Hard Rock Hotel Update: Buying a Condominium Unit is NOT Buying a “Security”
A US federal judge has recently ruled — again — that buying a condominium unit is not buying a “security” as defined by the California Corporate Securities Law of 1968. See Brooks v. Tarsadia Hotels, Case No. 3:18-cv-2290-GPC-KSC (US Dist. S.D. California, June 11, 2019). The decision was handed down in yet another case involving the Hard Rock Hotel in San Diego. At issue in the case were various purchase documents and contracts for a condominium unit and for management services. The plaintiff Brooks claimed that he was fraudulently induced to purchase his condominium unit because he understood that the Defendants would be manage his unit through a Rental Management Agreement. Brooks argued that the purchase contract and the rental management agreement together were a “security” under federal and California laws. The court disagreed and dismissed the case.
The Corporate Securities Law of 1968 prohibits the sale of securities through fraud or the use of any misleading statements or omissions. See Cal. Corp. Code, § 25401. Section 25501 creates a private cause of action for violation of section 25401. However, these provisions only apply if what is being sold is a “security.” Under applicable California and federal law, a “security” is broadly defined to include any sort of investment vehicle like stock in a corporation or ownership units in a limited liability company. The key is the idea of a passive investment where money is at risk. There are two related tests used by courts here in the Golden states — the Howey test and the “capital risk” test. The Howey test requires three elements:
- An investment of money
- In a common enterprise
- With an expectation of profits produced by the efforts of others
See SEC v. W.J. Howey Co., 328 U.S. 293 (1946). The alternative “capital risk” test looks to whether money given, paid over, or invested is at risk to be lost as the business venture proceeds. See Silver Hills Country Club v. Sobieski, 55 Cal.2d 811 (Cal. Supreme Court 1961).
In Brooks, the plaintiff argued that, because of the Rental Management Agreement, his purchase of a condominium unit at the Hard Rock Hotel was a “security.” He argued that he was “lured” into the purchase of his condominium unit with the “promise” of rental income based on the Agreement. According to the plaintiff, this satisfied the Howey test and the capital-risk test.
However, as noted, the court disagreed and dismissed those parts of the case. Importantly, the court noted that there was no requirement that the rental management agreement be signed by a potential purchaser of units at the Hard Rock Hotel. Furthermore, other rental companies might have been chosen or a unit owner might manage the unit for rental purposes. That there might be the opportunity to rent a condominium or other real estate does not convert the sale of the real property into a sale of a “security.” Without more, that the sale is promoted as an opportunity to obtain rental income does not convert the sale of the real property into a the sale of a “security.”
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For more information, call corporate attorney Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard provides legal services related to business law, private securities offerings/sales, the sale/purchase of a business, and for mergers and acquisitions. Mr. Leonard can also assist with setting up a new corporate entity, annual corporate maintenance, and review and draft business contracts. Mr. Leonard can be reached at (858) 483-9200 or via email. Like us on Facebook.
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