Published on: October 30, 2014

The “new breed” of condominium hotels — Key to financing new hotel development? Selling condo hotels as “securities” under new SEC Rule 506(c) . . .

By Jim Butler and the Global Hospitality Group®

30 October 2014

Click here for the latest articles on Condo Hotels.

Condo hotel revolution and resurgence:
Why developers are using “new breed” of condo hotels for financing

One “little” legal change has revolutionized and revitalized condo hotels

Jim Butler, Bob Braun and Guy Maisnik
Condo Hotel Lawyers

The condo hotel lawyers at JMBM have helped clients with more than 100 condo hotels and hotel condos. Our experience proves that well-structured condo hotels play a valuable role and have earned an enduring legacy in the hospitality industry. They make new hotel development feasible where limited financing and high construction costs would otherwise be prohibitive. And now one recent legal change sweeps away some of the knotty issues that have hampered condo hotel growth, and reignites the popularity of this approach with a “new breed” of condo hotels.

We are now at a pivotal point for condo hotels. We are witnessing the complete turnaround in the way developers will structure condo hotel deals — particularly for high-end and luxury properties. This 180 degree turnaround in approach is creating a new and better breed of condo hotels that builds upon past successes and takes a giant step forward.

This was all accomplished with the stroke of a pen late last year when the Securities and Exchange Commission (SEC) adopted Rule 506(c) in response to the express requirements of the JOBS Act. The JOBS Act required the SEC to eliminate the prohibition on using “general solicitation” in private placements under Rule 506 where all the purchasers of the securities are “accredited investors.” Effectively, this single legal change has suddenly made it feasible for most hotel developers to structure and sell their condo hotel projects as “securities.”

This is a big change! Over the past 50 years or more, with only a few isolated exceptions, all condo hotel deals were tortured monstrosities of legal convolution. Because of the prior securities laws, it was not practical for most developers to have their offering be considered a “security” because it was not practical to register the securities with the SEC (as in an IPO), and general public solicitation is essential to the sale of real estate like condo hotel units. However, under the prior law, achieving the critical “non-security” status imposed some nonsensical legal requirements.

Most of these absurdities resulted from the fact that investors typically buy condo hotels as an investment and want the kind of information that would be relevant to making an intelligent investment decision. However the prior SEC rules effectively prevented developers from selling condo hotels as an investment with the relevant information and structure to provide the greatest prospects of success. This created the practical paradox that it was illegal for developers to sell condo hotels as an investment, but it was not illegal for buyers to purchase condo hotels as an investment (and most buyers did so).

Practical implications of the new approach

In other articles, we intend to provide more background and detail for those who are new to the condo hotel scene. But this piece is designed for those who already know the basics, and perhaps even struggled with the limitations of condo hotel structure under the old rules. Thus, we move straight to the key considerations that hampered condo hotels under the old rules, and explore how the “new breed” of condo hotels (structured as securities to take advantage of the latest legal changes) is now positioned to become the dominant approach for this entire niche.

The table below summarizes some of the most significant requirements or features that distinguish the old approach of avoiding security status (and the old SEC rules on private offerings), from the new approach of accepting security status and complying with the new Rule 506(c). The critical requirement for the new approach is that all buyers of condo hotel units must be “accredited investors.” Generally speaking, this means that each purchaser must meet the requirement of either (1) a minimum net worth of $1 million (excluding primary residence), or (2) a minimum income of more than $200,000 per year (or $300,000 for a married couple) for each of the last two years, and reasonably expects the same for the current year.

So here it is in a nutshell, or in this case, a table.

Summary of the big changes wrought by new SEC Rule 506(c)
and how it will revolutionize condo hotels

