-----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, BH1k1MY631ZzbtJaz3j7HJRTmVuMbGclO3DW0ktmr9Wh6ON2/JEFKfADBNkJwihp tBANPxgPJKBpib/d5GJuvA== 0000892569-98-000705.txt : 19980317 0000892569-98-000705.hdr.sgml : 19980317 ACCESSION NUMBER: 0000892569-98-000705 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980313 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: SUNSTONE HOTEL INVESTORS INC CENTRAL INDEX KEY: 0000930600 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 521891908 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-26304 FILM NUMBER: 98565691 BUSINESS ADDRESS: STREET 1: 115 CALLE DE INDUSTRIAS SUITE 201 CITY: SAN CLEMENTE STATE: CA ZIP: 92672 BUSINESS PHONE: 7143613900 MAIL ADDRESS: STREET 1: 115 CALLE DE INDUSTRIAS STREET 2: SUITE 201 CITY: SAN CLEMENTE STATE: CA ZIP: 92672 10-K 1 FORM 10-K 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ------------------- (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended DECEMBER 31, 1997 OR [ ] 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 0-26304 SUNSTONE HOTEL INVESTORS, INC. (Exact name of registrant as specified in its charter) -------------------- Maryland 52-1891908 (State or Other Jurisdiction (I.R.S. Employer of Incorporation or Organization) Identification No.) 115 Calle de Industrias, Suite 201, San Clemente, CA 92672 (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, Including Area Code: (714) 361-3900 - -------------------------------------------------------------------------------- Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, Par Value $.01 (Title of Class) 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 --- --- Indicated by a check mark if disclosure of delinquent fliers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Based on the closing sale price on New York Stock Exchange on February 27, 1998, the aggregate market value of the voting stock held by non-affiliates of the registrant was $566,643,000. As of February 27, 1998, there were 37,503,851 shares of Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Part III of this Report incorporates information by reference from the definitive Proxy Statement for the Annual Meeting of Stockholders, to be held April 17, 1998. ================================================================================ 2 SUNSTONE HOTEL INVESTORS, INC. ANNUAL REPORT ON FORM 10-K DECEMBER 31, 1997 TABLE OF CONTENTS PART I
Page ---- ITEMS 1 & 2. BUSINESS AND PROPERTIES........................................1 ITEM 3. LEGAL MATTERS.................................................29 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...........29 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS...........................................30 ITEM 6. SELECTED FINANCIAL DATA.......................................31 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS...........................33 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...................40 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE...........................40 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY...............41 ITEM 11. EXECUTIVE COMPENSATION........................................41 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT....................................................41 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................41 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K......................................................42
-i- 3 PART I Forward-Looking Statements When used throughout this Annual Report, the words "believes", "anticipates" and "expects" and similar expressions are intended to identify forward-looking statements. Such statements are subject to the many risks and uncertainties which affect the Company's business, and actual results could differ materially from those projected and forecasted. These uncertainties, which include competition within the lodging industry, the balance between supply and demand for hotel rooms, the Company's continued ability to execute acquisitions and renovations, the effect of economic conditions, and the availability of capital to finance planned growth, are described but are not limited to those disclosed in this Annual Report. These and other factors which could cause actual results to differ materially from those in the forward-looking statements are discussed under the heading "Risk Factors". Given these uncertainties, readers are cautioned not to place undue reliance on such statements. The Company also undertakes no obligation to publicly release the result of any revisions to these forward-looking statements that may be made to reflect any future events or circumstances. ITEMS 1 AND 2. BUSINESS AND PROPERTIES GENERAL Sunstone Hotel Investors, Inc. (the "Company") is a self-administered, equity real estate investment trust ("REIT") that owns and leases luxury, upscale and mid-price hotels located primarily in the Pacific and Mountain regions of the western United States. The hotels operate primarily under national franchises that are among the most respected and widely recognized in the lodging industry, including brands affiliated with Hilton Hotels Corporation, Holiday Hospitality Corporation, Marriott International, Inc. and Promus Hotel Corporation. As of February 27, 1998, the Company's portfolio consisted of 57 hotels with a total of 10,355 rooms, 46 of which were acquired and one of which was developed subsequent to the Company's initial public offering (the "IPO") in August 1995. The majority of the Company's hotel portfolio consists of luxury, upscale and mid-price full-service hotels and upscale extended-stay properties (approximately 75.4%) with the remainder of the Company's portfolio consisting of mid-price limited service properties primarily located in markets where significant barriers exist for new competitive supply. The Company's growth strategy is to maximize shareholder value by (i) acquiring underperforming and undercapitalized hotels that are in strong market locations with significant barriers to entry and (ii) improving such hotels' financial performance by renovating, redeveloping, rebranding and repositioning the hotels and through the implementation of focused sales and marketing programs. The Company's business strategy emphasizes a commitment to have market share increased at each of its hotels. This increase in market share is achieved through an expansion of a strong base of direct sales and marketing with an emphasis on repeat customers. Each hotel's customer base is increased by providing a high level of guest satisfaction, high-quality hotels and quality food and beverage services through its program of subleasing its food and beverage operations to national and regional restaurant chains. The Company's business strategy encompasses increasing revenue per available room ("REVPAR") by increasing average daily rate ("ADR") and occupancy. This strategy is typically implemented by replacing certain discontinued group business with higher-rate group and transient business and by selectively increasing room rates. Success with this strategy has been achieved primarily because of (i) the relatively high occupancy rates at certain of its hotels, (ii) the success of a superior marketing strategy implemented at each acquired hotel, and (iii) the effects of repositioning recently acquired hotels as high-quality properties with strong national franchises through the Company's redevelopment and rebranding program. -1- 4 While national in scope, success in the hospitality industry is measured among competition in local markets and is a street-corner-by-street-corner business. Management believes that its hotels are distinguished in their competing local hotel markets through the providing of high levels of guest service, with high-quality hotels combined with superior marketing practices. Based on data provided by Smith Travel Research, the Company believes that its portfolio of renovated and rebranded hotels consistently outperforms the industry's average year-over-year growth in revenues by a significant margin and has averaged 8.7% annual growth in REVPAR since 1991 for hotels owned under common management compared to 5.7% average REVPAR growth for the lodging industry as a whole. OVERVIEW OF THE LODGING INDUSTRY The fundamentals of the lodging industry in the United States have improved significantly in each year since 1990. The industry as a whole generated record earnings in 1997, with industry-wide pre-tax profits of approximately $14.3 billion. This amount represented an increase of 14.4% from $12.5 billion in pre-tax profits in 1996, and represented the industry's fifth consecutive year of profitability. Coopers & Lybrand L.L.P. projects that industry profits will reach $18.6 billion per year in 1999. The REIT organizational structure has become increasingly important within the lodging industry. The total asset value of the lodging industry that is controlled by equity REITs has grown from $872.9 million in 1994 to over $21.1 billion as of February 1998 as measured by the aggregate book value of total assets, according to the National Association of Real Estate Investment Trusts. Demand and Supply. The industry's profitability has been fueled by five consecutive years in which the growth in demand for hotel rooms has exceeded the growth in room supply. Based on data from Smith Travel Research, industry-wide growth in total room demand exceeded the growth in total room supply by 2.7%, 3.0%, 3.3%, 1.4% and 0.8% in 1992, 1993, 1994, 1995 and 1996, respectively. This trend of demand exceeding supply continued in the Pacific Region (California, Oregon and Washington) in 1997, with total room demand exceeding total room supply by 0.6%, even though room supply exceeded room demand by 0.9% for the country as a whole during the same period. REVPAR. This favorable relationship between demand growth and supply growth has enabled the industry to increase REVPAR for the years 1991 through 1996. Based on data from Smith Travel Research, REVPAR for the industry as a whole grew 3.9%, 4.8%, 7.5%, 5.2% and 7.7% in 1992, 1993, 1994, 1995 and 1996, respectively. For 1997, even though industry-wide growth in total room supply exceeded growth in room demand, REVPAR increased 5.3%. REVPAR for hotels in the Pacific Region, where approximately 40.9% of the Company's hotel rooms are located, grew by 8.2% during 1997, as compared to 5.3% for the industry as a whole. According to Coopers & Lybrand's Hospitality Directions, REVPAR for the industry is expected to increase by 3.9%, 3.5% and 3.7% in 1998, 1999 and 2000, respectively. Luxury, Upscale and Mid-Price Segments The lodging industry as a whole, and the luxury, upscale and mid-price segments in particular, have benefited from a favorable supply and demand imbalance in the United States. The Company believes supply growth will continue to be limited - particularly in the markets that the Company focuses its acquisitions - in the luxury and upscale segment due to (i) the continued availability of hotel acquisition opportunities in most markets in which the Company acquires hotels at prices below replacement cost, (ii) the high relative cost of construction for hotels in this segment, and (iii) the long construction lead times in this segment. -2- 5 The following tables show historical and projected information with respect to the changes in the demand and the supply of hotel rooms in the United States, as well as the changes in REVPAR (1):
1995 1996 1997 1998 (P) 1999 (P) ------------------------------------------------------------------- LUXURY: Demand 1.6% 4.2% 3.2% 2.5% 2.7% Supply 2.0 2.7 3.2 3.3 2.8 REVPAR 5.4 8.6 5.9 5.5 4.7 UPSCALE: Demand 1.8% 3.2% 3.7% 2.8% 2.8% Supply 3.0 4.2 4.0 4.6 4.4 REVPAR 4.2 4.5 4.8 3.1 2.7 MID-PRICE: Demand 3.1% 2.5% 3.3% 2.9% 2.7% Supply 1.9 3.9 4.4 4.5 3.9 REVPAR 5.9 5.7 4.6 3.1 3.0
- ---------- (1) Source: Coopers & Lybrand L.L.P., February 1998 U.S. Lodging Forecast. Management believes that demand increases at the Company's hotels have resulted primarily from an improved economic environment in the Company's markets and a corresponding increase in business travel, as well as favorable demographic factors. However, in spite of increased demand for rooms, the room supply growth rate has generally not kept pace with the growth in demand in some of the markets in which the Company owns hotels. This supply and demand imbalance currently exists in the Pacific Region where the Company currently emphasizes its acquisition focus. Management believes that this lag in the supply growth rate is attributable to many factors including the limited availability of attractive building sites for hotels in the markets in which the Company operates, more stringent requirements for obtaining financing for new hotel construction and the availability of existing properties for sale at a discount to their replacement cost. The Company expects this supply and demand imbalance in the Pacific Region, to continue, which should result in improved REVPAR for its hotels, and consequently, lease revenue to the Company in the near term. ORGANIZATION, INITIAL PUBLIC OFFERING AND GENERAL DEVELOPMENT OF BUSINESS The Company is a Maryland corporation which was formed on September 21, 1994. The Company completed its IPO on August 16,1995. The Company contributed all of the net proceeds of the IPO to Sunstone Hotel Investors, L.P. (the "Partnership") in exchange for approximately 82.5% aggregate equity interest in the Partnership. The Company conducts all its business through and is the sole general partner of the Partnership. As of February 27, 1998, the Company has a 94.8% aggregate equity interest in the Partnership. Since its IPO in August 1995 through February 27, 1998, the Company has: o acquired or invested in 46 hotels for an aggregate purchase price of $649.6 million, increasing the number of states in which the Company owns properties from five to 12; o increased the number of rooms in its hotel portfolio by over six times through acquisition, investment and development, from 1,328 rooms to 10,355; o completed $58.4 million in renovation and redevelopment to 27 hotels through December 31, 1997, and is currently, or will shortly begin, renovating and redeveloping another 26 hotels for an additional estimated aggregate cost of $62.2 million; -3- 6 o completed the development of one hotel for $7.6 million, and is currently, or will shortly begin, developing another five hotels for an additional estimated aggregate cost of $55.4 million; o increased funds from operations from $8.1 million on a pro forma basis after giving effect to the IPO in 1995 to $32.2 million on an historical basis in 1997, a compound annual increase of 75.9%, and increased FFO per share on the same basis from $1.05 in 1995 to $1.34 in 1997, a compound annual increase of 10.8%. FFO and diluted FFO per share for all periods presented herein have been calculated in accordance with the newly adopted Financial Accounting Standards Board Statement No. 128 directive to all public companies regarding the calculation of weighted average shares outstanding. The additional disclosure includes the potentially dilutive securities such as options, convertible preferred stock and operating Partnership units convertible into Common Stock; o increased REVPAR for all hotels during periods of non-renovation during 1997 by approximately 18.0% over the comparable period in 1996. According to Smith Travel Research, the lodging industry as a whole reported a 5.3% REVPAR increase during the year ended December 31, 1997; o increased the annualized quarterly dividend on its Common Stock twice, for an aggregate increase of approximately 20.0%, from an initial annualized quarterly dividend of $0.92 per share to the current annualized quarterly dividend of $1.10 per share; o entered into an alliance with Westbrook Partners L.L.C. ("Westbrook Partners") which includes representation on the Company's Board of Directors (the "Board") and an approximate 10.6% ownership interest in the Company; o raised approximately $407.8 million of equity capital through the sale of common stock in six follow-on offerings; and o increased availability under the Company's unsecured bank credit facility on four occasions, from $30.0 million to $300.0 million, and reduced its borrowing cost from an initial rate of LIBOR plus 2.75% per annum to as low as LIBOR plus 1.40% per annum, based upon the leverage of the Company. In order for the Company to qualify as a REIT under Federal income tax law, neither the Company nor the Partnership can operate hotels. Therefore, the Partnership leases its hotels to Sunstone Hotel Properties, Inc., a Colorado corporation (the "Lessee"), pursuant to percentage leases (the "Percentage Leases") with initial terms of ten years, which provide for rent payments based principally on a percentage of room revenues of the hotels. The Lessee is owned by Robert A. Alter, Chairman and President of the Company, and Charles L. Biederman, Vice Chairman and Executive Vice President of the Company. Certain management functions for the hotels including all finance and accounting responsibilities are provided by Sunstone Hotel Management, Inc., a Colorado corporation (the "Management Company"), pursuant to a management agreement between the Lessee and the Management Company for a fee equal to 1% to 2% of gross revenues of the hotels plus reimbursement of accounting costs. The Management Company is wholly-owned by Mr. Alter. The Kahler Acquisition On October 15, 1997, the Company completed the acquisition of all the outstanding capital stock of Kahler Realty Corporation ("Kahler") from Westbrook Real Estate Fund I, L.P. and Westbrook Real Estate Co-Investment Partnership I, L.P. (collectively, "Westbrook") for an aggregate purchase price of approximately $372.3 million. The acquisition was a significant milestone for the Company. The purchase price of this acquisition (the "Kahler Acquisition") was funded with the net proceeds from the Company's public offering in October 1997, the assumption of Kahler debt, the issuance of common and preferred stock to Westbrook and with borrowings from its then $200.0 million unsecured revolving line of credit. Concurrent with the closing of the Kahler Acquisition, the Company acquired the third-party ownership interests in three Kahler Hotels (as defined below) that were previously partially owned by Kahler: the 220-room University Park Hotel in Salt Lake City, Utah (76% third-party -4- 7 ownership interest), and the 114-room Residence Inn and 333-room Provo Park Hotel in Provo, Utah (50% third-party ownership interest). The Kahler portfolio purchased by the Company consisted of 17 hotels with 4,255 rooms (the "Kahler Hotels"), principally in two markets, the Mountain region states of Utah, Idaho, Montana and Arizona (11 hotels) and Rochester, Minnesota (four hotels). The largest number of rooms owned by Kahler were concentrated in Rochester, Minnesota, with four hotels and 1,329 rooms, three of which are connected by an underground walkway to the internationally renowned Mayo Clinic, and in the Salt Lake City area of Utah, with six hotels and 1,509 rooms. Nine of the hotels are operated independently, while the balance are currently operated under Sheraton(R), Hilton(R), Holiday Inn(R), Residence Inn(R) and other national franchises. The Company has commenced an extensive renovation program and intends to brand or rebrand a number of the hotels, both of which the Company expects will increase its return on investment by increasing the revenues of the hotels. The Kahler Acquisition is consistent with the Company's growth strategy of acquiring hotels with upside potential within the western United States. The Company believes that the Kahler acquisition is attractive because the Kahler Hotel portfolio (i) contains primarily underperforming full service hotels with significant opportunities for renovation, redevelopment, rebranding and repositioning, (ii) includes the largest number of rooms under common management in Rochester, Minnesota, and a significant concentration of hotel rooms in the Salt Lake City area of Utah, which the Company believes will enable it to be a leader in pricing and to achieve economies of scale in its operations, (iii) includes the Rochester, Minnesota hotels that service the Mayo Clinic, which recently announced an 850,000 square foot expansion, (iv) creates an alliance with Westbrook partners through its equity ownership and Board representation in the Company, which the Company believes will result in additional hotel acquisition opportunities and (v) was being purchased at a significant discount to replacement cost. Recent Acquisitions and Investments On December 30, 1997, the Company invested in a 126-suite Residence Inn by Marriott in Sacramento, California and a 144-suite Residence Inn by Marriott in San Diego, California from Ssang Young International, Inc. for approximately $13.5 million and $17.0 million, respectively. The Residence Inn by Marriott in Sacramento consists of six two-story buildings containing 20 guest rooms each. The hotel is located just north of downtown Sacramento, within five miles of the State Capitol, Old Sacramento and the Arco Arena. Hotel features include an exercise room, a meeting area, valet service, an outdoor swimming pool and spa and a SportCourt. Occupancy and ADR for the nine months ended September 30, 1997 were 91.6% and $94.64, respectively. The Residence Inn by Marriott in San Diego consists of 18 two-story buildings, a hearthroom, two meeting rooms, a pool and two spas, a barbecue area and a SportCourt. The hotel is centrally located to the Computer Science Corporation and Miramar Marine Corps Air Station. Occupancy and ADR for the nine months ended September 1997 were 92.1% and $96.35, respectively. On January 23, 1998, the Company purchased the Vacation Inn in San Diego, California located at the corner of Old Town and San Diego Avenues in the Old Town area of San Diego, approximately one and one-half blocks from the Company's Ramada Plaza Hotel for approximately $11.5 million. The Vacation Inn was constructed in 1987 and consists of three three-story buildings containing 124 guest rooms, including five suites. The hotel has an outdoor pool, approximately 1,250 square feet of meeting space in two meeting rooms and a lobby area suitable for serving a continental style breakfast. Throughout its existence, the hotel has had no franchise or reservation system affiliation. On January 27, 1998, the Company purchased the Residence Inn and the Fairfield Inn, developed on a single site in Santa Clarita, California located near the Six Flags Magic Mountain Amusement Park for approximately $16.5 million. The 90-unit Residence Inn consists of a single three-story building with several meeting rooms and an outdoor swimming pool. The 66-room Fairfield Inn consists of a single three-story building. Between the two hotels is a stand-alone meeting/conference building of approximately 1,500 square feet. The -5- 8 Residence Inn occupancy and ADR for the year ended January 2, 1998 were 74.7% and $98.59, respectively. The Fairfield Inn occupancy and ADR since opening in September 1997 through January 2, 1998 were 77.1% and $69.57, respectively. On February 19, 1998, the Company purchased the 221-room Hilton Inn at the Civic Plaza Conference Center in Carson, California from KPOD, Ltd., PBA Partners, and DRAD Associates for $12.5 million. Strategically located off Interstate 405, the Hilton Inn is adjacent to the Carson Conference Center and a business center. The hotel is approximately ten years old and consists of a eight-story, interior corridor complex which features eight different meeting and banquet rooms, a cocktail lounge and restaurant and an outdoor heated pool and jacuzzi. Increase in Line of Credit On January 26, 1998, the Company increased its unsecured revolving line of credit facility (the "Credit Facility") from $200.0 to $300.0 million and further reduced its borrowing rate to accrue interest at as low as LIBOR plus 1.40% per annum based upon the leverage of the Company (from LIBOR plus 2.75% at the time of the IPO), with provisions for reduced rates upon receipt by the Company of an investment grade rating. 1998 Common Stock Offering On February 11, 1998, the Company completed a follow-on offering for 4,500,000 shares of its common stock. The offering price of the shares sold was $16.375 per share, resulting in net proceeds of approximately $69.9 million. The Company used the net proceeds of the offering to finance the acquisition of additional hotels and to repay outstanding indebtedness under the Credit Facility. GROWTH STRATEGY The Company's principal growth strategy is to maximize shareholder value by increasing cash available for distribution on its Common Stock ("Cash Available for Distribution") per share by: o acquiring or investing in underperforming and undercapitalized luxury, upscale and mid-price hotels located principally in the western United States that are, or can be renovated, redeveloped and repositioned by branding or rebranding with nationally recognized franchises, with an increasing emphasis on multiple-property acquisitions; o enhancing the operating performance of hotels owned by the Company through such renovation, redevelopment, rebranding and repositioning, and through the implementation of focused management and marketing programs; and o selectively developing new luxury, upscale and mid-price hotels in markets where room demand and other competitive factors justify new construction. The Company believes that its recently completed and planned future renovation, redevelopment, rebranding and repositioning activities, as well as improvements in management and marketing, will continue to fuel REVPAR growth at its hotels, thereby increasing percentage lease revenue to the Company. In addition, the Company believes that there will continue to be substantial acquisition, renovation, redevelopment, rebranding and repositioning opportunities in the luxury, upscale and mid-price hotel markets in the western United States. The Company believes these opportunities will result from the aging of a significant portion of the nation's hotel supply and the imposition of capital improvement requirements by certain national hotel franchisors on the owners of franchised hotels, many of which are small independent hotel companies or private hotel owners that may be unwilling or unable to satisfy such requirements. -6- 9 EXTERNAL GROWTH STRATEGY The Company's external growth strategy is to (i) acquire underperforming luxury, upscale and mid-price hotels located principally in the western United States that are, or can be renovated or redeveloped and repositioned by branding or rebranding the hotels with nationally recognized franchises, with an increasing emphasis on multiple-property acquisitions and (ii) selectively develop new luxury, upscale and mid-price hotels in markets where room demand and other competitive factors justify new construction. Acquisitions. The Company intends to acquire hotels located principally in the western United States which meet one or more of the following criteria: (i) underperforming hotels which have the potential for improved performance through the implementation of quality management and marketing programs, and/or association with a national franchisor; (ii) hotels in a deteriorated physical condition that would benefit significantly from renovation or redevelopment; (iii) hotels in attractive locations that would benefit significantly by changing franchises ("upbranding") to a nationally recognized franchise brand that have a greater potential to produce significant REVPAR growth such as Marriott, Courtyard by Marriott, Doubletree Hotel, Hilton, Holiday Inn Select, Holiday Inn Hotel & Suites and Residence Inn by Marriott; (iv) hotels owned by franchisees who are unable or unwilling to meet capital improvement requirements of the franchisor; (v) hotels in markets with favorable room supply and demand fundamentals; and (vi) hotels in markets where there are significant barriers to entry, such as limited opportunities to change existing franchises at competitive hotels, scarcity of suitable hotel sites or zoning restrictions. Multiple Property Acquisitions. The Company believes it will continue to have access to capital for multiple-property acquisitions and has increased availability under its Credit Facility from $30.0 million at the time of the Company's IPO to $300.0 million. Additionally, the Company has successfully accessed the public equity markets on six different occasions and raised over $407.8 million. Furthermore, rather than paying cash, the Company also has the flexibility of issuing its common stock, preferred stock or units in the Partnership ("Units") to acquire hotels, which under certain circumstances allows the sellers to defer tax liability which would otherwise arise upon a sale for cash. In addition to its financial resources, the Lessee's experience in successfully operating hotels has given it significant knowledge of a variety of markets and the ability to quickly identify strategic acquisition opportunities. The Company believes that its increasing profile in the hotel industry and its record of closing acquisitions will enable it to continue to attract sellers of hotel portfolios. Acquisitions and Investments. The following table sets forth certain information related to the Company's hotel acquisition and investment activity since January 1, 1996:
ACQUISITION/ ACQUISITION/ INVESTMENT INVESTMENT NUMBER OF COST DATE BRAND(1) LOCATION ROOMS (IN MILLIONS) ---- --------- -------- -------------- -------------- 1996 February Holiday Inn Hotel & Suites Kent (Seattle), Washington 125 $ 4.6 February Hampton Inn Clackamas (Portland), Oregon 114 2.5 February Holiday Inn Express Portland, Oregon 84 2.1 February Holiday Inn Express Poulsbo, Washington 63 2.4 March Courtyard by Marriott Riverside, California 163 4.0 June Holiday Inn Select Renton (Seattle), Washington 226 8.2 August Holiday Suites Price, Utah 151 4.5 August Comfort Suites South San Francisco, California 166 11.2 October Holiday Inn Flagstaff, Arizona 157 7.6 October Holiday Inn Hotel & Suites Mesa, Arizona 246 13.5 October Hampton Inn Tucson, Arizona 126 6.7 December Residence Inn Oxnard, California 251 15.7 -------------- -------------- 1,872 83.0 -------------- --------------
-7- 10
ACQUISITION/ ACQUISITION/ INVESTMENT INVESTMENT NUMBER OF COST DATE BRAND(1) LOCATION ROOMS (IN MILLIONS) ---- --------- -------- -------------- -------------- 1997 January Holiday Inn San Diego, California 218 9.0 January Courtyard by Marriott Cypress, California 180 12.0 March Hawthorn Suites Kent, Washington 152 13.6 March Holiday Inn Select La Mirada, California 289 18.0 May Hawthorn Suites(2) Sacramento, California 301 16.8 June Holiday Inn Hotel & Suites(3) San Diego, California 151 11.8 July Best Western Lynnwood, Washington 103 7.4 August Holiday Inn Mission Valley San Diego, California 174 9.1 August Hawthorn Suites(2) Anaheim, California 130 8.7 August Regency Plaza Los Angeles, California 178 12.6 October Kahler Hotels(4) Midwest and Mountain Regions of the United States 4,255 372.3 December Residence Inn Sacramento, California 126 13.5 December Residence Inn San Diego, California 144 17.0 -------------- -------------- 6,401 521.8 -------------- -------------- 1998 January Ramada San Diego, California 124 11.5 January Residence Inn Santa Clarita, California 90 8.5 January Fairfield Inn Santa Clarita, California 66 8.0 February Hilton Inn Carson, California 221 12.5 -------------- -------------- 501 40.5 -------------- -------------- Total 8,774 $645.3 ============== ==============
- ---------- (1) In cases where the Company has obtained approval of a new franchise license, subject to completion of renovations or improvements, the franchise brand indicated in this column represents the approved new franchise brand. Many of the hotels were operated under different brands at the time of their acquisition or are currently operating under brands that the Company intends to change. (2) The Company has received a franchise license to rebrand these hotels as Hawthorn Suites. The Sacramento hotel will be reconfigured to create 32 two-room suites, which will reduce the room count to 269. The new franchise licenses are subject to completion of certain renovations and improvements. The Anaheim and the Sacramento hotels are currently operated independently. (3) The Company has received or applied for franchise licenses to change these hotels to various Holiday Inn brands, subject to completion of certain renovations and improvements. The San Diego hotel has been a Holiday Inn, but will become a Holiday Inn & Suites. (4) Of the 17 Kahler Hotels, nine are independent, three are subject to Best Western franchise licenses, one is subject to a Hilton franchise license, one is subject to a Holiday Inn franchise license, one is subject to a Quality Inn franchise license, one is subject to a Residence Inn by Marriott franchise license and one is subject to a Sheraton franchise license. The Company anticipates reflagging certain of these hotels. Selective Development of Additional Hotels. The Company may also selectively develop new luxury, upscale and mid-price hotels which will operate under national franchises in markets where room demand and other competitive factors justify new construction. The Company may develop hotels itself or may contract with unaffiliated developers who will build hotels and then sell them to the Company upon completion on pre-agreed terms. Such arrangements with developers will enable the Company to minimize risks associated with development. -8- 11 The following table shows the Company's completed, in process and planned development:
Completed/ Expected Number of Completion Hotel Location Rooms Date - ----------------------------------------- ----------------------------------------- -------------- -------------- Residence Inn by Marriott Highlands Ranch, CO 78 1996 Residence Inn (Room Addition) Highlands Ranch, CO 39 1997 Marriott Pueblo, CO 164 1998 Hawthorn Suites Denver, CO 93 1998 Residence Inn by Marriott San Diego, CA 120 1999 Courtyard by Marriott Lynnwood, WA 141 1998 Hilton Garden Inn Sacramento, CA 153 1999
INTERNAL GROWTH STRATEGY The Company's internal growth strategy is to enhance the operating performance of hotels owned and acquired by the Company by (i) selectively renovating and redeveloping the hotels, and when advantageous rebranding them under national franchises, (ii) improving the marketing and management of the hotels, (iii) leasing restaurants in the hotels to national or regional restaurant companies, and (iv) selectively expanding the number of rooms at certain hotels where market conditions justify such expansion. The Company intends to apply its internal growth strategy to enhance the operating performance of its recently acquired hotels. Redevelopment and Renovation In conjunction with the Company's strategy of acquiring hotels that can benefit from extensive improvements, branding and repositioning, the Company's principal internal growth strategy is to redevelop or extensively renovate such hotels and brand them with a national franchise that the Company believes will generate higher REVPAR than that currently being generated. In addition to the redevelopment strategy, the Company periodically renovates its hotels, not only to satisfy requirements of the franchise agreements, but also to maintain or increase its market share. The Company believes that after taking into account the purchase price of each hotel in its portfolio and the cost of renovating or redeveloping it, the overall expenditure for each hotel is below its replacement cost. The Company has and intends, to the extent practicable, to continue to keep hotels operational while conducting renovation and redevelopment work by performing such work during off-peak periods and in a manner least disruptive to hotel operations. As with its acquisition pace, the Company has significantly increased the amount of renovation and redevelopment activity. During 1996, the Company expended $9.6 million redeveloping and renovating eight hotels. During 1997, the Company expended $48.8 million redeveloping and renovating 19 hotels. During 1998, the Company estimates it will expend $29.7 million redeveloping and renovating 20 of its recently acquired hotels. Scope of Renovation and Redevelopment. For those hotels whose franchise affiliation will not be changed, the Company typically makes renovations following acquisition in order to not only satisfy the existing franchisor's capital improvement plan, but more importantly to ensure a high level of guest satisfaction and consequently, increase market share and revenue. The Company also performs periodic routine maintenance to all of its hotels in order to keep them competitive. -9- 12 Renovations typically consist of many of the following activities:
GUEST ROOMS PUBLIC AREAS EXTERIOR ----------- ------------ --------- o selectively replacing o replacing drapes and valances o repainting bedspreads, linens, drapes and o refinishing and selectively o seal coating parking lot valances o replacing furniture o adding light o refinishing and selectively o replacing wallpaper and vinyl replacing furniture and adding wallcovering televisions, telephones with data o repainting ports and voicemail, clock o recarpeting radios, coffeemakers, irons and ironing boards o replacing wallpaper and vinyl wallcovering o repainting o recarpeting
Redevelopments are expanded in scope and typically include many of the following activities:
GUEST ROOMS PUBLIC AREAS EXTERIOR ----------- ------------ -------- o replacing all bedspreads, o replacing drapes and valances o repainting linens, drapes and valances o replacing wallpaper and vinyl o installing new window treatments o replacing all furniture wallcovering and grill work o adding televisions, telephones o repainting o modifying the facade with data ports and voicemail, o recarpeting o constructing port-cochere clock radios, coffeemakers, irons o redecorating o repaving or seal coating parking and ironing boards o replacing furniture lot o replacing wallpaper and vinyl o rebuilding reception area o adding lighting wallcovering o redesigning lobby for improved o re-roofing o repainting traffic flow o recarpeting o remodeling restaurant to o remodeling guestrooms, including standards of regional or national changing room layout and restaurant operator modifying closets o installing fire safety o remodeling guest bathrooms with equipment, including sprinklers new countertops, tile floors, and smoke detectors plumbing fixtures, lights and valances o installing fire safety equipment, including sprinklers and smoke detectors
-10- 13 -11- The following table sets forth certain information with respect to the Company's completed, pending and planned renovation and redevelopment activities and completed and pending changes in franchise affiliations. The table includes renovation and redevelopment work on certain hotels completed by affiliates of the Company prior to the transfer of the initial hotels to the Company in connection with the Initial Public Offering. The table does not include work completed by any other prior owners of the hotels. COMPLETED, PENDING AND PLANNED RENOVATION AND REDEVELOPMENT(1)
PUBLIC AREAS ------------------------------ ADD/ REPLACE/ UPGRADE EXPECTED TO REFURBISH MEETING COMPLETED BE COMPLETED EXTERIOR RESTAURANT LOBBY SPACE ---------------- ----------------- ------------ ---------- ------ --------- MARRIOTT Ogden, Utah(3)..................... September 1998 X X Park City, Utah(3)................. May 1998 X X X Provo, Utah........................ June 1998 X X Rochester, Minnesota............... June 1998 X X Salt Lake City, Utah..............` April 1998 COURTYARD BY MARRIOTT: Cypress, California................ June 1997 X X X X Fresno, California................. February 1994 X X X X Riverside, California.............. June 1994 X X X X RESIDENCE INN BY MARRIOTT: Highlands Ranch, Colorado.......... September 1996 NEWLY CONSTRUCTED Oxnard, California................. May 1997 X X X X Provo, Utah........................ NEWLY CONSTRUCTED HILTON Salt Lake City, Utah............... February 1998 X X X X DOUBLETREE HOTEL: Santa Fe, New Mexico............... April 1996 X X X X SHERATON Chandler, Arizona.................. June 1998 X X HOLIDAY INN SELECT: La Mirada, California.............. March 1998 X X X X Renton (Seattle), Washington....... July 1997 X X X X HOLIDAY INN HOTEL & SUITES: Craig, Colorado.................... April 1997 X Kent (Seattle), Washington......... October 1996 X X X Mesa, Arizona...................... November 1997 X X X X Price, Utah........................ June 1997 X X X X San Diego (Old Town), California... January 1998 X X X X HOLIDAY INN: Flagstaff, Arizona................. July 1997 X Provo, Utah........................ June 1994/ X X X June 1997 X Rochester, Minnesota............... June 1998 X X San Diego (Harbor), California..... July 1997 X X X San Diego (Mission Valley), California......................... January 1998 X X X X Steamboat Springs, Colorado........ June 1996 X X X HOLIDAY INN EXPRESS: Portland, Oregon................... October 1996 X X X Poulsbo, Washington................ September 1996 X X
GUEST ROOMS --------------------------- PRIOR SOFT GUEST FRANCHISE GOODS FURNITURE BATH AFFILIATION --------- ----------- ----- --------------------------- MARRIOTT Ogden, Utah(3)..................... X X X Best Western Park City, Utah(3)................. X X X Independent Provo, Utah........................ X X X Independent Rochester, Minnesota............... X X X Kahler Salt Lake City, Utah..............` X X X Independent COURTYARD BY MARRIOTT: Cypress, California................ X X X Ramada Hotel Fresno, California................. X X X Hampton Inn Riverside, California.............. X X X Days Inn RESIDENCE INN BY MARRIOTT: Highlands Ranch, Colorado.......... Oxnard, California................. X X X Radisson Suites Provo, Utah........................ HILTON Salt Lake City, Utah............... X X X DOUBLETREE HOTEL: Santa Fe, New Mexico............... X X X Best Western SHERATON Chandler, Arizona.................. X HOLIDAY INN SELECT: La Mirada, California.............. X X X Holiday Inn Renton (Seattle), Washington....... X X Holiday Inn HOLIDAY INN HOTEL & SUITES: Craig, Colorado.................... X X X Kent (Seattle), Washington......... X X X Cypress Inn Mesa, Arizona...................... X X X Holiday Inn Price, Utah........................ X X X Days Inn San Diego (Old Town), California... X X Ramada Hotel HOLIDAY INN: Flagstaff, Arizona................. X X X Provo, Utah........................ X X X Rochester, Minnesota............... X X X San Diego (Harbor), California..... X X San Diego (Mission Valley), California......................... X X X Steamboat Springs, Colorado........ X X Best Western HOLIDAY INN EXPRESS: Portland, Oregon................... X X X Cypress Inn Poulsbo, Washington................ X X X Cypress Inn
-11- 14 COMPLETED, PENDING AND PLANNED RENOVATION AND REDEVELOPMENT(1), CONTINUED
PUBLIC AREAS --------------------------- ADD/ REPLACE/ UPGRADE EXPECTED TO REFURBISH MEETING COMPLETED BE COMPLETED EXTERIOR RESTAURANT LOBBY SPACE ----------- ------------ --------- ---------- ----- ------- HAMPTON INN: Arcadia, California................ February 1997 Clackamas (Portland), Oregon....... October 1996 X X X Denver, Colorado................... June 1996 X Mesa, Arizona...................... October 1997 X Oakland, California................ July 1996 X X X Pueblo, Colorado................... February 1997 X Silverthorne, Colorado............. June 1996 X X X June 1997 X Tucson, Arizona.................... October 1997 X X HAWTHORN SUITES: Anaheim, California(2)............. February 1998 X Kent, Washington................... February 1998 Sacramento, California(2).......... February 1998 X X X X RADISSON: Boise, Idaho(3).................... September 1998 X X X X BEST WESTERN: Helena, Montana.................... September 1998 X X X Lynnwood, Washington............... September 1998 X X X X Twin Falls, Idaho.................. September 1998 X X X COMFORT SUITES: South San Francisco, California.... June 1997 X X QUALITY INN: Pocatello, Idaho................... June 1998 X X X INDEPENDENT KAHLER INN & SUITES - Rochester, Minnesota............. June 1998 X X X X REGENCY PLAZA - Los Angeles, California.......... September 1996 NEWLY CONSTRUCTED THE KAHLER HOTEL - Rochester, Minnesota............. April 1998 X
GUEST ROOMS ------------------------- PRIOR SOFT GUEST FRANCHISE GOODS FURNITURE BATH AFFILIATION ----- ---------- ----- -------------- HAMPTON INN: Arcadia, California................ Clackamas (Portland), Oregon....... X X X Cypress Inn Denver, Colorado................... X X Mesa, Arizona...................... X X Oakland, California................ X X Pueblo, Colorado................... X X X Silverthorne, Colorado............. X Tucson, Arizona.................... X X X HAWTHORN SUITES: Anaheim, California(2)............. X Independent Kent, Washington................... X X Independent Sacramento, California(2).......... X X X Independent RADISSON: Boise, Idaho(3).................... X X X Independent BEST WESTERN: Helena, Montana.................... X X X Lynnwood, Washington............... X X X Twin Falls, Idaho.................. X X COMFORT SUITES: South San Francisco, California.... X X X QUALITY INN: Pocatello, Idaho................... X X X INDEPENDENT KAHLER INN & SUITES - Rochester, Minnesota............. X X X REGENCY PLAZA - Los Angeles, California.......... THE KAHLER HOTEL - Rochester, Minnesota............. X X X
- ---------- (1) Does not include the Green Oaks Park Hotel in Texas or the Lakeview Resort and Conference Center in West Virginia which the Company intends to sell or exchange or the following recent acquisitions (scope of renovation and franchise affiliation have not been finalized): the Residence Inn by Marriott, Sacramento, California, the Residence Inn by Marriott, San Diego, California, the Residence Inn by Marriott, Santa Clarita, California, the Fairfield Inn, Santa Clarita, California, the Vacation Inn, San Diego, California and the Hilton Inn, Carson California. (2) The Company has received a franchise license to rebrand these hotels as Hawthorn Suites. The Sacramento hotel will be reconfigured to create 32 two-room suites, which will reduce the room count to 269. The new franchise licenses are subject to completion of certain renovations and improvements. The Anaheim and the Sacramento hotels are currently operated independently. (3) Franchise applications have been submitted to the applicable franchisor, certain of which are pending approval; however, there can be no assurance that such franchise applications will be approved, or if approved, the cost or scope of the renovations and improvements that will be required. -12- 15 Franchise Rebranding The Company generally believes that franchise affiliations provide advantages to certain hotels. Such advantage include brand recognition, access to national reservation systems, national direct sales efforts and national volume purchasing agreements, and technical and business assistance. The use of multiple franchise systems provides the Company with further diversification, less dependence on the continued popularity of one brand and less vulnerability to new requirements of any individual franchise affiliation. The Company expects to focus its franchise affiliations on nationally recognized luxury and upscale hotel chains. During 1996, upon completion of each renovation resulting in a high quality property, the Company rebranded and upgraded seven hotels with new and existing franchises and also added, or will shortly add, full service Marriotts, Hiltons and Sheratons to its portfolio. During 1997, the Company rebranded and upgraded seven hotels. Marriott Preferred Business Relationship. Also during 1997, Marriott International, Inc., performed a review of the Company's and the Lessee's management and operations and, based on the operating culture of the two companies, management track record and hotel-level operations, approved the companies as qualified full-service franchisees. The Company expects to brand five of the Kahler hotels as full service Marriott hotels after completion of product improvement plans. When these five hotels are branded with the Marriott flag, approximately 25.2% of the Company's hotel rooms will be branded with Marriott franchises. Management of the Company will consider the Marriott brands when repositioning future acquired hotels and believes that the preferred business relationship with Marriott will enhance its opportunities for future franchises. The following table summarizes certain information with respect to the current or anticipated franchise affiliations of the hotels. FRANCHISE AFFILIATIONS
Number of Percentage Franchise Affiliations(1) Hotels Rooms of Rooms - -------------------------- ---------- --------- ----------- Marriott(2)................................................................... 15 2,605 25.2% Holiday Inn................................................................... 15 2,366 22.8 Hampton....................................................................... 8 1,063 10.3 Kahler ....................................................................... 2 965 9.3 Independent................................................................... 3 649 6.3 Hawthorn Suites(3)............................................................ 3 583 5.6 Hilton 2 572 5.5 Best Western.................................................................. 3 364 3.5 Sheraton...................................................................... 1 295 2.8 Radisson...................................................................... 1 238 2.3 Doubletree Hotel.............................................................. 1 213 2.1 Comfort Suites................................................................ 1 166 1.6 Ramada........................................................................ 1 124 1.2 Quality Inn................................................................... 1 152 1.5 ---------- --------- ----------- Total.................................................................... 57 10,355 100.0% ========== ========= ===========
- ----------- (1) Several of the Kahler Hotels will be branded or rebranded following renovation and redevelopment, under either Marriott, Holiday Inn Hotel & Suites, Holiday Inn or Radisson brands. Certain of the Company's planned changes in franchise affiliations are included in this table. There can be no assurance that the Company will receive final approval from the applicable franchisor. (2) Includes five hotels from the Kahler Acquisition with 1,238 rooms which the Company anticipates converting to various Marriott franchises. The Company has obtained approval of these new franchise licenses, subject to completion of renovations or improvements. (3) Includes the Anaheim and Sacramento, California hotels which will be rebranded as Hawthorn Suites hotels upon completion of renovation and improvements which are expected to be completed in the second quarter of 1998. -13- 16 The typical term of a franchise agreement is 20 years for newly developed and constructed hotels and ten years for the conversion of an existing hotel. The Company believes that the loss of any one of its franchise agreements would not have a material adverse effect on the Company. Repositioning - Combining Renovations, Redevelopments and Rebranding with Comprehensive Marketing and Management Strategies The hotels acquired by the Company often lack adequate management and marketing programs. The Lessee implements a full complement of management and marketing programs at each acquired hotel designed to maximize sales and operational efficiency. The Company believes that these marketing activities significantly contribute to the growth in REVPAR for the Company's acquired hotels. On average, the Company believes that the implementation of focused sales and marketing programs alone - before any improvements to the physical condition of the hotel are made by the Company - have increased same-unit-sales REVPAR growth approximately 11.0% for the months following acquisition, but before renovation begins compared to the respective corresponding periods in the prior year. The Lessee has also developed a sales program to direct and manage the sales activities of personnel located at each hotel and a program to ensure that sales staff is properly trained and that staffing levels are adequate. As part of the required reporting process, each hotel must contact every business within a five-mile radius to evaluate possible hotel use and revenue potential. Under each Percentage Lease, the Lessee is also obligated to have a sales manager at each hotel, as reasonably required by the Company, to coordinate, direct and manage the sales activities of personnel located at that hotel in order to maximize revenue. The combined efforts to reposition each of the Company's hotels have resulted in significant same-unit-sales, year-over-year revenue increases as indicated in the following table:
For the Years Ended For the Years Ended December 31, December 31, ----------------------------- ----------------------------- 1997 1996 1996 1995 --------- --------- --------- --------- Number of hotels 53 53 24 24 Number of rooms 9,854 9,854 3,389 3,389 Occupancy rate 67.9% 63.9% 66.7% 66.2% ADR $ 71.46 $ 64.35 $ 62.01 $ 57.51 REVPAR $ 48.51 $ 41.10 $ 41.38 $ 38.08 REVPAR % change 18.0% 8.7%
Restaurant Leases. The Company also subleases restaurant facilities in the hotels (other than the Courtyard by Marriott Hotels) to regional or national restaurant companies. The Company believes this strategy is beneficial because it (i) allows the Lessee to concentrate on increasing room revenue, which benefits the Company because of the higher percentage rent thresholds (from 60% to 68%) than the 5% of food and beverage revenue it would otherwise receive, and (ii) significantly enhances guest satisfaction by providing food service from experienced national or regional restaurant companies. Thirty-six of the Company's hotels have restaurant facilities, twenty-four of which the Lessee operates and twelve of which the Lessee has subleased to unaffiliated restaurant companies including Red Robin International, Hazelwoods, Old Chicago Bar & Grill, Mitzell American Restaurant, Ruby River Steak House and Village Inn. The Lessee is currently negotiating with national and regional restaurant companies for the development of restaurants at seven of the hotels in which the restaurants are operated by the Lessee. Expansions. In certain cases, the Company may expand the number of rooms at a hotel where it believes it can achieve a favorable return on the cost of such expansion, and where occupancy, ADR and other market conditions are otherwise believed to justify such expansion, and where building permits can be obtained. During 1997, the Company completed the 39-room expansion of the Residence Inn Highlands Ranch (Denver), Colorado. -14- 17 THE HOTEL PROPERTIES Geographically, 40.9% and 41.7% of the Company's portfolio is located in the Pacific and Mountain regions, respectively, which collectively comprise the western United States. The western United States has experienced some of the fastest growth in population in the 1990's and, according to the Bureau of Census, is expected to continue to grow at an faster rate than the national average well into the next century. In addition, between 2000 and 2005 the population in the western United States is projected to grow 7.9% while the population growth in the northeast, Midwest and south is projected to grow 1.1%, 2.1% and 5.3%, respectively. While the Company's hotel portfolio is located primarily in the western United States, it is nevertheless diverse. The geographic distribution of the hotels, which are located in 12 states, reflects the Company's belief that a certain amount of geographic distribution helps to insulate the Company's hotel portfolio from local market fluctuations that are typical for the hotel industry. The Company has also sought to increase its geographic distribution by focusing on major metropolitan areas. The following table summarizes the Company's presence in each of these 12 markets: LOCATION BY REGION
NUMBER OF PERCENTAGE REGION HOTELS ROOMS OF ROOMS ---------- ---------- ---------- Mountain(1) .............. 24 4,319 41.7% Pacific(2) ............... 27 4,236 40.9 Minnesota ................ 4 1,329 12.8 Other(3) ................. 2 471 4.6 ---------- ---------- ---------- Total ........... 57 10,355 100.0% ========== ========== ==========
- ---------- (1) Includes Arizona, Colorado, Idaho, Montana, New Mexico and Utah. (2) Includes California, Oregon and Washington. (3) The Company is considering the sale or exchange of the two hotels acquired in the Kahler acquisition located in Texas and West Virginia. -15- 18 The following table sets forth additional information with respect to the Company's hotel portfolio as of February 27, 1998:
Date Last Type of Service/ No. of Acquired/ Year Opened/ Renovated Segment(1) Product Rooms Invested In Redeveloped In --------------- ----------------- ------ ----------- ------------ ---------- MARRIOTT HOTEL: Ogden, Utah(2) Luxury Full 288 10/15/97 1982 1998* Park City, Utah(2) Luxury Full 203 10/15/97 1985 1998* Provo, Utah(2) Luxury Full 333 10/15/97 1982 1998* Rochester, Minnesota(2) Luxury Full 194 10/15/97 1991 1998* Salt Lake City, Utah(2) Luxury Full 220 10/15/97 1987 1998* HILTON: Salt Lake City, Utah Luxury Full 351 10/15/97 1975 1997 SHERATON: Chandler, Arizona Luxury Full 295 10/15/97 1987 1998* THE KAHLER HOTEL: Rochester, Minnesota Luxury Full 699 10/15/97 Various 1998* DOUBLETREE HOTEL: Santa Fe, New Mexico Upscale Full 213 8/16/95 1985 1996 HILTON: Carson, California Upscale Full 221 2/19/98 1989 1998 HOLIDAY INN: Craig, Colorado Upscale Full 152 8/16/95 1981 1997 Flagstaff, Arizona Upscale Full 157 10/29/96 1987 1997 La Mirada, California Upscale Full 289 3/31/97 1984 1998* Mesa, Arizona Upscale Full 246 10/29/96 1985 1997 Price, Utah Upscale Full 151 8/12/96 1984 1997 Provo, Utah Upscale Full 78 8/16/95 1968 1994 Steamboat Springs, Colorado Upscale Full 82 8/16/95 1971 1996 Renton (Seattle), Washington Upscale Full 226 6/28/96 1968 1997 San Diego, California Upscale Full 218 1/17/97 1968 1997 San Diego, California (Old Town)(2) Upscale Full 151 6/11/97 1986 1998* INDEPENDENT: Lakeview Resort & Conference Center Morgantown, West Virginia Upscale Full 187 10/15/97 Various 1998* Regency Plaza Los Angeles, California (LAX) Upscale Full 178 8/28/97 1996 1996 HAWTHORN SUITES: Anaheim, California(2) Upscale Extended-Stay 130 8/7/97 1992 1997 Kent, Washington Upscale Extended-Stay 152 3/11/97 1990 1997 Sacramento, California(2) Upscale Extended-Stay 301 5/17/97 1988 1998* RESIDENCE INN: Highlands Ranch (Denver), Colorado Upscale Extended-Stay 117 12/22/95 1996 N/A Oxnard, California Upscale Extended-Stay 251 12/19/96 1987 1997 Provo, Utah Upscale Extended-Stay 114 10/15/97 1996 N/A Sacramento, California Upscale Extended-Stay 126 12/30/97 1992 1998 San Diego, California Upscale Extended-Stay 144 12/30/97 1989 1998 Santa Clarita, California Upscale Extended-Stay 90 1/27/98 1997 N/A
-16 19
Date Last Type of Service/ No. of Acquired/ Year Opened/ Renovated Segment(1) Product Rooms Invested In Redeveloped In --------------- ----------------- ------ ----------- ------------ ---------- RADISSON: Boise, Idaho(2) Upscale Full 238 10/15/97 1991 1998* COURTYARD BY MARRIOTT: Cypress, California Mid-Priced Full 180 1/17/97 1990 1997 Fresno, California Mid-Priced Full 116 8/16/95 1989 1994 Riverside, California Mid-Priced Full 163 4/1/96 1988 1994 HOLIDAY INN: Kent (Seattle), Washington Mid-Priced Full 125 2/2/96 1986 1996 Rochester, Minnesota Mid-Priced Full 170 10/15/97 1969 1998* San Diego, California (Stadium) Mid-Priced Full 174 8/7/97 1991 1998* KAHLER HOTEL: Rochester, Minnesota Mid-Priced Full 266 10/15/97 Various 1998* BEST WESTERN: Helena, Montana Mid-Priced Full 149 10/15/97 1971 1988 Lynnwood, Washington Mid-Priced Full 103 7/17/97 1978 1998* Twin Falls, Idaho Mid-Priced Full 112 10/15/97 1974 1998* QUALITY INN: Pocatello, Idaho Mid-Priced Full 152 10/15/97 1976 1998* INDEPENDENT: Green Oaks Park Hotel: Fort Worth, Texas Mid-Priced Full 284 10/15/97 1964 1998* COMFORT SUITES: San Francisco, California Mid-Priced Limited 166 8/13/96 1985 1997 FAIRFIELD INN: Santa Clarita, California Mid-Priced Limited 66 1/27/98 1997 N/A HAMPTON INN: Arcadia, California Mid-Priced Limited 129 8/16/95 1989 1997 Clackamas, Oregon Mid-Priced Limited 114 2/2/96 1986 1996 Denver, Colorado Mid-Priced Limited 152 8/16/95 1986 1996 Mesa, Arizona Mid-Priced Limited 118 8/16/95 1987 1997 Oakland, California Mid-Priced Limited 152 12/18/95 1986 1996 Pueblo, Colorado Mid-Priced Limited 112 8/16/95 1986 1997 Silverthorne, Colorado Mid-Priced Limited 160 8/16/95 1976 1997 Tucson, Arizona Mid-Priced Limited 126 10/29/96 1986 1997 HOLIDAY INN: Portland, Oregon Mid-Priced Limited 84 2/2/96 1986 1996 Poulsbo, Washington Mid-Priced Limited 63 2/2/96 1986 1996 RAMADA: San Diego, California(2) Mid-Priced Limited 124 1/23/98 1987 1998
- ---------- * Expected year of completion (1) Per F.W. Dodge segmentation criteria. (2) This hotel will be rebranded upon completion of renovation. -17- 20 The Percentage Leases In order for the Company to qualify as a REIT, neither the Company nor the Partnership can operate any hotels. The Partnership, therefore, leases hotels to the Lessee typically for a term of ten years pursuant to Percentage Leases which provide for rent equal to base rent and percentage rent. Each Percentage Lease contains the provisions generally described below, and the Company intends that future Percentage leases with respect to additional hotels it may acquire will contain substantially similar provisions, although the Independent Directors may, in their discretion, alter any of these provisions with respect to any proposed percentage lease, depending on the purchase price paid, economic conditions and other factors deemed relevant at the time. The Lessee will not lease or operate any hotel other than those owned by the Partnership. Percentage Lease Terms. The Percentage leases typically have a noncancelable term of ten years, subject to earlier termination upon the occurrence of defaults thereunder and certain other events (including provisions for damage to the hotels, condemnation of the hotels and termination of Percentage Leases on disposition of the hotels). Amounts Payable Under the Percentage Leases. During the term of each Percentage Lease, the Lessee is obligated to pay to the Partnership (i) base rent and percentage rent (which includes a specified percentage of room revenues, 5% of the Lessee's food and beverage revenues, 100% of any sublease and concession rentals and other net revenues described in the Percentage Leases), and (iii) certain other amounts, including interest accrued on any late payments or charges. Base rent accrues and is required to be paid monthly in arrears. Both the base rent and the threshold room revenue amount in each percentage rent formula is adjusted annually for inflation. The adjustment will be calculated at the beginning of each calendar year based upon the change in the CPI during the prior calendar year. Percentage rent, if any, is due monthly within 45 days after the end of each calendar month and is reconciled on a quarterly basis. In 1997, the Lessor and Lessee amended the Percentage Leases for hotels then currently under renovation and for any future hotels to allow for the abatement of base rent related to rooms taken out of service during major renovations. -18- 21 The following table sets forth the annual base rent and percentage rent formulas for the hotels:
Annual 1997 Percentage Lease Annual --------------------------------- Room Base First Second Revenue Rent(1) Tier Tier Threshold(1) -------------- -------------- --------------- --------------- HOTELS: Marriott: Ogden, Utah $ 1,030,000 25.0% 62.0% $ 4,115,000 Park City, Utah 926,000 24.4 62.0 3,793,000 Provo, Utah 2,040,000 37.2 62.0 5,490,000 Rochester, Minnesota 2,899,000 42.3 62.0 6,861,000 Salt Lake City, Utah 2,101,000 46.0 62.0 4,566,000 Courtyard by Marriott: Cypress, California 1,007,000 37.3 62.0 2,699,000 Fresno, California 423,000 30.0 63.0 1,410,000 Riverside, California 436,000 30.0 60.0 1,454,000 Residence Inn by Marriott: Highlands Ranch (Denver), Colorado 303,000 30.0 63.0 1,009,000 Oxnard, California 1,091,000 32.0 61.0 3,410,000 Provo, Utah 670,000 34.6 62.0 1,936,000 Sacramento, California 983,000 43.2 60.0 2,276,000 San Diego, California 1,393,000 45.8 60.0 3,043,000 Santa Clarita, California 775,000 40.6 60.0 1,911,000 Fairfield Inn: Santa Clarita, California 370,000 36.5 60.0 1,015,000 Hilton: Salt Lake City, Utah 3,843,000 50.2 62.0 7,659,000 Carson, California 932,000 37.1 60.0 2,059,000 Holiday Inn Select: La Mirada, California 1,506,000 39.3 60.0 3,835,000 Renton (Seattle), Washington 823,000 30.0 62.0 2,744,000 Holiday Inn Hotel & Suites: Craig, Colorado 445,000 30.0 60.0 1,483,000 Kent (Seattle), Washington 584,000 36.0 63.0 1,621,000 Mesa, Arizona 810,000 31.0 60.5 2,614,000 Price, Utah 273,000 24.0 60.0 1,114,000 San Diego (Old Town), California 1,161,000 46.0 60.0 2,541,000 Holiday Inn: Flagstaff, Arizona 303,000 30.0 61.5 1,010,000 Provo, Utah 167,000 20.0 65.0 836,000 Rochester, Minnesota 245,000 9.2 62.0 2,655,000 San Diego, California 867,000 25.9 62.0 3,348,000 San Diego (Stadium), California 730,000 37.0 60.0 1,982,000 Steamboat Springs, Colorado 392,000 30.0 60.0 1,305,000 Holiday Inn Express: Portland, Oregon 374,000 30.0 63.0 1,158,000 Poulsbo, Washington 333,000 35.0 63.0 952,000
-19- 22
Annual 1997 Percentage Lease Annual --------------------------------- Room Base First Second Revenue Rent(1) Tier Tier Threshold(1) -------------- -------------- --------------- --------------- Hampton Inn: Arcadia, California 414,000 36.0 63.0 1,149,000 Clackamas (Portland), Oregon 450,000 38.0 63.0 1,184,000 Denver, Colorado 591,000 37.5 63.0 1,577,000 Mesa, Arizona 497,000 34.0 63.0 1,462,000 Oakland, California 432,000 22.0 63.0 1,963,000 Pueblo, Colorado 470,000 36.0 63.0 1,305,000 Silverthorne, Colorado 504,000 30.0 63.0 1,681,000 Tucson, Arizona 347,000 30.0 62.0 1,156,000 Hawthorn Suites: Anaheim, California 825,000 39.0 60.0 2,095,000 Kent, Washington 1,103,000 40.2 68.0 2,743,000 Sacramento, California 1,587,000 25.9 60.0 4,463,000 Doubletree Hotel: Santa Fe, New Mexico 689,000 30.0 63.0 2,298,000 Sheraton: Chandler, Arizona 2,889,000 34.7 62.0 8,316,000 Best Western: Helena, Montana 955,000 42.7 62.0 2,237,000 Lynnwood, Washington 573,000 45.0 60.0 1,260,000 Twin Falls, Idaho 604,000 40.3 62.0 1,501,000 Comfort Suites: South San Francisco, California 729,000 30.0 60.0 2,430,000 Quality Inn: Pocatello, Idaho 390,000 23.1 62.0 1,686,000 Ramada: San Diego, California 774,000 45.7 60.0 1,694,000 Radisson: Boise, Idaho 1,227,000 37.5 62.0 3,275,000 Independent: Kahler Inn & Suites Rochester, Minnesota 1,721,000 47.3 62.0 3,635,000 Regency Plaza Los Angeles, California 964,000 47.0 60.0 2,058,000 The Kahler Hotel Rochester, Minnesota 4,126,000 35.2 62.0 11,720,000 Green Oaks Park Hotel Forth Worth, Texas 586,000 23.8 62.0 2,466,000 Lakeview Resort & Conference Morgantown, West Virginia 1,042,000 22.7 62.0 4,586,000 -------------- Total $ 54,724,000 ==============
(1) Effective January 1, 1996 and 1997, base rent payable and the room revenue threshold under the Percentage Leases were adjusted based upon the change in the CPI for those hotels acquired in 1995 and 1996. The lease terms for those hotels acquired subsequent to December 31, 1997 have also been included. -20- 23 Other than real estate and personal property taxes, ground lease rent, where applicable, the cost of certain furniture, fixtures and equipment, capital expenditures and insurance (other than workers' compensation insurance), which are obligations of the Partnership, the Percentage Leases require the Lessee to pay base rent, percentage rent, other additional charges and the operating expenses of the hotel (including workers' compensation insurance, utility, repairs and maintenance costs and other charges incurred in the operation of the hotel) during the terms of the Percentage Leases. The Percentage Leases also provide for rent reductions and abatements in the event of damage or destruction or during major renovation. Maintenance and Modifications. Under the Percentage Leases, the Company is required to pay for capital improvements at each hotel. In addition, the Percentage Leases obligate the Company to make available to the Lessee for the repair, replacement and refurbishment of furniture, fixtures and equipment in the hotel, when and as deemed necessary by the Lessee, an amount equal to 4.0% of room revenue per quarter on a cumulative basis, provided that such amount may be used for capital expenditures made by the Partnership respecting the hotel. The amount in the reserve is carried forward to the extent that the Lessee or the Company has not expended such amount, and any unexpended amounts will remain the property of the Partnership upon termination of the Percentage Leases. Otherwise, the Lessee will be required, at its expense, to maintain the hotel in good order and to repair and to pay for all operating expenses of the hotel. The Company owns substantially all personal property including that portion affixed to, or deemed a part of, the real estate or improvements. Property Taxes and Insurance. The Company is responsible for paying real estate and personal property taxes on the hotels (except for taxes on personal property associated with the hotels which are owned by the Lessee) and for paying all premiums for property, casualty, comprehensive general public liability (naming the Lessee as an additional named insured) and other insurance appropriate and customary for properties similar to the hotel, as determined by the Company. The Lessee is required to pay for workers' compensation insurance. The Company believes that the coverages specified in the Percentage Leases are of the type and amount customarily obtained by owners of hotels similar to the Company's hotels. TAX STATUS The Company has elected to be taxed as a REIT under Section 856 of the Code, commencing with its taxable year ending December 31, 1995. If the Company qualifies for taxation as a REIT, then under current federal income tax laws the Company generally will not be taxed at the corporate level to the extent it currently distributes at least 95% of its net taxable income to its stockholders. Even if the Company qualifies for taxation as a REIT, the Company may be subject to certain federal, state and local taxes on its income and property and to federal income and excise tax on its undistributed income. COMPETITION Intense competition exists for investment opportunities in luxury, upscale and mid-priced hotels from entities organized for purposes substantially similar to the Company's objectives as well as from other purchasers of hotels. The Company competes for such hotel investment opportunities with entities which have substantially greater financial resources than the Company or better relationships with franchisors, sellers or lenders. These entities may also generally be able to accept more risk than the Company can prudently manage. Competition may generally reduce the number of suitable hotel investment opportunities offered to the Company and increase the bargaining power of property owners seeking to sell. The Company believes that the inclusion of not only underperforming, but also undercapitalized properties as well as secondary markets in its strategy lessens competition for the types of properties targeted by the Company. There are a number of companies which develop, construct and renovate hotels. Some of these companies perform these services only for their own portfolios, while others actively pursue contracts for these services with third party owners. The Company believes that it can develop, construct and renovate hotels at costs which are competitive. -21- 24 There is a significant operational competition in the hotel industry. There are numerous hotel chains that operate on a national or regional basis, as well as other hotels, motor inns and other independent lodging establishments throughout the western United States. Competition is primarily in the areas of price, location, quality and services. Many of the Company's competitors have recognized trade names, greater resources and longer operating histories than the Company. However, the Company brands its hotels with strong national franchises and believes that its management and that of the Lessee is sufficiently experienced to efficiently manage its hotels, enabling the Company and Lessee to compete successfully. There can be no assurances, however, that competitors will not develop or renovate hotels in the markets in which the Company has historically operated. Increased competition may have a negative impact on the Company's operating results and consequently cash available for distribution. SEASONALITY The hotel industry is seasonal in nature and this seasonality is typically geographically and market specific. The effects of seasonality may be expected to cause significant quarterly fluctuations in the Company's Percentage Lease revenues. Effects of this seasonality on the Company's operating results may change depending upon the locations and markets of additional hotels the Company acquires or develops. ENVIRONMENTAL MATTERS Under various federal, state and local laws and regulations, an owner or operator of real estate may be liable for the costs of removal or remediation of certain hazardous or toxic substances on such property. Such laws often impose such liability without regard to whether the owner or operator knew of, or was responsible for, the presence of hazardous or toxic substances on the property. The costs of removal or remediation of such substances may be substantial, and the presence of such substances, or the failure to promptly remediate such substances, may adversely affect the owner's ability to fully utilize such property without restriction, to sell such property or to borrow using such property as collateral. In connection with the ownership and operation of the hotels, the Company, and the Lessee, as the case may be, may be potentially liable for any such costs. The Company believes that its hotels are in compliance, in all material respects, with all federal, state and local ordinances and regulations regarding hazardous or toxic substances and other environmental matters, the violation of which could have a material adverse effect on the Company, or the Lessee. The Company has not been notified by any governmental authority of any material noncompliance, liability or claim relating to hazardous or toxic substances or other environmental matters in connection with any of its present or former properties. EMPLOYEES Messrs. Alter and Biederman have each entered into employment agreements with the Company for one-year terms which renew automatically until terminated. While Mr. Alter is required to devote substantially all of his time to the business of the Company; Mr. Biederman is not. The Company has 19 other employees. The Lessee employed approximately 4,800 people as of December 31, 1997 to operate the hotels leased from the Company. The Lessee has advised the Company that its relationship with its employees is good. None of the employees of the Company or the Lessee is a party to any collective bargaining agreement or other similar agreement. MINIMIZING THE RISKS OF POTENTIAL CONFLICTS OF INTEREST In order to minimize conflicts of interest inherent in the legal structure required to maintain the Company's status as a REIT, Messrs. Alter and Biederman each have entered into several agreements. Their respective employment agreements restrict competitive activities and third party pledge agreements require each of Messrs. Alter and Biederman to pledge Units to the Company to secure obligations of the Lessee under the Percentage Leases limited to the total number of Units that Mr. Alter or Mr. Biederman must pledge to the current number owned of 481,955 shares representing a market value of $7.8 million at February 27, 1998. The Third Party Pledge Agreement -22- 25 subordinates the Company's lien on these Units to the lien in favor of an institutional lender providing a working capital line to the Lessee guaranteed by Mr. Alter and secured by a pledge of Mr. Alter's Units. In addition, Messrs. Alter and Biederman entered into a unit purchase agreement (the "Unit Purchase Agreement") with the Company and the Lessee requiring that the Lessee's income (net of shareholder tax liability) be used to either accumulate reserves to pay rent under the Percentage Leases or to purchase Units from the Partnership at the then current price of the Company's common stock. The Percentage Leases also contain cross-default provisions permitting the Company to terminate the Percentage Leases, subject to certain conditions, upon a default by Messrs. Alter or Biederman under the Unit Purchase Agreement or any other agreement with the Company. Further, the Management Company has agreed not to collect any payments from the Lessee after receiving notice of an event of default under a Percentage Lease. Mr. Alter has personally guaranteed the Lessee's obligation to return any amounts received by the Management Company in violation of this agreement. RISK FACTORS IMPEDIMENTS TO GROWTH AND INCREASING CASH AVAILABLE FOR DISTRIBUTION The Company's ability to increase cash available for distribution on its Common Stock ("Cash Available for Distribution") will depend significantly on the Company's ability to acquire or develop additional hotels at attractive prices. Risks associated with this growth strategy include: Acquisition Risks. There is significant competition for investment opportunities in mid-price and upscale economy hotels for entities organized for purposes similar to the Company's. Such entities may have substantially greater financial resources than the Company or better relationships with franchisors, sellers or lenders. They may also generally be able to accept more risk than the Company can. Competition may generally reduce the number of suitable hotel investment opportunities offered to the Company and increase the bargaining power of property owners seeking to sell. Renovation and Redevelopment Risks. The Company faces risks arising from its strategy of acquiring hotels in need of substantial renovation or redevelopment, particularly the risk that the cost or time to complete the renovation or redevelopment will exceed the budgeted amount. Such delays or cost overruns may arise from shortages of materials or skilled labor, a change in the scope of the original project, the need to comply with building code or other legal requirements, the discovery of structural or other latent problems with a hotel once construction has commenced and other risks inherent in the construction process. In particular, renovation and redevelopment must comply with the Americans with Disabilities Act of 1990 (the "ADA"), which provides that all public accommodations meet certain federal requirements related to access and use by disabled persons. The Company may be required to make substantial modifications at the hotels to comply with the ADA. Delays or cost overruns in connection with renovations or redevelopment could have a material adverse effect on Cash Available for Distribution. Development Risks. A component of the Company's growth strategy is to develop new hotels in markets where room supply and other competitive factors justify new construction or to purchase such hotels from unaffiliated developers after they have been completed. New project development will increase the Company's indebtedness and is subject to a number of other risks, including risks of construction delays or cost overruns, and the risk that required zoning, occupancy and other governmental permits might not be obtained and the risk that projects might not be completed. Additional risks of development projects include the risks associated with effectively marketing a hotel in order to ramp up occupancy at projected room rates after the hotel has been opened. Any failure to complete a development project in a timely manner and within budget or to ramp up occupancy after completion of the project could have a material adverse effect on Cash Available for Distribution. -23- 26 TOTAL DEPENDENCE ON THE LESSEE AND PAYMENTS UNDER THE PERCENTAGE LEASES Certain tax rules relating to the qualification of a REIT prohibit the Company from operating hotels. Therefore, the Company enters into Percentage Leases with the Lessee, and the Lessee operates the hotels and pays rent to the Company based, in large part, on the revenues from the hotels. Consequently, the Company relies entirely on the Lessee to effectively operate the Company's hotels in a manner which generates sufficient cash flow to enable the Lessee to timely make the rent payments under the applicable Percentage Leases. Ineffective operation of the hotels may result in the Lessee's being unable to pay rent at the higher tier level necessary for the Company to fund distributions to stockholders because payment of base rent alone is insufficient for such purposes. In the event that all or a portion of such higher tier rent is not received by the Company, the Company may not be able to make such distributions to its stockholders. There can be no assurance that the Company will receive such higher tier rent from the Lessee or that the Lessee will even be able to pay base rent. The Lessee controls the daily operations of the hotels under the Percentage Leases, which have noncancelable initial terms of ten years. The Company selected the Lessee without consideration of other lessees because Mr. Alter and Mr. Biederman, who own the Lessee, owned and were involved in the management of a number of the hotels contributed to the Company in connection with its IPO and because Mr. Alter and Mr. Biederman significant Units in the Partnership and options to acquire Common Stock of the Company, and therefore have an incentive to cause the Lessee to maximize rents. Except as set forth in the Percentage Leases, neither the Company nor the Partnership has the authority to require the Lessee to operate the hotels in a manner that results in a maximization of rent to the Company. Other than working capital to operate the hotels, the Lessee will have only nominal assets, which will likely be insufficient to satisfy any claims the Company may have if the Lessee defaults under the Percentage Leases. Mr. Alter and Mr. Biederman have entered into an agreement (the "Third Party Pledge Agreement") whereby the obligations of the Lessee under the Percentage Leases are secured with a pledge by Mr. Alter and Mr. Biederman of Units in the Partnership. The Third Party Pledge Agreement has been amended, however, to limit the total number of Units that Mr. Alter or Mr. Biederman must pledge to the current number owned and has also been amended to subordinate the Company's lien on these Units to the lien in favor of an institutional lender providing a working capital line to the Lessee guaranteed by Mr. Alter and secured by a pledge of Mr. Alter's Units. The obligations of the Lessee under the Percentage Leases are not secured by any additional security deposits or guarantees by third parties. MULTIPLE-HOTEL ACQUISITION RISKS The Company has increasingly emphasized, and intends to continue to emphasize, acquisitions of multiple hotels in a single transaction in order to reduce acquisition expenses per hotel and enable the Company to more rapidly expand its hotel portfolio. Consistent with this emphasis, in October 1997, the Company completed the Kahler Acquisition which almost doubled the Company's room total. Multiple-hotel acquisitions, such as the Kahler Acquisition are, however, more complex than single-hotel acquisitions and the risk that a multiple-hotel acquisition will not close may be greater than in a single-hotel acquisition. Such portfolio acquisition, whether by stock or asset purchase, may also result in the Company owning hotels in geographically dispersed markets. For instance, several of the Kahler Hotels are located in areas geographically removed from most of the Company's current hotel portfolio. This geographic diversity will place significant additional demands on the Company's ability to manage such operations. In addition, the Company's costs for a hotel portfolio acquisition that does not close are generally greater than for an individual hotel acquisition which does not close. If the Company fails to close multiple-hotel acquisitions, its ability to increase Cash Available for Distribution will be limited. See "Dependence on Acquisitions to Increase Cash Available for Distribution." Another risk associated with multiple-hotel acquisitions is that a seller may require that a group of hotels be purchased as a package, even though one or more of the hotels in the package does not meet the Company's investment criteria. In such cases, the Company may purchase the group of hotels with the intent to resell those which do not meet its criteria. It is anticipated that any hotel acquired in a portfolio acquisition that does not fit geographic or operating parameters of the Company may be sold or exchanged, including the Kahler Hotels located in Texas and West Virginia. There can be no assurance, however, as to how quickly the Company could sell or exchange such hotels or the terms on which they could be sold or exchanged. Such hotels might reduce Cash Available for Distribution if they operate at a loss during the time the Company owns them, or if the Company sells them at a loss. In addition, any -24- 27 gains on the sale of such hotels within four years of the date of acquisition could be subject to a 100% tax. See "United States Federal Income Tax Considerations." The Company may finance multiple-hotel acquisitions by issuing shares of Common Stock or Units which are convertible into Common Stock. Such issuances may have an adverse effect on the market price of the Common Stock. FAILURE TO MANAGE RAPID GROWTH; FAILURE TO SUCCESSFULLY INTEGRATE KAHLER To successfully implement its acquisition strategy, the Company must integrate the hotels acquired since the IPO and any other subsequently acquired hotels into its existing operations. Since the closing of the IPO, the Company's portfolio of hotel properties has increased dramatically. During such period, the Company also entered geographic markets where it previously did not have any properties. As a result, the consolidation of functions and integration of departments, systems and procedures of acquired properties with the Company's existing operations presents a significant management challenge, and the failure to integrate such properties into the Company's management and operating structures could have a material adverse effect on the results of operations and financial condition of the Company. The Company continues to accelerate its acquisition activity. As a result, the Company's recent acquisitions, including that of the Kahler Hotels, will place significant demands on the Company's management and other resources. There can be no assurances that these hotels and the Company's other business operations can be integrated successfully, that there will be any operating efficiencies between these hotels and the Company's other hotels or that the combined businesses can be operated profitably. The failure to integrate and operate these hotels successfully could have a material adverse effect on the Company's business and future prospects. Also, certain of the Current Hotels are in the same geographic regions and may, therefore, compete with one another. There can be no assurance that the Kahler Acquisition, or any other acquisition, and in particular any subsequent multiple-hotel portfolio acquisition, will not adversely affect the operations, revenues or prospects of the Company's hotels located in such geographic areas. GEOGRAPHIC CONCENTRATION OF KAHLER HOTELS The concentration of four Kahler Hotels with 1,329 rooms in Rochester, Minnesota and six Kahler Hotels with 1,509 rooms in and around the Salt Lake City area of Utah, makes Kahler dependent on factors such as the local economy, local competition, increases in local real and personal property tax rates and local catastrophes. The results of operations of the Kahler Hotels in Rochester, Minnesota, are also dependent on the level of demand generated by the Mayo Clinic for hotel accommodations by patients and by medical conferences organized by the Mayo Clinic. Significant disruption in these local markets that result in decreased operating performance of the Kahler Hotels will have a material adverse effect on the Company's results of operations and Cash Available for Distribution. CONFLICTS OF INTEREST BETWEEN THE COMPANY AND CERTAIN OFFICERS AND DIRECTORS Because of Mr. Alter's and Mr. Biederman's ownership in and positions with the Company and the Lessee and Mr. Alter's ownership of the Management Company, there are inherent conflicts of interest between the Lessee and the Company in the leasing, acquisition, disposition, operation and management of the Company's hotels. Accordingly, the interests of stockholders may not have been, and in the future may not be, reflected fully in all decisions made or actions taken by the officers and directors of the Company. In the event revenues from the Company's hotels increase significantly over prior periods and the operating expenses with respect thereto are less than historical or projected operating expenses, the Lessee could disproportionately benefit. In addition, there may be conflicts of interest in connection with the sale of certain hotels. Unrealized gain from the sale to the Company of certain hotels in connection with its IPO is specially allocated to Mr. Alter and Mr. Biederman and any sale of such hotels by the Partnership may cause adverse tax consequences to them. In addition, the reduction of mortgage indebtedness by the Partnership at any time below certain levels would create adverse tax consequences to Mr. Alter and Mr. Biederman. These conflicts may result in decisions relating to the sale of certain hotels and/or the incurrence -25- 28 or repayment of indebtedness which do not reflect solely the interests of the stockholders. In addition, the Company will generally be required under the Percentage Leases to pay a lease termination fee to the Lessee if the Company elects to sell a hotel and not replace it with another hotel. The payment of a termination fee to the Lessee, which is owned by Mr. Alter and Mr. Biederman, may result in the decisions regarding the sale of a hotel which do not reflect solely the interests of the Company. RELIANCE ON MR. ALTER The Company places substantial reliance on the hotel industry knowledge and experience and the continued services of Robert A. Alter, the Company's Chairman and President. The Company's future success and its ability to manage future growth depends in large part upon the efforts of Mr. Alter and on the Company's ability to attract and retain other highly qualified personnel. Competition for such personnel is intense and there can be no assurance that the Company will be successful in attracting and retaining such personnel. The loss of Mr. Alter's services or the Company's inability to attract and retain highly qualified personnel may adversely affect the operations of the Company and the Cash Available for Distribution. HOTEL INDUSTRY RISKS Operating Risks and Competition. Many of the Company's competitors have substantially greater marketing and financial resources than the Company and the Lessee. In addition, the Company's hotels are subject to all operating risks common to the hotel industry. The hotel industry has experienced volatility in the past, as have the Company's hotels. Hotel industry risks include, among other things, competition from other hotels; overbuilding in the hotel industry which has adversely affected occupancy ADR and REVPAR increases in operating costs due to inflation and other factors, which may not necessarily be offset by increased room rates; dependence on business and commercial travelers and tourism; strikes and other labor disturbances of hotel employees for hotels owned by the Company; increases in energy costs and other expenses of travel and adverse effects of general and local economic conditions. These factors could decrease room revenues of the hotels and adversely affect the Lessee's ability to make payments of rent under the Percentage Leases to the Company, and therefore reduce Cash Available for Distribution. Seasonality of Hotel Business and the Company's Hotels. The hotel industry is seasonal in nature. This seasonality can be expected to cause quarterly fluctuations in the Company's Percentage Lease revenues which, therefore, may be insufficient to provide all of the Cash Available for Distribution necessary to pay dividends in a given quarter. Increased Competition Resulting from Overbuilding. The hotel industry has historically experienced cycles of overbuilding in certain geographic markets and product segments. Such overbuilding increases competition for hotel guests, resulting in lower occupancies and lower average daily rates, thereby reducing the profitability of the hotels affected by the increased competition. While the Company's investment strategy is to acquire underperforming hotels or hotels where there are significant barriers to entry, there can be no assurance that the current hotel development activities, particularly in the limited service segment, will not create additional significant competition for the Company's hotels. Such increased competition would reduce the revenue generated by the Lessee, thus reducing percentage rent paid to the Company and Cash Available for Distribution. RISKS OF INCREASES IN OPERATING COSTS AND CAPITAL EXPENDITURES; FRANCHISE AGREEMENTS Hotels in general, including the Company's hotels, have an ongoing need for renovations and other capital improvements, including periodic replacement of furniture, fixtures and equipment. In addition, the franchise agreements under which the Company's hotels are operated impose specified operating standards and may permit the franchisor to condition the continuation of a franchise agreement on the completion of capital improvements. Under the terms of the Percentage Leases, the Company is obligated to pay the cost of certain capital expenditures at its hotels and to pay for furniture, fixtures and equipment. The ability of the Company to fund these and other capital expenditures and periodic replacement of furniture, fixtures and equipment will depend in part on the financial performance of the Lessee and the hotels. If these expenses exceed the Company's estimate, the additional expenses -26- 29 could have an adverse effect on Cash Available for Distribution. Any inability or failure to fund these expenditures could have a material adverse effect on occupancy rates, ADRs and REVPAR and may constitute a breach under the franchise agreements. HAWTHORN SUITES DEVELOPMENT RISKS The Company has entered into a five-year master development agreement with U.S. Franchise Systems, Inc. and Hawthorn Suites Franchising, Inc. to permit the Company to franchise properties operated under the Hawthorn Suites brand. Pursuant to the agreement, the Company will have the right to obtain franchise licenses in several major urban markets on the West Coast. Under the agreement, certain development rights may terminate if the Company does not establish a certain minimum number of licenses for Hawthorn Suites during each year. This timetable may cause the Company to overcommit to developing and owning Hawthorn Suites at the expense of other growth opportunities. As a franchise with a limited number of hotels currently operating, the Company's focus on this brand subjects it to greater risks than a more diversified approach. FRANCHISE RISKS Forty-five of the Company's hotels are operated pursuant to franchise or license agreements and additional hotels may be, including seven of the Kahler Hotels, or become subject to franchise arrangements. The Lessee will hold the franchise or license agreements for the hotels and will be responsible for complying with the terms of these agreements. Such franchise or license arrangements are often helpful in providing marketing services and room reservations to hotels, but these arrangements also impose financial obligations on hotels generally related to maintaining the condition of hotels and the payment of franchise fees. Continuation of such franchises is subject to specified operating standards and other terms and conditions. Franchisors periodically inspect franchised hotels to confirm compliance. In addition, franchisors may required the Company to fund significant capital improvements to the hotels in the future to maintain such franchises. The failure of a franchisee to maintain standards or adhere to terms and conditions imposed by the franchisor may result in the loss of a license or termination of the franchise or damages as a result of the breach. It is possible that a franchisor could condition the continuation of a franchise on the completion of capital improvements or replacements of furniture, fixtures and equipment which the Board of Directors determines are too expensive or otherwise unwarranted in light of general economic conditions or operating results or prospects of the affected hotel. The loss of a franchise could have a material adverse effect upon the operation, financing or value of the hotel subject to the franchise because of the loss of associated name recognition, marketing support and centralized reservation systems. There can be no assurance that an alternative franchise arrangement can be obtained or that significant expenditures might not be imposed as a condition to obtaining a new franchise. The loss of a franchise for one or more of the hotels could have a material adverse effect on the Company's revenues under the Percentage Leases and Cash Available for Distribution to its shareholders. DEPENDENCE ON ACQUISITIONS TO INCREASE CASH AVAILABLE FOR DISTRIBUTION The Company's success in implementing its growth plan will depend significantly on the Company's ability to acquire additional hotels at attractive prices. After the ramp-up of certain of the hotels which were recently redeveloped or renovated and repositioned or which are expected to be redeveloped or renovated and repositioned in the near future, internal growth in ADR and occupancy for the hotels is not expected to provide as much growth in Cash Available for Distribution as will acquisition of additional hotels. However, since the Company intends to borrow funds to purchase, redevelop or renovate and reposition hotels, the Company will be subject to the risks associated with increased indebtedness, such as paying debt service even if cash flow from such additional hotels is not sufficient to pay it or cost overruns in the redeveloping or renovating such additional hotels. -27- 30 REAL ESTATE INVESTMENT RISKS IN GENERAL The Company's hotels will be subject to varying degrees of risk generally incident to the ownership of real property. Income from the hotels may be adversely affected by changes in national and local economic conditions, changes in interest rates and in the availability, cost and terms of mortgage funds, the impact of present or future environmental legislation and compliance with environmental laws, the ongoing need for capital improvements, changes in real estate tax rates and other operating expenses, changes in governmental rules (such as those requiring upgrades for disabled persons) and fiscal policies, civil unrest, acts of God, including earthquakes, hurricanes and other natural disasters (which may result in uninsured losses), acts of war, changes in zoning laws, and other factors which are beyond the control of the Company. In addition, real estate investments are relatively illiquid, and the ability of the Company to vary its portfolio in response to changes in economic and other conditions will be limited. DISTRIBUTION OF SUBSTANTIALLY ALL OF CASH AVAILABLE FOR DISTRIBUTIONS; DISTRIBUTIONS INCLUDE RETURN OF CAPITAL Consistent with the Company's practice of acquiring properties in need of renovation or redevelopment, the Company's annual distributions to stockholders have constituted a high percentage of the Company's Cash Available for Distribution. If this continues, the Company will retain little or no cash from the rent payments under the Percentage Leases, and expenditures for additional acquisitions or future capital improvements would have to be funded from borrowings, or from proceeds from the sale of assets (including the hotels) or equity securities. In addition, a percentage of the estimated annual distribution has constituted a return of capital rather than a distribution of retained earnings. Consequently, there is a risk that the distribution rate has been set too high and may not be substantial. TAX RISKS The Company intends to operate so as to be taxes as a REIT under Sections 856-860 of the Internal Revenue Code of 1986 as amended (the "Code"). As long as the Company qualifies for taxation as a REIT, with certain exceptions, the Company will not be taxed at the corporate level on its taxable income that is distributed to its stockholders. A REIT is subject to a number of organizational and operational requirements, including requirements as to the nature of its income and assets, distribution requirements, diversity of stock ownership requirements and record keeping requirements. While the Company intends to satisfy all of these requirements for treatment as a REIT, it is possible that the Company may in the future fail to satisfy one or more of these requirements. Failure to qualify as a REIT would render the Company subject to tax (including any applicable minimum tax) on its taxable income at regular corporate rates and distributions to the stockholders in any such year would not be deductible by the Company. Unless entitled to relief under certain Code provisions, the Company also would be disqualified from treatment as a REIT for the four taxable years following the year during which qualification was lost. Even if the Company qualifies for taxation as a REIT, the Company may be subject to certain state and local taxes on its income and property. In order for the Company to be taxed as a REIT, the Partnership must be classified as a partnership for federal income tax purposes. If the Partnership were to be taxable as a corporation, because the Company's ownership interest in the Partnership constitutes more than 10% of the Partnership's voting securities and exceeds 5% of the value of the Company's assets, the Company would cease to qualify as a REIT. The imposition of corporate income tax on the Company and the Partnership would substantially reduce the amount of Cash Available for Distribution. OWNERSHIP LIMITATION In order for the Company to maintain its qualification as a REIT, not more than 50% in value of its outstanding stock may be owned, directly or indirectly, by five or fewer individuals (as defined in the Code to include certain entities). Furthermore, if any stockholder or group of stockholders of the Lessee owns, actually or constructively, 10% or more of the stock of the Company, the Lessee could become a related party tenant of the Partnership, which likely would result in loss of REIT status for the Company. For the purpose of preserving the -28- 31 Company's REIT qualification, the Company's Articles of Incorporation prohibit direct or indirect ownership of more than 9.8% of the outstanding shares of any class of the Company's stock by any person or group (the "Ownership Limitation"). Generally, the capital stock owned by affiliated owners will be aggregated for purposes of the Ownership Limitation. Subject to certain exceptions, any transfer of Common or Preferred Stock that would prevent the Company from continuing to qualify as a REIT under the Code will be designated as "Shares-in-Trust" and transferred automatically to a trust (the "Share Trust") effective on the day before the purported transfer of such Common or Preferred Stock. The record holder of the Common or Preferred Stock that are designated at Shares-in-Trust will be required to submit such number of Common or Preferred Stock to the Share Trust and the beneficiary of the Share Trust will be one or more charitable organizations that are named by the Company. ITEM 3. LEGAL MATTERS Neither the Company nor the Partnership is currently involved in any material litigation, nor, to the Company's knowledge, is any material litigation currently threatened against the Company or the Partnership or any of the hotels. The Lessee and the Management Company have each advised the Company that is currently is not involved in any material litigation. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the quarter ended December 31, 1997. -29- 32 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS PRICE RANGE OF COMMON STOCK The Company's Common Stock commenced trading in the over-the-counter market on August 16, 1995 and since July 23, 1996, has been listed on the New York Stock Exchange under the symbol "SSI". The following table sets forth the periods indicated, the high and low price information for the Common Stock on the NASDAQ National Market or New York Stock Exchange, as applicable.
