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FILED PURSUANT TO RULE NO. 424(b)(3)
REGISTRATION NO. 333-36127
PROSPECTUS SUPPLEMENT
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(TO PROSPECTUS DATED NOVEMBER 20, 1997)
2,172,370 SHARES
AMERICAN GENERAL HOSPITALITY CORPORATION
COMMON STOCK
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American General Hospitality Corporation (collectively with its subsidiaries,
the "Company") is a self-administered real estate investment trust (a "REIT"),
organized as a corporation under the laws of Maryland, which owns hotels,
diversified by franchisor or brand affiliation, in several states (the
"Hotels"). The Company's Common Stock, $0.01 par value per share, (the "Common
Stock") is listed on the New York Stock Exchange, Inc. (the "NYSE") under the
symbol "AGT."
The shares of Common Stock offered hereby are being offered on the account of
certain security holders of the Company. See "Registering Stockholders" and "The
Company--Securities to be Offered" in the accompanying Prospectus. The Company
will not receive any proceeds from the sale of any Exchanged Shares nor from the
sale of any shares of Common Stock. The Company has agreed to bear certain
expenses of registration of the shares of Common Stock under federal and state
securities laws.
SEE "RISK FACTORS" BEGINNING ON PAGE 4 FOR CERTAIN FACTORS RELEVANT TO AN
INVESTMENT IN THE COMMON STOCK.
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 SUPPLEMENT OR THE ACCOMPANYING
PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
July 10, 1998
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PROSPECTUS SUPPLEMENT SUMMARY
The following summary is qualified in its entirety by the more detailed
information appearing elsewhere in this Prospectus Supplement. Unless the
context requires otherwise, the term "Company," as used herein, includes
American General Hospitality Corporation and its two wholly owned subsidiaries,
AGH GP, Inc. ("AGH GP") and AGH LP, Inc. ("AGH LP"), and American General
Hospitality Operating Partnership, L.P., a Delaware limited partnership (the
"Operating Partnership"). The term "Operating Partnership," unless the context
requires otherwise, includes subsidiaries of the Operating Partnership. Unless
otherwise defined, defined terms used herein shall have such meaning ascribed
such terms in the accompanying Prospectus.
This Prospectus Supplement and the accompanying Prospectus, including periodic
reports of the Company, and the information incorporated by reference herein and
therein, may contain forward-looking statements within the meaning of Section
27A of the Securities Act of 1933, as amended (the "Act"), and the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and as such may involve
known and unknown risks, uncertainties and other factors which may cause the
actual results, performance or achievements of the Company to be materially
different from future results, performance or achievements expressed or implied
by such forward-looking statements. Factors that might cause such a difference
include, but are not limited to, those discussed under the caption "Risk
Factors" in this Prospectus Supplement, the accompanying Prospectus and set
forth in the periodic reports and other documents incorporated by referenced
herein and therein. The Company cautions the reader, however, that any such
list of factors may not be exhaustive.
THE COMPANY
The Company is a self-administered real estate investment trust (a "REIT")
that owns a geographically diverse portfolio of primarily full-service hotels.
As of July 1, 1998, the Company owned 53 hotels located in 21 states and
containing an aggregate of approximately 12,600 guest rooms (the "Hotels").
Substantially all of the Hotels are operated under licensing or franchising
agreements with national hotel brands, including Crowne Plaza(R), Hilton(R),
Wyndham(R), Marriott(R), Holiday Inn Select(R), Radisson(R), Westin(R),
DoubleTree(R), Holiday Inn(R) and Sheraton(R). Management believes that the
full-service segment of the hotel market continues to offer numerous
opportunities to acquire hotels at attractive multiples of cash flow and at
discounts to replacement value, including underperforming hotels that may
benefit from the Company's repositioning strategies.
The Company expects to continue to expand and enhance the value of its hotel
portfolio by continuing to (i) make opportunistic acquisitions of full-service
hotels and (ii) strategically reposition selected hotels through product
upgrades brand conversions and operational repositionings. The Company will
continue to pursue the acquisition of full-service hotels, primarily in the
moderate and lower upscale segments at prices which management believes are
below replacement cost, and that have attractive yields on investment that the
Company believes can be improved over time.
In order to qualify as a REIT, the Company may not operate hotels. The
Company has leased each of the Hotels to AGH Leasing, L.P. and its subsidiary,
Twin Towers Leasing, L.P. ("Twin Towers," and together with AGH Leasing, L.P.,
"AGH Leasing") and to independent lessees that are affiliates of Prime
Hospitality Corp. ("Prime"), a NYSE listed company (together, the "Prime
Lessee"), each pursuant to separate participating leases (the "Participating
Leases"). In the event that the Merger (as defined below) is not consummated,
the Company expects to continue to lease future acquired hotels to AGH Leasing
or the Prime Lessee (collectively, the "Lessees"). The Participating Leases are
designed to allow the Company to achieve substantial participation in any future
growth of revenues generated at the Hotels. AGH Leasing has entered into
separate management agreements with American General Hospitality, Inc. ("AGHI")
to manage 44 of the Hotels and Wyndham Hotel Corporation ("Wyndham") to manage
one of the Hotels (the "Management Agreements"). The remaining eight Hotels are
leased and managed by the Prime Lessee. AGH Leasing and AGHI are owned, in
part, by certain executive officers of the Company. Neither the Company nor
members of its management own an interest in, or participate in the management
of, the Prime Lessee.
RECENT DEVELOPMENTS
CapStar Merger
On March 15, 1998 the Company and CapStar Hotel Company ("CapStar") entered
into a definitive Agreement and Plan of Merger, dated March 15, 1998, as amended
(the "Merger Agreement") pursuant to which the parties agreed, subject to
stockholder approval and other conditions and covenants, to merge as equals (the
"Merger"). Accordingly, no assurance can be given that the Merger will be
consummated. Pursuant to the Merger Agreement, CapStar will spin off (the
"Spin-Off") in a taxable transaction, its hotel operations and management
business to its current stockholders as a new C-corporation to be called
MeriStar Hotels & Resorts, Inc. ("OpCo"). CapStar will
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subsequently merge with and into the Company, which will qualify as a
reorganization under Section 368 of the Internal Revenue Code of 1986, as
amended (the "Code"). The Company will be renamed MeriStar Hospitality
Corporation ("MeriStar") if the Merger is consummated. In a separate
transaction, which will close immediately after the closing of the Merger,
MeriStar H&R Operating Company, L.P., a wholly-owned subsidiary of OpCo (the
"OpCo OP"), will acquire AGH Leasing and AGHI, which acquisition is a condition
to closing the Merger. If the Merger is consummated, OpCo will become the lessee
and manager of all the hotels currently leased by AGH Leasing and will have a
right of first refusal to become the lessee of hotels acquired by MeriStar in
the future with the exception of the eleven hotels to be acquired in connection
with the purchase and sale agreement, dated November 20, 1997, as amended on
January 7, 1998, between the Operating Partnership and Prime.
The Merger Agreement defines the exchange ratios for both the Company's and
CapStar's stockholders. CapStar stockholders will receive one share of MeriStar
for each CapStar share owned and the Company's stockholders will receive 0.8475
shares of MeriStar for each share of Common Stock owned. Both exchange ratios
are fixed, with no adjustment mechanism.
The Company expects the Merger to close in late July or early August 1998.
The Merger will be submitted for approval at separate meetings of the
stockholders of the Company and CapStar currently scheduled to be held on July
28, 1998. The consummation of the merger is subject, among other things, upon
obtaining such approvals. Accordingly, no assurance can be given that the Merger
will be consummated. The Company has filed a registration statement on Form S-
4, which includes the Joint Proxy Statement/Prospectus, with the Securities and
Exchange Commission (the "SEC" or the "Commission") (Registration No. 333-
49611), which was declared effective by the Commission on June 22, 1998.
The Company's executive offices are located at 5605 MacArthur Boulevard, Suite
1200, Irving, Texas 75038, and its telephone number is (972) 550-6800.
TAX STATUS OF THE COMPANY
The Company has elected to be taxed as a REIT under Sections 856 through 860
of the Internal Revenue Code of 1986, as amended (the "Code"), commencing with
its taxable year ended December 31, 1996. As a REIT, the Company generally will
not be subject to federal income tax on net income that it distributes to its
shareholders as long as it distributes at least 95% of its taxable income each
year and complies with a number of other organizational and operational
requirements. Failure to qualify as a REIT will render the Company subject to
federal income tax (including any applicable alternative minimum tax) on its
taxable income at regular corporate rates, and distributions to the shareholders
in any such year will not be deductible by the Company. Even if the Company
qualifies for taxation as a REIT, the Company may be subject to certain federal,
state and local taxes on its income and property. In connection with the
Company's election to be taxed as a REIT, the Company's Charter imposes certain
restrictions on the transfer of shares of Common Stock. The Company has adopted
the calendar year as its taxable year.
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RISK FACTORS
An investment in the shares of Common Stock involves various risks.
Prospective investors should carefully consider the following information and
the information discussed under the caption "Risk Factors" contained the
accompanying Prospectus in conjunction with the other information contained and
incorporated by reference in this Prospectus Supplement and the accompanying
Prospectus before making an investment decision regarding the Common Stock
offered hereby.
RISK FACTORS RESULTING FROM THE MERGER
RISK THAT MERGER WILL NOT CLOSE
A number of covenants and conditions, including stockholder approval, must be
satisfied before completion of the Merger with CapStar. Accordingly, there can
be no assurance that the Merger will be consummated.
FAILURE TO MANAGE RAPID GROWTH AND INTEGRATE OPERATIONS
The Company and CapStar are currently experiencing a period of rapid growth.
Since their initial public offerings in July 1996 and August 1996, respectively,
the Company and CapStar have invested an aggregate of approximately $1,807
million to purchase 84 hotels, increasing their combined guest room portfolios
by more than 421%. Based upon the respective portfolios of the Company and
CapStar at April 1, 1998, MeriStar's aggregate rooms portfolio after giving
effect to the Merger will consist of 25,854 rooms. The consolidation of
functions and integration of departments, systems and procedures and the
formation of OpCo to manage the 53 hotels currently owned by the Company and the
55 hotels currently owned by CapStar (collectively, the "MeriStar Owned Hotels")
will present a significant management challenge, and the failure to integrate
all of such hotels into OpCo's management and operating structures could have a
material adverse effect on the results of operations and financial condition of
MeriStar. There can be no assurance that the anticipated benefits from the
Merger will be realized or that the integration will be successful and timely
implemented.
MeriStar's ability to manage its growth effectively requires MeriStar to
select capable lessees and managers for its newly acquired hotels. There can be
no assurance that OpCo or other hotel management companies and/or operators will
be able to manage MeriStar's newly acquired hotels. See "--Dependence on OpCo
and Payments under the Participating Leases."
FAILURE TO OBTAIN ANTICIPATED COST SAVINGS
MeriStar expects to achieve certain benefits from the consummation of the
Merger, particularly cost savings and other operating efficiencies resulting
from a reduction of overhead and the elimination of management and
administrative fees and other property expenses, which could result in operating
cost savings of $5 to $10 million during the first year of combined operations,
which savings were based upon a pro forma analysis of the Merger, the operating
costs savings are expected to be realized at the hotel property level, which
savings were accounted for in structuring the departmental participating rent to
thresholds under the separate lease agreements pursuant to which, upon
consummation of the Merger, MeriStar will lease substantially all of the
MeriStar Owned Hotels to OpCo (the "MeriStar Participating Leases") and through
a decrease to general and administration expenses at MeriStar. The expected
operating cost savings were determined by CapStar based upon the following
assumptions: (i) the centralization of personnel; (ii) the implementation of
product purchasing programs; (iii) the reduction in employee benefit expenses
and workers compensation premiums; (iv) the reduction in financing expenses due
to an increased credit facility; and (v) the reduction of property and general
liability insurance premiums. No assurance can be given that any such cost
savings anticipated from the Merger will be achieved or, if cost savings are
realized, that they will be as substantial as anticipated.
FIXED EXCHANGE RATIO
Upon completion of the Merger, each share of common stock, par value $0.01 per
share, of CapStar (the "CapStar Common Stock") will be converted into the right
to receive 1.0 share of common stock, par value $0.01 per share, of MeriStar
(the "MeriStar Common Stock") and each share of Common Stock will be converted
into 0.8475 of a share of MeriStar Common Stock. The exchange ratios are fixed
numbers and will not be adjusted in the event of any increase or decrease in the
price of either Common Stock or CapStar Common Stock. As a result, the value of
the shares of MeriStar Common Stock received by the CapStar and the Company's
stockholders in the
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Merger could vary depending on fluctuations in the value of CapStar Common Stock
or the Company's Common Stock. Such fluctuations may be the result of changes in
business, operations or prospects of CapStar, the Company or MeriStar (as a
combined company) market assessments of the likelihood that the Merger will be
consummated, the timing thereof, regulatory considerations, general market and
economic conditions and other factors. Accordingly, there can be no assurance
that the value of the MeriStar Common Stock received pursuant to the Merger on
the date of the Merger Agreement will be the same as on the date of the
Company's 1997 Annual Meeting of Stockholders and CapStar's Special Meeting of
Stockholders, or the effective time of the Merger (the "Effective Time").
FAILURE TO TRANSFER LIQUOR AND FOOD LICENSES
In connection with the Merger, CapStar intends to transfer certain operating
licenses, such as food and beverage licenses, to OpCo. MeriStar will also be
subject to the risk that in connection with the Merger, it may not be possible
to transfer such operating licenses, or to obtain new licenses in a timely
manner in the event such licenses cannot be transferred. Although hotels can
provide alcoholic beverages under interim licenses or licenses obtained prior to
the acquisition of these hotels, there can be no assurance that these licenses
will remain in effect until OpCo obtains new licenses or that new licenses will
be obtained. The failure to have alcoholic beverage licenses or other operating
licenses could adversely affect the ability of OpCo to generate revenues and
make lease payments to MeriStar.
REDISTRIBUTION OF OPCO COMMON STOCK
Trading in shares of OpCo will likely be characterized by a period of
redistribution among the MeriStar shareholders who receive such shares in the
Spin-Off (especially in light of the taxable nature of the Spin-Off) which may
temporarily depress the market price of such shares during such period.
SIGNIFICANT INDEBTEDNESS; REFINANCING RISKS
Upon consummation of the Merger, MeriStar will have significant amounts of
debt outstanding and, accordingly, will be subject to the risks normally
associated with debt financing, including the risk that its cash flow from
operations will be insufficient to make required payments of principal and
interest, the risk that existing indebtedness, including secured indebtedness,
may not be refinanced or that the terms of any refinancing will not be as
favorable as the terms of existing indebtedness. MeriStar has received
commitments for the $1.0 billion revolver and term loan facility (the "Credit
Facility") and a $300.0 million secured mortgage facility (the "Mortgage
Facility" and together with the Credit Facility, the "Credit Facilities"). Upon
consummation of the Merger, MeriStar expects that it will have approximately
$905.0 million of outstanding indebtedness under the Credit Facilities, $150.0
million of outstanding 8.75% Senior Subordinated Notes due 2007 and $173.0
million of outstanding 4.75% Convertible Notes due 2004, and will have other
outstanding mortgage indebtedness encumbering nine of the hotels of
approximately $104.0 million. The Credit Facility restricts, among other things,
MeriStar's ability to effect certain mergers, asset sales and change of control
events, and the incurrence of certain indebtedness, imposes minimum net worth
requirements and requires MeriStar to comply with certain financial covenants,
including certain leverage and interest rate coverage ratios. In addition, the
Credit Facility limits MeriStar from distributing the lesser of (i) 90% of funds
from operations and (ii) 100% of free cash flow (funds from operations less a
capital expenditure reserve equal to 4% of gross room revenues) to MeriStar's
stockholders.
MeriStar's organizational documents will not limit the amount of indebtedness
which may be incurred by MeriStar and its subsidiaries. If MeriStar does not
have sufficient funds to repay its indebtedness at maturity, it may be necessary
to refinance such indebtedness through additional debt financing, private or
public offerings of debt securities or additional equity offerings. If, at the
time of any such refinancing, prevailing interest rates or other factors result
in higher interest rates on refinancings, increases in interest expense could
adversely affect cash flow, and, consequently, cash available for distribution
to stockholders. If MeriStar is unable to refinance its indebtedness on
acceptable terms, it might be forced to dispose of hotels or other assets on
disadvantageous terms, potentially resulting in losses and adverse effects on
cash flow from operating activities. If MeriStar is unable to make required
payments of principal and interest on indebtedness secured by its hotels, such
properties could be foreclosed upon by the lender with a consequent loss of
income and asset value.
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RISK OF RISING INTEREST RATES
Certain of MeriStar's borrowings, including borrowings under the revolver
portion of the Credit Facility and the Mortgage Facility, will bear interest at
a variable rate. Following the Merger, approximately 33.3% of MeriStar's total
indebtedness will be subject to variable interest rates. Accordingly, increases
in interest rates could increase MeriStar's interest expense and adversely
affect cash flow.
BENEFITS TO CERTAIN DIRECTORS AND OFFICERS OF THE COMPANY AND CAPSTAR
In considering the recommendation of the Board of Directors of the Company and
CapStar to approve the Merger and the transactions related thereto, stockholders
of the Company and CapStar should be aware that certain members of management
and the Board of Directors of the Company and CapStar have certain interests in,
and will receive benefits as a consequence of, the Merger and the transactions
related thereto that are separate from the interests of, and benefits to,
stockholders of the Company and CapStar generally, and which may result in
conflicts of interest with respect to their obligations to the Company and
CapStar in determining whether it should consummate the Merger. Among the
material benefits to be received by such persons in connection to the Merger are
(i) the receipt by Steven D. Jorns, Chairman of the Board, Chief Executive
Officer and President of the Company, Bruce G. Wiles, Executive Vice President
of the Company, and Kenneth E. Barr, Executive Vice President, Chief Financial
Officer, Secretary and Treasurer of the Company, of approximately $3.5 million,
1.1 million and .3 million, respectively, of units of limited partnership
interest in the OpCo OP (the "OpCo OP Units") (which are exchangeable for OpCo
shares on a one for one basis) and approximately $14.1 million, $4.4 million and
$1.0 million, respectively, of cash in connection with the sale of AGH Leasing
and the assets of AGHI to OpCo, (ii) the grant of 150,000 shares of restricted
MeriStar Common Stock (that vest over a three-year period commencing one year
after the date of grant) to the holders of CapStar stock options, including to
the following executive officers and/or directors of CapStar; 21,726 shares of
MeriStar Common Stock to Paul W. Whetsell, 11,949 shares of MeriStar Common
Stock to Daniel E. McCaslin, 9,043 shares of MeriStar Common Stock to John
Emery, 8,596 shares of MeriStar Common Stock to John E. Plunket, 3,079 shares of
MeriStar Common Stock to Scott Livchak, 2,994 shares of MeriStar Common Stock to
Robert Gauthier, 869 shares of MeriStar Common Stock to Bradford Bernstein, 869
shares of MeriStar Common Stock to Edwin Burton III, 869 shares of MeriStar
Common Stock to Edward Cohen, 869 shares of MeriStar Common Stock to Daniel L.
Doctoroff, 869 shares of MeriStar Common Stock to Edward Dowd, 869 shares of
MeriStar Common Stock to William S. Janes, 869 shares of MeriStar Common Stock
to Mahmood Khimji and 869 shares of MeriStar Common Stock to Joseph McCarthy,
(iii)(a) 80,000 outstanding CapStar options held by the non-employee directors
of CapStar and 669,582 outstanding CapStar options held by executive officers of
CapStar will become immediately vested and exercisable and (b) 40,000
outstanding Company stock options (prior to adjustment pursuant to Merger) held
by non-employee directors of the Company and 1,323,973 outstanding Company stock
options (prior to adjustment pursuant to the Merger) held by certain executive
officers of the Company as well as 57,500 shares of restricted stock awards
(prior to adjustment pursuant to the Merger), will become immediately vested and
exercisable (except that Messrs. Whetsell, Jorns, Wiles and Emery have agreed
subject to certain limitations to waive such acceleration), (iv) the receipt by
(a) Messrs. Whetsell and Jorns of new employment agreements from MeriStar and
OpCo at higher salary levels than they are currently receiving, including a base
salary of $285,000 per year for each as employees of MeriStar and a base salary
of $190,000 per year for each as employees of OpCo, respectfully, as compared to
$225,000 and $125,000, respectively, under their current employment agreements,
(b) Messrs. Wiles and Emery of new employment agreements, and with respect to
Mr. Barr a continuation of his current employment, from MeriStar at higher
salary levels than they are currently receiving, including a base salary of
$300,000, $275,000 and $190,000, respectively, as compared to $110,000, $200,000
and $95,000, respectively, under their respective current employment agreements,
and (c) Messrs. McCaslin, Calder and Plunket of new employment agreements from
OpCo at higher salary levels than they are currently receiving, including a base
salary of $300,000, $200,000 and $160,000, respectively, as compared to
$215,000, $132,600 and $150,000, respectively, under their respective current
employment agreements and (v)(a) each of Messrs. Whetsell, Emery, Calder and
Plunket will receive MeriStar stock options in the following share amounts:
353,743, 120,936, 47,500 and 12,500, respectively, and (b) each of Messrs.
Jorns, Wiles, Emery, Calder and Plunket will receive OpCo stock options in the
following share amounts: 250,000, 125,000, 87,500, 20,936, 47,500 and 10,000.
COMPENSATION OF FINANCIAL ADVISORS
A significant portion of the fees related to the financial advisory services
of the financial advisors to the Company and CapStar in connection with the
Merger is contingent upon the consummation of the Merger. While such fees were
negotiated at arm's-length and are standard and customary for transactions
similar to the Merger, the
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contingent nature of such fee arrangements might be viewed as giving such
financial advisors a financial interest in the successful completion of the
Merger.
NO APPRAISAL OR DISSENTERS' RIGHTS
Under the Maryland General Corporate Law (the "MGCL") and the Delaware General
Corporate Law, stockholders of the Company and CapStar, respectively, who do not
vote in favor of the Merger will not have appraisal or dissenters' rights in
connection with the Merger if it is approved.
CONFLICT OF INTEREST RISKS IN RELATIONSHIP BETWEEN MERISTAR AND OPCO
GENERAL CONFLICTS OF INTEREST
MeriStar and OpCo will have several common members of their Boards of
Directors, as well as their two senior executives. MeriStar and OpCo will
operate in a relationship governed by an agreement between MeriStar, MeriStar
Hospitality Operating Partnership, L.P., a Delaware limited partnership (the
"MeriStar OP"), OpCo and the OpCo OP (the "Intercompany Agreement"), which
restricts each party from taking advantage of certain business opportunities
without first presenting those opportunities to the other party. Also, in their
relationship with MeriStar as owner and OpCo as lessee and manager of hotels,
MeriStar and OpCo may have conflicting views on the manner in which the MeriStar
hotels are operated and managed, and with respect to lease arrangements,
acquisitions and dispositions. As a result, the directors and senior executives
of MeriStar (who serve in similar capacities at OpCo) may well be presented with
several decisions which provide them the opportunity to benefit MeriStar to the
detriment of OpCo or benefit OpCo to the detriment of MeriStar. Such inherent
potential conflicts of interest will be present in all of the numerous
transactions between MeriStar and OpCo.
RESTRICTIONS ON OPCO'S AND MERISTAR'S BUSINESS AND FUTURE OPPORTUNITIES
The certificate of incorporation of OpCo (the "OpCo Charter") provides that,
for so long as the Intercompany Agreement remains in effect, OpCo is prohibited
from engaging in activities or making investments that a REIT could make unless
MeriStar was first given the opportunity but elected not to pursue such
activities or investments. The OpCo Charter also provides that a corporate
purpose of OpCo is to perform its obligations under the Intercompany Agreement.
Under the OpCo Charter and the Intercompany Agreement, OpCo has agreed not to
acquire or make (i) investments in real estate (which, for purposes of the
Intercompany Agreement, include the provision of services related to real estate
and investment in hotel properties, real estate mortgages, real estate
derivatives or entities that invest in real estate assets) or (ii) any other
investments that may be structured in a manner that qualifies under the federal
income tax requirements applicable to REITs, unless in either case it has
notified MeriStar of the acquisition or investment opportunity, in accordance
with the terms of the Intercompany Agreement, and MeriStar has determined not to
pursue such acquisition or investment; provided, however, that OpCo may make
limited minority investments or contributions as part of a lease arrangement
with a party that is not an affiliate of OpCo in a bona fide arm's-length
transaction; provided further, that such investment or contribution does not
materially impact OpCo's financial and legal qualifications to lease and manage
additional MeriStar properties. OpCo also has agreed to assist MeriStar in
structuring and consummating any such acquisition or investment which MeriStar
elects to pursue, on terms determined by MeriStar. On the other hand, the
Intercompany Agreement grants OpCo the right of first refusal to become the
lessee of any real property acquired by MeriStar as to that MeriStar determines
that, consistent with MeriStar's status as a REIT, it is required to enter into
a separate MeriStar Participating Lease. This lessee opportunity will be
available to OpCo only if MeriStar determines, in its sole discretion, that OpCo
is qualified to be the lessee. Because of the provisions of the Intercompany
Agreement and the OpCo Charter, the nature of OpCo's business and the
opportunities it may pursue are restricted.
OPCO'S DEPENDENCE UPON MERISTAR; LIMITED RESOURCES FOR GROWTH THROUGH NEW
OPPORTUNITIES
Due to OpCo's restricted corporate purpose and the Intercompany Agreement,
OpCo will rely on MeriStar to provide OpCo with the lessee opportunities
described in the Intercompany Agreement only if it is necessary for MeriStar,
consistent with its status as a REIT, to enter into a MeriStar Participating
Lease and only if OpCo and MeriStar negotiate a mutually satisfactory MeriStar
Participating Lease. If MeriStar in the future should fail to qualify as a REIT,
such failure could have a substantial adverse effect on those aspects of OpCo's
business operations and business opportunities that are dependent upon MeriStar.
For example, the Intercompany Agreement remains effective even if MeriStar
ceases to qualify as a REIT, with OpCo's rights relating to lessee opportunities
under the
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Intercompany Agreement continuing to be based on MeriStar's need to enter into a
MeriStar Participating Lease due to its status as a REIT. Accordingly, if
MeriStar failed to qualify as a REIT and thereafter acquired a property,
MeriStar would have the right under the Intercompany Agreement to lease the
property to any person or entity pursuant to any type of lease (including a
MeriStar Participating Lease) or to operate the property itself. OpCo, however,
would remain subject to all of the limitations on its operations contained in
the OpCo Charter and the Intercompany Agreement. In addition, although it is
anticipated that any MeriStar Participating Lease involving OpCo generally will
provide that OpCo's rights will continue following a sale of the property or an
assignment of the lease (with the likelihood of a sale or assignment of lease
possibly increasing if MeriStar fails to qualify as a REIT), OpCo could lose its
rights under any such MeriStar Participating Lease upon the expiration of the
lease. If OpCo and MeriStar do not negotiate a mutually satisfactory MeriStar
Participating Lease within 30 days after MeriStar provides OpCo with written
notice of the lessee opportunity (or such longer period to which OpCo and
MeriStar may agree), MeriStar may offer the opportunity to others for a period
of one year before it must again offer the opportunity to OpCo.
CONFLICTS RELATING TO SALE OF HOTELS SUBJECT TO LEASES
MeriStar generally will be obligated under its master leases with OpCo to pay
a lease termination fee to OpCo if MeriStar elects to sell a hotel or if it
elects not to restore a hotel after a casualty and does not replace it with
another hotel on terms that would create a leasehold interest in such hotel with
a fair market value equal to the fair market value of OpCo's remaining leasehold
interest under the lease to be terminated. Where applicable, the termination fee
is equal to the fair market value of OpCo's leasehold interest in the remaining
term of the lease to be terminated. A decision to sell a hotel may, therefore,
have significantly different consequences for MeriStar and OpCo.
DEPENDENCE ON OPCO AND PAYMENTS UNDER THE MERISTAR PARTICIPATING LEASES
Upon consummation of the Merger, MeriStar will lease substantially all of the
MeriStar Owned Hotels to OpCo pursuant to the MeriStar Participating Leases.
