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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON APRIL 4, 1997
REGISTRATION NO. 33-92548
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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POST-EFFECTIVE AMENDMENT NO. THREE
TO
FORM S-3
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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CRESCENT REAL ESTATE EQUITIES COMPANY
(formerly known as Crescent Real Estate Equities, Inc.)
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
TEXAS 52-1862813
(STATE OR OTHER JURISDICTION (IRS EMPLOYER
OF ORGANIZATION) IDENTIFICATION NO.)
</TABLE>
777 MAIN STREET
SUITE 2100
FORT WORTH, TEXAS 76102
TELEPHONE: (817) 877-0477
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
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GERALD W. HADDOCK
CRESCENT REAL ESTATE EQUITIES COMPANY
777 MAIN STREET, SUITE 2100
FORT WORTH, TEXAS 76102
TELEPHONE: (817) 877-0477
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING
AREA CODE, OF AGENT FOR SERVICE)
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Copies to:
<TABLE>
<C> <C>
ROBERT B. ROBBINS, ESQ. DAVID M. DEAN, ESQ.
SYLVIA M. MAHAFFEY, ESQ. CRESCENT REAL ESTATE EQUITIES COMPANY
SHAW, PITTMAN, POTTS & TROWBRIDGE 777 MAIN STREET, SUITE 2100
2300 N STREET, N.W. FORT WORTH, TEXAS 76102
WASHINGTON, D.C. 20037
</TABLE>
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE OF THE SECURITIES TO THE
PUBLIC:
From time to time after the effective date of the Registration Statement.
If the only securities being registered on this Form are being offered
pursuant to dividend or interest reinvestment plans, please check the following
box. [ ]
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, other than securities offered only in connection with dividend or interest
reinvestment plans, check the following box. [X]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act of 1933, please check the
following box and list the Securities Act registration statement number of the
earlier effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act of 1933, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434
of the Securities Act of 1933, please check the following box. [ ]
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PROSPECTUS
19,196,432 SHARES
[CRESCENT LOGO]
COMMON SHARES
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Crescent Real Estate Equities Company (together with its subsidiaries, the
"Company") is a fully integrated real estate company operating as a real estate
investment trust ("REIT"). The Company, through its subsidiaries, directly or
indirectly owns a portfolio of real estate assets located primarily in 17
metropolitan submarkets in Texas and Colorado. The portfolio includes 58 office
properties with an aggregate of approximately 18.0 million net rentable square
feet, four full-service hotels with a total of 1,471 rooms, two destination
health and fitness resorts, six retail properties and economic interests in
three residential development corporations.
This Prospectus relates to (i) the possible issuance by the Company of up to
12,948,576 common shares (the "Original Exchange Shares") of beneficial
interest, par value $.01 per share ("Common Shares"), of the Company if, and to
the extent that, holders of up to 6,474,288 units (the "Original Units") of
limited partnership interest ("Units") in Crescent Real Estate Equities Limited
Partnership (the "Operating Partnership") tender such Original Units in exchange
for Common Shares, (ii) the offer and sale from time to time of up to 4,034,784
outstanding Common Shares (the "Original Shares") by the holders thereof, (iii)
the possible distribution of up to 1,234,784 Original Shares if, and to the
extent that, the holder thereof (which is a limited partnership) distributes
such Original Shares pro rata to its partners as part of the liquidation and
winding up of the affairs of such holder, (iv) the possible issuance by the
Company of up to 2,194,028 shares (the "RER Exchange Shares") if, and to the
extent that, the holder of up to 1,097,014 Units (the "RER Units") tenders such
RER Units in exchange for Common Shares, (v) the possible issuance by the
Company of up to 19,044 shares (the "JME Exchange Shares") if, and to the extent
that, the holder of up to 9,522 Units (the "JME Units") tenders such JME Units
in exchange for Common Shares, and (vi) the offer and sale or other distribution
from time to time by the holders thereof (the "Selling Shareholders") of any
Original Exchange Shares, RER Exchange Shares and JME Exchange Shares
(collectively, the "Exchange Shares") and any Original Shares (collectively with
the Exchange Shares, the "Secondary Shares"). The Original Units and the
Original Shares were issued (or reserved for issuance) in connection with the
formation of the Company and the Company's initial public offering. The RER
Units were issued, in a private placement in April 1995 to an affiliate of
Richard E. Rainwater, the Chairman of the Board of Trust Managers, and the
issuance of Common Shares upon any exchange thereof was approved by the
shareholders of the Company at its Annual Meeting held on June 12, 1995. The JME
Units were issued to an employee of the general partner of the Operating
Partnership in a private placement in May 1995. The Company has registered the
Original Shares and the Exchange Shares to provide the Selling Shareholders with
freely tradeable securities, but the registration of such shares does not
necessarily mean that any of such shares will be offered or sold by the Selling
Shareholders. See "The Company" and "Registration Rights." A portion of the
Original Units and all of the RER Units and JME Units have been exchanged for
Common Shares. In addition, a portion of the Original Units and the Secondary
Shares have been distributed as of March 31, 1997. All references to the number
of Common Shares to which this Prospectus relates have been adjusted to reflect
the Company's two-for-one stock split relating to its Common Shares and effected
in the form of a 100% share dividend paid on March 26, 1997. See "Selling
Shareholders."
SEE "RISK FACTORS" AT PAGE 4 FOR CERTAIN FACTORS RELEVANT TO AN INVESTMENT
IN THE COMMON SHARES.
The Common Shares are listed on the New York Stock Exchange under the symbol
"CEI." To ensure that the Company maintains its qualification as a REIT for
federal income tax purposes, ownership by any person generally is limited to
8.0% of the issued and outstanding Common Shares. See "Description of Shares of
the Company."
The Selling Shareholders from time to time may offer and sell Secondary
Shares held by them directly or through agents or broker-dealers on terms to be
determined at the time of sale. To the extent required, the name of any agent or
broker-dealer and applicable commissions or discounts and any other required
information with respect to any particular offer will be set forth in an
accompanying Prospectus Supplement. See "Plan of Distribution." Each of the
Selling Shareholders reserves the sole right to accept or reject, in whole or in
part, any proposed purchase of the Secondary Shares to be made directly or
through agents.
The Selling Shareholders and any agents or broker-dealers that participate
with the Selling Shareholders in the distribution of Secondary Shares may be
deemed to be "underwriters" within the meaning of the Securities Act of 1933, as
amended (the "Securities Act"), and any commissions received by them and any
profit on the resale of the Secondary Shares may be deemed to be underwriting
commissions or discounts under the Securities Act. See "Registration Rights" for
indemnification arrangements between the Company and the Selling Shareholders.
The Company will not receive any proceeds from the issuance of the Exchange
Shares or the sale of any Secondary Shares by the Selling Shareholders but has
agreed to bear certain expenses of registration of the Secondary Shares under
federal and state securities laws, not including commissions and discounts of
agents or broker-dealers and transfer taxes, if any. The Company's interest in
the Operating Partnership will increase in connection with any issuance by the
Company of Exchange Shares to Unit holders pursuant to this Prospectus.
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
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THE DATE OF THIS PROSPECTUS IS APRIL , 1997.
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[THIS PAGE INTENTIONALLY LEFT BLANK]
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THE COMPANY
Crescent Real Estate Equities Company ("Crescent Equities"), together with
its subsidiaries, is a fully integrated real estate company operating as a real
estate investment trust for federal income tax purposes (a "REIT"). Crescent
Equities is organized as a Texas real estate investment trust and became the
successor to Crescent Real Estate Equities, Inc., a Maryland corporation (the
"Predecessor Corporation"), on December 31, 1996, through the merger (the
"Merger") of the Predecessor Corporation and CRE Limited Partner, Inc., a
subsidiary of the Predecessor Corporation, into Crescent Equities. The Merger
was structured to preserve the existing business, purpose, tax status,
management, capitalization and assets, liabilities and net worth (other than due
to the costs of the transaction) of the Predecessor Corporation, and the
economic interests and voting rights of the stockholders of the Predecessor
Corporation (who became the shareholders of the Company as a result of the
Merger). The Board of Trust Managers and the executive officers of the Company
are identical to, and have the same terms of office as, the Board of Directors
and executive officers of the Predecessor Corporation. The Company, as successor
issuer to the Predecessor Corporation, expressly adopts, to the extent
applicable, the statements of the Predecessor Corporation in the registration
statement on Form S-3 (the "Registration Statement") to which this Prospectus is
a part as its own Registration Statement for all purposes of the Securities Act
of 1933, as amended (the "Securities Act") and the Securities Exchange Act of
1934, as amended (the "Exchange Act"). The Registration Statement also sets
forth additional information necessary to reflect any material changes resulting
from the Merger.
The direct and indirect subsidiaries of Crescent Equities include Crescent
Real Estate Equities Limited Partnership (the "Operating Partnership"); Crescent
Real Estate Equities, Ltd. (the "General Partner" or "CREE, Ltd."), which is the
sole general partner of the Operating Partnership; Crescent Real Estate Funding
I, L.P. ("Funding I"), Crescent Real Estate Funding II, L.P. ("Funding II"),
Crescent Real Estate Funding III, L.P. ("Funding III"), Crescent Real Estate
Funding IV, L.P. ("Funding IV"), Crescent Real Estate Funding V, L.P. ("Funding
V") and Crescent Real Estate Funding VI, L.P. ("Funding VI"), limited
partnerships in which the Operating Partnership owns substantially all of the
economic interests directly or indirectly, with the remaining interests owned
indirectly by the Company through CRE Management I Corp. ("Management I"), CRE
Management II Corp. ("Management II"), CRE Management III Corp. ("Management
III"), CRE Management IV Corp. ("Management IV"), CRE Management V Corp.
("Management V") and CRE Management VI Corp. ("Management VI"), which are
wholly-owned subsidiaries of the General Partner and are the general partners of
Funding I, Funding II, Funding III, Funding IV, Funding V and Funding VI,
respectively. The term "Company" includes, unless the context otherwise
requires, Crescent Equities, the Predecessor Corporation, the Operating
Partnership, and the other subsidiaries of Crescent Equities.
As of March 31, 1997, the Company directly or indirectly owned a portfolio
of real estate assets (the "Properties") located primarily in 17 metropolitan
submarkets in Texas and Colorado. The Properties include 58 office properties
(the "Office Properties") with an aggregate of approximately 18.0 million net
rentable square feet, four full-service hotels with a total of 1,471 rooms, two
destination health and fitness resorts (the "Hotel Properties"), six retail
properties (the "Retail Properties") with an aggregate of approximately .6
million net rentable square feet and real estate mortgages (the "Residential
Development Property Mortgages") and non-voting common stock in three
residential development corporations (the "Residential Development
Corporations") that own all or a portion of six single-family residential land
developments and three prospective condominium/townhome developments (the
"Residential Development Properties").
The Company provides management, leasing and development services with
respect to certain of its Properties. As of March 31, 1997, the Company had
approximately 240 employees and its executive officers had over 100 years of
combined experience in the real estate industry.
The Company conducts all of its business through the Operating Partnership
and its other subsidiaries. The Company also has an economic interest in the
development activities of the Residential Development Corporations. The General
Partner controls the Operating Partnership, and the Company is the sole
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stockholder of the General Partner. In addition, as of March 31, 1997, the
Company owned an approximately 84.5% limited partner interest in the Operating
Partnership.
Pursuant to the limited partnership agreement of the Operating Partnership
(the "Operating Partnership Agreement"), limited partners of the Operating
Partnership (the "Limited Partners") may elect to exchange (the "Exchange
Right") their units of partnership interest in the Operating Partnership
("Units") for common shares of beneficial interest, par value $.01 per share
("Common Shares") on a one-for-two basis (subject to certain exceptions) or, at
the election of the Company, for cash equal to the then-current fair market
value of the number of Common Shares for which such Units are exchangeable. The
Company anticipates that, consistent with the Ownership Limit, it generally will
elect to issue Common Shares rather than pay cash in connection with such
exchanges. See "Exchange of Units -- General" and "Description of Shares of the
Company -- Ownership Limits and Restrictions on Transfer." To the extent that
Limited Partners elect to exchange their Units, the Company's interest in the
Operating Partnership will increase.
The Company's executive offices are located at 777 Main Street, Suite 2100,
Fort Worth, Texas 76102, and its telephone number is (817) 877-0477.
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SECURITIES TO BE OFFERED
This Prospectus relates to (i) the possible issuance by the Company of up
to 12,948,576 Common Shares (the "Original Exchange Shares") if, and to the
extent that, holders of up to 6,474,288 Units (the "Original Units") tender such
Original Units in exchange for Common Shares, (ii) the offer and sale from time
to time of up to 4,034,784 outstanding Common Shares (the "Original Shares") by
the holders thereof, (iii) the possible distribution of up to 1,234,784 Original
Shares if, and to the extent that, the holder thereof (which is a limited
partnership) distributes such Original Shares pro rata to its partners as part
of the liquidation and winding up of the affairs of such holder, (iv) the
possible issuance by the Company of up to 2,194,028 shares (the "RER Exchange
Shares") if, and to the extent that, the holder of up to 1,097,014 Units (the
"RER Units") tenders such RER Units in exchange for Common Shares, (v) the
possible issuance by the Company of up to 19,044 shares (the "JME Exchange
Shares") if, and to the extent that, the holder of up to 9,522 Units (the "JME
Units") tenders such JME Units in exchange for Common Shares, and (vi) the offer
and sale or other distribution from time to time by the holders thereof (the
"Selling Shareholders") of any Original Exchange Shares, RER Exchange Shares and
JME Exchange Shares (collectively, the "Exchange Shares") and any Original
Shares (collectively with the Exchange Shares, the "Secondary Shares"). The
Original Units and the Original Shares were issued (or reserved for issuance) in
connection with the formation of the Company and the Company's initial public
offering. The RER Units were issued, in a private placement in April 1995 to an
affiliate of Richard E. Rainwater, the Chairman of the Board of Trust Managers,
and the issuance of Common Shares upon any exchange thereof was approved by the
shareholders of the Company at its Annual Meeting held on June 12, 1995. The JME
Units were issued to an employee of the General Partner in a private placement
in May 1995. The Company has registered the Original Shares and the Exchange
Shares to provide the Selling Shareholders with freely tradeable securities, but
the registration of such shares does not necessarily mean that any of such
shares will be offered or sold by the Selling Shareholders. See "The Company"
and "Registration Rights." A portion of the Original Units and all of the RER
Units and JME Units have been exchanged for Common Shares. In addition, a
portion of the Original Units and the Secondary Shares have been distributed as
of March 31, 1997. All references to the number of Common Shares to which this
Prospectus relates have been adjusted to reflect the Company's two-for-one stock
split relating to its Common Shares and effected in the form of a 100% share
dividend paid on March 26, 1997. See "Selling Shareholders."
RISK FACTORS
Prospective investors should carefully consider the following summary
information in conjunction with the other information contained in this
Prospectus before exchanging Units or purchasing Common Shares.
CONCENTRATION OF ASSETS
A significant portion of the Company's assets are, and revenues are derived
from, Properties located in the metropolitan areas of Dallas-Fort Worth, Houston
and Austin, Texas and Denver, Colorado. Due to this geographic concentration,
any deterioration in economic conditions in the Dallas-Fort Worth, Houston,
Austin and Denver metropolitan areas or other geographic markets in which the
Company in the future may acquire substantial assets could have a substantial
effect on the financial condition and results of operations of the Company.
RISKS ASSOCIATED WITH THE ACQUISITION OF SUBSTANTIAL NEW ASSETS
From the closing of the Company's initial public offering in May 1994
through December 31, 1996, the Company has experienced rapid growth, increasing
its total assets by more than 318 percent. There can be no assurance either that
the Company will be able to manage its growth effectively or that the Company
will be able to maintain its current rate of growth in the future.
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PURCHASES FROM FINANCIALLY DISTRESSED SELLERS
Implementation of the Company's strategy of investing in real estate assets
in distressed circumstances has resulted in the acquisition of certain
Properties from owners that were in poor financial condition, and such strategy
is expected to result in the purchase of additional properties under similar
circumstances in the future. In addition to general real estate risks,
properties acquired in distress situations present risks related to inadequate
maintenance, negative market perception and continuation of circumstances which
precipitated the distress originally.
RELIANCE ON KEY PERSONNEL
The Company is dependent on the efforts of Mr. Richard E. Rainwater,
Chairman of the Board of Trust Managers, and other senior management personnel.
While the Company believes that it could find replacements for these key
executives, the loss of their services could have an adverse effect on the
operations of the Company. Mr. Rainwater has no employment agreement with the
Company and, therefore, is not obligated to remain with the Company for any
specified term. John C. Goff, Vice Chairman of the Board of Trust Managers, and
Gerald W. Haddock, President, Chief Executive Officer and Trust Manager, have
entered into employment agreements with the Company, and Messrs. Rainwater, Goff
and Haddock each has entered into a noncompetition agreement with the Company.
The Company has not obtained key-man insurance for any of its senior management
personnel.
RISKS RELATING TO QUALIFICATION AND OPERATION AS A REIT
The Company intends to continue to operate in a manner so as to qualify as
a REIT under the Internal Revenue Code of 1986, as amended (the "Code"). A
qualified REIT generally is not taxed at the corporate level on income it
currently distributes to its shareholders, so long as it distributes at least 95
percent of its taxable income currently and satisfies certain other highly
technical and complex requirements. Unlike many REITs, which tend to make only
one or two types of real estate investments, the Company invests in a broad
range of real estate products, and certain of its investments are more
complicated than those of other REITs. As a result, the Company is likely to
encounter a greater number of interpretative issues under the REIT qualification
rules, and more such issues which lack clear guidance, than are other REITs. The
Company, as a matter of policy, regularly consults with outside tax counsel in
structuring its new investments. The Company has received an opinion from Shaw,
Pittman, Potts & Trowbridge ("Tax Counsel") that the Company qualified as a REIT
under the Code for its taxable years ending on or before December 31, 1996, is
organized in conformity with the requirements for qualification as a REIT under
the Code and its proposed manner of operation will enable it to continue to meet
the requirements for qualification as a REIT. However, this opinion is based
upon certain representations made by the Company and the Operating Partnership
and upon existing law, which is subject to change, both retroactively and
prospectively, and to different interpretations. Furthermore, Tax Counsel's
opinion is not binding upon either the Internal Revenue Service or the courts.
Because the Company's qualification as a REIT in its current and future taxable
years depends upon its meeting the requirements of the Code in future periods,
no assurance can be given that the Company will continue to qualify as a REIT in
the future. If, in any taxable year, the Company were to fail to qualify as a
REIT for federal income tax purposes, it would not be allowed a deduction for
distributions to shareholders in computing taxable income and would be subject
to federal income tax (including any applicable alternative minimum tax) on its
taxable income at regular corporate rates. In addition, unless entitled to
relief under certain statutory provisions, the Company would be disqualified
from treatment as a REIT for federal income tax purposes for the four taxable
years following the year during which qualification was lost. The additional tax
liability resulting from the failure to so qualify would significantly reduce
the amount of funds available for distribution to shareholders.
RISKS RELATING TO DEBT
The Company's organizational documents do not limit the level or amount of
debt that it may incur. It is the Company's current policy to pursue a strategy
of conservative use of leverage, generally with a ratio of debt to total market
capitalization targeted at approximately 40 percent, although this policy is
subject to
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reevaluation and modification by the Company and could be increased above 40
percent. The Company has based its debt policy on the relationship between its
debt and its total market capitalization, rather than the book value of its
assets or other historical measures that typically have been employed by
publicly traded REITs, because management believes that market capitalization
more accurately reflects the Company's ability to borrow money and meet its debt
service requirements. Market capitalization is, however, more variable than book
value of assets or other historical measures. There can be no assurance that the
ratio of indebtedness to market capitalization (or any other measure of asset
value) or the incurrence of debt at any particular level would not adversely
affect the financial condition and results of operations of the Company.
RISKS RELATING TO CONTROL OF THE COMPANY
Ability to Change Policies and Acquire Assets without Shareholder
Approval. The Company's operating and financial policies, including its
policies with respect to acquisitions, growth, operations, indebtedness,
capitalization and distributions, will be determined by the Board of Trust
Managers. The Board of Trust Managers generally may revise these policies, from
time to time, without shareholder approval. Changes in the Company's policies
could adversely affect the Company's financial condition and results of
operations. In addition, the Company has the right and intends to acquire
additional real estate assets pursuant to and consistent with its investment
strategies and policies without shareholder approval.
Hotel Risks. The Company has leased the Hotel Properties and the lessee of
each Hotel Property, rather than the Company, is entitled to exercise all rights
of the owner of the respective hotel. The Company will receive both base rent
and, as additional rent, a percentage of gross sales above a certain minimum
level pursuant to the leases, which expire between the years 2004 and 2006. As a
result, the Company will participate in the economic operations of the Hotel
Properties only through its indirect participation in gross sales. To the extent
that operations of the Hotel Properties may affect the ability of the lessees of
the Hotel Properties to pay rent, the Company also may indirectly bear the risks
associated with any increases in expenses or decreases in revenues. Each of the
Hotel Properties is managed pursuant to a management agreement. The Company,
therefore, will be dependent upon the lessees and managers of the Hotel
Properties to manage the operations of the Hotel Properties successfully. As a
result, the amount of additional rent payable to the Company under the leases
with respect to the Hotel Properties will depend on the ability of the lessees
and managers of the Hotel Properties to maintain and increase revenues from the
Hotel Properties. Accordingly, the Company's results of operations will be
affected by such factors as changes in general economic conditions, the level of
demand for rooms and related services at the Hotel Properties, the ability of
the lessees and managers of the Hotel Properties to maintain and increase gross
revenues at the Hotel Properties, competition in the hotel industry and other
factors relating to the operation of the Hotel Properties.
Lack of Control of Residential Development Corporations. The Company is
not able to elect the boards of directors of the Residential Development
Corporations, and does not have the authority to control the management and
operation of the Residential Development Corporations. As a result, the Company
does not have the right to control the timing or amount of dividends paid by the
Residential Development Corporations and, therefore, does not have the authority
to require that funds be distributed to it by any of these entities.
Possible Adverse Consequences of Ownership Limit. The limitation on
ownership of Common Shares set forth in the Company's Restated Declaration of
Trust (the "Declaration of Trust") could have the effect of discouraging offers
to acquire the Company and of inhibiting or impeding a change in control and,
therefore, could adversely affect the shareholders' ability to realize a premium
over the then-prevailing market price for the Common Shares in connection with
such a transaction. See "Description of Shares of the Company -- Ownership
Limits and Restrictions on Transfer."
GENERAL REAL ESTATE RISKS
Uncontrollable Factors Affecting Performance and Value. The economic
performance and value of the Company's real estate assets will be subject to all
of the risks incident to the ownership and operation of real estate. These
include the risks normally associated with changes in national, regional and
local economic and market conditions. Such local real estate market conditions
may include excess supply and competition for
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tenants, including competition based on rental rates, attractiveness and
location of the property and quality of maintenance and management services. In
addition, other factors may affect the performance and value of a property
adversely, including changes in laws and governmental regulations (including
those governing usage, zoning and taxes), changes in interest rates (including
the risk that increased interest rates may result in decreased sales of lots in
the Residential Development Properties) and the availability of financing.
Illiquidity of Real Estate Investments. Because real estate investments
are relatively illiquid, the Company's ability to vary its portfolio promptly in
response to economic or other conditions will be limited. In addition, certain
significant expenditures, such as debt service (if any), real estate taxes, and
operating and maintenance costs, generally are not reduced in circumstances
resulting in a reduction in income from the investment. The foregoing and any
other factor or event that would impede the ability of the Company to respond to
adverse changes in the performance of its investments could have an adverse
effect on the Company's financial condition and results of operations.
Environmental Matters. Under various federal, state and local laws,
ordinances and regulations, an owner or operator of real property may become
liable for the costs of removal or remediation of certain hazardous or toxic
substances released on or in its property, as well as certain other costs
relating to hazardous or toxic substances. Such liability may be imposed without
regard to whether the owner or operator knew of, or was responsible for, the
release of such substances. The presence of, or the failure to remediate
properly, such substances, may adversely affect the owner's ability to sell the
affected real estate or to borrow using such real estate as collateral. Such
costs or liabilities could exceed the value of the affected real estate. The
Company has not been notified by any governmental authority of any
non-compliance, liability or other claim in connection with any of the
Properties and the Company is not aware of any other environmental condition
with respect to any of the Properties that management believes would have a
material adverse effect on the Company's business, assets or results of
operations. Prior to the Company's acquisition of its Properties, independent
environmental consultants conducted or updated Phase I environmental assessments
(which generally do not involve invasive techniques such as soil or ground water
sampling) on the Properties. None of these Phase I assessments or updates
revealed any materially adverse environmental condition not known to the Company
or the independent consultants preparing the assessments. There can be no
assurance, however, that environmental liabilities have not developed since such
environmental assessments were prepared, or that future uses or conditions
(including, without limitation, changes in applicable environmental laws and
regulations) will not result in imposition of environmental liability.
REAL ESTATE RISKS SPECIFIC TO THE COMPANY'S BUSINESS
Investment Risks. In implementing its investment strategies, the Company
has invested in a broad range of real estate assets and in the future intends to
invest in additional types of real estate assets not currently included in its
portfolio. There can be no assurance, however, that the Company will be able to
implement its investment strategies successfully in the future. As a result of
its real estate investments, the Company will be subject to risks, in addition
to general real estate risks, relating to the specific assets and asset types in
which it invests. For example, the Company is subject to the risks that, upon
expiration, leases for space in the Office Properties and Retail Properties may
not be renewed, the space may not be re-leased, or the terms of renewal or
re-lease (including the cost of required renovations or concessions to tenants)
may be less favorable than current lease terms. Similarly, the Company is
subject to the risk that the success of the Hotel Properties will be highly
dependent upon their ability to compete in such features as access, location,
quality of accommodations, room rate structure and, to a lesser extent, the
quality and scope of other amenities such as food and beverage facilities. In
addition, the Company will be subject to risks relating to the approximately 90
behavioral healthcare facilities which it intends to acquire and lease to a
single tenant, including the effect of any failure of the tenant under the lease
to make the required lease payments (which are expected to equal more than 10%
of the Company's current base rental revenues); the effects of factors such as
regulation of the healthcare industry and limitations on government
reimbursement programs on the ability of the tenant to make the required lease
payments; and the limited number of replacement tenants in the event of a
default under, or non-renewal of, the lease.
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Risks of Joint Ownership of Assets. The Company has the right to invest,
and in certain cases has invested, in properties and assets jointly with other
persons or entities. Joint ownership of properties, under certain circumstances,
may involve risks not otherwise present, including the possibility that the
Company's partners or co-investors might become bankrupt, that such partners or
co-investors might at any time have economic or other business interests or
goals which are inconsistent with the business interests or goals of the
Company, and that such partners or co-investors may be in a position to take
action contrary to the instructions or the requests of the Company or contrary
to the Company's policies or objectives, including the Company's policy with
respect to maintaining its qualification as a REIT.
SPECIAL CONSIDERATIONS APPLICABLE TO EXCHANGING LIMITED PARTNERS
Tax Consequences of Exchange of Units. The exercise by a holder of Units
of his Exchange Right will be treated for tax purposes as a sale of the Units by
the Limited Partner. Such a sale will be fully taxable to the exchanging Limited
Partner, and such exchanging Limited Partner will be treated as realizing for
tax purposes an amount equal to the sum of the cash or the value of the Common
Shares received in the exchange plus the amount of the Operating Partnership
nonrecourse liabilities allocable to the exchanged Units at the time of the
exchange. It is possible that the amount of gain recognized or even the tax
liability resulting from such gain could exceed the amount of cash and the value
of other property (e.g., Exchange Shares) received upon such disposition. See
"Exchange of Units -- Tax Consequences of Exchange." In addition, the ability of
the Limited Partner to sell a substantial number of Exchange Shares in order to
raise cash to pay tax liabilities associated with exchange of Units may be
restricted, and, as a result of fluctuations in the stock price, the price the
Limited Partner receives for such shares may not equal the value of his Units at
the time of exchange.
Potential Change in Investment Upon Exchange of Units. If a Limited
Partner exercises an Exchange Right, such Limited Partner may receive cash or
Common Shares of the Company in exchange for the Units. If the Limited Partner
receives cash, the Limited Partner will no longer have any interest in the
Company and will not benefit from any subsequent increases in share price and
will not receive any future distributions from the Company (unless the Limited
Partner currently owns or acquires in the future additional Common Shares or
Units). If the Limited Partner receives Common Shares, the Limited Partner will
become a shareholder of the Company rather than a holder of Units in the
Operating Partnership. Although the nature of an investment in Common Shares is
substantially equivalent to an investment in Units in the Operating Partnership,
there are some differences between ownership of Units and ownership of Common
Shares relating to, among other things, form of organization, permitted
investments, policies and restrictions, management structure, compensation and
fees, investor rights and federal income taxation. These differences, some of
which may be material to investors, are discussed in "Exchange of
Units -- Comparison of Ownership of Units and Common Shares."
Under the Operating Partnership Agreement, the Company, acting through the
General Partner, has full and complete authority, responsibility and discretion
in the management and control of the Operating Partnership, subject to limited
consent rights of the other Limited Partners with respect to amendments to the
Operating Partnership Agreement (which, in general, require the approval of a
majority in interest of the Limited Partners) and amendments which adversely
affect the rights of Limited Partners (certain of which require the approval of
each Limited Partner so affected). See "Description of Units -- Management." The
Company's interests in the Operating Partnership (directly and through the
General Partner) entitle it to share in cash distributions from, and in the
profits and losses of, the Operating Partnership in accordance with its
percentage of partnership interests therein.
DESCRIPTION OF SHARES OF THE COMPANY
Common Shares. The Declaration of Trust authorizes the Board of Trust
Managers of the Company to issue up to 250,000,000 Common Shares, as well as
250,000,000 Excess Shares, par value $0.01 per share, issuable in exchange for
Common Shares as described below under "-- Ownership Limits and Restrictions on
Transfer."
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Subject to such preferential rights as may be granted by the Board of Trust
Managers in connection with the future issuance of Preferred Shares, holders of
Common Shares are entitled to one vote per share on all matters to be voted on
by shareholders and are entitled to receive ratably such dividends as may be
declared on the Common Shares by the Board of Trust Managers in its discretion
from funds legally available therefor. In the event of the liquidation,
dissolution or winding up of the Company, holders of Common Shares are entitled
to share ratably in all assets remaining after payment of all debts and other
liabilities and any liquidation preference of the holders of Preferred Shares.
Holders of Common Shares have no subscription, redemption, conversion or
preemptive rights. Matters submitted for shareholder approval generally require
a majority vote of the shares present and voting thereon.
Preferred Shares. The Declaration of Trust of the Company authorizes the
Board of Trust Managers of the Company to issue up to 100,000,000 preferred
shares of beneficial interest, par value $.01 per share (the "Preferred
Shares"), to establish one or more series of such Preferred Shares and to
determine, with respect to any series of Preferred Shares, the preferences,
rights and other terms of such series. As of the date of this Prospectus, there
are no Preferred Shares outstanding. Although the Board of Trust Managers has no
present intention to do so, it could, in the future, issue a series of Preferred
Shares which, due to its terms, could impede a merger, tender offer or other
transaction that some, or a majority, of the Company's shareholders might
believe to be in their best interests or in which shareholders might receive a
premium over then prevailing market prices for their Common Shares. The
Declaration of Trust also authorizes the issuance of up to an aggregate of
100,000,000 Excess Shares issuable in exchange for Preferred Shares as described
below under "-- Ownership Limits and Restrictions on Transfer."
Ownership Limits and Restrictions on Transfer. For the Company to qualify
as a REIT under the Code, (i) not more than 50% in value of outstanding equity
securities of all classes ("Equity Shares") may be owned, directly or
indirectly, by five or fewer individuals (as defined in the Code to include
certain entities) during the last half of a taxable year; (ii) the Equity Shares
must be beneficially owned by 100 or more persons during at least 335 days of a
taxable year of 12 months or during a proportionate part of a shorter taxable
year; and (iii) certain percentages of the Company's gross income must come from
certain activities.
To ensure that five or fewer individuals do not own more than 50% in value
of the outstanding Equity Shares, the Company's Declaration of Trust provides
generally that no holder may own, or be deemed to own by virtue of certain
attribution provisions of the Code, more than 8.0% of the issued and outstanding
Common Shares (the "Common Shares Ownership Limit") or more than 9.9% of the
issued and outstanding shares of any series of Preferred Shares (the "Preferred
Shares Ownership Limit"), except that Mr. Rainwater, the Chairman of the Board
of Trust Managers, and certain related persons together may own, or be deemed to
own, by virtue of certain attribution provisions of the Code, up to 9.5% (the
"Rainwater Ownership Limit") of the issued and outstanding Common Shares
(collectively, the "Ownership Limit"). The Board of Trust Managers, upon receipt
of a ruling from the IRS, an opinion of counsel, or other evidence satisfactory
to the Board of Trust Managers, in its sole discretion, may waive or change, in
whole or in part, the application of the Ownership Limit with respect to any
person that is not an individual (as defined in Section 542(a)(2) of the Code).
In connection with any such waiver or change, the Board of Trust Managers may
require such representations and undertakings from such person or affiliates and
impose such other conditions as the Board deems necessary, advisable or prudent,
in its sole discretion, to determine the effect, if any, of a proposed
transaction or ownership of Equity Shares on the Company's status as a REIT for
federal income tax purposes.
In addition, the Board of Trust Managers, from time to time, may increase
the Common Shares Ownership Limit, except that (i) the Common Shares Ownership
Limit may not be increased and no additional limitations may be created if,
after giving effect thereto, the Company would be "closely held" within the
meaning of Section 856(h) of the Code and (ii) the Common Shares Ownership Limit
may not be increased to a percentage that is greater than 9.9%. Under the
Declaration of Trust, neither the Preferred Shares Ownership Limit nor the
Rainwater Ownership Limit may be increased. The Board of Trust Managers may
reduce the Rainwater Ownership Limit, with the written consent of Mr. Rainwater,
after any transfer permitted by the Declaration of Trust. Prior to any
modification of the Ownership Limit or the Rainwater Ownership Limit with
respect to any person, the Board of Trust Managers will have the right to
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require such opinions of counsel, affidavits, undertakings or agreements as it
may deem necessary, advisable or prudent, in its sole discretion, in order to
determine or ensure the Company's status as a REIT.
Under the Declaration of Trust, the Ownership Limit will not be
automatically removed even if the REIT provisions of the Code are changed so as
to no longer contain any ownership concentration limitation or if the ownership
concentration limit is increased. In addition to preserving the Company's status
as a REIT for federal income tax purposes, the Ownership Limit may prevent any
person or small group of persons from acquiring control of the Company.
The Declaration of Trust of the Company also provides that if any issuance,
transfer or acquisition of Equity Shares (i) would result in a holder exceeding
the Ownership Limit, (ii) would cause the Company to be beneficially owned by
less than 100 persons, (iii) would result in the Company's being "closely held"
within the meaning of Section 856(h) of the Code, or (iv) would otherwise result
in the failure of the Company to qualify as a REIT for federal income tax
purposes, such issuance, transfer or acquisition shall be null and void to the
intended transferee or holder, and the intended transferee or holder will
acquire no rights to the shares. Pursuant to the Declaration of Trust, Equity
Shares owned, transferred or proposed to be transferred in excess of the
Ownership Limit or which would otherwise jeopardize the Company's status as a
REIT under the Code will automatically be converted to Excess Shares. A holder
of Excess Shares is not entitled to distributions, voting rights and other
benefits with respect to such shares except the right to payment of the purchase
price for the shares and the right to certain distributions upon liquidation.
Any dividend or distribution paid to a proposed transferee on Excess Shares
pursuant to the Company's Declaration of Trust will be required to be repaid to
the Company upon demand. Excess Shares will be subject to repurchase by the
Company at its election. The purchase price of any Excess Shares will be equal
to the lesser of (i) the price in such proposed transaction or (ii) either (a)
if the shares are then listed on the New York Stock Exchange ("NYSE"), the fair
market value of such shares reflected in the average closing sales prices for
the shares on the 10 trading days immediately preceding the date on which the
Company or its designee determines to exercise its repurchase right; or (b) if
the shares are not then so listed, such price for the shares on the principal
exchange (including the Nasdaq National Market) on which the shares are listed;
or (c) if the shares are not then listed on a national securities exchange, the
latest quoted price for the shares; or (d) if not quoted, the average of the
high bid and low asked prices if the shares are then traded over-the-counter, as
reported by the Nasdaq Stock Market; or (e) if such system is no longer in use,
the principal automated quotation system then in use; or (f) if the shares are
not quoted on such system, the average of the closing bid and asked prices as
furnished by a professional market maker making a market in the shares; or (g)
if there is no such market maker or such closing prices otherwise are
unavailable, the fair market value, as determined by the Board of Trust Managers
in good faith, on the last trading day immediately preceding the day on which
notice of such proposed purchase is sent by the Company. The Declaration of
Trust also establishes certain restrictions relating to transfers of any
Exchange Shares that may be issued. If such transfer restrictions are determined
to be void or invalid by virtue of any legal decision, statute, rule or
regulation, then the Company will have the option to deem the intended
transferee of any Excess Shares to have acted as an agent on behalf of the
Company in acquiring such Excess Shares and to hold such Excess Shares on behalf
of the Company.
Under the Declaration of Trust, the Company has the authority, at any time,
to waive the requirement that Excess Shares be issued or be deemed outstanding
in accordance with the provisions of the Declaration of Trust if the issuance of
such Excess Shares or the fact that such Excess Shares is deemed to be
outstanding would, in the opinion of nationally recognized tax counsel,
jeopardize the status of the Company as a REIT for federal income tax purposes.
All certificates issued by the Company representing Equity Shares will bear
a legend referring to the restrictions described above.
The Declaration of Trust of the Company also provides that all persons who
own, directly or by virtue of the attribution provisions of the Code, more than
5.0% of the outstanding Equity Shares (or such lower percentage as may be set by
the Board of Trust Managers), must file an affidavit with the Company containing
information specified in the Declaration of Trust no later than January 31 of
each year. In addition, each shareholder will be required, upon demand, to
disclose to the Company in writing such information with
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respect to the direct, indirect and constructive ownership of shares as the
trust managers may request in order to comply with the provisions of the Code,
as applicable to a REIT, or to comply with the requirements of an authority or
governmental agency.
The ownership limitations described above may have the effect of inhibiting
or impeding acquisitions of control of the Company by a third party. See
"Certain Provisions of the Declaration of Trust, Bylaws and Texas Law."
CERTAIN PROVISIONS OF THE DECLARATION OF TRUST
AND BYLAWS AND TEXAS LAW
The Declaration of Trust and the Bylaws of the Company contain certain
provisions that may inhibit or impede acquisition or attempted acquisition of
control of the Company by means of a tender offer, a proxy contest or otherwise.
These provisions are expected to discourage certain types of coercive takeover
practices and inadequate takeover bids and to encourage persons seeking to
acquire control of the Company to negotiate first with the Board of Trust
Managers. The Company believes that these provisions increase the likelihood
that proposals initially will be on more attractive terms than would be the case
in their absence and increase the likelihood of negotiations, which might
outweigh the potential disadvantages of discouraging such proposals because,
among other things, negotiation of such proposals might result in improvement of
terms. The description set forth below is only a summary of the terms of the
Declaration of Trust and the Bylaws (copies of which have been filed as exhibits
to the Registration Statement of which this Prospectus forms a part). See
"Description of Shares of the Company -- Ownership Limits and Restrictions on
Transfer."
Staggered Board of Trust Managers. The Declaration of Trust and the Bylaws
of the Company provide that the Board of Trust Managers will be divided into
three classes of trust managers, each class constituting approximately one-third
of the total number of trust managers, with the classes serving staggered
three-year terms. The classification of the Board of Trust Managers will have
the effect of making it more difficult for shareholders to change the
composition of the Board of Trust Managers, because only a minority of the trust
managers are up for election, and may be replaced by vote of the shareholders,
at any one time. The Company believes, however, that the longer terms associated
with the classified Board of Trust Managers will help to ensure continuity and
stability of the Company's management and policies.
The classification provisions also could have the effect of discouraging a
third party from accumulating a large block of the Company's capital shares or
attempting to obtain control of the Company, even though such an attempt might
be beneficial to the Company and some, or a majority, of its shareholders.
Accordingly, under certain circumstances shareholders could be deprived of
opportunities to sell their Common Shares at a higher price than might otherwise
be available.
Number of Trust Managers; Removal; Filling Vacancies. Subject to any
rights of holders of Preferred Shares to elect additional trust managers under
specified circumstances ("Preferred Holders' Rights"), the Declaration of Trust
provides that the number of trust managers will be fixed by, or in the manner
provided in, the Bylaws, but must not be more than 25 or less than one. In
addition, the Bylaws provide that, subject to any Preferred Holders' Rights, the
number of trust managers will be fixed by the Board of Trust Managers, but must
not be more than 25 or less than three. In addition, the Bylaws provide that,
subject to any Preferred Holders' Rights, and unless the Board of Trust Managers
otherwise determines, any vacancies (other than vacancies created by an increase
in the total number of trust managers) will be filled by the affirmative vote of
a majority of the remaining trust managers, although less than a quorum, and any
vacancies created by an increase in the total number of trust managers may be
filled by a majority of the entire Board of Trust Managers. Accordingly, the
Board of Trust Managers could temporarily prevent any shareholder from enlarging
the Board of Trust Managers and then filling the new trust manager position with
such shareholder's own nominees.
The Declaration of Trust and the Bylaws provide that, subject to any
Preferred Holders' Rights, trust managers may be removed only for cause upon the
affirmative vote of holders of at least 80% of the entire
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voting power of all the then-outstanding Equity Shares entitled to vote
generally in the election of trust managers, voting together as a single class.
Relevant Factors to be Considered by the Board of Trust Managers. The
Declaration of Trust provides that, in determining what is in the best interest
of the Company in evaluating a "business combination," "change in control" or
other transaction, a trust manager of the Company shall consider all of the
relevant factors. These factors may include (i) the immediate and long-term
effects of the transaction on the Company's shareholders, including
shareholders, if any, who do not participate in the transaction; (ii) the social
and economic effects of the transaction on the Company's employees, suppliers,
creditors and customers and others dealing with the Company and on the
communities in which the Company operates and is located; (iii) whether the
transaction is acceptable, based on the historical and current operating results
and financial condition of the Company; (iv) whether a more favorable price
could be obtained for the Company's shares or other securities in the future;
(v) the reputation and business practices of the other party or parties to the
proposed transaction, including its or their management and affiliates, as they
would affect employees of the Company; (vi) the future value of the Company's
securities; (vii) any legal or regulatory issues raised by the transaction; and
(viii) the business and financial condition and earnings prospects of the other
party or parties to the proposed transaction including, without limitation, debt
service and other existing financial obligations, financial obligations to be
incurred in connection with the transaction, and other foreseeable financial
obligations of such other party or parties. Pursuant to this provision, the
Board of Trust Managers may consider subjective factors affecting a proposal,
including certain nonfinancial matters, and, on the basis of these
considerations, may oppose a business combination or other transaction which,
evaluated only in terms of its financial merits, might be attractive to some, or
a majority, of the Company's shareholders.
Advance Notice Provisions for Shareholder Nominations and Shareholder
Proposals. The Bylaws provide for an advance notice procedure for shareholders
to make nominations of candidates for trust manager or bring other business
before an annual meeting of shareholders of the Company (the "Shareholder Notice
Procedure").
Pursuant to the Shareholder Notice Procedure (i) only persons who are
nominated by, or at the direction of, the Board of Trust Managers, or by a
shareholder who has given timely written notice containing specified information
to the Secretary of the Company prior to the meeting at which trust managers are
to be elected, will be eligible for election as trust managers of the Company
and (ii) at an annual meeting, only such business may be conducted as has been
brought before the meeting by, or at the direction of the Chairman or the Board
of Trust Managers or by a shareholder who has given timely written notice to the
Secretary of the Company of such shareholder's intention to bring such business
before such meeting. In general, for notice of shareholder nominations or
proposed business to be conducted at an annual meeting to be timely, such notice
must be received by the Company not less than 70 days nor more than 90 days
prior to the first anniversary of the previous year's annual meeting.
The purpose of requiring shareholders to give the Company advance notice of
nominations and other business is to afford the Board of Trust Managers a
meaningful opportunity to consider the qualifications of the proposed nominees
or the advisability of the other proposed business and, to the extent deemed
necessary or desirable by the Board of Trust Managers, to inform shareholders
and make recommendations about such nominees or business, as well as to ensure
an orderly procedure for conducting meetings of shareholders. Although the
Bylaws do not give the Board of Trust Managers power to block shareholder
nominations for the election of trust managers or proposal for action, they may
have the effect of discouraging a shareholder from proposing nominees or
business, precluding a contest for the election of trust managers or the
consideration of shareholder proposals if procedural requirements are not met,
and deterring third parties from soliciting proxies for a non-management
proposal or slate of trust managers, without regard to the merits of such
proposal or slate.
Preferred Shares. The Declaration of Trust authorizes the Board of Trust
Managers to establish one or more series of Preferred Shares and to determine,
with respect to any series of Preferred Shares, the preferences, rights and
other terms of such series. See "Description of Shares of the
Company -- Preferred Shares." The Company believes that the ability of the Board
of Trust Managers to issue one or more series of Preferred Shares provides the
Company with increased flexibility in structuring possible future financings and
acquisitions, and in
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meeting other corporate needs. The authorized Preferred Shares are available for
issuance without further action by the Company's shareholders, 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. Although the Board of Trust Managers has no present intention to do so,
it could, in the future, issue a series of Preferred Shares which, due to its
terms, could impede a merger, tender offer or other transaction that some, or a
majority, of the Company's shareholders might believe to be in their best
interests or in which shareholders might receive a premium over then prevailing
market prices for their Common Shares.
Amendment of Declaration of Trust. The Declaration of Trust provides that
it may be amended only by the affirmative vote of the holders of not less than
two-thirds of the votes entitled to be cast, except that the provisions of the
Declaration of Trust relating to "business combinations" or "control shares" (as
described below under "-- Business Combinations" and "-- Control Share
Acquisitions") may be amended only with the affirmative vote of 80% of the votes
entitled to be cast, voting together as a single class.
Rights to Purchase Securities and Other Property. The Declaration of Trust
authorizes the Board of Trust Managers, subject to any rights of holders of any
series of Preferred Shares, to create and issue rights entitling the holders
thereof to purchase from the Company Equity Shares or other securities of the
Company or successor-in-interest of the Company, or property. The times at which
and terms upon which such rights are to be issued are within the discretion of
the Board of Trust Managers. This provision is intended to confirm the authority
of the Board of Trust Managers to issue share purchase rights which could have
terms that would impede a merger, tender offer or other takeover attempt, or
other rights to purchase securities of the Company or any other entity.
Business Combinations. The Declaration of Trust establishes special
requirements with respect to "business combinations" (including a merger,
consolidation, share exchange, or, in certain circumstances, an asset transfer
or issuance or reclassification of securities) between the Company and any
person who beneficially owns, directly or indirectly, 10% or more of the voting
power of the Company's voting shares (an "Interested Shareholder"), subject to
certain exemptions. In general, the Declaration of Trust provides that an
Interested Shareholder or any affiliate thereof may not engage in a "business
combination" with the Company for a period of five years following the date he
becomes an Interested Shareholder. Thereafter, pursuant to the Declaration of
Trust, such transactions must be (i) approved by the Board of Trust Managers of
the Company and (ii) approved by the affirmative vote of at least 80% of the
votes entitled to be cast by holders of voting shares other than voting shares
held by the Interested Shareholder with whom the business combination is to be
effected, unless, among other things, the holders of Equity Shares receive a
minimum price (as such term is defined in the Declaration of Trust) for their
shares and the consideration is received in cash or, in general, in the same
form as previously paid by the Interested Shareholder for his shares. These
provisions of the Declaration of Trust do not apply, however, to business
combinations that are approved or exempted by the Board of Trust Managers of the
Company prior to the time that the Interested Shareholder becomes an Interested
Shareholder.
Control Share Acquisitions. The Declaration of Trust provides that
"control shares" of the Company 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 by the holders of Equity Shares, excluding shares as to
which the acquiror, officers of the Company and employees of the Company who are
also trust managers have the right to vote or direct the vote. Accordingly,
"control shares" are Equity Shares which, if aggregated with all other Equity
Shares previously acquired which the person is entitled to vote, would entitle
the acquiror to vote (i) 20% or more but less than one-third, (ii) one-third or
more but less than a majority, or (iii) a majority, of the outstanding voting
shares. Control shares do not include Equity Shares that the acquiring person is
entitled to vote on the basis of prior shareholder approval. A "control share
acquisition" is defined as the acquisition of control shares, subject to certain
exemptions enumerated in the Declaration of Trust.
The Declaration of Trust provides that a person who has made or proposes to
make a control share acquisition and who has obtained a definitive financing
agreement with a responsible financial institution providing for any amount of
financing not to be provided by the acquiring person may compel the Board of
Trust Managers of the Company to call a special meeting of shareholders to be
held within 50 days of demand
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to consider the voting rights of such Equity Shares. If no request for a meeting
is made, the Declaration of Trust permits the Company itself to present the
question at any shareholders' meeting.
Pursuant to the Declaration of Trust, if voting rights are not approved at
a shareholders' meeting or if the acquiring person does not deliver an acquiring
person statement as required by the Declaration of Trust, then, subject to
certain conditions and limitations set forth in the Declaration of Trust, the
Company will have the right to 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 of the control
shares, as of the date of the last control share acquisition or of any meeting
of shareholders at which the voting rights of such shares are considered and not
approved. Under the Declaration of Trust, if voting rights for control shares
are approved at a shareholders' meeting and, as a result, the acquiror would be
entitled to vote a majority of the Equity Shares entitled to vote, all other
shareholders will have the rights of dissenting shareholders under the Texas
Real Estate Investment Trust Act (the "TRA"). The Declaration of Trust provides
that the fair value of the Equity Shares 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 that certain limitations and restrictions of the
TRA otherwise applicable to the exercise of dissenters' rights will not apply.
These provisions of the Declaration of Trust do not apply to Equity Shares
acquired in a merger, consolidation or share exchange if the Company is a party
to the transaction, or if the acquisition is approved or exempted by a provision
of the Declaration of Trust or Bylaws of the Company adopted prior to the
control share acquisition.
Ownership Limit. The limitation on ownership of Common Shares set forth in
the Company's Declaration of Trust, as well as provisions of the TRA, could have
the effect of discouraging offers to acquire the Company and of increasing the
difficulty of consummating any such offer. See "Description of Shares of the
Company -- Ownership Limits and Restrictions on Transfer."
DESCRIPTION OF UNITS
The following is a summary of the material terms of the Units, including a
summary of certain provisions of the Operating Partnership Agreement. Such
summary, including the descriptions of certain provisions set forth elsewhere in
this Prospectus, is qualified in its entirety by reference to the Operating
Partnership Agreement which has been filed as an exhibit to the Registration
Statement of which this Prospectus is a part. For a comparison of the voting and
other rights of the holders of Units and the Company's shareholders, see
"Exchange of Units -- Comparison of Ownership of Units and Common Shares."
MANAGEMENT
Pursuant to the Operating Partnership Agreement, the Company, through the
General Partner, which is the sole general partner of the Operating Partnership,
generally has full and complete authority, responsibility and discretion in the
management and control of the Operating Partnership, and the Limited Partners
have no authority to transact business for, or participate in the management
activities or decisions of, the Operating Partnership. The Company, through the
General Partner, has the power to amend the Operating Partnership Agreement to
(i) add to the obligations of the General Partner or surrender any right or
power granted to the General Partner or its affiliates for the benefit of the
Limited Partners, (ii) reflect the admission, substitution, termination or
withdrawal of partners in accordance with the terms of Operating Partnership
Agreement, (iii) reflect an inconsequential change that has no material adverse
effect on the Limited Partners, (iv) cure an ambiguity, or correct or supplement
the Operating Partnership Agreement in a manner not inconsistent with law or the
other provisions of the Operating Partnership Agreement, or (v) make other
changes with respect to matters arising under the Operating Partnership
Agreement not inconsistent with law or the provisions of the Operating
Partnership Agreement. However, any other amendments to the Operating
Partnership Agreement require the consent of a majority in interest of the
Limited Partners. In addition, the Operating Partnership Agreement cannot be
amended without the prior written consent of each partner adversely affected if
such amendment would (i) convert a Limited Partner's interest in the Operating
Partnership into a general partner's interest; (ii) modify the limited liability
of a Limited Partner; (iii) except
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as expressly permitted by the Operating Partnership Agreement, alter rights of
the partner to receive distributions pursuant to the Operating Partnership
Agreement, or the allocations specified in the Operating Partnership Agreement;
(iv) alter or modify the Exchange Rights; (v) cause the termination of the
Operating Partnership prior to the expiration of its term; or (vi) amend the
section of the Operating Partnership Agreement setting forth these consent
rights.
BUSINESS OPERATIONS
The Operating Partnership Agreement provides that all business activities
of the Company, including all activities pertaining to the acquisition,
development and ownership of the Properties, must be conducted through the
Operating Partnership or through partnerships and limited liability companies
affiliated with the Operating Partnership. The Operating Partnership Agreement
prohibits the Company from borrowing for the purpose of making distributions to
shareholders unless it arranges such borrowing through the Operating
Partnership.
The Operating 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 for federal income tax purposes and to avoid any
federal income or excise tax liability.
CAPITAL CONTRIBUTIONS
The Operating Partnership Agreement provides that, if the Operating
Partnership requires additional funds at any time or from time to time, the
Operating Partnership may borrow such funds directly from a financial
institution or other lender, or the Company (including the General Partner) may
borrow such funds from a financial institution or other lender and the Company
may lend such funds to the Operating Partnership on the same terms and
conditions as are applicable to the Company's borrowing of such funds.
Alternatively, the Company may contribute the amount of such required funds as
an additional capital contribution to the Operating Partnership. If the Company
contributes additional capital to the Operating Partnership in the form of cash
or property, the limited partnership interest of the Company in the Operating
Partnership will be adjusted on a proportionate basis based upon the value of
such additional capital contributions and the value of the Operating Partnership
immediately after such contributions, while the partnership interests of the
other Limited Partners will be decreased on a proportionate basis. Except in
connection with the Exchange Rights or an incentive compensation plan, the
Company may not issue additional Common Shares except on a pro rata basis to all
shareholders unless the proceeds from the issuance are contributed to the
Operating Partnership as an additional capital contribution.
If the Company issues preferred stock, rights, options (other than options
issued pursuant to the existing stock incentive plans of the Company), warrants
or convertible or exchangeable securities containing the right to subscribe for
or purchase Common Shares ("New Securities") to other than all holders of Common
Shares, it is required to contribute the proceeds from the issuance of the New
Securities to the Operating Partnership in exchange for a preferential
partnership interest having economic rights substantially similar to those of
the New Securities. If the New Securities subsequently are converted into Common
Shares, the preferential partnership interest of the Company will be converted
into an additional limited partnership interest in the Operating Partnership,
and the partnership interests of the other Limited Partners will be decreased
proportionately, based on the value of the Common Shares into which the New
Securities are converted and the value of the Operating Partnership at the time
of conversion of the New Securities.
AWARDS UNDER STOCK INCENTIVE PLANS
If grants of restricted Common Shares ("Restricted Shares") are made
pursuant to the existing stock incentive plans of the Company (or any stock
incentive plan adopted in the future by the Company), the Operating Partnership
Agreement requires the Company to contribute to the Operating Partnership as an
additional capital contribution the price received (if any) in connection with
such grant. Upon any issuance of Restricted Shares, the Company will be deemed
to have contributed to the Operating Partnership an amount equal to the fair
market value of the Restricted Shares issued. This will have the effect of
increasing the
15
<PAGE> 18
limited partnership interest of the Company (and thus reducing the percentage
interests of the other Limited Partners) in connection with any grants of
Restricted Shares.
If options granted in connection with the existing stock incentive plans of
the Company (or any other stock incentive plan adopted in the future by the
Company) are exercised at any time or from time to time, the Operating
Partnership Agreement requires the Company to contribute to the Operating
Partnership as an additional capital contribution the exercise price received by
the Company in connection with such exercise. Although the Company will
contribute to the Operating Partnership an amount equal to the exercise price
received, the Company will be deemed to have contributed an amount equal to the
fair market value of the Common Shares issued. This will have the effect of
increasing the limited partnership interest of the Company (and thus reducing
the percentage interests of the other Limited Partners) in connection with such
additional capital contributions.
OTHER EQUITY COMPENSATION PLANS
The Operating Partnership has adopted two compensation plans that grant
limited partnership interests in the Operating Partnership (including Units), or
options to acquire limited partnership interests, to employees (including
officers) of the Operating Partnership and may adopt other such plans in the
future. The partnership interests of the other Limited Partners (including the
Company) are reduced upon any issuance of limited partnership interests
(including Units) to an employee of the Operating Partnership.
The Operating Partnership or certain of its affiliates may adopt other
incentive compensation plans in which their employees, agents or consultants are
compensated based on the Operating Partnership's revenue or income amounts, or
based on increases in the market value of Operating Partnership assets,
partnership interests in the Operating Partnership or Common Shares.
TRANSFERABILITY OF PARTNERSHIP INTERESTS
The Operating Partnership Agreement generally provides that the General
Partner may not voluntarily withdraw from the Operating Partnership or transfer
its interest therein. In addition, Limited Partners of the Operating Partnership
have the right to be treated in a merger or other combination of the Company on
a substantially equivalent basis with the Company's shareholders or to retain
rights substantially equivalent to the Exchange Rights. (The Limited Partners
retained Exchange Rights in the Merger effected on December 31, 1996.) Limited
Partners may not voluntarily withdraw from the Operating Partnership, but
generally may transfer their interests in the Operating Partnership, except that
a transferee of a limited partnership interest generally may not become a
substitute Limited Partner except with the consent of the General Partner.
REDEMPTION OF SHARES
If the Company redeems Common Shares, it will cause the Operating
Partnership to redeem a proportionate portion of its limited partnership
interest in the Operating Partnership.
ALLOCATIONS AND DISTRIBUTIONS
The net income or net loss of the Operating Partnership for tax purposes
will generally be allocated among the partners in accordance with their
respective percentage interests, subject to compliance with the provisions of
Sections 704(b) and 704(c) of the Code and the regulations promulgated
thereunder.
Pursuant to the Operating Partnership Agreement, the net operating cash
revenues of the Operating Partnership, as well as net sales and refinancing
proceeds, will be distributed from time to time as determined by the Company
(but not less frequently than quarterly) pro rata in accordance with the
partners' ownership interests.
Pursuant to the Operating Partnership Agreement, the Operating Partnership
will also assume and pay when due, or reimburse the Company for payment of,
certain costs and expenses relating to the continuity of existence and
operations of the Company and the General Partner.
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<PAGE> 19
ISSUANCE OF ADDITIONAL PARTNERSHIP INTERESTS
The Company (through the General Partner) has the authority to cause the
Operating Partnership to issue additional interests in the Operating Partnership
and admit additional Limited Partners in the Operating Partnership in exchange
for the contribution of cash or property if it determines that such action is in
the best interest of the Operating Partnership, without the consent of the other
partners. In such event, an additional Limited Partner's interest in the
Operating Partnership will be based on the value of the assets contributed and
the value of the Operating Partnership at the time of such contribution, while
the partnership interest of each existing Limited Partner will be decreased
proportionately. Such additional partner will have all of the rights of a
Limited Partner except that such partner will not receive Units exchangeable for
Common Shares unless agreed to by the General Partner.
TAX MATTERS
Pursuant to the Operating Partnership Agreement, the General Partner will
be the tax matters partner of the Operating Partnership and, as such, will have
authority to make tax elections under the Code on behalf of the Operating
Partnership.
DUTIES AND CONFLICTS
The Operating Partnership Agreement provides that all business activities
of the Company must be conducted through the Operating Partnership or through
partnerships and limited liability companies affiliated with the Operating
Partnership. The General Partner may hold no assets other than its interest in
the Operating Partnership, interests in subsidiary corporations that own up to
1% of partnerships or limited liability companies in which the Operating
Partnership also owns an interest and such bank accounts and similar instruments
as are necessary for it to conduct its business in accordance with its
Certificate of Incorporation and the Operating Partnership Agreement.
The Operating Partnership is authorized to enter into transactions with
partners and their affiliates, as long as the terms of such transactions are
fair and reasonable, and no less favorable to the Operating Partnership than
could be obtained from an unaffiliated third party.
Any Limited Partner may engage in other business activities outside the
Operating Partnership, including business activities that directly compete with
the Operating Partnership, except that Messrs. Rainwater, Goff and Haddock have
each agreed that, as long as his noncompetition agreement remains in effect
(generally until at least one year after such individual ceases to be a trust
manager or executive officer), he will offer to the Company real estate
investment opportunities presented to him and, if the Company rejects the
opportunity, neither he nor his controlled affiliates will participate in the
investment without the approval of a majority of the independent trust managers.
INDEMNIFICATION
The Operating Partnership Agreement contains indemnification provisions
comparable to those contained in the Declaration of Trust.
TERM
The Operating Partnership will continue in full force and effect until
December 31, 2093, or until sooner dissolved (subject to certain exceptions)
upon (i) the bankruptcy, dissolution or termination of the General Partner
(unless a majority in interest of the Limited Partners elect to continue the
Operating Partnership); (ii) the election of the General Partner to dissolve the
Operating Partnership; or (iii) the sale or other disposition of all or
substantially all the assets of the Operating Partnership.
RESOLUTION OF DISPUTES
Disputes arising under the Operating Partnership Agreement will be resolved
by arbitration.
17
<PAGE> 20
REGISTRATION RIGHTS
The Company has filed the Registration Statement of which this Prospectus
is a part pursuant to its obligations under a Registration Rights, Lock-Up and
Pledge Agreement dated as of May 5, 1994, by and among the Company and certain
holders of Original Shares and Original Units (the "Registration Rights
Agreement"). The following summary does not purport to be complete and is
qualified in its entirety by reference to the Registration Rights Agreement. A
copy of the Registration Rights Agreement has been filed as an exhibit to the
Registration Statement of which this Prospectus is a part.
Under the Registration Rights Agreement, the Company is obligated to
maintain the effectiveness of the Registration Statement until a date to be
agreed upon or until such time as all of the Common Shares covered by the
Registration Rights Agreement (i) have been disposed of pursuant to the
Registration Statement of which this Prospectus is a part; (ii) have been sold
pursuant to Rule 144; or (iii) have become eligible for sale pursuant to Rule
144(k) under the Securities Act. The Registration Rights Agreement grants these
rights to holders of Common Shares and Units specified therein (the "Rights
Holders"). The Company has no obligation under the Registration Rights Agreement
to retain any underwriter to effect the sale of the shares covered thereby.
Pursuant to the Registration Rights Agreement, the Company agreed to pay
all expenses of effecting the registration of the Exchange Shares and Original
Shares issued to the Rights Holders (other than underwriting discounts and
commissions, fees and disbursements of counsel to a Rights Holder, and transfer
taxes, if any) pursuant to the Registration Statement. The Company also agreed
to indemnify each Rights Holder and each person, if any, who controls a Rights
Holder against certain losses, claims, damages and expenses arising under the
securities laws.
SELLING SHAREHOLDERS
The following table provides the names of each Selling Shareholder, the
number of Common Shares owned by each Selling Shareholder and the number of
Exchange Shares into which Units held by the person are exchangeable (if the
Company elects to issue shares rather than pay cash upon such exchange). All
references to the number of Common Shares to which this Prospectus relates have
been adjusted to reflect the Company's two-for-one stock split relating to its
Common Shares and effected in the form of a 100% share dividend paid on March
26, 1997. Since the Selling Shareholders may sell all, a portion or none of
their Secondary Shares, no estimate can be made of the aggregate number of
Secondary Shares that are to be offered hereby or that will be owned by each
Selling Shareholder upon completion of the offering to which this Prospectus
relates. In addition to the Common Shares they currently own, certain Selling
Shareholders may also offer the Exchange Shares they will own if the Units they
hold are exchanged for shares.
