-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, A2Mq7okuPqucwVRRwDuddXOOKRg+T9CERU8vDo+cQBp49s9hx9VVMgk79PXkujUL pVC3F9g43bUbx0QDPY9Gow== 0000950144-02-008893.txt : 20020814 0000950144-02-008893.hdr.sgml : 20020814 20020814181401 ACCESSION NUMBER: 0000950144-02-008893 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20020630 FILED AS OF DATE: 20020814 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AMERICAN RETIREMENT CORP CENTRAL INDEX KEY: 0000787784 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-SKILLED NURSING CARE FACILITIES [8051] IRS NUMBER: 621674303 STATE OF INCORPORATION: TN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-13031 FILM NUMBER: 02738268 BUSINESS ADDRESS: STREET 1: 111 WESTWOOD PLACE STREET 2: SUITE 202 CITY: BRENTWOOD STATE: TN ZIP: 37027 BUSINESS PHONE: 6152212250 10-Q 1 g77554e10vq.txt AMERICAN RETIREMENT CORPORATION SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) (X) Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 2002 ( ) Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _________ to ___________ Commission file number 01-13031 --------- AMERICAN RETIREMENT CORPORATION ------------------------------- (Exact name of Registrant as specified in its charter) Tennessee 62-1674303 --------- ---------- (State or Other Jurisdiction (I.R.S. Employer of Incorporation or Organization) Identification No.) 111 Westwood Place, Suite 200, Brentwood, TN 37027 - -------------------------------------------- ----- (Address of principal executive offices) (Zip Code) (615) 221-2250 -------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] As of August 14, 2002, there were 17,310,209 shares of the Registrant's common stock, $.01 par value, outstanding. INDEX PART I. FINANCIAL INFORMATION Item 1. Financial Statements Page Condensed Consolidated Balance Sheets as of June 30, 2002 and December 31, 2001...............................................3 Condensed Consolidated Statements of Operations for the Three Months Ended June 30, 2002 and 2001 ...........................................................4 Condensed Consolidated Statements of Operations for the Six Months Ended June 30, 2002 and 2001 ...........................................................5 Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2002 and 2001 ....................................................................6 Notes to Condensed Consolidated Financial Statements .............................8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................................... 21 Item 3. Quantitative and Qualitative Disclosures About Market Risk ..................... 43 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K................................................ 44 Signatures ................................................................................ 45
AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) (in thousands, except share data)
June 30, 2002 December 31, 2001 ------------- -------------------- ASSETS Current assets: Cash and cash equivalents $ 12,250 $ 19,334 Assets limited as to use 16,102 10,122 Accounts receivable, net of allowance for doubtful accounts 14,030 11,447 Inventory 1,349 1,249 Prepaid expenses 3,122 3,016 Deferred income taxes 1,285 1,285 Other current assets 3,620 5,799 ------------ ------------ Total current assets 51,758 52,252 Assets limited as to use, excluding amounts classified as current 59,550 68,618 Land, buildings and equipment, net 498,823 525,174 Notes receivable 55,403 84,537 Goodwill, net 36,463 36,463 Leasehold acquisition costs, net 23,929 33,484 Other assets 65,501 49,663 ------------ ------------ Total assets $ 791,427 $ 850,191 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current portion of long-term debt, including convertible subordinated debentures $ 165,355 $ 371,667 Accounts payable 4,961 7,919 Accrued interest 3,134 3,584 Accrued payroll and benefits 5,309 4,838 Accrued property taxes 7,732 7,998 Other accrued expenses 6,401 9,926 Other current liabilities 22,650 17,436 ------------ ------------ Total current liabilities 215,542 423,368 Long-term debt, excluding current portion 349,399 190,458 Refundable portion of life estate fees 56,393 46,309 Deferred life estate income 68,742 51,211 Tenant deposits 5,410 6,016 Deferred gain on sale-leaseback transactions 29,193 13,055 Deferred income taxes 1,970 2,055 Other long-term liabilities 14,652 10,171 ------------ ------------ Total liabilities 741,301 742,643 Commitments and contingencies (See notes) Shareholders' equity: Preferred stock, no par value; 5,000,000 shares authorized, no shares issued or outstanding -- -- Common stock, $.01 par value; 200,000,000 shares authorized, 17,310,209 and 17,276,520 shares issued and outstanding, respectively 173 173 Additional paid-in capital 145,657 145,590 Accumulated deficit (95,704) (38,215) ------------ ------------ Total shareholders' equity 50,126 107,548 ------------ ------------ Total liabilities and shareholders' equity $ 791,427 $ 850,191 ============ ============
See accompanying notes to condensed consolidated financial statements 3 AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (in thousands, except share data)
Three Months Ended June 30, ------------------------------------- 2002 2001 ----------------- ----------------- Revenues: Resident and health care $ 80,787 $ 62,405 Management services 620 964 Reimbursable out-of-pockets 1,236 1,729 ----------------- ----------------- Total revenues 82,643 65,098 Operating expenses: Community operating expenses 59,010 43,615 General and administrative 6,554 6,756 Lease expense, net 18,098 6,700 Depreciation and amortization 5,510 4,799 Amortization of leasehold acquisition costs 2,994 396 Reimbursable out-of-pockets 1,236 1,729 ----------------- ----------------- Total operating expenses 93,402 63,995 ----------------- ----------------- Operating (loss) income (10,759) 1,103 Other income (expense): Interest expense (9,969) (9,293) Interest income 1,268 2,969 Loss on sale of assets (27) (303) Equity in losses of managed special purpose entity communities - (972) Other 191 510 ----------------- ----------------- Other expense, net (8,537) (7,089) ----------------- ----------------- Loss from continuing operations before income taxes, minority interest, and extraordinary item (19,296) (5,986) Income tax expense (benefit) 122 (1,952) ----------------- ----------------- Loss from continuing operations before minority interest and extraordinary item (19,418) (4,034) Minority interest in losses of consolidated subsidiaries, net of tax - 4 ----------------- ----------------- Loss from continuing operations before extraordinary item (19,418) (4,030) Extraordinary loss on extinguishment of debt, net of tax - (576) ----------------- ----------------- Net loss $ (19,418) $ (4,606) ================= ================= Basic loss per share: Basic loss per share before extraordinary item $ (1.12) $ (0.23) Extraordinary loss, net of tax - (0.03) ----------------- ----------------- Basic loss per share $ (1.12) $ (0.27) ================= ================= Diluted loss per share: Diluted loss per share before extraordinary item $ (1.12) $ (0.23) Extraordinary loss, net of tax - (0.03) ----------------- ----------------- Diluted loss per share $ (1.12) $ (0.27) ================= ================= Weighted average shares used for basic loss per share data 17,277 17,200 Effect of dilutive common stock options - - ----------------- ----------------- Weighted average shares used for diluted loss per share data 17,277 17,200 ================= =================
See accompanying notes to condensed consolidated financial statements. 4 AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (in thousands, except per share data)
Six Months Ended June 30, -------------------------------------- 2002 2001 ----------------- ----------------- Revenues: Resident and health care $ 156,040 $ 122,077 Management and development services 685 1,673 Reimbursable out-of-pockets 2,687 3,400 ----------------- ----------------- Total revenues 159,412 127,150 Operating expenses: Community operating expenses 112,987 85,404 General and administrative 12,474 11,750 Lease expense, net 51,063 13,451 Depreciation and amortization 10,532 9,526 Amortization of leasehold acquisition costs 10,116 761 Reimbursable out-of-pockets 2,687 3,400 ----------------- ----------------- Total operating expenses 199,859 124,292 ----------------- ----------------- Operating (loss) income (40,447) 2,858 Other income (expense): Interest expense (19,694) (18,519) Interest income 2,928 6,153 Loss on sale of assets (53) (122) Equity in losses of managed special purpose entity communities - (1,938) Other 752 1,023 ----------------- ----------------- Other expense, net (16,067) (13,403) ----------------- ----------------- Loss from continuing operations before income taxes, minority interest, and extraordinary item (56,514) (10,545) Income tax expense (benefit) 219 (3,398) ----------------- ----------------- Loss from continuing operations before minority interest and extraordinary item (56,733) (7,147) Minority interest in earnings of consolidated subsidiaries, net of tax - (96) ----------------- ----------------- Loss from continuing operations before extraordinary item (56,733) (7,243) Extraordinary loss on extinguishment of debt, net of tax (756) (181) ----------------- ----------------- Net loss $ (57,489) $ (7,424) ================= ================= Basic loss per share: Basic loss per share before extraordinary item $ (3.28) $ (0.42) Extraordinary loss, net of tax (0.04) (0.01) ----------------- ----------------- Basic loss per share $ (3.33) $ (0.43) ================= ================= Diluted loss per share: Diluted loss per share before extraordinary item $ (3.28) $ (0.42) Extraordinary loss, net of tax (0.04) (0.01) ----------------- ----------------- Diluted loss per share $ (3.33) $ (0.43) ================= ================= Weighted average shares used for basic loss per share data 17,277 17,167 Effect of dilutive common stock options - - ----------------- ----------------- Weighted average shares used for diluted loss per share data 17,277 17,167 ================= =================
See accompanying notes to the condensed consolidated financial statements. 5 AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (in thousands)
Six Months Ended June 30, ---------------------------------------------- 2002 2001 -------------------- --------------------- Cash flows from operating activities: Net loss $ (57,489) $ (7,424) Extraordinary loss on extinguishment of debt, net of tax 756 181 -------------------- --------------------- Loss from continuing operations (56,733) (7,243) Adjustments to reconcile loss from continuing operations to net cash and cash equivalents used by operating activities: Depreciation and amortization 20,648 10,287 Amortization of deferred entrance fee revenue (5,675) (5,206) Amortization of deferred financing costs 1,658 1,262 Residual value guarantee lease costs 30,279 - Advances to joint ventures - (1,512) Proceeds from life estate sales, net of refunds 6,258 5,372 Deferred income tax benefit (85) (3,091) Amortization of deferred gain on sale-leaseback transactions (1,641) (1,310) Minority interest in earnings of consolidated subsidiaries - 96 Losses (gains) from unconsolidated joint ventures 279 (14) Loss on sale of assets 53 122 Issuance of stock to employee 401k plan - 333 Changes in assets and liabilities: Accounts receivable (1,592) 41 Inventory (30) (60) Prepaid expenses 71 1,291 Other assets 5,809 3,860 Accounts payable (3,344) (4,732) Accrued expenses and other current liabilities (5,332) 1,407 Tenant deposits (632) (346) Other liabilities 1,880 (588) -------------------- --------------------- Net cash and cash equivalents used by operating activities (8,129) (31) Cash flows from investing activities: Additions to land, buildings and equipment (13,133) (11,408) Purchase of assets limited as to use (7,677) (2,864) (Issuance of) receipts from notes receivable (8,641) 2,090 Proceeds from the sale of assets 92,113 7,708 Other investing activities (2,235) 308 -------------------- --------------------- Net cash provided (used) by investing activities 60,427 (4,166)
See accompanying notes to condensed consolidated financial statements 6 AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED (UNAUDITED) (in thousands)
Six Months Ended June 30, ---------------------------------------------- 2002 2001 --------------------- --------------------- Cash flows from financing activities: Proceeds from issuance of stock through employee stock purchase plan 67 84 Proceeds from the issuance of long-term debt 189,381 21,745 Principal payments on long-term debt (236,752) (7,444) Purchase of convertible debentures - (4,029) Principal reductions in master trust liability (3,109) (3,092) Expenditures for contingent earnouts (5,294) (567) Expenditures for financing costs (3,675) - --------------- --------------------- Net cash (used) provided by financing activities (59,382) 6,697 --------------- --------------------- Net (decrease) increase in cash and cash equivalents (7,084) 2,500 --------------- --------------------- Cash and cash equivalents at beginning of period 19,334 19,850 --------------- --------------------- Cash and cash equivalents at end of period $ 12,250 $ 22,350 =============== ===================== Supplemental disclosure of cash flow information: Cash paid during the period for interest (including capitalized interest) $ 17,003 $ 18,400 =============== ===================== Income taxes paid (received) $ 330 $ (1,533) =============== ===================== Supplemental disclosure of non-cash transactions: During the quarter ended June 30, 2002, the Company terminated a management agreement and entered into a long-term operating lease. Under the terms of the lease, the Company acquired the following assets and assumed the following liabilities: Accounts receivable $ 991 $ - Other current assets 441 - Note receivable 18,756 - Other assets 11,651 - Other current liabilities 1,527 - Refundable portion of life estate fees 11,348 - Deferred life estate income 16,335 - Other long-term liabilities 2,629 - During the six months ended June 30, 2002, the Company terminated five operating leases, and acquired $69.3 million of land, buildings and equipment in exchange for $58.1 million of notes receivable and $11.2 million of certificates of deposit (included in assets whose use is limited), previously securing these leases. In conjunction with the transactions, assets and liabilities changed as follows: Notes receivable $ (58,110) $ - Assets limited as to use (11,176) - Land, buildings and equipment 44,313 - Other current liabilities 24,973 - During the six months ended June 30, 2001, the Company funded its 401(k) contribution with 81,788 shares of its common stock at a fair market value of approximately $333,000.
See accompanying notes to condensed financial statements. 7 AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements of American Retirement Corporation (the "Company") have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Certain fiscal year 2001 amounts have been reclassified to conform to the fiscal year 2002 presentation. Operating results for the three and six months ended June 30, 2002 are not necessarily indicative of the results that may be expected for the entire year ending December 31, 2002. These financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2001. 2. LIQUIDITY AND REFINANCING PLAN The Company has a substantial amount of debt and lease obligations maturing during 2002, comprised primarily of $132.9 million of its 5 3/4% Convertible Subordinated Debentures Due October 1, 2002 (the "Debentures"). The Company has scheduled debt maturities during the 12 months ended June 30, 2003 of $165.4 million, which includes $32.5 million of periodic mortgage debt payments and $132.9 million of Debentures. As a result of these current maturities, the Company had a net working capital deficit of $163.8 million as of June 30, 2002. As of June 30, 2002, the Company also had minimum rental obligations of $50.3 million under long-term operating leases due during the twelve months ended June 30, 2003. In addition, as of June 30, 2002, the Company had guaranteed $93.1 million of third-party senior debt in connection with a community that the Company manages, the Company's joint ventures and certain of the Company's lease financings. The Company and certain of its lenders and lessors also agreed to amendments or waivers of various financial covenants as of June 30, 2002. As of June 30, 2002, the Company had approximately $12.3 million in unrestricted cash and cash equivalents. The Company currently does not generate sufficient cash flow to meet its debt and lease payment obligations. The Company expects that its cash flow from operations will improve, and, accordingly, expects that its current cash and cash equivalents, expected cash flow from operations, and the proceeds from certain recently completed financings will be sufficient to fund its operating requirements, its capital expenditure requirements and its periodic debt service requirements through June 30, 2003. However, the Company's current cash balances and internally generated cash (including the proceeds from recently completed financings) will not be sufficient to satisfy its scheduled debt maturities in 2002. In order to satisfy or extend the Company's debt and lease payment obligations and to address its net working capital deficit, the Company considered a number of financing and capital raising alternatives and developed a refinancing plan in consultation with its investment banking advisor and its legal counsel and through discussions with its lenders and other third parties (the "Refinancing Plan"). The Refinancing Plan included extensions of existing debt maturities, refinancings of existing mortgage facilities, new mortgage financings, and sale lease-back arrangements. Pursuant to the Refinancing Plan, since November 2001, the Company has consummated sale lease-back transactions relating to 16 communities and various other refinancing and capital raising transactions, which in the aggregate generated gross proceeds of approximately $362.0 million. The Company used approximately $327.2 million of the proceeds to repay related debt and to fund reserve and escrow requirements related to these transactions. The Company used the remaining $34.8 million of proceeds to pay transaction costs associated with the Refinancing Plan and for working capital. As a result of the Refinancing Plan, the Company has extended the maturity of substantially all of its debt arrangements, other than the Debentures, to January 2004 or later. The Debentures are the Company's only material remaining outstanding debt obligation maturing during the next 12 months. In order to address the maturity of the Debentures, during March of 2002, the Company entered into a non-binding commitment letter with Health Care Property Investors, Inc. ("HCPI"), a real estate investment trust, relating to a proposed $125 million financing transaction. On August 14, 2002, the Company entered into a binding 8 loan agreement with HCPI (the "HCPI Loan Agreement") pursuant to which HCPI has agreed to loan one of the Company's subsidiaries $112.8 million (the "HCPI Loan"). The Company also contemporaneously entered into a binding securities purchase agreement with HCPI (the "HCPI Investment Agreement") under which HCPI has agreed to make a $12.2 million equity investment in certain other subsidiaries of the Company (the "HCPI Equity Investment"). The HCPI Loan and the HCPI Equity Investment are collectively referred to as the "HCPI Transactions." HCPI's obligation to consummate the HCPI Transactions is subject to a number of conditions and contingencies. Those conditions include the requirement that the Company successfully complete an exchange offer with the holders of the outstanding Debentures (the "Exchange Offer"), pursuant to which the Company will exchange for each $1,000 principal amount of outstanding Debentures and accrued interest thereon (i) $839 principal amount of the Company's new 5 3/4% Series A Senior Subordinated Notes Due September 30, 2002 (the "Series A Notes"), (ii) $190 principal amount of the Company's new 10% Series B Senior Subordinated Notes Due September 30, 2009 (the "Series B Notes"), and (iii) 13 warrants, each warrant to purchase one share of the Company's common stock at an exercise price of $3.50 per share and with an expiration date of September 30, 2009 (the "Warrants"). With respect to the Exchange Offer, HCPI is also requiring that the Company receive the valid tender of at least 75% of the outstanding principal amount of the Debentures (approximately $99.7 million) to provide the Company with additional cash on hand to meet its on-going liquidity requirements. The Series A Notes and the Series B Notes will be unsecured and subordinated to all of the Company's existing and future indebtedness and capital lease obligations, but they will rank senior to the Debentures. The Company has the option to pay up to 2% interest per year on the Series B Notes through the issuance of additional Series B Notes rather than in cash. The Company initiated the Exchange Offer on August 14, 2002, and anticipates that, if successful, it will be consummated during September 2002. The HCPI Loan will mature five years after initial funding, and will have a stated interest rate of 19.5%; however, the Company will only be required to pay in cash 9% interest per year until April 2004. Thereafter, the cash interest payment rate will increase each year by fifty-five basis points. The cash portion of interest will be payable quarterly, with any unpaid interest accruing and compounding quarterly. The $112.8 million principal balance and all accrued interest will be payable at the maturity of the loan. The Company will be permitted to repay the loan at any time after three years from the date of initial funding. The $12.2 million HCPI Equity Investment will be made in return for a 9.8% ownership interest in certain subsidiaries of the Company's subsidiary that is the borrower under the HCPI Loan (the "Real Estate Companies"). The Real Estate Companies function solely as passive real estate holding companies owning the real property and improvements of nine of the Company's large retirement communities. These retirement communities are leased to, and operated by, other operating subsidiaries of the borrower subsidiary in which HCPI will have no interest. During the term of its investment in each Real Estate Company, HCPI and the borrower subsidiary will have mutual decision making authority with respect to the Real Estate Companies. HCPI will have the right to receive certain preferred distributions from any cash generated by the Real Estate Companies. The borrower subsidiary will have the right to repurchase HCPI's minority interest in the Real Estate Companies for one year beginning four years after closing. HCPI will have the right to purchase the borrower subsidiary's interests in the Real Estate Companies beginning five years after closing. The HCPI Loan will be non-recourse and will be secured by a first-priority security interest in the borrower subsidiary's 90.2% ownership interests in the Real Estate Companies, and in certain cash reserve accounts. Since the HCPI Loan is non-recourse, if the borrower subsidiary defaults or fails to repay the loan at maturity, HCPI's only claim against that subsidiary will be to exercise its security interests and, absent fraud or certain other customary events of malfeasance, neither the Company nor any of its subsidiaries will have any further obligation to repay the HCPI Loan. Accordingly, even in the event of default by the borrower subsidiary, the operating subsidiaries will continue to operate these communities under a lease, which has an initial term of 15 years, commencing at the date of funding of the loan, and two ten-year extensions that are exercisable at the Company's option. The HCPI Loan Agreement contains numerous affirmative, negative and financial covenants. In addition, under the HCPI Loan Agreement, HCPI's obligation to make the HCPI Loan is subject to customary and usual conditions and certain other conditions and requirements. Those conditions include, among others, the following: 9 o the loan must be funded by September 30, 2002; o the Company must complete the Exchange Offer on the terms currently contemplated and the holders of the Debentures must validly tender at least 75% of the outstanding principal amount, or approximately $99.7 million, of the Debentures; o operating results must be within budget and the Company must meet certain liquidity and financial tests relating to the Company and to the nine retirement communities owned by the Real Estate Companies; and o no material adverse change shall have occurred with respect to the nine retirement communities, the borrower subsidiary or the Company. HCPI's obligation to make the $12.2 million HCPI Equity Investment in the Real Estate Companies is also subject to substantially similar conditions. In the event the Exchange Offer is successful and the Company receives the valid tender of at least 75% of the aggregate principal amount of the outstanding Debentures, the Company expects that it will be able to satisfy the other conditions in the HCPI Loan Agreement and in the HCPI Investment Agreement and close those transactions on or before September 30, 2002. The Company anticipates that it will receive net proceeds of approximately $119.8 million from the HCPI Transactions after paying approximately $5.2 million of transaction costs associated with those transactions and the Exchange Offer. However, the success of the Exchange Offer and the Company's ability to satisfy HCPI's other conditions and close the HCPI Transactions are subject to a number of uncertainties and depend upon a number of factors, many of which are beyond the Company's control. Accordingly, there can be no assurance that the Company can successfully complete the Exchange Offer as required by HCPI or satisfy the other conditions required by HCPI and consummate the HCPI Loan or obtain the HCPI Equity Investment. The Company will use the net proceeds of the HCPI Transactions, together with cash on hand, to repay first the principal amount of and accrued interest on the Series A Notes when they mature on September 30, 2002 and then the principal amount of and interest on the remaining Debentures when they mature on October 1, 2002. If the holders of the Debentures do not validly tender at least 75% of the aggregate principal amount of the Debentures on the terms currently contemplated and the Company does not consummate the HCPI Transactions, the Company will be forced to seek other financing alternatives. At the present time, the Company does not have any alternative sources of financing that would provide it with sufficient funds to repay the Series A Notes and the Debentures at maturity. As a result of the Company's current financial condition and the fact that substantially all of the Company's properties are fully encumbered by mortgage or lease financings, the Company does not believe it would be able to obtain such alternative financing prior to the maturity of the Series A Notes and the Debentures. The Company also does not believe that it would be able to sell its properties in the time or at values necessary to raise sufficient cash to satisfy the Series A Notes and the Debentures at maturity. In addition, a sale of the Company's assets could have adverse tax consequences to the Company. If the Company is unable to consummate the HCPI Transactions by September 30, 2002 and repay the principal of and interest on the Series A Notes, the Company will be in default under approximately $137.3 million of mortgage indebtedness and under the indenture governing the Series A Notes. In addition, because of cross-default and cross-collateralization provisions in many of the Company's other debt instruments and leases, those defaults are likely to result in a default and acceleration of substantially all of the Company's other debt and lease obligations, including the Series B Notes and the Debentures. As of June 30, 2002, the Company had approximately $381.8 million of senior secured debt and capital lease obligations, $132.9 million of Debentures and approximately $50.3 million of annual lease obligations. In addition, as of June 30, 2002, the Company had guaranteed $93.1 million of third-party senior debt in connection with a community that the Company manages, the Company's joint ventures and certain of the Company's lease financings. As a result, a default under the indentures governing the Series A Notes, the Series B Notes and the Debentures and the Company's other debt and lease obligations would have a material adverse effect upon the Company and could make it necessary for the Company to seek protection from its creditors under federal bankruptcy laws. 10 In the event that the Company successfully consummates the Exchange Offer and the HCPI Transactions, it will remain highly leveraged with a substantial amount of debt and lease obligations, and will have increased interest and lease expenses. The Company, however, expects that its cash flow from operations will improve, and, accordingly, expects that its current cash and cash equivalents, expected cash flow from operations, and the proceeds from successful completion of the refinancing plan will be sufficient to fund its operating requirements, its capital expenditure requirements, its periodic debt service requirements and its lease obligations during the next twelve months. 3. EARNINGS PER SHARE Basic loss per share for the three and six months ended June 30, 2002 has been computed on the basis of the weighted average number of shares outstanding. During the three months ended June 30, 2002, there were 3,000 options to purchase shares of common stock outstanding which had an exercise price below the average market price of the common shares. Such options were anti-dilutive because the Company incurred a loss from continuing operations for the three and six months ended June 30, 2002, and therefore were not included in the computation of diluted earnings per share. Note that for the six months ended June 30, 2002, there were no options to purchase shares of common stock outstanding which had an exercise price below the average market price of the common shares. The Debentures outstanding during the periods presented were not included in the computation of diluted earnings per share because the conversion price of $24.00 per share was greater than the average market price of the common shares for the respective periods and, therefore, the effect would be anti-dilutive. The following options to purchase shares of common stock were outstanding during each of the following periods, but were also not included in the computation of diluted earnings per share because the options' exercise price was greater than the average market price of the common shares for the respective periods and, therefore, the effect would be anti-dilutive.
Three Months Six Months Ended June 30, Ended June 30, -------------- -------------- -------------- ------------- 2002 2001 2002 2001 -------------- -------------- -------------- ------------- Average number of options (in thousands) 2,108 829 2,124 809 Weighted-average exercise price $ 4.83 $ 7.86 $ 4.83 $ 8.11
4. LONG TERM DEBT AND OTHER FINANCING TRANSACTIONS On January 1, 2002, the Company completed a sale lease-back of a retirement center in North Carolina for $45.0 million. The lessor assumed $34.8 million of debt associated with the property, resulting in an assumption penalty of $348,000, coupled with $50,000 of unamortized financing costs, which the Company has recorded as an extraordinary loss. The lease agreement has an initial term of 15 years with two five-year renewal options and a right of first refusal to repurchase the community. The Company recorded a gain of $11.7 million on the sale, which is being amortized over the term of the lease. In conjunction with this sale, on January 1, 2002, the Company acquired a Free-standing assisted living community ("Free-standing AL") in Florida for $7.1 million, which it had previously managed for the buyer of the North Carolina community. The Company funded this acquisition by assuming a $4.7 million mortgage note bearing interest at a floating rate of 5.63% at March 31, 2002. Interest is due monthly with remaining principal and unpaid interest due December 31, 2002. The note is secured by certain land, buildings, and equipment. On January 25, 2002, the Company amended two loan agreements with aggregate outstanding indebtedness of $7.2 million. The amendment extends the due dates of the agreements to December 31, 2002, requires additional monthly principal payments of $60,000, and a $1.0 million cash collateral deposit. In connection with the amendment, the Company agreed to, among other things, (1) retire or refinance approximately $92.3 million of 11 indebtedness on or before July 1, 2002, so as to mature no earlier than December 1, 2003 and (2) retire or refinance the $132.9 million outstanding principal amount of its Debentures on or before September 1, 2002 so as to mature no earlier than October 1, 2004. Failure to accomplish the retirement or refinancing of this debt could result in the acceleration of the outstanding indebtedness. On July 11, 2002, this debt was paid off in conjunction with the sale leasebacks of the respective properties. See notes 2 and 10. On February 12, 2002, the Company sold a Free-standing AL in Florida for $9.7 million. The Company contemporaneously leased the property back from the buyer under a 15-year lease agreement with two five-year renewal options and a right of first refusal to repurchase the community. The Company used a portion of the sale proceeds to repay $8.6 million of debt associated with the property. The sale agreement contains certain formula-based earnout provisions which may provide additional sales proceeds to the Company based on future performance. As a result of the contingent earn-out provisions, for financial reporting purposes, this transaction was recorded as a financing transaction and the Company recorded $9.7 million of lease obligation as debt, bearing interest of 7.55%. The Company recorded a $1.4 million loss as a result of this transaction. For financial reporting purposes, these losses are considered residual value guarantee amounts under the previous leases terminated in connection with the sale lease-back transaction and have been fully recognized as lease expense. On February 12, 2002, the Company sold for $18.5 million a retirement center in Illinois. The Company used a majority of the sale proceeds to repay $12.9 million of debt associated with the property. The Company contemporaneously leased the property back from the buyer under a 15-year lease agreement with two five-year renewal options, and has the right of first refusal to repurchase the community. The Company recorded a gain of $5.3 million on the sale, which is being amortized on a straight-line basis over the term of the lease. On March 22, 2002, the Company sold a Free-standing AL in Colorado, for $17.9 million. The Company contemporaneously leased the property back from the buyer under a 15-year lease agreement with two five-year renewal options and a right of first refusal to repurchase the community. The Company used a portion of the sale proceeds to repay $16.3 million of debt associated with the property, resulting in the Company expensing $259,000 of unamortized financing cost as an extraordinary item. The sale agreement contains certain formula-based earnout provisions which may provide additional sales proceeds to the Company based on future performance. As a result of the contingent earn-out provisions, for financial reporting purposes, this transaction was recorded as a financing transaction and the Company recorded $17.9 million of lease obligation as debt, bearing interest of 7.46%. The Company recorded a $5.8 million loss as a result of this transaction. For financial reporting purposes, these losses are considered residual value guarantee amounts under the previous leases terminated in connection with the sale lease-back transaction and have been fully recognized as lease expense. On March 28, 2002, the Company sold two retirement centers and three Free-standing ALs for $73.2 million. The Company used a portion of the proceeds to repay $55.2 million of debt, resulting in the Company expensing $99,000 of unamortized financing cost as an extraordinary item. The Company contemporaneously leased the properties back from the buyer under a 15-year lease agreement with two ten-year renewal options. The sale agreements for the three Free-standing ALs contain certain formula-based earnout provisions which may provide additional sales proceeds to the Company based on future performance. As a result of the contingent earn-out provisions, for financial reporting purposes, the Free-standing AL transactions were recorded as financing transactions and the Company recorded $18.2 million of lease obligation as debt, bearing interest of 9.37%. The Company recorded a $17.8 million loss as a result of the sale of these three AL's. For financial reporting purposes, these losses are considered residual value guarantee amounts under the previous leases terminated in connection with the sale lease-back transaction and have been fully recognized as lease expense. One of the retirement center leases is recorded as a capital lease and the Company recorded $25.0 million of lease obligation as debt, bearing interest of 8.27%. The other retirement center lease is being accounted for as an operating lease, since the sale agreement for this community did not contain a contingent earnout provision or other continuing involvement provisions. The Company recorded a gain of $697,000 on the sale of this retirement center, which is being amortized on a straight-line basis over the term of the lease. The Company has an option to acquire the retirement center that has been accounted for as a capital lease after March 28, 2006, subject to certain conditions. 12 On May 31, 2002, the Company replaced two mortgage notes maturing December 31, 2002 totaling $82.7 million with a $95.7 million mortgage note with the same lender which matures May 31, 2005. The Company applied the provisions of EITF 96-19, "Debtor's Accounting for a Modification or Exchange of Debt Instruments" in determining the treatment of costs incurred related to the exchange of debt instruments. As such, the commitment fee of $957,000 which, along with $128,000 of unamortized financing costs on the previous notes, will be amortized as a yield adjustment over the term of the new mortgage note, while $972,000 of legal and investment advisor fees are recorded in general and administrative expense. The new mortgage debt has a fixed and variable interest component, principal and interest is due monthly, based on a 25-year amortization, and remaining principal and unpaid interest is due May 31, 2005, with two one-year renewal options. The fixed rate component converts to a variable rate on January 1, 2003. The Company purchased an interest rate cap agreement for $789,000, which limits the Company's variable interest expense if 30-day LIBOR exceeds 5.8% over the term of the mortgage. The Company has designated the cap as a cashflow hedge. As such, any changes in the fair value of the cap while 30-day LIBOR does not exceed 5.8% is recognized as interest expense during the current period. The fair value of the cap was $584,000 at June 30, 2002. In connection with the debt, in the event that on or before September 30, 2002, either the Debentures have not been retired or the Company has not provided to the Lender evidence that the Company holds an amount of unrestricted cash sufficient to retire the Debentures, the Company would be in default and the lender could exercise its contractual remedies, including the acceleration of the loan. The note is secured by certain land, buildings, and equipment and contains cross-default provisions. As a result of completed and anticipated transactions under the Refinancing Plan, the Company has recorded losses from sale lease-back transactions of $7.9 million during the quarter ended December 31, 2001, $23.2 million during the quarter ended March 31, 2002, and $7.0 million during the quarter ended June 30, 2002, bringing the total loss on these sale lease-back transactions to $38.1 million. For financial reporting purposes, these losses are considered residual value guarantee amounts under the previous leases terminated in connection with the sale lease-back transactions and have been fully recognized as lease expense. The Company does not expect to incur any additional residual value guarantee amounts. In addition, due to the shorter than expected remaining life of the previous leases terminated in connection with the sale lease-back transactions, the Company accelerated the amortization of leasehold acquisition costs beginning in the fourth quarter of 2001. As a result of this acceleration, the Company recorded additional amortization costs of $472,000 during the quarter ended December 31, 2001, $6.5 million during the quarter ended March 31, 2002, and $2.3 million during the quarter ended June 30, 2002, bringing the total amount of accelerated amortization related to these sale lease-back transactions to $9.3 million. Effective as of June 30, 2002, the Company obtained waivers under various financing and lease agreements with respect to certain of its financial covenants. In connection with a $95.7 million mortgage note, in the event that on or before September 30, 2002, either the Debentures have not been retired or the Company has not provided to the Lender evidence that the Company holds an amount of unrestricted cash sufficient to retire the Debentures, the Company would be in default and the lender could exercise its contractual remedies, including the acceleration of the loan. See note 2. The Company announced, during the quarter ended March 31, 2000, that its Board of Directors had authorized the repurchase, from time to time, of up to $30.0 million of its Debentures. During the six months ended June 30, 2001, the Company purchased $3.3 million of the Debentures, resulting in an extraordinary gain on extinguishment of debt, net of tax, of $395,000. The Company has initiated the Exchange Offer with respect to the Debentures, and no longer expects to purchase any of the Debentures on the open market. 5. ASSET IMPAIRMENTS AND CONTRACTUAL LOSSES During the quarter ended December 31, 1999, the Company abandoned five development projects. The Company has sold three of the five land parcels associated with the abandoned projects, and intends to continue marketing the remaining two land parcels during the remainder of 2002. The remaining two land parcels are classified as held for 13 sale and are included in other assets. The net carrying amount of these assets was $2.7 million at June 30, 2002. The Company will continue to evaluate the land parcels for impairment. 6. ACQUISITION AND OTHER TRANSACTIONS On January 1, 2002, the Company acquired a Free-standing AL community in Florida for $7.1 million. The Company funded this acquisition by assuming a $4.7 million mortgage note. The community has 83 units, of which 57 are assisted living and 26 are memory enhanced. See note 4. The Company previously managed a senior living community in Arizona under a long-term management agreement with a third party owner. The owner of the community agreed to terminate the existing management agreement and to enter into a long-term lease with the Company upon the Arizona Department of Insurance's (DOI) approval of the Company as the "provider" (as defined by the applicable Arizona statutes) at the Community. On April 1, 2002, the Department approved the application of the Company as the provider at the Community and the Company contemporaneously terminated the management agreement and leased the property from the owner for an initial term of approximately 16 years (the remainder of the original management agreement), with two 10-year renewal options. In addition to the payments for the lease of the facility, the Company is responsible for making payments under the existing ground lease as well as debt service payments on the $10.6 million mortgage debt associated with the community which the Company guarantees. As a result of this lease transaction, the Company and the community are in compliance with all requirements under Arizona DOI regulations effectively remedying the owner's previous non-compliance. As a result of this operating lease, consolidated community operating results will increase and management service fees will decrease. Upon the execution of the lease agreement, the Company acquired the working capital assets, assumed the working capital liabilities and assumed approximately $27.0 million of resident contract liabilities. The Company received a $18.3 million, 6% note receivable from the lessor as compensation for the assumption of the resident contract liabilities, the value of which approximates the tax basis of the resident contract liabilities. Monthly payments of $104,000 are required under the terms of the note receivable. At the termination of the lease agreement, the resident liabilities revert to the lessor. Any excess of the tax basis of the resident liabilities above the note receivable balance at the termination of the lease will be repaid by the Company through the issuance of a note payable bearing interest at 6%. 7. SEGMENT INFORMATION The Company has significant operations principally in two industry segments: (1) retirement centers and (2) Free-standing ALs. Retirement centers represent 31 of the Company's senior living communities and provide a continuum of care services such as independent living, assisted living and skilled nursing care. The Company currently operates 34 Free-standing ALs. Free-standing ALs are generally comprised of stand-alone assisted living communities that are not located on a retirement center campus, some of which also provide some skilled nursing and/or specialized care such as Alzheimer's and memory enhancement programs. Free-standing ALs are generally much smaller than retirement centers. The Company evaluates its performance in part based upon EBITDAR, which is defined as earnings before net interest expense, income tax expense (benefit), depreciation, amortization, rent, and other special charges related to asset impairment and other losses, equity in loss of special purpose entities, other income (expense), minority interest, and extraordinary items. The following is a summary of total revenues, EBITDAR, and total assets by segment for the three and six months ended June 30, 2002 and 2001 (in thousands).(1)(2)(3) 14
THREE MONTHS ENDED JUNE 30, JUNE 30, $ % 2002 2001 CHANGE CHANGE ---- ---- ------- ------ Revenues: Retirement centers $ 61,877 $ 53,511 $ 8,366 15.6% Free-standing ALs 18,910 8,894 10,016 112.6% Corporate/other 1,856 2,693 (837) (31.1%) ---------------------------------------------------- Total $ 82,643 $ 65,098 $ 17,545 27.0% ==================================================== NOI / Community EBITDAR: Retirement centers $ 20,473 $ 18,956 $ 1,517 8.0% Free-standing ALs 1,665 (162) 1,827 1127.8% Corporate/other (6,295) (5,796) (499) (8.6%) ---------------------------------------------------- Net operating income 21.9% 15,843 12,998 2,845 Lease expense (4) 18,098 6,700 11,398 170.1% Depreciation and amortization(5) 8,504 5,195 3,309 63.7% ---------------------------------------------------- Operating (loss) income $ (10,759) $ 1,103 $ (11,862) (1075.4%) ====================================================
SIX MONTHS ENDED JUNE 30, JUNE 30, $ % 2002 2001 CHANGE CHANGE ---- ---- ------- ------ Revenues: Retirement centers $ 119,493 $ 105,749 $ 13,744 13.0% Free-standing ALs 36,547 16,328 20,219 123.8% Corporate/other 3,372 5,074 (1,702) (33.5%) ---------------------------------------------------- Total $ 159,412 $ 127,151 $ 32,261 25.4% ==================================================== NOI / Community EBITDAR: Retirement centers $ 41,184 $ 38,327 $ 2,857 7.5% Free-standing ALs 2,614 (962) 3,576 371.7% Corporate/other (12,534) (10,769) (1,765) (16.4%) ---------------------------------------------------- Net operating income 31,264 26,596 4,668 17.6% Lease expense (4) 51,063 13,451 37,612 279.6% Depreciation and amortization(5) 20,648 10,287 10,361 100.7% ---------------------------------------------------- Operating (loss) income $ (40,447) $ 2,858 $ (43,305) (1515.2%) ====================================================
TOTAL ASSETS JUNE 30, DECEMBER 31, $ % 2002 2001 CHANGE CHANGE ---- ---- ------- ------ Total Assets: Retirement centers $ 470,231 $ 509,732 $ (39,501) (7.8%) Free-standing ALs 221,643 241,069 (19,426) (8.1%) Corporate/other 99,553 99,390 163 0.0% ---------------------------------------------------- Total $ 791,427 $ 850,191 $ (58,764) (6.9%) ====================================================
(1) Segment data does not include any inter-segment transactions or allocated costs. (2) Net Operating Income ("NOI"), or Community EBITDAR, is defined as earnings before net interest expense, income tax expense (benefit), depreciation, amortization, rent, and other special charges related to asset impairments and other losses, equity in loss of communities that are managed by the Company and owned by special purpose entities, other income (expense), minority interest, and extraordinary items. While NOI and EBITDAR are not GAAP measurements, the Company believes they are relevant in analyzing its operating results. (3) Corporate/other revenues represent the Company's development and management fee revenues. Corporate/Other NOI includes operating expenses related to corporate operations, including human resources, financial services, and information systems, as well as senior living network and assisted living management costs. (4) Includes $7.0 million and $30.2 million of additional lease expense for the three and six months ended June 30, 2002 as a result of sale lease-back transactions. See note 4 to the condensed consolidated financial statements. 15 (5) Includes $2.3 million and $ 8.8 million of additional amortization expense for the three and six months ended June 30, 2002 as a result of sale lease-back transactions. See note 4 to the condensed consolidated financial statements. 8. COMMITMENTS AND CONTINGENCIES The Company is subject to various legal proceedings and claims that arise in the ordinary course of its business. In the opinion of management, the ultimate liability with respect to those proceedings and claims will not materially affect the financial position, operations, or liquidity of the Company. The Company maintains commercial insurance on a claims-made basis for medical malpractice and professional liabilities. Insurance The Company has operated under a workers' compensation self-insurance program with excess loss coverage provided by third party carriers since July 1995. During July 2002, the Company renewed its self-insurance for workers' compensation claims with excess loss coverage of $350,000 per individual claim and approximately $7.25 million in the aggregate. The Company currently provides letters of credit in the aggregate amount of $3.5 million related to this program. The letters of credit are collateralized by cash. The Company utilizes a third party administrator to process and pay filed claims. The Company has accrued amounts to cover open claims not yet settled and incurred but not reported claims as of June 30, 2002, which management believes are adequate. The delivery of personal and health care services entails an inherent risk of liability. In recent years, participants in the senior living and health care services industry have become subject to an increasing number of lawsuits alleging negligence or related legal theories, many of which involve large claims and result in the incurrence of significant defense costs and significant exposure. The Company currently maintains property, liability, and professional medical malpractice insurance policies for the Company's owned, leased and certain of its managed communities under a master insurance program. The number of insurance companies willing to provide general and professional liability insurance for the nursing and assisted living industry has declined dramatically and the premiums and deductibles associated with such insurance have risen substantially in recent years. The Company's previous liability policies expired on July 1, 2001, and the Company was able to obtain an extended policy through December 2001 only by paying significantly higher premiums and agreeing to higher deductibles (ranging from $200,000 to $3,000,000). As a result, in the third quarter of 2001, the Company began incurring significantly higher costs for premiums and accruals for potential liability claims. As part of this renewal process, four incidents were excluded from policy coverage. To date, the Company believes one of these incidents may result in liability exposure to the Company, and the Company has established an accrual for this claim as of June 30, 2002. The Company renewed this liability policy effective January 1, 2002, expiring December 31, 2002, paying increased premiums and continuing the foregoing deductible program. The Company also has underlying and umbrella excess liability protection policies in the amount of up to $25.0 million in the aggregate. On January 1, 2002, the Company became self-insured for employee medical coverage. The Company maintains stop loss insurance coverage of $150,000 per employee and approximately $17.7 million for aggregate claims. Estimated costs related to these self-insurance programs are accrued based on known claims and projected settlements of unasserted claims incurred but not yet reported to the Company. Subsequent changes in actual experience (including claim costs, claim frequency, and other factors) could result in additional costs to the Company. Leases As of June 30, 2002, the Company operated 38 of its senior living communities under long-term leases. Of the 38 communities, 11 are operated under a master lease agreement, with the remaining communities leased under individual agreements. The Company also leases its corporate offices and is obligated under a ground lease for a senior living community purchased during 2001. The remaining base lease terms vary from five to 22 years. Certain of the leases provide for renewal and purchase options. 16 Synthetic Leases At June 30, 2002, the Company operated nine of its leased senior living communities under leases which are treated as operating leases for financial reporting purposes and financing leases for income tax purposes (synthetic leases). As of June 30, 2002, the Company had approximately $80.6 million of assets related to the nine communities being operated under synthetic leases (including $31.1 million of notes receivable, $37.4 million of security deposits and $7.4 million of land). At June 30, 2002, the Company was a guarantor on $54.0 million of the $57.6 million of third party lessor debt and had $31.1 million of notes receivable from the lessors. These leases provide the Company with termination rights whereby the Company can terminate the leases and acquire the property at predetermined amounts in exchange for assuming the lessors' debt, forgiving the notes receivable from the lessor, and repaying the lessors' equity. The Company may also elect to terminate the leases and remarket the properties on behalf of the lessors. If the net sales proceeds from a leased property are an amount higher than the lessors' costs, such excess is paid to the Company. If the net sales proceeds are less than the lessors' costs, the Company is obligated, under residual value guarantees, to pay to the lessors any shortfall, not to exceed approximately 85% of the lessors' original cost of the properties. At June 30, 2002, the Company's residual value guarantees under these nine leases aggregated $162.8 million. These residual value guaranties represent an off-balance sheet contingent liability, for which the Company does not believe it has any significant exposure for additional cash costs. In order to simplify its financial structure, and as a condition of certain elements of its Refinancing Plan, the Company will terminate these nine leases during the third quarter of 2002. Upon the termination of these leases, the Company will become the owner of each community for financial reporting purposes. See notes 4 and 10. Other A portion of the Company's skilled nursing revenues are attributable to reimbursements under Medicare. Certain temporary rate add-ons for the Company's skilled nursing reimbursement rates under the Prospective Payment System are set to expire as of October 1, 2002, unless extended by Congress. It is uncertain at this time, whether any extension of these add-ons or some portion of the add-on reimbursement rates will be approved. Failure to extend the current rate for add-on services or a reduction in the current rates would negatively impact future revenues of the Company. 9. NEW ACCOUNTING PRONOUNCEMENTS On July 30, 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards Statement No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" (SFAS No. 146). The standard replaces EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)" and requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Examples of costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity. SFAS 146 is effective prospectively to exit or disposal activities initiated after December 31, 2002. In November 2001, the Emerging Issues Task Force reached a consensus on Issue 01-14, "Income Statement Characterization of Reimbursements Received for 'Out-of Pocket' Expenses Incurred" ("EITF 01-14"), which became effective on January 1, 2002. Under EITF 01-14, certain reimbursements received for out-of-pocket expenses incurred as part of its management agreements should be characterized as revenue and the associated costs be included as operating expenses in the income statement. Upon adoption of EITF 01-14, comparative financial statements for prior periods should be reclassified to comply with the current presentation. The Company typically incurs various expenses which may include payroll, insurance and benefit related cost and other management related costs in association with its managed communities. Such costs are billed to and reimbursed by the owners of the respective communities. The Company implemented EITF 01-14 beginning with the quarter ended June 30, 2002 and as required, has also reclassified comparative financial information for the three and six months ended June 30, 2002. The implementation of EITF 01-14 resulted only in the equal gross up of revenues and expenses and did not have any impact on net earnings in any reported period. The effect of the reclassifications made by the Company pursuant to EITF No. 01-14 was to increase total revenues and total operating expenses by $1.2 million and $1.7 million and $2.7 million and $3.4 million for the three and six months ended June 30, 2002 and 2001, respectively. 17 In July 2001, the Financial Accounting Standards Board issued SFAS No. 141, Business Combinations and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 addresses financial accounting and reporting for business combinations requiring the use of the purchase method of accounting and reporting for goodwill and other intangible assets requiring that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 requires intangible assets with definite useful lives be amortized over their respective useful life to their estimated residual values, and reviewed for impairment. As of June 30, 2002, the Company had $36.5 million of goodwill. Amortization expense related to goodwill was approximately $500,000 for the six months ended June 30, 2001, or $0.03 per dilutive share. The Company adopted SFAS No. 142 on January 1, 2002. Accordingly, effective January 1, 2002, the Company no longer amortizes goodwill. Goodwill amortization expense for the three and six months ended June 30, 2001 was $250,000 and $500,000, respectively. Goodwill amortization expense was $0, $486,000 and $1.0 million for the years ended 1997, 1998, and 1999 through 2001, respectively. Basic and diluted earnings per share, excluding the impact of prior periods' goodwill amortization expense, are as follows:
Three Six Year Ended December 31, ----- ---- ----------------------------------------- Months Ended 1997 1998 1999 2000 2001 June 30, 2001 ---- ---- ---- ---- ---- ------------- Basic earnings (loss) per share from continuing operations before extraordinary item and cumulative effect of change accounting principle $0.71 $0.18 $ (0.28) $(1.97) $(0.22) $(0.39) Basic EPS $0.53 $0.18 $(0.28) $(1.97) $(0.26) $(0.40) Pro forma basic earnings per share before extraordinary item available for distribution to partners and shareholders $0.36 Basic earnings (loss) per share from continuing operations before extraordinary item and cumulative effect of change in accounting principle $0.70 $0.18 $(0.28) $(1.97) $(0.22) $(0.39) Diluted EPS $0.53 $0.18 $(0.28) $(1.97) $(0.26) $(0.40) Pro forma diluted earnings per share before extraordinary item available for distribution to partners and shareholders $0.35
With the adoption of SFAS No. 142, the Company has reassessed the useful lives and residual values of all intangible assets acquired in purchase business combinations, and has determined that no amortization period adjustments are required. As of June 30, 2002, the Company has not identified any intangible assets with indefinite useful lives, other than goodwill. The transitional provisions of SFAS No. 142 require the Company to perform an assessment of whether there is an indication that goodwill is impaired as of the date of adoption. To accomplish this, the Company must identify its reporting units and determine the carrying value of each reporting unit by assigning the assets and liabilities, including the existing goodwill and intangible assets, to those reporting units as of the date of 18 adoption. For purposes of allocating and evaluating goodwill and intangible assets, the Company considers retirement centers and Free-standing AL's as its reporting units. All recorded goodwill as of the date of adoption was attributable to the retirement centers reporting unit. The Company has up to six months from the date of adoption to determine the fair value of each reporting unit and compare it to the reporting unit's carrying amount. To the extent a reporting unit's carrying amount exceeds its fair value, an indication exists that the reporting unit's goodwill may be impaired and the Company must perform the second step of the transitional impairment test. The Company has completed step one and believes that its goodwill is not impaired. In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which supersedes both SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business (as previously defined in APB Opinion No. 30). SFAS No. 144 retains the fundamental provisions in SFAS No. 121 for recognizing and measuring impairment losses on long-lived assets held for use and long-lived assets to be disposed of by sale, while also resolving significant implementation issues associated with SFAS No. 121. For example, SFAS No. 144 provides guidance on how a long-lived asset that is used as part of a group should be evaluated for impairment, establishes criteria for when a long-lived asset is held for sale, and prescribes the accounting for a long-lived asset that will be disposed of other than by sale. SFAS No. 144 retains the basic provisions of APB Opinion No. 30 on how to present discontinued operations in the income statement but broadens that presentation to include a component of an entity (rather than a segment of a business). Unlike SFAS No. 121, an impairment assessment under SFAS No. 144 will never result in a write-down of goodwill. Rather, goodwill is evaluated for impairment under SFAS No. 142. The Company adopted SFAS No. 144 on January 1, 2002. The adoption had no material impact on the Company's current year financial statements because the impairment assessment under SFAS No. 144 is largely unchanged from SFAS No. 121. 10. SUBSEQUENT EVENTS On July 1, 2002 the Company replaced $18.8 million of mortgage debt due August 31, 2002 with a $18.5 million mortgage note bearing interest at the greater of 7.25% or 4% above one-month LIBOR. Principal and interest are due monthly with remaining principal and unpaid interest due July 1, 2007. The Company purchased an interest rate cap agreement for $106,000, which would limit the Company's interest expense if one-month LIBOR should exceed 6.5% during the term of the mortgage. The Company used the proceeds from the replacement mortgage note to repay the remaining $18.5 million balance outstanding under the Company's $95 million revolving credit facility and in the process, terminated a synthetic lease and became the owner of the previously leased assets including $12.8 million of property and equipment. The $18.8 million note is secured by certain land, buildings, and equipment affiliated with a community in Arizona. The community has 344 units, of which 217 are independent living, 70 are assisted living, 15 are memory enhanced and 42 are skilled nursing. On July 11, 2002 the Company terminated synthetic leases on two communities in South Carolina and Arizona and the Company became the owner of each community. The termination of the synthetic leases facilitated the Company simultaneously selling and leasing-back these communities and certain others on the same date (see below). The Company did not incur any cash costs in connection with the termination of the synthetic leases other than transaction costs. On July 11, 2002 the Company sold for $56.5 million three retirement centers in Arizona, Colorado, and Texas and two Free-standing ALs in South Carolina and Florida. The Company used a portion of the sale proceeds to repay debt associated with the properties. The Company contemporaneously leased these properties back from the buyer. The leases are classified as operating leases, with the exception that one of the retirement center leases is recorded as a capital lease and the Company recorded $30.1 million of lease obligation as debt in connection with the retirement center lease. Note that this lease agreement additionally includes other communities previously leased by the Company to the lessor. 19 On July 11, 2002 the Company modified the February 7, 2002 master lease agreement which included 11 communities, one Retirement Center and ten Free-standing ALs, into two new master lease agreements (Pool I and Pool II). The Pool I lease agreement includes one Retirement Center and six Free-standing ALs from the original lease, as well as two additional Retirement Centers from the July 11, 2002 sale. The Pool II lease agreement includes four Free-standing ALs from the original lease, as well as one Retirement Centers and two Free-standing ALs from the July 11, 2002 sale leaseback transaction. Pool I is a 12-year lease with four ten-year renewal options and the Company has the right of first refusal to repurchase the communities. Pool II is a 10-year lease with four ten-year renewal options and the Company has the right of first refusal to repurchase the communities. These master leases will be treated as operating leases for financial reporting purposes. On July 18, 2002, the Company refinanced $25.7 million of mortgage debt on three communities and two land parcels. Under the terms of the new mortgage debt agreements, previous maturities ranging from 2002 to 2006 were amended to 2004 and certain financial covenants were eliminated or amended. Measurement of the modified covenants begins on September 30, 2002. On July 26, 2002, the Company terminated synthetic leases on three Free-standing AL's in Texas and the Company became the owner of each community. The Company did not incur any cash costs in connection with the termination of the synthetic leases other than transaction costs. Simultaneously, the Company extended and modified an existing $11.0 million mortgage note and refinanced $33.7 million of mortgage debt on the three communities which the Company previously leased under synthetic leases and for which the Company was guarantor. The original maturities were extended to 2004, and certain existing financial covenants were amended, the measurement of which begins on September 30, 2002. Interest on the notes increased from 6.75% to 7.25%. In connection with the extended and modified notes, in the event that the Company does not repay the Debentures on or before October 1, 2002, or extend such Debentures to a date no earlier than 2004, the Company would be in default and the Lender could exercise its contractual remedies, including all amounts due being payable on demand. On August 2, 2002, the Company determined that assets acquired in 2001 as part of a like-kind exchange, specifically land in Virginia and land and buildings associated with the equity interests in a single member limited liability company that the Company acquired during 2001, would be placed for sale. The value of the land and buildings, net of accumulated depreciation, as of June 30, 2002, is $29.2 million. As of June 30, 2002, the Company had a $12.0 million non-recourse mortgage loan bearing interest at 7.43% with principal due monthly, and a maturity date of January 2024 and a $15.1 million non-recourse mortgage loan, with interest at 8.41% and principal and interest due monthly, and a maturity date of September 2005, respectively, related to these assets. The Company acquired the various land parcels subject to lease agreements that provide annual rental payments of $980,000 through February 23, 2023 and $1.3 million through March 7, 2022, respectively. The Company has no reason to believe the sale prices for these assets will be below the net book value, however, the Company will continue to evaluate the land parcels and buildings for impairment. On August 14, 2002, as part of the Refinancing Plan, the Company initiated an Exchange Offer seeking to exchange up to $126.0 million of the Debentures. On August 14, 2002, the Company also entered into the HCPI Loan Agreement pursuant to which HCPI has agreed to make the HCPI Loan to one of the Company's subsidiaries in the amount of $112.8 million. The Company also contemporaneously entered into the HCPI Investment Agreement under which HCPI has agreed to make the $12.2 million HCPI Equity Investment in certain other subsidiaries of the Company. See note 2. 20 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company is a national senior living and health care services provider offering a broad range of care and services to seniors within a residential setting. As of June 30, 2002, the Company operated 65 senior living communities, consisting of 31 large continuing care retirement communities and independent living communities ("Retirement Centers") and 34 Free-standing ALs in 14 states with an aggregate capacity for approximately 11,200 and 3,200 residents, respectively. The Company owns 21 communities, leases 38 communities pursuant to long-term leases, and manages six communities pursuant to management agreements. Of its Retirement Centers, the Company owns 12, leases 13, and manages six. Of its Free-standing ALs, the Company owns nine and leases 25. During the three months ended June 30, 2002 and 2001, the Company's Retirement Centers and Free-standing ALs generated 76.6% and 23.4%, and 85.8% and 14.2%, respectively, of resident and healthcare revenues. During the six months ended June 30, 2002 and 2001, the Company's Retirement Centers and Free-standing ALs generated 76.6% and 23.4%, and 86.6% and 13.4%, respectively, of resident and healthcare revenues. The Company's long-term strategy is to develop and operate multiple communities within a major metropolitan region in order to create a Senior Living Network that provides a continuum of housing and care for seniors. Many of the Free-standing ALs are located within the same major metropolitan regions as the Retirement Centers and function as satellites to those Retirement Center hubs in order to form Senior Living Networks and expand the continuum of housing and care into the market. The Company believes that this hub and satellite approach produces management efficiencies and market penetration by offering a range of senior living arrangements at various price levels. CRITICAL ACCOUNTING POLICIES Certain critical accounting policies are complex and involve significant judgments by management, including the use of estimates and assumptions, which affect the reported amounts of assets, liabilities, revenues and expenses. As a result, changes in these estimates and assumptions could significantly affect the Company's financial position or results of operations. The Company bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. The significant accounting policies used in the preparation of the Company's financial statements are more fully described in the Company's Annual Report on Form 10-K for the year ended December 31, 2001 and the Company's consolidated financial statements and the notes thereto. SYNTHETIC LEASE COMMUNITIES As of December 31, 2001, the Company operated 14 of its communities (two Retirement Centers and 12 Free-standing ALs) under an operating lease structure commonly referred to as a synthetic lease. During the fourth quarter of 2001, the Company determined that in order to simplify its financial structure, and as a condition of certain elements of its Refinancing Plan, it would terminate all synthetic leases during 2002. Upon the termination of these synthetic leases, the Company will become the owner of each community for financial reporting purposes. The Company will not incur any cash costs in connection with the termination of the synthetic leases other than transaction costs. As of June 30, 2002, 21 the Company had completed the termination of five of these 14 synthetic leases. The Company operated nine of its communities (two Retirement Centers and seven Free-standing ALs) under synthetic leases and subsequently completed the termination of six additional synthetic leases. The Company expects to terminate the three remaining synthetic leases during the third quarter of 2002. Upon completion of these three transactions, the Company will not have any remaining synthetic leases. The Company has substantial investments in these synthetic lease communities in the form of land, security deposits (certificates of deposit and treasury bills) and loans to the lessors (notes receivable). The Company has pledged security deposits to the lessors to secure its obligations under the synthetic lease agreements. As of June 30, 2002, the Company had approximately $80.6 million of assets related to the nine communities being operated under synthetic leases (including $31.1 million of notes receivable, $37.4 million of security deposits and $7.4 million of land). The Company owns the land under seven of these synthetic lease communities, and leases such land to the lessors under long-term operating leases. As of June 30, 2002, of the third party mortgage debt secured by the synthetic lease assets, the Company is the borrower of approximately $5.6 million of mortgage loans, which is debt recorded on the Company's condensed consolidated balance sheets. As of June 30, 2002, the Company is the guarantor of approximately $54.0 million of third party mortgage debt associated with these synthetic leases which were made directly to the lessors and therefore are not recorded on the Company's condensed consolidated balance sheet. This nonconsolidated debt is secured by the synthetic lease assets, and is cross-defaulted with a portion of the Company's consolidated debt. SALE LEASE-BACK TRANSACTIONS The table below summarizes the sale lease-back transactions that the Company completed during the six months ended June 30, 2002 into two categories. The first six communities presented are accounted for as capital leases as a result of contingent earnout agreements or conditional purchase options. The remaining three communities presented are accounted for as operating leases.
