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As filed with the Securities and Exchange Commission on May 27, 1999
Registration No. 333-65037
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
AMENDMENT NO. 1
TO
FORM S-3
REGISTRATION STATEMENT
UNDER THE SECURITIES ACT OF 1933
SUNSTONE HOTEL INVESTORS, INC.
(Exact name of Registrant as specified in its charter)
MARYLAND 52-1891908
(State or other jurisdiction of (I.R.S. Employer
Incorporation) Identification Number)
903 CALLE AMANECER
SAN CLEMENTE, CALIFORNIA 92673
(Address of Principal Executive Offices)
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ROBERT A. ALTER
SUNSTONE HOTEL INVESTORS, INC.
903 CALLE AMANECER
SAN CLEMENTE, CALIFORNIA 92673
(949) 369-4000
(Name and address of Agent for Service of Process)
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Copies to:
ROGER M. COHEN, ESQ.
BROBECK, PHLEGER & HARRISON LLP
38 TECHNOLOGY DRIVE
IRVINE, CALIFORNIA 92618
(949) 790-6300
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
FROM TIME TO TIME AFTER THE EFFECTIVE DATE OF THIS REGISTRATION STATEMENT.
If the only securities being registered on this Form are being offered
pursuant to dividend or interest reinvestment plans, please check the following
box. [ ]
If any of the securities being registered on this Form are to be offered
on a delayed or continuous basis pursuant to Rule 415 under the Securities Act
of 1933, other than securities offered only in connection with dividend or
interest reinvestment plans, check the following box. [X]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule
434, please check the following box. [ ]
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
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PROSPECTUS
SUNSTONE HOTEL INVESTORS, INC.
447,000 WARRANTS TO PURCHASE COMMON STOCK
447,000 SHARES OF COMMON STOCK
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This Prospectus relates to the issuance of warrants (the "Warrants") to
purchase up to 447,000 shares of common stock, par value $.01 per share ("Common
Stock"), at prices ranging from $9.50 to $16.63 per share (the "Warrant Shares",
together with the Warrants, the "Offered Securities"), of Sunstone Hotel
Investors, Inc. a Maryland corporation ("Sunstone" or the "Company"). The
Warrants have an expiration date of September 24, 2003.
The Company is a self-administered equity real estate investment trust
that owns luxury, upscale and mid-price hotels located primarily in the Pacific
and Mountain regions of the western United States. The hotels operate under
nationally recognized franchises, including brands affiliated with Marriott
International, Inc., Bass Hotels and Resorts, Hilton Hotels Corporation and
Promus Hotel Corporation. The Warrants have been issued under the Company's 1994
Stock Incentive Plan (the "Option Plan") to Messrs. Robert Alter, the Chief
Executive Officer and Chairman of the Company, and Charles Biederman, the
Executive Vice President and Vice Chairman of the Company, in consideration for
their surrender of options to purchase an aggregate of 447,000 shares of Common
Stock previously granted to such individuals under the Option Plan. Such options
were intended to provide a source of funding for the obligations of Messrs.
Alter and Biederman to support stock appreciation rights ("SARs") granted by
Sunstone Hotel Properties, Inc. (the "Lessee") to its employees under its 1996
Stock Appreciation Rights Plan ("SAR Plan"). The SAR Plan will be terminated by
the Lessee and the holders of outstanding SARs will be given an opportunity to
surrender such SARs in exchange for an assignment from Messrs. Alter and
Biederman of the Warrants. The Warrants will become exercisable on October 25,
1999. The Company will not receive any cash proceeds from the issuance of the
Warrants, but will receive the cash proceeds of all shares of Common Stock
purchased upon exercise of the Warrants.
The Common Stock is traded on the New York Stock Exchange (the "NYSE")
under the symbol "SSI." On May 24, 1999, the last reported sale price of Common
Stock on the NYSE was $9.3125 per share. To ensure compliance with certain
requirements related to the Company's qualification as a real estate investment
trust ("REIT") under the Internal Revenue Code of 1986, as amended, the
Company's Articles of Incorporation limits the number of shares of Common Stock
that may be owned by any single person or affiliated group to no more than 9.8%
of the outstanding shares of Common Stock (the "Ownership Limitation") and
restricts the transferability of Common Stock if the purported transfer would
prevent the Company from qualifying as a REIT. See "Risk Factors -- Limitation
on Acquisition and Change in Control" and "Description of Common Stock --
Provisions of Maryland Law and of the Company's Articles of Incorporation and
Bylaws."
SEE "RISK FACTORS" BEGINNING ON PAGE 6 FOR A DISCUSSION OF CERTAIN
FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE SECURITIES
OFFERED HEREBY.
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THESE SECURITIES HAVE NOT BEEN APPROVED
OR DISAPPROVED BY THE SECURITIES AND EXCHANGE
COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF
THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
----------------------------------------------------
The date of this prospectus is May __, 1999.
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AVAILABLE INFORMATION
The Company is subject to the information requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith files reports, proxy statements and other information with the
Securities and Exchange Commission (the "Commission"). Such reports, proxy
statements and other information filed by the Company can be inspected and
copied at the public reference facilities maintained by the Commission at Room
1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at
regional offices of the Commission located at 7 World Trade Center, 13th Floor,
New York, New York 10048 and Citicorp Corp. Center, 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661-2511. Copies of such material can be
obtained by mail from the Public Reference Section of the Commission, 450 Fifth
Street, N.W., Washington, D.C. 20549 at prescribed rates. The Commission also
maintains a web site that contains reports, proxy and information statements and
other information regarding registrants that file electronically with the
Commission, such as the Company, and the address is http://www.sec.gov. The
Company's Common Stock is listed on the NYSE, and reports, proxy statements and
other information concerning the Company can be inspected at the offices of The
New York Stock Exchange, Inc., 20 Broad Street, New York, New York 10005.
The Company has filed with the Commission a Registration Statement on
Form S-3 under the Securities Act of 1933, as amended (the "Securities Act"),
and the rules and regulations promulgated thereunder, with respect to the
Offered Securities. This Prospectus, which is part of the Registration
Statement, does not contain all of the information set forth in the Registration
Statement and the exhibits thereto. For further information concerning the
Company and the Offered Securities, reference is made to the Registration
Statement and the exhibits and schedules filed therewith, which may be obtained
as described above.
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INCORPORATION OF CERTAIN INFORMATION BY REFERENCE
The following documents, which have been filed with the Commission, are
hereby incorporated by reference:
1. Annual Report on Form 10-K of the Company for the fiscal
year ended December 31, 1998. The discussion regarding
the proposed acquisition of the Company and related
legal proceedings commencing on page 6 of this
Registration Statement should be read in conjunction
with the Company's consolidated financial statements
included in such Annual Report on Form 10-K;
2. Quarterly Report on Form 10-Q for the quarter ended
March 31, 1999;
3. Current Report on Form 8-K filed with the Commission on
April 8, 1999; and
4. The description of the Common Stock of the Company
included in the Company's Registration Statement on Form
8-A, filed with the Commission on June 26, 1995; and on
Form 8-A/A, filed with the Commission on July 19, 1996.
In addition, all reports and other documents subsequently filed by the
Company with the Commission pursuant to Section 13, 14 or 15(d) of the Exchange
Act after the date of this Prospectus and prior to the termination of the
offering shall be deemed to be incorporated by reference in this Prospectus and
to be a part hereof from the date of the filing of such documents (such
documents, and the documents enumerated above, being herein referred to as
"Incorporated Documents"; provided however, that the documents enumerated above
or subsequently filed by the Company pursuant to Section 13, 14 or 15(d) of the
Exchange Act prior to the filing by the Company of any subsequent Annual Report
on Form 10-K with the Commission shall not be Incorporated Documents or be
incorporated by reference in this Prospectus or be a part hereof from and after
any such filing of an Annual Report on Form 10-K). Any statement contained in a
document incorporated or deemed to be incorporated by reference herein shall be
deemed to be modified or superseded for purposes of this Prospectus to the
extent that a statement contained herein (or in any other subsequently filed
document which also is or is deemed to be incorporated by reference herein)
modifies or supersedes such statement. Any statements so modified or superseded
shall not be deemed to constitute a part of this Prospectus, except as so
modified or superseded.
The Company will provide without charge to each person to whom this
Prospectus is delivered, upon written or oral request of such person, a copy of
any or all of the documents referred to above which have been or may be
incorporated by reference in this Prospectus (other than certain exhibits to
such documents). Requests for such documents should be directed to Sunstone
Hotel Investors, Inc., 903 Calle Amanecer, San Clemente, California 92673,
Attention: Secretary (telephone: (949) 369-4000).
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PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and financial statements and the notes thereto appearing elsewhere
herein or incorporated by reference herein. Unless the context otherwise
indicates, all references herein to the "Company" include Sunstone Hotel
Investors, Inc. and the Sunstone Hotel Investors, LP (the "Partnership"). This
Prospectus, including the Incorporated Documents, may contain forward-looking
statements within the meaning of Section 27A of the Securities Act and Section
21E of the Exchange Act. The Company's actual results could differ materially
from those set forth in any such forward-looking statements. Certain factors
that might cause such a difference are discussed in the sections entitled "Risk
Factors" commencing on page 6 of this Prospectus and in certain of the
Incorporated Documents. The Company cautions the reader, however, that the
factors discussed in those sections may not be exhaustive.
THE COMPANY
The Company is a self-administered, equity real estate investment trust
("REIT") that, through its 94.8% ownership interest in Sunstone Hotel Investors,
LP, owns and leases luxury, upscale and mid-price hotels located primarily in
the Pacific and Mountain regions of the western United States (the "Primary
Region"). The hotels operate primarily under national franchises that are among
the most widely recognized in the lodging industry, including brands affiliated
with Marriott International, Inc., Bass Hotels and Resorts, Hilton Corporation
and Promus Hotel Corporation.
The Company's growth strategy is to maximize shareholder value by (i)
acquiring underperforming and undercapitalized hotels that are in strong market
locations with significant barriers to entry and (ii) improving such hotels'
financial performance by renovating, redeveloping, repositioning and rebranding
the hotels, and through the implementation of focused sales and marketing
programs.
The Company was incorporated as a Maryland corporation in 1995 and is
structured as a REIT. The Company's principal executive offices are located at
903 Calle Amanecer, San Clemente, CA 92673, and its telephone number is (949)
369-4000.
The Company leases its hotels to the Lessee pursuant to separate
percentage leases (the "Percentage Leases") which provide for rent payments
equal to the greater of (i) fixed based rent and (ii) percentage rent based on
room revenues, Lessee's food and beverage revenues and sublease and concession
rentals. The Lessee is owned by Mr. Alter, Chief Executive and Chairman of the
Company (80%), and Mr. Biederman, Executive Vice President and Director of the
Company (20%). The Lessee has entered into a management agreement pursuant to
which all of the hotels it leases from the Company are managed by Sunstone Hotel
Management, Inc. (the "Management Company"), of which Mr. Alter is the sole
shareholder.
THE TRANSACTION
The Lessee adopted the SAR Plan in 1996 for the benefit of its
employees. Under the SAR Plan, the Lessee's employees were granted SARs with an
exercise price tied to the fair market value of the Company's Common Stock on
the date of grant of the SAR. A SAR entitles the holder, to the extent vested in
the SARs, to exercise the SAR and receive from the Lessee a cash payment equal
to the excess of the fair market value of the Common Stock on the date of
exercise over the SAR exercise price. Messrs. Alter and Biederman agreed to
contribute in cash, in the 80%/20% proportion reflecting their respective
ownership interests in the Lessee, the amount necessary to enable the Lessee to
pay the amounts due to the Lessee's employees upon exercise of their SARs, to
the extent the Lessee did not otherwise have sufficient cash available to meet
such obligation. In consideration for their services to the Company, the Company
granted Messrs. Alter and Biederman options under the Option Plan to purchase up
to an aggregate of 447,000 shares of Common Stock (the "SAR Support Options") at
prices ranging from $9.50 to $16.63 per share to provide Messrs. Alter and
Biederman with a source of cash to fund this obligation to the Lessee.
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The Lessee has determined that it is in its best interests to terminate
the SAR Plan because of the negative impact on its financial statements caused
by the appreciation in the fair market value of the Company's Common Stock over
the SAR exercise prices, which is treated as compensation expense to the Lessee.
To continue to incentivize current SAR holders, however, Messrs. Alter and
Biederman have agreed to assign them warrants to purchase the Company's Common
Stock ("Warrants") to replace the SARs, which the SAR holders will be requested
to surrender to the Lessee for cancellation. The Company has agreed to issue to
Messrs. Alter and Biederman the Warrants in exchange for the surrender of their
outstanding SAR Support Options. Messrs. Alter and Biederman have agreed to the
surrender for cancellation of the SAR Support Options as they will no longer be
necessary.
The exercise price for each Warrant issued to Messrs. Alter and
Biederman is the same exercise price as applied under the SAR Support Option
which such Warrant replaces and accordingly ranges from $9.50 to $16.63 per
share. Each Warrant has an expiration date of September 24, 2003.
Upon assignment of the Warrants by Messrs. Alter and Biederman to the
SAR holders, the Warrant Shares purchasable upon exercise of each such Warrant
may be subject to repurchase by the assignors (in the ratio of 80% by Mr. Alter
and 20% by Mr. Biederman), at the Warrant exercise price paid per share, in the
event the assignee terminates service with the Lessee prior to vesting in the
Warrant Shares. Such repurchase right will lapse and the assignee will vest in
the Warrant Shares in installments over the assignee's continued period of
service with the Lessee. The installment schedule and the other provisions
regarding the repurchase right of Messrs. Alter and Biederman will be set forth
in an agreement entered into in connection with the assignment of the Warrants.
The number of Lessee's employees who currently hold outstanding SARs and
are therefore entitled to receive an assignment of the Warrants is approximately
96.
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RECENT DEVELOPMENTS
PROPOSED ACQUISITION OF THE COMPANY
On April 5, 1999, the Company received an offer by SHP Acquisition, LLC
("SHP Acquisition"), formed by Robert A. Alter, certain management personnel of
the Lessee and Westbrook Funds III. The Lessee leases and operates each of the
Company's 56 hotels and is owned by Robert A. Alter, Chairman, President and
Chief Executive Officer of the Company and Charles L. Biederman, Vice Chairman
and Executive Vice President of the Company. Westbrook Partners LLC is a New
York based real estate opportunity fund, an affiliate of which is a 9.6%
stockholder in the Company, whose managing principal, Paul Kazilionis, is a
director of the Company. The acquisition proposal is for all of the common stock
of the Company at $9.50 to $10.00 in cash per share. Under this proposal, the
holders of outstanding units in the Partnership other than the Company ("Units")
would receive, at their option, either cash in an amount per Partnership unit
equal to the cash price per common share or redeemable perpetual preferred units
in the Partnership having a face value equal to the cash price. The Company's
7.9% Class A Preferred Stock would be redeemed in accordance with its term of a
cash amount equal to its liquidation preference plus accrued and unpaid
dividends. The acquisition proposal is subject to certain conditions, including
due diligence review of the Company and obtaining the necessary financing.
In response to the acquisition proposal, the Company formed a Special
Committee of the Board of Directors, comprised of all the independent members of
the Board of Directors, to study the proposal and consider the Company's
alternatives. The Special Committee has appointed Goldman, Sachs & Co. to act as
its independent financial advisor to evaluate the proposal made by SHP
Acquisition and to review the Company's strategic alternatives. The Special
Committee also appointed the law firm of Altheimer & Gray to act as its
independent legal advisor. The Special Committee and its advisors are currently
in the process of considering the acquisition proposal and the Company's
alternatives.
In connection with the proposed acquisition, eight lawsuits have been
filed naming the Company, certain directors and officers of the Company and
other parties as defendants. The factual basis alleged to underlie all eight
lawsuits are essentially identical. Substantively, they assert that Robert A.
Alter, Charles L. Biederman and Paul Kazilionis, in conjunction with Westbrook
Partners, LLC (and other purported Westbrook affiliated entities), SHP
Acquisition and the Lessee, have offered an unfair buyout price for the
outstanding shares of the Company. Plaintiffs in each of these lawsuits purport
to seek both injunctive relief and damages on behalf of the purported class
based upon these allegations.
Management is unable to determine whether these lawsuits will have a
material adverse effect on the Company's financial position or results of
operations. Management's current intentions are to defend the actions
vigorously.
RISK FACTORS
DISTRIBUTION OF SUBSTANTIALLY ALL CASH AVAILABLE FOR DISTRIBUTION
Our hotels generate cash flow in the form of rent we receive from the
Lessee, the entity that leases and operates our hotels. The Lessee's rent is
tied to hotel operating performance and consists of base rent and rent that is a
percentage of certain hotel revenues. In addition, we also have cash available
from our credit facility with certain lenders (led by Bank One of Arizona, N.A.,
as agent bank) (the "Credit Facility") with a maximum commitment of $350.0
million with the actual availability based on our assets and financial
performance. We also have been able to raise cash by issuing equity securities
in the public markets. We use these three sources of cash -- from hotel
operations, from borrowings and from sales of stock -- to fund our acquisition
of hotels, renovation of hotels, recurring capital expenditures, operating
expenses and the payment of dividends to our shareholders. Because of the recent
conditions in the capital markets, it is currently difficult for many companies,
especially REITs, to raise capital by issuing debt or equity securities.
Therefore, we are more dependent on our cash flows from hotel operations and
from our Credit Facility to fund our obligations. During the three months ended
March 31, 1999, we paid out approximately $11.8 million in distributions to our
stockholders and minority interests which was approximately 84% of our $14.0
million of funds from operations. If our operating cash flows decreased or our
availability under the Credit Facility were reduced, it would be necessary for
us to reduce future acquisitions, defer
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or reduce the scope of renovations or capital expenditures, sell assets
(including hotels) or to reduce our dividends paid to shareholders.
TOTAL DEPENDENCE ON THE LESSEE AND PAYMENTS UNDER THE PERCENTAGE LEASES
Because of our status as a REIT, we are prohibited from operating hotels
and must lease them to the Lessee or other third parties. Our ability to pay
dividends to our shareholders depends on our Lessee's ability to generate
sufficient revenue to pay percentage rent required under the Percentage Leases.
We chose the Lessee because Messrs. Alter and Biederman, who own the Lessee,
were involved in the management of certain hotels contributed as part of our
initial public offering ("IPO") in 1995, and are motivated to maximize
percentage rent paid under the Percentage Leases through their financial and
ownership interests in us.
The Lessee has incurred significant losses since its inception in 1995.
At March 31, 1999, the Lessee's stockholders' deficit amounted to $9.7 million.
At March 31, 1999, the Lessee's rent payable to the Company amounted to $12.3
million. Also at March 31, 1999, the Lessee's current liabilities exceeded its
current assets by $9.1 million. The ability of the Lessee to fund its daily
operations and continue to remain current on its substantial rent obligation to
the Company is a result of the original terms under the Percentage Leases, for
the payment of rent to the Company, which allow monthly base rent to be paid in
arrears and monthly percentage rent to be paid within 45 days after the
respective month-end. There can be no assurances, however, that the Lessee will
continue to make its rent payments in a timely fashion.
According to the Lessee, the losses are due to several factors,
including:
o the substantial number of renovations we undertook adversely
affected occupancy rates and revenues at the hotels;
o renovations caused greater revenue losses than expected; and
o poorer performance at certain hotels than expected.
There can be no assurance that the Lessee will generate adequate
operating cash flows to meet its obligations. Other than its cash flow generated
by operating the hotels, the Lessee has no financial resources or other assets
to pay its operating obligations or its rent under the Percentage Leases.
Messrs. Alter and Biederman have pledged a subordinated interest in 481,955
Units to secure the Lessee's obligations under the Percentage Leases. However,
if the Lessee defaults under the Percentage Leases, the value of these Units and
other assets of the Lessee will be insufficient to satisfy our claims against
the Lessee.
RISKS RELATED TO DEVELOPMENT AND RENOVATION OF HOTELS
Subject to obtaining adequate capital resources, we intend to continue
our growth strategy of acquiring hotels needing substantial renovation or
redevelopment. This strategy creates significant risks including the following:
o We may continue to incur significant renovation and construction
cost overruns and time delays due to:
o labor shortages;
o changes in the scope of a project;
o requirements imposed by local building inspectors;
o discovery of defects in the building once renovation has begun;
and
o compliance with the Americans with Disabilities Act of 1990,
which may require expensive modifications to existing hotels to
bring them into compliance.
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o We may purchase a hotel or contract to acquire a hotel (after a
third party completes construction) when market conditions are
favorable but then face deteriorated local demand for hotel
rooms when the hotel is available for occupancy resulting in
revenues that are less than projected;
o We may complete our renovation after significant delays reducing
the amount of revenues expected to be received during the delay
period; and
o We may spend more than budgeted for a renovation project
reducing our anticipated return on the investment.
CONFLICTS OF INTEREST BETWEEN THE COMPANY AND CERTAIN OFFICERS AND DIRECTORS
The relationship among Mr. Alter and Mr. Biederman, the Lessee, the
Management Company and us creates several inherent conflicts of interest that
may result in decisions being made by our management that are not in the best
interests of our stockholders. The most significant conflicts of interest
include the following:
o As the owners of the Lessee, Mr. Alter and Mr. Biederman will
benefit from any profits the Lessee may generate from the
operation of the hotels and retain for itself, even though under
an agreement, Messrs. Alter and Biederman have agreed to
reinvest the Lessee's profits (net of tax liabilities) in
additional units or retain the profits as security for future
rent payments.
o As the owner of the Management Company, Mr. Alter is entitled to
the profits of the Management Company, which receives from the
Lessee management fees (1% to 2% of gross revenues of the
hotels) and reimbursements for certain accounting expenses.
o The Percentage Leases generally require us to pay a termination
fee to the Lessee if we elect to sell a hotel and not replace it
with a Percentage Lease for another hotel. As a result, our
decisions about which hotels to sell may be influenced by the
conflict of interest of Messrs. Alter and Biederman who, as
owners of the Lessee, would benefit from the termination fee.
o In connection with our IPO, Messrs. Alter and Biederman
contributed tax free certain hotels that had a tax basis less
than their fair market value. Significant taxable gains that
would arise if we were to sell these hotels would be
specifically allocated to Messrs. Alter and Biederman. Further,
in order to prevent adverse tax consequences to Messrs. Alter
and Biederman, we must maintain mortgage debt at certain minimum
levels. Because of these conflicts, our decisions concerning
whether to sell certain hotels or to incur or repay debt will be
influenced by the tax consequences for Messrs. Alter and
Biederman.
o We did not negotiate the Percentage Leases on an arm's length
basis with the Lessee. The base rent, percentage rent and the
economic terms of each Percentage Lease are determined by us and
approved by the Lessee based on historical financial data and
projected operating and financial data for each hotel. See
"Total Dependence on the Lessee and Payments under the
Percentage Leases."
