0000912057-01-533064.txt : 20011009 0000912057-01-533064.hdr.sgml : 20011009 ACCESSION NUMBER: 0000912057-01-533064 CONFORMED SUBMISSION TYPE: S-1 PUBLIC DOCUMENT COUNT: 11 FILED AS OF DATE: 20010921 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIVE STAR QUALITY CARE INC CENTRAL INDEX KEY: 0001159281 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 043516029 FILING VALUES: FORM TYPE: S-1 SEC ACT: 1933 Act SEC FILE NUMBER: 333-69846 FILM NUMBER: 1742433 BUSINESS ADDRESS: STREET 1: 400 CENTRE STREET CITY: NEWTON STATE: MA ZIP: 02458 BUSINESS PHONE: 617 796 8387 MAIL ADDRESS: STREET 1: 400 CENTRE ST CITY: NEWTON STATE: MA ZIP: 02458 S-1 1 a2059384zs-1.txt S-1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 21, 2001 REGISTRATION NO. 333- -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------ FIVE STAR QUALITY CARE, INC. (Exact name of registrant as specified in its charter) MARYLAND 8051 04-3516029 (State or other jurisdiction (Primary Standard (I.R.S. Employer of Industrial Identification Number) incorporation or organization) Classification Code Number)
400 CENTRE STREET NEWTON, MASSACHUSETTS 02458 (617) 796-8387 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) EVRETT W. BENTON, PRESIDENT FIVE STAR QUALITY CARE, INC. 400 CENTRE STREET NEWTON, MASSACHUSETTS 02458 (617) 796-8387 (Name, address, including zip code, telephone number, including area code, of agent for service) ------------------------------ COPY TO: WILLIAM J. CURRY, ESQ. SULLIVAN & WORCESTER LLP ONE POST OFFICE SQUARE BOSTON, MASSACHUSETTS 02109 (617) 338-2800 ------------------------ APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after this Registration Statement becomes effective. 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, check the following box. / / 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. / / ------------------------ CALCULATION OF REGISTRATION FEE
PROPOSED MAXIMUM PROPOSED MAXIMUM TITLE OF EACH CLASS OF AMOUNT TO OFFERING PRICE AGGREGATE AMOUNT OF SECURITIES TO BE REGISTERED BE REGISTERED PER UNIT OFFERING PRICE(1) REGISTRATION FEE Common stock, $.01 par value................ (2) (2) $40,000,000 $10,000
(1) Computed based on the book value as of December 31, 2000 of the net assets to be contributed to the Registrant in accordance with Rule 457 under the Securities Act of 1933. (2) Omitted pursuant to Rule 457(o) under the Securities Act of 1933. ------------------------------ 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 THIS REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BY ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF SUCH STATE. SUBJECT TO COMPLETION PROSPECTUS DATED SEPTEMBER 21, 2001 PROSPECTUS FIVE STAR QUALITY CARE, INC. SPIN-OFF OF FIVE STAR QUALITY CARE, INC. THROUGH DISTRIBUTION OF 2,937,470 SHARES OF COMMON STOCK ------------------ We are furnishing this prospectus to the shareholders of Senior Housing Properties Trust and HRPT Properties Trust, each a Maryland real estate investment trust. We are currently a 100% owned subsidiary of Senior Housing. Senior Housing will distribute substantially all of our outstanding common shares as a special distribution to its shareholders. HRPT owns 44% of the shares of Senior Housing and will distribute substantially all of our shares that it receives from Senior Housing to its shareholders. Shareholders of Senior Housing will receive one of our shares for every 10 Senior Housing common shares owned on , 2001. Shareholders of HRPT will receive one of our shares for every 100 HRPT common shares owned on , 2001. These distributions will be made on or about , 2001. We have applied to list our common shares on the American Stock Exchange, or AMEX, under the symbol "[ ]". Senior Housing's common shares will continue to trade on the New York Stock Exchange under the symbol "SNH", and HRPT's common shares will continue to trade on the New York Stock Exchange under the symbol "HRP". This distribution of our common shares is the first public distribution of our shares. Accordingly, we can provide no assurance to you as to what the market price of our shares may be. INVESTMENT IN OUR SHARES INVOLVES RISKS. YOU SHOULD READ CAREFULLY THIS ENTIRE PROSPECTUS, INCLUDING THE SECTION ENTITLED "RISK FACTORS" THAT BEGINS ON PAGE 5 OF THIS PROSPECTUS, WHICH DESCRIBES SOME OF THESE RISKS. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful and complete. Any representation to the contrary is a criminal offense. The date of this Prospectus is , 2001. QUESTIONS AND ANSWERS ABOUT THE SPIN-OFF Q: HOW MANY FIVE STAR COMMON SHARES WILL I RECEIVE? A: Senior Housing will distribute to you one share of our common stock for every 10 common shares of Senior Housing you own on the record date; and HRPT will distribute to you one share of our common stock for every 100 common shares of HRPT you own on the record date. Q: WHAT ARE SHARES OF FIVE STAR WORTH? A: The value of our shares will be determined by their trading price after the spin-off. We do not know what the trading price will be and we can provide no assurances as to value. Q: WHAT WILL FIVE STAR DO AFTER THE SPIN-OFF? A: We will lease and operate 56 senior living properties which are now owned by Senior Housing. Shortly after the spin-off, we will lease an additional 31 senior living facilities when they are purchased by Senior Housing. These 31 facilities will be managed for us by Marriott Senior Living Services, Inc. ("Marriott"). In the future we may lease and operate additional senior living facilities. We will not be a REIT. Q: WHAT ARE THE REASONS FOR THIS SPIN-OFF? A: Senior Housing owns nursing homes repossessed from former tenants. Senior Housing has agreed to purchase 31 Marriott senior living facilities. By making us a separate, tax paying company to lease and operate these properties, Senior Housing may receive rents from these facilities and remain a REIT. Also, Senior Housing believes its affiliation with us may enhance its ability to grow. Q: WHAT WILL SENIOR HOUSING DO AFTER THE SPIN-OFF? A: Senior Housing will continue to operate as a REIT. Immediately after the spin-off, Senior Housing will own 86 senior living facilities, including 56 which we will lease. When Senior Housing purchases the Marriott senior living facilities, it will own 117 senior living facilities, including 87 which we will lease. In the future Senior Housing may purchase additional senior living facilities and some of these additional facilities may be leased to us. Q: WHY IS HRPT INVOLVED? A: HRPT owns 44% of Senior Housing. HRPT will receive a substantial amount of our shares from Senior Housing. If HRPT does not reduce its ownership of our shares below 10%, both HRPT and Senior Housing may cease to qualify as REITs under applicable tax rules. Accordingly, HRPT will distribute substantially all of our shares that it receives. Q: WHAT WILL HRPT DO AFTER THE SPIN-OFF? A: HRPT will continue to be a REIT, principally focused upon investing and owning office buildings. Q: WILL THE SPIN-OFF AFFECT MY CASH DISTRIBUTIONS? A: No. Senior Housing expects to continue quarterly cash distributions of $0.30/share ($1.20/share per year). HRPT expects to continue quarterly cash distributions of $0.20/share ($0.80/share per year). We do not expect to make distributions to our shareholders. Q: WILL FIVE STAR SHARES BE LISTED ON A STOCK EXCHANGE? A: We have applied to list our shares on the AMEX under the trading symbol " ". Q: WILL MY SENIOR HOUSING OR HRPT SHARES CONTINUE TO BE LISTED ON AN EXCHANGE? A: Senior Housing's common shares will continue to be listed on the NYSE under the symbol "SNH". HRPT's common shares will continue to be listed on the NYSE under the symbol "HRP". ii Q: WHAT ARE THE TAX CONSEQUENCES TO ME OF THE SPIN-OFF? A: Our shares distributed to you in the spin-off will be treated for tax purposes like all other distributions from Senior Housing or HRPT. The total value of this distribution, as well as your aggregate initial tax basis in our shares, will be determined by the trading price of our common shares at the time of the spin-off. However, if you have held your Senior Housing or HRPT common shares, as applicable, for the entire year, we expect you will have little or no additional taxable dividend as a result of the spin-off distribution. Q: WHAT DO I HAVE TO DO TO RECEIVE MY FIVE STAR SHARES? A: No action by you is required. You do not need to pay any money or surrender your Senior Housing or HRPT common shares to receive our common shares. The number of Senior Housing or HRPT common shares you own will not change. If your Senior Housing or HRPT common shares are held in a brokerage account, our common shares will be credited to that account. If you own Senior Housing or HRPT common shares in certificated form, certificates representing your Five Star common shares will be mailed to you. No cash distributions will be paid and fractional shares will be issued as necessary. iii TABLE OF CONTENTS
PAGE -------- Summary..................................................... 1 Risk Factors................................................ 5 The Spin-off................................................ 9 Dividend Policy............................................. 13 Capitalization.............................................. 13 The Company................................................. 14 Selected Historical Financial Information................... 30 Management's Discussion and Analysis of Financial Condition and Results of Operations................................. 32 Management.................................................. 37 Security Ownership After the Spin-off....................... 42 Certain Relationships....................................... 44 Federal Income Tax Considerations........................... 45 Shares Eligible for Future Sale............................. 55 Description of Capital Stock................................ 55 Material Provisions of Maryland Law, Our Charter and Bylaws.................................................... 57 Plan of Distribution........................................ 64 Legal Matters............................................... 64 Experts..................................................... 65 Where You Can Find More Information......................... 65
ABOUT THIS PROSPECTUS You should rely only on the information contained in this prospectus. We have not, and Senior Housing and HRPT have not, authorized anyone to provide you with different information. If anyone provides you with different or inconsistent information, you should not rely on it. We, Senior Housing and HRPT believe that the information contained in this prospectus is accurate as of the date on the cover. Changes may occur after that date; and we, Senior Housing and HRPT may not update this information except as required by applicable law. CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS We have made statements in this document that constitute "forward-looking statements" as that term is defined in the federal securities laws. These forward-looking statements concern: - our ability to manage effectively the 56 senior housing facilities which we will operate; - the ability of Senior Housing and us to acquire the 31 Marriott senior housing facilities; - Marriott's ability to manage effectively the 31 Marriott senior housing facilities we will lease from Senior Housing; - the continued ability of our senior housing facilities to generate cash flow in excess of our rent obligations to Senior Housing and our other operating expenses; - our policies and plans regarding operations, investments, financings and other matters; and - our ability to access capital markets or other sources of funds. Also, whenever we use words such as "believe," "expect," "anticipate," "estimate" or similar expressions, we are making forward-looking statements. Forward-looking statements are not guarantees of future performance and involve risks and uncertainties. Our expected results may not be achieved, and actual results may differ materially from our expectations. This may be a result of various factors, including: - the status of the economy; - the Crestline transaction not closing; iv - compliance with and changes to regulations and payment policies within the healthcare industry; - competition within the senior housing and healthcare industries; - the status of capital markets (including prevailing interest rates); and - changes in federal, state and local legislation. Investors should not rely upon forward-looking statements except as statements of our present intentions and of our expectations which may or may not occur. We assume no obligation to update or revise any forward-looking statements or to update the reason why actual results could differ from those contained in any forward-looking statements. v SUMMARY REFERENCES IN THIS PROSPECTUS TO "WE", "US", "OUR", THE "COMPANY" OR "FIVE STAR" MEAN FIVE STAR QUALITY CARE, INC. AND ITS SUBSIDIARIES. REFERENCES IN THIS PROSPECTUS TO "SENIOR HOUSING" MEAN SENIOR HOUSING PROPERTIES TRUST AND ITS SUBSIDIARIES. REFERENCES IN THIS PROSPECTUS TO "HRPT" MEAN HRPT PROPERTIES TRUST AND ITS SUBSIDIARIES. REFERENCES IN THIS PROSPECTUS TO "CRESTLINE" MEAN CRESTLINE CAPITAL CORPORATION AND ITS SUBSIDIARIES. REFERENCES IN THIS PROSPECTUS TO "MARRIOTT" MEAN MARRIOTT SENIOR LIVING SERVICES, INC., AND ITS SUBSIDIARIES. THE DISTRIBUTION Distributing Companies.................... Senior Housing and HRPT. Shares to be Distributed.................. 2,937,470 of our common shares, $.01 par value per share. Immediately after the spin-off we will have a total of 2,962,470 common shares outstanding and the distributed shares will represent 99% of our total common shares outstanding. Distribution Ratio........................ One of our common shares for every 10 common shares of Senior Housing owned of record on , 2001. One of our common shares for every 100 common shares of HRPT owned of record on , 2001. No cash distributions will be paid and fractional shares will be issued as necessary. No Payment Required....................... No holder of Senior Housing or HRPT common shares will be required to make any payment, exchange any shares or to take any other action in order to receive our common shares. Record Date............................... The spin-off record date for Senior Housing's and HRPT's distribution of our shares is expected to be , 2001. Distribution Date......................... The spin-off distribution date is expected to be , 2001. Federal Income Tax Consequences........... Our shares distributed to you in the spin-off will be treated for tax purposes like all other distributions from Senior Housing or HRPT. The total value of this distribution, as well as your aggregate initial tax basis in our shares, will be determined by the trading price of our common shares at the time of the spin-off. However, if you have held your Senior Housing or HRPT common shares, as applicable, for the entire year, we expect you will have little or no additional taxable dividend as a result of the spin-off distribution. Background and Reasons for the Distribution.............................. In July 2000, Senior Housing repossessed or acquired senior living facilities from former tenants. Senior Housing contracted with FSQ, Inc. to manage a number of these properties. Under applicable provisions of the Internal Revenue Code, or IRC, REITs such as Senior Housing are not permitted to contract in this manner for facilities management for extended periods. We will lease 56 of these facilities from Senior Housing, and after the spin-off we will acquire FSQ.
1 In August 2001, Senior Housing agreed to acquire 31 senior living facilities from Crestline. These senior living facilities are managed by Marriott under agreements extending to 2027, plus renewal options thereafter. Upon the closing of this transaction, we will lease these 31 facilities from Senior Housing, assume the rights and obligations under the existing management agreements with Marriott, and acquire assets and liabilities relating to the operation of facilities which Senior Housing cannot assume under IRC REIT rules. Both Senior Housing and HRPT are REITs. We were created to lease and operate senior living facilities which cannot be leased or operated by REITs under the IRC. HRPT owns 44% of Senior Housing. Accordingly, when our shares are distributed by Senior Housing, a substantial number of our shares will be received by HRPT and then distributed to its shareholders. Shareholders who continue to own our shares and their respective shares of Senior Housing or HRPT will be able to participate in REIT qualified ownership of real estate in Senior Housing and HRPT and in our continuing operations of our leased real estate. The Crestline transaction is subject to conditions, including approval by Crestline shareholders and approval from Marriott under its management agreements. At this time, we expect that the Crestline transaction will close in early 2002. However, there can be no assurance that the Crestline transaction will close, and the spin-off is not conditioned on the closing of the Crestline transaction. Distribution Agent, Transfer Agent and Registrar................................. EquiServe Trust Company, N.A. will be the distribution agent, transfer agent and registrar for our shares. Listing................................... There is currently no public market for our shares. We have applied to list our shares on the American Stock Exchange under the symbol " ". If the application is approved, we expect trading will commence on or around the distribution date, , 2001. The listing of our shares does not ensure that an active trading market will be available to you.
2 RELATED TRANSACTIONS Merger Transaction........................ Following the spin-off, in exchange for of our common shares, we will acquire all of the capital stock of FSQ, the company which currently manages the 56 properties which we will lease from Senior Housing. Gerard M. Martin and Barry M. Portnoy, Managing Trustees of Senior Housing and members of our Board of Directors, are the owners of FSQ. We expect to receive an opinion from an internationally recognized investment banking firm that the consideration to be received by Messrs. Martin and Portnoy pursuant to the merger is fair, from a financial point of view, to us and our shareholders. For more detailed discussion of the merger, see "The Spin-off -- The Merger Transaction". Crestline Transaction..................... Senior Housing has agreed to acquire 31 senior housing facilities from Crestline. Upon the closing of the Crestline transaction, we will lease these 31 facilities from Senior Housing, assume the rights and obligations under existing management agreements with Marriott and acquire assets and liabilities relating to operation of these facilities. For a more detailed discussion of the Crestline transaction and our lease, see "The Spin-off -- The Crestline Transaction" and "The Company -- Our Leases for the Marriott Facilities". THE COMPANY General................................... We are a corporation originally formed under Delaware law in 2000 and reincorporated under Maryland law on September 20, 2001. Our principal place of business is 400 Centre Street, Newton, Massachusetts 02458, and our telephone number is (617) 796-8387. Business.................................. We were formed by Senior Housing to lease and operate senior living facilities, including facilities owned by Senior Housing. We are not a real estate investment trust, or REIT. Initially we will lease and operate 56 senior living facilities which are owned by Senior Housing and currently managed by FSQ. These 56 facilities contain 5,137 nursing home beds and 145 independent and assisted living units. In early 2002, we expect to lease an additional 31 senior living facilities when they are acquired by Senior Housing from Crestline. These 31 facilities contain 7,487 living units and are operated by Marriott under management agreements extending to 2027, plus renewal options thereafter.
3 In connection with this spin-off transaction, we have entered agreements which prohibit us from financing or purchasing certain types of real estate unless we first offer those investment opportunities to Senior Housing, HRPT and Hospitality Properties Trust ("HPT"), a REIT that invests in hotels. Aside from this restriction and a similar restriction in our shared services agreement, we may engage in any business activity. At present, we expect that our future business will be focused principally upon leasing, operating and managing senior living facilities, possibly including additional facilities which we will lease from Senior Housing. Initial Capitalization.................... At the time of the spin-off we will be capitalized with $40 million of equity consisting of cash and working capital, primarily operating receivables, net of operating payables. We will have no funded debt at the time of the spin-off. Management................................ Prior to completion of the spin-off we expect to have five Board members, and four of our five Board members will also be members of Senior Housing's Board of Trustees. Our chief executive officer and our chief financial officer are also part time employees of REIT Management & Research, Inc., or RMR. RMR is the investment manager to Senior Housing, HRPT and HPT. We have entered a shared services agreement with RMR. Dividend Policy........................... We do not expect to pay dividends.
4 RISK FACTORS Ownership of our shares will involve various risks. The following is a summary of the material risks: THERE IS NO HISTORICAL MARKET FOR OUR SHARES. We do not know what the trading prices of our shares will be after the spin-off. There is no historical market for our shares. The distribution of our shares is not being underwritten by an investment bank or otherwise. We have applied to list our shares on the American Stock Exchange, but there is no assurance that our request for listing will be approved. Until an orderly trading market develops, the trading prices of our shares may fluctuate significantly. If no regular trading market develops for our shares, holders of shares may not be able to sell their shares at fair prices. OUR OPERATING MARGINS ARE NARROW. Our pro forma total operating revenues for the six months ended June 30, 2001, assuming completion of the Crestline transaction, were $240 million; and our pro forma income before income taxes for the same period was $657,000. A small decline in our revenues or increase in our expenses might have a dramatic negative impact upon our pre-tax income or loss. THE CRESTLINE TRANSACTION MAY NOT CLOSE. We expect to lease 31 Marriott senior living facilities when they are acquired by Senior Housing. The operations associated with this lease will represent over 50% of our total revenues. The closing of the Crestline transaction is subject to conditions, including approval by Crestline's shareholders and by Marriott under its management agreements. The closing of the Crestline transaction is also subject to healthcare regulatory approvals. If the Crestline transaction is not completed, our actual revenues and income will be substantially less than the pro forma amounts presented herein. THE OPERATIONS OF SOME OF OUR FACILITIES ARE DEPENDENT UPON PAYMENTS FROM MEDICARE AND MEDICAID PROGRAMS. At some of our facilities, operating revenues are received from the Medicare and Medicaid programs. On a pro forma basis, assuming completion of the Crestline transaction, over 40% of our total revenues for the six months ended June 30, 2001, was derived from these programs. Since 1998, a Medicare prospective payment system has lowered Medicare rates paid to nursing homes. Many states have adopted formulas to limit Medicaid rates. As a result, in some instances Medicare and Medicaid reimbursement rates no longer cover costs incurred by operators, including us. At present there is an active debate within the federal government and within many state governments between advocates who want to raise Medicare and Medicaid rates and others who want to retain or lower current Medicare and Medicaid rates. We cannot predict the outcome of this debate. If we cannot cover operating costs, our financial condition and results of operations will be adversely impacted. OUR FACILITIES AND THEIR OPERATIONS ARE SUBJECT TO COMPLEX REGULATIONS. Physical characteristics of senior living facilities are mandated by various governmental authorities. Changes in these regulations may require significant expenditures. Our leases with Senior Housing require us to maintain our facilities in compliance with applicable laws. In the future, our facilities may require significant expenditures to address ongoing required maintenance and make them attractive to residents. Our available financial resources may be insufficient to fund these expenditures. State licensing and Medicare and Medicaid laws require operators of senior living facilities to comply with standards governing operations. During the past three years, the Federal Center for 5 Medicare and Medicaid Services, or CMS, has increased its efforts to enforce Medicare and Medicaid standards and its oversight of state survey agencies which inspect senior living facilities and investigate complaints. When deficiencies are identified, sanctions and remedies such as denials of payment for new Medicare and Medicaid admissions, civil money penalties, state oversight and loss of Medicare and Medicaid participation may be imposed. CMS and the states are increasingly using such sanctions and remedies when deficiencies, especially those involving findings of substandard care or repeat violations, are identified. Sanctions and remedies have been imposed on some of our nursing homes from time to time. If such sanctions are imposed upon our future operations our financial results will be adversely affected. HEALTHCARE OPERATIONS ARE SUBJECT TO LITIGATION RISKS. There are various federal and state laws prohibiting fraud by healthcare providers, including criminal provisions that prohibit filing false claims for Medicare and Medicaid payments and laws that govern patient referrals. The state and federal governments seem to be devoting increasing resources to anti-fraud initiatives against healthcare providers. In some states, advocacy groups have been created to monitor the quality of care at senior living facilities, and these groups have brought litigation against operators. Also, in several instances private litigation by nursing home patients has succeeded in winning very large damage awards for alleged abuses. The effect of this litigation and potential litigation has been to increase materially the costs of monitoring and reporting quality of care compliance and obtaining insurance. In addition, the cost of medical malpractice insurance has increased and may continue to increase so long as the present litigation environment affecting the operations of nursing homes and other senior living facilities continues. SENIOR HOUSING AND ITS MANAGING TRUSTEES WILL REALIZE SIGNIFICANT BENEFITS FROM THIS SPIN-OFF AND RELATED TRANSACTIONS. Senior Housing and its Managing Trustees, Barry M. Portnoy and Gerard M. Martin, will realize significant benefits from this spin-off and the related transactions, including the following: - In July 2000, Senior Housing repossessed or acquired nursing homes from bankrupt former tenants. These facilities are now operated for Senior Housing's account. IRC rules applicable to REITs restrict the manner and period these operations may be conducted and make the profits from these operations subject to corporate income tax. By completing this spin-off, Senior Housing will be able to continue indefinitely its ownership of these facilities, and the rent Senior Housing receives from us may generally be distributed to Senior Housing shareholders without any corporate income tax being paid by Senior Housing. - In August 2001, Senior Housing agreed to acquire 31 Marriott facilities from Crestline. The income now realized from these properties is not the type of income which REITs may receive under applicable IRC rules. By completing this spin-off and leasing these facilities to us, Senior Housing may remain a REIT and realize a significant part of the future income from these facilities as rent. - Messrs. Portnoy and Martin created FSQ to manage the nursing homes which were repossessed and acquired by Senior Housing. After the spin-off, we will acquire FSQ and, as a result, Messrs. Portnoy and Martin will each receive of our common shares. - Messrs. Portnoy and Martin own RMR. RMR is the investment manager for Senior Housing. RMR provides various services to FSQ. After the spin-off, we will enter a shared services agreement pursuant to which we will purchase various services from RMR. On a pro forma basis, assuming completion of the Crestline transaction, our payments to RMR under the shared services agreement were $2.9 million for the year ended December 31, 2000. 6 OUR CREATION WAS, AND OUR OPERATIONS WILL BE, SUBJECT TO CONFLICTS OF INTEREST. Our creation was, and our operations will be, subject to conflicts of interest, including the following: - All of our directors were trustees of Senior Housing at the time we were created. - Prior to completion of the spin-off we expect to have five directors, four of whom also will be trustees of Senior Housing. - Our chief executive officer and our chief financial officer are currently employees of RMR, and they will remain part time employees of RMR. RMR is the investment manager for Senior Housing, HRPT and HPT, and we will purchase various services from RMR pursuant to the shared services agreement. - Two of our directors, Barry M. Portnoy and Gerard M. Martin, are also Managing Trustees of Senior Housing and of other REITs managed by RMR. Messrs. Portnoy and Martin also own FSQ and RMR. Although we believe all transactions between ourselves and Senior Housing have been and will be fair, these conflicts may have caused, and may in the future cause, our business to be adversely affected. For example: - The leases we have entered with Senior Housing may be on terms less favorable to us than leases which would have been entered as a result of arm's length negotiations. - The terms of our merger with FSQ and of our shared services agreement with RMR may be less favorable to us than we could have achieved on an arm's length basis; specifically, the consideration we will pay in the merger and for shared services may be greater than it would be if these matters were negotiated with third parties. - Future business dealings between us and Senior Housing may be on terms less favorable to us than we could achieve on an arm's length basis. - We will have to compete with Senior Housing and RMR for the time and attention of our directors and officers, including Messrs. Portnoy and Martin. OWNERSHIP LIMITATIONS AND ANTI-TAKEOVER PROVISIONS MAY PREVENT YOU FROM RECEIVING A TAKEOVER PREMIUM. Our charter will prohibit any party from owning more than 9.8% of our outstanding common shares. Our leases with Senior Housing similarly restrict our share ownership and prohibit any change of control of us, without Senior Housing's approval. Our charter and bylaws contain other provisions that may increase the difficulty of acquiring control of us by means of a tender offer, open market purchases, a proxy fight or otherwise, if the acquisition is not approved by our Board of Directors. These other anti-takeover provisions include the following: - a staggered Board of Directors with separate terms of service for each class of directors; - the availability of additional shares and classes of shares that our Board of Directors may authorize and issue on terms that it determines; - a two-thirds shareholder vote required for removal of directors; and - advance notice procedures with respect to nominations of directors and shareholder proposals. For all of these reasons, you may be unable to realize a change of control premium for the common shares that you receive in the spin-off distribution. 7 THE SENIOR LIVING INDUSTRY IS HIGHLY COMPETITIVE. We will compete with numerous other companies which provide senior living alternatives, including home healthcare companies and other real estate based service providers. Historically, nursing homes have been somewhat protected from competition by state requirements of obtaining certificates of need to develop new facilities; however, these barriers are being eliminated in many states. Also, there are few barriers to competition for home healthcare or for independent and assisted living services. Many of our existing competitors are larger and have greater financial resources than us. Accordingly, we cannot provide any assurances that we will be able to attract a sufficient number of residents to our facilities to operate profitably, and we do not know whether we will be able to grow our business by acquiring additional operations. OUR RELATIONSHIPS WITH SENIOR HOUSING AND WITH RMR MAY INHIBIT OUR ABILITY TO GROW OUR BUSINESS. In connection with this spin-off we will enter an agreement which prohibits us from acquiring or financing real estate in competition with Senior Housing, HRPT, HPT or other real estate entities managed by RMR, unless those investment opportunities are first offered to Senior Housing, HRPT, HPT or those real estate entities. Because of our various relationships with Senior Housing and RMR, competitors of those companies may be unwilling to lease senior living facilities to us or conduct business with us. Also, because we have limited financeable assets and ownership of more than 9.8% of our shares by a party is subject to approval by Senior Housing, we may be unable to finance future growth opportunities. These circumstances may prevent us from realizing some growth opportunities. WE HAVE A LIMITED OPERATING HISTORY. We are a recently formed company and have a limited operating history. Our management team has been assembled for less than two years and does not have extensive experience working together. Accordingly, we may be unable to execute our business plan effectively. THE LEASE OF SENIOR HOUSING FACILITIES CREATES RISKS AND LIABILITIES ASSOCIATED WITH REAL ESTATE. Our business will be subject to risks associated with real estate leasing and operations including casualty losses, some of which may be uninsured, and environmental hazards or liabilities incurred at our facilities. 8 THE SPIN-OFF KEY DATES
DATE ACTIVITY ---- -------- December , 2001.................... PROSPECTUS MAILING DATE. The date the registration statement of which this prospectus is a part is declared effective by the SEC. We will mail this prospectus to you on or about this date. December , 2001.................... RECORD DATE. Senior Housing common shareholders will receive one share of our common stock for every 10 Senior Housing common shares owned of record on this date. HRPT common shareholders will receive one share of our common stock for every 100 HRPT common shares owned of record on this date. A "when issued" market on the AMEX may develop before the record date. If a "when issued" market develops for our common stock, Senior Housing and HRPT common shares may begin to trade "when issued/ex distribution". December , 2001.................... DISTRIBUTION DATE. 2,937,470 of our common shares will be delivered to the distribution agent on this date, and the spin-off will be completed. If you hold Senior Housing or HRPT common shares in a brokerage account, your shares of our common stock will be credited to that account. If you hold Senior Housing or HRPT common shares in certificated form, a certificate representing your shares of our common stock will be mailed to you; the mailing process is expected to take about 30 days. If a "when issued" and "when issued/ex distribution" market has developed for our shares and for Senior Housing and HRPT shares, respectively, it will cease on this date; and thereafter all those shares will trade in the regular way. January 2, 2002...................... MERGER DATE. FSQ will merge with a subsidiary of ours on this date after the distribution of shares is completed. As a result of this merger, FSQ will become a wholly owned subsidiary of ours and Messrs. Portnoy and Martin will each receive of our common shares. Early in 2002........................ CRESTLINE TRANSACTION DATE. We expect Senior Housing to acquire 31 Marriott facilities from Crestline on this date. Simultaneously with this closing, we will lease these 31 Marriott facilities from Senior Housing.
DISTRIBUTION AGENT The distribution agent for the spin-off is EquiServe Trust Company, N.A. LISTING AND TRADING OF OUR SHARES There is currently no public market for our shares. We have applied to list our shares on the AMEX under the symbol " ". A "when issued" market, if one develops, may permit you and others to trade our shares on the AMEX before the shares are distributed. 9 Until we have distributed our shares and an orderly trading market develops, the price of our shares may fluctuate significantly. If our listing application is approved, we expect trading will commence on the distribution date. You should understand that the listing of our shares will not ensure that an active trading market will be available to you. Many factors will influence the market price of our shares, including the depth and liquidity of the market which develops, investor perception of our business and growth prospects and general market conditions. BACKGROUND AND REASONS FOR THE SPIN-OFF In order to maintain its status as a REIT for federal income tax purposes, in most cases a substantial majority of Senior Housing's revenues must be derived from real estate rents and mortgage interest. In July 2000, Senior Housing repossessed or acquired facilities from former tenants, and retained FSQ to manage these properties. Tax laws applicable to REITs allow these arrangements only for limited periods, after which Senior Housing must either sell or locate one or more tenants for these facilities. In August 2001, Senior Housing entered an agreement with Crestline to purchase 31 senior living facilities managed by Marriott. Tax laws applicable to REITs do not allow Senior Housing to own these facilities without a third party tenant. We have been formed by Senior Housing to meet Senior Housing's need for a tenant for the 56 facilities managed by FSQ and the 31 Marriott facilities and to own other assets that Senior Housing could not itself own and conduct other business activities that Senior Housing could not itself conduct. We will be able to do so because we will be taxed as a regular corporation rather than a REIT. Also, in order to acquire the personnel, systems and assets used in managing the 56 facilities, we have agreed to acquire FSQ promptly after the spin-off. HRPT is a REIT which owns 44% of Senior Housing's shares. When our shares are distributed by Senior Housing, HRPT will simultaneously distribute substantially all of our shares that it receives to HRPT shareholders. HRPT has agreed to make this simultaneous distribution because doing so will allow HRPT to retain its own REIT status as well as assist Senior Housing to retain its REIT status. For a more detailed discussion of the tax provisions applicable to REITs which underlie this spin-off, see "Federal Income Tax Considerations". MANNER OF EFFECTING THE SPIN-OFF AND RELATED TRANSACTIONS To effect the spin-off and related transactions, the following material actions will occur: - Senior Housing will capitalize us with $40 million of net assets, consisting primarily of cash and receivables net of payables arising from the operations of 56 senior living facilities now managed for Senior Housing by FSQ. Our agreement with Senior Housing to lease the 31 Marriott facilities which Senior Housing has agreed to purchase from Crestline will become binding. - Senior Housing will distribute 99% of our shares to its shareholders. Senior Housing shareholders will receive one of our shares for every 10 common shares of Senior Housing owned on the record date. - HRPT will distribute all of our shares it receives to its shareholders. HRPT shareholders will receive one of our shares for every 100 common shares of HRPT owned on the record date. - Our lease for the 56 facilities now managed for Senior Housing by FSQ will become effective. - Promptly after the spin-off, we will acquire FSQ and the now existing management agreement between FSQ and Senior Housing will be cancelled. 10 - The lease for the 31 Marriott facilities will be effective when the Crestline transaction is closed, which we expect to occur in early 2002. If you hold Senior Housing or HRPT common shares in a brokerage account, your shares of our common stock will be credited to that account. If you hold Senior Housing or HRPT common shares in certificated form, a certificate representing your shares of our common stock will be mailed to you by the distribution agent; the mailing process is expected to take about 30 days. No cash distributions will be paid and we will issue fractional shares of our common stock in connection with the spin-off distribution as necessary. No holder of common shares of Senior Housing or HRPT is required to make any payment or exchange any shares in order to receive our common shares. THE TRANSACTION AGREEMENT In order to provide for an orderly spin-off and to govern relations after the spin-off, we entered a transaction agreement with Senior Housing, HRPT, HPT, FSQ and RMR. This transaction agreement has been filed with the SEC as an exhibit to the registration statement of which this prospectus is a part. If you want more information about the actions which have been and will be taken to effect the spin-off or about the agreements among us, Senior Housing, HRPT, HPT, FSQ and RMR concerning future relations, you should read the entire transaction agreement. The material provisions of the transaction agreement are summarized as follows: - Prior to the distribution date, Senior Housing will reorganize our business. This reorganization will include the transfer to Senior Housing's subsidiaries, other than us, of substantially all of our real estate assets and certain of our receivables, and the assumption by Senior Housing of correcting deferred maintenance items at the 56 senior living facilities. - Senior Housing will capitalize us with net equity of $40 million consisting primarily of cash and accounts receivable net of accounts payable arising from the operation of the 56 senior living facilities now owned by Senior Housing which we will lease. - On the distribution date Senior Housing will distribute 99% of our shares to its shareholders; and HRPT will distribute substantially all of our shares that it receives as a Senior Housing shareholder to HRPT's shareholders. - Our lease for the 56 facilities now owned by Senior Housing will be effective on the distribution date. See "The Company--Our Lease for the 56 Facilities". - Promptly after the distribution of our shares to Senior Housing and HRPT shareholders, in order to acquire the personnel, systems and assets necessary to operate the 56 facilities which we will lease, we will acquire FSQ. See "--The Merger Transaction". - To retain certain services now provided by RMR to FSQ, simultaneously with the FSQ merger we will enter a shared services agreement with RMR. See "Management--Our Shared Services Agreement with RMR". - When Senior Housing acquires the 31 Marriott facilities from Crestline, we will simultaneously assume the rights and obligations under existing management agreements with Marriott, acquire certain operating assets and liabilities of those facilities operations and lease those facilities from Senior Housing. See "--The Crestline Transaction" and "The Company--Our Leases for the Marriott Facilities". - HPT will provide certain consents to Crestline in order to facilitate the closing of the Crestline transaction and our lease of the 31 Marriott facilities. 11 - We will afford Senior Housing, HRPT and HPT a right of first refusal before we acquire or finance any real estate investments of the types in which Senior Housing, HRPT or HPT, respectively, invests. - We will agree to restrict the ownership of our shares and conduct all of our business activities in a manner which does not jeopardize Senior Housing's or HRPT's status as a REIT. See "Material Provisions of Maryland Law, Our Charter and Bylaws--Restrictions on Share Ownership and Transfer". - We and Senior Housing will cooperate to file future tax returns including appropriate allocation of taxable income, expenses and other tax attributes. - From and after the distribution date, we will agree to indemnify Senior Housing from any damages, claims, losses, expenses, costs or liabilities, arising out of any breach of ours under the transaction agreement, any liability assumed by us under various assignment and assumption agreements relating to the reorganization and the Crestline transaction and any liability relating to the operation of our business or assets. - Senior Housing will pay all of the costs and expenses of the spin-off and related transactions which may be incurred by the parties to the transaction agreement. THE MERGER TRANSACTION Promptly after completion of the spin-off, one of our subsidiaries will merge into FSQ so that we may acquire the personnel, operating systems and assets now used by FSQ to manage the 56 facilities which we will lease from Senior Housing. The merger agreement between FSQ and us has been filed as an exhibit to the registration statement of which this prospectus is a part. If you want more information about this merger transaction, you should read the merger agreement. The material terms of the merger agreement are summarized as follows: - The merger will be a stock for stock transaction. - One of our wholly owned subsidiaries will merge into FSQ. - As consideration in the merger, we will issue shares of our common stock to each of Messrs. Portnoy and Martin, the current owners of FSQ. - After the merger we will own 100% of FSQ. - The merger agreement will contain representations, warranties and indemnities between us and Messrs. Portnoy and Martin, as owners of FSQ. In connection with this merger we expect to receive an opinion of an internationally recognized investment banking firm that the consideration which we will pay to Messrs. Portnoy and Martin is fair from a financial point of view, to us and our shareholders. THE CRESTLINE TRANSACTION In August 2001, Senior Housing agreed to purchase all of the outstanding capital stock of one of Crestline's subsidiaries that owns 31 senior living facilities which are managed by Marriott. The total purchase price Senior Housing will pay is $600 million, subject to adjustments. We have agreed with Senior Housing to assume the rights and obligations under the existing management agreements with Marriott and to acquire certain operating assets and liabilities of these Marriott facilities simultaneously with Senior Housing's closing with Crestline. The assets and liabilities are expected to be principally composed of accounts receivable and accrued operating liabilities. The net of these operating assets and liabilities, if any, will be settled between Senior Housing and us in cash. Also, simultaneously with 12 this closing we will lease these facilities from Senior Housing. We expect this transaction to close in early 2002. However, this transaction is subject to certain conditions, including the following: - approval by Crestline shareholders; - consents from Marriott as required under its management agreements; - consent from certain Crestline lenders to Senior Housing's assuming their debt and our leasing the properties; - Crestline's obtaining new financing which may be assumed by Senior Housing which is currently expected to be $170 million; and - various regulatory approvals for the change of ownership for these facilities from Crestline to Senior Housing and for Senior Housing's leases to us. The Crestline transaction may be terminated, in addition to other customary reasons, by either Crestline or Senior Housing: - if the closing has not occurred prior to June 30, 2002; - for regulatory reasons; and - if Crestline's shareholders do not approve the transaction or if Crestline accepts an offer to purchase the facilities from a third party other than Senior Housing. Under certain termination events, Crestline is required to pay a termination fee to Senior Housing. If Senior Housing receives this fee, it will pay up to $7.5 million to us. A copy of the purchase agreement between Senior Housing and Crestline has been filed as an exhibit to the registration statement of which this prospectus is a part. If you want more information about this agreement and the various conditions to closing you should read this purchase agreement. For more information about the terms of our prospective lease of these 31 Marriott facilities, see "The Company--Our Leases for the Marriott Facilities". DIVIDEND POLICY We do not expect to pay dividends in the foreseeable future. CAPITALIZATION The following table describes our pro forma capitalization as of June 30, 2001, assuming the capitalization by Senior Housing pursuant to the transaction agreement and the closing of the Crestline transaction (in 000s):
AS ADJUSTED FOR THE SPIN-OFF AND CRESTLINE ACQUISITION BY AS ADJUSTED FOR THE SPIN-OFF SENIOR HOUSING ---------------------------- -------------------------------- Debt........................................ $ -- $ -- Common Equity (1)........................... 40,000 40,000 ------- ------- Total Capital............................... $40,000 $40,000 ======= =======
------------------------ (1) In the merger transaction with FSQ, we will issue additional common shares which will increase our common equity. As described in "Security Ownership After the Spin-off", the number of our shares to be issued in the merger has not yet been determined. The table above does not reflect any impact on our capitalization from our acquisition of FSQ. 13 THE COMPANY GENERAL We are a corporation organized under Maryland law. We are in the business of leasing and operating senior living facilities, including senior apartments, assisted living facilities, congregate communities and nursing homes. Upon the completion of the spin-off and the FSQ merger, we will lease and operate 56 senior living facilities. Upon completion of the Crestline transaction, we will lease an additional 31 senior living facilities. HISTORY Messrs. Portnoy and Martin have been active in the senior living industry for over 25 years. In 1986 they organized HRPT as a REIT to invest in senior living and healthcare related real estate. In the mid-1990s HRPT began to diversify its investments by purchasing hotels and office buildings. In 1995 HRPT's hotel subsidiary, HPT, completed an initial public offering, and it now operates as a separate public company. By the late 1990s the amount of HRPT's office building investments greatly exceeded its investments in senior living properties; and, in October 1999, HRPT concentrated its senior living investments in Senior Housing, and a majority interest in Senior Housing was spun-out to HRPT shareholders. Today, HRPT continues to own 44% of the common shares of Senior Housing, but HRPT is primarily focused on owning office buildings. In July 2000, Senior Housing repossessed or acquired senior living facilities from two bankrupt former tenants. Under IRC rules applicable to REITs, Senior Housing was required to engage an operating company to manage the healthcare businesses conducted at their facilities. Messrs. Portnoy and Martin formed FSQ to manage these facilities for Senior Housing. During the past year, we believe the combined operations at these 56 facilities has stabilized and improved. Simultaneously with the repossession of these facilities, Senior Housing foreclosed upon one million HPRT shares which had been pledged by one of its bankrupt former tenants to secure its lease. In August 2001, Senior Housing agreed to acquire 31 senior living facilities from Crestline for $600 million. The operations at these 31 facilities are managed by Marriott under management contracts, generally with terms through 2027 plus one five year renewal option. The operating income generated by these facilities is not REIT qualified income under applicable IRC rules. To complete the Crestline transaction and remain a REIT, Senior Housing must identify a taxable entity to lease these facilities. We are now a 100% owned subsidiary of Senior Housing. Currently, all of the operations of the 56 facilities are managed by FSQ for Senior Housing. We will enter a lease agreement with Senior Housing for these facilities. This lease will become effective upon completion of the spin-off. Promptly after completion of the spin-off, in order to acquire the personnel, systems and assets now used to manage the 56 facilities which we will lease, we will acquire FSQ. Also, we have entered an agreement to lease the 31 Marriott facilities when they are acquired by Senior Housing from Crestline. BUSINESS AND GROWTH STRATEGY The population of the United States is aging. We expect we may be able to take advantage of this demographic fact by attracting new residents to, and retaining existing residents at, our leased facilities. This attraction and retention will be pursued through a combination of high-quality resident care services and facilities. We also expect to expand our operations by leasing or managing additional senior living facilities in conjunction with Senior Housing and independently of Senior Housing. 14 TYPES OF FACILITIES Upon completion of the spin-off, the FSQ merger and the Crestline transaction, we will manage senior apartments, assisted living facilities, congregate care communities and nursing homes. Our present business plan contemplates the leasing and management of these types of senior living facilities, including some facilities that combine more than one type in a single building or campus. SENIOR APARTMENTS. Senior apartments, or independent living, are marketed to residents who are generally capable of caring for themselves. Residence is usually restricted on the basis of age. Purpose built facilities may have special function rooms, concierge services, high levels of security and assistance call systems for emergency use. Tenants at these facilities who need healthcare or assistance with the activities of daily living are expected to contract independently for these services with homemakers or home healthcare companies. CONGREGATE COMMUNITIES. Congregate communities also provide high levels of privacy to residents and require residents to be capable of relatively high degrees of independence. Unlike a senior apartment facility, a congregate community usually bundles several services as part of a regular monthly charge--for example, one or two meals per day in a central dining room, weekly maid service and a social director. Additional services are generally available from staff employees on a fee-for-service basis. In some congregate communities, separate parts of the facility are dedicated to assisted living or nursing services. ASSISTED LIVING FACILITIES. Assisted living facilities are typically comprised of one bedroom suites which include private bathrooms and efficiency kitchens. Services bundled within one charge usually include three meals per day in a central dining room, daily housekeeping, laundry, medical reminders and 24 hour availability of assistance with the activities of daily living such as dressing and bathing. Professional nursing and healthcare services are usually available at the facility on call or at regularly scheduled times. Since the early 1990s there has been explosive growth in the number of purpose built assisted living facilities. NURSING HOMES. Nursing homes generally provide extensive nursing and healthcare services similar to those available in hospitals, without the high costs associated with operating theaters, emergency rooms or intensive care units. A typical purpose built nursing home includes mostly two-bed unit with a separate bathroom in each unit and shared dining and bathing facilities. Some private rooms are often available for those residents who can afford to pay higher rates or for patients whose medical conditions require segregation. Nursing homes are generally staffed by licensed nursing professionals 24 hours per day. During the past few years, nursing home operators have faced two significant business challenges. First, the rapid expansion of the assisted living industry which started in the early 1990s has attracted a number of residents away from nursing homes. This was especially significant because the residents who chose assisted living facilities often previously had been the most profitable residents in the nursing homes. These residents required a lesser amount of care and were able to pay higher private rates rather than government rates. The second major challenge arose as a result of Medicare and Medicaid cost containment laws, particularly 1997 federal legislation that required the Medicare program to implement a prospective payment program for various subacute services provided in nursing homes. Implementation of this Medicare prospective payment program began on July 1, 1998. Prior to the prospective payment program, Medicare generally paid nursing home operators based upon audited costs for services provided. The prospective payment system sets Medicare rates based upon government estimated costs of treating specified medical conditions. Although it is possible that a nursing home may increase its profit if it is able to provide quality services at below average costs, we believe that the effect of the new Medicare rate setting methodology has been and will be to reduce the profitability of Medicare 15 services in nursing homes. This belief is based upon our observation of the impact of similar Medicare changes that were implemented for hospitals during the 1980s and the large number of bankruptcies which have occurred in the nursing home industry since the implementation of the Medicare prospective payment system began. GOVERNMENT REGULATION AND RATE SETTING SENIOR APARTMENTS. Generally, government programs do not pay for housing in senior apartments. Rents are paid from the residents' private resources. Accordingly, the government regulations that apply to these types of properties are generally limited to zoning, building and fire codes, Americans with Disabilities Act requirements and other life safety type regulations applicable to residential real estate. Government rent subsidies and government assisted development financing for low income senior housing are exceptions to these general statements. The development and operation of subsidized senior housing properties are subject to numerous governmental regulations. While it is possible that we may lease some subsidized senior apartment facilities, we do not expect these facilities to be a major part of our future business, and after the spin-off and the Crestline transaction, we will own no senior apartments where rent subsidies are applicable. CONGREGATE COMMUNITIES. Government benefits generally are not available for services at congregate communities and the resident charges in these facilities are paid from private resources. However, a number of Federal Supplemental Security Income program benefits pay housing costs for elderly or disabled residents to live in these types of residential facilities. The Social Security Act requires states to certify that they will establish and enforce standards for any category of group living arrangement in which a significant number of supplemental security income residents reside or are likely to reside. Categories of living arrangements which may be subject to these state standards include congregate communities and assisted living facilities. Because congregate communities usually offer common dining facilities, in many locations they are required to obtain licenses applicable to food service establishments in addition to complying with land use and life safety requirements. In many states, congregate communities are licensed by state health departments, social service agencies, or offices on aging with jurisdiction over group residential facilities for seniors. To the extent that congregate communities maintain units in which assisted living or nursing services are provided, these units are subject to applicable state licensing regulations, and if the facilities receive Medicaid or Medicare funds, to certification standards. In some states, insurance or consumer protection agencies regulate congregate communities in which residents pay entrance fees or prepay other costs. ASSISTED LIVING. According to the National Academy for State Health Policy, 38 states provide or are approved to provide Medicaid payments for residents in some assisted living facilities under waivers granted by the federal center for Medicare and Medicaid Services, or CMS or under Medicaid state plans, and eight other states are planning some Medicaid funding by requesting waivers implementing assisted living pilot programs or demonstration projects. Because rates paid to assisted living facility operators are lower than rates paid to nursing home operators, some states use Medicaid funding of assisted living as a means of lowering the cost of services for residents who may not need the higher intensity of health-related services provided in nursing homes. States that administer Medicaid programs for assisted living facilities are responsible for monitoring the services at, and physical conditions, of the participating properties. Different states apply different standards in these matters, but generally we believe these monitoring processes are similar to the concerned states' inspection processes for nursing homes. In light of the large number of states using Medicaid to purchase services at assisted living facilities and the growth of assisted living, a majority of states have adopted licensing standards applicable to assisted living facilities. According to the National Academy for State Health Policy, 29 states have licensing statutes or standards specifically using the term "assisted living". The majority of states have revised their licensing regulations recently or are reviewing their policies or drafting or 16 revising their regulations. State regulatory models vary; there is no national consensus on a definition of assisted living, and no uniform approach by the states to regulating assisted living facilities. Most state licensing standards apply to assisted living facilities whether or not they accept Medicaid funding. Also, according to the National Academy for State Health Policy, seven states require certificates of need from state health planning authorities before new assisted living facilities may be developed and two states have exempted assisted living facilities from certificate of need laws. Based on our analysis of current economic and regulatory trends, we believe that assisted living facilities that become dependent upon Medicaid payments for a majority of their revenues may decline in value because Medicaid rates may fail to keep up with increasing costs. We also believe that assisted living facilities located in states that adopt certificate of need requirements or otherwise restrict the development of new assisted living facilities may increase in value because these limitations upon development may help ensure higher occupancy and higher non-governmental rates. Two federal government studies provide background information and make recommendations regarding the regulation of, and the possibility of increased governmental funding for, the assisted living industry. The first study, an April 1999 report by the General Accounting Office to the Senate Special Committee on Aging assisted living facilities in four states, found a variety of residential settings serving a wide range of resident health and care needs. The General Accounting Office found that consumers often receive insufficient information to determine whether a particular facility can meet their needs and that state licensing and oversight approaches vary widely. The General Accounting Office anticipates that as the states increase the use of Medicaid to pay for assisted living, federal financing will likewise grow, and these trends will focus more public attention on the place of assisted living in the continuum of long-term care and upon state standards and compliance approaches. The second study, a National Study of Assisted Living for the Frail Elderly, was funded by the U.S. Department of Health and Human Services Assistant Secretary for Planning and Evaluation and is expected to result in a report on the effects of different service and privacy arrangements on resident satisfaction, aging in place, and affordability. In 2001, the Senate Special Committee on Aging held hearings on assisted living and its role in the continuum of care and on community-based alternatives to nursing homes. We cannot predict whether these studies will result in governmental policy changes or new legislation, or what impact any changes may have. Based upon our analysis of current economic and regulatory trends, we do not believe that the federal government is likely to have a material impact upon the current regulatory environment in which the assisted living industry operates unless it also undertakes expanded funding obligations, and we do not believe a materially increased financial commitment from the federal government is presently likely. However, we do anticipate that assisted living facilities will increasingly be licensed and regulated by the various states, and that in absence of federal standards, the states' policies will continue to vary widely. NURSING HOMES. About 58% of all nursing home revenues in the U.S. in 1999 came from government Medicare and Medicaid programs, including about 47% from Medicaid programs. Nursing homes are among the most highly regulated businesses in the country. The federal and state governments regularly monitor the quality of care provided at nursing homes. State health departments conduct surveys of resident care and inspect the physical condition of nursing home properties. These periodic inspections and occasional changes in life safety and physical plant requirements sometimes require nursing home operators to make significant capital improvements. These mandated capital improvements have in the past usually resulted in Medicare and Medicaid rate adjustments, albeit on the basis of amortization of expenditures over expected useful lives of the improvements. However, under the Medicare prospective payment system, or PPS, which began being phased in for cost reporting years starting on or after July 1, 1998, and will be completely phased in during 2001, capital costs are part of the prospective rate and are not facility specific. Medicare PPS and other recent legislative and regulatory actions with respect to state Medicaid rates are limiting the reimbursement levels for some nursing home and other eldercare services. At the same time federal and state enforcement and oversight of nursing homes is increasing, making licensing and certification of these 17 facilities more rigorous. These actions have adversely affected the revenues and increased the expenses of many nursing home operators, including us. PPS was established by the Balanced Budget Act of 1997, and was intended to reduce the rate of growth in Medicare payments for skilled nursing facilities. Before PPS, Medicare rates were facility-specific and cost-based. Under PPS, facilities receive a fixed payment for each day of care provided to an eligible Medicare beneficiary. Payments are adjusted to reflect differences in patient characteristics and service needs. Each patient is assigned to one of 44 resource utilization groups (RUGs) and the per diem payment rate is based on that RUG. Medicare payments cover substantially all services provided to Medicare beneficiaries in skilled nursing facilities, including ancillary services such as rehabilitation therapies. PPS is intended to provide incentives to providers to furnish only necessary services and to deliver those services efficiently. During the three-year phase-in period, Medicare rates for skilled nursing facilities are based on a blend of facility-specific costs and federal PPS rates. Once PPS is fully phased in for a facility, its per diem rates are set by the federal system. According to the General Accounting Office, between fiscal year 1998 and fiscal year 1999, the first full year of PPS phase-in, the average Medicare payment per day declined by about nine percent. As of June 30, 2001, all of the 56 facilities we will lease from Senior Housing on the distribution date have derived their Medicaid revenues under the final PPS rates for at least three months. PPS rates have been applied to 34 of our 53 leased facilities since January 1, 2001. Since November 1999, Congress has provided some relief from the impact of the Balanced Budget Act of 1997. Effective April 1, 2000, the Medicare, Medicaid, and SCHIP Balanced Budget Refinement Act of 1999, known as the BBRA, temporarily boosted payments for certain skilled nursing cases by 20 percent and allowed nursing facilities to transition more rapidly to the federal payment system. The BBRA also increased all PPS payment rates across the board by four percent for fiscal years 2001 and 2002 and imposed a two-year moratorium on certain therapy limitations for skilled nursing patients covered under Medicare Part B. In December 2000, the Medicare, Medicaid and SCHIP Benefits Improvement and Protection Act of 2000, known as BIPA, was approved. Effective April 1, 2001, to October 1, 2002, BIPA increased the nursing component of the payment rate for each RUG by 16.6%. BIPA also increased annual inflation adjustments for fiscal year 2001. BIPA increased rehabilitation RUG rates by 6.7% across the board and maintained the 20% increase in the other RUG rates established by the BBRA. CMS has begun to implement an initiative to increase the effectiveness of Medicare and Medicaid nursing facility survey and enforcement activities. CMS's initiative follows a July 1998 General Accounting Office investigation which found inadequate care in a significant proportion of California nursing homes and CMS's July 1998 report to Congress on the effectiveness of the survey and enforcement system. In 1999, the HHS Office of Inspector General issued several reports concerning quality of care in nursing homes, and the General Accounting Office issued reports in 1999 and 2000 which recommended that CMS and the states strengthen their compliance and enforcement practices to better ensure that nursing homes provide adequate care. In 1998, 1999 and 2000, the Senate Special Committee on Aging held hearings on these issues. CMS is taking steps to focus more survey and enforcement efforts on nursing homes with findings of substandard care or repeat violations of Medicare and Medicaid standards and to identify chain-operated facilities with patterns of noncompliance. CMS is increasing its oversight of state survey agencies and requiring state agencies to use enforcement sanctions and remedies more promptly when substandard care or repeat violations are identified, to investigate complaints more promptly, and to survey facilities more consistently. In addition, CMS has adopted regulations expanding federal and state authority to impose civil money penalties in instances of noncompliance. Medicare survey results for each nursing home are posted on the internet. In 2000, CMS issued a report on its study linking nursing staffing levels with quality of care, and CMS is assessing the impact that minimum staffing requirements would have on facility costs and operations. Federal efforts to target fraud and abuse and violations of anti-kickback laws and physician referral laws by Medicare and Medicaid providers have also increased. In March 2000, the 18 Department of Health and Human Services Office of Inspector General issued compliance guidelines for nursing facilities, to assist them in developing voluntary compliance programs to prevent fraud and abuse. Also, new CMS rules governing the privacy, use and disclosure of individually identified health information became final in 2001 and will require compliance by 2003, with civil and criminal sanctions for noncompliance. An adverse determination concerning any of our licenses or eligibility for Medicare or Medicaid reimbursement or compliance with applicable federal or state regulations could negatively affect our financial condition and results of operations. Most states also limit the number of nursing homes by requiring developers to obtain certificates of need before new facilities may be built. Even states such as California and Texas that have eliminated certificate of need laws have often retained other means of limiting new nursing home development, such as the use of moratoria, licensing laws or limitations upon participation in the state Medicaid program. We believe that these governmental limitations generally make nursing homes more valuable by limiting competition. A number of legislative proposals that would affect major reforms of the healthcare system have been introduced in Congress, such as additional Medicare and Medicaid reforms and cost containment measures. We cannot predict whether any of these legislative proposals will be adopted or, if adopted, what effect, if any, these proposals would have on our business. 19 OUR SENIOR LIVING FACILITIES Upon completion of the spin-off we will lease and operate 56 senior living facilities which are owned by Senior Housing. These 56 facilities include 54 nursing homes and two assisted living facilities; three of the nursing homes contain independent living units. These 56 facilities have 5,282 beds or living units and they are located in 12 states. The following table provides additional information about these facilities and their current operations:
PERCENT OF REVENUES NO. OF BEDS/UNITS FROM (FUNCTIONALLY MEDICARE/ FACILITY/LOCATION TYPE OF FACILITY AVAILABLE)* OCCUPANCY* REVENUES** MEDICAID** -------------------------- ----------------- ----------------- ---------- ------------ ---------- 1. Phoenix, AZ Nursing Home 119 80.1% $ 4,317,395 76% 2. Yuma, AZ Nursing Home 125 93.3% 5,928,972 80% 3. Yuma, AZ Assisted Living 55 82.1% 582,870 0% 4. Arleta, CA Assisted Living 90 81.7% 1,459,218 0% 5. Lancaster, CA Nursing Home 99 92.2% 4,779,480 72% 6. Stockton, CA Nursing Home 116 96.1% 6,525,950 71% 7. Thousand Oaks, CA Nursing Home 124 93.7% 7,423,101 76% 8. Van Nuys, CA Nursing Home 58 96.2% 2,913,483 79% 9. Canon City, CO Nursing Home/ 133 90.2% 3,551,855 61% Senior Apartments 10. Cherrelyn, CO Nursing Home 200 89.8% 9,400,288 81% 11. Colorado Springs, CO Nursing Home 100 78.5% 4,020,305 74% 12. Delta, CO Nursing Home 76 86.9% 3,547,393 83% 13. Grand Junction, CO Nursing Home 95 87.2% 3,969,035 64% 14. Grand Junction, CO Nursing Home 82 92.8% 4,105,093 74% 15. Lakewood, CO Nursing Home 125 83.7% 5,696,717 80% 16. New Haven, CT Nursing Home 150 97.7% 9,920,444 93% 17. Waterbury, CT Nursing Home 150 94.4% 9,882,460 92% 18. College Park, GA Nursing Home 99 90.0% 3,162,701 98% 19. Dublin, GA Nursing Home 130 85.7% 3,695,865 96% 20. Glenwood, GA Nursing Home 61 84.7% 1,676,598 92% 21. Marietta, GA Nursing Home 109 83.1% 3,585,206 86% 22. Clarinda, IA Nursing Home 96 61.2% 2,385,759 68% 23. Council Bluffs, IA Nursing Home 62 93.9% 2,358,472 89% 24. Des Moines, IA Nursing Home 85 90.9% 3,937,520 81% 25. Glenwood, IA Nursing Home 116 99.3% 6,607,220 99% 26. Mediapolis, IA Nursing Home 62 88.4% 2,160,313 64% 27. Pacific Junction, IA Nursing Home 12 100.0% 726,773 95% 28. Winterset, IA Nursing Home/ 99 63.7% 2,681,835 50% Senior Apartments 29. Ellinwood, KS Nursing Home 55 92.5% 1,719,623 53% 30. Farmington, MI Nursing Home 149 75.3% 10,130,836 75% 31. Howell, MI Nursing Home 172 76.4% 9,822,434 84% 32. Tarkio, MO Nursing Home 76 68.7% 2,012,824 69% 33. Ainsworth, NE Nursing Home 48 87.6% 1,688,920 67% 34. Ashland, NE Nursing Home 101 93.8% 4,358,762 68% 35. Blue Hill, NE Nursing Home 63 87.9% 2,114,337 67% 36. Campbell, NE Nursing Home 45 89.3% 1,622,376 75% 37. Central City, NE Nursing Home 66 92.3% 2,320,280 72% 38. Columbus, NE Nursing Home 48 97.4% 2,110,355 62%
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PERCENT OF REVENUES NO. OF BEDS/UNITS FROM (FUNCTIONALLY MEDICARE/ FACILITY/LOCATION TYPE OF FACILITY AVAILABLE)* OCCUPANCY* REVENUES** MEDICAID** -------------------------- ----------------- ----------------- ---------- ------------ ---------- 39. Edgar, NE Nursing Home 52 84.9% 1,586,679 64% 40. Exeter, NE Nursing Home 48 90.7% 1,479,450 57% 41. Grand Island, NE Nursing Home 76 97.2% 2,996,307 65% 42. Gretna, NE Nursing Home 63 90.3% 2,446,227 67% 43. Lyons, NE Nursing Home 63 81.0% 1,814,797 59% 44. Milford, NE Nursing Home 54 89.0% 1,909,712 70% 45. Sutherland, NE Nursing Home 62 89.8% 2,311,664 82% 46. Utica, NE Nursing Home 40 94.0% 1,670,543 72% 47. Waverly, NE Nursing Home 50 89.1% 2,118,789 49% 48. Brookfield, WI Nursing Home 226 92.9% 11,330,719 70% 49. Clintonville, WI Nursing Home 103 82.8% 3,238,509 79% 50. Clintonville, WI Nursing Home 62 91.9% 3,250,084 68% 51. Madison, WI Nursing Home 63 73.3% 2,740,329 59% 52. Milwaukee, WI Nursing Home 154 80.7% 6,061,982 81% 53. Pewaukee, WI Nursing Home 204 71.1% 6,736,316 75% 54. Waukesha, WI Nursing Home 105 95.2% 4,987,382 57% 55. Laramie, WY Nursing Home 120 75.6% 4,441,783 68% 56. Worland, WY Nursing Home/ 86 81.4% 3,347,953 72% Senior Apartments ----- ------ ------------ --- TOTALS: 5,282 86.2% $223,372,293 76% beds/ units
------------------------ */ Based upon functionally available beds/units for the period January 1, 2001, through July 31, 2001. Total licensed bed/unit capacity is 5,590. **/ January 1, 2001, through July 31, 2001, annualized. After it repossessed or acquired the foregoing facilities from bankrupt former tenants, Senior Housing undertook to correct deferred maintenance which had been allowed to occur at these facilities by their former tenants. Between July 2000 and August 2001, $3 million was spent by Senior Housing under this program. In the transaction agreement, Senior Housing has agreed to complete any of these projects which remain unfinished at the time of the spin-off without any adjustment to our rent. During the course of these projects, parts of these facilities are sometimes closed and these closings can adversely impact occupancy; however, we believe these projects are necessary for continuing operations at these facilities and may make the facilities more attractive to residents. 21 Upon completion of the Crestline transaction we expect to lease an additional 31 senior living facilities from Senior Housing. These facilities contain 7,487 living units and are located in 13 states. The following table provides additional information about these facilities and their current operations:
PERCENT OF REVENUES NO. OF ANNUALIZED FROM PRIVATE FACILITY LOCATION TYPE OF UNITS UNITS OCCUPANCY* REVENUES** PAY SOURCES*** ------------------- ------------------ -------- ---------- ------------ ------------------- 1. Peoria, AZ Independent Living 155 Assisted Living 79 Nursing Care 57 ----- 291 90.2% $ 9,067,692 95.8% 2. Scottsdale, AZ Independent Living 167 Assisted Living 33 Nursing Care 96 ----- 296 92.3% 11,405,919 92.3% 3. Tucson, AZ Independent Living 202 Assisted Living 30 Special Care 27 Nursing Care 67 ----- 326 95.8% 11,707,833 93.4% 4., 5. San Diego, CA Independent Living 246 (2 properties) Assisted Living 100 Nursing Care 59 ----- 405 94.3% 18,368,578 97.7% 6. Newark, DE Independent Living 62 Assisted Living 26 Nursing Care 110 ----- 198 97.0% 9,753,414 70.1% 7. Wilmington, DE Independent Living 140 Assisted Living 37 Nursing Care 66 ----- 243 96.6% 11,389,212 86.1% 8. Wilmington, DE Independent Living 71 Assisted Living 44 Nursing Care 46 ----- 161 94.2% 6,053,341 98.4% 9. Wilmington, DE Independent Living 62 Assisted Living 15 Nursing Care 82 ----- 159 92.9% 7,278,866 69.1% 10. Wilmington, DE Assisted Living 51 Special Care 26 Nursing Care 31 ----- 108 66.8% 3,006,521 100.0% 11. Coral Springs, FL Independent Living 184 Assisted Living 62 Nursing Care 35 ----- 281 90.2% 9,188,577 82.1%
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PERCENT OF REVENUES NO. OF ANNUALIZED FROM PRIVATE FACILITY LOCATION TYPE OF UNITS UNITS OCCUPANCY* REVENUES** PAY SOURCES*** ------------------- ------------------ -------- ---------- ------------ ------------------- 12. Deerfield Beach, FL Independent Living 198 Assisted Living 33 Nursing Care 60 ----- 291 89.6% 10,648,204 74.0% 13. Ft. Lauderdale, FL Assisted Living 109 90.3% 2,111,031 100.0% 14. Ft. Myers, FL Assisted Living 85 89.8% 2,229,715 100.0% 15. Palm Harbor, FL Independent Living 230 Assisted Living 87 ----- 317 81.3% 7,165,685 100.0% 16. West Palm Beach, FL Independent Living 276 Assisted Living 64 ----- 340 85.2% 7,262,231 100.0% 17. Indianapolis, IN Independent Living 117 Special Care 30 Nursing Care 74 ----- 221 93.3% 10,589,132 81.9% 18. Overland Park, KS Independent Living 117 Assisted Living 30 Nursing Care 60 ----- 207 94.3% 8,116,167 95.4% 19. Lexington, KY Independent Living 140 Assisted Living 9 ----- 149 93.0% 4,070,984 100.0% 20. Lexington, KY Assisted Living 22 Nursing Care 111 ----- 133 94.6% 6,860,024 66.8% 21. Louisville, KY Independent Living 240 Assisted Living 44 Nursing Care 40 ----- 324 97.2% 10,604,084 93.4% 22. Winchester, MA Assisted Living 125 98.1% 5,619,081 100.0% 23. Lakewood, NJ Independent Living 217 Assisted Living 108 Special Care 31 Nursing Care 60 ----- 416 80.5% 14,995,539 88.5% 24. Albuquerque, NM Independent Living 114 Assisted Living 34 Nursing Care 60 ----- 208 98.7% 9,200,641 93.4% 25. Columbus, OH Independent Living 143 Assisted Living 87 Special Care 25 Nursing Care 60 ----- 315 91.7% 13,122,036 95.3%
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PERCENT OF REVENUES NO. OF ANNUALIZED FROM PRIVATE FACILITY LOCATION TYPE OF UNITS UNITS OCCUPANCY* REVENUES** PAY SOURCES*** ------------------- ------------------ -------- ---------- ------------ ------------------- 26. Myrtle Beach, SC Assisted Living 60 Special Care 36 Nursing Care 68 ----- 164 80.9% 5,619,390 70.1% 27. Dallas, TX Independent Living 190 Assisted Living 38 Nursing Care 90 ----- 318 90.9% 12,624,555 92.0% 28. El Paso, TX Independent Living 123 Special Care 15 Nursing Care 120 ----- 258 85.9% 9,551,475 76.4% 29. Houston, TX Independent Living 197 Assisted Living 71 Special Care 60 Nursing Care 87 ----- 415 95.8% 17,407,423 93.3% 30. San Antonio, TX Independent Living 151 Assisted Living 30 Special Care 28 Nursing Care 60 ----- 269 96.3% 10,721,836 96.2% 31. Woodlands, TX Independent Living 239 Assisted Living 100 Special Care 16 ----- 355 91.8% 10,295,048 100.0% TOTALS: 31 properties Independent Living 3,981 13 states Assisted Living 1,613 Special Care 294 Nursing Care 1,599 ----- ----- ------------ ------ 7,487 90.9% $276,034,234 89.8%
-------------------------- */ December 30, 2000, through August 10, 2001. **/ December 30, 2000, through August 10, 2001, annualized. ***/ Fiscal year 2000. 24 OUR LEASE FOR THE 56 FACILITIES Upon completion of the spin-off, our lease for the 56 facilities now owned by Senior Housing will become effective. This lease requires us to maintain Senior Housing's facilities during the lease term and to indemnify Senior Housing for any liability which may arise by reason of its ownership of the properties during the lease term. The lease has been filed as an exhibit to the registration statement of which this prospectus is a part. If you want more information about the lease terms, you should read the entire lease. The following is a summary of material terms of this lease: OPERATING COSTS. The lease is a so-called "triple-net" lease which requires us to pay all costs incurred in the operation of the facilities, including the costs of personnel, service to residents, insurance and real estate and personal property taxes. MINIMUM RENT. The lease requires us to pay minimum rent to Senior Housing of $7 million per year. PERCENTAGE RENT. Starting in 2004, the lease requires additional rent with respect to each lease year in an amount equal to three percent (3%) of net patient revenues at the leased facilities in excess of net patient revenues during 2003. TERM. The lease expires on June 30, 2018. RENEWAL OPTION. We have the option to renew the lease for all but not less than all the facilities for one renewal term ending on June 30, 2033, by notice to Senior Housing on or before June 30, 2016. RENT DURING RENEWAL TERM. Rent during the renewal term shall be a continuation of minimum rent and percentage rent payable during the initial term. MAINTENANCE AND ALTERATIONS. We are required to maintain, at our expense, the leased facilities in good order and repair, including structural and nonstructural components. We may request Senior Housing to fund such amounts in return for rent adjustments to provide Senior Housing a return on its investment according to a formula set forth in the lease. At the end of the lease term, we are required to surrender the leased facilities in substantially the same condition as existed on the commencement date of the lease, subject to any permitted alterations and subject to ordinary wear and tear. ASSIGNMENT AND SUBLETTING. Senior Housing's consent is generally required for any direct or indirect assignment or sublease of any of the facilities. In the event of any assignment or subletting, we remain liable under the lease. 25 ENVIRONMENTAL MATTERS. We are required, at our expense, to remove and dispose of any hazardous substance at the leased facilities in compliance with all applicable environmental laws and regulations and to pay any costs Senior Housing incurs in connection with such removal and disposal. We are generally required to indemnify Senior Housing for any claims asserted as a result of the presence of hazardous substances during the lease term at any leased facilities and from any violation or alleged violation of any applicable environmental law or regulation. INDEMNIFICATION AND INSURANCE. With limited exceptions, we are required to indemnify Senior Housing from all claims arising from Senior Housing's ownership, or our use, of its facilities during the lease term. We generally are required to maintain commercially reasonable insurance. At the outset, that insurance will include the following types of insurance: - "all-risk" property insurance, in an amount equal to 100% of the full replacement cost of the facilities; - business interruption insurance; - comprehensive general liability insurance, including bodily injury and property damage, in amounts as are generally maintained by companies providing senior living services; - flood insurance (if any facility is located in whole or in part in a flood plain); - worker's compensation insurance if required by law; and - such additional insurance as may be generally maintained by companies providing senior living services. The lease requires that Senior Housing be named as an additional insured under these policies. DAMAGE, DESTRUCTION OR CONDEMNATION. If any of the leased facilities is damaged by fire or other casualty or any is taken for a public use, we are generally obligated to rebuild unless the facility cannot be restored. If the facility cannot be restored, Senior Housing will generally receive all insurance or taking proceeds. EVENTS OF DEFAULT. Events of default under the lease include the following: - our failure to pay rent or any other sum when due; - our failure to maintain the insurance required under the lease for 10 days after receiving notice thereof; - our failure to perform any terms, covenants or agreements of the lease and the continuance thereof for a specified period of time after written notice; - the occurrence of certain events with respect to our insolvency; - the institution of any proceeding for our dissolution; - any person or group of affiliated persons acquiring ownership of more than 9.8% of us without Senior Housing's consent; - any change in our control, without Senior Housing's consent; - our failure to perform under any management or operating agreement involving any facility owned by Senior Housing; and - our default under any other lease involving any facility owned by Senior Housing. REMEDIES. Upon the occurrence of any event of default, the lease provides that, among other things, Senior Housing may, to the extent legally permitted: - accelerate the rent; - terminate the lease; - terminate any other lease which we have with Senior Housing; 26 - enter the property and take possession of any and all our personal property and retain or sell the same at public or private sale; and - make any payment or perform any act required to be performed by us under the lease. We are obligated to reimburse Senior Housing for all costs and expenses incurred in connection with any exercise of the foregoing remedies. MANAGEMENT. We may not enter into, amend or modify any management agreement affecting any leased property without the prior written consent of Senior Housing. PLEDGE OF SUBSIDIARY SHARES. If any of our subsidiaries is or becomes a tenant or subtenant of any of the leased facilities, we are required to pledge 100% of the capital stock of such subsidiary to Senior Housing and we shall remain a co-obligor and guarantor of the lease. OUR LEASES FOR THE MARRIOTT FACILITIES We expect that Senior Housing will acquire 31 Marriott facilities from Crestline in early 2002. We will lease these properties from Senior Housing at the time they are acquired. The material terms of our leases for these facilities will be substantially the same as those of our lease for the 56 facilities now owned by Senior Housing, except as follows: MINIMUM RENT. The leases require us to pay minimum rent to Senior Housing of $63 million per year. PERCENTAGE RENT. Starting in 2003 the leases require additional rent with respect to each lease year in an amount equal to five percent (5%) of net patient revenues at the leased facilities in excess of 2002 net patient revenues. TERM. The lease terms expire on June 20, 2017. RENEWAL OPTIONS. We will have two options to renew the leases for all but not less than all the facilities which are then subject to a Marriott management agreement: the first for 10 years ending on June 20, 2027; and the second for five years ending June 20, 2032. The second renewal option is exercisable by us only if Marriott renews, as provided under its management agreement with us, for a five-year term ending in June 2032. The first renewal option must be exercised by us by notice to Senior Housing two years prior to the expiration of the initial term. The second renewal option must be exercised by notice to Senior Housing at least 11 months before the then current term expires. A representative form of lease has been filed as an exhibit to the registration statement of which this prospectus is a part. If you want more information about the leases' terms, you should read the entire representative form of lease. MARRIOTT MANAGEMENT The 31 facilities to be acquired by Senior Housing from Crestline are each subject to a management agreement with Marriott. At the time the leases of these 31 facilities commence, we will assume all of the owners' rights and responsibilities under these management agreements. The following is a description of the material terms of the agreements. If you want more information about these agreements, you should read the representative form of agreement which has been filed as an exhibit to the registration statement of which this prospectus is a part. TERM. Generally each of the management agreements has an initial term expiring in 2027, with one five-year renewal term at Marriott's option. FACILITY SERVICES. Marriott has responsibility and authority for all day-to-day operations of the managed facilities, including obtaining and maintaining all licenses necessary for operations, establishing resident care policies and procedures, carrying out and supervising all necessary repairs and maintenance, procuring food, supplies, equipment, furniture and fixtures, and establishing prices, rates 27 and charges for services provided. Marriott also recruits, employs and directs all facility based employees, including managerial employees. CENTRAL SERVICES. Marriott also furnishes certain central administrative services, which are provided on a central or regional basis to all senior living facilities managed by Marriott. Such services include: (i) marketing and public relations; (ii) human resources program development; (iii) information systems development and support; and (iv) centralized computer payroll and accounting. WORKING CAPITAL. We will be required to maintain working capital at each of the managed facilities at levels consistent with the Marriott senior living system standard. FF&E RESERVES AND CAPITAL IMPROVEMENTS. Marriott has established a reserve account, referred to as an FF&E Reserve, to cover the expected recurring cost of replacements and renewals to the furniture, furnishings, fixtures, soft goods, case goods, vehicles and equipment, and for routine building repairs and maintenance which are normally capitalized. The FF&E Reserve accounts are funded from the operating revenues of the managed facilities. The amount of this funding varies somewhat among the managed facilities; however, for most facilities it is currently set at 2.65% of gross revenues and is expected to gradually increase to 3.5% of gross revenues in 2008 and thereafter. In the event major capital improvements are required, or if the amounts set aside in the FF&E Reserve accounts are inadequate for required repairs, we may be required to fund such repairs and improvements. Any such funding which we provide increases the amount of our owner's priority, described below. Also, under our leases we have the option to request Senior Housing to provide such required funding in return for rent adjustments to provide Senior Housing a return on its investment according to a formula set forth in the lease. FEES. For its facility services, Marriott receives a base fee generally equal to 5% of the managed facilities' gross revenues, plus an incentive fee generally equal to 20% of operating profits in excess of owner's priority amounts, as defined in the agreements. For its central services, Marriott receives a fee generally equal to 2% of gross revenues. Payment of up to one half of this central services fee (i.e., 1%) is conditional, and is waived if specified annual profit targets are not achieved. OWNER'S PRIORITY. We will receive the net profits of the Marriott managed facilities on a priority basis before Marriott receives any incentive fees for facility services or any conditional central services fees. The amount of the owner's priority for each managed facility is established based upon a specified rate of return on historical capital investments in these facilities, including capital investments funded in addition to the FF&E Reserve. For fiscal year 2001, the aggregate amount of owner's priority for all 31 properties is $69.4 million. POOLING. Twenty-eight of the Marriott management agreements are subject to pooling arrangements whereby the calculation and payment of FF&E Reserves, fees payable to Marriott and owner's priority for several groups of these 28 facilities are combined. EVENTS OF DEFAULT. Events of default under the operating agreements include, among others, certain events relating to the insolvency or bankruptcy of either party. TERMINATION. The Marriott management agreements are terminable as follows: - Upon material default, by the non-defaulting party after applicable cure periods lapse. - By us, if a specific facility, or a pooled combination of facilities, fails to achieve specified financial performance; provided, however, Marriott has the option to avoid financial performance terminations by making specified payments to us or by temporarily reducing certain of its fees. - By us, upon 120 days notice, provided we make a termination payment to Marriott calculated according to a formula set forth in the agreements. 28 Our right to exercise termination options under the Marriott management agreements is subject to approval by Senior Housing under the terms of our leases for these 31 Marriott facilities. COMPETITION The senior living services business is highly competitive. We will compete with service providers offering different modes of treatment, such as homemaker or home healthcare services, as well as other companies providing real estate facility based services. We believe we will be able to compete successfully for the following reasons: - Our merger with FSQ and our shared services agreement with RMR may provide us a depth and quality of management which is equal to or stronger than most other senior living services providers. - Our historical and continuing relationship with Senior Housing may provide us opportunities to expand our business by acquiring new leaseholds for senior living facilities from Senior Housing. - The senior living services industry has experienced severe financial distress during the past few years. Many operators of nursing homes and assisted living facilities have been forced into bankruptcy. As a new company without any material debt, we do not expect to be burdened with financial difficulties of the types which currently burden some of these competitors. Our management team has been recently assembled within the past two years, and, although we believe it is highly talented, it does not have extensive experience working together. We expect we may expand our business with Senior Housing; however, Senior Housing is not obligated to provide us with opportunities to lease additional properties. We have no debt, but we also have large lease obligations, limited financeable assets and only about $40 million of equity capital; and many of our competitors have greater financial resources than us. For all of these reasons and others, we cannot provide you any assurance that we will be able to successfully compete for business in the senior living industry. ENVIRONMENTAL MATTERS Under various federal, state and local laws, ordinances and regulations, tenants as well as owners of real estate may be required to investigate and clean up hazardous substances released at a property, and may be held liable to a governmental entity or to third parties for property damage or personal injuries and for investigation and clean-up costs incurred in connection with any contamination. As part of our leases, we have also agreed to indemnify Senior Housing for any such liabilities it incurs at facilities leased from Senior Housing during the lease term. In addition, some environmental laws create a lien on a contaminated site in favor of the government for damages and costs it incurs in connection with the contamination, which lien may be senior in priority to our leases. We have reviewed some preliminary environmental surveys of the properties we will lease upon completion of the spin-off and upon completion of the Crestline transaction. Based upon that review we do not believe that any of these properties are subject to any material environmental contamination. However, no assurances can be given that: - a prior owner, operator or occupant of our leased properties did not create a material environmental condition not known to us which might have been revealed by more in-depth study of the properties; and - future uses or conditions (including, without limitation, changes in applicable environmental laws and regulations) will not result in the imposition of environmental liability upon us. 29 EMPLOYEES As of September 1, 2001, the 56 nursing homes and FSQ operations which will be part of our initial operations had 6,541 employees, including 5,099 full time equivalents. Approximately 763 employees, including 570 full time equivalents, are represented under seven collective bargaining agreements. We believe our relations with these union and non-union employees to be good. LEGAL PROCEEDINGS We have a limited operating history and are not currently a party to any legal proceedings, and we are not aware of any material legal proceeding affecting our facilities for which we may become liable. Moreover, Senior Housing has agreed to indemnify us for pending litigation affecting the properties leased to us. SELECTED HISTORICAL FINANCIAL INFORMATION The following table presents our selected historical financial information and has been derived from our historical financial statements for the period from April 27, 2000 (the date we commenced operations) through December 31, 2000 and the for the six months ended June 30, 2001. The following data should be read in conjunction with our financial statements and the notes thereto included elsewhere in the prospectus, and "Management's Discussion and Analysis of Financial Condition and Results of Operations".
