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As filed with the Securities and Exchange Commission on September 30, 1998
Registration No. 333-_____
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM S-3
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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SUNSTONE HOTEL INVESTORS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MARYLAND 52-1891908
(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
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115 CALLE DE INDUSTRIAS, SUITE 201
SAN CLEMENTE, CALIFORNIA 92672
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
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ROBERT A. ALTER
SUNSTONE HOTEL INVESTORS, INC.
115 CALLE DE INDUSTRIAS, SUITE 201
SAN CLEMENTE, CALIFORNIA 92672
(714) 361-3900
(NAME AND ADDRESS OF AGENT FOR SERVICE OF PROCESS)
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COPIES TO:
ROGER M. COHEN, ESQ.
LAURA B. HUNTER, ESQ.
BROBECK, PHLEGER & HARRISON LLP
38 TECHNOLOGY DRIVE
IRVINE, CALIFORNIA 92618
(949) 790-6300
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: From
time to time after the effective date of this Registration Statement.
If the only securities being registered on this form are being offered
pursuant to dividend or interest reinvestment plans, please check the following
box. [ ]
If any of the securities being registered on this form are to be offered
on a delayed or continuous basis pursuant to Rule 415 under the Securities Act
of 1933, other than securities offered only in connection with dividend or
interest reinvestment plans, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the Prospectus is expected to be made pursuant to Rule
434, please check the following box. [ ]
CALCULATION OF REGISTRATION FEE
====================================================================================================================
TITLE OF EACH CLASS OF SECURITIES AMOUNT TO PROPOSED MAXIMUM PROPOSED MAXIMUM AMOUNT OF
TO BE REGISTERED BE AGGREGATE PRICE AGGREGATE REGISTRATION
REGISTERED(1) PER UNIT(2) OFFERING PRICE(2) FEE
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Warrants to purchase Common
Stock............................................. 447,000 N/A N/A N/A
- --------------------------------------------------------------------------------------------------------------------
Shares of Common Stock,
$0.01 par value................................... 447,000 $12.49 $5,583,100 $1,647.00
====================================================================================================================
(1) This Registration Statement shall also cover any additional shares of
Common Stock which become issuable under the Warrants hereby registered
by reason of any stock dividend, stock split, recapitalization or other
similar transaction effected without the Registrant's receipt of
consideration which results in an increase in the number of outstanding
shares of Registrant's Common Stock.
(2) Based on the weighted average exercise price of the Warrants hereby
registered.
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant shall
file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
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INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
PROSPECTUS
SUNSTONE HOTEL INVESTORS, INC.
447,000 WARRANTS TO PURCHASE COMMON STOCK
447,000 SHARES OF COMMON STOCK
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This Prospectus relates to the issuance of warrants (the "Warrants") to
purchase up to 447,000 shares of common stock, par value $.01 per share ("Common
Stock") and up to 447,000 shares of Common Stock at prices ranging from $9.50 to
$16.63 per share issuable upon exercise of the Warrants (the "Warrant Shares"),
of Sunstone Hotel Investors, Inc. a Maryland corporation ("Sunstone" or the
"Company"). The Warrants have an expiration date of September 24, 2003.
The Company is a leading self-administered equity real estate investment
trust that owns luxury, upscale and mid-price hotels located primarily in the
Pacific and Mountain regions of the western United States. The hotels operate
under nationally recognized franchises, including brands affiliated with Holiday
Hospitality Corporation, Marriott International, Inc. and Promus Hotel
Corporation. The Warrants have been issued under the Company's 1994 Stock
Incentive Plan (the "Option Plan") to Messrs. Robert Alter, the Chief Executive
Officer and Chairman of the Company, and Charles Biederman, the Executive Vice
President and Director of the Company, in consideration for their surrender of
options to purchase an aggregate of 447,000 shares of Common Stock previously
granted to such individuals under the Option Plan. Such options were intended to
provide a source of funding for the obligations of Messrs. Alter and Biederman
to support stock appreciation rights ("SARs") granted by Sunstone Hotel
Properties, Inc. (the "Lessee") to its employees under its 1996 Stock
Appreciation Rights Plan ("SAR Plan"). The SAR Plan will be terminated by the
Lessee and the holders of outstanding SARs will be given an opportunity to
surrender such SARs in exchange for an assignment from Messrs. Alter and
Biederman of the Warrants. The Warrants will become exercisable on October 25,
1999. The Company will not receive any cash proceeds from the issuance of the
Warrants, but the Company has agreed to bear certain expenses of registration of
the Warrants and the Warrant Shares under federal and state securities laws and
will receive the cash proceeds of all shares of Common Stock purchased upon
exercise of the Warrants.
The Common Stock is traded on the New York Stock Exchange (the "NYSE")
under the symbol "SSI." On September 28, 1998, the last reported sale price of
Common Stock on the NYSE was $9.50 per share. To ensure compliance with certain
requirements related to the Company's qualification as a real estate investment
trust ("REIT") under the Internal Revenue Code of 1986, as amended, the
Company's Articles of Incorporation limits the number of shares of Common Stock
that may be owned by any single person or affiliated group to no more than 9.8%
of the outstanding shares of Common Stock (the "Ownership Limitation") and
restricts the transferability of Common Stock if the purported transfer would
prevent the Company from qualifying as a REIT. See "Risk Factors -- Limitation
on Acquisition and Change in Control" and "Description of Common Stock --
Provisions of Maryland Law and of the Company's Articles of Incorporation and
Bylaws."
SEE "RISK FACTORS" BEGINNING ON PAGE 6 FOR A DISCUSSION OF CERTAIN
FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE SECURITIES
OFFERED HEREBY.
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF
THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
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The date of this Prospectus is September 30, 1998.
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AVAILABLE INFORMATION
The Company is subject to the information requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith files reports, proxy statements and other information with the
Securities and Exchange Commission (the "Commission"). Such reports, proxy
statements and other information filed by the Company can be inspected and
copied at the public reference facilities maintained by the Commission at Room
1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at
regional offices of the Commission located at 7 World Trade Center, 13th Floor,
New York, New York 10048 and Citicorp Corp. Center, 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661-2511. Copies of such material can be
obtained by mail from the Public Reference Section of the Commission, 450 Fifth
Street, N.W., Washington, D.C. 20549 at prescribed rates. The Commission also
maintains a web site that contains reports, proxy and information statements and
other information regarding registrants that file electronically with the
Commission, such as the Company, and the address is http://www.sec.gov. The
Company's Common Stock is listed on the NYSE, and reports, proxy statements and
other information concerning the Company can be inspected at the offices of The
New York Stock Exchange, Inc., 20 Broad Street, New York, New York 10005.
The Company has filed with the Commission a Registration Statement on
Form S-3 under the Securities Act of 1933, as amended (the "Securities Act"),
and the rules and regulations promulgated thereunder, with respect to the
Offered Shares. This Prospectus, which is part of the Registration Statement,
does not contain all of the information set forth in the Registration Statement
and the exhibits thereto. For further information concerning the Company and the
Offered Shares, reference is made to the Registration Statement and the exhibits
and schedules filed therewith, which may be obtained as described above.
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INCORPORATION OF CERTAIN INFORMATION BY REFERENCE
The following documents, which have been filed with the Commission, are
hereby incorporated by reference:
1. Annual Report (i) on Form 10-K of the Company for the fiscal
year ended December 31, 1997; and (ii) on Form 10-K/A filed with
the Commission on March 30, 1998;
2. Quarterly Reports (i) on Form 10-Q for the quarters ended March
31, 1998 and June 30, 1998; and (ii) on Form 10-Q/A filed with
the Commission on June 16, 1998;
3. Current Reports (i) on Form 8-K filed with the Commission on
January 29, 1998, February 9, 1998, July 29, 1998 and August 4,
1998; and
4. The description of the Common Stock of the Company included in
the Company's Registration Statement on Form 8-A, filed with the
Commission on June 26, 1995; and on Form 8-A/A, filed with the
Commission on July 19, 1996.
In addition, all reports and other documents subsequently filed by the
Company with the Commission pursuant to Section 13, 14 or 15(d) of the Exchange
Act after the date of this Prospectus and prior to the termination of the
offering shall be deemed to be incorporated by reference in this Prospectus and
to be a part hereof from the date of the filing of such documents (such
documents, and the documents enumerated above, being herein referred to as
"Incorporated Documents"; provided however, that the documents enumerated above
or subsequently filed by the Company pursuant to Section 13, 14 or 15(d) of the
Exchange Act prior to the filing by the Company of any subsequent Annual Report
on Form 10-K with the Commission shall not be Incorporated Documents or be
incorporated by reference in this Prospectus or be a part hereof from and after
any such filing of an Annual Report on Form 10-K). Any statement contained in a
document incorporated or deemed to be incorporated by reference herein shall be
deemed to be modified or superseded for purposes of this Prospectus to the
extent that a statement contained herein (or in any other subsequently filed
document which also is or is deemed to be incorporated by reference herein)
modifies or supersedes such statement. Any statements so modified or superseded
shall not be deemed to constitute a part of this Prospectus, except as so
modified or superseded.
The Company will provide without charge to each person to whom this
Prospectus is delivered, upon written or oral request of such person, a copy of
any or all of the documents referred to above which have been or may be
incorporated by reference in this Prospectus (other than certain exhibits to
such documents). Requests for such documents should be directed to Sunstone
Hotel Investors, Inc., 115 Calle de Industrias, Suite 201, San Clemente,
California 92672, Attention: Secretary (telephone: (949) 361-3900).
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PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and financial statements and the notes thereto appearing elsewhere
herein or incorporated by reference herein. Unless the context otherwise
indicates, all references herein to the "Company" include Sunstone Hotel
Investors, Inc. and the Sunstone Hotel Investors, LP (the "Partnership"). This
Prospectus, including the Incorporated Documents, may contain forward-looking
statements within the meaning of Section 27A of the Securities Act and Section
21E of the Exchange Act. The Company's actual results could differ materially
from those set forth in any such forward-looking statements. Certain factors
that might cause such a difference are discussed in the sections entitled "Risk
Factors" commencing on page 5 of this Prospectus and in certain of the
Incorporated Documents. The Company cautions the reader, however, that the
factors discussed in those sections may not be exhaustive.
THE COMPANY
The Company is a leading self-administered equity real estate investment
trust ("REIT") that owns luxury, upscale and mid-price hotels located primarily
in the Pacific and Mountain regions of the western United States (the "Primary
Region"), which includes the states of California, Utah, Colorado, Arizona,
Washington, Oregon, and New Mexico. The Company also operates a number of hotels
outside the Primary Region, in geographic markets where opportunities exist for
the Company to implement its growth strategy. The hotels operate primarily under
national franchises that are among the most widely recognized in the lodging
industry, including brands affiliated with Holiday Hospitality Corporation,
Marriott International, Inc. and Promus Hotel Corporation.
The Company's growth strategy is to maximize shareholder value by (i)
acquiring underperforming hotels within the Primary Region that are in
attractive locations with significant barriers to entry and (ii) improving such
hotels' financial performance by renovating, redeveloping, repositioning and
rebranding the hotels, and through the implementation of focused sales and
marketing programs.
The Company was incorporated as a Maryland corporation in 1995 and is
structured as a REIT. The Company's principal executive offices are located at
115 Calle de Industrias, Suite 201, San Clemente, CA 92672, and its telephone
number is (949) 361-3900.
The Company leases its hotels to the Lessee pursuant to separate
percentage leases which provide for rent payments equal to the greater of (i)
fixed based rent and (ii) percentage rent based on room revenues, Lessee's food
and beverage revenues and sublease and concession rentals. The Lessee is owned
by Mr. Alter, Chief Executive and Chairman of the Company (80%), and Mr.
Biederman, Executive Vice President and Director of the Company (20%). The
Lessee has entered into a management agreement pursuant to which all of the
hotels it leases from the Company are managed by Sunstone Hotel Management, Inc.
(the "Management Company"), of which Mr. Alter is the sole shareholder.
THE TRANSACTION
The Lessee adopted the SAR Plan in 1996 for the benefit of its
employees. Under the SAR Plan, the Lessee's employees were granted SARs with an
exercise price tied to the fair market value of the Company's Common Stock on
the date of grant of the SAR. An SAR entitles the holder, to the extent vested
in the SARs, to exercise the SAR and receive from the Lessee a cash payment
equal to the excess of the fair market value of the Common Stock on the date of
exercise over the SAR exercise price. Messrs. Alter and Biederman agreed to
contribute in cash, in the 80%/20% proportion reflecting their respective
ownership interests in the Lessee, the amount necessary to enable the Lessee to
pay the amounts due to the Lessee's employees upon exercise of their SARs, to
the extent the Lessee did not otherwise have sufficient cash available to meet
such obligation. In consideration for their services to the Company, the Company
granted Messrs. Alter and Biederman options under the Option Plan to purchase up
to an aggregate of 447,000 shares of Common Stock (the "SAR Support Options") at
prices ranging from $9.50 to $16.63 per share to provide Messrs. Alter and
Biederman with a source of cash to fund this obligation to the Lessee.
The Lessee has determined that it is in its best interests to terminate
the SAR Plan because of the negative impact on its financial statements caused
by the appreciation in the fair market value of the Company's Common
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Stock over the SAR exercise prices, which appreciation is treated as
compensation expense to the Lessee. To continue to incentivize current SAR
holders, however, Messrs. Alter and Biederman have agreed to assign them
warrants to purchase the Company's Common Stock ("Warrants") to the SAR holders,
to replace the SARs, which the SAR holders will be requested to surrender to the
Lessee for cancellation. The Company has agreed to issue to Messrs. Alter and
Biederman the Warrants in exchange for the surrender of their outstanding SAR
Support Options. Messrs. Alter and Biederman have agreed to the surrender for
cancellation of the SAR Support Options as they will no longer be necessary.
The exercise price for each Warrant issued to Messrs. Alter and
Biederman is the same exercise price as applied under the SAR Support Option
which such warrant replaces and accordingly ranges from $9.50 to $16.63 per
Share. Each Warrant has an expiration date of September 24, 2003.
Upon assignment of the Warrants by Messrs. Alter and Biederman to the
SAR holders, the Warrant Shares purchasable upon exercise of each such warrant
may be subject to repurchase by the assignors (in the ratio of 80% repurchase by
Mr. Alter and 20% by Mr. Biederman), at the warrant exercise price paid per
share, in the event the assignee terminates service with the Lessee prior to
vesting in the Warrant Shares. Such repurchase right will lapse and the assignee
will vest in the Warrant Shares in installments over the assignee's continued
period of service with the Lessee, such installment schedule and the other
provisions regarding the repurchase right of Messrs. Alter and Biederman to be
set forth in an agreement entered into in connection with the assignment of the
Warrants.
The number of Lessee's employees who currently hold outstanding SARs and
are therefore entitled to receive an assignment of the Warrants is approximately
170.
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RISK FACTORS
IMPEDIMENTS TO GROWTH AND INCREASING CASH AVAILABLE FOR DISTRIBUTION
The Company's ability to increase cash available for distribution on its
Common Stock ("Cash Available for Distribution") will depend significantly on
the Company's ability to acquire or develop additional hotels at attractive
prices. Risks associated with this growth strategy include:
Competition For Future Acquisitions. There is competition for investment
opportunities in luxury, upscale and mid-price hotels from entities organized
for purposes substantially similar to the Company's objectives as well as from
other purchasers of hotels. The Company is competing for such hotel investment
opportunities with entities which have substantially greater financial resources
than the Company or better relationships with franchisors, sellers or lenders.
These entities may also generally be able to accept more risk than the Company
prudently can manage. There can be no assurance that competition will not
generally reduce the number of suitable hotel investment opportunities offered
to the Company and increase the bargaining power of property owners seeking to
sell.
Renovation and Redevelopment Risks. The Company faces risks arising from
its strategy of acquiring hotels in need of substantial renovation or
redevelopment, particularly the risk that the cost or time to complete the
renovation or redevelopment will exceed the budgeted amount. Such delays or cost
overruns may arise from shortages of materials or skilled labor, a change in the
scope of the original project, the need to comply with building code or other
legal requirements, the discovery of structural or other latent defects with a
hotel once construction has commenced and other risks inherent in the
construction process. These risks are increased by the significant number of
renovations the Company is currently undertaking as a result of the significant
number of hotels recently acquired by the Company. In particular, renovation and
redevelopment must comply with the Americans with Disabilities Act of 1990 (the
"ADA"), which provides that all public accommodations meet certain federal
requirements related to access and use by disabled persons. The Company may be
required to make substantial modifications at the hotels to comply with the ADA.
Cost overruns incurred during renovation and redevelopment projects increase the
Company's total investment in a hotel and may reduce the Company's anticipated
return on such investment. Delays in completing such renovation and
redevelopment projects decrease the Lessee's operations at the hotel, resulting
in lower revenues which either increases the Lessee's operating losses or, if a
rental abatement is provided, reduces rent received by the Company. Delays or
cost overruns in connection with renovations or redevelopments, and any related
rental abatements could have a material adverse effect on Cash Available for
Distribution.
