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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported): February 13, 1998
CRESCENT REAL ESTATE EQUITIES COMPANY
(Exact name of Registrant as specified in its Charter)
Texas 1-13038 52-1862813
(State of Organization) (Commission File Number) (IRS Employer
Identification Number)
777 Main Street, Suite 2100
Fort Worth, Texas 76102
(Address of Principal Executive Offices) (Zip Code)
(817) 877-0477
(Registrant's telephone number, including area code)
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Item 7. Financial Statements and Exhibits.
(c) Exhibits
The exhibits listed in the following index relate to the Registration
Statement on Form S-3 (No. 333-38071), as amended, of the registrant and are
filed herewith for incorporation by reference in such Registration Statement.
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<S> <C>
1.01 Purchase Agreement, dated as of February 13, 1998, by
and among the Registrant, Crescent Real Estate Equities
Limited Partnership and Smith Barney Inc.
4.04 Second Amended and Restated Agreement of Limited
Partnership of Crescent Real Estate Equities Limited
Partnership dated as of November 1, 1997 (filed as
Exhibit 4.06 to the Registrant's Registration Statement
on Form S-3 (File No. 333-41049) and incorporated herein
by reference
4.05 Form of Certificate of 6-3/4% Series A Preferred Shares
of the Registrant
4.06 Form of Statement of Designation of 6-3/4% Series A
Convertible Cumulative Preferred Shares of the
Registrant
5.01 Opinion of Shaw, Pittman, Potts & Trowbridge as to the
legality of the securities being registered by the
registrant
8.01 Opinion of Shaw, Pittman, Potts & Trowbridge regarding
certain material tax issues relating to the registrant
8.02 Opinion of Locke Purnell Rain Harrell (A Professional
Corporation) regarding certain Texas franchise tax
matters
23.01 Consent of Shaw, Pittman, Potts & Trowbridge (included
in its opinions filed as Exhibits 5.01 and 8.01)
23.02 Consent of Locke Purnell Rain Harrell (A Professional
Corporation) (included in its opinion filed as Exhibit
8.02)
</TABLE>
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned hereunto duly authorized.
Dated: February 18, 1998 CRESCENT REAL ESTATE EQUITIES COMPANY
By: /s/ DALLAS E. LUCAS
-----------------------
Dallas E. Lucas
Senior Vice President and
Chief Financial Officer
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EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<S> <C>
1.01 Purchase Agreement, dated as of February 13, 1998, by
and among the Registrant, Crescent Real Estate Equities
Limited Partnership and Smith Barney Inc.
4.04 Second Amended and Restated Agreement of Limited
Partnership of Crescent Real Estate Equities Limited
Partnership dated as of November 1, 1997 (filed as
Exhibit 4.06 to the Registrant's Registration Statement
on Form S-3 (File No. 333-41049) and incorporated herein
by reference
4.05 Form of Certificate of 6-3/4% Series A Preferred Shares
of the Registrant
4.06 Form of Statement of Designation of 6-3/4% Series A
Convertible Cumulative Preferred Shares of the
Registrant
5.01 Opinion of Shaw, Pittman, Potts & Trowbridge as to the
legality of the securities being registered by the
registrant
8.01 Opinion of Shaw, Pittman, Potts & Trowbridge regarding
certain material tax issues relating to the registrant
8.02 Opinion of Locke Purnell Rain Harrell (A Professional
Corporation) regarding certain Texas franchise tax
matters
23.01 Consent of Shaw, Pittman, Potts & Trowbridge (included
in its opinions filed as Exhibits 5.01 and 8.01)
23.02 Consent of Locke Purnell Rain Harrell (A Professional
Corporation) (included in its opinion filed as Exhibit
8.02)
</TABLE>
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EXHIBIT 1.01
CRESCENT REAL ESTATE EQUITIES COMPANY
(a Texas real estate investment trust)
Preferred Shares of Beneficial Interest
PURCHASE AGREEMENT
February 13, 1997
SMITH BARNEY INC.
388 Greenwich Street
New York, New York 10013
Ladies and Gentlemen:
Crescent Real Estate Equities Company, a Texas real estate
investment trust (the "COMPANY"), proposes to issue and sell to Smith Barney
Inc. ("YOU" or the "UNDERWRITER") an aggregate of 8,000,000 shares (the "INITIAL
SHARES") of the Company's 6.75% Series A Preferred Shares of beneficial
interest, $.01 par value per share (the "SERIES A PREFERRED SHARES"). In
addition, solely for the purpose of covering overallotments, if any, the Company
proposes to grant to the Underwriter the option to purchase from the Company up
to an additional 1,200,000 Series A Preferred Shares (the "OPTION SHARES"). The
Initial Shares and the Option Shares are hereinafter referred to collectively as
the "UNDERWRITTEN SECURITIES".
The Company has filed with the U.S. Securities and Exchange
Commission (the "COMMISSION") a registration statement on Form S-3 (No.
333-38071) for the registration of certain preferred shares of beneficial
interest, $.01 par value per share (the "PREFERRED SHARES"), common shares of
beneficial interest, $.01 par value per share (the "COMMON SHARES"), and
warrants for the purchase of Common Shares (collectively, the "REGISTERED
SECURITIES") under the Securities Act of 1933, as amended (the "1933 ACT"), and
the offering thereof from time to time in accordance with Rule 415 of the rules
and regulations of the Commission under the 1933 Act (the "1933 ACT
REGULATIONS"), and the Company has filed such amendment or amendments thereto as
may have been required prior to the execution of this Purchase Agreement (the
"AGREEMENT"). Such registration statement, as amended, has been declared
effective by the Commission. Such registration statement and the prospectus
constituting a part thereof (including, in each case, any information deemed to
be a part thereof pursuant to Rule 430A(b) of the 1933 Act Regulations and any
prospectus supplement relating to the offering of
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the Underwritten Securities pursuant to Rule 415 of the 1933 Act regulations (a
"PROSPECTUS SUPPLEMENT")), as from time to time amended or supplemented pursuant
to the 1933 Act or otherwise, are hereinafter referred to as the "REGISTRATION
STATEMENT," and the "PROSPECTUS," except that if any revised prospectus shall be
provided to you by the Company for use in connection with the offering of the
Underwritten Securities that differs from the Prospectus on file at the
Commission at the time the Registration Statement became effective (whether or
not such revised prospectus is required to be filed by the Company pursuant to
Rule 424(b) of the 1933 Act Regulations), the term "PROSPECTUS" shall refer to
each such revised prospectus from and after the time it is first provided to
you, for such use; and except further that a Prospectus Supplement shall be
deemed to have supplemented a Prospectus only with respect to the offering of
the Underwritten Securities. All references in this Agreement to financial
statements and schedules and other information that are "contained," "included"
or "stated" in the Registration Statement or a Prospectus (and all other
references of like import) shall be deemed to mean and include all such
financial statements and schedules and other information that are or are deemed
to be incorporated by reference in the Registration Statement or the Prospectus,
as the case may be; and all references in this Agreement to amendments or
supplements to the Registration Statement or a Prospectus shall be deemed to
mean and include the filing of any document under the 1934 Act that is or is
deemed to be incorporated by reference in the Registration Statement or the
Prospectus, as the case may be. If the Company elects to rely on Rule 434 under
the 1933 Act Regulations, all references to a Prospectus shall be deemed to
include, without limitation, the form of prospectus and the abbreviated term
sheet, taken together, provided by the Company in reliance on Rule 434 under the
1933 Act (the "RULE 434 PROSPECTUS").
SECTION 1. REPRESENTATIONS AND WARRANTIES OF THE COMPANY AND THE OPERATING
PARTNERSHIP.
(a) The Company and Crescent Real Estate Equities Limited
Partnership, a Delaware limited partnership (the "OPERATING PARTNERSHIP"),
jointly and severally, represent and warrant to you as of the date hereof, as
follows:
(i) The Registration Statement and the Prospectus, at the time
the Registration Statement became effective and as of the date hereof,
complied, and at the Closing Time (as defined herein) or any Date of
Delivery (as defined herein) will comply, in all material respects, with
the requirements of the 1933 Act and the 1933 Act Regulations; the
Registration Statement, at the time the Registration Statement became
effective and as of the date hereof, did not contain an untrue statement
of a material fact or omit to state a material fact required to be
stated therein or necessary to make the statements therein not
misleading. The Prospectus, as of the date hereof, does comply, and at
the Closing Time and any Date of Delivery will comply,
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in all material respects with the requirements of the 1933 Act and the
1933 Act Regulations, and as of the date hereof does not, and as of the
Closing Date will not, contain an untrue statement of a material fact or
omit to state a material fact necessary in order to make the statements
therein, in the light of the circumstances under which they were made,
not misleading; provided, however, that the representations and
warranties in this paragraph shall not apply to statements in or
omissions from the Registration Statement or the Prospectus made in
reliance upon and in conformity with written information furnished to
the Company through you specifically for inclusion in the Registration
Statement or the Prospectus.
(ii) No stop order suspending the effectiveness of the
Registration Statement or any part thereof has been issued, and no
proceeding for that purpose has been instituted or, to the knowledge of
the Company or the Operating Partnership, threatened by the Commission
or by the state securities authority of any jurisdiction. No order
preventing or suspending the use of the Prospectus has been issued, and
no proceeding for that purpose has been instituted or, to the knowledge
of the Company or the Operating Partnership, threatened by the
Commission or by the state securities authority of any jurisdiction.
(iii) Each of Arthur Andersen LLP, the accounting firm whose report
on the financial statements and supporting schedule of the Company is
included in the Registration Statement, and any other accounting firm
whose report on financial statements is included in the Registration
Statement, is an independent public accountant as required by the 1933
Act and the 1933 Act Regulations.
(iv) The financial statements (including the notes thereto)
included in the Registration Statement and the Prospectus present fairly
the financial position of the respective entity or entities presented
therein at the respective dates indicated and the results of their
operations for the respective periods specified, and except as otherwise
stated in the Registration Statement, said financial statements have
been prepared in conformity with generally accepted accounting
principles applied on a consistent basis. The supporting schedule
included in the Registration Statement presents fairly the information
required to be stated therein. The financial information and data
included in the Registration Statement and the Prospectus present fairly
the information included therein and have been prepared on a basis
consistent with that of the financial statements included in the
Registration Statement and the Prospectus and the books and records of
the respective entities presented therein. The pro forma financial
information included in the Prospectus has been prepared in accordance
with the applicable requirements of Rules 11-01 and 11-02 of Regulation
S-X under the 1933 Act and other 1933 Act Regulations and American
Institute of Certified Public
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Accountants ("AICPA") guidelines with respect to pro forma financial
information and includes all adjustments necessary to present fairly the
pro forma financial position of the respective entity or entities
presented therein at the respective dates indicated and the results of
their operations for the respective periods specified. Other than the
historical and pro forma financial statements (and schedule) included
therein, no other historical or pro forma financial statements (or
schedules) are required by the 1933 Act or the 1933 Act Regulations to
be included in the Registration Statement. Except as reflected or
disclosed in the financial statements included in the Registration
Statement or otherwise set forth in the Prospectus, none of the Company,
the Operating Partnership, any of the Subsidiaries or the Residential
Development Corporations (as such terms are hereinafter defined) is
subject to any material indebtedness, obligation, or liability,
contingent or otherwise.
(v) Since the respective dates as of which information is given in
the Registration Statement and the Prospectus, except as otherwise
stated therein, (A) there has been no material adverse change in the
condition, financial or otherwise, or in the earnings, assets, business
affairs or business prospects of the Company, the Operating Partnership,
the Subsidiaries and the Residential Development Corporations,
considered as one enterprise, whether or not arising in the ordinary
course of business, (B) no material casualty loss or material
condemnation or other material adverse event with respect to any real
property or improvements thereon owned or leased by any of the Company,
the Operating Partnership, any of its Subsidiaries or any of the
Residential Development Corporations, including any property underlying
indebtedness held by the Company (each individually a "PROPERTY" and
collectively, the "PROPERTIES"), the Operating Partnership, any of the
Subsidiaries or any of the Residential Development Corporations, has
occurred that is material to the Company, the Operating Partnership, the
Subsidiaries and the Residential Development Corporations considered as
one enterprise, (C) there have been no acquisitions or other
transactions entered into by the Company, the Operating Partnership, any
Subsidiary or any Residential Development Corporation other than those
in the ordinary course of business that are material with respect to
such entities, considered as one enterprise, or would result in any
inaccuracy in the representations contained in Section 1(a)(iv) above,
(D) except as described in the Prospectus and except for regular
quarterly dividends or distributions on the Common Shares, there has
been no dividend or distribution of any kind declared, paid or made by
the Company, or by the Operating Partnership with respect to its
partnership interests, and (E) there has been no change in the capital
stock of the Company or its Subsidiaries or the Residential Development
Corporations or the partnership interests of the Operating Partnership,
or any increase in the indebtedness of the Company, the Operating
Partnership,
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the Subsidiaries or the Residential Development Corporations that is
material to such entities, considered as one enterprise.
(vi) The Company has been duly formed as a real estate investment
trust under the laws of the State of Texas with power and authority to
own, lease and operate its properties, to conduct the business in which
it is engaged or proposes to engage as described in the Prospectus and
to enter into and perform its obligations under this Agreement.
According to the County Clerk of Tarrant County, Texas, the Restated
Declaration of Trust of the Company is recorded in Volume 12645,
beginning at Page 1811, in the records of the County Clerk. The Restated
Declaration of Trust is in effect, and no dissolution, revocation or
forfeiture proceedings regarding the Company have been commenced. The
Company is duly qualified as a foreign organization to transact business
and is in good standing in each jurisdiction in which such qualification
is required, whether by reason of the ownership or leasing of property
or the conduct of business, except where the failure to so qualify would
not have a material adverse effect on the condition, financial or
otherwise, or the earnings, assets, business affairs or business
prospects of the Company, the Operating Partnership, the Subsidiaries
and the Residential Development Corporations considered as one
enterprise.
(vii) The Operating Partnership has been duly formed and is validly
existing as a limited partnership in good standing under the Delaware
Revised Uniform Limited Partnership Act (the "DELAWARE ACT") with
partnership power and authority to own, lease and operate its
properties, to conduct the business in which it is engaged or proposes
to engage as described in the Prospectus and to enter into and perform
its obligations under this Agreement. The Operating Partnership is duly
qualified or registered as a foreign partnership and is in good standing
in each jurisdiction in which such qualification or registration is
required, whether by reason of the ownership or leasing of property or
the conduct of business, except where the failure to so qualify or
register would not have a material adverse effect on the condition,
financial or otherwise, or the earnings, assets, business affairs or
business prospects of the Company, the Operating Partnership, the
Subsidiaries and the Residential Development Corporations considered as
one enterprise. The Second Amended and Restated Agreement of Limited
Partnership of the Operating Partnership (the "PARTNERSHIP AGREEMENT"),
is a valid and binding agreement enforceable in accordance with its
terms. At Closing Time (as hereinafter defined), Crescent Real Estate
Equities, Ltd., a Delaware corporation ("CGP, INC."), a wholly owned
subsidiary of the Company, will be the sole general partner of the
Operating Partnership and will be the holder of one percent (1%) of the
interests in the Operating Partnership. Entities in which the Company
directly or indirectly has a majority ownership interest are hereinafter
referred to as the "SUBSIDIARIES," and each, individually, as a
"SUBSIDIARY." Houston Area
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Development Corp., a Texas corporation, Mira Vista Development Corp., a
Texas corporation, Crescent Development Management Corp., a Delaware
corporation, Desert Mountain Development Corporation, a Delaware
corporation, and The Woodlands Land Company, Inc., a Texas corporation,
are referred to herein collectively as the "RESIDENTIAL DEVELOPMENT
CORPORATIONS."
(viii) Each of the Subsidiaries and the Residential Development
Corporations has been duly organized and is validly existing as a
corporation, limited partnership, or limited liability company, as the
case may be, in good standing under the laws of its respective state of
organization, with full power and authority to own, lease and operate
its properties, to conduct the business in which it is engaged or
proposes to engage as described in the Prospectus. Each of the
Subsidiaries and the Residential Development Corporations is duly
qualified as a foreign corporation, limited partnership, or limited
liability company, as the case may be, to transact business and is in
good standing in each jurisdiction in which such qualification is
required, whether by reason of the ownership or leasing of property or
the conduct of business, except where the failure to so qualify would
not have a material adverse effect on the condition, financial or
otherwise, or the earnings, assets, business affairs or business
prospects of the Company, the Operating Partnership, the Subsidiaries
and the Residential Development Corporations considered as one
enterprise. Each of the partnership agreements, limited liability
company agreements, or other, similar instruments to which the Company
or any of its Subsidiaries is a party has been duly authorized, executed
and delivered by the parties thereto and constitutes the valid agreement
thereof, enforceable in accordance with its terms. All of the issued and
outstanding shares of capital stock of each of the corporate
Subsidiaries and the Residential Development Corporations have been duly
authorized and validly issued and are fully paid and non-assessable. The
ownership by the Company, the Operating Partnership or the Subsidiaries
of the shares of capital stock or limited partnership or equity
interests, as the case may be, of each of the Subsidiaries and the
Residential Development Corporations is as described in the Prospectus
and all of such shares or limited partnership or equity interests, or
other, similar instruments owned by the Company, the Operating
Partnership or the Subsidiaries are free and clear of all liens, charges
and encumbrances.
(ix) The authorized, issued and outstanding beneficial interests in
the Company are as set forth in the Prospectus (except for subsequent
issuances, if any, pursuant to clauses (A) and (B) below); and all of
such beneficial interests have been duly authorized, are validly issued,
fully paid and non-assessable and have been offered and sold in
compliance with all applicable laws (including, without limitation,
federal securities laws). No shares of capital stock of the Company are
reserved for any purpose except in
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connection with: (A) the incentive compensation plans of the Company as
described in the Prospectus, (B) the possible issuance of Common Shares
upon the exchange of units of ownership interest in the Operating
Partnership (the "UNITS") pursuant to the Partnership Agreement, (C) the
possible issuance of Common Shares upon exercise of an existing option
to acquire up to 217,530 Common Shares and (D) the possible issuance of
up to 664,294 Common Shares upon the exchange of a portion of a
partnership interest in Desert Mountain Properties Limited Partnership,
for which sufficient Common Shares have been reserved for possible
future issuance. Except for (A) Units, (B) Common Shares issuable upon
the exercise of options (C) Common Shares issuable pursuant to the
Forward Stock Purchase Contract agreement, dated as of August 12, 1997
with an affiliate of Union Bank of Switzerland and (D) Common Shares
issuable pursuant to the Swap Agreement, dated as of December 12, 1997,
with an affiliate of Merrill Lynch & Co., Inc., there are no outstanding
securities convertible into or exchangeable for any beneficial interests
in the Company and no outstanding options, rights (preemptive or
otherwise) or warrants to purchase or to subscribe for such interests or
any other securities of the Company.
(x) The Underwritten Securities have been duly authorized for
issuance and sale to you pursuant to this Agreement and, when issued and
delivered by the Company pursuant to such Agreement against payment of
the consideration set forth herein, will be validly issued, fully paid
and non-assessable. Upon payment of the purchase price and delivery of
the Underwritten Securities in accordance with this Agreement you will
receive good, valid and marketable title to the Underwritten Securities,
free and clear of all security interests, mortgages, pledges, liens,
encumbrances and claims. The Underwritten Securities will be offered and
sold at Closing Time or the Date of Delivery, as the case may be, in
compliance with all applicable laws (including, without limitation,
federal securities laws). The terms of the Series A Preferred Shares and
the Preferred Shares conform to all statements and descriptions related
thereto contained in the Prospectus. The form of the certificate used to
evidence the Underwritten Securities and the Common Shares into which
they may be converted are in due and proper form and comply with all
applicable legal requirements. The issuance of the Underwritten
Securities is not subject to any preemptive or other similar rights and,
except as summarized in the Prospectus and set forth in the Company's
Restated Declaration of Trust (the "DECLARATION OF TRUST") or the
Company's Amended and Restated Bylaws, as amended (the "BYLAWS"), there
are no restrictions on the voting or transfer of the Common Shares or
the Preferred Shares pursuant to the Company's Declaration of Trust or
Bylaws or any agreement or other instrument.
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(xi) The Common Shares issuable upon conversion of the Underwritten
Securities will have been duly and validly authorized and reserved for
issuance upon such conversion by all necessary corporate action and such
shares, when issued upon such conversion or exercise, will be duly
authorized and validly issued and will be fully paid and non-assessable,
and the issuance of such shares upon conversion will not be subject to
preemptive or other similar rights; the Common Shares issuable upon
conversion of the Underwritten Securities conform in all material
respects to all statements relating thereto contained in the Prospectus.
(xii) The authorized, issued and outstanding Units are as set forth
in the Prospectus except to the extent of changes due to the conversion
of Units to Common Shares or the exercise of existing options to acquire
Units. All of the Units outstanding at Closing Time were duly authorized
for issuance by the Operating Partnership and are validly issued and
fully paid. The Units were offered and sold in compliance with all
applicable laws (including, without limitation, federal and state
securities laws). Except as summarized in the Prospectus or set forth in
the Partnership Agreement, there are no preemptive or other rights to
subscribe for or to purchase, nor any restriction upon the voting or
transfer of, any Units pursuant to the Partnership Agreement or any
other instrument. The terms of the Units conform to all statements and
descriptions related thereto contained in the Prospectus.
(xiii) None of the Company, the Operating Partnership, any
Subsidiary or any Residential Development Corporation is in violation of
its declaration of trust, charter, by-laws, certificate of limited
partnership, partnership agreement, or limited liability company
agreement, as the case may be, and none of the Company, the Operating
Partnership, any Subsidiary or any Residential Development Corporation
is in default in the performance or observance of any obligation,
agreement, covenant or condition contained in any contract, indenture,
mortgage, loan agreement, note, lease or other instrument to which such
entity is a party or by which such entity may be bound, or to which any
of the property or assets of such entity is subject, except where a
default thereunder would not have a material adverse effect on the
condition, financial or otherwise, or the earnings, assets, business
affairs or business prospects of the Company, the Operating Partnership,
the Subsidiaries and the Residential Development Corporations considered
as one enterprise.
(xiv) The execution and delivery of this Agreement and the
performance of the obligations set forth herein, and the consummation of
the transactions contemplated hereby or in the Prospectus by the
Company, the Operating Partnership, the Subsidiaries and the Residential
Development Corporations, as applicable, will not conflict with or
constitute a breach or
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violation by such party of, or default under, (A) any material contract,
indenture, mortgage, loan agreement, note, lease, joint venture or
partnership agreement or other instrument or agreement to which the
Company, the Operating Partnership, any Subsidiary or any Residential
Development Corporation is a party or by which they, any of them, any of
their respective assets or any Property may be bound or subject; (B) the
declaration of trust, charter, by-laws, certificate of limited
partnership, partnership agreement, or limited liability company
agreement, as the case may be, of the Company, the Operating
Partnership, any Subsidiary or any Residential Development Corporation;
or (C) any applicable law, rule, order, administrative regulation or
administrative or court decree.
(xv) The Company has full right, power and authority under its
organizational documents to enter into this Agreement, and this
Agreement has been duly authorized, executed and delivered by the
Company
(xvi) The Operating Partnership has full right, power and authority
under its organizational documents to enter into this Agreement and this
Agreement has been duly authorized, executed and delivered by the
Operating Partnership.
(xvii) There is no action, suit or proceeding before or by any court
or governmental agency or body, domestic or foreign, now pending, or, to
the knowledge of the Company or the Operating Partnership, threatened
against or affecting the Company, the Operating Partnership, any
Subsidiary, any Residential Development Corporation, any Property, or
any property underlying indebtedness held by the Company, the Operating
Partnership, any of the Subsidiaries or any of the Residential
Development Corporations, or any officer or trust manager of the Company
that is required to be disclosed in the Registration Statement (other
than as disclosed therein) or that, if determined adversely to the
Company, the Operating Partnership, any Subsidiary, any Residential
Development Corporation, any Property, including any property underlying
indebtedness held by the Company, the Operating Partnership, any of the
Subsidiaries and any of the Residential Development Corporations, or any
such officer or trust manager, might (A) result in any material adverse
change in the condition, financial or otherwise, or in the earnings,
assets, business affairs or business prospects of the Company, the
Operating Partnership, the Subsidiaries and the Residential Development
Corporations considered as one enterprise or (B) materially and
adversely affect the consummation of the transactions contemplated by
this Agreement. There is no pending legal or governmental proceeding to
which the Company, the Operating Partnership, any Subsidiary or any
Residential Development Corporation is a party or of which any of their
respective properties or assets or any Property, including any property
underlying indebtedness held by the Company, the Operating Partnership,
any of the Subsidiaries or any of the Residential Development
Corporations, is the subject, including ordinary routine litigation
incidental to the business, that is, considered in the aggregate,
material to the condition, financial or otherwise, or the earnings,
assets, business affairs or business prospects of the Company, the
Operating
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Partnership, the Subsidiaries and the Residential Development
Corporations considered as one enterprise. There are no contracts or
documents that are required to be filed as exhibits to the Registration
Statement by the 1933 Act or by the 1933 Act Regulations which have not
been filed as exhibits to the Registration Statement or to a document
incorporated therein by reference.
(xviii) The Company qualified as a real estate investment trust
under the Internal Revenue Code of 1986, as amended (the "CODE"), with
respect to its taxable years ended December 31, 1994, December 31, 1995,
December 31, 1996 and December 31, 1997 and is organized in conformity
with the requirements for qualification as a real estate investment
trust, and its manner of operation has enabled it to meet the
requirements for qualification as a real estate investment trust as of
the date of the Prospectus, and its proposed manner of operation will
enable it to meet the requirements for qualification as a real estate
investment trust in the future.
(xix) None of the Company, the Operating Partnership, any Subsidiary
or any Residential Development Corporation is, or at Closing Time will
be, required to be registered under the Investment Company Act of 1940,
as amended (the "1940 ACT").
(xx) None of the Company, the Operating Partnership, any Subsidiary
or any Residential Development Corporation is required to own or possess
any trademarks, service marks, trade names or copyrights (collectively,
"PROPRIETARY RIGHTS") not now lawfully owned or possessed in order to
conduct the business now operated by such entity or as proposed to be
operated by it as described in the Prospectus and no such entity has
received any notice or is otherwise aware of any infringement of or
conflict with asserted rights of others with respect to any proprietary
rights.