PERIOD FROM APRIL 27, 2000 SIX MONTHS THROUGH ENDED DECEMBER 31, JUNE 30, 2001 2000 ------------- -------------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) FIVE STAR QUALITY CARE, INC. Operating data Operating revenues........................... $113,260 $ 2,520 Net income................................... (1,906) (1,316) Balance sheet data Total assets................................. $ 87,989 $54,788 Long term obligations........................ 100 100
The following table presents selected historical financial information of our two predecessors and has been derived from the historical financial statements of those predecessors included elsewhere in the prospectus. The following data should be read in conjunction with the financial statements and notes thereto entitled Combined Financial Statements of Forty-Two Facilities acquired by Senior Housing Properties Trust from Integrated Health Services, Inc. and Combined Financial Statements of Certain Mariner Post-Acute Network Facilities (Operated by Subsidiaries of Mariner Post-Acute Network) included elsewhere in the prospectus, and "Management's Discussion and Analysis of Financial Condition and Results of Operations--Mariner Predecessor" and "--Integrated Predecessor". 30 The following table presents the information from 1996 to 2000 to the extent it was available from the two predecessor entities.
YEAR ENDED DECEMBER 31, ----------------------------------------------------- 2000 1999 1998 1997 1996 -------- --------- -------- -------- -------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) INTEGRATED PREDECESSOR Operating data Operating revenues................... $135,378 $ 130,333 $140,116 $104,727 $112,805 Net loss............................. (25,252) (126,939) (17,183) (10,432) (1,190) Balance sheet data Total assets......................... $ 34,942 $ 61,274 $190,553 $174,954 * Long term obligations................ -- 17,500 17,751 18,006 * MARINER PREDECESSOR Operating data Operating revenues................... $ 85,325 $ 86,945 $105,486 $107,829 $111,985 Net loss............................. (7,421) (43,804) (7,710) (9,453) * Balance sheet data Total assets......................... $ 23,052 $ 17,433 $ 62,502 $ 84,119 $ 36,846 Long term obligations................ 32,091 28,603 33,195 15,498 12,528
------------------------ * Mariner Predecessor and Integrated Predecessor have indicated to us that certain financial information, some of which relates to periods during which these operations were conducted by third parties for 1996 is not available. 31 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW We were incorporated in April 2000 as a Delaware corporation and reincorporated in Maryland on September 20, 2001. We were formed to operate healthcare facilities owned or mortgaged by Senior Housing. Effective July 1, 2000, we assumed the operations of healthcare facilities from two bankrupt former tenants of Senior Housing. At the time we assumed operations of these facilities, we still had not received substantially all of the required licenses for these facilities. As a result, for the period from July 1, 2000, through December 31, 2000, we accounted for the operations of these facilities using the equity method of accounting and we only recorded from these operations their net income. On January 1, 2001, we began to consolidate the results of operations of these facilities. Since we succeeded to substantially all of the business formerly conducted by subsidiaries or units of two former tenants of Senior Housing, we consider these subsidiaries and units to be our predecessors. We have included the financial statements of these predecessors in this prospectus and discuss their results of operations. For the reasons described below, we believe that the historical results of operations of the predecessors are not comparable to our future results of operations. Our predecessors' financial statements are entitled: Certain Mariner Post-Acute Network Facilities (referred to herein as Mariner Predecessor); and Forty-Two Facilities Acquired by Senior Housing Properties Trust from Integrated Health Services, Inc. (referred to herein as Integrated Predecessor). You should read the following discussion in conjunction with our historical and pro forma financial statements and the financial statements of our predecessors included elsewhere in this prospectus. Our revenues consist primarily of resident fees and healthcare service revenues associated with services provided to patients at our facilities. The payments are either paid for by the patient or provided from the Medicare and Medicaid programs. The substantial majority of our historical revenues are paid from the Medicare and Medicaid programs. The substantial majority of the revenues associated with the 31 Marriott facilities are paid by the patients, or private pay. On a pro forma basis, assuming the Crestline transaction closes, for the six months ended June 30, 2001, private pay revenues would have represented 59% of our total revenues. Our expenses consist primarily of wages and benefits of personnel, food, supplies and other patient care costs. OUR HISTORICAL RESULTS OF OPERATIONS As described above, we succeeded to substantially all of the business of subsidiaries of Senior Housing. Senior Housing's operations of these subsidiaries differs from our expected operations as follows: - The operating business acquired included certain facilities, assets and activities to which we have not succeeded. - The principal source of financing for these operating businesses was intercompany advances from Senior Housing, an entity with financial resources substantially in excess of ours. We believe that because of these differences, the historical results of operations described below are not comparable to future operations which we expect to conduct. Specifically, we will operate only 56 properties for Senior Housing immediately after the spin-off, and we will not own real estate which was owned by Senior Housing through its subsidiaries. We will lease these facilities from Senior Housing, and we will conduct our own affairs and incur costs as a separate public company which may be more or less than the costs incurred by Senior Housing and allocated to us. 32 SIX MONTHS ENDED JUNE 30, 2001, VERSUS 2000 We did not begin to operate the senior living facilities of our predecessors until July 1, 2001. As a result, we generated no revenue and made only limited expenditures during the period from April 27, 2000, the day we commenced operations, to June 30, 2000. Revenues for the six month period ended June 30, 2001 were $113.3 million. On a combined basis, the two predecessor entities had revenues of $107.9 million for the six month period ended June 30, 2000. This increase was due mainly to an increase in the average daily rate received during these periods. Expenses for the six month period ended June 30, 2001 were $115.1 million. On a combined basis, the two predecessor entities had expenses of $118.9 million. The decrease is due primarily to rent and interest expenses which were included in the 2000 expenses but were zero in 2001 because after our foreclosures, rent and interest payments on the mortgages and leases with Senior Housing ceased. This decrease was offset by non-recurring general and administrative expenses recorded in 2001 which were zero in 2000. PERIOD APRIL 27, 2000 (DATE OPERATIONS COMMENCED) THROUGH DECEMBER 31, 2000 This period is the first period of operations and, therefore, there is no comparable period. During 2000 we accounted for our investment in these operating businesses using the equity method of accounting. As a result, the reported revenues included our equity in earnings of these investees. Revenues for 2000 were $2.5 million and represent the net amount of net patient revenues in excess of expenses of these operations for the 2000 period. Net patient revenues at the operating businesses for the six months ended December 31, 2000 were $114.5 million and expenses incurred for the period were $111.9 million. LIQUIDITY AND CAPITAL RESOURCES On a historical basis our expenditures, including capital expenditures and for working capital, were provided by Senior Housing, our parent company, and Senior Housing charged only a nominal amount of interest to us. We maintained no financing sources apart from Senior Housing. After the spin-off, our primary source of cash to fund operating expenses, including rent payable to Senior Housing, will be the patient revenues we generate at our leased facilities. We believe that this operating revenue will be sufficient to allow us to meet our ongoing operating expenses and rent payments to Senior Housing in the short term and long term. Our agreement to purchase shared services from RMR allows us to defer payments to RMR under the shared services agreement if necessary to make rent payments to Senior Housing. On a pro forma basis, payments to RMR for shared services totaled $2.9 million during the year ended December 31, 2000. As of the spin-off date, our pro forma assets and liabilities provided by Senior Housing will include cash, operating accounts receivable and accrued operating liabilities. On a pro forma basis, assuming the Crestline transaction does not occur, our cash balance at June 30, 2001, was $13.8 million. Assuming the Crestline transaction does occur, our pro forma cash balance at June 30, 2001, was $17.5 million. As of the spin-off date, on a pro forma basis we will have no debt. Our principal asset other than cash will be our accounts receivable from residents at the 56 nursing homes that we will lease from Senior Housing. On a pro forma basis, these receivables at June 30, 2001, totaled $40.8 million. We have had preliminary discussions with two financing companies regarding using a portion of our receivables as collateral for a line of credit, but have not engaged either of these financing sources in 33 negotiations to date. We expect, but can provide no assurances, that our receivables will support a line of credit available to us for general corporate purposes and for business expansion opportunities. SEASONALITY Our business is subject to the effects of seasonality. Our nursing home operations in particular typically see higher occupancies in the second, third and fourth quarters versus the first quarter within a year. This seasonality is not expected to cause fluctuations in our revenues or operating cash flow to such an extent that we will have difficulty paying our expenses, including rent, which do not fluctuate seasonally. INFLATION AND DEFLATION Inflation in the past several years in the United States has been modest. Future inflation might have both positive or negative impacts on our business. Rising price levels may allow us to increase occupancy charges to residents, but may also impact our operating costs. Because a portion of our revenues are set by Medicare and Medicaid formulae, our revenues may change by either more or less than the rate of change in our expenses. Because a large component of our expenses will consist of fixed rental obligations to Senior Housing, we may not be able to fully capitalize on declines in general price levels. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We have no obligations for funded debt and as such are not directly affected by changes in market interest rates. However, as discussed above, we expect to negotiate with financing sources for a line of credit secured by some or all of our receivables. We expect that this line of credit will bear interest for funded amounts at floating rates. We may from time to time consider our exposure to interest rate risks if we have or expect to have material amounts of floating rate obligations. These considerations may include the purchase of interest rate caps or other hedging instruments. HISTORICAL RESULTS OF OPERATIONS--MARINER PREDECESSOR The Mariner Predecessor conducted operations of 17 facilities leased from Senior Housing. The operations of the Mariner Predecessor during the period prior to its acquisition by Senior Housing differs from our expected operations as follows: - The operating business acquired included certain properties, assets and activities to which we have not succeeded. - The business of the Mariner Predecessor was conducted by its then parent, Mariner Post-Acute Network, an entity with a capital structure, corporate overhead costs, and operating synergies which we expect to be substantially different than ours. - During the period of Mariner's operation of the business, significant writeoffs of goodwill and other long-lived assets of the Mariner Predecessor occurred and Mariner filed for bankruptcy. We believe that because of these differences, the historical results of operations described below are not comparable to future operations which we expect to conduct. YEAR ENDED DECEMBER 31, 2000, VERSUS 1999--MARINER PREDECESSOR Revenues for the year ended December 31, 2000, were $85.3 million. These revenues represent primarily net patient revenues, a decrease of $1.5 million over the net patient revenues in the 1999 34 period. This decrease is attributable primarily to a slight decrease in occupancy at the facilities now operated for Senior Housing's account and by the closing of one facility. Expenses for the year ended December 31, 2000, were $92.7 million, a decrease of $1.6 million over the 1999 period, after adjusting for non-recurring or unusual charges and write-offs incurred in 1999. This decrease is attributable primarily to decreases in facility, general and administrative costs, provision for bad debts and rent offset by an increase in salary, wages and benefits. Net loss for the year ended December 31, 2000, was $7.4 million, a decrease in loss of $36.4 million over the 1999 period. This decrease in loss is attributable to the impact of unusual charges related to the impairment of long-lived assets in 1999. YEAR ENDED DECEMBER 31, 1999, VERSUS 1998--MARINER PREDECESSOR Revenues for the year ended December 31, 1999, were $86.9 million. These revenues represent primarily net patient revenues, a decrease of $18.5 million over the net patient revenues in the 1998 period. This decrease is attributable primarily to the detrimental effects of reductions in reimbursement rates under the prospective payment system for skilled nursing facilities under the federal Medicare program. The per diem rates under PPS were significantly lower than the amounts received under the former cost-based system. Expenses, excluding losses related to the impairment of long-lived assets aggregating $36.3 million and $8.7 million, in 1999 and 1998, respectively, and discussed in the next paragraph, were $94.3 million and $103.4 million in 1999 and 1998, respectively. This $9.1 million decrease is the result of cost cutting measures undertaken to offset the reductions in reimbursement under PPS. During 1999 and 1998, the Mariner Predecessor incurred losses related to the impairment of long lived assets of $36.3 million and $8.7 million, respectively. These charges were a result of write-downs related to goodwill of $30.4 million and $8.1 million and to property and equipment of $5.9 million and $546,000, in 1999 and 1998, respectively. Net loss for the year ended December 31, 1999, was $43.8 million, a $36.1 million increase in loss over the 1998 period. This increase in loss is attributable to the reduction in net patient revenues and the additional impairment write-downs discussed above. HISTORICAL RESULTS OF OPERATIONS--INTEGRATED PREDECESSOR The Integrated Predecessor conducted operations of 42 facilities leased from Senior Housing. The operations of the Integrated Predecessor during the period prior to its acquisition by Senior Housing differs from our expected operations as follows: - The operating business acquired included certain properties, assets and activities to which we have not succeeded. - The business of the Integrated Predecessor was conducted by its then parent, Integrated Health Services, Inc., an entity with a capital structure, corporate overhead costs, and operating synergies which we expect to be substantially different than ours. - During the period of Integrated Health Services' operation of the business, significant write-offs of goodwill and other long-lived assets of the Integrated Predecessor occurred and Integrated Health Services filed for bankruptcy. We believe that because of these differences, the historical results of operations described below are not comparable to future operations, which we expect to conduct. 35 YEAR ENDED DECEMBER 31, 2000, VERSUS 1999--INTEGRATED PREDECESSOR Revenues for the year ended December 31, 2000, were $135.4 million. These revenues represent primarily net patient revenues, an increase of $5.1 million over the net patient revenues in the 1999 period. This increase is attributable primarily to an increase in Medicaid rates that resulted in an additional $2.9 million of revenues and an increase in occupancy at the Integrated Predecessor facilities. Expenses, excluding non-recurring or unusual charges and write-offs aggregating $16.7 million and discussed in the next paragraph for the year ended December 31, 2000, were $143.9 million, a decrease of $2.1 million over the 1999 period. This decrease is attributable primarily to a decrease in rent, depreciation and amortization at the Integrated Predecessor facilities offset by increased operating expenses. During the 2000 period, the Integrated Predecessor incurred unusual charges related to a loss on settlement of lease and mortgage obligations of $16.7 million. These charges were a result of the settlement agreement between Integrated and Senior Housing and represent the carrying value of the tangible and intangible assets of the facilities conveyed to Senior Housing, less the related mortgage debt. During the 1999 period, the Integrated Predecessor incurred write-offs and unusual charges related to a loss on impairment of long-lived assets of $120.0 million. Net loss for the year ended December 31, 2000, was $25.3 million, a decrease of $101.6 million over the net loss of $126.9 million in 1999. This decrease in loss is attributable the decreases in rent, depreciation and amortization and the impact of unusual charges discussed above. YEAR ENDED DECEMBER 31, 1999, VERSUS 1998--INTEGRATED PREDECESSOR Revenues for the year ended December 31, 1999, were $130.3 million. These revenues represent primarily net patient revenues, a decrease of $9.8 million over the net patient revenues in the 1998 period. This decrease is attributable primarily to the detrimental effects of reductions in reimbursement rates under the PPS for skilled nursing facilities under the federal Medicare program. The per diem reimbursement rates under PPS were significantly lower than the amounts the facilities received under the former cost-based system. Expenses, excluding non-recurring or unusual charges and write-offs aggregating $120.0 million and discussed in the next paragraph, for the year ended December 31, 1999, were $146.0 million, a decrease of $8.4 million over the 1998 period. This decrease is attributable primarily to a decrease in operating expenses resulting from cost cutting measures undertaken to combat the reductions in reimbursement under PPS. During the 1999 period, the Integrated Predecessor incurred unusual charges related to a loss on impairment of long-lived assets of $120 million. No such charge occurred in 1998. Net loss for the year ended December 31, 1999, was $126.9 million, an increase of $109.7 million over the net loss of $17.2 million in 1998. This increase in loss is primarily attributable to the impact of unusual charges discussed above, as well as decreases in net patient revenues and offset somewhat by decreases in operating expenses. 36 MANAGEMENT The following sets forth the names, ages and positions of the persons who will be our directors and executive officers upon completion of the spin-off:
NAME AGE POSITION ---- -------- -------- Barry M. Portnoy................................... 56 Director (term will expire in 2002) Gerard M. Martin................................... 66 Director (term will expire in 2003) Bruce M. Gans, M.D................................. 54 Director (term will expire in 2004) John L. Harrington................................. 65 Director (term will expire in 2002) Arthur G. Koumantzelis............................. 71 Director (term will expire in 2003) Evrett W. Benton................................... 53 President, Chief Executive Officer and Secretary Rosemary Esposito, RN.............................. 53 Senior Vice President, Chief Operating Officer Gretchen A. Holtz, RN.............................. 59 Vice President, Chief Clinical Officer MaryAnn Hughes..................................... 54 Vice President, Director of Human Resources Bruce J. Mackey Jr................................. 31 Treasurer, Chief Financial Officer and Assistant Secretary
DIRECTORS BARRY M. PORTNOY has been one of the Managing Trustees of Senior Housing, HRPT and HPT, since each began business in 1999, 1986 and 1995, respectively. Mr. Portnoy is also a director and 50% owner of RMR and FSQ. From 1978 through March 1997, Mr. Portnoy was a partner of the law firm of Sullivan & Worcester LLP, our counsel, and he was Chairman of that firm from 1994 through March 1997. GERARD M. MARTIN has been one of the Managing Trustees of Senior Housing, HRPT and HPT since each began business in 1999, 1986 and 1995, respectively. Mr. Martin is also a director and 50% owner of each of RMR and FSQ. FUTURE DIRECTORS Prior to the completion of the spin-off, we expect to appoint the following individuals to our Board of Directors: BRUCE M. GANS, M.D. has been Executive Vice President and Chief Medical Officer at Kessler Rehabilitation Corporation, a provider of healthcare services headquartered in West Orange, New Jersey, since June 1, 2001. From April 1999 to May 31, 2001, Dr. Gans was Senior Vice President for Continuing Care and Chairman of Physical Medicine and Rehabilitation at North Shore Long Island Jewish Health System, a provider of healthcare services headquartered in New Hyde Park, New York, and Professor of Physical Medicine and Rehabilitation at the Albert Einstein College of Medicine in New York City. From 1989 through March 1999, Dr. Gans was a Professor and Chairman of the Department of Physical Medicine and Rehabilitation at Wayne State University and a Senior Vice President of the Detroit Medical Center, both located in Detroit, Michigan. Dr. Gans was a trustee of HRPT from October 1995 through October 11, 1999. Dr. Gans has been a trustee of Senior Housing since October 12, 1999; and he will resign that position when the spin-off is completed. JOHN L. HARRINGTON has been the Chief Executive Officer of the Boston Red Sox Baseball Club, Executive Director and Trustee of the Yawkey Foundation and a Trustee of the JRY Trust for over five years. The Yawkey Foundation and JRY Trust are not-for-profit charitable foundations headquartered in Dedham, Massachusetts. Mr. Harrington was a trustee of HRPT from 1991 through August 1995 and a trustee of HPT and Senior Housing since those companies became publicly owned in 1995 and 1999, respectively, through the present. 37 ARTHUR G. KOUMANTZELIS has been the President and Chief Executive Officer of Gainesborough Investments LLC, a private investment company, located in Lexington, Massachusetts since June 1998. Since April 2000, he has served as the President, Chief Executive Officer and a member of the Board of Directors of Peponi Investments, LLC, a private company, also located in Lexington, Massachusetts. In addition, Mr. Koumantzelis has served as Treasurer and has been a 33% stockholder of Mosaic Communications Group, LLC, a media company, since December 2000. He is also a Trustee of Milo Trust and Lemoni Trust and a member of the Board of Directors of Wang Healthcare Information Systems, Inc.; all of these private companies are headquartered in Massachusetts. From 1990 until February 1998, Mr. Koumantzelis was Senior Vice President and Chief Financial Officer of Cumberland Farm's, Inc., a private company headquartered in Canton, Massachusetts, engaged in the convenience store business and the distribution and retail sale of gasoline. Mr. Koumantzelis was a trustee of HRPT from 1992 to 1995, and he has been a trustee of HPT and Senior Housing since they became publicly owned in 1995 and 1999, respectively, through the present. EXECUTIVE OFFICERS EVRETT W. BENTON has been President and Chief Executive Officer of FSQ since it began operations in 2000. From November 1999 until FSQ began operations, Mr. Benton served as a business and legal consultant to RMR and Senior Housing in connection with their negotiations with former tenants of Senior Housing who filed for bankruptcy. From 1998 to November 1999, Mr. Benton was an independent consultant working in the healthcare and real estate industries. From December 1991 to 1998, Mr. Benton was Chief Administrative Officer and General Counsel to Grancare, Inc., a publicly owned healthcare services company. Prior to December 1991, Mr. Benton was the Managing Partner of the Los Angeles office of the law firm of Andrews & Kurth LLP. Mr. Benton has been a Vice President of RMR since February 2000 and will continue in that office. ROSEMARY ESPOSITO, RN, has been Senior Vice President and Chief Operating Officer of FSQ since February 2001. Between 1996 and February 2001, Ms. Esposito was Vice President and Chief Operating Officer of Lenox Healthcare, Inc., a privately owned nursing home chain headquartered in Pittsfield, Massachusetts, that filed for Chapter 11 bankruptcy in February 2000. Prior to 1996, Ms. Esposito held senior management positions with Berkshire Health Systems, Inc., an acute care medical center and multi-facility, long-term care company headquartered in Pittsfield, Massachusetts. GRETCHEN A. HOLTZ, RN, has been Vice President and Chief Clinical Officer of FSQ since May 2000. From 1999 until May 2000, Ms. Holtz was a private consultant for various healthcare insurance and referral businesses specializing in elder care services. From 1997 to 1999, Ms. Holtz was Vice President for Clinical Services at the Frontier Group, Inc., a Boston, Massachusetts based private company in the nursing home business. From 1994 to 1997, Ms. Holtz was National Director of Subacute Services for Sun Healthcare Group, Inc., a publicly owned company which provided healthcare services. MARYANN HUGHES has been Vice President and Director of Human Resources for FSQ since May 2000. Between 1996 and May 2000, Ms. Hughes was Senior Vice President of Human Resources for Olympus Healthcare Group, Inc., a privately held company headquartered in Waltham, Massachusetts in the business of operating nursing homes and rehabilitation hospitals. From 1994 to 1996, Ms. Hughes was Senior Vice President of Health Alliance, a partnership of two acute care hospitals, two nursing homes and other medical services businesses based in Leominster, Massachusetts. BRUCE J. MACKEY JR. has been the Treasurer and Chief Financial Officer of FSQ since September 2001. From 1997 to September 2001, Mr. Mackey was an Assistant Vice President and Controller of RMR. From 1992 to 1997, Mr. Mackey was an accountant with the firm of Arthur Andersen LLP. Mr. Mackey is a certified public accountant. Mr. Mackey was elected a Vice President of RMR in September 2001 and will continue in that office. 38 COMMITTEES OF THE BOARD OF DIRECTORS Our Board of Directors will establish three committees when the spin-off is completed: - AUDIT COMMITTEE. The audit committee will evaluate the performance of, and make recommendations to the Board of Directors as to the selection of, our independent auditors; and it will review our published financial statements and the adequacy of our internal accounting controls. The initial members of the audit committee will be Messrs. Gans, Harrington and Koumantzelis, each of whom will be independent directors as defined by the AMEX. The audit committee will operate under a written charter which will be adopted by our Board of Directors and become effective upon the completion of the spin-off. A copy of the proposed audit committee charter has been filed as an exhibit to the registration statement of which this prospectus is a part. - COMPENSATION COMMITTEE. Our entire Board of Directors will initially serve as our compensation committee to review the performance and establish the compensation of our executive officers. The compensation committee will also serve as the administrator of our stock option and stock incentive plan described below. - QUALITY OF CARE COMMITTEE. Our quality of care committee will initially consist of Dr. Gans and Mr. Martin. The quality of care committee will periodically meet with our officers and other employees to evaluate the quality of services provided to residents at our facilities. COMPENSATION OF DIRECTORS We will pay each director other than Messrs. Martin and Portnoy an annual fee of $15,000, plus a fee of $500 for each Board meeting attended. In addition, each director will automatically receive an annual grant of 1,000 of our common shares at the first meeting of the Board of Directors following each annual meeting of shareholders, commencing in 2002. Board members will not be separately compensated for serving on board committees; however, we will pay the Board member serving as chairman of our audit committee an additional annual fee of $5,000, and the Board member serving as chairman of our quality of care committee an additional annual fee of $10,000. We will reimburse directors for reasonable out-of pocket expenses incurred in attending meetings of the Board of Directors or Board committees on which they serve. Messrs. Portnoy and Martin will not receive any cash compensation as directors or as members of Board committees, but they will receive the annual share grants and they will be reimbursed for their expenses. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION Our entire Board of Directors is expected initially to serve as our compensation committee. None of our Board members is expected to be our employee or an employee of any of our subsidiaries. Two of our directors, Messrs. Portnoy and Martin, are owners, directors and employees of RMR. Messrs. Benton and Mackey, our president and treasurer, respectively, are also officers, and will be part-time employees, of RMR. Messrs. Portnoy and Martin, our two current directors, are trustees of Senior Housing, our landlord. Upon completion of the spin-off and our appointment of additional directors, all of our directors, other than Dr. Gans, are expected to continue as trustees of Senior Housing. Messrs. Portnoy, Martin, Harrington and Koumantzelis are also trustees of HPT; Messrs. Portnoy and Martin are also trustees of HRPT; and our directors to be appointed prior to the spin-off, Messrs. Harrington and Koumantzelis and Dr. Gans, formerly served as trustees of HRPT. RMR is the investment manager for Senior Housing, HPT and HRPT, and will be a party to a shared services agreement with us. Messrs. Portnoy and Martin also own the building where we will rent space for our headquarters. 39 For more information about possible relationships which might impact compensation decisions see below at "Certain Relationships". EXECUTIVE COMPENSATION Our five highest paid executive officers and the amount of their annual compensation at the time of the spin-off are expected to be as follows:
ANNUAL POSITION COMPENSATION --------------------------------------- ------------ Evrett W. Benton....................... President, Chief Executive Officer and $400,000 Secretary Rosemary Esposito, RN.................. Senior Vice President, Chief Operating $225,000 Officer Gretchen A. Holtz, RN.................. Vice President, Chief Clinical $152,500 Officer MaryAnn Hughes......................... Vice President, Director of Human $152,500 Resources Bruce J. Mackey Jr..................... Treasurer, Chief Financial Officer and $120,000 Assistant Secretary
We have no employment agreements with any of our executive officers. Messrs. Benton and Mackey are each expected to devote a substantial majority of their business time to providing services to us as officers and employees. We also expect Messrs. Benton and Mackey to continue to dedicate some of their business time to providing services to RMR unrelated to us. Therefore, in addition to receiving compensation paid by us, RMR will pay each of Messrs. Benton and Mackey compensation for their services to RMR. During 2000 and in the current year through the date of the spin-off, services which otherwise would be provided by employees of Senior Housing were and are provided by RMR, which received fees from Senior Housing under its advisory agreement. Except with respect to incentive share awards under Senior Housing's 1999 Incentive Share Award Plan, neither we nor Senior Housing paid or prior to the spin-off expect to pay compensation to our executive officers. Their compensation for services to RMR and Senior Housing was and is paid by RMR. In each of 2000 and 2001, Mr. Benton, our president and chief executive officer, received a grant of 2,000 restricted shares of Senior Housing, having a value of $17,250 and $26,040, respectively, based upon the share closing prices for Senior Housing's common shares on the New York Stock Exchange on the grant dates. At December 31, 2000, the 2,000 incentive shares granted to Mr. Benton in that year had a value of $18,625, based upon a $9.3125 per share closing price for Senior Housing's common shares on the New York Stock Exchange on that date. Each share award provided that one-third of the award vested immediately upon grant and one-third vests on the first and second anniversaries of the grant. Under Senior Housing's plan, if Mr. Benton ceases to perform duties for Senior Housing and is no longer an officer or employee of RMR during the vesting period, the Senior Housing common shares which have not yet vested may be repurchased by Senior Housing for nominal consideration. Vested and unvested common shares under Senior Housing's plan are entitled to distributions paid by Senior Housing, including the spin-off distribution described in this prospectus. OUR STOCK OPTION AND STOCK INCENTIVE PLAN We have adopted the Five Star Quality Care, Inc. 2001 Stock Option and Stock Incentive Plan (the "Plan"). Under the Plan, we are authorized to grant our employees, officers, directors and other individuals rendering services to us and our subsidiaries equity-based awards, including incentive stock options, nonqualified stock options, common shares, restricted common shares and stock appreciation 40 rights. The Plan is administered by our compensation committee. The Plan provides that the compensation committee has the authority to select the participants and determine the terms of the stock options and other awards granted under the Plan. An incentive stock option is not transferable by the recipient except by will or by the laws of descent and distribution. Nonqualified stock options and other awards are transferable only to the extent provided in the agreement relating to such option or award. In the event that termination of employment is due to death or disability, the stock option is exercisable for a maximum of 12 months after such termination. The aggregate number of shares of common stock which may be issued under the Plan is . No awards have been made to date under the Plan and none are expected to be made before the first meeting of the Board of Directors following the annual meeting of our shareholders in 2002. If you want more information about this plan you should review the copy of the Plan which has been filed as an exhibit to the registration statement of which this prospectus is a part. OUR SHARED SERVICES AGREEMENT WITH RMR In order that we may have the benefit of certain shared services which RMR has historically provided to FSQ and otherwise, we have entered a shared services agreement with RMR. The following is a summary of the material provisions of the shared services agreement between us and RMR. If you want more information, you should read the entire shared services agreement, which has been filed as an exhibit to the registration statement of which this prospectus is part. GENERAL. Under this agreement, RMR will provide, or assist us with, certain services relating to: human resources, management information systems, tax, accounting, property maintenance and repairs, investor relations, acquisition, business expansion or reduction, capital markets advice, office support, cash management, SEC compliance and supervision of our relationship with Marriott. COMPENSATION TO RMR. For RMR's services rendered to us pursuant to the shared services agreement, we will pay RMR a fee equal to 0.6% of our gross revenues. The fee will be paid monthly in advance based upon the prior month's revenues. We will also reimburse RMR for its reasonable out-of-pocket expenses. SUBORDINATION OF RMR FEES TO SENIOR HOUSING RENT. No fees shall be paid to RMR unless our rents due Senior Housing are current. Unpaid fees shall accrue, together with interest at the prime rate, and will be payable when the condition preventing their payment is no longer in effect. The fees due RMR are not subordinated to any of our other obligations. CONFLICTS OF INTEREST WITH SENIOR HOUSING. We have acknowledged that RMR may continue to serve as the investment manager for Senior Housing and we have agreed that, regarding issues and in circumstances where there is a conflict of interest between us and Senior Housing, RMR will serve as the investment manager for Senior Housing and will not be required to consider our interests. NON-COMPETITION WITH RMR. We have agreed not to compete with any real estate entity RMR manages during the term of the shared services agreement by purchasing or financing real estate interests without first offering such financing or purchase to the appropriate real estate entity. TERMINATIONS. The initial term of the agreement expires on December 31, 2002, and it will renew automatically from year to year unless either we or RMR provide written notice of termination 90 days prior to the termination date. In addition, we may elect to terminate this agreement at any time upon 90 days written notice to RMR, though in such event we will be obligated to pay RMR's fee for the remainder of the then current term. Any decision regarding termination on our behalf will be made by 41 majority vote of our directors who are not owners, officers, directors or employees of RMR. RMR may also terminate this agreement at any time upon 90 days written notice to us. INDEMNIFICATION, DEFAULT AND DAMAGES. We have agreed to indemnify RMR, its owners, directors, officers and employees for any damages, liabilities, losses or out-of-pocket expenses incurred by them in the course of performing services other than any such damage, liability or loss resulting from RMR's gross negligence or willful misconduct. In the event of RMR's default, our remedy is limited to termination of the agreement and we cannot collect damages, except when RMR has taken action willfully and in bad faith. SECURITY OWNERSHIP AFTER THE SPIN-OFF GENERAL As of the date on the cover of this prospectus: - Senior Housing has 29,374,700 common shares outstanding; - HRPT owns 12,809,238 common shares of Senior Housing; and - Senior Housing owns 1,000,000 common shares of HRPT. We have agreed to issue common shares to each of Messrs. Portnoy and Martin in connection with our merger with FSQ. Messrs. Portnoy and Martin and entities they control also own some shares of Senior Housing and HRPT and they will receive some of our shares in those capacities. The following table sets forth our common share ownership following the spin-off. For purposes of the following table, we have assumed: (1) a distribution ratio of one of our common shares for every 10 Senior Housing common shares and one of our common shares for every 100 HRPT common shares; and (2) no change in the number of shares of Senior Housing outstanding, no change in the number of Senior Housing shares owned by HRPT and no change in the number of HRPT shares owned by Senior Housing. In connection with the FSQ merger we will issue our shares to each of Messrs. Martin and Portnoy. At this time the number of shares to be issued to Messrs. Martin and Portnoy has not been determined and is dependent upon negotiations between FSQ and Senior Housing, including Senior Housing's disinterested trustees. For purposes of the following table, we have not given effect to the issuance of shares in the FSQ merger.
PERCENTAGE NO. OF FIVE STAR OWNERSHIP OWNER COMMON SHARES OF FIVE STAR ----- ---------------- ------------ Senior Housing shareholders (other than HRPT)............... 1,656,546.2 55.9% HRPT shareholders (other than Senior Housing)............... 1,270,923.8 42.9% Senior Housing.............................................. 35,000 1.2% HRPT........................................................ 0 --
We estimate that we may have over 8,000 shareholders of record after giving effect to the distributions based on the number of record holders of common shares of Senior Housing and HRPT, respectively, as of August, 2001. CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information regarding beneficial ownership of our common shares following the distribution of our common shares pursuant to the spin-off: - each named executive officer; 42 - each of our current directors and those individuals we expect to appoint as directors prior to the spin-off; - each person known to us to be the beneficial owner of more than 5% of our common shares; and - all directors and executive officers as a group. Information in the following table is based upon public filings relating to the holders of Senior Housing's and HRPT's common shares. Under federal securities laws, shareholders are generally required to publicly disclose their holdings if they beneficially own more than 5% of a company. It is possible that a shareholder that beneficially owns shares in both Senior Housing and HRPT may beneficially own more than 5% of our shares after the spin-off as a result of their combined ownership of Senior Housing and HRPT. As a result, it is possible that we may not now be aware of beneficial owners of more than 5% of our shares after giving effect to the spin-off. Unless otherwise noted below, the address of each beneficial owner listed on the table is c/o Five Star Quality Care, Inc., 400 Centre Street, Newton, Massachusetts 02458, and each beneficial owner has sole voting and investing power over the shares shown as beneficially owned except to the extent authority is shared by spouses under applicable law and except as set forth in the footnotes to the table. The following table sets forth our common share ownership following the spin-off. For purposes of the following table, we have assumed: (1) a distribution ratio of one of our common shares for every 10 Senior Housing common shares and one of our common shares for every 100 HRPT common shares; and (2) no change in the number of shares of Senior Housing outstanding, no change in the number of Senior Housing shares owned by HRPT and no change in the number of HRPT shares owned by Senior Housing. In connection with the FSQ merger we will issue our shares to each of Messrs. Martin and Portnoy. At this time the number of shares to be issued to Messrs. Martin and Portnoy has not been determined and is dependent upon negotiations between FSQ and Senior Housing, including Senior Housing's disinterested trustees. For purposes of the following table, we have not given effect to the issuance of shares in the FSQ merger.
BENEFICIAL OWNERSHIP -------------------- NUMBER OF NAME AND ADDRESS SHARES PERCENT ---------------- --------- -------- Barry M. Portnoy(1)......................................... 47,371.88 1.6 Gerard M. Martin(1)......................................... 47,371.88 1.6 Bruce M. Gans, M.D.......................................... 190 * John L. Harrington.......................................... 150 * Arthur G. Koumantzelis...................................... 224.65 * Evrett W. Benton............................................ 405 * All directors and executive officers as a group............. 60,723.94 2.0
------------------------ * Less than 1% (1) Mr. Martin is the sole stockholder of a corporation which will own 12,371.88 common shares. Mr. Portnoy is the sole stockholder of a separate corporation which will own 12,371.88 common shares. Messrs. Martin and Portnoy are each 50% owners and directors of RMR, the investment manager to Senior Housing and HRPT. Senior Housing and HRPT, of which Messrs. Martin and Portnoy are Managing Trustees, will own 35,000 common shares. Under some interpretations of applicable law, Messrs. Martin and Portnoy may be deemed to have beneficial ownership of our shares owned by Senior Housing; however, Messrs. Martin and Portnoy disclaim beneficial ownership of the common shares owned by Senior Housing. As noted above, this table does not include shares Messrs. Portnoy and Martin will receive in the FSQ merger. 43 CERTAIN RELATIONSHIPS Our creation was, and our continuing business operations will be, subject to possible conflicts of interest. These conflicts may have caused, and in the future may cause, our business to be adversely affected. These conflicts and their possible adverse effects upon us include the following: - All of the persons expected to serve as our directors following the spin-off were trustees of Senior Housing at the time we were created, and four of them will remain trustees of Senior Housing after the spin-off. Upon completion of the spin-off all of our operating facilities will be leased from Senior Housing. Upon closing of the Crestline transaction, we will lease 31 Marriott facilities from Senior Housing. We believe that our lease terms with Senior Housing are commercially reasonable. Nonetheless, it is possible that, if these leases were negotiated on an arm's length basis, the rent and other lease terms might be more favorable to us. We also believe that our historical and continuing relationships with Senior Housing will provide us with a competitive advantage in locating business expansion opportunities. Nonetheless, we will afford Senior Housing, HRPT and HPT a right of first refusal before we acquire or finance any real estate investments of the type in which Senior Housing, HRPT and HPT, respectively, invests. However, future business dealings between Senior Housing and us could be on less favorable terms than would be possible if there were no historical or continuing management relationships between Senior Housing and us. - Messrs. Portnoy and Martin are two of the five directors we expect to have following the completion of the spin-off, and they are the Managing Trustees of Senior Housing. Messrs. Portnoy and Martin formed FSQ to manage properties repossessed by Senior Housing. Upon completion of the spin-off, we will acquire FSQ and Messrs. Portnoy and Martin will each receive of our shares. RMR advised Senior Housing on this merger transaction. We expect to receive an opinion from an internationally recognized investment banking firm that the consideration being paid to Messrs. Portnoy and Martin in this merger is fair from a financial point of view to us and our shareholders, and the terms of this merger have been approved by our disinterested directors. Nonetheless, it is possible that, if this merger were negotiated on an arm's length basis, different terms more favorable to us might have been achieved. - Our chief executive officer and our chief financial officer are currently also officers and employees of RMR, and they will remain officers and part time employees of RMR after the spin-off. At present, we expect that these officers will devote a substantial majority of their business time to our affairs and the remainder of their business time to RMR's business which is separate from us. The current compensation which we will pay to these officers reflects our expectation of their division of business time. Periodically hereafter these individuals may devote a larger percentage of their time to our or RMR's affairs and the compensation they receive from us may become disproportionate to their efforts on our behalf. Also, because of this dual employment arrangement we may have to compete with RMR for the time and attention of these officers. - Messrs. Portnoy and Martin own RMR. RMR is the investment manager for Senior Housing, HRPT and HPT, and has other business interests. After the spin-off, we will enter a shared services agreement with RMR under which RMR will provide certain administrative services to us similar to the services it now provides to FSQ as well as other services which we may require. Under this shared services agreement, we will pay RMR a fee equal to 0.6% of our gross revenues. On a pro forma basis, assuming completion of the spin-off and the Crestline transaction, this fee was $2.9 million for the year ended December 31, 2000. We believe we will receive fair value for the fee paid to RMR. Also, the shared services agreement is terminable upon 90 days notice by majority vote of our directors who are not owners, officers, directors or employees of RMR, though, in the event of such a termination, we will still be required to pay 44 RMR its fee for the remainder of the then current term. However, despite our beliefs and this termination provision, you should be aware that equivalent services might be available away from RMR on an arm's length basis on a more favorable basis to us, including for a lesser fee. Also, the fact that RMR has responsibilities to other entities, including our landlord, Senior Housing, could create conflicts; and, in the event of such conflicts between Senior Housing and us, the shared services agreement allows RMR to prefer its responsibilities to Senior Housing. See "Management--Our Shared Services Agreement with RMR". - Messrs. Portnoy and Martin own the building in which our headquarters is located. As a result of our acquisition of FSQ we will become obligated for a lease for the space we occupy. This lease expires in 2011 and requires rent of $531,069 per year, subject to annual increases of $16,093 per year. We believe that the terms of this lease are commercially reasonable. However, this lease was negotiated at a time when Messrs. Portnoy and Martin simultaneously owned the building and FSQ, and, accordingly, it was not done on an arm's length basis. If the lease were negotiated on an arm's length basis it is possible that the lease might have been more favorable to FSQ, and to us after the merger, including for a lesser rent. - Until March 31, 1997, Mr. Portnoy was a partner in the law firm Sullivan & Worcester LLP, our counsel and counsel to Senior Housing, HRPT, HPT, FSQ, RMR and certain of their affiliates. Mr. Portnoy has received in 2000 and 2001 payments from Sullivan & Worcester LLP in respect of his retirement. FEDERAL INCOME TAX CONSIDERATIONS GENERAL In order to maintain its status as a REIT for federal income tax purposes, a substantial majority of Senior Housing's gross income must generally be derived from real estate rents and mortgage interest. Thus, the Internal Revenue Code of 1986, as amended, or IRC, imposes strict limits on Senior Housing's ability to own properties that it or others operate for Senior Housing's own account. Even in circumstances where Senior Housing is permitted to own properties operated for its own account, the IRC encourages leasing the properties to one or more qualified tenants. A qualified tenant is a tenant in whom Senior Housing has at all times during the taxable year an actual or constructive ownership interest of less than 10% by vote and by value. In particular, Senior Housing must generally pay federal corporate income tax on its net income from operated property, whereas Senior Housing generally does not pay any corporate income tax on its rental income from qualified tenants that is distributed to shareholders. With respect to Senior Housing's repossessed properties from former tenants, the REIT foreclosure property tax rules generally permit Senior Housing to have those properties operated for its own account only through 2004. Further, during the period that these properties are operated for Senior Housing's own account, Senior Housing cannot make improvements to the repossessed properties other than repairs, and the net income from the repossessed property operations is subject to corporate income tax. In contrast, Senior Housing's leased properties can generally be improved without limitation, and rental income from leased properties that is distributed to shareholders is generally not subject to corporate income tax. Finally, if and when Senior Housing closes the Crestline transaction, the IRC REIT qualification rules require Senior Housing to lease those properties to one or more qualified tenants. Sullivan & Worcester LLP, Boston, Massachusetts, has rendered a legal opinion that the discussions in the following summary are accurate in all material respects and fairly summarize the federal income tax issues of the spin-off, and the opinions of counsel referred to in this section represent Sullivan & Worcester LLP's opinions on those subjects. Specifically, subject to the 45 qualifications and assumptions contained in its opinions and in this prospectus, Sullivan & Worcester LLP has rendered opinions to the effect that: - Senior Housing has been organized and has qualified as a REIT under the IRC for its 1999 and 2000 taxable years, and its current investments and plan of operation will enable it to continue to meet the requirements for qualification and taxation as a REIT under the IRC; Senior Housing's actual qualification as a REIT, however, will depend upon its ability to meet, and its meeting, through actual annual operating results and distributions, the various REIT qualification tests imposed under the IRC; - HRPT has been organized and has qualified as a REIT under the IRC for its 1987 through 2000 taxable years, and HRPT's current investments and plan of operation will enable it to continue to meet the requirements for qualification and taxation as a REIT under the IRC; HRPT's actual qualification as a REIT, however, will depend upon its ability to meet, and its meeting, through actual annual operating results and distributions, the various REIT qualification tests imposed under the IRC; - Senior Housing's and HRPT's distributions of our common shares to shareholders will be treated for federal income tax purposes like other REIT distributions, as described below; and - commencing with our 2001 taxable year that begins on the date of the spin-off, we will be taxed as a subchapter C corporation under the IRC. These opinions are conditioned upon the assumption that our leases and other contracts with Senior Housing, our charter and bylaws, the declarations of trust and bylaws of both Senior Housing and HRPT, and all other legal documents to which we, Senior Housing or HRPT are or have been a party, have been and will be complied with by all parties to these documents, upon the accuracy and completeness of the factual matters described in this prospectus, and upon representations that we, Senior Housing, and HRPT have made. The opinions of Sullivan & Worcester LLP are based on the law as it exists today, but the law may change in the future, possibly with retroactive effect. Also, an opinion of counsel is not binding on the Internal Revenue Service or the courts, and the IRS or a court could take a position different from that expressed by counsel. The following summary of federal income tax considerations is based on existing law, and is limited to investors who own our common shares, Senior Housing common shares, and/or HRPT common shares as investment assets rather than as inventory or as property used in a trade or business. The summary does not discuss the particular tax consequences that might be relevant to you if you are subject to special rules under the federal income tax law, for example if you are: - a bank, life insurance company, regulated investment company, or other financial institution, - a broker or dealer in securities or foreign currency, - a person who has a functional currency other than the U.S. dollar, - a person who acquires our common shares, Senior Housing shares, or HRPT shares in connection with his employment or other performance of services, - a person subject to alternative minimum tax, - a person who owns our common shares, Senior Housing common shares, or HRPT common shares as part of a straddle, hedging transaction, constructive sale transaction, or conversion transaction, or - except as specifically described in the following summary, a tax-exempt entity or a foreign person. 46 The sections of the IRC that govern the federal income tax qualification and treatment of a REIT and its shareholders are complex. This summary is based on applicable IRC provisions, related rules and regulations and administrative and judicial interpretations, all of which are subject to change, possibly with retroactive effect. Future legislative, judicial, or administrative actions or decisions could affect the accuracy of statements made in this summary. Neither we, Senior Housing, nor HRPT has sought a ruling from the IRS with respect to the spin-off, and neither we, Senior Housing, nor HRPT can assure you that the IRS or a court will agree with the statements made in this summary. In addition, the following summary is not exhaustive of all possible tax consequences, and does not discuss any state, local, or foreign tax consequences. For all these reasons, we urge you to consult with a tax advisor about the federal income tax and other tax consequences of your acquisition, ownership and disposition of our common shares, as well as your acquisition, ownership and disposition of Senior Housing shares and HRPT shares. Your federal income tax consequences may differ depending on whether or not you are a "U.S. person". For purposes of this summary, a U.S. person for federal income tax purposes is: - a citizen or resident of the United States, including an alien individual who is a lawful permanent resident of the United States or meets the substantial presence residency test under the federal income tax laws, - a corporation, partnership or other entity treated as a corporation or partnership for federal income tax purposes, that is created or organized in or under the laws of the United States, any state thereof or the District of Columbia, unless otherwise provided by Treasury regulations, - an estate the income of which is subject to federal income taxation regardless of its source, or - a trust if a court within the United States is able to exercise primary supervision over the administration of the trust and one or more United States persons have the authority to control all substantial decisions of the trust, or electing trusts in existence on August 20, 1996 to the extent provided in Treasury regulations, whose status as a U.S. person is not overridden by an applicable tax treaty. Conversely, a "non-U.S. person" is a beneficial owner of our common shares, Senior Housing common shares, or HRPT common shares who is not a U.S. person. FEDERAL INCOME TAX CONSEQUENCES OF THE SPIN-OFF TO SENIOR HOUSING AND HRPT COMMON SHAREHOLDERS IN GENERAL. Senior Housing's and HRPT's distribution of our common shares by spin-off will generally affect each REIT's shareholders in the same manner as any other distribution of cash or property by a REIT on its common shares. These tax consequences are summarized below: - A REIT is generally not subject to tax on its net income to the extent that net income is distributed to its shareholders. - Distributions to a REIT's shareholders out of a REIT's current or accumulated earnings and profits that are not designated by the REIT as capital gain dividends generally will be taken into account by the REIT's shareholders as ordinary income dividends. To the extent of a REIT's net capital gain for the taxable year, the REIT may designate dividends as capital gain dividends that will be taxable to its shareholders as long-term capital gain. - Distributions in excess of a REIT's current and accumulated earnings and profits will not be taxable to a REIT shareholder to the extent that they do not exceed the shareholder's adjusted basis in its REIT common shares, but rather will reduce the adjusted basis in those shares. 47 - Distributions in excess of a REIT's current and accumulated earnings and profits that exceed a REIT shareholder's adjusted basis in its REIT common shares generally will be taxable as capital gain from a deemed sale of those shares. - A REIT's earnings and profits for a year will be allocated among each of the distributions for that year in proportion to the amount of each distribution. - Neither a REIT's ordinary income dividends nor its capital gain dividends will entitle the REIT's corporate shareholders to any dividends received deduction. Accordingly, the spin-off of our common shares will be treated as a distribution by Senior Housing and HRPT to you in the amount of the fair market value of the common shares distributed. Senior Housing and HRPT expect that a portion of this distribution will be taxable to you as a dividend and a portion will be treated as a tax-free reduction in the adjusted basis in your REIT shares. You will have a tax basis in our common shares received in the spin-off equal to their fair market value at the time of the spin-off, and your holding period in our common shares commences on the day after the spin-off. We, Senior Housing and HRPT believe that for all federal income tax purposes each of our common shares may be properly valued on the distribution date as the average of the reported high and low trading prices in the public market on that date, and Senior Housing and HRPT will perform all tax reporting, including statements supplied to you and to the IRS, on the basis of this average price, called the distribution price. Because of the factual nature of the value determinations, Sullivan & Worcester LLP is unable to render an opinion on the fair market value of our common shares. As described in more detail below, although the amount and extent to which Senior Housing and HRPT recognize gains and losses in the spin-off is not free from doubt, Senior Housing and HRPT expect: (1) to recognize neither gain nor loss on our and our subsidiaries' properties and other assets; and (2) to recognize gain but not loss on the distribution of our common shares. Any gain that Senior Housing and HRPT recognize in the spin-off will increase their 2001 current earnings and profits, and this will increase the total amount of their 2001 distributions, including the distribution of our common shares, that is taxable as a dividend to you. Computing the amount of these gains and the additional taxable dividend amount is a calculation which requires some information, including the distribution price for our common shares at the time of the spin-off, that is not available at this time. Assuming that you have held your Senior Housing or HRPT common shares, as applicable, for the entire 2001 calendar year, Senior Housing and HRPT estimate: - If the distribution price for our common shares equals pro-forma per share book value, or $13.50 per share, you will have no additional taxable dividend as a result of the spin-off. - You will have little or no additional taxable dividend for distribution prices up to $15.00 per Five Star share. - For each $1.00 increase in the distribution price in excess of $15.00, you will have additional taxable dividends of $0.10 per Senior Housing common share and $0.01 per HRPT common share. - The spin-off distribution will not reduce the taxable dividends to you for the year. However, a definitive additional taxable dividend computation will not be possible until after the spin-off. To the extent Senior Housing and HRPT are able, they intend to designate a portion of their taxable dividends for the year as capital gain dividends that generally will be subject to tax at the maximum capital gain rates of 20% and 25% in the case of Senior Housing and HRPT noncorporate shareholders. 48 TAXATION OF TAX-EXEMPT ENTITIES. Tax-exempt entities are generally not subject to federal income taxation except to the extent of their "unrelated business taxable income," often referred to as UBTI, as defined in Section 512(a) of the IRC. As with Senior Housing's and HRPT's other distributions, the distribution of our common shares to you if you are a tax-exempt entity should generally not constitute UBTI, provided that you have not financed the acquisition of your Senior Housing and HRPT common shares with acquisition indebtedness within the meaning of Section 514 of the IRC. However, if you are a tax-exempt pension trust, including a so-called 401(k) plan but excluding an individual retirement account or government pension plan, that owns more than 10% by value of a pension-held REIT, then you may have to report a portion of the dividends that you receive from that REIT as UBTI. Although Senior Housing and HRPT cannot provide complete assurance on this matter, each of Senior Housing and HRPT believes that it has not been and will not become a pension-held REIT. TAXATION OF NON-U.S. PERSONS. If you are a non-U.S. person who holds common shares in Senior Housing or HRPT, the spin-off of our common shares will generally be taxable to you in the same manner as any other distribution of cash or property that Senior Housing or HRPT makes to you. The rules governing the federal income taxation of non-U.S. persons are complex, and the following discussion is intended only as a summary of these rules. If you are a non-U.S. person, you should consult with your own tax advisor to determine the impact of federal, state, local, and foreign tax laws, including any tax return filing and other reporting requirements, with respect to the spin-off of our common shares and your investment in Senior Housing and HRPT common shares. You will generally be subject to regular federal income tax in the same manner as a U.S. person with respect to the spin-off of our common shares and your investment in Senior Housing or HRPT shares, if this investment in REIT shares is effectively connected with your conduct of a trade or business in the United States. In addition, if you are a corporate shareholder of Senior Housing or HRPT, your income that is effectively connected with a trade or business in the United States may also be subject to the 30% branch profits tax under Section 884 of the IRC, which is payable in addition to regular federal corporate income tax. The balance of this summary addresses only those non-U.S. persons whose investment in Senior Housing and HRPT common shares is not effectively connected with the conduct of a trade or business in the United States. Neither Senior Housing nor HRPT is at this time designating the distribution of our common shares as a capital gain dividend that is subject to 35% withholding for non-U.S. persons, and accordingly the 30% or applicable lower treaty rate withholding will be imposed upon the fair market value of our common shares that Senior Housing or HRPT distributes to you. Senior Housing, HRPT or other applicable withholding agents will collect the amount required to be withheld by reducing to cash for remittance to the IRS a sufficient portion of our common shares that you would otherwise receive, and you will bear the brokerage or other costs for this withholding procedure. Because neither Senior Housing nor HRPT can determine its current and accumulated earnings and profits until the end of its taxable year, withholding at the rate of 30% or applicable lower treaty rate will be imposed on the gross fair market value of our common shares distributed to you. Notwithstanding this and other withholding on distributions in excess of a REIT's current and accumulated earnings and profits, these distributions are a nontaxable return of capital to the extent that they do not exceed your adjusted basis in your common shares of that REIT, and the nontaxable return of capital will reduce your adjusted basis in your common shares of that REIT. To the extent that distributions in excess of the REIT's current and accumulated earnings and profits exceed your adjusted basis in your common shares of that REIT, the distributions will give rise to tax liability only if you would otherwise be subject to tax on any gain from the sale or exchange of your common shares in that REIT. Your gain from the sale or exchange of your common shares in a REIT will not be taxable if: (1) the REIT's common shares are "regularly traded" within the meaning of Treasury regulations under Section 897 of the IRC and you have at all times during the preceding five years owned 5% or less by value of that REIT's outstanding common shares, or (2) the REIT is a "domestically-controlled REIT" within the meaning 49 of Section 897 of the IRC. Although neither can provide complete assurance on this matter, each of Senior Housing and HRPT believes that its shares are regularly traded and that it is a domestically-controlled REIT. You may seek a refund of amounts withheld on distributions to you in excess of Senior Housing's or HRPT's current and accumulated earnings and profits, as applicable, provided that you furnish the required information to the IRS. Some of Senior Housing's and HRPT's 2001 distributions may be treated for federal income tax purposes as attributable to dispositions of United States real property interests. To the extent that a portion of any of Senior Housing's or HRPT's distributions to you, including the distribution of our common shares, is attributable to a disposition by Senior Housing or HRPT of United States real property interests, you will be subject to tax on this portion as though it were gain effectively connected with a trade or business conducted in the United States. Accordingly, you will be taxed on these amounts at the capital gain rates applicable to a U.S. person, subject to any applicable alternative minimum tax and to a special alternative minimum tax in the case of nonresident alien individuals; you will be required to file a United States federal income tax return reporting these amounts, even if applicable 35% withholding is imposed as described below; and if you are a corporation, you may owe the 30% branch profits tax under Section 884 of the IRC in respect of these amounts. If you are a non-U.S. person, Senior Housing, HRPT and other applicable withholding agents will be required to withhold from distributions to you, and to remit to the IRS, 35% of the maximum amount of any distribution that could be designated as a capital gain dividend by Senior Housing or HRPT, as applicable. In addition, if either Senior Housing or HRPT designates any of its prior distributions as capital gain dividends, then its subsequent distributions up to the amount of the designated prior distributions will be treated as capital gain dividends for purposes of this 35% withholding rule. After the close of each of Senior Housing's and HRPT's 2001 taxable year, each REIT expects to designate to the maximum extent possible a portion of one or more of its 2001 distributions as capital gain dividends, and accordingly 35% withholding will be imposed upon its subsequent distributions to you to that extent. FEDERAL INCOME TAX CONSEQUENCES OF THE SPIN-OFF TO SENIOR HOUSING The IRC imposes upon Senior Housing various REIT qualification tests discussed more fully in Senior Housing's Annual Report on Form 10-K. While Senior Housing believes that it has operated and will operate in a manner to satisfy the various REIT qualification tests, counsel has not reviewed and will not review its compliance with these tests on a continuing basis. The following discussion summarizes how the spin-off affects Senior Housing's REIT qualification and taxation issues under the IRC. IN GENERAL. So long as we and our subsidiaries remain wholly owned direct or indirect subsidiaries of Senior Housing, we and most all of our subsidiaries will be qualified REIT subsidiaries under Section 856(i) of the IRC or, equivalently, noncorporate entities that are taxed as part of Senior Housing under regulations issued under Section 7701 of the IRC. During these periods we and these subsidiaries will not be taxpayers separate from Senior Housing for federal income tax purposes. A few of our subsidiaries are Senior Housing taxable REIT subsidiaries, with federal income tax filing and payment obligations that are separate from Senior Housing. Under the transaction agreement, Senior Housing is generally responsible for our federal income tax liabilities and filings, as well as those of all our subsidiaries, for the periods prior to the spin-off. When we cease to be wholly owned by Senior Housing as a result of the spin-off, the following will be deemed to have occurred for federal income tax purposes: - Immediately preceding the spin-off distribution of our common shares, Senior Housing disposed of our properties and assets, and the properties and assets of our subsidiaries, in a tax-free exchange called the deemed incorporation, in which the aggregate amount Senior Housing 50 realized equaled the sum of: (1) the fair market value of all our common shares immediately preceding the spin-off, plus (2) the aggregate amount of liabilities that are associated with our and our subsidiaries' properties and assets and that remain our and our subsidiaries' responsibility after the spin-off. For these purposes, the assets and liabilities of the Senior Housing taxable REIT subsidiaries are ignored, and instead the stock in the parent taxable REIT subsidiary is treated like any other asset of ours. - Immediately after the deemed incorporation, Senior Housing distributed to its common shareholders, including HRPT, 99% of our common shares that Senior Housing was treated as having received in the deemed incorporation. TAXATION OF THE DISTRIBUTION. The distribution by Senior Housing to its shareholders of our common shares in the spin-off will be treated in the same manner as any other distribution of cash or property that Senior Housing may make. Thus, the distribution of our common shares together with Senior Housing's other 2001 distributions will entitle Senior Housing to a dividends paid deduction to the extent of its earnings and profits for the year. In addition, Senior Housing will recognize gain from the distribution of our common shares equal to the excess, if any, of the fair market value of our common shares that Senior Housing distributes, over Senior Housing's tax basis in those shares. In contrast, Senior Housing will not recognize loss on the distribution even if its tax basis in our common shares exceeds its fair market value. Under applicable judicial precedent, it is possible that for federal income tax purposes the per share fair market value of our common shares Senior Housing distributes will differ from the average of the reported high and low trading prices for our common shares in the public market on the date of the spin-off, called the distribution price. Because of the factual nature of value determinations, Sullivan & Worcester LLP is unable to render an opinion on the fair market value of our common shares that Senior Housing will distribute. However, for purposes of computing any gain that Senior Housing may have on the distribution of our common shares, we and Senior Housing believe that the fair market value of our common shares may be computed as the distribution price multiplied by the number of our common shares distributed. Senior Housing's tax basis in our common shares distributed is computed as described below. Any gain that Senior Housing recognizes on the distribution of our common shares will be qualifying gross income under the 95% gross income test of Section 856(c) of the IRC, provided that Senior Housing is not treated as holding our common shares as inventory or other property held primarily for sale to customers. If any of this gain were characterized as the sale of inventory or other property held primarily for sale to customers, this would not affect Senior Housing's ability to satisfy the 95% gross income test, but the recharacterized gain would be subject to the 100% penalty tax of Section 857(b)(6) of the IRC. Although Senior Housing can provide no assurance on this matter, Senior Housing does not believe that it has held our common shares as inventory or other property held primarily for sale to customers, and accordingly it believes that its gain, if any, on our distributed common shares will be short-term capital gain. Senior Housing's tax basis in the 100% of our common shares that it owns immediately prior to the spin-off will be equal to, and its tax basis in each distributed share of our common stock will be the per share value of, the following sum: (1) Senior Housing's aggregate adjusted tax basis in our properties and assets, and the properties and assets of our subsidiaries, immediately prior to the deemed incorporation; minus (2) the aggregate amount of liabilities that are associated with our properties and assets, and the properties and assets of our subsidiaries, that remain our and our subsidiaries' responsibility after the spin-off. For these purposes, the assets and liabilities of the Senior Housing taxable REIT subsidiaries are ignored, and instead the stock in the parent taxable REIT subsidiary is treated like any other asset of ours. Accordingly, Senior Housing expects that its tax basis in each of our shares that it owns immediately prior to the distribution will be approximately equal to 51 the distribution price, and may possibly exceed the distribution price. Under these circumstances, Senior Housing could recognize some gain but no loss on its distribution of our common shares. OUR POST SPIN-OFF RELATIONSHIP WITH SENIOR HOUSING. After the distribution of our common shares, Senior Housing will own 35,000, or one percent, of our common shares. In addition, our leases with Senior Housing, our charter, and the transaction agreement collectively contain restrictions upon our ownership and provisions that require us to refrain from taking any actions that may jeopardize Senior Housing's or HRPT's qualification as REITs under the IRC, including actions which would result in Senior Housing or HRPT obtaining actual or constructive ownership of 10% or more of our shares for IRC Section 856(d) purposes. Accordingly, commencing with its 2002 taxable year, Senior Housing anticipates that the rental income it receives from us will be "rents from real property" under Section 856(d) of the IRC, as well as qualifying income under the 75% and 95% gross income tests of Section 856(c) of the IRC. FEDERAL INCOME TAX CONSEQUENCES OF THE SPIN-OFF TO HRPT The IRC imposes upon HRPT various REIT qualification tests discussed more fully in HRPT's Annual Report on Form 10-K. While HRPT believes that it has operated and will operate in a manner to satisfy the various REIT qualification tests, counsel has not reviewed and will not review its compliance with these tests on a continuing basis. The following discussion summarizes how the spin- off affects HRPT's REIT qualification and taxation issues under the IRC. HRPT currently owns approximately 44% of the common shares of Senior Housing. Accordingly, HRPT will receive a substantial number of our common shares as a distribution from Senior Housing. To the extent of Senior Housing's allocable earnings and profits, this distribution from Senior Housing will be a REIT dividend to HRPT that qualifies under the 75% and 95% gross income tests of Section 856(c) of the IRC. To the extent the distribution exceeds Senior Housing's allocable earnings and profits, HRPT will treat the distribution as a tax-free recovery of basis in its Senior Housing shares. The distribution by HRPT to its shareholders of our common shares in the spin-off will be treated in the same manner as any other distribution of cash or property that HRPT may make. Thus, the distribution of our common shares together with HRPT's other 2001 distributions will entitle HRPT to a dividends paid deduction to the extent of its earnings and profits for the year. In addition, HRPT will recognize gain from the distribution of our common shares equal to the excess, if any, of the fair market value of our common shares that HRPT distributes, over HRPT's tax basis in those shares. In contrast, HRPT will not recognize loss on the distribution even if its tax basis in our common shares exceeds its fair market value. Any gain that HRPT recognizes on the distribution of our common shares will be qualifying gross income under the 95% gross income test of Section 856(c) of the IRC, provided that HRPT is not treated as holding our common shares as inventory or other property held primarily for sale to customers. If any of this gain were characterized as the sale of inventory or other property held primarily for sale to customers, this would not affect HRPT's ability to satisfy the 95% gross income test, but the recharacterized gain would be subject to the 100% penalty tax of Section 857(b)(6) of the IRC. Although HRPT can provide no assurance on this matter, HRPT does not believe that it has held our common shares as inventory or other property held primarily for sale to customers, and accordingly it believes that its gain, if any, on our distributed common shares will be short-term capital gain. Furthermore, as discussed below, HRPT expects to have no gain on its distribution of our common shares. HRPT's tax basis in our common shares it distributes will follow the valuation assumptions that Senior Housing is employing for the Senior Housing common shareholders, of which HRPT is one: the tax basis in each of our common shares will equal the average of the reported high and low trading 52 prices for our common shares in the public market on the date of the spin-off, called the distribution price. Under applicable judicial precedent, it is possible that for federal income tax purposes the per share fair market value of our common shares that HRPT distributes will differ from the distribution price. Because of the factual nature of value determinations, Sullivan & Worcester LLP is unable to render an opinion on the fair market value of our common shares that HRPT will distribute. However, for purposes of computing any gain that HRPT may have on the distribution of our common shares, we and HRPT believe that the fair market value of our common shares may be computed as the distribution price multiplied by the number of shares of our common shares distributed. Accordingly, HRPT does not expect to have any gain or loss on its distribution of our common shares. If Senior Housing as a result of the spin-off recognizes additional gain and distributes that additional gain as a REIT dividend to its common shareholders, then HRPT as a Senior Housing common shareholder will receive its pro rata share of the additional Senior Housing REIT dividend. In addition, if HRPT's valuation methodologies for our common shares are successfully challenged by the IRS, then HRPT could have gain on its distribution of our common shares. In either case, this could correspondingly increase HRPT's income, distribution requirement, and taxable REIT dividend to its common shareholders. FEDERAL INCOME TAXATION OF FIVE STAR AND OUR SHAREHOLDERS IN GENERAL. We will be taxable as a subchapter C corporation. Accordingly, we will pay federal income taxes on our income, and not be subject to the distribution and other requirements applicable to REITs. Under the transaction agreement, Senior Housing is generally responsible for our federal income tax liabilities and filings, as well as those of all our subsidiaries, for the periods prior to the spin-off. DISTRIBUTIONS ON OUR COMMON SHARES. At the present time, we do not expect to pay any dividends on our common shares. However, if we do later decide to do so, your tax consequences would generally be as follows. If you are a U.S. person, distributions to you on our common shares during taxable years beginning on or after the spin-off will be treated as ordinary income dividends to the extent attributable to our current or accumulated earnings and profits and thereafter as a return of basis to the extent of that basis, with any excess being treated as gain from a deemed disposition of our common shares. If you are a corporation, dividends paid to you on our common shares will generally be eligible for the dividends received deduction, subject to the limitations of the IRC with respect to the corporate dividends received deduction. If you are a non-U.S. person, dividends paid to you will be subject to withholding of federal income tax at a 30% rate or a lower rate as may be specified by an applicable income tax treaty. If you are eligible for a reduced rate of withholding tax pursuant to a tax treaty, you may obtain a refund of any excess amounts previously withheld by filing an appropriate claim for refund with the IRS. To