	Requirement or Feature	Old condo hotel approach: Avoiding “security” status	Revived condo hotel approach: Embracing “security” status
1.	Public solicitation or advertising to promote the condo hotel	Prohibited if condo hotel is a “security” but allowed if security status is avoided. However, if the developer inadvertently fails over any of the strict prohibitions in avoiding security status, the offering then becomes a security and the public solicitation made impossible any colorable claim of a private offering.	Allowed. The new rule permits a public solicitation to investors even for a private offering under 506(c) as long as all the ultimate buyers are “accredited investors” meeting minimum net worth and income standards. The requirement of a prior relationship with each potential customers is eliminated.
2.	Selling condos based on investment merit	Prohibited. Cannot emphasize economic, profit or tax benefits of the investment.	Allowed. Can provide full and accurate information.
3.	Promote hotel brand and rental program	Prohibited. Cannot give any information prior to purchase of condo hotel, even on availability or terms of the rental program, except to say: “Ownership may include the opportunity to place your home in a rental arrangement.”	Allowed. Can provide full details of rental program, copies of relevant agreements and contract terms.
4.	Provide relevant financial information about investment (such as comparable hotel performance and real estate values, projections of cash flow and expenses of condo association)	Prohibited. All this highly relevant information is prohibited. Best answer was, “Because of legal regulations, we are prevented from providing this information.”	Allowed. Full and fair disclosure of all appropriate information is permitted, including projections.
5.	Require condo buyers to participate in hotel rental program	Prohibited. Cannot provide any terms about rental program until after sale of condo, and then cannot require any rental program participation. Participation in the rental program must be completely voluntary.	Allowed. Sale of each condo unit can be conditioned on contemporaneous execution of mandatory rental program agreement, maintenance agreement, and related documents.
6.	Limit buyer’s rental of condo to program offered by hotel and operator’s front desk	Prohibited. Cannot impose any substantial restriction on buyer’s use or rental of condo unit. Presented serious issues of multiple rental agents, security, access, maintenance, and the like.	Allowed. Seller can impose any reasonable contractual conditions to create harmonious condo hotel regime.
7.	Limit buyer’s use of condo	Prohibited. Seller cannot impose restrictions on owner use. Certain use restrictions mandated by municipalities or local government can be passed through to the buyers, at some risk.	Allowed. No limitation on use restrictions as part of sale or rental program (e.g. owner will not use condo for more than 180 days in any calendar year).
8	Require buyer to rent condo when not in use	Prohibited. As with the preceding item, developers generally accepted the risk that they could pass through government-mandated requirements that buyers rent their condos, but this was somewhat problematic.	Allowed.
9	Pooling of income and expenses for owners	Prohibited. Each owner’s income and expenses must be accounted for separately, and must address issues of rotation so all owners get fair share of income.	Allowed.
10	Use single sales force for selling real estate and rental participation program	Prohibited. Under the Intrawest no action letter, the rental program cannot be discussed until after the buyer has purchased the unit, and then the rental program must be handled by a completely separate team of professionals from those who handle real estate sales.	Allowed.
11.	Licensing	Real estate broker. As long as the condo hotel is not a security, no securities broker licenses are required.	Real estate broker and securities broker required. Best to find dual licensed sales force.
12.	Operator considerations	Many operators have shied away from branding or managing condo hotels because the limitations imposed on avoiding security status present operational issues (such as guaranteeing adequate room inventory and consistency of hotel product).	Many operators will find the new structure satisfies virtually all of their concerns with the condo hotel approach. Branding a new breed condo hotel is similar to branding a hotel owned by a REIT or other investment vehicle — there is no impact on hotel operations.
13.	Securities liabilities	Some felt that avoiding securities status avoided securities liabilities. The highly technical and strict requirement of achieving this status may impose greater liability for inadvertent failures, and create a false sense of comfort. Unhappy investors typically sue and claim the offering did involve the sale of a security and failed to have any exemption (such as Rule 506).	Well-structured and documented securities offering may offer less legal exposure to all concerned than the alternative.

Other condo hotel resources

You can access the full library of Condo Hotel materials on Hotel Law Blog by going to the home page, selecting the tab at the top that says “HOTEL LAW TOPICS”, and then clicking on “Condo Hotels” in the drop down menu . . . or by clicking here.

Below is a partial listing of articles by JMBM’s Condo Hotel Lawyers:

This is Jim Butler, author of www.HotelLawBlog.com and hotel lawyer, signing off. We’ve done more than $87 billion of hotel transactions and have developed innovative solutions to unlock value from hotels. Who’s your hotel lawyer?

Our Perspective. We represent hotel owners, developers and investors. We have helped our clients find business and legal solutions for more than $125 billion of hotel transactions, involving more than 4,700 properties all over the world, including more than 100 condo hotels and hotel condos. For more information, please contact Jim Butler at jbutler@jmbm.com or +1 (310) 201-3526.

Jim Butler is a founding partner of JMBM, and Chairman of its Global Hospitality Group® and Chinese Investment Group®. Jim is one of the top hospitality attorneys in the world. GOOGLE “hotel lawyer” and you will see why. Jim and his team are more than “just” great hotel lawyers. They are also hospitality consultants and business advisors. They are deal makers. They can help find the right operator or capital provider. They know who to call and how to reach them.