RELIANCE ON MR. ALTER AND OTHER KEY PERSONNEL
Our success depends in large part upon our ability to attract and retain
highly qualified personnel. Further, because our sole source of operating
revenue is base and percentage rent paid by the Lessee, our success is also
dependent on the Lessee's management's ability to effectively operate the
hotels. Competition for qualified employees for us and the Lessee is extremely
intense and there is no assurance that we or the Lessee can attract and retain
qualified employees. In particular, we substantially rely on the hotel and real
estate knowledge and experience and continuing services of Mr. Robert Alter, our
Chairman, Chief Executive Officer and President. Our inability (or the Lessee's)
to attract and retain qualified employees could negatively affect our ability to
generate revenues and pay distributions to our shareholders.
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INVESTMENT CONCENTRATION IN SINGLE INDUSTRY
Our investment strategy is to focus exclusively on acquiring and owning
hotels. This strategy concentrates all our investment in a single industry and
therefore does not diversify our sources of revenues. As a result, a downturn in
the hotel industry will have a greater impact on our revenues and funds from
operations than if we had a diversified portfolio of properties. In addition,
because we have focused on the western United States and in the luxury, upscale
and mid-price segments of the hotel industry, economic or other conditions that
affect this geographic region or these segments may disproportionately impact
us.
FAILURE TO REALIZE BENEFITS OF RECENT ACQUISITIONS
We have grown rapidly since our IPO. This growth has required us, and,
to a greater extent, the Lessee to develop scaleable operating systems, develop
construction management procedures and systems and other procedures and systems
to operate our multi-state hotel portfolio. If we, or the Lessee, fail to
effectively integrate the acquired hotels into our operating systems, then we
will not achieve the expected benefits of the acquisition.
The revenues generated by the hotels we acquire are used to pay the debt
service on the funds we borrow to fund these acquisitions. If the acquired
hotels do not generate sufficient cash flow to fund debt service on the money
borrowed to purchase those hotels, we will be required to service the debt with
cash flows from other hotels which might adversely affect our cash available for
other purposes, including distributions to our shareholders.
FAILURE TO MAINTAIN REIT STATUS
We intend to operate so as to be taxed as a REIT under the Internal
Revenue Code of 1986, as amended. As long as we qualify for taxation as a REIT,
with certain exceptions, we will not be taxed at the corporate level on our
taxable income that is distributed to our shareholders. A REIT is subject to a
number of organizational and operational requirements, including requirements as
to the nature of its income and assets, distribution requirements, diversity of
stock ownership requirements and record-keeping requirements. We intend to
satisfy all of these requirements for treatment as a REIT. It is possible that
we may fail to satisfy one or more of these requirements. Failure to qualify as
a REIT would render us subject to tax on our income at regular corporate rates
and we could not deduct distributions to our shareholders. Unless entitled to
relief under certain Internal Revenue Code provisions, we also would be
disqualified from treatment as a REIT for the four taxable years following the
year during which qualification was lost. Even if we qualify for taxation as a
REIT, we may be subject to certain state and local taxes on our income and
property.
In order for us to be taxed as a REIT, the Partnership must be
classified as a partnership for federal income tax purposes. If the Partnership
were to be taxable as a corporation, because our ownership interest in the
Partnership constitutes more than 10% of the Partnership's voting securities and
exceeds 5% of the value of our assets, we would cease to qualify as a REIT. The
imposition of corporate income tax on us and the Partnership would substantially
reduce the amount of cash available for distribution to our shareholders.
OWNERSHIP LIMITATION
In order for us to maintain our qualification as a REIT, not more than
50% in value of our outstanding stock may be owned, directly or indirectly, by
five or fewer individuals (which includes certain entities). Furthermore, if any
shareholder or group of shareholders of the Lessee owns, actually or
constructively, 10% or more of our stock we would likely lose our REIT status.
To protect our REIT qualification, our Articles of Incorporation prohibit direct
or indirect ownership of more than 9.8% of the outstanding shares of our stock
by any person or group. Generally, the capital stock owned by affiliated owners
will be aggregated for purposes of this ownership limitation. Subject to certain
exceptions, any stock subject to a purported transfer that would prevent us from
continuing to qualify as a REIT will be designated as "Shares-in-Trust" and
transferred automatically to a trust effective on the day before the purported
transfer of such stock. The record holder of the common or preferred stock that
are designated as Shares-in-Trust will be required to submit such number of
shares of stock to the trust and the beneficiary of the trust will be one or
more charitable organizations that are named by us.
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INABILITY TO RETAIN EARNINGS
In order to qualify as a REIT, we generally are required each year to
distribute to our shareholders at least 95% of our net taxable income (excluding
any net capital gain). In addition, we are subject to a 4% nondeductible excise
tax on the amount, if any, by which certain distributions paid by us with
respect to any calendar year are less than the sum of (i) 85% of our ordinary
income, (ii) 95% of our capital gain net income for that year, and (iii) any
undistributed taxable income from prior periods. We intend to continue to make
distributions to our shareholders to comply with the 95% distribution
requirement and to avoid the nondeductible excise tax. Differences in timing
between taxable income and cash available for distribution to our shareholders
due to the seasonality of the hospitality industry could require us to borrow
funds on a short-term basis to meet the 95% distribution requirement and to
avoid the nondeductible excise tax.
THE COMPANY MAY NOT BE ABLE TO CONTINUE ITS EXTERNAL GROWTH RATE
Our growth strategy has been to acquire underperforming and
undercapitalized hotels located in strong markets where we believe significant
barriers to entry exist. We then seek to improve the hotels' financial
performance by renovating, redeveloping, and repositioning the hotels and
requiring the Lessee to implement a focused sales and marketing program. The
current conditions in the equity and debt capital markets limit our ability to
access new capital on favorable terms. Without additional capital to fund
acquisitions we will not be able to continue to acquire additional hotels. We
anticipate that our acquisition activity will diminish significantly for the
remainder of 1999. Accordingly, we cannot assure you that our external growth
rate will equal or exceed our recent historical external growth rate.
ENVIRONMENTAL RISKS
Various federal, state and local laws subject property owners or
operators to liability for the costs of removal or remediation of certain
hazardous substances released on property. These laws often impose liability
without regard to whether the owner or operator knew of, or was responsible for,
the release of the hazardous substances. The presence of or the failure to
properly remediate hazardous substances may adversely affect occupancy of a
contaminated hotel property, the ability to operate hotels, and our ability to
sell or borrow against contaminated properties. In addition to the costs
associated with investigation and remediation actions brought by governmental
agencies, the presence of hazardous waste on a property could result in personal
injury or similar claims or lawsuits.
Various laws also impose, on persons who arrange for the disposal or
treatment of hazardous or toxic substances, liability for the cost of removal or
remediation of hazardous or toxic substances at the disposal or treatment
facility. These laws often impose liability whether or not the person arranging
for the disposal ever owned or operated the disposal facility. The obligation to
pay for these costs or our inability to pay for such costs, could adversely
affect our operating costs and the value of our properties.
Phase I environmental site assessments have been obtained on all of our
owned properties. The purpose of Phase I environmental site assessments is to
identify potential sources of contamination for which an owner may be
responsible and to assess the status of environmental regulatory compliance.
None of the environmental site assessments revealed any environmental condition,
liability or compliance concern that we believe would have a material adverse
affect on our business, assets or results of operations. Nor are we aware of any
such condition, liability or concern by any other means. However, it is possible
that the environmental site assessments relating to any one of the properties
did not reveal all environmental conditions, liabilities or compliance concerns
that arose at a property before or after the related review was completed.
REAL ESTATE INVESTMENT RISKS IN GENERAL
Each of our hotels are subject to a variety of risks associated with
real estate ownership. Some of these risks include:
o Changes in national and local economic conditions;
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o Changes in interest rates;
o Changes in costs of, or terms of, loans from lenders;
o Changes in environmental laws;
o The ongoing requirement to make capital improvements, repairs or
maintenance;
o Changes in the tax rates or laws;
o The continuing requirement to pay operating expenses;
o Changes in governmental requirements or zoning laws;
o Occurrences beyond the control of an owner, such as natural
disasters like earthquakes and weather, civil unrest or
so-called "acts of God;"
o The possibility of unexpected, uninsured or under-insured
losses; and
o Condemnation by a government agency seeking to use a property
for a public purpose.
Risks such as those listed above, and other risks which may occur from
time to time, may adversely affect our profit from the property because they
cause increased costs, expenses, liabilities, restrictions and operational
delays. Such risks may also affect the price we may obtain on a sale of a
property or whether the property can be sold at all.
UNINSURED AND UNDER-INSURED LOSSES
We carry comprehensive policies of insurance for our hotels which
include liability for personal injury, property damage, fire and extended
coverage. We believe the coverage we carry is typical and customary for owners
of hotels such as ours. Even though we carry the insurance referenced above,
certain losses may be uninsurable by virtue of the type or amount of loss.
Losses which result from catastrophes, such as hurricanes, tornadoes,
earthquakes, floods or so-called "acts of God," may fall within that category.
More than half of our hotels are located in California and the Pacific
northwest, an area which is subject to a high degree of seismic activity and
risk. Although we carry earthquake insurance for our hotels, there is no
assurance that such insurance will be available in the future under terms and
amounts which are sufficient to provide adequate protection. It also could be
possible that the current insurance coverage we carry would not be sufficient to
pay the full market value or replacement cost of an affected hotel with a
resulting loss of our entire investment. Therefore, a possibility does exist for
substantial uninsured or under-insured losses as a result of an earthquake.
Other factors also affect whether a loss is uninsured or under-insured
and may include inflation, changes in law or environmental contamination. Such
factors may affect whether insurance proceeds received by us are adequate to
restore our entire investment in the property. Factors such as these may also
make it impractical to use insurance proceeds to replace or repair our property
after it has been damaged or destroyed.
BECAUSE REAL ESTATE INVESTMENTS ARE ILLIQUID, WE MAY NOT BE ABLE TO SELL
PROPERTIES WHEN APPROPRIATE
Real estate investments generally cannot be sold quickly. We may not be
able to vary our portfolio promptly in response to economic or other conditions.
This inability to respond promptly to changes in the performance of our
investments could adversely affect our financial condition and ability to
service debt and make distributions to our shareholders.
OUR EARNINGS AND CASH DISTRIBUTIONS WILL AFFECT THE MARKET PRICE OF OUR PUBLICLY
TRADED SECURITIES
We believe that the market value of a REIT's equity securities is based
primarily upon the market's
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<PAGE> 13
perception of the REIT's growth potential and its current and potential future
cash distributions, and is secondarily based upon the real estate market value
of the underlying assets. For that reason, REIT shares may trade at prices that
are higher or lower than the net asset value per share. To the extent we retain
operating cash flow for investment purposes, working capital reserves or other
purposes, these retained funds, while increasing the value of our underlying
assets, may not correspondingly increase the market price of our shares. Our
failure to meet the market's expectations with regard to future earnings and
cash distributions would likely adversely affect the market price of our
publicly traded securities.
YEAR 2000 ISSUE
The term "Year 2000 issue" is a general term used to describe the
complications that may be caused by existing computer hardware and software that
were designed by the respective manufacturers without consideration of the
upcoming change in the century. Many computer systems recognize calendar years
by the last two digits in the date code field. Beginning in the year 2000, these
date code fields will need to accept four digit entries to distinguish
twenty-first century dates from twentieth century dates. If not corrected,
computer systems may fail or create erroneous results which could have
significant negative operational and financial consequences. We have adopted a
Year 2000 Compliance Program (the "Compliance Program") to minimize disruptions
to our business which could be caused by computer system error or failure. These
computerized systems include information and non-information technology systems
and applications, as well as, financial and operational reporting systems. For
discussion of the Company's and the Lessee's efforts to address the Year 2000
issue and the related Compliance Program. See "Year 2000 Issue" elsewhere
herein.
There can be no assurances that our Compliance Program will be properly
and timely completed, and failure to do so could have a material adverse effect
our business operations and financial condition. We cannot predict the actual
effects of the Year 2000 issue on our business operations and financial
condition. The actual effects may be impacted by: (i) whether significant third
parties properly and timely address the Year 2000 issue; and (ii) whether
broad-based or systemic economic failures may occur. We are also unable to
predict the severity and duration of any such failures, which could include
disruptions in passenger transportation or transportation systems generally,
loss of utility and telecommunications services, the loss or disruption of hotel
reservations made on centralized reservation systems and errors or failures in
financial transactions or payment processing systems such as credit cards. Due
to the general uncertainty inherent in the Year 2000 issue and our dependence on
third parties, we are unable to determine at this time whether the consequences
of Year 2000 failures will have a material impact on us. Our Compliance Program
is expected to significantly reduce the level of uncertainty about the Year 2000
issue and we believe that the possibility of significant interruptions of normal
operations should be reduced.
MARKET INTEREST RATES MAY HAVE AN EFFECT ON THE VALUE OF OUR PUBLICLY TRADED
SECURITIES
One of the factors that investors consider important in deciding whether
to buy or sell shares of a REIT is the distribution rate on such shares (as a
percentage of the price of such shares) relative to market interest rates. If
market interest rates go up, prospective purchasers of REIT shares may expect a
higher distribution rate. Higher interest rates would not, however, result in
more funds for us to distribute and, in fact, would likely increase our
borrowing costs and potentially decrease funds available for distribution. Thus,
the higher market interest rates could cause the market price of our publicly
traded securities to go down.
HOTEL INDUSTRY RISKS
Operating Risks. In addition to the investment risks associated with
investing all of our resources in the hotel industry, we face operating risks
associated with hotels. These risks include, among others, the following:
o Competition for customers at our hotels from other hotels, many
of which are owned by competitors who have significantly greater
financial resources and marketing power and therefore compete
with our hotels;
o The risk of loss of market share in areas in which overbuilding
occurs and adversely affects occupancy, average daily room rate
("ADR") and revenue per available room ("REVPAR");
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<PAGE> 14
o Erosion of operating margins arising from an increase in
operating costs due to inflation or other factors that may
exceed increases in REVPAR;
o Dependence on demand for our accommodations from both business
travelers, commercial travelers and tourism, each of which may
be affected in different markets by different economic factors;
o Strikes and other labor disturbances by the Lessee's employees
which would seriously disrupt the Lessee's ability to provide
services to hotel guests;
o The deterioration of economic conditions either generally or in
particular markets in which our hotels are located causing a
reduction in demand for our accommodations.
The Lessee's operating results at our hotels are directly affected by
the factors described above and a significant decrease in operating revenues by
the Lessee will adversely affect the Lessee's ability to make payments of rent
under the percentage leases. Any reduction in such rent will reduce our cash and
could adversely affect our ability to make distributions to our stockholders.
Seasonality of Hotel Business and Our Hotels. The hotel industry in
general is seasonal with certain periods generating greater revenues than
others. In particular, our revenues are greater in the second and the third
quarters than in the first and the fourth quarters. In addition, winter weather
in the markets in which our hotels operate can severely impact the operating
results of particular hotels. The Lessee's revenues can vary significantly from
quarter to quarter. It is possible that the significant fluctuation of revenues
in a particular quarter due to weather or other factors could cause us to earn
less percentage rent than we had originally anticipated which could have an
adverse effect on our ability to make distributions to our stockholders.
Increased Competition from Overbuilding. The hotel industry has
historically experienced cycles of overbuilding in certain geographic markets
and product segments. This overbuilding increases competition for hotel guests,
resulting in lower occupancies and lower ADRs thereby reducing revenues of the
hotels effected by the increased competition. While our investment strategy is
to acquire underperforming hotels in markets where we believe there are
significant barriers to entry, we can give no assurance that the current hotel
development activities, particularly in the limited service segment, will not
create additional significant competition for our hotels. This increased
competition would reduce the revenues generated by the Lessee at the effected
hotel, thus reducing percentage rent we receive and therefore potentially
adversely effecting our distributions to our stockholders.
Impact of Increased Operating Costs and Capital Expenditures. Our hotels
need to be periodically renovated and furniture, fixtures and equipment replaced
in order to remain competitive in their markets and to comply with the terms of
franchise agreements under which our hotels are operated. Under our Percentage
Leases, we are obligated to make available to the Lessee for periodic
refurbishment of furniture, fixtures and equipment an amount equal to four
percent (4%) of the room revenues of each hotel. Our ability to fund these and
other capital expenditures including periodic replacement of furniture, fixtures
and equipment will depend in part on the financial performance of the Lessee and
our hotels. If these expenditures exceed our estimates, then the increased costs
would adversely effect the cash available for other purposes such as making
distributions to our stockholders. Alternatively, if we fail to make these
expenditures, we may adversely effect the competitive position of the hotels and
have an adverse effect on occupancy rates, ADRs and REVPAR. In certain
instances, our failure to make certain capital expenditures may constitute a
default under the applicable franchise agreement.
RISKS OF OPERATING UNDER FRANCHISE AGREEMENTS
Of our 56 hotels, 54 are operated under franchise agreements with
national franchisors. The Lessee is the franchisee and is responsible for
complying with the franchise agreements. Under these arrangements, a franchisor
provides marketing service and room reservations and certain other operating
assistance, but requires the Lessee to pay significant fees as well as maintain
the hotel in a certain condition. If the Lessee fails to maintain these required
standards or we fail to make required capital expenditures (or to fund the
Lessee's expenditures) then there may be a termination of the franchise
agreement and possible liability for damages. If the Lessee were to lose a
franchise on a particular hotel, it could have a material adverse effect upon
the operation, financing or value of that hotel due to the
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<PAGE> 15
loss of the franchise name, marketing support and centralized reservation
system. In addition, adverse publicity affecting a franchisor could reduce the
revenues we receive from the hotels subject to such franchise. Any loss of
revenues by the Lessee at a hotel because of loss of the franchise agreement
would adversely effect the Lessee's ability to pay rent and could effect our
ability to make distributions to our stockholders.
OUR DEGREE OF LEVERAGE COULD LIMIT OUR ABILITY TO OBTAIN ADDITIONAL FINANCING
Our Articles of Incorporation limits consolidated indebtedness to 50% of
our investment in hotel properties, at cost on a consolidated basis, after
giving effect to our use of proceeds from the indebtedness. As of March 31,
1999, our ratio of debt to total investment in hotel properties and other real
estate investments was approximately 42%. Our Credit Facility has further
restrictions on the amount of Company indebtedness. The degree of leverage could
have important consequences to our stockholders, including, effecting our
ability to obtain additional financing in the future for working capital,
capital expenditures, acquisitions, development or other general corporate
purposes including the payment of distributions and could make us more
vulnerable to a downturn in business or the economy.
YEAR 2000 ISSUE
GENERAL
The term "Year 2000 issue" is a general term used to describe the
complications that may be caused by existing computer hardware and software that
were designed by the respective manufacturers without consideration of the
upcoming change in the century. Many computer systems recognize calendar years
by the last two digits in the date code field. Beginning in the year 2000, these
date code fields will need to accept four digit entries to distinguish
twenty-first century dates from twentieth century dates. If not corrected,
computer systems may fail or create erroneous results causing disruptions of
operations.
The Company's in-house computer systems environment is limited to
software and hardware developed by third parties. All of the Company's computer
systems, consisting of financial reporting and accounting systems only, were
installed in the last two years and management believes such systems are Year
2000 compliant. However, the Company's business is heavily dependent upon the
efforts of the Lessee and third parties with whom the Lessee conducts
significant business.
The Lessee relies on information technology ("IT") systems and other
systems and facilities such as PBX switches, elevators, heating, ventilation and
air conditioning, security, fire and life safety and other environmental systems
("embedded systems") to conduct its business. Both the IT and the embedded
systems are subject to the Year 2000 Issue which, if not remedied in time, could
have an impact on the operations of the Lessee. The Lessee may also be exposed
to risk from third parties with whom the Lessee interacts who fail to adequately
address their own Year 2000 issues. Such third parties include franchisors,
vendors, suppliers and significant customers.
To mitigate and minimize the number and seriousness of any disruptions
caused by the Year 2000 Issue, the Company and the Lessee have developed and
adopted a Year 2000 Compliance Program (the "Compliance Program") which involves
the following four phases: assessment, which includes development of an action
plan and inventorying of hotel systems, remediation, testing and implementation.
With the assistance of outside consultants, site surveys are being performed and
all hotel systems will be identified and inventoried and will include
information such as the manufacturer or vendor who performed the installation,
currently services or maintains each system. The Lessee has begun contacting
these vendors to obtain certification relating to their Year 2000 compliance
testing. In addition, all parties for building systems that service leased
premises, or a facility within leased premises are located and are operated and
controlled by or interact with a software program will be identified and
contacted. It should be noted that due to the complexity of some of the systems,
in many cases, the only way to determine the potential impact of the systems
would be to verify the Year 2000 effect with the particular vendor. The
assessment phase was completed in February 1999.
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STATUS OF PROGRESS IN BECOMING YEAR 2000 COMPLIANT, INCLUDING TIMETABLE FOR
COMPLETION OF EACH REMAINING PHASE - HOTEL AND LESSEE SYSTEMS
Based on the results of the site assessments, the identified IT and
embedded systems will be replaced or upgraded. The system upgrades will be
prioritized according to their critical importance. Life safety systems and
emergency services will take priority in accordance with the steps laid out in
the Compliance Program. The various vendors associated with any system
replacements or upgrades will be contacted to determine their readiness to deal
with these system enhancements. Performance of certain testing by the vendors
may be required in several cases to ensure Year 2000 compliance. All vendors,
manufacturers, service personnel, consultants, contractors, lessees and lessors
will be requested to prepare a letter certifying and warranting that all
systems, utilities and services containing time and date-related coding and
internal programs, shall continue without interruption beyond December 31, 1999.
