As filed with the Securities and Exchange Commission on January 28, 2013
Registration Statement No. 333-185932
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Amendment No. 1
to
FORM S-11
FOR REGISTRATION
UNDER
THE SECURITIES ACT OF 1933
OF CERTAIN REAL ESTATE COMPANIES
ZAIS Financial Corp.
(Exact name of registrant as specified in its governing instruments)
ZAIS Financial Corp.
Two Bridge Avenue, Suite 322
Red Bank, New Jersey 07701-1106
(732) 978-7518
(Address, including Zip Code, and Telephone Number, including Area Code,
of Registrant's Principal Executive Offices)
Michael Szymanski
Chief Executive Officer and President
ZAIS Financial Corp.
Two Bridge Avenue, Suite 322
Red Bank, New Jersey 07701-1106
(732) 978-7518
(Name, Address, including Zip Code, and Telephone Number,
including Area Code, of Agent for Service)
Copies to: | ||
Jay L. Bernstein, Esq. Clifford Chance US LLP 31 West 52nd Street New York, New York 10019 Tel (212) 878-8000 Fax (212) 878-8375 |
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David J. Goldschmidt, Esq. Skadden, Arps, Slate, Meagher & Flom LLP Four Times Square New York, New York 10036 Tel (212) 735-3000 Fax (212) 735-2000 |
Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this registration statement.
If any of the Securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act, check the following box: o
If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o | Accelerated filer o | Non-accelerated filer ý | Smaller reporting company o |
(Do not check if a smaller reporting company)
The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.
The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is declared effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.
Subject to Completion, Dated January 28, 2013
ZAIS Financial Corp.
Shares
Common Stock
ZAIS Financial Corp. is a Maryland corporation that invests in, finances and manages a diversified portfolio of residential mortgage assets, other real estate-related securities and financial assets, which we refer to as our target assets. We are externally managed and advised by ZAIS REIT Management, LLC (or our Advisor), a subsidiary of ZAIS Group, LLC (or ZAIS), a privately-held, investment advisor registered with the U.S. Securities and Exchange Commission with approximately $5.5 billion of assets under management as of September 30, 2012.
This is the initial public offering of common stock of ZAIS Financial Corp. We are offering shares of our common stock, $0.0001 par value per share. We anticipate that the initial public offering price will be $ per share. We have applied to list our common stock for trading on the New York Stock Exchange under the symbol "ZFC".
We have elected to be taxed as a real estate investment trust (or REIT) for U.S. federal income tax purposes, commencing with our taxable year ended December 31, 2011. To assist us in qualifying as a REIT, among other purposes, no person may own, with certain exceptions, more than 9.8% in value or in number, whichever is more restrictive, of the outstanding shares of our common or capital stock. In addition, our charter contains various other restrictions relating to the ownership and transfer of our capital stock. See "Description of Capital StockRestrictions on Ownership and Transfer."
We are an "emerging growth company" as defined in the Jumpstart Our Business Startups Act of 2012.
Investing in our common stock involves risks. See "Risk Factors" beginning on page 31
of this prospectus for a discussion of the following and other material risks of investing in our common stock:
Neither the U.S. Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.
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Per Share
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Total
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Public offering price |
$ | $ | ||
Underwriting fee (1) |
$ | $ | ||
Proceeds, before expenses, to us |
$ | $ |
We have granted the underwriters the right to purchase up to an additional shares of our common stock from us at the initial public offering price, less the underwriting fee, within 30 days after the date of this prospectus.
The underwriters expect to deliver the shares of common stock on or about , 2013.
Deutsche Bank Securities | Citigroup | Barclays | Credit Suisse |
Stifel Nicolaus Weisel
Oppenheimer & Co. | Ladenburg Thalmann & Co. Inc. |
The date of this prospectus is , 2013
This summary highlights some of the information in this prospectus. It does not contain all of the information that you should consider before investing in our common stock. You should read carefully the detailed information set forth under "Risk Factors" and the other information included in this prospectus. Except where the context suggests otherwise, the terms "company," "we," "us" and "our" refer to ZAIS Financial Corp., a Maryland corporation, together with its consolidated subsidiaries; references in this prospectus to "our Operating Partnership" refer to ZAIS Financial Partners, L.P., a Delaware limited partnership; and references to "risk-adjusted returns" refer to the profile of expected asset returns across a range of potential macroeconomic scenarios. Unless indicated otherwise, the information in this prospectus assumes (1) the common stock to be sold in this offering is to be sold at $ per share, which is the anticipated initial public offering price shown on the cover page of this prospectus, (2) no exercise by the underwriters of their overallotment option to purchase up to an additional shares of our common stock and (3) the redemption of the 133 shares of 12.5% Series A Cumulative Non-Voting Preferred Stock outstanding for an aggregate redemption price of $146,300.
Overview
We are a Maryland corporation that invests in, finances and manages a diversified portfolio of residential mortgage assets, other real estate-related securities and financial assets, which we refer to as our target assets. We currently primarily invest in, finance and manage residential mortgage-backed securities (or RMBS), including RMBS that are not issued or guaranteed by a federally chartered corporation, such as the Federal National Mortgage Association (or Fannie Mae), or the Federal Home Loan Mortgage Corporation (or Freddie Mac), or an agency of the U.S. Government, such as the Government National Mortgage Association (or Ginnie Mae) (or non-Agency RMBS), as well as RMBS that are issued or guaranteed by a federally chartered corporation or a U.S. Government agency (or Agency RMBS). Our RMBS strategy focuses on non-Agency RMBS with an emphasis on securities that, when originally issued, were rated in the highest rating category by one or more of the nationally recognized statistical rating organizations, as well as Agency RMBS. Our strategy will also emphasize the purchase of performing and re-performing residential whole loans. We will also have the discretion to invest in other real estate-related and financial assets, including mortgage servicing rights (or MSRs), interest only strips created from RMBS (or IOs), commercial mortgage-backed securities (or CMBS) and asset-backed securities (or ABS).
Our income is generated primarily by the net spread between the income we earn on our assets and the cost of our financing and hedging activities. Our objective is to provide attractive risk-adjusted returns to our stockholders, primarily through quarterly distributions and secondarily through capital appreciation.
We are externally managed and advised by ZAIS REIT Management, LLC (or our Advisor), a subsidiary of ZAIS Group, LLC (or ZAIS). ZAIS was established in 1997 and is an investment adviser registered with the U.S. Securities and Exchange Commission (or SEC) and specializing in structured credit, including residential whole loans, RMBS and ABS. As of September 30, 2012, ZAIS estimates that it had approximately $5.5 billion of assets under management (comprised of the net asset value of managed funds, and the aggregate principal balance of collateralized debt obligation (or CDO) vehicles and other entities, which do not mark their securities to fair market value under U.S. generally accepted accounting principles (or U.S. GAAP) and has built long-term relationships with a global investor base, including public and private pension funds, endowment/foundations, insurance companies, family offices, fund of funds, sovereign wealth funds and investment advisors. ZAIS possesses
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a comprehensive analytics and technology infrastructure, credit modeling, loan and securities valuation, loan data management and servicing oversight capabilities and significant structuring and securitization experience. As of September 30, 2012, ZAIS's team included 123 professionals in the United States, Europe and Asia. ZAIS is the managing member of our Advisor and ZAIS and its employees support our Advisor in providing services to us pursuant to the terms of a shared facilities and services agreement between ZAIS and our Advisor. We rely on our Advisor and ZAIS to provide or obtain on our behalf the personnel and services necessary for us to conduct our business, and we have no employees of our own.
We completed our formation transaction and commenced operations on July 29, 2011. The formation transaction involved the exchange by investors in two funds from the Matrix VI series of funds (or the Matrix VI Funds) of cash and RMBS assets for an aggregate of 3,022,617 shares of our common stock. We received $60.5 million in this transaction, including $8.65 million from certain current and former employees of ZAIS and relatives of such persons as well as current and former members and owners of ZAIS (or, collectively, the ZAIS Parties) and deployed the cash together with additional borrowings to build a diversified portfolio of RMBS assets. As part of the initial formation transactions, we anticipated completing our initial public offering on or prior to August 3, 2012 and viewed our initial public offering as a means for our stockholders to achieve liquidity in their investments. We determined, due to our assessment of market conditions, to delay the initial public offering beyond August 3, 2012. In connection with our delay of the initial public offering, we offered to repurchase shares from our stockholders who desired to achieve liquidity around the time of the original August 3, 2012 time frame. Accordingly, on October 11, 2012, we repurchased 668,525 shares of common stock from our existing stockholders at the per share book value as of July 31, 2012. On January 24, 2013, we also repurchased 265,245 shares of our common stock from one of our institutional stockholders. We paid to such stockholder approximately $5.2 million, which represents 90% of the repurchase amount based on the estimated book value per share as of December 31, 2012, the remaining 10% of the repurchase price will be paid following the completion of our December 31, 2012 year-end audit. In October of 2012, we also completed a private placement in which we sold 195,457 shares of common stock and 22,492 Operating Partnership units (or OP units) at a price per share equal to the per share book value as of August 31, 2012. Subsequently, in December of 2012, we completed another private placement in which we sold 36,581 shares of common stock and 904,422 OP units at a price per share equal to the per share book value as of November 30, 2012. As a consequence of these transactions, we currently have outstanding 2,320,882 shares of common stock and 926,914 OP units.
As of September 30, 2012, we held a diversified portfolio of RMBS assets with an estimated fair market value of $163.4 million, consisting primarily of senior tranches of non-Agency RMBS that were originally highly rated but subsequently downgraded, and Agency RMBS collateralized by either fixed rate loans or adjustable rate mortgages (or ARMs). The borrowings we used to fund the purchase of our portfolio totaled approximately $110.1 million as of September 30, 2012 under master repurchase agreements with two counterparties. As of September 30, 2012, we had entered into master repurchase agreements with three counterparties and had outstanding borrowings with two of these counterparties. We are also in discussions with other financial institutions in order to potentially provide us with additional repurchase agreement capacity.
We have elected to be taxed as a real estate investment trust (or REIT) for U.S. federal income tax purposes commencing with our taxable year ended December 31, 2011. We are organized in a traditional umbrella partnership real estate investment trust (or UpREIT) format pursuant to which we serve as the general partner of, and conduct substantially all of our
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business through, our Operating Partnership subsidiary, ZAIS Financial Partners, L.P., a Delaware limited partnership. We also expect to operate our business so that we are not required to register as an investment company under the Investment Company Act of 1940, as amended (or the 1940 Act).
Current Market Opportunities
Residential Mortgage Market Opportunities. While U.S. financial markets have recovered significantly since the financial crisis that began in 2007, much of the residential mortgage market remains under a great deal of distress. The unprecedented liquidity injections into the U.S. financial system have restored stability in the financial sector and supported the flow of capital and credit into the broader economy. At the same time, the U.S. housing market recovery remains tepid, and bank holdings of delinquent mortgage loans remain high. We believe that the slow resolution of mortgage foreclosures has constrained the volume of distressed home sales and may have provided a floor to home prices. This floor has also been supported in some local markets by bulk buyers of foreclosed homes targeting the single family rental market. Continued high levels of "shadow inventory" will likely increase the volume of distressed sales in the future and slow the pace of recovery. While yield levels in the RMBS market have recovered from the depths of the financial crisis and we expect to see further credit spread tightening, we believe the volatility of expected credit performance across the RMBS market presents many opportunities based on individual sector and security selection. In addition, we expect the opportunity to acquire mortgage loans from legacy portfolios to continue for some time as economic risk factors persist.
Reduced Exposure of Banks and Traditional Lenders. Despite generally higher capital levels, many financial institutions continue to reduce their exposure to residential mortgage-related assets including whole loans and MSRs. This is, in part, because the servicing of legacy loan portfolios has become a significant operational risk and resource drain for banks and regulatory changes related to capital requirements have made it more costly for traditional lenders, such as banks, to hold MSRs on their balance sheets. Additionally, we believe that the state of the housing market along with subsequent legislative and regulatory initiatives have permanently altered the mortgage landscape. Banks and traditional lenders face ongoing uncertainties related to the Dodd Frank Wall Street Reform and Consumer Protection Act (or the Dodd-Frank Act) and other such legislative initiatives. In particular, the Dodd-Frank Act seeks to reform the mortgage-backed securities market by requiring the retention of a portion of the credit risk inherent in the pool of securitized assets and it also imposes significant regulatory restrictions on the origination and securitization of residential mortgage loans. We believe that the requirements imposed by the Dodd-Frank Act and other such legislative initiatives have had an effect on the willingness of some banks and traditional lenders to participate in mortgage loan origination on terms attractive to borrowers, which should lead to attractive risk-adjusted return opportunities for us.
Opportunities Created by Housing Finance Reform. We believe the U.S. housing finance system will evolve at an increasingly rapid pace in the coming years, although the pace of mortgage market restructuring has been slow to date. Currently, the primary mortgage market is being supported by the government's deep involvement through its receivership relationship with Fannie Mae and Freddie Mac, and an indirect subsidization of the Federal Housing Authority (or the FHA). The housing finance reform report issued by the U.S. Department of Treasury and the Department of Housing and Urban Development in February 2011 indicates an intent to reduce the government's role in the residential mortgage market from current levels. The options outlined in the report all share a common objective of significantly increasing the role of private sector capital in bearing credit risk in the residential
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mortgage market. The October 2011 proposal by the Obama administration to have Fannie Mae and Freddie Mac sell tranches of RMBS that would not carry such entities' guaranty is another example of this trend. It is not yet possible to determine whether or when any of such proposals may be enacted, what form any final legislation or policies might take and how proposals, legislation or policies emanating from this report may impact our business, operations and financial condition. We expect this process of privatizing mortgage credit risk will create attractive investment opportunities consistent with our investment objectives. We believe ZAIS's capabilities in evaluating, acquiring and risk managing residential mortgage whole loans will provide us with an important advantage as this new market opportunity evolves.
Credit Constraints and Mortgage Gap. Since 2008, credit availability in the residential mortgage market has been highly constrained, despite the Federal Reserve's monetary policies and other efforts to maintain short term interest rates at relatively low levels. Large segments of potential borrowers have limited access to credit due to tightening credit standards for loans eligible for Fannie Mae, Freddie Mac, or FHA programs. As a result, the average FICO credit scores of borrowers obtaining mortgages eligible for Agency RMBS or for the FHA pools significantly increased since the onset of the financial crisis in 2007. Additionally, non-agency origination programs have contracted significantly, with mortgages eligible for Agency RMBS or FHA pools representing the vast majority of new originations. Many of these changes may be warranted. For example, "low documentation loans," which refer to loans in which the underlying documentation or application process requires little information with respect to the employment, income or assets of the proposed borrower, as a percentage of all mortgage loans originated, fell sharply beginning in 2008 and these types of mortgages are, for the most part, no longer being originated. However, the impact of the mortgage crisis has gone beyond just increasing the requisite credit standards of lenders, as it has, in our view, created a mortgage gap for many qualified borrowers. We believe that credit availability in the residential mortgage market will remain highly constrained over the next several years, which will present an opportunity for new providers of mortgage credit to emerge as the government's share of mortgage origination declines.
ZAIS's Investment Platform. We believe that ZAIS's investment platform is well positioned to take advantage of the current investment environment. ZAIS currently invests in both residential mortgage loans and RMBS, which allows it to seek risk-adjusted returns regardless of the investment form. We believe that ZAIS's capability to model, analyze, diligence, acquire, structure and manage risk across both residential mortgage loans and RMBS is an important part of our value proposition. Furthermore, the robustness of ZAIS's credit modeling and analytics framework is enhanced by its access to various loan level data. ZAIS's existing loan platform has servicing oversight and asset management capabilities at the individual loan level that we believe will enable us to acquire and manage loan risk prudently. ZAIS's existing loan platform, and corresponding relationships, also provides a sourcing advantage for acquiring risk in unsecuritized assets such as mortgage loans and MSRs.
Our Competitive Advantages
We believe that our competitive advantages include the following:
Significant Experience of ZAIS. Founded in 1997, ZAIS focuses on alternative investment strategies in the credit markets. ZAIS has been an active investor in residential mortgage loans, non-Agency RMBS and ABS. Additionally, ZAIS's senior management team has previous experience investing in a wide array of other asset classes, including Agency RMBS
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and MSRs. As the mortgage market deteriorated in 2007, ZAIS began to raise capital to invest in distressed residential mortgage securities and loans. Since September 2007, ZAIS attracted approximately $2.6 billion (as of September 30, 2012) in capital commitments from investors for distressed mortgage investment mandates. ZAIS has built long-term relationships with a global investor base, including public and private pension funds, endowment/foundations, insurance companies, family offices, fund of funds, sovereign wealth funds and investment advisors. ZAIS manages assets using a range of strategies and investment vehicles, including private equity-style funds, hedge funds and separately managed accounts. Most recently, ZAIS has established managed accounts and dedicated funds on behalf of individual investors that focus on opportunities in the RMBS sector and, in some instances, utilize derivative financial instruments to hedge against changes in the fair value of RMBS in periods of general market risk aversion. We believe that ZAIS's senior management team, which has a long track record and broad experience in managing mortgage loan and RMBS assets through a variety of credit and interest rate environments, will provide us with a competitive advantage. For a description of ZAIS's historical performance, see "Our Advisor and the Investment Advisory AgreementHistorical Performance of Certain Funds and Managed Accounts Managed by ZAIS."
Whole Loan Investment Platform. We believe ZAIS's capabilities in managing residential whole loan investments will provide us with a competitive advantage in acquiring loans that offer relative value advantages to non-Agency RMBS assets backed by similar loan collateral. In addition, ZAIS's whole loan investment capabilities will provide us with the capability to invest in newly originated loans as the mortgage market is restructured to significantly increase the role of private sector capital in bearing mortgage credit risk. See "BusinessCurrent Market Opportunities."
Access to ZAIS Infrastructure. ZAIS maintains a proprietary database, analytics and modeling infrastructure. This infrastructure is focused on loan level data aggregation, evaluation and modeling, allowing ZAIS to apply a common analytics platform across the residential mortgage loan and securities markets. It integrates the analysis of borrower credit, collateral (property) value and economic variables to forecast loan prepayment, delinquency, default, and recovery rates. Utilizing a common analytics platform for both securities and loans enables ZAIS to make relative value allocations across these sectors. We expect that ZAIS will benefit from these systems and tools, as well as an established qualitative approach to originator, issuer and servicer due diligence, for our benefit in evaluating, acquiring and managing our investment portfolio. We believe that ZAIS's rigorous approach will support us in a variety of market conditions.
Extensive Strategic Relationships. ZAIS maintains extensive long-term relationships with other financial intermediaries, including primary dealers, leading investment banks, brokerage firms, leading mortgage originators, mortgage servicers and commercial banks. ZAIS-managed funds actively source investments, finance positions, hedge exposures, and securitize assets with these counterparties currently. We believe these relationships enhance our ability to source, finance and hedge investment opportunities and, thus, enable us to grow in various credit and interest rate environments.
Alignment of Interests. We have taken steps to structure our relationship with ZAIS and our Advisor so that our interests and those of ZAIS and our Advisor are closely aligned. Upon completion of this offering, the ZAIS Parties will beneficially own 543,705 shares and OP units, or %, of our outstanding common stock and OP units (or % if the underwriters fully exercise their overallotment option). These shares will be subject to a 270-day lock-up following this offering. We believe that the investment in us by the ZAIS Parties has aligned
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ZAIS and our Advisor's interests with our interests and creates an incentive to maximize returns, while prudently managing risks, for our stockholders.
Our Investment Strategy
Our objective is to provide attractive risk-adjusted returns to our stockholders over the long-term, primarily through quarterly distributions and secondarily through capital appreciation. We intend to achieve this objective by selectively constructing a portfolio of our target assets. We may utilize ZAIS's existing whole loan investment platform to purchase loans originated prior to the financial crisis that began in 2007 at prices below the par amount of unpaid principal. For example, our Advisor is actively reviewing for us a pipeline of multiple whole loan portfolio transactions totaling approximately $680 million in unpaid principal balance. Although there can be no assurance that any such transactions will be completed, the pipeline is reflective of the type and size of opportunities that may be available for us in this asset class. We believe that our target assets currently present attractive risk-adjusted return profiles and that current market conditions present opportunities for us to selectively acquire our target assets at attractive trading prices. As market conditions change over time, we intend to adjust our strategy by shifting our asset allocations across our target asset classes to take advantage of changes in interest rates and credit spreads as well as economic and credit conditions. We believe that the diversification of our portfolio of assets, our expertise among mortgage loans and securities and the flexibility of our strategy will position us to generate attractive risk-adjusted returns for our stockholders over the long-term.
We rely on our Advisor's investment expertise in identifying assets within our target assets and efficiently financing those assets. Our Advisor makes investment decisions based on a variety of factors, including expected risk-adjusted returns, credit fundamentals, liquidity, availability of adequate financing, borrowing costs and macroeconomic conditions, as well as maintaining our REIT qualification and our exemption from registration under the 1940 Act. We intend to follow a predominantly long-term buy and hold strategy with respect to the assets that we acquire. For more information, see "BusinessOur Investment Strategy."
Our Portfolio
The following diagrams and tables illustrate our asset types and set out certain information with respect to our RMBS assets as of September 30, 2012.
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The following diagrams illustrate the seniority and vintage of our non-Agency RMBS as of September 30, 2012.
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Our Performance
As illustrated by the following table, from the date of the commencement of our operations through September 30, 2012, we have delivered total returns to stockholders that have held our common stock from inception, taking into account both distributions and capital appreciation (measured by increases in our estimated book value per share), of 26.9%. The following table shows our book value per outstanding share of common stock as of our inception date and as of the end of each completed fiscal quarter thereafter, the dividends per
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share we paid with respect to each such quarter, the quarterly total return for each such quarter and the cumulative total return as of the end of each such quarter:
ZAIS Financial Corp. Book Value and Total Return
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Book Value
Per Share |
Dividends
Paid |
Quarterly
Total Return (2) |
Cumulative
Total Return (2) |
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Commenced operations (July 29, 2011) (1) |
$ | 20.00 | N/A | N/A | N/A | ||||||||
July 29, 2011 through September 30, 2011 |
$ | 18.73 | $ | 0.00 | (6.4 | )% | (6.4 | )% | |||||
Three-month period ended December 31, 2011 |
$ | 18.30 | $ | 0.00 | (2.3 | )% | (8.5 | )% | |||||
Three-month period ended March 31, 2012 |
$ | 20.40 | $ | 0.00 | 11.5 | % | 2.0 | % | |||||
Three-month period ended June 30, 2012 (3) |
$ | 20.42 | $ | 1.08 | 5.4 | % | 7.5 | % | |||||
Three-month period ended September 30, 2012 |
$ | 24.29 | $ | 0.00 | 19.0 | % | 26.9 | % |
All performance data presented above is historical in nature and not indicative of our future results of operations or financial condition. We cannot provide any assurance as to our future results of operations or financial condition, or that our future results of operations or financial condition will be comparable to those presented above.
Target Assets
Our target assets are as follows:
Non-Agency RMBS. RMBS that are not issued or guaranteed by a U.S. Government agency or federally chartered corporation, with an emphasis on securities that, when originally issued, were rated in the highest rating category by one or more of the nationally recognized statistical rating organizations.
The mortgage loan collateral for non-Agency RMBS consists of residential mortgage loans that do not generally conform to underwriting guidelines issued by Fannie Mae, Freddie Mac or Ginnie Mae, due to certain factors, including mortgage balances in excess of agency underwriting guidelines, borrower characteristics, loan characteristics and level of documentation, and therefore are not issued or guaranteed by an agency. The mortgage loan collateral may be classified as prime, subprime and alternative-A and alternative-B mortgage loans, which may be adjustable-rate, hybrid and/or fixed-rate residential mortgage loans, and pay option ARMs.
