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EXHIBIT 99.2
Skadden, Arps, Slate, Meagher & Flom LLP
One Beacon Street
Boston, MA 02108-3194
November 13, 2002
BY FEDERAL EXPRESS AND TELECOPY
TO OPERATOR:
Marriott Senior Living Services, Inc.
10400 Fernwood Road
Bethesda, Maryland 20817
Attn: Chief Financial Officer and
Law Department (Senior Living Services Operations)
COPY TO:
Marriott International, Inc.
10400 Fernwood Road
Bethesda, Maryland 20817
Attn: General Counsel and
Law Department (Senior Living Services Operations)
RE: NOTICE OF DEFAULT
Ladies and Gentlemen:
This firm represents Senior Housing Properties Trust ("SNH")
and Five Star Quality Care, Inc. ("FVE") and is authorized to send this notice
of default on their behalf.
As you know, SNH owns 31 senior living communities leased to
FVE, and managed by Marriott Senior Living Services, Inc. ("MSLS"). The
contractual relationship between SNH/FVE and MSLS is governed by 31 Operating
Agreements, one for each senior living community, as amended (collectively, the
"Agreements"). For the reasons stated below, MSLS is hereby notified that it is
in Default of these 31 Agreements.
Among other prior communications, SNH/FVE sent a detailed
letter to MSLS on October 11, 2002, in which SNH/FVE detailed multiple instances
of MSLS's failures to perform its duties pursuant to the Agreements, failures to
act in good faith and deal fairly, and failures to provide SNH/FVE with
reasonable information. SNH/FVE requested that MSLS respond to the
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letter and provide reasons for its failures to perform as required by the
Agreements. A copy of the October 11th letter is attached to this notice and
incorporated by reference herein.
For the reasons stated in the October 11th letter and in our
prior communications, you are hereby on express notice that MSLS is in material
breach of the Agreements. MSLS's material breaches include, but are not limited
to, violations of the following duties pursuant to the Agreements:
Establish and revise, as necessary, resident care and health
care policies and procedures and general administrative
policies and procedures, including policies and procedures for
the control of revenue and expenditures, for the purchasing of
supplies and services, for the control of credit, and for the
scheduling of maintenance, and verify that the foregoing
policies and procedures are implemented in a sound manner in
accordance with Marriott standards - SECTION 2.03(A)(3)(1)
Procure such food stuffs, supplies, equipment, furniture and
fixtures (including, FF&E, Fixed Asset Supplies and
Inventories), and third-party services as are necessary to
keep, operate and maintain the Retirement Community in
accordance with Marriott Standards - SECTION 2.03(A)(5)
Maintain the operating accounts and pay all Operating
Expenses to the extent funds are available - SECTION
2.03(A)(6)
Prepare and deliver the statements, projections and reports
as are specified herein - SECTION 2.03(A)(7)
Provide, or cause to be provided, risk management services
relating to the types of insurance required to be obtained or
provided by Operator under this Agreement, provided that the
costs and expenses of providing such services are to be paid
as described in Section 12.04 - SECTION 2.03(A)(11)
Endeavor to manage the timing of expenditures to replenish
Inventories, Fixed Asset Supplies, payments on accounts
payable and collections of accounts receivable, so as to avoid
or minimize any cash deficits with respect to Retirement
Community operations, which deficits would otherwise require
additional funding of Working Capital by Owner -
SECTION 2.03(A)(15)
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(1) All of the duties listed in Section 2.03(A) are subject to the following
introductory language: "In accordance with Marriott Standards and the other
requirements imposed by this Agreement, Operator shall, in connection with the
Retirement Community, perform each of the following functions:"
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Exercise its reasonable best efforts to give Owner as early
notice as is practicable of all extraordinary developments
with respect to the operation of the Retirement Community,
including, but not limited to, Operator's forecast of the need
for any additional Working Capital or other cash requirements
- SECTION 2.03(A)(20)
Operator will manage the Working Capital of the Retirement
Community prudently and in accordance with the Marriott
Standards. Operator shall review and analyze the Working
Capital needs of the Retirement Community on an annual basis.