HIGH LOW --------- --------- 1995 Third Quarter (from August 16, 1995) .............. $ 9.625 $ 8.875 Fourth Quarter .................................... 10.500 7.875 1996 First Quarter ..................................... $ 11.500 $ 9.750 Second Quarter .................................... 11.625 9.875 Third Quarter ..................................... 10.875 9.500 Fourth Quarter .................................... 13.625 10.000 1997 First Quarter ..................................... $ 14.000 $ 12.250 Second Quarter .................................... 14.500 12.625 Third Quarter ..................................... 18.125 13.750 Fourth Quarter..................................... 18.125 15.500 1998 First Quarter (through February 27, 1998) ......... $ 17.375 $ 15.125 --------- ---------
STOCKHOLDER INFORMATION As of February 27, 1998, there were approximately 663 record holders of the Company's Common Stock. On February 27, 1998, the last reported sale price of the Common Stock on the NYSE was $16.125 per share. In addition, the Partnership Units (which are exchangeable for Common Stock) were held by 51 entities and/or individuals as of February 27, 1998. In order to comply with certain requirements related to qualification of the Company as a REIT, the Company's Articles of Incorporation limits the number of shares of Common Stock that may be beneficially owned by any single person to 9.8% of the Company's outstanding Common Stock. -30- 33 DIVIDENDS The Company has adopted a policy of paying regular quarterly dividends on its common stock, and cash distributions have been paid on the Company's common stock with respect to each quarter since its inception. The following table sets forth information regarding the declaration and payment of distributions by the Company since its inception of operation on August 16, 1995.
Quarter Distribution Distribution Per Share to Which Record Payment Distribution Distribution Relates Date Date Amount - --------------------- ------------ ------------ ------------- 1995 3rd Quarter 10/20/95 11/1/95 $0.115 (1) 4th Quarter 12/29/95 1/31/96 $0.23 1996 1st Quarter 5/1/96 5/15/96 $0.23 2nd Quarter 8/1/96 8/15/96 $0.23 3rd Quarter 11/1/96 11/15/96 $0.25 4th Quarter 2/1/97 2/14/97 $0.25 1997 1st Quarter 4/29/97 5/15/97 $0.25 2nd Quarter 7/31/97 8/15/97 $0.25 3rd Quarter 9/30/97 11/14/97 $0.275 4th Quarter 12/31/97 2/15/98 $0.275
- ---------- (1) Represents the pro rata portion (for the period from August 16, 1995 to September 30, 1995, of a quarterly distribution of $0.23. ITEM 6. SELECTED FINANCIAL DATA The following tables set forth (i) selected historical financial information for the Company for the years ended December 31, 1997 and 1996 and for the period August 16, 1995 (inception) through December 31, 1995, (ii) pro forma information for the Company for the year ended December 31, 1995 which assumes that all transactions related to the IPO occurred on January 1, 1995, (iii) historical information for the Lessee for the years ended December 31, 1997 and 1996 and the period August 16, 1995 (inception) to December 31, 1995, and (iv) historical information for the predecessor of the Company ("Sunstone Hotels") for the period January 1 1995 through August 15, 1995 and for the years ended December 31, 1995 and 1994. The selected combined historical financial information for Sunstone Hotels for the years ended December 31, 1994 and 1993 has been derived for the combined historical financial statements and notes thereto of Sunstone Hotels audited by Coopers and Lybrand LLP, independent accountants. -31- 34 The following selected historical financial information should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the financial statements and notes thereto included in this Annual Report. SUNSTONE HOTEL INVESTORS, INC. (THE COMPANY)
Inception For the Year Ended December 31, August 16, 1995 ------------------------------------------------------- to December 31, 1997 1996 1995 1995 ------------- ------------- ------------- ------------- (Actual) (Actual) (Pro Forma) (Actual) REVENUES: Lease revenue - Lessee $ 44,680,000 $ 14,848,000 $ 9,300,000 $ 3,013,000 Interest income 471,000 236,000 47,000 47,000 ------------- ------------- ------------- ------------- 45,151,000 15,084,000 9,347,000 3,060,000 ------------- ------------- ------------- ------------- EXPENSES: Real estate related depreciation and amortization 14,749,000 4,514,000 2,276,000 968,000 Interest expense and amortization of financing costs 6,365,000 1,558,000 47,000 47,000 Real estate and personal property taxes and insurance 4,670,000 1,273,000 853,000 312,000 General and administrative 1,890,000 1,015,000 375,000 109,000 ------------- ------------- ------------- ------------- Total expenses 27,674,000 8,360,000 3,551,000 1,436,000 ------------- ------------- ------------- ------------- Income before minority interest and extraordinary item 17,477,000 6,724,000 5,796,000 1,624,000 Minority interest (1,886,000) (1,090,000) (1,011,000) (284,000) ------------- ------------- ------------- ------------- Income before extraordinary item 15,591,000 5,634,000 4,785,000 1,340,000 Extraordinary charge for early extinguishment of debt (net of $34,000 of minority interest) -- -- -- (159,000) ------------- ------------- ------------- ------------- NET INCOME 15,591,000 5,634,000 4,785,000 1,181,000 Dividends on preferred shares (422,000) -- -- -- ------------- ------------- ------------- ------------- INCOME AVAILABLE TO COMMON SHAREHOLDERS $ 15,169,000 $ 5,634,000 $ 4,785,000 $ 1,181,000 ============= ============= ============= ============= DILUTED EARNINGS PER SHARE $ 0.71 $ 0.69 $ 0.76 $ 0.19 FUNDS FROM OPERATIONS ("FFO") $ 32,226,000 $ 11,238,000 $ 8,072,000 $ 2,592,000 Balance Sheet and Other Data: Investments in hotel properties, net $ 704,323,000 $ 152,937,000 $ 50,063,000 $ 50,063,000 Total debt 307,830,000 63,300,000 11,510,000 11,510,000 Number of properties owned at end of period 53 24 11 11 Number of rooms at end of period 9,854 3,389 1,477 1,477
-32- 35 SELECTED FINANCIAL INFORMATION (THE LESSEE AND THE PREDECESSOR)
Sunstone Hotel Properties Inc. Sunstone Hotels (Predecessor) --------------------------------------------------- -------------------------------------------------- For the Years Ended From For the Period December 31, August 16, January 1 to For the Years Ended December 31, ------------- ------------- 1995 (Inception) to August 15, --------------------------------- 1997 1996 December 31, 1995 1995 1994 1993 ------------- ------------- ----------------- ------------- ------------- -------------- Hotel operating revenue $ 118,153,000 $ 38,593,000 $ 7,925,000 $ 9,675,000 $ 13,863,000 $ 11,937,000 Hotel operating expense 75,604,000 26,907,000 5,658,000 5,679,000 9,168,000 7,514,000 Operating Profit 42,549,000 11,686,000 2,267,000 3,996,000 4,695,000 4,423,000 Lease rent expense 44,680,000 14,848,000 3,013,000 -- -- -- Net income (loss) (2,131,000) (3,162,000) (746,000) 1,674,000 398,000 245,000
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL The Company is a self-administered equity REIT that owns and leases luxury, upscale and mid-price hotels located primarily in the Pacific and Mountain regions of the western United States. The hotels operate primarily under national franchises that are among the most respected and widely recognized in the lodging industry, including brands affiliated with Hilton Hotels Corporation, Holiday Hospitality Corporation, Marriott International, Inc. and Promus Hotel Corporation. As of February 27, 1998, the Company's portfolio consisted of 57 hotels with a total of 10,355 rooms, 46 of which were acquired and one which was developed subsequent to the Company's IPO in August 1995. The majority of the Company's hotel portfolio consists of luxury, upscale and mid-price full-service hotels and upscale extended-stay properties (approximately 75.4%) with the remainder of the Company's portfolio consisting of mid-price, limited service properties primarily located in markets where significant barriers exist for new competitive supply. The Company's growth strategy is to maximize shareholder value by (i) acquiring underperforming and undercapitalized hotels that are in strong market locations with significant barriers to entry, and (ii) improving such hotels' financial performance by renovating, redeveloping, rebranding and repositioning the hotels and through the implementation of focused sales and marketing programs. The Company's business strategy encompasses increasing REVPAR by increasing ADR and occupancy. This strategy is typically implemented by replacing certain discontinued group business with higher-rate group and transient business and by selectively increasing room rates. Success with this strategy has been achieved because of (i) the relatively high occupancy rates at certain of its hotels, (ii) the success of a superior marketing strategy implemented at each acquired hotel, and (iii) the effects of repositioning recently acquired hotels as high-quality properties with strong national franchisers through the Company's redevelopment and rebranding program. RESULTS OF OPERATIONS COMPARISON OF THE QUARTERS AND YEARS ENDED DECEMBER 31, 1997 AND 1996 During 1997, the Company: o acquired or invested in 29 hotels for an aggregate purchase price of $521.8 million, increasing the number of states the Company owns properties in from five to 12; o increased the number of rooms in its hotel portfolio nearly two times through acquisition and development, from 3,389 rooms to 9,854; -33- 36 o invested $48.8 million in renovation and redevelopment to 19 hotels; o completed the development of a 39-room addition to its Residence Inn in Highlands Ranch, Colorado for approximately $2.2 million; o raised approximately $288.1 million of equity capital through the sale of common stock in four follow-on offerings; and o increased availability under the Company's unsecured bank credit facility from $50.0 million to $200.0 million. Fourth Quarter. For the fourth quarter ended December 31, 1997, income available to common shareholders doubled to $3.0 million from $1.5 million, and diluted earnings per share decreased by 23.1% to $0.10 per share from $0.13 per share, while revenues increased 284% to $17.3 million from $4.5 million, as compared to the fourth quarter of 1996. The decrease in net income per share was primarily due to the effects of straight-line depreciation expense recorded during the off-peak season activity typically experienced during the fourth quarter. The Company experienced strong revenue growth of its hotels for the fourth quarter of 1997. Fourth quarter total room revenue from the Company's hotels increased 238%, from $10.4 million to $35.1 million over the fourth quarter of 1996, primarily due to the completion of $521.8 million of hotel acquisitions during the preceding twelve months. On a same-unit-sales basis for the entire portfolio, the Company achieved a 7.7% increase in REVPAR for the fourth quarter of 1997 over the corresponding quarter of 1996. REVPAR for the non-renovation hotels significantly increased by 15.4%, from $37.42 to $43.17, over the fourth quarter of 1996. Non-renovation hotels consist of 43 of the Company's 51 hotels owned by Sunstone that were not undergoing significant renovation either in the fourth quarter of 1996 or 1997. The 15.4% increase in REVPAR was driven by a 14.2% increase in average daily rate, from $63.40 to $72.43, while occupancy remained constant. Strong revenue performance was achieved not only with the Company's renovated properties, but also with many of the recently acquired Kahler Hotels. REVPAR for the fourth quarter of 1997 for the eight 1997-renovation hotels (which were undergoing renovation during the fourth quarter of 1997) decreased 15.6% over the corresponding quarter of 1996, a period during which these hotels were not undergoing renovation. There were no hotels undergoing renovation in the fourth quarter of 1996. Year-End. For the year ended December 31, 1997, income available to common shareholders increased 171.4% to $15.2 million from $5.6 million, and diluted earnings per share increased by 2.9% to $0.71 from $0.69 per share. Revenues increased 199% to $45.2 million from $15.1 million, as compared to the year ended December 31, 1996. The increase in net income, diluted net income per share and revenues was due to the Company's execution of its growth strategy. (See related discussion of Funds From Operations following in "Liquidity and Capital Resources.") The Company experienced strong revenue growth of its hotels during 1997. Total room revenue from the Company' hotels increased 177.1% from $34.1 million to $95.1 million over 1996, primarily due to the completion of $521.8 million of hotel acquisitions during the preceding twelve months. On a same-unit-sales basis for the entire portfolio, the Company achieved an 8.6% increase in REVPAR during 1997 compared to 1996. The strong 8.6% REVPAR growth for the year ended December 31, 1997 over 1996 was a result of both the performance of the recently repositioned hotels and the internal revenue growth from continuously operated hotels. For comparative purposes, for the year ended December 31, 1997, the nationwide lodging industry, REVPAR growth for the luxury, upscale and mid-price hotel segments, the segments most representative of the Company's hotels, were 5.9%, 4.8% and 4.6%, respectively. The 8.6% increase was fueled by a 9.4% increase in ADR, from $64.65 in 1996 to $70.75 in 1997. REVPAR for 1997 for the non-renovation hotels significantly increased by 18.0%, from $41.10 to $48.51, over 1996. Non-renovation hotels represent the Company's portfolio of hotels during periods of stabilized activity in -34- 37 both 1997 and 1996. The 18.0% increase in REVPAR was driven by a 11.0% increase in average daily rate, from $64.35 to $71.46, while occupancy increased four percentage points. REVPAR for 1997, for the hotels which were undergoing renovation during certain months of 1996 or 1997, decreased 3.9% over the corresponding periods of 1996. During 1997, the Company invested $48.8 million redeveloping and renovating 19 of the 53 hotels owned during the year as compared to $9.6 million invested in eight of the 24 hotels owned during the year ended December 31, 1996. In conjunction with the current year redevelopment and renovation activities, the Company rebranded and upgraded seven hotels with new and existing franchises. The following table summarizes average occupancy, ADR and REVPAR on a same-unit-sales basis for the hotels for the quarters and years ended December 31, 1997 and 1996 and the year ended December 31, 1995:
For the Quarters Ended For the Years Ended For the Years Ended December 31 December 31 December 31 ---------------------- ------------------- ------------------- 1997 1996 1997 1996 1996 1995 ------ ------ ------ ------ ------ ------ SAME-UNIT SALES ANALYSIS Number of Hotels 53 53 53 53 24 24 Number of Rooms 9,854 9,854 9,854 9,854 3,389 3,389 ALL HOTELS: Occupancy 58.5% 61.2% 65.4% 65.9% 64.9% 66.9% ADR $73.32 $65.02 $70.75 $64.65 $62.13 $58.04 REVPAR $42.87 $39.82 $46.24 $42.57 $40.30 $38.82 REVPAR growth 7.7% 8.6% 3.8% NON-RENOVATION HOTELS: Occupancy 59.6% 59.0% 67.9% 63.9% 66.7% 66.2% ADR 72.43 $63.40 $71.46 $64.35 $62.01 $57.51 REVPAR $43.17 $37.42 $48.51 $41.10 $41.38 $38.08 REVPAR growth 15.4% 18.0% 8.7% RENOVATION HOTELS: Occupancy 54.1% 74.5% 61.1% 68.4% 54.5% 66.2% ADR $77.14 $66.37 $67.90 $63.11 $62.72 $60.17 REVPAR $41.70 $49.43 $41.50 $43.19 $34.17 $39.85 REVPAR growth (15.6%) (3.9)% (14.3%)
Interest expense and amortization of financing costs increased to $6.4 million from $1.6 million, and real estate and personal property taxes and insurance increased to $4.7 million from $1.3 million, for the year ended December 31, 1997 in comparison to the prior year. Additionally, real estate related depreciation and amortization increased $10.2 million in 1997. These increases are attributable to the growth of the Company's hotel portfolio to 53 hotels during 1997 compared to 24 hotels owned during 1996. Acquisitions are typically initially financed with debt contributing to the increase in interest expense and amortization of financing costs. During 1997, the Company recorded increased general and administrative expenses relating to due diligence for hotels not acquired and other general and administrative costs incurred to the growth of the Company's hotel portfolio. Additionally, effective January 1, 1997, the Company increased the compensation of the President and added a chief financial officer, corporate controller, cash manager and other administrative staff necessitated by the Company's growth. As a result, general and administrative expenses increased to $1.9 million from $1.0 million for the year ended December 31, 1997 in comparison to the prior year. -35- 38 Comparison of the Year Ended December 31, 1996 and the Year Ended December 31, 1995 (Pro Forma) For the year ended December 31, 1996, net income increased by 16.7% to $5.6 million from pro forma net income of $4.8 million, while revenues increased 62.4% to $15.1 million from pro forma revenues of $9.3 million, as compared to the pro forma year ended December 31, 1995. For those hotels not undergoing renovation, results for the year ended December 31, 1996 reflect same-unit-sales increases in REVPAR of 8.7% from $38.08 to $41.38 and ADR of 7.8% from $57.51 to $62.01, with an increase in occupancy rates of 0.5 percentage points to 66.7%. REVPAR for hotels under renovation during 1996 decreased 14.3% compared to 1995. National Franchise Affiliations The Company generally believes that franchise affiliations provide advantages to certain hotels. Such advantages include brand recognition, access to national reservation systems, national direct sales efforts and national volume purchasing agreements, and technical and business assistance. The use of multiple franchise systems provides the Company with further diversification, less dependence on the continued popularity of one brand and less vulnerability to new requirements of any individual franchise affiliation. The Company expects to focus its franchise affiliations on nationally recognized upscale hotel chains. The following table summarizes certain information with respect to the current or anticipated franchise affiliations of the hotels. FRANCHISE AFFILIATIONS (As of and for the Year Ended December 31, 1997)
Percentage of Number of Percentage of Lease Lease Franchise Affiliation (1) Hotels Rooms Rooms Revenues Revenues - ------------------------- ------------- ---------------- -------------- ------------------ ------------ Marriott - Courtyard and Residence Inn (2) 13 2,449 24.9% $ 9,251,000 20.7% Holiday Inns 15 2,366 24.0 13,397,000 30.0 Hampton Inns 8 1,063 10.8 8,883,000 19.9 Kahler 2 965 9.8 2,260,000 5.0 Independent 3 649 6.6 876,000 2.0 Hawthorn Suites (3) 3 583 5.9 3,742,000 8.4 Best Western 3 364 3.7 779,000 1.7 Hilton 1 351 3.5 980,000 2.2 Sheraton 1 295 3.0 940,000 2.1 Radisson 1 238 2.4 278,000 0.6 Doubletree Hotels 1 213 2.2 1,334,000 3.0 Comfort Suites 1 166 1.7 1,848,000 4.1 Quality Inn 1 152 1.5 112,000 0.3 ------------- ---------------- -------------- ------------------ ------------ 53 9,854 100.0% $ 44,680,000 100.0% ============= ================ ============== ================== ============
- ---------- (1) Several of the other Kahler Hotels will likely be branded or rebranded, under either Marriott, Courtyard by Marriott, Holiday Inn Hotel & Suites or Holiday Inn Brands. Certain of the Company's planned changes in franchise affiliations are included in this table. There can be no assurance that the Company will receive final approval from the applicable franchisor. (2) Includes five hotels from the Kahler Acquisition with 1,238 rooms which the Company anticipates converting to various Marriott franchises. The Company has obtained approval of these new franchise licenses, subject to completion of renovations or improvements. (3) Includes the Anaheim and Sacramento, California hotels which will be rebranded as Hawthorn Suites hotels upon completion of renovation and improvements which are expected to be completed in the first quarter of 1998. -36- 39 Seasonality and Regional Focus The Company focuses its acquisition efforts principally on the Pacific and Mountain regions which collectively comprise the western United States where favorable supply and demand demographic trends currently exist. The geographic distribution of the hotels, which are located in 12 states, reflects the Company's belief that a certain amount of geographic distribution helps to insulate the Company's hotel portfolio from local market fluctuations that are typical for the hotel industry. The Company has also sought to increase its geographic distributions by focusing on major metropolitan areas. The following table summarizes the Company's presence in each of these 12 markets, including the Kahler Hotels: GEOGRAPHIC DIVERSIFICATION (As of and for the Year Ended December 31, 1997)
PERCENTAGE PERCENTAGE NUMBER OF OF LEASE OF LEASE REGION HOTELS ROOMS ROOMS REVENUES REVENUES - ------ --------- ----- ---------- -------- ---------- Mountain (1)........................ 24 4,319 43.8% $ 18,186,000 40.7% Pacific (2)......................... 23 3,735 37.9 22,708,000 50.8 Minnesota........................... 4 1,329 13.5 3,275,000 7.3 Other (3)........................... 2 471 4.8 511,000 1.2 ------- ------ -------- -------------- ----- Total.......................... 53 9,854 100.0% $ 44,680,000 100.0% ======= ====== ======== ============== =====
- ------------------- (1) Includes Arizona, Colorado, Idaho, Montana, New Mexico and Utah. (2) Includes California, Oregon and Washington (3) The Company is considering the sale or exchange of the two Kahler Hotels located in Texas and West Virginia. LIQUIDITY AND CAPITAL RESOURCES Cash Flow Provided by Operating Activities. The Company's operating activities provide the principal source of cash to fund the Company's operating expenses, interest expense, recurring capital expenditures and dividend payments. The Company anticipates that its cash flow provided by leasing the hotels to the Lessee will provide the necessary funds on a short- and long-term basis to meet its operating cash requirements. In 1997, the Company paid dividends and distributions totaling $21.1 million representing an average of $0.26 per share or Unit on a quarterly basis. Beginning with the third quarter of 1997, the Company increased its regular quarterly dividend 10.0% to $0.275 per share. Cash Flows from Investing and Financing Activities. The Company believes a regular program of capital improvements, including replacement and refurbishment of furniture, fixtures and equipment at its hotels, as well as the periodic renovation and redevelopment of certain of its hotels, is essential to maintaining the competitiveness of the hotels and maximizing revenue growth. The Company is also required under the Percentage Leases to make available to the Lessee for the repair, replacement and refurbishment of furniture, fixtures and equipment an amount equal to 4% of the room revenue per quarter on a cumulative basis, provided that such amount may be used for capital expenditures made by the Company with respect to the hotels. The Company expects that this amount will be adequate to fund the required repairs, replacements and refurbishments and to maintain its hotels in a competitive condition. -37- 40 Additionally, the Company intends to finance the acquisition of additional hotel properties, hotel renovations and non-recurring capital improvements principally through its $300 million unsecured revolving line of credit facility (the "Credit Facility") from its lenders (led by Bank One of Arizona, N.A., as the agent bank) and, when market conditions warrant, to issue additional equity or debt securities. During 1997 and 1998, the Credit Facility was increased from a $50 million secured credit facility accruing interest at a rate of the three-month LIBOR plus 1.75% to a $300 million unsecured facility accruing interest at a rate as low as LIBOR plus 1.40% based upon the debt leverage of the Company, with provisions for reduced rates upon receipt by the Company of an investment grade rating. During 1997, the Company raised $301.2 million through issuance and assumption of debt and $330.9 million through issuance of common and preferred stock. As of December 31, 1997, the Company had $11.1 million of unused credit on the Credit Facility and immediately after the Company's February 11, 1998 spot offering had $116.7 million available under the Credit Facility (net of $10.1 million reserved availability for the development of hotels). Up to $15.0 million of the Credit Facility may be used for working capital purposes. The Credit Facility has a two year term, maturing July 1, 1999, with a one-year extension option in favor of the Company. The Credit Facility may be retired in whole or in part from the proceeds of public or private issuances of equity or debt securities by the Company and may be refinanced in whole or in part with fixed-rate financing. The Company may seek to obtain such a stand-alone mortgage facility if market conditions are appropriate in management's view. As part of its investment strategy, the Company plans to acquire additional hotels. Future acquisitions are expected to be funded through the use of the Credit Facility or other borrowings and the issuance of additional equity or debt securities. The Company's Articles of Incorporation limits consolidated indebtedness to 50% of the Company's investment in hotel properties, at cost on a consolidated basis, after giving effect to the Company's use of proceeds from any indebtedness. Management believes that it will have access to capital resources sufficient to satisfy the Company's cash requirements and to expand and develop its business in accordance with its strategy for future growth. During 1997, the Company used cash in the amount of $389.6 million as well as debt and the issuance of Units to acquire hotel assets, including redevelopment and recurring capital expenditures. During 1997, the Company substantially completed approximately $48.8 million in major renovations and conversions of 19 of its hotels. The Company is currently engaged in renovating 20 of its more recently acquired hotels for approximately $29.7 million. Management believes the renovation should result in incremental increases in REVPAR at these renovation hotels and increased lease revenue for the Company. In addition, the Company may acquire additional hotels and invest additional cash for renovations during 1998. Funds from Operations ("FFO"). Management believes that FFO is one measure of financial performance of an equity REIT, such as the Company. FFO (as defined) (1) grew by 187.0% to $32.2 from $11.2 million.
1997 1996 1995 Actual Actual Pro Forma ----------- ----------- ----------- Income before minority interest $17,477,000 $ 6,724,000 $ 5,796,000 Real estate related depreciation 14,749,000 4,514,000 2,276,000 ----------- ----------- ----------- Funds from operations $32,226,000 $11,238,000 $ 8,072,000 =========== =========== ===========
(1) Management and industry analysts generally consider funds from operations to be one measure of the financial performance of an equity REIT that provides a relevant basis for comparison among REITs and it is presented to assist investors in analyzing the performance of the Company. Funds From Operations is defined as income before minority interest (computed in accordance with generally accepted accounting principles), excluding gains (losses) from debt restructuring and sales of property plus real estate related depreciation and amortization (excluding amortization of financing costs). Funds From Operations does not represent cash generated from operating activities in accordance with generally accepted accounting principles and is not necessarily indicative of cash available to fund cash needs. Funds From Operations should not be considered an alternative to net income as an indication of the Company's financial performance or as an alternative to cash flows from operating activities as a measure of liquidity. -38- 41 Year 2000 Management has examined the Year 2000 issues and believes that they will not have a material effect on the business, results of operations or financial condition of the Company. The Lessee For a discussion of the Lessee's revenue operations and a comparison of the year ended December 31, 1997 to 1996, see "Results of Operations" of the Company. Additionally, the Lessee reported a net loss of $2.1 million in 1997. Notwithstanding the net loss, cash flows were provided by operating activities during 1997 in the amount of $2.1 million. The loss is primarily due to the combined effects on the Lessee of (i) the acquisition of the Kahler portfolio on October 15, 1997 and the related off-peak seasonality activity of that portfolio during the fourth quarter of 1997 and (ii) the effect of the renovations of the Hilton Hotel in Salt Lake City, Utah, the Holiday Inn in Mesa, Arizona and the Ramada Hotel in San Diego, California, representing approximately $1.1 million of the loss. Additional losses are primarily attributable to executing the Company's strategy of renovating and repositioning its acquired hotels, to the transition to new management at acquired hotels and to the operating leverage of certain Percentage Leases. Typically, the Company's renovations and redevelopments of acquired hotels are extensive involving refurbishing exteriors, renovations to restaurants and lobbies and extensive renovations to guest rooms, including guest bath, furniture and soft goods. The Company typically expends 10% to 30% of the purchase price on renovations which typically last approximately three to six months. During the renovations, the Lessee's revenues are significantly reduced. In addition, there is typically a brief ramp up period of approximately one to three months before the renovated hotels produce positive cash flow for the Lessee. Management of the Company and the Lessee believe that the renovation related losses represent costs that have a reasonable assurance of future economic benefit that will be derived from significantly improved operating performance of the renovated and redeveloped hotels. During the periods following renovation and redevelopment in 1996, 1997 and the first two months of 1998, the 26 renovated hotels have experienced significant increases in REVPAR when comparing stabilized, normal, pre-renovation operations in months of the prior year to the corresponding months of stabilized post-renovation operations in 1995, 1996 and 1997. The weighted average REVPAR growth for these periods for the renovated and redeveloped hotels is 16.1% while the national average for 1996 and 1997 was 7.7% and 5.3%, respectively. While the Company significantly benefited from this upside improvement, the Lessee also minimized its losses from these hotels during the post-renovation periods. Management of the Company and the Lessee believe that REVPAR and operations for the renovated and redeveloped hotels will continue to show improved results in the short- and long-term. There can be no assurance, however, that the Lessee's operating results will improve because of various factors described under "Risk Factors." Further, the acquisition by the Company of additional hotels, requiring extensive renovations or redevelopment could create significant negative cash flows offsetting the improved operating results of the renovated and redeveloped hotels. As of December 31, 1997, the Lessee had a net working capital deficit of $6.0 million. The Lessee has access to a $1.5 million working capital line of credit. Executives of the Lessee have pledged $7.6 million of units to secure obligations of the Lessee to the Company under the Percentage Leases. The Lessee anticipates that cash provided by operations will be an adequate source of liquidity for the foreseeable future. -39- 42 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements and supplementary data required by Regulation S-X are included in this Report on Form 10-K commencing on page F-1. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Information with respect to changes in accountants has been previously filed on Current Report on Form 8-K dated July 7, 1997 with disclosure under Item 4 regarding a change in the Company's certifying accountants and is incorporated herein by reference. There were no disagreements with accountants on accounting and financial disclosure. -40- 43 PART III Certain information required by Part III is omitted from this Report in that the Company has filed a definitive proxy statement pursuant to Regulation 14A (the "Proxy Statement") for its Annual Meeting of Stockholders to be held April 17, 1998 and the information included therein is incorporated herein by reference. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY Information with respect to directors of the Company is incorporated by reference from the information under the caption "Election of Director-Nominees" in the Company's Proxy Statement. Information with respect to executive officers of the Company is incorporated by reference from the information under the caption "Executive Officers" in the Company's Proxy Statement. ITEM 11. EXECUTIVE COMPENSATION The information under the caption "Executive Compensation and Other Information" in the Company's Proxy Statement is Incorporated by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information under the caption "Stock Ownership of Management and Principal Stockholders" in the Company's Proxy Statement is Incorporated by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information under the caption "Certain Transactions" in the Company's Proxy Statement is Incorporated by reference. -41- 44 ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) The following documents are filed as part of this report: 1. Financial Statements - See Index to Financial Statements on page F-1. 2. Financial Statement Schedule - See Index to Financial Statements on page F-1. 3. Exhibits: EXHIBIT NO. DESCRIPTION - ------- ----------- 3.1 Amended Articles of Incorporation of the Company, as further amended by the Articles of Amendment of the Company, as filed with the State Department of Assessments and Taxation of Maryland on November 9, 1994, filed as Exhibit 3.1 to the Company's Registration Statement No. 33-84346 and incorporated herein by this reference. 3.2* Amended Bylaws of the Company, as currently in effect, filed as Exhibit 3.2 to the Company's 1997 Annual Report on Form 10-K and filed herewith. 3.3 Articles of Amendment of the Company, as filed with the State Department of Assessments and Taxation of Maryland on June 19, 1995, filed as Exhibit 3.3 to the Company's Registration Statement No. 33-84346 and incorporated herein by this reference. 3.4 Articles of Amendment of the Company, as filed with the State Department of Assessments and Taxation of Maryland on August 14, 1995, filed as Exhibit 3.4 to the Company's Current Report on Form 10-Q for the quarter ended March 31, 1997 and incorporated herein by this reference 3.5 Articles of Amendment of the Company, as filed with the State Department of Assessments and Taxation of Maryland on May 2, 1997, filed as Exhibit 3.5 to the Company's Current Report on Form 10-Q/A for the quarter ended June 30, 1997 and incorporated herein by this reference. 3.6* Articles Supplementary Classifying Shares of 7.9% Class A Cumulative Convertible Preferred Stock, as filed with the State Department of Assessments and Taxation of Maryland on October 14, 1997, filed as Exhibit 3.6 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997. 10.1 thru Omitted 10.1.14 10.1.15* Second Amended and Restated Agreement of Limited Partnership dated as of October 4, 1997, filed as Exhibit 10.1.15 to the Company's 1997 Annual Report on Form 10-K and filed herewith. 10.2 Form of Percentage Lease, filed as Exhibit 10.2 to the Company's Registration Statement No. 33-84346 and incorporated herein by this reference. 10.2.1 Lease Agreement dated as of August 16, 1995 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Hampton Inn Hotel located in Denver S.E., Colorado, filed as Exhibit 10.2.1 to the Company's 1995 10-K and incorporated herein by this reference. 10.2.2 Lease Agreement dated as of August 16, 1995 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Hampton Inn Hotel located in Pueblo, Colorado, filed as Exhibit 10.2.2 to the Company's 1995 10-K and incorporated herein by this reference. 10.2.3 Lease Agreement dated as of August 16, 1995 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Courtyard By Marriott Hotel located in -42- 45 Fresno, California, filed as Exhibit 10.2.3 to the Company's 1995 10-K and incorporated herein by this reference. 10.2.4 Lease Agreement dated as of August 16, 1995 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Courtyard By Marriott Hotel located in Fresno, California, filed As Exhibit 10.2.4 to the Company's 1995 10-K and incorporated herein by this reference. 10.2.5 Lease Agreement dated as of August 16, 1995 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Holiday Inn Hotel located in Steamboat Springs, Colorado, filed as Exhibit 10.2.5 to the Company's 1995 10-K and incorporated herein by this reference. 10.2.6 Lease Agreement dated as of August 16, 1995 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Holiday Inn Hotel located in Craig, Colorado, filed as Exhibit 10.2.6 to the Company's 1995 10-K and incorporated herein by this reference. 10.2.7 Lease Agreement dated as of August 16, 1995 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Holiday Inn Hotel located in Provo, Utah, filed as Exhibit 10.2.7 to the Company's 1995 10-K and incorporated herein by this reference. 10.2.8 Lease Agreement dated as of August 16, 1995 by and between Sunstone Hotel Investors, L.P. as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Hampton Inn Hotel located in Silverthorne, Colorado, filed as Exhibit 10.2.7 to the Company's 1995 10-K and incorporated herein by this reference. 10.2.9 Lease Agreement dated as of August 16, 1995 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Doubletree Hotel located in Santa Fe, New Mexico, filed as Exhibit 10.2.9 to the Company's 1995 10-K and incorporated herein by this reference. 10.2.10 Lease Agreement dated as of August 16, 1995 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Hampton Inn Hotel located in Arcadia, California, filed as Exhibit 10.2.10 to the Company's 1995 10-K and incorporated herein by this reference. 10.2.11 Lease Agreement dated as of December 13, 1995 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Hampton Inn Hotel located in Oakland, California, filed as Exhibit 10.2.11 to the Company's 1995 10-K and incorporated herein by this reference. 10.2.12 Lease Agreement dated February 2, 1996 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Cypress Inn Hotel located in Clackamas, Oregon, filed as Exhibit 10.2.12 to the Company's Quarterly Quarter 1996 10-Q for the quarter ended March 31, 1996 and incorporated herein by this reference. 10.2.13 Lease Agreement dated February 2, 1996 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Cypress Inn Hotel located in Kent, Washington, filed as Exhibit 10.2.13 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1996 and incorporated herein by this reference. 10.2.14 Lease Agreement dated February 2, 1996 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Cypress Inn Hotel located in Poulsbo, Washington, filed as Exhibit 10.2.14 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1996 and incorporated herein by this reference. 10.2.15 Lease Agreement dated February 2, 1996 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Cypress Inn Hotel located in Portland, Oregon, -43- 46 filed as Exhibit 10.2.15 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1996 and incorporated herein by this reference. 10.2.16 Lease Agreement dated March 28, 1996 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Courtyard by Marriott Hotel located in Riverside, California, filed as Exhibit 10.2.16 to the Company's Registration Statement No. 333-07685 and incorporated herein by this reference. 10.2.17 Lease Agreement dated June 28, 1996 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Holiday Inn Hotel located in Renton, Washington, filed as Exhibit 10.2.17 to the Company's Registration Statement No. 333-07685 and incorporated herein by this reference. 10.2.18 Lease Agreement dated August 13, 1996 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Days Inn Hotel located in Price, Utah, filed as Exhibit 10.2.18 to the Company's Registration Statement No. 333-07685 and incorporated herein by this reference. 10.2.19 Lease Agreement dated September 20, 1996 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Residence Inn Hotel located in Highlands Ranch, Colorado, filed as Exhibit 10.2.18 to the Company's Registration Statement No. 333-07685 and incorporated herein by this reference. 10.2.20 Lease Agreement dated August 13, 1996 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Comfort Suites Hotel located in South San Francisco, California, filed as Exhibit 10.2.20 to the Company's Registration Statement No. 333-07685 and incorporated herein by this reference. 10.2.21 Lease Agreement dated October 29, 1996 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Hampton Inn located in Tucson, Arizona. Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2 to Item 601 of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are set forth in the schedule filed as Exhibit 10.2.21 to the Company's Quarterly Report on Form 10-Q/A for the quarter ended June 30, 1997 and incorporated herein by this reference. 10.2.22 Lease Agreement dated October 29, 1996 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Holiday Inn located in Mesa, Arizona. Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2 to Item 601 of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are set forth in the schedule filed as Exhibit 10.2.22 to the Company's Quarterly Report on Form 10-Q/A for the quarter ended June 30, 1997 and incorporated herein by this reference. 10.2.23 Lease Agreement dated October 29, 1996 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Holiday Inn located in Flagstaff, Arizona. Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2 to Item 601 of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are set forth in the schedule filed as Exhibit 10.2.23 to the Company's Quarterly Report on Form 10-Q/A for the quarter ended June 30, 1997 and incorporated herein by this reference. 10.2.24 Lease Agreement dated December 19, 1996 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Radisson Suites located in Oxnard, California. Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2 to Item 601 of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are set forth in the schedule filed as Exhibit 10.2.24 to the Company's Quarterly Report on Form 10-Q/A for the quarter ended June 30, 1997 and incorporated herein by this reference. 10.2.25 Lease Agreement dated January 17, 1997 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Holiday Inn located in San Diego, California. -44- 47 Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2 to Item 601 of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are set forth in the schedule filed as Exhibit 10.2.25 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997 and incorporated herein by this reference. 10.2.26 Lease Agreement dated January 17, 1997 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Ramada Hotel located in Cypress, California. Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2 to Item 601 of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are set forth in the schedule filed as Exhibit 10.2.26 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997 and incorporated herein by this reference. 10.2.27 Lease Agreement dated March 10, 1997 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Hawthorne Suites Hotel located in Kent, Washington. Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2 to Item 601 of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are set forth in the schedule filed as Exhibit 10.2.27 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997 and incorporated herein by this reference. 10.2.28 Lease Agreement dated March 31, 1997 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Holiday Inn located in La Mirada, California. Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2 to Item 601 of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are set forth in the schedule filed as Exhibit 10.2.28 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997 and incorporated herein by this reference. 10.2.29 Lease Agreement dated May 6, 1997 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Fountain Suites located in Sacramento, California. Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2 to Item 601 of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are set forth in the schedule filed as Exhibit 10.2.29 to the Company's Quarterly Report on Form 10-Q/A for the quarter ended June 30, 1997 and incorporated herein by this reference. 10.2.30 Lease Agreement dated June 11, 1997 by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Ramada Plaza Hotel located in Old Town, San Diego, California. Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2 to Item 601 of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are set forth in the schedule filed as Exhibit 10.2.30 to the Company's Quarterly Report on Form 10-Q/A for the quarter ended June 30, 1997 and incorporated herein by this reference. 10.2.31 Lease Agreement dated July 17, 1997, by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Best Western located in Lynnwood, Washington. Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2 to Item 601 of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are set forth in the schedule filed as Exhibit 10.2.31 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997 and incorporated herein by this reference. 10.2.32 Lease Agreement dated August 7, 1997, by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Holiday Inn located in San Diego, California. Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2 to Item 601 of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are set forth in the schedule filed as Exhibit 10.2.32 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997 and incorporated herein by this reference. 10.2.33 Lease Agreement dated August 7, 1997, by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Crystal Suites located in Anaheim, California. Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2 to Item 601 of -45- 48 Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are set forth in the schedule filed as Exhibit 10.2.33 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997 and incorporated herein by this reference. 10.2.34 Lease Agreement dated August 28, 1997, by and between Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Regency Plaza located in Los Angeles. Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2 to Item 601 of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are set forth in the schedule filed as Exhibit 10.2.34 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997 and incorporated herein by this reference. 10.2.35* Lease Agreement by and between Sunstone Hotel Investors, L.P. or its subsidiaries as lessor, and Sunstone Hotel Properties, Inc., as lessee, substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2 to Item 601 of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are set forth in the schedule filed herewith. 10.3 Form of Right of First Refusal and Option to Purchase, filed as Exhibit 10.3 to the Company's Registration Statement No. 33-84346 and incorporated herein by this reference. 10.4 Form of Alter Employment Agreement, filed as Exhibit 10.4 to the Company's Registration Statement No. 33-84346 and incorporated herein by this reference. 10.5 Form of Biederman Employment Agreement, filed as Exhibit 10.5 to the Company's Registration Statement No. 33-84346 and incorporated herein by this reference. 10.6 Form of Indemnification Agreement to be entered into with officers and directors of the Company, filed as Exhibit 10.6 to the Company's Registration Statement No. 33-84346 and incorporated herein by this reference. 10.7 1994 Stock Incentive Plan, filed as Exhibit 10.7 to the Company's Registration Statement No. 33-84346 and incorporated herein by this reference. 10.7.1 Amendment to the 1994 Stock Incentive Plan filed on March 17, 1997 as Appendix A with the Company's 1997 Proxy Statement and incorporated herein by this reference. 10.8 Form of Notice of Grant of Stock Option and Form of Stock Option Agreement (and Addendum thereto) to be generally used in connection with the Discretionary Option Grant Program of the 1994 Stock Incentive Plan, filed as Exhibit 10.8 to the Company's Registration Statement No. 33-84346 and incorporated herein by this reference. 10.9 Form of Stock Purchase Agreement to be generally used in connection with the Discretionary Option Grant Program of the 1994 Stock Incentive Plan, filed as Exhibit 10.9 to the Company's Registration Statement No. 33-84346 and incorporated herein by this reference. 10.10 1994 Directors Plan, filed as Exhibit 10.10 to the Company's Registration Statement No. 33-84346 and incorporated herein by this reference. 10.10.1 Amendment to the 1994 Directors Plan filed on March 17, 1997 as Appendix B with the Company's 1997 Proxy Statement and incorporated herein by this reference. 10.11 Form of Notice of Grant of Automatic Stock Option, Automatic Stock Option Agreement, Stock Purchase Agreement and Automatic Direct Stock Issuance Agreement to be generally used in connection with the 1994 Directors Plan, filed as Exhibit 10.11 to the Company's Registration Statement No. 33-84346 and incorporated herein by this reference. 10.12 thru Omitted 10.20 -46- 49 10.21* List of Subsidiaries of the Registrant 10.22 thru Omitted 10.30.17 10.30.18* Amended and Restated Third Party Pledge Agreement among the Partnership, Robert A. Alter and Charles Biederman, effective August 28, 1997 filed as Exhibit 10.30.18 to the Company's 1997 Annual Report on Form 10-K and filed herewith. 10.31 Omitted 1031.1* Amended and Restated Revolving Credit Agreement dated as of October 10, 1997, among Sunstone Hotel Investors, L.P., Bank One Arizona, NA, Credit Lyonnais New York Branch, Wells Fargo Bank, National Association, filed as Exhibit 10.31.1 to the Company's 1997 Annual Report on Form 10-K and filed herewith. 10.32 Stock Purchase Agreement among the Company, Westbrook Real Estate Fund I, L.P., Westbrook Real Estate Co-Investment Partnership I, L.P. and Kahler Realty Corporation dated as of August 5, 1997, filed on August 14, 1997 as Exhibit 10.1 to the Company's Current Report on Form 8-K and incorporated herein by this reference. 10.33* Registration Rights Agreement among the Company, Westbrook Real Estate Fund I, L.P., Westbrook Real Estate Co-Investment Partnership I, L.P. dated as of October 15, 1997 and filed as Exhibit 10.33 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997. 23.1* Consent of Ernst & Young LLP 23.2* Consent of Coopers & Lybrand L.L.P. 27* Financial Data Schedule - ---------- * Filed herewith. (b) Reports on Form 8-K; all other exhibits previously filed. Current Report on Form 8-K dated October 9, 1997 with disclosure under Item 5 filing the Underwriting Agreement and the Opinion letters relating to a securities offering by the Company. Current Report on Form 8-K dated October 15, 1997, with disclosure under Item 2 regarding Acquisition and Disposition of Assets. -47- 50 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form 10 to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of San Clemente, State of California, on March 9, 1998. SUNSTONE HOTEL INVESTORS, INC. By: /s/ ROBERT A. ALTER --------------------------------------- Robert A. Alter President, Secretary and Chairman of the Board of Directors Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10K has been signed below by the following persons in the capacities and on the dates indicated:
SIGNATURE TITLE DATE --------- ----- ---- /s/ ROBERT A. ALTER President, Secretary and Chairman March 9, 1998 - ---------------------------- of the Board of Directors (Principal Robert A. Alter Executive Officer) /s/ CHARLES L. BIEDERMAN Vice Chairman of the Board of March 9, 1998 - ---------------------------- Directors Charles L. Biederman /s/ KENNETH J. BIEHL Vice President and Chief Financial March 9, 1998 - ---------------------------- Officer (Principal Financial and Kenneth J. Biehl Accounting Officer) /s/ C. ROBERT ENEVER Director March 9, 1998 - ---------------------------- C. Robert Enever /s/ LAURENCE GELLER Director March 9, 1998 - ---------------------------- Laurence Geller /s/ DAVID E. LAMBERT Director March 9, 1998 - ---------------------------- David E. Lambert /s/ H. RAYMOND BINGHAM Director March 9, 1998 - ---------------------------- H. Raymond Bingham /s/ FREDRIC H. GOULD Director March 9, 1998 - ---------------------------- Fredric H. Gould /s/ PAUL D. KAZILIONIS - ---------------------------- Director March 9, 1998 Paul D. Kazilionis /s/ EDWARD H. SONDKER Director March 9, 1998 - ---------------------------- Edward H. Sondker
-48- 51 INDEX TO FINANCIAL STATEMENTS SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE HOTELS ("PREDECESSOR") Report of Independent Auditors.......................................................................... F-2 Sunstone Hotel Investors, Inc. -- Consolidated Balance Sheets as of December 31, 1997 and 1996........................................................................... F-3 Sunstone Hotel Investors, Inc. -- Consolidated Statements of Income for the years ended December 31, 1997 and 1996 and for the period August 16, 1995 to December 31, 1995 and Sunstone Hotels (Predecessor) -- Combined Statement of Operations for the period January 1, 1995 to August 15, 1995....................................................................................... F-4 Sunstone Hotel Investors, Inc. -- Consolidated Statements of Equity for the years ended December 31, 1997 and 1996 and for the period August 16, 1995 to December 31, 1995 and Sunstone Hotels (Predecessor) -- Combined Statement of Deficit for the period January 1, 1995 to August 15, 1995.................................................................... F-5 Sunstone Hotel Investors, Inc. -- Consolidated Statements of Cash Flows for the years ended December 31, 1997 and 1996 and for the period August 16, 1995 to December 31, 1995 and Sunstone Hotels (Predecessor) - Combined Statement of Cash Flows for the period January 1, 1995 to August 15, 1995 ...................................................................................... F-6 Notes to Consolidated and Combined Financial Statements................................................. F-7 Schedule III -- Real Estate and Accumulated Depreciation as of December 31, 1997..................................................................................... F-27 Report of Predecessor Accountants........................................................................ F-29 SUNSTONE HOTEL PROPERTIES, INC. ("LESSEE") Reports of Independent Auditors......................................................................... F-30 Consolidated Balance Sheets as of December 31, 1997 and 1996............................................ F-31 Consolidated Statements of Operations and Stockholders' Deficit for the year ended December 31, 1997 and 1996 and for the period August 16, 1995 through December 31, 1995....................................... F-32 Consolidated Statements of Cash Flows for the years ended December 31, 1997 and 1996 and for the period August 16, 1995 through December 31, 1995.................................................................................................. F-33 Notes to Consolidated Financial Statements.............................................................. F-34 Report of Predecessor Accountants........................................................................ F-41
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted. F-1 52 REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Stockholders Sunstone Hotel Investors, Inc. We have audited the accompanying consolidated balance sheet of Sunstone Hotel Investors, Inc. (the "Company") as of December 31, 1997 and the related consolidated statements of income, equity and cash flows for the year then ended. Our audit also included the financial statement schedule listed in the Index to Financial Statements. These consolidated financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audit. The consolidated financial statements of Sunstone Hotel Investors, Inc. as of December 31, 1996 and for the year then ended and for the period from August 16, 1995 (inception) to December 31, 1995 and the combined financial statements of Sunstone Hotels ("Predecessor") for the period January 1, 1995 to August 15, 1995 were audited by other auditors whose report dated February 28, 1997, expressed an unqualified opinion on those statements. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements as of and for the year ended December 31, 1997 present fairly, in all material respects, the consolidated financial position of Sunstone Hotel Investors, Inc. as of December 31, 1997 and the consolidated results of its operations and its cash flows for the year then ended, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. ERNST & YOUNG LLP Newport Beach, California February 27, 1998 F-2 53 SUNSTONE HOTEL INVESTORS, INC. CONSOLIDATED BALANCE SHEETS
December 31, ---------------------------------- 1997 1996 ------------- ------------- ASSETS: Investments in hotel properties, net $ 704,323,000 $ 152,937,000 Notes receivable 6,085,000 2,850,000 Cash and cash equivalents 3,584,000 142,000 Restricted cash 2,421,000 -- Rent receivable - Lessee 7,641,000 2,360,000 Other assets, net 15,523,000 1,790,000 ------------- ------------- $ 739,577,000 $ 160,079,000 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY: Revolving line of credit $ 179,800,000 $ 40,400,000 Notes payable 116,671,000 19,651,000 Accounts payable and other accrued expenses 10,937,000 3,249,000 Dividends payable to preferred shareholders 422,000 -- ------------- ------------- 307,830,000 63,300,000 ============= ============= Commitments and contingencies (Note 10) Minority interest 33,860,000 15,978,000 Stockholders' equity: 7.9% Class A Cumulative Convertible Preferred Stock, $.01 par value, 10,000,000 authorized; 250,000 issued and outstanding as of December 31, 1997 (liquidation preference $100 per share aggregating $25,000,000) 3,000 -- Common stock, $.01 par value, 50,000,000 authorized; 32,284,103 and 10,936,457 issued and outstanding as of December 31, 1997 and 1996, respectively 323,000 109,000 Additional paid-in capital 401,098,000 80,700,000 Distributions in excess of earnings (3,537,000) (8,000) ------------- ------------- 397,887,000 80,801,000 ------------- ------------- $ 739,577,000 $ 160,079,000 ============= =============
The accompanying notes are an integral part of these financial statements. F-3 54 SUNSTONE HOTEL INVESTORS, INC. -- CONSOLIDATED STATEMENTS OF INCOME SUNSTONE HOTELS (PREDECESSOR) -- COMBINED STATEMENT OF OPERATIONS
Sunstone Hotel Investors, Inc. Sunstone Hotels -------------------------------------------------- --------------- For the period For the period For the Years Ended December 31, August 16, 1995 January 1, 1995 -------------------------------- to December 31, to August 15, 1997 1996 1995 1995 ------------ ------------ ------------ ------------ REVENUES: Lease revenue - Lessee $ 44,680,000 $ 14,848,000 $ 3,013,000 $ -- Hotel operating revenue -- -- -- 9,675,000 Interest income 471,000 236,000 47,000 -- ------------ ------------ ------------ ------------ 45,151,000 15,084,000 3,060,000 9,675,000 ------------ ------------ ------------ ------------ EXPENSES: Real estate related depreciation and amortization 14,749,000 4,514,000 968,000 696,000 Interest expense and amortization of financing costs 6,365,000 1,558,000 47,000 1,270,000 Real estate and personal property taxes and insurance 4,670,000 1,273,000 312,000 356,000 Property operating costs -- -- -- 3,550,000 General and administrative 1,890,000 1,015,000 109,000 721,000 Management fees -- -- -- 409,000 Franchise costs -- -- -- 323,000 Advertising and promotion -- -- -- 676,000 ------------ ------------ ------------ ------------ Total expenses 27,674,000 8,360,000 1,436,000 8,001,000 ------------ ------------ ------------ ------------ Income before minority interest and extraordinary item 17,477,000 6,724,000 1,624,000 1,674,000 Minority interest (1,886,000) (1,090,000) (284,000) -- ------------ ------------ ------------ ------------ Income before extraordinary item 15,591,000 5,634,000 1,340,000 1,674,000 Extraordinary charge for early extinguishment of debt (net of $34,000 of minority interest) -- -- (159,000) -- ------------ ------------ ------------ ------------ NET INCOME 15,591,000 5,634,000 1,181,000 1,674,000 Dividends on preferred shares (422,000) -- -- -- ------------ ------------ ------------ ------------ INCOME AVAILABLE TO COMMON SHAREHOLDERS $ 15,169,000 $ 5,634,000 $ 1,181,000 $ 1,674,000 ============ ============ ============ ============ EARNINGS PER SHARE (Note 9) Basic $ 0.72 $ 0.70 $ 0.19 ============ ============ ============ Diluted $ 0.71 $ 0.69 $ 0.19 ============ ============ ============
The accompanying notes are an integral part of these financial statements. F-4 55 SUNSTONE HOTEL INVESTORS, INC. CONSOLIDATED STATEMENTS OF EQUITY