Agency RMBS. RMBS that are issued or guaranteed by a federally chartered corporation or a U.S. Government agency. The Agency RMBS we target can be collateralized by either fixed rate loans or ARMs.
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Residential Mortgage Loans. Prime, subprime and alternative-A and alternative-B mortgage loans, which may be adjustable-rate, hybrid and/or fixed-rate residential mortgage loans, and pay option ARMs. We expect that the residential mortgage loans that we may acquire will be primarily, but not exclusively, performing and re-performing loans at the time of acquisition.
MSRs and Other Real Estate-Related and Financial Assets. An MSR provides a mortgage servicer with the right to service a pool of mortgages in exchange for a portion of the interest payments made on the underlying mortgages. "Interest only" securities are mortgage-backed securities structured with two or more classes that receive different distributions of principal or interest on a pool of Agency RMBS or non-Agency RMBS or whole loans. IOs receive only interest. CMBS are securities backed by obligations (including certificates of participation in obligations) that are principally secured by commercial mortgages on real property or interests therein having a multifamily or commercial use, such as regional malls, other retail space, office buildings, industrial or warehouse properties, hotels, apartments, nursing homes and senior living facilities. Subject to maintaining our qualification as a REIT, we may acquire debt and equity tranches of securitizations backed by various asset classes, including small balance commercial mortgages, manufactured housing, aircraft, automobiles, credit cards, equipment, manufactured housing, franchises, recreational vehicles and student loans.
Asset Allocations. Based on current market conditions, over time, we expect to allocate an estimated: 50% to 60% of our equity to whole loans; 30% to 40% of our equity to non-Agency RMBS; 5% to 10% of our equity to MSRs, other real estate-related and financial assets and cash; and 0% to 5% of our equity to Agency RMBS. As market conditions change, we intend to adjust our strategy by shifting our asset allocations across our target asset classes. We believe that the diversification of our portfolio of assets, our expertise among our target assets and the flexibility of our strategy will position us to generate attractive risk-adjusted returns for our stockholders in a variety of assets and market conditions. We will rely on our Advisor's expertise in identifying assets within the target assets described above and, to the extent that leverage is employed, efficiently financing those assets. We expect allocation decisions will be based on a variety of factors, including expected risk-adjusted returns, credit fundamentals, and liquidity.
Investment Guidelines
Our Board, which includes our Chief Executive Officer and President, Michael Szymanski, has adopted a set of investment guidelines that sets forth our target assets and other criteria used to evaluate specific assets as well as the overall portfolio composition. Our Advisor makes determinations as to the percentage of assets that will be invested in each of the target asset classes, consistent with the investment guidelines adopted by our Board. Our Advisor's investment decisions will depend on prevailing market conditions and may change over time in response to opportunities available in different interest rate, economic and credit environments. As a result, we cannot predict the percentage of assets that will be invested in any of the target asset classes at any given time, and such allocations may differ from the allocations provided above. In addition, our investment guidelines may be changed from time to time by our Board without the approval of our stockholders. Changes to our investment guidelines may include, without limitation, modification or expansion of the types of assets in which we may invest. To the extent that our Board approves material changes to our investment guidelines, we will inform stockholders of such changes through disclosure in our periodic reports and other filings required under the Securities Exchange Act of 1934, as amended (or the Exchange Act). For more information, see "BusinessGuidelines."
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Our Financing and Hedging Strategy
We fund the acquisition of our target assets through the use of prudent amounts of leverage. The borrowings we used to fund the purchase of our portfolio totaled approximately $110.1 million as of September 30, 2012 under master repurchase agreements with two counterparties. As of September 30, 2012, we had entered into master repurchase agreements with three counterparties and had outstanding borrowings with two of these counterparties. We are also in discussions with other financial institutions in order to potentially provide us with additional repurchase agreement capacity. We may also, in the future, finance investments in our target assets through other private funding sources, including borrowings structured as securitizations and term financings.
Our income is generated primarily by the net spread between the income we earn on our assets and the cost of our financing and hedging activities. Although we are not required to maintain any particular leverage ratio, the amount of leverage we deploy for particular investments in our target assets depends upon our Advisor's assessment of a variety of factors, which may include the anticipated liquidity and price volatility of the assets in our investment portfolio, the gap between the duration of our assets and liabilities, including hedges, the availability and cost of financing the assets, our opinion of the creditworthiness of our financing counterparties, the health of the U.S. economy and residential and commercial mortgage-related markets, our outlook for the level, slope, and volatility of interest rates, the credit quality of collateral underlying our non-Agency RMBS, Agency RMBS, residential mortgage loans and other target assets, our outlook for asset spreads relative to the London Interbank Offered Rate (or LIBOR) curve and regulatory requirements limiting the permissible amount of leverage to be utilized. Based on current market conditions, we expect that we may deploy, on a debt-to-equity basis, up to nine to one leverage on our Agency RMBS assets. In addition, we expect that we may deploy, on a debt-to-equity basis, up to three to one leverage on our non-Agency RMBS assets and up to four to one leverage on our residential whole loans. To the extent we securitize any residential mortgage loans in the future, we expect that the leverage obtained through such structures will vary considerably depending on the characteristics of the underlying loans.
We intend to use leverage for the primary purpose of financing our portfolio and not for the purpose of speculating on changes in interest rates. We are, however, limited or restricted in the amount of leverage we may employ by the terms and provisions of our existing repurchase agreement borrowings as well as other financing agreements that we may enter into in the future. We may also be subject to margin calls as a result of our financing activity. In addition, we intend to rely on short-term financing such as repurchase transactions under master repurchase agreements, the duration of which is typically 30 to 90 days but in some cases may be longer.
We utilize derivative financial instruments to hedge the interest rate risk associated with our borrowings. Subject to maintaining our qualification as a REIT and exemption from registration under the 1940 Act, we may also engage in a variety of interest rate management techniques that seek on one hand to mitigate the influence of interest rate changes on the values of some of our assets and on the other hand help us achieve our risk management objectives. Our interest rate management techniques may include:
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For more information, see "BusinessOur Financing Strategy" and "BusinessOur Hedging Strategy."
Risk Management
To the extent consistent with maintaining our REIT qualification, we may seek to manage our risk to protect our stockholders' equity from adverse changes in the fair market value of our investment portfolio and our net interest income from the impact of changing interest rates and prepayment rates. When our Advisor deems appropriate, we may incorporate a variety of risk management techniques, including the following:
Summary Risk Factors
An investment in shares of our common stock involves various risks. You should consider carefully the risks discussed below and under the heading "Risk Factors" beginning on page 29 of this prospectus before purchasing our common stock. If any of the following risks occurs, our business, financial condition or results of operations could be materially and adversely affected. In that case, the value of our common stock could decline and you may lose some or all of your investment.
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a material adverse effect on our business, financial condition, liquidity, results of operations and ability to make distributions to our stockholders.
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Our Structure
The following chart shows our structure after giving effect to this offering:
Investment Advisory Agreement
We and our Operating Partnership are externally managed and advised by ZAIS REIT Management, LLC pursuant to an amended and restated investment advisory agreement (or the Investment Advisory Agreement).
Pursuant to the Investment Advisory Agreement, our Advisor implements our business strategy and performs certain services for us, subject to oversight by our Board. Our Advisor
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is responsible for, among other duties, (i) performing all of our day-to-day functions, (ii) determining investment criteria in conjunction with our Board, (iii) sourcing, analyzing and executing investments, asset sales and financings, (iv) performing asset management duties and (v) performing financial and accounting management, and tax services.
The Investment Advisory Agreement may be amended or modified by agreement between us and our Advisor. The initial term of our Investment Advisory Agreement with our Advisor only extends until the third anniversary of our listing, with automatic one-year renewal terms on each anniversary date thereafter unless previously terminated as described below. Our Board will review our Advisor's performance and the management fees annually and, following the three-year initial term, the Investment Advisory Agreement may be terminated annually upon the affirmative vote of at least two-thirds of our independent directors or by a vote of the holders of at least two-thirds of the outstanding shares of our common stock (other than those shares held by the ZAIS Parties), based upon (i) unsatisfactory performance that is materially detrimental to us or (ii) our determination that the advisory fees payable to our Advisor are not fair, subject to our Advisor's right to prevent such termination due to unfair fees by accepting a reduction of advisory fees agreed to by at least two-thirds of our independent directors. We must provide 180 days' prior notice of any such termination. Unless terminated for cause, our Advisor will be paid a termination fee as described in the table below. We may also terminate the Investment Advisory Agreement at any time, including during the initial term, with 30 days' prior notice from our Board, without payment of a termination fee, for cause, as defined in the Investment Advisory Agreement. Our Advisor may terminate the Investment Advisory Agreement if we become required to register as an investment company under the 1940 Act, with such termination deemed to occur immediately before such event, in which case we would not be required to pay a termination fee. Our Advisor may also decline to renew the Investment Advisory Agreement by providing us with 180 days written notice, in which case we would not be required to pay a termination fee. Our Advisor may, without our consent, assign the Investment Advisory Agreement to a majority-owned and controlled affiliate of ZAIS. It is expected that, in the event of such an assignment, ZAIS employees will support the affiliate in providing services to us.
The following table summarizes the fees and expense reimbursements that we will pay to our Advisor:
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Advisory fee | Our Operating Partnership will pay to our Advisor an advisory fee, calculated and payable quarterly in arrears, equal to 1.5% per annum, calculated and paid (in cash) quarterly in arrears, of our Stockholders' Equity (as defined below). The fee totaled $0.7 million for the nine-month period ended September 30, 2012. However, prior to the completion of this offering, the fee was calculated based on our Net Asset Value as defined in the Investment Advisory Agreement (not our Stockholders' Equity). | Quarterly in cash. | ||
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Type
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Description | Payment | ||
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"Stockholders' Equity" means our net asset value of our Operating Partnership at completion of this offering, plus the sum of the net proceeds from all issuances of our capital stock and our Operating Partnership's equity securities (exclusive of Operating Partnership equity securities held by us or our controlled subsidiaries) following the completion of this offering (allocated on a pro rata basis for such issuances during the fiscal quarter of any such issuance), plus our retained earnings at the end of the most recently completed calendar quarter (without taking into account any non-cash equity compensation expense incurred in current or prior periods), less any amount that we pay to repurchase common stock following the closing of this offering, and excluding any unrealized gains, losses or other items that do not affect realized net income (regardless of whether such items are included in other comprehensive income or loss, or in net income). This amount is adjusted to exclude one-time events pursuant to changes in U.S. GAAP and certain other non-cash items after discussions between our Advisor and our independent directors and approved by a majority of our independent directors. For purposes of calculating Stockholders' Equity, outstanding OP units (other than OP units held by us) are treated as outstanding shares of our capital stock. The definition of Stockholders' Equity for purposes of determining the advisory fee that we will pay our Advisor is different than the determination of stockholders' equity under U.S. GAAP. | ||||
Expense reimbursement | Reimbursement of operating expenses related to us incurred by our Advisor, including legal, accounting, due diligence and other services. We will not reimburse our Advisor or its affiliates for the salaries and other compensation of their personnel. | Quarterly in cash. | ||
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Type
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Description | Payment | ||
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Incentive plans | We have adopted an equity incentive plan whereby the compensation committee of our Board is authorized to approve grants of equity-based awards to our officers and directors and officers and employees of our Advisor or its affiliates. Our equity incentive plan provides for grants (following the completion of this offering) of equity awards up to, in the aggregate, the equivalent of 5% of the shares of common stock issued and outstanding from time to time following the completion of this offering. See "ManagementEquity Incentive Plan." | |||
Termination fee |
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Termination fee equal to three times the average annual advisory fee earned by our Advisor during the prior 24-month period prior to such termination, calculated as of the end of the most recently completed fiscal quarter prior to such termination. See "Our Advisor and the Investment Advisory AgreementInvestment Advisory AgreementAdvisory Fees, Expense Reimbursements and Termination Fee." |
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Upon termination of the Investment Advisory Agreement by us without cause or by our Advisor if we materially breach the Investment Advisory Agreement. |
Conflicts of Interest
Asset Allocations
We are dependent on our Advisor for our day-to-day management, and we do not have any independent officers or employees. Each of our officers and directors is also an employee of our Advisor or its affiliates. Our Investment Advisory Agreement with our Advisor was negotiated between related parties and its terms, including fees and other amounts payable, may not be as favorable to us as if they had been negotiated on an arm's-length basis with unaffiliated third parties. In addition, the ability of our Advisor and its officers and personnel to engage in other business activities, including the management of other entities and separate accounts, may reduce the time our Advisor and its officers and personnel spend managing us.
Various potential and actual conflicts of interest may arise from the overall investment activities of our Advisor, its affiliates, investment management clients or investment funds managed by it. ZAIS has in the past served, is currently serving and will in the future serve as the investment adviser to a series of funds, dedicated funds and managed accounts, which also invest in our target assets.
In 2006, ZAIS formed the Matrix V series of funds (or the Matrix V Funds), which are private investment vehicles with finite investment periods that primarily focus on investing in collateral loan obligations, CDO securities and RMBS assets, primarily subordinate and distressed credits. Beginning in late 2007, ZAIS formed the Matrix VI series of funds (or the Matrix VI Funds, and, together with the Matrix V Funds, the Matrix Funds), which are private investment vehicles with finite investment periods that deploy a long-only, unlevered strategy that sought to capitalize on the market dislocation and leverage unwind in the mortgage securities sector. The Matrix Funds have liquidated their investment assets and are in the process of winding down their operations.
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In August 2008, ZAIS formed the SerVertis Master Fund I, LP (or the SerVertis Fund). ZAIS manages the SerVertis Fund and has engaged a sub-advisor to assist ZAIS in asset selection and disposition decisions. The SerVertis Fund is a private investment vehicle with an investment strategy focused on acquiring distressed residential loan portfolios (whether through loan acquisitions or structured securities backed by residential loans), consisting primarily of current loans as opposed to delinquent loans, and controlling the loans by utilizing the mortgage servicing and collections platform of a mortgage servicer with which ZAIS has formed a strategic relationship. While the SerVertis Fund has only limited reinvestment capacity since it has exited its commitment period, certain conflicts of interest may still exist with respect to the SerVertis Fund, including, circumstances where we may purchase assets being disposed of by the SerVertis Fund as it begins to liquidate its assets. As of September 30, 2012, the SerVertis Fund had a net asset value of $784.2 million.
In 2009 and 2010, ZAIS also formed various managed accounts (or the 2009-2010 Managed Accounts) which are accounts for certain institutional investors seeking to capitalize on a strategy similar to the Matrix VI Funds through a separate managed account format. As of September 30, 2012, the 2009-2010 Managed Accounts had a net asset value of $40.1 million.
In 2012, ZAIS formed ZAIS Mortgage Securities Master Fund, L.P. (or the ZAIS Mortgage Securities Fund) and the Specialized Investment Management SICAV-SIFINARI Fund (or the INARI Fund). Additionally, in 2012, ZAIS entered into an investment advisory agreement to serve as the investment advisor to a managed account (or the 2012 Managed Account, and together with the 2009-2010 Managed Accounts, the Managed Accounts). ZAIS serves as the investment advisor to each of these funds formed in 2012 and the 2012 Managed Account, which deploy predominantly long strategies focused on opportunities in the RMBS sector and, in some instances, utilize explicit leverage and utilize derivative financial instruments to mitigate mark-to-market risk on the predominantly long positions held by each fund. As of September 30, 2012, the ZAIS Mortgage Securities Fund, the INARI Fund and the 2012 Managed Account had net asset values of $154.2 million, $104.0 million and $71.9 million, respectively.
In addition to RMBS and residential mortgage loan focused funds, in 2003, ZAIS established the ZAIS Opportunity Master Fund Ltd. (or the ZAIS Opportunity Fund, and collectively with the SerVertis Fund, the ZAIS Mortgage Securities Fund and the INARI Fund, the ZAIS Funds) with a focus on investing in various structured finance securities, including a permitted investment in certain of our target assets. Unlike the SerVertis Fund, the ZAIS Opportunity Fund has no defined reinvestment period and the ability to accept new subscriptions of capital. Accordingly, we may compete with the ZAIS Opportunity Fund for both our target assets and for ZAIS's resources. As of September 30, 2012, the ZAIS Opportunity Fund had a net asset value of $486.5 million. ZAIS has also served as the collateral manager of a number of CDO vehicles, some of which encountered events of default as a result of ratings downgrades during the recent financial crisis.
Further, ZAIS and its affiliates may also invest for their own respective accounts (such accounts, together with the ZAIS Funds and the Managed Accounts, are collectively referred to herein as the Other Clients). Certain of the Other Clients have significant uninvested capital and will likely compete with us. Accordingly, we and the Other Clients may co-invest in many of the same securities and issues. The Other Clients may also invest in target assets that would be appropriate investments for us. Our Advisor intends to allocate investment opportunities to us and the Other Clients in a fair and equitable manner, consistent with our and the Other Clients' investment objectives and approaches. Our Advisor allocates investment opportunities to Other Clients which have a current strategy allocation to a given sector (or the Allocation Accounts). The allocation of individual investments is specifically documented and retained on record. In general, allocations are made on a pro-rata basis taking into account the available cash and capital of the respective Allocation Accounts. Pro-rata allocations may be modified for constraints unique to the Allocation Account such as portfolio concentrations, tax consequences, regulatory restrictions or liquidity requirements, among others.
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This policy does not require our Advisor to act in a way that is favorable to us, and such investments made on our behalf may be different from those made on behalf of the Other Clients.
Our Advisor, its affiliates and/or the Other Clients may have economic interests in or other relationships with issuers in whose obligations or securities we may invest. In particular, such persons may make and/or hold an investment in an issuer's securities that may be pari passu , senior or junior in ranking to an investment in such issuer's securities made and/or held by us. In particular, we and the Other Clients may also hold different tranches of the same RMBS or CDO securities where the tranche of an RMBS or CDO security held by us may be subordinate or senior to the tranche held by the Other Clients. We may also invest in an issuer's securities in which our Advisor, its affiliates and/or the Other Clients serve on boards of directors, or own an equity interest, have a financial interest or otherwise have ongoing relationships. Each of such ownership and other relationships may result in securities laws restrictions on transactions in such securities by us and otherwise create conflicts of interest for us. In such instances, our Advisor and its affiliates may in their discretion make investment recommendations and decisions that may be the same as or different from those made with respect to us. Additionally, we and the Other Clients may take adverse positions in the same securities and issues and we and the Other Clients may choose to liquidate positions at different times.
In addition to the existing funds for which ZAIS acts as investment advisor, ZAIS may, in the future, establish new funds or enter into new managed account arrangements with investment strategies that are substantially similar to our strategy, including funds and accounts investing primarily in our target assets, including RMBS and residential mortgage loans. Our Advisor will allocate investments between us and such other funds in a fair and equitable manner, taking into account any capacity or liquidity constraints.
Although the officers and employees of our Advisor and its affiliates will devote as much time to us as each of them deems appropriate, they may have conflicts in allocating their time and services among us, their affiliates, and the Other Clients. In the course of performing its duties to us, our Advisor may consider its relationships with its affiliates and their respective clients. Our Advisor may decline to pursue a particular investment opportunity on our behalf in view of such relationships. In providing services to Other Clients, our Advisor and its affiliates may recommend activities that would compete with or otherwise adversely affect us.
In addition, our Advisor, its affiliates, its investment management clients and investment funds managed by it in connection with their other business activities, may acquire material non-public confidential information that may restrict them from purchasing securities or selling securities (or recommending purchases or sales) for itself or its clients or otherwise using such information for the benefit of their clients or themselves. Accordingly, during certain periods or in certain circumstances, our Advisor may be unable as a result of such restrictions to buy or sell securities or to take other actions that it might consider to be in our best interests.
ZAIS and one or more of its affiliates may hold equity or other interests in the collateral managers of issuers in whose securities we have invested or may invest, or any reference entities referred to in credit default swap (or CDS) or ABS indices, and receives and may continue to receive such equity interests or distributions in respect thereof from such collateral managers as a result of our investment or other funds or issuers for which ZAIS acts as investment advisor. Receipt of any such interests or amounts will be solely the property of ZAIS or such affiliate(s), as the case may be, without any credit to us or any reduction in the fees payable by us to our Advisor. In addition, ZAIS may take a long (or short) position for one or more Other Clients in an investment in which we are short (or long). More particularly, ZAIS or its affiliates may serve as collateral manager or investment adviser for an Other Client (including a CDO) whose reference portfolio contains long positions in the
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same reference obligation that we are short, or, alternatively, an Other Client (including a CDO) whose reference portfolio contains short positions in the same reference obligation that we are long.
Additionally, some of the target assets purchased by us may be purchased from portfolios of investments held for the account(s) of one or more of the Other Clients. We may purchase target assets from our Advisor, its affiliates or any such Other Client only to the extent (i) such purchases are made at fair market value (as determined in good faith by our Advisor) and otherwise on arm's-length terms and (ii) our Advisor determines that such purchases are consistent with our investment guidelines and objectives, the restrictions contained in our Investment Advisory Agreement and applicable law. We may also invest in other companies or pooled investment vehicles focused on investing in Agency RMBS and/or any class of our targeted assets. We may make investments in such vehicles which are managed by our Advisor or one of its affiliates. Our Advisor and its affiliates also may sell target assets initially purchased for us to Other Clients.
We will not, however, purchase any assets from, or issued by, any Other Client or any entity managed by our Advisor or its affiliates, or sell any asset to any Other Client or any such other entity without the consent of a majority of our independent directors. A majority of our independent directors may amend this affiliated investment policy at any time without stockholder consent.
Further, our Advisor may purchase on our behalf securities in one or more ZAIS Funds so long as the underlying investments of such ZAIS Funds primarily consist of our target assets. Our investments in such ZAIS Funds may include debt or equity interests that are subordinate in right of payment to other securities or interests issued by such ZAIS Funds and generally will not be readily marketable. In certain cases, we may sell assets to a ZAIS Fund but repurchase a portion of the credit risk of the assets through ownership of a subordinated debt or equity interest in the ZAIS Fund. ZAIS, or its affiliates, as applicable, shall either cause the documentation for any such ZAIS Fund to, or shall itself, waive or rebate any applicable senior management fees, subordinated management fees, incentive fees or residual interests of such ZAIS Fund that would otherwise payable by us. Instances may arise wherein funds sponsored or managed by ZAIS and from which ZAIS receives substantial compensation could not have been formed without our participation as a seller of assets to or a purchaser of securities issued by such ZAIS Fund. Our Advisor may have a conflict of interest in causing us to participate in, as well as in using our assets to help form, such funds.
Advisory Fee
We have agreed to pay our Advisor an advisory fee that is not tied to our performance. Because of this, the advisory fee may not sufficiently incentivize our Advisor to generate attractive risk adjusted returns for us.
Code of Business Conduct and Ethics
We do not have a policy that expressly prohibits our directors, officers, security holders and affiliates from engaging for their own account in business activities of the types conducted by us. However, our code of business conduct and ethics contains a conflicts of interest policy that prohibits our directors, officers and employees, to the extent we have employees in the future, from engaging in any transaction that involves an actual conflict of interest with us as determined by a majority of our directors.
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Operating and Regulatory Structure
REIT Qualification
We have elected to be taxed as a REIT under the Internal Revenue Code, commencing with our taxable year ended December 31, 2011. We believe that we have been organized and have operated in conformity with the requirements for qualification and taxation as a REIT under the Internal Revenue Code. In addition, we believe that our intended manner of operation will enable us to continue to meet the requirements for qualification and taxation as a REIT, provided that we are able to satisfy the REIT requirements relating to the diversity of ownership of our shares following certain share repurchases that occurred in January 2013. To qualify as a REIT, we must meet on a continuing basis, through organizational and actual investment and operating results, various requirements under the Internal Revenue Code relating to, among other items, the sources of our gross income, the composition and values of our assets, our distribution levels and the diversity of ownership of our shares. If we fail to qualify as a REIT in any taxable year and do not qualify for certain statutory relief provisions, we will be subject to U.S. federal income tax at regular corporate rates and may be precluded from qualifying as a REIT for the subsequent four taxable years following the year during which we failed to qualify as a REIT. Even if we qualify for taxation as a REIT, we may be subject to some U.S. federal, state and local taxes on our income or property. Distributions paid by us generally will not be eligible for taxation at the preferred U.S. federal income tax rates that apply to certain distributions received by individuals from taxable corporations.