If Operator reasonably determines that there is excess Working
Capital, such excess shall be returned to Owner. -
SECTION 7.01(B)
Operator shall use the Retirement Community solely for
operation of a Retirement Community pursuant to the Marriott
Standards and for all activities in connection therewith which
are customary and usual to such an operation. -
SECTION 11.02(A)
Operator may self insure or otherwise retain such risks or
portions thereof as it does with respect to other similar
retirement communities it owns, leases or manages under the
Marriott name in the United States. - SECTION 12.03(B)
Insurance premiums and any other costs or expenses with
respect to the insurance or self-insurance required under
Section 12.02, including any Retirement Community Retention,
shall be paid from Gross Revenues as Operating Expenses. To
the extent that such costs or expenses include reimbursement
by Operator of its own costs or expenses, or those of one of
its Affiliates, such costs or expenses shall be generally
competitive (as calculated over the Term of this Agreement)
with costs and expenses of non-affiliated entities providing
similar services. Such premiums and costs shall be allocated
on an equitable basis to the retirement communities
participating under Operator's blanket insurance or
self-insurance program...." - SECTION 12.04
MSLS is also in material breach for its failure to perform its
duties in compliance with "Marriott Standards," as defined in the Agreements:
"MARRIOTT STANDARDS" means from time to time both the
operational standards (for example staffing levels, accounting
and fiscal management, resident care and health care policies
and procedures, accounting and financial reporting policies
and procedures) and the physical standards (for example,
quality of FF&E, frequency of FF&E replacement) that are then
generally and consistently (but not necessarily, absolutely or
without exception) applied at or to retirement communities in
the Marriott Retirement Community
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System which are of comparable size, age and market
orientation as the Retirement Community, (provided, however,
that the Marriott Standards shall in no event be lower than
(i) what is required, from time-to-time during the Term, by
Legal Requirements, or (ii) the operational and physical
standards, as of the date in question, of comparable
retirement communities in the quality segment of the
retirement communities industry in the state in which the
Retirement Community is located). - SECTION 1.01
In addition, MSLS is in material breach for its failure to
make a truthful certification in the Estoppel, Consent, Amendment and Agreement
(the "Estoppel Agreement") of December 13, 2001, in which MSLS falsely
certified:
There is no uncured default, event of default or other breach
by MSLS under any Communities-Related Agreement and there are
no facts or circumstances which, with the giving of notice or
passage of time, or both, could constitute a default, event of
default or other breach by MSLS under any Communities-Related
Agreement. - ESTOPPEL AGREEMENT, CERTIFICATIONS OF MSLS
SNH/FVE was entitled to rely on MSLS's certification pursuant
to the following language in the Estoppel Agreement:
The Marriott Parties acknowledge and agree that the SNH/Five
Star Parties, CLJ, and the CSL Parties shall be entitled to
rely on certifications, consents and waivers set forth herein.
The SNH/Five Star Parties, CLJ and CSL Parties acknowledge and
agree that the Marriott Parties shall be entitled to rely on
certifications, consents and waivers set forth herein -
ESTOPPEL AGREEMENT, RELIANCE
Further, MSLS's mismanagement of the senior living communities
and MSLS's subsequent failures to adequately respond to reasonable inquiries
made by SNH/FVE in the October 11th letter, renders MSLS in material breach of
the Agreements pursuant to Maryland law.
Moreover, MSLS's obfuscation and misconduct in its dealings
with SNH/FVE renders MSLS in material breach of its implied duties pursuant to
the Agreements as well as its duties pursuant to Maryland law.
Finally, MSLS's misconduct, including but not limited to its
material breaches of the Agreements and failures to adequately respond to
reasonable inquiries, constitutes a material breach of the duty of good faith
and fair dealing that arises under Agreements governed by Maryland law.
By violating the aforementioned duties, MSLS has committed
multiple Defaults pursuant to Sections 16.01(D), (E), and (F) of the Agreements.