Common Stock Preferred Stock ------------------------------- ------------------------------- Total Shares $ Shares $ ------------- ------------- ------------- ------------- ------------- Balance at August 16, 1995 $ 490,000 -- $ -- -- $ -- Reorganization and issuance of common stock 53,306,000 6,322,000 63,000 -- -- Predecessor deficit (6,627,000) -- -- -- -- Issuance of common stock to directors 71,000 -- -- -- -- Dividends/distributions declared (2,695,000) -- -- -- -- Net income 1,181,000 -- -- -- -- Minority interest (8,231,000) -- -- -- -- ------------- ------------- ------------- ------------- ------------- Balance at December 31, 1995 37,495,000 6,322,000 63,000 -- -- Issuance of common stock, net 43,151,000 4,614,457 46,000 -- -- Distributions declared (5,642,000) -- -- -- -- Net income 5,634,000 -- -- -- -- Redeemed Operating Partnership Units in excess of book value (7,000) -- -- -- -- Reallocation of minority interest 170,000 -- -- -- -- ------------- ------------- ------------- ------------- ------------- Balance at December 31, 1996 80,801,000 10,936,457 109,000 -- -- Issuance of common stock, net 306,067,000 21,347,646 214,000 -- -- Issuance of preferred stock 25,000,000 -- -- 250,000 3,000 Distributions declared (18,698,000) -- -- -- -- Income available to common shareholders 15,169,000 -- -- -- -- Redeemed Operating Partnership Units in excess of book value (184,000) -- -- -- -- Reallocation of minority interest (10,268,000) -- -- -- -- ------------- ------------- ------------- ------------- ------------- Balance at December 31, 1997 $ 397,887,000 32,284,103 $ 323,000 250,000 $ 3,000 ============= ============= ============= ============= =============
Additional Distributions Paid-In in Excess of Capital Earnings ------------- ------------- Balance at August 16, 1995 $ 490,000 $ -- Reorganization and issuance of common stock 53,243,000 -- Predecessor deficit (6,627,000) -- Issuance of common stock to directors 71,000 -- Dividends/distributions declared (1,514,000) (1,181,000) Net income -- 1,181,000 Minority interest (8,231,000) -- ------------- ------------- Balance at December 31, 1995 37,432,000 -- Issuance of common stock, net 43,105,000 -- Distributions declared -- (5,642,000) Net income -- 5,634,000 Redeemed Operating Partnership Units in excess of book value (7,000) -- Reallocation of minority interest 170,000 -- ------------- ------------- Balance at December 31, 1996 80,700,000 (8,000) Issuance of common stock, net 305,853,000 -- Issuance of preferred stock 24,997,000 -- Distributions declared -- (18,698,000) Income available to common shareholders -- 15,169,000 Redeemed Operating Partnership Units in excess of book value (184,000) -- Reallocation of minority interest (10,268,000) -- ------------- ------------- Balance at December 31, 1997 $ 401,098,000 $ (3,537,000) ============= =============
SUNSTONE HOTELS (PREDECESSOR) COMBINED STATEMENT OF DEFICIT
Partners' Deficit -------------------- Balance at December 31, 1994 $ (8,274,000) Net income 1,674,000 Capital contributions 15,000 Distributions (42,000) -------------------- Balance at August 15, 1995 $ (6,627,000) ====================
The accompanying notes are an integral part of these financial statements. F-5 56 SUNSTONE HOTEL INVESTORS, INC. -- CONSOLIDATED STATEMENTS OF CASH FLOWS SUNSTONE HOTELS (PREDECESSOR) -- COMBINED STATEMENT OF CASH FLOWS
Sunstone Hotel Investors, Inc. ------------------------------------------------------------ For the year ended For the period December 31, August 16, 1995 -------------------------------------- to December 31, 1997 1996 1995 ---------------- ---------------- ---------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 15,169,000 $ 5,634,000 $ 1,181,000 Extraordinary item due to early extinguishment of debt -- -- 159,000 Adjustments to reconcile net income to net cash provided by operating activities: Minority interest 1,886,000 1,090,000 284,000 Depreciation and amortization 14,849,000 4,514,000 968,000 Amortization of financing costs 637,000 221,000 35,000 Increase in due to affiliates for management fees -- -- -- Management fees waived by partner -- -- -- Changes in assets and liabilities: Receivables, net -- -- -- Rent receivable - Lessee (5,281,000) (1,714,000) (646,000) Other assets, net (996,000) 21,000 (900,000) Accounts payable and other accrued expenses (2,368,000) 1,903,000 1,210,000 Dividends payable to preferred shareholders 420,000 -- -- ---------------- ---------------- ---------------- Net cash provided by operating activities 24,316,000 11,669,000 2,291,000 ---------------- ---------------- ---------------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition, improvements and additions to hotel properties (389,577,000) (83,857,000) (32,899,000) Proceeds from sale of hotel properties -- 1,100,000 -- Decrease in restricted cash 44,000 -- -- Issuance of notes receivable (5,474,000) -- -- Payments received on notes receivable 2,461,000 -- -- ---------------- ---------------- ---------------- Net cash used in investing activities (392,546,000) (82,757,000) (32,899,000) ---------------- ---------------- ---------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds from issuance of common stock 273,317,000 43,151,000 52,982,000 Net proceeds from issuance of partnership units 483,000 -- -- Payments to noncontinuing equity investors of Predecessor -- -- (832,000) Payment of deferred financing costs (1,720,000) (308,000) (425,000) Borrowings on revolving line of credit 185,900,000 53,200,000 8,400,000 Principal payments on revolving line of credit (46,500,000) (21,200,000) -- Principal payments on notes payable (18,233,000) (411,000) (23,420,000) Payments on advances from affiliates -- -- -- Distributions to shareholders (18,698,000) (7,096,000) (727,000) Distributions to partners (2,877,000) (1,328,000) (154,000) ---------------- ---------------- ---------------- Net cash provided by (used in) financing activities 371,672,000 66,008,000 35,824,000 ---------------- ---------------- ---------------- Net change in cash and cash equivalents 3,442,000 (5,080,000) 5,216,000 Cash and cash equivalents, beginning of period 142,000 5,222,000 6,000 ---------------- ---------------- ---------------- Cash and cash equivalents, end of period $ 3,584,000 $ 142,000 $ 5,222,000 ================ ================ ================ Supplemental disclosure: Cash paid for interest, net of amounts capitalized $ 5,732,000 $ 1,337,000 $ 11,000 ================ ================ ================
Sunstone Hotels ---------------- For the period January 1, 1995 to August 15, 1995 ---------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 1,674,000 Extraordinary item due to early extinguishment of debt -- Adjustments to reconcile net income to net cash provided by operating activities: Minority interest -- Depreciation and amortization 696,000 Amortization of financing costs -- Increase in due to affiliates for management fees 70,000 Management fees waived by partner 15,000 Changes in assets and liabilities: Receivables, net 255,000 Rent receivable - Lessee -- Other assets, net 79,000 Accounts payable and other accrued expenses (1,595,000) Dividends payable to preferred shareholders -- ---------------- Net cash provided by operating activities 1,194,000 ---------------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition, improvements and additions to hotel properties (463,000) Proceeds from sale of hotel properties -- Decrease in restricted cash 104,000 Issuance of notes receivable -- Payments received on notes receivable -- ---------------- Net cash used in investing activities (359,000) ---------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds from issuance of common stock -- Net proceeds from issuance of partnership units -- Payments to noncontinuing equity investors of Predecessor -- Payment of deferred financing costs -- Borrowings on revolving line of credit -- Principal payments on revolving line of credit -- Principal payments on notes payable (846,000) Payments on advances from affiliates (418,000) Distributions to shareholders -- Distributions to partners (42,000) ---------------- Net cash provided by (used in) financing activities (1,306,000) ---------------- Net change in cash and cash equivalents (471,000) Cash and cash equivalents, beginning of period 718,000 ---------------- Cash and cash equivalents, end of period $ 247,000 ================ Supplemental disclosure: Cash paid for interest, net of amounts capitalized $ 1,750,000 ================
The accompanying notes are an integral part of these financial statements. F-6 57 SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE HOTELS (PREDECESSOR) NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS December 31, 1997 1. ORGANIZATION AND BASIS OF PRESENTATION Sunstone Hotel Investors, Inc., a Maryland corporation (the "Company"), was formed in 1995 as a real estate investment trust ("REIT"). At December 31, 1997, the Company had a 92.2% interest in Sunstone Hotel Investors, L.P. (the "Operating Partnership") which began operations as of August 16, 1995, upon receipt of the proceeds from the Company's initial public offering (the "Offering") and consummation of certain formation transactions (Note 8). The Company conducts all of its business through and is the sole general partner of the Operating Partnership. In connection with the Offering, the Company acquired seven hotels (the "Sunstone Hotels") from seven entities controlled by officers and a director of the Company and acquired three additional hotels (the "Acquisition Hotels" and together, the "Initial Hotels") from unrelated third parties in exchange for (i) units in the Operating Partnership ("Units"), (ii) the payment of mortgage indebtedness for the Sunstone Hotels, and (iii) payment of cash to purchase the Acquisition Hotels. At December 31, 1997, the Company's portfolio included 53 hotel properties, primarily located in the western United States, all of which are leased to Sunstone Hotel Properties, Inc. (the "Lessee") under operating leases (the "Percentage Leases") that provide for the payment of base and percentage rent. The Lessee is owned by Robert A. Alter, Chairman and President of the Company (80%), and Charles L. Biederman, Vice Chairman of the Company (20%). The Lessee has entered into a management agreement pursuant to which all of the hotels are managed by Sunstone Hotel Management, Inc. (the "Management Company"), of which Mr. Alter is the sole shareholder. Basis Of Presentation: The consolidated financial statements include the accounts of the Company and its subsidiaries, including the Operating Partnership. All significant intercompany transactions and balances have been eliminated. The Predecessor: The predecessor to the Company was Sunstone Hotels ("Predecessor"), consisting of the seven entities as referred to above. Due to common ownership and management of the Predecessor, the historical combined financial statements have been accounted for as a group of entities under common control. All significant intercompany transactions and balances have been eliminated in the combined presentation. The financial statements of the Predecessor do not include the Acquisition Hotels or other hotel properties acquired subsequent to the Offering and are, therefore, not comparable to the financial statements of the Company. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Investments In Hotel Properties: The Sunstone Hotels are recorded at the historical cost of the Predecessor including accumulated depreciation. All other hotel properties are recorded at cost, less accumulated depreciation. During periods of construction or major renovation, interest attributable to rooms under construction or major renovation and not in service is capitalized until such rooms are available for their intended use under a specific identification method. Hotel properties are depreciated using the straight-line method over estimated useful lives ranging from five to thirty-five years for buildings and improvements and three to ten years for furniture, fixtures and equipment. A gain or loss is recorded to the extent the amounts ultimately received upon disposition differ from the book values of the hotel assets. Franchise fees are recorded at cost and amortized using the straight-line method over the lives of the franchise agreements ranging from 10 to 20 years. F-7 58 SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE HOTELS (PREDECESSOR) NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued Investments In Hotel Properties, continued: In 1996, the Company adopted Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the estimated undiscounted cash flows to be generated by those assets are less than the carrying amount of the assets. At December 31, 1997, management believes that the sum of the expected future undiscounted cash flows, excluding interest charges, for each hotel asset is greater than the carrying amount of each hotel property. No such impairment losses have been recognized to date. Cash And Cash Equivalents: Cash and cash equivalents are defined as cash on hand and in banks plus all short-term investments with an original maturity of three months or less. Restricted Cash: Restricted cash is comprised of reserve accounts for capital replacements, property taxes and debt service. These restricted funds are subject to supervision and approval by the lenders. Other Assets: Other assets consist primarily of laundry facilities located in Rochester, Minnesota and Salt Lake City, Utah, deferred offering costs, deferred financing costs, deposits and amounts due from affiliates. Laundry facilities, which are held as long-term investments, are stated at cost less accumulated depreciation and are depreciated using the straight-line method over estimated useful lives ranging from five to thirty-five years for buildings and improvements and three to ten years for furniture, fixtures and equipment. Amortization of deferred loan costs is computed using the straight-line method over the life of the loan based upon the terms of the loan agreements. Deferred offering costs are offset against equity when the related offering proceeds are received. Minority Interest: Minority interest carried on the balance sheet is adjusted periodically upon issuance of either common stock of the Company or Units based on the number of Units outstanding held by affiliates and other unrelated parties divided by the sum of total Units outstanding at the measurement date (Note 8). Such adjustments are recorded as adjustments to additional paid-in capital. Concentrations: At December 31, 1997 and 1996, the Company had amounts in banks that were in excess of federally insured amounts. The Company currently invests exclusively in hotel properties. The hotel industry is highly competitive and the Company's hotel investments are subject to competition from other hotels for guests. Each of the Company's hotels competes for guests primarily with other similar hotels in its immediate vicinity and other similar hotels in its geographic market. The Company believes that brand recognition, location, the quality of the hotel and services provided, and price are the principal competitive factors affecting its hotel investments. F-8 59 SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE HOTELS (PREDECESSOR) NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued Concentrations, continued: In 1997 and 1996, the Company earned rents under the Percentage Leases of $44,680,000 and $14,848,000, respectively, all of which was earned from the Percentage Leases with the Lessee (Note 11). The Company must rely solely on the Lessee to generate sufficient cash flow from operation of the hotels to enable the Lessee to meet rent obligations under the Percentage Leases. From inception, the Lessee has generated sufficient operating cash flow to meet its obligations under the Percentage Leases and has remained current in its payments to the Company. During 1998, management of the Lessee anticipates generating positive operating cash flow, however, there can be no assurance that operating expectations will be met in the future. See the Lessee's consolidated financial statements included elsewhere herein. Revenue Recognition: All of the Company's operating hotel properties are leased to the Lessee under Percentage Leases. The Company recognizes lease revenue when earned over the terms of the respective Percentage Leases. Advertising Expense: Advertising and promotion costs are expensed when incurred. Income Taxes: The Company expects to qualify as a REIT under the Internal Revenue Code of 1986, as amended. A REIT will generally not be subject to federal income taxation to the extent that it distributes at least 95% of its taxable income to its stockholders and complies with other requirements. The Company is subject to state income and franchise taxes in certain states in which it operates. Stock-Based Compensation: The Company applies Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, in accounting for its Stock Incentive Plans and its Directors Plan. Per Share Data: In 1997, the Financial Accounting Standards Board issued Statement No. 128, Earnings per Share ("Statement No. 128"). Statement No. 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. All earnings per share amounts for all periods have been presented, and where appropriate, restated to conform to the Statement No. 128 requirements. F-9 60 SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE HOTELS (PREDECESSOR) NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued Fair Value Of Financial Instruments: Management has estimated the fair value of its financial instruments. Considerable judgment is required in interpreting market data in order to develop estimates of the fair value of the Company's financial instruments. Accordingly, the estimated values are not necessarily indicative of the amounts that could be realized in current market exchanges. For those financial instruments for which it is practical to estimate value, management believes that the carrying amounts of the Company's financial instruments reasonably approximate their fair value at December 31, 1997 and 1996. Use Of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates in the near term. Seasonality: The hotel industry is seasonal in nature. Seasonal variations in revenues at the Company's hotels may cause quarterly fluctuations in the Company's lease revenues Reclassifications: Certain prior year balances have been reclassified to conform to the current year presentation. 3. INVESTMENTS IN HOTEL PROPERTIES Investments in hotel properties consists of the following at December 31:
1997 1996 ------------- ------------- Land $ 93,456,000 $ 25,774,000 Buildings and improvements 549,770,000 121,550,000 Fixtures, furniture and equipment 76,753,000 19,681,000 Construction in process 15,991,000 2,851,000 ------------- ------------- 735,970,000 169,856,000 Accumulated depreciation and amortization (31,647,000) (16,919,000) ------------- ------------- Investments in hotel properties, net $ 704,323,000 $ 152,937,000 ============= =============
F-10 61 SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE HOTELS (PREDECESSOR) NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS 3. INVESTMENTS IN HOTEL PROPERTIES, continued The Kahler Acquisition: On October 15, 1997, the Company completed the acquisition of all the outstanding capital stock of Kahler Realty Corporation ("Kahler") from Westbrook Real Estate Fund I, L.P. and Westbrook Real Estate Co-Investment Partnership I, L.P. (collectively, "Westbrook") for aggregate consideration of approximately $372.3 million (the "Kahler Acquisition"), including the concurrent buyout of minority interests in certain hotels that were partially owned by Kahler. In addition, the Company may be required to pay up to $16.0 million in additional consideration, based upon specified future operating results of the acquired hotels. Any upward adjustment in the purchase price will be treated as additional consideration and will be capitalized to the hotel properties. The Kahler Acquisition was funded with the net proceeds from the Company's public offering in October 1997, the assumption of Kahler debt, the issuance of common and preferred stock to Westbrook and with borrowings from the Company's unsecured revolving line of credit. The Kahler portfolio purchased by the Company consists of 17 hotels with 4,255 rooms (the "Kahler Hotels"), principally in two markets, the Mountain region states of Utah, Idaho, Montana and Arizona (11 hotels) and Rochester, Minnesota (four hotels). Total consideration for the Kahler Hotels, including transaction costs, consisted of the following: Cash $213,404,000 Assumed notes payable 94,494,000 Issuance of common stock 32,000,000 Issuance of 7.9% Class A Cumulative Convertible Preferred Shares 25,000,000 Assumed other assets and liabilities, net 7,363,000 ------------ $372,261,000 ============
Other 1997 Activity: During 1997, the Company acquired or invested in 12 hotel properties, excluding the Kahler Acquisition, for aggregate consideration of $150,427,000, including transaction costs, comprised of $121,404,000 in cash, $20,529,000 in assumed notes payable and the issuance of 624,740 Units valued at $8,493,000, which are exchangeable for a like number of shares of common stock of the Company. During 1997, the Company completed, or was in the process of completing, substantial renovations at 19 of the hotel properties, and in connection with such renovations, incurred costs of approximately $48,756,000. 1996 Activity: During 1996, the Company acquired 12 hotel properties for aggregate consideration of $85,884,000, including transaction costs, comprised of $57,942,000 in cash, $20,062,000 in assumed notes payable and the issuance of 786,347 Units, which are exchangeable for a like number of shares of common stock of the Company. During 1996, the Company completed, or was in the process of completing, substantial renovations at ten of the hotel properties, and in connection with such renovations, incurred costs of approximately $9,600,000. In addition, during 1996, the Company completed the development and construction of one hotel property and incurred related costs in 1996 of $5,189,000. In May 1996, the Company sold two hotel properties acquired in February 1996 for aggregate consideration of $3,950,000, comprised of $1,100,000 in cash and mortgage notes receivable aggregating $2,850,000. The Company did not recognize any gain or loss in connection with the sale of the assets. F-11 62 SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE HOTELS (PREDECESSOR) NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS 3. INVESTMENTS IN HOTEL PROPERTIES, continued The Kahler acquisition and all of the other hotels properties acquired have been accounted for as purchase business acquisitions and, accordingly, the results of operations of the acquisitions have been included in the Company's consolidated results of operations from the respective date of acquisition. 4. NOTES RECEIVABLE Notes receivable consisted of the following at December 31:
1997 1996 ---------- ---------- Note receivable dated May 17, 1996; monthly payments of interest only at 9.1% until maturity on May 17, 1997; collateralized by a deed of trust, assignment of rents and fixtures $ -- $1,250,000 Note receivable dated May 17, 1996 as amended June 25, 1997; monthly payments of principal and interest at 4.25% over LIBOR until maturity on July 1, 2002; collateralized by a deed of trust, assignment of rents and fixtures 395,000 1,600,000 Note receivable dated December 23, 1997; monthly payments of principal and interest at 10% until maturity on September 30, 1998; collateralized by a deed of trust, assignment of rents and fixtures (Note 10) 2,224,000 -- Note receivable dated December 23, 1997; monthly payments of principal and interest at 10% until maturity on September 30, 1998; collateralized by a deed of trust, assignment of rents and fixtures (Note 10) 3,250,000 -- Note receivable dated June 30, 1997; monthly payments of principal and interest at 12% until maturity on July 30, 2002; collateralized by a deed of trust, assignment of rents and fixtures 216,000 -- ---------- ---------- $6,085,000 $2,850,000 ========== ==========
Related interest income for the years ended December 31, 1997 and 1996 was $176,000 and $167,000, respectively. The Company has not recognized interest income on certain of the above notes receivable which are related to development agreements (Note 10). F-12 63 5. OTHER ASSETS Other assets consists of the following at December 31:
1997 1996 ------------ ------------ Laundry facilities: Land $ 2,867,000 $ -- Buildings and improvements 6,857,000 -- Fixtures, furniture and equipment 1,834,000 -- ------------ ------------ 11,558,000 -- Accumulated depreciation (100,000) -- ------------ ------------ 11,458,000 -- Deferred financing costs, net of accumulated amortization of $839,000 in 1997 and $253,000 in 1996 1,737,000 654,000 Prepaid expenses and other 2,328,000 1,136,000 ------------ ------------ $ 15,523,000 $ 1,790,000 ============ ============
6. REVOLVING LINE OF CREDIT On October 10, 1997, the Company increased its unsecured revolving line of credit facility (the "Credit Facility") from $100 million to $200 million. The Credit Facility accrues interest at LIBOR plus 1.80% per annum, has a two year term, maturing July 1, 1999, with a one-year extension option in favor of the Company and provides for a reduction in the interest rate margin if the Company's debt securities are rated by a national rating agency. The Credit Facility may be used for acquisitions, capital improvements, working capital and general corporate purposes and requires the Company to pay a 0.25% fee on the unused portion. Prior to the increase from $100 million to $200 million, availability under the Credit Facility ranged from $30 million in 1996 to $100 million in 1997 and accrued interest at rates ranging from LIBOR plus 2.25% to LIBOR plus 1.75%. As of December 31, 1997 and 1996, additional borrowings available under the credit facility were $11.1 million (net of $10.1 million reserved availability for development of hotels) and $9.6 million, respectively. The weighted average interest rates on outstanding borrowings at December 31, 1997 and 1996 was 7.73% and 7.53%, respectively. The line of credit requires the Company to maintain a specified debt to net worth ratio, a coverage ratio of EBITDA to debt service and a debt service coverage ratio. In addition, the Company is restricted in the amount of distributions to share and unit holders and must maintain a specified liquidity. Further, the Company is required to maintain national franchises at each of its properties and maintain its REIT status. The Credit Facility requires that the Company provide collateral if the Company fails to satisfy certain financial covenants. At December 31, 1997 and 1996, the Company was in compliance with such covenants. F-13 64 SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE HOTELS (PREDECESSOR) NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS 7. NOTES PAYABLE Notes payable consist of the following at December 31:
1997 1996 ----------- ----------- $2,100,000 note payable dated June 9, 1994; monthly payments of principal and interest at 9.76%, maturing in 2004; collateralized by a first deed of trust, assignment of rents and fixtures $ 1,978,000 $ 2,025,000 $1,000,000 note payable dated October 12, 1994; monthly payments of principal and interest at 8.73%; maturing in 2014; collateralized by a second deed of trust, assignment of rents and fixtures 930,000 955,000 $9,000,000 note payable dated September 26, 1995; monthly payments of principal and interest at 9.95%; maturing in 1999; collateralized by a first deed of trust, assignment of rents and fixtures (this note was repaid in January 1998) 7,622,000 8,018,000 $9,500,000 note payable dated December 28, 1993; monthly payments of principal and interest at 9.67%; maturing in 1999; collateralized by a first deed of trust, assignment of rents and fixtures (this note was repaid in January 1998) 8,343,000 8,653,000 $3,420,000 note payable dated May 27, 1994; monthly payments of principal and interest at 8.25%; maturing in 2004; collateralized by a first deed of trust, assignment of rents and fixtures 3,350,000 -- $10,000,000 note payable dated September 1, 1992; monthly payments of principal and interest at 9.88%; maturing in 2013; collateralized by a first deed of trust, assignment of rents and fixtures 9,059,000 -- $33,000,000 note payable dated October 10, 1997; monthly payments of principal and interest at 7.96%; maturing in 2002; collateralized by a first deed of trust, assignment of rents and fixtures 32,944,000 -- $22,600,000 note payable dated October 14, 1997; monthly payments of interest only at LIBOR plus 2.25%; maturing in 2000; collateralized by a first deed of trust, assignment of rents and fixtures 22,600,000 -- $13,120,000 industrial development bonds dated July 9, 1997; monthly payments of principal and interest at a variable rate ranging from 3.7% to 4.1% during 1997 with principal amounts deposited into a restricted cash account; maturing in 2015; collateralized by a first deed of trust, assignment of rents and fixtures 13,060,000 --
F-14 65 SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE HOTELS (PREDECESSOR) NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS 7. NOTES PAYABLE, continued
1997 1996 ------------------- ------------------- $9,500,000 industrial development bonds dated December 1, 1985; monthly payments of principal and interest at a variable rate ranging from 4.25% to 4.30% during 1997 with principal amounts deposited into a restricted cash account; maturing in 2015; collateralized by a first deed of trust, assignment of rents and fixtures 8,495,000 -- $9,700,000 industrial development bonds dated October 10, 1986; monthly payments of principal and interest at a variable rate of 4.25% during 1997 with principal amounts deposited into a restricted cash account; maturing in 2013; collateralized by a first deed of trust, assignment of rents and fixtures 7,900,000 -- $390,000 note payable dated December 19, 1997; with no interest if paid in full on the maturity date of December 19, 1998; collateralized by a first deed of trust, assignment of rents and fixtures 390,000 -- ------------------- ------------------- $ 116,671,000 $ 19,651,000 =================== ===================
Notes payable are secured by hotel properties carried at $274,069,000 at December 31, 1997. Interest expense on these mortgage notes payable was $3,597,000 and $506,000 for the years ended December 31, 1997 and 1996, respectively. Total interest incurred under the Company's notes payable and the revolving line of credit (Note 6), during 1997, 1996 and during the periods August 16, 1995 to December 31, 1995 and January 1, 1995 through August 15, 1995 totaled $8,001,000, $2,468,000, $12,000 and $1,270,000, respectively, of which $2,273,000 and $1,131,000 was capitalized for the years ended December 31, 1997 and 1996, respectively. Future principal maturities of notes payable at December 31, 1997, are as follows: 1998 $ 18,073,000 1999 1,865,000 2000 24,577,000 2001 2,108,000 2002 31,477,000 Thereafter 38,567,000 ---------------------- $ 116,671,000 ======================
8. EQUITY Initial Public Offering and Formation Transactions: The Company completed an initial public offering of 5,910,000 shares of its common stock on August 16, 1995. The Company issued an additional 404,500 shares of common stock on September 3, 1995 upon a partial exercise of the underwriters' over-allotment option. The offering price of all shares sold in the Offering was $9.50 per share, resulting in gross proceeds of approximately $60.0 million and net proceeds (less underwriters' discount and offering costs) of approximately $53.3 million. F-15 66 SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE HOTELS (PREDECESSOR) NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS 8. EQUITY, continued Initial Public Offering and Formation Transactions, continued: The Company contributed all of the net proceeds of the Offering to the Operating Partnership in exchange for an approximately 82.5% aggregate equity interest in the Operating Partnership. In connection with the Offering, the Company acquired seven hotels, the Sunstone Hotels, from seven entities controlled by officers and a director of the Company and acquired the three Acquisition Hotels from unrelated third parties in exchange for (i) 1,288,500 units ("Units") in the Operating Partnership (representing the remaining 17.5% of equity interest in the Operating Partnership) which are exchangeable for a like number of shares of the common stock of the Company, (ii) the payment of mortgage indebtedness for the Sunstone Hotels of approximately $23.5 million and other obligations relating to the Sunstone Hotels, and (iii) payment of approximately $25.8 million to purchase the Acquisition Hotels. 1996 Stock Offerings: On August 7, 1996, the Company completed a follow-on offering for 4,000,000 shares of its common stock. On September 10, 1996, 600,000 shares of common stock were issued by the Company upon the full exercise of the underwriters' over-allotment option. The offering price of the shares sold was $10.00 per share, resulting in gross proceeds of approximately $46.0 million and net proceeds (less the underwriters' discount and offering costs) of approximately $43.1 million. 1997 Stock Offerings: On January 6, 1997, the Company completed a follow-on offering for 4,000,000 shares of its common stock. Concurrently, 600,000 shares of common stock were issued by the Company upon the full exercise of the underwriters' over-allotment option. The offering price of the shares sold in the offering was $13.00 per share, resulting in gross proceeds of approximately $59.8 million and net proceeds (less underwriters' discount and offering costs) of approximately $56.8 million. On March 31, 1997, the Company completed a follow-on offering for 700,000 shares of its common stock. On April 28, 1997, 105,000 shares of common stock were issued by the Company upon the full exercise of the underwriter's over-allotment option. The offering price of the shares sold was $13.75 per share, resulting in gross proceeds of approximately $11.1 million and net proceeds (less underwriter's discount and offering costs) of approximately $10.6 million. On May 6, 1997, the Company completed a follow-on offering for 4,000,000 shares of common stock. The offering price of the shares sold was $13.375 per share, resulting in gross proceeds of approximately $53.5 million and net proceeds (less underwriters' discount and offering costs) of approximately $51.4 million. On October 15, 1997, in connection with the closing of the Kahler Acquisition, the Company completed a follow-on offering for 9,000,000 shares of common stock. The offering price of the shares sold was $17.25 per share, resulting in gross proceeds of approximately $155.3 million and net proceeds (after deducting the underwriters' discount and offering costs) of approximately $147.1 million. On November 7, 1997, 490,000 shares of common stock were issued by the Company upon the partial exercise of the underwriter's over-allotment option. The offering price of the shares sold was $17.25 per share, resulting in gross proceeds of approximately $8.5 million and net proceeds (after deducting the underwriter's discount and offering costs) of approximately $8.0 million. Additionally, the Company issued 2,284,262 shares of common stock at a price of $14.01 per share, for a total of $32,000,000 and 250,000 shares of 7.9% Class A Cumulative Convertible Preferred Stock at $100 per share for a total of $25,000,000, to Westbrook. F-16 67 SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE HOTELS (PREDECESSOR) NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS 8. EQUITY, continued 1997 Stock Offerings, continued: In October 1997, the Company filed a shelf registration statement with the Securities and Exchange Commission providing for the issuance of up to $325 million of common stock, preferred stock and warrants to purchase common stock and preferred stock. This registration statement was in addition to the registration statement providing for the issuance of up to $200 million in securities, which was filed in 1996. The Company intends to use the proceeds raised from any securities issued under its shelf registration statement for general corporate purposes, including the acquisition and development of additional hotels, the renovation of currently owned hotels, and the repayment of debt. Availability under the Company's shelf registration statement was $188.1 million at December 31, 1997. Preferred Stock: Subject to certain limitations, the Board of Directors is authorized to issue, from the 10,000,000 authorized but unissued shares of capital stock of the Company, Preferred Stock in such classes or series as the Board of Directors may determine. In connection with the Kahler Acquisition the Company issued 250,000 shares of its newly designated 7.9% Class A Cumulative Convertible Preferred Stock (the "Class A Shares"). The holders of the Class A Shares are entitled to one vote for each share of Common Stock into which such holder's Class A Shares could then be converted, and with respect to such vote, such holder shall have full voting rights and powers equal to the voting rights and powers of the holders of Common Stock. The holders of Class A Shares shall be entitled to vote, together with holders of Common Stock as a single class. Subject to preferences that may be applicable to any future class of Preferred Stock, the holders of Class A Shares are entitled to receive, ratably, a dividend equal to the greater of (i) 7.9% per share per annum or (ii) the percentage dividend that would be paid on the Common Stock into which the Preferred Stock is convertible. Each Class A Share is convertible at the option of the holder at any time into a number of shares of Common Stock that is equal to the quotient obtained by dividing $100 by $14.7093, subject to adjustment for stock splits, stock dividends, recapitalizations and the like. On or at any time after the fifth anniversary of issuance of the Class A Shares, the Company may, at its option, redeem the Class A Shares in whole or in part by paying an amount equal to the redemption percentage of $100.00 per share then in effect (as adjusted for any stock dividends, combinations or splits), plus all accrued but unpaid dividends on such shares. The redemption percentage declines one percent per year, from 105% to par commencing in 2002. F-17 68 SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE HOTELS (PREDECESSOR) NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS 8. EQUITY, continued Dividends: The Company has adopted a policy of paying regular quarterly dividends on its common stock, and cash distributions have been paid on the Company's common stock with respect to each quarter since its inception. The following table sets forth information regarding the declaration and payment of distributions by the Company.
Quarter to Which Distribution Distribution Per Share Distribution Relates Record Date Payment Date Distribution Amount - ------------------------------ ------------------------ ------------------------- ------------------------------ 1996 1st Quarter 5/1/96 5/15/96 $0.23 2nd Quarter 8/1/96 8/15/96 $0.23 3rd Quarter 11/1/96 11/15/96 $0.25 4th Quarter 2/1/97 2/14/97 $0.25 1997 1st Quarter 4/29/97 5/15/97 $0.25 2nd Quarter 7/31/97 8/15/97 $0.25 3rd Quarter 9/30/97 11/14/97 $0.275 4th Quarter 12/31/97 2/16/98 $0.275
Reconciliation of Operating Partnership Units Outstanding:
Year Ended December 31, 1997 ------------------------------------------------------------------------ Company Affiliates Other Total ----------------- -------------- ------------- ----------------- Balance at beginning of year 10,936,457 1,455,799 706,347 13,098,603 Stock options exercised 41,860 41,860 Stock awards issued 13,766 13,766 Warrants exercised 50,850 50,850 Operating Partnership units redeemed/ exchanged 58,446 (90,409) (31,963) Dividend reinvestment plan and additional cash investment plan 54,312 54,312 Common stock offerings 21,179,262 21,179,262 Contributions of hotel properties 624,740 624,740 ----------------- ------------- ------------- ----------------- Balance at end of year 32,284,103 1,416,240 1,331,087 35,031,430 ----------------- ------------- ------------- ----------------- Ownership interest at end of year 92.2% 4.0% 3.8% 100.0% ================= ============= ============= =================
Year Ended December 31, 1996 -------------------------------------------------------------------- Company Affiliates Other Total ----------------- -------------- ----------- -------------- Balance at beginning of year 6,322,000 1,387,859 7,709,859 Stock options exercised Stock awards issued 10,250 10,250 Warrants exercised Operating Partnership units redeemed/ exchanged (12,060) (12,060) Dividend reinvestment plan and additional cash investment plan 2,707 2,707 Common stock offerings 4,601,500 4,601,500 Contributions of hotel properties 80,000 706,347 786,347 ---------------- ------------- ----------- -------------- Balance at end of year 10,936,457 1,455,799 706,347 13,098,603 ---------------- ------------- ----------- -------------- Ownership interest at end of year 83.5% 11.1% 5.4% 100.0% ================ ============= =========== ==============
F-18 69 SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE HOTELS (PREDECESSOR) NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS 9. EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share which have been restated to comply with Statement No. 128:
For the Period For the Years Ended December 31, August 16, 1995 ------------------------------------- to December 31, 1997 1996 1995 ------------- ------------- ------------- Numerator: Net income $ 15,591,000 $ 5,634,000 $ 1,181,000 Dividends on preferred shares (422,000) -- -- ------------- ------------- ------------- Numerator for basic and diluted earnings per share Income available to common shares after effect of dilutive securities $ 15,169,000 $ 5,634,000 $ 1,181,000 ------------- ------------- ------------- Denominator: Denominator for basic earnings per share - weighted average shares outstanding 21,089,971 8,041,805 6,269,239 Effect of dilutive securities: Stock options 158,160 82,133 12,000 ------------- ------------- ------------- Denominator for diluted earnings per share - adjusted weighted average shares and assumed conversion 21,248,131 8,123,938 6,281,239 ============= ============= ============= Basic earnings per share: Income before extraordinary items $ 0.72 $ 0.70 $ 0.21 Extraordinary charge for early extinguishment of debt, net of amount allocated to minority interest -- -- (0.02) ------------- ------------- ------------- Basic earnings per share $ 0.72 $ 0.70 $ 0.19 ============= ============= ============= Diluted earnings per share: Income before extraordinary item $ 0.71 $ 0.69 $ 0.21 Extraordinary charge for early extinguishment of debt, net of amount allocated to minority interest -- -- (0.02) ------------- ------------- ------------- Diluted earnings per share $ 0.71 $ 0.69 $ 0.19 ============= ============= =============
F-19 70 SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE HOTELS (PREDECESSOR) NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS 10. COMMITMENTS AND CONTINGENCIES Development Agreements: In January 1997, the Company entered into a purchase agreement to acquire a to be developed hotel property located in Pueblo, Colorado which is subject to a ground lease. The guaranteed maximum purchase price to the Company is $8.5 million. The seller is required to pay for all project costs and is at risk for any project cost overruns. Construction of the hotel is to be satisfactory to the Company and completed within a specific timeframe. In order to secure its obligation to perform under the purchase agreement, the Company was required to issue a letter of credit to the construction lender for $8.5 million. Such letter of credit was outstanding as of December 31, 1997. Upon timely and satisfactory completion of the hotel, the property will be purchased by the Company. The seller is required to assign the related ground lease to the Company upon the closing of the purchase transaction. In July 1997, the Company entered into a purchase agreement to acquire a to be developed hotel property located in Denver, Colorado. The guaranteed maximum purchase price to the Company is $7.6 million. The seller is required to pay for all project costs and is at risk for any project cost overruns. Construction of the hotel is to be satisfactory to the Company and completed within 14 months after commencement of construction, subject to certain extensions. In order to secure its obligation to perform under the purchase agreement, the Company was required to provide a limited repayment guarantee of the construction loan. Such repayment guarantee is not to exceed 25% of the revised project cost budget. At December 31, 1997, budgeted construction costs were $7.4 million. Upon timely and satisfactory completion of the hotel, the property will be purchased by the Company. In November 1997, the Company entered into a purchase agreement to acquire a to be developed hotel property located in Sacramento, California. The guaranteed maximum purchase price to the Company is $13.3 million. The seller is required to pay for all project costs and is at risk for any project cost overruns. Construction of the hotel is to be satisfactory to the Company and completed within 14 months after commencement of construction, subject to certain extensions. As of December 31, 1997, the Company has advanced the seller $2.2 million of project financing. Such amount is secured by a deed of trust and is included in notes receivable (Note 4). The Company is currently assisting the seller in obtaining project financing. The Company is not recognizing interest income on the amounts advanced to the seller and expects to be reimbursed the amounts advanced upon the seller attaining project financing. In December 1997, the Company entered into a purchase agreement to acquire a to be developed hotel property located in San Diego, California. The guaranteed maximum purchase price to the Company is $14.5 million. The seller is required to pay for all project costs and is at risk for any project cost overruns. Construction of the hotel is to be satisfactory to the Company and completed within 14 months after commencement of construction, subject to certain extensions. As of December 31, 1997, the Company has advanced the seller $3.4 million of project financing. Such amount is included in notes receivable (Note 4). The Company is currently assisting the seller in obtaining project financing. The Company is not recognizing interest income on the amounts advanced to the seller and expects to be reimbursed the amounts advanced upon the seller attaining project financing. At December 31, 1997, the Company has various contracts outstanding with third parties in connection with the renovation of the Company's hotel properties. The Company's remaining commitments under these contracts at December 31, 1997 totaled approximately $25.4 million. Litigation: The Company is involved from time to time in various claims and legal actions in the ordinary course of business. Management does not believe that the impact of such matters will have a material adverse effect on the Company's financial position or results of operations when resolved. F-20 71 SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE HOTELS (PREDECESSOR) NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS 11. PERCENTAGE LEASE AGREEMENTS Through December 31, 1997, the Company had entered into 53 Percentage Leases with the Lessee. Future minimum rentals (base rents) to be received by the Company from the Lessee under the Percentage Leases in effect at December 31, 1997 are as follows: 1998 $ 50,083,000 1999 50,083,000 2000 50,083,000 2001 50,083,000 2002 50,083,000 Thereafter 215,749,000 ---------------------------- $ 466,164,000 ============================
The term of each lease is ten years. The Percentage Leases contain various covenants and are cross-defaulted. The minimum rent due under each lease is the greater of base rent (subject to annual adjustments based on increases in the United States Consumer Price Index) or percentage rent. Percentage rent is calculated as 20% to 37% of room revenues, up to a certain baseline revenue (the base rent component) then 60% to 65% of room revenues in excess of the baseline revenues. Generally, percentage rent includes 5% of food and beverage revenue and 100% of net other revenues. Rental income pursuant to the Percentage Leases in 1997, 1996 and 1995 was $44,680,000, $14,848,000 and $3,013,000, respectively, of which $19,842,000, $6,807,000 and $1,328,000, respectively, was in excess of base rents. The stockholders of the Lessee have pledged 481,955 Units as collateral for the lease payments. In 1997, the Lessor and Lessee amended the Percentage Leases for hotels then currently under renovation and for any future hotels to allow for the amendment of base rent related to rooms taken out of service during major renovations. Pursuant to the Percentage Leases, the Company is required to make available to the Lessee for the repair, replacement and refurbishment of furniture, fixtures and equipment in the hotels, when and as deemed necessary by the Lessee, an amount equal to 4% of room revenue per quarter on a cumulative basis. To the extent the amount is not fully utilized by the Lessee in any year, the Company may use the amount to fund certain capital expenditures. The Company is responsible for payment of (i) real estate and personal property taxes on its hotel properties (except to the extent that personal property associated with the hotels is owned by the Lessees), (ii) casualty insurance on the hotels and (iii) business interruption insurance on the hotels. The Lessee is required to pay for all liability insurance on the Company's hotels with extended coverage, including comprehensive general public liability, workers' compensation and other insurance appropriate and customary for properties similar to the Company's hotels with the Company as an additional named insured. Upon acquisition of the hotel properties, the Company acquired the hotel inventories, which were transferred to the Lessee for its use in the operation of the hotels. Under the terms of Participating Leases, the Lessee is obligated to return an equivalent inventory to the Company at the end of the respective lease term. 12. STOCK INCENTIVE PLANS AND DIRECTORS PLAN The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"), and related Interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under Statements of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation ("Statement No. 123"), requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, if the stock options are granted at the market price of the underlying stock on the date of grant, no compensation expense is recognized. F-21 72 SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE HOTELS (PREDECESSOR) NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS 12. STOCK INCENTIVE PLANS AND DIRECTORS PLAN, continued 1994 Stock Incentive Plan: In September 1994, the Company adopted the 1994 Stock Incentive Plan, as amended, under which officers, nonemployee members of the Board of Directors and key employees and consultants of the Company are eligible to be granted options to purchase common stock of the Company. Through December 31, 1997, the Company's Board of Directors have set aside 1,200,000 shares of common stock to be issued pursuant to the Stock Incentive Plan. The 1994 Stock Incentive Plan is being administered by a committee established by the Company's Board of Directors. All options granted had exercise prices equal to their fair values on the dates granted, have ten year terms and vest and become fully exercisable over five years. A summary of the Company's 1994 Stock Incentive Plan activity and related information for the period from August 16, 1995 to December 31, 1995 and the years ended December 31, 1997 and 1996 as follows:
Weighted Available for Future Number of Exercise Price Average Grant Options Per Share Exercise Price --------------------- -------------- ------------------- ------------------- Outstanding at August 16, 1995 500,000 -- $ -- $ -- Granted (240,000) 240,000 9.50 9.50 --------------------- -------------- ------------------- ------------------- Outstanding at December 31, 1995 260,000 240,000 9.50 9.50 Granted (247,900) 247,900 9.88 to 10.50 10.42 --------------------- -------------- ------------------- ------------------- Outstanding at December 31, 1996 12,100 487,900 9.50 to 10.50 9.97 Additional options authorized 700,000 -- -- -- Granted (355,000) 355,000 12.88 to 17.25 16.99 Exercised -- (38,680) 9.50 to 10.50 9.83 --------------------- -------------- ------------------- ------------------- Outstanding at December 31, 1997 357,100 804,220 $ 9.50 to 17.25 $ 12.58 ===================== ============== =================== ===================
1994 Directors Plan: In September 1994, the Company adopted the 1994 Directors Plan (the "Directors Plan"), as amended, under which nonemployee members of the Board of Directors of the Company are eligible to be granted options to purchase common stock of the Company The maximum number of shares of the Company's common stock issuable under the Directors Plan is 150,000 shares. All options granted through December 31, 1997 had exercise prices equal to their fair values on the dates granted, have ten year terms and vests immediately. A summary of the Company's Directors Plan, activity and related information for the period from August 16, 1995 to December 31, 1995 and the years ended December 31, 1997 and 1996 as follows:
Weighted Available for Future Number of Exercise Price Average Grant Options Per Share Exercise Price -------------------- ------------- -------------------- ----------------- Outstanding at December 31, 1995 150,000 -- $ -- $ -- Granted (15,000) 15,000 9.75 to 10.13 9.94 Exercised -- (1,500) 9.75 9.75 -------------------- ------------- -------------------- ----------------- Outstanding at December 31, 1996 135,000 13,500 9.75 to 10.13 9.96 Granted (9,000) 9,000 12.88 to 14.50 14.23 Exercised -- (3,000) 9.75 to 10.13 9.94 -------------------- ------------- -------------------- ----------------- Outstanding at December 31, 1997 126,000 19,500 $ 9.50 to 14.50 $ 11.93 ==================== ============= ==================== =================
F-22 73 SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE HOTELS (PREDECESSOR) NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS 12. STOCK INCENTIVE PLANS AND DIRECTORS PLAN, continued 1997 Supplemental Stock Option Plan: In October 1997, the Company adopted the 1997 Supplemental Stock Option Plan (the "Supplemental Plan"), as amended under which employees, who are neither officers nor members of the Board of Directors of the Company are eligible to be granted options to purchase common stock of the Company. The maximum number of shares of the Company's common stock issuable under the Supplemental Plan is 20,000 shares. All options granted through December 31, 1997 had exercise prices less than their fair values on the dates granted, have ten year terms and vest over five years. A summary of the Company's Supplemental Plan activity and related information for the year ended December 31, 1997 as follows:
Available for Future Number of Exercise Price Weighted Average Grant Options Per Share Exercise Price -------------------- ------------ ------------ ------------ Outstanding at December 31, 1996 -- -- $ -- $ -- Authorized 20,000 -- -- -- Granted (15,300) 15,300 14.01 14.01 Forfeited 3,000 (3,000) 14.01 14.01 ------------ ------------ ------------ ------------ Outstanding at December 31, 1997 7,700 12,300 $ 14.01 $ 14.01 ============ ============ ============ ============
Pro forma information regarding net income and earnings per share is required by Statement No. 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. These pro forma effects are not likely to be representative of the effects on reported pro forma net income for future years because options vest over several years and additional awards are generally made each year. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for 1995, 1996 and 1997, respectively; risk-free interest rates of 6.5%, from 6.48% to 6.85% and from 5.89% to 6.75%; dividend yields of 7.1%, 7.1% and from 6.38% to 8.54%; volatility factors of the expected market price of the Company's common stock of 0.279, 0.279 and 0.330; and a weighted average expected life of the option of seven years. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded option, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows:
For the Period For the Years Ended December 31, August 16, 1995 -------------------------------------- to December 31, 1997 1996 1995 -------------- -------------- -------------- Pro forma net income $ 15,006,000 $ 5,559,000 $ 1,165,000 Pro forma net income per share: Basic $ 0.71 $ 0.69 $ 0.19 Diluted 0.71 0.68 0.19
F-23 74 SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE HOTELS (PREDECESSOR) NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS 12. STOCK INCENTIVE PLANS AND DIRECTORS PLAN, continued The weighted average remaining contracted life of all employee stock options outstanding at December 31, 1997 is nine years. The weighted average fair value of stock options with stock prices equal to their exercise prices issued during 1997, 1996 and 1995 is $3.29, $0.96 and $0.88, respectively. The weighted average fair value of stock prices in excess of their exercise prices issued during 1997 is $4.21. Options exercisable at December 31: 1995 -- $ -- 1996 58,500 9.58 1997 115,900 10.37
13. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) The following summarized quarterly financial data for the years ended December 31, 1997 and 1996, have been restated to comply with Statement No. 128, and the summarized quarterly financial data for the year ended December 31, 1997 has been restated to reflect the allocation of a fourth quarter depreciation expense adjustment to the first three quarters.
For the Quarter Ended ------------------------------------------------------------------------------------ March 31, June 30, September 30, December 31, 1997 1997 1997 1997 -------------- -------------- -------------- -------------- Lease revenues $ 7,572,000 $ 7,775,000 $ 12,129,000 $ 17,204,000 Net income 3,276,000 3,295,000 5,569,000 3,029,000 Basic earnings per share 0.22 0.18 0.27 0.10 Diluted earnings per share 0.22 0.17 0.27 0.10
For the Quarter Ended ------------------------------------------------------------------------------------ March 31, June 30, September 30, December 31, 1996 1996 1996 1996 -------------- -------------- -------------- -------------- Lease revenues $ 3,190,000 $ 2,965,000 $ 4,252,000 $ 4,441,000 Net income 1,337,000 877,000 1,955,000 1,465,000 Basic earnings per share 0.21 0.14 0.23 0.13 Diluted earnings per share 0.21 0.14 0.23 0.13
14. RELATED PARTY TRANSACTIONS The Management Company provides certain accounting and management services for the Company. The Company expensed $142,000, $60,000 and $11,000 for these services for the year ended December 31, 1997 and 1996 and for the period August 16, 1995 to December 31, 1995, respectively, and are included in general and administrative expenses in the statements of income and operations. Additionally, certain Management Company employee salaries, identifiable employee expenses and other costs incurred in connection with acquisition and construction and renovation services are reimbursed by the Company. During the year ended December 31, 1997, $341,000 was incurred for such costs. No reimbursements were made to the Management Company in 1996 and during the period from August 16, 1995 to December 31, 1995. In April 1996, the Company acquired a hotel property from an affiliate for $4.0 million, comprised of $3.2 million of an assumed mortgage note payable and the issuance of 80,000 Units. F-24 75 SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE HOTELS (PREDECESSOR) NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS 14. RELATED PARTY TRANSACTIONS, continued Certain Lessee employee salaries and identifiable employee expenses incurred in connection with acquisition and construction services are reimbursed by the Company. During the years ended December 31, 1997 and 1996 and for the period August 16, 1995 to December 31, 1995, $634,000, $200,000 and $13,000 was paid to the Lessee for such services, respectively. The Company reimburses the Lessee for capitalizable costs that the Lessee incurs on behalf of the Company during periods of major renovation of the hotel properties and capitalizes such costs to the related hotel properties. The total costs reimbursable to the Lessee during 1997 totaled 1,821,000. No reimbursements were made to the Lessee in 1996 and during the period from August 16, 1995 to December 31, 1995. 15. PRO FORMA FINANCIAL INFORMATION (UNAUDITED) The unaudited pro forma financial information set forth below is presented as if: (i) the acquisition, development and disposition of hotel properties, and (ii) the equity offerings completed in 1996 and 1997, had occurred on January 1, 1996. The pro forma financial information is not necessarily indicative of what actual results of operations of the Company would have been assuming the acquisition, development and disposition of the hotel properties, and the equity offerings completed in 1996 and 1997 had occurred on January 1, 1996, nor does it purport to represent the results of operations for future periods.