claim the benefits on an income tax treaty, you are required to satisfy the applicable certification requirements, generally by executing an IRS Form W-8. DISPOSITIONS OF OUR COMMON SHARES. If you are a U.S. person, you will generally recognize gain or loss on a disposition of our common shares in an amount equal to the difference between the amount realized on the disposition and your adjusted basis in the disposed of common shares. This gain or loss will be capital gain or loss, and will be long-term capital gain or loss if your holding period in the disposed of common shares exceeds one year. Special rates of tax may apply to long-term capital gains recognized by noncorporate U.S. persons. If you are a non-U.S. person, you will generally not be subject to United States federal income tax in respect of gain you recognize on a disposition of our common shares. However, you may be subject 53 to taxation if you are an individual who is present in the United States for 183 or more days in the taxable year of the sale. In addition, you may be subject to taxation if we are or have been a "United States real property holding corporation" for federal income tax purposes; however, this taxation will not apply if our stock is "regularly traded" within the meaning of Treasury regulations under Section 897 of the IRC and you have at all times during the preceding five years owned 5% or less by value of our common shares. For corporate non-U.S. persons, taxable gains recognized on a United States real property holding corporation may also be subject to an additional "branch profits" tax at a 30% or lower applicable treaty rate. At this time, we do not believe that we are or will become a "United States real property holding corporation" for federal income tax purposes, but can provide no assurance in this regard. INFORMATION REPORTING AND BACKUP WITHHOLDING Information reporting and backup withholding may apply to distributions or proceeds paid to Senior Housing and HRPT shareholders and our shareholders in the circumstances discussed below. Amounts withheld under backup withholding are generally not an additional tax and may be refunded or credited against your federal income tax liability, provided that you furnish the required information to the IRS. The current backup withholding rate is 30.5%, but that rate falls to 30% for the calendar years 2002 and 2003, and is scheduled to gradually decrease to 28% by calendar year 2006. The spin-off distribution of our common shares is an in-kind distribution to Senior Housing and HRPT shareholders, and thus Senior Housing, HRPT, or other applicable withholding agents will have to collect any applicable backup withholding by reducing to cash for remittance to the IRS a sufficient portion of our common shares that a Senior Housing shareholder or HRPT shareholder would otherwise receive, and the recipient shareholder will bear the brokerage or other costs for this withholding procedure. IF YOU ARE A U.S. PERSON. You may be subject to backup withholding when you receive distributions on, or proceeds upon the sale, exchange, redemption, retirement or other disposition of, Senior Housing shares, HRPT shares, or our common shares. Thus, backup withholding may apply to common shares you receive in the spin-off distribution. In general, you can avoid this backup withholding if you properly execute under penalties of perjury an IRS Form W-9 or substantially similar form on which you: - provide your correct taxpayer identification number, and - certify that you are exempt from backup withholding because (a) you are a corporation or come within another enumerated exempt category, (b) you have not been notified by the IRS that you are subject to backup withholding or (c) you have been notified by the IRS that you are no longer subject to backup withholding. If you have not previously provided and do not provide your correct taxpayer identification number on the IRS Form W-9 or substantially similar form, you may be subject to penalties imposed by the IRS and the withholding agent may also have to withhold a portion of any capital gain distributions paid to you. Unless you have established on a properly executed IRS Form W-9 or substantially similar form that you are a corporation or come within another exempt category, distributions and other payments on Senior Housing shares, HRPT shares, and our common shares paid to you during the calendar year, and the amount of tax withheld if any, will be reported to you and to the IRS. IF YOU ARE A NON-U.S. PERSON. Distributions on Senior Housing shares, HRPT shares, and our common shares paid to you during each calendar year, and the amount of tax withheld if any, will generally be reported to you and to the IRS. This information reporting requirement applies regardless of whether you were subject to withholding, or whether the withholding was reduced or eliminated by 54 an applicable tax treaty. Also, distributions and other payments to you on Senior Housing shares, HRPT shares, or our common shares may be subject to backup withholding as discussed above, unless you have properly certified your non-U.S. person status on an IRS Form W-8 or substantially similar form. Similarly, information reporting and backup withholding will not apply to proceeds you receive upon the sale, exchange, redemption, retirement or other disposition of Senior Housing shares, HRPT shares, or our common shares if you have properly certified your non-U.S. person status on an IRS Form W-8 or substantially similar form. Even without having executed an IRS Form W-8 or substantially similar form, however, in some cases information reporting and backup withholding will not apply to proceeds that you receive upon the sale, exchange, redemption, retirement or other disposition of Senior Housing shares, HRPT shares, or our common shares if you receive those proceeds through a broker's foreign office. OTHER TAX CONSEQUENCES You should recognize that our and our shareholders' federal income tax treatment, as well as Senior Housing's, HRPT's and their respective shareholders' federal income tax treatment, may be modified by legislative, judicial, or administrative actions at any time, which actions may be retroactive in effect. The rules dealing with federal income taxation are constantly under review by the Congress, the IRS and the Treasury Department, and statutory changes as well as promulgation of new regulations, revisions to existing regulations, and revised interpretations of established concepts occur frequently. No prediction can be made as to the likelihood of passage of new tax legislation or other provisions either directly or indirectly affecting us, Senior Housing, HRPT or any of our respective shareholders. Revisions in federal income tax laws and interpretations of these laws could adversely affect the tax consequences of an investment in our common shares, Senior Housing shares, or HRPT shares. We, Senior Housing, and HRPT, as well as our respective shareholders, may also be subject to state or local taxation in various state or local jurisdictions, including those in which we, Senior Housing, HRPT and our respective shareholders transact business or reside. State and local tax consequences may not be comparable to the federal income tax consequences discussed above. SHARES ELIGIBLE FOR FUTURE SALE Our shares being distributed as part of the spin-off will be freely transferable, except for shares held by persons that are "affiliates" as defined in the Securities Act of 1933. The Securities Act of 1933 generally defines affiliates as individuals or entities that control, are controlled by, or are under common control with us and may include our officers, directors and principal shareholders. Shares held by affiliates may only be sold pursuant to an effective registration statement under the Securities Act of 1933 or Rule 144 of the Securities Act of 1933. We cannot predict whether substantial amounts of our shares will be sold in the open market following the distribution. Sales of substantial amounts of our shares in the public market, or the perception that substantial sales may occur, could adversely affect their market price. The common shares we will issue to Messrs. Portnoy and Martin as consideration in our acquisition of FSQ will not be registered under the Securities Act of 1933, and therefore these shares can only be sold pursuant to an effective registration statement or Rule 144. DESCRIPTION OF CAPITAL STOCK The following description of our capital stock and certain provisions of our charter and bylaws are summaries and are qualified by reference to our charter and our bylaws. Copies of these documents have been filed with the SEC as exhibits to the registration statement of which this prospectus is a part. 55 COMMON SHARES Upon completion of the spin-off and the FSQ merger, we will have only one class of common shares, $.01 par value per share, of which 50 million shares will be authorized and million shares will have been issued. Our charter provides that our Board of Directors, without any action by the shareholders, may amend the charter to increase or decrease the number of our authorized common shares. All of our common shares distributed in the spin-off and issued in the merger will be duly authorized, fully paid and non-assessable. The holders of common shares are entitled to one vote for each share held of record on our books for the election of directors and on all matters submitted to a vote of shareholders. The holders of common shares are entitled to receive ratably dividends, if any, when, as and if authorized by the Board of Directors out of assets legally available therefor, subject to any preferential dividend rights of any outstanding preferred shares. Upon our dissolution, liquidation or winding up, the holders of common shares are entitled to receive ratably our net assets available after the payment of all debts and other liabilities, subject to the preferential rights of any outstanding preferred shares. Holders of common shares have no preemptive, subscription, redemption or conversion rights. The rights, preferences and privileges of holders of common shares are subject to, and may be adversely affected by, the rights of the holders of shares of any series of preferred shares that we may designate and issue in the future. Our charter authorizes our Board of Directors to reclassify any unissued common shares into other classes or series of stock and to establish the number of shares in each class or series and to set the preferences, conversion and other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications or terms or conditions of redemption for each such class or series. Our charter and our bylaws contain certain provisions that could have the effect of delaying, deferring or preventing a change in our control. See "Material Provisions of Maryland Law, Our Charter and Bylaws" below for a description of these provisions. PREFERRED SHARES Upon completion of the spin-off, we will have ten million preferred shares authorized, none of which will be outstanding. Our Board of Directors will be authorized, without further vote or action by the shareholders, to issue from time to time preferred shares in one or more series and to classify any unissued preferred shares and to reclassify any previously classified but unissued preferred shares of any series. Prior to issuance of shares of each series, our Board of Directors is required by Maryland law and our charter to set, subject to the provisions of our charter regarding the restrictions on transfer of shares, the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms or conditions of redemption for each such series. Our charter provides that our Board of Directors, without any action by the shareholders, may amend the charter to increase or decrease the number of our authorized preferred shares. The issuance of preferred shares could adversely affect the voting power of holders of common shares and the likelihood that such holders will receive dividend payments and payments upon liquidation and could have the effect of delaying, deferring or preventing a change in control. We believe that the ability of our Board of Directors to issue one or more series of preferred shares provides us with flexibility in structuring possible future financings and acquisitions, and in meeting other corporate needs that may arise. TRANSFER AGENT AND REGISTRAR Upon completion of the spin-off, our transfer agent and registrar for the common shares will be EquiServe Trust Company, N.A. 56 MATERIAL PROVISIONS OF MARYLAND LAW, OUR CHARTER AND BYLAWS We are organized as a Maryland corporation. The following is a summary of our charter and bylaws that will be in effect on the date of the spin-off and several provisions of Maryland law. Because it is a summary, it does not contain all the information that may be important to you. If you want more information, you should read our entire charter and bylaws, copies of which we have filed as exhibits to the registration statement of which this prospectus is a part, or refer to the provisions of applicable Maryland corporate law summarized below. RESTRICTIONS ON SHARE OWNERSHIP AND TRANSFER Our charter will restrict the amount of shares that shareholders may own. These restrictions are intended to assist Senior Housing with REIT compliance under the IRC, and otherwise to promote our orderly governance. All certificates representing our shares will bear a legend referring to these restrictions. Our charter provides that no person may own, or be deemed to own by virtue of the attribution provisions of the IRC, more than 9.8% of the number or value of any class or series of our outstanding shares of capital stock. Any person who acquires or attempts or intends to acquire actual or constructive ownership of shares of our capital stock that will or may violate this 9.8% ownership limitation must give notice immediately to us and provide us with any other information that we may request. The ownership limitations in our charter will be effective against all of our shareholders as of the spin-off distribution date; however, the ownership limitations will not apply to any person whose ownership exceeds the limitation solely by reason of receipt of common shares in the distribution on the spin-off distribution date. With the written consent of Senior Housing, our Board of Directors may grant an exemption from the ownership limitation if it is satisfied that: (i) the shareholder's ownership will not cause us or any of our subsidiaries that are tenants of Senior Housing to be deemed a "related party tenant" under the IRC rules applicable to REITs; (ii) the shareholder's ownership will not cause a default under any lease we have outstanding; and (iii) the shareholder's ownership is otherwise in our interest as determined by our Board of Directors in the exercise of its business judgment. If a person attempts a transfer of our shares in violation of the ownership limitations described above, then that number of shares which would cause the violation will be automatically transferred to a trust for the exclusive benefit of one or more charitable beneficiaries designated by us. The prohibited owner will not acquire any rights in the shares held in trust, will not benefit economically from ownership of the shares held in trust, will have no rights to distributions and will not possess any rights to vote the shares held in trust. This automatic transfer will be deemed to be effective as of the close of business on the business day prior to the date of the violative transfer. Within 20 days after receiving notice from us that shares have been transferred to the trust, the trustee will sell the shares held in the trust to a person selected by the trustee whose ownership of the shares will not violate the ownership limitations. Upon this sale, the interest of the charitable beneficiary in the shares sold will terminate and the trustee will distribute the net proceeds of the sale to the prohibited owner and to the charitable beneficiary as follows: - The prohibited owner will receive the lesser of: (1) the net price paid by the prohibited owner for the shares or, if the prohibited owner did not give value for the shares in connection with the event causing the shares to be held in the trust (e.g., a gift, devise or other similar transaction), the market price of the shares on the day of the event causing the shares to be transferred to the trust; and (2) the net price received by the trustee from the sale of the shares held in the trust. 57 - Any net sale proceeds in excess of the amount payable to the prohibited owner shall be paid to the charitable beneficiary. If, prior to our discovery that shares of our capital stock have been transferred to the trust, a prohibited owner sells those shares, then: - those shares will be deemed to have been sold on behalf of the trust; and - to the extent that the prohibited owner received an amount for those shares that exceeds the amount that the prohibited owner was entitled to receive from a sale by the trustee, the prohibited owner must pay the excess to the trustee upon demand. Also, shares of capital stock held in the trust will be offered for sale to us, or our designee, at a price per share equal to the lesser of: - the price per share in the transaction that resulted in the transfer to the trust or, in the case of a devise or gift, the market price at the time of the devise or gift; and - the market price on the date we or our designee accepts the offer. We will have the right to accept the offer until the trustee has sold the shares held in the trust. The net proceeds of the sale to us will be distributed similar to any other sale by the trustee. Every owner of 5% or more of any class or series of our shares may be required to give written notice to us within 30 days after the end of each taxable year stating the name and address of the owner, the number of shares of each class and series of our shares which the owner beneficially owns, and a description of the manner in which those shares are held. In addition, each shareholder is required to provide us upon demand with any additional information that we may request in order to assist us and Senior Housing in its determination of its status as a REIT and to determine and ensure compliance with the foregoing share ownership limitations. The restrictions described above will not preclude the settlement of any transaction entered into through the facilities of the AMEX or any other national securities exchange or automated inter-dealer quotation system. Our charter will provide, however, that the fact that the settlement of any transaction occurs will not negate the effect of any of the foregoing limitations and any transferee in this kind of transaction will be subject to all of the provisions and limitations described above. These ownership limitations could have the effect of delaying, deferring or preventing a takeover or other transaction in which holders of some, or a majority, of our common shares 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. POSSIBLE LIABILITY OF SHAREHOLDERS FOR BREACH OF RESTRICTIONS ON OWNERSHIP Our leases with Senior Housing are terminable by Senior Housing in the event that any shareholder or group of shareholders acting in concert becomes the owner of more than 9.8% of our capital stock without Senior Housing's consent. If a breach of the ownership limitations in our charter results in a lease termination, the breaching shareholders may become liable to us or to our other shareholders for damages. These damages may be in addition to the loss of beneficial ownership and voting rights, the transfer to a trust and the forced sale of excess shares described above. These damages may be for material amounts. DIRECTORS Our charter and bylaws provide that our Board of Directors establishes the number of directors. However, there may not be less than the minimum number required by Maryland law nor more than seven directors. In the event of a vacancy, a majority of the remaining directors will fill the vacancy and 58 the director elected to fill the vacancy will serve for the remainder of the full term of the directorship in which the vacancy occurred. Our charter divides our Board of Directors into three classes. The initial term of the first class will expire in 2002; the initial term of the second class will expire in 2003; and the initial term of the third class will expire in 2004. Beginning in 2002, shareholders will elect directors of each class for three-year terms upon the expiration of their current terms. Shareholders will elect only one class of directors each year. There will be no cumulative voting in the election of directors. Consequently, at each annual meeting of shareholders, a majority of the votes cast will be able to elect all of the successors of the class of directors whose term expires at that meeting. We believe that classification of the board will help to assure the continuity of our business strategies and policies. However, the classified board provision could have the effect of making the replacement of incumbent directors more time consuming and difficult. At least two annual meetings of shareholders will generally be required to effect a change in a majority of the Board of Directors. Our charter provides that a director may be removed only for cause by the affirmative vote of at least two-thirds of the shares entitled to vote in the election of directors. This provision precludes shareholders from removing incumbent directors unless they can obtain a substantial affirmative vote of shares. ADVANCE NOTICE OF DIRECTOR NOMINATIONS AND NEW BUSINESS Our bylaws provide that nominations of persons for election to our Board of Directors and other business may only be considered at our shareholders meetings if the nominations or other business are included in the notice of the meeting, made or proposed by our Board of Directors or made or proposed by a shareholder who: - is a shareholder of record at the time of giving notice of the nomination or the business to be considered; - is a shareholder of record entitled to vote at the meeting at which the nomination or business is to be considered; - is a shareholder of record at the time of the meeting and physically present in person or by proxy at the meeting to answer questions about the nomination or business; and - has complied in all respects with the advance notice provisions for shareholder nominations and other business set forth in our bylaws. Under our bylaws, a shareholder's notice of nominations for director or business to be transacted at an annual meeting of shareholders must be delivered to our secretary at our principal office not later than the close of business on the 90th day and not earlier than the close of business on the 120th day prior to the first anniversary of the date of mailing of our notice for the preceding year's annual meeting. In the event that the date of mailing of our notice of the annual meeting is advanced or delayed by more than 30 days from the anniversary date of the mailing of our notice for the preceding year's annual meeting, a shareholder's notice must be delivered to us not earlier than the close of business on the 120th day prior to the mailing of notice of such annual meeting and not later than the close of business on the later of: (1) the 90th day prior to the date of mailing of the notice for an annual meeting, or (2) the 10th day following the day on which we first make a public announcement of the date of mailing of our notice for such meeting. The public announcement of a postponement of the mailing of the notice for an annual meeting or of an adjournment or postponement of an annual meeting to a later date or time will not commence a new time period for the giving of a shareholder's notice. If the number of directors to be elected to our Board of Directors is increased and we make no public announcement of such action or do not specify the size of the increased Board of Directors at 59 least 100 days prior to the first anniversary of the date of mailing of notice for our preceding year's annual meeting, a shareholder's notice also will be considered timely, but only with respect to nominees for any new positions created by such increase, if the notice is delivered to our secretary at our principal office not later than the close of business on the 10th day immediately following the day on which such public announcement is made. For special meetings of shareholders, our bylaws require a shareholder who is nominating a person for election to our Board of Directors at a special meeting at which directors are to be elected to give notice of such nomination to our secretary at our principal office not earlier than the close of business on the 120th day prior to such special meeting and not later than the close of business on the later of: (1) the 90th day prior to such special meeting or (2) the 10th day following the day on which public announcement is first made of the date of the special meeting and of the nominees proposed by the directors to be elected at such meeting. The public announcement of a postponement or adjournment of a special meeting to a later date or time will not commence a new time period for the giving of a shareholder's notice as described above. Any notice from a shareholder of nominations for director or business to be transacted at a shareholders meeting must be in writing and include the following: - as to each person nominated for election or reelection as a director, (1) the person's name, age, business and residence addresses, (2) the principal occupation or employment of the person for the past five years, (3) the class and number of shares beneficially owned or owned of record by the person and (4) all information relating to the person that is required to be disclosed in solicitations of proxies for election of directors or otherwise required by Regulation 14A under the Securities Exchange Act of 1934, as amended, together with the nominee's written consent to being named in the proxy statement as a nominee and to serving as a director if elected; - as to other business that the shareholder proposes to bring before the meeting, a brief description of the business, the reasons for considering the business and any interest in the business of the shareholder giving the notice and of the beneficial owner, if any, on whose behalf the proposal is made; and - as to the shareholder giving the notice and the beneficial owner, if any, on whose behalf the nomination or proposal is made, the name and address of the shareholder and beneficial owner and the class and number of each class of our shares of capital stock which (s)he or they own beneficially and of record. MEETINGS OF SHAREHOLDERS The Board of Directors will determine the place and time of the annual meeting of shareholders. Special meetings of shareholders may only be called by the majority of the Board of Directors, the chairman of the Board of Directors, our president or our chief executive officer or upon the written request of shareholders entitled to cast not less than a majority of all the votes entitled to be cast at that meeting. LIABILITY AND INDEMNIFICATION OF DIRECTORS AND OFFICERS Maryland corporate law permits a Maryland corporation to include in its charter a provision limiting the liability of its directors and officers to the corporation and its shareholders for money damages except for liability resulting from (i) actual receipt of an improper benefit or profit in money, property or services or (ii) acts committed in bad faith or active and deliberate dishonesty established by a final judgment as being material to the cause of action. Our charter contains such a provision which eliminates such liability to the maximum extent permitted by Maryland law. In accordance with Maryland corporate law, our charter authorizes us, to the maximum extent permitted by Maryland law, 60 to obligate ourselves to indemnify and to pay or reimburse reasonable expenses in advance of final disposition of a proceeding to (i) any present or former director or officer or (ii) any individual who, while a director and at our request, serves or has served another corporation, real estate investment trust, partnership, joint venture, trust, employee benefit plan or other enterprise from and against any claim or liability to which he or she may become subject or which he or she may incur by reason of his or her status as a present or former director or officer of ours. Our bylaws obligate us, to the maximum extent permitted by Maryland law, to indemnify and to pay or reimburse reasonable expenses in advance of final disposition of a proceeding to (a) any present or former director or officer who is made party to the proceeding by reason of his service in that capacity or (b) any individual who, while a director, at our request, serves or has served another corporation, real estate investment trust, partnership, joint venture, trust, employee benefit plan or any other enterprise as a director, officer, partner or trustee of such corporation, real estate investment trust, partnership, joint venture, trust, employee benefit plan or other enterprise and who is made a party to the proceeding by reason of his service in that capacity. Our charter and bylaws also permit us to indemnify and advance expenses to any person who served a predecessor of ours in any of the capacities described above and to any employee or agent of ours or a predecessor of ours. The Maryland corporation statutes require a corporation (unless its charter provides otherwise, which our charter does not) to indemnify a director or officer who has been successful, on the merits or otherwise, in the defense of any proceeding to which he or she is made a party by reason of his or her service in that capacity. The Maryland corporation statutes permit a corporation to indemnify its directors and officers, among others, against judgments, penalties, fines, settlements and reasonable expenses actually incurred by them in connection with any proceedings to which they may be made a party by reason of their service in those or other capacities unless it is established that: - the act or omission of the director or officer was material to the matter giving rise to the proceedings and (a) was committed in bad faith or (b) was the result of active and deliberate dishonesty; - the director or officer actually received an improper personal benefit in money, property or services; or - in the case of any criminal proceeding, the director or officer had reasonable cause to believe that the act or omission was unlawful. However, under the corporation statutes of Maryland, a Maryland corporation may not indemnify for an adverse judgment in a suit by or in the right of the corporation or for a judgment of liability on the basis that personal benefit was improperly received, unless in either case a court orders indemnification and then only for expenses. In accordance with Maryland corporate law, our bylaws require us, as a condition to advancing expenses, to obtain: - a written affirmation by the director or officer of his or her good faith belief that he or she has met the standard of conduct necessary for indemnification by us as authorized by our bylaws; and - a written statement by or on his or her behalf to repay the amount paid or reimbursed by us if it shall ultimately be determined that the standard of conduct was not met. AMENDMENTS TO OUR CHARTER AND BYLAWS Under Maryland corporate law, in order to amend our charter, our Board of Directors first must adopt a resolution setting forth the proposed amendment and declaring its advisability and direct that the proposed amendment be submitted to shareholders for their consideration either at an annual or special meeting of shareholders. Then, the proposed amendment must be approved by shareholders by the affirmative vote of two-thirds of all the votes entitled to be cast on the matter, unless a greater or 61 lesser proportion of votes (but not less than a majority of all votes entitled to be cast) is specified in our charter. Amendments to our charter may be made by requisite action of our Board of Directors and approval by shareholders by the affirmative vote of two-thirds of the votes entitled to be cast on the matter. As permitted under the Maryland corporate law, our bylaws provide that our Board of Directors has the exclusive right to amend the bylaws. BUSINESS COMBINATIONS The Maryland corporation statutes contain a provision which regulates business combinations with interested shareholders. Under Maryland corporate law, business combinations such as mergers, consolidations, share exchanges and the like between a Maryland corporation and an interested shareholder or an affiliate of the interested shareholder are prohibited for five years after the most recent date on which the shareholder becomes an interested shareholder. Under the statute, the following persons are deemed to be interested shareholders: - any person who beneficially owns 10% or more of the voting power of the corporation's shares of capital stock; or - an affiliate or associate of the corporation who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of the voting power of the then outstanding voting shares of the corporation. A person is not an interested shareholder under the statute if the board of directors approved in advance the transaction by which the person otherwise would have become an interested shareholder. The board of directors may provide that its approval is subject to compliance with any terms and conditions determined by the board of directors. After the five-year prohibition period has ended, a business combination between a corporation and an interested shareholder or an affiliate of the interested shareholder must be recommended by the board of directors of the corporation and must receive the following shareholder approvals: - the affirmative vote of at least 80% of the votes entitled to be cast; and - the affirmative vote of at least two-thirds of the votes entitled to be cast by holders of shares other than shares held by the interested shareholder with whom or with whose affiliate the business combination is to be effected or by an affiliate or associate of the interested shareholder. The second shareholder approval is not required if the corporation's shareholders receive the minimum price set forth in the Maryland corporation statute for their shares of capital stock and the consideration is received in cash or in the same form as previously paid by the interested shareholder for its shares of capital stock. The foregoing provisions of Maryland corporate law do not apply, however, to business combinations that are approved or exempted by the board of directors of the corporation prior to the time that the interested shareholder becomes an interested shareholder. Our Board of Directors has adopted a resolution that any business combination between us and any other person is exempted from the provisions of the Maryland corporation statutes described in the preceding paragraphs, provided that the business combination is first approved by our Board of Directors, including the approval of a majority of the members of our Board of Directors who are not affiliates or associates of the acquiring person. This resolution, however, may be altered or repealed in whole or in part at any time. 62 CONTROL SHARE ACQUISITIONS The Maryland corporation statutes contain a provision which provides that control shares of a Maryland corporation acquired in a control share acquisition have no voting rights except to the extent that the acquisition is approved by a vote of two-thirds of the votes entitled to be cast on the matter, excluding shares of capital stock owned by the acquiror, by employees who are also directors of the corporation or by officers of the corporation. Control shares are voting shares of capital stock which, if aggregated with all other shares of capital stock previously acquired by the acquiror, or in respect of which the acquiror is able to exercise or direct the exercise of voting power (except solely by virtue of a revocable proxy), would entitle the acquiror to exercise voting power in electing directors within one of the following ranges of voting power: - one-tenth or more but less than one-third; - one-third or more but less than a majority; or - a majority or more of all voting power. An acquiror must obtain the necessary shareholder approval each time he acquires control shares in an amount sufficient to cross one of the thresholds noted above. Control shares do not include shares which the acquiring person is entitled to vote as a result of having previously obtained shareholder approval. A control share acquisition means the acquisition of control shares. There is a list of exceptions from the definition of control share acquisition. A person who has made or proposes to make a control share acquisition, upon satisfaction of the conditions set forth in the statute, including an undertaking to pay expenses, may compel the board of directors of the corporation to call a special meeting of shareholders to be held within 50 days after demand to consider the voting rights of the shares. If no request for a meeting is made, the corporation may itself present the matter 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 the corporation may redeem any or all of the control shares for fair value determined 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 those shares are considered and not approved. The right of the corporation to redeem any or all of the control shares is subject to conditions and limitations listed in the statute. The corporation may not redeem shares for which voting rights have previously been approved. Fair value is determined without regard to the absence of voting rights for the control shares. 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 these appraisal rights may not be less than the highest price per share paid by the acquiror in the control share acquisition. The control share acquisition statute does not apply to the following: - shares acquired in a merger, consolidation or share exchange if the corporation is a party to the transaction; or - acquisitions approved or exempted by a provision in the charter or bylaws of the corporation adopted before the acquisition of shares. Our bylaws contain a provision exempting any and all acquisitions by any person of our shares of capital stock from the control share acquisition statute. However, this provision may be amended or eliminated at any time in the future. 63 ANTI-TAKEOVER EFFECT OF MARYLAND LAW AND OF OUR CHARTER AND BYLAWS The following provisions in our charter and bylaws and in Maryland law could delay or prevent a change in our control: - the limitation on ownership and acquisition of more than 9.8% of our shares of capital stock; - the ability of our Board of Directors to authorize and issue additional shares, including additional classes of shares with rights defined at the time of issuance, without shareholder approval; - the classification of our Board of Directors into classes and the election of each class for three-year staggered terms; - the requirement of cause and a two-thirds majority vote of shareholders for removal of our directors; - the provision that the number of our directors may be fixed only by vote of our Board of Directors and that a vacancy on our Board of Directors may be filled by the affirmative vote of a majority of our remaining directors; - the advance notice requirements for shareholder nominations for directors and other proposals; - the control share acquisitions provisions of Maryland law, if the applicable provisions in our bylaws are rescinded; and - the business combination provisions of Maryland law, if the applicable resolution of our Board of Directors is rescinded or if our Board of Directors' approval of a combination is not obtained. PLAN OF DISTRIBUTION Our common shares will be distributed by Senior Housing by the declaration and payment of a dividend on Senior Housing common shares. Simultaneously, HRPT, a 44% shareholder in Senior Housing, will distribute our common shares received from Senior Housing to the HRPT common shareholders by declaration and payment of a dividend. This distribution is not being underwritten by an investment bank or otherwise. The purpose of the spin-off is described in the section of this prospectus entitled "The Spin-off--Background and Reasons for the Spin-off". Senior Housing will pay any fees or other expenses incurred in connection with the listing of the common shares on the American Stock Exchange and the distributions. We anticipate the aggregate fees and expenses in connection with the spin-off distribution to be . Underwriters will not be used in connection with the distribution of our common shares. LEGAL MATTERS Sullivan & Worcester LLP will pass upon the validity of our distributed common shares. As to certain matters of Maryland law, Sullivan & Worcester LLP will rely upon an opinion of Ballard Spahr Andrews & Ingersoll, LLP. Barry M. Portnoy, a former partner of the firm of Sullivan & Worcester LLP, is one of our directors, and he is a Managing Trustee of Senior Housing, HRPT and HPT. Mr. Portnoy is also a 50% owner and a director of RMR and FSQ. Sullivan & Worcester LLP represents Senior Housing, HRPT, HPT, FSQ, RMR and certain of their affiliates. 64 EXPERTS The consolidated financial statements of Five Star Quality Care, Inc. (formerly known as SHOPCO Holdings, Inc.), at December 31, 2000, and for the period April 27, 2000 (date of commencement of operations) through December 31, 2000, and the combined financial statements and schedule of Certain Mariner Post-Acute Network Facilities (operated by subsidiaries of Mariner Post-Acute Network, Inc.) at December 31, 2000 and 1999 appearing in this prospectus and registration statement have been audited by Ernst & Young, LLP, independent auditors, as set forth in their reports thereon appearing elsewhere herein, and are included in reliance upon such reports given on the authority of such firm as experts in accounting and auditing. The combined financial statements and schedule of Forty-two Facilities Acquired by Senior Housing Properties Trust from Integrated Health Services, Inc. at December 31, 2000 and 1999, and for each of the years in the three-year period ended December 31, 2000, appearing in this prospectus and registration statement have been audited by KPMG LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given on the authority of such firm as experts in accounting and auditing. The consolidated financial statements of CSL Group, Inc. and Subsidiaries as Partitioned for Sale to Senior Housing Properties Trust at December 29, 2000 and December 31, 1999, and for the years ended December 29, 2000, December 31, 1999 and January 1, 1999 appearing in this prospectus and registration statement have been audited by Arthur Andersen LLP, independent public accountants, as indicated in their report with respect thereto appearing elsewhere herein, and are included in reliance upon the authority of said firm as experts in accounting and auditing. WHERE YOU CAN FIND MORE INFORMATION We have filed with the SEC a registration statement on Form S-1 (including the exhibits, schedules and any amendments thereto) under the Securities Act of 1933 with respect to the shares being distributed pursuant to this prospectus. This prospectus is part of this registration statement and does not contain all of the information set forth in the registration statement. Statements contained in this prospectus as to the content of any agreement or other document filed as an exhibit are not necessarily complete, and you should consult a copy of those contracts or other documents filed as exhibits to the registration statement. For further information regarding us, please read the registration statement and the exhibits and schedules thereto. You may read and copy the registration statement and its exhibits and schedules or other information on file at the SEC's Public Reference room at 450 Fifth Street, N.W., Washington, D.C. 20549. You may also review a copy of the registration statement at the SEC's regional offices in Chicago, Illinois and New York, New York. You can request copies of those documents upon payment of a duplicating fee to the SEC. When our registration statement on Form S-1 becomes effective, we will be subject to the reporting requirements of the Securities Exchange Act of 1934 and the reports, proxy statements and other information filed by us with the SEC can then copied at the SEC's Public Reference Room. Please call the SEC at 1-800-SEC-0330 for further information on the operation of the public reference rooms. You can review our SEC filings and the registration statement by accessing the SEC's Internet site at http://www.sec.gov. We intend to furnish to our shareholders annual reports containing financial statements audited by an independent public accounting firm. ------------------------ 65 INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
PAGE -------- FIVE STAR QUALITY CARE, INC. UNAUDITED PRO FORMA FINANCIAL STATEMENTS Introduction to Unaudited Pro Forma Financial Statements.............................................. F-3 Unaudited Pro Forma Consolidated Balance Sheet at June 30, 2001........................................... F-4 Unaudited Pro Forma Consolidated Statement of Income for the year ended December 31, 2000....................................... F-5 Unaudited Pro Forma Consolidated Statement of Income for the six months ended June 30, 2001..................................... F-6 Notes to Unaudited Pro Forma Consolidated Financial Statements.............................................. F-7 FIVE STAR QUALITY CARE, INC. HISTORICAL FINANCIAL STATEMENTS Condensed Consolidated Balance Sheet at June 30, 2001 (unaudited)............................................. F-12 Condensed Consolidated Statements of Income for the six months ended June 30, 2001 and the period from April 27, 2000 (date of commencement of operations) through June 30, 2000 (unaudited)....................... F-13 Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2001 and the period from April 27, 2000 (date of commencement of operations) through June 30, 2000 (unaudited)....................... F-14 Notes to Consolidated Financial Statements (unaudited).... F-15 Report of Independent Auditors............................ F-17 Consolidated Balance Sheet at December 31, 2000........... F-18 Consolidated Statement of Income for the period April 27, 2000 (date of commencement of operations) through December 31, 2000....................................... F-19 Consolidated Statement of Ownership Interest of Senior Housing Properties Trust for the period April 27, 2000 (date of commencement of operations) through December 31, 2000....................................... F-20 Consolidated Statement of Cash Flows for the period April 27, 2000 (date of commencement of operations) through December 31, 2000............................... F-21 Notes to Consolidated Financial Statements................ F-22 COMBINED FINANCIAL STATEMENTS OF FORTY-TWO FACILITIES ACQUIRED BY SENIOR HOUSING PROPERTIES TRUST FROM INTEGRATED HEALTH SERVICES, INC. (INTEGRATED PREDECESSOR) Independent Auditors' Report.............................. F-27 Combined Balance Sheets at December 31, 2000 and 1999..... F-28 Combined Statements of Operations for the three years ended December 31, 2000, 1999 and 1998.................. F-29 Combined Statements of Changes in Net Equity (Deficit) of Parent Company for the three years ended December 31, 2000, 1999 and 1998..................................... F-30 Combined Statements of Cash Flows for the three years ended December 31, 2000, 1999 and 1998.................. F-31 Notes to Combined Financial Statements.................... F-32 Schedule II--Valuation and Qualifying Accounts for the years ended December 31, 2000, 1999 and 1998............ F-43
F-1 COMBINED FINANCIAL STATEMENTS OF CERTAIN MARINER POST-ACUTE NETWORK FACILITIES (OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK) (MARINER PREDECESSOR) Report of Independent Auditors............................ F-44 Combined Balance Sheets at December 31, 2000 and 1999..... F-45 Combined Statements of Operations for each of the three years ended December 31, 2000........................... F-46 Combined Statements of Divisional Equity (Deficit) for each of the three years ended December 31, 2000......... F-47 Combined Statements of Cash Flows for each of the three years ended December 31, 2000........................... F-48 Notes To Combined Financial Statements.................... F-49 Schedule II--Valuation and Qualifying Accounts for the years ended December 31, 2000, 1999 and 1998............ F-59 CONSOLIDATED FINANCIAL STATEMENTS OF CSL GROUP, INC. AND SUBSIDIARIES AS PARTITIONED FOR SALE TO SENIOR HOUSING PROPERTIES TRUST Unaudited Condensed Consolidated Balance Sheet at June 15, 2001........................................... F-60 Unaudited Condensed Consolidated Statements of Operations for the twenty-four weeks ended June 15, 2001 and June 16, 2000........................................... F-61 Unaudited Condensed Consolidated Statements of Cash Flows for the twenty-four weeks ended June 15, 2001 and June 16, 2000........................................... F-62 Notes to Unaudited Condensed Consolidated Financial Statements.............................................. F-63 Report of Independent Public Accountants.................. F-64 Consolidated Balance Sheets at December 31, 2000 and 1999.................................................... F-65 Consolidated Statements of Operations for the three fiscal years ended December 29, 2000, December 31, 1999 and January 1, 1999......................................... F-66 Consolidated Statements of Equity for the three fiscal years ended December 29, 2000, December 31, 1999 and January 1, 1999......................................... F-67 Consolidated Statements of Cash Flows for the three fiscal years ended December 29, 2000, December 31, 1999 and January 1, 1999......................................... F-68 Notes to Consolidated Financial Statements................ F-69
F-2 FIVE STAR QUALITY CARE, INC. INTRODUCTION TO UNAUDITED PRO FORMA FINANCIAL STATEMENTS The unaudited pro forma balance sheet at June 30, 2001, presents the financial position of Five Star Quality Care, Inc. as if its spin-off from Senior Housing, its merger with FSQ and, separately, the commencement of its lease of 31 Marriott facilities from Senior Housing had been completed as of June 30, 2001 as described in the notes thereto. The unaudited pro forma statements of income for the year ended December 31, 2000, and six months ended June 30, 2001, present the results of operations of Five Star Quality Care, Inc. as if these transactions had been completed as of January 1, 2000 as described in the notes thereto. These unaudited pro forma financial statements do not represent our financial condition or results of operations for any future date or period. Actual future results may be materially different from pro forma results. Differences could arise from many factors, including, but not limited to, those related to competition in our business, the impact of changes to rates under Medicare and Medicaid reimbursement programs, our ability to successfully attract residents to our facilities, our ability to control operating expenses, our capital structure and other changes. These unaudited pro forma financial statements should be read in connection with our and our predecessors' audited and unaudited financial statements and the related Management's Discussion and Analysis included elsewhere in this prospectus. The financial statements of the predecessors to our business included in this prospectus are entitled: Certain Mariner Post-Acute Network Facilities (referred to herein as Mariner Predecessor); and Forty-Two Facilities Acquired by Senior Housing Properties Trust from Integrated Health Services, Inc. (referred to herein as Integrated Predecessor). In addition, in connection with these unaudited pro forma financial statements, you should read the financial statements of the 31 Marriott facilities, as owned and operated by Crestline, which are also included in this prospectus and are entitled CSL Group, Inc. and Subsidiaries as Partitioned For Sale to Senior Housing Properties Trust. F-3 FIVE STAR QUALITY CARE, INC. UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET JUNE 30, 2001 (DOLLARS IN THOUSANDS)
CRESTLINE FIVE STAR Reorganization Acquisition PRO FORMA and By INCLUDING Transaction FSQ Senior CRESTLINE Agreement Merger FIVE STAR Housing ACQUISITION BY FIVE STAR Adjustments Adjustments PRO FORMA Adjustments SENIOR HOUSING --------- -------------- ----------- ---------- ------------- -------------- (A) (I) (J) ASSETS Current assets Cash............................ $ 4,772 $ 8,986 (B) $ -- $13,758 $ 3,703 $17,461 Accounts receivable, net........ 47,665 (6,812)(C) -- 40,853 9,349 50,202 Prepaid expenses and other...... 964 -- -- 964 -- 964 ------- -------- ------ ------- ------- ------- Total current assets.............. 53,401 2,174 -- 55,575 13,052 68,627 Fixed assets, net................. 30,028 (30,028)(D) 1,148 1,148 -- 1,148 Other assets...................... 4,560 (4,560)(E) 84 84 -- 84 ------- -------- ------ ------- ------- ------- Total assets...................... $87,989 $(32,414) $1,232 $56,807 $13,052 $69,859 ======= ======== ====== ======= ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities Accounts payable................ $ 6,560 $ -- $ -- $ 6,560 $ -- $ 6,560 Accrued expenses................ 3,750 -- -- 3,750 -- 3,750 Accrued compensation............ 5,265 -- -- 5,265 -- 5,265 Note payable.................... 100 (100)(F) -- -- -- -- Other liabilities............... 7,206 (7,206)(G) -- -- 13,052 13,052 ------- -------- ------ ------- ------- ------- Total liabilities................. 22,881 (7,306) -- 15,575 13,052 28,627 Shareholders' equity Common stock, par value $0.01... -- 30 (H) [ ] (I) 30 -- 30 Additional paid in capital...... -- 39,970 (H) 1,232 (I) 41,202 -- 41,202 Ownership interest of Senior Housing....................... 65,108 (65,108)(H) -- -- -- -- ------- -------- ------ ------- ------- ------- Total shareholders' equity........ 65,108 (25,108) 1,232 41,232 -- 41,232 ------- -------- ------ ------- ------- ------- Total liabilities and shareholders' equity............ $87,989 $(32,414) $1,232 $56,807 $13,052 $69,859 ======= ======== ====== ======= ======= =======
SEE ACCOMPANYING NOTES. F-4 FIVE STAR QUALITY CARE, INC. UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF INCOME FOR THE YEAR ENDED DECEMBER 31, 2000 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
CRESTLINE FIVE STAR ACQUISITION PRO FORMA BY INCLUDING Transaction and Senior CRESTLINE Mariner Integrated Merger FIVE STAR Housing ACQUISITION BY FIVE STAR Predecessor Predecessor Adjustments PRO FORMA Adjustments SENIOR HOUSING --------- ----------- ----------- --------------- ---------- ------------- -------------- (K) (L) (M) REVENUES Net revenues.......... $ -- $85,128 $135,378 -- $220,506 $261,923(U) $482,429 Interest and other income.............. 2,520 197 -- $ (2,520)(N) 197 -- 197 ------- ------- -------- -------- -------- -------- -------- Total revenues........ 2,520 85,325 135,378 (2,520) 220,703 $261,923 $482,626 ------- ------- -------- -------- -------- -------- -------- EXPENSES Property level operating costs and expenses: Routine............. -- 60,478 125,832 -- 186,310 152,023(U) 338,333 Ancillary........... -- 4,077 -- -- 4,077 14,493(U) 18,570 Depreciation and amortization........ 317 1,766 889 (2,800)(O) 172 -- 172 General and administrative...... 3,519 4,101 6,084 (2,381)(P) 11,323 17,229(V) 28,552 Rent.................. -- 8,748 9,102 (10,850)(Q) 7,000 63,000(W) 70,000 FF&E rent............. -- -- -- -- -- 7,188(X) 7,188 Property taxes and other............... -- 13,459 -- -- 13,459 9,263(U) 22,722 Loss on settlement.... -- -- 16,670 (16,670)(R) -- -- -- Interest expense, net................. -- 117 2,053 (2,170)(S) -- -- -- ------- ------- -------- -------- -------- -------- -------- Total expenses........ 3,836 92,746 160,630 (34,871) 222,341 263,196 485,537 Income (loss) before income taxes........ (1,316) (7,421) (25,252) 32,351 (1,638) (1,273) (2,911) ------- ------- -------- -------- -------- -------- -------- Provision (benefit) for income taxes.... -- -- -- (573) (573) (445)(Y) (1,018) ------- ------- -------- -------- -------- -------- -------- Net income (loss)..... $(1,316) $(7,421) $(25,252) $ 32,351 $ (1,065) $ (828) $ (1,893) ======= ======= ======== ======== ======== ======== ======== Weighted average shares outstanding......... -- -- -- 2,962 (T) 2,962 -- 2,962 Earnings per share.... -- -- -- -- $ (0.36) -- $ (0.64)
SEE ACCOMPANYING NOTES. F-5 FIVE STAR QUALITY CARE, INC. UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF INCOME FOR SIX MONTHS ENDED JUNE 30, 2001 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FIVE STAR CRESTLINE PRO FORMA ACQUISITION INCLUDING BY CRESTLINE Transaction and Senior ACQUISITION BY MERGER FIVE STAR HOUSING SENIOR FIVE STAR Adjustments PRO FORMA Adjustments HOUSING --------- --------------- --------- ----------- -------------- (K) Revenues............................ $113,260 $ -- $113,260 $126,405 $239,665 -------- ------- -------- -------- -------- EXPENSES Property level operating costs and expenses: Routine........................... 91,273 -- 91,273 73,542(U) 164,815 Ancillary......................... 5,520 -- 5,520 6,064(U) 11,584 Depreciation and amortization....... 632 (546)(O) 86 -- 86 General and administrative.......... 9,813 (4,134)(P) 5,679 8,987(V) 14,666 Rent................................ -- 3,500 (Q) 3,500 29,077(W) 32,577 FF&E rent........................... -- -- -- 3,318(X) 3,318 Property taxes and other............ 7,928 -- 7,928 4,034(U) 11,962 -------- ------- -------- -------- -------- Total expenses...................... 115,166 (1,180) 113,986 125,022 239,008 -------- ------- -------- -------- -------- Income (loss) before income taxes... (1,906) 1,180 (726) 1,383 657 Provision (benefit) for income taxes............................. -- (254) (254) 484(Y) 230 -------- ------- -------- -------- -------- Net income (loss)................... $ (1,906) $ 1,434 $ (472) $ 899 $ 427 ======== ======= ======== ======== ======== Weighted average shares outstanding....................... 2,962 (T) 2,962 2,962 Earnings per share.................. $ (0.16) $ 0.14
SEE ACCOMPANYING NOTES. F-6 FIVE STAR QUALITY CARE, INC. NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) PRO FORMA BALANCE SHEET ADJUSTMENTS A. Represents the historical results of Five Star Quality Care, Inc., formerly known as SHOPCO Holdings, Inc., a subsidiary of Senior Housing. B. In connection with the distribution, Senior Housing will undertake an internal reorganization. As part of the transaction agreement between Senior Housing and Five Star which governs the spin-off, Senior Housing is required to contribute $40 million of equity to Five Star. On a pro forma basis, cash is expected to be contributed as follows: Investments and advances from Senior Housing, June 30, 2001.................................................... $ 65,108 Assets retained by Senior Housing: Accounts receivable (see Note C)........................ (6,812) Property and equipment (see Note D)..................... (30,028) Other assets (see Note E)............................... (4,560) Liabilities retained by Senior Housing (see Note G)....... 7,206 -------- Net historical assets over liabilities contributed........ 30,914 Total contribution required by Transaction Agreement...... (40,000) -------- Total additional cash contributed by Senior Housing....... 9,086 Payment of note payable due from Five Star to Senior Housing (see note F)............................................ (100) -------- Net additional cash contributed by Senior Housing......... $ 8,986 ========
C. Historically, Five Star was responsible for the conduct of substantially all of Senior Housing's affairs related to property foreclosures on two former tenants of Senior Housing. In connection with those activities, Five Star and Senior Housing are due $6,812 from these former tenants as of June 30, 2001. These receivables will be collected or transferred to other subsidiaries of Senior Housing by Five Star prior to the spin-off date. D. As part of the internal reorganization, a number of operating real estate properties will be transferred to other subsidiaries of Senior Housing prior to the spin-off. These properties were received by Five Star and Senior Housing in connection with foreclosures of two former tenants of Senior Housing and have a net book value of $30,028 as of June 30, 2001. On the date of the spin-off, substantially all of these facilities will be leased by Five Star from Senior Housing. E. Also in connection with the internal restructuring, miscellaneous other assets, primarily consisting of reimbursements due to Senior Housing related to the foreclosures, which total $4,560 as of June 30, 2001 will be transferred to subsidiaries of Senior Housing by Five Star prior to the spin-off. F. Senior Housing capitalized Five Star at formation in part in exchange for a note due from Five Star to Senior Housing. Five Star will repay this note prior to the spin-off in connection with the internal reorganization. G. In connection with the foreclosures of two former bankrupt tenants, Five Star and Senior Housing identified deferred maintenance at the facilities which had been allowed to occur by F-7 FIVE STAR QUALITY CARE, INC. NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) its former tenants. In connection therewith, Senior Housing made an accounting of the estimated liability, of which $7,206 remains at June 30, 2001, and, as part of the transaction agreement, Senior Housing has agreed to pay for the completion of the improvements which remain unfinished at the time of the spin-off. H. As discussed in Note B, as part of the spin-off, we will no longer be wholly owned by Senior Housing. The historical ownership interest of Senior Housing will be eliminated as a result of the spin-off and substantially all of our shares will be distributed to shareholders of Senior Housing. On the distribution date our shares will have an aggregate book value of $40,000. Total outstanding shares of Senior Housing.............. 29,370,000 Spin off ratio.......................................... 1:10 ---------- Total shares distributed................................ 2,937,000 Total shares retained by Senior Housing................. 25,000 ---------- Total shares of Five Star outstanding after the spin-off and just prior to the merger.......................... 2,962,000 Par value per share..................................... $ 0.01 ---------- Par value............................................... $ 30 ========== Common equity contributed to Five Star by Senior Housing............................................... $ 40,000 Par value............................................... (30) ---------- Additional Paid In Capital.............................. $ 39,970 ==========
I. Our merger agreement with FSQ provides that we will issue our shares to effect our acquisition of FSQ. At this time, the number of shares to be issued to FSQ has not been determined and is dependent upon the results of negotiation between FSQ and Senior Housing, including Senior Housing's disinterested Trustees. Because of this, for purposes of this pro forma balance sheet, we have given no effect of the FSQ acquisition on our par capital and it has been assumed that the common shares issued for the acquisition of FSQ will be valued as equity equal to the FSQ book equity existing on the date of the merger, or $1,232 as of June 30, 2001. J. In connection with Senior Housing's acquisition of the 31 Marriott facilities, we have agreed to act as tenant under a lease of the 31 facilities with Senior Housing. In connection with this lease, we will acquire receivables due from Marriott as manager of these facilities of $9,349, and we will assume operating liabilities of $13,052 consisting primarily of refundable resident deposits and liabilities to provide future services under contracts with residents. The net amount is required to be settled in cash between us and Senior Housing under the terms of the transaction agreement: Operating liabilities assumed.............................. $13,052 Accounts receivable acquired............................... (9,349) ------- Net cash from Senior Housing............................... $ 3,703 =======
F-8 FIVE STAR QUALITY CARE, INC. NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) PRO FORMA INCOME STATEMENT ADJUSTMENTS K. Represents the historical results of Five Star Quality Care, Inc., formerly known as SHOPCO Holdings, Inc., a subsidiary of Senior Housing, since the date we began operations on April 27, 2000. During 2000, we recorded our investment in the businesses we acquired from Mariner Predecessor and Integrated Predecessor under the equity method of accounting, until the transfer of healthcare operating licenses to us was resolved. L. Represents the operating results, for the 2000 period, for Mariner Predecessor. During 2000, Mariner Predecessor owned the business of operating 17 facilities which we ultimately acquired through foreclosure. These results represent the revenues and expenses of Mariner Predecessor from January 1, 2000, through December 31, 2000, the last day that we recorded the properties operating results on the equity method of accounting (see Notes K and N). During 2000, we and Mariner closed one facility which will not be leased by us from Senior Housing as a result of the spin-off. This closure had no material impact on results of operations. M. Represents the operating results, for the 2000 period, for Integrated Predecessor. During 2000, Integrated Predecessor owned the business of operating 42 facilities which we acquired. These results represent the revenues and expenses of Integrated Predecessor from January 1, 2000, through December 31, 2000, the last day that we recorded the properties operating results on the equity method of accounting (see Notes K and N). During 2000, we and Integrated closed two facilities which will not be leased by us from Senior Housing as a result of the spin-off. These closures had no material impact on results of operations. N. Represents the elimination of our equity in the income of businesses acquired from Mariner Predecessor and Integrated Predecessor realized in 2000 from the date we began operations on July 1, 2000, through December 31, 2000. O. After the spin-off, Senior Housing will retain substantially all of the real estate that we currently own. See Note D. Adjustment represents the elimination of depreciation expense related to us and both of our predecessor entities, and the addition of depreciation expense related to fixed assets to be acquired by us in the FSQ merger as follows:
YEARS ENDED SIX MONTHS DECEMBER 31, ENDED 2000 JUNE 30, 2001 ------------ ------------- Elimination of Five Star depreciation..... $ (317) $(632) Elimination of Mariner Predecessor depreciation............................ (1,766) -- Elimination of Integrated Predecessor depreciation............................ (889) -- Addition of FSQ depreciation.............. 172 86 ------- ----- Total adjustment.......................... $(2,800) $(546) ======= =====
P. For a portion of the 2000 period, some of the daily business of operating our facilities was conducted by affiliates of Mariner Predecessor and Integrated Predecessor. After a transition period, Senior Housing retained FSQ to operate the facilities, also in exchange for a fee. Because we will acquire FSQ and our management agreement with FSQ will be terminated, F-9 FIVE STAR QUALITY CARE, INC. NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) promptly after the spin-off date we will begin to operate these facilities. Also, after the spin-off, we will enter into a shared services agreement with REIT Management & Research, Inc., the investment manager to Senior Housing under which we will receive services described elsewhere in this prospectus in exchange for a fee equal to 0.6% of annual revenues. The net adjustment is derived as follows:
YEAR ENDED SIX MONTHS DECEMBER 31, ENDED 2000 JUNE 30, 2001 ------------ ------------- Elimination of management fees incurred by: Mariner Predecessor.................... $(4,101) $ -- Integrated Predecessor................. (6,084) -- Shared services fee: Pro forma revenues..................... $220,506 $113,260 Contract rate.......................... 0.6% 0.6% -------- -------- 1,323 679 Elimination of general and administrative costs incurred or allocated by Senior Housing to Five Star on a historical basis (April 27, 2000 through June 30, 2001).................................. (3,519) (9,813) Addition of corporate costs estimated to be incurred by Five Star as an entity separate from Senior Housing........... 10,000 5,000 ------- ------- Total adjustment......................... $(2,381) $(4,134) ======= =======
Q. Our agreement to lease 56 facilities currently owned by Senior Housing requires us to make minimum rent payments of $7 million per annum through June 30, 2018. During a portion of 2000, Mariner Predecessor and Integrated Predecessor had rent and mortgage interest obligations (see Note S) directly with Senior Housing. Adjustment represents the elimination of historical rent expense and addition of the rent under our new lease with Senior Housing as follows:
YEAR ENDED SIX MONTHS DECEMBER 31, ENDED 2000 JUNE 30, 2001 ------------ ------------- Elimination of rent incurred by: Mariner Predecessor..................... $ (8,748) -- Integrated Predecessor.................. (9,102) -- Addition of new rent to be paid by us to Senior Housing.......................... 7,000 $3,500 -------- ------ Total adjustment.......................... $(10,850) $3,500 ======== ======
R. Represents elimination of foreclosure settlement expenses incurred by Integrated Predecessor. Because these unusual charges were incurred by Integrated Predecessor in the process of settling with Senior Housing, they are eliminated because they are not expected to recur. S. Represents elimination of interest expense of Mariner Predecessor and Integrated Predecessor on mortgages due to Senior Housing and foreclosed upon by Senior Housing in 2000. See Note Q. F-10 FIVE STAR QUALITY CARE, INC. NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) T. Represents total common shares expected to be issued in the spin-off by Senior Housing (see Note I). Total shares of Five Star outstanding after the spin-off and just prior to the merger (See Note I)..................... 2,962 Total shares issued to FSQ in the merger (See Note I)....... [] ------ Total outstanding shares (See Note I)....................... 2,962 ======
Our merger agreement with FSQ provides that we will issue our shares to effect our acquisition of FSQ. At this time, the number of shares to be issued to FSQ has not been determined and is dependent upon the results of negotiations between FSQ and Senior Housing, including Senior Housing's disinterested Trustees. For purposes of the table above and the related pro forma adjustment, we have not given effect of the issuance of shares in the FSQ merger. U. Represents operating revenues and facility operating expenses which we would have incurred during the pro forma periods for the 31 Marriott facilities expected to be purchased by Senior Housing from Crestline. The 31 Marriott facilities results are accounted for on the basis of 13 four-week periods per fiscal year. Amounts presented as 2000 represent the period from January 1, 2000, through December 29, 2000, and the amounts presented as 2001 represent the period from December 30, 2000, through June 15, 2001. Pro forma expenses in 2000 exclude amortization of a portion of Crestline's allocated purchase price. V. Represents the historically incurred management fees paid by Crestline under the terms of its management agreement with Marriott, to which we will become a party upon the commencement of the lease for these properties from Senior Housing, plus the impact of the shared services agreement on our additional revenues.
TWENTY-FOUR WEEKS YEAR ENDED ENDED DECEMBER 31, 2000 JUNE 15, 2001 ----------------- ----------------- Management fees paid to Marriott........................ $15,658 $ 8,229 Shared services fee: Pro forma revenues.............. $261,923 $126,405 Contract rate................... 0.6% 0.6% -------- -------- 1,571 758 ------- -------- Total adjustment.................. $17,229 $ 8,987 ======= ========
W. Our agreement to lease 31 Marriott facilities expected to be acquired by Senior Housing requires us to make minimum rent payments of $63 million per annum as follows:
TWENTY FOUR YEAR ENDED WEEKS ENDED DECEMBER 31, 2000 JUNE 15, 2001 ----------------- ------------- Total adjustment........................ $63,000 $29,077
X. Represents deposits made into reserves for capital improvements in accordance with existing management agreements for the 31 Marriott facilities and which, under our lease with Five Star will be paid to Senior Housing as additional rent. Y. Represents the cumulative tax provision based on all transactions and merger adjustments, and the Crestline acquisition by Senior Housing. Tax provision is based on a blended Federal and State income tax rate which equates to 35%. F-11 FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.) (A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST) CONDENSED CONSOLIDATED BALANCE SHEET (DOLLARS IN THOUSANDS)
JUNE 30, 2001 ----------- (UNAUDITED) ASSETS Cash and cash equivalents................................... $ 4,772 Accounts receivable, net.................................... 47,665 Prepaid expenses............................................ 964 ------- 53,401 Property and equipment, net................................. 30,028 Other assets................................................ 4,560 ------- $87,989 ======= LIABILITIES AND OWNERSHIP INTEREST OF SENIOR HOUSING Accounts payable............................................ $ 6,560 Accrued expenses............................................ 3,750 Accrued compensation........................................ 5,265 Note payable................................................ 100 Other liabilities........................................... 7,206 ------- Total liabilities........................................... 22,881 Commitments and contingencies Ownership interest of Senior Housing........................ 65,108 ------- $87,989 =======
SEE ACCOMPANYING NOTES. F-12 FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.) (A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST) CONDENSED CONSOLIDATED STATEMENTS OF INCOME (DOLLARS IN THOUSANDS) (UNAUDITED)
PERIOD FROM APRIL 27, 2000 (DATE OF SIX MONTHS ENDED COMMENCEMENT OF OPERATIONS) JUNE 30, 2001 THROUGH JUNE 30, 2000 ---------------- --------------------------- Net revenues:...................................... $113,260 $ -- Expenses: Operating expenses............................... 104,721 -- General and administrative....................... 9,813 870 Depreciation..................................... 632 -- -------- ----- Total expenses..................................... 115,166 870 -------- ----- Loss before income taxes........................... (1,906) (870) Income taxes....................................... -- -- -------- ----- Net loss........................................... $ (1,906) $(870) ======== =====
SEE ACCOMPANYING NOTES. F-13 FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.) (A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST) CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS) (UNAUDITED)
PERIOD FROM APRIL 27, 2000 (DATE OF SIX MONTHS ENDED COMMENCEMENT OF OPERATIONS) JUNE 30, 2001 THROUGH JUNE 30, 2000 ---------------- --------------------------- Cash flows from operating activities: Net loss.......................................... $ (1,906) $(870) Adjustments to reconcile net income to used in operating activities: Depreciation.................................... 632 -- Changes in assets and liabilities: Accounts receivable, net...................... (72) -- Prepaid expenses.............................. 51 -- Other assets.................................. (4,410) -- Accounts payable.............................. (2,395) -- Accrued expenses.............................. (828) -- Accrued compensation.......................... (513) -- Other liabilities............................. (2,774) -- -------- ----- Cash used in operating activities............... (12,215) (870) -------- ----- Cash flows from investing activities: Equipment purchases............................... (2,518) -- -------- ----- Cash used for investing activities.............. (2,518) -- -------- ----- Cash flows from financing activities: Proceeds from note payable........................ -- 100 Contribution from Senior Housing.................. 12,326 770 -------- ----- Cash provided by financing activities............. 12,326 870 -------- ----- Decrease in cash and cash equivalents............... (2,407) -- Cash and cash equivalents at beginning of period.... -- -- Cash and cash equivalents at facilities' operations, beginning of period............................... 7,179 -- -------- ----- Cash and cash equivalents at end of period.......... $ 4,772 $ -- ======== =====
SEE ACCOMPANYING NOTES. F-14 FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.) (A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. ORGANIZATION AND BASIS OF PRESENTATION Five Star Quality Care, Inc. (formerly known as SHOPCO Holdings, Inc.), together with its subsidiaries ("Five Star"), a subsidiary of Senior Housing Properties Trust ("Senior Housing"), a Maryland real estate investment trust (REIT), commenced operations on April 27, 2000 to operate healthcare facilities owned or mortgaged by Senior Housing. Effective July 1, 2000, Five Star assumed the operations of healthcare facilities from bankrupt tenants pursuant to negotiated settlement agreements. Mariner Post-Acute Network, Inc. ("Mariner"), which previously leased 26 healthcare facilities from Senior Housing, filed for bankruptcy in January 2000. During 2000 Senior Housing and Mariner reached an agreement that was approved by the Bankruptcy Court in June 2000. In connection with the settlement agreement, which was effective July 1, 2000, Five Star assumed operating responsibility for 17 of the 26 facilities, subject to the receipt of necessary healthcare licenses. Integrated Health Services, Inc. ("IHS") filed for bankruptcy in February 2000. In July 2000 the Bankruptcy Court approved a settlement agreement between Five Star and IHS, whereby subject to the receipt of necessary healthcare licenses, Senior Housing assumed operating responsibility for facilities previously leased by IHS, 11 facilities previously owned by IHS and subject to mortgages with Senior Housing, and nine facilities which were previously owned by IHS free of debt and conveyed to Five Star, effective July 1, 2000. Nine facilities delivered to Senior Housing by IHS in 2000 were not previously owned or mortgaged to Senior Housing. These facilities were transferred to Senior Housing by IHS as partial compensation for IHS defaults under leases and mortgages. Because these facilities were not owned or mortgaged by Senior Housing they do not qualify under Internal Revenue Code ("IRC") provisions for operation by a REIT. To comply with laws applicable to REITs, these facilities were operated during 2000 by corporations which were 99% beneficially owned by Five Star and 1% beneficially owned by Senior Housing's Managing Trustees, Barry M. Portnoy and Gerard M. Martin, who also controlled 100% of the voting power of these corporations. On January 1, 2001, the laws concerning Senior Housing's ability to own and operate these facilities changed and Five Star purchased Messrs. Portnoy and Martin's ownership interests in these entities at their initial cost. The consolidated financial statements include the accounts of Five Star. All intercompany transactions have been eliminated. These interim financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. Operating results for interim periods are not necessarily indicative of the results that may be expected for the full year. F-15 FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.) (A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Revenues are recognized when the related patient services are provided. Receivables and revenues are stated at amounts estimated to be net realizable value. Five Star's investment activities were financed primarily by Senior Housing. Substantially all amounts invested in or advanced by Five Star do not carry interest and have no specific repayment terms. 3. TRANSACTIONS WITH AFFILIATES Five Star is party to a management arrangement with FSQ, Inc. ("FSQ"), an affiliate of REIT Management & Research, Inc. ("RMR"), the investment manager for Senior Housing, pursuant to which FSQ will manage the facility operations for Five Star. FSQ is paid a fee equal to five percent of net patient revenues at the facilities. Fees paid to FSQ totaled $5.6 million for the six months ended June 30, 2001. 4. CONTINGENCIES Until Five Star received the required licenses and contracts to operate its facilities, billings for patients were made through Mariner and IHS as licensees. As of June 30, 2001, approximately $6.7 million of Five Star's revenue which was received by IHS and Mariner is included on the balance sheet in accounts receivable. Five Star believes that these funds will be collected from Mariner and IHS pursuant to their contractual obligations approved by the Bankruptcy Courts. However, IHS and Mariner remain in bankruptcy proceedings and their record keeping and payment processing has not always been timely. F-16 REPORT OF INDEPENDENT AUDITORS To the Trustees and Shareholders of Senior Housing Properties Trust We have audited the accompanying consolidated balance sheet of Five Star Quality Care, Inc. (formerly known as SHOPCO Holdings, Inc.) ("Five Star") as of December 31, 2000, and the related consolidated statements of income, ownership interest of Senior Housing, and cash flows for the period April 27, 2000, (date of commencement of operations) through December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Five Star at December 31, 2000 and the consolidated results of their operations and their cash flows for the period April 27, 2000 through December 31, 2000 in conformity with accounting principles generally accepted in the United States. /s/ ERNST & YOUNG LLP Boston, Massachusetts March 22, 2001 F-17 FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.) (A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST) CONSOLIDATED BALANCE SHEET DECEMBER 31, 2000 (DOLLARS IN THOUSANDS) ASSETS Net investment in facilities' operations.................... $29,046 Property and equipment: Land...................................................... 2,949 Building and improvements................................. 20,584 Furniture and equipment................................... 2,526 ------- 26,059 Less accumulated depreciation............................. (317) ------- 25,742 ------- $54,788 ======= LIABILITIES AND OWNERSHIP INTEREST OF SENIOR HOUSING Notes payable............................................... $ 100 Commitments and contingencies Ownership interest of Senior Housing........................ 54,688 ------- $54,788 =======
SEE ACCOMPANYING NOTES. F-18 FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.) (A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST) CONSOLIDATED STATEMENT OF INCOME FOR THE PERIOD APRIL 27, 2000 (DATE OF COMMENCEMENT OF OPERATIONS) THROUGH DECEMBER 31, 2000 (DOLLARS IN THOUSANDS) Income from facilities' operations.......................... $ 2,520 ------- Depreciation................................................ 317 General and administrative.................................. 3,519 ------- 3,836 ------- Loss before income taxes.................................... (1,316) Income taxes................................................ -- ------- Net loss.................................................... $(1,316) =======
SEE ACCOMPANYING NOTES. F-19 FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.) (A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST) CONSOLIDATED STATEMENT OF OWNERSHIP INTEREST OF SENIOR HOUSING FOR THE PERIOD APRIL 27, 2000 (DATE OF COMMENCEMENT OF OPERATIONS) THROUGH DECEMBER 31, 2000 (DOLLARS IN THOUSANDS) Balance at April 27, 2000................................... $ -- Owner's contribution, net................................... 56,004 Net loss.................................................... (1,316) ------- Balance at December 31, 2000................................ $54,688 ======= SEE ACCOMPANYING NOTES.