Development Risks. A component of the Company's growth strategy is to
develop new hotels in markets where room supply and other competitive factors
justify new construction or to purchase such hotels from unaffiliated developers
after they have been completed. New project development will increase the
Company's indebtedness and is subject to a number of other risks, including
risks of construction delays or cost overruns, the risk that required zoning,
occupancy and other government permits might not be obtained, and the risk that
projects might not be completed. Additional risks of development projects
include the risks associated with effectively marketing a hotel in order to
ramp-up occupancy at projected room rates after the hotel has been opened. Any
failure to complete a development project in a timely manner and within budget
or to ramp-up occupancy after completion of the project could have a material
adverse effect on the Company's results of operations and Cash Available for
Distribution.
TOTAL DEPENDENCE ON THE LESSEE AND PAYMENTS UNDER THE PERCENTAGE LEASES
Certain tax rules relating to the qualification of a REIT prohibit the
Company and the Partnership from operating hotels. Therefore, the Partnership
enters into Percentage Leases with the Lessee, and the Lessee operates the
hotels and pays rent to the Partnership based, in large part, on the revenues
from the hotels. Consequently, the Company relies entirely on the Lessee to
effectively operate the Company's hotels in a manner which generates sufficient
cash flow to enable the Lessee to timely make the rent payments under the
applicable Percentage Leases. Ineffective operation of the hotels may result in
the Lessee's being unable to pay rent at the higher tier level necessary for the
Company to fund distributions to shareholders because payment of base rent alone
is insufficient for such purposes. In the event that all or a portion of such
higher tier rent is not received by the Partnership, the Company may not be able
to make such distributions to its shareholders. There can be no assurance that
the Company will receive such higher tier rent from the Lessee or that the
Lessee will even be able to pay base rent
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in light of its historical performance of incurring operating losses since its
inception. The Lessee controls the daily operations of the hotels under the
Percentage Leases, which have non-cancelable initial terms of ten years. The
Company selected the Lessee without consideration of other lessees because Mr.
Alter and Mr. Biederman, who own the Lessee, owned and were involved in the
management of a number of the hotels contributed to the Company in connection
with its IPO in 1995 (the "IPO"). Except as set forth in the Percentage Leases,
neither the Company nor the Partnership has the authority to require the Lessee
to operate the hotels in a manner that results in a maximization of rent to the
Company. Other than working capital to operate the hotels, the Lessee only has
nominal assets, which will likely be insufficient to satisfy any claims the
Company may have if the Lessee defaults under the Percentage Leases. Mr. Alter
and Mr. Biederman have entered into an agreement (the "Third Party Pledge
Agreement"), whereby the obligations of the Lessee under the Percentage Leases
are secured with a pledge of Mr. Alter's and Mr. Biederman's Units, up to
481,955 Units. This may limit the Company's ability to recover in full for any
claims it may have against the Lessee for defaults under the Percentage Leases.
The amendment to the Third Party Pledge Agreement also subordinated the
Company's lien on the majority of Mr. Alter's Units to the lien in favor of an
institutional lender providing a working capital line to the Lessee guaranteed
by Mr. Alter and secured by a pledge of a significant portion of Mr. Alter's
Units. The obligations of the Lessee under the Percentage Leases are not secured
by any additional security deposits or guarantees by third parties. The Lessee
had an accumulated deficit of $8.0 million as of June 30, 1998. Consequently,
both the Company and the Lessee are substantially dependent upon the operations
of its hotels. In 1997, the Company and the Lessee amended the Percentage
Leases for hotels then currently under renovation and any future hotels to allow
for the abatement of base rent related to rooms taken out of service during
major renovations. See "-- Hotel Industry Risks."
FAILURE TO MANAGE RAPID GROWTH
To successfully implement its acquisition strategy, the Company must
integrate the hotels it acquires into its existing operations. Since the closing
of the IPO, the Company's portfolio of hotel properties has increased
dramatically and the Company also entered into geographic markets where it
previously did not have any properties. As a result, the consolidation of
functions and integration of departments, systems and procedures of acquired
properties with the Company's existing operations presents a significant
management challenge, and the failure to integrate such properties into the
Company's management and operating structures could have a material adverse
effect on the results of operations and financial condition of the Company.
The Company continues to execute its acquisition activity. As a result,
the Company's recent acquisitions will place significant demands on the
Company's management and other resources. There can be no assurances that these
hotels and other business operations can be integrated successfully, that there
will be any operating efficiencies between these hotels or that the combined
businesses can be operated profitably. The failure to integrate and operate
these hotels successfully could have a material adverse effect on the Company's
business and future prospects. Also, certain of the Company's hotels are in the
same geographic regions and may, therefore, compete with one another. There can
be no assurance that any acquisition, and in particular any subsequent
multiple-hotel portfolio acquisition, will not adversely affect the operations,
revenues or prospects of the Company's hotels located in such geographic areas.
CONFLICTS OF INTEREST BETWEEN THE COMPANY AND CERTAIN OFFICERS AND DIRECTORS
Because of Mr. Alter's and Mr. Biederman's ownership in and positions
with the Company and the Lessee and Mr. Alter's ownership of the Management
Company, there are inherent conflicts of interest between the Lessee, the
Management Company and the Company in the leasing, acquisition, disposition,
operation and management of the Company's hotels. Accordingly, the interests of
shareholders may not have been, and in the future may not be, reflected fully in
all decisions made or actions taken by the officers and directors of the
Company. In the event revenues from the Company's hotels increase significantly
over prior periods and operating expenses with respect thereto are less than
historical or projected operating expenses, the Lessee could disproportionately
benefit. In addition, the Lessee pays a management fee of between 1% and 2% of
gross revenues from the Company's hotels and reimburses certain accounting
expenses to the Management Company, which is wholly owned by Mr. Alter. As a
result, there may be conflicts of interest in connection with the sale of
certain hotels. Unrealized gain from the sale to the Company of certain hotels
contributed to the Company in connection with its IPO is specially allocated to
Mr. Alter and Mr. Biederman and any sale of such hotels by the Partnership may
cause adverse tax consequences to them. In addition, the reduction of mortgage
indebtedness by the Partnership at any time below certain levels would create
adverse tax consequences to Mr. Alter and Mr. Biederman. These conflicts may
result in decisions relating to the sale of certain hotels and/or the incurrence
or repayment of indebtedness which do not
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reflect solely the interests of the Company and the shareholders. In addition,
the Company will generally be required under the Percentage Leases to pay a
lease termination fee to the Lessee if the Company elects to sell a hotel and
not replace it with another hotel. The payment of a termination fee to the
Lessee, which is owned by Mr. Alter and Mr. Biederman, may also result in
decisions regarding the sale of a hotel which do not reflect solely the
interests of the Company and its shareholders.
INVESTMENT CONCENTRATION IN SINGLE INDUSTRY
The Company's current strategy is to acquire interests exclusively in
hotel properties. The Company will not seek to invest in assets selected to
reduce the risks associated with investments in the hotel industry, and will be
subject to risks inherent in concentrating investments in a single industry.
Therefore, the adverse effect on the Company's lease revenue and Cash Available
For Distribution resulting from a downturn in the hotel industry will be more
pronounced than if the Company had diversified its investments outside of the
hotel industry. In addition, the Company's hotels are concentrated in the
luxury, upscale and mid-price segments of the hotel industry and therefore, any
adverse changes in these segments of the hotel industry may disproportionately
impact the Company, due to the Company's concentration in those segments.
EMPHASIS ON MARRIOTT
Eighteen of the Company's 57 hotels are operated under, and one is in
the process of being converted to, the Marriott brand. Accordingly, the Company
is subject to risks inherent in concentrating the Company's investments in the
Marriott brand, such as a reduction in business following adverse publicity
related to the brand, which could have an adverse effect on the Company's lease
revenues and its ability to satisfy its debt service requirements.
RELIANCE ON MR. ALTER AND OTHER KEY PERSONNEL
The Company's future success and its ability to manage future growth
depends in large part upon the efforts of its senior management and its ability
to attract and retain key executive officers and other highly qualified
personnel. In particular, the Company places substantial reliance on the hotel
industry knowledge and experience and the continued services of Robert A. Alter,
the Company's Chairman, Chief Executive Officer and President. Competition for
such personnel is intense and there can be no assurance that the Company will be
successful in attracting and retaining such personnel. Accordingly, there can be
no assurance that the Company's senior management will be able to successfully
execute or implement the Company's growth and operating strategies. In addition,
the loss of Mr. Alter's services or the Company's inability to attract and
retain highly qualified personnel may adversely affect the operations of the
Company and Cash Available for Distribution.
HOTEL INDUSTRY RISKS
Operating Risks and Competition. Many of the Company's competitors have
substantially greater marketing and financial resources than the Company and the
Lessee. In addition, the Company's hotels are subject to all operating risks
common to the hotel industry. The hotel industry has experienced volatility in
the past, as have the Company's hotels. Hotel industry risks include, among
other things, competition from other hotels; over-building in the hotel industry
which has adversely affected occupancy, average daily rate ("ADR") and revenue
per available room ("REVPAR") increases in operating costs due to inflation and
other factors, which may not necessarily be offset by increased room rates;
dependence on business and commercial travelers and tourism; strikes and other
labor disturbances of hotel employees for hotels owned by the Company; increases
in energy costs and other expenses of travel; and adverse effects of general and
local economic conditions. These factors could decrease room revenues of the
hotels and adversely affect the Lessee's ability to make payments of rent under
the Percentage Leases to the Company, and therefore reduce Cash Available for
Distribution.
Seasonality of Hotel Business and the Company's Hotels. The hotel
industry is seasonal in nature. Generally, revenues for the Company's hotels are
greater in the first and third quarters than in the second and fourth quarters.
In addition, weather conditions in the mid-west and eastern parts of the United
States can cause fluctuations in revenues, particularly in the winter months.
This seasonality can be expected to cause quarterly fluctuations in the
Company's Percentage Lease revenues which may be insufficient to provide all of
the Cash Available for Distribution necessary to pay dividends in a given
quarter.
10
Increased Competition Resulting From Overbuilding. The hotel industry
has historically experienced cycles of overbuilding in certain geographic
markets and product segments. Such overbuilding increases competition for hotel
guests, resulting in lower occupancies and lower ADRs, thereby reducing the
profitability of the hotels affected by the increased competition. While the
Company's investment strategy is to acquire underperforming hotels or hotels
where there are significant barriers to entry, there can be no assurance that
the current hotel development activities, particularly in the Company's limited
service segment, will not create additional significant competition for the
Company's hotels. Such increased competition would reduce the revenue generated
by the Lessee, thus reducing percentage rent paid to the Company and Cash
Available for Distribution.
IMPACT OF INCREASED OPERATING COSTS AND CAPITAL EXPENDITURES
Hotels in general, including the Company's hotels, have an ongoing need
for renovations and other capital improvements, including periodic replacement
of furniture, fixtures and equipment. In this regard, the Company may spend
significant dollars renovating, rebranding or repositioning a number of its
hotels to maximize financial performance; however, the Company is unable to
estimate the amounts to be expended at this time. In addition, the franchise
agreements under which the Company's hotels are operated impose specified
operating standards and may permit the franchisor to condition the continuation
of a franchise agreement on the completion of capital improvements. Under the
terms of the Percentage Leases, the Company is also obligated to pay the cost of
certain capital expenditures at its hotels and to pay for furniture, fixtures
and equipment. The ability of the Company to fund these and other capital
expenditures and periodic replacement of furniture, fixtures and equipment will
depend in part on the financial performance of the Lessee and the hotels. If
these expenses exceed the Company's estimate, the additional expenses could have
material adverse effect on Cash Available for Distribution. Furthermore, any
inability or failure to fund these expenditures could have a material adverse
effect on occupancy rates, ADRs and REVPAR and may constitute a breach under the
franchise agreements.
NO ARMS-LENGTH BARGAINING ON PERCENTAGE LEASES
The terms of the Percentage Leases were not negotiated on an arm's-
length basis and, accordingly, may not reflect fair market values or terms. The
lease payments under the Percentage Leases have been, and will be, calculated
with reference to historical financial data and the projected operating and
financial performance of the hotels. The Company does not own any interest in
the Lessee. All of the capital stock in the Lessee is owned by Messrs. Alter and
Biederman. As a result, such persons may have a conflict of interest with the
Company in the performance of their management services to the Company in
connection with the Percentage Leases.
FRANCHISE RISKS
Fifty-four of the Company's hotels are operated pursuant to franchise or
license agreements and additional hotels may be or will become subject to
franchise arrangements. The Lessee will hold the franchise or license agreements
for the hotels and will be responsible for complying with the terms of these
agreements. Such franchise or license arrangements are often helpful in
providing marketing services and room reservations to hotels, but these
arrangements also impose financial obligations on hotels generally related to
maintaining the condition of hotels and the payment of franchise fees.
Continuation of such franchises is subject to specified operating standards and
other terms and conditions. Franchisors periodically inspect franchised hotels
to confirm compliance. In addition, franchisors may require the Company to fund
significant capital improvements to the hotels in the future to maintain such
franchises. The failure of the Lessee to maintain required standards or adhere
to terms and conditions imposed by the franchisor may result in the loss of a
license or termination of the franchise or damages as a result of the breach. It
is possible that a franchisor could condition the continuation of a franchise on
the completion of capital improvements or replacements of furniture, fixtures
and equipment which the Company's Board of Directors determines are too
expensive or otherwise unwarranted in light of general economic conditions or
operating results or prospects of the affected hotel. The loss of a franchise
could have a material adverse effect upon the operation, financing or value of
the hotel subject to the franchise because of the loss of associated name
recognition, marketing support and centralized reservation systems. There can be
no assurance that an alternative franchise arrangement can be obtained or that
significant expenditures might not be imposed as a condition to obtaining a new
franchise. The loss of a franchise for one or more of the hotels could have a
material adverse effect on the Company's revenues under the Percentage Leases
and Cash Available for Distribution to its shareholders.
11
DEPENDENCE ON ACQUISITIONS TO INCREASE CASH AVAILABLE FOR DISTRIBUTION
The Company's success in implementing its growth plan will depend
significantly on the Company's ability to acquire additional hotels at
attractive prices. After the ramp-up of certain of the hotels which were
recently redeveloped or renovated and repositioned or which are expected to be
redeveloped or renovated and repositioned in the near future, internal growth in
ADR and occupancy for the hotels is not expected to provide as much growth in
Cash Available for Distribution as will acquisition of additional hotels.
However, since the Company intends to borrow funds to purchase, redevelop or
renovate and reposition hotels, the Company will be subject to the risks
associated with increased indebtedness, such as paying debt service even if cash
flow from such additional hotels is not sufficient to cover such costs.
FINANCING AND ABILITY TO FUND FUTURE ACQUISITIONS
The Company historically has financed hotel acquisitions through
advances on its $350 million credit facility (the "Credit Facility") and
issuances of equity securities. The Company intends to finance future
acquisitions of hotel properties, hotel renovations and non-recurring capital
improvements principally through the Credit Facility and, when market conditions
warrant, by issuing additional equity or debt securities. There can be no
assurance that the Company will have access to capital on favorable terms. If
the Company's access to capital is restricted, its ability to acquire additional
hotel properties [or fund developments and renovations] may be adversely
affected. A decline in the Company's acquisition pace relative to historical
periods may result in a decline in earnings growth.
FAILURE TO MAINTAIN REIT STATUS
The Company intends to operate so as to be taxed as a REIT under
Sections 856-860 of the Internal Revenue Code of 1986, as amended (the "Code").
As long as the Company qualifies for taxation as a REIT, with certain
exceptions, the Company will not be taxed at the corporate level on its taxable
income that is distributed to its shareholders. A REIT is subject to a number of
organizational and operational requirements, including requirements as to the
nature of its income and assets, distribution requirements, diversity of stock
ownership requirements and record-keeping requirements. While the Company
intends to satisfy all of these requirements for treatment as a REIT, it is
possible that the Company may in the future fail to satisfy one or more of these
requirements. Failure to qualify as a REIT would render the Company subject to
tax (including any applicable minimum tax) on its taxable income at regular
corporate rates and distributions to the shareholders would not be deductible by
the Company. Unless entitled to relief under certain Code provisions, the
Company also would be disqualified from treatment as a REIT for the four taxable
years following the year during which qualification was lost. Even if the
Company qualifies for taxation as a REIT, the Company may be subject to certain
state and local taxes on its income and property.
In order for the Company to be taxed as a REIT, the Partnership must be
classified as a partnership for federal income tax purposes. If the Partnership
were to be taxable as a corporation, because the Company's ownership interest in
the Partnership constitutes more than 10% of the Partnership's voting securities
and exceeds 5% of the value of the Company's assets, the Company would cease to
qualify as a REIT. The imposition of corporate income tax on the Company and the
Partnership would substantially reduce the amount of Cash Available for
Distribution.
See "Federal Income Tax Considerations" for a discussion of the material
tax consequences and risks of an investment in the Company.