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SNH/FVE hereby demands that MSLS cure the multiple Defaults(2)
within the contractually specified time periods in Sections 16.02(B) and (C) of
the Agreements.
Very truly yours,
/s/ James R. Carroll
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James R. Carroll
Encl.
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(2) SNH/FVE does not waive its right to claim that either one, some, or all of
these Defaults are incurable.
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SENIOR HOUSING PROPERTIES TRUST FIVE STAR QUALITY CARE, INC.
400 CENTRE STREET 400 CENTRE STREET
NEWTON, MA 02458 NEWTON, MA 02458
TEL: 617-796-8350 TEL: 877-349-5349
October 11, 2002
Mr. Jeffrey W. Ferguson
President
Marriott Senior Living Services, Inc.
Marriott Drive, Dept. 831-80
Washington, D.C. 20058
Dear Jeff:
We have studied the letter from Sandy Graves dated September 9, 2002,
and the supplemental information provided to us by MSLS since then. While
Sandy's letter and this information do provide some answers to the requests in
our letter of July 26, 2002, it is not responsive in several important respects:
1. INSURANCE. On July 26 we asked how insurance costs for the
Marriott self insurance and pooled insurance programs are allocated to our 31
managed communities vs. other participating Marriott operations. The written
information provided does not explain the insurance allocation formulae. When we
pressed this issue and asked follow up insurance questions in a teleconference
which Sandy arranged, the responses were evasive or contrary to standard
insurance industry practices. For example:
- Mike Owens of MSLS' risk management staff said that workers
compensation insurance cost allocations are based upon community sales rather
than payroll.
- When we asked about premium credits or refunds, we were told
that credits are allocated based upon a projected trend analysis rather than
historical experience.
- When we discussed the Houston elevator death claim, the
Marriott insurance staff stated that efforts are not regularly undertaken to
seek subrogation or contribution from others (e.g., the elevator manufacturer or
maintenance contractor) who may be jointly or primarily liable.
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The formula for allocating insurance administration to our 31 managed
communities was provided in a supplement to Sandy's letter. It shows that these
costs are charged as a percent of total community sales during the past four
years. Obviously, if this same formula is applied to all communities and
Marriott operations which participate in the pooled insurance arrangements,
mature operations such as ours are being charged on a basis which subsidizes
recently opened communities which do not have full four year histories.
Some of the answers we have been given regarding insurance so obviously
represent bad business practices that we assume that persons who have provided
this information may be mistaken. We ask that you confirm or deny in writing the
business practices set forth in the bullet points listed above. Also, we again
ask MSLS to provide a written explanation of how Marriott self insurance and
pooled insurance costs are allocated to our 31 managed communities vs. other
participating Marriott operations. This explanation should include (but not be
limited to) the formula which is applied to charge insurance administration
costs to our 31 managed properties vs. other participating Marriott operations.
2. BAD DEBTS. Sandy's letter states that this approximately $400,000
expense: "was not the result of a deteriorating accounts receivable position.
Rather it resulted from a change in MSLS's bad debt reserve calculation
methodology."
Based upon a subsequent conversation it seems this change of
methodology may be a response to increases in the aged accounts receivables
(over 60 days) at our MSLS managed communities. Comparing our own operating
experience and published competitor information for comparable mature senior
living communities with approximately 90% private pay revenues, we find that
accounts receivable/days of revenues outstanding for our 31 communities managed
by MSLS are among the highest. We hereby request that MSLS, as manager, assign
home office personnel to monitor and encourage better collection practices so
that we may avoid similar surprise charges of this magnitude in the future.
Please identify this person so we may periodically monitor these efforts.
On July 26, we asked you to refund the management fees which MSLS
received based upon the revenues which were reversed because of the
changed methodology. Sandy's letter implies that no refund will be
paid. Please explain in writing the rationale by which MSLS believes it
should retain management fees based upon revenues which the new
methodology implies will not be received.
