The U.S. Court of Appeals for the Ninth Circuit has affirmed the dismissal with prejudice of a putative securities class action concerning the sale of 420 hotel-condominium units at the Hard Rock Hotel in San Diego. The appeal attracted competing amicus briefs from the Securities and Exchange Commission and real estate business groups because of its potentially far-reaching effects on future resort real estate developments. Ballard Spahr attorney Daniel M. Benjamin successfully represented the defendant real estate brokerage firm in the appeal and before the trial court.

The plaintiffs in Salameh v. Tarsadia contracted to purchase hotel-condominium units at the Hard Rock Hotel that were subject to restrictions that included a city zoning ordinance limiting owner occupancy to 28 days each year. Owners of units also were subject to additional restrictions related to the operation of the hotel and the services provided to the condominium units. Months after the plaintiffs contracted to purchase the units, but before the hotel’s completion, the plaintiffs signed optional rental management contracts with an alleged affiliate of the developer.

The plaintiffs and the SEC argued that the optional rental program was sold as a “package” with the sale of the units, and that the units therefore constituted securities under Hocking v. Dubois, a 1989 Ninth Circuit decision. In that case, the Ninth Circuit had concluded that packaging the sale of real estate with a rental program created an investment contract (i.e., a security) because the purchaser invested money in a common enterprise and with an expectation of profits by the efforts of others.

In Salameh, the Ninth Circuit based its decision on Hocking. In doing so, however, the court concluded the Salameh purchasers were unable to allege that the sale of the units was inherently packaged with rental management agreements at the time of purchase. The Ninth Circuit explained that “[a] large time gap between the real estate purchase and the execution of a rental-management agreement may not be dispositive in every case,” but that in this case it “underscores” that the two contracts were not sold as a package.

The court also considered the plaintiffs’ argument that the “economic reality” of the transaction was such that the purchasers had to enter into rental agreements. It rejected that argument, explaining: “Plaintiffs’ economic-reality argument rests on the implicit assumption that the only viable use for the condominiums was as an investment property, but there is no plausible reason why there cannot be a viable market for owner-occupied hotel-condominiums for use as short-term vacation homes.”

In making its arguments as an amicus, the SEC relied upon its oft-cited 1973 release on when the sale of condominiums constitutes the sale of a security (see Applicability of the Federal Securities Laws to Offers and Sales of Condominiums or Units in a Real Estate Development, Securities Act Release No. 33-5347 (January 4, 1973)). The Ninth Circuit, however, declined to adopt the SEC’s reasoning. In particular, the court noted that its decision in Hocking was issued after the 1973 Release and controlled the disposition of the case.

Many following the Salameh case and the SEC’s amicus position feared the adoption of a new ambiguous “economic reality” test that would dramatically undercut the underwriting assumptions for hotel-condominiums. Although careful structuring of any hotel-condominium is still required, by retaining the Hocking test, the Ninth Circuit reinforced long-standing interpretations of securities laws.

Ballard Spahr’s Real Estate Department has substantial experience counseling real estate developers and brokers in regard to all issues concerning real estate development, including the potential application of the securities laws to the development, structuring, and sale of hotels, resorts, and mixed-use projects. The firm’s Litigation Department has substantial experience defending clients against securities claims, class actions, and other litigation concerning real estate development.

For more information, please contact Christopher W. Payne, Practice Leader, Resort and Hotel Group, at 303.299.7345 or; Roger D. Winston, Team Leader, Mixed-Use Development and Condominiums Team, at 301.664.6201 or; M. Norman Goldberger, Practice Leader, Securities Enforcement and Litigation Group, at 215.864.8850 or; or Daniel M. Benjamin at 619.487.0787 or 

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