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<PAGE> 21
The Secondary Shares offered by this Prospectus may be offered from time to
time by the Selling Shareholders named below (based on Common Shares or Units
held at March 31, 1997):
<TABLE>
<CAPTION>
NUMBER OF SHARES MAXIMUM NUMBER OF
OWNED AND EXCHANGE SHARES ISSUABLE
NAME OFFERED HEREBY UPON UNIT EXCHANGE
---- ---------------- ------------------------
<S> <C> <C>
Richard E. Rainwater(1)(2)(4)............................... 2,033,914 359,468
Courtney E. Rainwater Trust UA(4)........................... 400,000 42,196
Matthew J. Rainwater Trust UA(4)............................ 400,000 42,196
Richard T. Rainwater Trust UA(4)............................ 400,000 42,196
James R. Bartlett(1)........................................ 148,174
Michael J. Kosak(1)......................................... 49,392
Nick J. Hackstock, Inc.(1).................................. 49,392
Mark Isakson(1)............................................. 24,696
Randall L. Harkness(1)...................................... 24,696
J.R. Bartlett, Inc.(1)...................................... 12,346
Rainwater, Inc.(1)(7)(11)(12)............................... 12,346 49,506
Darla Moore(1)(2)(4)........................................ 60,000 1,780
John C. Goff(1)(4)(12)...................................... 111,130 617,554
Gerald W. Haddock(1)(4)(12)................................. 12,348 438,932
Peter M. Joost(1)(4)........................................ 255,624 100,000
JFI, Inc.(1)................................................ 37,044
Christopher J. O'Brien(1)(4)................................ 30,870 36,310
J. Randall Chappel(1)....................................... 12,348
Thomas L. Kelly, II(1)(4)................................... 12,348 16,880
Walter J. Rainwater, Jr.(1)................................. 12,348
Alan D. Friedman(1)(4)...................................... 12,348 54,300
Harry H. Frampton, III(1)................................... 6,174
The Richard E. Rainwater 1995 Charitable Remainder Unitrust
No. 1 dated March 10, 1995(3)............................. 2,194,028
Pridemore Asset Trust UA(2)(4).............................. 16,128
Scott Asset Trust UA(2)(4).................................. 16,128
Cynthia Morgan Carpenter Trust UA(2)(3)..................... 8,006
Office Towers LLC(4)(7)(8)(11).............................. 3,260,994
Tower Holdings, Inc.(4)..................................... 10,070
Morton H. Meyerson(4)....................................... 37,978
David N. Meyerson 1982 Trust UA(4).......................... 8,440
Marti A. Meyerson 1982 Trust UA(4).......................... 8,440
The Lone Star Trust UA(4)................................... 8,440
Robert I. Small(4).......................................... 4,220
Sanjay Varma(4)............................................. 2,532
Ervin D. Cruce(4)........................................... 4,220
The Joost Family Living Trust(4)............................ 4,220
Samuel S. Moore(4).......................................... 2,110
Friedman and Uhelemeyer, Inc.(4)............................ 2,110
Steven D. Brooks(4)......................................... 1,688
Joseph W. Autem(4).......................................... 3,610
Richard D. Squires(4)....................................... 10,224
Kenneth A. Hersh(4)......................................... 844
Murphy C. Yates(4).......................................... 2,570
W. Whitney Kelly(4)......................................... 2,570
Thomas L. Wilson(4)......................................... 1,284
777 Main Street Corp.(5).................................... 33,296
Taurus Investment Group, Inc.(5)............................ 2,410
Amstar Continental Plaza Limited Partnership(6)............. 34,000
Rainwater Investor Partners, Ltd.(7)........................ 2,425,836
Caroline Hunt Trust Estate(7)............................... 742,602
Rainwater RainAm Investors(8)(9)............................ 555,424
American Airlines Fixed Benefit Plan(8)(9).................. 944,764
Retirement Plans of Aluminum Company of America Master
Trust(8)(9)............................................... 629,084
Rosewood Property Company(10)............................... 760,000 1,265,996
Goff Family, L.P.(12)....................................... 152,560
Haddock Family, L.P.(12).................................... 101,706
James M. Eidson, Jr.(13).................................... 19,044
</TABLE>
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<PAGE> 22
- ---------------
(1) Upon the partial liquidation of Mira Vista Investors, L.P., (i) Mr. James
R. Bartlett received 148,174 Common Shares, (ii) Mr. Michael J. Kosak
received 24,696 Common Shares, (iii) Nick J. Hackstock, Inc. received
49,392 Common Shares, (iv) Mr. Mark Isakson received 24,696 Common Shares,
(v) Mr. Randall L. Harkness received 24,696 Common Shares, (vi) J.R.
Bartlett, Inc. received 12,346 Common Shares, (vii) Rainwater, Inc.
received 12,346 Common Shares and (viii) Mira Vista Partners received
913,742 Common Shares which were immediately distributed to its partners as
follows: (a) 493,914 to Mr. Richard E. Rainwater, 30,000 of which were
subsequently gifted to his spouse, Ms. Darla Moore, (b) 111,130 to Mr. John
C. Goff, (c) 12,348 to Mr. Gerald W. Haddock, (d) 172,870 to Mr. Peter M.
Joost, (e) 37,044 to JFI, Inc., (f) 30,870 to Mr. Christopher J. O'Brien,
(g) 12,348 to Mr. J. Randall Chappel, (h) 12,348 to Mr. Thomas L. Kelly,
II, (i) 12,348 to Mr. Walter J. Rainwater, Jr., (j) 12,348 to Mr. Alan D.
Friedman, and (k) 6,174 to Mr. Harry H. Frampton, III.
(2) In February of 1997, Mr. Rainwater assigned (i) 2,200 Units to Ms. Moore,
(of which 954 Units were immediately gifted to each of Pridemore Asset
Trust UA and Scott Asset Trust UA), (ii) 954 Units to each of Pridemore
Asset Trust UA and Scott Asset Trust UA and (iii) 311 Units to Cynthia
Morgan Carpenter Trust UA.
(3) CRUT NO. 1, Inc. elected to exchange its Units for Common Shares in July of
1995 and promptly liquidated by distributing all such shares to The Richard
E. Rainwater 1995 Charitable Remainder Unitrust No. 1 dated March 10, 1995.
(4) Upon the partial liquidation of 777 Main Holding, Ltd., (i) Mr. Rainwater
received 217,060 Units, of which (a) 8,600 were subsequently gifted to Ms.
Darla Moore (who later gifted 3,078 to each of Pridemore Asset Trust UA and
Scott Asset Trust UA, and 1,846 to Cynthia Morgan Carpenter Trust UA), (b)
16,305 were subsequently contributed to Office Towers LLC, (c) 3,078 were
subsequently gifted to each of Pridemore Asset Trust UA and Scott Asset
Trust UA, (d) 1,846 were subsequently gifted to Cynthia Morgan Carpenter
Trust, (ii) Tower Holdings, Inc. received 5,035 Units, (iii) Courtney E.
Rainwater Trust UA, Matthew J. Rainwater Trust UA and Richard Todd
Rainwater Trust UA each received 21,098 Units, (iv) Mr. Goff received 4,037
Units, (v) Mr. Haddock received 16,307 Units, (vi) Mr. Joost received
91,377 Units, of which 41,377 Units were exchanged for Common Shares in May
of 1996, (vii) Mr. Morton H. Meyerson received 18,989 Units, (viii) David
N. Meyerson 1982 Trust UA and Marti A. Meyerson 1982 Trust UA each received
4,220 Units, (ix) Mr. Thomas L. Kelly, II received 8,440 Units, (x) Mr.
George W. Bush received 4,220 Units, all of which were assigned to The Lone
Star Trust UA in December of 1995, (xi) Mr. Robert I. Small received 3,376
Units, of which 1,266 Units were assigned to Mr. Sanjay Varma in June of
1995, (xii) Mr. Ervin D. Cruce received 2,110 Units, (xiii) The Joost
Family Living Trust received 2,110 Units, (xiv) Mr. Alan D. Friedman
received 27,150 Units, (xv) Mr. Samuel S. Moore received 1,055 Units, (xvi)
Friedman and Uhelemeyer, Inc. received 1,055 Units, (xvii) Mr. Christopher
J. O'Brien received 18,155 Units, (xviii) Mr. Steven D. Brooks received 844
Units, all of which were exchanged for Common Shares in January of 1996,
(xix) Mr. Joseph W. Autem received 1,805 Units, (xx) Mr. Richard D. Squires
received 5,112 Units, all of which were exchanged for Common Shares in July
of 1995, (xxi) Mr. Kenneth A. Hersh received 422 Units, (xxii) Mr. Murphy
C. Yates received 1,285 Units, (xxiii) Mr. W. Whitney Kelly received 1,285
Units and (xxiv) Mr. Thomas L. Wilson received 642 Units.
(5) The actual amount of Units to be registered under this Registration
Statement by 777 Main Street Corp. should have been 17,853. 1,475 Units
were inadvertently registered under the name of 777 Main Holding, Ltd.
1,205 Units owned by 777 Main Street were subsequently assigned to Taurus
Investment Group, Inc. in September of 1995.
(6) Amstar Continental Plaza Limited Partnership elected to exchange Units for
Common Shares in July of 1995.
(7) Upon the partial liquidation of RRCC Limited Partnership, (i) Rainwater
Investor Partners, Ltd received 1,212,918 Units, (ii) Rainwater, Inc.
received 24,753 Units, of which 636 Units were subsequently contributed to
Office Towers LLC in December of 1995, (iii) Rosewood Real Estate
Investments, Inc. received 866,370 Units, 380,000 of which were immediately
exchanged for 380,000 Common Shares (see footnote no. 9 for more
information on Rosewood Real Estate Investments, Inc.), and (iv) Caroline
Hunt Trust Estate received 371,301 Units.
(8) Upon the partial liquidation of MacArthur Center Partnership, Ltd., (i)
Rainwater RainAm Investors received 143,846 Units, (ii) Rainwater, Inc.
received 6,510 Units, all of which were subsequently contributed to Office
Towers LLC in December of 1995, (iii) American Airlines Fixed Benefit Plan
received 170,175 Units, all of which were subsequently exchanged for Common
Shares in June of 1995, and (iv) Retirement Plans of Aluminum Company of
America Master Trust received 113,438 Units, all of which were immediately
exchanged for Common Shares in June of 1995.
(9) Upon the partial liquidation of RainAm Investment Properties Ltd., (i)
Rainwater RainAm Investors received 133,866 Units, (ii) Rainwater, Inc.
received 7,046 Units, all of which were subsequently contributed to Office
Towers LLC in December of 1995, (iii) American Airlines Fixed Benefit Plan
received 302,207 Units, all of which were subsequently exchanged for Common
Shares in June of 1995, and (iv) Retirement Plans of Aluminum Company of
America Master Trust received 201,104 Units, all of which were immediately
exchanged for Common Shares in June of 1995.
(10) In the fourth quarter of 1995, Rosewood Real Estate Investments, Inc.,
which at the time owned 486,370 Units and 760,000 Common Shares, was
merged with and into an entity which was merged with and into Rosewood
Property Company, which at the time owned 39,101 Units. In March of 1996,
Las Colinas Plaza, Ltd. contributed its 107,527 Units to Rosewood Property
Company.
(11) Rainwater, Inc. contributed a total of 1,614,192 Units to Office Towers,
LLC in December of 1995.
(12) Upon the partial liquidation of FW-Irving Partners, Ltd., (i) Rainwater,
Inc. received 636 Units, (ii) Mr. Goff received 304,740 Units, (iii) Goff
Family, L.P. received 76,280 Units, (iv) Mr. Haddock received 203,159
Units, and (v) Haddock Family, L.P. received 50,853 Units.
(13) Mr. James M. Eidson, Jr. elected to exchange his 9,522 Units for Common
Shares in January of 1996.
20
<PAGE> 23
EXCHANGE OF UNITS
GENERAL
Pursuant to the Operating Partnership Agreement and except as described
below, the Limited Partners have the Exchange Rights, which, subject to the
Ownership Limit, enable each of them to exchange all or a portion of their Units
in the Operating Partnership to the Company for Common Shares or, at the
election of the Company, for cash (the "Cash Amount") equal to the then-current
fair market value of the number of Common Shares for which such Units are
exchangeable. The Exchange Rights relating to the Original Units became
exercisable by the Limited Partners from time to time, in whole or in part,
commencing on April 28, 1995; provided, however, that a Limited Partner has not
been and is not permitted to exercise the Exchange Rights if and to the extent
the issuance of Common Shares to such Limited Partner would violate the
Ownership Limit. See "Description of Shares of the Company -- Ownership Limits
and Restrictions on Transfer." In addition, all the Original Units were subject
to the lock-up and security agreement in the Registration Rights Agreement that
prohibited the exercise of the Exchange Rights until May 16, 1995. The Exchange
Rights with respect to the RER Units became exercisable following the approval
of the holders of a majority of the Company's outstanding Common Shares at the
Company's Annual Meeting held on June 12, 1995.
Pursuant to the Exchange Rights, the Units are exchangeable into Common
Shares (or the cash equivalent thereof) on a one-for-two basis. This one-for-two
exchange ratio will be adjusted from time to time to reflect stock dividends,
stock splits or reverse stock splits. On March 2, 1997, the Company declared a
two-for-one stock split in the form of a 100% share dividend paid on March 26,
1997, which resulted in an adjustment of the exchange ratio from a ratio of one
Common Share for each one Unit exchanged to a ratio of two Common Shares for
each one Unit exchanged.
The Exchange Rights also grant an exchanging Unit holder the right to
receive (or to receive the cash equivalent of) any rights, options, warrants or
other securities issued to all shareholders. If the Company elects to exchange
the Units for cash and raises such funds through a public offering of its
securities, by borrowing or otherwise, the price otherwise payable for the
offered Units will be reduced by the amount equal to the transaction expenses
incurred by the Company in raising such funds (but not exceeding 5% of the total
amount paid for the Units computed without regard to such expenses).
To require the Company to exchange Units, a Limited Partner must send a
Notice of Exchange (in the form attached as an exhibit to the Operating
Partnership Agreement, a copy of which is available from the Company)
accompanied by any certificate or certificates evidencing the Units to be
exchanged. To the extent that delivery of Exchange Shares would cause the
exchanging Unit holder to violate the Ownership Limit, the Company may not
deliver Exchange Shares to such Unit holder but may, in its sole and absolute
discretion, elect either (i) to pay the consideration to such Unit holder in the
form of the Cash Amount or (ii) refuse, in whole or in part, to accept the
Notice of Exchange.
TAX CONSEQUENCES OF EXCHANGE
The following discussion summarizes certain federal income tax
considerations that may be relevant to a Limited Partner who exercises the right
to require the exchange of his or its Units.
Tax Treatment of Exchange of Units. If the Company exchanges the Units for
Common Shares or cash, the exchange will be treated by the Company, the
Operating Partnership and the exchanging Limited Partner as a sale of Units by
such Limited Partner to the Company at the time of such exchange. In that event,
such sale will be fully taxable to the exchanging Limited Partner and such
exchanging Limited Partner will be treated as realizing for tax purposes an
amount equal to the sum of the cash and the value of the Common Shares received
in the exchange plus the amount of Operating Partnership nonrecourse liabilities
allocable to the exchanged Units at the time of the redemption. The
determination of the amount of gain or loss is discussed more fully below.
21
<PAGE> 24
Tax Treatment of Disposition of Units by Limited Partner Generally. If a
Unit is exchanged in a manner that is treated as a sale of the Unit, or a
Limited Partner otherwise disposes of a Unit, the determination of gain or loss
from the sale or other disposition will be based on the difference between the
amount considered realized for tax purposes and the tax basis in such Unit. See
"-- Basis of Units," below. Upon the sale of a Unit, the "amount realized" will
be measured by the sum of the cash and fair market value of other property
(e.g., Exchange Shares) received plus the portion of the Operating Partnership's
nonrecourse liabilities allocable to the Unit sold. To the extent that the sum
of the amount of cash and the fair market value of property received plus the
allocable share of the Operating Partnership's nonrecourse liabilities exceeds
the Limited Partner's basis for the Unit disposed of, such Limited Partner will
recognize gain. It is possible that the amount of gain recognized or even the
tax liability resulting from such gain could exceed the amount of cash and the
value of any other property (e.g., Exchange Shares) received upon such
disposition.
Except as described below, any gain recognized upon a sale or other
disposition of Units will be treated as gain attributable to the sale or
disposition of a capital asset. To the extent, however, that the amount realized
upon the sale of a Unit attributable to a Limited Partner's share of "unrealized
receivables" of the Operating Partnership (as defined in Section 751 of the
Code) exceeds the basis attributable to those assets, such excess will be
treated as ordinary income. Unrealized receivables include, to the extent not
previously included in Operating Partnership income, any rights to payment for
services rendered or to be rendered. Unrealized receivables also include amounts
that would be subject to recapture as ordinary income if the Operating
Partnership had sold its assets at their fair market value at the time of the
transfer of a Unit.
Basis of Units. In general, a Limited Partner who contributed property at
the time of his or its admission to the Operating Partnership had an initial tax
basis in his or its Units ("Initial Basis") equal to his or its basis in his or
its contributed property at the time of such contribution. A Limited Partner's
Initial Basis in his or its Units generally is increased by (a) such Limited
Partner's share of Operating Partnership taxable income and (b) increases in his
or its share of liabilities of the Operating Partnership (including any increase
in his or its share of nonrecourse liabilities of the Operating Partnership).
Generally, such Partner's basis in his or its Units is decreased (but not below
zero) by (i) his or its share of Operating Partnership distributions, (ii)
decreases in his or its share of liabilities of the Operating Partnership
(including any decrease in his or its share of nonrecourse liabilities of the
Operating Partnership), (iii) his or its share of losses of the Operating
Partnership, and (iv) his or its share of nondeductible expenditures of the
Operating Partnership that are not chargeable to capital. A Limited Partner is
considered to have the same basis in each of his or its Units. Thus, although a
Limited Partner may have received Units in respect of more than one transaction,
his or its basis in each Unit is the average of the basis in all Units.
Potential Application of the Disguised Sale Regulations to an Exchange of
Units. There is a risk that an exchange of Units may cause the original
transfer of property to the Operating Partnership by the Limited Partner in
exchange for Units to be treated as a "disguised sale" of property. The Code and
the United States Department of Treasury regulations promulgated thereunder
("Treasury Regulations," and as they apply to a "disguised sale," the "Disguised
Sale Regulations") generally provide that, unless one of the prescribed
exceptions is applicable, a partner's contribution of property to a partnership
and a simultaneous or subsequent transfer of money or other consideration
(including the assumption of or taking subject to a liability) from the
partnership to the partner will be presumed to be a sale, in whole or in part,
of such property by the partner to the partnership. Further, the Disguised Sale
Regulations provide generally that in the absence of an applicable exception, if
money or other consideration is transferred by a partnership to a partner within
two years of the partner's contribution of property, the transactions are
presumed to be a sale of the contributed property unless the facts and
circumstances clearly establish that the transfers do not constitute a sale. The
Disguised Sale Regulations also provide that if two years have passed between
the transfer of money or other consideration and the contribution of property,
the transactions will not be presumed to be a sale unless the facts and
circumstances clearly establish that the transfers constitute a sale.
If a Unit is exchanged, the IRS could contend that the Disguised Sale
Regulations apply because as a result of the exchange a Limited Partner receives
cash or Common Shares subsequent to the Limited Partner's previous contribution
of property to the Operating Partnership. In that event, the IRS would contend
22
<PAGE> 25
that the transactions relating to the formation of the Company themselves were
taxable as a disguised sale under the Disguised Sale Regulations.
COMPARISON OF OWNERSHIP OF UNITS AND COMMON SHARES
Generally, the nature of an investment in Common Shares of the Company is
substantially equivalent economically to an investment in Units in the Operating
Partnership. A holder of Common Shares receives the same distribution that a
holder of a Unit receives and shareholders and Unit holders generally share in
the risks and rewards of ownership in the enterprise being conducted by the
Company (through the Operating Partnership). However, there are some differences
between ownership of Units and ownership of Common Shares, some of which may be
material to investors.
The information below highlights a number of the significant differences
between the Operating Partnership and the Company relating to, among other
things, form of organization, permitted investments, policies and restrictions,
management structure, compensation and fees, investor rights and federal income
taxation, and compares certain legal rights associated with the ownership of
Units and Common Shares, respectively. These comparisons are intended to assist
Limited Partners of the Operating Partnership in understanding how their
investment will be changed if their Units are exchanged for Common Shares. THIS
DISCUSSION IS SUMMARY IN NATURE AND DOES NOT CONSTITUTE A COMPLETE DISCUSSION OF
THESE MATTERS, AND HOLDERS OF UNITS SHOULD CAREFULLY REVIEW THE BALANCE OF THIS
PROSPECTUS AND THE REGISTRATION STATEMENT OF WHICH THIS PROSPECTUS IS A PART FOR
ADDITIONAL IMPORTANT INFORMATION ABOUT THE COMPANY.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------
<S> <C>
OPERATING PARTNERSHIP COMPANY
<CAPTION>
- --------------------------------------------------------------------------------------------
<S> <C>
FORM OF ORGANIZATION AND ASSETS OWNED
The Operating Partnership is organized as a The Company is organized as a Texas real
Delaware limited partnership. The Operating estate investment trust. The Company (and the
Partnership owns (through its subsidiaries) Predecessor Corporation) elected to be taxed
the Properties. See "The Company." as a REIT under the Code, commencing with its
taxable year ended December 31, 1994, and
intends to maintain its qualification as a
REIT. Its only assets are its interests
(directly and through a subsidiary
corporation) in the Operating Partnership and
in certain corporations that own up to 1% of
limited partnerships in which the Operating
Partnership also owns an interest, which
gives the Company an indirect investment in
the Properties.
LENGTH OF INVESTMENT
The Operating Partnership will terminate on The Company has a perpetual term and intends
December 31, 2093, unless earlier dissolved to continue its operations for an indefinite
in accordance with the terms of the Operating time period.
Partnership Agreement or as otherwise
provided by law. See "Description of
Units -- Term."
</TABLE>
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<PAGE> 26
<TABLE>
<CAPTION>
<S> <C>
MANAGEMENT CONTROL
All management powers over the business and The Board of Trust Managers has exclusive
affairs of the Operating Partnership are control over the Company's business and
vested in the General Partner, and no Limited affairs subject only to the restrictions in
Partner has any right to participate in or the Declaration of Trust, Bylaws, the
exercise control or management power over the Operating Partnership Agreement and the TRA.
business and affairs of the Operating The Board of Trust Managers is classified
Partnership. The General Partner has the into three classes of trust managers. At each
power to amend the Operating Partnership annual meeting of the shareholders, the
Agreement to (i) add to the obligations of successors of the class of trust managers
the General Partner or surrender any right or whose terms expire at that meeting will be
power granted to the General Partner or its elected. The policies adopted by the Board of
affiliates for the benefit of the Limited Trust Managers may be altered or eliminated
Partners, (ii) reflect the admission, without a vote of the shareholders.
substitution, termination or withdrawal of Accordingly, except for their vote in the
partners in accordance with the terms of elections of trust managers, shareholders
Operating Partnership Agreement, (iii) have no control over the ordinary business
reflect an inconsequential change that has no policies of the Company. The Board of Trust
material adverse effect on the Limited Managers cannot change the policy of the
Partners, (iv) cure an ambiguity, or correct Company of maintaining its status as a REIT
or supplement the Operating Partnership for federal income tax purposes, however,
Agreement in a manner not inconsistent with without the approval of holders of majority
law or the other provisions of the Operating of the outstanding Common Shares.
Partnership Agreement, or (v) make other
changes with respect to matters arising under
the Operating Partnership Agreement not
inconsistent with law or the provisions of
the Operating Partnership Agreement. However,
any other amendments to the Operating
Partnership Agreement require the consent of
a majority in interest of the Limited
Partners, and the Operating Partnership
Agreement cannot be amended without the prior
written consent of each partner adversely
affected if such amendment would (i) convert
a Limited Partner's interest in the Operating
Partnership into a General Partner's inter-
est; (ii) modify the limited liability of a
Limited Partner; (iii) except as expressly
permitted by the Operating Partnership
Agreement, alter rights of a partner to
receive distributions pursuant to the Oper-
ating Partnership Agreement, or the
allocations specified in the Operating
Partnership Agreement; (iv) alter or modify
the Exchange Rights; (v) cause the
termination of the Operating Partnership
prior to the expiration of its term; or (vi)
amend the section of the Operating
Partnership Agreement setting forth these
consent rights. The General Partner may not
be removed by the Limited Partners with or
without cause.
</TABLE>
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<PAGE> 27
<TABLE>
<CAPTION>
<S> <C>
FIDUCIARY DUTIES
Under Delaware law, the General Partner is Under Texas law, the trust managers must
accountable to the Operating Partnership as a perform their duties in good faith in a
fiduciary and, consequently, is required to manner that they reasonably believe to be in
exercise good faith and integrity in all of the best interests of the Company. Trust
its dealings with respect to partnership managers of the Company who act in such a
affairs. Under the Operating Partnership manner generally will not be liable to the
Agreement, however, the General Partner is Company for monetary damages arising from
under no obligation to take into account the their activities.
tax consequences to any partner of any action
taken by it, and the General Partner is not
liable for monetary damages for losses
sustained or liabilities incurred by partners
as a result of errors of judgment or of any
act or omission, provided that the General
Partner has acted in good faith.
MANAGEMENT LIABILITY AND INDEMNIFICATION
As a matter of Delaware law, the General The Declaration of Trust provides that the
Partner has liability for the payment of the liability of each trust manager for monetary
obligations and debts of the Operating damages shall be eliminated to the fullest
Partnership unless limitations upon such extent permitted by applicable law. In
liability are stated in the document or general, under current Texas law, a trust
instrument evidencing the obligation. Under manager is liable to the trust only for
the Operating Partnership Agreement, the liabilities arising from such trust manager's
Operating Partnership has agreed to indemnify own willful misfeasance or willful
the Company, the General Partner and their malfeasance or gross negligence, except for
wholly owned subsidiaries (the "Crescent certain liabilities if the person (i) is
Group") and any director or officer of the found liable to the Company or (ii) is found
members of the Crescent Group (the "Indemni- liable on the basis that the person
tees") from and against all losses, claims, improperly received a personal benefit. The
damages, liabilities, joint or several, Declaration of Trust and Bylaws require the
expenses (including legal fees and expenses), Company to indemnify its trust managers and
judgments, fines, settlements and other officers to the fullest extent permitted
amounts incurred in connection with any ac- under Texas law, thereby generally providing
tions relating to the operations of the indemnification to the same extent that
Operating Partnership in which the Indemnitee indemnification is provided under the
is involved, unless (i) the act was in bad Operating Partnership Agreement.
faith and was material to the action; (ii)
the Indemnitee received an improper personal
benefit; or (iii) in the case of any criminal
proceeding, the Indemnitee had reasonable
cause to believe the act or omission was
unlawful. The reasonable expenses incurred by
an Indemnitee may be reimbursed by the
Operating Partnership in advance of the final
disposition of the proceeding upon receipt by
the Operating Partnership of an affirmation
by such Indemnitee of his, her or its good
faith belief that the standard of conduct
necessary for indemnification has been met
and an undertaking by such Indemnitee to
repay the amount if it is determined that
such standard was not met.
</TABLE>
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<PAGE> 28
<TABLE>
<CAPTION>
<S> <C>
ANTITAKEOVER PROVISIONS
Except in limited circumstances (see The Declaration of Trust and Bylaws of the
"-- Voting Rights" below), the General Company contain a number of provisions that
Partner has exclusive management power over may have the effect of delaying or
the business and affairs of the Operating discouraging an unsolicited proposal for the
Partnership. The Limited Partners do not have acquisition of the Company or the removal of
the right to remove the General Partner, incumbent management. These provisions
either with or without cause. See include, among others: (i) a staggered Board
"Description of Units." of Trust Managers; (ii) authorized capital
stock that may be issued as Preferred Shares
in the discretion of the Board of Trust
Managers, with voting rights superior to
those of Common Shares; (iii) a requirement
that, subject to any rights of holders of the
Company's Preferred Shares, trust managers
may be removed only for cause and only by a
vote of holders of at least 80% of the
then-outstanding Equity Shares entitled to
vote, voting together as a single class; and
(iv) provisions designed to avoid
concentration of share ownership in a manner
that would jeopardize the status of the
Company as a REIT under the Code. See
"Description of Shares of the Company" for a
more detailed explanation of these provisions
as well as a description of certain other
provisions that could have the effect of
inhibiting or impeding acquisition of control
of the Company.
VOTING RIGHTS
Under the Operating Partnership Agreement, The Company is managed and controlled by a
the Limited Partners have limited voting Board of Trust Managers consisting of three
rights. See "Description of classes having staggered terms of office.
Units -- Management." Otherwise, all Each class is to be elected by the
decisions relating to the operation and shareholders at annual meetings of the Com-
management of the Operating Partnership are pany. Texas law requires that certain major
made by the General Partner. corporate transactions, including most
amendments to the Declaration of Trust, may
not be consummated without the approval of
shareholders as set forth below. All Common
Shares have one vote, and the Declaration of
Trust permits the Board of Trust Managers to
classify and issue Preferred Shares in one or
more series having voting power which may
differ from that of the Common Shares. See
"Description of Shares of the Company."
</TABLE>
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<PAGE> 29
<TABLE>
<CAPTION>
<S> <C>
The following is a comparison of the voting rights of the Limited Partners of the
Operating Partnership and the shareholders of the Company as they relate to certain major
transactions.
AMENDMENT OF THE OPERATING PARTNERSHIP AGREEMENT OR THE DECLARATION OF TRUST
The Operating Partnership Agreement may be Amendments to the Declaration of Trust must
amended through a proposal by the General be approved by the Board of Trust Managers
Partner. Such proposal, in order to be and by the vote of at least two-thirds of the
effective, must be approved by the General votes entitled to be cast at a meeting of
Partner and by Limited Partners owning a shareholders.
majority-in-interest of the total outstanding
partnership interests. Certain amendments
that affect the fundamental rights of a
Limited Partner must be approved by each
affected Limited Partner. In addition, the
General Partner may, without the consent of
the Limited Partners, amend the Operating
Partnership Agreement as to certain min-
isterial matters. See "-- Management
Control," above.
VOTE REQUIRED TO DISSOLVE THE OPERATING PARTNERSHIP OR THE COMPANY
The General Partner may dissolve the Under Texas law, the Board of Trust Managers
Operating Partnership without the consent of must obtain approval of holders of at least
the Limited Partners in its sole discretion. two-thirds of the outstanding Common Shares
in order to dissolve the Company.
VOTE REQUIRED TO SELL ASSETS OR MERGE
Under the Operating Partnership Agreement, Under Texas law, the sale of all or
the sale, exchange, transfer or other substantially all of the assets of the
disposition of all or substantially all of Company or merger or consolidation of the
the Operating Partnership's assets or merger Company requires the approval of the Board of
or consolidation of the Operating Partner- Trust Managers and the affirmative vote of at
ship (other than a reincorporation, a change least two-thirds of the votes entitled to be
in par value, or as a result of a dividend on cast at a meeting of shareholders. No
its Common Shares or subdivision or approval of the shareholders is required for
combination of its outstanding Common Shares) the sale of less than all or substantially
does not require the consent of the Limited all of the assets of the Company.
Partners if (i) the Limited Partners receive
cash, securities or other property of a
specified amount in exchange for their Units
or (ii) the Operating Partnership continues
as a separate entity and the Limited Partners
receive exchange rights substantially
equivalent to the Exchange Rights.
</TABLE>
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<PAGE> 30
<TABLE>
<CAPTION>
<S> <C>
COMPENSATION, FEES AND DISTRIBUTIONS
The General Partner does not receive any The trust managers and officers of the
compensation for its service as general Company receive compensation for their
partner of the Operating Partnership. As a services.
partner in the Operating Partnership,
however, the General Partner has the same
right to allocations and distributions as
other partners of the Operating Partnership.
In addition, the Operating Partnership will
reimburse the General Partner and other
members of the Crescent Group for all ex-
penses incurred relating to the ongoing
operation of the Company and any other
offering of additional partnership interests
in the Operating Partnership or capital stock
of the Company.
LIABILITY OF INVESTORS
Under the Operating Partnership Agreement and Under Texas law, holders of Common Shares are
applicable state law, the liability of the not personally liable for any contractual
Limited Partners for the Operating obligation of the Company on the basis (i)
Partnership's debts and obligations is that the person is or was the alter ego of
generally limited to the amount of their the Company, or (ii) of actual or
investment in the Operating Partnership. constructive fraud, a sham to perpetrate a
fraud, or similar theory, unless the obligee
demonstrates that the shareholder caused the
Company to be used for the purpose of
perpetrating and did perpetrate an actual
fraud on the obligee primarily for the direct
personal benefit of the shareholder.
REVIEW OF INVESTOR LISTS
Under the Operating Partnership Agreement, a Under Texas law, a shareholder who holds at
Limited Partner of the Operating Partnership, least 5% of the outstanding shares of a real
for a purpose reasonably related to his or estate investment trust or who has held
its interest as a Limited Partner, upon shares of a real estate investment trust for
written demand with a statement of the six months or longer may, upon written
purpose of such demand and at the Limited request, inspect and copy any such trust's
Partner's expense, is entitled to obtain a books and records, including its list of its
current list of the name and last known shareholders of record.
business, residence or mailing address of
each Limited Partner of the Operating
Partnership.
NATURE OF INVESTMENT
The Units constitute equity interests The Common Shares constitute equity interests
entitling each Limited Partner to his or its in the Company. The Company is entitled to
pro rata share of cash distributions made to receive its pro rata share of distributions
the Limited Partners of the Operating made by the Operating Partnership with
Partnership. The Operating Partnership respect to the Units, and each shareholder
generally intends to retain and reinvest will be entitled to his pro rata share of any
proceeds of the sale of property or excess dividends or distributions paid with respect
refinancing proceeds in its business. to the Common Shares. The dividends payable
to the shareholders are not fixed in amount
and are only paid if, when and as declared by
the Board of Trust Managers. In order to
qualify as a REIT for federal income tax
purposes, the Company must distribute at
least 95% of its taxable income (excluding
capital gains), and any taxable income
(including capital gains) not distributed
will be subject to corporate income tax.
</TABLE>
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<PAGE> 31
<TABLE>
<CAPTION>
<S> <C>
POTENTIAL DILUTION OF RIGHTS
The General Partner is authorized, in its The Board of Trust Managers may issue, in its
sole discretion and without Limited Partner discretion, additional Common Shares and have
approval, to cause the Operating Partnership the authority to issue from the authorized
to issue additional limited partnership capital shares a variety of other equity
interests and other equity securities for any securities of the Company with such powers,
partnership purpose at any time to the preferences and rights as the Board of Trust
Limited Partners or to other persons on terms Managers may designate at the time. The
established by the General Partner. issuance of either additional Common Shares
or other similar equity securities may result
in the dilution of the interests of the
shareholders.
LIQUIDITY
Limited Partners generally can transfer their The Exchange Shares will be freely
Units, except that a transferee of a limited transferable as registered securities under
partnership interest generally cannot become the Securities Act. The Common Shares are
a substitute Limited Partner except with the listed on the NYSE. The breadth and strength
consent of the General Partner. Each Limited of this secondary market will depend, among
Partner has the right, subject to the other things, upon the number of shares
Ownership Limit, to tender his Units for ex- outstanding, the Company's financial results
change by the Operating Partnership. and prospects, the general interest in the
Company's and other real estate investments,
and the Company's dividend yield compared to
that of other debt and equity securities.
FEDERAL INCOME TAXATION
The Operating Partnership is not subject to The Company has elected to be taxed as a REIT
federal income taxes. Instead, each holder of for federal income tax purposes. So long as
Units includes his or its allocable share of it qualifies as a REIT, the Company will be
the Operating Partnership's taxable income or permitted to deduct distributions paid to its
loss in determining his or its individual shareholders, which effectively will reduce
federal income tax liability. The maximum the "double taxation" that typically results
federal income tax rate for individuals under when a corporation earns income and distrib-
current law is 39.6%. utes that income to its shareholders in the
form of dividends. A qualified REIT, however,
is subject to federal income tax on income
that is not distributed and also may be
subject to federal income and excise taxes in
certain circumstances. The maximum federal
income tax rate for corporations under
current law is 35%.
Income and loss from the Operating Dividends paid by the Company will be treated
Partnership generally is subject to the as "portfolio" income and cannot be offset
"passive activity" limitations. Under the with losses from "passive activities." The
"passive activity" rules, income and loss maximum federal income tax rate for
from the Operating Partnership that is individuals under current law is 39.6%.
considered "passive income" generally can be
offset against income and loss from other
investments that constitute "passive
activities." The "passive activity" limi-
tations generally apply to individuals,
trusts, estates, personal service
corporations and closely held corporations.
</TABLE>
29
<PAGE> 32
<TABLE>
<CAPTION>
<S> <C>
Cash distributions from the Operating Distributions made by the Company to its
Partnership are not taxable to a holder of taxable domestic shareholders out of current
Units except to the extent they exceed such or accumulated earnings and profits will be
holder's basis in his or its interest in the taken into account by them as ordinary
Operating Partnership (which will include income. Distributions that are designated as
such holder's allocable share of the capital gain dividends generally will be
Operating Partnership's nonrecourse debt). taxed as long-term capital gain, subject to
certain limitations. Distributions in excess
of current or accumulated earnings and
profits will be treated as a non-taxable
return of basis to the extent of a
shareholder's adjusted basis in its Common
Shares, with the excess taxed as capital
gain.
Each year, holders of Units will receive a Each year, shareholders will receive Form
Schedule K-I tax form containing detailed tax 1099 used by corporations to report dividends
information for inclusion in preparing their paid to their shareholders.
federal income tax returns.
Holders of Units may be required, in some Shareholders who are individuals generally
cases, to file state income tax returns will not be required to file state income tax
and/or pay state income taxes in the states returns and/or pay state income taxes outside
in which the Operating Partnership owns of their state of residence with respect to
property, even if they are not residents of the operations and distributions of the
those states. Company. The Company may be required to pay
state income taxes in certain states.
</TABLE>
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<PAGE> 33
FEDERAL INCOME TAX CONSIDERATIONS
INTRODUCTION
The following is a summary of the material federal income tax
considerations associated with an investment in the Common Shares offered hereby
prepared by Shaw, Pittman, Potts & Trowbridge, tax counsel to Crescent Equities
("Tax Counsel"). This discussion is based upon the laws, regulations and
reported rulings and decisions in effect as of the date of this Prospectus
Supplement, all of which are subject to change, retroactively or prospectively,
and to possibly differing interpretations. This discussion does not purport to
deal with the federal income or other tax consequences applicable to all
investors in light of their particular investment circumstances or to all
categories of investors, some of whom may be subject to special rules
(including, for example, insurance companies, tax-exempt organizations,
financial institutions, broker-dealers, foreign corporations and persons who are
not citizens or residents of the United States). No ruling on the federal, state
or local tax considerations relevant to the operation of Crescent Equities or
the Operating Partnership or to the purchase, ownership or disposition of the
Common Shares is being requested from the Internal Revenue Service (the "IRS")
or from any other tax authority. Tax Counsel has rendered certain opinions
discussed herein and believes that if the IRS were to challenge the conclusions
of Tax Counsel, such conclusions would prevail in court. However, opinions of
counsel are not binding on the IRS or on the courts, and no assurance can be
given that the conclusions reached by Tax Counsel would be sustained in court.
EACH PROSPECTIVE PURCHASER IS URGED TO CONSULT HIS OR HER OWN TAX ADVISOR
REGARDING THE SPECIFIC TAX CONSEQUENCES TO HIM OR HER OF THE PURCHASE, OWNERSHIP
AND DISPOSITION OF THE COMMON SHARES IN AN ENTITY ELECTING TO BE TAXED AS A REAL
ESTATE INVESTMENT TRUST, INCLUDING THE FEDERAL, STATE, LOCAL, FOREIGN AND OTHER
TAX CONSEQUENCES OF SUCH PURCHASE, OWNERSHIP, DISPOSITION AND ELECTION AND OF
POTENTIAL CHANGES IN APPLICABLE TAX LAWS.
TAXATION OF CRESCENT EQUITIES
Crescent Equities has made an election to be treated as a real estate
investment trust under Sections 856 through 860 of the Code (as used in this
section, a "REIT"), commencing with its taxable year ended December 31, 1994.
Crescent Equities believes that it was organized and has operated in such a
manner so as to qualify as a REIT, and Crescent Equities intends to continue to
operate in such a manner, but no assurance can be given that it has operated in
a manner so as to qualify, or will operate in a manner so as to continue to
qualify as a REIT.
The sections of the Code relating to qualification and operation as a REIT
are highly technical and complex. The following sets forth the material aspects
of the Code sections that govern the federal income tax treatment of a REIT and
its shareholders. This summary is qualified in its entirety by the applicable
Code sections, rules and regulations promulgated thereunder, and administrative
and judicial interpretations thereof.
In the opinion of Tax Counsel, Crescent Equities qualified as a REIT under
the Code with respect to its taxable years ending on or before December 31,
1996, and is organized in conformity with the requirements for qualification as
a REIT, its manner of operation has enabled it to meet the requirements for
qualification as a REIT as of the date of this Prospectus Supplement, and its
proposed manner of operation will enable it to meet the requirements for
qualification as a REIT in the future. It must be emphasized that this opinion
is based on various assumptions relating to the organization and operation of
Crescent Equities and the Operating Partnership and is conditioned upon certain
representations made by Crescent Equities and the Operating Partnership as to
certain relevant factual matters, including matters related to the organization,
expected operation, and assets of Crescent Equities and the Operating
Partnership. Moreover, continued qualification as a REIT will depend upon
Crescent Equities' ability to meet, through actual annual operating results, the
distribution levels, stock ownership requirements and the various qualification
tests and other requirements imposed under the Code, as discussed below.
Accordingly, no assurance can be given that the actual stock ownership of
Crescent Equities, the mix of its assets, or the results of its operations for
any
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<PAGE> 34
particular taxable year will satisfy such requirements. For a discussion of the
tax consequences of failing to qualify as a REIT, see "-- Taxation of Crescent
Equities -- Failure to Qualify," below.
If Crescent Equities qualifies for taxation as a REIT, it generally will
not be subject to federal corporate income taxes on its net income that is
currently distributed to shareholders. This treatment substantially eliminates
the "double taxation" (at the corporate and shareholder levels) that generally
results from investments in a corporation. However, Crescent Equities will be
subject to federal income tax in the following circumstances. First, Crescent
Equities will be taxed at regular corporate rates on any undistributed "real
estate investment trust taxable income," including undistributed net capital
gains. Second, under certain circumstances, Crescent Equities may be subject to
the "alternative minimum tax" on its items of tax preference. Third, if Crescent
Equities has "net income from foreclosure property," it will be subject to tax
on such income at the highest corporate rate. "Foreclosure property" generally
means real property and any personal property incident to such real property
which is acquired as a result of a default either on a lease of such property or
on indebtedness which such property secured and with respect to which an
appropriate election is made, except that property ceases to be foreclosure
property (i) after a two-year period (which in certain cases may be extended by
the IRS) or, if earlier, (ii) when the REIT engages in construction on the
property (other than for completion of certain improvements) or for more than 90
days uses the property in a business conducted other than through an independent
contractor. "Net income from foreclosure property" means (a) the net gain from
disposition of foreclosure property which is held primarily for sale to
customers in the ordinary course of business or (b) other net income from
foreclosure property which would not satisfy the 75% gross income test
(discussed below). Property is not eligible for the election to be treated as
foreclosure property if the loan or lease with respect to which the default
occurs (or is imminent) was made, entered into or acquired by the REIT with an
intent to evict or foreclose or when the REIT knew or had reason to know that
default would occur. Fourth, if Crescent Equities has "net income derived from
prohibited transactions," such income will be subject to a 100% tax. The term
"prohibited transaction" generally includes a sale or other disposition of
property (other than foreclosure property) that is held primarily for sale to
customers in the ordinary course of business. Fifth, if Crescent Equities should
fail to satisfy the 75% gross income test or the 95% gross income test (as
discussed below), but has nonetheless maintained its qualification as a REIT
because certain other requirements have been met, it will be subject to a 100%
tax on the net income attributable to the greater of the amount by which
Crescent Equities fails the 75% or 95% test. Sixth, if, during each calendar
year, Crescent Equities fails to distribute at least the sum of (i) 85% of its
"real estate investment trust ordinary income" for such year, (ii) 95% of its
"real estate investment trust capital gain net income" for such year, and (iii)
any undistributed taxable income from prior periods, Crescent Equities will be
subject to a 4% excise tax on the excess of such required distribution over the
amounts actually distributed. Seventh, if Crescent Equities acquires any asset
from a C corporation (i.e., a corporation generally subject to full corporate
level tax) in a transaction in which the basis of the asset in Crescent
Equities' hands is determined by reference to the basis of the asset (or any
other property) in the hands of the corporation, and Crescent Equities
recognizes gain on the disposition of such asset during the 10-year period
beginning on the date on which such asset was acquired by Crescent Equities,
then, to the extent of such property's "built-in" gain (the excess of the fair
market value of such property at the time of acquisition by Crescent Equities
over the adjusted basis in such property at such time), such gain will be
subject to tax at the highest regular corporate rate applicable (as provided in
Treasury Regulations that have not yet been promulgated). (The results described
above with respect to the recognition of "built-in gain" assume that Crescent
Equities will make an election pursuant to IRS Notice 88-19.)
Requirements of Qualification. The Code defines a REIT as a corporation,
trust or association (1) which is managed by one or more trustees or trust
managers; (2) the beneficial ownership of which is evidenced by transferable
shares, or by transferable certificates of beneficial interest; (3) which would
be taxable as a domestic corporation, but for Sections 856 through 860 of the
Code; (4) which is neither a financial institution nor an insurance company
subject to certain provisions of the Code; (5) the beneficial ownership of which
is held (without reference to any rules of attribution) by 100 or more persons;
(6) during the last half of each taxable year not more than 50% in value of the
outstanding stock of which is owned, directly or indirectly, by five or fewer
individuals (as defined in the Code); and (7) which meets certain other tests,
described below, regarding certain distributions and the nature of its income
and assets and properly files
32
<PAGE> 35
an election to be treated as a REIT. The Code provides that conditions (1)
through (4), inclusive, must be met during the entire taxable year and that
condition (5) must be met during at least 335 days of a taxable year of 12
months (or during a proportionate part of a taxable year of less than 12
months).
Crescent Equities issued sufficient Common Shares pursuant to its initial
public offering in 1994 to satisfy the requirements described in (5) and (6)
above. While the existence of the Exchange Rights may cause Limited Partners to
be deemed to own the Common Shares they could acquire through the Exchange
Rights, the amount of Common Shares that can be acquired at any time through the
Exchange Rights is limited to an amount which, together with any other Common
Shares actually or constructively deemed, under the Declaration of Trust, to be
owned by any person, does not exceed the Ownership Limit. See "Description of
Shares of the Company -- Ownership Limits and Restrictions on Transfer."
Moreover, the ownership of Common Shares by persons other than contributing
Limited Partners generally is limited under the Ownership Limit to no more than
8.0% of the outstanding Common Shares. In addition, the Declaration of Trust
provides for restrictions regarding the ownership or transfer of Common Shares
in order to assist Crescent Equities in continuing to satisfy the share
ownership requirements described in (5) and (6) above. See "Description of
Shares of the Company -- Ownership Limits and Restrictions on Transfer."
If a REIT owns a "qualified REIT subsidiary," the Code provides that the
qualified REIT subsidiary is disregarded for federal income tax purposes, and
all assets, liabilities and items of income, deduction and credit of the
qualified REIT subsidiary are treated as assets, liabilities and such items of
the REIT itself. A qualified REIT subsidiary is a corporation all of the capital
stock of which has been owned by the REIT from the commencement of such
corporation's existence. CREE Ltd., Management I, Management II, Management III,
Management IV, Management V, Management VI, CresCal Properties, Inc. and
Crescent Commercial Realty Corp. are qualified REIT subsidiaries, and thus all
of the assets (i.e., the respective partnership interests in the Operating
Partnership, Funding I, Funding II, Funding III, Funding IV, Funding V, Funding
VI, CresCal Properties, L.P. and Crescent Commercial Realty Holdings, L.P.),
liabilities and items of income, deduction and credit of CREE Ltd., Management
I, Management II, Management III, Management IV, Management V, Management VI,
CresCal Properties, Inc. and Crescent Commercial Realty Corp. are treated as
assets and liabilities and items of income, deduction and credit of Crescent
Equities. Unless otherwise required, all references to Crescent Equities in this
"Federal Income Tax Considerations" section refer to Crescent Equities and its
qualified REIT subsidiaries.
In the case of a REIT which is a partner in a partnership, Treasury
Regulations provide that the REIT will be deemed to own its proportionate share
of the assets of the partnership and will be deemed to be entitled to the income
of the partnership attributable to such share. In addition, the assets and gross
income (as defined in the Code) of the partnership attributed to the REIT shall
retain the same character as in the hands of the partnership for purposes of
Section 856 of the Code, including satisfying the gross income tests and the
assets tests described below. Thus, Crescent Equities' proportionate share of
the assets, liabilities and items of income of the Operating Partnerships and
its subsidiary partnerships are treated as assets, liabilities and items of
income of Crescent Equities for purposes of applying the requirements described
herein.
Income Tests. In order for Crescent Equities to achieve and maintain its
qualification as a REIT, there are three requirements relating to Crescent
Equities' gross income that must be satisfied annually. First, at least 75% of
Crescent Equities' gross income (excluding gross income from prohibited
transactions) for each taxable year must consist of temporary investment income
or of certain defined categories of income derived directly or indirectly from
investments relating to real property or mortgages on real property. These
categories include, subject to various limitations, rents from real property,
interest on mortgages on real property, gains from the sale or other disposition
of real property (including interests in real property and in mortgages on real
property) not primarily held for sale to customers in the ordinary course of
business, income from foreclosure property, and amounts received as
consideration for entering into either loans secured by real property or
purchases or leases of real property. Second, at least 95% of Crescent Equities'
gross income (excluding gross income from prohibited transactions) for each
taxable year must be derived from income qualifying under the 75% test and from
dividends, other types of interest and gain from the sale or disposition of
stock or securities, or from any combination of the foregoing. Third, for each
taxable year, gain from the sale or other disposition of stock or securities
held for less than one year, gain from prohibited transactions and gain on the
sale or other
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disposition of real property held for less than four years (apart from
involuntary conversions and sales of foreclosure property) must represent less
than 30% of Crescent Equities' gross income (including gross income from
prohibited transactions) for such taxable year. Crescent Equities, through its
partnership interests in the Operating Partnership and all subsidiary
partnerships, believes it satisfied all three of these income tests for 1994,
1995 and 1996 and expects to satisfy them for subsequent taxable years.
The bulk of the Operating Partnership's income is currently derived from
rents with respect to the Office Properties, the Hotel Properties and the Retail
Properties. Rents received by Crescent Equities will qualify as "rents from real
property" in satisfying the gross income requirements for a REIT described above
only if several conditions are met. First, the amount of rent must not be based
in whole or in part on the income or profits of any person. An amount received
or accrued generally will not be excluded from the term "rents from real
property" solely by reason of being based on a fixed percentage or percentages
of receipts or sales. Second, the Code provides that rents received from a
tenant will not qualify as "rents from real property" if the REIT, or an owner
of 10% or more of the REIT, directly or constructively, owns 10% or more of such
tenant (a "Related Party Tenant"). Third, if rent attributable to personal
property leased in connection with a lease of real property is greater than 15%
of the total rent received under the lease, then the portion of rent
attributable to such personal property will not qualify as "rents from real
property." Finally, for rents to qualify as "rents from real property," a REIT
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 REIT derives no revenue, except that a REIT may directly perform
services which are "usually or customarily rendered" in connection with the
rental of space for occupancy, other than services which are considered to be
rendered to the occupant of the property.
Crescent Equities, based in part upon opinions of Tax Counsel as to whether
various tenants, including the lessees of the Hotel Properties, constitute
Related Party Tenants, believes that the income it received in 1994, 1995, and
1996 and will receive in subsequent taxable years from (i) charging 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 percentage or percentages of
receipts or sales, as described above); (ii) charging rent for personal property
in an amount greater than 15% of the total rent received under the applicable
lease; (iii) directly performing services considered to be rendered to the
occupant of property or which are not usually or customarily furnished or
rendered in connection with the rental of real property; or (iv) entering into
any lease with a Related Party Tenant, will not cause Crescent Equities to fail
to meet the gross income tests. 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.
The Operating Partnership will also receive fixed and contingent interest
on the Residential Development Property Mortgages. Interest on mortgages secured
by real property satisfies the 75% and 95% gross income tests only if it does
not include any amount whose determination depends in whole or in part on the
income of any person, except that (i) an amount is not excluded from the term
"interest" solely by reason of being based on a fixed percentage or percentages
of receipts or sales and (ii) income derived from a shared appreciation
provision in a mortgage is treated as gain recognized from the sale of the
secured property. Certain of the Residential Development Property Mortgages
contain provisions for contingent interest based upon property sales. In the
opinion of Tax Counsel, each of the Residential Development Property Mortgages
constitutes debt for federal income tax purposes, any contingent interest
derived therefrom will be treated as being based on a fixed percentage of sales,
and therefore all interest derived therefrom will constitute interest received
from mortgages for purposes of the 75% and 95% gross income tests. If, however,
the contingent interest provisions were instead characterized as shared
appreciation provisions, any resulting income would, because the underlying
properties are primarily held for sale to customers in the ordinary course, be
treated as income from prohibited transactions, which would not satisfy the 75%
and 95% gross income tests, which would count toward the 30% gross income test,
and which would be subject to a 100% tax.
In applying the 95% and 75% gross income tests to Crescent Equities, it is
necessary to consider the form in which certain of its assets are held, whether
that form will be respected for federal income tax purposes, and whether, in the
future, such form may change into a new form with different tax attributes (for
example, as a result of a foreclosure on debt held by the Operating
Partnership). For example, the Residential Development
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Properties are primarily held for sale to customers in the ordinary course of
business, and the income resulting from such sales, if directly attributed to
Crescent Equities, would not qualify under the 75% and 95% gross income tests
and would count as gain from the sale of assets for purposes of the 30%
limitation. In addition, such income would be considered "net income from
prohibited transactions" and thus would be subject to a 100% tax. The income
from such sales, however, will be earned by the Residential Development
Corporations rather than by the Operating Partnership and will be paid to the
Operating Partnership in the form of interest and principal payments on the
Residential Development Property Mortgages or distributions with respect to the
stock in the Residential Development Corporations held by the Operating
Partnership. In similar fashion, the income earned by the Hotel Properties, if
directly attributed to Crescent Equities, would not qualify under the 75% and
95% gross income tests because it would not constitute "rents from real
property." Such income is, however, earned by the lessees of these Hotel
Properties and what the Operating Partnership receives from the lessees of these
Hotel Properties is rent. Comparable issues are raised by the Operating
Partnership's acquisition of subordinated debt secured by a Florida hotel and by
the acquisition by one of the Residential Development Corporations ("CDMC") of
an interest in the partnership which owns the hotel. If such debt were
recharacterized as equity, or if the ownership of the partnership were
attributed from CDMC to the Operating Partnership, the Operating Partnership
would be treated as receiving income from hotel operations rather than interest
income on the debt or dividend income from CDMC. Tax Counsel is of the opinion
that (i) the Residential Development Properties or any interest therein will be
treated as owned by the Residential Development Corporations, (ii) amounts
derived by the Operating Partnership from the Residential Development
Corporations under the terms of the Residential Development Property Mortgages
will qualify as interest or principal, as the case may be, paid on mortgages on
real property for purposes of the 75% and 95% gross income tests, (iii) amounts
derived by the Operating Partnership with respect to the stock of the
Residential Development Corporations will be treated as distributions on stock
(i.e., as dividends, a return of capital, or capital gain, depending upon the
circumstances) for purposes of the 75% and 95% gross income tests and (iv) the
leases of the Hotel Properties will be treated as leases for federal income tax
purposes, and the rent payable thereunder will qualify as "rents from real
property," and (v) the subordinated debt secured by the Florida hotel will be
treated as debt for federal income tax purposes, the income payable thereunder
will qualify as interest, and CDMC's ownership of the partnership interests in
the partnerhip which owns the hotel will not be attributed to the Operating
Partnership. Tax Counsel has provided opinions similar to those provided with
respect to the Operating Partnership's investment in the Residential Development
corporations with respect to its investments in certain other entities through
non-voting securities and secured debt. Investors should be aware that there are
no controlling Treasury Regulations, published rulings, or judicial decisions
involving transactions with terms substantially the same as those with respect
to the Residential Development Corporations and the leases of the Hotel
Properties. Therefore, the opinions of Tax Counsel with respect to these matters
are 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 one
or more of the Hotel Properties leases is not a true lease, part or all of the
payments that the Operating Partnership receives from the respective lessee may
not satisfy the various requirements for qualification as "rents from real
property," or the Operating Partnership might be considered to operate the Hotel
Properties directly. In that case, Crescent Equities likely would not be able to
satisfy either the 75% or 95% gross income tests and, as a result, likely would
lose its REIT status. Similarly, if the IRS were to challenge successfully the
arrangements with the Residential Development Corporations, Crescent Equities'
qualification as a REIT could be jeopardized.
If any of the Residential Development Properties were to be acquired by the
Operating Partnership as a result of foreclosure on any of the Residential
Development Property Mortgages, or if any of the Hotel Properties were to be
operated directly by the Operating Partnership or a subsidiary partnership as a
result of a default by the lessee under the lease, such property would
constitute foreclosure property for two years following its acquisition (or for
up to an additional four years if an extension is granted by the IRS), provided
that (i) the Operating Partnership or its subsidiary partnership conducts sales
or operations through an independent contractor; (ii) the Operating Partnership
or its subsidiary partnership does not undertake any construction on the
foreclosed property other than completion of improvements which were more than
10%
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complete before default became imminent; and (iii) foreclosure was not regarded
as foreseeable at the time Crescent Equities acquired the Residential
Development Property Mortgages or leased the Hotel Properties. For so long as
any of these properties constitutes foreclosure property, the income from such
sales would be subject to tax at the maximum corporate rates and would qualify
under the 75% and 95% gross income tests. However, if any of these properties
does not constitute foreclosure property at any time in the future, income
earned from the disposition or operation of such property will not qualify under
the 75% and 95% gross income tests and, in the case of the Residential
Development Properties, will count toward the 30% test and will be subject to
the 100% tax.
Crescent Equities anticipates that it will have certain income which will
not satisfy the 75% or the 95% gross income test and/or which will constitute
income whose receipt could cause Crescent Equities not to comply with the 30%
gross income test. For example, income from dividends on the stock of the
Residential Development Corporations will not satisfy the 75% gross income test.
It is also possible that certain income resulting from the use of creative
financing or acquisition techniques would not satisfy the 75%, 95%, or 30% gross
income tests. Crescent Equities believes, however, that the aggregate amount of
nonqualifying income will not cause Crescent Equities to exceed the limits on
nonqualifying income under the 75%, 95% or 30% gross income tests.
Any gross income derived from a prohibited transaction is taken into
account in applying the 30% gross income test necessary to qualify as a REIT.
Crescent Equities believes that no asset owned by the Operating Partnership is
primarily held for sale to customers and that the sale of any of the Properties
will not be in the ordinary course of business. Whether property is held
primarily for sale to customers in the ordinary course of business depends,
however, on the facts and circumstances in effect from time to time, including
those related to a particular property. No assurance can be given that Crescent
Equities can (a) comply with certain safe-harbor provisions of the Code which
provide that certain sales do not constitute prohibited transactions or (b)
avoid owning property that may be characterized as property held primarily for
sale to customers in the ordinary course of business.
If Crescent Equities fails to satisfy one or both of the 75% or 95% gross
income tests for any taxable year, it may nevertheless qualify as a REIT for
such year if it is entitled to relief under certain provisions of the Code.
These relief provisions generally will be available if Crescent Equities'
failure to meet such tests is due to reasonable cause and not to willful
neglect, Crescent Equities attaches a schedule of the sources of its income to
its tax return, and any incorrect information on the schedule is not due to
fraud with intent to evade tax. It is not possible, however, to state whether in
all circumstances Crescent Equities would be entitled to the benefit of these
relief provisions. As discussed above, even if these relief provisions apply, a
tax equal to approximately 10% of the corresponding net income would be imposed
with respect to the excess of 75% or 95% of Crescent Equities' gross income over
Crescent Equities' qualifying income in the relevant category, whichever is
greater.
Asset Tests. Crescent Equities, at the close of each quarter of its
taxable year, must also satisfy three tests relating to the nature of its
assets. First, at least 75% of the value of Crescent Equities' total assets must
be represented by real estate assets (including (i) its allocable share of real
estate assets held by the Operating Partnership, any partnerships in which the
Operating Partnership owns an interest, or qualified REIT subsidiaries of
Crescent Equities and (ii) stock or debt instruments held for not more than one
year purchased with the proceeds of a stock offering or long-term (at least five
years) debt offering of Crescent Equities), cash, cash items and government
securities. Second, not more than 25% of Crescent Equities' total assets may be
represented by securities other than those in the 75% asset class. Third, of the
investments included in the 25% asset class, the value of any one issuer's
securities owned by Crescent Equities may not exceed 5% of the value of Crescent
Equities' total assets, and Crescent Equities may not own more than 10% of any
one issuer's outstanding voting securities. The 25% and 5% tests generally must
be met for any quarter in which Crescent Equities acquires securities of an
issuer. Thus, this requirement must be satisfied not only on the date Crescent
Equities first acquires corporate securities, but also each time Crescent
Equities increases its ownership of corporate securities (including as a result
of increasing its interest in the Operating Partnership by acquiring Units from
Limited Partners upon the exercise of their Exchange Rights).
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The Operating Partnership owns 100% of the non-voting stock of each
Residential Development Corporation. In addition, the Operating Partnership owns
the Residential Development Property Mortgages. As stated above, in the opinion
of Tax Counsel each of these mortgages will constitute debt for federal income
tax purposes and therefore will be treated as a real estate asset; however, the
IRS could assert that such mortgages should be treated as equity interests in
their respective issuers, which would not qualify as real estate assets. By
virtue of its ownership of partnership interests in the Operating Partnership,
Crescent Equities will be considered to own its pro rata share of these assets.
Neither Crescent Equities nor the Operating Partnership, however, will directly
own more than 10% of the voting securities of any Residential Development
Corporation and, in the opinion of Tax Counsel, Crescent Equities will not be
considered to own any of such voting securities. In addition, Crescent Equities
and its senior management believe that Crescent Equities' pro rata share of the
value of the securities of each Residential Development Corporation do not
separately exceed 5% of the total value of Crescent Equities' total assets. This
belief is based in part upon its analysis of the estimated values of the various
securities owned by the Operating Partnership relative to the estimated value of
the total assets owned by the Operating Partnership. No independent appraisals
will be obtained to support this conclusion, and Tax Counsel, in rendering its
opinion as to the qualification of Crescent Equities as a REIT, is relying on
the conclusions of Crescent Equities and its senior management as to the value
of the various securities and other assets. There can be no assurance, however,
that the IRS might not contend that the values of the various securities held by
Crescent Equities through the Operating Partnership separately exceed the 5%
value limitation or, in the aggregate, exceed the 25% value limitation or that
the voting securities of the Residential Development Corporations should be
considered to be owned by Crescent Equities. Finally, if the Operating
Partnership were treated for tax purposes as a corporation rather than as a
partnership, Crescent Equities would violate the 10% of voting securities and 5%
of value limitations, and the treatment of any of the Operating Partnership's
subsidiary partnerships as a corporation rather than as a partnership could also
violate one or the other, or both, of these limitations. In the opinion of Tax
Counsel, for federal income tax purposes the Operating Partnership and all the
subsidiary partnerships will be treated as partnerships and not as either
associations taxable as corporations or publicly traded partnerships. See
"-- Tax Aspects of the Operating Partnership and the Subsidiary Partnerships,"
below.
As noted above, the 5% and 25% value requirements must be satisfied not
only on the date Crescent Equities first acquires corporate securities, but also
each time Crescent Equities increases its ownership of corporate securities
(including as a result of increasing its interest in the Operating Partnership
either with the proceeds of this Offering or by acquiring Units from Limited
Partners upon the exercise of their Exchange Rights). Although Crescent Equities
plans to take steps to ensure that it satisfies the 5% and 25% value tests for
any quarter with respect to which retesting is to occur, there can be no
assurance that such steps (i) will always be successful; (ii) will not require a
reduction in Crescent Equities' overall interest in the various corporations; or
(iii) will not restrict the ability of the Residential Development Corporations
to increase the sizes of their respective businesses, unless the value of the
assets of Crescent Equities is increasing at a commensurate rate.
Annual Distribution Requirements. In order to qualify as a REIT, Crescent
Equities is required to distribute dividends (other than capital gains
dividends) to its shareholders in an amount at least equal to (A) the sum of (i)
95% of the "real estate investment trust taxable income" of Crescent Equities
(computed without regard to the dividends paid deduction and Crescent Equities'
net capital gain) and (ii) 95% of the net income (after tax), if any, from
foreclosure property, minus (B) certain excess noncash income. Such
distributions must be paid in the taxable year to which they relate, or in the
following taxable year if declared before Crescent Equities timely files its tax
return for such year, and if paid on or before the date of the first regular
dividend payment after such declaration. To the extent that Crescent Equities
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," as
adjusted, it will be subject to tax thereon at regular capital gains and
ordinary corporate tax rates. Furthermore, if Crescent Equities should fail to
distribute, during each calendar year, at least the sum of (i) 85% of its "real
estate investment trust ordinary income" for such year; (ii) 95% of its "real
estate investment trust capital gain income" for such year; and (iii) any
undistributed taxable income from prior periods, Crescent Equities would be
subject to a 4% excise tax on the excess of such required distribution over the
amounts actually distributed.
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Crescent Equities believes that it has made and intends to make timely
distributions sufficient to satisfy all annual distribution requirements. In
this regard, the Operating Partnership Agreement authorizes CREE Ltd., as
General Partner, to take such steps as may be necessary to cause the Operating
Partnership to distribute to its partners an amount sufficient to permit
Crescent Equities to meet these distribution requirements. It is possible,
however, that, from time to time, Crescent Equities may experience 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 its "real estate investment trust taxable income."
Issues may also arise as to whether certain items should be included in income.