Jim Butler

Jim Butler is recognized as one of the top hotel lawyers in the world. He devotes 100% of his practice to hospitality, representing hotel owners, developers and lenders. Jim leads JMBM’s Global Hospitality Group® — a team of seasoned professionals who have helped clients around the world with more than 4,700 hospitality properties worth more than $125 billion.
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Robert Braun

Robert Braun is a partner in JMBM's Corporate Department and a senior member of JMBM's Global Hospitality Group® -- a team of seasoned professionals who have helped clients around the world with more than 4,700 hospitality properties worth more than $125 billion. Bob represents owners in both transactional and operational issues. He advises clients with respect to business formation, financing, mergers and acquisitions, venture capital financing, joint ventures and strategic partnerships. He has represented hotel owners in the negotiation of several hundred management agreements, as well as spa management and franchise agreements. Bob also advises hotel owners regarding telecommunications, software, internet, e-commerce, data processing and outsourcing agreements. To read Bob's articles, go to www.HotelLawBlog.com and select "Management Agreements." For more information, please contact Bob Braun at 310.785.5331 or rbraun@jmbm.com.

Marta Fernandez

Marta Fernandez is a partner in JMBM's Employment and Labor Department and a senior member of JMBM’s Global Hospitality Group® -- a team of seasoned professionals who have helped clients around the world with more than 4,700 hospitality properties worth more than $125 billion. As a management labor lawyer with more than 20 years of experience, Marta specializes in representing hospitality industry clients in all aspects of labor and employment including labor-management relations such as union prevention, collective bargaining for single as well as multi-employer bargaining units, neutrality agreements and defense of unfair labor practice charges before the NLRB. She defends employers in administrative and litigation claims, such as employee claims of sexual harassment and discrimination and counsels clients in preventative strategies such as executive training, arbitration enforcement, and policies and procedures. To read Marta's articles, go to www.HotelLawBlog.com and select "Labor & Employment." For more information, please contact Marta Fernandez at 310.201.3534 or at mfernandez@jmbm.com.

Guy Maisnik

Guy Maisnik is a partner in JMBM's Real Estate Department and a senior member of JMBM's Global Hospitality Group® -- a team of seasoned professionals who have helped clients around the world with more than 4,700 hospitality properties worth more than $125 billion. Guy's deep and broad transactional practice includes complex real estate finance and venture capital transactions, including project finance, commercial finance, leveraged leasing and real estate acquisitions. He assists clients with development, leasing and disposition, loan portfolio acquisitions, loan and debt restructure, workouts and real estate exchanges. Go to www.HotelLawBlog.com for current information in these areas. For more information, please contact Guy Maisnik at 310.201.3588 or mgm@jmbm.com.

David Sudeck

David Sudeck is a Partner in JMBM's Real Estate Department and a senior member of JMBM’s Global Hospitality Group® -- a team of seasoned professionals who have helped clients around the world with more than 4,700 hospitality properties worth more than $125 billion. David has significant experience in the vacation ownership arena, focusing on the formation and registration of condominiums, timeshares and fractional interest regimes. He negotiates hotel, spa and restaurant management agreements, and assists client in the development, acquisition, sale and leasing of hotels, golf courses and restaurants. For David's take on current issues in the timeshare arena, go to www.HotelLawBlog.com and click on the topic, "Timeshare." For more information, please contact David Sudeck at 310.201.3518 or dsudeck @jmbm.com.

Robert Kaplan

Robert Kaplan is a partner in JMBM's Bankruptcy, Insolvency and Restructurings Group and a senior member of the Global Hospitality Group® -- a team of seasoned professionals who have helped clients around the world with more than 4,700 hospitality properties worth more than $125 billion. Bob represents lenders, special servicers, hard money lenders, community banks, national banking associations, distressed debt investors, and equity investors, positioning them for the best possible outcome by acting expeditiously to preserve value and increase cash flow. His industry experience and his knowledge of the current capital markets -- where distressed assets often include complex deal structures and securitized loans -- allows him to bring creative and effective strategies to the table. When aggressive litigation is the best strategy, he is a vigorous and effective advocate for his clients. Bob represented the securitized lender in the Chapter 11 bankruptcy case filed by the Clift Hotel in San Francisco, and in the subsequent negotiations and successful sale of the loan to a third party. The lender -- acting by and through GMAC Commercial Mortgage Corporation as special servicer -- was the holder of a $60 million loan secured by a Deed of Trust on the Clift Hotel. He has also served as counsel to CapMark, J.E. Robert Company, Inc., AMRESCO Management Inc. and Midland Loan Servicer in their capacity as special servicers on troubled hotel loans in CMBS pools. For more information, contact Robert Kaplan at 415.984.9673 or rkaplan@jmbm.com.

