By Robert Webb
My law partner Kurt Gruber and I were privileged to speak as part of the panel at Shared Ownership Boot Camp, which was the opening session of Interval International’s recent Shared Ownership Investment Conference in Miami. The session was very well attended by both new participants and seasoned players, most of whom demonstrated great enthusiasm about the future of the timeshare industry.
What really struck me about the questions we received from the group was how many of the legal fundamentals of timesharing continue to be misunderstood, even by seasoned veterans. This was particularly the case in four key areas:
“Timeshare” vs. “Fractional”
Many people believe that there is a legal difference between “timeshare” and “fractional.” There isn’t. From a product perspective, fractional products have a significantly higher land and improvements cost per square foot than do timeshare products. From an operational viewpoint, fractional products provide a higher level of service that is generally built into annual maintenance fees, while timeshare products tend to provide any non-basic services on an à la carte basis. With respect to financing, timeshare loans—which are primarily consumer loans at credit card rates that may or may not be secured by a timeshare interest—are much more available and marketable than are fractional loans, which tend to be much larger and are underwritten on more of a loan-to-value basis. Timeshare products are usually marketed as a value alternative to hotels and other transient offerings, while fractional products tend to thrive in areas where and at times when comparable whole ownership prices are very high. And the use plans for timeshare products are usually more flexible and system-oriented, incorporating point systems and the like, while fractional use is much more concentrated on the specific property purchased.
So why isn’t there a legal difference between these two very different products? In almost every state, fractional products are registered and regulated as timeshare plans. The same basic pillars of consumer protection (e.g., disclosure, recision, deposit escrow, financial assurance and one-to-one use rights to accommodations ratio) apply to both products. While most regulators have become fairly permissive about using the term “fractional” instead of “timeshare” for any of these products, the bottom line is that the many things that make the products different are not considered reasons to regulate the products differently or to provide their respective purchasers with different levels of protection against the risks of buying and owning them.
Right-to-use v. Deeded Products
Many people, particularly in other countries, also believe that timeshare products are contract-based while fractional products are deeded. They think this with good reason, as it is primarily the United States that is so obsessed with backing its timeshare products with some sort of real estate or substantive corporate- or trust-based interest. In the U.S., the best way to think about this issue is that all timeshare and fractional products are rights to use vacation or leisure property, and that most of those rights to use are backed by a substantive regime interest for two reasons: federal and state tax considerations (described below), and bankruptcy protection.
The bankruptcy of a right-to-use (contract based) timeshare project in the Florida Keys in 1982 culminated in a landmark court ruling that allowed the developer’s bankruptcy trustee to “avoid” all of the consumer timeshare licenses and to sell the project free and clear of their claims to benefit the developer’s unsecured creditors (which now included the timeshare purchasers at a few cents on the dollar). The Florida Legislature responded to this anti-consumer outcome with strong legislation that dramatically limited a developer’s ability to sell timeshare interests that are at risk of the developer’s default under its debt obligations, and included a perpetual recision period for timeshare licenses that essentially eliminated that product from the marketplace. So deeded timeshare products became the norm for the U.S. timeshare industry and remain so today—notwithstanding the significant time and cost of judicial foreclosures in many jurisdictions after consumer finance or assessment default. Many of today’s newer timeshare plans back their use rights with real or personal property trust interests that provide a more flexible platform for multisite developers, as well as relief from judicial foreclosure burdens in some cases.
But a more important element driving U.S. timeshare developers towards offering deed-backed timeshare interests is the adverse consequence of offering a contract-based timeshare product from a federal and state tax perspective.
In the late 1970’s, the Internal Revenue Service published a decision known as the Windrifter ruling. The Windrifter developer had manifested its timeshare use rights in a 40-year license certificate, which entitled the purchaser to use the timeshare property for a designated week each year but otherwise did not vest the purchaser with any of the benefits and burdens of ownership and management of the timeshare property. So when the Windrifter developer attempted to report its consumer timeshare transactions to the IRS as sales, allowing the developer to reduce its taxable profits by deducting all of its related product costs, sales and marketing costs and overhead, the IRS ruled instead that the developer had not sold the timeshare use rights, but had merely leased them. The Service reached this conclusion based upon the fact that the developer retained all of the ownership, management rights, and insurable interest of and in the timeshare property, and that the purchaser had received only a naked license to periodically enter the property and use it pursuant to the developer’s rules. As a result, the developer was required to report all of its income from the timeshare transactions but was required to amortize each of its related expense deductions, resulting in a much larger federal income tax bill.A similar adverse consequence attaches to timeshare license sales in the U.S. under state tax laws. As a general rule, the use of someone else’s property for other than long-term residential purposes tends to be subject to state sales and use or transient occupancy taxes, while the use of your own property does not. So this “double whammy” of higher federal and state taxes has been a major contributor to the prevalence of deed-based timesharing in the U.S.
The U.S. is a nation of laws. Way too many laws. And in addition to the federal government, each state has its own idea on how best to regulate consumer conduct and risks within (and sometimes without) its borders. This is particularly true with respect to the “offering,” or marketing and sale, of timeshare interests. Most people know that timeshare is heavily regulated and requires advance registration in order to receive a license to offer in a particular state. What many new entrants into timeshare don’t realize is that registering in the state in which the project is located may only be the first step in obtaining the necessary offering licenses, depending on the developer’s marketing plan.
A good rule of thumb is that a developer must register in the situs state of its timeshare project, as well as in any state in which he intends to have a physical sales presence. But most of the 35+ state laws that regulate timeshare also require registration in those states by an out-of-state developer who enters the state and makes offers to its residents via the mail, by telephone or e-mail, or through the Internet. This is a somewhat tricky legal area, and there are potential constitutional defenses to having to comply with these out-of-state registration requirements, but the wise developer will not invoke the awesome power of the states (and their unlimited legal enforcement budgets) by unnecessarily testing these waters.
The best approach to safely navigating the various U.S. jurisdictional whirlpools is to register in any state in which you intend to offer a “hooked” timeshare promotion that requires the resident’s attendance at a timeshare sale presentation as a condition of the offer. But if your project is completed and ready for occupancy, you always have the option of offering the “unhooked” rental of the property, which does not require registration so long as the rental offer is honored even if the consumer declines to attend a sales presentation when she arrives at the property. Another safe harbor is to put a disclaimer in your offering materials that the offer is not valid for residents of, say, New York, but this is only effective so long as the developer tells New York residents who respond to the promotion that they are ineligible to use it. “Offer void where prohibited by law” is a disclaimer that really works so long as you mean it.
Based upon the enthusiasm and interest of the Boot Camp participants, I am confident that timeshare has a very bright future.
Robert J. Webb, B.C.S., RRPPartner, BakerHostetlerOrlandoT: firstname.lastname@example.org
Overview: Rob Webb maintains a diverse international hospitality law practice with a strong emphasis on resort development and the travel and leisure industry. Rob has been active in the American Resort Development Association (ARDA)—the U.S. shared ownership trade association—for more than 30 years, and he has participated in the negotiation, drafting, and lobbying of and for laws and administrative rules affecting the timeshare industry throughout the U.S. and the Caribbean since 1983. During an absence from BakerHostetler, Rob served as president of Island One, Inc., a multisite timeshare developer based in Orlando, where he gained valuable experience in the business side of the timeshare industry. With this perspective, as well as his involvement in the timeshare industry from its birth, Rob is able to anticipate trends and change in the industry and serve his clients beyond expectations.