INCREASE IN REDUCTION NEW CAPITAL LAND, BUILDINGS IN NOTES LEASE TRANSACTION 2002 COMMUNITY PROCEEDS AND EQUIPMENT RECEIVABLE OBLIGATION(2) LOSSES(3) - --------------- ------------------------------- ---- ---------- ---------------- ------------ ------------ ------------ (in thousands) February 12 Free-standing AL in Florida (1) $ 9,687 9,687 (8,559) (9,687) 1,381 March 22 Free-standing AL in Colorado (1) 17,865 17,865 (20,012) (17,865) 5,817 March 28 Three (3) Free-standing ALs (1) 18,200 18,200 (29,537) (18,200) 17,786 March 28 Retirement Center in Texas 25,000 25,000 - (25,000) - ---------- ---------------- ------------ ------------ ------------ $70,752 70,752 (58,108) (70,752) 24,984 ========== ================ ============ ============ ============
REDUCTION IN DEFERRED LAND, BUILDINGS REDUCTION TRANSACTION 2002 COMMUNITY PROCEEDS AND EQUIPMENT IN DEBT GAINS - --------------- ------------------------------- ---- ---------- ---------------- ------------ ------------ (in thousands) Retirement Center in North January 1 Carolina $ 45,000 (32,802) 34,780 11,758 February 12 Retirement Center in Illinois 18,469 (12,669) 12,933 5,268 March 28 Retirement Center in Florida 30,000 (28,387) 19,538 697 ---------- ---------------- ------------ ------------ $ 93,469 (73,858) 67,251 17,723 ========== ================ ============ ============
(1) In conjunction with the Refinancing Plan, the Company determined during the fourth quarter of 2001 to terminate all of the synthetic leases and subsequently enter into sale lease-back transactions with respect to eight of the fourteen synthetic lease communities during the first and second quarters of 2002. As of June 30, 2002, the Company had completed five of the eight synthetic lease termination and sale lease-back transactions. These transactions raised gross proceeds of $45.8 million, net of $1.3 million of transaction costs. (2) For financial reporting purposes, these capital lease obligations are included in debt. (3) The determination of transaction losses assumes $5.3 million of estimated earnout payments. As a result of the completed and anticipated transactions under the Refinancing Plan, the Company has recorded losses from sale lease-back transactions of $7.9 million during the quarter ended December 31, 2001, $23.2 million during the quarter ended March 31, 2002, and $7.0 million during the quarter ended June 30, 2002, bringing the total loss on these sale lease-back transactions to $38.1 million ($30.2 million for the six months ended June 30, 2002). For financial reporting purposes, these losses are considered residual value guarantee amounts and have been fully recognized as lease expense. See note 4 to the condensed consolidated financial statements. 22 In addition, because the Company's sale lease-back transactions resulted in the early termination of certain existing synthetic leaseholds, the Company accelerated the amortization of leasehold acquisition costs beginning in the fourth quarter of 2001. As a result of this acceleration, the Company recorded additional amortization costs of $472,000 during the quarter ended December 31, 2001, $6.5 million during the quarter ended March 31, 2002, and $2.3 million of additional amortization during the quarter ended June 30, 2002, bringing the total amount of accelerated amortization related to these sale lease-back transactions to $9.3 million ($8.8 million for the six months ended June 30, 2002). The Company has not incurred, and does not expect to incur, any cash costs other than transaction costs in connection with these transactions. Given the long-term nature of the lease-back arrangements, the Company views these transactions as long term financings. As such, the Company believes that although sale lease-back accounting rules require the recognition of a loss in the amount of the difference between the sales prices and the Company's cost basis in the assets (including the leasehold acquisition costs of its synthetic leases), the Company will continue to derive economic benefits from the assets in the form of future payments under the earn-out provisions in excess of the amounts currently included in the sales price, as well as from any improvement in operating results as the communities increase occupancy and performance. RESULTS OF OPERATIONS The Company reported a net loss of $19.4 million, or $1.12 loss per diluted share, on total revenues of $82.6 million, as compared with net loss of $4.6 million, or $0.27 loss per diluted share, on revenues of $65.1 million for the three months ended June 30, 2002 and 2001, respectively. The loss of $1.12 per dilutive share for the three months ended June 30, 2002 was entirely comprised of a loss from continuing operations. The Company reported a net loss of $57.5 million, or $3.33 loss per diluted share, on total revenues of $159.4 million, as compared with net loss of $7.4 million, or $0.43 loss per diluted share, on revenues of $127.2 million for the six months ended June 30, 2002 and 2001, respectively. The loss of $3.33 per dilutive share for the six months ended June 30, 2002 was comprised of a $3.28 loss from continuing operations, plus a $0.04 loss from the extinguishment of debt. Included in the loss from continuing operations for the three and six months ended June 30, 2002 is approximately $7.0 million and $30.2 million, respectively, of additional lease expense resulting from losses on certain sale lease-back transactions, and approximately $2.3 million and $8.8 million, respectively, of accelerated leasehold acquisition cost amortization from these transactions. See notes 4 and 8 to the condensed consolidated financial statements. REVENUES The Company's revenues from continuing operations are comprised of resident and health care revenues, which includes revenues from the Company's owned and leased communities and management and development services revenues, which include fees, net of reimbursements, for the development, marketing, and management of communities owned by third parties. The following table sets forth each of the components of the Company's revenues as a percentage of the total revenues for the three and six months ended 2002 and 2001: 23
THREE MONTHS ENDED SIX MONTHS ENDED ------------------ ---------------- JUNE 30, JUNE 30, JUNE 30, JUNE 30, 2002 2001 2002 2001 Resident and health care revenues: Monthly service fees and ancillary revenues from independent and assisted living residents 72.4% 74.0% 72.8% 73.7% Per diem charges from skilled nursing and 23.1% 19.3% 22.9% 19.5% therapy services Amortization of non-refundable entrance fees(1) 2.3% 2.6% 2.2% 2.8% Management and development services 0.7% 1.5% 0.4% 1.3% Reimbursable out-of-pockets 1.5% 2.6% 1.7% 2.7% ------------ ------------ ------------- ----------- Total revenues 100.0% 100.0% 100.0% 100.0% ============ ============ ============= ===========
(1) Amortized over each resident's actuarially determined life expectancy (or building life for contingent refunds). The Company's management agreements are generally for terms of three to 20 years, but certain of such agreements may be canceled by the owner of the community, without cause, on three to six months notice. Pursuant to the management agreements, the Company is generally responsible for providing management personnel, marketing, nursing, resident care and dietary services, accounting and data processing services, and other services for these communities at the owners' expense, and receives a monthly fee for its services based either on a contractually fixed amount or a percentage of revenues or income. One of the Company's management agreements is for a community with aggregate resident capacity for approximately 900 residents and has a 20-year term, with approximately 16 years remaining, with two ten-year renewals, as well as a purchase option. The management fee for this agreement is equal to all cash received in excess of operating and financing expenses and certain cash payments to the owner of the community. The Company's existing management agreements expire at various times through June 2018. See note 6 to the condensed consolidated financial statements. SEGMENT RESULTS The Company's operations are divided into two segments: (1) Retirement Centers and (2) Free-standing ALs. The Retirement Centers are generally comprised of the Company's continuing care retirement centers and lifecare communities and its independent living communities, including those at which assisted living and/or nursing services are provided. The Retirement Centers are established communities with strong reputations within their respective markets, and generally maintain high and consistent occupancy levels, most with waiting lists of prospective residents. The Company's Retirement Centers form the core segment of the Company's business and comprise 31 of the 65 communities that the Company operates, with capacity for approximately 11,200 residents, representing approximately 78% of the total resident capacity of the Company's communities. At June 30, 2002 and 2001, the Company's Retirement Centers had occupancy rates of 92% and 93%, respectively. The Company has also developed and acquired a number of Free-standing ALs, most of which began operations during 1999 and 2000. Free-standing ALs are much smaller than Retirement Centers and generally are stand-alone communities that are not located on a Retirement Center campus. Most Free-standing ALs provide specialized care such as Alzheimer's, memory enhancement and other dementia programs. During the last several years and continuing through 2002, the Free-standing AL market has suffered from adverse market conditions, including significant overcapacity in most markets, longer than anticipated fill-up periods, price discounting and price pressures. The Company expects these conditions to continue for the intermediate term. Although the Company ceased development of additional Free-standing ALs in late 1999, many that were already in development were opened during 2000 and early 2001. The Company's community operating results include only the Free-standing ALs that the Company owns or leases. The number of Free-standing ALs included in the Company's consolidated 24 operations grew from 22 at June 30, 2001 to 34 at June 30, 2002 as a result of acquisitions of Free-standing ALs and leasehold interests of various communities that were managed by the Company and owned by special purpose entities which were owned by third parties ("Managed SPE Communities"), including leasehold interests in ten Managed SPE Communities acquired as of December 31, 2001. The Company operates 34 Free-standing ALs, with capacity for approximately 3,200 residents, representing approximately 22% of the total resident capacity of the Company's communities. Many of these Free-standing ALs are in the fill-up stage. At June 30, 2002 and 2001, the Company's Free-standing ALs had occupancy rates of 74% and 58%, respectively. The Company evaluates its performance in part based upon EBITDAR, which is defined as earnings before net interest expense, income tax expense, depreciation, amortization, rent, and other special charges related to asset impairment and other losses, equity in loss of managed special purpose entities, other income (expense), minority interest, and extraordinary items. As a result of increased occupancy, the Company's Free-standing ALs generated positive community EBITDAR since the fourth quarter of 2001. On an operating income basis, however, they are still generating losses after lease, amortization and depreciation expense. The following is a summary of total revenues, EBITDAR, and total assets by segment for the three and six months ended June 30, 2002 and 2001 (in thousands).(1)(2)(3)
THREE MONTHS ENDED JUNE 30, JUNE 30, $ % 2002 2001 CHANGE CHANGE ---- ---- ------- ------ Revenues: Retirement centers $ 61,877 $ 53,511 $ 8,366 15.6% Free-standing ALs 18,910 8,894 10,016 112.6% Corporate/other 1,856 2,693 (837) (31.1%) ----------------------------------------------------- Total $ 82,643 $ 65,098 $ 17,545 27.0% ===================================================== NOI / Community EBITDAR: Retirement centers $ 20,473 $ 18,956 $ 1,517 8.0% Free-standing ALs 1,665 (162) 1,827 1127.8% Corporate/other (6,295) (5,796) (499) (8.6%) ----------------------------------------------------- Net operating income 21.9% 15,843 12,998 2,845 Lease expense (4) 18,098 6,700 11,398 170.1% Depreciation and amortization(5) 8,504 5,195 3,309 63.7% ------------------------------------------------------ Operating income $ (10,759) $ 1,103 $ (11,862) (1075.4%) ======================================================
SIX MONTHS ENDED JUNE 30, JUNE 30, $ % 2002 2001 CHANGE CHANGE ---- ---- ------- ------ Revenues: Retirement centers $ 119,493 $ 105,749 $ 13,744 13.0% Free-standing ALs 36,547 16,328 20,219 123.8% Corporate/other 3,372 5,074 (1,702) (33.5%) -------------------------------------------------------- Total $ 159,412 $ 127,151 $ 32,261 25.4% ========================================================
25
JUNE 30, JUNE 30, $ % 2002 2001 CHANGE CHANGE ---- ---- ------- ------ NOI / Community EBITDAR: Retirement centers $ 41,184 $ 38,327 $ 2,857 7.5% Free-standing ALs 2,614 (962) 3,576 371.7% Corporate/other (12,534) (10,769) (1,765) (16.4%) --------------------------------------------------- Net operating income 31,264 26,596 4,668 17.6% Lease expense (4) 50,063 13,451 37,612 279.6% Depreciation and amortization(5) 20,648 10,287 10,361 100.7% ---------------------------------------------------- Operating (loss) income $ (40,447) $ 2,858 $ (43,305) (1515.2%) ====================================================
TOTAL ASSETS JUNE 30, DECEMBER 31, $ % 2002 2001 CHANGE CHANGE ---- ---- -- ------- ------ Total Assets: Retirement centers $ 470,231 $ 509,732 $ (39,501) (7.8%) Free-standing ALs 221,643 241,069 (19,426) (8.1%) Corporate/other 99,553 99,390 163 0.0% -------------------------------------------------------- Total $ 791,427 $ 850,191 $ (58,764) (6.9%) ========================================================
(1) Segment data does not include any inter-segment transactions or allocated costs. (2) Net Operating Income ("NOI"), or Community EBITDAR, is defined as earnings before net interest expense, income tax expense (benefit), depreciation, amortization, rent, and other special charges related to asset impairments and other losses, equity in loss of communities that are managed by the Company and owned by special purpose entities, other income (expense), minority interest, and extraordinary items. While NOI and EBITDAR are not GAAP measurements, the Company believes it is relevant in analyzing its operating results. (3) Corporate/Other revenues represent the Company's development and management fee revenues. Corporate/Other NOI includes operating expenses related to corporate operations, including human resources, financial services, and information systems, as well as senior living network and assisted living management costs. (4) Includes $7.0 million and $30.2 million of additional lease expense for the three and six months ended June 30, 2002 as a result of sale lease-back transactions. See note 4 to the condensed consolidated financial statements. (5) Includes $2.3 million and $8.8 million of additional amortization expense for the three and six months ended June 30, 2002 as a result of sale lease-back transactions. See note 4 to the condensed consolidated financial statements. PRO FORMA SEGMENT RESULTS: The following table presents, on a pro forma basis, quarterly community results on a segment basis for each of the Company's last six fiscal quarters (2002 and 2001), assuming that all communities currently owned or leased were consolidated for the entire period. As a result, the operating results for 25 Retirement Centers and 34 Free-standing ALs owned or leased as of June 30, 2002, are included for all quarters shown. This information is presented in order to show the historical results of the communities that currently make up each segment (many of which were not consolidated in some or all quarters shown). Communities managed as of June 30, 2002, communities sold during these periods, not subsequently leased-back, and unconsolidated joint ventures are excluded from all quarters shown. While this pro forma information is not presented in accordance with accounting principles generally accepted in the United States of America, the Company believes such information is useful in evaluating the Company's performance. The pro forma results of any particular quarter are not necessarily indicative of results of operations for a full year or predictive of future periods. All dollar amounts are in thousands. 26
2001 Quarter Ended Year Ended 2002 Quarter Ended --------------------------------------- ----------------------- March 31 June Sept Dec 31 Dec 31, March 31 June 30 ---------- ------ ------ -------- -------- ---------- --------- 30 30 2001 --- --- ---- Retirement Centers Revenues $55,692 $58,205 $58,696 $59,536 $232,129 $61,761 $61,877 Community EBITDAR 18,864 19,818 18,743 19,371 76,796 21,576 20,473 Free-standing ALs Revenues 11,927 13,716 15,160 16,465 57,268 17,637 18,910 Community EBITDAR (1,769) (473) (86) 648 (1,680) 949 1,665
This pro forma table shows the significant trends in each of the two business segments. Retirement Center revenues have grown primarily as a result of price increases for new residents, increased occupancy and the fill up of expansions at certain communities, growth of therapy services and the expansion of other service offerings. These revenue increases, as well as control of expenses and recoupment of expense increases through rate increases to current residents, have resulted in increases in community EBITDAR from the Retirement Centers. During 1999 and 2000, the Company opened many new Free-standing AL communities which added significant unit capacity to the Company's portfolio of Free-standing ALs. Free-standing AL revenues have increased primarily as a result of increased occupancy as Free-standing AL communities fill-up. Free-standing AL revenues have also increased as a result of selective price increases and growth of ancillary revenues. As the Free-standing AL communities continue to fill, the Company expects community EBITDAR to increase. THREE MONTHS ENDED JUNE 30, 2002 COMPARED WITH THE THREE MONTHS ENDED JUNE 30, 2001 Revenues. Total revenues were $82.6 million in the quarter ended June 30, 2002, compared to $65.1 million in the quarter ended June 30, 2001, representing an increase of $17.5 million, or 27.0%. Resident and health care revenues increased by $18.4 million, management and development services revenue decreased by $344,000 during the 2002 period, and reimbursable out-of-pocket revenues decreased $493,000. The increases in resident and health care revenues resulted primarily from an increase of: (a) approximately $6.5 million as a result of the increase in the number of Free-standing ALs included in the Company's consolidated operations, as well as $2.8 million related to the continued fill-up of these communities, (b) $3.5 million and $1.8 million related to the April 2002 and July 2001 long-term leases of Freedom Plaza Arizona and Freedom Plaza Care Center, respectively, (c) an increase of $1.8 million in revenue from therapy services, (d) $704,000 attributable to increased capacity as a result of Retirement Center expansions and (e) $2.1 million related increased average occupancy and additional entrance fee revenues. The offsetting decrease relates to the July 1, 2001 sale of Rossmoor Regency, which had $1.2 million in total revenues for the three months ended June 30, 2001. Management and development services revenue and reimbursable out-of-pocket revenues decreased by $344,000 and $493,000 and decreased as a percentage of total revenue to 0.7% and 1.5% in the quarter ended June 30, 2002 from 1.5% and 2.6% in the quarter ended June 30, 2001, respectively. The decrease is primarily related to the reduction in managed communities, decreased management fees at certain properties as a result of lower sales of new units, which reduces the formula-based management fees, as well as the decrease in the number of managed communities from 20 at June 30, 2001 to six at June 30, 2002, including Freedom Plaza Arizona and Freedom Plaza Care Center. Retirement Center resident and health care revenues were $61.9 million in the quarter ended June 30, 2002, compared to $53.5 million in the quarter ended June 30, 2001, representing an increase of $8.4 million, or 15.6%. This increase resulted primarily from additional revenues as a result of the long-term lease, and consolidation of Freedom Plaza Arizona and Freedom Plaza Care Center, increased capacity related to expansions and increased 27 therapy services provided by the Company during 2002. Retirement Center resident and health care revenues were also positively affected by increased average occupancy and additional entrance fee revenues. Free-standing AL resident and health care revenues increased from $8.9 million in the quarter ended June 30, 2001 to $18.9 million in the quarter ended June 30, 2002. This increase is largely related to the increase in the number of Free-standing ALs included in the Company's consolidated operations from 22 to 34 communities, as well as increased occupancy at these communities. Community Operating Expense. Community operating expense increased to $59.0 million in the quarter ended June 30, 2002, as compared to $43.6 million in the quarter ended June 30, 2001, representing an increase of $15.4 million, or 35.3%. The increase in community operating expense was primarily attributable to communities acquired or leased during 2001 and expansions. Additionally, the increase was the result of increased labor, insurance, utility, property and marketing costs at various new communities, as well as costs associated with the expansion of therapy services to additional communities during 2001 and 2002. Community operating expense as a percentage of resident and health care revenues increased to 73.0% from 69.9% for the quarters ended June 30, 2002 and 2001, respectively, primarily attributable to the acquisition of leasehold interests in various Managed SPE Communities during the second half of 2001 which are in the fill-up stage. The Company expects community operating expense to remain at greater than historical levels as a percentage of resident and health care revenues as the Free-standing ALs acquired during 2001 complete the fill-up stage. Retirement Center operating expenses were $41.4 million in the quarter ended June 30, 2002, compared to $34.6 million in the quarter ended June 30, 2001, representing an increase of $6.8 million, or 19.7%. Approximately $3.1 and $1.8 million of this increase was attributable to the April 1, 2002 and July 1, 2001 long-term lease of Freedom Plaza Arizona and Freedom Plaza Care Center, respectively. In addition, the expansions at several Retirement Centers increased operating expenses by $630,000. Finally, $926,000 of the increase related to expenses associated with increased therapy services during the quarter ended June 30, 2002. The remaining increase relates primarily to increased average occupancies resulting in increased Retirement Center operating expenses. Free-standing AL operating expenses increased from $9.1 million in the quarter ended June 30, 2001 to $17.2 million in the quarter ended June 30, 2002. This increase is largely related to the increase in the number of Free-standing ALs included in the Company's consolidated operations from 22 to 34 communities, as well as increased occupancy at these communities. General and Administrative. General and administrative expense decreased to $6.5 million for the quarter ended June 30, 2002, as compared to $6.8 million for the quarter ended June 30, 2001, representing a decrease of $202,000, or 3.0%. This decrease is primarily attributable to additional accruals in the prior period for general and professional liability claims, workers' compensation, and other insurance related accruals, resulting from general conditions in the insurance markets and changes in the Company's insurance program at that time. General and administrative expense as a percentage of total revenues decreased to 7.9% compared to 10.4% for the quarters ended June 30, 2002 and 2001, respectively. EBITDAR (Community NOI). EBITDAR increased $2.8 million from $13.0 million in the quarter ended June 30, 2001 to $15.8 million in the quarter ended June 30, 2002 as further described below. Retirement Center EBITDAR increased $1.5 million, or 8.0%, from $19.0 million for the quarter ended June 30, 2001 to $20.5 million for the quarter ended June 30, 2002. This increase primarily relates to the April 2002 and July 2001 addition of the long-term leases of Freedom Plaza Arizona and Freedom Plaza Care Center, as well as continued operational improvement throughout the Retirement Centers, resulting from stabilized occupancy and increased capacity through expansions, rate increases, and improved control of community-level overhead expense. Free-standing AL EBITDAR improved by $1.8 million from a $162,000 loss in the quarter ended June 30, 2001, to $1.7 million of income in the quarter ended June 30, 2002, primarily as a result of increased occupancy at these communities. 28 Other EBITDAR losses increased $499,000 to $6.3 million in the quarter ended June 30, 2002 resulting from $972,000 of legal and consulting costs affiliated with the exchange of a debt instrument, as well as the $344,000 reduction in management and development fees. These costs were offset by approximately $198,000 of reductions in bad debt expense and $684,000 of reductions in general liability and other insurance accruals in the prior period. The remaining increase relates to additional costs associated with therapy services, marketing, corporate operations, human resources, financial services and overhead, and increased senior living network and assisted living management costs. Lease Expense. As of June 30, 2002, the Company had operating leases for 38 of its communities, including 13 Retirement Centers and 25 Free-standing ALs. Lease expense increased $11.4 million from $6.7 million for the quarter ended June 30, 2001 to $18.1 million for the quarter ended June 30, 2002. Lease expense (excluding synthetic leases) increased to $9.1 million for the quarter ended June 30, 2002, as compared to $4.0 million for the quarter ended June 30, 2001, representing an increase of $5.1 million. This increase was attributable to 15 additional leases entered into by the Company during 2001 and 2002, consisting of five Retirement Center leases which increased lease expense $3.4 million, and the acquisition of leasehold interests in ten Free-standing AL communities, which increased lease expense $1.7 million. As of June 30, 2002, the Company operated nine of its communities, including two Retirement Centers and seven Free-standing ALs, under operating lease structures commonly referred to as synthetic leases. Synthetic lease expense increased to $9.0 million for the quarter ended June 30, 2002, as compared to $2.7 million for the quarter ended June 30, 2001, representing an increase of $6.3 million. Of the total $9.0 million of synthetic lease expense for the quarter ended June 30, 2002, $2.1 million related to Retirement Centers and $6.9 million related to Free-standing ALs. Of the total $9.0 million of synthetic lease expense for the quarter ended June 30, 2002, $7.0 million resulted from residual value guarantee amounts related to losses on sale leaseback transactions, of which $1.7 million related to Retirement Centers and $5.3 million related to Free-standing ALs. As a result of completed and anticipated transactions under the Refinancing Plan, the Company has recorded losses from sale lease-back transactions of $7.9 million during the quarter ended December 31, 2001 and $23.2 million during the quarter ended March 31, 2002, and $7.0 million for the quarter ended June 30, 2002, bringing the total loss on these sale lease-back transactions to approximately $38.1 million. For financial reporting purposes, these losses are considered residual value guarantee amounts and have been fully recognized as lease expense. Depreciation and Amortization. Depreciation and amortization expense increased to $5.5 million in the quarter ended June 30, 2002 from $4.8 million in the quarter ended June 30, 2001, representing an increase of $711,000, or 14.8%. The increase was primarily related to the increase in depreciable assets of approximately $19.7 million. These assets relate primarily to the acquisition of communities, including leasehold interests, and expansion of communities since June 30, 2001, as well as ongoing capital expenditures. Amortization of Leasehold Acquisition Costs. Amortization of leasehold acquisition costs increased $2.6 million from $396,000 in the quarter ended June 30, 2001 to $3.0 million in the quarter ended June 30, 2002. During the fourth quarter of 2001, the Company determined that in order to simplify its financial structure, and as a condition of certain elements of its Refinancing Plan, it would exercise its termination rights under its synthetic leases during 2002. As a result of the completed and anticipated transactions under the Refinancing Plan, which would result in a shorter than expected remaining life of various leases, the Company accelerated the amortization of leasehold acquisition costs beginning in the fourth quarter of 2001. As a result of this acceleration, the Company recorded additional amortization costs of $472,000 during the quarter ended December 31, 2001, $6.5 million during the quarter ended March 31, 2002, and $2.3 million of additional amortization during June 30, 2002, bringing the total amount of accelerated amortization related to these sale lease-back transactions to $9.3 million. The remaining portion of this increase relates to the acquisition of twelve leasehold interests in Free-standing ALs during 2001. Other Income (Expense). Interest expense increased to $10.0 million in the quarter ended June 30, 2002 from $9.3 million in the quarter ended June 30, 2001, representing an increase of $676,000, or 7.3%. Although total indebtedness has decreased slightly to $514.8 million from $520.2 million at June 30, 2002 and June 30, 2001, respectively, this increase was primarily attributable to a higher average amount of indebtedness, prior to certain 29 refinancing transactions, during the six months ended June 30, 2002, as well as higher interest rates. Interest expense, as a percentage of total revenues, decreased to 12.1% for the quarter ended June 30, 2002 from 14.3% in the quarter ended June 30, 2001. Considering certain financings expected to be completed in the refinancing plan, the Company expects interest expense to continue at greater than historical levels as a percentage of total revenues. Interest income decreased to $1.3 million in the quarter ended June 30, 2002 from $3.0 million in the quarter ended June 30, 2001, representing a decrease of $1.7 million, or 57.3%. The decrease in interest income was primarily attributable to lower income generated from the reduced amount of certificates of deposit and notes receivable balances associated with certain leasing transactions and management agreements. Equity in loss of Managed SPE Communities (representing the losses that the Company funded when operating deficits at the Managed SPE Communities exceeded specified limits) decreased from $972,000 in the quarter ended June 30, 2001 to $0 in the quarter ended June 30, 2002. The Company had no further Managed SPE Communities after December 31, 2001. Income Tax Benefit. The provision for income taxes was a $122,000 expense, compared to a $2.0 million benefit for the quarters ended June 30, 2002 and 2001, respectively. The Company has applied a full valuation allowance against its net operating carryforwards. Net Loss. Based upon the factors noted above, the Company experienced a net loss of $19.4 million, or $1.12 loss per dilutive share, compared to a net loss of $4.6 million, or $0.27 loss per dilutive share, for the quarters ended June 30, 2002 and 2001, respectively. The $1.12 loss per dilutive share for the quarter ended June 30, 2002 was comprised of a $1.12 loss from operations. The loss of $0.27 per dilutive share for the quarter ended June 30, 2001 was comprised of a $0.23 loss from operations and a $0.03 loss from the extinguishment of debt. SIX MONTHS ENDED JUNE 30, 2002 COMPARED WITH THE SIX MONTHS ENDED JUNE 30, 2001 Revenues. Total revenues were $159.4 million in the six months ended June 30, 2002, compared to $127.2 million in the six months ended June 30, 2001, representing an increase of $32.3 million, or 25.4%. Resident and health care revenues increased by $34.0 million, management and development services revenue decreased by $988,000, and reimbursable out-of-pocket revenues decreased $713,000 during the 2002 period. The increases in resident and health care revenues resulted primarily from an increase of: (a) approximately $12.7 million as a result of the increase in the number of Free-standing ALs included in the Company's consolidated operations, as well as $6.1 million related to the continued fill-up of these communities, (b) $3.5 million and $3.5 million related to the April 2002 and July 2001 long-term leases of Freedom Plaza Arizona and Freedom Plaza Care Center, respectively, (c) an increase of $3.4 million in revenue from therapy services, and (d) $1.4 million attributable to increased capacity as a result of Retirement Center expansions. The remaining increase relates primarily to increased average occupancy and additional entrance fee revenues. Management and development services and reimbursable out-of-pocket revenue decreased by $988,000 and $713,000 and decreased as a percentage of total revenue to 0.4% and 1.7% in the six months ended June 30, 2002 from 1.3% and 2.7% in the six months ended June 30, 2001. The decrease is primarily related to the reduction in managed communities, decreased management fees at certain properties as a result of lower sales of new units, which reduces the formula-based management fees, as well as the decrease in the number of managed communities from 20 at June 30, 2001 to six at June 30, 2002, including Freedom Plaza Arizona and Freedom Plaza Care Center. Retirement Center resident and health care revenues were $119.5 million in the six months ended June 30, 2002, compared to $105.8 million in the six months ended June 30, 2001, representing an increase of $13.8 million, or 13.0%. This increase resulted primarily from additional revenues as a result of the long-term lease, therefore now consolidated, Freedom Plaza Arizona and Freedom Plaza Care Center, increased capacity related to expansions and increased therapy services provided by the Company during 2002. Retirement Center resident and health care revenues were also positively affected by increased average occupancy and additional entrance fee revenues. Free-standing AL resident and health care revenues increased from $16.3 million in the six months ended June 30, 2001 to $36.5 million in the six months ended June 30, 2002. This increase is largely related to the increase in the number of Free-standing ALs included in the Company's consolidated operations from 22 to 34 communities, as well as increased occupancy at these communities. 30 Community Operating Expense. Community operating expense increased to $113.0 million in the six months ended June 30, 2002, as compared to $85.4 million in the six months ended June 30, 2001, representing an increase of $27.6 million, or 32.3%. The increase in community operating expense was primarily attributable to communities acquired or leased during 2001 and expansions. Additionally, the increase was the result of increased labor, insurance, utility, property and marketing costs at various new communities, as well as costs associated with the expansion of therapy services to additional communities during 2001 and 2002. Community operating expense as a percentage of resident and health care revenues increased to 72.4% from 70.0% for the quarters ended June 30, 2002 and 2001, respectively, primarily attributable to the acquisition of leasehold interests in various Managed SPE Communities during the second half of 2001 which are in the fill-up stage. The Company expects community operating expense to remain at greater than historical levels as a percentage of resident and health care revenues as the Free-standing ALs acquired during 2001 complete the fill-up stage. Retirement Center operating expenses were $78.3 million in the six months ended June 30, 2002, compared to $67.4 million in the six months ended June 30, 2001, representing an increase of $10.9 million, or 16.2%. Approximately $3.1 and $3.5 million of this increase was attributable to the April 1, 2002 and July 1, 2001 long-term lease of Freedom Plaza Arizona and Freedom Plaza Care Center, respectively. In addition, the expansions at several Retirement Centers increased operating expenses by $1.4 million. Finally, $1.8 million of the increase related to expenses associated with increased therapy services during the six months ended June 30, 2002. The remaining increase relates primarily to increased average occupancies resulting in increased Retirement Center operating expenses. Free-standing AL operating expenses increased from $17.3 million in the six months ended June 30, 2001 to $33.9 million in the six months ended June 30, 2002. This increase is largely related to the increase in the number of Free-standing ALs included in the Company's consolidated operations from 22 to 34 communities, as well as increased occupancy at these communities. General and Administrative. General and administrative expense decreased to $12.5 million for the six months ended June 30, 2002, as compared to $11.8 million for the six months ended June 30, 2001, representing an increase of $724,000, or 6.2%. This increase is primarily attributable to legal and consulting costs affiliated with the exchange of a debt instrument, offset by additional accruals in the prior period for general and professional liability claims, workers' compensation, and other insurance related accruals, resulting from general conditions in the insurance markets and changes in the Company's insurance program at that time. General and administrative expense as a percentage of total revenues decreased to 7.8% compared to 9.2% for the six month periods ended June 30, 2002 and 2001, respectively. EBITDAR (Community NOI). EBITDAR increased $4.7 million from $26.6 million profit in the six months ended June 30, 2001 to $31.3 million loss in the six months ended June 30, 2002 as further described below. Retirement Center EBITDAR increased $2.9 million, or 7.5%, from $38.3 million for the six months ended June 30, 2001 to $41.2 million for the six months ended June 30, 2002. This increase primarily relates to the April 2002 and July 2001 addition of the long-term leases of Freedom Plaza Arizona and Freedom Plaza Care Center, as well as continued operational improvement throughout the Retirement Centers, resulting from stabilized occupancy and increased capacity through expansions, rate increases, and improved control of community-level overhead expense. Free-standing AL EBITDAR improved by $3.6 million from a $962,000 loss in the six months ended June 30, 2001, to $2.6 million of income in the six months ended June 30, 2002, primarily as a result of increased occupancy at these communities. Other EBITDAR losses increased by $1.8 million to $12.5 million in the six months ended June 30, 2002 resulting from the $988,000 reduction in management and development fees and $972,000 of legal and consulting costs affiliated with the exchange of a debt instrument. 31 Lease Expense. As of June 30, 2002, the Company had operating leases for 38 of its communities, including 13 Retirement Centers and 25 Free-standing ALs. Lease expense increased $37.6 million from $13.5 million for the six months ended June 30, 2001 to $51.1 million for the six months ended June 30, 2002. Lease expense (excluding synthetic leases) increased to $15.9 million for the six months ended June 30, 2002, as compared to $7.6 million for the six months ended June 30, 2001, representing an increase of $8.4 million. This increase was attributable to 15 additional leases entered into by the Company during 2001 and 2002, consisting of five Retirement Center leases which increased lease expense $5.0 million, and the acquisition of leasehold interests in ten Free-standing AL communities, which increased lease expense $3.4 million. As of June 30, 2002, the Company operated nine of its communities, including two Retirement Centers and seven Free-standing ALs, under operating lease structures commonly referred to as synthetic leases. Synthetic lease expense increased to $35.1 million for the six months ended June 30, 2002, as compared to $5.9 million for the six months ended June 30, 2001, representing an increase of $29.2 million. Of the total $35.1 million of synthetic lease expense for the six months ended June 30, 2002, $4.3 million related to Retirement Centers and $30.8 million related to Free-standing ALs. Of the total $35.1 million of synthetic lease expense for the six months ended June 30, 2002, $30.2 million resulted from residual value guarantee amounts related to losses on sale lease-back transactions, of which $3.4 million related to Retirement Centers and $26.8 million related to Free-standing ALs. As a result of completed and anticipated transactions under the Refinancing Plan, the Company has recorded losses from sale lease-back transactions of $7.9 million during the three months ended December 31, 2001, $23.2 million during the three months ended March 31, 2002, and $7.0 million for the three months ended June 30, 2002, bringing the total loss on these sale lease-back transactions to approximately $38.1 million. For financial reporting purposes, these losses are considered residual value guarantee amounts and have been fully recognized as lease expense. Depreciation and Amortization. Depreciation and amortization expense increased to $10.5 million in the six months ended June 30, 2002 from $9.5 million in the six months ended June 30, 2001, representing an increase of $1.0 million, or 10.6%. The increase was primarily related to the increase in depreciable assets of approximately $19.7 million. These assets relate primarily to the acquisition of communities, including leasehold interests, and expansion of communities since June 30, 2001, as well as ongoing capital expenditures. Amortization of Leasehold Acquisition Costs. Amortization of leasehold acquisition costs increased $9.4 million from $761,000 in the six months ended June 30, 2001 to $10.1 million in the six months ended June 30, 2002. During the fourth quarter of 2001, the Company determined that in order to simplify its financial structure, and as a condition of certain elements of its Refinancing Plan, it would exercise its termination rights under its synthetic leases during 2002. As a result of the completed and anticipated transactions under the Refinancing Plan, which would result in a shorter than expected remaining life of various leases, the Company accelerated the amortization of leasehold acquisition costs beginning in the fourth quarter of 2001. As a result of this acceleration, the Company recorded additional amortization costs of $472,000 during the three months ended December 31, 2001, $6.5 million during the three months ended March 31, 2002, and $2.3 million of amortization during the three months ended June 30, 2002, bringing the total amount of accelerated amortization related to these sale lease-back transactions to $9.3 million. The remaining portion of this increase relates to the acquisition of twelve leasehold interests in Free-standing ALs during 2001. Other Income (Expense). Interest expense increased to $19.7 million in the six months ended June 30, 2002 from $18.5 million in the six months ended June 30, 2001, representing an increase of $1.2 million, or 6.3%. This increase was primarily attributable to a higher average amount of indebtedness, prior to certain refinancing transactions, during the six months ended June 30, 2002, as well as higher interest rates. Interest expense, as a percentage of total revenues, decreased to 12.4% for the six months ended June 30, 2002 from 14.6% in the six months ended June 30, 2001. Considering certain financings expected to be completed in the refinancing plan, the Company expects interest expense to continue at greater than historical levels as a percentage of total revenues. Interest income decreased to $2.9 million in the six months ended June 30, 2002 from $6.1 million in the six months ended June 30, 2001, representing a decrease of $3.2 million, or 52.4%. The decrease in interest income was primarily attributable to lower income generated from the reduced amount of certificates of deposit and notes receivable balances associated with certain leasing transactions and management agreements. Equity in loss of 32 Managed SPE Communities (representing the losses that the Company funded when operating deficits at the Managed SPE Communities exceeded specified limits) decreased from $1.9 million in the six months ended June 30, 2001 to $0 in the six months ended June 30, 2002. The Company had no further Managed SPE Communities after December 31, 2001. Income Tax Benefit. The provision for income taxes was a $219,000 expense, compared to a $3.4 million benefit for the six months ended June 30, 2002 and 2001, respectively. The Company has applied a full valuation allowance against its net operating carryforwards. Extraordinary Loss. During the six months ended June 30, 2002, the Company repaid a term note to a bank in connection with the sale of its Carriage Club Charlotte community, resulting in a prepayment penalty of $348,000. In addition, the Company expensed the unamortized portions of financing costs, totaling $408,000 related to the sale lease-backs of Holley Court Terrace and Hampton at Post Oak. The Company recorded $756,000 or a $0.04 loss per dilutive share, net of income taxes, as an extraordinary loss on the extinguishment of debt. Net Loss. Based upon the factors noted above, the Company experienced a net loss of $57.5 million, or $3.33 loss per dilutive share, compared to a net loss of $7.4 million, or $0.43 loss per dilutive share, for the six months ended June 30, 2002 and 2001, respectively. The $3.33 loss per dilutive share for the six months ended June 30, 2002 was comprised of a $3.28 loss from operations and a $0.04 loss from the Company's extinguishment of debt. The loss of $0.43 per dilutive share for the six months ended June 30, 2001 was comprised of a $0.42 loss from operations and a $0.01 loss from the extinguishment of debt. LIQUIDITY AND CAPITAL RESOURCES Refinancing Plan The Company has a substantial amount of debt and lease obligations maturing during 2002, comprised primarily of $132.9 million of its Debentures. The Company has scheduled debt maturities during the 12 months ended June 30, 2003 of $165.4 million, which includes $32.5 million of periodic mortgage debt payments and $132.9 million of Debentures. As a result of these current maturities, the Company had a net working capital deficit of $163.8 million as of June 30, 2002. As of June 30, 2002, the Company also had minimum rental obligations of $50.3 million under long-term operating leases due during the 12 months ended June 30, 2003. In addition, as of June 30, 2002, the Company had guaranteed $93.1 million of third-party senior debt in connection with a community that the Company manages, the Company's joint ventures and certain of the Company's lease financings. In addition, the Company and certain of its lenders and lessors agreed to amendments or waivers of various financial covenants as of June 30, 2002. As of June 30, 2002, the Company had approximately $12.3 million in unrestricted cash and cash equivalents. The Company currently does not generate sufficient cash flow to meet its debt and lease payment obligations. The Company expects that its cash flow from operations will improve, and, accordingly, expects that its current cash and cash equivalents, expected cash flow from operations, and the proceeds from certain recently completed financings will be sufficient to fund its operating requirements, its capital expenditure requirements and its periodic debt service requirements during 2002. However, the Company's current cash balances and internally generated cash (including the proceeds from recently completed financings) will not be sufficient to satisfy its scheduled debt maturities in 2002. In order to satisfy or extend the Company's debt and lease payment obligations and to address its net working capital deficit, the Company considered a number of financing and capital raising alternatives and developed the Refinancing Plan in consultation with its investment banking advisor and its legal counsel and through discussions with its lenders and other third parties. The Refinancing Plan included extensions of existing debt maturities, refinancings of existing mortgage facilities, new mortgage financings, and sale lease-back arrangements. Pursuant to the Refinancing Plan, since November 2001, the Company has consummated sale lease-back transactions relating to 16 communities and various other refinancing and capital raising transactions, which in the aggregate generated gross proceeds of approximately $362.0 million. The Company used approximately $327.2 million of the proceeds to repay related debt and to fund reserve and escrow requirements related to these transactions. The Company used the remaining $34.8 million of proceeds to pay transaction costs associated with the Refinancing Plan and for 33 working capital. As a result of the Refinancing Plan, the Company has extended the maturity of substantially all of its debt arrangements, other than the Debentures, to January 2004 or later. The Debentures are the Company's only material remaining outstanding debt obligation maturing during the next 12 months. In order to address the maturity of the Debentures, during March of 2002, the Company entered into a non-binding commitment letter with HCPI relating to a proposed $125.0 million financing transaction. On August 14, 2002, the Company entered into the HCPI Loan Agreement pursuant to which HCPI has agreed to make the HCPI Loan to one of the Company's subsidiaries in the amount of $112.8 million. The Company also contemporaneously entered into the HCPI Investment Agreement under which HCPI has agreed to make the $12.2 million HCPI Equity Investment in certain other subsidiaries of the Company. Exchange Offer HCPI's obligation to consummate the HCPI Transactions is subject to a number of conditions and contingencies. Those conditions include the requirement that the Company successfully complete the Exchange Offer with the holders of the outstanding Debentures. Under the Exchange Offer, the Company will exchange for each $1,000 principal amount of outstanding Debentures and accrued interest thereon (i) $839 principal amount of the Company's new 5 3/4% Series A Notes, (ii) $190 principal amount of the Company's new 10% Series B Notes, and (iii) 13 Warrants, each Warrant to purchase one share of the Company's common stock at an exercise price of $3.50 per share and with an expiration date of September 30, 2009. With respect to the Exchange Offer, HCPI is also requiring that the Company receive the valid tender of at least 75% of the outstanding principal amount of the Debentures (approximately $99.7 million) to provide the Company with additional cash on hand to meet its on-going liquidity requirements. The Series A Notes and the Series B Notes will be unsecured and subordinated to all of the Company's existing and future indebtedness and capital lease obligations, but they will rank senior to the Debentures. The Company has the option to pay up to 2% interest per year on the Series B Notes through the issuance of additional Series B Notes rather than in cash. The Company is seeking to exchange up to $126.0 million of the Debentures in the Exchange Offer, but the Exchange Offer is not conditioned upon the tender of any minimum amount of Debentures and the Company intends to accept all Debentures tendered, regardless of whether the HCPI Transactions are consummated. The Company initiated the Exchange Offer on August 14, 2002, and anticipates that, if successful, it will be consummated during September 2002. HCPI Transactions The HCPI Loan will mature five years after initial funding, and will have a stated interest rate of 19.5%; however, the Company will only be required to pay in cash 9% interest per year until April 2004. Thereafter, the cash interest payment rate will increase each year by fifty-five basis points. Interest only at the cash rate will be payable quarterly, with any unpaid interest accruing and compounding quarterly. The $112.8 million principal balance and all accrued interest will be payable at the maturity of the loan. The Company will be permitted to repay the loan at any time after three years from the date of initial funding. The HCPI Equity Investment will be made in return for a 9.8% ownership interest in the Real Estate Companies. The Real Estate Companies function solely as passive real estate holding companies owning the real property and improvements of nine of the Company's large retirement communities. These retirement communities are leased to, and operated by, other operating subsidiaries of the borrower subsidiary in which HCPI will have no interest. During the term of its investment in each Real Estate Company, HCPI and the borrower subsidiary will have mutual decision making authority with respect to the Real Estate Companies. HCPI will have the right to receive certain preferred distributions from any cash generated by the Real Estate Companies. The borrower subsidiary will have the right to repurchase HCPI's minority interest in the Real Estate Companies for one year beginning four years after closing. HCPI will have the right to purchase the borrower subsidiary's interests in the Real Estate Companies beginning five years after closing. The HCPI Loan will be non-recourse and will be secured by a first-priority security interest in the borrower subsidiary's 90.2% ownership interests in the Real Estate Companies, and in certain cash reserve accounts. Since the HCPI Loan is non-recourse, if the borrower subsidiary defaults or fails to repay the loan at maturity, HCPI's only claim against that subsidiary will be to exercise its security interests and, absent fraud or certain other 34 customary events of malfeasance, neither the Company nor any of its subsidiaries will have any further obligation to repay the HCPI Loan. Accordingly, even in the event of default by the borrower subsidiary, the operating subsidiaries will continue to operate these communities under a lease, which has an initial term of 15 years, commencing at the date of funding of the loan, and two ten-year extensions exercisable at our option. The HCPI Loan Agreement contains numerous affirmative, negative and financial covenants. In addition, under the HCPI Loan Agreement, HCPI's obligation to make the HCPI Loan is subject to customary and usual conditions and certain other conditions and requirements. Those conditions include, among others, the following: o the loan must be funded by September 30, 2002; o the Company must complete the Exchange Offer on the terms currently contemplated and the holders of the Debentures must validly tender at least 75% of the outstanding principal amount, or approximately $99.7 million, of the Debentures; o operating results must be within budget and the Company must meet certain liquidity and financial tests relating to the Company and to the nine retirement communities owned by the Real Estate Companies; and o no material adverse change shall have occurred with respect to the nine retirement communities, the borrower subsidiary or the Company. HCPI's obligation to make the $12.2 million HCPI Equity Investment in the Real Estate Companies is also subject to substantially similar conditions. In the event the Exchange Offer is successful and the Company receives the valid tender of at least 75% of the aggregate principal amount of the outstanding Debentures, the Company expects that it will be able to satisfy the other conditions in the HCPI Loan Agreement and in the HCPI Investment Agreement and close those transactions on or before September 30, 2002. The Company anticipates that it will receive net proceeds of approximately $119.8 million from the HCPI Transactions after paying approximately $5.2 million of transaction costs associated with those transactions and the Exchange Offer. However, the success of the Exchange Offer and the Company's ability to satisfy HCPI's other conditions and consummate the HCPI Transactions are subject to a number of uncertainties and depend upon a number of factors, many of which are beyond the Company's control. Accordingly, there can be no assurance that the Company can successfully complete the Exchange Offer as required by HCPI or satisfy the other conditions required by HCPI and consummate the HCPI