MeriStar's ability to make distributions to its stockholders will depend
primarily upon the ability of OpCo to make rent payments under the MeriStar
Participating Leases (which will be dependent primarily on the ability of OpCo
and other potential operators to generate sufficient revenues in excess of
operating expenses from those hotels which are leased to them). A failure or a
delay by OpCo in making such payments may be caused by reductions in revenue
from such hotels or in the net operating income of OpCo or otherwise. Any
failure or delay by OpCo in making rent payments may adversely affect MeriStar's
ability to make distributions to stockholders. Although failure on the part of
OpCo to materially comply with the terms of a MeriStar Participating Lease
(including failure to pay rent when due) will give MeriStar the non-exclusive
right to terminate such lease, repossess the applicable property and enforce the
payment obligations under the lease, MeriStar would then be required to find
another lessee to lease such hotel. There can be no assurance that MeriStar
would be able to find another lessee or that, if another lessee were found,
MeriStar would be able to enter into a new lease on favorable terms.
LACK OF CONTROL OVER MANAGEMENT AND OPERATIONS OF THE HOTELS
MeriStar will be dependent on the ability of OpCo and other operators of
hotels to operate and manage the MeriStar Owned Hotels. To maintain its status
as a REIT, MeriStar will not be able to operate the MeriStar Owned Hotels or any
subsequently acquired hotels. As a result, MeriStar will be unable to directly
implement strategic business decisions with respect to the operation and
marketing of the MeriStar Owned Hotels, such as decisions with respect to the
setting of room rates, food and beverage operations and certain similar matters.
POTENTIAL NEGATIVE IMPACT ON MERISTAR ACQUISITIONS
MeriStar's ability to acquire additional hotels could be negatively impacted
by the relationship between MeriStar and OpCo because hotel management
companies, franchisees and others who historically approached CapStar or the
Company with acquisition opportunities in hopes of establishing lessee or
management relationships may not do so in the future knowing that MeriStar will
rely primarily on OpCo to lease and/or manage the acquired properties. Such
persons may instead provide such acquisition opportunities to hotel companies
that will allow them to manage the properties following the sale. This could
have a negative impact on MeriStar's acquisition activities in the future.
NO ARM'S LENGTH BARGAINING
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The terms of the Intercompany Agreement, the agreement pursuant to which (i)
MeriStar and OpCo will provide to each other a right of first opportunity with
respect to certain investment opportunities available to each of them, (ii) OpCo
will provide certain corporate and other general services to MeriStar and (iii)
MeriStar and OpCo agree to cooperate and coordinate with each other with regard
to certain matters, was not negotiated on an arm's-length basis. Because Messrs.
Whetsell, Jorns, Worms and Doctoroff, will be directors of both MeriStar and
OpCo and Messrs. Whetsell and Jorns will be executive officers of both MeriStar
and OpCo, there is a potential conflict of interest with respect to the
enforcement and termination of the Intercompany Agreement to benefit MeriStar to
the detriment of OpCo or benefit OpCo to the detriment of MeriStar. Because of
these conflicts, Messrs. Whetsell, Jorns, Worms and Doctoroff may have conflicts
of interest with respect to their decisions relating to enforcement of the
Intercompany Agreement.
ADVERSE EFFECTS RELATING TO THE LODGING INDUSTRY
OPERATING RISKS
MeriStar's business will be subject to all of the operating risks inherent in
the lodging industry. These risks include the following: (i) changes in general
and local economic conditions; (ii) cyclical overbuilding in the lodging
industry; (iii) varying levels of demand for rooms and related services; (iv)
competition from other hotels, motels and recreational properties, some of which
may have greater marketing and financial resources than MeriStar; (v) dependence
on business and commercial travelers and tourism, which business may fluctuate
and be seasonal; (vi) the recurring need for renovations, refurbishment and
improvements of hotel properties; (vii) changes in governmental regulations that
influence or determine wages, prices and construction and maintenance costs; and
(viii) changes in interest rates and the availability of credit. Demographic,
geographic or other changes in one or more of MeriStar's markets could impact
the convenience or desirability of the sites of certain hotels, which would in
turn affect the operations of those hotels. In addition, due to the level of
fixed costs required to operate full-service hotels, certain significant
expenditures necessary for the operation of hotels generally cannot be reduced
when circumstances cause a reduction in revenue.
These factors could adversely affect the ability of OpCo to generate revenues
and make lease payments to MeriStar and, therefore, MeriStar's ability to make
distributions to its stockholders.
SEASONALITY
The lodging industry is seasonal in nature. Generally, hotel revenues are
greater in the second and third quarters than in the first and fourth quarters
although this may not be true for hotels in major tourist destinations. Revenues
for hotels in tourist areas generally are substantially greater during tourist
season than other times of the year. Seasonal variations in revenue at the
MeriStar Owned Hotels can be expected to cause quarterly fluctuations in the
lease revenues of MeriStar. Quarterly earnings also may be adversely affected by
events beyond MeriStar's control, such as extreme weather conditions, economic
factors and other considerations affecting travel.
FRANCHISE AGREEMENTS
Upon completion of the Merger, 103 of the MeriStar Owned Hotels will be
operated pursuant to existing franchise or license agreements with nationally
recognized hotel companies (the "Franchise Agreements"). The Franchise
Agreements generally contain specific standards for, and restrictions and
limitations on, the operation and maintenance of a hotel in order to maintain
uniformity within the franchisor system. Those limitations may conflict with
MeriStar's and OpCo's philosophy of creating specific business plans tailored to
each hotel and to each market. Such standards are often subject to change over
time, in some cases at the discretion of the franchisor, and may restrict a
franchisee's ability to make improvements or modifications to a hotel without
the consent of the franchisor. In addition, compliance with such standards could
require a franchisee to incur significant expenses or capital expenditures.
Action or inaction on the part of any of MeriStar, OpCo or third-party operators
could result in a breach of such standards or other terms and conditions of the
franchise agreements and could result in the loss or cancellation of a franchise
license.
In connection with terminating or changing the franchise affiliation of a
MeriStar Owned Hotel or a subsequently acquired hotel, OpCo may be required to
incur significant expenses or capital expenditures. Moreover, the loss of a
franchise license could have a material adverse effect upon the operations or
the underlying value of the hotel covered by the franchise because of the loss
of associated name recognition, marketing support and centralized reservation
systems provided by the franchisor. The Franchise Agreements covering the
MeriStar Owned Hotels
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expire or terminate, without specified renewal rights, at various times and have
differing remaining terms. As a condition to renewal, the Franchise Agreements
frequently contemplate a renewal application process, which may require
substantial capital improvements to be made to the hotel.
Under their existing Franchise Agreements, the Company and CapStar may be
required to obtain the consent of the franchisors under such agreements to
consummate the transactions contemplated by the Merger Agreement (the
"Transactions"). There can be no assurance that these consents will be obtained.
ADVERSE EFFECTS OF NECESSARY OPERATING COSTS AND CAPITAL EXPENDITURES
Hotels in general, including the MeriStar Owned Hotels, require ongoing
renovations and other capital improvements, including periodic replacement or
refurbishment of furniture, fixture and equipment ("FF&E"). Under the terms of
the Participating Leases, MeriStar is obligated to establish a reserve to pay
the cost of certain capital expenditures at the MeriStar Owned Hotels and pay
for periodic replacement or refurbishment of FF&E. MeriStar controls the use of
funds in this reserve. However, if capital expenditures exceed MeriStar's
expectations, there can be no assurance that sufficient sources of financing
will be available to fund such expenditures. The additional cost of such
expenditures could have an adverse effect on cash available for distribution. In
addition, MeriStar may acquire hotels in the future that require significant
renovation. Renovation of hotels involves certain risks, including the
possibility of environmental problems, construction cost overruns and delays,
uncertainties as to market demand or deterioration in market demand after
commencement of renovation and the emergence of unanticipated competition from
other hotels.
COMPETITION IN THE LODGING INDUSTRY
The lodging industry is highly competitive. There is no single competitor or
small number of competitors of MeriStar that will be dominant in the industry.
The MeriStar Owned Hotels will operate in areas that contain numerous
competitors, some of which have substantially greater resources than MeriStar
and the ability to accept more risk than MeriStar will be able to manage.
Competition in the lodging industry is based generally on location, room rates
and range and quality of services and guest amenities offered. New or existing
competitors could significantly lower rates or offer greater conveniences,
services or amenities or significantly expand, improve or introduce new
facilities in markets in which the MeriStar Owned Hotels will compete, thereby
adversely affecting MeriStar's operations and the number of suitable investment
opportunities.
In addition, the success of the MeriStar Owned Hotels and any hotel acquired
in the future is dependent on the supply/demand fundamentals in their respective
markets. According to Smith Travel Research, total room supply in the United
States increased by 3.4%, or approximately 116,000 rooms from 1996 to 1997. This
is compared to an average annual increase in room supply in the United States of
1.1% from 1991 to 1996. Although management believes that most of the increase
in room supply in the United States is in the limited service or extended stay
sections of the industry (which constitute approximately 2% of MeriStar Owned
Hotels based upon the number of guest rooms), it is possible that a dramatic
increase in the supply of full service midscale and lower upscale hotels could
occur. Any significant increase in the supply of full service hotel rooms in the
markets where the MeriStar Owned Hotels are located that outpaces the growth in
demand in such markets could have a material adverse effect on occupancy, ADR
and REVPAR at such hotels or at hotels acquired in the future.
POTENTIAL COSTS OF COMPLIANCE WITH ENVIRONMENTAL LAWS
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. In addition, the presence of contamination from
hazardous or toxic substances, or the failure to properly remediate such
contaminated property, may adversely affect the owner's ability to sell or rent
such real property or to borrow using such real 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. The operation and removal of certain
underground storage tanks are also regulated by federal and state laws. In
connection with the ownership and operation of the hotels, MeriStar could be
held liable for the costs of remedial action with respect to such regulated
substances and storage tanks and claims related thereto. Activities have been
undertaken to close or remove storage tanks located on the property of several
of the MeriStar Owned Hotels.
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All of the MeriStar Owned Hotels have undergone Phase I environmental site
assessments ("Phase Is"), which generally provide a nonintrusive physical
inspection and database search, but not soil or groundwater analyses, by a
qualified independent environmental engineer, within the last 18 months. The
purpose of a Phase I is to identify potential sources of contamination for which
the MeriStar Owned Hotels may be responsible and to assess the status of
environmental regulatory compliance. The Phase Is have not revealed any
environmental liability or compliance concerns that MeriStar believes would have
a material adverse effect on MeriStar's results of operation or financial
condition, nor is MeriStar aware of any such liability or concerns.
In addition, the MeriStar Owned Hotels have been inspected to determine the
presence of asbestos. Federal, state and local environmental laws, ordinances
and regulations also require abatement or removal of certain asbestos-containing
materials ("ACMs") and govern emissions of and exposure to asbestos fibers in
the air. ACMs are present in various building materials such as sprayed-on
ceiling treatments, roofing materials or floor tiles at some of the MeriStar
Owned Hotels. Operations and maintenance programs for maintaining such ACMs have
been or are in the process of being designed and implemented, or the ACMs have
been scheduled to be or have been abated, at such hotels. Any liability
resulting from non-compliance or other claims relating to environmental matters
could have a material adverse effect on MeriStar's results of operations or
financial condition.
GOVERNMENTAL REGULATION
A number of states regulate the licensing of hotels and restaurants, including
liquor license grants, by requiring registration, disclosure statements and
compliance with specific standards of conduct. MeriStar believes that it is
substantially in compliance with these requirements. Managers of hotels are also
subject to laws governing their relationship with hotel employees, including
minimum wage requirements, overtime, working conditions and work permit
requirements. Compliance with, or changes in, these laws could reduce the
revenue and profitability of the MeriStar Owned Hotels and could otherwise
adversely affect MeriStar's results of operations or financial condition.
Under the Americans with Disabilities Act (the "ADA"), all public
accommodations are required to meet certain requirements related to access and
use by disabled persons. These requirements became effective in 1992. Although
significant amounts have been and continue to be invested in ADA required
upgrades to the MeriStar Owned Hotels, a determination that MeriStar is not in
compliance with the ADA could result in a judicial order requiring compliance,
imposition of fines or an award of damages to private litigants. MeriStar is
likely to incur additional costs of complying with the ADA.
INVESTMENT IN SINGLE INDUSTRY
MeriStar's current strategy is to acquire interests only in hospitality and
lodging. As a result, MeriStar will be subject to risks inherent in investments
in a single industry. The effects on cash available for distribution resulting
from a downturn in the hotel industry may be more pronounced than if MeriStar
had diversified its investments.
ADVERSE EFFECTS RELATING TO THE OWNERSHIP OF REAL ESTATE
GENERAL
Upon consummation of the Merger, MeriStar will continue the businesses
previously undertaken separately by the Company and CapStar of owning, operating
and acquiring hotels. The business risks to be faced by MeriStar will be similar
to those now faced separately by the Company and CapStar. MeriStar's strategy to
acquire interests only in hotels will be subject to varying degrees of risk
generally incident to the ownership of real property and investment in a single
industry. The underlying value of MeriStar's hotel investments and MeriStar's
income and ability to make distributions to its stockholders will be dependent
upon the ability of OpCo or any third-party operators to operate the hotels in a
manner sufficient to maintain or increase revenues and to generate sufficient
revenue in excess of operating expenses to make lease payments to MeriStar.
Income from the hotels may be adversely affected by changes in national,
regional and local economic conditions, changes in local real estate market
conditions, changes in interest rates and in the availability, cost and terms of
financing, the potential for uninsured casualty or other losses, 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 and adverse changes in zoning laws and other
governmental rules and fiscal policies. Many of these risks are beyond the
control of MeriStar, and the effects of these risks are likely to be more
pronounced than if MeriStar had diversified investments. In addition, real
estate investments are relatively illiquid, resulting in a limited ability of
MeriStar to vary its portfolio of hotels in response to changes in economic and
other conditions.
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VALUE AND ILLIQUIDITY OF REAL ESTATE
Real estate investments are relatively illiquid. The ability of MeriStar to
vary its portfolio in response to changes in economic and other conditions will
be limited. If MeriStar must sell an investment, there can be no assurance that
MeriStar will be able to dispose of it in the time period it desires or that the
sale price of any investment will recoup or exceed the amount of MeriStar's
investment.
COMPETITION FOR EXPANSION OPPORTUNITIES
MeriStar will compete for the acquisition of hotels with entities that have
substantially greater financial resources than MeriStar. MeriStar believes that,
as a result of the downturn experienced by the lodging industry from the late
1980s through the early 1990s and the significant number of foreclosures and
bankruptcies created thereby, the prices for many hotels have for several years
been at historically low levels and often well below the cost to build new
hotels. The economic recovery in the lodging industry and the resulting increase
in funds available for hotel acquisitions may cause additional investors to
enter the hotel acquisition market, which may in turn cause hotel acquisition
costs to increase and the number of attractive hotel acquisition opportunities
to decrease.
CONSENT OF GROUND LESSOR REQUIRED FOR SALE AND RENOVATION OF CERTAIN HOTELS
Certain of MeriStar's hotels will be subject to ground leases, space leases
and a bay bottom lease for certain offshore property. In addition, MeriStar may
acquire hotels in the future that are subject to ground leases. Any proposed
sale of such hotels by MeriStar or any proposed assignment of MeriStar's
leasehold interest in the ground leases, space leases and bay bottom lease, as
well as subletting, may require the consent of the respective third-party
lessors. Upon consummation of the Merger, there can be no assurance that
MeriStar will be able to obtain such requisite consents. As a result, MeriStar
may not be able to sell, assign, transfer or convey its interest in any such
property in the future absent the consent of such third parties, even if such
transaction may be in the best interests of the stockholders of MeriStar.
Under certain of their existing ground leases and mortgages, the Company and
CapStar will be required to obtain the consent of third parties to consummate
the Transactions. Although the Company and CapStar expect to obtain such
consents, there can be no assurance that they will be obtained.
REIT TAX RISKS
DEPENDENCE ON QUALIFICATION AS A REIT
The Company has and MeriStar intends to operate in a manner designed to permit
it to qualify as a REIT for federal income tax purposes. Qualification as a REIT
involves the application of highly technical and complex provisions of the Code,
for which there are only limited judicial or administrative interpretations.
The determination of various factual matters and circumstances not entirely
within MeriStar's control may affect its ability to continue to qualify as a
REIT. The complexity of these provisions and of the applicable income tax
regulations that have been promulgated under the Code is greater in the case of
a REIT that holds its assets through a partnership, such as MeriStar. Moreover,
no assurance can be given that legislation, new regulations, administrative
interpretations or court decisions will not change the tax laws with respect to
qualification as a REIT or the federal income tax consequences of such
qualification. the Company and CapStar will receive an opinion of Battle Fowler
LLP, counsel to the Company and MeriStar, to the effect that, based on various
assumptions relating to the operation of the Company and CapStar and
representations made by the Company and CapStar as to certain factual matters,
commencing with the taxable year ending December 31, 1998, the Company has been
organized and has operated in conformity with the requirements for qualification
as a REIT within the meaning of the Code and the proposed method of operation of
MeriStar, including, without limitation, the consummation of the Transactions,
will enable MeriStar to continue to meet the requirements for qualification and
taxation as a REIT under the Code. Such legal opinion is not binding on the
Internal Revenue Service (the "IRS").
If MeriStar and OpCo were treated as stapled entities under Section 269B(a)(3)
of the Code or if the separate corporate existence of OpCo were disregarded or
OpCo were treated as an agent of MeriStar for federal income tax purposes,
MeriStar would not qualify as a REIT under the Code. The Company and CapStar
will receive an opinion of counsel to the effect that MeriStar and OpCo will not
be treated as stapled entities under Section 269B(a)(3) of the Code and that,
based upon the intended operations of each entity and certain other factors and
upon
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representations made by certain persons who will be members of management of
MeriStar and OpCo, the separate corporate identities of MeriStar and OpCo will
be respected and OpCo will not be treated as an agent of MeriStar for federal
income tax purposes.
If MeriStar fails to qualify as a REIT in any taxable year, MeriStar will not
be allowed a deduction for distributions to its stockholders in computing its
taxable income and will be subject to federal income tax (including any
applicable alternative minimum tax) on its taxable income at the applicable
corporate rate. In addition, unless it were entitled to relief under certain
statutory provisions, MeriStar would be disqualified from treatment as a REIT
for the four taxable years following the year during which qualification is
lost. This disqualification would reduce the funds of MeriStar available for
investment or distribution to stockholders because of the additional tax
liability of MeriStar for the year or years involved.
If MeriStar were to fail to qualify as a REIT, it no longer would be subject
to the distribution requirements of the Code and, to the extent that
distributions to stockholders would have been made in anticipation of MeriStar's
qualifying as a REIT, MeriStar might be required to borrow funds or to liquidate
certain of its assets to pay the applicable corporate income tax. Although
MeriStar currently operates in a manner designed to qualify as a REIT, it is
possible that future economic, market, legal, tax or other considerations may
cause the MeriStar Board to decide to revoke the REIT election.
ADVERSE EFFECTS OF REIT MINIMUM DISTRIBUTION REQUIREMENTS
To obtain the favorable tax treatment accorded to REITs under the Code,
MeriStar generally will be required each year to distribute to its stockholders
at least 95% of its REIT taxable income. MeriStar will be subject to income tax
on any undistributed REIT taxable income and net capital gain, and 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 for the calendar year, (ii) 95% of its capital gain net
income for such year, and (iii) 100% of its undistributed income from prior
years. The requirement to distribute a substantial portion of MeriStar's net
taxable income could cause MeriStar to distribute amounts that otherwise would
be spent on future acquisitions, unanticipated capital expenditures or repayment
of debt, which would require MeriStar to borrow funds or to sell assets to fund
the costs of such items.
MeriStar intends to make distributions to its stockholders to comply with the
distribution provisions of the Code and generally to avoid federal income taxes
and the nondeductible 4% excise tax. MeriStar's income will consist primarily of
its share of the income of MeriStar OP, and MeriStar's cash flow will consist
primarily of its share of distributions from MeriStar OP. Differences in timing
between the receipt of income and the payment of expenses in arriving at taxable
income (of MeriStar or MeriStar OP) and the effect of nondeductible capital
expenditures, the creation of reserves or required debt amortization payments
could in the future require MeriStar to borrow funds directly or through
MeriStar OP on a short- or long-term basis to meet the distribution requirements
that are necessary to continue to qualify as a REIT and avoid federal income
taxes and the 4% nondeductible excise tax. In such circumstances, MeriStar might
need to borrow funds directly in order to avoid adverse tax consequences even if
management believes that the then prevailing market conditions generally are not
favorable for such borrowings or that such borrowings are not advisable in the
absence of such tax considerations.
Distributions by MeriStar OP will be determined by its sole general partner, a
wholly owned subsidiary of MeriStar, and are dependent on a number of factors,
including the amount of cash available for distribution, MeriStar OP's financial
condition, any decision by the MeriStar Board to reinvest funds rather than to
distribute such funds, MeriStar OP's capital expenditure requirements, the
annual distribution requirements under the REIT provisions of the Code and such
other factors as the MeriStar Board deems relevant. Accordingly, although
MeriStar intends to continue to satisfy the annual distribution requirement so
as to avoid corporate income taxation on the earnings that it distributes, there
can be no assurance that it will be able to do so.
CONSEQUENCES OF FAILURE TO QUALIFY AS PARTNERSHIPS
The Company and CapStar will receive an opinion of Battle Fowler LLP, counsel
to the Company and MeriStar, stating that, based upon the provisions of the form
of partnership agreement of the MeriStar OP and on certain factual assumptions
and representations, including the assumption that the MeriStar OP partnership
agreement will contain provisions to ensure that in the event that the MeriStar
OP is a publicly traded partnership it will be eligible for treatment as a
partnership for federal income tax purposes the Operating Partnership and its
subsidiary partnerships have been and continue to be, and giving effect to the
Transactions, the MeriStar OP and each of its subsidiary partnerships will be
treated as partnerships, and not as corporations, for federal income tax
purposes. Such opinion
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is not binding on the IRS. If the IRS were successfully to determine that any
such partnership is properly treated as a corporation, MeriStar would cease to
qualify as a REIT for federal income tax purposes. The imposition of a corporate
tax on MeriStar OP or any of the subsidiary partnerships, with a concomitant
loss of REIT status of MeriStar, would substantially reduce the amount of cash
available for distribution.
POSSIBLE FEDERAL TAX DEVELOPMENTS
If the Merger is consummated after December 31, 1998, certain proposed
legislation applicable to REITs would require CapStar to recognize taxable gain
equal to the excess of the fair market value of its assets transferred to
MeriStar in the Merger over its tax basis in such assets as of the date
preceding the date of such transfer.
RISK OF IRS RECHARACTERIZATION OF THE SPIN-OFF AND THE RIGHTS OFFERING
It is possible that the IRS could successfully assert that the distributions
of the OpCo Common Stock in the Spin-Off and the distribution of rights in the
rights offering to holders of CapStar Common Stock should be treated as
distributions of property subject to the rules governing dividend distributions,
rather than as boot received by such stockholders in the Merger. In such event,
an amount equal to the fair market value of the OpCo Common Stock and the rights
on the date of distribution would be treated as a dividend to holders of CapStar
Common Stock to the extent of the current and accumulated earnings and profits
of CapStar on such date, including earnings and profits resulting from such
distributions. Any amount in excess of the earnings and profits of CapStar would
be treated first as a tax-free return of capital, reducing the stockholder's tax
basis in its CapStar Common Stock, and any amount in excess of tax basis would
be taxable as a capital gain from the sale or exchange of such stockholder's
shares of CapStar Common Stock. Such gain would be capital gain if such
stockholder's shares of CapStar Common Stock were held as a capital asset on the
date of distribution.
PAPER-CLIP STRUCTURE RISKS
Pursuant to the Intercompany Agreement, MeriStar and OpCo will provide each
other with reciprocal rights to participate in certain transactions entered into
by such parties. In particular, subject to certain exceptions, OpCo will have a
right of first refusal to become the lessee of any real property acquired by
MeriStar if MeriStar determines that, consistent with MeriStar's status as a
real estate investment trust, MeriStar is required to enter into such a lease
arrangement; provided that OpCo or an entity that OpCo controls is, as
determined by MeriStar in its sole discretion, qualified to be the lessee. This
is known as the "paper-clip" REIT structure. However, because of the independent
trading of MeriStar and OpCo, stockholders in each company may develop divergent
interests which could lead to conflicts of interest. This divergence of
interests could also reduce the anticipated benefits of the "paper-clip" REIT
structure.
DEPENDENCE ON KEY PERSONNEL
Upon consummation of the Merger, MeriStar and OpCo will place substantial
reliance on the lodging industry knowledge and experience and the continued
services of both the Company and CapStar senior management, led by Messrs.
Whetsell and Jorns. MeriStar's future success and its ability to manage future
growth depend in large part upon the efforts of these persons and on MeriStar's
ability to attract and retain other highly qualified personnel. Competition for
such personnel is intense, and there can be no assurance that MeriStar will be
successful in attracting and retaining such personnel. MeriStar's inability to
attract and retain other highly qualified personnel may adversely affect the
results of operations and financial condition. MeriStar and OpCo will have
employment agreements with Messrs. Whetsell and Jorns for initial terms of five
years with automatic renewals on a year-to-year basis thereafter, unless
terminated in accordance with their terms.
POSSIBLE ADVERSE EFFECTS ON MARKET PRICE OF MERISTAR COMMON STOCK
ARISING FROM SHARES AVAILABLE FOR FUTURE SALE
No prediction can be made as to the effect, if any, that any future sales of
shares, or the availability of shares for future sale, will have on the market
prices for MeriStar Common Stock following the Merger. Sales of substantial
amounts of MeriStar Common Stock (including MeriStar Common Stock issued in
connection with outstanding stock options or the exchange or sale of units of
limited partner interest ("MeriStar OP Units") in the MeriStar OP) or the
perception that such sales could occur could adversely affect the prevailing
market price for MeriStar Common
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Stock. With the exception of the MeriStar Common Stock issued to affiliates of
MeriStar and CapStar in connection with the Merger, all of the MeriStar Common
Stock to be issued to holders of Common Stock or CapStar Common Stock in
connection with the Merger will be freely transferable, except as otherwise
restricted by the Company's Charter.
ADVERSE EFFECT OF INCREASE IN MARKET INTEREST RATES ON PRICES FOR MERISTAR
COMMON STOCK
One of the factors that may influence the prices for the MeriStar Common Stock
in public trading markets will be the annual yield from distributions by
MeriStar on the MeriStar Common Stock as compared to yields on certain financial
instruments. An increase in market interest rates will result in higher yields
on certain financial instruments, which could adversely affect the market prices
for the MeriStar Common Stock.
ABSENCE OF A PUBLIC MARKET FOR OPCO COMMON STOCK
There is currently no public market for OpCo Common Stock. Application has
been made to list the OpCo Common Stock on the NYSE. There can be no assurance
as to the prices at which trading in OpCo Common Stock will occur after the
Spin-Off or that an active trading market in the OpCo Common Stock will develop
or be sustained in the future. In the event no active trading market develops
for the OpCo Common Stock, holders of shares of OpCo Common Stock may not be
able to sell their shares promptly at a reasonable price. Accordingly, holders
of OpCo Common Stock should consider the OpCo Common Stock a long-term
investment.
The prices at which the OpCo Common Stock trades will be determined by the
marketplace and may be influenced by many factors, including, among others,
MeriStar's and OpCo's performance and prospects, the depth and liquidity of the
market for the OpCo Common Stock, investor perception of MeriStar, OpCo and of
the hotel industry in which MeriStar and OpCo operate, economic conditions in
general, OpCo's dividend policy, and general financial and other market
conditions. Such volatility and other factors may materially adversely affect
the market price of the OpCo Common Stock.
POTENTIAL ANTI-TAKEOVER EFFECT OF CERTAIN PROVISIONS OF MARYLAND LAW AND OF THE
MERISTAR CHARTER AND MERISTAR BYLAWS
Certain provisions of Maryland law and of the MeriStar Charter and the
MeriStar Bylaws may have the effect of discouraging a third party from making an
acquisition proposal for MeriStar and could delay, defer or prevent a change in
control of MeriStar or other transaction under circumstances that could give the
holders of MeriStar Common Stock the opportunity to realize a premium over the
then-prevailing market prices of the MeriStar Common Stock. Such provisions
include the following:
OWNERSHIP LIMITATION
In order for MeriStar to maintain its qualification as a REIT under the Code,
not more than 50% in value of the outstanding shares of stock of MeriStar may be
owned, directly or indirectly, by five or fewer individuals (as defined in the
Code to include certain entities) at any time during the last half of MeriStar's
taxable year. Furthermore, if any stockholder of MeriStar owns, actually or
constructively, 10% or more of OpCo, OpCo could become a related party tenant of
MeriStar, which would result in loss of REIT status for MeriStar. The MeriStar
Charter prohibits direct or indirect ownership (taking into account applicable
ownership provisions of the Code) of more than 9.8% of any class of MeriStar's
outstanding stock by any person (the "Ownership Limitation"), subject to an
exception that permits mutual funds and certain other entities to own as much as
15% of any class of MeriStar's stock in appropriate circumstances (the "Look-
Through Ownership Limitation"). Generally, the stock owned by affiliated owners
will be aggregated for purposes of the Ownership Limitation. In addition, the
MeriStar Charter prohibits a stockholder of MeriStar from owning MeriStar Common
Stock if such ownership would cause MeriStar to own, actually or constructively,
10% or more of the ownership interests in a tenant of MeriStar's, the MeriStar
OP's or a subsidiary partnership's real property. The Ownership Limitation could
have the effect of delaying, deferring or preventing a change in control of
MeriStar or other transaction in which holders of some or a majority of the
MeriStar Common Stock might receive a premium for their MeriStar Common Stock
over the then-prevailing market price or which such holders might believe to be
otherwise in their best interests.