For the Year Ended December 31, -------------------------------------- 1997 1996 -------------- -------------- (Unaudited) Lease revenues $ 87,159,000 $ 77,450,000 Net income 29,426,000 19,872,000 Basic earnings per share 0.85 0.55 Diluted earnings per share 0.85 0.55
16. SUBSEQUENT EVENTS On January 26, 1998, the Company increased its Credit Facility from $200.0 to $300.0 million and further reduced its borrowing rate to accrue interest at as low as LIBOR plus 1.40% per annum based upon the leverage of the Company, with provisions for reduced rates upon receipt by the Company of an investment grade rating. On February 11, 1998, the Company completed a shelf offering for 4,500,000 shares of its common stock. The offering price of the shares sold was $16.375 per share, resulting in gross proceeds of approximately $73.7 million and net proceeds (less underwriters' discount and offering costs) of approximately $69.8 million. The Company used the net proceeds of the offering to finance the acquisition of additional hotels and to repay outstanding indebtedness under the Credit Facility. On January 23, 1998, the Company purchased the Vacation Inn in San Diego, California located at the corner of Old Town and San Diego Avenues in the Old Town area of San Diego, approximately one and one-half blocks from the Company's Ramada Plaza Hotel for approximately $11.5 million in cash. The Vacation Inn consists of three three-story buildings containing 124 guest rooms, including five suites. The hotel has an outdoor pool, approximately 1,250 square feet of meeting space in two meeting rooms and a lobby area suitable for serving a continental style breakfast. On January 27, 1998, the Company purchased the Residence Inn and the Fairfield Inn, developed on a single site in Santa Clarita, California for approximately $16.5 million in cash. The 90-unit Residence Inn consists of a single three-story building with several meeting rooms and an outdoor swimming pool. The 66-room Fairfield Inn consists of a single three-story building. Between the two hotels is a stand-alone meeting/conference building of approximately 1,500 square feet. F-25 76 SUNSTONE HOTEL INVESTORS, INC. AND SUNSTONE HOTELS (PREDECESSOR) NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS 16. SUBSEQUENT EVENTS, continued On February 19, 1998, the Company purchased the 221-room Hilton Inn at the Civic Plaza Conference Center in Carson, California from KPOD, Ltd., PBA Partners, and DRAD Associates for $12.5 million. The hotel consists of an eight-story, interior corridor complex which features eight different meeting and banquet rooms, a cocktail lounge and restaurant and an outdoor heated pool and jacuzzi. Subsequent to December 31, 1997, the Company declared a dividend of $0.275 per common share which was paid February 16, 1998. 77 SUNSTONE HOTEL INVESTORS, INC. SCHEDULE III- REAL ESTATE AND ACCUMULATED DEPRECIATION AS OF DECEMBER 31, 1997
Cost Capitalized Initial Cost to Company Subsequent to Acquisition -------------------------------------------------------------------- Buildings and Buildings and Description Encumbrances Land Improvements Land Improvements - ----------- ---------------------------------------------------------------------------------------- Courtyard by Marriott - Fresno $ $ 800,000 $ 2,936,460 $ 150,000 $ 792,129 Doubletree - Santa Fe 2,296,000 8,610,000 -- 1,798,517 Hampton Inn - Arcadia 1,660,500 6,226,875 -- 14,066 Hampton Inn - Denver 1,250,462 2,597,505 -- 898,658 Hampton Inn - Mesa 900,000 2,117,321 -- 258,666 Hampton Inn - Oakland 1,223,045 3,109,435 542 490,469 Hampton Inn - Pueblo 607,183 1,745,054 335,438 545,984 Hampton Inn - Silverthorne 1,337,625 5,016,094 1,925 1,102,617 Holiday Inn - Steamboat Springs 400,000 2,959,000 56,157 2,318,483 Holiday Inn Hotel & Suites - Craig 70,000 915,024 207,098 1,309,654 Holiday Inn Select - Renton 2,119,815 5,622,685 71 6,003,706 Residence Inn - Highlands Ranch 809,159 4,151,567 155,226 2,752,542 Comfort Suites - S. San Francisco 1,731,368 8,935,209 -- 1,577,809 Courtyard by Marriott - Riverside 2,908,000 395,323 3,098,797 -- 91,856 Holiday Inn - Price 240,167 4,034,833 235,459 2,802,052 Hampton Inn - Clackamas -- 2,261,998 3,322 2,318,053 Hampton Inn - Tucson (c) 500,000 5,817,500 -- 243,101 Holiday Inn - Flagstaff (c) 1,148,000 6,072,000 -- 1,132,325 Holiday Inn - Provo 850,000 1,116,708 5,266 960,193 Holiday Inn Express - Portland (Stark) 376,254 1,643,824 27,211 1,834,294 Holiday Inn Express - Poulsbo 613,485 1,558,033 21,996 1,057,200 Holiday Inn Hotel & Suites - Kent 1,166,955 2,963,452 21,996 1,953,485 Holiday Inn Hotel & Suites - Mesa CC 15,965,000 (c) 1,800,000 11,025,000 -- 1,675,447 Residence Inn - Oxnard 2,894,000 11,996,825 -- 1,460,384 Best Western - Helena 1,377,629 7,946,130 -- 5,500 Best Western - Lynnwood 2,952,000 4,090,985 -- 181,597 Best Western - Ogden 7,900,000 1,481,911 11,460,688 -- 48,700 Best Western - Twin Falls 597,513 5,600,221 -- 5,500 Boise Park Suite Hotel - Boise 659,934 11,237,521 -- -- Clinic View Inn & Suites - Rochester 1,666,170 16,703,101 -- -- Courtyard by Marriott - Cypress 1,216,537 10,340,564 -- 1,098,279 Hawthorn Suites - Anaheim -- 6,167,984 -- 109,174 Green Oaks Park Hotel - Ft Worth -- 4,582,321 -- -- Hawthorn Suites - Kent 3,350,000 1,744,000 11,607,036 -- 176,746 Hawthorn Suites - Sacramento 3,517,000 11,619,998 -- 136,966 Hilton - Salt Lake City 22,600,000 8,926,272 33,785,121 -- 20,000 Holiday Inn Select - La Mirada 3,001,000 13,541,158 -- 241,833 Holiday Inn - Rochester 1,099,890 6,691,023 -- 85,000
Life on Which Gross Amount at Depreciation Close of Period In Latest ----------------------------- Statement of Buildings and Accumulated Date of Date Financial Position Description Land Improvements Totals (a) Depreciation (b) Construction Acquired is Conducted - ----------- ----------------------------------------------------------------------------------------------------- Courtyard by Marriott - Fresno $ 950,000 $ 3,728,589 $ 4,678,589 $ 921,756 1989 1995 5-35 Doubletree - Santa Fe 2,296,000 10,408,517 12,704,517 1,400,286 1985 1995 5-35 Hampton Inn - Arcadia 1,660,500 6,240,941 7,901,441 715,447 1989 1995 5-35 Hampton Inn - Denver 1,250,462 3,496,163 4,746,625 1,872,508 1986 1995 5-35 Hampton Inn - Mesa 900,000 2,375,987 3,275,987 755,126 1987 1995 5-35 Hampton Inn - Oakland 1,223,587 3,599,904 4,823,491 221,733 1986 1995 5-35 Hampton Inn - Pueblo 942,621 2,291,038 3,233,659 1,160,977 1986 1995 5-35 Hampton Inn - Silverthorne 1,339,550 6,118,711 7,458,261 523,318 1976 1995 5-35 Holiday Inn - Steamboat Springs 456,157 5,277,483 5,733,640 2,469,977 1971 1995 5-35 Holiday Inn Hotel & Suites - Craig 277,098 2,724,678 2,501,776 477,833 1981 1995 5-35 Holiday Inn Select - Renton 2,119,886 11,626,391 13,746,277 438,467 1968 1995 5-35 Residence Inn - Highlands Ranch 964,385 6,904,109 7,868,494 233,653 1996 1995 5-35 Comfort Suites - S. San Francisco 1,731,368 10,513,018 12,244,386 498,495 1985 1996 5-35 Courtyard by Marriott - Riverside 395,323 3,190,653 3,585,976 235,669 1988 1996 5-35 Holiday Inn - Price 475,626 6,836,885 7,312,511 251,255 1984 1996 5-35 Hampton Inn - Clackamas 3,322 4,580,051 4,583,373 254,345 1986 1996 5-35 Hampton Inn - Tucson 500,000 6,060,601 6,560,601 260,429 1986 1996 5-35 Holiday Inn - Flagstaff 1,148,000 7,204,325 8,352,325 289,028 1987 1996 5-35 Holiday Inn - Provo 855,266 2,076,901 2,932,167 161,446 1968 1996 5-35 Holiday Inn Express - Portland (Stark) 403,465 3,478,118 3,881,583 183,798 1986 1996 5-35 Holiday Inn Express - Poulsbo 635,481 2,615,233 3,250,714 163,752 1986 1996 5-35 Holiday Inn Hotel & Suites - Kent 1,188,951 4,916,937 6,105,888 298,296 1986 1996 5-35 Holiday Inn Hotel & Suites - Mesa CC 1,800,000 12,700,447 14,500,447 505,535 1985 1996 5-35 Residence Inn - Oxnard 2,894,000 13,457,209 16,351,209 489,278 1987 1996 5-35 Best Western - Helena 1,377,629 7,951,630 9,329,259 72,545 1971 1997 5-35 Best Western - Lynnwood 2,952,000 4,272,582 7,224,582 38,365 1978 1997 5-35 Best Western - Ogden 1,481,911 11,509,388 12,991,299 104,971 1982 1997 5-35 Best Western - Twin Falls 597,513 5,605,721 6,203,234 51,141 1974 1997 5-35 Boise Park Suite Hotel - Boise 659,934 11,237,521 11,897,455 102,529 1991 1997 5-35 Clinic View Inn & Suites - Rochester 1,666,170 16,703,101 18,369,271 152,396 Various 1997 5-35 Courtyard by Marriott - Cypress 1,216,537 11,438,843 12,655,380 299,166 1990 1997 5-35 Hawthorn Suites - Anaheim -- 6,277,158 6,277,158 57,752 1992 1997 5-35 Green Oaks Park Hotel - Ft. Worth -- 4,582,321 4,582,321 41,808 1964 1997 5-35 Hawthorn Suites - Kent 1,744,000 11,783,782 13,527,782 320,750 1990 1997 5-35 Hawthorn Suites - Sacramento 3,517,000 11,756,964 15,273,964 214,701 1988 1997 5-35 Hilton - Salt Lake City 8,926,272 33,805,121 42,731,393 308,416 1975 1997 5-35 Holiday Inn Select - La Mirada 3,001,000 13,782,991 16,783,991 379,168 1984 1997 5-35 Holiday Inn - Rochester 1,099,890 6,776,023 7,875,913 61,756 1969 1997 5-35
F-27 78 SUNSTONE HOTEL INVESTORS, INC. SCHEDULE III- REAL ESTATE AND ACCUMULATED DEPRECIATION AS OF DECEMBER 31, 1997
Cost Capitalized Initial Cost to Company Subsequent to Acquisition -------------------------------------------------------------------- Buildings and Buildings and Description Encumbrances Land Improvements Land Improvements - ----------- -------------------------------------------------------------------------------------- Holiday Inn - San Diego $ $ 875,062 $ 7,438,037 $ -- $ 3,534,725 Holiday Inn - San Diego (Stadium) -- 9,943,238 -- 148,585 Kahler Plaza Hotel - Rochester 1,851,300 36,162,150 -- 29,100 Lakeview Resort - Morgantown 1,107,618 8,860,941 -- -- Olympia Park Hotel - Park City 32,944,000 (d) 2,259,675 15,909,442 -- -- Provo Park Hotel - Provo 1,117,314 22,120,724 -- 49,950 Quality Inn - Pocatello 576,734 4,483,486 -- -- Ramada Plaza - San Diego (Old Town) 1,188,000 10,258,897 380,814 191,425 Regency Court - LAX -- 11,120,680 -- 38,247 Residence Inn - Provo 893,851 5,603,726 -- -- Residence Inn - Sacramento 2,020,000 9,590,182 -- -- Residence Inn - San Diego 3,130,000 12,798,740 -- -- Sheraton - Chandler 13,450,000 18,752,580 23,712,592 1,241,439 -- The Kahler Hotel - Rochester (d) 3,410,748 43,097,136 -- -- University Park Hotel - Salt Lake City 8,495,000 -- 25,238,738 -- 33,000 --------------- -------------------------------------------------------------------- $ 107,612,000 $ 90,612,079 $508,243,759 $2,843,960 $ 41,526,017 --------------- --------------------------------------------------------------------
Life on Which Depreciation Gross Amount at In Latest Close of Period Statement of ------------------------------ Financial Buildings and Accumulated Date of Date Position Description Land Improvements Totals (a) Depreciation (b) Construction Acquired is Conducted - ----------- ----------------------------------------------------------------------------------------------------- Holiday Inn - San Diego $ 875,062 $ 10,972,762 $ 11,847,824 $ 161,481 1968 1997 5-35 Holiday Inn - San Diego (Stadium) -- 10,091,823 10,091,823 91,618 1991 1997 5-35 Kahler Plaza Hotel - Rochester 1,851,300 36,191,250 38,042,550 330,179 1991 1997 5-35 Lakeview Resort - Morgantown 1,107,618 8,860,941 9,968,559 80,846 Various 1997 5-35 Olympia Park Hotel - Park City 2,259,675 15,909,442 18,169,117 145,155 1985 1997 5-35 Provo Park Hotel - Provo 1,117,314 22,170,674 23,287,988 202,242 1982 1997 5-35 Quality Inn - Pocatello 576,734 4,483,486 5,060,220 40,906 1976 1997 5-35 Ramada Plaza - San Diego (Old Town) 1,568,814 10,450,322 12,019,136 190,322 1986 1997 5-35 Regency Court - LAX -- 11,158,927 11,158,927 101,463 1996 1997 5-35 Residence Inn - Provo 893,851 5,603,726 6,497,577 51,127 1996 1997 5-35 Residence Inn - Sacramento 2,020,000 9,590,182 11,610,182 -- 1992 1997 5-35 Residence Inn - San Diego 3,130,000 12,798,740 15,928,740 -- 1989 1997 5-35 Sheraton - Chandler 19,994,019 23,712,592 43,706,611 216,349 1987 1997 5-35 The Kahler Hotel - Rochester 3,410,748 43,097,136 46,507,884 393,210 Various 1997 5-35 University Park Hotel - Salt Lake City -- 25,271,738 25,271,738 230,548 1987 1997 5-35 ---------------------------------------------------------------- $ 93,456,039 $ 549,769,776 $ 643,225,815 $ 19,223,317 ----------------------------------------------------------------
1996 1997 ------------------ ------------------ (a) Reconciliation of Land and Buildings and Improvements: Balance at the beginning of the year $ 52,012,431 $147,323,633 Additions during year: Acquisitions 88,198,970 467,135,297 Improvements 11,062,230 28,766,885 Disposals during the year (3,949,998) -- ------------------ ------------------ Balance at end of year $ 147,323,633 $643,225,815 ------------------ ------------------ (b) Reconciliation of Accumulated Depreciation: Balance at beginning of year 6,735,996 9,558,217 Depreciation for the year 2,861,351 9,665,100 Retirement (39,130) -- ------------------ ------------------ Balance at end of year $ 9,558,217 $ 19,223,317 ------------------ ------------------
(c) The $15,965,000 of encumbrances are cross-collateralized by the Mesa Holiday Inn, the Tucson Hampton Inn and the Flagstaff Holiday Inn. (d) The $32,944,000 encumbrance is cross-collateralized by the Olympia Park Hotel and the Kahler Hotel. F-28 79 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors Sunstone Hotel Investors, Inc. We have audited the accompanying consolidated balance sheets of Sunstone Hotel Investors, Inc. (the "Company") as of December 31, 1996 and the related consolidated statements of operations, equity and cash flows for the year ended December 31, 1996 and for the period August 16, 1995 to December 31, 1995 and the combined statements of operations, deficit and cash flows of Sunstone Hotels (the "Predecessor") for the period January 1, 1995 to August 15, 1995. Our audit also included the accompanying financial statement schedule as of December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated and combined financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sunstone Hotel Investors, Inc. as of December 31, 1996 and 1995, and the consolidated results of their operations and cash flows for the year ended December 31, 1996 and for the period August 16, 1995 to December 31, 1995 and the combined results of operations and cash flows of the Predecessor for the period January 1, 1995 to August 15, 1995, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein. COOPERS & LYBRAND LLP San Francisco, California February 28, 1997 F-29 80 REPORT OF INDEPENDENT AUDITORS To the Board of Directors Sunstone Hotel Properties, Inc. We have audited the accompanying consolidated balance sheet of Sunstone Hotel Properties, Inc. (the "Lessee") as of December 31, 1997, and the related consolidated statements of operations and stockholders' deficit and cash flows for the year then ended. These financial statements are the responsibility of the Lessee's management. Our responsibility is to express an opinion on these financial statements based on our audit. The financial statements of Sunstone Hotel Properties, Inc. as of December 31, 1996 and for the year then ended and for the period from August 16, 1995 (inception) to December 31, 1995 were audited by other auditors whose report dated February 28, 1997 expressed an unqualified opinion on those statements. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the 1997 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sunstone Hotel Properties, Inc. as of December 31, 1997, and the consolidated results of its operations and its cash flows for the year then ended, in conformity with generally accepted accounting principles. ERNST & YOUNG LLP Newport Beach, California February 27, 1998 F-30 81 SUNSTONE HOTEL PROPERTIES, INC. CONSOLIDATED BALANCE SHEETS
December 31, -------------------------------- 1997 1996 ------------ ------------ ASSETS: Current assets Cash and cash equivalents $ 4,352,000 $ 1,165,000 Receivables, net of allowance for doubtful accounts of $267,000 in 1997 and $99,000 in 1996 10,037,000 1,217,000 Due from affiliates, net (Note 9) 321,000 66,000 Inventories 1,798,000 208,000 Prepaid expenses 306,000 134,000 ------------ ------------ 16,814,000 2,790,000 Management agreements 723,000 -- Property and equipment, net (Notes 2 and 5) 3,116,000 306,000 ------------ ------------ $ 20,653,000 $ 3,096,000 ============ ============ LIABILITIES AND STOCKHOLDERS' DEFICIT Current liabilities Rent payable - Sunstone Hotel Investors, Inc. (Note 6) $ 7,641,000 $ 2,360,000 Accounts payable 8,836,000 2,328,000 Customer deposits 550,000 276,000 Sales taxes payable 1,640,000 224,000 Accrued payroll 3,093,000 718,000 Accrued vacation 1,795,000 163,000 Accrued bonuses 573,000 176,000 Capital lease obligation - current portion (Note 5) 55,000 -- Other accrued expenses 1,007,000 759,000 ------------ ------------ 25,190,000 7,004,000 Long-term liabilities Capital lease obligation (Note 5) 366,000 -- Accrued pension liability (Note 7) 1,017,000 -- ------------ ------------ 26,573,000 7,004,000 ------------ ------------ Minority interest 119,000 -- Commitments (Notes 5 and 6) Stockholders' deficit: Common stock, no par value, 1,000 shares authorized; 100 shares issued and outstanding -- -- Deficit (Note 3) (6,039,000) (3,908,000) ------------ ------------ $ 20,653,000 $ 3,096,000 ============ ============
The accompanying notes are an integral part of these financial statements. F-31 82 SUNSTONE HOTEL PROPERTIES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS AND STOCKHOLDERS' DEFICIT
For the Period August 16, 1995 to For the Years ended December 31, December 31, ------------- ------------- ------------- 1997 1996 1995 ------------- ------------- ------------- REVENUES: Room $ 95,106,000 $ 34,085,000 $ 7,060,000 Food and beverage 14,159,000 2,576,000 572,000 Other (Note 2) 8,888,000 1,932,000 293,000 ------------- ------------- ------------- Total revenues 118,153,000 38,593,000 7,925,000 ------------- ------------- ------------- EXPENSES: Room 22,073,000 9,041,000 2,487,000 Food and beverage 11,978,000 2,436,000 531,000 Franchise costs 3,428,000 1,326,000 285,000 Advertising and promotion 9,574,000 3,895,000 602,000 Utilities 5,013,000 2,034,000 363,000 Repairs and maintenance 4,719,000 1,829,000 376,000 Management fees to related party (Note 9) 1,776,000 983,000 157,000 Rent expense - Sunstone Hotel Investors, Inc. (Notes 3 and 6) 44,680,000 14,848,000 3,013,000 General and administrative 11,889,000 4,098,000 726,000 Other 5,154,000 1,265,000 131,000 ------------- ------------- ------------- Total expenses 120,284,000 41,755,000 8,671,000 ------------- ------------- ------------- Net loss (2,131,000) (3,162,000) (746,000) Stockholders' deficit: Deficit, beginning of period (3,908,000) (746,000) -- ------------- ------------- ------------- Deficit, end of period $ (6,039,000) $ (3,908,000) $ (746,000) ============= ============= =============
The accompanying notes are an integral part of these financial statements. F-32 83 SUNSTONE HOTEL PROPERTIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Period For the Years ended December 31, August 16, 1996 to ------------------------------ December 31, 1997 1996 1995 ----------- ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(2,131,000) $(3,162,000) $ (746,000) Adjustments to reconcile net loss to net cash provided by operating activities: Bad debt 267,000 -- -- Depreciation 53,000 -- -- Amortization 94,000 -- -- Changes in assets and liabilities: Receivables, net (2,011,000) (751,000) (466,000) Inventories (140,000) (389,000) (125,000) Prepaid expenses and other assets 91,000 (45,000) (70,000) Rent payable - Sunstone Hotel Investors, Inc. 5,281,000 1,715,000 645,000 Accounts payable (1,060,000) 2,034,000 294,000 Customer deposits 274,000 77,000 199,000 Sales taxes payable 1,416,000 (1,000) 225,000 Accrued payroll 2,372,000 476,000 242,000 Accrued vacation 481,000 81,000 82,000 Accrued bonuses 397,000 61,000 115,000 Due from/to affiliates, net (1,852,000) (170,000) 104,000 Accrued pension liability (180,000) -- -- Other accrued expenses (1,250,000) 458,000 301,000 ----------- ----------- ----------- Net cash provided by operating activities 2,102,000 384,000 800,000 ----------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (174,000) (19,000) -- Proceeds from lessor upon execution of certain leases (Note 9) 1,269,000 -- -- ----------- ----------- ----------- Net cash provided by investing activities 1,095,000 -- -- ----------- ----------- ----------- CASH FLOWS USED IN FINANCING ACTIVITIES: Payments on capital lease obligation (10,000) -- -- ----------- ----------- ----------- Net cash used in financing activities (10,000) -- -- ----------- ----------- ----------- Net change in cash and cash equivalents 3,187,000 365,000 800,000 Cash and cash equivalents, beginning of period 1,165,000 800,000 -- ----------- ----------- ----------- Cash and cash equivalents, end of period $ 4,352,000 $ 1,165,000 $ 800,000 =========== =========== ===========
F-33 84 SUNSTONE HOTEL PROPERTIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION Sunstone Hotel Properties, Inc. (the "Lessee") was incorporated in Colorado in August 1995 and commenced operations effective with the completion of an initial public stock offering by Sunstone Hotel Investors, Inc. (the "Lessor") on August 16, 1995. The Lessee leases hotel properties, which are primarily located in the western United States, from the Lessor pursuant to long-term leases (the "Percentage Leases"). The Lessee is owned by Robert A. Alter, Chairman and President of the Lessor (80%), and Charles L. Biederman, Director and Executive Vice President of the Lessor (20%). At December 31, 1997, 51 hotel properties were leased from the Lessor. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Consolidation: The accompanying financial statements include the accounts of the Lessee and its subsidiaries in which it has controlling interests. All significant intercompany transactions have been eliminated in consolidation. Cash And Cash Equivalents: Cash and cash equivalents are defined as cash on hand and in banks plus all short-term investments with an original maturity of three months or less. Concentrations Of Credit Risk: At December 31, 1997 and 1996, the Lessee had amounts in banks that were in excess of federally-insured amounts. Receivables: Accounts receivable primarily represents receivables from hotel guests who occupy hotel rooms and utilize the hotel services. Accounts receivable also includes receivables from customers who utilize the Lessee's laundry facilities in Provo, Utah and Rochester, Minnesota. Inventories: Inventories, consisting primarily of food and beverages are stated at the lower of cost or market, with cost determined on a method that approximates first-in, first-out basis. Management Agreements: Management agreements are carried at the Lessor's allocated cost of such agreements prior to the agreements being assigned to the Lessee. The allocated costs were based upon the estimated fair value of the management agreements in connection with the Lessor's acquisition of the stock of Kahler Realty Corporation. The management agreements are amortized over the estimated term of the agreements. Accumulated amortization totaled $94,000 at December 31, 1997. Property and Equipment: Property and equipment is stated on the basis of cost and includes real estate assets, computer equipment, telephone equipment (Note 5) and other hotel equipment. Property and equipment also includes a sewage treatment plant and related assets located in Morgantown, West Virginia. Property and equipment is depreciated on a straight-line basis over estimated useful lives ranging from 3 to 25 years. F-34 85 SUNSTONE HOTEL PROPERTIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued Property and Equipment, continued: Property and equipment consists of the following at December 31:
1997 1996 ----------- ----------- Land $ 26,000 $ -- Sewage treatment plant and equipment 521,000 19,000 ----------- ----------- 547,000 19,000 Hotel equipment 2,622,000 287,000 ----------- ----------- 3,169,000 306,000 Accumulated depreciation (53,000) -- ----------- ----------- $ 3,116,000 $ 306,000 ----------- -----------
Revenue Recognition: Revenue is recognized as earned, which is generally defined as the date upon which a guest occupies a room and utilizes the hotel's services. Ongoing credit evaluations are performed and potential credit losses are expensed at the time the account receivable is estimated to be uncollectible. Historically, credit losses have not been material to the hotels' results of operations. Other Revenue: Other revenue consist of revenue derived from incidental hotel services such as concession, movie, golf, retail and fitness services. Such revenues are recognized in the period the related services are provided. Rent Expense: Rent expense is recognized as incurred to the Lessee under the Percentage Leases, commencing on the date the lease is executed. Advertising and Promotion Costs: Advertising and promotion costs are expensed when incurred. Advertising and promotion costs represent the expense for franchise advertising and reservation systems under the terms of the hotel franchise agreements and general and administrative expenses that are directly attributable to advertising and promotions. Franchise Costs: Franchise costs represent the expense for franchise royalties under the terms of hotel franchise agreements, generally ranging from 10 to 20 years. F-35 86 SUNSTONE HOTEL PROPERTIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued Income Taxes: The Lessee has elected to be treated as an S Corporation under Subchapter S of the Internal Revenue Code. As a Subchapter S Corporation, the tax attributes of the Lessee will pass through to its stockholders, who will then owe any income related taxes. Accordingly, the accompanying statements of operations and stockholders' deficit do not include income tax expense. Fair Value of Financial Instruments: Management has estimated the fair value of its financial instruments. Considerable judgment is required in interpreting market data in order to develop estimates of the fair value of the Lessee's financial instruments. Accordingly, the estimated values are not necessarily indicative of the amounts that could be realized in current market exchanges. For those financial instruments for which it is practical to estimate value, management believes that the carrying amounts of the Lessee's financial instruments reasonably approximate their fair value at December 31, 1997 and 1996. Long-Lived Assets: Impairment losses are recognized on long-lived assets used in operations when indicators of impairment are present and the estimated undiscounted cash flows to be generated by those assets are less than the carrying amount of the assets. Management estimates that the sum of the future undiscounted cash flows, excluding interest charges, for each of the Lessee's long-lived assets is greater than the carrying amount of such assets at December 31, 1997. Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates in the near term. 3. DEFICIT From inception, the Lessee has incurred cumulative losses of $6.0 million. The 1997 $2.1 million loss is substantially due to the combined effects on the Lessee of (i) the acquisition of the Kahler portfolio on October 15, 1997 and the related off-peak seasonality activity of that portfolio during the fourth quarter of 1997 and (ii) the effect of the renovations of the Hilton Hotel in Salt Lake City, Utah, the Holiday Inn in Mesa, Arizona and the Ramada Hotel in San Diego, California, representing approximately $1.2 million of the loss. Additional losses are primarily attributable to executing the Company's strategy of renovating and repositioning its acquired hotels, to the transition to new management at acquired hotels and to the operating leverage of certain Percentage Leases. The 1996 $3.2 million loss was primarily attributable to seven hotels that under went substantial renovations. Such renovations were made in conjunction with the Lessor's strategy of acquiring hotels that can benefit from extensive improvements, reflagging and repositioning, resulting in higher potential revenue. During periods of renovation, the hotels generally do not generate sufficient revenue to meet operating expenses, including lease payments. Accordingly, the Lessee incurred substantial operating losses primarily due to the terms of the Percentage Leases. In 1997, the Lessor and Lessee amended the Percentage Leases for hotels then currently under renovation and for any future hotels to allow for the abatement of base rent related to rooms taken out of service during major renovations. F-36 87 SUNSTONE HOTEL PROPERTIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3. DEFICIT, continued The Lessee has remained current in its payments to the Company under the terms of the Percentage Leases. During 1998, management of the Lessee anticipates generating positive operating cash flow, however, there can be no assurance that operating expectations will be met. 4. REVOLVING LINE OF CREDIT The Lessee has a one-year commitment for a $1.5 million credit facility that bears interest at the bank's prime rate plus 0.25% and matures in May 1998. The credit facility, which is collateralized by 225,000 Partnership Units of Sunstone Hotel Investors, L.P. and is guaranteed by Robert A. Alter, is to be used exclusively for general short-term working capital and requires the Lessee to pay a 0.125% fee on the portion of the undisbursed loan proceeds. Through December 31, 1997, the Company had not drawn any funds on this credit facility. Management believes that the Lessee is in compliance with all covenants under this credit facility. 5. COMMITMENTS Property and equipment includes $421,000 for telephone equipment that is being leased and has been capitalized at December 31, 1997 (Note 2). Future minimum payments under the capital lease consist of the following at December 31, 1997: 1998 $ 92,000 1999 92,000 2000 209,000 2001 123,000 --------------- 516,000 Amounts representing interest (95,000) --------------- Present value of net minimum lease payments $ 421,000 ===============
Ten of the Lessee's hotels have telephone service agreements with the same telecommunications company which call for contingent payments based upon telephone usage. These agreements expire in June 2000. Expenses incurred pursuant to these service agreements totaled $533,000 in 1997. The Lessee is involved from time to time in various claims and legal actions in the ordinary course of business. Management does not believe that the impact of such matters will have a material adverse effect on the Lessee's financial position or results of operations when resolved. 6. PERCENTAGE LEASE AGREEMENTS The Lessee has future commitments to the Lessor under the Percentage Leases through 2007. At December 31, 1997, future minimum rentals (base rents) payable under the Percentage Leases, exclusive of any base rent to be abated during periods of major renovation (Note 3), with the Lessor are as follows: 1998 $ 50,083,000 1999 50,083,000 2000 50,083,000 2001 50,083,000 2002 50,083,000 Thereafter 215,749,000 --------------------- $ 466,164,000 =====================
F-37 88 SUNSTONE HOTEL PROPERTIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6. PERCENTAGE LEASE AGREEMENTS, continued The term of each lease is ten years. The Percentage Leases contain various covenants and are cross-defaulted. The rent payable under each lease is the greater of base rent (subject to annual adjustments based on increases in the United States Consumer Price Index) or percentage rent. Percentage rent is calculated as 20% to 37% of room revenues, up to a certain baseline revenue, then 60% to 65% of room revenues in excess of the baseline revenues. Generally, percentage rent includes 5% of food and beverage revenue and 100% of net other revenues. Rent expense for the year ended December 31, 1997 and 1996 and for the period August 16, 1995 to December 31, 1995 was $44,680,000, $14,848,000 and $3,013,000, respectively, of which $19,842,000, $6,807,000 and $1,328,000, respectively, was in excess of base rent. The stockholders of the Lessee have collateralized the lease payments by pledging 481,955 units owned in Sunstone Hotel Investors, L.P., a majority-owned partnership of the Lessor. 7. RETIREMENT PLANS The Lessee has a defined benefit plan covering union employees at certain properties located in Rochester, Minnesota. This was previously a plan of Kahler Realty Corporation ("Kahler"), which was assumed by the Lessor in connection with its acquisition of Kahler in October 1997. The plan was assigned to the Lessee upon execution of the Percentage Leases of the related Kahler Hotels. Pension contributions and expenses for this plan are determined based on the actuarial cost of current service. Net periodic pension cost for the defined benefit plan includes the following components since assigned October 15, 1997: Service costs - benefits earned during the year $ 30,000 Interest cost on projected benefit obligation 51,000 Return on assets - actual 76,000 Net amortization and deferral (119,000) ----------- Net periodic pension cost $ 38,000 =========== The following table sets forth the plan's funded status at December 31, 1997: Accumulated benefit obligation, including vested benefits of $3,411,000 $ 3,509,000 =========== Projected benefit obligation $ 3,509,000 Fair market value of plan assets (1) 2,492,000 Unrecognized net loss 119,000 Additional minimum liability (119,000) ----------- Unfunded projected benefit obligation/pension liability $ 1,017,000 ===========
- ---------- (1) Plan assets consist primarily of equity and fixed income securities. The benefit formula is based upon a monthly benefit level times the years of benefit service. The weighted-average discount rate used in determining the actuarial present value of the projected benefit obligation in 1997 was 7% and the expected long-term rate of return on assets was 8%. The Lessee's funding policy is to contribute amounts to the plan sufficient to meet minimum funding requirements set forth in the Employee Retirement Income Security Act of 1974, plus such additional amount as the Lessee may determine appropriate from time to time. F-38 89 SUNSTONE HOTEL PROPERTIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7. RETIREMENT PLANS, continued The Lessee also provides post-retirement benefits to a fixed number of retired employees of acquired hotels relating to service provided prior to 1992. At December 31, 1997, the estimated liability was $179,000 and is included in other accrued expenses. The Lessee's employees may participate, subject to eligibility, in Sunstone Hotel Properties, Inc.'s Retirement and Savings Plan (the "401(k) Plan"). Employees are eligible to participate in the 401(k) Plan after attaining 21 years of age and performing one year of service and working at least 1,000 hours. Up to 6% of employee contributions are matched by the Lessee at 25%. Matching contributions made by the Lessee totaled $69,000 and $11,000 for the years ended December 31, 1997 and 1996, respectively. 8. STOCK APPRECIATION RIGHTS PLAN In July 1996, the Company adopted the 1996 Stock Appreciation Rights Plan (the "Plan"), as amended, under which employees, consultants and nonemployee members of the Board of Directors of the Company are eligible to receive stock appreciation rights that are based upon the quoted market prices of the Lessor's common stock. Through December 31, 1997, the maximum number of rights of the Lessor's common stock issuable under the Plan is 500,000 shares. All rights are issued at prices equal to their fair values on the dates granted, have ten year terms and vest over five years. A summary of the Plan activity and related information for the years ended December 31, 1997 and 1996 is as follows:
Number of Stock Available for Future Appreciation Grant Rights Grant Price ----------------------- -------------------- ----------------------- Outstanding at December 31, 1995 - - $ - Authorized 267,000 - - Granted (177,110) 177,110 9.50 to 10.25 Exercised - (4,120) 9.50 Forfeited 7,280 (7,280) 9.50 ----------------------- -------------------- ----------------------- Outstanding at December 31, 1996 97,170 165,710 9.50 to 10.25 Additional options authorized 233,000 - - Granted (276,289) 276,289 10.87 to 14.01 Forfeited 7,290 (7,290) 12.88 to 14.01 ----------------------- -------------------- ----------------------- Outstanding at December 31, 1997 61,171 434,709 $ 9.50 to 14.01 ======================= ==================== =======================
Weighted Average Exercise Price ----------------------- Outstanding at December 31, 1995 $ - Authorized - Granted 9.52 Exercised 9.50 Forfeited 9.50 ----------------------- Outstanding at December 31, 1996 9.52 Additional options authorized - Granted 13.45 Forfeited 12.93 ----------------------- Outstanding at December 31, 1997 $ 13.47 =======================
During 1997, compensation expense totaling $456,000 was recognized with respect to the stock appreciation rights plan. The compensation expense is the effect of applying Statement of Financial Accounting Standard No. 123's fair value method to the Lessee's stock appreciation rights results in net income and earnings per share that are not materially different from amounts reported. 9. OTHER RELATED PARTY TRANSACTIONS Sunstone Hotel Management, Inc. (the "Management Company"), a company wholly owned by Robert A. Alter, Chairman and President of the Company, provides management services to the Lessee pursuant to the terms of a management agreement. The agreement has a one year term and is automatically renewed. Management fees are computed based on 1% to 2% of gross revenues. The cost of these services is classified as management fees in the statements of operations. F-39 90 SUNSTONE HOTEL PROPERTIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 9. OTHER RELATED PARTY TRANSACTIONS, continued Certain Lessee employees' salaries and identifiable employee expenses incurred in connection with acquisition and construction services are reimbursed by the Company. The reimbursements are recorded as a reduction of the related expenses. During the years ended December 31, 1997 and 1996 and for the period August 16, 1995 to December 31, 1995, $634,000, $200,000 and $13,000 was reimbursed to the Lessee for such services, respectively. Upon the execution of each Percentage Lease, the Lessor assigns all hotel operating assets and liabilities to the Lessee at the Lessor's cost. The Lessee records all such hotel operating assets and liabilities at the Lessor's cost with a corresponding net amount payable to or receivable from the Lessor, depending on whether net assets or liabilities were assigned. During 1997 and 1996, the net assets assigned in this manner totaled $1,870,000 and $147,000, respectively. In connection with the Lessor's acquisition of Kahler Realty Corporation, the Lessor assigned net liabilities to the Lessee and paid the Lessee $1,069,000, plus on additional $200,000 of assigned cash. The Lessee is reimbursed by the Lessor for certain costs it incurs related to the Lessor's renovation of the hotels. The total costs incurred and reimbursable by the Lessor totaled $1,821,000 in 1997. Amounts due from affiliates primarily represents reimbursements due from the Lessor netted with the amounts due to the Lessor for net hotel operating assets assigned by the Lessor to the Lessee upon the execution of each Percentage Lease. 10. SUBSEQUENT EVENTS Subsequent to December 31, 1997, the Lessee executed four additional Percentage Leases with the Lessor with terms similar to the existing Percentage Leases (Note 6). The aggregate future minimum monthly rentals (base rents) payable under these leases, exclusive of any base rent to be abated during periods of major renovations is $2,851,000 per year. F-40 91 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors Sunstone Hotel Properties, Inc. We have audited the accompanying balance sheets of Sunstone Hotel Properties, Inc. (the "Lessee") as of December 31, 1996 and 1995, and the related statements of operations, stockholders' deficit, and cash flows for the year ended December 31, 1996 and for the period August 16, 1995 (inception) to December 31, 1995. These financial statements are the responsibility of the Lessee's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Sunstone Hotel Properties, Inc. as of December 31, 1996 and 1995, and the results of its operations and cash flows for the year ended December 31, 1996 and for the period August 16, 1995 to December 31, 1995, in conformity with generally accepted accounting principles. COOPERS & LYBRAND LLP Newport Beach, California February 28, 1997 F-41 EX-3.2 2 AMENDED BYLAWS 1 AMENDED AND RESTATED BYLAWS OF SUNSTONE HOTEL INVESTORS, INC. 2 TABLE OF CONTENTS
Page ---- ARTICLE I -- Offices....................................................... 1 Section 1. Principal Office...................................... 1 Section 2. Additional Offices.................................... 1 Section 3. Fiscal and Taxable Years.............................. 1 ARTICLE II -- Definitions.................................................. 1 ARTICLE III -- Meetings of Shareholders.................................... 2 Section 1. Place................................................. 2 Section 2. Annual Meeting........................................ 2 Section 3. Special Meetings...................................... 2 Section 4. Notice................................................ 2 Section 5. Organization.......................................... 2 Section 6. Quorum................................................ 3 Section 7. Voting................................................ 3 Section 8. Proxies............................................... 3 Section 9. Voting of Shares by Certain Holders................... 3 Section 10. Inspectors............................................ 4 Section 11. Determination of Shareholders of Record............... 4 Section 12. Action Without a Meeting.............................. 5 Section 13. Voting by Ballot...................................... 5 Section 14. Control Share Acquisition Statute..................... 5 ARTICLE IV -- Directors.................................................... 5 Section 1. General Powers........................................ 5 Section 2. Number, Tenure and Qualifications..................... 5 Section 3. Changes in Number; Vacancies.......................... 6 Section 4. Resignations.......................................... 6 Section 5. Removal of Directors.................................. 6 Section 6. Annual and Regular Meetings........................... 6 Section 7. Special Meetings...................................... 6 Section 8. Notice................................................ 6 Section 9. Quorum................................................ 7 Section 10. Voting................................................ 7 Section 11. Telephone Meetings.................................... 8 Section 12. Action Without a Meeting.............................. 8 Section 13. Compensation.......................................... 8 Section 14. Policies and Resolutions.............................. 8 ARTICLE V -- Committees.................................................... 8 Section 1. Committees of the Board............................... 8
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Page ---- Section 2. Telephone Meetings.................................... 9 Section 3. Action By Committees Without a Meeting................ 9 ARTICLE VI -- Officers..................................................... 9 Section 1. General Provisions.................................... 9 Section 2. Subordinate Officers, Committees and Agents........... 10 Section 3. Removal and Resignation............................... 10 Section 4. Vacancies............................................. 10 Section 5. General Powers........................................ 10 Section 6. Chief Executive Officer............................... 10 Section 7. Chief Operating Officer............................... 10 Section 8. Chairman and Vice Chairman of the Board............... 11 Section 9. President............................................. 11 Section 10. Vice Presidents....................................... 11 Section 11. Secretary............................................. 11 Section 12. Chief Financial Officer or Treasurer.................. 11 Section 13. Assistant Secretaries and Assistant Treasurers........ 12 Section 14. Salaries.............................................. 12 ARTICLE VII -- Contracts, Notes, Checks and Deposits....................... 12 Section 1. Contracts............................................. 12 Section 2. Checks and Drafts..................................... 12 Section 3. Deposits.............................................. 12 ARTICLE VIII -- Capital Shares..............................................13 Section 1. Certificates of Shares................................ 13 Section 2. Lost Certificate...................................... 13 Section 3. Transfer Agents and Registrars........................ 13 Section 4. Transfer of Shares.................................... 13 Section 5. Share Ledger.......................................... 14 ARTICLE IX - Dividends..................................................... 14 Section 1. Declaration........................................... 14 Section 2. Contingencies......................................... 14 ARTICLE X - Indemnification and Limitation of Liability.................... 14 Section 1. Indemnification of Agents............................. 14 Section 2. Insurance............................................. 15 Section 3. Indemnification Non-Exclusive......................... 15 Section 4. Limitation of Liability............................... 15 ARTICLE XI - Seal.......................................................... 15 Section 1. Seal.................................................. 15 Section 2. Affixing Seal......................................... 15
(ii) 4 TABLE OF CONTENTS
Page ---- ARTICLE XII -- Waiver of Notice............................................. 16 ARTICLE XIII -- Amendment of Bylaws......................................... 16 Section 1. By Directors.......................................... 16 Section 2. By Shareholders....................................... 16
(iii) 5 EXHIBIT 3.2 AMENDED AND RESTATED BYLAWS OF SUNSTONE HOTEL INVESTORS, INC. ARTICLE I Offices Section 1. Principal Office. The principal office of SunStone Hotel Investors, Inc. (the "Corporation") shall be located in California or at any other place or places as the Board of Directors may designate. Section 2. Additional Offices. The Corporation may have additional offices at such places as the Board of Directors may from time to time determine or the business of the Trust may require. Section 3. Fiscal and Taxable Years. The fiscal and taxable years of the Corporation shall begin on January 1 and end on December 31. ARTICLE II Definitions For purposes of these Bylaws, the following words shall have the meanings set forth below: (a) "Affiliate" of a person shall mean (i) any person that, directly or indirectly, controls or is controlled by or is under common control with such person, (ii) any other person that owns, beneficially, directly or indirectly, five percent (5%) or more of the outstanding capital shares, shares or equity interests of such person, or (iii) any officer, director, employee, partner or trustee of such person or any person controlling, controlled by or under common control with such person (excluding trustees and persons serving in similar capacities who are not otherwise an Affiliate of such person). The term "person" means and includes individuals, corporations, general and limited partnerships, stock companies or associations, joint ventures, associations, companies, trusts, banks, trust companies, land trusts, business trusts, or other entities and governments and agencies and political subdivisions thereof. For the purposes of this definition, "control" (including the correlative meanings of the terms "controlled by" and "under common control with"), as used with respect to any person, shall mean the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of such person, through the ownership of voting securities, partnership interests or other equity interests. 1 6 (b) "Independent Director" shall mean a Director of the Corporation, other than C. Robert Enever, who is not an officer or employee of the Corporation. ARTICLE III Meetings of Shareholders Section 1. Place. All meetings of shareholders shall be held at Suite 203, 300 South El Camino Real, San Clemente, California 92672, or at such other place within the United States as shall be stated in the notice of the meeting. Section 2. Annual Meeting. The President or the Board of Directors may fix the time of the annual meeting of the shareholders for the election of Directors and the transaction of any business as may be properly brought before the meeting, but if no such date and time is fixed by the President or the Board of Directors, the meeting for any calendar year shall be held on the fourth Thursday in May, if that day is not a legal holiday. If that day is a legal holiday, the annual meeting shall be held on the next succeeding business day that is not a legal holiday. Failure to hold an annual meeting does not invalidate the Corporation's existence or affect any otherwise valid corporate acts. Section 3. Special Meetings. The President, a majority of the Board of Directors or a majority of the Independent Directors may call special meetings of the shareholders. Special meetings of shareholders also shall be called by the Secretary upon the written request of the holders of shares entitled to cast not less than ten percent (10%) of all the votes entitled to be cast at such meeting. Such request shall state the purpose of such meeting and the matters proposed to be acted on at such meeting. The Secretary shall inform such shareholders of the reasonably estimated cost of preparing and mailing notice of the meeting and, upon payment to the Corporation of such costs by such shareholders, the Secretary shall give notice to each shareholder entitled to notice of the meeting. Unless requested by shareholders entitled to cast a majority of all the votes entitled to be cast at such meeting, a special meeting need not be called to consider any matter which is substantially the same as a matter voted on at any special meeting of the shareholders held during the preceding twelve months. Section 4. Notice. Not less than 10 nor more than 60 days before each meeting of shareholders, the Secretary shall give to each shareholder entitled to vote at such meeting and to each shareholder not entitled to vote who is entitled to notice of the meeting, written or printed notice stating the time and place of the meeting and, in the case of a special meeting or as otherwise may be required by statute, the purpose for which the meeting is called, either by mail or by presenting it to such shareholder personally or by leaving it at his residence or usual place of business. If mailed, such notice shall be deemed to be given when deposited in the United States mail addressed to the shareholder at his post office address as it appears on the records of the Corporation, with postage thereon prepaid. Section 5. Organization. At every meeting of the shareholders, the Chairman of the Board, if there be one, shall conduct the meeting or, in the case of vacancy in office or absence of the Chairman of the Board, one of the following officers present shall conduct the meeting in the order 2 7 stated: the Vice Chairman of the Board, if there be one, the President, the Vice Presidents in their order of rank and seniority, or a Chairman chosen by the shareholders entitled to cast a majority of the votes which all shareholders present in person or by proxy are entitled to cast, shall act as Chairman, and the Secretary, or, in his absence, an assistant secretary, or in the absence of both the Secretary and assistant secretaries, a person appointed by the Chairman shall act as Secretary. Section 6. Quorum. At any meeting of shareholders, the presence in person or by proxy of shareholders entitled to cast fifty percent (50%) of all the votes entitled to be cast at such meeting shall constitute a quorum; but this Section 7 shall not affect any requirement under any statute, the Charter or these Bylaws for the vote necessary for the adoption of any measure. If such quorum shall not be present at any meeting of the shareholders, the shareholders representing a majority of the shares entitled to vote at such meeting, present in person or by proxy, may vote to adjourn the meeting from time to time to a date not more than 120 days after the original record date without notice other than announcement at the meeting until such quorum shall be present. At such adjourned meeting at which a quorum shall be present, any business may be transacted which might have been transacted at the meeting as originally notified. Section 7. Voting. A plurality of all the votes cast at a meeting of shareholders duly called and at which a quorum is present shall be sufficient to elect a director. There shall be no cumulative voting. Each common share may be voted for as many individuals as there are Directors to be elected and for whose election the share is entitled to be voted. A majority of the votes cast at a meeting of shareholders duly called and at which a quorum is present shall be sufficient to approve any other matter which may properly come before the meeting, unless more than a majority of the votes cast is required by statute, by the Charter or by these Bylaws. Each shareholder of record shall have the right, at every meeting of shareholders, to one vote for each share held, except shares which are the subject of a redemption notice as provided in the Charter. Section 8. Proxies. A shareholder may vote the common shares owned of record by him, either in person or by proxy executed in writing by the shareholder or by his duly authorized attorney in fact. Such proxy shall be filed with the Secretary of the Corporation before or at the time of the meeting. No proxy shall be valid after eleven months from the date of its execution, unless otherwise provided in the proxy. Section 9. Voting of Shares by Certain Holders. Shares registered in the name of a trust or another corporation, if entitled to be voted, may be voted by the president, a vice president or a proxy appointed by the president or a vice president of such trust or other corporation, unless some other person who has been appointed to vote such shares pursuant to a bylaw or a resolution of the board of such trust or other corporation presents a certified copy of such bylaw or resolution, in which case such person may vote such shares. Any fiduciary may vote shares registered in his name as such fiduciary, either in person or by proxy. Shares indirectly owned by this Corporation shall not be voted at any meeting and shall not be counted in determining the total number of outstanding shares entitled to be voted at any given time, unless they are held by it in a fiduciary capacity, in which case they may be voted and shall all be counted in determining the total number of outstanding shares at any given time. 3 8 The Board of Directors may adopt by resolution a procedure by which a shareholder may certify in writing to the Corporation that any shares registered in the name of the shareholder are held for the account of a specified person other than the shareholder. The resolution shall set forth the class of shareholders who may make the certification, the purpose for which the certification may be made, the form of certification and the information to be contained in it; if the certification is with respect to a record date or closing of the share transfer books, the time after the record date or closing of the share transfer books within which the certification must be received by the Corporation; and any other provisions with respect to the procedure which the Board of Directors considers necessary or desirable. On receipt of such certification, the person specified in the certification shall be regarded as, for the purposes set forth in the certification, the shareholder of record of the specified shares in place of the shareholder who makes the certification. Section 10. Inspectors. At any meeting of shareholders, the Chairman of the meeting may, or upon the request of any shareholder shall, appoint one or more persons as inspectors for such meeting. Such inspectors shall ascertain and report the number of shares represented at the meeting based upon their determination of the validity and effect of proxies, count all votes, report the results and perform such other acts as are proper to conduct the election and voting with impartiality and fairness to all the shareholders. Each report of an inspector shall be in writing and signed by him or by a majority of them if there is more than one inspector acting at such meeting. If there is more than one inspector, the report of a majority shall be the report of the inspectors. The report of the inspector or inspectors on the number of shares represented at the meeting and the results of the voting shall be prima facie evidence thereof. Section 11. Determination of Shareholders of Record. The Board of Directors shall fix a date, not more than sixty (60) nor less than ten (10) days preceding the date of any meeting of shareholders, and not more than sixty (60) days preceding the date fixed for the payment of any dividend or distribution, or the date for the allotment of rights, or the date when any change or conversion or exchange of shares will be made or go into effect, as a record date for the determination of the shareholders entitled to notice of, or to vote at, any such meeting, or entitled to receive any such dividend or distribution or allotment of rights, or to exercise the rights in respect to any such change, conversion or exchange of shares. When a determination of shareholders entitled to vote at any meeting of shareholders has been made as provided in this Section 12, such determination shall apply to any adjournment thereof unless the meeting is adjourned to a date more than 120 days after the date fixed for the original meeting, in which case the Board of Directors shall fix a new record date. Section 12. Action Without a Meeting. Any action required or permitted to be taken at a meeting of shareholders may be taken without a meeting if a consent in writing, setting forth such action, is signed by each shareholder entitled to vote on the matter and any other shareholder entitled to notice of a meeting of shareholders (but not to vote thereat) has waived in writing any right to dissent from such action, and such consent and waiver are filed with the minutes of proceedings of the shareholders. 4 9 Section 13. Voting by Ballot. Voting on any question or in any election may be viva voce unless the presiding officer shall order or any shareholder shall demand that voting be by ballot. Section 14. Control Share Acquisition Statute. Subtitle 7 of Title 3 of the Maryland General Corporation Law does not apply to any acquisition of shares of capital stock of the Corporation. ARTICLE IV Directors Section 1. General Powers. The Board of Directors shall have full power to conduct, manage, and direct the business and affairs of the Corporation, and all powers of the Corporation, except those specifically reserved or granted to the shareholders by statute or by the Charter or these Bylaws, shall be exercised by, or under the authority of, the Board of Directors. Unless otherwise agreed between the Corporation and the Director, each individual Director, including each Independent Director, may engage in other business activities of the type conducted by the Corporation and is not required to present to the Corporation any investment opportunities presented to them even though the investment opportunities may be within the scope of the Corporation's investment policies. Section 2. Number, Tenure and Qualifications. The number of Directors of the Corporation shall be not less than three (3) nor more than nine (9) members, with the exact number of directors to be fixed from time to time within this range by the shareholders or by the affirmative vote of at least 80% of the members of the Board of Directors, but shall never be less than the minimum number permitted by the General Laws of the State of Maryland now or hereafter in force. At each annual meeting of shareholders, the shareholders shall elect Directors to serve until the date of the third annual meeting of shareholders following their election and until their successors are elected and qualify. Directors need not be shareholders in the Corporation. At all times (except (i) during a period not to exceed 60 days following the death, resignation, incapacity or removal from office of a Director prior to the expiration of the Director's term of office or (ii) prior to the closing date of the Initial Public Offering (as hereinafter defined) and the consummation of all transactions related thereto), a majority of the Directors shall be Independent Directors. Section 3. Changes in Number; Vacancies. Any vacancy occurring on the Board of Directors may, subject to the provisions of Section 5 of this Article IV, be filled by a majority of the remaining members of the Board of Directors, although such majority is less than a quorum; provided, however, that a majority of Independent Directors shall nominate replacements for vacancies among the Independent Directors, which replacements must be elected by a majority of the Directors, including a majority of the Independent Directors. Any vacancy occurring by reason of an increase in the number of Directors may be filled by action of a majority of the entire Board of Directors including a majority of Independent Directors. If the shareholders of any class or series are entitled separately to elect one or more Directors, a majority of the remaining Directors elected by that class or series or the sole remaining Director elected by that class or series may fill any vacancy among 5 10 the number of Directors elected by that class or series. A Director elected by the Board of Directors to fill a vacancy shall be elected to hold office until the next annual meeting of shareholders or until his successor is elected and qualified. The Board of Directors may declare unqualified a Director who has been declared of unsound mind by an order of court, who has pled guilty or nolo contendere to, or been convicted of, a felony involving moral turpitude, or who has willfully violated the Corporation's Charter or these Bylaws. The office of a Director declared unqualified shall be considered vacant until filled as herein provided. Section 4. Resignations. Any Director or member of a committee may resign at any time. Such resignation shall be made in writing and shall take effect at the time specified therein, or if no time be specified, at the time of the receipt by the Chairman of the Board, the President or the Secretary. Section 5. Removal of Directors. The shareholders may, at any time, remove any Director, with or without cause, by the affirmative vote of the holders of not less than two-thirds (66 2/3%) of all the shares entitled to vote on the election of Directors and may elect a successor to fill any resulting vacancy for the balance of the term of the removed Director by the affirmative vote of the holders of not less than a majority of all the shares entitled to vote on the election of Directors. Section 6. Annual and Regular Meetings. An annual meeting of the Board of Directors shall be held immediately after and at the same place as the annual meeting of shareholders, no notice other than this bylaw being necessary. The Board of Directors may provide, by resolution, the time and place, either within or without the State of California, for the holding of regular meetings of the Board of Directors without other notice than such resolution. Section 7. Special Meetings. Special meetings of the Board of Directors may be called by or at the request of the President, a majority of the Board of Directors or a majority of the Independent Directors then in office. The person or persons authorized to call special meetings of the Board of Directors may fix any place, either within or without the State of California, as the place for holding any special meeting of the Board of Directors called by them. Section 8. Notice. Notice of any special meeting of the Board of Directors shall be given by written notice delivered personally, telegraphed or mailed to each Director at his business or resident address. Personally delivered or telegraphed notices shall be given at least two days prior to the meeting. Notice by mail shall be given at least five days prior to the meeting. If mailed, such notice shall be deemed to be given when deposited in the United States mail properly addressed, with postage thereon prepaid. If given by telegram, such notice shall be deemed to be given when the telegram is delivered to the telegraph company. Neither the business to be transacted at, nor the purpose of, any annual, regular or special meeting of the Board of Directors need be stated in the notice, unless specifically required by statute or these Bylaws. Section 9. Quorum. Subject to the provisions of Section 10(b) of this Article IV, a majority of the entire Board of Directors shall constitute a quorum for transaction of business at any meeting of the Board of Directors, provided that, if less than a quorum is present at said meeting, a majority of the Directors present may adjourn the meeting from time to time without further notice. 6 11 Subject to the provisions of Section 10(b) of this Article IV, the Directors present at a meeting which has been duly called and convened may continue to transact business until adjournment, notwithstanding the withdrawal of enough Directors to leave less than a majority of the entire Board, provided, that at least one-third of the entire Board of Directors remains present at that meeting, in which case a quorum will still be deemed present. Section 10. Voting. (a) Except as provided in subsection (b) of this Section 10, the action of the majority of the Directors present at a meeting at which a quorum is present shall be the action of the Board of Directors, unless the concurrence of a greater proportion is required for such action by the Charter, these Bylaws, or applicable statute. (b) Notwithstanding anything in these Bylaws to the contrary, except (a) during a period not to exceed sixty (60) days following the death, resignation, incapacity or removal from office of a Director prior to the expiration of the director's term in office or (b) prior to the closing date of the Initial Public Offering (as hereinafter defined) and the consummation of all transactions related thereto, (i) any action pertaining to a sale or other disposition of a "Sunstone Hotel," as defined in the Corporation's registration statement on Form S-11 (the "Registration Statement"), as declared effective by the Securities and Exchange Commission (the "SEC") in connection with the Corporation's initial public offering of common shares (the "Initial Public Offering") and (ii) any other action pertaining to any transaction involving the Corporation, including the purchase, sale, lease, or mortgage of any real estate asset or any other transaction of a kind or nature typically requiring approval by the Board of Directors in which an advisor, Director or officer of the Corporation, or any Affiliate of any of the foregoing persons, has any direct or indirect interest other than solely as a result of their status as a director, officer, or shareholder of the Corporation, must (x) be approved by a majority of the Directors, including a majority of the Independent Directors, even if the Independent Directors constitute less than a quorum, or (y) be authorized, approved or ratified by a majority of the votes entitled to be cast by the shareholders of the Corporation or (z) be fair and reasonable to the Corporation. Section 11. Telephone Meetings. Members of the Board of Directors may participate in a meeting by means of a conference telephone or similar communications equipment if all persons participating in the meeting can hear each other at the same time. Participation in a meeting by these means shall constitute presence in person at the meeting. Section 12. Action Without a Meeting. Any action required or permitted to be taken at any meeting of the Board of Directors may be taken without a meeting, if a consent in writing to such action is signed by each Director and such written consent is filed with the minutes of proceedings of the Board of Directors. Section 13. Compensation. Independent Directors shall receive such reasonable compensation for their services as Directors as the Board of Directors may fix or determine from time to time; such compensation may include a fixed sum, capital shares of the Corporation and reimbursement of reasonable expenses incurred in traveling to and from or attending regular or special meetings of the Board of Directors or of any committee thereof. 7 12 Section 14. Policies and Resolutions. It shall be the duty of the Board of Directors to insure that the purchase, sale, retention and disposal of the Corporation's assets, the investment policies and the borrowing policies of the Corporation and the limitations thereon or amendment thereof are all times: (a) consistent with such policies, limitations and restrictions as are contained in these Bylaws, or in the Corporation's Charter, or as described in the Registration Statement or in the Corporation's ongoing periodic reports filed with the SEC following the Initial Public Offering, subject to revision from time to time at the discretion of the Board of Directors without shareholder approval unless otherwise required by law; and (b) in compliance with the restrictions applicable to real estate investment trusts pursuant to the Internal Revenue Code of 1986, as amended. ARTICLE V Committees Section 1. Committees of the Board. The Board of Directors may appoint from among its members an executive committee and other committees comprised of two or more Directors. A majority of the members of any committee so appointed shall be Independent Directors. The Board of Directors shall appoint an audit committee comprised of not less than two members, a majority of whom are Independent Directors. The Board of Directors may delegate to any committee any of the powers of the Board of Directors except the power to elect Directors, declare dividends or distributions on shares, recommend to the shareholders any action which requires shareholder approval, amend or repeal these Bylaws, approve any merger or share exchange which does not require shareholder approval, or issue shares. However, if the Board of Directors has given general authorization for the issuance of shares, a committee of the Board of Directors, in accordance with a general formula or method specified by the Board of Directors by resolution or by adoption of a share option plan, may fix the terms of shares, subject to classification or reclassification, and the terms on which any shares may be issued. Notice of committee meetings shall be given in the same manner as notice for special meetings of the Board of Directors. One-third, but not less than two, of the members of any committee shall be present in person at any meeting of such committee in order to constitute a quorum for the transaction of business at such meeting, and the act of a majority present shall be the act of such committee. The Board of Directors may designate a chairman of any committee, and such chairman or any two members of any committee may fix the time and place of its meetings unless the Board shall otherwise provide. In the absence or disqualification of any member of any such committee, the members thereof present at any meeting and not disqualified from voting, whether or not they constitute a quorum, may unanimously appoint another Director to act at the meeting in the place of such absent or disqualified members; provided, however, that in the event of the absence or disqualification of an Independent Director, such appointee shall be an Independent Director. 8 13 Each committee shall keep minutes of its proceedings and shall report the same to the Board of Directors at the meeting next succeeding, and any action by the committees shall be subject to revision and alteration by the Board of Directors, provided that no rights of third persons shall be affected by any such revision or alteration. Subject to the provisions hereof, the Board of Directors shall have the power at any time to change the membership of any committee, to fill all vacancies, to designate alternative members to replace any absent or disqualified member, or to dissolve any such committee. Section 2. Telephone Meetings. Members of a committee of the Board of Directors may participate in a meeting by means of a conference telephone or similar communications equipment if all persons participating in the meeting can hear each other at the same time. Participation in a meeting by these means shall constitute presence in person at the meeting. Section 3. Action By Committees Without a Meeting. Any action required or permitted to be taken at any meeting of a committee of the Board of Directors may be taken without a meeting, if a consent in writing to such action is signed by each member of the committee and such written consent is filed with the minutes of proceedings of such committee. ARTICLE VI Officers Section 1. General Provisions. The officers of the Corporation may consist of a Chairman of the Board, a Vice Chairman of the Board, a President, one or more Vice Presidents, a Chief Financial Officer or Treasurer, one or more assistant treasurers, a Secretary, and one or more assistant secretaries and such other officers as may be elected in accordance with the provisions of Section 2 of this Article VI. The officers of the Corporation shall be elected annually by the Board of Directors at the first meeting of the Board of Directors held after each annual meeting of shareholders. If the election of officers shall not be held at such meeting, such election shall be held as soon thereafter as may be convenient. Each officer shall hold office until his successor is elected and qualifies or until his death, resignation or removal in the manner hereinafter provided. Any two or more offices may be held by the same person. In its discretion, the Board of Directors may leave unfilled any office except that of President and Secretary. Election appointment of an officer or agent shall not of itself create contract rights between the Corporation and such officer or agent. Section 2. Subordinate Officers, Committees and Agents. The Board of Directors may from time to time elect such other officers and appoint such committees, employees, other agents as the business of the Corporation may require, including one or more assistant secretaries, and one or more assistant treasurers, each of whom shall hold office for such period, have such authority, and perform such duties as are provided in these Bylaws, or as the Board of Directors may from time to time determine. The Directors may delegate to any officer or committee the power to elect subordinate officers and to retain or appoint employees or other agents. 9 14 Section 3. Removal and Resignation. Any officer or agent of the Corporation may be removed by the Board of Directors if in its judgment the best interests of the Corporation would be served thereby, but such removal shall be without prejudice to the contract rights, if any, of the person so removed. Any officer of the Corporation may resign at any time by giving written notice of his resignation to the Board of Directors, the Chairman of the Board, the President or the Secretary. Any resignation shall take effect at the time specified therein or, if the time when it shall become effective is not specified therein, immediately upon its receipt. The acceptance of a resignation shall not be necessary to make it effective unless otherwise stated in the resignation. Section 4. Vacancies. A vacancy in any office may be filled by the Board of Directors for the balance of the term. Section 5. General Powers. All officers of the Corporation as between themselves and the Corporation shall, respectively, have such authority and perform such duties in the management of the property and affairs of the Corporation as may be determined by resolution of the Board of Directors, or in the absence of controlling provisions in a resolution of the Board of Directors, as may be provided in these Bylaws. Section 6. Chief Executive Officer. The Board of Directors may designate a chief executive officer from among the elected officers. The chief executive officer shall have responsibility for implementation of the policies of the Corporation, as determined by the Board of Directors, and for the administration of the business affairs of the Corporation. Section 7. Chief Operating Officer. The Board of Directors may designate a chief operating officer from among the elected officers. Said officer will have the responsibility and duties as set forth by the Board of Directors or the chief executive officer. Section 8. Chairman and Vice Chairman of the Board. The Chairman of the Board, if there be one, shall preside over the meetings of the Board of Directors and of the shareholders at which he shall be present. In the absence of the Chairman of the Board, the Vice Chairman of the Board, if there be one, shall preside at such meetings at which he shall be present. The Chairman of the Board and the Vice Chairman of the Board shall, respectively, perform such other duties as may be assigned to him or them by the Board of Directors. Section 9. President. The President shall in general supervise and control all of the business and affairs of the Corporation. Unless the President is not a member of the Board of Directors, in the absence of both the Chairman and Vice Chairman of the Board, he shall preside at all meetings of the Board of Directors and of the shareholders at which he shall be present. In the absence of a designation of a chief executive officer by the Board of Directors, the President shall be the chief executive officer and shall be ex officio a member of all committees that may, from time to time, be constituted by the Board of Directors. He may execute any deed, mortgage, bond, contract or other instrument to which the Corporation is a party, except in cases where the execution thereof shall be expressly delegated by the Board of Directors or by these Bylaws to some other officer or agent of the Corporation or shall be required by law to be otherwise executed; and in general shall perform 10 15 all duties incident to the office of President and such other duties as may be prescribed by the Board of Directors from time to time. Section 10. Vice Presidents. In the absence of the President or in the event of a vacancy in such office, the Vice President (or in the event there be more than one Vice President, the Vice Presidents in the order designated at the time of their election or, in the absence of any designation, then in the order of the election) shall perform the duties of the President and when so acting shall have all the powers of and be subject to all the restrictions upon the President; and shall perform such other duties as from time to time may be assigned to him by the President or by the Board of Directors. The Board of Directors may designate one or more Vice Presidents as executive Vice President or as Vice President for particular areas of responsibility. Section 11. Secretary. The Secretary shall (a) keep the minutes of the proceedings of the shareholders, the Board of Directors and committees of the Board of Directors in one or more books provided for that purpose; (b) see that all notices are duly given in accordance with the provisions of these Bylaws or as required by law; (c) be custodian of the corporate records and of the seal of the Corporation; (d) keep a register of the post office address of each shareholder which shall be furnished to the Secretary by such shareholder; (e) have general charge of the share transfer books of the Corporation; and (f) in general perform such other duties as from time to time may be assigned to him by the President or by the Board of Directors. Section 12. Chief Financial Officer or Treasurer. The Chief Financial Officer or Treasurer shall have the custody of the corporate funds and securities and shall deposit all moneys and other valuable effects in the name and to the credit of the Corporation in such depositories as may be designated by the Board of Directors. He shall disburse the funds of the Corporation as may be ordered by the Board of Directors, taking proper vouchers for such disbursements, and shall render to the President and Board of Directors, at the regular meetings of the Board of Directors or whenever they may require it, an account of all his transactions as Chief Financial Officer or Treasurer and of the financial condition of the Corporation. If required by the Board of Directors, he shall give the Corporation a bond in such sum and with such surety or sureties as shall be satisfactory to the Board of Directors for the faithful performance of the duties of his office and for the restoration to the Corporation, in case of his death, resignation, retirement or removal from office, all books, papers, vouchers, moneys and other property of whatever kind in his possession or under his control belonging to the Corporation. Section 13. Assistant Secretaries and Assistant Treasurers. The assistant secretaries and assistant treasurers, in general, shall perform such duties as shall be assigned to them by the Secretary or the Chief Financial Officer Treasurer, respectively, or by the President or the Board of Directors. The assistant treasurers shall, if required by the Board of Directors, give bonds for the faithful performance of their duties in such sums and with such surety or sureties as shall be satisfactory to the Board of Directors. 11 16 Section 14. Salaries. The salaries of the officers shall be fixed from time to time by the Board of Directors and no officer shall be prevented from receiving such salary by reason of the fact that he is also a Director of the Corporation. ARTICLE VII Contracts, Notes, Checks and Deposits Section 1. Contracts. The Board of Directors may authorize any officer or agent to enter into any contract or to execute and deliver any instrument in the name of and on behalf of the Corporation and such authority may be general or confined to specific instances. Section 2. Checks and Drafts. All checks, drafts or other orders for the payment of money, notes or other evidences of indebtedness issued in the name of the Corporation shall be signed by such officer or officers, agent or agents of the Corporation and in such manner as shall from time to time be determined by the Board of Directors. Section 3. Deposits. All funds of the Corporation not otherwise employed shall be deposited from time to time to the credit of the Corporation in such banks, trust companies or other depositories as the Board of Directors may designate. ARTICLE VIII Capital Shares Section 1. Certificates of Shares. Each shareholder shall be entitled to a certificate or certificates which shall represent and certify the number of shares of each kind and class of shares held by him in the Corporation. Each certificate shall be signed by the Chairman of the Board or the President or a Vice President and countersigned by the Secretary or an assistant secretary or the Treasurer or an assistant treasurer and may be sealed with the corporate seal. The signatures may be either manual or facsimile. Certificates shall be consecutively numbered; and if the Corporation shall, from time to time, issue several classes of shares, each class may have its own number series. A certificate is valid and may be issued whether or not an officer who signed it is still an officer when it is issued. Each certificate representing shares which is restricted as to its transferability or voting powers, which is preferred or limited as to its dividends or as to its share of the assets upon liquidation or which is redeemable at the option of the Corporation, shall have a statement of such restriction, limitation, preference or redemption provision, or a summary thereof, plainly stated on the certificate. In lieu of such statement or summary, the Corporation may set forth upon the face or back of the certificate a statement that the Corporation will furnish to any shareholder, upon request and without charge, a full statement of such information. Section 2. Lost Certificate. The Board of Directors may direct a new certificate to be issued in place of any certificate previously issued by the Corporation alleged to have been lost, stolen or 12 17 destroyed upon the making of an affidavit of that fact by the person claiming the shares certificate to be lost, stolen or destroyed. When authorizing the issuance of a new certificate, the Board of Directors may, in its discretion and as a condition precedent to the issuance thereof, require the owner of such lost, stolen or destroyed certificate or his legal representative to advertise the same in such manner as it shall require and/or to give bond, with sufficient surety, to the Corporation to indemnify it against any loss or claim which may arise as a result of the issuance of a new certificate. Section 3. Transfer Agents and Registrars. At such time as the Corporation lists its securities on a national securities exchange or qualifies for trading in the over-the-counter market, the Board of Directors shall appoint one or more banks or trust companies in such city or cities as the Board of Directors may deem advisable, from time to time, to act as transfer agents and/or registrars of the shares of the Corporation; and, upon such appointments being made, no certificate representing shares shall be valid until countersigned by one of such transfer agents and registered by one of such registrars. Section 4. Transfer of Shares. No transfers of shares of the Corporation shall be made if (i) void ab initio pursuant to any provision of the Corporation's Charter or (ii) the Board of Directors, pursuant to any provision of the Corporation's Charter, shall have refused to permit the transfer of such shares. Permitted transfers of shares of the Corporation shall be made on the share records of the Corporation only upon the instruction of the registered holder thereof, or by his attorney thereunto authorized by power of attorney duly executed and filed with the Secretary or with a transfer agent or transfer clerk, and upon surrender of the certificate or certificates, if issued, for such shares properly endorsed or accompanied by a duly executed share transfer power and the payment of all taxes thereon. Upon surrender to the Corporation or the transfer agent of the Corporation of a certificate for shares duly endorsed or accompanied by proper evidence of succession, assignment or authority to transfer, as to any transfers not prohibited by any provision of the Corporation's Charter by action of the Board of Directors thereunder, it shall be the duty of the Corporation to issue a new certificate to the person entitled thereto, cancel the old certificate and record the transaction upon its books. Section 5. Share Ledger. The Corporation shall maintain at its principal office or at the office of its counsel, accountants or transfer agent, an original or duplicate share ledger containing the name and address of each shareholder and the number of shares of each class held by such shareholder. ARTICLE IX Dividends Section 1. Declaration. Dividends upon the shares of the Corporation may be declared by the Board of Directors, subject to applicable provisions of law and the Charter. Dividends may be paid in cash, property or shares of the Corporation, subject to applicable provisions of law and the Charter. 13 18 Section 2. Contingencies. Before payment of any dividends, there may be set aside out of any funds of the Corporation available for dividends such sum or sums as the Board of Directors may from time to time, in its absolute discretion, think proper as a reserve fund for contingencies, for equalizing dividends, for repairing or maintaining the property of the Corporation, its subsidiaries or any partnership for which it serves as general partner, or for such other purpose as the Board of Directors shall determine to be in the best interest of the Corporation, and the Board of Directors may modify or abolish any such reserve in the manner in which it was created. ARTICLE X Indemnification and Limitation of Liability Section 1. Indemnification of Agents. The Corporation shall indemnify, in the manner and to the fullest extent permitted by law, any person (or the estate of any person) who is or was a party to, or is threatened to be made a party to, any threatened, pending or completed action, suit or proceeding, whether or not by or in the right of the Corporation, and whether civil, criminal, administrative, investigative or otherwise, by reason of the fact that such person is or was a director or officer of the Corporation, or such director or officer is or was serving at the request of the Corporation as a director, officer, agent or employee of another corporation, partnership, joint venture, trust or other enterprise. To the fullest extent permitted by law, the indemnification provided herein shall include expenses (including attorneys' fees), judgments, fines and amounts paid in settlement and any such expenses may be paid by the Corporation in advance of the final disposition of such action, suit or proceeding. The Corporation shall indemnify other employees and agents to such extent as shall be authorized by the Board of Directors or these Bylaws and be permitted by law. Any repeal or modification of this Article X by the shareholders of the Corporation shall be prospective only, and shall not adversely affect any right to indemnification or advancement of expenses hereunder existing at the time of such repeal or modification. Section 2. Insurance. The Corporation may, to the fullest extent permitted by law, purchase and maintain insurance on behalf of any such person against any liability which may be asserted against such person. Section 3. Indemnification Non-Exclusive. The indemnification provided herein shall not be deemed to limit the right of the Corporation to indemnify any other person for any such expenses to the fullest extent permitted by law, nor shall it be deemed exclusive of any other rights to which any person seeking indemnification from the Corporation may be entitled under any agreement, vote of shareholders or disinterested directors, or otherwise, both as to action in such person's official capacity and as to action in another capacity while holding such office. Section 4. Limitation of Liability. To the fullest extent permitted by Maryland statutory or decisional law, as amended or interpreted from time to time, no director or officer of this Corporation shall be personally liable to the Corporation or its shareholders, or any of them, for money damages. No amendment of these Bylaws or repeal of any of its provisions shall limit or eliminate the benefits provided to directors and officers under this provision with respect to any act or omission which occurred prior to such amendment or repeal. 14 19 ARTICLE XI Seal Section 1. Seal. The Corporation may have a corporate seal, which may be altered at will by the Board of Directors. The Board of Directors may authorize one or more duplicate or facsimile seals and provide for the custody thereof. Section 2. Affixing Seal. Whenever the Corporation is required to place its corporate seal to a document, it shall be sufficient to meet the requirements of any law, rule or regulation relating to a corporate seal to place the word "(SEAL)" adjacent to the signature of the person authorized to execute the document on behalf of the Corporation. ARTICLE XII Waiver of Notice Whenever any notice is required to be given pursuant to the Charter or these Bylaws of the Corporation or pursuant to applicable law, a waiver thereof in writing, signed by the person or persons entitled to such notice, whether before or after the time stated therein, shall be deemed equivalent to the giving of such notice. Neither the business to be transacted at nor the purpose of any meeting need be set forth in the waiver of notice, unless specifically required by statute. The attendance of any person at any meeting shall constitute a waiver of notice of such meeting, except where such person attends a meeting for the express purpose of objecting to the transaction of any business on the ground that the meeting is not lawfully called or convened. ARTICLE XIII Amendment of Bylaws Section 1. By Directors. The Board of Directors shall have the power to adopt, alter or repeal any Bylaws of the Corporation and to make new Bylaws, except that the Board of Directors shall not have the power to alter, amend or repeal Section 10(b) of Article IV, which may only be amended by the shareholders of the Corporation as provided in Section 2 of this Article XIII, or to alter, amend or repeal any Bylaws made by the shareholders, provided that any amendment to Section 2, Section 3, Section 5 or Section 9 of Article IV requires the affirmative vote of 80% of the entire Board of Directors. Section 2. By Shareholders. The shareholders shall have the power to adopt, alter or repeal any Bylaws of the Corporation and to make new Bylaws, provided that any amendment to Section 2, Section 3, Section 5, Section 9, or Section 10(b) of Article IV requires the affirmative vote of the holders of two thirds (66 2/3%) of all the outstanding shares entitled to vote on the election of Directors, voting separately as a class. 