F-20 FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.) (A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST) CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE PERIOD APRIL 27, 2000 (DATE OF COMMENCEMENT OF OPERATIONS) THROUGH DECEMBER 31, 2000 (DOLLARS IN THOUSANDS) Cash flows from operating activities: Net loss.................................................. $ (1,316) Adjustments to reconcile net income to cash used for operating activities: Depreciation expense.................................... 317 Income from facilities' operations...................... (2,502) -------- Cash used for operating activities.................... (3,519) -------- Cash flows from investing activities: Real estate acquisitions................................ (2,300) Investment in facilities' operations.................... (38,530) -------- Cash used for investing activities...................... (40,830) -------- Cash flows from financing activities: Proceeds from note payable.................................. 100 Contribution from Senior Housing............................ 44,249 -------- Cash provided by financing activities..................... 44,349 -------- Change in cash and cash equivalents......................... -- Cash and cash equivalents at beginning of period............ -- -------- Cash and cash equivalents at end of period.................. $ -- ======== Non-cash investing and financing activities: Real estate and related property received................. $(23,759) Liabilities assumed by facilities' operations............. 12,004
SEE ACCOMPANYING NOTES. F-21 FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.) (A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 1. ORGANIZATION Five Star Quality Care, Inc. (formerly known as SHOPCO Holdings, Inc.), together with its subsidiaries ("Five Star" or the "Company") was organized on April 27, 2000, and is a wholly owned subsidiary of Senior Housing Properties Trust ("Senior Housing"), a Maryland real estate investment trust (REIT) organized on December 16, 1998. Effective July 1, 2000, Five Star assumed the operations of 49 healthcare facilities from former bankrupt tenants of Senior Housing pursuant to negotiated settlement agreements. Mariner Post-Acute Network, Inc. ("Mariner"), which previously leased 26 healthcare facilities from Senior Housing, filed for bankruptcy in January 2000. During 2000 Senior Housing and Mariner reached an agreement that was approved by the Bankruptcy Court in June 2000. In connection with the settlement agreement, which was effective July 1, 2000, Five Star assumed operating responsibility for 17 of the 26 facilities, subject to the receipt of necessary healthcare licenses. Integrated Health Services, Inc. ("IHS") filed for bankruptcy in February 2000. In July 2000 the Bankruptcy Court approved a settlement agreement between Senior Housing and IHS, whereby subject to the receipt of necessary healthcare licenses, Five Star assumed operating responsibility for 22 facilities previously leased by IHS, 11 facilities previously owned by IHS and subject to mortgages with Senior Housing, and nine facilities which were previously owned by IHS free of debt and conveyed to Five Star, effective July 1, 2000. Nine facilities delivered to Senior Housing by IHS, which were not previously owned by or mortgaged to Senior Housing, were transferred to Senior Housing by IHS as partial compensation for its defaults under leases and mortgages. Because these facilities were not owned or mortgaged by Senior Housing they do not qualify under Internal Revenue Code, IRC, provisions for operation by a REIT. To comply with laws applicable to REITs, these facilities were operated during 2000 by corporations which were 99% beneficially owned by Five Star and 1% beneficially owned by Senior Housing's Managing Trustees, Barry M. Portnoy and Gerard M. Martin, who also control 100% of the voting power of these corporations (the "Preferred Stock Corporations"). Effective January 1, 2001, applicable laws were changed to permit REITs to have voting control of taxable REIT subsidiaries. Effective January 1, 2001, Messrs. Martin and Portnoy exchanged their beneficial ownership and voting control of the Preferred Stock Corporations to Five Star for fair market value, which was deemed to be their historical investment. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION. The consolidated financial statements include the accounts of Five Star. All intercompany transactions have been eliminated. Minority interest related to the Preferred Stock Corporations is not material and has not been presented. The Company is owned by Senior Housing and transactions are presented on Senior Housing's historical basis. Substantially all of the income from facilities' operations received by the Company from the former tenants was deposited in and commingled with Senior Housing's general funds. Senior Housing provided funds for capital investments and other cash required by the Company. General and administrative expenses represent costs incurred with the formation of the Company. In the opinion of management, general and administrative costs allocated to the Company are reasonable. It is not F-22 FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.) (A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) practicable to estimate additional costs that would have been incurred by the Company as a separate entity. The facility operations received from Mariner and IHS are subject to obtaining licenses from state agencies and entering into payor agreements with the federal and state governments. The Company had not received substantially all of the required licenses as of December 31, 2000. As a result, for the period July 1, 2000, through December 31, 2000, the operations of the facilities are accounted for using the equity method of accounting and the net income from the facilities' operations is reported as Income from facilities' operations in the Consolidated Statement of Income and the capital invested in the operations by the Company is included in Net Investment in Facilities' Operations in the Consolidated Balance Sheet. OWNERSHIP INTEREST OF SENIOR HOUSING. The Company's activities were financed primarily by Senior Housing. Substantially all amounts invested in or advanced by the Company do not carry interest and have no specific repayment terms. PROPERTY AND EQUIPMENT. Property and equipment is stated at cost. Depreciation on property and equipment is expensed on a straight-line basis over the estimated useful lives of up to 40 years for buildings and improvements and up to 12 years for personal property. IMPAIRMENT OF LONG LIVED ASSETS. Impairment losses are recognized where indicators of impairment are present and the undiscounted cash flow estimated to be generated by the Company's investments is less than the carrying amount of such investments. INCOME TAXES. Income generated by the Preferred Stock Corporations and a portion of Five Star's income from the operation of foreclosure properties are subject to income taxes. Income taxes have been provided using the liability method in accordance with the requirements of SFAS No. 109, "Accounting for Income Taxes." USE OF ESTIMATES. Preparation of these financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that may affect the amounts reported in these financial statements and related notes. The actual results could differ from these estimates. 3. NET INVESTMENT IN FACILITIES' OPERATIONS Five Star assumed operating responsibility for its repossessed or acquired facilities effective July 1, 2000, pending final regulatory approvals, which are required in the healthcare industry. Five Star entered into management arrangements with FSQ, Inc. ("FSQ"), an affiliate of REIT Management & Research, Inc. ("RMR"), the manager of Senior Housing, pursuant to which FSQ will manage the properties for the Company following relicensing. Mariner and IHS agreed with Five Star and FSQ to perform transition services with respect to the facilities formerly operated by them until appropriate licenses are received by Five Star and FSQ. At December 31, 2000, all approvals had not been received. Since such approvals were not received, Five Star reported the net income from these facilities as Income from facilities' operations in the Consolidated Statement of Income for the period F-23 FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.) (A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 3. NET INVESTMENT IN FACILITIES' OPERATIONS (CONTINUED) ended December 31, 2000. The capital invested in these operations by Five Star is included in Net investment in facilities' operations in the Consolidated Balance Sheet at December 31, 2000. Summary financial data is as follows (dollars in thousands):
JULY 1 THROUGH DECEMBER 31, DECEMBER 31, 2000 2000 ------------- ------------- Current assets................... $55,938 Revenues......................... $114,483 Property and equipment, net...... 2,399 Expenses......................... 111,963 ------- -------- Income from facilities' $58,337 operations..................... $ 2,520 ======= ======== Current liabilities.............. $29,291 Net investment in facilities' operations..................... 29,046 ------- $58,337 =======
4. INCOME TAXES Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the deferred tax assets and liabilities as of December 31, 2000 are as follows (dollars in thousands): Deferred tax assets (liabilities) Allowances for doubtful accounts............................ $ 65 Net operating loss carryforward............................. 66 Fixed assets................................................ (37) ---- Net deferred tax assets before valuation allowance.......... 94 Valuation allowance......................................... (94) ---- Net deferred tax assets..................................... $ -- ====
A full valuation allowance has been recorded in the accompanying financial statements to offset the net deferred tax asset because its future realizability is uncertain. At December 31, 2000, Five Star had federal and state net operating loss carryforwards of $189,000 which may be used to reduce future income tax liabilities and expires in 2015. F-24 FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.) (A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 4. INCOME TAXES (CONTINUED) The reconciliation of the amount computed by applying the statutory Federal and State income tax rates to income before income taxes to the provision for income taxes is as follows: Tax expense at blended statutory rate....................... (35)% Change in valuation allowance............................... 35% ---- --% ====
5. TRANSACTIONS WITH AFFILIATES Five Star has entered a third party management agreement with FSQ to manage the operations of the facilities. Messrs. Martin and Portnoy, Senior Housing's Managing Trustees, own FSQ. Under this management agreement, during the first 90 days FSQ was paid its costs and expenses incurred in managing the facilities for Five Star and thereafter it is paid a fee equal to five percent of patient revenues at the managed facilities. During 2000 the fees paid to FSQ by Five Star totaled $5.1 million. This amount includes fees with respect to all services provided by FSQ to Five Star including those described in this paragraph and in the next two paragraphs. Prior to July 1, 2000, Senior Housing leased three nursing homes to Advisors Healthcare Group, Inc. ("AHG"). AHG is owned by Senior Housing's Managing Trustees, Messrs. Martin and Portnoy. AHG assumed responsibility as the licensee of these facilities to facilitate a transfer of operations among predecessors of IHS. Prior to July 1, 2000, IHS managed these facilities and was financially responsible for the rent due Senior Housing. IHS filed for bankruptcy in February 2000 and, pursuant to the settlement approved by the IHS Bankruptcy Court, the IHS management agreements and the AHG leases for these three facilities were cancelled effective July 1, 2000 and Five Star began operating these facilities on that date. Since July 1, 2000, FSQ has managed these facilities' operations for Five Star. During 2000 HRPT Properties Trust, an affiliate of Senior Housing, foreclosed on a mortgage with a principal balance outstanding of $2.4 million that went into default. In November 2000 Five Star purchased this assisted living facility from HRPT for its appraised value of $2.3 million. FSQ has managed this facility since its acquisition by Five Star. 6. COMMITMENTS AND CONTINGENCIES The settlement agreements entered by Senior Housing with Mariner and IHS were contingent, in part, upon Five Star obtaining licenses and other government approvals necessary to operate the affected healthcare facilities. Five Star applied for all of the required licenses and as of December 31, 2000, the required licenses for 26 of these facilities had been received. Required licenses for an additional 22 facilities were received in January 2001 and two more licenses were received in February 2001. The required licenses for the remaining seven facilities which are located in one state are pending. A substantial majority of the revenues at the facilities operated for Five Star's behalf is received from the Federal Medicare program and from various state Medicaid programs. Until Five Star F-25 FIVE STAR QUALITY CARE, INC. (FORMERLY KNOWN AS SHOPCO HOLDINGS, INC.) (A SUBSIDIARY OF SENIOR HOUSING PROPERTIES TRUST) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 6. COMMITMENTS AND CONTINGENCIES (CONTINUED) received the required licenses to operate these facilities, billings for these patients were made through Mariner and IHS as licensees. As of December 31, 2000, approximately $18.2 million received by IHS and Mariner since July 1, 2000, which is due to Five Star is included on the Consolidated Balance Sheet as Net investment in facilities' operations. At March 22, 2001, the receivable balance due from Mariner has been paid in full and approximately $8.5 million remained due from IHS. Five Star believes IHS will pay these funds pursuant to its contractual obligation approved by its Bankruptcy Court. However, IHS remains in bankruptcy proceedings and its record keeping and payment processing has not been timely. Applicable provisions of Federal and some state laws allow paying agents for these Medicare and Medicaid programs to recoup amounts owed by Mariner and IHS to these programs for historical overpayments from current payments despite the bankruptcy filings by Mariner and IHS. Also, some state nursing home licensing agencies have in the past required that a successor nursing home licensee, such as Five Star, agree to assume financial responsibility for a predecessor licensee's obligations due to those state Medicaid programs. Five Star has negotiated agreements with the U.S. Department of Justice and understandings with several state Medicaid agencies to limit Five Star's liabilities for obligations of Mariner and IHS to the Federal Medicare and state Medicaid programs. F-26 INDEPENDENT AUDITORS' REPORT The Board of Directors Senior Housing Properties Trust: We have audited the accompanying combined balance sheets of the Forty-two Facilities Acquired by Senior Housing Properties Trust from Integrated Health Services, Inc. (Acquired Facilities) as described in note 1 as of December 31, 2000 and 1999 and the related statements of operations, changes in net equity (deficit) of parent company and cash flows for each of the years in the three-year period ended December 31, 2000. In connection with our audits of the combined financial statements, we also have audited the financial statement schedule of valuation and qualifying accounts. These financial statements and the financial statement schedule are the responsibility of the Acquired Facilities' management. Our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the combined financial position of the Acquired Facilities as of December 31, 2000 and 1999 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic combined financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. /s/ KPMG LLP Baltimore, Maryland September 13, 2001 F-27 FORTY-TWO FACILITIES ACQUIRED BY SENIOR HOUSING PROPERTIES TRUST FROM INTEGRATED HEALTH SERVICES, INC. COMBINED BALANCE SHEETS (NOTE 1) DECEMBER 31, 2000 AND 1999 (DOLLARS IN THOUSANDS)
2000 1999 -------- -------- ASSETS Current assets: Cash and cash equivalents................................. $ 4,514 1,684 Patient accounts and third-party payor settlements receivable (note 3)..................................... 29,266 22,624 Other current assets...................................... 576 2,657 ------- ------- Total current assets.................................... 34,356 26,965 Property, plant and equipment (note 4)...................... 586 16,199 Intangible assets, net (note 5)............................. -- 18,110 ------- ------- $34,942 61,274 ======= ======= LIABILITIES AND NET EQUITY (DEFICIT) OF PARENT COMPANY Current liabilities: Accounts payable and accrued expenses (note 6)............ $ 9,499 12,891 Current maturities of long-term debt (note 7)............. -- 273 Due to Senior Housing Properties Trust (note 8)........... 27,323 -- ------- ------- Total current liabilities............................... 36,822 13,164 Long-term debt, less current maturities (note 7)............ -- 17,500 Commitments and contingencies (notes 11 and 13)............. Net equity (deficit) of Parent Company...................... (1,880) 30,610 ------- ------- $34,942 61,274 ======= =======
See accompanying notes to financial statements. F-28 FORTY-TWO FACILITIES ACQUIRED BY SENIOR HOUSING PROPERTIES TRUST FROM INTEGRATED HEALTH SERVICES, INC. COMBINED STATEMENTS OF OPERATIONS (NOTE 1) YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS)
2000 1999 1998 -------- -------- -------- Total patient service revenues.............................. $135,378 130,333 140,116 -------- -------- ------- Costs and expenses: Operating expenses........................................ 131,916 124,732 131,728 Depreciation and amortization............................. 889 4,265 5,043 Rent (note 9)............................................. 9,102 13,191 13,810 Interest, net............................................. 2,053 3,899 3,865 Loss on impairment of long-lived assets (note 12)......... -- 120,007 -- Loss on settlement of lease and mortgage obligations (note 1)................................................ 16,670 -- -- -------- -------- ------- Total costs and expenses................................ 160,630 266,094 154,446 -------- -------- ------- Loss before income taxes................................ (25,252) (135,761) (14,330) Federal and state income taxes (benefit) (note 10).......... -- (8,822) 2,853 -------- -------- ------- Net loss................................................ $(25,252) (126,939) (17,183) ======== ======== =======
See accompanying notes to financial statements. F-29 FORTY-TWO FACILITIES ACQUIRED BY SENIOR HOUSING PROPERTIES TRUST FROM INTEGRATED HEALTH SERVICES, INC. COMBINED STATEMENTS OF CHANGES IN NET EQUITY (DEFICIT) OF PARENT COMPANY (NOTE 1) YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS) Balance at December 31, 1997................................ $ 139,153 Net contributions from Parent............................... 25,055 Net loss.................................................... (17,183) --------- Balance at December 31, 1998................................ 147,025 Net contributions from Parent............................... 10,524 Net loss.................................................... (126,939) --------- Balance at December 31, 1999................................ 30,610 Net contributions from (distributions to) Parent............ (7,238) Net loss.................................................... (25,252) --------- Balance at December 31, 2000................................ $ (1,880) =========
See accompanying notes to financial statements. F-30 FORTY-TWO FACILITIES ACQUIRED BY SENIOR HOUSING PROPERTIES TRUST FROM INTEGRATED HEALTH SERVICES, INC. COMBINED STATEMENTS OF CASH FLOWS (NOTE 1) YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS)
2000 1999 1998 -------- -------- -------- Cash flows from operating activities: Net loss.................................................. $(25,252) (126,939) (17,183) Adjustments to reconcile net loss to net cash used by operating activities: Loss on impairment of long-lived assets................. -- 120,007 -- Loss on settlement...................................... 16,670 -- -- Deferred income taxes................................... -- (8,822) 2,853 Depreciation and amortization........................... 889 4,265 5,043 Decrease (increase) in patient accounts and third-party payor settlements receivable.......................... (6,642) 7,540 (8,058) Increase (decrease) in other current assets............. 2,081 (60) (1,336) Increase (decrease) in accounts payable................. (3,392) (3,822) 5,066 -------- -------- ------- Net cash used by operating activities................. (15,646) (7,831) (13,615) -------- -------- ------- Cash flows from investing activities: Purchases of property, plant and equipment................ (1,472) (3,108) (10,338) -------- -------- ------- Net cash used by investing activities................. (1,472) (3,108) (10,338) -------- -------- ------- Cash flows from financing activities: Repayments of long-term debt.............................. (137) (220) (193) Net contributions from (distributions to) parent company................................................. (7,238) 10,524 25,055 Advances from Senior Housing Properties Trust............. 27,323 -- -- -------- -------- ------- Net cash provided by financing activities............. 19,948 10,304 24,862 -------- -------- ------- Increase (decrease) in cash and cash equivalents...... 2,830 (635) 909 Cash and cash equivalents, beginning of period.............. 1,684 2,319 1,410 -------- -------- ------- Cash and cash equivalents, end of period.................... $ 4,514 1,684 2,319 ======== ======== =======
See accompanying notes to financial statements. F-31 FORTY-TWO FACILITIES ACQUIRED BY SENIOR HOUSING PROPERTIES TRUST FROM INTEGRATED HEALTH SERVICES, INC. NOTES TO COMBINED FINANCIAL STATEMENTS DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS) (1) BACKGROUND AND BASIS OF PRESENTATION Prior to July 7, 2000, Integrated Health Services, Inc. (IHS or the Parent Company), through its wholly owned subsidiaries, operated various skilled nursing facilities with respect to which Senior Housing Properties Trust (SNH) was owner/lessor or first mortgage lender. In January 2000, IHS ceased making rent and interest payments on these obligations and subsequently filed for bankruptcy in February 2000. On July 7, 2000, effective as of July 1, 2000, the Bankruptcy Court approved a settlement agreement whereby IHS' lease and mortgage obligations to SNH were cancelled and IHS conveyed nine nursing homes and one parcel of non-operating real property to a subsidiary of SNH. As a result, SNH has obtained the operations of 42 facilities previously operated by IHS (the Acquired Facilities). IHS managed the Acquired Facilities under a management agreement with SNH for the period from July 1, 2000 to September 30, 2000. The Acquired Facilities' financial statements are presented for the purposes of complying with the Securities and Exchange Commission's rules and regulations regarding acquired businesses. The combined financial statements of the Acquired Facilities reflect the historical accounts of the skilled nursing facilities, including allocations of general and administrative expenses from the IHS corporate office to the individual facilities. Such corporate office allocations, calculated as a percentage of revenue, are based on determinations that management believes to be reasonable. However, IHS has operated certain other businesses and has provided certain services to the Acquired Facilities, including financial, legal, accounting, human resources and information systems services. Accordingly, expense allocations to the Company may not be representative of costs of such services to be incurred in the future (see note 11). The financial statements for periods prior to July 1, 2000 represent the financial position and results of operations of the Acquired Facilities as reflected in the accounts of IHS' subsidiaries. Such subsidiaries leased 19 facilities from SNH, owned 11 facilities with respect to which SNH was mortgagee, and owned, leased or managed 12 other facilities not previously affiliated with SNH. The financial statements for the period subsequent to July 1, 2000 represent the financial position and results of operations of the Acquired Facilities as described above and give effect to the terms of the aforementioned settlement agreement. Accordingly, as of July 1, 2000, the accounts of the Acquired Facilities no longer include the property, plant and equipment and intangible assets of the facilities conveyed to SNH, related mortgage debt, mortgage interest, and depreciation and amortization of such facilities. The loss on settlement represents the carrying value of the tangible and intangible assets of the facilities conveyed to SNH, less the related mortgage debt. F-32 FORTY-TWO FACILITIES ACQUIRED BY SENIOR HOUSING PROPERTIES TRUST FROM INTEGRATED HEALTH SERVICES, INC. NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS) (1) BACKGROUND AND BASIS OF PRESENTATION (CONTINUED) The operating results of the Acquired Facilities for the six-month period ended June 30, 2000 (prior to the settlement agreement) and the six-month period ended December 31, 2000 are summarized below:
SIX MONTHS SIX MONTHS YEAR ENDED ENDED ENDED JUNE 30, DECEMBER 31, DECEMBER 31, 2000 2000 2000 ---------- ------------- ------------- Total patient service revenues............ $65,195 70,183 135,378 ------- ------- ------- Costs and expenses: Operating expenses...................... 63,865 68,051 131,916 Depreciation and amortization........... 876 13 889 Rent (note 9)........................... 6,323 2,779 9,102 Interest, net........................... 2,053 -- 2,053 Loss on settlement...................... -- 16,670 16,670 ------- ------- ------- Total costs and expenses.............. 73,117 87,513 160,630 ------- ------- ------- Loss before income taxes.............. $(7,922) (17,330) (25,252) ======= ======= =======
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (A) REVENUES Revenues, primarily patient services revenues related to room and board charges, ancillary charges and revenues of pharmacy, rehabilitation and similar service operations, are recorded at established rates and adjusted for differences between such rates and estimated amounts reimbursable by third-party payors. As of January 1, 1999, Medicare revenue is recognized pursuant to the Prospective Payment System (PPS). Under PPS, per diem federal rates were established for urban and rural areas. Rates are case-mix adjusted using Resource Utilization Groups. PPS is implemented over a three-year transition period that blends a facility-specific payment rate with the federal case-mix adjusted rate. Estimated settlements under third-party payor retrospective rate setting programs (primarily Medicare for periods prior to January 1, 1999 and Medicaid) are accrued in the period that related services are rendered. Settlements receivable and related revenues under such programs are based on annual cost reports prepared in accordance with federal and state regulations, which reports are subject to audit and retroactive adjustment. In the opinion of management, adequate provision has been made therefor, and such adjustments in determining final settlements will not have a material effect on financial position or results of operations. F-33 FORTY-TWO FACILITIES ACQUIRED BY SENIOR HOUSING PROPERTIES TRUST FROM INTEGRATED HEALTH SERVICES, INC. NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS) (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (B) CASH AND CASH EQUIVALENTS Cash equivalents consist of highly liquid debt instruments with original maturities of three months or less. (C) DEPRECIATION AND AMORTIZATION Property, plant and equipment are recorded at cost. Depreciation and amortization are provided using the straight-line method over the estimated useful lives of the related assets, generally 25 years for land improvements, 10 years for equipment, 40 years for buildings and the term of the lease for costs of leasehold interests and improvements. (D) INTANGIBLE ASSETS Prior to the fourth quarter of 1999, intangible assets of businesses acquired (primarily goodwill) were amortized by the straight-line method primarily over 40 years, the period over which such costs were estimated to be recoverable through operating cash flows. As discussed in note 12, management of IHS continued to evaluate the impact of the 1997 Balanced Budget Act (BBA), particularly the impact of the prospective payment system (PPS), upon future operating results of the facilities. Utilizing IHS' experience with PPS since January 1, 1999, management performed a preliminary analysis of such impact in the third quarter of 1999 and a more comprehensive analysis at December 31, 1999. PPS has had a dramatic negative impact on the operating results and financial condition of the Acquired Facilities. The PPS system has significantly reduced the revenues, cash flow and liquidity of the Acquired Facilities and the long-term care industry in 1999. As a result of the negative impact of the provisions of PPS, management changed the estimated life of its goodwill to 20 years. This change has been treated as a change in accounting estimate and is being recognized prospectively beginning October 1, 1999. (E) IMPAIRMENT OF LONG-LIVED ASSETS Management regularly evaluates whether events or changes in circumstances have occurred that could indicate an impairment in the value of long-lived assets. If there is an indication that the carrying value of an asset is not recoverable, management estimates the projected undiscounted cash flows of the related individual facilities (the lowest level for which there are identifiable cash flows independent of other groups of assets) to determine if an impairment loss should be recognized. The amount of impairment loss is determined by comparing the historical carrying value of the asset to its estimated fair value. Estimated fair value is determined through an evaluation of recent financial performance and projected discounted cash flows of facilities using standard industry valuation techniques. In addition to consideration of impairment upon the events or changes in circumstances described above, management regularly evaluates the remaining lives of its long-lived assets. If estimates are changed, the carrying value of affected assets is allocated over the remaining lives. Management performed such an analysis at December 31, 1999 (see notes 1 (d) and 12). F-34 FORTY-TWO FACILITIES ACQUIRED BY SENIOR HOUSING PROPERTIES TRUST FROM INTEGRATED HEALTH SERVICES, INC. NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS) (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (F) INCOME TAXES The Acquired Facilities are included in the Parent Company's consolidated federal income tax return. The income taxes reported in the Acquired Facilities financial statements are an allocation of income taxes calculated as if the Acquired Facilities were a separate taxpayer, in accordance with Statement of Financial Accounting Standards No. 109 (SFAS No. 109), ACCOUNTING FOR INCOME TAXES. Deferred income taxes are recognized for the tax consequences of temporary differences between financial statement carrying amounts and the related tax bases of assets and liabilities as required by SFAS No. 109. Such tax effects are measured by applying enacted statutory tax rates applicable to future years in which the differences are expected to reverse, and any change in tax rates will be recognized in the period that includes the date of enactment. (G) NET EQUITY (DEFICIT) OF PARENT COMPANY The Parent Company transfers excess cash from and makes working capital advances and corporate allocations to the Acquired Facilities. These advances include amounts to fund cash shortfalls, capital expenditures, advances for accounts payable and amounts paid for employee benefits and other programs administered by the Parent Company. The resulting net balance of the aforementioned transactions, the Parent Company's initial investment in the Acquired Facilities and the cumulative deficit of the Acquired Facilities is classified as Net Equity (Deficit) of Parent Company in the accompanying balance sheet. (H) BUSINESS AND CREDIT CONCENTRATIONS The Acquired Facilities' patient services are provided through 42 facilities located in 10 states throughout the United States. The Acquired Facilities generally do not require collateral or other security in extending credit to patients; however, the Acquired Facilities routinely obtain assignments of (or are otherwise entitled to receive) benefits receivable under the health insurance programs, plans or policies of patients (e.g., Medicare, Medicaid, commercial insurance and managed care organizations) (see note 3). (I) USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (J) RECLASSIFICATION Certain amounts presented in 1998 and 1999 have been reclassified to conform with the presentation for 2000. F-35 FORTY-TWO FACILITIES ACQUIRED BY SENIOR HOUSING PROPERTIES TRUST FROM INTEGRATED HEALTH SERVICES, INC. NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS) (3) PATIENT ACCOUNTS AND THIRD-PARTY PAYOR SETTLEMENTS RECEIVABLE Patient accounts and third-party payor settlements receivable consist of the following at December 31:
2000 1999 -------- -------- Patient accounts......................................... $ 28,996 $19,396 Third-party payor settlements............................ 13,147 12,194 -------- ------- 42,143 31,590 Allowance for doubtful accounts and contractual adjustments............................................ (12,877) (8,966) -------- ------- $ 29,266 $22,624 ======== =======
Patient accounts receivable and third party payor settlements receivable from the Federal government (Medicare) were approximately $14,246 and $10,757 at December 31, 2000 and 1999, respectively. Amounts receivable from various states (Medicaid) were approximately $17,161 and $16,189 at December 31, 2000 and 1999, respectively. (4) PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment are summarized as follows at December 31:
2000 1999 -------- -------- Land and improvements....................................... $ -- $ 6,306 Buildings and improvements.................................. -- 3,104 Leasehold interests and improvements........................ -- 2,637 Equipment................................................... 598 7,134 ---- ------- 598 19,181 Less accumulated depreciation and amortization.............. 12 2,982 ---- ------- Net property, plant and equipment....................... $586 $16,199 ==== =======
(5) INTANGIBLE ASSETS Intangible assets are summarized as follows at December 31, 1999: Intangible assets of businesses acquired, primarily goodwill.................................................. $23,287 Less accumulated amortization............................... (5,177) ------- Net intangible assets................................... $18,110 =======
Management regularly evaluates whether events or circumstances have occurred that would indicate an impairment in the carrying value or the life of goodwill. In accordance with SFAS No. 121, F-36 FORTY-TWO FACILITIES ACQUIRED BY SENIOR HOUSING PROPERTIES TRUST FROM INTEGRATED HEALTH SERVICES, INC. NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS) (5) INTANGIBLE ASSETS (CONTINUED) if there is an indication that the carrying value of an asset, including goodwill, is not recoverable, Management estimates the projected undiscounted cash flows, excluding interest, of the related business unit to determine if an impairment loss should be recognized. Such impairment loss is determined by comparing the carrying amount of the asset, including goodwill, to its estimated fair value. Management performs the impairment analysis at the individual facility level. See note 12 for information regarding impairment of assets in the year ended December 31, 1999. (6) ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses are summarized as follows at December 31:
2000 1999 -------- -------- Accounts payable........................................... $5,105 $ 8,294 Accrued salaries and wages................................. 3,015 3,468 Other accrued expenses..................................... 1,379 1,129 ------ ------- $9,499 $12,891 ====== =======
(7) LONG-TERM DEBT Long-term debt is summarized as follows at December 31, 1999: Mortgages payable in monthly installments of $87, including interest at rates ranging from 10.3% to 10.86%, due December 2016............................................. $ 8,687 Mortgages payable in monthly installments of $95, including interest at 11.5%, due January 2006....................... 9,086 ------- 17,773 Less current maturities..................................... 273 ------- Total long-term debt, less current portion.............. $17,500 =======
At December 31, 1999 the aggregate maturities of long-term debt for the five years ending December 31, 2004 are as follows: 2000........................................................ $ 273 2001........................................................ 304 2002........................................................ 339 2003........................................................ 378 2004........................................................ 421 Thereafter.................................................. 16,058 ------- $17,773 =======
F-37 FORTY-TWO FACILITIES ACQUIRED BY SENIOR HOUSING PROPERTIES TRUST FROM INTEGRATED HEALTH SERVICES, INC. NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS) (8) DUE TO SENIOR HOUSING PROPERTIES TRUST (SNH) Subsequent to July 1, 2000, SNH advanced funds for operating expenses and working capital of the Acquired Facilities and allocated facility rents. Such advances bear no interest (see notes 9 and 11). (9) LEASES The Acquired Facilities leased equipment under short-term operating leases having rental costs of approximately $1,146 in 2000, $1,800 in 1999 and $2,214 in 1998. Leases of facilities were terminated in 2000 as discussed in note 1; however, in accordance with Staff Accounting Bulletin No. 55, "Allocation of Expenses and Related Disclosure in Financial Statements of Subsidiaries, Divisions or Lesser Business Components of Another Entity", $2,159 is included in rent expense for the period subsequent to July 1, 2000, representing an allocation of the total estimated fair market rental value of the facilities. The annual fair market rental value has been estimated for a combined group of facilities, including the Acquired Facilities, and has been allocated based on the respective total revenues of the facilities. (10) INCOME TAXES The Acquired Facilities have been included in the Parent Company's consolidated federal income tax return. The allocated provision (benefit) for income taxes on loss before income taxes is summarized as follows at December 31:
2000 1999 1998 --------- -------- -------- Current................................................. $ -- -- -- Deferred................................................ -- (8,822) 2,853 --------- ------ ----- $ -- (8,822) 2,853 ========= ====== =====
The amount computed by applying the Federal corporate tax rate of 35% in 2000, 1999 and 1998 to loss before income taxes is summarized as follows at December 31:
2000 1999 1998 -------- -------- -------- Income tax computed at statutory rates............. $(8,083) (47,516) (5,016) State income taxes, net of Federal tax benefit and nondeductible items.............................. (1,090) (6,724) (666) Jobs tax credit.................................... (93) (94) (90) Valuation allowance adjustment..................... 9,266 45,512 8,625 ------- ------- ------ $ -- (8,822) 2,853 ======= ======= ======
F-38 FORTY-TWO FACILITIES ACQUIRED BY SENIOR HOUSING PROPERTIES TRUST FROM INTEGRATED HEALTH SERVICES, INC. NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS) (10) INCOME TAXES (CONTINUED) Deferred income tax liabilities (assets) at December 31, 2000 and 1999, are summarized as follows:
2000 1999 -------- -------- Difference in book and tax bases of intangible assets.... $ -- (28,002) Difference in book and tax bases of fixed assets......... 4 (9,327) Allowance for doubtful accounts.......................... (5,151) (3,586) Net operating loss carryforwards......................... (57,979) (13,038) Job tax credit carryovers................................ (277) (184) -------- ------- Total before valuation allowance..................... (63,403) (54,137) -------- ------- Valuation allowance...................................... 63,403 54,137 -------- ------- Net deferred tax liabilities......................... $ -- -- ======== =======
(11) OTHER RELATED PARTY TRANSACTIONS Corporate administrative and general expenses (included in operating expenses) represent management fees for certain services, including financial, legal, accounting, human resources and information systems services provided by the Parent Company. Management fees have been provided at approximately 6% of total revenues of each facility. Management fees charged by the Parent Company were $4,311 for the nine months ended September 30, 2000, $6,254 in 1999 and $7,689 in 1998, and have been determined based on an allocation of the Parent Company's corporate general and administrative expenses. Such allocation has been made because specific identification of expenses is not practicable. Management believes that this allocation method is reasonable. However, management believes that the Acquired Facilities' corporate administrative and general expenses on a stand-alone basis may have been different had the Acquired Facilities operated as an unaffiliated entity. Management fees charged by SNH were $1,773 for the three months ended December 31, 2000. (12) LOSS ON IMPAIRMENT OF LONG-LIVED ASSETS During the year ended December 31, 1999, the Parent Company continued to evaluate the impact of the 1997 Balanced Budget Act (BBA), particularly the impact of the Prospective Payment System (PPS), upon the future operating results on its facilities. Utilizing the Parent Company's (including the Acquired Facilities) experience with PPS since January 1, 1999, the Parent Company performed a preliminary analysis of such impact as of September 30, 1999 and a more comprehensive analysis at December 31, 1999. PPS has had a dramatic impact on the operating results and financial condition of the Acquired Facilities. PPS has significantly reduced the revenues, cash flow and liquidity of the Acquired Facilities and others in the industry in 1999. As a result of the negative impact of the provisions of PPS, the Acquired Facilities assessed the impairment of its long-lived assets in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 121 in 1999. In F-39 FORTY-TWO FACILITIES ACQUIRED BY SENIOR HOUSING PROPERTIES TRUST FROM INTEGRATED HEALTH SERVICES, INC. NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS) (12) LOSS ON IMPAIRMENT OF LONG-LIVED ASSETS (CONTINUED) accordance with SFAS No. 121, the Acquired Facilities estimated the future cash flows expected to result from those assets to be held and used. In estimating the future cash flows for determining whether an asset is impaired, and if expected future cash flows used in measuring assets are impaired, the Acquired Facilities grouped the assets at the lowest level for which there are identifiable cash flows independent of other groups of assets, which is at the facility level. After determining the facilities eligible for an impairment charge, Management determined the estimated fair value of such facilities and compared such fair value to the carrying values of the related assets. The carrying value of buildings and improvements, leasehold improvements, equipment and goodwill exceeded the fair value by $120,007; accordingly, the Acquired Facilities recognized such amount as a loss on impairment of long-lived assets during the year ended December 31, 1999. (13) CERTAIN SIGNIFICANT RISKS AND UNCERTAINTIES The following information is provided in accordance with the AICPA Statement of Position No. 94-6, DISCLOSURE OF CERTAIN SIGNIFICANT RISKS AND UNCERTAINTIES. The Acquired Facilities and others in the healthcare business are subject to certain inherent risks, including the following: - Substantial dependence on revenues derived from reimbursement by the Federal Medicare and state Medicaid programs which have been drastically cut in recent years and which entail exposure to various healthcare fraud statutes; - Government regulations, government budgetary constraints and proposed legislative and regulatory changes; and - Lawsuits alleging malpractice and related claims. Such inherent risks require the use of certain management estimates in the preparation of the Acquired Facilities financial statements and it is reasonably possible that a change in such estimates may occur. The Acquired Facilities receives payment for a significant portion of services rendered to patients from the Federal government under Medicare and from the states in which its facilities and/or services are located under Medicaid. The Acquired Facilities operations are subject to a variety of Federal, state and local legal and regulatory risks, including without limitation the federal Anti-Kickback statute and the federal Ethics in Patient Referral Act (so-called "Stark Law"), many of which apply to virtually all companies engaged in the health care services industry. The Anti-Kickback statute prohibits, among other things, the offer, payment, solicitation or receipt of any form of remuneration in return for the referral of Medicare and Medicaid patients. The Stark Law prohibits, with limited exceptions, financial relationships between ancillary service providers and referring physicians. Other regulatory risks F-40 FORTY-TWO FACILITIES ACQUIRED BY SENIOR HOUSING PROPERTIES TRUST FROM INTEGRATED HEALTH SERVICES, INC. NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS) (13) CERTAIN SIGNIFICANT RISKS AND UNCERTAINTIES (CONTINUED) assumed by the Acquired Facilities and other companies engaged in the health care industry are as follows: - False Claims--"Operation Restore Trust" is a major anti-fraud demonstration project of the Office of the Inspector General. The primary purpose for the project is to scrutinize the activities of healthcare providers which are reimbursed under the Medicare and Medicaid programs. False claims are prohibited pursuant to criminal and civil statutes and are punishable by imprisonment and monetary penalties. - Regulatory Requirement Deficiencies--In the ordinary course of business health care facilities receive notices of deficiencies for failure to comply with various regulatory requirements. In some cases, the reviewing agency may take adverse actions against a facility, including the imposition of fines, temporary suspension of admission of new patients, suspension or decertification from participation in the Medicare and Medicaid programs and, in extreme cases, revocation of a facility's license. - Changes in laws and regulations--Changes in laws and regulations could have a material adverse effect on licensure, eligibility for participation in government programs, permissable activities, operating costs and the levels of reimbursement from governmental and other sources. In response to the aforementioned regulatory risks, the Parent Company formed a Corporate Compliance Department in 1996 to help identify, prevent and deter instances of Medicare and Medicaid noncompliance. Although the Parent Company and the Acquired Facilities strive to manage these regulatory risks, there can be no assurance that federal and/or state regulatory agencies that currently have jurisdiction over matters including, without limitation, Medicare, Medicaid and other government reimbursement programs, will take the position that the Acquired Facilities business and operations are in compliance with applicable law or with the standards of such regulatory agencies. In some cases, violation of such applicable law or regulatory standards by the Acquired Facilities can carry significant civil and criminal penalties and can give rise to qui tam litigation. In this connection, the Acquired Facilities are a defendant in certain actions or the subject of investigations concerning alleged violations of the False Claims Act or of Medicare regulations. As a result of the Parent Company's and the Acquired Facilities' financial position, various agencies of the federal government accelerated efforts to reach a resolution of all outstanding claims and issues related to the Parent Company's and the Acquired Facilities' alleged violations of healthcare statutes and related causes of action. The Parent Company has commenced global settlement negotiations with the government; however, the Parent Company is unable to assess fully the merits of the government's monetary claims at this time. In addition, the Parent Company is unable to determine the amount, if any, that might relate to the Acquired Facilities. The BBA, enacted in August 1997, made numerous changes to the Medicare and Medicaid programs that are significantly affecting the Acquired Facilities. With respect to Medicare, the BBA provides, among other things, for a prospective payment system for skilled nursing facilities. As a result, F-41 FORTY-TWO FACILITIES ACQUIRED BY SENIOR HOUSING PROPERTIES TRUST FROM INTEGRATED HEALTH SERVICES, INC. NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS) (13) CERTAIN SIGNIFICANT RISKS AND UNCERTAINTIES (CONTINUED) in 1999 the Acquired Facilities bore the cost risk of providing care inasmuch as they receive specified reimbursement for each treatment regardless of actual cost. With respect to Medicaid, the BBA repeals the so-called Boren Amendment, which required state Medicaid programs to reimburse nursing facilities for the costs that are incurred by efficiently and economically operated providers in order to meet quality and safety standards. As a result, states now have considerable flexibility in establishing payment rates and management believes many states are moving toward a prospective payment type system for skilled nursing facilities. The BBA mandates the establishment of a PPS for Medicare skilled nursing facility services, under which facilities are paid a fixed fee for virtually all covered services. PPS is being phased in over a four-year period, effective January 1, 1999 for the Acquired Facilities. During the first three years, payments will be based on a blend of the facility's historical costs and a pre-determined federal rate. Thereafter, the per diem rates will be based 100% on the federal cost rate. Under PPS, each patient's clinical status is evaluated and placed into a payment category. The patient's payment category dictates the amount that the provider will receive to care for the patient on a daily basis. The per diem rate covers (i) all routine inpatient costs currently paid under Medicare Part A, (ii) certain ancillary and other items and services currently covered separately under Medicare Part B on a "pass-through" basis, and (iii) certain capital costs. The Acquired Facilities ability to offer the ancillary services required by higher acuity patients, such as those in its subacute care programs to Medicare beneficiaries, in a cost-effective manner will continue to be critical to the Acquired Facilities services and will affect the profitability. To date the per diem reimbursement rates have generally been significantly less than the amount the Acquired Facilities received on a daily basis under cost based reimbursement, particularly in the case of higher acuity patients. As a result, PPS has had a material adverse impact on the Acquired Facilities' results of operations and financial condition (see note 12). The Acquired Facilities are also subject to malpractice and related claims, which arise in the normal course of business and which could have a significant effect on the Acquired Facilities. As a result, the Acquired Facilities maintain occurrence basis professional and general liability insurance with coverage and deductibles which management believes to be appropriate. F-42 FORTY-TWO FACILITIES ACQUIRED BY SENIOR HOUSING PROPERTIES TRUST FROM INTEGRATED HEALTH SERVICES, INC. SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E -------- ---------- ----------------- ------------- ----------- BALANCE AT ADDITIONS CHARGED BEGINNING TO OPERATING BALANCE AT DESCRIPTION OF YEAR ACCOUNTS DEDUCTIONS(1) END OF YEAR ----------- ---------- ----------------- ------------- ----------- Allowance for doubtful accounts: Year ended December 31, 2000................... $ 8,966 $ 5,001 $(1,090) $12,877 ======= ======= ======= ======= Year ended December 31, 1999................... $ 7,016 $ 2,598 $ (648) $ 8,966 ======= ======= ======= ======= Year ended December 31, 1998................... $ 1,744 $ 5,537 $ (265) $ 7,016 ======= ======= ======= =======
------------------------ (1) Amounts represent bad debt write-offs. F-43 REPORT OF INDEPENDENT AUDITORS To the Board of Trustees and Shareholders of Senior Housing Properties Trust: We have audited the accompanying combined balance sheets of Certain Mariner Post-Acute Network Facilities (Operated by subsidiaries of Mariner Post-Acute Network, Inc.) (the "Facilities"), as defined in Note 1, as of December 31, 2000 and 1999, and the related combined statements of operations, divisional equity (deficit), and cash flows for each of the three years in the period ended December 31, 2000. Our audits also included the financial statement schedule listed in the Index on page F-1. These financial statements and schedule are the responsibility of the Facilities' management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the combined financial position of Certain Mariner Post-Acute Network Facilities, as defined in Note 1, at December 31, 2000 and 1999, and the combined results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. /s/ ERNST & YOUNG LLP September 19, 2001 Boston, Massachusetts F-44 CERTAIN MARINER POST-ACUTE NETWORK FACILITIES (OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK) (DEBTOR IN POSSESSION AS OF JANUARY 20, 2000) COMBINED BALANCE SHEETS (DOLLARS IN THOUSANDS)
DECEMBER 31 ------------------- 2000 1999 -------- -------- ASSETS Current assets: Cash and cash equivalents................................. $ 2,508 $ -- Patient receivables, less allowance for doubtful accounts of $1,834 in 2000 and $1,534 in 1999.................... 7,501 6,888 Other receivables......................................... 3,489 321 Other current assets...................................... 477 226 -------- -------- Total current assets........................................ 13,975 7,435 Property and equipment: Building improvements..................................... 4,128 3,563 Furniture, fixtures and equipment......................... 635 371 -------- -------- 4,763 3,934 Less accumulated depreciation............................. (3,725) (2,425) -------- -------- 1,038 1,509 Goodwill, net............................................... 8,012 8,471 Other assets................................................ 27 18 -------- -------- Total assets................................................ $ 23,052 $ 17,433 ======== ======== LIABILITIES AND DIVISIONAL DEFICIT Current liabilities: Accounts payable and accrued expenses..................... $ 12,645 $ 9,638 Accrued wages and related liabilities..................... 3,570 3,584 Due to Senior Housing Properties Trust.................... 5,760 -- Current portion of long-term debt......................... -- 919 Current portion of unfavorable lease obligations and other non-current liabilities................................. 3,673 3,719 -------- -------- Total current liabilities................................... 25,648 17,860 Liabilities subject to compromise........................... 7,111 -- Unfavorable lease obligations and other non-current liabilities............................................... 24,980 28,603 -------- -------- Total liabilities........................................... 57,739 46,463 Commitments and contingencies Divisional deficit.......................................... (34,687) (29,030) -------- -------- Total liabilities and divisional deficit.................... $ 23,052 $ 17,433 ======== ========
SEE ACCOMPANYING NOTES. F-45 CERTAIN MARINER POST-ACUTE NETWORK FACILITIES (OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK) (DEBTOR IN POSSESSION AS OF JANUARY 20, 2000) COMBINED STATEMENTS OF OPERATIONS (DOLLARS IN THOUSANDS) YEAR ENDED DECEMBER 31,
2000 1999 1998 -------- -------- -------- Revenues: Net patient revenues...................................... $85,128 $ 86,643 $105,130 Other..................................................... 197 302 356 ------- -------- -------- Total revenues.............................................. 85,325 86,945 105,486 Expenses: Salaries, wages and benefits.............................. 55,033 50,619 43,582 Nursing, dietary and other supplies....................... 5,445 5,592 4,982 Ancillary services........................................ 4,077 3,848 24,441 Facility general and administrative costs................. 7,205 9,394 8,090 Allocation of corporate overhead.......................... 4,101 4,347 5,274 Insurance................................................. 4,496 4,876 4,267 Rent...................................................... 8,748 9,315 8,241 Depreciation and amortization............................. 1,766 2,027 2,886 Impairment of long-lived assets........................... -- 36,322 8,670 Provision for bad debts................................... 1,758 4,233 1,627 ------- -------- -------- Total expenses.............................................. 92,629 130,573 112,060 ------- -------- -------- Loss from operations........................................ (7,304) (43,628) (6,574) Interest expense............................................ (121) (181) (1,138) Interest income............................................. 4 5 2 ------- -------- -------- Loss before income taxes.................................... (7,421) (43,804) (7,710) Provision for income taxes.................................. -- -- -- ------- -------- -------- Net loss.................................................... $(7,421) $(43,804) $ (7,710) ======= ======== ========
SEE ACCOMPANYING NOTES. F-46 CERTAIN MARINER POST-ACUTE NETWORK FACILITIES (OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK) (DEBTOR IN POSSESSION AS OF JANUARY 20, 2000) COMBINED STATEMENTS OF DIVISIONAL EQUITY (DEFICIT) (DOLLARS IN THOUSANDS) Balance at December 31, 1997................................ $ 21,671 Contributions from Parent, net............................ 503 Net loss.................................................. (7,710) -------- Balance at December 31, 1998................................ 14,464 Contributions from Parent, net............................ 310 Net loss.................................................. (43,804) -------- Balance at December 31, 1999................................ (29,030) Contributions from Parent, net............................ 1,764 Net loss.................................................. (7,421) -------- Balance at December 31, 2000................................ $(34,687) ========
SEE ACCOMPANYING NOTES. F-47 CERTAIN MARINER POST-ACUTE NETWORK FACILITIES (OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK) (DEBTOR IN POSSESSION AS OF JANUARY 20, 2000) COMBINED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS) YEAR ENDED DECEMBER 31,
2000 1999 1998 -------- -------- -------- OPERATING ACTIVITIES Net loss.................................................... $(7,421) $(43,804) $ (7,710) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization........................... 1,766 2,027 2,886 Amortization of unfavorable lease obligations and other non-current liabilities..................... (3,673) (3,691) (2,248) Provision for bad debts................................. 1,758 4,233 1,627 Impairment of long-lived assets......................... -- 36,322 8,670 Increase (decrease) in cash arising from changes in operating assets and liabilities: Patient receivables..................................... 3,567 2,915 (2,564) Other receivables....................................... (3,168) 987 2,887 Other assets............................................ (9) (35) 51 Accounts payable and accrued expenses................... 3,007 1,527 111 Accrued wages and related liabilities................... (14) 621 (514) Due to Senior Housing Properties Trust.................. 5,760 -- -- ------- -------- -------- Net cash provided by operating activities................... 1,573 1,102 3,196 ------- -------- -------- INVESTING ACTIVITIES Purchases of property and equipment......................... (829) (1,362) (2,160) Disposals of property, equipment and other assets........... -- -- 9,971 ------- -------- -------- Net cash provided by (used in) investing activities......... (829) (1,362) 7,811 ------- -------- -------- FINANCING ACTIVITIES Capital contributions, net.................................. 1,764 310 503 Repayment of debt........................................... -- -- (11,466) Repayment of capital lease.................................. -- (50) (44) ------- -------- -------- Net cash provided by (used in) financing activities......... 1,764 260 (11,007) ------- -------- -------- Net increase in cash........................................ 2,508 -- -- Cash at beginning of year................................... -- -- -- ------- -------- -------- Cash at end of year......................................... $ 2,508 $ -- $ -- ======= ======== ========
SEE ACCOMPANYING NOTES. F-48 CERTAIN MARINER POST-ACUTE NETWORK FACILITIES (OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK) (DEBTOR IN POSSESSION AS OF JANUARY 20, 2000) NOTES TO COMBINED FINANCIAL STATEMENTS 1. ORGANIZATION The combined financial statements of Certain Mariner Post-Acute Network Facilities (the "Facilities") include the accounts of 17 nursing home facilities and certain related assets and liabilities owned and controlled by Mariner Post-Acute Network, Inc. ("Mariner" or the "Parent"). The Facilities are owned by wholly owned subsidiaries of GranCare, Inc. ("GranCare"), a wholly owned subsidiary of Mariner. The Facilities constitute a division of Mariner and are not separate legal entities. Mariner, formerly known as Paragon Health Network, Inc., was formed in November 1997 through the recapitalization by merger of Living Centers of America, Inc. ("LCA") with a newly-formed entity owned by certain affiliates of Apollo Management, L.P. and the subsequent merger of GranCare (the "GranCare Merger"). Mariner and certain of its respective subsidiaries, including those subsidiaries operating the Facilities, filed separate voluntary petitions (collectively, the "Chapter 11 Filings") for relief under Chapter 11 of Title 11 of the United States Code (the "Bankruptcy Code") with the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court") on January 18, 2000 (the "Petition Date"). Mariner is presently operating its business as a debtor-in-possession and is subject to the jurisdiction of the Bankruptcy Court while a plan of reorganization is formulated. Mariner's and its subsidiaries' need to seek relief afforded by the Bankruptcy Code is due, in part, to the significant financial pressure created by the implementation of the Balanced Budget Act of 1997. Mariner, through its GranCare subsidiaries, leased the Facilities from a wholly owned subsidiary of Senior Housing Properties Trust ("SNH"), which succeeded to the interests of Health and Retirement Properties Trust ("HRPT"). On May 10, 2000, the Bankruptcy Court approved a settlement agreement (the "Settlement Agreement") between Mariner, certain of its GranCare subsidiaries, and subsidiaries of SNH. The Settlement Agreement is effective at the close of business on June 30, 2000 and is subject to obtaining regulatory approvals in the states where the Facilities are located. Based upon the terms of the Settlement Agreement: (a) the Facilities leased by the GranCare subsidiaries and the related personal property were assigned to subsidiaries of SNH and (b) Mariner agreed to manage the Facilities transferred to the SNH during a transition period that was expected to last less than six months. As of December 31, 2000, the transition period has ended and management of the Facilities is being performed by SNH. As specified in the Settlement Agreement, certain assets and liabilities reflected on the accompanying combined balance sheet as of December 31, 2000 will remain with Mariner including liabilities subject to compromise, unfavorable lease obligations and goodwill. In connection with the Settlement Agreement, outstanding indebtedness of the Facilities was terminated (see Note 8) and Mariner paid SNH at closing approximately $2,335,000 to settle its obligations for property taxes payable and certain employee accrued liabilities. The aforementioned transaction has not been reflected in the accompanying combined financial statements. The Settlement Agreement is contingent upon SNH obtaining licenses and other governmental approvals necessary to operate the Facilities. SNH has applied for all of the required licenses and, as of January 31, 2001, the required licenses for substantially all of these facilities have been received. F-49 CERTAIN MARINER POST-ACUTE NETWORK FACILITIES (OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK) (DEBTOR IN POSSESSION AS OF JANUARY 20, 2000) NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The accompanying combined financial statements have been prepared on the basis of accounting principles applicable to going concerns and contemplate the realization of assets and the settlement of liabilities and commitments in the normal course of business. The financial statements do not include adjustments, if any, to reflect the possible future effects on the recoverability and classification of recorded assets or the amounts and classifications of liabilities that may result from the outcome of these uncertainties. The accompanying combined financial statements have also been presented in conformity with the American Institute of Certified Public Accountants Statement of Position 90-7, "Financial Reporting of Entities in Reorganization Under the Bankruptcy Code" ("SOP 90-7"). SOP 90-7 requires the segregation of liabilities subject to compromise by the Bankruptcy Court as of the Petition Date and identification of all transactions and events that are directly associated with the reorganization of the Facilities. Pursuant to SOP 90-7, prepetition liabilities are reported on the basis of the expected amounts of such allowed claims, as opposed to the amounts for which those claims may be settled. Under a confirmed plan of reorganization, those claims may be settled at amounts substantially less than their allowed amounts. Substantially all of the patient revenues and other income received by the Facilities is deposited in and commingled with the Parent's general corporate funds. Certain cash requirements of the Facilities were paid by the Parent and were charged directly to the Facilities. General and administrative costs of the Parent were allocated to the Facilities based upon management's estimate of the actual costs based upon the Facilities' level of operations. The Parent maintains insurance policies for the Facilities for workers' compensation, general and professional liability and employee health and dental insurance (see Note 9). In the opinion of management, the method for allocating Mariner's corporate general and administrative and insurance expenses is reasonable. It is not practicable to estimate additional costs, if any, that would have been incurred if the Facilities were not controlled by Mariner. PROPERTY AND EQUIPMENT Property and equipment is presented at cost. Maintenance and repairs are charged to operations as incurred and replacements and significant improvements, which would extend the useful life are capitalized. Depreciation and amortization are expensed over the estimated useful lives of the assets on a straight-line basis as follows: Building improvements....................................... 10 - 15 years Furniture, fixtures and equipment........................... 3 - 15 years
Depreciation expense related to property and equipment for the years ended December 31, 2000, 1999 and 1998 was approximately $1,307,000, $880,000, and $1,212,000, respectively. GOODWILL Goodwill represents the excess of acquisition cost over the fair market value of net assets acquired in the GranCare Merger. Goodwill of approximately $53,177,000 was recorded at the Facilities and is being amortized on a straight-line basis over 30 years. Management periodically re-evaluates goodwill and makes any adjustments, if necessary, whenever events or changes in circumstances indicate that the F-50 CERTAIN MARINER POST-ACUTE NETWORK FACILITIES (OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK) (DEBTOR IN POSSESSION AS OF JANUARY 20, 2000) NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) carrying amount may not be recoverable or the estimated useful life has changed. Accumulated amortization at December 31, 2000 and 1999 was approximately $1,159,000 and $700,000, respectively. Amortization of goodwill charged to expense was approximately $459,000, $1,147,000, and $1,674,000 for the years ended December 31, 2000, 1999 and 1998, respectively. IMPAIRMENT OF LONG-LIVED ASSETS Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets to be Disposed Of," requires impairment losses to be recognized for long-lived assets when indicators of impairment are present and the undiscounted cash flows estimated to be generated by the long-lived assets are not sufficient to recover the assets' carrying amount. Goodwill is also evaluated for recoverability by estimating the projected undiscounted cash flows, excluding interest, of the related business activities. The impairment loss of long-lived assets, including goodwill, is measured by comparing the carrying amount of the asset to its fair value with any excess of the carrying value over the fair value written off. Fair market value is determined by various valuation techniques including discounted cash flow (see Note 7). NON-CURRENT LIABILITIES Non-current liabilities principally include unfavorable lease obligations related to facilities acquired in the GranCare Merger. The unfavorable lease obligations are amortized as a reduction of rent expense over the remaining lease term. REVENUE RECOGNITION Net patient revenue includes patient revenues payable by patients and amounts reimbursable by third party payors under contracts. Patient revenues payable by patients are recorded at established billing rates. Patient revenues to be reimbursed by contracts with third-party payors are recorded at the amount estimated to be realized under these contractual arrangements. Revenues from Medicare and Medicaid are generally based on reimbursement of the reasonable direct and indirect costs of providing services to program participants or, for the Facilities' cost reporting periods beginning January 1, 1999, determined under the Prospective Payment System ("PPS"). Management separately estimates revenues due from each third party with which it has a contractual arrangement and records anticipated settlements with these parties in the contractual period during which services were rendered. The amounts actually reimbursable under Medicare and Medicaid cost reimbursement programs for periods prior to January 1, 1999 are determined by filing cost reports that are then subject to audit and retroactive adjustment by the payor. Legislative changes to state or federal reimbursement systems may also retroactively affect recorded revenues. Changes in estimated revenues due in connection with Medicare and Medicaid may be recorded by management subsequent to the year of origination and prior to final settlement based on improved estimates. Such adjustments and final settlements with third party payors are reflected in operations at the time of the adjustment or settlement. Medicare revenues represented 21%, 23%, and F-51 CERTAIN MARINER POST-ACUTE NETWORK FACILITIES (OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK) (DEBTOR IN POSSESSION AS OF JANUARY 20, 2000) NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 38%, and Medicaid revenues represented 55%, 53%, and 43% of net revenues for the years ended December 31, 2000, 1999 and 1998, respectively. On January 1, 1999, Mariner transitioned the Facilities to PPS for services to Medicare patients. Revenue recorded for 1999 consists of the aggregate payments expected from Medicare for individual claims at the appropriate payment rates, which include reimbursement for ancillary services. In April 1995, the Health Care Finance Administration ("HCFA") issued a memorandum to its Medicare fiscal intermediaries as a guideline to assess costs incurred by inpatient providers relating to payment of occupational and speech language pathology services furnished under arrangements that include contracts between therapy providers and inpatient providers. While not binding on the fiscal intermediaries, the memorandum suggested certain rates to assist the fiscal intermediaries in making annual "prudent buyer" assessments of speech and occupational therapy rates paid by inpatient providers. In addition, HCFA has promulgated new salary equivalency guidelines effective April 1, 1998, which updated the then current physical therapy and respiratory therapy rates and established new guidelines for occupational therapy and speech therapy. These new payment guidelines were in effect until the Facilities transitioned to PPS, at which time payment for therapy services were included in the PPS rate. HCFA, through its intermediaries, is also subjecting physical therapy, occupational therapy and speech therapy to a heightened level of scrutiny resulting in increasing audit activity. A majority of the Facilities' provider and rehabilitation contracts provided for indemnification of the facilities for potential liabilities in connection with reimbursement for rehabilitation services. There can be no assurance that actions ultimately taken by HCFA with regard to reimbursement rates for such therapy services will not materially adversely affect the Facilities results of operations. Laws and regulations governing the Medicare and Medicaid programs are complex and subject to interpretation. Management believes that the Facilities are in compliance with all applicable laws and regulations, and is not aware of any pending or threatened investigations involving allegations of potential wrongdoing. While no such regulatory inquiries have been made, compliance with such laws and regulations can be subject to future government review and interpretation as well as significant regulatory action including fines, penalties, and exclusion from the Medicare and Medicaid programs. USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make certain estimates and assumptions that may affect the amounts reported in these financial statements and related notes. The actual results could differ from these estimates. INCOME TAXES The Parent files a consolidated federal income tax return. Throughout the years and periods presented herein, the Facilities' operations were included in the Parent's income tax returns. The income tax provision reported in the combined financial statements is an allocation of the Parent's total income tax provision. The Facilities' allocation was determined based on a calculation of income taxes as if the Facilities were a separate taxpayer, in accordance with Statement of Financial Accounting F-52 CERTAIN MARINER POST-ACUTE NETWORK FACILITIES (OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK) (DEBTOR IN POSSESSION AS OF JANUARY 20, 2000) NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). Income taxes paid was zero for all periods presented. Non-current deferred income taxes arise primarily from timing differences resulting from the recognition of rent expense for tax and financial reporting purposes and from the use of accelerated depreciation for tax purposes. Current deferred income taxes result from timing differences in the recognition of revenues and expenses for tax and financial reporting purposes which are expected to reverse within one year. 3. PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE On January 18, 2000, Mariner and certain of its respective subsidiaries, including those subsidiaries operating the Facilities, filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code (the "Chapter 11 Proceedings"). Mariner is presently operating its business as a debtor-in-possession and is subject to the jurisdiction of the Bankruptcy Court while a plan of reorganization is formulated. As a debtor-in-possession, Mariner is authorized to operate its business but may not engage in transactions outside its ordinary course of business without the approval of the Bankruptcy Court. While the Chapter 11 Proceedings constituted a default under Mariner's and such subsidiaries' various financing arrangements, Section 362 of the Bankruptcy Code imposes an automatic stay that generally precludes any creditors and other interested parties under such arrangements from taking any remedial action in response to any such resulting default outside of the Chapter 11 Proceedings with obtaining relief from the automatic stay from the Bankruptcy Court. On January 19, 2000, Mariner received approval from the Bankruptcy Court to pay prepetition and postpetition employee wages, salaries, benefits and other employee obligations. The Bankruptcy Court also approved orders granting authority to pay prepetition claims of certain critical vendors, utilities and patient obligations. All other prepetition liabilities at December 31, 2000 are disclosed in Note 5 as liabilities subject to compromise. The Facilities have been and intend to continue to pay postpetition claims to all vendors and providers in the ordinary course of business. 4. GOING CONCERN AND ISSUES AFFECTING LIQUIDITY The accompanying combined financial statements have been prepared assuming that the Facilities will continue to operate as a going concern. The Facilities have violated certain covenants of its loan agreement, have experienced significant losses and have a working capital deficiency of approximately $11,673,000 and a divisional deficit of approximately $34,687,000 as of December 31, 2000. Mariner and certain of its subsidiaries, including those subsidiaries operating the Facilities, filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code. These matters, among others, raise substantial doubt about the Facilities ability to continue as a going concern. As described in Note 1, on May 10, 2000 the Bankruptcy Court approved a settlement agreement between Mariner and SNH whereby the Facilities leased by Mariner and related personal property were assigned to affiliates of SNH. SNH agreed to provide working capital to the facilities. The agreement is effective at the close of business on June 30, 2000 and is subject to obtaining regulatory approvals in F-53 CERTAIN MARINER POST-ACUTE NETWORK FACILITIES (OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK) (DEBTOR IN POSSESSION AS OF JANUARY 20, 2000) NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) 4. GOING CONCERN AND ISSUES AFFECTING LIQUIDITY (CONTINUED) the states where the Facilities are located. At December 31, 2000, $5,760,000 had been advanced to the facilities by SNH. On December 31, 2000, SNH has approximately $173,000,000 available for borrowing under a $270,000,000 bank credit facility. Management of SNH believes that the available borrowings under the bank credit facility are sufficient to provide the necessary working capital to the Facilities for operations subsequent to the closing of the June 30, 2000 transaction. 5. LIABILITIES SUBJECT TO COMPROMISE "Liabilities subject to compromise" represents liabilities incurred prior to the commencement of the Chapter 11 Proceedings. These liabilities, consisting primarily of long-term debt and certain accounts payable, represent the Facilities' estimate of known or potential prepetition claims to be resolved in connection with the Chapter 11 Proceedings. Such claims remain subject to future adjustments based on negotiations, actions of the Bankruptcy Court, further developments with respect to disputed claims, future rejection of executory contracts or unexpired leases, determination as to the value of any collateral securing claims, treatment under the plan of reorganization and other events. Payment for these amounts will be established in connection with the plan of reorganization. A summary of the principal categories of claims classified as liabilities subject to compromise at December 31, 2000 is as follows (in thousands): Accounts payable and accrued expenses....................... $6,223 Long-term debt.............................................. 888 ------ $7,111 ======
6. IMPAIRMENT OF LONG-LIVED ASSETS The revenues recorded by the Facilities under PPS are substantially less than the cost-based reimbursement it received previously. The implementation of PPS resulted in a greater than expected decline in reimbursement for inpatient services. Management determined that these revenue declines are other than temporary and are expected to have a materially adverse effect on future revenues and cash flow. As a result of such indicators of impairment, in the third quarter of 1999, a detailed analysis of the Facilities' long-lived assets and their estimated future cash flows was completed. The analysis resulted in the identification and measurement of an impairment loss of approximately $36,322,000. In the third quarter of 1998, management recorded an impairment charge based on a detailed analysis of the Facilities' long-lived assets and their estimated cash flows. The analysis resulted in the identification and measurement of an impairment loss of approximately $8,670,000 for the Facilities. Each analysis included management's estimate of the undiscounted cash flows to be generated by these assets with a comparison to their carrying value. If the undiscounted future cash flow estimates were less than the carrying value of the asset then the carrying value was written down to estimated fair value. Goodwill associated with an impaired asset was included with the carrying value of that asset in F-54 CERTAIN MARINER POST-ACUTE NETWORK FACILITIES (OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK) (DEBTOR IN POSSESSION AS OF JANUARY 20, 2000) NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) 6. IMPAIRMENT OF LONG-LIVED ASSETS (CONTINUED) performing both the impairment test and in measuring the amount of impairment loss related to the asset. Fair value was estimated based on the present value of future cash flows. The following is a summary of the impairment losses recognized during 1999 and 1998 by asset category (in thousands):
1999 1998 -------- -------- Goodwill................................................... $30,378 $8,123 Property and equipment..................................... 5,944 547 ------- ------ $36,322 $8,670 ======= ======
7. DEBT On December 28, 1990, a mortgage loan agreement was entered into for $15,000,000 with HRPT, secured by two nursing home facilities' (Northwest Health Care Center and River Hills West Health Care Center) land, building and improvements. The interest rate on the note was 11.5%. The loan was repaid in September 1998 as part of the sale-leaseback transaction discussed in Note 6. On March 28, 1992, a loan agreement was entered into with HRPT for the purpose of funding renovations to the Christopher East facility, maturing on January 31, 2013. Advances to AMS Properties, Inc. totaled approximately $883,000 for the years ended December 31, 2000 and 1999. The loan is interest bearing and principal is payable upon maturity. The interest rate on the note is 13.75%. The Bankruptcy Proceedings are considered an Event of Default as defined in the loan agreement. Current portion of long-term debt at December 31, 1999 includes the principal balance of the note. In consideration of the terms of the Settlement Agreement, the Christopher East note obligation was terminated in July 2000. Interest paid was approximately $60,000, $181,000 and $1,252,000 during the years ended December 31, 2000, 1999 and 1998, respectively. 8. TRANSACTIONS WITH AFFILIATES Mariner provided various services to the Facilities including, but not limited to, financial, legal, insurance, information systems, employee benefit plans and certain administrative services, as required. The combined financial statements reflect charges for certain corporate general and administrative expenses from Mariner's corporate office to the Facilities. Such corporate charges represent allocations based on determinations management believes to be reasonable (5% of total revenues). Administrative costs charged by Mariner were approximately $2,133,000, $4,347,000 and $5,274,000 for the years ended December 31, 2000, 1999 and 1998, respectively. For the year ended December 31, 2000, fees charged by SNH for management services were approximately $1,968,000, all of which have been paid. The Facilities participated in the various benefit plans of Mariner, primarily the profit sharing and 401(k) plans. These plans include matching provisions for employee contributions to the 401(k) plan. The financial statements reflect charges for benefits attributable to the Facilities' employees. Such amounts totaled approximately $108,000, $221,000, and $133,000, for the years ended December 31, 2000, 1999 and 1998, respectively. F-55 CERTAIN MARINER POST-ACUTE NETWORK FACILITIES (OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK) (DEBTOR IN POSSESSION AS OF JANUARY 20, 2000) NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) 8. TRANSACTIONS WITH AFFILIATES (CONTINUED) Through March 31, 1998, the Facilities participated in a program for insurance of workers' compensation risks through a captive insurance subsidiary of Mariner. Effective March 31, 1998, Mariner purchased a fully-insured workers' compensation policy with no deductible or retention with a catastrophic policy in place to cover any loss above $500,000 per occurrence. Additionally, in 1998 Mariner purchased general and professional liability insurance through a third party. The maximum loss exposure with respect to this policy is $100,000 per occurrence. Mariner obtains and provides insurance coverage for health, life and disability, auto, general liability and workers' compensation through its self-insurance and outside insurance programs and allocates to the Facilities based on its estimate of the actual costs incurred on behalf of the Facilities. Total insurance costs allocated were approximately $2,537,000, $4,876,000 and $4,267,000 for the years ended December 31, 2000, 1999 and 1998, respectively. These costs are included in facility general and administrative costs in the accompanying combined statements of operations. The Facilities purchased certain therapy services from rehabilitation subsidiaries of Mariner. These purchases amounted to approximately $0, $2,955,000 and $3,402,000 for the years ended December 31, 2000, 1999 and 1998, respectively. 9. COMMITMENTS AND CONTINGENCIES As discussed in Note 1, the Facilities are party to various agreements between GranCare and SNH. SNH is the lessor with respect to the Facilities leased by two subsidiaries of GranCare (the "Tenant Entities") under operating leases. Pursuant to a Collateral Pledge Agreement dated October 31, 1997, Mariner provided an unlimited guaranty to SNH, which is secured by a cash collateral deposit of $15,000,000, the earned interest on which is retained by SNH. In June 2000, the Facilities ceased payment of rents. As part of the Settlement Agreement, Mariner was released from its lease obligations. Rent expense, net of amortization of unfavorable lease obligation, for all operating leases was approximately $8,748,000, $9,314,000, and $8,241,000 for the years ended December 31, 2000, 1999 and 1998, respectively. From time to time, the Facilities have been subject to various legal proceedings in the ordinary course of business. In the opinion of management, except as described below, there are currently no proceedings which could potentially have a material adverse effect on the Facilities' financial position or results of operations after taking into account the insurance coverage maintained by Mariner. Although management believes that any of the proceedings discussed below will not have a material adverse impact on the Facilities if determined adversely to the Facilities, given the Facilities' current financial condition, lack of liquidity and the current lack of aggregate limit under Mariner's current GL/PL insurance policy, settling a large number of cases within the Company's $1 million self-insured retention limit could have a material adverse effect on the Facilities. On August 26, 1996, a class action complaint was asserted against GranCare in the Denver, Colorado District Court. On March 15, 1998, the Court entered an Order in which it certified a class action in the matter. On June 10, 1998, Mariner filed a Motion to Dismiss all claims and Motion for Summary Judgment Precluding Recovery of Medicaid Funds and these motions were partially granted F-56 CERTAIN MARINER POST-ACUTE NETWORK FACILITIES (OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK) (DEBTOR IN POSSESSION AS OF JANUARY 20, 2000) NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) 9. COMMITMENTS AND CONTINGENCIES (CONTINUED) by the Court on October 30, 1998. Plaintiffs filed a writ with the Colorado Supreme Court and an appeal with the Colorado Court of Appeals. The Supreme Court writ has been denied, the Court of Appeals matter has been briefed and Oral Argument was set for January 18, 2000. In accordance with the Chapter 11 Proceedings and more particularly, Section 362 of the Bankruptcy Code, this matter was stayed on January 18, 2000. However, Mariner did agree to limited relief from the stay in order to allow for certain parts of the appeal to continue. On January 4, 2001, the Court of Appeals reversed the District Court's decision. Mariner is currently considering whether to pursue a request for rehearing and/or appeal to the Colorado Supreme Court. The Company intends to vigorously contest the remaining allegations of class status. 10. INCOME TAXES The components of the net deferred tax asset are approximately as follows (in thousands):