Loan or obtain the HCPI Equity Investment. The Company will use the net proceeds of the HCPI Transactions, together with cash on hand, to repay first the principal amount of and accrued interest on the Series A Notes when they mature on September 30, 2002 and then the principal amount of and interest on the remaining Debentures when they mature on October 1, 2002. If the holders of the Debentures do not validly tender at least 75% of the aggregate principal amount of the Debentures on the terms currently contemplated and the Company does not consummate the HCPI Transactions, the Company will be forced to seek other financing alternatives. At the present time, the Company does not have any alternative sources of financing that would provide it with sufficient funds to repay the Series A Notes and the Debentures at maturity. As a result of the Company's current financial condition and the fact that substantially all of the Company's properties are fully encumbered by mortgage or lease financings, the Company does not believe it would be able to obtain such alternative financing prior to the maturity of the Series A Notes and the Debentures. The Company also does not believe that it would be able to sell its properties in the time or at values necessary to raise sufficient cash to satisfy the Series A Notes and the Debentures at maturity. In addition, a sale of the Company's assets could have adverse tax consequences to the Company. If the Company is unable to consummate the HCPI Transactions by September 30, 2002 and repay the principal of and interest on the Series A Notes, the Company will be in default under approximately $137.3 million of mortgage indebtedness and under the indenture governing the Series A Notes. In addition, because of cross-default and cross-collateralization provisions in many of the Company's other debt instruments and leases, those defaults are likely to 35 result in a default and acceleration of substantially all of the Company's other debt and lease obligations, including the Series B Notes and the Debentures. As of June 30, 2002, the Company had approximately $381.8 million of senior secured debt and capital lease obligations, $132.9 million of Debentures and approximately $50.3 million of annual lease obligations. In addition, as of June 30, 2002, the Company had guaranteed $93.1 million of third-party senior debt in connection with a community that the Company manages, the Company's joint ventures and certain of the Company's lease financings. As a result, a default under the indenture governing the Series A Notes, the Series B Notes and the Debentures and the Company's other debt and lease obligations would have a material adverse effect upon the Company and could make it necessary for the Company to seek protection from its creditors under federal bankruptcy laws. In the event that the Company successfully consummates the Exchange Offer and the HCPI Transactions, it will remain highly leveraged with a substantial amount of debt and lease obligations, and will have increased interest and lease expenses. The Company, however, expects that its cash flow from operations will improve, and, accordingly, expects that its current cash and cash equivalents, expected cash flow from operations, and the proceeds from successful completion of the Refinancing Plan (including the HCPI Transactions and the Exchange Offer) will be sufficient to fund its operating requirements, its capital expenditure requirements, its periodic debt service requirements and its lease obligations during the next twelve months. Cash flow Net cash used by operating activities was $8.1 million for the six months ended June 30, 2002, as compared with $31,000 used for the six months ended June 30, 2001. The Company's cash and cash equivalents totaled $12.3 million as of June 30, 2002, as compared to $19.3 million as of December 31, 2001. Net cash provided by investing activities was $60.4 million for the six months ended June 30, 2002, as compared with $4.2 million used for the six months ended June 30, 2001. During the six months ended June 30, 2002, the Company received $92.1 million from sales of assets, purchased assets limited as to use of $7.7 million, added $13.1 million to land, building and equipment, issued $8.6 million of notes receivable, and made $1.9 million in security deposits. Net cash used by financing activities was $59.4 million compared with $6.7 million provided by financing activities during the six months ended June 30, 2002 and 2001, respectively. During the six months ended June 30, 2002, the Company borrowed $189.4 million under long-term debt arrangements, made principal payments on its indebtedness of $236.8 million, recorded $5.3 million of contingent earnouts, and paid $3.7 million of financing costs. In connection with certain lifecare communities, the Company made principal payments and refunds under master trust agreements of $3.1 million. Liquidity The Company currently does not generate sufficient cash flow to meet its debt and lease payment obligations. The Company expects that its cash flow from operations will improve, and, accordingly, expects that its current cash and cash equivalents, expected cash flow from operations, and the proceeds from certain recently completed financings will be sufficient to fund its operating requirements, its capital expenditure requirements and its periodic debt service requirements through June 30, 2003. However, the Company's current cash balances and internally generated cash (including the proceeds from recently completed financings) will not be sufficient to satisfy its scheduled debt maturities in 2002. Accordingly, the Company's ability to satisfy its maturing obligations in 2002 will depend primarily upon its ability to successfully complete the Exchange Offer on the terms required by HCPI and to consummate the HCPI Loan and the HCPI Equity Investment. Many of the Company's credit and other agreements contain restrictive covenants that include, among other things, the maintenance of prescribed debt service coverage, liquidity, capital expenditure reserves and occupancy levels. In addition, certain of these agreements require that the Company raise a prescribed amount of capital and provide evidence of sufficient capacity to pay off the Debentures prior to their maturity. Effective as of June 30, 2002, the Company and certain of its lenders agreed to waivers relating to certain financial covenants in order to allow the 36 Company to remain in compliance. As part of its Refinancing Plan, the Company has renegotiated most of its financial covenants to levels that it believes it can satisfy for the forseeable future. Included in the renegotiated financial covenants related to approximately $137.3 million of mortgage indebtedness are covenants that require the Company to successfully retire or extend the Debentures. There can be no assurances, however, that the Company will remain in compliance with those covenants or that the Company's creditors will grant further amendments or waivers in the event of future non-compliance. Failure to remain in compliance with those covenants would have a material adverse impact on the Company, and would result in a default under a substantial majority of the Company's indebtedness and other obligations, and could result in an acceleration of the maturity of those obligations. A significant amount of the Company's indebtedness and lease agreements is cross-defaulted. Any non-payment or other default with respect to such obligations (including non-compliance with a financial or restrictive covenant) could cause the Company's lenders to declare defaults, accelerate payment obligations or foreclose upon the communities securing such indebtedness or exercise their remedies with respect to such communities. Furthermore, because of cross-default and cross-collateralization provisions in most of the Company's mortgages, debt instruments, and leases, a default by the Company on one of its debt instruments or lease agreements is likely to result in a default or acceleration of substantially all of the Company's other obligations, which would have a material adverse effect on the Company. While the Company anticipates completing the Refinancing Plan and consummating the Exchange Offer, the HCPI Loan and the HCPI Equity Investment on or before September 30, 2002, there can be no assurances that the Company will be able to do so or that the Company will be able to satisfy its maturing obligations (including the Debentures). The Company's ability to consummate the Exchange Offer and the HCPI Transactions depends upon a number of factors, many of which are beyond the Company's control. These factors include the satisfaction of conditions relating to the HCPI Transactions (including a successful completion of the Exchange Offer on the terms required by HCPI), the Company's financial condition and operating performance, the financial strength of the Company's assets, the requirement for regulatory approvals and other approvals and consents, general economic conditions, general conditions in the credit markets, the condition of the senior living industry, and other factors. The failure to consummate the Exchange Offer on the terms required by HCPI or to consummate the HCPI Transactions will have a material adverse effect on the Company and could make it necessary for the Company to seek protection from its creditors under federal bankruptcy laws. The Company's financial condition could adversely effect the Company's ability to retain existing residents, attract prospective residents and maintain customary terms of payment from its vendors, which could have a material adverse effect on the Company's operating results and liquidity and could adversely effect the Company's ability to consummate the Refinancing Plan and the HCPI Transactions. The Company believes that, if the Exchange Offer and the HPCI Transactions are consummated as currently planned, the HCPI Transactions will generate sufficient net proceeds to satisfy the scheduled debt maturities during 2002. In the event that the Company successfully consummates the HCPI Loan and HCPI Equity Investment, it will continue to be highly leveraged, and will have substantial debt and lease obligations, and will have increased interest and lease expenses. The Company will incur substantial costs in connection with the consummation of the Refinancing Plan, the Exchange Offer, the HCPI Loan and the HCPI Equity Investment. As a part of the Refinancing Plan, the Company has consummated sale lease-back transactions relating to 16 communities and various other refinancing and capital raising transactions, generating gross proceeds of approximately $362.0 million. As part of these extensions and refinancings, the Company has replaced a significant amount of mortgage debt with higher cost leases, increasing the Company's annual debt and lease payments by approximately $14.4 million. In addition, the interest costs under the HCPI Loan and the Series B Notes are significantly higher than the interest cost of the Debentures. Assuming that the Company completes the Exchange Offer and exchanges $99.7 million principal amount of the Debentures in the Exchange Offer and that the Company elects to pay 2% interest on the Series B Notes through the issuance of additional Series B Notes rather than in cash, the Company's annual interest payments would increase by approximately $4.0 million. In addition, the Company would accrue an additional $12.5 million of interest expense, that is not currently payable, pursuant to the HCPI Loan and the Series B Notes. 37 Financing Activity During the six months ended June 30, 2002, the Company entered into various financing transactions. On January 1, 2002, the Company completed a sale lease-back of a retirement center in North Carolina for $45.0 million. The lessor assumed $34.8 million of debt associated with the property, resulting in an assumption penalty of $348,000, coupled with $50,000 of unamortized financing costs, which the Company has recorded as an extraordinary loss. The lease agreement has an initial term of 15 years with two five-year renewal options and a right of first refusal to repurchase the community. The Company recorded a gain of $11.7 million on the sale, which is being amortized over the term of the lease. In conjunction with this sale, on January 1, 2002, the Company acquired a Free-standing AL in Florida for $7.1 million, which it had previously managed for the buyer of the Retirement Center located in North Carolina. The Company funded this acquisition by assuming a $4.7 million mortgage note bearing interest at a floating rate of 5.63% at March 31, 2002. Interest is due monthly with remaining principal and unpaid interest due December 31, 2002. The note is secured by certain land, buildings, and equipment. On January 25, 2002, the Company amended two loan agreements with aggregate outstanding indebtedness of $7.2 million. The amendment extends the due dates of the agreements to December 31, 2002, requires additional monthly principal payments of $60,000, and a $1.0 million cash collateral deposit. In connection with the amendment, the Company agreed to, among other things, (1) retire or refinance approximately $92.3 million of indebtedness on or before July 1, 2002, so as to mature no earlier than December 1, 2003 and (2) retire or refinance the $132.9 million outstanding principal amount of its Debentures on or before September 1, 2002 so as to mature no earlier than October 1, 2004. Failure to accomplish the retirement or refinancing of this debt could result in the acceleration of the outstanding indebtedness. On July 11, 2002, this debt was paid off in conjunction with the sale leasebacks of the respective properties. See notes 2 and 10 to the condensed consolidated financial statements. On February 12, 2002, the Company sold a Free-standing AL in Florida for $9.7 million. The Company contemporaneously leased the property back from the buyer under a 15-year lease agreement with two five-year renewal options and a right of first refusal to repurchase the community. The Company used a portion of the sale proceeds to repay $8.6 million of debt associated with the property. The sale agreement contains certain formula-based earnout provisions which may provide additional sales proceeds to the Company based on future performance. As a result of the contingent earn-out provisions, for financial reporting purposes, this transaction was recorded as a financing transaction and the Company recorded $9.7 million of lease obligation as debt, bearing interest of 7.55%. The Company recorded a $1.4 million loss as a result of this transaction. For financial reporting purposes, these losses are considered residual value guarantee amounts under the previous leases terminated in connection with the sale lease-back transaction and have been fully recognized as lease expense. On February 12, 2002, the Company sold for $18.5 million a retirement center in Illinois. The Company used a majority of the sale proceeds to repay $12.9 million of debt associated with the property, resulting in the Company expensing $259,000 of unamortized financing cost as an extraordinary item. The Company contemporaneously leased the property back from the buyer under a 15-year lease agreement with two five-year renewal options, and has the right of first refusal to repurchase the community. The Company recorded a gain of $5.3 million on the sale, which is being amortized on a straight-line basis over the term of the lease. On March 22, 2002, the Company sold a Free-standing AL in Colorado, for $17.9 million. The Company contemporaneously leased the property back from the buyer under a 15-year lease agreement with two five-year renewal options and a right of first refusal to repurchase the community. The Company used a portion of the sale proceeds to repay $16.3 million of debt associated with the property, resulting in the Company expensing $259,000 of unamortized financing cost as an extraordinary item. The sale agreement contains certain formula-based earnout provisions which may provide additional sales proceeds to the Company based on future performance. As a result of the contingent earn-out provisions, for financial reporting purposes, this transaction was recorded as a financing transaction and the Company recorded $17.9 million of lease obligation as debt, bearing interest of 7.46%. The Company recorded a $5.8 million loss as a result of this transaction. For financial reporting purposes, these losses are 38 considered residual value guarantee amounts under the previous leases terminated in connection with the sale lease-back transaction and have been fully recognized as lease expense. On March 28, 2002, the Company sold two retirement centers and three Free-standing ALs for $73.2 million. The Company used a portion of the proceeds to repay $55.2 million of debt, resulting in the Company expensing $99,000 of unamortized financing cost as an extraordinary item. The Company contemporaneously leased the properties back from the buyer under a 15-year lease agreement with two ten-year renewal options. The sale agreements for the three Free-standing ALs contain certain formula-based earnout provisions which may provide additional sales proceeds to the Company based on future performance. As a result of the contingent earn-out provisions, for financial reporting purposes, the Free-standing AL transactions were recorded as financing transactions and the Company recorded $18.2 million of lease obligation as debt, bearing interest of 9.37%. The Company recorded a $17.8 million loss as a result of the sale of these three AL's. For financial reporting purposes, these losses are considered residual value guarantee amounts under the previous leases terminated in connection with the sale lease-back transaction and have been fully recognized as lease expense. One of the retirement center leases is recorded as a capital lease and the Company recorded $25.0 million of lease obligation as debt, bearing interest of 8.27%. The other retirement center lease is being accounted for as an operating lease, since the sale agreement for this community did not contain a contingent earnout provision or other continuing involvement provisions. The Company recorded a gain of $697,000 on the sale of this retirement center, which is being amortized on a straight-line basis over the term of the lease. The Company has an option to acquire the retirement center that has been accounted for as a capital lease after March 28, 2006, subject to certain conditions. On May 31, 2002, the Company replaced two mortgage notes maturing December 31, 2002 totaling $82.7 million with a $95.7 million mortgage note with the same lender which matures May 31, 2005. The Company applied the provisions of EITF 96-19, "Debtor's Accounting for a Modification or Exchange of Debt Instruments" in determining the treatment of costs incurred related to the exchange of debt instruments. As such, the commitment fee of $957,000 which, along with $128,000 of unamortized financing costs on the previous notes, will be amortized as a yield adjustment over the term of the new mortgage note, while $972,000 of legal and investment advisor fees are recorded in general and administrative expense. The new mortgage debt has a fixed and variable interest component, principal and interest due monthly, based on a 25-year amortization, and remaining principal and unpaid interest due May 31, 2005, with two one-year renewal options. The fixed rate component converts to a variable rate on January 1, 2003. The Company purchased an interest rate cap agreement for $789,000, which would limit the Company's variable interest expense if one-month LIBOR should exceed 5.8% over the term of the mortgage. The Company has designated the cap as a cashflow hedge. As such, any changes in the fair value of the cap while 30-day LIBOR does not exceed 5.8% is recognized as interest expense during the current period. The fair value of the cap was $584,000 at June 30, 2002. In connection with the debt, in the event that on or before September 30, 2002, either the Debentures have not been retired or the Company has not provided to the Lender evidence that the Company holds an amount of unrestricted cash sufficient to retire the Debentures, the Company would be in default and the Lender could exercise its contractual remedies, including all amounts due being payable on demand. The note is secured by certain land, buildings, and equipment, and contains cross-default provisions. As a result of completed and anticipated transactions under the Refinancing Plan, the Company has recorded losses from sale lease-back transactions of $7.9 million during the quarter ended December 31, 2001, $23.2 million during the quarter ended March 31, 2002, and $7.0 million during the quarter ended June 30, 2002, bringing the total loss on these sale lease-back transactions to $38.1 million. For financial reporting purposes, these losses are considered residual value guarantee amounts under the previous leases terminated in connection with the sale lease-back transactions and have been fully recognized as lease expense. See note 4. In addition, due to the shorter than expected remaining life of the previous leases terminated in connection with the sale lease-back transactions, the Company accelerated the amortization of leasehold acquisition costs beginning in the fourth quarter of 2001. As a result of this acceleration, the Company recorded additional amortization costs of $472,000 during the quarter ended December 31, 2001, $6.5 million during the quarter ended March 31, 2002, and $2.3 million during the quarter ended June 30, 2002, bringing the total amount of accelerated amortization related to these sale lease-back transactions to $9.3 million. 39 Effective as of June 30, 2002, the Company obtained waivers under various financing agreements with respect to certain of its financial covenants. See note 2 to the condensed consolidated financial statements. The Company announced, during the quarter ended March 31, 2000, that its Board of Directors had authorized the repurchase, from time to time, of up to $30.0 million of its Debentures. During the six months ended June 30, 2001, the Company purchased $3.3 million of the Debentures, resulting in an extraordinary gain on extinguishment of debt, net of tax, of $395,000. The Company has initiated the Exchange Offer with respect to the Debentures and no longer expects to purchase any of the Debentures on the open market. FUTURE CASH COMMITMENTS The following tables summarize the Company's total contractual obligations and commercial commitments as of June 30, 2002 (amounts in thousands). This information only reflects the effect of those elements of the Company's Refinancing Plan that have been completed as of June 30, 2002, and does not include the impact of remaining transactions contemplated in the Refinancing Plan that were not yet completed as of that date: 40
Payments Due by Period --------------------------------------------------------------------------- Less than 1 - 3 4 - 5 After 5 Total 1 year years years Years ----- ------ ----- ----- ----- Long-term debt $ 423,751 $ 162,663 $ 141,786 $ 36,700 $82,602 Capital lease obligations 91,003 2,692 5,622 7,328 75,361 Operating leases 425,071 50,256 106,277 101,979 166,559 Lease payments that apply to debt(1) (54,010) (54,010) -- -- -- Interest income on notes receivable and security deposits(2) (5,992) (501) (2,943) (1,376) (1,172) =========================================================================== Total contractual cash obligations (3) $ 879,823 $ 161,100 $ 250,742 $ 144,631 $ 323,350 ===========================================================================
(1) Approximately $54.0 million of the $93.1 million of guaranteed mortgage debt is associated with seven of the nine synthetic leases remaining at June 30, 2002. As such, these lease payments are included within both operating leases and guaranties listed in the table below. (2) A portion of the lease payments noted in the above table are repaid to the Company as interest income on notes receivable from lessors. (3) See note 2 to the condensed consolidated financial statements related to the Company's plans regarding the 2002 obligations. These amounts do not include the impact of the remaining transactions contemplated in the Refinancing Plan that were not yet completed as of June 30, 2002, nor do they reflect cash requirements for certain debt that is accelerated if the refinancing plan is not consummated.
Amount of Commitment Expiration Per Period ------------------------------------------------------------------------- Total Amounts Less than 1 - 3 4 - 5 After 5 Committed 1 year years years Years Guaranties(1) $ 93,092 9,540 39,079 11,623 32,850 ------------------------------------------------------------------------- Total commercial commitments $ 93,092 $ 9,540 $ 39,079 $ 11,623 $ 32,850 =========================================================================
(1) Guaranties include mortgage debt related to 11 communities (four Retirement Centers, five Free-standing ALs, and two joint ventures). Approximately $54.0 million of the $93.1 million is associated with seven of the 14 synthetic leases the Company determined during the fourth quarter of 2001 to terminate. The remaining mortgage debt guaranteed by the Company relates to two Retirement Centers under a long-term management agreement and a long-term operating lease agreement and the Company's two joint ventures. These amounts do not include the Company's residual value guaranties under the remaining nine synthetic leases which were $162.8 million as of June 30, 2002. The Company routinely makes capital expenditures to maintain or enhance communities under its control. The Company's capital expenditure budget for fiscal 2002 is approximately $14.7 million. RISKS ASSOCIATED WITH FORWARD LOOKING STATEMENTS This Form 10-Q contains certain forward-looking statements within the meaning of the federal securities laws, which are intended to be covered by the safe harbors created thereby. Those forward-looking statements include all statements that are not historical statements of fact and those regarding the intent, belief or expectations of the Company or its management including, but not limited to, all statements concerning the Company's expectations regarding the HCPI Loan, the HCPI Equity Investment and the Exchange Offer; the Company's anticipated improvement in operations and anticipated or expected cashflow; the discussions of the Company's operating and growth strategy (including its development plans and possible dispositions); the Company's liquidity and financing needs; the Company's alternatives for raising additional capital and satisfying its maturing obligations; the 41 projections of revenue, income or loss, capital expenditures, and future operations; and the availability of insurance programs. Investors are cautioned that all forward-looking statements involve risks and uncertainties including, without limitation, (i) the possibility that the Company will be unable to consummate the Exchange Offer on the terms required by HCPI, (ii) the possibility that the Company will be unable to satisfy the other conditions to the HCPI Loan Agreement or the HCPI Equity Investment Agreement or that such agreements may be amended or modified or that the Company will be unable to obtain the HCPI Loan or HCPI Equity Investment, (iii) the possibility of future defaults under the Company's debt and lease agreements (including the Debentures), (iv) the risks associated with the Company's financial condition and the fact that the Company is highly leveraged, (v) the risk that the Company will be unable to reduce the operating losses at its Free-standing ALs or increase its cash flow or generate expected levels of cash, (vi) the risks associated with the adverse market conditions for the senior living industry, (vii) the risk that the Company will be unable to obtain liability insurance in the future or that the costs associated with such insurance (including the costs of deductibles) will be prohibitive, (viii) the likelihood of further and tighter governmental regulation, and (viii) the risks and uncertainties set forth under the caption "Risk Factors" in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2001 and the Company's other filings with the Securities and Exchange Commission. Should one or more of these risks materialize, actual results could differ materially from those forecasted or expected. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of these assumptions could prove to be inaccurate, and therefore, there can be no assurance that the forward-looking statements included in this Form 10-Q will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the forecasts, expectations, objectives or plans of the Company will be achieved. The Company undertakes no obligation to publicly release any revisions to any forward-looking statements contained herein to reflect events and circumstances occurring after the date hereof or to reflect the occurrence of unanticipated events. 42 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Disclosure About Interest Rate Risk. The Company is subject to market risk from exposure to changes in interest rates based on its financing, investing, and cash management activities. The Company utilizes a balanced mix of debt maturities along with both fixed-rate and variable-rate debt to manage its exposures to changes in interest rates. The Company has entered into an interest rate swap agreement with a major financial institution to manage its exposure. The swap involves the receipt of a fixed interest rate payment in exchange for the payment of a variable rate interest payment without exchanging the notional principal amount. Receipts on the agreement are recorded as a reduction to interest expense. At June 30, 2002, the Company's outstanding notional amount of its existing swap agreement was $34.8 million maturing July 1, 2008. Under the agreement the Company receives a fixed rate of 6.87% and pays floating rates based upon LIBOR and a foreign currency index with a maximum rate through July 1, 2002 of 8.12%. The Company has also entered into an interest rate cap agreement on a $95.7 million mortgage note to limit the Company's interest rate exposure. Under the terms of the interest rate cap agreement, the Company receives payments from the counterparty if one-month LIBOR exceeds 5.8% over the term of the mortgage. The Company does not expect changes in interest rates to have a material effect on income or cash flows in 2002, since 64.6% of the Company's debt has fixed rates. There can be no assurances, however, that interest rates will not significantly change and materially affect the Company. As a part of its Refinancing Plan, the Company has consummated sale lease-back transactions relating to 16 communities and various other refinancing and capital raising transactions, generating gross proceeds of approximately $362.0 million. As part of these extensions and refinancings, the Company has replaced a significant amount of mortgage debt with higher cost leases, increasing the Company's annual debt and lease payments by approximately $14.4 million. In addition, the interest costs under the HCPI Loan and the Series B Notes are significantly higher than the interest cost of the Debentures. Assuming that the Company completes the Exchange Offer and exchanges $99.7 million principal amount of the Debentures in the Exchange Offer and that the Company elects to pay 2% interest on the Series B Notes through the issuance of additional Series B Notes rather than in cash, the Company's annual interest and lease costs would increase by approximately $4.0 million. In addition, the Company would accrue an additional $12.5 million of interest expense, that is not currently payable, pursuant to the HCPI Loan and the Series B Notes. 43 PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a. Exhibits 10.1 Loan Agreement Among Fort Austin Real Estate Holdings, LLC, as Borrower, Fort Austin Limited Partnership, as Operating Lessee, and General Electric Capital Corporation, as Lender, dated May 15, 2002 10.2 Lease Agreement by and between Freedom Plaza Limited Partnership, an Arizona Limited Partnership, and American Retirement Corporation, a Tennessee Corporation, dated April 1, 2002 10.3 Promissory Note dated April 1, 2002, between Freedom Plaza Limited Partnership, an Arizona Limited Partnership, and American Retirement Corporation, a Tennessee Corporation 99.1 Certification of W.E. Sheriff Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.2 Certification of George T. Hicks Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 b. Reports on Form 8-K On May 16, 2002, the Company furnished to the SEC a Form 8-K disclosing for purposes of Regulation FD supplemental financial information relating to the Company's first quarter ended March 31, 2002. 44 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. AMERICAN RETIREMENT CORPORATION Date: August 14, 2002 By: /s/ George T. Hicks ------------------- George T. Hicks Executive Vice President-Finance, Chief Financial Officer, Secretary and Treasurer (Principal Financial and Accounting Officer) 45 EX-10.1 3 g77554exv10w1.txt LOAN AGREEMENT EXHIBIT 10.6 LOAN AGREEMENT AMONG FORT AUSTIN REAL ESTATE HOLDINGS, LLC, AS BORROWER, FORT AUSTIN LIMITED PARTNERSHIP, AS OPERATING LESSEE, AND GENERAL ELECTRIC CAPITAL CORPORATION, AS LENDER MAY 15, 2002 TABLE OF CONTENTS
Page No. -------- ARTICLE 1 CERTAIN DEFINITIONS...........................................................1 Section 1.1 Certain Definitions................................................1 ARTICLE 2 LOAN TERMS....................................................................9 Section 2.1 The Loan...........................................................9 Section 2.2 Interest Rate; Late Charge.........................................9 Section 2.3 Terms of Payment..................................................10 Section 2.4 Security..........................................................11 Section 2.5 Partial Releases..................................................11 Section 2.6 Extension of Maturity Date........................................12 ARTICLE 3 INSURANCE, CONDEMNATION, AND IMPOUNDS........................................13 Section 3.1 Insurance.........................................................13 Section 3.2 Use and Application of Insurance Proceeds.........................14 Section 3.3 Condemnation Awards...............................................15 Section 3.4 Impounds..........................................................15 ARTICLE 4 ENVIRONMENTAL MATTERS........................................................16 Section 4.1 Certain Definitions...............................................16 Section 4.2 Representations and Warranties on Environmental Matters...........16 Section 4.3 Covenants on Environmental Matters................................17 Section 4.4 Allocation of Risks and Indemnity.................................17 Section 4.5 Collateral Assignment of Indemnities..............................18 Section 4.6 No Waiver.........................................................18 ARTICLE 5 LEASING MATTERS..............................................................18 Section 5.1 Representations and Warranties on Residency Agreements............18 Section 5.2 Standard Residency Agreement Form; Material Leases................19 Section 5.3 Covenants.........................................................19 Section 5.4 Operating Lease...................................................19 ARTICLE 6 REPRESENTATIONS AND WARRANTIES...............................................20 Section 6.1 Organization and Power............................................20 Section 6.2 Validity of Loan Documents........................................20 Section 6.3 Liabilities; Litigation...........................................20 Section 6.4 Taxes and Assessments.............................................20 Section 6.5 Other Agreements; Defaults........................................20 Section 6.6 Compliance with Law...............................................21 Section 6.7 Location of Borrower..............................................21 Section 6.8 ERISA.............................................................21 Section 6.9 Margin Stock......................................................21 Section 6.10 Tax Filings.......................................................21 Section 6.11 Solvency..........................................................21 Section 6.12 Full and Accurate Disclosure......................................22 Section 6.13 Borrower Separateness.............................................22 Section 6.14 Operating Lessee Separateness.....................................24 Section 6.15 Licenses and Compliance...........................................27
i ARTICLE 7 FINANCIAL REPORTING..........................................................27 Section 7.1 Financial Statements..............................................27 Section 7.2 Accounting Principles.............................................28 Section 7.3 Other Information.................................................28 Section 7.4 Annual Budget and Cash Flow Summary...............................28 Section 7.5 Audits............................................................28 ARTICLE 8 COVENANTS....................................................................29 Section 8.1 Due on Sale and Encumbrance; Transfers of Interests...............29 Section 8.2 Taxes; Charges....................................................30 Section 8.3 Control; Management...............................................30 Section 8.4 Non-compliance....................................................31 Section 8.5 Consultant........................................................31 Section 8.6 Permits and Licenses; Operation; Maintenance; Inspection..........32 Section 8.7 Taxes on Security.................................................32 Section 8.8 Reserves, Deposits, Escrows.......................................32 Section 8.9 Legal Existence; Name, Etc........................................32 Section 8.10 Affiliate Transactions............................................33 Section 8.11 Further Assurances................................................33 Section 8.12 Estoppel Certificates.............................................33 Section 8.13 Notice of Certain Events..........................................33 Section 8.14 Indemnification...................................................33 Section 8.15 ERISA.............................................................34 Section 8.16 Satisfaction of Debentures........................................34 Section 8.17 HCPI Transaction..................................................34 Section 8.18 Immediate Repairs.................................................34 Section 8.19 Debt Service Coverage and Cash on Cash Return.....................34 Section 8.20 Operation.........................................................34 Section 8.21 Services..........................................................34 Section 8.22 Non-Competition...................................................34 ARTICLE 9 EVENTS OF DEFAULT............................................................35 Section 9.1 Payments..........................................................35 Section 9.2 Insurance.........................................................35 Section 9.3 Sale, Encumbrance, Etc............................................35 Section 9.4 Covenants.........................................................35 Section 9.5 Representations and Warranties....................................36 Section 9.6 Other Encumbrances................................................36 Section 9.7 Involuntary Bankruptcy or Other Proceeding........................36 Section 9.8 Voluntary Petitions, etc..........................................36 Section 9.9 Material Adverse Change...........................................36 Section 9.10 Other Loans.......................................................36 Section 9.11 Debentures........................................................36 Section 9.12 HCPI Transaction..................................................36 ARTICLE 10 REMEDIES....................................................................37 Section 10.1 Remedies - Insolvency Events......................................37
ii Section 10.2 Remedies - Other Events........................................37 Section 10.3 Lender's Right to Perform the Obligations......................37 ARTICLE 11 MISCELLANEOUS...............................................................38 Section 11.1 Notices........................................................38 Section 11.2 Amendments and Waivers.........................................39 Section 11.3 Limitation on Interest.........................................39 Section 11.4 Invalid Provisions.............................................40 Section 11.5 Reimbursement of Expenses......................................40 Section 11.6 Approvals; Third Parties; Conditions...........................40 Section 11.7 Lender Not in Control; No Partnership..........................41 Section 11.8 Time of the Essence............................................41 Section 11.9 Successors and Assigns.........................................41 Section 11.10 Renewal, Extension or Rearrangement............................41 Section 11.11 Divisions of the Loan; Syndication or Placement................41 Section 11.12 Waivers........................................................42 Section 11.13 Cumulative Rights..............................................42 Section 11.14 Singular and Plural............................................42 Section 11.15 Phrases........................................................42 Section 11.16 Exhibits and Schedules.........................................42 Section 11.17 Titles of Articles, Sections and Subsections...................42 Section 11.18 Promotional Material...........................................42 Section 11.19 Survival.......................................................42 Section 11.20 Waiver of Jury Trial...........................................43 Section 11.21 Waiver of Punitive or Consequential Damages....................43 Section 11.22 Governing Law..................................................43 Section 11.23 Entire Agreement...............................................43 Section 11.24 Counterparts...................................................43 ARTICLE 12 LIMITATIONS ON LIABILITY....................................................43 Section 12.1 Limitation on Liability........................................43 Section 12.2 Limitation on Liability of Lender's Officers, Employees, etc...44
iii LIST OF DEFINED TERMS
Page No. -------- Adjusted Operating Expenses....................................................1 Adjusted Operating Revenues....................................................1 Affiliate......................................................................1 Agreement......................................................................1 Allocated Loan Balance.........................................................1 ARC............................................................................1 ARCSPE.........................................................................1 Assignment of Interest Rate Protection Agreement...............................2 Assignment of Rents and Leases.................................................2 Bankruptcy Party..............................................................36 Blocked Account................................................................2 Blocked Account Agreement......................................................2 Borrower.......................................................................1 Borrower Party.................................................................2 Broadway.......................................................................2 Budget.........................................................................3 Business Day...................................................................3 Capital Expenditures...........................................................1 Capital Expenditures Budget....................................................1 Capital Improvements Reserve...................................................1 Cash on Cash Return............................................................3 Commitment Fee.................................................................3 Contract Rate..................................................................1 Control........................................................................3 Debentures.....................................................................3 Debt...........................................................................3 Debt Service...................................................................4 Debt Service Coverage..........................................................4 Default Rate...................................................................4 Environmental Laws............................................................16 ERISA.........................................................................34 Eurodollar Business Day........................................................4 Existing Facility..............................................................3 Facility Capacity..............................................................4 Fixed Rate.....................................................................9 Floating Rate..................................................................9 Hazardous Materials...........................................................16 HCPI Transaction...............................................................4 Heller Loans...................................................................4 Immediate Repairs..............................................................4 Independent Director......................................................24, 26 Independent Govenor...........................................................24 Insolvency Opinion........................................................24, 27 Interest Rate Protection Agreement.............................................4
iv Joinder.......................................................................47 Joinder Parties...............................................................47 Joinder Party..................................................................4 Lender.........................................................................5 LIBOR Rate.....................................................................5 Lien...........................................................................5 Loan...........................................................................5 Loan Administration Fee....................................................5, 10 Loan Documents.................................................................5 Loan to Value Ratio............................................................5 Maturity Date..................................................................5 Mortgage.......................................................................5 Net Cash Flow..................................................................6 Net Operating Income...........................................................6 Net Worth......................................................................6 Note...........................................................................6 Obligations...................................................................10 Operating Expenses.............................................................6 Operating Lease................................................................7 Operating Lessee............................................................1, 7 Operating Revenues.............................................................7 Parkplace......................................................................8 Person.........................................................................8 Plan..........................................................................34 Potential Default..............................................................8 Project........................................................................8 Projects.......................................................................8 Replacement Treasury Yield.....................................................2 Residency Agreement............................................................8 Resident.......................................................................8 Single Purpose Entity..........................................................8 Site Assessment................................................................8 SPC Party.................................................................23, 26 State..........................................................................9 State Agencies.................................................................9 Summit.........................................................................9 Yield Maintenance Amount.......................................................1 Yield Maximum Amount...........................................................9