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<PAGE>
STAGGERED BOARD
The MeriStar Board will be divided into three classes of directors. The
initial term of the first class expired in 1997 and the current term of such
class expires in 2000, and the initial terms of the second and third classes
will expire in 1998, and 1999, respectively. Directors of each class will be
elected for three-year terms upon the expiration of the current class terms,
and, beginning in 1999 and each year thereafter, one class of directors will be
elected by the stockholders. A director may be removed, with or without cause,
by the affirmative vote of 75% of the votes entitled to be cast for the election
of directors, which super-majority vote may have the effect of delaying,
deferring or preventing a change in control of MeriStar or other transaction
even though a change in control might be in the best interests of the
stockholders of MeriStar.
MARYLAND BUSINESS COMBINATION STATUTE
Under the MGCL, certain "business combinations" (including certain issuances
of equity securities) between a Maryland corporation such as MeriStar and any
person who owns 10% or more of the voting power of the corporation's shares (an
"Interested Stockholder") or an affiliate thereof are prohibited for five years
after the most recent date on which the Interested Stockholder became an
Interested Stockholder. Thereafter, any such business combination must be
approved by two super-majority votes unless, among other conditions, the holders
of shares of MeriStar Common Stock receive a minimum price (as defined in the
MGCL) for their stock and the consideration is received in cash or in the same
form as previously paid by the Interested Stockholder for its shares.
MARYLAND CONTROL SHARE ACQUISITION STATUTE
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 eligible under the statute to be
cast on the matter. "Control shares" are voting shares of stock, which, if
aggregated with all other such shares of stock 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
of all voting power. Control shares do not include shares that the acquiring
person is then entitled to vote as a result of having previously obtained
stockholder approval. A "control share acquisition" means the acquisition of
control shares, subject to certain exceptions.
The MeriStar bylaws contain a provision exempting from the control share
acquisition statute any and all acquisitions by any persons of shares of stock
of MeriStar. There can be no assurance that such provision will not be amended
or eliminated at any point in the future. If the foregoing exemption in the
MeriStar Bylaws is rescinded, the control share acquisition statute could have
the effect of delaying, deferring, preventing or otherwise discouraging offers
to acquire MeriStar and of increasing the difficulty of consummating any such
offer.
ISSUANCE OF ADDITIONAL SHARES
Upon stockholder approval of the amendment and restatement of the Company's
Charter (which upon approval will become the MeriStar Charter), the MeriStar
Charter will authorize the MeriStar Board, without a vote of the stockholders,
to (i) amend the MeriStar Charter to increase or decrease the aggregate number
of shares of any class that MeriStar has the authority to issue; provided that
House Bill 360, or a similar bill, is ratified, (ii) cause MeriStar to issue
additional authorized but unissued shares of MeriStar Common Stock or MeriStar
preferred stock (the "MeriStar Preferred Stock"), and (iii) classify any
unissued shares of MeriStar Preferred Stock and to set the preferences, rights
and other terms of such classified or unclassified shares. Although there is no
such intention at the present time, the MeriStar Board could establish a series
of MeriStar Preferred Stock that could, depending on the terms of such series,
adversely affect the voting power of the holders of MeriStar Common Stock and
could delay, defer or prevent a change in control of MeriStar or other
transaction that might involve a premium price for the MeriStar Common Stock or
otherwise be in the best interest of the stockholders. The MeriStar Charter and
MeriStar Bylaws will also contain other provisions that may have the effect of
delaying, deferring or preventing a change in control of MeriStar or other
transaction that might involve a premium price for the MeriStar Common Stock or
otherwise be in the best interest of the stockholders.
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<PAGE>
ABILITY OF MERISTAR BOARD TO CHANGE POLICIES
The major policies of MeriStar, including its policies with respect to
acquisitions, financing, growth, operations, debt capitalization and
distributions, will be determined by the MeriStar Board. The MeriStar Board may
amend or revise these and other policies at any time and from time to time at
its discretion without a vote of the stockholders of MeriStar.
RESTRICTIONS RELATING TO ALTERNATIVE TRANSACTIONS
Subject to certain limited exceptions, the Company and CapStar have agreed
under the Merger Agreement that each will not, nor permit their respective
subsidiaries, officers, directors, agents or representatives, to (i) solicit,
initiate or encourage the submission of any proposal, other than by the other
party, for a merger, consolidation, share exchange, business combination or
other similar transaction or any proposal or offer, other than by the other
party, to acquire, directly or indirectly, more than a 10% equity interest in
any voting securities of, or 10% or more of the consolidated assets of, CapStar
or the Company, as the case may be, (ii) enter into any agreement with respect
to such transactions, or (iii) participate in any discussions or negotiations,
or provide any information, regarding such transactions, or take any other
action to facilitate such transactions. Notwithstanding the foregoing, upon
appropriate board of director action, the board of directors of CapStar and the
Company, to the extent required by Delaware law or Maryland law, as the case may
be, may in response to certain unsolicited requests for such a transaction,
participate in discussions or negotiations with any person or entity that makes
a proposal regarding such a transaction. In addition, if either the Company or
CapStar enters into an acquisition agreement with a third party, under certain
circumstances such contracting party shall be required to pay to the other party
a break-up fee in the amount of $35.0 million plus an expense reimbursement
equal to the lesser of (i) $3.0 million and (ii) such party's actual out-of-
pocket expenses. The non-solicitation covenant, together with the requirement to
pay break-up fees and break-up expenses, could have the effect of deterring
other potential acquirors from making competing offers for CapStar or the
Company, including certain offers that may be more favorable to the stockholders
of CapStar or the Company.
DIFFERENCES IN STOCKHOLDER RIGHTS OF MERISTAR AND CAPSTAR STOCKHOLDERS
As a result of the Merger, CapStar stockholders will no longer own shares of
CapStar and will become stockholders of MeriStar. While CapStar is a Delaware
corporation, MeriStar will be a Maryland corporation, and the different laws
governing the two corporations, together with differences in the provisions of
the respective corporate charters and bylaws of MeriStar and CapStar, result in
differences in the rights of stockholders of the two corporations. As a result
of these differences, the rights of MeriStar stockholders may in some cases be
considered less favorable than the rights of CapStar stockholders.
RISKS FACTORS UPDATING THE BASE PROSPECTUS
RISKS ASSOCIATED WITH THE COMPANY'S ACQUISITION OF A SUBSTANTIAL NUMBER OF
ADDITIONAL HOTELS
As part of its ongoing business, the Company continuously seeks opportunities
to acquire additional hotel properties. Currently, the Company is experiencing
a period of rapid growth. As of July 1, 1998, since the Company's IPO, the
Company has spent approximately $863 million to purchase 40 additional hotels,
increasing its guest room portfolio by more than 300%. The Company's ability to
manage its growth effectively will require it to select companies to lease and
manage newly acquired hotels. There can be no assurance that the Company, the
Lessee, AGHI or other hotel management companies and/or operators will be able
to manage the Company's newly acquired or subsequently acquired hotels
effectively.
DEPENDENCE ON LESSEES AND PAYMENTS UNDER THE PARTICIPATING LEASES
The Company's revenues and its ability to make distributions to its
stockholders depends solely upon the ability of the Lessees to make rent
payments under the Participating Leases. Any failure or delay by any Lessee in
making such rent payments would adversely affect the Company's ability to make
distributions to its stockholders. Such failure or delay by the Lessees may be
caused by reductions in revenue from the Company hotels they lease or in the net
operating income of the Lessees or otherwise. AGH Leasing experienced net
losses for the year ended December 31, 1996 and 1997 of $721,039 and $1,450,855,
respectively. AGH Leasing generated positive net cash flow from operations
during the same periods, and recognized taxable income of $70,090 for its 1996
taxable year and $50,000 for its 1997 taxable year. However, there can be no
assurance that AGH Leasing will not experience
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<PAGE>
net losses in the future or that it will be able to fund its lease obligations
to the Company. In addition, in connection with the lease of one of the
Company's hotels, AGH Leasing has received cash flow guarantee payments in 1996
and 1997 of approximately $730,000 and $1,370,000 respectively; however,
pursuant to the terms of such guarantee agreements such payments have ceased.
AGH Leasing is a recently organized limited purpose entity; accordingly, it has
limited net assets and net worth at March 31, 1998 of approximately $1,357,136.
The partners of AGH Leasing, L.P. have pledged 275,000 OP Units to the Company
which, as of July 7, 1998, have a value of approximately $6.3 million, to secure
AGH Leasing's obligations under the Participating Leases (the "AGH Lessee
Pledge"). The Prime Lessee is a newly formed entity and, pursuant to the
Participating Leases with the Company, is required to maintain a minimum net
worth of $3.4 million through the end of 1998, and thereafter an amount equal to
17.5% of the prior year's rent under the Participating Leases in the form of
cash, marketable securities and/or letter(s) of credit or any combination
thereof. Although failure on the part of either AGH Leasing or the Prime Lessee
to materially comply with the terms of a Participating Lease (including failure
to pay rent when due) gives the Company the non-exclusive right to terminate
such lease, repossess the applicable hotel and enforce the payment obligations
under such lease and, in the case of AGH Leasing, in order to enforce the
payment obligations under the AGH Lessee Pledge, the Company would then be
required to find another lessee to lease such hotel because the Company cannot
operate hotels directly due to certain federal income tax restrictions. In
addition, it is possible that, except for the AGH Lessee Pledge, the Company
will be unable to enforce the payment obligations under the leases following any
such termination. There can be no assurance that the Company would be able to
find another lessee or that, if another lessee were found, the Company would be
able to enter into a new lease on favorable terms.
RISKS OF LEVERAGE; NO LIMITS ON INDEBTEDNESS
Neither the Company's Bylaws nor its charter (the "Charter") limits the amount
of indebtedness the Company may incur. As a result of incurring debt, the
Company is subject to risks normally associated with debt financing, including
the risks (i) that revenues from the Participating Leases will be insufficient
to meet required payments of principal and interest and (ii) that existing debt
may not be refinanced or that the terms of any refinancing will not be as
favorable as the terms of existing debt. As of July 7, 1998, the Company had
total outstanding indebtedness of approximately $506.2 million. Although the
Company anticipates that it will be able to repay or refinance its existing
indebtedness and any other indebtedness, there can be no assurance that it will
be able to do so or that the terms of such refinancing will be favorable to the
Company. If the Company is unable to refinance its indebtedness on acceptable
terms, it might be forced to dispose of properties or other assets on
disadvantageous terms, potentially resulting in losses and adverse effects on
cash flow from operating activities. If the Company is unable to make required
payments of principal and interest on indebtedness secured by certain of the
Hotels, such properties could be foreclosed upon by the lender with a consequent
loss of income and asset value to the Company.
RISK OF RISING INTEREST RATES
The Company's borrowings under its line of credit bear interest at a variable
rate. Increases in interest rates could increase the Company's interest expense
and adversely affect cash flow.
RISKS FACTOR RELATING TO YEAR 2000 ISSUE
Many existing computer programs were designed and developed without
considering the impact of the upcoming change in the century. The problem
exists when a computer program uses only two digits to identify a year in the
date field. Extensive problems can result to a company's business, requiring
substantial resources to remedy. The Company believes that the "Year 2000"
problem is material to the Company's business and operations. Although the
Company is addressing the problem with respect to its business operations, there
can be no assurance that the "Year 2000" problem will be properly or timely
resolved, which could have a material adverse effect on the Company's results of
operations and, in turn, cash available for distribution.
S-18
<PAGE>
PRICE RANGE OF COMMON STOCK AND DISTRIBUTION POLICY
The Common Stock began trading on the NYSE on July 26, 1996 under the
symbol "AGT." On July 10, 1998, the last reported sale price per share of Common
Stock on the NYSE was $23 1/8 and there were 104 holders of record of Common
Stock. The following table sets forth the quarterly high and low closing sale
prices per share of Common Stock reported on the NYSE and the cash distributions
declared per share by the Company with respect to each such period.
<TABLE>
<CAPTION>
CASH
PRICE RANGE DISTRIBUTIONS
-----------
DECLARED
HIGH LOW PER SHARE
---- --- ---------
<S> <C> <C> <C>
1996
Third Quarter from July 26, 1996 ................................. $19 $17 1/2 $0.2476(1)
Fourth Quarter ................................................... 23 3/4 18 7/8 0.4075
1997
First Quarter .................................................... 28 3/8 23 1/8 0.4075
Second Quarter.................................................... 27 1/8 23 0.4075
Third Quarter .................................................... 29 1/4 24 1/4 0.4275
Fourth Quarter ................................................... 29 7/8 24 5/8 0.4275
1998
First Quarter .................................................... 28 1/2 26 1/2 0.4275
Second Quarter ................................................... 27 3/4 20 9/16 0.4275(2)
Third Quarter (through July 10, 1998) ............................. 23 1/2 21 5/16 (3)
</TABLE>
- --------------------
(1) Represents a pro rata distribution of the Company's initial quarterly
distribution of $0.4075 per share of Common Stock, based on a partial
calendar quarter beginning on July 31, 1996 (the closing date of the IPO)
through September 30, 1996.
(2) On June 17, 1998, the Company declared a distribution of $0.4275 per share
of Common Stock relating to the second quarter of 1998 that will be paid on
July 30, 1998 to the Company's stockholders of record as of June 30, 1998.
(3) Not yet declared.
Future distributions by the Company will be at the discretion of the Board
of Directors and will depend on the Company's financial condition, its capital
requirements, the annual distribution requirements under the REIT provisions of
the Code and such other factors as the Board of Directors deems relevant. There
can be no assurance that any such distributions will be made by the Company.
Distributions by the Company to the extent of its current and accumulated
earnings and profits for federal income tax purposes generally will be taxable
to stockholders as ordinary dividend income. Distributions in excess of current
and accumulated earnings and profits will be treated as a non-taxable reduction
of the stockholder's basis in its shares of Common Stock to the extent thereof,
and thereafter as taxable gain. Distributions that are treated as a reduction of
the stockholder's basis in its shares of Common Stock will have the effect of
deferring taxation until the sale of the stockholder's shares. The Company
estimates that, for federal income tax purposes, approximately 6.1% of the $1.67
per share distribution paid for 1997 represented a return of capital to its
stockholders. No assurances can be given regarding what portion of future
distributions will constitute return of capital for federal income tax purposes.
S-19
<PAGE>
CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
This discussion supplements the discussion set forth in the accompanying
Prospectus under the heading "Federal Income Tax Considerations." In the opinion
of Battle Fowler LLP, which is based on certain representations from the
Company, the Company qualified as a REIT under the Internal Revenue Code of
1986, as amended, for its taxable years ended December 31, 1996 and 1997 and the
Company's current and proposed method of operation will enable it to continue to
qualify as a REIT for its taxable year ending December 31, 1998 and in future
years. Investors should be aware, however, that opinions of counsel are not
binding upon the IRS or any court. It must be emphasized that Battle Fowler
LLP's opinion is based on various assumptions and is conditioned upon certain
representations made by the Company as to factual matters, including
representations regarding the nature of the Company's properties and the future
conduct of its business. Such factual assumptions and representations are set
out in the federal income tax opinion delivered by Battle Fowler LLP in
connection with the Registration Statement of which this Prospectus Supplement
and the accompanying Prospectus are a part. Battle Fowler LLP will not review
the Company's compliance with those tests on a continuing basis. Accordingly, no
assurance can be given that the actual results of the Company's operations for
any particular taxable year will satisfy such requirements. For a discussion of
the tax consequences of the failure to qualify as a REIT, see " Tax Risks --
Failure to Qualify as a REIT" in the accompanying Prospectus.
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<PAGE>
EXPERTS
The (a) Consolidated Financial Statements and financial statement schedule
of AGH as of December 31, 1997 and 1996, and for the year ended December 31,
1997 and for the period from July 31, 1996 through December 31, 1996, and (b)
the Financial Statements of AGH Leasing as of December 31, 1997 and 1996 and for
the year ended December 31, 1997 and for the period from July 31, 1996 through
December 31, 1996, included in the AGH Form 10-K (and the 10-K/A); (a) the
Financial Statements and financial statement schedule of the Chicago O'Hare
Hotel as of and for the year ended December 31, 1996, (b) the Combined Financial
Statements and financial statement schedule of the Potomac Acquisition Hotels as
of and for the year ended December 31, 1996, (c) the Combined Financial
Statements and financial statement schedule of the Prime Acquisition Hotels (as
defined therein) as of December 1995, and 1996 and for each of the three years
in the period ended December 31, 1996, and (d) the Combined Financial Statements
and financial statement schedule of the FSA Acquisition Hotels (as defined
therein) as of December 31, 1996 and September 30, 1997 and for the years ended
December 31, 1995 and 1996 and for the nine month period ended September 30,
1997, included in the AGH Report on Form 8-K dated January 8, 1998; and the
Combined and Combining Financial Statements and financial statement schedule of
the Prime Acquisition Hotels as of December 31, 1996, and 1997 and for each of
the three years in the period ended December 31, 1997, included on the AGH
Report on Form 8-K, dated April 6, 1998 and filed on April 7, 1998 (and the
8-K/A filed on May 22, 1998, June 5, 1998 and June 19, 1998), and the financial
statements of (a) AGH Leasing, L.P. as of December 31, 1997 and 1996 and for the
year ended December 31, 1997 and for the period from July 31, 1996 through
December 31, 1996, and (b) American General Hospitality, Inc. as of December 31,
1997 and 1996, and for each of the three years in the period ended December 31,
1997, included on the CapStar report on Form 8-K, dated and filed on April 7,
1998 (and the 8-K/A filed on May 22, 1998 and June 5, 1998), incorporated by
reference in the Registration Statement, of which the Prospectus forms a part,
have been audited by PricewaterhouseCoopers LLP, independent accounts, as set
forth in their reports thereon. Each of the above referenced financial
statements have been incorporated by reference herein in reliance upon the
authority of said firm as expert in accounting and auditing.
The consolidated financial statements and supplementary schedule of CapStar
Hotel Company and subsidiaries as of December 31, 1997 and 1996 and for each of
the years in the three-year period ended December 31, 1997, included in
CapStar's Annual Report on Form 10-K (and the Form 10-K/A filed on May 22, 1998)
and incorporated by reference herein, and the combined financial statements of
the management and leasing business of CapStar and its subsidiaries (OpCo) as of
December 31, 1997 and 1996 and for each of the years in the three-year period
ended December 31, 1997 included in CapStar's Current Report on Form 8-K dated
April 7, 1998 (and the related Form 8-K/A, dated May 22, 1998) and incorporated
by reference herein, and certain financial statements included in CapStar's
Current Reports on Form 8-K, dated August 1, 1997, September 5, 1997, September
9, 1997 and March 2, 1998 (and the related Form 8-K/A filed on May 6, 1998),
have been incorporated by reference in reliance on the reports of KPMG Peat
Marwick LLP, independent accountants, and on the authority of said firm as
experts in accounting and auditing. The financial statements of certain hotel
entities incorporated by reference herein and filed in CapStar's Current Reports
on Forms 8-K dated August 18, 1997, September 5, 1997, September 18, 1997,
September 22, 1997 and January 6, 1998, have been incorporated by reference in
reliance on reports of Pannel Kerr Forster PC, Pinsker, Goldberg, Ivanicki &
Apuzzo, Wertheim & Company, King Griffin & Adamson P.C., Mann Frankfort Stein &
Lipp, P.C. and PricewaterhouseCoopers LLP, independent accountants, and on the
authority of said firms as experts in accounting and auditing.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
In addition to the documents incorporated by reference in the accompanying
Prospectus, the following documents filed by the Company with the Commission are
incorporated herein by reference and made a part hereof:
1.The Company's Annual Report on Form 10-K and 10-K/A for the year ended
December 31, 1997, filed with the Commission pursuant to the Exchange Act;
and
2.The Company's Quarterly Report on Form 10-Q and 10-Q/A for the quarter
ended March 31, 1998, filed with the Commission pursuant to the Exchange
Act;
3.The Company's Current Reports on Form 8-K, dated January 8, 1998 and
filed on January 23, 1998; dated February 12, 1998 and filed on February
13, 1998; dated February 13, 1998 and filed on February 27, 1998; dated
February 18, 1998 and filed February 19, 1998; dated February 24, 1998 and
filed on February 25, 1998; dated March 15, 1998 and filed on March 1 7,
1998; dated April 6, 1998 and filed on April 7, 1998 (and the related
Current Reports on Form 8-K/A, filed on May 22, 1998, May 28, 1998, June 5,
1998 and June 19,
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<PAGE>
1998); dated April 22, 1998 and filed on April 27, 1998; and dated and
filed on June 5, 1998, filed with the Commission pursuant to the Exchange
Act.
4.Definitive proxy statement dated June 22, 1998.
All other documents filed by the Company pursuant to Section 13(a), 13(c),
14 or 15(d) of the Exchange Act subsequent to the date of this Prospectus
Supplement and prior to the termination of the Offering shall be deemed to be
incorporated by reference into this Prospectus Supplement and to be a part
hereof from the date of filing such documents. 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 Supplement
to the extent that a statement contained herein (or in the accompanying
Prospectus) or in any other document subsequently filed with the Commission
which also is deemed to be incorporated by reference herein modifies or
supersedes such statement. Any such statement so modified or superseded shall
not be deemed, except as so modified or superseded, to constitute a part of this
Prospectus Supplement or the accompanying Prospectus.
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<PAGE>
PROSPECTUS
---------------------------------
2,172,370 Shares
AMERICAN GENERAL HOSPITALITY CORPORATION
COMMON STOCK
American General Hospitality Corporation (collectively with its subsidiaries,
the "Company") is a self-administered real estate investment trust (a "REIT"),
organized as a corporation under the laws of Maryland, which owns hotels,
diversified by franchisor or brand affiliation, in several states (the
"Hotels"). The Company's Common Stock, $0.01 par value per share, (the "Common
Stock") is listed on the New York Stock Exchange, Inc. under the symbol "AGT."
Of the 2,172,370 shares of Common Stock offered hereby (i) 1,896,996 shares of
restricted Common Stock (the "Exchanged Shares") are being registered on account
of the holders ("Unitholders") of 1,896,996 units of limited partnership
interest ("OP Units") in American General Hospitality Operating Partnership,
L.P., a Delaware limited partnership (the "Operating Partnership"), which shares
have been, or may be acquired by such Unitholders upon exchange of their OP
Units for such shares of Common Stock; and (ii) 275,374 shares of restricted
Common Stock (the "Restricted Stock") are being registered for the account of
certain stockholders (the "Restricted Stockholders," and, together with the
Unitholders, the "Registering Stockholders"). 1,896,996 OP Units and 137,008
shares of Restricted Stock were issued, in connection with the initial public
offering of the Company (the "IPO) on July 31, 1996, in exchange for the
acquisition by the Company of equity interests in certain of the 13 initial
hotels (the "Initial Hotels"). 25,397 shares of the Restricted Stock were
issued in connection with the acquisition by the Company of the Wyndham(R) Royal
Safari Lake Buena Vista in Lake Buena Vista, Florida and 112,969 shares of the
Restricted Stock were issued pursuant to an alliance agreement between the
Company and WHC Franchise Corporation, an affiliate of Wyndham Hotel
Corporation. See "Registering Stockholders."
Pursuant to the agreement of limited partnership of the Operating Partnership
(the "Operating Partnership Agreement") and an Exchange Rights Agreement among
the Company, the Operating Partnership and the Unitholders, a Unitholder may
tender its OP Units to the Operating Partnership for cash; provided, however,
that the Company may acquire any OP Units so tendered for an equivalent number
of shares of Common Stock. As a result, the Company may from time to time issue
up to 1,896,996 Exchanged Shares upon the acquisition of OP Units tendered to
the Company for exchange. The Company has undertaken to register the Exchanged
Shares and the Restricted Stock, all of which are, or will be, owned
beneficially and of record by the Unitholders, the Restricted Stockholders or by
pledgees, donees, transferees or other successors in interest thereto, under the
Securities Act of 1933, as amended (the "Securities Act") pursuant to a
registration statement to be declared effective and to remain effective until
the earlier of the distribution of the Exchanged Shares or the Restricted Stock,
as the case may be, has been completed in accordance with the Plan of
Distribution or the Exchanged Shares have become eligible for sale pursuant to
Rule 144 under the Securities Act.
To ensure that the Company maintains its qualification as a REIT under the
Internal Revenue Code of 1986, as amended (the "Code"), the Company's Charter
limits the number of shares of Common Stock that may be owned by any single
person or affiliated group to 9.8% of the number of outstanding shares of Common
Stock and restricts the transferability of shares of Common Stock if the
purported transfer would prevent the Company from qualifying as a REIT. See
"Risk Factors --Potential Anti-Takeover Effect of Certain Provisions of Maryland
Law and of the Company's Charter and Bylaws" and "Description of Capital Stock -
- - Restrictions on Transfer."
Each of the Registering Stockholders, directly or through agents or dealers,
may, from time to time, sell all or a portion of the Restricted Stock or
Exchanged Shares on terms to be determined at the time of sale. To the extent
required, the specific terms of a particular offer will be set forth in an
accompanying Prospectus Supplement. See "Plan of Distribution." Each
Registering Stockholder reserves the right to accept and, together with its
agents or dealers, to reject, in whole or in part, any proposed purchase of
Restricted Stock or Exchanged Shares.
The Company will not receive any proceeds from the sale of any Exchanged
Shares nor from the sale of shares of Restricted Stock. The Company has agreed
to bear certain expenses of registration of the Exchanged Shares and the
Restricted Stock under federal and state securities laws.
SEE "RISK FACTORS" BEGINNING ON PAGE 6 FOR CERTAIN FACTORS RELEVANT TO AN
INVESTMENT IN THE COMMON STOCK.
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.
The date of this Prospectus is November 20, 1997.
<PAGE>
AVAILABLE INFORMATION
The Company has filed with the Securities and Exchange Commission (the "SEC"
or "Commission") a Registration Statement on Form S-3 (the "Registration
Statement") under the Securities Act of 1933, as amended (the "Securities Act"),
with respect to the Securities. This Prospectus, which constitutes part of the
Registration Statement, omits certain of the information contained in the
Registration Statement and the exhibits thereto on file with the Commission
pursuant to the Securities Act and the rules and regulations of the Commission
thereunder. Statements contained in this Prospectus as to the contents of any
contract or other document referred to are not necessarily complete, and in each
instance reference is made to the copy of such contract or other document filed
as an exhibit to the Registration Statement, each such statement being qualified
in all respects by such reference. The Registration Statement, including
exhibits thereto, may be inspected and copies obtained from the Commission at
Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and
at the following Regional Offices of the Commission: 7 World Trade Center, 13th
Floor, New York, New York 10048, and Citicorp Center, 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661-2511. Copies of such material may be
obtained from the Public Reference Section of the Commission at Judiciary Plaza,
450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. The
Company files information electronically with the Commission, and the Commission
maintains a Web Site that contains reports, proxy and information statements and
other information regarding registrants (including the Company) that file
electronically with the Commission. The address of the Commission's Web Site is
(http://www.sec.gov).