OWNERSHIP LIMITATION
In order for the Company to maintain its qualification as a REIT, not
more than 50% in value of its outstanding stock may be owned, directly or
indirectly, by five or fewer individuals (as defined in the Code to include
certain entities). Furthermore, if any shareholder or group of shareholders of
the Lessee owns, actually or constructively, 10% or more of the stock of the
Company, the Lessee could become a related party tenant of the Partnership,
which likely would result in loss of REIT status for the Company. For the
purpose of preserving the Company's REIT qualification, the Company's Articles
of Incorporation prohibit direct or indirect ownership of more than 9.8% of the
outstanding shares of any class of the Company's stock by any person or
group(the "Ownership Limitation"). Generally, the capital stock owned by
affiliated owners will be aggregated for purposes of the Ownership Limitation.
Subject to certain exceptions, any transfer of Common or Preferred Stock that
would
12
prevent the Company from continuing to qualify as a REIT under the Code will be
designated as "Shares-in-Trust" and transferred automatically to a trust (the
"Share Trust") effective on the day before the purported transfer of such Common
or Preferred Stock. The record holder of the Common or Preferred Stock that are
designated as Shares-in-Trust will be required to submit such number of shares
of Common or Preferred Stock to the Share Trust and the beneficiary of the Share
Trust will be one or more charitable organizations that are named by the
Company.
INABILITY TO RETAIN EARNINGS
In order to qualify as a REIT, the Company generally is required each
year to distribute to its shareholders at least 95% of its net taxable income
(excluding any net capital gain). In addition, the Company is subject to a 4%
nondeductible excise tax on the amount, if any, by which certain distributions
paid by it with respect to any calendar year are less than the sum of (i) 85% of
its ordinary income, (ii) 95% of its capital gain net income for that year, and
(iii) any undistributed taxable income from prior periods. The Company intends
to continue to make distributions to its shareholders to comply with the 95%
distribution requirement and to avoid the nondeductible excise tax. The
Company's income consists primarily of its share of the income of the Operating
Partnership, and the Company's Cash Available For Distribution consists
primarily of its share of cash distributions from the Operating Partnership.
Differences in timing between taxable income and Cash Available For Distribution
due to the seasonality of the hospitality industry could require the Company to
borrow funds on a short-term basis to meet the 95% distribution requirement and
to avoid the nondeductible excise tax.
REAL ESTATE INVESTMENT RISKS IN GENERAL
The Company's hotels are and will be subject to varying degrees of risk
generally incident to the ownership of real property. Income from the hotels
maybe adversely affected by changes in national and local economic conditions,
changes in interest rates and in the availability, cost and terms of mortgage
funds, the impact of present or future environmental legislation and compliance
with environmental laws, the ongoing need for capital improvements, changes in
real estate tax rates and other operating expenses, changes in governmental
rules (such as those requiring upgrades for disabled persons) and fiscal
policies, civil unrest, acts of God, including earthquakes, hurricanes and other
natural disasters (which may result in uninsured losses), acts of war, changes
in zoning laws, and other factors which are beyond the control of the Company.
In addition, real estate investments are relatively illiquid, and the ability of
the Company to vary its portfolio in response to changes in economic and other
conditions will be limited.
DISTRIBUTION OF SUBSTANTIALLY ALL CASH AVAILABLE FOR DISTRIBUTION
Consistent with the Company's practice of acquiring properties in need
of renovation or redevelopment, the Company's annual distributions to
shareholders have constituted a high percentage of the Company's Cash Available
for Distribution. If this continues, the Company will retain little or no cash
from the rent payments under the Percentage Leases, and expenditures for
additional acquisitions or future capital improvements would have to be funded
from borrowings, or from proceeds from the sale of assets (including the
hotels), or debt or equity securities. In addition, a percentage of the
estimated annual distribution has constituted a return of capital rather than a
distribution of retained earnings. Consequently, there is a risk that the
distribution rate has been set too high and may not be sustainable.
UNINSURED AND UNDERINSURED LOSSES
Each of the Company's hotels is covered by comprehensive policies of
insurance, including liability, fire and extended coverage. The Company believes
such specified coverage is of the type and amount customarily obtained by owners
of real property assets, including hotels. However, there are certain types of
losses, generally of a catastrophic nature, such as earthquakes, hurricanes and
floods, that may be uninsurable or not economically insurable. Twenty-four of
the Company's hotels are located in California, which is subject to relatively
higher seismic risks. Although each of such hotels was constructed under the
more recent and stringent post-1984 building codes that were intended to reduce
the likelihood or extent of damage from seismic activity, no assurance can be
given that an earthquake would not cause substantial damage and losses. The
Company presently maintains and currently intends to continue to maintain
earthquake insurance on each of its hotels located in California. The Company's
Board of Directors may exercise discretion in determining amounts, coverage
limits and the deductibility provisions of insurance, with a view to maintaining
appropriate insurance coverage on the Company's investments at a reasonable cost
and on suitable terms. This may result in insurance coverage that, in the event
of a substantial
13
loss, would not be sufficient to pay the full current market value or current
replacement cost of the Company's lost investment. Inflation, changes in
building codes and ordinances, environmental considerations, and other factors
also might make it impractical to use insurance proceeds to replace the property
after such property has been damaged or destroyed. Under such circumstances, the
insurance proceeds received by the Company might not be adequate to restore its
economic position with respect to such property.
ENVIRONMENTAL MATTERS
Under various federal, state, and local environmental laws, ordinances
and regulations, a current or previous owner or operator of real property may be
liable for the costs of removal or remediation of hazardous or toxic substances
on, under or in such property. Such laws often impose liability whether or not
the owner or operator knew of, or was responsible for, the presence of such
hazardous or toxic substances. Under certain limited circumstances, liability
may also extend to persons holding a security interest in the property. In
addition, the presence of hazardous or toxic substances, or the failure to
properly remediate contaminated property, may adversely affect the owner's
ability to dispose of such property, to fully utilize such property without
restriction or to borrow using such property as collateral. Persons who arrange
for the disposal or treatment of hazardous or toxic substances may also be
liable for the costs of removal or remediation of such substances at the
disposal or treatment facility, whether or not such facility is or ever was
owned or operated by such person. Certain environmental laws and common law
principles could be used to impose liability for release of hazardous or toxic
substances, including the release of asbestos-containing materials ("ACMs") into
the air, and third parties may seek recovery from owners or operators of real
properties for personal injury or property damage associated with such releases,
including exposure to released ACMs. Environmental laws may also impose
restrictions on the manner in which property may be used or businesses may be
operated, and these restrictions may require expenditures. Environmental laws
provide for sanctions in the event of noncompliance and may be enforced by
governmental agencies or, in certain circumstances, by private parties. In
connection with the ownership of its hotels and any subsequently acquired
hotels, the Company may be potentially liable for such costs. Other federal,
state and local laws, ordinances and regulations require abatement or removal of
certain asbestos containing materials in the event of demolition or certain
renovations or remodeling and govern emissions of and exposure to asbestos
fibers in the air. The operation and subsequent removal of certain underground
storage tanks also are regulated by federal and state laws. The cost of
defending against claims of liability, of compliance with environmental
regulatory requirements or of remediating a contaminated property could
materially adversely affect the business, assets or results of operations of the
Company and, consequently, the Company's ability to satisfy its debt service
requirements.
ADVERSE EFFECT OF SHARES AVAILABLE FOR FUTURE ISSUANCE AND SALE ON MARKET
PRICE OF COMMON STOCK
The Company's Articles of Incorporation authorize the Board of Directors
to issue up to 160,000,000 shares of capital stock, consisting of 150,000,000
shares of Common Stock and 10,000,000 shares of Preferred Stock. As of June
30,1998, the Board of Directors was able to reclassify and issue an aggregate of
approximately 112,000,000 unissued or unreserved shares of Common Stock and to
classify and issue 9,750,000 shares of Preferred Stock. The Company's
acquisition strategy depends in part on access to additional capital through
sales and issuances of equity securities. The market price of the Common Stock
may be adversely affected by the availability for future sale and issuance of
such unissued and unreserved shares of Common Stock and Preferred Stock and the
consequent dilutive effect of such issuances.
14
In addition, the market price of the Common Stock may also be adversely
affected by the availability for future sale and issuance of shares of Common
Stock that could be issued upon the redemption of Units of the Partnership. The
Company recently filed a registration statement and may at any time in the
future file additional registration statements to give the limited partners of
the Partnership the ability to sell shares of Common Stock issued upon
redemption of Units. In addition, the Westbrook Funds were granted certain
registration rights in connection with the shares issued to them in the Kahler
Acquisition.
RISK OF DILUTION
As hotel acquisition opportunities arise from time to time, the Company
may issue additional shares of Common Stock or Preferred Stock to raise the
capital necessary to finance the hotel acquisitions or may issue Common Stock or
Preferred Stock or Partnership Units, which are redeemable on a one-to-one basis
for Common Stock, to acquire hotels. Such issuances could result in dilution of
shareholders' equity.
15
USE OF PROCEEDS
The Company will not receive any of the proceeds from the issuance of
the Warrants.
DETERMINATION OF THE OFFERING PRICE
The Warrants were issued to Messrs. Alter and Biederman in consideration
for their surrender for cancellation of the SAR Support Options. The exercise
price for each Warrant is equal to the exercise price of the SAR Support Option
it replaces. The exercise price of each SAR Support Option was the fair market
value of the Common Stock on the date of grant of such option. The following
table compares the exercise prices for the Warrants and SAR Support Options.
SAR SUPPORT OPTIONS WARRANTS
-------------------------------------- -------------------------------------------
GRANT DATE NUMBER OF EXERCISE GRANT NUMBER OF EXERCISE PRICE
OPTION PRICE PER DATE WARRANT PER SHARE
SHARES SHARE SHARES
---------- --------- --------- -------- --------- --------------
Robert A. Alter 08/10/95 130,000 $ 9.50 09/25/98 130,000 $ 9.50
07/16/96 83,600 $10.50 09/25/98 83,600 $10.50
10/27/97 24,000 $16.63 09/25/98 24,000 $16.63
01/16/98 120,000 $16.25 09/25/98 120,000 $16.25
------- -------
357,600 357,600
Charles L. Biederman 08/10/95 10,680 $ 9.50 09/25/98 10,680 $ 9.50
03/12/96 26,000 $ 9.88 09/25/98 26,000 $ 9.88
07/16/96 16,720 $10.50 09/25/98 16,720 $10.50
10/27/97 6,000 $16.63 09/25/98 6,000 $16.63
01/16/98 30,000 $16.25 09/25/98 30,000 $16.25
------- -------
89,400 89,400
SELLING SHAREHOLDERS
Because the Warrants are to be assigned by Messrs. Alter and Biederman
to the employees of the Lessee prior to their becoming exercisable, the
issuance of the Warrants will not alter the beneficial ownership interest of
each such individual.
Following surrender by the Lessee's employees of the SARs, the Warrants
will be assigned in whole or in part to up to approximately 200 of the Lessee's
employees. The names of such individuals, the number of Warrant Shares
assigned to each such individual and the number of shares of Common Stock
retained by each such individual after the assignment of the Warrants will be
incorporated into this Prospectus pursuant to a post-effective amendment to
the Form S-3 Registration Statement pursuant to which this Prospectus is filed
with the Securities and Exchange Commission and each such individual, together
with Messrs. Alter and Biederman, will be considered a "Selling Shareholder"
for purposes of this Prospectus.
Mr. Alter has served as President, Secretary, Chief Executive Officer
and Chairman of the Board of Directors of the Company since August 1994. From
1990 until August 1995, Mr. Alter served as President of the Management
Company, which currently manages all of the hotels owned by the Company. Mr.
Alter is the sole shareholder of the Management Company. Mr. Alter also serves
as chairman of the board of directors of both the Management Company and the
Lessee.
Mr. Biederman has served as Executive Vice President and director of the
Company since September 1994.
The Lessee is owned by Mr. Alter (80%) and Mr. Biederman (20%).
16
DESCRIPTION OF COMMON STOCK AND PREFERRED STOCK
The following summary description of Common Stock of the Company is
subject to and qualified in its entirety by reference to Maryland law described
herein, and to the Articles of Incorporation and Bylaws of the Company (and any
amendments or supplements thereto) which are filed as exhibits to, or
incorporated by reference in, the Registration Statement of which this
Prospectus is a part.
GENERAL
The Articles of Incorporation of the Company provide that the Company
may issue up to 160,000,000 shares of capital stock, consisting of 150,000,000
shares of Common Stock, $0.01 par value per share, and 10,000,000 shares of
preferred stock, $0.01 par value per share. As of September 28, 1998, (i)
37,556,484 shares of Common Stock were issued and outstanding, (ii) 1,000,000
shares of Common Stock were reserved for issuance under the Company's Dividend
Reinvestment and Stock Purchase Plan, (iii) 2,400,000 shares of Common Stock
were reserved for issuance under the Company's 1994 Stock Incentive Plan, (iv)
150,000 shares of Common Stock were reserved for issuance under the 1994
Directors Plan, (v) 1,699,605 shares of Common Stock were reserved for issuance
upon the conversion of Preferred Stock, units into Common Stock, and (vi)
39,942,659 shares of Common Stock were reserved for issuance upon the conversion
of units of Partnership interest ("Units") into Common Stock (each Unit is
convertible into one share of Common Stock at the Unitholder's election), and
(vii) 17,042 shares of Common Stock were reserved for issuance upon the
conversion of warrants or for other purposes. As of June 30, 1998, 250,000
shares of Preferred Stock were issued and outstanding.
The following description sets forth certain general terms and
provisions of the Common Stock to which any Prospectus Supplement may relate,
including a Prospectus Supplement providing that Common Stock will be issuable
upon conversion of Preferred Stock or upon the exercise of Warrants issued by
the Company. The Common Stock is listed on the NYSE under the symbol "SSI."
ChaseMellon Shareholder Services LLC is the Company's registrar and transfer
agent for the Common Stock and Partnership Stock.
COMMON STOCK
Subject to the preferential rights of any other shares, series or class
of shares of capital stock that may from time to time come into existence, and
to the provisions of the Company's Articles of Incorporation regarding owning
shares in excess of the Ownership Limitation holders of Common Stock will be
entitled to receive dividends on such Common Stock if, as and when authorized
and declared by the Board of Directors of the Company out of assets legally
available therefor and to share ratably in the assets of the Company legally
available for distribution to its shareholders in the event of its liquidation,
dissolution or winding-up after payment of, or adequate provision for, all known
debts and liabilities of the Company. The Company intends to continue its
practice of paying regular quarterly dividends to the holders of its Common
Stock.
Holders of the Company's Common Stock can elect to participate in the
Company's Dividend Reinvestment and Stock Purchase Plan (the "Plan") and have
all or part of their dividends reinvested in additional shares of Common Stock.
Participants in the Plan can also purchase additional shares of Common Stock
with cash (subject to certain limitations). The terms of the Plan are described
in a separate prospectus which may be obtained by calling the Plan
administrator, Mellon Bank, N.A., at (888) 261-6776.
Subject to the provisions of the Articles of Incorporation regarding
owning shares in excess of the Ownership Limitation, each outstanding share of
Common Stock entitles the holder to one vote on all matters submitted to a vote
of shareholders, including the election of directors, and, except as otherwise
required by law or except as provided with respect to any other class or series
of shares of stock, the holders of such shares of Common Stock will possess the
exclusive voting power. There is no cumulative voting in the election of
directors, which means that the holders of a majority of the outstanding shares
of Common Stock can elect all of the directors then standing for election and
the holders of the remaining shares, if any, will not be able to elect any
directors.
Holders of Common Stock have no conversion, sinking fund, redemption
rights or any preemptive rights to subscribe for any securities of the Company,
nor do they have any preference, appraisal or exchange rights.
Subject to limitations prescribed by Maryland law and the Company's
Articles of Incorporation, the Board of Directors is authorized to classify and
reclassify any unissued portion of the authorized shares of capital stock to
17
provide for the issuance of shares in other classes or series, including other
classes or series of Common Stock or classes or series of Preferred Stock to
establish the number of shares in each class or series and to fix the
designation and any preferences, conversion and other rights, voting powers,
restrictions, limitations as to dividends, qualifications and terms and
conditions of redemption of such class or series. The rights, preferences,
privileges and restrictions of such class or series will be fixed by Articles
Supplementary to the Company's Articles of Incorporation relating to such class
or series.
PREFERRED STOCK
Subject to limitations prescribed by Maryland law and the Company's
Articles of Incorporation, the Board of Directors is authorized to issue, from
the 10,000,000 authorized but unissued shares of capital stock of the Company,
Preferred Stock in such classes or series as the Board of Directors may
determine and to establish from time to time the number of shares of Preferred
Stock to be included in any such class or series and to fix the designation and
any preferences, conversion and other rights, voting powers, restrictions,
limitations as to dividends, qualifications and terms and conditions of
redemption of the shares of any such class or series, and such other subjects or
matters as may be fixed by resolution of the Board of Directors. As of the date
of this Prospectus, 250,000 shares of Preferred Stock are outstanding. The
issuance of Preferred Stock may have the effect of delaying, deferring or
preventing a change in control of the Company or other transaction in which
holders of shares of Common Stock might receive a premium for such shares over
the market price.