v LOAN AGREEMENT This Loan Agreement is entered into as of May 15, 2002 among GENERAL ELECTRIC CAPITAL CORPORATION, a Delaware corporation (formerly organized under the laws of the State of New York), FORT AUSTIN REAL ESTATE HOLDINGS, LLC, a Tennessee limited liability company ("BORROWER"), and FORT AUSTIN LIMITED PARTNERSHIP, a Texas limited partnership ("OPERATING LESSEE"). In consideration of the mutual promises contained herein and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Lender and Borrower agree as follows: ARTICLE 1 CERTAIN DEFINITIONS Section 1.1 CERTAIN DEFINITIONS. As used herein, the following terms have the meanings indicated: "ADJUSTED OPERATING EXPENSES" means Operating Expenses as determined and adjusted by Lender in accordance with its current audit policies and procedures. "ADJUSTED OPERATING REVENUES" means Operating Revenues as determined and adjusted by Lender in accordance with its current audit policies and procedures. "AFFILIATE" means (a) any corporation in which Borrower or Operating Lessee or any partner, shareholder, director, officer, member, or manager of Borrower or Operating Lessee directly or indirectly owns or Controls more than ten percent (10%) of the beneficial interest, (b) any partnership, joint venture or limited liability company in which Borrower or Operating Lessee or any partner, shareholder, director, officer, member, or manager of Borrower or Operating Lessee is a partner, joint venturer or member, (c) any trust in which Borrower or Operating Lessee or any partner, shareholder, director, officer, member or manager of Borrower is a trustee or beneficiary, (d) any entity of any type which is directly or indirectly owned or Controlled by Borrower or any partner, shareholder, director, officer, member or manager of Borrower or Operating Lessee, (e) any partner, shareholder, director, officer, member, manager or employee of Borrower or Operating Lessee, (f) any Person related by birth, adoption or marriage to any partner, shareholder, director, officer, member, manager, or employee of Borrower or Operating Lessee, or (g) any Borrower Party. "AGREEMENT" means this Loan Agreement, as amended from time to time. "ALLOCATED LOAN BALANCE" means, for each Project, the portion of the principal balance of the Loan allocated to such Project as specified in Exhibit D attached hereto and made a part hereof. "ARC" means American Retirement Corporation, a Tennessee corporation. "ARCSPE" means ARCPI Holdings, Inc., a Tennessee corporation whose sole shareholder is ARC, and the sole member of Borrower. 1 "ASSIGNMENT OF INTEREST RATE PROTECTION AGREEMENT" means that Assignment of Interest Rate Protection Agreement executed by Borrower and assigning the Interest Rate Protection Agreement to Lender. "ASSIGNMENT OF RENTS AND LEASES" means, collectively, and as amended, the following Assignments of Rents and Leases: (a) Assignment of Rents and Leases of even date herewith, executed by Borrower, filed for recording in the Real Property Records of Tarrant County, Texas, and in the Real Property Records of Travis County, Texas, assigning to Lender the Operating Lease and all rents and income from the Operating Lease as it relates to Broadway and Summit; (b) the Assignment of Rents and Leases dated of even date herewith, executed by Borrower, filed for recording in the Real Property Records of Denver County, Colorado, assigning to Lender the Operating Lease and all rents and income from the Operating Lease as it relates to Parkplace; (c) the Assignment of Rents, Leases, and Income dated of even date herewith, executed by Operating Lessee, filed for recording in the Real Property Records of Tarrant County, Texas, and in the Real Property Records of Travis County, Texas, and assigning to Lender the rents and income from Residency Agreements and other leases and subleases of Broadway and Summit; (d) the Assignment of Rents, Leases, and Income dated of even date herewith, executed by Operating Lessee, filed for recording in the Real Property Records of Denver County, Colorado, and assigning to Lender the rents and income from Residency Agreements and other leases and subleases of Parkplace; and (e) any other assignment of rents and leases in favor of Lender and pertaining to the rents, and leases, and income of the Projects. "BLOCKED ACCOUNT" means an account established at a bank satisfactory to Lender, and controlled by Lender, into which all Operating Revenues of the Projects shall be deposited for further funding into a collection account controlled by Lender upon the occurrence of an Event of Default. "BLOCKED ACCOUNT AGREEMENT" means an agreement among Lender, Borrower, Operating Lessee, and the depository bank in which the Blocked Account is established, providing for the collection and application of Operating Revenues of the Projects. "BORROWER PARTY" means any Joinder Party, ARC, ARCSPE, Operating Lessee, any member in Borrower, any member in any limited liability company that is a member in Borrower, any general partner of Operating Lessee, and any general partner in any partnership that is a general partner of Operating Lessee, at any level. "BROADWAY" means Broadway Plaza at Cityview Retirement Center, consisting of approximately 126 independent residential living units, 88 villas, 40 assisted living units, and a 2 122-bed skilled/intermediate care health center on 20.013 acres located at 5301 Bryant Irvin Road, Fort Worth, Texas, including parking for 355 automobiles, and more particularly described on Exhibit A. "BUDGET" means that budget for allocation of proceeds of the Loan attached hereto as Exhibit B and made a part hereof. "BUSINESS DAY" means any day that is not a Saturday, Sunday, or day on which banks are required or permitted to be closed in the State of New York. "CAPITAL EXPENDITURES" has the meaning assigned to such term in Schedule 2.4 of this Agreement. "CAPITAL EXPENDITURES BUDGET" has the meaning assigned to such term in Schedule 2.4 of this Agreement. "CAPITAL IMPROVEMENTS RESERVE" has the meaning assigned to such term in Schedule 2.4 of this Agreement. "CASH ON CASH RETURN" means the ratio, expressed as a percentage, of (a) annualized Net Operating Income to (b) the sum of the outstanding principal balance of the Loan. "COMMITMENT FEE" means a commitment fee payable by Borrower to Lender on or before the initial advance of the Loan, in the amount of $957,000 (one percent of the maximum amount of the Loan). "CONTROL" means the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of a Person, whether through ownership of voting securities, by contract, or otherwise. "DEBENTURES" shall mean the $138,000,000 in subordinated convertible debentures issued by ARC in September 1997 and maturing October 2002. "DEBT" means, for any Person, without duplication: (a) all indebtedness of such Person for borrowed money (whether personal or non-recourse, secured or unsecured), for amounts drawn under a letter of credit, or for the deferred purchase price of property for which such Person or its assets is liable, (b) all unfunded amounts under a loan agreement, letter of credit, or other credit facility for which such Person would be liable, if such amounts were advanced under the credit facility, (c) all amounts required to be paid by such Person as a guaranteed payment to partners or a preferred or special dividend, including any mandatory redemption of shares or interests, (d) all indebtedness guaranteed by such Person, directly or indirectly, (e) all obligations under leases that constitute capital leases for which such Person is liable, and (f) all obligations of such Person under interest rate swaps, caps, floors, collars and other interest hedge agreements, in each case whether such Person is liable contingently or otherwise, as obligor, guarantor or otherwise, or in respect of which obligations such Person otherwise assures a creditor against loss. 3 "DEBT SERVICE" means the aggregate principal payments, interest payments and other payments by Borrower on the Loan, other than Net Cash Flow payments in reduction of the principal balance of the Loan under Section 2.3(b), and required additions to the Capital Expenditures Reserve and any other reserves deemed necessary by Lender, and on all other outstanding Debt of Borrower or Operating Lessee for the period of time for which calculated. "DEBT SERVICE COVERAGE" means, for the period of time for which the calculation is being made, the ratio of Net Operating Income to Debt Service. "DEFAULT RATE" means the lesser of (a) the maximum rate of interest allowed by applicable law, or (b) five percent (5%) per annum in excess of the Floating Rate. "EVENT OF DEFAULT" has the meaning assigned to such term in Article 9. "EURODOLLAR BUSINESS DAY" means any day on which banks in the City of London are generally open for interbank or foreign exchange transactions. "FACILITY CAPACITY" means the total number of independent living units and the total number of assisted living units and skilled nursing beds, if applicable, in the Projects. "FIXED RATE" has the meaning assigned to such term in Section 2.2. "FLOATING RATE" has the meaning assigned to such term in Section 2.2. "HELLER LOANS" means those mortgage loans held by Heller Healthcare Finance, Inc. or Heller Financial, Inc. or one or more of their related entities and secured by first priority mortgages or deeds of trust on those retirement centers operated by Affiliates of ARC and known as Countryside, Parklane West, Greenville, and Park Regency. "HCPI TRANSACTION" means that $125,000,000 loan by Health Care Property Investors, Inc. to an ARCSPE to be secured by, among other interests, pledges of ownership interests in Borrower. "IMMEDIATE REPAIRS" means those capital improvements, repairs and replacements to the Projects recommended in the engineering reports furnished to Lender in connection with the initial advance of the Loan, such Immediate Repairs to be completed no later than November 30, 2002. "INTEREST RATE PROTECTION AGREEMENT" means an interest rate swap agreement, interest rate cap agreement, interest rate collar agreement or similar interest rate protection agreement, as approved by Lender and as purchased by Borrower and issued or entered into with a creditworthy counterparty satisfactory to Lender, and providing for interest rate protection that results in a minimum Debt Service Coverage of 1.05:1 on the Net Operating Income of the Projects, as determined by Lender at the time of the initial advance of the Loan. "JOINDER PARTY" means the Persons, if any, executing the Joinder hereto. 4 "LENDER" means General Electric Capital Corporation, and its successors and assigns. "LIBOR RATE" means the U.S. Dollar rate (rounded upward to the nearest one-sixteenth of one percent) listed on page 3750 (i.e., the Libor page) of the Telerate News Services titled "British Banker Association Interest Settlement Rates" for a designated maturity of one (1) month determined as of 11:00 a.m. London Time on the second (2nd) full Eurodollar Business Day next preceding the first day of each month with respect to which interest is payable under the Loan (unless such date is not a Business Day in which event the next succeeding Eurodollar Business Day which is also a Business Day will be used). If the Telerate News Services (1) publishes more than one (1) such Libor Rate, the average of such rates shall apply, or (2) ceases to publish the Libor Rate, then the Libor Rate shall be determined from such substitute financial reporting service as Lender in its discretion shall determine. "LIEN" means any interest, or claim thereof, in the Projects securing an obligation owed to, or a claim by, any Person other than the owner of the Projects, whether such interest is based on common law, statute or contract, including the lien or security interest arising from a deed of trust, mortgage, assignment, encumbrance, pledge, security agreement, conditional sale or trust receipt or a lease, consignment or bailment for security purposes. The term "Lien" shall include reservations, exceptions, encroachments, easements, rights of way, covenants, conditions, restrictions, leases and other title exceptions and encumbrances affecting the Projects. "LOAN" means the loan to be made by Lender to Borrower under this Agreement, and all other amounts owing from time to time and secured by the Loan Documents. "LOAN ADMINISTRATION FEE" has the meaning assigned to such term in Section 2.3(c). "LOAN DOCUMENTS" means: (a) this Agreement, (b) the Note, (c) the Mortgage, (d) the Assignment of Rents and Leases, (e) financing statements, (f) the Assignment of Interest Rate Protection Agreement, (g) the Blocked Account Agreement, (h) the Interest Rate Protection Agreement, (i) any and all other documents evidencing, securing, governing or otherwise pertaining to the Loan, and (j) all amendments, modifications, renewals, substitutions and replacements of any of the foregoing. "LOAN TO VALUE RATIO" means the ratio, expressed as a percentage, of the outstanding principal balance of the Loan divided by the fair market value of the Projects, as determined by Lender's customary underwriting and valuation methods and procedures. "MATURITY DATE" means the earlier of (a) May 31, 2005, or (b) any earlier on which the entire Loan is required to be paid in full, by acceleration or otherwise, under this Agreement or any of the other Loan Documents. "MORTGAGE" means, collectively, the following deeds of trust and mortgages: (a) Deed of Trust, Security Agreement and Fixture Filing, dated of even date herewith, executed by Borrower for the benefit of Lender, recorded in the Real 5 Property Records of Tarrant County, Texas, and in the Real Property Records of Travis County, Texas, and encumbering Broadway and Summit; (b) Leasehold Deed of Trust, Security Agreement and Fixture Filing, dated of even date herewith, executed by Operating Lessee for the benefit of Lender, recorded in the Real Property Records of Tarrant County, Texas, and in the Real Property Records of Travis County, Texas, encumbering the leasehold interest of Operating Lessee in Broadway and Summit under the Operating Lease; (c) Deed of Trust, Security Agreement and Fixture Filing, dated of even date herewith, executed by Borrower for the benefit of Lender, recorded in the Real Property Records of Denver County, Colorado, and encumbering Parkplace; (d) Leasehold Deed of Trust, Security Agreement and Fixture Filing, dated of even date herewith, executed by Operating Lessee for the benefit of Lender, recorded in the Real Property Records of Denver County, Colorado, and encumbering the leasehold interest of Operating Lessee in Parkplace under the Operating Lease; and (e) any other deed of trust, mortgage or similar instrument encumbering the Projects as security for the Loan. "NET CASH FLOW" means, for any period, the amount by which Operating Revenues exceed the sum of (a) Operating Expenses, (b) Debt Service, and (c) any actual payment into impounds, escrows, or reserves required by Lender, except to the extent included within the definition of Operating Expenses. "NET OPERATING INCOME" means the amount by which Adjusted Operating Revenues exceed Adjusted Operating Expenses, calculated on the basis of occupancy of not more than 95% of the Projects and taking into account a management fee equal to four percent (4%) of Operating Revenues. "NET WORTH" means, as to any period of time, total assets (after adding back accumulated depreciation, amortization, and other reasonable non-cash charges determined in accordance with generally accepted accounting principles), less total liabilities (contingent or otherwise) determined on a book basis in accordance with generally accepted accounting principles, including declared and unpaid distributions or dividends; however, excluded from the determination of total assets shall be all assets that are classified as intangible, including good will, licenses, patents, trademarks, trade names, copyrights and franchises. "NOTE" means the Promissory Note of even date herewith in the principal amount of up to $95,700,000, executed by Borrower, payable to the order of Lender and evidencing the Loan. "OPERATING EXPENSES" means all customary expenses of operating the Projects in the ordinary course of business which are paid in cash by Borrower or Operating Lessee and which are directly associated with and fairly allocable to the Projects for the applicable period, including ad valorem real estate taxes and assessments, insurance premiums, regularly scheduled tax impounds paid to Lender, maintenance costs, management fees and costs equal to the greater 6 of four percent (4%) of Operating Revenues, accounting, legal, and other professional fees, fees relating to environmental and Net Cash Flow and Net Operating Income audits, and other expenses incurred by Lender and reimbursed by Borrower under this Agreement and the other Loan Documents, Capital Expenditures specifically identified in a Capital Expenditures Budget (as defined in Schedule 2.4), deposits to the Capital Improvements Reserve required by Lender, wages, salaries, and personnel expenses, but excluding Debt Service, Capital Expenditures unless specifically included in a Capital Expenditures Budget, any of the foregoing expenses which are paid from deposits to cash reserves previously included as Operating Expenses, any payment or expense for which Operating Lessee was or is to be reimbursed from proceeds of the Loan or insurance or by any third party, and any non-cash charges such as depreciation and amortization. Any management fee or other expense payable to Operating Lessee or to an Affiliate of Operating Lessee shall be included as an Operating Expense only with Lender's prior approval. Operating Expenses shall not include federal, state or local income taxes or legal and other professional fees unrelated to the operation of the Projects. "OPERATING LEASE" means that Master Lease between Borrower, as Lessor, and Operating Lessee, as Lessee, under which Borrower leases Broadway, Summit, and Parkplace to Operating Lessee for the operation of retirement communities or senior living centers, together with any modifications, amendments, restatements, or subsequent leases in connection with the HCPI Transaction that specifically replace the foregoing Master Lease, and that may include other subsidiaries of ARCSPE as additional Lessors and/or Lessees. "OPERATING LESSEE" means Fort Austin Limited Partnership, a Texas limited partnership whose sole limited partner is ARC Partners II, Inc., a Tennessee corporation, which is owned by ARCSPE, and the operator of the Projects. "OPERATING REVENUES" means all cash receipts of Borrower and Operating Lessee from leasing and operation of the Projects or otherwise arising in respect of the Projects after the date hereof which are properly allocable to the Projects for the applicable period, including (a) gross resident service revenues, including revenues from companion care and therapy services, less contractual allowances and provisions for uncollectible accounts, free care and discounted care, if any, (b) non-operating revenues, (c) entrance fees actually paid, if any, net of refunds, (d) revenues from parking agreements, concession fees and charges and other miscellaneous operating revenues, (e) proceeds from rental or business interruption insurance, (f) proceeds of any loans (other than the Loan and any refinancing of the Loan) obtained by Borrower or Operating Lessee after the date hereof which are secured by a Project (less only reasonable and customary expenses incurred in procuring and closing such loan and actually paid in cash to individuals or entities other than Borrower or Operating Lessee or any Affiliate of Borrower or Operating Lessee and without implying any consent of Lender to the granting of any security for any such loans), (g) withdrawals from cash reserves (except to the extent any operating expenses paid therewith are excluded from Operating Expenses). Operating Revenues shall not include (1) security deposits and earnest money deposits until they are forfeited by the depositor, (2) advance rentals until they are earned, (3) proceeds from a sale or other disposition, (4) any gain or loss resulting from the early extinguishment of indebtedness or the sale, exchange or other disposition of properties not in the ordinary course of business, (5) gifts, grants, bequests or donations restricted as to use by the donor or grantor for a purpose inconsistent with the payment of Debt Service, or (6) insurance proceeds (other than rental or business interruption 7 proceeds) and condemnation proceeds. For purposes of any calculation that is made with reference to both Adjusted Operating Revenues and Adjusted Operating Expenses, any deduction from gross resident service revenues otherwise required by the preceding provisions of this definition shall not be made if and to the extent that the amount of such deduction is included in Adjusted Operating Expenses. "PERSON" means any individual, corporation, partnership, joint venture, association, joint stock company, trust, trustee, estate, limited liability company, unincorporated organization, real estate investment trust, government or any agency or political subdivision thereof, or any other form of entity. "POTENTIAL DEFAULT" means the occurrence of any event or condition which, with the giving of notice, the passage of time, or both, would constitute an Event of Default. "PARKPLACE" means Parkplace Retirement Community, consisting of approximately 173 independent residential living units, and 53 assisted living units on 1.623 acres located at 111 Emerson Street in Denver, Colorado, including adequate parking for automobiles, and more particularly described on Exhibit A. "PROJECTS" means, collectively, Broadway, Summit, Parkplace, and any other retirement communities acquired, constructed or developed by Borrower and made subject to the Mortgage and the other Loan Documents, and the term "PROJECT" shall mean and refer to any of the Projects and all related facilities, other amenities, fixtures, and personal property owned by Borrower and any improvements now or hereafter located on the real property related thereto. Any property that is sold and released from the Mortgage shall not be a Project after the date of such sale and release. "RESIDENCY AGREEMENT" means (a) any lease, residency or other rental agreement for the occupancy of residential living units of any Project, (b) any admission and financial agreement for the use and occupancy of an assisted living unit of any Project, (c) any health center admission and financial agreement (private payment) or health center admission agreement (Medicare payment) and (d) any other express or implied agreement for the occupancy of nursing beds in a Project or for space in or use of the Project. "RESIDENT" means any resident of a Project under a Residency Agreement. "SINGLE PURPOSE ENTITY" shall mean a Person (other than an individual, a government, or any agency or political subdivision thereof), which exists solely for the purpose of owning the Projects, conducts business only in its own name, does not engage in any business or have any assets unrelated to the Projects (other than facilities which previously were Projects and were released under Section 2.5 of this Agreement), does not have any indebtedness other than as permitted by this Agreement, has its own separate books, records, and accounts (with no commingling of assets), holds itself out as being a Person separate and apart from any other Person, and observes corporate and partnership formalities independent of any other entity, and which otherwise constitutes a single purpose, bankruptcy remote entity as determined by Lender. "SITE ASSESSMENT" means an environmental engineering report for a Project prepared by an engineer engaged by Lender at Borrower's expense, and in a manner satisfactory 8 to Lender, based upon an investigation relating to and making appropriate inquiries concerning the existence of Hazardous Materials on or about a Project, and the past or present discharge, disposal, release or escape of any such substances, all consistent with good customary and commercial practice, and certified for the use and reliance by Lender and its Affiliates, successors and assigns. "STATE" means the State of Texas. "STATE AGENCIES" means any governmental authority having jurisdiction over Borrower, any Joinder Party or any Project, including, with respect to Broadway and Summit, the Texas Department of Health and the Texas Department of Human Services, and with respect to Parkplace, the Colorado Department of Public Health and Environment and the Colorado Department of Health Care Policy and Financing, and any other governmental authorities having enforcement authority over the statutes, rulings, rules, regulations, permits, certificates and ordinances promulgated with respect to Borrower and Joinder Party, or any Project. "SUMMIT" means Summit at Westlake Hills Retirement Community consisting of approximately 149 independent residential living units, 30 assisted living units, and a 90-bed skilled/intermediate care health center on 14.003 acres located at 1034 Liberty Park Avenue, Austin, Texas, including parking for 212 automobiles, and more particularly described on Exhibit A. "YIELD MAINTENANCE AMOUNT" shall have the meaning assigned to such term in Schedule 2.3(e). ARTICLE 2 LOAN TERMS Section 2.1 THE LOAN. The Loan shall be funded in one or more advances and repaid in accordance with this Agreement. The initial advance of the Loan shall be made upon Borrower's satisfaction of the conditions to initial advance described in Schedule 2.1, Part A, and shall be in an amount equal to $95,700,000. The Loan shall be advanced for payment of those costs set forth in the Budget, with any excess proceeds (that is, any allocated funds in excess of the actual amount spent in any Budget category) being applied to reduce the principal balance of the Heller Loans. Section 2.2 INTEREST RATE; LATE CHARGE. The outstanding principal balance of the Loan (including any amounts added to principal under the Loan Documents) shall bear interest as follows: (a) $62,330,000 of the principal balance of the Loan shall bear interest at eight and twenty one-hundredths percent (8.20%) per annum (the "FIXED RATE") until December 31, 2002 and thereafter shall bear interest at the Floating Rate; however, Borrower may at any time before December 31, 2002 and on 30 days prior notice to Lender and payment of the Yield Maintenance Amount, convert the interest rate on such $62,330,000 portion of the principal balance of the Loan to a rate of interest equal to the greater of (i) three and ninety-five one hundredths percent (3.95%) per annum in excess of the LIBOR Rate or (ii) six and seventy-five one hundredths percent (6.75%) per annum (the "FLOATING RATE"); and 9 (b) Prior to January 1, 2003, the principal balance of the Loan in excess of $62,330,000 and from and after January 1, 2003 the entire principal balance of the Loan shall bear interest at the Floating Rate. Interest shall be computed on the basis of a fraction, the denominator of which is three hundred sixty (360) and the numerator of which is the actual number of days elapsed from the date of the initial advance or the date on which the immediately preceding payment was due. If Borrower fails to pay any installment of interest or principal within five (5) days after the date on which the same is due, Borrower shall pay to Lender a late charge on such past-due amount, as liquidated damages and not as a penalty, equal to the greater of (A) interest at the Default Rate on such amount from the date when due until paid, or (B) five percent (5%) of such amount, but not in excess of the maximum amount of interest allowed by applicable law. While any Event of Default exists, the Loan shall bear interest at the Default Rate. Section 2.3 TERMS OF PAYMENT. The Loan and the interest thereon shall be evidenced by, and be payable as hereinafter provided (the Loan and the interest thereon, together with any other sums payable by Borrower under the Loan Documents, are herein collectively called the "OBLIGATIONS"), and, from and after the date hereof shall be payable as follows: (a) INTEREST AND PRINCIPAL. Commencing on June 1, 2002, Borrower shall pay interest in arrears at the rate or rates set forth in Section 2.2, and a principal installment based on a 25-year monthly amortization of the principal balance of the Loan in equal monthly installments of principal and interest at the rate of seven percent (7%) per annum, on the first day of each month until all amounts due under the Loan Documents are paid in full. (b) PRINCIPAL AMORTIZATION. In addition to monthly payments of interest and principal hereunder, if for any calendar quarter (January through March, April through June, July through September, or October through December) the Debt Service Coverage is less than 1.20:1, then, in addition to regular monthly installments of interest and principal, Borrower and Operating Lessee shall pay to Lender on the first (1st) day of each month commencing with the first day of the second calendar month following such calendar quarter and continuing until Borrower has demonstrated a Debt Service Coverage of at least 1.20:1 for at least two (2) consecutive calendar quarters, all Net Cash Flow from the Projects, such Net Cash Flow to be applied in reduction of the principal balance of the Loan (subject to any Yield Maintenance Amount that may be owing). (c) LOAN ADMINISTRATION FEE. Commencing June 1, 2002 and continuing on the first day of each month thereafter so long as the Loan is outstanding, Borrower shall pay to Lender, in monthly installments of $7,083.40 each, an annual loan administration fee of $85,000 per year (the "LOAN ADMINISTRATION FEE"). (d) MATURITY. On the Maturity Date, Borrower shall pay to Lender all outstanding principal, accrued and unpaid interest, and any other amounts due under the Loan Documents. (e) PREPAYMENT. Borrower may not prepay any portion of the Loan before December 1, 2002. Commencing December 1, 2002, the Loan may be prepaid as follows: 10 (1) From and after December 1, 2002 and before June 1, 2003, but only in connection with a sale or refinancing as allowed for a partial release under Section 2.5, Borrower may prepay the Loan in whole or in part, upon ten (10) days prior written notice to Lender, and on any regularly scheduled interest payment due date, by paying Lender all or a portion of the principal balance of the Loan and a prepayment fee equal to one and one-half percent (1.5%) of the amount prepaid. (2) From and after June 1, 2003 and before June 1, 2004, but only in connection with a sale or refinancing as allowed for a partial release under Section 2.5, Borrower may prepay the Loan in whole or in part, upon ten (10) days prior written notice to Lender, and on any regularly scheduled interest payment due date, by paying Lender all or a portion of the principle balance of the Loan and a prepayment fee equal to one percent (1%) of the amount prepaid. (3) From and after June 1, 2004, Borrower may prepay all or a portion of the Loan, in whole or in part, upon ten (10) days prior written notice to Lender and on any regularly scheduled interest payment due day, by paying Lender all or a portion of the principal balance of the Loan, but without any premium or penalty. In addition, Borrower may not prepay the Loan in whole or in part in any amount which would reduce the unpaid principal balance of the Loan to less than $62,330,000 at any time before December 31, 2002, or the earlier conversion of the Fixed Rate portion of the Loan to a Floating Rate. (f) MANDATORY REPAYMENT. If at any time the number of Projects encumbered by the Mortgage is fewer than two, Lender may upon ninety (90) days prior notice to Borrower declare the unpaid principal balance of the Loan, together with all accrued and unpaid interest and other charges, any prepayment fee required under Section 2.3(e), and the Yield Maintenance Amount for payment of any portion of the Loan which is payable at the Fixed Rate, due and payable, and the Loan then shall be due and payable at the expiration of the ninety (90) - day period after Lender's notice to Borrower. (g) APPLICATION OF PAYMENTS. All payments received by Lender under the Loan Documents shall be applied: first, to any fees and expenses due to Lender under the Loan Documents; second, to any Default Rate interest or late charges; third, to accrued and unpaid interest; fourth, to the principal sum of the Loan. Lender reserves the right to require any payment on the Loan, whether such payment is of a regular installment or represents a prepayment or final payment, to be by wired federal funds or other immediately available funds. Section 2.4 SECURITY. The Loan shall be secured by the Mortgage, the Assignments of Rents and Leases, and the other Loan Documents. As further security for the Loan, Borrower shall fund the Capital Improvements Reserve in accordance with Schedule 2.4. Section 2.5 PARTIAL RELEASES. Upon either (a) a sale of a Project to an entity which is owned by a third party which is not an Affiliate of Borrower or ARC or ARCSPE, or (b) for Summit or Broadway, a refinancing or recapitalization of Summit or Broadway in connection with the expansion of either such Project, Borrower shall have the right to obtain a partial release 11 of such Project from the Mortgage and the other Loan Documents on the following terms and conditions: (a) No Event of Default or Potential Default shall have occurred and be continuing hereunder; (b) Borrower shall submit a prepared release instrument (the "PARTIAL RELEASE") in form and substance satisfactory to Lender, accompanied with information necessary for Lender to process the Partial Release, including the name and address of the title insurance company, if any, to whose attention the Partial Release should be directed, numbers that reference the Partial Release (i.e., order numbers, release numbers, etc.) and the date when the Partial Release is to become effective. Borrower shall also specify the name and address of the prospective purchaser of or lender for the Project being released, and such other documents and information as Lender may reasonably request; (c) Borrower shall make a payment in reduction of the outstanding principal balance of the Loan in an amount of at least 115% of the Allocated Loan Balance of the Project being released and any additional payment in reduction of the principal balance of the Loan which may be required in order that after the Partial Release (1) the Cash on Cash Return will be equal to or greater than the Cash on Cash Return immediately before the Partial Release and equal to or greater than 14.25%, and (2) the Debt Service Coverage will be equal to or greater than the Debt Service Coverage immediately before the Partial Release and equal to or greater than 1.75:1, and (3) the Loan to Value Ratio will be not more than 80%; (d) All accrued but unpaid interest on the outstanding principal balance of the Loan shall be paid at the time the Partial Release is made; and (e) Borrower shall pay all costs and expenses of Lender arising in connection with the Partial Release, including but not limited to, legal fees of Lender's counsel, all title insurance premiums arising as a result of endorsements required by Lender in connection with the Partial Release and all other costs arising in connection with the execution and delivery of the Partial Release. Section 2.6 EXTENSION OF MATURITY DATE. Provided no Event of Default or Potential Default exists, Lender shall on request of Borrower not more than ninety (90) days before and not fewer than sixty (60) days before the Maturity Date, or any extension thereof, extend the Maturity Date for up to two (2) additional one-year periods upon the following conditions: (a) receipt and approval by Lender of a satisfactory current environmental Site Assessment and engineering report for each of the Projects; (b) determination by Lender, based on Lender's audit of the Operating Revenues and Operating Expenses of the Projects, that the Net Operating Income of the Projects provides a Cash on Cash Return of at least 13.0% per annum, a Debt Service Coverage of at least 1.45:1, and a Loan to Value Ratio of not more than 80%; (c) receipt by Lender of an extension fee in the amount of one-half percent (0.5%) of the principal balance of the Loan; 12 (d) Borrower's purchase of a further Interest Rate Protection Agreement satisfactory to Lender, and the assignment of such Interest Rate Protection Agreement to Lender, in form satisfactory to Lender; (e) receipt by Lender of an estoppel certificate executed by Operating Lessee and confirming that the Operating Lease is in full force and effect, is not subject to any offsets, credits or defenses, and as to such other matters as Lender reasonably shall request. (f) execution by Borrower of an agreement, in form and substance satisfactory to Lender, renewing and extending the Maturity Date of the Loan and the liens, security interests and other obligations created by the Mortgages and the other Loan Documents for the applicable extension period; and (g) payment by Borrower of all costs and expenses of extending the Maturity Date, including, without limitation, the fees and expenses of Lender's counsel, recording costs, and any endorsement to title insurance required by Lender. ARTICLE 3 INSURANCE, CONDEMNATION, AND IMPOUNDS Section 3.1 INSURANCE. Borrower and Operating Lessee shall maintain insurance as follows: (a) CASUALTY; BUSINESS INTERRUPTION. Borrower and Operating Lessee shall keep the Projects insured against damage by fire and the other hazards covered by a standard extended coverage and all-risk insurance policy for the full insurable value thereof (without reduction for depreciation or co-insurance), and shall maintain such other casualty insurance as reasonably required by Lender. Borrower and Operating Lessee shall keep any Project that is located in an area identified by the Federal Emergency Management Agency as an area having special flood hazards and in which flood insurance has been made available under the National Flood Insurance Act of 1968 (and any successor act thereto) insured against loss by flood in an amount at least equal to the lesser of (1) the maximum amount of the Loan or (2) the maximum limit of coverage available under said act. Borrower and Operating Lessee shall maintain use and occupancy insurance covering, as applicable, rental income or business interruption, with coverage in an amount not less than twelve (12)-months anticipated gross rental income or gross business earnings, as applicable in each case, attributable to the Projects. Neither Borrower nor Operating Lessee shall maintain any separate or additional insurance which is contributing in the event of loss unless it is properly endorsed and otherwise satisfactory to Lender in all respects. The proceeds of insurance paid on account of any damage or destruction to a Project shall be paid to Lender to be applied as provided in Section 3.2. (b) LIABILITY. Borrower and Operating Lessee shall maintain (1) commercial general liability insurance with respect to each Project providing for limits of liability of not less than $11,000,000 for both injury to or death of a person and for property damage per occurrence, and (2) other liability insurance as reasonably required by Lender. (c) FORM AND QUALITY. All insurance policies shall be endorsed in form and substance acceptable to Lender to name Lender as an additional insured, loss payee or mortgagee 13 thereunder, as its interest may appear, with loss payable to Lender, without contribution, under a standard New York (or local equivalent) mortgagee clause. All such insurance policies and endorsements shall be fully paid for and contain such provisions and expiration dates and be in such form and issued by such insurance companies licensed to do business in the State, with a rating of "A-X" or better as established by Best's Rating Guide (or an equivalent rating approved in writing by Lender). Each policy shall provide that such policy may not be canceled or materially changed except upon thirty (30) days' prior written notice of intention of non-renewal, cancellation or material change to Lender and that no act or thing done by Borrower shall invalidate any policy as against Lender. At Lender's request from time to time, Borrower shall furnish to Lender true and correct copies of all policies of insurance required hereunder. If Borrower or Operating Lessee fails to maintain insurance in compliance with this Section 3.1, Lender may obtain such insurance and pay the premium therefor and Borrower and Operating Lessee shall, on demand, reimburse Lender for all expenses incurred in connection therewith. Borrower and Operating Lessee shall assign the policies or proofs of insurance to Lender, in such manner and form that Lender and its successors and assigns shall at all times have and hold the same as security for the payment of the Loan. Borrower and Operating Lessee shall deliver copies of all original policies certified to Lender by the insurance company or authorized agent as being true copies, together with the endorsements required hereunder. The proceeds of insurance policies coming into the possession of Lender shall not be deemed trust funds, and Lender shall be entitled to apply such proceeds as herein provided. (d) ADJUSTMENTS. Borrower and Operating Lessee shall give immediate written notice of any loss to the insurance carrier and to Lender. Borrower and Operating Lessee hereby irrevocably authorize and empower Lender, as attorney-in-fact for Borrower and Operating Lessee coupled with an interest, to make proof of loss, to appear in and prosecute any action arising from such insurance policies, to collect and receive insurance proceeds, and to deduct therefrom Lender's expenses incurred in the collection of such proceeds, and if an Event of Default or Potential Default exists, to adjust and compromise any claim under insurance policies. Nothing contained in this Section 3.1(d), however, shall require Lender to incur any expense or take any action hereunder. Section 3.2 USE AND APPLICATION OF INSURANCE PROCEEDS. Lender shall apply insurance proceeds (other than proceeds of rental income or business interruption insurance which shall constitute Operating Revenues) to costs of restoring a damaged Project or the Loan as follows: (a) if the loss is less than or equal to $300,000, Lender shall apply the insurance proceeds to restoration provided (1) no Event of Default or Potential Default exists, and (2) Borrower promptly commences and is diligently pursuing restoration of the Project; (b) if the loss exceeds $300,000 but is not more than 10% of the replacement value of the improvements (for projects containing multiple phases or stand alone structures, such calculation to be based on the damaged phase or structure, not the project as a whole), Lender shall apply the insurance proceeds to restoration provided that at all times during such restoration (1) no Event of Default or Potential Default exists; (2) Lender determines that there are sufficient funds available to restore and repair the Project to a condition approved by Lender; (3) Lender determines that the Net Operating Income of the Projects during restoration will be 14 sufficient to pay Debt Service; (4) Lender determines that after restoration the Debt Service Coverage will be at least 1.48:1, the Cash on Cash Return will be at least 12.70% and the Loan to Value Ratio will not exceed 80%; (5) Lender determines that restoration and repair of the Project to a condition approved by Lender will be completed within six months after the date of loss or casualty and in any event ninety (90) days prior to the Maturity Date; and (6) Borrower or Operating Lessee promptly commences and is diligently pursuing restoration of the Project; (c) if the conditions set forth above are not satisfied or the loss exceeds the maximum amount specified in Section 3.2(b) above, in Lender's sole discretion, Lender may apply any insurance proceeds it may receive to the payment of the Loan or allow all or a portion of such proceeds to be used for the restoration of the Project; and (d) insurance proceeds applied to restoration will be disbursed on receipt of satisfactory plans and specifications, contracts and subcontracts, schedules, budgets, lien waivers and architects' certificates, and otherwise in accordance with prudent commercial construction lending practices for construction loan advances, including, as applicable, the advance conditions under Schedule 2.1. Section 3.3 CONDEMNATION AWARDS. Borrower and Operating Lessee shall immediately notify Lender of the institution of any proceeding for the condemnation or other taking of a Project or any portion thereof. Lender may participate in any such proceeding and Borrower and Operating Lessee will deliver to Lender all instruments necessary or required by Lender to permit such participation. Without Lender's prior consent, Borrower and Operating Lessee, individually or together, (a) shall not agree to any compensation or award, and (b) shall not take any action or fail to take any action which would cause the compensation to be determined. All awards and compensation for the taking or purchase in lieu of condemnation of a Project or any part thereof are hereby assigned to and shall be paid to Lender. Borrower and Operating Lessee authorize Lender to collect and receive such awards and compensation, to give proper receipts and acquittances therefor, and in Lender's sole discretion to apply the same toward the payment of the Loan, notwithstanding that the Loan may not then be due and payable, or to the restoration of the Project; however, if the award is less than or equal to $300,000 and Borrower and Operating Lessee request that such proceeds be used for non-structural site improvements (such as landscape, driveway, walkway and parking area repairs) required to be made as a result of such condemnation, Lender will apply the award to such restoration in accordance with disbursement procedures applicable to insurance proceeds provided there exists no Potential Default or Event of Default. Borrower and Operating Lessee, upon request by Lender, shall execute all instruments requested to confirm the assignment of the awards and compensation to Lender, free and clear of all liens, charges or encumbrances. Section 3.4 IMPOUNDS. Borrower and Operating Lessee shall deposit with Lender, monthly, one-twelfth (1/12th) of the annual charges for real estate taxes, assessments and similar charges relating to the Projects. At or before the initial advance of the Loan, Borrower and Operating Lessee shall deposit with Lender a sum of money which together with the monthly installments will be sufficient to make each of such payments thirty (30) days prior to the date any delinquency or penalty becomes due with respect to such payments. Deposits shall be made on the basis of Lender's estimate from time to time of the charges for the current year (after giving effect to any reassessment or, at Lender's election, on the basis of the charges for the prior 15 year, with adjustments when the charges are fixed for the then current year). All funds so deposited shall be held by Lender in an interest-bearing account controlled by Lender and may be commingled with Lender's general funds. Borrower and Operating Lessee hereby grant to Lender a security interest in all funds so deposited with Lender for the purpose of securing the Loan. While an Event of Default exists, the funds deposited may be applied in payment of the charges for which such funds have been deposited, or to the payment of the Loan or any other charges affecting the security of Lender, as Lender may elect, but no such application shall be deemed to have been made by operation of law or otherwise until actually made by Lender. Borrower and Operating Lessee shall furnish Lender with bills for the charges for which such deposits are required at least thirty (30) days prior to the date on which the charges first become payable. If at any time the amount on deposit with Lender, together with amounts to be deposited by Borrower or Operating Lessee before such charges are payable, is insufficient to pay such charges, Borrower or Operating Lessee shall deposit any deficiency with Lender immediately upon demand. Lender shall pay such charges when the amount on deposit with Lender is sufficient to pay such charges and Lender has received a bill for such charges. Pursuant to Section 8.2, Borrower and Operating Lessee unconditionally and irrevocably covenant and agree to pay all real estate taxes, assessments, and similar charges on the Projects, prior to the delinquency thereof. ARTICLE 4 ENVIRONMENTAL MATTERS Section 4.1 CERTAIN DEFINITIONS. As used herein, the following terms have the meanings indicated: (a) "ENVIRONMENTAL LAWS" means any federal, state or local law (whether imposed by statute, or administrative or judicial order, or common law), now or hereafter enacted, governing health, safety, industrial hygiene, the environment or natural resources, or Hazardous Materials, including, such laws governing or regulating the use, generation, storage, removal, recovery, treatment, handling, transport, disposal, control, discharge of, or exposure to, Hazardous Materials. (b) "HAZARDOUS MATERIALS" means (1) petroleum or chemical products, whether in liquid, solid, or gaseous form, or any fraction or by-product thereof, (2) asbestos or asbestos-containing materials, (3) polychlorinated biphenyls (pcbs), (4) radon gas, (5) underground storage tanks, (6) any explosive or radioactive substances, (7) lead or lead-based paint, or (8) any other substance, material, waste or mixture which is or shall be listed, defined, or otherwise determined by any governmental authority to be hazardous, toxic, dangerous or otherwise regulated, controlled or giving rise to liability under any Environmental Laws. Section 4.2 REPRESENTATIONS AND WARRANTIES ON ENVIRONMENTAL MATTERS. To the knowledge of Borrower and Operating Lessee, except as set forth in the Site Assessment, (a) no Hazardous Material is now or was formerly used, stored, generated, manufactured, installed, disposed of or otherwise present at or about any Project or any property adjacent to a Project (except for cleaning and other products currently used in connection with the routine maintenance or repair of the Project in full compliance with Environmental Laws), (b) all permits, licenses, approvals and filings required by Environmental Laws have been obtained, and 16 the use, operation and condition of the Projects do not, and did not previously, violate any Environmental Laws, and (c) no civil, criminal or administrative action, suit, claim, hearing, investigation or proceeding has been brought or been threatened, nor have any settlements been reached by or with any parties or any liens imposed in connection with any Project concerning Hazardous Materials or Environmental Laws. Section 4.3 COVENANTS ON ENVIRONMENTAL MATTERS. (a) Borrower and Operating Lessee shall (1) comply strictly and in all respects with applicable Environmental Laws; (2) notify Lender immediately upon discovery of any spill, discharge, release or presence of any Hazardous Material at, upon, under, within, contiguous to or otherwise affecting a Project by Borrower or Operating Lessee; (3) promptly remove such Hazardous Materials and remediate a Project in full compliance with Environmental Laws and in accordance with the recommendations and specifications of an independent environmental consultant approved by Lender; and (4) promptly forward to Lender copies of all orders, notices, permits, applications or other communications and reports in connection with any spill, discharge, release or the presence of any Hazardous Material or any other matters relating to the Environmental Laws or any similar laws or regulations, as they may affect a Project, Borrower or Operating Lessee. (b) Borrower and Operating Lessee shall not cause, shall prohibit any other Person within the Control of Borrower or Operating Lessee from causing, and shall use prudent, commercially reasonable efforts to prohibit other Persons (including tenants) from (1) causing any spill, discharge or release, or the use, storage, generation, manufacture, installation, or disposal, of any Hazardous Materials at, upon, under, within or about a Project or the transportation of any Hazardous Materials to or from a Project (except for cleaning and other products used in connection with routine maintenance or repair of the Project in full compliance with Environmental Laws), (2) installing any underground storage tanks at a Project, or (3) conducting any activity that requires a permit or other authorization under Environmental Laws. (c) Borrower and Operating Lessee shall provide to Lender, at Borrower's and Operating Lessee's expense promptly upon the written request of Lender from time to time, a Site Assessment or, if required by Lender, an update to any existing Site Assessment, to assess the presence or absence of any Hazardous Materials and the potential costs in connection with abatement, cleanup or removal of any Hazardous Materials found on, under, at or within a Project. Borrower and Operating Lessee shall pay the cost of no more than one such Site Assessment or update in any twelve (12)-month period, unless Lender's request for a Site Assessment is based on information provided under Section 4.3(a), a reasonable suspicion of Hazardous Materials at or near a Project (exclusive of the matters established in the Site Assessment), a breach of representations under Section 4.2, or an Event of Default, in which case any such Site Assessment or update shall be at Borrower's expense. Section 4.4 ALLOCATION OF RISKS AND INDEMNITY. As between Borrower and Lender and as between Operating Lessee and Lender, all risk of loss associated with non-compliance with Environmental Laws, or with the presence of any Hazardous Material at, upon, within, contiguous to or otherwise affecting a Project, shall lie solely with Borrower and Operating Lessee. Accordingly, Borrower and Operating Lessee shall bear all risks and costs associated 17 with any loss (including any loss in value attributable to Hazardous Materials), damage or liability therefrom, including all costs of removal of Hazardous Materials or other remediation required by Lender or by law. Borrower and Operating Lessee shall indemnify, defend and hold Lender harmless from and against all loss, liabilities, damages, claims, costs and expenses (including reasonable costs of defense) arising out of or associated, in any way, with the non-compliance with Environmental Laws, or the existence of Hazardous Materials in, on, or about a Project, or a breach of any representation, warranty or covenant contained in this Article 4, whether based in contract, tort, implied or express warranty, strict liability, criminal or civil statute or common law, including those arising from the joint, concurrent, or comparative negligence of Lender; however, Borrower and Operating Lessee shall not be liable under such indemnification to the extent such loss, liability, damage, claim, cost or expense results solely from Lender's gross negligence or willful misconduct occurring after foreclosure. Borrower's and Operating Lessee's obligations under this Section 4.4 shall arise upon the discovery of the presence of any Hazardous Material, whether or not any governmental authority has taken or threatened any action in connection with the presence of any Hazardous Material, and whether or not the existence of any such Hazardous Material or potential liability on account thereof is disclosed in the Site Assessment and shall continue notwithstanding the repayment of the Loan or any transfer or sale of any right, title and interest in a Project (by foreclosure, deed in lieu of foreclosure or otherwise). Section 4.5 COLLATERAL ASSIGNMENT OF INDEMNITIES. Borrower and Operating Lessee hereby collaterally assign all of the rights and benefits (but none of the obligations or liabilities) under any indemnity agreement or provision with respect to one or more of the Projects, including any indemnification agreement for the benefit of Borrower or Operating Lessee executed by any previous owner of any of the Projects. Section 4.6 NO WAIVER. Notwithstanding any provision in this Article 4 or elsewhere in the Loan Documents, or any rights or remedies granted by the Loan Documents, Lender does not waive and expressly reserves all rights and benefits now or hereafter accruing to Lender under the "security interest" or "secured creditor" exception under applicable Environmental Laws, as the same may be amended. No action taken by Lender pursuant to the Loan Documents shall be deemed or construed to be a waiver or relinquishment of any such rights or benefits under the "security interest exception." ARTICLE 5 LEASING MATTERS Section 5.1 REPRESENTATIONS AND WARRANTIES ON RESIDENCY AGREEMENTS. Operating Lessee represents and warrants to Lender with respect to Residency Agreements of the Projects that: (a) to the knowledge of Operating Lessee, the rent roll last delivered to Lender is true and correct, and the Residency Agreements are valid and in and full force and effect; (b) the Residency Agreements (including amendments) are in writing, and, to the knowledge of Operating Lessee, there are no material oral agreements with respect thereto; (c) the copies of the Residency Agreements available to be furnished to Lender at Lender's request are true and complete; (d) to the knowledge of Operating Lessee, neither the landlord nor any resident is in default under any of the Residency Agreements; (e) Operating Lessee has no knowledge of any notice of termination or default with respect to any Residency Agreement; (f) Operating Lessee 18 has not assigned or pledged any of the Residency Agreements, the rents or any interests therein except to Lender; (g) except as set forth in the rent roll last delivered to Lender, no resident or other party has an option to purchase all or any portion of a Project; and (h) no resident has prepaid more than one month's rent in advance (except for bona fide security deposits not in excess of an amount equal to two month's rent). Section 5.2 STANDARD RESIDENCY AGREEMENT FORM; MATERIAL LEASES. All Residency Agreements and other rental arrangements shall in all respects be approved by Lender and shall be on a standard form approved by Lender with no material unfavorable modifications (except as approved by Lender). Within ten (10) days after Lender's request, Borrower and Operating Lessee shall furnish to Lender a statement of all resident security deposits, and copies of all Residency Agreements not previously delivered to Lender, certified by Borrower as being true and correct. Further, except for the Operating Lease, neither Borrower nor Operating Lessee shall enter into any lease for occupancy of space in any Project of in excess of 10,000 rentable square feet or five percent (5%) of the total rentable square feet of a Project without the prior written approval of Lender. Section 5.3 COVENANTS. Operating Lessee (a) shall perform in all material respects the obligations which Operating Lessee is required to perform under the Residency Agreements; (b) shall enforce the obligations to be performed by the residents in accordance with the normal prudent operation of the Projects; (c) shall not collect any rents for more than thirty (30) days in advance of the time when the same shall become due, except for bona fide security deposits not in excess of an amount equal to two months rent; (d) shall not enter into any ground lease or master lease of any part of a Project; (e) shall not further assign or encumber any Residency Agreement; (f) shall not, except in the ordinary course of business and the normal prudent operation of the Projects, cancel or accept surrender or termination of any Residency Agreement; and (g) shall not, except in the ordinary course of business and the normal prudent operation of the Projects, modify or amend any Residency Agreement and any action in violation of clauses (e), (f), and (g) of this Section 5.3, shall be void at the election of Lender. Section 5.4 OPERATING LEASE. Borrower and Operating Lessee represent and warrant to Lender that (a) the Operating Lease furnished to Lender is true, correct and complete, (b) neither Borrower nor Operating Lessee is in default under the Operating Lease, (c) Borrower has not pledged or assigned the Operating Lease or any interest therein, except to Lender; and (d) Operating Lessee has not prepaid more than one month's rent in advance under the Operating Lease. Borrower and Operating Lessee shall perform in all material respects the obligations which Borrower and Operating Lessee are required to perform under the Operating Lease. Borrower shall enforce the obligations to be performed by Operating Lease under the Operating Lease, shall not collect any rents under the Operating Lease for more than thirty (30) days in advance of the time when the same shall become due, shall not further assign or encumber the Operating Lease, and shall not modify, accrue, terminate or cancel any obligation or liability under the Operating Lease and any action by Borrower or Operating Lessee in violation of this Section 5.4 shall be void at the election of Lender. 