DECEMBER 31 ------------------- 2000 1999 -------- -------- Deferred tax assets: Bad debts............................................. $ 325 $ 598 Amounts related to property and equipment............. 1,681 1,585 Payroll and benefits.................................. 271 620 Unfavorable lease obligations and other liabilities... 11,304 12,736 NOL carryforwards..................................... 11,878 7,205 -------- -------- Total deferred tax assets............................... 25,459 22,744 Less valuation allowance................................ (25,459) (22,744) -------- -------- Net deferred tax asset.................................. $ -- $ -- ======== ========
The Facilities have established a full valuation allowance, which completely offsets all net deferred tax assets generated from the Facilities' net losses because its future realizability is uncertain. The net change in the valuation allowance was an increase of approximately $2,715,000 and $4,789,000 at December 31, 2000 and 1999, respectively. F-57 CERTAIN MARINER POST-ACUTE NETWORK FACILITIES (OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK) (DEBTOR IN POSSESSION AS OF JANUARY 20, 2000) NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) 10. INCOME TAXES (CONTINUED) The provision for income taxes varies from the amount determined by applying the Federal statutory rate to pre-tax loss as a result of the following:
YEAR ENDED DECEMBER 31 ------------------------------------ 2000 1999 1998 -------- -------- -------- Federal statutory income tax rate.................... (34.0)% (34.0)% (34.0)% Increase (decrease) in taxes resulting from: State and local taxes, net of federal tax benefits....................................... (4.7) (1.4) 1.4 Permanent book/tax differences, primarily resulting from goodwill amortization........... 2.1 0.9 7.4 Impairment of assets............................. -- 23.6 35.8 Change in valuation allowance.................... 36.6 10.9 (10.6) ----- ----- ----- Effective tax rate................................... --% --% --% ===== ===== =====
11. CONCENTRATIONS OF CREDIT RISK Financial instruments that potentially subject the Facilities to concentration of credit risk consist principally of trade receivables. There have been, and the Facilities expect that there will continue to be, a number of proposals to limit reimbursement allowable to skilled nursing facilities. Should the related government agencies suspend or significantly reduce contributions to the Medicare or Medicaid programs, the Facilities' ability to collect its receivables would be adversely impacted. Management believes that the remaining receivable balances from various payors, including individuals involved in diverse activities, subject to differing economic conditions, do not represent a concentration of credit risk to the Facilities. Management continually monitors and adjusts its allowance for doubtful accounts associated with its receivables. 12. FAIR VALUE OF FINANCIAL INSTRUMENTS The Facilities financial instruments include notes payable. Fair values for fixed rate debt instruments were estimated based on the present value of cash flows that would be paid on the note over the remaining note term using the Facilities' current incremental borrowing rate rather than the stated interest rate on the notes. The fair values of the financial instruments approximate their carrying values. F-58 CERTAIN MARINER POST-ACUTE NETWORK FACILITIES (OPERATED BY SUBSIDIARIES OF MARINER POST-ACUTE NETWORK) (DEBTOR IN POSSESSION AS OF JANUARY 20, 2000) SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS)
BALANCE AT CHARGED BEGINNING (CREDITED) TO WRITE-OFFS/ BALANCE AT DESCRIPTION OF YEAR OPERATIONS RECOVERIES OTHER END OF YEAR ----------- ---------- ------------- ----------- -------- ----------- Year ended December 31, 2000: Allowance for doubtful accounts:.............. $1,534 $1,758 $(1,458) $ -- $1,834 ------ ------ ------- ----- ------ $1,534 $1,758 $(1,458) $ -- $1,834 ====== ====== ======= ===== ====== Year ended December 31, 1999: Allowance for doubtful accounts:.............. $2,927 $4,233 $(5,468) $(158) $1,534 ------ ------ ------- ----- ------ $2,927 $4,233 $(5,468) $(158) $1,534 ====== ====== ======= ===== ====== Year ended December 31, 1998: Allowance for doubtful accounts:.............. $1,109 $1,627 $ -- $ 191 $2,927 ------ ------ ------- ----- ------ $1,109 $1,627 $ -- $ 191 $2,927 ====== ====== ======= ===== ======
F-59 CSL GROUP, INC. AND SUBSIDIARIES AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST CONDENSED CONSOLIDATED BALANCE SHEET (UNAUDITED, IN THOUSANDS)
JUNE 15, 2001 --------- ASSETS Property and equipment, net................................. $635,024 Due from Marriott Senior Living Services, net............... 9,289 Other assets................................................ 10,960 Cash and cash equivalents................................... 14,454 -------- Total assets............................................ $669,727 ======== LIABILITIES AND EQUITY Debt........................................................ $247,723 Accounts payable and accrued expenses....................... 451 Deferred income taxes....................................... 62,502 Other liabilities........................................... 16,669 -------- Total liabilities....................................... $327,345 -------- Equity: Investments in and advances from parent................... 342,382 -------- Total liabilities and equity............................ $669,727 ========
See Notes to Condensed Consolidated Financial Statements. F-60 CSL GROUP, INC. AND SUBSIDIARIES AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE TWENTY-FOUR WEEKS ENDED JUNE 15, 2001 AND JUNE 16, 2000 (UNAUDITED, IN THOUSANDS)
JUNE 15, JUNE 16, 2001 2000 --------- --------- REVENUES Routine................................................... $115,715 $109,002 Ancillary................................................. 10,690 10,985 -------- -------- 126,405 119,987 Equity in earnings of affiliates.......................... -- 20 -------- -------- Total revenues.......................................... 126,405 120,007 -------- -------- OPERATING COSTS AND EXPENSES Property-level operating costs and expenses Routine................................................. 73,542 69,796 Ancillary............................................... 6,064 6,729 Other operating costs and expenses Depreciation and amortization........................... 11,090 10,902 Management fees......................................... 8,229 7,402 Property taxes and other................................ 4,034 4,409 -------- -------- Total operating costs and expenses.................... 102,959 99,238 -------- -------- OPERATING PROFIT............................................ 23,446 20,769 Corporate expenses.......................................... (940) (967) Interest expense............................................ (9,776) (7,620) Interest income............................................. 432 227 -------- -------- INCOME BEFORE INCOME TAXES.................................. 13,162 12,409 Provision for income taxes.................................. (5,397) (5,088) -------- -------- NET INCOME.................................................. $ 7,765 $ 7,321 ======== ========
See Notes to Condensed Consolidated Financial Statements. F-61 CSL GROUP, INC. AND SUBSIDIARIES AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE TWENTY-FOUR WEEKS ENDED JUNE 15, 2001 AND JUNE 16, 2000 (UNAUDITED, IN THOUSANDS)
JUNE 15, JUNE 16, 2001 2000 --------- --------- OPERATING ACTIVITIES Cash provided by operations................................. $15,205 $ 24,259 ------- -------- INVESTING ACTIVITIES Expansions of senior living communities................... -- (3,163) Other capital expenditures................................ (3,348) (3,275) Increase (decrease) in capital improvement reserve........ (23) 412 ------- -------- Cash used in investing activities........................... (3,371) (6,026) ------- -------- FINANCING ACTIVITIES Repayments of debt........................................ (1,151) (1,808) Net advances to parent.................................... (2,905) (16,946) ------- -------- Cash used in financing activities........................... (4,056) (18,754) ------- -------- Increase (decrease) in cash and cash equivalents............ 7,778 (521) Cash and cash equivalents, beginning of period.............. 6,676 3,006 ------- -------- Cash and cash equivalents, end of period.................... $14,454 $ 2,485 ======= ========
See Notes to Condensed Consolidated Financial Statements. F-62 CSL GROUP, INC. AND SUBSIDIARIES AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. On August 9, 2001, Crestline Capital Corporation ("Crestline Capital") and CSL Group, Inc. ("CSL Group") entered into a stock purchase agreement (the "Stock Purchase Agreement") with Senior Housing Properties Trust ("SNH") and SNH/CSL Properties Trust ("SNH/CSL"). Pursuant to the Stock Purchase Agreement, SNH/CSL would purchase the stock of CSL Group and certain other subsidiaries of Crestline Capital that compose Crestline Capital's senior living business (the "Partitioned Business") for $600 million, including the assumption of approximately $235 million in existing debt. The transaction is expected to close in the first quarter of 2002 and is subject to a successful vote by at least two-thirds of Crestline Capital's shareholders, arranging additional mortgage debt financing for $150 million to $175 million, obtaining certain consents and customary closing conditions. These condensed consolidated financial statements include only the assets and liabilities, along with the results from operations generated from the Partitioned Business, as described in the Stock Purchase Agreement. The Partitioned Business is an organizational unit of Crestline Capital and is not a distinct legal entity. As of June 15, 2001, the Partitioned Business consisted of the ownership of 31 senior living communities, a general partnership interest in one senior living community and a second mortgage note receivable on a senior living community. The accompanying condensed consolidated financial statements of the Partitioned Business have been prepared by management without audit. Certain information and footnote disclosures normally included in financial statements presented in accordance with generally accepted accounting principles have been condensed or omitted. Management believes the disclosures made are adequate to make the information presented not misleading. However, the condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Partitioned Business's audited financial statements for the fiscal year ended December 29, 2000. The accompanying unaudited condensed consolidated financial statements reflect all adjustments (which include only normal and recurring adjustments) necessary to present fairly the financial position of the Partitioned Business as of June 15, 2001 and the results of operations and cash flows for the twenty-four week period ended June 15, 2001. All significant intercompany accounts and transactions have been eliminated. Interim results are not necessarily indicative of fiscal year performance because of the impact of seasonal and short-term variations. F-63 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Crestline Capital Corporation: We have audited the accompanying consolidated balance sheets of CSL Group, Inc. and subsidiaries (a business unit wholly owned by Crestline Capital Corporation) as partitioned for sale to SNH/CSL Properties Trust (see Note 1) as of December 29, 2000 and December 31, 1999, and the related consolidated statements of operations, equity and cash flows for the fiscal years ended December 29, 2000, December 31, 1999 and January 1, 1999. These consolidated financial statements are the responsibility of Crestline Capital Corporation's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of CSL Group, Inc. as partitioned for sale to SNH/CSL Properties Trust, as of December 29, 2000 and December 31, 1999 and the results of its operations, equity and its cash flows for the fiscal years ended December 29, 2000, December 31, 1999 and January 1, 1999, in conformity with accounting principles generally accepted in the United States. /s/ ARTHUR ANDERSEN LLP Vienna, Virginia August 31, 2001 F-64 CSL GROUP, INC. AND SUBSIDIARIES AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST CONSOLIDATED BALANCE SHEETS DECEMBER 29, 2000 AND DECEMBER 31, 1999 (IN THOUSANDS)
2000 1999 -------- -------- ASSETS Property and equipment, net................................. $643,110 $656,758 Due from Marriott Senior Living Services, net............... 6,106 5,729 Other assets................................................ 12,522 17,246 Cash and cash equivalents................................... 6,676 3,006 -------- -------- Total assets............................................ $668,414 $682,739 ======== ======== LIABILITIES AND EQUITY Debt........................................................ $249,190 $205,629 Accounts payable and accrued expenses....................... 701 1,184 Deferred income taxes....................................... 63,660 61,554 Other liabilities........................................... 17,342 17,240 -------- -------- Total liabilities....................................... 330,893 285,607 -------- -------- Equity: Investments in and advances to parent..................... 337,521 397,132 -------- -------- Total liabilities and equity............................ $668,414 $682,739 ======== ========
See Notes to Consolidated Financial Statements. F-65 CSL GROUP, INC. AND SUBSIDIARIES AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST CONSOLIDATED STATEMENTS OF OPERATIONS FISCAL YEARS ENDED DECEMBER 29, 2000, DECEMBER 31, 1999 AND JANUARY 1, 1999 (IN THOUSANDS)
2000 1999 1998 -------- -------- -------- REVENUES Routine................................................... $239,065 $223,794 $213,378 Ancillary................................................. 22,821 22,704 27,899 -------- -------- -------- 261,886 246,498 241,277 Equity in earnings of affiliates.......................... 37 92 20 -------- -------- -------- Total revenues.......................................... 261,923 246,590 241,297 -------- -------- -------- OPERATING COSTS AND EXPENSES Property-level operating costs and expenses Routine................................................. 153,049 145,778 138,099 Ancillary............................................... 14,493 15,414 21,317 Other operating costs and expenses Depreciation and amortization........................... 24,083 21,624 22,115 Management fees......................................... 15,658 14,965 13,973 Property taxes and other................................ 9,263 8,549 8,554 Loss on impairment of asset............................. -- 3,522 -- Other................................................... -- 1,650 -- -------- -------- -------- Total operating costs and expenses.................... 216,546 211,502 204,058 -------- -------- -------- OPERATING PROFIT............................................ 45,377 35,088 37,239 Corporate expenses.......................................... (1,917) (2,096) (2,092) Interest expense............................................ (19,586) (17,061) (22,173) Interest income............................................. 942 773 2,028 -------- -------- -------- INCOME BEFORE INCOME TAXES AND EXTRAORDINARY ITEM........... 24,816 16,704 15,002 Provision for income taxes.................................. (10,175) (6,849) (6,151) -------- -------- -------- INCOME BEFORE EXTRAORDINARY ITEM............................ 14,641 9,855 8,851 Gain on early extinguishment of debt, net of taxes.......... 253 -- -- -------- -------- -------- NET INCOME.................................................. $ 14,894 $ 9,855 $ 8,851 ======== ======== ========
See Notes to Consolidated Financial Statements. F-66 CSL GROUP, INC. AND SUBSIDIARIES AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST CONSOLIDATED STATEMENTS OF EQUITY FISCAL YEARS ENDED DECEMBER 29, 2000, DECEMBER 31, 1999 AND JANUARY 1, 1999 (IN THOUSANDS) Balance, January 2, 1998.................................... $230,727 Investment from parent, net............................... 159,225 Net income................................................ 8,851 -------- Balance, January 1, 1999.................................... 398,803 Net income................................................ 9,855 Advances to parent, net................................... (11,526) -------- Balance, December 31, 1999.................................. 397,132 Net income................................................ 14,894 Advances to parent, net................................... (74,505) -------- Balance, December 29, 2000.................................. $337,521 ========
See Notes to Consolidated Financial Statements. F-67 CSL GROUP, INC. AND SUBSIDIARIES AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS FISCAL YEARS ENDED DECEMBER 29, 2000, DECEMBER 31, 1999 AND JANUARY 1, 1999 (IN THOUSANDS)
2000 1999 1998 -------- -------- -------- OPERATING ACTIVITIES Net income.................................................. $ 14,894 $ 9,855 $ 8,851 Adjustments to reconcile net income to cash from operations: Depreciation and amortization............................. 24,083 21,624 22,115 Gain on early extinguishment of debt, net of taxes........ (253) -- -- Loss on impairment of asset............................... -- 3,522 -- Amortization of debt premiums and deferred financing costs................................................... (710) (1,550) (1,550) Change in amounts due from Marriott Senior Living Services................................................ (377) 2,156 (10,934) Change in other operating accounts........................ 11,867 2,820 (303) -------- -------- -------- Cash provided by operations................................. 49,504 38,427 18,179 -------- -------- -------- INVESTING ACTIVITIES Expansions of senior living communities................... (3,204) (18,451) (8,653) Purchase of minority partnership interest................. -- (7,010) -- Other capital expenditures................................ (10,380) (9,239) (5,567) Other..................................................... 998 535 (3,432) -------- -------- -------- Cash used in investing activities........................... (12,586) (34,165) (17,652) -------- -------- -------- FINANCING ACTIVITIES Repayments of debt........................................ (47,250) (4,197) (3,608) Issuances of debt......................................... 92,370 -- -- Net advances to parent.................................... (74,505) (11,526) -- Other..................................................... (3,863) -- (96) -------- -------- -------- Cash used in financing activities........................... (33,248) (15,723) (3,704) -------- -------- -------- Increase (decrease) in cash and cash equivalents............ 3,670 (11,461) (3,177) Cash and cash equivalents, beginning of year................ 3,006 14,467 17,644 -------- -------- -------- Cash and cash equivalents, end of year...................... $ 6,676 $ 3,006 $ 14,467 ======== ======== ======== SUPPLEMENTAL INFORMATION--NON-CASH ACTIVITY: Investments from parent: Property and equipment.................................. $ -- $ -- $ 20,959 Acquisition of minority interests paid by Crestline Capital............................................... -- -- 12,963 Debt forgiveness........................................ -- -- 92,195 Debt prepayment paid by Host Marriott................... -- -- 26,405 Other................................................... -- -- 6,703
See Notes to Consolidated Financial Statements. F-68 CSL GROUP, INC. AND SUBSIDIARIES AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION AND ORGANIZATION On June 21, 1997, Crestline Capital Corporation ("Crestline Capital", formerly known as HMC Senior Living Communities, Inc.), a wholly owned subsidiary of Host Marriott Corporation ("Host Marriott"), acquired all the outstanding stock of CSL Group, Inc. and subsidiaries ("CSL Group", formerly known as Forum Group, Inc. "Forum") from Marriott Senior Living Services, Inc. ("MSLS"), a subsidiary of Marriott International, Inc., pursuant to a stock purchase agreement dated June 21, 1997. In connection with the acquisition, Crestline Capital acquired the ownership of 29 senior living communities, and assigned to MSLS its interest as manager under long-term operating agreements. Subsequent to Crestline Capital's acquisition of Forum, the Partitioned Business acquired two additional senior living communities. On December 29, 1998 (the "Distribution Date"), Crestline Capital became a publicly traded company when Host Marriott completed its plan of reorganizing its business operations by spinning-off Crestline Capital to the shareholders of Host Marriott (the "Distribution"), as part of a series of transactions pursuant to which Host Marriott elected to be considered a real estate investment trust. On August 9, 2001, Crestline Capital and CSL Group entered into a stock purchase agreement (the "Stock Purchase Agreement") with Senior Housing Properties Trust ("SNH") and SNH/CSL Properties Trust ("SNH/CSL"). Pursuant to the Stock Purchase Agreement, SNH/CSL would purchase the stock of CSL Group and certain other subsidiaries of Crestline Capital that compose Crestline Capital's senior living business (the "Partitioned Business") for $600 million, including the assumption of approximately $235 million in existing debt. The transaction is expected to close in the first quarter of 2002 and is subject to a successful vote by at least two-thirds of Crestline Capital's shareholders, arranging additional mortgage debt financing for $150 million to $175 million, obtaining certain consents and customary closing conditions. These consolidated financial statements include only the assets and liabilities, along with the results from operations generated from the Partitioned Business, as described in the Stock Purchase Agreement. The Partitioned Business is an organizational unit of Crestline Capital and is not a distinct legal entity. As of December 29, 2000, the Partitioned Business consisted of the ownership of 31 senior living communities, a general partnership interest in one senior living community and a second mortgage note receivable on a senior living community. The Securities and Exchange Commission, in Staff Accounting Bulletin Number 55 (SAB 55), requires that historical financial statements of a subsidiary, division, or lesser business component of another entity include certain expenses incurred by the parent on its behalf. These expenses include officer and employee salaries, rent or depreciation, advertising, accounting and legal services, other selling, general and administrative expenses and other such expenses. Investments and advances from parent represents the net amount of investments and advances made by Crestline Capital as a result of the acquisition and operation of the Partitioned Business. These financial statements include the adjustments necessary to comply with SAB 55. Through the Distribution Date, the Partitioned Business operated as a wholly owned business unit of Host Marriott utilizing Host Marriott's employees, insurance and administrative services since the Partitioned Business had no employees. Subsequent to the Distribution Date, the Partitioned Business operated as a wholly-owned business unit of Crestline Capital utilizing Crestline Capital's employees, insurance and administrative services since the Partitioned Business had no employees. Periodically, certain operating expenses, capital expenditures and other cash requirements of the Partitioned F-69 CSL GROUP, INC. AND SUBSIDIARIES AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. BASIS OF PRESENTATION AND ORGANIZATION (CONTINUED) Business were paid by either Host Marriott or Crestline Capital and charged directly or allocated to the Partitioned Business. Certain general and administrative costs of Host Marriott or Crestline Capital were allocated to the Partitioned Business using a variety of methods, principally including Host Marriott's or Crestline Capital's specific identification of individual cost items and otherwise through allocations based upon estimated levels of effort devoted by its general and administrative departments to individual entities or relative measures of size of the entities based on assets or revenues. In the opinion of management, the methods for allocating corporate, general and administrative expenses and other direct costs are reasonable. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Partitioned Business and its subsidiaries and controlled affiliates. Investments in affiliates owned 20 percent or more and over which the Partitioned Business has the ability to exercise significant influence, but does not control, are accounted for using the equity method. All material intercompany transactions and balances have been eliminated. FISCAL YEAR The Partitioned Business's fiscal year ends on the Friday nearest to December 31. REVENUES Revenues represent operating revenues from senior living communities. Routine revenues consist of resident fees and health care service revenues, which are generated primarily from monthly charges for independent and assisted living apartments and special care center rooms and daily charges for healthcare beds and are recognized monthly based on the terms of the residents' agreements. Advance payments received for services are deferred until the services are provided. Ancillary revenue is generated on a "fee for service" basis for supplemental items requested by residents and is recognized as the services are provided. A portion of revenues from health care services was attributable to patients whose bills are paid by Medicare or Medicaid under contractual arrangements. For fiscal year 1998 and earlier, reimbursements under these contractual arrangements were subject to retroactive adjustments based on agency reviews. Revenues from health care services in 1998 were generally recorded net of estimated contractual allowances in the Partitioned Business's consolidated financial statements. Audits under the reimbursement agreements have generally been completed through fiscal year 1998 and there were no material audit adjustments. For fiscal years 1999 and 2000, the Partitioned Business is generally paid a fixed payment rate for its Medicare and Medicaid services and therefore, there are no contractual allowances for these fiscal years in the Partitioned Business's consolidated financial statements. CASH AND CASH EQUIVALENTS All highly liquid investments with a maturity of three months or less at date of purchase are considered cash equivalents. F-70 CSL GROUP, INC. AND SUBSIDIARIES AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) PROPERTY AND EQUIPMENT Property and equipment are recorded at cost. Replacements and improvements that extend the useful life of property and equipment are capitalized. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, generally 40 years for buildings and three to 10 years for furniture and equipment. Leasehold improvements are amortized over the shorter of the lease term or the useful lives of the related assets. In cases where management is holding for sale a particular property, management assesses impairment based on whether the estimated sales price less cost of disposal of each individual property to be sold is less than the net book value. A property is considered to be held for sale when a decision is made to dispose of the property. Otherwise, impairment is assessed based on whether it is probable that undiscounted future cash flows from each property will be less than its net book value. If a property is impaired, its basis is adjusted to its fair value. CONCENTRATION OF CREDIT RISK Financial instruments that potentially subject the Partitioned Business to significant concentration of credit risk consist principally of cash and cash equivalents. The Partitioned Business maintains cash and cash equivalents with various high credit-quality financial institutions and limits the amount of credit exposure with any institution. WORKING CAPITAL Pursuant to the terms of the senior living operating agreements (see Note 6), the Partitioned Business is required to provide MSLS with working capital and supplies to meet the operating needs of the senior living communities. MSLS converts cash advanced by the Partitioned Business into other forms of working capital consisting primarily of operating cash, inventories, resident deposits and trade receivables and payables which are maintained and controlled by MSLS. Upon the termination of the operating agreements, MSLS is required to convert working capital and supplies into cash and return it to the Partitioned Business. As a result of these conditions, the individual components of working capital and supplies controlled by MSLS are not reflected in the Partitioned Business's consolidated balance sheets, however, the net working capital advanced is included in due from Marriott Senior Living Services on the Partitioned Business's consolidated balance sheets. DEFERRED REVENUE Monthly fees deferred for the non-refundable portion of the entry fees are recorded as deferred revenue and included in other liabilities in the Partitioned Business's consolidated balance sheets. These amounts are recognized as revenue as services are performed over the expected term of the residents' contracts. LIABILITY FOR FUTURE HEALTH CARE SERVICES Certain resident and admission agreements at the communities entitled residents to receive limited amounts of health care up to defined maximums. The estimated liabilities associated with the health care obligation have been accrued in other liabilities in the Partitioned Business's consolidated balance F-71 CSL GROUP, INC. AND SUBSIDIARIES AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) sheets. As of December 29, 2000 and December 31, 1999, the liability totaled $977,000 and $1,140,000, respectively. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. NEW STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS During July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations", SFAS No. 142, "Goodwill and Intangible Assets" and SFAS No. 143, "Accounting for Asset Retirement Obligations". In the opinion of management the adoption of these statements will not have a material effect on the Partitioned Business's consolidated financial statements. 3. PROPERTY AND EQUIPMENT Property and equipment consists of the following:
2000 1999 -------- -------- (IN THOUSANDS) Land.................................................... $107,425 $107,425 Buildings and leasehold improvements.................... 564,867 560,029 Furniture and equipment................................. 49,292 43,675 -------- -------- 721,584 711,129 Less accumulated depreciation and amortization.......... (78,474) (54,371) -------- -------- $643,110 $656,758 ======== ========
In 1999, management determined that one of its senior living communities was impaired as a result of a deterioration of the community's operating results due to its size and age and the new supply of communities in its market. A $3.5 million pre-tax charge was recorded to reduce the net book value of the property to its fair value. F-72 CSL GROUP, INC. AND SUBSIDIARIES AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 4. RESTRICTED CASH Restricted cash, which is included in other assets on the Partitioned Business's consolidated balance sheets, consists of the following:
2000 1999 -------- -------- (IN THOUSANDS) Debt service escrows....................................... $1,137 $ 1,624 Fixed asset escrows........................................ 4,878 5,310 Real estate tax escrows.................................... 1,697 4,092 Insurance escrows.......................................... 64 3,364 ------ ------- $7,776 $14,390 ====== =======
The debt service, fixed asset, real estate tax and insurance escrows consist of cash transferred into segregated escrow accounts out of revenues generated by the senior living communities, pursuant to the secured debt agreements. Funds from these reserves are periodically disbursed by the collateral agent to pay for debt service, capital expenditures, insurance premiums and real estate taxes relating to the secured properties. In addition, the fixed asset escrows also include cash transferred into segregated escrow accounts pursuant to the senior living community operating agreements to fund certain capital expenditures at the senior living communities (see Note 6). 5. LEASES The Partitioned Business is the lessee under capital and operating leases. Future minimum annual rental commitments for all non-cancelable leases as of December 29, 2000 are as follows:
CAPITAL OPERATING LEASES LEASES -------- --------- (IN THOUSANDS) 2001..................................................... $ 1,240 $ 281 2002..................................................... 1,258 281 2003..................................................... 1,477 281 2004..................................................... 1,384 281 2005..................................................... 1,384 281 Thereafter............................................... 8,392 2,205 ------- ------ Total minimum lease payments............................. 15,135 $3,610 ====== Less amount representing interest........................ (5,293) ------- Present value of minimum lease payments.................. $ 9,842 =======
The Partitioned Business leases two senior living communities under capital leases expiring in 2016. Upon the expiration of the lease or anytime prior to lease expiration, the Partitioned Business has the first right of refusal to submit a counter offer to any acceptable bona fide offer from a third party within 30 days of notice from the lessor. If the Partitioned Business fails to exercise its right of first refusal, then the lessor may proceed with the sale of the leased property and all assets therein. The assets recorded under capital leases, which are included in property and equipment on the Partitioned Business's consolidated balance sheets, were $13.4 million and $14.1 million as of December 29, 2000 F-73 CSL GROUP, INC. AND SUBSIDIARIES AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 5. LEASES (CONTINUED) and December 31, 1999, respectively, net of accumulated amortization of $3.6 million and $2.4 million, respectively. The amortization for assets recorded under capital leases is included in depreciation and amortization on the Partitioned Business's consolidated statements of operations. The Partitioned Business also has one long-term operating ground lease which expires in 2013. The operating lease includes three renewal options exercisable in five-year increments through the year 2028. Rent expense for fiscal years 2000, 1999 and 1998 was $278,000, $281,000 and $279,000, respectively. 6. OPERATING AGREEMENTS The senior living communities are subject to operating agreements which provide for MSLS to operate the senior living communities, generally for an initial term of 25 to 30 years with renewal terms subject to certain performance criteria at the option of MSLS of up to an additional five to ten years. The operating agreements provide for payment of base management fees equal to five percent of revenues and incentive management fees equal to 20% of operating profit (as defined in the operating agreements) over a priority return to the owner. In the event of early termination of the operating agreements, MSLS will receive additional fees based on the unexpired term and expected future base and incentive management fees. The Partitioned Business has the option to terminate certain, but not all, management agreements if specified performance thresholds are not satisfied. No operating agreement with respect to a single community is cross-collateralized or cross-defaulted to any other operating agreement, and any single operating agreement may be terminated following a default by the Partitioned Business or MSLS, although such termination will not trigger the cancellation of any other operating agreement. Most of the senior living communities are also subject to pooling agreements whereby for the limited purpose of calculating management fees and exercising certain termination rights under the operating agreements, the management fees and rights are considered in the aggregate for the senior living communities in each pool. The operating agreements require MSLS to furnish certain services ("Central Administrative Services") which are generally furnished on a central or regional basis to other senior living communities in the Marriott retirement community system. Such services will include the following: (i) marketing and public relations services; (ii) human resources program development; (iii) information systems support and development; and (iv) centralized computer payroll and accounting services. In lieu of reimbursement for such services, MSLS is paid an amount equal to 2% of revenues. Generally, through the earlier of (i) the end of the seventh year of the operating agreement or (ii) the date upon which certain performance criteria have been met, 50% of the Central Administrative services fee is payable only to the extent that operating profit for the communities exceeds a priority return to the owner. However, the payment of fees for the Central Administrative Services were generally waived for the first year of the operating agreement. The Partitioned Business is required under the operating agreements to contribute a percentage of revenues into an interest-bearing reserve account to cover the cost of (a) certain routine repairs and maintenance to the senior living communities which are normally capitalized and (b) replacements and F-74 CSL GROUP, INC. AND SUBSIDIARIES AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. OPERATING AGREEMENTS (CONTINUED) renewals to the senior living communities' property and improvements. The annual contribution amount (expressed as a percentage of revenues) generally will be 2.65% through fiscal year 2002, 2.85% for fiscal years 2003 through 2007, and 3.5% thereafter. The amount contributed for fiscal years 2000, 1999 and 1998 was $6.9 million, $6.4 million and $6.3 million, respectively. The operating agreements provide that the Partitioned Business shall separately fund the cost of certain major or non-routine repairs, alterations, improvements, renewals and replacements to the senior living communities. 7. DEBT Debt consists of the following as of December 29, 2000 and December 31, 1999:
2000 1999 -------- -------- (IN THOUSANDS) Mortgage debt secured by eight senior living communities with $242 million of real estate assets, with an interest rate of 10.01%, maturing through 2020 (amount includes debt premium of $13.5 million in 2000 and $14.1 million in 1999)................................ $131,298 $133,586 Mortgage debt secured by eight senior living communities with $117 million of real estate assets, with an interest rate of 9.56%, maturing in July 2005......... 92,370 -- Mortgage debt secured by nine senior living communities (amount included debt premium of $0.9 million in 1999)................................................. -- 45,097 Revenue bonds with an interest rate of 5.875%, due 2027.................................................. 14,700 14,700 Capital lease obligations............................... 9,842 10,277 Other notes, with an interest rate of 7.5%, maturing through December 31, 2001............................. 980 1,969 -------- -------- Total debt.......................................... $249,190 $205,629 ======== ========
Debt maturities at December 29, 2000, excluding the unamortized debt premiums of $13.5 million, are as follows (in thousands): 2001........................................................ $ 3,200 2002........................................................ 2,500 2003........................................................ 2,967 2004........................................................ 3,154 2005........................................................ 95,870 Thereafter.................................................. 128,024 -------- $235,715 ========
In conjunction with the June 21, 1997 acquisition of Forum, the Partitioned Business issued $72 million in notes payable to MSLS. Subsequent to the acquisition, the Partitioned Business issued additional notes payable to MSLS to finance additional senior living expansion units totaling approximately $20 million. In the second quarter of 1998, Host Marriott loaned the Partitioned F-75 CSL GROUP, INC. AND SUBSIDIARIES AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 7. DEBT (CONTINUED) Business $92 million to repay the notes payable to MSLS. In the third quarter of 1998, Host Marriott forgave the $92 million note and it was recorded as an investment in the Partitioned Business. During the first quarter of 1998, Host Marriott prepaid $26.4 million of the Partitioned Business's mortgage debt. Host Marriott's prepayment of the debt was recorded as an investment in the Partitioned Business. In 2000, the Partitioned Business entered into five loan agreements totaling $92.4 million secured by mortgages on eight senior living communities. The non-recourse loans bear interest at the 30-day LIBOR rate plus 275 basis points (9.56% at December 29, 2000). The loans mature in July 2005 and there is no principal amortization during the term of the loans. The proceeds of the financing were used to repay the existing loan secured by the senior living communities with a principal balance of $43.5 million, which bore interest at 9.93% and had a scheduled maturity of January 1, 2001. In connection with the prepayment of the existing loan, the Partitioned Business recognized an extraordinary gain on the early extinguishment of debt of $253,000, net of income taxes of $175,000. The indentures governing the mortgages of certain of the Partitioned Business's senior living communities contain restrictive covenants that, among other restrictions, (i) require maintenance of segregated cash collection of all rents for certain of the senior living communities; (ii) require separate cash reserves for debt service, property improvements, real estate taxes and insurance; and (iii) limit the ability to incur additional indebtedness, enter into or cancel leases, enter into certain transactions with affiliates or sell certain assets. As of December 29, 2000 and December 31, 1999, the Partitioned Business was in compliance with all debt covenants. In conjunction with the acquisition of Forum, the Partitioned Business recorded the debt assumed at its fair value. The Partitioned Business is amortizing this premium to interest expense over the remaining life of the related debt. The amortization of this debt premium for fiscal years 2000, 1999 and 1998 was $1.1 million, $1.6 million and $1.6 million, respectively. Cash paid for interest for fiscal years 2000, 1999 and 1998 totaled $20.8 million, $18.6 million and $19.8 million, respectively. Deferred financing costs, which are included in other assets on the Partitioned Business's consolidated balance sheets, was $3.4 million net of accumulated amortization of $0.4 million as of December 29, 2000. There was no deferred financing cost in 1999. 8. INCOME TAXES Total deferred tax assets and liabilities as of December 29, 2000 and December 31, 1999 were as follows:
2000 1999 -------- -------- (IN THOUSANDS) Deferred tax assets..................................... $ 17,359 $ 18,596 Deferred tax liabilities................................ (81,019) (80,150) -------- -------- Net deferred income tax liability..................... $(63,660) $(61,554) ======== ========
F-76 CSL GROUP, INC. AND SUBSIDIARIES AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 8. INCOME TAXES (CONTINUED) The tax effect of each type of temporary difference and carryforward that gives rise to a significant portion of deferred tax assets and liabilities was as follows:
2000 1999 -------- -------- (IN THOUSANDS) Property and equipment.................................. $(80,552) $(77,170) Debt adjustment to fair value at acquisition............ 5,700 6,160 Net operating losses and other, net..................... 11,192 9,456 -------- -------- Net deferred income tax liability..................... $(63,660) $(61,554) ======== ========
The provision for income taxes for fiscal years 2000, 1999 and 1998 consists of the following:
2000 1999 1998 -------- -------- -------- (IN THOUSANDS) Current............................................ $ 8,667 $6,928 $4,781 Deferred........................................... 1,508 (79) 1,370 ------- ------ ------ $10,175 $6,849 $6,151 ======= ====== ======
A reconciliation of the statutory Federal tax rate to the Partitioned Business's effective income tax rate for fiscal years 2000, 1999 and 1998 is as follows:
2000 1999 1998 -------- -------- -------- Statutory federal tax rate.............................. 35.0% 35.0% 35.0% State income taxes, net of federal tax benefit.......... 6.0 6.0 6.0 ---- ---- ---- 41.0% 41.0% 41.0% ==== ==== ====
The Partitioned Business was included in the consolidated federal income tax return of Host Marriott and its affiliates for the period from January 3, 1998 through the Distribution Date, and subsequent to the Distribution Date, the Partitioned Business was included in the consolidated federal income tax return of Crestline Capital (collectively, the "Group"). Tax expense was allocated to the Partitioned Business as a member of the Group based upon the relative contribution to the Group's consolidated taxable income/loss and changes in temporary differences. This allocation method results in federal and net state tax expense allocated for all periods presented that is substantially equal to the expense that would have been recognized if the Partitioned Business had filed separate tax returns. For income tax purposes, the Partitioned Business, through CSL Group, has net operating loss carryforwards of $8.4 million which expire through 2006. F-77 CSL GROUP, INC. AND SUBSIDIARIES AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. FAIR VALUE OF FINANCIAL INSTRUMENTS The fair values of certain financial liabilities are shown below:
2000 1999 ------------------- ------------------- CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE -------- -------- -------- -------- (IN THOUSANDS) Debt, net of capital leases......... $239,348 $243,718 $195,352 $186,705
Valuations for secured debt are determined based on the expected future payments discounted at risk-adjusted rates. The fair values of other notes are estimated to be equal to their carrying value. The fair value of all of the Partitioned Business' other financial assets and liabilities are assumed to equal their carrying amounts. In 1999, the Partitioned Business recorded a pre-tax charge of $1.7 million, which is included in other operating costs and expenses, to fully reserve a second mortgage note receivable due to uncertainty in the collectibility of the note. 10. CONTINUING LIFECARE CONTRACTS Residents at two of the communities are offered continuing care life contracts that provide reduced monthly rental rates in exchange for significant security deposits, which become partially or totally non-refundable over time. At the Pueblo Norte senior living community, two types of continuing care contracts are currently offered to new residents. One contract provides that 10% of the resident admission fees is non-refundable upon occupancy. The remaining 90% of the resident admission fees becomes non-refundable at a rate of 1 1/2% per month over the subsequent 60 months and is amortized over the expected life of the resident. The second contract type provides that the resident admission fee is 30% non-refundable and 70% fully refundable. The non-refundable portions are amortized over the expected life of the resident. The liability for the refundable portion of the admission fees at December 29, 2000 and December 31, 1999 is $5,161,000 and $4,237,000, respectively, and is included in other liabilities on the Partitioned Business's consolidated balance sheets. The non-refundable portion of the admission fees at December 29, 2000 and December 31, 1999 totaled $2,820,000 and $1,888,000, respectively and is included in other liabilities on the Partitioned Business's consolidated balance sheets. Three other types of continuing care agreements are in effect at Pueblo Norte with existing residents but are no longer offered to new residents. One agreement provides that the resident admission fee is 10% non-refundable and 90% fully refundable. Each resident is entitled to 70 free days of care in the health center based on a prescribed formula. The second type of agreement provides that the resident admission fee is 1% refundable and 99% non-refundable. The non-refundable portion of the resident admission fees are amortized over the expected life of the resident. The liability at December 29, 2000 and December 31, 1999 for the non-refundable portion of these contracts is $3,208,000 and $4,131,000, respectively, and is included in other liabilities on the Partitioned Business's consolidated balance sheets. At two additional senior living communities, lifecare contracts are in effect with existing residents, but no longer offered to new residents. The agreements provide that the resident admission fees are F-78 CSL GROUP, INC. AND SUBSIDIARIES AS PARTITIONED FOR SALE TO SNH/CSL PROPERTIES TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 10. CONTINUING LIFECARE CONTRACTS (CONTINUED) either fully refundable or non-refundable. As of December 29, 2000 and December 31, 1999, the refundable portion of these contracts was $965,000 in both years, and the non-refundable portion of these contracts was $618,000 and $1,428,000, respectively, and are included in other liabilities on the Partitioned Business's consolidated balance sheets. 11. LITIGATION On June 15, 1995, the Russell F. Knapp Revocable Trust (the "Plaintiff") filed a complaint in the United States District Court for the Southern District of Indiana (the "Indiana Court") against the general partner of one of CSL Group's subsidiary partnerships, CCC Retirement Partners, LP, formerly Forum Retirement Partners, LP, ("FRP"), alleging breach of the partnership agreement, breach of fiduciary duty, fraud, insider trading and civil conspiracy/aiding and abetting. On February 4, 1998, the Plaintiff, MSLS, the general partner, CSL Group, Host Marriott and Crestline Capital entered into a Settlement and Release Agreement (the "Settlement Agreement"), pursuant to which Host Marriott agreed to purchase, at a price of $4.50 per unit, the partnership units of each limited partner electing to join in the Settlement Agreement. CSL Group held 79% of the outstanding limited partner units in the partnership at that time. Host Marriott and CSL Group also agreed to pay as much as an additional $.75 per unit (the "Additional Payment") to the settling limited partners (the "Settling Partners"), under certain conditions, in the event that CSL Group within three years following the date of settlement initiates a tender offer for the purchase of units not presently held by CSL Group or the Settling Partners. On February 5, 1998, the Indiana Court entered an order approving the dismissal of the Plaintiff's case. In connection with the Settlement Agreement, CSL Group acquired 2,141,795 limited partner units in 1998 for approximately $9,638,000, increasing CSL Group's ownership interest in FRP to approximately 93%. In 1999, CSL Group and FRP completed a merger pursuant to a consent solicitation whereby the partnership unit holders received the right to receive cash consideration for each limited partnership unit from CSL Group. In connection with this merger, CSL Group acquired the remaining limited partnership units for approximately $6,158,000. Also, CSL Group paid the Settling Partners an Additional Payment in 1999 of approximately $557,000 pursuant to the merger transaction. As of December 29, 2000, CSL Group had a liability of $247,000 representing cash consideration for the remaining untendered FRP limited partnership units. The purchase price of the units for both transactions approximated fair value, and accordingly, no portion of the purchase price has been expensed. F-79 -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- SPIN-OFF OF FIVE STAR QUALITY CARE, INC. THROUGH DISTRIBUTION OF 2,937,470 SHARES OF COMMON STOCK --------------------- PROSPECTUS --------------------- , 2001 Until , 2001 (25 days after the date of this prospectus), all dealers that effect transactions in these securities may be required to deliver this prospectus. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION Set forth below is an estimate (except in the case of the registration fee) of the amount of fees and expenses to be incurred in connection with the issuance and distribution of the offered securities. All such fees and expenses are to be paid by Senior Housing Properties Trust. Registration Fee Under Securities Act of 1933............... $10,000 Blue Sky Fees and Expenses.................................. * American Stock Exchange Listing Fee......................... * Legal Fees and Expenses..................................... * Accounting Fees and Expenses................................ * Printing and Engraving...................................... * Distribution Agent, Transfer Agent and Registrar Fees and Expenses.................................................. * Miscellaneous Fees and Expenses............................. * Total:...................................................... $ *
------------------------ * To be filed by amendment. ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS The Maryland General Corporation Law permits a Maryland corporation to include in its charter a provision limiting the liability of its directors and officers to the corporation and its shareholders for money damages except for liability resulting from (a) actual receipt of an improper benefit or profit in money, property or services or (b) acts committed in bad faith or active and deliberate dishonesty established by a final judgment as being material to the cause of action. The Company's charter contains such a provision which eliminates such liability to the maximum extent permitted by Maryland law. The Company's charter authorizes the Company, to the maximum extent permitted by Maryland law, to obligate itself to indemnify and to pay or reimburse reasonably expenses in advance of final disposition of a proceeding to (i) any present or former director or officer or (ii) any individual who, while a director and at the Company's request, serves or has served another corporation, real estate investment trust, partnership, joint venture, trust, employee benefit plan or other enterprise from and against any claim or liability to which he or she may become subject or which he or she may incur by reason of his or her status as a present or former director or officer of the Company. The Company's bylaws obligate it, to the maximum extent permitted by Maryland law, to indemnify and to pay or reimburse reasonable expenses in advance of final disposition of a proceeding to (a) any present or former director or officer who is made party to the proceeding by reason of his service in that capacity or (b) any individual who, while a director or officer of the Company and at the request of the Company, serves or has served another corporation, real estate investment trust, partnership, joint venture, trust, employee benefit plan or any other enterprise as a director, officer, partner or trustee of such corporation, real estate investment trust, partnership, joint venture, trust, employee benefit plan or other enterprise and who is made a party to the proceeding by reason of his service in that capacity, against any claim or liability to which he may become subject by reason of such status. The Company's charter and bylaws also permit the Company to indemnify and advance expenses to any person who served a predecessor of the Company in any of the capacities described above and to any employee or agent of the Company or a predecessor of the Company. The Maryland General Corporation Law requires a corporation (unless its charter provides otherwise, which the Company's charter does not) to indemnify a director or officer who has been successful, on the merits or otherwise, in the defense of any proceeding to which he or she is made a party by reason of his or her service in that capacity. The II-1 Maryland General Corporation Law permits a corporation to indemnify its directors and officers, among others, against judgments, penalties, fines, settlements and reasonable expenses actually incurred by them in connection with any proceedings to which they may be made a party by reason of their service in those or other capacities unless it is established that (a) the act or omission of the director or officer was material to the matter giving rise to the proceedings and (i) was committed in bad faith or (ii) was the result of active and deliberate dishonesty, (b) the director or officer actually received an improper personal benefit in money, property or services or (c) in the case of any criminal proceeding, the director or officer had reasonable cause to believe that the act or omission was unlawful. However, under the Maryland General Corporation Law, a Maryland corporation may not indemnify for an adverse judgment in a suit by or in the right of the corporation or for a judgment of liability on the basis that personal benefit was improperly received, unless in either case a court orders indemnification and then only for expenses. In accordance with the Maryland General Corporation Law, the Company's bylaws require it, as a condition to advancing expenses, to obtain (1) a written affirmation by the director or officer of his or her good faith belief that he or she has met the standard of conduct necessary for indemnification by the Company as authorized by the Company's bylaws and (2) a written statement by or on his or her behalf to repay the amount paid or reimbursed by the Company if it shall ultimately be determined that the standard of conduct was not met. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES In the three years preceding the filing of this registration statement, we have issued the following securities that were not registered under the Securities Act: (a) Issuances of Capital Stock. On September 17, 2001, we issued 1,000 shares of common stock to Senior Housing Properties Trust for $1,000 in connection with its organization under Maryland law. No underwriters were used in the foregoing transactions. The sale of securities described above were made in reliance upon the exemption from registration provided by Section 4(2) of the Securities Act for transactions by an issuer not involving a public offering. II-2 ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) Exhibits:
EXHIBIT NO. DESCRIPTION ------- ------------------------------------------------------------ 2.1* Merger Agreement between the Registrant and FSQ, Inc. 3.1 Articles of Incorporation of the Registrant (currently in effect) 3.2* Form of Articles of Amendment and Restatement of Articles of Incorporation 3.3 Bylaws of the Registrant (currently in effect) 3.4* Form of Amended and Restated Bylaws 4.1* Specimen Certificate for shares of common stock of the Registrant 4.2 Description of Capital Stock (contained in Exhibits 3.1 and 3.2) 5.1* Legal Opinion of Sullivan & Worcester LLP 5.2* Legal Opinion of Ballard Spahr Andrews & Ingersoll, LLP 8.1* Legal Opinion of Sullivan & Worcester LLP re: tax matters 10.1* Transaction Agreement by and among Senior Housing Properties Trust, the Registrant, FSQ, Inc., Hospitality Properties Trust, HRPT Properties Trust and REIT Management & Research, Inc. 10.2 Stock Purchase Agreement among Senior Housing Properties Trust, SNH/CSL Properties Trust, Crestline Capital Corporation and CSL Group, Inc., dated August 9, 2001 #10.3* Operating Agreement between CCC Financing Limited, L.P. and Marriott Senior Living Services, Inc. dated June 21, 1997 #10.4* Pooling Agreement between HMC Senior Communities, Inc. and Marriott Senior Living Services, Inc. dated June 21, 1997 10.5* Shared Services Agreement between the Registrant and REIT Management & Research, Inc. 10.6* Lease between the Registrant and Senior Housing Properties Trust relating to the 56 properties managed by FSQ, Inc. #10.7* Lease between the Registrant and Senior Housing Properties Trust relating to the 31 properties managed by Marriott Senior Living Services, Inc. 10.8* 2001 Stock Option and Stock Incentive Plan 11.1 Statement re: Computation of Per Share Earnings 21.1* Subsidiaries of the Registrant 23.1* Consent of Sullivan & Worcester LLP (contained in Exhibits 5.1 and 8.1) 23.2* Consent of Ballard Spahr Andrews & Ingersoll, LLP (contained in Exhibit 5.2) 23.3 Consent of Ernst & Young LLP 23.4 Consent of KPMG LLP 23.5 Consent of Arthur Andersen LLP 24.1 Power of Attorney (contained on page II-5) 99.1 Consent of John L. Harrington to being named a Director 99.2 Consent of Bruce M. Gans to being named a Director 99.3 Consent of Arthur G. Koumantzelis to being named a Director 99.4* Form of Audit Committee Charter
------------------------ * To be filed by amendment. # Agreement filed is illustrative of numerous other agreements to which the Registrant will be a party. (b) Financial Statement Schedules: 1. Schedule II--Valuation and Qualifying Accounts of Forty-two Facilities Acquired by Senior Housing Properties Trust from Integrated Health Services, Inc. II-3 2. Schedule II--Valuation and Qualifying Accounts of Certain Mariner Post-Acute Network Facilities (Operated by subsidiaries of Mariner Post-Acute Network) All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are not applicable, and therefore have been omitted. ITEM 17. UNDERTAKINGS Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Registrant pursuant to the provisions described under Item 14 of this registration statement, 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 of 1933 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 of 1933 and will be governed by the final adjudication of such issue. II-4 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Newton, Commonwealth of Massachusetts, on September 21, 2001. FIVE STAR QUALITY CARE, INC. By: /s/ EVRETT W. BENTON ----------------------------------------- Evrett W. Benton PRESIDENT AND CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Act of 1933, this registration statement on Form S-1 has been signed below by the following persons in the capacities and on the dates indicated; and each of the undersigned officers and directors of Five Star Quality Care, Inc., hereby severally constitute and appoint Evrett W. Benton, Gerard M. Martin and Barry M. Portnoy to sign for him, and in his name in the capacity indicated below, this registration statement for the purpose of registering such securities under the Securities Act of 1933, and any and all amendments thereto, and any other registration statement filed by Five Star Quality Care, Inc. pursuant to Rule 462(b) which registers additional amounts of equity securities for the offering or offerings contemplated by this registration statement (a "462(b) Registration Statement") hereby ratifying and confirming our signatures as they may be signed by our attorneys to this registration statement, any 462(b) Registration Statement and any and all amendments to either thereof.
SIGNATURE TITLE DATE --------- ----- ---- /s/ EVRETT W. BENTON President and Chief Executive September 21, 2001 ---------------------------------------- Officer Evrett W. Benton /s/ BRUCE J. MACKEY JR. Chief Financial Officer and September 21, 2001 ---------------------------------------- Treasurer Bruce J. Mackey Jr. /s/ BARRY M. PORTNOY Director September 21, 2001 ---------------------------------------- Barry M. Portnoy /s/ GERARD M. MARTIN Director September 21, 2001 ---------------------------------------- Gerard M. Martin
II-5 EX-3.1 3 a2059384zex-3_1.txt EX-3.1 EXHIBIT 3.1 FIVE STAR QUALITY CARE, INC. ARTICLES OF INCORPORATION THIS IS TO CERTIFY THAT: FIRST: The undersigned, Michael A. Mingolelli, Jr., Esq., whose address is c/o Sullivan & Worcester LLP, One Post Office Square, Boston, Massachusetts, 02109, being at least 18 years of age, does hereby form a corporation under the general laws of the State of Maryland. SECOND: The name of the corporation (which is hereinafter called the "Corporation") is: Five Star Quality Care, Inc. THIRD: The Corporation is formed for the purpose of carrying on any lawful business. FOURTH: The address of the principal office of the Corporation in this State is c/o Ballard Spahr Andrews & Ingersoll, LLP, 300 East Lombard Street, Baltimore, Maryland 21202, Attention: James J. Hanks, Jr. FIFTH: The name and address of the resident agent of the Corporation are James J. Hanks, Jr., c/o Ballard Spahr Andrews & Ingersoll, LLP, 300 East Lombard Street, Baltimore, Maryland 21202. The resident agent is a citizen of and resides in the State of Maryland. SIXTH: The total number of shares of stock which the Corporation has authority to issue is 1,000 shares of common stock, $.01 par value per share. The aggregate par value of all authorized shares having a par value is $10.00. SEVENTH: The Corporation shall have a board of one director unless the number is increased or decreased in accordance with the Bylaws of the Corporation. However, the number of directors shall never be less than the minimum number required by the Maryland General Corporation Law. The initial director is: Gerard M. Martin EIGHTH: (a) The Corporation reserves the right to make any amendment of the charter, now or hereafter authorized by law, including any amendment which alters the contract rights, as expressly set forth in the charter, of any shares of outstanding stock. (b) The Board of Directors of the Corporation may authorize the issuance from time to time of shares of its stock of any class, whether now or hereafter authorized, or securities convertible into shares of its stock of any class, whether now or hereafter authorized, for such consideration as the Board of Directors may deem advisable, subject to such restrictions or limitations, if any, as may be set forth in the Bylaws of the Corporation. (c) The Board of Directors of the Corporation may, by articles supplementary, classify or reclassify any unissued stock from time to time by setting or changing the preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends, qualifications, or terms or conditions of redemption of the stock. NINTH: No holder of shares of stock of any class shall have any preemptive right to subscribe to or purchase any additional shares of any class, or any bonds or convertible securities of any nature; provided, however, that the Board of Directors may, in authorizing the issuance of shares of stock of any class, confer any preemptive right that the Board of Directors may deem advisable in connection with such issuance. TENTH: To the maximum extent that Maryland law in effect from time to time permits limitation of the liability of directors and officers, no director or officer of the Corporation shall be liable to the Corporation or its stockholders for money damages. Neither the amendment nor repeal of this Article, nor the adoption or amendment of any other provision of the charter or Bylaws inconsistent with this Article, shall apply to or affect in any respect the applicability of the preceding sentence with respect to any act or failure to act which occurred prior to such amendment, repeal or adoption. IN WITNESS WHEREOF, I have signed these Articles of Incorporation and acknowledge the same to be my act on this 17th day of September, 2001. /s/ Michael A. Mingolelli, Jr. ------------------------------------------- Michael A. Mingolelli, Jr., Esq. 2 EX-3.3 4 a2059384zex-3_3.txt EXHIBIT 3.3 EXHIBIT 3.3 FIVE STAR QUALITY CARE, INC. ---------------------------- BYLAWS ARTICLE I OFFICES Section 1. PRINCIPAL OFFICE. The principal office of the Corporation in the State of Maryland shall be located at such place as the Board of Directors may designate. Section 2. ADDITIONAL OFFICES. The Corporation may have additional offices, including a principal executive office, at such places as the Board of Directors may from time to time determine or the business of the Corporation may require. ARTICLE II MEETINGS OF STOCKHOLDERS Section 1. PLACE. All meetings of stockholders shall be held at the principal executive office of the Corporation or at such other place as shall be set by the Board of Directors and stated in the notice of the meeting. Section 2. ANNUAL MEETING. An annual meeting of the stockholders for the election of directors and the transaction of any business within the powers of the Corporation shall be held on a date and at the time set by the Board of Directors during the month of May in each year. Section 3. SPECIAL MEETINGS. The chairman of the board, president, chief executive officer or Board of Directors may call special meetings of the stockholders. Special meetings of stockholders shall also be called by the secretary of the Corporation upon the written request of the holders of shares entitled to cast not less than a majority of all the votes entitled to be cast at such meeting. Such request shall state the purpose of such meeting and the matters proposed to be acted on at such meeting. The secretary shall inform such stockholders of the reasonably estimated cost of preparing and mailing notice of the meeting and, upon payment to the Corporation by such stockholders of such costs, the secretary shall give notice to each stockholder entitled to notice of the meeting. Section 4. NOTICE. Not less than ten nor more than 90 days before each meeting of stockholders, the secretary shall give to each stockholder entitled to vote at such meeting and to each stockholder not entitled to vote who is entitled to notice of the meeting written or printed notice stating the time and place of the meeting and, in the case of a special meeting or as otherwise may be required by any statute, the purpose for which the meeting is called, either by mail, by presenting it to such stockholder personally, by leaving it at the stockholder's residence or usual place of business or by any other means permitted by Maryland law. If mailed, such notice shall be 2 deemed to be given when deposited in the United States mail addressed to the stockholder at the stockholder's address as it appears on the records of the Corporation, with postage thereon prepaid. Any business of the Corporation may be transacted at an annual meeting of stockholders without being specifically designated in the notice, except such business as is required by any statute to be stated in such notice. No business shall be transacted at a special meeting of stockholders except as specifically designated in the notice. Section 5. ORGANIZATION AND CONDUCT. Every meeting of stockholders shall be conducted by an individual appointed by the Board of Directors to be chairman of the meeting or, in the absence of such appointment, by the chairman of the board or, in the case of a vacancy in the office or absence of the chairman of the board, by one of the following officers present at the meeting: the vice chairman of the board, if there be one, the president, the vice presidents in their order of rank and seniority, or, in the absence of such officers, a chairman chosen by the stockholders by the vote of a majority of the votes cast by stockholders present in person or by proxy. The secretary, or, in the secretary's absence, an assistant secretary, or in the absence of both the secretary and assistant secretaries, a person appointed by the Board of Directors or, in the absence of such appointment, a person appointed by the chairman of the meeting shall act as secretary. In the event that the secretary presides at a meeting of the stockholders, an assistant secretary shall record the minutes of the meeting. The order of business and all other matters of procedure at any meeting of stockholders shall be determined by the chairman of the meeting. The chairman of the meeting may prescribe such rules, regulations and procedures and take such action as, in the discretion of such chairman, are appropriate for the proper conduct of the meeting, including, without limitation, (a) restricting admission to the time set for the commencement of the meeting; (b) limiting attendance at the meeting to stockholders of record of the Corporation, their duly authorized proxies or other such persons as the chairman of the meeting may determine; (c) limiting participation at the meeting on any matter to stockholders of record of the Corporation entitled to vote on such matter, their duly authorized proxies or other such persons as the chairman of the meeting may determine; (d) limiting the time allotted to questions or comments by participants; (e) maintaining order and security at the meeting; (f) removing any stockholder who refuses to comply with meeting procedures, rules or guidelines as set forth by the chairman of the meeting; and (g) recessing or adjourning the meeting to a later date and time and place announced at the meeting. Unless otherwise determined by the chairman of the meeting, meetings of stockholders shall not be required to be held in accordance with the rules of parliamentary procedure. Section 6. QUORUM. At any meeting of stockholders, the presence in person or by proxy of stockholders entitled to cast a majority of all the votes entitled to be cast at such meeting shall constitute a quorum; but this section shall not affect any requirement under any statute or the charter of the Corporation for the vote necessary for the adoption of any measure. If, however, such quorum shall not be present at any meeting of the stockholders, the chairman of the meeting or the stockholders entitled to vote at such meeting, present in person or by proxy, shall have the power to adjourn the meeting from time to time to a date not more than 120 days after the original record date without notice other than announcement at the meeting. At such adjourned meeting at which a quorum shall be present, any business may be transacted which might have been transacted at the meeting as originally notified. 3 The stockholders present either in person or by proxy, at a meeting which has been duly called and convened, may continue to transact business until adjournment, notwithstanding the withdrawal of enough stockholders to leave less than a quorum. Section 7. VOTING. A plurality of all the votes cast at a meeting of stockholders duly called and at which a quorum is present shall be sufficient to elect a director. Each share may be voted for as many individuals as there are directors to be elected and for whose election the share is entitled to be voted. A majority of the votes cast at a meeting of stockholders duly called and at which a quorum is present shall be sufficient to approve any other matter which may properly come before the meeting, unless more than a majority of the votes cast is required by statute or by the charter of the Corporation. Unless otherwise provided in the charter, each outstanding share, regardless of class, shall be entitled to one vote on each matter submitted to a vote at a meeting of stockholders. Section 8. PROXIES. A stockholder may cast the votes entitled to be cast by the shares of stock owned of record by the stockholder in person or by proxy executed by the stockholder or by the stockholder's duly authorized agent in any manner permitted by law. Such proxy or evidence of authorization of such proxy shall be filed with the secretary of the Corporation before or at the meeting. No proxy shall be valid more than eleven months after its date unless otherwise provided in the proxy. Section 9. VOTING OF STOCK BY CERTAIN HOLDERS. Stock of the Corporation registered in the name of a corporation, partnership, trust or other entity, if entitled to be voted, may be voted by the president or a vice president, a general partner or trustee thereof, as the case may be, or a proxy appointed by any of the foregoing individuals, unless some other person who has been appointed to vote such stock pursuant to a bylaw or a resolution of the governing body of such corporation or other entity or agreement of the partners of a partnership presents a certified copy of such bylaw, resolution or agreement, in which case such person may vote such stock. Any director or other fiduciary may vote stock registered in his or her name as such fiduciary, either in person or by proxy. Shares of stock of the Corporation directly or indirectly owned by it shall not be voted at any meeting and shall not be counted in determining the total number of outstanding shares entitled to be voted at any given time, unless they are held by it in a fiduciary capacity, in which case they may be voted and shall be counted in determining the total number of outstanding shares at any given time. The Board of Directors may adopt by resolution a procedure by which a stockholder may certify in writing to the Corporation that any shares of stock registered in the name of the stockholder are held for the account of a specified person other than the stockholder. The resolution shall set forth the class of stockholders who may make the certification, the purpose for which the certification may be made, the form of certification and the information to be contained in it; if the certification is with respect to a record date or closing of the stock transfer books, the time after the record date or closing of the stock transfer books within which the certification must be received by 4 the Corporation; and any other provisions with respect to the procedure which the Board of Directors considers necessary or desirable. On receipt of such certification, the person specified in the certification shall be regarded as, for the purposes set forth in the certification, the stockholder of record of the specified stock in place of the stockholder who makes the certification. Section 10. INSPECTORS. The Board of Directors, in advance of any meeting, may, but need not, appoint one or more individual inspectors or one or more entities that designate individuals as inspectors to act at the meeting or any adjournment thereof. If an inspector or inspectors are not appointed, the person presiding at the meeting may, but need not, appoint one or more inspectors. In case any person who may be appointed as an inspector fails to appear or act, the vacancy may be filled by appointment made by the Board of Directors in advance of the meeting or at the meeting by the chairman of the meeting. The inspectors, if any, shall determine the number of shares outstanding and the voting power of each, the shares represented at the meeting, the existence of a quorum, the validity and effect of proxies, and shall receive votes, ballots or consents, hear and determine all challenges and questions arising in connection with the right to vote, count and tabulate all votes, ballots or consents, determine the result, and do such acts as are proper to conduct the election or vote with fairness to all stockholders. Each such report shall be in writing and signed by him or her or by a majority of them if there is more than one inspector acting at such meeting. If there is more than one inspector, the report of a majority shall be the report of the inspectors. The report of the inspector or inspectors on the number of shares represented at the meeting and the results of the voting shall be PRIMA FACIE evidence thereof. Section 12. VOTING BY BALLOT. Voting on any question or in any election may be VIVA VOCE unless the presiding officer shall order or any stockholder shall demand that voting be by ballot. ARTICLE III DIRECTORS Section 1. GENERAL POWERS. The business and affairs of the Corporation shall be managed under the direction of its Board of Directors. Section 2. NUMBER, TENURE AND QUALIFICATIONS. At any regular meeting or at any special meeting called for that purpose, a majority of the entire Board of Directors may establish, increase or decrease the number of directors, provided that the number thereof shall never be less than the minimum number required by the Maryland General Corporation Law, nor more than 15, and further provided that the tenure of office of a director shall not be affected by any decrease in the number of directors. Section 3. ANNUAL AND REGULAR MEETINGS. An annual meeting of the Board of Directors shall be held immediately after and at the same place as the annual meeting of stockholders, no notice other than this Bylaw being necessary. In the event such meeting is not so 5 held, the meeting may be held at such time and place as shall be specified in a notice given as hereinafter provided for special meetings of the Board of Directors. Section 4. SPECIAL MEETINGS. Special meetings of the Board of Directors may be called by or at the request of the chairman of the board, the chief executive officer, the president or by a majority of the directors then in office. The person or persons authorized to call special meetings of the Board of Directors may fix any place as the place for holding any special meeting of the Board of Directors called by them. The Board of Directors may provide, by resolution, the time and place for the holding of special meetings of the Board of Directors without other notice than such resolution. Section 5. NOTICE. Notice of any special meeting of the Board of Directors shall be delivered personally or by telephone, electronic mail, facsimile transmission, United States mail or courier to each director at his or her business or residence address. Notice by personal delivery, telephone, electronic mail or facsimile transmission shall be given at least 24 hours prior to the meeting. Notice by United States mail shall be given at least three days prior to the meeting. Notice by courier shall be given at least two days prior to the meeting. Telephone notice shall be deemed to be given when the director or his or her agent is personally given such notice in a telephone call to which the director or his or her agent is a party. Electronic mail notice shall be deemed to be given upon transmission of the message to the electronic mail address given to the Corporation by the director. Facsimile transmission notice shall be deemed to be given upon completion of the transmission of the message to the number given to the Corporation by the director and receipt of a completed answer-back indicating receipt. Notice by United States mail shall be deemed to be given when deposited in the United States mail properly addressed, with postage thereon prepaid. Notice by courier shall be deemed to be given when deposited with or delivered to a courier properly addressed. Neither the business to be transacted at, nor the purpose of, any annual, regular or special meeting of the Board of Directors need be stated in the notice, unless specifically required by statute or these Bylaws. Section 6. QUORUM. A majority of the directors shall constitute a quorum for transaction of business at any meeting of the Board of Directors, provided that, if less than a majority of such directors are present at said meeting, a majority of the directors present may adjourn the meeting from time to time without further notice, and provided further that if, pursuant to the charter of the Corporation or these Bylaws, the vote of a majority of a particular group of directors is required for action, a quorum must also include a majority of such group. The directors present at a meeting which has been duly called and convened may continue to transact business until adjournment, notwithstanding the withdrawal of enough directors to leave less than a quorum. Section 7. VOTING. The action of the majority of the directors present at a meeting at which a quorum is present shall be the action of the Board of Directors, unless the concurrence of a greater proportion is required for such action by applicable statute or the charter. If enough directors have withdrawn from a meeting to leave less than a quorum but the meeting is not adjourned, the action of the majority of the directors still present at such meeting shall be the action 6 of the Board of Directors, unless the concurrence of a greater proportion is required for such action by applicable statute or the charter. Section 8. ORGANIZATION. At each meeting of the Board of Directors, the chairman of the board or, in the absence of the chairman, the vice chairman of the board, if any, shall act as Chairman. In the absence of both the chairman and vice chairman of the board, the chief executive officer or in the absence of the chief executive officer, the president or in the absence of the president, a director chosen by a majority of the directors present, shall act as Chairman. The secretary or, in his or her absence, an assistant secretary of the Corporation, or in the absence of the secretary and all assistant secretaries, a person appointed by the Chairman, shall act as Secretary of the meeting. Section 9. TELEPHONE MEETINGS. Directors may participate in a meeting by means of a conference telephone or similar communications equipment if all persons participating in the meeting can hear each other at the same time. Participation in a meeting by these means shall constitute presence in person at the meeting. Section 10. WRITTEN CONSENT BY DIRECTORS. Any action required or permitted to be taken at any meeting of the Board of Directors may be taken without a meeting, if a consent in writing to such action is signed by each director and such written consent is filed with the minutes of proceedings of the Board of Directors. Section 11. VACANCIES. If for any reason any or all the directors cease to be directors, such event shall not terminate the Corporation or affect these Bylaws or the powers of the remaining directors hereunder (even if fewer than three directors remain). Any vacancy on the Board of Directors for any cause other than an increase in the number of directors shall be filled by a majority of the remaining directors, even if such majority is less than a quorum. Any vacancy in the number of directors created by an increase in the number of directors may be filled by a majority vote of the entire Board of Directors. Any individual so elected as director shall serve until the next annual meeting of stockholders and until his or her successor is elected and qualifies. Section 12. COMPENSATION. Directors shall not receive any stated salary for their services as directors but, by resolution of the Board of Directors, may receive compensation per year and/or per meeting and/or per visit to real property or other facilities owned or leased by the Corporation and for any service or activity they performed or engaged in as directors. Directors may be reimbursed for expenses of attendance, if any, at each annual, regular or special meeting of the Board of Directors or of any committee thereof and for their expenses, if any, in connection with each property visit and any other service or activity they performed or engaged in as directors; but nothing herein contained shall be construed to preclude any directors from serving the Corporation in any other capacity and receiving compensation therefor. Section 13. LOSS OF DEPOSITS. No director shall be liable for any loss which may occur by reason of the failure of the bank, trust company, savings and loan association, or other institution with whom moneys or stock have been deposited. 