For example, Tax Counsel has opined that the Operating Partnership should
include in income only its share of the interest income actually paid on the two
mortgage notes purchased by the Company and secured by the Spectrum Center and
Three Westlake Park Office Properties, respectively and the two mortgage notes
purchased by the Company secured by the Trammell Crow Center Office Property
(the "Mortgage Notes"), all of which were acquired at a substantial discount,
rather than its share of the amount of interest accruing pursuant to the terms
of the these investments, but opinions of counsel are not binding on the IRS or
the courts. In this regard, the IRS has taken a contrary view in a recent
technical advice memorandum concerning the accrual of original issue discount
("OID"). The Company believes, however, that even if the Operating Partnership
were to include in income the full amount of interest income accrued on these
notes, and the Operating Partnership were not allowed any offsetting deduction
for the amount of such interest to the extent it is uncollectible, the Company
nonetheless would be able to satisfy the 95% distribution requirement without
borrowing additional funds or distributing stock dividends (as discussed below).
In addition, it is possible that certain creative financing or creative
acquisition techniques used by the Operating Partnership may result in income
(such as income from cancellation of indebtedness or gain upon the receipt of
assets in foreclosure whose fair market value exceeds the Operating
Partnership's basis in the debt which was foreclosed upon) which is not
accompanied by cash proceeds. In this regard, the modification of a debt can
result in taxable gain equal to the difference between the holder's basis in the
debt and the principal amount of the modified debt. Tax Counsel has opined that
the Mortgage Notes were not modified in the hands of the Operating Partnership.
Based on the foregoing, Crescent Equities may have less cash available for
distribution in a particular year than is necessary to meet its annual 95%
distribution requirement or to avoid tax with respect to capital gain or the
excise tax imposed on certain undistributed income for such year. To meet the
95% distribution requirement necessary to qualify as a REIT or to avoid tax with
respect to capital gain or the excise tax imposed on certain undistributed
income, Crescent Equities may find it appropriate to arrange for borrowings
through the Operating Partnership or to pay distributions in the form of taxable
share dividends.
Under certain circumstances, Crescent Equities may be able to rectify a
failure to meet the distribution requirement for a year by paying "deficiency
dividends" to shareholders in a later year, which may be included in Crescent
Equities' deduction for dividends paid for the earlier year. Thus, Crescent
Equities may be able to avoid being taxed on amounts distributed as deficiency
dividends; however, Crescent Equities will be required to pay interest based
upon the amount of any deduction taken for deficiency dividends.
Ownership Information. Pursuant to applicable Treasury Regulations, in
order to be treated as a REIT, Crescent Equities must maintain certain records
and request certain information from its shareholders designed to disclose the
actual ownership of its Equity Shares. Crescent Equities believes that it has
complied and intends to continue to comply with such requirements.
Failure to Qualify. If Crescent Equities fails to qualify as a REIT in any
taxable year and the relief provisions do not apply, Crescent Equities will be
subject to tax (including any applicable alternative minimum tax) on its taxable
income at regular corporate rates. Distributions to shareholders in any year in
which Crescent Equities fails to qualify as a REIT will not be deductible by
Crescent Equities; nor will they be required to be made. If Crescent Equities
fails to qualify as a REIT, then, to the extent of Crescent Equities' current
and accumulated earnings and profits, all distributions to shareholders will be
taxable as ordinary income and, subject to certain limitations of the Code,
corporate distributees may be eligible for the dividends received deduction.
Unless entitled to relief under specific statutory provisions, Crescent Equities
will also be disqualified from electing to be treated as a REIT for the four
taxable years following the year during which it
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ceased to qualify as a REIT. It is not possible to state whether in all
circumstances Crescent Equities would be entitled to such statutory relief.
Possible Legislation. On October 6, 1995, the House of Representatives
passed budget reconciliation legislation entitled the Tax Simplification Act of
1995, which contained various amendments to the Code, including amendments to
the provisions governing the tax treatment of REITs. The modifications to the
REIT rules were sponsored by the REIT industry and would generally have operated
to liberalize the requirements for qualification as a REIT. These modifications
would have become effective in the first taxable year following their enactment.
However, these modifications were not part of the budget reconciliation
legislation which passed Congress and which, in any event, President Clinton
subsequently vetoed. On March 20, 1997, 18 members of the House Ways and Means
Committee introduced a substantially similar package of REIT amendments. Whether
or when modifications to the REIT rules will ultimately be enacted, or what
provisions they will contain if they are enacted, cannot be ascertained at this
time.
TAXATION OF TAXABLE DOMESTIC SHAREHOLDERS
As long as Crescent Equities qualifies as a REIT, distributions made to
Crescent Equities' taxable U.S. shareholders out of Crescent Equities' current
or accumulated earnings and profits (and not designated as capital gain
dividends) will be taken into account by such U.S. shareholders as ordinary
income and, for corporate shareholders, will not be eligible for the dividends
received deduction. Distributions that are properly designated as capital gain
dividends will be taxed as long-term capital gains (to the extent they do not
exceed Crescent Equities' actual net capital gain for the taxable year) without
regard to the period for which the shareholder has held its Common Shares.
However, corporate shareholders may be required to treat up to 20% of certain
capital gain dividends as ordinary income. Distributions in excess of current
and accumulated earnings and profits will not be taxable to a shareholder to the
extent that they do not exceed the adjusted basis of the shareholder's Common
Shares, but rather will reduce the adjusted basis of such shares. To the extent
that distributions in excess of current and accumulated earnings and profits
exceed the adjusted basis of a shareholder's Common Shares, such distributions
will be included in income as long-term capital gain (or short-term capital gain
if the shares have been held for one year or less) assuming the shares are a
capital asset in the hands of the shareholder. In addition, any distribution
declared by Crescent Equities in October, November or December of any year
payable to a shareholder of record on a specified date in any such month shall
be treated as both paid by Crescent Equities and received by the shareholder on
December 31 of such year, provided that the distribution is actually paid by
Crescent Equities during January of the following calendar year. Shareholders
may not include any net operating losses or capital losses of Crescent Equities
in their respective income tax returns.
In general, any loss upon a sale or exchange of shares by a shareholder who
has held such shares for six months or less (after applying certain holding
period rules) will be treated as a long-term capital loss to the extent of
distributions from Crescent Equities required to be treated by such shareholder
as long-term capital gain.
TAXATION OF TAX-EXEMPT SHAREHOLDERS
Most tax-exempt employees' pension trusts are not subject to federal income
tax except to the extent of their receipt of "unrelated business taxable income"
as defined in Section 512(a) of the Code ("UBTI"). Distributions by the Company
to a shareholder that is a tax-exempt entity should not constitute UBTI,
provided that the tax-exempt entity has not financed the acquisition of its
Common Shares with "acquisition indebtedness" within the meaning of the Code and
the Common Shares is not otherwise used in an unrelated trade or business of the
tax-exempt entity. In addition, certain pension trusts that own more than 10% of
a "pension-held REIT" must report a portion of the dividends that they receive
from such a REIT as UBTI. The Company has not been and does not expect to be
treated as a pension-held REIT for purposes of this rule.
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TAXATION OF FOREIGN SHAREHOLDERS
The rules governing United States federal income taxation of nonresident
alien individuals, foreign corporations, foreign partnerships and other foreign
shareholders (collectively, "Non-U.S. Shareholders") are complex, and no attempt
will be made herein to provide more than a summary of such rules. Prospective
Non-U.S. Shareholders should consult with their own tax advisors to determine
the impact of federal, state and local tax laws with regard to an investment in
Common Shares, including any reporting requirements.
Distributions that are not attributable to gain from sales or exchanges by
Crescent Equities of United States real property interests and not designated by
Crescent Equities as capital gain dividends will be treated as dividends of
ordinary income to the extent that they are made out of current and accumulated
earnings and profits of Crescent Equities. Such distributions ordinarily will be
subject to a withholding tax equal to 30% of the gross amount of the
distribution, unless an applicable tax treaty reduces or eliminates that tax.
Crescent Equities expects to withhold U.S. income tax at the rate of 30% on the
gross amount of any such distribution made to a Non-U.S. Shareholder unless (i)
a lower treaty rate applies and the Non-U.S. Shareholder has filed the required
IRS Form 1001 with Crescent Equities or (ii) the Non-U.S. Shareholder files an
IRS Form 4224 with Crescent Equities claiming that the distribution is
effectively connected with the Non-U.S. Shareholder's conduct of a U.S. trade or
business. Distributions in excess of Crescent Equities' current and accumulated
earnings and profits will be subject to a 10% withholding requirement but will
not be taxable to a shareholder to the extent that such distributions do not
exceed the adjusted basis of the shareholder's Common Shares, but rather will
reduce the adjusted basis of such shares. To the extent that distributions in
excess of current and accumulated earnings and profits exceed the adjusted basis
of a Non-U.S. Shareholder's shares, such distributions will give rise to tax
liability if the Non-U.S. Shareholder would otherwise be subject to tax on any
gain from the sale or disposition of the Common Shares, as described below. If
it cannot be determined at the time a distribution is made whether or not such
distribution will be in excess of current and accumulated earnings and profits,
the distributions would be subject to withholding at the same rate as dividends.
However, a Non-U.S. Shareholder may seek a refund from the IRS of amounts of tax
withheld in excess of the Non-U.S. Shareholder's actual U.S. tax liability.
For any year in which Crescent Equities qualifies as a REIT, distributions
that are attributable to gain from sales or exchanges by Crescent Equities of
United States real property interests will be taxed to a Non-U.S. Shareholder
under the provisions of the Foreign Investment in Real Property Tax Act of 1980,
as amended ("FIRPTA"). Under FIRPTA, distributions attributable to gain from
sales of United States real property interests are taxed to a Non-U.S.
Shareholder as if such gain were effectively connected with a United States
business. Non-U.S. Shareholders would thus be taxed at the normal capital gain
rates applicable to U.S. shareholders (subject to applicable alternative minimum
tax and a special alternative minimum tax in the case of nonresident alien
individuals). Also, distributions subject to FIRPTA may be subject to a 30%
branch profits tax in the hands of a foreign corporate shareholder not entitled
to treaty exemption. Crescent Equities is required to withhold 35% of any
distribution that could be designated by Crescent Equities as a capital gain
dividend. This amount is creditable against the Non-U.S. Shareholder's FIRPTA
tax liability.
Gain recognized by a Non-U.S. Shareholder upon a sale of Common Shares
generally will not be taxed under FIRPTA if Crescent Equities is a "domestically
controlled REIT," defined generally as a REIT in which at all times during a
specified testing period less than 50% in value of the stock was held directly
or indirectly by foreign persons. Crescent Equities is and currently expects to
continue to be a "domestically controlled REIT," and in such case the sale of
Common Shares would not be subject to taxation under FIRPTA. However, gain not
subject to FIRPTA nonetheless will be taxable to a Non-U.S. Shareholder if (i)
investment in the Common Shares is treated as effectively connected with the
Non-U.S. Shareholder's U.S. trade or business, in which case the Non-U.S.
Shareholder will be subject to the same treatment as U.S. shareholders with
respect to such gain or (ii) the Non-U.S. Shareholder is a nonresident alien
individual who was present in the United States for 183 days or more during the
taxable year and either the individual has a "tax home" in the United States or
the gain is attributable to an office or other fixed place of business
maintained by the individual in the United States, in which case gains will be
subject to a 30% tax. If the gain on the sale of Common Shares were to be
subject to taxation under FIRPTA, the Non-U.S. Shareholder
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would be subject to the same treatment as U.S. shareholders with respect to such
gain (subject to applicable alternative minimum tax and a special alternative
minimum tax in the case of nonresident alien individuals), and the purchaser of
the Common Shares would be required to withhold and remit to the IRS 10% of the
purchase price.
TAX ASPECTS OF THE OPERATING PARTNERSHIP AND THE SUBSIDIARY PARTNERSHIPS
The following discussion summarizes certain federal income tax
considerations applicable solely to Crescent Equities' investment in the
Operating Partnership and its subsidiary partnerships and represents the views
of Tax Counsel. The discussion does not cover state or local tax laws or any
federal tax laws other than income tax laws.
Classification of the Operating Partnership and its Subsidiary Partnerships
for Tax Purposes. In the opinion of Tax Counsel, based on the provisions of the
Operating Partnership Agreement and the partnership agreements of the various
subsidiary partnerships, certain factual assumptions and certain representations
described in the opinion, the Operating Partnership and the subsidiary
partnerships will each be treated as a partnership and neither an association
taxable as a corporation for federal income tax purposes, nor a "publicly traded
partnership" taxable as a corporation. Unlike a ruling from the IRS, however, an
opinion of counsel is not binding on the IRS or the courts, and no assurance can
be given that the IRS will not challenge the status of the Operating Partnership
and its subsidiary partnerships as partnerships for federal income tax purposes.
If for any reason the Operating Partnership were taxable as a corporation rather
than as a partnership for federal income tax purposes, Crescent Equities would
fail to qualify as a REIT because it would not be able to satisfy the income and
asset requirements. See "-- Taxation of Crescent Equities," above. In addition,
any change in the Operating Partnership's status for tax purposes might be
treated as a taxable event, in which case Crescent Equities might incur a tax
liability without any related cash distributions. See "-- Taxation of Crescent
Equities," above. Further, items of income and deduction for the Operating
Partnership would not pass through to the respective partners, and the partners
would be treated as shareholders for tax purposes. The Operating Partnership
would be required to pay income tax at regular corporate tax rates on its net
income, and distributions to partners would constitute dividends that would not
be deductible in computing the Operating Partnership's taxable income.
Similarly, if any of the subsidiary partnerships were taxable as a corporation
rather than as a partnership for federal income tax purposes, such treatment
might cause Crescent Equities to fail to qualify as a REIT, and in any event
such partnership's items of income and deduction would not pass through to its
partners, and its net income would be subject to income tax at regular corporate
rates.
Income Taxation of the Operating Partnership and its Subsidiary
Partnerships. A partnership is not a taxable entity for federal income tax
purposes. Rather, Crescent Equities will be required to take into account its
allocable share of the Operating Partnership's income, gains, losses, deductions
and credits for any taxable year of such Partnership ending within or with the
taxable year of Crescent Equities, without regard to whether Crescent Equities
has received or will receive any cash distributions. The Operating Partnership's
income, gains, losses, deductions and credits for any taxable year will include
its allocable share of such items from its subsidiary partnerships.
Tax Allocations with Respect to Pre-Contribution Gain. Pursuant to Section
704(c) of the Code, income, gain, loss and deduction attributable to appreciated
property that is contributed to a partnership in exchange for an interest in the
partnership must be allocated for federal income tax purposes in a manner such
that the contributor is charged with the unrealized gain associated with the
property at the time of the contribution. The amount of such unrealized gain is
generally equal to the difference between the fair market value of the
contributed property at the time of contribution and the adjusted tax basis of
such property at the time of contribution (the "Book-Tax Difference"). In
general, the fair market value of the properties initially contributed to the
Operating Partnership were substantially in excess of their adjusted tax bases.
The Operating Partnership Agreement requires that allocations attributable to
each item of initially contributed property be made so as to allocate the tax
depreciation available with respect to such property first to the partners other
than the partner that contributed the property, to the extent of, and in
proportion to, such partners' share of book depreciation, and then, if any tax
depreciation remains, to the partner that contributed the property. Accordingly,
the depreciation deductions allocable will not correspond exactly to the
percentage
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interests of the partners. Upon the disposition of any item of initially
contributed property, any gain attributable to an excess at such time of basis
for book purposes over basis for tax purposes will be allocated for tax purposes
to the contributing partner and, in addition, the Operating Partnership
Agreement provides that any remaining gain will be allocated for tax purposes to
the contributing partners to the extent that tax depreciation previously
allocated to the noncontributing partners was less than the book depreciation
allocated to them. These allocations are intended to be consistent with Section
704(c) of the Code and with Treasury Regulations thereunder. The tax treatment
of properties contributed to the Operating Partnership subsequent to its
formation is expected generally to be consistent with the foregoing.
In general, the contributing partners will be allocated lower amounts of
depreciation deductions for tax purposes and increased taxable income and gain
on sale by the Operating Partnership of one or more of the contributed
properties. These tax allocations will tend to reduce or eliminate the Book-Tax
Difference over the life of the Operating Partnership. However, the special
allocation rules of Section 704(c) of the Code do not always entirely rectify
the Book-Tax Difference on an annual basis. Thus, the carryover basis of the
contributed assets in the hands of the Operating Partnership will cause Crescent
Equities to be allocated lower depreciation and other deductions. This may cause
Crescent Equities to recognize taxable income in excess of cash proceeds, which
might adversely affect Crescent Equities' ability to comply with the REIT
distribution requirements. See "-- Taxation of Crescent Equities," above.
SALE OF PROPERTY
Generally, any gain realized by the Operating Partnership on the sale of
real property, if the property is held for more than one year, will be long-term
capital gain, except for any portion of such gain that is treated as
depreciation or cost recovery recapture.
Crescent Equities' share of any gain realized on the sale of any property
held by the Operating Partnership as inventory or other property held primarily
for sale to customers in the ordinary course of the Operating Partnership's
business, however, will be treated as income from a prohibited transaction that
is subject to a 100% penalty tax. See "-- Taxation of Crescent Equities," above.
Such prohibited transaction income will also have an adverse effect upon
Crescent Equities' ability to satisfy the income tests for status as a REIT for
federal income tax purposes. Under existing law, whether property is held as
inventory or primarily for sale to customers in the ordinary course of the
Operating Partnership's business is a question of fact that depends on all the
facts and circumstances with respect to the particular transaction. The
Operating Partnership intends to hold its properties for investment with a view
to long-term appreciation, to engage in the business of acquiring, developing,
owning and operating the properties, and to make such occasional sales of
properties as are consistent with these investment objectives.
TAXATION OF THE RESIDENTIAL DEVELOPMENT CORPORATIONS
A portion of the amounts to be used to fund distributions to shareholders
is expected to come from the Residential Development Corporations through
dividends on non-voting stock thereof held by the Operating Partnership and
interest on the Residential Development Property Mortgages held by the Operating
Partnership. The Residential Development Corporations do not qualify as REITs
and pay federal, state and local income taxes on their taxable incomes at normal
corporate rates, which taxes reduce the cash available for distribution by
Crescent Equities to its shareholders. Crescent Equities anticipates that,
initially, deductions for interest and amortization will largely offset the
otherwise taxable income of the Residential Development Corporations, but there
can be no assurance that this will be the case or that the IRS will not
challenge such deductions. Any federal, state or local income taxes that the
Residential Development Corporations are required to pay will reduce the cash
available for distribution by Crescent Equities to its shareholders.
STATE AND LOCAL TAXES
Crescent Equities and its shareholders may be subject to state and local
tax in various states and localities, including those states and localities in
which it or they transact business, own property, or reside.
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The tax treatment of Crescent Equities and the shareholders in such
jurisdictions may differ from the federal income tax treatment described above.
Consequently, prospective shareholders should consult their own tax advisors
regarding the effect of state and local tax laws upon an investment in the
Common Shares.
In particular, the State of Texas imposes a franchise tax upon corporations
and limited liability companies that do business in Texas. The Texas franchise
tax is imposed on each such entity with respect to the entity's "net taxable
capital" and its "net taxable earned surplus" (generally, the entity's federal
taxable income, with certain adjustments). The franchise tax on net taxable
capital is imposed at the rate of 0.25% of an entity's net taxable capital. The
franchise tax rate on "net taxable earned surplus" 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. Any Texas franchise tax that Crescent Equities is
indirectly required to pay will reduce the cash available for distribution by
Crescent Equities to shareholders. Even if an entity is doing business in Texas
for Texas franchise tax purposes, the entity is subject to the Texas franchise
tax only on the portion of the taxable capital or taxable earned surplus
apportioned to Texas.
As a Texas real estate investment trust, Crescent Equities will not be
subject directly to the Texas franchise tax. However, Crescent Equities will be
subject indirectly to the Texas franchise tax as a result of its interests in
CREE Ltd., Management I, Management II, Management III, Management IV and
Management V, which will be subject to the Texas franchise tax because they are
general partners of the Operating Partnership, Funding I, Funding II, Funding
III, Funding IV and Funding V, and the Operating Partnership, Funding I, Funding
II, Funding III, Funding IV and Funding V will be doing business in Texas.
It is anticipated that the Crescent Equities' Texas franchise tax liability
will not be substantial because CREE Ltd., Management I, Management II,
Management III, Management IV and Management V are allocated only a small
portion of the taxable income of the Operating Partnership, Funding I, Funding
II, Funding III, Funding IV and Funding V. In addition, Management VI and
Funding VI are not anticipated to be subject to the Texas franchise tax.
The Operating Partnership, Funding I, Funding II, Funding III, Funding IV
and Funding V will not be subject to the Texas franchise tax, under the laws in
existence at the time of this Prospectus because they are partnerships instead
of corporations. There is no assurance, however, that the Texas legislature,
which is currently meeting in regular session in 1997, will not expand the scope
of the Texas franchise tax to apply to limited partnerships such as the
Operating Partnership, Funding I, Funding II, Funding III, Funding IV and
Funding V or enact other legislation which may result in subjecting Crescent
Equities to the Texas franchise tax. Any statutory change by the Texas
legislature may be applied retroactively.
In addition, it should be noted that two of the Residential Development
Corporations will be doing business in Texas and will be subject to the Texas
franchise tax. Further, Crescent/301, L.L.C. will be subject to the Texas
franchise tax because it is doing business in Texas and limited liability
companies are subject to Texas franchise tax. However, this franchise tax should
not be substantial because Crescent/301, L.L.C. owns a 1% interest in 301
Congress Avenue, L.P. Other entities that will be subject to the Texas franchise
tax include CresTex Development, LLC and its member CresCal Properties, Inc. and
any corporations or limited liability companies doing business in Texas with
Texas receipts. It is expected that the franchise tax liability of these
entities will not be substantial.
Governor George W. Bush of Texas has announced his desire that the Texas
legislature consider in its 1997 regular session, and the Texas legislature is
currently considering, proposals for property tax relief in Texas. Such relief
would require increasing the proportion of education funding costs paid by the
State of Texas and reducing the proportion paid by local property taxes.
Alternatives for increasing State of Texas revenues that have been considered
include broadening the franchise tax base to include other entities, enactment
of a new gross receipts tax, enactment of a new business activity tax and/or an
increase in the sales tax. If the franchise tax is broadened, it could be
expanded to apply to partnerships such as the Operating Partnership, Funding I,
Funding II, Funding III, Funding IV and Funding V. If either a gross receipts
tax or a business activity tax was enacted, it most likely would replace the
current franchise tax. However, a gross receipts tax or a business activities
tax could apply to partnerships such as the Operating Partnership,
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Funding I, Funding II, Funding III, Funding IV and Funding V. Whether or when
any of these provisions, or any alternative provisions, will ultimately be
enacted, or what provisions they will contain if they are enacted, cannot be
ascertained at this time.
Locke Purnell Rain Harrell (A Professional Corporation), special tax
counsel to Crescent Equities ("Special Tax Counsel"), has reviewed the
discussion in this section with respect to Texas franchise tax matters and is of
the opinion that, based on the current structure of Crescent Equities and based
upon current law, it accurately summarizes the Texas franchise tax matters
expressly described herein. Special Tax Counsel expresses no opinion on any
other tax considerations affecting Crescent Equities or a holder of Common
Shares, including, but not limited to, other Texas franchise tax matters not
specifically discussed above.
Tax Counsel has not reviewed the discussion in this section with respect to
Texas franchise tax matters and has expressed no opinion with respect thereto.
ERISA CONSIDERATIONS
The following is a summary of material considerations arising under the
Employee Retirement Income Security Act of 1974, as amended ("ERISA"), and the
prohibited transaction provisions of Section 4975 of the Code that may be
relevant to prospective investors. This discussion does not purport to deal with
all aspects of ERISA or the Code that may be relevant to particular investors in
light of their particular circumstances. A PROSPECTIVE INVESTOR THAT IS AN
EMPLOYEE BENEFIT PLAN SUBJECT TO ERISA, A TAX QUALIFIED RETIREMENT PLAN, AN IRA
OR A GOVERNMENTAL, CHURCH OR OTHER PLAN THAT IS EXEMPT FROM ERISA IS URGED TO
CONSULT ITS OWN LEGAL ADVISOR REGARDING THE SPECIFIC CONSIDERATIONS ARISING
UNDER APPLICABLE PROVISIONS OF ERISA, THE CODE AND STATE LAW WITH RESPECT TO THE
PURCHASE, OWNERSHIP, OR SALE OF THE SECURITIES BY SUCH PLAN OR IRA.
FIDUCIARY DUTIES AND PROHIBITED TRANSACTIONS
A fiduciary of a pension, profit-sharing, retirement or other employee
benefit plan subject to ERISA (an "ERISA Plan") should consider the fiduciary
standards under ERISA in the context of the ERISA Plan's particular
circumstances before authorizing an investment of any portion of the ERISA
Plan's assets in the Common Shares. Accordingly, such fiduciary should consider
(i) whether the investment satisfies the diversification requirements of Section
404(a)(1)(C) of ERISA; (ii) whether the investment is in accordance with the
documents and instruments governing the ERISA Plan as required by Section
404(a)(1)(D) of ERISA; (iii) whether the investment is prudent under Section
404(a)(1)(B) of ERISA; and (iv) whether the investment is solely in the
interests of the ERISA Plan participants and beneficiaries and for the exclusive
purpose of providing benefits to the ERISA Plan participants and beneficiaries
and defraying reasonable administrative expenses of the ERISA Plan as required
by Section 404(a)(1)(A) of ERISA.
In addition to the imposition of fiduciary standards, ERISA and Section
4975 of the Code prohibit a wide range of transactions between an ERISA Plan, an
IRA or certain other plans (collectively, a "Plan") and persons who have certain
specified relationships to the Plan ("parties in interest" within the meaning of
ERISA and "disqualified persons" within the meaning of the Code). Thus, a Plan
fiduciary or person making an investment decision for a Plan also should
consider whether the acquisition or the continued holding of the Common Shares
might constitute or give rise to a direct or indirect prohibited transaction.
PLAN ASSETS
The prohibited transactions rules of ERISA and the Code apply to
transactions with a Plan and also to transactions with the "plan assets" of a
Plan. The "plan assets" of a Plan include the Plan's interest in an entity in
which the Plan invests and, in certain circumstances, the assets of the entity
in which the Plan holds such interest. The term "plan assets" is not
specifically defined in ERISA or the Code, nor, as of the date hereof, has it
been interpreted definitively by the courts in litigation. On November 13, 1986,
the United
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States Department of Labor, the governmental agency primarily responsible for
administering ERISA, adopted a final regulation (the "DOL Regulation") setting
out the standards it will apply in determining whether an equity investment in
an entity will cause the assets of such entity to constitute "plan assets." The
DOL Regulation applies for purposes of both ERISA and Section 4975 of the Code.
Under the DOL Regulation, if a Plan acquires an equity interest in an
entity, which equity interest is not a "publicly-offered security," the Plan's
assets generally would include both the equity interest and an undivided
interest in each of the entity's underlying assets unless certain specified
exceptions apply. The DOL Regulation defines a publicly-offered security as a
security that is "widely held," "freely transferable," and either part of a
class of securities registered under Section 12(b) or 12(g) of the Exchange Act,
or sold pursuant to an effective registration statement under the Securities Act
(provided the securities are registered under the Exchange Act within 120 days
after the end of the fiscal year of the issuer during which the offering
occurred). The Common Shares will be sold in an offering registered under the
Securities Act and registered under Section 12(b) of the Exchange Act.
The DOL Regulation provides that a security is "widely held" only if it is
part of a class of securities that is owned by 100 or more investors independent
of the issuer and of one another. However, a class of securities will not fail
to be "widely held" solely because the number of independent investors falls
below 100 subsequent to the initial public offering as a result of events beyond
the issuer's control. The Company expects the Common Shares to be "widely held"
upon completion of any offering.
The DOL Regulation provides that whether a security is "freely
transferable" is a factual question to be determined on the basis of all the
relevant facts and circumstances. The DOL Regulation further provides that when
a security is part of an offering in which the minimum investment is $10,000 or
less, as will be the case with any offering, certain restrictions ordinarily
will not affect, alone or in combination, the finding that such securities are
freely transferable. The Company believes that the restrictions imposed under
the Declaration of Trust on the transfer of the Common Shares are limited to
restrictions on transfer generally permitted under the DOL Regulation and are
not likely to result in the failure of the Common Shares to be "freely
transferable." See "Description of the Shares of the Company -- Ownership Limits
and Restrictions on Transfer." The DOL Regulation only establishes a presumption
in favor of a finding of free transferability and, therefore, no assurance can
be given that the Department of Labor and the U.S. Treasury Department would not
reach a contrary conclusion with respect to the Common Shares. Any additional
transfer restrictions imposed on the transfer of the Common Shares will be
discussed in the applicable Prospectus Supplement.
Assuming that the Common Shares will be "widely held" and "freely
transferable," the Company believes that the Common Shares will be
publicly-offered securities for purposes of the DOL Regulation and that the
assets of the Company will not be deemed to be "plan assets" of any plan that
invests in the Common Shares.
PLAN OF DISTRIBUTION
This Prospectus relates to (i) the possible issuance by the Company of
Original Exchange Shares if, and to the extent that, holders of Original Units
tender such Original Units in exchange for Common Shares, (ii) the offer and
sale from time to time of the Original Shares by the holders thereof, (iii) the
possible distribution of 1,234,784 Original Shares if, and to the extent that,
the holder thereof (which is a limited partnership) distributes such Original
Shares pro rata to its partners as part of the liquidation and winding up of
affairs of such holder, (iv) the possible issuance by the Company of up to
2,194,028 RER Exchange Shares, if, and to the extent that, the holder of the RER
Units tenders such RER Units in exchange for Common Shares, (v) the possible
issuance by the Company of up to 19,044 JME Exchange Shares if, and to the
extent that, the holder of up to 9,522 JME Units tenders such JME Units in
exchange for Common Shares, and (vi) the offer and sale or other distribution
from time to time of any Secondary Shares by Selling Shareholders. A portion of
the Original Units and all of the RER Units and JME Units have been exchanged
for Common Shares. In addition, a portion of the Original Units and the
Secondary Shares have been distributed as of March 31, 1997. The Company has
registered the Original Shares and the Exchange Shares
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for sale to provide the Selling Shareholders with freely tradeable securities,
but registration of such shares does not necessarily mean that any of such
shares will be offered or sold by the Selling Shareholders.
The Company will not receive any proceeds from the offering by the Selling
Shareholders or from the issuance of the Exchange Shares to holders of Original
Units upon receiving a notice of exchange (but it may acquire from such holders
the Units tendered for exchange). The Selling Shareholders may from time to time
sell all or a portion of the Secondary Shares on the NYSE, in the
over-the-counter market, on any other national securities exchange on which the
Common Shares is listed or traded, in negotiated transactions or otherwise, at
prices then prevailing or related to the then current market price or at
negotiated prices. The Secondary Shares may be sold directly or through brokers
or dealers, or in a distribution by one or more underwriters on a firm
commitment or best efforts basis. The methods by which the Secondary Shares may
be sold or distributed include, without limitation, (i) a block trade (which may
involve crosses) in which the broker or dealer so engaged will attempt to sell
the securities as agent but may position and resell a portion of the block as
principal to facilitate the transaction, (ii) purchases by a broker or dealer as
principal and resale by such broker or dealer for its account pursuant to this
Prospectus, (iii) exchange distributions and/or secondary distributions in
accordance with the rules of the NYSE, (iv) ordinary brokerage transactions and
transactions in which the broker solicits purchasers, (v) pro rata distributions
as part of the liquidation and winding up of the affairs of the holders thereof,
and (vi) privately negotiated transactions. The Selling Shareholders may from
time to time deliver all or a portion of the Secondary Shares to cover a short
sale or sales or upon the exercise, settlement or closing of a call equivalent
position or a put equivalent position. The Selling Shareholders and any
broker-dealers participating in the distribution of the Secondary Shares may be
deemed to be "underwriters" within the meaning of the Securities Act and any
profit on the sale of the Secondary Shares by the Selling Shareholders and any
commissions received by any such broker-dealers may be deemed to be underwriting
commissions under the Securities Act. Underwriters, brokers, dealers or agents
may be entitled, under agreements with the Company, to indemnification against,
and contribution toward, certain civil liabilities, including liabilities under
the Securities Act. The Selling Shareholders may sell all or any portion of the
Secondary Shares in reliance upon Rule 144 under the Securities Act.
At a time a particular offer of Secondary Shares is made, a Prospectus
Supplement, if required, will be distributed that will set forth the name of any
dealers or agents and any commissions and other terms constituting compensation
from the Selling Shareholders and any other required information. The Secondary
Shares may be sold from time to time at varying prices determined at the time of
sale or at negotiated prices. In order to comply with the securities laws of
certain states, if applicable, the Secondary Shares may in such circumstances be
sold only through registered or licensed brokers or dealers.
The Company will pay all expenses in connection with the registration of
the Secondary Shares. The Selling Shareholders will pay for any brokerage or
underwriting commissions and taxes of any kind (including, without limitation,
transfer taxes) with respect to any disposition, sale or transfer of the
Secondary Shares.
The Company may from time to time issue up to 10,486,062 Exchange Shares
upon the acquisition of the Units tendered for exchange. The Company will
acquire the exchanging partner's Unit in exchange for each Exchange Share that
the Company issues in connection with these acquisitions. Consequently, with
each exchange, the Company's interest in the Operating Partnership will
increase.
AVAILABLE INFORMATION
The Company is subject to the informational requirements of the Exchange
Act and, in accordance therewith, files reports and other information with the
Securities and Exchange Commission (the "Commission"). Such reports, proxy
statements and other information can be inspected at the Public Reference
Section maintained by the Commission at Judiciary Plaza, Room 1024, 450 Fifth
Street, N.W., Washington, D.C. 20549 and the following regional offices of the
Commission: Citicorp Center, Suite 1400, 500 West Madison Street, Chicago,
Illinois 60661-2511 and 7 World Trade Center, Suite 1300, New York, New York
10048. Copies of such material can 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 Commission also maintains a Web site
(http://www.sec.gov) that contains reports, proxy and information statements and
other
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information regarding registrants that file electronically with the Commission.
In addition, the Company's Common Shares are listed on the New York Stock
Exchange and such reports, proxy statements and other information concerning the
Company can be inspected at the offices of the New York Stock Exchange, 20 Broad
Street, New York, New York 10005.
The Company has filed with the Commission the Registration Statement, of
which this Prospectus is a part, under the Securities Act, with respect to the
Common Shares offered hereby. This Prospectus does not contain all of the
information set forth in the Registration Statement, certain portions of which
have been omitted as permitted by the rules and regulations of the Commission.
Statements contained in this Prospectus as to the contents of any contract or
other documents are not necessarily complete, and in each instance, reference is
made to the copy of such contract or documents filed as an exhibit to the
Registration Statement, each such statement being qualified in all respects by
such reference and the exhibits and schedules thereto. For further information
regarding the Company and the Common Shares, reference is hereby made to the
Registration Statement and such exhibits and schedules which may be obtained
from the Commission at its principal office in Washington, D.C. upon payment of
the fees prescribed by the Commission.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The documents listed below have been filed under the Exchange Act by the
Company (Exchange Act file number 1-13038) with the Commission and are
incorporated herein by reference:
1. The Company's Registration Statement on Form 8-B filed on March 24, 1997
registering the Common Shares Section 12(b) of the Exchange Act.
2. The Company's Annual Report on Form 10-K for the year ended December 31,
1996.
3. The Company's Current Report on Form 8-K dated February 28, 1997 and
filed March 17, 1997, as amended on March 21, 1997.
4. The Company's Current Report on Form 8-K dated January 27, 1997 and
filed March 24, 1997.
All documents filed subsequent to the date of this Prospectus pursuant to
Section 13(a), 13(c), 14 or 15(d) of the Exchange Act and prior to termination
of the offering of all Common Shares to which this Prospectus relates shall be
deemed to be incorporated by reference in this Prospectus and shall be part
hereof from the date of filing of such document.
Any statement contained herein 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 in this
Prospectus (in the case of a statement in a previously filed document
incorporated or deemed to be incorporated by reference herein), in any
accompanying Prospectus Supplement or in any other subsequently filed document
that is also incorporated or 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 or any accompanying Prospectus Supplement.
Subject to the foregoing, all information appearing in this Prospectus and each
accompanying Prospectus Supplement is qualified in its entirety by the
information appearing in the documents incorporated by reference.
The Company undertakes to provide without charge to each person to whom a
copy of this Prospectus has been delivered, upon the written or oral request of
any such person, a copy of any or all of the documents incorporated by reference
in this Prospectus (other than exhibits and schedules thereto, unless such
exhibits or schedules are specifically incorporated by reference into the
information that this Prospectus incorporates). Written or telephonic requests
for copies should be directed to Crescent Real Estate Equities Company, 777 Main
Street, Suite 2100 Fort Worth, Texas 76102, Attention: Company Secretary
(telephone number: (817) 877-0477).
47
<PAGE> 50
EXPERTS
The financial statements and schedule incorporated in this Prospectus by
reference to the Company's Annual Report on Form 10-K for the year ended
December 31, 1996 have been audited by Arthur Andersen LLP, independent public
accountants, as indicated in their report with respect thereto, and are included
herein in reliance upon the authority of said firm as experts in giving said
reports.
The financial statements incorporated in this Prospectus by reference to
the Company's Current Reports on Form 8-K (i) dated February 28, 1997 and filed
on March 17, 1997, as amended on March 21, 1997 and (ii) dated January 29, 1997
and filed on March 24, 1997, respectively, have been audited by Arthur Andersen
LLP, independent public accountants, as indicated in their report with respect
thereto, and are included herein in reliance upon the authority of said firm as
experts in giving said reports.
LEGAL MATTERS
The legality of the issuance of the Common Shares will be passed upon for
the Company by Shaw, Pittman, Potts & Trowbridge, Washington, D.C. Certain legal
matters relating to federal income tax considerations will be passed upon for
the Company by Shaw, Pittman, Potts & Trowbridge, which will rely, as to all
Texas franchise tax matters upon the opinion of Locke Purnell Rain Harrell (A
Professional Corporation), Dallas, Texas.
48
<PAGE> 51
================================================================================
NO DEALER, SALESMAN OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS. IF
GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY OR THE UNDERWRITERS. THIS PROSPECTUS DOES
NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, THE
COMMON SHARES 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 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
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
The Company........................... 2
Securities to be Offered.............. 4
Risk Factors.......................... 4
Description of Shares of the
Company............................. 8
Certain Provisions of the Declaration
of Trust and Bylaws and Texas Law... 11
Description of Units.................. 14
Registration Rights................... 18
Selling Shareholders.................. 18
Exchange of Units..................... 21
Federal Income Tax Considerations..... 31
ERISA Considerations.................. 44
Plan of Distribution.................. 45
Available Information................. 46
Incorporation of Certain Documents by
Reference........................... 47
Experts............................... 47
Legal Matters......................... 48
</TABLE>
================================================================================
================================================================================
19,196,432 SHARES
LOGO
COMMON SHARES
------------------------
PROSPECTUS
------------------------
APRIL , 1997
================================================================================
<PAGE> 52
PART II
INFORMATION REQUIRED IN THE REGISTRATION STATEMENT
ITEM 16. EXHIBITS.
The following is a list of all exhibits filed as a part of this
Registration Statement on Form S-3, including those incorporated herein by
reference.
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION OF EXHIBIT
- ----------- ----------------------
<C> <C> <S>
4.01 -- Restated Declaration of Trust of Crescent Real Estate
Equities Company (filed as Exhibit 4.01 to the Registrant's
Registration Statement on Form S-3 (File No. 333-21905 (the
"Shelf S-3") and incorporated by reference herein).
4.02 -- Amended and Restated Bylaws of Crescent Real Estate Equities
Company (filed as Exhibit 4.02 to the Shelf S-3 and
incorporated by reference herein).
4.03 -- First Amended and Restated Agreement of Limited Partnership
of Crescent Real Estate Equities Limited Partnership dated
May 5, 1994 (filed as Exhibit 10.01 to the Registrant's
Registration Statement on Form S-11 (File No. 33-78188) and
incorporated herein by reference).
4.04 -- Form of Common Share Certificate (filed as Exhibit 4.03 to
the Shelf S-3 and incorporated by reference herein).
4.05 -- Registration Rights, Lock-Up and Pledge Agreement dated as
of May 5, 1994 (previously filed).
5.01 -- Opinion of Shaw, Pittman, Potts & Trowbridge as to the
legality of the securities being registered by Crescent Real
Estate Equities Company (filed herewith).
8.01 -- Opinion of Shaw, Pittman, Potts & Trowbridge regarding
certain material tax issues relating to Crescent Real Estate
Equities Company (filed herewith).
8.02 -- Opinion of Locke Purnell Rain Harrell (A Professional
Corporation) regarding Texas franchise tax matters relating
to Crescent Real Estate Equities Company (filed herewith).
23.01 -- Consent of Arthur Andersen LLP, Certified Public
Accountants, dated April 4, 1997 (filed herewith).
23.05 -- Consent of Shaw, Pittman, Potts & Trowbridge (included in
its opinions filed as Exhibits 5.01 and 8.01 to this
Registration Statement and incorporated herein by
reference).
23.06 -- Consent of Locke Purnell Rain Harrell (A Professional
Corporation) (included in its opinion filed as Exhibit 8.02
to this Registration Statement and incorporated herein by
reference).
24.01 -- Powers of Attorney (previously filed).
</TABLE>
II-1
<PAGE> 53
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-3 and has duly caused this Post-Effective
Amendment No. Three to the Registration Statement to be signed on its behalf by
the undersigned, thereunto duly authorized, in the City of Fort Worth, State of
Texas, on the 4th day of April, 1997.
CRESCENT REAL ESTATE EQUITIES COMPANY
By: /s/ GERALD W. HADDOCK
----------------------------------------
GERALD W. HADDOCK
PRESIDENT AND CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Act of 1933, this
Post-Effective Amendment No Three to the Registration Statement has been signed
by the following persons in the capacities and on the date indicated.
<TABLE>
<CAPTION>
SIGNATURES TITLE DATE
---------- ----- ----
<C> <S> <C>
/s/ RICHARD E. RAINWATER* Trust Manager and Chairman of the April 4, 1997
- ------------------------------------------------ Board
RICHARD E. RAINWATER
/s/ JOHN C. GOFF* Trust Manager and Vice Chairman of April 4, 1997
- ------------------------------------------------ the Board
JOHN C. GOFF
/s/ GERALD W. HADDOCK Trust Manager, President and Chief April 4, 1997
- ------------------------------------------------ Executive Officer (Principal
GERALD W. HADDOCK Executive Officer)
/s/ DALLAS E. LUCAS Senior Vice President and Chief April 4, 1997
- ------------------------------------------------ Financial Officer (Principal
DALLAS E. LUCAS Financial and Accounting Officer)
/s/ ANTHONY M. FRANK* Trust Manager April 4, 1997
- ------------------------------------------------
ANTHONY M. FRANK
/s/ MORTON H. MEYERSON* Trust Manager April 4, 1997
- ------------------------------------------------
MORTON H. MEYERSON
/s/ WILLIAM F. QUINN* Trust Manager April 4, 1997
- ------------------------------------------------
WILLIAM F. QUINN
/s/ PAUL E. ROWSEY* Trust Manager April 4, 1997
- ------------------------------------------------
PAUL E. ROWSEY, III
Trust Manager
- ------------------------------------------------
MELVIN ZUCKERMAN
</TABLE>
*By: /s/ GERALD W. HADDOCK
---------------------------------
GERALD W. HADDOCK
ATTORNEY-IN-FACT
II-2
<PAGE> 54
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION OF EXHIBIT
- ----------- ----------------------
<C> <C> <S>
4.01 -- Restated Declaration of Trust of Crescent Real Estate
Equities Company (filed as Exhibit 4.01 to the Registrant's
Registration Statement on Form S-3 (File No. 333-21905 (the
"Shelf S-3") and incorporated by reference herein).
4.02 -- Amended and Restated Bylaws of Crescent Real Estate Equities
Company (filed as Exhibit 4.02 to the Shelf S-3 and
incorporated by reference herein).
4.03 -- First Amended and Restated Agreement of Limited Partnership
of Crescent Real Estate Equities Limited Partnership dated
May 5, 1994 (filed as Exhibit 10.01 to the Registrant's
Registration Statement on Form S-11 (File No. 33-78188) and
incorporated herein by reference).
4.04 -- Form of Common Share Certificate (filed as Exhibit 4.03 to
the Shelf S-3 and incorporated by reference herein).
4.05 -- Registration Rights, Lock-Up and Pledge Agreement dated as
of May 5, 1994 (previously filed).
5.01 -- Opinion of Shaw, Pittman, Potts & Trowbridge as to the
legality of the securities being registered by Crescent Real
Estate Equities Company (filed herewith).
8.01 -- Opinion of Shaw, Pittman, Potts & Trowbridge regarding
certain material tax issues relating to Crescent Real Estate
Equities Company (filed herewith).
8.02 -- Opinion of Locke Purnell Rain Harrell (A Professional
Corporation) regarding Texas franchise tax matters relating
to Crescent Real Estate Equities Company (filed herewith).
23.01 -- Consent of Arthur Andersen LLP, Certified Public
Accountants, dated April 4, 1997 (filed herewith).
23.05 -- Consent of Shaw, Pittman, Potts & Trowbridge (included in
its opinions filed as Exhibits 5.01 and 8.01 to this
Registration Statement and incorporated herein by
reference).
23.06 -- Consent of Locke Purnell Rain Harrell (A Professional
Corporation) (included in its opinion filed as Exhibit 8.02
to this Registration Statement and incorporated herein by
reference).
24.01 -- Powers of Attorney (previously filed).
</TABLE>
<PAGE> 1
EXHIBIT 5.01
[Letterhead of Shaw, Pittman, Potts & Trowbridge]
April 4, 1997
Crescent Real Estate Equities Company,
777 Main Street, Suite 2100
Fort Worth, Texas 76102
RE: CRESCENT REAL ESTATE EQUITIES COMPANY
Ladies and Gentleman:
We have acted as counsel to Crescent Real Estate Equities Company, a
Texas real estate investment trust (the "Company"), in connection with
Post-Effective Amendment No. Three (the "Amendment") to the Registration
Statement on Form S-3 (File No. 33-92548) that originally was declared
effective on June 12, 1995 under the Securities Act of 1933 (collectively with
the Amendment and all prior amendments, the "Registration Statement"),
relating to the offering by the Company and certain Selling Shareholders (as
defined in the Registration Statement) from time to time of up to 19,196,432
common shares of beneficial interest, par value $.01 per share ("Common
Shares").
Based upon our examination of the originals and copies of such
documents, records of the Company, and other instruments as we have deemed
necessary and upon the laws as presently in effect, we are of the opinion that,
upon issuance of the Common Shares as contemplated by the Registration
Statement, the Common Shares will be validly issued by the Company, fully paid,
and nonassessable.
We hereby consent to your filing of this opinion as an exhibit to the
Registration Statement and to the reference to our firm under the caption "Legal
Matters" in the Prospectus included therein.
Very truly yours,
/s/ Shaw, Pittman, Potts & Trowbridge
Shaw, Pittman, Potts & Trowbridge
<PAGE> 1
EXHIBIT 8.01
April 4, 1997
Crescent Real Estate Equities Company
777 Main Street
Suite 2100
Fort Worth, Texas 76102
Ladies and Gentlemen:
We have acted as tax counsel to Crescent Real Estate Equities Company
("Crescent Equities") in connection with the registration statement on Form
S-3, No. 33-92548, which was filed with the Securities and Exchange Commission
and which, as amended, was declared effective on June 12, 1995. We also have
acted as tax counsel in connection with the post-effective amendments to such
registration statement, including Post-Effective Amendment No. Three to
Registration Statement (the "Amendment"). Capitalized terms used hereunder but
not defined have the meaning ascribed to them in such registration statement,
as amended, including the Amendment (the "Registration Statement").
In connection with filing the Amendment, you have asked us to render
certain opinions regarding the application of the U.S. federal income tax laws
to Crescent Equities,(1) Crescent Real Estate Equities Limited Partnership (the
"Operating Partnership") and certain partnerships and limited liability
companies in which the Operating Partnership has an ownership interest (the
"Subsidiary Partnerships"). The Subsidiary Partnerships currently include
Crescent Real Estate Funding I, L.P. ("Funding I"), Crescent Real Estate
Funding II, L.P. ("Funding II"), Crescent Real Estate Funding III, L.P.
("Funding III"), Crescent Real Estate Funding IV, L.P. ("Funding IV"), Crescent
Real Estate Funding V, L.P. ("Funding V"), Crescent Real Estate Funding VI,
L.P. ("Funding VI"), CresCal Properties, L.P. ("CresCal"), CresTex Development,
L.L.C. ("CresTex"), Waterside Commons Limited Partnership ("Waterside"), G/C
Waterside Associates LLC ("Associates"), Woodlands Office Equities - '95
Limited (the "Woodlands Partnership"), Woodlands Retail Equities - '96 Limited
("WRE"), 301 Congress Avenue, L.P ("301 Congress"),
<PAGE> 2
Crescent Real Estate Equities Company
April 4, 1997
Page 2
Crescent/301, L.L.C. ("Crescent/301"), Spectrum Mortgage Associates, L.P.
("SMA") and Crescent Commercial Realty Holdings, L.P. ("CCRH").
Specifically, you have requested that we render opinions addressing
the following:
1. Whether Crescent Equities qualified as a REIT under sections 856
through 860 of the Internal Revenue Code of 1986, as amended (the
"Code"), with respect to its taxable years ending on or before
December 31, 1996, whether Crescent Equities is organized in
conformity with the requirements for qualification as a REIT, whether
its manner of operation enabled it to meet the requirements for
qualification as a REIT as of the date of the Registration Statement,
and whether Crescent Equities' proposed manner of operation, as set
forth in the Registration Statement, will enable it to meet the
requirements for qualification as a REIT in the future;
2. Whether the Residential Development Properties will be treated for
federal income tax purposes as owned by the Residential Development
Corporations;(2)
3. Whether amounts derived by the Operating Partnership with respect to
the stock of the Residential Development Corporations will be treated
as distributions on stock (i.e., as dividends, a return of capital, or
capital gain, depending upon the circumstances) for purposes of the 75
percent and 95 percent gross income tests of section 856(c) of the
Code;
4. Whether the Residential Development Property Mortgages constitute
debt for federal income tax purposes, (3)
5. Whether contingent interest derived by the Operating Partnership from
the Residential Development Corporations under the terms of certain of
the Residential Development Property Mortgages will be treated as
being based on a fixed percentage of sales, and therefore all interest
derived therefrom will qualify
<PAGE> 3
Crescent Real Estate Equities Company
April 4, 1997
Page 3
as interest paid on mortgages on real property for purposes of the 75
percent and 95 percent gross income tests of section 856(c) of the
Code;
6. Whether the subordinate note secured by the Ritz-Carlton Hotel will
constitute debt for federal income tax purposes and whether the
Operating Partnership will be construed as owning at any time a
partnership interest in Manalapan Hotel Partners for federal income
tax purposes.
7. Whether the leases of the Hotel Properties will be treated as leases
for federal income tax purposes and whether the rent payable
thereunder will qualify as "rents from real property" for purposes of
the 75 percent and 95 percent gross income tests of section 856(c) of
the Code;
8. Whether Crescent Equities will be considered to own any of the voting
securities of the Residential Development Corporations for purposes of
section 856(c)(5)(B) of the Code;
9. Whether the Operating Partnership and each of the Subsidiary
Partnerships will be classified for federal income tax purposes as
partnerships and not as (a) associations taxable as corporations or
(b) publicly traded partnerships; and
10. Whether the material under the heading "Federal Income Tax
Considerations" in the Prospectus is accurate and summarizes the
material federal income tax considerations to a prospective holder of
Common Shares.
The opinions set forth herein are based upon the existing provisions
of the Code, Treasury Regulations, and the reported interpretations thereof by
the Internal Revenue Service ("IRS") and by the courts in effect as of the date
hereof, all of which are subject to change, both retroactively or
prospectively, and to possibly different interpretations. We assume no
obligation to update the opinions set forth in this letter. We believe that the
conclusions expressed herein, if challenged by the IRS, would be sustained in
court. Because our opinions are not binding upon the IRS or the courts,
however, there can be no assurance that contrary positions may not be
successfully asserted by the IRS.
I. Documents and Representations
For the purpose of rendering these opinions, we have examined and
relied on originals, or copies certified or otherwise identified to our
satisfaction, of the following: (1) the Restated Declaration of Trust of
Crescent Real Estate Equities Company (the "Declaration of Trust"); (2)
<PAGE> 4
Crescent Real Estate Equities Company
April 4, 1997
Page 4
the First Amended and Restated Agreement of Limited Partnership of Crescent
Real Estate Equities Limited Partnership, as amended (the "Operating
Partnership Agreement"); (3) the First Amended and Restated Agreement of
Limited Partnership of Crescent Real Estate Funding I, L.P. (the "Funding I
Agreement"); (4) the First Amended and Restated Agreement of Limited
Partnership of Crescent Real Estate Funding II, L.P., as amended (the "Funding
II Agreement"); (5) the First Amended and Restated Agreement of Limited
Partnership of Crescent Real Estate Funding III, L.P., as amended (the "Funding
III Agreement"); (6) the First Amended and Restated Agreement of Limited
Partnership of Crescent Real Estate Funding IV, L.P., as amended (the "Funding
IV Agreement"); (7) the First Amended and Restated Agreement of Limited
Partnership of Crescent Real Estate Funding V, L.P., as amended (the "Funding V
Agreement"); (8) the First Amended and Restated Agreement of Limited
Partnership of Crescent Real Estate Funding VI, L.P. (the "Funding VI
Agreement"); (9) the Agreement of Limited Partnership of CresCal Properties,
L.P., as amended by the First Amendment to the Agreement of Limited Partnership
of CresCal Properties, L.P. (the "CresCal Agreement"); (10) the Limited
Liability Company Agreement of CresTex Development, L.L.C. (the "CresTex
Agreement"); (11) the Limited Partnership Agreement of Waterside Commons
Limited Partnership, as amended by the First Amendment to the Limited
Partnership Agreement of Waterside Commons Limited Partnership, dated August
23, 1995 (the "Waterside Agreement"); (12) the Articles of Organization of G/C
Waterside Associates LLC (the "Associates Articles"); (13) the Regulations of
G/C Waterside Associates, LLC (the "Associates Regulations"); (14) the Amended
and Restated Agreement of Limited Partnership of Woodlands Office Equities -
'95 Limited (the "Woodlands Partnership Agreement"); (15) the Amended and
Restated Agreement of Limited Partnership of Woodlands Retail Equities - '96
Limited (the "WRE Agreement"); (16) the Limited Partnership Agreement of 301
Congress Avenue, L.P. (the "301 Congress Partnership Agreement"); (17) the
Limited Liability Company Agreement of Crescent/301, L.L.C. (the "Crescent/301
Agreement"); (18) the Amended and Restated Agreement of Limited Partnership of
Spectrum Mortgage Associates, L.P. (the "SMA Agreement"); (19) the Agreement of
Limited Partnership of Crescent Realty Investments, LLP (the "CCRH Agreement");
(20) copies of all existing leases (including amendments) entered into as of
the date hereof with respect to property owned or probably to be acquired by
the Operating Partnership or the Subsidiary Partnerships; (21) copies of the
Residential Development Property Mortgages; (22) the Registration Statement, as
amended through the date hereof; (23) the Prospectus; and (24) such other
documents or information as we have deemed necessary for the opinions set forth
below. In our examination, we have assumed the genuineness of all signatures,
the legal capacity of natural persons, the authenticity of all documents
submitted to us as originals, the conformity to original documents of all
documents submitted to us as certified or photostatic copies, and the
authenticity of the originals of such copies.
In addition, these opinions are conditioned upon certain
representations made by Crescent Equities and the Operating Partnership as to
factual and other matters as set forth in a
<PAGE> 5
Crescent Real Estate Equities Company
April 4, 1997
Page 5
letter submitted to us and in the discussion of "Federal Income Tax
Considerations" in the Prospectus. These opinions are also based on the
assumptions that (i) the Operating Partnership will be operated in accordance
with the terms and provisions of the Operating Partnership Agreement, (ii) each
of the Subsidiary Partnerships will be operated in accordance with the terms
and provisions of its organizational documents, (iii) Crescent Equities will be
operated in accordance with the terms and provisions of its Restated
Declaration of Trust, and (iv) the various elections, procedural steps, and
other actions by Crescent Equities or the Operating Partnership described in
the discussion of "Federal Income Tax Considerations" in the Prospectus will be
completed in a timely fashion or otherwise carried out as so described.
Unless facts material to the opinions expressed herein are
specifically stated to have been independently established or verified by us,
we have relied as to such facts solely upon the representations made by
Crescent Equities and the Operating Partnership. We are not, however, aware of
any facts or circumstances contrary to or inconsistent with the
representations. To the extent the representations are with respect to matters
set forth in the Code or Treasury Regulations, we have reviewed with the
individuals making such representations the relevant provisions of the Code,
the Treasury Regulations and published administrative interpretations.
II. Opinions
1. Qualification of Crescent Real Estate Equities, Inc. as a REIT
Based on the foregoing, it is our opinion that (i) Crescent Equities
qualified as a REIT under sections 856 through 860 of the Code with respect to
its taxable years ending on or before December 31, 1996, (ii) Crescent Equities
is organized in conformity with the requirements for qualification as a REIT
and its manner of operation has enabled it to meet the requirements for
qualification as a REIT as of the date of the Registration Statement, and (iii)
Crescent Equities' proposed manner of operation will enable it to meet the
requirements for qualification as a REIT in the future.
2. Ownership of the Residential Development Properties and Treatment
of Amounts Derived by the Operating Partnership with Respect to the Stock of
the Residential Development Corporations
If the Residential Development Corporations are not respected for tax
purposes, then the Operating Partnership would be treated for tax purposes as
directly owning certain of the Residential Development Properties. In such a
case, the income from the sales of the Residential Development Properties
treated as directly owned by the Operating Partnership would not qualify under
the 75 percent and 95 percent gross income tests and would count as gain from
the
<PAGE> 6
Crescent Real Estate Equities Company
April 4, 1997
Page 6
sale of assets for purposes of the 30 percent of gross income limitation. In
addition, such income would be considered "net income from prohibited
transactions" and thus would be subject to a 100 percent tax. Moreover, to the
extent that the Operating Partnership would be treated as directly owning
HBCLP's limited partner interest in Hudson Bay Partners, L.P. ("HB Partners"),
the Operating Partnership would be treated as owning any securities held by HB
Partners, and such deemed ownership could cause Crescent Equities to be treated
as owning more than 10 percent of the voting securities of one or more issuers
in violation of section 856(c)(5)(B). As a general rule, however, corporations,
as long as they have a business purpose or carry on any business activity, are
not disregarded for federal income tax purposes. Moline Properties, Inc. v.
Commissioner, 319 U.S. 436, 438-439 (1943).
The Residential Development Corporations are not mere formalities
created for tax purposes. Crescent Equities and the Operating Partnership have
represented that each of the Residential Development Companies will have their
own employees (except HBCLP, which will have no employees), will act
independently in owning, developing, and selling the Residential Development
Properties, and will not act as agents of the Operating Partnership or Crescent
Equities. Moreover, Mira Vista Development Corporation ("MVDC") and Houston
Area Development Corporation ("HADC") should shield the Operating Partnership
against any liabilities generated by their respective property development
businesses, while Crescent Development Management Corporation ("CDMC") and
HBCLP should shield the Operating Partnership from any liabilities generated by
any future business conducted directly by CDMC and HBCLP, respectively.
Therefore, it is our opinion that for federal income tax purposes the
Operating Partnership will not be treated as owning the Residential Development
Properties held directly by the Residential Development Corporations and,
consequently, all amounts derived by the Operating Partnership with respect to
the stock of the Residential Development Corporations will be characterized as
distributions on stock (i.e., as dividends, a return of capital, or capital
gain, depending on the circumstances) for purposes of the 75 percent and 95
percent gross income tests.
3. Characterization of the Residential Development Property Mortgages
as Debt and Treatment of Amounts Paid Pursuant to Residential Development
Property Mortgages
a. Characterization as Debt. Debt instruments, especially
instruments that are held by persons related to the debtor, may under
certain circumstances be characterized for income tax purposes as
equity, rather than as debt. The characterization of an instrument as
debt or equity is a question of fact to be determined from all
surrounding facts and circumstances, no one of which is conclusive.
See Kingbay v. Commissioner, 46 T.C. 147 (1966); Hambuechen v.
<PAGE> 7
Crescent Real Estate Equities Company
April 4, 1997
Page 7
Commissioner, 43 T.C. 90 (1964). Among the criteria that have been
found relevant in characterizing such instruments are: (1) the intent
of the parties, (2) the extent of participation in management by the
holder of the instrument, (3) the ability of the corporation to obtain
funds from outside sources, (4) the "thinness" of the capital
structure in relation to debt, (5) the risk involved, (6) the formal
indicia of the arrangement, (7) the relative position of the obligees
as to other creditors regarding payment of interest and principal, (8)
the voting power of the holder of the instrument, (9) the provision of
a fixed rate of interest, (10) the contingency of the obligation to
repay, (11) the source of the interest payments, (12) the presence or
absence of a fixed maturity date, (13) a provision for redemption by
the corporation, (14) a provision for redemption at the option of the
holder, and (15) the timing of the advance with reference to the
organization of the corporation. Fin Hay Realty Co. v. United States,
398 F.2d 694 (3d Cir. 1968).
Although the Residential Development Property Mortgages are held by
the Operating Partnership, which owns all of the nonvoting stock of the
Residential Development Corporations, and an approximately 19 percent indirect
equity interest in Whitehawk Development Group, LLC, these mortgages possess a
number of attributes weighing in favor of debt treatment. For instance, each of
the Residential Development Property Mortgages is clearly denominated as debt,
has a fixed term of seven or more years (except the HBCLP Note which has a term
of five years), provides for the return of a fixed principal amount plus
interest, and is secured by the Residential Development Properties (or in the
case of the CDMC Mortgage, secured by an interest in a limited partnership
which holds indirect interests in several Residential Development Properties,
or in the case of the HBCLP Note, secured by HBCLP's interest in HB Partners).
The interest on the Residential Development Property Mortgages accrues at
either a fixed rate or, in the case of the Whitehawk Note, at the prime rate
plus one percent per annum (not including any additional interest based on
gross sales proceeds). In addition, the Residential Development Property
Mortgages are not subordinated to other indebtedness of the Residential
Development Corporations. Crescent Equities and the Operating Partnership have
represented that at the time that each of the Residential Development Property
Mortgages were acquired by the Operating Partnership, the outstanding principal
amount of such mortgages did not exceed approximately 80 percent of the fair
market value of the Residential Development Properties (or in the case of the
three notes secured by the Houston Area Properties, that the combined principal
amount of the three loans did not exceed approximately 85 percent of the fair
market value of the Houston Area Properties, or in the case of the HBCLP Note,
Crescent Equities and the Operating Partnership have represented that at the
time the HBCLP Note was acquired by the Operating Partnership the maximum
amount that could be drawn under the line of credit under such note did not
exceed 50 percent of the fair market value of HBCLP's interest in HB Partners)
and that the interest to be charged, including any contingent interest,
represents a commercially reasonable rate of interest. In addition, based on
our experience and an examination of the
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Residential Development Property Mortgages, the interest appears to represent a
commercially reasonable rate of interest.
Based on the foregoing, it is our opinion that each of the Residential
Development Property Mortgages constitutes debt for federal income tax
purposes.
b. Treatment of Amounts Paid Pursuant to Residential
Development Property Mortgages. Section 856(f) of the Code defines "interest"
for the purposes of section 856(c)'s gross income tests to include contingent
interest that is based on a fixed percentage of any person's receipts or sales.
On the other hand, contingent interest provisions that are based on a specified
portion of the gain realized on the sale of the real property securing a
mortgage (or any gain that would be realized if such property were sold on a
specified date) may be characterized as "shared appreciation provisions" under
section 856(j) of the Code. If the properties underlying such a provision are
primarily held for sale to customers in the ordinary course of business, any
income derived from such a provision would be treated as income from prohibited
transactions. Such income would not satisfy the 75 percent and 95 percent gross
income tests and would be subject to a 100 percent tax on "net income from
prohibited transactions."
Any contingent interest payable under the terms of the mortgage in the
principal amount of $14.4 million secured by the Mira Vista Residential
Development Property (the "Mira Vista Mortgage") will qualify as interest on an
obligation secured by a mortgage on real property, rather than income derived
from a shared appreciation provision, because such contingent interest will be
based on a percentage of the gross receipts derived from any sale of portions
of the Mira Vista Residential Development Property, as opposed to a portion of
the gain realized on such sales. Similarly, any contingent interest payable
under the terms of the mortgages in the aggregate principal amount of $14.4
million secured by the Falcon Point Residential Development Property and the
Spring Lakes Residential Development Property (the "Houston Area Development
Properties") (the "Houston Area Mortgages") will qualify as interest on
obligations secured by mortgages on real property, rather than income derived
from shared appreciation provisions, because such contingent interest will be
based on a percentage of the gross receipts derived from any sale of portions
of the Houston Area Development Properties, as opposed to a portion of the gain
realized on such sales.
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The fact that the contingent interest provided for by the Mira Vista
Mortgage and the Houston Area Mortgages is based on gross receipts, rather than
gain, could have economic significance with respect to the return received by a
holder of such mortgages. For example, if the value of the Houston Area
Development Properties were to increase, but few lots were sold, the Operating
Partnership, as holder of the Houston Area Mortgages would not accrue any
contingent interest. On the other hand, the Operating Partnership would accrue
contingent interest if numerous lot sales were made at the Houston Area
Development Properties, even if such sales were made at a loss.
