<big>In commercial real estate transactions, disclosures and representations are often heavily negotiated terms. Sacramento real estate attorneys work with the Buyers and Sellers where the Buyer/Investor seeking complete disclosure and subsequent liability of the Seller, while the Seller seeks the opposite. In a recent decision, some investors were buying tenancy-in-common interests in an office complex and were provided with a Private Placement Memorandum that explained how expensive and risky the investment would be. But they claimed that they relied on representations of the selling agents instead.
In WA Southwest 2, LLC v. First American Title Insurance Company et al., The plaintiffs had sold an investment property and needed to complete a 1031 exchange to defer capital gains. They did so by making a tenancy-in-common investment in an office building in Tempe, Arizona. Involved in the investments were the defendants- a title company, a tax attorney, and the real estate broker. The property failed and was lost to foreclosure, and plaintiffs filed this suit. They claimed that they were misled by defendants’ misrepresentations regarding the sales load and risks of the investment (sales load being the fees, expenses, and commissions paid). Plaintiffs claimed that they would not have invested in the Property had they known that the total sales load percentage actually exceeded the 15 percent capital gains tax they had sought to defer.
At issue in this case was the statute of limitations– they made the investment in 2006, and filed suit in 2012. However, plaintiffs argued that the court should apply the delayed discovery rule. This rule delays starting the time running when until the plaintiff discovered, or had reason to discovery, the claim. In making this argument, the plaintiffs must show that they were reasonably diligent, but still could not have discovered it sooner.
The court described what plaintiffs claimed to be misleading representations as a recommendation that the plaintiffs should make the investment “because it has been subjected to thorough due diligence review, is designed and structured by experts for the tenants in common, offers long term professional experienced management and leasing and will allow you to invest more of your money in income producing property because the sales loads are less than 10% while the taxes you will have to pay if you do not timely invest will be 15%. ”
To the claim that the sales load was greater than 10% (it was more than 20%), the court looked at the Disclosures in the private placement memorandum which the plaintiffs received. The memo stated that the facilitator was buying the property for $11,600,000, which was not market value, nor would an appraisal be done. The total investment cost was to be $13,170,000, over 11 million dollars more than the price of the property.
“The Investment Cost consists of the purchase price of $11,600,000 payable to the seller plus the costs described herein, including:
(i) the Acquisition Fee of $505,000 payable to Acquisitions for identifying and analyzing the Property, negotiating the contract to purchase the Property and assigning the purchase contract to the Purchasers;
(ii) selling commissions and due diligence allowances;
(iii) organizational and offering expenses;
(iv) loan costs and fees payable to the Lender;
(v) closing costs …;
(vi) working capital reserves …; and
(vii) $300,000 in reserves which Acquisitions expects the Lender will withhold from Loan proceeds.
Right off the bat, in (i) above, the facilitator is being paid over half a million for putting the deal together.
Plaintiffs argued that the statute of limitations did not begin to run until, after the foreclosure, they consulted with tax experts who pointed out the problems. However, these plaintiffs were all accredited investors who had received the private placement memorandum. Reasonable diligence on their part does not allow them to ignore the memorandum. The court found that the entire sales load, including the $505,000 fee, was disclosed to them prior to closing the deal. The court found that they were on notice that the sales load exceeded the 15% capital gains rate they were trying to defer. Perhaps the plaintiffs didn’t do the math.
Not that it was required for the decision; the Court also quoted the placement memorandum’s bold-faced all caps disclosure:
“THE INTERESTS AND INVESTOR UNITS OFFERED HEREBY ARE HIGHLY SPECULATIVE. AN INVESTMENT IN THE INTERESTS OR INVESTOR UNITS INVOLVES SUBSTANTIAL INVESTMENT AND TAX RISKS.” “THE PURCHASE OF INTERESTS AND INVESTOR UNITS INVOLVES SIGNIFICANT RISKS. INVESTORS MUST READ AND CAREFULLY CONSIDER THE DISCUSSION SET FORTH BELOW IN ‘RISK FACTORS.’ ” “PURCHASE OF THE INTERESTS AND INVESTOR UNITS IS SUITABLE ONLY FOR PERSONS OF SUBSTANTIAL MEANS WHO HAVE NO NEED FOR LIQUIDITY IN THEIR INVESTMENT.”</big>