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Florida Federal District Court Applies Howey Test in Condo Rental Program Litigation
Published: February 3, 2010
Author: Edward J. Lawton
In December of 2009 the Federal District Court for the Middle District of Florida ruled that federal securities law claims brought by disappointed purchasers of condominium units failed because their transactions did not create securities. [1]
The defendants, Pulte Home Corporation along with its sales and management agents, developed and marketed units in certain condominium communities in Florida. Short term rental management programs were available in connection with the ownership of units in these communities. Under these programs a unit owner could derive rental income from their units while the owner did not occupy its unit through the management services of a rental management firm. However, while these services were available there was no requirement that units purchased in these communities be made available for the rental management program.
The following securities law claims were alleged: the sale of unregistered securities, the sale of securities by an unlicensed person, and securities fraud. As the court noted, these claims first require the creation of a type of security known as an investment contract because real estate transactions generally do not result in the creation of a security.
An investment contract consists of three elements most notably described in SEC v. W. J. Howey and Co., 328 U.S. 293 (1946): (i) an investment of money, (ii) in a common enterprise, and (iii) with the expectation of profits to be derived solely from the efforts of others. The court applied these factors to the Pulte condominium developments and determined that no investment contract was created (and therefore no security existed) because of the control each unit owner had the right to exercise over its unit.
The court focused on the following control factors in determining that these transactions where not investment contracts:
- The purchase transactions bore the indicia of standard real estate transactions with specifically identifiable units, independent escrow agents, and the purchase of specific units of real property which the purchase contracts stated would be the possession of the purchasers at the closing who became responsible for the maintenance and upkeep of the units at the time of their respective closings.
- The purchase agreements made clear that the rental programs were completely separate from the purchase of the real estate and there was a clear statement that there was no obligation of the purchasers to participate.
- The fact that the defendants entering into the rental management program pre-closing did not mean they were required to, rather they exercised their control rights over their units in making that decision.
Edward J. Lawton is a member of Axley Brynelson, LLP’s Business Practice Group. His practice focuses on a variety of business matters including the acquisition and disposition of businesses and real estate. For more information on the Howey test, please contact Mr. Lawton at 608.283.6717 or elawton@axley.com.
[1] Bamert et al. v. Pulte Home Corporation et. al., 6:2008-cv-02120.
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