Condo Hotels As Securities: Has the Litigation Boom Begun?

By Dan Brown Partner, Sheppard Mullin Richter & Hampton LLP | January 14, 2010

During the past couple of years, it's been hard to miss articles in the press concerning one or more aspects of the proliferation of the "condo hotel." Those articles have generally dealt with potential issues that might arise from the new mixed property uses, the soundness and reasons for investments in condo hotels, and legal issues relating to the purchase, sale, and management of the condo hotel. One potential issue that was the subject of many articles concerning the condo hotel boom - - including an article by this author - - was whether dissatisfied condo-hotel unit owners would seek to assert claims against developers alleging that the sale of a condo hotel unit constitutes the sale of a security, thus giving rise to the right to rescind a condo unit purchase contract and seek damages, under federal and state securities laws.

Thus it is not surprising that a review of recent press reports concerning failing condo hotel projects indicates that disgruntled condo hotel owners and investors are, indeed, relying on federal and state securities laws to attempt to rescind their purchase agreements and seek damages. As such, and because the issue of whether the sale of a condo hotel unit constitutes the sale of a security has been thus far unresolved by any court, the outcomes of these first cases will be watched closely by, among others, attorneys, purchasers of condo hotels, developers, and management companies involved in condo hotels.

For example, the Wall Street Journal recently reported about a lawsuit filed in federal district court in Florida by the owners of condo hotel units at the Clearwater Cay Clubs Resort (the "Clearwater Resort") in Clearwater, Florida. In that lawsuit, the plaintiffs allege that the Clearwater Resorts' vendors and developers violated both federal and Florida state securities laws by fraudulently inducing them to invest in condo hotel units. Specifically, the plaintiffs allege that defendants promised them: (i) "substantial profits" from the investments through guaranteed income from a pool of short-term rental units; and (ii) capital appreciation due to a large scale conversion/development. Based on the allegation that the sale of a condo hotel unit constitutes a sale of a security, plaintiffs allege that the units were required to be, but were not, registered with the Securities and Exchange Commission ("SEC"), and seek damages.

A similar lawsuit was filed by condo hotel unit purchasers at the Resort at Singer Island (the "Singer Island Resort") in Palm Beach, Florida. The Singer Island Resort plaintiffs allege that defendants violated federal securities law by selling the condo hotel units as investments without registering the units with the SEC. As a remedy, the plaintiffs are seeking monetary damages and the rescission of their purchase agreements.

Finally, the New York Attorney General's Office has joined the condo hotel as securities fray, recently ordering The Related Group to refund pre-construction deposits to buyers who were marketed and sold Florida condo hotel units in New York State. The directive was issued under New York State securities law.

It is still difficult to predict whether the recent lawsuits alleging federal and state securities laws violations arising from the sale of condo hotels will prove to be successful. The difficulty in answering this question is, among other things, that courts have yet to decide whether a condo hotel sale constitutes the sale of a security.

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