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 and proxy statements and other information with the
Commission. Such reports, proxy statements and other information can be
inspected and copied at the locations described above. Copies of such materials
can be obtained by mail from the Public Reference Section of the Commission at
Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, at
prescribed rates. In addition, the Common Stock is listed on the New York Stock
Exchange, Inc. (the "NYSE"), and such materials can be inspected and copied at
the NYSE, 20 Broad Street, New York, New York 10005.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents are incorporated herein by reference:
1. The Company's Annual Report on Form 10-K for the year ended December 31,
1996, filed with the Commission pursuant to the Exchange Act;
2. The Company's Quarterly Reports on Form 10-Q for the quarter ended March
31, 1997, June 30, 1997 and September 30, 1997, filed with the Commission
pursuant to the Exchange Act;
3. The Company's Current Reports on Form 8-K, as amended, dated March 17,
1997, June 25, 1997, September 9, 1997 and November 7, 1997 and filed with the
Commission pursuant to the Exchange Act and the Company's Current Reports on
Form 8-K/A dated January 3, 1997, and August 4, 1997, filed with the Commission
pursuant to the Exchange Act; and
4. The description of the Company's Common Stock contained in its Registration
Statement on Form 8-A, filed with the Commission on July 6, 1996 pursuant to the
Exchange Act, including all amendments and reports updating such description.
All other documents filed with the Commission by the Company pursuant to
Section 13(a), 13(c), 14 or 15(d) of the Exchange Act subsequent to the date of
this Prospectus and prior to the termination of the offering of the securities
are to be incorporated herein by reference and such documents shall be deemed to
be a part hereof from the date of filing of such documents. Any statement
contained in this Prospectus or 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 that also is or is deemed to be
incorporated by reference herein modifies or supersedes such statement. Any
statement so modified or superseded shall not be deemed, except as so modified
or superseded, to constitute a part of this Prospectus.
Any person receiving a copy of this Prospectus may obtain, without charge,
upon written or oral request, a copy of any of the documents incorporated by
reference herein, except for the exhibits to such documents. Written requests
should be mailed to Kenneth E. Barr, Secretary, American General Hospitality
Corporation, 5605 MacArthur Boulevard, Suite 1200, Irving, Texas 75038.
Telephone requests may be directed to (972) 550-6800.
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CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR"
PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"
for certain forward-looking statements. The factors discussed under "Risk
Factors," among others, could cause actual results to differ materially from
those contained in forward-looking statements made in this Prospectus, filings
by the Company with the Securities and Exchange Commission (the "Commission"),
in the Company's press releases and in oral statements made by authorized
officers of the Company. When used in this Prospectus, the words "estimate,"
"project," "anticipate," "expect," "intend," "believe," and similar expressions
are intended to identify forward-looking statements. Readers are cautioned not
to place undue reliance on these forward-looking statements, which speak only as
of the date hereof. The Company undertakes no obligation to publicly revise
these forward-looking statements to reflect events or circumstances occurring
after the date hereof or to reflect the occurrence of unanticipated events.
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PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information appearing elsewhere in this Prospectus. Unless the context requires
otherwise, the term "Company," as used herein, includes American General
Hospitality Corporation and its two wholly owned subsidiaries, AGH GP, Inc.
("AGH GP") and AGH LP, Inc. ("AGH LP"), and American General Hospitality
Operating Partnership, L.P., a Delaware limited partnership (the "Operating
Partnership"). The term "Operating Partnership," unless the context requires
otherwise, includes subsidiaries of the Operating Partnership.
THE COMPANY
The Company is a self-administered real estate investment trust (a "REIT")
that owns a portfolio of primarily full- service hotels located in major
metropolitan markets. As of November 1, 1997, the Company owned a
geographically diverse portfolio of 26 hotel properties, located in sixteen
states and containing an aggregate of approximately 6,750 guest rooms (the
"Hotels"). Substantially all of the Hotels are operated under licensing or
franchising agreements with national hotel brands, including Crowne Plaza(R),
Hilton(R), Wyndham(R), Marriott(R), Holiday Inn Select(R), Radisson(R),
Westin(R), DoubleTree Guest Suites(R), Holiday Inn(R) and Hampton Inn(R).
Management believes that the full-service segment of the hotel market continues
to offer numerous opportunities to acquire hotels at attractive multiples of
cash flow, and at discounts to replacement value, including underperforming
hotels that may benefit from the Company's repositioning strategies.
The Company expects to continue to expand and enhance the value of its hotel
portfolio by continuing to (i) make opportunistic acquisitions of full-service
hotels and (ii) strategically reposition selected hotels through product
upgrades and brand conversions. The Company will continue to pursue the
acquisition of full-service hotels, primarily in the moderate and lower upscale
segments at prices which management believes are below replacement cost, and
that have attractive yields on investment that the Company believes can be
improved over time. The Company believes that its continued use of a flexible
lessee/manager structure, coupled with the continued expansion of its brand and
franchise relationships, will result in additional acquisition opportunities for
the Company.
In order to qualify as a REIT, the Company may not operate hotels. As a
result, the Company has leased the Hotels to AGH Leasing, L.P. ("AGH Leasing")
and its subsidiary, Twin Towers Leasing, L.P. ("Twin Towers," and together with
AGH Leasing, the "Lessee") pursuant to separate participating leases (the
"Participating Leases"). The Participating Leases are designed to allow the
Company to achieve substantial participation in any future growth of revenues
generated at the Hotels. The Lessee, in turn, has entered into separate
management agreements with American General Hospitality, Inc. ("AGHI") and
Wyndham Hotel Corporation ("Wyndham") to manage the Hotels (the "Management
Agreements"). The Lessee and AGHI are owned, in part, by certain executive
officers of the Company.
The Company's executive offices are located at 5605 MacArthur Boulevard, Suite
1200, Irving, Texas 75038, and its telephone number is (972) 550-6800.
RISK FACTORS
Prospective investors should carefully consider the matters discussed under
"Risk Factors" before making an investment decision regarding the Common Stock
offered hereby.
TAX STATUS OF THE COMPANY
The Company has elected to be taxed as a REIT under Section 856 through 860 of
the Code, commencing with its taxable year ended December 31, 1996. As a REIT,
the Company generally will not be subject to federal income tax on net income
that it distributes to its shareholders as long as it distributes at least 95%
of its taxable income each year and complies with a number of other
organizational and operational requirements. Failure to qualify as a REIT will
render the Company subject to tax (including any applicable minimum tax) on its
taxable income at regular corporate rates, and distributions to the shareholders
in any such year will not be deductible by the Company. Even if the Company
qualifies for taxation as a REIT, the Company may be subject to certain federal,
state and local taxes on its income and property. In connection with the
Company's election to be taxed as a REIT, the Company's Charter imposes certain
restrictions on the transfer of shares of Common Stock. The Company has adopted
the calendar year as its taxable year.
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SECURITIES TO BE OFFERED
This Prospectus relates to (i) the possible offer and sale of up to 1,896,996
Exchanged Shares, if and to the extent that Unitholders of up to 1,896,996 OP
Units receive such shares of Common Stock in exchange for such OP Units; and
(ii) the possible offer and sale of up to 275,374 shares of Restricted Stock by
certain Restricted Stockholders. The 1,896,996 OP Units and 137,008 shares of
Restricted Stock were issued, in connection with the IPO, in exchange for the
acquisition by the Company of equity interests in the Initial Hotels. 25,397 of
the shares of Restricted Stock were issued in connection with the acquisition by
the Company of the Wyndham Royal Safari in Lake Buena Vista, Florida and 112,969
shares of the Restricted Stock were issued pursuant to an alliance agreement
between the Company and WHC Franchise Corporation, an affiliate of Wyndham Hotel
Corporation.
Pursuant to the Operating Partnership Agreement and the Exchange Rights
Agreement, a Unitholder may tender its OP Units to the Operating Partnership for
cash; provided, however, that the Company may acquire any OP Units so tendered
for an equivalent number of shares of Common Stock. As a result, the Company
may from time to time issue up to 1,896,996 Exchange Shares upon the acquisition
of OP Units tendered to the Operating Partnership for exchange. Accordingly,
the Company is registering the Exchanged Shares to provide Unitholders with
freely tradeable securities upon exchange.
The Company will not receive any proceeds from the sale of any Exchanged
Shares nor from the sale of shares of Restricted Stock offered hereby. The
Company has agreed to bear certain expenses of registration of the Exchanged
Shares and the Restricted Stock under federal and state securities laws.
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<PAGE>
RISK FACTORS
An investment in the shares of Common Stock involves various risks. Prospective
investors should carefully consider the following information in conjunction
with the other information contained in this Prospectus and incorporated by
reference herein before making an investment decision regarding the Common
Shares offered hereby.
RISKS ASSOCIATED WITH THE COMPANY'S ACQUISITION OF A SUBSTANTIAL NUMBER OF
ADDITIONAL HOTELS
As part of its ongoing business, the Company continuously seeks opportunities
to acquire additional hotel properties. Currently, the Company is experiencing
a period of rapid growth. As of September 30, 1997, since the Company's IPO,
the Company has spent approximately $325 million to purchase 13 additional
hotels, increasing its guest room portfolio by more than 120%. The Company's
ability to manage its growth effectively will require it to select companies to
lease and manage newly acquired hotels. There can be no assurance that the
Company, the Lessee, AGHI or other hotel management companies and/or operators
will be able to manage the Company's newly acquired or subsequently acquired
hotels effectively.
CONFLICTS OF INTEREST
General
The four key executive officers of the Company, including Steven D. Jorns, the
Chairman, Chief Executive Officer and President of the Company, also hold a
variety of ownership and management interests in AGHI and the Lessee.
Accordingly, there are inherent conflicts of interest in the ongoing lease,
acquisition, disposition, operation and management of the Hotels. As a result,
the interests of the Company's stockholders may not be reflected fully in all
decisions made or actions taken or to be taken by the Company's management.
No Arm's-Length Bargaining
The terms of the Participating Leases, the Management Agreements entered into
between the Lessee and AGHI, certain agreements granting the Company a right of
first refusal to acquire AGHI's interest in certain hotels and agreements
related to the sublease of alcoholic beverage service areas in certain of the
Hotels to corporations wholly owned by Mr. Jorns were not negotiated on an
arm's-length basis. In the event revenues from the Hotels increase
significantly over prior periods, and operating expenses with respect thereto
are less than historical or projected operating expenses, the Lessee could
benefit disproportionately. In the event incremental increases in expenses at
the Hotels exceed incremental increases in revenues, conflicts of interest may
arise between the Lessee and the Company. The Company does not own any interest
in the Lessee. Because certain executive officers of the Company are also
partners in the Lessee, there is an inherent conflict of interest with respect
to the enforcement and termination of the Participating Leases. Because of
these conflicts, management's decisions relating to the Company's enforcement of
its rights under the Participating Leases may not solely reflect the interests
of the Company's stockholders.
Conflicts Relating to Sale of Hotels Subject to Participating Leases
The Company generally will be obligated under the Participating Leases to pay
a lease termination fee to the Lessee if the Company elects to sell a Hotel and
does not replace it with another hotel on terms that would create a leasehold
interest in such hotel with a fair market value equal to the Lessee's remaining
leasehold interest under the Participating Lease to be terminated. Where
applicable, the termination fee is equal to the fair market value of the
Lessee's leasehold interest in the remaining term of the Participating Lease to
be terminated. The payment of a termination fee to the Lessee, which is owned
in part by three key executive officers of the Company, including Mr. Jorns, may
result in decisions regarding the sale of a Hotel that do not reflect solely the
interests of the Company's stockholders.
Conflicts Relating to Continued Management of Hotels
AGHI, in which certain executive officers of the Company (including Mr. Jorns)
own collectively an approximate 21% interest, manages hotels for third parties.
There are no restrictions in either the Participating Leases or the Management
Agreements that limit the Lessee's or AGHI's ability to lease or manage hotels
which may compete with the Company's hotels. Accordingly, the Lessee's and
AGHI's decisions relating to the operation of any of the Hotels that are in
competition with other hotels leased or managed by either of them may not fully
reflect the interests of the Company's stockholders.
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DEPENDENCE ON LESSEE AND PAYMENTS UNDER THE PARTICIPATING LEASES
The Company's ability to make distributions to its stockholders depends solely
upon the ability of the Lessee to make rent payments under the Participating
Leases. Any failure or delay by the Lessee in making such rent payments would
adversely affect the Company's ability to make anticipated distributions to its
stockholders. Such failure or delay by the Lessee may be caused by reductions
in revenue from the Hotels or in the net operating income of the Lessee or
otherwise. Although the Lessee experienced net losses for the period ended
December 31, 1996 and for the six month period ended June 30, 1997 of $721,039
and $589,449, respectively, the Lessee generated approximately $5.2 million and
$2.6 million of net cash flow from operations during the same periods,
respectively. Accordingly, there can be no assurance that the Lessee will not
experience net losses in the future. The Lessee is a recently organized limited
purpose entity; accordingly, it has limited assets. The partners of AGH Leasing
have pledged 275,000 OP Units to the Company to secure the Lessee's obligations
under the Participating Leases (the "Lessee Pledge"). Although failure on the
part of the Lessee to materially comply with the terms of a Participating Lease
(including failure to pay rent when due) gives the Company the non-exclusive
right to terminate such lease, repossess the applicable property and enforce the
payment obligations under such lease and the Lessee Pledge, the Company would
then be required to find another lessee to lease such hotel because the Company
cannot operate hotels directly due to certain federal income tax restrictions.
There can be no assurance that the Company would be able to find another lessee
or that, if another lessee were found, the Company would be able to enter into a
new lease on favorable terms.
LACK OF CONTROL OVER OPERATIONS OF THE HOTELS
The Company is dependent on the ability of the Lessee, AGHI and other
operators of hotels to operate and manage the Hotels. To maintain its status as
a REIT, the Company will not be able to operate the Hotels or any subsequently
acquired hotels. As a result, the Company will be unable to directly implement
strategic business decisions with respect to the operation and marketing of its
hotels, such as decisions with respect to the setting of room rates, food and
beverage operations and certain similar matters.
HOTEL INDUSTRY RISKS
Operating Risks
The Hotels are subject to all operating risks common to the hotel industry.
These risks include, among other things, (i) competition for guests from other
hotels, some of which may have greater marketing and financial resources than
the Company, the Lessee and AGHI may have; (ii) increases in operating costs due
to inflation and other factors, which increases may not have been offset in
recent years, and may not be offset in the future by increased room rates; (iii)
dependence on business and commercial travelers and tourism, which business may
experience seasonality and other fluctuations; (iv) increases in energy costs
and other expenses of travel, which may deter travelers; and (v) adverse effects
of general and local economic conditions. These factors could adversely affect
the Lessee's ability to generate revenues and to make rent payments and
therefore the Company's ability to make expected distributions to its
stockholders.
Risks of Necessary Operating Costs and Capital Expenditures; Required Hotel
Renovations
Hotels in general, including the Hotels, require ongoing renovations and other
capital improvements, including periodic replacement or refurbishment of
furniture, fixtures and equipment ("FF&E"). Under the terms of the
Participating Leases, the Company is obligated to establish a reserve to pay the
cost of certain capital expenditures at the Hotels and pay for periodic
replacement or refurbishment of FF&E. The Company controls the use of funds in
this reserve. However, if capital requirements exceed the amount of the reserve,
there can be no assurance that sufficient sources of financing will be available
to fund such requirements. The additional cost of such expenditures could have
an adverse effect on cash available for distribution to the Company's
stockholders. In addition, the Company may acquire hotels in the future that
require significant renovation. Renovation of hotels involves certain risks,
including the possibility of environmental problems, construction cost overruns
and delays, uncertainties as to market demand or deterioration in market demand
after commencement of renovation and the emergence of unanticipated competition
from other hotels. In addition, the Company plans substantial renovations at
the hotels it acquires. Such substantial renovations will likely disrupt the
operations of those hotels due to hotel guest rooms and common areas being taken
out of service for extended periods.
Competition for Investment Opportunities
The Company may be competing for investment opportunities with entities that
have substantially greater financial resources than the Company. These entities
generally may be able to accept more risk than the Company can prudently manage,
including risks with respect to the creditworthiness of a hotel operator or the
geographic
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proximity of its investments. Competition generally may reduce the number of
suitable investment opportunities offered to the Company and increase the
bargaining power of property owners seeking to sell.
Seasonality of Hotel Industry
The hotel industry is seasonal in nature. Generally, hotel revenue for
business hotels is greater in the second and third quarters of a calendar year,
although this may not be true for hotels in major tourist destinations. Revenue
for hotels in tourist areas generally is substantially greater during the
tourist season than other times of the year. Seasonal variations in revenue at
the Hotels may cause quarterly fluctuations in the Company's lease revenue.
Investment in Single Industry
The Company's current strategy is to acquire interests only in hotels. As a
result, the Company will be subject to risks inherent in investments in a single
industry. The effects on cash available for distribution resulting from a
downturn in the hotel industry may be more pronounced than if the Company had
diversified its investments.
RISKS OF LEVERAGE; NO LIMITS ON INDEBTEDNESS
Neither the Company's Bylaws nor its charter (the "Charter") limits the amount
of indebtedness the Company may incur. As a result of incurring debt, the
Company is subject to risks normally associated with debt financing, including
the risks (i) that revenues from the Participating Leases will be insufficient
to meet required payments of principal and interest and (ii) that interest rates
may fluctuate. Although the Company anticipates that it will be able to repay
or refinance its existing indebtedness and any other indebtedness, there can be
no assurance that it will be able to do so or that the terms of such refinancing
will be favorable to the Company.
COMPETITION FOR MANAGEMENT TIME
The Company's four key executive officers are also employed by AGHI and are
thus necessarily subject to competing demands on their time. See "-Conflicts of
Interest."
REAL ESTATE INVESTMENT RISKS
General Risks
The Company's investments are subject to varying degrees of risk generally
incident to the ownership of real property. The underlying value of the
Company's hotel investments and the Company's income and ability to make
distributions to its stockholders is dependent upon the ability of the Lessee,
AGHI and certain third party operators to operate the Hotels in a manner
sufficient to maintain or increase revenues and to generate sufficient revenue
in excess of operating expenses to make rent payments under the Participating
Leases. Income from the Hotels may be adversely affected by changes in national
economic conditions, changes in local market conditions due to changes in
general or local economic conditions and neighborhood characteristics, 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, particularly in
older structures, changes in real estate tax rates and other operating expenses,
adverse changes in governmental rules and fiscal policies, civil unrest, acts of
God, including earthquakes, hurricanes, floods and other natural disasters
(which may result in uninsured losses), acts of war, adverse changes in zoning
laws, and other factors which are beyond the control of the Company.
Value and Illiquidity of Real Estate
Real estate investments are relatively illiquid. The ability of the Company
to vary its portfolio in response to changes in economic and other conditions
will be limited. If the Company must sell an investment, there can be no
assurance that the Company will be able to dispose of it in the time period it
desires or that the sale price of any investment will recoup or exceed the
amount of the Company's investment.
Property Taxes and Casualty Insurance
Each Hotel is subject to real and personal property taxes. Under the
Participating Leases, the Company is required to pay real and personal property
taxes. The real and personal property taxes on hotel properties in which the
Company invests may increase or decrease as property tax rates change and as the
properties are assessed or reassessed by taxing authorities. Each Hotel is
covered by casualty insurance, which, pursuant to the Participating Leases, must
be paid by the Company, the rates for which may increase or decrease depending
on claims experience.
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The increase in property taxes or casualty insurance premiums could adversely
affect the Company's ability to make expected distributions to its stockholders.
Environmental Matters
The Company's operating costs may be affected by the obligation to pay for the
cost of complying with existing environmental laws, ordinances and regulations,
as well as the cost of future legislation. 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. In
addition, the presence of hazardous or toxic substances, or the failure to
remediate such property properly, may adversely affect the owner's ability to
use the property, sell the property or borrow by using such real 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 releases of
hazardous materials, including asbestos-containing materials ("ACMs"), into the
environment, and third parties may seek recovery from owners or operators of
real properties for personal injury associated with exposure to released ACMs or
other hazardous materials.
Environmental laws also may impose restrictions on the manner in which a
property may be used or transferred or in which businesses may be operated, and
these restrictions may require expenditures. In connection with the ownership
of the Hotels, the Company or the Lessee may be potentially liable for any such
costs. The cost of defending against claims of liability or remediating
contaminated property and the cost of complying with environmental laws could
materially adversely affect the Company's results of operations and financial
condition. Phase I environmental site assessments ("ESAs") have been conducted
at all of the Hotels by qualified independent environmental engineers. The
purpose of Phase I ESAs is to identify potential sources of contamination for
which the Hotels may be responsible and to assess the status of environmental
regulatory compliance. The ESAs have not revealed any environmental liability
or compliance concerns that the Company believes would have a material adverse
effect on the Company's business, assets, results of operations or liquidity,
nor is the Company aware of any material environmental liability or concerns.
Nevertheless, it is possible that these ESAs did not reveal all environmental
liabilities or compliance concerns or that material environmental liabilities or
compliance concerns exist of which the Company is currently unaware.
Compliance with Americans with Disabilities Act
Under the Americans with Disabilities Act of 1990, as amended (the "ADA"), all
public accommodations are required to meet certain federal requirements related
to access and use by disabled persons. A determination that the Company is not
in compliance with the ADA could result in the imposition of fines or an award
of damages to private litigants. If the Company were required to make
modifications to its hotels to comply with the ADA, the Company's ability to
make expected distributions to its stockholders could be adversely affected.
Uninsured and Underinsured Losses
Each Participating Lease requires that the Company maintain comprehensive
insurance on each of the Hotels, including liability, fire and extended
coverage. Management believes such specified coverage is of the type and amount
customarily obtained for or by an owner of hotels. Leases for subsequently
acquired hotels will contain similar provisions. However, there are certain
types of losses, generally of a catastrophic nature, such as those caused by
earthquakes, hurricanes and floods, that may be uninsurable or not economically
insurable. The Company's Board of Directors and management will use their
discretion in determining amounts, coverage limits and 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 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
infeasible 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.
Acquisition and Development Risks
The Company intends to pursue acquisitions of additional hotels and, under
appropriate circumstances, may pursue development opportunities. Acquisitions
entail risks that investments will fail to perform in accordance with
expectations and that estimates of the cost of improvements necessary to market
and acquire hotels will prove
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inaccurate, as well as general investment risks associated with any new real
estate investment. New project development is subject to numerous risks,
including risks of construction delays or cost overruns that may increase
project costs, new project commencement risks such as receipt of zoning,
occupancy and other required governmental approvals and permits and the
incurrence of development costs in connection with projects that are not pursued
to completion. The fact that the Company must distribute 95.0% of REIT taxable
income in order to maintain its qualification as a REIT may limit the Company's
ability to rely upon lease income from the Hotels or subsequently acquired
hotels to finance acquisitions or new developments. As a result, if debt or
equity financing were not available on acceptable terms, further acquisitions or
development activities might be curtailed or cash available for distribution
might be adversely affected.
TAX RISKS
Failure to Qualify as a REIT
The Company operates in a manner designed to permit it to qualify as a REIT
for federal income tax purposes. Qualification as a REIT involves the
application of the provisions of the highly technical and complex Internal
Revenue Code of 1986, as amended (the "Code") for which there are only limited
judicial or administrative interpretations. The determination of various
factual matters and circumstances not entirely within the Company's control may
affect its ability to continue to qualify as a REIT. The complexity of these
provisions and of the applicable income tax regulations that have been
promulgated under the Code is greater in the case of a REIT that holds its
assets through a partnership, such as the Company. Moreover, no assurance can
be given that legislation, new regulations, administrative interpretations or
court decisions will not change the tax laws with respect to qualification as a
REIT or the federal income tax consequences of such qualification. The Company
has received an opinion of Battle Fowler LLP, counsel to the Company
("Counsel"), to the effect that, based on various assumptions relating to the
operation of the Company and representations made by the Company as to certain
factual matters, the Company meets the requirements for qualification and
taxation as a REIT. Such legal opinion is not binding on the Internal Revenue
Service (the "IRS").
If the Company fails to qualify as a REIT in any taxable year, the Company
will not be allowed a deduction for distributions to its stockholders in
computing its taxable income and will be subject to federal income tax
(including any applicable alternative minimum tax) on its taxable income at the
applicable corporate rate. In addition, unless it were entitled to relief under
certain statutory provisions, the Company would be disqualified from treatment
as a REIT for the four taxable years following the year during which
qualification is lost. This disqualification would reduce the funds of the
Company available for investment or distribution to stockholders because of the
additional tax liability of the Company for the year or years involved.
If the Company were to fail to qualify as a REIT, it no longer would be
subject to the distribution requirements of the Code and, to the extent that
distributions to stockholders would have been made in anticipation of the
Company's qualifying as a REIT, the Company might be required to borrow funds or
to liquidate certain of its assets to pay the applicable corporate income tax.
Although the Company currently operates in a manner designed to qualify as a
REIT, it is possible that future economic, market, legal, tax or other
considerations may cause the Company's Board of Directors to decide to revoke
the REIT election.
Adverse Effects of REIT Minimum Distribution Requirements
To obtain the favorable tax treatment accorded to REITs under the Code, the
Company generally will be required each year to distribute to its stockholders
at least 95% of its REIT taxable income. The Company will be subject to income
tax on any undistributed REIT taxable income and net capital gain, and 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 for the calendar year, (ii) 95% of its capital gain net
income for such year, and (iii) 100% of its undistributed income from prior
years.
The Company has made, and intends to continue to make, distributions to its
stockholders to comply with the distribution provisions of the Code and to avoid
federal income taxes and the non-deductible 4% excise tax. The Company's income
consists primarily of its share of the income of the Operating Partnership, and
the Company's cash flow consists primarily of its share of distributions from
the Operating Partnership. Differences in timing between the receipt of income
and the payment of expenses in arriving at taxable income (of the Company or the
Operating Partnership) and the effect of non-deductible capital expenditures,
the creation of reserves or required debt amortization payments could in the
future require the Company to borrow funds through the Operating Partnership on
a short-term or long-term basis to meet the distribution requirements that are
necessary to continue to qualify as a REIT. In such circumstances, the Company
might need to borrow funds to avoid adverse tax consequences even if management
believes that the then prevailing market conditions generally are not favorable
for such borrowings or that such borrowings are not advisable in the absence of
such tax considerations.
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Distributions by the Operating Partnership are determined by its sole general
partner, a wholly owned subsidiary of the Company, and are dependent on a number
of factors, including the amount of cash available for distribution, the
Operating Partnership's financial condition, any decision by the Company's Board
of Directors to reinvest funds rather than to distribute such funds, the
Operating Partnership's capital expenditure requirements, the annual
distribution requirements under the REIT provisions of the Code and such other
factors as the Board of Directors deems relevant. There can be no assurance
that the Company will be able to continue to satisfy the annual distribution
requirement so as to avoid corporate income taxation on the earnings that it
distributes.
Consequences of Failure to Qualify as Partnerships
The Operating Partnership has received an opinion of Counsel stating that,
assuming that the Operating Partnership and each subsidiary partnership or
limited liability company of the Operating Partnership (each, a "Subsidiary
Partnership") is being operated in accordance with its respective organizational
documents, the Operating Partnership and each of the Subsidiary Partnerships
have been and will continue to be treated as partnerships, and not as
corporations, for federal income tax purposes. Such opinion is not binding on
the IRS. If the IRS were to challenge successfully the status of the Operating
Partnership or any Subsidiary Partnership as a partnership for federal income
tax purposes, the Operating Partnership or the affected Subsidiary Partnership
would be taxable as a corporation. In such event, the Company would cease to
qualify as a REIT for federal income tax purposes. The imposition of a
corporate tax on the Operating Partnership or any of the Subsidiary
Partnerships, with a resulting loss of REIT status of the Company, would reduce
substantially the amount of cash available for distribution to the Company's
stockholders.
RISKS OF OPERATING HOTELS UNDER FRANCHISE AGREEMENTS; APPROVAL FOR BRAND
CONVERSIONS
As of November 1, 1997, 25 of the Hotels are subject to franchise agreements
with nationally recognized hotel companies. The continuation of such franchise
agreements is subject to specified operating standards and other terms and
conditions. Franchisors typically inspect licensed properties periodically to
confirm adherence to operating standards. Action or inaction on the part of any
of the Company, the Lessee, AGHI or third party operators could result in a
breach of such standards or other terms and conditions of the franchise
agreements and could result in the loss or cancellation of a franchise license.
It is possible that a franchisor could condition the continuation of a franchise
license on the completion of capital improvements that the Board of Directors
determines are too expensive or otherwise unwarranted in light of general
economic conditions or the operating results or prospects of the affected Hotel.
In that event, the Board of Directors may elect to allow the franchise license
to lapse. In any case, if a franchise is terminated, the Company and the Lessee
may seek to obtain a suitable replacement franchise or to operate the Hotel
independent of a franchise license. The loss of a franchise license could have a
material adverse effect upon the operations or the underlying value of the Hotel
covered by the franchise because of the loss of associated name recognition,
marketing support and centralized reservation systems provided by the
franchisor.