1940 Act Exemption
We intend to conduct our operations so that we are not required to register as an investment company under the 1940 Act. Section 3(a)(1)(A) of the 1940 Act defines an investment company as any issuer that is or holds itself out as being engaged primarily in the business of investing, reinvesting or trading in securities. Section 3(a)(1)(C) of the 1940 Act defines an investment company as any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40% of the value of the issuer's total assets (exclusive of U.S. Government securities and cash items) on an unconsolidated basis. Excluded from the term "investment securities," among other things, are U.S. Government securities and securities issued by majority-owned subsidiaries that are not themselves investment companies and are not relying on the exception from the definition of investment company set forth in Section 3(c)(1) or Section 3(c)(7) of the 1940 Act.
We intend to conduct our operations so that we do not come within the definition of an investment company because fewer than 40% of our total assets on an unconsolidated basis will consist of "investment securities." The securities issued to us by any wholly-owned or majority-owned subsidiary that we may form in the future that is exempted from the definition of "investment company" by Section 3(c)(1) or 3(c)(7) of the 1940 Act, together with any other investment securities we may own, may not have a value in excess of 40% of the value of our total assets on an unconsolidated basis. We will monitor our holdings to ensure continuing and ongoing compliance with this test. However, qualification for exemption from registration under the 1940 Act will limit our ability to make certain investments. See "Risk FactorsRisks Related to Our Organization and StructureMaintenance of our 1940 Act exemption imposes limits on our operations" and "BusinessOperating and Regulatory Structure1940 Act Exemption."
We believe that certain of our subsidiaries qualify for an exemption from registration under the 1940 Act as an investment company pursuant to Section 3(c)(5)(C) of the 1940 Act, which is available for entities "primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate." This exemption generally requires that at least 55% of
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such subsidiaries' assets must be comprised of qualifying assets and at least 80% of their total assets must be comprised of qualifying assets and real estate related assets under the 1940 Act. We will treat as qualifying assets for this purpose mortgage loans, Agency RMBS in which we hold all the certificates issued by the pool and other interests in real estate, in each case meeting certain other qualifications based upon SEC staff no-action letters. Although SEC staff no-action letters have not specifically addressed the categorization of these types of assets, we will also treat as qualifying assets for this purpose bridge loans wholly secured by first priority liens on real estate that provide interim financing to borrowers seeking short-term capital (with terms of generally up to three years), non-Agency RMBS representing ownership of an entire pool of mortgage loans, and real estate owned properties. We expect each of our subsidiaries relying on Section 3(c)(5)(C) to invest an additional 25% of its assets in other types of mortgages, MBS, CMBS, securities of REITs and other real estate-related assets. We expect each of our subsidiaries relying on Section 3(c)(5)(C) to rely on guidance published by the SEC staff or on our analyses of guidance published with respect to other types of assets to determine which assets are qualifying real estate assets and real estate-related assets. The SEC staff has not, however, published guidance with respect to the treatment of some of these assets under Section 3(c)(5)(C). To the extent that the SEC, or its staff, publishes new or different guidance with respect to these matters, we may be required to adjust our strategy accordingly. Although we intend to monitor our portfolio periodically and prior to each investment acquisition, there can be no assurance that we will be able to maintain an exemption from registration for these subsidiaries. In addition, we may be limited in our ability to make certain investments and these limitations could result in the subsidiary holding assets we might wish to sell or selling assets we might wish to hold.
In 2011, the SEC solicited public comment on a wide range of issues relating to Section 3(c)(5)(C) of the 1940 Act, including the nature of the assets that qualify for purposes of the exemption and whether mortgage REITs should be regulated in a manner similar to registered investment companies. There can be no assurance that the laws and regulations governing the 1940 Act status of REITs, including the SEC, or its staff, providing more specific or different guidance regarding these exemptions, will not change in a manner that adversely affects our operations. If we or our subsidiaries fail to maintain an exception or exemption from the 1940 Act, we could, among other things, be required either to (i) change the manner in which we conduct our operations to avoid being required to register as an investment company, (ii) effect sales of our assets in a manner that, or at a time when, we would not otherwise choose to do so, or (iii) register as an investment company, any of which would negatively affect the value of our shares of common stock, the sustainability of our business model, and our ability to make distributions which would have an adverse effect on our business and the value of our shares of common stock.
Certain of our subsidiaries may rely on the exemption provided by Section 3(c)(6) to the extent that they hold mortgage assets through majority-owned subsidiaries that rely on Section 3(c)(5)(C). The SEC staff has issued little interpretive guidance with respect to Section 3(c)(6) and any guidance published by the staff could require us to adjust our strategy accordingly. Although the SEC staff has issued little interpretive guidance with respect to Section 3(c)(6), we believe that our subsidiaries may rely on Section 3(c)(6) if, among other things, 55% of the assets of such subsidiaries consist of, and at least 55% of the income of such subsidiaries are derived from, qualifying real estate investment assets owned by wholly owned or majority-owned subsidiaries of such subsidiaries.
Qualification for exemption from registration under the 1940 Act will limit our ability to make certain investments. For example, these restrictions will limit the ability of our subsidiaries to invest directly in MBS that represent less than the entire ownership in a pool of mortgage loans, debt and equity tranches of securitizations and ABS, and real estate companies or in assets not related to real estate.
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Dividend Reinvestment Plan
In the future, we intend to adopt a dividend reinvestment plan that will permit stockholders who elect to participate in the plan to have their cash dividends reinvested in additional shares of our common stock. As a result, if our Board authorizes, and we declare, a cash dividend or other distribution, then our stockholders who have elected to participate in our dividend reinvestment plan will have their cash distribution reinvested in additional shares of common stock, rather than receiving the cash distribution.
Restrictions on Ownership of Our Common Stock
To assist us in complying with the limitations on the concentration of ownership of a REIT imposed by the Internal Revenue Code, among other purposes, our certificate of incorporation prohibits, with certain exceptions, any stockholder from beneficially or constructively owning, applying certain attribution rules under the Internal Revenue Code, more than 9.8% by value or number of shares, whichever is more restrictive, of our outstanding shares of common stock, or 9.8% by value or number of shares, whichever is more restrictive, of our outstanding capital stock. Our Board may, in its sole discretion, waive the 9.8% ownership limit with respect to a particular stockholder; provided, however, that our Board may only waive the 9.8% ownership limit after it is presented with evidence satisfactory to it that such ownership will not then or in the future jeopardize our qualification as a REIT. Our Board has granted waivers of these ownership limits to certain persons, which have allowed certain individuals to be attributed more than 9.8% of our common stock for purposes of the REIT concentration of ownership requirements. As a result, if we do not issue at least approximately 5.6 million shares to sufficiently diverse holders in this offering to sufficiently dilute the ownership of these persons, our Board will be required to reduce our common stock and capital stock ownership limitations below 9.8% in order for these ownership limitations to adequately safeguard our REIT qualification.
Our certificate of incorporation also prohibits any person from, among other things:
In addition, our certificate of incorporation provides that any ownership or purported transfer of our capital stock in violation of the foregoing restrictions will result in the shares so owned or transferred being automatically transferred to a charitable trust for the benefit of a charitable beneficiary and the purported owner or transferee acquiring no rights in such shares. If a transfer to a charitable trust would be ineffective for any reason to prevent a violation of the restriction, the transfer resulting in such violation will be void from the time of such purported transfer.
Implications of being an Emerging Growth Company
We are an "emerging growth company" as defined in the Jumpstart Our Business Startups Act (or the JOBS Act) and we intend to take advantage of certain exemptions from various disclosure and reporting requirements that are otherwise generally applicable to public companies including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002 (or the Sarbanes-Oxley Act), reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. We may take
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advantage of these exemptions for up to five years or such earlier time that we are no longer an "emerging growth company." We will cease to be an "emerging growth company" on the earliest of (i) the last day of the first fiscal year in which our annual gross revenues exceed $1.0 billion, (ii) December 31 of the fiscal year that we become a "large accelerated filer" as defined in Rule 12b-2 under the Exchange Act which would occur if the fair market value of our common stock that is held by non-affiliates exceeds $700.0 million as of the last business day of our most recently completed second fiscal quarter and we have been publicly reporting for at least 12 months, (iii) the date on which we have issued more than $1.0 billion in non-convertible debt securities during the preceding three-year period, or (iv) the end of the fiscal year following the fifth anniversary of our initial public offering. We have irrevocably opted-out of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933, as amended (or the Securities Act) for complying with new or revised accounting standards. As a result, we will comply with new or revised accounting standards on the same time frames as other public companies that are not "emerging growth companies." If we take advantage of one or more of these exemptions, we do not know if investors will find our common stock less attractive as a result. If they do, there would likely be a less active trading market for our securities than would otherwise be the case.
Our Corporate Information
Our principal executive offices are located at Two Bridge Avenue, Suite 322, Red Bank, New Jersey 07701-1106. Our telephone number is (732) 978-7518.
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SUMMARY HISTORICAL FINANCIAL DATA
The table below sets forth certain of our historical financial data as of and for the periods indicated. We derived our summary consolidated financial data (i) as of December 31, 2011 and for the period from July 29, 2011 (the date of our inception) to December 31, 2011, from our audited consolidated financial statements appearing in this prospectus and (ii) as of September 30, 2012 and for the nine-month period ended September 30, 2012, from our unaudited consolidated financial statements appearing in this prospectus. The following summary consolidated financial data should be read in conjunction with our consolidated financial statements and related notes and with "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing in this prospectus.
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For the period from
July 29, 2011 (the date of our inception) to December 31, 2011 |
Nine-month period ended
September 30, 2012 |
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(unaudited)
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(dollars in thousands, except share and per share data)
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Operating Data: |
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Interest income |
$ | 3,617 | $ | 7,100 | |||
Interest expense |
295 | 1,044 | |||||
Net interest income |
3,322 | 6,056 | |||||
Operating expense |
(779 | ) | (2,007 | ) | |||
Change in unrealized (loss)/gain on real estate securities |
(5,960 | ) | 15,872 | ||||
Realized loss on real estate securities |
(1,482 | ) | (1,097 | ) | |||
Loss on derivative instruments |
(235 | ) | (1,216 | ) | |||
Net (loss)/income applicable to common stockholders |
$ | (5,134 | ) | $ | 17,608 | ||
Net (loss)/income per share applicable to common stockholdersbasic and diluted; based on 3,022,617 weighted average shares outstanding for the year ended December 31, 2011 and 2,930,421 weighted average shares outstanding for the nine-month period ended September 30, 2012. |
$ | (1.70 | ) | $ | 6.01 | ||
Dividends declared per share of common stock; based on 3,022,617 shares of record on December 31, 2011 and 3,022,617 shares of record on September 30, 2012. |
$ | | $ | 1.08 | (1) |
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As of December 31, 2011 | As of September 30, 2012 | |||||
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(unaudited)
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(dollars in thousands, except per share data)
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Balance Sheet Data (at period end): |
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Total assets |
$ | 154,105 | $ | 182,333 | |||
Total liabilities |
$ | 98,787 | $ | 137,660 | (2) | ||
Total stockholders' equity |
$ | 55,318 | $ | 44,674 | |||
Stockholders' equity per share of common stock |
$ | 18.30 | 24.29 | (3) |
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(the date of our inception) to December 31, 2011 of $0.51 per share of common stock, payable to stockholders of record on May 1, 2012, which was paid on May 15, 2012, and (2) on June 5, 2012, we declared a dividend in respect of the first quarter of 2012 of $0.57 per share of common stock, payable to stockholders of record on June 5, 2012, which was paid on June 21, 2012. Subsequently, (1) on October 22, 2012, we declared a dividend in respect of the second quarter of 2012 of $0.89 per share of common stock and OP unit, payable to stockholders and OP unit holders of record on October 22, 2012, which was paid on October 29, 2012, (2) on November 29, 2012, we declared a dividend in respect of the third quarter of 2012 of $0.98 per share of common stock and OP unit, payable to stockholders and OP unit holders of record on November 29, 2012, which was paid on December 6, 2012 and (3) on December 19, 2012, we declared a dividend in respect of the fourth quarter of 2012 of $1.16 per share of common stock and OP unit, payable to stockholders and OP unit holders of record on December 19, 2012, which is expected to be paid on December 26, 2012.
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Shares of common stock offered by us |
shares (plus up to an additional shares of our common stock that we may issue and sell upon the exercise of the underwriters' overallotment option). | |
Common stock to be outstanding after this offering |
shares (1) |
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Use of proceeds |
We estimate that our net proceeds from this offering, after deducting estimated offering expenses of $ , will be $ million (based on an offering price of $ per share, which is the anticipated initial public offering price shown on the cover page of this prospectus). The underwriting fee incurred in this offering will be paid by our Advisor. Our Advisor has also agreed to pay any expenses in connection with this offering in excess of $1.2 million. We will not be obligated to repay our Advisor for any of these costs. |
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We plan to use the net proceeds from this offering, together with additional borrowings, to purchase our target assets such that, over time, our equity is allocated 50% to 60% to whole loans, 30% to 40% to non-agency RMBS, 5% to 10% to MSRs, other real-estate related and financial assets and cash, and 0% to 5% to agency RMBS. Until appropriate investments can be identified, our Advisor may invest the net proceeds from this offering in our target asset classes in different allocations than indicated above, and/or interest-bearing, short-term investments, including money market accounts and/or funds, that are consistent with our intention to qualify as a REIT and maintain our exemption from registration under the 1940 Act, or may elect to pay-down outstanding repurchase agreements. These initial investments, if any, are expected to provide a lower net return than we will seek to achieve from investments in non-Agency RMBS, Agency RMBS, residential mortgage loans and our other target assets. In addition, we will use the net proceeds from this offering to redeem 133 shares of our 12.5% Series A Cumulative Non-Voting Preferred Stock outstanding for an aggregate redemption price of $146,300. Prior to the time we have fully used the net proceeds of this offering to acquire non-Agency RMBS, Agency RMBS, residential mortgage loans and our other target assets, we may fund our quarterly distributions out of such net proceeds. See "Use of Proceeds." |
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Ownership and transfer restrictions |
To assist us in complying with limitations on the concentration of ownership of a REIT imposed by the Internal Revenue Code, our charter generally prohibits, among other prohibitions, any stockholder from beneficially or constructively owning more than 9.8% in value or in number of shares, whichever is more restrictive, of any class or series of the outstanding shares of our capital stock. Our Board has granted waivers of these ownership limits to certain of our stockholders, which allow (1) one individual to beneficially or constructively own 723,969 shares of our common stock, or 31.2% of our outstanding common stock; (2) a second individual to beneficially or constructively own 321,830 shares of our common stock, or 13.9% of our outstanding common stock; and (3) an institutional investor to beneficially or constructively own 325,000 shares of our common stock, or 14.0% of our outstanding common stock. As a result, if we do not issue at least approximately 5.6 million shares to sufficiently diverse holders in this offering to sufficiently dilute the ownership of these persons, our Board will be required to reduce our common stock and capital stock ownership limitations below 9.8% in order for these ownership limitations to adequately safeguard our REIT qualification. See "Description of Capital StockRestrictions on Ownership and Transfer." |
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We are currently in the process of finalizing results for the three months and year ended December 31, 2012. Based on preliminary unaudited information for the three months and year ended December 31, 2012, we estimate that:
The preliminary estimated ranges of our net income and leverage ratio, and our preliminary estimate of our book value per share, total assets, the fair value of our portfolio and our total borrowings, are subject to revision as we prepare our financial statements for the three months and year ended and as of December 31, 2012, including all disclosures required by U.S. GAAP, and as our auditors conduct their audit of these financial statements. Our actual results may differ materially from these estimates as a result of the completion of our financial closing procedures, final adjustments and other developments arising between now and the time that our financial results for the year ended December 31, 2012 are finalized.
The financial data for the year ended and as of December 31, 2012 included in this prospectus has been prepared by, and is the responsibility of, our management. All financial information for the year ended and as of December 31, 2012 is preliminary and subject to adjustment. PricewaterhouseCoopers LLP has not audited, reviewed, compiled or performed any procedures with respect to the accompanying financial information for the year ended and as of December 31, 2012. Accordingly, PricewaterhouseCoopers LLP does not express an opinion or any other form of assurance with respect thereto.
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Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors and all other information contained in this prospectus before acquiring our common stock. If any of the following risks occur, our business, financial condition, liquidity and results of operations could be materially and adversely affected. In that case, the value of our common stock could decline, and you may lose some or all of your investment. Some statements in this section constitute forward-looking statements. Please refer to the section entitled "Forward-Looking Statements."
Risks Relating to Our Business
There are material limitations with making preliminary estimates of our financial information for the three months and year ended and as of December 31, 2012 prior to the completion of our and our auditors' financial review procedures for such period.
The preliminary financial estimates contained in "Prospectus SummaryRecent Developments" are not a comprehensive statement of our financial information for the three months and year ended or as of December 31, 2012 and have not been audited by our independent registered public accounting firm. Our consolidated financial statements for the year ended and as of December 31, 2012 will not be available until after this offering is completed. Our actual results may differ materially from these estimates as a result of the completion of our financial closing procedures, final adjustments and other developments arising between now and the time that our financial information for the three months and year ended and as of December 31, 2012 is finalized. The preliminary financial data included herein have been prepared by, and are the responsibility of, management. PricewaterhouseCoopers LLP has not audited, reviewed, compiled or performed any procedures with respect to the accompanying December 31, 2012 financial information. Accordingly, PricewaterhouseCoopers LLP does not express an opinion or any other form of assurance with respect thereto.
The lack of liquidity in our assets may adversely affect our business.
A portion of the securities we own or acquire may be subject to legal and other restrictions on resale or will otherwise be less liquid than publicly-traded securities. The illiquidity of our assets may make it difficult for us to sell such assets if the need or desire arises. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we have previously recorded our assets. As a result, our ability to vary our portfolio in response to changes in economic and other conditions may be relatively limited, which could adversely affect our results of operations and financial condition.
We operate in a highly competitive market for investment opportunities and competition may limit our ability to acquire desirable investments in our target assets and could also affect the pricing of these securities.
We operate in a highly competitive market for investment opportunities. Our profitability depends, in large part, on our ability to acquire our target assets at attractive prices. In acquiring our target assets, we will compete with a variety of institutional investors, including other REITs, specialty finance companies, public and private funds (including other funds managed by ZAIS), commercial and investment banks, commercial finance and insurance companies and other financial institutions. Many of our competitors are substantially larger and have considerably greater financial, technical, marketing and other resources than we do. Several other REITs have recently raised, or are expected to raise, significant amounts of capital, and may have investment objectives that overlap with ours, which may create
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additional competition for investment opportunities. Some competitors may have a lower cost of funds and access to funding sources that may not be available to us. Many of our competitors are not subject to the operating constraints associated with REIT tax compliance or maintenance of an exemption from the 1940 Act. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships than us. Furthermore, competition for investments in our target assets may lead to the price of such assets increasing, which may further limit our ability to generate desired returns. We cannot assure you that the competitive pressures we face will not have a material adverse effect on our business, financial condition and results of operations. Also, as a result of this competition, desirable investments in our target assets may be limited in the future and we may not be able to take advantage of attractive investment opportunities from time to time, as we can provide no assurance that we will be able to identify and make investments that are consistent with our investment objectives.
We have not yet identified any specific investments we may make with the net proceeds of this offering.
We have not yet identified any specific investments we may make with the net proceeds of this offering and as a result, you will not be able to evaluate any proposed investments before purchasing shares of our common stock. Additionally, our investments will be selected by our Advisor and our stockholders will not have input into such investment decisions. Both of these factors will increase the uncertainty, and thus the risk, of investing in shares of our common stock.
Until appropriate investments can be identified, our Advisor may invest the net proceeds of this offering in our target asset classes in allocations ranging from those of our current targets, and/or interest-bearing, short-term investments, including money market accounts and/or funds, that are consistent with our intention to maintain our qualification as a REIT. These initial investments, if any, are expected to provide a lower net return than we will seek to achieve from investments in non-Agency RMBS, Agency RMBS, residential mortgage loans and our other target assets. Our Advisor intends to conduct due diligence with respect to each investment and suitable investment opportunities may not be immediately available. Even if opportunities are available, there can be no assurance that our Advisor's due diligence processes will uncover all relevant facts or that any investment will be successful.
Furthermore, you will be unable to evaluate the manner in which the net proceeds of this offering will be invested or the economic merit of our expected investments and, as a result, we may use the proceeds from this offering to make investments with which you may not agree. The failure of our management to apply these proceeds effectively or find investments that meet our investment criteria in sufficient time or on acceptable terms could result in unfavorable returns, could cause a material adverse effect on our business, financial condition, liquidity, results of operations and ability to make distributions to our stockholders, and could cause the value of our common stock to decline.
We are highly dependent on information systems and communication systems; systems failures and other operational disruptions could significantly affect our business, which may, in turn, negatively affect our operating results and our ability to pay dividends to our stockholders.
Our business is highly dependent on the communications and information systems of ZAIS which may interface with or depend on systems operated by third parties, including market counterparties and other service providers. Any failure or interruption of these systems could cause delays or other problems in our activities, including in our target asset acquisition
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activities, which could have a material adverse effect on our operating results and negatively affect the value of our common stock and our ability to pay dividends to our stockholders.
Additionally, we rely heavily on financial, accounting and other data processing systems and operational risks arising from mistakes made in the confirmation or settlement of transactions, from transactions not being properly booked, evaluated or accounted for or other similar disruption in our operations may cause us to suffer financial loss, the disruption of our business, liability to third parties, regulatory intervention or reputational damage.
Our Advisor will utilize analytical models and data in connection with the valuation of our loans and securities, and any incorrect, misleading or incomplete information used in connection therewith would subject us to potential risks.
Given the complexity of our investment strategies, our Advisor must rely heavily on analytical models (both proprietary models developed by ZAIS and those supplied by third parties) and information and data supplied by third parties. Models and data will be used to value potential target assets and also in connection with hedging our acquisitions. In the event models and data prove to be incorrect, misleading or incomplete, any decisions made in reliance thereon expose us to potential risks. For example, by relying on incorrect models and data, especially valuation models, our Advisor may be induced to buy certain target assets at prices that are too high, to sell certain other assets at prices that are too low or to miss favorable opportunities altogether. Similarly, any hedging based on faulty models and data may prove to be unsuccessful.
Difficult conditions in the mortgage, residential and commercial real estate markets may cause us to experience market losses related to our holdings, and there is no assurance that these conditions will improve in the near future.
Our results of operations are materially affected by conditions in the mortgage market, the residential and commercial real estate markets, the financial markets and the economy generally. The mortgage market has been severely affected by changes in the lending landscape and there is no assurance that these conditions have stabilized or that they will not worsen. Disruption in the mortgage market negatively impacts new demand for homes and home price performance. There is a strong inverse correlation between home price growth rates and mortgage loan delinquencies. A deterioration of the RMBS market may cause us to experience losses related to our assets and to sell assets at a loss. Declines in the fair market values of our investments may adversely affect our results of operations and credit availability, which may reduce earnings and, in turn, cash available for distribution to our stockholders.