Martin Orlick

Martin Orlick is a partner in JMBM's Real Estate Department and a senior member of JMBM's Global Hospitality Group® -- a team of seasoned professionals who have helped clients around the world with more than 4,700 hospitality properties worth more than $125 billion. Marty specializes in representing hospitality industry clients in Americans With Disabilities Act (ADA) compliance and defense. He has represented more than 500 businesses in ADA issues, many of them hotels and restaurants, as well as hotel mixed-use properties. Marty is a member of the American College of Real Estate Lawyers (ACREL) and a frequent speaker on the ADA and other topics. To read Marty's articles, go to www.HotelLawBlog.comand select "ADA." For more information, please contact Marty Orlick at 415.984.9667 or morlick@jmbm.com.

Scott Brink

Scott Brink is a senior member of JMBM's Global Hospitality Group® and a partner in JMBM's Labor & Employment Law Department. Scott is a management labor lawyer with more than two decades of experience representing employers in all aspects of labor relations and employment law including union prevention, collective bargaining negotiations, defense of unfair labor practice charges before the NLRB, wrongful discharge litigation, individual and class action employment discrimination and wage-and-hour claims, sexual-harassment litigation, arbitrations, personnel policies, California wage and hour law, and employee discipline and discharge. An experienced trial attorney, Scott has litigated a number of high-profile and complex cases involving a wide range of labor and employment law matters. For more information, contact Scott Brink at RSB@jmbm.com or 310.785.5365.

Travis Gemoets

Travis Gemoets is an experienced trial attorney and represents management in all facets of labor and employment law, including wage/hour class actions, claims of discrimination, harassment, wrongful termination, trade secrets and unfair competition, union/management relations and workplace violence. He is a member of JMBM's Global Hospitality Group(r), in which capacity he negotiates union contracts and resolves labor disputes throughout the country, defends class action claims, develops strategies for the mass onboarding and separation of employees, and recommends proactive changes to employers' policies and practices in order to minimize potential liability risks. Reach him at 310.785.5387 or tgemoets@jmbm.com.

Mark S. Adams

Mark S. Adams is an experienced trial lawyer and a member of JMBM's Global Hospitality Group® and Chinese Investment Group™. He focuses his practice on business litigation including contracts, corporate and partnership disputes, and hospitality disputes and litigation. On behalf of hotel and resort owners, Mark has successfully litigated the termination of long-term, no-cut, hotel management agreements, franchise agreements, fiduciary duty issues, investor-owner disputes, TOT assessments, and more. He has wide-ranging trial experience in a variety of commercial disputes, including complex multi-party litigation and class actions. He has tried numerous cases in state courts, federal courts, and in domestic and international arbitrations, and is a frequent author and speaker on trial practice. Mark's trial wins have been covered by Forbes, Reuters, and other publications. He has obtained two of California's annual 50 largest jury verdicts in the same year. Mark has taken or defended nearly 1,000 depositions throughout North America, Europe and the Middle East. He has been quoted as an expert on noncompete agreements in the Wall Street Journal. For more information, contact Mark at 949. 623.7230 or markadams@jmbm.com.

Bennett Young

Bennett Young is a partner in JMBM's Bankruptcy, Insolvency and Restructurings Group and a senior member of the Global Hospitality Group® -- a team of seasoned professionals who have helped clients around the world with more than 4,700 hospitality properties worth more than $125 billion. His clients include lenders, financial institutions, secured and unsecured creditors, distressed investment funds, businesses, receivers, special servicers and creditors' committees. Ben represented the owner of a partially completed multi-billion dollar resort property in the restructuring of its finances and has represented lenders to hotels and casinos. For more information, contact Ben Young at 415.984.9626 or byoung@jmbm.com

Sheri Bonstelle

Sheri Bonstelle is a partner in JMBM's Government, Land Use, Environment and Energy Department, and a member of JMBM's Global Hospitality Group®. She represents owners and developers in land use, zoning, environmental, litigation and construction matters. She manages all aspects of the entitlement process, including representing clients before local and state agencies, commissions and councils. Sheri also represents clients in a variety of land use and real estate litigation matters in state and federal courts, including cases arising under CEQA and other environmental laws. Her hotel experience includes handling the adaptive reuse of an historic office building as a luxury boutique hotel. For more information, please contact Sheri Bonstelle at 310.712.6847 or SBonstelle@jmbm.com.

