Without any discussion or rationale, the U.S. Supreme Court denied certiorari in the case Tamer Salmeh, et al. v. Tarsadia Hotel, et al.1, perhaps signaling finality to the issue of whether interests in condominium-hotels, combined with the opportunity for rental income, are governed by the federal securities laws. The case has been followed closely by real estate developers, purchasers, and attorneys since it was first filed in December 2009. The Supreme Court’s refusal amounts to a significant win for hotel-condominium developers who have faced an onslaught of litigation since the beginning of the economic downturn involving hotel-condo and time share projects. However, the ruling is limited to securities laws issues, and does not address broader legal claims that purchasers had made relying on the Interstate Land Sales Full Disclosure Act.
In 2006, the Hard Rock Hotel San Diego (“HRHSD”) began offering the opportunity to purchase ownership interests in individual HRHSD units at prices ranging from $350,000 to more than $2 million.2 The units were subject to restrictions required by the City of San Diego, which limited an
owner’s personal use of a unit to a maximum of 28 days per year, and required that the units were to be managed as part of the HRHSD at all times.3
Some time after purchasing the units, each purchaser was offered the opportunity to participate in an optional rental management program operated by the hotel operator. Most of the purchasers did not enter into rental management agreements until eight to fifteen months after they had entered into their purchase agreements.4
In December 2009, the purchasers filed suit, claiming that the units were marketed as real estate transactions, but were actually investment contracts, or securities, that were in violation of federal and state securities laws. To support their claims, the Salameh plaintiffs emphasized their expectation of profits based on the efforts of the hotel developer or operator.5
However, in March 2011, the United States District Court for the Southern District of California ruled that the plaintiffs could not sufficiently allege facts to support their claims that the offering of the HRHSD units were “investment contracts,” dismissing the plaintiffs’ complaint without leave to amend.6 First, the court noted the “significant gap” between the execution of the purchase
agreements and the execution of the rental management agreements.7 Second, the court focused on the specific terms in the purchase agreements that expressly represented that the plaintiffs were not purchasing the units for investments and were not relying on any representations regarding the rental revenue of the units.8
Plaintiffs promptly appealed the decision to the Ninth Circuit.
The Securities and Exchange Commission Sides With Investors
Significantly, in August 2011, the Securities and Exchange Commission (“SEC”) filed an Amicus Brief with the Ninth Circuit siding with the Salameh plaintiffs, arguing that the units were offered and sold as investment contracts contrary to the District Court’s conclusion.9 In its brief, the SEC argued that the District Court “failed to appreciate the broader realities underlying the arrangements between the parties.”10 Specifically, the SEC contended that the length of time between the execution of the purchase and rental management agreements was of no consequence, stating that the subsequent execution of the rental management agreement was a “necessary and essential component of the room sales, making the two a single transaction or package.”11 Additionally, the SEC argued that the plaintiffs had a clear expectation of profit from the efforts of the hotel operator or developer, as “plaintiffs were precluded for all practical purposes from exercising any meaningful control over their rooms.”12
The Ninth Circuit Holds No Securities Were Offered
Despite the SEC’s Amicus Brief, in August 2013, the Ninth Circuit affirmed the District Court’s dismissal of plaintiffs’ claims on the basis that they could not allege the sale of a security.13 Using its prior holding in Hocking v. Dubois, 885 F.2d 1449 (9th Cir. 1989) as a baseline,14 the Ninth Circuit found that plaintiffs’ allegations were not sufficient to show that a security was sold when the interests in the units were transferred because, among other things, plaintiffs had not alleged that the rental management agreement was promoted at the time of the sale or that they were told that the rental management agreement would result in investment-like profits.15 Moreover, the Ninth Circuit agreed that the “large time gap” between the execution of the relevant agreements underscored the holding that plaintiffs were not offered a security.16
Again, the Salameh plaintiffs refused to give up, petitioning the Supreme Court for a writ of certiorari. However, on February 24, 2014, the Supreme Court ended plaintiffs’ options and refused to grant the petition, allowing the Ninth Circuit dismissal of the case to stand.17
The Future of Hotel-Condo Developments Post-Salameh
While hotel-condo developers are still fighting litigation alleged on other legal bases relating to disclosures in purchase and sale agreements and public reports, the Supreme Court’s denial of certiorari to the Salameh plaintiffs effectively offers hotel-condominium-hotel developers a safe pathway to follow in publicly offering hotel-condo units out of the purview of federal and state securities laws. With the current upswing in the real estate market, hotel-condo developments are slowly beginning to pop up again in states like Florida and New York.18 However, before the development of any hotel-condo project, developers should take care to consult with counsel to design a detailed blueprint to follow in the sale and marketing of any hotel-condo units.