Dramatic declines in the residential and commercial real estate markets have resulted in significant asset write-downs by financial institutions, which have caused many financial institutions to seek additional capital, to merge with other institutions and, in some cases, to fail. Institutions from which we may seek to obtain financing may have owned or financed residential or commercial mortgage loans, real estate-related securities and real estate loans, which have declined in value and caused them to suffer losses as a result of the financial crisis that began in 2007. Many lenders and institutional investors have reduced and, in some cases, ceased to provide funding to borrowers, including other financial institutions. If these conditions persist, these institutions may become insolvent or tighten their lending standards, which could make it more difficult for us to obtain financing on favorable terms or at all. Our profitability may be adversely affected if we are unable to obtain cost-effective financing for our assets.
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Standard & Poor's downgrade of the U.S. Government's credit rating, and in the credit ratings of instruments issued, insured or guaranteed by certain companies, institutions, agencies and instrumentalities, or a further downgrade of the U.S. Government's credit rating by Standard & Poor's or the other credit ratings agencies could result in economic uncertainty and a significant rise in interest rates, either of which could have a material adverse effect on our business, financial condition, liquidity, results of operations and ability to make distributions to our stockholders.
On August 2, 2011, legislation was enacted to increase the federal debt ceiling and to reduce future U.S. Government spending levels by as much as $2.4 trillion over the next decade. Notwithstanding the passage of this legislation, there remains uncertainty about whether the U.S. Government could default on its obligations in the future. On August 5, 2011, Standard and Poor's Ratings Services (or Standard & Poor's) downgraded the long-term debt rating of the United States from AAA to AA+ for the first time in history due to its belief that legislative solutions have been inadequate to address the country's growing debt burden. Standard & Poor's decision to further downgrade the U.S. Government's credit rating could create broader financial and global banking turmoil and uncertainty and could lead to a significant rise in interest rates. On August 8, 2011, Standard & Poor's downgraded the credit ratings of certain long-term debt instruments issued by Fannie Mae and Freddie Mac and other U.S. Government agencies linked to long-term U.S. debt. These downgrades could adversely affect the fair market value of such instruments, and could adversely impact the value of instruments that are collateralized by affected instruments, thus impacting our investment portfolio. Moreover, these events could cause the interest rates on our borrowings and our cost of capital to increase significantly. As a result, these events could materially and adversely affect our interest expense and other costs of borrowing and our ability to continue to acquire our target assets on attractive terms. These consequences could be exacerbated if other statistical rating agencies, decide to downgrade the U.S. Government's credit rating in the future. Each of Moody's Investors Service, Inc. (or Moody's) and Fitch, Inc. (or Fitch) has maintained its rating of U.S. debt at AAA, but has warned of potential future downgrades if legislative solutions to address the rising levels of U.S. Government debt are not found. Any of these outcomes could have a material adverse effect on our business, financial condition, liquidity, results of operations and ability to make distributions to our stockholders.
The current debt crisis in Europe, the recent downgrades of the credit ratings of certain European countries and the risk that certain countries may default on their sovereign debt, and the resulting impact on the financial markets, could have a material adverse impact on our business, financial condition, results of operations and ability to make distributions to our stockholders.
The current financial crisis in Europe has created economic uncertainty with respect to the ability of certain European countries to continue to service their sovereign debt obligations. These conditions have adversely impacted financial markets and have created substantial volatility and uncertainty, and will likely continue to do so. The downgrades of the credit ratings of certain European countries have created broader financial turmoil and uncertainty, which has recently weighed heavily on the global banking system. Risks related to the current debt crisis in Europe have had, and are likely to continue to have, a negative impact on global economic activity and the financial markets. There can be no assurance that governmental or other measures to aid economic recovery, including economic stimulus legislation, will be effective. As these conditions persist, our business, financial condition, results of operations and ability to make distributions to our stockholders could be materially adversely affected.
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The federal conservatorship of Fannie Mae and Freddie Mac and related efforts, along with any changes in laws and regulations affecting the relationship between these agencies and the U.S. Government, may adversely affect our business.
The payments of principal and interest we receive on our Agency RMBS, which depend directly upon payments on the mortgages underlying such securities, are guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae. Fannie Mae and Freddie Mac are government-sponsored entities (or GSEs), but their guarantees are not backed by the full faith and credit of the United States. Ginnie Mae is part of a U.S. Government agency and its guarantees are backed by the full faith and credit of the United States.
In September 2008, the U.S. Treasury, the U.S. Federal Housing Finance Agency (or the FHFA) and the Board of Governors of the Federal Reserve System announced a comprehensive action plan to help stabilize the financial markets, support the availability of mortgage financing and protect taxpayers. Under this plan, among other things, the FHFA was appointed as conservator of both Fannie Mae and Freddie Mac, allowing the FHFA to control the actions of the two GSEs, without forcing them to liquidate, which would be the case under receivership. Importantly, the primary focus of the plan was to increase the availability of mortgage financing by allowing these GSEs to continue to grow their guarantee business without limit, while limiting the size of their retained mortgage and agency security portfolios and requiring that these portfolios be reduced over time.
In an effort to further stabilize the U.S. mortgage market, the U.S. Treasury pursued three additional initiatives beginning in 2008. First, it entered into preferred stock purchase agreements, which have been subsequently amended, with each of the GSEs to ensure that they maintain a positive net worth. Second, it established a new secured short-term credit facility, which was available to Fannie Mae and Freddie Mac (as well as Federal Home Loan Banks) when other funding sources were unavailable. Third, it established an agency security purchase program under which the U.S. Treasury purchased Agency mortgage-backed securities (or MBS) in the open market. The U.S. Federal Reserve also established a program of purchasing Agency MBS.
Those efforts resulted in significant U.S. Government financial support and increased control of the GSEs. In December 2010, the FHFA reported that, from the time of execution of the preferred stock purchase agreements through November 30, 2010, funding provided to Fannie Mae and Freddie Mac under the preferred stock purchase agreements amounted to $88.0 billion and $63.0 billion, respectively. The U.S. Treasury has committed to support the positive net worth of Fannie Mae and Freddie Mac, through preferred stock purchases as necessary, through 2012. Those agreements, as amended, also require the reduction of Fannie Mae's and Freddie Mac's mortgage and agency security portfolios (they were limited to $900.0 billion as of December 31, 2009, and to $810.0 billion as of December 31, 2010, and must be reduced each year until their respective mortgage assets reach $250.0 billion).
Both the secured short-term credit facility and the agency security program initiated by the U.S. Treasury expired on December 31, 2009. However, through that securities purchase program (from September 2008 through December 2009), the U.S. Treasury acquired $220.0 billion of Agency MBS. In addition, while the U.S. Federal Reserve's program of agency security purchases terminated in 2010, the FHFA reported that through January 2010, the U.S. Federal Reserve had purchased $1.03 trillion net of Agency MBS. Subject to specified investment guidelines, the portfolios of Agency MBS purchased through the programs established by the U.S. Treasury and the U.S. Federal Reserve may be held to maturity and, based on mortgage market conditions, adjustments may be made to these portfolios. This flexibility may adversely affect the pricing and availability of Agency MBS that we own or seek to acquire during the remaining term of these portfolios.
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Although the U.S. Government has committed to support the positive net worth of Fannie Mae and Freddie Mac through 2012, there can be no assurance that these actions will be adequate for their needs. These uncertainties lead to questions about the availability of, and trading market for, Agency MBS. Despite the steps taken by the U.S. Government, Fannie Mae and Freddie Mac could default on their guarantee obligations which would materially and adversely affect the value of our Agency MBS. Accordingly, if these government actions are inadequate and the GSEs continue to suffer losses or cease to exist, our business, operations and financial condition could be materially and adversely affected.
In addition, the problems faced by Fannie Mae and Freddie Mac resulting in their being placed into federal conservatorship and receiving significant U.S. Government support have sparked serious debate among federal policy makers regarding the continued role of the U.S. Government in providing liquidity for mortgage loans. The future roles of Fannie Mae and Freddie Mac could be significantly reduced and the nature of their guarantee obligations could be considerably limited relative to historical measurements. Any such changes to the nature of their guarantee obligations could redefine what constitutes an agency security and could have broad adverse implications for the market and our business, operations and financial condition.
Alternatively, Fannie Mae and Freddie Mac could be dissolved or privatized, and the U.S. Government could determine to stop providing liquidity support of any kind to the mortgage market. In February 2011, the U.S. Treasury and the Department of Housing and Urban Development released a report to Congress entitled Reforming America's Housing Finance Market in which they proposed to reduce or eliminate the role of GSEs in mortgage financing. The report calls for phasing in increased pricing of Fannie Mae and Freddie Mac guarantees to help level the playing field for the private sector to take back market share, reducing conforming loan limits by allowing the temporary increase in Fannie Mae's and Freddie Mac's conforming loan limits to reset as scheduled on October 1, 2011 to the lower levels set in the Housing and Economic Recovery Act of 2008 (or HERA) and continuing to wind down Fannie Mae's and Freddie Mac's investment portfolio at an annual rate of no less than 10% per year. It is not yet possible to determine whether or when any of such proposals may be enacted, what form any final legislation or policies might take and how proposals, legislation or policies emanating from this report may impact our business, operations and financial condition. On August 17, 2012, the U.S. Treasury announced further steps to expedite the wind-down of Fannie Mae and Freddie Mac to an annual rate of 15% per year.
If Fannie Mae or Freddie Mac were eliminated, or their structures were to change radically (i.e., limitation or removal of the guarantee obligation), or their market share reduced because of required price increases or lower limits on the loans they can guarantee, we could be unable to acquire additional Agency MBS and our existing Agency MBS could be materially and adversely impacted.
We could be negatively affected in a number of ways depending on the manner in which related events unfold for Fannie Mae and Freddie Mac. We rely on our Agency RMBS (as well as non-Agency RMBS) as collateral for our financings under repurchase agreements. Any decline in their value, or perceived market uncertainty about their value, would make it more difficult for us to obtain financing on our Agency RMBS on acceptable terms or at all, or to maintain our compliance with the terms of any financing transactions. Further, the current support provided by the U.S. Treasury to Fannie Mae and Freddie Mac, and any additional support it may provide in the future, could have the effect of lowering the interest rates we expect to receive from Agency RMBS, thereby tightening the spread between the interest we earn on our Agency RMBS and the cost of financing those assets. A reduction in the supply of Agency RMBS could also negatively affect the pricing of Agency RMBS by reducing the
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spread between the interest we earn on our investment portfolio of Agency RMBS and our cost of financing that portfolio.
As indicated above, recent legislation has changed the relationship between Fannie Mae and Freddie Mac and the U.S. Government. Future legislation could further change the relationship between Fannie Mae and Freddie Mac and the U.S. Government, and could also nationalize, privatize, or eliminate such entities entirely. Any law affecting these GSEs may create market uncertainty and have the effect of reducing the actual or perceived credit quality of securities issued or guaranteed by Fannie Mae or Freddie Mac. As a result, such laws could increase the risk of loss on our investments in Agency RMBS guaranteed by Fannie Mae and/or Freddie Mac. It also is possible that such laws could adversely impact the market for such securities and spreads at which they trade. All of the foregoing could materially and adversely affect our financial condition and results of operations.
Actions of the U.S. Government, including the U.S. Congress, Federal Reserve, U.S. Treasury and other governmental and regulatory bodies, including the SEC, to stabilize or reform the financial markets may not achieve the intended effect and may adversely affect our business.
In response to the financial issues affecting the banking system and financial markets and going concern threats to commercial banks, investment banks and other financial institutions, the Emergency Economic Stabilization Act (or EESA), was enacted by the U.S. Congress in 2008. There can be no assurance that the EESA or any other U.S. Government actions will have a beneficial impact on the financial markets. To the extent the markets do not respond favorably to any such actions by the U.S. Government or such actions do not function as intended, our business may not receive the anticipated positive impact from the legislation and such result may have broad adverse market implications.
In July 2010, the U.S. Congress enacted the Dodd-Frank Act in part to impose significant investment restrictions and capital requirements on banking entities and other organizations that are significant to U.S. financial markets. For instance, the Dodd-Frank Act has imposed significant restrictions on the proprietary trading activities of certain banking entities and subject other systemically significant organizations regulated by the U.S. Federal Reserve to increase capital requirements and quantitative limits for engaging in such activities. The Dodd-Frank Act also seeks to reform the asset-backed securitization market (including the mortgage-backed securities market) by requiring the retention of a portion of the credit risk inherent in the pool of securitized assets and by imposing additional registration and disclosure requirements. Certain of the new requirements and restrictions exempt Agency RMBS, other government issued or guaranteed securities, or other securities. Nonetheless, the Dodd-Frank Act also imposes significant regulatory restrictions on the origination and securitization of residential mortgage loans. The Dodd-Frank Act also created a new regulator, the Consumer Financial Protection Bureau (or the CFPB), which oversees many of the core laws which regulate the mortgage industry, including among others the Real Estate Settlement Procedures Act and the Truth in Lending Act. While the full impact of the Dodd-Frank Act and the role of the CFPB cannot be assessed until all implementing regulations are released, the Dodd-Frank Act's extensive requirements may have a significant effect on the financial markets, and may affect the availability or terms of financing from our lender counterparties and the availability or terms of mortgage-backed securities, both of which may have an adverse effect on our financial condition and results of operations.
On September 13, 2012, the Federal Reserve announced a third round of quantitative easing (or QE3), which is an open-ended program designed to expand the U.S. Federal Reserve's holdings of long-term securities by purchasing an additional $40 billion of Agency RMBS per month until key economic indicators, such as the unemployment rate, show signs of improvement. When combined with existing programs to extend the average maturity of
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the U.S. Federal Reserve's holdings of securities, and reinvest principal and interest payments from the Federal Reserve's holdings of agency debt and Agency RMBS into newly acquired Agency RMBS through the end of 2012, QE3 is expected to increase the Federal Reserve's holdings of long-term securities by $85 billion each month through the end of 2012. The Federal Reserve also announced that it will keep the target range for the Federal Funds Rate between zero and 0.25% through at least mid-2015, which is six months longer than previously expected. The Federal Reserve provided further guidance to the market in December 2012 by stating that it intends to keep the Federal Funds Rate close to zero for so long as the unemployment rate is above 6.5% and inflation does not rise above 2.5%. In December 2012, the Federal Reserve announced that it would continue to purchase Agency MBS at a pace of $40 billion per month. The Federal Reserve also announced that it would initially begin buying $45 billion of long-term Treasury bonds each month and noted that such amount may increase in the future. This bond purchase program will replace the existing program known as "Operation Twist," in which the Federal Reserve has been repurchasing approximately $45 billion of long-term Treasury bonds each month and selling approximately the same amount of short-term Treasury bonds. The Federal Reserve expects these measures to put downward pressure on long-term interest rates. While the Federal Reserve hopes that QE3 and related measures will expedite an economic recovery, stabilize prices, reduce unemployment and accelerate business and household spending, we cannot predict the impact of this program or any future actions by the Federal Reserve on the prices and liquidity of Agency RMBS or other assets in which we invest, although the Federal Reserve's action could increase the prices of our target assets and reduce the spread that we earn on our investments.
In addition, the U.S. Government, Federal Reserve, U.S. Treasury, the SEC and other governmental and regulatory bodies have taken or are considering taking other actions to address the financial crisis that began in 2007. We cannot predict whether or when such actions may occur or what effect, if any, such actions could have on our business, results of operations and financial condition.
Mortgage loan modification and refinance programs as well as future legislative action may adversely affect the value of, and the returns on, the target assets in which we intend to invest.
The U.S. Government, through the Federal Reserve, the FHA and the Federal Deposit Insurance Corporation (or the FDIC), commenced implementation of programs designed to provide homeowners with assistance in avoiding residential or commercial mortgage loan foreclosures, including the Home Affordable Modification Program (or HAMP), which provides homeowners with assistance in avoiding residential mortgage loan foreclosures, the Hope for Homeowners Program (or H4H Program), which allows certain distressed borrowers to refinance their mortgages into FHA-insured loans in order to avoid residential mortgage loan foreclosures, and the Home Affordable Refinance Program (or HARP), which allows borrowers who are current on their mortgage payments to refinance and reduce their monthly mortgage payments at loan-to-value ratios up to 125% without new mortgage insurance. The programs may involve, among other things, the modification of mortgage loans to reduce the principal amount of the loans or the rate of interest payable on the loans, or to extend the payment terms of the loans.
Loan modification and refinance programs may adversely affect the performance of Agency RMBS and non-Agency RMBS. Especially with non-Agency RMBS, a significant number of loan modifications with respect to a given security, including those related to principal forgiveness and coupon reduction, could negatively impact the realized yields and cash flows on such security. These loan modification programs, future legislative or regulatory
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actions, including possible amendments to the bankruptcy laws, which result in the modification of outstanding residential mortgage loans, as well as changes in the requirements necessary to qualify for refinancing mortgage loans with Fannie Mae, Freddie Mac or Ginnie Mae, may adversely affect the value of, and the returns on, Agency RMBS and our other target assets that we may purchase.
The increasing number of proposed U.S. federal, state and local laws may increase our risk of liability with respect to certain mortgage loans and could increase our cost of doing business.
The U.S. Congress and various state and local legislatures are considering, and in the future may consider, legislation which, among other provisions, would permit limited assignee liability for certain violations in the mortgage loan origination process. We cannot predict whether or in what form the U.S. Congress or the various state and local legislatures may enact legislation affecting our business. We will evaluate the potential impact of any initiatives which, if enacted, could affect our practices and results of operations. We are unable to predict whether federal, state or local authorities will require changes in our practices in the future. These changes, if required, could adversely affect our profitability, particularly if we make such changes in response to new or amended laws, rules, regulations or ordinances in any state where we acquire a significant portion of our mortgage loans, or if such changes result in us being held responsible for any violations in the mortgage loan origination process.
Risks Associated With Our Management and Our Relationship With Our Advisor
We are dependent on our Advisor and its key personnel for our success, and we may not find a suitable replacement for our Advisor if our Investment Advisory Agreement is terminated, or if key personnel leave the employment of ZAIS or otherwise become unavailable to us.
We are dependent on our Advisor for our day-to-day management, as we do not have any independent officers or any employees. Our Advisor has significant discretion as to the implementation of our asset acquisition and operating policies and strategies. Accordingly, we believe that our success will depend to a significant extent upon the efforts, experience, diligence, skill and network of business contacts of the executive officers and key personnel of our Advisor. The executive officers and key personnel of our Advisor will evaluate, negotiate, structure, close and monitor our asset acquisitions, and our success will depend on their continued service. The departure of any of the executive officers or key personnel of our Advisor could have a material adverse effect on our performance.
In addition, we offer no assurance that our Advisor will remain our advisor or that we will continue to have access to our Advisor's principals and professionals, including those of ZAIS. The initial term of our Investment Advisory Agreement with our Advisor only extends until the third anniversary of our listing, with automatic one-year renewal terms on each anniversary date thereafter unless previously terminated. If the Investment Advisory Agreement is terminated and no suitable replacement is found to advise us, we may not be able to execute our business plan.
We have no recourse to ZAIS if it does not fulfill its obligations under the shared facilities and services agreement.
Neither we nor our Advisor have any employees or separate facilities. Our day-to-day operations will be conducted by employees of ZAIS, the parent company of our Advisor, pursuant to a shared facilities and services agreement between our Advisor and ZAIS. Under the shared facilities and services agreement, our Advisor will also be provided with the
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services and other resources necessary for our Advisor to perform its obligations and responsibilities under the Investment Advisory Agreement in exchange for certain fees payable by our Advisor. ZAIS may assign its rights and obligations thereunder to any of its majority-owned and controlled affiliates. In addition, because we will not be a party to the shared facilities and services agreement, we do not have any recourse to ZAIS if it does not fulfill its obligations under the shared facilities and services agreement or if it elects to assign the agreement to one of its affiliates. Also, our Advisor only has nominal assets and we will have limited recourse against our Advisor under the Investment Advisory Agreement to remedy any liability to us from a breach of contract or fiduciary duties.
There are conflicts of interest in our relationship with ZAIS and its affiliates, which could result in decisions that are not in the best interests of our stockholders.
We are subject to conflicts of interest arising out of our relationship with ZAIS and its affiliates, including our Advisor. Specifically, each of our officers and directors is also an employee of ZAIS or its affiliates. ZAIS and our officers may have conflicts between their duties to us and their duties to, and interests in, our Advisor or its affiliates. Our Advisor is not required to devote a specific amount of time or the services of any particular individual to our operations. ZAIS manages or provides services to Other Clients, and we will compete with these Other Clients for ZAIS's resources and support through our Advisor. During turbulent conditions in the mortgage industry, distress in the credit markets or other times when we will need focused support and assistance from ZAIS through our Advisor, entities for which ZAIS also acts as an investment advisor will likewise require greater focus and attention, placing ZAIS's resources in high demand. In such situations, we may not receive the necessary support and assistance we require or would otherwise receive if we were internally managed or if ZAIS did not act as an advisor for other entities. The ability of ZAIS and its officers and personnel to engage in other business activities may reduce the time they spend assisting our Advisor advising us.
We and certain of our affiliates and ZAIS's Other Clients and their affiliates may compete to acquire our targeted assets.
There may also be conflicts in allocating assets that are suitable for us and Other Clients of ZAIS and its affiliates. Other Clients of ZAIS and its affiliates may compete with us with respect to certain assets which we may want to acquire and, as a result, we may either not be presented with the opportunity or have to compete with such Other Clients to acquire these assets. For example, we may compete directly with other entities managed by ZAIS or one of its affiliates with respect to our target assets. Certain of these Other Clients have significant uninvested capital and will likely compete with us. Additionally, certain conflicts of interest may exist with respect to funds that have only limited reinvestment capacity including, circumstances where we may purchase assets being disposed of by these funds as they begin to liquidate various assets. In addition to the ZAIS Funds and Managed Accounts for which ZAIS acts as investment advisor, ZAIS may, in the future, establish new funds or enter into new managed account arrangements with investment strategies that are substantially similar to our strategy, including funds and accounts investing primarily in our target assets, including RMBS and residential mortgage loans. Such Other Clients may compete with us for our target assets. We may also make investments in other entities which are managed by ZAIS or one of its affiliates. We will not, however, purchase any assets from, or issued by, any Other Client or any entity managed by our Advisor or its affiliates, or sell any asset to any Other Client or any such other entity without the consent of a majority of our independent directors. A majority of our independent directors may amend this affiliated investment policy at any time without stockholder consent. See "ManagementConflicts of Interest." There may be certain situations where ZAIS allocates assets that may be suitable for us to Other Clients
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managed by ZAIS or its affiliates instead of to us. See "ManagementConflicts of InterestAsset Allocations." Further, we may liquidate our investments at different times than Other Clients due to, among other things, differences in investment strategies.
We will pay our Advisor substantial advisory fees regardless of the performance of our portfolio. Our Advisor's entitlement to an advisory fee, which is not based upon performance metrics or goals, might reduce its incentive to devote its time and effort to seeking assets that provide attractive risk-adjusted returns for our portfolio. This in turn could hurt both our ability to make distributions to our stockholders and the value of our common stock.
The Investment Advisory Agreement with our Advisor was not negotiated on an arm's-length basis and may not be as favorable to us as if it had been negotiated with an unaffiliated third party.
Because each of our officers and directors is also an employee of our Advisor or its affiliates, the Investment Advisory Agreement was not negotiated on an arm's-length basis, and we did not have the benefit of arm's-length negotiations of the type normally conducted with an unaffiliated third party. As a result, the terms, including the fees payable, may not be as favorable to us as an arm's-length agreement. Furthermore, because each of our officers and directors is also an employee of our Advisor or its affiliates, we may choose not to enforce, or to enforce less vigorously, our rights under the Investment Advisory Agreement because of our desire to maintain our ongoing relationship with our Advisor.
Termination by us of our Investment Advisory Agreement with our Advisor without cause is difficult and costly.