15 20 The foregoing are certified as the Amended and Restated Bylaws of the Corporation adopted by the Board of Directors effective July 11, 1997. /s/ ROGER M. COHEN ---------------------------------------- Roger M. Cohen, Assistant Secretary 16 EX-3.6 3 ARTICLES CLASSIFYING SHARES 1 EXHIBIT 3.6 SUNSTONE HOTEL INVESTORS, INC. ARTICLES SUPPLEMENTARY CLASSIFYING 250,000 SHARES OF PREFERRED STOCK AS 7.9% CLASS A CUMULATIVE CONVERTIBLE PREFERRED STOCK SUNSTONE HOTEL INVESTORS, INC., a corporation organized and existing under the laws of the State of Maryland (the "Company"), and having its principal office in the State of Maryland at c/o The Prentice Hall Corporation System, Inc., 11 East Chase Street, Suite 7-C, Baltimore City, Maryland 21202, hereby certifies to the State Department of Assessments and Taxation of Maryland (the "Department") that: FIRST: Pursuant to the authority expressly vested in the Board of Directors (the "Board") of the Company by Article V, Section 5 of the Company's Amended Articles of Incorporation filed with the Department on September 23, 1994, as amended, (the "Charter") and Section 2-105 of the Maryland General Corporation Law ("MGCL"), the Board has, at a duly called and noticed meeting held on August 1, 1997 at which a quorum of directors was present and acting throughout, adopted resolutions classifying 250,000 authorized but unissued shares of preferred stock of the Company, par value $0.01 per share ("Preferred Stock"), as a separate class of Preferred Stock to be known as "7.9% Class A Cumulative Convertible Preferred Stock," setting the preferences, conversion and other rights, voting powers, restrictions, limitations as to dividends and other distributions, qualifications and terms and conditions of redemption of the 7.9% Class A Cumulative Convertible Preferred Stock, as set forth in Article SECOND of these Articles Supplementary, and authorizing the issuance of up to 250,000 shares of 7.9% Class A Cumulative Convertible Preferred Stock. SECOND: The class of Preferred Stock of the Company created by the resolutions duly adopted by the Board and referred to in these Articles Supplementary shall have the following designation, number of shares, powers, rights, preferences, qualifications, limitations and restrictions, as to dividends, voting rights, conversion, terms and conditions of redemption, liquidation and other terms and conditions. 1. Designation and Number. A class of Preferred Stock of the Company designated as "7.9% Class A Cumulative Preferred Stock" (the "Class A Preferred Stock") is hereby established. The number of shares of Class A Preferred Stock shall be 250,000. 1 2 2. Maturity. The Class A Preferred Stock has no stated maturity and will not be subject to any sinking fund or a mandatory redemption. 3. Other Classes or Series of Preferred Stock. The Board is hereby authorized to fix or alter the powers, rights, designations, preferences, qualifications, limitations and restrictions granted to or imposed upon additional classes of Preferred Stock, and the number of shares constituting any such class and the designation thereof, or of any of them. Subject to compliance with applicable protective voting rights which may be granted to any class of Preferred Stock in Articles Supplementary or to the Class A Preferred Stock ("Protective Provisions"), but notwithstanding any other rights of the Preferred Stock or any class thereof, the powers, rights, designations, preferences, qualifications, limitations and restrictions of any such additional class may be subordinated to, pari passu with (including, without limitation, inclusion in provisions with respect to liquidation and acquisition preferences, redemption and/or approval of matters by vote or written consent), or senior to any of those of any present or future class of Preferred or Common Stock. Subject to compliance with applicable Protective Provisions and these Articles Supplementary, the Board is also authorized to increase or decrease the number of shares of any class (including the Class A Preferred Stock), prior or subsequent to the issue of that class, but not below the number of shares of such class then outstanding. In case the number of shares of any class shall be so decreased, the shares constituting such decrease shall resume the status which they had prior to the adoption of the resolution originally fixing the number of shares of such class. 4. Dividend Provisions. Subject to the rights of classes of Preferred Stock which may from time to time come into existence in compliance with Section 9, the holders of shares of Class A Preferred Stock shall be entitled to receive for each share of Class A Preferred Stock cash dividends, out of any assets legally available therefor, prior and in preference to any declaration or payment of any cash dividend on the Common Stock of the Company, at the greater of (i) 7.9% of the Original Class A Issue Price (as defined below) (as adjusted for any stock dividends, combinations or splits with respect to such shares) per share per annum or (ii) the product of the dividend or other distribution paid by the Company for the quarter in question on each share of the Common Stock (including all regular and special dividends and distributions) multiplied by the number of shares of Common Stock into which such shares of Class A Preferred Stock could be converted pursuant to subsection 7(a) below. All such dividends shall be declared and paid quarterly in arrears contemporaneously with payment of the dividends or other distributions on the Common Stock and with the same record date for determining holders entitled to receive such dividend as the corresponding record date on the Common Stock; provided that if no dividends or other distributions are declared and paid on the Common Stock for 150 days, a cash dividend for such quarter will be declared and paid to the holders of shares of Class A Preferred Stock in accordance with clause (i) on such 150th day. The determination of whether the amount of the quarterly dividend on the Class A Preferred Stock will be established pursuant to clause (i) or clause (ii) of this Section 4 will be made for each three-month period ending each March 31, June 30, September 30 or December 31 and the determination of whether clause (i) or 2 3 clause (ii) is greater shall be made solely on the basis of the dividends paid or to be paid on the Common Stock during such quarterly period. Such dividends shall accrue on each share of Class A Preferred Stock from the initial date of issuance of such share, and shall accrue from day to day, whether or not earned or declared. Such dividends shall be cumulative so that, except as provided below, if such dividends in respect of any previous or current annual dividend period, at the annual rate specified above, shall not have been paid the deficiency shall first be fully paid before any dividend or other distribution shall be paid on or declared and set apart for the Common Stock. If any dividend is not paid when due, interest shall accrue on such unpaid dividend at the rate of 7.9% per annum compounded quarterly from the date that such dividend was due to the date such dividend is paid. Cumulative dividends with respect to a share of Class A Preferred Stock with a record date for payment prior to the Conversion Date or which have accrued and remain unpaid for any prior quarterly dividend period shall, upon conversion of such share to Common Stock, be paid to the holder of such share. Except as provided in the immediately preceding sentence, cumulative dividends with respect to a share of Class A Preferred Stock which are accrued shall, upon conversion of such share to Common Stock, not then or thereafter be paid and shall cease to be accrued, payable and/or in arrears. In the event that the Company has failed to pay when due any dividend on the Class A Preferred Stock then, until such dividend has been paid in full, neither the Company nor any corporation, partnership, limited liability company or other entity directly or indirectly controlled by the Company will redeem, purchase or otherwise acquire any shares of Common Stock. Any dividend or distribution which is declared by the Company and payable with assets of the Company other than cash shall be governed by the provisions of subsections 7(d)(i) and 7(e), as applicable, of these Articles Supplementary. 5. Liquidation Preference. (a) In the event of any liquidation, dissolution or winding up of the Company, either voluntary or involuntary, subject to the rights of classes of Preferred Stock that may from time to time come into existence in compliance with Section 9, the holders of Class A Preferred Stock shall (unless such shares of Class A Preferred Stock are converted into shares of Common Stock pursuant to Section 7 hereof) be entitled to receive, prior and in preference to any distribution of any of the assets of the Company to the holders of Common Stock by reason of their ownership thereof, an amount per share equal to the sum of (i) $100.00 for each outstanding share of Class A Preferred Stock (the "Original Class A Issue Price") (as adjusted for any stock dividends, combinations or splits with respect to such shares) and (ii) an amount equal to accrued but unpaid dividends on each such share to the date of dissolution, liquidation or winding up (collectively, the "Liquidation Preference"). If upon the occurrence of such event, the assets and funds thus distributed among the holders of the Class A Preferred Stock shall be insufficient to permit the payment to such holders of the full aforesaid preferential amounts, then, subject to the rights of classes of Preferred Stock that may from time to time come into existence in compliance 3 4 with Section 9, the entire assets and funds of the Company legally available for distribution shall be distributed ratably among the holders of the Class A Preferred Stock in proportion to the amount of such stock owned by each such holder. (b) Upon the completion of the distribution required by subsection (a) of this Section 5 and any other distribution that may be required with respect to classes of Preferred Stock that may from time to time come into existence in compliance with Section 9, if assets remain in the Company, the holders of the Common Stock of the Company shall receive all of the remaining assets of the Company. (c)(i) For purposes of this Section 5, a liquidation, dissolution or winding up of the Company shall be deemed to be occasioned by, or to include (A) the acquisition of a majority of the beneficial voting control of the Company by another entity by means of any transaction or series of related transactions (including, without limitation, any reorganization, merger or consolidation) unless, in the case of any acquisition of the Company to which the Company is not a party, the holders of a majority of the outstanding shares of Class A Preferred Stock determines otherwise within 15 days of receiving notice of such event or (B) a sale of all or substantially all of the assets of the Company; unless the Company's shareholders of record as constituted immediately prior to such acquisition or sale will, immediately after such acquisition or sale (by virtue of securities issued as consideration for the Company's acquisition or sale or otherwise) hold at least 50% of the voting power of the surviving or acquiring entity. (ii) In any of such events, if the consideration received by the Company is other than cash, its value will be deemed its fair market value. (A) The method of valuation of securities not subject to investment letter or other similar restrictions on free marketability covered by subparagraph (B) below shall be as follows: (1) If traded on a securities exchange or through the Nasdaq National Market, the value shall be deemed to be the average of the closing prices of the securities on such exchange over the thirty-day period ending three (3) days prior to the closing; (2) If actively traded over-the-counter, the value shall be deemed to be the average of the closing bid or sale prices (whichever is applicable) over the thirty-day period ending three (3) days prior to the closing; and (3) If there is no active public trading market, the value shall be the fair market value thereof, as mutually determined by the Company and the holders of at least a majority of the voting power of all then outstanding shares of Class A Preferred Stock. 4 5 (B) The method of valuation of securities subject to investment letter or other restrictions on free marketability (other than restrictions arising solely by virtue of a shareholder's status as an affiliate or former affiliate) shall be to make an appropriate discount from the market value determined as above in subparagraph (A) (1), (2) or (3) to reflect the approximate fair market value thereof, as mutually determined by the Company and the holders of at least a majority of the voting power of all then outstanding shares of Class A Preferred Stock. (C) The fair market value of any other property or assets shall be mutually determined by the Company and the holders of at least a majority of the voting power of all then outstanding shares of Class A Preferred Stock. (iii) In the event the requirements of this subsection 3(c) are not complied with, the Company shall forthwith either: (A) cause such closing to be postponed until such time as the requirements of this subsection 5(c) have been complied with; or (B) cancel such transaction, in which event the powers, rights, designations and preferences of the holders of the Class A Preferred Stock shall revert to and be the same as such powers, rights, designations and preferences existing immediately prior to the date of the first notice referred to in subsection 5(c)(iv) below. (iv) The Company shall give each holder of record of Class A Preferred Stock written notice of such impending transaction not later than twenty (20) days prior to the shareholders' meeting called to approve such transaction, or twenty (20) days prior to the closing of such transaction, whichever is earlier, and shall also notify such holders in writing of the final approval of such transaction (in either instance a "Liquidation Notice"). The first of such notices shall describe the material terms and conditions of the impending transaction and the provisions of this Section 5, and the Company shall thereafter give such holders prompt notice of any material changes. The transaction shall in no event take place sooner than twenty (20) days after the Company has given the first notice provided for herein or sooner than ten (10) days after the Company has given notice of any material changes provided for herein; provided, however, that such periods may be shortened upon the written consent of the holders of Class A Preferred Stock that are entitled to such notice rights or similar notice rights and that represent at least a majority of the voting power of all then outstanding shares of such Class A Preferred Stock. 6. Redemption. (a) Subject to the rights of classes of Preferred Stock which may from time to time come into existence in compliance with Section 9, on or at any time and from time to time after October 15, 2002 (each a "Class A Redemption Date"), the Company may at any time 5 6 it may lawfully do so, at the option of the Board, redeem in whole or in part the Class A Preferred Stock by paying in cash therefor an amount per share equal to the Redemption Percentage (as defined below) of the Original Class A Issue Price (as adjusted for any stock dividends, combinations or splits with respect to such shares) plus all accrued but unpaid dividends on such shares (the "Class A Redemption Price"). Any redemption effected pursuant to this subsection (6)(a) shall be made on a pro rata basis among the holders of the Class A Preferred Stock in proportion to the number of shares of Class A Preferred Stock then held by them. As used herein the "Redemption Percentage" shall mean the percentage specified in the following table:
Redemption Date Redemption Percentage (%) --------------- ------------------------- October 15, 2002 to October 14, 2003 105 October 15, 2003 to October 14, 2004 104 October 15, 2004 to October 14, 2005 103 October 15, 2005 to October 14, 2006 102 October 15, 2006 to October 14, 2007 101 October 15, 2007 and thereafter 100
(b) As used herein and in subsections (6)(c) and (d) below, the term "Redemption Date" shall refer to each "Class A Redemption Date" and the term "Redemption Price" shall refer to each "Class A Redemption Price." Subject to the rights of classes of Preferred Stock which may from time to time come into existence in compliance with Section 9, at least thirty (30) but no more than forty-five (45) days prior to each Redemption Date, written notice shall be mailed, first class postage prepaid, to each holder of record (at the close of business on the business day next preceding the day on which notice is given) of the Class A Preferred Stock to be redeemed, at the address last shown on the records of the Company for such holder, notifying such holder of the redemption to be effected, specifying the number of shares to be redeemed from such holder, the Redemption Date, the Redemption Price, the place at which payment may be obtained and calling upon such holder to surrender to the Company, in the manner and at the place designated, his, her or its certificate or certificates representing the shares to be redeemed (the "Redemption Notice"). Except as provided in subsection (6)(c), on or after the Redemption Date, each holder of Series A Preferred Stock to be redeemed shall surrender to the Company the certificate or certificates representing such shares, in the manner and at the place designated in the Redemption Notice, and thereupon the Redemption Price of such shares shall be paid to the order of the person whose name appears on such certificate or certificates as the owner thereof and each surrendered certificate shall be cancelled. In the event less than all the shares represented by any such certificate are redeemed, a new certificate shall be issued representing the unredeemed shares. (c) From and after the Redemption Date, unless there shall have been a default in payment of the Redemption Price, all rights of the holders of shares of Class A Preferred Stock designated for redemption in the Redemption Notice as holders of Class A 6 7 Preferred Stock (except the right to receive the Redemption Price without interest upon surrender of their certificate or certificates) shall cease with respect to such shares, and such shares shall not thereafter be transferred on the books of the Company or be deemed to be outstanding for any purpose whatsoever. Subject to the rights of classes of Preferred Stock which may from time to time come into existence in compliance with Section 9, if the funds of the Company legally available for redemption of shares of Class A Preferred Stock on any Redemption Date are insufficient to redeem the total number of shares of Class A Preferred Stock to be redeemed on such date, those funds which are legally available will be used to redeem the maximum possible number of such shares ratably among the holders of such shares to be redeemed based upon their holdings of Class A Preferred Stock. The shares of Class A Preferred Stock not redeemed shall remain outstanding and entitled to all the rights and preferences provided herein. Subject to the rights of classes of Preferred Stock which may from time to time come into existence in compliance with Section 9, at any time thereafter when additional funds of the Company are legally available for the redemption of shares of Class A Preferred Stock, such funds will immediately be used to redeem the balance of the shares which the Company has become obliged to redeem on any Redemption Date but which it has not redeemed. (d) On or prior to each Redemption Date, the Company may deposit the Redemption Price of all shares of Class A Preferred Stock designated for redemption in the Redemption Notice, and not yet redeemed or converted, with a bank or trust corporation having aggregate capital and surplus in excess of $100,000,000 as a trust fund for the benefit of the respective holders of the shares designated for redemption and not yet redeemed, with irrevocable instructions and authority to the bank or trust corporation to publish the notice of redemption thereof and pay the Redemption Price for such shares to their respective holders on or after the Redemption Date, upon receipt of notification from the Company that such holder has surrendered his, her or its share certificate to the Company pursuant to subsection (6)(b) above. As of the date of any such deposit (even if prior to the Redemption Date), the deposit shall constitute full payment of the shares to the holders, and from and after the date of the deposit the shares so called for redemption shall be redeemed and shall be deemed to be no longer outstanding, and the holders thereof shall cease to be shareholders with respect to such shares and shall have no rights with respect thereto except the rights to receive from the bank or trust corporation payment of the Redemption Price of the shares, without interest, upon surrender of their certificates therefor, and the right to convert such shares as provided in Section 5 hereof. Such instructions shall also provide that any monies deposited by the Company pursuant to this subsection (6)(d) for the redemption of shares thereafter converted into shares of the Company's Common Stock pursuant to Section 7 hereof prior to the Redemption Date shall be returned to the Company forthwith upon such conversion. The balance of any monies deposited by the Company pursuant to this subsection (6)(d) remaining unclaimed at the expiration of two (2) years following the Redemption Date shall thereafter be returned to the Company upon its request expressed in a resolution of its Board. 7 8 7. Conversion. The holders of the Class A Preferred Stock shall have conversion rights as follows (the "Conversion Rights"): (a) Right to Convert. Each share of Class A Preferred Stock shall be convertible, at the option of the holder thereof, at any time after the date of issuance of such share and on or prior to the fifth day prior to the Redemption Date or the closing of any transaction involving the liquidation, dissolution or winding up of the Company, if any, as may have been fixed in any Redemption Notice or Liquidation Notice with respect to the Class A Preferred Stock, at the office of the Company or any transfer agent for such stock, into such number of fully paid and nonassessable shares of Common Stock as is determined by dividing the Original Class A Issue Price by the Conversion Price applicable to such share, determined as hereafter provided, in effect on the date the certificate is surrendered for conversion. The initial Conversion Price per share for shares of Class A Preferred Stock shall be $14.7093; provided, however, if after August 4, 1997 and prior to the filing date of these Articles Supplementary, any event occurs that would result in an adjustment to the Conversion Price if such event occurred after the date of issue, the initial Conversion Price shall be correspondingly adjusted to reflect such change; and provided further, however, that the Conversion Price for the Class A Preferred Stock shall be subject to adjustment as set forth in subsection 7(d) after the date of issuance. (b) Automatic Conversion. [Intentionally Omitted] (c) Mechanics of Conversion. Before any holder of Class A Preferred Stock shall be entitled to convert the same into shares of Common Stock, such holder shall surrender the certificate or certificates therefor, duly endorsed, at the office of any transfer agent of the Company for the Class A Preferred Stock, and shall give written notice to the Company at its principal corporate office, of the election to convert the same and shall state therein the name or names in which the certificate or certificates for shares of Common Stock are to be issued. The Company shall, as soon as practicable thereafter, issue and deliver at such office to such holder of Class A Preferred Stock, or to the nominee or nominees of such holder, a certificate or certificates for the number of shares of Common Stock to which such holder shall be entitled as aforesaid. Such conversion shall be deemed to have been made immediately prior to the close of business on the date of such surrender of the shares of Class A Preferred Stock to be converted (the "Conversion Date"), and the person or persons entitled to receive the shares of Common Stock issuable upon such conversion shall be treated for all purposes as the record holder or holders of such shares of Common Stock as of the Conversion Date. The holder of record of shares of Class A Preferred Stock on a dividend record date who surrenders such shares for conversion during the period between a dividend record date and the corresponding dividend payment date shall be entitled to receive the dividend on such dividend payment date notwithstanding the prior conversion of such shares. 8 9 (d) Conversion Price Adjustments of Preferred Stock for Certain Splits and Combinations. The Conversion Price of the Class A Preferred Stock shall be subject to adjustment from time to time as follows: (i) In the event the Company should at any time or from time to time after the date upon which any shares of Class A Preferred Stock were first issued (the "Purchase Date") fix a record date for the effectuation of a split or subdivision of the outstanding shares of Common Stock or the determination of holders of Common Stock entitled to receive a dividend or other distribution payable in additional shares of Common Stock or other securities or rights convertible, exchangeable or exercisable into, or entitling the holder thereof to receive directly or indirectly, additional shares of Common Stock (hereinafter referred to as "Common Stock Equivalents"), without payment of any consideration by such holder for the additional shares of Common Stock or the Common Stock Equivalents (including the additional shares of Common Stock issuable upon conversion, exchange or exercise thereof), then, as of such record date (or the date of such dividend distribution, split or subdivision if no record date is fixed), the Conversion Price of the Class A Preferred Stock shall be appropriately decreased so that the number of shares of Common Stock issuable on conversion of each share of such class shall be increased in proportion to such increase in the aggregate number of shares of Common Stock outstanding and those issuable with respect to such Common Stock Equivalents, with the number of shares issuable with respect to Common Stock Equivalents determined from time to time in the manner provided for deemed issuances in subsection 7(d)(iii) below. (ii) If the number of shares of Common Stock outstanding at any time after the Purchase Date is decreased by a combination of the outstanding shares of Common Stock, then, following the record date of such combination, the Conversion Price for the Class A Preferred Stock shall be appropriately increased so that the number of shares of Common Stock issuable on conversion of each share of such class shall be decreased in proportion to such decrease in the aggregate number of shares of Common Stock outstanding. (iii) In the case of the issuance (whether before, on or after the Purchase Date) of Common Stock Equivalents, the following provisions shall apply for all purposes of subsection 7(d)(i): (A) The aggregate maximum number of shares of Common Stock deliverable upon conversion of or in exchange (to the extent then convertible or exchangeable) for any such convertible or exchangeable securities or upon the exercise of options to purchase or rights to subscribe for such convertible or exchangeable securities and subsequent conversion or exchange thereof shall be deemed to have been issued at the time such securities were issued or such options or rights were issued and for a consideration equal to the consideration, if any, received by the Company for any such securities and related options or rights (excluding any cash received on account of accrued interest or accrued dividends), plus the 9 10 minimum additional consideration, if any, to be received by the Company upon the conversion or exchange of such securities or the exercise of any related options or rights. (B) In the event of any change in the number of shares of Common Stock deliverable or in the consideration payable to the Company upon exercise of such options or rights or upon conversion of or in exchange for such convertible or exchangeable securities, including, but not limited to, the Conversion Price of the Class A Preferred Stock, to the extent in any way affected by or computed using such options, rights or securities, shall be recomputed to reflect such change, but no further adjustment shall be made for the actual issuance of Common Stock or any payment of such consideration upon the exercise of any such options or rights or the conversion or exchange of such securities. (C) Upon the expiration of any such options or rights, the termination of any such rights to convert or exchange or the expiration of any options or rights related to such convertible or exchangeable securities, the Conversion Price of the Class A Preferred Stock, to the extent in any way affected by or computed using such options, rights or securities or options or rights related to such securities, shall be recomputed to reflect the issuance of only the number of shares of Common Stock (and convertible or exchangeable securities which remain in effect) actually issued upon the exercise of such options or rights, upon the conversion or exchange of such securities or upon the exercise of the options or rights related to such securities. (D) The number of shares of Common Stock deemed issued and the consideration deemed paid therefor pursuant to subsection 7(d)(iii)(A) shall be appropriately adjusted to reflect any change, termination or expiration of the type described in either subsection 7(d)(iii)(B) or (C). (e) Other Distributions. In the event the Company shall declare or otherwise effect a dividend or distribution payable in securities of other persons, evidences of indebtedness issued by the Company or other persons, assets (excluding cash dividends) or Common Stock Equivalents not referred to in subsection 7(d)(i), then, in each such case, the holders of the Class A Preferred Stock shall be entitled to a proportionate share of any such dividend or distribution as though they were the holders of the number of shares of Common Stock of the Company into which their shares of Class A Preferred Stock are convertible as of the record date fixed for the determination of the holders of Common Stock of the Company entitled to receive such dividend or distribution. (f) Recapitalizations. If at any time or from time to time there shall be a recapitalization of the Common Stock (other than a subdivision, combination or merger or sale of assets transaction provided for elsewhere in this Section 7 or Section 5), provision shall be made so that the holders of the Class A Preferred Stock shall thereafter be entitled to receive upon conversion of the Class A Preferred Stock the number of shares of stock or other securities or 10 11 property of the Company or otherwise, to which a holder of Common Stock deliverable upon conversion would have been entitled on such recapitalization. In case of any such recapitalization, the successor or acquiring corporation (if other than the Company) shall expressly assume the due and punctual observance and performance of each and every covenant and condition of this Agreement to be performed and observed by the Company and all the obligations and liabilities hereunder, subject to such modifications as may be deemed appropriate (as determined by resolution of the Board of Directors of the Company) in order to provide for adjustments of shares of the Common Stock issuable upon conversion of the Class A Preferred Stock which shall be as nearly equivalent as practicable to the adjustments provided for in subsection 7(d). (g) No Impairment. The Company will not, by amendment of its Articles of Incorporation or through any reorganization, recapitalization, transfer of assets, consolidation, merger, dissolution, issue or sale of securities or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms to be observed or performed hereunder by the Company, but will at all times in good faith assist in the carrying out of all the provisions of this Section 7 and in the taking of all such action as may be necessary or appropriate in order to protect the Conversion Rights of the holders of the Class A Preferred Stock against impairment. (h) No Fractional Shares and Certificate as to Adjustments. (i) No fractional shares shall be issued upon the conversion of any share or shares of the Class A Preferred Stock. Any fractional interest in a share of Common Stock resulting from conversion of shares of Class A Preferred Stock will be paid in cash (computed to the nearest cent) based on the fair market value (as defined in subsection 5(c)(ii) above) of the Common Stock. If more than one share of Class A Preferred Stock is surrendered for conversion at substantially the same time by the same holder, the number of full shares of Common Stock issuable upon the conversion will be computed on the basis of all the shares of Class A Preferred Stock surrendered at that time by that holder. (ii) Upon the occurrence of each adjustment or readjustment of the Conversion Price of Class A Preferred Stock pursuant to this Section 7, the Company, at its expense, shall promptly compute such adjustment or readjustment in accordance with the terms hereof and prepare and furnish to each holder of Class A Preferred Stock a certificate setting forth such adjustment or readjustment and showing in detail the facts upon which such adjustment or readjustment is based. The Company shall, upon the written request at any time of any holder of Class A Preferred Stock, furnish or cause to be furnished to such holder a like certificate setting forth (A) such adjustment and readjustment, (B) the Conversion Price for such class of Preferred Stock at the time in effect, and (C) the number of shares of Common Stock and the amount, if any, of other property which at the time would be received upon the conversion of a share of Class A Preferred Stock. 11 12 (i) Notices of Record Date. In the event of any taking by the Company of a record of the holders of any class of securities for the purpose of determining the holders thereof who are entitled to receive any dividend (other than a cash dividend) or other distribution, any right to subscribe for, purchase or otherwise acquire any shares of stock of any class or any other securities or property, or to receive any other right, the Company shall mail to each holder of Class A Preferred Stock, at least 20 days prior to the date specified therein, a notice specifying the date on which any such record is to be taken for the purpose of such dividend, distribution or right, and the amount and character of such dividend, distribution or right. (j) Reservation of Stock Issuable Upon Conversion. (i) The Company shall at all times reserve and keep available out of its authorized but unissued shares of Common Stock, solely for the purpose of effecting the conversion of the shares of the Class A Preferred Stock, such number of its shares of Common Stock as shall from time to time be sufficient to effect the conversion of all outstanding shares of the Class A Preferred Stock; and if at any time the number of authorized but unissued shares of Common Stock shall not be sufficient to effect the conversion of all then outstanding shares of the Class A Preferred Stock, in addition to such other remedies as shall be available to the holder of such Preferred Stock, the Company will use its best efforts to take such corporate action as may, in the opinion of its counsel, be necessary to increase its authorized but unissued shares of Common Stock to such number of shares as shall be sufficient for such purposes, including, without limitation, engaging in best efforts to obtain the requisite shareholder approval of any necessary amendment to its Articles of Incorporation. (ii) For the purposes of this subsection 7(j)(i), the number of shares of Common Stock which the Company would be required to deliver upon the conversion of all the outstanding shares of Class A Preferred Stock will be computed as if at the time of the computation all the outstanding shares of Class A Preferred Stock were held by a single holder. (iii) If any shares of Common Stock required to be reserved for purposes of conversion of the Class A Preferred Stock hereunder require registration with or approval of any governmental authority under any Federal or State law before such shares may be issued upon conversion, the Company shall in good faith and as expeditiously as possible endeavor to cause such shares to be duly registered or approved, as the case may be. The Company will seek to list the shares of Common Stock required to be delivered upon conversion of the Class A Preferred Stock, prior to the delivery, upon each national securities exchange, if any, upon which the outstanding shares of Common Stock are listed at the time of delivery. (k) Taxes. The Company will pay any documentary stamp of similar issue or transfer taxes payable in respect of the issue or delivery of shares of Common Stock on conversion of Class A Preferred Stock; provided, however, that the Company will not be required to pay any tax which may be payable in respect of any transfer involved in the issue or delivery 12 13 of shares of Common Stock in a name other than that of the holder of record of the Class A Preferred Stock to be converted and no such issue or delivery will be made unless and until the person requesting the issue or delivery has paid to the Company the amount of any such tax or has established, to the satisfaction of the Company, that the tax has been paid. (l) Notices. Any notice required by the provisions of this Section 5 to be given to the holders of shares of Class A Preferred Stock shall be deemed given if deposited in the United States mail, postage prepaid, and addressed to each holder of record at such holder's address appearing on the books of the Company. 8. Voting Rights. (a) Except as required by law or by the provisions of subsections 6(b) and (c), the holders of each share of Class A Preferred Stock shall have the right to one vote for each share of Common Stock into which such holder's shares of Class A Preferred Stock could then be converted, and with respect to such vote, such holder shall have full voting rights and powers equal to the voting rights and powers of the holders of Common Stock, and shall be entitled, notwithstanding any provision hereof, to notice of any shareholders' meeting in accordance with the bylaws of the Company, and shall be entitled to vote, together with holders of Common Stock as a single class, with respect to any matter submitted to a vote of holders of Common Stock. Fractional votes shall not, however, be permitted and any fractional voting rights available on an as-converted basis (after aggregating all shares into which shares of Class A Preferred Stock held by each holder could be converted) shall be rounded to the nearest whole number (with one-half being rounded upward). (b) In the event the Company fails to pay dividends to the holders of Class A Preferred Stock contemporaneously with dividends paid to the holders of Common Stock for two consecutive quarters or, in the event no dividends have been paid or declared on the Common Stock, by the 150th day thereafter, in either event in accordance with Section 2 hereof, then and until such accrued but unpaid dividends shall have been paid in full, the holders of Class A Preferred Stock shall, voting separately as one class, have the exclusive and special right to elect one (1) director to the Board of the Company, provided, however, that if, at such time, the number of directors of the Company, as fixed by the shareholders or the Board of Directors of the Company, is the maximum number permitted by the Charter of the Company, the Company shall use its best efforts to cause its Charter to be amended to increase the maximum number of directors of the Company so as to allow for the election on one (1) director by the holders of the Class A Preferred Stock, and the right of the holders of the Class A Preferred stock to elect one (1) director in such instance will be deferred until such time as the Charter of the Company is amended to appropriately increase the maximum number of directors permitted thereunder. Once all accrued but unpaid dividends on the Class A Preferred Stock shall have been paid in full, the holders of Class A Preferred Stock shall no longer be entitled to a special right to elect a director under this subsection 8(b) but shall instead vote together with the holders of Common Stock in the 13 14 election of directors in accordance with subsection 8(a) above, and any such director then in office shall be deemed to have resigned effective with such payment. In any election of directors pursuant to this subsection 8(b), each holder of shares of Class A Preferred Stock shall be entitled to one vote for each share of Common Stock into which such holder's Class A Preferred Stock is convertible as determined in accordance with subsection 8(a) above. The special and exclusive voting right of the holders of the Class A Preferred Stock, voting separately as one class, contained in this subsection 8(b) may be exercised either at a special meeting of the holders of Class A Preferred Stock called as provided below, or at any annual or special meeting of the shareholders of the Company, or by unanimous written consent of such holders in lieu of a meeting. The director to be elected by the holders of the Class A Preferred Stock, voting separately as one class, pursuant to this subsection 8(b), shall serve for terms extending from the date of his election and qualification until the earlier of (i) the next succeeding annual meeting of shareholders, (ii) his successor has been elected and qualified or (iii) all such accrued but unpaid dividends on the Class A Preferred Stock shall have been paid in full. (c) If at any time any directorship to be filled by the holders of Class A Preferred Stock, voting separately as one class pursuant to subsection 8(b) above, has been vacant for a period of ten (10) days, the Secretary of the Company shall, upon the written request of the holders of record of shares representing at least ten percent (10%) of the voting power of the Class A Preferred Stock then outstanding, call a special meeting of the holders of Class A Preferred Stock for the purpose of electing the director to fill such vacancy. Such meeting shall be held at the earliest practicable date at such place as is specified in or determined in accordance with the Bylaws of the Company. If such meeting shall not be called by the Secretary of the Company within ten (10) days after personal service of said written request on him, then the holders of record of shares representing at least ten percent (10%) of the voting power of the Class A Preferred Stock then outstanding may designate in writing one of their number to call such meeting at the expense of the Company, and such meeting may be called by such person so designated upon the notice required for annual meetings of shareholders and shall be held at the place specified in the notice. Any holder of the Class A Preferred Stock so designated shall have access to the stock books of the Company relating to the Class A Preferred Stock for the purpose of calling a meeting of the shareholders pursuant to these provisions. 9. Protective Provisions. Subject to the rights of classes of Preferred Stock which may from time to time come into existence in compliance with Section 9, so long as any shares of Class A Preferred Stock are outstanding, the Company shall not (including through a merger or consolidation with another corporation or otherwise), without first obtaining the approval (by vote or written consent, as provided by law) of the holders of at least a majority of the then outstanding shares of Class A Preferred Stock: (a) alter or change the rights, preferences or privileges of the shares of Class A Preferred Stock so as to affect adversely the shares; 14 15 (b) increase or decrease (other than by redemption or conversion) the total number of authorized shares of Class A Preferred Stock; (c) authorize or issue, or obligate itself to issue, any other equity security, including any other security convertible into or exercisable for any equity security having a preference over, or being on a parity with, the Class A Preferred Stock with respect to voting, dividends or upon liquidation. 10. Status of Converted or Redeemed Stock. In the event any shares of Class A Preferred Stock shall be redeemed or converted pursuant to Section 6 or Section 7 hereof, the shares so converted or redeemed shall be cancelled and shall not be issuable by the Company. THIRD: These Articles Supplementary have been approved by the Board in the manner and by the vote required by law. FOURTH: The undersigned Vice President of the Company acknowledges these Articles Supplementary to be the corporate act of the Company and, as to all matters or facts required to be verified under oath, the undersigned Vice President of the Company acknowledges that to the best of his knowledge, information and belief, these matters and facts are true in all material respects and that this statement is made under the penalties of perjury. 15 16 IN WITNESS WHEREOF, SUNSTONE HOTEL INVESTORS, INC. has caused these Articles Supplementary to be executed under seal in its name and on its behalf by its Vice President and attested to by its Assistant Secretary on this 13th day of October, 1997. SUNSTONE HOTEL INVESTORS, INC. By: /S/ KENNETH J. BIEHL -------------------------- Kenneth J. Biehl, Vice President ATTEST: By: /S/ ROGER M. COHEN ------------------------------------- Roger M. Cohen, Assistant Secretary 16 EX-10.1.15 4 AGREEMENT OF LIMITED PARTNERSHIP 1 EXHIBIT 10.1.15 SECOND AMENDED AND RESTATED AGREEMENT OF LIMITED PARTNERSHIP OF SUNSTONE HOTEL INVESTORS, L.P. 2 TABLE OF CONTENTS
PAGE ---- ARTICLE I - DEFINED TERMS.................................................................. 1 ARTICLE II - PARTNERSHIP CONTINUATION AND IDENTIFICATION................................... 11 2.1 Organization................................................................ 11 2.2 Name........................................................................ 11 2.3 Registered Office and Agent; Principal Office............................... 12 2.4 Partners.................................................................... 12 2.5 Term and Dissolution........................................................ 12 2.6 Filing of Certificate and Perfection of Limited Partnership................. 13 ARTICLE III - PURPOSE OF THE PARTNERSHIP................................................... 13 3.1 Business.................................................................... 13 3.2 Powers...................................................................... 14 3.3 Partnership Only for Purposes Specified..................................... 14 ARTICLE IV - CAPITAL CONTRIBUTIONS AND ACCOUNTS............................................ 14 4.1 Capital Contributions....................................................... 14 4.2 Additional Capital Contributions and Issuances of Additional Partnership Interests................................................................... 15 4.3 Company Loans............................................................... 20 4.4 Capital Accounts............................................................ 21 4.5 Percentage Interests........................................................ 21 4.6 No Interest on Contributions................................................ 21 4.7 Return of Capital Contributions............................................. 21 4.8 No Third Party Beneficiary.................................................. 22 4.9 No Preemptive Rights........................................................ 22 ARTICLE V - PROFITS AND LOSSES: DISTRIBUTIONS.............................................. 22 5.1 Allocation of Profit and Loss............................................... 22 5.2 Distribution of Cash........................................................ 25 5.3 REIT Distribution Requirements.............................................. 25 5.4 No Right to Distributions in Kind........................................... 25 5.5 Limitations on Return of Capital Contributions.............................. 25 5.6 Distributions upon Liquidation.............................................. 25 5.7 Substantial Economic Effect................................................. 26 5.8 Amounts Withheld............................................................ 26 ARTICLE VI - RIGHTS, OBLIGATIONS AND POWERS OF THE GENERAL PARTNERSHIP........................................................................ 27 6.1 Management of the Partnership............................................... 27 6.2 Delegation of Authority..................................................... 30 6.3 Indemnification and Exculpation of Indemnitees.............................. 30
i 3 6.4 Liability of the General Partner............................................ 31 6.5 Expenditures by Partnership................................................. 32 6.6 Outside Activities; Redemption Tender Offer of REIT Shares.................. 32 6.7 Employment or Retention of Affiliates....................................... 32 6.8 Company Participation....................................................... 33 ARTICLE VII - CHANGES IN GENERAL PARTNER................................................... 33 7.1 Transfer of the General Partner's Partnership Interest...................... 33 7.2 Admission of a Substitute or Successor General Partner...................... 34 7.3 Effect of Bankruptcy, Withdrawal, Death or Dissolution of a General Partner..................................................................... 35 7.4 Purchase of Partnership Units............................................... 36 ARTICLE VIII - RIGHTS AND OBLIGATIONS OF THE LIMITED PARTNERS.............................. 36 8.1 Management of the Partnership............................................... 36 8.2 Power of Attorney........................................................... 36 8.3 Limitation on Liability of Limited Partners................................. 37 8.4 Ownership by Limited Partner of Corporate General Partner or Affiliate...... 37 8.5 Redemption Right............................................................ 38 8.6 Registration................................................................ 41 8.7 Meetings of the Partners.................................................... 45 ARTICLE IX - TRANSFERS OF LIMITED PARTNERSHIP INTERESTS.................................... 46 9.1 Purchase for Investment..................................................... 46 9.2 Restrictions on Transfer of Limited Partnership Interests and Redemption Shares...................................................................... 47 9.3 Admission of Substitute Limited Partner..................................... 49 9.4 Rights of Assignees of Partnership Interests................................ 50 9.5 Effect of Bankruptcy, Death, Incompetence or Termination of a Limited Partner..................................................................... 50 9.6 Joint Ownership of Interests................................................ 51 9.7 Assignment of all Partnership Units......................................... 51 9.8 Limitation on Transfer of Partnership Units and Other Rights to Avoid Adverse Tax Effects......................................................... 51 ARTICLE X - BOOKS AND RECORDS: ACCOUNTING: TAX MATTERS..................................... 52 10.1 Books and Records........................................................... 52 10.2 Custody of Partnership Funds: Bank Accounts................................. 52 10.3 Fiscal and Taxable Year..................................................... 53 10.4 Annual Tax Information and Report........................................... 53 10.5 Tax Matters Partner; Tax Elections; Special Basis Adjustments............... 53 10.6 Reports to Limited Partners................................................. 53 10.7 Title to Partnership Assets................................................. 54 10.8 Reliance by Third Parties................................................... 54 10.9 Withholding................................................................. 55
ii 4 ARTICLE XI - AMENDMENT OF AGREEMENT........................................................ 56 ARTICLE XII - GENERAL PROVISIONS........................................................... 56 12.1 Notices..................................................................... 56 12.2 Survival of Rights.......................................................... 57 12.3 Additional Documents........................................................ 57 12.4 Severability................................................................ 57 12.5 Entire Agreement............................................................ 57 12.6 Pronouns and Plurals........................................................ 57 12.7 Headings.................................................................... 57 12.8 Counterparts................................................................ 57 12.9 Waiver...................................................................... 57 12.10 Applicable Law.............................................................. 57 12.11 Invalidity of Provisions.................................................... 58 12.12 No Rights as Stockholders................................................... 58 12.13 Partition................................................................... 58 12.14 No Third-Party Rights Created Hereby........................................ 58
EXHIBITS EXHIBIT A - Notice of Exercise of Redemption Right EXHIBIT B - Certificate(s) of Designation of Preferred Partnership Units iii 5 SECOND AMENDED AND RESTATED AGREEMENT OF LIMITED PARTNERSHIP OF SUNSTONE HOTEL INVESTORS, L.P. This Second Amended and Restated Agreement of Limited Partnership (this "Agreement") of Sunstone Hotel Investors, L.P. dated as of October 14, 1997, is entered into by and among Sunstone Hotel Investors, Inc., a Maryland corporation, in its individual capacity (the "Company") and in its capacity as the general partner of the Partnership (the "General Partner") and each of the limited partners of the Partnership (the "Limited Partners"), together with any other Persons who become Partners in the Partnership as provided herein. R E C I T A L S: A. WHEREAS, the General Partner and certain Limited Partners executed that certain First Amended and Restated Agreement of Limited Partnership dated as of October 16, 1995 (the "First Restated Agreement"), amending and restating that certain Limited Partnership Agreement dated as of September 22, 1994 (the "Original Agreement"). B. WHEREAS, the First Restated Agreement was amended by fourteen amendments thereto. C. WHEREAS, the parties hereto have determined it to be in their mutual best interests to amend and restate the First Restated Agreement to incorporate the fourteen amendments thereto and to make certain other changes to the First Restated Agreement. AGREEMENT NOW, THEREFORE, in consideration of the foregoing, of mutual covenants between the parties hereto, and of other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree to amend the First Restated Agreement to read in its entirety as follows: ARTICLE I DEFINED TERMS The following defined terms used in this Agreement shall have the meanings specified below: "ACT" means the Delaware Revised Uniform Limited Partnership Act, as it may be amended from time to time, and any successor to such statute. "ADDITIONAL LIMITED PARTNER" means a Person admitted to this Partnership as a Limited Partner pursuant to Section 4.2 hereof and who is shown as such on the Unitholder Ledger. 1 6 "ADMINISTRATIVE EXPENSES" means (i) all administrative and operating costs and expenses incurred by the Partnership, (ii) those administrative costs and expenses of the General Partner, including any salaries or other payments to directors, officers and/or employees of the General Partner, and any accounting and legal expenses of the General Partner, which expenses, the Partners have agreed, are expenses of the Partnership and not the General Partner, and (iii) to the extent not included in clause (ii) above, REIT Expenses; provided, however, that Administrative Expenses shall not include any administrative costs and expenses incurred by the Company that are attributable to Properties owned by the Company directly, if any. "AFFILIATE" means (i) any Person that, directly or indirectly, controls or is controlled by or is under common control with such Person, (ii) any other Person that owns, beneficially, directly or indirectly, 5% or more of the outstanding capital stock, shares or equity interests of such Person, or (iii) any officer, director, employee, partner or trustee of such Person or any Person controlling, controlled by or under common control with such Person (excluding trustees and persons serving in similar capacities who are not otherwise an Affiliate of such Person). For the purposes of this definition, "control" (including the correlative meanings of the terms "controlled by" and "under common control with"), as used with respect to any Person, shall mean the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of such Person, through the ownership of voting securities, partnership interests or other equity interests. "AGREED VALUE" means the fair market value of a Partner's non-cash Capital Contribution as of the date of such contribution as agreed to by the Partners making such contribution and the General Partner. For purposes of this Partnership Agreement, the Agreed Value of a Partner's non-cash Capital Contribution shall be equal to the number of Partnership Units received by such Partner in consideration for the conveyance or exchange of a Hotel or an interest in a Hotel, or in connection with the merger of a limited liability company, corporation or a partnership of which such Person is a member, shareholder or partner with and into the Partnership, or for any other non-cash asset so contributed, multiplied by the Public Offering Price or, if the contribution is or was made after the date of the closing of the Initial Offering, the Market Price; provided, that if there is no Market Price, the price agreed to by the Partners making such contribution and the General Partner. For Partners who contributed assets to the Partnership prior to the use of the Unitholder Ledger, the names and addresses of such Partners, number of Partnership Units issued to each Partner and the Agreed Value of non-cash Capital Contributions was as set forth on Exhibit "A" to the First Restated Agreement. After the introduction of the Unitholder Ledger, the names and addresses of the Partners and the number of Partnership Units issued to each Partner in exchange for assets contributed have been recorded in the Unitholder Ledger. "AGREEMENT" means this Second Amended and Restated Agreement of Limited Partnership, as it may be further amended, supplemented or restated from time to time. "ARTICLES OF INCORPORATION" means the Articles of Incorporation of the General Partner originally filed in the State of Maryland on September 21, 1994, as amended and restated on September 23, 1994, as amended on November 9, 1994, June 19, 1995, August 14, 1995 and May 2, 1997, and as further amended or restated from time to time. 2 7 "ASSIGNEE" means a Person to whom one or more Partnership Units have been transferred in a manner permitted under this Agreement, but who has not become a Substituted Limited Partner. "BOOK VALUE" means, with respect to any asset, the asset's adjusted basis for federal income tax purposes, except as follows: (a) The initial Book Value of any asset contributed by a Partner to the Partnership shall be the gross fair market value of such asset (not reduced by any associated liabilities), as agreed to by the Partners; (b) The Book Value of the Properties of the Partnership shall be adjusted to equal their respective gross fair market values as provided in Section 4.4 hereof; and (c) The Book Value of any Property distributed to a Partner shall be adjusted to equal the gross fair market value of such asset on the date of distribution as determined by the General Partner. The Book Value of any Property which has been established or adjusted to reflect gross fair market value hereunder shall thereafter be adjusted by the Depreciation taken into account with respect to such asset for purposes of computing net income or net loss. "BUSINESS DAY" means any day except a Saturday, Sunday or other day on which commercial banks in New York, New York or Orange County, California are authorized or required by law to close. "CAPITAL ACCOUNT" has the meaning provided in Section 4.4 hereof. "CAPITAL CONTRIBUTION" means the total amount of capital contributed or agreed to be contributed, as the context requires, to the Partnership by each Partner pursuant to the terms of the Agreement. Any reference to the Capital Contribution of a Partner shall include the Capital Contribution made by a predecessor holder of the Partnership Interest of such Partner. The paid-in Capital Contribution shall mean the cash amount or the Agreed Value of other assets actually contributed by each Partner to the capital of the Partnership. "CASH AMOUNT" means an amount of cash per Partnership Unit equal to the value of the REIT Shares Amount on the date of receipt by the General Partner of a Notice of Redemption or, if such date is not a Business Day, the first Business Day thereafter. The value of the REIT Shares Amount shall be the Market Price. "CERTIFICATE" means the Certificate of Limited Partnership relating to the Partnership together with any instrument or document that is required under the laws of Delaware or any other jurisdiction in which the Partnership conducts business, to be signed by the Partners of the Partnership (either by themselves or pursuant to the power-of-attorney granted to the General Partner in Section 8.2 hereof) and filed for recording in the appropriate public offices within Delaware or such other jurisdiction to perfect or maintain the Partnership as a limited partnership, to effect the 3 8 admission, withdrawal, or substitution of any Partner of the Partnership, or to protect the limited liability of the Limited Partners as limited partners under the laws of Delaware or such other jurisdiction. "CERTIFICATE OF DESIGNATION" means, for a particular class of Preferred Partnership Units, the description of the rights, preferences and privileges to which the holders of Preferred Partnership Units of such class are entitled. For each class of Preferred Partnership Units that may be issued, a Certificate of Designation shall be attached hereto as Exhibit "B" and shall be incorporated by reference herein. "CODE" means the Internal Revenue Code of 1986, as amended and in effect from time to time, or any successor statute thereto, as interpreted by the applicable regulations thereunder. Any reference herein to a specific section or sections of the Code shall be deemed to include a reference to any corresponding provision of future law. "COMMISSION" means the U.S. Securities and Exchange Commission. "COMMON PARTNERSHIP UNITS" means a fractional, undivided share of the Partnership Interests of all Partners issued hereunder, excluding any Preferred Partnership Units. "COMMON UNITHOLDER" means a holder of Common Partnership Units. "COMPANY" means Sunstone Hotel Investors, Inc., a Delaware corporation, in its capacity other than as the General Partner or Limited Partner. "COMPANY CONTRIBUTION" has the meaning provided in Section 4.2(a)(ii) hereof. "CONVERSION FACTOR" means one (1), provided that in the event that the General Partner (i) declares or pays a dividend on its outstanding REIT Shares in REIT Shares or makes a distribution to all holders of its outstanding REIT Shares in REIT Shares, (ii) subdivides its outstanding REIT Shares, or (iii) combines its outstanding REIT Shares into a smaller number of REIT Shares, the Conversion Factor shall be adjusted by multiplying the Conversion Factor by a fraction, the numerator of which shall be the number of REIT Shares issued and outstanding on the record date for such dividend, distribution, subdivision or combination (assuming for such purposes that such dividend, distribution, subdivision or combination has occurred as of such time), and the denominator of which shall be the actual number of REIT Shares (determined without the above assumption) issued and outstanding on such date. Any adjustment to the Conversion Factor shall become effective immediately after the effective date of such event retroactive to the record date, if any, for such event. "DEPRECIATION" means, for each accounting period, an amount equal to the depreciation, amortization or other cost recovery deduction allowable with respect to an asset for such period, except that if the Book Value of an asset differs from its adjusted basis for federal income tax purposes during such accounting period, Depreciation shall be an amount which bears the same ratio to Book Value as the federal income tax depreciation, amortization, or other cost recovery deduction 4 9 for such period bears to such beginning adjusted tax basis; provided, however, that if the adjusted basis for federal income tax purposes of an asset at the beginning of such accounting period is zero, Depreciation shall be determined with reference to such asset as if the adjusted basis of the asset for federal income tax purposes were equal to the Book Value and using any reasonable method of cost recovery selected by the General Partner. "DIRECTORS' PLAN" means the 1994 Directors' Plan of the Company relating to the issuance of REIT shares and the grant of options to acquire REIT Shares and similar rights to directors of the Company. "DIVIDEND REINVESTMENT PLAN" means the Dividend Reinvestment and Stock Purchase Plan of the Company pursuant to which certain eligible persons may purchase REIT Shares directly from the Company, and holders of REIT Shares may elect to have some or all of their dividends on their REIT Shares reinvested to purchase additional REIT Shares from the Company. "ELIGIBLE PERSON" has the meaning provided in Section 4.2(f) hereof. "EVENT OF BANKRUPTCY" as to any Person means the filing of a petition for relief as to such Person as debtor or bankrupt under the Bankruptcy Code of 1978 or similar provision of law of any jurisdiction (except if such petition is contested by such Person and has been dismissed within ninety (90) days of filing); insolvency or bankruptcy of such Person as finally determined by a court proceeding; filing by such Person of a petition or application to accomplish the same or for the appointment of a receiver or a trustee for such Person or a substantial part of his assets; commencement of any proceedings relating to such Person as a debtor under any other reorganization, arrangement, insolvency, adjustment of debt or liquidation law of any jurisdiction, whether now in existence or hereinafter in effect, either by such Person or by another, provided that if such proceeding is commenced by another, such Person indicates his approval of such proceeding, consents thereto or acquiesces therein, or such proceeding is contested by such Person and has not been finally dismissed within ninety (90) days of filing. "FINANCIAL STATEMENTS" has the meaning provided in Section 10.6(a) hereof. "FUNDING LOAN" has the meaning provided in Section 4.3 hereof. "GENERAL PARTNER" means Sunstone Hotel Investors, Inc., a Maryland corporation and any Person who becomes a substitute or additional General Partner as provided herein, and any of their successors as General Partner. "GENERAL PARTNERSHIP INTEREST" means the Partnership Interest held by the General Partner that is a general partnership interest representing a fractional part of the Partnership Interests at any particular time, including the right of such limited partner to any and all benefits to which such limited partner may be entitled as provided in this Agreement and in the Act, together with the obligations of such general partner to comply with provisions of this Agreement and Act. A General Partner Interest may be expressed as a number of Partnership Units. 5 10 "IMMEDIATE FAMILY MEMBER" has the meaning provided in Section 9.2(d)(iii) hereof. "INCENTIVE RIGHTS" has the meaning provided in Section 4.2(f)(iii) hereof. "INDEMNIFIED PARTY" has the meaning provided in Section 8.6(e) hereof. "INDEMNIFYING PARTY" has the meaning provided in Section 8.6(e) hereof. "INDEMNITEE" means (i) any Person made a party to a proceeding by reason of his status as (A) the General Partner or (B) a director or officer of the Partnership or the General Partner, or (C) a party liable, pursuant to a loan guarantee or otherwise, for any indebtedness of the Partnership or any Subsidiary of the Partnership (including, without limitation, any indebtedness which the Partnership or any Subsidiary of the Partnership has assumed or taken assets subject to), and (ii) such other Persons (including Affiliates of the General Partner or the Partnership) as the General Partner may designate from time to time (whether before or after the event giving rise to potential liability), in its sole and absolute discretion. "INDEPENDENT DIRECTOR" has the meaning provided in the Articles of Incorporation. "INITIAL HOTELS" means the Hampton Inn-Denver (S.W.), the Hampton Inn-Pueblo, Colorado, the Hampton Inn-Mesa, Arizona, the Hampton Inn, Silverthorne, Colorado, the Hampton Inn, Arcadia, California, the Best Western, Santa Fe, New Mexico, the Holiday Inn-Craig, Colorado, the Holiday Inn-Steamboat Springs, Colorado, the Holiday Inn-Provo, Utah, and the Courtyard by Marriott-Fresno, California, and any other hotel contributed by an Additional Limited Partner prior to the date of this Agreement. "INITIAL OFFERING" means the initial offer and sale by the General Partner and the purchase by the Underwriters (as defined in the prospectus for such offering) of the shares of common stock of the General Partner for sale to the public. "LIMITED PARTNER" means any Person named as a Limited Partner on the Unitholder Ledger, and any Person who becomes a Substitute or Additional Limited Partner, in such Person's capacity as a Limited Partner in the Partnership. "LIMITED PARTNERSHIP INTEREST" means a Partnership Interest of a Limited Partner in the Partnership representing a fractional part of the Partnership Interests at any particular time, including the right of such Limited Partner to any and all benefits to which such Limited Partner may be entitled as provided in this Agreement and in the Act, together with the obligations of such Limited Partner to comply with all the provisions of this Agreement and of the Act. A Limited Partner Interest may be expressed as a number of Partnership Units. "LIQUIDATOR" has the meaning provided in Section 8.2 hereof. "LOSS" has the meaning provided in Section 5.1(f) hereof. 6 11 "MARKET PRICE" on any date shall mean the average of the Closing Price for the five consecutive Trading Days ending on such date. The "Closing Price" on any day shall mean the last reported sale price, regular way, or, in case no such sale takes place on such day, the average of the closing bid and asked prices, regular way, in either case as reported in the principal consolidated transaction reporting system with respect to securities listed or admitted to trading on the New York Stock Exchange, of the class of REIT Shares or REIT Preferred Shares, or, if not, then listed or admitted to trading on the New York Stock Exchange, as reported in the principal consolidated transaction reporting system with respect to securities listed on the principal national securities exchange on which such shares are listed or admitted to trading or, if such shares are not then listed or admitted to trading on any national securities exchange, the last quoted price, or if not so quoted, the average of the high bid and low asked prices in the over-the-counter market, as reported by the National Association of Securities Dealers, Inc. Automated Quotation System or, if such system is no longer in use, the principal other automated quotations system that may then be in use or, if such shares are not quoted by any such organization, the average of the closing bid and asked prices as furnished by a professional market marker making a market in such shares as selected in good faith by the Board of Directors of the Company. "Trading Day" shall mean a day on which the principal national securities exchange on which such REIT Shares or REIT Preferred Shares are listed or admitted to trading is open for the transaction of business or, if such shares are not listed or admitted to trading on any national securities exchange, shall mean any day other than a Saturday, a Sunday or a day on which banking institutions in the State of New York are authorized or obligated by law or executive order to close. "MINIMUM LIMITED PARTNERSHIP INTEREST" means the lesser of (i) 1 % or (ii) if the total Capital Contributions to the Partnership exceeds $50 million, 1% divided by the ratio of the total Capital Contributions to the Partnership to $50 million; provided, however, that the Minimum Limited Partnership Interest shall not be less than 0.2% at any time. "NEW SECURITIES" has the meaning provided in Section 4.2(a)(ii) hereof. "NOTICE OF REDEMPTION" means the Notice of Exercise of Redemption Right substantially in the form attached as Exhibit "A" hereto. "OFFER" has the meaning provided in Section 7.1(c) hereof. "PARTNER" means any General Partner or any Limited Partner, and "PARTNERS" means collectively the General Partner and all of the Limited Partners. "PARTNER NONRECOURSE DEBT MINIMUM GAIN" has the meaning set forth in Regulations Section 1.704-2(i). A Partner's share of Partner Nonrecourse Debt Minimum Gain shall be determined in accordance with Regulations Section 1.704-2(i)(5). "PARTNERSHIP" means the limited partnership formed under the Act and pursuant to the Original Agreement, as amended and restated pursuant to the First Restated Agreement and this Agreement and any successor partnership thereto. 7 12 "PARTNERSHIP INTEREST" means an ownership interest in the Partnership representing a Capital Contribution by either a Limited Partner or the General Partner and includes any and all benefits to which the holder of such a Partnership Interest may be entitled as provided in this Agreement, together with all obligations of such Person to comply with the terms and provisions of this Agreement or the Act. A Partnership Interest may be expressed as a number of Partnership Units. "PARTNERSHIP MINIMUM GAIN" has the meaning set forth in Regulations Section 1.704- 2(d). In accordance with Regulations Section 1.704-2(d), the amount of Partnership Minimum Gain is determined by first computing, for each Partnership nonrecourse liability, any gain the Partnership would realize if it disposed of the property subject to that liability for no consideration other than full satisfaction of the liability, and then aggregating the separately computed gains. A Partner's share of Partnership Minimum Gain shall be determined in accordance with Regulations Section 1.704-2(g)(1). "PARTNERSHIP RECORD DATE" means the record date established by the General Partner for the distribution of Distributable Cash pursuant to Section 5.2 hereof, which record date shall be the same as the record date established by the General Partner for a distribution to its stockholders of some or all of its portion of such distribution. "PARTNERSHIP UNIT" means a fractional, undivided share of the Partnership Interests of all Partners issued at any time and from time to time by the Partnership, consisting of either Common Partnership Units or Preferred Partnership Units. The ownership of Partnership Units shall be evidenced by book entry on the Unitholder Ledger maintained by the Transfer Agent that reflects the issuance, redemption, exchange or conversion of Partnership Units. In the absence of manifest error, the Unitholder Ledger shall be final, conclusive and binding on all Limited Partners. "PERCENTAGE INTEREST" means the percentage ownership interest in the Partnership that each Partner, as determined by dividing the Partnership Units owned by a Partner as of the date of determination by the total number of Partnership Units then outstanding, as may be adjusted by Section 4.2 hereof. The Percentage Interest of each Partner is set forth opposite its respective name on the Unitholder Ledger. "PERSON" means any individual, partnership, limited liability company, corporation, joint venture, trust, association or other entity. "PLEDGE" has the meaning provided in Section 9.2(a) hereof. "PREFERRED UNIT" means a fractional, undivided share of the Partnership interest of all Partners issued at any time and from time to time by the Partnership, which has the rights, preferences and other privileges designated in the Certificate of Designation related to a particular class of Preferred Partnership Units. With respect to any class of Preferred Partnership Units, the allocation of Preferred Partnership Units among the Partners holding units of such class shall be as set forth on the Unitholder Ledger. 8 13 "PREFERRED UNITHOLDER" means a Partner holding one or more Preferred Partnership Units. "PROFIT" has the meaning provided in Section 5.1(f) hereof. "PROPERTIES" means the Initial Hotels together with any other hotel property or other investment in which the Partnership holds an ownership or ground lessee interest, including collectively real and personal property. "PROSPECTUS" means the final prospectus delivered to purchasers of shares of the General Partner's common stock in the most recent public offering of securities of the Company. "PUBLIC OFFERING PRICE" shall mean the initial public offering price set forth in the Prospectus for the Initial Offering. "REDEEMING PARTNER" has the meaning provided in Section 8.5(a) hereof. "REDEMPTION AMOUNT" means the Cash Amount, or the REIT Shares Amount, as selected by the General Partner in its sole discretion pursuant to Section 8.5 hereof, subject to the obligation under Section 8.5(c) hereof in certain cases to pay the Cash Amount. "REDEMPTION RIGHT" has the meaning provided in Section 8.5(a) hereof. "REDEMPTION SHARES" means all of the REIT Shares issued or to be issued upon the redemption of Partnership Units under Section 8.5 hereof. "REGISTERED REDEMPTION SHARES" means any Redemption Shares covered by a Shelf Registration. "REGULATIONS" means the Federal Income Tax Regulations promulgated under the Code, as amended and as hereafter amended from time to time. Reference to any particular provision of the Regulations shall mean that provision of the Regulations on the date hereof and any succeeding provision of the Regulations. "REIT" means a real estate investment trust under Sections 856 through 860 of the Code. "REIT EXPENSES" means (i) all of the costs and expenses relating to the formation and continuity of existence of the Company (as a General Partner and Limited Partner) and any Subsidiaries thereof (which Subsidiaries shall, for purposes of this definition, be included within the definition of Company), including taxes, fees and assessments associated therewith, any and all costs, expenses or fees payable to any director, officer, or employee of the Company, (ii) costs and expenses relating to the public offering and registration of securities from time to time by the Company and all statements, reports, fees and expenses incidental thereto, including underwriting discounts and selling commissions applicable to any such offering of securities by the Company, (iii) costs and expenses associated with the preparation and filing of any periodic reports by the Company under federal, state or local laws or regulations, including filings with the Commission, (iv) costs 9 14 and expenses associated with compliance by the Company with laws, rules and regulations promulgated by any regulatory body, including the Commission, and (v) all other operating or administrative costs of the Company incurred in the ordinary course of its business on behalf of the Partnership. "REIT PREFERRED SHARE" means a share of preferred stock of the Company. "REIT SHARE" means a share of common stock of the Company. "REIT SHARES AMOUNT" shall mean a whole number of REIT Shares equal to the product of the number of Partnership Units offered for redemption by a Redeeming Partner, multiplied by the Conversion Factor (rounded down to the nearest whole number in the event such product is not a whole number); provided that in the event the Company issues to all holders of REIT Shares rights, options, warrants or convertible or exchangeable securities entitling the shareholders to subscribe for or purchase REIT Shares, or any other securities or property (collectively, the "Rights"), then the REIT Shares Amount for such Redeeming Parties shall also include the Rights that a holder of that number of REIT Shares would be entitled to receive at the time of such redemption. "SECURITIES ACT" shall have the meaning provided in Section 8.6(a) hereof. "SERVICE" means the Internal Revenue Service. "SHELF REGISTRATION" has the meaning provided in Section 8.6(a) hereof. "SHELF REGISTRATION PERIOD" has the meaning provided in Section 8.6(a) hereof. "SPECIFIED REDEMPTION DATE" means the first business day of the month that is at least ten (10) Business Days after the receipt by the General Partner of the Notice of Redemption; provided that if the General Partner enters into a merger, combination or other transaction with another Person to combine its outstanding REIT Shares, then no Specified Redemption Date shall occur after the record date and prior to the effective date of such combination. "STOCK INCENTIVE PLAN" means the 1994 Stock Incentive Plan of the Company relating to the issuance of REIT Shares and grant of options to acquire REIT Shares and similar rights to employees of the Company and other eligible persons. "SUBSIDIARY" means, with respect to any Person, any corporation or other entity of which a majority of (i) the voting power of the voting equity securities or (ii) the outstanding equity interests is owned, directly or indirectly, by such Person. "SUBSTITUTE LIMITED PARTNER" means any Person admitted to the Partnership as a Limited Partner pursuant to Section 9.3 hereof. "SURVIVING GENERAL PARTNER" has the meaning provided in Section 7.1(d) hereof. 10 15 "TARGET CAPITAL ACCOUNT" means, with respect to any Partner, the amount which such Partner would be entitled to receive if all of the assets of the Partnership were sold at their Book Value and the proceeds distributed in accordance with Section 5.6 hereof. "THRESHOLD CASH AMOUNT" has the meaning provided in Section 8.5(a) hereof. "TRANSACTION" has the meaning provided in Section 7.1(c) hereof. "TRANSFER" has the meaning provided in Section 9.2(a) hereof. "TRANSFER AGENT" shall mean the transfer agent or agents engaged by the General Partner in its sole discretion with respect to the common or preferred stock of the General Partner or Partnership Units. "UNITHOLDER LEDGER" shall mean the ledger maintained by the Transfer Agent which reflects the ownership of the Partnership Units and shall be revised from time to time pursuant to the instructions by the General Partner to the Transfer Agent to reflect the issuance, redemption, exchange, or conversion of Partnership Units. "WARRANTS" means in the aggregate (i) the Warrants to Purchase Partnership Units dated as of August 16, 1995, to be issued by the Partnership to Robert A. Alter covering Partnership Units; (ii) the Warrants to Purchase Partnership Units dated as of August 16, 1995, to be issued by the Partnership to Charles L. Biederman covering Partnership Units; (iii) the Warrants to Purchase Partnership Units dated as of August 16, 1995, to be issued by the Partnership to C. Robert Enever covering Partnership Units; and (iv) the Warrants to Purchase Partnership Units dated as of August 16, 1995, to be issued by the Partnership to MYPC covering Partnership Units. ARTICLE II PARTNERSHIP CONTINUATION AND IDENTIFICATION 2.1 ORGANIZATION. The Partnership is a limited partnership organized pursuant to the provisions of the Act and upon the terms and conditions set forth in the First Restated Agreement. The Partners hereby amend and restate the First Restated Agreement in its entirety as of the date first hereinabove written. Except as expressly provided herein to the contrary, the rights and obligations of the Partners and the administration and termination of the Partnership shall be governed by the Act. The Partnership Interest of each Partner shall be personal property for all purposes. The Partners hereby agree to continue the Partnership pursuant to the Act and upon the terms and conditions set forth in this Agreement. 2.2 NAME. The name of the Partnership shall be Sunstone Hotel Investors, L.P. The Partnership's business may be conducted under any other name or names deemed advisable by the General Partner, including the name of the General Partner or any Affiliate thereof. The words "Limited Partnership," "L.P.," "Ltd." or similar words or letters shall be included in the Partnership's 11 16 name where necessary for the purposes of complying with the laws of any jurisdiction that so requires. The General Partner in its sole and absolute discretion may change the name of the Partnership at any time and from time to time and shall notify the Limited Partners of such change in the next regular communication to the Limited Partners. 2.3 REGISTERED OFFICE AND AGENT; PRINCIPAL OFFICE. The address of the registered office of the Partnership in the State of Delaware shall be located at 32 Loockerman Square, Suite L-100, Dover, Delaware 19901, and the registered agent for service of process on the Partnership in the State of Delaware at such registered office shall be The Prentice-Hall Corporation System, Inc. The principal office of the Partnership shall be 115 Calle de Industrias, Suite 203, San Clemente, California 92672 or such other place as the General Partner may from time to time designate by notice to the Limited Partners. The Partnership may maintain offices at such other place or places within or outside the State of Delaware as the General Partner deems advisable. 2.4 PARTNERS. (a) The General Partner of the Partnership is Sunstone Hotel Investors, Inc., a Maryland corporation. Its principal place of business shall be the same as that of the Partnership. The Partnership Units that are owned by the Company from time to time shall be deemed held by it in its capacity as the General Partner, up to the number of Partnership Units required to give it a one percent (1%) Percentage Interest, and the balance of such Partnership Units shall be deemed Partnership Units held by the Company in its capacity as a Limited Partner. (b) The Limited Partners shall be those Persons identified as Limited Partners on the Unitholder Ledger, as modified from time to time. Additional Limited Partners may be admitted to the Partnership through the issuance of Partnership Units as provided in Section 4.2, and Substitute Limited Partners may be admitted to the Partnership through the assignment or other disposition of Partnership Units as provided in Section 9.3. Limited Partners may withdraw from the Partnership upon the redemption or transfer of all of their Limited Partnership interests as provided in Section 9.7. 2.5 TERM AND DISSOLUTION. (a) The term of the Partnership shall continue in full force and effect until December 31, 2050, except that the Partnership shall be dissolved upon the happening of any of the following events: (i) The occurrence of an Event of Bankruptcy as to a General Partner or the dissolution, death or withdrawal of a General Partner unless the business of the Partnership is continued pursuant to Section 7.3(b) hereof; provided if a General Partner is on the date of such occurrence a partnership, the dissolution of such General Partner as a result of the dissolution, death, withdrawal, removal or Event of Bankruptcy of a partner in such partnership shall not be an event of dissolution of the Partnership if the business of such General Partner is continued by the remaining partner or partners, either alone or with 12 17 additional partners, and such General Partner and such partners comply with any other applicable requirements of this Agreement; (ii) The passage of ninety (90) days after the sale or other disposition of all or substantially all the assets of the Partnership (provided that if the Partnership receives an installment obligation as consideration for such sale or other disposition, the Partnership shall continue, unless sooner dissolved under the provisions of this Agreement, until such time as such installment obligation or obligations are paid in full); (iii) The redemption of all Limited Partnership Interests (other than any of such interests held by the General Partner); or (iv) The election by the General Partner that the Partnership should be dissolved. (b) Upon dissolution of the Partnership (unless the business of the Partnership is continued pursuant to Section 7.3(b) hereof), the General Partner (or its trustee, receiver, successor or legal representative, including the Liquidator) shall amend or cancel the Certificate and liquidate the Partnership's assets and apply and distribute the proceeds thereof in accordance with Section 5.6 hereof. Notwithstanding the foregoing, the liquidating General Partner may either (i) defer liquidation of, or withhold from distribution for a reasonable time, any assets of the Partnership (including those necessary to satisfy the Partnership's debts and obligations), or (ii) distribute the assets to the Partners in kind. 2.6 FILING OF CERTIFICATE AND PERFECTION OF LIMITED PARTNERSHIP. The General Partner shall execute, acknowledge, record and file at the expense of the Partnership, the Certificate and any and all amendments thereto and all requisite fictitious name statements and notices in such places and jurisdictions as may be necessary to cause the Partnership to be treated as a limited partnership under, and otherwise to comply with, the laws of each state or other jurisdiction in which the Partnership conducts business. ARTICLE III PURPOSE OF THE PARTNERSHIP 3.1 BUSINESS. The purpose and nature of the business to be conducted by the Partnership is (i) to conduct any business that may be lawfully conducted by a limited partnership organized pursuant to the Act, provided, however, that such business shall be limited to and conducted in such a manner as to permit the Company at all times to qualify as a REIT, unless the Company otherwise ceases to qualify as a REIT, (ii) to enter into any partnership, joint venture or other similar arrangement to engage in any of the foregoing or the ownership of interests in any entity engaged in any of the foregoing and (iii) to do anything necessary or incidental to the foregoing. The General Partner shall also be empowered to do any and all acts and things necessary or prudent to ensure that the Partnership will not be classified as a "publicly traded partnership" for the purposes of Section 13 18 7704(a) of the Code. In connection with the foregoing, and without limiting the General Partner's right in its sole discretion to cease qualifying as a REIT, the Partners acknowledge that the General Partner's current status as a REIT inures to the benefit of all the Partners and not solely to the General Partner. 3.2 POWERS. The Partnership is empowered to do any and all acts and things necessary, appropriate, proper, advisable, incidental to or convenient for the furtherance and accomplishment of the purposes and business described herein and for the protection and benefit of the Partnership, provided that the Partnership shall not take, or refrain from taking, any action which, in the judg ment of the General Partner, in its sole and absolute discretion, (i) could adversely affect the ability of the Company to continue to qualify as a REIT, (ii) could subject the General Partner to any additional taxes under Section 857 or Section 4981 of the Code, or (iii) could violate any law or regulation of any governmental body or agency having jurisdiction over the Company or its securities, unless such action (or inaction) shall have been specifically consented to by the General Partner in writing. 