(xxi) All authorizations, approvals and consents of any court or
governmental authority or agency that are necessary in connection with
the offering, issuance or sale of the Underwritten Securities hereunder
have been obtained, except such as may be required under the 1933 Act or
the 1933 Act Regulations or state securities or real estate syndication
laws.
(xxii) Each of the Company, the Operating Partnership, the
Subsidiaries and the Residential Development Corporations possesses such
certificates, authorizations or permits issued by the appropriate state,
federal or foreign regulatory agencies or bodies necessary to conduct
the business
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now conducted by it, or proposed to be conducted by it, as described in
the Prospectus, and none of the Company, the Operating Partnership, any
Subsidiary or any Residential Development Corporation has received any
notice of proceedings relating to the revocation or modification of any
such certificate, authorization or permit which, singly or in the
aggregate, if the subject of an unfavorable decision, ruling or finding,
would materially and adversely affect the condition, financial or
otherwise, or the earnings, assets, business affairs or business
prospects of the Company, the Operating Partnership, the Subsidiaries
and the Residential Development Corporations considered as one
enterprise.
(xxiii) The documents incorporated or deemed to be incorporated by
reference in the Prospectus, at the time it was or hereafter is filed
with the Commission, complied and will comply in all material respects
with the requirements of the 1934 Act and the rules and regulations of
the Commission under the 1934 Act (the "1934 ACT REGULATIONS"), and,
when read together with the other information in the Prospectus, at the
time the Registration Statement became effective, as of the date hereof
or during the period specified in Section 3(f) hereof, did not and will
not include an untrue statement of a material fact or omit to state a
material fact required to be stated therein or necessary to make the
statements therein, in the light of the circumstances under which they
were made, not misleading.
(xxiv) No labor dispute with the employees of the Company, the
Operating Partnership, any Subsidiary or any Residential Development
Corporation exists or, to the knowledge of the Company or the Operating
Partnership, is imminent.
(xxv) Except as otherwise described in the Prospectus, (A) each of
the Company, the Operating Partnership, the Subsidiaries, and each
Residential Development Corporation, as the case may be, has good and
marketable title in fee simple to all real property owned by such entity
and good and marketable title to the improvements, if any, thereon and
all other assets that are required for the effective operation of such
real property in the manner in which they currently are operated except
where the failure to own real property or improvements thereon in fee
simple would not have a material adverse effect on the condition,
financial or otherwise, or on the earnings, assets, business affairs or
business prospects of or with respect to the Company, the Operating
Partnership, the Subsidiaries and the Residential Development
Corporations considered as one enterprise; (B) any real property and
buildings held under lease by the Company, the Operating Partnership,
any Subsidiary or any Residential Development Corporation are in full
force and effect, and such entity is not in default in respect of any of
the terms or provisions of such leases and such entity has not received
notice of the assertion of any claim by anyone adverse to the Operating
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Partnership's rights as lessee under such leases, or affecting or
questioning the Operating Partnership's right to the continued
possession or use of the real property and buildings held under such
leases or of a default under such leases, in each case with such
exceptions as would not have a material adverse impact on the condition,
financial or otherwise, or on the earnings, assets, business affairs or
business prospects of or with respect to the Company, the Operating
Partnership, the Subsidiaries and the Residential Development
Corporations considered as one enterprise; (C) all liens, charges,
encumbrances, claims, or restrictions on or affecting any of the
Properties, including any property underlying indebtedness held by the
Company, the Operating Partnership, any of the Subsidiaries or any of
the Residential Development Corporations, and the assets of the Company,
the Operating Partnership, any Subsidiary or any Residential Development
Corporation which are required to be disclosed in the Prospectus are
disclosed therein; (D) none of the Company, the Operating Partnership,
any of the Subsidiaries, any of the Residential Development Corporations
or any tenant of any of the Properties is in default under any of the
leases pursuant to which the Operating Partnership, as lessor, leases
its Property (and neither the Company nor the Operating Partnership
knows of any event which, but for the passage of time or the giving of
notice, or both, would constitute a default under any of such leases)
other than such defaults that would not have a material adverse effect
on the condition, financial or otherwise, or on the earnings, assets,
business affairs or business prospects of or with respect to the
Operating Partnership, any Subsidiary or any Residential Development
Corporation or any Property; (E) except as described in the Prospectus,
no person has an option or right of first refusal to purchase all or
part of any Property or any interest therein, other than such options or
rights of first refusal which would not have a material adverse effect
on the condition, financial or otherwise, or on the earnings, assets,
business affairs or business prospects of or with respect to the
Company, the Operating Partnership, the Subsidiaries and the Residential
Development Corporations, considered as one enterprise; (F) each of the
Properties complies with all applicable codes, laws and regulations
(including, without limitation, building and zoning codes, laws and
regulations and laws relating to access to the Properties), except if
and to the extent disclosed in the Prospectus and except for such
failures to comply that would not individually or in the aggregate have
a material adverse impact on the condition, financial or otherwise, or
on the earnings, assets, business affairs or business prospects of such
Property or the Operating Partnership; (G) there are in effect for the
Properties, including, to the knowledge of the Company, any property
underlying indebtedness held by the Company, the Operating Partnership,
any of the Subsidiaries and any of the Residential Development
Corporations, and the other assets of the Company, the Operating
Partnership, the Subsidiaries and the Residential Development
Corporations, insurance policies covering risks and in amounts that are
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<PAGE> 13
commercially reasonable for the assets owned by them and that are
consistent with the types and amounts of insurance typically maintained
by present owners of similar types of properties; and (H) neither the
Company nor the Operating Partnership has knowledge of any pending or
threatened condemnation proceedings, zoning change, or other proceeding
or action that will in any manner affect the size of, use of,
improvements on, construction on or access to the Properties, including
any property underlying indebtedness held by the Company, the Operating
Partnership, any of the Subsidiaries or any Residential Development
Corporation, except such proceedings or actions that would not have a
material adverse effect on the condition, financial or otherwise, or on
the earnings, assets, business affairs or business prospects of the
Operating Partnership or with respect to such Property, including any
property underlying indebtedness held by the Company, the Operating
Partnership, any of the Subsidiaries or any Residential Development
Corporation.
(xxvi) Except as disclosed in the Prospectus, (A) each Property,
including, without limitation, the Environment (as defined below)
associated with such Property, is free of any Hazardous Substance (as
defined below), except for Hazardous Substances that would not have a
material adverse effect on the condition, financial or otherwise, or on
the earnings, assets, business affairs or business prospects of or with
respect to the Company, the Operating Partnership, the Subsidiaries and
the Residential Development Corporations considered as one enterprise;
(B) none of the Company, the Operating Partnership, any Subsidiary or
any Residential Development Corporation has caused or suffered to occur
any Release (as defined below) of any Hazardous Substance into the
Environment on, in, under or from any Property, and no condition exists
on, in, under or, to the knowledge of the Company and the Operating
Partnership, adjacent to any Property that is reasonably likely to
result in the incurrence of material liabilities or any material
violations of any Environmental Law (as defined below), give rise to the
imposition of any Lien (as defined below) under any Environmental Law,
or cause or constitute a health, safety or environmental hazard to any
property, person or entity; (C) none of the Company, the Operating
Partnership, any Subsidiary or any Residential Development Corporation
intends to use the properties or assets described in the Prospectus or
any other real property for the purpose of handling, burying, storing,
retaining, refining, transporting, processing, manufacturing,
generating, producing, spilling, seeping, leaking, escaping, leaching,
pumping, pouring, emitting, emptying, discharging, injecting, dumping,
transferring or otherwise disposing of or dealing with a Hazardous
Substance, except for materials utilized in the ordinary course of
business of the properties, provided such use would not, in the ordinary
course of business, give rise to liability under any Environmental Law;
(D) none of the Company, the Operating Partnership, any Subsidiary or
any Residential Development Corporation
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<PAGE> 14
has received any notice of a claim under or pursuant to any
Environmental Law or under common law pertaining to Hazardous Substances
on or originating from any Property; (E) none of the Company, the
Operating Partnership, any Subsidiary or any Residential Development
Corporation has received any notice from any Governmental Authority (as
defined below) claiming any violation of any Environmental Law; (F) no
Property is included or, to the knowledge of the Company and the
Operating Partnership, proposed for inclusion on the National Priorities
List issued pursuant to CERCLA (as defined below) by the United States
Environmental Protection Agency (the "EPA") or on the Comprehensive
Environmental Response, Compensation, and Liability Information System
database maintained by the EPA, and has not otherwise been identified by
the EPA as a potential CERCLA removal, remedial or response site or
included or, to the knowledge of the Company and the Operating
Partnership, proposed for inclusion on, any similar list of potentially
contaminated sites pursuant to any other Environmental Law and (G) there
are no underground storage tanks located on or in any Property except
where the presence thereof would not have a material adverse effect on
the condition, financial or otherwise, or the earnings, assets or
business affairs or business prospects of the Company, the Operating
Partnership, the Subsidiaries and the Residential Development
Corporations considered as one enterprise.
As used herein, "HAZARDOUS SUBSTANCE" shall include, without
limitation, any hazardous substance, hazardous waste, toxic substance,
pollutant, solid waste or similarly designated materials, including,
without limitation, oil, petroleum or any petroleum-derived substance or
waste, asbestos or asbestos-containing materials, PCBs, pesticides,
explosives, radioactive materials, dioxins, urea formaldehyde insulation
or any constituent of any such substance, pollutant or waste, including
any such substance, pollutant or waste identified or regulated under any
Environmental Law (including, without limitation, materials listed in
the United States Department of Transportation Optional Hazardous
Material Table, 49 C.F.R. ss. 172.101, as the same may now or hereafter
be amended, or in the EPA's List of Hazardous Substances and Reportable
Quantities, 40 C.F.R. Part 302, as the same may now or hereafter be
amended); "ENVIRONMENT" shall mean any surface water, drinking water,
ground water, land surface, subsurface strata, river sediment,
buildings, structures, and ambient, workplace and indoor air;
"ENVIRONMENTAL LAW" shall mean the Comprehensive Environmental Response,
Compensation and Liability Act of 1980, as amended (42 U.S.C. ss. 9601
et seq.) ("CERCLA"), the Resource Conservation and Recovery Act of 1976,
as amended (42 U.S.C. ss. 6901 et seq.), the Clean Air Act, as amended
(42 U.S.C. ss. 7401 et seq.), the Clean Water Act, as amended (33 U.S.C.
ss. 1251 et seq.), the Toxic Substances Control Act, as amended (15
U.S.C. ss. 2601 et seq.), the Occupational Safety and Health Act of
1970, as amended (29 U.S.C. ss. 651 et seq.), the Hazardous
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<PAGE> 15
Materials Transportation Act, as amended (49 U.S.C. ss. 1801 et seq.),
and all other federal, state and local laws, ordinances, regulations,
rules, orders, decisions and permits relating to the protection of the
environment or of human health from environmental effects; "GOVERNMENTAL
AUTHORITY" shall mean any federal, state or local governmental office,
agency or authority having the duty or authority to promulgate,
implement or enforce any Environmental Law; "LIEN" shall mean, with
respect to any Property, any mortgage, deed of trust, pledge, security
interest, lien, encumbrance, penalty, fine, charge, assessment, judgment
or other liability in, on or affecting such Property; and "RELEASE"
shall mean any spilling, leaking, pumping, pouring, emitting, emptying,
discharging, injecting, escaping, leaching, dumping, emanating or
disposing of any Hazardous Substance into the Environment, including,
without limitation, the abandonment or discard of barrels, containers,
tanks (including, without limitation, underground storage tanks) or
other receptacles containing or previously containing any Hazardous
Substance or any release, emission, discharge or similar term, as those
terms are defined or used in any Environmental Law.
(xxvii) Each of the Company, the Operating Partnership, the
Subsidiaries and the Residential Development Corporations has filed all
federal, state, local and foreign income tax returns which have been
required to be filed (except in any case in which the failure to so file
would not have a material adverse effect on the condition, financial or
otherwise, or the earnings, assets, business affairs or business
prospects of such entities considered as one enterprise) and has paid
all taxes required to be paid and any other assessment, fine or penalty
levied against it, to the extent that any of the foregoing is due and
payable, except, in all cases, for any such tax, assessment, fine or
penalty that is being contested in good faith.
(xxviii) None of the Company, the Subsidiaries, the Residential
Development Corporations or the Operating Partnership, nor any of their
trust managers, directors, officers or controlling persons, has taken or
will take, directly or indirectly, any action resulting in a violation
of Regulation M under the 1934 Act, or designed to cause or result under
the 1934 Act or otherwise in, or which has constituted or which
reasonably might be expected to constitute, the unlawful stabilization
or manipulation of the price of any security of the Company or
facilitation of the sale or resale of the Underwritten Securities.
(b) Any certificate signed by any officer of the Company or the
Operating Partnership and delivered to you or to your counsel shall be deemed a
representation and warranty by such entity to you as to the matters covered
thereby.
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SECTION 2. PURCHASE AND SALE.
(a) On the basis of the representations, warranties, covenants and
agreements herein contained, and subject to the terms and conditions herein set
forth, the Company agrees to sell to you, and you agree to purchase from the
Company, the Initial Shares on the terms and at the price set forth on Schedule
A attached hereto and made a part hereof.
(b) In addition, on the basis of the representations and warranties
herein contained, and subject to the terms and conditions herein set forth, the
Company hereby grants you an option to purchase up to 1,200,000 Option Shares at
the same price per share and on the same terms as is applicable to the Initial
Shares. Such option will expire 30 days after the date hereof, and may be
exercised in whole or in part from time to time only for the purpose of covering
over-allotments which may be made in connection with the offering and
distribution of the Initial Shares upon notice by you to the Company setting
forth the number of Option Shares as to which you are then exercising the option
and the time and date of payment and delivery for such Option Shares. Any such
time and date of delivery (a "DATE OF DELIVERY") shall be determined by you, but
shall not be later than seven full business days and not be earlier than two
full business days after the exercise of said option, unless otherwise agreed
upon by you and the Company.
(c) Payment of the purchase price for, and delivery of, the
Underwritten Securities to be purchased by you shall be made at the offices of
Hogan & Hartson L.L.P., Columbia Square, 555 Thirteenth Street, N.W.,
Washington, D.C. 20004-1109, or at such other place as shall be agreed upon by
you and the Company, at 9:00 A.M., New York City time, on the third business day
following the date of this Agreement or, if pricing takes place after 4:30 P.M.
New York City time on the date of this Agreement, on the fourth business day
following the date of this Agreement, or at such other time as shall be agreed
upon by you and the Company (such time and date being referred to as the
"CLOSING TIME"). In addition, if any or all of the Option Shares are purchased
by you, payment of the purchase price for, and delivery of certificates
representing, such Option Shares shall be made at the above-mentioned offices of
Hogan & Hartson L.L.P., or at such other place as shall be agreed upon by you
and the Company, on each Date of Delivery as specified in the notice from you to
the Company. Unless otherwise agreed upon by the parties to this Agreement,
payment shall be made to the Company by wire transfer or by certified or
official bank check or checks in federal or similar same-day funds payable to
the order of the Company against delivery to you for your account. The
Underwritten Securities shall be in such authorized denominations and registered
in such names as you may request in writing at least two business days prior to
the Closing Time. The Underwritten Securities, which may be in temporary form,
will be made available for examination and packaging by you on or before the
first business day prior to the Closing Time.
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SECTION 3. COVENANTS OF THE COMPANY AND THE OPERATING PARTNERSHIP.
Each of the Company and the Operating Partnership covenants with you
as follows:
(a) Immediately following the execution of this Agreement, the
Company will prepare a Prospectus Supplement setting forth the number of
Underwritten Securities covered thereby and their terms not otherwise specified
in the Prospectus pursuant to which the Underwritten Securities are being
issued, your name as an underwriter in the offering, the price at which the
Underwritten Securities are to be purchased by you from the Company, the initial
public offering price, if any, the selling concession and reallowance, if any,
any delayed delivery arrangements, and such other information as you and the
Company deem appropriate in connection with the offering of the Underwritten
Securities; and the Company will promptly transmit copies of the Prospectus
Supplement to the Commission for filing pursuant to Rule 424(b) of the 1933 Act
Regulations within the time period required by such Rule and will furnish to you
as many copies of the Prospectus and such Prospectus Supplement as you shall
reasonably request. If the Company elects to rely on Rule 434 under the 1933 Act
Regulations, the Company will prepare an abbreviated term sheet that complies
with the requirements of Rule 434 under the 1933 Act Regulations and will
provide you with copies of the form of Rule 434 Prospectus, in such number as
you may reasonably request, and file or transmit for filing with the Commission
the form of Prospectus complying with Rule 434(c)(2) of the 1933 Act Regulations
in accordance with Rule 424(b) of the 1933 Act Regulations by the close of
business in New York on the business day immediately succeeding the date of this
Agreement.
(b) The Company will notify you immediately, and confirm such notice
in writing, of (i) the effectiveness of any amendment to the Registration
Statement relating to or affecting the offering of the Underwritten Securities,
(ii) the transmittal to the Commission for filing of any Prospectus Supplement
or other supplement or amendment to the Prospectus or any document to be filed
pursuant to the 1934 Act relating to or affecting the offering of the
Underwritten Securities, (iii) the receipt of any comments from the Commission
relating to or affecting the offering of the Underwritten Securities, (iv) any
request by the Commission for any amendment to the Registration Statement or any
amendment or supplement to the Prospectus or for additional information relating
to or affecting the offering of the Underwritten Securities, and (v) the
issuance by the Commission of any stop order suspending the effectiveness of the
Registration Statement relating to or affecting the offering of the Underwritten
Securities or the initiation of any proceedings for that purpose; and the
Company will make every reasonable effort to prevent the issuance of any such
stop order and, if any stop order is issued, to obtain the lifting thereof at
the earliest possible moment.
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<PAGE> 18
(c) At any time when the Prospectus is required to be delivered
under the 1933 Act or the 1934 Act in connection with sales of the Underwritten
Securities, the Company will give you notice of its intention to file or prepare
any amendment to the Registration Statement or any amendment or supplement to
the Prospectus (including any revised prospectus which the Company proposes for
use by you in connection with the offering of Underwritten Securities which
differs from the prospectus on file at the Commission at the time the
Registration Statement became effective, whether or not such revised prospectus
is required to be filed pursuant to Rule 424(b) of the 1933 Act Regulations),
whether pursuant to the 1933 Act, 1934 Act or otherwise, and will furnish you
with copies of any such amendment or supplement a reasonable amount of time
prior to such proposed filing or preparation, as the case may be, and will not
file or prepare any such amendment or supplement or other documents in a form to
which you or your counsel shall reasonably object.
(d) The Company will deliver to you, as soon as available, as many
signed and conformed copies of the Registration Statement as originally filed
and of each amendment thereto (including exhibits filed therewith or
incorporated by reference therein) as you may reasonably request.
(e) The Company will furnish to you, from time to time during the
period when the Prospectus is required to be delivered under the 1933 Act or the
Exchange Act, such number of copies of the Prospectus (as amended or
supplemented) as you may reasonably request for the purposes contemplated by the
1933 Act or the 1934 Act or the respective applicable rules and regulations of
the Commission thereunder.
(f) If any event shall occur as a result of which it is necessary,
in the opinion of your counsel or counsel for the Company, to amend or
supplement the Prospectus in order to make the Prospectus not contain any untrue
statement of a material fact or omit to state a material fact necessary in order
to make the statements therein, in the light of the circumstances existing at
the time it is delivered to a purchaser, not misleading, or if it shall be
necessary, in the opinion of either such counsel, at any such time to amend or
supplement the Registration Statement or the Prospectus in order to comply with
the 1933 Act or the 1934 Act, the Company will forthwith prepare an amendment of
or supplement to the Registration Statement or the Prospectus (in form and
substance satisfactory to your counsel), whether by filing documents pursuant to
the 1933 Act, the 1934 Act or otherwise, which will amend or supplement the
Prospectus so that it will not contain an untrue statement of a material fact or
omit to state a material fact necessary in order to make the statements therein,
in the light of the circumstances existing at the time it is delivered to a
purchaser, not misleading, or to make the Registration Statement and Prospectus
comply with such requirements, and the Company will furnish to you a reasonable
number of copies of such amendment or supplement.
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(g) The Company will endeavor, in cooperation with you, to qualify
the Underwritten Securities and the Common Shares issuable upon conversion
thereof for offering and sale under the applicable securities laws and real
estate syndication laws of such states and other jurisdictions of the United
States as you may designate. In each jurisdiction in which the Underwritten
Securities and such Common Shares have been so qualified, the Company will file
such statements and reports as may be required by the laws of such jurisdiction
to continue such qualification in effect for a period of not less than one year
from the effective date of the Registration Statement.
(h) With respect to the sale of Underwritten Securities pursuant to
this Agreement, the Company will make generally available to its security
holders as soon as practicable, but not later than 90 days after the close of
the period covered thereby, an earnings statement (in form complying with the
provisions of Rule 158 of the 1933 Act Regulations) covering a 12-month period
beginning not later than the first day of the Company's fiscal quarter next
following the "effective date of the registration statement" (as defined in such
Rule 158).
(i) The Company, during the period when the Prospectus is required
to be delivered under the 1933 Act or the 1934 Act in connection with sales of
the Underwritten Securities, will file all documents required to be filed with
the Commission pursuant to Section 13, 14 or 15 of the 1934 Act within the time
periods prescribed by the 1934 Act and the 1934 Act Regulations.
(j) If applicable, the Company will use the net proceeds received by
it from the sale of the Underwritten Securities in the manner specified in the
Prospectus under the caption "Use of Proceeds."
(k) The Company will use its best efforts to effect the listing of
the Underwritten Securities and the Common Shares issuable upon conversion
thereof on the New York Stock Exchange.
(l) During the period from the date hereof until 90 days after
Closing time, the Company and the Operating Partnership will not, without your
prior written consent, directly or indirectly, sell, offer to sell, grant any
option for the sale of, or otherwise dispose of, any Common Shares, Preferred
Shares or Units or any other security convertible into or exchangeable into or
exercisable for the Common Shares, otherwise than in accordance with this
Agreement or as contemplated in the Prospectus except for (i) options granted
under the incentive plans of the Company, (ii) Common Shares issued in exchange
for Units and (iii) Common Shares or Units issued in connection with the
acquisition of real property or interests therein.
(m) The Company will use its best efforts to meet the requirements
to continue to qualify as a "real estate investment trust" under the Code.
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<PAGE> 20
(n) The Company and the Operating Partnership will cause, or have
caused, the officers and trust managers of the Company to enter into lock-up
agreements in form and substance reasonably satisfactory to you and each of the
Company and the Operating Partnership acknowledges that you are or will be
intended third party beneficiaries of such agreements.
(o) The Company will reserve and keep available at all times, free
of preemptive or other similar rights, a sufficient number of Common Shares for
the purpose of enabling the Company to satisfy any obligations to issue such
shares upon conversion of such Preferred Shares.
(p) Except for the authorization of actions permitted to be taken by
you as contemplated herein or in the Prospectus, neither the Company nor the
Operating Partnership will (i) take, directly or indirectly, any action designed
to cause or to result in, or that might reasonably be expected to constitute,
the stabilization or manipulation of the price of any security of the Company to
facilitate the sale or resale of the Underwritten Securities, (ii) sell, bid for
or purchase the Underwritten Securities or pay any person any compensation for
soliciting purchases of the Underwritten Securities or (iii) pay or agree to pay
to any person any compensation for soliciting another to purchase any other
securities of the Company.
(q) During the period from Closing Time until five years after
Closing Time, the Company will deliver to you, (i) promptly upon their becoming
available, copies of all current, regular and periodic reports of the Company
mailed to its stockholders or filed with any securities exchange or with the
Commission or any governmental authority succeeding to any of the Commission's
functions, and (ii) such other information concerning the Company, the Operating
Partnership, any Subsidiary or any Residential Development Corporation as you
may reasonably request.
(r) Prior to Closing Time and if not described in the Prospectus,
the Company and the Operating Partnership will notify you in writing immediately
if any event occurs that renders any of the representations and warranties of
the Company and the Operating Partnership contained herein inaccurate or
incomplete in any respect.
(s) If at any time during the 25-day period after any amendment to
the Registration Statement becomes effective or during the period prior to the
final Date of Delivery, any rumor, publication or event relating to or affecting
the Company shall occur as a result of which in your opinion the market price of
the Underwritten Securities has been or is likely to be materially affected
(regardless of whether such rumor, publication or event necessitates supplements
to or amendments of the Prospectuses), the Company will, after written notice
from you advising the Company to that effect, promptly prepare, consult with you
concerning
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<PAGE> 21
the substance of, and disseminate a press release or other public
statement, reasonably satisfactory to you, responding to or commenting on such
rumor, publication or event.
(t) From the date hereof until notice of termination pursuant to
Section 9(a) hereof is received by you, the Company shall furnish to you and
your counsel, within two days after filing, copies of any document filed by the
Company with the Commission pursuant to Section 13, 14 or 15 of the 1934 Act.
SECTION 4. PAYMENT OF FEES AND EXPENSES.
The Company will pay all expenses incident to the performance of its
obligations under this Agreement, including (i) the printing and filing of the
Registration Statement as originally filed and of each amendment thereto, (ii)
the printing of this Agreement and other documents related hereto, (iii) the
preparation, issuance and delivery of the certificates for the Underwritten
Securities to you, (iv) the fees and other charges of the Company's counsel and
accountants, (v) the qualification of the Underwritten Securities and Common
Shares issuable upon conversion thereof under securities laws and real estate
syndication laws in accordance with the provisions of Section 3(g) hereof,
including filing fees and the fees and other charges of your counsel in
connection therewith and in connection with the preparation of a blue sky
memorandum (the "BLUE SKY MEMORANDUM"), (vi) the printing and delivery to you of
copies of the Registration Statement as originally filed and of each amendment
thereto, of the preliminary prospectus, and of the Prospectus and any amendments
or supplements thereto, (vii) the printing (and reproduction) and delivery to
you of copies of the Blue Sky Memorandum, and (viii) the fees and expenses, if
any, incurred with respect to the listing of the Underwritten Securities and the
Common Shares issuable upon conversion thereof on any national securities
exchange.