19 ARTICLE 6 REPRESENTATIONS AND WARRANTIES Borrower and Operating Lessee represent and warrant to Lender that: Section 6.1 ORGANIZATION AND POWER. Borrower and each Borrower Party is duly organized, validly existing and in good standing under the laws of the state of its formation or existence, and is in compliance with legal requirements applicable to doing business in the State. Borrower is not a "foreign person" within the meaning of ss. 1445(f)(3) of the Internal Revenue Code. Section 6.2 VALIDITY OF LOAN DOCUMENTS. The execution, delivery and performance by Borrower and each Borrower Party of the Loan Documents: (a) are duly authorized and do not require the consent or approval of any other party or governmental authority which has not been obtained; and (b) will not violate any law or result in the imposition of any lien, charge or encumbrance upon the assets of any such party, except as contemplated by the Loan Documents. The Loan Documents constitute the legal, valid and binding obligations of Borrower and each Borrower Party, enforceable in accordance with their respective terms, subject to applicable bankruptcy, insolvency, or similar laws generally affecting the enforcement of creditors' rights. Section 6.3 LIABILITIES; LITIGATION. (a) The financial statements last delivered by Borrower and each Borrower Party are true and correct with no significant change since the date of preparation. Except as disclosed in such financial statements, there are no liabilities (fixed or contingent) affecting the Projects, Borrower or any Borrower Party. Except as disclosed in such financial statements, there is no litigation, administrative proceeding, investigation or other legal action (including any proceeding under any state or federal bankruptcy or insolvency law) pending or, to the knowledge of Borrower, threatened, against the Projects, Borrower or any Borrower Party which if adversely determined could have a material adverse effect on such party, a Project or the Loan. (b) Neither Borrower nor any Borrower Party is contemplating either the filing of a petition by it under state or federal bankruptcy or insolvency laws or the liquidation of all or a major portion of its assets or property, and neither Borrower nor any Borrower Party has knowledge of any Person contemplating the filing of any such petition against it. Section 6.4 TAXES AND ASSESSMENTS. The Projects are comprised of one or more parcels, each of which constitutes a separate tax lot and none of which constitutes a portion of any other tax lot. There are no pending or, to the knowledge of Borrower or Operating Lessee, proposed, special or other assessments for public improvements or otherwise affecting a Project, nor are there any contemplated improvements to any Project that may result in such special or other assessments. Section 6.5 OTHER AGREEMENTS; DEFAULTS. Neither Borrower, nor Operating Lessee, nor any Borrower Party is a party to any agreement or instrument or subject to any court order, injunction, permit, or restriction which might adversely affect a Project or the business, operations, or condition (financial or otherwise) of Borrower or any Borrower Party. Neither Borrower, nor Operating Lessee, nor any Borrower Party is in violation of any agreement which 20 violation would have an adverse effect on a Project, Borrower, Operating Lessee, or any Borrower Party or Borrower's or Operating Lessee's or any Borrower Party's business, properties, or assets, operations or condition, financial or otherwise. Section 6.6 COMPLIANCE WITH LAW. (a) Operating Lessee holds all licenses, permits, approvals and provider agreements necessary to own, lease, operate and carry on its business in the Projects, and such licenses, permits, approvals, and provider agreements are valid and in full force and effect. Each Project is in compliance with all applicable legal requirements and, to Borrower's or Operating Lessee's knowledge, is free of structural defects, and all building systems contained therein are in good working order, subject to ordinary wear and tear. No Project constitutes, in whole or in part, a legally non-conforming use under applicable legal requirements; (b) No condemnation has been commenced or, to Borrower's or Operating Lessee's knowledge, is contemplated with respect to all or any portion of a Project or for the relocation of roadways providing access to a Project; and (c) Each Project has adequate rights of access to public ways and is served by adequate water, sewer, sanitary sewer and storm drain facilities. All public utilities necessary or convenient to the full use and enjoyment of each Project are located in the public right-of-way abutting the Project, and all such utilities are connected so as to serve the Project without passing over other property, except to the extent such other property is subject to a perpetual easement for such utility benefiting the Project. All roads necessary for the full utilization of each Project for its current purpose have been completed and dedicated to public use and accepted by all governmental authorities. Section 6.7 LOCATION OF BORROWER. Borrower's and Operating Lessee's principal place of business and chief executive offices are located at the address stated in Section 11.1. Section 6.8 ERISA. Neither Borrower nor Operating Lessee has established any pension plan for employees which would cause Borrower or Operating Lessee to be subject to the Employee Retirement Income Security Act of 1974, as amended. Section 6.9 MARGIN STOCK. No part of proceeds of the Loan will be used for purchasing or acquiring any "margin stock" within the meaning of Regulations G, T, U or X of the Board of Governors of the Federal Reserve System. Section 6.10 TAX FILINGS. Borrower and each Borrower Party have filed (or have obtained effective extensions for filing) all federal, state and local tax returns required to be filed and have paid or made adequate provision for the payment of all federal, state and local taxes, charges and assessments payable by Borrower and each Borrower Party, respectively. Section 6.11 SOLVENCY. Giving effect to the Loan, the fair saleable value of Borrower's assets exceeds and will, immediately following the making of the Loan, exceed Borrower's total liabilities, including, without limitation, subordinated, unliquidated, disputed and contingent liabilities. The fair saleable value of Borrower's assets is and will, immediately following the making of the Loan, be greater than Borrower's probable liabilities, including the maximum 21 amount of its contingent liabilities on its Debts as such Debts become absolute and matured, Borrower's assets do not and, immediately following the making of the Loan will not, constitute unreasonably small capital to carry out its business as conducted or as proposed to be conducted. Borrower does not intend to, and does not believe that it will, incur Debts and liabilities (including contingent liabilities and other commitments) beyond its ability to pay such Debts as they mature (taking into account the timing and amounts of cash to be received by Borrower and the amounts to be payable on or in respect of obligations of Borrower). Section 6.12 FULL AND ACCURATE DISCLOSURE. No statement of fact made by or on behalf of Borrower or any Borrower Party in this Agreement or in any of the other Loan Documents contains any untrue statement of a material fact or omits to state any material fact necessary to make statements contained herein or therein not misleading. There is no fact presently known to Borrower or Operating Lessee which has not been disclosed to Lender which adversely affects, nor as far as Borrower or Operating Lessee can foresee, might adversely affect, the Projects or the business, operations or condition (financial or otherwise) of Borrower or any Borrower Party. Section 6.13 BORROWER SEPARATENESS. Borrower represents, warrants and covenants as follows: (a) Borrower does not own and will not own any asset or property other than (1) the Projects, and (2) incidental personal property necessary for the ownership or operation of the Projects. (b) Borrower will not engage in any business other than the ownership, management and operation of the Projects (or as otherwise set forth in Borrower's Articles of Organization) and Borrower will conduct and operate its business as presently conducted and operated. (c) Borrower will not enter into any contract or agreement with any Affiliate of the Borrower, any constituent party of Borrower, any Joinder Party or any Affiliate of any constituent party or any Joinder Party, except upon terms and conditions that are intrinsically fair and substantially similar to those that would be available on an arms-length basis with third parties other than any such party. (d) Borrower shall not, without the prior written consent of Lender, incur any Debt other than the Loan or other than accounts payable incurred in the ordinary course of business, and no Debt other than the Loan may be secured (subordinate or pari passu) by the Project. (e) Borrower has not made and will not make any loans or advances to any third party (including any affiliate or constituent party, any Joinder Party or Affiliate of any constituent party or any Joinder Party), and shall not acquire obligations or securities of its affiliates or any constituent party. (f) Borrower is and will remain solvent and Borrower will pay its debts and liabilities (including, as applicable, shared personnel and overhead expenses) from its assets as the same shall become due. 22 (g) Borrower has done or caused to be done and will do all things necessary to observe organizational formalities and preserve its existence, and Borrower will not, nor will Borrower permit any constituent party or any Joinder Party to amend, modify or otherwise change the partnership certificate, partnership agreements, articles of incorporation and bylaws, operating agreement, trust or other organizational documents of Borrower or such constituent party or Joinder Party without the prior written consent of Lender. (h) Borrower will maintain all of its books, records, financial statements and bank accounts separate from those if its Affiliates and any constituent party and shall maintain its books, records, resolutions and agreements as official records; provided, however, that Borrower may also be included in consolidated financial statements of another Person, provided that such consolidated financial statements contain a note indicating that Borrower is a separate legal entity and Borrower's assets and liabilities are neither available to pay the debts of the consolidated entity nor constitute obligations of the consolidated entity and that the consolidated entity is not liable for any of the liabilities of Borrower and, provided further, that so long as Borrower's separate tax liability and its income and expenses are readily determinable based upon a review of Borrower's books and records, it may file consolidated tax returns. (i) Borrower will be, and at all times will hold itself out to the public as, a legal entity separate and distinct from any other entity (including any Affiliate of Borrower, any constituent party of Borrower, any Joinder Party or any Affiliate of any constituent party or Joinder Party), shall correct any known misunderstanding regarding its status as a separate entity, shall conduct business in its own name, shall not identify itself or any of its Affiliates as a division or part of the other and shall maintain and utilize a separate telephone number and separate stationery, invoices and checks. (j) Borrower will maintain adequate capital for the normal obligations reasonably foreseeable in a business of its size and character and in light of its contemplated business operations. (k) Neither Borrower nor any constituent party will seek the dissolution, winding up, liquidation, consolidation or merger in whole or in part, of the Borrower. (l) Borrower will not commingle the funds and other assets of Borrower with those of any Affiliate of constituent party, any Joinder Party, or any Affiliate of any constituent party or Joinder Party, or any other Person. (m) Borrower has and will maintain its assets in such a manner that it will not be costly or difficult to segregate, ascertain or identify its individual assets from those of any Affiliate or constituent party, any Joinder Party, or any Affiliate of any constituent party or Joinder Party, or any other Person. (n) Borrower does not and will not hold itself out to be responsible for the debts or obligations of any other person. (o) Each member of Borrower (each, an "SPC PARTY") shall be a corporation whose sole asset is its interest in Borrower and each such SPC Party will at all times comply, and will cause Borrower to comply, with each of the representations, warranties and covenants 23 contained in this Section 6.13 as if such representation, warranty or covenant was made directly by such SPC Party, except that ARCSPE also shall own the interests in and guarantee certain obligations of those entities identified in its Charter and to the extent necessary to consummate the HCPI Transaction. (p) Borrower shall at all times cause there to be at least one duly appointed member of the board of governors of Borrower ("INDEPENDENT GOVERNOR") and at least one duly appointed member of the board of directors ("INDEPENDENT DIRECTOR") of each SPC Party in Borrower, each of which Independent Governors and each of which Independent Directors shall be reasonably satisfactory to Lender and shall not have been at the time of such Independent Governors' and Independent Directors' appointment, and at any time during the preceding five years (1) a shareholder of, or an officer, director, partner or employee of Borrower or any Borrower Party or any of their respective shareholders, subsidiaries or Affiliates, (2) a customer of, or supplier to Borrower or any Borrower Party or any of their respective shareholders, subsidiaries or Affiliates, (3) a Person controlling or under common Control with any such shareholder, partner, supplier or customer, or (4) a member of the immediate family of any such shareholder, officer, director, partner, employee, supplier or customer of Borrower. (q) Borrower shall not take any action which under the Articles of Organization of Borrower requires the consent or approval of the board of governors of Borrower unless at the time of such action there shall be at least one Person who is an Independent Governor. (r) Borrower shall not cause or permit the board of directors of each SPC Party in Borrower to take any action which, under the terms of any certificate of incorporation, by-laws or any voting trust agreement with respect to any common stock, requires the vote of the board of governors of Borrower and/or the board of directors of any SPC Party in Borrower unless at the time of such action there shall be at least one member of such board of directors who is an Independent Director. (s) Borrower shall conduct its business so that the assumptions made with respect to Borrower in that certain opinion letter dated of even date herewith (the "INSOLVENCY OPINION") delivered by Bass, Berry and Sims are true and correct in all respects. Notwithstanding anything herein to the contrary, Borrower may, from time to time, (i) make lawful distributions in accordance with applicable law to its member(s) subject to Section 6.13(j), or (ii) obtain lawful capital contributions in accordance with applicable law from its member(s) to the extent necessary to satisfy its obligations as they become due; provided, however, that all such transactions are accurately reflected in the books and records of Borrower and each of its applicable affiliates. Section 6.14 OPERATING LESSEE SEPARATENESS. Operating Lessee represents, warrants and covenants as follows: (a) Operating Lessee does not own and will not own any asset or property other than (1) its interest in the Projects under the Operating Lease, (2) the membership interests in ARC Fleetwood, LLC, a Tennessee limited liability company, and (3) incidental personal 24 property necessary for the operation of the Projects and ARC Fleetwood, LLC, a Tennessee limited liability company. (b) Operating Lessee will not engage in any business other than the management and operation of the Projects (or as otherwise set forth in Operating Lessee's Amended and Restated Certificate of Limited Partnership) and Operating Lessee will conduct and operate its business as it is presently conducted and operated. (c) Operating Lessee will not enter into any contract or agreement with any Affiliate of the Operating Lessee, any constituent party of Operating Lessee, any Joinder Party or any Affiliate of any constituent party or any Joinder Party, except upon terms and conditions that are intrinsically fair and substantially similar to those that would be available on an arms-length basis with third parties other than any such party. (d) Operating Lessee (and each general partner in Operating Lessee) shall not, without the prior written consent of Lender, incur any Debt other than obligations under the Operating Lease and the Loan and customary trade payables which are payable, and shall be paid, within sixty (60) days of when incurred (or such longer period as may be allowed by trade creditors) and equipment or automobile lease obligations of not more than $40,000 for any single lease obligation and of not more than $120,000 for all such lease obligations in the aggregate for a particular Project. No Debt other than the Loan may be secured (subordinate or pari passu) by the Project or any interest in the Operating Lease. (e) Operating Lessee has not made and will not make any loans or advances to any third party (including any affiliate or constituent party, any Joinder Party or Affiliate of any constituent party or any Joinder Party), and shall not acquire obligations or securities of its affiliates or any constituent party (other than its membership interest in ARC Fleetwood, LLC). (f) Operating Lessee is and will remain solvent and Operating Lessee will pay its debts and liabilities (including, as applicable, shared personnel and overhead expenses) from its assets as the same shall become due. (g) Operating Lessee has done or caused to be done and will do all things necessary to observe organizational formalities and preserve its existence, and Operating Lessee will not, nor will Operating Lessee permit any constituent party or any Joinder Party to amend, modify or otherwise change the partnership certificate, partnership agreements, articles of incorporation and bylaws, operating agreement, trust or other organizational documents of Operating Lessee or such constituent party or Joinder Party without the prior written consent of Lender. (h) Operating Lessee will maintain all of its books, records, financial statements and bank accounts separate from those if its Affiliates and any constituent party and shall maintain its books, records, resolutions and agreements as official records; provided, however, that Operating Lessee may also be included in consolidated financial statements of another Person, provided that such consolidated financial statements contain a note indicating that Operating Lessee is a separate legal entity and Operating Lessee's assets and liabilities are neither available to pay the debts of the consolidated entity nor constitute obligations of the 25 consolidated entity and that the consolidated entity is not liable for any of the liabilities of Operating Lessee and, provided further, that so long as Operating Lessee's separate tax liability and its income and expenses are readily determinable based upon a review of Operating Lessee's books and records, it may file consolidated tax returns. (i) Operating Lessee will be, and at all times will hold itself out to the public as, a legal entity separate and distinct from any other entity (including any Affiliate of Operating Lessee, any constituent party of Operating Lessee, any Joinder Party or any Affiliate of any constituent party or Joinder Party), shall correct any known misunderstanding regarding its status as a separate entity, shall conduct business in its own name, shall not identify itself or any of its Affiliates as a division or part of the other and shall maintain and utilize a separate telephone number and separate stationery, invoices and checks; provided, however, that nothing herein shall be construed so as to prevent Operating Lessee from using the same telephone number as any general partner of Operating Lessee, so long as the costs and expenses associated with such telephone number are allocated as set forth in Operating Lessee's Amended and Restated Certificate of Limited Partnership. (j) Operating Lessee will maintain adequate capital for the normal obligations reasonably foreseeable in a business of its size and character and in light of its contemplated business operations. (k) Neither Operating Lessee nor any constituent party will seek the dissolution, winding up, liquidation, consolidation or merger in whole or in part, of the Operating Lessee. (l) Operating Lessee will not commingle the funds and other assets of Operating Lessee with those of any Affiliate of constituent party, any Joinder Party, or any Affiliate of any constituent party or Joinder Party, or any other Person. (m) Operating Lessee has and will maintain its assets in such a manner that it will not be costly or difficult to segregate, ascertain or identify its individual assets from those of any Affiliate or constituent party, any Joinder Party, or any Affiliate of any constituent party or Joinder Party, or any other Person. (n) Operating Lessee does not and will not hold itself out to be responsible for the debts or obligations of any other person. (o) Each general partner of Operating Lessee (each, an "SPC PARTY") shall be a corporation whose sole asset is its interest in Operating Lessee and each such SPC Party will at all times comply, and will cause Operating Lessee to comply, with each of the representations, warranties and covenants contained in this Section 6.13 as if such representation, warranty or covenant was made directly by such SPC Party. (p) Operating Lessee shall at all times cause there to be at least one duly appointed member of the board of directors ("INDEPENDENT DIRECTOR") of each SPC Party in Operating Lessee, each of which Independent Directors shall be reasonably satisfactory to Lender and shall not have been at the time of such Independent Directors' appointment, and at any time during the preceding five years (1) a shareholder of, or an officer, director, partner or 26 employee of, Operating Lessee or any of its shareholders, subsidiaries or affiliates, (2) a customer of, or supplier to, Operating Lessee or any of is shareholders, subsidiaries or affiliates, (3) a Person controlling or under common Control with any such shareholder, partner, supplier or customer, or (4) a member of the immediate family of any such shareholder, officer, director, partner, employee, supplier or customer of Operating Lessee. (q) Operating Lessee shall not cause or permit the board of directors of each SPC Party in Operating Lessee to take any action which, under the terms of any certificate of incorporation, by-laws or any voting trust agreement with respect to any common stock, requires the vote of the general partners of Operating Lessee and/or the board of directors of any SPC Party in Operating Lessee unless at the time of such action there shall be at least one member of such board of directors who is an Independent Director. (r) Operating Lessee shall conduct its business so that the assumptions made with respect to Operating Lessee in that certain opinion letter dated of even date herewith (the "INSOLVENCY OPINION") delivered by Bass, Berry and Sims are true and correct in all respects. Notwithstanding anything herein to the contrary, Operating Lessee may, from time to time, (i) make lawful distributions in accordance with applicable law to its partners subject to Section 6.14(j), or (ii) obtain lawful capital contributions in accordance with applicable law from its partners to the extent necessary to satisfy its obligations as they become due; provided, however, that all such transactions are accurately reflected in the books and records of Operating Lessee and each of its applicable affiliates. Section 6.15 LICENSES AND COMPLIANCE. All licenses, permits and approvals required under current ownership for the operation of the Projects as nursing homes and personal care facilities under applicable law have been issued and are in good standing, including, without limitation, (a) nursing home licenses issued by State Agencies; and (b) personal care facilities licenses issued by State Agencies, as the same are currently in full force and effect. ARTICLE 7 FINANCIAL REPORTING Section 7.1 FINANCIAL STATEMENTS. (a) MONTHLY AND QUARTERLY REPORTS. Within thirty (30) days after the end of each calendar month, and within thirty (30) days after the end of each calendar quarter, Borrower and Operating Lessee shall furnish to Lender a current (as of the calendar month or quarter just ended) balance sheet, a detailed operating statement (showing monthly and quarterly activity and year-to-date) stating Operating Revenues, Operating Expenses, Net Operating Income, and Net Cash Flow for the calendar month or calendar quarter just ended, including a summary of actual Operating Expenses, Operating Revenues, Net Operating Income, and Net Cash Flow as compared to projections for such items as set forth in the applicable operating and capital budgets, and updated rent rolls, written statement setting forth any variance from the annual budget, and, at Lender's request, copies of bank statements, bank reconciliations, and other documentation supporting the information disclosed in such financial statements. 27 (b) ARC INFORMATION. When and as available, Borrower and Operating Lessee shall furnish to Lender all quarterly and annual reports filed by ARC with the Securities Exchange Commission, together with any additional or further information as reasonably may be required by Lender to determine and confirm compliance with the requirements of Schedule 2.1, Part C.3. (c) ANNUAL REPORTS. Within ninety (90) days after the end of each fiscal year of Borrower's operation of the Projects, Borrower and Operating Lessee shall furnish to Lender a current (as of the end of such fiscal year) balance sheet, a detailed operating statement stating Operating Revenues, Operating Expenses, operating income and Net Cash Flow for each of Borrower, Operating Lessee, and the Projects, a detailed statement of all expenditures for capital improvements and replacements to the Projects during the preceding calendar year and a reconciliation to disbursements from the Capital Improvements Reserve (as defined in Schedule 2.4), and, if required by Lender, prepared on a review basis and certified by an independent public accountant satisfactory to Lender. (d) CERTIFICATION; SUPPORTING DOCUMENTATION. Each such financial statement shall be in scope and detail satisfactory to Lender and certified by the chief financial representative of Borrower and the chief financial officer of Operating Lessee, as applicable. Section 7.2 ACCOUNTING PRINCIPLES. All financial statements shall be prepared in accordance with sound accounting principles applicable to commercial real estate, consistently applied from year to year. Section 7.3 OTHER INFORMATION. Borrower and Operating Lessee shall deliver to Lender such additional information regarding Borrower, its subsidiaries, its business, any Borrower Party, and the Projects within 30 days after Lender's request therefor. Section 7.4 ANNUAL BUDGET AND CASH FLOW SUMMARY. At least thirty (30) days after the commencement of each fiscal year, each of Borrower and Operating Lessee will provide to Lender its proposed annual operating and capital improvements budget for such fiscal year for review and approval by Lender. Furthermore, within ninety (90) days after the end of each fiscal year, Borrower shall provide Lender a certified cash flow summary which includes certifications that each of Borrower and Operating Lessee, as applicable, has and will continue to (a) preserve its limited liability company, partnership or other separate legal existence, (b) preserve all its rights and licenses to the extent necessary or desirable in the operation of its business and affairs and (c) be and remain qualified to do business and conduct its affairs in each jurisdiction where its ownership of projects or the conduct of its business affairs requires such qualification. Section 7.5 AUDITS. As required by Lender to confirm the Cash on Cash Return, the Debt Service Coverage, the Loan to Value Ratio, and whether conditions for any requested advance of the Loan, any requested release of collateral under Section 2.5, any requested extension of the Maturity Date under Section 2.6, or any other requirements hereunder have been satisfied, and otherwise as Lender deems necessary, Lender shall conduct a complete audit of the Operating Revenues and Operating Expenses of the Projects, at Borrower's and Operating Lessee's expense if an audit has not been completed within the immediately preceding twelve-month period and otherwise at Lender's expense. Lender shall have the right to choose and 28 appoint a certified public accountant to perform such audits as it deems necessary. Borrower and Operating Lessee shall permit Lender to examine such records, books and papers of Borrower and Operating Lessee which reflect upon its financial condition and the income and expense relative to the Projects. Any waiver of the requirement for an audit under this Section 7.5 shall be at Lender's sole discretion, shall be effective only if in writing and signed by Lender, and unless specifically set forth therein, shall not limit or otherwise affect any requirement for a future audit of the Operating Revenues and Operating Expenses of the Projects. ARTICLE 8 COVENANTS Borrower and Operating Lessee, jointly and severally, covenant and agree with Lender as follows: Section 8.1 DUE ON SALE AND ENCUMBRANCE; TRANSFERS OF INTERESTS. Except for the Operating Lease and the Residency Agreements, without the prior written consent of Lender, (a) neither Borrower nor Operating Lessee, nor any other Person having an ownership or beneficial interest in Borrower or Operating Lessee shall (1) directly or indirectly sell, transfer, convey, mortgage, pledge, or assign any interest in a Project or any part thereof (including any membership, partnership or any other ownership interest in Borrower or Operating Lessee, assigned or pledged under a mezzanine loan, except for the pledge of membership interests in Borrower under the HCPI Transaction); (2) create or permit to be created any preferred equity or similar interest in Borrower or Operating Lessee or any member or partner in Borrower or Operating Lessee; (3) further encumber, alienate, grant a Lien (other than as described in Section 8.1(a)(4)) or grant any other interest in a Project or any part thereof (including any partnership or other ownership interest in Borrower or Operating Lessee, whether voluntarily or involuntarily); or enter into any easement or other agreement granting rights in or restricting the use or development of a Project that materially affects the use or operation of the subject Project; (b) no new member, general partner, or limited partner having the ability to control the affairs of Borrower or Operating lessee shall be admitted to or created in Borrower or Operating Lessee (nor shall any existing member or general partner or controlling limited partner withdraw from Borrower or Operating Lessee), and no change in Borrower's or Operating Lessee's organizational documents relating to Control over Borrower or Operating Lessee and/or a Project shall be effected and (c) no transfer shall be permitted which would cause ARC or ARCSPE to own, directly or indirectly, less than one hundred percent (100%) of Borrower or Operating Lessee. As used in this Section 8.1, "transfer" shall include the sale, transfer, conveyance, mortgage, pledge, or assignment of the legal or beneficial ownership of (1) a Project, (2) any partnership interest in any partner in Borrower that is a partnership, and (3) any voting stock in any general partner in Borrower that is a corporation; "transfer" shall not include the leasing of individual 29 units within a Project so long as Borrower and Operating Lessee comply with the provisions of the Loan Documents relating to such leasing activity. Section 8.2 TAXES; CHARGES. Borrower and Operating Lessee shall pay before any fine, penalty, interest or cost may be added thereto, and shall not enter into any agreement to defer, any real estate taxes and assessments, franchise taxes and charges, and other governmental charges that may become a Lien upon a Project or become payable during the term of the Loan, and will promptly furnish Lender with evidence of such payment; however, if applicable, Borrower's and Operating Lessee's compliance with Section 3.4 of this Agreement relating to impounds for taxes and assessments shall, with respect to payment of such taxes and assessments, be deemed compliance with this Section 8.2. Borrower and Operating Lessee shall not suffer or permit the joint assessment of a Project with any other real property constituting a separate tax lot or with any other real or personal property. Borrower and Operating Lessee shall pay when due all claims and demands of mechanics, materialmen, laborers and others which, if unpaid, might result in a Lien on a Project. Notwithstanding the foregoing, Borrower or Operating Lessee may contest such taxes and charges and such claims and demands so long as (a) Borrower or Operating Lessee notifies Lender that it intends to contest such claim or demand, (b) Borrower or Operating Lessee provides Lender with an indemnity, bond or other security satisfactory to Lender (including an endorsement to Lender's title insurance policy insuring against such claim or demand) assuring the discharge of Borrower's obligations for such claims and demands, including interest and penalties, and (c) Borrower or Operating Lessee is diligently contesting the same by appropriate legal proceedings in good faith and at its own expense and concludes such contest prior to the tenth (10th) day preceding the earlier to occur of the Maturity Date or the date on which a Project is scheduled to be sold for non-payment. Section 8.3 CONTROL; MANAGEMENT. Borrower and Operating Lessee shall remain under the Control of ARCSPE at all times while this Agreement is in effect. Operating Lessee shall not terminate, replace or appoint any manager or terminate or amend the management agreement for a Project without Lender's prior written approval. Operating Lessee shall fully perform all of its covenants, agreements and obligations under the management agreement. Operating Lessee, or an Affiliate of Operating Lessee, shall serve as manager of the Projects. If the manager is an Affiliate of Operating Lessee, such manager shall be entitled to receive a management fee of up to four percent (4%) of Operating Revenues pursuant to a management agreement approved by Lender, in Lender's sole and absolute discretion. No management fee shall be payable if Operating Lessee manages the Projects. If Operating Lessee seeks to replace the manager, Lender retains full and absolute approval right over such substitute manager, management fee and management agreement. Lender shall approve all managers and management contracts, both presently existing and prior to entering into such contracts in the future; in addition, all management fees payable under any management contract shall be subordinate to and be paid following full payment of all Debt Service payments on the Loan in each fiscal year. Any change in ownership or Control of the manager shall be cause for Lender to re-approve such manager and management contract. Operating Lessee shall hold and maintain all necessary licenses, certifications and permits required by law. Any manager of a Project, if not an Affiliate of Operating Lessee, shall enter a non-competition agreement to the effect that such manager will not acquire, construct, operate or manage any facility similar to the Projects (i.e., an independent living units facility or an assisted living facility) within a five-mile radius of any Project at any time while any portion of the Loan is outstanding. Operating Lessee shall 30 strictly comply with the Management Standards set forth in Exhibit C attached hereto, and shall not enter into, modify, amend, or terminate any existing management agreement, except in accordance with the Management Standards and this Section 8.3. Section 8.4 NON-COMPLIANCE. Borrower and Operating Lessee shall promptly deliver to Lender copies of all reports and other documents with respect to any inspections, surveys, investigations, or on-site visits of, or certification actions regarding, the Projects by any federal, state, or local licensing and regulatory authority having jurisdiction over the Projects, including any inspections by State Agencies. Subject to Section 8.5, Lender may retain a consultant, at Borrower's and Operating Lessee's expense, to evaluate and review such reports and documents. Borrower and Operating Lessee shall promptly correct any deficiency and comply with all remedial actions and recommendations set forth in such reports or specified by the consultant retained by Lender. Borrower and Operating Lessee will promptly notify Lender of (a) any non-compliance, or (b) any event which, with notice or lapse of time or both, would result in non-compliance, with any statute, law, ordinance, order, judgment, decree, regulation, direction or requirement concerning Operating Lessee, its operations, or any of the Projects, or in connection with which Operating Lessee has received any notice, correspondence other communication to or from any federal, state or local governmental official, body, board, department or regulatory authority. If any such notice or communication of a material nature is received by Borrower or Operating Lessee, Operating Lessee shall engage an independent consultant as described in Section 8.5 below and shall provide Lender with a statement setting forth its proposed action or response to the non-compliance situation. Borrower and Operating Lessee shall promptly notify Lender of any proposed local, state or federal law that, if enacted, would materially and adversely affect Operating Lessee's current operation of any of the Projects. Section 8.5 CONSULTANT. If (a) Borrower and Operating Lessee fail to maintain at all times a Debt Service Coverage of at least 1.20:1, or (b) the occupancy level of the Projects (on a consolidated basis) is less than 87% for three consecutive months, or (c) Borrower or Operating Lessee receives any notice, correspondence or other communication of a material nature from any federal, state or local governmental official, body, board, department or regulatory authority citing violations of or lack of compliance with any statute, ordinance and/or regulation concerning Operating Lessee, its operations, or any of the Projects, then Borrower and Operating Lessee shall, at their expense, retain an independent consultant selected from a list of independent consultants designated by Lender from time to time, which independent consultant is to make recommendations to increase the Debt Service Coverage to at least 1.30:1, increase the occupancy level to at least 90%, or make recommendations to address the violation and/or non-compliance situation, as the case may be. With regard to a notice of violation or non-compliance received by Borrower or Operating Lessee as described in Section 8.4 above, if such violation or non-compliance can be cured by Borrower or Operating Lessee within thirty (30) days from the date of receipt of the notice or other communication relating thereto, then the independent consultant's engagement may be limited to a review of Borrower's or Operating Lessee's proposed plan to cure such non-compliance. Such independent consultant will provide a copy of its report to Borrower and Operating Lessee and to Lender. Borrower and Operating Lessee further agree that compliance with this covenant and/or the independent consultant's recommendation will not limit any of Lender's rights and remedies upon default or excuse Borrower or Operating Lessee from any default whether by reason of failure to maintain the 31 above-specified Debt Service Coverage or occupancy level, or the receipt of a notice of non-compliance or for any other reason. Section 8.6 PERMITS AND LICENSES; OPERATION; MAINTENANCE; INSPECTION. On request of Lender, Operating Lessee shall furnish to Lender true and correct copies of all currently existing licenses, permits, approvals and agreements necessary to own, lease, operate and carry on its business in the Projects. Borrower and Operating Lessee shall observe and comply with all legal requirements applicable to the ownership, use and operation of the Projects, including the requirements of State Agencies, and any applicable requirements under the Medicare (or other reimbursement) program. Borrower and Operating Lessee shall maintain the Projects in good condition (ordinary wear and tear excepted) and promptly repair any damage or casualty. Borrower and Operating Lessee shall permit Lender and its agents, representatives and employees, upon reasonable prior notice to Operating Lessee, to inspect the Projects and conduct such environmental and engineering studies as Lender may require, provided such inspections and studies do not materially interfere with the use and operation of the Projects. Section 8.7 TAXES ON SECURITY. Borrower and Operating Lessee shall pay all taxes, charges, filing, registration and recording fees, excises and levies payable with respect to the Note or the Liens created or secured by the Loan Documents, other than income, franchise and doing business taxes imposed on Lender. If there shall be enacted any law (a) deducting the Loan from the value of a Project for the purpose of taxation, (b) affecting any Lien on a Project, or (c) changing existing laws of taxation of mortgages, deeds of trust, security deeds, or debts secured by real property, or changing the manner of collecting any such taxes, Borrower and Operating Lessee shall promptly pay to Lender, on demand, all taxes, costs and charges for which Lender is liable as a result thereof; however, if such payment would be prohibited by law or would render the Loan usurious, then instead of collecting such payment, Lender may declare all amounts owing under the Loan Documents to be immediately due and payable. Section 8.8 RESERVES, DEPOSITS, ESCROWS. Borrower and/or Operating Lessee shall at all times maintain all reserves, deposits and/or escrows required by Lender or State Agencies applicable from time to time to Borrower or Operating Lessee by virtue of the nature of Borrower's or Operating Lessee's business. Section 8.9 LEGAL EXISTENCE; NAME, ETC. Borrower, Operating Lessee, and each member or general partner in Borrower or Operating Lessee, if any, shall preserve and keep in full force and effect its entity status, franchises, rights and privileges under the laws of the state of its formation, and all qualifications, licenses and permits applicable to the ownership, use and operation of the Projects. Neither Borrower nor Operating Lessee, nor any member or general partner of Borrower or Operating Lessee, shall wind up, liquidate, dissolve, reorganize, merge, or consolidate with or into, or convey, sell, assign, transfer, lease, or otherwise dispose of all or substantially all of its assets. Borrower and each member in Borrower (and Operating Lessee and each partner in Operating Lessee) shall conduct business only in its own name and shall not change its name, identity, or organizational structure, or the location of its chief executive office or principal place of business unless it (a) shall have obtained the prior written consent of Lender to such change, and (b) shall have taken all actions necessary or requested by Lender to file or amend any financing statement or continuation statement to assure perfection and continuation of perfection of security interests under the Loan Documents. Each of Borrower (and each member 32 in Borrower) and Operating Lessee (and each partner in Operating Lessee) shall maintain its separateness as an entity and shall comply with the requirements of Section 6.13 and Section 6.14, accordingly. Section 8.10 AFFILIATE TRANSACTIONS. Without the prior written consent of Lender, except for management agreements complying with the provisions hereof, Borrower and Operating Lessee shall not engage in any transaction affecting a Project with an Affiliate of Borrower or Operating Lessee, unless the terms thereof are the same as terms otherwise available in the marketplace generally. Section 8.11 FURTHER ASSURANCES. Borrower and Operating Lessee shall promptly (a) cure any defects in the execution and delivery of the Loan Documents, and (b) execute and deliver, or cause to be executed and delivered, all such other documents, agreements and instruments as Lender may reasonably request to further evidence and more fully describe the collateral for the Loan, to correct any omissions in the Loan Documents, to perfect, protect or preserve any liens created under any of the Loan Documents, or to make any recordings, file any notices, or obtain any consents, as may be necessary or appropriate in connection therewith. Section 8.12 ESTOPPEL CERTIFICATES. Borrower, within ten (10) days after Lender's reasonable request, shall furnish to Lender a written statement, duly acknowledged, setting forth the amount due on the Loan, the terms of payment of the Loan, the date to which interest has been paid, whether any offsets or defenses exist against the Loan and, if any are alleged to exist, the nature thereof in detail, and such other matters as Lender reasonably may request. Section 8.13 NOTICE OF CERTAIN EVENTS. Borrower and Operating Lessee shall promptly notify Lender of (a) any Potential Default or Event of Default, together with a detailed statement of the steps being taken to cure such Potential Default or Event of Default; (b) any notice of default received by Borrower under other obligations relating to a Project or otherwise material to Borrower's business; and (c) any threatened or pending material legal, judicial or regulatory proceedings, including any dispute between Borrower or Operating Lessee and any governmental authority, affecting Borrower or Operating Lessee or a Project. Section 8.14 INDEMNIFICATION. Borrower and Operating Lessee, jointly and severally, shall indemnify, defend and hold Lender harmless from and against any and all losses (other than losses resulting solely from nonpayment of the Loan), liabilities, claims, damages, expenses, obligations, penalties, actions, judgments, suits, costs or disbursements of any kind or nature whatsoever, including the reasonable fees and actual expenses of Lender's counsel incurred by Lender, in connection with (a) any inspection, review or testing of or with respect to the Projects pursuant to this Agreement, (b) any investigative, administrative, mediation, arbitration, or judicial proceeding, whether or not Lender is designated a party thereto, commenced or threatened at any time (including after the repayment of the Loan) in any way related to the execution, delivery or performance of any Loan Document or to any Project, (c) any proceeding instituted by any Person claiming a Lien, (d) any brokerage commissions or finder's fees claimed by any broker or other party in connection with the Loan, any Project, or any of the transactions contemplated in the Loan Documents, except commissions and fees arising solely from Lender's actions, (e) the breach of any of the representations, warranties or covenants contained in any Loan Document, and (f) any professional malpractice or negligence relating to the operation of 33 the Projects, including those arising from the joint, concurrent, or comparative negligence of Lender, except to the extent any of the foregoing is caused by Lender's gross negligence or willful misconduct. Section 8.15 ERISA. Each of Borrower and Operating Lessee shall comply with the Employee Retirement Income Security Act of 1974, as amended, and the rules and regulations promulgated thereunder from time to time ("ERISA"), in all material respects. Without limiting the generality of the foregoing, Borrower and Operating Lessee shall cause all or any defined benefit pension plan, including both single employer and multi-employer plans, subject to Title IV of ERISA (a "PLAN"), to be funded in accordance with the minimum funding standards of ERISA, if applicable, and shall make in a timely manner all contributions due to any Plan. Section 8.16 SATISFACTION OF DEBENTURES. On or before August 31, 2002, either the Debentures shall have been satisfied or ARC shall have provided to Lender evidence satisfactory to Lender that ARC holds an amount of unrestricted cash sufficient to satisfy the Debentures. In any event, on or before October 1, 2002, the Debentures shall be satisfied. Section 8.17 HCPI TRANSACTION. On or before August 31, 2002, ARC and ARCSPE shall have consummated the HCPI Transaction. Section 8.18 IMMEDIATE REPAIRS. On or before November 30, 2002, Borrower and Operating Lessee shall complete the Immediate Repairs. Section 8.19 DEBT SERVICE COVERAGE AND CASH ON CASH RETURN. Borrower and Operating Lessee shall at all times maintain a minimum Debt Service Coverage of 1.10:1 and a minimum Cash on Cash Return of 10.75% per annum. Section 8.20 OPERATION. The Projects shall be operated as retirement communities, independent living units, assisted living units, memory impaired or Alzheimer units, or skilled nursing beds. The Projects shall be operated using prudent business judgment and, consistent with such business judgment, in such a manner so as to maximize the number of Residency Agreements and other occupancy agreements in effect and to maintain a favorable reputation for the Projects. Operating Lessee shall fully and faithfully perform, in all material respects, all of its covenants, agreements and obligations under the Residency Agreements and under any management agreement (and under any replacement instruments to the foregoing which are permitted pursuant to the terms of this Agreement.) Section 8.21 SERVICES. Operating Lessee shall maintain and continue to provide throughout the term of the Loan materially the same services to residents as are currently being provided at the Projects by Borrower or otherwise on the date a facility becomes a Project. Operating Lessee shall not materially change such services or reduce the Facility Capacity without the prior written consent and approval of Lender. Section 8.22 NON-COMPETITION. At any time while any portion of the Loan is outstanding, neither Borrower nor Operating Lessee nor any Affiliate of Borrower or Operating Lessee shall construct, develop or expand any congregate care, assisted living, or skilled or intermediate nursing facility or any combination of such types of facility (a) which is or is to be located within a five-mile radius of any Project, and (b) which, as determined by Lender in 34 Lender's sole and absolute discretion (without taking into account the financing source for such facility), would have a material adverse effect on the financial condition or operations of such Project. Nothing in this Section 8.22 shall prohibit Borrower or Operating Lessee or any Affiliate of Borrower or Operating Lessee from acquiring or managing any existing facility, but neither Borrower nor Operating Lessee nor any Affiliate of Borrower or Operating Lessee shall, in its marketing efforts, target Residents of any Project for transfers to any other facility. Borrower and Operating Lessee shall submit proposals for development of any facility which is to be located within a five-mile radius of any Project for Lender's determination prior to incurring substantial costs (excluding costs of demographic or market studies) for or commencing construction of any such facility, and Lender shall use good faith efforts to respond to such proposals within a reasonable period of time. ARTICLE 9 EVENTS OF DEFAULT Each of the following shall constitute an Event of Default under the Loan: Section 9.1 PAYMENTS. Borrower's failure to pay any regularly scheduled installment of principal, interest or other amount due under the Loan Documents within five (5) days after the date when due, or Borrower's failure to pay the Loan at the Maturity Date, whether by acceleration or otherwise. Section 9.2 INSURANCE. Borrower's or Operating Lessee's failure to maintain insurance as required under Section 3.1 of this Agreement. Section 9.3 SALE, ENCUMBRANCE, ETC. The sale, transfer, conveyance, pledge, mortgage or assignment of any part or all of a Project (other than disposition of obsolete items of equipment or replacement of worn items of equipment with new items in the ordinary course of business), or any interest therein, or of any interest in Borrower or Operating Lessee, in violation of Section 8.1 of this Agreement. Section 9.4 COVENANTS. Borrower's or Operating Lessee's failure to perform or observe any of the agreements and covenants contained in this Agreement or in any of the other Loan Documents (other than payments under Section 9.1, insurance requirements under Section 9.2, and transfers and encumbrances under Section 9.3), and the continuance of such failure for ten (10) days after notice by Lender to Borrower and Operating Lessee; however, subject to any shorter period for curing any failure by Borrower as specified in any of the other Loan Documents, Borrower and Operating Lessee shall have an additional thirty (30) days to cure such failure if (a) such failure does not involve the failure to make payments on a monetary obligation; (b) such failure cannot reasonably be cured within ten (10) days; (c) Borrower or Operating Lessee is diligently undertaking to cure such default, and (d) Borrower has provided Lender with security reasonably satisfactory to Lender against any interruption of payment or impairment of collateral as a result of such continuing failure. The notice and cure provisions of this Section 9.4 do not apply to any Event of Default arising under Section 8.9, Section 8.16, or Section 8.17, or to the Events of Default described in Section 9.5, Section 9.6, Section 9.7, Section 9.8, and Section 9.10. 35 Section 9.5 REPRESENTATIONS AND WARRANTIES. Any representation or warranty made in any Loan Document proves to be untrue in any material respect when made or deemed made. Section 9.6 OTHER ENCUMBRANCES. Any default under any document or instrument, other than the Loan Documents, evidencing or creating a Lien on a Project or any part thereof. Section 9.7 INVOLUNTARY BANKRUPTCY OR OTHER PROCEEDING. Commencement of an involuntary case or other proceeding against Borrower, any Borrower Party or any other Person having an ownership or security interest in a Project (excluding limited partners in Borrower or any Borrower Party) (each, a "BANKRUPTCY PARTY") which seeks liquidation, reorganization or other relief with respect to it or its debts or other liabilities under any bankruptcy, insolvency or other similar law now or hereafter in effect or seeks the appointment of a trustee, receiver, liquidator, custodian or other similar official of it or any of its property, and such involuntary case or other proceeding shall remain undismissed or unstayed for a period of 60 days; or an order for relief against a Bankruptcy Party shall be entered in any such case under the Federal Bankruptcy Code. Section 9.8 VOLUNTARY PETITIONS, ETC. Commencement by a Bankruptcy Party of a voluntary case or other proceeding seeking liquidation, reorganization or other relief with respect to itself or its Debts or other liabilities under any bankruptcy, insolvency or other similar law or seeking the appointment of a trustee, receiver, liquidator, custodian or other similar official for it or any of its property, or consent by a Bankruptcy Party to any such relief or to the appointment of or taking possession by any such official in an involuntary case or other proceeding commenced against it, or the making by a Bankruptcy Party of a general assignment for the benefit of creditors, or the failure by a Bankruptcy Party, or the admission by a Bankruptcy Party in writing of its inability, to pay its debts generally as they become due, or any action by a Bankruptcy Party to authorize or effect any of the foregoing. Section 9.9 MATERIAL ADVERSE CHANGE. The occurrence of any change in the financial condition of Borrower or Operating Lessee, or in the Net Operating Income of any Project which would have, in Lender's judgment, a material adverse effect on a Project, on Borrower's ability to repay the Loan, or on Borrower's, Operating Lessee's or any Borrower Party's ability to perform its obligations under any of the Loan Documents. Section 9.10 OTHER LOANS. The existence of any Event of Default under any other loan by Lender to either Borrower or Operating Lessee or any Affiliate of Borrower or Operating Lessee, which by its terms is intended to be secured by a Project, or any "Event of Default" or default (however named) under any of the Heller Loans. Section 9.11 DEBENTURES. ARC's or ARCSPE's failure, on or before August 31, 2002, to fully satisfy the Debentures or to provide to Lender evidence satisfactory to Lender that ARC holds an amount of unrestricted cash sufficient to satisfy the Debentures, or ARC's failure to satisfy the Debentures on or before October 1, 2002. Section 9.12 HCPI TRANSACTION. ARC's and ARCSPE's failure to consummate the HCPI transaction on or before August 31, 2002. 