7.9% Class A Cumulative Convertible Preferred Stock
In connection with a portfolio acquisition, the Company issued 250,000
shares of its newly designated 7.9% Class A Cumulative Convertible Preferred
Stock (the "Class A Shares"). The holders of the Class A Shares are entitled to
one vote for each share of Common Stock into which such holder's Class A Shares
could then be converted, and with respect to such vote, such holder shall have
full voting rights and powers equal to the voting rights and powers of the
holders of Common Stock. The holders of Class A Shares are entitled to vote,
together with holders of Common Stock as a single class. Subject to preferences
that may be applicable to any future class of Preferred Stock, the holders of
Class A Shares are entitled to receive, ratably, a dividend equal to the greater
of (i) 7.9% per share per annum or (ii) the percentage dividend that would be
paid on the Common Stock into which the Preferred Stock is convertible. In the
event of a liquidation, dissolution or winding up of the Company, subject to the
rights of future classes of Preferred Stock, the holders of Class A Shares are
entitled to receive, prior and in preference to the holders of Common Stock, an
amount per share equal to $100.00 for each outstanding Class A Share, plus
accrued and unpaid dividends. The Class A Shares have no preemptive rights.
Each Class A Share is convertible at the option of the holder at any
time into a number of shares of Common Stock that is equal to the quotient
obtained by dividing $100 by $14.7093, subject to adjustment for stock splits,
stock dividends, recapitalization and the like. On or at any time after the
fifth anniversary of issuance of the Class A Shares, the Company may, at its
option, redeem the Class A Shares in whole or in part by paying an amount equal
to the redemption percentage of $100.00 per share then in effect (as adjusted
for any stock dividends, combinations or splits), plus all accrued but unpaid
dividends on such shares. The redemption percentage declines one percent per
year, from 105% to par commencing in 2002. There are no sinking fund provisions
applicable to the Class A Shares. All outstanding Class A Shares will, upon
issuance, be fully paid and non-assessable.
Terms of Future Classes of Preferred Stock
The terms of any future class or series of Preferred Stock which may be
issued will be set forth in Articles Supplementary to the Company's Articles of
Incorporation which will be filed with the Maryland Department of Assessments
and Taxation and as an exhibit to (or incorporated by reference in) a report
filed with the Commission in connection with the Company's Exchange Act
reporting obligations.
RESTRICTIONS ON OWNERSHIP OF COMMON STOCK OR PREFERRED STOCK
The following is a description of the restrictions on ownership of the
Common Stock and Preferred Stock. There may be additional provisions that
further restrict ownership and transfer, which will be described in any
applicable Prospectus Supplement. Such description is, and will be, qualified in
its entirety by any supplements to the Articles of Incorporation or Bylaws filed
as exhibits to, or incorporated by reference in, the Registration Statement of
which this Prospectus is a part.
18
For the Company to qualify as a REIT under the Code, it must meet
certain requirements concerning the ownership of its outstanding shares of
capital stock. Specifically, not more than 50% in value of the Company's
outstanding shares may be owned, directly or indirectly, by five or fewer
individuals (as defined in the Code to include certain entities) during the last
half of a taxable year, and the Company must be beneficially owned by 100 or
more persons during at least 335 days of a taxable year of 12 months or during a
proportionate part of a shorter taxable year. See "United States Federal Income
Tax Considerations -- Requirements for Qualification." In addition, the Company
must meet certain requirements regarding the nature of its gross income in order
to qualify as a REIT. One such requirement is that at least 75% of the Company's
gross income for each year must consist of rents from real property and income
from certain other real property investments. The rents received by the
Partnership from the Lessee would not qualify as rents from real property, which
would result in loss of REIT status for the Company, if the Company were at any
time to own, directly or constructively, 10% or more of the ownership interests
in the Lessee within the meaning of Section 856(d)(2)(B) of the Code. See
"United States Federal Income Tax Considerations -- Requirements for
Qualification -- Income Tests."
Because the Board of Directors believes it is essential for the Company
to qualify as a REIT, the Articles of Incorporation, subject to certain
exceptions described below, provides that no person may own, or be deemed to own
by virtue of the constructive ownership provisions of the Code, more than 9.8%
of the lesser in value of the total number or value of the outstanding shares of
Common Stock or the outstanding shares of Preferred Stock (the "Ownership
Limitation"). The constructive ownership rules of the Code are complex and may
cause shares owned actually or constructively by two or more related individuals
and/or entities to be constructively owned by one individual or entity. As a
result, the acquisition of less than 9.8% of the outstanding shares of Common
Stock or 9.8% of the shares of Preferred Stock (or the acquisition of an
interest in an entity which owns the shares) by an individual or entity could
cause that individual or entity (or another individual or entity) to own
constructively in excess of 9.8% of the outstanding shares of Common Stock or
9.8% of the outstanding shares of Preferred Stock, and thus subject such shares
to the Ownership Limitation provisions of the Articles of Incorporation. The
Ownership Limitation also prohibits any transfer of Common Stock or Preferred
Stock that would (i) result in the Common Stock and Preferred Stock being owned
by fewer than 100 persons (determined without reference to any rules of
attribution), (ii) result in the Company being "closely held" within the meaning
of Section 856(h) of the Code, or (iii) cause the Company to own, directly or
constructively, 10% or more of the ownership interests in a tenant of the
Company's real property, within the meaning of Section 856(d)(2)(B) of the Code.
Except as otherwise provided below, any such acquisition or transfer of the
Company's capital stock (including any constructive acquisition or transfer of
ownership) shall be null and void, and the intended transferee or owner will
acquire no rights to, or economic interests in, the shares.
Subject to certain exceptions described below, any purported transfer of
Common Stock or Preferred Stock that would (i) result in any person owning,
directly or indirectly, Common Stock or Preferred Stock in excess of the
Ownership Limitation, (ii) result in the Common Stock and Preferred Stock being
owned by fewer than 100 persons (determined without reference to any rules of
attribution), (iii) result in the Company being "closely held" within the
meaning of Section 856(h) the Code, or (iv) cause the Company to own, directly
or constructively, 10.0% or more of the ownership interests in a tenant of the
Company's or the Partnership's real property, within the meaning of Section
856(d)(2)(B) of the Code, will be designated as "Shares-in-Trust" and
transferred automatically to a Trust (the "Share Trust") effective on the day
before the purported transfer of such Common Stock or Preferred Stock. The
record holder of the Common Stock or Preferred Stock that are designated as
Shares-in-Trust (the "Prohibited Owner") will be required to submit such number
of shares of Common Stock or Preferred Stock to the Share Trust for designation
in the name of a trustee to be designated by the Company (the "Share Trustee").
The beneficiary of the Share Trust (the "Beneficiary") will be one or more
charitable organizations that are named by the Company.
Shares-in-Trust will remain issued and outstanding Common Stock or
Preferred Stock and will be entitled to the same rights and privileges as all
other shares of the same class or series. The Share Trust will receive all
dividends and distributions on the Shares-in-Trust and will hold such dividends
or distributions in trust for the benefit of the Beneficiary. The Share Trustee
will vote all Shares-in-Trust. The Share Trustee will designate a permitted
transferee of the Shares-in-Trust, provided that the permitted transferee (i)
purchases such Shares-in-Trust for valuable consideration and (ii) acquires such
Shares-in-Trust without such acquisition resulting in a transfer to another
Share Trust.
The Prohibited Owner with respect to Shares-in-Trust will be required to
repay to the Share Trust the amount of any dividends or distributions received
by the Prohibited Owner (i) that are attributable to any Shares-in-Trust and
(ii) for which the record date was on or after the date that such shares became
Shares-in-Trust. The
19
Prohibited Owner generally will receive from the Share Trustee the lesser of (i)
the price per share such Prohibited Owner paid for the Common Stock or Preferred
Stock that were designated as Shares-in-Trust (or, in the case of a gift or
devise, the market price (based on a five day trading average) per share on the
date of such transfer) and (ii) the price per share received by the Share
Trustee from the sale or other disposition of such Shares-in-Trust. Any amounts
received by the Share Trustee in excess of the amounts to be paid to the
Prohibited Owner will be distributed to the Beneficiary.
The Shares-in-Trust will be deemed to have been offered for sale to the
Company, or its designee, at a price per share equal to the lesser of (i) the
price per share in the transaction that created such Shares-in-Trust (or, in the
case of a gift or devise, the market price per share on the date of such
transfer) or (ii) the market price per share on the date that the Company, or
its designee, accepts such offer. The Company will have the right to accept such
offer for a period of ninety days after the later of (i) the date of the
purported transfer which resulted in such Shares-in-Trust and (ii) the date the
Company determines in good faith that a transfer resulting in such Shares-
in-Trust occurred.
Any person who acquires or attempts to acquire Common Stock or Preferred
Stock in violation of the foregoing restrictions, or any person who owned shares
of Common Stock or Preferred Stock that were transferred to a Share Trust, will
be required (i) to give immediately written notice to the Company of such event
and (ii) to provide to the Company such other information as the Company may
request in order to determine the effect, if any, of such transfer on the
Company's status as a REIT.
All persons who own, directly or indirectly, more than 5% (or such lower
percentages as required pursuant to regulations under the Code) of the
outstanding shares of Common Stock and Preferred Stock must within 30 days after
January 1 of each year, provide to the Company a written statement or affidavit
stating the name and address of such direct or indirect owner, the number of
shares of Common Stock and Preferred Stock owned directly or indirectly, and a
description of how such shares are held. In addition, each direct or indirect
shareholder shall provide to the Company such additional information as the
Company may request in order to determine the effect, if any, of such ownership
on the Company's status as a REIT and to ensure compliance with the Ownership
Limitation.
The Ownership Limitation generally will not apply to the acquisition of
shares of Common Stock or Preferred Stock by an underwriter that participates in
a public offering of such shares. In addition, the Board of Directors, upon
receipt of a ruling from the Internal Revenue Service or an opinion of counsel
and upon such other conditions as the Board of Directors may direct, may exempt
a person from the Ownership Limitation under certain circumstances. The
foregoing restrictions will continue to apply until the Board of Directors, with
the approval of the holders of at least two-thirds of the outstanding shares of
all votes entitled to vote on such matter at a regular or special meeting of the
shareholders of the Company, determines to terminate its status as a REIT.
The Ownership Limitation will not be automatically removed even if the
REIT provisions of the Code are changed so as to remove any ownership
concentration limitation. Any change of the Ownership Limitation would require
an amendment to the Articles of Incorporation. Such amendment requires the
affirmative vote of holders holding at least two-thirds of the outstanding
shares entitled to vote on the matter. In addition to preserving the Company's
status as a REIT, the Ownership Limitation may have the effect of delaying,
deferring, discouraging or preventing a transaction or a change in control of
the Company without the approval of the Board of Directors.
Any certificates representing shares of Common Stock or Preferred Stock
will bear a legend referring to the restrictions described above.
WARRANTS
The Warrants will be evidenced by a Warrant Agreement. The Warrants may
be exercised upon written notice by the holder to the Company's transfer agent,
ChaseMellon Shareholders Services, LLC, on or prior to September 24, 2003,
accompanied by payment of the Warrant exercise price for the number of shares
with respect to which the Warrants are being exercised. Payment of the exercise
price may be made in cash, certified or bank check payable to the order of the
Company, the delivery of shares of Common Stock which have been held for the
requisite period to avoid a charge to the Company's earnings for financial
reporting purposes (generally six (6) months) or, to the extent the purchased
Warrant Shares are vested and no longer subject to repurchase by Mr. Alter or
Mr. Biederman as assignor of the Warrant, through a cashless exercise program
pursuant to which the holder may
20
direct the immediate sale of the Warrant Shares on the open market and payment
to the Company out of the sale proceeds on the settlement date, sufficient funds
to cover the exercise price payable for the Warrant Shares and all applicable
withholding taxes. The shares of Common Stock to be issued upon exercise of
these Warrants and payment in accordance with the terms thereof will be fully
paid and nonassessable.
The Warrants will become exercisable thirteen (13) months after the
September 25, 1998 date of issuance and will be transferrable by Messrs. Alter
and Biederman only to those employees of the Lessee who currently hold
outstanding SARs and agree to surrender such SARs in exchange for an assignment
of the Warrants. No further assignment of the Warrants will be permitted by the
Lessee's Each Warrant entitles the registered holder to purchase one share of
Common Stock at any time prior to 5:00 p.m. California time on September 24,
2003. The Exercise Price for the Warrants vary according to the schedule set
forth below:
NUMBER OF WARRANTS EXERCISE PRICE
------------------ --------------
140,680 $ 9.50
26,000 $ 9.88
100,320 $ 10.50
30,000 $ 16.63
150,000 $ 16.25
The Warrants provide for adjustment of the Exercise Price and for a
change in the number of shares issuable upon exercise to protect holders against
dilution in the event of stock dividends, stock splits, combinations or
reclassifications of the Common Stock.
The Warrants do not confer upon the holders any voting or other rights
of a shareholder of the Company. The Company has authorized the issuance of the
Warrants and reserved sufficient shares of Common Stock for issuance upon
exercise of the Warrants.
21
CERTAIN PROVISIONS OF MARYLAND LAW
AND OF THE COMPANY'S ARTICLES OF INCORPORATION AND BYLAWS
The following summary of certain provisions of Maryland law and of the
Articles of Incorporation and Bylaws of the Company does not purport to be
complete and is qualified in its entirety by reference to Maryland law and the
Articles of Incorporation and Bylaws of the Company (and any amendments and
supplements thereto) which are filed as exhibits to, or incorporated by
reference in, the Registration Statement of which this Prospectus is a part.
ANTI-TAKEOVER EFFECT OF CERTAIN PROVISIONS OF MARYLAND LAW AND OF THE
COMPANY'S ARTICLES OF INCORPORATION AND BYLAWS
The provisions in the Articles of Incorporation regarding the Ownership
Limitation and the classification of the Board of Directors, the business
combination provisions of the Maryland General Corporation Law ("MGCL"), the
control shares acquisition provisions of the MGCL, and the advance notice
provisions of the Bylaws could have the effect of delaying, deferring,
discouraging or preventing a transaction or a change in control of the Company
in which holders of some, or a majority, of the capital stock of the Company
might receive a premium for their shares over the then prevailing market price
or which such holders might believe to be otherwise in their best interest.
Certain significant provisions which might have this effect are described below.
CLASSIFICATION OF THE BOARD OF DIRECTORS
The Bylaws provide that the number of directors of the Company may be
established by the Board of Directors but may not be fewer than three nor more
than nine. The directors may increase the number of directors by a vote of a
least 80% of the members of the Board of Directors, provided that the number of
directors shall never be less than the number required by Maryland law and that
the tenure of office of a director shall not be affected by any decrease in the
number of directors. Any vacancy will be filled, including a vacancy created by
an increase in the number of directors, at any regular meeting or at any special
meeting called for that purpose, by a majority of the remaining directors,
except that a vacancy resulting from an increase in the number of directors must
be filled by a majority of the entire Board of Directors.
Pursuant to the Articles of Incorporation the Board of Directors will be
divided into three classes of directors. As the term of each class expires,
directors in that class will be elected by the shareholders of the Company for a
term of three years and until their successors are duly elected and qualify.
Classification of the Board of Directors is intended to assure the continuity
and stability of the Company's business strategies and policies as determined by
the Board of Directors. Shareholders will have no right to cumulative voting in
the election of directors. Consequently, at each annual meeting of shareholders,
the holders of a majority of the shares of Common Stock present in person or by
proxy at such meeting will be able to elect all of the successors of the class
of directors whose terms expire at that meeting.
The classified board provision could have the effect of making the
replacement of incumbent directors more time consuming and difficult, which
could delay, defer, discourage or prevent an attempt by a third party to obtain
control of the Company or other transaction, even though such an attempt or
other transaction might be beneficial to the Company and its shareholders. At
least two annual meetings of shareholders, instead of one, will generally be
required to effect a change in a majority of the Board of Directors. Thus, the
classified board provision could increase the likelihood that incumbent
directors will retain their positions.
REMOVAL OF DIRECTORS
The Articles of Incorporation provide that a director may be removed
with or without cause by the affirmative vote of at least two-thirds of the
votes entitled to be cast in the election of directors. This provision, when
coupled with the provision in the Bylaws authorizing the Board of Directors to
fill vacant directorships, could preclude shareholders from removing incumbent
directors except upon the existence of a substantial affirmative vote and by
filling the vacancies created by such removal with their own nominees upon the
affirmative vote of a majority of the votes entitled to be cast in the election
of directors.
22
LIMITATION OF LIABILITY AND INDEMNIFICATION
The Articles of Incorporation and Bylaws limit the liability of the
Company's directors and officers for money damages to the Company and its
shareholders to the fullest extent permitted from time to time by Maryland law.
Maryland law presently permits the liability of directors and officers to a
corporation or its shareholders for monetary damages to be limited, except (i)
to the extent that it is proved that the director or officer actually received
an improper benefit or profit, or (ii) to the extent that a judgment or other
final adjudication is entered in a proceeding based on a finding that the
director's or officer's action, or failure to act, was the result of active and
deliberate dishonesty and was material to the cause of action, as adjudicated in
the proceeding. This provision does not limit the ability of the Company or its
shareholders to obtain other relief, such as an injunction or rescission.