Based on the foregoing, it is our opinion that any contingent interest
derived from the Mira Vista Mortgage and the Houston Area Mortgages will be
treated as being based on a fixed percentage of sales and therefore such
interest will constitute interest received from real estate mortgages for
purposes of the 75 percent and 95 percent gross income tests, and that,
consequently, all amounts derived by the Operating Partnership from the
Residential Development Corporations under the terms of the Residential
Development Property Mortgages (other than the HBCLP Note) will be
characterized as interest or principal, as the case may be, paid on mortgages
on real property for purposes of the 75 percent and 95 percent gross income
tests. It is our opinion that all amounts derived by the Operating Partnership
from the HBCLP Note will be characterized as interest or principal, as the case
may be for purposes of the 95 percent gross income test.
4. Characterization of Ritz-Carlton Mortgage as Debt and Treatment of
Amounts Paid Pursuant to Ritz-Carlton Mortgage
a. Background. Manalapan Hotel Partners ("Manalapan") is a
Florida general partnership. The three original partners of Manalapan were as
follows: Siquille Developers, Inc., which held and still holds a 50 percent
interest; SCP (Palm Beach) Inc., as successor to Shimizu Land Corporation
("SCP"), which held and still holds a 25 percent interest; and AIT Manalapan
Limited Partnership ("AIT"), which also held a 25 percent interest. In 1989, in
order to construct The Ritz-Carlton Hotel in Palm Beach, Florida, Manalapan
entered into three different loan agreements with three different entities.
Each note is secured by the Ritz-Carlton Hotel and the land thereunder (the "RC
Property"). The senior note in the amount of $75 million is held by The Nippon
Credit Bank, New York Branch ("Nippon"). The two subordinate notes, each in the
initial principal amount of $9 million and due on June 22, 2004, were held by
SCP and by State Street Bank and Trust Company, as trustee of Ameritech Pension
Trust ("Ameritech"). As of February 28, 1997, the unpaid principal balance of
the senior note was $71,428,757.91, together with accrued interest of
$360,960.67; the unpaid principal balance of the note held by SCP was
$8,849,244.17, plus accrued interest of $1,526,548.60; and the unpaid principal
balance of Ameritech's note was $8,849,244.17, plus accrued interest of
$1,527,677.71.
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On December 22, 1996, the Operating Partnership entered into an
agreement to purchase Ameritech's subordinate note (the "RC Note") for
$6,490,000 and an option to purchase AIT's interest in Manalapan (the
"Option"). The purchase price of the Option was $10,000; its exercise price was
$100,000. On February 27, 1997, the Operating Partnership transferred the
Option to CDMC. The Operating Partnership closed on the Loan Purchase and Sale
Agreement on March 5, 1997, purchasing the RC Note. On the same day, CDMC
exercised the Option and purchased the partnership interest in Manalapan.(4)
CDMC has the consent of the other Manalapan partners to transfer its interest
to a not-yet-formed corporation ("New Crescent") that, if it is formed, will be
spun off by the Operating Partnership and Crescent Equities.
b. Characterization as Debt. Debt instruments, especially
instruments that are held by persons related to the debtor, may under
certain circumstances be characterized for income tax purposes as equity,
rather than as debt. The characterization of an instrument as debt or equity is
a question of fact to be determined from all surrounding facts and
circumstances, no one of which is conclusive. See Kingbay v. Commissioner, 46
T.C. 147 (1966); Hambuechen v. Commissioner, 43 T.C. 90 (1964). Among the
criteria that have been found relevant in characterizing such instruments are
the following: (1) the intent of the parties, (2) the extent of participation
in management by the holder of the instrument, (3) the ability of the
corporation to obtain funds from outside sources, (4) the "thinness" of the
capital structure in relation to debt, (5) the risk involved, (6) the formal
indicia of the arrangement, (7) the relative position of the obligees as to
other creditors regarding payment of interest and principal, (8) the voting
power of the holder of the instrument, (9) the provision of a fixed rate of
interest, (10) the contingency of the obligation to repay, (11) the source of
the interest payments, (12) the presence or absence of a fixed maturity date,
(13) a provision for redemption by the corporation, (14) a provision for
redemption at the option of the holder, and (15) the timing of the advance with
reference to the organization of the corporation. Fin Hay Realty Co. v. United
States, 398 F.2d 694 (3d Cir. 1968).
Although the purchase price of the RC Note reflects a significant
discount from its outstanding balance, this price does not establish that the
RC Property was in fact "under water." Rather, it indicates Ameritech's
reluctance to continue to bear the financing risk associated with the loan. In
addition, the RC Note possesses a number of attributes weighing in favor of
debt treatment. For instance, the RC Note is clearly denominated as debt, has a
fixed maturity date of June 22, 2004, provides for the return of interest on
the principal amount at a rate of 12 percent per annum, some of which already
has been paid, and is secured by the RC Property. As far as we are aware, the
RC Note was issued at a time when the fair market value of the RC Property
exceeded all debts that it secured, has never been in default, and has never
been modified. In addition, neither of the two subordinate notes was pro rata
among the owners of the partnership's
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equity; both were held only by two minority partners. Also, the purchase by
CDMC of the joint venture interest indicates CDMC's belief that the equity
interest had some value at the time of the purchase. Furthermore, Crescent
Equities and the Operating Partnership have represented that the value of the
RC Property exceeds the combined outstanding balance of the RC Note and the
notes held by Nippon and SCP. Crescent Equities and the Operating Partnership
have also represented that the interest provided for under the RC Note
represents a commercially reasonable rate of interest. In addition, based on
our experience and an examination of the RC Note, the interest appears to
represent a commercially reasonable rate of interest.
Based on the foregoing, it is our opinion that the RC Note constitutes
debt for federal income tax purposes. Further, it is our opinion that amounts
designated as interest by the RC Note will be treated as interest for purposes
of the 75 percent and 95 percent gross income tests of section 856(c).
c. Option to Purchase Partnership Interest
The Operating Partnership's purchase of the Option and subsequent
transfer of it to CDMC, as well as CDMC's exercise of the option, raises two
issues of concern to the Operating Partnership. The first issue is whether
ownership of the Option by the Operating Partnership was tantamount to
ownership of the joint venture interest. The second issue is whether CDMC will
be treated as an agent of the Operating Partnership.
The IRS, in Revenue Ruling 82-150, 1982-2 C.B. 110, held that where a
taxpayer purchases an option to purchase an asset and the price paid for
acquiring the option is relatively high compared to the fair market value of
the asset, the doctrine of "substance over form" will be applied to the
transaction, and the taxpayer will be considered to have assumed ownership of
the asset through purchase of the option. The $10,000 price paid by the
Operating Partnership to purchase the Option, however, was relatively
insignificant compared to the exercise price and is not likely to be considered
a purchase of the joint venture interest.
Also relevant is the Tax Court's decision in Penn-Dixie Steel
Corporation v. Commissioner, 69 T.C. 837 (1978). The court addressed the issue
of whether a transaction between two parties that entered into a joint venture
agreement providing for a put and a call should be construed as a sale of one
company's interest with payment of a portion of the purchase price deferred
until the put or the call was exercised. The court explained that, despite the
likelihood of the companies exercising either the put or the call, the put and
call arrangement did not legally, or as a practical matter, impose mutual
obligations upon one company to sell and the other to buy. Id. at 844. Under
the Penn-Dixie rationale, enough contingencies were present
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when the Operating Partnership purchased the Option to prevent the purchase of
the Option from being construed as purchase of the joint venture interest.
Based on the foregoing, it is our opinion that the Operating
Partnership's purchase of the Option will not be construed as ownership of a
partnership interest in Manalapan.
The second issue that must be addressed is whether CDMC could be
regarded as an agent for the Operating Partnership. In Commissioner v.
Bollinger, the Supreme Court discussed the tax treatment of corporations
purporting to be agents for their shareholders. 485 U.S. 340 (1988). The Court
enumerated three factors that will lead to the finding of an agency
relationship with respect to an asset: (1) the corporation acquires the asset
with a written agency agreement in place; (2) the corporation functions as an
agent and not as a principal; and (3) the corporation is held out to third
parties as an agent. Id. at 349-50.
CDMC has not and will not hold itself out as an agent for the
Operating Partnership. In addition, there are no agreements between Crescent
Equities and the Voting Shareholders, whether written or oral, that control the
manner in which the Voting Shareholders exercise the voting rights inherent in
the voting stock of CDMC or that restrict the ability of the Voting
Shareholders to alienate such stock. There will be no such agreements between
Crescent Equities and the Voting Shareholders in the future. Moreover, the
voting stock of CDMC owned by the Voting Shareholders is registered in the
names of such Voting Shareholders, and all dividends accruing on stock are
delivered to the addresses of such Voting Shareholders. No evidence exists to
indicate that CDMC did not act independently and in the best interests of its
shareholders when investing in the partnership interest in Manalapan, which has
significant potential for appreciation.
Although CDMC has the right to transfer its interest in Manalapan to
New Crescent, it is under no legal obligation to complete such a transfer. No
agreement, written or unwritten, to transfer the Manalapan interest to New
Crescent exists between the Operating Partnership and CDMC. Crescent Equities
has also represented that to the best of its knowledge the Board of Directors
of CDMC has not yet made a decision regarding the possible contribution to New
Crescent, will continue to act independently with regard to this matter, and
will take whatever actions it determines are in the best interest of CDMC at
such time, if any, as there is an opportunity to transfer the partnership
interest to New Crescent. In addition, the possibility remains that the
spin-off transaction will not occur and New Crescent will not be formed.
In our view, an application of the Bollinger inquiry to these facts is
unlikely to result in a characterization of the relationship between CDMC and
the Operating Partnership as one
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between agent and principal, especially because CDMC and the Operating
Partnership will not hold themselves out to the public as principal and agent.
Finally, it is unlikely that the Operating Partnership will be
considered the owner of the partnership interest because, should the value of
the partnership interest depreciate, CDMC bears the risk of loss. CDMC also
will be the entity that benefits should the interest appreciate.
Based on the foregoing, it is our opinion that the Operating
Partnership's purchase of the Option will not be construed as ownership of a
partnership interest in Manalapan.
5. Characterization of the Leases of the Hotel Properties and the
Treatment of Amounts Paid Pursuant To Such Leases as "Rents From Real Property"
On January 3, 1995, we provided the Operating Partnership with a
memorandum (a copy of which is attached hereto) in which we expressed our
opinion that, based on certain assumptions, that the lease of the Hyatt Regency
Beaver Creek would be treated as a lease for federal income tax purposes and
that the rent payable thereunder would qualify as "rents from real property."
On April 1, 1996, we provided the Operating Partnership with a letter (a copy
of which is attached hereto) in which we updated the facts relating to the
lease of the Hyatt Regency Beaver Creek as expressed in our January 3, 1995
memorandum and affirmed the opinions expressed in that memorandum.
On June 30, 1995, we provided the Operating Partnership with a
memorandum (a copy of which is attached hereto) in which we expressed our
opinion that, based on certain assumptions, that the lease of the Denver
Marriott City Center would be treated as a lease for federal income tax
purposes and that the rent payable thereunder would qualify as "rents from real
property." On September 27, 1996, we provided the Operating Partnership with a
letter (a copy of which is attached hereto) in which we affirmed the opinions
expressed in our June 30, 1995 memorandum.
On December 19, 1995, we provided the Operating Partnership with a
memorandum (a copy of which is attached hereto) in which we expressed our
opinion that, based on certain assumptions, that the lease of the Hyatt Regency
Albuquerque Plaza would be treated as a lease for federal income tax purposes
and that the rent payable thereunder would qualify as "rents from real
property." On April 1, 1996, we provided the Operating Partnership with a
letter (a copy of which is attached hereto) in which we updated the facts
relating to the lease of the Hyatt Regency Albuquerque Plaza as expressed in
our December 19, 1995 memorandum and affirmed the opinions expressed in that
memorandum.
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On July 26, 1996, we provided the Operating Partnership with a
memorandum (a copy of which is attached hereto) in which we expressed our
opinion that, based on certain assumptions, that the lease of the Canyon Ranch
Tucson resort would be treated as a lease for federal income tax purposes and
that the rent payable thereunder would qualify as "rents from real property."
On December 11, 1996 we provided the Operating Partnership with a
letter (a copy of which is attached hereto) in which we expressed our opinion
that, based on certain assumptions, that the lease of the Canyon Ranch Lenox
resort would be treated as a lease for federal income tax purposes and that the
rent payable thereunder would qualify as "rents from real property."
We hereby affirm the opinions expressed in our January 3, 1995, June
30, 1995, December 19, 1995 and July 26, 1996 memoranda, as updated by our
letters dated April 1, 1996, September 27, 1996 and December 11, 1996, and
authorize you to rely upon those opinions in connection with the preparation of
the Registration Statement.
6. Ownership of Residential Development Company Voting Stock
Section 856(c)(5) restricts the types of assets that can be held by an
entity seeking to qualify as a REIT. Specifically, section 856(c)(5)(B)
provides that at the close of each quarter of the taxable year, a REIT must
hold no more than 10 percent of the outstanding voting securities of any one
issuer.
The term "voting securities" as used in section 856(c)(5)(B) is not
defined in the Code. However, section 856(c)(6)(F) provides that terms not
defined in sections 856 through 859 shall have the same meaning as when used in
the Investment Company Act of 1940, as amended (the "ICA"). Section 2(a)(42) of
the ICA defines "voting security" as "any security presently entitling the
owner or holder thereof to vote for the election of directors of a company."
The IRS has not issued any revenue rulings discussing what constitutes
"voting securities" for purposes of section 856(c)(5)(B). However, the IRS has
issued one revenue ruling discussing what constitutes "voting securities" for
the purposes of section 851(b), which provides rules for qualification as a
regulated investment company (a "RIC"). (The RIC qualification provisions, like
section 856(c)(5)(B), incorporate the definition of "voting securities" found
in the ICA.) In Rev. Rul. 66-339, 1966-2 C.B. 274, the IRS held that a
shareholders' voting agreement was not a voting security for purposes of
section 851(b)(4). The taxpayer in the ruling was a small business investment
company which had made a loan to a corporation. Under the terms of the loan
agreement, a shareholders' agreement was executed, which required the election
of one director designated by the taxpayer during the term of the loan and,
thereafter, as long as the taxpayer owned or had the right to acquire at least
10 percent of the outstanding stock of the
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corporation. The IRS held that the shareholders' agreement was not a voting
security because the enforceability the taxpayer's rights under the agreement
depended upon the taxpayer's status as a party to the agreement, rather than as
a shareholder.
The IRS has not been entirely comfortable with Rev. Rul. 66-339,
however. In G.C.M. 36823, 1976 IRS GCM Lexis 114 (Aug. 24, 1976), which dealt
with the definition of "voting securities" for purposes of the REIT provisions,
the IRS recommended that Rev. Rul. 66-339 be modified to reflect the
interpretation of the term "voting security" as expressed in an opinion of the
chief counsel of the Securities and Exchange Commission ("SEC"). This opinion
held that "unless there are compelling considerations to the contrary in a
particular case, the definition of 'voting security' in the ICA should
generally be interpreted to include not only the formal legal right to vote for
the election of directors pursuant to the provisions of the law of the state of
incorporation and the corporation's charter and by-laws but also the de facto
power, based on all the surrounding facts and circumstances, to determine, or
influence the determination of, the identity of a corporation's directors." Id.
Despite this recommendation of G.C.M. 36823, however, Rev. Rul. 66-339 has
never been modified and would therefore continue to constitute good authority.
Since the issuance of G.C.M. 36823, the IRS has issued several private
letter rulings in which it has not treated a REIT as owning "voting securities"
of other corporations for purposes of section 856(c)(5)(B), despite the fact
that such securities were actually owned either by officers or shareholders of
the REIT. P.L.R. 8825112 (Mar. 30, 1988); P.L.R. 9340056 (July 13, 1993);
P.L.R. 9428033 (April 20, 1994); P.L.R. 9436025 (June 8, 1994). In each of
these rulings, the REIT either directly or indirectly held substantial amounts
of the other corporation's nonvoting stock. None of these rulings makes any
mention of either Rev. Rul. 66-339 or the de facto voting power issue raised by
the IRS in G.C.M. 36823.
Although private letter rulings like those mentioned above were issued
by the IRS until June 8, 1994, the IRS subsequently announced that, for the
indefinite future, it would no longer issue private letter rulings with regard
to fact situations involving corporations the voting stock of which is held by
relatives of principal REIT shareholders and/or REIT employees. The IRS has not
provided an explanation for this "no ruling" policy. Nonetheless, the policy
could indicate that the IRS is reconsidering its position on the treatment of
fact situations similar to those involving Crescent Equities and the
Residential Development Corporations.
Crescent Equities does not directly or indirectly own any of the
voting stock of any of the Residential Development Corporations. In the case of
MVDC, the voting stock is owned by James Bartlett, Nick Hackstock, Tom
Nezworski, John C. Goff and Gerald W. Haddock (together, the "MVDC Voting
Shareholders"). In the case of HADC, the voting stock is owned
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by Sam Yager, John C. Goff and Gerald W. Haddock (together, the "HADC Voting
Shareholders"). In the case of CDMC, the voting stock is owned by Harry
Frampton, John C. Goff and Gerald W. Haddock (together, the "CDMC Voting
Shareholders"). In the case of HBCLP, such stock is owned by K-Holdings Co. and
David Lesser (together, the "HBCLP Voting Shareholders" and together with the
MVDC Voting Shareholders, the HADC Voting Shareholders and the CDMC Voting
Shareholders, the "Voting Shareholders"). Moreover, the voting stock of the
Residential Development Corporations owned by the Voting Shareholders is
registered in the names of such Voting Shareholders, and all dividends accruing
on stock are delivered to the addresses of such Voting Shareholders. Therefore,
unless Crescent Equities is deemed to own some of the shares of voting stock of
the Residential Development Corporations actually held by the Voting
Shareholders, it will not own more than 10 percent of the voting securities of
any of the Residential Development Corporations in violation of section
856(c)(5)(B).
The IRS could argue that the ownership of some or all of the voting
stock actually held by the Voting Shareholders should be attributed to Crescent
Equities under two possible theories: (1) a "nominee" or "de facto ownership"
theory or (2) a constructive ownership theory. There is no authority indicating
that the Service could successfully assert either of these theories in a fact
situation similar to that involving Crescent Equities and the Residential
Development Corporations, however. Therefore, it is our opinion that Crescent
Equities will not be deemed to be the owner of the voting stock of the
Residential Development Corporations held by the Voting Shareholders for
purposes of section 856(c)(5)(B). In connection with this opinion we note that
both John C. Goff and Gerald W. Haddock are presently officers and trust
managers of Crescent Equities and officers of some of Crescent Equities'
subsidiaries, while David H. Lesser was an employee of Crescent Equities prior
to his acquiring voting stock in HBCLP.
a. "Nominee" or "De Facto Ownership" Theory. Under a
"nominee" or "de facto ownership" theory, the IRS could attribute ownership of
the Residential Development Company voting stock from the Voting Shareholders
to Crescent Equities for tax purposes, based on the "effective control" that
Crescent Equities exercises over the Voting Shareholders. The IRS has only
applied a "nominee" or "de facto ownership" theory in situations where there
was a written or oral agreement transferring "effective control" of the stock
away from the record owner, however. No such agreement exists between Crescent
Equities and the Voting Shareholders.
For example, in G.C.M. 36823, discussed above, the IRS based its
determination that a taxpayer was the "true owner" of another corporation's
voting stock for purposes of section 856(c)(5)(B) on the fact that the actual
owner of such stock had executed a written agreement giving the taxpayer a
proxy to vote the stock in a number of key situations. Under the agreement, the
taxpayer was given a proxy to vote all of the borrower's voting stock in the
event
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the borrower proposed (1) a merger or reorganization, (2) a liquidation and
dissolution, (3) any substantial change in business, (4) a sale or disposition
of all or substantially all of its assets, (5) any amendment to the certificate
of incorporation, (6) the organization of any significant subsidiary, or (7)
any substantial investment in any other corporation, partnership, or joint
venture. The proxy did not give the taxpayer the right to vote for the
borrower's directors, however. Nonetheless, the IRS concluded that the taxpayer
should be deemed to own the borrower's voting stock for purposes of section
856(c)(5)(B), because the agreement with the actual owner of the borrower's
voting stock provided the taxpayer "with the type of control over directors'
decisions that is usually reserved to those having the power to elect
directors, that is, the owners of voting stock." 1976 IRS GCM Lexis 114.
In contrast, the IRS has never attributed ownership of voting
securities to a taxpayer for purposes of section 856(c)(5)(B) in situations
where no agreement regarding how such securities were to be voted existed
between the taxpayer and the actual owners of the securities. For example, in a
series of private letter rulings issued after the issuance of G.C.M. 36823, the
IRS ignored the "effective control" that taxpayers might exercise over voting
stock in situations where such stock was held by the taxpayer's officers and
shareholders. Id.
Similarly, outside the context of section 856(c)(5)(B), the IRS has
treated the actual owners of corporate stock as mere nominees only in
situations where there was a written or oral agreement that provided another
party with effective control over such stock. For example, in Rev. Rul. 84-79,
1984-1 C.B. 190, the IRS found that the grantor and sole beneficiary of a
revocable voting trust "directly" owned stock for purposes of section 1504(a),
despite the fact that it had transferred the stock to the voting trust. The IRS
reached this conclusion because the voting trust agreement effectively allowed
the grantor to retain control over the stock, permitting it to revoke the trust
or replace the trustee without cause at any time. See also, Rev. Rul. 70-469,
1970-2 C.B. 179; Miami National Bank v. Commissioner, 67 T.C. 793 (1977). In
contrast, the IRS has not found that corporations retained effective control of
stock for purposes of section 1504(a)(4) in situations where they transferred
such stock to their shareholders, in the absence of a voting trust agreement.
See, e.g., T.A.M. 9206005 (Oct. 24, 1991); T.A.M. 9137003 (May 20, 1991).
The IRS has also refused to treat purchasers of corporate stock as
mere nominees when applying the "solely for voting stock" requirement for
section 368(a)(1)(B) reorganizations. For example, in Rev. Rul. 68-562, 1968-2
C.B. 157, the IRS found that an acquisition of all the stock of one corporation
("Y") by another corporation ("X"), in exchange for X corporation voting stock
qualified as a section 368(a)(1)(B) reorganization. The IRS reached this
conclusion despite the fact that an individual who owned 90 percent of X's
voting stock had purchased 50 percent of Y's stock for cash two months before
the such acquisition. The IRS did not attribute this
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purchase of Y stock to X, because the actual purchaser, even though he was X's
principal shareholder, was under no obligation to surrender such stock to X.
Id. See also, Rev. Rul. 72-354, 1972-2 C.B. 216 (acquiring corporation
satisfied "solely for voting stock" requirement for a section 368(a)(1)(B)
reorganization when it sold stock in the target corporation that it had
recently purchased for cash to a third party with no commitment on the part of
the third party to surrender such stock in subsequent reorganization). In
contrast, the IRS has attributed third-party purchases of corporate stock to
the acquiring party in a 368(a)(1)(B) reorganization in situations where a
third-party purchaser had previously agreed to transfer the purchased stock to
the acquiring party. See, e.g., G.C.M. 36041, 1974 IRS GCM Lexis 73.
Moreover, under the three-factor test for nominee status set forth by
the Supreme Court in Commissioner v. Bollinger, none of the Voting Shareholders
qualifies as a nominee of Crescent Equities with respect to the Residential
Development Corporation voting stock. 485 U.S. 340 (1988). Bollinger involved
partnerships that developed apartment complexes in Kentucky. In order to avoid
Kentucky's usury laws, which limited the annual interest rate for noncorporate
borrowers, the partnerships entered into agreements with a corporation wholly
owned by an individual that was a partner in each of the partnerships. Pursuant
to the agreements, the corporation was to hold title to the apartment complexes
as the partnerships' nominee and agent solely to secure financing. The
agreements also provided that the partnerships were to have sole control of and
responsibility for the complexes, and the partnerships were to be the principal
and owner of the property during financing, construction, and operation. All
parties who had contact with the complexes, if they were aware of the
corporation at all, regarded the partnerships as the owners and knew the
corporation was merely the partnerships' agent. Income and losses from the
complexes were reported on the partnerships' tax returns, and the partners each
reported their distributive share of such income and losses on their individual
returns. The IRS challenged the inclusion of the complexes' losses on the
partners' individual returns on the ground that the losses were attributable to
the corporation as the record owner of the complexes. The IRS argued that in
order for the partners to demonstrate that the corporation was acting merely as
an agent or nominee, they must give evidence of arms-length dealing between the
partnerships and the corporation and the payment of an agency fee. However, the
Supreme Court held that only three factors needed to be present to assure the
genuineness of an agency relationship: (1) the corporation must execute a
written agreement at the time the asset is acquired setting forth the
corporation's agency with respect to the asset, (2) the corporation must
function as an agent and not as a principal with respect to the asset for all
purposes, and (3) the corporation must be held out to be an agent and not a
principal in all dealings with third parties relating to the asset. Id.
Although Bollinger expressly dealt with situations where corporations
were acting as nominees for their shareholders, its three-factor test appears
to be relevant in determining the genuineness of all purported agency
relationships for federal income tax purposes. Therefore, if
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the IRS were to assert that the Voting Shareholders are holding the voting
stock of the Residential Development Corporations as mere nominees of Crescent
Equities, Bollinger's three-factor test should apply in evaluating the
relationship between Crescent Equities and the Voting Shareholders.
When Bollinger's three-factor test is applied to Crescent Equities'
relationship to the Voting Shareholders, it becomes apparent that the Voting
Shareholders are not acting as Crescent Equities' nominees with respect to
their ownership of the voting stock of the Residential Development
Corporations. First, in contrast to the situation in Bollinger, where there was
a written agreement between the corporation and the partnerships setting forth
the corporation's rights and duties as agent, here there is and will be no
written (or oral) agreement between Crescent Equities and the Voting
Shareholders regarding the Voting Shareholders' rights and duties with respect
to the voting stock of the Residential Development Corporations. Crescent
Equities has no control over the ability of the Voting Shareholders to alienate
the voting stock and vote such stock as they choose. Second, unlike the
situation in Bollinger, where the corporation functioned as an agent rather
than a principal with respect to the apartment complexes, here the Voting
Shareholders function as principals with respect to the voting stock. As noted
above, the Voting Shareholders make their own decisions about alienating the
voting stock and how to exercise their voting power, and they are independently
obligated to make their shares of any additional capital contributions. Third,
unlike the situation in Bollinger, where the corporation was clearly held out
to all third parties as a mere agent of the partnerships, here the Voting
Shareholders have been and will be held out to third parties as the true owners
of the voting stock in all respects. For example, the voting stock is
registered in the name of the Voting Shareholders, and all corporate notices
and dividends, if any, are delivered to the addresses of the Voting
Shareholders.
b. Constructive Ownership Theory. Under a "constructive
ownership theory," the IRS could attempt to attribute ownership of the voting
stock of the Residential Development Corporations from the Voting Shareholders
to Crescent Equities for purposes of applying section 856(c)(5)(B). The absence
of any relevant constructive ownership provision should defeat such a position,
however.
Although the Code contains several constructive ownership provisions,
such as sections 267(c), 318(a), 544(a), 554(a) and 1563(e), section 318(a) is
the only one that could possibly operate to attribute ownership of the voting
stock of the Residential Development Corporations from the Voting Shareholders
to Crescent Equities. This is because section 318(a) is the only constructive
ownership provision that provides for attribution of stock ownership to
corporations. All of the other constructive ownership provisions provide only
for attribution of stock ownership away from corporations.
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The IRS should not be successful in attributing ownership of the
voting stock of the Residential Development Corporations to Crescent Equities
under section 318(a), because that section applies only to other Code sections
that expressly provide for its application. There is no indication in the Code
or Treasury Regulations that taxpayers are to apply the constructive ownership
rules of section 318(a) in determining ownership of voting securities for
purposes of section 856(c)(5)(B).
Furthermore, the IRS and the courts have rejected all attempts to
apply section 318(a) to Code sections other than those to which it is expressly
made applicable. Thus, for example, in Brams v. Commissioner, 734 F.2d 290 (6th
Cir. 1984), the Sixth Circuit affirmed a decision of the Tax Court holding that
a transfer of property by a taxpayer to a corporation did not qualify for
nonrecognition treatment under section 351. Section 351 offers nonrecognition
treatment to persons who transfer property to corporations in exchange for
stock, only if such persons are in control of the corporation immediately after
the exchange. Section 368(c) defines "control" for this purpose as ownership of
80 percent of the total combined voting power of all classes of stock entitled
to vote and at least 80 percent of the total number of shares of all other
classes of stock. In Brams, the Sixth Circuit determined that the taxpayer
directly owned only 31.6 percent of the outstanding stock of the corporation
immediately after the transaction, and it refused to apply section 318(a) to
attribute to the taxpayer the ownership of an additional 52.6 percent of the
outstanding stock of the corporation held by the taxpayer's sons. Id. See also
Yamamoto v. Commissioner, 51 T.C.M. 1560 (1986) (Section 351 does not apply to
a transfer where the taxpayer owned part of the transferee's stock directly and
owned 100% of the stock of a second corporation which owned the balance of the
transferee corporation's stock).
Similarly, the IRS has refused to apply any attribution rules in
interpreting "control" for the purposes of interpreting the reorganization
provisions of section 368. For example, in Rev. Rul. 56-613, 1956-2 C.B. 212,
the IRS did not treat a corporation as satisfying the control requirement of
section 368(a)(1)(B) of the Code when it acquired 100 percent of one class of
shares of a target corporation, despite the fact that all the other shares of
the target corporation were owned by the acquiring corporation's wholly owned
subsidiary. See also Berghash v. Commissioner, 43 T.C. 743 (1965), aff'd, 361
F.2d 257 (2d Cir. 1966) (the option attribution rules of section 318(a) do not
apply in determining whether the control requirement of section 368(a)(1)(D) is
satisfied); Rev. Rul. 76-36, 1976-1 C.B. 105 (section 318(a) has no application
in determining "changes in ownership" under pre-1987 section 382).
Moreover, even if section 318(a) of the Code were applicable to the
determination of ownership of voting securities for purposes of section
856(c)(5)(B), it would not operate to attribute ownership of the voting stock
of the Residential Development Corporations from the Voting Shareholders to
Crescent Equities. Section 318(a)(3)(C) provides that stock ownership is
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Page 21
to be attributed from a shareholder to a corporation only if the shareholder
owns, directly or indirectly, 50 percent or more of the value of the stock of
such corporation. The Declaration of Trust currently contains limitations on
stock ownership that will prevent any shareholder, other than Richard E.
Rainwater, from owning, actually or constructively, more than 8.0 percent of
the value of Crescent Equities common shares. The Declaration of Trust also
prevents Richard E. Rainwater from owning, actually or constructively, more
than 9.5 percent of the value of Crescent Equities' common shares. Therefore,
unless these ownership limitations are waived, no person can possibly own,
actually or constructively, the 50 percent of the value of Crescent Equities'
common shares required for the application of section 318(a)(3)(C).
Consequently, it is our opinion that Crescent Equities will not be treated for
federal income tax purposes as owning any of the voting stock of any of the
Residential Development Corporations.
7. Characterization of the Operating Partnership for U.S. Federal
Income Tax Purposes
a. Classification for Periods on or after January 1, 1997
Section 301.7701-2(a) of the Treasury Regulations provides that a
business entity formed on or after January 1, 1997 with two or more members
will be classified for federal tax purposes as either a corporation or a
partnership, unless it is otherwise subject to special treatment under the
Code. Under sections 301.7701-2(b)(1), (3), (4), (5), (6), (7) and (8) of the
Treasury Regulations, a corporation includes business entities denominated as
such under applicable law, as well as joint-stock companies, insurance
companies, entities that conduct certain banking activities, entities wholly
owned by a state or any political subdivision thereof, entities that are
taxable as corporations under a provision of the Code other than section
7701(a)(3), and certain entities formed under the laws of a foreign
jurisdiction. Section 301.7701-3(a) of the Treasury Regulations provides that a
business entity with two or more members that is not classified as a
corporation under section 301.7701-2(b)(1), (3), (4), (5), (6), (7) or (8) of
the Treasury Regulations (an "Eligible Entity") can elect its classification
for federal income tax purposes. Section 301.7701-3(b)(1) of the Treasury
Regulations provides that a domestic Eligible Entity formed on or after January
1, 1997 will be classified as a partnership unless it elects otherwise. Under
section 301.7701-3(b)(3) of the Treasury Regulations, a domestic Eligible
Entity in existence prior to January 1, 1997 will have the same classification
that the entity claimed under sections 301.7701-1 through 301.7701-3 of the
Treasury Regulations as in effect prior to January 1, 1997 (the "Prior
Regulations"), unless it elects otherwise.
The Operating Partnership was duly organized as a limited partnership
prior to January 1, 1997. The Operating Partnership is not a corporation as
defined under section 301.7701-2(b)(1), (3), (4), (5), (6), (7) or (8) of the
Treasury Regulations. Accordingly, the Operating Partnership is an Eligible
Entity that can elect its classification for federal income tax purposes for
all periods
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on or after January 1, 1997. You have represented that the Operating
Partnership will claim classification as a partnership under the Prior
Regulations, as reflected on a federal income tax return to be filed by the
Operating Partnership for the tax year ending December 31, 1996. You have also
represented that the Operating Partnership will not file an election to be
treated as a corporation. Based on the foregoing, it is our opinion that the
Operating Partnership will be treated as a partnership for federal income tax
purposes as defined in Code sections 7701(a)(2) and 761(a) and not as an
association taxable as a corporation for all periods on or after January 1,
1997.
b. Classification for Periods Prior to January 1, 1997.
Section 301.7701-3(f)(2) of the Treasury Regulations provides that the claimed
classification of a business entity that is not described in section
301.7701-2(b)(1), (3), (4), (5), (6), (7) or (8) of the Treasury Regulations
and that was in existence prior to January 1, 1997 generally will be respected
for all periods prior to January 1, 1997 if the entity had a reasonable basis
for its claimed classification, and neither the entity nor any member thereof
was notified in writing on or before May 8, 1996 that the classification of the
entity was under examination.
Section 301.7701-2(a) of the Prior Regulations provided that an entity
that has associates and an objective to carry on a business for joint profit
will be treated as a partnership, and not as an association taxable as a
corporation, if it has not more than two of the following four characteristics
of a corporation: (i) continuity of life; (ii) centralization of management;
(iii) limited liability; and (iv) free transferability of interests. The entity
must also have no other characteristics that are significant in determining its
classification. Generally, other factors are considered only insofar as they
relate to the determination of the presence or absence of the foregoing
corporate characteristics. See Rev. Rul. 79-106, 1979-1 C.B. 448.
Revenue Procedure 89-12, 1989-1 C.B. 798, specified the conditions to
be satisfied for an entity to receive a favorable advanced ruling that it would
be classified as a partnership for federal income tax purposes. The Operating
Partnership may not have met all of the requirements necessary to obtain such a
ruling. Such requirements were applicable only in determining whether rulings
will be issued, however, and were not intended as substantive rules for the
determination of partnership status.
i. Limited Liability. Under section 301.7701-2(d)
of the Prior Regulations, an entity lacks the corporate characteristic
of limited liability if there is at least one member who is personally liable
for the debts of or claims against the partnership. In the case of a limited
partnership, a general partner of a limited partnership is personally liable
under the Prior Regulations if (i) it has substantial assets other than its
interest in the partnership or (ii) it is not a dummy acting as the agent of
the limited partners. As general partner of the Operating
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Partnership, Crescent Real Estate Equities, Ltd. ("CREE") is personally liable
for all the debts and obligations of the Operating Partnership and owns a
general partnership interest therein of approximately one percent. However,
section 856(i) of the Code provides that qualified REIT subsidiaries are
treated as the same entity as their REIT parent for federal income tax
purposes. Therefore, Crescent Equities will be treated as directly owning
CREE's one percent general partnership interest in the Operating Partnership.
Furthermore, Crescent Equities and the Operating Partnership have represented
that CREE will act independently of the Operating Partnership's limited
partners. Therefore, the Operating Partnership may have lacked the corporate
characteristic of limited liability.
ii. Continuity of Life. Section 301.7701-2(b) of
the Prior Regulations provided that if the bankruptcy, retirement,
resignation, expulsion, or other event of withdrawal of a general partner of a
limited partnership causes a dissolution of the partnership, continuity of life
does not exist, even if dissolution may be avoided by the remaining general
partners or by at least a majority in interest of all remaining partners
agreeing to continue the partnership. Under Section 13.1.B of the Operating
Partnership Agreement, the withdrawal of CREE and the bankruptcy of Crescent
Equities cause the Operating Partnership to terminate, unless a majority in
interest of the remaining partners consent to continue the Partnership and
appoint a new general partner. Accordingly, the Operating Partnership lacked
the corporate characteristic of continuity of life.
iii. Centralization of Management. Section
301.7701-2(c)(4) of the Prior Regulations provided that centralization of
management ordinarily will be found to exist in a limited partnership
in which substantially all of the partnership interests are held by the limited
partners, and that it may exist where the limited partners have a substantially
unrestricted right to remove the general partner. As noted above, under section
856(i) of the Code, Crescent Equities will be treated as owning a one percent
general partner interest and an approximately 84 percent limited partnership
interest in the Operating Partnership. Furthermore, Section 7.1.A of the
Operating Partnership Agreement provides that the limited partners may not
remove CREE as general partner. Therefore, the Operating Partnership lacked the
corporate characteristic of centralization of management.
iv. Free Transferability of Interests.
Section 301.7701-2(e) of the Prior Regulations provided that free
transferability of interests exists if the members owning all or substantially
all of the interests in an organization may substitute for themselves without
the consent of the other members a person who is not a member of the
organization. Section 11.4.A of the Operating Partnership Agreement provides
that if a limited partner transfers its interest in the Operating Partnership,
the transferee (unless it falls within certain enumerated categories of
transferees) will not become a substituted limited partner without the prior
consent of CREE.
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Accordingly, the Operating Partnership may have lacked the corporate
characteristic of free transferability of interests.
v. Summary. In sum, because the Operating
Partnership did not have the corporate characteristics of continuity
of life and centralization of management and may have lacked limited liability
and free transferability, it is our opinion that the Operating Partnership had
a reasonable basis for claiming partnership classification under the Prior
Regulations. Based on the foregoing, it is our opinion that the Operating
Partnership will be treated as a partnership as defined in sections 7701(a)(2)
and 761(a) of the Code and not as an association taxable as a corporation for
all periods prior to January 1, 1997.
c. Publicly Traded Partnership Status.
Section 7704 of the Code provides that certain publicly traded
partnerships may be taxed as corporations even though they otherwise meet all
of the relevant tests for treatment as partnerships for federal income tax
purposes. A partnership is considered to be a publicly traded partnership if
interests in the partnership are (or become) (i) traded on an established
securities market or (ii) readily tradable on a secondary market or the
substantial equivalent thereof. Treasury Regulations issued under section
7704(b) of the Code provide that interests in a partnership will not be treated
as readily tradable on a secondary market or the substantial equivalent thereof
if (i) all interests in the partnership were issued in a transaction that was
not registered under the Securities Act of 1933, and (ii) the partnership does
not have more than 100 partners at any time during its taxable year. For
purposes of determining the number of partners in the partnership, persons
owning an interest through a flow-through entity are treated as partners in the
partnership only if (i) substantially all of the value of the flow-through
entity is attributable to the lower-tier partnership interest, and (ii) a
principal purpose for the tiered arrangement is to permit the partnership to
satisfy the 100 partner requirement.
Based upon the structure and capitalization of the Operating
Partnership and representations of the Operating Partnership regarding its
current ownership, it is our opinion that the Operating Partnership will not
constitute a publicly traded partnership for purposes of section 7704 of the
Code.
8. Characterization of the Subsidiary Partnerships for U.S. Federal
Income Tax Purposes
a. Classification of Periods on or After January 1, 1997. As
previously discussed, under section 301.7701-3(b)(3) of the Treasury
Regulations, a domestic Eligible Entity in existence prior to January 1, 1997
will have the same classification that the entity claimed under sections
301.7701-1 through 301.7701-3 of the Prior Regulations, unless it elects
otherwise. The
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April 4, 1997
Page 25
Subsidiary Partnerships were duly organized as limited partnerships prior to
January 1, 1997. The Subsidiary Partnerships are not corporations as defined
under section 301.7701-2(b)(1), (3), (4), (5), (6), (7) or (8) of the Treasury
Regulations. Accordingly, each of the Subsidiary Partnerships is an Eligible
Entity that can elect its classification for federal income tax purposes for
all periods after January 1, 1997. Crescent Equities has represented to us that
each of the Subsidiary Partnerships will claim classification as a partnership
under the Prior Regulations, as reflected on federal income tax returns to be
filed by each Subsidiary Partnership for the tax year ending December 31, 1996.
Crescent Equities has also represented that none of the Subsidiary Partnerships
will file an election to be treated as a corporation. Based on the foregoing,
it is our opinion that the Subsidiary Partnerships will be treated as
partnerships for federal income tax purposes as defined in sections 7701(a)(2)
and 761(a) of the Code and not as associations taxable as corporations for all
periods on or after January 1, 1997.
b. Classification for Periods Prior to January 1, 1997
i. Funding I. The Operating Partnership owns a 99.6
percent interest in Funding I as a limited partner, while the
remaining 0.4 percent general partner's interest is owned by CRE Management I
Corp., a wholly owned subsidiary of CREE. (However, with respect to the
Waterside Commons property, which is held by Funding I, Waterside Commons
Limited Partnership owns a 99 percent interest in Funding I as a limited
partner, while the remaining 1 percent general partner's interest is owned by
CRE Management I Corp.)
The Funding I Agreement provides in Sections 13.1.B and 13.1.D that
the dissolution, insolvency, bankruptcy or other event of withdrawal of the
general partner will cause the partnership to terminate, unless a majority in
interest of the remaining partners consent to continue the partnership and
appoint a new general partner. Accordingly, Funding I lacked the corporate
characteristic of continuity of life.
The Funding I Agreement provides in Section 11.1.B that no partner may
transfer all or any portion of its interest in the partnership. Accordingly,
Funding I lacked the corporate characteristic of free transferability of
interests.
Based on the continued organization and operation of Funding I in
accordance with its partnership agreement and the Delaware Revised Uniform
Limited Partnership Act (the "Act"), Funding I lacked the corporate
characteristics of continuity of life and free transferability of interests.
Accordingly, it is our opinion that Funding I had a reasonable basis for
claiming partnership classification under the Prior Regulations. Based on the
foregoing, it is our opinion that Funding I will be treated as a partnership as
defined in sections 7701(a)(2) and 761(e) of the Code and not as an association
taxable as a corporation for all periods prior to January 1, 1997.
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In addition, based upon the structure and capitalization of Funding I
and representations of the Operating Partnership regarding Funding I's current
ownership, it is our opinion that Funding I will not constitute a publicly
traded partnership for purposes of section 7704 of the Code.(5)
ii. Funding II. The Operating Partnership owns a
99.8 percent interest in Funding II as a limited partner, while the
remaining 0.2 percent general partner's interest is owned by CRE Management II
Corp., a wholly owned subsidiary of CREE.
The Funding II Agreement provides in Sections 13.1.B and 13.1.D that
the dissolution, insolvency, bankruptcy or other event of withdrawal of the
general partner will cause Funding II to terminate, unless a majority in
interest of the remaining partners consent to continue the partnership and
appoint a new general partner. Accordingly, Funding II lacked the corporate
characteristic of continuity of life.
In addition, the Funding II Agreement provides in Section 11.1.B that
no partner may transfer all or any portion of its interest in the partnership.
Accordingly, Funding II lacked the corporate characteristic of free
transferability of interests.
Based on the continued organization and operation of Funding II in
accordance with its partnership agreement and the Act, Funding II lacked the
corporate characteristics of continuity of life and free transferability of
interests. Accordingly, it is our opinion that Funding II had a reasonable
basis for claiming partnership classification under the Prior Regulations.
Based on the foregoing, it is our opinion that Funding II will be treated as a
partnership as defined in sections 7701(a)(2) and 761(e) of the Code and not as
an association taxable as a corporation for all periods prior to January 1,
1997.
In addition, based upon the structure and capitalization of Funding II
and representations of the Operating Partnership regarding Funding II's current
ownership , it is our opinion that
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Funding II will not constitute a publicly traded partnership for
purposes of section 7704 of the Code.(6)
iii. Funding III, Funding IV and Funding V. The
Operating Partnership owns a 99 percent interest in each of Funding III,
Funding IV and Funding V as a limited partner. Nine Greenway, Ltd. owns a 0.1%
limited partnership interest in each of Funding III, Funding IV and Funding V.
The remaining 0.9 percent general partner's interest in Funding III is owned by
CRE Management III Corp., CRE Management IV Corp. owns a 0.9 percent general
partner interest in Funding IV, and CRE Management V Corp. owns a 0.9 percent
general partner interest in Funding V. CRE Management III Corp., CRE Management
IV Corp. and CRE Management V Corp. are each wholly owned subsidiaries of CREE.
The Funding III Agreement, the Funding IV Agreement and the Funding V Agreement
(together, the "Funding Agreements") are substantially identical with respect
to the terms discussed herein.
Each of the Funding Agreements provides in Paragraph 18 that the
partnership shall dissolve and be wound up upon the occurrence of any of the
following events: (i) the expiration of the term of the partnership on December
31, 2096 (unless terminated earlier); (ii) the sale or disposition of
substantially all of the assets of the partnership; (iii) the written election
of all of the partners to dissolve the partnership; and (iv) unless, the
limited partner elects within ninety days to continue the partnership, upon the
dissolution of the general partner or if the general partner (a) makes a
general assignment for the benefit of creditors, (b) is adjudicated bankrupt or
insolvent, or (c) files a voluntary petition in bankruptcy or in the event
there is an order for relief entered against the general partner under the
Federal Bankruptcy Code of 1978, as amended (or a similar order under a
successor statute). Accordingly, Funding III, Funding IV and Funding V each
lacked the corporate characteristic of continuity of life.
In addition, each of the Funding Agreements provides in Paragraph 14
that no partner may transfer all or any portion of its interest in the
partnership and that any purported transfer of a partnership interest will be
null and void. Accordingly, Funding III, Funding IV and Funding V each lacked
the corporate characteristic of free transferability of interests.
Based on the continued organization and operation of each of Funding
III, Funding IV and Funding V in accordance with its partnership agreement and
the Act, Funding III, Funding IV and Funding V each lacked the corporate
characteristics of continuity of life and free
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April 4, 1997
Page 28
transferability of interests. Accordingly, it is our opinion that Funding III,
Funding IV and Funding V each had a reasonable basis for claiming partnership
classification under the Prior Regulations. Based on the foregoing, it is our
opinion that each will be treated as a partnership as defined in sections
7701(a)(2) and 761(e) of the Code and not as an association taxable as a
corporation for all periods prior to January 1, 1997.
In addition, based upon the structure and capitalization of Funding
III, Funding IV and Funding V and representations of the Operating Partnership
regarding the current ownership of Funding III, Funding IV and Funding V, it
is our opinion that neither Funding III, Funding IV nor Funding V will
constitute a publicly traded partnership for purposes of section 7704 of the
Code.(7)
iv. Funding VI.
The Operating Partnership owns a 99 percent interest in Funding VI as
a limited partner, while the remaining one percent general partner's interest
is owned by CRE Management VI Corp., a wholly owned subsidiary of CREE.
The Funding VI Agreement provides in Section 13.1 that the
dissolution, insolvency, bankruptcy or other event of withdrawal of the general
partner will cause Funding VI to terminate, unless a majority in interest of
the remaining partners consent to continue the partnership and appoint a new
general partner. Accordingly, Funding VI lacked the corporate characteristic of
continuity of life.
In addition, the Funding VI Agreement provides in Section 11.1 that no
partner may transfer all or any portion of its interest in the partnership.
Accordingly, Funding VI lacked the corporate characteristic of free
transferability of interests.
Based on the continued organization and operation of Funding VI in
accordance with its partnership agreement and the Act, Funding VI lacked the
corporate characteristics of continuity of life and free transferability of
interests. Accordingly, it is our opinion that Funding VI had a reasonable
basis for claiming partnership classification under the Prior Regulations.
Based on the foregoing, it is our opinion that Funding VI will be treated as a
partnership as defined in
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April 4, 1997
Page 29
sections 7701(a)(2) and 761(e) of the Code and not as an association taxable as
a corporation for all periods prior to January 1, 1997.
In addition, based upon the structure and capitalization of Funding VI
and representations of the Operating Partnership regarding Funding VI's current
ownership , it is our opinion that Funding VI will not constitute a publicly
traded partnership for purposes of section 7704 of the Code.(8)
v. CresCal. The Operating Partnership owns a 99 percent
interest in CresCal as a limited partner, while the remaining one percent
general partner's interest is owned by CresCal Properties, Inc., a wholly owned
subsidiary of CREE.
The CresCal Agreement provides in Section 15(a) that the dissolution,
insolvency, bankruptcy or other event of withdrawal of the general partner will
cause CresCal to terminate, unless a majority in interest of the remaining
partners consent to continue the partnership and appoint a new general partner.
Accordingly, CresCal lacked the corporate characteristic of continuity of life.
In addition, the CresCal Agreement provides in Section 14 that no
partner may transfer all or any portion of its interest in the partnership.
Accordingly, CresCal lacked the corporate characteristic of free
transferability of interests.
Based on the continued organization and operation of CresCal in
accordance with its partnership agreement and the Act, CresCal lacked the
corporate characteristics of continuity of life and free transferability of
interests. Accordingly, it is our opinion that CresCal had a reasonable basis
for claiming partnership classification under the Prior Regulations. Based on
the foregoing, it is our opinion that CresCal will be treated as a partnership
as defined in sections 7701(a)(2) and 761(e) of the Code and not as an
association taxable as a corporation for all periods prior to January 1, 1997.
In addition, based upon the structure and capitalization of CresCal
and representations of the Operating Partnership regarding CresCal's current
ownership , it is our opinion that CresCal will not constitute a publicly
traded partnership for purposes of section 7704 of the Code.(9)
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Page 30
vi. CresTex. The Operating Partnership owns a 99
percent interest in CresTex, while the remaining one percent interest
is owned by CresCal Properties, Inc. The IRS has applied the same four-factor
test, described above, in determining whether limited liability companies, like
CresTex, which have been formed under the Delaware Limited Liability Company
Act, are treated as partnerships for federal income tax purposes.(10)
As noted above, under section 301.7701-2(b)(3) of the Prior
Regulations, an organization will be treated as possessing the corporate
characteristic of continuity of life, even if the agreement organizing an
entity provides that it is to continue only for a stated period, unless a
member has the power to dissolve the organization at an earlier time. Section
18-801 of the Delaware Limited Liability Company Act provides that a limited
liability company dissolves upon the first to occur of the following: (1) at
the time specified in an LLC agreement or 30 years from the date of formation
of the LLC if no time is set forth in the LLC agreement, (2) upon the happening
of events specified in an LLC agreement, (3) by the written consent of all
members, (4) by the death, retirement, resignation, expulsion, bankruptcy, or
dissolution of a member or the occurrence of any other event which terminates
the continued membership of a member in the LLC, unless the business of the LLC
is continued by the consent of all the remaining members within 90 days
following the occurrence of any terminating event or pursuant to a right to
continue stated in the LLC agreement, or (5) by the entry of a decree of
judicial dissolution under the Delaware Limited Liability Company Act. Section
1.04 of the CresTex Agreement provides that the duration of CresTex is until
the close of business on December 31, 2050, or until its earlier dissolution
upon an "Event of Dissolution" in accordance with Section 12.01 of the CresTex
Agreement. Section 12.01 of the CresTex Agreement provides that CresTex shall
be dissolved prior to December 31, 2050 upon the following "Events of
Dissolution": (1) the mutual consent of all members, (2) the withdrawal, death,
retirement, resignation, expulsion, bankruptcy, legal incapacity or dissolution
of any member, (3) a sale by CresTex of its assets, or (4) a decree of
judicial dissolution. Section 12.05 of the CresTex Agreement, however, provides
that if any Event of Dissolution occurs with respect to CresCal Properties,
Inc., the business of CresTex will be continued if, within ninety days, the
remaining members unanimously decide to continue the business and to approve
the admission of a new member,
<PAGE> 31
Crescent Real Estate Equities Company
April 4, 1997
Page 31
effective immediately before the dissolution event. Accordingly,
CresTex lacked the corporate characteristic of continuity of life.
Section 18-702(a) of the Delaware Limited Liability Company Act
provides, in part, that unless otherwise provided by the company's LLC
agreement, a membership interest is assignable in whole or in part; an
assignment of a member's interest does not entitle the assignee to participate
in the management of the business and affairs of the LLC. Section 18-704(a) of
the Delaware Limited Liability Company Act provides, in part, that an assignee
of a membership interest may become a member if and to the extent that the
company's LLC agreement so provides, or all members consent. Section 10.02 of
the CresTex Agreement provides that no member may withdraw from CresTex or
transfer all or any part of its interest in CresTex and that any purported
transfer of an interest in CresTex shall be null and void. Accordingly, CresTex
lacked the corporate characteristic of free transferability of interests.
In sum, because CresTex lacked the corporate characteristics of
continuity of life and free transferability of interests, it is our opinion
that CresTex had a reasonable basis for claiming partnership classification
under the Prior Regulations. Based on the foregoing, it is our opinion that
CresTex will be treated as a partnership as defined in sections 7701(a)(2) and
761(a) of the Code and not as an association taxable as a corporation for all
periods prior to January 1, 1997.
In addition, based upon the structure and capitalization of CresTex
and representations of the Operating Partnership regarding the current
ownership of CresTex, it is our opinion that CresTex will not constitute a
publicly traded partnership for purposes of section 7704 of the code.(11)
vii. Waterside. The Operating Partnership owns an
89 percent interest in Waterside as a general partner, while the
remaining 11 percent limited partner's interest is owned by Associates (1
percent) and CW #1 Limited Partnership (10 percent).
The Waterside Agreement provides in Section 7.1(c) that the bankruptcy
or other event of withdrawal of the general partner will cause the partnership
to terminate. Accordingly, Waterside lacked the corporate characteristic of
continuity of life.
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Crescent Real Estate Equities Company
April 4, 1997
Page 32
As the general partner of Waterside, the Operating Partnership will be
personally liable for all the debts and obligations of Waterside and, as noted
above, the Operating Partnership will own an 89 percent interest in Waterside.
In addition, the Operating Partnership has represented that it will act
independently of CW #1 Limited Partnership in managing Waterside. Therefore,
Waterside lacked the corporate characteristics of limited liability and
centralization of management.
Based on the continued organization and operation of Waterside in
accordance with its partnership agreement and the Act, Waterside lacked the
corporate characteristics of continuity of life, limited liability and
centralization of management. Accordingly, it is our opinion that Waterside had
a reasonable basis for claiming partnership classification under the Prior
Regulations. Based on the foregoing, it is our opinion that Waterside will be
treated as a partnership as defined in sections 7701(a)(2) and 761(e) and not
as an association taxable as a corporation for all periods prior to January 1,
1997.
In addition, based upon the structure and capitalization of Waterside
and representations of the Operating Partnership regarding Waterside's current
ownership, it is our opinion that Waterside will not constitute a publicly
traded partnership for purposes of section 7704 of the code.(12)
viii. Associates. The Operating Partnership owns a
90 percent interest in Associates, while the remaining 10 percent
interest is owned by CREE, Ltd.. The IRS has applied the same four-factor test,
described above, in determining whether limited liability companies, like
Associates, which have been formed under the Texas Limited Liability Company
Act, are treated as partnerships for federal income tax purposes.(13)
Article 6.01 of the Texas Limited Liability Company Act provides, in
part, that except as otherwise provided in the company's regulations, a limited
liability company shall be dissolved upon the death, retirement, resignation,
expulsion, bankruptcy, or dissolution of a member or the occurrence of any
other event which terminates the continued membership of a member in the
<PAGE> 33
Crescent Real Estate Equities Company
April 4, 1997
Page 33
limited liability company, unless there is at least one remaining member and
the business of the limited liability company is continued by the consent by
the number of members or class thereof stated in the articles of organization
or regulations of the limited liability company or of not so stated, by all
remaining members. Article 2 of the Associates Articles provides that the
duration of Associates is until the close of business on December 31, 2014, or
until its earlier dissolution in accordance with the provisions of the Act or
the Associates Regulations. Article 10.2(a)(iii) of the Associates Regulations
provides, in part, that Associates shall be dissolved upon the withdrawal,
death, retirement, resignation, expulsion, bankruptcy, legal incapacity or
dissolution of any member, unless the business of Associates is continued by
the consent of all the remaining members within ninety days. Accordingly,
Associates lacked the corporate characteristic of continuity of life.
Article 4.05 of the Texas Limited Liability Company Act provides, in
part, that unless otherwise provided by the company's regulations, a membership
interest is assignable in whole or in part; an assignment of a member's
interest does not entitle the assignee to become, or to exercise rights or
powers of a member; and until the assignee becomes a member, the assignor
member continues to be a member and to have the power to exercise any rights or
powers of a member, except to the extent those rights or powers are assigned.
Article 4.07 of the Texas Limited Liability Company Act provides, in part, that
an assignee of a membership interest may become a member if and to the extent
that the company's regulations so provide, or all members consent. Article 9.1
of the Associates Regulations, as amended by the First Amendment to the
Associates Regulations, provides that no member shall have the right to
withdraw from Associates or transfer all or any portion of its interest in
Associates. Accordingly, Associates lacked the corporate characteristic of free
transferability of interests.
In sum, because Associates lacked the corporate characteristics of
continuity of life and free transferability of interests, it is our opinion
that Associates had a reasonable basis for claiming partnership classification
under the Prior Regulations. Based on the foregoing, it is our opinion that
Associates will be treated as a partnership as defined in sections 7701(a)(2)
and 761(a) of the Code and not as an association taxable as a corporation for
all periods prior to January 1, 1997.
In addition, based upon the structure and capitalization of Associates
and representations of the Operating Partnership regarding Associates current
ownership , it is our opinion that Associates will not constitute a publicly
traded partnership for purposes of section 7704 of the code.(14)
<PAGE> 34
Crescent Real Estate Equities Company
April 4, 1997
Page 34
ix. Woodlands Partnership. The Operating
Partnership owns a 75 percent interest in the Woodlands Partnership as
a limited partner, while the remaining 25 percent general partner's interest is
owned by The Woodlands Office Equities, Inc., a wholly owned subsidiary of The
Woodlands Corporation ("TWC Sub").
The Woodlands Partnership Agreement provides in Articles 10.1 and 10.2
that the Woodlands Partnership will terminate upon any event affecting the
general partner that would cause the dissolution of a limited partnership under
the Texas Revised Limited Partnership Act, unless the limited partner consents
to continue the partnership and appoint a new general partner. Accordingly, the
Woodlands Partnership lacked the corporate characteristic of continuity of
life.
Article 7.2.1 of the Woodlands Partnership Agreement provides for
certain circumstances in which a partner may transfer its interest in the
Woodlands Partnership beginning after the eighth anniversary of the
Contribution Date. Article 7.2.2 of the Woodlands Partnership Agreement,
however, provides that a person to whom an interest in the Woodlands
Partnership is transferred shall not be admitted to the Woodlands Partnership
without the prior written consent of the other partner, which consent may be
granted or withheld at the sole discretion of the other partner. Accordingly,
the Woodlands Partnership lacked the corporate characteristic of free
transferability of interests.
As noted above, the general partner of the Woodlands Partnership, TWC
Sub, owns a 25 percent interest in the Woodlands Partnership. Furthermore,
Article 9.3 of the Woodlands Partnership Agreement provides that the limited
partner may not remove TWC Sub as general partner, except upon the occurrence
of specified events of default. Accordingly, the Woodlands Partnership lacked
the corporate characteristic of centralization of management.
In sum, because the Woodlands Partnership lacked the corporate
characteristics of continuity of life, free transferability of interests and
centralization of management, it is our opinion that the Woodlands Partnership
had a reasonable basis for claiming partnership classification under the Prior
Regulations. Based on the foregoing, it is our opinion that the Woodlands
Partnership will be treated as a partnership as defined in sections 7701(a)(2)
and 761(a) of the Code and not as an association taxable as a corporation for
all periods prior to January 1, 1997.
In addition, based upon the structure and capitalization of the
Woodlands Partnership and representations of the Operating Partnership
regarding the current ownership of the Woodlands
<PAGE> 35
Crescent Real Estate Equities Company
April 4, 1997
Page 35
Partnership, it is our opinion that the Woodlands Partnership will not
constitute a publicly traded partnership for purposes of section 7704 of the
code.(15)
x. WRE. The Operating Partnership owns a 75 percent
interest in WRE as a limited partner, while the remaining 25 percent
general partner's interest is owned by The Woodlands Office Equities, Inc., a
wholly owned subsidiary of The Woodlands Corporation ("TWC Sub").
The WRE Agreement provides in Articles 10.1 and 10.2 that WRE will
terminate upon any event affecting the general partner that would cause the
dissolution of a limited partnership under the Texas Revised Limited
Partnership Act, unless the limited partner consents to continue the
partnership and appoint a new general partner. Accordingly, WRE lacked the
corporate characteristic of continuity of life.
Article 7.2.1 of the WRE Agreement provides for certain circumstances
in which a partner may transfer its interest in WRE beginning after the eighth
anniversary of the Contribution Date. Article 7.2.2 of the WRE Agreement,
however, provides that a person to whom an interest in WRE is transferred shall
not be admitted to WRE without the prior written consent of the other partner,
which consent may be granted or withheld at the sole discretion of the other
partner. Accordingly, WRE lacked the corporate characteristic of free
transferability of interests.
As noted above, the general partner of WRE, TWC Sub, owns a 25 percent
interest WRE. Furthermore, Article 9.3 of the WRE Agreement provides that the
limited partner may not remove TWC Sub as general partner, except upon the
occurrence of specified events of default. Accordingly, WRE lacked the
corporate characteristic of centralization of management.
In sum, because WRE lacked the corporate characteristics of continuity
of life, free transferability of interests and centralization of management, it
is our opinion that WRE had a reasonable basis for claiming partnership
classification under the Prior Regulations. Based on the foregoing, it is our
opinion that WRE will be treated as a partnership as defined in sections
7701(a)(2) and 761(a) of the Code and not as an association taxable as a
corporation for all periods prior to January 1, 1997.
<PAGE> 36
Crescent Real Estate Equities Company
April 4, 1997
Page 36
In addition, based upon the structure and capitalization of WRE and
representations of the Operating Partnership regarding the current ownership of
WRE, it is our opinion that WRE will not constitute a publicly traded
partnership for purposes of section 7704 of the Code.(16)
xi. 301 Congress. The Operating Partnership owns a
49 percent limited partner interest in 301 Congress, a Delaware limited
partnership. The one percent general partner interest in 301 Congress
is owned by Crescent/301, a Delaware limited liability company that is wholly
owned by Operating Partnership and CREE, Ltd., and the remaining 50 percent
limited partner interest in 301 Congress is owned by Aetna Life Insurance
Company ("Aetna").
The 301 Congress Partnership Agreement provides in Section 2.6 that
301 Congress will terminate seven years from the effective date of the 301
Congress Partnership Agreement, unless dissolved earlier under Article X of
such agreement. Article X of the 301 Congress Partnership Agreement provides
that 301 Congress will be dissolved upon the first to occur of the following:
(1) the expiration of seven years from the effective date of the 301 Congress
Partnership Agreement; (2) the sale, transfer or other disposition of the 301
Congress assets; (3) the acquisition by one partner of all of the interests in
301 Congress; (4) the occurrence of any "Event of Withdrawal" with respect to
the general partner under the Delaware Limited Partnership Act, unless a
majority of the remaining partners consent within 90 days to continue the
partnership and appoint a new general partner, effective as of the date of the
Event of Withdrawal; (5) the decision of all partners to dissolve 301 Congress;
(6) the election of a non-defaulting partner to dissolve 301 Congress upon a
default of another partner under Section 9.5 of the 301 Congress Partnership
Agreement; or (7) the entry of a judicial decree of dissolution. Accordingly,
301 Congress lacked the corporate characteristic of continuity of life.
Section 9.2 of the 301 Congress Partnership Agreement provides that no
partner shall have the right, without the express written consent of each other
partner, to transfer an interest in 301 Congress Avenue, with the exception of
certain transfers between Aetna, Crescent/301 and the Operating Partnership and
their respective affiliates. However, in the case of transfers between Aetna,
Crescent/301 and the Operating Partnership and their respective affiliates,
Section 9.2 of the 301 Congress Partnership Agreement provides that the
transferee shall not be admitted as a substitute partner without the consent of
all other partners. Accordingly, 301 Congress lacked the corporate
characteristic of free transferability of interests.
<PAGE> 37
Crescent Real Estate Equities Company
April 4, 1997
Page 37
In sum, because 301 Congress lacked the corporate characteristics of
continuity of life and free transferability of interests, it is our opinion
that 301 Congress had a reasonable basis for claiming partnership
classification under the Prior Regulations. Based on the foregoing, it is our
opinion that 301 Congress will be treated as a partnership as defined in
sections 7701(a)(2) and 761(a) of the Code and not as an association taxable as
a corporation for all periods prior to January 1, 1997.