If this Agreement is canceled or terminated by you in accordance
with the provisions of Section 5 or Section 9 hereof, the Company also shall
reimburse you for all of your out-of-pocket expenses, including the reasonable
fees and other charges of your counsel.
SECTION 5. CONDITIONS OF UNDERWRITER'S OBLIGATIONS.
Your obligations hereunder are subject to the accuracy, as of the
date hereof and at Closing Time, of the representations and warranties of the
Company and the Operating Partnership herein contained, to the performance by
the Company and the Operating Partnership of their respective obligations
hereunder, and to the following further conditions:
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(a) At the applicable Closing Time (i) no stop order suspending the
effectiveness of the Registration Statement shall have been issued under the
1933 Act or proceedings therefor initiated or threatened by the Commission, (ii)
the rating assigned by any nationally recognized statistical rating organization
to any Preferred Shares of the Company and any indebtedness of the Company or
the Operating Partnership as of the date of this Agreement shall not have been
lowered since such date nor shall any such rating organization have publicly
announced that it has placed any Preferred Shares of the Company and any
indebtedness of the Company or the Operating Partnership on what is commonly
termed a "watch list" for possible downgrading, and (iii) there shall not have
come to your attention any facts that would cause you to believe that the
Prospectus, together with the Prospectus Supplement, at the time it was required
to be delivered to purchasers of the Underwritten Securities, included an untrue
statement of a material fact or omitted to state a material fact necessary in
order to make the statements therein, in light of the circumstances existing at
such time, not misleading.
(b) At Closing Time, you shall have received:
(i) The favorable opinions, dated as of Closing Time, of Shaw,
Pittman, Potts & Trowbridge, counsel for each of the Company, the Operating
Partnership and the Significant Subsidiaries, and Locke Purnell Rain
Harrell (A Professional Corporation), special Texas tax counsel for the
Subsidiaries that are Texas entities (collectively with the Residential
Development Corporations which are Texas entities, the "TEXAS ENTITIES"),
each in form and substance satisfactory to your counsel, to the effect
that:
(A) The Company has been duly formed as a real estate investment
trust under the laws of the State of Texas. The Company has power and
authority to own, lease and operate its properties, to conduct the
business in which it is engaged or proposes to engage as described in
the Prospectus, and to enter into and perform its obligations under
this Agreement and the Partnership Agreement (together, the "LISTED
AGREEMENTS"). According to the County Clerk of Tarrant County, Texas,
the Restated Declaration of Trust of the Company is recorded in Volume
12645, beginning at Page 1811, in the records of the County Clerk. The
Restated Declaration of Trust is in effect, and no dissolution,
revocation or forfeiture proceedings regarding the Company have been
commenced. The Company is duly qualified as a foreign organization to
transact business and is in good standing in each jurisdiction in
which such qualification is required, whether by reason of the
ownership or leasing of property or the conduct of business, except
where the failure to so qualify would not have a material adverse
effect on the condition, financial or otherwise, or the earnings,
assets, business affairs or business prospects of the
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<PAGE> 23
Company, the Operating Partnership, the Subsidiaries and the
Residential Development Corporations considered as one enterprise.
(B) The Operating Partnership has been duly formed and is validly
existing as a limited partnership in good standing under the Delaware
Act. The Operating Partnership has full partnership power and
authority to own, lease and operate its properties, to conduct the
business in which it is engaged or proposes to engage as described in
the Prospectus and to enter into and perform its obligations under
this Agreement and the Listed Agreements to which it is a party. The
Operating Partnership is duly qualified or registered as a foreign
partnership and is in good standing in Texas, Colorado, California,
Florida, Arizona, New Mexico, Louisiana, Nebraska and each other
jurisdiction in which such qualification or registration is required,
whether by reason of the ownership or leasing of property or the
conduct of business, except where the failure to so qualify or
register would not have a material adverse effect on the condition,
financial or otherwise, or the earnings, assets, business affairs or
business prospects of the Company, the Operating Partnership, the
Subsidiaries and the Residential Development Corporations considered
as one enterprise. CGP, Inc., a wholly owned subsidiary of the
Company, is the sole general partner of the Operating Partnership.
(C) Each of Crescent Real Estate Funding I, L.P., Crescent Real
Estate Funding II, L.P., Crescent Real Estate Funding VII, L.P. and
any other Subsidiary that would be considered a "Significant
Subsidiary" as defined in Article 1, Rule 1--02 of Regulation S-X
promulgated pursuant to the 1933 Act (collectively, the "Significant
Subsidiaries") has been organized and is validly existing as a
corporation, limited partnership or limited liability company, as the
case may be, in good standing under the laws of its respective state
of organization, with full corporate, partnership or limited liability
company (as the case may be) power and authority to own, lease and
operate its properties, to conduct the business in which it is engaged
or proposes to engage as described in the Prospectus, and to enter
into and perform its obligations under any Listed Agreements to which
it is a party. Each of the Significant Subsidiaries and the
Residential Development Corporations is duly qualified as a foreign
corporation, limited partnership or limited liability company, as the
case may be, to transact business and is in good standing in each
jurisdiction in which such qualification is required, whether by
reason of the ownership or leasing of property or the conduct of
business, except where the failure to so qualify would not have a
material adverse effect on the condition, financial or otherwise, or
the earnings, assets, business affairs or business prospects of the
Company, the Operating Partnership, the
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<PAGE> 24
Significant Subsidiaries and the Residential Development Corporations
considered as one enterprise. All of the issued and outstanding shares
of capital stock of each of the corporate Significant Subsidiaries
have been duly authorized and validly issued and are fully paid and
non-assessable. The ownership by the Company, the Operating
Partnership and the Significant Subsidiaries of the shares of capital
stock or limited partnership or equity interests, as the case may be,
of each of the Significant Subsidiaries is as described in the
Prospectus, and such ownership is free and clear of any security
interest, mortgage, pledge, lien, encumbrance, claim or equity.
(D) The authorized, issued and outstanding shares of beneficial
interest of the Company are as set forth in the Prospectus, except to
the extent of changes due to either the conversion of Units to Common
Shares or the exercise of existing options to acquire Common Shares.
All of such shares of beneficial interest are validly issued, fully
paid and non-assessable and have been offered and sold in compliance
with all applicable laws (including, without limitation, federal
securities laws). No shares of beneficial interest of the Company are
reserved for any purpose except in connection with (i) the option
plans of the Company as described in the Prospectus, (ii) the possible
issuance of Common Shares upon the exchange of Units pursuant to the
Partnership Agreement, (iii) the possible issuance of Common Shares
upon exercise of an existing option to acquire up to 217,530 Common
Shares, and (iv) the possible issuance of up to 664,294 Common Shares
upon the exchange of a portion of partnership interest in Desert
Mountain Properties Limited Partnership. Except for (i) Units, (ii)
Common Shares issuable upon the exercise of options, (iii) Units
issuable upon the exercise of options, (iv) Common Shares issuable
pursuant to the Forward Stock Purchase Contract agreement, dated as of
August 12, 1997 with an affiliate of Union Bank of Switzerland and (v)
Common Shares issuable pursuant to the Swap Agreement, dated as of
December 12, 1997, with an affiliate of Merrill Lynch & Co, Inc.,
there are no outstanding securities convertible into or exchangeable
for any shares of beneficial interest of the Company and no
outstanding options, rights (preemptive or other similar rights under
the Texas REIT Act, the Declaration of Trust, or to the knowledge of
such counsel, any other document) or warrants to purchase or to
subscribe for shares of beneficial interest or any other securities
of the Company.
(E) The Underwritten Securities have been duly authorized for
issuance and sale to you pursuant to this Agreement and, when issued
and delivered by the Company pursuant hereto against payment of the
consideration set forth herein, will be validly issued, fully paid and
non-assessable. Upon payment of the purchase price and delivery of the
Underwritten Securities in accordance herewith
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<PAGE> 25
you are receiving good, valid and marketable title to the Underwritten
Securities, free and clear of all security interests, mortgages,
pledges, liens, encumbrances and claims. The Underwritten Securities
will be offered and sold at Closing Time or the Date of Delivery, as
the case may be, in compliance with all applicable laws (including,
without limitation, federal securities laws). The terms of the
Underwritten Securities, the Preferred Shares and the Common Shares
conform to all statements and descriptions related thereto contained
in the Prospectus. The form of stock certificate evidencing the
Underwritten Securities and the Common Shares is in due and proper
form and complies with all applicable legal requirements. The issuance
of the Underwritten Securities is not subject to any preemptive or
other similar rights under the Texas REIT Act, the Declaration of
Trust, or to the knowledge of such counsel, any other document and,
except as set forth in the Prospectus, there are no restrictions on
the voting or transfer of Preferred Shares or Common Shares pursuant
to the Company's Declaration of Trust or Bylaws or any agreement or
other instrument known to such counsel.
(F) At Closing Time, the number of authorized, issued and
outstanding Units will be as set forth in the Prospectus, except to
the extent of changes due to either the conversion of Units to Common
Shares or the exercise of existing options to acquire Units. All of
the Units outstanding at Closing Time were duly authorized for
issuance by the Operating Partnership and are validly issued and fully
paid. To our knowledge, the Units were offered and sold in compliance
with all applicable laws (including, without limitation, federal
securities laws). Except as summarized in the Prospectus or as set
forth in the Partnership Agreement, there are no preemptive or other
rights to subscribe for or to purchase, or any restriction upon the
voting or transfer of, any Units pursuant to the Partnership Agreement
or any other instrument known to such counsel. The terms of the Units
conform to all statements and descriptions related thereto contained
in the Prospectus, including all documents incorporated therein by
reference.
(G) The Common Shares issuable upon conversion of the
Underwritten Securities have been duly authorized and reserved for
issuance upon such conversion by all necessary action on the part of
the Company and such Common Shares, when issued and declared upon such
conversion in accordance with the Declaration of Trust will be validly
issued, fully paid and non-assessable. The issuance of such Common
Shares upon such conversion will not be subject to preemptive or other
similar rights under the Texas REIT Act, the
25
<PAGE> 26
Declaration of Trust, or to the knowledge of such counsel, any other
document.
(H) The relative rights, preferences, interests and powers of the
Underwritten Securities are as set forth in a statement of designation
filed for record with the County Clerk of Tarrant County, Texas and
all such provisions are valid under Texas law.
(I) This Agreement has been duly authorized, executed and
delivered by each of the Company and the Operating Partnership.
(J) None of the Company, the Operating Partnership or any
Significant Subsidiary is in violation of its declaration of trust,
charter, by-laws, certificate of limited partnership, partnership
agreement, limited liability company agreement or similar instrument,
as the case may be, and, to the knowledge of counsel, none of the
Company, the Operating Partnership or any Significant Subsidiary is in
default in the performance or observance of any obligation, agreement,
covenant or condition contained in any contract, indenture, mortgage,
loan agreement, note, lease or other instrument filed as an exhibit to
the Registration Statement or any document incorporated therein by
reference or as otherwise identified by the Company as material in an
officer's certificate to which such entity is a party or by which such
entity is bound, or to which any of the property or assets of such
entity is subject, except where a default thereunder would not have a
material adverse effect on the condition, financial or otherwise, or
the earnings, assets, business affairs or business prospects of the
Company, the Operating Partnership, the Subsidiaries and the
Residential Development Corporations considered as one enterprise.
(K) Each of the Listed Agreements was duly and validly
authorized, executed and delivered by the Company and the Operating
Partnership, as applicable, and, assuming due authorization, execution
and delivery by any other party thereto, is a valid and binding
agreement, enforceable in accordance with its terms, except as such
enforceability may be (1) limited by bankruptcy, insolvency,
reorganization, liquidation, moratorium and other similar laws
affecting the rights and remedies of creditors generally and (2)
subject to general principles of equity (regardless of whether such
enforceability is considered in a proceeding in equity or at law).
(L) The execution and delivery of the Listed Agreements, the
performance of the obligations set forth in each of the Listed
Agreements, and the consummation of the transactions contemplated
thereby or in the Prospectus by the Company, the Operating
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<PAGE> 27
Partnership and the Significant Subsidiaries as applicable, will not
conflict with or constitute a breach or violation of, or default
under: (1) to the knowledge of counsel, any material contract,
indenture, mortgage, loan agreement, note, lease, joint venture or
partnership agreement or other instrument or agreement filed as an
exhibit to the Registration Statement or any document incorporated
therein by reference or as otherwise identified by the Company as
material in an officer's certificate to which the Company, the
Operating Partnership or any Significant Subsidiary is a party or by
which they or any of them or any of their respective properties or
other assets or any Property may be bound or subject; (2) the
declaration of trust, charter, by-laws, certificate of limited
partnership, partnership agreement, or limited liability company
agreement, or similar instrument, as the case may be, of the Company,
the Operating Partnership or any Significant Subsidiary; or (3) any
federal or Texas law or the Delaware Act. The descriptions of the
Listed Agreements, if any, contained in the Prospectus are correct and
complete in all material respects.
(M) To the knowledge of counsel, there is no action, suit or
proceeding before or by any court or governmental agency or body,
domestic or foreign, now pending or threatened against or affecting
the Company, the Operating Partnership or any Significant Subsidiary,
any Property, any property underlying indebtedness held by the
Company, the Operating Partnership or any of the Significant
Subsidiaries or any officer or trust manager of the Company that is
required to be disclosed in the Registration Statement (other than as
disclosed therein or that, if determined adversely to the Company, the
Operating Partnership, any Significant Subsidiary, any Property,
including any property underlying indebtedness held by the Company,
the Operating Partnership, any of the Significant Subsidiaries or any
such officer or trust manager, would reasonably be expected to (1)
result in any material adverse change in the condition, financial or
otherwise, or in the earnings, assets, business affairs or business
prospects of the Company, the Operating Partnership, the Subsidiaries
and the Residential Development Corporations, considered as one
enterprise, or (2) materially and adversely affect the consummation of
the transactions contemplated by this Agreement. To the knowledge of
counsel, there is no pending legal or governmental proceeding to which
the Company, the Operating Partnership or any Significant Subsidiary
is a party or of which any of their respective properties or assets or
any Property, including any property underlying indebtedness held by
the Company, the Operating Partnership, or any of the Significant
Subsidiaries is the subject, including ordinary routine litigation
incidental to the business, that is, considered in the aggregate,
material to the condition, financial or otherwise, or the earnings,
27
<PAGE> 28
assets, business affairs or business prospects of the Company, the
Operating Partnership, the Subsidiaries and the Residential
Development Corporations, considered as one enterprise. To the
knowledge of counsel, there are no contracts or documents of the
Company, the Operating Partnership, or the Significant Subsidiaries
which are required to be filed as exhibits to the Registration
Statement by the 1933 Act or by the 1933 Act Regulations which have
not been filed or incorporated by reference as exhibits to the
Registration Statement.
(N) The Company qualified as a real estate investment trust under
the Code with respect to its taxable years ending on or before
December 31, 1997 and is organized in conformity with the requirements
for qualification as a real estate investment trust, its manner of
operation has enabled it to meet the requirements for qualification as
a real estate investment trust as of the date of the Prospectus
Supplement, and its proposed manner of operation will enable it to
meet the requirements for qualification as a real estate investment
trust in the future. In connection therewith, you are entitled to rely
on the opinions of Shaw, Pittman, Potts & Trowbridge filed as Exhibit
8.01 to the Registration Statement, the opinions attached to such
opinions as exhibits thereto, and any other opinions rendered to the
Company with respect to tax matters and described in the Prospectus,
all as if rendered to you on the Closing Date.
(O) None of the Company, the Operating Partnership or any
Significant Subsidiary is required to be registered under the 1940
Act.
(P) All authorizations, approvals and consents of any court or
governmental authority or agency that are necessary in connection with
the offering, issuance or sale of the Underwritten Securities under
this Agreement have been obtained, except such as may be required
under the 1933 Act or the 1933 Act Regulations or the securities and
real estate syndication laws of any U.S. state or other jurisdiction
with respect to the Securities.
(Q) The Registration Statement has been declared effective under
the 1933 Act and, to the knowledge of counsel, no stop order
suspending the effectiveness of the Registration Statement has been
issued under the 1933 Act or proceedings therefor initiated or
threatened by the Commission.
(R) The Registration Statement and the Prospectus (other than the
financial statements and supporting schedules included therein, as to
which no opinion need be rendered) as of their respective
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<PAGE> 29
effective or issue dates and on the date hereof complied as to
form in all material respects with the requirements of the 1933
Act and the 1933 Act Regulations. Each document filed pursuant to
the 1934 Act (other than the financial statements and supporting
schedules, included therein as to which no opinion need be
rendered) and incorporated or deemed to be incorporated by
reference in the Prospectus complied when so filed or
incorporated or deemed to be incorporated as to form in all
material respects with the 1934 Act and the 1934 Act Regulations.
(S) The information in the Registration Statement under the
captions "Description of Series A Preferred Shares," "Description
of Preferred Shares," "Description of Common Shares," "Certain
Provisions of the Declaration of Trust, Bylaws and Texas Law" and
"ERISA Considerations," to the extent applicable to the offering
of the Underwritten Securities and to the extent that it
constitutes matters of law or legal conclusions, has been
reviewed by such counsel, is correct and presents fairly the
information required to be disclosed therein.
(T) The information in the Prospectus Supplement under the
caption "Federal Income Tax Considerations" and in the Prospectus
under the caption "Risks Relating to Qualification and Operation
as a REIT" fairly summarizes the federal income tax
considerations that are likely to be material to a holder of
Underwritten Securities and, to the extent that they constitute
matters of law or legal conclusions, they have been reviewed by
such counsel, they are correct and present fairly the information
required to be disclosed therein.
In giving the opinions required by this Section 5(b)(i),
such counsel shall in addition provide the opinions referenced in
the Prospectus under the caption "Federal Income Tax
Consequences."
In giving the opinions required by this Section 5(b)(i),
such counsel shall additionally state (which shall not constitute
an opinion) that nothing has come to the attention of such
counsel that causes it to believe that the Registration Statement
or any post-effective amendment thereto (except for financial
statements and schedules and other financial data included
therein or omitted therefrom, as to which counsel need make no
statement), at the time such Registration Statement became
effective under the 1933 Act or at the time an Annual Report on
Form 10-K or the latest Quarterly Report on Form 10-Q was filed
by the Company with the Commission (whichever is later) or at the
date of this Agreement, or as of the date such opinions are
given, contained an untrue statement of a material fact or
omitted
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<PAGE> 30
to state a material fact required to be stated therein or
necessary to make the statements therein not misleading, or the
Prospectus or any Prospectus Supplement (except for financial
statements and schedules and other financial data included
therein, as to which counsel need make no statement), as of the
date of this Agreement, or as of the date of such opinion,
included an untrue statement of a material fact or omitted to
state a material fact necessary in order to make the statements
therein, in light of the circumstances under which they were
made, not misleading.
In giving the opinions required by this Section 5(b)(i),
Shaw, Pittman, Potts & Trowbridge and Locke Purnell Rain Harrell
(A Professional Corporation) may rely, (A) as to all matters of
fact, upon certificates and written statements of officers and
employees of and accountants for each of the Company, the
Operating Partnership, the Subsidiaries or the Residential
Development Corporations; (B) as to the continued existence of
the Company, upon a certificate of an officer of the Company, and
as to the qualification and good standing of each of the
Operating Partnership or a Significant Subsidiary to do business
in any jurisdiction, upon certificates of appropriate government
officials or opinions of counsel in such jurisdictions; and (C)
as to all Texas franchise tax matters, upon the opinion, dated as
of Closing Time, of Locke Purnell Rain Harrell (A Professional
Corporation).
The opinion of Locke Purnell Rain Harrell (A Professional
Corporation) shall be limited to the laws of the State of Texas.
(ii) The favorable opinion, dated as of Closing Time, of Locke
Purnell Rain Harrell (A Professional Corporation), counsel to each of
the Company and the Operating Partnership, that it has reviewed the
discussion in the Prospectus under the caption "Federal Income Tax
Considerations - State and Local Taxes" with respect to Texas
franchise matters and is of the opinion that it accurately summarizes
the Texas franchise tax matters expressly described therein.
(iii) The favorable opinion, dated as of Closing Time, of
Hogan & Hartson L.L.P., your counsel, with respect to the matters set
forth in (A) (first sentence only), (B) (first sentence only), (E)
(first and fourth sentences only), (G)(first sentence only), (H), (I),
(Q) and (R) (first sentence only) of Section 5(b)(i) and a statement
(which shall not constitute an opinion) similar to the statement
referred to in the third to last paragraph of Section 5(b)(i) above. In
giving its opinion, Hogan & Hartson L.L.P. may rely, (A) as to all
matters of fact, upon certificates and written statements of officers
and employees of and accountants for each of the Company, the Operating
Partnership, the Subsidiaries or the Residential Development
30
<PAGE> 31
Corporations, (B) as to the qualification and good standing of each of
the Company, the Operating Partnership, or the Significant Subsidiaries
to do business in any state or jurisdiction, upon certificates of
appropriate government officials or opinions of counsel in such
jurisdictions, which opinions shall be in form and substance
satisfactory to your counsel, and (C) as to certain matters of law,
upon the opinion of Shaw, Pittman, Potts & Trowbridge given pursuant to
Section 5(b)(i) above.
(c) At Closing Time, (i) there shall not have been, since the respective
dates as of which information is given in the Registration Statement and the
Prospectus, any material adverse change in the condition, financial or
otherwise, or in the earnings, assets, business affairs or business prospects of
the Company, the Operating Partnership, the Subsidiaries, the Residential
Development Corporations and the Properties considered as one enterprise,
whether or not arising in the ordinary course of business, (ii) no proceedings
shall be pending or, to the knowledge of the Company or the Operating
Partnership, threatened against such entity before or by any federal, state or
other commission, board or administrative agency wherein an unfavorable
decision, ruling or finding might result in a material adverse change in the
condition, financial or otherwise, or in the earnings, assets, business affairs
or business prospects of the Company, the Operating Partnership, the
Subsidiaries, the Residential Development Corporations and the Properties
considered as one enterprise other than as set forth in the Prospectus, (iii) no
stop order suspending the effectiveness of the Registration Statement or any
part thereof shall have been issued and no proceedings for that purpose shall
have been instituted or, to the knowledge of the Company or the Operating
Partnership, threatened by the Commission or by the state securities authority
of any jurisdiction, and (iv) you shall have received, at Closing Time, a
Certificate of the Chief Executive Officer or any Senior Vice President of the
Company and CGP, Inc., on behalf of the Operating Partnership, and the chief
financial or chief accounting officer of each such entity, dated as of Closing
Time, evidencing compliance with the provisions of this subsection (c), stating
that the representations and warranties set forth in Section 1(a) hereof are
accurate as though expressly made at and as of Closing Time, and stating that
the conditions precedent set forth in this Section 5 have been satisfied or
waived. As used in this Section 5(c), the term "Prospectus" means the Prospectus
in the form first used to confirm sales of the Underwritten Securities.
(d) At the time of execution of this Agreement, you shall have received
from Arthur Andersen LLP a letter dated such date, in form and substance
satisfactory to you, to the effect that: (i) they are independent public
accountants with respect to the Company and the Rainwater Property Group (as
defined in the financial statements included in the Registration Statement) as
required by the 1933 Act and the 1933 Act Regulations; (ii) it is their opinion
that the financial statements and supporting schedule included in the
Registration Statement and
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<PAGE> 32
covered by their opinions therein comply as to form in all material respects
with the applicable accounting requirements of the 1933 Act and the 1933 Act
Regulations; (iii) they have performed limited procedures, not constituting an
audit, including a reading of the latest available consolidated interim
financial statements of the Company, a reading of the minute books of the
Company, inquiries of officials of the Company responsible for financial and
accounting matters and such other inquiries and procedures as may be specified
in such letter, and on the basis of such limited review and procedures nothing
came to their attention that caused them to believe that (A) the unaudited
financial statements and supporting schedules of the Rainwater Property Group
included in the Registration Statement do not comply as to form in all material
respects with the applicable accounting requirements of the 1933 Act and the
1933 Act Regulations or are not in conformity with generally accepted accounting
principles applied on a basis substantially consistent with that of the audited
financial statements included in the Registration Statement, (B) the unaudited
operating data and balance sheet data of the Company set forth in the Prospectus
under the caption "Selected Financial Information" were not determined on a
basis substantially consistent with that used in determining the corresponding
amounts in the audited financial statements included in the Registration
Statement (C) the pro forma financial information included in the Registration
Statement was not prepared in accordance with the applicable accounting
requirements of the 1933 Act and the 1933 Act Regulations with respect to pro
forma financial information or was not determined on a basis substantially
consistent with that of the audited financial statements included in the
Registration Statement or (D) at a specified date not more than three days prior
to the date of this Agreement, there has been any change in the shareholders'
equity or debt of the Company or any increase in the debt of the Company or any
decrease in the net assets of the Company, as compared with the amounts shown in
the most recent consolidated balance sheet of the Company included in the
Registration Statement or, during the period from most recent consolidated
statement of operations included in the Registration Statement to a specified
date not more than three days prior to the date of this Agreement, there were
any decreases, as compared with the corresponding period in the preceding year,
in revenues, net income or funds from operations of the Company, except in all
instances for changes, increases or decreases which the Registration Statement
and the Prospectus disclose have occurred or may occur; and (iv) in addition to
the examination referred to in their opinions and the limited procedures
referred to in clause (iii) above, they have carried out certain specified
procedures, not constituting an audit, with respect to certain amounts,
percentages and financial and statistical information which are included in the
Registration Statement and Prospectus (including the documents incorporated
therein by reference), and which are specified by you, and have found such
amounts, percentages and financial and statistical information to be in
agreement with the relevant accounting, financial and other records of the
Company identified in such letter.