Kevin McDonnell

Kevin McDonnell is a partner in JMBM's Government, Land Use, Environment and Energy Department, and a member of JMBM's Global Hospitality Group®. Kevin represents developers and owners of hotels in a broad range of land use and zoning issues including entitlements, code enforcement, easements and parking requirements, as well as related Parcel Map and Tract Map subdivision issues. His hospitality experience includes hotels, condo-hotels and mixed-use projects. A registered Civil Engineer and Structural Engineer in California, and a former building official for the City of Los Angeles, Kevin brings unique experience and insight in Zoning and Building Code applications and Code Enforcement issues. For more information, please contact Kevin McDonnell at 310.201.3590 or kkm@jmbm.com.

Jamie Ogden

Jamie Ogden is a tax lawyer at Jeffer Mangels Butler & Mitchell LLP. He advises individuals and businesses on a range of tax planning, tax controversy and estate planning matters. Jamie’s experience includes all tax aspects with respect to the hospitality industry, including acquisitions and dispositions (including Section 1031 exchanges), financing and management agreements. He also serves as lead tax counsel on M&A transactions, financing, internal corporate restructurings and deferred compensation matters. Jamie also works frequently with litigators on the tax aspects of litigation, judgments and settlements. Jamie has extensive experience with foreign compliance matters, including each variation of the IRS amnesty programs. In addition to his experience in private practice, Jamie also brings several years of service from both state and federal government. For more information, contact Jamie at JOgden@jmbm.com or 310.201.3510.

Wei Deng

Wei Deng is General Counsel of Bosen American Capital, Inc. where in addition to his legal duties, he is responsible for sourcing, evaluating and proposing United States investment opportunities to the company. Wei was previously with JMBM, where he focused on transactional and litigation matters.

Jay Thompson

Jay Thompson has extensive experience representing private companies, business owners, family offices and investors in mergers and acquisitions, private equity and venture capital transactions and private securities offerings. Jay serves as general counsel to many of his clients, their management, and board of directors, helping to shape and execute their business strategies, facilitate growth and liquidity, as well as to advise them on day-to-day legal and other strategic issues. He is known for his practical approach to business issues. Contact Jay at JThompson@jmbm.com or 949.623.7258

Marianne Martin

Marianne Martin has nearly fifteen years of experience advising clients on a variety of commercial, financing, bankruptcy, restructuring and M&A matters, with a particular niche dealing with distressed and/or turnaround situations. Her clients frequently include private equity and hedge funds, independent sponsors, family offices, public and private corporations, financial institutions and banks, healthcare-related companies, municipalities and venture capital funds. She has represented clients in various capacities, including as borrowers/debtors, lenders, acquirers, and agents/trustees in negotiating and documenting complex commercial transactions, out-of-court restructuring transactions and advising on purchasing considerations in secondary market debt transactions. Contact Marianne at MMartin@jmbm.com or 310.201.3531

Trevor Countryman

Trevor Countryman is an associate in the firm's Real Estate Department. He advises clients in all aspects of real estate transactions including property acquisitions and dispositions, financing, leasing, development and construction. Trevor's clients range from large funds to individual developers and opportunistic investors, engaged in deals involving office, retail, multi-family, single-family, mixed-use and hotel properties. Contact Trevor Countryman at 310.201.3546 or TCountryman@jmbm.com.

Vanessa Han

Vanessa Han is an associate in JMBM's Corporate group. Vanessa can be reached at VHan@jmbm.com or 310.785.5383

Vince Farhat

Vince Farhat is Chair of JMBM's White Collar Defense and Investigations practice. Vince has extensive jury trial experience and focuses his practice on representing companies and individuals in criminal and civil investigations and prosecutions by government enforcement agencies, as well as complex federal litigation. He also advises companies in connection with complex and sensitive internal investigations. Prior to joining JMBM, Vince served as an assistant United States attorney in the Major Frauds Section of the U.S. Attorney's Office for the Central District of California. Contact Vince Farhat at 310.785.5382 or VFarhat@jmbm.com.

Ask the Hotel Lawyer™ is a quarterly column that I write for JMBM's Global Hospitality Advisor®. If you have a question you would like to submit to Ask the Hotel Lawyer™ please use the comments box below. While your question may not be of sufficient general interest for the column, I will try to respond to you individually if you leave your contact information below.
Jim Butler.