2.	LEASES

The majority of our properties are leased on a triple-net basis primarily to petroleum distributors and, to a lesser extent, individual operators. Generally our tenants supply fuel and either operate our properties directly or sublet our properties to operators who operate their gas stations, convenience stores, automotive repair service facilities or other businesses at our properties. Our triple-net tenants are responsible for the payment of all taxes, maintenance, repairs, insurance and other operating expenses relating to our properties, and are also responsible for environmental contamination occurring during the terms of their leases and in certain cases also for preexisting environmental contamination. (See note 5 for additional information regarding environmental obligations.) Substantially all of our tenants’ financial results depend on the sale of refined petroleum products and rental income from their subtenants. As a result, our tenants’ financial results are highly dependent on the performance of the petroleum marketing industry, which is highly competitive and subject to volatility. As of June 30, 2014, we owned 796 properties and leased 114 properties from third-party landlords. Our 910 properties are located in 20 states across the United States and Washington, D.C., with concentrations in the Northeast and Mid-Atlantic regions.

Revenues from rental properties included in continuing operations for the three and six months ended June 30, 2014 were $24,244,000 and $47,883,000, respectively. Revenues from rental properties included in continuing operations for the three and six months ended June 30, 2013 were $23,384,000 and $45,465,000, respectively. Rental income contractually due or received from our tenants, including amounts realized under our prior interim fuel supply agreement, included in revenues from rental properties in continuing operations was $22,709,000 and $44,175,000 for the three and six months ended June 30, 2014, respectively, and $22,112,000 and $41,929,000 for the three and six months ended June 30, 2013, respectively. “Pass-through” real estate taxes and other municipal charges paid by us which were reimbursable by our tenants pursuant to the terms of triple-net lease agreements included in revenues from rental properties and rental property expenses in continuing operations totaled $3,389,000 and $6,088,000 for the three and six months ended June 30, 2014, respectively, and $3,512,000 and $6,786,000 for the three and six months ended June 30, 2013, respectively.

In accordance with GAAP, we recognize rental revenue in amounts which vary from the amount of rent contractually due or received during the periods presented. As a result, revenues from rental properties include non-cash adjustments recorded for deferred rental revenue due to the recognition of rental income on a straight-line (or average) basis over the current lease term, the net amortization of above-market and below-market leases, recognition of rental income recorded under direct financing leases using the effective interest method which produces a constant periodic rate of return on the net investments in the leased properties and the amortization of deferred lease incentives (the “Revenue Recognition Adjustments”). Revenue Recognition Adjustments included in revenues from rental properties in continuing operations were $1,535,000 and $3,708,000 for the three and six months ended June 30, 2014, respectively, as compared to $1,272,000 and $3,536,000 for the three and six months ended June 30, 2013, respectively. We provide reserves for a portion of the recorded deferred rent receivable if circumstances indicate that a tenant will not make all of its contractual lease payments during the current lease term. Our assessments and assumptions regarding the recoverability of the deferred rent receivable are reviewed on an ongoing basis and such assessments and assumptions are subject to change.

The components of the $96,492,000 net investment in direct financing leases as of June 30, 2014 are minimum lease payments receivable of $197,489,000 plus unguaranteed estimated residual value of $13,979,000 less unearned income of $114,976,000. The components of the $97,147,000 net investment in direct financing leases as of December 31, 2013 were minimum lease payments receivable of $203,438,000 plus unguaranteed estimated residual value of $13,979,000 less unearned income of $120,270,000.

Marketing and the Master Lease

Approximately 530 of the properties we own or lease as of June 30, 2014 were previously leased to Getty Petroleum Marketing Inc. (“Marketing”) pursuant to a master lease (the “Master Lease”). In December 2011, Marketing filed for Chapter 11 bankruptcy protection in the U.S. Bankruptcy Court. The Master Lease was terminated effective April 30, 2012, and in July 2012, the Bankruptcy Court approved Marketing’s Plan of Liquidation and appointed a trustee (the “Liquidating Trustee”) to oversee liquidation of the Marketing estate (the “Marketing Estate”). We incurred significant costs associated with Marketing’s bankruptcy, including legal expenses, of which $458,000 and $2,826,000, respectively, are included in general and administrative expense for the six months ended June 30, 2014 and 2013.

In December 2011, the Marketing Estate filed a lawsuit (the “Lukoil Complaint”) against Marketing’s former parent, Lukoil Americas Corporation, and certain of its affiliates (collectively, “Lukoil”). In October 2012, we entered into an agreement with the Marketing Estate to make loans and otherwise fund up to an aggregate amount of $6,725,000 to prosecute the Lukoil Complaint and for certain other expenses incurred in connection with the wind-down of the Marketing Estate (the “Litigation Funding Agreement”). We ultimately advanced $6,526,000 in the aggregate to the Marketing Estate pursuant to the Litigation Funding Agreement. The Litigation Funding Agreement also provided that we were entitled to be reimbursed for up to $1,300,000 of our legal fees incurred in connection with the Litigation Funding Agreement.

