E-Newsletter: Sale of Condominium Units & Compliance with Securities Law

E-Newsletter: Sale of Condominium Units & Compliance with Securities Law

Developers need to be aware that if the sale of a condominium unit is deemed the sale of a “security” that is not either registered with the Securities and Exchange Commission (“SEC”) or exempt from registration, buyers may be able to rescind the sale and developers may have to register with the SEC. Condominium units become securities only if offered or sold in such a manner as to create an “investment contract” or other type of security consisting of the condominium units and certain profit-making or profit-sharing arrangements. Under federal law, a sale of a condominium unit will be considered a security if it involves a contract, transaction or scheme whereby the purchaser (1) invests money in a (2) common enterprise and is (3) motivated or led to expect profits derived substantially from the efforts of the developer or a third-party designated or arranged by the developer.

 In order to avoid the sale of securities, a developer should avoid the following when selling units:

  • AVOID making express or implied representations as to the increasing value of property, other than mere mention of the general tendency of real estate values to appreciate.
  • AVOID mandatory rental programs, make-available-for-rent provisions whereby the purchaser must hold his unit available for any part of the year, mandatory use of exclusive rental agents or other mandatory collateral services. 
  • AVOID discussion of income or tax benefits that may be derived from ownership and rental of real estate.
  • AVOID representations regarding rental rates offered to the public for comparable facilities in the area. In addition, avoid representations regarding historical occupancy rates of similar facilities in Hawaii.
  • AVOID offering a rental pool arrangement in conjunction with the sale of any condominium unit.
  • AVOID establishing any resale arrangement or suggestion that resale for profit may be made.
  • AVOID offering rental services with an emphasis on economic benefits to the purchaser to be derived from the managerial effort of the developer or some third party. In addition, avoid entering into rental management agreements immediately after executing the sales contract.

In implementing a marketing and sales program, the developer should consider doing the following:

  • Keep a “burden of proof” file containing salespeople’s receipts for sales guidelines, memos of instruction sessions with the sales personnel on the sale of securities and records of enforcement procedures against sales personnel who violate the sales guidelines.
  • Warn all individual sales personnel that the SEC may send their own personnel posing as potential buyers (“shills”) to check if sellers are complying with the SEC guidelines. In addition, a seller should send their own shills to confirm whether selling procedures are being followed.
  • Emphasize to sales personnel that they risk being fired if they violate the sales guidelines.
  • Obtain receipts from purchasers, brokers and/or all others connected with a sale, that no rental representations have been made to them. If the purchaser refuses to sign such a receipt, then seller should cancel the sale.
  • Ensure that any sales contract with a prospective buyer is not made subject to any existing rental arrangement.

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