Bulldozers and bad Investments

The bulldozers are back.  All around town I see buildings being knocked down, dirt lots being leveled, and all the hum and bang of construction getting back in swing.  In the first ten minutes of my commute alone there are three major construction sites underway.  The prospect of an upswing in real estate whets a lot of appetites and conjures visions of great sums of money to me made.

But how exactly to get in on the action?

Here’s one bright idea that became the subject of a recent Georgia Court of Appeals case: a corporation accepts money from multiple people to build up a pool of funds.  In exchange for their money, the corporation gives each person a promissory note (a promise to pay back the funds on terms specified in the note).  The corporation also takes loans from banks at favorable rates to build up the pool of funds.  It then uses the pooled funds to make loans to real estate developers at higher interest rates.

Money making money… sounds pretty simple, right?

This was the setup in Cushing v. Cohen, Case No. A13A0736 (decided July 16, 2013).  For many years it was quite successful, but ultimately, three large deals failed all at once and the investors wanted their money back… all of it.

The investors argued that the defendant violated Georgia law by selling them unregistered securities.  Indeed, under the Georgia Securities Act of 1973, OCGA § 10-5-1 et seq. (which has since been updated by the Georgia Uniform Securities Act of 2008), the purchaser of an unregistered (and non-exempt) security is entitled to a full refund of his or her investment. 

The defendant argued that it did not sell securities, but only gave promissory notes to investors.  The Court of Appeals disagreed and found that the investments were in fact sales of securities.

A security is defined as (a) an investment in a common venture with (b) a reasonable expectation of profit from the entrepreneurial or managerial efforts of someone else.  First, the Court of Appeals found that the loans were investments in a common venture because in order to reach a mandatory minimum amount required for a deal, the investors had to pool together.  Second, the court found that the profits earned by investors would be based on the defendant’s skill in selecting the deals, managing the loans, and salvaging capital if the borrowers defaulted.  As such, these were not straightforward pass-through loans, but in fact securities as defined by law. Indeed under Georgia law, if a security is not registered (or exempted), a purchaser of said security has the right to receive a return of their full investment.  Moreover, the Court found, under former OCGA § 10–5–14(c), “every executive officer of an entity that sells unregistered securities is liable jointly and severally.”

Oh, and did I mention…  the investors invested over $14 million.  That’s a heck of a refund.

The lesson from this case is that there are many creative ways to structure a business, but there are legal implications for each one of them.  Talk to a business planning attorney at Briskin, Cross & Sanford to make sure that as you build your business, you do so on solid legal ground.


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