36 ARTICLE 10 REMEDIES Section 10.1 REMEDIES - INSOLVENCY EVENTS. Upon the occurrence of any Event of Default described in Section 9.7 or Section 9.8, the obligations of Lender to advance amounts hereunder shall immediately terminate, and all amounts due under the Loan Documents immediately shall become due and payable, all without written notice and without presentment, demand, protest, notice of protest or dishonor, notice of intent to accelerate the maturity thereof, notice of acceleration of the maturity thereof, or any other notice of default of any kind, all of which are hereby expressly waived by Borrower and Operating Lessee; however, if the Bankruptcy Party under Section 9.7 or Section 9.8 is a Person other than Borrower, then all amounts due under the Loan Documents shall become immediately due and payable at Lender's election, in Lender's sole discretion. Section 10.2 REMEDIES - OTHER EVENTS. Except as set forth in Section 10.1 above, while any Event of Default exists, Lender may (a) by written notice to Borrower, declare the entire Loan to be immediately due and payable without presentment, demand, protest, notice of protest or dishonor, notice of intent to accelerate the maturity thereof, notice of acceleration of the maturity thereof, or other notice of default of any kind, all of which are hereby expressly waived by Borrower, (b) terminate the obligation, if any, of Lender to advance amounts hereunder, and (c) exercise all rights and remedies therefor under the Loan Documents and at law or in equity. Section 10.3 LENDER'S RIGHT TO PERFORM THE OBLIGATIONS. If Borrower or Operating Lessee shall fail, refuse or neglect to make any payment or perform any act required by the Loan Documents, then while any Event of Default exists, and without notice to or demand upon Borrower or Operating Lessee and without waiving or releasing any other right, remedy or recourse Lender may have because of such Event of Default, Lender may (but shall not be obligated to) make such payment or perform such act for the account of and at the expense of Borrower and Operating Lessee, and shall have the right to enter upon the Projects for such purpose and to take all such action thereon and with respect to the Projects as it may deem necessary or appropriate. If Lender shall elect to pay any sum due with reference to a Project, Lender may do so in reliance on any bill, statement or assessment procured from the appropriate governmental authority or other issuer thereof without inquiring into the accuracy or validity thereof. Similarly, in making any payments to protect the security intended to be created by the Loan Documents, Lender shall not be bound to inquire into the validity of any apparent or threatened adverse title, lien, encumbrance, claim or charge before making an advance for the purpose of preventing or removing the same. Additionally, if any Hazardous Materials affect or threaten to affect a Project, Lender may (but shall not be obligated to) give such notices and take such actions as it deems necessary or advisable in order to abate the discharge of any Hazardous Materials or remove the Hazardous Materials. Borrower and Operating Lessee, jointly and severally, shall indemnify, defend and hold Lender harmless from and against any and all losses, liabilities, claims, damages, expenses, obligations, penalties, actions, judgments, suits, costs, or disbursements of any kind or nature whatsoever, including reasonable attorneys' fees, incurred or accruing by reason of any acts performed by Lender pursuant to the provisions of this Section 10.3, including those arising from the joint, concurrent, or comparative negligence of Lender, except as a result of Lender's gross negligence or willful misconduct. All sums paid by 37 Lender pursuant to this Section 10.3, and all other sums expended by Lender to which it shall be entitled to be indemnified, together with interest thereon at the Default Rate from the date of such payment or expenditure until paid, shall constitute additions to the Loan, shall be secured by the Loan Documents and shall be paid by Borrower to Lender upon demand. ARTICLE 11 MISCELLANEOUS Section 11.1 NOTICES. Any notice required or permitted to be given under this Agreement shall be in writing and either shall be mailed by certified mail, postage prepaid, return receipt requested, or sent by overnight air courier service, or personally delivered to a representative of the receiving party, or sent by telecopy (provided an identical notice is also sent simultaneously by mail, overnight courier, or personal delivery as otherwise provided in this Section 11.1). All such communications shall be mailed, sent or delivered, addressed to the party for whom it is intended at its address set forth below. If to Borrower or Operating Lessee: Fort Austin Real Estate Holdings, LLC Fort Austin Limited Partnership c/o American Retirement Corporation 111 Westwood Place, Suite 200 Brentwood, Tennessee 37027 Attention: Todd Kaestner, Executive Vice President Telecopy: (615) 221-2269 with a copy to: Bass, Berry & Sims AmSouth Center 315 Deaderick Street, Suite 2700 Nashville, Tennessee 37238 Attention: T. Andrew Smith Telecopy: (615) 742-2766 If to Lender: GE Capital Healthcare Financial Services Two Wisconsin Circle, Suite 400 Chevy Chase, Maryland 20815 Attention: Tim Sanders, Vice President, Senior Portfolio Manager Telecopy: (301) 664-9843 with a copy to: GE Capital Healthcare Financial Services 100 Congress Avenue, Suite 700 Austin, Texas 78701 Attention: Diana Pennington, Esquire Telecopy: (512) 476-7832 38 and a copy to: Vinson & Elkins L.L.P. 2001 Ross Avenue, Suite 3700 Dallas, Texas 75201-2875 Attention: Michael R. Boulden Telecopy: (214) 999-7840 Any communication so addressed and mailed shall be deemed to be given on the earliest of (a) when actually delivered, (b) on the first Business Day after deposit with an overnight air courier service, or (c) on the third Business Day after deposit in the United States mail, postage prepaid, in each case to the address of the intended addressee (except as otherwise provided in the Mortgage), and any communication so delivered in person shall be deemed to be given when receipted for by, or actually received by Lender or Borrower, as the case may be. If given by telecopy, a notice shall be deemed given and received when the telecopy is transmitted to the party's telecopy number specified above, and confirmation of complete receipt is received by the transmitting party during normal business hours or on the next Business Day if not confirmed during normal business hours, and an identical notice is also sent simultaneously by mail, overnight courier, or personal delivery as otherwise provided in this Section 11.1. Either party may designate a change of address by written notice to the other by giving at least ten (10) days prior written notice of such change of address. Section 11.2 AMENDMENTS AND WAIVERS. No amendment or waiver of any provision of the Loan Documents shall be effective unless in writing and signed by the party against whom enforcement is sought. Section 11.3 LIMITATION ON INTEREST. It is the intention of the parties hereto to conform strictly to applicable usury laws. Accordingly, all agreements between Borrower and Lender or between Operating Lessee and Lender with respect to the Loan are hereby expressly limited so that in no event, whether by reason of acceleration of maturity or otherwise, shall the amount paid or agreed to be paid to Lender or charged by Lender for the use, forbearance or detention of the money to be lent hereunder or otherwise, exceed the maximum amount allowed by law. If the Loan would be usurious under applicable law (including the laws of the State and the laws of the United States of America), then, notwithstanding anything to the contrary in the Loan Documents: (a) the aggregate of all consideration which constitutes interest under applicable law that is contracted for, taken, reserved, charged or received under the Loan Documents shall under no circumstances exceed the maximum amount of interest allowed by applicable law, and any excess shall be credited on the Note by the holder thereof (or, if the Note has been paid in full, refunded to Borrower); and (b) if maturity is accelerated by reason of an election by Lender, or in the event of any prepayment, then any consideration which constitutes interest may never include more than the maximum amount allowed by applicable law. In such case, excess interest, if any, provided for in the Loan Documents or otherwise, to the extent permitted by applicable law, shall be amortized, prorated, allocated and spread from the date of advance until payment in full so that the actual rate of interest is uniform through the term hereof. If such amortization, proration, allocation and spreading is not permitted under applicable law, then such excess interest shall be canceled automatically as of the date of such acceleration or prepayment and, if theretofore paid, shall be credited on the Note (or, if the Note has been paid in full, refunded to Borrower). The terms and provisions of this Section 11.3 shall control and supersede every other provision of the Loan Documents. The Loan Documents are contracts 39 made under and shall be construed in accordance with and governed by the laws of the State, except that if at any time the laws of the United States of America permit Lender to contract for, take, reserve, charge or receive a higher rate of interest than is allowed by the laws of the State (whether such federal laws directly so provide or refer to the law of any state), then such federal laws shall to such extent govern as to the rate of interest which Lender may contract for, take, reserve, charge or receive under the Loan Documents. Section 11.4 INVALID PROVISIONS. If any provision of any Loan Document is held to be illegal, invalid or unenforceable, such provision shall be fully severable; the Loan Documents shall be construed and enforced as if such illegal, invalid or unenforceable provision had never comprised a part thereof; the remaining provisions thereof shall remain in full effect and shall not be affected by the illegal, invalid, or unenforceable provision or by its severance therefrom; and in lieu of such illegal, invalid or unenforceable provision there shall be added automatically as a part of such Loan Document a provision as similar in terms to such illegal, invalid or unenforceable provision as may be possible to be legal, valid and enforceable. Section 11.5 REIMBURSEMENT OF EXPENSES. Borrower and Operating Lessee shall pay all expenses incurred by Lender in connection with the Loan, including fees and expenses of Lender's attorneys, environmental, engineering and other consultants, and fees, charges or taxes for the recording or filing of Loan Documents. Borrower and Operating Lessee shall pay all expenses of Lender in connection with the administration of the Loan, including audit costs, inspection fees, settlement of condemnation and casualty awards, and premiums for title insurance and endorsements thereto. Borrower and Operating Lessee shall, upon request, promptly reimburse Lender for all amounts expended, advanced or incurred by Lender to collect the Note, or to enforce the rights of Lender under this Agreement or any other Loan Document, or to defend or assert the rights and claims of Lender under the Loan Documents or with respect to the Projects (by litigation or other proceedings), which amounts will include all court costs, attorneys' fees and expenses, fees of auditors and accountants, and investigation expenses as may be incurred by Lender in connection with any such matters (whether or not litigation is instituted), together with interest at the Default Rate on each such amount from the date of disbursement until the date of reimbursement to Lender, all of which shall constitute part of the Loan and shall be secured by the Loan Documents. Section 11.6 APPROVALS; THIRD PARTIES; CONDITIONS. All approval rights retained or exercised by Lender with respect to leases, contracts, plans, studies and other matters are solely to facilitate Lender's credit underwriting, and shall not be deemed or construed as a determination that Lender has passed on the adequacy thereof for any other purpose and may not be relied upon by Borrower, Operating Lessee, or any other Person. This Agreement is for the sole and exclusive use of Lender and Borrower and may not be enforced, nor relied upon, by any Person other than Lender and Borrower. All conditions of the obligations of Lender hereunder, including the obligation to make advances, are imposed solely and exclusively for the benefit of Lender, its successors and assigns, and no other Person shall have standing to require satisfaction of such conditions or be entitled to assume that Lender will refuse to make advances in the absence of strict compliance with any or all of such conditions, and no other Person shall, under any circumstances, be deemed to be a beneficiary of such conditions, any and all of which may be freely waived in whole or in part by Lender at any time in Lender's sole discretion. 40 Section 11.7 LENDER NOT IN CONTROL; NO PARTNERSHIP. None of the covenants or other provisions contained in this Agreement shall, or shall be deemed to, give Lender the right or power to exercise Control over the affairs or management of Borrower or Operating Lessee, the power of Lender being limited to the rights to exercise the remedies referred to in the Loan Documents. The relationship between Borrower and Lender is, and at all times shall remain, solely that of debtor and creditor. No covenant or provision of the Loan Documents is intended, nor shall it be deemed or construed, to create a partnership, joint venture, agency or common interest in profits or income between Lender and Borrower, or between Lender and Operating Lessee, or to create an equity in the Projects in Lender. Lender neither undertakes nor assumes any responsibility or duty to Borrower, or to Operating Lessee, or to any other Person with respect to the Projects or the Loan, except as expressly provided in the Loan Documents; and notwithstanding any other provision of the Loan Documents: (a) Lender is not, and shall not be construed as, a partner, joint venturer, alter ego, manager, controlling person or other business associate or participant of any kind of Borrower or Operating Lessee or their respective stockholders, members, or partners and Lender does not intend to ever assume such status; (b) Lender shall in no event be liable for any Debts, expenses or losses incurred or sustained by Borrower or Operating Lessee; and (c) Lender shall not be deemed responsible for or a participant in any acts, omissions or decisions of Borrower or Operating Lessee or their respective stockholders, members, or partners. Lender and Borrower and Operating Lessee disclaim any intention to create any partnership, joint venture, agency or common interest in profits or income between Lender and Borrower, or between Lender and Operating Lessee, or to create an equity in the Projects in Lender, or any sharing of liabilities, losses, costs or expenses. Section 11.8 TIME OF THE ESSENCE. Time is of the essence with respect to this Agreement. Section 11.9 SUCCESSORS AND ASSIGNS. This Agreement shall be binding upon and inure to the benefit of Lender, Borrower, and Operating Lessee, and the successors and assigns of Lender, including any assignee or transferee of the Note, individually, and the successors and assigns of Borrower and Operating Lessee, provided that neither Borrower nor any other Borrower Party shall, without the prior written consent of Lender, assign any rights, duties or obligations hereunder. Section 11.10 RENEWAL, EXTENSION OR REARRANGEMENT. All provisions of the Loan Documents shall apply with equal effect to each and all promissory notes and amendments thereof hereinafter executed which in whole or in part represent a renewal, extension, increase or rearrangement of the Loan. Section 11.11 DIVISIONS OF THE LOAN; SYNDICATION OR PLACEMENT. For portfolio management purposes, Lender may elect to divide the Loan into two or more separate loans, evidenced by separate promissory notes with senior and junior priorities, or to syndicate the Loan to a group of lenders, or to sell the Loan in connection with a securitization, structured finance, or other placement transaction so long as the payment and other obligations of Borrower or Operating Lessee are not effectively increase or otherwise modified. Borrower and Operating Lessee agree to cooperate with Lender and to execute such documents as Lender reasonably may request to effect any division of the Loan required by Lender and otherwise to effect any syndication, securitization, structured finance, or secondary market transaction. 41 Section 11.12 WAIVERS. No course of dealing on the part of Lender, its officers, employees, consultants or agents, nor any failure or delay by Lender with respect to exercising any right, power or privilege of Lender under any of the Loan Documents, shall operate as a waiver thereof. Section 11.13 CUMULATIVE RIGHTS. Rights and remedies of Lender under the Loan Documents shall be cumulative, and the exercise or partial exercise of any such right or remedy shall not preclude the exercise of any other right or remedy. Section 11.14 SINGULAR AND PLURAL. Words used in this Agreement and the other Loan Documents in the singular, where the context so permits, shall be deemed to include the plural and vice versa. The definitions of words in the singular in this Agreement and the other Loan Documents shall apply to such words when used in the plural where the context so permits and vice versa. Section 11.15 PHRASES. When used in this Agreement and the other Loan Documents, the phrase "including" shall mean "including, but not limited to," the phrase "satisfactory to Lender" shall mean "in form and substance satisfactory to Lender in all respects," the phrase "with Lender's consent" or "with Lender's approval" shall mean such consent or approval at Lender's discretion, the phrase "acceptable to Lender" shall mean "acceptable to Lender at Lender's sole discretion," and, as the context may require, the phrase "Borrower and Operating Lessee" shall mean "Borrower and Operating Lessee, jointly and severally." Section 11.16 EXHIBITS AND SCHEDULES. The exhibits and schedules attached to this Agreement are incorporated herein and shall be considered a part of this Agreement for the purposes stated herein. Section 11.17 TITLES OF ARTICLES, SECTIONS AND SUBSECTIONS. All titles or headings to articles, sections, subsections or other divisions of this Agreement and the other Loan Documents or the exhibits hereto and thereto are only for the convenience of the parties and shall not be construed to have any effect or meaning with respect to the other content of such articles, sections, subsections or other divisions, such other content being controlling as to the agreement between the parties hereto. Section 11.18 PROMOTIONAL MATERIAL. Borrower and Operating Lessee authorize Lender to issue press releases, advertisements and other promotional materials in connection with Lender's own promotional and marketing activities, and describing the Loan, in a manner consistent with descriptions of other financings, and Lender's participation in the Loan. All references to Lender contained in any press release, advertisement or promotional material issued by Borrower or Operating Lessee shall be approved in writing by Lender in advance of issuance. Section 11.19 SURVIVAL. All of the representations, warranties, covenants, and indemnities hereunder (including environmental matters under Article 4), and under the indemnification provisions of the other Loan Documents shall survive the repayment in full of the Loan and the release of the liens evidencing or securing the Loan, and shall survive the transfer (by sale, foreclosure, conveyance in lieu of foreclosure or otherwise) of any or all right, 42 title and interest in and to the Projects to any party, whether or not an Affiliate of Borrower or Operating Lessee. Section 11.20 WAIVER OF JURY TRIAL. To the maximum extent permitted by law, Borrower, Operating Lessee, and Lender hereby knowingly, voluntarily and intentionally waive the right to a trial by jury in respect of any litigation based hereon, arising out of, under or in connection with this Agreement or any other Loan Document, or any course of conduct, course of dealing, statement (whether verbal or written) or action of either party or any exercise by any party of their respective rights under the Loan Documents or in any way relating to the Loan or the Projects (including, without limitation, any action to rescind or cancel this Agreement, and any claim or defense asserting that this Agreement was fraudulently induced or is otherwise void or voidable). This waiver is a material inducement for Lender to enter this Agreement. Section 11.21 WAIVER OF PUNITIVE OR CONSEQUENTIAL DAMAGES. Neither Lender nor Borrower nor Operating Lessee shall be responsible or liable to the other or to any other Person for any punitive, exemplary or consequential damages which may be alleged as a result of the Loan or the transaction contemplated hereby, including any breach or other default by any party hereto. Section 11.22 GOVERNING LAW. The Loan Documents are being executed and delivered, and are intended to be performed, in the State and the laws of the State and of the United States of America shall govern the rights and duties of the parties hereto and the validity, construction, enforcement and interpretation of the Loan Documents, except to the extent otherwise specified in any of the Loan Documents. Section 11.23 ENTIRE AGREEMENT. This Agreement and the other Loan Documents embody the entire agreement and understanding between Lender and Borrower, and between Lender and Operating Lessee, and supersede all prior agreements and understandings between such parties relating to the subject matter hereof and thereof. Accordingly, the Loan Documents may not be contradicted by evidence of prior, contemporaneous, or subsequent oral agreements of the parties. There are no unwritten oral agreements between the parties. Section 11.24 COUNTERPARTS. This Agreement may be executed in multiple counterparts, each of which shall constitute an original, but all of which shall constitute one document. ARTICLE 12 LIMITATIONS ON LIABILITY Section 12.1 LIMITATION ON LIABILITY. Except as provided below, neither Borrower nor Operating Lessee shall be personally liable for amounts due under the Loan Documents. Borrower and Operating Lessee shall be jointly and severally and personally liable to Lender for any deficiency, loss or damage suffered by Lender because of: (a) Borrower's or Operating Lessee's commission of a criminal act, (b) the failure to comply with provisions of the Loan Documents prohibiting the sale, transfer or encumbrance of the Projects, any other collateral, or any direct or indirect ownership interest in Borrower or Operating Lessee; (c) the misapplication by Borrower or Operating Lessee or any Borrower Party of any funds derived from the Projects, 43 including security deposits, insurance proceeds and condemnation awards; (d) the fraud or misrepresentation by Borrower, Operating Lessee, or any Borrower Party made in or in connection with the Loan Documents or the Loan; (e) Borrower's or Operating Lessee's collection of rents more than one month in advance or entering into or modifying the Operating Lease or any of the Residency Agreements, or receipt of monies by Borrower, Operating Lessee, or any Borrower Party in connection with the modification of the Operating Lease or any Residency Agreements, in violation of this Agreement or any of the other Loan Documents; (f) failure of Borrower or Operating Lessee to apply proceeds of rents or any other payments in respect of the Residency Agreements and other income of the Projects or any other collateral to the costs of maintenance and operation of the Projects and to the payment of taxes, lien claims, insurance premiums, Debt Service and other amounts due under the Loan Documents; (g) subject to the provisions of Section 8.2, Borrower's or Operating Lessee's failure to pay any real estate taxes, assessments or similar charges affecting the Projects prior to the delinquency thereof, (h) Borrower's or Operating Lessee's interference with Lender's exercise of rights under the Assignments of Rents and Leases; (i) if applicable, Borrower's or Operating Lessee's failure to timely renew any letter of credit issued in connection with the Loan; (j) Borrower's or Operating Lessee's failure to maintain insurance as required by this Agreement or to pay any taxes or assessments affecting a Project; (k) damage or destruction to a Project directly caused by the acts or omissions of Borrower, or Operating Lessee or their respective agents, employees, or contractors; (l) Borrower's and Operating Lessee's obligations with respect to environmental matters under Article 4; (m) Borrower's or Operating Lessee's failure to pay for any loss, liability or expense (including attorneys' fees) incurred by Lender arising out of any claim or allegation made by Borrower or Operating Lessee or their respective successors or assigns, or any creditor of Borrower or Operating Lessee, that this Agreement or the transactions contemplated by the Loan Documents establish a joint venture, partnership or other similar arrangement between Borrower and Lender or between Operating Lessee and Lender; (n) any failure on the part of Borrower or Operating Lessee to comply with any local, state or federal laws or regulations governing the operation of the Projects as nursing homes and personal care facilities, including the requirements of State Agencies, and any requirements under Medicare or other reimbursement program; (o) any liability for professional malpractice or negligence relating to the operation of the Projects; or (p) any brokerage commission or finder's fees claimed in connection with the transactions contemplated by the Loan Documents other than commissions or fees incurred solely as a result of Lender's actions. None of the foregoing limitations on the personal liability of Borrower or Operating Lessee shall modify, diminish or discharge the personal liability of any Joinder Party. Nothing herein shall be deemed to be a waiver of any right which Lender may have under Sections 506(a), 506(b), 1111(b) or any other provision of the United States Bankruptcy Code, as such sections may be amended, or corresponding or superseding sections of the Bankruptcy Amendments and Federal Judgeship Act of 1984, to file a claim for the full amount due to Lender under the Loan Documents or to require that all collateral shall continue to secure the amounts due under the Loan Documents. Section 12.2 LIMITATION ON LIABILITY OF LENDER'S OFFICERS, EMPLOYEES, ETC. Any obligation or liability whatsoever of Lender which may arise at any time under this Agreement or any other Loan Document shall be satisfied, if at all, out of the Lender's assets only. No such obligation or liability shall be personally binding upon, nor shall resort for the enforcement thereof be had to, the property of any of Lender's shareholders, directors, officers, employees or 44 agents, regardless of whether such obligation or liability is in the nature of contract, tort or otherwise. [THE REMAINDER OF THIS PAGE IS INTENTIONALLY LEFT BLANK] 45 EXECUTED as of the date first written above. LENDER: GENERAL ELECTRIC CAPITAL CORPORATION, a Delaware corporation (formerly organized as a New York corporation) By: ---------------------------------------------- Kevin J. McMeen, Senior Vice President BORROWER: FORT AUSTIN REAL ESTATE HOLDINGS, LLC, a Tennessee limited liability company By: ----------------------------------------------- , Executive Vice President ------------------- OPERATING LESSEE: FORT AUSTIN LIMITED PARTNERSHIP, a Texas limited partnership By: ARC Fort Austin Properties, Inc., a Tennessee corporation, General Partner By: ------------------------------------------ , Executive Vice President ----------------- 46 JOINDER By executing this Joinder (the "JOINDER"), the undersigned ("JOINDER PARTIES") jointly and severally guaranty the performance by Borrower and Operating Lessee of Borrower's and Operating Lessee's unconditional obligation to pay real estate taxes, assessments and similar charges relating to the Projects under Section 8.2 of this Agreement; Borrower's and Operating Lessee's obligations with respect to environmental matters under Article 4 of this Agreement, Borrower's and Operating Lessee's indemnification obligations under Section 8.14 of this Agreement, and all obligations and liabilities for which Borrower and Operating Lessee are personally liable under Section 12.1 of this Agreement. This Joinder is a guaranty of full and complete payment and performance and not of collectability. 1. WAIVERS. To the fullest extent permitted by applicable law, each Joinder Party waives all rights and defenses of sureties, guarantors, accommodation parties and/or co-makers and agrees that its obligations under this Joinder shall be primary, absolute and unconditional, and that its obligations under this Joinder shall be unaffected by any of such rights or defenses, including: (a) the unenforceability of any Loan Document against Borrower and/or Operating Lessee and/or any Joinder Party; (b) any release or other action or inaction taken by Lender with respect to the collateral, the Loan, Borrower and/or Operating Lessee and/or any Joinder Party, whether or not the same may impair or destroy any subrogation rights of any Joinder Party, or constitute a legal or equitable discharge of any surety or indemnitor; (c) the existence of any collateral or other security for the Loan, and any requirement that Lender pursue any of such collateral or other security, or pursue any remedies it may have against Borrower and/or Operating Lessee and/or any Joinder Party; (d) any requirement that Lender provide notice to or obtain a Joinder Party's consent to any modification, increase, extension or other amendment of the Loan, including the guaranteed obligations; (e) any right of subrogation (until payment in full of the Loan, including the guaranteed obligations, and the expiration of any applicable preference period and statute of limitations for fraudulent conveyance claims); (f) any defense based on any statute of limitations; (g) any payment by Borrower or Operating Lessee to Lender if such payment is held to be a preference or fraudulent conveyance under bankruptcy laws or Lender is otherwise required to refund such payment to Borrower, Operating Lessee, or any other party; and (h) any voluntary or involuntary bankruptcy, receivership, insolvency, reorganization or similar proceeding affecting Borrower or Operating Lessee or any of their respective assets. 47 2. AGREEMENTS. Each Joinder Party further represents, warrants and agrees that: (a) The obligations under this Joinder are enforceable against each such party and are not subject to any defenses, offsets or counterclaims; (b) The provisions of this Joinder are for the benefit of Lender and its successors and assigns; (c) Lender shall have the right to (A) renew, modify, extend or accelerate the Loan, (B) pursue some or all of its remedies against Borrower or any Joinder Party, (C) add, release or substitute any collateral for the Loan or party obligated thereunder, and (D) release Borrower or any Joinder Party from liability, all without notice to or consent of any Joinder Party (or other Joinder Party) and without affecting the obligations of any Joinder Party (or other Joinder Party) hereunder; (d) Each Joinder Party covenants and agrees to furnish to Lender, within one hundred twenty (120) days after the end of each fiscal year of such Joinder Party, a current (as of the end of such fiscal year) balance sheet of such Joinder Party, in scope and detail satisfactory to Lender, certified by the chief financial representative of such Joinder Party and, if required by Lender, prepared on an accounting review basis and certified by an independent public accountant satisfactory to Lender; and (e) To the maximum extent permitted by law, each Joinder Party hereby knowingly, voluntarily and intentionally waives the right to a trial by jury in respect of any litigation based hereon. This waiver is a material inducement to Lender to enter into this Agreement. This Joinder shall be governed by the laws of the State of Texas. Executed as of May 15, 2002. JOINDER PARTIES: ARC FORT AUSTIN PROPERTIES, INC., a Tennessee corporation By: -------------------------------------------------- , Executive Vice President ------------------------ AMERICAN RETIREMENT CORPORATION, a Tennessee corporation By: -------------------------------------------------- , Executive Vice President ------------------------ 48 ARCPI HOLDINGS, INC., a Tennessee corporation By: -------------------------------------------------- , Executive Vice President ------------------------ 49 EXHIBIT A LEGAL DESCRIPTION OF PROJECTS BROADWAY BEING all that certain lot, tract or parcel of land in the JOHN HEATH SURVEY, ABSTRACT 641, TARRANT County, Texas, being all of that certain 20.000 acre tract of land previously known as Lot 3, Block 7 CITYVIEW, conveyed to Fort Austin Limited Partnership by the deed recorded in Volume 10585, Page 1340, Deed Records of Tarrant County, Texas (D.R.,T.Co.,Tx.), currently being a portion of Lot 3R, Block 7, CITYVIEW ADDITION as recorded in Cabinet A, Slide 6207, Plat Records, Tarrant County, Texas (P.R.,T.Co.,Tx.), and being more particularly described by metes and bounds as follows: BEGINNING at a 5/8 inch steel rod set at the Southeast corner of that certain Lot 2, Block 7, Cityview, an Addition to the City of Fort Worth, Tarrant County, Texas, as recorded in Volume 388-181, Pages 27 and 28, P.R.,T.Co.,Tx., the Northeast corner of aforesaid Lot 3R, and being in the line common to Lot 3R and the C.O. Edwards Estate according to the deed recorded in Volume 1129, Page 620, D.R.,T.Co.,Tx., and in the line common to said Heath Survey and the I. & G.N. RR. Survey, Abstract 832, Tarrant County, Texas, said point being 881.12 feet South 00 degrees 00 minutes 14 seconds West along said common survey line and property line from a concrete monument with an aluminum cap set in place of a very old iron pin and post which were found in place for the Northwest corner of the I. & G.N. RR. Survey and a reentrant corner on the East side of the Heath Survey in May, 1983; THENCE with the line common to the Heath and I. & G.N. RR. Surveys and with the line common to the C.O. Edwards Estate and Lot 3R, South 00 degrees 00 minutes 14 seconds West, at approximately 220 feet (by General Land Office description) passing the Westerly common corner of said I. & G.N. RR. Survey and the Jacob Wilcox Survey, Abstract 1742, and continuing with said common property line and the line common to the Heath and Wilcox Surveys, in all 873-3/10 feet to a 5/8 inch steel rod found; THENCE departing said common property line and survey line North 81 degrees 20 minutes 40 seconds West 1100-37/100 feet to a 5/8 inch steel rod set in the curved East right-of-way (R/W) line of Bryant Irvin Road (a 120 foot wide public R/W); THENCE with said East R/W line and Northerly with the arc of a curve to the left having a radius of 4060-0/10 feet, a long chord that bears North 06 degrees 18 minutes 29 seconds East 327-01/100 feet and an arc distance of 327-1/10 feet to an "x" cut in walk at its point of tangency; THENCE continuing with said East R/W line, North 04 degrees 00 minutes East 455-31/100 feet to an "x" cut in walk at the Southwest corner of the aforesaid Lot 2, Block 7 and Northwest corner of said Lot 3R; A-1 THENCE with the line common to said Lot 2, Block 7 and Lot 3R, South 85 degrees 59 minutes 21 seconds East 1022-71/100 feet to the PLACE OF BEGINNING, containing in all some 20-000/1000 acres of land (871,205 square feet), more or less. Previously known as Lot 3, Block 7, CITYVIEW, an addition to the City of Fort Worth, Tarrant County, Texas, according to the map thereof recorded in Volume 388-203, Page 31, Plat Records, Tarrant County, Texas. SUMMIT TRACT I: (FEE SIMPLE Lot 1, Block H of TREEMONT, PHASE B, SECTION 3, a subdivision in Travis County, Texas, according to the Map or Plat thereof recorded in Book 87, Page(s) 122D, Plat Records, Travis County, Texas. SAVE AND EXCEPT THEREFROM a 0.439 acre of land, more or less, conveyed to the City of Rollingwood by Dedication Deed dated January 9, 2002, recorded as Document No. 2002007063, Official Public Records, Travis County, Texas. TRACT II: (EASEMENT ESTATE Easement for ingress and egress purposes in and to 0.4223 Acres of land, more or less, out of the Henry P. Hill Survey, Travis County, Texas, being set out in Volume 10186, Page 293, Real Property Records, Travis County, Texas; now being part of Lot 3, Block I of TREEMONT, PHASE B, SECTION FOUR, a subdivision in Travis County, Texas according to the Map or Plat thereof recorded in Book 90, Page(s) 253, Plat Records, Travis County, Texas, which has been replatted into LIBERTY PARK CONDOMINIUMS recorded in Volume 12675, Page 183, Real Property Records and in Volume 1, Page 136, and Volume 1, Page 138, Condominium Records, Travis County, Texas, and being described as follows FIELDNOTE Description of a tract or parcel of land containing 0.4223 acres, more or less, situated in the Henry P. Hill Survey No. 21, Travis County, Texas being a portion of the remainder of a 208.36 acre tract conveyed to George S. Nalle, III by a deed recorded in Volume 7667, Page 104 of the Travis County Deed Records and is that same 0.422 acre tract described in a Roadway and Maintenance Agreement between Forum Group, Inc. and George S. Nalle, III, and recorded in Volume 10186, Page 293 of the said Deed Records of Travis County, Texas. The herein described tract is more particularly described by metes and bounds as follows COMMENCING at an iron pipe found in concrete in the West right of way of Bee Cave Road (R.M. 2244 - 100 feet wide), said pipe is the most Northerly corner of Lot "A" Zilker Heights Resubdivision as shown on a map or plat thereof recorded in Book 75, Page 330 of the Plat Records of Travis County, Texas, and is the most Easterly Southeast corner of Lot 1 Block "H" Treemont Phase "B", Section Three Subdivision as shown on a map or plat thereof recorded in Book 87, Page 122-D, of the said Plat Records A-2 THENCE South 39 degrees 06 minutes 22 seconds West with the common line between Lot "A" and Lot 1 described above, 116.00 feet to an iron pipe found at an angle point THENCE South 32 degrees 17 minutes 14 seconds West, continuing with the above said common lot line 136.95 feet to an iron pipe found for another angle point being the Northeast corner of the above said 0.422 acre tract and the POINT OF BEGINNING of the herein described tract THENCE, leaving the Southerly line of above said Lot 1, and following the Westerly line of Lot "A" with the following five (5) courses 1) South 12 degrees 03 minutes 59 seconds West 89.90 feet to a found iron pipe 2) South 07 degrees 41 minutes 17 seconds West 108.55 feet to a found iron pipe; 3) South 03 degrees 45 minutes 43 seconds West 206.14 feet to a found iron pipe; 4) South 11 degrees 21 minutes 23 seconds East 85.99 feet to a found iron pipe; 5) South 18 degrees 56 minutes 02 seconds East 60.94 feet to a concrete monument found in the North right of way line of State Highway Loop 1 (Mopac), being the Southwest corner of Lot "A" described herein, also being a corner in the 208.36 acre tract and the 0.422 acre tract mentioned above; THENCE, South 69 degrees 17 minutes 28 seconds West, with the North line of said State Highway Loop 1 and the South line of the 208.36 acre tract, 57.84 feet to an iron rod found for the Southwest corner of the 0.422 acre tract; THENCE, leaving the said North line of Loop 1 and crossing the said 208.36 acre tract following the West line of the 0.422 acre tract with the following seven (7) courses and distances: 1) A distance of 21.38 feet with the arc of a curve to the right having a central angle of 12 degrees 38 minutes 37 seconds, a radius of 96.90 feet and a chord which bears North 02 degrees 39 minutes 54 seconds West, a distance of 21.34 feet to an iron rod set for a point of tangency; 2) North 03 degrees 46 minutes 02 seconds East, a distance of 29.87 feet to an iron rod set for a point of curvature: 3) A distance of 38.46 feet with the arc of a curve to the left having a central angle of 15 degrees 01 minutes 27 seconds, a radius of 146.67 feet and a chord which bears North 03 degrees 51 minutes 19 seconds West, a distance of 38.35 feet to an iron rod set for a point of tangency; 4) North 11 degrees 21 minutes 23 seconds West, a distance of 60.47 feet to an iron rod set for an angle point; 5) North 03 degrees 43 minutes 13 seconds East, a distance of 223.05 feet to an iron rod set for an angle point; A-3 6) North 07 degrees 41 minutes 17 seconds East, a distance of 104.46 feet to an iron rod set for an angle point; 7) North 40 degrees 13 minutes 54 seconds West, a distance of 35.96 feet to an iron rod set in the South line of above said Lot 1 Block "H" Treemont Phase B, Section Three THENCE North 49 degrees 46 minutes 06 seconds East, with the said South line of Lot 1, 95.00 feet to the POINT OF BEGINNING containing within these metes and bounds 0.4223 acres (18,394 square feet) of land area, more or less. A-4 PARKPLACE Parcel 1: Lots 1, 2, 3 and Lots 19 through 24, Block 22, Kettles Second Addition to the City of Denver, City and County of Denver, State of Colorado. Parcel 2: Lots 1 through 12, Block 11, Arlington Park Annex, together with that part of the West 1/2 of vacated Clarkson Street adjoining Lots 2 through 12 on the East as described in ordinance No. 348, Series of 1981, recorded on July 18, 1981, in Book 2407 at page 244, and together with the vacated alley in Block 11, being a part of original Lots 1 through 4 on the West, as vacated by Ordinance No. 576, Series of 1974, recorded August 29, 1974 in Book 937 at Page 566, except that portion of Lots 7 through 12 conveyed to the City and County of Denver, by deed recorded in Book 2769, page 25, City and County of Denver, State of Colorado. A-5 EXHIBIT B BUDGET
- ---------------------------------------------------------------------------- Sources Estimated Uses - ---------------------------------------------------------------------------- GECC Loan 95,700,000 Refinance GECC Debt 82,740,000 Reduce Heller Mortgages 10,007,000 GECC Fees 957,000 Estimated Closing Costs 1,207,000 Rate Protection Costs 789,000 - ---------------------------------------------------------------------------- Totals 95,700,000 95,700,000 - ----------------------------------------------------------------------------
B-1 EXHIBIT C MANAGEMENT STANDARDS 1. If Borrower desires to enter into, modify, amend or terminate any management agreement, leasing agreement or any other agreement relating to management, leasing or operation of the Projects, Borrower shall submit such proposed modification or change to Lender in writing for Lender's prior approval, which approval shall be given or withheld in Lender's sole discretion. Lender shall respond to such requests for approval within a reasonable period of time. 2. Upon Lender's request, Borrower shall, and shall cause its on-site administrator to (i) meet with Lender at least quarterly to discuss the financial and physical condition of the Projects and the management of the Projects, including personnel, resident satisfaction, marketing and other issues pertinent to the success of the Projects, and (ii) at Lender's request, provide Lender with reports relating to such information. 3. Borrower's agreements with its management and leasing agents, if any, shall be written so that if Lender acquires ownership of the Projects, Lender may, without cost or liability to Lender, within sixty (60) days' of Lender's notice, terminate the management and leasing agreement, and the on-site administrator and director of leasing. C-1 EXHIBIT D ALLOCATED LOAN BALANCES Broadway $37,041,000 Summit $32,376,000 Parkplace $26,283,000 =========== TOTAL $95,700,000
D-1 SCHEDULE 2.1 ADVANCE CONDITIONS Part A - Initial Advance Part B - General Conditions Part C - Advances for Immediate Repairs PART A. CONDITIONS TO INITIAL ADVANCE. The initial advance of the Loan shall be subject to Lender's receipt, review, approval and/or confirmation of the following, at Borrower's cost and expense, each in form and content satisfactory to Lender in its sole discretion: 1. The Commitment Fee, to the extent not previously paid. 2. The Loan Documents, including the Interest Rate Protection Agreement, executed by Borrower and, as applicable, Operating Lessee and each other Borrower Party. 3. ALTA (or equivalent) mortgagee policies of title insurance, in the aggregate maximum amount of the Loan, with reinsurance and endorsements as Lender may require, containing no exceptions to title (printed or otherwise) which are unacceptable to Lender, and insuring that the Mortgage is a first-priority Lien on the Projects and related collateral. 4. All documents evidencing the formation, organization, valid existence, good standing, and due authorization of and for Borrower, Operating Lessee, and each other Borrower Party for the execution, delivery, and performance of the Loan Documents by Borrower, Operating Lessee, and each other Borrower Party. 5. Legal opinions issued by counsel for Borrower, Operating Lessee, and each other Borrower Party, opining as to the due organization, valid existence and good standing of Borrower, Operating Lessee, and each other Borrower Party, and the due authorization, execution, delivery, enforceability and validity of the Loan Documents with respect to, Borrower, Operating Lessee, and each other Borrower Party; that the Loan, as reflected in the Loan Documents, is not usurious; to the extent that Lender is not otherwise satisfied, that the Projects and their use is in full compliance with all legal requirements; that the Loan Documents do not create or constitute a partnership, a joint venture or a trust or fiduciary relationship between Borrower and Lender or between Operating Lessee and Lender; that neither Borrower nor Operating Lessee is susceptible to being consolidated with ARC, ARCSPE or any other Affiliate of Borrower or Operating Lessee in any bankruptcy or insolvency proceeding; and as to such other matters as Lender and Lender's counsel reasonably may specify. 6. Current Uniform Commercial Code searches for Borrower and the immediately preceding owner of the Projects. 7. Copies of the policies of insurance required by this Agreement, containing all endorsements thereto and conforming in all respects to the requirements of Lender. Schedule 2.1 - 1 8. An "as-built" survey of each Project, dated or updated to a date not earlier than thirty (30) days prior to the date hereof, certified to Lender and such title insurer, prepared by a licensed surveyor acceptable to Lender and the issuer of the title insurance, and conforming to Lender's current standard survey requirements. 9. An engineering report or architect's certificate with respect to each Project, covering, among other matters, inspection of heating and cooling systems, roof and structural details and showing no failure of compliance with building plans and specifications, applicable legal requirements (including requirements of the Americans with Disabilities Act) and fire, safety and health standards, and certified for the use and reliance by Lender and its Affiliates, successors and assigns. As requested by Lender, such report shall also include an assessment of the Project's tolerance for earthquake and seismic activity. 10. A Site Assessment for each Project. 11. The Operating Lease and a subordination, non-disturbance and attornment agreement between Operating Lessee and Lender with respect to the Operating Lease. 12. A current rent roll of each Project, and copies of all Residency Agreements, certified by Borrower or the current owner of such Project. Such rent roll shall include the following information: (a) resident names; (b) unit/suite numbers; (c) area of each demised premises and total area of the Project (stated in net rentable square feet); (d) rental rate (including escalations, if any); (e) cancellation/termination provisions; (f) term (if any); and (g) security deposit. In addition, a copy of each standard lease form, admission agreement, occupancy or other residency agreement form to be used by Borrower in leasing space in the Projects, or conducting a retirement home business in the Projects, in form satisfactory to and approved by Lender. 13. Evidence satisfactory to Lender that Borrower and Operating Lessee are and have at all relevant times been in all respects in compliance with all requirements of the Social Security Act of 1965, the regulations promulgated thereunder, and, as applicable, all conditions of participation in the Medicare program thereunder, including, without limitation, those imposed by the State Agencies and the United States Department of Health and Human Services. 14. Certified copies of (a) Medicare provider agreements, as applicable, issued under Title XVIII and Title XIX of the Social Security Act of 1965, with current provider numbers, (b) as applicable, nursing home licenses (or "long-term-care licenses") issued by the State Agencies, (c) a personal care facilities license issued by the State Agencies, and (d) all licenses, permits and approvals required or convenient for the operation of the Projects as retirement communities under applicable laws and regulations, such certifications to state that such agreements, licenses, permits and approvals are in full force and effect. 15. A capital expenditures budget, as prepared by Borrower and Operating Lessee and approved by Lender, setting forth in detail satisfactory to Lender all capital expenditures for capital improvements to each of the Projects which Borrower and Operating Lessee intend to complete within the five-year period ending May 1, 2007, the schedule for completing such capital improvements, and the estimated cost therefor. Schedule 2.1 - 2 16. Such other documents and instruments as Lender or its counsel reasonably may require. 17. Borrower's deposit with Lender of the amount required by Lender to impound for taxes and assessments under Article 3 and to fund any other required escrows or reserves. 18. Evidence that the Projects and the operation thereof comply with all legal requirements, including that all requisite certificates of occupancy, building permits, and other licenses, certificates, approvals or consents required of any governmental authority have been issued without variance or condition and that there is no litigation, action, citation, injunctive proceedings, or like matter pending or threatened with respect to the validity of such matters. 19. No change shall have occurred in the financial condition of Borrower, Operating Lessee, or any other Borrower Party or in the Net Operating Income of any Project, which would have, in Lender's judgment, a material adverse effect on a Project or on Borrower's ability to repay the Loan or on Borrower's, Operating Lessee's or any Borrower Party's ability to perform its obligations under the Loan Documents. 20. No condemnation or adverse zoning or usage change proceeding shall have occurred or shall have been threatened against a Project; no Project shall have suffered any significant damage by fire or other casualty which has not been repaired; no law, regulation, ordinance, moratorium, injunctive proceeding, restriction, litigation, action, citation or similar proceeding or matter shall have been enacted, adopted, or threatened by any governmental authority, which would have, in Lender's judgment, a material adverse effect on Borrower, Operating Lessee, any Borrower Party or a Project. 21. All fees and commissions payable to real estate brokers, mortgage brokers, or any other brokers or agents in connection with the Loan or the acquisition of the Projects have been paid, such evidence to be accompanied by any waivers or indemnifications deemed necessary by Lender. 22. Payment of Lender's costs and expenses in underwriting, documenting, and closing the transaction, including fees and expenses of Lender's inspecting engineers, consultants, and outside counsel. 23. The representations and warranties contained in this Loan Agreement and in all other Loan Documents are true and correct. 24. No Potential Default or Event of Default shall have occurred or exist. 25. Prepayment of that loan by Lender to Borrower in the amount of up to $112,500,000 under Loan Agreement dated December 30, 1997 between Lender and Borrower (the "EXISTING FACILITY") (reserving the right to adjust the amount of such prepayment based on a reconciliation of payments previously made, including applications of reserves), it being understood and agreed that the initial advance of the Loan is a refinancing in renewal and extension of the remaining unpaid principal balance of the Existing Facility. Schedule 2.1 - 3 26. Heller Healthcare Finance, Inc., or Heller Financial, Inc. or one or more of their related entities shall have issued a commitment to or entered into an agreement with the borrowers under the Heller Loans for the extension of the maturity of Heller Loans to a date not earlier than May 31, 2005, subject to, among other conditions, (a) satisfaction of the Debentures, (b) the closing and funding of the HCPI Transaction, and (c) payment to the lender(s) under the Heller Loans of an extension fee in the aggregate amount of one percent (1%) of the outstanding principal balance of the Heller Loans. PART B. GENERAL CONDITIONS Each advance of the Loan shall be subject to Lender's receipt, review, approval and/or confirmation of the following, each in form and content satisfactory to Lender in its sole discretion: 1. There shall exist no Potential Default or Event of Default (currently and after giving effect to the requested advance). 2. The representations and warranties contained in this Loan Agreement and in all other Loan Documents are true and correct. 3. Such advance shall be secured by the Loan Documents, subject only to those exceptions to title approved by Lender at the time of Loan closing, or the time that a Project was first encumbered by a Mortgage, as evidenced by title insurance endorsements satisfactory to Lender, if necessary. 4. Borrower shall have paid Lender's costs and expenses in connection with such advance (including title charges, and costs and expenses of Lender's inspecting engineer and attorneys). 5. No change shall have occurred in the financial condition of Borrower, Operating Lessee, or any Borrower Party, or in the Net Operating Income of the Projects, or in the financial condition of Borrower, Operating Lessee, ARC, or ARCSPE, which would have, in Lender's judgment, a material adverse effect on the Loan, the Projects, or Borrower's, Operating Lessee's, or any Borrower Party's ability to perform its obligations under the Loan Documents. 6. No condemnation or adverse, as determined by Lender, zoning or usage change proceeding shall have occurred or shall have been threatened against a Project; no Project shall have suffered any damage by fire or other casualty which has not been repaired or is not being restored in accordance with this Agreement; no law, regulation, ordinance, moratorium, injunctive proceeding, restriction, litigation, action, citation or similar proceeding or matter shall have been enacted, adopted, or threatened by any governmental authority, which would have, in Lender's judgment, a material adverse effect on a Project or Borrower's, Operating Lessee's, or any Borrower Party's ability to perform its obligations under the Loan Documents. 7. Lender shall have no obligation to make any additional advance for less than $25,000, or to make advances more often than once in any one-month period or to make any advance after November 30, 2002. Schedule 2.1 - 4 8. At the option of Lender (a) each advance request shall be submitted to Lender at least ten (10) Business Days prior to the date of the requested advance; and (b) all advances shall be made at the Chevy Chase Maryland office of Lender or at such other place as Lender may designate unless Lender exercises its option to make an advance directly to the Person to whom payment is due. Schedule 2.1 - 5 SCHEDULE 2.3(E) DISCOUNTED YIELD MAINTENANCE A. Yield Maintenance Amount As used in this Schedule 2.3(e), "CONTRACT RATE" means the Fixed Rate. As used herein, "YIELD MAINTENANCE AMOUNT" means the sum of the Present Value (as defined below) on the date of prepayment of each Monthly Interest Shortfall (as defined below) for the remaining term of the Loan discounted at the monthly Replacement Treasury Yield (as defined below). The Monthly Interest Shortfall is calculated for each monthly payment date as follows: i) The positive difference, if any, of the Contract Rate less the Replacement Treasury Yield, plus the Break Contract Fee (as defined below) of 20 basis points; ii) Divided by 12; iii) Multiplied by the outstanding principal balance of the Loan on the date of prepayment The Present Value is then determined by discounting each Monthly Interest Shortfall at the Replacement Treasury Yield divided by 12. FOR EXAMPLE: If a loan with a Contract Rate of 9% were prepaid with 24 months remaining in the term, at a time when the two year Replacement Treasury Yield was 5%, and the outstanding loan balance was $10,000,000.00 then: Schedule 2.3(e) - 1 Contract Rate .0900 Less the Replacement Treasury Yield - .0500 --------------- = .0400 Plus the Break Contract Fee + .0020 --------------- Equals the rate difference = .0420 Divided by 12 / 12 =============== Equals the monthly rate difference = .0035 Times the principal balance x $10,000,000 --------------- Equals the Monthly Interest Shortfall = $35,000