Termination of the Investment Advisory Agreement with our Advisor without cause is difficult and costly. Our Board will review our Advisor's performance and the advisory fees annually and, following the three-year initial term, the Investment Advisory Agreement may be terminated annually upon the affirmative vote of at least two-thirds of our independent directors, or by a vote of the holders of at least two-thirds of the outstanding shares of our common stock (other than shares held by the ZAIS Parties), based upon: (i) unsatisfactory performance by our Advisor that is materially detrimental to us; or (ii) a determination that the advisory fees payable to our Advisor are not fair, subject to our Advisor's right to prevent termination based on unfair fees by accepting a reduction of advisory fees agreed to by at least two-thirds of our independent directors. We must provide our Advisor with 180 days' prior notice of any such termination. Additionally, upon such a termination without cause, the Investment Advisory Agreement provides that we will pay our Advisor a termination fee equal to three times the average annual advisory fee earned by our Advisor during the prior 24-month period immediately preceding such termination, calculated as of the end of the most recently completed fiscal year before the date of termination. These provisions may increase the cost to us of terminating the Investment Advisory Agreement and adversely affect our ability to terminate our Advisor without cause.
Our Advisor is only contractually committed to serve us until the third anniversary of our listing. Thereafter, the Investment Advisory Agreement is automatically renewable on an annual basis; provided, however, that our Advisor may terminate the Investment Advisory Agreement annually upon 180 days' prior notice. If the Investment Advisory Agreement is terminated and no suitable replacement is found to advise us, we may not be able to execute our business plan.
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Our Advisor's liability is limited under the management agreement, and we have agreed to indemnify our Advisor against certain liabilities.
Pursuant to the Investment Advisory Agreement, our Advisor will not assume any responsibility other than to render the services called for thereunder and will not be responsible for any action of our Board in following or declining to follow its advice or recommendations. Under the terms of the Investment Advisory Agreement, our Advisor, its principals, stockholders, members, managers, partners, directors and personnel, any person controlling or controlled by our Advisor, including ZAIS, and any person providing sub-advisory services to our Advisor will not be liable to us, any subsidiary of ours, our directors, our stockholders or any of our subsidiary's stockholders, members or partners for acts or omissions performed in accordance with and pursuant to the Investment Advisory Agreement, except acts or omissions constituting bad faith, willful misconduct, gross negligence, or reckless disregard of their duties under the Investment Advisory Agreement, as determined by a final non-appealable order of a court of competent jurisdiction. In addition, we have agreed to indemnify our Advisor, its principals, stockholders, members, managers, partners, directors and personnel, any person controlling or controlled by our Advisor and any person providing sub-advisory services to our Advisor with respect to all expenses, losses, damages, liabilities, demands, charges and claims arising from acts or omissions of our Advisor not constituting bad faith, willful misconduct, gross negligence, or reckless disregard of duties, performed in good faith in accordance with and pursuant to the Investment Advisory Agreement.
Our Advisor may have difficulty in complying with regulatory requirements applicable to REITs, including the REIT provisions of the Internal Revenue Code, which may hinder its ability to achieve our objectives or result in loss of our qualification as a REIT.
Our Advisor's management team has limited experience managing a REIT. The REIT rules and regulations are highly technical and complex, and the failure to comply with the income, asset, and other limitations imposed by these rules and regulations could prevent us from qualifying as a REIT or could force us to pay unexpected taxes and penalties. Failure to comply with the income, asset and other limitations imposed by the REIT rules and regulations may hinder our ability to achieve our objectives or result in loss of our qualification as a REIT or payment of taxes and penalties. As a result, we cannot assure you that we will be able to successfully operate as a REIT or comply with regulatory requirements applicable to REITs.
Our Board has approved broad guidelines for our Advisor and will not approve each acquisition decision made by our Advisor.
Our Advisor is authorized to follow broad guidelines in pursuing our asset acquisition strategy. Our Board will periodically review our guidelines and our portfolio of assets but will not, and will not be required to, review all of our proposed acquisitions or any type or category of asset, except that an acquisition of any security from, or issued by, an entity managed by our Advisor or its affiliates, must be approved by a majority of the independent members of our Board. In addition, in conducting periodic reviews, the directors will rely primarily on information provided to them by our Advisor. Furthermore, our Advisor may use complex strategies, and transactions entered into by our Advisor may be costly, difficult or impossible to unwind by the time they are reviewed by our Board. Our Advisor will have great latitude within the broad parameters of our guidelines in determining the types of assets it may decide are proper for us, which could result in returns that are substantially below expectations or that result in losses, which would materially and adversely affect our business
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operations and results. Further, decisions and acquisitions made by our Advisor may not fully reflect the best interests of our stockholders.
We may change any of our strategies, guidelines, policies or procedures without stockholder consent, which could result in our making acquisitions that are different from, and possibly riskier than, those described in this prospectus.
We may change any of our strategies, guidelines, policies or procedures with respect to acquisitions, asset allocation, growth, operations, indebtedness, financing strategy, hedging strategy and distributions at any time without the consent of our stockholders, which could result in our strategies becoming different from, and possibly riskier than, strategies described in this prospectus. A change in our strategy may increase our exposure to interest rate risk, prepayment risk, financing risk, credit risk, default risk and real estate market fluctuations. Furthermore, a change in our asset allocation could result in our making acquisitions in asset categories different from those described in this prospectus. In addition, our charter provides that our Board may revoke or otherwise terminate our REIT election, without the approval of our stockholders, if it determines that it is no longer in our best interests to qualify as a REIT. These changes could adversely affect our financial condition, results of operations, the value of our common stock and our ability to make distributions to our stockholders.
Our Advisor's advisory fee may reduce its incentive to devote its time and effort to seeking attractive assets for our portfolio because the fee is payable regardless of the performance of our portfolio and there is no incentive fee associated with the management of our assets.
Our Operating Partnership will pay to our Advisor an advisory fee, calculated and payable (in cash) quarterly in arrears, equal to 1.5% per annum of our Stockholders' Equity (as defined in "Our Advisor and the Investment Advisory AgreementAdvisory Fees, Expense Reimbursements and Termination FeeAdvisory Fee"). We will pay our Advisor an advisory fee regardless of the performance of our portfolio and there is no incentive fee associated with the management of our assets. Our Advisor's entitlement to nonperformance-based compensation might reduce its incentive to devote sufficient time and effort to seeking assets that provide attractive risk-adjusted returns for our portfolio. This in turn could negatively affect our ability to make distributions to our stockholders and the value of our common stock.
Risks Related to Financing and Hedging
We use leverage in executing our business strategy, which may adversely affect the return on our assets and may reduce cash available for distribution to our stockholders, as well as increase losses when economic conditions are unfavorable.
We leverage the acquisition of our target assets through private funding sources, including borrowings structured as repurchase agreements, securitizations, term financings and derivative contracts. Leverage can enhance our potential returns but can also exacerbate losses. Although we are not required to maintain any particular assets-to-equity leverage ratio, the amount of leverage we deploy for particular assets depends upon our Advisor's assessment of short-term interest rates, overall market conditions and the particular risks of the assets being financed. Our percentage of leverage varies over time depending on our ability to enter into repurchase agreements, term financings and derivative contracts, financing rates, type and/or amount of collateral required to be pledged, our assessment of the appropriate amount of leverage for the particular assets we are funding and regulatory requirements limiting the permissible amount of leverage to be utilized.
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The return on our assets and cash available for distribution to our stockholders may be reduced to the extent that market conditions prevent us from leveraging our assets or cause the cost of our financing to increase relative to the income that can be derived from the assets acquired. Our financing costs will reduce cash available for distribution to stockholders. We may not be able to meet our financing obligations and, to the extent that we cannot, we risk the loss of some or all of our assets to liquidation or sale to satisfy the obligations. A decrease in the value of our assets that are subject to repurchase agreement financing may lead to margin calls which we will have to satisfy. We may not have the funds available to satisfy any such margin calls and may be forced to sell assets at significantly depressed prices due to market conditions or otherwise, which may result in losses. The satisfaction of any such margin calls may reduce cash flow available for distribution to our stockholders. Any reduction in distributions to our stockholders may cause the value of our common stock to decline.
Our inability to access funding could have a material adverse effect on our results of operations, financial condition and business.
The borrowings we used to fund the purchase of our portfolio totaled approximately $110.1 million as of September 30, 2012 under master repurchase agreements with two counterparties. As of September 30, 2012, we had entered into master repurchase agreements with three counterparties and had outstanding borrowings with two of these counterparties. Our ability to fund our target asset acquisitions may be impacted by our ability to secure borrowings structured as repurchase agreements, securitizations, term financings and derivative contracts on acceptable terms. Because repurchase agreements are short-term commitments of capital, lenders may respond to market conditions making it more difficult for us to renew or replace on a continuous basis our maturing short-term borrowings. If we are not able to renew our then existing facilities or arrange for new financing on terms acceptable to us, or if we default on our covenants or are otherwise unable to access funds under our repurchase agreements, we may have to curtail our asset acquisition activities and/or dispose of assets.
It is possible that the lenders that will provide us with financing could experience changes in their ability to advance funds to us, independent of our performance or the performance of our portfolio of assets. Furthermore, if many of our potential lenders are unwilling or unable to provide us with financing, we could be forced to sell our assets at an inopportune time when prices are depressed. In addition, if the regulatory capital requirements imposed on our lenders change, they may be required to significantly increase the cost of the financing that they provide to us. Our lenders also may revise their eligibility requirements for the types of assets they are willing to finance or the terms of such financings, based on, among other factors, the regulatory environment and their management of perceived risk, particularly with respect to assignee liability. Moreover, the amount of financing we receive under our repurchase agreements will be directly related to the lenders' valuation of our target assets that cover the outstanding borrowings. Typically repurchase agreements grant the lender the absolute right to reevaluate the fair market value of the assets that cover outstanding borrowings at any time. If a lender determines in its sole discretion that the value of the assets has decreased, it has the right to initiate a margin call. A margin call would require us to transfer additional assets to such lender without any advance of funds from the lender for such transfer or to repay a portion of the outstanding borrowings. Any such margin call could have a material adverse effect on our results of operations, financial condition, business, liquidity and ability to make distributions to our stockholders, and could cause the value of our common stock to decline. We may be forced to sell assets at significantly depressed prices to meet such margin calls and to maintain adequate liquidity, which could cause us to incur losses.
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The dislocations in the residential mortgage sector in the financial crisis that began in 2007 have caused many lenders to tighten their lending standards, reduce their lending capacity or exit the market altogether. Further contraction among lenders, insolvency of lenders or other general market disruptions could adversely affect one or more of our potential lenders and could cause one or more of our potential lenders to be unwilling or unable to provide us with financing on attractive terms or at all. This could increase our financing costs and reduce our access to liquidity.
The repurchase agreements that we use to finance our assets may require us to provide additional collateral and may restrict us from leveraging our assets as fully as desired.
We use borrowings structured as repurchase agreements to finance our assets. If the fair market value of the assets pledged or sold by us to a financing institution declines, we may be required by the financing institution to provide additional collateral or pay down a portion of the funds advanced, but we may not have the funds available to do so, which could result in defaults. Posting additional collateral to support our credit will reduce our liquidity and limit our ability to leverage our assets, which could adversely affect our business. In the event we do not have sufficient liquidity to meet such requirements, financing institutions can accelerate repayment of our indebtedness, increase interest rates, liquidate our collateral or terminate our ability to borrow. Such a situation would likely result in a rapid deterioration of our financial condition and possibly necessitate a filing for bankruptcy protection.
Further, financial institutions providing the repurchase facilities may require us to maintain a certain amount of cash that is not invested or to set aside non-leveraged assets sufficient to maintain a specified liquidity position which would allow us to satisfy our collateral obligations. As a result, we may not be able to leverage our assets as fully as we would choose, which could reduce our return on equity. If we are unable to meet these collateral obligations, our financial condition could deteriorate rapidly.
If a counterparty to our repurchase transactions defaults on its obligation to resell the underlying security back to us at the end of the transaction term, or if the value of the underlying security has declined as of the end of that term, or if we default on our obligations under the repurchase agreement, we will lose money on our repurchase transactions.
Under our repurchase transactions, we generally sell securities to lenders (that is, repurchase agreement counterparties) and receive cash from the lenders. The lenders are obligated to resell the same securities back to us at the end of the term of the transaction, which typically ranges from 30 to 90 days, but which may have terms of up to 364 days or longer. Because the cash we will receive from the lender when we initially sell the securities to the lender is less than the value of those securities (this is referred to as the haircut), if the lender defaults on its obligation to resell the same securities back to us we would incur a loss on the transaction equal to the amount of the haircut (assuming there was no change in the value of the securities). We would also lose money on a repurchase transaction if the value of the underlying securities has declined as of the end of the transaction term, as we would have to repurchase the securities for their initial value but would receive securities worth less than that amount. Further, if we default on one of our obligations under a repurchase transaction, the lender will be able to terminate the transaction and cease entering into any other repurchase transactions with us. Our repurchase agreements may contain cross-default provisions, so that if a default occurs under any one agreement, the lenders under our other agreements could also declare a default. If a default occurs under any of our repurchase agreements and the lenders terminate one or more of our repurchase agreements, we may need to enter into replacement repurchase agreements with different lenders. There can be no assurance that we will be successful in entering into such replacement repurchase agreements
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on the same terms as the repurchase agreements that were terminated or at all. Any losses we incur on our repurchase transactions could adversely affect our earnings and thus our cash available for distribution to our stockholders.
An increase in our borrowing costs relative to the interest we receive on our leveraged assets may adversely affect our profitability and our cash available for distribution to our stockholders.
As our repurchase agreements and other short-term borrowings mature, we will be required either to enter into new borrowings or to sell certain of our assets. An increase in short-term interest rates at the time that we seek to enter into new borrowings would reduce the spread between the returns on our assets and the cost of our borrowings. This would adversely affect the returns on our assets, which might reduce earnings and, in turn, cash available for distribution to our stockholders.
Our rights under our repurchase agreements may be subject to the effects of the bankruptcy laws in the event of the bankruptcy or insolvency of us or our lenders under the repurchase agreements, which may allow our lenders to repudiate our repurchase agreements.
In the event of our insolvency or bankruptcy, certain repurchase agreements may qualify for special treatment under the U.S. Bankruptcy Code, the effect of which, among other things, would be to allow the lender under the applicable repurchase agreement to avoid the automatic stay provisions of the U.S. Bankruptcy Code and to foreclose on the collateral agreement without delay. In the event of the insolvency or bankruptcy of a lender during the term of a repurchase agreement, the lender may be permitted, under applicable insolvency laws, to repudiate the contract, and our claim against the lender for damages may be treated simply as an unsecured creditor. In addition, if the lender is a broker or dealer subject to the Securities Investor Protection Act of 1970, or an insured depository institution subject to the Federal Deposit Insurance Act, our ability to exercise our rights to recover our securities under a repurchase agreement or to be compensated for any damages resulting from the lender's insolvency may be further limited by those statutes. These claims would be subject to significant delay and, if and when received, may be substantially less than the damages we actually incur.
We enter into hedging transactions that could expose us to contingent liabilities in the future and adversely impact our financial condition.
Subject to maintaining our qualification as a REIT, part of our strategy involves entering into hedging transactions that could require us to fund cash payments in certain circumstances (such as the early termination of a hedging instrument caused by an event of default or other early termination event, or the decision by a counterparty to request margin securities it is contractually owed under the terms of the hedging instrument). The amount due would be equal to the unrealized loss of the open swap positions with the respective counterparty and could also include other fees and charges. These economic losses will be reflected in our results of operations. Our ability to fund these obligations will depend on the liquidity of our assets and access to capital at the time. The need to fund these obligations could adversely impact our financial condition.
Hedging against interest rate exposure may adversely affect our earnings, which could reduce our cash available for distribution to our stockholders.
Subject to maintaining our qualification as a REIT, we pursue various hedging strategies to seek to reduce our exposure to adverse changes in interest rates. Our hedging activity varies in scope based on the level and volatility of interest rates, the type of assets held and
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other changing market conditions. Interest rate hedging may fail to protect or could adversely affect us because, among other things:
In general, when we acquire a fixed-rate mortgage or hybrid ARM security, we may, but are not required to, enter into an interest rate swap agreement or other hedging instrument that effectively fixes our borrowing costs for a period close to the anticipated average life of the fixed-rate portion of the related assets. This strategy is designed to protect us from rising interest rates, because the borrowing costs are fixed for the duration of the fixed-rate portion of the related RMBS.
However, if prepayment rates decrease in a rising interest rate environment, the life of the fixed-rate portion of the related assets could extend beyond the term of the swap agreement or other hedging instrument. This could have a negative impact on our results of operations, as borrowing costs would no longer be fixed after the end of the hedging instrument while the income earned on the hybrid ARM security would remain fixed. This situation may also cause the fair market value of our hybrid ARM security to decline, with little or no offsetting gain from the related hedging transactions. In extreme situations, we may be forced to sell assets to maintain adequate liquidity, which could cause us to incur losses.
In addition, the use of this swap hedging strategy effectively limits increases in our book value in a declining rate environment, due to the effectively fixed nature of our hedged borrowing costs. In an extreme rate decline, prepayment rates on our assets might actually result in certain of our assets being fully paid off while the corresponding swap or other hedge instrument remains outstanding. In such a situation, we may be forced to liquidate the swap or other hedge instrument at a level that causes us to incur a loss.
Our hedging transactions, which are intended to limit losses, may actually adversely affect our earnings, which could reduce our cash available for distribution to our stockholders.
Our use of derivatives may expose us to counterparty and other risks.
We have entered into over-the-counter interest rate swap agreements to hedge risks associated with movements in interest rates. Because such interest rate swaps are not cleared through a central counterparty, the counterparty's performance is not guaranteed by an exchange or its clearing house. As a result, if a swap counterparty cannot perform under the terms of an interest rate swap, we would not receive payments due under that agreement, we may lose any unrealized gain associated with the interest rate swap and the hedged liability
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would cease to be hedged by the interest rate swap. We may also be at risk for any collateral we have pledged to secure our obligations under the interest rate swap if the counterparty becomes insolvent or files for bankruptcy.
Derivative instruments are also subject to liquidity risk and may be difficult or impossible to sell, close out or replace quickly and at the price that reflects the fundamental value of the instrument. Although both over-the-counter and exchange-traded markets may experience the lack of liquidity, over-the-counter non-standardized derivative transactions are generally less liquid than exchange-traded instruments.
Furthermore, the enforceability of agreements underlying hedging transactions may depend on compliance with applicable statutory and commodity and other regulatory requirements and, depending on the identity of the counterparty, applicable international requirements. Recently, new regulation has been promulgated by U.S. and foreign regulators attempting to strengthen oversight of derivative contracts. Any actions taken by regulators could constrain our strategy and could increase our costs either of which could materially and adversely impact our results of operations. In particular, the Dodd-Frank Act requires most derivatives to be executed on a regulated market and cleared through a central counterparty, which may result in increased margin requirements and costs. On December 7, 2012, the U.S. Commodity Futures Trading Commission (or CFTC) issued a No-Action Letter that provides mortgage REITs relief from such registration (or the No-Action Letter) if they meet certain conditions and submit a claim for such no-action relief by email to the CFTC. We believe we meet the conditions set forth in the No-Action Letter and we have filed our claim with the CFTC to perfect the use of the no-action relief from registration. However, if in the future we do not meet the conditions set forth in the No-Action Letter or the relief provided by the No-Action Letter becomes unavailable for any other reason and we are unable to obtain another exemption from registration, we may be required to reduce or eliminate our use of interest rate swaps or vary the manner we deploy interest rate swaps in our business and we and our directors may be required to register as a "commodity pool operator" (or CPO) and/or our Advisor may be required to register as a "commodity trading advisor" with the CFTC. In the event we, our directors, ZAIS or our Advisor is required to register with the CFTC, it will become subject to additional disclosure, recordkeeping and reporting requirements, which may increase our expenses.
The business failure of a hedging counterparty with whom we enter into a hedging transaction will most likely result in its default. Default by a party with whom we enter into a hedging transaction may result in the loss of unrealized profits and force us to cover our commitments, if any, at the then current market price. Although generally we will seek to reserve the right to terminate our hedging positions, it may not always be possible to dispose of or close out a hedging position without the consent of the hedging counterparty and we may not be able to enter into an offsetting contract in order to cover our risk. We cannot assure you that a liquid secondary market will exist for hedging instruments purchased or sold, and we may be required to maintain a position until exercise or expiration, which could result in losses.
Regulation as a commodity pool operator could subject us to additional regulation and compliance requirements which could materially adversely affect our business and financial condition.
The Dodd-Frank Act extended the reach of commodity regulations for the first time to include not just traditional futures contracts but also derivative contracts referred to as "swaps." As a consequence of this change, any investment fund that trades in swaps may be considered a "commodity pool," which would cause its operator to be regulated as a CPO. Under the new requirements, which become effective on December 31, 2012 for those who
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become CPOs solely because of use of swaps by the relevant commodity pool, CPOs must register with the CFTC and become subject to regulation by the CFTC, including with respect to disclosure, recordkeeping and reporting.
As described above, on December 7, 2012, the CFTC issued the No-Action Letter that provides mortgage REITs relief from such registration. We believe we meet the conditions set forth in the No-Action Letter and we have filed our claim with the CFTC to perfect the use of the no-action relief from registration. However, if in the future we do not meet the conditions set forth in the No-Action Letter or the relief provided by the No-Action Letter becomes unavailable for any other reason and we are unable to obtain another exemption from registration, we may be required to reduce or eliminate our use of interest rate swaps or vary the manner we deploy interest rate swaps in our business and we or our directors may be required to register with the CFTC as CPOs which will require compliance with CFTC rules and subject us and/or our directors to regulation by the CFTC. In the event registration for us or our directors is required but is not obtained, we and/or our directors may be subject to fines, penalties and other civil or governmental actions or proceedings, any of which could have a material adverse effect on our business, financial condition and results of operations.
If we attempt to qualify for hedge accounting treatment for our derivative instruments, but we fail to so qualify we may suffer because losses on the derivatives that we enter into may not be offset by a change in the fair value of the related hedged transaction.
If we attempt to qualify for hedge accounting treatment for our derivative instruments, but we fail to so qualify for a number of reasons, including if we use instruments that do not meet the definition of a derivative (such as short sales), we fail to satisfy hedge documentation and hedge effectiveness assessment requirements or our instruments are not highly effective, we may suffer because losses on the derivatives we hold may not be offset by a change in the fair value of the related hedged transaction.
Declines in the fair market values of our assets may adversely affect periodic reported results and credit availability, which may reduce earnings and, in turn, cash available for distribution to our stockholders.
A portion of our assets may be classified for accounting purposes as "available-for-sale." Other than in the instances of other-than-temporary impairment, changes in the fair market values of most of these assets will be directly charged or credited to stockholders' equity. As a result, a decline in values may reduce the book value of our company. Moreover, if the decline in value of an available-for-sale security is other than temporary, such decline will reduce earnings.
A decline in the fair market value of our assets may adversely affect us, particularly in instances where we have borrowed money based on the fair market value of those assets. If the fair market value of those assets declines, the lender may require us to post additional collateral to support the loan. If we were unable to post the additional collateral, we would have to sell the assets at a time when we might not otherwise choose to do so. A reduction in credit available may reduce our earnings and, in turn, cash available for distribution to stockholders.
Risks Related to Our Assets and Our Target Assets
We may not realize gains or income from our assets, which could cause the value of our common stock to decline.
We seek to generate both current income and capital appreciation for our stockholders. However, our assets or the assets we acquire may not appreciate in value and, in fact, may
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decline in value, and the debt securities we own or acquire may default on interest and/or principal payments. Accordingly, we may not be able to realize gains or income from our assets. Any gains that we do realize may not be sufficient to offset any other losses we experience. Any income that we realize may not be sufficient to offset our expenses.
Our portfolio of assets may be concentrated and will be subject to risk of default.