The implementation will be monitored and managed on a real-time basis to ensure
a smooth upgrade of the systems. Completion of the implementation and testing
phases for all significant systems is expected by June 30, 1999, with all
remediated systems fully tested and implemented by September 30, 1999, with 100%
completion targeted for October 31, 1999.
NATURE AND LEVEL OF IMPORTANCE OF THIRD PARTY SYSTEMS AND THEIR EXPOSURE TO THE
YEAR 2000
The Lessee is in the process of surveying its vendors and service
providers that are critical to the Lessee's business to determine whether they
are Year 2000 compliant. The Lessee expects that these surveys will be completed
by the end of the second quarter of 1999, but cannot guarantee that all vendors
or service providers will respond to the survey, and therefore the Lessee may
not be able to determine Year 2000 compliance of those vendors or service
providers. By the end of the second quarter of 1999, the Lessee will determine
the extent to which the Lessee will be able to replace those vendors not in
compliance. There may be instances in which the Lessee will have no alternative
but to remain with non-compliant vendors or service providers. The inability of
vendors to complete their Year 2000 resolution process in a timely fashion could
materially impact the Company and the Lessee. The effect of compliance by
vendors is not determinable.
COST OF ADDRESSING YEAR 2000 ISSUES
The Company estimates that total cost for the Year 2000 compliance
review, evaluation, assessment and remediation efforts should not exceed $1.0
million and will be funded by the Company through its operating cash flows. To
date, the costs incurred to address the Year 2000 issue consist primarily of
services provided by outside consultants for onsite system surveys and total
$163,000 which was expensed by the Company during the first quarter of 1999. The
remaining balance is also anticipated to be expended in 1999.
RISKS PRESENTED BY YEAR 2000 ISSUES
Management of the Company and the Lessee believe they have an effective
plan in place to resolve the Year 2000 Issue in a timely manner. As noted above,
the Lessee has not yet completed all necessary phases of the Year 2000 program.
In the event that the Lessee does not complete any additional phases, the Lessee
may encounter system failures associated with third-party vendors such as
disruptions in passenger transportation or transportation systems generally,
loss of utility and telecommunications services, the loss or disruption of hotel
reservations made on centralized reservation systems and errors or failures in
financial transactions or payment processing systems such as credit cards. These
disruptions could adversely affect the Company and the Lessee, their businesses
and their financial conditions. The Company and the Lessee cannot predict the
actual effects of the Year 2000 Issue on their businesses, such effects depend
on numerous uncertainties such as whether significant third parties have
properly and timely addressed the Year 2000 Issue, and whether broad-based or
systemic economic failures may occur. Due to the general uncertainty inherent in
the Year 2000 Issue and the Company's and Lessee's dependence on third parties,
management is unable to determine at this time whether the consequences of Year
2000 failures will have a material impact.
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CONTINGENCY PlAN
The Lessee is in the process of developing its contingency plan for the
systems operated and maintained by the Lessee and the hotels. This is necessary
in order to provide for the most likely worst case scenarios regarding Year 2000
compliance. The contingency plan is expected to be completed in 1999.
USE OF PROCEEDS
The Company will not receive any of the proceeds from the issuance of
the Warrants, but will receive all of the proceeds of all shares of Common Stock
purchased upon exercise of the Warrants, in an amount per share equal to the
exercise price of the Warrant covering the shares purchased. The Company has no
specific plans as to use of the proceeds from the exercise of the Warrants, but
anticipates using the proceeds for general working capital purposes or to repay
indebtedness.
DETERMINATION OF THE OFFERING PRICE
The Warrants were issued to Messrs. Alter and Biederman in consideration
for their surrender for cancellation of the SAR Support Options. The exercise
price for each Warrant is equal to the exercise price of the SAR Support Option
it replaces. The exercise price of each SAR Support Option was the fair market
value of the Common Stock on the date of grant of such option. The following
table summarizes the grant dates and exercise prices for both the Warrants and
SAR Support Options.
SAR SUPPORT OPTIONS
<TABLE>
<CAPTION>
NUMBER OF EXERCISE
GRANT DATE OPTION PRICE PER GRANT DATE
OF OPTIONS SHARES SHARE OF WARRANTS
---------- --------- --------- -----------
<S> <C> <C> <C> <C>
Robert A. Alter 08/10/95 130,000 $9.50 09/25/98
07/16/96 83,600 $10.50 09/25/98
10/27/97 24,000 $16.63 09/25/98
01/16/98 120,000 $16.25 09/25/98
============
357,600
============
Charles L. Biederman 08/10/95 10,680 $9.50 09/25/98
03/12/96 26,000 $9.88 09/25/98
07/16/96 16,720 $10.50 09/25/98
10/27/97 6,000 $16.63 09/25/98
01/16/98 30,000 $16.25 09/25/98
============
89,400
============
</TABLE>
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SELLING SHAREHOLDERS
Because the Warrants are to be assigned by Messrs. Alter and Biederman
to the employees of the Lessee prior to their becoming exercisable, the issuance
of the Warrants will not alter the beneficial ownership interest of Messrs.
Alter and Biederman.
Following surrender by the Lessee's employees of the SARs, the Warrants
will be assigned by Messrs. Alter and Biederman in whole or in part to
approximately 96 of the Lessee's employees. The names of such individuals, the
number of Warrant Shares assigned to each such individual and the number of
shares of Common Stock retained by each such individual after the assignment of
the Warrants will be incorporated into this Prospectus pursuant to a
post-effective amendment to the Form S-3 Registration Statement pursuant to
which this Prospectus is filed with the Securities and Exchange Commission and
each such individual, together with Messrs. Alter and Biederman, will be
considered a "Selling Shareholder" for purposes of this Prospectus.
Mr. Alter has served as President, Secretary, Chief Executive Officer
and Chairman of the Board of Directors of the Company since August 1994. From
1990 until August 1995, Mr. Alter served as President of the Management Company,
which currently manages all of the hotels owned by the Company. Mr. Alter is the
sole shareholder of the Management Company. Mr. Alter also serves as chairman of
the board of directors of both the Management Company and the Lessee.
Mr. Biederman has served as Executive Vice President and director of the
Company since September 1994.
The Lessee is owned by Mr. Alter (80%) and Mr. Biederman (20%).
DESCRIPTION OF COMMON STOCK, PREFERRED STOCK AND WARRANTS
The following summary description of Common Stock of the Company is
subject to and qualified in its entirety by reference to Maryland law described
herein, and to the Articles of Incorporation and Bylaws of the Company (and any
amendments or supplements thereto) which are filed as exhibits to, or
incorporated by reference in, the Registration Statement of which this
Prospectus is a part.
GENERAL
The Articles of Incorporation of the Company provide that the Company
may issue up to 160,000,000 shares of capital stock, consisting of 150,000,000
shares of Common Stock, $0.01 par value per share, and 10,000,000 shares of
preferred stock, $0.01 par value per share. As of April 30, 1999, (i) 37,572,263
shares of Common Stock were issued and outstanding, (ii) 1,000,000 shares of
Common Stock were reserved for issuance under the Company's Dividend
Reinvestment and Stock Purchase Plan, (iii) 2,400,000 shares of Common Stock
were reserved for issuance under the Company's 1994 Stock Incentive Plan, (iv)
150,000 shares of Common Stock were reserved for issuance under the 1994
Directors Plan, (v) 1,699,605 shares of Common Stock were reserved for issuance
upon the conversion of Preferred Stock, and partnership units into Common Stock,
and (vi) 39,694,871 shares of Common Stock were reserved for issuance upon the
conversion of units into Common Stock (each Unit is convertible into one share
of Common Stock at the Unitholder's election), and (vii) 17,042 shares of Common
Stock were reserved for issuance upon the conversion of warrants or for other
purposes. As of April 30, 1999, 250,000 shares of Preferred Stock were issued
and outstanding.
The following description sets forth certain general terms and
provisions of the Common Stock including Common Stock issuable upon the exercise
of Warrants issued by the Company. The Common Stock is listed on the NYSE under
the symbol "SSI." ChaseMellon Shareholder Services LLC is the Company's
registrar and transfer agent for the Common Stock and Partnership Stock.
COMMON STOCK
Subject to the preferential rights of any other shares, series or class
of shares of capital stock that may from time to time come into existence, and
to the provisions of the Company's Articles of Incorporation regarding
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<PAGE> 19
owning shares in excess of the Ownership Limitation holders of Common Stock will
be entitled to receive dividends on such Common Stock if, as and when authorized
and declared by the Board of Directors of the Company out of assets legally
available therefor and to share ratably in the assets of the Company legally
available for distribution to its shareholders in the event of its liquidation,
dissolution or winding-up after payment of, or adequate provision for, all known
debts and liabilities of the Company.
Holders of the Company's Common Stock can elect to participate in the
Company's Dividend Reinvestment and Stock Purchase Plan (the "Plan") and have
all or part of their dividends reinvested in additional shares of Common Stock.
Participants in the Plan can also purchase additional shares of Common Stock
with cash (subject to certain limitations). The terms of the Plan are described
in a separate prospectus which may be obtained by calling the Plan
administrator, Mellon Bank, N.A., at (888) 261-6776.
Subject to the provisions of the Articles of Incorporation regarding
owning shares in excess of the Ownership Limitation, each outstanding share of
Common Stock entitles the holder to one vote on all matters submitted to a vote
of shareholders, including the election of directors, and, except as otherwise
required by law or except as provided with respect to any other class or series
of shares of stock, the holders of such shares of Common Stock will possess the
exclusive voting power. There is no cumulative voting in the election of
directors, which means that the holders of a majority of the outstanding shares
of Common Stock can elect all of the directors then standing for election and
the holders of the remaining shares, if any, will not be able to elect any
directors.
Holders of Common Stock have no conversion, sinking fund, redemption
rights or any preemptive rights to subscribe for any securities of the Company,
nor do they have any preference, appraisal or exchange rights.
Subject to limitations prescribed by Maryland law and the Company's
Articles of Incorporation, the Board of Directors is authorized to classify and
reclassify any unissued portion of the authorized shares of capital stock to
provide for the issuance of shares in other classes or series, including other
classes or series of Common Stock or classes or series of Preferred Stock to
establish the number of shares in each class or series and to fix the
designation and any preferences, conversion and other rights, voting powers,
restrictions, limitations as to dividends, qualifications and terms and
conditions of redemption of such class or series. The rights, preferences,
privileges and restrictions of such class or series will be fixed by Articles
Supplementary to the Company's Articles of Incorporation relating to such class
or series.
PREFERRED STOCK
Subject to limitations prescribed by Maryland law and the Company's
Articles of Incorporation, the Board of Directors is authorized to issue, from
the 10,000,000 authorized but unissued shares of capital stock of the Company,
Preferred Stock in such classes or series as the Board of Directors may
determine and to establish from time to time the number of shares of Preferred
Stock to be included in any such class or series and to fix the designation and
any preferences, conversion and other rights, voting powers, restrictions,
limitations as to dividends, qualifications and terms and conditions of
redemption of the shares of any such class or series, and such other subjects or
matters as may be fixed by resolution of the Board of Directors. As of the date
of this Prospectus, 250,000 shares of Preferred Stock are outstanding. The
issuance of Preferred Stock may have the effect of delaying, deferring or
preventing a change in control of the Company or other transaction in which
holders of shares of Common Stock might receive a premium for such shares over
the market price.
7.9% Class A Cumulative Convertible Preferred Stock
In connection with a portfolio acquisition, the Company issued 250,000
shares of its newly designated 7.9% Class A Cumulative Convertible Preferred
Stock (the "Class A Shares"). The holders of the Class A Shares are entitled to
one vote for each share of Common Stock into which such holder's Class A Shares
could then be converted, and with respect to such vote, such holder shall have
full voting rights and powers equal to the voting rights and powers of the
holders of Common Stock. The holders of Class A Shares are entitled to vote,
together with holders of Common Stock as a single class. Subject to preferences
that may be applicable to any future class of Preferred Stock, the holders of
Class A Shares are entitled to receive, ratably, a dividend equal to the greater
of (i) 7.9% per share per annum or (ii) the percentage dividend that would be
paid on the Common Stock into which the Preferred Stock is convertible. In the
event of a liquidation, dissolution or winding up of the Company, subject to
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the rights of future classes of Preferred Stock, the holders of Class A Shares
are entitled to receive, prior and in preference to the holders of Common Stock,
an amount per share equal to $100.00 for each outstanding Class A Share, plus
accrued and unpaid dividends. The Class A Shares have no preemptive rights.
Each Class A Share is convertible at the option of the holder at any
time into a number of shares of Common Stock that is equal to the quotient
obtained by dividing $100 by $14.7093, subject to adjustment for stock splits,
stock dividends, recapitalization and the like. On or at any time after the
fifth anniversary of issuance of the Class A Shares, the Company may, at its
option, redeem the Class A Shares in whole or in part by paying an amount equal
to the redemption percentage of $100.00 per share then in effect (as adjusted
for any stock dividends, combinations or splits), plus all accrued but unpaid
dividends on such shares. The redemption percentage declines one percent per
year, from 105% to par commencing in 2002. There are no sinking fund provisions
applicable to the Class A Shares. All outstanding Class A Shares will, upon
issuance, be fully paid and non-assessable.
Terms of Future Classes of Preferred Stock
The terms of any future class or series of Preferred Stock which may be
issued will be set forth in Articles Supplementary to the Company's Articles of
Incorporation which will be filed with the Maryland Department of Assessments
and Taxation and as an exhibit to (or incorporated by reference in) a report
filed with the Commission in connection with the Company's Exchange Act
reporting obligations.
RESTRICTIONS ON OWNERSHIP OF COMMON STOCK OR PREFERRED STOCK
The following is a description of the restrictions on ownership of the
Common Stock and Preferred Stock. Such description is, and will be, qualified in
its entirety by any supplements to the Articles of Incorporation or Bylaws filed
as exhibits to, or incorporated by reference in, the Registration Statement of
which this Prospectus is a part.
For the Company to qualify as a REIT under the Code, it must meet
certain requirements concerning the ownership of its outstanding shares of
capital stock. Specifically, not more than 50% in value of the Company's
outstanding shares may be owned, directly or indirectly, by five or fewer
individuals (as defined in the Code to include certain entities) during the last
half of a taxable year, and the Company must be beneficially owned by 100 or
more persons during at least 335 days of a taxable year of 12 months or during a
proportionate part of a shorter taxable year. See "United States Federal Income
Tax Considerations -- Requirements for Qualification." In addition, the Company
must meet certain requirements regarding the nature of its gross income in order
to qualify as a REIT. One such requirement is that at least 75% of the Company's
gross income for each year must consist of rents from real property and income
from certain other real property investments. The rents received by the
Partnership from the Lessee would not qualify as rents from real property, which
would result in loss of REIT status for the Company, if the Company were at any
time to own, directly or constructively, 10% or more of the ownership interests
in the Lessee within the meaning of Section 856(d)(2)(B) of the Code. See
"Federal Income Taxation of the Company - Income Tests" elsewhere in this
Prospectus.
Because the Board of Directors believes it is essential for the Company
to qualify as a REIT, the Articles of Incorporation, subject to certain
exceptions described below, provides that no person may own, or be deemed to own
by virtue of the constructive ownership provisions of the Code, more than 9.8%
of the lesser in value of the total number or value of the outstanding shares of
Common Stock or the outstanding shares of Preferred Stock (the "Ownership
Limitation"). The constructive ownership rules of the Code are complex and may
cause shares owned actually or constructively by two or more related individuals
and/or entities to be constructively owned by one individual or entity. As a
result, the acquisition of less than 9.8% of the outstanding shares of Common
Stock or 9.8% of the shares of Preferred Stock (or the acquisition of an
interest in an entity which owns the shares) by an individual or entity could
cause that individual or entity (or another individual or entity) to own
constructively in excess of 9.8% of the outstanding shares of Common Stock or
9.8% of the outstanding shares of Preferred Stock, and thus subject such shares
to the Ownership Limitation provisions of the Articles of Incorporation. The
Ownership Limitation also prohibits any transfer of Common Stock or Preferred
Stock that would (i) result in the Common Stock and Preferred Stock being owned
by fewer than 100 persons (determined without reference to any rules of
attribution), (ii) result in the Company being "closely held" within the meaning
of Section 856(h) of the Code, or (iii) cause the Company to own, directly or
constructively, 10% or more of the ownership interests in a
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tenant of the Company's real property, within the meaning of Section
856(d)(2)(B) of the Code. Except as otherwise provided below, any such
acquisition or transfer of the Company's capital stock (including any
constructive acquisition or transfer of ownership) shall be null and void, and
the intended transferee or owner will acquire no rights to, or economic
interests in, the shares.
Subject to certain exceptions described below, any purported transfer of
Common Stock or Preferred Stock that would (i) result in any person owning,
directly or indirectly, Common Stock or Preferred Stock in excess of the
Ownership Limitation, (ii) result in the Common Stock and Preferred Stock being
owned by fewer than 100 persons (determined without reference to any rules of
attribution), (iii) result in the Company being "closely held" within the
meaning of Section 856(h) the Code, or (iv) cause the Company to own, directly
or constructively, 10.0% or more of the ownership interests in a tenant of the
Company's or the Partnership's real property, within the meaning of Section
856(d)(2)(B) of the Code, will be designated as "Shares-in-Trust" and
transferred automatically to a Trust (the "Share Trust") effective on the day
before the purported transfer of such Common Stock or Preferred Stock. The
record holder of the Common Stock or Preferred Stock that are designated as
Shares-in-Trust (the "Prohibited Owner") will be required to submit such number
of shares of Common Stock or Preferred Stock to the Share Trust for designation
in the name of a trustee to be designated by the Company (the "Share Trustee").
The beneficiary of the Share Trust (the "Beneficiary") will be one or more
charitable organizations that are named by the Company.
Shares-in-Trust will remain issued and outstanding Common Stock or
Preferred Stock and will be entitled to the same rights and privileges as all
other shares of the same class or series. The Share Trust will receive all
dividends and distributions on the Shares-in-Trust and will hold such dividends
or distributions in trust for the benefit of the Beneficiary. The Share Trustee
will vote all Shares-in-Trust. The Share Trustee will designate a permitted
transferee of the Shares-in-Trust, provided that the permitted transferee (i)
purchases such Shares-in-Trust for valuable consideration and (ii) acquires such
Shares-in-Trust without such acquisition resulting in a transfer to another
Share Trust.
The Prohibited Owner with respect to Shares-in-Trust will be required to
repay to the Share Trust the amount of any dividends or distributions received
by the Prohibited Owner (i) that are attributable to any Shares-in-Trust and
(ii) for which the record date was on or after the date that such shares became
Shares-in-Trust. The Prohibited Owner generally will receive from the Share
Trustee the lesser of (i) the price per share such Prohibited Owner paid for the
Common Stock or Preferred Stock that were designated as Shares-in-Trust (or, in
the case of a gift or devise, the market price (based on a five day trading
average) per share on the date of such transfer) and (ii) the price per share
received by the Share Trustee from the sale or other disposition of such
Shares-in-Trust. Any amounts received by the Share Trustee in excess of the
amounts to be paid to the Prohibited Owner will be distributed to the
Beneficiary.
The Shares-in-Trust will be deemed to have been offered for sale to the
Company, or its designee, at a price per share equal to the lesser of (i) the
price per share in the transaction that created such Shares-in-Trust (or, in the
case of a gift or devise, the market price per share on the date of such
transfer) or (ii) the market price per share on the date that the Company, or
its designee, accepts such offer. The Company will have the right to accept such
offer for a period of ninety days after the later of (i) the date of the
purported transfer which resulted in such Shares-in-Trust and (ii) the date the
Company determines in good faith that a transfer resulting in such Shares-
in-Trust occurred.
Any person who acquires or attempts to acquire Common Stock or Preferred
Stock in violation of the foregoing restrictions, or any person who owned shares
of Common Stock or Preferred Stock that were transferred to a Share Trust, will
be required (i) to give immediately written notice to the Company of such event
and (ii) to provide to the Company such other information as the Company may
request in order to determine the effect, if any, of such transfer on the
Company's status as a REIT.
All persons who own, directly or indirectly, more than 5% (or such lower
percentages as required pursuant to regulations under the Code) of the
outstanding shares of Common Stock and Preferred Stock must within 30 days after
January 1 of each year, provide to the Company a written statement or affidavit
stating the name and address of such direct or indirect owner, the number of
shares of Common Stock and Preferred Stock owned directly or indirectly, and a
description of how such shares are held. In addition, each direct or indirect
shareholder shall provide to the Company such additional information as the
Company may request in order to determine the effect, if
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<PAGE> 22
any, of such ownership on the Company's status as a REIT and to ensure
compliance with the Ownership Limitation.
The Ownership Limitation generally will not apply to the acquisition of
shares of Common Stock or Preferred Stock by an underwriter that participates in
a public offering of such shares. In addition, the Board of Directors, upon
receipt of a ruling from the Internal Revenue Service or an opinion of counsel
and upon such other conditions as the Board of Directors may direct, may exempt
a person from the Ownership Limitation under certain circumstances. The
foregoing restrictions will continue to apply until the Board of Directors, with
the approval of the holders of at least two-thirds of the outstanding shares of
all votes entitled to vote on such matter at a regular or special meeting of the
shareholders of the Company, determines to terminate its status as a REIT.
The Ownership Limitation will not be automatically removed even if the
REIT provisions of the Code are changed so as to remove any ownership
concentration limitation. Any change of the Ownership Limitation would require
an amendment to the Articles of Incorporation. Such amendment requires the
affirmative vote of holders holding at least two-thirds of the outstanding
shares entitled to vote on the matter. In addition to preserving the Company's
status as a REIT, the Ownership Limitation may have the effect of delaying,
deferring, discouraging or preventing a transaction or a change in control of
the Company without the approval of the Board of Directors.
Any certificates representing shares of Common Stock or Preferred Stock
will bear a legend referring to the restrictions described above.