The Present Value of each Monthly Interest Shortfall ($35,000) discounted at the monthly Replacement Treasury Yield (5% divided by 12 or ..4167%) equals $797,786. The Break Contract Fee shall be 20 basis points at all times. As used herein the term "REPLACEMENT TREASURY YIELD" shall mean the rate of interest equal to the yield to maturity of the most recently issued U.S. Treasury Security as quoted in The Wall Street Journal on the prepayment date. If the remaining term is less than one year, the Replacement Treasury Yield will equal the yield for 1-Year Treasury's. If the remaining term is 1-Year, 2-Year, etc., then the Replacement Treasury Yield will equal the yield for the Treasury's with a maturity equaling the remaining term. If the remaining term is longer than one year but does not equal one of the maturities being quoted, then the Replacement Treasury Yield will equal the yield for Treasury's with a maturity closest to but not exceeding the remaining term. If The Wall Street Journal (i) quotes more than one such rate, the highest of such quotes shall apply, or (ii) ceases to publish such quotes, the U.S. Treasury security shall be determined from such financial reporting service or source as Lender shall determine. Schedule 2.3(e) - 2 SCHEDULE 2.4 CAPITAL IMPROVEMENTS RESERVE CAPITAL IMPROVEMENTS RESERVE. On the date hereof and by the fifteenth (15th) day of each January hereafter, Borrower or Operating Lessee shall deposit into a reserve with Lender the greater of (a) $352,400 ($400 times the number of units in the Projects subject to reduction of and as the number of units is reduced), or (b) such higher amount as may be recommended by Lender's consulting engineer (the "CAPITAL IMPROVEMENTS RESERVE") for replacing or correcting damages or defects (as opposed to normal repairs and recurring expenses) to any Project, including but not limited to, roofing, foundation work, exterior painting, parking lot and structures, kitchen appliances, carpeting, furnishings, fixtures, equipment, vehicles, office equipment, landscaping, heating, ventilating and air-conditioning systems, plumbing, electrical and mechanical systems ("CAPITAL EXPENDITURES") as specified in a Capital Expenditures Budget (as hereinafter defined) or otherwise approved in advance by Lender; however, the amount of the initial deposit into the Capital Improvements Reserve shall be reduced by the amount of funds expended for capital improvements to the Projects approved by Lender in calendar year 2002. The Capital Improvements Reserve will be held by Lender in an interest-bearing reserve account controlled by Lender. The Capital Improvements Reserve shall be advanced by Lender to Borrower or Operating Lessee for Capital Expenditures. Operating Lessee grants to Lender a security interest in the Capital Improvements Reserve. While an Event of Default or a Potential Default exists, Lender shall not be obligated to advance to Borrower or Operating Lessee any portion of the Capital Improvements Reserve, and while an Event of Default exists, Lender shall be entitled, without notice to Borrower or Operating Lessee, to apply any funds in the Capital Improvements Reserve to satisfy Borrower's obligations under the Loan Documents. Within thirty (30) days after the beginning of any calendar year Borrower or Operating Lessee shall submit to Lender a budget for Capital Expenditures for that calendar year (the "CAPITAL EXPENDITURES BUDGET"). The Capital Expenditures Budget shall be based on the previous year's experience and an assessment of anticipated future needs, and shall be subject to Lender's approval. The Capital Improvements Reserve shall be advanced in accordance with the conditions for advances under Schedule 2.1, Part C, and Lender's customary procedures for improvements advances. Schedule 2.4 - 1 EX-10.2 4 g77554exv10w2.txt LEASE AGREEMENT EXHIBIT 10.7 LEASE AGREEMENT by and between FREEDOM PLAZA LIMITED PARTNERSHIP an Arizona limited partnership as "Landlord" and AMERICAN RETIREMENT CORPORATION a Tennessee corporation as "Tenant" TABLE OF CONTENTS 1. TERM....................................................................3 1.1 TERM...........................................................3 1.2 RENEWAL TERMS..................................................3 2. RENT....................................................................3 2.1 ADDITIONAL CHARGES.............................................3 2.2 DIRECT PAYMENT TO GROUND LESSORS...............................4 2.3 PRORATION FOR PARTIAL PERIODS..................................4 2.4 ABSOLUTE NET LEASE.............................................4 2.5 DELINQUENT NOTE PAYMENT........................................5 3. TAXES, ASSESSMENTS AND OTHER CHARGES:...................................5 3.1 TENANT'S OBLIGATIONS...........................................5 3.2 PRORATION......................................................5 3.3 RIGHT TO PROTEST...............................................6 3.4 TAX BILLS......................................................6 3.5 OTHER CHARGES..................................................6 4. INSURANCE...............................................................6 4.1 REQUIRED COVERAGE..............................................6 4.2 NOTICE TO LANDLORD.............................................7 4.3 NAMED INSUREDS.................................................7 4.4 NOTICE OF CLAIMS...............................................7 5. USE, MAINTENANCE AND ALTERATION OF THE PREMISES.........................8 5.1 TENANT'S MAINTENANCE OBLIGATIONS...............................8 5.2 REGULATORY COMPLIANCE..........................................8 5.3 PERMITTED USE..................................................9 5.4 NO LIENS; PERMITTED CONTESTS...................................9 5.5 ALTERATIONS BY TENANT..........................................9 6. CONDITION AND TITLE OF PREMISES........................................10 6.1 CONDITION AND TITLE OF PREMISES...............................10 6.2 RIGHT OF FIRST REFUSAL TO PURCHASE PREMISES...................11 7. TENANT PERSONAL PROPERTY...............................................11 7.1 TENANT PERSONAL PROPERTY......................................11 7.2 REQUIREMENTS FOR TENANT PERSONAL PROPERTY.....................11
i 8. REPRESENTATIONS, WARRANTIES AND COVENANTS..............................12 8.1 MUTUAL REPRESENTATIONS AND WARRANTIES.........................12 8.2 COVENANTS OF LANDLORD.........................................13 9. FINANCIAL REPORTS......................................................15 9.1 QUARTERLY STATEMENTS..........................................15 9.2 MONTHLY REPORTS...............................................15 9.3 ANNUAL STATEMENTS.............................................16 9.4 BUDGETS.......................................................16 9.5 REPORTS RECEIVED BY LANDLORD..................................20 9.6 AUDITED FINANCIAL STATEMENTS OF LANDLORD. ...................20 10. EVENTS OF DEFAULT; REMEDIES............................................20 10.1 EVENTS OF DEFAULT.............................................20 10.2 LANDLORD'S REMEDIES...........................................22 10.3 RECEIVERSHIP..................................................24 10.4 REMEDIES CUMULATIVE; NO WAIVER................................24 10.5 PERFORMANCE OF TENANT'S OBLIGATIONS BY LANDLORD...............25 10.6 TENANT'S RIGHT OF SETOFF......................................26 11. DAMAGE BY FIRE OR OTHER CASUALTY.......................................26 11.1 RECONSTRUCTION USING INSURANCE................................26 11.2 SURPLUS PROCEEDS..............................................26 11.3 NO RENT ABATEMENT.............................................26 11.4 END OF TERM...................................................26 12. CONDEMNATION...........................................................27 12.1 COMPLETE TAKING...............................................27 12.2 PARTIAL TAKING................................................27 12.3 LEASE REMAINS IN EFFECT.......................................28 13. PROVISIONS ON TERMINATION OF TERM......................................28 13.1 SURRENDER OF POSSESSION.......................................28 13.2 REMOVAL OF PERSONAL PROPERTY..................................28 13.3 MANAGEMENT OF PREMISES........................................29 13.4 ASSIGNMENT OF RESIDENCY AGREEMENTS............................31 13.5 CERTAIN AGREEMENTS RELATING TO THE NOTE.......................32 14. NOTICES AND DEMANDS....................................................32 15. RIGHT OF ENTRY; EXAMINATION OF RECORDS.................................33 16. QUIET ENJOYMENT........................................................33
ii 17. APPLICABLE LAW.........................................................34 18. HAZARDOUS MATERIALS....................................................34 18.1 HAZARDOUS MATERIAL COVENANTS..................................34 18.2 TENANT NOTICES TO LANDLORD....................................34 18.3 PARTICIPATION IN HAZARDOUS MATERIALS CLAIMS...................35 18.4 ENVIRONMENTAL ACTIVITIES......................................35 18.5 HAZARDOUS MATERIALS...........................................35 18.6 HAZARDOUS MATERIALS CLAIMS ...................................36 18.7 HAZARDOUS MATERIALS LAWS......................................36 19. ASSIGNMENT AND SUBLETTING..............................................36 19.1 ..............................................................37 19.2 ..............................................................38 20. INDEMNIFICATION........................................................38 20.1 ..............................................................38 20.2 ..............................................................38 21. TENANT AS PROVIDER; MLR DEPOSITS.......................................39 21.1 PROVIDER......................................................39 21.2 MLR DEPOSITS..................................................39 21.3 TENANT MLR DEPOSITS...........................................39 21.4 MLR INCOME....................................................39 22. EXISTING LOAN; REFINANCING INDEBTEDNESS................................40 22.1 ..............................................................40 22.2 ..............................................................40 22.3 ..............................................................41 23. HOLDING OVER...........................................................42 24. ESTOPPEL CERTIFICATES..................................................42 25. ATTORNEYS' FEES........................................................43 26. SEVERABILITY...........................................................43 27. COUNTERPARTS...........................................................43 28. BINDING EFFECT.........................................................43
iii 29. WAIVER AND SUBROGATION.................................................43 30. MEMORANDUM OF LEASE....................................................44 31. INCORPORATION OF RECITALS AND ATTACHMENTS..............................44 32. TITLES AND HEADINGS....................................................44 33. NATURE OF RELATIONSHIP; USURY SAVINGS CLAUSE...........................44 34. ENTIRE AGREEMENT.......................................................45 35. SURVIVAL OF REPRESENTATIONS, WARRANTIES AND COVENANTS..................45 36. RIGHT TO RELY ON TENANT WITHOUT JOINDER OF LANDLORD....................45 37. INTERPRETATION, ETC....................................................45 37.1 ..............................................................45 37.2 ..............................................................45 37.3 ..............................................................46 38. .......................................................................46
iv EXHIBITS EXHIBIT A-1 - LEGAL DESCRIPTION OF PREMISES EXHIBIT A-2 - LANDLORD PERSONAL PROPERTY EXHIBIT A-3 - PERMITTED EXCEPTIONS EXHIBIT B- APPRAISAL PROCEDURE SCHEDULE 1- MINIMUM RENT v LEASE AGREEMENT THIS LEASE AGREEMENT ("LEASE") is made and entered into as of the 1st day of April, 2002 by and between FREEDOM PLAZA LIMITED PARTNERSHIP, an Arizona limited partnership ("LANDLORD"), and AMERICAN RETIREMENT CORPORATION, a Tennessee corporation ("TENANT"). W I T N E S S E T H: WHEREAS, pursuant to that certain Ground Lease dated August 1, 1988, by and between Plaza II Limited Partnership, an Arizona limited partnership ("PLAZA II"), as lessor, and Landlord, as lessee, as amended by that certain Amendment to Ground Lease dated August 1, 1988 by and between Plaza II and Landlord, as further amended by that certain Amendment to Ground Lease effective September 1, 1992, by and between Plaza III Limited Partnership, an Arizona limited partnership (successor in interest to Plaza II) ("FREEDOM PLAZA GROUND LESSOR"), and Landlord, and as further amended by that certain Amendment to Ground Lease dated January 31, 1996, by and between Freedom Plaza Ground Lessor and Landlord (as amended, the "FREEDOM PLAZA GROUND LEASE"), Landlord has a long-term leasehold interest (the "INDEPENDENT LIVING LEASEHOLD INTEREST") in and to that certain real property located in Maricopa County, Arizona and more specifically described in Exhibit "A-1" attached hereto, together with all improvements thereon and all appurtenances thereto, presently used as a continuing care retirement community known as "FREEDOM PLAZA"; WHEREAS, pursuant to that certain Ground Lease (as the same amended from time to time, the "PLAZA DEL RIO GROUND LEASE"; the Freedom Plaza Ground Lease and the Plaza del Rio Ground 1 Lease sometimes referred to herein individually or collectively as the "GROUND LEASE") dated 1998, by and between Sun Health Properties Leasing, an Arizona corporation (the "PLAZA DEL RIO GROUND LESSOR"; the Freedom Plaza Ground Lessor and the Plaza del Rio Ground Lessor sometimes referred to herein individually or collectively as the "GROUND LESSOR"), Landlord has a long-term leasehold interest (the "PLAZA DEL RIO LEASEHOLD INTEREST") in and to that certain real property located in Maricopa County, Arizona and more specifically described in Exhibit "A-1" attached hereto, together with all improvements thereon and all appurtenances thereto, presently used as a skilled nursing facility known as "PLAZA DEL RIO". WHEREAS, Landlord owns the existing furniture, machinery, equipment, appliances, fixtures, and other personal property currently used in connection with the operation of Freedom Plaza and/or Plaza del Rio ("LANDLORD PERSONAL PROPERTY"), which includes, without limitation, those items described in Exhibit "A-2" attached hereto. The Freedom Plaza Leasehold Interest and the Plaza del Rio Leasehold Interest and the Landlord Personal Property shall be collectively referred to in this Lease as the "PREMISES"; and WHEREAS, Landlord desires to lease the Premises to Tenant, and Tenant desires to lease the Premises from Landlord. NOW THEREFORE, in consideration of the mutual covenants, conditions and agreements set forth herein, Landlord hereby leases and lets unto Tenant the Premises for the term and upon the conditions and provisions hereinafter set forth. 2 1. TERM. 1.1 TERM. The term of this Lease shall commence on April 1, 2002 (the "COMMENCEMENT Date") and shall end on July 13, 2018 (the "INITIAL TERM") unless extended pursuant to Section 1.2 of this Lease or earlier terminated in accordance with the provisions hereof. The Initial Term and all Renewal Terms (as hereinafter defined) are referred to collectively as the "TERM". (The 12 month period commencing on the first day of the first full month of the Initial Term and each subsequent 12 month period shall be referred to herein as a "LEASE YEAR".) 1.2 RENEWAL TERMS. The Term may be extended for two (2) separate renewal terms (each a "RENEWAL TERM"), the first Renewal Term being for a term of ten (10) years (which shall extend the Term through July 13, 2028), and the second Renewal Term being for a term of five (5) years, five (5) months and eighteen (18) days (which shall extend the Term through December 31, 2033), upon the satisfaction of all of the following terms and conditions: 1.2.1 Not less than one hundred eighty (180) days before the date on which the then current Term expires, Tenant shall give Landlord written notice that Tenant desires to exercise its right to extend the then current Term for one (1) Renewal Term. 1.2.2 All other provisions of this Lease shall remain in full force and effect and shall continuously apply throughout the Renewal Term(s). 2. RENT. During the Initial Term and, if applicable, all Renewal Terms, minimum rent ("MINIMUM RENT") shall be paid by Tenant to Landlord monthly in advance on the first business day of each month in the amounts set forth on Schedule 1 attached hereto and incorporated herein. 2.1 ADDITIONAL CHARGES. Tenant will also pay, and discharge as and when due, (a) all other amounts, liabilities, obligations and taxes which Tenant assumes or agrees to pay under this 3 Lease directly to the applicable taxing authority or other appropriate payee, and (b) in the event of any failure on the part of Tenant to pay any of those items referred to in clause (a) above, Tenant will also promptly pay and discharge every fine, penalty, interest and cost which may be added for non-payment or late payment of such items (such liabilities, charges, etc. being referred to as "ADDITIONAL CHARGES"). Landlord shall have all rights, powers and remedies provided in this Lease, by statute or otherwise, in the case of non-payment of the Additional Charges, as well as the Minimum Rent. To the extent that Tenant pays any Additional Charges to Landlord pursuant to any requirement of this Lease, Tenant shall be relieved of its obligation to pay such Additional Charges to the entity to which such Additional Charges would otherwise be due. 2.2 DIRECT PAYMENT TO GROUND LESSORS. Tenant shall pay any rent or additional charges due under the Ground Lease (the "GROUND LEASE RENT") directly to the Ground Lessor(s) entitled thereto. 2.3 PRORATION FOR PARTIAL PERIODS. The Rent for any month during the Term that begins or ends on other than the first or last calendar day of a month shall be prorated based on actual days elapsed. 2.4 ABSOLUTE NET LEASE. All Rent payments shall be absolutely net to the Landlord free of taxes (other than federal or state income, or similar taxes calculated on the income, revenue or receipts of Landlord), assessments, utility charges, operating expenses, refurnishings, insurance premiums or any other charge or expense in connection with the Premises. All expenses and charges in connection with the Premises (including without limitation all expenses and charges due under the Ground Lease) whether for upkeep, maintenance, repair, refurnishing, refurbishing, 4 restoration, replacement, insurance premiums, real estate or other property taxes, utilities and other operating or other charges of a like nature or otherwise, shall be paid by Tenant. 2.5 DELINQUENT NOTE PAYMENT. Notwithstanding anything to the contrary set forth herein, in the event Landlord shall fail to make any payments of principal and/or interest under that certain Promissory Note (the "NOTE") of even date herewith in the principal amount of $18,756,374 when due (each a "DELINQUENT NOTE PAYMENT"), and so long as no Event of Default then exists under this Lease, Tenant shall have the right to reduce the next monthly installment of Minimum Rent by an amount equal to the Delinquent Note Payment. The reduction in Minimum Rent set forth in this Section 2.5 shall not be construed as a novation of the Note or as a waiver of the right of acceleration thereunder or of the right of any holder thereafter to insist upon strict compliance with the terms of the Note or to prevent the exercise of such right of acceleration or any other right granted thereunder or by applicable laws 3. TAXES, ASSESSMENTS AND OTHER CHARGES: 3.1 TENANT'S OBLIGATIONS. Tenant agrees to pay and discharge (including the filing of all required returns) any and all taxes, including but not limited to real estate and personal property taxes and lease or rent taxes (but excluding federal or state income, franchise, excise or similar taxes calculated on the income, revenue, or receipts of Landlord), and other assessments levied or assessed against the Premises or any interest therein during the Term, prior to delinquency or imposition of any fine, penalty, interest or other cost. 3.2 PRORATION. At the end of the Term, all such taxes and assessments under Section 3.1 shall be prorated. 5 3.3 RIGHT TO PROTEST. Tenant shall have the right, but not the obligation, to protest the amount or payment of any real or personal property taxes or assessments levied against the Premises, this Lease or the Rent payable hereunder; provided that in the event of any protest by Tenant, Landlord shall not incur any expense because of any such protest, Tenant shall diligently and continuously prosecute any such protest and shall provide security satisfactory to Landlord in connection with such protest. 3.4 TAX BILLS. Tenant shall endeavor to have all tax bills relating to the Premises delivered directly to Tenant by the applicable taxing authorities; provided, however, that Landlord shall promptly forward to Tenant copies of all tax bills and payment receipts relating to the Premises received by Landlord. Notwithstanding anything to the contrary herein, Landlord shall be solely responsible for any fees, penalties or interest that accrue solely as a result of Landlord's failure to promptly forward such copies. 3.5 OTHER CHARGES. Tenant agrees to pay and discharge, prior to delinquency, all electricity, gas, garbage collection, cable television, telephone, water, sewer, and other utilities costs and all other charges, obligations or deposits assessed against the Premises during the Term. 4. INSURANCE. 4.1 REQUIRED COVERAGE. Tenant shall maintain insurance of such kinds and amounts as Tenant and Tenant's affiliates maintain for similar communities that they own or manage and as required pursuant to the provisions of any Approved Loan Documents (as hereinafter defined). Notwithstanding the foregoing, Tenant shall at all times maintain so-called "all-risk" casualty 6 insurance, with reasonable deductibles, in an amount equal to the full insurable value of the Premises (as determined by Tenant in its reasonable discretion). 4.2 NOTICE TO LANDLORD. At the commencement of the Term, and, upon Landlord's request, promptly following each anniversary of the date of this Lease, Tenant shall furnish Landlord with a schedule setting forth the kinds and amounts of insurance Tenant intends to procure in connection with the operation of the Premises, which schedule shall include, in addition to the kinds and amounts of insurance required to be maintained pursuant to any Approved Loan Documents, such other kinds and amounts of insurance as may be required under the terms of this Lease. 4.3 NAMED INSUREDS. All policies of liability insurance shall name the Landlord, Tenant and such other parties as may be required by the provisions of any note, loan agreement or mortgage as the insured thereunder, as their respective interests may appear. All policies of hazard insurance and business interruption insurance shall include loss payment clauses in the form required by any Approved Loan Documents. All insurance shall be obtained at the Tenant's expense. The originals of all policies of insurance and duplicates thereof shall be delivered to Landlord and to any lender, as Landlord shall direct. 4.4 NOTICE OF CLAIMS. Landlord and Tenant each shall give prompt notice to the other of any third party claims made against either or both of them, and shall cooperate fully with each other and with any insurance carrier to the end that all such claims will be properly investigated, defended and adjusted. 7 5. USE, MAINTENANCE AND ALTERATION OF THE PREMISES. 5.1 TENANT'S MAINTENANCE OBLIGATIONS. 5.1.1 Except as provided in Sections 11 and 12, Tenant will keep and maintain the Premises in good appearance, repair and condition. Tenant shall make or cause to be made all repairs, interior and exterior, structural and nonstructural, ordinary and extraordinary, foreseen and unforeseen, necessary to keep the Premises in good order and condition, ordinary wear and tear excepted. 5.1.2 As part of Tenant's obligations under this Section 5.1, Tenant shall maintain in good condition, repair and replace all material items of personal property, ordinary wear and tear excepted, consistent with prudent business practices. 5.2 REGULATORY COMPLIANCE. 5.2.1 Tenant shall comply in all material respects with any federal, state and local licensing and other laws and regulations applicable to the continuing care retirement community on the Premises (the "RETIREMENT CARE FACILITIES"). Tenant shall maintain, subject to all applicable notice or cure periods or procedures, all licenses, certificates, permits and approvals necessary for the operation of the Retirement Care Facilities issued by the State of Arizona or any other governmental authority having jurisdiction over the Retirement Care Facilities. Neither Landlord nor Tenant shall commit any act or omission that would in any way violate such compliance. 5.2.2 During the Term, all inspection fees, costs and charges associated with a change of any licensure or certification shall be borne solely by Tenant. 8 5.3 PERMITTED USE. Tenant shall use and occupy the Premises during the Term primarily as a facility for senior housing, retirement housing, independent living, assisted living, skilled and intermediate nursing, subacute care, Alzheimer's care, and/or related or ancillary uses (the "PERMITTED USE"). 5.4 NO LIENS; PERMITTED CONTESTS. Except as contemplated by Section 22 hereof, Tenant shall not cause or permit any liens, levies or attachments to be placed or assessed against Landlord's interest in the Premises for any reason. However, Tenant shall be permitted in good faith and at its expense to contest the existence, amount or validity of any lien upon the Premises by appropriate proceedings sufficient to prevent the collection or other realization of the lien or claim so contested, as well as the sale, forfeiture or loss of any of the Premises. Tenant shall provide Landlord with security satisfactory to Landlord in Landlord's reasonable judgment to assure the foregoing if the amount in dispute exceeds $150,000. Each contest permitted by this Section 5.4 shall be promptly and diligently prosecuted to a final conclusion by Tenant. 5.5 ALTERATIONS BY TENANT. Tenant shall have the right of altering, improving, replacing, modifying or expanding the facilities, equipment or appliances in the Premises from time to time as it may determine in its discretion; provided, however, that any structural alteration or modification to the Premises that materially alters or changes the character or use of any material portion of the improvements comprising the Premises shall require the prior written consent of the Landlord, which consent shall not be unreasonably withheld, conditioned, or delayed. The cost of all alterations, improvements, replacements, modifications, expansions or other purchases covered by this Section 5.5 shall be borne solely and exclusively by Tenant and shall immediately become a part 9 of the Premises and be subject to the terms and conditions of this Lease. All work performed in connection therewith shall be done in a good and workmanlike manner and in material compliance with all existing codes and regulations pertaining to the Premises and shall comply with the requirements of insurance policies required under this Lease. In the event any material item of the Premises has become inadequate, obsolete or worn out or requires replacement (by direction of any regulatory body or otherwise), Tenant shall remove such item(s) and exchange or replace the same at Tenant's sole cost and the same shall become part of the Premises. 6. CONDITION AND TITLE OF PREMISES. 6.1 CONDITION AND TITLE OF PREMISES. Tenant accepts the Premises on an "AS IS, WHERE IS, WITH ALL FAULTS" basis and will assume all responsibility and cost for the correction of any observed or unobserved deficiencies or violations. In making its decision to enter into this Lease, Tenant has not relied on any representations or warranties, express or implied, of any kind from Landlord. Notwithstanding any other provision of this Lease to the contrary, Tenant accepts the Premises in their present condition, AS IS, WHERE IS, WITH ALL FAULTS, and without any representations or warranties whatsoever, express or implied, including, without limitation, any express or implied representations or warranties as to the fitness, use, suitability, or condition of the Premises. Tenant hereby represents and warrants to Landlord that Tenant is thoroughly familiar with the Premises and the condition thereof, that Tenant is relying on Tenant's own personal knowledge of the condition of the Premises, that neither Landlord nor any person or entity acting or allegedly acting for or on behalf of Landlord has made any representations, warranties, agreements, statements, or expressions of opinions in any way or manner whatsoever 10 related to the condition of the Premises. Tenant acknowledges that title to the Premises is subject to the encumbrances and other exceptions to title set forth more fully on Exhibit "A-3" (the "PERMITTED EXCEPTIONS"). 6.2 RIGHT OF FIRST REFUSAL TO PURCHASE PREMISES. Intentionally Omitted. 7. TENANT PERSONAL PROPERTY. 7.1 TENANT PERSONAL PROPERTY. Tenant shall install, place, and use on the Premises such fixtures, furniture, equipment, inventory and other personal property in addition to Landlord Personal Property as Tenant may, from time to time, deem necessary or useful to operate the Premises for its permitted purposes. All fixtures, furniture, equipment, inventory, and other personal property installed, placed, or used on the Premises which is owned by Tenant or leased by Tenant from third parties is hereinafter referred to as "TENANT PERSONAL PROPERTY." 7.2 REQUIREMENTS FOR TENANT PERSONAL PROPERTY. Tenant shall comply with all of the following requirements in connection with Tenant Personal Property: 7.2.1 Tenant shall, at Tenant's sole cost and expense, maintain, repair, and replace Tenant Personal Property; 7.2.2 Tenant shall, at Tenant's sole cost and expense, keep Tenant Personal Property insured against loss or damage by fire, vandalism and malicious mischief, and other physical loss perils commonly covered by "all risk" insurance. Tenant shall use the proceeds for any such policy for the repair and replacement of Tenant Personal Property. The insurance shall meet the requirements of Section 4.1. 7.2.3 Tenant shall pay all taxes applicable to Tenant Personal Property. 11 7.2.4 Unless an Event of Default has occurred, Tenant may remove Tenant Personal Property from the Premises from time to time provided that (i) the items removed are not required to operate the Premises for the Permitted Use hereunder (unless such items are being replaced by Tenant); and (ii) Tenant repairs any damage to the Premises resulting from the removal of Tenant Personal Property. 8. REPRESENTATIONS, WARRANTIES AND COVENANTS. 8.1 MUTUAL REPRESENTATIONS AND WARRANTIES. Landlord and Tenant do hereby each for itself represent and warrant to each other as follows: 8.1.1 DUE AUTHORIZATION AND EXECUTION. This Lease and all agreements, instruments and documents executed or to be executed in connection herewith by either Landlord or Tenant were duly authorized and shall be binding upon the party that executed and delivered the same. 8.1.2 DUE ORGANIZATION. Landlord and Tenant are duly organized, validly existing and in good standing under the laws of the State of their respective formations and are duly authorized and qualified to do all things required of the applicable party under this Lease within the State of Arizona. 8.1.3 NO BREACH OF OTHER AGREEMENTS. Neither this Lease nor any agreement, document or instrument executed or to be executed in connection herewith by either Landlord or Tenant, violates the terms of any other agreement to which either Landlord or Tenant is a party where such violation would have a material adverse effect. 12 8.2 COVENANTS OF LANDLORD. Landlord hereby makes the following covenants and agreements: 8.2.1 NO CONVEYANCE. During the Term, the Premises will not be sold, transferred, encumbered or conveyed by Landlord, nor shall Landlord permit the sale, transfer, encumbrance, pledge, hypothecation or conveyance of any interest in Landlord or any interest in any equity holder in Landlord, without, in each instance, Tenant's prior written consent, which consent shall not be unreasonably withheld. Without limiting the foregoing, any such sale, transfer, encumbrance, pledge, hypothecation or conveyance shall be made expressly subject to the terms and provisions of this Lease. Landlord shall not sell, transfer, take, remove or convey any assets or items or personal property associated with, or comprising any portion of, the Premises, or associated or related to, the Premises without first obtaining the prior written consent of Tenant, which shall be granted or denied in Tenant's sole discretion. 8.2.2 NO INDEPENDENT LANDLORD ACTIONS. For so long as Tenant is in compliance with the terms of this Lease, Landlord shall take no action with respect to any aspect of the business or operation of the Premises without Tenant's prior written consent, which may be granted or denied by Tenant in its sole discretion. Neither party shall take any action that constitutes, or could constitute or give rise to, a breach under any Approved Loan Document or any other agreement that is material to the Premises. 8.2.3 NO INCURRENCE OF INDEBTEDNESS. Landlord will not incur any indebtedness, obligation or liability, directly or indirectly, that is secured or to be secured by 13 all or a portion of the Premises, without the prior written consent of Tenant, which may be granted or denied in Tenant's sole discretion. 8.2.4 NO OTHER ACTIVITIES. Landlord will not engage in any business activity other than those activities required to own the Premises subject to the provisions of this Lease and performance of its obligations hereunder. 8.2.5 TAX ACCOUNTING POLICIES. Landlord will not change any federal or state tax accounting policies without Tenant's prior written consent, which may be granted or denied in Tenant's sole discretion. 8.2.6 COOPERATION. Landlord shall cooperate with Tenant in good faith with respect to all aspects of the operation of the Premises. 8.2.7 PERMITTED EXCEPTIONS. There are no liens or encumbrances affecting the Premises, other than the Permitted Exceptions, and Landlord shall not allow any liens or encumbrances to affect the Premises other than the Permitted Exceptions. 8.2.8 RESIDENCY AGREEMENTS; LANDLORD'S SUBORDINATION. As used in this Lease, "RESIDENCY AGREEMENTS" shall mean all residency agreements, lifecare contracts, service agreements, occupancy agreements, leases or similar agreements with residents, tenants or occupants, of any unit or portion of the Premises, whether now or hereafter existing. Landlord has assigned to Tenant all Residency Agreements existing on the date of this Lease, and Tenant has assumed Landlord's obligations thereunder, all pursuant to the Assignment and Assumption Agreement of even date herewith (the "ASSIGNMENT AND ASSUMPTION AGREEMENT"). During the term of this Lease, Tenant shall have the right to enter 14 into Residency Agreements with tenants, residents or occupants of the Premises on such terms as Tenant shall deem advisable or desirable in Tenant's sole discretion and without the consent of Landlord. All of Landlord's right, title and interest in the Premises (including, without limitation, Landlord's reversion interest in the Premises) shall automatically be subordinate to the rights of residents, tenants and occupants under the Residency Agreements and Landlord shall recognize the rights of, and shall not disturb, the residents, tenants and occupants under the Residency Agreements before and after termination of this Lease. At the request of any such resident, tenant or occupant, Landlord shall deliver satisfactory evidence that Landlord has so subordinated all of its right, title and interest in the Premises. The residents under the Residency Agreements are express, intended third-party beneficiaries of the provisions of this Section 8.2.8. 9. FINANCIAL REPORTS. 9.1 QUARTERLY STATEMENTS. On or before the twenty-fifth (25th) day after the end of each calendar quarter, Tenant shall deliver to Landlord, and to any persons designated by Landlord, a balance sheet of the Premises as of the end of such quarter, and a statement of income and a statement of changes in cash flows and capital accounts of the Premises for such quarter and for the portion of the operating year ended on the last day of such quarter. 9.2 MONTHLY REPORTS. Tenant shall deliver to the Landlord monthly a written summary of results as reasonably necessary to inform Landlord of the status of the affairs of the Premises and of the status and resolution of any written, material complaints received by Tenant from 15 residents of the Premises, the Department (as hereinafter defined) or any other governmental authorities having jurisdiction over the Premises. 9.3 ANNUAL STATEMENTS. Tenant shall deliver to Landlord, and to any persons designated by Landlord, within three (3) months after the end of each operating year, a balance sheet of the Premises as of the end of such year, and a statement of income and a statement of changes in cash flows and capital accounts for such year, in form reasonably satisfactory to Landlord. Landlord may, at Landlord's expense, request an audited financial statement prepared by certified public accountants designated by Landlord and approved by Tenant. Tenant shall prepare and timely submit for Landlord's approval the annual report (the "ANNUAL REPORT") to be submitted to the Arizona Insurance Department (the "DEPARTMENT") and any reports required in connection with the Existing Loan (as hereinafter defined) or Refinancing Indebtedness (as hereinafter defined). 9.4 BUDGETS. 9.4.1 Upon Landlord's request, not more than 60 days prior to commencement of each full fiscal year during the term of this Lease (commencing with fiscal year 2003), Tenant shall submit to Landlord, for Landlord's approval in accordance with the standards set forth below, a proposed annual operating budget for the Premises (the "ANNUAL BUDGET"), which Annual Budget shall include estimated revenues, operating expenses, capital expenditures and any proposed new indebtedness for the ensuing fiscal year. Tenant may revise the Annual Budget from time to time to reflect any unanticipated items of revenue or expense or any unanticipated or other unforeseen event or circumstance. Any such revision shall be 16 submitted to Landlord for approval based upon the standards set forth below. Tenant may reallocate all or any portion of any amount budgeted with respect to any item(s) in the Annual Budget to another item(s) budgeted therein provided that the aggregate expenditures in the Annual Budget are not increased by more than ten percent (10%) during any fiscal year. Upon the request of Landlord, Tenant shall provide Landlord with the data and information utilized in preparing the Annual Budget (or any revisions thereto) to the extent reasonably necessary to allow Landlord to evaluate the proposed Annual Budget (or revisions thereto). 9.4.2 Tenant agrees that Tenant will establish an appropriate rate structure (in compliance with any required regulatory approvals) and/or secure financing or capital through other prudent means set forth in the Annual Budget (or revisions thereto) to provide sufficient funds for the maintenance and operation of the Premises as a "first class" community and in accordance with the terms of this Lease. 9.4.3 Tenant shall not be deemed to have made, and Tenant specifically disclaims, any assurance, guarantee, warranty or representation whatsoever in connection with the Annual Budget, any revision thereto, or with respect to any item or matter shown or reflected therein, including (without limitation) any guaranty or assurance that actual results or performance will be consistent with any Annual Budget. Landlord acknowledges that the Annual Budget (including revisions thereto) 17 and all estimates and projections furnished in connection therewith or reflected therein are intended only to be reasonable estimates based on Tenant's professional judgment at the time of preparation, and that actual results will differ. Under no circumstance shall a difference between actual results and those projected or forecast in an Annual Budget (or any revision thereto) result in an Event of Default hereunder or give rise to a cause of action by Landlord against Tenant. 9.4.4 Any approval of Landlord required under this Section 9.4 shall not be unreasonably withheld, conditioned or delayed, and shall be deemed given unless a specific written objection (including a detailed explanation of the reasons underlying such objection) is delivered by Landlord to Tenant within thirty (30) days after submission of the proposed Annual Budget or revisions thereto, as the case may be. Notwithstanding anything herein to the contrary, Landlord may disapprove any Annual Budget (or revision thereto) only if Landlord reasonably and in good faith determines that (i) the operating plans and assumptions underlying such Annual Budget are materially detrimental to the long-term financial viability of the Retirement Care Facilities, and (ii) Tenant does not have the financial resources necessary to satisfy its obligations under this Lease as and when they come due. 9.4.5 Neither Landlord's disapproval or objection to any proposed Annual Budget (or revision thereto) or any dispute relating to matters referred to in this Section 9.4 shall under any circumstances be deemed to be an Event of Default 18 under this Lease. In the event Landlord shall disapprove any proposed Annual Budget (or revision thereto), or in the event of a dispute with respect to the matter referred to in this Section 9.4, and Landlord and Tenant are unable to resolve the disputed matters submitted by Landlord within fifteen (15) days, then such disputed or objectionable matters shall be settled by arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association, and judgment upon the award rendered by the arbitrator(s) may be entered in any court having jurisdiction thereof. Any such arbitration shall be conducted in Phoenix, Arizona. Until such time as Landlord and Tenant are able to resolve the disputed or objectionable matters, through arbitration or otherwise, the aggregate amount of expenses reflected in the Annual Budget for the preceding fiscal year, plus or minus, at Tenant's discretion, the greater of (x) ten percent (10%) thereof or (y) the increase in the cost of living from the first day of the preceding fiscal year based upon the Consumer Price Index - United States (1982=100), Medical Costs, published by the bureau of Labor Statistics of the United States Department of Labor, shall be the amount of expenses authorized by the Annual Budget in effect until such time as a new Annual Budget has been approved by Landlord. 9.4.6 Notwithstanding anything to the contrary herein, Landlord's approval of any Annual Budget (or revision thereto) shall not be required if the Premises had an actual debt service coverage ratio of 1.6 to 1.0 for the previous fiscal year and the 19 Premises are reasonably projected to have a debt service coverage ratio of 1.6 to 1.0 for the current fiscal year. 9.5 REPORTS RECEIVED BY LANDLORD. Landlord shall within five (5) days of receipt thereof deliver to the Tenant all federal, state and local licensing, regulatory, reimbursement or other governmental reports received by Landlord as to the Premises or any portion thereof, and all written complaints received by Landlord from residents of the Premises. 9.6 AUDITED FINANCIAL STATEMENTS OF LANDLORD. For each fiscal year of Landlord during the Term of this Lease (which shall be the calendar year), Landlord shall prepare annual audited financial statements of Landlord, and shall timely deliver such statements to Tenant to be filed by Tenant as a supplement to the Annual Report. So long as Landlord is in compliance with this provisions of this Lease, (a) the cost of such audit shall be paid by Tenant and (b) Tenant shall, with all reasonable assitance of Landlord, maintain the books and records of Landlord to the extent reasonably practicable based upon Tenant's knowledge of Landlord's interest in the Premises. 10. EVENTS OF DEFAULT; REMEDIES. 10.1 EVENTS OF DEFAULT. The occurrence of any of the following shall constitute an event of default on the part of Tenant hereunder ("EVENT OF DEFAULT"): 10.1.1 The failure to pay within ten (10) calendar days of the date when due any Minimum Rent; 10.1.2 The appointment of a receiver, trustee, or liquidator for Tenant, or any of the property of Tenant, if within ten (10) business days of such appointment Tenant does 20 not inform Landlord in writing that Tenant intends to cause such appointment to be discharged or Tenant does not thereafter diligently prosecute such discharge to completion within one hundred and twenty (120) days after the date of such appointment; 10.1.3 The filing by Tenant of a voluntary petition under any federal bankruptcy law or under the law of any state to be adjudicated as bankrupt or for any arrangement or other debtor's relief, or in the alternative, if any such petition is involuntarily filed against Tenant by any other party and Tenant does not within ten (10) business days of any such filing inform Landlord in writing of the intent by Tenant to cause such petition to be dismissed, if Tenant does not thereafter diligently prosecute such dismissal, or if such filing is not dismissed within one hundred and twenty (120) days after filing thereof; 10.1.4 The failure to make any payment required under the Ground Lease or under the Existing Loan, subject in each case to all applicable grace and/or notice and cure periods or procedures; 10.1.5 The failure to make any monetary payment required by Tenant under this Lease not covered in Section 10.1.1 or Section 10.1.4 or the failure to perform or comply in any material respect with any other term or provision of this Lease not requiring the payment of money, or the breach of any representation or warranty of Tenant in this Lease; provided, however, if the default described in this Section 10.1.5 is curable it shall be deemed cured, if within thirty (30) business days of Tenant's receipt of a notice of default from Landlord, Tenant cures such default; provided, further, that if such default cannot with due 21 diligence be cured within a period of thirty (30) days because of the nature of the default or delays beyond the control of Tenant, then such default shall not constitute an Event of Default if Tenant uses its best efforts to cure such default by promptly commencing and diligently pursuing such cure to the completion thereof; 10.1.6 In the event that any resident or former resident does not timely receive any refund of entry fees pursuant to the terms of any applicable Residency Agreement (an "ENTRY FEE REFUND") that is due during the Term of this Lease, and Tenant does not promptly make such Entry Fee Refund after receiving notice of such failure; 10.1.7 If Tenant shall vacate, abandon or otherwise cease to operate the Premises for a period of twenty-four (24) consecutive hours or shall notify Landlord that Tenant intends to vacate, abandon or cease to transact business from and upon the Premises (a "VOLUNTARY ABANDONMENT"); and 10.1.8 If the Department initiates proceedings to assume control over Plaza del Rio and Freedom Plaza, and any such proceeding is not dismissed or stayed within ninety (90) days of commencement of such proceeding. 10.2 LANDLORD'S REMEDIES. Upon the occurrence of an Event of Default and during the continuance thereof, Landlord may exercise all rights and remedies under this Lease and the laws of the State of Arizona available to a lessor of real and personal property in the event of a default by its lessee. Without limiting the foregoing, Landlord shall have the right to do any of the following: 10.2.1 Sue for the specific performance of any covenant of Tenant under this Lease as to which Tenant is in breach; 22 10.2.2 Upon compliance with the requirements of applicable law and to the extent allowed thereunder, Landlord may do any of the following: enter upon the Premises, terminate this Lease, dispossess Tenant from the Premises and/or collect money damages by reason of Tenant's breach, including without limitation all rent which would have accrued after such termination and all obligations and liabilities of Tenant under this Lease which survive the termination of the Term; 10.2.3 Elect to leave this Lease in place and sue for rent and/or other money damages as the same come due; 10.2.4 Before or after repossession of the Premises pursuant to Section 10.2.2, and whether or not this Lease has been terminated, Landlord shall have the right (but shall be under no obligation except to the extent required by applicable law) to relet any portion of the Premises to such tenant or tenants, for such term or terms (which may be greater or less than the remaining balance of the Term), for such rent, or such conditions (which may include concessions or free rent) and for such uses, as Landlord, in its absolute discretion, may determine, and Landlord may collect and receive any rents payable by reason of such reletting. Tenant agrees to pay Landlord, immediately upon demand, all reasonable expenses incurred by Landlord in obtaining possession and in reletting any of the Premises, including fees, commissions and costs of attorneys, architects, agents and brokers; 10.2.5 If the Event of Default shall be or include a Voluntary Abandonment, 23 Landlord may, in addition to any other remedy authorized or permitted herein or by applicable law, either directly or acting by and through a duly appointed Receiver, enter upon and take possession of the Premises without terminating this Lease and thereupon and thereafter, Section 8.2.2 hereof notwithstanding, conduct and operate the business and operations of the Premises on behalf of and for the account of Tenant, and for such purposes Tenant shall and does hereby designate, constitute and appoint Landlord and/or such Receiver, as Tenant's true and lawful attorney in fact, which appointment shall conclusively be deemed coupled with an interest, and which appointment shall not be revocable prior to the expiration of a period of one (1) year from and after the occurrence of such Event of Default. 10.3 RECEIVERSHIP. Tenant acknowledges that one of the rights and remedies available to Landlord under applicable law is to secure a court-appointed receiver to take possession of the Premises or any portion thereof, to collect the rents, issues, profits and income of the Premises or any portion thereof, and to manage the operation of the Premises or any portion thereof. The receiver shall be entitled to a reasonable fee for its services as a receiver. All such fees and other expenses of the receivership estate shall be added to the monthly rent due to Landlord under this Lease. 10.4 REMEDIES CUMULATIVE; NO WAIVER. No right or remedy herein conferred upon or reserved to Landlord is intended to be exclusive of any other right or remedy, and each and every right and remedy shall be cumulative and in addition to any other right or remedy given hereunder or now or hereafter existing at law or in equity. No failure of Landlord to insist at any time 24 upon the strict performance of any provision of this Lease or to exercise any option, right, power or remedy contained in this Lease shall be construed as a waiver, modification or relinquishment thereof as to any similar or different breach (future or otherwise) by Tenant. A receipt by Landlord of any rent or other sum due hereunder with knowledge of the breach of any provision contained in this Lease shall not be deemed a waiver of such breach, and no waiver by Landlord of any provision of this Lease shall be deemed to have been made unless expressed in a writing signed by Landlord. 10.5 PERFORMANCE OF TENANT'S OBLIGATIONS BY LANDLORD. If Tenant at any time after applicable notice and cure periods shall fail to make any payment or perform any act on its part required to be made or performed under this Lease, then Landlord may, without waiving or releasing Tenant from any obligations or default of Tenant hereunder, make any such payment or perform any such act for the account and at the expense of Tenant, and may enter upon the Premises for the purpose of taking all such action thereon as may be reasonably necessary therefor. No such entry shall be deemed an eviction of Tenant. All reasonable sums so paid by Landlord and all necessary and incidental costs and expenses (including, without limitation, reasonable attorneys' fees and expenses) incurred in connection with the performance of any such act by Landlord, together with interest at the rate of the Prime Rate as reported daily by the Wall Street Journal plus 5% (or if said interest rate is violative of any applicable statute or law, then the maximum interest rate allowable) from the date of the making of such payment or the incurring of such costs and expenses by Landlord, shall be payable by Tenant to Landlord on demand. 10.6 TENANT'S RIGHT OF SETOFF. In addition to any other right or remedy that Tenant 25 may have at law, equity or otherwise, Tenant shall have the express right to offset against Rent or other sums due hereunder any amount(s) to which Tenant is due, directly or indirectly, as a result of Landlord's breach of any provision of this Lease. 11. DAMAGE BY FIRE OR OTHER CASUALTY. 11.1 RECONSTRUCTION USING INSURANCE. In the event of damage or destruction of the Premises, Tenant shall forthwith notify Landlord and diligently repair or reconstruct the same to a condition similar to that which existed prior to such damage or destruction. In the event of any material, structural damage or destruction of the Premises, Tenant shall undertake such repair or reconstruction work pursuant to plans and specifications reasonably acceptable to Landlord. Any net insurance proceeds payable with respect to the casualty shall be used for the repair or reconstruction of the Premises. If such proceeds are insufficient for such purposes, Tenant shall provide the required additional funds. 11.2 SURPLUS PROCEEDS. If there remains any surplus of insurance proceeds after the completion of the repair or reconstruction of the Premises, such surplus shall belong to and be paid to Tenant. 11.3 NO RENT ABATEMENT. The rent payable under this Lease shall not abate by reason of any damage or destruction of the Premises by reason of an insured or uninsured casualty. Tenant hereby waives all rights under applicable law to abate, reduce or offset rent by reason of such damage or destruction. 11.4 END OF TERM. Notwithstanding any other provision of this Section 11, if the 26 Premises are more than 30% destroyed (measured by square footage) by casualty during the last twenty-four (24) months of the Initial Term or any Renewal Term, Tenant may terminate this Lease by written notice to Landlord delivered within thirty (30) days after the date of such casualty, in which event Landlord shall retain all insurance proceeds and Tenant shall have no obligation to repair or reconstruct the Premises. 12. CONDEMNATION. 12.1 COMPLETE TAKING. If during the Term all or substantially all of the Premises is taken or condemned by any competent public or quasi-public authority (which shall include a taking of a part of the Premises such that the remaining portion is unsuitable or not economically feasible for continued operation by Tenant as contemplated hereby, as determined by Tenant), then Tenant may, at Tenant's election, made within thirty (30) days of such taking by condemnation, terminate this Lease, and the current Minimum Rent shall be prorated as of the date of such termination. The award payable upon such taking shall be allocated between Landlord and Tenant as so allocated by the taking authority. In the absence of such allocation by the taking authority, the award shall be allocated as agreed by Landlord and Tenant. Failing such agreement within thirty (30) days after the effective date of such taking, the award shall be allocated between Landlord and Tenant pursuant to the appraisal procedure described on Exhibit "B" attached hereto. 12.2 PARTIAL TAKING. If during the Term any portion of the Premises it taken or condemned and this Lease is not terminated pursuant to ss. 12.1, the Minimum Rent shall be abated to the same extent as the diminution in the fair market value of the Premises by reason of the 27 condemnation; provided, however, in no event shall Minimum Rent be reduced to an amount less than $1,268,076 per annum. Such diminution in the fair market value shall be as agreed between Landlord and Tenant, but failing such agreement within thirty (30) days of the effective date of the condemnation the same will be determined by appraisal pursuant to Exhibit "B" attached hereto. Landlord shall be entitled to receive and retain any and all awards for the partial taking and damage and Tenant shall not be entitled to receive or retain any such award for any reason. 12.3 LEASE REMAINS IN EFFECT. Except as provided above, this Lease shall not terminate and shall remain in full force and effect in the event of a taking or condemnation of the Premises, or any portion thereof, and Tenant hereby waives all rights under applicable law to abate, reduce or offset rent by reason of such taking. 13. PROVISIONS ON TERMINATION OF TERM. 13.1 SURRENDER OF POSSESSION. Tenant shall, on or before the last day of the Term, or upon earlier termination of this Lease, surrender to Landlord the Premises (including all resident charts and records) in good condition and repair, excepting only (i) ordinary wear and tear, (ii) any damage caused by condemnation pursuant to Section 12 above, or (iii) any damage caused by fire or other casualty resulting in the termination of the Lease pursuant to Section 11.4 above. 13.2 REMOVAL OF PERSONAL PROPERTY. If Tenant is not then the subject of an Event of DEFAULT hereunder, Tenant shall have the right in connection with the surrender of the Premises to remove from the Premises all Tenant Personal Property but not the Landlord Personal Property (including the Landlord Personal Property replaced by Tenant). Any such removal shall be done in a 28 workmanlike manner leaving the Premises in good and presentable condition and appearance, including repair of any damage caused by such removal. At the end of the Term or upon the earlier termination of this Lease (unless Tenant has terminated this Lease pursuant to Sections 11.4 or 12.1) Tenant shall return the Premises to Landlord with the Landlord Personal Property (or replacements thereof) in the same condition and utility as was delivered to Tenant at the commencement of the Term, normal wear and tear excepted. 13.3 MANAGEMENT OF PREMISES. 