POTENTIAL ANTI-TAKEOVER EFFECT OF CERTAIN PROVISIONS OF MARYLAND LAW AND OF THE
COMPANY'S CHARTERAND BYLAWS
Certain provisions of Maryland law and of the Company's Charter and Bylaws may
have the effect of discouraging a third party from making an acquisition
proposal for the Company and could delay, defer or prevent a transaction or a
change in control of the Company under circumstances that could give the holders
of Common Stock the opportunity to realize a premium over the then prevailing
market prices of the Common Stock or that might otherwise be in such holders'
best interest. Such provisions include the following:
Ownership Limitation
In order for the Company to maintain its qualification as a REIT under the
Code, not more than 50% in value of the outstanding shares of stock of the
Company may be owned, directly or indirectly, by five or fewer individuals (as
defined in the Code to include certain entities) at any time during the last
half of the Company's taxable year (other than the first year for which the
election to be treated as a REIT has been made). Furthermore, if any partner of
the Lessee owns, actually or constructively, 10% or more in value of the stock
of the Company, the Lessee could become a Related Party Tenant (as defined in
"Federal Income Tax Consequences -- Requirements for Qualification as a REIT --
Income Tests") of the Company, which would result in loss of REIT status for the
Company. For the purpose of preserving the Company's REIT qualification, the
Company's Charter prohibits direct or indirect ownership (taking into account
applicable ownership provisions of the Code) of more than 9.8% of the number of
outstanding shares of Common Stock by any person (the "Ownership Limitation"),
subject to an exception that permits mutual funds and certain other entities to
own as much as 15% of any class of the Company's stock in appropriate
circumstances (the "Look-Through Ownership Limitation"). Generally, the stock
owned by affiliated owners will be aggregated for purposes of the Ownership
Limitation. The Ownership Limitation could have the effect of delaying,
deferring or preventing a transaction or a change in control of the Company in
which holders of some
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or a majority of the Common Stock might receive a premium for their Common Stock
over the then prevailing market price or which such holders might believe to be
otherwise in their best interests.
Staggered Board
The Board of Directors is divided into three classes of directors. The initial
term of the first class expired in 1997 and that director was reelected to a
term scheduled to expire in 2000 and the initial terms of the second and third
classes will expire in 1998 and 1999, respectively. As the term of each class
expires, directors in that class will be elected by the stockholders of the
Company for a term of three years and until their successors are duly elected
and qualified. A director may be removed, with or without cause, by the
affirmative vote of 75% of the votes entitled to be cast for the election of
directors, which super-majority vote may have the effect of delaying, deferring
or preventing a change of control of the Company. The staggered terms of
directors may reduce the possibility of a tender offer or an attempt to change
control of the Company even though a tender offer or change in control might be
in the best interests of the stockholders.
Maryland Business Combination Law
Under the Maryland General Corporation Law, as may be amended from time to
time (the "MGCL"), certain "business combinations" (including certain issuances
of equity securities) between a Maryland corporation such as the Company and any
person who owns 10% or more of the voting power of the corporation's shares (an
"Interested Stockholder") or an affiliate thereof are prohibited for five years
after the most recent date on which the Interested Stockholder became an
Interested Stockholder. Thereafter, any such business combination must be
approved by two super-majority votes unless, among other conditions, the holders
of shares of Common Stock receive a minimum price (as defined in the MGCL) for
their stock and the consideration is received in cash or in the same form as
previously paid by the Interested Stockholder for its shares. These provisions
of the MGCL do not apply, however, to business combinations that are approved or
exempted by the board of directors of the Maryland corporation prior to the time
that the Interested Stockholder becomes an Interested Stockholder.
Maryland Control Share Acquisition Statute
Under the MGCL, "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 eligible under the statute to be cast on
the matter. "Control shares" are voting shares of stock, which, if aggregated
with all other such shares of stock 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 of
all voting power. Control shares do not include shares that the acquiring person
is then entitled to vote as a result of having previously obtained stockholder
approval. A "control share acquisition" means the acquisition of control shares,
subject to certain exceptions.
If voting rights are not approved at a meeting of stockholders, then, subject
to certain conditions and limitations, the issuer may redeem any or all of the
control shares (except those for which voting rights have previously been
approved) for fair value. If voting rights for control shares are approved at a
stockholders' meeting and the acquiror becomes entitled to vote a majority of
the shares of stock entitled to vote, all other stockholders 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.
The Company's Bylaws contain a provision exempting from the control share
acquisition statute any and all acquisitions by any persons of shares of stock
of the Company. There can be no assurance that such provision will not be
amended or eliminated at any point in the future. If the foregoing exemption in
the Company's Bylaws is rescinded or amended, the control share acquisition
statute could have the effect of delaying, deferring, preventing or otherwise
discouraging offers to acquire the Company and of increasing the difficulty of
consummating any such offer.
RELIANCE ON BOARD OF DIRECTORS AND MANAGEMENT
Stockholders have no right or power to take part in the management of the
Company except through the exercise of voting rights on certain specified
matters. The Board of Directors are responsible for directing the management of
the business and affairs of the Company. The Company relies upon the services
and expertise of its management for strategic business direction. The Company
has in effect employment agreements with Steven D. Jorns, Chairman of the Board,
Chief Executive Officer and President; Bruce G. Wiles, Executive Vice President;
Kenneth E. Barr, Executive Vice President and Chief Financial Officer; and Russ
C. Valentine, Senior Vice President -- Acquisitions, which currently provide for
base salary at below market rates for comparable positions. Accordingly, the
loss of
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services of any such officer may require the Company to hire a replacement
officer at a salary greater than the Company is currently obligated to pay,
which, in turn, would increase the Company's operating costs and reduce cash
available for distribution.
ABILITY OF BOARD TO CHANGE POLICIES
The major policies of the Company, including its policies with respect to
acquisitions, financing, growth, operations, debt capitalization and
distributions, are determined by its Board of Directors. The Board of Directors
may amend or revise these and other policies at any time and from time to time
at the Board's discretion without a vote of the stockholders of the Company.
ADVERSE EFFECT OF INCREASE IN MARKET INTEREST RATES ON PRICE OF COMMON STOCK
One of the factors that may influence the price of the Common Stock in public
trading markets will be the annual yield from distributions by the Company on
the Common Stock as compared to yields on certain financial instruments. Thus,
an increase in market interest rates will result in higher yields on certain
financial instruments, which could adversely affect the market price of the
Common Stock.
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DESCRIPTION OF CAPITAL STOCK
The following summary description of (i) the capital stock of the Company and
(ii) certain provisions of Maryland law and of the Charter and Bylaws of the
Company does not purport to be complete and is subject to and qualified in its
entirety by reference to Maryland law described herein, and to the Charter and
Bylaws of the Company.
GENERAL
Under its Charter, the Company has the authority to issue 100,000,000 shares
of Common Stock, $0.01 par value per share. Under Maryland law, stockholders
generally are not liable for a corporation's debts or obligations.
COMMON STOCK
All shares of Common Stock offered hereby will be duly authorized, fully paid
and nonassessable. Subject to the preferential rights of any other class or
series of stock, holders of shares of Common Stock are entitled to receive
dividends on such 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
stockholders 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.
Subject to the provisions of the Charter regarding the restrictions on
transfer of stock, each outstanding share of Common Stock entitles the holder to
one vote on all matters submitted to a vote of stockholders, including the
election of directors and, except as provided with respect to any other class or
series of stock, the holders of such shares 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 will not be able to elect any directors.
Holders of shares of Common Stock have no preference, conversion, exchange,
sinking fund redemption or appraisal rights and have no preemptive rights to
subscribe for any securities of the Company. Shares of Common Stock will have
equal dividend, liquidation and other rights.
Under the MGCL, a Maryland corporation generally cannot dissolve, amend its
charter, merge, sell all or substantially all of its assets, engage in a share
exchange or engage in similar transactions outside the ordinary course of
business unless approved by the affirmative vote of stockholders holding at
least two-thirds of the shares entitled to vote on the matter unless a lesser
percentage (but not less than a majority of all of the votes entitled to be cast
on the matter) is set forth in the corporation's charter. The Charter provides
that, with the exception of certain amendments to the Charter, the affirmative
vote of holders of shares entitled to cast a majority of all votes entitled to
be cast on such matters will be sufficient to approve the aforementioned
transactions.
POWER TO ISSUE ADDITIONAL SHARES OF COMMON STOCK
The Company believes that the power of the Board of Directors to issue
additional authorized but unissued shares of Common Stock will provide the
Company with increased flexibility in structuring possible future financings and
acquisitions and in meeting other needs which might arise. The additional
shares of Common Stock will be available for issuance without further action by
the Company's stockholders, unless such action is required by applicable law or
the rules of any stock exchange or automated quotation system on which the
Company's securities may be listed or traded.
RESTRICTIONS ON TRANSFER
For the Company to qualify as a REIT under the Code, it must meet certain
requirements concerning the ownership of its outstanding shares of stock.
Specifically, not more than 50% in value of the Company's outstanding shares of
stock 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 shares of stock of the Company must be beneficially owned
by 100 or more persons during at least 335 days of a taxable year of twelve
months or during a proportionate part of a shorter taxable year. These two
requirements do not apply until after the first taxable year for which the
Company makes an election to be taxed as a REIT. See "Federal Income Tax
Considerations -- Requirements for Qualification as a REIT." 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 calendar year must consist of rents from real
property and income from certain other real property investments. The rents
received by the Operating Partnership and the Subsidiary Partnerships from the
Lessee will not qualify as rents from real property, which could result in loss
of REIT status for the Company, if the Company
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owns, actually 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 "Federal
Income Tax Considerations --Requirements for Qualification as a REIT -- Income
Tests."
Because the Board of Directors believes it is essential for the Company to
continue to qualify as a REIT, the Charter, subject to certain exceptions
described below, provides that no person may own, or be deemed to own by virtue
of the attribution provisions of the Code, more than 9.8% of the number
outstanding shares of any class of Common Stock (subject to the Look-Through
Ownership Limitation applicable to certain stockholders, as described below).
Certain types of entities, such as pension trusts qualifying under section 401
(a) of the Code, mutual funds qualifying as regulated investment companies under
section 851 of the Code, and corporations, will be looked through for purposes
of the "closely held" test in section 856(h) of the Code. Subject to certain
limited exceptions, the Charter will allow such an entity under the Look-Through
Ownership Limitation to own up to 15% of the shares of any class or series of
the Company's stock, provided that such ownership does not cause any beneficial
owner of such entity to exceed the Ownership Limitation or otherwise result in a
violation of the tests described in clauses (ii), (iii) and (iv) of the second
sentence of the succeeding paragraph.
Any transfer of Common Stock that would (i) result in any person owning,
directly or indirectly, Common Stock in excess of the Ownership Limitation (or
the Look-Through Ownership Limitation, if applicable), (ii) result in Common
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) of the Code, or (iv) cause the Company to own,
actually or constructively, 9.9% or more of the ownership interests in a tenant
of the Company's, the Operating Partnership's or a Subsidiary Partnership's real
property, within the meaning of section 856(d)(2)(B) of the Code, will be void
ab initio, and the intended transferee will acquire no rights in such shares of
Common Stock.
Subject to certain exceptions described below, any purported transfer of
Common Stock that would (i) result in any person owning, directly or indirectly,
shares of Common Stock in excess of the Ownership Limitation (or the Look-
Through Ownership Limitation, if applicable), (ii) result in the shares of
Common 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) of the Code, or (iv) cause the Company to
own, actually or constructively, 10% or more of the ownership interests in a
tenant of the Company's, the Operating Partnership's or a Subsidiary
Partnership's real property, within the meaning of section 856(d)(2)(B) of the
Code, will be designated as "Shares-in-Trust" and will be transferred
automatically to a trust (a "Trust"), effective on the day before the purported
transfer of such shares of Common Stock. The record holder of the shares of
Common Stock that are designated as Shares-in-Trust (the "Prohibited Owner")
will be required to submit such number of shares of Common Stock to the Company
for registration in the name of the trustee of the Trust (the "Trustee"). The
Trustee will be designated by the Company but will not be affiliated with the
Company. The beneficiary of the Trust (the "Beneficiary") will be one or more
charitable organizations named by the Company.
Shares-in-Trust will remain issued and outstanding shares of Common Stock and
will be entitled to the same rights and privileges as all other shares of the
same class or series. The Trustee 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 Trustee will vote all Shares-in-Trust.
The 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 another transfer to another Trust.
The Prohibited Owner with respect to Shares-in-Trust will be required to repay
to the Trustee the amount of any dividends or distributions received by the
Prohibited Owner (i) that are attributable to any Shares-in-Trust and (ii) the
record date of which was on or after the date that such shares become Shares-in-
Trust. Any vote taken by a Prohibited Owner prior to the Company's discovery
that the Shares-in-Trust were held in trust will be rescinded as void ab initio
and recast by the Trustee, in its sole and absolute discretion; provided,
however, that if the Company has already taken irreversible corporate action
based on such vote, then the Trustee shall not have the authority to rescind and
recast such vote. The Prohibited Owner generally will receive from the Trustee
the lesser of (i) the price per share such Prohibited Owner paid for the shares
of Common Stock that were designated as Shares-in-Trust (or, in the case of a
gift or devise, the Market Price (as defined below) per share on the date of
such transfer) or (ii) the price per share received by the Trustee from the sale
of such Shares-in-Trust. Any amounts received by the 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. Subject to the Trustee's ability to designate
a permitted transferee, the Company will have the right to accept such offer for
a period of 90 days after the later of (i) the date
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of the purported transfer which resulted in the creation of such Shares-in-Trust
or (ii) the date the Company determines in good faith that a transfer resulting
in such Shares-in-Trust occurred. "Market Price" on any date shall mean the
average of the Closing Price for the five consecutive Trading Days ending on
such date. The "Closing Price" on any date shall mean the last sale price,
regular way, or, in case no such sale takes place on such day, the average of
the closing bid and asked prices, regular way, in either case as reported in the
principal consolidated transaction reporting system with respect to securities
listed or admitted to trading on the NYSE or, if the shares of Common Stock are
not listed or admitted to trading on the NYSE, as reported in the principal
consolidated transaction reporting system with respect to securities listed on
the principal national securities exchange on which the shares of Common Stock
are listed or admitted to trading or, if the shares of Common Stock are not
listed or admitted to trading on any national securities exchange, the last
quoted price, or if not so quoted, the average of the high bid and low asked
prices in the over-the-counter market, as reported by the National Association
of Securities Dealers, Inc. Automated Quotation System or, if such system is no
longer in use, the principal other automated quotations system that may then be
in use or, if the shares of Common Stock are not quoted by any such
organization, the average of the closing bid and asked prices as furnished by a
professional market maker making a market in the shares of Common Stock selected
by the Board of Directors. "Trading Day" shall mean a day on which the principal
national securities exchange on which the shares of Common Stock are listed or
admitted to trading is open for the transaction of business or, if the shares of
Common Stock are not listed or admitted to trading on any national securities
exchange, shall mean any day other than a Saturday, a Sunday or a day on which
banking institutions in the State of New York are authorized or obligated by law
or executive order to close.
Any person who acquires or attempts to acquire Common Stock in violation of
the foregoing restrictions, or any person who owned shares of Common Stock that
were transferred to a 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 must, within 30 days after January 1 of each
year, provide to the Company a written statement or affidavit stating (i) the
name and address of such direct or indirect owner, (ii) the number of shares of
Common Stock owned directly or indirectly, and (iii) a description of how such
shares are held. In addition, each direct or indirect stockholder shall provide
to the Company such additional information as the Company may request in order
to determine the effect, if any, of such ownership the Company's status as a
REIT and to ensure compliance with the Ownership Limitation.
The Ownership Limitation or the Look-Through Ownership Limitation, as
applicable, generally will not apply to the acquisition of shares of Common
Stock by an underwriter that participates in a public offering of such shares.
In addition, the Board of Directors, upon such conditions as the Board of
Directors may direct, may exempt a person from the Ownership Limitation or the
Look-Through Ownership Limitation, as applicable, under certain circumstances.
All certificates representing shares of Common Stock will bear a legend
referring to the restrictions described above.
The Ownership Limitation could have the effect of delaying, deferring or
preventing a takeover or other transaction in which holders of some, or a
majority, of shares of Common Stock might receive a premium from their shares of
Common Stock over the then prevailing market price or which such holders might
believe to be otherwise in their best interest.
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CHARTER AND BYLAW PROVISIONS AND CERTAIN PROVISIONS OF MARYLAND LAW
Number of Directors; Classification of the Board of Directors
The Charter and Bylaws provide that the number of directors will consist of
not less than three nor more than fifteen persons, as determined by the
affirmative vote of a majority of the members of the entire Board of Directors.
At all times, a majority of the directors shall be Independent Directors, except
that upon the death, removal, incapacity or resignation of an Independent
Director, such requirement shall not be applicable for 60 days. There are five
directors, four of whom are Independent Directors. The holders of Common Stock
are entitled to vote on the election or removal of directors, with each share
entitled to one vote. Any vacancy will be filled, 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 Charter, the Board of Directors is divided into three classes
of directors. The initial term of the first class expired in 1997 and that
director was reelected to a term scheduled to expire in 2000, and the initial
terms of the second and third classes will expire in 1998 and 1999,
respectively. As the term of each class expires, directors in that class will
be elected by the stockholders 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. Because holders of Common Stock will have no right to cumulative
voting in the election of directors, at each annual meeting of stockholders, the
holders of a majority of the shares of Common Stock 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 stockholders. At least
two annual meetings of stockholders, 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. See "Risk Factors -- Potential Anti-
Takeover Effect of Certain Provisions of Maryland Law and of the Company's
Charter and Bylaws."
Removal; Filling Vacancies
The Bylaws provide that, unless the Board of Directors otherwise determines,
any vacancies (except vacancies resulting from an increase in the number of
directors) will be filled by the affirmative vote of a majority of the remaining
directors, though less than a quorum. Any directors so elected shall hold
office until the next annual meeting of stockholders. The Charter provides that
directors may be removed, with or without cause, only by the affirmative vote of
the holders of at least 75.0% of votes entitled to be cast in the election of
the directors. This provision, when coupled with the provision of the Bylaws
authorizing the Board of Directors to fill vacant directorships precludes
stockholders from removing incumbent directors except upon a substantial
affirmative vote and filling the vacancies created by such removal with their
own nominees.
Limitation of Liability and Indemnification
The MGCL permits a Maryland corporation to include in its charter a provision
limiting the liability of its directors and officers to the corporation and its
stockholders for money damages except for liability resulting from (a) actual
receipt of an improper benefit or profit in money, property or services or (b)
active and deliberate dishonest established by a final judgment as being
material to the cause of active. The Charter of the Company contains such a
provision which eliminates such liability to the maximum extent permitted by
Maryland law.
The Charter obligates the Company, to the maximum extent permitted by Maryland
law, to indemnify and to pay or reimburse reasonable expenses in advance of
final disposition of a proceeding to any person (or the estate of any person)
who is or was a party to, or is threatened to be made a party to, and
threatened, pending or completed action, suit or proceeding whether or not by or
in the right of the Company, and whether civil, criminal, administrative,
investigative or otherwise, by reason of the fact that such person is or was a
director or officer of the Company, or is or was serving at the request of the
Company as a director, officer, trustee, partner, member, agent or employee of
another corporation, partnership, limited liability company, association, joint
venture, trust or other enterprise. The Charter also permits the Company to
indemnify and advance expenses to any person who served a predecessor of the
Company in any of the capacities described above and to any employee or agent of
the Company or a predecessor of the Company.
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The MGCL requires a Maryland corporation (unless its charter provides
otherwise, which the Company's Charter does not) to indemnify a director or
officer who has been successful, on the merits or otherwise, in the defense of
any proceeding to which he is made a party by reason of his service in that
capacity. The MGCL permits a Maryland corporation to indemnify its present and
former directors and officers, among others, 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 in those or other capacities unless it is established that (a) the
act or omission of the director or officer was material to the matter giving
rise to the proceeding and (i) was committed in bad faith or (ii) was the result
of active and deliberate dishonesty, (b) the director or officer actually
received an improper personal benefit in money, property or services or (c) in
the case of any criminal proceeding, the director or officer had reasonable
cause to believe that the act or omission was unlawful. However, a Maryland
corporation may not indemnify for an adverse judgment in a suit by or in the
right of the corporation or for a judgment of liability on the basis that a
personal benefit was improperly received, unless in either case a court orders
indemnification and then only for expenses. In addition, the MGCL requires the
Company, as a condition to advancing expenses, to obtain (a) written affirmation
by the director or officer of his good faith belief that he has met the standard
of conduct necessary for indemnification by the Company as authorized by the
Charter and (b) a written statement by or on his behalf to repay the amount paid
or reimbursed by the Company if it shall ultimately be determined that the
standard of conduct was not met. Indemnification under the provisions of the
MGCL is not deemed exclusive of any other rights, by indemnification or
otherwise, to which an officer or director may be entitled under the Company's
Charter or Bylaws, or under resolutions of stockholders 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.
The Company also has purchased and maintains insurance on behalf of all of its
directors and executive officers against liability asserted against or incurred
by them in their official capacities with the Company, whether or not the
Company is required or has the power to indemnify them against the same
liability.
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 10.0% 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 10.0% or more of the voting power of the then-outstanding
voting shares of such corporation (an "Interested Stockholder") or an affiliate
thereof are prohibited for five years after the most recent date on which the
Interested Stockholder became an Interested Stockholder. 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) 80.0% 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 the shares held by the Interested
Stockholder with whom (or with whose affiliate) the business combination is to
be affected, unless, among other conditions, the corporation's stockholders
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 Stockholder for its shares. These provisions of the MGCL do not
apply, however, to business combination that are approved or exempted by the
board of directors of the corporation prior to the time that the Interested
Stockholder becomes an Interested Stockholder.
Control Share Acquisition Statute
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 the 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 stockholder
approval. A "control share acquisition" means the acquisition of control
shares, subject to certain exceptions.
A person who has made or purposes to make a control share acquisition, upon
satisfaction of certain conditions (including an undertaking to pay expenses),
may compel the board of directors of the corporation to call a special meeting
of stockholders 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.
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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, the 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 stockholders at which the
voting rights of such shares are considered and not approved. If voting rights
for control shares are approved at a stockholders meeting and the acquiror
becomes entitled to vote a majority of the shares entitled to vote, all other
stockholders 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 charter or bylaws of
the 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. There can be no assurance that such provision will not be amended
or eliminated at any time in the future.
Amendment to the Charter
The Charter of the Company may be amended by the affirmative vote of holders
of shares entitled to cast a majority of all votes entitled to be cast on such
an amendment; provided, however, (i) no term or provision of the Charter may be
added, amended or repealed in any respect that would, in the determination of
the Board of Directors, cause the Company not to qualify as a REIT under the
Code, (ii) certain provisions of the Charter, including provisions relating to
the classification of directors, the removal of directors, Independent
Directors, preemptive rights of holders of stock and the indemnification and
limitation of liability of officers and directors may not be amended or repealed
and (iii) provisions imposing cumulative voting in the election of directors may
not be added to the Charter, unless, in each such case, such action is approved
by the affirmative vote of the holders of not less than two-thirds of all the
votes entitled to be cast on the matter.
Dissolution of the Company
The dissolution of the Company must be approved by the affirmative vote of the
holders of not less than a majority of all of the votes entitled to be cast on
the matter.
Advance Notice of Director Nominations and New Business
The Bylaws of the Company provide that (a) with respect to an annual meeting
of stockholders, nominations of persons for election of the Board of Directors
and the proposal of business to be considered by stockholders may be made only
(i) pursuant to the Company's notice of the meeting, (ii) by the Board of
Directors or (iii) by a stockholder who is entitled to vote at the meeting and
has complied with the advance notice procedures set forth in the Bylaws and (b)
with respect to special meetings of stockholders, only the business specified in
the Company's notice of meeting may be brought before the meeting of
stockholders and nominations of persons for election to the Board of Directors
(iii) provided that the Board of Directors has determined that directors shall
be elected at such meeting, by a stockholder who is entitled to vote at the
meeting and has complied with the advance notice provisions set forth in the
Bylaws.
Meetings of Stockholders
The Company's Bylaws provide that annual meetings of stockholders shall be
held on a date and at the time set by the Board of Directors during the month of
May each year (commencing in May 1997). Special meetings of the stockholders
may be called by (i) the President of the Company, (ii) the Chief Executive
Officer or (iii) the Board of Directors. As permitted by the MGCL, the Bylaws
of the Company provide that special meetings must be called by the Secretary of
the Company upon the written request of the holders of shares entitled to cast
not less than a majority of all votes entitled to be cast at the meeting.
Operations
The Charter requires the Board of Directors generally to use commercially
reasonable efforts to cause the Company to qualify as a REIT.
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Anti-Takeover Effect of Certain Provisions of Maryland Law and of the Charter
and Bylaws
The business combination provisions and, if the applicable provision in the
Bylaws is amended or rescinded, the control share acquisition provisions of the
MGCL, the provisions of the Charter on classification of the Board of Directors
and removal of directors and the advance notice provisions of the Bylaws could
delay, defer or prevent a transaction or a change in control of the Company that
might involve a premium price for holders of Common Stock or otherwise be in
their best interest.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Common Stock is Continental Stock
Transfer & Trust Company.
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DESCRIPTION OF OP UNITS
GENERAL
Substantially all of the Company's assets are held by, and all of its
operations are conducted through the Operating Partnership. AGH GP, Inc. is a
wholly owned subsidiary of the Company and is the sole general partner of the
Operating Partnership holding 1% of the issued OP Units therein. AGH LP, Inc.
is a wholly owned subsidiary of the Company and is a limited partner of the
Operating Partnership holding as of September 30, 1997 approximately 86.22% of
the issued OP Units therein. The remaining issued OP Units are held by other
Limited Partners who acquired their units in exchange for property or other
interests.
The material terms of the OP Units, including a summary of certain provisions
of the Partnership Agreement, are set forth below. The following description of
the terms and provisions of the OP Units and certain other matters does not
purport to complete and is subject to and qualified in its entirety by reference
to applicable provisions of Maryland law and the Partnership Agreement.
MANAGEMENT
The Operating Partnership is organized as a Delaware limited partnership with
AGH GP, as general partner, AGH LP, as a limited partner, and certain other
persons, as additional limited partners (the "Partnership Agreement"). Pursuant
to the Partnership Agreement, AGH GP, as the sole general partner of the
Operating Partnership (the "General Partner"), has full, exclusive and complete
responsibility and discretion in the management and control of the Operating
Partnership, and the Limited Partners in their capacity as such have no
authority to transact business for, or participate in the management activities
or decisions of, the Operating Partnership. However, any amendment to the
Partnership Agreement, other than amendments that (i) add to the obligations of
the General Partner, (ii) reflect the admission or withdrawal of partners, (iii)
set forth the rights or preferences of additional partnership interests issued
by the Operating Partnership, (iv) reflect a change that does not adversely
affect Limited Partner, and (v) are necessary to satisfy legal requirements,
requires the consent of Limited Partners holding more than 50.0% of the OP Units
held by such Limited Partners. The consent of each adversely affected partner is
required for any amendment that would affect a Limited Partner's liability or
right to receive distributions or that would dissolve the Operating Partnership
prior to December 31, 2046 (other than as a result of certain mergers or
consolidations).
TRANSFERABILITY OF INTERESTS
Subject to limited exceptions, AGH GP and AGH LP may not voluntarily withdraw
from the Operating Partnership or transfer or assign their interests in the
Operating Partnership unless the transaction in which such withdrawal or
transfer occurs results in the Limited Partners' receiving property in an amount
equal to the amount they would have received had they exercised their Exchange
Rights immediately prior to such transaction, or unless the successors to AGH GP
and AGH LP contribute substantially all of their assets to the Operating
Partnership in return for an interest in the Operating Partnership. With certain
exceptions, the Limited Partners may transfer their OP Units, in whole or in
part, without the consent of the General Partner.
CAPITAL CONTRIBUTION
The Partnership Agreement provides that if the Operating Partnership requires
additional funds at any time or from time to time in excess of funds available
to the Operating Partnership from borrowing or capital contributions, the
Company may borrow such funds from a financial institution or other lender and
lend such funds to the Operating Partnership on the same terms and conditions as
are applicable to the Company's borrowing of such funds. Under the Partnership
Agreement, the Company generally is obligated to contribute, through AGH GP and
AGH LP, the proceeds of any stock offering as additional capital to the
Operating Partnership. Moreover, the Company is authorized, through AGH GP and
AGH LP, to cause the Operating Partnership to issue partnership interests for
less than fair market value if the Company has concluded in good faith that such
issuance is in the best interests of the Company and the Operating Partnership.
