Tenants-In-Common Arrangements and the Securities Laws
Tenants-in-common (TIC) real-estate arrangements – where there is no separate entity such as a limited liability company that owns the property but the investors are each listed on the deed – have certain advantages regarding 1031 real-estate exchanges. Even if a TIC meets the IRS requirements for a 1031 exchange, though, that does not mean that sales of TIC’s are exempt from the securities laws. In fact, many TIC interests are securities. (See generally, Triple Net Leasing, LLC, SEC No-Action Letter, 2000 SEC No-Act. LEXIS 824 (Aug. 23, 2000).) TIC interests that are securities may be offered only in compliance with exemptions to the registration requirements of the securities laws. The only debate is whether all TIC’s that are offered as investments are securities or whether properly structured ones may be real-estate interests only.
Some believe that a TIC may not be a security if no management agreement is part of the offering, and the investors are allowed to choose the manager of the TIC and the manager is not the sponsor or an affiliate of the sponsor. This is based on the seminal U.S. Supreme Court case of SEC v. Howey, 32 US 293 (1946) and buttressed by cases such as Williamson v. Tucker, 645 F.2d 404 (5th Cir. 1981).
Unfortunately, at a 2007 Tenants-in-Common membership symposium, David Lynn, chief counsel in the SEC Division of Corporate Finance, stated that SEC v. Mutual Benefits Corporation, 408 F.3d 737 (11th Cir. 2005), which dealt with viatical contracts, reflected the SEC’s opinion that significant pre-purchase managerial activities undertaken to insure the success of the investment in themselves may well make the TIC interests securities. Of course, it would be extremely difficult for a sponsor to offer TIC interests without taking pre-purchase activities to aid the success of the investment. Further, the National Association of Securities Dealers, in a March 2005 Notice to Members stated that "when TICs are offered and sold together with other arrangements, they generally would constitute investment contracts and thus securities under the federal securities laws." The Notice indicates that "other arrangements" occur, for example, when the TIC sponsor structures the TIC and negotiates the sale price and the loan. (http://www.finra.org/web/groups/rules_regs/documents/notice_to_members/p013455.pdf)
A definitive resolution (at least at the federal level) may not occur unless and until the U.S. Supreme Court rules on this issue but, given the SEC’s view, taking the position that some TIC interests are not securities is certainly risky. Violating the securities laws not only subjects the sponsor to civil action – and even possible criminal liability – it may well cause a default under the loan documents with the lender financing the TIC.
Of course, if TIC interests are offered solely within a single state, then federal securities law does not apply. Still, some states take the position that all TIC interests are securities. For example, at a January 8, 2007, Washington State Bar Association continuing legal education offering on TIC’s and 1031 exchanges, counsel for the Washington State Securities Division stated that where TICs are being structured pursuant to an investment program they constitute securities even if post-sale management services are not included.
California even has case law indicating that all TIC’s established by a sponsor are securities. In Reiswig v. Department of Corporations(2006) 144 Cal.App.4th 327, 340, a case dealing with certificates of deposit, the Court stated that it believed "[s]ignificant pre-purchase managerial activities undertaken to insure the success of the investment may also satisfy Howey" with regard to its test for whether investments constitute securities. In making this statement the Court cited none other than the aforementioned SEC v. Mutual Benefits Corp. case (408 F.3d 737, 743 (11th Cir. 2005)) that the SEC is relying on for its position that TIC interests with significant pre-purchase managerial activities constitute securities. While the Court in the Reiswig case found that the certificates of deposit at issue did not constitute securities, its reasoning certainly forces one to conclude that, as far as offerings to California investors go, TIC interests that are offered as investments constitute securities.
Unless the case law changes, the only safe course is to assume that TIC interests offered as investments by a sponsor are securities – and for sponsors to use an appropriate securities-law exemption in making the offering.