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Using Regulation Crowdfunding For a Real Estate Fix And Flip Without Violating Securities Laws

As the internet developed, investors and real estate fix and flip companies have turned to “crowdfunding” for investments. While crowdfunding can provide great options for all involved, there are still legal requirements for the investor and the fix and flip business. This short guide provides some information about the federal and Nevada regulations involved in some crowdfunding scenarios.

“Regulation Crowdfunding” Exemption

Typically, any company or individual that wants to offer or sell securities to investors must be registered with the United States Securities and Exchange Commission (the “SEC”) in order to comply with the Securities Act of 1933. When a real estate flip and fix business seeks investors they are very likely issuing securities, and their activity may be regulated by governmental agencies like the SEC. However, the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”) allows for exemptions from registration for crowdfunding. Accordingly, in 2015, the SEC issued an agency rule adopting “Regulation Crowdfunding,” permitting some investments without requiring SEC licensing. This allows businesses to use crowdfunding without registration under certain limitations.

“Regulation Crowdfunding” Basics: Limits on Securities Sold, Limits on Investors, and Licensed Intermediary

The most significant limitations for Regulation Crowdfunding include limitations on how much can be raised, how much investors may contribute, and requiring the involvement of an SEC registered broker-dealer or funding portal. Regulation Crowdfunding caps the total amount of securities that may be sold to investors to $1,070,000.00 during a 12-month period, including amount sold by entitles controlled by or under common control with the issuer. This limitation means that Regulation Crowdfunding would likely be unavailable to a fix and flip company that created several securities opportunities in different LLCs. For example, if ABC Fix and Flip, LLC created three LLCs, each of which sought $500,000 in investments during a 12-month period, the aggregate total would be $1,500,000.00 and would exceed the securities sale cap, making Regulation Crowdfunding unavailable as on option.

Regulation Crowdfunding also limits the amounts investors can provide. Investors with an annual income or net worth under $107,000.00 may invest the greater of $2,200.00 or five percent of the lesser of their annual income or net worth. If the investor’s annual income or net worth is in excess of $107,000.00, the investor may invest the lesser of 10% of their annual income or net worth. No investor may be sold more than $107,000.00 in Regulation Crowdfunding securities in a 12-month period.

Finally, Regulation Crowdfunding requires the use of either a broker-dealer or portal that is registered with both the SEC and the Financial Industry Regulatory Authority (FINRA). So, even though the company seeking investments does not need to be SEC registered, the transaction will still involve an SEC licensed intermediary. This offers the company seeking investments the benefit of relying upon the intermediary’s determination that the investor limitations (see above) are followed.

Disclosures in Regulation Crowdfunding

While the issuer of a security taking advantage of Regulation Crowdfunding does not have to be SEC licensed, they must still provide information to the SEC in conjunction with the broker-dealer or portal intermediary. Issuers of securities must file “Form C” with included attachments on an annual basis. Form C requires disclosing information about officers, directors, and owners, information about the business including its financial condition. Financial information will include income tax returns. Additional disclosure requirements vary depending on the amount the business offers under Regulation Crowdfunding.

In addition to the annual reporting, the security issuer must also file progress updates under Form C-U when reaching 50% of its target offering amount, and again when it reaches 100%. Other SEC disclosures may be required on a case-by-case basis. State regulatory disclosures may also be required.

Advertising Limitations in Regulation Crowdfunding

The issuer of a security in Regulation Crowdfunding is strictly limited in its ability to advertise offering information. Generally, only facts about the issuer and offering terms may be provided. Issuer’s may still communicate with potential investors, but should do so through the intermediary broker-dealer or portal, clearly identifying itself as the security issuer. In sum, advertising should be done through the intermediary, and the issuer must direct investors there.

State “Blue Sky” Laws

In addition to SEC regulation, many states have laws regulating securities, often referred to as “Blue Sky” laws. It is important to make sure an investment offering will comply with relevant blue sky laws, which could include protecting an out of state investor (for example, if an investor is from another state than the state of the company offering the security, the investor’s state may seek to regulate that transaction for the protection of the investor).

Nevada requires anyone seeking to sell or offer to sell securities in Nevada to register, unless exempt. NRS 90.460 et. seq. Nevada allows for registration by filing, registration by coordination, or registration by qualification. NRS 90.470 – 90.490. However, Nevada exempts some types of securities from registration altogether, while exempting other particular transactions. (NRS 90.520(2) provides the list of exempt securities, while NRS 90.530 provides the list of exempt transactions.)