If the Company so contributes additional capital to the Operating Partnership,
AGH GP and AGH LP will receive additional OP Units, and their percentage
interests in the Operating Partnership will be increased on a proportionate
basis based upon the amount of such additional capital contributions and the
value of the Operating Partnership at the time of such contributions.
Conversely, the percentage interests of the Limited Partners, other than AGH LP,
will be decreased on a proportionate basis in the event of additional capital
contributions by the Company.
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EXCHANGE RIGHTS
Pursuant to the Exchange Rights Agreement among the Company, the Operating
Partnership and the Limited Partners other than AGH LP, such Limited Partners
received rights (the "Exchange Rights") that enable them to cause the Operating
Partnership to exchange each OP Unit for cash equal to the value of one share of
Common Stock (or, at the Company's election, the Company may purchase each OP
Unit offered for exchange for one share of Common Stock). The Company may not
satisfy a Limited Partner's Exchange Right by delivery of Common Stock, if and
to the extent that the delivery of Common Stock upon exercise of such rights
would (i) be prohibited under the Charter, (ii) otherwise jeopardize the REIT
status of the Company, or (iii) cause the acquisition of shares of Common Stock
by such exchanging Limited Partner to be "integrated" with any other
distribution of shares of Common Stock for purposes of complying with the
Securities Act. A Limited Partner may not exercise the Exchange Rights for less
than 1,000 OP Units or, if such Limited Partner holds less than 1,000 OP Units,
for all of the OP Units held by such Limited Partner.
REGISTRATION RIGHTS
Pursuant to the Registration Rights Agreements among the Company and the
Limited Partners other than AGH LP (the "Registration Rights Agreements"), the
Limited Partners have certain rights to require the registration for resale of
the shares of Common Stock held by them or received by them upon exchange of
their OP Units. Such rights include the right to include such shares in the
registration statement of which this Prospectus is a part. The Company is
required to bear the costs of such registration statements exclusive of
underwriting discounts, commissions and certain other costs attributable to, and
to be borne by, the selling stockholders.
OPERATIONS
The Partnership Agreement requires that the Operating Partnership be operated
in a manner that will enable the Company to satisfy the requirements for being
classified as a REIT, to avoid any federal income or excise tax liability
imposed under the Code and to ensure that the Operating Partnership will not be
classified as a "publicly traded partnership" for purposes of section 7704 of
the Code.
In addition to the administrative and operating costs and expenses incurred by
the Operating Partnership, the Operating Partnership pays all administrative
costs and expenses of the Company, AGH GP and AGH LP (the "Company Expenses"),
and the Company Expenses are treated as expenses of the Operating Partnership.
The Company Expenses generally include (i) all expenses relating to the
formation of the Company and the Operating Partnership, (ii) all expenses
relating to the public offering and registration of securities by the Company,
(iii) all expenses associated with the preparation and filing of any periodic
reports by the Company under federal, state or local laws or regulations, (iv)
all expenses associated with compliance by the Company, AGH GP and AGH LP with
laws, rules and regulations promulgated by any regulatory body and (v) all other
operating or administrative costs of AGH GP incurred in the ordinary course of
its business on behalf of the Operating Partnership. The Company Expenses,
however, do not include any administrative and operating costs and expenses
incurred by the Company that are attributable to hotel properties or partnership
interests in a Subsidiary Partnership that are owned by the Company directly
rather than through the Operating Partnership. The Company does not own any of
the Hotels directly.
DISTRIBUTIONS AND ALLOCATIONS
The Partnership Agreement provides that the Operating Partnership will
distribute cash from operations (including net sale or refinancing proceeds, but
excluding net proceeds from the sale of the Operating Partnership's property in
connection with the liquidation of the Operating Partnership) on a quarterly
(or, at the election of the General Partner, more frequent) basis, in amounts
determined by the General Partner in its sole discretion, to the partners in
accordance with their respective percentage interests in the Operating
Partnership. Upon liquidation of the Operating Partnership, after payment of, or
adequate provision for, debts and obligations of the Operating Partnership,
including any partner loans, any remaining assets of the Operating Partnership
will be distributed to all partners with positive capital accounts in accordance
with their respective positive capital account balances.
Profit and loss of the Operating Partnership for each fiscal year of the
Operating Partnership generally will be allocated among the partners in
accordance with their respective interests in the Operating Partnership. Taxable
income and loss will be allocated in the same manner, subject to compliance with
the provisions of Code sections 704(b) and 704(c) and the Treasury Regulations
promulgated thereunder.
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TERM
The Operating Partnership will continue until December 31, 2046, or until
sooner dissolved upon (i) the withdrawal of the General Partner (unless a
majority of remaining partners elect to continue the business of the Operating
Partnership), (ii) the election by the General Partner to dissolve the Operating
Partnership (which election, prior to December 31, 2046, requires the consent of
a majority of the Limited Partners other than AGH LP), (iii) the entry of a
decree of judicial dissolution of the Operating Partnership, (iv) the sale of
all or substantially all the assets and properties of the Operating Partnership,
or (v) the bankruptcy or insolvency of AGH GP, unless all of the remaining
partners elect to continue the business of the Operating Partnership.
TAX MATTERS
Pursuant to the Partnership Agreement, the General Partner will be the tax
matters partner of the Operating Partnership and, as such, will have authority
to handle tax audits and to make tax elections under the Code on behalf of the
Operating Partnership.
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FEDERAL INCOME TAX CONSIDERATIONS
The Company operates in such a manner so as to meet the Code requirements for
qualification as a REIT for federal income tax purposes. However, no assurance
can be given that such requirements will be met or that the Company will be so
qualified at any time. Based on various assumptions relating to the organization
and operation of the Company and the Operating Partnership and representations
made by the Company and the Operating Partnership as to certain factual matters,
including matters related to the organization and operation of the Company, the
Operating Partnership and the Subsidiary Partnerships, in the opinion of
Counsel, Battle Fowler LLP, the Company qualifies to be taxed as a REIT under
the Code commencing with its taxable year ending December 31, 1996 and the
Operating Partnership and the Subsidiary Partnerships will be treated as
partnerships for federal income tax purposes. Counsel will not review the
Company's operating results and no assurance can be given that the Company's
actual operating results will meet the REIT requirements on a continuing basis.
The opinions described herein represent Counsel's best legal judgment as to
the most likely outcome of an issue if the matter were litigated. Opinions of
counsel have no binding effect or official status of any kind, and in the
absence of a ruling from the IRS, there can be no assurance that the IRS will
not challenge the conclusion or propriety of any of Counsel's opinions. The
Company does not intend to apply for a ruling from the IRS that it qualifies as
a REIT.
The following summary includes a discussion of the material federal income tax
considerations associated with an investment in the Common Stock being sold in
the Offering. The summary should not be construed as tax advice. The provisions
governing treatment as a REIT are highly technical and complex, and this summary
is qualified in its entirety by the applicable Code provisions, the rules and
regulations promulgated thereunder and administrative and judicial
interpretations thereof. Moreover, this summary does not deal with all tax
aspects that might be relevant to a particular prospective stockholder in light
of his personal circumstances and it does not deal with particular types of
stockholders that are subject to special treatment under the Code, such as tax-
exempt organizations, insurance companies, financial institutions or broker-
dealers, and (with the exception of the general discussion below) foreign
corporations and persons who are not citizens or residents of the United States.
EACH PROSPECTIVE PURCHASER IS ADVISED TO CONSULT HIS OWN TAX ADVISOR REGARDING
THE SPECIFIC FEDERAL, STATE, LOCAL, FOREIGN AND OTHER TAX CONSEQUENCES TO HIM OF
THE PURCHASE, OWNERSHIP AND SALE OF COMMON STOCK, OF THE COMPANY'S ELECTION TO
BE TAXED AS A REIT AND OF POTENTIAL CHANGES IN APPLICABLE TAX LAWS.
REQUIREMENTS FOR QUALIFICATION AS A REIT
In General. Under the Code, a trust, corporation or unincorporated
association meeting certain requirements (see "--Structural Requirements") may
elect to be treated as a REIT for purposes of federal income taxation. If a
valid election is made, then, subject to certain conditions, the Company's
income which is distributed to its stockholders generally will be taxed to such
stockholders without being subject to tax at the Company level. This
substantially eliminates the "double taxation" (taxation at both the corporate
and stockholder levels) that typically results from the use of corporate
investment vehicles. However, the Company will be taxed at regular corporate
rates on any of its income that is not distributed to the stockholders. (See "--
Taxation of the Company.") Once made, the election to be taxed as a REIT
continues in effect until voluntarily revoked or automatically terminated by the
Company's failure to qualify as a REIT for a taxable year. If the Company's
election to be treated as a REIT is terminated automatically or is voluntarily
revoked, the Company will not be eligible to elect such status until the fifth
taxable year after the first taxable year for which the Company's election was
terminated. However, in the event such election is terminated automatically, the
four-year prohibition on a subsequent election to be taxed as a REIT is not
applicable if (i) the Company did not willfully fail to file a timely return
with respect to the termination taxable year, (ii) the inclusion of any
incorrect information in such return was not due to fraud with intent to evade
tax, and (iii) the Company establishes that its failure to meet the requirements
was due to reasonable cause and not to willful neglect.
The Company will make an election to be treated as a REIT commencing with its
taxable year ending December 31, 1996.
Structural Requirements. To be eligible to be taxed as a REIT, the Company
must satisfy certain structural and organizational requirements. Among the
requirements are the following: (i) the shares of Common Stock must be
transferable, (ii) the shares of Common Stock must be held by 100 or more
persons during at least 335 days of a taxable year of twelve months (or during a
proportionate part of a taxable year of less than twelve months) (the "100-
person requirement"), and (iii) no more than 50% of the value of the outstanding
shares of Common Stock may be owned, directly or indirectly, by five or fewer
individuals at any time during the last half of each taxable year (the "five or
fewer" requirement). The requirements of (ii) and (iii) are not applicable to
the first taxable year for which
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the Company makes an election to be treated as a REIT. However, the Company
believes that it has issued a sufficient amount of Common Stock with sufficient
diversity of ownership so that requirements (ii) and (iii) are satisfied. The
Company expects, and intends to take all necessary measures within its control
to ensure, that the beneficial ownership of the Company will at all times be
held by 100 or more persons. In addition, the Company's Charter contains certain
restrictions on the ownership and transfer of the Company's stock which are
designed to help ensure that the Company will be able to satisfy the "five or
fewer" requirement. If the Company were to fail to satisfy the "five or fewer"
requirement, the Company's status as a REIT would terminate, and the Company
would not be able to prevent such termination. See "--Failure to Qualify as a
REIT" and "Description of Capital Stock--Restrictions on Transfer."
If a REIT owns a corporate subsidiary that is a "qualified REIT subsidiary,"
that subsidiary is disregarded for federal income tax purposes, and all assets,
liabilities and items of income, deduction and credit of the subsidiary are
treated as assets, liabilities and such items of the REIT itself. A "qualified
REIT subsidiary" is a corporation all of the stock of which is owned by the
REIT. For taxable years ending on or before December 31, 1997, the Company must
own all of the stock of the corporate subsidiary from the commencement of such
corporation's existence. The Company has two wholly owned subsidiary
corporations, AGH GP and AGH LP, which are "qualified REIT subsidiaries."
Consequently, AGH GP and AGH LP will not be subject to federal corporate income
taxation, although they may be subject to state and local taxation. The Company
also may have additional corporate subsidiaries in the future.
Income Tests. In order to qualify and to continue to qualify as a REIT for
years ending on or before December 31, 1997, the Company must satisfy three
income tests for each taxable year. First, at least 75% of the Company's annual
gross income (excluding annual gross income from certain sales of property held
primarily for sale to customers in the ordinary course of business) must be
derived directly or indirectly from investments relating to real property or
mortgages on real property or certain temporary investments. Second, at least
95% of the Company's annual gross income (excluding gross income from certain
sales of property held primarily for sale in the ordinary course of business)
must be derived directly or indirectly from any of the sources qualifying for
the 75% test and from dividends, interest, and gain from the sale or disposition
of stock or securities. Third, subject to certain exceptions in the year in
which the Company is liquidated, (i) short-term gains from sales of stock or
securities, (ii) gains from sales of property (other than foreclosure property)
held primarily for sale to customers in the ordinary course of business and
(iii) gains from the sale or other taxable disposition of real property
(including interests in real property and mortgages on real property) held for
less than four years (other than from involuntary conversions and foreclosure
property) must represent in the aggregate less than 30% of the Company's annual
gross income. In applying these tests, because the Company is a partner in the
Operating Partnership, which is in turn a partner, either directly or
indirectly, in the Subsidiary Partnerships, the Company will be treated as
realizing its proportionate share of the income and loss of these respective
partnerships, as well as the character of such income or loss, and other
partnership items, as if the Company owned its proportionate share of the assets
owned by these partnerships directly. For taxable years beginning on or after
January 1, 1998, the third test noted above has been repealed by the enactment
of the Taxpayer Relief Act of 1997. Thus, for the Company's taxable years
beginning on and after January 1, 1998, the Company no longer is required to
satisfy the 30 percent income test.
Substantially all of the income received by the Company is expected to be
rental income from the Rents. In order to qualify as "rents from real property"
for purposes of satisfying the 75% and 95% gross income tests, several
conditions must be satisfied. First, the amount of rent must not be based in
whole or in part on the income or profits of any person, although rents
generally will qualify as rents from real property if they are based on a fixed
percentage of receipts or sales. Second, rents received from a tenant will not
qualify as "rents from real property" 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, the portion of rent attributable to such personal
property will not qualify as "rents from real property." Finally, 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"
from whom the Company derives no income. However, the "independent contractor"
requirement does not apply to the extent the services rendered by the Company
are customarily furnished or rendered in connection with the rental of the real
property (i.e., services which are not considered rendered to the occupant of
the property). In addition, for taxable years of the Company beginning on or
after January 1, 1998, the Company is permitted to receive up to 1% of the gross
income of each Hotel from the provision of non-customary services and still
treat all other amounts received from such Hotel as "rents from real property."
Pursuant to the Participating Leases, the Lessee has leased from the Operating
Partnership the land, buildings, improvements, furnishings, and equipment
comprising the Hotels for a term of twelve years. The Participating Leases
provide that the Lessee will be obligated to pay to the Operating Partnership
(i) the greater of Base Rent or Participating Rent and (ii) Additional Charges.
Participating Rent is calculated by multiplying fixed percentages by various
revenue categories for each of the Hotels. Generally, both Base Rent and the
thresholds in the Participating Rent formulas will be adjusted for
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inflation. Base Rent accrues and is required to be paid monthly. Participating
Rent is payable quarterly, with a yearly adjustment based on actual results.
In order for Base Rent, Participating Rent, and Additional Charges to
constitute "rents from real property," the Participating 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. The
determination of whether the Participating Leases are true leases depends on an
analysis of all the surrounding facts and circumstances. In making such a
determination, courts have considered a variety of factors, including: (i) the
intent of the parties, (ii) the form of the agreement, (iii) the degree of
control over the property that is retained by the property owner (e.g., whether
the lessee has substantial control over the operation of the property or whether
the lessee was required simply to use its best efforts to perform its
obligations under the agreement), and (iv) the extent to which the property
owner retains the risk of loss with respect to the property (e.g., whether the
lessee bears the risk of increases in operating expenses or the risk of damage
to the property) or the potential for economic gain (e.g., appreciation) with
respect to the property.
In addition, Code section 7701(e) provides that a contract that purports to be
a service contract (or a partnership agreement) is treated instead as a lease of
property if the contract is properly treated as such, taking into account all
relevant factors, including whether or not: (i) the service recipient is in
physical possession of the property, (ii) the service recipient controls the
property, (iii) the service recipient has a significant economic or possessory
interest in the property (e.g., the property's use is likely to be dedicated to
the service recipient for a substantial portion of the useful life of the
property, the recipient shares the risk that the property will decline in value,
the recipient shares in any appreciation in the value of the property, the
recipient shares in increases in the property's operating costs, or the
recipient bears the risk of damage to or loss of the property), (iv) the service
provider does not bear any risk of substantially diminished receipts or
substantially increased expenditures if there is nonperformance under the
contract, (v) the service provider does not use the property concurrently to
provide significant services to entities related to the service recipient, and
(vi) the total contract price does not substantially exceed the rental value of
the property for the contract period. Since the determination of whether a
service contract should be treated as a lease is inherently factual, the
presence or absence of any single factor may not be dispositive in every case.
Battle Fowler LLP is of the opinion that the Participating Leases will be
treated as true leases for federal income tax purposes. Such opinion is based,
in part, on the following facts: (i) the Operating Partnership or a Subsidiary
Partnership, as applicable, and the Lessee intend for their relationship to be
that of a lessor and lessee and such relationship will be documented by lease
agreements, (ii) the Lessee will have the right to exclusive possession and use
and quiet enjoyment of the Hotels during the term of the Participating Leases,
(iii) the Lessee will bear the cost of, and be responsible for, day-to-day
maintenance and repair of the Hotels and generally will control how the Hotels
are operated and maintained, (iv) the Lessee will bear all of the costs and
expenses of operating the Hotels (including the cost of any inventory used in
their operation) during the term of the Participating Leases (other than real
estate and personal property taxes, casualty insurance and capital improvements
(determined in accordance with generally accepted accounting principles)), (v)
the Lessee will benefit from any savings in the costs of operating the Hotels
during the term of the Participating Leases, (vi) the Lessee will indemnify the
Company against all liabilities imposed upon or asserted against the Company
during the term of the Participating Leases by reason of, among other things,
(A) accident, injury to or death of persons, or loss of or damage to property
occurring at the Hotels or (B) the Lessee's use, management, maintenance or
repair of the Hotels, (vii) the Lessee is obligated to pay substantial fixed
rent for the period of use of the Hotels, and (viii) the Lessee stands to incur
substantial losses (or reap substantial gains) depending on how successfully it
operates the Hotels.
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 Participating Leases that discuss whether such
leases constitute true leases for federal income tax purposes. Therefore, the
opinion of Battle Fowler LLP with respect to the relationship between the
Operating Partnership or a Subsidiary Partnership, as applicable, and the Lessee
is based upon all of the facts and circumstances and upon rulings and judicial
decisions involving situations that are considered to be analogous. Opinions of
counsel are not binding upon the IRS or any court, and there can be no complete
assurance that the IRS will not assert successfully a contrary position. If the
Participating Leases are recharacterized as service contracts or partnership
agreements, rather than true leases, part or all of the payments that the
Operating Partnership and the Subsidiary Partnerships receive 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 likely would not be able to satisfy either the 75% or 95% gross income
tests and, as a result, would lose its REIT status.
As noted above, the Rents attributable to personal property leased in
connection with the lease of the real property comprising a Hotel must not be
greater than 15% of the Rents received under the Participating Lease. 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
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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"). With respect to each
Hotel (or interest therein) that the Operating Partnership acquires for cash,
the aggregate initial adjusted bases of the real and personal property generally
will be allocated among real and personal property based on relative fair market
values. The Participating Leases provide that the Adjusted Basis Ratio for each
Hotel shall not exceed 15%. The Participating Leases further provide that the
Lessee will cooperate in good faith and use its best efforts to prevent the
Adjusted Basis Ratio for any Hotel from exceeding 15%, which cooperation
includes the purchase by Lessee at fair market value of enough personal property
at such Hotel so that the Adjusted Basis Ratio for such Hotel is less than 15%.
In the event that the amount of personal property relating to certain of the
Hotels will result in an Adjusted Basis Ratio in excess of 15% and therefore
would cause a portion of the Rents received attributable to such Hotels to not
qualify as rents from real property, the Operating Partnership will sell a
portion of such personal property relating to such Hotels to the Lessee in
exchange for the FF&E Note. In addition, the Participating Leases provide that
if future renovations and refurbishments to a Hotel would cause the Adjusted
Basis Ratio for such Hotel to exceed 15%, the Operating Partnership and/or a
Subsidiary Partnership, if applicable, has the right to sell as much personal
property to the Lessee as necessary so that the Adjusted Basis Ratio does not
exceed 15% for such Hotel. The interest income derived from the FF&E Note will
be qualifying income for the 95% gross income test but not for the 75% gross
income test. Finally, amounts in the Company's reserve for capital expenditures
may not be expended to acquire additional personal property for a Hotel to the
extent that such acquisition would cause the Adjusted Basis Ratio for that Hotel
to exceed 15%. The Company does not expect the Adjusted Basis Ratio for any
Hotel to exceed 15% and therefore expects that the portion of rents received
attributable to personal property will be treated as rents from real property.
However, there can be no assurance that the IRS would not assert that the
personal property acquired by the Operating Partnership or a Subsidiary
Partnership had a value in excess of the appraised value, or that a court would
not uphold such assertion. If such a challenge were successfully asserted, a
portion of the rents received under the Participating Leases would not qualify
as rents from real property. However, the Company does not expect such an
amount, if any, when combined with any other income that is nonqualifying income
for purposes of the 95% gross income test, to exceed 5% of the Company's annual
gross income, which would cause the Company to lose its status as a REIT.
As noted earlier, in order to be treated as "rents from real property," the
Participating Rent must not be based in whole or in part on the income or
profits of any person. The Participating 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 Participating Leases are entered into,
(ii) are not renegotiated during the term of the Participating Leases in a
manner that has the effect of basing Participating Rent on income or profits,
and (iii) conform with normal business practice. More generally, the
Participating Rent will not qualify as "rents from real property" if,
considering the Participating 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 Participating Rent on income or profits. Since the
Participating Rent is based on fixed percentages of the gross revenues from the
Hotels that are established in the Participating Leases, and the Company has
represented that the percentages (i) will not be renegotiated during the terms
of the Participating Leases in a manner that has the effect of basing the
Participating Rent on income or profits and (ii) conform with normal business
practice, the Participating Rent should not be considered based in whole or in
part on the income or profits of any person. Furthermore, the Company has
represented that, with respect to other hotel properties that it acquires in the
future, if any, it will not 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).
As noted above, rent received from a Related Party Tenant does not qualify as
"rents from real property." Thus, the Company must not own, actually or
constructively, 10% or more of the Lessee. Applicable constructive ownership
rules generally provide that, if 10% or more in value of the stock of the
Company is owned, directly or indirectly, by or for any person, the Company is
considered as owning the stock owned, directly or indirectly, by or for such
person. The Limited Partners of the Operating Partnership may acquire Common
Stock (at the Company's option) by exercising their Exchange Rights. In
addition, during the period of the Lessee Distribution Restriction, the Lessee
will be required, subject to compliance with applicable securities laws, to
purchase annually Common Stock on the open market or, if any such purchase would
violate the ownership limitation in the Company's Charter, at the option of the
Operating Partnership, OP Units from the Operating Partnership, in an amount
equal to the Lessee's cash flow attributable to the Participating Leases for the
preceding fiscal year (after establishing a reserve for partner tax
distributions). In addition, Messrs. Jorns and Wiles are required to use 50% of
the after-tax dividends received by them from AGHI that are attributable to
AGHI's earnings from the management of hotels owned by the Company to purchase
annually in the open market shares of Common Stock. The Exchange Agreement
provides that the Company may not satisfy an exchanging Limited Partner's
Exchange Right by delivery of Common Stock, if and to the extent the delivery of
Common Stock upon the exercise of such rights would cause the Company to own,
actually or constructively, 10% or more of the ownership interest in a tenant of
the Company's, the Operating Partnership's or a Subsidiary Partnership's real
property, within the meaning of section 856(d)(2)(B) of the Code. The Charter
likewise prohibits a stockholder of the Company from owning Common Stock that
would
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cause the Company to own, actually or constructively, 10% or more of the
ownership interests in a tenant of the Company's, the Operating Partnership's or
a Subsidiary Partnership's real property, within the meaning of section
856(d)(2)(B) of the Code. Thus, the Company should never own, actually or
constructively, 10% of more of the Lessee. However, because the Code's
constructive ownership rules for purposes of the Related Party Tenant rules are
broad and it is not possible to monitor continually direct and indirect
transfers of Common Stock, no absolute assurance can be given that such
transfers or other events of which the Company has no knowledge will not cause
the Company to own constructively 10% or more of the Lessee at some future date.
A fourth requirement noted above for qualification of the Rents as "rents from
real property" is that for taxable years ending on or before December 31, 1997,
the Company cannot furnish or render noncustomary services to the tenants of the
Hotels, or manage or operate the Hotels, 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 Participating Leases are
respected as true leases, the Company should satisfy this requirement, because
AGHI, pursuant to the Management Agreements, will be performing services to such
tenants for the Lessee, which will lease the Hotels from the Operating
Partnership. Neither the Company, the Operating Partnership nor any Subsidiary
Partnership will furnish or provide any services to a tenant, and none of such
entities will contract with any other person to provide any such services. The
Company has represented that if the Company decides to render noncustomary
services to tenants in the future, it will do so through an independent
contractor from which it will not receive any income.
If a portion of the Rents from a particular hotel property does not qualify as
"rents from real property" because the amount attributable to personal property
exceeds 15% of the total Rents for a taxable year, the portion of the Rents that
is attributable to personal property will not be qualifying income for purposes
of either the 75% or 95% gross income tests. A portion of the Rent paid to the
Company by the Lessee will be allocable to the Franchise Licenses. Appraisals
obtained by the Company with respect to the Initial Hotels indicate that the
Franchise Licenses with respect to the Initial Hotels represent less than 1.0%
of the total value of the Company's assets. The Company is currently in the
process of obtaining appraisals of the Franchise Licenses with respect to all
hotels acquired after the Initial Hotels. Because the Company does not expect
the total amount of Rents attributable to personal property plus any other non-
qualifying income it receives (including any amounts attributable to the
Franchise Licenses) to exceed 5% of its annual gross income, the Company's REIT
status should not be affected. If, however, the Rents do not qualify as "rents
from real property" because either (i) the Participating Rent is considered
based on income or profits of the Lessee, (ii) the Company owns, actually or
constructively, 10% or more of the Lessee, or (iii) the Company furnishes
noncustomary services to the tenants of the Hotels, or manages or operates the
Hotels, other than through a qualifying independent contractor, and for taxable
years of the Company beginning on or after January 1, 1998, the Company is
deemed to receive income from the provision of such noncustomary services or
from managing or operating the Hotels in excess of 1% of all amounts received
with respect to such Hotels, none of the Rents would qualify as "rents from real
property." In that case, the Company likely 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 Operating
Partnership Additional Charges. To the extent that Additional Charges represent
either (i) reimbursements of amounts that the Lessee is obligated to pay to
third parties or (ii) penalties for nonpayment or late payment of such amounts,
Additional Changes should qualify as "rents from real property." To the extent,
however, that Additional Charges represent interest that is accrued on the late
payment of the Rents or Additional Charges, Additional Charges would not qualify
as "rents from real property," but instead would be treated as interest that
qualifies for the 95% gross income test.
Based on the foregoing, the Rents and the Additional Charges should qualify as
"rents from real property" for purposes of the 75% and 95% gross income tests,
except to the extent that the Additional Charges represent interest that is
accrued on the late payment of the Rents or the Additional Charges (which will
be qualifying gross income for the 95% test but not the 75% test).
The term "interest" generally does not include any amount received or accrued
(directly or indirectly) if the determination of such amount depends 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 "interest" solely by reason
of being based on a fixed percentage or percentages of receipts or sales.
Furthermore, interest from a loan that is based on the residual cash proceeds
from sale of the property securing the loan will be treated as gain from the
sale of the secured property.
It is possible that, from time to time, the Company, the Operating Partnership
or a Subsidiary Partnership will enter into hedging transactions with respect to
one or more of its assets or liabilities. Any such hedging transactions could
take a variety of forms. If the Company, the Operating Partnership or a
Subsidiary Partnership enters into an interest rate swap or cap contract to
hedge any variable rate indebtedness incurred to acquire or carry real estate
assets, any periodic income or gain from the disposition of such contract should
be qualifying income for purposes
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of the 95% gross income test, but not for the 75% gross income test.
Furthermore, for taxable years of the Company on December 31, 1997, any such
contract would be considered a "security" for purposes of applying the 30% gross
income test. To the extent that the Company, the Operating Partnership or a
Subsidiary Partnership hedges with other types of financial instruments or in
other situations, it may not be entirely clear how the income from those
transactions will be treated for purposes of the various income tests that apply
to REITs under the Code. The Company intends to structure any hedging
transactions in a manner that does not jeopardize its status as a REIT.