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<PAGE> 33
(e) At Closing Time, you shall have received from Arthur Andersen LLP a
letter dated as of Closing Time to the effect that they reaffirm the statements
made in the letter furnished pursuant to subsection (d) of this Section 5,
except that the "specified date" referred to shall be a date not more than three
days prior to Closing Time and, if the Company has elected to rely upon Rule
430A of the 1933 Act Regulations, to the further effect that they have carried
out procedures as specified in clause (iv) of subsection (d) of this Section 5
with respect to certain amounts, percentages and financial information specified
by you and deemed to be a part of the Registration Statement pursuant to Rule
430A(b) and have found such amounts, percentages and financial information to be
in agreement with the records specified in such clause (iv).
(f) At Closing Time, your counsel shall have been furnished with such
documents and opinions as they may reasonably require for the purpose of
enabling them to pass upon the issuance and sale of the Underwritten Securities
as herein contemplated and related proceedings, or in order to evidence the
accuracy of any of the representations or warranties, or the fulfillment of any
of the conditions, herein contained, and all proceedings taken by the Company in
connection with the issuance and sale of the Underwritten Securities as
contemplated herein shall be satisfactory in form and substance to you and your
counsel.
(g) In the event you exercise your option set forth in Section 2(b) hereof
to purchase all or any portion of the Option Shares, the representations and
warranties of the Company and the Operating Partnership contained herein and the
statements in any certificates furnished by the Company and CGP, Inc., on behalf
of the Operating Partnership hereunder shall be true and correct as of each Date
of Delivery, and you shall have received:
(i) A certificate of the Chief Executive Officer or any Senior Vice
President of the Company and CGP, Inc., on behalf of the Operating
Partnership and the chief financial or chief accounting officer of each
such entity, dated such Date of Delivery, confirming that the certificate
delivered at Closing Time pursuant to Section 5(c) hereof remains true and
correct as of such Date of Delivery.
(ii) The favorable opinions of Shaw, Pittman, Potts & Trowbridge,
counsel for each of the Company, the Operating Partnership and the
Significant Subsidiaries and Locke Purnell Rain Harrell (A Professional
Corporation), special counsel for the Texas Entities, each in form and
substance satisfactory to your counsel, dated such Date of Delivery,
relating to the Option Shares and otherwise to the same effect as the
opinion and statement required by Section 5(b)(i) hereof.
(iii) The favorable opinion of Locke Purnell Rain Harrell (A
Professional Corporation), counsel to each of the Company and the Operating
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<PAGE> 34
Partnership, dated such Date of Delivery, with respect to all Texas
franchise tax matters and otherwise to the same effect as the opinion
required by Section 5(b)(ii) hereof.
(iv) The favorable opinion of Hogan & Hartson L.L.P., your counsel,
dated such Date of Delivery, relating to the Option Shares and otherwise to
the same effect as the opinion and statement required by Section 5(b)(iii)
hereof.
(v) A letter from Arthur Andersen LLP, in form and substance
satisfactory to you, dated such Date of Delivery, substantially the same in
scope and substance as the letter furnished to you pursuant to Section 5(e)
hereof, except that the "specified date" in the letter furnished pursuant
to this Section 5(g)(iv) shall be a date not more than three days prior to
such Date of Delivery.
If any condition specified in this Section 5 shall not have been
fulfilled when and as required to be fulfilled, this Agreement may be terminated
by you by notice to the Company at any time at or prior to Closing Time, and
such termination shall be without liability of any party to any other party,
except as provided in Section 4 hereof.
SECTION 6. INDEMNIFICATION.
(a) Each of the Company and the Operating Partnership agrees, jointly
and severally, to indemnify and hold harmless you and each person, if any, who
controls you within the meaning of section 15 of the 1933 Act, and any of your
directors, officers, employees or affiliates as follows:
(i) against any and all loss, liability, claim, damage and expense
whatsoever, as incurred, arising out of any untrue statement or alleged
untrue statement of a material fact contained in the Registration Statement
(or any amendment thereto), including the information deemed to be part of
the Registration Statement pursuant to Rule 430A(b) of the 1933 Act
Regulations, if applicable, or the omission or alleged omission therefrom
of a material fact required to be stated therein or necessary to make the
statements therein not misleading or arising out of any untrue statement or
alleged untrue statement of a material fact contained in any preliminary
prospectus or the Prospectus or the omission or alleged omission therefrom
of a material fact necessary in order to make the statements therein, in
the light of the circumstances under which they were made, not misleading;
provided, however, that neither the Company nor the Operating Partnership
shall be required under this subsection (i) to indemnify you with respect
to
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<PAGE> 35
any loss, liability, claim, damage or expense to the extent such loss,
liability, claim, damage or expense arises out of any untrue statement or
omission or alleged untrue statement or omission made in reliance upon and
in conformity with written information furnished to the Company by you
specifically for inclusion in the Registration Statement or the Prospectus;
(ii) against any and all loss, liability, claim, damage and expense
whatsoever, as incurred, to the extent of the aggregate amount paid in
settlement of any litigation or of any investigation or proceeding by any
governmental agency or body, commenced or threatened, or of any claim
whatsoever for which indemnification is provided under subsection (i)
above, if such settlement is effected with the written consent of the
Company and the Operating Partnership; and
(iii) against any and all expense whatsoever (including, without
limitation, the fees and other charges of counsel chosen by you) reasonably
incurred in investigating, preparing or defending against any litigation,
or any investigation or proceedings by any governmental agency or body,
commenced or threatened, or any claim whatsoever for which indemnification
is provided under subsection (i) above, to the extent that any such expense
is not paid under subsection (i) or (ii) above.
(b) You agree to indemnify and hold harmless the Company and the
Operating Partnership, and each person, if any, who controls the Company or the
Operating Partnership within the meaning of Section 15 of the 1933 Act, and any
trust manager, director, officer, employee or affiliate thereof, against any and
all loss, liability, claim, damage and expense described in the indemnity
contained in subsection (a) of this Section 6, as incurred, but only with
respect to untrue statements or omissions, or alleged untrue statements or
omissions, made in the Registration Statement (or any amendment thereto) or any
preliminary prospectus or the Prospectus (or any amendment or supplement
thereto) in reliance upon and in conformity with written information furnished
to the Company by you specifically for inclusion in the Registration Statement
or the Prospectus.
(c) Each indemnified party shall give notice as promptly as reasonably
practicable to each indemnifying party of any action commenced against it in
respect of which indemnity may be sought hereunder, but failure to so notify an
indemnifying party shall not relieve such indemnifying party from any liability
hereunder to the extent it is not materially prejudiced as a result thereof and
in any event shall not relieve it from any liability which it may have otherwise
than on account of this indemnity agreement. An indemnifying party may
participate at its own expense in the defense of such action. If it so elects
within a reasonable time after receipt of such notice, an indemnifying party,
jointly with any other indemnifying parties receiving such notice, may assume
the defense of such action
35
<PAGE> 36
with counsel chosen by it and approved by the indemnified parties defendant in
such action, unless such indemnified parties reasonably object to such
assumption on the ground that the named parties to any such action (including
any impleaded parties) include both such indemnified parties and an indemnifying
party, and such indemnified parties reasonably believe that there may be legal
defenses available to them which are different from or in addition to those
available to such indemnifying party. If an indemnifying party assumes the
defense of such action, the indemnifying parties shall not be liable for any
fees and expenses of counsel for the indemnified parties incurred thereafter in
connection with such action. In no event shall the indemnifying parties be
liable for fees and expenses of more than one counsel (in addition to any local
counsel) separate from their own counsel for all indemnified parties in
connection with any one action or separate but similar or related actions in the
same jurisdiction arising out of the same general allegations or circumstances.
No indemnifying party shall, without the prior written consent of the
indemnified parties, settle or compromise or consent to the entry of any
judgment with respect to any litigation, or any investigation or proceeding by
any governmental agency or body, commenced or threatened, or any claim
whatsoever in respect of which indemnification or contribution could be sought
under this Section 6 or Section 7 hereof (whether or not the indemnified parties
are actual or potential parties thereto), unless such settlement, compromise or
consent (i) includes an unconditional release of each indemnified party from all
liability arising out of such litigation, investigation, proceeding or claim and
(ii) does not include a statement as to or an admission of fault, culpability or
a failure to act by or on behalf of any indemnified party.
(d) If at any time an indemnified party shall have requested an
indemnifying party to reimburse the indemnified party for fees and expenses of
counsel, such indemnifying party agrees that it shall be liable for any
settlement of the nature contemplated by Section 6(a)(ii) effected without its
written consent if (i) such settlement is entered into more than 45 days after
receipt by such indemnifying party of the aforesaid request, (ii) such
indemnifying party shall have received notice of the terms of such settlement at
least 30 days prior to such settlement being entered into and (iii) such
indemnifying party shall not have reimbursed such indemnified party in
accordance with such request prior to the date of such settlement.
SECTION 7. CONTRIBUTION.
If the indemnification provided for in Section 6 hereof is for any
reason unavailable to or insufficient to hold harmless an indemnified party in
respect of any losses, liabilities, claims, damages or expenses referred to
therein, then each indemnifying party shall contribute to the aggregate amount
of such losses, liabilities, claims, damages and expenses incurred by such
indemnified party, as incurred, (i) in such proportion as is appropriate to
reflect the relative benefits received by the Company, on the one hand, and you,
on the other hand, from the
36
<PAGE> 37
offering of the Underwritten Securities pursuant to this Agreement or (ii) if
the allocation provided by clause (i) is not permitted by applicable law, in
such proportion as is appropriate to reflect not only the relative benefits
referred to in clause (i) above but also the relative fault of the Company, on
the one hand, and of you, on the other hand, in connection with the statements
or omissions which resulted in such losses, liabilities, claims, damages or
expenses, as well as any other relevant equitable considerations.
The relative benefits received by the Company, on the one hand, and by
you, on the other hand, in connection with the offering of the Underwritten
Securities pursuant to this Agreement shall be deemed to be in the same
respective proportions as the total net proceeds from the offering of such
Underwritten Securities (before deducting expenses) received by the Company and
the total underwriting discount received by you, in each case as set forth on
the cover of the Prospectus, or, if Rule 434 is used, the corresponding location
on the Term Sheet bear to the aggregate initial public offering price of such
Underwritten Securities as set forth on such cover.
The relative fault of the Company, on the one hand, and you on the other
hand, shall be determined by reference to, among other things, whether any such
untrue statement of a material fact or omission or alleged omission to state a
material fact relates to information and opportunity to correct or prevent such
statement or omission.
The Company and you agree that it would not be just and equitable if
contribution pursuant to this Section 7 were determined by pro rata allocation
or by any other method of allocation which does not take account of the
equitable considerations referred to above in this Section 7. The aggregate
amount of losses, liabilities, claims, damages and expenses incurred by an
indemnified party and referred to above in this Section 7 shall be deemed to
include any legal or other expenses reasonably incurred by such indemnified
party in investigating, preparing or defending against any litigation, or any
investigation or proceeding by any governmental agency or body, commenced or
threatened, or any claim whatsoever based upon any such untrue or alleged untrue
statement or omission or alleged omission.
Notwithstanding the provisions of this Section 7, you shall not be
required to contribute any amount in excess of the amount by which the total
price at which the Underwritten Securities underwritten by you and distributed
to the public were offered to the public exceeds the amount of any damages which
you otherwise have been required to pay by reason of any such untrue or alleged
untrue statement or omission or alleged omission.
37
<PAGE> 38
No person guilty of fraudulent misrepresentation (within the meaning of
Section 11(f) of the 1933 Act) shall be entitled to contribution from any person
who was not guilty of such fraudulent misrepresentation.
For purposes of this Section 7, each person, if any, who controls you
within the meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act
shall have the same rights to contribution as you, and each director of the
Company, each officer of the Company who signed the Registration Statement, and
each person, if any, who controls the Company within the meaning of Section 15
of the 1933 Act or Section 20 of the 1934 Act shall have the same rights to
contribution as the Company.
SECTION 8. REPRESENTATIONS, WARRANTIES AND AGREEMENTS TO SURVIVE DELIVERY.
All representations, warranties and agreements contained in this
Agreement, or contained in certificates of officers of the Company or CGP, Inc.
on behalf of the Operating Partnership submitted pursuant hereto, shall remain
operative and in full force and effect, regardless of any investigation made by
you or on your behalf or by any controlling person, or by or on behalf of the
Company or the Operating Partnership or any controlling persons, and shall
survive delivery of the Underwritten Securities to you.
SECTION 9. TERMINATION OF AGREEMENT.
(a) This Agreement may be terminated for any reason at any time by the
Company or by you upon the giving of 30 days' written notice of such termination
to the other party hereto, provided that the continued effectiveness of this
Agreement shall not in any way limit or prohibit the Company's right to offer
any or all of the Securities through any other underwriter or pursuant to any
other selling arrangement.
(b) You may also terminate this Agreement, by notice to the Company, at
any time at or prior to Closing Time, (i) if there has been, since the date of
this Agreement or since the date as of which information is given in the
Prospectus, any material adverse change in the condition, financial or
otherwise, or in the earnings, assets, business affairs or business prospects of
the Company, the Operating Partnership, the Subsidiaries and the Residential
Development Corporations considered as one enterprise, whether or not arising in
the ordinary course of business, (ii) if there has occurred any material adverse
change in the financial markets in the United States or any outbreak of
hostilities or other calamity or crisis or escalation of any existing
hostilities, or any change
38
<PAGE> 39
or development involving a prospective change in national or international
political, financial or economic conditions, in each case the effect of which is
such as to make it, in your judgment, impracticable to market the Underwritten
Securities or enforce contracts for the sale of the Underwritten Securities,
(iii) if trading in any of the securities of the Company has been suspended or
limited by the Commission or on any exchange or any over-the-counter market, or
if trading generally on either the New York Stock Exchange or the American Stock
Exchange or in the NASDAQ Stock Market's National Market has been suspended or
limited, or minimum or maximum prices for trading have been fixed, or maximum
ranges for prices for securities have been required, by either of said exchanges
or by order of the Commission or any other governmental authority, or if a
banking moratorium has been declared by federal or New York authorities, (iv) if
the rating assigned by any nationally recognized statistical rating organization
to any Preferred Shares of the Company or any indebtedness of the Company or the
Operating Partnership as of this Agreement shall have been lowered since such
date or if any such rating organization shall have publicly announced that it
has placed any Preferred Shares of the Company or any indebtedness of the
Company or the Operating Partnership on what is commonly termed a "watch list"
for possible downgrading, (v) a banking moratorium has been declared by either
Federal or New York authorities, or (vi) pursuant to Section 10(b) below. As
used in this Section 9(b), the term "Prospectus" means the Prospectus in the
form first used to confirm sales of the Underwritten Securities.
(c) In the event of any such termination, (x) the covenants set forth in
Section 3 hereof with respect to any offering of Underwritten Securities shall
remain in effect so long as you own any such Underwritten Securities purchased
from the Company pursuant to this Agreement and (y) the covenant set forth in
Section 3(h) hereof, the provisions of Section 4 hereof, the indemnity and
contribution agreements set forth in Sections 6 and 7 hereof, and the provisions
of Sections 8 and 12 hereof shall remain in effect.
SECTION 10. NOTICES.
All notices and other communications hereunder shall be in writing and
shall be deemed to have been duly given if mailed or transmitted by any standard
form of telecommunication. Notice to you shall be directed to Mark R. Patterson,
Managing Director, Smith Barney Inc., 388 Greenwich Street, New York, New York
10013; notices to either the Company or the Operating Partnership shall be
directed to each of them, c/o the Operating Partnership at 777 Main Street,
Suite 2100, Fort Worth, Texas, 76102, attention of Gerald W. Haddock, Chief
Executive Officer of Crescent and CGP, Inc.
39
<PAGE> 40
SECTION 11. PARTIES.
This Agreement shall inure to the benefit of and be binding upon the
parties hereto and thereto and their respective successors. Nothing expressed or
mentioned in this Agreement is intended or shall be construed to give any
person, firm or corporation, other than those referred to in Sections 6 and 7
hereof and their successors, heirs and legal representatives, any legal or
equitable right, remedy or claim under or in respect of this Agreement or any
provision herein or therein contained. This Agreement and all conditions and
provisions hereof and thereof are intended to be for the sole and exclusive
benefit of the parties hereto and thereto and their respective successors and
said controlling persons and officers, directors and trust managers and their
heirs and legal representatives, and for the benefit of no other person, firm or
corporation. No purchaser of Underwritten Securities from you shall be deemed to
be a successor merely by reason of such purchase.
SECTION 12. GOVERNING LAW AND TIME.
This Agreement shall be governed by and construed in accordance with the
laws of the State of New York applicable to agreements made and to be performed
in said State. Specified times of day refer to New York City time.
40
<PAGE> 41
If the foregoing is in accordance with your understanding of our
agreement please sign and return to the Company a counterpart hereof, whereupon
this instrument, along with all counterparts, will become a binding agreement
among the Underwriter, the Company and the Operating Partnership in accordance
with its terms.
Very truly yours,
CRESCENT REAL ESTATE EQUITIES COMPANY
By: /s/
---------------------------------------
CRESCENT REAL ESTATE EQUITIES
LIMITED PARTNERSHIP
By: Crescent Real Estate Equities, Ltd.
General Partner
By: /s/
----------------------------------
Name:
Title:
CONFIRMED AND ACCEPTED,
as of the date first above written:
SMITH BARNEY INC.
By: /s/
-------------------------------
Name:
Title:
41
<PAGE> 42
SCHEDULE A
The Underwritten Securities shall have the following
terms:
Title of Securities: 6.75% Series A Convertible Cumulative Preferred Shares
Number of Shares: 8,000,000
Dividend Rate: 6.75 %, Payable: quarterly, in arrears on or about the 15th day
of February, May, August and November of each year, beginning May 15, 1998.
Stated Value: $25.00
Liquidation Preference: $25.00
Public offering price per share: $25.00, plus accumulated distributions, if any,
from February 18, 1998.
Purchase price per share: $24.00, plus accumulated distributions, if any, from
February 18, 1998.
Conversion provisions: Convertible at any time, unless previously redeemed into
common shares of beneficial interest of the Company, par value $.01 per share
(the "Common Shares"), at a conversion price of $40.86, subject to adjustment in
certain circumstances, as described in the Prospectus Supplement.
Redemption provisions: On and after February 18, 2003, the Underwritten
Securities are redeemable at the option of the Company, in whole or in part, at
a redemption price of $25.00, plus distributions accrued and unpaid to the
redemption date.
Sinking fund requirements: None
Number of Option Shares, if any, that may be purchased: 1,200,000
Delayed Delivery Contracts: not authorized
Additional co-managers, if any: N/A
Other terms: Voting Rights: If distributions on the Underwritten Securities are
in arrears for six or more quarterly periods, holders voting separately as a
class with all other series of preferred shares upon which like voting rights
have been conferred and are exercisable, will be entitled to vote for the
election of two additional Trust Managers, to serve on the Board of Trust
Managers until all distribution arrearages are eliminated.
Closing date and location: February 19, 1997 at the offices of Hogan & Hartson
L.L.P., 555 13th Street, N.W., Washington, D.C. 20004-1109.
<PAGE> 1
EXHIBIT 4
[FRONT]
NUMBER SHARES
FORMED UNDER THE LAWS OF THIS CERTIFICATE IS TRANSFERABLE
THE STATE OF TEXAS IN NEW YORK, NEW YORK OR
BOSTON, MASS.
CUSIP (PENDING)
SEE REVERSE FOR CERTAIN DEFINITIONS
CRESCENT
REAL ESTATE EQUITIES COMPANY
A TEXAS REAL ESTATE INVESTMENT TRUST
6 3/4% SERIES A CONVERTIBLE
CUMULATIVE PREFERRED SHARES OF
BENEFICIAL INTEREST
PAR VALUE $.01
- --------------------------------------------------------------------------------
THIS CERTIFIES THAT
IS THE OWNER OF
- --------------------------------------------------------------------------------
FULLY PAID AND NONASSESSABLE 6-3/4% SERIES A CONVERTIBLE CUMULATIVE
PREFERRED SHARES OF BENEFICIAL INTEREST OF
Crescent Real Estate Equities Company (the "Company"), transferable to the
Company by the holder hereof in person, or by duly authorized attorney upon
surrender of this Certificate properly endorsed. This Certificate is not valid
unless countersigned by the Transfer Agent and registered by the Registrar.
Witness the facsimile seal of the Company and the facsimile signatures of its
duly authorized representatives.
Dated:
Countersigned and Registered
BANKBOSTON, N.A.
[SIG] [SIG] By Transfer Agent
Secretary President and Registrar
Authorized Signature
THERE ARE RESTRICTIONS ON THE TRANSFER OF THE SHARES EVIDENCED BY THIS
CERTIFICATE AS MORE FULLY SET FORTH ON THE REVERSE SIDE HEREOF.
<PAGE> 2
[REVERSE]
[CRESCENT REAL ESTATE EQUITIES COMPANY LOGO]
A FULL STATEMENT OF ALL OF THE DESIGNATIONS, PREFERENCES, LIMITATIONS, AND
RELATIVE RIGHTS OF THE SHARES OF EACH CLASS OR SERIES OF THE COMPANY'S SHARES
OF BENEFICIAL INTEREST, TO THE EXTENT THEY HAVE BEEN FIXED AND DETERMINED, AND
THE AUTHORITY OF THE TRUST MANAGERS TO FIX AND DETERMINE THE DESIGNATIONS,
PREFERENCES, LIMITATIONS, AND RELATIVE RIGHTS OF SUBSEQUENT SERIES IS SET FORTH
IN THE COMPANY'S DECLARATION OF TRUST AND THE STATEMENT OF DESIGNATION ON FILE
WITH THE COUNTY CLERK OF TARRANT COUNTY, TEXAS. THE COMPANY, ON WRITTEN REQUEST
TO THE SECRETARY OF THE COMPANY AT ITS PRINCIPAL PLACE OF BUSINESS OR
REGISTERED OFFICE, WILL FURNISH A COPY THEREOF TO THE RECORD HOLDER OF THIS
CERTIFICATE WITHOUT CHARGE.
THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO RESTRICTIONS ON
TRANSFER AND OWNERSHIP FOR THE PURPOSE OF THE MAINTENANCE OF THE COMPANY'S
STATUS AS A REAL ESTATE INVESTMENT TRUST (A "REIT") UNDER SECTIONS 856 THROUGH
860 OF THE INTERNAL REVENUE CODE OF 1986, AS AMENDED (THE "CODE"). EXCEPT AS
OTHERWISE PROVIDED PURSUANT TO THE RESTATED DECLARATION OF TRUST, NO PERSON MAY
(i) BENEFICIALLY OR CONSTRUCTIVELY OWN COMMON SHARES OF BENEFICIAL INTEREST OF
THE COMPANY IN EXCESS OF 8.0 PERCENT (OR SUCH GREATER PERCENT AS MAY BE
DETERMINED BY THE BOARD OF TRUST MANAGERS OF THE COMPANY) OF THE OUTSTANDING
COMMON SHARES OF BENEFICIAL INTEREST (EXCEPT, TO THE EXTENT APPLICABLE, IN SUCH
CIRCUMSTANCES AS THE EXISTING HOLDER LIMIT SHALL APPLY); (ii) BENEFICIALLY OR
CONSTRUCTIVELY OWN PREFERRED SHARES OF BENEFICIAL INTEREST OF THE COMPANY OF ANY
SERIES IN EXCESS OF 9.9 PERCENT OF THE OUTSTANDING PREFERRED SHARES OF
BENEFICIAL INTEREST OF SUCH SERIES; OR (iii) BENEFICIALLY OR CONSTRUCTIVELY OWN
COMMON SHARES OF BENEFICIAL INTEREST OR PREFERRED SHARES OF BENEFICIAL INTEREST
(OF ANY CLASS OR SERIES) WHICH WOULD RESULT IN THE COMPANY BEING "CLOSELY HELD"
UNDER SECTION 856(b) OF THE CODE OR WHICH OTHERWISE COULD CAUSE THE COMPANY TO
FAIL TO QUALIFY AS A REIT. ANY PERSON WHO HAS BENEFICIAL OR CONSTRUCTIVE
OWNERSHIP OR WHO ACQUIRES OR ATTEMPTS TO ACQUIRE BENEFICIAL OR CONSTRUCTIVE
OWNERSHIP OF COMMON SHARES OF BENEFICIAL INTEREST AND/OR PREFERRED SHARES OF
BENEFICIAL INTEREST IN EXCESS OF THE ABOVE LIMITATIONS AND ANY PERSON WHO
BENEFICIALLY OR CONSTRUCTIVELY OWNS EXCESS SHARES OF BENEFICIAL INTEREST AS A
TRANSFEREE OF COMMON OR PREFERRED SHARES OF BENEFICIAL INTEREST RESULTING IN AN
EXCHANGE FOR EXCESS SHARES OF BENEFICIAL INTEREST (AS DESCRIBED BELOW)
IMMEDIATELY MUST NOTIFY THE COMPANY IN WRITING OR IN THE EVENT OF A PROPOSED OR
ATTEMPTED TRANSFER OR ACQUISITION OR PURPORTED CHANGE IN BENEFICIAL OR
CONSTRUCTIVE OWNERSHIP, MUST GIVE WRITTEN NOTICE TO THE COMPANY AT LEAST FIFTEEN
(15) DAYS PRIOR TO THE PROPOSED OR ATTEMPTED TRANSFER, TRANSACTION OR OTHER
EVENT. ANY TRANSFER OR ACQUISITION OF COMMON SHARES OF BENEFICIAL INTEREST
AND/OR PREFERRED SHARES OF BENEFICIAL INTEREST OR OTHER EVENT WHICH RESULTS IN
VIOLATION OF THE OWNERSHIP OR TRANSFER LIMITATIONS SET FORTH IN THE COMPANY'S
RESTATED DECLARATION OF TRUST SHALL BE VOID AB INITIO AND
<PAGE> 3
THE PURPORTED BENEFICIAL AND RECORD TRANSFEREE SHALL NOT HAVE OR ACQUIRE ANY
RIGHTS IN SUCH COMMON SHARES OF BENEFICIAL INTEREST AND/OR PREFERRED SHARES OF
BENEFICIAL INTEREST. IF THE TRANSFER AND OWNERSHIP LIMITATIONS REFERRED TO
HEREIN ARE VIOLATED, THE COMMON OR PREFERRED SHARES OF BENEFICIAL INTEREST
REPRESENTED HEREBY AUTOMATICALLY WILL BE EXCHANGED FOR EXCESS SHARES OF
BENEFICIAL INTEREST TO THE EXTENT OF VIOLATION OF SUCH LIMITATIONS, AND SUCH
EXCESS SHARES OF BENEFICIAL INTEREST WILL BE HELD IN TRUST BY THE COMPANY, ALL
AS PROVIDED BY THE RESTATED DECLARATION OF TRUST OF THE COMPANY. ALL DEFINED
TERMS USED IN THIS LEGEND HAVE THE MEANINGS IDENTIFIED IN THE COMPANY'S RESTATED
DECLARATION OF TRUST, AS THE SAME MAY BE AMENDED FROM TIME TO TIME, AND THE
STATEMENT OF DESIGNATION, COPIES OF WHICH, INCLUDING THE RESTRICTIONS ON
TRANSFER, WILL BE SENT WITHOUT CHARGE TO EACH STOCKHOLDER WHO SO REQUESTS.