In addition, based upon the structure and capitalization of 301
Congress and representations of the Operating Partnership regarding the current
ownership of 301 Congress , it is our opinion that 301 Congress will not
constitute a publicly traded partnership for purposes of section 7704 of the
code.(17)
xii. Crescent/301. As noted above, the Operating
Partnership owns its general partner interest in 301 Congress through
Crescent/301, a Delaware limited liability company that is wholly owned by
Operating Partnership and CREE, Ltd. The IRS has applied the same four-factor
test, described above, in determining whether limited liability companies, like
Crescent/301, which have been formed under the Delaware Limited Liability
Company Act, are treated as partnerships for federal income tax purposes.(18)
As noted above, under section 301.7701-2(b)(3) of the Prior
Regulations, an organization will be treated as possessing the corporate
characteristic of continuity of life, even if the agreement organizing an
entity provides that it is to continue only for a stated period, unless a
member has the power to dissolve the organization at an earlier time. Section
18-801 of the Delaware Limited Liability Company Act provides that a limited
liability company dissolves upon the first to occur of the following: (1) at
the time specified in an LLC agreement or 30 years from the date of formation
of the LLC if no time is set forth in the LLC agreement, (2) upon the happening
of events specified in an LLC agreement, (3) by the written consent of all
members, (4) by the death, retirement, resignation, expulsion, bankruptcy, or
dissolution of a member or the occurrence of any other event which terminates
the continued membership of a member in
<PAGE> 38
Crescent Real Estate Equities Company
April 4, 1997
Page 38
the LLC, unless the business of the LLC is continued by the consent of all the
remaining members within 90 days following the occurrence of any terminating
event or pursuant to a right to continue stated in the LLC agreement, or (5) by
the entry of a decree of judicial dissolution under the Delaware Limited
Liability Company Act. Section 1.04 of the Crescent/301 Agreement provides that
the duration of Crescent/301 is until the close of business on December 31,
2050, or until its earlier dissolution upon an "Event of Dissolution" in
accordance with Section 12.01 of the Crescent/301 Agreement. Section 12.01 of
the Crescent/301 Agreement provides that Crescent/301 shall be dissolved prior
to December 31, 2050 upon the following "Events of Dissolution": (1) the mutual
consent of all members, (2) the withdrawal, death, retirement, resignation,
expulsion, bankruptcy, legal incapacity or dissolution of any member, (3) a
sale by Crescent/301 of its assets, or (4) a decree of judicial dissolution.
However, Section 12.05 of the Crescent/301 Agreement provides that if any Event
of Dissolution occurs with respect to CREE, Ltd., the business of Crescent/301
will be continued if, within ninety days, the remaining members unanimously
decide to continue the business and to approve the admission of a new member,
effective immediately before the dissolution event. Accordingly, Crescent/301
lacked the corporate characteristic of continuity of life.
Section 18-702(a) of the Delaware Limited Liability Company Act
provides, in part, that unless otherwise provided by the company's LLC
agreement, a membership interest is assignable in whole or in part; an
assignment of a member's interest does not entitle the assignee to participate
in the management of the business and affairs of the LLC. Section 18-704(a) of
the Delaware Limited Liability Company Act provides, in part, that an assignee
of a membership interest may become a member if and to the extent that the
company's LLC agreement so provides, or all members consent. Section 10.02 of
the Crescent/301 Agreement provides that no member may withdraw from
Crescent/301 or transfer all or any part of its interest in Crescent/301 and
that any purported transfer of an interest in Crescent/301 shall be null and
void. Accordingly, Crescent/301 lacked the corporate characteristic of free
transferability of interests.
In sum, because Crescent/301 lacked the corporate characteristics of
continuity of life and free transferability of interests, it is our opinion
that Crescent/301 had a reasonable basis for claiming partnership
classification under the Prior Regulations. Based on the foregoing, it is our
opinion that Crescent/301 will be treated as a partnership as defined in
sections 7701(a)(2) and 761(a) of the Code and not as an association taxable as
a corporation for all periods prior to January 1, 1997.
In addition, based upon the structure and capitalization of
Crescent/301 and representations of the Operating Partnership regarding the
current ownership of Crescent/301 , it is our opinion that Crescent/301 will
not constitute a publicly traded partnership for purposes of section 7704 of
the code.(19)
<PAGE> 39
Crescent Real Estate Equities Company
April 4, 1997
Page 39
xiii. SMA. The Operating Partnership owns an
interest in SMA as a general partner. Section 9.1 of the SMA Agreement
provides that the dissolution or adjudication of bankruptcy or any other
occurrence which would constitute an event of withdrawal by the Operating
Partnership as general partner (or, if there is more than one general partner,
by the last remaining general partner) causes a dissolution of SMA. Section 9.2
of the SMA Agreement provides that in the event of a dissolution under section
9.1, SMA may be reconstituted and its business continued only if Spectrum
Dallas Associates, L.P. ("SDA") and other limited partners with partnership
interests totaling more than 50% of the partnership interests of all limited
partners affirmatively elect to reconstitute SMA, agree on the identity of a
new general partner and execute an instrument affirming such facts.
Accordingly, SMA lacked the corporate characteristic of continuity of life.
The Operating Partnership, as general partner of SMA, owns a large
majority of the partnership interests in SMA and therefore should be viewed as
managing SMA on its own behalf. Moreover, section 7.1 of the SMA Agreement
provides that the limited partners have no power or authority with respect to
SMA except as specifically provided in the SMA Agreement, which does not
provide the limited partners with the power to remove the general partner of
SMA. Therefore, SMA lacked the corporate characteristic of centralization of
management.
As the general partner of SMA, the Operating Partnership will be
personally liable for all the debts and obligations of SMA. Moreover, the
Operating Partnership has substantial assets other than its general partner
interest in SMA. Furthermore, Crescent Equities has represented that the
Operating Partnership will act independently of the limited partners in SMA.
Therefore, SMA lacked the corporate characteristic of limited liability.
In sum, because SMA lacked the corporate characteristics of continuity
of life, centralization of management, and limited liability, it is our opinion
that SMA had a reasonable basis for claiming partnership classification under
the Prior Regulations. Based on the foregoing, it is our opinion that SMA will
be treated as a partnership as defined in sections 7701(a)(2) and 761(a) of the
Code and not as an association taxable as a corporation for all periods prior
to January 1, 1997.
<PAGE> 40
Crescent Real Estate Equities Company
April 4, 1997
Page 40
In addition, based upon the structure and capitalization of SMA and
representations of the Operating Partnership regarding SMA's current ownership,
it is our opinion that sma will not constitute a publicly traded partnership
for purposes of section 7704 of the code.(20)
xiv. CCRH. The Operating Partnership owns a 99.9
percent interest in CCRH as a limited partner, while the remaining 0.1 percent
general partner's interest is owned by Crescent Commercial Realty
Corp., a wholly owned subsidiary of CREE.
The CCRH Agreement provides in Section 15(a) that the dissolution,
insolvency, bankruptcy or other event of withdrawal of the general partner will
cause CCRH to terminate, unless a majority in interest of the remaining
partners consent to continue the partnership and appoint a new general partner.
Accordingly, CCRH lacked the corporate characteristic of continuity of life.
In addition, the CCRH Agreement provides in Section 14 that no partner
may transfer all or any portion of its interest in the partnership.
Accordingly, CCRH lacked the corporate characteristic of free transferability
of interests.
Based on the continued organization and operation of CCRH in
accordance with its partnership agreement and the Act, CCRH lacked the
corporate characteristics of continuity of life and free transferability of
interests. Accordingly, it is our opinion that CCRH had a reasonable basis for
claiming partnership classification under the Prior Regulations. Based on the
foregoing, it is our opinion that CCRH will be treated as a partnership as
defined in sections 7701(a)(2) and 761(e) of the Code and not as an association
taxable as a corporation for all periods prior to January 1, 1997.
In addition, based upon the structure and capitalization of CCRH and
representations of the Operating Partnership regarding CCRH's current
ownership, it is our opinion that CCRH will not constitute a publicly traded
partnership for purposes of section 7704 of the code.(21)
<PAGE> 41
Crescent Real Estate Equities Company
April 4, 1997
Page 41
9. Accuracy of the Matters Described under the Heading "Federal Income
Tax Considerations" in the Prospectus.
It is our opinion that the description of the federal income tax
considerations discussed under the heading "Federal Income Tax Considerations"
in the Prospectus is accurate and fairly summarizes the federal income tax
considerations that are likely to be material to a holder of Common Shares.
III. Additional Limitations
The foregoing opinions are limited to the specific matters covered
thereby and should not be interpreted to imply that the undersigned has offered
its opinion on any other matter. Moreover, Crescent Equities' ability to
achieve and maintain qualification and taxation as a REIT depends upon Crescent
Equities' ability to meet certain diversity of stock ownership requirements
and, through actual annual operating results, certain requirements under the
Code regarding its income, assets and distribution levels. No assurance can be
given that the actual ownership of Crescent Equities' shares and its actual
operating results and distributions for any taxable year will satisfy the tests
necessary to achieve and maintain its status as a REIT.
<PAGE> 42
Crescent Real Estate Equities Company
April 4, 1997
Page 42
IV. Consent to Filing
These opinions are furnished to you solely for use in connection with
the Registration Statement. We hereby consent to the incorporation by reference
of this letter as an exhibit to the Registration Statement and to the use of
our name under the captions "Legal Matters" and "Federal Income Tax
Considerations" in the Prospectus.
Very truly yours,
SHAW, PITTMAN, POTTS & TROWBRIDGE
/s/ CHARLES B. TEMKIN, P.C.
--------------------------------------
By: Charles B. Temkin, P.C.
Attachments
- ---------------------------
(1) Unless otherwise noted, all references to Crescent Equities herein
refer to Crescent Equities and its wholly owned subsidiaries, Crescent
Real Estate Equities, Ltd. ("CREE"), CRE Management I Corp., CRE
Management II Corp., CRE Management III Corp., CRE Management IV
Corp., CRE Management V Corp., CRE Management VI Corp., CresCal
Properties, Inc., and Crescent Commercial Realty Corp.
(2) For purposes of this letter, the term "Residential Development
Properties" will be deemed to include any assets of HBCLP, Inc.
("HBCLP"), unless otherwise noted, and the term "Residential
Development Corporations" will be deemed to include HBCLP, unless
otherwise noted.
(3) For purposes of this letter, the term "Residential Development
Property Mortgages" will be deemed to include the $25,000,000 line of
credit secured by HBCLP, Inc.'s limited partner interest in Hudson Bay
Partners, L.P. (the "HBCLP Note"), unless otherwise noted.
(4) This series of transactions discussed in this paragraph will
hereinafter be referred to as the "Transactions."
(5) For purposes of this opinion, we have assumed that Funding I will
not be treated as having more than four partners (Management II, the
Operating Partnership, Gerald Haddock and CW #1 Limited Partnership)
for purposes of section 1.7704-1(h) of the Treasury Regulations.
Although the Operating Partnership and CW #1 Limited Partnership are
flow-through entities for purposes of section 1.7704-1(h)(3), we have
assumed that the partners in the Operating Partnership and CW #1
Limited Partnership will not be treated as partners in Funding I for
purposes of the 100 partner requirement, based upon your
representation that Funding I will not represent substantially all of
the assets of either the Operating Partnership or CW #1 Limited
Partnership.
(6) For purposes of this opinion, we have assumed that Funding II will
not be treated as having more than two partners (Management II and the
Operating Partnership) for purposes of section 1.7704-1(h) of the
Treasury Regulations. Although the Operating Partnership is a
flow-through entity for purposes of section 1.7704-1(h)(3), we have
assumed that the partners in the Operating Partnership will not be
treated as partners in Funding II for purposes of the 100 partner
requirement, based upon your representation that Funding II will not
represent substantially all of the assets of the Operating
Partnership.
(7) For purposes of this opinion, we have assumed that each of Funding
III, Funding IV and Funding V will be treated as having no more than
three partners for purposes of section 1.7704-1(h) of the Treasury
Regulations. Although the Operating Partnership is a flow-through
entity for purposes of section 1.7704-1(h)(3), we have assumed that
the partners in the Operating Partnership will not be treated as
partners in Funding III, Funding IV or Funding V for purposes of the
100 partner requirement, based upon your representation that neither
Funding III, Funding IV nor Funding V will represent substantially all
of the assets of the Operating Partnership.
(8) For purposes of this opinion, we have assumed that Funding VI will
not be treated as having more than two partners (Management VI and the
Operating Partnership) for purposes of section 1.7704-1(h) of the
Treasury Regulations. Although the Operating Partnership is a
flow-through entity for purposes of section 1.7704-1(h)(3), we have
assumed that the partners in the Operating Partnership will not be
treated as partners in Funding VI for purposes of the 100 partner
requirement, based upon your representation that Funding VI will not
represent substantially all of the assets of the Operating
Partnership.
(9) For the purposes of this opinion we have assumed that CresCal will
not be treated as having more than two partners for purposes of
section 1.7704-1(h) of the Treasury Regulation (CresCal Properties,
Inc. and Crescent Real Estate Equities Limited Partnership (the
"Operating Partnership")). Although the Operating Partnership is a
flow-through entity for purposes of section 1.7704-1(h)(2), we have
assumed that the partners in the Operating Partnership will not be
treated as partners in CresCal for purposes of the 100 partner
requirement, based upon your representation that CresCal will not
represent substantially all of the assets of the Operating
Partnership.
(10) See, e.g., Rev. Rul. 93-38, 1993-21 I.R.B. 4, P.L.R. 9602012
(October 6, 1995) and P.L.R. 9507004 (November 8, 1994).
(11) For purposes of this opinion, we have assumed that CresTex will
not be treated as having more than two partners for purposes of
section 1.7704-1(h) of the Treasury Regulations (CresCal Properties,
Inc. and the Operating Partnership). Although the Operating
Partnership is a flow-through entity for purposes of section
1.7704-1(h)(3), we have assumed that the partners in the Operating
Partnership will not be treated as members of CresTex for purposes of
the 100 partner requirement, based upon your representation that
CresTex will not represent substantially all of the assets of the
Operating Partnership.
(12) For purposes of this opinion, we have assumed that Waterside will
not be treated as having more than three partners (CW #1 Limited
Partnership, CREE, Ltd. and the Operating Partnership) for purposes of
section 1.7704-1(h) of the Treasury Regulations. Although the
Operating Partnership and CW #1 Limited Partnership are flow-through
entities for purposes of section 1.7704-1(h)(3), we have assumed that
the partners in the Operating Partnership and CW #1 Limited
Partnership will not be treated as partners in Waterside for purposes
of the 100 partner requirement, based upon your representation that
Waterside will not represent substantially all of the assets of either
the Operating Partnership or CW #1 Limited Partnership.
(13) See, e.g., P.L.R. 9242025 (July 22, 1992) and P.L.R. 9218078
(January 31, 1992).
(14) For purposes of this opinion, we have assumed that Associates
will not be treated as having more than two partners for purposes of
section 1.7704-1(h) of the Treasury Regulations (CREE, Ltd. and the
Operating Partnership). Although the Operating Partnership is a
flow-through entity for purposes of section 1.7704-1(h)(3), we have
assumed that the partners in the Operating Partnership will not be
treated as partners in Associates for purposes of the 100 partner
requirement, based upon your representation that Associates will not
represent substantially all of the assets of the Operating
Partnership.
(15) For purposes of this opinion, we have assumed that the Woodlands
Partnership will not be treated as having more than two partners (TWC
Sub and the Operating Partnership) for purposes of section 1.7704-1(h)
of the Treasury Regulations. Although the Operating Partnership is a
flow-through entity for purposes of section 1.7704-1(h)(3), we have
assumed that the partners in the Operating Partnership will not be
treated as partners in the Woodlands Partnership for purposes of the
100 partner requirement, based upon your representation that the
Woodlands Partnership will not represent substantially all of the
assets of the Operating Partnership.
(16) For purposes of this opinion, we have assumed that WRE will not
be treated as having more than two partners (TWC Sub and the Operating
Partnership) for purposes of section 1.7704-1(h) of the Treasury
Regulations. Although the Operating Partnership is a flow-through
entity for purposes of section 1.7704-1(h)(3), we have assumed that
the partners in the Operating Partnership will not be treated as
partners in WRE for purposes of the 100 partner requirement, based
upon your representation that WRE will not represent substantially all
of the assets of the Operating Partnership.
(17) For purposes of this opinion, we have assumed that 301 Congress
will not be treated as having more than three partners (CREE, Ltd.,
the Operating Partnership and Aetna) for purposes of section
1.7704-1(h) of the Treasury Regulations. Although the Crescent/301 is
a flow-through entity for purposes of section 1.7704-1(h)(3), we have
treated Crescent/301 as having only two members, CREE, Ltd. and the
Operating Partnership. The partners in the Operating Partnership will
not be treated as members of Crescent/301 for purposes of the 100
partner requirement, based upon your representation that the Operating
Partnership's investment in 301 Congress, through Crescent/301, will
not represent substantially all of the assets of the Operating
Partnership.
(18) See, e.g., Rev. Rul. 93-38, 1993-21 I.R.B. 4, P.L.R. 9602012
(October 6, 1995) and P.L.R. 9507004 (November 8, 1994).
(19) For purposes of this opinion, we have assumed that Crescent/301
will not be treated as having more than two partners for purposes of
section 1.7704-1(h) of the Treasury Regulations (CREE, Ltd. and the
Operating Partnership). Although the Operating Partnership is a
flow-through entity for purposes of section 1.7704-1(h)(3), we have
assumed that the partners in the Operating Partnership will not be
treated as members of Crescent/301 for purposes of the 100 partner
requirement, based upon your representation that Crescent/301 will not
represent substantially all of the assets of the Operating
Partnership.
(20) For purposes of this opinion, we have assumed that SMA will not
be treated as having more than eighty partners for purposes of section
1.7704-1(h) of the Treasury Regulations. Although the Operating
Partnership is a flow-through entity for purposes of section
1.7704-1(h)(3), we have assumed that the partners in the Operating
Partnership will not be treated as members of SMA for purposes of the
100 partner requirement, based upon your representation that SMA will
not represent substantially all of the assets of the Operating
Partnership.
(21) For the purposes of this opinion we have assumed that CCRH will
not be treated as having more than two partners for purposes of
section 1.7704-1(h) of the Treasury Regulation (Crescent Commercial
Realty Corp., Inc. and Crescent Real Estate Equities Limited
Partnership (the "Operating Partnership")). Although the Operating
Partnership is a flow-through entity for purposes of section
1.7704-1(h)(2), we have assumed that the partners in the Operating
Partnership will not be treated as partners in CCRH for purposes of
the 100 partner requirement, based upon your representation that CCRH
will not represent substantially all of the assets of the Operating
Partnership.
<PAGE> 43
MEMORANDUM
TO: David Dean
FROM: Charles B. Temkin
Michael A. Jacobs
DATE: January 3, 1995
RE: Characterization of Income Derived from Hyatt Regency Beaver
Creek
I. OVERVIEW
Crescent Real Estate Equities Limited Partnership (the "Operating
Partnership") is about to purchase the Hyatt Regency Beaver Creek (the "Hotel
Property") from East West Properties (the "Current Owner"). Crescent Real
Estate Equities, Inc. (the "Company") is currently the sole shareholder of two
corporations, one of which is the sole general partner of and one of which is a
limited partner of the Operating Partnership. These two corporations
constitute qualified REIT subsidiaries within the meaning of section 856(i).(1)
This memorandum analyzes the impact that a purchase of the Hotel
Property will have on the ability of the Company to continue to qualify as a
real estate investment trust (a "REIT") under section 856(c). More
specifically, it analyzes whether the income the Operating Partnership will
derive from the Hotel Property will be treated as "qualifying income" for
purposes of the 75 percent and 95 percent gross income tests for REIT
qualification. This memorandum concludes that, subject to certain assumptions,
in our opinion (i) all of the income that the Operating Partnership derives
from the Hotel Property will be treated as "qualifying income" for purposes of
the 95 percent test and (ii) all of the income the Operating Partnership
derives from the Hotel Property, with the exception of certain interest income,
will be treated as "qualifying income" for purposes of the 75 percent test.
II. FACTS AND ASSUMPTIONS
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(1) All section references herein are to the Internal Revenue Code of 1986, as
amended (the "Code"), or to the regulations issued thereunder, unless otherwise
noted.
<PAGE> 44
The Current Owner has contracted with Hyatt Corporation ("Hyatt") to
operate the Hotel Property. Under the terms of the agreement between the
Current Owner and Hyatt dated December 11, 1987, as amended on September 12,
1988, February 15, 1990 and October 1, 1994 (the "Management Agreement"), Hyatt
is obligated to provide all services in relation to the operation of the Hotel
Property and collect all hotel receipts. In exchange for these services, Hyatt
is reimbursed for the costs of operating the Hotel Property and paid a
management fee. This fee is paid out of hotel receipts; it is based in part on
the gross hotel receipts and in part on the profits, if any, from operation of
the Hotel Property.
Section 15.2 of the Management Agreement requires that all
assignments of the Management Agreement be approved by Hyatt and that any
assignees expressly assume the obligations of the Current Owner under the
Management Agreement. Therefore, in connection with its purchase of the Hotel
Property, the Operating Partnership will assume all of the obligations of the
Current Owner under the Management Agreement.
When the Operating Partnership purchases the Hotel Property, it will
immediately lease it to Mogul Management LLC ("Mogul") pursuant to a Lease
Agreement dated January 3, 1995 (the "Lease"). Pursuant to Article 2 of the
Lease, the Operating Partnership will assign its interest in the Management
Agreement to Mogul; and pursuant to Section 15.2 of the Management Agreement,
Mogul will assume all of the Operating Partnership's obligations thereunder.
However, as a condition of its approval of the Lease, Hyatt will require that
the Operating Partnership remain liable for all obligations of the Operating
Partnership under the Management Agreement assumed by Mogul.
Currently, Walter P. Sprunt and Richard W. Adkisson each own a 45.5
percent interest in the assets and net profits of Mogul, while Gerald W.
Haddock and John C. Goff, the managers of Mogul, each own a 4.5 percent
interest in its assets and net profits.
For purposes of this memorandum, we have examined and relied upon (1)
the Management Agreement, (2) the Lease, (3) the Articles of Organization of
Mogul Management LLC (the "Mogul Articles"), (4) the Regulations of Mogul
Management LLC (the "Mogul Regulations"), (5) the First Amended and Restated
Articles of Incorporation of Crescent Real Estate Equities, Inc. (the "Crescent
Articles"), (6) the Contract of Sale between the Current Owner and the
Operating Partnership, (7) the Consent and Assumption Agreement between Hyatt
and the Operating Partnership, and (8) such other documents or information as
we deemed necessary for the opinions set forth below. In our examination, we
have assumed the genuineness of all signatures, the legal capacity of natural
persons, the authenticity of all documents submitted to us as originals, the
conformity to original documents of all documents submitted to us as certified
or photostatic copies, and the authenticity of the originals of such copies.
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<PAGE> 45
This memorandum is based upon existing provisions of the Code,
Treasury regulations, and the reported interpretations thereof by the Internal
Revenue Service ("IRS") and by the courts in effect (or, in the case of certain
proposed regulations, proposed) as of the date hereof, all of which are subject
to change, both retroactively or prospectively, and to possibly different
interpretations. We assume no obligation to update the opinions set forth in
this memorandum. We believe that the conclusions expressed herein, if
challenged by the IRS, would be sustained in court. However, because our
opinions are not binding upon the IRS or the courts, there can be no assurance
that contrary positions may not be successfully asserted by the IRS.
In addition, this memorandum is based on various assumptions and is
conditioned upon certain representations made by the Operating Partnership and
its sole general partner, Crescent Real Estate Equities, Ltd., as to factual
and other matters as set forth in the attached letter.
III. LEGAL BACKGROUND
A. 75 Percent and 95 Percent Tests
In order to qualify as a REIT for tax purposes, the Company must
satisfy certain tests with respect to the composition of its gross income on an
annual basis. First, at least 75 percent of the Company's gross income
(excluding gross income from certain prohibited transactions) for each taxable
year must consist of temporary investment income or of certain defined
categories of income derived directly or indirectly from investments relating
to real property or mortgages on real property. These categories include,
subject to various limitations, rents from real property, interest on mortgages
on real property, gains from the sale or other disposition of real property
(including interests in real property and mortgages on real property) not
primarily held for sale to customers in the ordinary course of business, income
from foreclosure property, and amounts received as consideration for entering
into either loans secured by real property or purchases or leases of real
property.(2) Second, at least 95 percent of the Company's gross income
(excluding gross income from certain prohibited transactions) for each taxable
year must be derived from income qualifying under the 75 percent test and from
dividends, other types of interest and gain from the sale or disposition of
stock or securities, or from any combination of the foregoing.(3)
In applying these income tests, REITs that are partners in a
partnership are required to include in their gross income their proportionate
share of the partnership's gross income. In addition, such REITs are to treat
this partnership gross income as retaining the same character as the items of
gross income of the partnership for purposes of section 856.(4) Thus, the
character of any
- ----------------------------------
(2) Section 856(c)(3).
(3) Section 856(c)(2).
(4) Treas. Reg. Section 1.856-3(g).
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<PAGE> 46
income derived by the Operating Partnership from the Hotel Property will affect
the ability of the Company to qualify as a REIT.
B. Rents from Real Property
Rents from real property satisfy both the 75 percent and 95 percent
tests for REIT qualification only if several conditions are met. First, the
amount of rent must not be based in whole or in part on the income or profits
of any person. An amount received or accrued generally will not be excluded
from the term "rents from real property" solely by reason of being based on a
fixed percentage or percentages of receipts or sales.(5) Second, the Code
provides that rents received from a tenant will not qualify as "rents from real
property" if the REIT, or an owner of 10 percent or more of the REIT, directly
or constructively, owns 10 percent or more of such tenant (a "Related Party
Tenant").(6) Third, if rent attributable to personal property leased in
connection with a lease of real property is greater than 15 percent of the
total rent received under the lease, then the portion of rent attributable to
such personal property will not qualify as "rents from real property."(7)
Finally, for rents to qualify as "rents from real property," a REIT 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 REIT derives no revenue. However, rents will be qualified as "rents
from real property" if a REIT directly performs services in connection with the
lease of the property, if those services are "usually or customarily rendered"
in connection with the rental of space for occupancy, and such services are not
considered to be rendered to the occupant of the property.(8)
C. Income from Foreclosure Property
Income from foreclosure property is treated as "qualifying income" for
purposes of the 75 percent and 95 percent tests (although any net income from
foreclosure property is taxed at the maximum corporate rate). Foreclosure
property is any real property, and any personal property incident to such real
property, acquired by a REIT through default under a mortgage or a lease. A
REIT may elect to treat such property as foreclosure property for a grace
period of up to two years.(9) However, such property will cease to qualify as
foreclosure property if it is used by the REIT in a trade or business more than
90 days after it is acquired and it is not operated through
- ----------------------------------
(5) Section 856(d)(2)(A).
(6) Section 856(d)(2)(B).
(7) Section 856(d)(1)(C).
(8) Sections 856(d)(1)(B), 856(d)(2)(C).
(9) Section 856(e).
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<PAGE> 47
an independent contractor from whom the REIT does not derive or receive any
income.(10) Moreover, property is not eligible to be treated as foreclosure
property if the lease is entered into with an intent to evict or foreclose, or
if the REIT knows or has reason to know that default would occur.(11)
I. DISCUSSION
A. Lease Will be Treated as a Lease for Federal Income Tax Purposes
In order for any income derived by the Operating Partnership from the
Hotel Property to constitute either "rents from real property," or in the case
of a default under the Lease, "gross income from foreclosure property," the
Lease must be treated as a lease for federal income tax purposes and not be
treated as a service contract, management contract or other type of
arrangement. This determination depends on an analysis of all the surrounding
facts and circumstances. In making this determination, courts have considered
a variety of factors, including the following: (i) the intent of the parties,
(ii) the form of the agreement, (iii) the degree of control over the business
conducted at the property that is provided to the lessee (e.g., whether the
lessee has substantial rights of control over the operation of the property and
its business), (iv) the extent to which the lessee has the risk of loss from
operations of the business conducted as the property (e.g., whether the lessee
bears the risk of increases in operating expenses and of decreases in
revenues), and (v) the extent to which the lessee has the opportunity to
benefit from operations of the business conducted at the property (e.g.,
whether the lessee benefits from decreased operating expenses or increased
revenues).(12)
In addition, section 7701(e) provides that a contract that purports to
be a service contract, partnership agreement, or another type of arrangement
will be 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 any savings
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
- ----------------------------------
(10) Section 856(e)(4).
(11) Treas. Reg. Section 1.856-6(b)(3).
(12) See, e.g., Xerox Corp. v. U.S., 80-2 USTC Paragraph 9530 (Ct. Cl. Tr. Div.
1980), aff'd per curiam, 656 F.2d 659 (Ct. Cl. 1981).
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<PAGE> 48
services to entities unrelated 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, partnership agreement, or some other type of arrangement should be
treated as a lease is inherently factual, the presence or absence of any single
factor may not be dispositive in every case.(13)
We have concluded that the Lease will be treated as a lease for
Federal income tax purposes, rather than a service contract, management
contract or other type of arrangement. This conclusion is based, in part, on
the following facts: (i) the Operating Partnership and Mogul intend their
relationship to be that of lessor and lessee (as evidenced by the terms of the
Lease), (ii) Mogul will have the right to exclusive possession, use and quiet
enjoyment of the Hotel Property during the term of the Lease and the right to
uninterrupted control in the operation of and business conducted at the Hotel
Property (subject to its assumption of the Management Agreement), (iii) Mogul
will bear the cost of, and be responsible for, capital expenditures, including
maintenance and repair of the Hotel Property, and will dictate how the Hotel
Property is maintained and improved, (iv) Mogul will bear all the costs and
expenses of operating the Hotel Property, (v) Mogul will benefit from any
savings in the costs of operating the Hotel Property during the term of the
Lease, (vi) in the event of damage or destruction to the Hotel Property, Mogul
will be at economic risk because its obligation to make rental payments will
not abate, (vii) Mogul will indemnify the Operating Partnership against all
liabilities imposed on the Operating Partnership during the term of the Lease
by reason of injury to persons or damage to property occurring at the Hotel
Property or Mogul's use, management, maintenance or repair of the Hotel
Property, (viii) Mogul is obligated to pay substantial fixed rent for the
period of use of the Hotel Property, regardless of whether its revenues exceed
its costs and expenses, and (ix) Mogul stands to incur substantial losses (or
derive substantial profits) depending on how successfully it operates the Hotel
Property.
We do not believe that our conclusion that the Lease of the Hotel
Property will be treated as a lease for Federal income tax purposes is affected
by the fact that Mogul will enter the Lease subject to its assumption of the
Operating Partnership's obligations under the preexisting Management Agreement.
The Management Agreement gives Hyatt control over the day-to-day operation of
the Hotel Property and will allow Hyatt to share with Mogul in the benefits of
any increases in revenues or cost savings in the operation of the Hotel
Property. However, Hyatt's operation of the Hotel Property will not be
controlled by the Operating Partnership, and the Management Agreement does not
affect the fact that Mogul bears most of the risk of loss if the Hotel Property
is not successful. Moreover, the IRS has issued a private letter ruling in
which it treated leases of several hotel properties as producing "rents from
real property" in a situation where the lessees had contracted with a third
party to conduct the day-to-day operations of the hotels.(14) This ruling
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(13) P.L.R. 8918012 (January 24, 1989).
(14) See, P.L.R. 8117036 (January 27, 1981).
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<PAGE> 49
suggests that the IRS will respect a lease of a hotel for federal income tax
purposes even if the hotel is operated by an independent contractor rather than
by the lessee.
B. Percentage Rent Provision is not Profit-Based
Pursuant to the Lease, Mogul will be obligated to pay the Operating
Partnership base rent and percentage rent. Under the regulations, percentage
rent based on a percentage of gross receipts or sales in excess of a floor
amount, which is how the percentage rent is structured under the Lease, will
not qualify as "rents from real property" unless (i) such floor amount does
not depend in whole or in part on the income or profits of the lessee, (ii) the
percentage and the floor amount are fixed at the time the lease is entered
into, (iii) the percentage and the floor amount are not renegotiated during the
term of the lease in a manner that has the effect of basing the percentage rent
on income or profits, and (iv) the percentage and the floor amount conform with
normal business practice.(15)
Under the terms of Article 4.2 of the Lease, Mogul will pay percentage
rent equal on an annual basis to the sum of (i) 17.5 percent of the excess of
annual gross receipts from room rentals over $9,300,000 and (ii) 2.5 percent of
the excess of annual gross receipts from the food and beverage facilities at
the Hotel Property over $3,000,000. This formula will effectively reward Mogul
for any increases in gross receipts from rooms and from other sources over the
threshold amounts. This type of formula does not base the percentage rent on
Mogul's income or profits, and similar formulas have been treated by the IRS as
generating "rents from real property."(16) Moreover, the Operating Partnership
has represented that (i) the floor amounts used to compute the percentage rent
under the Lease will not depend in whole or in part on the income or profits of
any person, (ii) the percentage rent provision of the Lease will not be
renegotiated during the term of the Lease or at the expiration or earlier
termination of the Lease in a manner that has the effect of basing the rent on
income or profits, and (iii) the percentage rent provision of the Lease
conforms with normal business practice. In addition, based on our experience
and an examination of the Lease and the Hotel Property projections, the Lease
appears to conform with normal business practice.
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(15) Treas. Reg. Section 1.866-4(b)(3).
(16) See, e.g., P.L.R. 8803007 (September 23, 1987) (percentage rent based on
gross revenues in excess of gross revenues for a base year treated as "rents
from real property"); cf. P.L.R. 9104018 (October 26, 1990) (interest based on
gross revenues in excess of a floor amount treated as qualifying interest under
section 856(f)).
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<PAGE> 50
C. Mogul is not a "Related Party Tenant"
Rents received from Mogul will not qualify as "rents from real
property" if Mogul is a "related party tenant." Mogul will be a "related party
tenant" if the Company, or an owner of 10 percent or more of the Company,
directly or constructively owns 10 percent or more of the assets or net profits
of Mogul.(17) Constructive ownership is determined for purposes of this test
by applying the rules of section 318(a) as modified by section 856(d)(5).
Those rules generally provide that if 10 percent 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.
Mogul will not be treated as a "related party tenant" because two
individuals, Walter P. Sprunt and Richard W. Adkisson, currently each own a
45.5 percent interest in its assets and net profits. In reaching this
conclusion we recognize that Mr. Sprunt and Mr. Adkisson are the owners of
Greenbriar Associates, Inc., which is a 10 percent member of G/C Waterside
Associates, LLC, which is a 1 percent partner of Waterside Commons Limited
Partnership, a partnership whose 89 percent partner is the Operating
Partnership.(18) The Operating Partnership has represented that (i) neither
Mr. Sprunt nor Mr. Adkisson owns more than 10 percent of the value of the
Company's stock, (ii) neither Mr. Sprunt nor Mr. Adkisson is expected to own
more than 10 percent of the value of the Company's stock in the future and
(iii) neither the Operating Partnership nor the Company intends to acquire,
directly or constructively, an interest of 10 percent or more in the assets or
net profits of Mogul at any time in the future. Moreover, Article 37.5 of the
Lease limits the ability of Mogul and its members and managers to acquire,
directly or constructively, a 10 percent stock interest in the Company, and
Section 6.4 of the First Amended and Restated Articles of Incorporation of the
Company prevents Mogul and its members and managers from acquiring more than 8
percent of the Company's stock.
The conclusion that Mogul will not be treated as a "related party
tenant" is based on the assumption that Mogul will be treated as a partnership
for federal income tax purposes. If Mogul is not treated as a partnership for
federal income tax purposes, but is instead treated as an association taxable
as a corporation, then it is likely that Mogul will be treated as a "related
party tenant" and the rents derived under the terms of the Lease will not be
treated as "rents from real property." This is because, if Mogul were treated
as a corporation for federal income tax purposes, Gerald W. Haddock and John C.
Goff would likely be deemed to own all of its voting stock, because of the
extensive powers that they are granted as managers under the Mogul
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(17) Section 856(d)(2)(B)(ii).
(18) See Rev. Rul. 73-194, 1973-1 C.B. 355 (management company treated as an
independent contractor with respect to a REIT, where an affiliate of the
management company and the REIT were partners).
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<PAGE> 51
Regulations. If this were the case, the ownership of such voting stock would
be attributed to the Company under the constructive ownership rules described
above.(19)
An entity which has associates and an objective to carry on a business
for joint profit will be treated as a partnership for federal income tax
purposes, and not as an association taxable as a corporation, if it has not
more than two of the following four characteristics of a corporation: (i)
continuity of life; (ii) centralization of management; (iii) limited liability;
and (iv) free transferability of interests.(20) The entity must also have no
other characteristics which are significant in determining its classification.
Generally, other factors are considered only insofar as they relate to the
determination of the presence or absence of the foregoing corporate
characteristics.(21) The IRS has applied this four-factor test in determining
whether limited liability companies formed under the Texas Limited Liability
Company Act (the "Act") are partnerships for federal income tax purposes.(22)
The IRS has issued Rev. Proc. 95-10, which specifies conditions which
must be satisfied for a limited liability company to receive a favorable
advanced ruling that it will be classified as a partnership for federal income
tax purposes.(23) Mogul should satisfy these conditions. However, such
conditions are applicable only in determining whether rulings will be issued
and are not intended as substantive rules for determination of partnership
status.
An organization will be treated as possessing the corporate
characteristic of continuity of life, even if the agreement organizing an
entity provides that it is to continue only for a stated period, unless a
member has the power to dissolve the organization at an earlier time.(24)
Article 6.01 of the Act provides, in part, that except as otherwise provided in
the company's regulations, a limited liability company shall be dissolved upon
the death, retirement, resignation, expulsion,
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(19) Richard Rainwater, Gerald Haddock and John Goff are each partners in
FW-Irving Partners, Ltd. (and apparently they are partners in other
partnerships as well). Richard Rainwater also owns more than 10 percent of the
value of the stock of the Company. Thus, assuming that the ownership interests
in Mogul held by Gerald Haddock and John Goff constitute stock, such interests,
along with Richard Rainwater's stock interest in the Company, will be
attributed to FW-Irving Partners, Ltd. pursuant to section 318(a)(3)(A), which
provides that stock owned, directly or indirectly, by or for a partners shall
be considered as owned by the partnership. Then, FW-Irving Partners, Ltd.'s
deemed interest in Mogul would be attributed to the Company pursuant to section
318(a)(3)(C) (as modified by section 856(d)(5)), which provides that stock
owned by any person that owns 10 percent or more of the value of the stock in a
corporation shall be considered owned by the corporation.
(20) Treas. Reg. Section 301.7701-2(a).
(21) See Rev. Rul. 79-106, 1979-1 C.B. 448.
(22) See, e.g., P.L.R. 9242025 (July 22, 1992) and P.L.R. 9218078 (January 31,
1992).
(23) 1995-3 I.R.B [ ] .
(24) Treas. Reg. Section 301.7701-2(b)(3).
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<PAGE> 52
bankruptcy, or dissolution of a member or the occurrence of any other event
which terminates the continued membership of a member in the limited liability
company, unless there is at least one remaining member and the business of the
limited liability company is continued by the consent by the number of members
or class thereof stated in the articles of organization or regulations of the
limited liability company or of not so stated, by all remaining members.
Article 2 of the Mogul Articles provides that the duration of Mogul is until
the close of business on December 31, 2015, or until its earlier dissolution in
accordance with the provisions of the Act or the Regulations. Article 10.2 of
the Mogul Regulations provides, in part, that Mogul shall be dissolved upon the
withdrawal, death, retirement, resignation, expulsion, bankruptcy, legal
incapacity or dissolution of any member, unless the business of Mogul is
continued by the consent of all the remaining members within ninety days.
Accordingly, Mogul will lack the corporate characteristic of continuity of
life.
An organization will be treated as possessing the corporate
characteristic of free transferability of interests if the members owning all
or substantially all of the interests in an organization may substitute for
themselves without the consent of the other members a person who is not a
member of the organization.(25) Article 4.05 of the Act provides, in part,
that unless otherwise provided by the company's regulations, a membership
interest is assignable in whole or in part; an assignment of a member's
interest does not entitle the assignee to become, or to exercise rights or
powers of a member; and until the assignee becomes a member, the assignor
member continues to be a member and to have the power to exercise any rights or
powers of a member, except to the extent those rights or powers are assigned.
Article 4.07 of the Act provides, in part, that an assignee of a membership
interest may become a member if and to the extent that the company's
regulations so provide, or all members consent. Article 9.3 of the Mogul
Regulations provides, in part, that no member shall have the right to
substitute in its place a transferee unless consent is given by the Managers
and a majority of the other members, which consent may be withheld in the
discretion of the Managers or the other members. Accordingly, Mogul will lack
the corporate characteristic of free transferability of interests. Because
Mogul will lack the corporate characteristics of continuity of life and free
transferability of interests, it will be treated as partnership for federal
income tax purposes.
D. Incidental Personal Property
1. Rents Attributable to Personal Property Will Be Treated as
"Rents from Real Property"
As noted above, the rents attributable to the Operating Partnership's
personal property leased under or in connection with the Lease must not be
greater than 15 percent of the rents received under the Lease. The rent
attributable to personal property leased under or in connection with a lease of
real property is the amount that bears the same ratio to total rent for the
taxable
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(25) Treas. Reg. Section 301.7701-2(e).
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<PAGE> 53
year as (i) the average of the adjusted bases of the personal property leased
under or in connection with a lease of real property at the beginning and at
the end of the taxable year bears to (ii) the average of the aggregate adjusted
bases of the real and personal property subject to the lease at the beginning
and at the end of such taxable year (the "Adjusted Basis Ratio").(26) The
Operating Partnership has represented that the adjusted tax basis of the
personal property leased under or in connection with the Lease will not
represent more than 15 percent of the aggregate adjusted tax basis of the Hotel
Property at any time.
2. Payments Attributable to Mogul's Acquisition of Certain
Personal Property Will Not Be Treated as "Rents from Real
Property"
Article 4.7 of the Lease provides that Mogul will be deemed to have
acquired all of the furniture, fixtures and operating equipment associated with
the Hotel Property (the "FF & E") with the proceeds of a loan from the
Operating Partnership. It further provides that Mogul is to make payments of
principal and interest on this deemed loan.
The payments that the Operating Partnership receives with regard to
the FF & E under the terms of Article 4.7 of the Lease will not qualify as
"rents from real property." Instead, such payments will be treated for federal
income tax purposes as payments of principal and interest resulting from the
Operating Partnership's deemed financing of Mogul's purchase of the FF & E. In
reaching this conclusion we have relied on the representations of the Operating
Partnership that (i) the useful life of the FF & E will be less than the term
of the Lease, (ii) the residual value of the FF & E at the end of the term of
the Lease will generally be less than 20 percent of the value of the FF & E at
the beginning of the term of the Lease, and (iii) the Operating Partnership and
Mogul will treat Mogul as the owner of the FF & E for federal income tax
purposes.
The payments pursuant to this "deemed financing," to the extent they
constitute interest, will be "qualifying income" for purposes of the 75 percent
test. However, because the deemed financing will be secured by personal,
rather than real property, such interest will not be qualifying income for
purposes of the 95 percent test.
E. Provision of Services by the Operating Partnership
1. Income Derived under the Terms of the Lease
Although the Operating Partnership may treat charges for services
customarily furnished or rendered in connection with the rental of the Hotel
Property as "rents from real property," any services rendered to the occupants
of the Hotel Property must be furnished or rendered by an
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(26) Section 856(d)(1)(C).
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<PAGE> 54
independent contractor from whom the Company does not derive or receive any
income.(27) Moreover, to the extent that any independent contractors provide
noncustomary services to the occupants of the Hotel Property, the cost of such
services must not be borne by the Operating Partnership.(28)
Under the terms of the Lease, the Operating Partnership will not be
required to provide any services, customary or noncustomary, in connection with
the rental of the Hotel Property. Instead, all services relating to the
operation of the Hotel Property will be provided by Hyatt under the terms of
the Management Agreement. The Operating Partnership has represented that Hyatt
is an independent contractor within the meaning of section 856(d)(3), from
which the Company and the Operating Partnership will not derive or receive any
income. The Operating Partnership will not bear the cost of any of the
services provided by Hyatt. Instead, such costs will be borne by Mogul when it
assumes the Operating Partnership's Obligations under the Management Agreement.
Based on the foregoing, we believe that the provision of any
noncustomary services to the occupants of the Hotel Property by Hyatt will have
no effect on the qualification of the income derived from the Hotel Property as
"rents from real property." In fact, the IRS has issued a private letter
ruling in which it has treated the income derived from several leases of hotel
properties as "rents from real property" in a situation where the lessees had
contracted with a third-party to conduct the day to day operations of the
hotels.(29) Our conclusion is not altered by the fact that the Operating
Partnership will remain liable for any obligations arising under the Management
Agreement, to the extent that they are not satisfied by the Tenant. The
Operating Partnership should not be treated as bearing the cost of the services
provided by Hyatt merely because it is liable for Mogul's obligations under the
Management Agreement. The Operating Partnership is not retaining this liability
in an attempt to provide services to Mogul. Instead, it is retaining this
liability only as an accommodation, in order to gain Hyatt's consent to its
purchase of the Hotel Property. Moreover, the Operating Partnership believes
that it is highly unlikely that it will ever be required to reimburse Hyatt for
the costs and expenses of operating the Hotel Property. This is because (i)
the Hotel Property is projected to generate enough gross income to cover the
payments to Hyatt under the Management Agreement, (ii) in connection with the
Lease, Mogul will represent that it has a net worth of at least $400,000 , and
(iii) in the view of the Operating Partnership, Mogul's capitalization is
adequate to allow Mogul to assume Mogul's obligations under the Lease.
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(27) Sections 856(d)(1), 856(d)(2)(C); Treas. Reg. Section 1.512(b)-1(c)(5).
(28) Treas. Reg. Section 1.856-4(b)(5).
(29) See, P.L.R. 8117036 (January 27, 1981).
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<PAGE> 55
2. Income Derived in the Case of a Default under the Lease
If the Operating Partnership were required to reimburse Hyatt for the
costs of operating the Hotel Property because of a default by Mogul under the
terms of the Management Agreement, we have concluded that the income derived by
the Operating Partnership from the Hotel Property would be treated as
"qualifying income" for purposes of the 75 percent and 95 percent tests. This
is because, if the Operating Partnership were required to reimburse Hyatt for
the cost of operating the Hotel Property, this would constitute an event of
default under Article 16.1(c) of the Lease, allowing the Operating Partnership
to terminate Mogul's leasehold interest in the Hotel Property. As a result of
such a termination of the Lease, any income derived by the Operating
Partnership from the Hotel Property after the default would be treated as
income from foreclosure property.
The Operating Partnership would be able to continue to operate the
Hotel Property after any default under the Lease, without affecting its status
as foreclosure property, because Hyatt, an independent contractor, from whom
the Company will not derive any income, will provide all services relating to
its operation. As noted above, a REIT can use foreclosure property in the
conduct of an active trade or business, as long as this is done through the use
of an independent contractor, from whom the REIT does not derive or receive any
income.(30)
As noted above, real property acquired upon default under a lease is
not eligible to be treated as foreclosure property if the lease is entered into
with an intent to evict or foreclose, or if the REIT knows or has reason to
know that default would occur.(31) This is not the case in the present
situation because (i) the Hotel Property is projected to generate enough gross
income to produce a profit for Mogul, (ii) in connection with the Lease, Mogul
will represent that it has a net worth of at $400,000, and (iii) in the view of
the Operating Partnership, Mogul's capitalization is adequate to allow Mogul to
assume Mogul's obligations under the Lease.
The Hotel Property would in any event qualify as foreclosure property
only for a period of up to two years, beginning of the date of its acquisition
by the Operating Partnership, unless the Operating Partnership obtains an
extension of the grace period from the IRS.(32) Therefore, in the event the
Operating Partnership takes possession of the Hotel Property as a result of a
default under the lease, presumably the Operating Partnership will sell the
Hotel Property or within two years rent it to another tenant under a lease
that will produce "rents from real property."
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(30) Section 856(e)(4)(C). (The IRS clearly intended for REITs to be able to
treat hotels operated by independent contractors as foreclosure property. For
instance, the Treasury regulations defining foreclosure property refer to hotel
properties twice. See, Treas. Reg. Sections 1.856-6(b)(2), 1.856-6(d)(2). In
addition, the IRS has also recently issued a private letter ruling in which it
treated income received from hotels acquired pursuant to a bankruptcy petition
as income from foreclosure property, where the hotels were operated by third
party managers. P.L.R. 9420013 (2/15/94).)
(31) Treas. Reg. Section 1.856-6(b)(3).
(32) Section 856(e)(2).
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<PAGE> 56
CONCLUSION
Based on the assumptions stated above, it is our opinion that (i) all
of the income that the Operating Partnership derives from the Hotel Property
will be treated as "qualifying income" for purposes of the 95 percent test and
(ii) all of the income the Operating Partnership derives from the Hotel
Property, with the exception of the interest income attributable to the deemed
financing of Mogul's acquisition of the FF & E, will be treated as "qualifying
income" for purposes of the 75 percent test.
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<PAGE> 57
April 1, 1996
Crescent Real Estate Equities, Inc.
900 Third Avenue, Suite 1800
New York New York 10022
Ladies and Gentlemen:
On January 3, 1995 we provided you with a memorandum analyzing the
impact of the purchase of the Hyatt Regency Beaver Creek (the "Hotel Property")
by Crescent Real Estate Equities Limited Partnership (the "Operating
Partnership") would have on the ability of Crescent Real Estate Equities, Inc.
(the "Company") to continue to qualify as a real estate investment trust (a
"REIT") under section 856(c).(1) That memorandum concluded that, subject to
certain assumptions, in our opinion (i) all of the income that the Operating
Partnership derived from the Hotel Property would be treated as "qualifying
income" for purposes of the 95 percent gross income test for REIT qualification
under section 856(c)(2) (the "95 percent test") and (ii) all of the income that
the Operating Partnership derived from the Hotel Property, with the exception
of certain interest income, would be treated as "qualifying income" for
purposes of the 75 percent gross income test for REIT qualification under
section 856(c)(3) (the "75 percent test"). The January 3, 1995 memorandum was
based upon, among other items, our review of a Lease Agreement between dated
January 3, 1995 between the Operating Partnership, as lessor, and Mogul
Management LLC ("Mogul"), as lessee, dated January 3, 1995 (the "Original
Lease").
On October 6, 1995, the Original Lease was amended to provide for the
subordination of the leasehold estate created by the Original Lease to any lien
or encumbrance placed against all or any part of the Hotel Property and to
provide for the approval by the Operating Partnership of a proposed merger of
Mogul into RoseStar Management, LLC, a Texas limited liability company
("RoseStar"). Currently, Sanjay Varma owns a 91 percent interest in the assets
and net profits of RoseStar, while Gerald W. Haddock and John C. Goff, the
managers of RoseStar, each own a 4.5 percent interest in its assets and net
profits.
Also on October 6, 1995, the Operating Partnership conveyed all of its
interest as lessor under the Original Lease to Crescent Real Estate Funding II,
L.P., a Delaware limited
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(1) All section references are to the Internal Revenue Code of 1986, as
amended (the "Code"), or to the regulations issued thereunder, unless
otherwise noted.
<PAGE> 58
Crescent Real Estate Equities, Inc.
April 1, 1996
Page 2
Partnership ("Funding II"). Funding II assumed all of the Operating
Partnership's liabilities and obligations under the Original Lease.
On January 1, 1996, the Funding II, Mogul and Rose Star executed an
Amended and Restated Lease Agreement for the Hotel Property (hereinafter the
Original Lease as amended and restated is referred to as the "Lease").
On February 9, 1996, Mogul was merged with and into RoseStar and
RoseStar succeeded Mogul as lessee under the Lease.
On March 29, 1996, pursuant to an Assignment and Assumption of
Leasehold Estate, RoseStar sold and assigned all of its interest and estate as
lessee under the Lease to RoseStar Southwest, LLC, a Delaware limited liability
company ("Southwest"). RoseStar owns a 99 percent interest in Southwest, while
the remaining one percent interest is owned by RSSW Corp., a Delaware
corporation.
On April 1, 1996, the Lease was amended to provide that, among other
things, (1) at all times during the term of the Lease, Southwest and RoseStar
would maintain a cumulative net worth equal to $200,000; and (2) Southwest
would retain all of the income it earned with respect to the Hotel Property
(except distributions to its beneficial owners in an amount sufficient to pay
their federal and state income taxes on the income) until such time as
Southwest and any affiliate of Southwest (including RoseStar) which has entered
into a long-term lease of a hotel with Funding II or any affiliate of Funding
II (including the Operating Partnership) have accumulated and are holding in
reserve funds in the aggregate which are sufficient to enable Southwest and any
affiliated entities to pay at least one monthly payment of base rent under each
lease between Southwest (or any affiliated entities) and Funding II or an
affiliate of Funding II.
This letter is intended to update the opinions expressed in our
January 3, 1995 memorandum to reflect the changes in the Lease Agreement and
the substitution of new parties as lessor and lessee of the Hotel Property.
The opinions set forth herein are based upon the existing provisions of the
Code, and the reported interpretations thereof by the IRS and by the courts in
effect as of the date hereof, all of which are subject to change, both
retroactively or prospectively, and to possibly different interpretations. We
assume no obligation to update the opinions set forth in this letter. We
believe that the conclusions expressed herein, if challenged by the IRS, would
be sustained in court. However, because our opinions are not binding upon the
IRS or the courts, there can be no assurance that contrary positions may not be
successfully asserted by the IRS.
<PAGE> 59
Crescent Real Estate Equities, Inc.
April 1, 1996
Page 3
I. Documents and Representations
For the purpose of rendering this opinion, we have examined
and relied on originals, or copies certified or otherwise identified to our
satisfaction, of the following: (1) the Original Lease; (2) the Amendment to
Lease Agreement between the Operating Partnership and Mogul dated October 6,
1995; (3) the Lease; (4) the Assignment and Assumption of Leasehold Estate by
and between RoseStar and Southwest dated March 29, 1996; (5) the First
Amendment to the Lease dated April 1, 1996; (6) the Limited Guaranty Agreement
by Gerald Haddock, John Goff and Sanjay Varma, as guarantors in favor of
Funding II (the "Guaranty); (7) the Articles of Organization of RoseStar
Management, LLC (the "RoseStar Articles"); (8) the Regulations of RoseStar
Management, LLC (the "RoseStar Regulations"); (9) the Operating Agreement of
RoseStar Southwest, LLC; (10) the First Amended and Restated Articles of
Incorporation of Crescent Real Estate Equities, Inc. (the "Crescent Articles");
and (11) such other documents or information as we have deemed necessary for
the opinion set forth below. In our examination, we have assumed the
genuineness of all signatures, the legal capacity of natural persons, the
authenticity of all documents submitted to us as originals, the conformity to
original documents of all documents submitted to us as certified or photostatic
copies, and the authenticity of the originals of such copies.
For the purpose of rendering this opinion, we have also assumed that
all statements of facts and assumptions described in our January 3, 1995
memorandum remain correct, unless otherwise noted.
II. Opinions
A. Lease Will be Treated as a Lease for Federal Income Tax Purposes
In order for any income derived by Funding II from the Hotel Property
to constitute either "rents from real property," or in the case of a default
under the Lease, "gross income from foreclosure property," the Lease must be
treated as a lease for federal income tax purposes and not be treated as a
service contract, management contract or other type of arrangement. This
determination depends on an analysis of all the surrounding facts and
circumstances. In making this determination, courts have considered a variety
of factors, including the following: (i) the intent of the parties, (ii) the
form of the agreement, (iii) the degree of control over the business conducted
at the property that is provided to the lessee (e.g., whether the lessee has
substantial rights of control over the operation of the property and its
business), (iv) the extent to which the lessee has the risk of loss from
operations of the business conducted as the property (e.g., whether the lessee
bears the risk of increases in operating expenses and of decreases in
revenues), and (v) the extent to which the lessee has
<PAGE> 60
Crescent Real Estate Equities, Inc.
April 1, 1996
Page 4
the opportunity to benefit from operations of the business conducted at the
property (e.g., whether the lessee benefits from decreased operating expenses
or increased revenues).(2)
In addition, section 7701(e) provides that a contract that purports to
be a service contract, partnership agreement, or another type of arrangement
will be 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 any savings
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
unrelated 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, partnership agreement,
or some other type of arrangement should be treated as a lease is inherently
factual, the presence or absence of any single factor may not be dispositive in
every case.(3)
We have concluded that the Lease will be treated as a lease for
Federal income tax purposes, rather than a service contract, management
contract or other type of arrangement. This conclusion is based, in part, on
the following facts: (i) Funding II and Southwest intend their relationship to
be that of lessor and lessee (as evidenced by the terms of the Lease), (ii)
Southwest has the right to exclusive possession, use and quiet enjoyment of the
Hotel Property during the term of the Lease and the right to uninterrupted
control in the operation of and business conducted at the Hotel Property
(subject to its assumption of the Management Agreement), (iii) Southwest will
bear the cost of, and be responsible for, capital expenditures, including
maintenance and repair of the Hotel Property, and will dictate how the Hotel
Property is maintained and improved (with the exception that Funding II, as
lessor, is responsible for the cost of certain capital expenditures in
situations where the funds available to Southwest are insufficient for such
expenditures), (iv) Southwest will bear all the costs and expenses of operating
the Hotel Property (with the exception of the costs of replacing certain
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(2) See, e.g., Xerox Corp. v. U.S., 80-2 USTC Paragraph 9530 (Ct. Cl. Tr.
Div. 1980), aff'd per curiam, 656 F.2d 659 (Ct. Cl. 1981).
(3) P.L.R. 8918012 (January 24, 1989).
<PAGE> 61
Crescent Real Estate Equities, Inc.
April 1, 1996
Page 5
FF & E associated with the Hotel Property, which is to be funded by Funding
II), (v) Southwest will benefit from any savings in the costs of operating the
Hotel Property during the term of the Lease, (vi) in the event of damage or
destruction to the Hotel Property, Southwest will be at economic risk because
its obligation to make rental payments will not abate, (vii) Southwest will
indemnify Funding II against all liabilities imposed on Funding II during the
term of the Lease by reason of injury to persons or damage to property
occurring at the Hotel Property or Southwest's use, management, maintenance or
repair of the Hotel Property, (viii) Southwest is obligated to pay substantial
fixed rent for the period of use of the Hotel Property, regardless of whether
its revenues exceed its costs and expenses, and (ix) Southwest stands to incur
substantial losses (or derive substantial profits) depending on how
successfully it operates the Hotel Property.
We do not believe that our conclusion that the Lease of the Hotel
Property will be treated as a lease for Federal income tax purposes is affected
by the fact that Southwest assumed RoseStar's rights and obligations as lessor
under the Lease subject to its assumption of Funding II's obligations under the
preexisting Management Agreement. The Management Agreement gives Hyatt control
over the day-to-day operation of the Hotel Property and will allow Hyatt to
share with Southwest in the benefits of any increases in revenues or cost
savings in the operation of the Hotel Property. However, Hyatt's operation of
the Hotel Property is not controlled by Funding II, and the Management
Agreement does not affect the fact that Southwest bears most of the risk of
loss if the Hotel Property is not successful. Moreover, the IRS has issued a
private letter ruling in which it treated leases of several hotel properties as
producing "rents from real property" in a situation where the lessees had
contracted with a third party to conduct the day-to-day operations of the
hotels.(4) This ruling suggests that the IRS will respect a lease of a hotel
for federal income tax purposes even if the hotel is operated by an independent
contractor rather than by the lessee.
The Lease is currently structured in form so that Funding II retains
ownership of all the personal property leased to Southwest in connection with
Southwest's lease of the Hotel Property (the "FF&E"). However, if the term of
the Lease equals or exceeds the useful life of some or all of the FF&E, it is
possible that the Lease could be treated for federal income tax purposes as a
financing arrangement. In such a case, Southwest would be treated as having
acquired ownership of the FF&E for federal income tax purposes in exchange for
an obligation to make future payments of principal and interest to Funding II.
Nonetheless, we do not believe that the recharacterization of the Lease as a
financing arrangement with respect to the FF&E would have a material effect on
the ability of the Company to satisfy the requirements for taxation as a REIT.
We reach this conclusion on the basis that, if a portion of the payments made
by Southwest under the Lease were characterized as interest on
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(4) See, P.L.R. 8117036 (January 27, 1981).
<PAGE> 62
Crescent Real Estate Equities, Inc.
April 1, 1996
Page 6
indebtedness secured by the FF&E, rather than rents from real property, that
portion would still satisfy the 95 percent gross income test (although it would
not satisfy the 75% gross income test).(5)
B. Percentage Rent Provision is not Profit-Based
Pursuant to the Lease, Southwest will be obligated to pay Funding II
base rent and percentage rent. Under the regulations, percentage rent based on
a percentage of gross receipts or sales in excess of a floor amount, which is
how the percentage rent is structured under the Lease, will not qualify as
"rents from real property" unless (i) such floor amount does not depend in
whole or in part on the income or profits of the lessee, (ii) the percentage
and the floor amount are fixed at the time the lease is entered into, (iii) the
percentage and the floor amount are not renegotiated during the term of the
lease in a manner that has the effect of basing the percentage rent on income
or profits, and (iv) the percentage and the floor amount conform with normal
business practice.(6)
Under the terms of Article 4.2 of the Lease, Southwest will pay
percentage rent equal on an annual basis to the sum of (i) 17.5 percent of the
excess of annual gross receipts from room rentals over $9,300,000 and (ii) 2.5
percent of the excess of annual gross receipts from the food and beverage
facilities at the Hotel Property over $3,000,000. This formula is unchanged
from the formula in the Original Lease between the Operating Partnership and
Mogul. It will effectively reward Southwest for any increases in gross
receipts from rooms and from other sources over the threshold amounts. This
type of formula does not base the percentage rent on Southwest's income or
profits, and similar formulas have been treated by the IRS as generating "rents
from real property."(7) Moreover, Funding II has represented that (i) the floor
amounts used to compute the percentage rent under the Lease do not depend in
whole or in part on the income or profits of any person, (ii) the percentage
rent provision of the Lease has not been and will not be renegotiated during
the term of the Lease or at the expiration or earlier termination of the Lease
in a manner that has the effect of basing the rent
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(5) If the Lease were recharacterized as a financing arrangement with
respect to the FF&E, it also might result in some minor timing
differences with respect to the Company's recognition of
income. These differences would result from (a) the
recharacterization of a portion Soutwest's payments under the Lease as
a return of principal and (b) the Company's loss of any depreciation
deductions attributable to the FF&E.
(6) Treas. Reg. Section 1.866-4(b)(3).
(7) See, e.g., P.L.R. 8803007 (September 23, 1987) (percentage rent based
on gross revenues in excess of gross revenues for a base year
treated as "rents from real property"); cf. P.L.R. 9104018 (October
26, 1990) (interest based on gross revenues in excess of a floor
amount treated as qualifying interest under section 856(f)).
<PAGE> 63
Crescent Real Estate Equities, Inc.
April 1, 1996
Page 7
on income or profits, and (iii) the percentage rent provision of the Lease
conforms with normal business practice. In addition, based on our experience
and an examination of the Lease and the Hotel Property projections, the Lease
appears to conform with normal business practice.
C. Southwest is not a "Related Party Tenant"
Rents received from Southwest will not qualify as "rents from real
property" if Southwest is a "related party tenant." Southwest will be a
"related party tenant" if the Company, or an owner of 10 percent or more of the
Company, directly or constructively owns 10 percent or more of the assets or
net profits of Southwest.(8) Constructive ownership is determined for purposes
of this test by applying the rules of section 318(a) as modified by section
856(d)(5). Those rules generally provide that if 10 percent 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.
Southwest will not be treated as a "related party tenant" because a 99
percent interest in Southwest's assets and net profits will be owned by
RoseStar, with the remaining one percent interest owned by RSSW Corp. An
individual, Sanjay Varma, currently owns a 91 percent interest in the assets
and net profits of RoseStar and RSSW Corp. In reaching this conclusion, we
recognize that Sanjay Varma owns certain Units of the Operating Partnership.(9)
Funding II has represented that (i) Sanjay Varma does not own more than 10
percent of the value of the Company's stock, (ii) Sanjay Varma is not expected
to own more than 10 percent of the value of the Company's stock in the future,
and (iii) neither the Funding II nor the Company intends to acquire, directly
or constructively, an interest of 10 percent or more in the assets or net
profits of RoseStar at any time in the future. Moreover, Article 7.8 of the
Lease limits the ability of Southwest or any person owning an interest in
Southwest (including RoseStar) to acquire, directly or constructively, a 6
percent stock interest in the Company, and Section 6.4 of the First Amended and
Restated Articles of Incorporation of the Company prevents RoseStar and its
members and managers from acquiring more than 8 percent of the Company's stock.
The conclusion that Southwest will not be treated as a "related party
tenant" is based on the assumption that its member RoseStar will be treated as
a partnership for federal income tax purposes. If RoseStar is not treated as a
partnership for federal income tax purposes, but
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(8) Section 856(d)(2)(B)(ii).
(9) See Rev. Rul. 73-194, 1973-1 C.B. 355 (management company treated as
an independent contractor with respect to a REIT, where an
affiliate of the management company and the REIT were partners).
<PAGE> 64
Crescent Real Estate Equities, Inc.