WARRANTS
The Warrants will be evidenced by a Warrant Agreement. The Warrants may
be exercised in part or in full after they are assigned by Messrs. Alter and
Biederman to the Lessee's employees who surrender SARs. The shares purchased are
subject to repurchase by Messrs. Alter and Biederman at the Warrant exercise
price if the employee's service with the Lessee terminates prior to vesting in
the Warrant Shares. The repurchase right will lapse, and the employee will vest
in installments over the employee's continued service with the Lessee, all as
set forth more specifically in the Warrant assignment agreement governing the
assignment of the Warrants to the employees. The Warrants may be exercised upon
written notice by the holder to the Company's transfer agent, ChaseMellon
Shareholders Services, LLC, on or prior to September 24, 2003, accompanied by
payment of the Warrant exercise price for the number of shares with respect to
which the Warrants are being exercised. Payment of the exercise price may be
made in cash, certified or bank check payable to the order of the Company, the
delivery of shares of Common Stock which have been held for the requisite period
to avoid a charge to the Company's earnings for financial reporting purposes
(generally six (6) months) or, to the extent the purchased Warrant Shares are
vested and no longer subject to repurchase by Mr. Alter or Mr. Biederman as
assignor of the Warrant, through a cashless exercise program pursuant to which
the holder may direct the immediate sale of the Warrant Shares on the open
market and payment to the Company out of the sale proceeds on the settlement
date, sufficient funds to cover the exercise price payable for the Warrant
Shares and all applicable withholding taxes. The shares of Common Stock to be
issued upon exercise of these Warrants and payment in accordance with the terms
thereof will be fully paid and nonassessable.
The Warrants will become exercisable thirteen (13) months after the
September 25, 1998 date of issuance and will be transferrable by Messrs. Alter
and Biederman only to those employees of the Lessee who currently hold
outstanding SARs and agree to surrender such SARs in exchange for an assignment
of the Warrants. No further assignment of the Warrants will be permitted by the
Lessee's employees. Each Warrant entitles the registered holder to purchase one
share of Common Stock at any time prior to 5:00 p.m. California time on
September 24, 2003.
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The Exercise Price for the Warrants vary according to the schedule set forth
below:
<TABLE>
<CAPTION>
NUMBER OF WARRANT SHARES EXERCISE PRICE
------------------------ --------------
<S> <C>
140,680 $9.50
26,000 $9.88
100,320 $10.50
30,000 $16.63
150,000 $16.25
</TABLE>
The exercise price of the Warrants assigned to each employee of the
Lessee is intended as closely as possible to match the exercise price of the
SARs held by such employee that are being surrendered. There is no assurance,
however, that the exercise price of the Warrants will match the exercise price
of the SARs for each employee, as the exercise price of the Warrants, when they
were issued, was not tied to the SAR exercise price, but the exercise price of
the SAR Support Options originally granted to Messrs. Alter and Biederman.
The Warrants provide for adjustment of the Exercise Price and for a
change in the number of shares issuable upon exercise to protect holders against
dilution in the event of stock dividends, stock splits, combinations or
reclassifications of the Common Stock.
The Warrants do not confer upon the holders any voting or other rights
of a shareholder of the Company. The Company has authorized the issuance of the
Warrants and reserved sufficient shares of Common Stock for issuance upon
exercise of the Warrants.
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CERTAIN PROVISIONS OF MARYLAND LAW
AND OF THE COMPANY'S ARTICLES OF INCORPORATION AND BYLAWS
The following summary of certain provisions of Maryland law and of the
Articles of Incorporation and Bylaws of the Company does not purport to be
complete and is qualified in its entirety by reference to Maryland law and the
Articles of Incorporation and Bylaws of the Company (and any amendments and
supplements thereto) which are filed as exhibits to, or incorporated by
reference in, the Registration Statement of which this Prospectus is a part.
ANTI-TAKEOVER EFFECT OF CERTAIN PROVISIONS OF MARYLAND LAW AND OF THE COMPANY'S
ARTICLES OF INCORPORATION AND BYLAWS
The provisions in the Articles of Incorporation regarding the Ownership
Limitation and the classification of the Board of Directors, the business
combination provisions of the Maryland General Corporation Law ("MGCL"), the
control shares acquisition provisions of the MGCL, and the advance notice
provisions of the Bylaws could have the effect of delaying, deferring,
discouraging or preventing a transaction or a change in control of the Company
in which holders of some, or a majority, of the capital stock of the Company
might receive a premium for their shares over the then prevailing market price
or which such holders might believe to be otherwise in their best interest.
Certain significant provisions which might have this effect are described below.
CLASSIFICATION OF THE BOARD OF DIRECTORS
The Bylaws provide that the number of directors of the Company may be
established by the Board of Directors but may not be fewer than three nor more
than nine. The directors may increase the number of directors by a vote of a
least 80% of the members of the Board of Directors, provided that the number of
directors shall never be less than the number required by Maryland law and that
the tenure of office of a director shall not be affected by any decrease in the
number of directors. Any vacancy will be filled, including a vacancy created by
an increase in the number of directors, at any regular meeting or at any special
meeting called for that purpose, by a majority of the remaining directors,
except that a vacancy resulting from an increase in the number of directors must
be filled by a majority of the entire Board of Directors.
Pursuant to the Articles of Incorporation the Board of Directors will be
divided into three classes of directors. As the term of each class expires,
directors in that class will be elected by the shareholders of the Company for a
term of three years and until their successors are duly elected and qualify.
Classification of the Board of Directors is intended to assure the continuity
and stability of the Company's business strategies and policies as determined by
the Board of Directors. Shareholders will have no right to cumulative voting in
the election of directors. Consequently, at each annual meeting of shareholders,
the holders of a majority of the shares of Common Stock present in person or by
proxy at such meeting will be able to elect all of the successors of the class
of directors whose terms expire at that meeting.
The classified board provision could have the effect of making the
replacement of incumbent directors more time consuming and difficult, which
could delay, defer, discourage or prevent an attempt by a third party to obtain
control of the Company or other transaction, even though such an attempt or
other transaction might be beneficial to the Company and its shareholders. At
least two annual meetings of shareholders, instead of one, will generally be
required to effect a change in a majority of the Board of Directors. Thus, the
classified board provision could increase the likelihood that incumbent
directors will retain their positions.
REMOVAL OF DIRECTORS
The Articles of Incorporation provide that a director may be removed
with or without cause by the affirmative vote of at least two-thirds of the
votes entitled to be cast in the election of directors. This provision, when
coupled with the provision in the Bylaws authorizing the Board of Directors to
fill vacant directorships, could preclude shareholders from removing incumbent
directors except upon the existence of a substantial affirmative vote and by
filling the vacancies created by such removal with their own nominees upon the
affirmative vote of a majority of the votes entitled to be cast in the election
of directors.
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LIMITATION OF LIABILITY AND INDEMNIFICATION
The Articles of Incorporation and Bylaws limit the liability of the
Company's directors and officers for money damages to the Company and its
shareholders to the fullest extent permitted from time to time by Maryland law.
Maryland law presently permits the liability of directors and officers to a
corporation or its shareholders for monetary damages to be limited, except (i)
to the extent that it is proved that the director or officer actually received
an improper benefit or profit, or (ii) to the extent that a judgment or other
final adjudication is entered in a proceeding based on a finding that the
director's or officer's action, or failure to act, was the result of active and
deliberate dishonesty and was material to the cause of action, as adjudicated in
the proceeding. This provision does not limit the ability of the Company or its
shareholders to obtain other relief, such as an injunction or rescission.
The Articles of Incorporation and Bylaws require the Company to
indemnify its directors and officers to the fullest extent permitted from time
to time by Maryland law. The Company's Articles of Incorporation and Bylaws also
permit the Company to indemnify employees, agents and other persons acting on
behalf of or at the request of the Company. The MGCL generally permits a
corporation to indemnify its directors, officers and certain other parties
against judgments, penalties, fines, settlements and reasonable expenses
actually incurred by them in connection with any proceeding to which they may be
made a party by reason of their service to or at the request of the Company.
Indemnification under the provisions of the MGCL is not deemed exclusive to any
other rights, by indemnification or otherwise, to which an officer or director
may be entitled under the Articles of Incorporation or Bylaws, or under
resolutions of shareholders or directors, contract or otherwise. It is the
position of the Commission that indemnification of directors and officers for
liabilities arising under the Securities Act is against public policy and is
unenforceable pursuant to Section 14 of the Securities Act.
BUSINESS COMBINATIONS
Under the MGCL, certain "business combinations" (including a merger,
consolidation, share exchange or, in certain circumstances, an asset transfer or
issuance or reclassification of equity securities) between a Maryland
corporation and any person who beneficially owns ten percent or more of the
voting power of such corporation's shares or an affiliate of such corporation
who, at any time within the two-year period prior to the date in question, was
the beneficial owner of ten percent or more of the voting power of the then-
outstanding voting shares of such corporation (an "Interested Shareholder") or
an affiliate thereof are prohibited for five years after the most recent date on
which the Interested Shareholder became an Interested Shareholder. Thereafter,
any such business combination must be recommended by the board of directors of
such corporation and approved by the affirmative vote of at least (a) 80% of the
votes entitled to be cast by holders of outstanding voting shares of such
corporation and (b) two-thirds of the votes entitled to be cast by holders of
voting shares of such corporation other than shares held by the Interested
Shareholder with whom (or with whose affiliate) the business combination is to
be effected, unless, among other things, such corporation's shareholders receive
a minimum price (as defined in the MGCL) for their shares and the consideration
is received in cash or in the same form as previously paid by the Interested
Shareholder for its shares. These provisions of Maryland law do not apply,
however, to business combinations that are approved or exempted by the board of
directors of a corporation prior to the time that the Interested Shareholder
becomes an Interested Shareholder. The Board of Directors has exempted from
these provisions of the MGCL any business combination with certain officers and
directors of the Company, and all present or future affiliates or associates of,
or any other person acting in concert or as a group with, any of the foregoing
persons and any other business combination which may arise in connection with
the Company formation transactions generally.
CONTROL SHARE ACQUISITIONS
The MGCL provides that "control shares" of a Maryland corporation
acquired in a "control share acquisition" have no voting rights except to the
extent approved by a vote of two-thirds of the votes entitled to be cast on the
matter, excluding shares owned by the acquiror, by officers or by directors who
are employees of a corporation. "Control Shares" are voting shares which, if
aggregated with all other such shares previously acquired by the acquiror, or in
respect of which the acquiror is able to exercise or direct the exercise of
voting power (except solely by virtue of a revocable proxy), would entitle the
acquiror to exercise voting power in electing directors within one of the
following ranges of voting power: (i) one-fifth or more but less than one-third
(ii) one-third or more but less than a majority, or (iii) a majority or more of
all voting power. Control Shares do not include shares
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<PAGE> 26
the acquiring person is then entitled to vote as a result of having previously
obtained shareholder approval. A "control share acquisition" means the
acquisition of control shares, subject to certain exceptions.
A person who has made or proposes to make a control share acquisition,
upon satisfaction of certain conditions (including an undertaking to pay
expenses), may compel the board of directors of a corporation to call a special
meeting of shareholders to be held within 50 days of demand to consider the
voting rights of the shares. If no request for a meeting is made, the
corporation may itself present the question at any shareholders meeting.
If voting rights are not approved at the meeting or if the acquiring
person does not deliver an acquiring person statement as required by the
statute, then, subject to certain conditions and limitations, a corporation may
redeem any or all of the control shares (except those for which voting rights
have previously been approved) for fair value determined, without regard to the
absence of voting rights for the control shares, as of the date of the last
control share acquisition by the acquiror or of any meeting of shareholders at
which the voting rights of such shares are considered and not approved. If
voting rights for control shares are approved at a shareholders meeting and the
acquiror becomes entitled to vote a majority of the shares entitled to vote, all
other shareholders may exercise appraisal rights. The fair value of the shares
as determined for purposes of such appraisal rights may not be less than the
highest price per share paid by the acquiror in the control share acquisition,
and certain limitations and restrictions otherwise applicable to the exercise of
dissenters' rights do not apply in the context of a control share acquisition.
The control share acquisition statute does not apply to shares acquired
in a merger, consolidation or share exchange, if the corporation is a party to
the transaction, or to acquisitions approved or exempted by the articles of
incorporation or bylaws of a corporation.
The Bylaws of the Company contain a provision exempting from the control
share acquisition statute any and all acquisitions by any person of the
Company's Common Stock or Preferred Stock. There can be no assurance that such
provision will not be amended or eliminated in the future.
AMENDMENTS TO THE COMPANY'S ARTICLES OF INCORPORATION AND BYLAWS
The Articles of Incorporation may only be amended by the affirmative vote of the
holders of not less than a majority of the votes entitled to be cast on the
matter, except that any proposal (i) to permit cumulative voting in the election
of directors, (ii) to alter provisions of the Articles of Incorporation
requiring a majority of the directors to be independent directors or provisions
of the Articles of Incorporation relative to the classification of the Company's
Board of Directors into three classes, removal of directors, preemptive rights,
indemnification of corporate agents and limitation of liability of officers and
directors, or (iii) that would terminate the Company's status as a REIT for tax
purposes, may not be amended, altered, changed or repealed without the
affirmative vote of at least two-thirds of all of the votes entitled to be cast
on the matter. Subject to the right of the Company's shareholders to adopt,
alter or repeal the Bylaws, the Bylaws may be amended by the Board of Directors,
except for provisions of the Bylaws relating to the sale of certain hotels and
transactions involving the Company in which an advisor, director or officer has
an interest, which may be altered or repealed only upon the vote of shareholders
holding at least two-thirds of the outstanding shares of stock entitled to vote
generally in the election of directors.
DISSOLUTION OF THE COMPANY
Pursuant to the Articles of Incorporation, the dissolution of the Company must
be approved and advised by the Board of Directors and approved by the
affirmative vote of the holders of a majority of all of the votes entitled to be
cast on the matter.
OPERATIONS
The Company is generally prohibited from engaging in certain activities,
including incurring consolidated indebtedness, in the aggregate, in excess of
50% of the Company's investment in hotels at cost, and acquiring or holding
property or engaging in any activity that would cause the Company to fail to
qualify as a REIT.
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FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of material federal income tax considerations
that may be relevant to a prospective holder of the Warrants and Common Stock.
The discussion contained herein does not address all aspects of taxation that
may be relevant to particular holders of the Warrants and Common Stock in light
of their personal investment or tax circumstances, or to certain types of
holders (including insurance companies, tax-exempt organizations, financial
institutions or broker-dealers, foreign corporations, and persons who are not
citizens or residents of the United States) subject to special treatment under
the federal income tax laws.
This discussion as to tax consequences is based on current provisions of
the Code, existing, temporary, and currently proposed Treasury Regulations
promulgated under the Code, the legislative history of the Code, existing
administrative rulings and practices of the Service, and judicial decisions. No
assurance can be given that future legislative, judicial, or administrative
actions or decisions, which may be retroactive in effect, will not affect the
accuracy of any statements in this Prospectus with respect to the transactions
entered into or contemplated prior to the effective date of such changes.
EACH PROSPECTIVE HOLDER OF WARRANTS AND COMMON STOCK IS ADVISED TO
CONSULT HIS OWN TAX ADVISOR REGARDING THE SPECIFIC TAX CONSEQUENCES TO HIM OF
THE ACQUISITION, OWNERSHIP AND DISPOSITION OF THE WARRANTS AND COMMON STOCK AND
OF THE COMPANY'S ELECTION TO BE TAXED AS A REIT, INCLUDING THE FEDERAL, STATE,
LOCAL, FOREIGN, AND OTHER TAX CONSEQUENCES OF SUCH ACQUISITION, OWNERSHIP,
DISPOSITION AND ELECTION, AND OF POTENTIAL CHANGES IN APPLICABLE TAX LAWS.
TAXATION OF ASSIGNEES OF WARRANTS
No taxable income will be recognized by an employee of the Lessee upon
assignment to him or her by Mr. Alter or Biederman of a Warrant or upon the
surrender by such individual to the Lessee of his or her outstanding SARs.
Following assignment of the Warrant, for purposes of taxation of the assignee,
the Warrant will be treated as if issued by the Lessee. Accordingly, the
assignee will in general recognize ordinary income, in the year in which the
Warrant is exercised, equal to the excess of the fair market value of the
purchased shares of Common Stock on the exercise date, over the Warrant exercise
price paid for those shares, and the assignee will be required to satisfy the
tax withholding requirements with respect to such income.
If the shares of Common Stock acquired upon exercise of the assigned
Warrant are subject to repurchase by Mr. Alter or Mr. Biederman in the event of
the assignee's termination of service with the Lessee prior to vesting in those
shares, then the assignee will not recognize any taxable income at the time of
exercise but will have to report as ordinary income, as and when such repurchase
right lapses, an amount equal to the excess of (i) the fair market value of the
shares on the date the repurchase right lapses over (ii) the warrant exercise
price paid for the shares. The assignee may, however, elect under Section 83(b)
of the Internal Revenue Code to include as ordinary income in the year of
exercise of the Warrant an amount equal to the excess of (i) the fair market
value of the purchased shares on the exercise date over (ii) the warrant
exercise price paid for such shares. If the Section 83(b) election is made
within thirty (30) days of exercising the Warrant for unvested shares, the
assignee will not recognize any additional income as and when the repurchase
right lapses.
Upon the sale by the assignee of the Warrant Shares, the assignee will
recognize capital gain equal to the excess of (i) the amount realized upon such
sale over (ii) the fair market value of such shares at the time the assignee
recognized the ordinary income with respect to their acquisition. A capital loss
will result if the amount realized upon the sale is less than such fair market
value.
The capital gain holding period for vested Warrant Shares will start at
the time the Warrant is exercised for those shares. If unvested Warrant Shares
are purchased, subject to repurchase by Messrs. Alter and Biederman, the holding
period will start either (i) at the time the Warrant Shares vest, if no Section
83(b) election is made at the time of exercise, or (ii) at the time the Warrant
Shares are exercised if the Section 83(b) election is within thirty (30) days
after the Warrant exercise date.
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TAXATION OF THE COMPANY
The Company has elected to be taxed as a REIT under Sections 856 through
860 of the Code, effective for each of its taxable years ended since December
31, 1995. The Company's qualification and taxation as a REIT depends upon the
Company's ability to meet, on a continuing basis, the various qualification
tests imposed under the Code discussed below. No assurance can be given that the
actual results of the Company's operations have or will satisfy all of the
requirements for qualification as a REIT.
The sections of the Code relating to qualification and operation as a
REIT are highly technical and complex. The following discussion sets forth the
material aspects of the Code sections that govern the federal income tax
treatment of a REIT and its shareholders. The discussion is qualified in its
entirety by the applicable Code provisions, Treasury Regulations promulgated
thereunder, and administrative and judicial interpretations thereof, all of
which are subject to change prospectively or retrospectively.
Assuming the Company qualifies for taxation as a REIT, it generally will
not be subject to federal corporate income tax on its net income that is
distributed currently to its shareholders. That treatment substantially
eliminates the "double taxation" (i.e., taxation at both the corporate and
shareholder levels) that generally results from investment in a corporation.
However, the Company will be subject to federal income tax in the following
circumstances. First, the Company will be taxed at regular corporate rates on
any undistributed REIT taxable income, including undistributed net capital
gains. Furthermore, under certain circumstances, the Company may be subject to
the "alternative minimum tax" on its items of tax preference. Third, if the
Company has (i) net income from the sale or other disposition of "foreclosure
property" that is held primarily for sale to customers in the ordinary course of
business or (ii) other nonqualifying income from foreclosure property, it will
be subject to tax at the highest corporate rate on such income. Fourth, if the
Company has net income from prohibited transactions (which are, in general,
certain sales or other dispositions of property (other than foreclosure
property) held primarily for sale to customers in the ordinary course of
business), such income will be subject to a 100% tax. Fifth, if the Company
should fail to satisfy the 75% gross income test or the 95% gross income test
(as discussed below), and has nonetheless maintained its qualification as a REIT
because certain other requirements have been met, it will be subject to a 100%
tax on the net income attributable to the greater of the amount by which the
Company fails the 75% or 95% gross income test. Sixth, if the Company should
fail to distribute during each calendar year at least the sum of (i) 85% of its
REIT ordinary income for such year, (ii) 95% of its REIT capital gain net income
for such year, and (iii) any undistributed taxable income from prior periods,
the Company would be subject to a 4% excise tax on the excess of such required
distribution over the amounts actually distributed. Seventh, if the Company
acquires any asset from a C corporation (i.e., a corporation generally subject
to full corporate-level tax) in a transaction in which the basis of the asset in
the Company's hands is determined by reference to the basis of the asset (or any
other asset) in the hands of the C corporation and the Company recognizes gain
on the disposition of such asset during the 10-year period beginning on the date
on which such asset was acquired by the Company, then the Company would be
taxable to the extent of such asset's "built-in-gain." Such taxation of the
Company on "built-in gains" will be applicable to gain on the disposition of
assets which were received by the Company in 1997 upon the liquidation of Kahler
Realty Corporation and its subsidiaries.
Requirements for Qualification Earnings and Profits
In order to maintain REIT status, the Company was required to distribute
any earnings and profits that it acquired as a result of the acquisition of
Kahler Realty Corporation (the "Kahler Acquisition") on or before December 31,
1997. In connection with the Kahler Acquisition, the Company received a
certification from the auditors for Kahler Realty Corporation ("Kahler") that,
subject to certain assumptions set forth therein, the pre-acquisition earnings
and profits of Kahler were $28.5 million (not considering the cash distribution
described immediately below), and the Company's auditors have reviewed and
approved this certification and the workpapers of Kahler's auditors. This
certification is not binding on the IRS, and there can be no assurance that it
will not be successfully challenged.
Immediately prior to the Kahler Acquisition, Kahler made a $28.75
million distribution to its shareholders The Company received a private letter
ruling from the IRS confirming that Kahler's pre-acquisition distribution was
treated as a "dividend" for tax purposes, and thus reduced Kahler's
pre-acquisition earnings and profits by the amount of the distribution.
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Based on the IRS's ruling and the certificates from Kahler's and the
Company's auditors, the Company anticipates that it had no non-REIT earnings and
profits as of the end of its 1997 taxable year. In the event, however, that the
Company had any such non-REIT earnings and profits, it would be disqualified as
a REIT in 1997 and thereafter.
