An investor commits money to a real estate syndication. Distributions stop. The property is in trouble, and the entity that sold the investment has little money left. The people who organized the offering say the investment was made through an LLC, so the investor can look only to the LLC.
That answer may be too simple. Texas securities law includes a control-person provision that can reach a person or company behind a securities transaction. But the provision is not a guarantee against investment losses, and it does not make every sponsor, officer, or owner personally liable.
Start with the underlying securities claim
The first question is whether the transaction involved a security and whether a claim exists under one of the provisions identified in the statute. An interest in a real estate venture may be a security depending on its structure and the surrounding circumstances. Calling an arrangement an LLC interest, a partnership interest, or a real estate investment does not by itself resolve the issue.
For example, Texas Government Code section 4008.052 addresses certain offers or sales made by means of a material untrue statement or a material omission that makes what was said misleading. The statute contains specific requirements and defenses. A disappointing return, declining property value, or failed business plan alone is not proof of such a violation.
Section 4008.055 addresses a person who directly or indirectly controls a seller, buyer, or issuer and ties that liability to specified underlying provisions. Where its requirements are met, the controlling person may be jointly and severally liable with the relevant seller, buyer, or issuer and to the same extent. That can matter when the entity that sold the investment cannot satisfy a judgment.
What does control mean?
Control requires a close look at actual authority and the transaction at issue. In Davis v. MSR Holdings, LLC, No. 01-22-00451-CV, slip op. at 38–41 (Tex. App.—Houston [1st Dist.] June 28, 2024, pet. denied), the court applied a test examining general control over the company’s operations and power to control the particular activity underlying the violation. The court explained that “status alone does not automatically cause defendants to be deemed control persons.” Id. at 40–41.
The court found the evidence insufficient to establish control-person liability against a minority owner who was one of three managers. Among other things, it distinguished the authority of a board acting collectively from the authority of one member acting individually. Id. at 41–45. The point is not that a minority owner or board member can never be liable. It is that the evidence must connect the particular defendant to the power the law requires.
Texas appellate courts have differed in how they describe participation in the violation. Davis expressly acknowledged that disagreement and, applying its own district’s test, stated that an investor need not prove participation in the alleged violation to establish control-person liability. Id. at 39–40 & n.8. The governing decisions and facts must be examined in the court where the dispute will be litigated.
A meaningful defense
The statute also protects a person who proves both that the person did not know and, exercising reasonable care, could not have known of the facts giving rise to the alleged liability. See Tex. Gov’t Code § 4008.055(b). The question is not simply whether someone says, “I did not know.” What information was available, who received it, what questions were asked, and what oversight was reasonable can all become important.
The LLC is not the end of the analysis
Control-person liability is distinct from the question whether an LLC’s separate existence should be disregarded. It is a statutory theory with its own requirements and defense. An investor considering a claim should identify the underlying transaction, the specific alleged violation, and each proposed defendant’s role. A sponsor defending one should examine the same evidence, including what the defendant could actually direct and what information was available.
Timing matters, too. Different claims can have different deadlines, and the right deadline depends on the claim and its facts. Waiting for the next distribution or the next investor update can make a difficult situation worse.
For a closer look at the documents and decisions that can establish or refute control, read Who Really Controlled the Deal? Proving Control in a Texas Syndication.
Matthew M. Clarke represents investors, sponsors, businesses, and individuals in securities, syndication, and commercial disputes. This article provides general information, not legal advice about a particular investment.