3. BROOKSIDE. We understand your response and have received your
check for the $409,337 for the entry fees which MSLS had retained. Provided that
the working capital issue discussed below is satisfactorily resolved, we will
waive our claim for interest.
4. ESTIMATED REVENUE REVERSAL. We understand your explanation and
we expect that procedures are now in effect to prevent future inappropriate
financial reporting.
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5. WORKING CAPITAL. On July 26 we asked you if our working capital
cash was being pooled with other MSLS operations so as to subsidize those other
operations. Sandy's letter does not respond to this question. Moreover, the
working capital analysis attached to Sandy's letter seems to support our
suspicions. The "Adj. Pd. 6" column shows cash of $4.5 million, plus $3.7
million due from Marriott.
The attempted explanation in Sandy's letter that these amounts are
"consistent with the standard we have recently used for a smaller portfolio of
Brighton Gardens properties without healthcare units" is not helpful. Brighton
Gardens in fill up should require working cash contributions from owners.
However, our 31 properties are mature operations which are predominately
occupied by residents who pay monthly in advance.
There are other items on or missing from the working capital analysis
attached to Sandy's letter which require explanation: for example, why are
"fixed assets" listed on this analysis and what are they; and, importantly, this
analysis fails to take account of the fact that MSLS pays the owner's return
about three or four weeks after the end of each reporting period.
For all of the foregoing reasons, it is apparent to us that the working
cash generated by these 31 properties is being retained by MSLS or used in other
MSLS operations. Based upon what we now know, we estimate that at least $10
million, and perhaps as much as $15 million, can be withdrawn without any
adverse impact to operations. We hereby request that there be a full accounting
of the working cash required by these operations and that excess cash be paid
over as soon as possible.
6. RELATED PARTY COSTS. Sandy's response to our request for
information about allocated charges and purchases of goods and services from
Marriott related parties is both lacking in specifics and inconsistent. For
example:
- We asked for a listing of marketing costs which were allocated
to our 31 communities during 2002 through June 14. In response Sandy described
the types of activities which are undertaken on a pooled basis to promote the
MSLS brand but provided no dollar amounts.
- We asked for "a list of all MSLS related entities which have
sold goods or services to the 31 managed communities in 2002 through June 14,
together with the amount of these transactions".
- In response Sandy wrote: "Regarding your request for a list
of all MSLS related entities that have sold goods or services to your
communities, there are none."
- However, elsewhere the same letter describes arrangements
for purchasing food and supplies with Marriott Distribution Services
and with Avendra LLC. And, no indication of the amounts of purchases
involved, Marriott's profits or "vendor discounts" are provided.
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- Benefits Administration Costs. We agree that all personnel
costs including wages and fringe benefits of our 31 managed communities should
be charged to the owner. However, we disagree that it is appropriate to add a
home office administrative cost allocation to these personnel costs. Rather, we
believe these administration costs are covered by the management and CAS fees
paid to MSLS. Such costs are commonly paid by managers. Whether or not you agree
with our interpretation of the management contracts and customary trade
practices, we again request that you provide the dollar amounts of these
administration costs charged during 2002 year to date to our 31 communities.
Please also provide an explanation of the formulae by which these costs are
allocated to our 31 communities vs. other Marriott operations.
- The one item for which Sandy's letter provides actual costs
and allocations is the charges for Medicare and Medicaid cost reporting and
billing. This information raises two serious issues:
(i) We compared MSLS' charges allocated to our
managed communities with our own experience in
Medicare and Medicaid cost reporting and billing
with the following results:
<Table>
<Caption>
MSLS Five Star
CHARGES COSTS
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No. of Medicare
communities: 22 50
Medicare revenues: $25 million $40 million
No. of Medicaid
communities: 12 52
Medicaid revenues: $9.2 million $128 million
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Costs: $443,000 $375,000
</Table>
We believe Five Star's costs in this area
are at or above industry norms. MSLS'
costs appear to be excessive. Please
provide written details of all items
included in the $1,330,329 of
Medicare/Medicaid total charges described
in the schedule attached to Sandy's
letter. [We understand that the total
charge of $1,330,329 includes the
$443,000 charged to our communities plus
charges to other MSLS operated
communities.]