Other Requirements
The Code defines a REIT as a corporation, trust or association (i) that
is managed by one or more trustees or directors; (ii) the beneficial ownership
of which is evidenced by transferable shares, or by transferable certificates of
beneficial interest; (iii) that would be taxable as a domestic corporation, but
for Sections 856 through 860 of the Code; (iv) that is neither a financial
institution nor an insurance company subject to certain provisions of the Code;
(v) the beneficial ownership of which is held by 100 or more persons; (vi) not
more than 50% in value of the outstanding shares of which is owned, directly or
indirectly, by five or fewer individuals (as defined in the Code to include
certain entities) during the last half of each taxable year (the "5/50 Rule");
(vii) that makes an election to be a REIT (or has made such election for a
previous taxable year) and satisfies all relevant filing and other
administrative requirements established by the Service that must be met in order
to elect and to maintain REIT status; (viii) that uses a calendar year for
federal income tax purposes and complies with the recordkeeping requirements of
the Code and Treasury Regulations promulgated thereunder; and (ix) that meets
certain other tests, described below, regarding the nature of its income and
assets. The Company's Articles of Incorporation provide for restrictions
regarding transfer of the Company's stock that are intended to assist the
Company in continuing to satisfy the share ownership requirements described in
(v) and (vi) above. See "Description of Common Stock, Preferred Stock and
Warrants -- Restrictions on Ownership of Common Stock or Preferred Stock."
In the case of a REIT that is a partner in a partnership, Treasury
Regulations provide that the REIT will be deemed to own its proportionate share
of the assets of the partnership and will be deemed to be entitled to the gross
income of the partnership attributable to such share. In addition, the assets
and gross income of the partnership will retain the same character in the hands
of the REIT as in the partnership for purposes of Section 856 of the Code,
including satisfying the gross income and asset tests, described below. Thus,
assuming the Partnership is classified as a partnership rather than as a
corporation for tax purposes, the Company's proportionate share of the assets,
liabilities and items of income of the Partnership will be treated as assets and
gross income of the Company for purposes of applying the requirements described
herein.
Income Tests
In order for the Company to maintain its qualification as a REIT, there
are three requirements relating to the Company's gross income that must be
satisfied annually. First, at least 75% of the Company's gross income (excluding
gross income from prohibited transactions) for each taxable year must consist of
defined types of income derived directly or indirectly from investments relating
to real property or mortgages on real property (including "rents from real
property" and, in certain circumstances, interest) or temporary investment
income. Second, at least 95% of the Company's gross income (excluding gross
income from prohibited transactions) for each taxable year must be derived from
such real property or temporary investments, and from dividends, other types of
interest, and gain from the sale or disposition of stock or securities, or from
any combination of the foregoing. Third, in taxable years through 1997, not more
that 30% of the Company's gross income (including gross income from prohibited
transactions) for each taxable year may be gain from the sale or other
disposition of (i) stock or securities held for less than one year, (ii) dealer
property that is not foreclosure property, and (iii) certain real property held
for less than four years (apart from involuntary conversions and sales of
foreclosure property). The 30% test does not apply for taxable years after 1997.
The specific application of these tests to the Company is discussed below.
Rents received by the Company will qualify as "rents from real property"
in satisfying the gross income requirements for a REIT described above only if
several conditions are met. First, the amount of rent must not be based in whole
or in part on the income or profits of any person. However, an amount received
or accrued generally will not be excluded from the term "rents from real
property" solely by reason of being based on a fixed percentage or percentages
of receipts or sales. Second, rents received from a tenant will not qualify as
"rents from real property" in satisfying the gross income tests if the Company,
or an owner of 10% or more of the Company, directly or constructively owns 10%
or more of such tenant (a "Related Party Tenant"). Third, if rent attributable
to personal property leased in connection with a lease of real property is
greater than 15% of the total rent received under the
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lease, then the portion of rent attributable to such personal property will not
qualify as "rents from real property." Finally, for rents received to qualify as
"rents from real property," the Company generally must not operate or manage the
property or furnish or render services to the tenants of such property, other
than through an "independent contractor" who is adequately compensated and from
whom the Company derives no revenue. The "independent contractor" requirement,
however, does not apply to the extent the services provided by the Company are
"usually or customarily rendered" in connection with the rental of space for
occupancy only and are not otherwise considered "rendered to the occupant."
Pursuant to percentage leases (the "Percentage Leases"), Sunstone Hotel
Properties, Inc., a Colorado corporation (the "Lessee") has leased from the
Partnership the land, buildings, improvements, furnishings and equipment
comprising the hotels for a 10-year period. The Percentage Leases provide that
the Lessee is obligated to pay to the Partnership (i) the greater of base rent
("Base Rent") or percentage rent ("Percentage Rent," and with Base Rent,
collectively, the "Rents") and (ii) certain other additional charges (the
"Additional Charges"). The Percentage Rent is calculated by multiplying fixed
percentages by the room revenues for each of the hotels in excess of certain
levels. Both the Base Rent and the threshold room revenue amount in each
Percentage Rent formula will be adjusted for inflation. The adjustment will be
calculated at the beginning of each calendar year based on the change in the CPI
during the prior calendar year. The Base Rent accrues and is required to be paid
monthly and the Percentage Rent (if any) accrues and is required to be paid
quarterly. In order for the Base Rent, the Percentage Rent and the Additional
Charges to constitute "rents from real property," the Percentage Leases must be
respected as "true leases" for federal income tax purposes and not treated as
service contracts, joint ventures or some other type of arrangement.
While the Company believes that the Percentage Leases should be treated
as true leases for tax purposes, investors should be aware that there are no
controlling Treasury Regulations, published rulings, or judicial decisions
involving leases with terms substantially the same as the Percentage Leases that
discuss whether such leases constitute true leases for federal income tax
purposes. If the Percentage Leases were recharacterized as service contracts or
partnership agreements, rather than true leases, part or all of the payments
that the Partnership receives from the Lessee would not be considered rent or
would not otherwise satisfy the various requirements for qualification as "rents
from real property." In that case, the Company would not be able to satisfy
either the 75% or 95% gross income tests and, as a result, would lose its REIT
status.
As stated above, in order for the Rents to constitute "rents from real
property," the Rents attributable to personal property leased in connection with
the lease of the real properties comprising a hotel must not be greater than 15%
of the Rents received under the Percentage Lease. The portion of the Rents
attributable to the personal property in a hotel is the amount that bears the
same ratio to total Rent for the taxable year as the average of the adjusted
bases of the personal property in the hotel at the beginning and at the end of
the taxable year bears to the average of the aggregate adjusted bases of both
the real and personal property comprising the hotel at the beginning and at the
end of such taxable year (the "Adjusted Basis Ratio"). The Company has
determined that the amount of any Rent attributable to personal property and not
qualifying as "rents from real property" has not and will not be of a
significant magnitude (together with other disqualified income) to cause the
Company to fail the 95% gross income test or 75% gross income test as described
above. In addition, Ernst & Young LLP has provided an analysis confirming this
representation. There can be no firm assurance, however, that the amount of the
Company's gross income not qualifying as "rents from real property" under the
15% adjusted basis ratio test described above will not be of a sufficient
magnitude to cause the Company to fail to satisfy the 95% or 75% gross income
test and thus lose its REIT status.
Another requirement for qualification of the Rents as "rents from real
property" is that the Percentage Rent must not be based in whole or in part on
the income or profits of any person. The Percentage Rent, however, will qualify
as "rents from real property" if it is based on percentages of receipts or sales
and the percentages (i) are fixed at the time the Percentage Leases are entered
into, (ii) are not renegotiated during the term of the Percentage Leases in a
manner that has the effect of basing Percentage Rent on income or profits, and
(iii) conform with normal business practice. More generally, the Percentage Rent
will not qualify as "rents from real property" if, considering the Percentage
Leases and all the surrounding circumstances, the arrangement does not conform
with normal business practice, but is in reality used as a means of basing the
Percentage Rent on income or profits. The Company has and will structure all of
its Percentage Leases in such a manner that (i) the Percentage Rent will be
based at all times on revenues from the hotels that are established in the
Percentage Leases, (ii) the Percentage Rent
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will not be renegotiated during the terms of the Percentage Leases in a manner
that has the effect of basing the Percentage Rent on income or profits and (ii)
the Percentage Leases and the Percentage Rent will conform with normal business
practice. Furthermore, with respect to other hotels that the Company acquires in
the future, the Company will not charge rent for any property that is based in
whole or in part on the income or profits of any person (except by reason of
being based on a fixed percentage of gross revenues, as described above). In the
event that it were to be determined that any of the foregoing requirements
relating to the Company's Percentage Ratio were not satisfied, the Company could
fail or cease to qualify as a REIT.
A further requirement for qualification of the Rents as "rents from real
property" is that the Company must not own, directly or constructively, 10% or
more of the Lessee. The constructive ownership rules generally provide that, if
10% or more in value of the shares of the Company are owned, directly or
indirectly, by or for any person, the Company is considered as owning the shares
of the Lessee owned, directly or indirectly, by or for such person. The Company
has not and will not at any time directly or indirectly own any stock of the
Lessee. However, because Mr. Alter and Mr. Biederman each owns more than 10% of
the stock of the Lessee, the Company would be deemed to own more than 10% of the
stock of the Lessee if either Mr. Alter or Mr. Biederman at any time owns,
directly, indirectly or constructively, 10% or more in value of the shares of
the Company's stock. The Partnership Agreement provides restrictions which
prevent any person from owning, directly or constructively, more than 9.8% of
the Company. Thus, neither Mr. Alter nor Mr. Biederman will ever be entitled to
acquire a 10% interest in the Company, and the Company should never own,
directly or constructively, 10% of more of the Lessee. Furthermore, the Company
has represented that it will not at any time rent any property to a related
party tenant.
A further requirement for qualification of the Rents as "rents from real
property" is that the Company cannot furnish or render noncustomary services to
the Lessee (or tenants of the hotels), or manage or operate the hotels or any
leased properties, other than through an independent contractor who is
adequately compensated and from whom the Company itself does not derive or
receive any income. Provided that the Percentage Leases are respected as true
leases, the Company should satisfy that requirement because neither the Company
nor the Partnership will be performing any services other than customary ones
for the Lessee. The Company has also represented that with respect to other
hotels that it acquires in the future, it will not perform noncustomary services
with respect to the tenant of the property and will not be managing or operating
such hotels. As described above, if the Percentage Leases were recharacterized
as service contracts or partnership agreements, the Rents likely would be
disqualified as "rents from real property" because the Company would be
considered to furnish or render nonqualifying services to the occupants of the
hotels and to manage or operate the hotels other than through an independent
contractor who is adequately compensated and from whom the Company derives or
receives no income.
If the Rents from a hotel do not qualify as "rents from real property"
because the rents attributable to personal property exceed 15% of the total
Rents for a taxable year, the portion of the Rents from that hotel that is
attributable to personal property will not be qualifying income for purposes of
either the 75% or 95% gross income tests. The Company would lose its REIT status
in this event only if the Rents attributable to personal property in all of its
hotels (plus any other nonqualifying income) during a taxable year exceed 5% of
the Company's gross income during the year. If, however, the Rents do not
qualify as "rents from real property" because either (i) the Percentage Rent is
considered based on income or profits of the Lessee, (ii) the Company owns,
directly or constructively, 10% or more of the Lessee, or (iii) the Company
furnishes noncustomary services to the Lessee or tenants of the hotels, or
manages or operates the hotels other than through a qualifying independent
contractor, none of the Rents would qualify as "rents from real property." In
that case, the Company would lose its REIT status because it would be unable to
satisfy either the 75% or 95% gross income tests.
In addition to the Rents, the Lessee is required to pay to the
Partnership the Additional Charges. To the extent that the Additional Charges
represent either (i) reimbursements of amounts paid by the Partnership to third
parties that the Lessee is obligated to bear or (ii) penalties for nonpayment or
late payment of such amounts, the Additional Charges should qualify as "rents
from real property." To the extent, however, that the Additional Charges
represent interest that is accrued on the late payment of the Rents or the
Additional Charges, the Additional Charges should not qualify as "rents from
real property," but instead should be treated as interest that qualifies for the
95% gross income test.
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Any gross income derived from a prohibited transaction is taken into
account in applying the 30% income test necessary to qualify as a REIT for
taxable years through 1997. In addition, the net income from that transaction is
subject to a 100% tax. The term "prohibited transaction" generally includes a
sale or other disposition of property (other than foreclosure property) that is
held primarily for sale to customers in the ordinary course of a trade or
business. The Company and the Partnership believe that no asset owned by the
Company or the Partnership has or will be held for sale to customers in the
ordinary course of business of the Company or the Partnership. Whether property
is held "primarily for sale to customers in the ordinary course of a trade or
business" will depend, however, on the facts and circumstances from time to
time. The Company and the Partnership will attempt to comply with the terms of
safe-harbor provisions in the Code prescribing when asset sales will not be
characterized as prohibited transactions. Complete assurance cannot be given,
however, that the Company or the Partnership can comply with the safe-harbor
provisions of the Code or avoid owning property that may be characterized as
property held "primarily for sale to customers in the ordinary course of a trade
or business."
If the Lessee defaults on its obligations under a Percentage Lease for a
hotel, the Company terminates the Lessee's leasehold interest, and the Company
is unable to find a qualifying replacement lessee for such hotel within 90 days
of such termination, gross income from hotel operations conducted by the Company
from such hotel would cease to qualify for the 75% and 95% gross income tests.
In such event, the Company likely would be unable to satisfy the 75% and 95%
gross income tests and, thus, would fail to qualify as a REIT.
If the Company fails to satisfy one or both of the 75% or 95% gross
income tests for any taxable year, it may nevertheless qualify as a REIT for
such year if it is entitled to relief under certain provisions of the Code.
Those relief provisions will be generally available if the Company's failure to
meet such tests is due to reasonable cause and not due to willful neglect, the
Company attaches a schedule of the sources of its income to its return, and any
incorrect information on the schedule was not due to fraud with intent to evade
tax. It is not possible, however, to state whether in all circumstances the
Company would be entitled to the benefit of these relief provisions. As
discussed above in "-- Taxation of the Company," even if those relief provisions
apply, a 100% tax would be imposed with respect to the amount by which it fails
the 75% or 95% gross income tests. No such relief is available for violations of
the 30% income test, which was applicable for taxable years through 1997.
Asset Tests
The Company, at the close of each quarter of its taxable year, also must
satisfy two tests relating to the nature of its assets. First, at least 75% of
the value of the Company's total assets must be represented by cash or cash
items (including certain receivables), government securities, "real estate
assets," or, in cases where the Company raises new capital through share or
long-term (at least five-year) debt offerings, temporary investments in stock or
debt instruments during the one-year period following the Company's receipt of
such capital. The term "real estate assets" includes interests in real property,
interests in mortgages on real property to the extent the mortgage balance does
not exceed the value of the associated real property, and shares of other REITs.
For purposes of the 75% asset test, the term "interest in real property"
includes an interest in land and improvements thereon, such as buildings or
other inherently permanent structures (including items that are structural
components of such buildings or structures), a leasehold in real property, and
an option to acquire real property (or a leasehold in real property). Second, of
the investments not included in the 75% asset class, the value of any one
issuer's securities owned by the Company may not exceed 5% of the value of the
Company's total assets and the Company may not own more than 10% of any one
issuer's outstanding voting securities (except for its ownership interest in the
stock of a qualified REIT subsidiary).
For purposes of the asset requirements, the Company will be deemed to
own its proportionate share of the assets of the Partnership, rather than its
partnership interest in the Partnership, assuming that the Partnership is
treated as a partnership and not as a corporation for tax purposes. The Company
has represented that at all times since the commencement of its taxable year
ended December 31, 1995, (i) at least 75% of the value of its total assets were
represented by assets qualifying under the 75% asset test, and (ii) it has not
owned any securities that do not satisfy the 75% asset test. The Company has
represented that it has not and will not acquire or dispose, or cause the
Partnership to acquire or dispose, of assets in a way that would cause it to
violate the asset tests for REIT status.
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Distribution Requirements
The Company, in order to qualify as a REIT, is required to distribute
dividends (other than capital gain dividends) to its shareholders in an amount
at least equal to (i) the sum of (A) 95% of its "REIT taxable income"(computed
without regard to the dividends paid deduction and its net capital gain) and (B)
95% of the net income (after tax), if any, from foreclosure property, minus (ii)
the sum of certain items of noncash income. Such distributions must be paid in
the taxable year to which they relate, or in the following taxable year if
declared before the Company timely files its tax return for such year and if
paid on or before the first regular dividend payment after such declaration. To
the extent that the Company does not distribute all of its net capital gain or
distributes at least 95%, but less than 100%, of its "REIT taxable income," as
adjusted, it will be subject to tax thereon at regular ordinary and capital
gains corporate tax rates. Furthermore, if the Company should fail to distribute
during each calendar year at least the sum of (i) 85% of its REIT ordinary
income for such year, (ii) 95% of its REIT capital gain income for such year,
and (iii) any undistributed taxable income from prior periods, the Company would
be subject to a 4% nondeductible excise tax on the excess of such required
distribution over the amounts actually distributed. For its taxable years
through December 31, 1998, the Company has made distributions sufficient to
satisfy the foregoing distribution requirements. The Company intends in the
future to make timely distributions sufficient to satisfy all annual
distribution requirements in 1999 and thereafter. However, there can be no
assurance that the Company will at all times have sufficient available cash to
satisfy such distribution requirements.
Recordkeeping Requirement
Pursuant to applicable Treasury Regulations, in order to qualify as a
REIT, the Company must maintain certain records and request on an annual basis
certain information from its shareholders designed to disclose the actual
ownership of its outstanding shares. The Company has complied with these
requirements on a timely basis for its taxable years through December 31, 1998
and intends to comply with such requirements in the future. For taxable years
through 1997, the penalty for failure to obtain information as to actual
ownership was disqualification as a REIT. For 1998 and thereafter, monetary
penalties of up to $50,000 apply.
Anti-Abuse Regulations
The Treasury Regulations authorize the Service, in certain "abusive"
transactions involving partnerships, to disregard the form of the transaction
and recast it for federal tax purposes as the Service deems appropriate (the
"Anti-Abuse Regulations"). The Anti-Abuse Regulations apply where a partnership
is formed or utilized in connection with a transaction (or series of related
transactions) with a principal purpose of substantially reducing the present
value of the partners' aggregate federal tax liability in a manner inconsistent
with the intent of the partnership provisions of the Code. The Company does not
believe that the Anti-Abuse Regulations will have any adverse impact on the
Company's ability to qualify as a REIT. However, because the Anti-Abuse
Regulations are extremely broad in scope and would be applied based on an
analysis of all of the facts and circumstances, there can be no assurance that
the Service will not successfully apply the Anti-Abuse Regulations to the
Company.
FAILURE TO QUALIFY
If the Company fails to qualify for taxation as a REIT in any taxable
year, and the relief provisions do not apply, the Company will be subject to tax
(including any applicable alternative minimum tax) on its taxable income at
regular corporate rates. Distributions to the shareholders in any year in which
the Company fails to qualify will not be deductible by the Company nor will they
be required to be made. In such event, to the extent of current and accumulated
earnings and profits, all distributions to shareholders will be taxable as
ordinary income and, subject to certain limitations of the Code, corporate
distributees may be eligible for the dividends received deduction. Unless
entitled to relief under specific statutory provisions, the Company also will be
disqualified from taxation as a REIT for the four taxable years following the
year during which the Company ceased to qualify as a REIT. It is not possible to
state whether in all circumstances the Company would be entitled to such
statutory relief.
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TAXATION OF SHAREHOLDERS
As long as the Company qualifies as a REIT, distributions made to the
Company's taxable shareholders out of current or accumulated earnings and
profits (and not designated as capital gain dividends) will be taken into
account by such shareholders as ordinary income and will not be eligible for the
dividends received deduction generally available to corporations. Distributions
that are designated as capital gain dividends will be taxed as long-term capital
gains (to the extent they do not exceed the Company's actual net capital gain
for the taxable year) without regard to the period for which the shareholder has
held his shares of Common Stock. However, corporate shareholders may be required
to treat up to 20% of certain capital gain dividends as ordinary income.
Distributions in excess of current and accumulated earnings and profits will not
be taxable to a shareholder to the extent that they do not exceed the adjusted
basis of the shareholder's Common Stock, but rather will reduce the adjusted
basis of such shares. To the extent that distributions in excess of current and
accumulated earnings and profits exceed the adjusted basis of a shareholder's
Common Stock, such distributions will be included in income as capital gain
assuming the shares of Common Stock are capital assets in the hands of the
shareholder. In addition, any distribution declared by the Company in October,
November, or December of any year and payable to a shareholder of record on a
specified date in any such month shall be treated as both paid by the Company
and received by the shareholder on December 31 of such year, provided that the
distribution is actually paid by the Company during January of the following
calendar year.
A Company shareholder at the close of the taxable year must include, in
computing his or her long-term capital gains for his or her taxable year in
which the last day of the Company's taxable year falls, the amount (if any) of
undistributed net capital gains of the Company that the Company designates by
written notice to the shareholder ("Designated Retained Capital Gains"). The
shareholder will be deemed to have paid his or her share of the taxes paid by
the Company on the Designated Retained Capital Gains. The shareholder's basis in
the Company's shares will be increased by the amount of the Designated Retained
Capital Gains in excess of the taxes deemed paid by the shareholder.
Shareholders may not include in their individual income tax returns any
net operating losses or capital losses of the Company. Instead, such losses
would be carried over by the Company for potential offset against its future
income (subject to certain limitations). Taxable distributions from the Company
and gain from the disposition of the Common Stock will not be treated as passive
activity income and, therefore, shareholders generally will not be able to apply
any "passive activity losses" (such as losses from certain types of limited
partnerships in which the shareholder is a limited partner) against such income.
In addition, taxable distributions from the Company and gain from the
disposition of shares of Common Stock generally will be treated as investment
income for purposes of the investment interest limitations. The Company will
notify shareholders after the close of the Company's taxable year as to the
portions of the distributions attributable to that year that constitute ordinary
income, return of capital, and capital gain.
TAXATION OF SHAREHOLDERS ON THE DISPOSITION OF THE COMMON STOCK
In general, any gain or loss realized upon a taxable disposition of the
Common Stock by a shareholder who is not a dealer in securities will be treated
as capital gain or loss. In the case of individuals, the maximum rate of federal
income tax applicable to capital gains is 20% in the case of assets held for
more than one year. No preferential rate of capital gains tax applies in the
case of corporations. Any loss upon a sale or exchange of shares of Common Stock
by a shareholder who has held such shares for six months or less (after applying
certain holding period rules), will be treated as a long-term capital loss to
the extent of distributions from the Company and Designated Retained Capital
Gains required to be treated by such shareholder as long-term capital gain. All
or a portion of any loss realized upon a taxable disposition of the shares of
Common Stock may be disallowed if the shares of Common Stock are purchased
within 30 days before or after the disposition.