7 Section 14. SURETY BONDS. Unless required by law, no director shall be obligated to give any bond or surety or other security for the performance of any of his or her duties. Section 15. RELIANCE. Each director, officer, employee and agent of the Corporation shall, in the performance of his or her duties with respect to the Corporation, be fully justified and protected with regard to any act or failure to act in reliance in good faith upon the books of account or other records of the Corporation, upon an opinion of counsel or upon reports made to the Corporation by any of its officers or employees or by the adviser, accountants, appraisers or other experts or consultants selected by the Board of Directors or officers of the Corporation, regardless of whether such counsel or expert may also be a director. ARTICLE IV COMMITTEES Section 1. NUMBER, TENURE AND QUALIFICATIONS. The Board of Directors may appoint from among its members an Executive Committee, an Audit Committee and other committees, composed of one or more directors, to serve at the pleasure of the Board of Directors. Section 2. POWERS. The Board of Directors may delegate to committees appointed under Section 1 of this Article any of the powers of the Board of Directors, except as prohibited by law. Section 3. MEETINGS. Notice of committee meetings shall be given in the same manner as notice for special meetings of the Board of Directors. A majority of the members of the committee shall constitute a quorum for the transaction of business at any meeting of the committee. The act of a majority of the committee members present at a meeting shall be the act of such committee. The Board of Directors may designate a chairman of any committee, and such chairman or, in the absence of a chairman, any two members of any committee (if there are at least two members of the Committee) may fix the time and place of its meeting unless the Board shall otherwise provide. In the absence of any member of any such committee, the members thereof present at any meeting, whether or not they constitute a quorum, may appoint another director to act in the place of such absent member. Each committee shall keep minutes of its proceedings. Section 4. TELEPHONE MEETINGS. Members of a committee of the Board of Directors may participate in a meeting by means of a conference telephone or similar communications equipment if all persons participating in the meeting can hear each other at the same time. Participation in a meeting by these means shall constitute presence in person at the meeting. Section 5. WRITTEN CONSENT BY COMMITTEES. Any action required or permitted to be taken at any meeting of a committee of the Board of Directors may be taken without a 8 meeting, if a consent in writing to such action is signed by each member of the committee and such written consent is filed with the minutes of proceedings of such committee. Section 6. VACANCIES. Subject to the provisions hereof, the Board of Directors shall have the power at any time to change the membership of any committee, to fill all vacancies, to designate alternate members to replace any absent or disqualified member or to dissolve any such committee. ARTICLE V OFFICERS Section 1. GENERAL PROVISIONS. The officers of the Corporation shall include a president, a secretary and a treasurer and may include a chairman of the board, a vice chairman of the board, a chief executive officer, one or more vice presidents, a chief operating officer, a chief financial officer, one or more assistant secretaries and one or more assistant treasurers. In addition, the Board of Directors may from time to time elect such other officers with such powers and duties as they shall deem necessary or desirable. The officers of the Corporation shall be elected annually by the Board of Directors, except that the chief executive officer or president may from time to time appoint one or more vice presidents, assistant secretaries and assistant treasurers or other officers. Each officer shall hold office until his or her successor is elected and qualifies or until his or her death, or his or her resignation or removal in the manner hereinafter provided. Any two or more offices except president and vice president may be held by the same person. Election of an officer or agent shall not of itself create contract rights between the Corporation and such officer or agent. Section 2. REMOVAL AND RESIGNATION. Any officer or agent of the Corporation may be removed, with or without cause, by the Board of Directors if in its judgment the best interests of the Corporation would be served thereby, but such removal shall be without prejudice to the contract rights, if any, of the person so removed. Any officer of the Corporation may resign at any time by giving written notice of his or her resignation to the Board of Directors, the chairman of the board, the president or the secretary. Any resignation shall take effect immediately upon its receipt or at such later time specified in the notice of resignation. The acceptance of a resignation shall not be necessary to make it effective unless otherwise stated in the resignation. Such resignation shall be without prejudice to the contract rights, if any, of the Corporation. Section 3. VACANCIES. A vacancy in any office may be filled by the Board of Directors for the balance of the term. Section 4. CHIEF EXECUTIVE OFFICER. The Board of Directors may designate a chief executive officer. In the absence of such designation, the chairman of the board shall be the chief executive officer of the Corporation. The chief executive officer shall have general responsibility for implementation of the policies of the Corporation, as determined by the Board of Directors, and for the management of the business and affairs of the Corporation. 9 Section 5. CHIEF OPERATING OFFICER. The Board of Directors may designate a chief operating officer. The chief operating officer shall have the responsibilities and duties as set forth by the Board of Directors or the chief executive officer. Section 6. CHIEF FINANCIAL OFFICER. The Board of Directors may designate a chief financial officer. The chief financial officer shall have the responsibilities and duties as set forth by the Board of Directors or the chief executive officer. Section 7. CHAIRMAN OF THE BOARD. The Board of Directors shall designate a chairman of the board. The chairman of the board shall preside over the meetings of the Board of Directors and of the stockholders at which he shall be present. The chairman of the board shall perform such other duties as may be assigned to him or her by the Board of Directors. Section 8. PRESIDENT. In the absence of a chief executive officer, the president shall in general supervise and control all of the business and affairs of the Corporation. In the absence of a designation of a chief operating officer by the Board of Directors, the president shall be the chief operating officer. He may execute any deed, mortgage, bond, contract or other instrument, except in cases where the execution thereof shall be expressly delegated by the Board of Directors or by these Bylaws to some other officer or agent of the Corporation or shall be required by law to be otherwise executed; and in general shall perform all duties incident to the office of president and such other duties as may be prescribed by the Board of Directors from time to time. Section 9. VICE PRESIDENTS. In the absence of the president or in the event of a vacancy in such office, the vice president (or in the event there be more than one vice president, the vice presidents in the order designated at the time of their election or, in the absence of any designation, then in the order of their election) shall perform the duties of the president and when so acting shall have all the powers of and be subject to all the restrictions upon the president; and shall perform such other duties as from time to time may be assigned to such vice president by the president or by the Board of Directors. The Board of Directors may designate one or more vice presidents as executive vice president or as vice president for particular areas of responsibility. Section 10. SECRETARY. The secretary shall (a) keep the minutes of the proceedings of the stockholders, the Board of Directors and committees of the Board of Directors in one or more books provided for that purpose; (b) see that all notices are duly given in accordance with the provisions of these Bylaws or as required by law; (c) be custodian of the corporate records and of the seal of the Corporation; (d) keep a register of the post office address of each stockholder which shall be furnished to the secretary by such stockholder; (e) have general charge of the stock transfer books of the Corporation; and (f) in general perform such other duties as from time to time may be assigned to him by the chief executive officer, the president or by the Board of Directors. Section 11. TREASURER. The treasurer shall have the custody of the funds and securities of the Corporation and shall keep full and accurate accounts of receipts and disbursements in books belonging to the Corporation and shall deposit all moneys and other valuable effects in the name and to the credit of the Corporation in such depositories as may be designated by the Board of 10 Directors. In the absence of a designation of a chief financial officer by the Board of Directors, the treasurer shall be the chief financial officer of the Corporation. The treasurer shall disburse the funds of the Corporation as may be ordered by the Board of Directors, taking proper vouchers for such disbursements, and shall render to the president and Board of Directors, at the regular meetings of the Board of Directors or whenever it may so require, an account of all his or her transactions as treasurer and of the financial condition of the Corporation. If required by the Board of Directors, the treasurer shall give the Corporation a bond in such sum and with such surety or sureties as shall be satisfactory to the Board of Directors for the faithful performance of the duties of his or her office and for the restoration to the Corporation, in case of his or her death, resignation, retirement or removal from office, of all books, papers, vouchers, moneys and other property of whatever kind in his or her possession or under his or her control belonging to the Corporation. Section 12. ASSISTANT SECRETARIES AND ASSISTANT TREASURERS. The assistant secretaries and assistant treasurers, in general, shall perform such duties as shall be assigned to them by the secretary or treasurer, respectively, or by the president or the Board of Directors. The assistant treasurers shall, if required by the Board of Directors, give bonds for the faithful performance of their duties in such sums and with such surety or sureties as shall be satisfactory to the Board of Directors. Section 13. SALARIES. The salaries and other compensation of the officers shall be fixed from time to time by the Board of Directors and no officer shall be prevented from receiving such salary or other compensation by reason of the fact that he is also a director. ARTICLE VI CONTRACTS, LOANS, CHECKS AND DEPOSITS Section 1. CONTRACTS. The Board of Directors may authorize any officer or agent to enter into any contract or to execute and deliver any instrument in the name of and on behalf of the Corporation and such authority may be general or confined to specific instances. Any agreement, deed, mortgage, lease or other document shall be valid and binding upon the Corporation when authorized or ratified by action of the Board of Directors and executed by an authorized person. Section 2. CHECKS AND DRAFTS. All checks, drafts or other orders for the payment of money, notes or other evidences of indebtedness issued in the name of the Corporation shall be signed by such officer or agent of the Corporation in such manner as shall from time to time be determined by the Board of Directors. Section 3. DEPOSITS. All funds of the Corporation not otherwise employed shall be deposited from time to time to the credit of the Corporation in such banks, trust companies or other depositories as the Board of Directors may designate. 11 ARTICLE VII STOCK Section 1. CERTIFICATES. Except as otherwise provided in these Bylaws, this Section shall not be interpreted to limit the authority of the Board of Directors to issue some or all of the shares of any or all of its classes or series without certificates. Each stockholder, upon written request to the secretary of the Corporation, shall be entitled to a certificate or certificates which shall represent and certify the number of shares of each class of stock held by him in the Corporation. Each certificate shall be signed by the chairman of the board, the president or a vice president and countersigned by the secretary or an assistant secretary or the treasurer or an assistant treasurer and may be sealed with the seal, if any, of the Corporation. The signatures may be either manual or facsimile. Certificates shall be consecutively numbered; and if the Corporation shall, from time to time, issue several classes of stock, each class may have its own number series. A certificate is valid and may be issued whether or not an officer who signed it is still an officer when it is issued. Each certificate representing shares which are restricted as to their transferability or voting powers, which are preferred or limited as to their dividends or as to their allocable portion of the assets upon liquidation or which are redeemable at the option of the Corporation, shall have a statement of such restriction, limitation, preference or redemption provision, or a summary thereof, plainly stated on the certificate. If the Corporation has authority to issue stock of more than one class, the certificate shall contain on the face or back a full statement or summary of the designations and any preferences, conversion and other rights, voting powers, restrictions, limitations as to dividends and other distributions, qualifications and terms and conditions of redemption of each class of stock and, if the Corporation is authorized to issue any preferred or special class in series, the differences in the relative rights and preferences between the shares of each series to the extent they have been set and the authority of the Board of Directors to set the relative rights and preferences of subsequent series. In lieu of such statement or summary, the certificate may state that the Corporation will furnish a full statement of such information to any stockholder upon request and without charge. If any class of stock is restricted by the Corporation as to transferability, the certificate shall contain a full statement of the restriction or state that the Corporation will furnish information about the restrictions to the stockholder on request and without charge. Section 2. TRANSFERS. Upon surrender to the Corporation or the transfer agent of the Corporation of a stock certificate duly endorsed or accompanied by proper evidence of succession, assignment or authority to transfer, the Corporation shall issue a new certificate to the person entitled thereto, cancel the old certificate and record the transaction upon its books. The Corporation shall be entitled to treat the holder of record of any share of stock as the holder in fact thereof and, accordingly, shall not be bound to recognize any equitable or other claim to or interest in such share or on the part of any other person, whether or not it shall have express or other notice thereof, except as otherwise provided by the laws of the State of Maryland. Notwithstanding the foregoing, transfers of shares of any class of stock will be subject in all respects to the charter of the Corporation and all of the terms and conditions contained therein. 12 Section 3. REPLACEMENT CERTIFICATE. Any officer designated by the Board of Directors may direct a new certificate to be issued in place of any certificate previously issued by the Corporation alleged to have been lost, stolen or destroyed upon the making of an affidavit of that fact by the person claiming the certificate to be lost, stolen or destroyed. When authorizing the issuance of a new certificate, an officer designated by the Board of Directors may, in his or her discretion and as a condition precedent to the issuance thereof, require the owner of such lost, stolen or destroyed certificate or the owner's legal representative to advertise the same in such manner as he shall require and/or to give bond, with sufficient surety, to the Corporation to indemnify it against any loss or claim which may arise as a result of the issuance of a new certificate. Section 4. CLOSING OF TRANSFER BOOKS OR FIXING OF RECORD DATE. The Board of Directors may set, in advance, a record date for the purpose of determining stockholders entitled to notice of or to vote at any meeting of stockholders or determining stockholders entitled to receive payment of any dividend or the allotment of any other rights, or in order to make a determination of stockholders for any other proper purpose. Such date, in any case, shall not be prior to the close of business on the day the record date is fixed and shall be not more than 90 days and, in the case of a meeting of stockholders, not less than ten days, before the date on which the meeting or particular action requiring such determination of stockholders of record is to be held or taken. In lieu of fixing a record date, the Board of Directors may provide that the stock transfer books shall be closed for a stated period but not longer than 20 days. If the stock transfer books are closed for the purpose of determining stockholders entitled to notice of or to vote at a meeting of stockholders, such books shall be closed for at least ten days before the date of such meeting. If no record date is fixed and the stock transfer books are not closed for the determination of stockholders, (a) the record date for the determination of stockholders entitled to notice of or to vote at a meeting of stockholders shall be at the close of business on the day on which the notice of meeting is mailed or the 30th day before the meeting, whichever is the closer date to the meeting; and (b) the record date for the determination of stockholders entitled to receive payment of a dividend or an allotment of any other rights shall be the close of business on the day on which the resolution of the directors, declaring the dividend or allotment of rights, is adopted. When a determination of stockholders entitled to vote at any meeting of stockholders has been made as provided in this section, such determination shall apply to any adjournment thereof, except when (i) the determination has been made through the closing of the transfer books and the stated period of closing has expired or (ii) the meeting is adjourned to a date more than 120 days after the record date fixed for the original meeting, in either of which case a new record date shall be determined as set forth herein. Section 5. STOCK LEDGER. The Corporation shall maintain at its principal office or at the office of its counsel, accountants or transfer agent, an original or duplicate share 13 ledger containing the name and address of each stockholder and the number of shares of each class held by such stockholder. Section 6. FRACTIONAL STOCK; ISSUANCE OF UNITS. The Board of Directors may issue fractional stock or provide for the issuance of scrip, all on such terms and under such conditions as they may determine. Notwithstanding any other provision of the charter or these Bylaws, the Board of Directors may issue units consisting of different securities of the Corporation. Any security issued in a unit shall have the same characteristics as any identical securities issued by the Corporation, except that the Board of Directors may provide that for a specified period securities of the Corporation issued in such unit may be transferred on the books of the Corporation only in such unit. ARTICLE VIII ACCOUNTING YEAR The Board of Directors shall have the power, from time to time, to fix the fiscal year of the Corporation by a duly adopted resolution. ARTICLE IX DISTRIBUTIONS Section 1. AUTHORIZATION. Dividends and other distributions upon the stock of the Corporation may be authorized by the Board of Directors, subject to the provisions of law and the charter of the Corporation. Dividends and other distributions may be paid in cash, property or stock of the Corporation, subject to the provisions of law and the charter. Section 2. CONTINGENCIES. Before payment of any dividends or other distributions, there may be set aside out of any assets of the Corporation available for dividends or other distributions such sum or sums as the Board of Directors may from time to time, in its absolute discretion, think proper as a reserve fund for contingencies, for equalizing dividends or other distributions, for repairing or maintaining any property of the Corporation or for such other purpose as the Board of Directors shall determine to be in the best interest of the Corporation, and the Board of Directors may modify or abolish any such reserve. ARTICLE X INVESTMENT POLICY Subject to the provisions of the charter of the Corporation, the Board of Directors may from time to time adopt, amend, revise or terminate any policy or policies with respect to investments by the Corporation as it shall deem appropriate in its sole discretion. 14 ARTICLE XI SEAL Section 1. SEAL. The Board of Directors may authorize the adoption of a seal by the Corporation. The seal shall contain the name of the Corporation and the year of its incorporation and the words "Incorporated Maryland." The Board of Directors may authorize one or more duplicate seals and provide for the custody thereof. Section 2. AFFIXING SEAL. Whenever the Corporation is permitted or required to affix its seal to a document, it shall be sufficient to meet the requirements of any law, rule or regulation relating to a seal to place the word "(SEAL)" adjacent to the signature of the person authorized to execute the document on behalf of the Corporation. ARTICLE XII INDEMNIFICATION AND ADVANCE OF EXPENSES To the maximum extent permitted by Maryland law in effect from time to time, the Corporation shall indemnify and, without requiring a preliminary determination of the ultimate entitlement to indemnification, shall pay or reimburse reasonable expenses in advance of final disposition of a proceeding to (a) any individual who is a present or former director or officer of the Corporation and who is made a party to the proceeding by reason of his or her service in that capacity or (b) any individual who, while a director of the Corporation and at the request of the Corporation, serves or has served as a director, officer, partner or trustee of such corporation, real estate investment trust, partnership, joint venture, trust, employee benefit plan or other enterprise and who is made a party to the proceeding by reason of his or her service in that capacity. The Corporation may, with the approval of its Board of Directors, provide such indemnification and advance for expenses to a person who served a predecessor of the Corporation in any of the capacities described in (a) or (b) above and to any employee or agent of the Corporation or a predecessor of the Corporation. Neither the amendment nor repeal of this Article, nor the adoption or amendment of any other provision of the Bylaws or charter of the Corporation inconsistent with this Article, shall apply to or affect in any respect the applicability of the preceding paragraph with respect to any act or failure to act which occurred prior to such amendment, repeal or adoption. ARTICLE XIII WAIVER OF NOTICE Whenever any notice is required to be given pursuant to the charter of the Corporation or these Bylaws or pursuant to applicable law, a waiver thereof in writing, signed by the person or persons entitled to such notice, whether before or after the time stated therein, shall be deemed equivalent to the giving of such notice. Neither the business to be transacted at nor the purpose of 15 any meeting need be set forth in the waiver of notice, unless specifically required by statute. The attendance of any person at any meeting shall constitute a waiver of notice of such meeting, except where such person attends a meeting for the express purpose of objecting to the transaction of any business on the ground that the meeting is not lawfully called or convened. ARTICLE XIV AMENDMENT OF BYLAWS The Board of Directors shall have the exclusive power to adopt, alter or repeal any provision of these Bylaws and to make new Bylaws. EX-10.2 5 a2059384zex-10_2.txt EX-10.2 EXHIBIT 10.2 STOCK PURCHASE AGREEMENT among SENIOR HOUSING PROPERTIES TRUST SNH/CSL PROPERTIES TRUST CRESTLINE CAPITAL CORPORATION and CSL GROUP, INC. Dated as of August 9, 2001 TABLE OF CONTENTS
PAGE SECTION 1. DEFINITIONS AND INTERPRETATIONS........................................................................1 1.1. Certain Definitions....................................................................1 1.2. Interpretation.........................................................................9 SECTION 2. SALE AND PURCHASE OF STOCK............................................................................10 2.1. Sale and Purchase of Stock, Etc.......................................................10 2.2. Deposit...............................................................................10 2.3. Purchase Price Adjustments and Payment................................................10 2.4. The Closing...........................................................................11 2.5. Post Closing Distributions............................................................11 2.6. Option to Purchase Lexington, Lafayette and Boynton Beach.............................12 SECTION 3. REPRESENTATIONS AND WARRANTIES OF CLJ AND CSL.........................................................12 3.1. Organization, Good Standing and Power of CLJ..........................................13 3.2. Organization; Qualification of CSL....................................................13 3.3. Subsidiaries and Affiliates...........................................................13 3.4. Capitalization of CSL.................................................................13 3.5. Authorization; Validity of Agreement; Corporate Action................................14 3.6. Consents and Approvals; No Violations.................................................14 3.7. Books and Records.....................................................................15 3.8. Financial Statements; No Undisclosed Liabilities......................................15 3.9. Absence of Certain Changes............................................................16 3.10. Litigation............................................................................16 3.11. Compliance with Laws and Permits......................................................16 3.12. Assets................................................................................17 3.13. Hazardous Materials...................................................................18 3.14. Contracts and Commitments.............................................................19 3.15. Employee Benefit Plans................................................................19 3.16. Employee Matters......................................................................19 3.17. Insurance.............................................................................19 3.18. Certain Payments......................................................................20 3.19. Taxes.................................................................................20 3.20. FF&E Reserves, Mortgage Reserves and Working Capital..................................23 3.21. Broker's or Finder's Fee..............................................................23 3.22. Supplements to Disclosure Schedule....................................................23 SECTION 4. REPRESENTATIONS AND WARRANTIES OF SNH AND ACQ. SUB....................................................24 4.1. Due Organization, Good Standing and Power.............................................24 4.2. Authorization and Validity of Agreement...............................................24 4.3. Consents and Approvals; No Violations.................................................24 4.4. Financial Statements..................................................................25 4.5. Bankruptcy............................................................................25 4.6. Litigation............................................................................25 4.7. Broker's or Finder's Fee..............................................................25
i TABLE OF CONTENTS (continued)
PAGE SECTION 5. ACCESS AND TRANSACTIONS PRIOR TO CLOSING DATE.........................................................25 5.1. Access to Information Concerning Properties and Records...............................25 5.2. Title Matters.........................................................................27 5.3. Survey Matters........................................................................27 5.4. Environmental and Engineering Reports.................................................28 5.5. Conduct of the Business of the Acquired Companies Pending the Closing Date............28 5.6. Conversion of Certain Acquired Companies..............................................30 5.7. Cooperation...........................................................................31 5.8. Dividends; Distributions..............................................................32 5.9. No Solicitation of Other Offers.......................................................32 5.10. Notification of Certain Matters.......................................................33 5.11. HSR Act Filing........................................................................33 5.12. Public Announcements..................................................................34 5.13. CLJ Stockholder Approval..............................................................34 SECTION 6. CONDITIONS............................................................................................34 6.1. Conditions to Each Party's Obligations................................................34 6.2. Conditions to Obligations of CLJ and CSL..............................................36 6.3. Conditions to Obligations of SNH and ACQ. SUB.........................................37 SECTION 7. NATURE AND SURVIVAL OF REPRESENTATIONS AND WARRANTIES; INDEMNIFICATIONS; TAX MATTERS..................39 7.1. Survival of Representations, Warranties, etc..........................................39 7.2. CLJ's Agreement to Indemnify..........................................................39 7.3. SNH's Agreement to Indemnify..........................................................40 7.4. Third Party Claims....................................................................40 7.5. Purchase Price Adjustment.............................................................41 SECTION 8. TERMINATION...........................................................................................41 8.1. Termination...........................................................................41 8.2. Effect of Termination.................................................................43 SECTION 9. MISCELLANEOUS PROVISIONS..............................................................................44 9.1. Notices...............................................................................44 9.2. Schedules and Exhibits................................................................45 9.3. Computation of Time...................................................................45 9.4. Assignment: Successors in Interest....................................................45 9.5. No Third-Party Beneficiaries..........................................................45 9.6. Expenses..............................................................................46 9.7. Investigations........................................................................46 9.8. Number; Gender........................................................................46 9.9. Captions..............................................................................46 9.10. Amendments............................................................................47 9.11. Integration: Waiver...................................................................47
ii TABLE OF CONTENTS (continued)
PAGE 9.12. Governing Law.........................................................................47 9.13. Consent to Jurisdiction...............................................................47 9.14. Severability..........................................................................48 9.15. Counterparts..........................................................................48 9.16. SNH Limitation of Liability...........................................................48 9.17. ACQ. SUB Limitation of Liability......................................................48 9.18. CLJ Limitation of Liability...........................................................48
iii STOCK PURCHASE AGREEMENT THIS STOCK PURCHASE AGREEMENT ("AGREEMENT") is made and entered into as of August 9, 2001, among SENIOR HOUSING PROPERTIES TRUST ("SNH"), a Maryland real estate investment trust, with its principal office located in Newton, Massachusetts, SNH/CSL PROPERTIES TRUST ("ACQ. SUB"), a Maryland real estate investment trust, with its principal office located in Newton, Massachusetts, CRESTLINE CAPITAL CORPORATION ("CLJ"), a Maryland corporation, with its principal office located in Bethesda, Maryland, and CSL GROUP, INC. ("CSL"), an Indiana corporation, with its principal office located in Bethesda, Maryland. RECITALS: CLJ is the record and beneficial owner of all of the issued and outstanding equity securities of CSL, CCC Boynton Beach, Inc., a Delaware corporation ("CCC BOYNTON") and CCC Senior Living Corporation, a Delaware corporation ("CCC SENIOR LIVING"). CLJ and certain of its subsidiaries are engaged in the business of owning (or leasing) and operating the 32 senior living communities listed in EXHIBIT A (collectively, the "COMMUNITIES"), which Communities are managed by Marriott Senior Living Services, Inc. and its wholly owned subsidiaries. SNH is the record and beneficial owner of all of the issued and outstanding equity securities of ACQ. SUB. On the terms and conditions set forth in this Agreement, CLJ desires to sell and ACQ. SUB desires (i) to purchase and acquire the Communities by means of acquiring all of the issued and outstanding equity securities of CSL, CCC Boynton and CCC Senior Living, and (ii) to lease all of the Communities to an entity to be designated by SNH ("TENANT"). In consideration of the foregoing, and the representations, warranties, covenants and agreements set forth in this Agreement, the parties agree as follows: SECTION 1. DEFINITIONS AND INTERPRETATIONS 1.1. CERTAIN DEFINITIONS. For purposes of this Agreement, except as otherwise provided or unless the context clearly requires otherwise, the terms set forth below shall have the meanings set forth below: (1) "Acquired Company": CSL, each CSL Subsidiary, CCC Boynton and CCC Senior Living. (2) "ACQ. SUB": SNH/CSL Properties Trust, a Maryland real estate investment trust, which is 100% owned by SNH. (3) "Affiliate": of any Person shall mean any Person directly or indirectly controlling, controlled by, or under common control with, such Person; provided that, for the purposes of this definition, "control" (including with correlative meanings, the terms "controlled by" and "under common control with"), as used with respect to any Person, shall mean the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of such Person, whether through the ownership of voting securities or partnership interests, by contract or otherwise. (4) "Agreement": this Stock Purchase Agreement as amended or otherwise modified from time to time in accordance with its terms. (5) "Alternative Proposal": as defined in SECTION 5.9(b). (6) "Antitrust Division": as defined in SECTION 5.11. (7) "Articles of Incorporation": the Articles of Incorporation of CSL, as amended through the date hereof. (8) "Asset": as defined in SECTION 3.12(a). (9) "Bankers Trust Line": a general line of credit from Bankers Trust to CLJ, which line of credit is secured by, INTER ALIA, the stock of CSL and certain of its Subsidiaries and mortgages on certain of the Properties listed in SECTION 1.1(65) of the Disclosure Schedule, and guaranteed by certain of the CSL Subsidiaries. (10) "Boynton Beach Mortgage Loan": the indebtedness secured by a Lien on the property of Senior Living of Boynton Beach Limited Partnership, listed on SECTION 1.1(10) to the Disclosure Schedule. (11) "Business Day": a day, other than a Saturday or a Sunday, on which banking institutions in the State of Maryland are required to be open. (12) "By-laws": the By-laws of CSL, as amended through the date hereof. (13) "Capital Leases": any capital lease of any of the Acquired Companies listed on SECTION 1.1(13) to the Disclosure Schedule. (14) "CCC Boynton": as defined in the Recitals. (15) "CCC Boynton Stock": as defined in SECTION 2.1. (16) "CCC Senior Living": as defined in the Recitals. (17) "CCC Senior Living Stock": as defined in SECTION 2.1. (18) "CLJ Woodlands Bonds": as defined in SECTION 3.12(a)(ix). (19) "Closing": the closing which will take place as described in SECTION 2.4. (20) "Closing Date": the date on which the Closing occurs. -2- (21) "Code": the Internal Revenue Code of 1986, as amended. (22) "Communities": as defined in the Recitals. (23) "Consent": any consent, registration, approval, authorization, waiver or similar affirmation by or of, or filing with or notification to, a Person pursuant to any Contract, Law, Order or Permit. (24) "Consent Reduction Amount": in the case of (A) the failure to obtain the Consent referred to in SECTION 6.1(c) with respect to CCC Boynton, the sum of $150,000; (B) the failure to obtain the Consent referred to in SECTION 6.1(c) relating to the Communities known as Lafayette at Country Place and/or Lexington at Country Place, an amount equal to that determined by multiplying the Purchase Price (less $150,000 but before any other adjustment), by a fraction, the numerator of which is EBITDAR with respect to such Community for the fiscal year ended December 28, 2001 less that portion of contributions made to the FF&E Reserves attributable to that Community for the fiscal year ended December 28, 2001 and the denominator of which is EBITDAR with respect to all Communities for the fiscal year ended December 28, 2001 less the total contributions made to the FF&E Reserves for all Communities for the fiscal year ended December 28, 2001. (25) "Contract": any written agreement, arrangement, commitment, contract, indenture, instrument, lease, license or other obligation of any kind or character, or other obligation that is binding on any Person or its capital stock, properties or business. (26) "CSL Stock": as defined in SECTION 2.1. (27) "CSL Subsidiary": each Person which is a direct or indirect Subsidiary of CSL and listed on SECTION 1.1(27) of the Disclosure Schedule. (28) "Deposit": as defined in SECTION 2.2. (29) "Disclosure Schedule": as defined in SECTION 3. (30) "EBITDAR": earnings before interest, taxes, depreciation, amortization and rent. (31) "Environmental Claims": any and all administrative, regulatory or judicial actions, suits, demands, demand letters, claims, liens, notices of noncompliance or violation, investigations or proceedings under any Environmental Law or any permit issued under any such Environmental Law including without limitation (A) any and all claims by governmental or regulatory authorities for enforcement, cleanup, removal, response, remedial or other actions or damages pursuant to any applicable Environmental Law and (B) any and all claims by any third party seeking damages, contribution, indemnification, cost recovery, compensation or injunctive relief resulting from Hazardous Materials or arising from alleged injury or threat of injury to health, safety or the environment. (32) "Environmental Law": any federal, state, foreign or local statute, law, rule, regulation, ordinance, guideline, policy, code or rule of common law in effect and in each case as amended as of the date hereof and the Closing Date, and any judicial or administrative -3- interpretation thereof applicable to any Acquired Company or its operations or property as of the date hereof and the Closing Date, including any judicial or administrative order, consent decree or judgment, relating to the environment, health, safety or Hazardous Materials, including the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, 42 U.S.C.ss. 9601 ET SEQ.; the Resource Conservation and Recovery Act, as amended, 42 U.S.C.ss. 6901 ET SEQ.; the Federal Water Pollution Control Act, as amended, 33 U.S.C.ss. 1251 ET SEQ.; the Toxic Substances Control Act, 15 U.S.C.ss. 2601 ET SEQ.; the Clean Air Act, 42 U.S.C.ss. 7401 ET SEQ.; Occupational Safety and Health Act, 29 U.S.C. 651 ET SEQ.; Oil Pollution Act of 1990, 33 U.S.C.ss. 2701 ET SEQ.; the Safe Drinking Water Act, 42 U.S.C.ss. 300f ET SEQ., and their state and local counterparts and equivalents. (33) "ERISA": as defined in SECTION 3.15. (34) "ERISA Affiliate": as defined in SECTION 3.15. (35) "Excess Life Care Amounts": any amounts paid after June 20, 1997 to any of the Acquired Companies for so-called "continuing care contracts" (whether or not refundable). (36) "FF&E Reserves": as defined in the Operating Agreements. (37) "FTC": as defined in SECTION 5.11. (38) "GAAP": generally accepted accounting principles as in effect from time to time in the United States. (39) "GMAC Fee": the fee due GMAC in an amount equal to 1% of the outstanding principal balance, as of the Closing Date, of the GMAC Mortgage Loans in connection with the assumption of the GMAC Mortgage Loans/change of control. (40) "GMAC Mortgage Loans": collectively, the Mortgage Loans listed as items 1 through 5 on SECTION 1.1(62) of the Disclosure Schedule. (41) "Governmental Entity": a court, arbitral tribunal, administrative agency or commission or other governmental or other regulatory authority or agency. (42) "Ground Lease": the ground lease described in SECTION 1.1(42) of the Disclosure Schedule. (43) "Hazardous Materials": any (A) petroleum or petroleum products, radioactive materials, asbestos in any form that is or could become friable, urea formaldehyde foam insulation, transformers or other equipment that contain dielectric fluid containing levels of polychlorinated biphenyls, and radon gas; (B) chemicals, materials or substances defined as or included in the definition of "hazardous substances," "hazardous wastes," "hazardous materials," "extremely hazardous wastes," "extremely hazardous substances," "restricted hazardous wastes," "toxic substances," "toxic pollutants," or words of similar import, under any applicable Environmental Law; and (C) other chemical, material or substance, exposure to which is prohibited, limited or regulated by any Governmental Entity. -4- (44) "HMC": Host Marriott Corporation, a Maryland corporation. (45) "HPT": Hospitality Properties Trust, a Maryland real estate investment trust. (46) "HSR Act": as defined in SECTION 3.6. (47) "Indemnified Party": as defined in SECTION 7.4(a). (48) "Indemnifying Party": as defined in SECTION 7.4(a). (49) "Interim Balance Sheet": defined in SECTION 3.8(a). (50) "IRS": the United States Internal Revenue Service. (51) "Knowledge": an individual will be deemed to have "Knowledge" of a particular fact or other matter if without further inquiry such individual is actually aware of such fact or other matter; and an entity (other than an individual) will be deemed to have "Knowledge" of a particular fact or other matter if any individual who is currently serving as a director, officer, a manager whose title includes the term "director," partner, executor, or trustee of such entity (or in any similar capacity) has Knowledge of such fact or other matter. In no event will the Knowledge of MSLS or any "independent director" of any CSL Subsidiary be imputed to CLJ, CSL or any of their respective officers, other directors or agents. (52) "Lakewood Loan Documents": as defined in SECTION 3.12(a)(xi). (53) "Law": any federal, state, local or foreign law, statute, ordinance, rule, regulation, order, judgment or decree, administrative or judicial decision, and any other executive or legislative proclamation. (54) "Lease": the master lease agreement (or collectively, the individual leases) dated the Closing Date, to be entered into as of the Closing Date by and between each Acquired Company which owns the Communities and Tenant, such master lease agreement (or individual leases, as the case may be) to be in form and substance satisfactory to SNH and ACQ. SUB on the one hand, and Tenant on the other. (55) "Lien": any interest in property, whether such interest is based on common law, statute, court decision or contract and including, without limitation, any mortgage, pledge, security interest, lease, encumbrance (including any easement, exception, reservation or limitation, right of way or the like), lien, purchase option, call or right, or charge of any kind (including any agreement to give or permit any of the foregoing), any conditional sale or other title retention agreement, any lease of property (whether real, personal or mixed) which is required, in accordance with GAAP, to be recorded by the lessee as the acquisition of an asset and the incurrence of a liability, and the filing of any financing statement under the Uniform Commercial Code or personal property security legislation of any jurisdiction. (56) "Losses": as defined in SECTION 7.2(a). -5- (57) "Marriott Agreements": collectively, the Operating Agreements, the Noncompetition Agreement, the MI Indemnity Agreement, the Pooling Agreements and the Transition Agreements. (58) "Material Adverse Effect": any adverse change in the business, assets, liabilities, financial condition or results of operations of the Acquired Companies taken as a whole (provided, that a matter or matters taken together shall be deemed to have a material adverse change in the business, assets, liabilities, financial condition or results of operations only if such matter or matters have resulted in or are reasonably likely to have or result in an adverse impact of at least $10,000,000 of value or a $1,000,000 reduction in net annual cash flow from the Properties, the termination of any Marriott Agreement (other than the Noncompetition Agreement), or any material adverse effect on the ability of CLJ or CSL to perform its respective obligations under this Agreement or to consummate the transactions contemplated hereby). The term "Material Adverse Effect" shall not include (i) any change, circumstance, event or consummation of the transactions contemplated by the Agreement or (ii) changes in general economic conditions or financial markets (including fluctuations in the price of the shares of common stock of CLJ or conditions in the business sectors in which the Acquired Companies operate not disproportionally affecting the Acquired Companies). (59) "MGCL": the Maryland General Corporation Law. (60) "MI": Marriott International, Inc., a Delaware corporation. (61) "MI Indemnity Agreement": the Indemnity Agreement among MSLS, MI, HMC Senior Communities, Inc. (the predecessor in interest to CLJ) and HMC dated as of June 21, 1997, as modified by a letter agreement dated June 21, 1997. (62) "Mortgage Loans": any indebtedness for borrowed money or for the deferred purchase price of property or services that is secured by a Lien on the property or assets of any Acquired Company, listed on SECTION 1.1(62) to the Disclosure Schedule, other than indebtedness secured by fixtures, furniture and equipment and leases for the same that in either case are incurred or entered into by MSLS in the ordinary course of business and in accordance with the terms of the Operating Agreements. The term "Mortgage Loan" does not include indebtedness under the Bankers Trust Line (provided that all indebtedness thereunder is repaid at or prior to Closing) or the Boynton Beach Mortgage Loan. (63) "Mortgage Reserves": any and all deposits, escrows and reserves required by holders of Mortgage Loans or lessors under Capital Leases. (64) "MSLS": Marriott Senior Living Services, Inc., a Delaware corporation. (65) "New Loan": means indebtedness in the principal amount of not less than $150,000,000 nor more than $175,000,000 to be incurred after the date of this Agreement, but prior to the Closing Date, by CSL and/or one or more of the CSL Subsidiaries and secured by a mortgage(s) on one or more Properties listed in SECTION 1.1(65) of the Disclosure Schedule, the proceeds of which shall be paid as a dividend or otherwise distributed to CLJ in accordance with Section 5.8. -6- (66) "Nomura Mortgage Loan": the Mortgage Loan listed as item 6 on SECTION 1.1(62) of the Disclosure Schedule. (67) "Noncompetition Agreement": the Amended and Restated Noncompetition Agreement dated as of December 28, 1998 among HMC, CLJ, Forum Group, Inc. (predecessor to CSL), MSLS and MI. (68) "Operating Agreements": collectively, the Operating Agreements between CSL, any CSL Subsidiary (and/or their respective Subsidiaries) or Senior Living of Boynton Beach Limited Partnership, as owner and MSLS, as operator and listed in SECTION 1.1(68) of the Disclosure Schedule. (69) "Order": any administrative decision or award, decree, injunction, judgment, order, quasi-judicial decision or award, ruling, or writ of any federal, state, local or foreign or other Governmental Entity. (70) "Organizational Documents": any of (a) the articles or certificate of incorporation and the by-laws of a corporation or other equivalent organizational documents; (b) the partnership agreement and any statement of partnership of a general partnership; (c) the limited partnership agreement and the certificate of limited partnership; (d) any charter, certificate or similar document adopted or filed in connection with the creation, formation, or organization of a Person; (e) the operating agreement of a limited liability company; and (f) any amendment to any of the foregoing. (71) "Party": SNH, ACQ. SUB, CSL or CLJ, and "Parties" shall mean each of SNH, ACQ. SUB, CSL and CLJ. (72) "Permit": any federal, state, local or foreign governmental approval, authorization, certificate, license, permit or exemption to which any Person is a party or that is or may be binding upon or inure to the benefit of any Person or its securities, properties or business. (73) "Permitted Liens": collectively (i) Liens securing the Mortgage Loans, the New Loan and the Boynton Beach Mortgage Loan, (ii) Liens set forth in SECTION 1.1(73) of the Disclosure Schedule, (iii) any Liens for Taxes not yet due or delinquent; (iv) any statutory encumbrance arising in the ordinary course of business by operation of law with respect to a liability that is not yet due or delinquent; (v) any applicable zoning regulation or ordinance or other governmental laws, ordinances and regulations, provided they do not prohibit or impair in any material respect the use of a Property as a functioning senior living community; (vi) any imperfection of title or similar non-monetary Lien that, individually or in the aggregate with other such Liens, has not, and would not be reasonably expected to, impair marketability and does not impair, in any material respect, the use of a Property as a functioning senior living community; (vii) any Lien created by MSLS which it is obliged to remove pursuant to the terms of the Operating Agreements; and (viii) Liens on fixtures, furniture and equipment securing indebtedness (including capitalized leases) incurred or entered into by MSLS in the ordinary course of business and in accordance with the terms of the Operating Agreements. (74) "Person": any individual, corporation, limited liability company, partnership, joint venture, trust, association, organization, Governmental Entity or other entity. -7- (75) "Pooling Agreements": collectively, the Pooling Agreements between MSLS and HMC Senior Communities, Inc. (predecessor in interest to CLJ) listed in SECTION 1.1(75) of the Disclosure Schedule. (76) "Properties": all the real property and improvements owned or leased, directly or indirectly, by any Acquired Company and described in SECTION 3.12(A)(II) of the Disclosure Schedule and constituting one or more of the Communities, each a "Property", together with related furnishings, fixtures and equipment. (77) "Prior Tax Matters Agreements": as defined in SECTION 3.19(a). (78) "Purchase Price": $600,000,000, adjusted as provided in SECTION 2.3 and SECTION 6.1(C). (79) "Subsidiary": with respect to any party, any corporation, limited liability company, partnership, limited partnership, or other business association or entity, at least a majority of the voting securities or economic interests of which is directly or indirectly owned or controlled by such party or by any one or more of its Subsidiaries. (80) "Survey": as defined in SECTION 5.3. (81) "Tax" or "Taxes": all taxes imposed by any federal, state, local or foreign governmental authority, including, but not limited to, income, gross receipts, excise, profits, AD VALOREM, net worth, value added, service, special assessments, workers' compensation, utility, severance, production, excise, stamp, occupation, premiums, windfall profits, real or personal property, sales, gain, use, license, custom duty, unemployment, capital stock, transfer, franchise, payroll, withholding, alternative minimum, social security, and estimated taxes, and other taxes, fees or assessments of a similar nature, and shall include interest, penalties or additions attributable thereto. (82) "Tax Allocation Agreement": as defined in SECTION 6.1(f). (83) "Tax Returns": all returns, reports, estimates, information statements, declarations and other filings required or permitted to be filed with any taxing authority related to Taxes. (84) "Tenant": as defined in the Recitals. (85) "Title Company": as defined in SECTION 5.2. (86) "Title Commitments": as defined in SECTION 5.2. (87) "Transfer Taxes": all Taxes imposed on or resulting from the sale of the CSL Stock, the CCC Boynton Stock or the CCC Senior Living Stock or the conversion of the Acquired Companies pursuant to SECTION 5.6 that are in the nature of (i) real property transfer Taxes, including Taxes levied upon the transfer of stock or other equity interests in an entity on account of such entity's direct or indirect ownership of real estate, (ii) excise, sales, use, valued added, registration stamp, recording, documentary, conveyancing, transfer or (iii) similar Taxes, -8- in each case including any deficiencies, interest, penalties, additions to Tax or additional amounts, but in all cases excluding Taxes imposed on income. (88) "Transition Agreements": the agreements listed in SECTION 1.1(88) of the Disclosure Schedule. (89) "Treasury Regulations": the Treasury Regulations promulgated under the Code, including proposed and temporary regulations. (90) "Unsecured Loans": any indebtedness for borrowed money or for the deferred purchase price of property or services that is not secured by a Lien on the property or assets of any Acquired Company, listed in SECTION 1.1(90) of the Disclosure Schedule unless incurred or entered into on behalf of an Acquired Company by MSLS in the ordinary course of business and in accordance with the terms of the Operating Agreements. The term Unsecured Loans shall not include intercompany loans between or among the Acquired Companies all of which shall be discharged prior to Closing. (91) "Working Capital": the working capital controlled by MSLS, relating to operation of the Properties and required to be maintained pursuant to the Operating Agreements. 1.2. INTERPRETATION. (1) When a reference is made in this Agreement to a section or article, such reference shall be to a section or article of this Agreement unless otherwise clearly indicated to the contrary. (2) Whenever the words "include", "includes" or "including" are used in this Agreement, they shall be deemed to be followed by the words "without limitation." (3) The words "hereof", "herein" and "herewith" and words of similar import shall, unless otherwise stated, be construed to refer to this Agreement as a whole and not to any particular provision of this Agreement, and article, section, paragraph, exhibit and schedule references are to the articles, sections, paragraphs, exhibits and schedules of this Agreement unless otherwise specified. (4) The plural of any defined term shall have a meaning correlative to such defined term, and words denoting any gender shall include all genders. Where a word or phrase is defined herein, each of its other grammatical forms shall have a corresponding meaning. (5) A reference to any party to this Agreement or any other agreement or document shall include such party's successors and permitted assigns. (6) A reference to any legislation or to any provision of any legislation shall include any amendment, modification or re-enactment thereof, any legislative provision substituted therefor and all regulations and statutory instruments issued thereunder or pursuant thereto. (7) The parties have participated jointly in the negotiation and drafting of this Agreement. In the event an ambiguity or question of intent or interpretation arises, this -9- Agreement shall be construed as if drafted jointly by the parties, and no presumption or burden of proof shall arise favoring or disfavoring any party by virtue of the authorship of any provision of this Agreement. SECTION 2. SALE AND PURCHASE OF STOCK 2.1. SALE AND PURCHASE OF STOCK, ETC. At the Closing, in consideration of the Purchase Price to be paid by SNH to CLJ, (i) CLJ shall sell to ACQ. SUB, and ACQ. SUB shall purchase from CLJ, all of the issued and outstanding capital stock of CSL (the "CSL STOCK"), CCC Boynton (the "CCC BOYNTON STOCK") and CCC Senior Living (the "CCC SENIOR LIVING STOCK"), in each case free and clear of all Liens, and (ii) CLJ shall assign to SNH or its designee the CLJ Woodland Bonds (unless terminated prior to closing), the Lakewood Loan Documents, the Pooling Agreements, the MI Indemnity Agreement, the Transition Agreements, all rights of CLJ under Section 7.16 of the Stock Purchase Agreement dated as of June 17, 1997 between HMC and MSLS and all rights of CLJ in respect of any expansion projects referenced in Section 7.14 of such Stock Purchase Agreement and (to the extent contemplated by the Tax Allocation Agreement) the Prior Tax Matters Agreements, in each case free and clear of all Liens. At Closing, CSL will own all the issued and outstanding equity securities of each of the CSL Subsidiaries, free and clear of all Liens other than those Liens listed on SECTION 2.1 of the Disclosure Schedule. 2.2. DEPOSIT. On the date of this Agreement, SNH shall deposit $7,500,000 (the "DEPOSIT") with American Title Company to be held pursuant to the terms of an Escrow Agreement in the form of EXHIBIT B. Except as otherwise provided in SECTION 8.2, on the Closing Date the Deposit will be paid to CLJ and applied to and constitute a portion of the portion of the Purchase Price paid by wire transfer. 2.3. PURCHASE PRICE ADJUSTMENTS AND PAYMENT. (a) The Purchase Price shall be reduced by (a) the sum of (A) the aggregate unpaid principal amount, together with accrued and unpaid interest, of all Mortgage Loans, Capital Leases (unless the Communities known as Lexington at Country Place and Lafayette at Country Place are not acquired as a result of the failure to obtain Consents), Unsecured Loans and the New Loan, in each case, as of the Closing Date, (B) the amount by which the Acquired Companies (other than CCC Boynton) have funded less than $4,707,092 of owner-funded capital expenditures required under the Operating Agreements for fiscal year 2001 (other than FF&E Reserves), as of the Closing Date, (C) any deficiency in Mortgage Reserves or amounts due for real estate taxes, insurance or other expenses separately accounted for by CLJ attributable to such expenses (and not provided for under the Operating Agreements) for any period(s) prior to the Closing Date, (D) an amount equal to the Excess Life Care Amounts not recognized as income pursuant to GAAP as of the Closing Date and (E) the remaining -10- payments to which holders of the preferred depositary units representing preferred limited partner interests in Forum Retirement Partners, L.P., a Delaware limited partnership, are entitled but which have not been paid to such holders as of the Closing Date, and shall be increased by (b) the sum of (A) the amount of capital expenditures required under the Operating Agreements for fiscal year 2002 (other than FF&E Reserves) which the Acquired Companies (other than CCC Boynton) have funded, provided SNH approved such additional capital expenditures to the extent of any approval rights in the Operating Agreements, in each case, as of the Closing Date, (B) all New Loan costs, including the fees and expenses paid to the lenders by or for the account of CLJ or the Acquired Companies prior to the Closing Date in connection with the New Loan (with CLJ to notify SNH in writing, upon receipt of invoices from the lenders or their counsel, of the amount and the basis for such fees and expenses) but without duplication for any amounts paid under SECTION 9.6, (C) without duplication, all prepaid interest under the Mortgage Loans, the Unsecured Loans and the Capital Leases, and all prepaid rent under the Ground Leases, in each case to the extent attributable to the period after the Closing Date, and that portion of the Mortgage Reserves attributable to interest for the period after the Closing Date, and (D) that portion of Mortgage Reserves and any other prepayments of or deposits for real estate taxes, insurance or other expenses separately accounted for by CLJ attributable to such expenses (and not provided for under the Operating Agreements) for any period(s) after the Closing Date. The Purchase Price will be subject to further adjustment as provided in SECTION 6.1(c) and to the extent necessary to allocate costs incurred by either Party in connection with the transaction to comply with the provisions of SECTION 9.6. (b) The Purchase Price (adjusted as provided in SECTION 2.3(a) and SECTION 6.1(c)) shall be paid as follows: $25,000,000 by delivery on the Closing Date of SNH's promissory note in the form of EXHIBIT C and the balance and all other amounts due at Closing shall be paid by SNH on the Closing Date by wire transfer of immediately available funds to CLJ to an account specified by CLJ to SNH at least two (2) Business Days prior to the Closing Date. 2.4. THE CLOSING. Subject to the terms and conditions of this Agreement, the Closing shall take place at the offices of Sullivan & Worcester LLP, in Boston, Massachusetts at 9:00 a.m. (local time), on January 31, 2002, or, if later, the date on which all conditions set forth in SECTION 6 have been satisfied, but not later than June 30, 2002, or at such other time, date or place as the Parties may agree. 2.5. POST CLOSING DISTRIBUTIONS. The owner's distribution under any Operating Agreement or Pooling Agreement for the four week fiscal period in which the Closing Date occurs shall be prorated between CLJ and SNH based on the number of days in such fiscal period preceding the Closing Date (in the case of CLJ) or on or after the Closing Date (in the case of SNH). If after the Closing Date, CSL or any CSL Subsidiary shall receive any owner's distribution under any Operating Agreement or Pooling Agreement for (i) the 2001 fiscal year, (ii) any four week fiscal period in the 2002 fiscal -11- year that precedes the Closing Date, or (iii) the four week fiscal period in which the Closing Date occurs, SNH and ACQ. SUB shall cause such amount to be remitted promptly to CLJ (or the applicable portion of such amount in the case of clause (iii)). SNH and ACQ. SUB shall use commercially reasonable efforts to enforce the provisions of the Operating Agreements and Pooling Agreements that require the distributions described in this SECTION 2.5. 2.6. OPTION TO PURCHASE LEXINGTON, LAFAYETTE AND BOYNTON BEACH. If, because of the failure to obtain the Consents referred to in SECTION 6.1(c) with respect to the Communities known as Lafayette at Country Place, Lexington at Country Place and/or Boynton Beach (the "APPLICABLE CONSENTS"), such Community and the relevant CSL Subsidiary or CCC Boynton is excluded from the transactions contemplated hereby, CLJ and CSL shall continue to use commercially reasonable efforts to obtain the Applicable Consent, shall cause the relevant CSL Subsidiary or CCC Boynton to comply with SECTION 5.5 and hereby grant SNH an option to purchase all the issued and outstanding equity of such CSL Subsidiary or CCC Boynton, or, at the election of SNH, all of the assets of such CSL Subsidiary or CCC Boynton, for a price equal to the relevant Consent Reduction Amount less the aggregate unpaid principal amount, together with accrued and unpaid interest, of the related Capital Lease, and such purchase shall be deemed to have been made with the benefit of the representations, warranties and covenants contained in this Agreement; provided that if SNH exercises such option before the Applicable Consents have been obtained, SNH shall indemnify CLJ from any loss, cost or expense that CLJ incurs to the extent attributable to the failure to obtain the Applicable Consents before the exercise of such option, and SNH shall not be entitled to the benefit of the representations and warranties to the extent pertaining to the Applicable Consents. Such option shall expire on the eighteen month anniversary of the Closing Date and may be exercised by written notice from SNH to CLJ given no less than 60 days prior to the requested purchase date. Subject to the prior receipt of the Applicable Consent for any excluded Community and the relevant CSL Subsidiary or CCC Boynton Beach, CLJ may require SNH or its designee to purchase all the issued and outstanding equity of such CSL Subsidiary or CCC Boynton (or at the election of SNH, all of the assets of such CSL Subsidiary or CCC Boynton), for a price equal to the relevant Consent Reduction Amount less the aggregate unpaid principal amount, together with accrued and unpaid interest, of the related Capital Lease, and such purchase shall be deemed to have been made with the benefit of the representations, warranties and covenants contained in this Agreement. CLJ's right to require such purchase shall expire on the eighteen month anniversary of the Closing Date and may be exercised by written notice from CLJ to SNH given no less than 60 days prior to the requested purchase date. SECTION 3. REPRESENTATIONS AND WARRANTIES OF CLJ AND CSL Except as specifically set forth in the disclosure schedule prepared by CLJ and CSL and delivered to SNH simultaneously with the execution hereof (the "DISCLOSURE SCHEDULE"), CLJ and CSL jointly and severally represent and warrant to SNH and ACQ. SUB that all of the statements contained in this SECTION 3 are true as of the date of this Agreement (or, if made as of a specified date, as of such date), and will be true as of the Closing Date as though made on the -12- Closing Date. Each exception set forth in the Disclosure Schedule and each other response to this Agreement set forth in the Disclosure Schedule is identified by reference to, or has been grouped under a heading referring to, a specific individual section of this Agreement and, except as otherwise specifically stated with respect to such exception, relates only to such section. 3.1. ORGANIZATION, GOOD STANDING AND POWER OF CLJ. CLJ is a corporation duly organized, validly existing and in good standing under the laws of the State of Maryland and has all requisite corporate power and authority to own, lease and operate its properties and to carry on its business as now being conducted. 3.2. ORGANIZATION; QUALIFICATION OF CSL. CSL (a) is a corporation duly organized, validly existing and in good standing under the laws of its state of incorporation; (b) has full corporate power and authority to carry on its business as it is now being conducted and to own and lease the properties and assets it now owns and leases; and (c) is duly qualified to do business as a foreign corporation and is in good standing in every jurisdiction in which ownership of property or the conduct of its business requires such qualification, except where the failure to do so would not, individually or in the aggregate, have a Material Adverse Effect. CSL has heretofore delivered to SNH complete and correct copies of the Articles of Incorporation and By-laws of CSL as presently in effect. 3.3. SUBSIDIARIES AND AFFILIATES. SECTION 3.3 of the Disclosure Schedule sets forth for each current CSL Subsidiary, and for each of CCC Boynton and CCC Senior Living, its name, type of entity, jurisdiction of incorporation or formation, capitalization, the names of the record holders of its equity interests and the jurisdictions in which it is qualified to do business. Except as set forth in SECTION 3.3 of the Disclosure Schedule, CSL currently does not own, directly or indirectly, any capital stock or other equity interests in any Person. Except as set forth in SECTION 3.3 of the Disclosure Schedule, all the equity interests in each CSL Subsidiary are owned directly or indirectly by CSL, free and clear of all Liens, and are validly issued, fully paid and nonassessable, and there are no outstanding options, rights or agreements of any kind relating to the issuance, sale or transfer of any capital stock or other equity securities of any CSL Subsidiary. All the capital stock of CCC Boynton and CCC Senior Living is owned directly by CLJ, free and clear of all Liens, and is validly issued, fully paid and nonassessable, and there are no outstanding options, rights or agreements of any kind relating to the issuance, sale or transfer of any capital stock or other equity securities of CCC Boynton or CCC Senior Living. Each of the CSL Subsidiaries, CCC Boynton and CCC Senior Living is duly organized, validly existing and in good standing under the laws of its state of organization, and is duly qualified to do business and in good standing in every jurisdiction in which ownership of property or the conduct of its business requires such qualification, except where the failure to do so would not, individually or in the aggregate, have a Material Adverse Effect. 3.4. CAPITALIZATION OF CSL. The authorized capital stock of CSL consists of 100 shares of common stock, no par value, of which 100 shares are issued and outstanding. All the issued and outstanding capital -13- stock of CSL has been duly authorized, validly issued, fully paid and non-assessable, is owned beneficially and of record by CLJ, and, except for the pledge of the CSL Stock securing obligations under the Bankers Trust Line, is free and clear of any Liens. None of the outstanding capital stock of CSL has been issued in violation of any federal or state securities Laws or any preemptive right or rights to subscribe for or purchase its capital stock or other securities. There is no indebtedness issued and outstanding having general voting rights or debt convertible into capital stock or other securities of CSL having such rights. Except as set forth above, (a) there is no capital stock or other securities of CSL authorized, issued or outstanding; (b) there are no securities outstanding which are convertible into or exercisable or exchangeable for common stock or other securities of CSL; and (c) there are no outstanding options, rights, Contracts, warrants, subscriptions, conversion rights or other agreements or commitments of any character pursuant to which CSL may be required to purchase, redeem, issue or sell any of its capital stock or other securities of CSL or any CSL Subsidiary. 3.5. AUTHORIZATION; VALIDITY OF AGREEMENT; CORPORATE ACTION. Subject to SECTION 3.6(B), each of CLJ and CSL has full power and authority to execute and deliver this Agreement and to consummate the transactions contemplated hereby. Subject to SECTION 3.6(B), the execution, delivery and performance by each of CLJ and CSL of this Agreement and the consummation by it of the transactions contemplated hereby have been duly authorized by their respective Boards of Directors and no other action on the part of CLJ or CSL is necessary to authorize the execution and delivery by CLJ or CSL of this Agreement or the consummation by it of the transactions contemplated hereby. Except as described in SECTION 3.6(b), no vote of, or consent by, the holders of any capital stock issued by CLJ or CSL is necessary to authorize the execution and delivery by CLJ or CSL of this Agreement or the consummation by it of the transactions contemplated hereby. This Agreement has been duly executed and delivered by each of CLJ and CSL and, assuming due and valid authorization, execution and delivery hereof by SNH and ACQ. SUB, this Agreement is a valid and binding obligation of each of CLJ and CSL enforceable against each of CLJ and CSL in accordance with its terms, except (a) as limited by applicable bankruptcy, insolvency, reorganization, moratorium, and other similar laws of general application affecting enforcement of creditors' rights generally and (b) the availability of the remedy of specific performance or injunctive or other forms of equitable relief may be subject to equitable defenses and would be subject to the discretion of the court before which any proceeding therefor may be brought. 3.6. CONSENTS AND APPROVALS; NO VIOLATIONS. Except for (a) the Consents as may be required under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the "HSR ACT"); (b) the approval of the sale of the CSL Stock by the holders of the common stock of CLJ; (c) compliance with the requirements of each of the Marriott Agreements (including, without limitation, Section 18 of the several Operating Agreements and of Section 2 of the Noncompetition Agreement); (d) the Consents listed in SECTION 6.1(c) of the Disclosure Schedule; and (e) Consents required for healthcare Permits (including Medicare and Medicaid provider agreements), none of the execution, delivery or performance of this Agreement by CLJ or CSL, or the consummation by CLJ or CSL of any of the transactions contemplated hereby, will (i) conflict with or result in any breach of any provision of the Organizational Documents of CLJ or any Acquired Company, (ii) require any -14- Consent of any Governmental Entity, or (iii) violate any Contract, Law, Order or Permit to which CLJ or any Acquired Company is a party or that is binding on or affects any of their properties or assets, excluding, however, from the foregoing clauses (ii) and (iii), such Consents, the failure of which to obtain would not, and violations, breaches or defaults, the occurrence of which would not, in either case individually or in the aggregate, have a Material Adverse Effect. SNH and ACQ. SUB acknowledge that (A) the representation and warranty set forth in this SECTION 3.6, insofar as pertaining to the conversion of certain Acquired Companies pursuant to SECTION 5.6, is given only to the Knowledge of CLJ and (B) no representation is given with respect to any Consents required in connection with the Leases. 3.7. BOOKS AND RECORDS. For the period from and after January 1, 1998: (i) the books of account of the Acquired Companies are complete and correct in all material respects and have been maintained in accordance with sound business practices; (ii) each Acquired Company has made and kept books, records and accounts which, in reasonable detail, accurately and fairly reflect its transactions and the dispositions of its assets and to permit preparation of financial statements in conformity with GAAP; (iii) the stock ledger (or equivalent partnership or limited liability company records) of each of the Acquired Companies is complete and correct; (iv) the minute books (or equivalent partnership or limited liability company records) of each of the Acquired Companies contain accurate and complete records in all material respects of all meetings held of, and corporate (or equivalent) action taken by, the stockholders (partners or members) and the Boards of Directors (general partners or managers) of the respective companies; and (v) no meeting of any such stockholders (partners or members) or Board of Directors (general partners or managers) has been held for which minutes have not been prepared and are not contained in such minute books. At the Closing, the Acquired Companies will have possession of their respective books and records. 3.8. FINANCIAL STATEMENTS; NO UNDISCLOSED LIABILITIES. (a) The unaudited balance sheet of each Acquired Company as of June 15, 2001 (the "INTERIM BALANCE SHEET") and the related statements of income of each Acquired Company for the fiscal period then ended, complete and correct copies of which shall be furnished to SNH on or before September 15, 2001, present fairly, in all material respects, the financial condition and results of operations of such Acquired Company as at such date and for such period, as the case may be. (b) The audited consolidated balance sheets of CSL and its Subsidiaries as at January 1, 1999, December 31, 1999 and December 29, 2000, and the related consolidated statements of income and cash flows for the fiscal years then ended, complete and correct copies of which shall be furnished to SNH on or before September 15, 2001, present fairly, in all material respects, the consolidated financial condition and results of operations and cash flows of CSL and its Subsidiaries as at such dates and for such fiscal years, as the case may be. (c) Except (i) as and to the extent of the amounts specifically reflected or reserved on the Interim Balance Sheet, (ii) obligations under Contracts and other -15- liabilities entered into in the ordinary course of business and consistent with past practice and not in excess of current requirements which are not required by GAAP to be reflected on the Interim Balance Sheet, and (iii) liabilities and obligations incurred in the ordinary course of business consistent with past practice since the date of the Interim Balance Sheet, no Acquired Company has any liabilities or obligations of any nature (whether absolute, accrued, contingent or otherwise) that would be required to be reflected on a consolidated balance sheet of the Acquired Company or in the notes thereto prepared in accordance with GAAP. (d) On the Closing Date, all real property owned or leased by the Acquired Companies will continue to be owned or leased by the Acquired Companies "AS IS and WHERE IS", but subject to no liabilities (whether absolute, accrued, known, or unknown, contingent or otherwise and whether due or to become due) other than (i) the Ground Lease, Capital Leases, the Mortgage Loans, the Unsecured Loans, the Boynton Beach Mortgage Loan and the New Loan, (ii) liabilities incurred by MSLS in the ordinary course of business in accordance with the Operating Agreements and (iii) those liabilities set forth on the appropriate Title Commitment for the Property (provided that the exclusion provided in this clause (iii) shall not limit the right of SNH to object to any such liability nor limit any obligation of CLJ to cure any title exception objected to by SNH under SECTION 5.2 or 5.3). (e) The financial statements referred to in this SECTION 3.8 have been prepared in accordance with GAAP consistently applied throughout the periods involved, except as set forth in the notes thereto. 3.9. ABSENCE OF CERTAIN CHANGES. Since June 15, 2001, (a) there has not occurred any event, change, effect, fact, circumstance or other occurrence which has had, or which could reasonably be expected to have, a Material Adverse Effect; (b) the business of each Acquired Company has been conducted only in the ordinary course consistent with past practice; and (c) no Acquired Company has engaged in any material transaction or entered into any material agreement outside the ordinary course of business. 3.10. LITIGATION. Neither CLJ nor CSL has received written notice of and, to the Knowledge of each of CLJ and CSL, no action or proceeding is pending or threatened and no investigation looking toward such an action or proceeding has begun, which (a) questions the validity of this Agreement or any action taken or to be taken pursuant hereto; (b) will have a Material Adverse Effect; (c) result in or subject any Acquired Company or any of the Properties to a material liability; or (d) involves any material condemnation or eminent domain proceedings against any of the Properties. 3.11. COMPLIANCE WITH LAWS AND PERMITS. To the Knowledge of each of CLJ and CSL, (a) the Acquired Companies, the Properties and the use and operation of the Properties do not violate any material Laws including, without -16- limitation, those relating to construction, occupancy, zoning, adequacy of parking, environmental protection, occupational health and safety and fire safety applicable thereto; and (b) except as set forth in SECTION 3.11 of the Disclosure Schedule, there are presently in effect all material Permits (including all healthcare licenses) necessary to operate the businesses of the Acquired Companies and for the current use, occupancy and operation of the Properties. Neither CLJ nor CSL has received written notice of any threatened request, application, proceeding, plan, study or effort which would materially adversely affect the present use or zoning of any of the Properties or which would modify or realign any adjacent street or highway. 3.12. ASSETS. (a) The assets being acquired, directly or indirectly, by SNH and ACQ. SUB pursuant to SECTION 2.1 hereof (collectively, the "ASSETS") consist of (1) the CSL Stock, the CCC Boynton Stock and the CCC Senior Living Stock and (2) the following assets of the Acquired Companies (including certain assets of CLJ that are to be sold, transferred and assigned to SNH or its designee at Closing as contemplated by SECTION 2.1): (i) as to CSL, the equity securities of each of the CSL Subsidiaries; (ii) the real property owned or leased, directly or indirectly by an Acquired Company and described in SECTION 3.12(a)(ii) of the Disclosure Schedule (which Section identifies the Acquired Company that so owns or leases such property); (iii) the general partnership interest of CCC Boynton in Senior Living of Boynton Beach Limited Partnership; (iv) the interest of CCC Senior Living as the independent member of CCFL Senior Living LLC, CCOP Senior Living LLC, CCCP Senior Living LLC, CCSL Senior Living LLC and CCDE Senior Living LLC; (v) the rights and interests of the Acquired Companies under the Marriott Agreements, the Ground Lease, and the Capital Leases; (vi) the FF&E Reserves and the Mortgage Reserves; (vii) the Working Capital; (viii) except as set forth in SECTION 3.12(b) of the Disclosure Schedule with respect to any Property (and except for any items subject to a lease entered into by MSLS in the ordinary course of business and in accordance with the Operating Agreements), all furniture, fixtures and equipment and all supplies used in connection with such Property; -17- (ix) all the outstanding bonds issued in respect of the Woodlands Community (unless terminated prior to closing), $16,765,000 of which are held by Panther Holdings Level I, L.P., a Delaware limited partnership and a CSL Subsidiary and the remaining $15,450,000 of which are currently held by CLJ (and will be assigned in accordance with SECTION 2.1) (the "CLJ WOODLANDS BONDS") ; (x) the rights and interests of the Acquired Companies in respect of the agreements listed in SECTION 3.12(a)(x) of the Disclosure Schedule; (xi) a promissory note in the original principal amount of $3,166,451 dated December 31, 1997 made by Senior Living of Lakewood, LLC, together with a Loan Agreement dated December 31, 1997 and the Loan Documents, as defined therein (collectively, the "LAKEWOOD LOAN DOCUMENTS") to which the Parties agree to ascribe no value; and (xii) the books and records of each Acquired Company referenced in SECTION 3.7. (b) Except (i) for Permitted Liens, and (ii) as disclosed in SECTION 3.12(b) of the Disclosure Schedule and on the Title Commitment for each Property (subject to the parenthetical in clause (iii) of SECTION 3.8(d)), to the Knowledge of CLJ and CSL, at the Closing CLJ and each Acquired Company will have good and marketable title, free and clear of all Liens, to all of its Assets, other than Assets that are leased or licensed by an Acquired Company, with respect to which such Acquired Company has valid and enforceable leases or licenses under which there exists no default, event of default or event which, with notice or lapse of time or both, would constitute a default, except for such defaults which have not had or are not reasonably likely to have, either individually or in the aggregate, a Material Adverse Effect. 3.13. HAZARDOUS MATERIALS. Except as disclosed to SNH in writing or as described in any environmental report identified in SECTION 3.13 of the Disclosure Schedule, true and complete copies of which have been furnished to SNH, to the Knowledge of CLJ and CSL, none of the Acquired Companies nor any tenant or other occupant or user of any Property, or any portion thereof, has stored or disposed of (or engaged in the business of storing or disposing of) or has released or caused the release of any Hazardous Materials on any Property or any portion thereof, the removal of which is required or the maintenance of which is regulated, prohibited or penalized by any Environmental Law, and, to the Knowledge of CLJ and CSL, except as disclosed to SNH in writing or as set forth in any environmental report identified in SECTION 3.13 of the Disclosure Schedule, each Property is free from any such Hazardous Materials, except any such materials maintained in accordance with applicable Environmental Law. -18- 3.14. CONTRACTS AND COMMITMENTS. Other than the Marriott Agreements, the Ground Lease, the Capital Leases, the agreements evidencing or securing the Mortgage Loans, the Unsecured Loans and the Boynton Beach Mortgage Loan (which agreements are listed on SECTIONS 1.1(62), 1.1(90) and 1.1(10) to the Disclosure Schedule), the agreements evidencing or securing the New Loan, the Prior Tax Matters Agreements, matters shown on the Title Commitments, Medicare and Medicaid provider agreements, and agreements entered into by MSLS, or by the Acquired Companies at the direction of MSLS, in the ordinary course of business and in accordance with the Operating Agreements for the Properties, and other than the matters set forth in SECTION 3.14 of the Disclosure Schedule there are no material Contracts affecting any of the Acquired Companies which will be binding on the Acquired Companies subsequent to the Closing Date. 3.15. EMPLOYEE BENEFIT PLANS. No Acquired Company sponsors, maintains or contributes or has maintained or contributed to any: deferred compensation, incentive compensation, stock purchase, stock option or other equity compensation plan, program, agreement or arrangement; severance or termination pay, medical, surgical, hospitalization, life insurance or other "welfare" plan, fund or program (within the meaning of Section 3(1) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA")); profit-sharing, stock bonus or other "pension" plan, fund or program (within the meaning of Section 3(2) of ERISA); employment, termination or severance agreement; Contract with any officer or director; or any other employee benefit plan, fund, program, agreement or arrangement; provided that the foregoing representation is given only as to the Knowledge of CLJ and CSL insofar as relating to the period prior to June 21, 1997. No Acquired Company nor any trade or business, whether or not incorporated, that together with any Acquired Company would be deemed a "single employer" within the meaning of Section 4001(b) of ERISA (an "ERISA AFFILIATE") has incurred any liability under Title IV of ERISA that has not been satisfied in full, and no condition exists that presents a material risk of any such liability being incurred by an Acquired Company. 3.16. EMPLOYEE MATTERS. Since June 20, 1997, no Acquired Company has had any employees. 3.17. INSURANCE. Each Acquired Company has policies of insurance of the type and in amounts customarily carried by Persons conducting businesses or owning assets similar to those of the Acquired Companies. All such policies are in full force and effect, all premiums due thereon have been paid and the Acquired Companies are otherwise in compliance in all material respects with the terms and provisions of such policies. Furthermore, except as would not, individually or in the aggregate, have a Material Adverse Effect, to the Knowledge of CLJ and CSL, (a) no Acquired Company has received any notice of cancellation or non-renewal of any such policy or arrangement nor is the termination of any such policies or arrangements threatened, (b) there is no claim pending under any of such policies or arrangements as to which coverage has been questioned, denied or disputed by the underwriters of such policies or arrangements, (c) no -19- Acquired Company has received any written notice from any of its insurance carriers that any insurance premiums will be increased in the future or that any insurance coverage presently provided for will not be available to it in the future on substantially the same terms as now in effect and (d) none of such policies or arrangements provides for any retrospective premium adjustment, experienced-based liability or loss sharing arrangement affecting any Acquired Company. 3.18. CERTAIN PAYMENTS. No Acquired Company, or director, officer or agent of any Acquired Company or, to the Knowledge of CLJ and CSL, any other Person associated with or acting for or on behalf of CLJ or CSL, has directly or indirectly (a) made any contribution, gift, bribe, rebate, payoff, influence payment, kickback, or other payment to any Person, private or public, regardless of form, whether in money, property, or services (i) to obtain favorable treatment in securing business, (ii) to obtain special concessions or for special concessions already obtained, for or in respect of any Acquired Company, or (iii) in violation of any Law; or (b) established or maintained any fund or asset that has not been recorded in the books and records of the Acquired Companies; provided that the foregoing representation is given only as to the Knowledge of CLJ and CSL insofar as relating to the period prior to June 21, 1997. No representation is made under this SECTION 3.18 as to any "independent director" of any CSL Subsidiary. 