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(ii) The Five Star costs set forth in the foregoing
table include both Five Star's personnel costs
as well as third party Medicare and Medicaid
billing service costs, as we assume the MSLS
charge may as well.
We understand that the operating agreements for
our 31 communities managed by MSLS list the costs
of preparing and submitting Medicare and Medicaid
cost reports and billings as an owners' expense.
In other instances the operating agreements
contain specific authorization to include MSLS
employee costs as an owner's expense. Because no
such authorization is referenced with regard to
Medicare and Medicaid cost reports and billings,
we believe that MSLS employee costs for this
Medicare and Medicaid accounting are covered in
the CAS and management fees paid to MSLS, and
that the Medicare/Medicaid costs and expenses
referenced in the operating agreements are third
party costs of billing services often engaged in
the senior living industry. If the scheduled MSLS
charges allocated to our 31 communities set forth
in the attachment to Sandy's letter include the
allocated costs of home office employees, please
itemize those costs and explain in writing why
MSLS believes it is appropriate to allocate these
home office costs to our 31 communities.
7. TIFFANY HOUSE. As you know, the proposal advanced by the Marriott
Finance Group that Five Star assume the operations of Tiffany House and other
loss making communities was rejected.
For several months we have asked MSLS to prepare a closing plan for
Tiffany House. On July 26 we made a specific written request. MSLS' continued
refusal to offer such a plan, while MSLS continues to collect management fees
based upon gross revenues and the owners suffer the economic losses, is a breach
of MSLS' responsibilities as manager. We consider that all management fees for
Tiffany House should cease and all losses generated by these operations should
be MSLS' financial responsibility effective October 1, 2002.
8. CHALLENGED COMMUNITIES. Sandy's letter is not responsive to our
requests of July 26. We asked that you provide specific plans and identify
specific MSLS home office personnel who have responsibility to develop and
implement plans to rectify the declining occupancies and profitability of our
communities. We hereby renew that request and state that it will not be helpful
for MSLS to again respond with a general description of another MSLS
reorganization or a the new project code name.
On October 1, 2002, Dave Hegarty visited several of the SNH and Five
Star communities in Florida which are managed or leased by MSLS (Park Summit,
Horizon Club, Deer Creek and Stratford Court at Boca Pointe). Although these
communities have historically been among the strongest properties operated by
MSLS, the continuing decline in the performance of these operations was
apparent. Independent and assisted living occupancies are declining. These
occupancies in the low to mid eighty percents (62% AL at Deer Creek!) are below
published
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industry averages and below our own current experience at similar mature
communities not managed by MSLS. Also, we are disturbed that the historical
flagship facility at Boca Pointe had a current occupancy of only 86% while an
adjacent Brighton Gardens, which is owned and operated by MSLS for its own
account and which was developed to accommodate the overflow from our community,
was at 90%.
The regular flow of news stories about the Host settlement and law
suits from hotel owners which challenge the management charges and allocations
of Marriott International in its hotel business is causing intense pressure upon
SNH and Five Star to review MSLS' performance as expeditiously as possible.
Rather than more aggressive actions, we are attempting to work with MSLS to
identify problems and propose solutions. The refusal to provide allocation
formulae, historical cost information and specific plans of correction as
evidenced in Sandy's letter is not helpful. Our attempts to resolve the real
problems in MSLS operations by negotiation should not be mistaken to evidence
that we are unwilling or incapable of taking more forceful actions to terminate
the MSLS contracts or otherwise. The specific requests in this letter should
receive priority attention.
Sincerely,
SENIOR HOUSING PROPERTIES TRUST
By /s/ David J. Hegarty
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David J. Hegarty
President
FIVE STAR QUALITY CARE, INC.
By /s/ Evrett W. Benton
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Evrett W. Benton
President
cc: Ms. Sandy Graves
Mr. Michael Dearing
Mr. Barry Portnoy