OTHER TAX CONSEQUENCES
State or Local Taxes
The Company, the Partnership, or the Company's shareholders may be
subject to state or local taxation in various state or local jurisdictions,
including those in which it or they own property, transact business, or reside.
33
<PAGE> 35
The state and local tax treatment of the Company and its shareholders may not
conform to the federal income tax consequences discussed above. CONSEQUENTLY,
PROSPECTIVE SHAREHOLDERS SHOULD CONSULT THEIR OWN TAX ADVISORS REGARDING THE
EFFECT OF STATE AND LOCAL TAX LAWS ON AN INVESTMENT IN THE COMPANY.
Dividend Reinvestment Program
Under the Company's Dividend Reinvestment and Stock Purchase Plan,
shareholders participating in the program will be deemed to have received the
gross amount of any cash distributions which would have been paid by the Company
to such shareholders had they not elected to participate. These deemed
distributions will be treated as actual distributions from the Company to the
participating shareholders and will retain the character and tax effect
applicable to distributions from the Company generally. See "-- Taxation of
Shareholders." Shares of Common Stock received under the program will have a
holding period beginning with the day after purchase, and a tax basis equal to
the gross amount of the deemed distribution.
TAX ASPECTS OF THE PARTNERSHIP
Classification as a Partnership
The Company will be entitled to include in its income its distributive
share of the Partnership's income and to deduct its distributive share of the
Partnership's losses only if the Partnership is classified for federal income
tax purposes as a partnership rather than as association taxable as a
corporation. No assurance can be given that the Service will not challenge the
status of the Partnership as a partnership for federal income tax purposes. If
such challenge were sustained by a court, the Partnership would be treated as a
corporation for federal income tax purposes.
Under Section 7704 of the Code, a partnership is treated as a
corporation for federal income tax purposes if it is a "publicly traded
partnership" (except in situations in which 90% or more of the partnership's
gross income is of a specified type). A partnership is deemed to be publicly
traded if its interests are either (i) traded on an established securities
market, or (ii) readily tradable on a secondary market (or the substantial
equivalent thereof). While the Partnership Units will not be traded on an
established securities market, they could possibly be deemed to be traded on a
secondary market or its equivalent due to the redemption rights enabling the
partners to dispose of their Units.
The Treasury Department has issued regulations (the "PTP Regulations")
governing the classification of partnerships under Section 7704. These
regulations provide that the classification of partnerships is generally based
on a facts and circumstances analysis. However, the regulations also provide
limited "safe harbors" which preclude publicly traded partnership status.
Pursuant to one of those safe harbors, interests in a partnership will not be
treated as readily tradable on a secondary market or the substantial equivalent
thereof if (i) all interests in the partnership were issued in a transaction (or
transactions) that was not required to be registered under the Securities Act,
and (ii) the partnership does not have more than 100 partners at any time during
the partnership's taxable year. In determining the number of partners in a
partnership for this purpose, a person owning an interest in a flow-through
entity (i.e., a partnership, grantor trust, or S corporation) that owns an
interest in the partnership is treated as a partner in such partnership only if
(x) substantially all of the value of the person's interest in the flow-through
entity is attributable to the flow-through entity's interest (direct or
indirect) in the partnership and (y) a principal purpose of the use of the
tiered arrangement is to permit the partnership to satisfy the 100-partner
limitation. Furthermore, pursuant to Notice 88-75 issued by the IRS, through the
year 2005, an existing partnership may qualify for non-publicly traded status if
it has less than 500 partners (looking through to the ultimate owners in the
case of flow-through entities), does not issue any Units registered under the
Securities Act and does not enter into a substantial new line of business.
The Partnership currently has less than 100 actual partners and less
than 500 partners calculated on a "lookthrough" basis. The Partnership has not
issued any Units required to be registered under the Securities Act. Thus, the
Partnership presently qualifies for the safe harbors provided in Notice 88-75
and the PTP Regulations. However, there is no assurance that the Partnership
will at all times in the future be able to avoid treatment as a publicly traded
partnership.
34
<PAGE> 36
Even if the Partnership were ever to be classified as a publicly traded
partnership, it would nevertheless be treated as a partnership for federal
income tax purposes (rather than an association taxable as a corporation) if at
least 90% of its gross income in each taxable year (commencing with the year in
which it is treated as a publicly traded partnership) consists of "qualifying
income" within the meaning of Section 7704(c)(2) of the Code (including
interest, dividends, "real property rents" and gains from the disposition of
real property). The Partnership has represented that, if in any taxable year the
Partnership falls outside of an applicable safe harbor from publicly traded
partnership status, it will satisfy the gross income test set forth in Section
7704(c)(2) of the Code in that taxable year and each subsequent taxable year.
Among other things, this will require that any shareholder of the Lessee who
owns at least 10% of the stock of the Lessee must own less than a 5% interest in
the Partnership in the particular taxable year. The Company anticipates that if
the Partnership is ever treated as a publicly traded partnership, it will
satisfy the qualifying income test of Section 7704(c)(2) of the Code in the
taxable year in which such treatment commences and all years thereafter.
If for any reason the Partnership were taxable as a corporation, rather
than as a partnership, for federal income tax purposes, the Company would not be
able to satisfy the income and asset requirements for REIT status. Thus the
Company would be subject to tax as a regular corporation and would not receive a
deduction for dividends paid to its shareholders. See "-- Taxation of the
Company -- Income Tests" and "-- Asset Tests." In addition, any change in the
Partnership's status for tax purposes might be treated as a taxable event, in
which case the Company might incur a tax liability without any related cash
distribution. Further, items of income and deduction of the Partnership would
not pass through to its partners, and its partners would be treated as
shareholders for tax purposes. Consequently, the Partnership would be required
to pay income tax at corporate tax rates on its net income, and distributions to
its partners would constitute dividends that would not be deductible in
computing the Partnership's taxable income.
Income Taxation of the Partnership and Its Partners
The following discussion assumes that the Partnership will at all times
be treated as a partnership for federal income tax purposes.
Partners, Not the Partnership, Subject to Tax. A partnership is not a
taxable entity for federal income tax purposes. Rather, the Company will be
required to take into account its allocable share of the Partnership's income,
gains, losses, deductions, and credits for any taxable year of the Partnership
ending within or with the taxable year of the Company, without regard to whether
the Company has received or will receive any distribution from the Partnership.
Tax Allocations With Respect to Contributed Properties. Pursuant to
Section 704(c) of the Code, income, gain, loss, and deduction attributable to
appreciated or depreciated property that is contributed to a partnership in
exchange for an interest in the partnership must be allocated for federal income
tax purposes in a manner such that the contributor is charged with, or benefits
from, the unrealized gain or unrealized loss associated with the property at the
time of the contribution. The amount of such unrealized gain or unrealized loss
is generally equal to the difference between the fair market value of the
contributed property at the time of contribution and the adjusted tax basis of
such property at the time of contribution. The Treasury Department has issued
regulations requiring partnerships to use a "reasonable method" for allocating
items affected by Section 704(c) of the Code and outlining certain reasonable
allocation methods.
Under the Partnership Agreement, depreciation or amortization deductions
of the Partnership generally will be allocated among the partners in accordance
with their respective interests in the Partnership, except to the extent
required under Code Section 704(c). In addition, gain on sale of a hotel will be
specially allocated to the Partners who contributed the hotel to the Partnership
to the extent of any "built-in" gain with respect to such hotel for federal
income tax purposes.
Basis in Partnership Interest. The Company's adjusted tax basis in its
Partnership interest in the Partnership generally will be equal to (i) the
amount of cash and the basis of any other property contributed to the
Partnership by the Company, (ii) increased by (A) its allocable share of the
Partnership's income and (B) its allocable share of indebtedness of the
Partnership, and (iii) reduced, but not below zero, by (A) the Company's
35
<PAGE> 37
allocable share of the Partnership's loss and (B) the amount of cash distributed
to the Company (including deemed distributions as a result of reductions in the
Company's allocable share of indebtedness of the Partnership).
Treatment of Partnership Distributions. Partnership distributions to the
Company will not generally constitute taxable distributions. However, to the
extent that Partnership distributions, or any decrease in the Company's share of
the indebtedness of the Partnership (such decrease being considered a
constructive cash distribution to the partners), exceeds the Company's adjusted
tax basis in its Partnership interest, such distributions (including such
constructive distributions) would constitute taxable income to the Company. Such
distributions and constructive distributions normally would be characterized as
capital gain.
Sale of the Partnership's Property. Generally, any taxable gain realized
by the Partnership on the sale of property by the Partnership will be capital
gain or gain described in Section 1231 of the Code, except for any portion of
such gain that is treated as depreciation or cost recovery recapture or
attributable to inventory or property held for sale to customers in the ordinary
course of business. Any taxable gain recognized by the Partnership on the
disposition of any hotels originally contributed to the Partnership by the
Partners will generally be allocated first to the contributing Partners under
Section 704(c) of the Code to the extent of their "built-in gain" on those
hotels for federal income tax purposes. Any remaining taxable gain recognized by
the Partnership on the disposition of the hotels will generally be allocated
among the partners in accordance with their respective percentage interests in
the Partnership.
The Company's share of any gain realized by the Partnership on the sale
of any property held by the Partnership as inventory or other property held
primarily for sale to customers in the ordinary course of the Partnership's
trade or business will be treated as income from a prohibited transaction that
is subject to a 100% penalty tax. Such prohibited transaction income also may
have an adverse effect upon the Company's ability to satisfy the income tests
for REIT status. The Company, however, does not presently intend to allow the
Partnership to acquire or hold any property that represents inventory or other
property held primarily for sale to customers in the ordinary course of the
Company's or the Partnership's trade or business. See "-- Taxation of the
Company -- Income Tests."
INFORMATION REPORTING REQUIREMENTS AND BACKUP WITHHOLDING
The Company will report to its U.S. stockholders and to the Service the
amount of distributions paid during each calendar year, and the amount of tax
withheld, if any. Under the backup withholding rules, a stockholder may be
subject to backup withholding at the rate of 31% with respect to distributions
paid unless such holder (i) is a corporation or comes within certain other
exempt categories and, when required, demonstrates this fact, or (ii) provides a
taxpayer identification number, certifies as to no loss of exemption from backup
withholding, and otherwise complies with the applicable requirements of the
backup withholding rules. A stockholder who does not provide the Company with
his correct taxpayer identification number also may be subject to penalties
imposed by the Service. Any amount paid as backup withholding will be creditable
against the stockholder's income tax liability. In addition, the Company may be
required to withhold a portion of capital gain distributions to any stockholders
who fail to certify their nonforeign status to the Company.
36
<PAGE> 38
PLAN OF DISTRIBUTION
The Warrants have been offered by the Company solely to Messrs. Alter
and Biederman, who have received, respectively, 357,600 Warrants and 89,400
Warrants in exchange for their surrender of options to purchase the same number
of shares of Common stock previously granted by the Company. Messrs. Alter and
Biederman intend to assign the Warrants to certain employees who participated in
the SAR Plan adopted by the Lessee. Each of the SAR holders will be asked to
agree to cancel his or her SARs in exchange for an assignment from Messrs. Alter
and Biederman of the Warrants.
The Company is registering the Warrants and the Warrant Shares on behalf
of Messrs. Alter and Biederman, the employees of the Lessee to whom the Warrants
may subsequently be assigned (and who, following such assignment, shall be
incorporated into this Prospectus as a named Selling Shareholder pursuant to a
post-effective amendment to the Form S-3 Registration Statement pursuant to
which this Prospectus is filed with the Securities and Exchange Commission) and
all donees and pledgees selling shares received from a Selling Shareholder after
the date of this prospectus. All such individuals are hereinafter collectively
referred to as the "Selling Shareholders." There will be no compensation paid to
any broker or dealer in connection with the distribution of the Warrants.
All costs, expenses and fees in connection with the registration of the
Warrants and Warrant Shares offered hereby will be borne by the Lessee.
Brokerage commissions and similar selling expenses, if any, attributable to the
sale of Warrant Shares will be borne by the Selling Shareholders. Sales of
Warrant Shares may be effected by Selling Shareholders from time to time in one
or more types of transactions (which may include block transactions) on the
NYSE, in the over-the-counter market, in negotiated transactions, through put or
call options transactions relating to the Warrant Shares, through short sales of
Warrant Shares, or a combination of such methods of sale, at market prices
prevailing at the time of sale, or at negotiated prices. Such transactions may
or may not involve brokers or dealers. The Selling Shareholders have advised the
Company that they have not entered into any agreements, understandings or
arrangements with any underwriters or broker-dealers regarding the sale of their
securities, nor is there an underwriter or coordinating broker acting in
connection with the proposed sale of Warrant Shares by the Selling Shareholders.
The Selling Shareholders may effect such transactions by selling Warrant
Shares directly to purchasers or to or through broker-dealers, which may act as
agents or principals. Such broker-dealers may receive compensation in the form
of discounts, concessions, or commissions from the Selling Shareholders and/or
the purchasers of Warrant Shares for whom such broker-dealers may act as agents
or to whom they sell as principal, or both (which compensation as to a
particular broker-dealer might be in excess of customary commissions).
The Selling Shareholders and any broker-dealers that act in connection
with the sale of Warrant Shares might be deemed to be "underwriters" within the
meaning of Section 2(11) of the Securities Act, and any commissions received by
such broker-dealers and any profit on the resale of the Warrant Shares sold by
them while acting as principals might be deemed to be underwriting discounts or
commissions under the Securities Act. The Company has agreed to indemnify each
Selling Shareholder against certain liabilities, including liabilities arising
under the Securities Act. The Selling Shareholders may agree to indemnify any
agent, dealer or broker-dealer that participates in transactions involving sales
of the Warrant Shares against certain liabilities, including liabilities arising
under the Securities Act.
Because Selling Shareholders may be deemed to be "underwriters" within
the meaning of Section 2(11) of the Securities Act, the Selling Shareholders
will be subject to the prospectus delivery requirements of the Securities Act,
which may include delivery through the facilities of the NYSE pursuant to Rule
153 under the Securities Act. The Company has informed the Selling Shareholders
that the anti-manipulative provisions of Regulation M promulgated under the
Exchange Act may apply to their sales in the market.
Selling Shareholders also may resell all or a portion of the Warrant
Shares in open market transactions in reliance upon Rule 144 under the
Securities Act, provided they meet the criteria and conform to the requirements
of such Rule.
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<PAGE> 39
Upon the Company being notified by a Selling Shareholder that any
material arrangement has been entered into with a broker-dealer for the sale of
Warrant Shares through a block trade, special offering, exchange distribution or
secondary distribution or a purchase by a broker or dealer, a supplement to this
prospectus will be filed, if required, pursuant to Rule 424(b) under the Act,
disclosing (i) the name of each such selling shareholder and of the
participating broker-dealer(s), (ii) the number of Warrant Shares involved,
(iii) the price at which such Warrant Shares were sold, (iv) the commissions
paid or discounts or concessions allowed to such broker-dealer(s), where
applicable, (v) that such broker-dealer(s) did not conduct any investigation to
verify the information set out or incorporated by reference in this prospectus
and (vi) other facts material to the transaction. In addition, upon the Company
being notified by a Selling Shareholder that a donee or pledgee intends to sell
more than 500 shares, a supplement to this Prospectus will be filed.
LEGAL MATTERS
The validity of the Offered Securities will be passed upon for the
Company by Brobeck, Phleger & Harrison LLP, Irvine, California. In rendering its
opinions, Brobeck, Phleger & Harrison LLP will rely on the opinion of Ballard
Spahr Andrews & Ingersoll, Baltimore, Maryland, as to certain matters of
Maryland law. Roger Cohen, a partner at Brobeck, Phleger & Harrison LLP, is
Assistant Secretary of the Company and owns 3,560 shares of Common Stock and has
been granted options to purchase 4,500 shares of Common Stock. In addition, the
description of federal income tax consequences contained in the section of this
Prospectus entitled "Federal Income Tax Considerations" and certain federal
income tax matters pertaining to the Company's status as a REIT will be based on
the opinion of the Company's tax advisor.
EXPERTS
The consolidated financial statements of Sunstone Hotel Investors, Inc.
at December 31, 1998 and 1997 and for each of the two years in the period ended
December 31, 1998 and the consolidated financial statements of Sunstone Hotel
Properties, Inc. at December 31, 1998 and 1997 and for each of the two years in
the period ended December 31, 1998, all appearing in Sunstone Hotel Investors,
Inc.'s Annual Report on Form 10-K for the year ended December 31, 1998, have
been audited by Ernst & Young LLP, independent auditors, and the consolidated
statements of operations, stockholders' equity and cash flows of Sunstone Hotel
Investors, Inc. for the year ended December 31, 1996, and the statements of
operations, stockholders' deficit and cash flows of Sunstone Hotel Properties,
Inc. for the year ended December 31, 1996, all appearing in Sunstone Hotel
Investors, Inc.'s Annual Report on Form 10-K for the year ended December 31,
1998, have been audited by PricewaterhouseCoopers LLP, independent accountants,
as set forth in their respective reports thereon included therein and
incorporated herein by reference in reliance upon such reports given on the
authority of such firms as experts in accounting and auditing.
38
<PAGE> 40
====================================== ======================================
NO PERSONS HAVE BEEN AUTHORIZED TO
GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE
CONTAINED OR INCORPORATED BY
REFERENCE IN THIS PROSPECTUS AND, IF
GIVEN OR MADE, SUCH INFORMATION OR SUNSTONE HOTEL INVESTORS, INC.
REPRESENTATIONS MUST NOT BE RELIED
UPON AS HAVING BEEN AUTHORIZED BY
THE COMPANY. THIS PROSPECTUS DOES
NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY ANY 447,000 WARRANTS TO PURCHASE
SECURITIES OTHER THAN THOSE TO WHICH COMMON STOCK
IT RELATES, OR AN OFFER OR
SOLICITATION WITH RESPECT TO THOSE
SECURITIES TO WHICH IT RELATES TO 447,000 SHARES OF COMMON STOCK
ANY PERSONS IN ANY JURISDICTION
WHERE SUCH OFFER OR SOLICITATION
WOULD BE UNLAWFUL. THE DELIVERY OF
THIS PROSPECTUS AT ANY TIME DOES NOT
IMPLY THAT THE INFORMATION CONTAINED
OR INCORPORATED BY REFERENCE HEREIN
AT ITS DATE IS CORRECT AS OF ANY
TIME SUBSEQUENT TO ITS DATE.
------------------------- --------------------
TABLE OF CONTENTS PROSPECTUS
--------------------
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Available Information............. 2
Incorporation of Certain
Information by Reference........ 3
Prospectus Summary................ 4
Recent Developments............... 6
Risk Factors...................... 6
Year 2000 Issue................... 14
Use of Proceeds................... 16
Description of Common Stock,
Preferred Stock and Warrants.... 17
Certain Provisions of Maryland
Law and of the Company's
Articles of Incorporation
and Bylaws...................... 23 MAY __, 1999
Federal Income Tax
Considerations.................. 26
Plan of Distribution.............. 37
Legal Matters..................... 38
Experts........................... 38
</TABLE>
====================================== ======================================
39
<PAGE> 41
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 14. OTHER EXPENSES
The estimated expenses in connection with the Offered Shares are as
follows:
<TABLE>
<CAPTION>
Amount Paid
Or To Be Paid
-------------
<S> <C>
SEC Registration fee.................................................... $ 1,647
New York Stock Exchange listing fees.................................... 0
Legal fees and expenses................................................. 35,000
Accounting fees and expenses............................................ 15,000
Transfer Agent and Registrar ........................................... 1,000
Printer fees ........................................................... 2,000
Miscellaneous .......................................................... 2,000
-------
Total .......................................................... $56,647
=======
</TABLE>
ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 2-418 of the Maryland General Corporation Law (the "MGCL")
empowers the Company to indemnify, subject to the standards set forth therein,
any person who is a party in any action in connection with any action, suit or
proceeding brought or threatened by reason of the fact that the person was a
director, officer, employee or agent of such company, or is or was serving as
such with respect to another entity at the request of such company. The MGCL
also provides that the Company may purchase insurance on behalf of any such
director, officer, employee or agent.
The Company's Articles of Incorporation provide for indemnification of
the officers and directors of the Company substantially identical in scope to
that permitted under Section 2-418 of the MGCL. The Bylaws of the Company also
provide that the expenses of officers and directors incurred in defending any
action, suit or proceeding, whether civil, criminal, administrative or
investigative, must be paid by the Company as they are incurred and in advance
of the final disposition of the action, suit or proceeding, upon receipt of an
undertaking by or on behalf of the director or officer to repay all amounts so
advanced if it is ultimately determined by a court of competent jurisdiction
that the officer or director is not entitled to be indemnified by the Company.
The Company has entered into indemnification agreements with each of its
directors and executive officers. In addition, the Company maintains a
directors' and officers' liability policy.
The Company's Charter limits the liability of the Company's directors
and officers for money damages to the Company and its stockholders to the
fullest extent permitted from time to time by Maryland law. Maryland law
presently permits the liability of directors and officers to a corporation or
its stockholders for money damages to be limited, except (i) to the extent that
it is proved that the director or officer actually received an improper benefit
or profit or (ii) if a judgment or other final adjudication is entered in a
proceeding based on a finding that the director's or officer's action, or
failure to act, was the result of active and deliberate dishonesty and was
material to the cause of action adjudicated in the proceeding. This provision
does not limit the ability of the Company or its stockholders to obtain other
relief, such as an injunction or rescission.
II-1
<PAGE> 42
ITEM 16. EXHIBITS
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<S> <C>
3.1 Amended Articles of Incorporation of the Company, as further
amended by the Articles of Amendment of the Company, as filed
with the State Department of Assessments and Taxation of
Maryland on November 9, 1994. Filed as Exhibit 3.1 to the
Company's Registration Statement No. 33-84346 and incorporated
herein by this reference.