The Articles of Incorporation and Bylaws require the Company to
indemnify its directors and officers to the fullest extent permitted from time
to time by Maryland law. The Company's Articles of Incorporation and Bylaws also
permit the Company to indemnify employees, agents and other persons acting on
behalf of or at the request of the Company. The MGCL generally permits a
corporation to indemnify its directors, officers and certain other parties
against judgments, penalties, fines, settlements and reasonable expenses
actually incurred by them in connection with any proceeding to which they may be
made a party by reason of their service to or at the request of the Company.
Indemnification under the provisions of the MGCL is not deemed exclusive to any
other rights, by indemnification or otherwise, to which an officer or director
may be entitled under the Articles of Incorporation or Bylaws, or under
resolutions of shareholders or directors, contract or otherwise. It is the
position of the Commission that indemnification of directors and officers for
liabilities arising under the Securities Act is against public policy and is
unenforceable pursuant to Section 14 of the Securities Act.
BUSINESS COMBINATIONS
Under the MGCL, certain "business combinations" (including a merger,
consolidation, share exchange or, in certain circumstances, an asset transfer or
issuance or reclassification of equity securities) between a Maryland
corporation and any person who beneficially owns ten percent or more of the
voting power of such corporation's shares or an affiliate of such corporation
who, at any time within the two-year period prior to the date in question, was
the beneficial owner of ten percent or more of the voting power of the then-
outstanding voting shares of such corporation (an "Interested Shareholder") or
an affiliate thereof are prohibited for five years after the most recent date on
which the Interested Shareholder became an Interested Shareholder. Thereafter,
any such business combination must be recommended by the board of directors of
such corporation and approved by the affirmative vote of at least (a) 80% of the
votes entitled to be cast by holders of outstanding voting shares of such
corporation and (b) two-thirds of the votes entitled to be cast by holders of
voting shares of such corporation other than shares held by the Interested
Shareholder with whom (or with whose affiliate) the business combination is to
be effected, unless, among other things, such corporation's shareholders receive
a minimum price (as defined in the MGCL) for their shares and the consideration
is received in cash or in the same form as previously paid by the Interested
Shareholder for its shares. These provisions of Maryland law do not apply,
however, to business combinations that are approved or exempted by the board of
directors of a corporation prior to the time that the Interested Shareholder
becomes an Interested Shareholder. The Board of Directors has exempted from
these provisions of the MGCL any business combination with certain officers and
directors of the Company, and all present or future affiliates or associates of,
or any other person acting in concert or as a group with, any of the foregoing
persons and any other business combination which may arise in connection with
the Company formation transactions generally.
CONTROL SHARE ACQUISITIONS
The MGCL provides that "control shares" of a Maryland corporation
acquired in a "control share acquisition" have no voting rights except to the
extent approved by a vote of two-thirds of the votes entitled to be cast on the
matter, excluding shares owned by the acquiror, by officers or by directors who
are employees of a corporation. "Control Shares" are voting shares which, if
aggregated with all other such shares previously acquired by the acquiror, or in
respect of which the acquiror is able to exercise or direct the exercise of
voting power (except solely by virtue of a revocable proxy), would entitle the
acquiror to exercise voting power in electing directors within one of the
following ranges of voting power: (i) one-fifth or more but less than one-third
(ii) one-third or more but less than a majority, or (iii) a majority or more of
all voting power. Control Shares do not include shares the acquiring person is
then entitled to vote as a result of having previously obtained shareholder
approval. A "control share acquisition" means the acquisition of control shares,
subject to certain exceptions.
23
A person who has made or proposes to make a control share acquisition,
upon satisfaction of certain conditions (including an undertaking to pay
expenses), may compel the board of directors of a corporation to call a special
meeting of shareholders to be held within 50 days of demand to consider the
voting rights of the shares. If no request for a meeting is made, the
corporation may itself present the question at any shareholders meeting.
If voting rights are not approved at the meeting or if the acquiring
person does not deliver an acquiring person statement as required by the
statute, then, subject to certain conditions and limitations, a corporation may
redeem any or all of the control shares (except those for which voting rights
have previously been approved) for fair value determined, without regard to the
absence of voting rights for the control shares, as of the date of the last
control share acquisition by the acquiror or of any meeting of shareholders at
which the voting rights of such shares are considered and not approved. If
voting rights for control shares are approved at a shareholders meeting and the
acquiror becomes entitled to vote a majority of the shares entitled to vote, all
other shareholders may exercise appraisal rights. The fair value of the shares
as determined for purposes of such appraisal rights may not be less than the
highest price per share paid by the acquiror in the control share acquisition,
and certain limitations and restrictions otherwise applicable to the exercise of
dissenters' rights do not apply in the context of a control share acquisition.
The control share acquisition statute does not apply to shares acquired
in a merger, consolidation or share exchange, if the corporation is a party to
the transaction, or to acquisitions approved or exempted by the articles of
incorporation or bylaws of a corporation.
The Bylaws of the Company contain a provision exempting from the control
share acquisition statute any and all acquisitions by any person of the
Company's Common Stock or Preferred Stock. There can be no assurance that such
provision will not be amended or eliminated in the future.
AMENDMENTS TO THE COMPANY'S ARTICLES OF INCORPORATION AND BYLAWS
The Articles of Incorporation may only be amended by the affirmative
vote of the holders of not less than a majority of the votes entitled to be cast
on the matter, except that any proposal (i) to permit cumulative voting in the
election of directors, (ii) to alter provisions of the Articles of Incorporation
requiring a majority of the directors to be independent directors or provisions
of the Articles of Incorporation relative to the classification of the Company's
Board of Directors into three classes, removal of directors, preemptive rights,
indemnification of corporate agents and limitation of liability of officers and
directors, or (iii) that would terminate the Company's status as a REIT for tax
purposes, may not be amended, altered, changed or repealed without the
affirmative vote of at least two-thirds of all of the votes entitled to be cast
on the matter. Subject to the right of the Company's shareholders to adopt,
alter or repeal the Bylaws, the Bylaws may be amended by the Board of Directors,
except for provisions of the Bylaws relating to the sale of certain hotels and
transactions involving the Company in which an advisor, director or officer has
an interest, which may be altered or repealed only upon the vote of shareholders
holding at least two-thirds of the outstanding shares of stock entitled to vote
generally in the election of directors.
DISSOLUTION OF THE COMPANY
Pursuant to the Articles of Incorporation, the dissolution of the
Company must be approved and advised by the Board of Directors and approved by
the affirmative vote of the holders of a majority of all of the votes entitled
to be cast on the matter.
OPERATIONS
The Company is generally prohibited from engaging in certain activities,
including incurring consolidated indebtedness, in the aggregate, in excess of
50% of the Company's investment in hotels at cost, and acquiring or holding
property or engaging in any activity that would cause the Company to fail to
qualify as a REIT.
24
FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of material federal income tax considerations
that may be relevant to a prospective holder of the Warrants and Common Stock.
The discussion contained herein does not address all aspects of taxation that
may be relevant to particular holders of the Warrants and Common Stock in light
of their personal investment or tax circumstances, or to certain types of
holders (including insurance companies, tax-exempt organizations, financial
institutions or broker-dealers, foreign corporations, and persons who are not
citizens or residents of the United States) subject to special treatment under
the federal income tax laws.
This discussion as to tax consequences is based on current provisions of
the Code, existing, temporary, and currently proposed Treasury Regulations
promulgated under the Code, the legislative history of the Code, existing
administrative rulings and practices of the Service, and judicial decisions. No
assurance can be given that future legislative, judicial, or administrative
actions or decisions, which may be retroactive in effect, will not affect the
accuracy of any statements in this Prospectus with respect to the transactions
entered into or contemplated prior to the effective date of such changes.
EACH PROSPECTIVE HOLDER OF WARRANTS AND COMMON STOCK IS ADVISED TO
CONSULT HIS OWN TAX ADVISOR REGARDING THE SPECIFIC TAX CONSEQUENCES TO HIM OF
THE ACQUISITION, OWNERSHIP AND DISPOSITION OF THE WARRANTS AND COMMON STOCK AND
OF THE COMPANY'S ELECTION TO BE TAXED AS A REIT, INCLUDING THE FEDERAL, STATE,
LOCAL, FOREIGN, AND OTHER TAX CONSEQUENCES OF SUCH ACQUISITION, OWNERSHIP,
DISPOSITION AND ELECTION, AND OF POTENTIAL CHANGES IN APPLICABLE TAX LAWS.
TAXATION OF ASSIGNEES OF WARRANTS
No taxable income will be recognized by an employee of the Lessee upon
assignment to him or her by Mr. Alter or Biederman of a Warrant or upon the
surrender by such individual to the Lessee of his or her outstanding SARs.
Following assignment of the Warrant, for purposes of taxation of the assignee,
the Warrant will be treated as if issued by the Lessee. Accordingly, the
assignee will in general recognize ordinary income, in the year in which the
Warrant is exercised, equal to the excess of the fair market value of the
purchased shares of Common Stock on the exercise date, over the warrant exercise
price paid for those shares, and the assignee will be required to satisfy the
tax withholding requirements with respect to such income.
If the shares of Common Stock acquired upon exercise of the assigned
Warrant are subject to repurchase by Mr. Alter or Mr. Biederman in the event of
the assignee's termination of service with the Lessee prior to vesting in those
shares, then the assignee will not recognize any taxable income at the time of
exercise but will have to report as ordinary income, as and when such repurchase
right lapses, an amount equal to the excess of (i) the fair market value of the
shares on the date the repurchase right lapses over (ii) the warrant exercise
price paid for the shares. The assignee may, however, elect under Section 83(b)
of the Internal Revenue Code to include as ordinary income in the year of
exercise of the Warrant an amount equal to the excess of (i) the fair market
value of the purchased shares on the exercise date over (ii) the warrant
exercise price paid for such shares. If the Section 83(b) election is made, the
assignee will not recognize any additional income as and when the repurchase
right lapses.
Upon the sale by the assignee of the Warrant Shares, the assignee will
recognize capital gain equal to the excess of (i) the amount realized upon such
sale over (ii) the fair market value of such shares at the time the assignee
recognized the ordinary income with respect to their acquisition. A capital loss
will result if the amount realized upon the sale is less than such fair market
value.
The capital gain holding period for vested Warrant Shares will start at
the time the Warrant is exercised for those shares. If unvested Warrant Shares
are purchased, subject to repurchase by Messrs. Alter and Biederman, the holding
period will start either (i) at the time the Warrant Shares vest, if no Section
83(b) election is made at the time of exercise, or (ii) at the time the Warrant
Shares are exercised if the Section 83(b) election is within thirty (30) days
after the Warrant exercise date.
The Lessee will be entitled to a deduction equal to the amount of
ordinary income recognized by the employee with respect to the exercise of the
assigned Warrant. The deduction will in general be allowed for the taxable year
of the Lessee in which such ordinary income is recognized by the assignee.
However, if the deduction is attributable to a Warrant which is exercised for
shares of Common Stock which are subject to repurchase by Mr. Alter or Mr.
Biederman, then, in the absence of a Section 83(b) election, the deduction will
not be allowed until the taxable year of the Company which includes the last day
of the calendar year in which the assignee recognizes the ordinary income with
respect to the shares acquired under the Warrant.
TAXATION OF THE COMPANY
The Company has elected to be taxed as a REIT under Sections 856 through
860 of the Code, effective for each of its taxable years ended since December
31, 1995. The Company's qualification and taxation as a REIT depends upon the
Company's ability to meet, on a continuing basis, the various qualification
tests imposed under
25
the Code discussed below. No assurance can be given that the actual results of
the Company's operations have or will satisfy all of the requirements for
qualification as a REIT.
The sections of the Code relating to qualification and operation as a
REIT are highly technical and complex. The following discussion sets forth the
material aspects of the Code sections that govern the federal income tax
treatment of a REIT and its shareholders. The discussion is qualified in its
entirety by the applicable Code provisions, Treasury Regulations promulgated
thereunder, and administrative and judicial interpretations thereof, all of
which are subject to change prospectively or retrospectively.
Assuming the Company qualifies for taxation as a REIT, it generally will
not be subject to federal corporate income tax on its net income that is
distributed currently to its shareholders. That treatment substantially
eliminates the "double taxation" (i.e., taxation at both the corporate and
shareholder levels) that generally results from investment in a corporation.
However, the Company will be subject to federal income tax in the following
circumstances. First, the Company will be taxed at regular corporate rates on
any undistributed REIT taxable income, including undistributed net capital
gains. Furthermore, under certain circumstances, the Company may be subject to
the "alternative minimum tax" on its items of tax preference. Third, if the
Company has (i) net income from the sale or other disposition of "foreclosure
property" that is held primarily for sale to customers in the ordinary course of
business or (ii) other nonqualifying income from foreclosure property, it will
be subject to tax at the highest corporate rate on such income. Fourth, if the
Company has net income from prohibited transactions (which are, in general,
certain sales or other dispositions of property (other than foreclosure
property) held primarily for sale to customers in the ordinary course of
business), such income will be subject to a 100% tax. Fifth, if the Company
should fail to satisfy the 75% gross income test or the 95% gross income test
(as discussed below), and has nonetheless maintained its qualification as a REIT
because certain other requirements have been met, it will be subject to a 100%
tax on the net income attributable to the greater of the amount by which the
Company fails the 75% or 95% gross income test. Sixth, if the Company should
fail to distribute during each calendar year at least the sum of (i) 85% of its
REIT ordinary income for such year, (ii) 95% of its REIT capital gain net income
for such year, and (iii) any undistributed taxable income from prior periods,
the Company would be subject to a 4% excise tax on the excess of such required
distribution over the amounts actually distributed. Seventh, if the Company
acquires any asset from a C corporation (i.e., a corporation generally subject
to full corporate-level tax) in a transaction in which the basis of the asset
in the Company's hands is determined by reference to the basis of the asset (or
any other asset) in the hands of the C corporation and the Company recognizes
gain on the disposition of such asset during the 10-year period beginning on the
date on which such asset was acquired by the Company, then the Company would be
taxable to the extent of such asset's "built-in-gain." Such taxation of the
Company on "built-in gains" will be applicable to gain on the disposition of
assets which were received by the Company upon the liquidation of Kahler Realty
Corporation and its subsidiaries.
Requirements for Qualification Earnings and Profits
- ---------------------------------------------------
In order to maintain REIT status, the Company was required to distribute
any earnings and profits that it acquired as a result of the Kahler Acquisition
on or before December 31, 1997. In connection with the Kahler Acquisition, the
Company has received a certification from the auditors for Kahler that, subject
to certain assumptions set forth therein, the pre-acquisition earnings and
profits of Kahler were $28.5 million (not considering the cash
26
distribution described immediately below), and the Company's auditors have
reviewed and approved this certification and the workpapers of Kahler's
auditors. In rendering any tax opinion in connection with an offering under this
Prospectus, Brobeck, Phleger & Harrison LLP will assume that this certification
is correct, a factual question upon which counsel has expressed no opinion.
However, the certification is not binding on the IRS, and there can be no
assurance that it will not be successfully challenged.
Immediately prior to the Kahler Acquisition, Kahler made a $28.75
million distribution to its shareholders. The Company received a private letter
ruling from the IRS confirming that Kahler's pre-acquisition distribution will
be treated as a "dividend" for tax purposes, and thus reduced Kahler's
pre-acquisition earnings and profits by the amount of the distribution.
Based on the IRS's ruling and the certificates from Kahler's and the
Company's auditors, the Company anticipates that it had no non-REIT earnings
and profits as of the end of its 1997 taxable year. In the event, however, that
the Company had any such non-REIT earnings and profits, it would be
disqualified as a REIT in 1997 and thereafter.
Other Requirements
The Code defines a REIT as a corporation, trust or association (i) that
is managed by one or more trustees or directors; (ii) the beneficial ownership
of which is evidenced by transferable shares, or by transferable certificates of
beneficial interest; (iii) that would be taxable as a domestic corporation, but
for Sections 856 through 860 of the Code; (iv) that is neither a financial
institution nor an insurance company subject to certain provisions of the Code;
(v) the beneficial ownership of which is held by 100 or more persons; (vi) not
more than 50% in value of the outstanding shares of which is owned, directly or
indirectly, by five or fewer individuals (as defined in the Code to include
certain entities) during the last half of each taxable year (the "5/50 Rule");
(vii) that makes an election to be a REIT (or has made such election for a
previous taxable year) and satisfies all relevant filing and other
administrative requirements established by the Service that must be met in order
to elect and to maintain REIT status; (viii) that uses a calendar year for
federal income tax purposes and complies with the recordkeeping requirements of
the Code and Treasury Regulations promulgated thereunder; and (ix) that meets
certain other tests, described below, regarding the nature of its income and
assets. The Company's Articles of Incorporation provide for restrictions
regarding transfer of the Company's stock that are intended to assist the
Company in continuing to satisfy the share ownership requirements described in
(v) and (vi) above. See "Description of Common Stock -- Restrictions on
Ownership of Common Stock or Preferred Stock."
In the case of a REIT that is a partner in a partnership, Treasury
Regulations provide that the REIT will be deemed to own its proportionate share
of the assets of the partnership and will be deemed to be entitled to the gross
income of the partnership attributable to such share. In addition, the assets
and gross income of the partnership will retain the same character in the hands
of the REIT as in the partnership for purposes of Section 856 of the Code,
including satisfying the gross income and asset tests, described below. Thus,
assuming the Partnership is classified as a partnership rather than as a
corporation for tax purposes, the Company's proportionate share of the assets,
liabilities and items of income of the Partnership will be treated as assets and
gross income of the Company for purposes of applying the requirements described
herein.
