Friday, September 07, 2018

Purchasers cannot attach securities fraud to deed transferors

By Jay Fishman, J.D.

The North Carolina Court of Appeals affirmed North Carolina Business Court orders absolving two defendant real estate companies of securities fraud in connection with their transferring to the plaintiff purchasers a deed for tenancy in common interests (TICs) in five parcels of real property that the companies previously sold to a real property developer (NNN Durham Office Portfolio 1, LLC v. Highwoods Realty Limited Partnership, September 4, 2018, Tyson, J.).

The basic facts are as follows: 
  • In 2006, the two companies entered into an exclusive listing agreement to sell the five parcels on which sat two medical facility tenants. A confidential offering memorandum (COM) was drafted to contain percentages predicting the probability that the tenants would renew their leases after expiration. 
  • In 2007, the companies sold the parcels to the developer who prepared a private placement memorandum (PPM) for investors interested in purchasing the TICs. The developer cautioned potential purchasers to read the PPM section on risk of financial loss should the tenants not renew their lease. The PPM, like the COM, contained percentages predicting the probability that the tenants would renew their lease after expiration, but the PPM percentages were lower than those contained in the COM. 
  • After the sale, the buyer-developer instructed the seller-companies to transfer the TIC deed to the purchaser-investors. 
  • In 2011, the tenants announced their decision to not renew the leases which led to the financial loss mentioned in the PPM, after which the lender began a public foreclosure of the property. The property was ultimately conveyed to the highest bidder. 
  • In 2012, the purchasers filed a complaint in business court against the two companies for fraud, unfair and deceptive practices, negligent misrepresentation, secondary liability and punitive damages under the North Carolina Securities Act. A primary argument by the purchasers was that out-of-state TIC buyers, as well as North Carolina-residing buyers, should be permitted to file civil liability claims against the companies. The business court, however, granted the companies’ motions to dismiss the case and for summary judgment and judgment on the pleadings.
  • The purchasers appealed, claiming that the business court erred by: (1) dismissing the purchasers’ claims against the companies for primary liability under the North Carolina Securities Act; (2) granting summary judgment to the companies on the purchasers’ secondary liability claims; (3) granting the companies’ motion for judgment on the pleadings against the out-of-state purchasers; and (4) dismissing the purchasers’ common law claims for fraud and negligent misrepresentation. 
NASAA intercedes. Following the purchasers' appeal filing, the North American Securities Administrators Association (NASAA) submitted a joint amicus brief with the North Carolina Secretary of State urging the North Carolina Court of Appeals to: (1) consider the TIC interests to be “securities” under the North Carolina Securities Act; and (2) reverse the business court’s ruling that only plaintiffs who actually received or accepted an offer in North Carolina could bring claims under the North Carolina Securities Act. The amici argued that the lower court’s failure to consider relevant precedents would subvert the North Carolina legislature’s intent to safeguard the integrity of North Carolina’s securities markets for out-of-state and North Carolina investors (NNN Durham Office Portfolio 1, LLC v. Grubb & Ellis Co., October 16, 2017).

The court of appeals did not, however, abide by the amicus brief: 
  1. Primary liability claims dismissed. The court agreed with the business court’s assertion that primary liability under the North Carolina Securities Act is imposed only on a person or entity who sells or offers to sell a security. In this case, the purchasers did not allege that the companies solicited them to buy the TICs. In fact, said the court, the companies’ only role was in transferring to the purchasers the deed to the TICs at the developer’s instructions following the parcel sale to the developer. The transfer by itself, said the court, could not impose any liability on the companies as purported sellers of securities. 
  2. Secondary liability claims dismissed. The court declared that the North Carolina Securities Act imposes secondary liability only if the purchasers can prove that the companies “materially aided” the developer in the fraud. Because there is little North Carolina case law on the matter, the court looked to the United States Court of Appeals for the Fourth Circuit which has proclaimed no secondary liability even if the companies knew of the developer’s wrongdoing and failed to act, unless the companies had a duty to disclose the developer’s wrongdoing. The North Carolina Court of Appeals, in this case, determined that the companies’ only duty was to transfer the TICs’ deed to the purchasers. 
  3. Judgment on the pleading argument moot. The purchasers argued in business court that out-of-state purchasers, as well as North Carolina-residing purchasers, could proceed on their claims because the TIC offering was made nationwide. Therefore, said the purchasers, under the North Carolina Securities Act “any person” who purchased securities could claim civil liability against the companies whether or not the purchasers received their offer in North Carolina. But the appeals court found this argument to be moot by affirming the business court’s other orders.
  4. Common law claims dismissed. The purchasers lastly contended that their common law fraud and negligent misrepresentation claims must stand because they had adequately pled justifiable reliance against the companies. But, said the appeals court, the purchasers could only have adequately pled justifiable reliance in this case if they could prove that any reliance the developer had on the companies’ COM could be transferred to the purchasers’ reliance on the developers’ PPM. The business court concluded, and the appeals court agreed, that this reliance was not, in fact, “transferred” from the COM to the PPM since the lease renewal probability percentages on the documents differed—the PPM percentages were lower than the COM percentages. 
The case is No. COA17-756.