3.2 Bylaws of the Company, as currently in effect.
3.3 Articles of Amendment of the Company, as filed with the State
Department of Assessments and Taxation of Maryland on June 19,
1995. Filed as Exhibit 3.3 to the Company's Registration
Statement No. 33-84346 and incorporated herein by this
reference.
3.4 Certificate of Articles Supplementary, as filed with the State
Department of Assessments and Taxation of Maryland on October
14, 1997, designating the rights, preferences and privileges of
the 7.9% Class A Cumulative Preferred Stock. Filed as Exhibit to
Exhibit 10.1 to the Company's Report on Form 8-K dated August
13, 1997 and incorporated herein by reference.
3.5 Articles of Amendment, as filed with the State Department of
Assessments and Taxation of Maryland on April 22, 1998.
4.1 See exhibits 3.1, 3.2, 3.3, 3.4, and 3.5.
4.2* Form of Warrant Agreement for Purchase of Common Stock.
5.1* Opinion of Brobeck, Phleger & Harrison LLP as to legality of
securities being registered.
5.2* Opinion of Ballard Spahr Andrews & Ingersoll as to Maryland law.
8.1* Opinion of Brobeck, Phleger & Harrison LLP.
23.1* Consent of Ernst & Young LLP.
23.2* Consent of PricewaterhouseCoopers LLP.
23.3 Consent of Ballard Spahr Andrews & Ingersoll (Included with
opinion filed as Exhibit 5.2).
23.4 Consent of Brobeck, Phleger & Harrison LLP (Included with
opinion filed as Exhibit 5.1).
24.1 Power of Attorney (included in signature page on page II-4).
</TABLE>
- -----------------
* Filed herewith.
II-2
<PAGE> 43
ITEM 17. UNDERTAKINGS
The undersigned Registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being
made, a post-effective amendment to this Registration Statement:
(i) To include any prospectus required by Section 10(a)(3)
of the Securities Act of 1933, as amended (the "Securities Act");
(ii) To reflect in the prospectus any facts or events arising
after the effective date of this Registration Statement (or the most
recent post-effective amendment hereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in this Registration Statement. Notwithstanding the foregoing, any
increase or decrease in volume of securities offered (if the total
dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high and of the estimated
maximum offering price may be reflected in the form of prospectus filed
with the Commission pursuant to Rule 424(b) if, in the aggregate the
changes in volume and price represent no more than 20 percent change in
the maximum aggregate offering price set forth in the "Calculation of
Registration Fee" table in the effective registration statement; and
(iii) To include any material information with respect to the
plan of distribution not previously disclosed in this Registration
Statement or any material change to such information in this
Registration Statement.
Provided, however, that paragraphs (i) and (ii) do not apply if
the information is required to be included in a post-effective amendment
by those paragraphs is contained in periodic reports filed by the
Company pursuant to Section 13 or Section 15(d) of the Exchange Act that
are incorporated by reference in this Registration Statement.
(2) That, for the purpose of determining any liability under the
Securities Act, each such post-effective amendment shall be deemed to be a new
registration statement relating to the securities offered herein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
(3) To remove from registration by means of a post-effective
amendment any of the securities being registered which remain unsold at the
termination of the offering.
The undersigned Registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act, each filing of the Company's
Annual Report pursuant to Section 13(a) or Section 15(d) of the Exchange Act
that is incorporated by reference into this Registration Statement shall be
deemed to be a new registration statement relating to the securities offered
herein, and the offering of such securities at that time shall be deemed to be
the initial bona fide offering thereof.
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Registrant of expenses
incurred or paid by a director, officer or controlling person of the Registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
II-3
<PAGE> 44
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended,
the Registrant certifies that it has reasonable grounds to believe that it meets
all the requirements for filing on Form S-3 and has duly caused this Amendment
No. 1 to Registration Statement to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of San Clemente, State of California, on
May 27, 1999.
SUNSTONE HOTEL INVESTORS, INC.
By: /S/ ROBERT A. ALTER
-------------------------------------
Robert A. Alter
President, Secretary
and Chairman of the Board of
Directors
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Amendment No. 1 to the Registration Statement has been signed below by the
following persons in the capacities and on the dates indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- --------- ----- ----
<S> <C> <C>
* President, Secretary and Chairman of May 27, 1999
- ------------------------------- the Board of Directors (Principal
Robert A. Alter Executive Officer)
/s/ R. TERRENCE CROWLEY Chief Operating Officer May 27, 1999
- ------------------------------- (Principal Financial and Accounting
R. Terrence Crowley Officer)
* Executive Vice President and Director May 27, 1999
- -------------------------------
Charles L. Biederman
* Director May 27, 1999
- -------------------------------
H. Raymond Bingham
Director May 27, 1999
- -------------------------------
C. Robert Enever
Director May 27, 1999
- -------------------------------
Laurence S. Geller
* Director May 27, 1999
- -------------------------------
Fredric H. Gould
Director May 27, 1999
- -------------------------------
Paul D. Kazilionis
* Director May 27, 1999
- -------------------------------
David Lambert
* Director May 27, 1999
- -------------------------------
Edward H. Sondker
/s/ ROBERT A. ALTER
- -------------------------------
By *Robert Alter, as
Attorney-in-Fact
</TABLE>
II-4
<PAGE> 45
EXHIBIT INDEX
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NO. DESCRIPTION PAGE
------ ----------- -----------
<S> <C> <C>
3.1 Amended Articles of Incorporation of the Company, as further
amended by the Articles of Amendment of the Company, as filed
with the State Department of Assessments and Taxation of
Maryland on November 9, 1994. Filed as Exhibit 3.1 to the
Company's Registration Statement No. 33-84346 and incorporated
herein by this reference.
3.2 Bylaws of the Company, as currently in effect.
3.3 Articles of Amendment of the Company, as filed with the State
Department of Assessments and Taxation of Maryland on June 19,
1995. Filed as Exhibit 3.3 to the Company's Registration
Statement No. 33-84346 and incorporated herein by this
reference.
3.4 Certificate of Articles Supplementary, as filed with the State
Department of Assessments and Taxation of Maryland on October
14, 1997, designating the rights, preferences and privileges of
the 7.9% Class A Cumulative Preferred Stock. Filed as Exhibit to
Exhibit 10.1 to the Company's Report on Form 8-K dated August
13, 1997 and incorporated herein by reference.
3.5 Articles of Amendment, as filed with the State Department of
Assessments and Taxation of Maryland on April 22, 1998.
4.1 See items 3.1, 3.2, 3.3, 3.4. and 3.5.
4.2* Form of Warrant Agreement for Purchase of Common Stock.
5.1* Opinion of Brobeck, Phleger & Harrison LLP as to legality of
shares being registered.
5.2* Opinion of Ballard Spahr Andrews & Ingersoll as to Maryland law.
8.1* Opinion of Brobeck, Phleger & Harrison LLP.
23.1* Consent of Ernst & Young LLP.
23.2* Consent of PricewaterhouseCoopers LLP.
23.3 Consent of Ballard Spahr Andrews & Ingersoll (Included with
opinion filed as Exhibit 5.2).
23.4 Consent of Brobeck, Phleger & Harrison LLP (Included with
opinion filed as Exhibit 5.1).
24.1 Power of Attorney (included in signature page on page II-4).
</TABLE>
- -----------------------------
* Filed herewith.
II-5
<PAGE> 1
Exhibit 4.2
SUNSTONE HOTEL INVESTORS, INC.
1994 STOCK INCENTIVE PLAN
NOTICE OF ISSUANCE OF WARRANT
Notice is hereby given of the issuance to the individual named below
(the "Holder") of the following warrant (the "Warrant") to purchase shares of
the Common Stock of Sunstone Hotel Investors, Inc. (the "Corporation"):
HOLDER:
WARRANT ISSUE DATE: September 25, 1998
EXERCISE PRICE: $______ per share
NUMBER OF WARRANT SHARES: ________ shares
EXPIRATION DATE: September 24, 2003
EXERCISE DATE: The Warrant shall become exercisable for all of
the Warrant Shares on October 25, 1999 and shall remain so
exercisable until the Expiration Date. All Warrant Shares
purchased upon the exercise of the Warrant shall be fully
vested.
Holder agrees to be bound by the terms and conditions of the Warrant as
set forth in the Warrant Agreement attached hereto as Exhibit A. Holder hereby
acknowledges receipt of a copy of the Prospectus for the Warrant in the form
attached hereto as Exhibit B. Holder further understands and agrees that the
Warrant is granted subject to and in accordance with the express terms and
conditions of the Sunstone Hotel Investors, Inc. 1994 Stock Incentive Plan (the
"Plan").
NO EMPLOYMENT OR SERVICE CONTRACT. Nothing in this Notice of Issuance,
the attached Warrant Agreement or the Plan shall confer upon Holder any right to
continue in the employment or other service of the Corporation, Sunstone Hotel
Properties, Inc. (the "Lessee") (or any parent or subsidiary of either such
entity) for any period of specific duration or interfere with or otherwise
restrict in any way the rights of the Corporation or the Lessee (or any parent
or subsidiary of such entity employing or retaining Holder) or Holder, which
rights are hereby expressly reserved by each, to terminate Holder's employment
or other service at any time for any reason whatsoever, with or without cause.
<PAGE> 2
DEFINITIONS. All capitalized items in this Notice shall have the meaning
assigned to them in this Notice or in the attached Warrant Agreement.
____________________, 1998
SUNSTONE HOTEL INVESTORS, INC.
By:
-------------------------------------
Title:
----------------------------------
-------------------------------------
By:
-------------------------------------
HOLDER
ATTACHMENTS:
Exhibit A: Warrant Agreement
Exhibit B: Warrant Prospectus dated May 10, 1999
2
<PAGE> 3
EXHIBIT A
TO NOTICE OF
ISSUANCE OF WARRANT
FORM OF WARRANT AGREEMENT
<PAGE> 4
SUNSTONE HOTEL INVESTORS, INC.
1994 STOCK INCENTIVE PLAN
WARRANT AGREEMENT
WITNESSETH:
RECITALS
(a) The Corporation's Board of Directors (the "Board") has
adopted the Corporation's 1994 Stock Incentive Plan (the "Plan") for the purpose
of attracting and retaining the services of employees (including officers and
directors), and consultants and other advisors (and their respective employees).
(b) The Corporation previously granted to Holder a stock
option (the "Option") under the Plan to purchase shares of the Corporation's
Common Stock (the "Common Stock").
(c) Holder has surrendered the Option to the Corporation for
cancellation, and in replacement of such cancelled Option, the Compensation
Committee of the Board, acting in its capacity as Plan Administrator of the
Plan, has approved the issuance to Holder of a warrant to purchase the number of
shares of Common Stock equal to the number of shares of Common Stock subject to
such Option. The warrant shall have an exercise price per share equal to the
exercise price per share in effect under of the Option immediately prior to
cancellation, and this Agreement is executed pursuant to, and is intended to
carry out the purposes of the Plan in connection with the issuance of such
warrant.
(d) The Plan Administrator has approved the assignment of
this warrant by Holder to certain service providers of Sunstone Hotel
Properties, Inc. (the "Lessee") in consideration of the surrender by such
individuals to the Lessee of their outstanding stock appreciation rights under
the Lessee's 1996 Stock Appreciation Rights Plan (the "SAR Plan").
A-1
<PAGE> 5
NOW, THEREFORE, it is hereby agreed as follows:
I. ISSUANCE OF WARRANT. SUBJECT TO AND UPON THE TERMS AND CONDITIONS SET
FORTH IN THIS AGREEMENT, THE CORPORATION HEREBY ISSUES TO HOLDER AS OF
SEPTEMBER 25, 1998 (THE "ISSUE DATE"), A WARRANT (THE "WARRANT") TO
PURCHASE UP TO THAT NUMBER OF SHARES OF COMMON STOCK (THE "WARRANT
SHARES") AS IS SPECIFIED IN THE ACCOMPANYING NOTICE OF ISSUANCE OF
WARRANT (THE "NOTICE OF ISSUANCE") AT THE EXERCISE PRICE PER WARRANT
SHARE (THE "EXERCISE PRICE") SPECIFIED IN THE NOTICE OF ISSUANCE.
II. WARRANT EXERCISABILITY AND TERM. THE WARRANT SHALL BECOME EXERCISABLE ON
OCTOBER 25, 1999, SUBJECT TO ACCELERATION PURSUANT TO THE PROVISIONS OF
PARAGRAPH 4 OF THIS AGREEMENT, AND SHALL REMAIN EXERCISABLE UNTIL THE
CLOSE OF BUSINESS ON SEPTEMBER 24, 2003 (THE "EXPIRATION DATE") UNLESS
SOONER TERMINATED IN ACCORDANCE WITH SUCH PARAGRAPH 4.
III. LIMITED TRANSFERABILITY. THE WARRANT SHALL BE TRANSFERABLE OR ASSIGNABLE
BY HOLDER TO CERTAIN SERVICE PROVIDERS OF THE LESSEE WHO AGREE TO
SURRENDER TO THE LESSEE THEIR OUTSTANDING STOCK APPRECIATION RIGHTS
UNDER THE SAR PLAN IN EXCHANGE FOR SUCH ASSIGNMENT OF HOLDER'S INTEREST
IN THE WARRANT. THE ASSIGNED PORTION SHALL BE EXERCISABLE ONLY BY THE
PERSON OR PERSONS WHO ACQUIRE A PROPRIETARY INTEREST IN THE WARRANT
PURSUANT TO SUCH ASSIGNMENT OR THE LEGAL REPRESENTATIVES OF THEIR
ESTATE, WITH EACH SUCH PERSON THEREAFTER TO BE TREATED AS A HOLDER FOR
PURPOSES OF THIS AGREEMENT. THE TERMS APPLICABLE TO THE ASSIGNED PORTION
SHALL BE THE SAME AS THOSE IN EFFECT FOR THE WARRANT IMMEDIATELY PRIOR
TO SUCH ASSIGNMENT. TO THE EXTENT THE WARRANT IS NOT SO ASSIGNED TO
SERVICE PROVIDERS OF THE LESSEE, THE WARRANT SHALL BE TRANSFERABLE OR
ASSIGNABLE ONLY PURSUANT TO HOLDER'S WILL OR BY THE LAWS OF DESCENT AND
DISTRIBUTION FOLLOWING HOLDER'S DEATH AND MAY BE EXERCISED, DURING
HOLDER'S LIFETIME, ONLY BY HOLDER.
IV. SPECIAL ACCELERATION EVENTS.
A. In the event of any of the following stockholder-approved
transactions to which the Corporation is a party (a "Corporate
Transaction"):
1. a merger or consolidation in which the Corporation is
not the surviving entity, except for a transaction the principal purpose
of which is to change the state in which the Corporation is
incorporated,
2. the sale, transfer or other disposition of all or
substantially all of the assets of the Corporation in complete
liquidation or dissolution of the Corporation, or
3. any reverse merger in which the Corporation is the
surviving entity but in which securities possessing more than fifty
percent (50%) of the total combined voting power of the Corporation's
outstanding securities are transferred to a person or persons different
from the persons holding those securities immediately prior to such
merger, the Warrant, to the extent outstanding but not otherwise fully
exercisable at the time of such Corporate Transaction, shall
automatically accelerate so that such warrant shall, immediately prior
to the effective date of such Corporate Transaction, become fully
exercisable with respect to all of the Warrant Shares and may be
exercised for any or all such Warrant Shares as fully vested shares of
Common Stock.
A-2
<PAGE> 6
B. Immediately following the consummation of the Corporate
Transaction, the Warrant shall terminate and cease to remain
outstanding, except to the extent assumed by the successor corporation
or parent thereof.
C. In the event of any of the following transactions effecting a
change in ownership of the Lessee (a "Lessee Change in Ownership"):
1. a merger or consolidation in which securities possessing
more than fifty percent (50%) of the total combined voting power of the
Lessee's outstanding securities are transferred to a person or persons
different from the persons holding those securities immediately prior to
such transaction,
2. the sale, transfer or other disposition of all or
substantially all of the Lessee's assets in complete liquidation or
dissolution of the Lessee, or
3. the sale, transfer or other disposition for value, by
one or more security holders of the Lessee, of securities possessing
more than fifty percent (50%) of the total combined voting power of the
Lessee's outstanding securities in a single transaction or a series of
related transactions, the Warrant, to the extent outstanding but not
otherwise fully exercisable at the time of such Lessee Change in
Ownership, shall automatically accelerate so that such warrant shall,
immediately prior to the effective date of such change in ownership,
become fully exercisable with respect to all of the Warrant Shares and
may be exercised for any or all such Warrant Shares as fully vested
shares of Common Stock.
D. In the event the Lessee completes an initial public offering of
its Common Stock yielding net proceeds of at least $15 million, the
Warrant, to the extent outstanding but not otherwise fully exercisable
at the time of such offering, shall automatically accelerate so that
such warrant shall, immediately upon completion of such offering, become
fully exercisable with respect to all of the Warrant Shares and may be
exercised for any or all such Warrant Shares as fully vested shares of
Common Stock.
E. This Agreement shall in no way affect the right of the
Corporation to adjust, reclassify, reorganize or otherwise change its
capital or business structure or to merge, consolidate, dissolve,
liquidate or sell or transfer all or any part of its business or assets.
V. ADJUSTMENT IN WARRANT SHARES.
A. In the event any change is made to the Common Stock issuable
under the Plan by reason of any stock split, stock dividend,
recapitalization, combination of shares, exchange of shares or other
change affecting the outstanding Common Stock as a class effected
without the Corporation's receipt of consideration, the Plan
Administrator shall make appropriate adjustments to (i) the number
and/or class of securities subject to the Warrant and (ii) the Exercise
Price payable per warrant share in order to prevent any dilution or
enlargement of rights and benefits hereunder. Such adjustments shall be
final, binding and conclusive.
B. If the Warrant is to be assumed in connection with a Corporate
Transaction under Paragraph 4, then the Warrant shall, immediately after
such Corporate Transaction, be appropriately adjusted to apply and
pertain to the number and class of securities which would have been
issued to Holder in the consummation of such Corporate Transaction had
the Warrant been exercised immediately prior to such Corporate
Transaction. Appropriate adjustments shall also be made to the Exercise
Price payable per share, provided the aggregate Exercise Price payable
hereunder shall remain the same.
A-3
<PAGE> 7
VI. PRIVILEGE OF STOCK OWNERSHIP. THE HOLDER OF THIS WARRANT SHALL NOT HAVE
ANY OF THE RIGHTS OF A STOCKHOLDER WITH RESPECT TO THE WARRANT SHARES
UNTIL SUCH INDIVIDUAL SHALL HAVE EXERCISED THE WARRANT, PAID THE
EXERCISE PRICE AND BECOME THE RECORD HOLDER OF THE PURCHASED WARRANT
SHARES.
VII. MANNER OF EXERCISING WARRANT.
A. In order to exercise the Warrant with respect to all or any part
of the Warrant Shares for which the Warrant is at the time exercisable,
Holder (or in the case of exercise after Holder's death, Holder's
executor, administrator, heir or legatee, as the case may be) must take
the following actions:
a. Deliver to the Secretary of the Corporation a notice of
exercise in the form attached hereto as Exhibit I (the
"Exercise Notice") for the Warrant Shares for which the
Warrant is exercised.
b. Pay the aggregate Exercise Price for the purchased
shares in one or more of the following alternative
forms:
(i) cash or check made payable to the Corporation's
order;
(ii) shares of Common Stock held for the requisite
period necessary to avoid a charge to the
Corporation's earnings for financial reporting
purposes and valued at Fair Market Value on the
Exercise Date (as such terms are defined below);
or
(iii) through a broker-dealer sale and remittance
procedure pursuant to which Holder shall provide
concurrent irrevocable instructions (i) to a
Corporation-designated brokerage firm to effect
the immediate sale of the purchased shares and
remit to the Corporation, out of the sale
proceeds available on the settlement date,
sufficient funds to cover the aggregate Exercise
Price payable for the purchased shares plus all
applicable Federal, state and local income and
employment taxes required to be withheld in
connection with such purchase and (ii) to the
Corporation to deliver the certificates for the
purchased shares directly to such brokerage firm
in order to complete the sale transaction.
c. Furnish to the Corporation appropriate documentation
that the person or persons exercising the Warrant (if
other than Holder) have the right to exercise the
Warrant.
d. Execute and deliver to the Corporation such written
representations as may be requested by the Corporation
in order for it to comply with the applicable
requirements of Federal and state securities laws.
e. Make appropriate arrangements with the Corporation (or
parent or subsidiary employing or retaining Holder) for
the satisfaction of all Federal, state and local income
and employment tax withholding requirements applicable
to the warrant exercise.
B. For purposes of this Agreement, the Exercise Date shall be the
date on which the executed Notice of Exercise shall have been delivered
to the Secretary of the Corporation. Except to the extent the sale and
remittance procedure specified above is utilized in connection with the
warrant exercise, payment of the Exercise Price for the purchased shares
must accompany such Notice of Exercise.
C. For all valuation purposes under this Agreement, the Fair Market
Value per share of Common Stock on any relevant date shall be determined
in accordance with the following provisions:
A-4
<PAGE> 8
a. If the Common Stock is at the time traded on the Nasdaq
National Market, the Fair Market Value shall be the
closing selling price per share on the date in question,
as such price is reported by the National Association of
Securities Dealers on the Nasdaq National Market. If
there is no reported closing selling price for the
Common Stock on the date in question, then the closing
selling price on the last preceding date for which such
quotation exists shall be determinative of Fair Market
Value.
b. If the Common Stock is at the time listed or admitted to
trading on any national securities exchange, then the
Fair Market Value shall be the closing selling price per
share on the date in question on the securities exchange
determined by the Plan Administrator to be the primary
market for the Common Stock, as such price is officially
quoted in the composite tape of transactions on such
exchange. If there is no reported sale of Common Stock
on such exchange on the date in question, then the Fair
Market Value shall be the closing selling price on the
exchange on the last preceding date for which such
quotation exists.
D. As soon as practical after the Exercise Date, the Corporation
shall issue to or on behalf of Holder (or any other person or persons
exercising the Warrant in accordance herewith) a certificate or
certificates representing the purchased Warrant Shares.
E. In no event may the Warrant be exercised for any fractional
shares.