Income Tests
In order for the Company to maintain its qualification as a REIT, there
are three requirements relating to the Company's gross income that must be
satisfied annually. First, at least 75% of the Company's gross income (excluding
gross income from prohibited transactions) for each taxable year must consist of
defined types of income derived directly or indirectly from investments relating
to real property or mortgages on real property (including "rents from real
property" and, in certain circumstances, interest) or temporary investment
income. Second, at least 95% of the Company's gross income (excluding gross
income from prohibited transactions) for each taxable year must be derived from
such real property or temporary investments, and from dividends, other types of
interest, and gain from the sale or disposition of stock or securities, or from
any combination of the foregoing. Third, in taxable years through 1997, not more
that 30% of the Company's gross income (including gross income from prohibited
transactions) for each taxable year may be gain from the sale or other
disposition of (i) stock or securities held for less than one year, (ii) dealer
property that is not foreclosure property, and (iii) certain real property held
for less than four years (apart from involuntary conversions and sales of
foreclosure property). The 30% test does not apply for taxable years after 1997.
The specific application of these tests to the Company is discussed below.
Rents received by the Company will qualify as "rents from real property"
in satisfying the gross income requirements for a REIT described above only if
several conditions are met. First, the amount of rent must not be based in whole
or in part on the income or profits of any person. However, an amount received
or accrued generally will not be excluded from the term "rents from real
property" solely by reason of being based on a fixed percentage or percentages
of receipts or sales. Second, rents received from a tenant will not qualify as
"rents from real property" in satisfying the gross income tests if the Company,
or an owner of 10% or more of the Company, directly or constructively owns 10%
or more of such tenant (a "Related Party Tenant"). Third, if rent attributable
to personal property leased in connection with a lease of real property is
greater than 15% of the total rent received under the lease, then the portion of
rent attributable to such personal property will not qualify as "rents from real
property."
27
Finally, for rents received to qualify as "rents from real property," the
Company generally must not operate or manage the property or furnish or render
services to the tenants of such property, other than through an "independent
contractor" who is adequately compensated and from whom the Company derives no
revenue. The "independent contractor" requirement, however, does not apply to
the extent the services provided by the Company are "usually or customarily
rendered" in connection with the rental of space for occupancy only and are not
otherwise considered "rendered to the occupant."
Pursuant to percentage leases (the "Percentage Leases"), Sunstone Hotel
Properties, Inc., a Colorado corporation (the "Lessee") has leased from the
Partnership the land, buildings, improvements, furnishings and equipment
comprising the hotels for a 10-year period. The Percentage Leases provide that
the Lessee is obligated to pay to the Partnership (i) the greater of base rent
("Base Rent") or percentage rent ("Percentage Rent," and with Base Rent,
collectively, the "Rents") and (ii) certain other additional charges (the
"Additional Charges"). The Percentage Rent is calculated by multiplying fixed
percentages by the room revenues for each of the hotels in excess of certain
levels. Both the Base Rent and the threshold room revenue amount in each
Percentage Rent formula will be adjusted for inflation. The adjustment will be
calculated at the beginning of each calendar year based on the change in the CPI
during the prior calendar year. The Base Rent accrues and is required to be paid
monthly and the Percentage Rent (if any) accrues and is required to be paid
quarterly. In order for the Base Rent, the Percentage Rent and the Additional
Charges to constitute "rents from real property," the Percentage Leases must be
respected as "true leases" for federal income tax purposes and not treated as
service contracts, joint ventures or some other type of arrangement.
While the Company believes that the Percentage Leases should be treated
as true leases for tax purposes, investors should be aware that there are no
controlling Treasury Regulations, published rulings, or judicial decisions
involving leases with terms substantially the same as the Percentage Leases that
discuss whether such leases constitute true leases for federal income tax
purposes. If the Percentage Leases were recharacterized as service contracts or
partnership agreements, rather than true leases, part or all of the payments
that the Partnership receives from the Lessee would not be considered rent or
would not otherwise satisfy the various requirements for qualification as "rents
from real property." In that case, the Company would not be able to satisfy
either the 75% or 95% gross income tests and, as a result, would lose its REIT
status.
As stated above, in order for the Rents to constitute "rents from real
property," the Rents attributable to personal property leased in connection with
the lease of the real properties comprising a hotel must not be greater than 15%
of the Rents received under the Percentage Lease. The portion of the Rents
attributable to the personal property in a hotel is the amount that bears the
same ratio to total Rent for the taxable year as the average of the adjusted
bases of the personal property in the hotel at the beginning and at the end of
the taxable year bears to the average of the aggregate adjusted bases of both
the real and personal property comprising the hotel at the beginning and at the
end of such taxable year (the "Adjusted Basis Ratio"). The Company has
determined that the amount of any Rent attributable to personal property and not
qualifying as "rents from real property" has not and will not be of a
significant magnitude (together with other disqualified income) to cause the
Company to fail the 95% gross income test or 75% gross income test as described
above. In addition, Ernst & Young LLP has provided an analysis confirming this
representation. There can be no firm assurance, however, that the amount of the
Company's gross income not qualifying as "rents from real property" under the
15% adjusted basis ratio test described above will not be of a sufficient
magnitude to cause the Company to fail to satisfy the 95% or 75% gross income
test and thus lose its REIT status.
Another requirement for qualification of the Rents as "rents from real
property" is that the Percentage Rent must not be based in whole or in part on
the income or profits of any person. The Percentage Rent, however, will qualify
as "rents from real property" if it is based on percentages of receipts or sales
and the percentages (i) are fixed at the time the Percentage Leases are entered
into, (ii) are not renegotiated during the term of the Percentage Leases in a
manner that has the effect of basing Percentage Rent on income or profits, and
(iii) conform with normal business practice. More generally, the Percentage Rent
will not qualify as "rents from real property" if, considering the Percentage
Leases and all the surrounding circumstances, the arrangement does not conform
with normal business practice, but is in reality used as a means of basing the
Percentage Rent on income or profits. The Company has and will structure all of
its Percentage Leases in such a manner that (i) the Percentage Rent will be
based at all times on revenues from the hotels that are established in the
Percentage Leases, (ii) the Percentage Rent will not be renegotiated during the
terms of the Percentage Leases in a manner that has the effect of basing the
Percentage Rent on income or profits and (ii) the Percentage Leases and the
Percentage Rent will conform with normal business practice. Furthermore, with
respect to other hotels that the Company acquires in the future, the Company
will not
28
charge rent for any property that is based in whole or in part on the income or
profits of any person (except by reason of being based on a fixed percentage of
gross revenues, as described above). In the event that it were to be determined
that any of the foregoing requirements relating to the Company's Percentage
Ratio were not satisfied, the Company could fail or cease to qualify as a REIT.
A further requirement for qualification of the Rents as "rents from real
property" is that the Company must not own, directly or constructively, 10% or
more of the Lessee. The constructive ownership rules generally provide that, if
10% or more in value of the shares of the Company are owned, directly or
indirectly, by or for any person, the Company is considered as owning the shares
of the Lessee owned, directly or indirectly, by or for such person. The Company
has not and will not at any time directly or indirectly own any stock of the
Lessee. However, because Mr. Alter and Mr. Biederman each owns more than 10% of
the stock of the Lessee, the Company would be deemed to own more than 10% of the
stock of the Lessee if either Mr. Alter or Mr. Biederman at any time owns,
directly, indirectly or constructively, 10% or more in value of the shares of
the Company's stock. In addition, the Partnership Agreement provides that a
redeeming Limited Partner will receive cash, rather than shares of Common Stock,
at the election of the Company or if the acquisition of shares of Common Stock
by such partner would result in such partner or any other person owning,
directly or constructively, more than 9.8% of the Company for purposes of the
related party tenant rule. Thus, neither Mr. Alter nor Mr. Biederman will ever
be entitled to acquire a 10% interest in the Company, and the Company should
never own, directly or constructively, 10% of more of the Lessee. Furthermore,
the Company has represented that, with respect to other hotels that it acquires
in the future it has represented that, with respect to other hotels that it
acquires in the future it will not rent any Property to a related party tenant.
A further requirement for qualification of the Rents as "rents from real
property" is that the Company cannot furnish or render noncustomary services to
the Lessee (or tenants of the hotels), or manage or operate the hotels or any
leased properties, other than through an independent contractor who is
adequately compensated and from whom the Company itself does not derive or
receive any income. Provided that the Percentage Leases are respected as true
leases, the Company should satisfy that requirement because neither the Company
nor the Partnership will be performing any services other than customary ones
for the Lessee. The Company has also represented that with respect to other
hotels that it acquires in the future, it will not perform noncustomary services
with respect to the tenant of the property and will not be managing or operating
such hotels. As described above, if the Percentage Leases were recharacterized
as service contracts or partnership agreements, the Rents likely would be
disqualified as "rents from real property" because the Company would be
considered to furnish or render nonqualifying services to the occupants of the
hotels and to manage or operate the hotels other than through an independent
contractor who is adequately compensated and from whom the Company derives or
receives no income.
If the Rents from a hotel do not qualify as "rents from real property"
because the rents attributable to personal property exceed 15% of the total
Rents for a taxable year, the portion of the Rents from that hotel that is
attributable to personal property will not be qualifying income for purposes of
either the 75% or 95% gross income tests. The Company would lose its REIT status
in this event only if the Rents attributable to personal property in all of its
hotels (plus any other nonqualifying income) during a taxable year exceed 5% of
the Company's gross income during the year. If, however, the Rents do not
qualify as "rents from real property" because either (i) the Percentage Rent is
considered based on income or profits of the Lessee, (ii) the Company owns,
directly or constructively, 10% or more of the Lessee, or (iii) the Company
furnishes noncustomary services to the Lessee or tenants of the hotels, or
manages or operates the hotels other than through a qualifying independent
contractor, none of the Rents would qualify as "rents from real property." In
that case, the Company would lose its REIT status because it would be unable to
satisfy either the 75% or 95% gross income tests.
In addition to the Rents, the Lessee is required to pay to the
Partnership the Additional Charges. To the extent that the Additional Charges
represent either (i) reimbursements of amounts paid by the Partnership to third
parties that the Lessee is obligated to bear or (ii) penalties for nonpayment or
late payment of such amounts, the Additional Charges should qualify as "rents
from real property." To the extent, however, that the Additional Charges
represent interest that is accrued on the late payment of the Rents or the
Additional Charges, the Additional Charges should not qualify as "rents from
real property," but instead should be treated as interest that qualifies for the
95% gross income test.
Any gross income derived from a prohibited transaction is taken into
account in applying the 30% income test necessary to qualify as a REIT for
taxable years through 1997. In addition, the net income from that transaction is
subject to a 100% tax. The term "prohibited transaction" generally includes a
sale or other disposition of property (other than foreclosure property) that is
held primarily for sale to customers in the ordinary course of a trade or
29
business. The Company and the Partnership believe that no asset owned by the
Company or the Partnership has or will be held for sale to customers in the
ordinary course of business of the Company or the Partnership. Whether property
is held "primarily for sale to customers in the ordinary course of a trade or
business" will depend, however, on the facts and circumstances from time to
time. The Company and the Partnership will attempt to comply with the terms of
safe-harbor provisions in the Code prescribing when asset sales will not be
characterized as prohibited transactions. Complete assurance cannot be given,
however, that the Company or the Partnership can comply with the safe-harbor
provisions of the Code or avoid owning property that may be characterized as
property held "primarily for sale to customers in the ordinary course of a trade
or business."
If the Lessee defaults on its obligations under a Percentage Lease for a
hotel, the Company terminates the Lessee's leasehold interest, and the Company
is unable to find a qualifying replacement lessee for such hotel within 90 days
of such termination, gross income from hotel operations conducted by the Company
from such hotel would cease to qualify for the 75% and 95% gross income tests.
In such event, the Company likely would be unable to satisfy the 75% and 95%
gross income tests and, thus, would fail to qualify as a REIT.
If the Company fails to satisfy one or both of the 75% or 95% gross
income tests for any taxable year, it may nevertheless qualify as a REIT for
such year if it is entitled to relief under certain provisions of the Code.
Those relief provisions will be generally available if the Company's failure to
meet such tests is due to reasonable cause and not due to willful neglect, the
Company attaches a schedule of the sources of its income to its return, and any
incorrect information on the schedule was not due to fraud with intent to evade
tax. It is not possible, however, to state whether in all circumstances the
Company would be entitled to the benefit of these relief provisions. As
discussed above in "-- Taxation of the Company," even if those relief provisions
apply, a 100% tax would be imposed with respect to the amount by which it fails
the 75% or 95% gross income tests. No such relief is available for violations of
the 30% income test, which was applicable for taxable years through 1997.
Asset Tests
The Company, at the close of each quarter of its taxable year, also must
satisfy two tests relating to the nature of its assets. First, at least 75% of
the value of the Company's total assets must be represented by cash or cash
items (including certain receivables), government securities, "real estate
assets," or, in cases where the Company raises new capital through share or
long-term (at least five-year) debt offerings, temporary investments in stock or
debt instruments during the one-year period following the Company's receipt of
such capital. The term "real estate assets" includes interests in real property,
interests in mortgages on real property to the extent the mortgage balance does
not exceed the value of the associated real property, and shares of other REITs.
For purposes of the 75% asset test, the term "interest in real property"
includes an interest in land and improvements thereon, such as buildings or
other inherently permanent structures (including items that are structural
components of such buildings or structures), a leasehold in real property, and
an option to acquire real property (or a leasehold in real property). Second, of
the investments not included in the 75% asset class, the value of any one
issuer's securities owned by the Company may not exceed 5% of the value of the
Company's total assets and the Company may not own more than 10% of any one
issuer's outstanding voting securities (except for its ownership interest in the
stock of a qualified REIT subsidiary).
For purposes of the asset requirements, the Company will be deemed to
own its proportionate share of the assets of the Partnership, rather than its
partnership interest in the Partnership, assuming that the Partnership is
treated as a partnership and not as a corporation for tax purposes. The Company
has represented that at all times since the commencement of its taxable year
ended December 31, 1995, (i) at least 75% of the value of its total assets were
represented by assets qualifying under the 75% asset test, and (ii) it has not
owned any securities that do not satisfy the 75% asset test. The Company has
represented that it has not and will not acquire or dispose, or cause the
Partnership to acquire or dispose, of assets in a way that would cause it to
violate the asset tests for REIT status.
Distribution Requirements
The Company, in order to qualify as a REIT, is required to distribute
dividends (other than capital gain dividends) to its shareholders in an amount
at least equal to (i) the sum of (A) 95% of its "REIT taxable income"(computed
without regard to the dividends paid deduction and its net capital gain) and (B)
95% of the net income (after tax), if any, from foreclosure property, minus (ii)
the sum of certain items of noncash income. Such distributions must be paid in
the taxable year to which they relate, or in the following taxable year if
declared before the Company timely files its tax return for such year and if
paid on or before the first regular dividend payment after
30
such declaration. To the extent that the Company does not distribute all of its
net capital gain or distributes at least 95%, but less than 100%, of its "REIT
taxable income," as adjusted, it will be subject to tax thereon at regular
ordinary and capital gains corporate tax rates. Furthermore, if the Company
should fail to distribute during each calendar year at least the sum of (i) 85%
of its REIT ordinary income for such year, (ii) 95% of its REIT capital gain
income for such year, and (iii) any undistributed taxable income from prior
periods, the Company would be subject to a 4% nondeductible excise tax on the
excess of such required distribution over the amounts actually distributed. For
its taxable years through December 31, 1997, the Company has made distributions
sufficient to satisfy the foregoing distribution requirements. The Company
intends in the future to make timely distributions sufficient to satisfy all
annual distribution requirements in 1998 and thereafter. However, there can be
no assurance that the Company will at all times have sufficient available cash
to satisfy such distribution requirements.
Recordkeeping Requirement
Pursuant to applicable Treasury Regulations, in order to qualify as a
REIT, the Company must maintain certain records and request on an annual basis
certain information from its shareholders designed to disclose the actual
ownership of its outstanding shares. The Company has complied with these
requirements on a timely basis for its taxable years through December 31, 1997
and intends to comply with such requirements in the future. For taxable years
through 1997, the penalty for failure to obtain information as to actual
ownership was disqualification as a REIT. For 1998 and thereafter, monetary
penalties of up to $50,000 apply.
Anti-Abuse Regulations
The Treasury Regulations authorize the Service, in certain "abusive"
transactions involving partnerships, to disregard the form of the transaction
and recast it for federal tax purposes as the Service deems appropriate (the
"Anti-Abuse Regulations"). The Anti-Abuse Regulations apply where a partnership
is formed or utilized in connection with a transaction (or series of related
transactions) with a principal purpose of substantially reducing the present
value of the partners' aggregate federal tax liability in a manner inconsistent
with the intent of the partnership provisions of the Code. The Company does not
believe that the Anti-Abuse Regulations will have any adverse impact on the
Company's ability to qualify as a REIT. However, because the Anti-Abuse
Regulations are extremely broad in scope and would be applied based on an
analysis of all of the facts and circumstances, there can be no assurance that
the Service will not successfully apply the Anti-Abuse Regulations to the
Company.