April 1, 1996
Page 8
is instead treated as an association taxable as a corporation, then it is
possible that Southwest would be treated as a "related party tenant" and the
rents derived under the terms of the Lease would not be treated as "rents from
real property." This is because, if RoseStar were treated as a corporation for
federal income tax purposes, Gerald W. Haddock and John C. Goff would likely be
deemed to own all of its voting stock, because of the extensive powers that
they are granted as managers under the RoseStar Regulations. If this were the
case, the ownership of such voting stock (and ownership of Southwest) might be
attributed to the Company under a literal reading of the constructive ownership
rules described above.(10)
An entity which has associates and an objective to carry on a business
for joint profit will be treated as a partnership for federal income tax
purposes, and not as an association taxable as a corporation, if it has not
more than two of the following four characteristics of a corporation: (i)
continuity of life; (ii) centralization of management; (iii) limited liability;
and (iv) free transferability of interests.(11) The entity must also have no
other characteristics which are significant in determining its classification.
Generally, other factors are considered only insofar as they relate to the
determination of the presence or absence of the foregoing corporate
characteristics.(12) The IRS has applied this four-factor test in determining
whether limited liability companies formed under the Texas Limited Liability
Company Act (the "Act") are partnerships for federal income tax purposes.(13)
The IRS has issued Rev. Proc. 95-10, which specifies conditions which must be
satisfied for a limited liability company to receive a favorable advanced
ruling that it will be classified as a partnership for federal income tax
purposes.(14) RoseStar should satisfy these conditions. However, such
conditions are
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(10) Richard Rainwater, Gerald Haddock and John Goff are each partners in
FW-Irving Partners, Ltd. (and apparently they are partners in
other partnerships as well). Richard Rainwater also owns more than 10
percent of the value of the stock of the Company. Thus, assuming that
the ownership interests in RoseStar held by Gerald Haddock and John
Goff constitute stock, such interests, along with Richard Rainwater's
stock interest in the Company, will be attributed to FW-Irving
Partners, Ltd. pursuant to section 318(a)(3)(A), which provides that
stock owned, directly or indirectly, by or for a partners shall be
considered as owned by the partnership. Then, FW-Irving Partners,
Ltd.'s deemed interest in RoseStar would be attributed to the Company
pursuant to section 318(a)(3)(C) (as modified by section 856(d)(5)),
which provides that stock owned by any person that owns 10 percent or
more of the value of the stock in a corporation shall be considered
owned by the corporation. As you are aware, however, we have opined
to you in a similar context that we do not believe that these
attribution rules should be read literally.
(11) Treas. Reg. Section 301.7701-2(a).
(12) See Rev. Rul. 79-106, 1979-1 C.B. 448.
(13) See, e.g., P.L.R. 9242025 (July 22, 1992) and P.L.R. 9218078 (January
31, 1992).
(14) 1995-3 I.R.B. 20.
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Crescent Real Estate Equities, Inc.
April 1, 1996
Page 9
applicable only in determining whether rulings will be issued and are not
intended as substantive rules for determination of partnership status.
An organization will be treated as possessing the corporate
characteristic of continuity of life, even if the agreement organizing an
entity provides that it is to continue only for a stated period, unless a
member has the power to dissolve the organization at an earlier time.(15)
Article 6.01 of the Act provides, in part, that except as otherwise provided in
the company's regulations, a limited liability company shall be dissolved upon
the death, retirement, resignation, expulsion, bankruptcy, or dissolution of a
member or the occurrence of any other event which terminates the continued
membership of a member in the limited liability company, unless there is at
least one remaining member and the business of the limited liability company is
continued by the consent by the number of members or class thereof stated in
the articles of organization or regulations of the limited liability company or
of not so stated, by all remaining members. Article 2 of the RoseStar Articles
provides that the duration of RoseStar is until the close of business on
December 31, 2015, or until its earlier dissolution in accordance with the
provisions of the Act or the Regulations. Article 10.2 of the RoseStar
Regulations provides, in part, that RoseStar shall be dissolved upon the
withdrawal, death, retirement, resignation, expulsion, bankruptcy, legal
incapacity or dissolution of any member, unless the business of RoseStar is
continued by the consent of all the remaining members within ninety days.
Accordingly, RoseStar will lack the corporate characteristic of continuity of
life.
An organization will be treated as possessing the corporate
characteristic of free transferability of interests if the members owning all
or substantially all of the interests in an organization may substitute for
themselves without the consent of the other members a person who is not a
member of the organization.(16) Article 4.05 of the Act provides, in part,
that unless otherwise provided by the company's regulations, a membership
interest is assignable in whole or in part; an assignment of a member's
interest does not entitle the assignee to become, or to exercise rights or
powers of a member; and until the assignee becomes a member, the assignor
member continues to be a member and to have the power to exercise any rights or
powers of a member, except to the extent those rights or powers are assigned.
Article 4.07 of the Act provides, in part, that an assignee of a membership
interest may become a member if and to the extent that the company's
regulations so provide, or all members consent. Article 9.3 of the RoseStar
Regulations provides, in part, that no member shall have the right to
substitute in its place a transferee unless consent is given by the Managers
and a majority of the other members, which consent may be withheld in the
discretion of the Managers or the
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(15) Treas. Reg. Section 301.7701-2(b)(3).
(16) Treas. Reg. Section 301.7701-2(e).
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Crescent Real Estate Equities, Inc.
April 1, 1996
Page 10
other members. Accordingly, RoseStar will lack the corporate characteristic of
free transferability of interests. Because RoseStar will lack the corporate
characteristics of continuity of life and free transferability of interests, in
our opinion it will be treated as partnership for federal income tax purposes.
D. Incidental Personal Property
1. Rents Attributable to Personal Property Will Be Treated as
"Rents from Real Property"
The rents attributable to Funding II's personal property leased under
or in connection with the Lease must not be greater than 15 percent of the
rents received under the Lease. The rent attributable to personal property
leased under or in connection with a lease of real property is the amount that
bears the same ratio to total rent for the taxable year as (i) the average of
the adjusted bases of the personal property leased under or in connection with
a lease of real property at the beginning and at the end of the taxable year
bears to (ii) the average of the aggregate adjusted bases of the real and
personal property subject to the lease at the beginning and at the end of such
taxable year (the "Adjusted Basis Ratio").(17) Funding II has represented that
the adjusted tax basis of the personal property leased under or in connection
with the Lease (including, for the period beginning on January 1, 1996, any
furniture, fixtures or equipment formerly treated as owned by Mogul, as
described below) has not represented and will not represent more than 15
percent of the aggregate adjusted tax basis of the Hotel Property at any time.
2. Payments Attributable to Mogul's Deemed Acquisition of Certain
Personal Property Will Not Be Treated as "Rents from Real
Property"
Article 4.7 of the Original Lease provided that Mogul was to be deemed
to have acquired all of the furniture, fixtures and operating equipment
associated with the Hotel Property (the "FF & E") with the proceeds of a loan
from the Operating Partnership. It further provided that Mogul was to make
payments of principal and interest on this deemed loan. Pursuant to Funding
II's assumption of all of the Operating Partnership's liabilities and
obligations under the Original Lease, after October 6, 1995, all payments of
principal and interest on this deemed loan were accrued by Funding II. On
January 1, 1996, in connection with the execution of the Lease, Article 4.7 of
the Original Lease ceased to be effective and the parties ceased to treat the
FF & E as owned by Mogul. Instead, beginning on January 1, 1996, the FF & E
has been treated by all parties as if it had been conveyed by Mogul to
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(17) Section 856(d)(1)(C).
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Crescent Real Estate Equities, Inc.
April 1, 1996
Page 11
Funding II in exchange for the cancellation the balance owed by Mogul under the
deemed financing arrangement established under the Original Lease.
The payments that the Operating Partnership and Funding II received
with regard to the FF & E under the terms of Article 4.7 of the Original Lease
prior to January 1, 1996 did not qualify as "rents from real property."
Instead, such payments were treated for federal income tax purposes as payments
of principal and interest resulting from a deemed financing of Mogul's purchase
of the FF & E.
The payments pursuant to this "deemed financing," to the extent they
constituted interest, were "qualifying income" for purposes of the 75 percent
test. However, because the deemed financing was secured by personal, rather
than real property, such interest was not qualifying income for purposes of the
95 percent test.
E. Provision of Services by the Funding II
1. Income Derived under the Terms of the Lease
Although Funding II may treat charges for services customarily
furnished or rendered in connection with the rental of the Hotel Property as
"rents from real property," any services rendered to the occupants of the Hotel
Property must be furnished or rendered by an independent contractor from whom
the Company does not derive or receive any income.(18) Moreover, to the extent
that any independent contractors provide noncustomary services to the occupants
of the Hotel Property, the cost of such services must not be borne by Funding
II.(19)
Under the terms of the Lease, Funding II will not be required to
provide any services, customary or noncustomary, in connection with the rental
of the Hotel Property. Instead, all services relating to the operation of the
Hotel Property will be provided by Hyatt under the terms of the Management
Agreement. Funding II has represented that Hyatt is an independent contractor
within the meaning of section 856(d)(3), from which the Company and Funding II
will not derive or receive any income. Funding II will not bear the cost of
any of the services provided by Hyatt. Instead, such costs are borne by
Southwest, because it has assumed Funding II's obligations, as owner, under the
Management Agreement.
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(18) Sections 856(d)(1), 856(d)(2)(C); Treas. Reg. Section 1.512(b)-1(c)(5).
(19) Treas. Reg. Section 1.856-4(b)(5).
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Crescent Real Estate Equities, Inc.
April 1, 1996
Page 12
Based on the foregoing, we believe that the provision of any
noncustomary services to the occupants of the Hotel Property by Hyatt will have
no effect on the qualification of the income derived from the Hotel Property as
"rents from real property." In fact, the IRS has issued a private letter
ruling in which it has treated the income derived from several leases of hotel
properties as "rents from real property" in a situation where the lessees had
contracted with a third-party to conduct the day to day operations of the
hotels.(20) Our conclusion is not altered by the fact that Funding II will
remain liable for any obligations arising under the Management Agreement, to
the extent that they are not satisfied by Southwest. Funding II should not be
treated as bearing the cost of the services provided by Hyatt merely because it
is liable for Southwest's obligations under the Management Agreement. Funding
II is not retaining this liability in an attempt to provide services to
Southwest. Instead, it is retaining this liability only as an accommodation to
Hyatt. Moreover, Funding II believes that it is highly unlikely that it will
ever be required to reimburse Hyatt for the costs and expenses of operating the
Hotel Property. This is because (i) the Hotel Property is projected to
generate enough gross income to cover the payments to Hyatt under the
Management Agreement, (ii) in connection with Section 7.7 the Lease, as
amended, Southwest has represented that it has a net worth of at least
$200,000, (iii) in connection with Section 7.9 of the Lease, as amended,
Southwest has agreed to retain all of the income it earns from the Hotel
Property (except distributions to its beneficial owners in an amount sufficient
to pay their federal and state income taxes on such income) until such time as
Southwest and any affiliate of Southwest (including RoseStar) which has entered
into a long-term lease of a hotel with Funding II or any affiliate of Funding
II (including the Operating Partnership) have accumulated and are holding in
reserve funds in the aggregate which are sufficient to enable Southwest and any
affiliated entities to pay at least one monthly payment of base rent under each
lease between Southwest and any such affiliated entities and Funding II or an
affiliate of Funding II, (iv) pursuant to the Guaranty, RoseStar's individual
members have guaranteed RoseStar's obligations under the Lease, and (v) in the
view of Funding II, Southwest's capitalization is adequate to allow Southwest
to assume its obligations as lessee under the Lease.
2. Income Derived in the Case of a Default under the Lease
If Funding II were required to reimburse Hyatt for the costs of
operating the Hotel Property because of a default by Southwest under the terms
of the Management Agreement, we have concluded that the income derived by
Funding II from the Hotel Property would be treated as "qualifying income" for
purposes of the 75 percent and 95 percent tests. This is because, if Funding
II were required to reimburse Hyatt for the cost of operating the Hotel
Property, this would constitute an event of default under Article 16.1(c) of
the Lease, allowing Funding II to terminate Southwest's leasehold interest in
the Hotel Property. As a
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(20) See, P.L.R. 8117036 (January 27, 1981).
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Crescent Real Estate Equities, Inc.
April 1, 1996
Page 13
result of such a termination of the Lease, any income derived by Funding II
from the Hotel Property after the default would be treated as income from
foreclosure property.
Funding II would be able to continue to operate the Hotel Property
after any default under the Lease, without affecting its status as foreclosure
property, because Hyatt, an independent contractor, from whom the Company will
not derive any income, will provide all services relating to its operation. A
REIT can use foreclosure property in the conduct of an active trade or
business, as long as this is done through the use of an independent contractor,
from whom the REIT does not derive or receive any income.(21)
Real property acquired upon default under a lease is not eligible to
be treated as foreclosure property if the lease is entered into with an intent
to evict or foreclose, or if the REIT knows or has reason to know that default
would occur.(22) This is not the case in the present situation because (i) the
Hotel Property is projected to generate enough gross income to cover the
payments to Hyatt under the Management Agreement, (ii) in connection with
Section 7.7 the Lease, as amended, Southwest has represented that it has a net
worth of at least $200,000, (iii) in connection with Section 7.9 of the Lease,
as amended, Southwest has agreed to retain all of the income it earns from the
Hotel Property (except distributions to its beneficial owners in an amount
sufficient to pay their federal and state income taxes on such income) until
such time as Southwest and any affiliate of Southwest (including RoseStar)
which has entered into a long-term lease of a hotel with Funding II or any
affiliate of Funding II (including the Operating Partnership) have accumulated
and are holding in reserve funds in the aggregate which are sufficient to
enable Southwest and any affiliated entities to pay at least one monthly
payment of base rent under each lease between Southwest and any such affiliated
entities and Funding II or an affiliate of Funding II, (iv) pursuant to the
Guaranty, RoseStar's individual members have guaranteed RoseStar's obligations
under the Lease, and (v) in the view of Funding II, Southwest's capitalization
is adequate to allow Southwest to assume its obligations as lessee under the
Lease.
The Hotel Property would in any event qualify as foreclosure property
only for a period of up to two years, beginning of the date of its acquisition
by Funding II, unless
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(21) Section 856(e)(4)(C). (The IRS clearly intended for REITs to be able
to treat hotels operated by independent contractors as
foreclosure property. For instance, the Treasury regulations defining
foreclosure property refer to hotel properties twice. See, Treas.
Reg. Sections 1.856-6(b)(2), 1.856-6(d)(2). In addition, the IRS has
also recently issued a private letter ruling in which it treated
income received from hotels acquired pursuant to a bankruptcy petition
as income from foreclosure property, where the hotels were operated by
third party managers. P.L.R. 9420013 (2/15/94).)
(22) Treas. Reg. Section 1.856-6(b)(3).
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Crescent Real Estate Equities, Inc.
April 1, 1996
Page 14
Funding II obtains an extension of the grace period from the IRS.(23)
Therefore, in the event Funding II takes possession of the Hotel Property as a
result of a default under the Lease, presumably Funding II will sell the Hotel
Property or, within two years, rent it to another tenant under a lease that
will produce "rents from real property."
F. Conclusions
Based on the assumptions and representations stated above, it is our
opinion that (i) all of the income that Funding II derives from the Hotel
Property will be treated as "qualifying income" for purposes of the 95 percent
test and (ii) all of the income that Funding II derives from the Hotel
Property, will be treated as "qualifying income" for purposes of the 75 percent
test. However, we note that certain interest income accrued prior to January
1, 1996 and attributable to the deemed financing of Mogul's acquisition of the
FF & E under Section 4.7 of the Original Lease has properly been treated by the
Operating Partnership and Funding II as qualifying income for purposes of the
95 percent test, but not for purposes of the 75 percent test.
III. Additional Limitations
The foregoing opinions are limited to the specific matters covered
thereby and should not be interpreted to imply that the undersigned has offered
its opinion on any other matter.
Very truly yours,
SHAW, PITTMAN, POTTS & TROWBRIDGE
By:
--------------------------------
Charles B. Temkin, P.C.
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(23) Section 856(e)(2).
<PAGE> 71
MEMORANDUM
TO: David Dean
FROM: Charles B. Temkin
Michael A. Jacobs
DATE: June 30, 1995
RE: Characterization of Income Derived from Denver Marriott City
Center
I. OVERVIEW
Crescent Real Estate Equities Limited Partnership (the "Operating
Partnership") is scheduled to purchase the Denver Marriott City Center (the
"Denver Marriott") from the Prudential Insurance Company of America
("Prudential"), the successor to the Denver Energy Center Hotel Partnership
(the "Original Owner"), on June 30, 1995. Crescent Real Estate Equities, Inc.
(the "Company") is currently the sole shareholder of two corporations, one of
which is the sole general partner of and one of which is a limited partner of
the Operating Partnership. These two corporations constitute qualified REIT
subsidiaries within the meaning of section 856(i).(1)
This memorandum analyzes the impact that the purchase of the Denver
Marriott will have on the ability of the Company to continue to qualify as a
real estate investment trust (a "REIT") under section 856(c). More
specifically, it analyzes whether the income the Operating Partnership will
derive from the Denver Marriott will be "qualifying income" for purposes of the
75 percent and 95 percent gross income tests for REIT qualification. This
memorandum concludes that, subject to certain assumptions, in our opinion (i)
all of the income that the Operating Partnership will derive from the Denver
Marriott will be treated as "qualifying income" for purposes of the 95 percent
test and (ii) all of the income the Operating Partnership will derive from the
Denver Marriott, with the exception of certain interest income, will be treated
as "qualifying income" for purposes of the 75 percent test.
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(1)All section references herein are to the Internal Revenue Code of 1986, as
amended (the "Code"), or to the regulations issued thereunder, unless otherwise
noted.
<PAGE> 72
II. FACTS AND ASSUMPTIONS
The Original Owner contracted with Marriott Corporation to operate
the Denver Marriott. Under the terms of the agreement between the Original
Owner and Marriott Corporation dated January 10, 1979, as amended on January
10, 1979, February 16, 1979, May 11, 1979, July 27, 1979, March 25, 1980,
December 18, 1980, July 15, 1981, January 4, 1982, and November 19, 1993. (the
"Management Agreement"), Marriott Corporation is obligated to provide all
services in relation to the operation of the Denver Marriott and collect all
hotel receipts. In exchange for these services, Marriott Corporation is to be
reimbursed for the costs of operating the Denver Marriott and paid a management
fee. This fee is paid out of hotel receipts; it is based on the profits, if
any, from operation of the Denver Marriott. Marriott International, Inc.
("Marriott") is currently operating the Denver Marriott as the successor to
Marriott Corporation.
Article 18.01 of the Management Agreement requires that all
assignments of the Management Agreement be approved by Marriott and that any
assignees expressly assume the obligations of the owner under the Management
Agreement. Therefore, in connection with its purchase of the Denver Marriott,
the Operating Partnership will assume all of the obligations of Prudential
under the Management Agreement.
When the Operating Partnership purchases the Denver Marriott, it will
lease it to RoseStar Management, LLC ("RoseStar") pursuant to a Lease Agreement
dated June 30, 1995, as amended and restated by an Amended and Restated Lease
Agreement dated June 30, 1995 (as amended and restated, the "Lease"). Pursuant
to Article 2 of the Lease, the Operating Partnership will assign its interest
in the Management Agreement to RoseStar; and pursuant to Article 18.01 of the
Management Agreement, RoseStar will assume all of the Operating Partnership's
obligations thereunder. However, as a condition of its approval of the Lease,
Marriott will require that the Operating Partnership remain liable for all
obligations of the Operating Partnership under the Management Agreement that
will be assumed by RoseStar.
Currently, Sanjay Varma owns a 91 percent interest in the assets and
net profits of RoseStar, while Gerald W. Haddock and John C. Goff, the
managers of RoseStar, each own a 4.5 percent interest in its assets and net
profits.
For purposes of this memorandum, we have examined and relied upon (1)
the Management Agreement, (2) the Lease, (3) the Articles of Organization of
RoseStar Management, LLC (the "RoseStar Articles"), (4) the Regulations of
RoseStar Management, LLC (the "RoseStar Regulations"), (5) the First Amended
and Restated Articles of Incorporation of Crescent Real Estate Equities, Inc.
(the "Crescent Articles"), (6) the Purchase and Sale Agreement between
Prudential and the Operating Partnership, (7) the Consent Agreement between
Marriott and the Operating Partnership, and (8) such other documents or
information as we deemed necessary for the opinions set forth below. In our
examination, we have assumed the genuineness of all
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<PAGE> 73
signatures, the legal capacity of natural persons, the authenticity of all
documents submitted to us as originals, the conformity to original documents of
all documents submitted to us as certified or photostatic copies, and the
authenticity of the originals of such copies.
This memorandum is based upon existing provisions of the Code,
Treasury regulations, and the reported interpretations thereof by the Internal
Revenue Service ("IRS") and by the courts in effect (or, in the case of certain
proposed regulations, proposed) as of the date hereof, all of which are subject
to change, both retroactively or prospectively, and to possibly different
interpretations. We assume no obligation to update the opinions set forth in
this memorandum. We believe that the conclusions expressed herein, if
challenged by the IRS, would be sustained in court. However, because our
opinions are not binding upon the IRS or the courts, there can be no assurance
that contrary positions may not be successfully asserted by the IRS.
In addition, this memorandum is based on various assumptions and is
conditioned upon certain representations made by the Operating Partnership and
its sole general partner, Crescent Real Estate Equities, Ltd., as to factual
and other matters as set forth in the attached letter.
III. LEGAL BACKGROUND
A. 75 Percent and 95 Percent Tests
In order to qualify as a REIT for tax purposes, the Company must
satisfy certain tests with respect to the composition of its gross income on an
annual basis. First, at least 75 percent of the Company's gross income
(excluding gross income from certain prohibited transactions) for each taxable
year must consist of temporary investment income or of certain defined
categories of income derived directly or indirectly from investments relating
to real property or mortgages on real property. These categories include,
subject to various limitations, rents from real property, interest on mortgages
on real property, gains from the sale or other disposition of real property
(including interests in real property and mortgages on real property) not
primarily held for sale to customers in the ordinary course of business, income
from foreclosure property, and amounts received as consideration for entering
into either loans secured by real property or purchases or leases of real
property.(2) Second, at least 95 percent of the Company's gross income
(excluding gross income from certain prohibited transactions) for each taxable
year must be derived from income qualifying under the 75 percent test and from
dividends, other types of interest and gain from the sale or disposition of
stock or securities, or from any combination of the foregoing.(3)
In applying these income tests, REITs that are partners in a
partnership are required to include in their gross income their proportionate
share of the partnership's gross income. In
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(2)Section 856(c)(3).
(3)Section 856(c)(2).
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<PAGE> 74
addition, such REITs are to treat this partnership gross income as retaining
the same character as the items of gross income of the partnership for purposes
of section 856.(4) Thus, the character of any income derived by the Operating
Partnership from the Denver Marriott will affect the ability of the Company to
qualify as a REIT.
B. Rents from Real Property
Rents from real property satisfy both the 75 percent and 95 percent
tests for REIT qualification only if several conditions are met. First, the
amount of rent must not be based in whole or in part on the income or profits
of any person. An amount received or accrued generally will not be excluded
from the term "rents from real property" solely by reason of being based on a
fixed percentage or percentages of receipts or sales.(5) Second, the Code
provides that rents received from a tenant will not qualify as "rents from real
property" if the REIT, or an owner of 10 percent or more of the REIT, directly
or constructively, owns 10 percent or more of such tenant (a "Related Party
Tenant").(6) Third, if rent attributable to personal property leased in
connection with a lease of real property is greater than 15 percent of the
total rent received under the lease, then the portion of rent attributable to
such personal property will not qualify as "rents from real property."(7)
Finally, for rents to qualify as "rents from real property," a REIT 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 REIT derives no revenue. However, rents will be qualified as "rents
from real property" if a REIT directly performs services in connection with the
lease of the property, if those services are "usually or customarily rendered"
in connection with the rental of space for occupancy, and such services are not
considered to be rendered to the occupant of the property.(8)
C. Income from Foreclosure Property
Income from foreclosure property is treated as "qualifying income" for
purposes of the 75 percent and 95 percent tests (although any net income from
foreclosure property is taxed at the maximum corporate rate). Foreclosure
property is any real property, and any personal property incident to such real
property, acquired by a REIT through default under a mortgage or a lease. A
REIT may elect to treat such property as foreclosure property for a grace
period of up to two
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(4)Treas. Reg. Section 1.856-3(g).
(5)Section 856(d)(2)(A).
(6)Section 856(d)(2)(B).
(7)Section 856(d)(1)(C).
(8)Sections 856(d)(1)(B), 856(d)(2)(C).
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<PAGE> 75
years.(9) However, such property will cease to qualify as foreclosure property
if it is used by the REIT in a trade or business more than 90 days after it is
acquired and it is not operated through an independent contractor from whom the
REIT does not derive or receive any income.(10) Moreover, property is not
eligible to be treated as foreclosure property if the lease is entered into
with an intent to evict or foreclose, or if the REIT knows or has reason to
know that default would occur.(11)
IV. DISCUSSION
A. Lease Will be Treated as a Lease for Federal Income Tax Purposes
In order for any income derived by the Operating Partnership from the
Denver Marriott to constitute either "rents from real property," or in the case
of a default under the Lease, "gross income from foreclosure property," the
Lease must be treated as a lease for federal income tax purposes and not be
treated as a service contract, management contract or other type of
arrangement. This determination depends on an analysis of all the surrounding
facts and circumstances. In making this determination, courts have considered
a variety of factors, including the following: (i) the intent of the parties,
(ii) the form of the agreement, (iii) the degree of control over the business
conducted at the property that is provided to the lessee (e.g., whether the
lessee has substantial rights of control over the operation of the property and
its business), (iv) the extent to which the lessee has the risk of loss from
operations of the business conducted as the property (e.g., whether the lessee
bears the risk of increases in operating expenses and of decreases in
revenues), and (v) the extent to which the lessee has the opportunity to
benefit from operations of the business conducted at the property (e.g.,
whether the lessee benefits from decreased operating expenses or increased
revenues).(12)
In addition, section 7701(e) provides that a contract that purports to
be a service contract, partnership agreement, or another type of arrangement
will be 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
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(9)Section 856(e).
(10)Section 856(e)(4).
(11)Treas. Reg. Section 1.856-6(b)(3).
(12)See, e.g., Xerox Corp. v. U.S., 80-2 USTC Paragraph 9530 (Ct. Cl. Tr. Div.
1980), aff'd per curiam, 656 F.2d 659 (Ct. Cl. 1981).
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<PAGE> 76
recipient shares in any savings 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 unrelated 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, partnership agreement, or some other type of arrangement
should be treated as a lease is inherently factual, the presence or absence of
any single factor may not be dispositive in every case.(13)
We have concluded that the Lease will be treated as a lease for
Federal income tax purposes, rather than a service contract, management
contract or other type of arrangement. This conclusion is based, in part, on
the following facts: (i) the Operating Partnership and RoseStar intend their
relationship to be that of lessor and lessee (as evidenced by the terms of the
Lease), (ii) RoseStar will have the right to exclusive possession, use and
quiet enjoyment of the Denver Marriott during the term of the Lease and the
right to uninterrupted control in the operation of the business conducted at
the Denver Marriott (subject to its assumption of the Management Agreement),
(iii) RoseStar will dictate how the Denver Marriott is maintained and improved,
(iv) Rose-Star will bear all the costs and expenses of operating the Denver
Marriott (with the exception of the cost of replacing certain FF & E, which is
to be funded by the Operating Partnership pursuant to Article 7.5 of the
Lease), (v) RoseStar will benefit from any savings in the costs of operating
the Denver Marriott during the term of the Lease, (vi) in the event of damage
or destruction to the Denver Marriott, RoseStar will be at economic risk
because its obligation to make rental payments will not abate, (vii) RoseStar
will indemnify the Operating Partnership against all liabilities imposed on the
Operating Partnership during the term of the Lease by reason of injury to
persons or damage to property occurring at the Denver Marriott or RoseStar's
use, management, maintenance or repair of the Denver Marriott, (viii) RoseStar
is obligated to pay substantial fixed rent for the period of use of the Denver
Marriott, regardless of whether its revenues exceed its costs and expenses, and
(ix) RoseStar stands to incur substantial losses (or derive substantial
profits) depending on how successfully it operates the Denver Marriott.
We do not believe that our conclusion that the Lease of the Denver
Marriott will be treated as a lease for Federal income tax purposes is affected
by the fact that RoseStar entered the Lease subject to its assumption of the
Operating Partnership's obligations under the preexisting Management Agreement.
The Management Agreement gives Marriott control over the d ay-to-day operation
of the Denver Marriott and allows Marriott to share with RoseStar in the
benefits of any increases in revenues or cost savings in the operation of the
Denver Marriott. However, Marriott's operation of the Denver Marriott will not
be controlled by the Operating Partnership, and the Management Agreement does
not affect the fact that RoseStar bears most of the risk of loss if the Denver
Marriott is not successful. Moreover, the IRS has issued a private letter
ruling
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(13)P.L.R. 8918012 (January 24, 1989).
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in which it treated leases of several hotel properties as producing "rents from
real property" in a situation where the lessees had contracted with a third
party to conduct the d ay-to-day operations of the hotels.(14) This ruling
suggests that the IRS will respect a lease of a hotel for federal income tax
purposes even if the hotel is operated by an independent contractor rather than
by the lessee.
The Lease is structured in form so that the Operating Partnership
retains ownership of all the personal property leased to RoseStar in connection
with RoseStar's lease of the Denver Marriott (the "FF&E"). However, if the
term of the Lease equals or exceeds the useful life of some or all of the FF&E,
it is possible that the Lease could be treated for federal income tax purposes
as a financing arrangement. In such a case, RoseStar would be treated as
having acquired ownership of the FF&E for federal income tax purposes in
exchange for an obligation to make future payments of principal and interest to
the Operating Partnership. Nonetheless, we do not believe that the
recharacterization of the Lease as a financing arrangement with respect to the
FF&E would have a material effect on the ability of the Company to satisfy the
requirements for taxation as a REIT. This is because, if a portion the of the
payments made by RoseStar under the Lease were characterized as interest on
indebtedness secured by the FF&E, rather than rents from real property, that
portion would still satisfy the 95 percent gross income test (although it would
not satisfy the 75% gross income test).(15)
B. Percentage Rent Provision is not Profit-Based
Pursuant to the Lease, RoseStar will be obligated to pay the Operating
Partnership base rent and percentage rent. Under the regulations, percentage
rent based on a percentage of gross receipts or sales in excess of a floor
amount, which is how the percentage rent is structured under the Lease, will
not qualify as "rents from real property" unless (i) such floor amount does
not depend in whole or in part on the income or profits of the lessee, (ii) the
percentage and the floor amount are fixed at the time the lease is entered
into, (iii) the percentage and the floor amount are not renegotiated during the
term of the lease in a manner that has the effect of basing the percentage rent
on income or profits, and (iv) the percentage and the floor amount conform with
normal business practice.(16)
Under the terms of Article 4.2 of the Lease, RoseStar will pay
percentage rent equal on an annual basis to the sum of (i) 22.5 percent of the
excess of annual gross receipts from room rentals over $9,800,000 and (ii) 4.0
percent of the excess of annual gross receipts from the food and
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(14)See, P.L.R. 8117036 (January 27, 1981).
(15)If the Lease were recharacterized as a financing arrangement with respect
to the FF&E, it also might result in some minor timing differences with respect
to the Company's recognition of income. These differences would result from
(a) the recharacterization of a portion RoseStar's payments under the Lease as
a return of principal and (b) the Company's loss of any depreciation
deductions attributable to the FF&E.
(16)Treas. Reg. Section 1.856-4(b)(3).
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<PAGE> 78
beverage facilities at the Denver Marriott over $4,000,000. This formula
effectively rewards RoseStar for any increases in gross receipts from rooms
and from other sources over the threshold amounts. This type of formula does
not base the percentage rent on RoseStar's income or profits, and similar
formulas have been treated by the IRS as generating "rents from real
property."(17) Moreover, the Operating Partnership has represented that (i) the
floor amounts used to compute the percentage rent under the Lease do not depend
in whole or in part on the income or profits of any person, (ii) the percentage
rent provision of the Lease will not be renegotiated during the term of the
Lease or at the expiration or earlier termination of the Lease in a manner that
has the effect of basing the rent on income or profits, and (iii) the
percentage rent provision of the Lease conforms with normal business practice.
In addition, based on our experience and an examination of the Lease and the
Denver Marriott projections, the Lease appears to conform with normal business
practice.
C. RoseStar is not a "Related Party Tenant"
Rents received from RoseStar will not qualify as "rents from real
property" if RoseStar is a "related party tenant." RoseStar will be a "related
party tenant" if the Company, or an owner of 10 percent or more of the Company,
directly or constructively owns 10 percent or more of the assets or net profits
of RoseStar.(18) Constructive ownership is determined for purposes of this test
by applying the rules of section 318(a) as modified by section 856(d)(5).
Those rules generally provide that if 10 percent 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.
RoseStar will not be treated as a "related party tenant" because an
individual, Sanjay Varma, currently owns a 91 percent interest in its assets
and net profits. In reaching this conclusion, we recognize that Sanjay Varma
owns certain Units of the Operating Partnership.(19) The Operating Partnership
has represented that (i) Sanjay Varma does not own more than 10 percent of the
value of the Company's stock, (ii) Sanjay Varma is not expected to own more
than 10 percent of the value of the Company's stock in the future, and (iii)
neither the Operating Partnership nor the Company intends to acquire, directly
or constructively, an interest of 10 percent or more in the assets or net
profits of RoseStar at any time in the future. Moreover, Article 7.8 of the
Lease limits the ability of RoseStar and its members and managers to acquire,
directly or constructively, a 6 percent stock interest in the Company, and
Section 6.4 of the First Amended and
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(17)See, e.g., P.L.R. 8803007 (September 23, 1987) (percentage rent based on
gross revenues in excess of gross revenues for a base year treated as "rents
from real property"); cf. P.L.R. 9104018 (October 26, 1990) (interest based on
gross revenues in excess of a floor amount treated as qualifying interest under
section 856(f)).
(18)Section 856(d)(2)(B)(ii).
(19)See Rev. Rul. 73-194, 1973-1 C.B. 355 (management company treated as an
independent contractor with respect to a REIT, where an affiliate of the
management company and the REIT were partners).
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<PAGE> 79
Restated Articles of Incorporation of the Company prevents RoseStar and its
members and managers from acquiring more than 8 percent of the Company's stock.
In concluding that RoseStar will not be treated as a "related party
tenant," we have applied the definition of related party tenant set forth in
section 856(d)(2)(B)(ii), which applies to tenants which are not corporations.
If RoseStar is not treated as a partnership for federal income tax purposes,
but is instead treated as an association taxable as a corporation, then the
applicable definition of related party tenant is the one set forth in section
856(d)(2)(B)(i), which looks to control over voting securities. If RoseStar
were treated as a corporation for federal income tax purposes, Gerald W.
Haddock and John C. Goff would likely be deemed to own all of its voting stock,
because of the extensive powers that they are granted as managers under the
RoseStar Regulations. If this were the case, it would be necessary to consider
whether the ownership of such voting stock could possibly be attributed to the
Company under the constructive ownership rules described above or otherwise.
An entity which has associates and an objective to carry on a business
for joint profit will be treated as a partnership for federal income tax
purposes, and not as an association taxable as a corporation, if it has not
more than two of the following four characteristics of a corporation: (i)
continuity of life; (ii) centralization of management; (iii) limited liability;
and (iv) free transferability of interests.(20) The entity must also have no
other characteristics which are significant in determining its classification.
Generally, other factors are considered only insofar as they relate to the
determination of the presence or absence of the foregoing corporate
characteristics.(21) The IRS has applied this four-factor test in determining
whether limited liability companies formed under the Texas Limited Liability
Company Act (the "Act") are partnerships for federal income tax purposes.(22)
The IRS has issued Rev. Proc. 95-10, which specifies conditions which must be
satisfied for a limited liability company to receive a favorable advanced
ruling that it will be classified as a partnership for federal income tax
purposes.(23) RoseStar should satisfy these conditions. However, such
conditions are applicable only in determining whether rulings will be issued
and are not intended as substantive rules for determination of partnership
status.
An organization will be treated as possessing the corporate
characteristic of continuity of life, even if the agreement organizing an
entity provides that it is to continue only for a stated period, unless a
member has the power to dissolve the organization at an earlier time.(24)
Article 6.01
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(20)Treas. Reg. Section 301.7701-2(a).
(21)See Rev. Rul. 79-106, 1979-1 C.B. 448.
(22)See, e.g., P.L.R. 9242025 (July 22, 1992) and P.L.R. 9218078 (January 31,
1992).
(23)1995-3 I.R.B. 20.
(24)Treas. Reg. Section 301.7701-2(b)(3).
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of the Act provides, in part, that except as otherwise provided in the
company's regulations, a limited liability company shall be dissolved upon the
death, retirement, resignation, expulsion, bankruptcy, or dissolution of a
member or the occurrence of any other event which terminates the continued
membership of a member in the limited liability company, unless there is at
least one remaining member and the business of the limited liability company is
continued by the consent by the number of members or class thereof stated in
the articles of organization or regulations of the limited liability company or
of not so stated, by all remaining members. Article 2 of the RoseStar Articles
provides that the duration of RoseStar is until the close of business on
December 31, 2015, or until its earlier dissolution in accordance with the
provisions of the Act or the Regulations. Article 10.2 of the RoseStar
Regulations provides, in part, that RoseStar shall be dissolved upon the
withdrawal, death, retirement, resignation, expulsion, bankruptcy, legal
incapacity or dissolution of any member, unless the business of RoseStar is
continued by the consent of all the remaining members within ninety days.
Accordingly, RoseStar will lack the corporate characteristic of continuity of
life.
An organization will be treated as possessing the corporate
characteristic of free transferability of interests if the members owning all
or substantially all of the interests in an organization may substitute for
themselves without the consent of the other members a person who is not a
member of the organization.(25) Article 4.05 of the Act provides, in part, that
unless otherwise provided by the company's regulations, a membership interest
is assignable in whole or in part; an assignment of a member's interest does
not entitle the assignee to become, or to exercise rights or powers of a
member; and until the assignee becomes a member, the assignor member continues
to be a member and to have the power to exercise any rights or powers of a
member, except to the extent those rights or powers are assigned. Article 4.07
of the Act provides, in part, that an assignee of a membership interest may
become a member if and to the extent that the company's regulations so provide,
or all members consent. Article 9.3 of the RoseStar Regulations provides, in
part, that no member shall have the right to substitute in its place a
transferee unless consent is given by the Managers and a majority of the other
members, which consent may be withheld in the discretion of the Managers or the
other members. Accordingly, RoseStar will lack the corporate characteristic of
free transferability of interests. Because RoseStar will lack the corporate
characteristics of continuity of life and free transferability of interests, in
our opinion it will be treated as partnership for federal income tax purposes.
D. Incidental Personal Property
As noted above, in order for the rent under the Lease to be treated as
"rents from real property," the rents attributable to the Operating
Partnership's personal property leased under or in connection with the Lease
must not be greater than 15 percent of the rents received under the Lease. The
rent attributable to personal property leased under or in connection with a
lease of real property is the amount that bears the same ratio to total rent
for the taxable year as (i) the
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(25)Treas. Reg. Section 301.7701-2(e).
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<PAGE> 81
average of the adjusted bases of the personal property leased under or in
connection with a lease of real property at the beginning and at the end of the
taxable year bears to (ii) the average of the aggregate adjusted bases of the
real and personal property subject to the lease at the beginning and at the end
of such taxable year (the "Adjusted Basis Ratio").(26) The Operating
Partnership has represented that the adjusted tax basis of the personal
property leased under or in connection with the Lease will not represent more
than 15 percent of the aggregate adjusted tax basis of the Denver Marriott at
any time. Moreover, in Article 36.2 of the Lease, the parties agreed that the
adjusted tax basis of the personal property leased under or in connection with
the Lease will not represent more than 15 percent of the aggregate adjusted tax
basis of the Denver Marriott at any time.
E. Provision of Services by the Operating Partnership
1. Income Derived under the Terms of the Lease
Although the Operating Partnership may treat charges for services
customarily furnished or rendered in connection with the rental of the Denver
Marriott as "rents from real property," any services rendered to the occupants
of the Denver Marriott must be furnished or rendered by an independent
contractor from whom the Company does not derive or receive any income.(27)
Moreover, to the extent that any independent contractors provide noncustomary
services to the occupants of the Denver Marriott, the cost of such services
must not be borne by the Operating Partnership.(28) Under the terms of the
Lease, the Operating Partnership will not be required to provide any services,
customary or noncustomary, in connection with the rental of the Denver
Marriott. Instead, all services relating to the operation of the Denver
Marriott will be provided by Marriott to RoseStar under the terms of the
Management Agreement. The Operating Partnership will not bear the cost of any
of the services provided by Marriott to RoseStar. Instead, such costs will be
borne by RoseStar pursuant to its assumption of the Operating Partnership's
obligations under the Management Agreement.
Based on the foregoing, we believe that the provision of any
noncustomary services to the occupants of the Denver Marriott by Marriott will
have no effect on the qualification of the income derived from the Denver
Marriott as "rents from real property." In fact, the IRS has issued a private
letter ruling in which it has treated the income derived from several leases of
hotel properties as "rents from real property" in a situation where the lessees
had contracted with a third-party to conduct the day-to-day operations of the
hotels.(29) Our conclusion is not altered by the
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(26)Section 856(d)(1)(C).
(27)Sections 856(d)(1), 856(d)(2)(C); Treas. Reg. Section 1.512(b)-1(c)(5).
(28)Treas. Reg. Section 1.856-4(b)(5).
(29)See, P.L.R. 8117036 (January 27, 1981).
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<PAGE> 82
fact that the Operating Partnership will remain liable for any obligations
arising under the Management Agreement, to the extent that they are not
satisfied by the Tenant. The Operating Partnership should not be treated as
bearing the cost of the services provided by Marriott merely because it will be
liable for RoseStar's obligations under the Management Agreement. The Operating
Partnership will not be retaining this liability in an attempt to provide
services to RoseStar. Instead, it will be retaining this liability only as an
accommodation, in order to gain Marriott's consent to its purchase of the
Denver Marriott. Moreover, the Operating Partnership believes that it is
highly unlikely that it will ever be required to reimburse Marriott for the
costs and expenses of operating the Denver Marriott because of a default by
RoseStar under the Management Agreement. This is because (i) the Denver
Marriott is projected to generate enough gross income to cover the payments to
Marriott under the Management Agreement, (ii) in connection with Section 7.7 of
the Lease, RoseStar represents that it has a net worth of at least $200,000,
(iii) in connection with Section 7.9 of the Lease, RoseStar covenants that it
will retain all of the income it earns from the Denver Marriott and shall not
distribute any earnings to its beneficial owners, except as needed for federal
and state income taxes payable on taxable income from the Denver Marriott,
until it has accumulated and is holding in reserve funds which are sufficient
to pay at least one monthly payment of Base Rent under the Lease, plus at least
one monthly payment of Base Rent under all other leases between it and the
Operating Partnership, and (iv) in the view of the Operating Partnership,
RoseStar's capitalization is adequate to allow RoseStar to assume RoseStar's
obligations under the Lease.
2. Income Derived in the Case of a Default under the Lease
If the Operating Partnership were required to reimburse Marriott for
the costs of operating the Denver Marriott because of a default by RoseStar
under the terms of the Management Agreement, we have concluded that the income
derived by the Operating Partnership from the Denver Marriott would be treated
as "qualifying income" for purposes of the 75 percent and 95 percent tests,
assuming that such default does not occur before May 1, 1996. This is because,
if the Operating Partnership were required to reimburse Marriott for the cost
of operating the Denver Marriott, this would constitute an event of default
under Article 16.1 of the Lease, allowing the Operating Partnership to
terminate RoseStar's leasehold interest in the Denver Marriott. As a result of
such a termination of the Lease, any income derived by the Operating
Partnership from the Denver Marriott after the default would be treated as
income from foreclosure property.
The Operating Partnership would be able to continue to operate the
Denver Marriott after any default under the Lease, without affecting its status
as foreclosure property, assuming that any such default does not occur before
May 1, 1996. This is because Marriott will provide all services relating to
the operation of the Denver Marriott and starting on May 1, 1996, Marriott will
qualify as an independent contractor from whom the Company will not derive any
income . As noted above, a REIT can use foreclosure property in the conduct of
an active trade or business, as long
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<PAGE> 83
as this is done through the use of an independent contractor, from whom the
REIT does not derive or receive any income.(30)
As noted above, real property acquired upon default under a lease is
not eligible to be treated as foreclosure property if the lease is entered into
with an intent to evict or foreclose, or if the REIT knows or has reason to
know that default would occur.(31) This is not the case in the present
situation because (i) the Denver Marriott is projected to generate enough gross
income to produce a profit for RoseStar, (ii) in connection with Section 7.7 of
the Lease, RoseStar will represent that it has a net worth of at least
$200,000, (iii) in connection with Section 7.9 of the Lease, RoseStar covenants
that it will retain all of the income it earns from the Denver Marriott and
shall not distribute any earnings to its beneficial owners, except as needed
for federal and state income taxes payable on taxable income from the Denver
Marriott, until it has accumulated and is holding in reserve funds which are
sufficient to pay at least one monthly payment of Base Rent under the Lease,
plus at least one monthly payment of Base Rent under all other leases between
it and the Operating Partnership, and (iv) in the view of the Operating
Partnership, RoseStar's capitalization is adequate to allow RoseStar to assume
RoseStar's obligations under the Lease.
The Denver Marriott would in any event qualify as foreclosure property
only for a period of up to two years, beginning on the date of its acquisition
by the Operating Partnership, unless the Operating Partnership obtains an
extension of the grace period from the IRS.(32) Therefore, in the event the
Operating Partnership takes possession of the Denver Marriott as a result of a
default under the lease, presumably the Operating Partnership will sell the
Denver Marriott or within two years rent it to another tenant under a lease
that will produce "rents from real property."
Prior to May 1, 1996, Crescent may be treated as deriving income from
Marriott, because on April 24, 1995 the Operating Partnership received a
payment of $600,000 and a note in the principal amount of $1,800,000 from
Marriott in connection with its sale of certain contract rights and investments
rights to Marriott. The principal balance of the note and all accrued interest
thereon are to be paid by Marriott in a single payment on April 30, 1996. As a
consequence, prior to May 1, 1996 the Operating Partnership will be treated as
deriving interest income and capital
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(30)Section 856(e)(4)(C). The IRS clearly intended for REITs to be able to
treat hotels operated by independent contractors as foreclosure property. For
instance, the Treasury regulations defining foreclosure property refer to hotel
properties twice. See, Treas. Reg. Sections 1.856-6(b)(2), 1.856-6(d)(2). In
addition, the IRS has also recently issued a private letter ruling in which it
treated income received from hotels acquired pursuant to a bankruptcy petition
as income from foreclosure property, where the hotels were operated by third
party managers. P.L.R. 9420013 (2/15/94).
(31)Treas. Reg. Section 1.856-6(b)(3).
(32)Section 856(e)(2).
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<PAGE> 84
gains income from Marriott. Therefore, during the period prior to May 1, 1996,
Marriott will not qualify as an independent contractor from whom the Company
does not derive any income.(33)
V. CONCLUSION
Based on the assumptions stated above, it is our opinion that (i) all
of the income that the Operating Partnership derives from the Denver Marriott
will be treated as "qualifying income" for purposes of the 95 percent test and
(ii) all of the income the Operating Partnership derives from the Denver
Marriott, will be treated as "qualifying income" for purposes of the 75 percent
test.
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(33)The fact that the Operating Partnership will derive income from Marriott
at a time prior to any default under the Lease should not have any affect on
the treatment of any income that the Operating Partnership derives from the
Denver Marriott after any default under the Lease. See, Tax Management
Memorandum, p. 7 (November 7, 1975), as cited in Allen and Fisher, 107-5th
T.M., Real Estate Investment Trusts , p. A-77 (the IRS has ruled privately that
an entity should be treated as an independent contractor from whom a REIT
derived no income for the period such entity managed the REIT's rental
properties, despite the fact that the entity purchased foreclosure property
from the REIT immediately after the termination of its management contract).
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<PAGE> 85
September 27, 1996
Crescent Real Estate Equities, Inc.
900 Third Avenue, Suite 1800
New York New York 10022
Ladies and Gentlemen:
On June 30, 1995 we provided you with a memorandum analyzing the
impact of the purchase of the Denver Marriott City Center (the "Hotel
Property") by Crescent Real Estate Equities Limited Partnership (the "Operating
Partnership") would have on the ability of Crescent Real Estate Equities, Inc.
(the "Company") to continue to qualify as a real estate investment trust (a
"REIT") under section 856(c).(1) That memorandum concluded that, subject to
certain assumptions, in our opinion (i) all of the income that the Operating
Partnership derived from the Hotel Property would be treated as "qualifying
income" for purposes of the 95 percent gross income test for REIT qualification
under section 856(c)(2) (the "95 percent test") and (ii) all of the income that
the Operating Partnership derived from the Hotel Property would be treated as
"qualifying income" for purposes of the 75 percent gross income test for REIT
qualification under section 856(c)(3) (the "75 percent test"). The June 30,
1995 memorandum was based upon, among other items, our review of an Amended and
Restated Lease Agreement between dated June 30, 1995 between the Operating
Partnership, as lessor, and RoseStar Management, LLC ("RoseStar"), as lessee
(the "Lease"). The ownership of RoseStar remains the same as described in our
June 30, 1995 memorandum.
This letter is intended to update the opinions expressed in our June
30, 1995 memorandum. The opinions set forth herein are based upon the existing
provisions of the Code, and the reported interpretations thereof by the IRS and
by the courts in effect as of the date hereof, all of which are subject to
change, both retroactively or prospectively, and to possibly different
interpretations. We assume no obligation to update the opinions set forth in
this letter. We believe that the conclusions expressed herein, if challenged
by the IRS, would be sustained in court. However, because our opinions are not
binding upon the IRS or the courts, there can be no assurance that contrary
positions may not be successfully asserted by the IRS.
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(1) All section references are to the Internal Revenue Code of 1986, as
amended (the "Code"), or to the regulations issued thereunder, unless
otherwise noted.
<PAGE> 86
Crescent Real Estate Equities, Inc.
September 27, 1996
Page 2
I. Documents and Representations
For the purpose of rendering this opinion, we have examined and
relied on originals, or copies certified or otherwise identified to our
satisfaction, of the following: (1) the Lease; (2) the Limited Guaranty
Agreement by Gerald Haddock, John Goff and Sanjay Varma, as guarantors in favor
of the Operating Partnership (the "Guaranty); (3) the Articles of Organization
of RoseStar Management, LLC (the "RoseStar Articles"), (4) the Regulations of
RoseStar Management, LLC (the "RoseStar Regulations"), (5) the First Amended
and Restated Articles of Incorporation of Crescent Real Estate Equities, Inc.
(the "Crescent Articles"); and (6) such other documents or information as we
have deemed necessary for the opinion set forth below. In our examination, we
have assumed the genuineness of all signatures, the legal capacity of natural
persons, the authenticity of all documents submitted to us as originals, the
conformity to original documents of all documents submitted to us as certified
or photostatic copies, and the authenticity of the originals of such copies.
For the purpose of rendering these opinions, we have also assumed
that all statements of facts and assumptions described in our June 30, 1995
memorandum remain correct, unless otherwise noted.
II. Opinions
Based on the foregoing, it is our opinion that (i) the Lease will be
treated as a lease for federal income tax purposes, (ii) all of the income that
the Operating Partnership derives from the Hotel Property will be treated as
"qualifying income" for purposes of the 95 percent test, and (iii) all of the
income that Operating Partnership derives from the Hotel Property will be
treated as "qualifying income" for purposes of the 75 percent test.
In giving these opinions, we note that Marriott International, Inc.
("Marriott") which operates the Hotel Property as successor to Marriott
Corporation under the terms of the agreement between the Original Owner and
Marriott Corporation dated January 10, 1979, as amended on January 10, 1979,
February 16, 1979, May 11, 1979, July 27, 1979, March 25, 1980, December 18,
1980, July 15, 1981, January 4, 1982, and November 19, 1993 (the "Management
Agreement") is currently subleasing space from Gaskins Real Estate Brokerage,
Inc. ("Gaskins"), a tenant at 301 Congress Avenue, a property in which the
Operating Partnership owns an indirect interest. Under the terms of Gaskins'
prime lease, Gaskins is required make a payment to the lessor (an "excess rent
payment") equal to the amount by which any rents under a sublease exceed the
amount that Gaskins is required to pay to the lessor under the terms of the
lease. Gaskins' sublease to Marriott was entered into before the Operating
Partnership acquired its interest in 301 Congress Avenue and it is scheduled to
<PAGE> 87
Crescent Real Estate Equities, Inc.
September 27, 1996
Page 3
expire at the end of February 1997. Marriott has already vacated the premises
sublet from Gaskins at 301 Congress Avenue and the Operating Partnership will
use its best efforts to prevent any extension or renewal of this sublease. We
do not believe that the existence of the sublease of space in 301 Congress
Avenue by Gaskins to Marriott will affect the opinion expressed in our June 30,
1995 memorandum regarding the treatment of amounts derived from the Hotel
Property in the event of a default under the Lease, to the extent any such
default occurs after the termination of the sublease to Marriott. In our June
30, 1995 memorandum we indicated that amounts derived from the Hotel Property
in the event of a default under the Lease would qualify as income from
foreclosure property, if, among other things, at the time of the default,
Marriott qualifed as an independent contractor from whom the Company did not
derive any income. We do not believe that the Company will be treated as
indirectly deriving income from Marriott as a result of accruing any Excess
Rent Payments under the terms of Gaskins' lease at 301 Congress, and in any
event, even if the Company is treated as indirectly deriving income from
Marriott, it will cease to be treated as derivng such income from Marriott
after the end of February 1996, if Marriott's sublease terminates at that time.
III. Additional Limitations
The foregoing opinions are limited to the specific matters covered
thereby and should not be interpreted to imply that the undersigned has offered
its opinion on any other matter.
Very truly yours,
SHAW, PITTMAN, POTTS & TROWBRIDGE
By:
--------------------------------
Charles B. Temkin, P.C.
<PAGE> 88
MEMORANDUM
TO: David Dean
FROM: Charles B. Temkin
Michael A. Jacobs
DATE: December 19, 1995
RE: Characterization of Income Derived from the Hyatt Regency
Albuquerque Plaza
I. OVERVIEW
Crescent Real Estate Equities Limited Partnership (the "Operating
Partnership") purchased the Hyatt Regency Albuquerque Plaza (the "Albuquerque
Hyatt") from Albuquerque Plaza Partners (the "Prior Owner"), on December 19,
1995. Crescent Real Estate Equities, Inc. (the "Company") is currently the
sole shareholder of two corporations, one of which is the sole general partner
of and one of which is a limited partner of the Operating Partnership. These
two corporations constitute qualified REIT subsidiaries within the meaning of
section 856(i).(1)
This memorandum analyzes the impact that the purchase of the
Albuquerque Hyatt will have on the ability of the Company to continue to
qualify as a real estate investment trust (a "REIT") under section 856(c).
More specifically, it analyzes whether the income the Operating Partnership
derives from the Albuquerque Hyatt is "qualifying income" for purposes of the
75 percent and 95 percent gross income tests for REIT qualification. This
memorandum concludes that, subject to certain assumptions, in our opinion (i)
all of the income that the Operating Partnership derives from the Albuquerque
Hyatt will be treated as "qualifying income" for purposes of the 95 percent
test and (ii) all of the income the Operating Partnership derives from the
Albuquerque Hyatt will be treated as "qualifying income" for purposes of the 75
percent test.
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(1) All section references herein are to the Internal Revenue Code of 1986, as
amended (the "Code"), or to the regulations issued thereunder, unless otherwise
noted.
<PAGE> 89
II. FACTS AND ASSUMPTIONS
The Prior Owner contracted with Hyatt Corporation ("Hyatt") to operate
the Albuquerque Hyatt. Under the terms of the agreement between the Prior
Owner and Hyatt dated October 11, 1988, as amended on February 14, 1990, and
August 30, 1994 (the "Management Agreement"), Hyatt is obligated to provide all
services in relation to the operation of the Albuquerque Hyatt and collect all
hotel receipts. In exchange for these services, Hyatt is to be reimbursed for
the costs of operating the Albuquerque Hyatt and paid a management fee. This
fee is paid out of hotel receipts; it is based on the profits, if any, from
operation of the Albuquerque Hyatt. Article 15.2 of the Management Agreement
requires that all assignments of the Management Agreement be approved by Hyatt
and that any assignees expressly assume the obligations of the owner under the
Management Agreement. Therefore, in connection with its purchase of the
Albuquerque Hyatt, the Operating Partnership assumed all of the obligations of
the Prior Owner under the Management Agreement.
When the Operating Partnership purchased the Albuquerque Hyatt, it
immediately leased it to RoseStar Management, LLC ("RoseStar") pursuant to a
Lease Agreement dated December 19, 1995 (the "Lease"). Pursuant to Article 2
of the Lease, the Operating Partnership assigned its interest in the Management
Agreement to RoseStar; and pursuant to Article 15.2 of the Management
Agreement, RoseStar assumed all of the Operating Partnership's obligations
thereunder. However, as a condition of its approval of the Lease, Hyatt
required that the Operating Partnership remain liable for all obligations of
the Operating Partnership under the Management Agreement that was assumed by
RoseStar.
Currently, Sanjay Varma owns a 91 percent interest in the assets and
net profits of RoseStar, while Gerald W. Haddock and John C. Goff, the
managers of RoseStar, each own a 4.5 percent interest in its assets and net
profits. RoseStar currently leases another hotel, located in Denver, Colorado
(the "Denver Marriott"), from the Operating Partnership. We have provided you
with a memorandum dated June 30, 1995 regarding the characterization of income
derived by the Operating Partnership from the lease of the Denver Marriott to
RoseStar.
For purposes of this memorandum, we have examined and relied upon (1)
the Management Agreement, (2) the Lease, (3) the Articles of Organization of
RoseStar Management, LLC (the "RoseStar Articles"), (4) the Regulations of
RoseStar Management, LLC (the "RoseStar Regulations"), (5) the First Amended
and Restated Articles of Incorporation of Crescent Real Estate Equities, Inc.
(the "Crescent Articles"), and (6) such other documents or information as we
deemed necessary for the opinions set forth below. In our examination, we have
assumed the genuineness of all signatures, the legal capacity of natural
persons, the authenticity of all documents submitted to us as originals, the
conformity to original documents of all documents submitted to us as certified
or photostatic copies, and the authenticity of the originals of such copies.
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<PAGE> 90
This memorandum is based upon existing provisions of the Code,
Treasury regulations, and the reported interpretations thereof by the Internal
Revenue Service ("IRS") and by the courts in effect as of the date hereof, all
of which are subject to change, both retroactively or prospectively, and to
possibly different interpretations. We assume no obligation to update the
opinions set forth in this memorandum. We believe that the conclusions
expressed herein, if challenged by the IRS, would be sustained in court.
However, because our opinions are not binding upon the IRS or the courts, there
can be no assurance that contrary positions may not be successfully asserted by
the IRS.
In addition, this memorandum is based on various assumptions and is
conditioned upon certain representations made by the Operating Partnership and
its sole general partner, Crescent Real Estate Equities, Ltd., as to factual
and other matters as set forth in the attached letter.
III. LEGAL BACKGROUND
A. 75 Percent and 95 Percent Tests
In order to qualify as a REIT for tax purposes, the Company must
satisfy certain tests with respect to the composition of its gross income on an
annual basis. First, at least 75 percent of the Company's gross income
(excluding gross income from certain prohibited transactions) for each taxable
year must consist of temporary investment income or of certain defined
categories of income derived directly or indirectly from investments relating
to real property or mortgages on real property. These categories include,
subject to various limitations, rents from real property, interest on mortgages
on real property, gains from the sale or other disposition of real property
(including interests in real property and mortgages on real property) not
primarily held for sale to customers in the ordinary course of business, income
from foreclosure property, and amounts received as consideration for entering
into either loans secured by real property or purchases or leases of real
property.(2) Second, at least 95 percent of the Company's gross income
(excluding gross income from certain prohibited transactions) for each taxable
year must be derived from income qualifying under the 75 percent test and from
dividends, other types of interest and gain from the sale or disposition of
stock or securities, or from any combination of the foregoing.(3)
In applying these income tests, REITs that are partners in a
partnership are required to include in their gross income their proportionate
share of the partnership's gross income. In addition, such REITs are to treat
this partnership gross income as retaining the same character as the items of
gross income of the partnership for purposes of section 856.(4) Thus, the
character of any
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(2)Section 856(c)(3).
(3)Section 856(c)(2).
(4)Treas. Reg. Section 1.856-3(g).
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<PAGE> 91
income derived by the Operating Partnership from the Albuquerque Hyatt will
affect the ability of the Company to qualify as a REIT.
B. Rents from Real Property
Rents from real property satisfy both the 75 percent and 95 percent
tests for REIT qualification only if several conditions are met. First, the
amount of rent must not be based in whole or in part on the income or profits
of any person. An amount received or accrued generally will not be excluded
from the term "rents from real property" solely by reason of being based on a
fixed percentage or percentages of receipts or sales.(5) Second, the Code
provides that rents received from a tenant will not qualify as "rents from real
property" if the REIT, or an owner of 10 percent or more of the REIT, directly
or constructively, owns 10 percent or more of such tenant (a "Related Party
Tenant").(6) Third, if rent attributable to personal property leased in
connection with a lease of real property is greater than 15 percent of the
total rent received under the lease, then the portion of rent attributable to
such personal property will not qualify as "rents from real property."(7)
Finally, for rents to qualify as "rents from real property," a REIT 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 REIT derives no revenue. However, rents will be qualified as "rents
from real property" if a REIT directly performs services in connection with the
lease of the property, if those services are "usually or customarily rendered"
in connection with the rental of space for occupancy, and such services are not
considered to be rendered to the occupant of the property.(8)
C. Income from Foreclosure Property
Income from foreclosure property is treated as "qualifying income" for
purposes of the 75 percent and 95 percent tests (although any net income from
foreclosure property is taxed at the maximum corporate rate). Foreclosure
property is any real property, and any personal property incident to such real
property, acquired by a REIT through default under a mortgage or a lease. A
REIT may elect to treat such property as foreclosure property for a grace
period of up to two years.(9) However, such property will cease to qualify as
foreclosure property if it is used by the REIT in a trade or business more than
90 days after it is acquired and it is not operated through
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(5)Section 856(d)(2)(A).
(6)Section 856(d)(2)(B).
(7)Section 856(d)(1)(C).
(8)Sections 856(d)(1)(B), 856(d)(2)(C).
(9)Section 856(e).
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<PAGE> 92
an independent contractor from whom the REIT does not derive or receive any
income.(10) Moreover, property is not eligible to be treated as foreclosure
property if the lease is entered into with an intent to evict or foreclose, or
if the REIT knows or has reason to know that default would occur.(11)
IV. DISCUSSION
A. Lease Will be Treated as a Lease for Federal Income Tax
Purposes
In order for any income derived by the Operating Partnership from the
Albuquerque Hyatt to constitute either "rents from real property," or in the
case of a default under the Lease, "gross income from foreclosure property,"
the Lease must be treated as a lease for federal income tax purposes and not be
treated as a service contract, management contract or other type of
arrangement. This determination depends on an analysis of all the surrounding
facts and circumstances. In making this determination, courts have considered
a variety of factors, including the following: (i) the intent of the parties,
(ii) the form of the agreement, (iii) the degree of control over the business
conducted at the property that is provided to the lessee (e.g., whether the
lessee has substantial rights of control over the operation of the property and
its business), (iv) the extent to which the lessee has the risk of loss from
operations of the business conducted as the property (e.g., whether the lessee
bears the risk of increases in operating expenses and of decreases in
revenues), and (v) the extent to which the lessee has the opportunity to
benefit from operations of the business conducted at the property (e.g.,
whether the lessee benefits from decreased operating expenses or increased
revenues).(12)
In addition, section 7701(e) provides that a contract that purports to
be a service contract, partnership agreement, or another type of arrangement
will be 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 any savings
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
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(10)Section 856(e)(4).
(11)Treas. Reg. Section 1.856-6(b)(3).
(12)See, e.g., Xerox Corp. v. U.S., 80-2 USTC Paragraph 9530 (Ct. Cl. Tr. Div.
1980), aff'd per curiam, 656 F.2d 659 (Ct. Cl. 1981).