If the sum of the income realized by the Company (whether directly or through
its interest in the Operating Partnership or the Subsidiary Partnerships) which
does not satisfy the requirements of the 95% gross income test (collectively,
"Non-Qualifying Income"), exceeds 5% of the Company's gross income for any
taxable year, the Company's status as a REIT would be jeopardized. The Company
has represented that the amount of its Non-Qualifying Income will not exceed 5%
of the Company's annual gross income for any taxable year.
If the Company fails to satisfy one or both of the 75% or 95% gross income
tests for any taxable year, it may still qualify as a REIT for such year if the
Company's failure to meet such tests was due to reasonable cause and not 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 supplied
fraudulently with the intent to evade tax. It is not possible to specify the
circumstances under which the Company may be entitled to the benefit of these
relief provisions. Even if these relief provisions apply, a 100% tax is imposed
on the net income attributable to the greater of the amount by which the Company
failed the 75% test or the 95% test. Failure to comply with the 30% gross
income test is not excusable; therefore, if the Company fails to meet the
requirements of the 30% gross income test for a taxable year ending on or before
December 31, 1997, its status as a REIT automatically terminates regardless of
the reason for such failure.
Asset Tests. At the close of each quarter of its taxable year, the Company
also must satisfy two tests relating to the nature and diversification of its
assets. First, at least 75% of the value of the Company's total assets must be
represented by real estate assets (including its allocable share of real estate
assets held by the Operating Partnership and the Subsidiary Partnerships), stock
or debt instruments held for not more than one year purchased with the proceeds
of an issuance of stock or long-term (at least five years) debt of the Company,
cash, cash items and government securities. Second, no more than 25% of the
Company's total assets may be represented by securities other than those that
can satisfy the 75% asset test described in the preceding sentence. Of the
investments included in the 25% asset class, the value of any one issuer's
securities (excluding shares in qualified REIT subsidiaries such as AGH GP and
AGH LP or another REIT and excluding partnership interests such as those in the
Operating Partnership and in any Subsidiary Partnerships) 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
(excluding securities of a qualified REIT subsidiary or another REIT and
excluding partnership interests). The Company has represented that, as of the
date of the Offering, (i) at least 75% of the value of its total assets will be
represented by real estate assets, cash and cash items (including receivables),
and government securities and (ii) it will not own any securities that do not
satisfy the 25% asset requirement. In addition, the Company has represented that
it will not acquire or dispose, or cause the Operating Partnership or a
Subsidiary Partnership to acquire or dispose, of assets in the future in a way
that would cause it to violate either asset requirement. See "--Other Tax
Considerations--State and Local Taxes."
Annual Distribution Requirements. In order to qualify as a REIT, the Company
must distribute to the holders of shares of Common Stock an amount at least
equal to (A) the sum of 95% of (i) the Company's "real estate investment trust
taxable income" (computed without regard to the deduction for dividends paid and
excluding any net capital gain) plus (ii) the excess of the net income, if any,
from foreclosure property over the tax on such income, minus (B) the excess of
the sum of certain items of non-cash income (income attributable to leveled
stepped rents, original issue discount on purchase money debt, or a like-kind
exchange that is later determined to be taxable (plus, for taxable years
beginning on or after January 1, 1998, income from cancellation of
indebtedness, original issue discount and coupon interest) over 5% of the amount
determined under clause (i) above). 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 distribution date after such declaration. The amount
distributed must not be preferential--i.e., each holder of shares of Common
Stock must receive the same distribution per share. A REIT may have more than
one class of stock, as long as distributions within each class are pro rata and
non-preferential. Such distributions are taxable to holders of Common Stock
(other than tax-exempt entities or nontaxable persons, as discussed below) in
the year in which paid, even though such distributions reduce the Company's
taxable income for the year in which declared. 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 "real estate investment trust taxable income," it will be
subject to tax thereon at regular corporate tax rates. Finally, as discussed
below, the Company may be subject to an excise tax if it fails to meet certain
other distribution requirements.
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The Company expects, and intends to take measures within its control, to make
quarterly distributions to the holders of shares of Common Stock in an amount
sufficient to satisfy the requirements of the annual distribution test. In this
regard, the Partnership Agreement authorizes AGH GP, as general partner, to take
such steps as are necessary to distribute to the partners of the Operating
Partnership an amount sufficient to permit the Company to meet the annual
distribution requirements. However, it is possible that the Company, from time
to time, may not have sufficient cash or other liquid assets to meet the 95%
distribution requirement, or to distribute such greater amount as may be
necessary to avoid income and excise taxation, due to timing differences between
(i) the actual receipt of income and actual payment of deductible expenses and
(ii) the inclusion of such income and deduction of such expenses in arriving at
taxable income of the Company, or if the amount of nondeductible expenses, such
as principal amortization or capital expenditures exceeds the amount of noncash
deductions, such as depreciation. In the event that such timing differences
occur, the Company may find it necessary to cause the Operating Partnership to
arrange for borrowings or liquidate some of its investments in order to meet the
annual distribution requirement, or attempt to declare a consent dividend, which
is a hypothetical distribution to holders of shares of Common Stock out of the
earnings and profits of the Company. The effect of such a consent dividend
(which, in conjunction with dividends actually paid, must not be preferential to
those holders who agree to such treatment) would be that such holders would be
treated for federal income tax purposes as if they had received such amount in
cash and they then had immediately contributed such amount back to the Company
as additional paid-in capital. This would result in taxable income to those
holders without the receipt of any actual cash distribution but would also
increase their tax basis in their shares of Common Stock by the amount of the
taxable income recognized.
If the Company fails to meet the 95% distribution test due to an adjustment to
the Company's income by reason of a judicial decision or by agreement with the
IRS, the Company may pay a "deficiency dividend" to holders of shares of Common
Stock in the taxable year of the adjustment, which dividend would relate back to
the year being adjusted. In such case, the Company also would be required to pay
interest plus a penalty to the IRS. However, a deficiency dividend cannot be
used to meet the 95% distribution test if the failure to meet such test was due
to the Company's failure to distribute sufficient amounts to the holders of
shares of Common Stock.
In addition, if the IRS successfully challenged the Company's deduction of all
or a portion of the salary and bonus it pays to officers who are also holders of
shares of Common Stock, such payments could be recharacterized as dividend
distributions to such employees in their capacity as stockholders. If such
distributions were viewed as preferential distributions, they would not count
toward the 95% distribution test.
FAILURE TO QUALIFY AS A REIT
The Company's treatment as a REIT for federal income tax purposes will be
terminated automatically if the Company fails to meet the requirements described
above and any available relief provisions do not apply. In such event, the
Company will be subject to tax (including any applicable alternative minimum
tax) on its taxable income at regular corporate rates, and distributions to
holders of shares of Common Stock will not be deductible by the Company. All
distributions to holders of shares of Common Stock will be taxable as ordinary
income to the extent of current and accumulated earnings and profits of the
Company and distributions in excess thereof will be treated first as a tax free
return of capital (to the extent of a holder's tax basis in his shares of Common
Stock) and then as gain realized from the sale of shares of Common Stock.
Corporate stockholders will be eligible for the dividends received deduction to
the extent that distributions are made out of earnings and profits. As noted
above, the Company will not be eligible to elect REIT status again until the
beginning of the fifth taxable year after the year during which the Company's
qualification was terminated, unless the Company meets certain relief
requirements. Failure to qualify for even one year could result in the Company
incurring substantial indebtedness (to the extent borrowings are feasible) or
liquidating substantial investments in order to pay the resulting corporate
income taxes.
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TAXATION OF THE COMPANY
In General. For any taxable year in which the Company qualifies as a REIT, it
will generally not be subject to federal income tax on that portion of its REIT
taxable income which is distributed to stockholders (except income or gain with
respect to foreclosure property, which will be taxed at the highest corporate
rate--currently 35%). If the Company were to fail to qualify as a REIT, it would
be taxed at rates applicable to corporations on all its income, whether or not
distributed to holders of shares of Common Stock. Even if it qualifies as a
REIT, the Company will be taxed on the portion of its REIT taxable income which
it does not distribute to the holders of shares of Common Stock, such as taxable
income retained as reserves.
100 Percent Tax. The Company will be subject to a 100% tax on (i) the greater
of the net income attributable to the amount by which it fails the 75% income
test or the 95% income test; and (ii) any net income derived from a "prohibited
transaction" (i.e., the sale of "dealer" property by the Company). The
imposition of any such tax on the Company would reduce the amount of cash
available for distribution to holders of shares of Common Stock.
A "dealer" is one who holds property primarily for sale to customers in the
ordinary course of its trade or business. All inventory required in the
operation of the Hotels will be owned by the Lessee under the terms of the
Participating Leases. Accordingly, the Company believes no asset owned by the
Company, the Operating Partnership or a Subsidiary Partnership is held for sale
to customers and that a sale of any such asset will not be in the ordinary
course of business of the Company, the Operating Partnership or a Subsidiary
Partnership. Whether property is held "primarily for sale to customers in the
ordinary course of a trade or business" depends, however, on the facts and
circumstances in effect from time to time, including those related to a
particular property. Nevertheless, the Company 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 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.
Because a determination of "dealer status" is necessarily dependent upon facts
which will occur in the future, Counsel cannot render an opinion on this issue.
Tax on Net Income from Foreclosure Property. The Company will be subject to a
tax at the highest rate applicable to corporations (currently 35%) on any "net
income from foreclosure property." "Foreclosure property" is property acquired
by the Company as a result of a foreclosure proceeding or by otherwise reducing
such property to ownership by agreement or process of law. "Net income from
foreclosure property" is the gross income derived during the taxable year from
foreclosure property, less applicable deductions, but only to the extent such
income does not qualify under the 75% income test and 95% income test. As a
result of the rules with respect to foreclosure property, if the Lessee defaults
on its obligations under a Participating Lease for a Hotel, the Company
terminates the Participating Lease, and the Company is unable to find a
replacement lessee for such Hotel within 90 days of such foreclosure, gross
income from hotel operations conducted by the Company from such Hotel would
cease to qualify for the 75% and 95% gross income tests and, thus, the Company
would fail to qualify as a REIT. However, although it is unclear under the
Code, if the hotel operations were conducted by an independent contractor, it
may be possible for the Hotel to cease to be foreclosure property two years
after such foreclosure, (which period could be extended an additional four
years).
Alternative Minimum Tax. The Company will be subject to the alternative
minimum tax on undistributed items of tax preference allocable to it. Code
Section 59(d) authorizes the Treasury to issue regulations allocating items of
tax preference between a REIT and its stockholders. Such regulations have not
yet been issued; however, the Company does not anticipate any significant items
of tax preference.
Excise Tax. In addition to the tax on any undistributed income, the Company
would also be subject to a 4% excise tax on the amount if any by which (i) the
sum of (A) 85% of its REIT taxable income for a calendar year, (B) 95% of any
net capital gain for such year and (C) any undistributed amounts (for purpose of
avoiding this excise tax) from prior years, exceeds (ii) the amount actually
distributed by the Company to holders of shares of Common Stock during the
calendar year (or declared as a dividend during the calendar year, if
distributed during the following January) as ordinary income dividends. The
imposition of any excise tax on the Company would reduce the amount of cash
available for distribution to holders of shares of Common Stock. The Company
intends to take all necessary measures within its control to avoid imposition of
the excise tax.
Tax on Built-In Gain of Certain Assets. If a C corporation elects to be taxed
as a REIT, or if assets of a C corporation are transferred to a REIT in a
transaction in which the REIT has a carryover basis in the assets acquired, such
C corporation generally will be treated as if it sold all of its assets to such
REIT at their respective fair market values and liquidated immediately
thereafter, recognizing and paying tax on all gain. However, under such
circumstances under present law, the REIT is permitted to make an election under
which the C corporation will not recognize gain and instead the REIT will be
required to recognize gain and pay any tax thereon only if it disposes
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of such assets during the subsequent 10-year period (the "10-Year Rule"). The
Company intends to make the appropriate election to obtain the above-described
tax consequences. Thus, if the Company acquires any asset from a C corporation
as a result of a merger or other nontaxable exchange, and the Company recognizes
gain on the disposition of such asset during the 10-year period following
acquisition of the asset, then such gain will be subject to tax at the highest
regular corporate rate to the extent the Built-In Gain (the excess of (a) the
fair market value of such asset as of the date of acquisition over (b) the
Company's adjusted basis in such asset as of such date) on the sale of such
asset exceeds any Built-In Loss arising from the disposition during the same
taxable year of any other assets acquired in the same transaction, where Built-
In Loss equals the excess of (x) the Company's adjusted basis in such other
assets as of the date of acquisition over (y) the fair market value of such
other assets as of such date.
TAXATION OF STOCKHOLDERS
Taxable U.S. Stockholders
Dividend Income. Distributions from the Company (other than distributions
designated as capital gains dividends) will be taxable to holders of shares of
Common Stock which are not tax-exempt entities as ordinary income to the extent
of the current or accumulated earnings and profits of the Company. Distributions
from the Company which are designated (by notice to stockholders within 30 days
after the close of the Company's tax year or with its annual report) as capital
gains dividends by the Company will be taxed as long-term capital gains to
taxable holders of shares of Common Stock to the extent that they do not exceed
the Company's actual net capital gain for the taxable year. Holders of shares of
Common Stock that are corporations may be required to treat up to 20% of any
such capital gains dividends as ordinary income. Such distributions, whether
characterized as ordinary income or as capital gain, are not eligible for the
70% dividends received deduction for corporations.
Distributions from the Company to holders which are not designated as capital
gains dividends and which are in excess of the Company's current and accumulated
earnings and profits are treated as a return of capital to such holders and
reduce the tax basis of a holder's shares of Common Stock (but not below zero).
Any such distribution in excess of the tax basis is taxable to any such holder
that is not a tax-exempt entity as gain realized from the sale of the shares of
Common Stock, taxable as described below.
The declaration by the Company of a consent dividend would result in taxable
income to consenting holders of shares of Common Stock (other than tax-exempt
entities) without any corresponding cash distributions. See "--Requirements for
Qualification as a REIT--Annual Distribution Requirements."
Portfolio Income. Dividends paid to holders of shares of Common Stock will be
treated as portfolio income. Such income therefore will not be subject to
reduction by losses from passive activities (i.e., any interest in a rental
activity or in a trade or business in which the holder does not materially
participate, such as certain interests held as a limited partner) of any holder
who is subject to the passive activity loss rules. Such distributions will,
however, be considered investment income which may be offset by certain
investment expense deductions.
No Flow-Through of Losses. Holders of shares of Common Stock will not be
permitted to deduct any net operating losses or capital losses of the Company.
Sale of Shares. A holder of shares of Common Stock who sells shares will
recognize taxable gain or loss equal to the difference between (i) the amount of
cash and the fair market value of any property received on such sale or other
disposition and (ii) the holder's adjusted basis in such shares. Gain or loss
recognized by a holder of shares of Common Stock who is not a dealer in
securities and whose shares have been held for more than one year will generally
be taxable as long-term capital gain or loss.
Back-up Withholding. Distributions from the Company will ordinarily not be
subject to withholding of federal income taxes, except as discussed under
"Foreign Stockholders." Withholding of income tax at a rate of 31% may be
required, however, by reason of a failure of a holder of shares of Common Stock
to supply the Company or its agent with the holder's taxpayer identification
number. Such "backup" withholding also may apply to a holder of shares of Common
Stock who is otherwise exempt from backup withholding (including a nonresident
alien of the United States and, generally, a foreign entity) if such holder
fails to properly document his status as an exempt recipient of distributions.
Each holder will therefore be asked to provide and certify his correct taxpayer
identification number or to certify that he is an exempt recipient.
TAX-EXEMPT STOCKHOLDERS
Non-taxability of Dividend Income. In general, a holder of shares of Common
Stock which is a tax-exempt entity will not be subject to tax on distributions
from the Company. The IRS has ruled that amounts distributed as dividends by a
qualified REIT do not constitute unrelated business taxable income ("UBTI") when
received by certain tax-
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exempt entities. Thus, distributions paid to a holder of shares of Common Stock
which is a tax-exempt entity and gain on the sale of shares of Common Stock by a
tax-exempt entity (other than those tax-exempt entities described below) will
not be treated as UBTI, even if the Company incurs indebtedness in connection
with the acquisition of real property (through its percentage ownership of the
Operating Partnership and the Subsidiary Partnerships) provided that the tax-
exempt entity has not financed the acquisition of its shares of Common Stock of
the Company.
For tax-exempt entities which are social clubs, voluntary employee beneficiary
associations, supplemental unemployment benefit trusts, and qualified group
legal services plans exempt from federal income taxation under Code Sections
501(c)(7), (c)(9), (c)(17) and (c)(20), respectively, income from an investment
in the Company will constitute UBTI unless the organization is able to properly
deduct amounts set aside or placed in reserve for certain purposes so as to
offset the UBTI generated by its investment in the Company. Such prospective
investors should consult their own tax advisors concerning these "set aside" and
reserve requirements.
In the case of a "qualified trust" (generally, a pension or profit-sharing
trust) holding shares in a REIT, the beneficiaries of such a trust are treated
as holding shares in the REIT in proportion to their actuarial interests in the
qualified trust, instead of treating the qualified trust as a single individual
(the "look through exception"). A qualified trust that holds more than 10% of
the shares of a REIT is required to treat a percentage of REIT dividends as UBTI
if the REIT incurs debt to acquire or improve real property. This rule applies,
however, only if (i) the qualification of the REIT depends upon the application
of the "look through" exception (described above) to the restriction on REIT
shareholdings by five or fewer individuals, including qualified trusts (see
"Description of Capital Stock--Restrictions on Transfer"), and (ii) the REIT is
"predominantly held" by qualified trusts, i.e., if either (x) single qualified
trust held more than 25% by value of the interests in the REIT or (y) one or
more qualified trusts, each owning more than 10% by value, held in the aggregate
more than 50% of the interests in the REIT. The percentage of any dividend paid
(or treated as paid) to such a qualified trust that is treated as UBTI is equal
to the amount of modified gross income (gross income less directly connected
expenses) from the unrelated trade or business of the REIT (treating the REIT as
if it were a qualified trust), divided by the total modified gross income of the
REIT. A de minimis exception applies where the percentage is less than 5%.
Because the Company expects the shares of Common Stock to be widely held, this
provision should not result in UBTI to any tax-exempt entity.
Foreign Stockholders
The rules governing United States federal income taxation of nonresident alien
individuals, foreign corporations, foreign partnerships, foreign estates and
foreign trusts (collectively, "Foreign Investors") are complex, and no attempt
will be made herein to provide more than a summary of such rules. Prospective
Foreign Investors should consult their own tax advisors to determine the impact
of federal, state and local income tax laws on an investment in the shares of
Common Stock, including any reporting requirements, as well as the tax treatment
of such an investment under their home country laws.
Foreign Investors which are not engaged in the conduct of a business in the
United States and who purchase shares of Common Stock will generally not be
considered as engaged in the conduct of a trade or business in the United States
by reason of ownership of such shares. The taxation of distributions by the
Company to Foreign Investors will depend upon whether such distributions are
attributable to operating income or are attributable to sales or exchanges by
the Company of its United States Real Property Interests ("USRPIs"). USRPIs are
generally direct interests in real property located in the United States and
interests in domestic corporations in which the fair market value of its USRPIs
exceeds a certain percentage.
The Company anticipates that a substantial portion of the distributions to
holders of shares of Common Stock will be attributable to receipt of Rent by the
Company. To the extent that such distributions do not exceed the current or
accumulated earnings and profits of the Company, they will be treated as
dividends and will be subject to a withholding tax equal to 30% of the gross
amount of the dividend, which tax will be withheld and remitted to the IRS by
the Company. Such 30% rate may be reduced by United States income tax treaties
in effect with the country of residence of the Foreign Investor; however, a
Foreign Investor must furnish a completed IRS Form 1001 to the Company to secure
such a reduction. Distributions in excess of the Company's earnings and profits
will be treated as a nontaxable return of capital to a Foreign Investor to the
extent of the basis of his shares of Common Stock, and any excess amount will be
treated as an amount received in exchange for the sale of his shares of Common
Stock and treated under the rules described below for the sale of Common Stock.
Distributions which are attributable to net capital gains realized from the
disposition of USRPIs (i.e., the Hotels) by the Company will be taxed as though
the Foreign Investors were engaged in a trade or business in the United States
and the distributions were gains effectively connected with such trade or
business. Thus, a Foreign Investor would be entitled to offset its gross income
by allowable deductions and would pay tax on the resulting taxable income at the
graduated rates applicable to United States citizens or residents. For both
individuals and corporations, the Company must withhold a tax equal to 35% of
all dividends that could be designated by the Company as capital
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gain dividends. To the extent that such withholding exceeds the actual tax owed
by the Foreign Investor, a Foreign Investor may claim a refund from the IRS.
The Company or any nominee (e.g., a broker holding shares in street name) may
rely on a certificate of non-foreign status on Form W-8 or Form W-9 to determine
whether withholding is required on gains realized from the disposition of
USRPIs. A domestic person (a "nominee") who holds shares of Common Stock on
behalf of a Foreign Investor will bear the burden of withholding, provided that
the Company has properly designated the appropriate portion of a distribution as
a capital gain dividend.
It is anticipated that the shares owned directly or indirectly by Foreign
Investors will be less than 50% in value of the shares of Common Stock and
therefore the Company will be a "domestically controlled REIT." Accordingly,
shares of Common Stock held by Foreign Investors in the United States will not
be considered USRPIs and gains on sales of such shares will not be taxed to such
Foreign Investors as long as the seller is not otherwise considered to be
engaged in a trade or business in the United States. (The same rule applies to
gains attributable to distributions in excess of the Foreign Investor's cost for
its shares, discussed above.) Similarly, a foreign corporation not otherwise
subject to United States tax which distributes shares of Common Stock to its
stockholders will not be taxed under this rule.
The IRS is authorized to impose annual reporting requirements on certain
United States and foreign persons directly holding USRPIs. The required reports
are in addition to any necessary income tax returns, and do not displace
existing reporting requirements imposed on Foreign Investors by the Agricultural
Foreign Investment Disclosure Act of 1978 and the International Investment
Survey Act of 1976. As of the date of this Prospectus, the IRS has not
exercised its authority to impose reporting under this provision. Furthermore,
because shares in a domestically controlled REIT do not constitute a USRPI, such
reporting requirements are not expected to apply to a Foreign Investor in the
Company. However, the Company is required to file an information return with
the IRS setting forth the name, address and taxpayer identification number of
the payee of distributions from the Company (whether the payee is a nominee or
is the actual beneficial owner).
STATEMENT OF STOCK OWNERSHIP
The Company is required to demand annual written statements from the record
holders of designated percentages of its shares of Common Stock disclosing the
actual owners of the shares of Common Stock. The Company must also maintain,
within the Internal Revenue District in which it is required to file its federal
income tax return, permanent records showing the information it has received as
to the actual ownership of such shares of Common Stock and a list of those
persons failing or refusing to comply with such demand.
TAX ASPECTS OF THE OPERATING PARTNERSHIP
The following discussion summarizes certain federal income tax considerations
applicable solely to the Company's investment in the Operating Partnership and
the Subsidiary Partnerships. The discussion does not cover state or local tax
laws or any federal tax laws other than income tax laws.
Classification as a Partnership. A substantial portion the Company's real
estate investments will be made through the Operating Partnership and the
Subsidiary Partnerships, certain of which will hold interests in other
partnerships. In general, partnerships are "pass-through" entities which are not
subject to federal income tax. Instead, partners are allocated their
proportionate shares of the items of income, gain, loss, deduction and credit of
a partnership, and are subject to tax thereon, without regard to whether the
partners receive cash distributions from the partnership. The Company will be
entitled to include in its REIT taxable income its distributive share of the
income of any partnership (including the Operating Partnership) in which it has
an interest and to deduct its distributive share of the losses of any
partnership (including the Operating Partnership) in which it has an interest
only if each such partnership is classified for federal income tax purposes as a
partnership rather than as an association taxable as a corporation.
Under recently issued regulations ("check the box regulations"), an
organization with two or more members will be classified as a partnership on or
after January 1, 1997 unless it elects to be treated as an association (and
therefore taxable as a corporation) or falls within one of several specific
provisions which define a corporation. For entities which were in existence
prior to January 1, 1997 (such as the Operating Partnership and the Subsidiary
Partnerships), the claimed classification by the entity will be respected for
all periods prior to January 1, 1997 if (i) the entity had a reasonable basis
for its claimed classification under the law prior to January 1, 1997; (ii) the
entity and all members thereof recognized the federal tax consequence of any
change in the entity's classification within the sixty (60) months prior to
January 1, 1997; and (iii) neither the entity nor any member was notified in
writing on or before May 8, 1996 that the classification of the entity was under
examination (in which case the entity's classification would be determined in
the examination). An exception to partnership classification under the "check
the box
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regulations" exists for a "publicly traded partnership" (i.e., a partnership in
which interests are traded on an established securities market or are readily
tradable on a secondary market or the substantial equivalent thereof). A
publicly traded partnership is treated as a corporation unless at least 90% of
the gross income of such partnership, for each taxable year the partnership is a
publicly traded partnership, consists of "qualifying income." "Qualifying
income" includes income from real property rents, gain from the sale or other
disposition of real property, interest and dividends.
The IRS has issued final regulations providing limited safe harbors from the
definition of a publicly traded partnership. Pursuant to one of those safe
harbors (the "Private Placement Exclusion"), interests in a partnership will not
be treated as readily tradable on a secondary market or the substantial
equivalent thereof if (i) all of the partnership interests are issued in a
transaction that is 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
taxable year (taking into account as a partner each person who indirectly owns
an interest in the partnership through a partnership, grantor trust, or S
corporation (a "flow-through entity"), but only if (a) substantially all the
value of the beneficial owner's interest in the flow-through entity is
attributable to the flow-through entity's interest (direct or indirect) in the
partnership, and (b) a principal purpose of the use of the tiered arrangement is
to permit the partnership to satisfy the 100-partner limitation).
All of the partnership interests in the Operating Partnership and the
Subsidiary Partnerships have been issued in transactions that are not required
to be registered under the Securities Act. In addition, the Operating
Partnership and the Subsidiary Partnerships do not have more than 100 partners
(even taking into account indirect ownership of such partnerships through
partnerships, grantor trusts, and S corporations). Thus, the Operating
Partnership and each Subsidiary Partnership should satisfy the Private Placement
Exclusion.
None of the Operating Partnership and the Subsidiary Partnerships has
requested and none intends to request, a ruling from the IRS that it will be
classified as a partnership for federal income tax purposes. Instead, Battle
Fowler LLP has delivered its opinion that, based on the provisions of the
partnership agreement of the Operating Partnership and each Subsidiary
Partnership, certain factual assumptions, and certain representations described
in the opinion, the Operating Partnership and each Subsidiary Partnership
pursuant to the provisions of the "check the box regulations" as well as the law
prior to January 1, 1997 will be treated for federal income tax purposes as
partnerships and not as associations taxable as corporations or as publicly
traded partnerships. Unlike a tax ruling, an opinion of counsel is not binding
upon the IRS, and no assurance can be given that the IRS will not challenge the
status of the Operating Partnership and each Subsidiary Partnership as
partnerships for federal income tax purposes. If such challenge were sustained
by a court, the Operating Partnership and each Subsidiary Partnership would be
treated as corporations for federal income tax purposes, as described below. In
addition, the opinion of Battle Fowler LLP is based on existing law, which is to
a great extent the result of administrative and judicial interpretation. No
assurance can be given that administrative or judicial changes would not modify
the conclusions expressed in the opinion.
If for any reason any partnership in which the Company has an interest was
taxable as a corporation rather than as a partnership for federal income tax
purposes, the Company likely would not be able to satisfy the asset requirements
for REIT status. See "--Requirements for Qualification as a REIT--Asset Tests."
In addition, any change in the partnership status of such entities 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. See "--Income
Taxation of the Operating Partnership and Its Partners--Basis in Operating
Partnership Interest." Further, items of income and deduction of such
partnerships would not pass through to its partners (including the Company), and
such partners would be treated as stockholders for tax purposes. The
partnerships in which the Company has an interest would be required to pay
income tax at corporate tax rates on their net income, and distributions to
their partners would constitute dividends that would not be deductible in
computing the relevant entities' taxable income.
