On February 24, 2014, the U.S. Supreme Court denied certiorari in the Ninth Circuit case Salameh v. Tarsadia Hotel, effectively rejecting a securities fraud claim by purchasers of hotel condominiums and affirming one method of publicly offering hotel-condo units outside the purview of federal and state securities law. 726 F.3d 1124, 1128 (2013).
In 2006, the Hard Rock Hotel San Diego began offering ownership interests in individual condo units. Salameh,726 F.3d at 1128. The units were subject to restrictions imposed by the city of San Diego that both (i) limited an owner’s personal use to a maximum of 28 days per year and (ii) required that the units be managed at all times by the Hard Rock Hotel. After purchasing the units, each purchaser was given the opportunity to enter into a rental management agreement operated by the hotel. The rental management agreement stated that Tarsadia Hotel would be the exclusive management agent for the hotel and the units.
In December 2009, the plaintiffs brought a class action against the defendants alleging that, although the unit sales were marketed as real estate transactions, they were, in fact, investment contracts or securities that had been offered for sale in violation of securities laws.
The issue before the court was whether the hotel condominium sales and subsequent rental management agreements constituted a single transaction requiring compliance with federal and state securities laws. The District Court held in favor of the defendants and the Ninth Circuit affirmed and held that the purchase agreements, when coupled with the rental management agreements, did not constitute the sale of securities.
The Ninth Circuit noted that an eight- to 15-month gap between when the owners purchased the condo units and when they entered into the rental management agreements suggested that these were distinct transactions that did not require compliance with securities regulations. Furthermore, the plaintiffs set forth no evidence that the purchase contracts and the rental management agreements were offered as a package or were otherwise connected transactions. The plaintiffs also failed to allege that they were induced to buy the condos by the rental agreement. “The economic reality as we see it is that these two transactions were distinct.” Salameh, 726 F.3d at 1132.
In Salameh, the Ninth Circuit Court makes clear that condo offerings associated with rental programs can be real estate offerings – i.e., not securities – if properly structured. There are several stated and implied guidelines for structuring the sale of hotel condo units with voluntary rental programs that can assist with avoiding SEC compliance issues:
- Separate the timing of the sale of the condo from the disclosure of the rental agreement and its terms. It must be clear that the purchase of the condo unit was not influenced by the availability of the rental program. In other words, the rental program may not serve as an incentive for the purchaser to buy the condo.
- Ensure that the execution of the purchase agreement and the execution of the rental agreement are distinct transactions.
- Avoid inducing buyers to enter into rental programs.
- Do not attempt to persuade a buyer to purchase a unit by discussing and offering information about an offered rental program.
- Avoid pooling revenues from condos and sharing profits amongst various owners.
- Include investment disclaimers in the agreements.