While we intend to diversify our portfolio of assets in the manner described in this prospectus, we are not required to observe specific diversification criteria, except as may be set forth in the guidelines adopted by our Board. Therefore, our portfolio of assets may at times be concentrated in certain property types that are subject to higher risk of foreclosure, or secured by properties concentrated in a limited number of geographic locations. For example, as of September 30, 2012, the five states that represented the largest portion of mortgage loans underlying our non-agency RMBS assets (measured by outstanding principal balance) were: California (44.3%); Florida (7.6%); New York (6.7%); Virginia (4.6%); and New Jersey (4.3%). If we raise less money in this offering than anticipated, we will have fewer assets and less diversification. To the extent that our portfolio is concentrated in any one region or type of security, downturns relating generally to such region or type of security may result in defaults on a number of our assets within a short time period, which may reduce our net income and the value of our common stock and accordingly reduce our ability to pay dividends to our stockholders.
The spread between swap rates and residential mortgage loans and non-Agency RMBS may widen due to difficult market conditions, which may adversely affect lending terms for these assets and have a negative impact on our stated book value.
Since the onset of the financial crisis that began in 2007, the spread between swap rates and residential mortgage loans and non-Agency RMBS has been volatile. Spreads on these assets initially moved wider due to the difficult credit conditions and have only recovered a portion of that widening. As the prices of securitized assets declined, a number of investors and a number of structured investment vehicles faced margin calls from dealers and were forced to sell assets in order to reduce leverage. The price volatility of these assets also impacted lending terms in the repurchase market, as counterparties raised margin requirements to reflect the more difficult environment. The spread between the yield on our assets and our funding costs is an important factor in the performance of this aspect of our business. Wider spreads imply greater income on new asset purchases but may have a negative impact on our stated book value. Wider spreads generally negatively impact asset prices. In an environment where spreads are widening, counterparties may require additional collateral to secure borrowings which may require us to reduce leverage by selling assets.
We hold and may acquire additional non-Agency RMBS collateralized by subprime mortgage loans, which are subject to increased risks.
We hold and may acquire additional non-Agency RMBS backed by collateral pools of mortgage loans that have been originated using underwriting standards that are less restrictive than those used in underwriting "prime mortgage loans" and "alternative-A mortgage loans." These lower standards include mortgage loans made to borrowers having imperfect or impaired credit histories, mortgage loans where the amount of the loan at origination is 80% or more of the value of the mortgage property, mortgage loans made to borrowers with low credit scores, mortgage loans made to borrowers who have other debt that represents a large portion of their income and mortgage loans made to borrowers whose income is not required to be disclosed or verified. Due to recent economic conditions, including lower home prices, as well as aggressive lending practices, subprime mortgage loans have in recent years experienced increased rates of delinquency, foreclosure, bankruptcy
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and loss, and they are likely to continue to experience delinquency, foreclosure, bankruptcy and loss rates that are higher, and that may be substantially higher, than those experienced by mortgage loans underwritten in a more traditional manner. Thus, because of the higher delinquency rates and losses associated with subprime mortgage loans, the performance of non-Agency RMBS backed by subprime mortgage loans that we hold and may acquire could be correspondingly adversely affected, which could adversely impact our results of operations, financial condition and business.
The residential mortgage loans and the mortgage loans underlying the RMBS that we hold and intend to acquire may be subject to defaults, foreclosure timeline extension, fraud and residential price depreciation and unfavorable modification of loan principal amount, interest rate and amortization of principal, which could result in losses to us.
The residential mortgage loans and the mortgage loans underlying the RMBS that we hold and intend to acquire may be subject to the risks of defaults, foreclosure timeline extension, fraud and home price depreciation and unfavorable modification of loan principal amount, interest rate and amortization of principal. The ability of a borrower to repay a mortgage loan secured by a residential property is dependent upon the income or assets of the borrower.
A number of factors may impair borrowers' abilities to repay their loans, including:
In the event of defaults on the residential mortgage loans that we hold or acquire or that underlie our investments in RMBS and the exhaustion of any underlying or any additional credit support, we may not realize our anticipated return on our investments and we may incur a loss on these investments. In addition, our investments in non-Agency RMBS will be backed by residential real property but, in contrast to Agency RMBS, their principal and interest will not be guaranteed by federally chartered entities such as Fannie Mae and Freddie Mac and, in the case of Ginnie Mae, the U.S. Government. The ability of a borrower to repay these loans or other financial assets is dependent upon the income or assets of these borrowers.
We may be affected by alleged or actual deficiencies in foreclosure practices of third parties, as well as related delays in the foreclosure process.
Allegations of deficiencies in servicing and foreclosure practices among several large sellers and servicers of residential mortgage loans that surfaced in 2010 raised various concerns relating to such practices, including the improper execution of the documents used in foreclosure proceedings (or robo signing), inadequate documentation of transfers and registrations of mortgages and assignments of loans, improper modifications of loans, violations of representations and warranties at the date of securitization and failure to enforce put-backs.
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As a result of alleged deficiencies in foreclosure practices, a number of servicers temporarily suspended foreclosure proceedings beginning in the second half of 2010 while they evaluated their foreclosure practices. In late 2010, a group of state attorneys general and state bank and mortgage regulators representing nearly all 50 states and the District of Columbia, along with the U.S. Justice Department and the Department of Housing and Urban Development, began an investigation into foreclosure practices of banks and servicers. The investigations and lawsuits by several state attorneys general led to a settlement agreement in March 2012 with five of the nation's largest banks, pursuant to which the banks agreed to pay more than $25 billion to settle claims relating to improper foreclosure practices. The settlement does not prohibit the states, the federal government, individuals or investors in RMBS from pursuing additional actions against the banks and servicers in the future.
The integrity of the servicing and foreclosure processes are critical to the value of the mortgage loan portfolios underlying the RMBS in which we invest, and our financial results could be adversely affected by deficiencies in the conduct of those processes. For example, delays in the foreclosure process that have resulted from investigations into improper servicing practices may adversely affect the values of, and our losses on, the non-Agency RMBS we may acquire. Foreclosure delays may also increase the administrative expenses of any securitization trusts that we may sponsor for non-Agency RMBS that we own or in which we may invest, thereby reducing the amount of funds available for distribution to our stockholders. In addition, the subordinate classes of securities issued by any such securitization trusts may continue to receive interest payments while the defaulted loans remain in the trusts, rather than absorbing the default losses. This may reduce the amount of credit support available for the senior classes we may own, thus possibly adversely affecting these securities.
While we believe that the sellers and servicers would be in violation of their servicing contracts to the extent that they have improperly serviced mortgage loans or improperly executed documents in foreclosure or bankruptcy proceedings, or do not comply with the terms of servicing contracts when deciding whether to apply principal reductions, it may be difficult, expensive, and time consuming for us to enforce our contractual rights. We continue to monitor and review the issues raised by the alleged improper foreclosure practices. While we cannot predict exactly how the servicing and foreclosure matters or the resulting litigation or settlement agreements will affect our business, there can be no assurance that these matters will not have an adverse impact on our results of operations and financial condition.
The commercial mortgage loans underlying the CMBS we may hold and acquire may be subject to defaults, foreclosure timeline extension, fraud and commercial price depreciation and unfavorable modification of loan principal amount, interest rate and amortization of principal, which could result in losses to us.
CMBS are secured by a single commercial mortgage loan or a pool of commercial mortgage loans. Commercial mortgage loans are secured by multifamily or commercial property and may be subject to risks of delinquency and foreclosure, and risks of loss that may be greater than similar risks associated with loans made on the security of single-family residential property. The ability of a borrower to repay a loan secured by an income-producing property typically is dependent primarily upon the successful operation of such property rather than upon the existence of independent income or assets of the borrower. If the net operating income of the property is reduced, the borrower's ability to repay the loan may be impaired. Net operating income of an income-producing property can be affected by, among other things,
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Our investments may include subordinated tranches of RMBS or CMBS, which are subordinate in right of payment to more senior securities.
Our investments may include subordinated tranches of RMBS or CMBS, which are subordinated classes of securities in a structure of securities collateralized by a pool of mortgage loans and, accordingly, are the first or among the first to bear the loss upon a restructuring or liquidation of the underlying collateral and the last to receive payment of interest and principal. Additionally, estimated fair values of these subordinated interests tend to be more sensitive to changes in economic conditions than more senior securities. As a result, such subordinated interests generally are not actively traded and may not provide holders thereof with liquid investments.
If our Advisor underestimates the loss-adjusted yields of our CMBS investments, we may experience losses.
Our Advisor expects to value our CMBS investments based on loss-adjusted yields, taking into account estimated future losses on the mortgage loans included in the securitization's pool of loans, and the estimated impact of these losses on expected future cash flows. Our Advisor's loss estimates may not prove accurate, as actual results may vary from estimates. In the event that our Advisor underestimates the pool level losses relative to the price we pay for a particular CMBS investment, we may experience losses with respect to such investment.
We may not control the special servicing of the mortgage loans included in the CMBS in which we may invest and, in such cases, the special servicer may take actions that could adversely affect our interests.
With respect to CMBS in which we may invest, overall control over the special servicing of the related underlying mortgage loans will be held by a "directing certificateholder" or a "controlling class representative," which is appointed by the holders of the most subordinate class of CMBS in such series. We may not have the right to appoint the directing certificateholder. In connection with the servicing of the specially serviced mortgage loans, the related special servicer may, at the direction of the directing certificateholder, take actions with respect to the specially serviced mortgage loans that could adversely affect our interests.
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We may purchase interests in mortgage servicing rights, which will expose us to significant risks.
MSRs, are among our target assets. GSEs, such as Fannie Mae and Freddie Mac, generally require mortgage servicers to be paid a minimum servicing fee, that significantly exceeds the amount a servicer would charge in an arm's-length transaction. The minimum servicing fee required by GSEs is therefore made up of the normal arm's-length servicing fee and the excess mortgage servicing amount.
Any MSRs we acquire will be recorded at fair value on our balance sheet based upon significant estimates and assumptions, with changes in fair value included in our consolidated results of operations. The determination of the fair value of MSRs will require our management to make numerous estimates and assumptions. Such estimates and assumptions would include, without limitation, estimates of future cash flows associated with MSRs based upon assumptions involving interest rates as well as the prepayment rates, delinquencies and foreclosure rates of the underlying serviced mortgage loans.
The ultimate realization of the value of MSRs, which are measured at fair value on a recurring basis, may be materially different than the fair values of such MSRs as may be reflected in our consolidated statement of financial position as of any particular date. The use of different estimates or assumptions in connection with the valuation of these assets could produce materially different fair values for such assets, which could have a material adverse effect on our consolidated financial position, results of operations and cash flows. Accordingly, there may be material uncertainty about the fair value of any MSRs we acquire.
Changes in interest rates are a key driver of the performance of MSRs, since the values of MSRs are highly sensitive to the impact of changes in interest rates on mortgage prepayment rates. Historically, the value of MSRs has increased when interest rates rise and decreased when interest rates decline due to the effect those changes in interest rates have on prepayment estimates. We may pursue various hedging strategies to seek to reduce our exposure to adverse changes in interest rates. See "BusinessOur Hedging Strategy." Our hedging activity will vary in scope based on the level and volatility of interest rates, the type of assets held and other changing market conditions. Interest rate hedging may fail to protect or could adversely affect us. To the extent we do not utilize derivatives to hedge against changes in fair value of MSRs, our balance sheet, results of operations and cash flows would be susceptible to significant volatility due to changes in the fair value of, or cash flows from, MSRs as interest rates change.
Prepayment speeds significantly affect excess mortgage servicing fees. Prepayment speed is the measurement of how quickly borrowers pay down the unpaid principal balance of their loans or how quickly loans are otherwise brought current, modified, liquidated or charged off. We will base the price we pay for MSRs and the rate of amortization of those assets on, among other things, our projection of the cash flows from the related pool of mortgage loans. Our expectation of prepayment speeds will be a significant assumption underlying those cash flow projections. If prepayment speeds are significantly greater than expected, the carrying value of MSRs could exceed their estimated fair value. If the fair value of MSRs decreases, we would be required to record a non-cash charge, which would have a negative impact on our financial results. Furthermore, a significant increase in prepayment speeds could materially reduce the ultimate cash flows we receive from MSRs, and we could ultimately receive substantially less than what we paid for such assets.
Moreover, delinquency rates have a significant impact on the valuation of any excess mortgage servicing fees. An increase in delinquencies will generally result in lower revenue because typically we will only collect servicing fees from GSEs or mortgage owners for performing loans. We will base the price we pay for MSRs on, among other things, our projections of the cash flows from related pools of mortgage loans. Our expectation of
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delinquencies is a significant assumption underlying those cash flow projections. If delinquencies are significantly greater than we expect, the estimated fair value of the MSRs could be diminished. When the estimated fair value of MSRs are reduced, we could suffer a loss, which could have a negative impact on our financial results.
Furthermore, MSRs are subject to numerous U.S. federal, state and local laws and regulations and may be subject to various judicial and administrative decisions imposing various requirements and restrictions on our business. Our failure to comply, or the failure of the servicer to comply, with the laws, rules or regulations to which we or they are subjected due by virtue of ownership of MSRs, whether actual or alleged, could expose us to fines, penalties or potential litigation liabilities, including costs, settlements and judgments, any of which could have a material adverse effect on our business, financial condition, results of operations or cash flows.
The receivables underlying the ABS we may acquire are subject to credit risks, liquidity risks, interest rate risks, market risks, operations risks, structural risks and legal risks, which could result in losses to us.
ABS are securities backed by various asset classes, including auto loans, student loans, credit card loans, equipment loans, floor plan loans and small business loans fully guaranteed as to principal and interest by the U.S. Small Business Administration. A portion of our target assets may be ABS. The structure of an ABS, and the terms of the investors' interest in the underlying collateral, can vary widely depending on the type of collateral, the desires of investors and the use of credit enhancements. Individual transactions can differ markedly in both structure and execution. Important determinants of the risk associated with issuing or holding ABS include (i) the relative seniority or subordination of the class of ABS held by an investor, (ii) the relative allocation of principal, and interest payments in the priorities by which such payments are made under the governing documents, (iii) the effect of credit losses on both the issuing vehicle and investors' returns, (iv) whether the underlying collateral represents a fixed set of specific assets or accounts, (v) whether the underlying collateral assets are revolving or closed-end, (vi) the terms (including maturity of the ABS) under which any remaining balance in the accounts may revert to the issuing vehicle and (vii) the extent to which the entity that sold the underlying collateral to the issuing vehicle is obligated to provide support to the issuing vehicle or to investors. With respect to some types of ABS, the foregoing risks are more closely correlated with similar risks on corporate bonds of similar terms and maturities than with the performance of a pool of similar assets.
In addition, certain ABS (particularly subordinated ABS) provide that the non-payment of interest thereon in cash will not constitute an event of default in certain circumstances, and the holders of such ABS will not have available to them any associated default remedies. Interest not paid in cash will generally be capitalized and added to the outstanding principal balance of the related security. Deferral of interest through such capitalization will reduce the yield on such ABS.
Holders of ABS bear various risks, including credit risks, liquidity risks, interest rate risks, market risks, operations risks, structural risks and legal risks. Credit risk arises from (i) losses due to defaults by obligors under the underlying collateral and (ii) the issuing vehicle's or servicer's failure to perform their respective obligations under the transaction documents governing the ABS. These two risks may be related, as, for example, in the case of a servicer that does not provide adequate credit-review scrutiny to the underlying collateral, leading to a higher incidence of defaults.
Market risk arises from the cash flow characteristics of the ABS, which for most ABS tend to be predictable. The greatest variability in cash flows come from credit performance,
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including the presence of wind-down or acceleration features designed to protect the investor in the event that credit losses in the portfolio rise well above expected levels.
Interest rate risk arises for the issuer from (i) the pricing terms on the underlying collateral, (ii) the terms of the interest rate paid to holders of the ABS and (iii) the need to mark to market the excess servicing or spread account proceeds carried on the issuing vehicle's balance sheet. For the holder of the security, interest rate risk depends on the expected life of the ABS, which may depend on prepayments on the underlying assets or the occurrence of wind-down or termination events. If the servicer becomes subject to financial difficulty or otherwise ceases to be able to carry out its functions, it may be difficult to find other acceptable substitute servicers and cash flow disruptions or losses may occur, particularly with underlying collateral comprised of non-standard receivables or receivables originated by private retailers who collect many of the payments at their stores.
Structural and legal risks include the possibility that, in a bankruptcy or similar proceeding involving the originator or the servicer (often the same entity or affiliates), a court having jurisdiction over the proceeding could determine that, because of the degree to which cash flows on the assets of the issuing vehicle may have been commingled with cash flows on the originator's other assets (or similar reasons), (i) the assets of the issuing vehicle could be treated as never having been truly sold by the originator to the issuing vehicle and could be substantively consolidated with those of the originator, or (ii) the transfer of such assets to the issuer could be voided as a fraudulent transfer. The time and expense related to a challenge of such a determination also could result in losses and/or delayed cash flows.
An increase in interest rates may cause a decrease in the volume of certain of our target assets, which could adversely affect our ability to acquire target assets that satisfy our investment objectives and to generate income and make distributions.
Rising interest rates generally reduce the demand for mortgage loans due to the higher cost of borrowing. A reduction in the volume of mortgage loans originated may affect the volume of our target assets available to us, which could adversely affect our ability to acquire assets that satisfy our investment objectives. Rising interest rates may also cause our target assets that were issued prior to an interest rate increase to provide yields that are below prevailing market interest rates. If rising interest rates cause us to be unable to acquire a sufficient volume of our target assets with a yield that is above our borrowing cost, our ability to satisfy our investment objectives and to generate income and make distributions may be materially and adversely affected.
The relationship between short-term and longer-term interest rates is often referred to as the "yield curve." Ordinarily, short-term interest rates are lower than longer-term interest rates. If short-term interest rates rise disproportionately relative to longer-term interest rates (a flattening of the yield curve), our borrowing costs may increase more rapidly than the interest income earned on our assets. Because we expect our investments, on average, generally will bear interest based on longer-term rates than our borrowings, a flattening of the yield curve would tend to decrease our net income and the fair market value of our net assets. Additionally, to the extent cash flows from investments that return scheduled and unscheduled principal are reinvested, the spread between the yields on the new investments and available borrowing rates may decline, which would likely decrease our net income. It is also possible that short-term interest rates may exceed longer-term interest rates (a yield curve inversion), in which event our borrowing costs may exceed our interest income and we could incur operating losses.
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Increases in interest rates could adversely affect the value of our investments and cause our interest expense to increase, which could result in reduced earnings or losses and negatively affect our profitability as well as the cash available for distribution to our stockholders.
We seek to invest in non-Agency RMBS, Agency RMBS, residential mortgage loans and other real estate-related and financial assets, including MSRs, IOs, CMBS and ABS. In a normal yield curve environment, an investment in such assets will generally decline in value if long-term interest rates increase. Declines in fair market value may ultimately reduce earnings or result in losses to us, which may negatively affect cash available for distribution to our stockholders.
A significant risk associated with our target assets is the risk that both long-term and short-term interest rates will increase significantly. If long-term rates increased significantly, the fair market value of these investments would decline, and the duration and weighted average life of the investments would increase. We could realize a loss if the securities were sold. At the same time, an increase in short-term interest rates would increase the amount of interest owed on our repurchase agreements.
Fair market values of our investments may decline without any general increase in interest rates for a number of reasons, such as increases or expected increases in defaults, or increases or expected increases in voluntary prepayments for those investments that are subject to prepayment risk or widening of credit spreads.
In addition, in a period of rising interest rates, our operating results will depend in large part on the difference between the income from our assets and our financing costs. We anticipate that, in most cases, the income from such assets will respond more slowly to interest rate fluctuations than the cost of our borrowings. Consequently, changes in interest rates, particularly short-term interest rates, may significantly influence our net income. Increases in these rates will tend to decrease our net income and fair market value of our assets.
Interest rate mismatches between our RMBS backed by ARMs or hybrid ARMs and our borrowings used to fund our purchases of these assets may cause us to suffer losses.
We fund our RMBS with borrowings that have interest rates that adjust more frequently than the interest rate indices and repricing terms of RMBS backed by ARMs, or hybrid ARMs. Accordingly, if short-term interest rates increase, our borrowing costs may increase faster than the interest rates on RMBS backed by ARMs or hybrid ARMs adjust. As a result, in a period of rising interest rates, we could experience a decrease in net income or a net loss.
In most cases, the interest rate indices and repricing terms of RMBS backed by ARMs or hybrid ARMs and our borrowings are not identical, thereby potentially creating an interest rate mismatch between our investments and our borrowings. While the historical spread between relevant short-term interest rate indices has been relatively stable, there have been periods when the spread between these indices was volatile. During periods of changing interest rates, these interest rate index mismatches could reduce our net income or produce a net loss, and adversely affect the level of our dividends and the market price of our common stock.
In addition, RMBS backed by ARMs or hybrid ARMs are typically subject to lifetime interest rate caps that limit the amount an interest rate can increase through the maturity of the RMBS. However, our borrowings under repurchase agreements typically are not subject to similar restrictions. Accordingly, in a period of rapidly increasing interest rates, the interest rates paid on our borrowings could increase without limitation while caps could limit the
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interest rates on these types of RMBS. This problem is magnified for RMBS backed by ARMs or hybrid ARMs that are not fully indexed. Further, some RMBS backed by ARMs or hybrid ARMs may be subject to periodic payment caps that result in a portion of the interest being deferred and added to the principal outstanding. As a result, we may receive less cash income on these types of RMBS than we need to pay interest on our related borrowings. These factors could reduce our net interest income and cause us to suffer a loss during periods of rising interest rates.
Interest rate fluctuations may adversely affect the level of our net income and the value of our assets and common stock.
Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control. Interest rate fluctuations present a variety of risks, including the risk of a narrowing of the difference between asset yields and borrowing rates, flattening or inversion of the yield curve and fluctuating prepayment rates, and may adversely affect our income and the value of our assets and common stock.
Because we hold and may acquire additional fixed-rate securities, an increase in interest rates on our borrowings may adversely affect our book value.
Increases in interest rates may negatively affect the fair market value of our assets. Any fixed-rate securities we hold or acquire generally will be more negatively affected by these increases than adjustable-rate securities. In accordance with accounting rules, in most cases, we will be required to reduce our earnings by the amount of any decrease in the fair market value of our assets that are accounted for under the fair value option. We will be required to evaluate our assets on a quarterly basis to determine their fair value by using third-party bid price indications provided by dealers who make markets in these securities or by third-party pricing services. If the fair value of a security is not available from a dealer or third-party pricing service, we will estimate the fair value of the security using a variety of methods, including discounted cash flow analysis, matrix pricing, option-adjusted spread models and fundamental analysis. Aggregate characteristics taken into consideration include type of collateral, index, margin, periodic cap, lifetime cap, underwriting standards, age and delinquency experience. However, the fair value reflects estimates and may not be indicative of the amounts we would receive in a current market exchange. If we determine that an agency security is other-than-temporarily impaired, we would be required to reduce the value of such agency security on our balance sheet by recording an impairment charge in our income statement and our stockholders' equity would be correspondingly reduced. Reductions in stockholders' equity decrease the amounts we may borrow to purchase additional target assets, which could restrict our ability to increase our net income.
Because the assets we hold and expect to acquire may experience periods of illiquidity, we may lose profits or be prevented from earning capital gains if we cannot sell mortgage-related assets at an opportune time.
We bear the risk of being unable to dispose of our assets at advantageous times or in a timely manner because mortgage-related assets generally experience periods of illiquidity, including the recent period of delinquencies and defaults with respect to residential mortgage loans. The lack of liquidity may result from the absence of a willing buyer or an established market for these assets, as well as legal or contractual restrictions on resale or the unavailability of financing for these assets. As a result, our ability to vary our portfolio in
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response to changes in economic and other conditions may be relatively limited, which may cause us to incur losses.
We may experience a decline in the fair market value of our assets.
