Investments in Affiliates

9 Months Ended

Sep. 30, 2012

Investments in Affiliates

Investments in Affiliates

8.Investments in Affiliates

The Company has a 51% ownership interest in Bay Holdings, which is the sole member of Kapalua Bay LLC (Kapalua Bay).  The other members of Bay Holdings are MH Kapalua Venture, LLC, 34%, and ER Kapalua Investors Fund, LLC, 15%. Bay Holdings is not a variable interest entity, as defined in GAAP. The Company accounts for its investment in Bay Holdings using the equity method of accounting because, although it has the ability to exercise significant influence over operating and financial policies, it does not control Bay Holdings through a majority voting interest or other means. Under the LLC agreement, major decisions require the approval of either 75% or 100% of the membership interests. The Company has been designated as the managing member of Bay Holdings. Profits and losses of Bay Holdings were allocated in proportion to the members’ ownership interests, which approximated the estimated cash distributions to the members.

Kapalua Bay constructed a residential and timeshare development called The Ritz-Carlton Club and Residences, Kapalua Bay on land that it owns at the site of the former Kapalua Bay Hotel, and a spa on an adjacent parcel of land that is owned by the Company and leased to Kapalua Bay. Through September 30, 2012, the sale of 28 (84 total) whole-ownership units and 177 (744 total) fractional units have closed escrow.

As a result of the 2009 losses incurred by Bay Holdings, the Company’s carrying value of its investment in Bay Holdings was written down to zero in 2009. The Company does not expect to recover any amounts from its investment in Bay Holdings. The Company will not recognize any additional equity in the earnings (losses) of Bay Holdings until the Company’s income attributable to Bay Holdings exceeds its accumulated losses. The Company had made cash contributions to Bay Holdings of $53.2 million and non-monetary contributions of land valued at $25 million.

Kapalua Bay has a construction loan agreement under which $284.1 million was outstanding at September 30, 2012, and that matured on August 1, 2011. The loan is collateralized by the project assets including the land that is owned by Kapalua Bay that underlies the project. The Company and the other members of Bay Holdings have guaranteed to the lenders completion of the project and recourse with regard to certain acts, but have not guaranteed repayment of the loan. On March 13, 2012, the lenders notified Kapalua Bay that the loan was in default and on June 13, 2012, the lenders filed for foreclosure against Kapalua Bay, Bay Holdings and other entities related to the project. The public auction for the foreclosure proceeding has been scheduled for December 3, 2012. On September 27, 2012, Kapalua Bay was notified that three of its five lenders assigned their loans and other interests to a third-party investment firm.

Pursuant to a previous agreement, the Company agreed to purchase from Kapalua Bay the Amenities that were completed in 2009 at the actual construction cost of approximately $35 million. Through December 31, 2010, Bay Holdings recorded impairment charges in its consolidated financial statements of approximately $23 million related to the Amenities. In 2011 and for the nine months ended September 30, 2012, loss from the operations of the Amenities was $432,000 and $394,000, respectively. The Company does not have sufficient liquidity to purchase the Amenities at the actual construction cost of approximately $35 million and has been in discussions with the other members of Bay Holdings and the lenders to negotiate the terms of the purchase and sale. No provision has been recorded in the accompanying condensed consolidated financial statements with respect to the Company’s executory contract to purchase the Amenities. If the Amenities are subsequently acquired, they will be evaluated for impairment and could result in a loss.

A group of owners of 10 whole-ownership units filed a lawsuit on June 7, 2012 against multiple parties, including Kapalua Bay and the Company. The lawsuit alleges that the defendant parties breached their fiduciary duties to the Association of Apartment Owners of Kapalua Bay Condominium (AOAO) and the plaintiffs. In addition, the lawsuit seeks certain injunctive and declaratory relief regarding the management and operations of the AOAO and the project. On July 10, 2012, The Ritz-Carlton Management Company, LLC (RCMC) issued a notice of default and termination to the AOAO and Kapalua Bay Vacation Owners Association (VOA) effective September 10, 2012 as a result of insufficient funding of the ongoing operating costs of the AOAO and VOA in accordance with the terms of its operating agreement. On August 31, 2012, the termination date was extended to October 29, 2012. The Company is presently unable to reasonably determine the impact, if any, of these matters on the accompanying condensed consolidated financial statements.

The Company has recorded $4.1 million in accrued contract terminations in the condensed consolidated balance sheets representing the remaining expected exposure to loss related to our involvement with the project.

Summarized operating information for Bay Holdings for the three and nine months ended September 30, 2012 and 2011 were as follows:

	Three Months						Nine Months
	Ended September 30,						Ended September 30,
	2012			2011			2012			2011
	(in thousands)						(in thousands)
Revenues	$	(455	)	$	11,529		$	(873	)	$	17,391
Expenses	17,190			21,203			37,335			40,202
Net Loss	$	(17,645	)	$	(9,674	)	$	(38,208	)	$	(22,811	)

During June 2012, Bay Holdings recorded cancellations of contracts that will no longer be closed as scheduled.  Bay Holdings has not recognized any impairment of the project’s assets during the nine months ended September 30, 2012. As discussed above, the Company’s carrying value of its investment in Bay Holdings was written down to zero in the past, and the Company does not recognize any equity in the losses of Bay Holdings. As a result, management does not believe an adjustment for impairment charges, if any, would have a material impact to the condensed consolidated financial statements.