Under a regulatory "anti-abuse" rule (the "Anti-Abuse Rule"), the IRS may (i)
recast a transaction involving the use of a partnership to reflect the
underlying economic arrangement under the partnership provisions of the Code
(the "Partnership Provisions"), or (ii) prevent the use of a partnership to
circumvent the intended purpose of a Code provision. The Anti-Abuse Rule
contains an example in which a corporation that elects to be treated as a REIT
contributes substantially all of the proceeds from a public offering to a
partnership in exchange for a general partnership interest. The example
concludes that the use of the partnership is not inconsistent with the intent of
the Partnership Provisions and, thus, cannot be recast by the IRS. However, the
Exchange Rights do not conform in all respects to the exchange rights contained
in the foregoing example. Moreover, the Anti-Abuse Rule is extraordinarily broad
in scope and is applied based on an analysis of all of the facts and
circumstances. As a result, there can be no assurance that the IRS will not
attempt to apply the Anti-Abuse Rule to the Company. If the conditions of the
Anti-Abuse Rule are met, the IRS is authorized to take appropriate enforcement
action, including disregarding the Operating Partnership for federal income tax
purposes or treating one or more of the partners as nonpartners. Any such action
potentially could jeopardize the Company's status as a REIT.
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INCOME TAXATION OF THE OPERATING PARTNERSHIP AND ITS PARTNERS
Operating Partnership Allocations. As noted above, the Company must include
in its REIT taxable income its distributive share of the income and losses of
any partnership in which it has an interest. Although the provisions of a
partnership agreement generally will determine the allocation of income and
losses among partners, such allocations will be disregarded for tax purposes
under Section 704(b) of the Code if they do not have "substantial economic
effect" or otherwise do not comply with the provisions of Section 704(b) of the
Code and Treasury Regulations.
If an allocation is not recognized for federal income tax purposes, the item
subject to the allocation will be reallocated in accordance with the partners'
interests in the partnership, which will be determined by taking into account
all of the facts and circumstances relating to the economic arrangement of the
partners in respect of such item. The allocations of taxable income and loss of
partnerships in which the Company has an interest are intended to comply with
the requirements of Section 704(b) of the Code and Treasury Regulations.
Basis in Operating Partnership Interest. The Company's adjusted tax basis in
each of the partnerships in which it has an interest generally (i) will be equal
to the amount of cash and the basis of any other property contributed to such
partnership by the Company, (ii) will be increased by (a) its allocable share of
such partnership's income and (b) its allocable share of any indebtedness of
such partnership and (iii) will be reduced, but not below zero, by the Company's
allocable share of (a) such partnership's loss and (b) the amount of cash and
the fair market value of any property distributed to the Company, and by
constructive distributions resulting from a reduction in the Company's share of
indebtedness of such partnership.
If the Company's allocable share of the loss (or portion thereof) of any
partnership in which it has an interest would reduce the adjusted tax basis of
the Company's partnership interest in such partnership below zero, the
recognition of such loss will be deferred until such time as the recognition of
such loss (or portion thereof) would not reduce the Company's adjusted tax basis
below zero. To the extent that distributions from a partnership to the Company,
or any decrease in the Company's share of the nonrecourse indebtedness of a
partnership (each such decrease being considered a constructive cash
distribution to the partners), would reduce the Company's adjusted tax basis
below zero, such distributions (including such constructive distributions) would
constitute taxable income to the Company. Such distributions and constructive
distributions normally would be characterized as long-term capital gain if the
Company's interest in such partnership has been held for longer than the long-
term capital gain holding period (currently one year).
Depreciation Deductions Available to the Operating Partnership. The Company
will allocate the cash purchase price of newly acquired hotels among land,
building and personal property and will claim depreciation deductions based on
prescribed tax depreciation rates.
OTHER TAX CONSIDERATIONS
State and Local Taxes. The tax treatment of the Company and holders of shares
of Common Stock in states having taxing jurisdiction over them may differ from
the federal income tax treatment. Accordingly, only a very limited discussion of
state taxation of the Company, the shares of Common Stock or the holders of
shares of Common Stock is provided herein, and no representation is made as to
the tax status of the Company (other than with respect to the Texas franchise
tax, as discussed below), the shares of Common Stock or the holders of shares of
Common Stock in such states. However, holders of shares of Common Stock should
note that certain states impose a withholding obligation on partnerships
carrying on a trade or business in a state having partners who are not resident
in such state. The Partnership Agreement contains a provision which permits the
Operating Partnership to withhold a portion of a non-resident partner's
distribution (e.g., a distribution to the Company) and to pay such withheld
amount to the taxing state as agent for the non-resident partner. Most (but not
all) states follow the Code in their taxation of REITs. In such states, the
Company should generally not be liable for tax and should be able to file a
claim for refund and obtain any withheld amount from the taxing state. However,
due to the time value of money, the requirement of the Operating Partnership to
withhold on distributions to the Company will reduce the yield on an investment
in shares of Common Stock. Each holder of shares of Common Stock should consult
his own tax advisor as to the status of the shares of Common Stock under the
respective state tax laws applicable to him. In particular, Texas imposes a
franchise tax upon corporations that do business in Texas. The Company is
organized as a Maryland corporation and has an office in Texas. AGH LP is
organized as a Nevada corporation and will not have any contacts with Texas
other than ownership of its limited partnership interest in the Operating
Partnership. The Operating Partnership is registered in Texas as a foreign
limited partnership qualified to transact business in Texas.
The Texas franchise tax is imposed on a corporation doing business in Texas
with respect to the corporation's net "taxable capital" (generally, financial
accounting net worth, with certain adjustments) and its net "taxable earned
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surplus" (generally, a corporation's federal taxable income, with certain
adjustments) apportioned to Texas. A corporation's taxable capital and taxable
earned surplus are apportioned to Texas based on a fraction, the numerator of
which is the corporation's gross receipts from business transacted in Texas, and
the denominator of which is the corporation's gross receipts from its entire
business, with the amount and timing of such gross receipts being generally
determined in accordance with generally accepted accounting principles (in the
case of "taxable capital") and the Code (in the case of taxable earned surplus).
For purposes of determining the source of gross receipts, dividends and interest
received by a corporation are generally apportioned based upon the state of
incorporation of a corporate payor or a corporate debtor, respectively. A
similar rule applies to receipts by a corporation from a limited liability
company. Thus, interest and dividends received by a corporation from another
corporation or distributions and interest received by a corporation from a
limited liability company will not be treated as gross receipts from business
transacted in Texas unless the payor is incorporated or organized, respectively,
in Texas. To calculate the tax on net taxable capital, receipts reflecting the
corporation's share of net profits from a partnership are apportioned to Texas
if the partnership's principal place of business (the location of its day-to-day
operations) is in Texas; however, if the corporation's share of the gross
receipts from the partnership is treated as revenue of the corporation under
generally accepted accounting principles, then the receipts of the partnership
are apportioned based on normal apportionment rules as if the receipts were
received directly by the corporation. For purposes of the tax on net taxable
earned surplus, receipts are apportioned as though the corporation directly
received the receipts from the underlying activities of the partnership. The
franchise tax on "net taxable capital" ("taxable capital" apportioned to Texas)
is imposed at the rate of .25% of a corporation's net taxable capital. The
franchise tax rate on "net taxable earned surplus" ("taxable earned surplus"
apportioned to Texas) is 4.5%. The Texas franchise tax is generally equal to the
greater of the tax on "net taxable capital" and the tax on "net taxable earned
surplus." The Texas franchise tax is not applied on a consolidated group basis.
In addition, with respect to REITs organized as corporations, the Comptroller of
Public Accounts (the "Comptroller") has taken the position administratively that
the tax on net taxable earned surplus is determined based upon the income of
such corporation prior to reduction for the dividends-paid deduction available
to REITs. Any Texas franchise tax that the Company is required to pay will
reduce the Cash Available for Distribution by the Company to its stockholders.
The Comptroller has issued a rule providing that a corporation is not
considered to be doing business in Texas for purposes of the Texas franchise tax
imposed on net taxable capital solely by virtue of its ownership of an interest
as a limited partner in a limited partnership that does business in Texas. The
same rule provides, however, that a corporation is considered to be doing
business in Texas if it owns an interest as a general partner in a partnership
that does business in Texas. A parallel rule for purposes of the tax on net
taxable earned surplus, by negative implication, incorporates the taxable
capital nexus standards, including the limited partner exception. The
Comptroller has verified these results in private determinations. The
Comptroller also has expressed informally its view that a corporation is not
considered to be doing business in Texas for Texas franchise tax purposes merely
because the corporation owns stock in another corporation that does business in
Texas.
In accordance with these pronouncements by the Comptroller, AGH GP will be
treated as doing business in Texas because it will be the general partner of the
Operating Partnership, and the Operating Partnership will be doing business in
Texas. Accordingly, AGH GP will be subject to the Texas franchise tax. The
Company will be treated as doing business in Texas because it will have an
office in Texas. Accordingly, the Company will be subject to the Texas franchise
tax. However, the Company anticipates that its only source of gross receipts for
Texas franchise tax purposes will be dividends from its two wholly owned
qualified REIT subsidiaries, AGH GP and AGH LP, which are both Nevada
corporations. Since dividends are sourced to the state of incorporation of a
corporate payor for gross receipts apportionment purposes (although dividends
received from another member of a consolidated group are not taken into account
as a gross receipt or earned surplus for purposes of computing the franchise tax
on net taxable earned surplus), the Company does not anticipate that any
significant portion of its "taxable capital" or "taxable earned surplus" will be
apportioned to Texas. As a result, the Company's Texas franchise tax liability
is not expected to be substantial. Further, based on the pronouncements by the
Comptroller, AGH LP will not be treated as doing business in Texas merely as a
result of its status as a limited partner of the Operating Partnership. As long
as AGH LP is not otherwise doing business in Texas, AGH LP should not be subject
to the Texas franchise tax. Finally, two limited liability companies that have
been formed to be general partners of the Subsidiary Partnerships likewise will
be subject to the Texas franchise tax under the foregoing rules because they are
treated like corporations for Texas franchise tax purposes and they have taxable
nexus with Texas by virtue of being general partners in two Subsidiary
Partnerships that own real property in Texas. However, since these limited
liability companies only own 1.0% general partnership interests, the Texas
franchise tax due from these entities will not be substantial. Two other limited
liability companies have been formed, one of which will own a hotel located
outside of Texas and the other of which will be the general partner in a limited
partnership owning a hotel located outside of Texas. Thus, while these limited
liability companies will be conducting activities that will create taxable nexus
with Texas, these companies will generate all of their gross receipts from non-
Texas sources and thus will not be required to pay a material amount of Texas
franchise tax.
-37-
<PAGE>
The Company has received a private determination from the Comptroller that
verifies the foregoing Texas franchise tax consequences of this structure. There
can be no assurance, however, that the Comptroller will not revoke the
pronouncements upon which that determination is based. In addition, that
determination will not be binding upon the Comptroller to the extent the Company
or its subsidiaries fail to comply with the factual representations set forth in
the determination.
The Operating Partnership and the Subsidiary Partnerships (other than the
Subsidiary Partnership organized as a limited liability company) will not be
subject to the Texas franchise tax under the laws in existence as of the date of
this Prospectus. There can be no assurance, however, that the Texas legislature
will not in the future expand the scope of the Texas franchise tax to apply to
limited partnerships such as the Operating Partnership and the Subsidiary
Partnerships organized as limited partnerships under state law.
Coopers & Lybrand L.L.P., special tax consultant to the Company ("Special Tax
Consultant"), has reviewed the discussion in this section with respect to Texas
franchise tax matters and is of the opinion that it accurately summarizes the
Texas franchise tax matters expressly described herein. The Special Tax
Consultant expresses no opinion on any other federal or state tax considerations
affecting the Company or a holder of Common Stock, including, but not limited
to, other Texas franchise tax matters not specifically discussed above.
Possible Legislative or Other Actions Affecting Tax Consequences; Possible
Adverse Tax Legislation. The taxpayer Relief Act of 1997 (the "1997 Act") was
signed into law on August 5, 1997. The Act contains many provisions which
generally make it easier for entities to operate and to continue to qualify as a
REIT for taxable years beginning on or after January 1, 1998. Nevertheless,
prospective stockholders should recognize that the present federal income tax
treatment of an investment in the Company may be modified by legislative,
judicial or administrative action at any time and that any such action may
affect investments and commitments previously made. The rules dealing with
federal income taxation are constantly under legislative and administrative
review, resulting in revisions of regulations and revised interpretations of
established concepts as well as statutory changes. Revisions in federal tax laws
and interpretations thereof could adversely affect the tax consequences of an
investment in the Company.
Current Texas franchise tax law applies only to corporations and limited
liability companies. Thus, partnerships engaged in business in Texas, including
the Subsidiary Partnerships that own property in Texas, presently are not
subject to the Texas franchise tax. The corporate general partners in those
partnerships, however, are subject to the Texas franchise tax. It is expected
that Texas legislators and/or the Comptroller will propose or recommend, as the
case may be, statutory amendments subjecting all comparable limited partners to
the franchise tax or expanding the application of the Texas franchise tax to
include certain non-corporate businesses, specifically including partnerships,
in the franchise tax base. It cannot be predicted whether such proposals will be
adopted by the legislature. If such proposals are enacted, AGH LP and/or
Subsidiary Partnerships that own property in Texas would be subjected to the
then applicable Texas franchise tax.
-38-
<PAGE>
USE OF PROCEEDS
The Registering Stockholders will receive all of the proceeds from the sale of
the Exchanged Shares and the Restricted Stock offered hereby. The Company will
not receive any proceeds from the sale of such shares of Common Stock.
-39-
<PAGE>
REGISTERING STOCKHOLDERS
As described elsewhere herein, the Registering Stockholders are persons who
either (i) have received or may receive Exchanged Shares in exchange for OP
Units or (ii) have already received shares of Restricted Stock of the Company.
The Table below sets forth, as of August 31, 1997, certain information regarding
the beneficial ownership of the shares of Common Stock by each Registering
Stockholder prior to this offering and adjusted to give effect to the sale of
all the shares of Common Stock offered hereby. As the Registering Stockholders
may sell all, some or none of the Exchanged Shares or Restricted Stock that are
to be offered hereby, no estimate can be made of the aggregate number of shares
of Common Stock offered hereby, or the aggregate number of shares of Common
Stock that will be owned by each Registering Stockholder upon completion of the
offering to which this Prospectus relates. Except as otherwise noted below,
none of the Registering Stockholders has, within the past three years, had any
position, office or other material relationship with the Company.
The Exchanged Shares and Restricted Stock offered by this Prospectus may be
offered from time to time directly by the Registering Stockholders named below
or by pledgees, donees, transferees or other successors in interest thereto:
<TABLE>
<CAPTION>
Number of
Maximum Shares to
Number of Beneficially Percentage to
Shares Beneficially Shares Which Owned After Be Beneficially
Owned Prior to May Be Sold this Owned After
Name this Offering(1) Hereunder Offering(2) this Offering(2)
- ---------------------------------- ------------------- ------------ ------------ ----------------
Holders of Exchanged Shares:
<S> <C> <C> <C> <C>
3005 Hotel Associates, Ltd. 31,430 31,430 0 *
Jackson-Shaw Partners No. 51, Ltd. 28,933 28,933 0 *
3100 Hotel Associates, L.P. 24,321 24,321 0 *
Virtual Hospitality, Inc. (3) 6,229 6,229 0 *
James E. Sowell (4) 112,358 112,358 0 *
Lewis W. Shaw, II (5) 71,800 71,800 0 *
Kenneth W. Shaw (6) 70,687 70,687 0 *
Monica Jorns (7) 19,104 19,104 0 *
Steven D. Jorns (8) 235,208(9) 52,696 182,512 1.2%
Bruce G. Wiles (10) 76,999(11) 21,286 55,713 *
Kenneth E. Barr (12) 36,779(13) 10,000 26,779 *
3860 Investors Joint Venture 21,556 21,556 0 *
Jim Sowell Construction Co., Inc. 89,778 89,778 0 *
John D. Gourley 6,731 6,731 0 *
Louis E. Capt 29,767 28,741 1,026 *
Richard O. Jacobson 43,112 43,112 0 *
Thomas J. Corcoran, Jr. (14) 48,112 43,112 5,000 *
Hervey A. Feldman (15) 21,556 21,556 0 *
Jerry Jacob 10,059 10,059 0 *
Pin Nien Hwang 7,185 7,185 0 *
Thomas L. Wiese 3,593 3,593 0 *
Steven L. Cobb 3,593 3,593 0 *
Richard and Barbara Hess 8,207 8,207 0 *
DFW South Acquisition 115,683 115,683 0 *
Corporation
Corporate Property Associates 4, a 427,008 427,008 0 *
California Limited Partnership
Corporate Property Associates 8, 493,664 493,664 0 *
L.P.
Craig Stark, Inc. 100,257 100,257 0 *
</TABLE>
-40-
<PAGE>
<TABLE>
<CAPTION>
Number of
Maximum Shares to
Number of Beneficially Percentage to
Shares Beneficially Shares Which Owned After Be Beneficially
Owned Prior to May Be Sold this Owned After
Name this Offering(1) Hereunder Offering(2) this Offering(2)
- ---------------------------------- ------------------- ------------ ------------ ----------------
<S> <C> <C> <C> <C>
Devlo, Inc. 24,317 24,317 0 *
Holders of Restricted Stock:
American General Hospitality, Inc. 137,008 137,008 0 *
Retirement Savings Plan
Richard C. Kessler 25,397 25,397 0 *
WHC Franchise Corporation 112,969 112,969 0 *
</TABLE>
____________________
(*) Less than 1%
(1) Beneficial ownership as of August 31, 1997, based upon information provided
by the respective Registering Stockholders. Unless otherwise noted in the
following footnotes, the Exchanged Shares and/or Restricted Stock set forth
in this column with respect to a particular Registering Stockholder have
not also been attributed to the shareholders, limited partners or general
partners of such Registering Stockholders.
(2) Assumes sale of all shares of Common Stock registered hereunder, although
Registering Stockholders are under no obligation known to the Company to
sell any shares of Common Stock at this time. Assumes that all OP Units
held by or attributable to the person are exchanged for shares of Common
Stock. The total number of shares of Common Stock outstanding used in
calculating this percentage assumes that none of the OP Units held by other
persons are exchanged for shares of Common Stock.
(3) Virtual Hospitality, Inc. is a limited partner in 3005 Hotel Associates,
L.P. and in 3100 Hotel Associates, Ltd.
(4) James E. Sowell controls all of the voting stock of Jim Sowell Construction
Co., Inc. and controls the general partner of Jackson-Shaw Partners No. 51,
Ltd. James E. Sowell is a shareholder in Virtual Hospitality, Inc., a
general partner in 3860 Investors Joint Venture and a limited partner in
3100 Hotel Associates, L.P.
(5) Lewis W. Shaw, II is a limited partner in 3005 Hotel Associates, Ltd. and
3100 Hotel Associates, L.P., a general partner in 3860 Investors Joint
Venture and a shareholder in Virtual Hospitality, Inc.
(6) Kenneth W. Shaw is a limited partner in 3005 Hotel Associates, Ltd. and
3100 Hotel Associates, L.P. and a shareholder in Virtual Hospitality, Inc.
(7) Monica Jorns is the wife of Steven D. Jorns. Steven D. Jorns disclaims
beneficial ownership of the Exchanged Shares that may be issued to Mrs.
Jorns in exchange for OP Units held by her.
(8) Steven D. Jorns, who is the Chairman of the Board, Chief Executive Officer
and President of the Company, is also a limited partner in 3100 Hotel
Associates, L.P., an indirect holder of limited partnership interests in
3005 Hotel Associates, Ltd., a general partner in 3860 Investors Joint
Venture, a shareholder in Virtual Hospitality, Inc. and a participant in
American General Hospitality Inc.'s Retirement Savings Plan (the "Plan").
(9) Includes 3,811, 3,412, 1,123 and 9,295 Exchanged Shares that may be issued
in exchange for OP Units held by 3100 Hotel Associates, L.P., 3860
Investors Joint Venture, Virtual Hospitality, Inc. and 3005 Hotel
Associates, Ltd., respectively, and attributable to Mr. Jorns; 2,167 shares
of Restricted Stock held by the Plan and attributable to Mr. Jorns; and
19,104 Exchanged Shares that may be issued in exchange for OP Units held by
Monica Jorns, Mr. Jorns' wife, with respect to which Mr. Jorns disclaims
beneficial ownership.
(10) Bruce G. Wiles, who is an Executive Vice President of the Company, is also
a limited partner in 3100 Hotel Associates, L.P. and 3005 Hotel Associates,
Ltd., a general partner in 3860 Investors Joint Venture, and a shareholder
in Virtual Hospitality, Inc. and a participant in the Plan.
(11) Includes 1,203, 2,924, 1,079, and 355 Exchanged Shares that may be issued
in exchange for OP Units held by 3100 Hotel Associates, L.P., 3005 Hotel
Associates, Ltd., 3860 Investors Joint Venture and Virtual Hospitality,
Inc., respectively, and attributable to Mr. Wiles; and 2,532 shares of
Restricted Stock held by the Plan and attributable to Mr. Wiles.
(12) Kenneth E. Barr is the Executive Vice President, Chief Financial Officer,
Secretary, Treasurer and Principal Accounting Officer of the Company. Mr.
Barr is a participant in the Plan.
(13) Includes 79 shares of Restricted Stock held by the Plan and attributable to
Mr. Barr.
(14) Thomas J. Corcoran controls 50% of the voting stock of DFW South
Acquisition Corporation.
(15) Hervey A. Feldman controls 50% of the voting stock of DFW South Acquisition
Corporation.
-41-
<PAGE>
PLAN OF DISTRIBUTION
This Prospectus relates to the offer and sale from time to time of the
Exchanged Shares and the Restricted Shares by the Registering Stockholders, or
by pledgees, donees, transferees or other successors in interest thereto, who
have received or may receive Exchanged Shares and/or Restricted Stock without
registration. The Registering Stockholders may sell the Exchanged Shares and
the Restricted Stock being offered hereby: (i) in ordinary brokerage
transactions and in transactions in which brokers solicit purchasers; (ii) in
privately negotiated direct sales or sales effected through agents not involving
established trading markets; or (iii) through transactions in put or call
options or other rights (whether exchange-listed or otherwise) established after
the effectiveness of the Registration Statement of which this Prospectus is a
part. The Exchanged Shares and the Restricted Stock may be sold at prices and
at terms then prevailing or at prices related to the then current market price
of the Common Stock on the NYSE or at other negotiated prices. In addition, any
of the Exchanged Shares and the Restricted Stock that qualify for sale pursuant
to Rule 144 may be sold in transactions complying with such rule, rather than
pursuant to this Prospectus.
The Restricted Shares and the Exchanged Stock consist of (i) Common Stock
previously issued to Restricted Stockholders in private transactions exempt from
the registration requirements of the Securities Act and (ii) Common Stock issued
or to be issued in private transactions exempt from the registration
requirements of the Securities Act to Unitholders upon exchange by the Company
of OP Units previously issued to such persons in private transactions exempt
from the registration requirements of the Securities Act.
In the case of sales of the Exchanged Shares and the Restricted Stock effected
to or through broker-dealers, such broker-dealers may receive compensation in
the form of discounts, concessions or commissions from the Registering
Stockholders or the purchasers of the Exchanged Shares and the Restricted Stock
sold by or through such broker-dealers, or both. The Company has advised the
Registering Stockholders that the anti-manipulative Rules 10b-6 and 10b-7 under
the Securities Exchange Act of 1934, as amended ("Exchange Act") may apply to
their sales in the market and has informed them of the need for delivery of
copies of this Prospectus. The Company is not aware as of the date of this
Prospectus of any agreements between any of the Registering Stockholders and any
broker-dealers with respect to the sale of the shares offered by this
Prospectus. The Registering Stockholders and any broker-dealer or other agent
executing sell orders on behalf of the Registering Stockholders may be deemed to
be "underwriters" within the meaning of the Securities Act, in which case the
commissions received by any such broker-dealer or agent and profit on any resale
of the shares of Common Stock may be deemed to be underwriting commissions under
the Securities Act. The commissions received by a broker-dealer or agent may be
in excess of customary compensation. The Company will receive no part of the
proceeds from the sale of any Exchanged Shares and the Restricted Stock offered
hereunder.
Pursuant to the terms of the Registering Stockholders registration rights
agreements entered into by and among the Company and the Registering
Stockholders, the Registering Stockholders will pay their costs and expenses of
selling the Exchanged Shares and the Restricted Stock offered hereunder,
including commissions and discounts of underwriters, brokers, dealers or agents,
and the Company has agreed to pay the costs and expenses incident to its
registration and qualification of the Exchanged Shares and the Restricted Stock
offered hereby, including applicable filing fees, legal and accounting fees and
expenses. In addition the Company has agreed to indemnify the Registering
Stockholders against certain liabilities, including certain liabilities arising
under the Securities Act.
The Registering Stockholders may elect to sell all, a portion or none of the
Exchanged Shares and the Restricted Stock offered by them hereunder.
EXPERTS
The Consolidated Financial Statements of American General Hospitality
Corporation as of December 31, 1996 and for the period from August 31, 1996
through December 31, 1996 and the related financial statement schedule; the
Financial Statements of AGH Leasing, L.P. as of December 31, 1996 and for the
period from August 31, 1996 through December 31, 1996 and the Combined Financial
Statements of the AGH Predecessor Hotels as of December 30, 1994, December 29,
1995 and August 30, 1996 and for the period from December 30, 1993 through
December 31, 1993, each of the two years in the period ended December 29, 1995
and for the period from December 30, 1995 through August 30, 1996 and the
related financial statement schedule are incorporated by reference in this
Registration Statement by reference to the Company's Annual Report on Form 10-K.
independent accountants.
The Combined Financial Statements of the AKL Acquisition Hotels as of and for
the year ended December 31, 1995 are incorporated by reference in this
Registration Statement by reference to the Company's Report on Form 8-K dated
March 17, 1997. The Combined Financial Statements of the MUI Acquisition Hotels
as of and for the year ended December 31, 1996 are incorporated by reference in
this Registration Statement by reference to the Company's Report on Form 8-K/A
dated August 1, 1997.
-42-
<PAGE>
The above said financial statements have been so incorporated in reliance on
the reports of Coopers & Lybrand L.L.P.
LEGAL MATTERS
The validity of the shares of Common Stock offered hereby will be passed upon
for the Company by Battle Fowler LLP, New York, New York. In addition, the
description of federal income tax consequences contained in the section of the
Prospectus entitled "Federal Income Tax Considerations" is based on the opinion
of Battle Fowler LLP, New York, New York. The description of Texas franchise
tax matters contained in the section of the Prospectus entitled "Federal Income
Tax Considerations--Other Tax Considerations," is based on the opinion of
Coopers & Lybrand L.L.P., Dallas, Texas. Battle Fowler LLP will rely on Ballard
Spahr Andrews & Ingersoll, Baltimore, Maryland as to certain matters of Maryland
law.
-43-
<PAGE>
No dealer, salesperson or other individual has been authorized to give any
information or make any representations not contained in this Prospectus in
connection with the offering covered by this Prospectus. If given or made, such
information or representation must not be relied upon as having been authorized
by the Company or the Registering Stockholders. This Prospectus does not
constitute an offer to sell, or a solicitation of an offer to buy, the Common
Stock in any jurisdiction where, or to any person to whom, it is unlawful to
make such offer or solicitation. Neither the delivery of this Prospectus nor any
sale made hereunder shall, under any circumstances, create an implication that
there has not been any change in the facts set forth in this Prospectus or in
the affairs of the Company since the date hereof.
-----------------
TABLE OF CONTENTS
-----------------
Prospectus Supplement
<TABLE>
<CAPTION>
Page
<S> <C>
Prospectus Supplement Summary ............................................. S-2
Risk Factors .............................................................. S-4
Price Range of Common Stock and
Distribution Policy ....................................................... S-19
Certain Federal Income Tax Consequences ................................... S-20
Experts ................................................................... S-21
Incorporation of Certain Documents
by Reference .............................................................. S-21
Prospectus
Available Information ..................................................... 2
Incorporation of Certain Documents
by Reference .............................................................. 2
Cautionary Statement for Purposes
of the "Safe Harbor" Provisions
of the Private Securities Litigation
Reform Act of 1995 ........................................................ 3
Prospectus Summary ........................................................ 4
Risk Factors .............................................................. 6
Description of Capital Stock .............................................. 14
Description of OP Units ................................................... 21
Federal Income Tax Considerations ......................................... 24
Use of Proceeds ........................................................... 39
Registering Stockholders .................................................. 40
Plan of Distribution ...................................................... 42
Experts ................................................................... 42
Legal Matters ............................................................. 43
</TABLE>
2,172,370 Shares
AMERICAN GENERAL
HOSPITALITY CORPORATION
Common Stock
-----------------------
PROSPECTUS SUPPLEMENT
-----------------------
July 10, 1998