A decline in the fair market value of our assets and the assets which we intend to acquire may require us to recognize an "other-than-temporary" impairment against such assets under U.S. GAAP, if we were to determine that, with respect to any debt security in unrealized loss positions, we do not have the ability and intent to hold such assets to maturity or for a period of time sufficient to allow for recovery to the amortized cost of such assets. If such a determination were to be made, we would recognize unrealized losses through earnings and write down the amortized cost of such assets to a new cost basis, based on the fair market value of such assets on the date they are considered to be other-than-temporarily impaired. Such impairment charges reflect non-cash losses at the time of recognition; subsequent disposition or sale of such assets could further affect our future losses or gains, as they are based on the difference between the sale price received and adjusted amortized cost of such assets at the time of sale.
Many of the assets in our portfolio will be recorded at fair value and, as a result, there will be uncertainty as to the value of these assets.
Many of the assets in our portfolio are and will likely be in the form of securities that are not publicly traded. The fair value of securities and other assets that are not publicly traded may not be readily determinable. We value these assets quarterly at fair value, as determined in accordance with applicable accounting standards, which may include unobservable inputs. Because such valuations are subjective, the fair value of certain of our assets may fluctuate over short periods of time and our determinations of fair value may differ materially from the values that would have been used if a ready market for these securities existed. The value of our common stock could be adversely affected if our determinations regarding the fair value of these assets were materially higher than the values that we ultimately realize upon their disposal.
Prepayment rates may adversely affect the value of our portfolio of assets.
Pools of residential mortgage loans underlie the RMBS that we hold and will acquire. In the case of residential mortgage loans, there are seldom any restrictions on borrowers' abilities to prepay their loans. Declines in interest rates may cause an increase in prepayment rates of mortgage loans. In addition, both HARP and QE3 may also cause an increase in prepayment rates. We generally receive distributions from principal payments that are made on these underlying mortgage loans. When borrowers prepay their mortgage loans faster than expected, this results in prepayments that are faster than expected on the RMBS. Faster than expected prepayments could adversely affect our profitability, including in the following ways:
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While we will seek to minimize prepayment risk to the extent practical, in selecting assets we must balance prepayment risk against other risks and the potential returns of each asset. No strategy can completely insulate us from prepayment risk.
Recent market conditions may upset the historical relationship between interest rate changes and prepayment trends, which would make it more difficult for us to analyze our portfolio of assets. We are vulnerable to loss from prepayments if we purchase assets above par, especially in the event of additional mortgage loan modification and refinance programs or similar future legislative action.
Our success depends in part on our ability to analyze the relationship of changing interest rates on prepayments of the mortgage loans that underlie our RMBS. Changes in interest rates and prepayments affect the market price of the RMBS that we intend to purchase and any RMBS that we hold at a given time. As part of our overall portfolio risk management, we will analyze interest rate changes and prepayment trends separately and collectively to assess their effects on our portfolio of assets. In conducting our analysis, we will depend on certain assumptions based upon historical trends with respect to the relationship between interest rates and prepayments under normal market conditions. If dislocations in the residential mortgage market or other developments change the way that prepayment trends have historically responded to interest rate changes, our ability to (i) assess the fair market value of our portfolio of assets, (ii) implement our hedging strategies and (iii) implement techniques to reduce our prepayment rate volatility would be significantly affected, which could materially adversely affect our financial position and results of operations. In particular, despite the historically low interest rates, recent dislocations, including home price depreciation resulting in many borrowers owing more on their mortgage than the values of their homes have prevented many such borrowers from refinancing their mortgage loans which has impacted prepayment rates and the value of RMBS assets. However, mortgage loan modification and refinance programs or future legislative action may make refinancing mortgage loans more accessible or attractive to such borrowers which could cause the rate of prepayments on RMBS assets to accelerate. For RMBS assets, including some of our RMBS assets, that were purchased or are trading at premium to their par value, higher prepayment rates would adversely affect the value of such assets or cause the holder to incur losses with respect to such assets.
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Risks Related to Owning Our Common Stock
There is no public market for our common stock and a market may never develop, which could cause our common stock to trade at a discount and make it difficult for holders of our common stock to sell their shares.
Prior to the offering, there has been no established trading market for our common stock, and there can be no assurance that an active trading market for our common stock will develop, or if one develops, be maintained. Accordingly, no assurance can be given as to the ability of our stockholders to sell their common stock or the price that our stockholders may obtain for their common stock.
Some of the factors that could negatively affect the market price of our common stock include:
Market factors unrelated to our performance could also negatively impact the market price of our common stock. One of the factors that investors may consider in deciding whether to buy or sell our common stock is our distribution rate as a percentage of our stock price relative to market interest rates. If market interest rates increase, prospective investors may demand a higher distribution rate or seek alternative investments paying higher dividends or interest. As a result, interest rate fluctuations and conditions in capital markets can affect the fair market value of our common stock. For instance, if interest rates rise, it is likely that the market price of our common stock will decrease as market rates on interest-bearing securities increase.
Common stock and preferred stock eligible for future sale may have adverse effects on our share price.
Subject to applicable law, our Board has the authority, without further stockholder approval, to authorize us to issue additional authorized shares of common stock and preferred stock on the terms and for the consideration it deems appropriate. We cannot predict the effect, if any, of future sales of our common stock, or the availability of shares for future sales,
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on the market price of our common stock. The market price of our common stock may decline significantly when the restrictions on resale by certain of our stockholders lapse or a registration statement is filed pursuant to a registration rights agreement in respect of shares of our common stock that were purchased in unregistered transactions. Sales of substantial amounts of common stock or the perception that such sales could occur may adversely affect the prevailing market price for our common stock. Prior to this offering, we had outstanding 2,320,882 shares of our common stock, after giving effect to the 2013 repurchase described elsewhere in this prospectus, and 926,914 OP units, which are exchangeable on a one-for-one basis into shares of our common stock and we have agreed with these stockholders and OP unitholders to file a registration statement in respect of these shares of common stock, including the shares of common stock issuable upon exchange of the OP units. See "History and Formation of Our CompanyRegistration Rights Agreement." Holders of 92.3% of our outstanding shares of common stock and OP units, after giving effect to the 2013 repurchase described elsewhere in this prospectus, have agreed with ZAIS, as the managing member of our Advisor, not to, directly or indirectly, sell, transfer, assign, mortgage, hypothecate, pledge or otherwise dispose of or encumber or permit or suffer any encumbrance of all or any part of the shares of our common stock or OP units acquired as part of the above formation transactions or subsequent purchases of such shares of common stock or OP units, until 270 days following the completion of our listing without the prior written consent of ZAIS, subject to certain exceptions relating to private resales where the transferee continues to be bound by the lock-up agreement. See "The History and Formation of our CompanyLock-up." In addition, our directors and executive officers and the ZAIS Parties who collectively own an aggregate of 510,047 shares of our common stock and 33,658 OP units have entered into lock-up agreements with the underwriters restricting resales, of shares of common stock with limited exceptions, for a period of 270 days after the date of this prospectus. See "UnderwritingNo Sales of Similar Securities."
The market price of our common stock may decline, perhaps significantly, when these restrictions on resale by certain of our stockholders or OP unitholders lapse. Sales of substantial amounts of common stock or the perception that such sales could occur may adversely affect the prevailing market price for our common stock.
For as long as we are an emerging growth company, we will not be required to comply with certain reporting requirements, including those relating to accounting standards and disclosure about our executive compensation, that apply to other public companies.
Upon the completion of this offering, we will become subject to reporting and other obligations under the Exchange Act. In April 2012, the JOBS Act was enacted into law. The JOBS Act contains provisions that, among other things, relax certain reporting requirements for "emerging growth companies," including certain requirements relating to accounting standards and compensation disclosure. We are an "emerging growth company" as defined in the JOBS Act. For as long as we are an emerging growth company, which may be up to five full fiscal years, unlike other public companies, we will not be required to (i) provide an auditor's attestation report on management's assessment of the effectiveness of our system of internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act, (ii) comply with any new or revised financial accounting standards applicable to public companies until such standards are also applicable to private companies under Section 102(b)(1) of the JOBS Act, (iii) comply with any new requirements adopted by the Public Company Accounting Oversight Board (or the PCAOB) requiring mandatory audit firm rotation or a supplement to the auditor's report in which the auditor would be required to provide additional information about the audit and the financial statements of the issuer, (iv) comply with any new audit rules adopted by the PCAOB after April 5, 2012 unless the SEC
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determines otherwise, (v) provide certain disclosure regarding executive compensation required of larger public companies or (vi) hold shareholder advisory votes on executive compensation. We cannot predict if investors will find our shares of common stock less attractive if we choose to rely on these exemptions.
As noted above, under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards that have different effective dates for public and private companies until such time as those standards apply to private companies. If we were to elect to comply with these public company effective dates, such election would be irrevocable pursuant to Section 107 of the JOBS Act.
Future offerings of debt or equity securities, which may rank senior to our common stock, may adversely affect the market price of our common stock.
If we decide to issue debt securities in the future, which would rank senior to our common stock, it is likely that they will be governed by an indenture or other instrument containing covenants restricting our operating flexibility. Additionally, any equity securities or convertible or exchangeable securities that we issue in the future may have rights, preferences and privileges more favorable than those of our common stock and may result in dilution to owners of our common stock. We and, indirectly, our stockholders, will bear the cost of issuing and servicing such securities. Because our decision to issue debt or equity securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, holders of our common stock will bear the risk of our future offerings reducing the market price of our common stock and diluting the value of their stock holdings in us.
We have not established a minimum distribution payment level and we cannot assure you of our ability to pay distributions in the future.
To maintain our qualification as a REIT and generally not be subject to U.S. federal income and excise tax, we intend to make regular quarterly distributions to holders of common stock out of legally available funds. Our current policy is to pay quarterly distributions which, on an annual basis, will equal all or substantially all of our net taxable income. We have not, however, established a minimum distribution payment level and our ability to pay distributions may be adversely affected by a number of factors, including the risk factors described in this prospectus. All distributions will be made at the discretion of our Board and will depend on our earnings, our financial condition, any debt covenants, maintenance of our REIT qualification, restrictions on making distributions under Maryland law and other factors as our Board may deem relevant from time to time. We may not be able to make distributions in the future and our Board may change our distribution policy in the future. We believe that a change in any one of the following factors, among others, could adversely affect our results of operations and impair our ability to pay distributions to our stockholders:
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We cannot assure you that we will achieve results that will allow us to make a specified level of cash distributions or year-to-year increases in cash distributions in the future. In addition, some of our distributions may include a return of capital.
Investing in our common stock may involve a high degree of risk and may result in loss of principal.
The acquisitions we make in accordance with our objectives and strategies may result in a high amount of risk when compared to alternative strategies and volatility or loss of principal. Our acquisitions may be highly speculative and aggressive, and therefore an investment in our shares of common stock may not be suitable for someone with lower risk tolerance.
Risks Related to Our Organization and Structure
Conflicts of interest could arise as a result of our UpREIT structure.
Conflicts of interest could arise in the future as a result of the relationships between us and our affiliates, on the one hand, and our Operating Partnership or any partner thereof, on the other. Our directors and officers have duties to our company under applicable Maryland law in connection with their management of our company. At the same time, we, through our Operating Partnership subsidiary, have fiduciary duties, as a general partner, to our Operating Partnership and to the limited partners under Delaware law in connection with the management of our Operating Partnership. Our duties, through our Operating Partnership subsidiary, as a general partner to our Operating Partnership and its partners may come into conflict with the duties of our directors and officers. The partnership agreement of our Operating Partnership does not require us to resolve such conflicts in favor of either our stockholders or the limited partners in our Operating Partnership.
Certain provisions of Maryland law could inhibit changes in control and prevent our stockholders from realizing a premium over the then-prevailing market price of our common stock.
Certain provisions of the Maryland General Corporation Law (or the MGCL) may have the effect of deterring a third party from making a proposal to acquire us or of impeding a change in control under circumstances that otherwise could provide the holders of shares of our common stock with the opportunity to realize a premium over the then-prevailing market price of such shares.
We are subject to the "business combination" provisions of the MGCL that, subject to limitations, prohibit certain business combinations (including generally, a merger, consolidation, share exchange, or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities) between us and an "interested stockholder" (defined generally as any person who beneficially owns 10% or more of the voting power of our outstanding voting stock or an affiliate or associate of ours who, at any time within the two-year period immediately prior to the date in question, was the beneficial owner of 10% or more of the voting power of our outstanding stock) or an affiliate thereof for five years after the most recent date on which the stockholder becomes an interested stockholder. After the five-year prohibition, any business combination between us and an interested stockholder generally must be recommended by our Board and approved by the affirmative vote of at least (i) eighty percent of the votes entitled to be cast by holders of outstanding shares of our voting stock; and (ii) two-thirds of the votes entitled to be cast by holders of voting stock of the corporation other than shares held by the interested stockholder with whom or with whose affiliate the business combination is to be effected or held by an affiliate or associate
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of the interested stockholder. These super-majority vote requirements do not apply if our common stockholders receive a minimum price, as defined under Maryland law, for their shares in the form of cash or other consideration in the same form as previously paid by the interested stockholder for its shares. These provisions of the MGCL do not apply, however, to business combinations that are approved or exempted by a board of directors prior to the time that the stockholder would otherwise have become an interested stockholder. Pursuant to the statute, our Board will by resolution exempt business combinations (i) between us and ZAIS or its affiliates and (ii) between us and any person, provided that such business combination is first approved by our Board (including a majority of our directors who are not affiliates or associates of such person). Consequently, the five-year prohibition and the super-majority vote requirements will not apply to business combinations between us and any of them. As a result, any person described above may be able to enter into business combinations with us that may not be in the best interest of our stockholders, without compliance with the super-majority vote requirements and the other provisions of the statute.
The "control share" provisions of the MGCL provide that "control shares" of a Maryland corporation (defined as voting shares of stock which, when aggregated with all other shares of stock owned by the stockholder or in respect of which the stockholder is able to exercise or direct the exercise of voting power (except solely by virtue of a revocable proxy), would entitle the stockholder to exercise one of three increasing ranges of voting power in electing directors) acquired in a "control share acquisition" (defined as the direct or indirect acquisition of ownership of or the power to direct the exercise of voting power with respect to "control shares," subject to certain exceptions) have no voting rights except to the extent approved by our stockholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter, excluding votes entitled to be cast by the acquirer of control shares, our officers and our employees who are also our directors. Our bylaws contain a provision exempting from the control share acquisition statute any and all acquisitions by any person of shares of our stock. There can be no assurance that this provision will not be amended or eliminated at any time in the future.
Our ability to issue additional shares of common and preferred stock may prevent a change in our control.
Our charter authorizes us to issue additional authorized but unissued shares of common or preferred stock. In addition, our Board may, without stockholder approval, amend our charter to increase or decrease the aggregate number of shares of our stock or the number of shares of stock of any class or series that we have the authority to issue. As a result, our board may establish a series of shares of common or preferred stock that could delay or prevent a transaction or a change in control that might involve a premium price for shares of our common stock or otherwise be in the best interest of our stockholders.
Our rights and your rights to take action against our directors and officers are limited, which could limit your recourse in the event of actions not in your best interests.
As permitted by Maryland law, our charter limits the liability of our directors and officers to us and you for money damages, except for liability resulting from:
In addition, our charter authorizes us, to the maximum extent permitted by Maryland law, to obligate our company to indemnify any present or former director or officer or any
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individual who, while a director or officer of our company and at our request, serves or has served another corporation, real estate investment trust, limited liability company, partnership, joint venture, trust, employee benefit plan or other enterprise as a director, officer, partner, trustee, member or manager from and against any claim or liability to which that individual may become subject or which that individual may incur by reason of his or her service in any of the foregoing capacities and to pay or reimburse his or her reasonable expenses in advance of final disposition of a proceeding. Our bylaws obligate us, to the maximum extent permitted by Maryland law, to indemnify any present or former director or officer or any individual who, while a director or officer of our company and at our request, serves or has served another corporation, real estate investment trust, limited liability company, partnership, joint venture, trust, employee benefit plan or other enterprise as a director, officer, partner, trustee, member or manager and who is made or threatened to be made a party to the proceeding by reason of his or her service in that capacity from and against any claim or liability to which that individual may become subject or which that individual may incur by reason of his or her service in any of the foregoing capacities and to pay or reimburse his or her reasonable expenses in advance of final disposition of a proceeding. Our charter and bylaws also permit us to indemnify and advance expenses to any individual who served a predecessor of our company in any of the capacities described above and any employee or agent of our company or a predecessor of our company. See "Certain Provisions of the Maryland General Corporation Law and Our Charter and BylawsIndemnification and Limitation of Directors' and Officers' Liability."
Maintenance of our 1940 Act exemption imposes limits on our operations.
We conduct, and intend to continue to conduct, our operations so as not to become regulated as an investment company under the 1940 Act. Because we are a holding company and conduct our businesses primarily through wholly-owned or majority-owned subsidiaries, the securities issued by these subsidiaries that are excepted from the definition of "investment company" under Section 3(c)(1) or Section 3(c)(7) of the 1940 Act, together with any other investment securities we may own, may not have a combined value in excess of 40% of the value of our total assets (exclusive of U.S. Government securities and cash items) on an unconsolidated basis, which we refer to as the 40% test. This requirement limits the types of businesses in which we may engage through our subsidiaries.
The determination of whether an entity is a majority-owned subsidiary of our company is made by us. The 1940 Act defines a majority-owned subsidiary of a person as a company 50% or more of the outstanding voting securities of which are owned by such person, or by another company which is a majority-owned subsidiary of such person. The 1940 Act further defines voting securities as any security presently entitling the owner or holder thereof to vote for the election of directors of a company. We treat companies in which we own at least a majority of the outstanding voting securities as majority-owned subsidiaries for purposes of the 40% test. We have not requested the SEC to approve our treatment of any company as a majority-owned subsidiary and the SEC has not done so. If the SEC, or its staff, were to disagree with our treatment of one of more companies as majority-owned subsidiaries, we would need to adjust our strategy and our assets in order to continue to pass the 40% test. Any such adjustment in our strategy could have a material adverse effect on us.
We believe that certain of our subsidiaries qualify for an exemption from registration under the 1940 Act as an investment company pursuant to Section 3(c)(5)(C) of the 1940 Act, which is available for entities "primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate." This exemption generally requires that at least 55% of such subsidiaries' assets must be comprised of qualifying assets
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and at least 80% of their total assets must be comprised of qualifying assets and real estate-related assets under the 1940 Act. We will treat as qualifying assets for this purpose mortgage loans Agency RMBS in which we hold all the certificates issued by the pool and other interests in real estate, in each case meeting certain other qualifications based upon SEC staff no-action letters. Although SEC staff no-action letters have not specifically addressed the categorization of these types of assets, we will also treat as qualifying assets for this purpose bridge loans wholly secured by first priority liens on real estate that provide interim financing to borrowers seeking short-term capital (with terms of generally up to three years), non-Agency RMBS representing ownership of an entire pool of mortgage loans, and real estate owned properties. We expect each of our subsidiaries relying on Section 3(c)(5)(C) to invest an additional 25% of its assets in other types of mortgages, MBS, CMBS, securities of REITs and other real estate-related assets. We expect each of our subsidiaries relying on Section 3(c)(5)(C) to rely on guidance published by the SEC, or its staff, or on our analyses of guidance published with respect to other types of assets to determine which assets are qualifying real estate assets and real estate-related assets. The SEC staff has not, however, published guidance with respect to the treatment of some of these assets under Section 3(c)(5)(C). To the extent that the SEC, or its staff, publishes new or different guidance with respect to these matters, we may be required to adjust our strategy accordingly. Although we intend to monitor our portfolio periodically and prior to each investment acquisition, there can be no assurance that we will be able to maintain an exemption from registration for these subsidiaries. In addition, we may be limited in our ability to make certain investments and these limitations could result in the subsidiary holding assets we might wish to sell or selling assets we might wish to hold.
In 2011, the SEC solicited public comment on a wide range of issues relating to Section 3(c)(5)(C) of the 1940 Act, including the nature of the assets that qualify for purposes of the exemption and whether mortgage REITs should be regulated in a manner similar to registered investment companies. There can be no assurance that the laws and regulations governing the 1940 Act status of REITs, including the SEC, or its staff, providing more specific or different guidance regarding these exemptions, will not change in a manner that adversely affects our operations. If we or our subsidiaries fail to maintain an exception or exemption from the 1940 Act, we could, among other things, be required either to (i) change the manner in which we conduct our operations to avoid being required to register as an investment company, (ii) effect sales of our assets in a manner that, or at a time when, we would not otherwise choose to do so, or (iii) register as an investment company, any of which would negatively affect the value of our shares of common stock, the sustainability of our business model, and our ability to make distributions which would have an adverse effect on our business and the value of our shares of common stock.
Qualification for exemption from registration under the 1940 Act will limit our ability to make certain investments. For example, these restrictions will limit the ability of our subsidiaries to invest directly in MBS that represent less than the entire ownership in a pool of mortgage loans, debt and equity tranches of securitizations and ABS, and real estate companies or in assets not related to real estate.
Certain of our subsidiaries may rely on the exemption provided by Section 3(c)(6) to the extent that they hold mortgage assets through majority-owned subsidiaries that rely on Section 3(c)(5)(C). The SEC has issued little interpretive guidance with respect to Section 3(c)(6) and any guidance published by the staff could require us to adjust our strategy accordingly.
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No assurance can be given that the SEC, or its staff, will concur with our classification of our or our subsidiaries' assets or that the SEC, or its staff, will not, in the future, issue further guidance that may require us to reclassify those assets for purposes of qualifying for an exclusion from regulation under the 1940 Act. To the extent that the SEC, or its staff, provides more specific guidance regarding any of the matters bearing upon the definition of investment company and the exceptions to that definition, we may be required to adjust our investment strategy accordingly. Additional guidance from the SEC, or its staff, could provide additional flexibility to us, or it could further inhibit our ability to pursue the investment strategy we have chosen. If the SEC or its staff takes a position contrary to our analysis with respect to the characterization of any of the assets or securities we invest in, we may be deemed an unregistered investment company. Therefore, in order not to be required to register as an investment company, we may need to dispose of a significant portion of our assets or securities or acquire significant other additional assets which may have lower returns than our expected portfolio, or we may need to modify our business plan to register as an investment company, which would result in significantly increased operating expenses and would likely entail significantly reducing our indebtedness, which could also require us to sell a significant portion of our assets. We cannot assure you that we would be able to complete these dispositions or acquisitions of assets, or deleveraging, on favorable terms, or at all. Consequently, any modification of our business plan could have a material adverse effect on us. Further, if the SEC determined that we were an unregistered investment company, we would be subject to monetary penalties and injunctive relief in an action brought by the SEC, we would potentially be unable to enforce contracts with third parties and third parties could seek to obtain rescission of transactions undertaken during the period for which it was established that we were an unregistered investment company. Any of these results would have a material adverse effect on us. See "BusinessOperating and Regulatory Structure1940 Act Exemption."
Since we will not be subject to the 1940 Act, we will not be subject to its substantive provisions, including provisions requiring diversification of investments, limiting leverage and restricting investments in illiquid assets.
Rapid changes in the values of our target assets may make it more difficult for us to maintain our qualification as a REIT or our exemption from the 1940 Act.
If the fair market value or income potential of our target assets declines as a result of increased interest rates, prepayment rates, general market conditions, government actions or other factors, we may need to increase our real estate assets and income or liquidate our non-qualifying assets to maintain our REIT qualification or our exemption from the 1940 Act. If the decline in real estate asset values or income occurs quickly, this may be especially difficult to accomplish. We may have to make decisions that we otherwise would not make absent the REIT and 1940 Act considerations.
Our taxable income is calculated differently than net income based on U.S. GAAP.
Our taxable income may substantially differ from our net income based on U.S. GAAP. For example, interest income on our mortgage related securities does not necessarily accrue under an identical schedule for U.S. federal income tax purposes as for accounting purposes.