VIII. NO EMPLOYMENT/SERVICE CONTRACT. NOTHING IN THIS AGREEMENT OR IN THE PLAN
SHALL CONFER UPON HOLDER ANY RIGHT TO CONTINUE IN THE EMPLOYMENT OR
OTHER SERVICE OF THE CORPORATION OR THE LESSEE (OR ANY PARENT OR
SUBSIDIARY OF EITHER SUCH ENTITY EMPLOYING OR RETAINING HOLDER) FOR ANY
PERIOD OF SPECIFIC DURATION OR INTERFERE WITH OR OTHERWISE RESTRICT IN
ANY WAY THE RIGHTS OF ANY SUCH EMPLOYER ENTITY OR HOLDER, WHICH RIGHTS
ARE HEREBY EXPRESSLY RESERVED BY EACH PARTY, TO TERMINATE HOLDER'S
EMPLOYMENT OR OTHER SERVICE AT ANY TIME FOR ANY REASON WHATSOEVER, WITH
OR WITHOUT CAUSE.
IX. COMPLIANCE WITH LAWS AND REGULATIONS. THE EXERCISE OF THE WARRANT AND
THE ISSUANCE OF WARRANT SHARES UPON SUCH EXERCISE SHALL BE SUBJECT TO
COMPLIANCE BY THE CORPORATION AND HOLDER WITH ALL APPLICABLE
REQUIREMENTS OF LAW RELATING THERETO AND WITH ALL APPLICABLE REGULATIONS
OF ANY SECURITIES EXCHANGE (OR THE NASDAQ NATIONAL MARKET, IF
APPLICABLE) ON WHICH SHARES OF THE COMMON STOCK MAY BE LISTED AT THE
TIME OF SUCH EXERCISE AND ISSUANCE.
X. SUCCESSORS AND ASSIGNS. EXCEPT TO THE EXTENT OTHERWISE PROVIDED IN
PARAGRAPHS 3 AND 4, THE PROVISIONS OF THIS AGREEMENT SHALL INURE TO THE
BENEFIT OF, AND BE BINDING UPON, THE SUCCESSORS, ADMINISTRATORS, HEIRS
AND LEGAL REPRESENTATIVES OF HOLDER AND THE SUCCESSORS AND ASSIGNS OF
THE CORPORATION.
XI. LIABILITY OF CORPORATION. THE INABILITY OF THE CORPORATION TO OBTAIN
APPROVAL FROM ANY REGULATORY BODY HAVING AUTHORITY DEEMED BY THE
CORPORATION TO BE NECESSARY TO THE LAWFUL ISSUANCE AND SALE OF ANY
COMMON STOCK PURSUANT TO THE WARRANT SHALL RELIEVE THE CORPORATION OF
ANY LIABILITY WITH RESPECT TO THE NON-ISSUANCE OR SALE OF THE COMMON
STOCK AS TO WHICH SUCH APPROVAL SHALL NOT HAVE BEEN OBTAINED. THE
CORPORATION, HOWEVER, SHALL USE ITS BEST EFFORTS TO OBTAIN ALL SUCH
APPROVALS.
A-5
<PAGE> 9
XII. NOTICES. ANY NOTICE REQUIRED TO BE GIVEN OR DELIVERED TO THE CORPORATION
UNDER THE TERMS OF THIS AGREEMENT SHALL BE IN WRITING AND ADDRESSED TO
THE CORPORATION IN CARE OF THE CORPORATE SECRETARY AT THE CORPORATION'S
PRINCIPAL OFFICES AT 115 CALLE DE INDUSTRIAS, SUITE 201, SAN CLEMENTE,
CALIFORNIA 92672. ANY NOTICE REQUIRED TO BE GIVEN OR DELIVERED TO HOLDER
SHALL BE IN WRITING AND ADDRESSED TO HOLDER AT THE ADDRESS INDICATED ON
THE NOTICE OF ISSUANCE. ALL NOTICES SHALL BE DEEMED TO HAVE BEEN GIVEN
OR DELIVERED UPON PERSONAL DELIVERY OR UPON DEPOSIT IN THE U.S. MAIL, BY
REGISTERED OR CERTIFIED MAIL, POSTAGE PREPAID AND PROPERLY ADDRESSED TO
THE PARTY TO BE NOTIFIED.
XIII. CONSTRUCTION. THIS AGREEMENT AND THE WARRANT EVIDENCED HEREBY ARE MADE
AND GRANTED PURSUANT TO THE PLAN AND ARE IN ALL RESPECTS LIMITED BY AND
SUBJECT TO THE EXPRESS TERMS AND PROVISIONS OF THE PLAN. HOWEVER, SHOULD
THERE BE ANY CONFLICT BETWEEN THE PROVISIONS OR INTERPRETATION OF THE
WARRANT AGREEMENT AND THE PLAN, THE WARRANT AGREEMENT SHALL CONTROL. ALL
DECISIONS OF THE PLAN ADMINISTRATOR WITH RESPECT TO ANY QUESTION OR
ISSUE ARISING UNDER THE PLAN OR THIS AGREEMENT SHALL BE CONCLUSIVE AND
BINDING ON ALL PERSONS HAVING AN INTEREST IN THE WARRANT.
XIV. GOVERNING LAW. THE INTERPRETATION, PERFORMANCE AND ENFORCEMENT OF THIS
AGREEMENT SHALL BE GOVERNED BY THE LAWS OF THE STATE OF CALIFORNIA, AS
SUCH LAWS ARE APPLIED TO CONTRACTS ENTERED INTO AND PERFORMED IN SUCH
STATE, WITHOUT RESORT TO THAT STATE'S CONFLICT-OF-LAWS RULES.
A-6
<PAGE> 10
EXHIBIT I TO WARRANT AGREEMENT
FORM OF NOTICE OF EXERCISE OF WARRANT
I hereby notify Sunstone Hotel Investors, Inc. (the "Corporation") that
I elect to purchase _________ shares of the Corporation's Common Stock (the
"Purchased Shares") at the warrant exercise price of $_______ per share (the
"Exercise Price") pursuant to that certain warrant (the "Warrant") granted to me
under the Corporation's 1994 Stock Incentive Plan on September 25, 1998.
Concurrently with the delivery of this Exercise Notice to the
Corporation, I shall hereby pay to the Corporation the Exercise Price for the
Purchased Shares in accordance with the provisions of my agreement with the
Corporation (or other documents) evidencing the Warrant and shall deliver
whatever additional documents may be required by such agreement as a condition
for exercise. Alternatively, I may utilize the special broker-dealer sale and
remittance procedure specified in my agreement to effect payment of the Exercise
Price.
___________________, 199__
Date
Holder
----------------------------------
Print name in exact manner it Address:
is to appear on the stock ----------------------------------
certificate:
----------------------------------
----------------------------------
Address to which certificate from
address above: ----------------------------------
----------------------------------
----------------------------------
Social Security Number:
----------------------------------
<PAGE> 11
EXHIBIT B
WARRANT SUMMARY AND PROSPECTUS
DATED MAY __, 1999
[FINAL PROSPECTUS TO BE ATTACHED]
<PAGE> 1
Exhibit 5.1
May 25, 1999
Sunstone Hotel Investors, Inc.
903 Calle Amanecer
San Clemente, California 92673
Attention: Robert A. Alter
RE: SUNSTONE HOTEL INVESTORS, INC., A MARYLAND CORPORATION (THE
"COMPANY") ISSUANCE OF UP TO FOUR HUNDRED FORTY-SEVEN THOUSAND
(447,000) WARRANTS (THE "WARRANTS") TO PURCHASE COMMON STOCK OF
THE COMPANY, PAR VALUE $.01 PER SHARE ("COMMON STOCK"), AND UP
TO FOUR HUNDRED FORTY-SEVEN THOUSAND HUNDRED (447,000) SHARES
(THE "WARRANT SHARES") OF COMMON STOCK ISSUABLE UPON THE
EXERCISE OF THE WARRANTS, PURSUANT TO REGISTRATION STATEMENT ON
FORM S-3
Gentlemen:
We have examined the Registration Statement on Form S-3 transmitted for
filing by you with the Securities and Exchange Commission (the "Commission") on
September 30, 1998 and Amendment No. 1 to the Registration Statement on Form S-3
transmitted for filing by you with the Commission on or about the date of this
letter, in connection with the registration under the Securities Act of 1933, as
amended, of the Warrants and the Warrants Shares. As your counsel in connection
with this transaction, we have examined the proceedings taken and are familiar
with the proceedings proposed to be taken by you in connection with the sale and
issuance of the Shares.
It is our opinion that, upon conclusion of the proceedings being taken
or contemplated by us, as your counsel, to be taken prior to the issuance of the
Shares, and upon completion of the proceedings being taken in order to permit
such transactions to be carried out in accordance with the securities laws of
the various states where required, the Shares, when sold in the manner described
in the Registration Statement, will be legally issued, fully paid and
nonassessable.
We consent to the use of this opinion as an exhibit to the Registration
Statement, and further consent to the use of our name wherever appearing in such
Registration Statement, including the prospectus constituting a part thereof,
and any amendment thereto.
Very truly yours,
BROBECK, PHLEGER & HARRISON
<PAGE> 1
Exhibit 5.2
May 19, 1999
Sunstone Hotel Investors, Inc.
115 Calle de Industrias
Suite 201
San Clemente, California 92672
RE: SUNSTONE HOTEL INVESTORS, INC., A MARYLAND CORPORATION (THE
"COMPANY") ISSUANCE OF UP TO FOUR HUNDRED FORTY-SEVEN THOUSAND
(447,000) WARRANTS (THE "WARRANTS") TO PURCHASE COMMON STOCK OF
THE COMPANY, PAR VALUE $.01 PER SHARE ("COMMON STOCK"), AND UP
TO FOUR HUNDRED FORTY-SEVEN THOUSAND HUNDRED (447,000) SHARES
(THE "WARRANT SHARES") OF COMMON STOCK ISSUABLE UPON THE
EXERCISE OF THE WARRANTS, PURSUANT TO REGISTRATION STATEMENT ON
FORM S-3
Ladies and Gentlemen:
In connection with the registration of the Warrants and the Warrant
Shares under the Securities Act of 1933, as amended (the "Act"), by the Company
on the Registration Statement on Form S-3 filed with the Securities and Exchange
Commission on or about September 30, 1998, as amended (the "Registration
Statement"), you have requested our opinion with respect to the matters set
forth below. Capitalized terms not otherwise defined herein shall have the
meanings ascribed to them in the Registration Statement.
We have acted as special Maryland corporate counsel for the Company in
connection with the matters described herein. In our capacity as special
Maryland corporate counsel to the Company, we have reviewed and are familiar
with proceedings proposed to be taken by the Company in connection with the
authorization, issuance and sale of the Shares, and for purposes of this opinion
have assumed such proceedings will be timely completed in the manner presently
proposed. In addition, we have relied upon certificates and advice from the
officers of the Company upon which we believe we are justified in relying and on
various certificates from, and documents recorded with, the State Department of
Assessments and Taxation of Maryland (the "SDAT"), including the charter of the
Company (the "Charter"), consisting of Amended Articles of Incorporation filed
with the SDAT on September 23, 1999, Articles of Amendment filed with the SDAT
on November 9, 1999, June 19, 1998, August 14, 1995, May 2, 1997 and April 22,
1998 and Articles Supplementary filed with the SDAT on October 14, 1997. We have
also examined the Bylaws of the Company, as amended through the date hereof (the
"Bylaws") and Resolutions of the Board of Directors of the Company and
committees thereof adopted on or before the date hereof and in full force and
effect on the date hereof; and such laws, records, documents, certificates,
opinions and instruments as we deem necessary to render this opinion.
We have assumed the genuineness of all signatures, the authenticity of
all documents submitted to us as originals and the conformity to the originals
of all documents submitted to us as certified, photostatic or conformed copies.
In addition, we have assumed that each person executing any instrument, document
or certificate referred to herein on behalf of any party is duly authorized to
do so. We have also assumed that none of the Warrants or the Warrant Shares will
be issued or transferred in violation of the restrictions on ownership and
transfer of stock contained in Section 2 of Article V of the Charter of the
Company entitled REIT - Related Restrictions and Limitations on the Equity
Shares of the Corporation.
Based on the foregoing, and subject to the assumptions and
qualifications set forth herein, it is our opinion that, as of the date of this
letter:
1. The Warrants have been duly authorized by all necessary
corporate action on the part of the Company, and when issued in accordance with
the terms and conditions described in the Registration Statement, in
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exchange for payment of the consideration therefore, as set by the Board of
Directors, will be validly issued warrants to purchase Warrant Shares.
2. The Warrant Shares have been duly authorized for issuance by all
necessary corporate action on the part of the Company, and when issued and
delivered upon exercise of validly issued Warrants in exchange for payment of
the consideration therefore as set forth in such Warrants, will be validly
issued, fully paid and nonassessable shares of Common Stock.
We consent to your filing this opinion as an exhibit to the Registration
Statement, and further consent to the filing of this opinion as an exhibit to
the applications to securities commissioners for the various states of the
United States for registration of the Warrants and the Warrant Shares. We also
consent to the identification of our firm as Maryland counsel to the Company in
the section of the Prospectus (which is part of the Registration Statement)
entitled "Legal Matters."
The opinions expressed herein are limited to the laws of the State of
Maryland and we express no opinion concerning any laws other than the laws of
the State of Maryland. Furthermore, the opinions presented in this letter are
limited to the matters specifically set forth herein and no other opinion shall
be inferred beyond the matters expressly stated.
` Very truly yours,
BALLARD SPAHR ANDREWS & INGERSOLL, LLP
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Exhibit 8.1
May 17, 1999
Sunstone Hotel Investors, Inc.
903 Calle Amanecer
San Clemente, CA 92672
RE: SUNSTONE HOTEL INVESTORS, INC./TAX OPINION
Ladies and Gentlemen:
We have acted as counsel to Sunstone Hotel Investors, Inc., a
Maryland corporation (the "Company"), in connection with the preparation of the
Registration Statement on Form S-3 filed with the Securities and Exchange
Commission (the "Registration Statement") with respect to the issuance by the
Company of warrants (the "Warrants") to purchase common stock ("Common Stock")
of the Company and the issuance of Common Stock upon the exercise of the
Warrants.
The Company currently owns more than a 90% general partner
interest in Sunstone Hotel Investors, L.P. (the "Partnership"). The Partnership
currently owns, either directly or indirectly through subsidiary entities,
several hotels and associated personal property (the "Hotels"). Each of the
Hotels is leased to Sunstone Hotel Properties, Inc., a Colorado corporation (the
"Lessee"), pursuant to a percentage lease (collectively, the "Leases"). Sunstone
Hotel Management, Inc. (the "Management Company") is managing the Hotels. Robert
A. Alter and Charles L. Biederman are 80% and 20% shareholders, respectively, of
the Lessee and Mr. Alter is the sole shareholder of the Management Company. Mr.
Alter is the Chairman of the Board of Directors and President of the Company and
will continue to serve as such.
In 1997, the Company acquired all of the stock of Kahler Realty
Corporation ("Kahler"). (This transaction is referred to herein as the
"Acquisition".) Kahler adopted a plan of liquidation after the Acquisition and
all of its assets, subject to all of its outstanding liabilities, were
transferred to the Company during 1997. The Company in turn contributed all such
assets to the Partnership.
In connection with the opinions rendered below, we have examined
the following:
1. The Amended Articles of Incorporation of the Company.
2. The Company's By-laws, as amended to date.
3. The Registration Statement.
4. The Limited Partnership Agreement of the Partnership, as
amended and restated to date (the "Partnership Agreement").
5. The cost segmentation analysis dated August 15, 1995,
the cost segmentation analysis as of December 31, 1995, the cost segmentation
analysis as of May 31, 1996, and the cost segmentation analysis as of December
31, 1996, prepared by Coopers & Lybrand L.L.P., and the cost segmentation
analysis prepared by Ernst & Young LLP ("Ernst & Young") in connection with the
Acquisition. (The foregoing analyses and information are referred to herein as
the "Cost Segmentation Analyses.")
6. An analysis dated April 1, 1999, of the Company's
satisfaction of the tests for qualification as a REIT for income tax purposes
prepared by Ernst & Young (the "REIT Qualification Analysis").
7. Projections as to the expected financial performance of
the Company, the Lessee and the Management Company.
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8. The analysis of Kahler's pre-Acquisition earnings and
profits prepared by KPMG Peat Marwick LLP in connection with the Acquisition
(the "KPMG E&P Analysis").
9. The review of the KPMG E&P Analysis prepared by Ernst &
Young in connection with the Acquisition (the "Ernst & Young E&P Review").
10. A representation certificate from the Company as to
certain factual matters (the "Representation Certificate").
11. Such other documents and data as we have deemed
necessary or appropriate for purposes of this opinion.
In connection with the opinions rendered below, we have assumed
that:
A. Each of the documents referred to above has been duly
authorized, executed, and delivered, is authentic if an original or accurate if
a copy, and has not been amended.
B. Each of the representations set forth in the
Representation Certificate is true and correct.
C. The Company will not make any amendments to its
organizational documents, or in its operations or the Leases, after the date of
this opinion that would affect its qualification as a REIT for any taxable year.
D. No actions will be taken by the Company, the
shareholders of the Company, the Partnership, the partners of the Partnership or
any other entity in which the Company owns an interest (either directly or
indirectly) after the date hereof that would have the effect of materially
altering the facts upon which we have relied in rendering our opinion, including
those facts set forth in the Representation Certificate.
E. The Cost Segmentation Analyses and the REIT
Qualification Analysis are accurate in all material respects and there have been
no material changes in the information reflected in the Ernst & Young REIT
Qualification Analysis since the date thereof that would adversely affect the
Company's qualification as a REIT.
F. The information and conclusions reflected in the KPMG
E&P Analysis and the Ernst & Young E&P Review are accurate in all material
respects.
G. The projections provided to us regarding the expected
financial performance of the Company, the Lessee and the Management Company
represented reasonable projections when prepared, and there have been no
material changes in the information reflected in those projections since the
date thereof.
H. The rental payments pursuant to the Leases have not been
and will not be calculated based on the net income of the Lessee (and no rent
abatements have been or will be calculated with reference to the net income of
the Lessee).
Based on the documents, assumptions and representations
described in this letter, we are of the opinion that the statements regarding
federal income tax considerations set forth in the Registration Statement under
the caption "Federal Income Tax Considerations," insofar as such statements
constitute statements of law or legal conclusions, are correct in all material
respects.
# # #
The foregoing opinion is based on current provisions of the
Internal Revenue Code of 1986, as amended (the "Code"), and the Regulations,
published administrative interpretations thereof, and published court decisions.
The Internal Revenue Service (the "Service") has not issued Regulations or
administrative interpretations with respect to various provisions of the Code
relating to REITs. The foregoing opinion is not binding on the Service, and no
assurance can be given that the Service will not successfully challenge our
opinion upon audit.
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Furthermore, no assurance can be given that the tax law will not change in a way
that will adversely affect the Company and its shareholders.
Our opinion is conditioned and based upon the accuracy of
substantial factual information, representations and conclusions provided to us
by various parties, including (without limitation) the Representation
Certificate, the Cost Segmentation Analyses, the REIT Qualification Analysis,
the KPMG E&P Analysis and the Ernst & Young E&P Review. We have not rendered an
opinion as to any factual matters, including (without limitation) the accuracy
of the information, representations and conclusions referred to in the preceding
sentence. In particular, we have rendered no opinion as to such factual matters
as the amount of Kahler's pre-Acquisition earnings and profits, the conformity
of the Leases with normal business practices (as represented by the Company) or
the accuracy of the Cost Segmentation Analyses or the REIT Qualification
Analysis. If any such information, representations or conclusions as to factual
matters is inaccurate in any material respect, our opinion could be different.
Furthermore, we have not monitored and will not monitor compliance by the
Company with the ongoing requirements for qualification as a REIT and,
therefore, cannot assure that the Company has or will satisfy each of those
requirements.
We hereby consent to the filing of this opinion as an exhibit to
the Registration Statement. We also consent to the references to Brobeck,
Phleger & Harrison LLP under the captions "Federal Income Tax Considerations"
and "Legal Matters" in the Registration Statement.
The foregoing opinion is limited to the federal income tax
matters specifically addressed herein, and no other opinion is rendered with
respect to other federal tax matters or to any issues arising under the tax laws
of any state or locality. We undertake no obligation to update the opinion
expressed herein after the date of this letter. This opinion letter is solely
for the information and use of the Company and the purchasers of the Warrants
and Common Stock from the Company, and may not be relied upon for any purpose by
any other person without our express written consent.
Very truly yours,
BROBECK, PHLEGER & HARRISON LLP
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Exhibit 23.1
Consent of Independent Auditors
We consent to the reference to our firm under the caption "Experts" in the
Registration Statement (Form S-3 No. 333-65037) and related Prospectus of
Sunstone Hotel Investors, Inc. for the registration of 447,000 warrants to
purchase its common stock and 447,000 shares of its common stock and to the
incorporation by reference therein of our reports dated February 19, 1999 with
respect to the consolidated financial statements and schedule of Sunstone Hotel
Investors, Inc. as of December 31 1998 and 1997 and for the years then ended and
the consolidated financial statements of Sunstone Hotel Properties, Inc as of
December 31, 1998 and 1997 and for the years then ended included in Sunstone
Hotel Investors, Inc.'s Annual Report on Form 10-K for the year ended December
31, 1998, filed with the Securities and Exchange Commission.
/s/Ernst & Young LLP
--------------------
Newport Beach, California
May 24, 1999
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Exhibit 23.2
Consent of Independent Accountants
We hereby consent to the incorporation by reference in this amendment No. 1 to
the registration statement of Sunstone Hotel Investors, Inc. on Form S-3 (File
No. 333-65037) of our report dated February 28, 1997 on our audit of the
consolidated financial statements of Sunstone Hotel Investors, Inc. for the year
ended December 31, 1996 and of our report dated February 28, 1997 on our audit
of the consolidated financial statements of Sunstone Hotel Properties, Inc. (the
"Lessee") for the year ended December 31, 1996, which reports appear in Sunstone
Hotel Investors, Inc." Annual Report on Form 10-K. We also consent to the
reference to us under the heading "Experts" in such registration statement.
/s/PricewaterhouseCoopers LLP
-----------------------------
San Francisco, California
May 24, 1999