3.3 PARTNERSHIP ONLY FOR PURPOSES SPECIFIED. The Partnership shall be a partnership only for the purposes specified in Section 3.1 hereof, and this Agreement shall not be deemed to create a partnership among the Partners with respect to any activities whatsoever other than the activities within the purposes of the Partnership as specified in Section 3.1 hereof. Except as otherwise provided in this Agreement, no Partner shall have any authority to act for, bind, commit or assume any obligation or responsibility on behalf of the Partnership, its properties or any other Partner. No Partner, in its capacity as a Partner under this Agreement, shall be responsible or liable for any indebtedness or obligation of another Partner, nor shall the Partnership be responsible or liable for any indebtedness or obligation of any Partner, incurred either before or after the execution and delivery of this Agreement by such Partner, except as to those responsibilities, liabilities, indebtedness or obligations incurred pursuant to and as limited by the terms of this Agreement and the Act. ARTICLE IV CAPITAL CONTRIBUTIONS AND ACCOUNTS 4.1 CAPITAL CONTRIBUTIONS. The Company, as a General Partner and Limited Partner, initially contributed to the capital of the Partnership cash in an amount set forth opposite its name on Exhibit "A" to the First Restated Agreement. The Limited Partners (or their predecessors-in-interest) contributed prior to the date of this Agreement to the Capital of the Partnership interests in one or more of the Initial Hotels pursuant to the Purchase Agreements or Contribution Agreements. The Agreed Value of each Limited Partner's ownership interest in the Initial Hotels (other than the Company) that were contributed to the Partnership were set forth opposite such Limited Partner's names on Exhibit "A" to the First Restated Agreement for contributions made prior to the introduction of the Unitholder Ledger; or, for contributions made after the introduction of the Unitholder Ledger, such Agreed Value is established by reference to the number of Partnership Units issued in exchange for such contribution as evidenced on the Unitholder Ledger and calculating the value of such units in accordance with the definition of "Agreed Value." 14 19 4.2 ADDITIONAL CAPITAL CONTRIBUTIONS AND ISSUANCES OF ADDITIONAL PARTNERSHIP INTERESTS. Except as provided in this Section 4.2 or in Section 4.3, the Partners shall have no right or obligation to make any additional Capital Contributions or loans to the Partnership. The General Partner may contribute additional capital to the Partnership, from time to time, and receive additional Partnership Interests in respect thereof, in the manner contemplated in this Section 4.2. (a) Issuances of Additional Partnership Interests. (i) General. The General Partner is hereby authorized to cause the Partnership to issue such additional Partnership Interests in the form of Partnership Units for any Partnership purpose at any time or from time to time, to the Partners (including the General Partner) or to other Persons for such consideration and on such terms and conditions as shall be established by the General Partner in its sole and absolute discretion, all without the approval of any Limited Partners. The Partnership issued Partnership Units in the number set forth on Exhibit "A" to the First Restated Agreement or on the Unitholder Ledger to each of the Limited Partners who contributed an Initial Hotel to the Partnership. Any additional Partnership Interests issued by the General Partner have been and may be issued in one or more classes, or one or more series of any of such classes, with such designations, preferences and relative, participating, optional or other special rights, powers and duties, including rights, powers and duties senior, equal or subordinate to Limited Partnership Interests, all as shall be determined by the General Partner in its sole and absolute discretion and without the approval of any Limited Partner, subject to only to mandatory provisions of applicable Delaware law, including, without limitation, (i) the allocations of items of Partnership income, gain, loss, deduction and credit to each such class or series of Partnership Interests; (ii) the rights of each such class or series of Partnership Interests to share in Partnership allocations and distributions; and (iii) the rights of each such class or series of Partnership Interests upon dissolution and liquidation of the Partnership. The General Partner may issue additional Partnership Interests to any Person (including the General Partner) as full or partial consideration for the contribution of a hotel or other asset from such Person to the Partnership in which case such Person's resultant Capital Contribution to the Partnership shall equal the Agreed Value of the hotel or other asset contributed. In addition to the foregoing, no additional Partnership Interests shall be issued to the Company (as a General and Limited Partner) unless either: (1)(A) the additional Partnership Interests are issued in connection with an issuance of shares of or other debt or equity interests in the Company, which shares or interests have designations, preferences and other rights, all such that the economic interests are substantially similar to the designations, preferences and other rights of the additional Partnership Interests issued to the Company by the Partnership in accordance with this Section 4.2 and (B) the Company shall make a Capital Contribution to the Partnership in cash in an amount equal to the net proceeds raised in connection with the issuance of such shares of or other interests in the Company or of assets acquired by the Company with such net proceeds or a combination of such cash and assets, or 15 20 (2) the additional Partnership Interests are issued to all Partners in proportion to their respective Percentage Interests. Without limiting the foregoing, the General Partner is expressly authorized to cause the Partnership to issue Partnership Units (i) for less than fair market value, so long as the General Partner concludes in good faith that such issuance is in the best interests of the General Partner and the Partnership, (ii) upon the exercise of any of the Warrants from time to time, and (iii) upon the exercise of any rights, options, warrants or convertible or exchangeable securities containing the right to subscribe for, purchase or receive in an exchange Partnership Units. (ii) Upon Issuance of New Securities. After the Initial Offering, the Company shall not grant, award or issue any (i) REIT Shares (other than REIT Shares issued in connection with a redemption pursuant to Section 8.5 hereof), (ii) REIT Preferred Shares, (iii) rights, options, warrants or convertible or exchangeable securities containing the right to subscribe for or purchase REIT Shares or REIT Preferred Shares, or (iv) debt securities (the securities described in (i), (ii), (iii) and (iv), collectively, "New Securities") unless: (1) the General Partner shall cause the Partnership to issue to the Company, Partnership Interests or rights, options, warrants or convertible or exchangeable securities of the Partnership having designations, preferences and other rights, all such that the economic interests of such Partnership Interests or securities are substantially similar to those of the New Securities, and (2) the Company contributes to the Partnership (A) the cash proceeds from the issuance of such New Securities and from the exercise of rights contained in such New Securities, (B) the assets acquired by the Company from a third party with the cash proceeds from the issuance of New Securities or in exchange for the New Securities issued to such third party (which includes assets of businesses whose equity interests are acquired by the Company where the business is then dissolved by or merged into the Company), or (C) a combination of (A) and (B) as determined in the sole discretion of the Company (the contributions referred to in (A), (B) and (C) collectively, a "Company Contribution"). The assets referred to in (B), which must be contributed by the Company to the Partnership, need not consist of the assets directly acquired by the Company (or the assets of businesses whose equity interests are acquired by the Company where the business is then dissolved by or merged into the Company). Rather, the Company may first acquire such assets and sell all or any part thereof to a third party (which may include Sunstone Hotel Properties, Inc. or any successor thereto) in exchange for any type and amount of consideration agreed upon by the Company in its sole discretion and the third party, and the Company may then contribute to the Partnership the consideration the Company received in such sale. Notwithstanding the foregoing, the Partnership shall (i) have no legal, equitable or beneficial ownership of any cash or other assets of the Company unless and until the Company contributes such cash or other assets to the Partnership; (ii) shall have no obligation to the transferor of assets to the Company; and (iii) shall not be 16 21 obligated to accept any stock of a corporation as a contribution if the Partnership would have to liquidate or recapitalize such corporation in order for the Company to maintain its REIT status. Notwithstanding anything in this Section 4.2(a) to the contrary, the Company is allowed to issue New Securities in connection with an acquisition of assets to be held directly by the Company if such direct acquisition and issuance of New Securities has been approved and determined to be in the best interests of the Company and the Partnership by a majority of the Independent Directors. Without limiting the foregoing, the Company is expressly authorized to issue New Securities for less than fair market value, and to cause the Partnership to issue to the Company corresponding Partnership Interests, so long as (x) the Company concludes in good faith that such issuance is in the best interests of the Company and the Partnership (for example, and not by way of limitation, the issuance of REIT Shares and corresponding Partnership Units pursuant to an employee stock purchase plan providing for employee purchases of REIT Shares at a discount from fair market value or employee stock options that have an exercise price that is less than the fair market value of the REIT Shares, either at the time of issuance or at the time of exercise), and (y) the Company contributes the Company Contribution to the Partnership. By way of example, in the event the Company issues REIT Shares for a cash purchase price and contributes all of the proceeds of such issuance to the Partnership as required hereunder, the Company shall be issued a number of additional Partnership Units equal to the product of (A) the number of such REIT Shares issued by the Company the proceeds of which were so contributed, multiplied by (B) a fraction, the numerator of which is one hundred percent (100%), and the denominator of which is the Conversion Factor in effect on the date of such contribution. (b) Value of Company Contribution; Certain Deemed Contributions. In connection with any and all issuances of New Securities the Company shall contribute the resultant Company Contribution to the Partnership as a Capital Contribution. For purposes of determining the number of Partnership Units to be issued to the Company in exchange for such Capital Contribution, the value of the Capital Contribution shall be deemed to equal the gross proceeds of all New Securities issued in connection with such contribution. The value of the gross proceeds shall be deemed to equal the sum of (i) the gross cash proceeds of any issuance of New Securities for cash (even though the proceeds actually received by the Company are less than the gross proceeds of such issuance as a result of any underwriter's commission or discount or other expenses paid or incurred in connection with such issuance), and (ii) the aggregate value, as agreed upon by the Company and the party or parties selling assets to the Company which are included in a Company Contribution, of all REIT Shares, REIT Preferred Shares and debt securities of the Company issued to such party or parties in exchange for such assets. If, pursuant to clause (i) in the preceding sentence, the Company is deemed to have contributed gross cash proceeds from the issuance of New Securities for cash when the actual contribution of cash is less than the gross proceeds as a result of an underwriter's commission or discount or other expenses paid or incurred in connection with such issuance, then the Partnership shall be deemed simultaneously to have incurred such offering expenses in connection with the issuance of additional Partnership Units to the Company for its required Company Contribution pursuant to Section 4.2(a). 17 22 (c) Adjustment of Value of Company Contribution for Contingent Payment. In the event all or a portion of a particular Company Contribution to the Partnership includes assets acquired from a third party and the Company's agreement with such third party requires that the Company make a contingent payment to such third party for such assets on a date subsequent to the date on which the Company purchased the assets from the third party and contributed the assets to the Partnership (e.g., an earn-out payment to be made on a future date based on the performance of assets acquired from the third party), then immediately following payment by the Company of such contingent purchase price to the third party (whether in cash or New Securities, or a combination of cash and New Securities), the value of the assets acquired from the third party and previously contributed by the Company to the Partnership shall be deemed to be increased by an amount equal to the contingent payment made by the Company to such third party, and the Partnership shall make an equivalent cash payment or corresponding issuance of Partnership Units to the Company, as follows: (i) The Partnership shall pay to the Company cash in an amount equal to the cash portion, if any, of the contingent payment; (ii) The Partnership shall issue to the Company a number of Common Partnership Units equal to the number of REIT Shares, if any, included in the contingent payment; and (iii) The Partnership shall issue to the Company a number of Preferred Partnership Units equal to the number of REIT Preferred Shares, if any, included in the contingent payment, which Preferred Partnership Units shall have rights, preferences and privileges that mirror the rights, preferences and privileges of such REIT Preferred Shares and which Preferred Partnership Units shall be designated by attaching as Exhibit "B" hereto an appropriate Certificate of Designation at the time of issuance. (d) Classes of Partnership Units to be Issued to the Company in Exchange for Company Contribution. As provided in Section 4.2(a)(ii), in exchange for a Company Contribution, the Partnership shall issue to the Company Partnership Units having the rights, preferences and privileges equivalent to the rights, preferences and privileges of the New Securities issued by the Company to fund the Company Contribution. Specifically, the Partnership shall issue to the Company (i) Common Partnership Units corresponding to REIT Shares issued by the Company (whether such REIT Shares were issued for cash or in exchange for assets), and (ii) Preferred Partnership Units corresponding to any Preferred REIT Shares issued by the Company (whether such Preferred REIT Shares were issued for cash or for assets). Whenever the Company issues a class of Preferred REIT Shares not previously issued by the Company, the Partnership shall attach as Exhibit "B" to this Agreement a Certificate of Designation for the corresponding Preferred Partnership Units, setting forth rights, preferences and privileges mirroring those of the corresponding REIT Preferred Shares. (e) Minimum Limited Partnership Interest. In the event that either a redemption pursuant to Section 8.5 hereof or an additional Capital Contribution by the Company would result in the Limited Partners (other than the General Partner), in the aggregate, owning less than the 18 23 Minimum Limited Partnership Interest, the General Partner and the Limited Partners shall form another partnership and contribute sufficient Limited Partnership Interests together with such other Limited Partners so that such partnership owns at least the Minimum Limited Partnership Interest (f) Stock Incentive Plan, Directors' Plan and Dividend Reinvestment Plan. The General Partner has established the Stock Incentive Plan and Directors' Plan and may from time to time establish other compensation or other incentive plans to provide incentives to its Directors, executive officers and certain key employees and consultants. The Company has also established the Dividend Reinvestment Plan to permit certain persons to purchase REIT Shares directly from the Company and to allow holders of REIT Shares to reinvest all or a portion of their dividends on their REIT Shares in the purchase of additional REIT Shares from the Company. The following examples are illustrative of the operation of the provisions of Section 4.2(a)(ii) with respect to issuances of New Securities to such Directors, officers, employees and consultants under the Stock Incentive Plan and Directors' Plan, and the other persons under the Dividend Reinvestment Plan (each, an "Eligible Person"): (i) If the Company awards REIT Shares to any such Eligible Person (A) the Company shall, as soon as practicable, contribute to the Partnership (to be thereafter taken into account for the purposes of calculating any cash distributable to the Partners) an amount equal to the price, if any, paid to the Company by such party for such REIT Shares, and (B) the Company shall be issued by the Partnership a number of additional Partnership Units equal to the product of (1) the number of such REIT Shares issued by the Company to such Eligible Person, multiplied by (2) a fraction, the numerator of which is one hundred percent (100%), and the denominator of which is the Conversion Factor in effect on the date of such contribution; (ii) If the Company awards an option or warrant relating to REIT Shares pursuant to the Stock Incentive Plan, the Director's Plan or otherwise to any Eligible Person, then the Partnership shall grant to the Company a corresponding option or warrant to acquire Partnership Units. Upon the exercise of such option or warrant to purchase REIT Shares, (A) the Company shall, as soon as practicable after such exercise, contribute to the capital of the Partnership (to be thereafter taken into account for the purposes of calculating distributable cash) an amount equal to the exercise price, if any, paid to the General Partner by such exercising party in connection with the exercise of the option or warrant, and (B) the Company shall be issued by the Partnership a number of additional Partnership Units equal to the product of (1) the number of REIT Shares issued by the Company in satisfaction of such exercised option or warrant, multiplied by (2) a fraction, the numerator of which is one hundred percent (100%), and the denominator of which is the Conversion Factor in effect on the date of such contribution; and (iii) If the Company grants any director, officer or employee share appreciation rights, performance share awards or other similar rights ("Incentive Rights"), then simultaneously, the Partnership shall grant the Company corresponding and economically equivalent rights. Consequently, upon the cash payment by the Company to 19 24 its directors, officers or employees pursuant to such Incentive Rights, the Partnership shall make an equal cash payment to the Company. (g) Automatic Adjustments in Percentage Interests. In lieu of issuing any rights, options, warrants, convertible or exchangeable securities to purchase Partnership Units as contemplated by Sections 4.2(a)(ii), 4.2(f)(ii) or 4.2(f)(iii), the Partnership may at its election cause the Company's Partnership Interests set forth on the Unitholder Ledger to be revised to reflect the exercise of any such rights, options, warrants or convertible or exchangeable securities. (h) Admission of Additional Limited Partners; Pro Rata First Quarter Distributions; Lock-Up. Any Person who receives Partnership Units pursuant to this Section 4.2 who does not already hold Partnership Units shall upon execution of a counterpart to this Agreement, by which such Person agrees to be bound by all of the provisions hereof, become a Limited Partner of the Partnership; provided that the General Partner may in its sole discretion require that an amendment to this Agreement be effected in order to add a Person as a new Limited Partner in order to address the specific terms of such admission. Notwithstanding any provision in this Agreement to the contrary, any Person who becomes a Limited Partner pursuant to this Section 4.2 shall not be entitled to a full quarter's distributions on such Partnership Units for the quarter in which such Partnership Units were issued to such Partner, but shall only be entitled to a pro rata distribution on such Partnership Units for such quarter based upon the number of days in such quarter such Partner held such Partnership Units, unless the General Partner has waived this restriction in writing for a particular Partner for a particular quarter. In addition, the Limited Partners listed below and any person who becomes a Limited Partner after the date of this Agreement shall execute a lock-up agreement at the request of the managing underwriter in connection with any public underwritten securities offering by the General Partner on the same terms and conditions as any such agreement executed by Mr. Robert A. Alter, but in no event shall such lock-up exceed 120 days after the first date that any shares are released for sale to the public from such offering, and as a condition to any transfer of any Partnership Units or Redemption Shares otherwise permitted under this Agreement such Limited Partners shall cause any shareholder or other affiliate who receives any Partnership Units from such Limited Partners to agree to be subject to the obligation to execute such a lock-up agreement. The enumerated Limited Partners referenced in the preceding sentence are: (i) Flagstaff Hotel Assets, Inc.; (ii) Tucson Desert Assets, Inc.; (iii) Shivani, LLC; (iv) O.T. Hill, LLC; and (v) Peacock, LLC. 4.3 COMPANY LOANS. The Company may from time to time advance funds to the Partnership for any proper Partnership purpose as a loan ("Funding Loan"), provided that the funds for any such Funding Loans must first be obtained by the Company from a third party lender, and then all of such funds must be loaned by the Company to the Partnership on the same terms and conditions, including principal amount, interest rate, repayment schedule and costs and expenses, as shall be applicable with respect to or incurred in connection with such loan with such third party lender. Except for Funding Loans, the Company shall not incur any indebtedness for borrowed funds; provided, however, that upon a majority vote of the Independent Directors, any loan proceeds received by the Company may be distributed to its shareholders or other equity holders if such loan and distribution have been approved and determined by a majority of the Independent Directors to be necessary to enable the Company to maintain its status as a REIT under Sections 856-860 of the 20 25 Code. The Company may agree in its sole discretion to subordinate the repayment of the Funding Loan to any other loan by an institutional lender to the Partnership. 4.4 CAPITAL ACCOUNTS. A separate capital account (a "Capital Account") shall be established and maintained for each Partner in accordance with Regulations Section 1.704- 1(b)(2)(iv). If (i) a new or existing Partner acquires an additional Partnership Interest in exchange for more than a de minimis Capital Contribution, (ii) the Partnership distributes to a Partner more than a de minimis amount of Partnership property as consideration for a Partnership Interest, or (iii) the Partnership is liquidated within the meaning of Regulation Section 1.704-1(b)(2)(ii)(g), the General Partner shall revalue the property of the Partnership to its fair market value (taking into account Section 7701(g) of the Code) in accordance with Regulations Section 1.704-1(b)(2)(iv)(f). When the Partnership's property is revalued by the General Partner, the Capital Accounts of the Partners shall be adjusted in accordance with Regulations Sections 1.704-1(b)(2)(iv)(f) and (g), which generally require such Capital Accounts to be adjusted to reflect the manner in which the unrealized gain or loss inherent in such property (that has not been reflected in the Capital Accounts previously) would be allocated among the Partners pursuant to Section 5.1 if there were a taxable disposition of such property for its fair market value (taking into account Section 7701(g) of the Code) on the date of the revaluation. 4.5 PERCENTAGE INTERESTS. If the number of outstanding Partnership Units increases or decreases during a taxable year, each Partner's Percentage Interest shall be adjusted to a percentage equal to the number of Partnership Units held by such Partner divided by the aggregate number of outstanding Partnership Units. If the Partners' Percentage Interests are adjusted pursuant to this Section 4.5, the Profits and Losses for the taxable year in which the adjustment occurs shall be allocated between the part of the year ending on the day when the Partnership's property is revalued by the General Partner and the part of the year beginning on the following day either (i) as if the taxable year had ended on the date of the adjustment or (ii) based on the number of days in each part. The General Partner, in its sole discretion, shall determine which method shall be used to allocate Profits and Losses for the taxable year in which the adjustment occurs. The allocation of Profits and Losses for the earlier part of the year shall be based on the Percentage Interests before adjustment, and the allocation of Profits and Losses for the later part shall be based on the adjusted Percentage Interests. 4.6 NO INTEREST ON CONTRIBUTIONS. No Partner shall be entitled to interest on its Capital Contribution. 4.7 RETURN OF CAPITAL CONTRIBUTIONS. No Partner shall be entitled to withdraw any part of its Capital Contribution or its Capital Account or to receive any distribution from the Company, except as specifically provided in this Agreement. Except as otherwise provided herein, there shall be no obligation to return to any Partner or withdrawn Partner any part of such Partner's Capital Contribution for so long as the Partnership continues in existence. 4.8 NO THIRD PARTY BENEFICIARY. No creditor or other third party having dealings with the Partnership shall have the right to enforce the right or obligation of any Partner to make Capital Contributions or loans or to pursue any other right or remedy hereunder or at law or in equity, it 21 26 being understood and agreed that the provisions of this Agreement shall be solely for the benefit of, and may be enforced solely by, the parties hereto and their respective successors and assigns. None of the rights or obligations of the Partners herein set forth to make Capital Contributions or loans to the Partnership shall be deemed an asset of the Partnership for any purpose by any creditor or other third party, nor may such rights or obligations be sold, transferred or assigned by the Partnership or pledged or encumbered by the Partnership to secure any debt or other obligation of the Partnership or of any of the Partners. In addition, it is the intent of the parties hereto that no distribution to any Limited Partner shall be deemed a return of money or other property in violation of the Act. The payment of any such money or distribution of any such property to a Limited Partner shall be deemed to be a compromise within the meaning of Section 17-502(b) of the Act, and the Limited Partner receiving any such money or property shall not be required to return any such money or property to any Person, the Partnership or any creditor of the Partnership. However, if any court of competent jurisdiction holds that, notwithstanding the provisions of this Agreement, any Limited Partner is obligated to return such money or property, such obligation shall be the obligation of such Limited Partner and not of the General Partner. Without limiting the generality of the foregoing, a deficit Capital Account of a Partner shall not be deemed to be a liability of such Partner nor an asset or property of the Partnership. 4.9 NO PREEMPTIVE RIGHTS. No Person shall have any preemptive, preferential or other similar right with respect to (i) additional Capital Contributions or loans to the Partnership; or (ii) issuance or sale of any Partnership Units or other Partnership Interests. ARTICLE V PROFITS AND LOSSES: DISTRIBUTIONS 5.1 ALLOCATION OF PROFIT AND LOSS. (a) General. After giving effect to the special allocations set forth in the other provisions of this Section 5.1, Profit or Loss, or items of income, gain, loss or deduction included in the determination of Profit or Loss, for each accounting period shall be allocated to the Partners as follows: (i) Profit, or items of income or gain to the extent necessary, shall be allocated to each Partner in an amount equal to the excess of (i) the sum of (A) such Partner's Target Capital Account as of the last day of the accounting period, and (B) any distributions made by the Partnership to such Partner during the accounting period, over (ii) the sum of such Partner's (X) Capital Account as of the beginning of the accounting period, (Y) any Capital Contributions made by such Partner during the accounting period, and (Z) any income or gain (or minus any deduction or loss) allocated to the Partner under any other provision of this Section 5.1; and (ii) Loss, or items of deduction or loss to the extent necessary, shall be allocated to each Partner in an amount equal to the excess, if any, of (i) the sum of (A) such Partner's Capital Account as of the beginning of the accounting period, (B) any Capital Contributions made 22 27 by such Partner during the accounting period, and (C) any income or gain (or minus any deduction or loss) allocated to the Partner under any other provisions of this Section 5.1, over (ii) the sum of (X) such Partner's Target Capital Account as of the last day of the accounting period, and (Y) any distributions made by the Partnership to such Partner during the accounting period. (b) Minimum Gain Chargeback. Notwithstanding any provision to the contrary, (i) any expense of the Partnership that is a "nonrecourse deduction" within the meaning of Regulations Section 1.704-2(b)(1) shall be allocated in accordance with the Partners' respective Percentage Interests, (ii) any expense of the Partnership that is a "partner nonrecourse deduction" within the meaning of Regulations Section 1.704-2(i)(2) shall be allocated in accordance with Regulations Section 1 .704-2(i)(1), (iii) if there is a net decrease in Partnership Minimum Gain within the meaning of Regulations Section 1.704-2(f)(1) for any Partnership taxable year, items of gain and income shall be allocated among the Partners in accordance with Regulations Section 1.704-2(f) and the ordering rules contained in Regulations Section 1.704-2(j), and (iv) if there is a net decrease in Partner Nonrecourse Debt Minimum Gain within the meaning of Regulations Section 1.704-2(i)(4) for any Partnership taxable year, items of gain and income shall be allocated among the Partners in accordance with Regulations Section 1.704-2(i)(4) and the ordering rules contained in Regulations Section 1.704-2(j). A Partner's "interest in partnership profits" for purposes of determining its share of the nonrecourse liabilities of the Partnership within the meaning of Regulations Section 1.752-3(a)(3) shall be such Partner's Percentage Interest. (c) Qualified Income Offset. If a Limited Partner receives in any taxable year an adjustment, allocation, or distribution described in subparagraphs (4), (5), or (6) of Regulations Section 1.704-1(b)(2)(ii)(d) that causes or increases a negative balance in such Partner's Capital Account that exceeds the sum of such Partner's shares of Partnership Minimum Gain and Partner Nonrecourse Debt Minimum Gain, as determined in accordance with Regulations Sections 1.704- 2(g) and 1.704-2(i), such Partner shall be allocated specially for such taxable year (and, if necessary, later taxable years) items of income and gain in an amount and manner sufficient to eliminate such negative Capital Account balance as quickly as possible as provided in Regulations Section 1.704-1(b)(2)(ii)(d). After the occurrence of an allocation of income or gain to a Limited Partner in accordance with this Section 5.1(c), to the extent permitted by Regulations Section 1.704-1(b), items of expense or loss shall be allocated to such Partner in an amount necessary to offset the income or gain previously allocated to such Partner under this Section 5.1(c). (d) Capital Account Deficits. Loss shall not be allocated to a Limited Partner to the extent that such allocation would cause a deficit in such Partner's Capital Account (after reduction to reflect the items described in Regulations Section 1.704-1(b)(2)(ii)(d)(4), (5) and (6)) to exceed the sum of such Partner's shares of Partnership Minimum Gain and Partner Nonrecourse Debt Minimum Gain. Any Loss in excess of that limitation shall be allocated to the General Partner. After the occurrence of an allocation of Loss to the General Partner in accordance with this Section 5.1(d), to the extent permitted by Regulations Section 1.704-1(b), Profit shall be allocated to the General Partner in an amount necessary to offset the Loss previously allocated to the General Partner under this Section 5.1(d). 23 28 (e) Allocations Between Transferor and Transferee. If a Partner transfers any part or all of its Partnership Interest, and the transferee is admitted as a substitute Partner as provided herein, the distributive shares of the various items of Profit and Loss allocable among the Partners during such fiscal year of the Partnership shall be allocated between the transferor and the substitute Partner either (i) as if the Partnership's fiscal year had ended on the date of the transfer, or (ii) based on the number of days of such fiscal year that each was a Partner without regard to the results of Partnership activities in the respective portions of such fiscal year in which the transferor and the transferee were Partners. The General Partner, in its sole discretion, shall determine which method shall be used to allocate the distributive shares of the various items of Profit and Loss between the transferor and the substitute Partner. (f) Definition of Profit and Loss. "Profit" or "Loss" means for any accounting period, the amount, computed as of the last day thereof, of the net income or loss of the Partnership determined in accordance with federal income tax principles (but without requiring any items to be stated separately pursuant to Code Section 703), but with the following adjustments: (i) Any income of the Partnership that is exempt from federal income tax shall be included in the computation of Profit or Loss; (ii) Any expenditures of the Partnership described in Code Section 705(a)(2)(B) or treated as Code Section 705(a)(2)(B) expenditures pursuant to Regulations Section 1.704-1(b)(2)(iv)(1) shall be included in the computation of Profit or Loss; (iii) In any situation in which an item of income, gain, loss or deduction is affected by the adjusted basis of property, the Book Value of the Property shall be used in lieu of adjusted basis. (g) Tax Allocations. Except as otherwise provided in this Section 5.1, items of income, gain, loss or deduction recognized for income tax purposes shall be allocated in the same manner that the corresponding items entering into the calculation of Profit or Loss are allocated pursuant to this Agreement. (h) Section 704(c) Adjustments. In accordance with Code Section 704(c) and the Treasury Regulations thereunder and notwithstanding Section 5.1(g), items of income, gain, loss and deduction with respect to an asset, if any, which has a Book Value different from its adjusted basis for federal income tax purposes shall, solely for tax purposes, be allocated between the Partners so as to take account of any such variation in the manner required by Code Section 704(c) and Regulations Section 1.704-3(b). The allocation of such items shall be made pursuant to the "Traditional Method" of Regulation Section 1.704-3(b). The assets of the Partnership (and the Limited Partners who contributed such assets) that may be affected by this Section 5.1(h) include, without limitation, (i) the Hampton Inn Hotel, Oakland, California (Inns Properties and Westpac Shelter Corporation); and (ii) the Courtyard by Marriott Hotel, Riverside, California (Riverside Hotel Partners, Inc.). 24 29 5.2 DISTRIBUTION OF CASH. (a) Except as otherwise provided in Section 5.6, cash available for distribution by the Partnership shall be distributed as follows: (1) First, for any class of Preferred Partnership Units, if there are any Preferred Partnership Units of such class outstanding on any record date set forth in the applicable Certificate of Designation for payment of a distribution to the holders thereof, the General Partner shall distribute on the distribution date set forth in the Certificate of Designation to such Preferred Unitholder(s) an amount per Preferred Partnership Unit required to be paid pursuant to the Certificate of Designation. If there is more than one class of Preferred Partnership Units, the priority of payment of distributions as among the classes shall be governed by the Certificates of Designation for such classes. (2) Second, the General Partner shall distribute cash on a quarterly (or, at the election of the General Partner, more frequent) basis, in an amount determined by the General Partner in its sole discretion, to the Partners who are Partners on the Partnership Record Date with respect to such quarter (or other distribution period) in accordance with their respective Percentage Interests on the Partnership Record Date. (b) In no event may a Partner receive a distribution of cash with respect to a Partnership Unit if such Partner is entitled to receive a dividend with respect to a REIT Share for which all or part of such Partnership Unit has been or will be exchanged. 5.3 REIT DISTRIBUTION REQUIREMENTS. The General Partner shall use its reasonable efforts to cause the Partnership to distribute amounts sufficient to enable the General Partner (i) to meet its distribution requirement for qualification as a REIT as set forth in Section 857(a)(1) of the Code and (ii) to avoid any federal income or excise tax liability imposed by the Code. 5.4 NO RIGHT TO DISTRIBUTIONS IN KIND. No Partner shall be entitled to demand property other than cash in connection with any distributions by the Partnership. 5.5 LIMITATIONS ON RETURN OF CAPITAL CONTRIBUTIONS. Notwithstanding any of the provisions of this Article V, no Partner shall have the right to receive and the General Partner shall not have the right to make, a distribution which includes a return of all or part of a Partner's Capital Contributions, unless after giving effect to the return of a Capital Contribution, the sum of all Partnership liabilities, other than the liabilities to a Partner for the return of his Capital Contribution, does not exceed the fair market value of the Partnership's assets. 5.6 DISTRIBUTIONS UPON LIQUIDATION. (a) Upon liquidation of the Partnership, after payment of, or adequate provision for, debts and obligations of the Partnership, including any Partner loans, any remaining assets of the Partnership shall be distributed in the following order of priority: 25 30 (i) First, if there are any Preferred Partnership Units outstanding, to the Preferred Unitholder(s) of each class of Preferred Partnership Units, an amount per Preferred Partnership Unit of a particular class of Preferred Partnership Units required to be paid upon liquidation as set forth in the Certificate of Designation for such class. If there is more than one class of Preferred Partnership Units, the priority of liquidation distributions among the classes shall be governed by the Certificates of Designation for such classes. (ii) Thereafter, to the Common Unitholders with positive Capital Accounts in accordance with their respective Percentage Interests. For purposes of the preceding sentence, the Capital Account of each Partner shall be determined after all adjustments made in accordance with Sections 5.1 and 5.2 resulting from Partnership operations and from all sales and dispositions of all or any part of the Partnership's assets. Any distributions pursuant to this Section 5.6 should be made by the end of the Partnership's taxable year in which the liquidation occurs (or, if later, within ninety (90) days after the date of the liquidation). To the extent deemed advisable by the General Partner, appropriate arrangements (including the use of a liquidating trust) may be made to assure that adequate funds are available to pay any contingent debts or obligations. (b) If the General Partner has a negative balance in its Capital Account following a liquidation of the Partnership, as determined after taking into account all Capital Account adjustments in accordance with Sections 5.1 and 5.2 resulting from Partnership operations and from all sales and dispositions of all or any part of the Partnership's assets, the General Partner shall contribute to the Partnership an amount of cash equal to the negative balance in its Capital Account and such cash shall be paid or distributed by the Partnership to creditors, if any, and then to the Limited Partners in accordance with Section 5.6(a). Such contribution by the General Partner shall be made by the end of the Partnership's taxable year in which the liquidation occurs (or, if later, within ninety (90) days after the date of the liquidation). 5.7 SUBSTANTIAL ECONOMIC EFFECT. It is the intent of the Partners that the allocations of Profit and Loss under the Agreement have substantial economic effect (or be consistent with the Partners' interests in the Partnership in the case of the allocation of losses attributable to nonrecourse debt) within the meaning of Section 704(b) of the Code as interpreted by the Regulations promulgated pursuant thereto. Article V and other relevant provisions of this Agreement shall be interpreted in a manner consistent with such intent. 5.8 AMOUNTS WITHHELD. All amounts withheld pursuant to the Code or any provisions of any state or local tax law and Section 10.9 hereof with respect to any allocation, payment or distribution to the General Partner, the Limited Partners or Assignees shall be treated as amounts distributed to the General Partner, Limited Partners, or Assignees pursuant to Section 5.1 for all purposes under this Agreement. 26 31 ARTICLE VI RIGHTS, OBLIGATIONS AND POWERS OF THE GENERAL PARTNERSHIP 6.1 MANAGEMENT OF THE PARTNERSHIP. (a) Except as otherwise expressly provided in this Agreement, the General Partner shall have full, complete and exclusive discretion to manage and control the business of the Partnership for the purposes herein stated, and shall make all decisions affecting the business and assets of the Partnership. The General Partner may not be removed by the Limited Partners with or without cause. In addition to the powers now or hereafter granted a general partner of a limited partnership under applicable law or which are granted to the General Partner under any other provision of this Agreement, the General Partner, subject to Section 7.1 hereof, shall have full power and authority to do all things deemed necessary or desirable by it to conduct the business of the Partnership, to exercise all powers set forth in Section 3.2 hereof and to effectuate the purposes set forth in Section 3.1 hereof, including, without limitation: (i) to acquire, purchase, own, lease and dispose of any real property and any other property or assets that the General Partner determines are necessary or appropriate or in the best interests of the business of the Partnership; (ii) to landscape, renovate, reconstruct, remodel or construct buildings, including without limitation hotels, and make other improvements on the properties now or hereafter owned or leased by the Partnership or any Subsidiary of the Partnership; (iii) to borrow money for the Partnership, issue evidences of indebtedness in connection therewith, refinance, guarantee, increase the amount of, modify, amend or change the terms of, or extend the time for the payment of, any indebtedness or obligation to the Partnership, and secure such indebtedness by mortgage, deed of trust, pledge or other lien on the Partnership's assets; (iv) to pay, either directly or by reimbursement, for all operating costs and general administrative expenses of the General Partner or the Partnership, to third parties or to the General Partner as set forth in this Agreement; (v) to lease all or any portion of any of the Partnership's assets, whether or not the terms of such leases extend beyond the termination date of the Partnership and whether or not any portion of the Partnership's assets so leased are to be occupied by the lessee, or, in turn, subleased in whole or in part to others, for such consideration and on such terms as the General Partner may determine; (vi) to prosecute, defend, arbitrate, or compromise any and all claims or liabilities in favor of or against the Partnership, on such terms and in such manner as the General Partner may reasonably determine, and similarly to prosecute, settle or defend 27 32 litigation with respect to the Partners, the Partnership, or the Partnership's assets; provided, however, that the General Partner may not, without the consent of all of the Partners, confess a judgment against the Partnership; (vii) to file applications, communicate, and otherwise deal with any and all governmental agencies having jurisdiction over, or in any way affecting, the Partnership's assets or any other aspect of the Partnership business; (viii) to make or revoke any election permitted or required of the Partnership by any taxing authority; (ix) to maintain such insurance coverage for public liability, fire and casualty, and any and all other insurance for the protection of the Partnership, for the conservation of Partnership assets, or for any other purpose convenient or beneficial to the Partnership, in such amounts and such types, as it shall determine from time to time; (x) to determine whether or not to apply any insurance proceeds for any property to the restoration of such property or to distribute the same; (xi) to retain legal counsel, accountants, consultants, real estate brokers, and such other persons as the General Partner may deem necessary or appropriate in connection with the Partnership business and to pay therefor such reasonable remuneration as the General Partner may deem reasonable and proper; (xii) to retain other services of any kind or nature in connection with the Partnership business, and to pay therefor such remuneration as the General Partner may deem reasonable and proper; (xiii) to negotiate and conclude agreements on behalf of the Partnership with respect to any of the rights, powers and authority conferred upon the General Partner; (xiv) to maintain accurate accounting records and to file promptly all federal, state and local income tax returns on behalf of the Partnership; (xv) to distribute Partnership cash or other partnership assets in accordance with this Agreement; (xvi) to form or acquire an interest in, and contribute property to, any further limited or general partnerships, joint ventures or other relationships that it deems desirable (including, without limitation, the acquisition of interests in, and the contributions of properly to, its Subsidiaries and any other Person in which it has an equity interest from time to time); (xvii) to establish Partnership reserves for working capital, capital expenditures, contingent liabilities, or any other valid Partnership purpose; 28 33 (xviii) to negotiate, execute, and perform any contracts, conveyances or other instruments that the General Partner considers useful or necessary to the conduct of the Partnership's operations or the implementation of the General Partner's powers under this Agreement, including contracting with contractors, developers, consultants, accountants, legal counsel, other professional advisors and other agents and the payment of their expenses and compensation out of the Partnership's assets; (xix) to establish one or more divisions of the Partnership, the selection and dismissal of employees of the Partnership, any division of the Partnership, or the General Partner (including, without limitation, employees having titles such as "president," "vice president," "secretary" and "treasurer" of the Partnership, any division of the Partnership or the General Partner), and agents, outside attorneys, accountants, consultants and contractors of the General Partner, the Partnership or any division of the Partnership, and the determination of their compensation and other terms of employment or hiring; (xx) to issue REIT Shares to acquire Partnership Units held by a Limited Partner in connection with such Limited Partner's exercise of its Redemption Right under Section 8.5; and (xxi) to take such other action, execute, acknowledge, swear to or deliver such other documents and instruments, and perform any and all other acts the General Partner deems necessary or appropriate for the formation, continuation and conduct of the business and affairs of the Partnership and to possess and enjoy all of the rights and powers of a general partner as provided by the Act. Except as otherwise provided herein, to the extent the duties of the General Partner require expenditures of funds to be paid to third parties, the General Partner shall not have any obligations hereunder except to the extent that partnership funds are reasonably available to it for the performance of such duties, and nothing herein contained shall be deemed to require the General Partner, in its capacity as such, to expend its individual funds for payment to third parties or to undertake any individual liability or obligation on behalf of the Partnership. (b) The Partnership shall not incur or allow to exist Indebtedness (as defined in the Articles of Incorporation) in excess of the limitations contained in the Articles of Incorporation. (c) The General Partner is expressly authorized to enter into, in the name and on behalf of the Partnership, a right of first opportunity arrangement and other conflict avoidance agreements with various Affiliates of the Partnership and the General Partner, on such terms as the General Partner, in its sole and absolute discretion, believes are advisable. 6.2 DELEGATION OF AUTHORITY. The General Partner may delegate any or all of its powers, rights and obligations hereunder, and may appoint, employ, contract or otherwise deal with any Person for the transaction of the business of the Partnership, which Person may, under supervision of the General Partner, perform any acts or services for the Partnership as the General Partner may approve. 29 34 6.3 INDEMNIFICATION AND EXCULPATION OF INDEMNITEES. (a) The Partnership shall indemnify each Indemnitee from and against any and all losses, claims, damages, (joint or several) liabilities, expenses (including reasonable legal fees and expenses), judgments, fines, settlements, and other amounts arising from any and all claims, demands, actions, suits or proceedings, civil, criminal, administrative or investigative, that relate to the operations of the Partnership as set forth in this Agreement in which any Indemnitee may be involved, or is threatened to be involved, as a party or otherwise, unless it is established that: (i) the act or omission of the Indemnitee was material to the matter giving rise to the proceeding and either was committed in bad faith or was the result of active and deliberate dishonesty; (ii) the Indemnitee actually received an improper personal benefit in money, property or services; or (iii) in the case of any criminal proceeding, the Indemnitee had reasonable cause to believe that the act or omission was unlawful. The termination of any proceeding by judgment, order or settlement does not create a presumption that the Indemnitee did not meet the requisite standard of conduct set forth in this Section 6.3(a). The termination of any proceeding by conviction or upon a plea of nolo contendere or its equivalent, or an entry of an order of probation prior to judgment, creates a rebuttable presumption that the Indemnitee acted in a manner contrary to that specified in this Section 6.3(a). Any indemnification pursuant to this Section 6.3 shall be made only out of the assets of the Partnership. (b) The Partnership may reimburse an Indemnitee for reasonable expenses incurred by an Indemnitee who is a party to a proceeding in advance of the final disposition of the proceeding upon receipt by the Partnership of (i) a written affirmation by the Indemnitee of the Indemnitee's good faith belief that the standard of conduct necessary for indemnification by the Partnership as authorized in this Section 6.3 has been met, and (ii) a written undertaking by or on behalf of the Indemnitee to repay the amount if it shall ultimately be determined that the standard of conduct has not been met. (c) The indemnification provided by this Section 6.3 shall be in addition to any other rights to which an Indemnitee or any other Person may be entitled under any agreement, pursuant to any vote of the Partners, as a matter of law or otherwise, and shall continue as to an Indemnitee who has ceased to serve in such capacity. (d) The Partnership may purchase and maintain insurance, on behalf of the Indemnitees and such other Persons as the General Partner shall determine, against any liability that may be asserted against or expenses that may be incurred by such Person in connection with the Partnership's activities, regardless of whether the Partnership would have the power to indemnify such Person against such liability under the provisions of this Agreement. (e) For purposes of this Section 6.3, the Partnership shall be deemed to have requested an Indemnitee to serve as fiduciary of an employee benefit plan whenever the performance by it of its duties to the Partnership also imposes duties on, or otherwise involves services by, it to the plan or participants or beneficiaries of the plan; excise taxes assessed on an Indemnitee with respect to an employee benefit plan pursuant to applicable law shall constitute fines within the meaning of this Section 6.3; and actions taken or omitted by the Indemnitee with respect to an 30 35 employee benefit plan in the performance of its duties for a purpose reasonably believed by it to be in the interest of the participants and beneficiaries of the plan shall be deemed to be for a purpose which is not opposed to the best interests of the Partnership. (f) In no event may an Indemnitee subject the Limited Partners to personal liability by reason of the indemnification provisions set forth in this Agreement. (g) An Indemnitee shall not be denied indemnification in whole or in part under this Section 6.3 because the Indemnitee had an interest in the transaction with respect to which the indemnification applies if the transaction was otherwise permitted by the terms of this Agreement. (h) The provisions of this Section 6.3 are for the benefit of the Indemnitees, their heirs, successors, assigns and administrators and shall not be deemed to create any rights for the benefit of any other Persons. 6.4 LIABILITY OF THE GENERAL PARTNER. (a) Notwithstanding anything to the contrary set forth in this Agreement, the General Partner shall not be liable for monetary damages to the Partnership or any Partners for losses sustained or liabilities incurred as a result of errors in judgment or of any act or omission if the General Partner acted in good faith. (b) The Limited Partners expressly acknowledge that the General Partner is acting on behalf of the Partnership and the General Partner's shareholders collectively, that the General Partner is under no obligation to consider the separate interests of the Limited Partners (including, without limitation, the tax consequences to Limited Partners) in deciding whether to cause the Partnership to take (or decline to take) any actions, and that the General Partner shall not be liable for monetary damages for losses sustained, liabilities incurred, or benefits not derived by Limited Partners in connection with such decisions, provided that the General Partner has acted in good faith. (c) Subject to its obligations and duties as General Partner set forth in Section 6.1 hereof, the General Partner may exercise any of the powers granted to it under this Agreement and perform any of the duties imposed upon it hereunder either directly or by or through its agents. The General Partner shall not be responsible for any misconduct or negligence on the part of any such agent appointed by it in good faith. (d) Notwithstanding any other provisions of this Agreement or the Act, any action of the General Partner on behalf of the Partnership or any decision of the General Partner to refrain from acting on behalf of the Partnership, undertaken in the good faith belief that such action or omission is necessary or advisable in order (i) to protect the ability of the General Partner to continue to qualify as a REIT or (ii) to prevent the General Partner from incurring any taxes under Section 857, Section 4981, or any other provision of the Code, is expressly authorized under this Agreement and is deemed approved by all of the Limited Partners. 31 36 (e) Any amendment, modification or repeal of this Section 6.4 or any provision hereof shall be prospective only and shall not in any way affect the limitations on the General Partner's liability to the Partnership and the Limited Partners under this Section 6.4 as in effect immediately prior to such amendment, modification or repeal with respect to matters occurring, in whole or in part, prior to such amendment, modification or repeal, regardless of when claims relating to such matters may arise or be asserted. 6.5 EXPENDITURES BY PARTNERSHIP. The General Partner is hereby authorized to pay compensation for accounting, administrative, legal, technical, management and other services rendered to the Partnership. All of the aforesaid expenditures (including Administrative Expenses) shall be made on behalf of the Partnership, and the General Partner shall be entitled to reimbursement by the Partnership for any expenditure (including Administrative Expenses) incurred by it on behalf of the Partnership which shall be made other than out of the funds of the Partnership. The Partnership shall also assume, and pay when due, all Administrative Expenses. 6.6 OUTSIDE ACTIVITIES; REDEMPTION TENDER OFFER OF REIT SHARES. Subject to Section 6.8 hereof, the Articles of Incorporation and any agreements entered into by the General Partner or its Affiliates with the Partnership or a Subsidiary, any officer, director, employee, agent, trustee, Affiliate or shareholder of the General Partner shall be entitled to and may have business interests and engage in business activities in addition to those relating to the Partnership, including business interests and activities substantially similar or identical to those of the Partnership. Neither the Partnership nor any of the Limited Partners shall have any rights by virtue of this Agreement in any such business ventures, interest or activities. None of the Limited Partners nor any other Person shall have any rights by virtue of this Agreement or the partnership relationship established hereby in any such business ventures, interests or activities, and the General Partner shall have no obligation pursuant to this Agreement to offer any interest in any such business ventures, interests and activities to the Partnership or any Limited Partner, even if such opportunity is of a character which, if presented to the Partnership or any Limited Partner, could be taken by such Person. 6.7 EMPLOYMENT OR RETENTION OF AFFILIATES. (a) Any Affiliate of the General Partner may be employed or retained by the Partnership and may otherwise deal with the Partnership (whether as a buyer, lessor, lessee, manager, furnisher of goods or services, broker, agent, lender or otherwise) and may receive from the Partnership any compensation, price, or other payment therefor which the General Partner determines to be fair and reasonable. (b) The Partnership may lend or contribute to its Subsidiaries or other Persons in which it has an equity investment, and such Persons may borrow funds from the Partnership, on terms and conditions established in the sole and absolute discretion of the General Partner. The foregoing authority shall not create any right or benefit in favor of any Subsidiary or any other Person. 32 37 (c) The Partnership may transfer assets to joint ventures, other partnerships, corporations or other business entities in which it is or thereby becomes a participant upon such terms and subject to such conditions as the General Partner deems are consistent with this Agreement and applicable law. (d) Except as expressly permitted by this Agreement, neither the General Partner nor any of its Affiliates shall sell, transfer or convey any property to, or purchase any property from, the Partnership, directly or indirectly, except pursuant to transactions that are on terms that are fair and reasonable to the Partnership. 6.8 COMPANY PARTICIPATION. The General Partner agrees that all business activities of the General Partner, including activities pertaining to the acquisition, development and/or ownership of hotels or other property, shall be conducted through the Partnership; provided, however, that the Company is allowed to make a direct acquisition, but if and only if, such acquisition is made in connection with the issuance of New Securities, which direct acquisition and issuance have been approved and determined to be in the best interests of the Company and the Partnership by a majority of the Independent Directors. The Company also agrees that all borrowings of the Company shall constitute Funding Loans, subject to the exception set forth in Section 4.3 hereof. ARTICLE VII CHANGES IN GENERAL PARTNER 7.1 TRANSFER OF THE GENERAL PARTNER'S PARTNERSHIP INTEREST. (a) The General Partner may not transfer any of its General Partnership Interest or Limited Partnership Interests or withdraw as General Partner except as provided in Article 9, Section 7.1(c) or in connection with a transaction described in Section 7.1(d). (b) The General Partner agrees that it will at all times own (as a general or limited partner) at least a 20% Percentage Interest. (c) Except as otherwise provided in Section 6.8 or Section 7.1(d) hereof, the General Partner shall not engage in any merger, consolidation or other combination with or into another Person or sale of all or substantially all of its assets, or any reclassification, or any recapitalization or change of outstanding REIT Shares (other than a change in par value, or from par value to no par value, or as a result of a subdivision or combination of REIT Shares) (each a "Transaction"), unless (i) the Transaction also includes a merger of the Partnership or sale of substantially all of the assets of the Partnership as a result of which all Limited Partners will receive for each Partnership Unit an amount of cash, securities, or other property equal to the product of the Conversion Factor and the greatest amount of cash, securities or other property paid in the Transaction to a holder of one REIT Share in consideration of one REIT Share, provided that if, in connection with the Transaction, a purchase, tender or exchange offer ("Offer") shall have been made to and accepted by the holders of more than 50 percent of the outstanding REIT Shares, each holder 33 38 of Partnership Units shall be given the option to exchange its Partnership Units for the greatest amount of cash, securities, or other property which a Limited Partner would have received had it (A) exercised its Redemption Right and (B) sold, tendered or exchanged pursuant to the Offer the REIT Shares received upon exercise of the Redemption Right immediately prior to the expiration of the Offer; and (ii) no more than 75 percent of the equity securities of the acquiring Person in such Transaction shall be owned, after consummation of such Transaction, by the General Partner or Persons who were Affiliates of the Partnership or the General Partner immediately prior to the date on which the Transaction is consummated. (d) Notwithstanding Section 7.1(c), the General Partner may merge into or consolidate with another entity if immediately after such merger or consolidation (i) substantially all of the assets of the successor or surviving entity (the "Surviving General Partner"), other than Partnership Units held by the General Partner, are contributed to the Partnership as a Capital Contribution in exchange for Partnership Units with a fair market value equal to the value of the assets so contributed as determined by the Surviving General Partner in good faith and (ii) the Surviving General Partner expressly agrees to assume all obligations of the General Partner hereunder. Upon such contribution and assumption, the Surviving General Partner shall have the right and duty to amend this Agreement as set forth in this Section 7.1(d). The Surviving General Partner shall in good faith arrive at a new method for the calculation of the Cash Amount and Conversion Factor for a Partnership Unit after any such merger or consolidation so as to approximate the existing method for such calculation as closely as reasonably possible. Such calculation shall take into account, among other things, the kind and amount of securities, cash and other property that was receivable upon such merger or consolidation by a holder of REIT Shares and/or options, warrants or other rights relating thereto, and which a holder of Partnership Units could have acquired had such Partnership Units been redeemed immediately prior to such merger or consolidation. Such amendment to this Agreement shall provide for adjustment to such method of calculation which shall be as nearly equivalent as may be practicable to the adjustments provided for with respect to the Conversion Factor. The above provisions of this Section 7.1(d) shall similarly apply to successive mergers or consolidations permitted hereunder. 7.2 ADMISSION OF A SUBSTITUTE OR SUCCESSOR GENERAL PARTNER. A Person shall be admitted as a substitute or successor General Partner of the Partnership only if the following terms and conditions are satisfied: (a) a majority-in-interest of the Limited Partners (other than the General Partner) shall have consented in writing to the admission of the substitute or successor General Partner, which consent may be withheld in the sole discretion of such Limited Partners; (b) the Person to be admitted as a substitute or additional General Partner shall have accepted and agreed to be bound by all the terms and provisions of this Agreement by executing a counterpart thereof and such other documents or instruments as may be required or appropriate in order to effect the admission of such Person as a General Partner, and a certificate evidencing the admission of such Person as a General Partner shall have been filed for recordation and all other actions required by Section 2.6 hereof in connection with such admission shall have been performed; 34 39 (c) if the Person to be admitted as a substitute or additional General Partner is a corporation or a partnership it shall have provided the Partnership with evidence satisfactory to counsel for the Partnership of such Person's authority to become a General Partner and to be bound by the terms and provisions of this Agreement; and (d) counsel for the Partnership shall have rendered an opinion (relying on such opinions from other counsel and the state or any other jurisdiction as may be necessary) that the admission of the person to be admitted as a substitute or additional General Partner is in conformity with the Act, that none of the actions taken in connection with the admission of such Person as a substitute or additional General Partner will cause (i) the Partnership to be classified other than as a partnership for federal income tax purposes, or (ii) the loss of any Limited Partner's limited liability. 7.3 EFFECT OF BANKRUPTCY, WITHDRAWAL, DEATH OR DISSOLUTION OF A GENERAL PARTNER. (a) Upon the occurrence of an Event of Bankruptcy as to a General Partner or the withdrawal, removal or dissolution of a General Partner (except that, if a General Partner is on the date of such occurrence a partnership, the withdrawal, death, dissolution, Event of Bankruptcy as to, or removal of a partner in, such partnership shall be deemed not to be a dissolution of such General Partner if the business of such General Partner is continued by the remaining partner or partners), the Partnership shall be dissolved and terminated unless the Partnership is continued pursuant to Section 7.3(b) hereof. (b) Following the occurrence of an Event of Bankruptcy as to a General Partner or the withdrawal, removal or dissolution of a General Partner (except that, if a General Partner is on the date of such occurrence a partnership, the withdrawal, death, dissolution, Event of Bankruptcy as to, or removal of a partner in, such partnership shall be deemed not to be a dissolution of such General Partner if the business of such General Partner is continued by the remaining partner or partners), the Limited Partners, within ninety (90) days after such occurrence, may elect to reconstitute the Partnership and continue the business of the Partnership for the balance of the term specified in Section 2.5 hereof by selecting, subject to Section 7.2 hereof and any other provisions of this Agreement, a substitute General Partner by unanimous consent of the Limited Partners. If the Limited Partners elect to reconstitute the Partnership and admit a substitute General Partner, the relationship with the Partners and of any Person who has acquired an interest of a Partner in the Partnership shall be governed by this Agreement. 7.4 PURCHASE OF PARTNERSHIP UNITS. In the event the General Partner exercises any right it has under the Articles of Incorporation or otherwise to purchase REIT Shares, REIT Preferred Shares or debt securities of the Company, or to otherwise redeem REIT Shares, REIT Preferred Shares or debt securities of the Company (whether pursuant to a tender offer or otherwise), then the General Partner shall cause the Partnership to purchase from it that number and type of Partnership Units corresponding to the REIT Shares, REIT Preferred Shares or debt securities of the Company, on the same terms and for the same aggregate price that the General Partner purchased such REIT Shares, REIT Preferred Shares or debt securities of the Company. 35 40 ARTICLE VIII RIGHTS AND OBLIGATIONS OF THE LIMITED PARTNERS 8.1 MANAGEMENT OF THE PARTNERSHIP. The Limited Partners shall not participate in the management or control of Partnership business nor shall they transact any business for the Partnership, nor shall they have the power to sign for or bind the Partnership, such powers being vested solely and exclusively in the General Partner. 8.2 POWER OF ATTORNEY. (a) Each Limited Partner and each Assignee hereby irrevocably constitutes and appoints the General Partner, any Liquidator (as defined below), and authorized officers and attorneys-in-fact of each, and each of those acting singly, in each case with full power of substi tution, as its true and lawful agent and attorney-in-fact, with full power and authority in its name, place and stead to: (i) execute, swear to, acknowledge, deliver, file and record in the appropriate public offices (a) all certificates, documents and other instruments (including, without limitation, this Agreement and the Certificate and all amendments or restatements thereof) that the General Partner or any liquidator of the Partnership's assets (the "Liquidator") deems appropriate or necessary to form, qualify or continue the existence or qualification of the Partnership as a limited partnership (or a partnership in which the Limited Partners have limited liability) in the State of Delaware and in all other jurisdictions in which the Partnership may or plans to conduct business or own property; (b) all instruments that the General Partner or the Liquidator deems appropriate or necessary to reflect any amendment, change, modification or restatement of this Agreement in accordance with its terms; (c) all conveyances and other instruments or documents that the General Partner deems appropriate or necessary to reflect the dissolution and liquidation of the Partnership pursuant to the terms of this Agreement, including, without limitation, a certificate of cancellation; (d) all instruments relating to the admission, withdrawal, removal or substitution of any Partner pursuant to, or other events described herein or the Capital Contribution of any Partner; and (e) all certificates, documents and other instruments relating to the determination of the rights, preferences and privileges of Partnership Interests; and (ii) execute, swear to, seal, acknowledge and file all ballots, consents, approvals, waivers, certificates and other instruments appropriate or necessary, in the sole and absolute discretion of the General Partner or the Liquidator, to make, evidence, give, confirm or ratify any vote, consent, approval, agreement or other action which is made or given by the Partners hereunder or is consistent with the terms of this Agreement or appropriate or necessary, in the sole discretion of the General Partner or any Liquidator, to effectuate the terms or intent of this Agreement. 36 41 Nothing contained herein shall be construed as authorizing the General Partner or any Liquidator to amend this Agreement except as may be otherwise expressly provided for in this Agreement. (b) The foregoing power of attorney is hereby declared to be irrevocable and a special power coupled with an interest, in recognition of the fact that each of the Partners will be relying upon the power of the General Partner and any Liquidator to act as contemplated by this Agreement in any filing or other action by it on behalf of the Partnership, and it shall survive and not be affected by the subsequent incapacity of any Limited Partner or Assignee and the transfer of all or any portion of such Limited Partner's or Assignee's Partnership Units and shall extend to such Limited Partner's or Assignee's heirs, successors, assigns and personal representatives. Each such Limited Partner or Assignee hereby agrees to be bound by any representation made by the General Partner or any Liquidator, acting in good faith pursuant to such power of attorney, and each such Limited Partner or Assignee hereby waives any and all defenses which may be available to contest, negate or disaffirm the action of the General Partner or any Liquidator, taken in good faith under such power of attorney. Each Limited Partner or Assignee shall execute and deliver to the General Partner or the Liquidator, within fifteen (15) days after receipt of the General Partner's or Liquidator's request therefor, such further designation, powers of attorney and other instruments as the General Partner or the Liquidator, as the case may be, deems necessary to effectuate this Agreement and the purposes of the Partnership. 8.3 LIMITATION ON LIABILITY OF LIMITED PARTNERS. No Limited Partner shall be liable for any debts, liabilities, contracts or obligations of the Partnership. A Limited Partner shall be liable to the Partnership only to make payments of his Capital Contribution, if any, as and when due hereunder. After his Capital Contribution is fully paid, no Limited Partner shall, except as otherwise required by the Act, be required to make any further Capital Contributions or other payments or lend any funds to the Partnership. 8.4 OWNERSHIP BY LIMITED PARTNER OF CORPORATE GENERAL PARTNER OR AFFILIATE. No Limited Partner shall at any time, either directly or indirectly, own any stock or other interest in the General Partner or in any Affiliate thereof, if such ownership by itself or in conjunction with other stock or other interests owned by other Limited Partners would, in the opinion of counsel for the Partnership, jeopardize the classification of the Partnership as a partnership for federal income tax purposes. The General Partner shall be entitled to make such reasonable inquiry of the Limited Partners as is required to establish compliance by the Limited Partners with the provisions of this Section. 8.5 REDEMPTION RIGHT. (a) Subject to Section 8.5(c) and Section 9.8, each Limited Partner who holds Common Partnership Units (including Limited Partners who have obtained Common Partnership Units through the exercise of conversion rights, if any, applicable to their Preferred Partnership Units), other than the General Partner, shall have the right (the "Redemption Right") to require the Partnership on a Specified Redemption Date to either (i) redeem all or a portion of the Common Partnership Units held by such Limited Partner at a redemption price equal to Cash Amount or (ii) to exchange all or a portion of the Common Partnership Units held by such Limited Partner for REIT 37 42 Shares at a ratio equal to the Conversion Factor. The Redemption Right shall be exercised pursuant to a Notice of Redemption delivered to the General Partner by the Limited Partner who is exercising the Redemption Right (the "Redeeming Partner"), provided that no more than two (2) Notices of Redemption from any single Limited Partner may be delivered to the General Partner during each calendar year. No such Limited Partner may exercise the Redemption Right for less than five hundred (500) Common Partnership Units or, if such Limited Partner holds less than five hundred (500) Common Partnership Units, all of the Common Partnership Units held by such Limited Partner. The Redeeming Partner shall have no right, with respect to any Common Partnership Units so redeemed, to receive any distribution paid with respect to Common Partnership Units if the record date for such distribution is on or after the Specified Redemption Date. Notwithstanding the preceding sentence to the contrary, if the Partnership or the General Partner elects under Section 8.5(c) to extend the payment date for the Cash Amount, then to the extent a Partnership Record Date occurs between the Specified Redemption Date and the date such Cash Amount is paid, the Redeeming Partner shall receive the distribution relating to such Partnership Record Date with respect to such Common Partnership Units being redeemed. (b) Notwithstanding the provisions of Section 8.5(a), the General Partner may, in its sole and absolute discretion, assume directly and satisfy a Redemption Right by paying to the Redeeming Partner the Redemption Amount on the Specified Redemption Date, whereupon the General Partner shall acquire the Common Partnership Units offered for redemption by the Redeeming Partner and shall be treated for all purposes of this Agreement as the owner of such Common Partnership Units. In the event the General Partner shall exercise its right to satisfy the Redemption Right in the manner described in the preceding sentence, the Partnership shall have no obligation to pay any amount to the Redeeming Partner with respect to such Redeeming Partner's exercise of the Redemption Right, and each of the Redeeming Partner, the Partnership, and the General Partner shall treat the transaction between the General Partner and the Redeeming Partner as a sale of the Redeeming Partner's Common Partnership Units to the General Partner for federal income tax purposes. Each Redeeming Partner agrees to execute such documents and take such other actions as the General Partner may reasonably require in connection with the issuance of REIT Shares upon exercise of the Redemption Right. (c) The Partnership or the General Partner, as the case may be, shall pay the Cash Amount to a Redeeming Partner as the Redemption Amount for such Limited Partner if: (i) the acquisition of REIT Shares by such Limited Partner on the Specified Redemption Date would (A) result in such Limited Partner or any other person owning, directly or indirectly REIT Shares in excess of the "Ownership Limit," as defined in the Articles of Incorporation, (B) result in REIT Shares being owned by fewer than one hundred (100) persons (determined as provided by Section 856(a)(5) of the Code), except as provided in the Articles of Incorporation, (C) result in the General Partner being "closely held" within the meaning of Section 856(h) of the Code, (D) cause the Company to own, directly or constructively, ten percent (10%) or more of the ownership interests in a tenant of the Company's or the Partnership's real property, within the meaning of Section 856(d)(2)(B) of the Code, or (E) cause the acquisition of REIT Shares by such Partner to be "integrated" with 38 43 any other distribution of REIT Shares or other securities of the Company for purposes of complying with the registration provisions of the Securities Act; (ii) there is not an effective registration statement on file with the Commission covering the Redemption Shares to be issued upon the redemption of the Partnership Units described in the Notice of Redemption for such Redeeming Partner (a) as of the Specified Redemption Date, if the Cash Amount is less than the Threshold Cash Amount, and (b) within 45 days of the Specified Redemption Date (and if such date is not a Business Day, then the next Business Day) if the Cash Amount is more than the Threshold Cash Amount; or (iii) the Partnership or the General Partner, as the case may be, so elects in its sole discretion. Any Cash Amount to be paid to a Redeeming Partner pursuant to this Section 8.5 shall be paid on the Specified Redemption Date; provided, however, that if the Cash Amount to be paid to all Limited Partners who have sent a Notice of Redemption during the period from the date of receipt of the initial Notice of Redemption triggering a Specified Redemption Date and such Specified Redemption Date exceeds $500,000 (the "Threshold Cash Amount"), then such payment date may be extended for up to an additional one hundred eighty (180) days to the extent required for the General Partner to cause additional REIT Shares to be issued to provide financing to be used to make such payment of the Cash Amount. Notwithstanding the foregoing, the General Partner and the Partnership agree to use their best efforts to cause the closing of the acquisition of redeemed Partnership Units hereunder to occur as quickly as reasonably possible without incurring unreasonable expense. (d) Each certificate, if any, evidencing REIT Shares that may be issued in redemption of Partnership Units under Section 8.5 above (the "Redemption Shares") shall bear a restrictive legend in substantially the following form: "The shares represented by this certificate have not been registered under the Securities Act of 1933, as amended (the "Act"), or any state securities law. No transfer of the Shares represented by this certificate shall be valid or effective unless (A) such transfer is made pursuant to an effective registration statement under the Act, or (B) the holder of the securities proposed to be transferred shall have delivered to the company either a no-action letter from the Securities and Exchange Commission or an opinion of counsel (who may be an employee of such holder) experienced in securities matters to the effect that such proposed transfer is exempt from the registration requirements of the act which opinion shall be reasonably satisfactory to the company." (e) The Assignee of any Limited Partner may exercise the rights of such Limited Partner pursuant to this Section 8.5, and such Limited Partner shall be deemed to have assigned such rights to such Assignee and shall be bound by the exercise of such rights by such Limited Partner's Assignee. In connection with any exercise of such rights by such Assignee on behalf of such Limited 39 44 Partner, the Cash Amount or REIT Shares Amount shall be paid by the Partnership directly to such Assignee and not to such Limited Partner. Neither the Redeeming Partner nor any Assignee of any Limited Partner shall have any right, with respect to any Part nership Units so redeemed, to receive any distributions paid after the Effective Date or the Specified Redemption Date. (f) Each Limited Partner covenants and agrees with the General Partner that all Partnership Units delivered for redemption shall be delivered to the Partnership or the General Partner, as the case may be, free and clear of all liens and, notwithstanding anything herein contained to the contrary, neither the General Partner nor the Partnership shall be under any obligation to acquire Partnership Units which are or may be subject to any liens. Each Limited Partner further agrees that, in the event any state or local property transfer tax is payable as a result of the transfer of its Partnership Units to the Partnership or the General Partner, such Limited Partner shall assume and pay such transfer tax. (g) Notwithstanding anything to the contrary herein, and, unless otherwise indicated, with respect to the Redemption Right pursuant to this Section 8.5: (i) The consummation of such redemption shall be subject to the expiration and termination of the applicable waiting period, if any, under the Hart-Scott-Rodino Antitrust Improvement Act of 1976, as amended. (ii) The consummation of such redemption shall be subject to and effected in compliance with all federal and state securities laws. (iii) The Redeeming Partner shall continue to own all Partnership Units subject to any redemption for REIT Shares or the Cash Amount and be treated as a Limited Partner with respect to such Partnership Units for all purposes (other than as provided in Section 8.5(e) above) of this Agreement until such Partnership Units are transferred to the Partnership or General Partner and the consideration provided by this Section 8.5 is delivered in full on the Specified Redemption Date. Until the issuance of the Redemption Shares the Redeeming Partner shall have no rights as stockholder of the General Partner. (h) Notwithstanding any other provision of this Section 8.5, unless Preferred Unitholders shall have converted their Preferred Partnership Units into Common Partnership Units pursuant to conversion rights set forth in the Certificate of Designation for their respective class of Preferred Partnership Units, Preferred Unitholders shall not have the Redemption Rights specified in this Section 8.5, but rather shall have such redemption rights, if any, as are set forth in the Certificate of Designation for a particular class of Preferred Partnership Units. In addition, the rights, if any, of the General Partner to redeem a particular class of Preferred Partnership Units shall be set forth in the Certificate of Designation applicable to such Preferred Partnership Units. 