On July 29, 2013, the Bankruptcy Court approved a settlement of the claims made in the Lukoil Complaint (the “Lukoil Settlement”). The terms of the Lukoil Settlement included a collective payment to the Marketing Estate of $93,000,000. In August 2013, the settlement payment was received by the Marketing Estate of which $25,096,000 was distributed to us pursuant to the Litigation Funding Agreement and $6,585,000 was distributed to us in full satisfaction of our post-petition priority claims related to the Master Lease.

Of the $25,096,000 received by us in the third quarter of 2013 pursuant to the Litigation Funding Agreement, $7,976,000 was applied to the advances made to the Marketing Estate plus accrued interest; $13,994,000 was applied to unpaid rent and real estate taxes due from Marketing and the related bad debt reserve was reversed; and the remainder of $3,126,000 was recorded as additional income attributed to the partial recovery of damages resulting from Marketing’s default of its obligations under the Master Lease and is reflected in continuing operations in our consolidated statements of operations as other revenue in the third quarter of 2013.

We believe that we will receive additional distributions from the Marketing Estate to partially satisfy our remaining general unsecured claims. We cannot provide any assurance as to our proportionate interest in any Marketing Estate assets, or the amount or timing of recoveries, if any, with respect to our remaining general unsecured claims against the Marketing Estate.

Leasing Activities

As of June 30, 2014, we have entered into long-term triple-net leases with petroleum distributors for 13 separate property portfolios comprising 467 properties in the aggregate that were previously leased to Marketing. We have also entered into month-to-month license agreements with occupants of 40 properties previously leased to Marketing (substantially all of whom were Marketing’s former subtenants) allowing such occupants to continue to occupy and use these properties as gas stations, convenience stores, automotive repair service facilities or other businesses. Under our month-to-month license agreements, we receive monthly licensing fees and are responsible for the payment of certain Property Expenditures (as defined below) and environmental costs.

The long-term triple-net leases with petroleum distributors are unitary triple-net lease agreements generally with an initial term of 15 years, and options for successive renewal terms of up to 20 years. Rent is scheduled to increase at varying intervals of up to three years on the anniversary of the commencement date of the leases. The majority of the leases provide for additional rent based on the aggregate volume of petroleum products sold. In addition, the majority of the leases require the tenants to make capital expenditures at our properties substantially all of which are related to the replacement of underground storage tanks (“USTs”) that are owned by our tenants. We have committed to co-invest up to $15,263,000 in the aggregate with our tenants for a portion of such capital expenditures, which deferred expense is recognized on a straight-line basis as a reduction of rental revenue in our consolidated statements of operations over the terms of the various leases. As of June 30, 2014 and December 31, 2013, we have invested $433,000 and $308,000, respectively, of our capital commitment. As part of the triple-net leases whose terms commenced through June 30, 2014, we transferred title of the USTs to our tenants, and the obligation to pay for the retirement and decommissioning or removal of USTs at the end of their useful life or earlier if circumstances warranted was fully or partially transferred to our new tenants. We remain contingently liable for this obligation in the event that our tenants do not satisfy their responsibilities. Accordingly, we removed $12,997,000 of asset retirement obligations and $10,615,000 of net asset retirement costs related to USTs from our balance sheet through June 30, 2014. The net amount of $2,382,000 is recorded as deferred rental revenue and is recognized on a straight-line basis as additional revenues from rental properties over the terms of the various leases. We incurred $60,000 and $365,000 of lease origination costs for the six months ended June 30, 2014 and June 30, 2013, respectively, which deferred expense is recognized on a straight-line basis as amortization expense in our consolidated statements of operations over the terms of the various leases.

Chestnut Petroleum Dist. Inc.

As of June 30, 2014, we leased 141 gasoline station and convenience store properties in two separate unitary leases to subsidiaries of Chestnut Petroleum Dist. Inc. We lease 58 properties to CPD NY Energy Corp. (“CPD NY”) and 83 properties to NECG Holdings Corp. (“NECG”). CPD NY and NECG together represented 20% and 22% of our rental revenues for the six months ended June 30, 2014 and 2013, respectively. Although we have separate, non-cross defaulted leases with each of these subsidiaries, because such subsidiaries are affiliated with one another and under common control, a material adverse impact on one subsidiary, or failure of such subsidiary to perform its rental and other obligations to us, may contribute to a material adverse impact on the other subsidiary and/or failure of the other subsidiary to perform its rental and other obligations to us.