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<PAGE> 93
services to entities unrelated 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, partnership agreement, or some other type of arrangement should be
treated as a lease is inherently factual, the presence or absence of any single
factor may not be dispositive in every case.(13)
We have concluded that the Lease will be treated as a lease for
Federal income tax purposes, rather than a service contract, management
contract or other type of arrangement. This conclusion is based, in part, on
the following facts: (i) the Operating Partnership and RoseStar intend their
relationship to be that of lessor and lessee (as evidenced by the terms of the
Lease), (ii) RoseStar will have the right to exclusive possession, use and
quiet enjoyment of the Albuquerque Hyatt during the term of the Lease and the
right to uninterrupted control in the operation of the business conducted at
the Albuquerque Hyatt (subject to its assumption of the Management Agreement),
(iii) RoseStar will dictate how the Albuquerque Hyatt is maintained and
improved, (iv) RoseStar will bear all the costs and expenses of operating the
Albuquerque Hyatt other than the replacement of furniture, fixtures and
equipment, (v) RoseStar will benefit from any savings in the costs of operating
the Albuquerque Hyatt during the term of the Lease, (vi) in the event of damage
or destruction to the Albuquerque Hyatt, RoseStar will be at economic risk
because its obligation to make rental payments will not abate, (vii) RoseStar
will indemnify the Operating Partnership against all liabilities imposed on the
Operating Partnership during the term of the Lease by reason of injury to
persons or damage to property occurring at the Albuquerque Hyatt or RoseStar's
use, management, maintenance or repair of the Albuquerque Hyatt, (viii)
RoseStar is obligated to pay substantial fixed rent for the period of use of
the Albuquerque Hyatt, regardless of whether its revenues exceed its costs and
expenses, and (ix) RoseStar stands to incur substantial losses (or derive
substantial profits) depending on how successfully it operates the Albuquerque
Hyatt.
We do not believe that our conclusion that the Lease of the
Albuquerque Hyatt will be treated as a lease for Federal income tax purposes is
affected by the fact that RoseStar entered the Lease subject to its assumption
of the Operating Partnership's obligations under the preexisting Management
Agreement. The Management Agreement gives Hyatt control over the day-to-day
operation of the Albuquerque Hyatt and allows Hyatt to share with RoseStar in
the benefits of any increases in revenues or cost savings in the operation of
the Albuquerque Hyatt. However, Hyatt's operation of the Albuquerque Hyatt
will not be controlled by the Operating Partnership, and the Management
Agreement does not affect the fact that RoseStar bears most of the risk of loss
if the Albuquerque Hyatt is not successful. Moreover, the IRS has issued a
private letter ruling in which it treated leases of several hotel properties as
producing "rents from real property" in a situation where the lessees had
contracted with a third party to conduct the day-to-day
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(13)P.L.R. 8918012 (January 24, 1989).
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<PAGE> 94
operations of the hotels.(14) This ruling suggests that the IRS will respect a
lease of a hotel for federal income tax purposes even if the hotel is operated
by an independent contractor rather than by the lessee.
The Lease is structured in form so that the Operating Partnership
retains ownership of all the personal property leased to RoseStar in connection
with RoseStar's lease of the Albuquerque Hyatt (the "FF&E"). However, if the
term of the Lease equals or exceeds the useful life of some or all of the FF&E,
it is possible that the Lease could be treated for federal income tax purposes
as a financing arrangement. In such a case, RoseStar would be treated as
having acquired ownership of the FF&E for federal income tax purposes in
exchange for an obligation to make future payments of principal and interest to
the Operating Partnership. Nonetheless, we do not believe that the
recharacterization of the Lease as a financing arrangement with respect to the
FF&E would have a material effect on the ability of the Company to satisfy the
requirements for taxation as a REIT. This is because, if a portion the of the
payments made by RoseStar under the Lease were characterized as interest on
indebtedness secured by the FF&E, rather than rents from real property, that
portion would still satisfy the 95 percent gross income test (although it would
not satisfy the 75% gross income test).(15)
B. Percentage Rent Provision is not Profit-Based
Pursuant to the Lease, RoseStar will be obligated to pay the Operating
Partnership base rent and percentage rent. Under the regulations, percentage
rent based on a percentage of gross receipts or sales in excess of a floor
amount, which is how the percentage rent is structured under the Lease, will
not qualify as "rents from real property" unless (i) such floor amount does not
depend in whole or in part on the income or profits of the lessee, (ii) the
percentage and the floor amount are fixed at the time the lease is entered
into, (iii) the percentage and the floor amount are not renegotiated during the
term of the lease in a manner that has the effect of basing the percentage rent
on income or profits, and (iv) the percentage and the floor amount conform with
normal business practice.(16)
Under the terms of Article 4.2 of the Lease, RoseStar will pay
percentage rent equal on an annual basis to the sum of (i) 17.5 percent of the
excess of annual gross receipts from room rentals over $6,000,000 and (ii) 2.5
percent of the excess of annual gross receipts from the food and beverage
facilities at the Albuquerque Hyatt over $2,000,000. This formula effectively
rewards
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(14)See, P.L.R. 8117036 (January 27, 1981).
(15)If the Lease were recharacterized as a financing arrangement with respect
to the FF&E, it also might result in some minor timing differences with respect
to the Company's recognition of income. These differences would result from
(a) the recharacterization of a portion RoseStar's payments under the Lease as
a return of principal and (b) the Company's loss of any depreciation
deductions attributable to the FF&E.
(16)Treas. Reg. Section 1.866-4(b)(3).
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<PAGE> 95
RoseStar for any increases in gross receipts from rooms and from other sources
over the threshold amounts. This type of formula does not base the percentage
rent on RoseStar's income or profits, and similar formulas have been treated by
the IRS as generating "rents from real property."(17) Moreover, the Operating
Partnership has represented that (i) the floor amounts used to compute the
percentage rent under the Lease do not depend in whole or in part on the income
or profits of any person, (ii) the percentage rent provision of the Lease will
not be renegotiated during the term of the Lease or at the expiration or
earlier termination of the Lease in a manner that has the effect of basing the
rent on income or profits, and (iii) the percentage rent provision of the Lease
conforms with normal business practice. In addition, based on our experience
and an examination of the Lease and the Albuquerque Hyatt projections, the
Lease appears to conform with normal business practice.
C. RoseStar is not a "Related Party Tenant"
Rents received from RoseStar will not qualify as "rents from real
property" if RoseStar is a "related party tenant." RoseStar will be a "related
party tenant" if the Company, or an owner of 10 percent or more of the Company,
directly or constructively owns 10 percent or more of the assets or net profits
of RoseStar.(18) Constructive ownership is determined for purposes of this
test by applying the rules of section 318(a) as modified by section 856(d)(5).
Those rules generally provide that if 10 percent 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.
RoseStar will not be treated as a "related party tenant" because an
individual, Sanjay Varma, currently owns a 91 percent interest in its assets
and net profits. In reaching this conclusion, we recognize that Sanjay Varma
owns certain Units of the Operating Partnership.(19) The Operating Partnership
has represented that (i) Sanjay Varma does not own more than 10 percent of the
value of the Company's stock, (ii) Sanjay Varma is not expected to own more
than 10 percent of the value of the Company's stock in the future, and (iii)
neither the Operating Partnership nor the Company intends to acquire, directly
or constructively, an interest of 10 percent or more in the assets or net
profits of RoseStar at any time in the future. Moreover, Article 7.8 of the
Lease limits the ability of RoseStar and its members and managers to acquire,
directly or constructively, a 6 percent stock interest in the Company, and
Section 6.4 of the First Amended and
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(17)See, e.g., P.L.R. 8803007 (September 23, 1987) (percentage rent based on
gross revenues in excess of gross revenues for a base year treated as "rents
from real property"); cf. P.L.R. 9104018 (October 26, 1990) (interest based on
gross revenues in excess of a floor amount treated as qualifying interest under
section 856(f)).
(18)Section 856(d)(2)(B)(ii).
(19)See Rev. Rul. 73-194, 1973-1 C.B. 355 (management company treated as an
independent contractor with respect to a REIT, where an affiliate of the
management company and the REIT were partners).
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<PAGE> 96
Restated Articles of Incorporation of the Company prevents RoseStar and its
members and managers from acquiring more than 8 percent of the Company's stock.
In concluding that RoseStar will not be treated as a "related party
tenant," we have applied the definition of related party tenant set forth in
section 856(d)(2)(B)(ii), which applies to tenants which are not corporations.
If RoseStar is not treated as a partnership for federal income tax purposes,
but is instead treated as an association taxable as a corporation, then the
applicable definition of related party tenant is the one set forth in section
856(d)(2)(B)(i), which looks to control over voting securities. If RoseStar
were treated as a corporation for federal income tax purposes, Gerald W.
Haddock and John C. Goff would likely be deemed to own all of its voting stock,
because of the extensive powers that they are granted as managers under the
RoseStar Regulations. If this were the case, it would be necessary to consider
whether the ownership of such voting stock could possibly be attributed to the
Company under the constructive ownership rules described above or otherwise.
An entity which has associates and an objective to carry on a business
for joint profit will be treated as a partnership for federal income tax
purposes, and not as an association taxable as a corporation, if it has not
more than two of the following four characteristics of a corporation: (i)
continuity of life; (ii) centralization of management; (iii) limited liability;
and (iv) free transferability of interests.(20) The entity must also have no
other characteristics which are significant in determining its classification.
Generally, other factors are considered only insofar as they relate to the
determination of the presence or absence of the foregoing corporate
characteristics.(21) The IRS has applied this four-factor test in determining
whether limited liability companies formed under the Texas Limited Liability
Company Act (the "Act") are partnerships for federal income tax purposes.(22)
The IRS has issued Rev. Proc. 95-10, which specifies conditions which must be
satisfied for a limited liability company to receive a favorable advanced
ruling that it will be classified as a partnership for federal income tax
purposes.(23) RoseStar should satisfy these conditions. However, such
conditions are applicable only in determining whether rulings will be issued
and are not intended as substantive rules for determination of partnership
status.
An organization will be treated as possessing the corporate
characteristic of continuity of life, even if the agreement organizing an
entity provides that it is to continue only for a stated period, unless a
member has the power to dissolve the organization at an earlier time.(24)
Article 6.01
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(20)Treas. Reg. Section 301.7701-2(a).
(21)See Rev. Rul. 79-106, 1979-1 C.B. 448.
(22)See, e.g., P.L.R. 9242025 (July 22, 1992) and P.L.R. 9218078 (January 31,
1992).
(23)1995-3 I.R.B. 20.
(24)Treas. Reg. Section 301.7701-2(b)(3).
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of the Act provides, in part, that except as otherwise provided in the
company's regulations, a limited liability company shall be dissolved upon the
death, retirement, resignation, expulsion, bankruptcy, or dissolution of a
member or the occurrence of any other event which terminates the continued
membership of a member in the limited liability company, unless there is at
least one remaining member and the business of the limited liability company is
continued by the consent by the number of members or class thereof stated in
the articles of organization or regulations of the limited liability company or
of not so stated, by all remaining members. Article 2 of the RoseStar Articles
provides that the duration of RoseStar is until the close of business on
December 31, 2015, or until its earlier dissolution in accordance with the
provisions of the Act or the Regulations. Article 10.2 of the RoseStar
Regulations provides, in part, that RoseStar shall be dissolved upon the
withdrawal, death, retirement, resignation, expulsion, bankruptcy, legal
incapacity or dissolution of any member, unless the business of RoseStar is
continued by the consent of all the remaining members within ninety days.
Accordingly, RoseStar will lack the corporate characteristic of continuity of
life.
An organization will be treated as possessing the corporate
characteristic of free transferability of interests if the members owning all
or substantially all of the interests in an organization may substitute for
themselves without the consent of the other members a person who is not a
member of the organization.(25) Article 4.05 of the Act provides, in part,
that unless otherwise provided by the company's regulations, a membership
interest is assignable in whole or in part; an assignment of a member's
interest does not entitle the assignee to become, or to exercise rights or
powers of a member; and until the assignee becomes a member, the assignor
member continues to be a member and to have the power to exercise any rights or
powers of a member, except to the extent those rights or powers are assigned.
Article 4.07 of the Act provides, in part, that an assignee of a membership
interest may become a member if and to the extent that the company's
regulations so provide, or all members consent. Article 9.3 of the RoseStar
Regulations provides, in part, that no member shall have the right to
substitute in its place a transferee unless consent is given by the Managers
and a majority of the other members, which consent may be withheld in the
discretion of the Managers or the other members. Accordingly, RoseStar will
lack the corporate characteristic of free transferability of interests. Because
RoseStar will lack the corporate characteristics of continuity of life and free
transferability of interests, in our opinion it will be treated as partnership
for federal income tax purposes.
D. Incidental Personal Property
As noted above, the rents attributable to the Operating Partnership's
personal property leased under or in connection with the Lease must not be
greater than 15 percent of the rents received under the Lease. The rent
attributable to personal property leased under or in connection with a lease of
real property is the amount that bears the same ratio to total rent for the
taxable year as (i) the average of the adjusted bases of the personal property
leased under or in connection
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(25) Treas. Reg. Section 301.7701-2(e).
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with a lease of real property at the beginning and at the end of the taxable
year bears to (ii) the average of the aggregate adjusted bases of the real and
personal property subject to the lease at the beginning and at the end of such
taxable year (the "Adjusted Basis Ratio").(26) The Operating Partnership has
represented that, assuming that the Lease is not characterized as a financing
arrangement with respect to the FF&E, the adjusted tax basis of the FF&E will
not represent more than 15 percent of the aggregate adjusted tax basis of the
Albuquerque Hyatt at any time.
E. Provision of Services by the Operating Partnership
1. Income Derived under the Terms of the Lease
Although the Operating Partnership may treat charges for services
customarily furnished or rendered in connection with the rental of the
Albuquerque Hyatt as "rents from real property," any services rendered to the
occupants of the Albuquerque Hyatt must be furnished or rendered by an
independent contractor from whom the Company does not derive or receive any
income.(27) Moreover, to the extent that any independent contractors provide
noncustomary services to the occupants of the Albuquerque Hyatt, the cost of
such services must not be borne by the Operating Partnership.(28) Under the
terms of the Lease, the Operating Partnership will not be required to provide
any services, customary or noncustomary, in connection with the rental of the
Albuquerque Hyatt. Instead, all services relating to the operation of the
Albuquerque Hyatt will be provided by Hyatt to RoseStar under the terms of the
Management Agreement. The Operating Partnership will not bear the cost of any
of the services provided by Hyatt to RoseStar. Instead, such costs will be
borne by RoseStar pursuant to its assumption of the Operating Partnership's
obligations under the Management Agreement.
Based on the foregoing, we believe that the provision of any
noncustomary services to the occupants of the Albuquerque Hyatt by Hyatt will
have no effect on the qualification of the income derived from the Albuquerque
Hyatt as "rents from real property." In fact, the IRS has issued a private
letter ruling in which it has treated the income derived from several leases of
hotel properties as "rents from real property" in a situation where the lessees
had contracted with a third-party to conduct the day-to-day operations of the
hotels.(29) Our conclusion is not altered by the fact that the Operating
Partnership will remain liable for any obligations arising under the Management
Agreement, to the extent that they are not satisfied by the Tenant. The
Operating Partnership should not be treated as bearing the cost of the services
provided by Hyatt merely because it will be liable for RoseStar's obligations
under the Management Agreement. The Operating
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(26)Section 856(d)(1)(C).
(27)Sections 856(d)(1), 856(d)(2)(C); Treas. Reg. Section 1.512(b)-1(c)(5).
(28)Treas. Reg. Section 1.856-4(b)(5).
(29)See, P.L.R. 8117036 (January 27, 1981).
-11-
<PAGE> 99
Partnership will not be retaining this liability in an attempt to provide
services to RoseStar. Instead, it will be retaining this liability only as an
accommodation, in order to gain Hyatt's consent to its purchase of the
Albuquerque Hyatt. Moreover, the Operating Partnership believes that it is
highly unlikely that it will ever be required to reimburse Hyatt for the costs
and expenses of operating the Albuquerque Hyatt because of a default by
RoseStar under the Management Agreement. This is because (i) the Albuquerque
Hyatt is projected to generate enough gross income to cover the payments to
Hyatt under the Management Agreement, (ii) in the event that the Albuquerque
Hyatt does not generate enough gross income to cover the payments to Hyatt
under the Management Agreement, RoseStar may still be able to make such
payments out of gross income generated by the Denver Marriott, (iii) in
connection with the Lease, RoseStar has represented that it has a net worth of
at least $200,000, (iv) in the view of the Operating Partnership, RoseStar's
capitalization is adequate to allow RoseStar to assume RoseStar's obligations
under the Lease, and (v) in connection with the Lease, RoseStar has agreed to
limit distributions to its members to an amount necessary to pay federal and
state income taxes on income from the Albuquerque Hyatt until RoseStar is
holding sufficient reserves funds to enable it to pay at least one monthly
payment of base rent under the Lease and all other leases between RoseStar and
the Operating Partnership.
2. Income Derived in the Case of a Default under the Lease
If the Operating Partnership were required to reimburse Hyatt for the
costs of operating the Albuquerque Hyatt because of a default by RoseStar under
the terms of the Management Agreement, we have concluded that the income
derived by the Operating Partnership from the Albuquerque Hyatt would be
treated as "qualifying income" for purposes of the 75 percent and 95 percent
tests. This is because, if the Operating Partnership were required to
reimburse Hyatt for the cost of operating the Albuquerque Hyatt, this would
constitute an event of default under Article 16.1 of the Lease, allowing the
Operating Partnership to terminate RoseStar's leasehold interest in the
Albuquerque Hyatt. As a result of such a termination of the Lease, any income
derived by the Operating Partnership from the Albuquerque Hyatt after the
default would be treated as income from foreclosure property.
The Operating Partnership would be able to continue to operate the
Albuquerque Hyatt after any default under the Lease, without affecting its
status as foreclosure property. This is because Hyatt, which will provide all
services relating to the operation of the Albuquerque Hyatt, qualifies as an
independent contractor from whom the Company does not derive any income. As
noted above, a REIT can use foreclosure property in the conduct of an active
trade or business, as long as this is done through the use of an independent
contractor, from whom the REIT does not derive or receive any income.(30)
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(30)Section 856(e)(4)(C). The IRS clearly intended for REITs to be able to
treat hotels operated by independent contractors as foreclosure property. For
instance, the Treasury regulations defining foreclosure property refer to hotel
Footnote continued on next page
-12-
<PAGE> 100
As previously noted, real property acquired upon default under a lease
is not eligible to be treated as foreclosure property if the lease is entered
into with an intent to evict or foreclose, or if the REIT knows or has reason
to know that default would occur.(31) This is not the case in the present
situation because (i) the Albuquerque Hyatt is projected to generate enough
gross income to cover the payments to Hyatt under the Management Agreement,
(ii) in the event that the Albuquerque Hyatt does not generate enough gross
income to cover the payments to Hyatt under the Management Agreement, RoseStar
may still be able to make such payments out of gross income generated by the
Denver Marriott, (iii) in connection with the Lease, RoseStar has represented
that it has a net worth of at least $200,000, (iv) in the view of the Operating
Partnership, RoseStar's capitalization is adequate to allow RoseStar to assume
RoseStar's obligations under the Lease, and (v) in connection with the Lease,
RoseStar has agreed to limit distributions to its members to an amount
necessary to pay federal and state income taxes on income from the Albuquerque
Hyatt until RoseStar is holding sufficient reserves funds to enable it to pay
at least one monthly payment of base rent under the Lease and all other leases
between RoseStar and the Operating Partnership.
The Albuquerque Hyatt will in any event qualify as foreclosure
property only for a period of up to two years, beginning on the date of its
acquisition by the Operating Partnership, unless the Operating Partnership
obtains an extension of the grace period from the IRS.(32) Therefore, in the
event the Operating Partnership takes possession of the Albuquerque Hyatt as a
result of a default under the lease, presumably the Operating Partnership will
sell the Albuquerque Hyatt or within two years rent it to another tenant under
a lease that will produce "rents from real property."
V. CONCLUSION
Based on the assumptions stated above, it is our opinion that (i) all
of the income that the Operating Partnership derives from the Albuquerque Hyatt
will be treated as "qualifying income" for purposes of the 95 percent test and
(ii) all of the income the Operating Partnership derives from the Albuquerque
Hyatt will be treated as "qualifying income" for purposes of the 75 percent
test.
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Footnote continued from previous page
properties twice. See, Treas. Reg. Sections 1.856-6(b)(2), 1.856-6(d)(2). In
addition, the IRS has also recently issued a private letter ruling in which it
treated income received from hotels acquired pursuant to a bankruptcy petition
as income from foreclosure property, where the hotels were operated by
third-party managers. P.L.R. 9420013 (2/15/94).
(31)Treas. Reg. Section 1.856-6(b)(3).
(32)Section 856(e)(2).
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<PAGE> 101
April 1, 1996
Crescent Real Estate Equities, Inc.
900 Third Avenue, Suite 1800
New York New York 10022
Ladies and Gentlemen:
On December 19, 1995 we provided you with a memorandum analyzing the
impact that the purchase of the Hyatt Regency Albuquerque Plaza (the
"Albuquerque Hyatt") by Crescent Real Estate Equities Limited Partnership (the
"Operating Partnership") would have on the ability of Crescent Real Estate
Equities, Inc. (the "Company") to continue to qualify as a real estate
investment trust (a "REIT") under section 856(c).(1) That memorandum concluded
that, subject to certain assumptions, in our opinion (i) all of the income that
the Operating Partnership derived from the Albuquerque Hyatt would be treated
as "qualifying income" for purposes of the 95 percent gross income test for
REIT qualification and (ii) all of the income that the Operating Partnership
derived from the Albuquerque Hyatt would be treated as "qualifying income" for
purposes of the 75 percent gross income test for REIT qualification. The
December 19, 1995 memorandum was based upon, among other items, our review of a
Lease Agreement between the Operating Partnership, as lessor, and RoseStar
Management, LLC ("RoseStar"), as lessee, dated December 19, 1995 (the "Lease").
On March 11, 1996, the Operating Partnership conveyed all of its
interest as lessor under the Lease to Crescent Real Estate Funding II, L.P., a
Delaware limited Partnership ("Funding II"). Funding II assumed all of the
Operating Partnership's liabilities and obligations under the Original Lease.
On March 29, 1996, pursuant to an Assignment and Assumption of
Leasehold Estate, RoseStar sold and assigned all of its interest and estate as
lessee under the Lease to RoseStar Southwest, LLC, a Delaware limited liability
company ("Southwest"). RoseStar owns a 99 percent interest in Southwest, while
the remaining one percent interest is owned by RSSW Corp., a Delaware
corporation. The ownership of RoseStar is unchanged from December 19, 1995.
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(1) All section references are to the Internal Revenue Code of 1986, as
amended (the "Code"), or to the regulations issued thereunder, unless
otherwise noted.
<PAGE> 102
Crescent Real Estate Equities, Inc.
April 1, 1996
Page 2
On April 1, 1996, the Lease was amended to provide that, among other
things, (1) at all times during the term of the Lease, Southwest and RoseStar
would maintain a cumulative net worth equal to $200,000; and (2) Southwest
would retain all of the income it earns from the Albuquerque Hyatt (except
distributions to its beneficial owners in an amount sufficient to pay their
federal and state income taxes on such income) until such time as Southwest and
any affiliate of Southwest (including RoseStar) which has entered into a
long-term lease of a hotel with Funding II or any affiliate of Funding II
(including the Operating Partnership) have accumulated and are holding in
reserve funds in the aggregate which are sufficient to enable Southwest and any
affiliated entities to pay at least one monthly payment of base rent under each
lease between Southwest and any such affiliated entities and Funding II or an
affiliate of Funding II.
This letter is intended to update the opinions expressed in our
December 19, 1995 memorandum to reflect the changes in the Lease and the
substitution of new parties as lessor and lessee of the Albuquerque Hyatt. The
opinions set forth herein are based upon the existing provisions of the Code,
and the reported interpretations thereof by the IRS and by the courts in effect
as of the date hereof, all of which are subject to change, both retroactively
or prospectively, and to possibly different interpretations. We assume no
obligation to update the opinions set forth in this letter. We believe that
the conclusions expressed herein, if challenged by the IRS, would be sustained
in court. However, because our opinions are not binding upon the IRS or the
courts, there can be no assurance that contrary positions may not be
successfully asserted by the IRS.
I. Documents and Representations
For the purpose of rendering this opinion, we have examined and
relied on originals, or copies certified or otherwise identified to our
satisfaction, of the following: (1) the Lease; (2) the Assignment and
Assumption of Leasehold Estate by and between RoseStar and Southwest dated
March 29, 1996; (3) the First Amendment to the Lease dated April 1, 1996; (4)
the Limited Guaranty Agreement by Gerald Haddock, John Goff and Sanjay Varma,
as guarantors in favor of Funding II (the "Guaranty); (5) the Articles of
Organization of RoseStar Management, LLC (the "RoseStar Articles"), (6) the
Regulations of RoseStar Management, LLC (the "RoseStar Regulations"), (7) the
First Amended and Restated Articles of Incorporation of Crescent Real Estate
Equities, Inc. (the "Crescent Articles"); and (8) such other documents or
information as we have deemed necessary for the opinion set forth below. In
our examination, we have assumed the genuineness of all signatures, the legal
capacity of natural persons, the authenticity of all documents submitted to us
as originals, the conformity to original documents of all documents submitted
to us as certified or photostatic copies, and the authenticity of the originals
of such copies.
<PAGE> 103
Crescent Real Estate Equities, Inc.
April 1, 1996
Page 3
For the purpose of rendering this opinion, we have also assumed that
all statements of facts and assumptions described in our December 19, 1995
memorandum remain correct, unless otherwise noted.
II. Opinions
A. Lease Will be Treated as a Lease for Federal Income Tax Purposes
In order for any income derived by Funding II from the Albuquerque
Hyatt to constitute either "rents from real property," or in the case of a
default under the Lease, "gross income from foreclosure property," the Lease
must be treated as a lease for federal income tax purposes and not be treated
as a service contract, management contract or other type of arrangement. This
determination depends on an analysis of all the surrounding facts and
circumstances. In making this determination, courts have considered a variety
of factors, including the following: (i) the intent of the parties, (ii) the
form of the agreement, (iii) the degree of control over the business conducted
at the property that is provided to the lessee (e.g., whether the lessee has
substantial rights of control over the operation of the property and its
business), (iv) the extent to which the lessee has the risk of loss from
operations of the business conducted as the property (e.g., whether the lessee
bears the risk of increases in operating expenses and of decreases in
revenues), and (v) the extent to which the lessee has the opportunity to
benefit from operations of the business conducted at the property (e.g.,
whether the lessee benefits from decreased operating expenses or increased
revenues).(2)
In addition, section 7701(e) provides that a contract that purports
to be a service contract, partnership agreement, or another type of arrangement
will be 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 any savings
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
unrelated to the service recipient and (vi) the total contract price does not
substantially exceed the rental
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(2) See, e.g., Xerox Corp. v. U.S., 80-2 USTC Paragraph 9530 (Ct. Cl. Tr.
Div. 1980), aff'd per curiam, 656 F.2d 659 (Ct. Cl. 1981).
<PAGE> 104
Crescent Real Estate Equities, Inc.
April 1, 1996
Page 4
value of the property for the contract period. Since the determination of
whether a service contract, partnership agreement, or some other type of
arrangement should be treated as a lease is inherently factual, the presence or
absence of any single factor may not be dispositive in every case.(3)
We have concluded that the Lease will be treated as a lease for
Federal income tax purposes, rather than a service contract, management
contract or other type of arrangement. This conclusion is based, in part, on
the following facts: (i) Funding II and Southwest intend their relationship to
be that of lessor and lessee (as evidenced by the terms of the Lease), (ii)
Southwest has the right to exclusive possession, use and quiet enjoyment of the
Albuquerque Hyatt during the term of the Lease and the right to uninterrupted
control in the operation of and business conducted at the Albuquerque Hyatt
(subject to its assumption of the Management Agreement), (iii) Southwest will
bear the cost of, and be responsible for, capital expenditures, including
maintenance and repair of the Albuquerque Hyatt, and will dictate how the
Albuquerque Hyatt is maintained and improved (with the exception that Funding
II, as lessor, is responsible for the cost of certain capital expenditures in
situations where the funds available to Southwest are insufficient for such
expenditures), (iv) Southwest will bear all the costs and expenses of operating
the Albuquerque Hyatt (with the exception of the costs of replacing certain FF
& E associated with the Albuquerque Hyatt, which are to be funded by Funding
II), (v) Southwest will benefit from any savings in the costs of operating the
Albuquerque Hyatt during the term of the Lease, (vi) in the event of damage or
destruction to the Albuquerque Hyatt, Southwest will be at economic risk
because its obligation to make rental payments will not abate, (vii) Southwest
will indemnify Funding II against all liabilities imposed on Funding II during
the term of the Lease by reason of injury to persons or damage to property
occurring at the Albuquerque Hyatt or Southwest's use, management, maintenance
or repair of the Albuquerque Hyatt, (viii) Southwest is obligated to pay
substantial fixed rent for the period of use of the Albuquerque Hyatt,
regardless of whether its revenues exceed its costs and expenses, and (ix)
Southwest stands to incur substantial losses (or derive substantial profits)
depending on how successfully it operates the Albuquerque Hyatt.
We do not believe that our conclusion that the Lease of the
Albuquerque Hyatt will be treated as a lease for Federal income tax purposes is
affected by the fact that Southwest assumed RoseStar's rights and obligations
as lessor under the Lease subject to its assumption of Funding II's obligations
under the preexisting Management Agreement. The Management Agreement gives
Hyatt control over the day-to-day operation of the Albuquerque Hyatt and will
allow Hyatt to share with Southwest in the benefits of any increases in
revenues or cost savings in the operation of the Albuquerque Hyatt. However,
Hyatt's operation of the
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(3) P.L.R. 8918012 (January 24, 1989).
<PAGE> 105
Crescent Real Estate Equities, Inc.
April 1, 1996
Page 5
Albuquerque Hyatt is not controlled by Funding II, and the Management Agreement
does not affect the fact that Southwest bears most of the risk of loss if the
Albuquerque Hyatt is not successful. Moreover, the IRS has issued a private
letter ruling in which it treated leases of several hotel properties as
producing "rents from real property" in a situation where the lessees had
contracted with a third party to conduct the day-to-day operations of the
hotels.(4) This ruling suggests that the IRS will respect a lease of a hotel
for federal income tax purposes even if the hotel is operated by an
independent contractor rather than by the lessee.
The Lease is structured in form so that Funding II retains ownership
of all the personal property leased to Southwest in connection with Southwest's
lease of the Albuquerque Hyatt (the "FF&E"). However, if the term of the Lease
equals or exceeds the useful life of some or all of the FF&E, it is possible
that the Lease could be treated for federal income tax purposes as a financing
arrangement. In such a case, Southwest would be treated as having acquired
ownership of the FF&E for federal income tax purposes in exchange for an
obligation to make future payments of principal and interest to Funding II.
Nonetheless, we do not believe that the recharacterization of the Lease as a
financing arrangement with respect to the FF&E would have a material effect on
the ability of the Company to satisfy the requirements for taxation as a REIT.
This is because, if a portion the of the payments made by Southwest under the
Lease were characterized as interest on indebtedness secured by the FF&E,
rather than rents from real property, that portion would still satisfy the 95
percent gross income test (although it would not satisfy the 75% gross income
test).(5)
B. Percentage Rent Provision is not Profit-Based
Pursuant to the Lease, Southwest will be obligated to pay Funding II
base rent and percentage rent. Under the regulations, percentage rent based on
a percentage of gross receipts or sales in excess of a floor amount, which is
how the percentage rent is structured under the Lease, will not qualify as
"rents from real property" unless (i) such floor amount does not depend in
whole or in part on the income or profits of the lessee, (ii) the percentage
and the floor amount are fixed at the time the lease is entered into, (iii) the
percentage and the floor amount are not renegotiated during the term of the
lease in a manner that has the effect
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(4) See, P.L.R. 8117036 (January 27, 1981).
(5) If the Lease were recharacterized as a financing arrangement with
respect to the FF&E, it also might result in some minor timing differences
with respect to the Company's recognition of income. These differences
would result from (a) the recharacterization of a portion Southwest's
payments under the Lease as a return of principal and (b) the Company's
loss of any depreciation deductions attributable to the FF&E.
<PAGE> 106
Crescent Real Estate Equities, Inc.
April 1, 1996
Page 6
of basing the percentage rent on income or profits, and (iv) the percentage and
the floor amount conform with normal business practice.(6)
Under the terms of Article 4.2 of the Lease, Southwest will pay
percentage rent equal on an annual basis to the sum of (i) 17.5 percent of the
excess of annual gross receipts from room rentals over $6,000,000 and (ii) 2.5
percent of the excess of annual gross receipts from the food and beverage
facilities at the Albuquerque Hyatt over $2,000,000. It will effectively
reward Southwest for any increases in gross receipts from rooms and from other
sources over the threshold amounts. This type of formula does not base the
percentage rent on Southwest's income or profits, and similar formulas have
been treated by the IRS as generating "rents from real property."(7) Moreover,
Funding II has represented that (i) the floor amounts used to compute the
percentage rent under the Lease do not depend in whole or in part on the income
or profits of any person, (ii) the percentage rent provision of the Lease has
not been and will not be renegotiated during the term of the Lease or at the
expiration or earlier termination of the Lease in a manner that has the effect
of basing the rent on income or profits, and (iii) the percentage rent
provision of the Lease conforms with normal business practice. In addition,
based on our experience and an examination of the Lease and the Albuquerque
Hyatt projections, the Lease appears to conform with normal business practice.
C. Southwest is not a "Related Party Tenant"
Rents received from Southwest will not qualify as "rents from real
property" if Southwest is a "related party tenant." Southwest will be a
"related party tenant" if the Company, or an owner of 10 percent or more of the
Company, directly or constructively owns 10 percent or more of the assets or
net profits of Southwest.(8) Constructive ownership is determined for purposes
of this test by applying the rules of section 318(a) as modified by section
856(d)(5). Those rules generally provide that if 10 percent 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.
Southwest will not be treated as a "related party tenant" because a
99 percent interest in Southwest's assets and net profits will be owned by
RoseStar, with the remaining one
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(6) Treas. Reg. Section 1.866-4(b)(3).
(7) See, e.g., P.L.R. 8803007 (September 23, 1987) (percentage rent based on
gross revenues in excess of gross revenues for a base year treated as
"rents from real property"); cf. P.L.R. 9104018 (October 26, 1990)
(interest based on gross revenues in excess of a floor amount treated as
qualifying interest under section 856(f)).
(8) Section 856(d)(2)(B)(ii).
<PAGE> 107
Crescent Real Estate Equities, Inc.
April 1, 1996
Page 7
percent interest owned by RSSW, Corp. An individual, Sanjay Varma, currently
owns a 91 percent interest in the assets and net profits of RoseStar and RSSW,
Corp. In reaching this conclusion, we recognize that Sanjay Varma owns certain
Units of the Operating Partnership.(9) Funding II has represented that (i)
Sanjay Varma does not own more than 10 percent of the value of the Company's
stock, (ii) Sanjay Varma is not expected to own more than 10 percent of the
value of the Company's stock in the future, and (iii) neither Funding II nor
the Company intends to acquire, directly or constructively, an interest of 10
percent or more in the assets or net profits of RoseStar at any time in the
future. Moreover, Article 7.8 of the Lease limits the ability of Southwest or
any person owning an interest in Southwest (including RoseStar) to acquire,
directly or constructively, a 6 percent stock interest in the Company, and
Section 6.4 of the First Amended and Restated Articles of Incorporation of the
Company prevents RoseStar and its members and managers from acquiring more than
8 percent of the Company's stock.
The conclusion that Southwest will not be treated as a "related party
tenant" is based on the assumption that its member RoseStar will be treated as
a partnership for federal income tax purposes. If RoseStar is not treated as a
partnership for federal income tax purposes, but is instead treated as an
association taxable as a corporation, then it is possible that Southwest would
be treated as a "related party tenant" and the rents derived under the terms of
the Lease would not be treated as "rents from real property." This is because,
if RoseStar were treated as a corporation for federal income tax purposes,
Gerald W. Haddock and John C. Goff would likely be deemed to own all of its
voting stock, because of the extensive powers that they are granted as managers
under the RoseStar Regulations. If this were the case, the ownership of such
voting stock (and ownership of Southwest) might be attributed to the Company
under a literal reading of the constructive ownership rules described above.(10)
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(9) See Rev. Rul. 73-194, 1973-1 C.B. 355 (management company treated as an
independent contractor with respect to a REIT, where an affiliate of the
management company and the REIT were partners).
(10) Richard Rainwater, Gerald Haddock and John Goff are each partners in
FW-Irving Partners, Ltd. (and apparently they are partners in other
partnerships as well). Richard Rainwater also owns more than 10 percent
of the value of the stock of the Company. Thus, assuming that the
ownership interests in RoseStar held by Gerald Haddock and John Goff
constitute stock, such interests, along with Richard Rainwater's stock
interest in the Company, will be attributed to FW-Irving Partners, Ltd.
pursuant to section 318(a)(3)(A), which provides that stock owned,
directly or indirectly, by or for a partners shall be considered as owned
by the partnership. Then, FW-Irving Partners, Ltd.'s deemed interest in
RoseStar would be attributed to the Company pursuant to section
318(a)(3)(C) (as modified by section 856(d)(5)), which provides that stock
owned by any person that owns 10 percent or more of the value of the stock
in a corporation shall be considered owned by the corporation. As you are
aware, however, we have opined to you in a similar context that we do not
believe that these attribution rules should be read literally.
<PAGE> 108
Crescent Real Estate Equities, Inc.
April 1, 1996
Page 8
An entity which has associates and an objective to carry on a
business for joint profit will be treated as a partnership for federal income
tax purposes, and not as an association taxable as a corporation, if it has not
more than two of the following four characteristics of a corporation: (i)
continuity of life; (ii) centralization of management; (iii) limited liability;
and (iv) free transferability of interests.(11) The entity must also have no
other characteristics which are significant in determining its classification.
Generally, other factors are considered only insofar as they relate to the
determination of the presence or absence of the foregoing corporate
characteristics.(12) The IRS has applied this four-factor test in determining
whether limited liability companies formed under the Texas Limited Liability
Company Act (the "Act") are partnerships for federal income tax purposes.(13)
The IRS has issued Rev. Proc. 95-10, which specifies conditions which must be
satisfied for a limited liability company to receive a favorable advanced
ruling that it will be classified as a partnership for federal income tax
purposes.(14) RoseStar should satisfy these conditions. However, such
conditions are applicable only in determining whether rulings will be issued
and are not intended as substantive rules for determination of partnership
status.
An organization will be treated as possessing the corporate
characteristic of continuity of life, even if the agreement organizing an
entity provides that it is to continue only for a stated period, unless a
member has the power to dissolve the organization at an earlier time.(15)
Article 6.01 of the Act provides, in part, that except as otherwise provided in
the company's regulations, a limited liability company shall be dissolved upon
the death, retirement, resignation, expulsion, bankruptcy, or dissolution of a
member or the occurrence of any other event which terminates the continued
membership of a member in the limited liability company, unless there is at
least one remaining member and the business of the limited liability company is
continued by the consent by the number of members or class thereof stated in
the articles of organization or regulations of the limited liability company or
of not so stated, by all remaining members. Article 2 of the RoseStar Articles
provides that the duration of RoseStar is until the close of business on
December 31, 2015, or until its earlier dissolution in accordance with the
provisions of the Act or the Regulations. Article 10.2 of the RoseStar
Regulations provides, in part, that RoseStar shall be dissolved upon the
withdrawal, death, retirement, resignation, expulsion, bankruptcy, legal
incapacity or dissolution of any member, unless the business of RoseStar is
continued by the consent of all the remaining members
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(11) Treas. Reg. Section 301.7701-2(a).
(12) See Rev. Rul. 79-106, 1979-1 C.B. 448.
(13) See, e.g., P.L.R. 9242025 (July 22, 1992) and P.L.R. 9218078 (January
31, 1992).
(14) 1995-3 I.R.B. 20.
(15) Treas. Reg. Section 301.7701-2(b)(3).
<PAGE> 109
Crescent Real Estate Equities, Inc.
April 1, 1996
Page 9
within ninety days. Accordingly, RoseStar will lack the corporate
characteristic of continuity of life.
An organization will be treated as possessing the corporate
characteristic of free transferability of interests if the members owning all
or substantially all of the interests in an organization may substitute for
themselves without the consent of the other members a person who is not a
member of the organization.(16) Article 4.05 of the Act provides, in part, that
unless otherwise provided by the company's regulations, a membership interest
is assignable in whole or in part; an assignment of a member's interest does
not entitle the assignee to become, or to exercise rights or powers of a
member; and until the assignee becomes a member, the assignor member continues
to be a member and to have the power to exercise any rights or powers of a
member, except to the extent those rights or powers are assigned. Article 4.07
of the Act provides, in part, that an assignee of a membership interest may
become a member if and to the extent that the company's regulations so provide,
or all members consent. Article 9.3 of the RoseStar Regulations provides, in
part, that no member shall have the right to substitute in its place a
transferee unless consent is given by the Managers and a majority of the other
members, which consent may be withheld in the discretion of the Managers or the
other members. Accordingly, RoseStar will lack the corporate characteristic of
free transferability of interests. Because RoseStar will lack the corporate
characteristics of continuity of life and free transferability of interests, in
our opinion it will be treated as partnership for federal income tax purposes.
D. Incidental Personal Property
As noted in the December 19, 1995 memorandum, in order for the rent
under the Lease to be treated as "rents from real property," the rents
attributable to personal property leased under or in connection with the Lease
must not be greater than 15 percent of the rents received under the Lease. The
rent attributable to personal property leased under or in connection with a
lease of real property is the amount that bears the same ratio to total rent
for the taxable year as (i) the average of the adjusted bases of the personal
property leased under or in connection with a lease of real property at the
beginning and at the end of the taxable year bears to (ii) the average of the
aggregate adjusted bases of the real and personal property subject to the lease
at the beginning and at the end of such taxable year (the "Adjusted Basis
Ratio").(17) Funding II has represented that the adjusted tax basis of the
personal property leased under or in connection with the Lease has not
represented and will not represent more than 15 percent of the aggregate
adjusted tax basis of the Albuquerque
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(16) Treas. Reg. Section 301.7701-2(e).
(17) Section 856(d)(1)(C).
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Crescent Real Estate Equities, Inc.
April 1, 1996
Page 10
Hyatt at any time. Moreover, in Article 36.2 of the Lease, the parties agreed
that the adjusted tax basis of the personal property leased under or in
connection with the Lease will not represent more than 15 percent of the
aggregate adjusted tax basis of the Albuquerque Hyatt at any time.
E. Provision of Services by the Funding II
1. Income Derived under the Terms of the Lease
Although Funding II may treat charges for services customarily
furnished or rendered in connection with the rental of the Albuquerque Hyatt as
"rents from real property," any services rendered to the occupants of the
Albuquerque Hyatt must be furnished or rendered by an independent contractor
from whom the Company does not derive or receive any income.(18) Moreover, to
the extent that any independent contractors provide noncustomary services to
the occupants of the Albuquerque Hyatt, the cost of such services must not be
borne by the Funding II.(19)
Under the terms of the Lease, Funding II will not be required to
provide any services, customary or noncustomary, in connection with the rental
of the Albuquerque Hyatt. Instead, all services relating to the operation of
the Albuquerque Hyatt will be provided by Hyatt under the terms of the
Management Agreement. Funding II has represented that Hyatt is an independent
contractor within the meaning of section 856(d)(3), from which the Company and
Funding II will not derive or receive any income. Funding II will not bear the
cost of any of the services provided by Hyatt. Instead, such costs are borne
by Southwest, because it has assumed Funding II's obligations, as owner, under
the Management Agreement.
Based on the foregoing, we believe that the provision of any
noncustomary services to the occupants of the Albuquerque Hyatt by Hyatt will
have no effect on the qualification of the income derived from the Albuquerque
Hyatt as "rents from real property." In fact, the IRS has issued a private
letter ruling in which it has treated the income derived from several leases of
hotel properties as "rents from real property" in a situation where the lessees
had contracted with a third-party to conduct the day to day operations of the
hotels.(20) Our conclusion is not altered by the fact that Funding II will
remain liable for any obligations arising under the Management Agreement, to
the extent that they are not satisfied by Southwest. Funding II should not be
treated as bearing the cost of the services provided by
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(18) Sections 856(d)(1), 856(d)(2)(C); Treas. Reg. Section 1.512(b)-1(c)(5).
(19) Treas. Reg. Section 1.856-4(b)(5).
(20) See, P.L.R. 8117036 (January 27, 1981).
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Crescent Real Estate Equities, Inc.
April 1, 1996
Page 11
Hyatt merely because it is liable for Southwest's obligations under the
Management Agreement. Funding II is not retaining this liability in an attempt
to provide services to Southwest. Instead, it is retaining this liability only
as an accommodation to Hyatt. Moreover, Funding II believes that it is highly
unlikely that it will ever be required to reimburse Hyatt for the costs and
expenses of operating the Albuquerque Hyatt. This is because (i) the
Albuquerque Hyatt is projected to generate enough gross income to cover the
payments to Hyatt under the Management Agreement, (ii) in connection with
Section 7.7 the Lease, as amended, Southwest has represented that it has a net
worth of at least $200,000, (iii) in connection with Section 7.9 of the Lease,
as amended, Southwest has agreed to retain all of the income it earns from the
Albuquerque Hyatt (except distributions to its beneficial owners in an amount
sufficient to pay their federal and state income taxes on such income) until
such time as Southwest and any affiliate of Southwest (including RoseStar)
which has entered into a long-term lease of a hotel with Funding II or any
affiliate of Funding II (including the Operating Partnership) have accumulated
and are holding in reserve funds in the aggregate which are sufficient to
enable Southwest and any affiliated entities to pay at least one monthly
payment of base rent under each lease between Southwest and any such affiliated
entities and Funding II or an affiliate of Funding II, (iv) pursuant to the
Guaranty, RoseStar's individual members have guaranteed RoseStar's obligations
under the Lease, and (v) in the view of Funding II, Southwest's capitalization
is adequate to allow Southwest to assume its obligations as lessee under the
Lease.
2. Income Derived in the Case of a Default under the Lease
If Funding II were required to reimburse Hyatt for the costs of
operating the Albuquerque Hyatt because of a default by Southwest under the
terms of the Management Agreement, we have concluded that the income derived by
Funding II from the Albuquerque Hyatt would be treated as "qualifying income"
for purposes of the 75 percent and 95 percent tests. This is because, if
Funding II were required to reimburse Hyatt for the cost of operating the
Albuquerque Hyatt, this would constitute an event of default under Article
16.1(c) of the Lease, allowing Funding II to terminate Southwest's leasehold
interest in the Albuquerque Hyatt. As a result of such a termination of the
Lease, any income derived by Funding II from the Albuquerque Hyatt after the
default would be treated as income from foreclosure property.
Funding II would be able to continue to operate the Albuquerque Hyatt
after any default under the Lease, without affecting its status as foreclosure
property, because Hyatt, an independent contractor, from whom the Company will
not derive any income, will provide all services relating to its operation. A
REIT can use foreclosure property in the conduct of an
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Crescent Real Estate Equities, Inc.
April 1, 1996
Page 12
active trade or business, as long as this is done through the use of an
independent contractor, from whom the REIT does not derive or receive any
income.(21)
Real property acquired upon default under a lease is not eligible to
be treated as foreclosure property if the lease is entered into with an intent
to evict or foreclose, or if the REIT knows or has reason to know that default
would occur.(22) This is not the case in the present situation because (i) the
Albuquerque Hyatt is projected to generate enough gross income to cover the
payments to Hyatt under the Management Agreement, (ii) in connection with
Section 7.7 the Lease, as amended, Southwest has represented that it has a net
worth of at least $200,000, (iii) in connection with Section 7.9 of the Lease,
as amended, Southwest has agreed to retain all of the income it earns from the
Albuquerque Hyatt (except distributions to its beneficial owners in an amount
sufficient to pay their federal and state income taxes on such income) until
such time as Southwest and any affiliate of Southwest (including RoseStar)
which has entered into a long-term lease of a hotel with Funding II or any
affiliate of Funding II (including the Operating Partnership) have accumulated
and are holding in reserve funds in the aggregate which are sufficient to
enable Southwest and any affiliated entities to pay at least one monthly
payment of base rent under each lease between Southwest and any such affiliated
entities and Funding II or an affiliate of Funding II, (iv) pursuant to the
Guaranty, RoseStar's individual members have guaranteed RoseStar's obligations
under the Lease, and (v) in the view of Funding II, Southwest's capitalization
is adequate to allow Southwest to assume its obligations as lessee under the
Lease.
The Albuquerque Hyatt would in any event qualify as foreclosure
property only for a period of up to two years, beginning of the date of its
acquisition by Funding II, unless Funding II obtains an extension of the grace
period from the IRS.(23) Therefore, in the event Funding II takes possession
of the Albuquerque Hyatt as a result of a default under the Lease, presumably
Funding II will sell the Albuquerque Hyatt or, within two years, rent it to
another tenant under a lease that will produce "rents from real property."
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(21) Section 856(e)(4)(C). (The IRS clearly intended for REITs to be able to
treat hotels operated by independent contractors as foreclosure property.
For instance, the Treasury regulations defining foreclosure property
refer to hotel properties twice. See, Treas. Reg. Sections 1.856-6(b)(2),
1.856-6(d)(2). In addition, the IRS has also recently issued a private
letter ruling in which it treated income received from hotels acquired
pursuant to a bankruptcy petition as income from foreclosure property,
where the hotels were operated by third party managers. P.L.R.
9420013 (2/15/94).)
(22) Treas. Reg. Section 1.856-6(b)(3).
(23) Section 856(e)(2).
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Crescent Real Estate Equities, Inc.
April 1, 1996
Page 13
F. Conclusions
Based on the assumptions and representations stated above, it is our
opinion that (i) all of the income that Funding II derives from the Albuquerque
Hyatt will be treated as "qualifying income" for purposes of the 95 percent
test and (ii) all of the income that Funding II derives from the Albuquerque
Hyatt, will be treated as "qualifying income" for purposes of the 75 percent
test.
III. Additional Limitations
The foregoing opinions are limited to the specific matters covered
thereby and should not be interpreted to imply that the undersigned has offered
its opinion on any other matter.
Very truly yours,
SHAW, PITTMAN, POTTS & TROWBRIDGE
By:
---------------------------------
Charles B. Temkin, P.C.
<PAGE> 114
July 26, 1996
Crescent Real Estate Equities, Inc.
900 Third Avenue
Suite 1800
New York, New York 10022
Re: Canyon Ranch
Ladies and Gentlemen:
You have requested certain opinions regarding the application of U.S.
federal income tax laws to Crescent Real Estate Equities, Inc. (the "Company")
and Crescent Real Estate Equities Limited Partnership (the "Operating
Partnership") in connection with the acquisition of Canyon Ranch, a health and
fitness resort located in Tucson, Arizona from Canyon Ranch, Inc. ("CRI").
I. TRANSACTION DOCUMENTS
In rendering the opinions expressed below, we have examined and relied
upon the following documents (collectively, the "Transaction Documents"):
(i) the Contribution Agreement between CRI and the Operating
Partnership, dated July 26, 1996 ("the Contribution
Agreement");
(ii) the Lease Agreement between CRI and Canyon Ranch Leasing,
L.L.C. ("CRL"), dated July 26, 1996 (the "Lease");
(iii) the Management Agreement between CRI and Canyon Ranch
Management, L.L.C. ("CRM"), dated July 26, 1996 (the
"Management Agreement");
(iv) the Assignment and Assumption of Management Agreement between
CRI and the Operating Partnership, dated July 26, 1996 (the
"Assignment and Assumption Agreement");
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Crescent Real Estate Equities, Inc.
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Page 2
(v) the Assignment and Assumption of Master Lease between CRI and
the Operating Partnership, dated July 26, 1996;
(vi) the Assignment and Assumption of Contracts between CRI and
the Operating Partnership, dated July 26, 1996;
(vii) the Assignment and Assumption of Store Leases between CRI and
the Operating Partnership, dated July 26, 1996;
(viii) the Asset Purchase Agreement between CRL, CRI and the
Operating Partnership, dated July 26, 1996 (the "FF & E
Purchase Agreement");
(ix) the Contract of Sale between CRI and CRL, dated July 26, 1996
(the "Life Share Contract");
(x) the Promissory Note for $2,400,000 with CRL as maker and the
Operating Partnership as payee bearing interest at the rate
of 10.75 percent, dated July 26, 1996 (the "Crescent FF & E
Note");
(xi) the Promissory Note in the amount of $648,360 with CRL as
maker and the Operating Partnership as payee bearing interest
at the rate of 10.75 percent per annum, dated July 26, 1996
(the "Life Share Note");
(xii) the Security Agreement between CRL and the Operating
Partnership, dated July 26, 1996 (the "Security Agreement");
(xiii) the Promissory Note in the amount of $162,090 with CRL as
maker and RoseStar Management, L.L.C. ("RoseStar") as payee
bearing interest at the rate of 10.75 percent per annum,
dated July 26, 1996 ("RoseStar Life Share Note");
(xiv) the Guaranty Agreement between RoseStar as GUARANTOR and the
Operating Partnership, dated July 26, 1996 (the "Guaranty");
(xv) the Limited Guaranty Agreement between Gerald Haddock, John
C. Goff and Sanjay Varma, together, as guarantors and the
Operating Partnership, dated July 26, 1996 (the "Limited
Guaranty");
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Crescent Real Estate Equities, Inc.
July 26, 1996
Page 3
(xvi) the Agreement Between CRI as Lessee and the Operating
Partnership as Substitute Lessor, dated July 26, 1996;
(xvii) the Option Agreement between Melvin Zuckerman ("Zuckerman")
and RoseStar, dated July 26, 1996 (the "Zuckerman Option
Agreement");
(xviii) the Option Agreement between Jerry Cohen ("Cohen") and RSCR
Arizona Corp., a Delaware Corporation ("RSCR"), dated July
26, 1996 (the "Cohen Option Agreement");
(xix) the Option Agreement between CRL and the Operating
Partnership, dated July 26, 1996 (the "Life Share Option
Agreement");
(xx) the Articles of Organization of RoseStar (the "RoseStar
Articles");
(xxi) the Regulations of RoseStar (the "RoseStar Regulations");
(xxii) the Articles of Organization of CRL (the "CRL Articles");
(xxiii) the Regulations of CRL (the "CRL Regulations");
(xxiv) the Articles of Incorporation of RSCR;
(xxv) the Bylaws of RSCR;
(xxvi) the First Amended and Restated Articles of Incorporation of
Crescent Real Estate Equities, Inc. (the "Crescent
Articles"); and
(xxvii) such other documents or information as we deemed necessary
for the opinions set forth below.
II. BACKGROUND OF TRANSACTION
A. The Management Agreement: Under the Management Agreement, CRI,
as owner of Canyon Ranch, has contracted with CRM to manage and operate Canyon
Ranch, to collect all Canyon Ranch receipts, and to manage certain related
properties and time share programs (as described more fully below). In
addition, CRM has also agreed to honor resort memberships issued to various
persons by CRI. CRM was also granted the right to issue
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Crescent Real Estate Equities, Inc.
July 26, 1996
Page 4
additional memberships in the resort in the future. In exchange for these
services, CRM is to be paid a profits-based management fee collected from the
gross receipts of the resort.
Under the Management Agreement, CRI, as owner, is obligated to
establish a capital improvement reserve to be funded from gross receipts from
the resort. CRM, as manager, is entitled to withdraw funds from this reserve
to pay for capital improvements and additions to the furniture, fixtures and
equipment used in connection with the resort.
Section 15.2 of the Management Agreement requires that all assignments
of the Management Agreement (other than certain assignments to permitted
transferees) be approved by CRM and under Section 15.3 of the Management
Agreement any assignees are bound by the obligations of the owner under the
Management Agreement.
B. The Lease: Under the terms of the Lease, CRL leased the
following property (the "Leased Property") from CRI: (i) the land, buildings,
fixtures and other improvements commonly known as Canyon Ranch; (ii) various
contracts entitling persons to use the guest rooms and/or the resort
facilities; (iii) various contracts (excluding employment contracts) relating
to the operation of the resort; (iv) CRI's interest as owner under the
Management Agreement (including the obligation to fund the capital improvement
reserve); (v) CRI's interest under certain Individual Unit Management
Agreements and a Common Element Management Agreement relating to the Canyon
Ranch Casitas (described more fully below); (vi) CRI's interest under certain
Individual Unit Management Agreements relating to the Canyon Ranch Estates
(described more fully below); (vii) CRI's interest under all existing leases of
the resort property; and (viii) certain personal property used in connection
with the resort. The Leased Property does not include certain machinery,
equipment, fixtures, furniture, vehicles, artwork, signage and other decorative
items located in or used in connection with the operation of the resort (the
"FF & E"), which was sold by CRI to CRL (as described more fully below).
C. The Zuckerman and Cohen Option Agreements: Under the
Zuckerman Option Agreement, Zuckerman granted to RoseStar, a Texas limited
liability company, the exclusive option to purchase, on or after December 15,
1996, but not after December 31, 1996, his 99 percent interest in CRL, the
Delaware limited liability company that is lessee under the Lease. In order to
exercise this option, RoseStar must give notice to Zuckerman and pay him $1.00.
In addition, under the Zuckerman Option Agreement, Zuckerman has the right to
require RoseStar to purchase his 99 percent interest in CRL for $1.00 at any
time on or after December 15, 1996, but not after December 31, 1996.
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Crescent Real Estate Equities, Inc.
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Page 5
Currently, Sanjay Varma owns a 91 percent interest in the assets and
net profits of RoseStar, while Gerald W. Haddock and John C. Goff, the managers
of RoseStar, each own a 4.5 percent interest in its assets and net profits.
Under the Cohen Option Agreement, Cohen granted to RSCR the exclusive
option to purchase, on or after December 15, 1996, but not after December 31,
1996, his one percent interest in CRL. In order to exercise this option, RSCR
must give notice to Cohen and pay him $1.00. In addition, under the Cohen
Option Agreement, Cohen has the right to require RSCR to purchase his one
percent interest in CRL for $1.00 at any time on or afterDecember 15, 1996, but
not after December 31, 1996.
Sanjay Varma owns 91 percent of the stock of RSCR. Gerald W. Haddock
and John C. Goff each own 4.5 percent of the stock of RSCR.
D. The Contribution Agreement and the Assignment and Assumption
Agreement: Under the Contribution Agreement, CRI contributed the land,
buildings, fixtures and other improvements commonly known as Canyon Ranch, as
well as certain personal property used in connection with the operation of the
resort to the Operating Partnership, subject to the Lease and the Management
Agreement, in exchange for Units in the Operating Partnership. Under the
Contribution Agreement, the Operating Partnership also acquired CRI's interest
as owner under the Management Agreement and as lessor under the Lease.
Under the Assignment and Assumption Agreement, the Operating
Partnership assumed and agreed to perform all obligations of CRI as owner under
the Management Agreement to the extent that such obligations are not performed
by CRL as lessee under the Lease.
E. FF & E: As noted above, the Operating Partnership did not
acquire any of the FF & E. Instead, CRL purchased the FF & E from CRI under
the Asset Purchase Agreement with the proceeds of a loan. The loan, in the
principal amount of $2,400,000, was made to CRL by the Operating Partnership,
is evidenced by the Crescent FF & E Note, and is secured by the FF & E under
the terms of the Security Agreement.
F. Canyon Ranch Casitas: Adjacent to Canyon Ranch is the Canyon
Ranch Casitas Subdivision, consisting of 47 platted lots. Immediately prior to
the execution of the Contribution Agreement and the Life Share Property
Contract, CRI owned interests in 19 of these lots. The interests owned by CRI
consisted of: (a) the fee interest in 10 developed lots, which are used for
accommodations just like other rooms contained in Canyon Ranch proper, (b) the
fee interest in 6 unimproved lots, and (c) the fee interest in three improved
lots (the
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Crescent Real Estate Equities, Inc.
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Page 6
"Casitas Time Share Lots") dedicated to the Canyon Ranch Casitas time share
program (described more fully below). Under the terms of the Contribution
Agreement, CRI's fee interest in the 10 developed and 6 undeveloped lots in
the Casitas Subdivision was contributed to the Operating Partnership subject to
the Lease and the Management Agreement. As a consequence, CRM will be
responsible for operating these lots for CRL. CRI sold its interest in the
Casitas Time Share Lots to CRL under the terms of the Life Share Property
Contract. CRL borrowed funds pursuant to the Life Share Note to acquire these
lots.
The other 28 lots in the Canyon Ranch Casitas subdivision are not
owned by CRI (one is owned by Zuckerman and the other 27 are owned by third
parties) and have not been contributed to the Operating Partnership. However,
under the terms of the Management Agreement, CRM has assumed the obligation to
manage approximately 20 of these lots under the terms of certain Individual
Unit Management Agreements between CRI and the owners of these lots. CRM has
also assumed CRI's obligation to maintain certain common areas in the Canyon
Ranch Casitas subdivision under the terms of a Common Element Management
Agreement. Under prior agreements, CRI granted third parties using the Casitas
units the right to use the resort facilities in exchange for an additional fee.
Under the terms of the Management Agreement, CRM has assumed CRI's obligations
under these prior agreements.
G. Canyon Ranch Estates: Also adjacent to Canyon Ranch is the
Canyon Ranch Estates Subdivision. Immediately prior to the execution of the
Contribution Agreement, CRI owned interests in five units in the Canyon Ranch
Estates Subdivision. The interests owned by CRI consisted of: (a) the fee
interest in one house in the Canyon Ranch Estates Subdivision used for
accommodations just like other rooms contained in Canyon Ranch proper, and (b)
the fee interest in three improved lots (the "EstatesTime Share Lots")
dedicated to the Canyon Ranch Hacienda time share program (described more fully
below). Under the terms of the Contribution Agreement, CRI's fee interest in
the house in the Canyon Ranch Estates subdivision was contributed to the
Operating Partnership subject to the Lease and the Management Agreement. As a
consequence, CRM will be responsible for operating this unit for CRL. CRI sold
its interest in the Estates Time Share Lots to CRL under the terms of the Life
Share Property Contract. CRL borrowed funds pursuant to the Life Share Note to
acquire these lots.
The other units in the Canyon Ranch Estates Subdivision were not
contributed to the Operating Partnership.
H. Time Share Arrangements: Time share arrangements exist with
respect to the Casitas Time Share Lots and the Estates Time Share Lots.
Purchasers of time share interests
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Crescent Real Estate Equities, Inc.
July 26, 1996
Page 7
in these properties ("Interval Owners") entered into agreements with CRI that
allow the Interval Owners to (i) become members of Canyon Ranch, (ii) use the
time share accommodations for a certain period of time each year, and (iii)
receive certain personal health benefits. However, an Interval Owner must pay
to CRI additional fees for use of the spa, for meals and any special services
utilized. Interval Owners must also pay an annual maintenance fee to their
life share association (described more fully below). Under the Management
Agreement, CRM has agreed to perform all duties of CRI, as owner, under these
time share arrangements, to the extent such duties do not arise after the
termination of the Management Agreement. CRM has also agreed not to sell any
more time share interests under any of the above described programs.
III. REQUESTED OPINIONS
You have asked for our opinion concerning the impact that the purchase
of Canyon Ranch will have on the ability of the Company to continue to qualify
as a real estate investment trust (a "REIT") under section 856.(1)
Specifically, you have requested that we render opinions addressing the
following:
1. whether the Lease will be treated as a lease for federal
income tax purposes;
2. whether the income that the Operating Partnership derives from
the Lease will be treated as "qualifying income" for purposes
of the 95 percent and 75 percent gross income tests for REIT
qualification under section 856(c); and
3. whether the income that the Operating Partnership derives from
the Crescent FF & E Note and the Life Share Note will be
treated as "qualifying income" for purposes of the 75 percent
gross income test for REIT qualification under section
856(c)(3).
IV. LEGAL BACKGROUND
A. 75 Percent and 95 Percent Tests
In order to qualify as a REIT for tax purposes, the Company must
satisfy certain tests with respect to the composition of its gross income on an
annual basis. First, at least 75 percent of the Company's gross income
(excluding gross income from certain prohibited
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(1) All section references herein are to the Internal Revenue Code of 1986,
as amended (the "Code"), or to the regulations issued thereunder, unless
otherwise noted.
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Crescent Real Estate Equities, Inc.
July 26, 1996
Page 8
transactions) for each taxable year must consist of temporary investment income
or of certain defined categories of income derived directly or indirectly from
investments relating to real property or mortgages on real property. These
categories include, subject to various limitations, rents from real property,
interest on mortgages on real property, gains from the sale or other
disposition of real property (including interests in real property and
mortgages on real property) not primarily held for sale to customers in the
ordinary course of business, income from foreclosure property, and amounts
received as consideration for entering into either loans secured by real
property or purchases or leases of real property.(2) Second, at least 95
percent of the Company's gross income (excluding gross income from certain
prohibited transactions) for each taxable year must be derived from income
qualifying under the 75 percent test and from dividends, other types of
interest and gain from the sale or disposition of stock or securities, or from
any combination of the foregoing.(3)
In applying these income tests, REITs that are partners in a
partnership are required to include in their gross income their proportionate
share of the partnership's gross income. In addition, such REITs are to treat
this partnership gross income as retaining the same character as the items of
gross income of the partnership for purposes of section 856.(4) Thus, the
character of any income derived by the Operating Partnership from Canyon Ranch
will affect the ability of the Company to qualify as a REIT.
B. Rents from Real Property
Rents from real property satisfy both the 75 percent and 95 percent
tests for REIT qualification only if several conditions are met. First, the
amount of rent must not be based in whole or in part on the income or profits
of any person. An amount received or accrued generally will not be excluded
from the term "rents from real property" solely by reason of being based on a
fixed percentage or percentages of receipts or sales.(5) Second, the Code
provides that rents received from a tenant will not qualify as "rents from real
property" if the REIT, or an owner of 10 percent or more of the REIT, directly
or constructively, owns 10 percent or more of such tenant (a "Related Party
Tenant").(6) Third, if rent attributable to personal property leased in
connection with a lease of real property is greater than 15 percent of the
total rent received under the lease, then the portion of rent attributable to
such personal
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(2) Section 856(c)(3).