8.6 REGISTRATION. (a) Shelf Registration. In lieu of paying the Cash Amount to a Redeeming Partner as the Redemption Amount pursuant to Section 8.5(c)(ii) hereof, the General Partner may file within 40 45 the applicable time period required pursuant to Section 8.5(c)(ii) hereof a shelf registration statement under Rule 415 of the Securities Act, or any similar rule that may be adopted by the Commission (the "Shelf Registration"), with respect to all of the Redemption Shares to be issued upon the redemption of the Partnership Units described in the Notice of Redemption provided by the Redeeming Partner entitled to payment under Section 8.5(c)(ii) hereof. The General Partner may elect in its sole discretion to register any other Redemption Shares pursuant to the Shelf Registration or any pre or post-effective amendment thereto. The General Partner will use its best efforts to have the Shelf Registration declared effective under the Securities Act as soon as practicable after filing in order to permit the disposition of the Registered Redemption Shares by the holders thereof in accordance with the method or methods of disposition specified by the holders, and to keep the Shelf Registration continuously effective until the earlier of (i) the second anniversary of the date the Shelf Registration is declared effective by the Commission (the "Shelf Registration Period"); (ii) the date when all of the Registered Redemption Shares are sold thereunder, or (iii) the date on which all of the holders of Registered Redemption Shares, pursuant to Rule 144(k) under the Securities Act, may sell the Registered Redemption Shares without registration under the Securities Act. The General Partner further agrees to supplement or make amendments to the Shelf Registration, if required by the rules, regulations or instructions applicable to the registration form utilized by the Company or by the Securities Act or rules and regulations thereunder for the Shelf Registration. Notwithstanding the foregoing, if for any reason the effectiveness of the Shelf Registration is delayed or suspended or it ceases to be available for sales of Registered Redemption Shares thereunder, the Shelf Registration Period shall be extended by the aggregate number of days of such delay, suspension or unavailability. (b) Registration and Qualification Procedures. If and to the extent the General Partner files the Shelf Registration pursuant to the provisions of Section 8.6(a) above in lieu of making a payment of the Cash Amount pursuant to Section 8.5(c)(ii) hereof, then the General Partner will, subject to the provisions of Section 9.8 below: (i) prepare and file with the Commission a registration statement, including amendments thereof and supplements relating thereto, with respect to the Redemption Shares, in connection with which the General Partner will give each holder of Redemption Shares, their underwriters, if any, and their counsel and accountants a reasonable opportunity to participate in the preparation thereof and will give such persons reasonable access to its books, records, officers and independent public accountants; (ii) use its best efforts to cause the registration statement to be declared effective by the Commission; (iii) keep the registration statement effective and the related prospectus current throughout the Shelf Registration Period; provided, however, that the General Partner shall have no obligation to file any amendment or supplement at its own expense or the Partnership's expense at any time in connection with any underwritten public offering; 41 46 (iv) furnish to each holder of Redemption Shares such number of copies of prospectuses, and supplements or amendments thereto, and such other documents as such holder reasonably requests; (v) register or qualify the Redemption Shares covered by the registration statement under the securities or blue sky laws of such jurisdictions within the United States as any holder whose Redemption Shares are covered by such registration statement shall reasonably request, and do such other reasonable acts and things as may be required of it to enable such holders to consummate the sale or other disposition in such jurisdictions of the Redemption Shares; provided, however, that the General Partner shall not be required to (i) qualify as a foreign corporation or consent to a general and unlimited service or process in any jurisdictions in which it would not otherwise be required to be qualified or so consent or (ii) qualify as a dealer in securities; (vi) furnish, at the request of the holders of Redemption Shares, on the date Redemption Shares are delivered to the underwriters for sale pursuant to such registration, or, if such Shares are not being sold through underwriters, on the date the Shelf Registration with respect to such Redemption Shares becomes effective, (A) a securities opinion of counsel representing the General Partner for the purposes of such registration covering such legal matters as are customarily included in such opinions and (B) letters of the firm of independent public accountants that certified the financial statements included in the registration statement, addressed to the underwriters, covering substantially the same matters as are customarily covered in accountant's letters delivered to underwriters in underwritten public offerings of securities and such other financial matters as such holders (or the underwriters, if any) may reasonably request; (vii) otherwise use its best efforts to comply with all applicable rules and regulations of the Commission, and make available to its stockholders as soon as reasonably practicable, but not later than sixteen (16) months after the effective date of the Shelf Registration, an earnings statement covering a period of at least twelve (12) months beginning after the effective date of the Shelf Registration, which earnings statement shall satisfy the provisions of Section 11(a) of the Securities Act; (viii) enter into and perform an underwriting agreement with the managing underwriter, if any, selected as provided herein, containing customary (A) terms of offer and sale of the securities, payment provisions, underwriting discounts and commissions and (B) representations, warranties, covenants, indemnities, terms and conditions; and (ix) keep the holders of Redemption Shares whose Shares are included in such Shelf Registration advised as to the initiation and progress of the registration. (a) Allocation of Expenses. The Partnership shall pay all expenses in connection with the Shelf Registration, including without limitation (i) all expenses incident to filing with the National Association of Securities Dealers, Inc., (ii) registration fees, (iii) printing expenses, (iv) accounting and legal fees and expenses, except to the extent holders of Redemption Shares whose 42 47 Shares are included in such Shelf Registration elect to engage accountants or attorneys in addition to the accountants and attorneys engaged by the General Partner, (v) accounting expenses incident to or required by any such registration or qualification and (vi) expenses of complying with the securities or blue sky laws of any jurisdictions in connection with such registration or qualification; provided, however, the Partnership shall not be liable for (A) any discounts or commissions to any underwriter or broker attributable to the sale of Redemption Shares, or (B) any fees or expenses incurred by holders of Redemption Shares in connection with such registration which, according to the written instructions of any regulatory authority, the Partnership is not permitted to pay. The Partnership shall not be required to pay any of the expenses set forth in this Section 8.6(c)(i) through (vi) in connection with any underwritten public offering after the Shelf Registration has been declared effective, except to the extent that such underwritten public offering occurs concurrently with the declaration of effectiveness of the Shelf Registration; provided, however, that this sentence shall not affect the Partnership's obligation to cooperate in connection with any such underwritten public offering. (b) Indemnification. (i) In connection with the Shelf Registration, the Partnership agrees to indemnify holders of Redemption Shares within the meaning of Section 15 of the Securities Act, against all losses, claims, damages, liabilities and expenses (including reasonable costs of investigation) caused by any untrue, or alleged untrue, statement of a material fact contained in the Shelf Registration, preliminary prospectus or prospectus (as amended or supplemented if the General Partner shall have furnished any amendments or supplements thereto) or caused by any omission, or alleged omission, to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, except insofar as such losses, claims, damages, liabilities or expenses are caused by any untrue statement, alleged untrue statement, omission, or alleged omission based upon information furnished to the General Partner expressly for use therein. The General Partner and each officer, director and controlling person of the General Partner shall be indemnified by each holder of Redemption Shares covered by the Shelf Registration for all such losses, claims, damages, liabilities and expenses (including reasonable costs of investigation) caused by any such untrue, or alleged untrue, statement or any such omission, or alleged omission, based upon information furnished to the General Partner expressly for use therein in a writing signed by the holder. (ii) Promptly upon receipt by a party indemnified under this Section 8.6(d) of notice of the commencement of any action against such indemnified party in respect of which indemnity or reimbursement may be sought against any indemnifying party under this Section 8.6(d), such indemnified party shall notify the Partnership in writing of the commencement of such action, but the failure to so notify the Partnership shall not relieve it of any liability which it may have to any indemnified party otherwise than under this Section 8.6(d) unless such failure shall materially adversely affect the defense of such action. In case notice of commencement of any such action shall be given to the Partnership as above provided, the Partnership shall be entitled to participate in and, to the extent it may wish, jointly with any other indemnifying party similarly notified, to assume the defense of 43 48 such action at its own expense, with counsel chosen by it and reasonably satisfactory to such indemnified party. The indemnified party shall have the right to employ separate counsel in any such action and participate in the defense thereof, but the fees and expenses of such counsel (other than reasonable costs of investigation) shall be paid by the indemnified party unless (i) the Partnership agrees to pay the same, (ii) the General Partner fails to assume the defense of such action with counsel reasonably satisfactory to the indemnified party or (iii) the named parties to any such action (including any impleaded parties) have been advised by such counsel that representation of such indemnified party and the General Partner by the same counsel would be inappropriate under applicable standards of professional conduct (in which case the General Partner shall not have the right to assume the defense of such action on behalf of such indemnified party). No indemnifying party shall be liable for any settlement entered into without its consent. (c) Contribution. (i) If for any reason the indemnification provisions contemplated by Section 8.6(d) are either unavailable or insufficient to hold harmless an indemnified party in respect of any losses, claims, damages or liabilities referred to therein, then the party that would otherwise be required to provide indemnification or the indemnifying party (in either case, for purposes of this Section 8.6(e), the "Indemnifying Party") in respect of such losses, claims, damages or liabilities, shall contribute to the amount paid or payable by the party that would otherwise be entitled to indemnification or the indemnified party (in either case, for purposes of this Section 8.6(e), the "Indemnified Party") as a result of such losses, claims, damages, liabilities or expense, in such proportion as is appropriate to reflect the relative fault of the Indemnifying Party and the Indemnified Party, as well as any other relevant equitable considerations. The relative fault of the Indemnifying Party and Indemnified Party shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or omission or alleged omission to state a material fact related to information supplied by the Indemnifying Party or Indemnified Party, and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The amount paid or payable by a party as a result of the losses, claims, damages, liabilities and expenses referred to above shall be deemed to include any legal or other fees or expenses reasonably incurred by such party. In no event shall any holder of Redemption Shares covered by the Shelf Registration be required to contribute an amount greater than the dollar amount of the proceeds received by such holder from the sale of Redemption Shares pursuant to the registration giving rise to the liability. (ii) The parties hereto agree that it would not be just and equitable if contribution pursuant to this Section 8.6(e) were determined by pro rata allocation (even if the holders or any underwriters or all of them were treated as one entity for such purpose) or by any other method of allocation which does not take account of the equitable considerations referred to in the immediately preceding paragraph. No person or entity determined to have committed a fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person or entity who was not guilty of such fraudulent misrepresentation. 44 49 (iii) The contribution provided for in this Section 8.6(e) shall survive the termination of this Agreement and shall remain in full force and effect regardless of any investigation made by or on behalf of any Indemnified Party. (d) Listing on Securities Exchange. If the General Partner shall list or maintain the listing of any shares of its common stock on any securities exchange or national market system, it will at its expense and as necessary to permit the registration and sale of the Redemption Shares hereunder, list thereon, maintain and, when necessary, increase such listing to include such Redemption Shares. 8.7 MEETINGS OF THE PARTNERS. (a) Meetings of the Partners may be called by the General Partner and shall be called upon the receipt by the General Partner of a written request by Limited Partners holding ten percent (10%) or more of the Limited Partner Interests, taking into account any Preferred Partnership Units that are convertible into Common Partnership Units and are required by the Certificate of Designation for the particular class of Preferred Partnership Units to be counted for such purposes on an as-converted basis. Upon request in writing to the General Partner by any person(s) entitled to call a meeting, the General Partner shall cause notice to be given (not less than fifteen (15) nor more than sixty (60) days after receipt of request) to the Limited Partners that a meeting will be held at a time requested by the person(s) calling the meeting. The call shall state the nature of the business to be transacted. Notice of any such meeting shall be given to all Partners not less than ten (10) days nor more than sixty (60) days prior to the date of such meeting. Partners may vote in person or by proxy at such meeting. Whenever the vote or consent of the Partners is permitted or required under this Agreement, such vote or consent may be given at a meeting of the Partners or may be given in accordance with the procedure prescribed in Section 8.7 hereof. Except as otherwise expressly provided in this Agreement, the consent of holders of a majority of the Percentage Interests held by Limited Partners (including Limited Partnership Interests held by the General Partner) shall control. (b) Any action required or permitted to be taken at a meeting of the Partners may be taken without a meeting if a written consent setting forth the action so taken is signed by a majority of the Percentage Interests of the Partners (or such other percentage as is expressly required by this Agreement), taking into account any Preferred Partnership Units that are convertible into Common Partnership Units and are required by the Certificate of Designation for the particular class of Preferred Partnership Units to be counted for such purposes on an as-converted basis. Such consent may be in one instrument or in several instruments, and shall have the same force and effect as a vote of a majority of the Percentage Interests of the Partners (or such other percentage as is expressly required by this Agreement). Such consent shall be filed with the General Partner. An action so taken shall be deemed to have been taken at a meeting held on the effective date so certified. (c) Each Limited Partner may authorize any Person or Persons to act for him by proxy on all matters in which a Limited Partner is entitled to participate, including waiving notice of any meeting, or voting or participating at a meeting. Every proxy must be signed by the Limited 45 50 Partner or his attorney-in-fact. No proxy shall be valid after the expiration of eleven (11) months from the date thereof unless otherwise provided in the proxy. Every proxy shall be revocable at the pleasure of the Limited Partner executing it, such revocation to be effective upon the Partnership's receipt of or written notice of such revocation from the Limited Partner executing such proxy. (d) Each meeting of Partners shall be conducted by the General Partner or such other Person as the General Partner may appoint pursuant to such rules for the conduct of the meeting as the General Partner or such other Person deems appropriate in its sole discretion. Without limitation, meetings of Partners may be conducted in the same manner as meetings of the stockholders of the General Partner and may be held at the same time as, and as part of, meetings of the stockholders of the General Partner. ARTICLE IX TRANSFERS OF LIMITED PARTNERSHIP INTERESTS 9.1 PURCHASE FOR INVESTMENT. (a) Each Limited Partner hereby represents and warrants to the General Partner and to the Partnership that the acquisition of his Partnership Interest is made as a principal for his account for investment purposes only and not with a view to the resale or distribution of such Partnership Interest. (b) Each Limited Partner agrees that he will not sell, assign or otherwise transfer his Partnership Interest or any fraction thereof, whether voluntarily or by operation of law or at judicial sale or otherwise, to any Person who does not make the representations and warranties to the General Partner set forth in Section 9.1(a) above and similarly agree not to sell, assign or transfer such Partnership Interest or fraction thereof to any Person who does not similarly represent, warrant and agree. 9.2 RESTRICTIONS ON TRANSFER OF LIMITED PARTNERSHIP INTERESTS AND REDEMPTION SHARES. (a) Except as otherwise provided in Section 9.2(d) hereof, no Limited Partner other than the General Partner may offer, sell, assign, hypothecate, pledge or otherwise transfer his Limited Partnership Interest, in whole or in part, whether voluntarily or by operation of law or at judicial sale or otherwise (collectively, a "Transfer") without the written consent of the General Partner, which consent may be withheld in the sole discretion of the General Partner. The General Partner may require, as a condition of any Transfer, that the transferor assume all costs incurred by the Partnership in connection therewith. (b) No Limited Partner may effect a Transfer of his Limited Partnership Interest, in whole or in part, if, in the opinion of legal counsel for the Partnership, such proposed Transfer would require the registration of the Limited Partnership Interest under the Securities Act, or would 46 51 otherwise violate any applicable federal or state securities or "Blue Sky" law (including investment suitability standards). (c) No transfer by a Limited Partner of his or its Partnership Units, in whole or in part, may be made to any Person if: (i) in the opinion of legal counsel for the Partnership, the transfer would result in the Partnership's being treated as an association taxable as a corporation (other than a qualified REIT subsidiary within the meaning of Section 856(i) of the Code); (ii) such transfer is effectuated through an "established securities market" or a "secondary market (or the substantial equivalent thereof)" within the meaning of Section 7704 of the Code; (iii) such transfer would cause the Partnership to become, with respect to any employee benefit plan subject to Title I of ERISA, a "party-in-interest" (as defined in Section 3(14) of ERISA) or a "disqualified person" (as defined in Section 4975(c) of the Code); or (iv) if such transfer would, in the opinion of counsel to the Partnership, cause any portion of the assets of the Partnership to constitute assets of any employee benefit plan pursuant to Department of Labor Regulations Section 2510.2-101. (d) Section 9.2(a) shall not apply to the following transactions, except as they may be prohibited by Section 9.2(h) and except that the General Partner may require that the transferor assume all costs incurred by the Partnership in connection therewith: (i) any Transfer by a Limited Partner pursuant to the exercise of its Redemption Right under Section 8.5 hereof; (ii) any Transfer by a Limited Partner that is a corporation or other business entity to any of its Affiliates or subsidiaries or to any successor in interest of such Limited Partner; (iii) any donative Transfer by an individual Limited Partner to his immediate family members or any trust in which the individual or his immediate family members own, collectively, one hundred percent (100%) of the beneficial interests. For purposes of this Section 9.2(d)(iii), the term "immediate family member" shall be deemed to include only an individual Limited Partner's spouse, children and grandchildren; (iv) any Transfer described in Section 9.3(a)(vii); or (v) any Transfer of Preferred Partnership Units that is expressly permitted under the Certificate of Designation for a particular class of Preferred Partnership Units. (e) Notwithstanding Section 9.2(a) to the contrary, any Limited Partner (including the Additional Limited Partners) may pledge, encumber or hypothecate ("Pledge") all or any portion of his Limited Partnership Interest upon satisfaction of each of the following conditions: (i) the General Partner shall have determined in the exercise of its reasonable judgment that such Pledge will not either jeopardize the status of the Partnership as a partnership for federal or state income tax purposes or otherwise create any adverse tax 47 52 consequences to the Partnership or result in a transfer that might jeopardize any exemption from registration under federal or state securities laws; (ii) the pledgee of the Pledge shall either be (i) an institutional lender; or (ii) a non-institutional lender reasonably acceptable to the General Partner; and (iii) the Limited Partner making the Pledge shall provide a copy of all documents evidencing the Pledge or relating to the Pledge transaction and reimburse the Partnership for all reasonable costs and expenses incurred by the Partnership in connection with such Pledge. (f) Any Transfer in contravention of any of the provisions of this Article IX shall be void ab initio and ineffectual and shall not be binding upon, or recognized by, the Partnership. (g) Transfers pursuant to this Article IX may only be made on the first Business Day of a fiscal quarter of the Partnership, unless the General Partner otherwise agrees. (h) Notwithstanding anything in this Agreement to the contrary: (i) Flagstaff Hotel Assets, Inc. and Tucson Desert Assets, Inc. in their capacity as a Limited Partner and any successors thereto or assignees thereof, as well as any Person who becomes a Limited Partner after the effective date of this Agreement, shall not sell any Redemption Shares at any time if such sale could reasonably be expected to result in a violation of any applicable law or regulation due to any other securities offering or transaction by the General Partner or any administrator or agent for the General Partner's Dividend Reinvestment Plan; (ii) any Person who becomes a Limited Partner after the effective date of this Agreement shall not, unless the General Partner in its sole discretion consents in writing, convey, assign, distribute or otherwise voluntarily or involuntarily transfer (other than a Pledge permitted by Section 9.2(e)) to any Person, including any shareholder, any of the Partnership Units (or any other substitute securities or other securities received on account of such Partnership Units) held by any such Limited Partners, for a period of one year from the date such Partnership Units were issued to such Limited Partners; and (iii) the following Limited Partners shall not, unless the General Partner in its sole discretion consents in writing, convey, assign, distribute or otherwise voluntarily or involuntarily transfer (other than a Pledge permitted by Section 9.2(e)) to any Person, including any other Partner, any of the Partnership Units (or any other substitute securities or other securities received on account of such Partnership Units) held by such Limited Partners, at any time prior to the date listed next to each such Limited Partner's name, as follows: (1) Flagstaff Hotel Assets, Inc. and Tucson Desert Assets, Inc. (October 29, 1997), (2) Shivani, LLC (January 17, 1998), and (3) O.T. Hill, LLC (November 28, 1997). 48 53 9.3 ADMISSION OF SUBSTITUTE LIMITED PARTNER. (a) Subject to the other provisions of this Article IX, an assignee of the Limited Partnership Interest of a Limited Partner (which shall be understood to include any purchaser, transferee, donee, or other recipient of any disposition of such Limited Partnership Interest) shall be deemed admitted as a Limited Partner of the Partnership only upon the satisfactory completion of the following: (i) The assignee shall have accepted and agreed to be bound by the terms and provisions of this Agreement by executing a counterpart or an amendment thereof, and such other documents or instruments as the General Partner may require in order to effect the admission of such Person as a Limited Partner. (ii) To the extent required, an amended Certificate evidencing the admission of such Person as a Limited Partner shall have been signed, acknowledged and filed for record in accordance with the Act. (iii) The assignee shall have delivered a letter containing the representation set forth in Section 9.1(a) hereof and the agreement set forth in Section 9.1(b) hereof. (iv) If the assignee is a corporation, partnership or trust, the assignee shall have provided the General Partner with evidence satisfactory to counsel for the Partnership of the assignee's authority to become a Limited Partner under the terms and provisions of this Agreement. (v) The assignee shall have executed a power of attorney containing the terms and provisions set forth in Section 8.2 hereof. (vi) The assignee shall have paid all reasonable legal fees of the Partnership and the General Partner and filing and publication costs in connection with his substitution as a Limited Partner. (vii) The assignee has obtained the prior written consent of the General Partner to its admission as a Substitute Limited Partner, which consent may be given or denied in the exercise of the General Partner's sole and absolute discretion; provided, however, that subject to Section 9.8 below, the General Partner hereby agrees to consent to the admission of any Assignee of any Limited Partner who was a party to this Agreement as of August 16, 1995 described in Section 9.2(f) (by distribution in accordance with the terms of the partnership agreement or other applicable governing agreement of such Limited Partner), which consent shall be effective with no further action by the General Partner upon the execution of such assignment by such Limited Partner to such Assignee. (b) For the purpose of allocating profits and losses and distributing cash received by the Partnership, a Substitute Limited Partner shall be treated as having become, and appearing in the records of the Partnership as, a Partner upon the filing of the Certificate described in Section 49 54 9.3(a)(ii) hereof or, if no such filing is required, the later of the date specified in the transfer documents or the date on which the General Partner has received all necessary instruments of transfer and substitution. (c) The General Partner shall cooperate with the Person seeking to become a Substitute Limited Partner by preparing the documentation required by this Section and making all official filings and publications. The Partnership shall take all such action as promptly as practicable after the satisfaction of the conditions in this Article IX to the admission of such Person as a Limited Partner of the Partnership. 9.4 RIGHTS OF ASSIGNEES OF PARTNERSHIP INTERESTS. (a) Subject to the provisions of Sections 9.1 and 9.2 hereof, except as required by operation of law, the Partnership shall not be obligated for any purposes whatsoever to recognize the assignment by any Limited Partner of his Partnership Interest until the Partnership has received notice thereof. (b) Any Person who is the assignee of all or any portion of a Limited Partner's Limited Partnership Interest, but does not become a Substitute Limited Partner and desires to make a further assignment of such Limited Partnership Interest, shall be subject to all the provisions of this Article IX to the same extent and in the same manner as any Limited Partner desiring to make an assignment of his Limited Partnership Interest. 9.5 EFFECT OF BANKRUPTCY, DEATH, INCOMPETENCE OR TERMINATION OF A LIMITED PARTNER. The occurrence of an Event of Bankruptcy as to a Limited Partner, the death of a Limited Partner or a final adjudication that a Limited Partner is incompetent (which term shall include, but not be limited to, insanity) shall not cause the termination or dissolution of the Partnership, and the business of the Partnership shall continue if an order for relief in a bankruptcy proceeding is entered against a Limited Partner, the trustee or receiver of his estate or, if he dies, his executor, administrator or trustee, or, if he is finally adjudicated incompetent, his committee, guardian or conservator, shall have the rights of such Limited Partner for the purpose of settling or managing his estate property and such power as the bankrupt, deceased or incompetent Limited Partner possessed to assign all or any part of his Partnership Interest and to join with the assignee in satisfying conditions precedent to the admission of the assignee as a Substitute Limited Partner. 9.6 JOINT OWNERSHIP OF INTERESTS. A Partnership Interest may be acquired by two individuals as joint tenants with right of survivorship, provided that such individuals either are married or are related and share the same home as tenants in common. The written consent o vote of both owners of any such jointly held Partnership Interest shall be required to constitute the action of the owners of such Partnership Interest; provided, however, that the written consent of only one joint owner will be required if the Partnership has been provided with evidence satisfactory to the counsel for the Partnership that the actions of a single joint owner can bind both owners under the applicable laws of the state of residence of such joint owners. Upon the death of one owner of a Partnership Interest held in a joint tenancy with a right of survivorship, the Partnership Interest shall become owned solely by the survivor as a Limited Partner and not as an Assignee. The Partnership 50 55 need not recognize the death of one of the owners of a jointly-held Partnership Interest until it shall have received notice of such death. Upon notice to the General Partner from either owner, the General Partner shall cause the Partnership Interest to be divided into two equal Partnership Interests, which shall thereafter be owned separately by each of the former owners. 9.7 ASSIGNMENT OF ALL PARTNERSHIP UNITS. Any Limited Partner who shall transfer all of his Partnership Units in a transfer permitted pursuant to this Article IX shall cease to be a Limited Partner upon the admission of all Assignees of such Partnership Units as Substitute Limited Partners. Similarly, any Limited Partner who shall transfer all of his Partnership Units pursuant to a redemption of all of his Partnership Units under Section 8.5 shall cease to be a Limited Partner. 9.8 LIMITATION ON TRANSFER OF PARTNERSHIP UNITS AND OTHER RIGHTS TO AVOID ADVERSE TAX EFFECTS. Notwithstanding any provision in this Agreement to the contrary, no transfer or purported transfer by any Limited Partner of any Partnership Interest or Partnership Units, nor exercise of any redemption right under Section 8.5, nor exercise of any registration rights under Section 8.5, nor exercise of any other right or benefit provided under this Agreement shall be effective or of any force or effect if as a result of the exercise or purported exercise of any such right, the Partnership will be taxed as a corporation, association or publicly traded partnership, rather than as a limited partnership, under the Code, any Regulations, or any administrative pronouncements of the Internal Revenue Service. The General Partner's determination as to whether a particular transfer, exercise of redemption rights, exercise of registration rights, or exercise of any other right or benefit will or may cause an adverse tax treatment to the Partnership shall be conclusive and binding on the Limited Partners. ARTICLE X BOOKS AND RECORDS: ACCOUNTING: TAX MATTERS 10.1 BOOKS AND RECORDS. At all times during the continuance of the Partnership, the Partners shall keep or cause to be kept at the Partnership's specified office true and complete books of account in accordance with generally accepted accounting principles, including: (a) a current list of the full name and last known business address of each Partner, (b) a copy of the Certificate of Limited Partnership and all certificates of amendment thereto, (c) copies of the Partnership's federal, state and local income tax returns and reports, (d) copies of the Agreement and any financial statements of the Partnership for the three most recent years and (e) all documents and information required under the Act. Any Partner or his duly authorized representative, upon paying the costs of collection, duplication and mailing, shall be entitled to inspect or copy such records during ordinary business hours. 10.2 CUSTODY OF PARTNERSHIP FUNDS: BANK ACCOUNTS. (a) All funds of the Partnership not otherwise invested under Section 10.2(b) below shall be deposited in one or more accounts maintained in such banking or brokerage 51 56 institutions as the General Partner shall determine, and withdrawals shall be made only on such signature or signatures as the General Partner may, from time to time, determine. (b) All deposits and other funds not needed in the operation of the business of the Partnership and deposited in accordance with Section 10.2(a) above, shall be invested by the General Partner in any of the following dollar denominated investments: (i) marketable direct obligations issued or unconditionally guaranteed by the United States government or issued by any agency thereof and backed by the full faith and credit of the United States; (ii) marketable direct obligations issued by any state of the United States or any political subdivision of any such state or any public instrumentality thereof and, at the time of acquisition, having an investment grade rating from either Standard & Poor's Corporation ("S&P") or Moody's Investors Service, Inc. ("Moody's"); (iii) publicly traded commercial paper bearing at the time of acquisition an investment grade rating either of S&P or Moody's issued by United States, Australian, Canadian, European or Japanese bank holding companies or industrial or financial companies; (iv) certificates of deposit issued by and bankers acceptances of and interest bearing deposits with any United States, Canadian, European or Japanese commercial banks either (x) is the lender of Non-discharged Indebtedness but only up to 125% of the amount of such Lender's Non-discharged indebtedness or (y) having capital and surplus of at least $100,000,000 or the equivalent and which issues (or the parent of which issues) commercial paper or other short term securities bearing an investment grade rating from either S&P or Moody's; and (v) money market funds organized under the laws of the United States or any state thereof that invest solely in any of the foregoing investments permitted under clauses (i), (ii), (iii), and (iv). The funds of the Partnership shall not be commingled with the funds of any other Person except for such commingling as may necessarily result from an investment in those investment companies permitted by this Section 10.2(b). 10.3 FISCAL AND TAXABLE YEAR. The fiscal and taxable year of the Partnership shall be the calendar year. 10.4 ANNUAL TAX INFORMATION AND REPORT. Within seventy-five (75) days after the end of each fiscal year of the Partnership, the General Partner shall furnish to each Person who was a Limited Partner at any time during such year the tax information necessary to file such Limited Partner's individual tax returns as shall be reasonably required by law. 10.5 TAX MATTERS PARTNER; TAX ELECTIONS; SPECIAL BASIS ADJUSTMENTS. (a) The General Partner shall be the "Tax Matters Partner" of the Partnership within the meaning of Section 6231(a)(7) of the Code. As Tax Matters Partner, the General Partner shall have the right and obligation to take all actions authorized and required, respectively, by the Code for the Tax Matters Partner. The General Partner shall have the right to retain professional assistance in respect of any audit of the Partnership by the Service and all out-of-pocket expenses and fees incurred by the General Partner on behalf of the Partnership as Tax Matters Partner shall constitute Administrative Expenses. In the event the General Partner receives notice of a final Partnership adjustment under Section 6223(a)(2) of the Code, the General Partner shall either (i) file a court petition for judicial review of such final adjustment within the period provided under Section 6226(a) of the Code, a copy of which petition shall be mailed to all Limited Partners on the date such 52 57 petition is filed, or (ii) mail a written notice to all Limited Partners, within such period, that describes the General Partner's reasons for determining not to file such a petition. (b) All elections required or permitted to be made by the Partnership under the Code shall be made by the General Partner in its sole discretion. (c) In the event of a transfer of all or any part of the Partnership Interest of any Partner, the Partnership, at the option of the General Partner, may elect pursuant to Section 754 of the Code to adjust the basis of the Properties. Notwithstanding anything contained in Article V of this Agreement, any adjustments made pursuant to Section 754 shall affect only the successor in interest to the transferring Partner and in no event shall be taken into account in establishing, maintaining or computing Capital Accounts for the other Partners for any purpose under this Agreement. Each Partner will furnish the Partnership with all information necessary to give effect to such election. 10.6 REPORTS TO LIMITED PARTNERS. (a) The books of the Partnership shall be audited annually as of the end of each fiscal year of the Partnership by accountants selected by the General Partner, who shall be the same accountants responsible for the examination of the General Partner's books. The General Partner shall determine and prepare an annual balance sheet, a statement of partners' capital as of the end of such year, as well as statements of cash flow and income, all in accordance with generally accepted accounting principles and accompanied by an independent auditor's report (collectively, the "Financial Statements"), together with all supplementary schedules and information prepared by the accountants related thereto. As a note to such Financial Statements, the General Partner shall prepare a schedule of all loans to the Partnership. Such schedule shall demonstrate that loans have been made, used, carried on the books of the Partnership (and repaid, if applicable) in accordance with the provisions of this Agreement. As soon as practicable, but in no event later than one hundred five (105) days after the close of each fiscal year, or such later date as they are filed with the Commission by the General Partner, the General Partner shall cause to be mailed to each Limited Partner as of the close of the fiscal year, an annual report containing Financial Statements of the Partnership, or of the General Partner if such statements are prepared solely on a consolidated basis with the General Partner, for such year. As soon as practicable, but in no event later than forty-five (45) days after the close of each calendar quarter (except the last calendar quarter of each year), or such later date as they are filed with the Commission by the General Partner, the General Partner shall cause to be mailed to each Limited Partner as of the last day of the calendar quarter, a report containing unaudited financial statements of the Partnership, or of the General Partner, if such statements are prepared solely on a consolidated basis with the General Partner, and such other information as may be required by applicable law or regulation, or as the General Partner determines to be appropriate. (b) Any Partner shall further have the right to a private audit of the books and records of the Partnership, provided such audit is made for Partnership purposes, at the expense of the Partner desiring it and is made during normal business hours. 53 58 10.7 TITLE TO PARTNERSHIP ASSETS. Title to Partnership assets, whether real, personal or mixed and whether tangible or intangible, shall be deemed to be owned by the Partnership as an entity, and no Partner, individually or collectively, shall have any ownership interest in such Partnership assets or any portion thereof. Title to any or all of the Partnership assets may be held in the name of the Partnership, the General Partner or one or more nominees, as the General Partner may determine, including Affiliates of the General Partner. The General Partner hereby declares and warrants that any Partnership assets for which legal title is held in the name of the General Partner or any nominee or Affiliate of the General Partner shall be held by the General Partner for the use and benefit of the Partnership in accordance with the provisions of this Agreement; provided, however, that the General Partner shall use its best efforts to cause beneficial and record title to such assets to be vested in the Partnership as soon as reasonably practicable. All Partnership assets shall be recorded as the property of the Partnership in its books and records, irrespective of the name in which legal title to such Partnership assets is held. 10.8 RELIANCE BY THIRD PARTIES. Notwithstanding anything to the contrary in this Agreement, any Person dealing with the Partnership shall be entitled to assume that the General Partner has full power and authority, without consent or approval of any other Partner or Person, to encumber, sell or otherwise use in any manner any and all assets of the Partnership and to enter into any contracts on behalf of the Partnership, and take any and all actions on behalf of the Partnership and such Person shall be entitled to deal with the General Partner as if the General Partner were the Partnership's sole party in interest, both legally and beneficially. Each Limited Partner hereby waives any and all defenses or other remedies which may be available against such Person to contest, negate or disaffirm any action of the General Partner in connection with any such dealing. In no event shall any Person dealing with the General Partner or its representatives be obligated to ascertain that the terms of this Agreement have been complied with or to inquire into the necessity or expedience of any act or action of the General Partner or its representatives. Each and every certificate, document, or other instrument executed on behalf of the Partnership by the General Partner or its representatives shall be conclusive evidence in favor of any and every Person relying thereon or claiming thereunder that (i) at the time of the execution and delivery of such certificate, document or instrument, this Agreement was in full force and effect, (ii) the Person executing and delivering such certificate, document or instrument was duly authorized and empowered to do so for and on behalf of the Partnership and (iii) such certificate, document or instrument was duly executed and delivered in accordance with the terms and provisions of this Agreement and is binding upon the Partnership. 10.9 WITHHOLDING. Each Limited Partner hereby authorizes the Partnership to withhold from or pay on behalf of or with respect to such Limited Partner any amount of federal, state, local, or foreign taxes that the General Partner determines that the Partnership is required to withhold or pay with respect to any amount distributable or allocable to such Limited Partner pursuant to this Agreement, including, without limitation, any taxes required to be withheld or paid by the Partnership pursuant to Sections 1441, 1442, 1445, or 1446 of the Code. Any amount paid on behalf of or with respect to a Limited Partner shall constitute a loan by the Partnership to such Limited Partner, which loan shall be repaid by such Limited Partner within fifteen (15) days after notice from the General Partner that such payment must be made unless (i) the Partnership withholds such payment from a distribution which would otherwise be made to the Limited Partner or (ii) the 54 59 General Partner determines, in its sole and absolute discretion, that such payment may be satisfied out of the available funds of the Partnership which would, but for such payment, be distributed to the Limited Partner. Any amounts withheld pursuant to the foregoing clauses (i) or (ii) shall be treated as having been distributed to such Limited Partner. Each Limited Partner hereby unconditionally and irrevocably grants to the Partnership a security interest in such Limited Partner's Partnership Interest to secure such Limited Partner's obligation to pay to the Partnership any amounts required to be paid pursuant to this Section 10.9. Any amounts payable by a Limited Partner hereunder shall bear interest at the lesser of (A) the base rate on corporate loans at large United States money center commercial banks, as published from time to time in the Wall Street Journal, plus one (1) percentage points, or (B) the maximum lawful rate of interest on such obligation, such interest to accrue from the date such amount is due (i.e., fifteen (15) days after demand) until such amount is paid in full. Each Limited Partner shall take such actions as the Partnership or the General Partner shall request in order to perfect or enforce the security interest created hereunder. ARTICLE XI AMENDMENT OF AGREEMENT The General Partner, without the consent of the Limited Partners, may amend this Agreement in any respect; provided, however, that the following amendments shall require the consent of Limited Partners holding more than sixty-six and two-thirds percent (66-2/3%) of the Percentage Interests of the Limited Partners (excluding the Percentage Interests held in the name of the General Partner of the Partnership, or held by any entity which is controlled by the General Partner, whether as the General Partner or a Limited Partner): (a) any amendment affecting the operation of the Conversion Factor, the Redemption Rights, or the Shelf Registration under Section 8.6 hereof; (b) any amendment that would adversely affect the rights of the Limited Partners to receive the distributions payable to them hereunder. (c) any amendment that would alter the Partnership's allocations of Profit and Loss to the Limited Partners, other than (i) an amendment (including attaching a new Certificate of Designation hereto) to issue a new class of Preferred Partnership Units or (ii) an amendment to admit a new Limited Partner provided such amendment to the allocations of Profit and Loss did not have an adverse effect on the existing Limited Partners; or (d) any amendment that would impose on the Limited Partners any obligation to make additional Capital Contributions to the Partnership. In determining what number of Partnership Units constitutes the requisite 66-2/3% consent for any of the amendments enumerated above, Preferred Partnership Units (other than those held in the name of the General Partner or an entity controlled by the General Partner, whether as the General Partner or a limited partner) shall be taken into account to the extent that, with respect to 55 60 a particular purpose enumerated above, the Certificate of Designation for a particular class of Preferred Partnership Units provides for conversion of such units into Common Partnership Units and provides that such Preferred Partnership Units shall vote on an as-converted basis. In addition to any of the voting rights that Preferred Unitholders may have under this Article X, Preferred Unitholders shall have such other voting rights, protective rights or similar rights as set forth in the Certificate of Designation for a particular class of Preferred Partnership Units. ARTICLE XII GENERAL PROVISIONS 12.1 NOTICES. All communications required or permitted under this Agreement shall be in writing and shall be deemed to have been given when delivered personally or upon deposit in the United States mail, registered, postage prepaid return receipt requested, to the Partners at the addresses set forth in the Unitholder Ledger; provided, however, that any Partner may specify a different address by notifying the General Partner in writing of such different address. Notices to the Partnership shall be delivered at or mailed to its specified office. 12.2 SURVIVAL OF RIGHTS. Subject to the provisions hereof limiting transfers, this Agreement shall be binding upon and inure to the benefit of the Partners and the Partnership and their respective legal representatives, successors, transferees and assigns. 12.3 ADDITIONAL DOCUMENTS. Each Partner agrees to perform all further acts and execute, swear to, acknowledge and deliver all further documents which may be reasonable, necessary, appropriate or desirable to carry out the provisions of this Agreement or the Act. 12.4 SEVERABILITY. If any provision of this Agreement shall be declared illegal, invalid, or unenforceable in any jurisdiction, then such provision shall be deemed to be severable from this Agreement (to the extent permitted by law) and in any event such illegality, invalidity or unenforceability shall not affect the remainder hereof. 12.5 ENTIRE AGREEMENT. This Agreement and exhibits attached hereto constitute the entire Agreement of the Partners and supersede all prior written agreements and prior and contemporaneous oral agreements, understandings and negotiations with respect to the subject matter hereof. 12.6 PRONOUNS AND PLURALS. When the context in which words are used in the Agreement indicates that such is the intent, words in the singular number shall include the plural and the masculine gender shall include the neuter or female gender as the context may require. 12.7 HEADINGS. The Article headings or sections in this Agreement are for convenience only and shall not be used in construing the scope of this Agreement or any particular Article. 12.8 COUNTERPARTS. This Agreement may be executed in several counterparts, each of which shall be deemed to be an original copy and all of which together shall constitute one and the 56 61 same instrument binding on all parties hereto, notwithstanding that all parties shall not have signed the same counterpart. 12.9 WAIVER. No failure by any party to insist upon the strict performance of any covenant, duty, agreement or condition of this Agreement or to exercise any right or remedy consequent upon a breach thereof shall constitute waiver of any such breach or any other covenant, duty, agreement or condition. 12.10 APPLICABLE LAW. This Agreement shall be construed and enforced in accordance with and governed by the laws of the State of Delaware (other than the law governing the choice of law), without regard to the principles of conflicts of law. In the event of a conflict between the provisions of this Agreement and any nonmandatory provision of the Act, the provisions of this Agreement shall control and take precedence. 12.11 INVALIDITY OF PROVISIONS. If any provision of this Agreement is or becomes invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions contained herein shall not be affected thereby. 12.12 NO RIGHTS AS STOCKHOLDERS. Nothing contained in this Agreement shall be construed as conferring upon the holders of the Partnership Units any rights whatsoever as stockholders of the General Partner, including, without limitation, any right to receive dividends or other distributions made to stockholders of the General Partner or to vote or to consent or to receive notice as stockholders in respect of any meeting of stockholders for the election of directors of the General Partner or any other matter. 12.13 PARTITION. No Partner nor any successor-in-interest to a Partner shall have the right while this Agreement remains in effect to have any property of the Partnership partitioned, or to file a complaint or to institute any proceeding at law or in equity to have such property of the Partnership partitioned, and each Partner, on behalf of itself and its successors and assigns hereby waives any such right. It is the intention of the Partners that the rights of the parties hereto and their successors-in-interest to Partnership property, as among themselves, shall be governed by the terms of this Agreement, and that the rights of the Partners and their successors-in-interest shall be subject to the limitations and restrictions as set forth in this Agreement. 12.14 NO THIRD-PARTY RIGHTS CREATED HEREBY. The provisions of this Agreement are solely for the purpose of defining the interests of the partners, inter se; and no other person, firm or entity (i.e., a party who is not a signatory hereto or a permitted successor to such signatory hereto) shall have any right, power, title or interest by way of subrogation or otherwise, in and to the rights, powers, title and provisions of this Agreement. [THE REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK] 57 62 IN WITNESS WHEREOF, the parties hereto have hereunder affixed their signatures to this Agreement, all as of the date first hereinabove written. GENERAL PARTNER LIMITED PARTNERS SUNSTONE HOTEL INVESTORS, INC., SUNSTONE HOTEL INVESTORS, INC., a Maryland corporation and the sole a Maryland corporation, as a Limited General Partner Partner By: /s/ ROBERT A. ALTER By: /s/ ROBERT A. ALTER ----------------------------- ------------------------------- Robert A. Alter Robert A. Alter Its: President Its: President /s/ ROBERT A. ALTER ------------------------------------ ROBERT A. ALTER /s/ C. ROBERT ENEVER ------------------------------------ C. ROBERT ENEVER /s/ CHARLES L. BIEDERMAN ------------------------------------ CHARLES L. BIEDERMAN MYPC PARTNERS, a general partnership By: /s/ KARL MATTHIES ------------------------------------ Karl Matthies Its: General Partner ------------------------------------ ANTHONY E. VAN BAAK /s/ LES LIMAN ------------------------------------ LES LIMAN 63 /s/ THOMAS R. SHARP ------------------------------------ THOMAS R. SHARP, TRUSTEE /s/ THOMAS R. SHARP ------------------------------------ THOMAS R. SHARP TRUST COMPANY OF AMERICA, for the benefit of Patrick E. Barney By: /s/ Trust Company of America ------------------------------------ Name: Its: ENEVER ROUTT INVESTMENT GROUP, LTD, a limited partnership By: /s/ C. ROBERT ENEVER ------------------------------------ C. Robert Enever Its: General Partner ALTER INVESTMENT GROUP, LTD, a limited partnership By: /s/ ROBERT A. ALTER ------------------------------------ Robert A. Alter Its: General Partner INNS PROPERTIES, a California limited partnership, formerly known as Inns Properties I, a California limited partnership By INSPAC, LTD., a Delaware corporation, formerly (and, in California, still known as) INSCO, LTD., a General Partner By: ------------------------------------ Richard M. Moss Its: President 64 RIVERSIDE HOTEL PARTNERS, INC., a California Corporation By: /s/ ROBERT A. ALTER ------------------------------------ Robert A. Alter Its: President FLAGSTAFF HOTEL ASSETS, INC., an Arizona corporation By: /s/ LOURIN KOONIN ------------------------------------ Lourin Koonin Its: President TUCSON DESERT ASSETS, INC., an Arizona corporation By: /s/ LOURIN KOONIN ------------------------------------ Lourin Koonin Its: President LINDA HAMLET & KENNETH HAMLET, as Joint Tenants ------------------------------------ Linda Hamlet ------------------------------------ Kenneth Hamlet CHANING DARRTEN HAMLET TRUST By: ------------------------------------ , TRUSTEE --------------------------- BRENDAN HUNTER HAMLET TRUST By: ------------------------------------ , TRUSTEE --------------------------- 65 TYLER JENSEN HAMLET TRUST By: ------------------------------------ , TRUSTEE --------------------------- SKLAR FAMILY PARTNERSHIP By: /s/ GERALD A. SKLAR ------------------------------------ Gerald A. Sklar Its: Partner ------------------------------------ SHARON DRUEHL ------------------------------------ GORDON E. DRUEHL /s/ MARGOT GASCH ------------------------------------ MARGOT GASCH O.T. HILL, LLC, a Delaware limited liability company By: /s/ GARY V. CHENSOFF ------------------------------------ Gary V. Chensoff Its: President ANDRA M. PALMROS, Personal Representative of the Estate of Alexander Palmros II a/k/a Alex Palmros II deceased /s/ PETER B. AYRES ------------------------------------ PETER B. AYRES, TRUSTEE 66 /s/ DANIEL E. CARSELLO ------------------------------------ DANIEL E. CARSELLO, TRUSTEE /s/ DANIEL E. CARSELLO ------------------------------------ DANIEL E. CARSELLO /s/ JEANNE H. CARSELLO ------------------------------------ JEANNE H. CARSELLO, TRUSTEE /s/ GERALD N. CLARK ------------------------------------ GERALD N. CLARK /s/ GAREY H. COONEN ------------------------------------ GAREY H. COONEN ------------------------------------ SHERMAN B. CORNELL /s/ AUDREY W. ENEVER ------------------------------------ AUDREY W. ENEVER C. ROBERT ENEVER & AUDREY W. ENEVER, as Joint Tenants /s/ C. ROBERT ENEVER ------------------------------------ C. Robert Enever /s/ AUDREY W. ENEVER ------------------------------------ Audrey W. Enever /s/ TERRY H. HILSON ------------------------------------ TERRY H. HILSON, TRUSTEE 67 JAMES HIVELY & SANDRA HIVELY, as Joint Tenants /s/ JAMES HIVELY ------------------------------------ James Hively /s/ SANDRA HIVELY ------------------------------------ Sandra Hively EUGENE O. HOGENSON & CHRISTINE M. LEICK, as Joint Tenants ------------------------------------ Eugene O. Hogenson ------------------------------------ Christine M. Leick EDGAR R. JOHNSON & JUNE A. JOHNSON, as Joint Tenants ------------------------------------ Edgar R. Johnson ------------------------------------ June A. Johnson SHIVANI LLC, a California Limited Liability Company By: /s/ TUSHAR PATEL ------------------------------------ Tushar Patel Its: Member PEACOCK LLC, a California Limited Liability Company By: /s/ TUSHAR PATEL ------------------------------------ Tushar Patel Its: Member 68 /s/ EVE E. POTH ------------------------------------ TRUSTEE FOR EDWARD C. POTH REVOCABLE TRUST /s/ RICHARD E. PYLE ------------------------------------ RICHARD E. PYLE, TRUSTEE /s/ DOUGLAS A. SLANSKY ------------------------------------ DOUGLAS A. SLANSKY RICHARD F. WEHRLI & JUDITH J. WEHRLI, as Joint Tenants ------------------------------------ Richard F. Wehrli ------------------------------------ Judith J. Wehrli /s/ H. DAVID ZABEL ------------------------------------ H. DAVID ZABEL DEAN A. SAMMONS & SARAH B. SAMMONS, as Joint Tenants /s/ DEAN A. SAMMONS ------------------------------------ Dean A. Sammon /s/ SARAH B. SAMMONS ------------------------------------ Sarah B. Sammons 69 EXHIBIT A NOTICE OF EXERCISE OF REDEMPTION RIGHT In accordance with Section ___ of the Second Amended and Restated Agreement of Limited Partnership of Sunstone Hotel Investors, Limited Partnership (the "Agreement"), the undersigned hereby irrevocably (i) presents for redemption _______ Partnership Units in Sunstone Hotel Investors, L.P. in accordance with the terms of the Agreement and the Redemption Right referred to in Section 8.5 thereof, (ii) surrenders such Partnership Units and all right, title and interest therein, and (iii) directs that the Cash Amount or REIT Shares (as defined in the Agreement) as determined by the General Partner deliverable upon exercise of the Redemption Right be delivered to the address specified below, and if REIT Shares are to be delivered, such REIT shares be registered or placed in the name(s) and at the address(es) specified below. Dated:__________ __, _____ Name of Limited Partner: ---------------------------------------- (Signature of Limited Partner) ---------------------------------------- (Mailing Address) ---------------------------------------- (City) (State) (Zip Code) Signature Guaranteed by: ---------------------------------------- If REIT Shares are to be issued, issue to: Please insert social security or identifying number: Name: A-1 70 EXHIBIT B SUNSTONE HOTEL INVESTORS, L.P. CERTIFICATE OF DESIGNATION CLASSIFYING 7.9% CLASS A CUMULATIVE CONVERTIBLE PREFERRED PARTNERSHIP UNITS This Certificate of Designation establishes the powers, rights, preferences, qualifications, limitations and restrictions, as to distributions, voting rights, conversion, terms and conditions of redemption, liquidation and other terms and conditions of the 250,000 7.9% Class A Cumulative Preferred Partnership Units (the "Series A Preferred Partnership Units") of Limited Partnership interest of the Partnership to be issued to the Company. All capitalized terms used but not defined herein shall have the meaning ascribed to them in the Second Amended and Restated Agreement of Limited Partnership (the "Agreement") of the Partnership. The Series A Preferred Partnership Units are being issued by the Partnership to the General Partner in connection with the issuance by the Company of 250,000 shares in the aggregate of its 7.9% Class A Cumulative Preferred Stock (the "Series A Preferred Stock") to Westbrook Real Estate Investment Fund I, L.P. and Westbrook Co-Investment Real Estate Fund I, L.P. (collectively, "Westbrook") in connection with the Company's acquisition from Westbrook of all of the capital stock of Kahler Realty Corporation ("Kahler"). The terms of the Units are intended to mirror those of the Series A Preferred Stock. 1. Designation and Number. The Series A Preferred Partnership Units shall consist of 250,000 Partnership Units which shall be issued to the Company when the Company issues the corresponding 250,000 shares of Series A Preferred Stock to Westbrook. Subject to compliance with applicable protective voting rights which may be granted to any class of Preferred Partnership Units ("Protective Provisions"), but notwithstanding any other rights of holders of any class of Preferred Partnership Units or the powers, rights, designations, preferences, qualifications, limitations and restrictions of any additional class may be subordinated to, pari passu with (including, without limitation, provisions with respect to liquidation and acquisition preferences, redemption and/or approval of matters by vote or written consent), or senior to any of those of any present or future class of Preferred or Common Partnership Units. 2. Distribution Provisions. Immediately prior to the Company's payment of dividends to holders of the Series A Preferred Stock, the holder(s) of Series A Preferred Partnership Units shall be entitled to receive for each outstanding Series A Preferred Partnership Unit a cash distribution, prior and in preference to any payment of any cash distribution on the Common Partnership Units, in an amount equal to the payment to be made on each outstanding share of the Series A Preferred Stock. B-1 71 3. Liquidation Preference. (a) In the event of any liquidation, dissolution or winding up of the Partnership, either voluntary or involuntary, subject to the rights of classes of Preferred Partnership Units that may from time to time come into existence, the holder(s) of Series A Preferred Partnership Units shall (unless such Partnership Units of Series A Preferred Partnership Units are converted into Common Partnership Units pursuant to Section 5 hereof) be entitled to receive, prior and in preference to any distribution of any of the assets of the Partnership to the holders of Common Partnership Units by reason of their ownership thereof, an amount per Unit equal to the amount that must be paid to the holders of Series A Preferred Stock upon liquidation of the Company (including any and all events constituting a liquidation under Section 3 of the Articles Supplementary clarifying the Series A Preferred Stock) (the "Liquidation Preference"). If the assets and funds thus distributed among the holders of the Series A Preferred Partnership Units shall be insufficient to permit the payment to such holder(s) of the full aforesaid amount, then, subject to the rights of classes of Preferred Partnership Units that may from time to time come into existence, the entire assets and funds of the Partnership legally available for distribution shall be distributed ratably among the holders of the Series A Preferred Partnership Units in proportion to the amount of such Partnership Units owned by each such holder. (b) Upon the completion of the distribution required by subsection (a) of this Section 3 and any other distribution that may be required with respect to classes of Preferred Partnership Units that may from time to time come into existence, if assets remain in the Partnership, the holders of the Common Partnership Units of the Partnership shall receive all of the remaining assets of the Partnership. 4. Redemption. (a) Subject to the rights of classes of Preferred Partnership Units which may from time to time come into existence immediately prior to a redemption of Series A Preferred Stock, the Company may redeem at its option a number of Series A Preferred Units equal to the number of shares of Series A Preferred Stock to be redeemed by the holder(s) thereof, and shall immediately receive from the Partnership an amount of cash equal to the cash to be paid by the Company to the redeeming holder(s) of shares of Series A Preferred Stock. (b) From and after the redemption of Series A Preferred Units, unless there shall have been a default in payment of the redemption price, all rights of the holders of the Series A Preferred Partnership Units redeemed shall cease with respect to such Partnership Units, and such Partnership Units shall not thereafter be transferred on the Unitholder Ledger of the Partnership or be deemed to be outstanding for any purpose whatsoever. Subject to the rights of classes of Preferred Partnership Units which may from time to time come into existence, if the funds of the Partnership legally available for redemption of Partnership Units of Series A Preferred Partnership Units on any redemption date are insufficient to redeem the total number of Partnership Units of Series A Preferred Partnership Units to be redeemed on such date, those funds which are legally available will be used to redeem the maximum possible number of such Partnership Units ratably among the holders of such Partnership Units to be redeemed based upon their holdings of B-2 72 Series A Preferred Partnership Units. The Partnership Units of Series A Preferred Partnership Units not redeemed shall remain outstanding and entitled to all the rights and preferences provided herein. Subject to the rights of classes of Preferred Partnership Units which may from time to time come into existence, at any time thereafter when additional funds of the Partnership are legally available for the redemption of Partnership Units of Series A Preferred Partnership Units, such funds will immediately be used to redeem the balance of the Partnership Units which the Partnership has become obliged to redeem but which it has not redeemed. 5. Conversion. On the date on which shares of Series A Preferred Stock are converted into Common Stock of the Company, Series A Preferred Partnership Units shall automatically be converted into Common Partnership Units, such that the number of Series A Preferred Partnership Units so converted shall equal the number of shares of Series A Preferred Stock converted and the number of Common Partnership Units received from such conversion will equal the number of shares of Common Stock of the Company received from the conversion of the shares of Series A Preferred Stock. Upon such conversion of Series A Preferred Stock, the Unitholder Ledger shall be amended to reflect such conversion. 6. Voting Rights. Except as to matters upon which the General Partner is not entitled to vote under the Agreement, the holder(s) of each Series A Preferred Partnership Unit shall have Partner consent and approval rights equal to such rights as would a holder of Common Partnership Units into which such holder's Partnership Series A Preferred Partnership Units could then be converted. This Certificate of Designation has been approved by the General Partner in the manner and required by law and is incorporated into the Agreement by reference. In the event of a conflict between the provisions of this Certificate of Designation and the provisions of the Agreement, the provisions of this Certificate of Designation shall govern. IN WITNESS WHEREOF, SUNSTONE HOTEL INVESTORS, L.P. has caused this Certificate of Designation to be executed on its behalf on this 14th day of October 1997. SUNSTONE HOTEL INVESTORS, L.P. By: SUNSTONE HOTEL INVESTORS, INC., its General Partner By: /s/ ROBERT A. ALTER ---------------------------- Robert A. Alter, President B-3 EX-10.2.35 5 LEASE AGREEMENT 1 EXHIBIT 10.2.35 SUNSTONE HOTEL INVESTORS, INC. SCHEDULE OF MATERIAL DIFFERENCES AMONG PERCENTAGE LEASES The following lists of material differences between the Percentage Lease filed as Exhibit 10.2 and the Percentage Lease identified by Exhibit 10.2.35 and is being filed pursuant to Instruction 2 to Item 601 of Regulation S-K.
ANNUAL 1ST TIER TIER 2ND TIER FOOD/BEVERAGE NAME CITY STATE INCEPTION BASE RENT AMOUNT PERCENT PERCENT PERCENT Hilton Hotel Salt Lake City UT 10/15/97 3,843,000 638,250 50.18% 62.00% 5.00% Olympia Park Park City UT 10/15/97 926,000 316,083 24.41% 62.00% 5.00% Sheraton San Marcos Chandler AZ 10/15/97 2,889,000 693,000 34.74% 62.00% 5.00% Quality Inn Pocatello ID 10/15/97 390,000 140,500 23.12% 62.00% 5.00% Boise Park Suites Boise ID 10/15/97 1,227,000 272,917 37.48% 62.00% 5.00% Best Western Helena MT 10/15/97 955,000 186,417 42.71% 62.00% 5.00% Best Western Twin Falls ID 10/15/97 604,000 125,083 40.26% 62.00% 5.00% Kahler Hotel Rochester MN 10/15/97 4,126,000 976,667 35.20% 62.00% 5.00% Kahler Inn Rochester MN 10/15/97 1,721,000 302,917 47.33% 62.00% 5.00% Holiday Inn Rochester MN 10/15/97 245,000 221,250 9.24% 62.00% 5.00% Lakeview Resort Morgantown WV 10/15/97 1,042,000 382,167 22.72% 62.00% 5.00% Green Oaks Fort Worth TX 10/15/97 586,000 205,500 23.77% 62.00% 5.00% University Park Salt Lake City UT 10/15/97 2,101,000 380,500 46.02% 62.00% 5.00% Best Western Ogden UT 10/15/97 1,030,000 342,917 25.02% 62.00% 5.00% Provo Park Provo UT 10/15/97 2,040,000 457,500 37.15% 62.00% 5.00% Residence Inn Provo UT 10/15/97 670,000 161,333 34.63% 62.00% 5.00% Kahler Plaza Hotel Rochester MN 10/15/97 2,899,000 571,750 42.25% 62.00% 5.00% Residence Inn Sacramento CA 12/30/97 983,000 189,692 43.17% 60.00% 5.00% Residence Inn San Diego CA 12/30/97 1,393,000 253,583 45.38% 60.00% 5.00%
EX-10.21 6 LIST OF SUBSIDIARIES 1 EXHIBIT 10.21 SUNSTONE HOTEL INVESTORS, INC. LIST OF SUBSIDIARIES OF THE REGISTRANT EXHIBIT
STATE OF NAME OF ENTITY FORMATION Sunstone Hotel Investors, L.P. Delaware Sunstone Hotels, LLC Delaware Kent Hotel Investors, Inc. California Sunstone/Kent Associates, L.P. California Sunstone E&P Corporation I Delaware Sunstone E&P Corporation II Delaware Kahler E&P Partners L.P. I Delaware Kahler E&P Partners L.P. II Delaware Park Hotels L.C. Utah University Inn Associates Utah Ogden Hotel Associates Utah
EX-10.30.18 7 THIRD PARTY PLEDGE AGREEMENT 1 EXHIBIT 10.30.18 THE RIGHTS OF THE HOLDER UNDER THIS AGREEMENT ARE SUBJECT TO A PLEDGE AGREEMENT DATED AS OF MAY 23, 1997 IN FAVOR OF WELLS FARGO BANK, N.A. AMENDED AND RESTATED THIRD PARTY PLEDGE (ALTER/BIEDERMAN:PARTNERSHIP UNITS) THIS AMENDED AND RESTATED THIRD PARTY PLEDGE (this "Agreement") is entered into as of this ____ day of August, 1997, by and between (i) SUNSTONE HOTEL INVESTORS, L.P., a Delaware limited partnership ("Secured Party"), and (ii) ROBERT A. ALTER ("Alter") and RIVERSIDE HOTEL PARTNERS, INC., a California corporation ("Riverside") and CHARLES L. BIEDERMAN ("Biederman") and RIVERSIDE HOTEL PARTNERS INC., a California corporation (collectively, with Biederman and Alter, "Pledgor"). RECITALS: This Agreement is entered into based on the following understandings: A. Alter, Biederman and the Secured Party have entered into a Third Party Pledge Agreement dated as of August 16, 1995 pursuant to which Alter and Biederman have pledged Units to secure the obligations of Sunstone Hotel Properties, Inc., a Colorado corporation ("Lessee") under certain leases (the "Initial Percentage Leases"). Capitalized terms used in this Agreement and not otherwise defined shall have the meaning given them in the Initial Percentage Leases. B. Under the Initial Agreement, Alter and Biederman were required to pledge additional Units in proportion to their ownership interests in the Lessee of 80% and 20% respectively. Because of the significant number of Hotels acquired by the Secured Party, Alter has pledged all of the 385,564 Units he owns directly or indirectly through Riverside. As the Secured Party anticipates additional acquisitions which will exceed the available Units Alter has to pledge under the existing formula, the Company desires to limit this obligation to the Units currently owned by Alter or Riverside (excluding any Units held by the Alter Investment Group, L.P., in which Robert Alter has only a 1% beneficial interest). C. The Lessee has arranged a credit facility with Wells Fargo Bank to provide working capital (the "Credit Facility"). As a condition to providing the Credit Facility, Wells Fargo Bank has required that Alter personally guarantee the obligations of the Lessee and that such guaranty be secured by a first priority lien in Units with a value at all times equal to 1.8 times the maximum available amount under the Credit Facility. The Pledgor and Secured Party desire to enter into this Amended and Restated Third Party Pledge Agreement in order to provide a limitation on the obligations of Alter or Biederman to pledge any additional Units as additional hotels are acquired 1 2 by the Secured Party and leased to the Lessee and to permit the consummation of the Credit Facility with Wells Fargo Bank by agreeing to permit the senior lien in favor of Wells Fargo Bank on the Units. NOW, THEREFORE, for and in consideration of the mutual covenants contained herein and for other valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Secured Party and Pledgor hereby agree as follows: 1. GRANT OF SECURITY INTEREST. a. As security for the performance of Lessee's obligations and liabilities to Secured Party under the Percentage Leases (the "Obligations"), Pledgor hereby pledges, hypothecates and grants to Secured Party a security interest in 481,955 Partnership Units (the "Units," representing 385,564 Units of Alter and 96,391 Units of Biederman, together with, after an occurrence and during the continuance of an Event of Default, any and all proceeds thereof, including without limitation, any and all dividends, income, interest and distributions earned from or attributable to the investment or deposit of the Units (the Units, together with all of the foregoing being collectively referred to herein as the "Security Fund"). Prior to any Event of Default, and after the cure thereof by Lessee (or Alter or Biederman, at their sole election), all dividends, income, interest and/or distributions earned from or attributable to the investment or deposit of the Security Fund shall be payable to Riverside, Alter and Biederman; following an Event of Default such amounts shall be added to and become a part of the Security Fund and shall only be disbursed in accordance with the terms of this Agreement. By its execution of this Agreement, Pledgor acknowledges that it has delivered the Units to Pledge Holder as required by this Agreement. The word "Obligations" is used herein in its most comprehensive sense and includes any and all debts, obligations and liabilities of Lessee under the Percentage Leases heretofore, now or hereafter made, incurred or created, whether voluntary or involuntary and however arising, whether due or not due, absolute or contingent, liquidated or unliquidated, determined or undetermined, and whether Lessee may be liable individually or jointly, or whether recovery upon such Obligations may be or hereafter become unenforceable. b. Pledgor shall execute and deliver to Secured Party such financing and continuation statements covering the Security Fund and take such other actions as Secured Party may from time to time require to perfect and continue the perfection of Secured Party's security interest in the Security Fund. This Agreement constitutes written notice to Sunstone Hotel Investors, L.P. of Secured Party's security interest in the Units as herein described. c. The Pledgor acknowledges and agrees that, as a condition precedent to the Secured Party entering into any additional leases (the "Percentage Leases") with the Lessee, that the Pledgor must execute an amendment to this Agreement amending Exhibit A to list the additional Units being pledged in an amount equal to four (4) months of Base Rent under the new Percentage Lease. References in this Agreement to "Percentage Leases" shall refer to the Initial Percentage Leases and, as and when entered into, subsequent Percentage Leases, each as listed on 2 3 Exhibit "A." Notwithstanding the foregoing, neither Riverside, Alter nor Biederman in their capacity as Pledgor shall have any obligation or duty whatsoever to pledge any additional Units in excess of the following amounts: Alter (and Riverside), 385,564 and Biederman, the lesser of 384,577 or the amount which corresponds to the same percentage of the aggregate Units pledged by the Pledgor as Biederman's ownership interest in the Lessee (currently 20%). 2. CONTINUING AGREEMENT; REVOCATION; OBLIGATION UNDER OTHER AGREEMENTS. This is a continuing agreement and all rights, powers and remedies hereunder shall apply to all past, present and future Obligations of Lessee to Secured Party under the Percentage Leases. 3. OBLIGATIONS JOINT AND SEVERAL; SEPARATE ACTIONS; WAIVER OF STATUTE OF LIMITATIONS; REINSTATEMENT OF LIABILITY. The obligations hereunder are joint and several and independent of the obligations of Lessee, and a separate action or actions may be brought and prosecuted against Pledgor whether action is brought against Lessee or any other person, or whether Lessee or any other person is joined in any such action or actions. Pledgor acknowledges that there are no conditions precedent to the effectiveness of this Agreement, and that this Agreement is in full force and effect and is binding on Pledgor as of the date written below, regardless of whether Secured Party obtains additional collateral or any guaranties from others or takes any other action contemplated by Pledgor. Pledgor waives the benefit of any statute of limitations affecting Pledgor's liability hereunder or the enforcement thereof, and Pledgor agrees that any payment of any Obligations or other act which shall toll any statute of limitations applicable thereto shall similarly operate to toll such statute of limitations applicable to Pledgor's liability hereunder. The liability of Pledgor hereunder shall be reinstated and revived and the rights of Secured Party shall continue if and to the extent for any reason any amount at any time paid on account of the Obligations is rescinded or must be otherwise restored by Secured Party, whether as a result of any proceedings in bankruptcy, insolvency, reorganization or otherwise, all as though such amount had not been paid. The determination as to whether any amount so paid must be rescinded or restored shall be made by Secured Party in its sole discretion; provided, however, that if Secured Party chooses to contest any such matter at the request of Pledgor, Pledgor agrees to indemnify and hold Secured Party harmless from and against all costs and expenses, including reasonable attorneys' fees, expended or incurred by Secured Party in connection therewith, including without limitation, in any litigation with respect thereto. 4. REPRESENTATIONS AND WARRANTIES. a. Pledgor represents and warrants to Secured Party that: (i) Pledgor is the owner directly or indirectly and has possession or control of the Units; (ii) Pledgor has the right to pledge the Units; (iii) the Units are genuine, free from liens, adverse claims, setoffs, default, prepayment, defenses and conditions precedent of any kind or character, except as heretofore disclosed to Secured Party in writing; (iv) specifically with respect to Units consisting of investment securities, instruments, chattel paper, documents, contracts, insurance policies or any like property, all persons appearing to be obligated thereon have authority and capacity to contract and are bound 3 4 as they appear to be, and the same comply with applicable laws concerning form, content and manner of preparation and execution; (v) all statements contained herein and, where applicable, in the Units are true and complete; and (vi) except as disclosed to Secured Party, no financing statement covering any of the Units and naming any secured party other than Secured Party, is on file in any public office. b. Pledgor further represents and warrants to Secured Party that: (i) the Units pledged hereunder is so pledged at Lessee's request; (ii) Secured Party has made no representation to Pledgor as to the creditworthiness of Lessee; and (iii) Pledgor has established adequate means of obtaining from Lessee on a continuing basis financial and other information pertaining to Lessee's financial condition. Pledgor agrees to keep adequately informed from such means of any facts, events or circumstances which might in any way affect Pledgor's risks hereunder, and Pledgor further agrees that Secured Party shall have no obligation to disclose to Pledgor any information or material about Lessee which is acquired by Secured Party in any manner. 5. COVENANTS OF PLEDGOR. a. Pledgor Agrees in General: (i) to indemnify Secured Party against all losses, claims, demands, liabilities and expenses of every kind caused by property subject hereto; (ii) to pay all costs and expenses, including reasonable attorneys' fees, incurred by Secured Party any time after the occurrence of an Event of Default in the realization, enforcement and exercise of its rights, powers and remedies hereunder; (iii) to permit Secured Party to exercise its powers; (iv) to execute and deliver such documents as Secured Party deems necessary to create, perfect and continue the security interests contemplated hereby; and (v) not to change its chief place of business or the place where Pledgor keeps any records concerning the Units without first giving Secured Party written notice of the address to which Pledgor is moving same. b. Pledgor Agrees with regard to the Security Fund: (i) not to permit any lien on the Security Fund except in favor of Secured Party and any lien in favor of Wells Fargo Bank to secure the Guaranty of Alter of the obligations of Lessee under the Credit Facility (the "Senior Lien"); (ii) not to withdraw any funds from any deposit account pledged to Secured Party hereunder without Secured Party's prior written consent; (iii) not to sell, hypothecate or otherwise dispose of any of the Units or any interest therein except with respect to the Senior Lien, without the prior written consent of Secured Party; (iv) to keep, in accordance with generally accepted accounting principles, complete and accurate records regarding all Units and to permit Secured Party to inspect the same at any reasonable time; (v) if requested by Secured Party following an Event of Default under any Percentage Lease, to receive and use reasonable diligence to collect proceeds from the Units, in trust and as part of the Security Fund to be held in accordance with Section l(a) above; (vi) not to commingle Units with other property; (vii) to provide any service and do any other acts or things necessary to keep the Units free and clear of all defenses, rights of offset and counterclaims; and (viii) if the Units consists of securities and so long as no Event of Default exists, to vote said securities and to give consents, waivers and ratifications with respect thereto, provided that no vote shall be cast or consent, waiver or ratification given or action taken which would impair Secured 4 5 Party's interest in the Security Fund or be inconsistent with or violate any provisions of this Agreement. 6. POWERS OF SECURED PARTY. Pledgor appoints Secured Party its true attorney in fact to perform any of the following powers, which are coupled with an interest, are irrevocable until termination of this Agreement and may be exercised from time to time by Secured Party's officers and employees: (a) to perform any obligation of Pledgor hereunder in Pledgor's name or otherwise; (b) to notify any person obligated on any security, instrument or other document subject to this Agreement of Secured Party's rights hereunder; (c) to collect by legal proceedings or otherwise all dividends, interest, principal or other sums now or hereafter payable upon or on account of the Security Fund; (d) to enter into any extension, reorganization, deposit, merger or consolidation agreement, or any other agreement relating to or affecting the Security Fund and in connection therewith to deposit or surrender control of the Security Fund to accept other property in exchange for the Security Fund, and to do and perform such acts and things as Secured Party may deem proper, with any money or property received in exchange for the Security Fund at Secured Party's option, to be applied to the Obligations or held by Secured Party under this Agreement; (e) to make any compromise or settlement Secured Party deems desirable or proper in respect of the Security Fund; (f) to insure, process and preserve the Security Fund; (g) to exercise all rights, powers and remedies which Pledgor would have, but for this Agreement, under all the Units subject to this Agreement; (h) to do all acts and things and execute all documents in the name of Pledgor or otherwise, deemed by Secured Party as necessary, proper or convenient in connection with the preservation, perfection or enforcement of its rights hereunder; and (i) to execute and file in Pledgor's name any financing statements and amendments thereto required to perfect Secured Party's security interest hereunder; provided, however, that until the occurrence and only during the continuation of an Event of Default shall have Secured Party have the right to exercise the power of attorney for the purposes described in paragraphs (a), (c), (d), (e), (f), (g), or (h). If an Event of Default has occurred and is continuing, any or all Security Fund consisting of securities may be registered, without notice, in the name of Secured Party or its nominee, and thereafter Secured Party or its nominee may exercise, without notice, all voting and partnership rights at any meeting of the partners of the issuer thereof, any and all rights of conversion, exchange or subscription, or any other rights, privileges or options pertaining to any Units all as if it were the absolute owner thereof. The foregoing shall include, without limitation, the right of Secured Party or its nominee to exchange, at its discretion, any and all Units upon the merger, consolidation, reorganization, recapitalization or other readjustment of the issuer thereof, or upon the exercise by the issuer thereof or Secured Party of any right, privilege or option pertaining to any Units and in connection therewith, the right to deposit and deliver any and all of the Units with any committee, depository, transfer agent, registrar or other designated agent upon such terms and conditions as Secured Party may determine. All of the foregoing rights, privileges or options may be exercised without liability except to account for property actually received by Secured Party. Secured Party shall have no duty to exercise any of the foregoing, or any other rights, privileges or options with respect to the Units and shall not be responsible for any failure to do so or delay in so doing. 5 6 7. CASH COLLATERAL ACCOUNT. Any money received by Secured Party in respect of the Security Fund will be retained in an interest bearing cash collateral account and the same shall, for all purposes, be deemed collateral hereunder. 8. SECURED PARTY'S CARE AND DELIVERY OF UNITS. a. Secured Party's obligation with respect to Security Fund in its possession shall be strictly limited to the duty to exercise reasonable care in the custody and preservation of the Security Fund, and such duty shall not include any obligation to ascertain or to initiate any action with respect to or to inform Pledgor of maturity dates, conversion, call or exchange rights, or offers to purchase the Units or any similar matters, notwithstanding Secured Party's knowledge of the same. Secured Party shall have no duty to take any steps necessary to preserve the rights of Pledgor against prior parties, or to initiate any action to protect against the possibility of a decline in the market value of the Units. Secured Party shall not be obligated to take any actions with respect to the Units requested by Pledgor unless such request is made in writing and Secured Party determines, in its sole discretion, that the requested action would not unreasonably jeopardize the value of the Units as security for the Obligations. Secured Party may at any time deliver the Security Fund, or any part thereof, to Pledgor, and the receipt thereof by Pledgor shall be a complete and full acquittance for the Security Fund so delivered, and Secured Party shall thereafter be discharged from any liability or responsibility therefor. b. Promptly following the third anniversary of the Percentage Lease to which the Units pledged pursuant hereto relate, as set forth on Exhibit A from time to time (or upon an earlier termination of the applicable Percentage Lease, including a termination resulting from a sale of the applicable hotel), and provided there is then existing no Event of Default under any Percentage Lease (and following any cure of such Event of Default if one then exists), Secured Party shall return the Units corresponding to such Percentage Lease to Pledgor (according to the respective interest in such Units of Alter and Biederman). 9. PLEDGOR'S WAIVERS. a. Pledgor waives any right to require Secured Party to: (i) proceed against any person, including Lessee; (ii) proceed against or exhaust any security held from Lessee; (iii) give notice of the terms, time and place of any public or private sale of personal property security held from Lessee or any other person or otherwise comply with any other provisions of Section 9504 of the California Uniform Commercial Code; (iv) pursue any other remedy in Secured Party's power; or (v) make any presentments or demands for performance, or give any notices of nonperformance, protests, notices of protest or notices of dishonor in connection with any obligations or evidences of indebtedness held by Secured Party as security or which constitute in whole or in part the Obligations secured hereunder, or in connection with the creation of new or additional Obligations. 6 7 b. Pledgor waives any defense arising by reason of: (i) any disability or other defense of Lessee or any other person; (ii) the cessation or limitation from any cause whatsoever, other than payment in full, of the Obligations of Lessee or any other person; (iii) any lack of authority of any officer, director, partner, agent or any other person acting or purporting to act on behalf of Lessee which is a corporation, partnership or other type of entity, or any defect in the formation of Lessee; (iv) any act or omission by Secured Party which directly or indirectly results in or aids the discharge of Lessee or any Obligations by operation of law or otherwise; or (v) any modification of the Obligations, in any form whatsoever, including any modification made after revocation hereof to any Obligations incurred prior to such revocation, and including without limitation the renewal, extension, acceleration or other change in time for payment of the Obligations, or other change in the terms of the Obligations, or any part thereof. Until all Obligations shall have been paid in full, Pledgor shall have no right of subrogation, and Pledgor waives any defense Pledgor may have based upon an election of remedies by Secured Party which destroys Pledgor's subrogation rights or Pledgor's rights to proceed against Lessee for reimbursement, including without limitation, any loss of rights Pledgor may suffer by reason of any rights, powers or remedies of Lessee in connection with any anti-deficiency laws or any other laws limiting, qualifying or discharging Lessee's Obligations (including without limitation, Sections 726 and 580d of the California Code of Civil Procedure as from time to time amended). Until all Obligations of Lessee to Secured Party shall have been paid in full, Pledgor further waives any right to enforce any remedy which Secured Party now has or may hereafter have against Lessee or any other person, and waives any benefit of, or any right to participate in, any security whatsoever now or hereafter held by Secured Party. 10. AUTHORIZATIONS TO SECURED PARTY. Pledgor authorizes Secured Party either before or after revocation hereof, without notice or demand and without affecting Pledgor's liability hereunder, from time to time to: (a) alter, compromise, renew, extend, accelerate or otherwise change the time for payment of, or otherwise change the terms of the Obligations or any part thereof; (b) take and hold security, other than the Units, for the payment of the Obligations or any part thereof and exchange, enforce, waive and release the Units, or any part thereof, or any such other security; (c) apply the Units or any other security and direct the order or manner of sale thereof, including without limitation, a non-judicial sale permitted by the terms of this Agreement, as Secured Party in its discretion may determine; (d) release or substitute any one or more of the endorsers or guarantors of the Obligations, or any part thereof, or any other parties thereto; and (e) apply payments received by Secured Party from Lessee to any Obligations of Lessee to Secured Party, in such order as Secured Party shall determine in its sole discretion, whether or not any such Obligations is covered by this Agreement, and Pledgor hereby waives any provision of law regarding application of payments which specifies otherwise. 11. PAYMENT OF TAXES, CHARGES, LIENS AND ASSESSMENTS. Pledgor agrees to pay, prior to delinquency, all taxes, charges, liens and assessments against the Security Fund, and upon the failure of Pledgor to do so, Secured Party at its option may pay any of them and shall be the sole judge of the legality or validity thereof and the amount necessary to discharge the same. Any such payments made by Secured Party shall be obligations of Pledgor to Secured Party, 7 8 due and payable immediately upon demand, together with interest at a rate determined in accordance with the provisions of Section 15 herein, and shall be secured by the Security Fund, subject to all terms and conditions of this Agreement. 12. EVENTS OF DEFAULT. The occurrence of any of the following shall constitute an "Event of Default" under this Agreement: (a) any default in the payment or performance of any obligation, or any defined event of default, after any applicable cure or grace period under any Percentage Lease which has not been cured by Pledgor within 10 days of the date such cure period of Lessee expired; (b) any representation or warranty made by Pledgor herein shall prove to be incorrect in any material respect when made; (c) Pledgor shall fail to observe or perform any obligation or agreement contained herein after Secured Party has provided written notice describing such failure and Pledgor has failed within thirty (30) days of receipt of such notice to cure such failure, provided if such cure cannot be completed within such thirty (30) day period, then such cure period shall be extended for so long as Pledgor is diligently prosecuting such cure to completion up to a maximum of ninety (90) days; and (d) any event of default under the Credit Facility. 13. REMEDIES. Upon the occurrence of any Event of Default, Secured Party shall have and may exercise without demand any and all rights, powers, privileges and remedies granted to a secured party upon default under the California Uniform Commercial Code or otherwise provided to Secured Party by law. All rights, powers, privileges and remedies of Secured Party shall be cumulative. Secured Party may exercise its right of setoff with respect to the Obligations in the same manner as if the Obligations were unsecured. No delay, failure or discontinuance of Secured Party in exercising any right, power, privilege or remedy hereunder shall affect or operate as a waiver of such right, power, privilege or remedy; nor shall any single or partial exercise of any such right, power, privilege or remedy preclude, waive or otherwise affect any other or further exercise thereof or the exercise of any other right, power, privilege or remedy. Any waiver, permit, consent or approval of any kind by Secured Party of any default hereunder, or any such waiver of any provisions or conditions hereof, must be in writing and shall be effective only to the extent set forth in writing. While an Event of Default exists: (a) Secured Party may, at any time and at Secured Party's sole option, liquidate any time deposits pledged to Secured Party hereunder, whether or not said time deposits have matured and notwithstanding the fact that such liquidation may give rise to penalties for early withdrawal of funds; (b) Secured Party may appropriate the Security Fund and apply all proceeds toward repayment of the Obligations in such order as Secured Party may from time to time elect or, at Secured Party's sole option, place any proceeds in the cash collateral account; and (c) at Secured Party's request, Pledgor will assemble and deliver all Units, and books and records pertaining thereto, to Secured Party at a reasonably convenient place designated by Secured Party. It is agreed that public or private sales, for cash or on credit, to a wholesaler or retailer or investor, or user of property of the types subject to this Agreement, or public auction, are all commercially reasonable since differences in the sales prices generally realized in the different kinds of sales are ordinarily offset by the differences in the costs and credit risks of such sales. For any Units consisting of securities, Secured Party shall be under no obligation to delay a sale of any portion thereof for the period of time necessary to permit the issuer thereof to register such securities for public sale under any applicable state or federal law, even if the issuer thereof would agree to do so. 8 9 14. DISPOSITION OF UNITS. Secured Party shall not transfer all or any part of the Units or Security Fund except in connection with the exercise of remedies as provided in Section 13 above. Any proceeds of any disposition of any of the Units or any part thereof, shall be applied by Secured Party to the payment of expenses incurred by Secured Party in connection with the foregoing, including reasonable attorneys' fees, and the balance of such proceeds shall be applied by Secured Party toward the payment of the Obligations in such order of application as Secured Party may from time to time elect. 15. COSTS, EXPENSES AND ATTORNEYS' FEES. Pledgor shall pay to Secured Party immediately upon demand the full amount of all payments, advances, charges, costs and expenses, including reasonable attorneys' fees incurred by Secured Party after the occurrence and during the continuance of any Event of Default in exercising any right, power, privilege or remedy conferred by this Agreement or in the enforcement thereof, including any of the foregoing incurred in connection with any bankruptcy proceeding relating to Pledgor or the valuation of the Units including without limitation, the seeking of relief from or modification of the automatic stay or the negotiation and drafting of a cash collateral order. All of the foregoing shall be paid to Secured Party by Pledgor with interest at a rate per annum equal to the lesser of ten percent (10%) or the maximum rate permitted by law. 16. GOVERNING LAW; SUCCESSORS, ASSIGNS. This Agreement shall be governed by and construed in accordance with the laws of the State of California, and shall be binding upon and inure to the benefit of the heirs, executors, administrators, legal representatives, successors and assigns of the parties. 17. SEVERABILITY OF PROVISIONS. If any provision of this Agreement shall be held to be prohibited by or invalid under applicable law, such provision shall be ineffective only to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or any remaining provisions of this Agreement. 18. AMENDMENT AND RESTATEMENT. This Agreement amends and restates and supersedes in its entirety the Third Party Pledge Agreement dated as of August 16, 1995. IN WITNESS WHEREOF, this Agreement has been duly executed as of the date first written above. PLEDGOR /S/ ROBERT A. ALTER ---------------------------------- Robert A. Alter /S/ CHARLES L. BIEDERMAN ---------------------------------- Charles L. Biederman 9 10 RIVERSIDE HOTEL PARTNERS, INC., a California corporation By: /s/ROBERT A. ALTER ------------------ Robert A. Alter By: /s/CHARLES BIEDERMAN -------------------- Charles Biederman SECURED PARTY SUNSTONE HOTEL INVESTORS, L.P., a Delaware limited partnership By: Sunstone Hotel Investors, Inc., a Maryland corporation By: /s/ROBERT A. ALTER ------------------ Its: President 10 11 EXHIBIT A