The following abbreviations, when used in the inscription on the face
of this certificate, shall be construed as though they were written out in full
according to applicable laws or regulations:
TEN COM - as tenants in common
TEN ENT - as tenants by the entireties
JT TEN - as joint tenants with right of
survivorship and not as tenants in
common
UNIF GIFT MIN ACT - _____ Custodian ________
(Cust) (Minor)
under Uniform Gifts to Minors
Act ___________
(State)
Additional abbreviations may also be used though not in the above list.
For value received, ___________________ hereby sell, assign and transfer
unto
PLEASE INSERT SOCIAL SECURITY NUMBER OR THE
IDENTIFYING NUMBER OF ASSIGNEE
- --------------------------------------------------------------------------------
- -----------------------------------------------------------------------Attorney
to transfer the said shares on the books of the within-named Company with full
power of substitution in the premises.
Dated, X
---------------------------- ----------------------------------
NOTICE: (SIGNATURE)
THE SIGNATURE(S) TO THIS
ASSIGNMENT MUST CORRESPOND
WITH THE NAME(S) AS WRITTEN X
UPON THE FACE OF THE ----------------------------------
CERTIFICATE IN EVERY (SIGNATURE)
PARTICULAR WITHOUT ALTERATION
OR ENLARGEMENT OR ANY CHANGE
WHATEVER.
<PAGE> 4
- --------------------------------------------------------------------------------
THE SIGNATURE(S) SHOULD BE GUARANTEED BY AN "ELIGIBLE GUARANTOR
INSTITUTION" AS DEFINED IN RULE 17Ad-15 UNDER THE SECURITIES EXCHANGE ACT OF
1934, AS AMENDED.
- --------------------------------------------------------------------------------
SIGNATURE(S) GUARANTEED BY:
- --------------------------------------------------------------------------------
<PAGE> 1
EXHIBIT 4.06
STATEMENT OF DESIGNATION
OF
6-3/4% SERIES A CONVERTIBLE CUMULATIVE PREFERRED SHARES
OF
CRESCENT REAL ESTATE EQUITIES COMPANY
The undersigned, the President and Chief Executive Officer of Crescent
Real Estate Equities Company, a real estate investment trust organized and
existing under the Texas Real Estate Investment Trust Act, as amended (the
"Company"), certifies that pursuant to the authority granted to and vested in
the Board of Trust Managers of the Company by the provisions of the Restated
Declaration of Trust of the Company, the Board of Trust Managers, acting
through an authorized committee thereof, has adopted the following resolution
designating a new series of preferred shares of beneficial interest of the
Company.
RESOLVED, that pursuant to the authority expressly granted to and vested
in the Board of Trust Managers of the Company by the provisions of the Restated
Declaration of Trust of the Company, the Board of Trust Managers, acting
through an authorized committee thereof, hereby designates 9,200,000 6- 3/4%
Series A Convertible Cumulative Preferred Shares of beneficial interest, $.01
par value per share (Liquidation Preference $25.00 Per Share) (the "Series A
Preferred Shares"), and authorizes the issuance thereof, and hereby fixes the
designation and number thereof and the voting powers, preferences and relative,
participating, optional and other special rights of such shares, and the
qualifications, limitations or restrictions thereto as follows:
A. Certain Definitions.
Unless the context otherwise requires, the terms defined in this
Paragraph A shall have, for all purposes of this Statement of Designation, the
meanings herein specified (with terms defined in the singular having comparable
meanings when used in the plural).
"Board of Trust Managers" shall mean the Board of Trust Managers
of the Company or any committee authorized by such Board of Trust Managers to
perform any of its responsibilities with respect to the Series A Preferred
Shares.
"Business Day" shall mean any day, other than a Saturday or
Sunday, that is neither a legal holiday nor a day on which banking institutions
in New York City, New York or Dallas, Texas are authorized or required by law,
regulation or executive order to close.
"Code" shall mean the Internal Revenue Code of 1986, as amended,
from time to time.
"Common Shares" shall mean the common shares of beneficial
interest, $.01 par value per share, of the Company.
<PAGE> 2
"Constituent Person" shall have the meaning set forth in
subsection (e) of subparagraph (7) of paragraph B.
"Conversion Price" shall mean the conversion price per Common
Share for which the Series A Preferred Shares are convertible, as such
Conversion Price may be adjusted pursuant to subsection (d) of subparagraph (7)
hereof. The initial conversion price per Common Share shall be $40.86
(equivalent to a conversion rate of .6119 Common Shares for each Series A
Preferred Share).
"Current Market Price" of publicly traded common shares or any
other class of shares of beneficial interest or other security of the Company
or any other issuer for any day shall mean the last reported sales price,
regular way, on such day or, if no sale takes place on such day, the average of
the reported closing bid and asked prices on such day, regular way, in either
case as reported on the New York Stock Exchange ("NYSE") or, if such security
is not listed or admitted for trading on the NYSE, on the principal national
securities exchange on which such security is listed or admitted for trading
or, if not listed or admitted for trading on any national securities exchange,
on the Nasdaq National Market or, if such security is not quoted on such Nasdaq
National Market, the average of the closing bid and asked prices on such day in
the over-the-counter market as reported by Nasdaq or, if bid and asked prices
for such security on such day shall not have been reported through Nasdaq, the
average of the bid and asked prices on such day as furnished by any NYSE member
firm regularly making a market in such security and selected for such purpose
by the Chief Executive Officer of the Company or the Board of Trust Managers.
"Declaration of Trust" shall mean the Company's Restated
Declaration of Trust, as the same may be amended from time to time.
"Distribution Payment Date" shall have the meaning set forth in
subparagraph (3) of paragraph B.
"Distribution Period" shall have the meaning set forth in
subparagraph (3) of paragraph B.
"Fair Market Value" shall mean the average of the daily Current
Market Prices of a Common Share during the five (5) consecutive Trading Days
selected by the Company commencing not more than 20 Trading Days before, and
ending not later than, the earlier of the day in question and the day before
the "ex date" with respect to the issuance or distribution requiring such
computation. The term "ex date" when used with respect to any issuance or
distribution, means the first day on which the Common Shares trade regular way,
without the right to receive such issuance or distribution, on the exchange or
in the market, as the case may be, used to determine that day's Current Market
Price.
"Issue Date" shall mean the first date on which Series A
Preferred Shares are issued and sold.
-2-
<PAGE> 3
"Junior Shares" shall have the meaning set forth in subparagraph
(2) of paragraph B.
"Non-Electing Share" shall have the meaning set forth in
subsection (e) of subparagraph (7) of paragraph B.
"Parity Shares" shall have the meaning set forth in subparagraph
(2) of paragraph B.
"Person" shall mean an individual, corporation, partnership,
estate, trust (including a trust qualified under Section 401(a) or 501(c)(17)
of the Code), a portion of a trust permanently set aside for or to be used
exclusively for the purposes described in Section 642(c) of the Code,
association, private foundation within the meaning of Section 509(a) of the
Code, joint stock company or other entity, and also includes a group as that
term is used for purposes of Section 13(d)(3) of the Securities Exchange Act of
1934, as amended; but does not include an underwriter which participates in a
public offering of the Series A Preferred Shares provided that the ownership of
Series A Preferred Shares by such Underwriter would not result in the Company
being "closely held" within the meaning of Section 856(h) of the Code, or would
otherwise result in the Company failing to qualify as a REIT.
"Preferred Shares" shall mean preferred shares of beneficial
interest, $.01 par value per share, of the Company.
"Record Date" shall have the meaning set forth in subparagraph
(3) of paragraph B.
"REIT" shall mean a real estate investment trust under Section
856 of the Code.
"Securities" shall have the meaning set forth in subsection
(d)(iii) of subparagraph (7) of paragraph B.
"Series A Preferred Shares" shall mean the Company's 6- 3/4%
Series A Convertible Cumulative Preferred Shares of beneficial interest, $.01
par value per share, liquidation value $25.00 per share.
"Series A Preferred Shares Redemption Date" shall have the
meaning set forth in subsection (d) of subparagraph (5) of paragraph B hereof.
"set apart for payment" shall be deemed to include, without any
action other than the following, the recording by the Company in its accounting
ledgers of any accounting or bookkeeping entry which indicates, pursuant to a
declaration of distributions by the Board of Trust Managers, the allocation of
funds to be so paid on any series or class of shares of beneficial interest;
provided, however, that if any funds for any class or series of Junior Shares
or any class or series of shares of beneficial interest ranking on a parity
with the Series A Preferred Shares as to the payment of distributions are
placed in a separate account of the Company
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<PAGE> 4
or delivered to a disbursing, paying or other similar agent, then "set apart
for payment" with respect to the Series A Preferred Shares shall mean placing
such funds in a separate account or delivering such funds to a disbursing,
paying or other similar agent.
"Trading Day" shall mean any day on which the securities in
question are traded on the NYSE, or if such securities are not listed or
admitted for trading on the NYSE, on the principal national securities exchange
on which such securities are listed or admitted, or if not listed or admitted
for trading on any national securities exchange, on the Nasdaq National Market,
or if such securities are not quoted on such Nasdaq National Market, in the
applicable securities market in which the securities are traded.
"Transaction" shall have the meaning set forth in subsection (e)
of subparagraph (7) of paragraph B hereof.
"Transfer Agent" means BankBoston, N.A. or such other agent or
agents of the Company as may be designated by the Board of Trust Managers or
their designee as the transfer agent for the Series A Preferred Shares.
B. Series A Preferred Shares.
(1) Number. The maximum number of Series A Preferred Shares
shall be 9,200,000.
(2) Relative Seniority. In respect of rights to receive
distributions and to participate in distributions or payments in the event of
any liquidation, dissolution or winding up of the Company, the Series A
Preferred Shares shall rank pari passu with any other preferred shares of
beneficial interest of the Company (the "Parity Shares"), and will rank senior
to the Common Shares and any other class or series of shares of beneficial
interest of the Company ranking, as to distributions and upon liquidation,
junior (collectively, the "Junior Shares") to the Parity Shares.
(3) Distributions. The holders of the then outstanding Series
A Preferred Shares shall be entitled to receive, when and as declared by the
Board of Trust Managers out of any funds legally available therefor, cumulative
cash distributions at the rate of $1.6875 per share per year, payable in equal
amounts of $.421875 per share quarterly in cash on the 15th day, or if not a
Business Day, the next succeeding Business Day, of February, May, August and
November in each year, beginning May 15, 1998 (each such day being hereinafter
called a "Distribution Payment Date" and each period ending on a Distribution
Payment Date being hereinafter called a "Distribution Period"), with respect to
each Distribution Period, to shareholders of record at the close of business on
such date as shall be fixed by the Board of Trust Managers at the time of
declaration of the distribution (the "Record Date"), which shall not be less
than 10 nor more than 30 days preceding the Distribution Payment Date. The
amount of any distribution payable for the initial Distribution Period and for
any other Distribution Period shorter than a full Distribution Period shall be
prorated and computed on the basis of a
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<PAGE> 5
360-day year of twelve 30-day months. Distributions on each Series A Preferred
Share shall accrue and be cumulative from and including the date of original
issue thereof, whether or not (i) distributions on such shares are earned or
declared or (ii) on any Distribution Payment Date there shall be funds legally
available for the payment of distributions. Distributions paid on the Series A
Preferred Shares in an amount less than the total amount of such distributions
at the time accrued and payable on such shares shall be allocated pro rata on a
per share basis among all such shares at the time outstanding. Distributions
on account of arrears for any past distribution periods may be declared and
paid at such time, if any, as may be fixed by the Board of Trust Managers, and
shall first be credited against the earliest accrued but unpaid distributions
due and payable with respect to such Series A Preferred Shares.
The amount of any distributions accrued on any Series A Preferred
Shares at any Distribution Payment Date shall be the amount of any unpaid
distributions accumulated thereon through and during such Distribution Period,
to and including such Distribution Payment Date, whether or not earned or
declared, and the amount of distributions accrued on any Series A Preferred
Shares at any date other than a Distribution Payment Date shall be equal to the
sum of the amount of any unpaid distributions accumulated thereon, to and
including the last preceding Distribution Payment Date, whether or not earned
or declared, plus an amount calculated on the basis of the annual distribution
rate of $1.6875 for the period after such last preceding Distribution Payment
Date to and including the date as of which the calculation is made, based on a
360-day year of twelve 30-day months.
If any Series A Preferred Shares are outstanding, no full
distributions shall be declared or paid or set apart for payment on any other
series of Parity Shares or any other class or series of Junior Shares for any
period unless full cumulative distributions have been declared and paid or
declared and a sum sufficient for the payment thereof has been set apart for
such payment on the Series A Preferred Shares for all past distribution periods
and the then current distribution period. If distributions are not paid in
full, or not declared in full and a sum sufficient for such full payment is not
set apart for the payment thereof, upon the Series A Preferred Shares and any
class or series of Parity Shares, all distributions declared upon Series A
Preferred Shares and upon any other class or series of Parity Shares shall be
paid or declared pro rata so that in all cases the amount of distributions paid
or declared per share on the Series A Preferred Shares and Parity Shares shall
bear to each other the same ratio that accumulated distributions per share,
including distributions accrued or in arrears, if any, on the Series A
Preferred Shares and Parity Shares bear to each other. Except as provided in
the preceding sentence, unless full cumulative distributions on the Series A
Preferred Shares have been paid or declared and a sum sufficient for such full
payment set apart for payment for all past Distribution Periods and the then
current Distribution Period, no distributions (other than distributions in
shares of Common Shares or in any other Junior Shares) shall be declared or
paid or set apart for payment or other distribution upon the Company's Common
Shares, or, except as provided above, on any other Junior Shares or Parity
Shares, nor shall any Common Shares or any other Junior Shares or Parity Shares
be redeemed, purchased or otherwise acquired for any consideration (or any
payment made to or available for a sinking fund for the redemption of any such
shares) by the Company or any subsidiary of the
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<PAGE> 6
Company (except by conversion into or exchange for Junior Shares). Holders of
the Series A Preferred Shares shall not be entitled to any distributions,
whether payable in cash, property or shares of beneficial interest, in excess
of full accrued and cumulative distributions as herein provided. No interest
or sum of money in lieu of interest shall be payable in respect of any
distribution payment or payments on the Series A Preferred Shares that may be
in arrears.
Except as provided in this Statement of Designation, the Series A
Preferred Shares shall not be entitled to participate in the earnings or assets
of the Company.
(4) Liquidation Preference.
(a) Upon the voluntary or involuntary dissolution,
liquidation or winding up of the Company, the
holders of the Series A Preferred Shares then
outstanding shall be entitled to receive and to be
paid out of the assets of the Company legally
available for distribution to its shareholders,
before any payment or distribution shall be made on
any Junior Shares, the amount of $25.00 per Series
A Preferred Share, plus an amount equal to
distributions accrued and unpaid thereon to the
date fixed for such dissolution, liquidation or
winding up of the Company.
(b) After the payment to the holders of the Series A
Preferred Shares of the full preferential amounts
provided for in this subparagraph (4), the holders
of the Series A Preferred Shares as such shall have
no right or claim to any of the remaining assets of
the Company.
(c) If, upon any voluntary or involuntary dissolution,
liquidation, or winding up of the Company, the
amounts payable with respect to the preference
value of the Series A Preferred Shares and any
Parity Shares are not paid in full, the holders of
the Series A Preferred Shares and of such Parity
Shares will share ratably in any such distribution
of assets of the Company in proportion to the full
respective preferential amounts provided for in
this subparagraph (4) to which they are entitled.
(d) Neither the sale of all or substantially all the
property or business of the Company, nor the merger
or consolidation of the Company into or with any
other entity or the merger or consolidation of any
other entity into or with the Company, shall be
deemed to be a dissolution, liquidation or winding
up, voluntary or involuntary, of the Company for
the purposes of this subparagraph (4).
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<PAGE> 7
(5) Redemption at the Option of the Company.
(a) Subject to subsections (b) and (h) of this
subparagraph (5), the Series A Preferred Shares
shall not be redeemable by the Company prior to
February 18, 2003. On and after February 18, 2003,
the Company, at its option, may redeem the Series A
Preferred Shares, in whole or from time to time in
part, as set forth herein, at a redemption price of
$25.00 per Series A Preferred Share, subject to the
provisions below.
(b) Prior to February 18, 2003, the Series A Preferred
Shares may be redeemed at the option of the
Company, in whole or from time to time in part, at
a redemption price of $25.00 per Series A Preferred
Share, if the Board of Trust Managers determines
that such a redemption is necessary or advisable to
preserve the status of the Company as a REIT for
federal income tax purposes, subject to the
provisions below.
(c) If fewer than all of the outstanding Series A
Preferred Shares are to be redeemed, the shares to
be redeemed will be determined pro rata or by lot
as may be determined by the Board of Trust Managers
or in such other manner as prescribed by the
Company's Board of Trust Managers in its sole
discretion to be equitable, provided that such
method satisfies any applicable requirements of any
securities exchange on which the Series A Preferred
Shares are listed. In the event that such
redemption is to be by lot, if as a result of such
redemption any holder of Series A Preferred Shares
would own, or be deemed to own by virtue of certain
attribution provisions of the Code, as specified in
the Declaration of Trust, in excess of 9.9% of the
Series A Preferred Shares issued and outstanding
because such holder's Series A Preferred Shares
were not redeemed, or were only redeemed in part,
then the Company will redeem the requisite number
of Series A Preferred Shares of such shareholder
such that he will not own, or be deemed to own by
virtue of certain attribution provisions of the
Code, as specified in the Declaration of Trust in
excess of 9.9% of Series A Preferred Shares issued
and outstanding subsequent to such redemption. A
new certificate shall be issued representing any
unredeemed Series A Preferred Shares without cost
to the holder thereof.
(d) Notice of redemption will be mailed, not less than
30 nor more than 60 days prior to the date fixed
for redemption, to each holder of record of Series
A Preferred Shares to be redeemed, notifying
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<PAGE> 8
such holder of the Company's election to redeem
such shares, stating the date fixed for redemption
thereof (the "Series A Preferred Shares Redemption
Date"), the redemption price, the number of shares
to be redeemed (and, if fewer than all the Series A
Preferred Shares are to be redeemed, the number of
shares to be redeemed from such holder), the
place(s) where the Series A Preferred Share
certificates are to be surrendered for payment, the
date on which such holder's conversion rights as to
the Series A Preferred Shares shall terminate, and
that distributions on the Series A Preferred Shares
will cease to accrue on the specified redemption
date.
(e) On or after the Series A Preferred Shares
Redemption Date, each holder of Series A Preferred
Shares to be redeemed must present and surrender
his Series A Preferred Share certificates to the
Company at the place designated in such notice and
thereupon the redemption price of such shares will
be paid to or on the order of the Person whose name
appears on such Series A Preferred Share
certificates as the owner thereof and each such
Series A Preferred Share certificate surrendered
will be canceled. From and after the Series A
Preferred Shares Redemption Date (unless the
Company defaults in payment of the redemption
price), all distributions on the Series A Preferred
Shares designated for redemption in such notice
will cease to accrue and all rights of the holders
thereof (including conversion rights), except the
right to receive the redemption price thereof
(including all accrued and unpaid distributions up
to the Series A Preferred Shares Redemption Date),
will cease and terminate and such shares will not
thereafter be transferred (except with the consent
of the Company) on the Company's books, and such
shares shall not be deemed to be outstanding for
any purpose whatsoever. At its election, the
Company, prior to the Series A Preferred Shares
Redemption Date, may irrevocably deposit the
redemption price (including accrued and unpaid
distributions) of the Series A Preferred Shares so
called for redemption in trust for the holders
thereof with a bank or trust company, in which case
such notice to holders of the Series A Preferred
Shares to be redeemed will (i) state the date of
such deposit, (ii) specify the office of such bank
or trust company as the place of payment of the
redemption price and (iii) call upon such holders
to surrender the Series A Preferred Share
certificates representing such shares at such place
on or about the date fixed in such redemption
notice (which may not be later than the Series A
Preferred Shares Redemption Date) against payment
of the redemption price (including all accrued
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<PAGE> 9
and unpaid distributions up to the Series A
Preferred Shares Redemption Date). Any moneys so
deposited which remain unclaimed by the holders of
the Series A Preferred Shares at the end of two
years after the Series A Preferred Shares
Redemption Date will be returned by such bank or
trust company to the Company.
(f) Notwithstanding the foregoing, unless full
cumulative distributions on all outstanding Series
A Preferred Shares for all past Distribution
Periods and the then current Distribution Period
have been paid, or declared and a sum sufficient
for the payment thereof set apart for payment, no
Series A Preferred Shares shall be redeemed unless
(i) all outstanding Series A Preferred Shares are
simultaneously redeemed or (ii) the Board of Trust
Managers determines that such redemption is
necessary or advisable to preserve the status of
the Company as a REIT for federal income tax
purposes; provided, however, that the foregoing
shall not prevent the purchase or acquisition of
Series A Preferred Shares pursuant to a purchase or
exchange offer made on the same terms to holders of
all outstanding Series A Preferred Shares.
(g) The holders of Series A Preferred Shares at the
close of business on a Distribution Record Date
will be entitled to receive the distribution
payable with respect to such Series A Preferred
Shares on the corresponding Distribution Payment
Date notwithstanding the redemption thereof between
such Distribution Record Date and the corresponding
Distribution Payment Date or the Company's default
in the payment of the distribution due. Except as
provided above, the Company will make no payment or
allowance for unpaid distributions, whether or not
in arrears, on Series A Preferred Shares which have
been called for redemption.
(h) If at any time, whether or not prior to February
18, 2003, the Company is subject to the
jurisdiction of an agency or other authority of any
state, county, city or other political subdivision
with respect to any activities of the Company or
any of its subsidiaries related to gaming (a
"Gaming Authority"), and such Gaming Authority
requires a record or beneficial owner to be found
suitable, then notwithstanding any other provision
of this Statement of Designation, the Company shall
have the right, by written notice to such record or
beneficial owner, (i) to require such record or
beneficial owner of Series A Preferred Shares to
apply, at such owner's sole cost and expense as to
the application and related investigation, for a
finding of suitability by such
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<PAGE> 10
Gaming Authority and (ii) as to any record or
beneficial owner that is required to be, but is
not, found suitable by such Gaming Authority, (A)
to require such record or beneficial owner to
dispose of such owner's Series A Preferred Shares
within 30 days or within the time prescribed by
such Gaming Authority, whichever is earlier, and
(B) if such disposition is not made in
accordance with clause (A), to redeem each Series
A Preferred Share of such owner at a redemption
price of $25.00 per Series A Preferred Share, on
the terms set forth above (other than subsection
(f) of this subparagraph (5), which subsection
shall not apply to any such redemption).
(i) The Series A Preferred Shares have no stated
maturity date and will not be subject to any
sinking fund or mandatory redemption.
(6) Shares to be Retired.
All Series A Preferred Shares which shall have been issued and
reacquired in any manner by the Company shall be restored to the status of
authorized but unissued Preferred Shares, without designation as to series.
(7) Conversion.
Holders of Series A Preferred Shares shall have the right to
convert all or a portion of such shares into Common Shares, as follows:
(a) Subject to and upon compliance with the provisions
of this subparagraph (7), a holder of Series A
Preferred Shares shall have the right, at his
option, at any time to convert such shares into the
number of fully paid and nonassessable Common
Shares obtained by dividing the aggregate
liquidation preference of such shares by the
Conversion Price (as in effect at the time and on
the date provided for in the last paragraph of
subsection (b) of this subparagraph (7)) by
surrendering such shares to be converted, such
surrender to be made in the manner provided in
subsection (b) of this subparagraph (7); provided,
however, that the right to convert shares called
for redemption pursuant to subparagraph (5) hereof
shall terminate at the close of business on the
Series A Preferred Shares Redemption Date fixed for
such redemption, unless the Company shall default
in making payment of any amounts payable upon such
redemption under subparagraph (5).
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<PAGE> 11
(b) In order to exercise the conversion right, the
holder of each Series A Preferred Share to be
converted shall surrender the certificate
representing such share, duly endorsed or assigned
to the Company or in blank, at the office of the
Transfer Agent, accompanied by written notice to
the Company that the holder thereof elects to
convert such Series A Preferred Share. Unless the
share issuable on conversion is to be issued in the
same name as the name in which such Series A
Preferred Share is registered, each share
surrendered for conversion shall be accompanied by
instruments of transfer, in form satisfactory to
the Company, duly executed by the holder or such
holder's duly authorized attorney and an amount
sufficient to pay any transfer or similar tax (or
evidence reasonably satisfactory to the Company
demonstrating that such taxes have been paid).
Holders of Series A Preferred Shares at the close
of business on a distribution payment Record Date
shall be entitled to receive the distribution
payable on such shares on the corresponding
Distribution Payment Date notwithstanding the
conversion thereof following such distribution
payment Record Date and prior to such Distribution
Payment Date. However, Series A Preferred Shares
surrendered for conversion during the period
between the close of business on any distribution
payment Record Date and the opening of business on
the corresponding Distribution Payment Date (except
shares converted after the issuance of notice of
redemption with respect to a Series A Preferred
Shares Redemption Date during such period or
coinciding with such Distribution Payment Date,
such Series A Preferred Shares being entitled to
such distribution on the Distribution Payment Date)
must be accompanied by payment of an amount equal
to the distribution payable on such shares on such
Distribution Payment Date. A holder of Series A
Preferred Shares on a distribution payment Record
Date who (or whose transferee) tenders any such
shares for conversion into Common Shares on such
Distribution Payment Date will receive the
distribution payable by the Company on such Series
A Preferred Shares on such date, and the converting
holder need not include payment of the amount of
such distribution upon surrender of Series A
Preferred Shares for conversion. Except as
provided above, the Company shall make no payment
or allowance for unpaid distributions, whether or
not in arrears, on converted shares or for
distributions on the Common Shares issued upon such
conversion.