3.19. TAXES. (a) With respect to periods ending after December 28, 1998, all material Tax Returns required to be filed with respect to each of the Acquired Companies have been timely filed and such Tax Returns are complete and accurate in all material respects. All material Taxes required to be paid by or on behalf of the Acquired Companies (other than Taxes for which CLJ or the Acquired Companies are indemnified) have been paid when due and payable or, to the extent of Taxes not yet due and payable, required estimated Tax payments have been made in respect thereof. With respect to periods ending after December 28, 1998, no request has been made for an extension of time within which to file any Tax Return in respect of any of the Acquired Companies, which Tax Return is due and has not yet been filed; to CLJ's Knowledge, none of CLJ, its Subsidiaries, or any Acquired Company has after December 28, 1998 requested an extension of time within which to file any Tax Return in respect of any of the Acquired Companies, which Tax Return is due and has not yet been filed. After December 28, 1998, none of CLJ, its Subsidiaries, or any Acquired Company has received written notice from any governmental agency in a jurisdiction in which a particular Acquired Company does not file a Tax Return stating that such Acquired Company is or may be subject to taxation by that jurisdiction. There are no Liens on any of the assets of any Acquired Company with respect to Taxes, other than statutory liens for Taxes not yet due and payable. The responsibility for filing Tax Returns and paying Taxes for CLJ and its Subsidiaries for periods prior to December 29, 1998 (and certain periods which straddle December 28, 1998) is addressed in a Tax Matters Agreement, dated as of June 21, 1997, by and among MI, MSLS, HMC, HMC Senior Communities, Inc., and Forum Group, Inc. (the predecessor of CSL), and/or a Tax Sharing Agreement, dated as of December 28, 1998 by and among HMC, Host Marriott L.P. and CLJ (collectively, the "PRIOR TAX -20- MATTERS AGREEMENTS"). Each of CLJ and CSL, and to the Knowledge of CLJ and CSL (except as disclosed on SECTION 3.19(a) of the Disclosure Schedule) each other party thereto, has complied in all material respects with each of the Prior Tax Matters Agreements, and each such Prior Tax Matters Agreement is a valid and binding obligation of each of the parties thereto enforceable in accordance with its terms. After December 28, 1998, each of CLJ, its Subsidiaries, and the Acquired Companies have taken all actions necessary to, and none of them have failed to take any actions necessary to, preserve and enforce all material rights which CLJ, its Subsidiaries, or the Acquired Companies may have or may have had under each Prior Tax Matters Agreement, including without limitation the rights to have parties other than CLJ, its Subsidiaries, or the Acquired Companies bear responsibility for Tax Returns and Taxes in respect of the Acquired Companies in respect of Tax periods (including partial periods and straddle periods) covered by the Prior Tax Matters Agreements. There is no claim pending or threatened by any party to any Prior Tax Matters Agreement to the effect (i) that any of CLJ, its Subsidiaries or the Acquired Companies has failed to duly comply with the terms of such Prior Tax Matters Agreement or (ii) that such party does not bear responsibility under such Prior Tax Matters Agreement for Tax Returns or Taxes in respect of the Acquired Companies for periods (including partial periods or straddle periods) prior to December 29, 1998. (b) With respect to periods ending after December 28, 1998, except as disclosed on SECTION 3.19(b) of the Disclosure Schedule (i) no deficiencies for any material Taxes have been proposed, assessed or asserted in writing in respect of any Tax Returns filed by or on behalf of any Acquired Company or claimed in writing to be due by any taxing authority or otherwise that have not been settled and paid in full; (ii) other than Tax Returns relating to sales and use Taxes and personal property Taxes wherein the contested Taxes for all such Tax Returns in the aggregate do not exceed $200,000, no Tax Return with respect to any Acquired Company has been or is currently being audited by the IRS or other taxing authority (whether foreign or domestic); (iii) none of CLJ, CSL, or any Acquired Company has executed or filed with the IRS or any other taxing authority (whether foreign or domestic) any agreement, waiver, or other document extending, or having the effect of extending, the period for assessment or collection of any Taxes, which extension or waiver is still in effect, and except for the Prior Tax Matters Agreements, no Acquired Company has entered into any tax allocation or sharing agreement with any other entity; (iv) each of CLJ and CSL has delivered to SNH correct and complete copies of all examination reports, statements of deficiencies and similar documents prepared by the IRS or any other taxing authority (whether foreign or domestic) that was received by CLJ or any of its Subsidiaries and involving any Acquired Company and a material amount of Taxes; (v) all final adjustments made by the IRS with respect to any Tax Return involving any Acquired Company have been reported to the relevant state, local, or foreign taxing authorities to the extent required by Law. Except under the Prior Tax Matters Agreements, (i) no requests for ruling or determination letters filed by CLJ or any Acquired Company are pending with any taxing authority, and (ii) no Acquired Company has any liability to any Person with respect to Taxes paid, owed or to be paid for periods of time during which any Acquired Company or any predecessor thereof were members of a consolidated group other than the consolidated group of which CLJ is the common parent. No Acquired Company is bound by any -21- currently effective private ruling, closing agreement, or similar agreement with any Taxing Authority relating to Taxes. (c) No Acquired Company has filed a consent pursuant to Section 341(f) of the Code, or agreed to have Section 341(f)(2) of the Code apply to any disposition of a subsection (f) asset (as such term is defined in Section 341(f)(4) of the Code) owned by it. No Acquired Company has a permanent establishment in any foreign country or operates or conducts business through any branch in any foreign country. No Acquired Company has agreed to or is required to make any adjustment pursuant to Section 481(a) of the Code by reason of a change in the accounting method initiated by CLJ or any Acquired Company, and neither CLJ nor CSL has any Knowledge that the IRS has proposed any such adjustment or change in accounting method. (d) Each of CSL and CLJ is a "United States person" within the meaning of Section 7701(a)(30) of the Code. (e) No Acquired Company is or has been a "reporting corporation" subject to the information reporting and record maintenance requirements of Section 6038A of the Code and the Treasury Regulations thereunder. No Acquired Company or predecessors by merger or consolidation of any of them has within the past three (3) years been a party to a transaction intended to qualify under Section 355 of the Code or under so much of Section 356 of the Code as relates to Section 355 of the Code. (f) SNH has been provided access by CLJ and CSL to true and complete copies of (i) relevant portions of income tax audit reports, statements of deficiencies, closing or other agreements received by or on behalf of CLJ or any Acquired Company relating to any material amount of Taxes owed by any Acquired Company, and (ii) all material federal, state, local and foreign income, franchise and value added Tax Returns and sales, use and property Tax Returns, together with all schedules and attachments thereto, for each Acquired Company for periods ending after December 28, 1998. (g) Except for those Acquired Companies listed in SECTION 3.19(g) of the Disclosure Schedule, each Acquired Company is (and through the Closing will remain) for federal income tax purposes either a partnership or a disregarded entity that is not separate from its owner, in each case pursuant to Treasury Regulation Section 301.7701-3, and to the extent allowed under applicable Law, each such Acquired Company is (and through the Closing will remain) similarly classified for state and local income tax purposes. No Acquired Company is classified for federal income tax purposes as a publicly traded partnership under Section 7704(b) of the Code. (h) Neither CSL nor any Acquired Company owns 10% or more, by vote or value, of the stock or securities of any one issuer, except for stock or securities in an Acquired Company. -22- 3.20. FF&E RESERVES, MORTGAGE RESERVES AND WORKING CAPITAL. (a) SECTION 3.20(a) of the Disclosure Schedule contains a true, accurate and complete description of all property comprising the FF&E Reserves as of June 15, 2001, and such FF&E Reserves have, to the Knowledge of CLJ and CSL, been maintained in accordance with the Operating Agreements. (b) SECTION 3.20(b) of the Disclosure Schedule contains a true, accurate and complete description of all property comprising the Mortgage Reserves as of July 13, 2001, and such Mortgage Reserves have, to the Knowledge of CLJ and CSL, been maintained in accordance with the documents governing the Mortgage Loans and the Capital Leases. (c) SECTION 3.20(c) of the Disclosure Schedule contains a true, accurate and complete description of all Working Capital as of July 13, 2001, and the Working Capital has, to the Knowledge of CLJ and CSL, been maintained in accordance with the Operating Agreements. 3.21. BROKER'S OR FINDER'S FEE. Except for Deutsche Banc Alex. Brown, no agent, broker, Person or firm acting on behalf of CLJ or CSL is, or will be, entitled to any fee, commission or broker's or finder's fees from CLJ or any Acquired Company, or from any Person controlling, controlled by, or under common control with CLJ or any Acquired Company, in connection with this Agreement or any of the transactions contemplated hereby. 3.22. SUPPLEMENTS TO DISCLOSURE SCHEDULE. From time to time prior to the Closing Date, CLJ will promptly supplement or amend the Disclosure Schedule with respect to any matter arising which, if existing or occurring at the date of this Agreement would have been required to have been set forth in the Disclosure Schedule or which is necessary to correct the information set forth therein which has been rendered inaccurate. The delivery of any such supplement or amendment shall not in any way constitute a waiver by SNH of any requirement that the representations and warranties of CLJ and CSL be true and correct on the date of this Agreement and on the Closing Date or of any of the conditions set forth in SECTION 6, provided that the disclosure in any such supplement or amendment of any matter arising after the date of this Agreement shall not form the basis of a claim for misrepresentation or breach of a representation under SECTION 7. -23- SECTION 4. REPRESENTATIONS AND WARRANTIES OF SNH AND ACQ. SUB SNH and ACQ. SUB each hereby represent and warrant to CLJ and CSL as follows: 4.1. DUE ORGANIZATION, GOOD STANDING AND POWER. SNH is a real estate investment trust duly organized, validly existing and in good standing under the laws of the State of Maryland and has all requisite power and authority to own, lease and operate its properties and to carry on its business as now being conducted. ACQ. SUB is a Maryland real estate investment trust, duly organized, validly existing and in good standing under the laws of the State of Maryland and has all requisite power and authority to own, lease and operate its properties and to carry on its business as now being conducted. 4.2. AUTHORIZATION AND VALIDITY OF AGREEMENT. Each of SNH and ACQ. SUB has full power and authority to execute and deliver this Agreement, to perform its obligations hereunder and to consummate the transactions contemplated hereby. The execution, delivery and performance of this Agreement by each of SNH and ACQ. SUB, and the consummation by it of the transactions contemplated hereby, have been duly authorized and approved by its Board of Trustees. No other action on the part of SNH or ACQ. SUB is necessary to authorize the execution, delivery and performance of this Agreement by SNH or ACQ. SUB and the consummation of the transactions contemplated hereby. This Agreement has been duly executed and delivered by SNH and ACQ. SUB and is a valid and binding obligation of SNH and ACQ. SUB, enforceable against SNH and ACQ. SUB in accordance with its terms, except that (a) such enforcement may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting the enforcement of creditors' rights generally and (b) the availability of the remedy of specific performance or injunctive or other forms of equitable relief may be subject to equitable defenses and would be subject to the discretion of the court before which any proceeding therefor may be brought. 4.3. CONSENTS AND APPROVALS; NO VIOLATIONS. Except for any filings required under the HSR Act, Consents required for healthcare Permits, and Consents required in connection with the Lease, none of the execution, delivery or performance of this Agreement by SNH or ACQ. SUB, or the consummation by SNH or ACQ. SUB of any of the transactions contemplated hereby will (i) conflict with or result in any breach of any provision of the Organizational Documents of SNH or ACQ. SUB, (ii) require any Consent of any Governmental Entity, or (iii) violate any Contract, Law, Order or Permit applicable to SNH, ACQ. SUB or any of their properties or assets, excluding from the foregoing clauses (ii) and (iii), such Consents, violations, breaches or defaults which would not, individually or in the aggregate, have a material adverse effect on SNH or ACQ. SUB. -24- 4.4. FINANCIAL STATEMENTS. The audited consolidated balance sheets of SNH and its Subsidiaries as at December 31, 2000, and the related consolidated statements of income and cash flows for the fiscal year then ended, complete and correct copies of which have been furnished to CLJ, present fairly, in all material respects, the consolidated financial condition and results of operations and cash flows of SNH and its Subsidiaries as at such date and for such fiscal year, as the case may be. 4.5. BANKRUPTCY. None of SNH, ACQ. SUB or their Subsidiaries are now, or have in the past three years has been: a debtor in any bankruptcy or similar proceeding, insolvent, made an assignment for the benefit of creditors, or the subject of a receivership. None of SNH, ACQ. SUB or any of their Subsidiaries is contemplating any of the foregoing or is aware of any credible threat by any third party to file an involuntary bankruptcy petition against any of them. 4.6. LITIGATION. Neither SNH nor ACQ. SUB has received written notice of and, to the Knowledge of SNH and ACQ. SUB, no action or proceeding is pending or threatened and no investigation looking toward such an action or proceeding has begun, which (a) questions the validity of this Agreement or any action taken or to be taken pursuant thereto; (b) will have a material adverse effect on SNH or ACQ. SUB; or (c) result in or subject SNH or ACQ. SUB to a material liability. 4.7. BROKER'S OR FINDER'S FEE. Except for UBS Warburg LLC, no agent, broker, Person or firm acting on behalf of SNH or ACQ. SUB is, or will be, entitled to any fee, commission or broker's or finder's fees from SNH or ACQ. SUB or from any Person controlling, controlled by, or under common control with, SNH or ACQ. SUB in connection with this Agreement or any of the transactions contemplated hereby. SECTION 5. ACCESS AND TRANSACTIONS PRIOR TO CLOSING DATE 5.1. ACCESS TO INFORMATION CONCERNING PROPERTIES AND RECORDS. (a) Between the date of this Agreement and the Closing Date, CLJ and CSL shall, and shall cause each Acquired Company to, upon reasonable notice, afford SNH, and its counsel, accountants, consultants, financing sources and other authorized representatives, reasonable access, during normal business hours, to employees of CLJ familiar with the business of the Acquired Companies and the Properties, to perform due diligence investigations and to examine the books of account and records of the Acquired Companies, including, without limitation, all Contracts affecting the Properties, and make copies thereof, at such reasonable times as SNH or its representatives may request by notice to CLJ (which notice may be oral). No such investigation shall affect the -25- representations and warranties made by CLJ and CSL in this Agreement. Each of CLJ and CSL agrees to cause its officers and the employees of CLJ, in a manner consistent with the fulfillment of their ongoing duties and obligations, to furnish such data and other information and respond to such inquiries as SNH and its representatives shall from time to time reasonably request. (b) Between the date of this Agreement and the Closing Date, SNH shall, upon reasonable notice, afford CLJ, and its counsel, accountants, consultants, financing sources and other authorized representatives, access to employees of SNH familiar with the business of SNH and ACQ. SUB, to perform due diligence investigations and to examine the books of account and records of SNH and ACQ. SUB, and make copies thereof, at such reasonable times as CLJ or its representatives may request by notice to SNH (which notice may be oral). No such investigation shall affect the representations and warranties made by SNH or ACQ. SUB in this Agreement. SNH agrees to cause its officers and the employees of SNH and ACQ. SUB, in a manner consistent with the fulfillment of their ongoing duties and obligations, to furnish such data and other information and respond to such inquiries as CLJ and its representatives shall from time to time reasonably request. (c) Unless otherwise required by Law, SNH shall keep confidential, and cause its counsel, accountants, consultants and other authorized representatives to keep confidential, any nonpublic information obtained pursuant to this SECTION 5.1; notwithstanding the foregoing, however, SNH shall not be required to keep confidential information that (i) is already in its possession (unless such information has been received from CLJ pursuant to the Confidentiality Agreement among CLJ, SNH, HPT and HRPT Properties Trust dated December 5, 2000, as amended by a letter dated July 31, 2001), or (ii) becomes generally available to the public other than as a result of a disclosure by SNH, HPT or HRPT Properties Trust, or (iii) becomes available to SNH on a non-confidential basis from a source other than an Acquired Company or CLJ (provided that SNH has no Knowledge that such source obtained such information subject to confidentiality restrictions). (d) Unless otherwise required by Law, CLJ shall keep confidential, and cause its counsel, accountants, consultants and other authorized representatives to keep confidential, any nonpublic information obtained pursuant to this SECTION 5.1; notwithstanding the foregoing, however, CLJ shall not be required to keep confidential information that (i) is already in its possession (unless such information has been received from SNH pursuant to the Confidentiality Agreement between CLJ and SNH dated February 20, 2001), or (ii) becomes generally available to the public other than as a result of a disclosure by CLJ or an Acquired Company, or (iii) becomes available to CLJ on a non-confidential basis from a source other than SNH (provided that CLJ has no Knowledge that such source obtained such information subject to confidentiality restrictions). -26- 5.2. TITLE MATTERS. Prior to the execution of this Agreement, SNH has ordered from American Title Company (the "TITLE COMPANY") and directed the Title Company promptly to deliver to SNH and CLJ a preliminary title commitment, having an effective date after the date of this Agreement, for an ALTA extended owner's policy of title insurance with respect to each of the Properties, together with complete and legible copies of all instruments and documents referred to as exceptions to title (collectively, the "TITLE COMMITMENTS"). On or before September 30, 2001 (which date shall be extended for an additional period of fifteen days upon the written request of SNH, provided that SNH is proceeding in good faith), SNH shall give CLJ notice of any title exceptions (other than Permitted Liens) which adversely affect any of the Properties in any material respect and as to which SNH reasonably objects, and CLJ shall, within ten Business Days of its receipt of such notice, notify SNH whether CLJ elects to take such action as may be required to cause such exceptions to be removed from the Title Commitments. If CLJ elects to remove the title exception objected to by SNH, such title exception shall be removed from the Title Commitment at or prior to Closing. If CLJ elects not to remove the title exception, SNH shall, within five Business Days of its receipt of notice of CLJ's election not to remove the title exception, elect whether to terminate this Agreement. If SNH does not so terminate this Agreement, the objected to exception shall become a Permitted Lien. 5.3. SURVEY MATTERS. Prior to the execution of this Agreement, SNH has arranged for the preparation of an ALTA survey with respect to each of the Properties (the "SURVEYS"), by a licensed surveyor in the jurisdiction in which each of the Properties is located, which (i) contains an accurate legal description, (ii) shows the exact location, dimension and description (including applicable recording information) of all utilities, easements, encroachments and other physical matters affecting such Property, the number of striped parking spaces located thereon and all applicable building set-back lines, (iii) states whether the applicable Property is located within a 100-year flood plain and (iv) includes a certification in a form reasonably acceptable to SNH, addressed to SNH, the Title Company and any other persons requested by SNH. SNH will deliver a copy of each Survey promptly to CLJ. On or before September 30, 2001 (which date shall be extended for an additional period of fifteen days upon the written request of SNH, provided that SNH is proceeding in good faith), SNH shall give CLJ notice of any matters shown on the Surveys (other than Permitted Liens) which adversely affect any of the Properties in any material respect and as to which SNH reasonably objects, and CLJ shall, within ten Business Days of its receipt of such notice, notify SNH whether CLJ elects to take such action as may be required to cause such matter to be remedied. If CLJ elects to remedy the matter objected to by SNH, such matter shall be remedied at or prior to Closing. If CLJ elects not to remedy such matter, SNH shall, within five Business Days of its receipt of notice of CLJ's election not to remedy the matter, elect whether to terminate this Agreement. If SNH does not so terminate this Agreement, the objected to exception shall become a Permitted Lien. -27- 5.4. ENVIRONMENTAL AND ENGINEERING REPORTS. Prior to the date of this Agreement, CLJ has delivered to SNH, all environmental audits, evaluations, assessments, studies or tests and engineering reports (with respect to roofs, electric, mechanical and structural elements of the Properties) in their possession. After the date hereof, SNH may arrange for the preparation of additional environmental audits, evaluations, assessments, studies or tests and engineering reports with respect to any of the Properties. SNH will direct each firm preparing such audit or report to deliver a copy of such audit or report promptly to CLJ. On or before September 30, 2001 (which date shall be extended for an additional period of fifteen days upon the written request of SNH, provided that SNH is proceeding in good faith), SNH shall give CLJ notice of any matters shown thereon which adversely affect any of the Properties in any material respect and as to which SNH reasonably objects, and CLJ shall, within ten Business Days of its receipt of such notice, notify SNH whether CLJ elects to take such action as may be required to cause such matter to be remedied. If CLJ elects to remedy the matter objected to by SNH, such matter shall be remedied at or prior to Closing, or, if such matter cannot be completed by Closing, CLJ shall promptly begin such remediation and diligently pursue completion through and, if necessary, after Closing. If CLJ elects not to remedy such matter, SNH shall, within five Business Days of its receipt of notice of CLJ's election not to remedy the matter, elect whether to terminate this Agreement. 5.5. CONDUCT OF THE BUSINESS OF THE ACQUIRED COMPANIES PENDING THE CLOSING DATE. Except as specifically contemplated by this Agreement, or as set forth in SECTION 5.5 of the Disclosure Schedule, or as required in connection with obtaining the New Loan, and unless CLJ obtains SNH's prior written approval in each instance, until the earlier of (i) the termination of this Agreement or (ii) the Closing Date: (1) CLJ shall and shall cause each Acquired Company to conduct its operations only according to its ordinary and usual course of business consistent with past practice and shall use all commercially reasonable efforts to preserve intact their current business operations, maintain their material Contracts, and maintain satisfactory relationships with lessors, lessees, suppliers, customers, joint venture partners and others having business relationships with them; and (2) no Acquired Company shall: (a) except as required by SECTION 5.6, make any change in or amendment to its Organizational Documents other than amendments to change the name of an Acquired Company or amendments or other changes that are ministerial or immaterial to such Acquired Company; (b) issue or sell, or authorize the issuance or sale of, any shares of its capital stock or any other equity securities, or issue or sell, or authorize the issuance or sale of, any securities convertible into, or options, warrants or rights to purchase or subscribe to, or enter into or create any Contract with respect to the issuance or sale of, any shares of its capital stock or any other equity securities, or make any other changes in its capital structure; -28- (c) sell or pledge or agree to sell or pledge any stock or other equity interest owned by it in any other Person; (d) declare, pay or set aside any dividend or other distribution or payment with respect to, or split, combine, redeem or reclassify, or purchase or otherwise acquire, any shares of its capital stock or its other securities; provided the Acquired Companies (i) shall pay a dividend or other distribution to CLJ in an aggregate amount equal to the proceeds (after reduction for expenses) of the New Loan required by SECTION 5.8, (ii) may make distributions of net income to CLJ and (iii) may upstream all cash in the CSL Subsidiaries and CCC Boynton to CLJ; (e) enter into any Contract which is reasonably expected to involve payment or receipts by any Acquired Company in excess of $100,000 during any twelve month period, or, in cases where the Acquired Company is the party responsible for such payment, which is not terminable without penalty upon 30 days notice, provided, however, that nothing in this SECTION 5.5 shall be deemed to prohibit (i) MSLS as agent for any Acquired Company from entering into any such Contract on behalf of such Acquired Company to the extent contemplated by the Operating Agreements or (ii) CSL or any CSL Subsidiary from purchasing an interest rate cap or other hedge device in respect of the GMAC Mortgage Loans out of monies held as part of the Mortgage Reserves for such purpose, and the remaining balance of such part of the Mortgage Reserves, if released, may be distributed or paid to CLJ; (f) grant any options to purchase common stock or provide for compensation or fringe benefits to any of its directors or officers; enter into any employment, consulting or severance agreement or arrangement with any Person; (g) other than in the ordinary course of business and draws taken under CLJ's corporate lines of credit, transfer, lease, license, guarantee, sell, mortgage, pledge, dispose of, encumber or subject to any Lien (except as contemplated by SECTION 5.7(b)) any of the Properties or any other material assets or incur or modify any indebtedness or other material liability; issue any debt securities or assume, guarantee or endorse or otherwise as an accommodation become responsible for the obligations of any Person; or make any loan or other extension of credit; (h) sell, assign, transfer, license or modify or amend any rights to any intellectual property owned by or licensed to any Acquired Company, except in the ordinary course of business consistent with past practice; (i) agree to the settlement of any material claim or litigation, other than settlements agreed to by MSLS on behalf of any Acquired Company to the extent contemplated by the Operating Agreements; (j) make or rescind any material Tax election or settle or compromise any material Tax liability (except as permitted to MSLS in the ordinary course of business and in accordance with the Operating Agreements); -29- (k) make any material change in its accounting principles, practices or methods; (l) (A) incur any indebtedness for borrowed money or guarantee any such indebtedness of another Person (except as contemplated by SECTION 5.7(b)) or (B) make any loans or advances to any other Person, other than to CSL or any CSL Subsidiary; provided, however, that CSL and its Subsidiaries may make draws under the Bankers Trust Line, in any amount, provided that such draws are repaid at or prior to Closing; (m) pay, discharge or satisfy any liabilities other than the payment, discharge or satisfaction of any liabilities in the ordinary course of business if now due and payable and consistent with past practice; (n) delay or postpone the payment of accounts payable or other liabilities, other than in the ordinary course of business consistent with past practice; (o) other than such actions as are permitted to be taken by MSLS in the ordinary course of business and in accordance with the Operating Agreements, take any action, engage in any transaction or enter into any agreement which could reasonably be expected to cause (A) any of the conditions in SECTION 6 not to be satisfied, or (B) a Material Adverse Effect; (p) other than in the ordinary course of business, and except for such actions as may be taken by MSLS in the ordinary course of business and in accordance with the Operating Agreements, modify, amend or terminate any material Contract to which it is a party or waive any of its material rights or claims; or (q) agree, in writing or otherwise, to take any of the foregoing actions. 5.6. CONVERSION OF CERTAIN ACQUIRED COMPANIES. On or before the date the Acquired Companies make a distribution or pay a dividend of the proceeds of the New Loan to CLJ, and subject to the receipt of applicable Consents under the Mortgage Loans, the Unsecured Loans, the Capital Leases and the Ground Leases and from partners of the relevant entities, each of the Acquired Companies listed in SECTION 5.6 of the Disclosure Schedule shall be reorganized as a business trust organized under the laws of the State of Maryland so that each such Acquired Company (as reorganized) shall for United States federal income and (to the extent allowed under applicable Law) state and local income tax purposes be classified as a disregarded entity that is not separate from its owner pursuant to Treasury Regulations Section 301.7701-3; PROVIDED that if, after the date hereof, CLJ identifies a material state or local tax liability that would be incurred by CLJ if an identified Acquired Company were to be reorganized as a business trust organized under the laws of the State of Maryland, such Acquired Company shall instead be reorganized as a Delaware limited liability company that would be classified as a disregarded entity that is not separate from its owner pursuant to Treasury Regulations Section 301.7701-3 unless SNH shall agree to indemnify CLJ against such tax liability. None of CLJ, CSL or any Acquired Company shall take or permit any action to materially modify such tax classification. -30- 5.7. COOPERATION. (a) Subject to the terms and conditions provided herein, each of CLJ, CSL, ACQ. SUB and SNH shall, and CLJ shall cause each Acquired Company to, cooperate and use their reasonable best efforts to take, or cause to be taken, all appropriate action, and to make, or cause to be made, all filings necessary, proper or advisable under applicable Laws to consummate and make effective the transactions contemplated by this Agreement, including, without limitation, all their reasonable best efforts to obtain, prior to the Closing Date, all Permits and Consents as are necessary for consummation of the transactions contemplated by this Agreement. (b) Each of CLJ and CSL shall, and CLJ shall cause each Acquired Company to, and SNH shall, and shall cause ACQ. SUB to, cooperate and use their reasonable best efforts to take, or cause to be taken, all appropriate action, and to execute and deliver, or cause to be executed and delivered all such instruments and documents necessary or desirable in connection with the New Loan, on such business terms as are reasonably acceptable to each of CLJ and SNH and evidenced by instruments and documents which are substantially the same as those evidencing the GMAC Mortgage Loans. (c) Each of CLJ and CSL shall, and CLJ shall cause each Acquired Company to conduct negotiations with MSLS relating to capital expenditure budgets required by the Operating Agreements for each of the Properties for fiscal year 2002, jointly with SNH and ACQ. SUB. (d) SNH shall cooperate with CLJ in providing all necessary information concerning SNH and its Subsidiaries (i) as required by applicable Law including, without limitation, audited financial statements for CLJ to distribute to its shareholders in connection with seeking approval of the transactions contemplated by this Agreement and in connection with other reports required to be filed by CLJ with the Securities and Exchange Commission and (ii) to the extent required in connection with obtaining any Consents (including Consents under the Mortgage Loans, the Unsecured Loans, the Capital Leases and the Ground Leases) required to consummate the transactions contemplated hereby and to obtain the New Loan. (e) CLJ and CSL shall and CLJ shall cause each Acquired Company to cooperate with SNH in providing all necessary information concerning CLJ and its Subsidiaries (i) as required by applicable Law, including, without limitation, additional unaudited and audited financial statements in connection with the distribution by SNH to its shareholders of the equity of the Tenant and other reports required to be filed by SNH with the Securities and Exchange Commission and (ii) to the extent required in connection with obtaining any Consents (including Consents under the Mortgage Loans, the Unsecured Loans, the Capital Leases and the Ground Leases) required to consummate the transactions contemplated hereby and to obtain the New Loan. (f) If the Consent of HMC, as guarantor of the Unsecured Loan in respect of the Leisure Park Community, identified as item 31 in SECTION 3.12(a)(ii) of the -31- Disclosure Schedule, pursuant to a Guaranty Agreement dated December 1, 1997 in favor of Marine Midland Bank, is required to permit the transactions contemplated by this Agreement, SNH will agree to replace HMC as the guarantor of such Unsecured Loan. If such replacement is not permitted, CLJ will use commercially reasonable efforts to obtain the Consent of HMC prior to Closing, if required. If SNH does not replace HMC as the guarantor, SNH shall indemnify CLJ for the liability of CLJ to HMC (if any) to reimburse HMC for payments made by HMC as guarantor. (g) SNH agrees to replace CLJ as guarantor or indemnitor, as the case may be under the several Guaranties of Recourse Obligations and Environmental Indemnity Agreements (each dated July 3, 2000 or July 28, 2000) each executed by CLJ for the benefit of GMAC in respect of a GMAC Mortgage Loan, subject to the Consent of GMAC. If such Consent is not obtained by the Closing Date with respect to any such Guaranty of Recourse Obligations or Environmental Indemnity Agreement, SNH agrees to indemnify CLJ against any payment made or required to be made by it as guarantor or indemnitor after the Closing Date in accordance with the terms of such Guaranty of Recourse Obligations or Environmental Indemnity Agreement. 5.8. DIVIDENDS; DISTRIBUTIONS. The Acquired Companies will declare and pay dividends and/or make distributions to CLJ in an aggregate amount equal to the proceeds (after reduction for transaction expenses) of the New Loan not later than one Business Day prior to the Closing Date. Such dividends or other distributions shall be treated by the Parties as "distributions" to CLJ for federal income tax purposes under Sections 301, 857(a)(2), and 857(d)(3) of the Code, and under Treasury Regulations 1.1502-13 and 1.1502-33. Solely for federal income (and, to the extent allowable under applicable Law, state and local) tax purposes, such dividends or other distributions shall not be treated by the Parties as part of the Purchase Price. 5.9. NO SOLICITATION OF OTHER OFFERS. (a) Until this Agreement has been terminated in accordance with SECTION 8 (and the payments, if any, required to be made by CLJ in connection with such termination pursuant to SECTION 8.2 have been made), none of CLJ, CSL, any of their respective Affiliates, nor any of their respective officers (or other senior management employees), directors, representatives, consultants, investment bankers, attorneys, accountants and other agents (collectively, the "REPRESENTATIVES") shall Knowingly (i) encourage, solicit, initiate or facilitate the making of, or take any other action to facilitate any inquiries or the making of any proposal that constitutes, or may reasonably be expected to lead to, any Alternative Proposal, (ii) participate in any way in discussions or negotiations with, or furnish or disclose any nonpublic information to, any Person (other than SNH) in connection with any Alternative Proposal, or (iii) enter into any agreement, letter of intent or similar document contemplating or otherwise relating to any Alternative Proposal; provided, however, that this SECTION 5.9(a) shall not prohibit CLJ, CSL or the Representatives from: (i) complying with all applicable laws, rules and regulations, including Rules 14d-9 and 14e-2 under the Securities Exchange Act of 1934, as amended (the "EXCHANGE ACT") or publicly disclosing the existence of an Alternative Proposal to -32- the extent required by applicable law, or (ii) furnishing non-public information to, or entering into discussions or negotiations with, or accepting an Alternative Proposal from, any person or entity in connection with an unsolicited bona fide written proposal or proposals from any person or entity relating to an Alternative Proposal if CLJ determines in good faith based upon the advice of counsel that such action is required in order for CLJ to comply with its fiduciary obligations under the MGCL. If CLJ or CSL shall receive any offer to purchase (or any request for non-public information concerning CSL's assets in connection with a potential offer to purchase such assets), which it determines it must respond to, it shall (i) inform SNH that an offer or request has been received, and (ii) furnish to SNH the identity of the offeror or Person making the request, and a description of the material terms thereof. (b) As used herein, "ALTERNATIVE PROPOSAL" shall mean (i) any written proposal or offer from any Person relating to any direct or indirect acquisition or purchase of a substantial amount of assets of any Acquired Company or of any class of equity securities of any Acquired Company (including any transaction in the nature of a management acquisition or "going private" transaction involving the Acquired Companies), (ii) any tender offer or exchange offer that, if consummated, would result in any Person beneficially owning any shares of equity securities of any Acquired Company, (iii) any merger, consolidation, business combination, sale of substantially all the assets, recapitalization, liquidation, dissolution or similar transaction effecting the transfer of any Acquired Company or (iv) any other transaction that relates to the Acquired Companies, the consummation of which could reasonably be expected to impede, interfere with, prevent or materially delay the purchase of the CSL Stock, the CCC Boynton Stock or the CCC Senior Living Stock contemplated hereby or any other transaction that relates to the Acquired Companies that could reasonably be expected to dilute materially the benefits to SNH of the transactions contemplated hereby; PROVIDED, HOWEVER, that no proposal or offer or other transaction described in any of clauses (i) through (iii) above that occurs after the eighteen month period referred to in Section 2.6 and that involves one of the Communities or CSL Subsidiaries or CCC Boynton that was excluded from the transaction in accordance with SECTION 6.1(c) shall constitute an Alternative Proposal. 5.10. NOTIFICATION OF CERTAIN MATTERS. CLJ shall give prompt notice to SNH, and SNH shall give prompt notice to CLJ, of the occurrence, or failure to occur, of any event, which occurrence or failure to occur would be likely to cause any representation or warranty contained in this Agreement to be untrue in any material respect at any time from the date of this Agreement to the Closing. Each of CLJ and SNH shall give prompt notice to the other party of any notice or other communication from any third party alleging that the consent of such third party is or may be required in connection with the transactions contemplated by this Agreement. 5.11. HSR ACT FILING. SNH and CLJ shall, as promptly as practicable, file, or cause to be filed, any required notification and report forms under the HSR Act with the Federal Trade Commission (the -33- "FTC") and the Antitrust Division of the United States Department of Justice (the "ANTITRUST DIVISION") in connection with the transactions contemplated by this Agreement, and will use all commercially reasonable efforts to respond as promptly as practicable to all inquiries received from the FTC or the Antitrust Division for additional information or documentation and to cause the waiting periods under the HSR Act to terminate or expire at the earliest possible date. SNH and CLJ will each furnish to the other such necessary information and reasonable assistance as the other may reasonably request in connection with its preparation of necessary filings or submissions to any governmental or regulatory agency, including, without limitation, any filings necessary under the provisions of the HSR Act. 5.12. PUBLIC ANNOUNCEMENTS. CLJ and SNH shall consult with each other before issuing any press release or otherwise making any public statements with respect to the transactions contemplated by this Agreement and shall not issue any such press release or make any such public statement prior to such consultation and review by the other party of such release or statement or without the prior consent of the other party, which consent shall not be unreasonably withheld or delayed; provided, however, that a party may, without the prior consent of the other party, issue such press release or make such public statement as may be required by Law or any listing agreement with a national securities exchange or automated quotation system which CLJ or SNH is a party to, if it has used all reasonable efforts to consult with the other party and to obtain such party's consent but has been unable to do so in a timely manner. 5.13. CLJ STOCKHOLDER APPROVAL. CLJ shall submit this Agreement and the transactions contemplated by this Agreement for the approval by its stockholders at a special meeting of stockholders to be held not later than March 31, 2002 (provided that such date may be postponed to not later than June 30, 2002 upon the written request of CLJ, provided that CLJ is proceeding in good faith), and, subject to the fiduciary duties of its Board of Directors, CLJ shall recommend approval of this Agreement and the transactions contemplated by this Agreement and shall use its reasonable business efforts to obtain stockholder approval. SECTION 6. CONDITIONS 6.1. CONDITIONS TO EACH PARTY'S OBLIGATIONS. The respective obligations of each Party to consummate the transactions contemplated hereby shall be subject to the fulfillment or waiver (subject to applicable Law) at or prior to the Closing of each of the following conditions: (a) APPROVAL OF SALE OF STOCK. The sale of the CSL Stock to ACQ. SUB pursuant to this Agreement shall have been approved and adopted by the requisite vote of or consent by the holders of common stock of CLJ entitled to vote thereon in accordance with applicable Law and CLJ's Organizational Documents. -34- (b) HSR ACT. Any waiting period (and any extension thereof) under the HSR Act applicable to the transactions contemplated hereby shall have expired or been terminated and no action shall have been instituted by the Antitrust Division or the FTC challenging or seeking to enjoin the consummation of the transactions contemplated hereby, which action shall have not been withdrawn or terminated. (c) CONSENTS. All Consents (i) listed in SECTION 6.1(c) of the Disclosure Schedule, (ii) that are required in connection with the Lease, (iii) that pertain to the conversion of certain of the Acquired Companies in accordance with Section 5.6, and (iv) relating to healthcare Permits (including Medicare and Medicaid provider agreements) shall have been obtained and shall (to the extent required) contemplate and permit the Lease; provided if, using commercial reasonable efforts, CLJ is unable to obtain one or more of the Consents referenced on SECTION 6.1(c) of the Disclosure Schedule for CCC Boynton, Lexington at Country Place or Lafayette at Country Place (A) the Purchase Price shall be reduced by the relevant Consent Reduction Amount, (B) the relevant CSL Subsidiary and Community shall be deleted from the definitions of Communities, Properties, CSL Subsidiaries and from the description of the Assets and (C) the Acquired Companies shall be relieved from and indemnified against any liabilities of CCC Boynton or CCC of Kentucky, Inc., as the case may be, on terms acceptable to SNH, whereupon the conditions of obtaining those Consents (subject to the provisions of SECTION 2.6) is deemed waived. To the extent modifications to the Lease are reasonably required to obtain any Consent required pursuant to this Agreement, so long as such modifications do not (taking into account the plan of SNH to spin off Tenant as a separate public company) affect the qualification of SNH or any Subsidiary of SNH as a "real estate investment trust" or a "qualified REIT subsidiary", as the case may be, under the Code, SNH will not, and will cause Tenant not to, unreasonably decline to make such modifications. (d) INJUNCTION. No preliminary or permanent injunction, judgment or other order shall have been issued by any federal, state or foreign court or by any Governmental Entity and be in effect on the Closing Date which prohibits, restrains, restricts or enjoins the consummation of the transactions contemplated by this Agreement. (e) STATUTES. No federal, state or foreign statute, law, rule, regulation, executive order, judgment, decree or order of any kind shall have been enacted, entered, promulgated or enforced by any court or Governmental Entity which prohibits, restrains, restricts or enjoins the consummation of the transactions contemplated by this Agreement or has the effect of making the transactions contemplated by this Agreement illegal. (f) TAX ALLOCATION AGREEMENT. CLJ, CSL, the Acquired Companies, ACQ. SUB and SNH shall have entered into a Tax Allocation Agreement in the form of EXHIBIT D. (g) MARRIOTT AGREEMENTS. The Marriott Agreements shall be in full force and effect on the Closing Date (except for the Noncompetition Agreement and the Transition Agreements, so long as such agreements have been terminated without -35- expense or liability to any of the Acquired Companies); MI, MSLS and HMC, as the case may be, shall have given their Consent to the assignment of the Operating Agreements to Tenant, the assignment of the Pooling Agreements to CSL, the assignment of the MI Indemnity Agreement to SNH and given such other Consents as are required in connection with the transactions contemplated by this Agreement. CLJ and CSL, on the one hand, and SNH, ACQ. SUB and Tenant, on the other, shall have fully complied with all applicable provisions of the Marriott Agreements; provided the Marriott Agreements shall have been amended to provide that neither SNH nor any Subsidiary of SNH shall be subject to any agreement not to compete or which would otherwise limit the conduct of their businesses and further provided that if, in connection with any Consent, MI, MSLS or HMC shall require any modification of or supplement to any of the Marriott Agreements or shall impose any other condition on their Consent, such modification, supplement or condition shall be in form and substance acceptable to SNH. 6.2. CONDITIONS TO OBLIGATIONS OF CLJ AND CSL. The obligations of CLJ and CSL to consummate the transactions contemplated hereby shall be subject to the fulfillment (or waiver by CLJ and CSL) at or prior to the Closing of each of the following conditions: (a) REPRESENTATIONS AND WARRANTIES. The representations and warranties of SNH and ACQ. SUB set forth in this Agreement shall be true and correct in all material respects as of the date of this Agreement and as of the Closing Date, provided, however, that such representations and warranties shall be deemed to be true and correct unless the failure or failures of such representations and warranties to be so true and correct, without regard to any materiality qualifiers contained therein, individually or in the aggregate, results or could reasonably be likely to result in a material adverse effect on the ability of SNH or ACQ. SUB to consummate the transactions contemplated by this Agreement. (b) LEASE AMENDMENTS. The subleases (and the related pledge agreements) between CLJ and HPT listed in SECTION 6.2(b) of the Disclosure Schedule for the properties known as CYBM and RIBM hotels shall have been amended as provided in EXHIBIT E; the costs and expenses of HPT in connection therewith shall have been paid by SNH and the costs and expenses of HMC in connection therewith shall have been paid by CLJ. (c) COVENANTS. SNH and ACQ. SUB shall have complied in all material respects with their respective obligations under the terms of this Agreement. (d) CERTIFICATE. CLJ shall have received a certificate signed by the president and chief financial officer of SNH certifying to the fulfillment of the conditions set forth above in this SECTION 6.2. (e) OPINION OF COUNSEL. CLJ shall have received an opinion of Sullivan & Worcester LLP, counsel to SNH and ACQ. SUB, in form and substance reasonably acceptable to CLJ. -36- 6.3. CONDITIONS TO OBLIGATIONS OF SNH AND ACQ. SUB. The obligations of SNH and ACQ. SUB to consummate the transactions contemplated hereby shall be subject to the fulfillment (or waiver by SNH) at or prior to the Closing Date of each of the following conditions: (a) REPRESENTATIONS AND WARRANTIES. The representations and warranties of CSL and CLJ set forth in this Agreement shall be true and correct as of the date of this Agreement and as of the Closing Date, provided, however, that such representations and warranties shall be deemed to be true and correct unless the failure or failures of such representations and warranties to be so true and correct, without regard to any materiality qualifiers contained therein, individually or in the aggregate, results or could reasonably be likely to result in a Material Adverse Effect. (b) COVENANTS. CLJ and CSL shall have complied in all material respects with their obligations under the terms of this Agreement. (c) ESTOPPEL CERTIFICATES. SNH shall have received estoppel certificates dated within sixty (60) days of the Closing Date executed by (i) each lender holding a Mortgage Loan, the lessor under the Ground Lease and each lessor under a Capital Lease, which shall specify the principal and interest balance outstanding and/or future rent(s), the amount of the Mortgage Reserves and other reserves held by such lender or lessor, and the date of the most recent payment thereunder, the prepayment premium (for the GMAC Mortgage Loans only), if any, and shall confirm whether a notice of default has been sent to the applicable borrower or lessee, and shall otherwise be in a form reasonably acceptable to SNH; and (ii) MI and/or MSLS with respect to each of the Operating Agreements, which shall specify the FF&E Reserves balance as of the end of the 2001 fiscal year and amounts due for owner funded capital expenditures for the 2001 fiscal year and the capital expenditures budget (including separately, those expenditures expected to be paid from the FF&E Reserve and those expected to be paid by owners) for the 2002 fiscal year, and shall confirm whether a notice of default has been sent to the applicable Acquired Company, and shall otherwise be in a form reasonably acceptable to SNH. (d) TITLE INSURANCE; ABSENCE OF LIENS. The Title Company shall be prepared, subject only to payment of the applicable premiums, to issue title insurance policies, or endorsements thereto, to the Acquired Companies, insuring title to the Properties is vested in the Acquired Companies, pursuant to ALTA title insurance policies in form and substance reasonably satisfactory to SNH, subject only to the Permitted Liens, or such other exceptions as may be approved by SNH. No Liens shall exist on any Assets (including the CSL Stock, the CCC Boynton Stock and the CCC Senior Living Stock), except for Permitted Liens and Liens disclosed in SECTIONS 2.1 or 3.12(b) of the Disclosure Schedule, and the CSL Subsidiaries that guarantied the Bankers Trust Line shall have been released as guarantors thereunder. (e) OPERATING AGREEMENTS. The Operating Agreements shall be in full force and effect on the Closing Date, the FF&E Reserves shall have been fully funded -37- through the Closing Date as required by the Operating Agreements, Working Capital shall have been maintained in a manner consistent with past practice and shall be at customary levels on the Closing Date and all amounts due MI/MSLS with respect to any of the Properties, whether arising under the Operating Agreements or otherwise, shall have been paid in full on the Closing Date. (f) MORTGAGE RESERVES. The Mortgage Reserves shall have been fully funded through the Closing Date as required by the Mortgage Loans and the Capitalized Leases. (g) CONVERSION OF CERTAIN ACQUIRED COMPANIES. Not later than two Business Days prior to the Closing Date (and in any event prior to the closing of the New Loan) each of the Acquired Companies listed in SECTION 5.6 of the Disclosure Schedule shall have been reorganized as a business trust organized under the laws of the State of Maryland (or, subject to the proviso to the first sentence of SECTION 5.6, a Delaware limited liability company) in accordance with SECTION 5.6. (h) CLOSING OF NEW LOAN. The New Loan shall have closed, and New Loan proceeds of not less than $150,000,000 and not more than $175,000,000 (before reduction for all transaction expenses associated with the New Loan) shall have been disbursed to one or more of the Acquired Companies, not later than two Business Days prior to the Closing Date. (i) DIVIDENDS; DISTRIBUTIONS. The Acquired Companies shall have declared and paid dividends and/or made distributions to CLJ in an aggregate amount equal to the proceeds (after reduction for all transaction expenses associated with the New Loan) of the New Loan not later than one Business Day prior to the Closing Date. (j) PRIOR TAX MATTERS AGREEMENTS. MI, MSLS, HMC and Host Marriott L.P., as the case may be, shall have consented to the assignment by CLJ of certain of its rights under the Prior Tax Matters Agreements to SNH pursuant to the Tax Allocation Agreement and shall have confirmed the Prior Tax Matters Agreements are in force and effect. (k) WOODLANDS. The limited partnership interests in Panther Holdings Level I, L. P., a Delaware limited partnership ("PANTHER HOLDINGS") that are not owned by an Acquired Company on the date hereof shall either have been acquired by an Acquired Company prior to the Closing Date, or CLJ shall have entered into an agreement with SNH in form reasonably acceptable to SNH pursuant to which CLJ shall agree to indemnify SNH for 50% of the actual costs incurred by SNH or its Affiliates after the Closing Date to purchase or redeem such limited partnership interests in Panther Holdings; provided that CLJ's obligation to pay such costs shall be limited to $250,000. (l) GABLES. CLJ shall have either paid the Contingent Purchase Price payable under Section 1.2.3 of the Agreement for Purchase and Sale for the Community known as Gables of Winchester dated as of December 10, 1997 on or prior to the Closing Date, or CLJ shall have entered into an agreement with SNH in form reasonably -38- acceptable to SNH pursuant to which CLJ shall agree to indemnify SNH for any amounts payable or paid by SNH or its Affiliates after the Closing Date pursuant to such provision. (m) CERTAIN RESIGNATIONS. The existing officers, directors and managers of each of the Acquired Companies shall have resigned effective as of the Closing Date (provided that any "independent" manager or director of any Acquired Company will only be required to resign if s/he is replaced with another qualified "independent" manager or director). (n) CERTIFICATE. SNH shall have received a certificate signed on behalf of CLJ and CSL by their respective chief executive officers and chief financial officers certifying to the fulfillment of the conditions set forth above in this SECTION 6.3. (o) OPINION OF COUNSEL. SNH shall have received an opinion of Arnold & Porter, counsel to CLJ, in form and substance reasonably acceptable to SNH. SECTION 7. NATURE AND SURVIVAL OF REPRESENTATIONS AND WARRANTIES; INDEMNIFICATIONS; TAX MATTERS 7.1. SURVIVAL OF REPRESENTATIONS, WARRANTIES, ETC. All representations and warranties of the parties set forth in this Agreement, and the rights of the parties to seek indemnification with respect thereto, shall survive the Closing. Such representations and warranties, and the rights of the parties to seek indemnification with respect thereto, shall expire, except with respect to claims asserted prior to and pending at the time of expiration, twelve (12) months following the Closing provided that the representations and warranties contained in SECTIONS 3.1, 3.2, 3.3 and 3.4 shall survive indefinitely (or if indefinite survival is not permitted by law, then for the maximum period permitted by applicable law) and provided further that the representations and warranties contained in SECTIONS 3.13 and 3.19 shall survive until the expiration of the applicable statute of limitations (including any waivers or extensions thereof). All such representations and warranties shall be deemed to have been given and made on the date hereof and as of the Closing Date. 7.2. CLJ'S AGREEMENT TO INDEMNIFY. (a) Subject to SECTION 7.1, CLJ shall defend, indemnify and hold harmless SNH, its Affiliates and their respective officers, trustees, employees and agents (the "SNH INDEMNITEE"), from and against and in respect of any and all losses, damages, liabilities, deficiencies, taxes, costs and expenses including, without limitation, interest, penalties, and reasonable attorney's fees and expenses (collectively, "LOSSES"), asserted against, relating to, imposed upon or incurred by the SNH Indemnitee resulting from, arising out of, or in connection with: (i) any breach by CLJ or CSL of any of their respective representations or warranties contained in this Agreement; (ii) any breach by CLJ or CSL of any of their respective covenants, agreements or obligations contained in -39- this Agreement and (iii) any and all actions, suits, proceedings, claims, demands, assessments and judgments incident to any of the foregoing. (b) Anything in this SECTION 7 to the contrary notwithstanding: (i) no amounts of indemnity shall be payable as a result of a claim, unless and until the SNH Indemnitee has suffered, incurred, sustained or become subject to Losses with respect thereto in excess of $500,000 in the aggregate, and (ii) the indemnification obligations of CLJ in respect of the Losses indemnified against shall not exceed the Purchase Price. 7.3. SNH'S AGREEMENT TO INDEMNIFY. (a) Subject to SECTION 7.1, SNH shall defend, indemnify and hold harmless CLJ, its Affiliates and their respective, officers, directors, employees and agents (the "CLJ INDEMNITEE"), against and in respect of any Losses resulting from: (i) any breach by SNH of any of its representations or warranties contained in this Agreement; (ii) any breach by SNH of any of its covenants, agreements or obligations contained in this Agreement and (iii) any and all actions, suits, proceedings, claims, demands, assessments and judgments incident to any of the foregoing. (b) Anything in this SECTION 7 to the contrary notwithstanding, no amounts of indemnity shall be payable as a result of a claim, unless and until the CLJ Indemnitee has suffered, incurred, sustained or become subject to Losses with respect thereto in excess of $500,000 in the aggregate. 7.4. THIRD PARTY CLAIMS. (a) Promptly after the receipt by any party hereto of notice of any claim, action, suit or proceeding of any third party which is subject to indemnification hereunder, such party ("INDEMNIFIED PARTY") shall give written notice of such claim to the party obligated to provide indemnification hereunder ("INDEMNIFYING Party"), stating the nature and basis of such claim and the amount thereof, to the extent known. Failure of the Indemnified Party to give such notice shall not relieve the Indemnifying Party from any liability which it may have on account of its indemnification obligation or otherwise, except to the extent that the Indemnifying Party is materially prejudiced thereby. (b) The Indemnifying Party shall be entitled to elect to participate in the defense of and, if it so chooses, to assume the defense of such claim, action, suit or proceeding with counsel selected by the Indemnifying Party and reasonably satisfactory to the Indemnified Party. Upon any such election by the Indemnifying Party to assume the defense of such claim, action, suit or proceeding, the Indemnifying Party shall not be liable for any legal or other expenses subsequently incurred by the Indemnified Party in connection with the defense thereof, PROVIDED, HOWEVER, that (i) if the Indemnified Party shall have reasonably concluded that separate counsel is required because a conflict of interest would otherwise exist, then the Indemnified Party shall have the right to select separate counsel to participate in the defense of such action on its behalf, at the expense of the Indemnifying Party and (ii) the Indemnified Party may, at its option and at its own expense, participate in such defense and employ counsel separate from the counsel -40- employed by the Indemnifying Party. The Indemnifying Party shall be liable for the reasonable fees and expenses of counsel employed by the Indemnified Party for any period in which the Indemnifying Party has not assumed the defense thereof (other than during any period in which the Indemnified Party failed to give the notice provided above). The parties shall use commercially reasonable efforts to minimize Losses from claims by third parties and shall act in good faith in responding to, defending against, settling or otherwise dealing with such claims, notwithstanding any dispute as to liability as between the parties under this SECTION 7. The parties shall also cooperate in any such defense, give each other full access to all non-privileged information relevant thereto and make employees and other representatives available on a mutually convenient basis to provide additional information and explanation of any material provided hereunder. Whether or not the Indemnifying Party shall have assumed the defense, the Indemnifying Party shall not be obligated to indemnify the Indemnified Party hereunder for any settlement entered into without the Indemnifying Party's prior written consent, which consent shall not be unreasonably withheld or delayed. Unless the sole relief is monetary damages which are payable in full by the Indemnifying Party, the Indemnifying Party shall not settle any claim without the prior written consent of the Indemnified Party, which consent shall not be unreasonably withheld or delayed. 7.5. PURCHASE PRICE ADJUSTMENT. Any amount paid by CLJ on the one hand, or SNH on the other hand, to the other pursuant to this SECTION 7 will be treated for federal income tax purposes as an adjustment to the Purchase Price. SECTION 8. TERMINATION 8.1. TERMINATION. This Agreement may be terminated at any time (subject to the provisions of this SECTION 8.1) prior to the Closing Date: (a) by mutual agreement of CLJ and SNH; (b) by either SNH or CLJ, in writing, if for any reason (other than a default by the noticing Party) the Closing has not occurred by June 30, 2002, except that no Party shall have the right to terminate under this SECTION 8.1(b) if the conditions precedent to such Party's obligation to close have been or at Closing would be satisfied or have been waived by such Party and such Party has nonetheless failed or refused to close; (c) by either SNH or CLJ in writing, if there shall be any order, writ, injunction or decree of any court or governmental or regulatory agency binding on SNH and/or CSL or CLJ, which prohibits or restrains SNH and/or CSL or CLJ from consummating the transactions contemplated by this Agreement, provided that SNH and CSL and CLJ shall have used their commercially reasonable efforts to have any such -41- order, writ, injunction or decree lifted and the same shall not have been lifted within 90 days after entry, by any such court or governmental or regulatory agency; (d) by CLJ in writing: (i) if the conditions set forth in SECTIONS 6.1 and 6.2 shall not have been complied with or performed and such noncompliance or nonperformance shall not have been cured or eliminated (or by its nature cannot be cured or eliminated) by SNH or otherwise by June 30, 2002; (ii) if, by September 15, 2001, HPT shall not have agreed, subject to the occurrence of the Closing, to satisfy the condition contained in SECTION 6.2(b) pursuant to an amendment acceptable to each of HPT and CLJ; (iii) if SNH shall have (i) failed to perform in any material respect its agreements contained in this Agreement required to be performed by it on or prior to the Closing Date or (ii) breached any of its representations or warranties contained in this Agreement, provided that the breach of such representations or warranties, without regard to any materiality qualifiers contained therein, individually or in the aggregate, results or could reasonably be likely to result in a material adverse effect on the ability of SNH or ACQ. SUB to consummate the transactions contemplated by this Agreement; (e) by SNH in writing: (i) pursuant to SECTION 5.2, SECTION 5.3 or SECTION 5.4; (ii) the conditions set forth in SECTIONS 6.1 and 6.3 shall not have been complied with or performed and such noncompliance or nonperformance shall not have been cured or eliminated (or by its nature cannot be cured or eliminated) by CLJ or otherwise by June 30, 2002; (iii) if CSL or CLJ shall have (i) failed to perform in any material respect its agreements contained in this Agreement required to be performed by it on or prior to the Closing Date, or (ii) breached any of its representations or warranties contained in this Agreement, provided that the breach of such representations or warranties, without regard to any materiality qualifiers contained therein, individually or in the aggregate, results or could reasonably be likely to result in a Material Adverse Effect; or (f) by either SNH or CLJ, in writing, (i) at any time following the rejection of this transaction by CLJ's shareholders or (ii) if CLJ accepts an Alternative Proposal. -42- 8.2. EFFECT OF TERMINATION. (a) If this Agreement is terminated by either SNH or CLJ pursuant to SECTION 8.1, this Agreement shall become void and there shall be no further obligation on the part of any of SNH, CSL or CLJ (except for the provisions of SECTION 9.6 and as set forth in this SECTION 8.2, which shall survive such termination). (b) If this Agreement is terminated by either SNH or CLJ pursuant to SECTION 8.1, except as provided in SECTION 8.2(g), the Deposit shall be paid to SNH. (c) If CLJ or SNH terminates this Agreement because, on or prior to December 14, 2001, CLJ's shareholders have rejected this transaction at a meeting of stockholders called to approve this transaction, CLJ shall immediately pay to SNH $7,500,000 by wire transfer of immediately available funds to an account designated by SNH. If thereafter CSL or substantially all of the Assets are sold or contracted for sale to a third party on or before August 9, 2003, then, on the date of the closing of such sale, CLJ will pay SNH an additional $7,500,000. (d) If CLJ or SNH terminates this Agreement because, after December 14, 2001, CLJ's shareholders have rejected this transaction at a meeting of stockholders called to approve this transaction, CLJ shall immediately pay to SNH $15,000,000 by wire transfer of immediately available funds to an account designated by SNH. (e) If CLJ or SNH terminates this Agreement because CLJ accepts an Alternative Proposal, CLJ shall immediately pay SNH $15,000,000 by wire transfer of immediately available funds to an account designated by SNH. (f) If SNH terminates this Agreement because any of the conditions set forth in SECTIONS 6.1 or 6.3 shall not have been complied with as a result of the willful acts or omissions of CLJ or an Acquired Company, CLJ shall immediately pay SNH a fee of $15,000,000 by wire transfer of immediately available funds to an account designated by SNH. (g) If CLJ terminates this Agreement because any of the conditions set forth in SECTIONS 6.1 or 6.2 shall not have been complied with as a result of the willful acts or omissions of SNH or if SNH fails to close because it does not have sufficient funds to pay the Purchase Price (other than as a result of the failure to obtain or close the New Loan), the Deposit shall be paid to CLJ and SNH shall immediately pay CLJ an amount by wire transfer of immediately available funds to an account designated by CLJ which, together with the Deposit, represents a fee of $15,000,000. -43- SECTION 9. MISCELLANEOUS PROVISIONS 9.1. NOTICES. Except where oral notice is specifically provided for herein, all notices, communications and deliveries required or permitted by this Agreement shall be made in writing signed by the Party making the same, shall specify the Section of this Agreement pursuant to which it is given or being made, and shall be deemed given or made (i) on the date delivered if delivered by telecopy or in person, (ii) on the third Business Day after it is mailed if mailed by registered or certified mail (return receipt requested) (with postage and other fees prepaid), or (iii) on the day after it is delivered, prepaid, to an overnight express delivery service that confirms to the sender delivery on such day, as follows: To SNH: Senior Housing Properties Trust 400 Centre Street Newton, Massachusetts 02458 Attn: David J. Hegarty, President and Chief Operating Officer Telecopy No.: (617) 796-8349 with a copy to (which shall not constitute notice): Sullivan & Worcester LLP One Post Office Square Boston, Massachusetts 02109 Attn: Richard Teller Telecopy No.: (617) 338-2880 -44- To CSL or CLJ: c/o Crestline Capital Corporation 6600 Rockledge Drive, Suite 600 Bethesda, Maryland 20817 Attn: Tracy M. J. Colden, Senior Vice President and General Counsel Telecopy No.: (240) 694-2040 with a copy to (which shall not constitute notice): c/o Crestline Capital Corporation 6600 Rockledge Drive, Suite 600 Bethesda, Maryland 20817 Attn: Larry K. Harvey, Senior Vice President and Treasurer Telecopy No.: (240) 694-2286 or to such other representative or at such other address of a Party as such Party may furnish to the other Party by notice similarly given. 9.2. SCHEDULES AND EXHIBITS. The Schedules, Exhibits and all documents expressly referred to in this Agreement, are incorporated into this Agreement and are made a part of this Agreement as if set out in full. 9.3. COMPUTATION OF TIME. Whenever the last day for the exercise of any privilege or the discharge of any duty under this Agreement shall fall upon a day other than a Business Day, the Party having such privilege or duty may exercise such privilege or discharge such duty on the next succeeding day which is a regular Business Day. 9.4. ASSIGNMENT: SUCCESSORS IN INTEREST. No assignment or transfer by SNH, CSL or CLJ, of its rights and obligations under this Agreement prior to the Closing shall be made except with the prior written consent of the other Party. This Agreement shall be binding upon and shall inure to the benefit of the Parties and their permitted successors and assigns, and any reference to a Party shall also be a reference to a permitted successor or assign. 9.5. NO THIRD-PARTY BENEFICIARIES. With the exception of the Parties, there shall exist no right of any person, including, without limitation, creditors of CSL or CLJ, to claim a beneficial interest in this Agreement or any rights occurring by virtue of this Agreement. -45- 9.6. EXPENSES. Except as otherwise provided below, CLJ (for itself and CSL) and SNH (for itself and ACQ. SUB) shall each pay their own attorneys', accountants' and other advisors' fees and costs, costs of internal personnel and filing fees charged by a governmental authority with respect to filings made by such Party in connection with the transactions contemplated by this Agreement. SNH shall pay: (i) the GMAC Fee and all other fees and expenses incurred in connection with the assumption or termination of the GMAC Mortgage Loans; (ii) all costs for Permits relating to healthcare licensing of the Communities arising out of the transactions contemplated by this Agreement (which shall not include costs incurred in connection with such Permits not being in full force and effect as of the date of this Agreement, which costs shall be paid by CLJ); (iii) all fees and costs (including any Transfer Taxes) incurred in connection with the conversion of any Subsidiaries pursuant to SECTION 5.6 or in connection with the New Loan (without duplication for amounts by which the Purchase Price is increased pursuant to SECTION 2.3(a)(b)(B)) or as required in connection with the GMAC Mortgage Loans; (iv) the cost of any "Earnings and Profits" analysis; and (v) any prepayment penalty or fee, or other fees and costs incurred in connection with the prepayment of the Nomura Mortgage Loan. All other costs associated with the transactions contemplated by this Agreement and not paid for as provided above in this SECTION 9.6, including, without limitation, filing fees paid in connection with filings under the HSR Act, Transfer Taxes, title insurance premiums, costs of surveys and environmental reports, any fees or costs paid to obtain the Consent of any Person (whether or not listed in SECTION 6.1(c) of the Disclosure Schedule), and the fees and costs incurred in connection with preparing audited financial statements pursuant to SECTION 3.8(b) of this Agreement, shall be paid one-half by SNH and one-half by CLJ, provided that fees paid to obtain the Consent of any Person (other than the GMAC Fee) including without limitation, any fees paid or costs incurred in connection with the matters set forth in SECTIONS 5.7(f) and 6.3(k), but excluding fees paid by either SNH or CLJ and referred to in SECTION 6.2(b) shall not be incurred by either Party (if included as a fee or cost to be paid under this sentence) without the consent of the other, such consent not to be unreasonably withheld. 9.7. INVESTIGATIONS. The respective representations and warranties of CSL, CLJ and SNH contained in this Agreement or in any Schedule, certificate, or other document delivered by any Party prior to Closing shall not be deemed waived or otherwise affected by any investigation made by a Party. 9.8. NUMBER; GENDER. Whenever the context so requires, the singular number shall include the plural and the plural shall include the singular, and the gender of any pronoun shall include the other genders. 9.9. CAPTIONS. The titles, captions and table of contents contained in this Agreement are inserted in this Agreement only as a matter of convenience and for reference and in no way define, limit, extend or describe the scope of this Agreement or the intent of any provision of this Agreement. Unless otherwise specified to the contrary, all references to Sections are references to Sections of this -46- Agreement and all references to Schedules and Exhibits are references to Schedules and Exhibits to this Agreement. 9.10. AMENDMENTS. To the extent permitted by Law, this Agreement may be amended by a subsequent writing signed by all of the Parties upon the approval of the general partner, board of directors or board of trustees, as the case may be, of each of the Parties. 9.11. INTEGRATION: WAIVER. This Agreement supersedes all negotiations, agreements and understandings among the Parties with respect to the subject matter of this Agreement (except (i) the, Confidentiality Agreement among CLJ, SNH, HPT and HRPT Properties Trust dated December 5, 2000, as amended by a letter dated July 31, 2001 and (ii) by a Confidentiality Agreement dated as of February 20, 2001 between SNH and CLJ, each of which shall continue in full force and effect) and constitutes the entire agreement among the Parties. The failure of any Party at any time or times to require performance of any provisions of this Agreement shall in no manner affect the right to enforce the same. No waiver by any Party of any conditions, or of the breach of any term, provision, warranty, representation, agreement or covenant contained in this Agreement, whether by conduct or otherwise, in any one or more instances shall be deemed or construed as a further or continuing waiver of any such condition or breach of any other term, provision, warranty, representation, agreement or covenant contained in this Agreement. 9.12. GOVERNING LAW. This Agreement is to be construed and enforced in accordance with, and the rights of the parties shall be governed by, the law of the State of Maryland (without giving effect to any laws or rules relating to conflicts of laws that would cause the application of the laws of any jurisdiction other than the State of Maryland). 9.13. CONSENT TO JURISDICTION. To the extent permitted by applicable Law, the Parties absolutely and irrevocably consent and submit to the nonexclusive jurisdiction of the courts of the State of Maryland and of any federal court located in said jurisdiction in connection with any actions or proceedings brought against a Party by any other Party arising out of or relating to the transactions contemplated by this agreement and hereby irrevocably agrees that all claims in respect of any such action or proceeding may be heard and determined in any such court. Each Party hereby waives and agrees not to assert in any such action or proceeding, in each case, to the fullest extent permitted by applicable Law, any claim that (a) it is not personally subject to the jurisdiction of any such court, (b) it is immune from any legal process (whether through service or notice, attachment prior to judgment, attachment in aid of execution, execution or otherwise) with respect to it or its property, or (c) any such suit, action or proceeding is brought in an inconvenient forum in any such action or proceeding. To the fullest extent permitted by applicable Law, each Party hereby absolutely and irrevocably waives trial by jury. -47- 9.14. SEVERABILITY. Any provision of this Agreement which is prohibited or unenforceable in any jurisdiction will, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions of this Agreement, and any such prohibition or unenforceability in any jurisdiction will not invalidate or render unenforceable such provision in any other jurisdiction. To the extent permitted by Law, the Parties waive any provision of law which renders any such provision prohibited or unenforceable in any respect. 9.15. COUNTERPARTS. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original and all of which shall together be considered one and the same agreement, and it shall not be necessary in making proof of this Agreement or the terms of this Agreement to produce or account for more than one of such counterparts. 9.16. SNH LIMITATION OF LIABILITY. The Declaration of Trust of SNH, a copy of which is duly filed with the Department of Assessments and Taxation of the State of Maryland, provides that the name "Senior Housing Properties Trust" refers to the trustees under such Declaration of Trust collectively as trustees, but not individually or personally, and that no trustee, officer, shareholder, employee or agent of SNH shall be held to any personal liability, jointly or severally, for any obligation of, or claim against, SNH. All persons dealing with SNH in any way shall look only to the assets of SNH for the payment of any sum or the performance of any obligation. 9.17. ACQ. SUB LIMITATION OF LIABILITY. The Declaration of Trust of ACQ. SUB, a copy of which is duly filed with the Department of Assessments and Taxation of the State of Maryland, provides that the name "SNH/CSL Properties Trust" refers to the trustees under such Declaration of Trust collectively as trustees, but not individually or personally, and that no trustee, officer, shareholder, employee or agent of ACQ. SUB shall be held to any personal liability, jointly or severally, for any obligation of, or claim against, ACQ. SUB. All persons dealing with ACQ. SUB in any way shall look only to the assets of ACQ. SUB for the payment of any sum or the performance of any obligation 9.18. CLJ LIMITATION OF LIABILITY. No director, officer, shareholder, employee or agent of CLJ shall be held to any personal liability, jointly or severally, for any obligation of, or claim against, CLJ or its Subsidiaries hereunder. All persons dealing with CLJ in any way shall look only to the assets of CLJ for the payment of any sum or the performance of any obligation. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] -48- EXECUTED under seal as of the date first above written. SENIOR HOUSING PROPERTIES TRUST By: /s/ David J. Hegarty -------------------------------------------------- Name: David J. Hegarty Title: President SNH/CSL PROPERTIES TRUST By: /s/ David J. Hegarty -------------------------------------------------- Name: David J. Hegarty Title: President -49- CSL GROUP, INC. By: /s/ James L. Francis -------------------------------------------------- Name: James L. Francis Title: President CRESTLINE CAPITAL CORPORATION By: /s/ Bruce D. Wardinski -------------------------------------------------- Name: Bruce D. Wardinski Title: Chief Executive Officer and President -50- EXHIBIT A COMMUNITIES
-------------------------------------------------------------------- PROPERTY STATE -------------------------------------------------------------------- 1 Forum at Memorial Woods Texas -------------------------------------------------------------------- 2 Forum at Tucson Arizona -------------------------------------------------------------------- 3 Forum at Brookside Kentucky -------------------------------------------------------------------- 4 Forum at Overland Park Kansas -------------------------------------------------------------------- 5 Forum at Desert Harbor Arizona -------------------------------------------------------------------- 6 Forum at Park Lane Texas -------------------------------------------------------------------- 7 Forum at Deer Creek Florida -------------------------------------------------------------------- 8 Foulk Manor South Delaware -------------------------------------------------------------------- 9 Tiffany House Florida -------------------------------------------------------------------- 10 Fountainview Florida -------------------------------------------------------------------- 11 Coral Oaks Florida -------------------------------------------------------------------- 12 Springwood Court Florida -------------------------------------------------------------------- 13 Lafayette at Country Place Kentucky -------------------------------------------------------------------- 14 Lexington at Country Place Kentucky -------------------------------------------------------------------- 15 The Forum at Knightsbridge Ohio -------------------------------------------------------------------- 16 The Forum at Pueblo Norte Arizona -------------------------------------------------------------------- 17 The Forum at the Crossing Indiana -------------------------------------------------------------------- 18 Forwood Manor Delaware -------------------------------------------------------------------- 19 Remington Club I California -------------------------------------------------------------------- 20 Remington Club II California -------------------------------------------------------------------- 21 The Montebello on Academy New Mexico -------------------------------------------------------------------- 22 Foulk Manor North Delaware -------------------------------------------------------------------- 23 Millcroft Delaware -------------------------------------------------------------------- 24 Shipley Manor Delaware -------------------------------------------------------------------- 25 Park Summit at Coral Springs Florida -------------------------------------------------------------------- 26 The Montevista at Coronado Texas -------------------------------------------------------------------- 27 Myrtle Beach Manor South Carolina -------------------------------------------------------------------- 28 The Forum at Lincoln Heights Texas -------------------------------------------------------------------- 29 Leisure Park New Jersey -------------------------------------------------------------------- 30 The Gables at Winchester Massachusetts -------------------------------------------------------------------- 31 Forum at Woodlands Texas -------------------------------------------------------------------- 32 Boynton Beach Florida --------------------------------------------------------------------