13.3.1 Upon the expiration or earlier termination of the Term (unless Tenant has purchased the Premises), Landlord shall use its best efforts to enter into a management, lease or other agreement with an entity qualified under the laws of the State of Arizona (including without limitation A.R.S. ss.ss. 20-1802 and 20-1808(A) or any successor statutes) and other applicable laws (a "QUALIFIED MANAGER") to assume the responsibilities and obligations for the management and operation of the Premises (including all obligations under all Residency Agreements affecting the Premises). 13.3.2 Until such time as Landlord enters into a management agreement for the management and operation of the Premises with a Qualified Manager, Tenant and Landlord shall enter into a management agreement the ("ARC MANAGEMENT AGREEMENT") for the management and operation of the Premises, which management agreement shall be in a form that is substantially the same as the customary form of management agreement then in use by Tenant and its affiliates, subject to the provisions of this Section 13.3.2. The ARC 29 Management Agreement shall provide that it shall terminate simultaneously with a Qualified Manager's assumption of all responsibilities and obligations relating to the operation of the Premises. The ARC Management Agreement shall further provide that, in consideration of Tenant's management and operation of the Premises, Tenant shall be entitled to receive a management fee equal to (a) if this Lease is terminated prior to the expiration of the Term on account of an Event of Default pursuant to Section 10.2.2 hereof, One Thousand Dollars ($1,000.00) per month; or (b) for each month, one hundred percent (100%) of the Available Cash Flow from the Premises (as hereinafter defined), in all other circumstances (including Tenant's management following the expiration of the Term). Furthermore, if this Lease is terminated for any reason other than Tenant's Event of Default pursuant to Section 10.2.2, then the provisions of Section 8.2 shall remain effective and be incorporated into the ARC Management Agreement. As used in this section 13.3, "AVAILABLE CASH FLOW FROM THE PREMISES" means the amount by which (i) all income and revenue of any kind whatsoever directly or indirectly arising or derived from or out of the ownership, operation or use of the Premises, exceeds (ii) all expenses of operating the Premises, including any debt service on any loan directly associated with the Premises that is incurred in compliance with this Lease, all as calculated on a cash basis. 13.3.3 Tenant agrees to cooperate with Landlord or its designee to accomplish the transfer of such management and operation without interrupting the operation of the Premises. Tenant shall not commit any act or be remiss in the undertaking of any act that 30 would jeopardize any licensure or certification of the facility, and Tenant shall comply with all reasonable requests for an orderly transfer of the licenses and certifications for the Premises, and possession at the time of any such surrender. Upon the expiration or earlier termination of the Term, Tenant shall deliver copies of all of Tenant's books and records relating to the Premises and its operations to Landlord. 13.4 ASSIGNMENT OF RESIDENCY AGREEMENTS. Automatically upon the expiration or termination of this Lease (unless Tenant has purchased the Premises), the Residency Agreements shall be deemed to have been assigned by Tenant to Landlord, and to have been assumed by Landlord, to the extent permitted by applicable law, all as more particularly set forth in the Assignment and Assumption Agreement. 31 13.5 CERTAIN AGREEMENTS RELATING TO THE NOTE. Notwithstanding any provision of the Note to the contrary and so long as Landlord is not in default thereunder, if Tenant elects not to exercise its right to extend the Term for the first or second Renewal Term so that the Term expires on either July 13, 2018 or July 13, 2028, then (a) Landlord shall have the right to reduce the outstanding principal amount of the Note as of the day that the Term expires by the Offset Amount (as hereinafter defined), and (b) to the extent that the Offset Amount exceeds the principal balance of the Note as of the expiration of the Term, Tenant shall issue to Landlord on the date the Term expires a promissory note in the amount of such excess (the "EXCESS NOTE"). The Excess Note shall be in the same form as the Note and shall bear interest at the rate of six percent (6%) per annum, shall mature 37 years after issuance, with level payments of the principal and interest due under a 37-year amortization schedule. As used herein, the term "OFFSET AMOUNT" shall mean Tenant's tax basis (as reflected in Tenant's tax books and records) in any liabilities to residents of the Premises that are actually assumed by Landlord pursuant to Section 13.4 of this Lease or the Assignment and Assumption Agreement, which liabilities will include, if applicable, all refundable entrance fee deposits and the amount of nonrefundable entrance fees that Tenant has not reported as taxable income as of the date of termination. The terms of this Section 13.5 shall control over any inconsistent provision(s) in the Note. 14. NOTICES AND DEMANDS. All notices and demands, certificates, requests, consents, approvals, and other similar instruments under this Lease shall be in writing and shall be deemed to 32 have been properly given upon actual receipt thereof or within two (2) business days of being placed in the United States certified or registered mail, return receipt requested, postage prepaid (a) if to Tenant, addressed to American Retirement Corporation, 111 Westwood Place, Suite 200, Brentwood, Tennessee 37027, Attn: Chief Executive Officer Facsimile No. (615) 221-2269 with a copy to Bass, Berry & Sims PLC, 315 Deaderick Street, Suite 2700, AmSouth Center, Nashville, Tennessee 37238, Attn: T. Andrew Smith, Esq., Facsimile No. (615) 742-2766 or at such other address as Tenant from time to time may have designated by written notice to Landlord, (b) if to Landlord, addressed to Freedom Plaza Limited Partnership, 1226 North Tamiami Trail, Suite 100, Sarasota, Florida 34236 Attn: Chief Executive Officer, Fax No. (941) 954-0909 with a copy to 1226 North Tamiami Trail, Suite 100, Sarasota, Florida 34236, Attn: Gregory L. Patterson, Fax No. (941) 954-0909, or at such address as Landlord may from time to time have designated by written notice to Tenant. Refusal to accept delivery shall be deemed delivery. 15. RIGHT OF ENTRY; EXAMINATION OF RECORDS. Landlord and its representative may enter the Premises at any reasonable time after reasonable notice to Tenant for the purpose of inspecting the Premises for any reason including, without limitation, Tenant's default under this Lease. Any such entry shall not unreasonably interfere with residents, resident care, or any of Tenant's operations. 16. QUIET ENJOYMENT. So long as no Event of Default is existing and continuing Landlord covenants and agrees that Tenant shall peaceably and quietly have, hold and enjoy the Premises for the Term, free of any claim or other action not caused or created by Tenant (excepting, however, 33 intrusion of Tenant's quiet enjoyment occasioned by condemnation or destruction of the property as referred to in Sections 11 and 12 hereof). 17. APPLICABLE LAW. This Lease shall be governed by and construed in accordance with the internal laws of the State of Arizona without regard to the conflict of laws rules of such State. 18. HAZARDOUS MATERIALS. 18.1 HAZARDOUS MATERIAL COVENANTS. Tenant's use of the Premises shall comply in all material respects with all Hazardous Materials Laws (as hereinafter defined). In the event any Environmental Activities (as hereinafter defined) occur or are suspected to have occurred in violation in any material respect of any Hazardous Materials Laws or if Tenant has received any Hazardous Materials Claim (as hereinafter defined) against the Premises, Tenant shall promptly obtain all permits and approvals necessary to remedy any such actual or suspected problem through the removal of Hazardous Materials (as hereinafter defined) or otherwise, and upon Landlord's approval of the remediation plan, remedy any such problem to the satisfaction of Landlord, in accordance with all Hazardous Materials Laws and good business practices. 18.2 TENANT NOTICES TO LANDLORD. Tenant shall immediately advise Landlord in writing of: 18.2.1 any Environmental Activities in violation of any Hazardous Materials Laws, 18.2.2 any Hazardous Materials Claims against Tenant or the Premises, 34 18.2.3 any remedial action taken by Tenant in response to any Hazardous Materials Claims or any Hazardous Materials on, under or about the Premises in violation of any Hazardous Materials Laws, 18.2.4 Tenant's discovery of any occurrence or condition on or in the vicinity of the Premises that materially increase the risk that the Premises will be exposed to Hazardous Materials, 18.2.5 all communications to or from Tenant, any governmental authority or any other person relating to Hazardous Materials Laws or Hazardous Materials Claims with respect to the Premises, including copies thereof. 18.3 PARTICIPATION IN HAZARDOUS MATERIALS CLAIMS. Landlord shall have the right, at Landlord's cost and expense and with counsel chosen by Landlord, to join and participate in, as a party if it so elects, any legal proceedings or actions initiated in connection with any Hazardous Materials Claims. 18.4 ENVIRONMENTAL ACTIVITIES shall mean the use, generation, transportation, handling, discharge, production, treatment, storage, release or disposal of any Hazardous Materials at any time to or from the Premises or located on or present on or under the Premises. 18.5 HAZARDOUS MATERIALS shall mean (i) any petroleum products and/or by-products (including any fraction thereof), flammable substances, explosives, radioactive materials, hazardous or toxic wastes, substances or materials, known carcinogens or any other materials, contaminants or pollutants which pose a hazard to the Premises or to persons on or about the Premises 35 or cause the Premises to be in violation of any Hazardous Materials Laws; (ii) asbestos in any form which is friable; (iii) urea formaldehyde in foam insulation or any other form; (iv) transformers or other equipment which contain dielectric fluid containing levels of polychlorinated biphenyls in excess of fifty (50) parts per million or any other more restrictive standard then prevailing; (v) medical wastes and biohazards; (vi) radon gas; and (vii) any other chemical, material or substance, exposure to which is prohibited, limited or regulated by any governmental authority or may or could pose a hazard to the health and safety of the occupants of the Premises or the owners and/or occupants of property adjacent to or surrounding the Premises. 18.6 HAZARDOUS MATERIALS CLAIMS shall mean any and all enforcement, clean-up, removal or other governmental or regulatory actions or orders threatened, instituted or completed pursuant to any Hazardous Material Laws, together with all claims made or threatened by any third party against the Premises, Landlord or Tenant relating to damage, contribution, cost recovery compensation, loss or injury resulting from any Hazardous Materials. 18.7 HAZARDOUS MATERIALS LAWS shall mean any laws, ordinances, regulations, rules, orders, guidelines or policies relating to the environment, health and safety, Environmental Activities, Hazardous Materials, air and water quality, waste disposal and other environmental matters, if the failure to comply with the same does or would have a material adverse effect on the Premises or the operation thereof. 19. ASSIGNMENT AND SUBLETTING. Tenant shall not, without the prior written consent of Landlord, which Landlord may not unreasonably withhold, condition or delay, voluntarily or involuntarily assign or hypothecate this Lease or any interest herein or sublet the Premises. Any of 36 the foregoing acts without such consent shall be void but shall, at the option of Landlord in its sole discretion, constitute an Event of Default giving rise to Landlord's right, among other things, to terminate this Lease. Without limiting the foregoing, this Lease shall not be assigned or encumbered by operation of law without the prior written consent of Landlord which may be withheld at Landlord's reasonable discretion. Notwithstanding the foregoing to the contrary, the provisions of this Section 19 shall be subject to the provisions of Section 22 hereof, and Tenant may without Landlord's consent assign this Lease or sublet the Premises or any portion thereof to a Successor (as such term is defined below) of Tenant, or a direct or indirect, wholly-owned subsidiary of Tenant (including a Successor of Tenant) (each, a "SUBSIDIARY"), provided that such Successor or Subsidiary fully assumes the obligations of Tenant under this Lease, no such assignment or sublease shall relieve Tenant of its obligations hereunder or be valid (and no such Successor shall take possession of the Premises) until an executed counterpart of such assignment or sublease has been delivered to Landlord, and each such sublease shall be expressly subordinate to this Lease. 19.1 Notwithstanding anything in this Section 19 to the contrary, Tenant may undertake the following without Landlord's prior consent: (i) enter into Residency Agreements, as contemplated by Section 8.2.8 hereof, (ii) lease a unit or bed to a resident of the Premises pursuant to agreements that are terminable upon 30 days notice, (iii) sublease any space in the Premises to an individual or entity that provides services to residents or occupants of the Premises, and (iv) sublease any space for uses ancillary or incidental to the primary use of the Premises. 37 19.2 As used herein, a "SUCCESSOR" is any entity which succeeds to materially all of the assets, operations and business of Tenant by merger, reorganization, recapitalization or similar transaction. 20. INDEMNIFICATION. 20.1 To the fullest extent permitted by law, Tenant agrees to protect, indemnify, defend and save harmless Landlord, its directors, officers, shareholders, agents and employees from and against any and all liability, expense loss, costs, deficiency, fine, penalty, or damage (including without limitation punitive or consequential damages) of any kind or nature, including reasonable attorneys' fees, from any suits, claims or demands arising out of any action or inaction on the part of Tenant or caused by any negligence, willful misconduct or bad faith of Tenant, or the breach by Tenant of any of its obligations hereunder. Upon receiving knowledge of any suit, claim or demand asserted by a third party that Landlord believes is covered by this indemnity, Landlord shall give Tenant notice of the matter. Tenant shall defend Landlord against such matter at Tenant's sole cost and expense and with counsel reasonably acceptable to Landlord. 20.2 Landlord agrees to indemnify and save Tenant and its officers, directors, shareholders and employees harmless from and against any and all claims, losses, damages and expenses, including reasonable attorney's fees through all appeals, arising out of any action or inaction on the part of Landlord or attributable to the negligence, willful misconduct or bad faith or Landlord or breach of this Lease by Landlord. 38 21. TENANT AS PROVIDER; MLR DEPOSITS. 21.1 PROVIDER. Landlord and Tenant intend that Tenant be the sole "provider" at the Premises for purposes of A.R.S. ss. 20-1801, et seq., and any successor or replacement statute. 21.2 MLR DEPOSITS. Landlord has previously made so called "minimum liquid reserve deposits" with respect to the Premises as required by applicable Arizona statutes in an aggregate amount of $1,763,153.00 (the "LANDLORD MLR DEPOSITS"). The Landlord MLR Deposits shall constitute Landlord's Personal Property, but shall remain on deposit for the benefit of the Premises pursuant to applicable Arizona statutes for the Term of this Lease. The Landlord shall not allow Landlord MLR Deposits to have a value that is at any time less than $1,763,153.00. 21.3 TENANT MLR DEPOSITS. In the event that applicable Arizona statutes require minimum liquid reserve deposits that exceed the Landlord MLR Deposits, Tenant shall make, from time to time as required, such excess deposits (the "TENANT MLR DEPOSITS"). The parties acknowledge that as of the date hereof Tenant has made Tenant MLR Deposits in the aggregate amount of $-0-. The Tenant MLR Deposits, whether now in existence or hereafter made, shall constitute, and shall remain, Tenant's personal property. So long as Tenant is not in default hereunder, in the event that the amount of the minimum liquid reserve deposits required for the Premises pursuant to applicable Arizona law is ever reduced in the future the Tenant MLR Deposits shall be returned first to Tenant, before reduction in the amount of Landlord MLR Deposits. Upon expiration of this Lease, and so long as Tenant is not in default hereunder, Tenant shall be entitled to receive the Tenant MLR Deposits. 21.4 MLR INCOME. Landlord hereby guarantees that the Landlord MLR Deposits shall generate actual, collected interest or investment income (the "LANDLORD MLR INTEREST 39 INCOME") in each calendar year that equals or exceeds $40,000 (the "THRESHOLD AMOUNT"). In the event that the Landlord MLR Interest Income is less than the Threshold Amount in any calendar year (an "MLR INTEREST INCOME DEFICIT"), then the Landlord shall pay to Tenant the amount of such MLR Interest Income Deficit before December 31 of each year. In the event that the Landlord MLR Interest Income is greater than the Threshold Amount in any calendar year, such excess shall be paid directly to Landlord. Tenant shall be entitled to retain all interest and investment income relating to Tenant's MLR Deposits, which deposits (including all interest and investment income thereon) shall remain Tenant's personal property, and Landlord shall have no interest therein. 22. EXISTING LOAN; REFINANCING INDEBTEDNESS. 22.1 The Premises is currently subject to a loan (the "EXISTING LOAN") from Aid Association for Lutherans, a Wisconsin corporation ("AAL") in the original principal amount of $11,850,000. Tenant shall cause the Premises to be in compliance with the provisions of the documents evidencing or securing the Existing Loan (such documents, together with any documents evidencing or securing a hereinafter described Refinancing Indebtedness, being referred to herein as the "APPROVED LOAN DOCUMENTS"). Without limiting the generality of the foregoing sentence, Tenant shall be responsible for making payments on the Existing Loan in accordance with the terms of the Approved Loan Documents and such payments shall be tendered directly to AAL. 22.2 Subject to the terms of this Section 22.2, Tenant shall have the right from time to time to incur additional indebtedness(es) and to refinance the Existing Loan, all secured by the Premises, including Landlord's and Tenant's interest therein (a "REFINANCING INDEBTEDNESS"). Tenant shall have the right, from time to time, to direct Landlord to execute and deliver all documents 40 necessary to consummate a Refinancing Indebtedness. Tenant shall pay all costs incurred in connection with any Refinancing Indebtedness, including, without limitation, any prepayment penalties. Landlord shall have the right to approve the incurrence of any such indebtedness in excess of the original principal balance of the Existing Loan (i.e., $11,850,000); provided, however, that such approval shall not be unreasonably withheld, conditioned or delayed if the reasonably projected debt service coverage ratio of the Premises equals or exceeds 1.6 to 1.0 (after giving effect to the incurrence of the additional indebtedness). Landlord shall not be obligated to execute and deliver documents in connection with Refinancing Indebtedness unless (i) the terms provided therein are reasonable and customary (including reasonable amortization provisions); (ii) interest on such Refinancing Indebtedness is payable not less often than quarterly and (iii) the principal of such Refinancing Indebtedness is amortized such that the principal amount of the Existing Loan (if still outstanding) and any Refinancing Indebtedness outstanding on the expiration of the Initial Term will not be greater than the principal amount of the Existing Loan that would be outstanding on such date under the documents relating to the Existing Loan currently in effect (the parties agree that such amount is $10,743,216), and (iv) such Refinancing Indebtedness does not require the guaranty of any limited partner of Landlord. 22.3 If (a) this Lease is terminated by Landlord due to Tenant's breach hereof prior to the expiration of the Initial Term, (b) the principal amount of any Refinancing Indebtedness outstanding on the date of such termination exceeds the principal amount of the Existing Loan that would have been outstanding on such date if the Existing Loan had not been refinanced and the Landlord had continued to make principal payments on the Existing Loan in accordance with the 41 terms of the documents relating thereto as of the date of this Lease (the "EXCESS INDEBTEDNESS"), and (c) the present value of the remaining scheduled debt service payments on the Refinancing Indebtedness (discounted at the interest rate applicable to the Existing Loan) as of the date of such termination exceeds the present value of the debt service payments on the Existing Loan that would have remained outstanding as of the date of such termination if the Existing Loan had not been refinanced (discounted at the interest rate applicable to the Existing Loan) (the "EXCESS DEBT SERVICE"), Tenant shall either (x) deposit with Landlord or make a principal payment on the Refinancing Indebtedness in an amount equal to the Excess Indebtedness, or (y) deposit with Landlord an amount equal to the Excess Debt Service. 23. HOLDING OVER. Intentionally Omitted. 24. ESTOPPEL CERTIFICATES. Tenant shall, at any time upon not less than fifteen (15) days prior written request by Landlord, execute, acknowledge and deliver to Landlord or its designee a statement in writing, executed by an officer or general partner of Tenant, certifying that this Lease is unmodified and in full force and effect (or, if there have been any modifications, that this Lease is in full force and effect as modified, and setting forth such modifications), the dates to which Minimum Rent, Additional Charges and additional amounts due hereunder have been paid, certifying that no default by either Landlord or Tenant exists hereunder or specifying each such default and as to other matters as Landlord may reasonably request. Landlord shall, at any time upon not less than fifteen (15) days prior written request by Tenant, execute, acknowledge and deliver to Tenant or its designee a written statement certifying that this Lease is unmodified and in full force and effect (or, if there have been any modifications, that this 42 Lease is in full force and effect as modified, and setting forth such modifications), the dates to which Minimum Rent, Additional Charges and additional amounts due hereunder have been paid, certifying that no default by either Landlord or Tenant exists hereunder or specifying each such default and as to other matters as Tenant may reasonably request. 25. ATTORNEYS' FEES. If Landlord or Tenant brings any action to interpret or enforce this Lease, or for damages for any alleged breach hereof, the prevailing party in any such action shall be entitled to reasonable attorneys' fees and costs as awarded by the court in addition to all other recovery, damages and costs. 26. SEVERABILITY. In the event any part or provision of the Lease shall be determined to be invalid or unenforceable, the remaining portion of this Lease shall nevertheless continue in full force and effect. 27. COUNTERPARTS. This Lease may be executed in any number of counterparts, each of which shall be deemed an original, but all of which shall constitute one and the same agreement. 28. BINDING EFFECT. Subject to the provisions of Section 19 above, this Lease shall be binding upon and inure to the benefit of Landlord and Tenant and their respective heirs, personal representatives, successors in interest and assigns. 29. WAIVER AND SUBROGATION. Landlord and Tenant hereby waive to each other all rights of subrogation which any insurance carrier, or either of them, may have as to the Landlord or Tenant by reason of any provision in any policy of insurance issued to Landlord or Tenant, provided such waiver does not thereby invalidate the policy of insurance. 43 30. MEMORANDUM OF LEASE. Landlord and Tenant shall, promptly upon the request of either, enter into a short form or memorandum of the Lease, in form suitable for recording under the laws of the State of Arizona in which reference to this Lease shall be made. Such memorandum may provide written notice of Landlord's covenants in this Agreement, and may further provide that any person or entity that deals directly with Landlord and does not ensure compliance with the provisions of this Lease shall, among other things, be liable to Tenant for tortious interference with this Lease. The party requesting such recordation shall pay all costs and expenses of preparing and recording such memorandum of this Lease. 31. INCORPORATION OF RECITALS AND ATTACHMENTS. The recitals and exhibits, schedules, addenda and other attachments to this Lease are hereby incorporated into this Lease and made a part hereof. 32. TITLES AND HEADINGS. The titles and headings of sections of this Lease are intended for convenience only and shall not in any way affect the meaning or construction of any provision of this Lease. 33. NATURE OF RELATIONSHIP; USURY SAVINGS CLAUSE. The parties intend that their relationship shall be that of lessor and lessee only. Nothing contained in this Lease shall be deemed or construed to constitute an extension of credit by Landlord to Tenant, nor shall this Lease be deemed to be a partnership or venture agreement between Landlord and Tenant. Notwithstanding the foregoing, in the event any payment made to Landlord hereunder is deemed to violate any applicable laws regarding usury, the portion of any payment deemed to be usurious shall be held by Landlord to pay the future obligations of Tenant as such obligations arise and, in the event Tenant discharges and 44 performs all obligations hereunder, such funds will be reimbursed to Tenant upon the expiration of the Term. No interest shall be paid on any such funds held by Landlord. 34. ENTIRE AGREEMENT. This Lease sets forth the entire agreement of the parties hereto with respect to the Premises and cannot be changed or modified by except by another agreement in writing signed by the party sought to be charged therewith or by its duly authorized agent. 35. SURVIVAL OF REPRESENTATIONS, WARRANTIES AND COVENANTS. All of the representations, warranties and covenants of Landlord and Tenant under this Lease shall survive the expiration or earlier termination of the Term and this Lease. 36. RIGHT TO RELY ON TENANT WITHOUT JOINDER OF LANDLORD. No person, entity or governmental authority dealing with the Premises shall be required to inquire into, or obtain any other documentation as to, the authority of Tenant acting alone to take any action relating to the Premises, or to obtain the signature of Landlord on any instrument or agreement relating to, or affecting, the Premises. 37. INTERPRETATION, ETC. 37.1 Both Landlord and Tenant have been represented by counsel and this Lease has been freely and fairly negotiated. Consequently, all provisions of this Lease shall be interpreted according to their fair meaning and shall not be strictly construed against any party. 37.2 All consents or approvals to be granted or withheld under this Lease shall not be unreasonably withheld, conditioned or delayed, except to the extent that any consent or approval is expressly conditioned pursuant to the terms hereof upon the sole discretion of the "consenting" party. 45 37.3 Except as explicitly set forth in Section 8.2.8 above, it is the intention of the parties that there shall be no third-party beneficiaries of this Lease, and that no third party shall have the benefit of, or any rights under, any provision hereof. 38. FURTHER ASSURANCES. Both parties hereto shall take all actions reasonably requested by the other party to give effect to the agreement contemplated in this Lease. 46 IN WITNESS WHEREOF, the parties have caused this Lease Agreement to be executed as of the day and year first above written. TENANT: AMERICAN RETIREMENT CORPORATION, a Tennessee corporation By: -------------------------------- Title: ----------------------------- LANDLORD: FREEDOM PLAZA LIMITED PARTNERSHIP, an Arizona limited partnership By: -------------------------------- Title: ----------------------------- Acknowledgment and Consent Sun Health Properties, as lessor of Plaza del Rio under the Plaza del Rio Ground Lease hereby joins in the execution of this Lease for the purpose of consenting to the execution of this Lease, and for the purpose of agreeing that, in the event the Plaza del Rio Ground Lease expires or terminates for any reason whatsoever prior to the expiration or termination of the term (including renewal terms) of this Lease, Sun Health Properties, its successors and assigns, shall honor the terms of this Lease and shall not disturb Tenant's possession of the Plaza del Rio Leasehold Interest under the terms of this Lease, except in accordance with the terms of this Lease. SUN HEALTH PROPERTIES LEASING, an Arizona corporation By: --------------------------------- Title: ------------------------------ Acknowledgment and Consent Plaza III Limited Partnership, as lessor of Freedom Plaza under the Freedom Plaza Ground Lease joins in the execution of this Lease for the purpose of consenting to the execution of this Lease, and for the purpose of agreeing that, in the event the Freedom Plaza Ground Lease expires or terminates for any reason whatsoever prior to the expiration or termination of the term (including renewal terms) of this Lease, Plaza III Limited Partnership, its successors and assigns, shall honor the terms of this Lease and shall not disturb Tenant's possession of the Freedom Plaza Leasehold Interest under the terms of this Lease, except in accordance with the terms of this Lease. PLAZA III LIMITED PARTNERSHIP, an Arizona limited partnership By: --------------------------------- Title: ------------------------------ EXHIBIT "A-1" LEGAL DESCRIPTION OF PREMISES 1. FREEDOM PLAZA 2. PLAZA DEL RIO EXHIBIT "A-2" LANDLORD PERSONAL PROPERTY EXHIBIT "A-3" PERMITTED EXCEPTIONS EXHIBIT "B" APPRAISAL PROCESS If Landlord and Tenant are unable to agree upon the fair market value of the Premises within any relevant period provided in this Lease, each shall within ten (10) days after written demand by the other select one MAI Appraiser to participate in the determination of fair market value. For all purposes under this Lease, the fair market value of the Premises shall be based on the fair market value of the Premises unencumbered by this Lease. Within ten (10) days of such selection, the MAI Appraisers so selected by Landlord and Tenant shall select a third MAI Appraiser. The three (3) selected MAI Appraisers shall each determine the fair market value of the Premises within thirty (30) days of the selection of the third appraiser. Each of Tenant and Landlord shall pay the fees and expenses of any MAI Appraiser which such party appoints pursuant to this Exhibit plus 50% of the cost of the third appraiser. In the event either Landlord or Tenant fails to select a MAI Appraiser within the time period set forth in the foregoing paragraph, the MAI Appraiser selected by the other party shall alone determine the fair market value of the Premises in accordance with the provisions of this Exhibit and the fair market value so determined shall be binding upon Landlord and Tenant. In the event the MAI Appraisers selected by Landlord and Tenant are unable to agree upon a third MAI Appraiser within the time period set forth in the first paragraph of this Exhibit, either Landlord or Tenant shall have the right to apply at their mutual expense to the presiding judge of the court of original trial jurisdiction in the county in which the Premises is located to name the third MAI Appraiser. Within five (5) days after completion of the third MAI Appraiser's appraisal, all three MAI Appraisers shall meet and a majority of the MAI Appraisers shall attempt to determine the fair market value of the Premises. If a majority are unable to determine the fair market value at such meeting, the three appraisals shall be added together and their total divided by three. The resulting quotient shall be the fair market value of the Premises. If, however, either or both of the low appraisal or the high appraisal are more than ten percent (10%) lower or higher than the middle appraisal, any such lower or higher appraisal shall be disregarded. If only one appraisal is disregarded, the remaining two appraisals shall be added together and their total divided by two, and the resulting quotient shall be such fair market value. If both the lower appraisal and higher appraisal are disregarded as provided herein, the middle appraisal shall be such fair market value. In any event, the result of the foregoing appraisal process shall be final and binding. Landlord and Tenant will exercise their respective best efforts to expedite the appraisal process and will cooperate fully and with all deliberate speed with each other and with all appraisers in order to allow the determination of fair market value to be finally completed. Notwithstanding anything else in this Exhibit, if any appraiser appointed hereunder fails to complete his or her report within 60 days of his or her appointment, the fair market value of the Premises will be determined by reference to the other report or reports completed within such period. "MAI APPRAISER" shall mean an appraiser licensed or otherwise qualified to do business in Arizona and who has substantial experience in performing appraisals of facilities similar to the Premises and is certified as a member of the American Institute of Real Estate Appraisers or certified as a SRPA by the Society of Real Estate Appraisers, or, if such organizations no longer exist or certify appraisers, such successor organization or such other organization as is approved by Landlord. SCHEDULE 1 Minimum Rent for any month included in this Schedule 1 that precedes the Commencement Date shall be inapplicable to Tenant's obligation to pay Rent under this Lease.
MONTH MONTH RENT MONTH MONTH RENT MONTH MONTH RENT PAYMENT PAYMENT PAYMENT 1 Jan-02 217,053 44 Aug-05 210,592 23 Nov-03 223,907 2 Feb-02 210,592 217,053 45 Sep-05 3 Mar-02 24 Dec-03 223,907 210,592 217,053 46 Oct-05 4 Apr-02 25 Jan-04 223,907 210,592 217,053 47 Nov-05 5 May-02 26 Feb-04 223,907 210,592 217,053 48 Dec-05 6 Jun-02 27 Mar-04 223,907 210,592 217,053 49 Jan-06 7 Jul-02 28 Apr-04 223,907 213,775 217,053 50 Feb-06 8 Aug-02 29 May-04 223,907 213,775 217,053 51 Mar-06 9 Sep-02 30 Jun-04 223,907 213,775 217,053 52 Apr-06 10 Oct-02 31 Jul-04 223,907 213,775 220,429 53 May-06 11 Nov-02 32 Aug-04 223,907 213,775 220,429 54 Jun-06 12 Dec-02 33 Sep-04 223,907 213,775 220,429 55 Jul-06 13 Jan-03 34 Oct-04 227,489 213,775 220,429 56 Aug-06 14 Feb-03 35 Nov-04 227,489 213,775 220,429 57 Sep-06 15 Mar-03 36 Dec-04 227,489 213,775 220,429 58 Oct-06 16 Apr-03 37 Jan-05 227,489 213,775 220,429 59 Nov-06 17 May-03 38 Feb-05 227,489 213,775 220,429 60 Dec-06 18 Jun-03 39 Mar-05 227,489 213,775 220,429 61 Jan-07 19 Jul-03 40 Apr-05 227,489 217,053 220,429 62 Feb-07 20 Aug-03 41 May-05 227,489 217,053 220,429 63 Mar-07 21 Sep-03 42 Jun-05 227,489 217,053 220,429 64 Apr-07 22 Oct-03 43 Jul-05 227,489 223,907 65 May-07
MONTH MONTH RENT MONTH MONTH RENT MONTH MONTH RENT PAYMENT PAYMENT PAYMENT 227,489 70 Oct-07 231,179 66 Jun-07 231,179 75 Mar-08 227,489 71 Nov-07 231,179 67 Jul-07 231,179 76 Apr-08 231,179 72 Dec-07 231,179 68 Aug-07 231,179 231,179 73 Jan-08 69 Sep-07 231,179 231,179 74 Feb-08 77 May-08 99 Mar-10 121 Jan-12 231,179 238,894 247,078 78 Jun-08 100 Apr-10 122 Feb-12 231,179 238,894 247,078 79 Jul-08 101 May-10 123 Mar-12 234,979 238,894 247,078 80 Aug-08 102 Jun-10 124 Apr-12 234,979 238,894 247,078 81 Sep-08 103 Jul-10 125 May-12 234,979 242,925 247,078 82 Oct-08 104 Aug-10 126 Jun-12 234,979 242,925 247,078 83 Nov-08 105 Sep-10 127 Jul-12 234,979 242,925 251,355 84 Dec-08 106 Oct-10 128 Aug-12 234,979 242,925 251,355 85 Jan-09 107 Nov-10 129 Sep-12 234,979 242,925 251,355 86 Feb-09 108 Dec-10 130 Oct-12 234,979 242,925 251,355 87 Mar-09 109 Jan-11 131 Nov-12 234,979 242,925 251,355 88 Apr-09 110 Feb-11 132 Dec-12 234,979 242,925 251,355 89 May-09 111 Mar-11 133 Jan-13 234,979 242,925 251,355 90 Jun-09 112 Apr-11 134 Feb-13 234,979 242,925 251,355 91 Jul-09 113 May-11 135 Mar-13 238,894 242,925 251,355 92 Aug-09 114 Jun-11 136 Apr-13 238,894 242,925 251,355 93 Sep-09 115 Jul-11 137 May-13 238,894 247,078 251,355 94 Oct-09 116 Aug-11 138 Jun-13 238,894 247,078 251,355 95 Nov-09 117 Sep-11 139 Jul-13 238,894 247,078 255,761 96 Dec-09 118 Oct-11 140 Aug-13 238,894 247,078 255,761 97 Jan-10 119 Nov-11 141 Sep-13 238,894 247,078 255,761 98 Feb-10 120 Dec-11 142 Oct-13 238,894 247,078 255,761
143 Nov-13 171 Mar-16 199 Jul-18 255,761 264,973 279,853 144 Dec-13 172 Apr-16 200 Aug-18 255,761 264,973 279,853 145 Jan-14 173 May-16 201 Sep-18 255,761 264,973 279,853 146 Feb-14 174 Jun-16 202 Oct-18 255,761 264,973 279,853 147 Mar-14 175 Jul-16 203 Nov-18 255,761 269,787 279,853 148 Apr-14 176 Aug-16 204 Dec-18 255,761 269,787 279,853 149 May-14 177 Sep-16 205 Jan-19 255,761 269,787 279,853 150 Jun-14 178 Oct-16 206 Feb-19 255,761 269,787 279,853 151 Jul-14 179 Nov-16 207 Mar-19 260,299 269,787 279,853 152 Aug-14 180 Dec-16 208 Apr-19 260,299 269,787 279,853 153 Sep-14 181 Jan-17 209 May-19 260,299 269,787 279,853 154 Oct-14 182 Feb-17 210 Jun-19 260,299 269,787 279,853 155 Nov-14 183 Mar-17 211 Jul-19 260,299 269,787 285,113 156 Dec-14 184 Apr-17 212 Aug-19 260,299 269,787 285,113 157 Jan-15 185 May-17 213 Sep-19 260,299 269,787 285,113 158 Feb-15 186 Jun-17 214 Oct-19 260,299 269,787 285,113 159 Mar-15 187 Jul-17 215 Nov-19 260,299 274,745 285,113 160 Apr-15 188 Aug-17 216 Dec-19 260,299 274,745 285,113 161 May-15 189 Sep-17 217 Jan-20 260,299 274,745 285,113 162 Jun-15 190 Oct-17 218 Feb-20 260,299 274,745 285,113 163 Jul-15 191 Nov-17 219 Mar-20 264,973 274,745 285,113 164 Aug-15 192 Dec-17 220 Apr-20 264,973 274,745 285,113 165 Sep-15 193 Jan-18 221 May-20 264,973 274,745 285,113 166 Oct-15 194 Feb-18 222 Jun-20 264,973 274,745 285,113 167 Nov-15 195 Mar-18 223 Jul-20 264,973 274,745 290,531 168 Dec-15 196 Apr-18 224 Aug-20 264,973 274,745 290,531 169 Jan-16 197 May-18 225 Sep-20 264,973 274,745 290,531 170 Feb-16 198 Jun-18 226 Oct-20 264,973 274,745 290,531
227 Nov-20 255 Mar-23 283 Jul-25 290,531 301,861 320,161 228 Dec-20 256 Apr-23 284 Aug-25 290,531 301,861 320,161 229 Jan-21 257 May-23 285 Sep-25 290,531 301,861 320,161 230 Feb-21 258 Jun-23 286 Oct-25 290,531 301,861 320,161 231 Mar-21 259 Jul-23 287 Nov-25 290,531 307,781 320,161 232 Apr-21 260 Aug-23 288 Dec-25 290,531 307,781 320,161 233 May-21 261 Sep-23 289 Jan-26 290,531 307,781 320,161 234 Jun-21 262 Oct-23 290 Feb-26 290,531 307,781 320,161 235 Jul-21 263 Nov-23 291 Mar-26 296,112 307,781 320,161 236 Aug-21 264 Dec-23 292 Apr-26 296,112 307,781 320,161 237 Sep-21 265 Jan-24 293 May-26 296,112 307,781 320,161 238 Oct-21 266 Feb-24 294 Jun-26 296,112 307,781 320,161 239 Nov-21 267 Mar-24 295 Jul-26 296,112 307,781 326,631 240 Dec-21 268 Apr-24 296 Aug-26 296,112 307,781 326,631 241 Jan-22 269 May-24 297 Sep-26 296,112 307,781 326,631 242 Feb-22 270 Jun-24 298 Oct-26 296,112 307,781 326,631 243 Mar-22 271 Jul-24 299 Nov-26 296,112 313,880 326,631 244 Apr-22 272 Aug-24 300 Dec-26 296,112 313,880 326,631 245 May-22 273 Sep-24 301 Jan-27 296,112 313,880 326,631 246 Jun-22 274 Oct-24 302 Feb-27 296,112 313,880 326,631 247 Jul-22 275 Nov-24 303 Mar-27 301,861 313,880 326,631 248 Aug-22 276 Dec-24 304 Apr-27 301,861 313,880 326,631 249 Sep-22 277 Jan-25 305 May-27 301,861 313,880 326,631 250 Oct-22 278 Feb-25 306 Jun-27 301,861 313,880 326,631 251 Nov-22 279 Mar-25 307 Jul-27 301,861 313,880 333,295 252 Dec-22 280 Apr-25 308 Aug-27 301,861 313,880 333,295 253 Jan-23 281 May-25 309 Sep-27 301,861 313,880 333,295 254 Feb-23 282 Jun-25 310 Oct-27 301,861 313,880 333,295
311 Nov-27 339 Mar-30 367 Jul-32 333,295 347,228 369,735 312 Dec-27 340 Apr-30 368 Aug-32 333,295 347,228 369,735 313 Jan-28 341 May-30 369 Sep-32 333,295 347,228 369,735 314 Feb-28 342 Jun-30 370 Oct-32 333,295 347,228 369,735 315 Mar-28 343 Jul-30 371 Nov-32 333,295 354,510 369,735 316 Apr-28 344 Aug-30 372 Dec-32 333,295 354,510 369,735 317 May-28 345 Sep-30 373 Jan-33 333,295 354,510 369,735 318 Jun-28 346 Oct-30 374 Feb-33 333,295 354,510 369,735 319 Jul-28 347 Nov-30 375 Mar-33 340,158 354,510 369,735 320 Aug-28 348 Dec-30 376 Apr-33 340,158 354,510 369,735 321 Sep-28 349 Jan-31 377 May-33 340,158 354,510 369,735 322 Oct-28 350 Feb-31 378 Jun-33 340,158 354,510 369,735 323 Nov-28 351 Mar-31 379 Jul-33 340,158 354,510 377,692 324 Dec-28 352 Apr-31 380 Aug-33 340,158 354,510 377,692 325 Jan-29 353 May-31 381 Sep-33 340,158 354,510 377,692 326 Feb-29 354 Jun-31 382 Oct-33 340,158 354,510 377,692 327 Mar-29 355 Jul-31 383 Nov-33 340,158 362,010 377,692 328 Apr-29 356 Aug-31 384 Dec-33 340,158 362,010 377,692 329 May-29 357 Sep-31 385 Jan-34 340,158 362,010 377,692 330 Jun-29 358 Oct-31 386 Feb-34 340,158 362,010 377,692 331 Jul-29 359 Nov-31 387 Mar-34 347,228 362,010 377,692 332 Aug-29 360 Dec-31 388 Apr-34 347,228 362,010 377,692 333 Sep-29 361 Jan-32 389 May-34 347,228 362,010 377,692 334 Oct-29 362 Feb-32 390 Jun-34 347,228 362,010 377,692 335 Nov-29 363 Mar-32 391 Jul-34 347,228 362,010 385,888 336 Dec-29 364 Apr-32 392 Aug-34 347,228 362,010 385,888 337 Jan-30 365 May-32 393 Sep-34 347,228 362,010 385,888 338 Feb-30 366 Jun-32 394 Oct-34 347,228 362,010 385,888
395 Nov-34 411 Mar-36 427 Jul-37 385,888 394,330 411,980 396 Dec-34 412 Apr-36 428 Aug-37 385,888 394,330 411,980 397 Jan-35 413 May-36 429 Sep-37 385,888 394,330 411,980 398 Feb-35 414 Jun-36 430 Oct-37 385,888 394,330 411,980 399 Mar-35 415 Jul-36 431 Nov-37 385,888 403,025 411,980 400 Apr-35 416 Aug-36 432 Dec-37 385,888 403,025 411,980 401 May-35 417 Sep-36 433 Jan-38 385,888 403,025 411,980 402 Jun-35 418 Oct-36 434 Feb-38 385,888 403,025 411,980 403 Jul-35 419 Nov-36 435 Mar-38 394,330 403,025 411,980 404 Aug-35 420 Dec-36 436 Apr-38 394,330 403,025 411,980 405 Sep-35 421 Jan-37 437 May-38 394,330 403,025 411,980 406 Oct-35 422 Feb-37 438 Jun-38 394,330 403,025 411,980 407 Nov-35 423 Mar-37 394,330 403,025 408 Dec-35 424 Apr-37 394,330 403,025 409 Jan-36 425 May-37 394,330 403,025 410 Feb-36 426 Jun-37 394,330 403,025
EX-10.3 5 g77554exv10w3.txt PROMISSORY NOTE EXHIBIT 10.8 PROMISSORY NOTE $18,548,483 April 1, 2002 FOR VALUE RECEIVED, on or before June 1, 2038 (the "Maturity Date"), the undersigned, FREEDOM PLAZA LIMITED PARTNERSHIP, an Arizona limited partnership, ("Maker"), promises to pay to the order of AMERICAN RETIREMENT CORPORATION, a Tennessee corporation ("Payee"; Payee and any subsequent holder[s] hereof are hereinafter referred to collectively as "Holder"), without grace, at 111 Westwood Place, Suite 200, Brentwood, Tennessee 37027 or at such other place as Holder may designate to Maker in writing from time to time, the principal sum of EIGHTEEN MILLION FIVE HUNDRED FORTY-EIGHT THOUSAND FOUR HUNDRED EIGHTY-THREE AND NO/100 DOLLARS ($18,548,483.00), together with interest on the outstanding principal balance hereof from date at the rate of six percent (6%) per annum. Equal payments of principal and interest in the amount of $104,502 each shall be due and payable in consecutive monthly installments, with the first installment being due and payable on April 1, 2002, and subsequent installments being due and payable on the first day of each calendar month thereafter until the Maturity Date, on which date the entire unpaid principal balance plus all accrued and unpaid interest shall be immediately due and payable in full. The indebtedness evidenced hereby may be prepaid in whole or in part, at any time and from time to time, at the option of Maker, without premium or penalty. MAKER AND, BY ITS ACCEPTANCE HEREOF, PAYEE, HEREBY FURTHER COVENANT AND AGREE AS FOLLOWS: 1. This Note and the indebtedness evidenced hereby shall be in default if: (a) Maker defaults in the payment of interest or principal as stipulated above and such default shall continue for ten (10) days following notice thereof to Maker; (b) Maker or any endorser, surety or guarantor of this Note or the indebtedness evidenced hereby (a) shall generally not pay or shall be unable to pay its debts as such debts become due, or (b) shall make an assignment for the benefit of creditors or petition or apply to any tribunal for the appointment of a custodian, receiver or trustee for it or a substantial part of its assets, or (c) shall commence any proceeding under any bankruptcy, reorganization, arrangement, readjustment of debt, dissolution or liquidation law or statute of any jurisdiction, whether now or hereafter in effect, or (d) shall have had any such petition or application filed or any such proceeding commenced against it in which an order for relief is entered or an adjudication or appointment is made, or (e) shall indicate, by any act or omission, its consent to, approval of or acquiescence in any such petition, application, proceeding or order for relief or the appointment of a custodian, receiver or trustee for it or a substantial part of its assets, or (f) shall suffer any such custodianship, receivership or trusteeship to continue undischarged for a period of thirty (30) days or more; or (c) Maker shall be liquidated, dissolved, partitioned or terminated, or the certificate of authority thereof shall expire or be revoked (excluding any administrative revocation that is remedied with reasonable promptness by reinstatement). Upon the occurrence of any default as set forth above, the entire outstanding principal balance of the indebtedness evidenced hereby, together with any other sums advanced hereunder and/or under any other instrument or document now or hereafter evidencing, securing or in any way relating to the indebtedness evidenced hereby, together with all unpaid interest accrued thereon, shall, at the option of Holder and without notice to Maker, at once become due and payable and may be collected forthwith, regardless of the stipulated date of maturity. Upon the occurrence of any default as set forth above, at the option of Holder and without notice to Maker, all accrued and unpaid interest, if any, shall be added to the outstanding principal balance hereof, and the entire outstanding principal balance, as so adjusted, shall bear interest thereafter until paid at an annual rate (the "Default Rate") equal to the lesser of (1) six percentage points (6.0%) in excess of the Prime Rate as reported daily by The Wall Street Journal, as such rate varies from time to time, or (2) the maximum rate of interest from time to time allowed by applicable law to be charged in respect of the indebtedness evidenced hereby in effect from time to time (the "Maximum Rate"), regardless of whether there has been an acceleration of the payment of principal as set forth herein. All such interest shall be paid at the time of and as a condition precedent to the curing of any such default. Time is of the essence of this Note. 2. The indebtedness and other obligations of Maker evidenced hereby are absolute and unconditional and shall be paid and performed when due, without credit or offset, except as set forth in this paragraph 2. Maker and Payee are parties to a certain Lease Agreement dated as of the date hereof, relating to a continuing care retirement community in Peoria, Arizona known as Freedom Plaza (as the same may be amended, modified, restated, supplemented, extended, renewed or replaced, the "Lease"). If an Event of Default by Payee has occurred and is continuing under the Lease, Maker shall have the right to set off the amount of any Rent, Additional Rent (as such terms are defined in the Lease) or other sums due Maker under the Lease against principal and interest due and payable hereunder. Maker shall exercise the foregoing right of setoff by written notice to Payee, specifying in reasonable detail the basis therefor and the amount thereof. Furthermore, if the Lease is terminated prior to the expiration of its stated term as a direct result of an Event of Default by Payee thereunder, then this Note shall expire and terminate contemporaneously with the termination of the Lease, and Maker shall have no further obligation whatsoever to Holder hereunder. Nothing herein shall be deemed to modify, amend, alter or impair the Lease, Payee's obligations thereunder or Maker's remedies for an Event of Default under the Lease. Without limiting the foregoing, the insufficiency of any setoff hereunder or the termination hereof shall not discharge Payee from its obligations under the Lease, except to the extent of the amounts offset. 3. In the event this Note is placed in the hands of an attorney for collection or for enforcement or protection of the security, if any, or if Holder incurs any costs incident to the collection of the indebtedness evidenced hereby or the enforcement or protection of any security, Maker and any indorsers hereof agree to pay a reasonable attorney's fees, all court and other costs, and the reasonable costs of any other collection efforts. -2- 4. Presentment for payment, demand, protest and notice of demand, protest and nonpayment are hereby waived by Maker and all other parties hereto. No failure to accelerate the indebtedness evidenced hereby by reason of default hereunder, acceptance of a past-due installment or other indulgences granted from time to time, shall be construed as a novation of this Note or as a waiver of such right of acceleration or of the right of Holder thereafter to insist upon strict compliance with the terms of this Note or to prevent the exercise of such right of acceleration or any other right granted hereunder or by applicable laws. Unless otherwise specifically agreed by Holder in writing, the liability of Maker and all other persons now or hereafter liable for payment of the indebtedness evidenced hereby, or any portion thereof, shall not be affected by (1) any renewal hereof or other extension of the time for payment of the indebtedness evidenced hereby or any amount due in respect thereof, (2) the release of all or any part of any collateral, if any, now or hereafter securing the payment of the indebtedness evidenced hereby or any portion thereof, or (3) the release of or resort to any person now or hereafter liable for payment of the indebtedness evidenced hereby or any portion thereof. This Note may not be changed orally, but only by an agreement in writing signed by the party against whom enforcement of any waiver, change, modification or discharge is sought. 5. To the extent permitted by applicable law, Maker hereby waives and renounces, for itself and its successors and assigns, all rights to the benefits of any appraisement, exception and homestead now provided, or that may hereafter be provided by the Constitution and laws of the United States of America and of any state thereof in and to all of its property, real and personal, against the enforcement and collection of the obligations evidenced by this Note. 6. All agreements herein made are expressly limited so that in no event whatsoever, whether by reason of advancement of proceeds hereof, acceleration of maturity of the unpaid balance hereof or otherwise, shall the interest and loan charges agreed to be paid to Holder for the use of the money advanced or to be advanced hereunder exceed the maximum amounts collectible under applicable laws in effect from time to time. If for any reason whatsoever the interest or loan charges paid or contracted to be paid in respect of the indebtedness evidenced hereby shall exceed the maximum amounts collectible under applicable laws in effect from time to time, then, ipso facto, the obligation to pay such interest and/or loan charges shall be reduced to the maximum amounts collectible under applicable laws in effect from time to time, and any amounts collected by Holder that exceed such maximum amounts shall be applied to the reduction of the principal balance remaining unpaid hereunder and/or refunded to Maker so that at no time shall the interest or loan charges paid or payable in respect of the indebtedness evidenced hereby exceed the maximum amounts permitted from time to time by applicable law. This provision shall control every other provision in any and all other agreements and instruments now existing or hereafter arising between Maker and Holder with respect to the indebtedness evidenced hereby. 7. Any and all notices or other communications permitted or required to be made under this Note shall be in writing and shall be delivered personally or sent by facsimile transmission, mail or nationally recognized courier service (such as Federal Express) using the intended recipient's address set forth below, or such other address as may have been supplied in writing by the intended recipient and of which receipt has been acknowledged in writing. Unless otherwise expressly provided herein, notices or other communications shall be deemed to have been duly given or made (a) upon personal delivery, (b) when sent by facsimile (confirmation of receipt received), (c) on the -3- third (3rd) day after the date of mailing, or (d) on the day after the date of delivery to such courier service, as the case may be. Rejection, refusal to accept or inability to deliver because of a changed address of which no notice was given shall not affect the validity of any notice or other communication given in accordance with the provisions of this Note. For purposes of this Note: The address of the Maker is: Freedom Plaza Limited Partnership 1226 North Tamiami Trail, Suite 100 Sarasota, FL 34236 Attention: Chief Executive Officer Facsimile Number: (941) 954-0909 with a copy to: Gregory L. Patterson 1226 North Tamiami Trail, Suite 100 Sarasota, FL 34236 Facsimile Number: (941) 954-0909 The address of the Payee is: American Retirement Corporation 111 Westwood Place, Suite 200 Brentwood, Tennessee 37027 Attention: Chief Executive Officer Facsimile Number: (615) 221-2269 with a copy to: Bass, Berry & Sims PLC 2700 AmSouth Center 315 Deaderick Street Nashville, Tennessee 37238 Attention: T. Andrew Smith Facsimile Number: (615) 742-2766 8. This Note is intended as a contract under and shall be construed and enforceable in accordance with the laws of the State of Tennessee, except to the extent that federal law may be applicable to the determination of the Maximum Rate. 9. As used herein, the terms "Maker" and "Holder" shall be deemed to include their respective successors, legal representatives and assigns, whether by voluntary action of the parties or by operation of law. In the event that more than one person, firm or entity is a maker hereunder, then all references to "Maker" shall be deemed to refer equally to each of said persons, firms and/or -4- entities, all of whom shall be jointly and severally liable for all of the obligations of Maker hereunder. 10. Notwithstanding anything herein to the contrary, this Note shall not be effective, and shall have no legal force and effect, except as described in that certain Irrevocable Agreement to Enter Into Lease dated January 1, 2002, by and between Maker and Payee. [THIS SPACE LEFT BLANK INTENTIONALLY; SIGNATURE APPEARS NEXT PAGE] -5- IN WITNESS WHEREOF, the undersigned Maker has caused this Note to be executed by its duly authorized representative as of the date first above written MAKER: FREEDOM PLAZA LIMITED PARTNERSHIP, an Arizona limited partnership By: --------------------------------------- Title: ------------------------------------ -6- EX-99.1 6 g77554exv99w1.txt CERTIFICATION Exhibit 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of American Retirement Corporation (the "Company") on Form 10-Q for the period ending June 30, 2002 as filed with the Securities and Exchange Commission on August 14, 2002 (the "Report"), I, W.E. Sheriff, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ W.E. Sheriff - -------------------------------------- W.E. Sheriff Chairman and Chief Executive Officer August 14, 2002 EX-99.2 7 g77554exv99w2.txt CERTIFICATION Exhibit 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of American Retirement Corporation (the "Company") on Form 10-Q for the period ending June 30, 2002 as filed with the Securities and Exchange Commission on August 14, 2002 (the "Report"), I, George T. Hicks, Executive Vice President - Finance, Chief Financial Officer, Secretary and Treasurer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ George T. Hicks - ------------------------------------------------ George T. Hicks Executive Vice President - Finance, Chief Financial Officer, Secretary and Treasurer August 14, 2002 -----END PRIVACY-ENHANCED MESSAGE-----