(3) Section 856(c)(2).
(4) Treas. Reg. Section 1.856-3(g).
(5) Section 856(d)(2)(A).
(6) Section 856(d)(2)(B).
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Crescent Real Estate Equities, Inc.
July 26, 1996
Page 9
property will not qualify as "rents from real property."(7) Finally, for rents
to qualify as "rents from real property," a REIT 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 REIT
derives no revenue. However, rents will be qualified as "rents from real
property" if a REIT directly performs services in connection with the lease of
the property, if those services are "usually or customarily rendered" in
connection with the rental of space for occupancy, and such services are not
considered to be rendered to the occupant of the property.(8)
C. Income from Foreclosure Property
Income from foreclosure property is treated as "qualifying income" for
purposes of the 75 percent and 95 percent tests (although any net income from
foreclosure property is taxed at the maximum corporate rate). Foreclosure
property is any real property, and any personal property incident to such real
property, acquired by a REIT through default under a mortgage or a lease. A
REIT may elect to treat such property as foreclosure property for a grace
period of up to two years.(9) However, such property will cease to qualify as
foreclosure property if it is used by the REIT in a trade or business more than
90 days after it is acquired and it is not operated through an independent
contractor from whom the REIT does not derive or receive any income.(10)
Moreover, property is not eligible to be treated as foreclosure property if the
lease is entered into with an intent to evict or foreclose, or if the REIT
knows or has reason to know that default would occur.(11)
V. OPINIONS
A. Lease Will be Treated as a Lease for Federal Income Tax
Purposes
In order for any income derived by the Operating Partnership from
Canyon Ranch to constitute either "rents from real property," or in the case of
a default under the Lease, "gross income from foreclosure property," the Lease
must be treated as a lease for federal income tax
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(7) Section 856(d)(1)(C).
(8) Sections 856(d)(1)(B), 856(d)(2)(C).
(9) Section 856(e).
(10) Section 856(e)(4).
(11) Treas. Reg. Section 1.856-6(b)(3).
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Page 10
purposes and not be treated as a service contract, management contract or other
type of arrangement. This determination depends on an analysis of all the
surrounding facts and circumstances. In making this determination, courts have
considered a variety of factors, including the following: (i) the intent of the
parties, (ii) the form of the agreement, (iii) the degree of control over the
business conducted at the property that is provided to the lessee (e.g.,
whether the lessee has substantial rights of control over the operation of the
property and its business), (iv) the extent to which the lessee has the risk of
loss from operations of the business conducted at the property (e.g., whether
the lessee bears the risk of increases in operating expenses and of decreases
in revenues), and (v) the extent to which the lessee has the opportunity to
benefit from operations of the business conducted at the property (e.g.,
whether the lessee benefits from decreased operating expenses or increased
revenues).(12)
In addition, section 7701(e) provides that a contract that purports to
be a service contract, partnership agreement, or another type of arrangement
will be 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 any savings
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
unrelated 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, partnership agreement,
or some other type of arrangement should be treated as a lease is inherently
factual, the presence or absence of any single factor may not be dispositive in
every case.(13)
We have concluded that the Lease will be treated as a lease for
Federal income tax purposes, rather than a service contract, management
contract or other type of arrangement. This conclusion is based, in part, on
the following facts: (i) the Operating Partnership and CRL intend their
relationship to be that of lessor and lessee (as evidenced by the terms of the
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(12) See, e.g., Xerox Corp. v. U.S., 80-2 USTC Paragraph 9530 (Ct. Cl. Tr.
Div. 1980), aff'd per curiam, 656 F.2d 659 (Ct. Cl. 1981).
(13) P.L.R. 8918012 (January 24, 1989).
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Crescent Real Estate Equities, Inc.
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Page 11
Lease), (ii) CRL, as tenant under the Lease, will have the right to exclusive
possession, use and quiet enjoyment of Canyon Ranch during the term of the
Lease and the right to uninterrupted control in the operation of the business
conducted at Canyon Ranch (subject to its assumption of the Management
Agreement), (iii) CRL will dictate how Canyon Ranch is maintained and improved,
(iv) CRL will bear all the costs and expenses of operating Canyon Ranch, (v)
CRL will benefit from any savings in the costs of operating Canyon Ranch during
the term of the Lease, (vi) in the event of damage or destruction to Canyon
Ranch, CRL will be at economic risk because its obligation to make rental
payments will not abate, (vii) CRL will indemnify the Operating Partnership
against all liabilities imposed on the Operating Partnership during the term of
the Lease by reason of injury to persons or damage to property occurring at
Canyon Ranch or CRL's use, management, maintenance or repair of Canyon Ranch,
(viii) CRL is obligated to pay substantial fixed rent for the period of use of
Canyon Ranch, regardless of whether its revenues exceed its costs and expenses,
and (ix) CRL stands to incur substantial losses (or derive substantial profits)
depending on how successfully it operates Canyon Ranch.
We do not believe that our conclusion that the Lease of Canyon Ranch
will be treated as a lease for Federal income tax purposes is affected by the
fact that CRL entered the Lease subject to its assumption of CRI's obligations
under the preexisting Management Agreement. The Management Agreement gives CRM
control over the day-to-day operation of Canyon Ranch and allows CRM to share
with CRL in the benefits of any increases in revenues or cost savings in the
operation of Canyon Ranch. However, CRM's operation of Canyon Ranch will not
be controlled by the Operating Partnership, and the Management Agreement does
not affect the fact that CRL bears most of the risk of loss if Canyon Ranch is
not successful. Moreover, the IRS has issued a private letter ruling in which
it treated leases of several hotel properties as producing "rents from real
property" in a situation where the lessees had contracted with a third party to
conduct the day-to-day operations of the hotels.(14) This ruling suggests that
the IRS will respect a lease of a hotel for federal income tax purposes even if
the hotel is operated by an independent contractor rather than by the lessee.
B. Percentage Rent Provision is not Profit-Based
Pursuant to the Lease, CRL will be obligated to pay the Operating
Partnership base rent and percentage rent. Under the regulations, percentage
rent based on a percentage of gross receipts or sales in excess of a floor
amount, which is how the percentage rent is structured under the Lease, will
not qualify as "rents from real property" unless (i) such floor amount does not
depend in whole or in part on the income or profits of the lessee, (ii) the
percentage and the floor amount are fixed at the time the lease is entered
into, (iii) the
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(14) See, P.L.R. 8117036 (January 27, 1981).
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Crescent Real Estate Equities, Inc.
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Page 12
percentage and the floor amount are not renegotiated during the term of the
lease in a manner that has the effect of basing the percentage rent on income
or profits, and (iv) the percentage and the floor amount conform with normal
business practice.(15)
Under the terms of Article 4.2 of the Lease, the Lessee will pay
percentage rent during the first seven years of the Lease on an annual basis
equal to the sum of (i) 15 percent of the amount by which gross receipts from
the Leased Property exceed $29,000,000 (with such amount not exceeding
$4,000,000), (ii) 11 percent of the amount by which gross receipts from the
Leased Property exceed $33,000,000 (with such amount not exceeding $7,000,000),
and (iii) 8.5 percent of the amount by which gross receipts from the Leased
Property exceed $40,000,000. During years eight through ten of the Lease the
Lessee will pay percentage rent equal to the sum of (i) 20 percent of the
amount by which gross receipts from the Leased Property exceed $29,000,000
(with such amount not exceeding $4,000,000), (ii) 16 percent of the amount by
which the gross receipts from the Leased Property exceed $33,000,000 (with such
amounts not exceeding $7,000,000) and (iii) 15 percent of the amount by which
gross receipts from the Leased Property exceed $40,000,000. This formula
effectively rewards the tenant for any increases in gross receipts over the
threshold amounts. This type of formula does not base the percentage rent on
the tenant's income or profits, and similar formulas have been treated by the
IRS as generating "rents from real property."(16) Moreover, the Operating
Partnership has represented that (i) the floor amounts used to compute the
percentage rent under the Lease do not depend in whole or in part on the income
or profits of any person, (ii) the percentage rent provision of the Lease will
not be renegotiated during the term of the Lease or at the expiration or
earlier termination of the Lease in a manner that has the effect of basing the
rent on income or profits, and (iii) the percentage rent provision of the Lease
conforms with normal business practice. In addition, based on our experience
and an examination of the Lease and certain projections regarding Canyon
Ranch's expected future performance, the Lease appears to conform with normal
business practice.
C. CRL is not a "Related Party Tenant"
Rents derived under the Lease will not qualify as "rents from real
property" if CRL is treated as a "related party tenant." CRL will be treated
as a "related party tenant" if the Company, or an owner of 10 percent or more
of the Company, directly or constructively owns
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(15) Treas. Reg. Section 1.866-4(b)(3).
(16) See, e.g., P.L.R. 8803007 (September 23, 1987) (percentage rent based on
gross revenues in excess of gross revenues for a base year treated as
"rents from real property"); cf. P.L.R. 9104018 (October 26, 1990)
(interest based on gross revenues in excess of a floor amount treated as
qualifying interest under section 856(f)).
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Crescent Real Estate Equities, Inc.
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Page 13
10 percent or more of the entity's assets or net profits.(17) Constructive
ownership is determined for purposes of this test by applying the rules of
section 318(a) as modified by section 856(d)(5). Those rules generally provide
that if 10 percent 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. In
determining whether CRL is a "related party tenant" it is necessary to consider
not only CRL's current ownership, but also its potential ownership after the
exercise of the Zuckerman and Cohen Options. This is because, for federal
income tax purposes, the Zuckerman and Cohen Options are likely to be treated
as currently exercised. These options are likely to be treated as currently
exercised, because each is composed of a matching put and call option for CRL
stock with a nominal exercise price.
1. CRL's Current Ownership
CRL will not be treated as a "related party tenant" under its current
ownership because two individuals, Zuckerman and Cohen, collectively own a 100
percent interest in CRL's assets and net profits. In reaching this conclusion,
we recognize that Zuckerman and Cohen each own certain Units of the Operating
Partnership as a result of the Acquisition Transaction.(18) We also recognize
that the Operating Partnership has an option to acquire a 30 percent interest
in a management company that will also be owned by Zuckerman. The Operating
Partnership has represented that (i) Zuckerman and Cohen do not individually,
or as a group, own more than 10 percent of the value of the Company's stock,
(ii) in the future Zuckerman and Cohen are not expected to own more than 10
percent of the value of the Company's stock individually, or as a group, and
(iii) neither the Operating Partnership nor the Company intends to acquire,
directly or constructively, an interest of 10 percent or more in the assets or
net profits of CRL at any time in the future. Moreover, Article 7.8 of the
Lease will prevent CRL and its members and managers from acquiring, directly or
constructively, a greater than six percent stock interest in the Company
without the Operating Partnership's prior written consent, and Section 6.4 of
the First Amended and Restated Articles of Incorporation of the Company
prevents CRL and its members and managers from acquiring more than 8 percent of
the Company's stock.
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(17) Section 856(d)(2)(B)(ii).
(18) See Rev. Rul. 73-194, 1973-1 C.B. 355 (management company treated as an
independent contractor with respect to a REIT, where an affiliate of the
management company and the REIT were partners).
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Crescent Real Estate Equities, Inc.
July 26, 1996
Page 14
2. CRL's Ownership-Treating the Zuckerman and Cohen
Options as Exercised
CRL will not be treated as a "related party tenant" if the Zuckerman
and Cohen Options are treated as exercised because after exercise of these
options a 99 percent interest in CRL's assets and net profits will be owned by
RoseStar, with the remaining one percent interest owned by RSCR. An
individual, Sanjay Varma, currently owns a 91 percent interest in the assets
and net profits of RoseStar and 91 percent of the stock of RSCR. In reaching
this conclusion, we recognize that Sanjay Varma owns certain Units of the
Operating Partnership.(19) The Operating Partnership has represented that (i)
Sanjay Varma does not own more than 10 percent of the value of the Company's
stock, (ii) Sanjay Varma is not expected to own more than 10 percent of the
value of the Company's stock in the future, and (iii) neither the Operating
Partnership nor the Company intends to acquire, directly or constructively, an
interest of 10 percent or more in the assets or net profits of RoseStar at any
time in the future. In concluding that CRL will not be treated as a "related
party tenant" if the Zuckerman and Cohen Options are treated as exercised, we
have applied the definition of related party tenant set forth in section
856(d)(2)(B)(ii), which applies to tenants which are not corporations. If CRL
is not treated as a partnership for federal income tax purposes, but is instead
treated as an association taxable as a corporation, then the applicable
definition of related party tenant is the one set forth in section
856(d)(2)(B)(i), which looks to control over voting securities. If CRL were
treated as a corporation for federal income tax purposes, Gerald W. Haddock and
John C. Goff could possibly be deemed to control all of its voting stock,
because of the extensive powers that they are granted as managers of RoseStar
under the RoseStar Regulations. If this were the case, it would be necessary
to consider whether the ownership of such voting stock could possibly be
attributed to the Company under the constructive ownership rules described
above or otherwise.
An entity which has associates and an objective to carry on a business
for joint profit will be treated as a partnership for federal income tax
purposes, and not as an association taxable as a corporation, if it has not
more than two of the following four characteristics of a corporation: (i)
continuity of life; (ii) centralization of management; (iii) limited liability;
and (iv) free transferability of interests.(20) The entity must also have no
other characteristics which are significant in determining its classification.
Generally, other factors are considered only insofar as they relate to the
determination of the presence or absence of the foregoing corporate
characteristics.(21) The IRS has applied this four-factor test in determining
whether
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(19) See Rev. Rul. 73-194, 1973-1 C.B. 355 (described above).
(20) Treas. Reg. Section 301.7701-2(a).
(21) See Rev. Rul. 79-106, 1979-1 C.B. 448.
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Crescent Real Estate Equities, Inc.
July 26, 1996
Page 15
limited liability companies formed under the ArizonaLimited Liability Company
Act (Ariz. Rev. Stat. Ann., Title 29, Chapter 4, sections 29-601 through 29-857
(1992), referred to herein as the "Act") are partnerships for federal income
tax purposes.(22) The IRS has issued Rev. Proc. 95-10, which specifies
conditions which must be satisfied for a limited liability company to receive a
favorable advanced ruling that it will be classified as a partnership for
federal income tax purposes.(23) CRL should satisfy these conditions.
However, such conditions are applicable only in determining whether rulings
will be issued and are not intended as substantive rules for determination of
partnership status.
An organization will be treated as possessing the corporate
characteristic of continuity of life, even if the agreement organizing an
entity provides that it is to continue only for a stated period, unless a
member has the power to dissolve the organization at an earlier time.(24)
Section 29-781.A of the Act provides that an LLC organized under the Act is
dissolved on the occurrence of the first of the following: (1) at the time or
on the happening of the events specified for dissolution in the articles of
organization or an operating agreement; (2) the written consent to dissolve by
all members; (3) an event of withdrawal of a member under section 29-733 of the
Act, unless the business of the LLC is continued by one or more managers or
members pursuant to a right to continue stated in an operating agreement or, if
an operating agreement does not provide a right to continue, by agreement or
consent of all of the remaining members within 90 days after the event of
withdrawal; (4) entry of a judgment of dissolution under section 29-785 of the
Act; or (5) acquisition by a single person of all outstanding interests in the
LLC. Section 29-733 of the Act provides that, except as approved by the
written consent of all members at the time, a person ceases to be a member of
an LLC on the occurrence of any of the following events of withdrawal: (1) the
member withdraws from the LLC as provided in section 29-734; (2) on assignment
of all the member's interest and admission of one or more of the assignees as a
member; (3) the member is expelled as a member pursuant to the articles of
organization or a operating agreement; (4) unless otherwise provided in an
operating agreement, the member does any of the following: (a) makes an
assignment for the benefit of creditors, (b) files a voluntary petition in
bankruptcy, (c) is adjudicated as bankrupt or insolvent, (d) files a petition
or answer seeking for himself any reorganization, arrangement, composition,
readjustment, liquidation or similar relief under any statute, law or rule, (e)
files an answer or other pleading admitting or failing to contest the material
allegations of a petition filed against him in a bankruptcy, insolvency,
reorganization or similar proceeding, (f) seeks, consents to or acquiesces in
the appointment of a trustee, receiver or liquidator of the member or of all or
any substantial part of the
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(22) See, e.g., Rev. Rul. 93-93, 1993-42 I.R.B. 13; and P.L.R. 9321047
(February 25, 1993).
(23) 1995-3 I.R.B. 20.
(24) Treas. Reg. Section 301.7701-2(b)(3).
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Crescent Real Estate Equities, Inc.
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Page 16
member's property; or (5) if a member is a natural person, the member's death,
or the entry of an order or judgment by a court of competent jurisdiction
adjudicating the member incompetent to manage the member's person or the
member's estate. Section 7.1.1 of the CRL Articles provides that CRL shall be
dissolved upon any withdrawal event, as defined in Section 29-733 of the Act,
unless a majority in interest of the remaining members consent to continue CRL
(and CRL has a least two remaining members). Accordingly, CRL will lack the
corporate characteristic of continuity of life.An organization will be treated
as possessing the corporate characteristic of free transferability of interests
if the members owning all or substantially all of the interests in an
organization may substitute for themselves without the consent of the other
members a person who is not a member of the organization.(25) Section 29-732.A
of the Act provides that an interest in an LLC is personal property and, is
assignable in whole or in part; an assignment of an interest in an LLC does not
dissolve the LLC or entitle the assignee to participate in the management of
the business and affairs of the LLC or to become a member or to exercise the
rights of a member, unless the assignee is admitted as a member as provided in
section 29-731 of the Act. Section 29-731.B.2 of the Act provides that after
an LLC's initial articles of organization are filed, a person who is an
assignee of all or part of a member's interest in an LLC may become a member on
the approval or consent of all members or of any one or more members who have
the right under an operating agreement to admit additional members. Section
29-731.B.3 provides that if the person is an assignee of an interest in the LLC
of a member who has the power under an operating agreement to grant the
assignee the right to become a member, the assignee may become a member on the
exercise of the power in compliance with all conditions limiting the member's
exercise of the power. Article 5 of the CRL Articles provides, in part, that
no member shall have the right to substitute in its place a transferee.
Accordingly, CRL will lack the corporate characteristic of free transferability
of interests.
An organization will be treated as lacking the corporate
characteristic of centralization of management if management decisions are made
by a vote of the majority of beneficial owners.(26) Section 3.1 of the CRL
Articles provides that CRL's management is vested in its members. Accordingly,
CRL will lack the corporate characteristic of centralization of management.
Because CRL will lack the corporate characteristics of continuity of life ,
free transferability of interests and centralization of management, in our
opinion it will be treated as partnership for federal income tax purposes.
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(25) Treas. Reg. Section 301.7701-2(e).
(26) Treas. Reg. Section 301.7701-2(g), Ex. (7).
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Crescent Real Estate Equities, Inc.
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Page 17
D. Incidental Personal Property
1. Rents Attributable to Personal Property Will Be
Treated as "Rents from Real Property"
As noted above, the rents attributable to the Operating Partnership's
personal property leased under or in connection with the Lease must not be
greater than 15 percent of the rents received under the Lease. The rent
attributable to personal property leased under or in connection with a lease of
real property is the amount that bears the same ratio to total rent for the
taxable year as (i) the average of the adjusted bases of the personal property
leased under or in connection with a lease of real property at the beginning
and at the end of the taxable year bears to (ii) the average of the aggregate
adjusted bases of the real and personal property subject to the lease at the
beginning and at the end of such taxable year (the "Adjusted Basis Ratio").(27)
Section 36.2 of the Lease provides that the average of the adjusted bases of
the personal property leased to the lessee under the Lease at the beginning and
end of any calendar year shall not exceed 15 percent of the average of the
adjusted tax bases of the Leased Property at the beginning and at the end of
each such calendar year. In addition, the Operating Partnership has
represented that the adjusted tax basis of the personal property leased under
or in connection with the Lease will not represent more than 15 percent of the
aggregate adjusted tax basis of Canyon Ranch at any time.
2. Payments Attributable to RoseStar's Acquisition of Certain
Personal Property Will Not Be Treated as "Rents from Real
Property"
Pursuant to Article I of the Contribution Agreement, the conveyance to
the Operating Partnership did not include the FF & E. Instead, the FF & E was
sold by CRI to CRL in exchange for the proceeds of loans from the Operating
Partnership. Under the terms of Article 7.5 of the Lease, however, the lessee
is obligated to transfer and assign the FF & E upon termination of the Lease to
a person designated by the lessor at a price equal to the then existing fair
market value of the FF & E.
The Operating Partnership will not be treated as the tax owner of the
FF & E. The FF & E is owned by CRL. The payments that the Operating
Partnership will receive under the Crescent FF & E Note will not qualify as
"rents from real property." Instead, such payments will be treated for federal
income tax purposes as payments of principal and interest resulting from the
Operating Partnership's financing of CRL's purchase of the FF & E. The
payments pursuant to this financing, to the extent they constitute interest,
will be "qualifying income" for
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(27) Section 856(d)(1)(C).
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Crescent Real Estate Equities, Inc.
July 26, 1996
Page 18
purposes of the 75 percent test. However, because the financing will be
secured by personal property under the terms of the Security Agreement, rather
than real property, such interest will not be "qualifying income" for purposes
of the 95 percent test. Similarly , interest accruing under the Life Share
Note, which is also secured by the FF & E under the terms of the Security
Agreement, will also be treated as "qualifying income" for purposes of the 75
percent test, but not for purposes of the 95 percent test.
E. Provision of Services by the Operating Partnership
1. Income Derived under the Terms of the Lease
Although the Operating Partnership may treat charges for services
customarily furnished or rendered in connection with the rental of Canyon Ranch
as "rents from real property," any services rendered to the occupants of Canyon
Ranch must be furnished or rendered by an independent contractor from whom the
Company does not derive or receive any income.(28) Moreover, to the extent
that any independent contractors provide noncustomary services to the occupants
of Canyon Ranch, the cost of such services must not be borne by the Operating
Partnership.(29) Under the terms of the Lease, the Operating Partnership will
not be required to provide any services, customary or noncustomary, in
connection with the rental of Canyon Ranch. Instead, all services relating to
the operation of Canyon Ranch will be provided by CRM under the terms of the
Management Agreement. The Operating Partnership will not bear the cost of any
of the services provided by CRM. Instead, such costs will be borne by CRL,
which as lessee under the Lease has assumed the obligations of the owner under
the Management Agreement.
Based on the foregoing, we believe that the provision of any
noncustomary services to the occupants of Canyon Ranch by CRM will have no
effect on the qualification of the income derived from Canyon Ranch as "rents
from real property." In fact, the IRS has issued a private letter ruling in
which it has treated the income derived from several leases of hotel properties
as "rents from real property" in a situation where the lessees had contracted
with a third-party to conduct the day-to-day operations of the hotels.(30) Our
conclusion is not altered by the fact that the Operating Partnership will
remain liable for any obligations arising under the Management Agreement, to
the extent that they are not satisfied by CRL, as lessee under the Lease. The
Operating Partnership should not be treated as bearing the cost of the services
provided by CRM merely because it could possibly be held liable for CRL's
obligations under
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(28) Sections 856(d)(1), 856(d)(2)(C); Treas. Reg. Section 1.512(b)-1(c)(5).
(29) Treas. Reg. Section 1.856-4(b)(5).
(30) See, P.L.R. 8117036 (January 27, 1981).
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Crescent Real Estate Equities, Inc.
July 26, 1996
Page 19
the Management Agreement. The Operating Partnership is not retaining this
liability in an attempt to provide services to CRL. Instead, it is retaining
this liability only as an accommodation, in order to gain CRM's consent to its
purchase of Canyon Ranch. Moreover, the Operating Partnership believes that it
is highly unlikely that it will ever be required to reimburse CRM for the costs
and expenses of operating Canyon Ranch because of a default by CRL in its
obligations as owner under the Management Agreement. This is because (i)
Canyon Ranch is projected to generate enough gross income to cover the payments
to CRM under the Management Agreement, (ii) in connection with Section 7.7 of
the Lease, CRL represents that it has a net worth of at least $200,000, (iii)
in connection with Section 7.9 of the Lease, CRL covenants that it will retain
all income generated by the Leased Property and shall not distribute any
earnings to its beneficial owners, except as needed for federal and state
income taxes payable on taxable income from the Leased Property, until the
tenant has accumulated and is holding in reserve funds which are sufficient to
pay at least one monthly payment of Base Rent under the Lease, plus at least
one monthly payment of Base Rent under all other leases between lessor and
lessee, (iv) RoseStar has guaranteed CRL's obligations under the Lease and its
individual members have guaranteed CRL's obligations under the Lease (as well
as the Crescent FF & E Note and the Life Share Note) up to $200,000, and (v) in
the view of the Operating Partnership, RoseStar's capitalization is adequate to
allow RoseStar to assume its obligations as guarantor under the Guaranty.
2. Income Derived in the Case of a Default under the Lease
If the Operating Partnership were required to reimburse CRM for the
costs of operating Canyon Ranch because of a default by the Tenant under the
terms of the Management Agreement, we have concluded that the income derived by
the Operating Partnership from Canyon Ranch would be treated as "qualifying
income" for purposes of the 75 percent and 95 percent tests. This is because,
if the Operating Partnership were required to reimburse CRM for the cost of
operating Canyon Ranch, this would constitute an event of default under Article
16.1(c) of the Lease, allowing the Operating Partnership to terminate the
lessee's leasehold interest in Canyon Ranch. As a result of such a termination
of the Lease, any income derived by the Operating Partnership from Canyon Ranch
after the default would be treated as income from foreclosure property.
The Operating Partnership would be able to continue to operate Canyon
Ranch after any default under the Lease, without affecting its status as
foreclosure property. This is because CRM will provide all services relating
to the operation of Canyon Ranch and CRM will qualify as an independent
contractor from whom the Company will not derive any income. As noted above, a
REIT can use foreclosure property in the conduct of an active trade or
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Crescent Real Estate Equities, Inc.
July 26, 1996
Page 20
business, as long as this is done through the use of an independent
contractor, from whom the REIT does not derive or receive any income.(31)
As noted above, real property acquired upon default under a lease is
not eligible to be treated as foreclosure property if the lease is entered into
with an intent to evict or foreclose, or if the REIT knows or has reason to
know that default would occur.(32) This is not the case in the present
situation because (i) Canyon Ranch is projected to generate enough gross income
to produce a profit for CRL, (ii) in connection with Section 7.7 of the Lease,
the Tenant represents that it has a net worth of at least $200,000, (iii) in
connection with Section 7.9 of the Lease, the tenant covenants that it will
retain all income generated by the Leased Property and shall not distribute any
earnings to its beneficial owners, except as needed for federal and state
income taxes payable on taxable income from the Leased Property, until the
tenant has accumulated and is holding in reserve funds which are sufficient to
pay at least one monthly payment of Base Rent under the Lease, plus at least
one monthly payment of Base Rent under all other leases between lessor and
lessee, (iv) RoseStar has guaranteed CRL's obligations under the Lease and its
individual members have guaranteed CRL's obligations under the Lease (as well
as the Crescent FF & E Note and the Life Share Note) up to $200,000, and (v) in
the view of the Operating Partnership, RoseStar's capitalization is adequate to
allow RoseStar to assume its obligations as guarantor under the Guaranty.
Canyon Ranch would qualify as foreclosure property only for a period
of up to two years, beginning on the date of its acquisition by the Operating
Partnership, unless the Operating Partnership obtains an extension of the grace
period from the IRS.(33) Therefore, in the event the Operating Partnership
takes possession of Canyon Ranch as a result of a default under the Lease,
presumably the Operating Partnership will sell Canyon Ranch or within two years
rent it to another tenant under a lease that will produce "rents from real
property."
VI. ASSUMPTIONS AND REPRESENTATIONS
In providing these opinions, we have with your permission assumed the
following: (i) the due authorization, execution and delivery by all parties
thereto of the Transaction
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(31) Section 856(e)(4)(C). The IRS clearly intended for REITs to be able to
treat hotels operated by independent contractors as foreclosure property. For
instance, the Treasury regulations defining foreclosure property refer to hotel
properties twice. See, Treas. Reg. Sections 1.856-6(b)(2), 1.856-6(d)(2). In
addition, the IRS has also recently issued a private letter ruling in which it
treated income received from hotels acquired pursuant to a bankruptcy petition
as income from foreclosure property, where the hotels were operated by third
party managers. P.L.R. 9420013 (2/15/94).
(32) Treas. Reg. Section 1.856-6(b)(3).
(33) Section 856(e)(2).
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Crescent Real Estate Equities, Inc.
July 26, 1996
Page 21
Documents, (ii) the authenticity of the originals of the Transaction Documents
and the genuineness of all signatures; (iii) the conformity to the original of
all documents submitted to us as copies; (iv) the absence of any evidence
extrinsic to the provisions of the written agreements between the parties that
the parties intended a meaning contrary to that expressed by those provisions;
(v) that each party to the Transaction Documents has the power and authority to
enter into and perform all of its obligations thereunder; (vi) that each of the
Transaction Documents is a legal, valid and binding obligation, enforceable in
accordance with its terms; and (vii) that each legal entity that is a party to
the Transaction Documents validly existing and in good standing under the laws
of the United States of America or one of the States thereof or the District of
Columbia. As to questions of fact material to such opinions, we have with your
permission, when relevant facts were not independently established. relied
upon, and assumed the truth, accuracy and completeness of, written and oral
statements and representations made by or on behalf of the parties to the
Transaction Documents by their respective officers or agents. With your
permission, we have further assumed that each of the parties to each of the
Transaction Documents fully complies with its obligations thereunder.
In addition, these opinions are conditioned upon certain
representations made by the Company and the Operating Partnership as to factual
and other matters as set forth in the attached letter. Unless facts material
to the opinions expressed herein are specifically stated to have been
independently established or verified by us, we have relied as to such facts
solely upon the representations made by the Company and the Operating
Partnership. We are not, however, aware of any facts or circumstances contrary
to or inconsistent with the representations. To the extent the representations
are with respect to matters set forth in the Code or Treasury Regulations, we
have reviewed with the individuals making such representations the relevant
provisions of the Code, the Treasury Regulations and published administrative
interpretations.
Our opinions contained herein are based in part upon our conclusion
that the U.S. federal income tax treatment of the transactions contemplated by
the Transaction Documents will be determined based on their economic substance.
Although there can be no assurance that the IRS will not take one or more
contrary positions, it is our opinion that none of those positions, if asserted
by the IRS, would prevail. However, because our opinions are not binding on
the IRS or the courts, there can be no assurance that contrary positions may
not be successfully asserted by the IRS. Our opinions are based upon the
present provisions of the Code, the regulations promulgated thereunder,
administrative rulings, judicial decisions, and any other applicable
authorities published and in effect on the date hereof (all of which are
subject to change, both prospectively and retroactively).
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Crescent Real Estate Equities, Inc.
July 26, 1996
Page 22
This letter and the opinions contained herein are based solely upon
our knowledge of the relevant facts. In this opinion, the words "our
knowledge" or words to similar effect signify that, in the course of our
representation of the Company or the Operating Partnership, in matters with
respect to which we have been engaged as counsel by such entity, no information
has come to the attention of those attorneys in our firm having detailed
knowledge of this transaction and the substance of this opinion that gives such
attorneys current, actual knowledge that any such opinions are not accurate.
In rendering this opinion, we have undertaken no investigation with respect to
such matters and we have not undertaken to communicate the details of this
transaction to all members or employees of our firm who may have performed, and
are currently performing, services for the Company or the Operating
Partnership, or any other person or entity.
The opinions contained herein are issued, and our opinions herein are
expressed, as of the date hereof. These opinions and this letter are limited
to the matters expressly set forth herein, and no statements or opinions may be
inferred beyond such matters. We do not assume any responsibility to update
these opinions or advise you of changes resulting from events (whether or note
they come to our attention) that may occur after the date hereof, including,
without limitation, future transactions or other actions under the Transaction
Documents, or any inaccuracy in any of the representations or warranties upon
which we have relied in rendering these opinions.
VII. CONCLUSION
Based on the assumptions stated above, it is our opinion that (i) the
Lease will be treated as a lease for federal income tax purposes, (ii) all of
the income that the Operating Partnership derives under the Lease will be
treated as "qualifying income" for purposes of the 95 percent test, and (iii)
all of the income the Operating Partnership derives under the Crescent FF & E
Note and the Life Share Note will be treated as "qualifying income" for
purposes of the 75 percent test.
Very Truly Yours,
SHAW, PITTMAN, POTTS & TROWBRIDGE
<PAGE> 136
December 11, 1996
Crescent Real Estate Equities Company
777 Main Street
Suite 2100
Fort Worth, Texas 76102
Re: Canyon Ranch Lenox
Ladies and Gentlemen:
You have requested certain opinions regarding the application of U.S.
federal income tax laws to Crescent Real Estate Equities Company ("Crescent
Equities") and Crescent Real Estate Equities Limited Partnership (the
"Operating Partnership") in connection with the acquisition by Crescent Real
Estate Funding VI, L.P. ("Funding VI") of Canyon Ranch, a health and fitness
resort located in Lenox, Massachusetts from Canyon Ranch - Bellefontaine
Associates, L.P. ("CRBA").
I. Transaction Documents
In rendering the opinions expressed below, we have examined and relied
upon the following documents (collectively, the "Transaction Documents"):
(i) the Purchase Agreement between CRBA and the Operating
Partnership, ("the Contribution Agreement") dated October 12,
1996;
(ii) the Lease Agreement between CRBA and Vintage Resorts, L.L.C.
("Vintage"), dated December 11, 1996 (the "Lease");
(iii) the Management Agreement between CRBA and Canyon Ranch
Management, L.L.C. ("CRM"), dated December 11, 1996 (the
"Management Agreement");
(iv) the Assignment and Assumption of Purchase Agreement between
the Operating Partnership and Funding VI, dated December 5,
1996;
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Crescent Real Estate Equities Company
December 11, 1996
Page 2
(v) the Assignment and Assumption of Management Agreement between
CRBA and Funding VI, dated December 11, 1996;
(vi) the Assignment and Assumption of Master Lease between CRBA and
Funding VI, dated December 11, 1996;
(vii) the Assignment and Assumption of Contracts between CRBA and
Funding VI, dated December 11, 1996;
(viii) the Assignment and Assumption of Store Leases between CRBA and
Funding VI, dated December 11, 1996;
(ix) the Limited Guaranty Agreement between Gerald Haddock, John C.
Goff and Harry H. Frampton, together, as guarantors and
Funding VI, dated December 5, 1996 (the "Limited Guaranty");
(x) the First Amended and Restated Agreement of Limited
Partnership of Crescent Real Estate Funding VI, L.P. dated
December 11, 1996 (the "Funding VI Agreement");
(xi) the Certificate of Limited Partnership of Crescent Real Estate
Funding VI, L.P.;
(xii) the Articles of Incorporation of CRE Management VI Corp;
(xiii) the Bylaws of CRE Management VI Corp.;
(xiv) the Restated Declaration of Trust of Crescent Real Estate
Equities Company, and
(xv) such other documents or information as we deemed necessary for
the opinions set forth below.
II. Background of Transaction
A. The Management Agreement
Under the Management Agreement, CRBA, as owner of Canyon Ranch, has
contracted with CRM to manage and operate Canyon Ranch and to collect all
Canyon Ranch
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Crescent Real Estate Equities Company
December 11, 1996
Page 3
receipts. In addition, CRM has also agreed to honor resort memberships issued
to various persons by CRBA. CRM was also granted the right to issue additional
memberships in the resort in the future. In exchange for these services, CRM is
to be paid a profits-based management fee collected from the gross receipts of
the resort.
Under the Management Agreement, CRBA, as owner, is obligated to
establish a capital improvement reserve to be funded from gross receipts from
the resort. CRM, as manager, is entitled to withdraw funds from this reserve to
pay for capital improvements and additions to the furniture, fixtures and
equipment used in connection with the resort. Section 15.2 of the Management
Agreement requires that all assignments of the Management Agreement (other than
certain assignments to permitted transferees) be approved by CRM; and under
Section 15.3 of the Management Agreement any assignees are bound by the
obligations of the owner under the Management Agreement.
B. The Lease
Under the terms of the Lease, Vintage leased the following property
(the "Leased Property") from CRBA and assumed the related obligations: (i) the
land, buildings, fixtures and other improvements commonly known as "Canyon
Ranch in the Berkshires;" (ii) all personal property, tangible or intangible,
owned by CRBA and used in connection with the operation of Canyon Ranch; (iii)
various contracts entitling persons to use the guest rooms and/or the resort
facilities; (iv) various contracts (excluding employment contracts) relating to
the operation of the resort; and (v) CRBA's interest as owner under the
Management Agreement.
C. The Purchase Agreement and the Assignment and Assumption
Agreements
Under the Purchase Agreement, the Operating Partnership agreed to
purchase and CRBA agreed to sell the land, buildings, fixtures and other
improvements commonly known as Canyon Ranch, as well as certain personal
property used in connection with the operation of the resort to the Operating
Partnership, subject to the Lease and the Management Agreement. Under the
Purchase Agreement, the Operating Partnership also acquired CRBA's interest as
owner under the Management Agreement and as lessor under the Lease.
Under the Assignment and Assumption of Purchase Agreement, the
Operating Partnership transferred to Funding VI, a partnership in which the
Operating Partnership holds a 99 percent limited partnership interest, its
right and obligation to purchase Canyon Ranch from CRBA.
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Crescent Real Estate Equities Company
December 11, 1996
Page 4
Under the subsequent Assignment and Assumption of Management
Agreement, Funding VI assumed and agreed to perform all obligations of CRBA as
owner under the Management Agreement to the extent that such obligations are
not performed by Vintage as lessee under the Lease.
III. Requested Opinions
You have asked for our opinion concerning the impact that the purchase
of Canyon Ranch will have on the ability of Crescent Equities to continue to
qualify as a real estate investment trust (a "REIT") under section 856.(1)
Specifically, you have requested that we render an opinions addressing (i)
whether the Lease will be treated as a lease for federal income tax purposes
and (ii) whether the income that the Operating Partnership derives from the
lease will be treated as "qualifying income" for purposes of the 95 percent and
75 percent gross income tests for REIT qualification under section 856(c).
IV. Legal Background
A. 75 Percent and 95 Percent Tests
In order to qualify as a REIT for tax purposes, Crescent Equities must
satisfy certain tests with respect to the composition of its gross income on an
annual basis. First, at least 75 percent of Crescent Equities' gross income
(excluding gross income from certain prohibited transactions) for each taxable
year must consist of temporary investment income or of certain defined
categories of income derived directly or indirectly from investments relating
to real property or mortgages on real property. These categories include,
subject to various limitations, rents from real property, interest on mortgages
on real property, gains from the sale or other disposition of real property
(including interests in real property and mortgages on real property) not
primarily held for sale to customers in the ordinary course of business, income
from foreclosure property, and amounts received as consideration for entering
into either loans secured by real property or purchases or leases of real
property.(2) Second, at least 95 percent of Crescent Equities' gross income
(excluding gross income from certain prohibited transactions) for each taxable
year must be derived from income qualifying under the 75 percent test and from
dividends, other types of interest and gain from the sale or disposition of
stock or securities, or from any combination of the foregoing.(3)
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(1) All section references herein are to the Internal Revenue Code of
1986, as amended (the "Code"), or to the regulations issued
thereunder, unless otherwise noted.
(2) Section 856(c)(3).
(3) Section 856(c)(2).
<PAGE> 140
Crescent Real Estate Equities Company
December 11, 1996
Page 5
In applying these income tests, REITs that are partners in a
partnership are required to include in their gross income their proportionate
share of the partnership's gross income. In addition, such REITs are to treat
this partnership gross income as retaining the same character as the items of
gross income of the partnership for purposes of section 856.(4) Thus, the
character of any income derived by the Operating Partnership, through its
partnership interest in Funding VI, from Canyon Ranch will affect the ability
of Crescent Equities to qualify as a REIT.
B. Rents from Real Property
Rents from real property satisfy both the 75 percent and 95 percent
tests for REIT qualification only if several conditions are met. First, the
amount of rent must not be based in whole or in part on the income or profits
of any person. An amount received or accrued generally will not be excluded
from the term "rents from real property" solely by reason of being based on a
fixed percentage or percentages of receipts or sales.(5) Second, the Code
provides that rents received from a tenant will not qualify as "rents from real
property" if the REIT, or an owner of 10 percent or more of the REIT, directly
or constructively, owns 10 percent or more of such tenant (a "Related Party
Tenant").(6) Third, if rent attributable to personal property leased in
connection with a lease of real property is greater than 15 percent of the
total rent received under the lease, then the portion of rent attributable to
such personal property will not qualify as "rents from real property."(7)
Finally, for rents to qualify as "rents from real property," a REIT 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 REIT derives no revenue. However, rents will be qualified as "rents
from real property" if a REIT directly performs services in connection with the
lease of the property, if those services are "usually or customarily rendered"
in connection with the rental of space for occupancy, and if such services are
not considered to be rendered to the occupant of the property.(8)
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(4) Treas. Reg. Section 1.856-3(g).
(5) Section 856(d)(2)(A).
(6) Section 856(d)(2)(B).
(7) Section 856(d)(1)(C).
(8) Sections 856(d)(1)(B), 856(d)(2)(C).
<PAGE> 141
Crescent Real Estate Equities Company
December 11, 1996
Page 6
C. Income from Foreclosure Property
Income from foreclosure property is treated as "qualifying income" for
purposes of the 75 percent and 95 percent tests (although any net income from
foreclosure property is taxed at the maximum corporate rate). Foreclosure
property is any real property, and any personal property incident to such real
property, acquired by a REIT through default under a mortgage or a lease. A
REIT may elect to treat such property as foreclosure property for a grace
period of up to two years.(9) However, such property will cease to qualify as
foreclosure property if it is used by the REIT in a trade or business more than
90 days after it is acquired and it is not operated through an independent
contractor from whom the REIT does not derive or receive any income.(10)
Moreover, property is not eligible to be treated as foreclosure property if the
lease is entered into with an intent to evict or foreclose, or if the REIT
knows or has reason to know that default would occur.(11)
V. Opinions
A. Lease Will be Treated as a Lease for Federal Income Tax
Purposes
In order for any income derived by the Operating Partnership, through
its partnership interest in Funding VI, from Canyon Ranch to constitute either
"rents from real property," or in the case of a default under the Lease, "gross
income from foreclosure property," the Lease must be treated as a lease for
federal income tax purposes and not be treated as a service contract,
management contract or other type of arrangement. This determination depends on
an analysis of all of the surrounding facts and circumstances. In making this
determination, courts have considered a variety of factors, including the
following: (i) the intent of the parties, (ii) the form of the agreement, (iii)
the degree of control over the business conducted at the property that is
provided to the lessee (e.g., whether the lessee has substantial rights of
control over the operation of the property and its business), (iv) the extent
to which the lessee has the risk of loss from operations of the business
conducted at the property (e.g., whether the lessee bears the risk of increases
in operating expenses and of decreases in revenues), and (v) the extent to
which the lessee has the opportunity to benefit from operations of the business
conducted at the property (e.g., whether the lessee benefits from decreased
operating expenses or increased revenues).(12)
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(9) Section 856(e).
(10) Section 856(e)(4).
(11) Treas. Reg. Section 1.856-6(b)(3).
(12) See, e.g., Xerox Corp. v. U.S., 80-2 USTC 9530 (Ct. Cl. Tr. Div.
1980), aff'd per curiam, 656 F.2d 659 (Ct. Cl. 1981).
<PAGE> 142
Crescent Real Estate Equities Company
December 11, 1996
Page 7
In addition, section 7701(e) provides that a contract that purports to
be a service contract, partnership agreement, or another type of arrangement
will be 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 any savings
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
unrelated 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, partnership agreement,
or some other type of arrangement should be treated as a lease is inherently
factual, the presence or absence of any single factor may not be dispositive in
every case.(13)
We have concluded that the Lease will be treated as a lease for
federal income tax purposes, rather than a service contract, management
contract or other type of arrangement. This conclusion is based, in part, on
the following facts: (i) Funding VI and Vintage intend their relationship to be
that of lessor and lessee (as evidenced by the terms of the Lease), (ii)
Vintage, as tenant under the Lease, will have the right to exclusive
possession, use and quiet enjoyment of Canyon Ranch during the term of the
Lease and the right to uninterrupted control in the operation of the business
conducted at Canyon Ranch (subject to its assumption of the Management
Agreement), (iii) Vintage will dictate how Canyon Ranch is maintained and
improved, (iv) Vintage will bear all the costs and expenses of operating Canyon
Ranch, (v) Vintage will benefit from any savings in the costs of operating
Canyon Ranch during the term of the Lease, (vi) in the event of damage or
destruction to Canyon Ranch, Vintage will be at economic risk because its
obligation to make rental payments will not abate, (vii) Vintage will indemnify
Funding VI against all liabilities imposed on Funding VI during the term of the
Lease by reason of injury to persons or damage to property occurring at Canyon
Ranch or Vintage's use, management, maintenance or repair of Canyon Ranch,
(viii) Vintage is obligated to pay substantial fixed rent for the period of use
of Canyon Ranch, regardless of whether its revenues exceed its costs and
expenses, and (ix) Vintage stands to incur
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(13) P.L.R. 8918012 (January 24, 1989).
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Crescent Real Estate Equities Company
December 11, 1996
Page 8
substantial losses (or derive substantial profits) depending on how
successfully it operates Canyon Ranch.
We do not believe that our conclusion that the Lease of Canyon Ranch
will be treated as a lease for federal income tax purposes is affected by the
fact that Vintage entered the Lease subject to its assumption of CRBA's
obligations under the preexisting Management Agreement. The Management
Agreement gives CRM control over the day-to-day operation of Canyon Ranch and
allows CRM to share with Vintage in the benefits of any increases in revenues
or cost savings in the operation of Canyon Ranch. CRM's operation of Canyon
Ranch will not be controlled by the Operating Partnership, however, and the
Management Agreement does not affect the fact that Vintage bears most of the
risk of loss if Canyon Ranch is not successful. Moreover, the IRS has issued a
private letter ruling in which it treated leases of several hotel properties as
producing "rents from real property" in a situation where the lessees had
contracted with a third party to conduct the day-to-day operations of the
hotels.(14) This ruling suggests that the IRS will respect a lease of a hotel
for federal income tax purposes even if the hotel is operated by an independent
contractor rather than by the lessee.
B. Percentage Rent Provision is not Profit-Based
Pursuant to the Lease, Vintage will be obligated to pay Funding VI
base rent and percentage rent. Under the regulations, percentage rent based on
a percentage of gross receipts or sales in excess of a floor amount, which is
how the percentage rent is structured under the Lease, will not qualify as
"rents from real property" unless (i) such floor amount does not depend in
whole or in part on the income or profits of the lessee, (ii) the percentage
and the floor amount are fixed at the time the lease is entered into, (iii) the
percentage and the floor amount are not renegotiated during the term of the
lease in a manner that has the effect of basing the percentage rent on income
or profits, and (iv) the percentage and the floor amount conform with normal
business practice.(15)
Under the terms of Article 4.2 of the Lease, the Lessee will pay
percentage rent on an annual basis equal to the sum of (i) 28 percent of the
amount by which gross receipts from the Leased Property exceed $20,000,000
(with such amount not exceeding $7,000,000), (ii) 21 percent of the amount by
which gross receipts from the Leased Property exceed $27,000,000 (with such
amount not exceeding $8,000,000), and (iii) 15 percent of the amount by which
gross receipts from the Leased Property exceed $35,000,000. This formula
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(14) See P.L.R. 8117036 (January 27, 1981).
(15) Treas. Reg. Section 1.856-4(b)(3).
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Crescent Real Estate Equities Company
December 11, 1996
Page 9
effectively rewards the tenant for any increases in gross receipts over the
threshold amounts. This type of formula does not base the percentage rent on
the tenant's income or profits, and similar formulas have been treated by the
IRS as generating "rents from real property."(16) Moreover, the Operating
Partnership has represented that (i) the floor amounts used to compute the
percentage rent under the Lease do not depend in whole or in part on the income
or profits of any person, (ii) the percentage rent provision of the Lease will
not be renegotiated during the term of the Lease or at the expiration or
earlier termination of the Lease in a manner that has the effect of basing the
rent on income or profits, and (iii) the percentage rent provision of the Lease
conforms with normal business practice. In addition, based on our experience
and an examination of the Lease and certain projections regarding Canyon
Ranch's expected future performance, the Lease appears to conform with normal
business practice.
C. Vintage is not a "Related Party Tenant"
Rents derived under the Lease will not qualify as "rents from real
property" if Vintage is treated as a "related party tenant." Vintage will be
treated as a "related party tenant" if Crescent Equities, or an owner of 10
percent or more of Crescent Equities, directly or constructively owns 10
percent or more of Vintage's assets or net profits.(17) Constructive ownership
is determined for purposes of this test by applying the rules of section 318(a)
as modified by section 856(d)(5). Those rules generally provide that if 10
percent or more in value of the stock of a 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. Vintage will not be
treated as a "related party tenant" under its current ownership because three
individuals, Frampton, Goff, and Haddock, collectively own a 100 percent
interest in Vintage's assets and net profits; Frampton owns 91 percent, and
Goff and Haddock each own 4.5 percent. In reaching this conclusion, we
recognize that each individual owns certain Units of the Operating
Partnership.(18) The Operating Partnership has represented that (i) Frampton,
Goff, and Haddock do not individually, or as a group, own more than 10 percent
of the value of Crescent Equities' stock, (ii) in the future Frampton, Goff,
and Haddock are not expected to own more than 10 percent of the value of
Crescent Equities' stock individually, or as a group, and (iii) neither the
Operating Partnership nor Crescent
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(16) See, e.g., P.L.R. 8803007 (September 23, 1987) (percentage rent based
on gross revenues in excess of gross revenues for a base year treated
as "rents from real property"); cf. P.L.R. 9104018 (October 26,
1990) (interest based on gross revenues in excess of a floor amount
treated as qualifying interest under section 856(f)).
(17) Section 856(d)(2)(B)(ii).
(18) See Rev. Rul. 73-194, 1973-1 C.B. 355 (management company treated as
an independent contractor with respect to a REIT, where an affiliate
of the management company and the REIT were partners).
<PAGE> 145
Crescent Real Estate Equities Company
December 11, 1996
Page 10
Equities intends to acquire, directly or constructively, an interest of 10
percent or more in the assets or net profits of Vintage at any time in the
future. Moreover, Article 7.8 of the Lease will prevent Vintage and its members
and managers from acquiring, directly or constructively, a greater than six
percent stock interest in Crescent Equities without the Operating Partnership's
prior written consent, and the Restated Declaration of Trust of Crescent
Equities prevents Vintage and its members and managers from acquiring more than
8 percent of Crescent Equities' stock.
D. Rents Attributable to Personal Property Will Be Treated as
"Rents from Real Property"
As noted above, the rents attributable to Funding VI's personal
property leased under or in connection with the Lease must not be greater than
15 percent of the rents received under the Lease. The rent attributable to
personal property leased under or in connection with a lease of real property
is the amount that bears the same ratio to total rent for the taxable year as
(i) the average of the adjusted bases of the personal property leased under or
in connection with a lease of real property at the beginning and at the end of
the taxable year bears to (ii) the average of the aggregate adjusted bases of
the real and personal property subject to the lease at the beginning and at the
end of such taxable year (the "Adjusted Basis Ratio").(19) Section 36.2 of the
Lease provides that the average of the adjusted bases of the personal property
leased to the lessee under the Lease at the beginning and end of any calendar
year shall not exceed 15 percent of the average of the adjusted tax bases of
the Leased Property at the beginning and at the end of each such calendar year.
In addition, Crescent Equities has represented that the adjusted tax basis of
the personal property leased under or in connection with the Lease will not
represent more than 15 percent of the aggregate adjusted tax basis of Canyon
Ranch at any time.
E. Provision of Services by Funding VI
1. Income Derived under the Terms of the Lease
Although Funding VI may treat charges for services customarily
furnished or rendered in connection with the rental of Canyon Ranch as "rents
from real property," any services rendered to the occupants of Canyon Ranch
must be furnished or rendered by an independent contractor from whom Crescent
Equities does not derive or receive any income.(20) Moreover, to the extent that
any independent contractors provide noncustomary services to the occupants of
Canyon Ranch, the cost of such services must not be borne by
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(19) Section 856(d)(1)(C).
(20) Sections 856(d)(1), 856(d)(2)(C); Treas. Reg. Section 1.512(b)-1(c)(5).
<PAGE> 146
Crescent Real Estate Equities Company
December 11, 1996
Page 11
Funding VI.(21) Under the terms of the Lease, Funding VI will not be required to
provide any services, customary or noncustomary, in connection with the rental
of Canyon Ranch. Instead, all services relating to the operation of Canyon
Ranch will be provided by CRM under the terms of the Management Agreement.
Funding VI will not bear the cost of any of the services provided by CRM.
Instead, such costs will be borne by Vintage, which as lessee under the Lease
has assumed the obligations of the owner under the Management Agreement.
Based on the foregoing, we believe that the provision of any
noncustomary services to the occupants of Canyon Ranch by CRM will have no
effect on the qualification of the income derived from Canyon Ranch as "rents
from real property." In fact, the IRS has issued a private letter ruling in
which it has treated the income derived from several leases of hotel properties
as "rents from real property" in a situation where the lessees had contracted
with a third-party to conduct the day-to-day operations of the hotels.(22) Our
conclusion is not altered by the fact that Funding VI will remain liable for
any obligations arising under the Management Agreement, to the extent that they
are not satisfied by Vintage, as lessee under the Lease. Funding VI should not
be treated as bearing the cost of the services provided by CRM merely because
it could possibly be held liable for Vintage's obligations under the Management
Agreement. Funding VI is not retaining this liability in an attempt to provide
services to Vintage. Instead, it is retaining this liability only as an
accommodation, in order to gain CRM's consent to its purchase of Canyon Ranch.
Moreover, Funding VI believes that it is highly unlikely that it will ever be
required to reimburse CRM for the costs and expenses of operating Canyon Ranch
because of a default by Vintage in its obligations as owner under the
Management Agreement. This is because (i) Canyon Ranch is projected to generate
enough gross income to cover the payments to CRM under the Management
Agreement, (ii) in connection with Section 7.7 of the Lease, Vintage represents
that it has a net worth of at least $200,000, (iii) in connection with Section
7.9 of the Lease, Vintage covenants that it will retain all income generated by
the Leased Property and shall not distribute any earnings to its beneficial
owners, except as needed for federal and state income taxes payable on taxable
income from the Leased Property, until the tenant has accumulated and is
holding in reserve funds which are sufficient to pay at least one monthly
payment of Base Rent under the Lease, plus at least one monthly payment of Base
Rent under all other leases between lessor and lessee, and (iv) Gerald W.
Haddock, John C. Goff and Harry H. Frampton have guaranteed Vintage's
obligations under the Lease.
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(21) Treas. Reg. Section 1.856-4(b)(5).
(22) See P.L.R. 8117036 (January 27, 1981).
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Crescent Real Estate Equities Company
December 11, 1996
Page 12
2. Income Derived in the Case of a Default under the Lease
If Funding VI were required to reimburse CRM for the costs of
operating Canyon Ranch because of a default by the Tenant under the terms of
the Management Agreement, we have concluded that the income derived by Funding
VI from Canyon Ranch would be treated as "qualifying income" for purposes of
the 75 percent and 95 percent tests. This is because, if Funding VI were
required to reimburse CRM for the cost of operating Canyon Ranch, this would
constitute an event of default under Article 16.1(c) of the Lease, allowing
Funding VI to terminate the lessee's leasehold interest in Canyon Ranch. As a
result of such a termination of the Lease, any income derived by Funding VI
from Canyon Ranch after the default would be treated as income from foreclosure
property.
Funding VI would be able to continue to operate Canyon Ranch after any
default under the Lease, without affecting its status as foreclosure property.
This is because CRM will provide all services relating to the operation of
Canyon Ranch and CRM will qualify as an independent contractor from whom the
Company will not derive any income. As noted above, a REIT can use foreclosure
property in the conduct of an active trade or business, as long as this is done
through the use of an independent contractor, from whom the REIT does not
derive or receive any income.(23)
As noted above, real property acquired upon default under a lease is
not eligible to be treated as foreclosure property if the lease is entered into
with an intent to evict or foreclose, or if the REIT knows or has reason to
know that default would occur.(24) This is not the case in the present situation
because (i) Canyon Ranch is projected to generate enough gross income to
produce a profit for Vintage, (ii) in connection with Section 7.7 of the Lease,
the Tenant represents that it has a net worth of at least $200,000, (iii) in
connection with Section 7.9 of the Lease, the tenant covenants that it will
retain all income generated by the Leased Property and shall not distribute any
earnings to its beneficial owners, except as needed for federal and state
income taxes payable on taxable income from the Leased Property, until the
tenant has accumulated and is holding in reserve funds which are sufficient to
pay at least one monthly payment of Base Rent under the Lease, plus at least
one monthly payment of Base
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(23) Section 856(e)(4)(C). The IRS clearly intended for REITs to be
able to treat hotels operated by independent contractors as foreclosure
property. For instance, the Treasury regulations defining foreclosure
property refer to hotel properties twice. See, Treas. Reg. Sections
1.856-6(b)(2), 1.856-6(d)(2). In addition, the IRS has also recently
issued a private letter ruling in which it treated income received from
hotels acquired pursuant to a bankruptcy petition as income from
foreclosure property, where the hotels were operated by third party
managers. P.L.R. 9420013 (February 15, 1994).
(24) Treas. Reg. Section 1.856-6(b)(3).
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Crescent Real Estate Equities Company
December 11, 1996
Page 13
Rent under all other leases between lessor and lessee, and (iv) Gerald W.
Haddock, John C. Goff, and Harry H. Frampton have guaranteed Vintage's
obligations under the Lease up to $200,000. Canyon Ranch would qualify as
foreclosure property only for a period of up to two years, beginning on the
date of its acquisition by Funding VI, unless Funding VI obtains an extension
of the grace period from the IRS.(25) Therefore, in the event Funding VI takes
possession of Canyon Ranch as a result of a default under the Lease, presumably
Funding VI will sell Canyon Ranch or within two years rent it to another tenant
under a lease that will produce "rents from real property."
VI. Assumptions and Representations
In providing these opinions, we have with your permission assumed the
following: (i) the due authorization, execution and delivery by all parties
thereto of the Transaction Documents, (ii) the authenticity of the originals of
the Transaction Documents and the genuineness of all signatures; (iii) the
conformity to the original of all documents submitted to us as copies; (iv) the
absence of any evidence extrinsic to the provisions of the written agreements
between the parties that the parties intended a meaning contrary to that
expressed by those provisions; (v) that each party to the Transaction Documents
has the power and authority to enter into and perform all of its obligations
thereunder; (vi) that each of the Transaction Documents is a legal, valid and
binding obligation, enforceable in accordance with its terms; and (vii) that
each legal entity that is a party to the Transaction Documents validly existing
and in good standing under the laws of the United States of America or one of
the States thereof or the District of Columbia. As to questions of fact
material to such opinions, we have with your permission, when relevant facts
were not independently established. relied upon, and assumed the truth,
accuracy and completeness of, written and oral statements and representations
made by or on behalf of the parties to the Transaction Documents by their
respective officers or agents. With your permission, we have further assumed
that each of the parties to each of the Transaction Documents fully complies
with its obligations thereunder.
In addition, these opinions are conditioned upon certain
representations made by the Company and the Operating Partnership as to factual
and other matters as set forth in the attached letter. Unless facts material to
the opinions expressed herein are specifically stated to have been
independently established or verified by us, we have relied as to such facts
solely upon the representations made by Crescent Equities and the Operating
Partnership. We are
- ---------------
(25) Section 856(e)(2).
<PAGE> 149
Crescent Real Estate Equities Company
December 11, 1996
Page 14
not, however, aware of any facts or circumstances contrary to or inconsistent
with the representations. To the extent the representations are with respect to
matters set forth in the Code or Treasury Regulations, we have reviewed with
the individuals making such representations the relevant provisions of the
Code, the Treasury Regulations and published administrative interpretations.
Our opinions contained herein are based in part upon our conclusion
that the U.S. federal income tax treatment of the transactions contemplated by
the Transaction Documents will be determined based on their economic substance.
Although there can be no assurance that the IRS will not take one or more
contrary positions, it is our opinion that none of those positions, if asserted
by the IRS, would prevail. Because our opinions are not binding on the IRS or
the courts, however, there can be no assurance that contrary positions may not
be successfully asserted by the IRS. Our opinions are based upon the present
provisions of the Code, the regulations promulgated thereunder, administrative
rulings, judicial decisions, and any other applicable authorities published and
in effect on the date hereof (all of which are subject to change, both
prospectively and retroactively).
This letter and the opinions contained herein are based solely upon
our knowledge of the relevant facts. In this opinion, the words "our knowledge"
or words to similar effect signify that, in the course of our representation of
Crescent Equities or the Operating Partnership, in matters with respect to
which we have been engaged as counsel by such entity, no information has come
to the attention of those attorneys in our firm having detailed knowledge of
this transaction and the substance of this opinion that gives such attorneys
current, actual knowledge that any such opinions are not accurate. In rendering
this opinion, we have undertaken no investigation with respect to such matters
and we have not undertaken to communicate the details of this transaction to
all members or employees of our firm who may have performed, and are currently
performing, services for Crescent Equities or the Operating Partnership, or any
other person or entity.
The opinions contained herein are issued, and our opinions herein are
expressed, as of the date hereof. These opinions and this letter are limited to
the matters expressly set forth herein, and no statements or opinions may be
inferred beyond such matters. We do not assume any responsibility to update
these opinions or advise you of changes resulting from events (whether or note
they come to our attention) that may occur after the date hereof, including,
without limitation, future transactions or other actions under the Transaction
Documents, or any inaccuracy in any of the representations or warranties upon
which we have relied in rendering these opinions.
<PAGE> 150
Crescent Real Estate Equities Company
December 11, 1996
Page 15
VII. Conclusion
Based on the assumptions stated above, it is our opinion that (i) the
Lease will be treated as a lease for federal income tax purposes and (ii) all
of the income that the Operating Partnership derives under the Lease through
its partnership interest in Funding VI will be treated as "qualifying income"
for purposes of the 95 percent test.
Very Truly Yours,
SHAW, PITTMAN, POTTS & TROWBRIDGE
/s/ CHARLES B. TEMKIN, P.C.
-------------------------------------
By: Charles B. Temkin, P.C.
<PAGE> 1
EXHIBIT 8.02
[LOCKE PURNELL RAIN HARRELL LETTERHEAD]
April 4, 1997
Crescent Real Estate Equities Company
777 Main Street, Suite 2100
Fort Worth, Texas 76102
Gentlemen:
We have acted as special tax counsel to Crescent Real Estate Equities
Company ("Crescent Equities") in connection with the registration statement on
Form S-3, No. 33-92548, which was filed with the Securities and Exchange
Commission, and which, as amended, was declared effective on June 12, 1995. We
have also acted as special tax counsel in connection with the post-effective
amendments to such registration statement, including Post-Effective Amendment
No. Three to Registration Statement (the "Amendment"). Capitalized terms used
hereunder but not defined have the meaning ascribed to them in such registration
statement, as amended, including the Amendment (the "Registration Statement").
In rendering this opinion we have examined such documents as we have
deemed relevant or necessary, including the Amendment, and our conclusions are
based upon the facts contained in the Amendment. The initial and continuing
accuracy of these facts constitutes an integral basis for the opinion expressed
herein.
In our opinion, the discussion contained in the Amendment in the
subsection entitled "Federal Income Tax Considerations - State and Local Taxes"
accurately summarizes the Texas franchise tax matters that are likely to be
material to a holder of common shares of Crescent Equities. The foregoing
opinion is limited to the specific matter covered hereby and does not apply to
any other matters discussed under the heading "Federal Income Tax
Considerations." This opinion is based upon existing State of Texas statutes
and regulations and positions of the Texas State Comptroller of Public Accounts
as of the date hereof, all of which are subject to change, both retroactively
or prospectively.
This opinion is furnished to you solely for use in connection with the
Registration Statement. We hereby consent to the incorporation by reference of
this opinion as an exhibit to the Registration Statement and to the reference
to our Firm in the Registration
<PAGE> 2
Crescent Real Estate Equities Company
April 4, 1997
Page 2
Statement under the caption "Federal Income Tax Considerations - State and
Local Taxes" and "Legal Matters". In giving this consent we do not thereby
admit that we come within the category of persons whose consent is required
under the Securities Act of 1933, as amended, or the rules and regulations of
the Securities and Exchange Commission promulgated thereunder.
Very truly yours,
LOCKE PURNELL RAIN HARRELL
(A Professional Corporation)
By: /s/ C. RONALD KALTEYER
----------------------------
C. Ronald Kalteyer
<PAGE> 1
EXHIBIT 23.01
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation by
reference in this Registration Statement on Form S-3 of our report dated
January 17, 1997 included in Crescent Real Estate Equities Company's Form 10-K
for the year ended December 31, 1996 and of our reports dated February 14, 1997
on Trammel Crow Center, and March 18, 1997 on Carter-Crowley Real Estate
Portfolio included in Crescent Real Estate Equities Company's Form 8-K and to
all references to our Firm included in this Registration Statement.
Dallas, Texas,
April 4, 1997
