News for the Hospitality Executive |
By
Jim
Butler
and the Global Hospitality Group®,
Author of www.HotelLawBlog.com April 15, 2011 Hotel
Lawyer with good news for well-structured condo hotel deals. With the experience gained as legal
and business
advisors on more than 100 condo hotel and hotel condo projects, we have
said
for many years that this type of project has earned an enduring place
in the landscape
of hotel and real estate development. We still believe that. The
main issues of successful hotel mixed-use development are managing
consumer
expectations, fulfilling those expectations, and creating a viable
mixed-use
regime structure. In the case of condo hotels, a viable structure must
work
from an operational standpoint, be economically sustainable, and avoid
triggering violations of Federal and State securities laws. In a
recent lawsuit, involving the Hard Rock Hotel San Diego, a federal
district
court in California ruled against the condo hotel buyers, finding that
no
securities laws were violated -- the plaintiffs did not allege facts
that would
cause the condo hotel units to constitute "securities." We see the
case as affirming the effectiveness in defeating plaintiffs' claims of
two
structural elements we have encouraged all our clients to use. My
partner, Catherine Holmes, who structures most of our condo hotel
regimes,
talks about these factors and the case below. Catherine advises clients
in the
specific business and legal aspects of condo hotel regime structuring
and
documentation, including securities compliance matters, documentation
and
training. In her article below, she talks about the case and what it
means for
us in the condo hotel world. It is good news! Condo Hotel Wars
- Developer,
Banks and Broker Win Latest Battle
As we
and other condo hotel experts predicted, the big guns being wielded by
the
plaintiffs are claims that the sale of condo hotels violated federal
and state
securities laws. In the
latest skirmish fought in the condo hotel wars, Salameh et al. v.
Tarsadia
Hotels, et al., involving the Hard Rock Hotel San Diego (HRHSD), a
federal
district court in California ruled on March 29, 2011, against the condo
hotel
buyers, finding that they did not allege facts that would cause the
condo hotel
units in the HRHSD to constitute securities. For
condo hotel developers, bankers and brokers, the case affirms some of
the
guidelines we have recommended to establish defenses against claims by
condo
hotel unit buyers based on securities law violations. Background. The HRHSD is a 420 unit hotel
condominium sold in 2006
through 2008. In December 2009, the plaintiffs filed their original
complaint
seeking class action status against seven bank defendants who provided
financing either to the project or to the unit buyers, Playground
Destination
Properties, as the broker of the units, and Tarsadia Hotels and its
affiliates,
as the developer of the project. A few months later, the plaintiffs
filed a
first amended complaint, which was dismissed by the court in July 2010.
The
plaintiffs filed a second amended complaint in September 2010. The
second amended complaint alleged federal and state securities law
violations
based on the claim that the restrictions imposed on unit purchasers
with
respect to the maintenance and use of the units created a security that
could
only be sold in accordance with federal and state securities laws.
Based on
those allegations, the plaintiffs sought to rescind their purchase of
units and
receive a return of 100% of their original purchase price, plus other
damages. Plaintiffs
Arguments. The
plaintiffs based
their securities claims on the theory that once they purchased their
units at
HRHSD, they had no control over the rental management of their units.
Even
though the rental program was voluntary, they claimed that for all
practical
purposes, it was in fact mandatory. In support of their position, the
plaintiffs argued that they were restricted by city zoning ordinance
from
staying in their units for more than 28 days per calendar year, and
they were
required to pay for the daily management, operation and marketing of
the units
as a hotel on the days that they were not allowed to personally use
their
units. As a result, the plaintiffs claimed that the economic reality of
the
project was that the units were required to be managed as part of a
common
enterprise under the rental management contract. The
plaintiffs relied largely on a 1989 case, Hocking v. Dubois, in which
buyers in
a condominium project in Hawaii were offered a voluntary rental pooling
agreement, where all of the participants would receive a portion of the
profits
of rental of the units. Court
Findings. The
court concluded that
the circumstances in HRHSD differed significantly in two important
respects
from the condominium units sold in Hocking, and that that those
differences
meant that the condo hotel units in HRHSD were not sold as securities. First,
the court found that there was a significant gap between the date of
execution
of purchase contracts for units, on the one hand, and the execution of
rental
management agreements, on the other hand. In HRHSD, the rental
management
agreement was not offered until at least 8 months after the purchasers
signed
purchase contracts. By contrast, in Hocking, a rental management
agreement was
offered just 6 days from the date of signing a purchase agreement, and
a rental
pooling agreement was offered less than 2 weeks after signing the
purchase
agreement. So, the court reasoned, the purchase contract and rental
management
contract were not offered as part of a single package, and therefore
were not
part of a single investment contract as the plaintiffs alleged. Lessons
Learned. The
court's ruling in
Salameh et al. vs. Tarsadia Hotels, et al. points out the importance of
two
elements in any condo hotel sales program:
Unanswered
Questions. What
would have happened
if the rental management contract in HRHSD had been offered at the same
time as
the purchase contract? Could other elements have been shown that,
together with
the disclaimers in the purchase contract, would have caused the court
to reach
the same ruling? The court did not discuss the other elements that the
SEC has
said are crucial to determining whether a condo hotel is a security,
although
it did mention two SEC no-action letters in passing, Marco Polo Hotel,
Inc.
(1987) and Intrawest Corp. (2002). To what extent might the other
elements in
those no-action letters influence the court's ruling? There are still
many
unanswered questions that we hope will be addressed in future
decisions. One
thing we know for certain is that the latest battle will not be the end
of the
condo hotel wars. ________________________ Catherine DeBono Holmes
is a
hotel lawyer with JMBM's Global Hospitality Group® and assists
clients with
hotel management and franchise agreements, purchase and sale
transactions, and condo
hotel regime structuring. She has significant expertise in condo hotels
and
advises clients in the specific business and legal aspects of condo
hotel
regime structuring and documentation, including CC&Rs, HOA docs,
unit
management agreements, shared facilities agreements, rental management
agreement programs and securities compliance matters (structuring,
documentation and training). For more information, please contact Cathy
Holmes
at 310.201.3553 or [email protected]. ________________________
________________________ Our
Perspective. We
represent hotel lenders,
owners and investors. We have helped our clients find business and
legal
solutions for more than $60 billion of hotel transactions, involving
more than
1,000 properties all over the world. For more information, please
contact Jim
Butler at [email protected]
or 310.201.3526. Jim
Butler is a founding partner of JMBM and Chairman of its Global
Hospitality
Group®. Jim is one of the top hospitality attorneys in the world.
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