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<PAGE> 12
As promptly as practicable after the surrender of
certificates for Series A Preferred Shares as
aforesaid, the Company shall issue and shall
deliver at the office of the Transfer Agent to such
holder, or on his written order, a certificate or
certificates for the number of full Common Shares
issuable upon the conversion of such shares in
accordance with the provisions of this subparagraph
(7), and any fractional interest in respect of a
Common Share arising upon such conversion shall be
settled as provided in subsection (c) of this
subparagraph (7).
Each conversion shall be deemed to have been
effected immediately prior to the close of business
on the date on which the certificates for Series A
Preferred Shares shall have been surrendered and
such notice (and if applicable, payment of an
amount equal to the distribution payable on such
shares) received by the Company as aforesaid, and
the Person or Persons in whose name or names any
certificate or certificates for Common Shares shall
be issuable upon such conversion shall be deemed to
have become the holder or holders of record of the
shares represented thereby at such time on such
date, and such conversion shall be at the
Conversion Price in effect at such time and on such
date unless the share transfer books of the Company
shall be closed on that date, in which event such
Person or Persons shall be deemed to have become
such holder or holders of record at the close of
business on the next succeeding day on which such
share transfer books are open, but such conversion
shall be at the Conversion Price in effect on the
date on which such shares have been surrendered and
such notice received by the Company.
(c) No fractional shares of scrip representing
fractions of Common Shares shall be issued upon
conversion of Series A Preferred Shares. Instead
of any fractional interest in a Common Share that
would otherwise be deliverable upon the conversion
of a Series A Preferred Share, the Company shall
pay to the holder of such share an amount in cash
based upon the Current Market Price of Common
Shares on the Trading Day immediately preceding the
date of conversion. If more than one Series A
Preferred Share shall be surrendered for conversion
at one time by the same holder, the number of full
Common Shares issuable upon conversion thereof
shall be computed on the basis of the aggregate
number of Series A Preferred Shares so surrendered.
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<PAGE> 13
(d) The Conversion Price shall be adjusted from time to
time as follows:
(i) If the Company shall after the Issue Date
(A) pay or make a distribution on its Common
Shares in Common Shares, (B) subdivide its
outstanding Common Shares into a greater
number of shares, (C) combine its
outstanding Common Shares into a smaller
number of shares or (D) issue any shares of
beneficial interest by reclassification of
its Common Shares, then in each such case
the Conversion Price in effect at the
opening of business on the day following the
date fixed for the determination of
shareholders entitled to receive such
distribution or at the opening of business
on the day following the day on which such
subdivision, combination or reclassification
becomes effective, as the case may be, shall
be adjusted so that the holder of any Series
A Preferred Shares thereafter surrendered
for conversion shall be entitled to receive
the number of Common Shares that such holder
would have owned or have been entitled to
receive after the happening of any of the
events described above had such shares been
converted immediately prior to the record
date in the case of a distribution or the
effective date in the case of a subdivision,
combination or reclassification. An
adjustment made pursuant to this subsection
(i) shall become effective immediately after
the opening of business on the day next
following the record date (except as
provided in paragraph (h) below) in the case
of a distribution and shall become effective
immediately after the opening of business on
the day next following the effective date in
the case of a subdivision, combination or
reclassification. Such adjustment(s) shall
be made successively whenever any of the
events listed above shall occur.
(ii) If the Company shall issue after the Issue
Date rights, options or warrants to all
holders of Common Shares entitling them (for
a period expiring within 45 days after the
record date mentioned below) to subscribe
for or purchase Common Shares at a price per
share less than the Fair Market Value per
Common Share on the record date for the
determination of shareholders entitled to
receive such rights, options or warrants,
then the Conversion Price in effect at the
opening of business on the day next
following such record date shall be adjusted
to equal the
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<PAGE> 14
price determined by multiplying (I) the
Conversion Price in effect immediately prior
to the opening of business on the day
following the date fixed for such
determination by (II) a fraction, the
numerator of which shall be the sum of (A)
the number of Common Shares outstanding on
the close of business on the date fixed for
such determination and (B) the number of
Common Shares that the aggregate proceeds to
the Company from the exercise of such
rights, options or warrants for Common
Shares would purchase at such Fair Market
Value, and the denominator of which shall be
the sum of (A) the number of Common Shares
outstanding on the close of business on the
date fixed for such determination and (B)
the number of additional Common Shares
offered for subscription or purchase
pursuant to such rights, options or
warrants. Such adjustments shall be made
successively whenever any such rights,
options or warrants are issued, and shall
become effective immediately after the
opening of business on the day next
following such record date (except as
provided in subsection (h) below). In
determining whether any rights, options or
warrants entitle the holders of Common
Shares to subscribe for or purchase Common
Shares at less than the Fair Market Value,
there shall be taken into account any
consideration received by the Company upon
issuance and upon exercise of such rights,
options or warrants, the value of such
consideration, if other than cash, to be
determined by the Chief Executive Officer of
the Company or the Board of Trust Managers.
(iii) If the Company shall distribute to all
holders of its Common Shares any shares of
beneficial interest of the Company (other
than Common Shares) or evidence of its
indebtedness or assets (excluding cash
distributions paid out of the total equity
applicable to Common Shares, including
revaluation equity, less the amount of
stated capital attributable to Common
Shares, determined on the basis of the most
recent annual consolidated cost basis and
current value basis and quarterly
consolidated balance sheets of the Company
and its consolidated subsidiaries available
at the time of the declaration of the
distribution) or rights, options or warrants
to subscribe for or purchase any of its
securities (excluding those rights, options
and warrants issued to all holders of Common
Shares entitling them for a period expiring
within 45 days after the record
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<PAGE> 15
date referred to in subsection (ii) above to
subscribe for or purchase Common Shares,
which rights, options and warrants are
referred to in and treated under subsection
(ii) above) (any of the foregoing being
hereinafter in this subsection (iii) called
the "Securities"), then in each case the
Conversion Price shall be adjusted so that
it shall equal the price determined by
multiplying (I) the Conversion Price in
effect immediately prior to the close of
business on the date fixed for the
determination of shareholders entitled to
receive such distribution by (II) a
fraction, the numerator of which shall be
the Fair Market Value per Common Share on
the record date mentioned below less the
then fair market value (as determined by the
Chief Executive Officer of the Company or
the Board of Trust Managers, whose
determination shall be conclusive) of the
portion of the shares of beneficial interest
or assets or evidences of indebtedness so
distributed or of such rights, options or
warrants applicable to one Common Share, and
the denominator of which shall be the Fair
Market Value per Common Share on the record
date mentioned below. Such adjustment shall
become effective immediately at the opening
of business on the Business Day next
following (except as provided in subsection
(h) below) the record date for the
determination of shareholders entitled to
receive such distribution. For the purposes
of this subsection (iii), the distribution
of a Security, which is distributed not only
to the holders of the Common Shares on the
date fixed for the determination of
shareholders entitled to such distribution
of such Security, but also is distributed
with each Common Share delivered to a Person
converting a Series A Preferred Share after
such determination date, shall not require
an adjustment of the Conversion Price
pursuant to this subsection (iii); provided
that on the date, if any, on which a Person
converting a Series A Preferred Share would
no longer be entitled to receive such
Security with a Common Share (other than as
a result of the termination of all such
Securities), a distribution of such
Securities shall be deemed to have occurred,
and the Conversion Price shall be adjusted
as provided in this subsection (iii) (and
such day shall be deemed to be "the date
fixed for the determination of the
shareholders entitled to receive such
distribution"
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<PAGE> 16
and "the record date" within the meaning of
the two preceding sentences).
(iv) No adjustment in the Conversion Price shall
be required unless such adjustment would
require a cumulative increase or decrease of
at least 1% in such price; provided,
however, that any adjustments that by reason
of this subsection (iv) are not required to
be made shall be carried forward and taken
into account in any subsequent adjustment
until made; and provided, further, that any
adjustment shall be required and made in
accordance with the provisions of this
subparagraph (7) (other than this subsection
(iv)) not later than such time as may be
required in order to preserve the tax-free
nature of a distribution to the holders of
Common Shares. Notwithstanding any other
provisions of this subparagraph (7), the
Company shall not be required to make any
adjustment of the Conversion Price for the
issuance of any Common Shares pursuant to
any plan providing for the reinvestment of
distributions or interest payable on
securities of the Company and the investment
of additional optional amounts in Common
Shares under such plan. All calculations
under this subparagraph (7) shall be made to
the nearest cent (with $.005 being rounded
upward) or to the nearest one-ten-thousandth
of a share (with .0005 of a share being
rounded upward), as the case may be.
Anything in this subsection (d) to the
contrary notwithstanding, the Company shall
be entitled, to the extent permitted by law,
to make such reductions in the Conversion
Price, in addition to those required by this
subsection (d), as it in its sole discretion
shall determine to be advisable in order
that any share distributions, subdivision of
shares, reclassification or combination of
shares, distribution of rights, options or
warrants to purchase shares or securities,
or distribution of other assets (other than
cash distributions) hereafter made by the
Company to its shareholders shall not be
taxable.
(e) If the Company shall be a party to any transaction
(including without limitation a merger,
consolidation, statutory share exchange, self
tender offer for all or substantially all of the
Common Shares, sale of all or substantially all of
the Company's assets or recapitalization of the
Common Shares and excluding any transaction as to
which subsection (d)(i) of this subparagraph (7)
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<PAGE> 17
applied) (each of the foregoing being referred to
herein as a "Transaction"), in each case as a
result of which Common Shares shall be converted
into the right to receive shares, stock, securities
or other property (including cash or any
combination thereof), each Series A Preferred Share
which is not converted into the right to receive
shares, stock, securities or other property in
connection with such Transaction shall thereafter
be convertible into the kind and amount of shares,
stock, securities and other property (including
cash or any combination thereof) receivable upon
the consummation of such Transaction by a holder of
that number of Common Shares into which one Series
A Preferred Share was convertible immediately prior
to such Transaction, assuming such holder of Common
Shares (i) is not a Person with which the Company
consolidated or into which the Company merged or
which merged into the Company or to which such sale
or transfer was made, as the case may be (a
"Constituent Person"), or an affiliate of a
Constituent Person and (ii) failed to exercise his
rights of the election, if any, as to the kind or
amount of shares, stock, securities and other
property (including cash) receivable upon such
Transaction (each a "Non-Electing Share") (provided
that if the kind or amount of shares, stock,
securities and other property (including cash)
receivable upon such Transaction by each Non-
Electing Share is not the same for each Non-
Electing Share, then the kind and amount of shares,
stock, securities and other property (including
cash) receivable upon such Transaction for each
Non-Electing Share shall be deemed to be the kind
and amount so receivable per share by a plurality
of the Non-Electing Shares). The Company shall not
be a party to any Transaction unless the terms of
such Transaction are consistent with the provisions
of this subsection (e), and it shall not consent or
agree to the occurrence of any Transaction until
the Company has entered into an agreement with the
successor or purchasing entity, as the case may be,
for the benefit of the holders of the Series A
Preferred Shares that will require such successor
or purchasing entity, as the case may be, to make
provision in its certificate or articles of
incorporation or other constituent documents to the
end that the provisions of this subsection (e)
shall thereafter correspondingly be made applicable
as nearly as may reasonably be, in relation to any
shares of stock or other securities or property
thereafter deliverable upon conversion of the
Series A Preferred Shares. The provisions of this
subsection (e) shall similarly apply to successive
Transactions.
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<PAGE> 18
(f) If:
(i) the Company shall declare a distribution on
the Common Shares (other than in cash out of
the total equity applicable to Common
Shares, including revaluation equity, less
the amount of stated capital attributable to
Common Shares, determined on the basis of
the most recent annual consolidated cost
basis and current value basis and quarterly
consolidated balance sheets of the Company
and its consolidated subsidiaries available
at the time of the declaration of the
distribution); or
(ii) the Company shall authorize the granting to
all holders of the Common Shares of rights,
options or warrants to subscribe for or
purchase any shares of any class or any
other rights, options or warrants; or
(iii) there shall be any reclassifications of the
Common Shares (other than an event to which
subsection (d)(i) of this subparagraph (7)
applied) or any consolidation or merger to
which the Company is a party and for which
approval of any shareholders of the Company
is required, or a statutory share exchange
involving the conversion or exchange of
Common Shares into securities or other
property, or a self tender offer by the
Company for all or substantially all of its
outstanding Common Shares, or the sale or
transfer of all or substantially all of the
assets of the Company and for which approval
of any stockholder of the Company is
required; or
(iv) there shall occur the voluntary or
involuntary liquidation, dissolution or
winding up of the Company,
then the Company shall cause to be filed with the
Transfer Agent and shall cause to be mailed to the
holders of the Series A Preferred Shares at their
addresses as shown on the share records of the
Company, as promptly as possible, but at least 15
days prior to the applicable date hereinafter
specified, a notice stating (A) the date on which a
record is to be taken for the purpose of such
distribution or grant of rights, options or
warrants, or, if a record is not to be taken, the
date as of which the holders of Common Shares of
record to be entitled to such distribution or grant
of rights, options or warrants are to be
determined, provided, however, that no such
notification need be made in respect
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<PAGE> 19
of a record or determination date for a
distribution or grant of rights unless the
corresponding adjustment in the Conversion Price
would be an increase or decrease of at least 1% or
(B) the date on which such reclassification,
consolidation, merger, statutory share exchange,
self tender offer, sale, transfer, liquidation,
dissolution or winding up is expected to become
effective, and the date as of which it is expected
that holders of Common Shares of record shall be
entitled to exchange their Common Shares for
securities or other property, if any, deliverable
upon such reclassification, consolidation, merger,
statutory share exchange, self tender offer, sale,
transfer, liquidation, dissolution or winding up.
Failure to give or receive such notice or any
defect therein shall not affect the legality or
validity of the proceedings described in this
subparagraph (7).
(g) Whenever the Conversion Price is adjusted as herein
provided, the Company shall promptly file with the
Transfer Agent an officer's certificate setting
forth the Conversion Price after such adjustment
and setting forth a brief statement of the facts
requiring such adjustment, which certificate shall
be conclusive evidence of the correctness of such
adjustment absent manifest error. Promptly after
delivery of such certificate, the Company shall
prepare a notice of such adjustment of the
Conversion Price setting forth the adjusted
Conversion Price and the effective date of such
adjustment and shall mail such notice of such
adjustment of the Conversion Price to the holder of
each Series A Preferred Share at such holder's last
address as shown on the share records of the
Company.
(h) In any case in which subsection (d) of this
subparagraph (7) provides that an adjustment shall
become effective on the date next following the
record date for an event, the Company may defer
until the occurrence of such event (A) issuing to
the holder of any Series A Preferred Shares
converted after such record date and before the
occurrence of such event the additional Common
Shares issuable upon such conversion by reason of
the adjustment required by such event over and
above the Common Shares issuable upon such
conversion before giving effect to such adjustment
and (B) fractionalizing any Series A Preferred
Share and/or paying to such holder any amount of
cash in lieu of any fraction pursuant to subsection
(c) of this subparagraph (7).
(i) There shall be no adjustment of the Conversion
Price in case of the issuance of any shares of
beneficial interest of the Company
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<PAGE> 20
in a reorganization, acquisition or other similar
transaction except as specifically set forth in
this subparagraph (7). If any action or
transaction would require adjustment of the
Conversion Price pursuant to more than one
subsection of this subparagraph (7), only one
adjustment shall be made, and such adjustment shall
be the amount of adjustment that has the highest
absolute value.
(j) If the Company shall take any action affecting the
Common Shares, other than action described in this
subparagraph (7), that in the opinion of the Board
of Trust Managers would materially adversely affect
the conversion rights of the holders of the Series
A Preferred Shares, the Conversion Price for the
Series A Preferred Shares may be adjusted, to the
extent permitted by law, in such manner, if any,
and at such time, as the Board of Trust Managers,
in its sole discretion, may determine to be
equitable in the circumstances.
(k) The Company covenants that it will at all times
reserve and keep available, free from preemptive
rights, out of the aggregate of its authorized but
unissued Common Shares, for the purpose of
effecting conversion of the Series A Preferred
Shares, the full number of Common Shares
deliverable upon the conversion of all outstanding
Series A Preferred Shares not theretofore
converted. For purposes of this subsection (k),
the number of Common Shares that shall be
deliverable upon the conversion of all outstanding
Series A Preferred Shares shall be computed as if
at the time of computation all such outstanding
shares were held by a single holder.
The Company covenants that any Common Shares issued
upon conversion of the Series A Preferred Shares
shall be validly issued, fully paid and
nonassessable. Before taking any action that would
cause an adjustment reducing the Conversion Price
below the then par value of the Common Shares
deliverable upon conversion of the Series A
Preferred Shares, the Company will take any action
that, in the opinion of its counsel, may be
necessary in order that the Company may validly and
legally issue fully paid and nonassessable Common
Shares at such adjusted Conversion Price.
The Company shall endeavor to list the Common
Shares required to be delivered upon conversion of
the Series A Preferred Shares, prior to such
delivery, upon each national securities exchange,
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<PAGE> 21
if any, upon which the outstanding Common Shares
are listed at the time of such delivery.
Prior to the delivery of any securities that the
Company shall be obligated to deliver upon
conversion of the Series A Preferred Shares, the
Company shall endeavor to comply with all federal
and state laws and regulations thereunder requiring
the registration of such securities, or any
approval of or consent to the delivery thereof by
any governmental authority.
(l) The Company will pay any and all documentary stamp
or similar issue or transfer taxes payable in
respect of the issue or delivery of Common Shares
or other securities or property on conversion of
the Series A Preferred Shares pursuant hereto;
provided, however, that the Company shall not be
required to pay any tax that may be payable in
respect of any transfer involved in the issue or
delivery of Common Shares or other securities or
property in a name other than that of the holder of
the Series A Preferred Shares to be converted, and
no such issue or delivery shall be made unless and
until the Person requesting such issue or delivery
has paid to the Company the amount of any such tax
or has established, to the reasonable satisfaction
of the Company, that such tax has been paid.
(m) In addition to the foregoing adjustments, the
Company will be permitted to make such reductions
in the Conversion Price as it considers to be
advisable in order that any event treated for
federal income tax purposes as a dividend of stock
or stock rights will not be taxable to the holders
of the Common Shares.
(n) Whenever reference is made in this subparagraph (7)
to the issuance or sale of Common Shares, the term
"Common Shares" shall include any shares of
beneficial interest of any class of the Company
other than preferred shares of any class with a
fixed (absolutely or by reference to an adjustment
formula) limit on dividends and a fixed amount
payable in the event of any voluntary or
involuntary liquidation, dissolution or winding up
of the Company.
(8) Voting Rights. Except as required by law or as provided
below, the holders of the Series A Preferred Shares shall not be entitled to
vote at any meeting of the shareholders for election of Trust Managers or for
any other purposes or otherwise to participate
-21-
<PAGE> 22
in any action taken by the Company or the shareholders thereof, or to receive
notice of any meeting of shareholders.
(a) In any matter in which the Series A Preferred
Shares are entitled to vote (as expressly provided
herein or as may be required by law), including any
action by written consent, each Series A Preferred
Share shall be entitled to one vote.
(b) Whenever distributions on any Series A Preferred
Shares shall be in arrears for six or more
Distribution Periods, whether or not such
Distribution Periods are consecutive, the holders
of the Series A Preferred Shares, voting separately
as a class with all other series of Preferred
Shares upon which like voting rights have been
conferred and are exercisable, will be entitled to
vote for the election of two additional Trust
Managers of the Company at a special meeting called
by the holders of record of at least ten percent
(10%) of any series of Preferred Shares so in
arrears (unless such request is received less than
90 days before the date fixed for the next annual
or special meeting of the shareholders) or at the
next annual meeting of shareholders, and all other
Trust Managers of the Company shall be elected by
the holders of the Company's Common Shares. In
such case, the entire Board of Trust Managers of
the Company will be increased by two Trust
Managers. Voting rights of the holders of the
Series A Preferred Shares shall continue at each
subsequent annual meeting until all distributions
accumulated on such Series A Preferred Shares for
the past Distribution Periods and the then current
Distribution Period shall have been fully paid or
declared and a sum sufficient for the payment
thereof set aside for payment.
(c) As long as any Series A Preferred Shares remain
outstanding, the Company will not, without the
affirmative vote or consent of the holders of at
least two-thirds of the Series A Preferred Shares
outstanding at the time, given in person or by
proxy, either in writing or at a meeting (such
series voting separately as a class) (i) authorize
or create, or increase the authorized or issued
amount of, any class or series of shares of
beneficial interest ranking prior to the Series A
Preferred Shares with respect to the payment of
distributions or the distribution of assets upon
liquidation, dissolution or winding up or
reclassify any authorized shares of beneficial
interest of the Company into such shares, or
create, authorize or issue any obligation or
security convertible into or evidencing the right
to purchase any such shares; or (ii) amend, alter
or repeal the provisions of the Declaration of
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<PAGE> 23
Trust or this Statement of Designation, whether by
merger, consolidation or otherwise (an "Event"), so
as to materially and adversely affect any right,
preference, privilege or voting power of the Series
A Preferred Shares or the holders thereof;
provided, however, with respect to the occurrence
of any of the Events set forth in (ii) above, so
long as the Series A Preferred Shares (or shares
into which the Series A Preferred Shares have been
converted in any successor entity to the Company)
remain outstanding with the terms thereof
materially unchanged, taking into account that upon
the occurrence of an Event, the Company may not be
the surviving entity, the occurrence of any such
Event shall not be deemed to materially and
adversely affect such rights, preferences,
privileges or voting power of holders of Series A
Preferred Shares and provided further that (x) any
increase in the amount of the authorized Preferred
Shares or the creation or issuance of any other
Series A Preferred Shares, or (y) any increase in
the amount of authorized Series A Preferred Shares,
in each case ranking on a parity with or junior to
the Series A Preferred Shares with respect to
payment of distributions or the distribution of
assets upon liquidation, dissolution or winding up,
shall not be deemed to materially and adversely
affect such rights, preferences, privileges or
voting power.
The foregoing voting provisions will not apply if,
at or prior to the time when the act with respect
to which such vote would otherwise be required
shall be effected, all outstanding Series A
Preferred Shares shall have been redeemed or called
for redemption and sufficient funds shall have been
deposited in trust to effect such redemption.
C. Exclusion of Other Rights.
Except as may otherwise be required by law, the Series A
Preferred Shares shall not have any voting powers, preferences and relative,
participating, optional or other special rights, other than those specifically
set forth in this Statement of Designation (as such Statement of Designation
may be amended from time to time) and in the Declaration of Trust. The Series
A Preferred Shares shall have no preemptive or subscription rights.
D. Headings of Subdivisions.
The headings of the various subdivisions hereof are for
convenience of reference only and shall not affect the interpretation of any of
the provisions hereof.
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<PAGE> 24
E. Severability of Provisions.
If any voting powers, preferences and relative, participating,
optional and other special rights of the Series A Preferred Shares and
qualifications, limitations and restrictions thereof set forth in this
Statement of Designation (as such Statement of Designation may be amended from
time to time) is invalid, unlawful or incapable of being enforced by reason of
any rule of law or public policy, all other voting powers, preferences and
relative, participating, optional and other special rights of Series A
Preferred Shares and qualifications, limitations and restrictions thereof set
forth in this Statement of Designation (as so amended) which can be given
effect without the invalid, unlawful or unenforceable voting powers,
preferences and relative, participating, optional or other special rights of
Series A Preferred Shares and qualifications, limitations and restrictions
thereof herein set forth shall be deemed dependent upon any other such voting
powers, preferences and relative, participating, optional or other special
right of Series A Preferred Shares and qualifications, limitations and
restrictions thereof unless so expressed herein.
F. Adoption.
This Statement of Designation was duly adopted by the Board of
Trust Managers of the Company. Shareholder action was not required.
* * *
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<PAGE> 25
IN WITNESS WHEREOF, I hereby certify that I, Gerald W. Haddock, am the
President and Chief Executive Officer of Crescent Real Estates Equities Company
(the "Company") and that as such, I am authorized to execute and file with the
County Clerk of Tarrant County, Texas this Statement of Designation (the
"Statement of Designation") on behalf of the Company and I further certify on
behalf of the Company that this Statement of Designation was authorized by the
Board of Trust Managers by unanimous written consent dated as of February 13,
1998 and is still in full force and effect as of the date hereof. I further
certify that my signature to this document is my free act and deed, that to the
best of my knowledge, information and belief, the matters and facts set forth
herein are true in all material respects and that this statement is made under
penalty of perjury.
CRESCENT REAL ESTATE EQUITIES COMPANY
---------------------------------------
Name: Gerald W. Haddock
Title: President and Chief Executive
Officer
The undersigned, David M. Dean, the Senior Vice President, Law and
Secretary of the Company, hereby certifies that Gerald W. Haddock is the
President and Chief Executive Officer of the Company and that the signature set
forth above is his genuine signature.
IN WITNESS WHEREOF, the undersigned has hereunto set his hand this ____
day of February, 1998.
---------------------------------------
Name: David M. Dean
Title: Senior Vice President, Law
and Secretary
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<PAGE> 1
EXHIBIT 5.01
[LETTERHEAD OF SHAW, PITTMAN, POTTS & TROWBRIDGE]
February 13, 1998
Crescent Real Estate Equities Company
777 Main Street, Suite 2100
Fort Worth, Texas 76102
Ladies and Gentlemen:
We have acted as counsel to Crescent Real Estate Equities Company, a
Texas real estate investment trust (the "Company"), in connection with the
registration under the Securities Act of 1933, as amended, of 9,200,000 6-3/4%
Series A Convertible Cumulative Preferred Shares of beneficial interest of the
Company (including 1,200,000 of such preferred shares issuable pursuant to an
overallotment option), par value $.01 per share (the "Shares"), pursuant to a
Registration Statement on Form S-3 (Registration No. 333-38071), including the
prospectus, the prospectus supplement and all amendments, exhibits and documents
related thereto (collectively, the "Registration Statement"), and with the
proposed sale of the Shares in accordance therewith.