FAILURE TO QUALIFY
If the Company fails to qualify for taxation as a REIT in any taxable
year, and the relief provisions do not apply, the Company will be subject to tax
(including any applicable alternative minimum tax) on its taxable income at
regular corporate rates. Distributions to the shareholders in any year in which
the Company fails to qualify will not be deductible by the Company nor will they
be required to be made. In such event, to the extent of current and accumulated
earnings and profits, all distributions to shareholders will be taxable as
ordinary income and, subject to certain limitations of the Code, corporate
distributees may be eligible for the dividends received deduction. Unless
entitled to relief under specific statutory provisions, the Company also will be
disqualified from taxation as a REIT for the four taxable years following the
year during which the Company ceased to qualify as a REIT. It is not possible to
state whether in all circumstances the Company would be entitled to such
statutory relief.
TAXATION OF SHAREHOLDERS
As long as the Company qualifies as a REIT, distributions made to the
Company's taxable shareholders out of current or accumulated earnings and
profits (and not designated as capital gain dividends) will be taken into
account by such shareholders as ordinary income and will not be eligible for the
dividends received deduction generally available to corporations. Distributions
that are designated as capital gain dividends will be taxed as long-term capital
gains (to the extent they do not exceed the Company's actual net capital gain
for the taxable year) without regard to the period for which the shareholder has
held his shares of Common Stock. However, corporate shareholders may be required
to treat up to 20% of certain capital gain dividends as ordinary income.
Distributions in excess of current and accumulated earnings and profits will not
be taxable to a shareholder to the extent that they do not exceed the adjusted
basis of the shareholder's Common Stock, but rather will reduce the adjusted
basis of such shares. To the extent that distributions in excess of current and
accumulated earnings and profits exceed the adjusted basis of a shareholder's
Common Stock, such distributions will be included in income as capital gain
assuming the shares of Common Stock are capital assets in the hands of the
shareholder. In addition, any distribution declared
31
by the Company in October, November, or December of any year and payable to a
shareholder of record on a specified date in any such month shall be treated as
both paid by the Company and received by the shareholder on December 31 of such
year, provided that the distribution is actually paid by the Company during
January of the following calendar year.
For a taxable year of the Company commencing in 1998 and thereafter, a
Company shareholder at the close of the taxable year must include, in computing
his or her long-term capital gains for his or her taxable year in which the last
day of the Company's taxable year falls, the amount (if any) of undistributed
net capital gains of the Company that the Company designates by written notice
to the shareholder ("Designated Retained Capital Gains"). The shareholder will
be deemed to have paid his or her share of the taxes paid by the Company on the
Designated Retained Capital Gains. The shareholder's basis in the Company's
shares will be increased by the amount of the Designated Retained Capital Gains
in excess of the taxes deemed paid by the shareholder.
Shareholders may not include in their individual income tax returns any
net operating losses or capital losses of the Company. Instead, such losses
would be carried over by the Company for potential offset against its future
income (subject to certain limitations). Taxable distributions from the Company
and gain from the disposition of the Common Stock will not be treated as passive
activity income and, therefore, shareholders generally will not be able to apply
any "passive activity losses" (such as losses from certain types of limited
partnerships in which the shareholder is a limited partner) against such income.
In addition, taxable distributions from the Company and gain from the
disposition of shares of Common Stock generally will be treated as investment
income for purposes of the investment interest limitations. The Company will
notify shareholders after the close of the Company's taxable year as to the
portions of the distributions attributable to that year that constitute ordinary
income, return of capital, and capital gain.
TAXATION OF SHAREHOLDERS ON THE DISPOSITION OF THE COMMON STOCK
In general, any gain or loss realized upon a taxable disposition of the
Common Stock by a shareholder who is not a dealer in securities will be treated
as capital gain or loss. In the case of individuals, the maximum rate of federal
income tax applicable to capital gains is 20% in the case of assets held for
more than one year. No preferential rate of capital gains tax applies in the
case of corporations. Any loss upon a sale or exchange of shares of Common Stock
by a shareholder who has held such shares for six months or less (after applying
certain holding period rules), will be treated as a long-term capital loss to
the extent of distributions from the Company and Designated Retained Capital
Gains required to be treated by such shareholder as long-term capital gain. All
or a portion of any loss realized upon a taxable disposition of the shares of
Common Stock may be disallowed if the shares of Common Stock are purchased
within 30 days before or after the disposition.
OTHER TAX CONSEQUENCES
State or Local Taxes
The Company, the Partnership, or the Company's shareholders may be
subject to state or local taxation in various state or local jurisdictions,
including those in which it or they own property, transact business, or reside.
The state and local tax treatment of the Company and its shareholders may not
conform to the federal income tax consequences discussed above. CONSEQUENTLY,
PROSPECTIVE SHAREHOLDERS SHOULD CONSULT THEIR OWN TAX ADVISORS REGARDING THE
EFFECT OF STATE AND LOCAL TAX LAWS ON AN INVESTMENT IN THE COMPANY.
Dividend Reinvestment Program
Under the Company's Dividend Reinvestment and Stock Purchase Plan,
shareholders participating in the program will be deemed to have received the
gross amount of any cash distributions which would have been paid by the Company
to such shareholders had they not elected to participate. These deemed
distributions will be treated as actual distributions from the Company to the
participating shareholders and will retain the character and tax effect
applicable to distributions from the Company generally. See "-- Taxation of
Shareholders." Shares of Common Stock received under the program will have a
holding period beginning with the day after purchase, and a tax basis equal to
the gross amount of the deemed distribution.
32
TAX ASPECTS OF THE PARTNERSHIP
Classification as a Partnership
The Company will be entitled to include in its income its distributive
share of the Partnership's income and to deduct its distributive share of the
Partnership's losses only if the Partnership is classified for federal income
tax purposes as a partnership rather than as association taxable as a
corporation. No assurance can be given that the Service will not challenge the
status of the Partnership as a partnership for federal income tax purposes. If
such challenge were sustained by a court, the Partnership would be treated as a
corporation for federal income tax purposes.
Under Section 7704 of the Code, a partnership is treated as a
corporation for federal income tax purposes if it is a "publicly traded
partnership" (except in situations in which 90% or more of the partnership's
gross income is of a specified type). A partnership is deemed to be publicly
traded if its interests are either (i) traded on an established securities
market, or (ii) readily tradable on a secondary market (or the substantial
equivalent thereof). While the Partnership Units will not be traded on an
established securities market, they could possibly be deemed to be traded on a
secondary market or its equivalent due to the redemption rights enabling the
partners to dispose of their Units.
The Treasury Department has issued regulations (the "PTP Regulations")
governing the classification of partnerships under Section 7704. These
regulations provide that the classification of partnerships is generally based
on a facts and circumstances analysis. However, the regulations also provide
limited "safe harbors" which preclude publicly traded partnership status.
Pursuant to one of those safe harbors, interests in a partnership will not be
treated as readily tradable on a secondary market or the substantial equivalent
thereof if (i) all interests in the partnership were issued in a transaction (or
transactions) that was not required to be registered under the Securities Act,
and (ii) the partnership does not have more than 100 partners at any time during
the partnership's taxable year. In determining the number of partners in a
partnership for this purpose, a person owning an interest in a flow-through
entity (i.e., a partnership, grantor trust, or S corporation) that owns an
interest in the partnership is treated as a partner in such partnership only if
(x) substantially all of the value of the person's interest in the flow-through
entity is attributable to the flow-through entity's interest (direct or
indirect) in the partnership and (y) a principal purpose of the use of the
tiered arrangement is to permit the partnership to satisfy the 100-partner
limitation. Furthermore, pursuant to Notice 88-75 issued by the IRS, through the
year 2005, an existing partnership may qualify for non-publicly traded status if
it has less than 500 partners (looking through to the ultimate owners in the
case of flow-through entities), does not issue any Units registered under the
Securities Act and does not enter into a substantial new line of business.
The Partnership currently has less than 100 actual partners and less
than 500 partners calculated on a "lookthrough" basis. The Partnership has not
issued any Units required to be registered under the Securities Act. Thus, the
Partnership presently qualifies for the safe harbors provided in Notice 88-75
and the PTP Regulations. However, there is no assurance that the Partnership
will at all times in the future be able to avoid treatment as a publicly traded
partnership.
Even if the Partnership were ever to be classified as a publicly traded
partnership, it would nevertheless be treated as a partnership for federal
income tax purposes (rather than an association taxable as a corporation) if at
least 90% of its gross income in each taxable year (commencing with the year in
which it is treated as a publicly traded partnership) consists of "qualifying
income" within the meaning of Section 7704(c)(2) of the Code (including
interest, dividends, "real property rents" and gains from the disposition of
real property). The Partnership has represented that, if in any taxable year the
Partnership falls outside of an applicable safe harbor from publicly traded
partnership status, it will satisfy the gross income test set forth in Section
7704(c)(2) of the Code in that taxable year and each subsequent taxable year.
Among other things, this will require that the President of the Company, Mr.
Robert A. Alter (or any other shareholder of the Lessee who owns at least 10% of
the stock of the Lessee) own less than a 5% interest in the Partnership in the
particular taxable year. The Company anticipates that if the Partnership is ever
treated as a publicly traded partnership, it will satisfy the qualifying income
test of Section 7704(c)(2) of the Code in the taxable year in which such
treatment commences and all years thereafter.
If for any reason the Partnership were taxable as a corporation, rather
than as a partnership, for federal income tax purposes, the Company would not be
able to satisfy the income and asset requirements for REIT status. Thus the
Company would be subject to tax as a regular corporation and would not receive a
deduction for dividends
33
paid to its shareholders. See "-- Requirements for Qualification -- Income
Tests" and "-- Requirements for Qualification -- Asset Tests." In addition, any
change in the Partnership's status for tax purposes might be treated as a
taxable event, in which case the Company might incur a tax liability without any
related cash distribution. Further, items of income and deduction of the
Partnership would not pass through to its partners, and its partners would be
treated as shareholders for tax purposes. Consequently, the Partnership would be
required to pay income tax at corporate tax rates on its net income, and
distributions to its partners would constitute dividends that would not be
deductible in computing the Partnership's taxable income.
Income Taxation of the Partnership and Its Partners
The following discussion assumes that the Partnership will be treated as
a partnership for federal income tax purposes.
Partners, Not the Partnership, Subject to Tax. A partnership is not a
taxable entity for federal income tax purposes. Rather, the Company will be
required to take into account its allocable share of the Partnership's income,
gains, losses, deductions, and credits for any taxable year of the Partnership
ending within or with the taxable year of the Company, without regard to whether
the Company has received or will receive any distribution from the Partnership.
Tax Allocations With Respect to Contributed Properties. Pursuant to
Section 704(c) of the Code, income, gain, loss, and deduction attributable to
appreciated or depreciated property that is contributed to a partnership in
exchange for an interest in the partnership must be allocated for federal income
tax purposes in a manner such that the contributor is charged with, or benefits
from, the unrealized gain or unrealized loss associated with the property at the
time of the contribution. The amount of such unrealized gain or unrealized loss
is generally equal to the difference between the fair market value of the
contributed property at the time of contribution and the adjusted tax basis of
such property at the time of contribution. The Treasury Department has issued
regulations requiring partnerships to use a "reasonable method" for allocating
items affected by Section 704(c) of the Code and outlining certain reasonable
allocation methods.
Under the Partnership Agreement, depreciation or amortization deductions
of the Partnership generally will be allocated among the partners in accordance
with their respective interests in the Partnership, except to the extent
required under Code Section 704(c). In addition, gain on sale of a hotel will be
specially allocated to the Partners who contributed the hotel to the Partnership
to the extent of any "built-in" gain with respect to such hotel for federal
income tax purposes.
Basis in Partnership Interest. The Company's adjusted tax basis in its
Partnership interest in the Partnership generally will be equal to (i) the
amount of cash and the basis of any other property contributed to the
Partnership by the Company, (ii) increased by (A) its allocable share of the
Partnership's income and (B) its allocable share of indebtedness of the
Partnership, and (iii) reduced, but not below zero, by (A) the Company's
allocable share of the Partnership's loss and (B) the amount of cash distributed
to the Company (including deemed distributions as a result of reductions in the
Company's allocable share of indebtedness of the Partnership).
Treatment of Partnership Distributions. Partnership distributions to the
Company will not generally constitute taxable distributions. However, to the
extent that Partnership distributions, or any decrease in the Company's share of
the indebtedness of the Partnership (such decrease being considered a
constructive cash distribution to the partners), exceeds the Company's adjusted
tax basis in its Partnership interest, such distributions (including such
constructive distributions) would constitute taxable income to the Company. Such
distributions and constructive distributions normally would be characterized as
capital gain.
Sale of the Partnership's Property. Generally, any taxable gain realized
by the Partnership on the sale of property by the Partnership will be capital
gain or gain described in Section 1231 of the Code, except for any portion of
such gain that is treated as depreciation or cost recovery recapture or
attributable to inventory or property held for sale to customers in the ordinary
course of business. Any taxable gain recognized by the Partnership on the
disposition of any hotels originally contributed to the Partnership by the
Partners will generally be allocated first to the contributing Partners under
Section 704(c) of the Code to the extent of their "built-in gain" on those
hotels for federal income tax purposes. Any remaining taxable gain recognized by
the Partnership on the disposition of the hotels will generally be allocated
among the partners in accordance with their respective percentage interests in
the Partnership.
34
The Company's share of any gain realized by the Partnership on the sale
of any property held by the Partnership as inventory or other property held
primarily for sale to customers in the ordinary course of the Partnership's
trade or business will be treated as income from a prohibited transaction that
is subject to a 100% penalty tax. Such prohibited transaction income also may
have an adverse effect upon the Company's ability to satisfy the income tests
for REIT status. The Company, however, does not presently intend to allow the
Partnership to acquire or hold any property that represents inventory or other
property held primarily for sale to customers in the ordinary course of the
Company's or the Partnership's trade or business. See "-- Requirements for
Qualification -- Income Tests."
INFORMATION REPORTING REQUIREMENTS AND BACKUP WITHHOLDING
The Company will report to its U.S. stockholders and to the Service the
amount of distributions paid during each calendar year, and the amount of tax
withheld, if any. Under the backup withholding rules, a stockholder may be
subject to backup withholding at the rate of 31% with respect to distributions
paid unless such holder (i) is a corporation or comes within certain other
exempt categories and, when required, demonstrates this fact, or (ii) provides a
taxpayer identification number, certifies as to no loss of exemption from backup
withholding, and otherwise complies with the applicable requirements of the
backup withholding rules. A stockholder who does not provide the Company with
his correct taxpayer identification number also may be subject to penalties
imposed by the Service. Any amount paid as backup withholding will be creditable
against the stockholder's income tax liability. In addition, the Company may be
required to withhold a portion of capital gain distributions to any stockholders
who fail to certify their nonforeign status to the Company.
35
PLAN OF DISTRIBUTION
The Warrants have been offered by the Company solely to Messrs. Alter
and Biederman, who have received, respectively, 375,600 Warrants and 89,400
Warrants in exchange for their surrender of options to purchase the same number
of shares of Common stock previously granted by the Company. Messrs. Alter and
Biederman intend to assign the Warrants to certain employees who participated in
the SAR Plan adopted by the Lessee. Each of the SAR holders will be asked to
agree to cancel his or her SARs in exchange for an assignment from Messrs. Alter
and Biederman of the Warrants.
The Company is registering the Warrants and the Warrant Shares on behalf
of Messrs. Alter and Biederman, the employees of the Lessee to whom the Warrants
may subsequently be assigned (and who, following such assignment, shall be
incorporated into this Prospectus as a named Selling Shareholder pursuant to a
post-effective amendment to the Form S-3 Registration Statement pursuant to
which this Prospectus is filed with the Securities and Exchange Commission) and
all donees and pledgees selling shares received from a Selling Shareholder after
the date of this prospectus. All such individuals are hereinafter collectively
referred to as the "Selling Shareholders". There will be no compensation paid to
any broker or dealer in connection with the distribution of the Warrants.
All costs, expenses and fees in connection with the registration of the
Warrants and Warrant Shares offered hereby will be borne by the Company.
Brokerage commissions and similar selling expenses, if any, attributable to the
sale of Warrant Shares will be borne by the Selling Shareholders. Sales of
Warrant Shares may be effected by Selling Shareholders from time to time in one
or more types of transactions (which may include block transactions) on the
NYSE, in the over-the-counter market, in negotiated transactions, through put or
call options transactions relating to the Warrant Shares, through short sales of
Warrant Shares, or a combination of such methods of sale, at market prices
prevailing at the time of sale, or at negotiated prices. Such transactions may
or may not involve brokers or dealers. The Selling Shareholders have advised the
Company that they have not entered into any agreements, understandings or
arrangements with any underwriters or broker-dealers regarding the sale of their
securities, nor is there an underwriter or coordinating broker acting in
connection with the proposed sale of Warrant Shares by the Selling Shareholders.