Percentage Leases & Pledge of Units FOUR Number of THIRD INITIALS PERCENTAGE MONTHS Allocable ANNIVERSARY OF LEASE BASE RENT PLEDGED UNITS DATE PLEDGOR - ----- --------- ------------- ---- ------- Hampton Inn - $188,750 19,868 August 16, 1998 RAA/CLB Denver S.E., CO Hampton Inn - 150,000 15,790 August 16, 1998 RAA/CLB Pueblo, CO Courtyard by Marriott - 135,000 14,211 August 16, 1998 RAA/CLB Fresno, CA Hampton Inn - 158,667 16,702 August 16, 1998 RAA/CLB Mesa, AZ Holiday Inn - 125,000 13,158 August 16, 1998 RAA/CLB Steamboat Springs, CO Holiday Inn - 142,000 14,947 August 16, 1998 RAA/CLB Craig, CO Holiday Inn - 53,333 5,614 August 16, 1998 RAA/CLB Provo, UT Hampton Inn - 161,000 16,947 August 16, 1998 RAA/CLB Silverthorne, CO Best Western - 220,000 23,158 August 16, 1998 RAA/CLB Santa Fe, NM Hampton Inn - 132,000 13,895 August 16, 1998 RAA/CLB Arcadia, CA Hampton Inn - 139,333 13,933 December 13, 1998 RAA/CLB Oakland, CA Holiday Inn - 189,000 17,182 February 2, 1999 RAA/CLB Kent, WA Holiday Inn - 107,917 9,811 February 2, 1999 RAA/CLB Poulsbo, WA Hampton Inn - 145,667 13,242 February 2, 1999 RAA/CLB Clackamas, WA
11 12
FOUR Number of THIRD INITIALS PERCENTAGE MONTHS Allocable ANNIVERSARY OF LEASE BASE RENT PLEDGED UNITS DATE PLEDGOR - ----- --------- ------------- ---- ------- Holiday Inn - 121,000 11,000 February 2, 1999 RAA/CLB Portland, OR Courtyard By Marriott - 142,000 14,025 April 1, 1999 RAA/CLB Riverside, CA Holiday Inn Select - 270,000 24,828 June 28, 1999 RAA/CLB Renton, WA Comfort Suites - 240,000 24,615 August 13, 1999 RAA/CLB So. San Francisco, CA Days Inn - 90,000 9,231 August 13, 1999 RAA/CLB Price, UT Residence Inn - 100,000 9,524 September 20, 1999 RAA/CLB Highlands Ranch, CO Holiday Inn - 100,000 9,090 October 29, 1999 RAA/CLB Flagstaff, Arizona Holiday Inn - 268,666 24,424 October 29, 1999 RAA/CLB Mesa, Arizona Hampton Inn - 115,400 10,455 October 29, 1999 RAA/CLB Tucson, Arizona Radisson Suite - 363,400 29,665 December 19, 1999 RAA/CLB Oxnard, California Ramada Hotel - 335,530 25,810 January 17, 2000 RAA/CLB Cypress, CA Holiday Inn Harbor View - $289,033 22,233 January 17, 2000 RAA/CLB San Diego, CA Hawthorn Suites - $367,533 26,479 March 10, 2000 RAA/CLB Kent, WA Holiday Inn - $501,992 38,232 March 31, 2000 RAA/CLB La Mirada, CA Fountain Suites - $528,900 39,529 May 6, 2000 RAA/CLB Sacramento, CA
12 13
FOUR Number of THIRD INITIALS PERCENTAGE MONTHS Allocable ANNIVERSARY OF LEASE BASE RENT PLEDGED UNITS DATE PLEDGOR - ----- --------- ------------- ---- ------- Ramada Plaza - $387,000 29,208 June 11, 2000 RAA/CLB Old Town - San Diego, CA COMBINED TOTALS: $6,268,121 556,806* ========== =======
* Maximum number of units pledged is 481,955 pursuant to Section 1(a) of the Agreement. 13 EX-10.31.1 8 REVOLVING CREDIT AGREEMENT 1 EXHIBIT 10.31.1 FIRST AMENDMENT TO AMENDED AND RESTATED REVOLVING CREDIT AGREEMENT THIS FIRST AMENDMENT TO AMENDED AND RESTATED REVOLVING CREDIT AGREEMENT ("Amendment") is dated as of January 26, 1998, among SUNSTONE HOTEL INVESTORS, L.P., a Delaware limited partnership, as the Borrower, BANK ONE, ARIZONA, NA, as a Lender, as Issuing Bank, as Administrative Agent and as Co-Agent, CREDIT LYONNAIS NEW YORK BRANCH, as a Lender, as Documentation Agent and as Co-Agent, WELLS FARGO BANK, NATIONAL ASSOCIATION, as a Lender, as Syndication Agent and as Co-Agent, DRESDNER BANK AG, NEW YORK AND GRAND CAYMAN BRANCHES, as a Lender, and SOCIETE GENERALE, SOUTHWEST AGENCY, as a Lender. W I T N E S S E T H: WHEREAS, the parties hereto have entered into that certain Amended and Restated Revolving Credit Agreement dated as of October 10, 1997 (the "Credit Agreement") providing for loans to the Borrower not to exceed $200,000,000 at any time outstanding; and WHEREAS, the parties desire to amend the Credit Agreement to increase the total Commitments to $300,000,000 and to modify certain other provisions of the Credit Agreement, all on and subject to the terms and conditions hereinafter set forth. NOW, THEREFORE, in consideration of the covenants and agreements herein contained, the parties hereto amend the Credit Agreement, and covenant and agree, as follows: 1. Defined Terms. 1.1 Terms used herein and not defined herein shall have the meanings provided therefor in the Credit Agreement. 1.2 The definitions of the following terms in the Credit Agreement are hereby amended as follows: (a) The definition of the term "Aggregate Value" is hereby amended and restated in its entirety as follows: "Aggregate Value" means, with respect to an Eligible Hotel, at any date, the aggregate value thereof to be calculated as follows: (a) For a Seasoned Property or a Special Property, (i) the Adjusted NOI for such Seasoned Property or Special Property 2 for the preceding four (4) Fiscal Quarters divided by (ii) ten and one-half percent (10.5%); and (b) For a New Property (other than a Special Property), the Borrower's Investment in such New Property. (b) The definition of the term "Applicable Letter of Credit Rate" is hereby amended and restated in its entirety as follows: "Applicable Letter of Credit Rate" means one and four-tenths percent (1.40%) per annum. (c) The definition of the term "Applicable Margin" is hereby amended and restated in its entirety as follows: "Applicable Margin" means, (a) with respect to each Loan made, continued or converted at any date prior to the first Pricing Date occurring after December 31, 1997, (i) 0.375% with respect to Base Rate Loans and (ii) 1.8% with respect to Eurodollar Rate Loans; (b) with respect to each Loan made, continued or converted at any date from and after the first Pricing Date occurring after December 31, 1997, the applicable percentage per annum set forth below based upon the Status in effect at the time such Loan is made, continued or converted, it being understood that the Applicable Margin for (i) Base Rate Loans shall be the percentage set forth under the column "Base Rate Loans," and (ii) Eurodollar Rate Loans shall be the percentage set forth under the column "Eurodollar Rate Loans;" and (c) with respect to the Unused Commitment Fee from and after the first Pricing Date occurring after December 31, 1997, the applicable percentage per annum set forth below under the column, "Unused Commitment Fee," based upon the Status then in effect. 2 3
Unused Base Rate Eurodollar Commitment Loans Rate Loans Fee --------- ---------- ---------- Level I Status 0.0% 1.00% 0.125% Level II Status 0.0% 1.125% 0.15% Level III Status 0.0% 1.25% 0.15% Level IV Status 0.0% 1.375% 0.20% Level V Status 0.0% 1.40% 0.20% Level VI Status 0.0% 1.50% 0.20% Level VII Status 0.125% 1.625% 0.25% Level VIII Status 0.25% 1.75% 0.30%
(d) The definition of the term "Borrowing Base" is hereby amended by changing the reference "40%" to "45%." (e) The definition of the term "Debt Service Coverage Ratio" is hereby deleted. (f) The definition of the term "Eligible Hotels" is hereby amended by changing the reference "ten percent (10%)" in subparagraph (ii)(E) to "fifteen percent (15%)." (g) The definition of the term "Minimum Tangible Net Worth" is hereby amended and restated in its entirety as follows: "Minimum Tangible Net Worth" means, with respect to the Borrower, at any time, the sum of $370,000,000 plus (a) 85% of the aggregate net proceeds received by Sunstone or any of its Subsidiaries after December 31, 1997 in connection with any offering of Stock or Stock Equivalents of Sunstone or its Subsidiaries taken as a whole and (b) 85% of the consideration for any partnership interests in Borrower issued for the acquisition of a Hotel or any interest in a Hotel permitted hereunder. 3 4 (h) The definition of the term "Status" is hereby amended and restated in its entirety as follows: "Status" means the existence of Level I Status, Level II Status, Level III Status, Level IV Status, Level V Status, Level VI Status, Level VII Status or Level VIII Status, as the case may be. As used in this definition (and subject to the provisions set forth below): "Level I Status" exists at any date if, at such date, Sunstone has a long-term senior unsecured actual or implied debt rating of A- or better by S&P and A3 or better by Moody's; "Level II Status" exists at any date if, at such date, Sunstone has a long-term senior unsecured actual or implied debt rating of BBB+ by S&P and Baa1 by Moody's; "Level III Status" exists at any date if, at such date, Sunstone has a long-term senior unsecured actual or implied debt rating of BBB by S&P and Baa2 by Moody's; "Level IV Status" exists at any date if, at such date, Sunstone has a long-term senior unsecured actual or implied debt rating of BBB- by S&P and Baa3 by Moody's; "Level V Status" exists at any date if, at such date, (i) neither Level IV Status nor any Status above Level IV Status exists and (ii) Sunstone has a Leverage Ratio of less than 25%; "Level VI Status" exists at any date if, at such date, (i) neither Level IV Status nor any Status above Level IV Status exists and (ii) Sunstone has a Leverage Ratio of 25% or more but less than 35%: "Level VII Status" exists at any date if, at such date, (i) neither Level IV Status nor any Status above Level IV Status exists and (ii) Sunstone has a Leverage Ratio of 35% or more, but less than 40%; and 4 5 "Level VIII Status" exists at any date if, at such date, (i) neither Level IV Status nor any Status above Level IV Status exists and (ii) Sunstone has a Leverage Ratio of 40% or more, but less than 45%. The determination of Status shall be subject to the following: (i) if S&P and/or Moody's shall cease to issue ratings of debt securities of REITs generally or (after issuing ratings with respect to Sunstone) shall cease to issue ratings with respect to Sunstone, then the Administrative Agent and the Borrower shall negotiate in good faith to agree upon a substitute rating agency or agencies (and to correlate the system of ratings of each substitute rating agency with that of the rating agency for which it is substituting) and (a) until such substitute rating agency or agencies are agreed upon, Status (to the extent based upon such ratings) shall be determined on the basis of the rating assigned by the other rating agency, and if both S&P and Moody's shall have ceased to issue such ratings, Status shall be determined based on the Leverage Ratio (and accordingly shall not be higher than Level V Status) and (b) after such substitute rating agency or agencies are agreed upon, Status (to the extent based upon such ratings) shall be determined on the basis of the rating assigned by the other rating agency and such substitute rating agency or the two substitute rating agencies, as the case may be; (ii) if the long-term senior unsecured actual or implied debt ratings of Sunstone by S&P and Moody's (or, if applicable, any substitute agency or agencies designated as provided in clause (i)) are not equivalent, the lower rating will apply for the purposes of determining Status (to the extent that Status is based upon such ratings); (iii) if the long-term senior unsecured actual or implied debt ratings of Sunstone by S&P and Moody's (or, if applicable, any substitute agency or agencies designated as provided in clause 5 6 (i)) are two or more Levels apart, the rating one Level above the lower rating will apply for the purposes of determining Status (to the extent that Status is based upon such ratings); (iv) the initial determination of Status pursuant hereto shall be effective from and after the first Pricing Date occurring after December 31, 1997; (v) changes in Status resulting from a change in the unsecured actual or implied debt ratings of Sunstone shall be effective on the first Business Day following any such change; and (vi) changes in Status resulting from a change in the Leverage Ratio shall be effective on the Pricing Date next following the applicable Fiscal Quarter with respect to which such Leverage Ratio is determined. 1.3 The following terms have the following meanings when used in the Credit Agreement as amended hereby: "Leverage Ratio" means, at the end of any Fiscal Quarter from and after the Fiscal Quarter ending December 31, 1997, the ratio (expressed as a percentage) of (a) the Total Indebtedness of Sunstone at the end of such Fiscal Quarter to (b) the Total Hotel Value at the end of such Fiscal Quarter. "Preferred Debt Service Coverage Ratio" has the meaning provided therefor in Section 6.2. "Pricing Date" means, with respect to any determination of Status based on the Leverage Ratio, the first day of the calendar month next following the date on which the Borrower is required to deliver to the Administrative Agent the quarterly financial statements provided for in Section 7.11(a) for the Fiscal Quarter with respect to which the Leverage Ratio is to be so determined and the Compliance Certificate provided for in Section 7.11(e) setting forth the Leverage Ratio as of the end of such Fiscal Quarter; provided that (i) if any of such quarterly financial statements or Compliance Certificate are delivered to the Administrative Agent later than the date on which required to be delivered and the Leverage Ratio determined pursuant thereto would result in a change in Status to a higher level, the Pricing Date shall not occur until the tenth day following the Administrative 6 7 Agent's receipt thereof and (ii) if the annual audited financial statements delivered by the Borrower pursuant to Section 7.11(b) for any Fiscal Year evidence a Leverage Ratio for the fourth quarter of such Fiscal Year that would result in a Status that is different than the Status evidenced by the quarterly financial statements for the fourth Fiscal Quarter of such Fiscal Year delivered by the Borrower, Status shall be adjusted to conform to the Leverage Ratio determined on the basis of such annual audited financial statements from and after the tenth day following the Administrative Agent's receipt of such annual audited financial statements and, if such adjustment results in a Status at a lower level than in effect since the most recent Pricing Date, such adjustment shall be retroactive to such Pricing Date, in which event the Borrower shall pay to the Administrative Agent on demand any additional interest resulting from such retroactive adjustment. "Special Property" means an Eligible Hotel that is designated by the Borrower as a "Special Property" in accordance with the provisions of Section 7.23(h). "Total Hotel Value" means, at any date, the aggregate value of all Hotels owned by the Borrower or any of its direct or indirect wholly-owned Subsidiaries, such value to be calculated as follows: (a) For all Seasoned Properties, (i) the Adjusted NOI for such Seasoned Properties for the preceding four (4) Fiscal Quarters divided by (ii) ten and one-half percent (10.5%); and (b) For all New Properties, the Borrower's Investment in such New Properties. "Unused Commitment Fee Rate" means (i) until the first Pricing Date to occur after December 31, 1997, 0.25% per annum and (ii) from and after the first Pricing Date to occur after December 31, 1997, a rate per annum equal to the Applicable Margin with respect to the Unused Commitment Fee. 2. Increase of Commitments. The aggregate amount of the Commitments is hereby increased to $300,000,000, and from and after the date hereof the Commitment of each Lender is as set 7 8 forth in Schedule II attached hereto and hereby incorporated herein, which replaces Schedule II to the Credit Agreement. 3. Unused Commitment Fee. Section 2.4(a) is hereby amended by changing the reference "0.25%" to "the Unused Commitment Fee Rate on the date on which such payment is due." 4. Trigger Date. Section 3.4(a) is amended and restated in its entirety as follows: (a) In the event that, at the end of any Fiscal Quarter (the "Trigger Date") commencing with the Fiscal Quarter ending on December 31, 1997, the Borrower shall fail to maintain an Interest Coverage Ratio of 2.5 to 1.0 or a Preferred Debt Service Coverage Ratio of 2.0 to 1.0, such failure shall not constitute an Event of Default if and for as long as (i) the Borrower shall maintain an Interest Coverage Ratio of not less than 2.0 to 1.0 and a Preferred Debt Service Coverage Ratio of not less than 1.5 to 1.0 and (ii) the Borrower shall or shall cause Sunstone or the Eligible Hotel Owners (as applicable) to execute and deliver to the Administrative Agent with respect to each of the Eligible Hotels (A) within seventy-five (75) days of the Trigger Date, the documents set forth in Section 3.4(b) and (B) within 135 days of the Trigger Date, the documents set forth in Section 3.4(c). 5. Facility Letters of Credit. Section 4.2(ii) is hereby amended by changing the reference "$15,000,000" to "$30,000,000" and the reference "$20,000,000" to "$40,000,000." 6. Use of Proceeds. Section 5.18 is hereby amended by changing the reference "$20,000,000" to "$40,000,000." 7. Financial Covenants. (a) Section 6.1 is hereby amended by changing the reference "3.0 to 1.0" to "2.5 to 1.0." (b) Section 6.2 is hereby amended and restated in its entirety as follows: 6.2 Preferred Debt Service Coverage Ratio. Sunstone shall maintain at the end of each 8 9 Fiscal Quarter, commencing with the Fiscal Quarter ending December 31, 1997, a ratio ("Preferred Debt Service Coverage Ratio") of (a) Adjusted EBITDA to (b) the sum of (i) Debt Service and (ii) dividends paid by Sunstone on any of its preferred Stock, in each case determined on the basis of the four (4) Fiscal Quarters ending on the date of determination, of not less than 2.0 to 1.0, except as otherwise provided in Section 3.4(a). (c) Section 6.4 is hereby amended (i) by changing in subparagraph (i) thereof the phrase "multiplied by four (4)" to "multiplied by four and one-half (4-1/2)" and (ii) by changing, in both subparagraph (i) and subparagraph (ii) thereof, the references "forty percent (40%)" to "forty-five percent (45%)." (d) Section 6.7 is hereby amended by changing the reference "85%" to "90%." 8. Financial Statements. (a) Section 7.11(a) is hereby amended by changing the phrase "each of the first three Fiscal Quarters of each Fiscal Year" to "each Fiscal Quarter." (b) After the date of this Amendment, each Compliance Certificate delivered shall reflect the amendments to the Credit Agreement provided for herein, all in a manner satisfactory to the Required Lenders, and, without limitation of the foregoing, shall include calculations of the Leverage Ratio, Preferred Debt Service Coverage Ratio and Total Hotel Value and the identification of any Eligible Hotels that are designated as Special Properties. (c) Section 7.11(d) is hereby amended by adding the following provision immediately following clause (ii) thereof: and (iii) financial projections for each of the succeeding four Fiscal Quarters, including projected balance sheets at the end of each such Fiscal Quarter, projected statements of income and cash flow for each such Fiscal Quarter and projected compliance with covenants hereunder at the end of each such Fiscal Quarter; 9. Borrowing Base Determination/Requirements. The following is hereby added to the Agreement as Section 7.23(h): 9 10 (h) Prior to the date on which, by reason of the duration of ownership thereof by the applicable Eligible Hotel Owner, a Renovating Property ceases to be a Renovating Property or any other New Property ceases to be a New Property, the Borrower may designate such Renovating Property or other New Property as a "Special Property" on and subject to the following terms and conditions: (i) Such designation shall be made in writing and delivered to the Administrative Agent prior to or along with the first Compliance Certificate delivered to the Administrative Agent that sets forth the Aggregate Value of such Eligible Hotel as determined as a Special Property; (ii) Such designation shall be irrevocable, and such Eligible Hotel shall from and after such designation continue to be a Special Property until such time as it becomes a Seasoned Property; (iii) The designation of such Eligible Hotel as a Special Property shall be solely for the purpose of determining the Aggregate Value of such Eligible Hotel and shall not otherwise affect such Eligible Hotel's status as a Renovating Property or other New Property hereunder; and (iv) A Renovating Property may not be designated as a Special Property prior to the last day of the Fiscal Quarter in which the renovation of such Renovating Property is substantially completed. 10. Additional Indebtedness. The following new Section 7.24 is hereby added to the Credit Agreement: 7.24 Approval of Additional Indebtedness. In the event that the Borrower desires to seek from the Lenders approval of any proposed Indebtedness not permitted under the provisions of Section 8.2, the Borrower 10 11 shall furnish to the Lenders such information as the Lenders may request with respect thereto, which may include without limitation (a) a summary of the terms and conditions of such proposed Indebtedness; (b) a pro forma Compliance Certificate prepared taking into account such proposed Indebtedness; (c) a pro forma calculation with respect to the Borrower's compliance with the covenants intended to be included in such proposed Indebtedness; (d) a detailed description of the intended use of proceeds of such Indebtedness; and (e) copies of the documentation evidencing such Indebtedness, which documentation shall evidence to the satisfaction of the Lenders that such Indebtedness is not secured in whole or in part and is subordinate to, or pari passu with, the Obligations. Neither the provisions of this Section 7.24 nor the Borrower's delivery to the Lenders of a request for approval of such proposed Indebtedness, whether in accordance with this Section 7.24 or otherwise, shall modify, limit or otherwise affect the provisions of Section 8.2. 11. Limitations on Development, Construction, Renovation and Purchase of Hotels. Section 8.5 is hereby amended and restated in its entirety as follows: 8.5 Limitations on Development, Construction, Renovation and Purchase of Hotels. Neither Sunstone nor the Borrower shall or shall permit any of their respective Subsidiaries to (a) engage in the development or construction of any Hotels with respect to which the cost to complete the same shall at any time exceed, for all such development and construction in the aggregate, the lesser of (i) ten percent (10%) of Total Hotel Value and (ii) $50,000,000, (b) engage in the renovation (including construction of additions) of any Hotels with respect to which the cost to complete the same shall at any time exceed in the aggregate the lesser of (i) fifteen percent (15%) of Total Hotel Value and (ii) $100,000,000, or (in the 11 12 aggregate with costs described in clause (a)) the lesser of (A) twenty percent (20%) of Total Hotel Value and (B) $125,000,000, or (c) engage in the development or construction of Hotels (without regard to whether the same is permitted under clauses (a) or (b) above) to enter into any agreements to purchase Hotels or other assets, unless Sunstone, the Borrower or such Subsidiary (as applicable) at all times has available sources of capital equal to the total cost to complete such development or construction and to pay in full the cost of the purchase of such Hotels or other assets (to the extent that the payment of such cost of purchase constitutes a recourse obligation of Sunstone, the Borrower or its Subsidiary), which available sources of capital may include the Available Credit to the extent that the Borrower may borrow the same for the purposes required. 12. Closing Deliveries. Prior to or simultaneously with the execution and delivery of this Amendment, and as a condition to this Amendment, the Borrower shall deliver to the Administrative Agent the following: (a) Payment of the fees provided for in the letter agreement dated January 14, 1998 and of all costs and expenses (including reasonable attorneys' fees and expenses) incurred in connection with this Amendment; (b) Notes payable to those Lenders whose Commitments have increased, each such Note to be in the amount of such Lender's increased Commitment; (c) The Consent of Guarantors attached to this Amendment; and (d) Certificates of good standing, certified corporate resolutions and incumbency certificates with respect to, and opinions of counsel for, the Borrower and Sunstone, all in form and substance satisfactory to the Administrative Agent. 13. Ratification. The Credit Agreement (as amended hereby) and the other Loan Documents (as amended as herein provided) are hereby ratified and remain in full force and effect. 12 13 14. Execution in Counterparts. This Amendment may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which when so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed by their respective officers, thereunto duly authorized, as of the date first above written. BORROWER: SUNSTONE HOTEL INVESTORS, L.P. By: Sunstone Hotel Investors, Inc. its general partner By: /s/ ROBERT A. ALTER ------------------------------------- Name: Robert A. Alter Title: President LENDER: BANK ONE, ARIZONA, NA as Administrative Agent, Co-Agent, Issuing Bank and Lender By: /s/ TODD T. POPOVICH ------------------------------------- Name: Todd T. Popovich Title: Assistant Vice President CREDIT LYONNAIS NEW YORK BRANCH as Documentation Agent, Co-Agent and Lender By: /s/ JOSEPH A. ASCIOLLA ------------------------------------- Name: Joseph A. Asciolla Title: Vice President WELLS FARGO BANK, NATIONAL ASSOCIATION as Syndication Agent, Co-Agent and Lender By: /s/ WAYNE BRANDER ------------------------------------- Name: Wayne Brander Title: Vice President 13 14 DRESDNER BANK AG, NEW YORK AND GRAND CAYMAN BRANCHES, as Lender By: /s/ JOHN W. SWEENEY ------------------------------------- Name: John W. Sweeney Title: Assistant Vice President SOCIETE GENERALE, SOUTHWEST AGENCY, as Lender By: /s/ THOMAS K. DAY ------------------------------------- Name: Thomas K. Day Title: Vice President 14 15 CONSENT OF GUARANTORS Each of the undersigned, being a Guarantor (as defined in the Credit Agreement referred to in the foregoing Amendment) does hereby consent to the foregoing Amendment, and ratify and affirm that the Guaranty (as defined in the Credit Agreement) heretofore executed by the undersigned remains in full force and effect for the benefit of the Lenders under the Credit Agreement, as amended by the foregoing Amendment. This Consent of Guarantors may be executed in counterparts and by different parties hereto in separate counterparts, each of which when so executed shall be deemed to be an original and all of which taken together shall constitute one and the same document. IN WITNESS WHEREOF, the undersigned have executed and delivered this Consent of Guarantors as of this ____ day of January, 1998. Sunstone Hotel Investors, Inc. By: /s/ ROBERT A. ALTER ------------------------ Its: PRESIDENT ------------------------ /s/ ROBERT A. ALTER ----------------------------- Robert A. Alter /s/ CHARLES BIEDERMAN ----------------------------- Charles Biederman /s/ DANIEL E. CARSELLO ----------------------------- Daniel E. Carsello /s/ GERALD N. CLARK ----------------------------- Gerald N. Clark /s/ C. ROBERT ENEVER ----------------------------- C. Robert Enever Peacock, LLC By: /s/ TUSHAR PATEL ------------------------ Its: Member ------------------------ Shivani, L.L.C. By: /s/ TUSHAR PATEL ------------------------ Its: Member ------------------------ 15 16 SCHEDULE II COMMITMENTS
Lender Commitment ------ ---------- Bank One, Arizona, NA $ 70,666,666.67 Credit Lyonnais New York Branch $ 70,666,666.67 Wells Fargo Bank, National $ 96,666,666.66 Association Dresdner Bank AG, New York $ 35,000,000.00 and Grand Cayman Branches Societe Generale, Southwest $ 27,000,000.00 Agency --------------- TOTAL: $300,000,000.00 ===============
16 EX-10.33 9 REGISTRATION RIGHTS AGREEMENT 1 EXHIBIT 10.33 REGISTRATION RIGHTS AGREEMENT ----------------------------- REGISTRATION RIGHTS AGREEMENT, dated as of October 15, 1997, among SUNSTONE HOTEL INVESTORS, INC. ("Sunstone"), a Maryland corporation, WESTBROOK REAL ESTATE FUND I, L.P., a Delaware limited partnership ("Westbrook Fund") and WESTBROOK CO-INVESTMENT PARTNERSHIP I, L.P., a Delaware limited partnership ("Westbrook Co-Investment Fund" and collectively with Westbrook Fund, the "Funds"). RECITALS -------- WHEREAS, pursuant to a Stock Purchase Agreement, dated as of August 4, 1997 (the "Stock Purchase Agreement"), among Sunstone, Westbrook Fund, Westbrook Co-Investment Fund and Kahler Realty Corporation ("Kahler"), Sunstone will purchase 100% of the outstanding common stock of Kahler from the Funds on the date hereof (the "Stock Purchase"). In consideration for the common stock of Kahler, the Funds shall receive, among other things, (i) 2,284,262 shares of common stock, par value $0.01 per share, of Sunstone (the "Common Stock") and (ii) 250,000 shares of 7.9% Series A Cumulative Convertible Preferred Stock, par value $0.01 per share, of Sunstone (the "Convertible Preferred Stock") on the terms and conditions set forth in the Stock Purchase Agreement; and WHEREAS, it is a condition to the obligations of each of Sunstone and the Funds to consummate the transactions contemplated by the Stock Purchase Agreement that this Registration Rights Agreement be executed and delivered by Sunstone and the Funds. NOW, THEREFORE, in consideration of the premises and mutual covenants and agreements herein contained the parties hereto agree as follows: AGREEMENT --------- 1. Definitions. As used in this Agreement, the following capitalized terms shall have the following respective meanings: "Common Stock" shall mean the common stock, par value $0.01 per share, of Sunstone and its successors. "Demand Party" shall mean (a) Westbrook Fund, (b) Westbrook Co-Investment Fund or (c) any other Holder or Holders, including, without limitation, any present or -1- 2 future general or limited partner of either of the Funds, or any general or limited partner of any general or limited partner thereof, that may become an assignee of such Funds' rights hereunder; provided that to be a Demand Party under clause (c), a Holder or Holders must either individually or in the aggregate with all other Holders with whom it is acting together to demand registration own at least 500,000 shares of Registrable Securities. "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended, or any similar federal statute, and the rules and regulations of the SEC thereunder, all as the same shall be in effect from time to time, and a reference to a particular section thereof shall be deemed to include a reference to the comparable section, if any, of any such similar federal statute. "Holder" shall mean each of the Funds, and any other holder of Registrable Securities (including any direct or indirect transferees of the Funds) who agree in writing to be bound by the provisions of this Agreement. "Initial Lock-Up Period" shall have the meaning set forth in the Stock Purchase Agreement. "Person" shall mean any individual, partnership, joint venture, corporation, trust, unincorporated organization, government or any department or agency thereof or other entity of whatever nature. "Registrable Securities" shall mean (1) the Common Stock issued to the Funds pursuant to the Stock Purchase Agreement, (2) the Common Stock issued or issuable upon conversion of the Convertible Preferred Stock issued to the Funds pursuant to the Stock Purchase Agreement, and (3) any Common Stock which may be issued or distributed by way of stock dividend or stock split or other distribution, recapitalization or reclassification with respect to, or in exchange for, or in replacement of, any other Registrable Securities. As to any particular Registrable Securities, once issued, such Registrable Securities shall cease to be Registrable Securities when (i) a registration statement with respect to the sale by the Holder of such securities shall have become effective under the Securities Act and such securities shall have been disposed of in accordance with such registration statement, (ii) such securities shall have been distributed to the public pursuant to Rule 144 (or any successor provision) under the Securities Act, (iii) such securities shall have been otherwise transferred, new certificates for such securities not bearing a legend restricting further transfer shall have been delivered by Sunstone and subsequent disposition of such securities shall not require registration or qualification of such securities under the Securities Act or any state securities or blue sky law then in force, or (iv) such securities shall have ceased to be outstanding. "Registration Expenses" shall mean any and all expenses incident to performance of or compliance with this Agreement, including, without limitation, (i) all SEC and stock -2- 3 exchange or National Association of Securities Dealers, Inc. (the "NASD") registration and filing fees (including, if applicable, the fees and expenses of any "qualified independent underwriter," as such term is defined in Schedule E to the By-laws of the NASD, and of its counsel), (ii) all fees and expenses of complying with securities or blue sky laws (including the reasonable fees and disbursements of counsel for the underwriters, if any, in connection with blue sky qualifications of the Registrable Securities), (iii) all printing, messenger and delivery expenses, (iv) all fees and expenses incurred in connection with the listing of the Registrable Securities on the New York Stock Exchange or on any securities exchange pursuant to clause (viii) of Section 5, (v) the fees and disbursements of one counsel for Sunstone and of its independent public accountants, including the expenses of any special audits and/or "cold comfort" letters required by or incident to such performance and compliance, (vi) the reasonable fees and disbursements of one counsel selected pursuant to Section 8 hereof by the Holders of the Registrable Securities being registered to represent such Holders in connection with each such registration, (vii) any fees and disbursements of underwriters, if any, customarily paid by the issuers or sellers of securities, including liability insurance if Sunstone so desires or if the underwriters so require, and the reasonable fees and expenses of any special experts retained in connection with the requested registration, but excluding underwriting discounts and commissions, transfer taxes, and (viii) other reasonable out-of-pocket expenses of Holders (provided that such expenses shall not include expenses of counsel other than those provided for in clause (vi) above). "Securities Act" shall mean the Securities Act of 1933, as amended, or any similar federal statute and the rules and regulations of the SEC thereunder, all as the same shall be in effect from time to time, and a reference to a particular section thereof shall be deemed to include a reference to the comparable section, if any, of any such similar federal statute. "SEC" shall mean the Securities and Exchange Commission or any other federal agency at the time administering the Securities Act or the Exchange Act. 2. Incidental Registrations. (a) Right to Include Common or Common Equivalent Registrable Securities. If Sunstone at any time after the Initial Lock-Up Period proposes to register its Common Stock under the Securities Act (other than a registration on Form S-4 or S-8, or any successor or other forms promulgated for similar purposes), for sale for its own account, in a manner which would permit registration of Registrable Securities for sale to the public under the Securities Act, it will, at each such time, give prompt written notice to all Holders of Registrable Securities of its intention to do so and of such Holders' rights under this Section 2. Upon the written request of any such Holder made within 15 days after the receipt of any such notice (which request shall specify the Registrable Securities intended to be disposed of by such Holder), Sunstone will use its best efforts to effect the registration under the Securities Act of all Registrable Securities which Sunstone has been so requested to register by the Holders thereof, to the extent requisite to permit the disposition of the Registrable Securities so to be registered; provided that (i) if, at any time after giving written notice of its intention to register -3- 4 any securities and prior to the effective date of the registration statement filed in connection with such registration, Sunstone shall determine for any reason not to proceed with the proposed registration of the securities to be sold by it, Sunstone may, at its election, give written notice of such determination to each Holder of Registrable Securities and, thereupon, shall be relieved of its obligation to register any Registrable Securities in connection with such registration (but not from its obligation to pay the Registration Expenses in connection therewith), and (ii) if such registration involves an underwritten offering, all Holders of Registrable Securities requesting to be included in Sunstone's registration must sell their Registrable Securities to the underwriters selected by Sunstone on the same terms and conditions as apply to Sunstone, with such differences, including any with respect to indemnification and liability insurance, as may be customary or appropriate in combined primary and secondary offerings; and provided further that under no circumstances will the scope of any indemnification or contribution obligations of any Holder be broader than the provisions of Section 6(b) hereof nor will the maximum liability of the Holders be greater than that specified in Section 6 hereof. If a registration requested pursuant to this Section 2(a) involves an underwritten public offering, any Holder of Registrable Securities requesting to be included in such registration may elect, in writing within seven (7) business days prior to the effective date of the registration statement filed in connection with such registration, not to register such securities in connection with such registration. Nothing in this Section 2(a) shall operate to limit the right of any Holder to request the registration of Common Stock issuable upon conversion or exercise of convertible securities held by such Holder notwithstanding the fact that at the time of request such Holder holds only convertible securities. (b) Expenses. Sunstone will pay all Registration Expenses in connection with each registration of Registrable Securities requested pursuant to this Section 2. (c) Priority in Incidental Registrations. If a registration pursuant to this Section 2 involves an underwritten offering and the managing underwriter advises Sunstone in writing that, in its opinion, the number of shares of Common Stock requested to be included in such registration exceeds the number which can be sold in such offering, so as to be likely to have an adverse effect on the price, timing or distribution of the Common Stock offered in such offering as contemplated by Sunstone, then Sunstone will include in such registration (i) first, 100% of the securities Sunstone proposes to sell and (ii) second, the number of Registrable Securities requested to be included in such registration which, in the opinion of such managing underwriter, can be sold without having the adverse effect referred to above, such amount to be allocated pro rata among all requesting Holders on the basis of the relative number of shares of Registrable Securities then held by each such Holder (provided that any shares thereby allocated to any such Holder that exceed such Holder's request will be reallocated among the remaining requesting Holders in like manner). (d) Limitations on Shelf Offerings. Notwithstanding the foregoing, in the event that Registrable Securities have been included in a registration effected by Sunstone pursuant to Rule 415 under the Securities Act in accordance with this Section 2, the Holders agree that, without the prior written consent of Sunstone, they will not effect more than one sale of Registrable Securities pursuant to such registration in any 30-day period. -4- 5 3. Registration on Request. (a) Request by the Demand Party. At any time after the Initial Lock-Up Period, upon the written request of the Demand Party requesting that Sunstone effect the registration under the Securities Act of all or part of such Demand Party's Registrable Securities and specifying the amount and intended method of disposition thereof, Sunstone will promptly give written notice of such requested registration to all other Holders of such Registrable Securities, and thereupon will, as expeditiously as possible, use its best efforts to effect the registration under the Securities Act of: (i) such Registrable Securities (including, if such request relates to a security which is convertible into shares of Common Stock, the shares of Common Stock issuable upon such conversion) which Sunstone has been so requested to register by the Demand Party; and (ii) all other Registrable Securities of the same class or series as are to be registered at the request of a Demand Party and which Sunstone has been requested to register by any other Holder thereof by written request given to Sunstone within 15 days after the giving of such written notice by Sunstone (which request shall specify the amount and intended method of disposition of such Registrable Securities), all to the extent necessary to permit the disposition (in accordance with the intended method thereof as aforesaid) of the Registrable Securities so to be registered; provided, that with respect to any Demand Party, Sunstone shall not be obligated to effect any registration of Registrable Securities under this Section 3(a) unless such Demand Party requests that Sunstone register at least 20% of the total number of Registrable Securities then outstanding (or such lesser percent if the anticipated aggregate offering price, net of underwriting discounts and commissions would exceed $10,000,000); and provided, further, that, Sunstone shall not be obligated to file a registration statement relating to any registration request under this Section 3(a) (x) within a period of six months after the effective date of any other registration statement relating to any registration request under this Section 3(a) or relating to any registration effected under Section 2 in which Registrable Securities were included in such registration, (y) if with respect thereto the managing underwriter, the SEC, the Securities Act or the rules and regulations thereunder, or the form on which the registration statement is to be filed, would require the completion of an audit other than the regular audit conducted by Sunstone at the end of its fiscal year, in which case the filing may be delayed until the completion of such regular audit (unless the Holders of the Registrable Securities to be registered agree to pay the expenses of Sunstone in connection with such an audit other than the regular audit) or (z) subject to Section 9(j)(ii), during any period of not more than 90 days that the Company, its executive officers or directors are precluded from selling shares of Common Stock as the result of any lock-up restrictions imposed by any underwriter in a previous primary offering, unless such underwriters agree otherwise. Nothing in this Section 3 shall operate to limit the right of a Holder to request the registration of Common Stock issuable upon conversion or exercise of convertible securities held by such Holder notwithstanding the fact that at the time of request such Holder holds only convertible securities. -5- 6 (b) Notwithstanding the foregoing provisions of Section 3(a), Sunstone shall not be obligated to effect more than two demand registrations pursuant to requests made by the Demand Holders pursuant to this Section 3. No Holder's rights under this Section 3 shall be affected by a registration pursuant to Section 2. (c) Registration Statement Form. If any registration requested pursuant to this Section 3, which is proposed by Sunstone to be effected by the filing of a registration statement on Form S-3 (or any successor or similar short-form registration statement), shall be in connection with an underwritten public offering, and if the managing underwriter shall advise Sunstone in writing that, in its opinion, the inclusion of additional information is of material importance to the success of such proposed offering, then such registration shall include such other information. (d) Expenses. Sunstone will pay all Registration Expenses in connection with each of the registrations of each class or series of Registrable Securities effected pursuant to this Section 3. (e) Effective Registration Statement. A registration requested pursuant to this Section 3 will not be deemed to have been effected unless the applicable registration statement has become effective; provided that if, prior to the end of any applicable distribution period as defined in the Securities Act, the offering of Registrable Securities pursuant to such registration is interfered with by any stop order, injunction or other order or requirement of the SEC or other governmental agency or court, such registration will be deemed not to have been effected with respect to any selling Holder whose Registrable Securities that are registered have not been fully distributed. (f) Selection of Underwriters. If a requested registration pursuant to this Section 3 involves an underwritten offering, the Holders of a majority of the shares of Registrable Securities which are held by Holders and which Sunstone has been requested to register shall have the right to select the investment banker or bankers and managers to administer the offering; provided, however, that such investment banker or bankers and managers shall be reasonably satisfactory to Sunstone. (g) Priority in Requested Registrations. If a requested registration pursuant to this Section 3 involves an underwritten offering and the managing underwriter advises Sunstone in writing that, in its opinion, the number of shares of Common Stock requested to be included in such registration (including securities of Sunstone which are not Registrable Securities) exceeds the number which can be sold in such offering, Sunstone will include in such registration only the Registrable Securities requested to be included in such registration. In the event that the number of Registrable Securities requested to be included in such registration exceeds the number which, in the opinion of such managing underwriter, can be sold, the number of such Registrable Securities to be included in such registration shall be allocated pro rata among all requesting Holders on the basis of the relative number of shares of Registrable Securities then held by each such Holder; provided that any shares thereby allocated to any such Holder that exceed such Holder's request shall be reallocated among the remaining requesting Holders in like manner; -6- 7 provided, further that if any such exclusion causes less than 90% of the number of shares of Registrable Securities as to which registration was requested by the Holders to be registered, such registration shall not constitute a request for registration under Section 3(b). In the event that the number of Registrable Securities requested to be included in such registration is less than the number which, in the opinion of the managing underwriter, can be sold, Sunstone may include in such registration up to the number of shares of Common Stock that, in the opinion of the underwriter, can be sold. (h) Additional Rights. If Sunstone at any time grants to any other holders of Common Stock, or Common Stock issuable upon conversion, exchange or exercise of a security, any rights to request Sunstone to effect the registration under the Securities Act of any such shares of Common Stock on terms more favorable to such holders than the terms set forth in this Section 3, the terms of this Section 3 shall be deemed amended or supplemented to the extent necessary to provide the Holders such more favorable rights and benefits. The provisions of this Section 3(h) will not be applicable to the registration rights of the limited partners of Sunstone Hotel Investors, L.P. permitting them to require Sunstone to register the shares of Common Stock into which their partnership units are exchangeable. 4. Stock Purchase Agreement Transfer Restrictions. Notwithstanding anything in this Agreement to the contrary, any sales of Registrable Securities shall be subject to the conditions set forth in Section 4.10 of the Stock Purchase Agreement. 5. Registration Procedures. If and whenever Sunstone is required to use its best efforts to effect or cause the registration of any Registrable Securities under the Securities Act as provided in this Agreement, Sunstone will, as expeditiously as possible: (a) prepare and, in any event within 120 days after the end of the period within which a request for registration may be given to Sunstone, file with the SEC a registration statement with respect to such Registrable Securities and use its best efforts to cause such registration statement to become effective; provided, however, that Sunstone may discontinue any registration of its securities which is being effected pursuant to Section 2 at any time prior to the effective date of the registration statement relating thereto or in accordance with Section 3(b); (b) prepare and file with the SEC such amendments and supplements to such registration statement and the prospectus used in connection therewith as may be necessary to keep such registration statement effective during the distribution period, in the case of a registration effected pursuant to Section 2, or for a period not in excess of 270 days (or such lesser period ending on the day after the distribution of all registered securities is complete) in the case of a registration effected pursuant to Section 3, and to comply with the provisions of the Securities Act, the Exchange Act and the rules and regulations of the SEC thereunder with respect to the disposition of all securities covered by such registration statement during such period in accordance with the intended methods of disposition by the seller or sellers thereof set forth in such registration statement; -7- 8 provided that before filing a registration statement or prospectus relating to the sale of Registrable Securities, or any amendments or supplements thereto, Sunstone will furnish to counsel selected pursuant to Section 8 hereof by the Holders of the Registrable Securities covered by such registration statement to represent such Holders, copies of all documents proposed to be filed, which documents will be subject to the review of such counsel within five (5) days after receipt thereof, and Sunstone will give reasonable consideration in good faith to any comments of such counsel; (c) furnish to each seller of such Registrable Securities such number of copies of such registration statement and of each amendment and supplement thereto (in each case including all exhibits filed therewith, including any documents incorporated by reference), such number of copies of the prospectus included in such registration statement (including each preliminary prospectus and summary prospectus), in conformity with the requirements of the Securities Act, and such other documents as such seller may reasonably request in order to facilitate the disposition of the Registrable Securities by such seller; (d) use its best efforts to register or qualify such Registrable Securities covered by such registration statement under such other securities or blue sky laws of such jurisdictions as each seller shall reasonably request, and do any and all other acts and things which may be reasonably necessary or advisable to enable such seller to consummate the disposition in such jurisdictions of the Registrable Securities owned by such seller, except that Sunstone shall not for any such purpose be required to qualify generally to do business as a foreign corporation in any jurisdiction where, but for the requirements of this clause (iv), it would not be obligated to be so qualified, to subject itself to taxation in any such jurisdiction or to consent to general service of process in any such jurisdiction; (e) use its best efforts to cause such Registrable Securities covered by such registration statement to be registered with or approved by such other governmental agencies or authorities as may be necessary to enable the seller or sellers thereof to consummate the disposition of such Registrable Securities; (f) notify promptly each seller of any such Registrable Securities covered by such registration statement, at any time when a prospectus relating thereto is required to be delivered under the Securities Act within the appropriate period mentioned in clause (b) of this Section 5, of Sunstone's becoming aware that the prospectus included in such registration statement, as then in effect, includes an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances then existing, and at the request of any such seller, prepare and furnish to such seller a reasonable number of copies of an amended or supplemental prospectus as may be necessary so that, as thereafter delivered to the purchasers of such Registrable Securities, such prospectus shall not include an untrue statement of a material fact or omit to state a material fact required to be stated -8- 9 therein or necessary to make the statements therein not misleading in the light of the circumstances then existing; (g) otherwise use its best efforts to comply with all applicable rules and regulations of the SEC, and make available to its security holders, as soon as reasonably practicable (but not more than eighteen months) after the effective date of the registration statement, if required, an earnings statement which shall satisfy the provisions of Section 11(a) of the Securities Act and the rules and regulations promulgated thereunder; (h) (i) use its best efforts to list such Registrable Securities on any securities exchange on which the Common Stock is then listed if such Registrable Securities are not already so listed and if such listing is then permitted under the rules of such exchange; and (ii) use its best efforts to provide a transfer agent and registrar for such Registrable Securities covered by such registration statement not later than the effective date of such registration statement; (i) enter into such customary agreements (including an underwriting agreement in customary form), which may include indemnification provisions in favor of underwriters and other persons in addition to, or in substitution for the provisions of Section 6 hereof, and take such other actions as sellers of a majority of shares of such Registrable Securities or the underwriters, if any, reasonably requested in order to expedite or facilitate the disposition of such Registrable Securities; (j) to the extent permitted by the rules of the AICPA, use its best efforts to obtain a "cold comfort" letter or letters from Sunstone's independent public accountants in customary form and covering matters of the type customarily covered by "cold comfort" letters as the seller or sellers of a majority of shares of such Registrable Securities shall reasonably request (provided that Registrable Securities constitute at least 25% of the securities covered by such registration statement, unless such a "cold comfort" letter or letters are provided to other selling holders in connection with such registration); it being understood, however, that Sunstone will, if requested by the underwriters in any underwritten offering, be obligated to use its best efforts to obtain for such underwriters a "cold comfort" letter or letters from Sunstone's independent public accountants in customary form; (k) make available for inspection by any seller of such Registrable Securities covered by such registration statement, by any underwriter participating in any disposition to be effected pursuant to such registration statement and by any attorney, accountant or other agent retained by any such seller or any such underwriter, all pertinent financial and other records, pertinent corporate documents and properties of Sunstone, and cause all of Sunstone's officers, directors and employees to supply all information reasonably requested by any such seller, underwriter, attorney, accountant or agent in connection with such registration statement; -9- 10 (l) notify counsel (selected pursuant to Section 8 hereof) for the Holders of Registrable Securities included in such registration statement and the managing underwriter or agent, immediately, and confirm the notice in writing (A) when the registration statement, or any post-effective amendment to the registration statement, shall have become effective, or any supplement to the prospectus or any amendment prospectus shall have been filed, (B) of the receipt of any comments from the SEC, (C) of any request of the SEC to amend the registration statement or amend or supplement the prospectus or for additional information and (D) of the issuance by the SEC of any stop order suspending the effectiveness of the registration statement or of any order preventing or suspending the use of any preliminary prospectus, or of the suspension of the qualification of the registration statement for offering or sale in any jurisdiction, or of the institution or threatening of any proceedings for any of such purposes; (m) use reasonable efforts to prevent the issuance of any stop order suspending the effectiveness of the registration statement or of any order preventing or suspending the use of any preliminary prospectus and, if any such order is issued, to obtain the withdrawal of any such order at the earliest possible moment; (n) if requested by the managing underwriter or agent or any Holder of Registrable Securities covered by the registration statement, promptly incorporate in a prospectus supplement or post-effective amendment such information as the managing underwriter or agent or such Holder reasonably requests to be included therein, including, without limitation, the number of Registrable Securities being sold by such Holder to such underwriter or agent, the purchase price being paid therefor by such underwriter or agent and any other terms of the underwritten offering of the Registrable Securities to be sold in such offering; and make all required filings of such prospectus supplement or post-effective amendment as soon as practicable after being notified of the matters incorporated in such prospectus supplement or post-effective amendment; (o) cooperate with the Holders of Registrable Securities covered by the registration statement and the managing underwriter or agent, if any, to facilitate the timely preparation and delivery of certificates (not bearing any restrictive legends) representing securities sold under the registration statement, and enable such securities to be in such denominations and registered in such names as the managing underwriter or agent, if any, or such Holders may request; (p) obtain for delivery to the Holders of Registrable Securities being registered and to the underwriter or agent an opinion or opinions of counsel for Sunstone in customary form and in form, substance and scope reasonably satisfactory to such Holders, underwriters or agents and their counsel; and (q) cooperate with each seller of Registrable Securities and each underwriter or agent participating in the disposition of such Registrable Securities and their respective counsel in connection with any filings required to be made with the NASD. -10- 11 Sunstone may require each seller of Registrable Securities as to which any registration is being effected to furnish Sunstone with such information regarding such seller and pertinent to the disclosure requirements relating to the registration and the distribution of such securities as Sunstone may from time to time reasonably request in writing. Each Holder of Registrable Securities agrees that, upon receipt of any notice from Sunstone of the happening of any event of the kind described in clause (f) of this Section 5, such Holder will forthwith discontinue disposition of Registrable Securities pursuant to the registration statement covering such Registrable Securities until such Holder's receipt of the copies of the supplemented or amended prospectus contemplated by clause (f) of this Section 5, and, if so directed by Sunstone, such Holder will deliver to Sunstone (at Sunstone's expense) all copies, other than permanent file copies then in such Holder's possession, of the prospectus covering such Registrable Securities current immediately prior to the receipt of such notice. In the event Sunstone shall give any such notice, the period mentioned in clause (b) of this Section 5 shall be extended by the number of days during the period from and including the date of the giving of such notice pursuant to clause (f) of this Section 5 and including the date when each seller of Registrable Securities covered by such registration statement shall have received the copies of the supplemented or amended prospectus contemplated by clause (f) of this Section 5. In lieu of satisfying the requirements of Sections 2 or 3 hereunder, Sunstone may, at any time after the Initial Lock-Up Period, elect to file a registration statement pursuant to Rule 415 under the Securities Act permitting the resale of all Registrable Securities and shall covenant and agree to keep such registration statement effective for a period of two years after the expiration of the Initial Lock-Up Period (or such shorter period as to any Holder that is then entitled to sell his or its Registrable Securities under Rule 144 in any three-month period without restriction). All other provisions of this Agreement shall continue to apply to any such registration. Upon expiration of the initial two-year registration, if a Holder still holds Registrable Securities that cannot be sold under Rule 144 during any three-month period without restriction, Sunstone will file a new registration statement pursuant to Rule 415 under the Securities Act (or maintain the effectiveness of the initial registration statement) permitting the resale of all such Registrable Securities that then remain unsold and shall keep such registration statement effective for one additional period of two years. 6. Indemnification. (a) Indemnification by Sunstone. In the event of any registration of any securities of Sunstone under the Securities Act pursuant to Section 2 or 3, Sunstone will, and it hereby does, indemnify and hold harmless, to the extent permitted by law, the seller of any Registrable Securities covered by such registration statement, each affiliate of such seller and their respective directors and officers or general and limited partners or members or managing members (including any director, officer, affiliate, employee, agent or controlling Person of any of the foregoing), each other Person who participates as an underwriter in the offering or sale of such securities and each other Person, if any, who controls such seller or any such underwriter within the meaning of the Securities Act (collectively, the "Seller Indemnified Parties"), against any and -11- 12 all losses, claims, damages or liabilities, joint or several, and expenses (including reasonable attorney's fees and reasonable expenses of investigation) to which such Seller Indemnified Party may become subject under the Securities Act, common law or otherwise, insofar as such losses, claims, damages or liabilities (or actions or proceedings in respect thereof, whether or not such Seller Indemnified Party is a party thereto) arise out of or are based upon (i) any untrue statement or alleged untrue statement of any material fact contained in any registration statement under which such securities were registered under the Securities Act, any preliminary, final or summary prospectus contained therein, or any amendment or supplement thereto, or (ii) any omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein (in the case of a prospectus, in light of the circumstances under which they were made) not misleading, and Sunstone will reimburse such Seller Indemnified Party for any legal or any other expenses reasonably incurred by it in connection with investigating or defending against any such loss, claim, liability, action or proceeding (collectively, a "Violation"); provided that Sunstone shall not be liable to any Seller Indemnified Party in any such case to the extent that any such loss, claim, damage, liability (or action or proceeding in respect thereof) or expense arises out of or is based upon any untrue statement or alleged untrue statement or omission or alleged omission made in such registration statement or amendment or supplement thereto or in any such preliminary, final or summary prospectus in reliance upon and in conformity with written information furnished to Sunstone through an instrument duly executed by such seller specifically stating that it is for use in the preparation thereof nor shall it apply to amounts paid in settlement of any such loss, claim, damage, liability, or action if such settlement is effected without the consent of Sunstone (which consent shall not be unreasonably withheld or delayed); and provided, further, that in the case of any registration effected pursuant to Section 3 or any registration effected pursuant to Section 2 in which the underwriters have agreed to indemnify the Holders for the matters set forth in this proviso, if any losses, claims, damages or liabilities arise out of or are based upon a Violation which did not appear in the final prospectus, Sunstone shall not have any liability with respect thereto to the Holder, any underwriter, or any person who controls such Holder or underwriter within the meaning of Section 15 of the Securities Act if the Holder or underwriter delivered a copy of the preliminary prospectus to the person alleging such losses, claims, damages or liabilities and failed to deliver a copy of the final prospectus, as so supplemented, to such person at or prior to the written confirmation of the sale to such person. Such indemnity shall remain in full force and effect regardless of any investigation made by or on behalf of such seller or any Seller Indemnified Party and shall survive the transfer of such securities by such seller. (b) Indemnification by the Seller. In the event of any registration of any securities of Sunstone under the Securities Act pursuant to Section 2 or 3, each selling Holder will, and it hereby does, indemnify and hold harmless, to the extent permitted by law, Sunstone and all other prospective sellers of Registrable Securities, each affiliate of Sunstone or such seller and their respective directors and officers or general and limited partners or members or managing members (including any director, officer, affiliate, employee, agent or controlling Person of any of the foregoing) and each other Person, if any, who controls Sunstone or any such seller within the meaning of the Securities Act (collectively, the "Company Indemnified Parties") against any and all losses, claims, damages or liabilities, joint or several, and expenses (including reasonable -12- 13 attorney's fees and reasonable expenses of investigation) to which such Company Indemnified Party may become subject under the Securities Act, common law or otherwise, insofar as such losses, claims, damages or liabilities (or actions or proceedings in respect thereof, whether or not such Company Indemnified Party is a party thereto) arise out of or are based upon any untrue statement or alleged untrue statement in or omission or alleged omission from such registration statement, any preliminary, final or summary prospectus contained therein, or any amendment or supplement, if such untrue statement or alleged untrue statement or omission or alleged omission was made in reliance upon and in conformity with written information furnished to Sunstone through an instrument duly executed by such seller specifically stating that it is for use in the preparation of such registration statement, preliminary, final or summary prospectus or amendment or supplement, or a document incorporated by reference into any of the foregoing, provided that no Holder shall be liable to any Company Indemnified Party with respect to amounts paid in settlement of any such loss, claim, damage, liability or action if such settlement is effected without the consent of such Holder (which consent shall not be unreasonably withheld or delayed); and provided further that if any losses, claims, damages or liabilities arise out of or are based upon a violation which did not appear in the final prospectus, no Holder shall have any liability with respect thereto to Sunstone, any other seller or any person who controls Sunstone or such other seller within the meaning of Section 15 of the Securities Act if Sunstone or an underwriter delivered a copy of the preliminary prospectus to the person alleging such losses, claims, damages or liabilities and failed to deliver a copy of the final prospectus, as so supplemented, to such person at or prior to the written confirmation of the sale to such person. Such indemnity shall remain in full force and effect regardless of any investigation made by or on behalf of Sunstone or any of the prospective sellers, or any of their respective affiliates, directors, officers or controlling Persons and shall survive the transfer of such securities by such seller. In no event shall the liability of any selling Holder of Registrable Securities hereunder be greater in amount than the dollar amount of the proceeds received by such Holder upon the sale of the Registrable Securities giving rise to such indemnification obligation. (c) Notices of Claims, Etc. Promptly after receipt by a Seller Indemnified Party or a Company Indemnified Party (an "Indemnified Party") hereunder of written notice of the commencement of any action or proceeding with respect to which a claim for indemnification may be made pursuant to this Section 6, such Indemnified Party will, if a claim in respect thereof is to be made against an indemnifying party, give written notice to the latter of the commencement of such action; provided that the failure of the Indemnified Party to give notice as provided herein shall not relieve the indemnifying party of its obligations under the preceding subdivisions of this Section 6, except to the extent that the indemnifying party is actually prejudiced by such failure to give notice. In case any such action is brought against an Indemnified Party, unless in such Indemnified Party's reasonable judgment a conflict of interest between such Indemnified Party and indemnifying parties may exist in respect of such claim, the indemnifying party will be entitled to participate in and to assume the defense thereof, jointly with any other indemnifying party similarly notified to the extent that it may wish, with counsel reasonably satisfactory to such Indemnified Party, and after notice from the indemnifying party to such Indemnified Party of its election so to assume the defense thereof, the indemnifying party will not be liable to such Indemnified Party for any legal or other expenses subsequently incurred -13- 14 by the latter in connection with the defense thereof other than reasonable costs of investigation. In the event that the Indemnified Parties are conducting the defense of any action or other claims, the indemnifying party will not be responsible for the costs and expenses of more than one counsel for all of the Indemnified Parties (plus the fees and expenses of one local counsel if the action is pending in a foreign jurisdiction). No indemnifying party will consent to entry of any judgment or enter into any settlement which does not include as an unconditional term thereof, the giving by the claimant or plaintiff to such Indemnified Party of a release from all liability in respect to such claim or litigation. (d) Contribution. If the indemnification provided for in this Section 6 from the indemnifying party is unavailable to an Indemnified Party hereunder in respect of any losses, claims, damages, liabilities or expenses referred to herein, then the indemnifying party, in lieu of indemnifying such Indemnified Party, shall contribute to the amount paid or payable by such Indemnified Party as a result of such losses, claims, damages, liabilities or expenses in such proportion as is appropriate to reflect the relative fault of the indemnifying party and Indemnified Parties in connection with the actions which resulted in such losses, claims, damages, liabilities or expenses, as well as any other relevant equitable considerations. The relative fault of such indemnifying party and Indemnified Parties shall be determined by reference to, among other things, whether any action in question, including any untrue or alleged untrue statement of a material fact or omission or alleged omission to state a material fact, has been made by, or relates to information supplied by, such indemnifying party or Indemnified Parties, and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such action. The amount paid or payable by a party under this Section 6(d) as a result of the losses, claims, damages, liabilities and expenses referred to above shall include any legal or other fees or expenses reasonably incurred by such party in connection with any investigation or proceeding. The parties hereto agree that it would not be just and equitable if contribution pursuant to this Section 6(d) were determined by pro rata allocation or by any other method of allocation which does not take into account the equitable considerations referred to in the immediately preceding paragraph. No Person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any Person who was not guilty of such fraudulent misrepresentation. (e) Other Indemnification. Indemnification similar to that specified in the preceding subdivisions of this Section 6 (with appropriate modifications) shall be given by Sunstone and each seller of Registrable Securities with respect to any required registration or other qualification of securities under any federal or state law or regulation or governmental authority other than the Securities Act. (f) Non-Exclusivity. The obligations of the parties under this Section 6 shall be in addition to any liability which any party may otherwise have to any other party. (g) Conflicting Provisions. To the extent that the provisions of this Section 6 differ from the terms and conditions of any indemnification provision contained in any -14- 15 underwriting agreement entered into in connection with any underwritten offering effected pursuant to Section 2 hereof, the indemnification provisions contained in such underwriting agreement will, for all purposes, supersede the terms and conditions of this Section 6. To the extent that the provisions of this Section 6 differ from the terms and conditions contained in any underwriting agreement entered into in connection with any underwritten offering effected pursuant to Section 3 hereof, then (x) unless otherwise agreed to by the Holders of Registrable Securities participating in any such registration, with respect to the substantive scope and limitations (including, without limitation, the maximum liability of the Holders) of the indemnification and contribution provided by Sunstone and the Holders to the Indemnified Person, the provisions of this Section 6 shall govern and supersede the terms of such Underwriting Agreement and (y) with respect to all other matters the terms of the underwriting agreement will supersede the terms and conditions of this Section 6. (h) Indemnification by Underwriters. Sunstone may require, as a condition to including any Registrable Securities in any registration statement filed in accordance with Section 3 herein, that Sunstone shall have received an undertaking reasonably satisfactory to it from any underwriter to indemnify and hold harmless Sunstone in customary form. 7. Rule 144. Sunstone covenants that it will file the reports required to be filed by it under the Securities Act and the Exchange Act and the rules and regulations adopted by the SEC thereunder (or, if Sunstone is not required to file such reports, it will, upon the request of any Holder of Registrable Securities, make publicly available such information), and it will take such further action as any Holder of Registrable Securities may reasonably request, all to the extent required from time to time to enable such Holder to sell shares of Registrable Securities without registration under the Securities Act within the limitation of the exemptions provided by (i) Rule 144 under the Securities Act, as such Rule may be amended from time to time or (ii) any similar rule or regulation hereafter adopted by the SEC. Upon the request of any Holder of Registrable Securities, Sunstone will deliver to such Holder a written statement as to whether it has complied with such requirements. Notwithstanding anything contained in this Section 7, Sunstone may de-register under Section 12 of the Exchange Act if it is then permitted to do so pursuant to the Exchange Act and the rules and regulations thereunder and, in such circumstances, shall not be required hereby to file any reports which may be necessary in order for Rule 144 or any similar rule or regulation to be available. 8. Selection of Counsel. In connection with any registration of Registrable securities pursuant to Sections 2 and 3 hereof, the Holders of a majority of the Registrable Securities covered by any such registration may select one counsel to represent all Holders of Registrable Securities covered by such registration. 9. Miscellaneous. (a) Amendments and Waivers. This Agreement may be amended and Sunstone may take any action herein prohibited, or omit to perform any act herein required to be performed by it, only if Sunstone shall have obtained the written consent to such amendment, -15- 16 action or omission to act, of the Holders of a majority of the Registrable Securities then outstanding; provided, however, that no amendment, waiver or consent to the departure from the terms and provisions of this Agreement that is adverse to the Funds or any of their respective successors and assigns shall be effective as against any such Person for so long as such Person holds any Registrable Securities unless consented to in writing by such Person. Each Holder of any Registrable Securities at the time or thereafter outstanding shall be bound by any consent authorized by this Section 9(a), whether or not such Registrable Securities shall have been marked to indicate such consent. (b) Successors, Assigns and Transferees. This Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective successors and assigns. The rights to cause the Company to register Registrable Securities pursuant to Section 2 or 3 may be assigned (but only with all related obligations) by a Holder to a transferee or assignee of such securities, provided: (a) the Company is, within a reasonable time after such transfer, furnished with written notice of the name and address of such transferee or assignee and the securities with respect to which such registration rights are being assigned; (b) such transferee or assignee assigns in writing to be bound by and subject to the terms and conditions of this Agreement. Without limitation of the foregoing, in the event that either of the Funds distributes or otherwise transfers any shares of the Registrable Securities to any of its present or future general or limited partners, Sunstone hereby acknowledges that the registration rights granted pursuant to this Agreement shall be transferred to such partner or partners on a pro rata basis, and that at or after the time of any such distribution or transfer, any such partner or group of partners shall designate a Person to act on its behalf in delivering any notices or making any requests hereunder. Notwithstanding the foregoing, in the event of a transfer of the registration rights granted pursuant to this Agreement to a Fund's general or limited partners, such partners shall not have any registration rights pursuant to Section 2 with respect to any registration effected pursuant to Rule 415 under the Securities Act. (c) Notices. All notices and other communications provided for hereunder shall be in writing and shall be sent by first class mail, telex, telecopier or hand delivery: (i) (A) if to Sunstone: Sunstone Hotel Investors, Inc. 115 Calle de Industrias Suite 201 San Clemente, CA 92672 Attention: Robert A. Alter -16- 17 with a copy to: Brobeck, Phleger & Harrison LLP 4675 MacArthur Court Suite 1000 Newport Beach, CA 92660 Attention: Roger M. Cohen, Esq. (ii) if to Westbrook Fund: Westbrook Real Estate Fund I, L.P. 599 Lexington Avenue Suite 3800 New York, New York 10022 Attention: Jonathan Paul with a copy to: Simpson Thatcher & Bartlett 425 Lexington Avenue New York, New York 10017 Attention: Richard Capelouto, Esq. (iii) if to Westbrook Co-Investment Fund Westbrook Co-Investment Partnership I, L.P. 599 Lexington Avenue Suite 3800 New York, New York 10022 Attention: Jonathan Paul with a copy to: Simpson Thatcher & Bartlett 425 Lexington Avenue New York, New York 10017 Attention: Richard Capelouto, Esq. (iv) if to any other holder of Registrable Securities, to the address of such other holder as shown in the stock record book of Sunstone, or to such other address as any of the above shall have designated in writing to all of the other above. -17- 18 All such notices and communications shall be deemed to have been given or made (1) when delivered by hand, (2) five business days after being deposited in the mail, postage prepaid, (3) when telexed answer-back received or (4) when telecopied, receipt acknowledged. (d) Descriptive Headings. The headings in this Agreement are for convenience of reference only and shall not limit or otherwise affect the meaning of terms contained herein. (e) Severability. In the event that any one or more of the provisions, paragraphs, words, clauses, phrases or sentences contained herein, or the application thereof in any circumstances, is held invalid, illegal or unenforceable in any respect for any reason, the validity, legality and enforceability of any such provision, paragraph, word, clause, phrase or sentence in every other respect and of the remaining provisions, paragraphs, words, clauses, phrases or sentences hereof shall not be in any way impaired, it being intended that all rights, powers and privileges of the parties hereto shall be enforceable to the fullest extent permitted by law. (f) Counterparts. This Agreement may be executed in counterparts, and by different parties in separate counterparts, each of which shall be deemed an original, but all such counterparts shall together constitute one and the same instrument. (g) Governing Law; Submission to Jurisdiction. This Agreement shall be governed by and construed and enforced in accordance with the laws of the State of New York applicable to contracts made and to be performed therein. The parties to this Agreement hereby agree to submit to the jurisdiction of the courts of the State of New York, the courts of the United States of America for the Southern District of New York, and appellate courts from any thereof in any action or proceeding arising out of or relating to this Agreement. (h) Specific Performance. The parties hereto acknowledge and agree that irreparable damage would occur in the event that any of the provisions of this Agreement were not performed in accordance with their specific terms or were otherwise breached. Accordingly, it is agreed that they shall be entitled to an injunction or injunctions to prevent breaches of the provisions of this Agreement and to enforce specifically the terms and provisions hereof in any court of competent jurisdiction in the United States or any state thereof, in addition to any other remedy to which they may be entitled at law or in equity. Notwithstanding the foregoing, no Holder shall have any right to obtain or seek an injunction restraining or otherwise delaying or requiring the completion of any such registration as the result of any controversy that might arise with respect to the interpretation or implementation of this Agreement. (i) Limited Liability of Partners. Notwithstanding any other provision of this Agreement, neither the general partner nor the limited partners, nor any future general or limited partner of the Funds, nor any member or managing member of the Funds shall have any personal liability for performance of any obligation of such Common Stock Partnership or the Funds under this Agreement. -18- 19 (j) "Market Stand-Off" Agreement. (i) Subject to clauses (ii) and (iii) below, each Holder hereby agrees that during the period in which Sunstone and its officers and directors are prohibited by the underwriters from selling, transferring or otherwise disposing of Common Stock (but in no event more than ninety (90) days) following the effective date of a registration statement of the Company filed under the Securities Act, without the prior written consent of the underwriters it shall not, whether or not such Holder is participating in the offering, to the extent requested by the Company, sell or otherwise transfer or dispose of (other than to donees who agree to be similarly bound) any Common Stock of the Company held by it at any time during such period except Common Stock included in such registration. In order to enforce the foregoing covenant, the Company may impose stop-transfer instructions with respect to the securities of each Holder (and the shares or securities of any other person subject to the foregoing restrictions) until the end of such period. (ii) Anything herein to the contrary notwithstanding, the Holders will not be prohibited from selling or otherwise disposing of shares of Common Stock pursuant to this Section 9(j) and/or clause (z) of Section 3(a) for more than 90 days during any nine-month period. (iii) The provisions of this Section 9(j) shall terminate as to any Holder at such time as such Holder is able to sell all of the Registrable Securities held by it under Rule 144 in any three-month period without restriction. -19- 20 IN WITNESS WHEREOF, each of the undersigned has executed this Agreement or caused this Agreement to be duly executed on its behalf as of the date first written above. SUNSTONE HOTEL INVESTORS, INC. By: /S/ ROBERT A. ALTER ---------------------------------------- Robert A. Alter President WESTBROOK REAL ESTATE FUND I, L.P. By: Westbrook Real Estate Partners Management, L.L.C., its general partner By: Westbrook Real Estate Partners, L.L.C., its managing member By: /S/ JONATHAN H. PAUL ------------------------------ Jonathan H. Paul Managing Principal WESTBROOK CO-INVESTMENT PARTNERSHIP I, L.P. By: Westbrook Real Estate Partners Management, L.L.C., its general partner By: Westbrook Real Estate Partners, L.L.C., its managing member By: /S/ JONATHAN H. PAUL ------------------------------ Jonathan H. Paul Managing Principal -20- EX-23.1 10 CONSENT OF ERNST & YOUNG LLP 1 Exhibit 23.1 Consent of Independent Auditors We consent to the incorporation by reference in the Registration Statements (Form S-3 No. 333-34377 and Form S-8 No. 333-14179), as amended, of Sunstone Hotel Investors, Inc. of our report dated February 27, 1998, with respect to the consolidated financial statements and schedule of Sunstone Hotel Investors, Inc. and our report dated February 27, 1998 with respect to the consolidated financial statements of Sunstone Hotel Properties, Inc. included in this Annual Report (Form 10-K) for the year ended December 31, 1997. ERNST & YOUNG LLP EX-23.2 11 CONSENT OF COOPERS & LYBRAND L.L.P. 1 Exhibit 23.2 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the registration statements of Sunstone Hotel Investors, Inc. on Form S-3 (File No. 333-34377), Form S-3 (File No. 333-31683), Form S-3 (File No. 333-13911), and Form S-8 (File No. 333-14179) of our report dated February 28, 1997 on our audits of the consolidated financial statements of Sunstone Hotel Investors, Inc. and Sunstone Initial Hotels (the Predecessor), as of December 31, 1996, and for the year ended December 31, 1996 and for the period August 16, 1995 to December 31, 1995 and the combined financial statements of Sunstone Hotels (the "Predecessor") for the period January 1, 1995 to August 15, 1995, and of our report dated February 28, 1997 on our audits of the financial statements of Sunstone Hotel Properties, Inc. (the "Lessee") as of December 31, 1996, and for the year ended December 31, 1996 and for the period August 16, 1995 (inception) to December 31, 1995, which reports are included in this Annual Report on Form 10-K. Coopers & Lybrand L.L.P. San Francisco, California March 9, 1998 EX-27 12 FINANCIAL DATA SCHEDULE
5 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 6,005,000 0 13,726,000 0 0 0 0 0 0 0 0 0 0 0 0 0 0 44,680,000 0 23,195,000 0 0 6,365,000 15,169,000 15,169,000 15,169,000 0 0 0 15,169,000 0.72 0.71
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