EXHIBIT B ESCROW AGREEMENT THIS ESCROW AGREEMENT (this "Escrow Agreement") is made as of August 9, 2001 by and among Senior Properties Housing Trust ("SNH"), Crestline Capital Corporation ("CLJ"), and American Title Company (the "Escrow Agent"). R E C I T A L: SNH and CLJ have entered into a Stock Purchase Agreement (the "Agreement") dated as of August 9, 2001, an executed copy of which has been provided to the Escrow Agent, pursuant to which, INTER ALIA, SNH/CLS Properties Trust will acquire certain assets of CLJ on the terms and conditions set forth in the Agreement. Pursuant to the Agreement, SNH has agreed to deposit $7,500,000 into escrow upon execution of this Escrow Agreement subject to the terms and conditions set forth in the Agreement and in this Escrow Agreement. NOW, THEREFORE, the parties agree as follows: SECTION 1. DEFINED TERMS. Terms not otherwise defined herein shall have the respective meanings prescribed therefor in the Agreement. The following terms are defined in this Escrow Agreement: "Bank" is Bank One, N.A.. "Escrow Fund" is defined in Section 3 of this Escrow Agreement. SECTION 2. APPOINTMENT OF ESCROW AGENT. SNH and CLJ hereby appoint the Escrow Agent as the escrow agent to hold the Escrow Fund in accordance with the terms and conditions of this Escrow Agreement. SECTION 3. DELIVERY AND RECEIPT OF FUNDS. Simultaneously with the execution of this Escrow Agreement, SNH shall deliver to the Escrow Agent the sum of $7,500,000 in immediately available funds by wire transfer. The Escrow Agent shall open an escrow account in the name of the Escrow Agent at the Bank and shall deposit into such account such immediately available funds. The amount so deposited, including accrued interest thereon, is referred to as the "Escrow Fund." Receipt of the Escrow Fund from SNH is hereby acknowledged by the Escrow Agent. SECTION 4. INVESTMENT OF ESCROW FUND. Until distributed and released in accordance with the terms and conditions of this Escrow Agreement, the Escrow Agent shall invest the Escrow Fund in a so-called "money market" deposit fund with the Bank or in such other liquid, investment grade securities as may be specified in writing by SNH and CLJ (CLJ's consent to SNH's choice of investment shall not be unreasonably withheld). The parties must furnish any form W-9 and any authorization to invest required by Bank. SECTION 5. RELEASE OF ESCROW FUND. (a) Upon receipt of joint written notice from SNH and CLJ, Escrow Agent shall release all or such portion of the Escrow Fund as directed in such notice. (b) Upon receipt of written notice from SNH that the Agreement has been terminated pursuant to Section 8.1 of the Agreement and not pursuant to Section 8.2(f) of the Agreement, the Escrow Agent shall distribute and release the Escrow Fund to SNH in accordance with wire transfer information contained in the notice. (c) Upon receipt of written notice from CLJ that the Agreement has been terminated pursuant to Section 8.2(f) of the Agreement, the Escrow Agent shall distribute and release the Escrow Fund to CLJ in accordance with wire transfer information contained in the notice. (d) Upon receipt of written notice from SNH directing Escrow Agent to release all or a portion of the Escrow Fund to CLJ, Escrow Agent shall release all or such portion of the Escrow Fund to CLJ as so directed. Any notice given pursuant to this Section 5 shall contain a certification by the sending party that a copy of such notice has been concurrently sent to the other party. On the later of the second business day (by 2:00 PM, Eastern Standard Time) after receipt of the notice from the sending party or the date specified in the notice, provided that the Escrow Agent shall not have received a contrary instruction (by 2:00 PM, Eastern Standard Time on the later of the second business day after receipt of the notice from the sending party or the date specified in the notice) from the other party, the Escrow Agent shall deliver the Escrow Fund to the party so specified. If the Escrow Agent has received such a contrary instruction, it shall release the Escrow Fund only pursuant to a joint direction in writing of SNH and CLJ or pursuant to the decision of a court of competent jurisdiction. Upon distribution and release of the Escrow Fund, this Escrow Agreement shall be deemed terminated and the Escrow Agent shall be released and discharged from all further obligations hereunder. SECTION 6. DUTIES OF ESCROW AGENT. The acceptance by the Escrow Agent of its duties as such under this Escrow Agreement is subject to the following terms and conditions, which SNH and CLJ hereby agree shall govern and control with respect to the rights, duties, liabilities and immunities of the Escrow Agent: (a) The Escrow Agent acts hereunder as a depositary only, and is not responsible or liable in any manner whatever for any investment made pursuant to the provisions of Section 4 or any failure, refusal or inability of the Bank to release or make payment pursuant to the Escrow Agent's direction of said Escrow Fund, including by reason of insolvency or bankruptcy of the Bank. -2- (b) The Escrow Agent shall not be liable for acting upon any written notice, request, waiver, consent, receipt or other instrument or document which the Escrow Agent in good faith believes to be genuine and what it purports to be. (c) It is understood and agreed that the duties of the Escrow Agent hereunder are purely ministerial in nature and that it shall not be liable for any error of judgment, fact or law, or any act done or omitted to be done, except for its own willful misconduct, breach of fiduciary duty, bad faith or gross negligence or that of its officers, directors, employees and agents. The Escrow Agent's determination as to whether an event or condition has occurred, or been met or satisfied, or as to whether a provision of this Escrow Agreement has been complied with, or as to whether sufficient evidence of the event or condition or compliance with the provision has been furnished to it, shall not subject the Escrow Agent to any claim, liability or obligation whatsoever, even if it shall be found that such determination was improper and incorrect, provided, only, that the Escrow Agent and its officers, directors, employees and agents shall not have been guilty of willful misconduct, breach of fiduciary duty, bad faith or gross negligence in making such determination. (d) The Escrow Agent may consult with, and obtain advice from, legal counsel including its own officers, employees and partners in the event of any dispute or question as to the construction of any of the provisions hereof or its duties hereunder, and it shall incur no liability and shall be fully protected in acting in good faith in accordance with the opinion and instructions of such counsel. (e) In the event of any disagreement or lack of agreement between SNH and CLJ of which the Escrow Agent has knowledge, resulting or which might result in adverse claims or demands with respect to the Escrow Fund, the Escrow Agent shall be entitled, in its sole discretion, to refuse to comply with any claims or demands on it with respect thereto until such matter shall be resolved, and in so refusing, the Escrow Agent may elect to make no delivery or other disposition of the Escrow Fund, and in so doing the Escrow Agent shall not be or become liable in any way to either SNH or CLJ for its failure or refusal to comply with such claims or demands, and it shall be entitled to continue so to refrain from acting, and so to refuse to act, until all such claims or demands (i) shall have been finally determined by a court of competent jurisdiction, or (ii) shall have been resolved by the agreement of SNH and CLJ and the Escrow Agent shall have been notified thereof in writing. (f) The Escrow Agent may resign at any time upon giving ten (10) days' notice to SNH and CLJ and may appoint a successor escrow agent hereunder so long as such successor shall accept and agree to be bound by the terms of this Escrow Agreement and shall be acceptable to SNH and CLJ. It is understood and agreed that the Escrow Agent's resignation shall not be effective until a successor escrow agent agrees to be bound by the terms of this Escrow Agreement. SECTION 7. NO REPRESENTATIONS BY ESCROW AGENT. The Escrow Agent makes no representation as to the validity, value, genuineness, negotiability or collectibility of any security or other document or instrument held by or delivered to or by it. -3- SECTION 8. OBLIGATIONS OF ESCROW AGENT. The Escrow Agent shall be under no obligation to institute or defend any actions, suits or legal proceedings in connection herewith or take any other action likely to involve it in expense unless first indemnified to its reasonable satisfaction. SECTION 9. EXPENSES. The reasonable out-of-pocket expenses (including, without limitation, reasonable legal fees and disbursements) incurred by the Escrow Agent in the performance of its duties hereunder shall be reimbursed one-half by CLJ and one-half by SNH. Such reimbursement for out-of-pocket expenses shall be made by cash payment to the Escrow Agent from time to time upon its written request. The Escrow Agent shall have no right or lien with respect to the Escrow Fund for payment of such expenses. Except as otherwise herein or in the Agreement provided, each party shall pay its own expenses incident to the performance or enforcement of this Escrow Agreement, including all fees and expenses of its counsel for all activities of such counsel undertaken pursuant to this Escrow Agreement. All parties recognize that the cost to enforce or defend by Escrow Agent could be significant since the venue is Maryland and they agree to pay all costs that the Escrow Agent may so incur, including reasonable attorney's fees. SECTION 10. [Intentionally Omitted]. SECTION 11. ASSIGNMENT; SUCCESSORS AND ASSIGNS. This Escrow Agreement shall not be assignable by SNH or CLJ without the prior written consent of the other. Nothing in this Escrow Agreement expressed or implied is intended to or shall be construed to confer upon or create in any Person (other than the parties hereto and their permitted successors and assigns) any rights or remedies under or by reason of this Agreement, including without limitation any rights to enforce this Escrow Agreement. SECTION 12. SPECIFIC PERFORMANCE; OTHER RIGHTS AND REMEDIES. Each party recognizes and agrees that the other party's remedy at law for any breach of the provisions of this Escrow Agreement would be inadequate and agrees that for breach of such provisions, such party shall, in addition to such other remedies as may be available to it at law or in equity or as provided in this Escrow Agreement, be entitled to injunctive relief and to enforce its rights by an action for specific performance to the extent permitted by applicable law. Each party hereby waives any requirement for security or the posting of any bond or other surety in connection with any temporary or permanent award of injunctive, mandatory or other equitable relief. Nothing herein contained shall be construed as prohibiting either party from pursuing any other remedies available to it for such breach or threatened breach, including without limitation the recovery of damages. SECTION 13 ENTIRE AGREEMENT. This Escrow Agreement constitutes the entire agreement between the parties with respect to the subject matter hereof and supersedes all prior agreements, arrangements, covenants, promises, conditions, understandings, inducements, representations and negotiations, expressed or implied, oral or written, between them as to such subject matter. SECTION 14. WAIVERS; AMENDMENTS. Anything in this Escrow Agreement to the contrary notwithstanding, amendments to and modifications of this Escrow Agreement may be made, required consents and approvals may be granted, compliance with any term, covenant, -4- agreement, condition or other provision set forth herein may be omitted or waived, either generally or in a particular instance and either retroactively or prospectively with, but only with, the written consent of the party entitled to the benefit thereof. SECTION 15. NOTICES. All notices and other communications which by any provision of this Escrow Agreement are required or permitted to be given shall be given in writing and shall be (a) sent by nationally recognized overnight courier service, (b) sent by facsimile confirmed by sending (by nationally recognized overnight courier service) written confirmation at substantially the same time, or (c) personally delivered to the receiving party. All such notices and communications shall be mailed, sent or delivered as follows: If to SNH, at: Senior Housing Properties Trust 400 Centre Street Newton, Massachusetts 02458 Attention: David J. Hegarty, President Facsimile: 617-796-8349 with a copy to (which shall not constitute notice): Sullivan & Worcester LLP One Post Office Square Boston, Massachusetts 02109 Attention: Richard Teller Facsimile: 617-338-2880 If to CLJ, at: c/o Crestline Capital Corporation. 6600 Rockledge Drive, Suite 600 Bethesda, Maryland 20817 Attn: Tracy M. J. Colden, Senior Vice President and General Counsel Facsimile: (240) 694-2040 with a copy to (which shall not constitute notice): c/o Crestline Capital Corporation. 6600 Rockledge Drive, Suite 600 Bethesda, Maryland 20817 Attn: Larry K. Harvey, Senior Vice President and Treasurer Facsimile: (240) 694-2286 -5- with a copy to (which shall not constitute notice): American Title Company (escrow agent) 6029 Belt Line Road Suite 250 Dallas, Texas 75254 Attn: Carole Badgett, Senior Vice President Facsimile (972) 789-8029 or to such other person(s) or facsimile number(s) or address(es) as the party to receive any such communication or notice may have designated by written notice to the other party. SECTION 16. SEVERABILITY. If any provision of this Escrow Agreement shall be held or deemed to be, or shall in fact be, invalid, inoperative, illegal or unenforceable as applied to any particular case in any jurisdiction or jurisdictions, or in all jurisdictions or in all cases, because of the conflicting of any provision with any constitution or statute or rule of public policy or for any other reason, such circumstance shall not have the effect of rendering the provision or provisions in question invalid, inoperative, illegal or unenforceable in any other jurisdiction or in any other case or circumstance or of rendering any other provision or provisions herein contained invalid, inoperative, illegal or unenforceable to the extent that such other provisions are not themselves actually in conflict with such constitution, statute or rule of public policy, but this Escrow Agreement shall be reformed and construed in any such jurisdiction or case as if such invalid, inoperative, illegal or unenforceable provision had never been contained herein and such provision reformed so that it would be valid, operative and enforceable to the maximum extent permitted in such jurisdiction or in such case. SECTION 17. COUNTERPARTS. This Escrow Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument, binding upon all the parties hereto. In pleading or proving any provision of this Escrow Agreement, it shall not be necessary to produce more than one of such counterparts. SECTION 18. SECTION HEADINGS. The headings contained in this Escrow Agreement are for reference purposes only and shall not in any way affect the meaning or interpretation of this Escrow Agreement. SECTION 19. GOVERNING LAW. This Escrow Agreement is to be construed and enforced in accordance with, and the rights of the parties shall be governed by, the laws of the State of Maryland (without giving effect to any laws or rules relating to conflicts of laws that would cause the application of the laws of any jurisdiction other than the State of Maryland). SECTION 20. CONSENT TO JURISDICTION. To the extent permitted by applicable law, the parties absolutely and irrevocably consent and submit to the nonexclusive jurisdiction of the courts of the State of Maryland and of any federal court located in said jurisdiction in connection with any actions or proceedings brought against a party by any other party arising out of or relating to this escrow agreement and hereby irrevocably agree that all claims in respect of any such action or proceeding may be heard and determined in any such court. Each party hereby waives and agrees not to assert in any such action or proceeding, in each case, to the fullest -6- extent permitted by applicable law, any claim that (a) it is not personally subject to the jurisdiction of any such court, (b) it is immune from any legal process (whether through service or notice, attachment prior to judgment, attachment in aid of execution, execution or otherwise) with respect to it or its property, or (c) any such suit, action or proceeding is brought in an inconvenient forum in any such action or proceeding. To the fullest extent permitted by applicable law, each party hereby absolutely and irrevocably waives trial by jury. SECTION 21. LIMITATION OF SNH LIABILITY. The Declaration of Trust of SNH, a copy of which is duly filed with the Department of Assessments and Taxation of the State of Maryland, provides that the name "Senior Housing Properties Trust" refers to the trustees under such Declaration of Trust collectively as trustees, but not individually or personally, and that no trustee, officer, shareholder, employee or agent of SNH shall be held to any personal liability, jointly or severally, for any obligation of, or claim against, SNH. All persons dealing with SNH in any way shall look only to the assets of SNH for the payment of any sum or the performance of any obligation. SECTION 22. LIMITATION OF CLJ LIABILITY. No director, officer, shareholder, employee or agent of CLJ shall be held to any personal liability, jointly or severally, for any obligation of, or claim against, CLJ or its Subsidiaries hereunder. All persons dealing with CLJ in any way shall look only to the assets of CLJ for the payment of any sum or the performance of any obligation. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] -7- IN WITNESS WHEREOF, the parties have caused this Agreement to be executed as a sealed instrument as of the date first above written. SENIOR HOUSING PROPERTIES TRUST By: ------------------------------------------------- CRESTLINE CAPITAL CORPORATION By: ------------------------------------------------- AMERICAN TITLE COMPANY, as Escrow Agent By: ------------------------------------------------- -8- EXHIBIT C PROMISSORY NOTE $25,000,000 [Closing Date] FOR VALUE RECEIVED, the undersigned, Senior Housing Properties Trust, a Maryland real estate investment trust ("SNH"), hereby promises to pay to the order of Crestline Capital Corporation, a Maryland corporation ("CLJ"), on or before the earlier of (i) January 31, 2004 and (ii) the date the indebtedness under a Loan Agreement dated as of September 1, 1995 by and among FGI Financing I Corporation, Forum Ohio HealthCare, Inc. and Nomura Asset Capital Corporation is repaid in full (the "Maturity Date"), the principal amount of Twenty-Five Million Dollars ($25,000,000) with interest (computed on the basis of a 360 day year and twelve 30 day months) on the unpaid principal hereof outstanding from time to time at the annual rate of 10% ("Interest"). In addition to all other rights contained in this promissory note (this "Note"), if any Event of Default (as defined herein) occurs and as long as an Event of Default continues, all obligations of SNH under this Note shall bear interest at the annual rate of Interest plus 3% ("Default Rate"). The Default Rate shall also apply from acceleration until the entire obligation or any judgment thereon is paid in full. Payments of principal of and interest on this Note shall be made to CLJ at 6600 Rockledge Drive, Suite 600, Bethesda, Maryland 20817, or to such other address as CLJ may direct by written notice to SNH. Payments of principal of and interest on this Note shall be made in lawful money of the United States of America. This Note will rank not less than pari passu in priority of payment with all other outstanding indebtedness for borrowed money of SNH, present or future, except indebtedness for borrowed money which is preferred as a result of being secured or as a matter of law. 1. PAYMENT. 1.1 PRINCIPAL AND INTEREST PAYMENT. Interest on this Note shall be payable by SNH in arrears in equal installments of ninety days' Interest on the last days of March, June, September and December each year. The principal of this Note shall be paid by SNH in its entirety, together with any interest accrued and unpaid thereon, on the Maturity Date. 1.2 PREPAYMENT. This Note may be prepaid in whole or in part at any time and from time to time without premium or penalty. -1- 1.3 APPLICATION OF PAYMENTS. All payments received on this Note shall be applied in the following order: first, to pay all costs of collection of the holder; then, to pay all accrued and unpaid Interest; and lastly to reduce the outstanding principal balance of the Note. 1.4 LATE CHARGE. If any payments are not timely made, SNH shall also pay a late charge equal to 5% of each payment past due for 15 or more days. 1.5 CERTIFICATE OF BORROWER. If at the time of any payment of Interest SNH does not have public stockholders, then together with such payment, SNH shall provide a certificate from its chief financial officer which states that no Event of Default (as defined below) has occurred. 2. DEFAULT. 2.1 EVENTS OF DEFAULT. If any of the following events (each an "Event of Default") shall have occurred: (a) SNH fails to pay any installment of Interest on this Note when the same shall become due and payable which failure continues for 5 days after notice from CLJ or fails to pay the principal of this Note when and as the same shall become due and payable; (b) SNH defaults in the payment of interest on or the principal of any indebtedness for borrowed money, the outstanding principal amount of which exceeds $10,000,000, beyond any period of grace provided with respect thereto; (c) The dissolution of, termination of existence of, appointment of a receiver for, assignment for the benefit of creditors of, or commencement of any bankruptcy or insolvency proceeding by or against SNH; or (d) The sale of substantially all of the business or assets of SNH or any merger or consolidation of SNH with or into another entity, where the purchaser or surviving entity has a net worth, determined in accordance with generally accepted accounting principles of less than $50,000,000, without the prior written consent of CLJ; then the unpaid balance of the principal of this Note, together with all interest accrued thereon shall become immediately due and payable without presentation, protest or notice of any kind. 2.2 WAIVER BY SNH. To the fullest extent permitted by applicable law, SNH hereby absolutely and irrevocably waives presentment, demand, notice, protest, and all other demands, notices and suretyship defenses generally, in connection with the delivery, acceptance, performance, default or enforcement of or under this Note. 2.3 COSTS AND EXPENSES OF COLLECTION. SNH covenants and agrees that if default be made in any payment of principal of or interest on this Note, it will pay to CLJ, such further amount as shall be sufficient to cover all costs and expenses of collection, including reasonable attorneys' fees. -2- 3. MISCELLANEOUS PROVISIONS. 3.1 GOVERNING LAW. This Note is to be construed and enforced in accordance with, and the rights of SNH and CLJ shall be governed by, the law of the State of Maryland (without giving effect to any laws or rules relating to conflicts of laws that would cause the application of the laws of any jurisdiction other than the State of Maryland). 3.2 NOTICES. All notices, communications and deliveries required or permitted by this Note shall be made in writing signed by the party making the same, shall be effective upon receipt and shall be delivered by telecopy, by hand, by registered or certified mail (return receipt requested) (with postage and other fees prepaid) or by an overnight express delivery service, as follows: To SNH: Senior Housing Properties Trust 400 Centre Street Newton, Massachusetts 02458 Attn: David J. Hegarty, President and Chief Operating Officer Telecopy No.: (617) 796-8349 with a copy to (which shall not constitute notice): Sullivan & Worcester LLP One Post Office Square Boston, Massachusetts 02109 Attn: Richard Teller Telecopy No.: (617) 338-2880 -3- To CLJ: c/o Crestline Capital Corporation 6600 Rockledge Drive, Suite 600 Bethesda, Maryland 20817 Attn: Tracy M. J. Colden, Senior Vice President and General Counsel Telecopy No.: (240) 694-2040 with a copy to (which shall not constitute notice): c/o Crestline Capital Corporation 6600 Rockledge Drive, Suite 600 Bethesda, Maryland 20817 Attn: Larry K. Harvey, Senior Vice President and Treasurer Telecopy No.: (240) 694-2286 or to such other representative or at such other address of a party as such party may furnish to the other party by notice similarly given. 3.3 SNH LIMITATION OF LIABILITY. The Declaration of Trust of SNH, a copy of which is duly filed with the Department of Assessments and Taxation of the State of Maryland, provides that the name "Senior Housing Properties Trust" refers to the trustees under such Declaration of Trust collectively as trustees, but not individually or personally, and that no trustee, officer, shareholder, employee or agent of SNH shall be held to any personal liability, jointly or severally, for any obligation of, or claim against, SNH. All persons dealing with SNH in any way shall look only to the assets of SNH for the payment of any sum or the performance of any obligation. EXECUTED under seal as of the date first above written. SENIOR HOUSING PROPERTIES TRUST By: -------------------------------------------------- -4- EXHIBIT D TAX ALLOCATION AGREEMENT TAX ALLOCATION AGREEMENT, dated as of _________, 2001, among Crestline Capital Corporation, a Maryland corporation, and any successor thereto ("CLJ"), Senior Housing Properties Trust, a Maryland real estate investment trust ("SNH"), CSL Group, Inc., an Indiana corporation, and any successor thereto ("CSL"), and their respective direct and indirect subsidiaries and affiliates. References herein to a "party" (or "parties") to this Agreement shall refer to CLJ, SNH, CSL, and where appropriate and the context so requires, their direct and indirect subsidiaries and affiliates. Any capitalized term not defined herein has the meaning given to it in the Stock Purchase Agreement. WHEREAS, CLJ and its subsidiaries, including CSL and its subsidiaries, have joined in filing consolidated federal Tax Returns and certain consolidated, combined or unitary state, local or foreign Tax Returns; WHEREAS, Host Marriott Corporation, a Delaware corporation ("Host Marriott"), pursuant to a Distribution Agreement dated as of December 28, 1998 (the "Distribution Agreement"), distributed approximately 93.6% of the outstanding common stock in CLJ on a PRO RATA basis to its stockholders (the "Distribution"); WHEREAS, in connection with the Distribution Agreement, Host Marriott and CLJ entered into a Tax Sharing Agreement dated as of December 28, 1998 (the "HM/CLJ Tax Sharing Agreement"), providing for allocations of and indemnifications with respect to certain liabilities for Taxes of Host Marriott and its subsidiaries and of CLJ and its subsidiaries; WHEREAS, in Section 3.(e) of the HM/CLJ Tax Sharing Agreement, CLJ was assigned certain rights arising under a Tax Matters Agreement dated as of June 21, 1997 among Host Marriott, Marriott International, Inc. ("MII"), Marriott Senior Living Services, Inc. ("Services"), HMC Senior Communities, Inc. and Forum Group, Inc. (the "Forum/MI Tax Matters Agreement"); WHEREAS, SNH, CLJ and CSL have entered into that certain Stock Purchase Agreement, dated as of August __, 2001 (the "Stock Purchase Agreement"), pursuant to which SNH through an acquisition subsidiary will acquire 100% of the capital stock of CSL and all of the outstanding equity securities of CCC Boynton Beach, Inc. and of CCC Senior Living Corporation; and WHEREAS, the parties hereto wish to provide for (i) allocations of, and indemnifications against, certain liabilities for Taxes, including Income Taxes and Other Taxes, (ii) the preparation and filing of Tax Returns on a basis consistent with prior practice and the payment of Taxes with respect thereto, and (iii) certain related matters; NOW THEREFORE, in consideration of their mutual promises, the parties hereby agree as follows: 1. DEFINITIONS. When used herein the following terms shall have the following meanings: "Acquired Companies" -- as defined in Section 1.1 of the Stock Purchase Agreement. "Affiliate" -- with respect to any corporation, partnership, limited liability company, business trust or other entity (the "given entity"), (i) each person, corporation, partnership, limited liability company, business trust or other entity that directly or indirectly, through one or more intermediaries, controls, is controlled by, or is under common control with, the given entity, provided that neither Host Marriott nor any subsidiary of Host Marriott shall be -2- considered an Affiliate of any party hereto, (ii) each corporation, partnership, limited liability company, business trust or other entity in which the given entity owns, directly or indirectly, through one or more intermediaries, at least 50% of the value of all outstanding equity interests, (iii) any partnership or limited liability company in which the given entity is the sole general partner or the sole managing member, or (iv) any successor of any of the above. For purposes of this definition, "control" means the possession, directly or indirectly, of (i) 50% or more of the voting power or value of outstanding equity interests, or (ii) the power to direct or cause the direction of the management of an entity, whether by contract or otherwise. "Affiliated Group" -- an affiliated group of corporations within the meaning of Code Section 1504(a) for the Taxable Period or, for purposes of any state, local or foreign income tax matters, any consolidated, combined or unitary group of corporations within the meaning of the corresponding provisions of Tax law for the jurisdiction in question. "CLJ" -- as defined in the preamble to this Agreement. "CLJ Group" -- CLJ and each corporation that joins with CLJ in filing a consolidated federal income tax return for CLJ's Taxable Period that includes the Closing Date. For purposes of this Agreement, the CLJ Group shall exist from the beginning of the day immediately after the Closing Date and shall exclude any Acquired Company with respect to the period after the Closing Date. "CLJ Member" -- a corporation that was immediately before the Transaction a Pre-Closing Member and is a member of the CLJ Group at the beginning of the day immediately after the Closing Date. -3- "CLJ Party" -- CLJ, each CLJ Member, and each Affiliate of CLJ or of a CLJ Member, where affiliation is determined after the Closing Date. "Closing Date" -- the date on which the Transaction closes, as defined in the Stock Purchase Agreement. "Code" -- the Internal Revenue Code of 1986, as amended, or any successor thereto, as in effect for the Taxable Year in question. "Combined Jurisdiction" -- for any Taxable Period, any state, local or foreign jurisdiction in which CLJ or a CLJ Affiliate (other than an Acquired Company) is included in a consolidated, combined, unitary or similar return with any Acquired Company for state, local or foreign Tax purposes. "CSL" -- as defined in the preamble to this Agreement. "Distribution" -- as defined in the preamble to this Agreement. "Distribution Agreement" -- as defined in the preamble to this Agreement. "Final Determination" -- (i) a decision, judgment, decree, or other order by a court of competent jurisdiction, which has become final and unappealable; (ii) a closing agreement or accepted offer in compromise under Code Sections 7121 or 7122, or comparable agreements under the laws of other jurisdictions; (iii) any other final settlement with the IRS or other Taxing Authority; (iv) the receipt of any refund; or (v) the expiration of an applicable statute of limitations. "Forum/MI Tax Matters Agreement" - as defined in the preamble to this Agreement. "Forum Tax Information" - as defined in the HM/CLJ Tax Sharing Agreement. -4- "HM/CLJ Tax Sharing Agreement" - as defined in the preamble to this Agreement. "Host Marriott" - as defined in the preamble to this Agreement. "Host Marriott Entity" or "Host Marriott Entities" - each or all of Host Marriott and every Affiliate of Host Marriott immediately prior to the Distribution. "Host Marriott Taxes" - any Taxes imposed upon or with respect to any Host Marriott Entity (including Taxes so imposed under the terms of the Forum/MI Tax Matters Agreement) for any Pre-Closing Taxable Period ending before, on or including the Distribution Date, excluding all Taxes allocable to CLJ or any of its Affiliates (including the Acquired Companies) under the terms of the HM/CLJ Tax Sharing Agreement. "Host Marriott Tax Information" - any information relating or pertaining to any Host Marriott Entity for any Pre-Closing Taxable Period ending before, on or including the Distribution Date, but excluding (i) any such information in the possession of CLJ, or in the possession of any Affiliate controlled by CLJ, or in the possession of any of the Acquired Companies, on or before the Closing Date, and (ii) any such information that is in, or may come into, the possession of CLJ or any then Affiliate of CLJ at any time after the Closing Date. "Host Marriott Tax Return(s)" - any Tax Returns required to be filed by or with respect to any Host Marriott Entity for any Pre-Closing Taxable Period ending before, on or including the Distribution Date, excluding all Tax Returns which CLJ is responsible for preparing or filing under the terms of the HM/CLJ Tax Sharing Agreement. "Income Tax(es)" -- with respect to any entity, any and all Taxes based upon or measured by net income, gross income, gross receipts or alternative minimum taxable income, regardless of whether denominated an "income tax," a "franchise tax," or otherwise, imposed by any -5- Taxing Authority, whether any such tax is imposed directly or through withholding or otherwise, together with any interest thereon and any related penalty, addition to tax or additional amount. "Income Tax Attribute" - any deduction, loss, adjustment, or other tax item or attribute, other than an Income Tax Credit, that can be used by a taxpayer to reduce its taxable income for purposes of determining its Income Tax liability (assuming for these purposes that the taxpayer has sufficient taxable income to fully utilize the deduction, loss or other tax attribute). "Income Tax Credit" - any credit, including without limitation any investment tax credit, foreign tax credit, targeted jobs credit, research and development credit, alternative minimum tax credit, or other credit, that can be used by a taxpayer to reduce its Income Tax liability (assuming for these purposes that the taxpayer has sufficient liability for Income Taxes to fully utilize the credits). "Information Return(s)" -- with respect to any entity, any and all reports, returns, declarations or other filings (other than Tax Returns) required to be supplied to any Tax Authority. "IRS" -- the United States Internal Revenue Service. "MII" - as defined in the preamble to this Agreement. "Other Tax(es)" -- with respect to any entity, any license, business privilege, payroll, employment, excise, severance, stamp, occupation, premium, windfall profits, environmental (including under Code Section 59A), customs duties, franchise, social security, unemployment, disability, real property, personal property, intangibles, sales, use, transfer, registration, value added, add-on minimum, or other tax of any kind whatsoever, whether any such tax is imposed directly or through withholding or otherwise, together with any interest thereon and any related -6- penalty, addition to tax or additional amount, provided, however, that the term "Other Tax(es)" shall not include Income Tax(es) and shall not include Transfer Taxes the responsibility for which is allocated in Section 9.6 of the Stock Purchase Agreement. "Overdue Rate" -- a rate of interest per annum that equals the prime rate, as reported in the Wall Street Journal for the period in which the Overdue Rate is applicable, plus 2.00%. "Post-Closing Straddle Period" -- with respect to any party's Straddle Period, the period beginning on the day immediately after the Closing Date and ending on the last day of the party's Taxable Year in which the Closing Date occurs. "Post-Closing Taxable Period" -- a party's Taxable Year that begins on or after the day immediately after the Closing Date. "Pre-Closing Affiliate" -- any Affiliate of any Pre-Closing Member, where affiliation is determined for all periods before the Closing Date. "Pre-Closing Group" -- CLJ and each corporation (including any Acquired Company) that joins with CLJ in filing a consolidated federal income tax return for CLJ's Taxable Period that includes the Closing Date. For purposes of this Agreement, the Pre-Closing Group shall terminate at the close of business on the Closing Date (except as otherwise provided in this Agreement). "Pre-Closing Member" -- a corporation (including any Acquired Company) that was a member of the Pre-Closing Group. "Pre-Closing Straddle Period" -- with respect to any party's Straddle Period, the period beginning on the first day of such Taxable Year and ending on the close of business on the Closing Date. -7- "Pre-Closing Taxable Period" -- a party's Taxable Year that ends at or before the close of business on the Closing Date. "Representative" -- with respect to any person or entity, any of such person's or entity's directors, officers, employees, agents, consultants, accountants, attorneys and other advisors. "Services" - as defined in the preamble to this Agreement. "SNH Party" -- SNH and any Affiliate of SNH, where affiliation is determined after the Closing Date. "Stock Purchase Agreement" -- as defined in the preamble to this Agreement. "Straddle Period" -- any party's Taxable Year beginning before and ending after the close of business on the Closing Date. "Tax(es)" -- collectively, Income Tax(es) and Other Tax(es). "Taxable Period" -- a party's Pre-Closing Taxable Period, Post-Closing Taxable Period or Straddle Period. "Taxable Year" -- a party's taxable year (which may be shorter than a full calendar or fiscal year), year of assessment or similar period with respect to which any Tax may be imposed. "Tax Benefit(s)" -- (i) in the case of an Income Tax Attribute, the sum of (a) the amount of the Income Tax Attribute multiplied by the sum of (x) if the Income Tax Attribute relates to a federal income Tax Return, the highest federal corporate Income Tax rate, and if the Income Tax Attribute does not relate to a federal income Tax Return, zero, and (y) highest applicable state corporate Income Tax rate, and (b) any interest received with respect to any related Tax refund or otherwise credited to the party that used the Income Tax Attribute; (ii) in the case of an -8- Income Tax Credit, 100% of the amount of the Income Tax Credit, plus any interest received with respect to any related Tax refund or otherwise credited to the party that used the Income Tax Credit; and (iii) in the case of any Other Tax, the amount by which the Tax liability of a corporation or other entity is actually reduced for any Taxable Period, plus any interest received with respect to any related Tax refund or otherwise credited to such corporation or entity. "Taxing Authority" -- the IRS and any other domestic or foreign governmental authority responsible for the administration of any Tax. "Tax Practices" -- the most recently applied policies, procedures and practices employed by CLJ or the Pre-Closing Group in the preparation and filing of, and positions taken on, any Tax Returns of CLJ or any Pre-Closing Member or Pre-Closing Affiliate for any Pre-Closing Taxable Period. "Tax Return(s)" -- all returns, reports, estimates, information statements, declarations and other filings relating to, or required to be filed with a Taxing Authority in connection with, the payments or refund of any Tax for any Taxable Period. "Transaction" -- the transactions contemplated by the Stock Purchase Agreement to occur at Closing. "Transfer Taxes" -- as defined in Section 1.1 of the Stock Purchase Agreement. 2. OBLIGATIONS, RESPONSIBILITIES AND RIGHTS OF CLJ, CSL AND SNH. (a) Preparation and Filing of Tax Returns (i) BY CLJ. Except for any Host Marriott Tax Return(s), CLJ shall prepare and timely file (or cause to be prepared and timely filed): -9- (A) all Tax Returns and Information Returns of the Pre-Closing Group, any Pre-Closing Member and any Pre-Closing Affiliate that are required to be filed on or before the Closing Date; (B) all Tax Returns and Information Returns of the Pre-Closing Group, any Pre-Closing Member and any Pre-Closing Affiliate for Pre-Closing Taxable Periods of the Acquired Companies that are not required to be filed on or before the Closing Date including, without limitation, CLJ's consolidated federal Income Tax Return for its Taxable Year that includes the Closing Date; (C) except as provided in Section 2(a)(ii)(A), all Tax Returns and Information Returns of the Pre-Closing Group, any Pre-Closing Member and any Pre-Closing Affiliate for Taxable Years of the Acquired Companies that include any Pre-Closing Straddle Periods; (D) except as provided in Section 2(a)(ii)(A), all state and local Tax Returns and state and local Information Returns of the Pre-Closing Group, any Pre-Closing Member and any Pre-Closing Affiliate for Straddle Periods of the Acquired Companies (for these purposes, the Pre-Closing Group shall be deemed to exist for each such Straddle Period and, to the extent not prohibited by applicable law, such state and local Tax Returns and state and local Information Returns shall be filed by treating each such Straddle Period as a single Taxable Year); -10- (E) except as provided in Section 2(a)(ii)(A), all Tax Returns and Information Returns of CLJ, the CLJ Group, any CLJ Member, and any then Affiliate of any CLJ Member for all of their Straddle Periods and all of their Post-Closing Taxable Periods; and (F) all Tax Returns and Information Returns not otherwise required to be filed by CLJ pursuant to paragraphs (A), (B), (C), (D) or (E) of this Section 2(a)(i) or by SNH pursuant to Section 2(a)(ii). (ii) BY SNH. SNH shall prepare and timely file or shall cause to be prepared and timely filed: (A) all Tax Returns and Information Returns of the SNH Parties for all Straddle Periods of the Acquired Companies except in any case that a jurisdiction requires or permits the filing of a Tax Return or Information Return for a Straddle Period of the Acquired Company that includes both one or more SNH Parties and one or more CLJ Parties, unless SNH has notified CLJ at least ninety (90) days before the initial due date of such return that SNH will file such Tax Return or Information Return, which notification, in the case of a Tax Return or Information Return the inclusion in which of any CLJ Party is permitted but not required, shall specify whether SNH will include any such CLJ Party in such return. -11- (B) any federal Income Tax Return reporting income of any Acquired Company for its Post-Closing Taxable Period beginning on the first day immediately following the Closing Date; (C) all other Tax Returns and Information Returns for the SNH Parties for any of their Post-Closing Taxable Periods beginning on the first day immediately following the Closing Date; and (D) all Tax Returns and Information Returns of the SNH Parties for any of their Post-Closing Taxable Periods (including without limitation the Post-Closing Taxable Periods described in Sections 2(a)(ii)(B) and (C), above). (b) PROVISION OF FILING INFORMATION. With respect to any matter directly related to any Acquired Company, or any Tax Return or Information Return that is to be filed by any SNH Party or CLJ Party, each party to this Agreement shall cooperate and assist the other party in connection with the preparation and filing of all Tax Returns and Information Returns that are required to be filed by a specified party pursuant to Section 2(a), including providing the party required to file such Tax Returns and Information Returns with (i) all necessary filing information in a manner consistent with past Tax Practices (whether or not a Tax Return or Information Return has previously been filed with respect to any Acquired Company) and (ii) all other information reasonably requested in connection with the preparation of such Tax Returns and Information Returns by the party responsible for preparing and filing such returns, in each case promptly after such request (which shall be within fourteen (14) days after such request or, if not -12- within such fourteen-day period, as soon as possible thereafter using all commercially reasonable efforts) and to the extent such information is in the possession of the party from which it is requested or can be obtained by the party for which it is requested with commercially reasonable efforts by that party. CLJ and SNH agree that (a) within 60 days after the Closing Date, CLJ shall provide SNH with all records, schedules, data, work product and other information then in the possession of CLJ (or any Affiliate of CLJ) that represent work done as of such date relating to the preparation of consolidated tax basis balance sheets for the Acquired Companies as of the Closing Date, (b) from and after 60 days after the Closing Date, CLJ shall provide SNH, within 14 days after SNH's request, any information in the possession of CLJ or its Affiliates reasonably deemed necessary by SNH (or SNH's Representative) to complete such consolidated tax basis balance sheets, and (c) CLJ shall assist, and cooperate with, SNH (or SNH's Representative) during the preparation of such consolidated tax basis balance sheets. Notwithstanding anything in this Section 2(b) to the contrary, CLJ shall not have any responsibility to provide to any SNH Party any Host Marriott Tax Information or Forum Tax Information, which information the SNH Parties shall seek directly from Host Marriott to the extent provided for in the Host Marriott Tax Matters Agreement (or from MII and Services pursuant to the Forum/MI Tax Matters Agreement), provided, however, that at SNH's written request, CLJ agrees to cooperate in good faith with the SNH Parties in their efforts to obtain such Host Marriott Tax Information (or Forum Tax Information) pursuant to the -13- terms of the HM/CLJ Tax Sharing Agreement and/or the Forum/MI Tax Matters Agreement. (c) TAXABLE YEAR. SNH and CLJ agree that, for all Tax purposes, (i) for the Pre-Closing Taxable Period of each Acquired Company that ends at the close of business on the Closing Date and for any other Pre-Closing Taxable Periods of each Acquired Company commencing after the Distribution Date, each Acquired Company shall be included in the consolidated federal Income Tax Return of the Pre-Closing Group for the Taxable Year that includes such Pre-Closing Taxable Period, subject to the "next day" rule set forth in Treas. Reg. Sec. 1.1502-76(b)(1)(ii)(B) (and, to the extent permitted by law and Section 2(a) hereof, in all corresponding consolidated, combined or unitary state or other Income Tax Returns of the Pre-Closing Group, to the extent the Pre-Closing Group (or a portion of such group) previously filed or elected to file such consolidated, combined or unitary state or other Income Tax Returns) and (ii) each Acquired Company shall either begin a new Taxable Year for purposes of such federal income and, to the extent permitted by law, state or other Taxes, on the day immediately after the Closing Date or, in any such case, beginning on such day as such Acquired Company or its income shall be included in a Tax Return of SNH. The parties further agree that, to the extent permitted by applicable law, all federal, state or other Tax Returns (including Income Tax Returns and Other Tax Returns) and all Information Returns shall be filed consistently with this position; provided, however, that with respect to any Acquired Company that was taxed as a partnership for federal tax purposes, solely for purposes of determining the -14- Taxable Period to which the Acquired Company's items of income, deduction, expense, loss, credit or other tax attributes are to be allocated, any Acquired Company that owns an interest in such Acquired Company shall be treated as selling or exchanging its entire interest in such Acquired Company immediately before the Closing and acquiring such interest at the beginning of the day immediately following the Closing Date, under the principles set forth in Treas. Reg. Sec. 1.1502-76(b)(2)(vi). (d) STRADDLE PERIOD TAXES. (i) For purposes of this Agreement, pursuant to Sections 2(a)(ii)(B) and 2(c), federal Income Taxes for SNH and any Acquired Company will not be reported in any Straddle Period or allocated pursuant to this Section 2(d). (ii) For purposes of this Agreement, Taxes of an Acquired Company (other than federal Income Taxes) for any Straddle Period of an Acquired Company shall be allocated between the Pre-Closing Straddle Period and Post-Closing Straddle Period in the following manner: (A) state and local Income Taxes shall be allocated between the Pre-Closing Straddle Period and Post-Closing Straddle Period based on the actual liability for Income Taxes of the Acquired Company after closing the books of the Acquired Company at the close of business on the Closing Date in a manner consistent with the reporting of federal taxable income pursuant to Sections 2(a)(ii)(B) and 2(c), and further taking into account SNH's status as a "real estate investment trust" under the Code and the provisions of Section 856(i) of the Code, and other federal or state and local provisions -15- concerning the Tax status of any SNH Party; and (B) Other Taxes shall be allocated between the Pre-Closing Straddle Period and Post-Closing Straddle Period on the basis of the actual transactions, events or activities (including, if applicable, days elapsed) that give rise to or create liability for such Other Taxes, and based on the periods with respect to which any Other Taxes that are imposed for the privilege of doing business may relate. (iii) SNH shall pay to CLJ, within fourteen (14) days after receipt of an executed Straddle Period Tax Return that has been prepared and filed by or on behalf of CLJ pursuant to Section 2(a)(i), the excess of (A) any amount allocated to any Acquired Company for its Post-Closing Straddle Period (based on the amount of Tax shown on such Tax Return, allocated as provided in Section 2(d)(ii)) plus any amount allocated to all SNH Parties that are not Acquired Companies on such Tax Return over (B) the amount of any estimated taxes previously paid by or on behalf of any SNH Party after the Closing to the relevant Taxing Authority with respect to such Tax with respect to the applicable Taxable Period. CLJ shall pay to SNH, within fourteen (14) days after receipt of an executed Straddle Period Tax Return that has been prepared and filed by or on behalf of SNH pursuant to Section 2(a)(ii), the excess of (A) any amount allocated to any Acquired Company for the Pre-Closing Straddle Period (based on the amount of Tax shown on such Tax Return, allocated as provided in Section 2(d)(ii)) plus any amount allocated to all CLJ Parties on such Tax -16- Return over (B) the amount of any estimated Taxes previously paid by or on behalf of any Pre-Closing Member or Pre-Closing Affiliate to the relevant Taxing Authority with respect to such Tax with respect to the applicable Taxable Period. (e) PAYMENT OF TAXES. CLJ shall pay (i) all Taxes (other than Host Marriott Taxes) shown to be due and payable on all Tax Returns filed by CLJ pursuant to Section 2(a)(i) hereof (except for any Taxes that are allocable to an Acquired Company for its Post-Closing Straddle Period under Section 2(d)(ii) or to an SNH Party that is not an Acquired Company, which Taxes shall be paid by SNH or CSL in the manner set forth in Section 2(d)(iii)), (ii) all Taxes (other than Host Marriott Taxes) that shall thereafter become due and payable with respect to all Tax Returns filed pursuant to Section 2(a)(i) for the applicable Taxable Periods as a result of a Final Determination (except for any Taxes that are allocable to an Acquired Company for its Post-Closing Straddle Period under Section 2(d)(ii) or to an SNH Party that is not an Acquired Company, which Taxes shall be paid by SNH or CSL in the manner set forth in Section 2(d)(iii)), (iii) all Taxes that are allocable to any Acquired Company for its Pre-Closing Straddle Period under Section 2(d)(ii) in the manner set forth in Section 2(d)(iii), and (iv) all Transfer Taxes for which CLJ is responsible under Section 9.6 of the Stock Purchase Agreement. SNH or CSL shall pay (i) all Taxes attributable to all Tax Returns filed by SNH or CSL pursuant to Section 2(a)(ii) hereof (except for any Taxes that are allocable to any Acquired Company for its Pre-Closing Straddle Period under Section 2(d)(ii) or to any CLJ Party, which Taxes shall be paid by CLJ in -17- the manner set forth in Section 2(d)(iii)), including without limitation (a) federal Income Taxes of the SNH Parties for the Acquired Companies' Post-Closing Taxable Period beginning on the first day immediately following the Closing Date as contemplated by Section 2(d)(i) and (b) all other Taxes of the SNH Parties for any of their Post-Closing Taxable Periods beginning on the first day immediately following the Closing Date, (ii) all Taxes that are allocable to any Acquired Company for its Post-Closing Straddle Period under Sections 2(d)(ii) in the manner set forth in Section 2(d)(iii), and (iii) all Transfer Taxes for which SNH is responsible under Section 9.6 of the Stock Purchase Agreement. (f) AMENDMENTS TO TAX RETURNS. No Tax Returns or Information Returns for any Pre-Closing Taxable Period or Straddle Period of any Acquired Company filed by CLJ or SNH may be amended without the consent of CLJ and SNH, which in each case shall not be unreasonably withheld; provided, however, that (i) SNH shall not be considered unreasonable in withholding such consent if such amendment would result in an increase in a Tax liability for which the SNH Parties have responsibility under this Agreement or would cause a material risk that SNH shall fail to qualify as a "real estate investment trust" under the Code (unless CLJ agrees to pay the SNH Parties an amount equal to the amount of such increase or to indemnify the SNH Parties for such failure to qualify, in which case a failure to consent will be considered unreasonable), (ii) CLJ shall not be considered unreasonable in withholding such consent if such amendment would result in an increase in a Tax liability for which CLJ has responsibility under this Agreement (unless SNH or CSL agrees to pay CLJ an amount equal to the amount -18- of such increase, in which case a failure to consent will be considered unreasonable), (iii) CLJ shall not be required to seek the consent of SNH if such amendment would not result in any adjustment to any Income Tax Attributes or Income Tax Credits, would not result in any increase in the Tax liability of any SNH Party for each Post-Closing Straddle Period and Post-Closing Taxable Period, and would not create any material risk that SNH shall fail to qualify as a "real estate investment trust" under the Code. (g) REFUNDS OF TAXES. (i) CLJ shall be entitled to (a) any refund of Taxes and any Tax Benefits realized as a result of a Final Determination with respect to all Tax Returns filed by (or caused to be prepared and filed by) CLJ pursuant to Section 2(a)(i) (except that the SNH Parties shall be entitled to any refund of, or Tax Benefit related to, any Taxes that are allocable to any Acquired Company for its Post-Closing Straddle Period under Section 2(d)(ii) or to any SNH Party that is not an Acquired Company) and (b) any refund of, and any Tax Benefit related to, any Taxes that are allocable to an Acquired Company for its Pre-Closing Straddle Period under Section 2(d)(ii). The SNH Parties shall be entitled to (a) any refund of Taxes and any Tax Benefit realized as a result of a Final Determination with respect to all Tax Returns filed by (or caused to be prepared and filed by) any SNH Party pursuant to Section 2(a)(ii) (except that CLJ shall be entitled to any refund of, or Tax Benefit related to, any Taxes that are allocable to an Acquired Company for its Pre-Closing Straddle Period under Section 2(d)(ii) or to -19- any CLJ Party) and (b) any refund of, and Tax Benefit related to, any Taxes that are allocable to an Acquired Company for its Post-Closing Straddle Period under Sections 2(d)(ii). Refunds attributable to a Tax Return shall be allocated between the Pre-Closing Straddle Period and Post-Closing Straddle Period and among the parties to such Tax Return on a basis consistent with the method used to allocate the Tax liability for such Tax Return under this Agreement. Notwithstanding the above, if and to the extent any refund of Taxes or other Tax Benefit for any Pre-Closing Taxable Period is required to be paid to Host Marriott pursuant to the HM/CLJ Tax Sharing Agreement or otherwise, none of CLJ, SNH or CSL (nor any Affiliate of any of them) shall be entitled to such refund of Tax or Tax Benefit. (ii) If any CLJ Party receives a Tax refund or Tax Benefit to which any SNH Party is entitled pursuant to this Agreement, CLJ shall pay (in accordance with Section 4) the amount of such Tax refund or Tax Benefit (including any interest received thereon) to SNH within fourteen (14) days of the receipt thereof. (iii) If any SNH Party receives a Tax refund or Tax Benefit to which any CLJ Party is entitled pursuant to this Agreement, CSL or SNH shall pay (in accordance with Section 4) the amount of such Tax refund or Tax Benefit (including any interest received thereon) to CLJ within fourteen (14) days of the receipt thereof. -20- (iv) Each party shall bear its own expenses with respect to the determination and receipt of any Tax refund or Tax Benefit under this Section 2(g). In the event any applicable Taxing Authority later seeks to recover or require the return of all or any portion of such a Tax refund, then for purposes of this Agreement (a) the resulting proceedings shall be treated as an effort by the applicable Taxing Authorities to collect Taxes with respect to the Taxable Period to which the Tax refund relates, (b) any such recovery or return shall be treated as the payment of additional Taxes with respect to the applicable Taxable Period, and (c) the responsibility of the parties shall be governed by the provisions of this Agreement that relate to Taxes for the applicable Taxable Period. (h) CARRYBACKS. None of SNH, CSL or CLJ shall file any carryback claim for federal Taxes or state, local or foreign Taxes in a Combined Jurisdiction for any SNH Party into a Pre-Closing Taxable Period without the prior written consent of CLJ and SNH. (i) CERTAIN DISTRIBUTIONS. The dividends or other distributions under Sections 5.8 and 6.3(i) of the Stock Purchase Agreement shall be treated by CLJ and SNH as "distributions" to CLJ for federal income tax purposes under Sections 301, 857(a)(2), and 857(d)(3) of the Code, and under Treasury Regulations 1.1502-13 and 1.1502-33. For federal (and, to the extent allowed under applicable law, state and local) income tax purposes, such dividends or other distributions shall not be treated by CLJ or SNH as part of the Purchase Price as defined under the Stock Purchase Agreement. -21- 3. INDEMNIFICATION. (a) BY CLJ (i) TAXES. CLJ shall indemnify and hold every SNH Party harmless from and against any and all (A) Taxes attributable to all Tax Returns filed (or required to be filed or caused to be prepared and filed) by CLJ pursuant to Section 2(a)(i), other than (i) Taxes that are allocable to an Acquired Company for its Post-Closing Straddle Period or to SNH under Section 2(d), (ii) Transfer Taxes for which SNH is responsible pursuant to Section 9.6 of the Stock Purchase Agreement, and (iii) Taxes for which CLJ is entitled to indemnification under either the HM/CLJ Tax Sharing Agreement or the Forum/MI Tax Matters Agreement and has assigned to SNH its rights to such indemnification (whether pursuant to paragraph (d) of this section or otherwise), (B) Taxes attributable to or arising from the Transaction (other than Transfer Taxes for which SNH is responsible pursuant to Section 9.6 of the Stock Purchase Agreement), and (C) Taxes that are allocable to any CLJ Party under Section 2(d) (other than Transfer Taxes for which SNH is responsible pursuant to Section 9.6 of the Stock Purchase Agreement). (ii) MEMBER LIABILITY. CLJ shall indemnify and hold every SNH Party harmless against each and every liability (a) under Treasury Regulation Section 1.1502-6 or any similar law, rule or regulation administered by any Taxing Authority, for Income Taxes of the Pre-Closing Group and any -22- other Affiliated Group in which any Acquired Company has been a member at any time and (b) for Other Taxes of the Pre-Closing Group, Pre-Closing Members and Pre-Closing Affiliates, provided that CLJ shall not have any liability to any SNH Party under (a) or (b) for any Host Marriott Taxes or Taxes of MII or Services for which CLJ is entitled to indemnification under either the HM/CLJ Tax Sharing Agreement or the Forum Tax Matters Agreement and has assigned to SNH its rights to such indemnification (whether pursuant to paragraph (d) of this section or otherwise). (b) BY SNH AND CSL. CSL and SNH shall jointly and severally indemnify and hold every CLJ Party harmless against (A) any and all Taxes attributable to all Tax Returns filed (or required to be filed or caused to be prepared and filed) by SNH pursuant to Section 2(a)(ii), other than Taxes that are allocable to any Acquired Company for its Pre-Closing Straddle Period or to a CLJ Party under Section 2(d), (B) any Taxes that are allocable to any SNH Party under Section 2(d), and (C) Transfer Taxes for which SNH is responsible pursuant to Section 9.6 of the Stock Purchase Agreement. (c) CERTAIN REIMBURSEMENTS. SNH (or CLJ, as the case may be) shall notify CLJ (or SNH) of any Taxes paid by any SNH Party (or any CLJ Party) which are subject to indemnification under this Section 3. To the extent not otherwise provided in this Section 3, any notification contemplated by this Section 3(c) shall include a detailed calculation (including, if applicable, separate allocations of such Taxes between Pre-Closing Taxable Periods and Post-Closing Taxable Periods and Pre- -23- Closing Straddle Periods and Post-Closing Straddle Periods and supporting work papers) and a brief explanation of the basis for indemnification hereunder. Whenever a notification described in this Section 3(c) is given, the notified party shall pay the amount requested in such notice to the notifying party in accordance with Section 4, but only to the extent that the notified party agrees with such request. To the extent the notified party disagrees with such request, it shall, within thirty (30) days, so notify the notifying party, whereupon the parties shall use their best efforts to resolve any such disagreement. Any payment made after such thirty-day period shall include interest at the Overdue Rate from the date such payment would have been made under Section 4 based upon the original notice given by the notifying party. (d) HM/CLJ TAX SHARING AGREEMENT AND FORUM/MI TAX MATTERS AGREEMENT. CLJ and CSL, on behalf of themselves and their Affiliates (i) represent that CLJ is a party to and entitled to the benefits of, the HM/CLJ Tax Sharing Agreement and is the assignee of Host Marriott and entitled to the benefits of the Forum Tax Matters Agreement; (ii) agree that, with respect to any Post-Closing Taxable Periods of an Acquired Company under this Agreement, CLJ (on behalf of itself and its Affiliates) hereby assigns to SNH its right, title and interest in the Forum Tax Matters Agreement and in the HM/CLJ Tax Sharing Agreement and the right to any and all payments for or with respect to any Host Marriott Taxes or any matter related to or arising out of the filing (or failure to file) of any Host Marriott Tax Return or otherwise related to the HM/CLJ Tax Sharing Agreement or the Forum Tax Matters Agreement to the extent that such rights, obligations and -24- payments relate to the Acquired Companies; (iii) agree that, with respect to Pre-Closing Taxable Periods of the Acquired Companies commencing after the Distribution Date, CLJ shall retain all rights and obligations under, and be entitled to any payments from Host Marriott, MII or Services arising from the HM/CLJ Tax Sharing Agreement or inuring to CLJ under the Forum Tax Matters Agreement; (iv) agree that, with respect to the Straddle Periods of the Acquired Companies, the rights and obligations under, and entitlement to payments from Host Marriott, MII or Services arising from the Host Marriott Tax Matters Agreement or inuring to CLJ under the Forum Tax Matters Agreement shall be allocated between CLJ and SNH in a manner consistent with the allocation and responsibility for the related Taxes with respect to such Straddle Periods under Section 2(d); (v) that with respect to the Pre-Closing Taxable Periods of the Acquired Companies, ending before, on, or including the Distribution Date, CLJ (on behalf of itself and its Affiliates) hereby assigns to SNH its right, title and interest in the Forum Tax Matters Agreement and in the HM/CLJ Tax Sharing Agreement and the right to any and all payments for or with respect to any Host Marriott Taxes or any matter related to or arising out of the filing (or failure to file) of any Host Marriott Tax Return or otherwise related to the HM/CLJ Tax Sharing Agreement or the Forum Tax Matters Agreement; and (vi) agree that notwithstanding any other provision of this Agreement (but in any case preserving the tax representations and indemnifications therefor under the Stock Purchase Agreement as contemplated by Section 7), CLJ shall not in any event have any liability to any SNH Party for any Host Marriott Taxes or for Taxes of MII or -25- Services, or for any matters related to or arising out of the filing (or failure to file) Host Marriott Tax Returns or the provision (or accuracy of) any Host Marriott Tax Information or Forum Tax Information, and that the sole recourse of the SNH Parties with respect to such matters shall be against Host Marriott, MII or Services as and to the extent provided in the HM/CLJ Tax Sharing Agreement or the Forum Tax Matters Agreement. CLJ, SNH and CSL agree to cooperate in good faith in asserting their respective rights, as set forth in this paragraph, against Host Marriott, MII or Services under the HM/CLJ Tax Sharing Agreement and the Forum Tax Matters Agreement. 4. METHOD, TIMING AND CHARACTER OF PAYMENTS REQUIRED BY THIS AGREEMENT. (a) PAYMENT IN IMMEDIATELY AVAILABLE FUNDS; INTEREST. All payments made pursuant to this Agreement shall be made in immediately available funds. Except as otherwise provided herein, any payment not made within fourteen (14) days of when due shall thereafter bear interest at the Overdue Rate from the date such payment was due. (b) CHARACTERIZATION OF PAYMENTS. Any payment (other than interest thereon) made hereunder by a CLJ Party to an SNH Party or by an SNH Party to CLJ shall be treated by all parties for Tax purposes to the extent permitted by law, and for accounting purposes to the extent permitted by generally accepted accounting principles, as a reimbursement and payment for the Tax liability to which such payment relates. -26- 5. TAX RETURNS; COOPERATION; DOCUMENT RETENTION; CONFIDENTIALITY. (a) PROVISION OF COOPERATION, DOCUMENTS AND OTHER INFORMATION. Upon the reasonable request of any party to this Agreement, the parties agree that, with respect to any matter directly related to any SNH Party or any CLJ Party, or any matter directly related to any Affiliate controlled by any SNH Party or any CLJ Party, they shall provide (and shall cause their Affiliates to provide) the requesting party, promptly upon request, with such cooperation and assistance, access to documents, and other information, without charge, as may reasonably be requested by such party in connection with (i) the preparation and filing of any original or amended Tax Return, (ii) the conduct of any audit or other examination or any judicial or administrative proceeding involving Taxes or Tax Returns, or (iii) the verification by a party of an amount payable hereunder to, or receivable hereunder from, another party. Such cooperation and assistance shall include, without limitation: (i) the prompt provision (which shall be within fourteen (14) days after a request or, if not within such fourteen-day period, as soon as possible thereafter using all commercially reasonable efforts) of books, records, Tax Returns, documentation or other information relating to any relevant Tax Return; (ii) the execution of any document that may be necessary or reasonably helpful in connection with the filing of any Tax Return, or in connection with any audit, proceeding, suit or action of the type generally referred to in the preceding sentence, including, without limitation, the execution of powers of attorney and extensions of applicable statutes of limitations, with respect to Tax Returns which any party may be obligated to file (but for which the -27- other party bears full or partial responsibility for Taxes) pursuant to Section 2(a); (iii) the prompt and timely filing of appropriate claims for refund; and (iv) the use of reasonable efforts to obtain any documentation from a governmental authority or a third party that may be necessary or helpful in connection with the foregoing. Each party shall make reasonable efforts to make available its employees and facilities on a mutually convenient basis to facilitate such cooperation. Notwithstanding anything in this Section 5(a) to the contrary, CLJ shall not have any responsibility to provide any SNH Party any Host Marriott Tax Information (or Forum Tax Information), which information the SNH Parties shall seek directly from Host Marriott (or MII and Services) to the extent provided for in the HM/CLJ Tax Sharing Agreement (or in the Forum/MI Tax Matters Agreement), provided, however, that at the written request of an SNH Party, each CLJ Party agrees to cooperate in good faith with the SNH Parties in their effort to obtain such Host Marriott Tax Information (or Forum Tax Information) from Host Marriott (or MII and Services) pursuant to the terms of the Host Marriott Tax Matters Agreement (or the Forum/MI Tax Matters Agreement). (b) RETENTION OF BOOKS AND RECORDS. Each CLJ Party and each SNH Party shall retain or cause to be retained all Tax Returns, and all books, records, schedules, workpapers, and other documents relating thereto, until the expiration of the later of (i) all applicable statutes of limitations (including any waivers or extensions thereof), and (ii) any retention period required by law or pursuant to any record retention agreement. The parties shall notify each other in writing of any waivers, extensions or expirations of applicable statutes of limitations. The parties shall -28- provide written notice of any intended destruction of the documents referred to in this subsection at least fourteen (14) days prior to the date of intended destruction. A party giving such a notification shall not dispose of any of the foregoing materials without first offering to transfer possession thereof to all notified parties. The parties agree that (i) SNH and CSL shall be deemed to own all Tax Returns and Information Returns relating to CSL and any Acquired Company, and all books, records, schedules, workpapers, and other documents relating thereto, and (ii) CLJ shall own all other Tax Returns and Information Returns, and the other related books, records, schedules, workpapers, and other documents relating thereto. Notwithstanding anything in this Section 5(b) to the contrary, none of the foregoing shall apply with respect to any Host Marriott Tax Information (or Forum Tax Information), and the exclusive rights of any SNH Party with respect to the Host Marriott Tax Information (or Forum Tax Information) shall be against Host Marriott (or MII and Services), provided, however, that at the written request of an SNH Party, CLJ agrees to cooperate in good faith with the SNH Parties in their effort to obtain such Host Marriott Tax Information from Host Marriott (or MII and Services) pursuant to the terms of the Host Marriott Tax Matters Agreement (or the Forum/MI Tax Matters Agreement). (c) STATUS AND OTHER INFORMATION REGARDING AUDITS AND LITIGATION. Each party shall use reasonable best efforts to keep the other party advised, as to the status of Tax audits and litigation involving any issue relating to any Taxes, Tax Returns or Tax Benefits subject to indemnification under this Agreement. To the extent relating to any such issue, each party shall promptly furnish the other party copies of any -29- inquiries or requests for information from any Taxing Authority or any other administrative, judicial or other governmental authority, as well as copies of any revenue agent's report or similar report, notice of proposed adjustment or notice of deficiency. (d) CONFIDENTIALITY OF DOCUMENTS AND INFORMATION. Except as required by law or with the prior written consent of the other party, all Tax Returns, documents, schedules, work papers and similar items and all information contained therein, which Tax Returns and other materials are within the scope of this Agreement, shall be kept confidential by the parties hereto and their Representatives, shall not be disclosed to any other person or entity and shall be used only for the purposes provided herein. 6. CONTESTS AND AUDITS. (a) NOTIFICATION OF AUDITS OR DISPUTES. Upon the receipt by a party of notice of any pending or threatened Tax audit or assessment which may affect the liability for Taxes that are subject to indemnification by the other party hereunder, the party receiving notice shall notify the other party in writing within fourteen (14) days of the receipt of such notice. The failure of any party to make such notification to another party shall not affect in any respect the other party's right to indemnification hereunder unless, and only to the extent that, such other party can demonstrate that it was materially prejudiced by such failure. (b) CONTROL AND SETTLEMENT. Except as otherwise provided in this paragraph, each of SNH and CLJ shall have the right and obligation, at its own expense, to control, and to represent the interests of all affected taxpayers in, any Tax audit or -30- administrative, judicial or other proceeding relating, in whole or in part, to any Tax Return or Information Return that is filed by such party under Section 2 (the "Filing Party"), and to employ counsel of its choice, at its own expense; provided, however, that, (a) with respect to such issues that may affect, directly or indirectly, the other party (the "Other Party") or an Affiliate thereof, the Filing Party (i) shall in good faith consult with the Other Party and counsel of the Other Party's choice as to the handling and disposition of such issues and (ii) shall not enter into any settlement that impacts, directly or indirectly, the Other Party or an Affiliate thereof without the prior written consent of the Other Party, which shall not be unreasonably withheld. The Other Party shall deliver to the Filing Party a written response to any written notification by the Filing Party of a proposed settlement within fourteen (14) days of the receipt by the other party of such notification. If the Other Party fails to so respond within such fourteen (14) day period, such Other Party shall be deemed to have consented to the proposed settlement. CLJ shall have no obligation with respect to any proceeding involving any Host Marriott Taxes or Host Marriott Tax Returns, except CLJ may elect to take control of any such proceeding (subject to the other provisions of this subparagraph (b)) to the extent (and only to the extent) that such proceeding involves Taxes for which CLJ is liable under this Agreement. (c) DELIVERY OF POWERS OF ATTORNEY AND OTHER DOCUMENTS. Each party shall execute and deliver to a Filing Party, promptly upon request, powers of attorney authorizing the Filing Party to extend statutes of limitations, receive refunds, negotiate settlements and take such other actions that are reasonably appropriate -31- in the exercise of the Filing Party's control rights pursuant to Section 6(b), and any other documents reasonably necessary to effect the exercising of such control rights, consistent with the Other Party's rights of consultation and consent as set forth in Section 6(b). 7. OTHER AGREEMENTS. To the extent any provision in this Agreement conflicts with any provision of the Stock Purchase Agreement, the parties agree that the provisions of this Agreement shall govern, except (i) as contemplated in the provisions of this Agreement addressing Section 9.6 of the Stock Purchase Agreement, and (ii) the provisions of this Agreement shall not affect the Tax representations and rights resulting from the breach thereof contained in the Stock Purchase Agreement (with the understanding that any amounts actually paid, reimbursed, or indemnified for under this Agreement shall not be the subject of indemnification under the Stock Purchase Agreement to the extent there would be a duplication). 8. MISCELLANEOUS. (a) EFFECTIVENESS. This Agreement shall have no force or effect if the Transaction does not occur. If the Transaction occurs, this Agreement shall be effective from and after the Closing Date and shall survive until the expiration of any applicable statute of limitations (including any waivers and extensions thereof). (b) ENTIRE AGREEMENT. This Agreement contains the entire agreement among the parties hereto with respect to the subject matter hereof. This Agreement terminates and supercedes any and all other sharing or allocation agreements with -32- respect to Taxes in effect at the time of the Transaction that relate to the Pre-Closing Group and the Acquired Companies, but (i) shall not affect any such agreement to the extent applicable only among CLJ Parties, (ii) shall not affect the HM/CLJ Tax Sharing Agreement or the Forum/MI Tax Matters Agreement (which shall remain in effect, except that the rights and responsibilities of CLJ and CSL under the HM/CLJ Tax Sharing Agreement and the Forum/MI Tax Matters Agreement shall be allocated between CLJ and CSL as contemplated by this Agreement), and (iii) shall not affect the tax representations and indemnifications therefor under the Stock Purchase Agreement. (c) GUARANTEES OF PERFORMANCE. CLJ hereby guarantees the complete and prompt performance by each CLJ Party, of all of their obligations and undertakings pursuant to this Agreement. CSL and SNH hereby jointly and severally guarantee the complete and prompt performance by each other and by each SNH Party, of all of their obligations and undertakings pursuant to this Agreement. (d) SEVERABILITY. In case any one or more of the provisions contained in this Agreement should be invalid, illegal or unenforceable, the enforceability of the remaining provisions hereof shall not in any way be affected or impaired thereby. It is hereby stipulated and declared to be the intention of the parties that they would have executed the remaining terms, provisions, covenants and restrictions hereof without including any of such which may hereafter be declared invalid, void or unenforceable. In the event that any such term, provision, covenant or restriction is hereafter held to be invalid, void or unenforceable, the parties hereto agree to use their best efforts to find and employ an alternate means to achieve the -33- same or substantially the same result as that contemplated by such term, provision, covenant or restriction. (e) INDULGENCES, ETC. Neither the failure nor any delay on the part of any party hereto to exercise any right under this Agreement shall operate as a waiver thereof, nor shall any single or partial exercise of any right preclude any other or further exercise of the same or any other right, nor shall any waiver of any right with respect to any occurrence be construed as a waiver of such right with respect to any other occurrence. (f) GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the internal laws of the State of Maryland without regard to the conflict of law principles thereof, except with respect to matters of law concerning the internal corporate affairs of any corporate entity which is a party to or subject of this Agreement, and as to those matters the law of the jurisdiction under which the respective entity derives its powers shall govern. (g) NOTICES. All notices, requests, demands and other communications required or permitted under this Agreement that are routine in nature shall be made in writing and shall be delivered by hand or mailed by registered or certified mail (return receipt requested) to the designated representative of the tax department of each party and confirmed by a way thereof directed to the general counsel of each party. (h) MODIFICATION OR AMENDMENT. This Agreement may be amended at any time by written agreement executed and delivered by duly authorized officers of SNH, CSL and CLJ. -34- (i) SUCCESSORS AND ASSIGNS. A party's rights and obligations under this Agreement may not be assigned without the prior written consent of the other party. All of the provisions of this Agreement shall be binding upon and inure to the benefit of the parties and their respective successors and permitted assigns, and shall survive any acquisition, disposition or other corporate restructuring or transaction involving any party. (j) NO THIRD PARTY BENEFICIARIES. This Agreement is solely for the benefit of the parties to this Agreement and their respective Affiliates and should not be deemed to confer upon third parties any remedy, claim, liability, reimbursement, claim of action or other right in excess of those existing without this Agreement. (k) OTHER COUNTERPARTS. This Agreement may be executed in any number of counterparts, each such counterpart being deemed to be an original instrument, and all of such counterparts shall together constitute one and the same instrument. The section numbers and captions herein are for convenience of reference only, do not constitute part of this Agreement and shall not be deemed to limit or otherwise affect any of the provisions hereof. (l) PREDECESSORS AND SUCCESSORS. To the extent necessary to give effect to the purposes of this Agreement, any reference to any corporation, partnership, limited liability company, business trust, Affiliated Group, member of an Affiliated Group or other entity shall also include any predecessors or successors thereto, by operation of law or otherwise. (m) TAX ELECTIONS. Except as provided in Section 6(b) or this paragraph, (i) nothing in this Agreement is intended to change or otherwise affect any previous tax election -35- made by or on behalf of the Pre-Closing Group (including the election with respect to the calculation of earnings and profits under Code Section 1552 and the regulations thereunder), and (ii) CLJ shall continue to have discretion, reasonably exercised, to make any and all elections with respect to all members of the Pre-Closing Group for all of the Acquired Companies' Pre-Closing Taxable Periods or other Tax Periods for which it is obligated to file Tax Returns or Information Returns under Section 2(a)(i). Notwithstanding anything to the contrary in this Agreement, (i) CLJ agrees that it shall consult with SNH regarding, and shall obtain SNH's written consent (which shall not be unreasonably withheld) with respect to, all accounting methods adopted or used (including without limitation with respect to useful lives) in connection with any property of any Acquired Company, that is placed in service in 2001 or 2002 (and before the Closing Date), (ii) CLJ agrees to provide to SNH, not later than January 30, 2002 (or, if later, 30 days following the Closing Date), a report detailing all property of any Acquired Company placed in service in 2001 or 2002 (and before the Closing Date) (based on the information reasonably available to CLJ at the time such report is prepared), and the accounting methods proposed to be adopted or used with respect to such property, and to provide an update of such report not later than the last business day of every month thereafter, and to provide a final report, not later than six months following the Closing Date (the "Final Report"), detailing all property of the Acquired Companies that is placed in service in 2001 or 2002 (and before the Closing Date) and the accounting methods proposed to be adopted or used with respect to such property. If SNH does not respond in writing to the -36- Final Report within twenty-one (21) days of receipt of such Final Report by SNH, SNH shall be deemed to have consented to the proposed accounting methods contained in the Final Report. (n) INJUNCTIONS. The parties acknowledge that irreparable damage would occur in the event that any of the provisions of this Agreement were not performed in accordance with its specific terms or were otherwise breached. The parties hereto shall be entitled to an injunction or injunctions to prevent breaches hereto and to enforce specifically the terms and provisions hereof in any court having jurisdiction; such remedy shall be in addition to any other remedy available at law or in equity. (o) FURTHER ASSURANCES. Subject to the provisions hereof, the parties hereto shall make, execute, acknowledge and deliver such other instruments and documents, and take all such other actions, as may be reasonably required in order to effectuate the purposes of this Agreement and to consummate the transactions contemplated hereby. Subject to the provisions hereof, each party shall, in connection with entering into this Agreement, performing its obligations hereunder and taking any and all actions relating hereto, comply with all applicable laws, regulations, orders and decrees, obtain all required consents and approvals and make all required filings with any governmental agency, other regulatory or administrative agency, commission or similar authority and promptly provide the other party with all such information as it may reasonably request in order to be able to comply with the provisions of this sentence. -37- (p) SETOFF. All payments to be made by any party under this Agreement shall be made without setoff, counterclaim or withholding, all of which are expressly waived. (q) COSTS AND EXPENSES. Unless otherwise specifically provided herein, each party agrees to pay its own costs and expenses resulting from the fulfillment of its respective obligations hereunder. (r) RULES OF CONSTRUCTION. Any ambiguities shall be resolved without regard to which party drafted the Agreement. (s) SNH LIMITATION OF LIABILITY. The Declaration of Trust of SNH, a copy of which is duly filed with the Department of Assessments and Taxation of the State of Maryland, provides that the name "Senior Housing Properties Trust" refers to the trustees under such Declaration of Trust collectively as trustees, but not individually or personally, and that no trustee, officer, shareholder, employee or agent of SNH shall be held to any personal liability, jointly or severally, for any obligation of, or claim against, SNH. All persons dealing with SNH in any way shall look only to the assets of SNH for the payment of any sum or the performance of any obligation. -38- IN WITNESS WHEREOF, the parties hereto have executed this Agreement, or have caused this Agreement to be executed on their respective behalf by their respective officers thereunto duly authorized, as of the day and year above written. CRESTLINE CAPITAL CORPORATION AND SUBSIDIARIES AND AFFILIATES By: ________________________________ Name: ________________________________ Title: ________________________________ CSL GROUP, INC. AND SUBSIDIARIES AND AFFILIATES By: ________________________________ Name: ________________________________ Title: ________________________________ SENIOR HOUSING PROPERTIES TRUST By:____________________________________ By:____________________________________ Name: _________________________________ Title: __________________________________ -39- EXHIBIT E The Master Lease, Consent to Sublease and Agreement, Membership Interest Pledge and Security Agreement, and Pledge and Security Agreement-Demand Note (Collateral Assignment of Demand Note, all dated as of April 30, 1999 will be amended as necessary, effective the Closing Date, to provide that: 1. The minimum tangible net worth (as defined in the Membership Interest Pledge and Security Agreement but amended to include, as an asset, the unamortized portion of the cash purchase price paid by CLJ for hotel management contracts then held by CLJ) of CLJ shall be not less than $30,000,000 ("Minimum Net Worth"); and 2. HPT consents to a reorganization, merger or sale of assets affecting CLJ, in which the resulting or surviving entity or purchaser A) is organized under the laws of and has its principal place of business in, a state of the United States or the District of Columbia, B) has a tangible net worth of not less than the Minimum Net Worth, C) is an experienced asset manager of hotel properties, D) is not a real estate investment trust or controlled by a real estate investment trust and E) is not controlled by convicted felons. 3. In the event of any reorganization, merger or sale of assets affecting CLJ, where the conditions set forth in Section 2 have not been met, then the modification set forth in Section 1 shall terminate (except that the definition of minimum tangible net worth shall continue to include, as an asset, the unamortized portion of the cash purchase price paid by CLJ for hotel management contracts then held by CLJ). EX-11.1 6 a2059384zex-11_1.txt EXHIBIT 11.1 Exhibit 11.1 FIVE STAR QUALITY CARE, INC. STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS (amounts in thousands, except per share amounts)
Six Months Ended For the Year Ended June 30, 2001 December 31, 2000 ---------------- ------------------ Net loss ................................. $(1,906) $ (1,316) ======= ========== Weighted average shares outstanding(1) .................. 2,962 2,962 Earnings per share ....................... $ (0.64) $ (0.44) ======= ==========
(1) During the periods Five Star Quality Care, Inc. was a wholly owned subsidiary of Senior Housing Properties Trust. The weighted average shares outstanding assumes completion of the spin-off distribution and does not give effect to common shares issued as part of Five Star Quality Care, Inc.'s acquisition of FSQ, Inc. EX-23.3 7 a2059384zex-23_3.txt EX-23.3 Exhibit 23.3 Consent of Independent Auditors We consent to the reference to our firm under the caption "Experts" and to the use of our report dated March 22, 2001 with respect to the consolidated financial statements of Five Star Quality Care, Inc. (formerly known as SHOPCO Holdings, Inc.) and our report dated September 19, 2001, with respect to the combined financial statements and schedule of Certain Mariner Post-Acute Network Facilities (Operated by subsidiaries of Mariner Post-Acute Network), both included in the Registration Statement (Form S-1) and related Prospectus of Five Star Quality Care, Inc. for the registration of shares of its common stock. /s/ Ernst & Young LLP Boston, Massachusetts September 19, 2001 EX-23.4 8 a2059384zex-23_4.txt EXHIBIT 23.4 Exhibit 23.4 INDEPENDENT AUDITORS' CONSENT The Board of Directors Senior Housing Properties Trust: We consent to the use of our report included herein and to the reference to our firm under the heading "Experts" in the prospectus. /s/ KPMG LLP Baltimore, Maryland September 21, 2001 EX-23.5 9 a2059384zex-23_5.txt EXHIBIT 23.5 Exhibit 23.5 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the use of our report (and to all references to our Firm) included in or made a part of this registration statement. /s/ Arthur Andersen LLP Vienna, Virginia September 21, 2001 EX-99.1 10 a2059384zex-99_1.txt EXHIBIT 99.1 Exhibit 99.1 CONSENT OF DIRECTOR NOMINEE I hereby consent to use of my name as a nominee for Director of Five Star Quality Care, Inc., where it appears in this Registration Statement on Form S-1, including the Prospectus constituting a part thereof, and any amendments thereto. /s/ JOHN L. HARRINGTON -------------------------------- John L. Harrington September 17, 2001 EX-99.2 11 a2059384zex-99_2.txt EX-99.2 Exhibit 99.2 CONSENT OF DIRECTOR NOMINEE I hereby consent to use of my name as a nominee for Director of Five Star Quality Care, Inc., where it appears in this Registration Statement on Form S-1, including the Prospectus constituting a part thereof, and any amendments thereto. /s/ BRUCE M. GANS ----------------------------------- Bruce M. Gans September 21, 2001 EX-99.3 12 a2059384zex-99_3.txt EXHIBIT 99.3 Exhibit 99.3 CONSENT OF DIRECTOR NOMINEE I hereby consent to use of my name as a nominee for Director of Five Star Quality Care, Inc., where it appears in this Registration Statement on Form S-1, including the Prospectus constituting a part thereof, and any amendments thereto. /s/ ARTHUR G. KOUMANTZELIS ------------------------------------- Arthur G. Koumantzelis September 18, 2001