The Selling Shareholders may effect such transactions by selling Warrant
Shares directly to purchasers or to or through broker-dealers, which may act as
agents or principals. Such broker-dealers may receive compensation in the form
of discounts, concessions, or commissions from the Selling Shareholders and/or
the purchasers of Warrant Shares for whom such broker-dealers may act as agents
or to whom they sell as principal, or both (which compensation as to a
particular broker-dealer might be in excess of customary commissions).
The Selling Shareholders and any broker-dealers that act in connection
with the sale of Warrant Shares might be deemed to be "underwriters" within the
meaning of Section 2(11) of the Securities Act, and any commissions received by
such broker-dealers and any profit on the resale of the Warrant Shares sold by
them while acting as principals might be deemed to be underwriting discounts or
commissions under the Securities Act. The Company has agreed to indemnify each
Selling Shareholder against certain liabilities, including liabilities arising
under the Securities Act. The Selling Shareholders may agree to indemnify any
agent, dealer or broker-dealer that participates in transactions involving sales
of the Warrant Shares against certain liabilities, including liabilities arising
under the Securities Act.
Because Selling Shareholders may be deemed to be "underwriters" within
the meaning of Section 2(11) of the Securities Act, the Selling Shareholders
will be subject to the prospectus delivery requirements of the Securities Act,
which may include delivery through the facilities of the NYSE pursuant to Rule
153 under the Securities Act. The Company has informed the Selling Shareholders
that the anti-manipulative provisions of Regulation M promulgated under the
Exchange Act may apply to their sales in the market.
Selling Shareholders also may resell all or a portion of the Warrant
Shares in open market transactions in reliance upon Rule 144 under the
Securities Act, provided they meet the criteria and conform to the requirements
of such Rule.
Upon the Company being notified by a Selling Shareholder that any
material arrangement has been entered into with a broker-dealer for the sale of
Warrant Shares through a block trade, special offering, exchange distribution or
secondary distribution or a purchase by a broker or dealer, a supplement to this
prospectus will be filed, if required, pursuant to Rule 424(b) under the Act,
disclosing (i) the name of each such selling shareholder and of the
participating broker-dealer(s), (ii) the number of Warrant Shares involved,
(iii) the price at which such Warrant Shares were sold, (iv) the commissions
paid or discounts or concessions allowed to such broker-dealer(s), where
applicable, (v) that such broker-dealer(s) did not conduct any investigation to
verify the information set out or incorporated by reference in this prospectus
and (vi) other facts material to the transaction. In addition, upon the Company
being notified by a Selling Shareholder that a donee or pledgee intends to sell
more than 500 shares, a supplement to this Prospectus will be filed.
LEGAL MATTERS
The validity of the Offered Shares will be passed upon for the Company
by Brobeck, Phleger & Harrison LLP, Newport Beach, California. In rendering its
opinions, Brobeck, Phleger & Harrison LLP will rely on the opinion of Ballard
Spahr Andrews & Ingersoll, Baltimore, Maryland, as to certain matters of
Maryland law. Roger Cohen, a partner at Brobeck, Phleger & Harrison LLP, is
Assistant Secretary of the Company and owns 3,560 shares of Common Stock and has
been granted options to purchase 4,500 shares of Common Stock. In addition, the
description of federal income tax consequences contained in the section of this
Prospectus entitled "Federal Income Tax Considerations" and certain federal
income tax matters pertaining to the Company's status as a REIT will be based on
the opinion of the Company's tax advisor.
EXPERTS
The consolidated financial statements of Sunstone Hotel Investors, Inc.
at December 31, 1997 and for the year then ended and the consolidated financial
statements of Sunstone Hotel Properties, Inc. at December 31, 1997 and for the
year then ended, all appearing in Sunstone Hotel Investors, Inc.'s Annual Report
on Form 10-K for the year ended December 31, 1997, have been audited by Ernst &
Young LLP, independent auditors, and the consolidated financial statements of
Sunstone Hotel Investors, Inc. as of December 31, 1996 and for the year ended
December 31, 1996, and the period August 16, 1995 to December 31, 1995, and the
combined financial statements of Sunstone Hotels (Predecessor) for the period
January 1, 1995 to August 15, 1995, and the financial statements of Sunstone
Hotel Properties, Inc. as of December 31, 1996, and for the year ended December
31, 1996, and for the period August 16, 1995 to December 31, 1995, all appearing
in Sunstone Hotel Investors, Inc.'s Annual Report on Form 10-K for the year
ended December 31, 1997, have been audited by PricewaterhouseCoopers LLP,
independent accountants, as set forth in their reports thereon included therein
and incorporated herein by reference in reliance upon such reports given upon
the authority of such firms as experts in accounting and auditing.
36
NO PERSONS HAVE BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED OR INCORPORATED BY REFERENCE IN THIS
PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT
BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY. THIS PROSPECTUS DOES
NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY
SECURITIES OTHER THAN THOSE TO WHICH IT RELATES, OR AN OFFER OR SOLICITATION
WITH RESPECT TO THOSE SECURITIES TO WHICH IT RELATES TO ANY PERSONS IN ANY
JURISDICTION WHERE SUCH OFFER OR SOLICITATION WOULD BE UNLAWFUL. THE DELIVERY OF
THIS PROSPECTUS AT ANY TIME DOES NOT IMPLY THAT THE INFORMATION CONTAINED OR
INCORPORATED BY REFERENCE HEREIN AT ITS DATE IS CORRECT AS OF ANY TIME
SUBSEQUENT TO ITS DATE.
----------------------------
TABLE OF CONTENTS
PAGE
Available Information.......................................................[ ]
Incorporation of Certain Information
by Reference..............................................................[ ]
Prospectus Summary..........................................................[ ]
Risk Factors................................................................[ ]
Use of Proceeds.............................................................[ ]
Description of Common Stock, Preferred Stock
and Warrants..............................................................[ ]
Certain Provisions of Maryland Law and
of the Company's Articles of
Incorporation and Bylaws..................................................[ ]
Federal Income Tax Considerations...........................................[ ]
Plan of Distribution........................................................[ ]
Legal Matters...............................................................[ ]
Experts.....................................................................[ ]
SUNSTONE HOTEL INVESTORS, INC.
447,000 WARRANTS TO PURCHASE
COMMON STOCK
447,000 SHARES OF COMMON STOCK
---------------
PROSPECTUS
---------------
SEPTEMBER 30, 1998
================================================================================
37
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 14. OTHER EXPENSES
The estimated expenses in connection with the Offered Shares are as
follows:
AMOUNT PAID
OR TO
BE PAID
------
SEC Registration fee ......................................... $ 1,647
New York Stock Exchange listing fees ......................... 0
Legal fees and expenses ...................................... 15,000
Accounting fees and expenses ................................. 15,000
Transfer Agent and Registrar fees ............................ 1,000
Printer fees ................................................. 2,000
Miscellaneous ................................................ 2,000
=======
Total ................................................ $36,647
-------
ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 2-418 of the Maryland General Corporation Law (the "MGCL") empowers
the Company to indemnify, subject to the standards set forth therein, any person
who is a party in any action in connection with any action, suit or proceeding
brought or threatened by reason of the fact that the person was a director,
officer, employee or agent of such company, or is or was serving as such with
respect to another entity at the request of such company. The MGCL also provides
that the Company may purchase insurance on behalf of any such director, officer,
employee or agent.
The Company's Articles of Incorporation provide for indemnification of the
officers and directors of the Company substantially identical in scope to that
permitted under Section 2-418 of the MGCL. The Bylaws of the Company also
provide that the expenses of officers and directors incurred in defending any
action, suit or proceeding, whether civil, criminal, administrative or
investigative, must be paid by the Company as they are incurred and in advance
of the final disposition of the action, suit or proceeding, upon receipt of an
undertaking by or on behalf of the director or officer to repay all amounts so
advanced if it is ultimately determined by a court of competent jurisdiction
that the officer or director is not entitled to be indemnified by the Company,
The Company has entered into indemnification agreements with each of its
directors and executive officers. In addition, the Company maintains a
directors' and officers' liability policy.
The Company's Charter limits the liability of the Company's directors and
officers for money damages to the Company and its stockholders to the fullest
extent permitted from time to time by Maryland law. Maryland law presently
permits the liability of directors and officers to a corporation or its
stockholders for money damages to be limited, except (i) to the extent that it
is proved that the director or officer actually received an improper benefit or
profit or (ii) if a judgment or other final adjudication is entered in a
proceeding based on a finding that the director's or officer's action, or
failure to act, was the result of active and deliberate dishonesty and was
material to the cause of action adjudicated in the proceeding. This provision
does not limit the ability of the Company or its stockholders to obtain other
relief, such as an injunction or rescission.
II-1
38
ITEM 16. EXHIBITS
EXHIBIT
NO. DESCRIPTION
- -------- -----------
3.1 Amended Articles of Incorporation of the Company, as further amended
by the Articles of Amendment of the Company, as filed with the State
Department of Assessments and Taxation of Maryland on November 9,
1994. Filed as Exhibit 3.1 to the Company's Registration Statement No.
33-84346 and incorporated herein by this reference.
3.2* Bylaws of the Company, as currently in effect.
3.3 Articles of Amendment of the Company, as filed with the State
Department of Assessments and Taxation of Maryland on June 19, 1995.
Filed as Exhibit 3.3 to the Company's Registration Statement No.
33-84346 and incorporated herein by this reference.
3.4 Certificate of Articles Supplementary, as filed with the State
Department of Assessments and Taxation of Maryland on October 14,
1997, designating the rights, preferences and privileges of the 7.9%
Class A Cumulative Preferred Stock. Filed as Exhibit to Exhibit 10.1
to the Company's Report on Form 8-K dated August 13, 1997 and
incorporated herein by reference.
3.5* Articles of Amendment, as filed with the State Department of
Assessments and Taxation of Maryland on April 22, 1998.
4.1 See exhibits 3.1, 3.2, 3.3, 3.4, and 3.5.
4.2** Form of Warrant Agreement for Purchase of Common Stock.
5.1** Opinion of Brobeck, Phleger & Harrison LLP as to legality of shares
being registered.
5.2** Opinion of Ballard Spahr Andrews & Ingersoll as to Maryland law.
8.1** Opinion of Brobeck, Phleger & Harrison LLP.
23.1* Consent of Ernst & Young LLP.
23.2* Consent of PricewaterhouseCoopers LLP.
23.3 Consent of Ballard Spahr Andrews & Ingersoll (Included with opinion
filed as Exhibit 5.2).
23.4 Consent of Brobeck, Phleger & Harrison LLP (Included with opinion
filed as Exhibit 5.1).
24.1 Power of Attorney (included in signature page on page II-4).
- -----------------------------
* Filed herewith.
** To be filed by Amendment.
II-2
39
ITEM 17. UNDERTAKINGS
The undersigned Registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this Registration Statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933, as amended (the "Securities Act");
(ii) To reflect in the prospectus any facts or events arising after the
effective date of this Registration Statement (or the most recent
post-effective amendment hereof) which, individually or in the aggregate,
represent a fundamental change in the information set forth in this
Registration Statement. Notwithstanding the foregoing, any increase or
decrease in volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered) and any
deviation from the low or high and of the estimated maximum offering price
may be reflected in the form of prospectus filed with the Commission
pursuant to Rule 424(b) if, in the aggregate the changes in volume and
price represent no more than 20 percent change in the maximum aggregate
offering price set forth in the "Calculation of Registration Fee" table in
the effective registration statement; and
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in this Registration Statement or any
material change to such information in this Registration Statement.
Provided, however, that paragraphs (i) and (ii) do not apply if the
information is required to be included in a post-effective amendment by
those paragraphs is contained in periodic reports filed by the Company
pursuant to Section 13 or Section 15(d) of the Exchange Act that are
incorporated by reference in this Registration Statement.
(2) That, for the purpose of determining any liability under the Securities
Act, each such post-effective amendment shall be deemed to be a new registration
statement relating to the securities offered herein, and the offering of such
securities at that time shall be deemed to be the initial bona fide offering
thereof.
(3) To remove from registration by means of a post-effective amendment any
of the securities being registered which remain unsold at the termination of the
offering.
The undersigned Registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act, each filing of the Company's
Annual Report pursuant to Section 13(a) or Section 15(d) of the Exchange Act
that is incorporated by reference into this Registration Statement shall be
deemed to be a new registration statement relating to the securities offered
herein, and the offering of such securities at that time shall be deemed to be
the initial bona fide offering thereof.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Registrant of expenses
incurred or paid by a director, officer or controlling person of the Registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
II-3
40
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant certifies that it has reasonable grounds to believe that it meets all
the requirements for filing on Form S-3 and has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of San Clemente, State of California, on September 30,
1998.
SUNSTONE HOTEL INVESTORS, INC.
By: /S/ ROBERT A. ALTER
--------------------------------------
Robert A. Alter
President, Secretary
and Chairman of the Board of Directors
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned directors of
Sunstone Hotel Investors, Inc., a Maryland corporation, do hereby constitute and
appoint Robert A. Alter his true and lawful attorneys-in-fact and agents, each
with full power of substitution and resubstitution, for him and in his name,
place and stead, in any and all capacities, to sign any and all amendments
(including post-effective amendments) to this Registration Statement, or any
related registration statement filed pursuant to Rule 462(b) under the
Securities Act of 1933, and to file the same, with exhibits thereto, and other
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorney-in-fact and agent full power and authority to do and
perform each and every act and thing requisite or necessary to be done in
connection therewith, as fully to all intents and purposes as he might or could
do in person, hereby ratifying and confirming all that said attorney-in-fact and
agent, or his substitute or substitutes, may lawfully do or cause to be done by
virtue hereof. This Power of Attorney may be signed in several counterparts.
IN WITNESS WHEREOF, each of the undersigned has executed this Power of
Attorney as of the date indicated.
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Registration Statement has been signed below by the following persons in
the capacities and on the dates indicated:
SIGNATURE TITLE DATE
- --------- ----- ----
/S/ ROBERT A. ALTER
- -----------------------------
Robert A. Alter President, Secretary and Chairman September 30, 1998
of the Board of Directors
(Principal Executive Officer)
/S/ KENNETH J. BIEHL
- -----------------------------
Kenneth J. Biehl Vice President and Chief Financial September 30, 1998
Officer (Principal Financial and
Accounting Officer)
/S/ CHARLES L. BIEDERMAN
- -----------------------------
Charles L. Biederman Executive Vice President and September 30, 1998
Director
/S/ H. RAYMOND BINGHAM
- -----------------------------
H. Raymond Bingham Director September 30, 1998
- -----------------------------
C. Robert Enever Director September 30, 1998
- -----------------------------
Laurence S. Geller Director September 30, 1998
/S/ FREDRIC H. GOULD
- -----------------------------
Fredric H. Gould Director September 30, 1998
II-4
41
SIGNATURE TITLE DATE
- --------- ----- ----
- -----------------------------
Paul D. Kazilionis Director September 30, 1998
/S/ DAVID LAMBERT
- -----------------------------
David Lambert Director September 30, 1998
/S/ EDWARD H. SONDKER
- -----------------------------
Edward H. Sondker Director September 30, 1998
II-5
42
EXHIBIT INDEX
SEQUENTIALLY
EXHIBIT NUMBERED
NO. DESCRIPTION PAGE
- ------- ----------- ----
3.1 Amended Articles of Incorporation of the Company, as further amended
by the Articles of Amendment of the Company, as filed with the State
Department of Assessments and Taxation of Maryland on November 9,
1994. Filed as Exhibit 3.1 to the Company's Registration Statement No.
33-84346 and incorporated herein by this reference.
3.2* Bylaws of the Company, as currently in effect.
3.3 Articles of Amendment of the Company, as filed with the State
Department of Assessments and Taxation of Maryland on June 19, 1995.
Filed as Exhibit 3.3 to the Company's Registration Statement No.
33-84346 and incorporated herein by this reference.
3.4 Certificate of Articles Supplementary, as filed with the State
Department of Assessments and Taxation of Maryland on October 14,
1997, designating the rights, preferences and privileges of the 7.9%
Class A Cumulative Preferred Stock. Filed as Exhibit to Exhibit 10.1
to the Company's Report on Form 8-K dated August 13, 1997 and
incorporated herein by reference.
3.5* Articles of Amendment, as filed with the State Department of
Assessments and Taxation of Maryland on April 22, 1998.
4.1 See items 3.1, 3.3 and 3.4.
4.2** Form of Warrant Agreement for Purchase of Common Stock.
5.1** Opinion of Brobeck, Phleger & Harrison LLP as to legality of shares
being registered.
5.2** Opinion of Ballard Spahr Andrews & Ingersoll as to Maryland law.
8.1** Opinion of Brobeck, Phleger & Harrison LLP.
23.1* Consent of Ernst & Young LLP.
23.2* Consent of PricewaterhouseCoopers LLP.
23.3 Consent of Ballard Spahr Andrews & Ingersoll (Included with opinion
filed as Exhibit 5.2).
23.4 Consent of Brobeck, Phleger & Harrison LLP (Included with opinion
filed as Exhibit 5.1).
24.1 Power of Attorney (included in signature page on page II-4).
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* Filed herewith.
** To be filed by Amendment.
II-6