The selected combined unaudited financial data of CPD NY and NECG, which has been prepared by Chestnut Petroleum Dist. Inc.’s management, is provided below:

(in thousands)

Operating Data:


	Three months ended June 30,				Six months ended June 30,
	2014		2013		2014		2013
Total revenue	$	147,229	$	147,046	$	274,396	$	266,991
Gross profit		10,923		10,947		20,183		19,787
Net income (loss)		688		1,621		699		1,459

Balance Sheet Data:


	June 30, 2014		December 31, 2013
Current assets	$	12,870	$	10,944
Noncurrent assets		30,461		28,852
Current liabilities		16,821		13,985
Noncurrent liabilities		16,043		16,043

Eviction proceedings are ongoing against a group of former Marketing subtenants (or sub-subtenants) who continue to occupy properties in the State of Connecticut which are subject to our unitary lease with NECG (the “NECG Lease”). These ongoing eviction proceedings have had a material adverse impact on NECG’s operations and profitability. In June 2013, the Connecticut Superior Court ruled in our favor with respect to all 24 locations involved in the proceedings. However, in July 2013, a majority of the operators against whom these Superior Court rulings were made appealed the decisions. As of the date of this Quarterly Report on Form 10-Q, 14 of the 24 former operators against whom eviction proceedings were brought have reached agreements with NECG to either remain in their respective properties or vacate them, and in either case their appeals have been withdrawn. Ten of the operators remain in contested occupancy of the subject sites during the pendency of their appeal. We remain confident that we will prevail in the remaining appeals and, although no assurances can be given, we anticipate a favorable resolution of this matter in 2015.

In August 2013, we entered into an agreement to modify the NECG Lease and, as part of such agreement, we deferred portions of the scheduled rent payments due from NECG. This lease modification agreement also included provisions under which we can recapture and sever properties from the NECG Lease and, as of June 30, 2014, 29 of these properties are accounted for as held for sale. As a result of the disruption and costs associated with the litigation, NECG was not current in its rent and certain other obligations to us under the NECG Lease. We increased our accounts receivable bad debt reserves related to the NECG Lease by approximately $320,000 for the six months ended June 30, 2014 so that the total bad debt reserve related to NECG as of June 30, 2014 is approximately $2,085,000 in aggregate.

As a result of the developments with NECG described above, we concluded that it was probable that we would not receive from NECG the entire amount of the contractual lease payments owed to us under the NECG Lease. Accordingly, during the six months ended June 30, 2014, we recorded a non-cash allowance for deferred rent receivable related to the NECG Lease of $1,584,000. As of June 30, 2014, we have fully reserved for the outstanding deferred rent receivable balance of $6,359,000. This non-cash allowance reduced our net earnings for the six months ended June 30, 2014, but did not impact our cash flow from operating activities.

We are monitoring the developments with NECG and are engaged in discussions with them about potential modifications to the NECG Lease, which may include, without limitations, the removal of certain properties from the NECG Lease. Our discussions with NECG are ongoing and we cannot predict the ultimate outcome of these discussions. As of June 30, 2014, and the date of this Quarterly Report on Form 10-Q, NECG is current in its rent payments to us, as amended.

Capitol Petroleum Group, LLC

As of June 30, 2014, we leased 97 gasoline station and convenience store properties in four separate unitary leases to subsidiaries of Capitol Petroleum Group, LLC. We lease 37 properties to White Oak Petroleum, LLC, 24 properties to Hudson Petroleum Realty, LLC, 20 properties to Dogwood Petroleum Realty, LLC and 16 properties to Big Apple Petroleum Realty, LLC. In aggregate, these Capitol affiliates represented 17% and 13% of our rental revenues for the six months ended June 30, 2014 and 2013, respectively. Although we have separate, non-cross defaulted leases with each of these subsidiaries, because such subsidiaries are affiliated with one another and under common control, a material adverse impact on one subsidiary, or failure of such subsidiary to perform its rental and other obligations to us, may contribute to a material adverse impact on the other subsidiaries and/or failure of the other subsidiaries to perform its rental and other obligations to us.

The selected combined unaudited financial data of White Oak Petroleum, LLC, Hudson Petroleum Realty, LLC, Dogwood Petroleum Realty, LLC and Big Apple Petroleum Realty, LLC, which has been prepared by Capitol Petroleum Group, LLC’s management, is provided below:

(in thousands)

Operating Data:


	Three months ended June 30,						Six months ended June 30,
	2014			2013			2014			2013
Total revenue	$	92,854		$	87,558		$	177,103		$	177,745
Gross profit		2,179			4,317			3,412			7,386
Net income (loss)		(1,053	)		(1,026	)		(3,048	)		(580	)

Balance Sheet Data:


	June 30, 2014		December 31, 2013
Current assets	$	6,640	$	10,128
Noncurrent assets		110,850		111,540
Current liabilities		9,863		10,880
Noncurrent liabilities		135,399		135,210