Based upon our examination of the originals or copies of such documents,
corporate records, certificates of officers 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 the Shares have been duly authorized for issuance by the
Company, and that, upon issuance and delivery in accordance with the purchase
agreement referred to in the Registration Statement, the Shares will be validly
issued, fully paid and nonassessable.
We hereby consent to the incorporation by reference of this opinion as
an exhibit to the Registration Statement. We also consent to the reference to
Shaw, Pittman, Potts & Trowbridge under the caption "Legal Matters" in the
prospectus and the prospectus supplement.
Very truly yours,
/s/ SHAW, PITTMAN, POTTS & TROWBRIDGE
-------------------------------------
SHAW, PITTMAN, POTTS & TROWBRIDGE
<PAGE> 1
EXHIBIT 8.01
February 13, 1998
Crescent Real Estate Equities Company
777 Main Street
Suite 2100
Fort Worth, Texas 76102
Ladies and Gentlemen:
On October 16, 1997, Crescent Real Estate Equities Company ("Crescent
Equities") filed a registration statement on Form S-3, No. 333-38071, with the
Securities and Exchange Commission, which was declared effective on October 29,
1997. Such registration statement (the "Registration Statement") includes a
prospectus supplement dated February 13, 1998 to the prospectus contained in
the Registration Statement (together, the "Prospectus"). In connection with
the filing of the prospectus supplement, 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 a direct or indirect 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"), Crescent Real Estate Funding VII, L.P.
("Funding VII"), 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"), Crescent/301, L.L.C.
("Crescent/301"), Spectrum Mortgage Associates, L.P. ("SMA"), Crescent
Commercial Realty Holdings, L.P. ("CCRH"), CresWood Development, LLC and the
Woodlands Commercial Properties Company, L.P. (the "Commercial Partnership").
Capitalized terms used hereunder but not defined have the meaning ascribed to
them in the Prospectus, unless otherwise noted.
Specifically, you have requested that we render opinions addressing
the following:
- ----------------------------------
(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., CRE Management
VII Corp., CresCal Properties, Inc., and Crescent Commercial Realty
Corp.
<PAGE> 2
Crescent Real Estate Equities Company
February 13, 1998
Page 2
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, 1997, 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 Mira Vista Residential Development Property, the
Falcon Point Residential Development Property, the Spring
Lakes Residential Development Property, The Highlands
Residential Development Property, The Reserve at Frisco
Residential Development Property, the Whitehawk Ranch
Residential Development Property, the One Beaver Creek
Residential Development Property, the Cresta Residential
Development Property, the Market Square Residential
Development Property, the Eagle Ranch Residential Development
Property, the Villa Montane Residential Development Property,
The Woodlands Residential Development Property and the Desert
Mountain Residential Development Property (collectively, the
"Residential Development Properties") will be treated for
federal income tax purposes as owned by Crescent Development
Management Corporation ("CDMC"), Houston Area Development
Corp. ("HADC"), Mira Vista Development Corporation ("MVDC"),
The Woodlands Land Company, Inc. ("Landevco"), and Desert
Mountain Development Corporation ("DMDC") (collectively, 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 mortgages secured by the Residential Development
Properties (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 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
- ----------------------------------
(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.
<PAGE> 3
Crescent Real Estate Equities Company
February 13, 1998
Page 3
construed as owning at any time a partnership interest in
Manalapan Hotel Partners for federal income tax purposes;
7. Whether the leases of the Hyatt Regency Beaver Creek, the
Denver Marriott City Center, the Hyatt Regency Albuquerque
Plaza, Canyon Ranch-Tucson, Canyon Ranch-Lenox, the Sonoma
Mission Inn & Spa, The Woodlands Executive Conference Center
and Resort, the Four Seasons-Houston Center and the Omni
Austin Hotel (collectively, 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
or DBL Holdings, Inc. ("DBLH") 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;
10. Whether the distribution of the stock of Crescent Operating,
Inc. ("Crescent Operating") by Crescent Equities to its
shareholders will be taxable to Crescent Equities as gain on
the sale of stock or securities for purposes of section
856(c) of the Code;
11. Whether Crescent Operating will be treated for federal income
tax purposes as a corporate entity separate from and not an
agent of either Crescent Equities or the Operating Partnership
in light of Crescent Operating's relationship with Crescent
Equities and the Operating Partnership;
12. Whether Crescent Operating and Crescent Equities will be
treated as a stapled entity for federal income tax purposes
under section 269B(a)(3) of the Code;
13. Whether the loan of approximately $35.9 million from the
Operating Partnership to Crescent Operating will constitute
debt for federal income tax purposes;
14. Whether Crescent Equities will be considered to have met the
requirements of section 856(c)(5) of the Code for the period
beginning April 1, 1997 and ending June 26, 1997 during which
it held Crescent Operating stock;
15. Whether the rents received by Crescent Equities from Charter
Behavioral Health Systems, LLC ("CBHS") and its affiliates
will constitute "rents from real property" under section
856(d) of the Code;
<PAGE> 4
Crescent Real Estate Equities Company
February 13, 1998
Page 4
16. Whether the Commercial Partnership and the Development
Partnership will be considered for federal income tax purposes
as separate entities and not as partners of or with each other;
17. Whether, assuming that the Commercial Partnership and The
Woodlands Land Development Company, L.P. (the "Development
Partnership") are considered to constitute one partnership for
federal income tax purposes, the allocations of profit and
loss from the Leased Properties to the partners of the
Commercial Partnership and the allocations of profit and loss
from the Development Properties (defined below) to the
partners of the Development Partnership will be respected
under section 704;
18. Whether, assuming that the Commercial Partnership and the
Development Partnership are considered to constitute one
partnership for federal income tax purposes, the allocation to
Crescent Equities under Treas. Reg. 1.856-3(g) of gross income
derived from the sale of Development Properties to customers in
the ordinary course of business would be taken into account for
purposes of determining whether Crescent Equities meets the
requirements of the 95 percent and 75 percent gross income
tests set forth in sections 856(c)(2) and (3) (the "Gross
Income Tests");
19. With respect to the sale of Common Shares to an affiliate of
Union Bank of Switzerland ("UBS") (the "UBS Transaction"), as
well as the sale of Common Shares to Merrill Lynch
International ("MLI") (the "MLI Transaction"), whether a
payment, if any, to Crescent Equities will be excluded from its
gross income under section 1032, and, if so, what effect it
would have on the application to Crescent Equities of the gross
income tests set forth in section 856(c); and
20. 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) the
Second 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 Crescent Real Estate
Funding VII, L.P., as amended (the "Funding VII Agreement"); (10) 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"); (11) the Limited Liability Company Agreement of
CresTex Development, L.L.C. (the "CresTex Agreement"); (12) 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"); (13)
the Articles of Organization of G/C Waterside Associates LLC (the "Associates
Articles"); (14) the Regulations of G/C Waterside Associates, LLC (the
"Associates Regulations"); (15) the
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Crescent Real Estate Equities Company
February 13, 1998
Page 5
Amended and Restated Agreement of Limited Partnership of Woodlands Office
Equities - '95 Limited (the "Woodlands Partnership Agreement"); (16) the Amended
and Restated Agreement of Limited Partnership of Woodlands Retail Equities - '96
Limited (the "WRE Agreement"); (17) the Limited Partnership Agreement of 301
Congress Avenue, L.P. (the "301 Congress Partnership Agreement"); (18) the
Limited Liability Company Agreement of Crescent/301, L.L.C. (the "Crescent/301
Agreement"); (19) the Amended and Restated Agreement of Limited Partnership of
Spectrum Mortgage Associates, L.P. (the "SMA Agreement"); (20) the Agreement of
Limited Partnership of Crescent Realty Investments, LLP (the "CCRH Agreement");
(21) copies of all existing leases (including amendments) entered into as of the
date hereof with respect to property owned by the Operating Partnership or the
Subsidiary Partnerships with the exception of those leases with respect to Post
Oak Central, acquired on February 13, 1998; (22) copies of the Residential
Development Property Mortgages; (23) the Intercompany Agreement between the
Operating Partnership and Crescent Operating (the "Intercompany Agreement");
(23) the Registration Statement of Crescent Operating on Form S-1 dated April
15, 1997; (24) the First Restated Certificate of Incorporation of Crescent
Operating (the "Restated Certificate"); (25) the Amended and Restated Bylaws of
Crescent Operating; (26) the Real Estate Purchase and Sale Agreement between
Magellan Health Services, Inc. and the Operating Partnership (the "Magellan
Agreement"); (27) the Certificate of Incorporation of The Woodlands Land
Company, Inc.; (28) the Agreement of WECCR General Partnership; (29) the
Agreement of BOCH General Partnership; (30) the Agreement of Limited
Partnership of The Woodlands Operating Company, L.P.; (31) the Agreement of
Limited Partnership of The Woodlands Land Development Company, L.P.; (32) the
Amended and Restated Agreement of Limited Partnership of the Woodlands
Commercial Properties Company, L.P.; (33) the Certificate of Merger of The
Woodlands Commercial Properties Company, L.P. and The Woodlands Land
Development Company, L.P.; (34) the Management and Advisory Agreement between
The Woodlands Commercial Properties Company, L.P. and The Woodlands Operating
Company, L.P.; (35) the Management and Advisory Agreement dated July 31, 1997
between The Woodlands Land Development Company, L.P. and The Woodlands
Operating Company, L.P.; (36) the Lease Agreement between The Woodlands
Commercial Properties Company, L.P. and WECCR General Partnership; (37) the
Registration Statement, as amended through the date hereof; (38) the
Prospectus; and (39) 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 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
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Crescent Real Estate Equities Company
February 13, 1998
Page 6
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 Company 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, 1997, (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 Prospectus Supplement, 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. 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).
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Crescent Real Estate Equities Company
February 13, 1998
Page 7
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 have their own
employees (except HBCLP and DBLH, which have no employees), act independently
in owning, developing, and selling the Residential Development Properties, and
do not act as agents of the Operating Partnership or Crescent Equities.
Moreover, MVDC, HADC, Landevco, and DMDC should shield the Operating
Partnership against any liabilities generated by their respective property
development businesses, while 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. 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).
<PAGE> 8
Crescent Real Estate Equities Company
February 13, 1998
Page 8
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 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
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Crescent Real Estate Equities Company
February 13, 1998
Page 9
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.
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.
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Crescent Real Estate Equities Company
February 13, 1998
Page 10
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.
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 corporation ("New Crescent") that would be formed and then spun off by the
Operating Partnership and Crescent Equities.(5)
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
- ----------------------------------
(4) This series of transactions discussed in this paragraph will
hereinafter be referred to as the "Transactions."
(5) This consent would apply to Crescent Operating.
<PAGE> 11
Crescent Real Estate Equities Company
February 13, 1998
Page 11
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 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) of the
Code.
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
<PAGE> 12
Crescent Real Estate Equities Company
February 13, 1998
Page 12
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 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 CDMC Voting Shareholders (defined below), whether written or
oral, that control the manner in which the CDMC Voting Shareholders exercise
the voting rights inherent in the voting stock of CDMC or that restrict the
ability of the CDMC Voting Shareholders to alienate such stock. There will be
no such agreements between Crescent Equities
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Crescent Real Estate Equities Company
February 13, 1998
Page 13
and the CDMC Voting Shareholders in the future. Moreover, the voting stock of
CDMC owned by the CDMC Voting Shareholders is registered in the names of such
shareholders, and all dividends accruing on stock are delivered to the
addresses of such 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 Crescent
Operating or any other 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 made no 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 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 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.
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Crescent Real Estate Equities Company
February 13, 1998
Page 14
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.
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 DBL Holdings, Inc. and 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.
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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 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);
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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 or DBLH. 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 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"). In the case of Landevco and DMDC, the voting
stock is owned by Crescent Operating. In the case of DBLH, such stock is owned
by Gerald W. Haddock and John C. Goff (together, the "DBLH Shareholders," and
together with the MVDC Voting Shareholders, the HADC Voting Shareholders, the
CDMC Voting Shareholders, the HBCLP Voting Shareholders, and Crescent
Operating, the "Voting Shareholders"). Moreover, the voting stock of the
Residential Development Corporations and DBLH 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 or DBLH actually held
by the Voting Shareholders, Crescent Equities will not own more than 10 percent
of the voting securities of any of the Residential Development Corporations or
DBLH 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 IRS could successfully assert either of these theories in a
fact situation similar to that involving Crescent Equities and the Residential
Development Corporations or DBLH, however. Therefore, it is our opinion that
Crescent Equities will not be
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deemed to be the owner of the voting stock of the Residential Development
Corporations or DBLH 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 and the DBLH 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 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.
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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 such acquisition. The IRS did not attribute this 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 or the DBLH 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
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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 the IRS were to
assert that the Voting Shareholders are holding the voting stock of the
Residential Development Corporations and DBLH 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
and DBLH. 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 and DBLH.
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.
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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 and DBLH 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.
The IRS should not be successful in attributing ownership of the
voting stock of the Residential Development Corporations and DBLH 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.
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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 and DBLH from the Voting
Shareholders to Crescent Equities. Section 318(a)(3)(C) provides that stock
ownership is 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 from owning,
actually or constructively, more than 8.0 percent of the value of Crescent
Equities common shares. Therefore, unless these ownership limitations are
waived, no person can possibly own, actually or constructively, 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 or DBLH.
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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 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
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February 13, 1998
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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 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
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February 13, 1998
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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.
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.
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Crescent Real Estate Equities Company
February 13, 1998
Page 25
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 Subsidiary Partnerships, other than Funding VII which was duly
organized as a limited Partnership on April 29, 1997, were duly organized as
limited partnerships prior to January 1, 1997. Such 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 formed prior to January 1, 1997 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 formed prior to January 1, 1997 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
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Crescent Real Estate Equities Company
February 13, 1998
Page 26
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.
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.(6)
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(6) For purposes of this opinion, we have assumed that Funding I will not
be treated as having more than three partners (Management I, the
Operating Partnership, 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 the
Operating Partnership, and assuming that Funding I will not represent
substantially all of the assets of CW #1 Limited Partnership.
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Crescent Real Estate Equities Company
February 13, 1998
Page 27
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 Funding II will not constitute a publicly
traded partnership for purposes of section 7704 of the Code.(7)
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(7) 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.
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Crescent Real Estate Equities Company
February 13, 1998
Page 28
iii. Funding III, Funding IV and Funding V. The Operating
Partnership owns an approximately 99 percent interest in each of Funding III,
Funding IV and Funding V as a limited partner. Nine Greenway, Ltd. owns a 0.1
percent limited partnership interest in each of Funding III, Funding IV and
Funding V. The remaining approximately 0.9 percent general partner's
interest in Funding III is owned by CRE Management III Corp., CRE Management IV
Corp. owns an approximately 0.9 percent general partner interest in Funding IV,
and CRE Management V Corp. owns an approximately 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 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
<PAGE> 29
Crescent Real Estate Equities Company
February 13, 1998
Page 29
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.(8)
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 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.(9)
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(8) 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.
(9) 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.
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Crescent Real Estate Equities Company
February 13, 1998
Page 30
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.(10)
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(10) 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.
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Crescent Real Estate Equities Company
February 13, 1998
Page 31
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.(11)
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, 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
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(11) 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).
<PAGE> 32
Crescent Real Estate Equities Company
February 13, 1998
Page 32
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.(12)
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 partnos will cause the partnership
to terminate. Accordingly, Waterside lacked the corporate characteristic of
continuity of life.
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.
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(12) 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.
<PAGE> 33
Crescent Real Estate Equities Company
February 13, 1998
Page 33
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.(13)
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.(14)
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
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
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(13) 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 the
Operating Partnership and assuming that Waterside will not represent
substantially all of the assets of CW #1 Limited Partnership.
(14) See, e.g., P.L.R. 9242025 (July 22, 1992) and P.L.R. 9218078 (January
31, 1992).
<PAGE> 34
Crescent Real Estate Equities Company
February 13, 1998
Page 34
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.(15)
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(15) 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.
<PAGE> 35
Crescent Real Estate Equities Company
February 13, 1998
Page 35
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 Partnership, it is our opinion
that the Woodlands Partnership will not constitute a publicly traded
partnership for purposes of section 7704 of the Code.(16)
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(16) 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.
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Crescent Real Estate Equities Company
February 13, 1998
Page 36
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.
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Crescent Real Estate Equities Company
February 13, 1998
Page 37
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.(17)
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
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(17) 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.
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Crescent Real Estate Equities Company
February 13, 1998
Page 38
as a substitute partner without the consent of all other partners.
Accordingly, 301 Congress lacked the corporate characteristic of free
transferability of interests.
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.(18)
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.(19)
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
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(18) 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 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.
(19) 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).
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Crescent Real Estate Equities Company
February 13, 1998
Page 39
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 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.
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Crescent Real Estate Equities Company
February 13, 1998
Page 40
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.(20)
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
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(20) 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.
<PAGE> 41
Crescent Real Estate Equities Company
February 13, 1998
Page 41
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.
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.(21)
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.
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(21) 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.
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Crescent Real Estate Equities Company
February 13, 1998
Page 42
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.(22)
9. Crescent Operating
a. Taxability to Crescent Equities of Distribution of Crescent
Operating Stock by Crescent Equities to Its Shareholders
The contribution of cash and assets by the Operating Partnership into
Crescent Operating was tax-free if it qualified under section 351, which
provides that a transfer to a corporation in exchange for its stock will be
tax-free provided that the transferor is in control of the corporation
following the transfer. For this purpose "control" is defined in section
368(c) as the ownership of stock possessing at least 80 percent of the total
combined voting power of all classes of stock entitled to vote. Because,
however, the stock of Crescent Operating was distributed, first by the
Operating Partnership to its partners, and then by Crescent Equities to its
shareholders, it is necessary to take into account such distributions.
Although not directly on point, section 351(c) provides that for
purposes of determining control, a distribution by any corporate transferor of
part or all of the stock which it receives in the exchange to its shareholders
shall not be taken into account. Furthermore, the IRS has ruled that, in the
context of a complete liquidation of a partnership, the distribution by the
partnership of stock received in an exchange otherwise complying with section
351 did not violate the control requirement. Rev. Rul. 84-111, 1984-2 C.B. 88.
We also note that in the instant situation, the parties could have had the
Operating Partnership distribute the assets and cash to its partners and then
have had them contribute the cash and assets directly into Crescent Operating,
and so the situation does not suggest that the redistribution of the stock in
Crescent Operating was in any way abusive. Based upon the foregoing, it is our
opinion that the transfer of cash and assets into Crescent Operating satisfied
the requirements of section 351.
Nevertheless, under section 311, the distribution of the Crescent
Operating stock by Crescent Equities to its shareholders caused Crescent
Equities to recognize taxable income corresponding to the difference, if any,
between its basis in such Crescent Operating stock and the fair market value
thereof at the time of the distribution. Assuming, as we do, that the transfer
of cash and assets into Crescent Operating satisfied section 351, the gain so
recognized would have
- -----------------------------------
(22) 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 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.
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Crescent Real Estate Equities Company
February 13, 1998
Page 43
constituted gain on stock or securities. The basis of Crescent Equities in the
stock was equal to its pro rata share of the basis of the Operating Partnership
in the cash and assets transferred into Crescent Operating.
It is our opinion that the amount of gain recognized by Crescent
Equities in connection with the distribution constituted gain on the sale of
stock or securities for purposes of the gross income tests. In general, at
least 75% of a REIT's gross income for each taxable year must be from "rents
from real property," interest on obligations secured by mortgages on real
property, gains from the sale or other disposition of real property and certain
other sources; thus, gain on the sale of stock or securities does not qualify
under the 75% gross income test. Even though the gain recognized in connection
with the distribution does not qualify under the 75% gross income test,
Crescent Equities believes and has represented that the amount of such gain,
along with any other income that does not qualify under the 75% gross income
test, did not exceed 25% of the gross income of Crescent Equities for 1997.
Because of the factual nature of valuation, we are unable to render an opinion
on the amount of such gain, but we have no reason to believe that this is
incorrect. Based on the foregoing, it is our opinion that the gain recognized
by Crescent Equities on the distribution of Crescent Operating stock did not
cause Crescent Equities to violate the 75% gross income test.
In addition to the 75% gross income test, for years before 1998, a
REIT must have derived less than 30% of its gross income from the sale or other
disposition of (i) real property held for less than four years; (ii) stock or
securities held for less than one year; and (iii) property sold or otherwise
disposed of in a prohibited transaction. Crescent Equities has represented
that the amount of gain that should be recognized by Crescent Equities on the
distribution of Crescent Operating stock, along with any other income that must
be included under the 30% gross income test, did not exceed 30% of the gross
income of Crescent Equities for 1997. Because of the factual nature of
valuation, we are unable to render an opinion on the amount of such gain, but
we have no reason to believe that this is incorrect. Based upon the foregoing,
it is our opinion that the gain recognized by Crescent Equities on the
distribution of Crescent Operating stock did not cause Crescent Equities to
violate the 30% gross income test.
b. Separate Corporate Entities
Because many, if not all, of the activities that Crescent Operating
will undertake would have an adverse impact on the status of Crescent Equities
as a REIT for federal income tax purposes were such activities to be engaged in
by the Operating Partnership, it is necessary to address the question of
whether Crescent Operating will be treated as a corporate entity separate from
and not an agent of either Crescent Equities or the Operating Partnership for
federal income tax purposes. The Operating Partnership and Crescent Operating
intend to establish a long-term business relationship. The facts as we
understand them to be are discussed below.
<PAGE> 44
Crescent Real Estate Equities Company
February 13, 1998
Page 44
According to the Restated Certificate, Crescent Operating will serve
the purpose of acting as lessee and/or operator of properties owned or to be
owned by Crescent Equities, the Operating Partnership, and other property
owners. The Restated Certificate also provides that one of Crescent
Operating's corporate purposes is to perform the Intercompany Agreement,
pursuant to which Crescent Operating and the Operating Partnership have agreed
to provide each other with rights of first opportunity and notification with
respect to certain transactions and investments. In addition, the Restated
Certificate and Intercompany Agreement prohibit Crescent Operating from
engaging in activities or making investments that a REIT could make, unless the
Operating Partnership was first given the opportunity but elected not to pursue
such activities or investments.
Some similarities in the day-to-day operations of the entities exist.
For instance, Crescent Operating's senior management is the same as that of
Crescent Equities. Five members of the Crescent Operating board are the same
as members of the Crescent Equities board, but the Crescent Operating board
includes two members unaffiliated with Crescent Equities. In addition, both
entities may have some or all of the same employees, especially at the
inception of Crescent Operating. Furthermore, Crescent Operating's ownership
was, at least initially, the same as the ownership of Crescent Equities and the
Operating Partnership. The Operating Partnership and Crescent Operating hold
themselves out to the public as separate entities, however, and do not
characterize their relationship as one between principal and agent. In
addition, it is contemplated that each corporation will be responsible for its
own contractual obligations, although certain payment obligations of Crescent
Operating related to its CBHS investment have been guaranteed by the Operating
Partnership. Furthermore, the Securities and Exchange Commission required that
Crescent Operating file a registration statement on Form S-1 because its
securities were distributed to the public. Finally, and perhaps most
important, the stock of Crescent Operating is being traded separately from that
of Crescent Equities.
The general principle of separate corporate entities was advanced by
the Supreme Court in Moline Properties v. Commissioner, 319 U.S. 436 (1943),
where a taxpayer sought to have the gain on sales of its real property treated
as the gain of its sole shareholder and have its corporate existence ignored as
merely fictitious. In Moline, the Court stated that "so long as [its] purpose
is the equivalent of a business activity or is followed by the carrying on of
business by the corporation, the corporation remains a separate taxable
entity." Id. at 439. The Tax Court has described the degree of corporate
purpose and activity requiring recognition of the corporation as a separate
entity as "extremely low" and has held that mortgaging corporate property is a
sufficient business activity to avoid classification as a dummy corporation.
Strong v. Commissioner, 66 T.C. 12, 24 (1976). Upholding the independent
existence of a one-person personal service corporation, the Tax Court concluded
that "[t]he policy favoring the recognition of corporations as entities
independent of their shareholders requires that we not ignore the
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Crescent Real Estate Equities Company
February 13, 1998
Page 45
corporate form so long as the corporation actually conducts business." Keller
v. Commissioner, 77 T.C. 1014, 1031 (1981), aff'd, 723 F.2d 58 (10th Cir.
1983).
Some of the activities leading courts to conclude that two entities
constitute separate corporations have included having separate checking
accounts, contracting in their own names, and holding themselves out to the
public as separate corporate businesses. See, e.g., Schuerholz v.
Commissioner, 35 T.C.M. (CCH) 726 (1976) (refusing to ignore the existence
separate from a partnership of an incorporated entity that engaged in such
activities, despite the absence of any annual meetings, failure to issue stock,
and lack of election of directors). Other business activities leading to
recognition of a company as a corporate entity have included the hiring and
contracting with employees, the keeping of its own books, and paying taxes.
See, e.g., Silvano Achiro v. Commissioner, 77 T.C. 881 (1981) (finding a
landfill management company that engaged in such activities to be a corporate
entity entitled to recognition). The Tenth Circuit found a business purpose to
be lacking and disregarded corporations that "paid no dividends, had no
employees, maintained no telephones, telephone listings, or separate business
addresses, and engaged in no substantive business activities." Lloyd F. Noonan
v. Commissioner, 451 F.2d 992 (9th Cir. 1971) (ignoring four corporations that
lacked a business purpose and concluding that partnership income attributed to
the corporations was properly attributable to the sole shareholders of such
corporations). Similarly, the Tax Court found bookkeeping entries and bank
accounts insufficient indicators of corporate existence where a corporation
owned no property, had no contracts except with a shareholder-employee, and did
not enter into its own arrangements with customers to whom its
shareholder-employee rendered services. Roubik v. Commissioner, 53 T.C. 365
(1969).
