve the sale of a security, the seller, absent an exemption, must comply with a wide range of registration, disclosure, anti-fraud and other requirements imposed by the federal securities laws. Failure to register may subject the seller to severe civil(fn2) as well as criminal liabilities.(fn3)
This article examines the circumstances in which the federal securities laws apply to the offer, sale and resale of resort condominiums. Although not addressed in this article, equal consideration should be given to the applicable state "blue sky" statutes, which in some states, including Colorado, closely parallel the federal provisions.(fn4)
It is generally viewed that transactions in real estate (including resort condominiums) do not constitute a "security"5 under the definitional provisions of the Securities Act of 1933 ("Securities Act")(fn6) or the Securities Exchange Act of 1934 ("Exchange Act").(fn7) However, if the real estate is offered in connection with certain services or promoted as an investment opportunity, the transaction may result in the offer of a security in the form of an investment contract.
In SEC v. W.J. Howey Co., the U.S. Supreme Court defined an investment contract as
The definition of an investment contract in Howey had its genesis in an earlier decision by the Court, SEC v. C.M. Joiner Leasing Corp. In Joiner, the Court defined a security in terms of the character the investment is given in commerce by the terms of the offer, the plan of distribution and the economic inducements held out to the offeree.(fn9)a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.(fn8)
In applying the Howey criteria, courts have repeatedly held that the test must be applied in light of the economic realities of the transaction. For example, in United Housing Foundation, Inc. v. Forman, the U.S. Supreme Court declined to hold that purchasers of "stock" in a housing cooperative were purchasing investment contracts, requiring registration under the Securities Act.(fn10) The Court reasoned that the purchasers were motivated by the prospect of acquiring a residence rather than an investment. As the Court stated:
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.(fn11)
In reliance on the trilogy of Joiner, Howey and Forman, courts have held that resort condominiums sold with the emphasis on the investment opportunity, rather than on occupancy by the purchaser, constitute securities under the federal securities laws. An illustrative case is SEC v. Marasol Properties.(fn12) In Marasol, the condominium developer's agents solicited prospective investors to purchase resort condominium
units located in Spain. The developer's agents promised to arrange continuing rental of the units from which the investors were to derive a guaranteed annual return. Citing Howey and Joiner, the court held that the sale of condominium units sold primarily for investment purposes, coupled with an undertaking to arrange continuing rental for the benefit of the purchasers, constituted the sale of a security in the form of an investment contract.
Similarly, in Wooldridge Homes, Inc. v. Bronze Tree, Inc., the U.S. District Court for the District of Colorado held that the sale of resort condominium units located in Steamboat Village, Colorado, coupled with a mandatory two-year management arrangement that included a rental pool, constituted an investment contract requiring registration.(fn13) The court found that the investors entered into condominium purchase agreements with the developer "with the intent of making an investment in a growing resort community."(fn14) The plaintiff maintained that he believed he was making a passive investment where little or no management of the condominium was required and that he expected to earn profits from the investment that were to be derived from the managerial efforts of the defendant.
In contrast to Marasol and Wooldridge, the court in Mosher v. South-ridge Associates, Inc. reached a different conclusion.(fn15) At issue in Mosher was whether the sale of resort condominiums, coupled with promises by the developer to promote the condominiums and provide managerial services for the common benefit of residents, involves the sale of an investment contract. Although the developer promoted the investment opportunities associated with the condominium, the court held that the transaction was outside the purview of the federal securities laws.
In so holding, the court noted...
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