One exemption, NRS 90.530(11) has similarities to Regulation Crowdfunding. Nevada does not require registration if the transaction is part of a series where there are less than 35 investors in a 12-month period, there is no general advertising or solicitation related to the securities sale, no commission or compensation is provided for the investment (except a licensed broker), and the seller reasonably believes the purchase is for investment. Id.

Conclusion and Additional Information

Crowdfunding offers new options for issuers of securities and investors alike. While regulatory compliance is narrower than a public offering scenario, regulations still apply. As always, if you think you might need an attorney, you probably do, and you can contact us here.

What You Should Know About Seller’s Disclosures in Nevada

Are you selling a house in Nevada? Are you buying a house in Nevada? Did you already buy a house in Nevada, and since discovered something that is wrong with the house? In any of these cases, you will need to know the requirements of NRS § 113.100 in regard to the seller’s disclosures. Below is an overview of the disclosure requirements, and what happens when something doesn’t get disclosed correctly.

Nevada’s Required Disclosures

In most residential property sales in Nevada, state law mandates the seller make disclosures about conditions on the property. See NRS § 113.130. These disclosures cover electrical, heating, cooling, plumbing and sewer systems, and anything else on the property that affects use or value. See NRS § 113.120. This process requires the seller to disclose any defect, which is defined in the statute as “a condition that materially affects the value or use of residential property in an adverse manner.”

What Needs to be Disclosed?

A seller is only required to disclose defects that they are aware of. In fact, the law makes clear that the seller is not required to disclose a defect of which they are not aware. NRS § 113.140. Additionally, the topics of disclosure are in a proscribed form that is adopted by the Nevada Real Estate Division, so you won’t be left trying to figure out the potential home or property features you need to address in the disclosures when selling your home.

Sellers can also rely on information that was given to them from government officials and experts like engineers, contractors, surveyors and inspectors. NRS § 113.150(5). This limits the ability of a buyer to claim damages from a known but undisclosed defect. So, a seller who is concerned about a potential defect is encouraged to consult with an appropriate expert to determine if there is a defect present before completing disclosures.

Sellers do not need to disclose defects that have been repaired. See Nelson v. Heer, 123 Nev. 217, 163 P.3d 420 (2007). For example, if a home had water damage, but the seller had it all repaired before making disclosures, it no longer needs to be disclosed.

Failure to Disclose

So, what happens if a seller fails to disclose a defect? The big risk is NRS § 113.150’s treble damages clause. Treble damages is a legal term for triple damages. The law allows a home purchaser who is saddled with a defect that the seller knew of, but did not disclose, to seek three times the cost of repair or replacement. This is a very big incentive for sellers to disclose known defects, because the consequences are steep. The purchaser can also seek court costs and attorney’s fees, making it even more crucial for sellers to make adequate disclosures. However, the treble damages, costs, and attorney’s fees are something the buyer can waive in a signed, notarized document.

What Real Estate Agents Should Know

Sellers’ real estate agents should be aware that they also have duties to disclose known defects, but are not in the precise situation that the seller is in. Licensed real estate agents are required to disclose to all parties “any material and relevant facts, data, or information which the licensee knows, or which by the exercise of reasonable care and diligence should have known, relating to the property which is the subject of the transaction.” NRS § 645.252. Generally, real estate agents are not liable for a misrepresentation of their client, but they can become liable if they knew the client made a misrepresentation, and the agent failed to inform the other party. NRS § 645.259. So, if a real estate agent knows of a defect and that her client failed to disclose it, she will need to disclose it to the buyer.

The good news for real estate agents is that even if they are liable for a failure to disclose, the treble damages clause does not apply, and the buyer’s recovery against an agent is limited to the decreased value of the property and damages resulting as a consequence of the nondisclosure. See Davis v. Beling, 128 Nev. 301, 278 P.3d 502 (2012)..  A successful plaintiff can recover the diminution in value as well as consequential damages from the agent. Id.

Conclusion

Real property transactions can be difficult and complicated, and seller’s disclosures are just one piece of the puzzle. Sellers and buyers should make use of the resources available through experts like engineers and inspectors, real estate agents, and even lawyers to ensure a smooth transaction. As always, if you think you might need an attorney, you probably do.