Applying these indicia of corporate existence to the proposed
activities of Crescent Operating and its relationship with Crescent Equities
and the Operating Partnership supports the conclusion that Crescent Operating
will be considered a corporate entity separate from Crescent Equities and the
Operating Partnership. Crescent Operating will enter into contracts, hire at
least some of its own employees, and, most important, hold itself out to the
public as a separate corporate entity. In fact, its stock is being publicly
traded separately from the stock of Crescent Equities. As the court stated in
Love v. United States, "[t]he decision to recognize or not to recognize the tax
identity of a corporation depends upon what the corporation does, not what it
is called, how many or how few own it, or how they regard it." 96 F. Supp.
919, 922 (Ct. Cl. 1951).
Even if Crescent Equities and Crescent Operating are treated as
separate entities, the non-REIT-qualified activities of Crescent Operating
could be attributed to Crescent Equities if Crescent Operating were 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
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Crescent Real Estate Equities Company
February 13, 1998
Page 46
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.
According to the Restated Certificate, Crescent Operating will serve
the purpose of acting as lessee and/or operator of properties owned or to be
owned by Crescent Equities, the Operating Partnership, and other property
owners unaffiliated with Crescent Equities. An application of the Bollinger
factors to this broad language should not result in a characterization of the
relationship between Crescent Operating and the Operating Partnership as one
between agent and principal, especially because the Operating Partnership and
Crescent Operating will not hold themselves out to the public as principal and
agent.
Based upon the foregoing, it is our opinion that Crescent Operating
will be treated as a corporate entity separate from and not an agent of
Crescent Equities and the Operating Partnership for federal income tax
purposes.
c. Paired Share Issue
Section 269B(a)(3) of the Code requires that all entities that are
stapled entities be treated as a single entity for purposes of determining
whether any stapled entity is a REIT. A "stapled entity" is defined as any
group of two or more entities if more than 50 percent of the beneficial
ownership in each of the entities consists of stapled interests, which are
interests that, by reason of form of ownership, restrictions on transfer, or
other terms or conditions, are transferred or required to be transferred in
connection with the transfer of the other such interests.
If shares of Crescent Operating were characterized as "stapled" to
shares of Crescent Equities, then the REIT status of Crescent Equities could be
in jeopardy because the two entities would be treated as a single entity for
tax purposes. Shares of Crescent Operating have been issued independently of
Crescent Equities shares and are being publicly traded separately as well,
however. Furthermore, in a ruling in which the shareholders of a REIT were
identical to the shareholders of its lessee, the IRS stated in dicta that
having the same shareholders was not a sufficient condition to characterize the
entities as stapled. P.L.R. 8705084 (Oct. 31, 1986).(23)
Based on the foregoing, it is our opinion that the shares of Crescent
Operating and Crescent Equities are not stapled interests, and that Crescent
Operating and Crescent Equities will not be treated as stapled entities under
section 269B(a)(3) of the Code.
- ----------------------------------
(23) Private letter rulings do not have precedential effect, but do shed
light on the thinking of the Internal Revenue Service and do
constitute substantial authority under section 6662.
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Crescent Real Estate Equities Company
February 13, 1998
Page 47
d. Characterization of the Crescent Operating Note
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).
The Crescent Operating Note possesses a number of attributes weighing
in favor of debt treatment. For instance, the Crescent Operating Note is
clearly denominated as debt, has a fixed maturity date of five years, provides
for the return of interest on the principal amount at a rate of 12 percent per
annum, and is secured by the Assets. In addition, Crescent Equities and the
Operating Partnership have represented that the value of the assets securing
the Crescent Operating Note exceeds the outstanding balance of the Crescent
Operating Note and that, based upon internal projections, they anticipate that
the Crescent Operating Note will be repaid in accordance with its terms.
Crescent Equities and the Operating Partnership have also represented that the
interest provided for under the Crescent Operating Note represents a
commercially reasonable rate of interest. In addition, based on our experience
and an examination of the Note, the interest appears to represent a
commercially reasonable rate of interest.
Based on the foregoing, it is our opinion that the Crescent Operating
Note constitutes debt for federal income tax purposes. Accordingly, it will
not constitute an ownership interest which could cause Crescent Equities to be
considered an owner of the Tenants under the section 318 attribution rules.
Further, it is our opinion that amounts designated as interest by the Crescent
Operating Note will be treated as interest for purposes of the 95 percent gross
income test of section 856(c).
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Crescent Real Estate Equities Company
February 13, 1998
Page 48
e. Related Party Tenant Issue
In signing the Magellan Agreement, the Operating Partnership entered
into an agreement involving the purchase of an entity that may pose a problem
under the related party rent provision of section 856(d)(2)(B) of the Code.
Although there is a possibility that a binding contract is not subject to the
application of the section rules,(25) we are not relying on that position. The
purpose of section 318 is to indicate in what circumstances taxpayers will be
deemed to have ownership interests that they do not actually have. We believe
that, whether a binding contract constitutes an option, or, arguably, actual
current ownership, a court would be likely to determine that there is no
attribution where there are significant contingencies that must be satisfied
prior to closing, but that there is attribution where any contingencies are
viewed as temporary or minor.(26)
The Magellan Agreement states that the formation of Crescent Operating
is a condition precedent to closing and that the failure of Crescent Equities
to cause the formation and distribution of Crescent Operating will not be
considered a breach entitling Magellan Health Services, Inc. to specific
performance. The requirement of the formation of a new corporate entity, which
must be independently approved by the Securities and Exchange Commission, is
clearly a significant contingency. In addition, acknowledging that ownership
by Crescent Equities of an ownership interest in CBHS or entities owned by CBHS
might lead to a violation of the REIT requirements of section 856 of the Code,
Section 8.4 of the Agreement states that neither Crescent Equities nor any
entity the assets of which would be attributed to Crescent Equities has the
right, option or obligation to enter into the Contribution Agreement or to own
any entities owned by CBHS and that any attempt to do so would be null and
void.
Based on the foregoing, it is our opinion that execution of the
Magellan Agreement will not be subject to the section 318 attribution rules
causing Crescent Equities to be considered the owner of the Tenants and that,
therefore, the rents from the Tenants should constitute rents from real
property under section 856(d).
10. Acquisition of Certain Assets from The Woodlands Corporation
a. Background
The Woodlands Corporation ("TWC") had significant real estate holdings,
directly, through wholly owned corporations, and through various partnerships
in which either TWC or a subsidiary were partners. The real estate included
office buildings, retail properties, rental housing, golf courses, a hotel,
conference centers, and residential land development projects. After merging
certain of the subsidiaries into itself, TWC merged its assets into The
Woodlands Commercial Properties Company, L.P.(the "Commercial Partnership") in
exchange for cash. The Commercial Partnership immediately divided into two
partnerships, one bearing its name and the other called The Woodlands Land
Development Company, L.P.(the "Development Partnership"), as a result of which
the commercial office buildings, the retail properties, the rental housing, the
hotel, the conference centers and the golf courses (the "Leased Properties")
were retained by the Commercial Partnership and the residential land
development projects and certain other assets (the "Development Properties")
became the assets of the Development Partnership. The partners of the
Commercial Partnership are the Operating Partnership, CresWood Development,
LLC (which is owned 100 percent by the Operating Partnership), and a group
comprised of affiliates of Morgan Stanley and various investors (the "MS
Group"). The partners of the Development Partnership are (i) Landevco, a
corporation all of the nonvoting common stock of which is currently owned by
the Operating Partnership and all of the voting common stock of which is owned
by Crescent Operating and (ii) the MS Group. A third partnership, The
Woodlands Operating Company (the "Management Company"), (a) employs the
employees previously employed by TWC and will furnish advisory and other
services to the Commercial Partnership and the Development Partnership and (b)
through a general partnership between itself and a wholly owned corporation,
WECCR General Partnership (the "Tenant Partnership"), has leased the hotel and
golf courses from the Commercial Partnership. The Partners of the Management
Partnership are WOCOI Investment Company, a Texas corporation, and the MS Group.
b. Characterization of Commercial Partnership and
Development Partnership as Separate Entities
The income of the Commercial Partnership will in general consist of
items which meet the requirements of the Gross Income Tests, and the income of
the Development Partnership will consist generally of items which either do not
meet such requirements or are subject to the tax imposed by section 857 on
prohibited transactions. In light of certain linkages of these two
partnerships, discussed below, it is necessary to consider whether they would
be considered as separate entities and not as partners of or with each other,
because if they were aggregated, the effect could be to cause Crescent Equities
to be treated as realizing gross income of a nature that could jeopardize its
status as a REIT or to subject it to the tax on prohibited transactions.(24)
- ------------------------------------
(24) The succeeding opinion addresses the allocation of income under
section 704 in the event of such an aggregation.
(25) Revenue Ruling 89-64, 1989-1 C.B. 91, (Jan. 1, 1989), distinguished
between an option and a binding contract for attribution rule
purposes. The ruling held that a taxpayer whose option was not
exercisable for a stated period of time was nevertheless considered to
have an option that resulted in tax attribution. Consequently, the
language distinguishing bilateral contracts was dictum. We believe,
therefore, that reliance on this ruling would present significant tax
risks.
(26) While the Code and Treasury Regulations do not indicate the likely
effect on the attribution rules of restrictions on the exercise of an
option, some authority does exist. In Rev. Rul. 89-64, for instance,
the IRS held that the requirement that a certain period of time pass
before an option would be exercisable was not a sufficient contingency
to prevent attribution. 1989-1 C.B. 91. In contrast, in a private
letter ruling, the IRS ruled that a right of first refusal would not
trigger attribution because the right to purchase was subject to a
contingency (i.e., the obligor's decision to sell). P.L.R. 8106008
(Oct. 21, 1980).
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Crescent Real Estate Equities Company
February 13, 1998
Page 49
There are four principal links between the two partnerships. First, in
both partnerships, the timing of the shift in allocations which will occur as a
result of the economic performance of the partnerships is determined on an
aggregate basis. Second, the failure of the Operating Partnership to make
certain capital contributions to the Commercial Partnership can result in not
only a dilution of its interest in the Commercial Partnership, but also a
dilution of Landevco in the Development Partnership, and vice versa; and the
failure of the MS Group to make certain capital contributions in one of the
partnerships can similarly lead to the increase of the Operating Partnership's
interest in the Commercial Partnership and the increase of Landevco's interest
in the Development Partnership. Third, the occurrence of an event that
triggers the operation of the buy-sell provisions in one partnership will
trigger the buy-sell provisions in the other, as well.(27) Finally, the senior
debt of each partnership provides for cross-collateralization and cross-
default.
Two of these links are significantly attenuated, however, by side
agreements. The Cross Reimbursement and Indemnity Agreement provides that the
Commercial Partnership and the Development Partnership must indemnify the other
against loss occasioned by a failure of the partnership to perform under its
loan agreement. Furthermore, because of the relatively low level of leverage
being employed (approximately 60 percent for the Commercial Partnership and
approximately 72 percent for the Development Partnership), no such failure is
anticipated. Under the Cross Indemnity Agreement, the Operating Partnership and
Landevco agree to indemnify each other against any loss as a result of failure
of each to comply with the terms of its respective partnership agreement.
Again, no such failure is anticipated. It should also be noted that while a
third link, regarding the buy-sell provisions, involves a commonality of
timing, it does not result in any sharing whatsoever of profits and losses
between the two partnerships, because each partnership's buy-sell provisions
take into account only that partnership's assets.
There are, moreover, significant respects in which the two partnerships
are clearly different. As a matter of state law, the creditors of one
partnership (other than the senior lender) will have no rights against the
assets or the partners of the other partnership. Furthermore, there is no
sharing of profits and losses between the two partnerships. That is, the
partners of one partnership have absolutely no right to receive any of the
income of the other partnership and are similarly not responsible for any
losses it might realize. While the internal sharing arrangements of each
partnership base a shift in allocations upon the partnerships' performance on a
joint basis, it is nevertheless true that the partners of each partnership
share only the income of that partnership.
Whether persons are considered partners of each other for federal
income tax purposes depends on a consideration of a number of factors.
Commissioner v. Culbertson, 337 U.S. 733 (1949); Luna v. Commissioner, 42 T.C.
1067 (1964). A representative statement of these factors appears in Luna:
The following factors, none of which is conclusive, bear on the issue:
The agreement of the parties and their conduct in executing its terms;
the contributions, if any, which each party has made to the venture;
the parties' control over
- -------------------------
(27) The buy-sell provisions of the Management Company would similarly be
triggered.
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Crescent Real Estate Equities Company
February 13, 1998
Page 50
income and capital and the right of each to make withdrawals; whether
each party was a principal and coproprietor, sharing a mutual
proprietary interest in the net profits and having an obligation to
share losses, or whether one party was the agent or employee of the
other . . .; whether business was conducted in the joint names of the
parties; whether the parties filed Federal partnership returns or
otherwise represented to [the IRS] or to persons with whom they
dealt that they were joint venturers; whether separate books of
account were maintained for the venture; and whether the parties
exercised mutual control over and assumed mutual responsibilities for
the enterprise. (citations omitted) Id. at 1077-78.
In the present case, all the formal expressions of intent indicate that
the Commercial Partnership and the Development Partnership are separate. In
addition, neither partnership (nor its partners) has any interest in the profits
of the other partnership, and the only fact that could be construed as
obligation to share losses is the cross-collateralization of the senior debt.
Accordingly, in our opinion the Commercial Partnership and the Development
Partnership will be considered for federal income tax purposes as separate
entities and not as partners of or with each other.
c. Validity of Profit and Loss Allocations in Event of Aggregation
For purposes of the following discussion it is assumed that, contrary to
our opinion, the Commercial Partnership and the Development Partnership are
aggregated and considered to constitute a single partnership.
We note that, for purposes of applying the Gross Income Tests, each
partner of a partnership is considered to share in partnership gross income and
other items in proportion to the relative size of the partner's capital
interest in the partnership. Accordingly, if the partnerships are considered a
single partnership, Crescent Equities, through its ownership interests in the
Operating Partnership and CresWood Development, LLC, would be treated as
realizing a share of the Development Partnership's gross income corresponding
to Crescent Equities' share of the total capital interest of the joint entity.
By contrast, whether Crescent Equities would be subject to the prohibited
transactions tax of section 857(b)(6) would depend on whether Crescent Equities
would be (indirectly) allocated under the rules set forth in section 704 and
the regulations thereunder any income arising from the sale of property held
for sale to customers in the ordinary course of the entity's trade or business.
Given that the allocation and capital account maintenance provisions of both
partnerships meet the requirements of Treas.Reg. Section 1.704-1(b)(2)(ii) as
to having economic effect, the issue here is whether the allocation to Crescent
Equities of the income from the Leasing Properties and the allocation to the
other partners, including Landevco, of the income from the Development
Properties would have substantial economic effect with the meaning of
Treas. Reg. Section 1.704-1(b)(2)(iii). Under this provision, the economic
effect of an allocation is not substantial if (a) the after-tax economic
consequences of at least one partner may, in present value terms, be enhanced
compared to such consequences if the allocation were not contained in the
partnership agreement and (b) there is a strong likelihood that the after-tax
economic consequences of no
<PAGE> 51
Crescent Real Estate Equities Company
February 13, 1998
Page 51
partner will, in present value terms, be substantially diminished compared to
such consequences if the allocation were not contained in the partnership
agreement.
In the present case the test is whether the allocation to Crescent
Equities of its stated share of the income from the Leased Properties, as
opposed to some lesser percentage of the income from both the Leased Properties
and the Development Properties, (a) would provide an after-tax benefit to
Crescent Equities and (b) would not have a strong likelihood of substantially
diminishing the after-tax economic return to any partner. Given the
applicability to Crescent Equities of the prohibited transactions tax, the
first half of this test appears to be met. The facts suggest, however, that
the second half is not. That is, there is no strong likelihood that, in either
the short or the long run, the economic results of the Leased Properties will
be comparable to the economic results of the Development Properties, so that a
share of the income from the Development Properties would offset the loss of a
portion of the income from the Leased Properties. Crescent Equities and the
Operating Partnership have represented this to be the case, and it is
consistent with our experience. Cf. Treas. Reg. Section 1.704-1(b)(5),
Example(10) (allocation to a foreign partner of 90 percent of all the income
and other items from the partner's operations within that country had
substantial economic effect, where the amount of such income could not
predicted with any reasonable certainty).
Based upon the foregoing, it is our opinion that if, contrary to our
opinion, the Commercial Partnership and the Development Partnership are
considered to constitute one partnership for federal income tax purposes, the
allocations of profit and loss from the leased Properties to the partners of
the Commercial Partnership and the allocations of profit and loss from the
Development Properties to the partners of the Development Partnership will be
respected under section 704.
d. The Treatment under Gross Income Tests of Gross Income
from the Sale of Properties to Customers in the Ordinary Course
As noted above, if, contrary to our opinion, the Commercial Partnership
and the Development Partnership are considered to constitute a single
partnership for federal income tax purposes, Crescent Equities would be
considered to realize that portion of the income of the Development Partnership
from the sale of properties to customers in the ordinary course which
corresponds to the capital of Crescent Equities in the combined entity.
However, the language of section 856(c) clearly indicates that the Gross Income
Tests are applied by first excluding gross income from prohibited transactions.
This result has also been acknowledged by the IRS in a private letter ruling.
See P.L.R.9308013 (Nov. 24, 1992) ("P3 derives income from the sale of oil and
gas . . . . The Internal Revenue Service has previously ruled that Taxpayer's
share of such income (less appropriate deductions) is net income derived from
prohibited transactions within the meaning of Code section 857(b)(6). As a
result, Taxpayer's share of gross income, if any, from such sales is subject to
the 100 percent prohibited transaction tax and does not affect Taxpayer's
ability to meet the 95 percent and 75 percent income tests.")
In our opinion, if, contrary to our opinion, the Commercial Partnership
and the Development Partnership are considered to constitute one partnership
for federal income tax purposes,
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Crescent Real Estate Equities Company
February 13, 1998
Page 52
the allocation to Crescent Equities under Treas. Reg. Section 1.856-3(g) of
gross income derived from the sale of Development Properties to customers in
the ordinary course of business would not be taken into account for purposes of
determining whether Crescent Equities meets the requirements of the "Gross
Income Tests."
e. The TWC Partnerships
(i) 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.
Wood Glen Venture, Limited, Woodlands Equity Partnership-89, Southwood
Limited I, PC Retail - 93 Limited Partnership, Medical Manufacturing Partners,
Cochran's Crossing - 94 Limited, Holly Creek Apartments I Limited, Holly Creek
Apartments II Limited, Timbermill - 94 Limited, Woodlands-Sarofim #1, Ltd.,
Parkside Phase I - TWC Limited Partnership, Parkside Phase II - TWC Limited
Partnership, Village Square - TWC Limited Partnership, Grogan's Landing - TWC
Limited Partnership, Panther Creek Limited Partnership, Tamarac Pines Ltd.,
Tamarac Pines II, Ltd., and The Woodlands Mall Associates (collectively, the
"TWC Partnerships") were duly organized as limited partnership pursuant to the
Texas Uniform Limited Partnership Act (except Woodlands Equity Partnership-89,
Medical Manufacturing Partners, and The Woodlands Mall Associates, which were
formed pursuant to the Texas Uniform Partnership Act). None of the TWC
Partnerships is a corporation as defined under section 301.7701-2(b)(1), (3),
(4), (5), (6), (7) or (8) of the Treasury Regulations. Accordingly, each of
the TWC Partnerships is an Eligible Entity that can elect its classification
for federal income tax purposes for all periods on or after January 1, 1997.
You have represented that each of the TWC Partnerships claimed classification
as a partnership under the Prior Regulations. Based on the foregoing, and
assuming that none of the TWC Partnerships will file an election to be treated
as a corporation, it is our opinion that each of the TWC Partnerships 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.
(ii) 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 each of the TWC
Partnerships, its current ownership, and the provisions limiting the transfer
of partnership interests included in the partnership agreements cited above, it
is our opinion that none of the TWC Partnerships will constitute a publicly
traded partnership for purposes of section 7704 of the Code.
11. The UBS and MLI Transactions
a. Background
Pursuant to the UBS Transaction documents, Crescent Equities (1) sold
4,700,000 shares of Crescent Equities to UBS for approximately $150,000,000,
less certain fees, and (ii) entered into a forward purchase contract, at a
higher price, with respect to an equivalent number of shares. Pursuant to the
MLI Transaction documents, Crescent Equities (i) sold 5,375,000 Common Shares
to MLI for approximately $205 million and (ii) entered into a forward purchase
contract at a higher price, with respect to an equivalent number of shares.
The forward purchase contracts can be settled either in Crescent Equities
shares or, in certain circumstances at the election of Crescent Equities, in
cash.
b. Opinions
Under section 1032(a), a corporation does not recognize gain or loss
(a) upon the receipt of money or other property in exchange for its stock or
(b) with respect to any lapse or acquisition of an option to buy or sell its
stock. In Revenue Ruling 88-31, 1988-1 C.B. 30, the Internal Revenue Service
("IRS") applied this provision in a situation where a corporation issued an
investment unit consisting of its stock and a right which the IRS characterized
as a cash settlement put option (because its holder had the right to receive a
payment which increased as the value of the stock declined). Noting that,
under section 1234, gain or loss from any closing transaction with respect to,
and gain on lapse of, an option in property is generally treated as a gain or
loss from the sale or exchange of the underlying property, and that a cash
settlement option in fact settled in cash is treated as a sale or exchange of
the option, the IRS concluded that any gain resulting from the cash settlement
put option (whether settlement was in cash or via the issuance of additional
stock) covered by section 1032.
In the UBS Transaction and the MLI Transaction, the effect of the
forward contract is economically equivalent to the issuance of a put option
and the purchase of a call option on Crescent Equities shares. The issuance
of the put option is the precise subject of Rev. Rul. 88-31. There is no
logical reason to treat the purchase of a call option differently, and it is
within the rationale of Rev. Rul. 88-31. Furthermore, the purchase of a call
option is within the literal language of section 1032(a). Accordingly, it is
our opinion that any payment to Crescent Equities under the UBS Transaction
and the MLI Transaction documents will be gain that is not recognized under
section 1032(a).
The treatment of this type of item as gross income is specifically
addressed in the regulations under section 61, which define what is gross
income. Gains or losses which are not recognized are not included or deducted
from gross income, and section 1032 is specifically mentioned among the
examples of situations involving nonrecognition. Treas. Reg. Section
1.61-7(b). It therefore follows that items of this nature cannot be taken into
account under section 856(c), which looks to gross income. In our opinion,
payments to Crescent Equities under the UBS Transaction and the MLI
Transaction documents will not be taken into account under section 856(c).
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February 13, 1998
Page 53
12. 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.
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
-----------------------------------
By: Charles B. Temkin, P.C.
<PAGE> 54
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
- ----------------------------------
(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> 55
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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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
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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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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
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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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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
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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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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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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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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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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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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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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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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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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> 67
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> 68
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> 69
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> 70
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> 71
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> 72
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> 73
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> 74
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> 75
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.
<PAGE> 76
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).
<PAGE> 77
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).
<PAGE> 78
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: /s/ CHARLES B. TEMKIN
--------------------------------
Charles B. Temkin, P.C.
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(23) Section 856(e)(2).
<PAGE> 82
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> 83
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> 84
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> 85
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> 86
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> 87
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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<PAGE> 88
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> 89
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> 90
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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<PAGE> 91
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> 92
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> 93
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> 94
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> 95
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> 96
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> 97
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> 98
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: /s/ CHARLES B. TEMKIN
--------------------------------
Charles B. Temkin, P.C.
<PAGE> 99
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> 100
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> 101
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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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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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> 104
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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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> 106
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> 107
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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<PAGE> 109
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).
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<PAGE> 110
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
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<PAGE> 111
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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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.
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Crescent Real Estate Equities, Inc.
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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.
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Crescent Real Estate Equities, Inc.
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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).
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Crescent Real Estate Equities, Inc.
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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).
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Crescent Real Estate Equities, Inc.
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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.
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Crescent Real Estate Equities, Inc.
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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).
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Crescent Real Estate Equities, Inc.
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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.
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Crescent Real Estate Equities, Inc.
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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).
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Crescent Real Estate Equities, Inc.
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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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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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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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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: /s/ CHARLES B. TEMKIN
---------------------------------
Charles B. Temkin, P.C.
<PAGE> 125
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.
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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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Crescent Real Estate Equities, Inc.
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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.
July 26, 1996
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.
July 26, 1996
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.
July 26, 1996
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.
July 26, 1996
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.
July 26, 1996
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).
<PAGE> 143
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
<PAGE> 144
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
By: /s/ CHARLES B. TEMKIN
------------------------------
Charles B. Temkin, P.C.
<PAGE> 147
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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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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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).
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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).
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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).
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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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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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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).
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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).
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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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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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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
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(25) Section 856(e)(2).
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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> 161
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]
February 13, 1998
Crescent Real Estate Equities Company
777 Main Street, Suite 2100
Fort Worth, Texas 76102
Ladies and Gentlemen:
On October 16, 1997, Crescent Real Estate Equities Company ("Crescent
Equities") filed a registration statement on Form S-3, No. 333-38071, with the
Securities and Exchange Commission, which was declared effective on October 29,
1997. Such registration statement (the "Registration Statement") includes a
prospectus supplement dated February 13, 1998 (the "Prospectus Supplement") to
the prospectus dated December 12, 1997 contained in the Registration Statement
(the "Prospectus"). We have acted as special tax counsel to Crescent Equities in
connection with the Prospectus Supplement. Capitalized terms used hereunder but
not defined have the meaning ascribed to them in the Prospectus Supplement.
In rendering this opinion we have examined such documents as we have
deemed relevant or necessary, including the Prospectus Supplement, and our
conclusions are based upon the facts contained in the Prospectus Supplement. 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 Prospectus Supplement
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 preferred shares or common shares of
Crescent Equities as of the date of the Prospectus Supplement. 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
Prospectus Supplement. 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 Prospectus
<PAGE> 2
Crescent Real Estate Equities Company
February 13, 1998
Page 2
Supplement 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