For U.S. GAAP purposes, interest income on our mortgage related securities is accrued based on the actual coupon rate and the outstanding principal amount of the underlying mortgages. Premiums and discounts are amortized or accreted into interest income over the estimated lives of the securities using the effective yield method adjusted for the effects of estimated prepayments. Adjustments are made using the retrospective method to the effective
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interest computation each reporting period based on the actual prepayment experiences to date, and the present expectation of future prepayments of the underlying mortgages. If our estimate of prepayments is incorrect, we are required to make an adjustment to the amortization or accretion of premiums and discounts that would have an impact on future income.
Management will estimate, at the time of purchase, the future expected cash flows and determine the effective interest rate based on these estimated cash flows and our purchase price. As needed, these estimated cash flows will be updated and a revised yield computed based on the current amortized cost of the investment. In estimating these cash flows, we will have to make assumptions regarding the rate and timing of principal payments and coupon rates. These uncertainties and contingencies are difficult to predict and are subject to future events that may impact management's estimates and our interest income.
In particular, interest income on mortgage related securities that were purchased at a discount to par value will be recognized based on the security's effective interest rate. The effective interest rate on these securities will be based on the projected cash flows from each security, which will be estimated based on our observation of current information and events and include assumptions related to interest rates, prepayment rates and the timing and amount of credit losses. Based on the projected cash flows from our mortgage related securities purchased at a discount to par value, a portion of the purchase discount may be designated as credit protection against future credit losses and, therefore, may not be accreted into interest income. The amount designated as credit discount may be adjusted over time, based on the actual performance of the security, its underlying collateral, actual and projected cash flow from such collateral, economic conditions and other factors. If the performance of a security with a credit discount is more favorable than forecasted, a portion of the amount designated as credit discount may be accreted into interest income over time. Conversely, if the performance of a security with a credit discount is less favorable than forecasted, additional amounts of the purchase discount may be designated as credit discount, or impairment charges and write-downs of such securities to a new cost basis could result.
For U.S. federal income tax purposes, if a debt instrument pays interest currently, we are generally required to treat all such interest as interest income. In addition, if we acquire RMBS or other debt instruments at a discount in the secondary market, the discount at which such debt instruments are acquired will generally be treated as "market discount" for U.S. federal income tax purposes and will accrue over the term of the debt instrument. Accrued market discount is reported as income when, and to the extent that, we receive any payment of principal on the debt instrument, unless we elect to include accrued market discount in incomes as it accrues. As a result, we will be required to treat principal payments on such a debt instrument as ordinary income for U.S. federal income tax purposes to the extent of any accrued market discount regardless of our expected return on our investment in the debt instrument. Similarly, if we acquire a debt instrument that is issued with original issue discount (or OID), we will generally be required to accrue such OID regardless of whether we expect to receive the full face amount of the debt instrument on its maturity. If we collect less on a debt instrument than our purchase price plus any market discount we had previously reported as income, we may not be able to benefit from any offsetting loss deductions in subsequent years. In certain cases, we may be able to cease accruing interest income with respect to a debt instrument, to the extent there is reasonable doubt as to our ability to collect such interest income. However, if we recognize insufficient interest income with respect to certain debt instruments that we acquire, and the Internal Revenue Service (or the IRS) were to successfully assert that we did not accrue the appropriate amount of income with respect to such a debt instrument in a given taxable year, we may be required to increase our taxable income with respect to such year, which could cause us to be required to pay a deficiency dividend or a tax
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on undistributed income, or fail to qualify as a REIT. See "U.S. Federal Income Tax ConsiderationsTaxation of Our CompanyGross Income TestsPhantom Income."
Tax Risks
Your investment in our common stock has various tax risks.
This summary of certain tax risks is limited to the U.S. federal income tax risks addressed below. Additional risks or issues may exist that are not addressed in this prospectus and that could affect the U.S. federal income tax treatment of our Company, our Operating Partnership or our stockholders.
We strongly urge you to review carefully the discussion under "U.S. Federal Income Tax Considerations" and to seek advice based on your particular circumstances from an independent tax advisor concerning the effects of U.S. federal, state, local and foreign tax law on an investment in our common stock and on your individual tax situation.
Our failure to qualify as a REIT would subject us to U.S. federal income tax and applicable state and local taxes, which would reduce the amount of cash available for distribution to our stockholders.
We believe that we have been organized and have operated in a manner that has enabled us to qualify as a REIT for U.S. federal income tax purposes commencing with our taxable year ended December 31, 2011. In addition, we believe that our intended manner of operation will enable us to continue to meet the requirements for qualification and taxation as a REIT, provided that we are able to satisfy the REIT requirements relating to the diversity of ownership of our shares following the share repurchases in January 2013, as further discussed below. We have not requested and do not intend to request a ruling from the IRS that we qualify as a REIT. The U.S. federal income tax laws governing REITs are complex, and judicial and administrative interpretations of the U.S. federal income tax laws governing REIT qualification are limited. The complexity of these provisions and of applicable Treasury Regulations is greater in the case of a REIT that, like us, holds its assets through a partnership. To qualify as a REIT, we must meet, on an ongoing basis, various tests regarding the nature of our assets and our income, the ownership of our outstanding shares, and the amount of our distributions. Our ability to satisfy the asset tests depends on our analysis of the characterization and fair market values of our assets, some of which are not susceptible to a precise determination, and for which we may not obtain independent appraisals. Moreover, new legislation, court decisions or administrative guidance, in each case possibly with retroactive effect, may make it more difficult or impossible for us to qualify as a REIT. Thus, while we believe that we have operated and intend to continue to operate so that we will qualify as a REIT, given the highly complex nature of the rules governing REITs, the ongoing importance of factual determinations, and the possibility of future changes in our circumstances, no assurance can be given that we have qualified or will so qualify for any particular year. These considerations also might restrict the types of assets that we can acquire in the future.
In order to qualify as a REIT, during the last half of each taxable year following our taxable year ended December 31, 2011 (the first year that we elected to qualify as a REIT), not more than 50% in value of our outstanding stock can be owned by five or fewer "individuals" as defined in the Internal Revenue Code to include certain entities (or the five or fewer rule). We believe that we currently satisfy the five or fewer rule and, following this offering, we believe that we will continue to satisfy the five or fewer rule. However, as described elsewhere in this prospectus, we repurchased 265,245 shares of our common stock from one of our institutional stockholders in January 2013 at a price per share equal to our book value per
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share as of December 31, 2012. If on or prior to June 30, 2013 we are not able to raise additional capital from sufficiently diverse sources to satisfy the five or fewer rule, including by issuing at least approximately 320,000 shares to sufficiently diverse holders in this offering, we would fail to qualify as a REIT for the 2013 taxable year and would likely proceed with an early orderly liquidation of our business. Although we believe that we have satisfied this requirement for prior taxable years, following the repurchase of 265,245 shares of our common stock on January 24, 2013, five individuals own in excess of 54% by value of our outstanding common stock, and one of these individuals owns approximately 31.2% by value of our outstanding common stock, under the attribution rules applicable for purposes of applying the five or fewer rule. While our charter contains restrictions on transfers of our shares to assist us in meeting the five or fewer rule, our charter does generally permit an individual to acquire up to 9.8% of our common stock subject to us continuing to meet the five or fewer rule. We intend to monitor all purchases and transfers of our common stock to ensure that we continue to meet the five or fewer rule. However, the attribution rules that apply for purposes of determining the ownership of shares for purposes of applying the five or fewer rule are complex and in some cases dependent on facts that are not always easy to determine. Accordingly, no assurance can be given that we have satisfied, currently satisfy or will at all times continue to satisfy the five or fewer rule. In the event we failed to satisfy the five or fewer rule we could fail to qualify as a REIT. In addition, if we do not issue at least approximately 5.6 million shares to sufficiently diverse holders in this offering to dilute the ownership of our current stockholders such that no individual will own in excess of 9.8% of our common stock under such attribution rules, our Board will be required to reduce our common stock and capital stock ownership limitations below 9.8% in order for these ownership limitations to prevent us from failing to satisfy the five or fewer rule.
If we fail to qualify as a REIT in any taxable year, and do not qualify for certain statutory relief provisions, we would be required to pay U.S. federal income tax on our taxable income, and distributions to our stockholders would not be deductible by us in determining our taxable income. In such a case, we might need to borrow money or sell assets in order to pay our taxes. Our payment of income tax would decrease the amount of our income available for distribution to our stockholders. Furthermore, if we fail to maintain our qualification as a REIT, we no longer would be required to distribute substantially all of our net taxable income to our stockholders. In addition, unless we were eligible for certain statutory relief provisions, we could not re-elect to qualify as a REIT until the fifth calendar year following the year in which we failed to qualify.
Complying with REIT requirements may force us to liquidate or forego otherwise attractive investments, which could reduce returns on our assets and adversely affect returns to our stockholders.
To qualify as a REIT, we generally must ensure that at the end of each calendar quarter at least 75% of the value of our total assets consists of cash, cash items, government securities and qualified REIT real estate assets, including certain mortgage loans and RMBS. The remainder of our investment in securities (other than government securities and qualifying real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our assets (other than government securities and qualifying real estate assets) can consist of the securities of any one issuer, and no more than 25% of the value of our total securities can be represented by stock and securities of one or more TRSs. See "U.S. Federal Income Tax ConsiderationsTaxation of Our CompanyAsset Tests." If we fail to comply with these requirements at the end of any quarter, we must correct the failure within 30 days after the end of such calendar
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quarter or qualify for certain statutory relief provisions to avoid losing our REIT qualification and suffering adverse tax consequences. As a result, we may be required to liquidate from our portfolio otherwise attractive investments. These actions could have the effect of reducing our income and amounts available for distribution to our stockholders. In addition, if we are compelled to liquidate our investments to repay obligations to our lenders, we may be unable to comply with these requirements, ultimately jeopardizing our qualification as a REIT. Furthermore, we may be required to make distributions to stockholders at disadvantageous times or when we do not have funds readily available for distribution, and may be unable to pursue investments that would be otherwise advantageous to us in order to satisfy the source of income or asset diversification requirements for qualifying as a REIT.
Distributions from us or gain on the sale of our common stock may be treated as an unrelated business taxable income (or UBTI) to U.S. tax exempt holders of common stock.
If (i) all or a portion of our assets are subject to the rules relating to taxable mortgage pools, (ii) a tax exempt U.S. person has incurred debt to purchase or hold our common stock, (iii) we purchase residual real estate mortgage investment conduit (or REMIC) interests that generate "excess inclusion income," or (iv) we are a "pension held REIT," then a portion of the distributions with respect to our common stock and, in the case of a U.S. person described in (ii), gains realized on the sale of such common stock by such U.S. person, may be subject to U.S. federal income tax as UBTI under the Internal Revenue Code.
We may lose our REIT qualification or be subject to a penalty tax if we earn and the IRS successfully challenges our characterization of income from foreign TRSs or other non-U.S. corporations in which we hold an equity interest.
We may make investments in non-U.S. corporations some of which may, together with us, make a TRS election. We likely will be required to include in our income, even without the receipt of actual distributions, earnings from any such foreign TRSs or other non-U.S. corporations in which we hold an equity interest. Income inclusions from equity investments in certain foreign corporations are technically neither dividends nor any of the other enumerated categories of income specified in the 95% gross income test for U.S. federal income tax purposes. However, in recent private letter rulings, the IRS exercised its authority under Internal Revenue Code section 856(c)(5)(J)(ii) to treat such income as qualifying income for purposes of the 95% gross income test notwithstanding the fact that the income is not included in the enumerated categories of income qualifying for the 95% gross income test. A private letter ruling may be relied upon only by the taxpayer to whom it is issued, and the IRS may revoke a private letter ruling. Consistent with the position adopted by the IRS in those private letter rulings and based on advice of counsel concerning the classification of such income inclusions for purposes of the REIT income tests, we intend to treat such income inclusions that meet certain requirements as qualifying income for purposes of the 95% gross income test. Notwithstanding the IRS's determination in the private letter ruling described above, it is possible that the IRS could successfully assert that such income does not qualify for purposes of the 95% gross income test, which, if such income together with other income we earn that does not qualify for the 95% gross income test exceeded 5% of our gross income, could cause us to be subject to a penalty tax and could impact our ability to qualify as a REIT. See "U.S. Federal Income Tax ConsiderationsTaxation of Our CompanyGross Income TestsFailure to Satisfy the Gross Income Tests" and "U.S. Federal Income Tax ConsiderationsTaxation of Our CompanyFailure to Qualify."
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The REIT distribution requirements could adversely affect our ability to execute our business plan and may require us to incur debt, sell assets or take other actions to make such distributions.
To qualify as a REIT, we must distribute to our stockholders each calendar year at least 90% of our REIT taxable income (including certain items of non-cash income), determined without regard to the deduction for dividends paid and excluding net capital gain. To the extent that we satisfy the 90% distribution requirement, but distribute less than 100% of our taxable income, we will be subject to U.S. federal corporate income tax on our undistributed income. In addition, we will incur a 4% nondeductible excise tax on the amount, if any, by which our distributions in any calendar year are less than a minimum amount specified under U.S. federal income tax laws. We intend to distribute our net taxable income to our stockholders in a manner intended to satisfy the 90% distribution requirement and to avoid both corporate income tax and the 4% nondeductible excise tax.
Our taxable income may substantially exceed our net income as determined based on U.S. GAAP, or differences in timing between the recognition of taxable income and the actual receipt of cash may occur. For example, it is likely that we will acquire assets, including RMBS requiring us to accrue OID or recognize market discount income, that generate taxable income in excess of economic income or in advance of the corresponding cash flow from the assets referred to as "phantom income." Finally, we may be required under the terms of the indebtedness that we incur to use cash received from interest payments to make principal payment on that indebtedness, with the effect that we will recognize income but will not have a corresponding amount of cash available for distribution to our stockholders.
As a result of the foregoing, we may generate less cash flow than taxable income in a particular year and find it difficult or impossible to meet the REIT distribution requirements in certain circumstances. In such circumstances, we may be required to (i) sell assets in adverse market conditions, (ii) borrow on unfavorable terms, (iii) distribute amounts that would otherwise be used for future investment or used to repay debt, or (iv) make a taxable distribution of shares of common stock as part of a distribution in which stockholders may elect to receive shares of common stock or (subject to a limit measured as a percentage of the total distribution) cash, in order to comply with the REIT distribution requirements. Thus, compliance with the REIT distribution requirements may hinder our ability to grow, which could adversely affect the value of our common stock.
We may be required to report taxable income with respect to certain of our investments in excess of the economic income we ultimately realize from them.
We may acquire mortgage backed securities or debt instruments in the secondary market for less than their face amount. The discount at which such securities are acquired may reflect doubts about their ultimate collectability rather than current market interest rates. The amount of such discount will nevertheless generally be treated as "market discount" for U.S. federal income tax purposes. Market discount accrues on the basis of the constant yield to maturity of the debt instrument based generally on the assumption that all future payments on the debt instrument will be made. Accrued market discount is reported as income when, and to the extent that, any payment of principal of the debt instrument is made. If we collect less on a debt instrument than our purchase price plus the market discount we had previously reported as income, we may not be able to benefit from any offsetting loss deduction in a subsequent taxable year. In addition, we may acquire distressed debt investments that are subsequently modified by agreement with the borrower. If the amendments to the outstanding debt are "significant modifications" under applicable Treasury regulations, the modified debt may be considered to have been reissued to us at a gain in a debt-for-debt
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exchange with the borrower. In that event, we may be required to recognize taxable gain to the extent the principal amount of the modified debt exceeds our adjusted tax basis in the unmodified debt, even if the value of the debt or the payment expectations have not changed.
Similarly, some of the RMBS that we purchase will likely have been issued with OID. We will be required to report such OID based on a constant yield method and income will accrue based on the assumption that all future projected payments due on such mortgage backed securities will be made. If such mortgage backed securities turn out not to be fully collectible, an offsetting loss deduction will become available only in the later year in which uncollectability is provable. Finally, in the event that any debt instruments or RMBS acquired by us are delinquent as to mandatory principal and interest payments, or in the event a borrower with respect to a particular debt instrument acquired by us encounters financial difficulty rendering it unable to pay stated interest as due, we may nonetheless be required to continue to recognize the unpaid interest as taxable income as it accrues, despite doubt as to its ultimate collectability. Similarly, we may be required to accrue interest income with respect to subordinate RMBS at their stated rate regardless of whether corresponding cash payments are received or are ultimately collectible. In each case, while we would in general ultimately have an offsetting loss deduction available to us when such interest was determined to be uncollectible, the loss would likely be treated as a capital loss, and the utility of that loss would therefore depend on our having capital gain in that later year or thereafter.
We may acquire excess MSRs, which means the portion of an MSR that exceeds the arm's-length fee for services performed by the mortgage servicer. Based on IRS guidance concerning the classification of MSRs, we intend to treat any excess MSRs we acquire as ownership interests in the interest payments made on the underlying mortgage loans, akin to an "interest only" strip. Under this treatment, for purposes of determining the amount and timing of taxable income, each excess MSR is treated as a bond that was issued with OID on the date we acquired such excess MSR. In general, we will be required to accrue OID based on the constant yield to maturity of each excess MSR, and to treat such OID as taxable income in accordance with the applicable U.S. federal income tax rules. The constant yield of an excess MSR will be determined, and we will be taxed, based on a prepayment assumption regarding future payments due on the mortgage loans underlying the excess MSR. If the mortgage loans underlying an excess MSR prepay at a rate different than that under the prepayment assumption, our recognition of OID will be either increased or decreased depending on the circumstances. Thus, in a particular taxable year, we may be required to accrue an amount of income in respect of an excess MSR that exceeds the amount of cash collected in respect of that excess MSR. Furthermore, it is possible that, over the life of the investment in an excess MSR, the total amount we pay for, and accrue with respect to, the excess MSR may exceed the total amount we collect on such excess MSR. No assurance can be given that we will be entitled to a deduction for such excess, meaning that we may be required to recognize phantom income over the life of an excess MSR.
The interest apportionment rules may affect our ability to comply with the REIT asset and gross income tests.
The interest apportionment rules under Treasury Regulation Section 1.856-5(c) provide that, if a mortgage is secured by both real property and other property, a REIT is required to apportion its annual interest income to the real property security based on a fraction, the numerator of which is the value of the real property securing the loan, determined when the REIT commits to acquire the loan, and the denominator of which is the highest "principal amount" of the loan during the year. IRS Revenue Procedure 2011-16 interprets the "principal amount" of the loan to be the face amount of the loan, despite the Code's requirement that taxpayers treat any market discount, which is the difference between the purchase price of the
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loan and its face amount, for all purposes (other than certain withholding and information reporting purposes) as interest rather than principal.
The interest apportionment regulations apply only if the mortgage loan in question is secured by both real property and other property. We expect that all or most of the mortgage loans that we acquire will be secured only by real property and no other property value is taken into account in our underwriting process. Accordingly, it is not contemplated that we will regularly invest in mortgage loans to which the interest apportionment rules described above would apply. Nevertheless, if the IRS were to assert successfully that our mortgage loans were secured by property other than real estate, that the interest apportionment rules applied for purposes of our REIT testing, and that the position taken in IRS Revenue Procedure 2011-16 should be applied to certain mortgage loans in our portfolio, then depending upon the value of the real property securing our mortgage loans and their face amount, and the other sources of our gross income generally, we may fail to meet the 75% REIT gross income test. If we do not meet this test, we could potentially lose our REIT qualification or be required to pay a penalty to the IRS.
In addition, the Code provides that a regular or a residual interest in a REMIC is generally treated as a real estate asset for the purposes of the REIT asset tests, and any amount includible in our gross income with respect to such an interest is generally treated as interest on an obligation secured by a mortgage on real property for the purposes of the REIT gross income tests. If, however, less than 95% of the assets of a REMIC in which we hold an interest consist of real estate assets (determined as if we held such assets), we will be treated as holding our proportionate share of the assets of the REMIC for the purpose of the REIT asset tests and receiving directly our proportionate share of the income of the REMIC for the purpose of determining the amount of income from the REMIC that is treated as interest on an obligation secured by a mortgage on real property. In connection with the recently expanded HARP program, the IRS recently issued guidance providing that, among other things, if a REIT holds a regular interest in an "eligible REMIC," or a residual interest in an "eligible REMIC" that informs the REIT that at least 80% of the REMIC's assets constitute real estate assets, then (i) the REIT may treat 80% of the value of the interest in the REMIC as a real estate asset for the purpose of the REIT asset tests and (ii) the REIT may treat 80% of the gross income received with respect to the interest in the REMIC as interest on an obligation secured by a mortgage on real property for the purpose of the 75% REIT gross income test. For this purpose, a REMIC is an "eligible REMIC" if (i) the REMIC has received a guarantee from Fannie Mae or Freddie Mac that will allow the REMIC to make any principal and interest payments on its regular and residual interests and (ii) all of the REMIC's mortgages and pass-through certificates are secured by interests in single-family dwellings. If we were to acquire an interest in an eligible REMIC less than 95% of the assets of which constitute real estate assets, the IRS guidance described above may generally allow us to treat 80% of our interest in such a REMIC as a qualifying real estate asset for the purpose of the REIT asset tests and 80% of the gross income derived from the interest as qualifying income for the purpose of the 75% REIT gross income test. Although the portion of the income from such a REMIC interest that does not qualify for the 75% REIT gross income test would likely be qualifying income for the purpose of the 95% REIT gross income test, the remaining 20% of the REMIC interest generally would not qualify as a real estate asset, which could adversely affect our ability to satisfy the REIT asset tests. Accordingly, owning such a REMIC interest could adversely affect our ability to qualify as a REIT.
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Our ownership of and relationship with any TRS which we may form or acquire will be limited, and a failure to comply with the limits would jeopardize our REIT qualification and our transactions with our TRSs may result in the application of a 100% excise tax if such transactions are not conducted on arm's-length terms.
A REIT may own up to 100% of the stock of one or more TRSs. A TRS may earn income that would not be qualifying income if earned directly by a REIT. Both the subsidiary and the REIT must jointly elect to treat the subsidiary as a TRS. Overall, no more than 25% of the value of a REIT's assets may consist of stock and securities of one or more TRSs. A domestic TRS will pay U.S. federal, state and local income tax at regular corporate rates on any income that it earns. In addition, the TRS rules impose a 100% excise tax on certain transactions between a TRS and its parent REIT that are not conducted on an arm's-length basis.
We have elected, together with ZAIS I TRS, Inc. (or ZAIS I TRS), for ZAIS I TRS to be treated as a TRS. ZAIS I TRS and any other domestic TRS that we may form would pay U.S. federal, state and local income tax on its taxable income, and its after tax net income would be available for distribution to us but would not be required to be distributed to us by such domestic TRS. We anticipate that the aggregate value of the TRS stock and securities owned by us will be less than 25% of the value of our total assets (including the TRS stock and securities). Furthermore, we will monitor the value of our investments in our TRSs to ensure compliance with the rule that no more than 25% of the value of our assets may consist of TRS stock and securities (which is applied at the end of each calendar quarter). In addition, we will scrutinize all of our transactions with TRSs to ensure that they are entered into on arm's-length terms to avoid incurring the 100% excise tax described above. There can be no assurance, however, that we will be able to comply with the TRS limitations or to avoid application of the 100% excise tax discussed above.
The ownership limits that apply to REITs, as prescribed by the Internal Revenue Code and by our charter, may inhibit market activity in shares of our common stock and restrict our business combination opportunities.
In order for us to qualify as a REIT, not more than 50% in value of our outstanding shares of stock may be owned, directly or indirectly, by five or fewer individuals (as defined in the Internal Revenue Code to include certain entities) at any time during the last half of each taxable year after the first year for which we elect to qualify as a REIT. Additionally, at least 100 persons must beneficially own our stock during at least 335 days of a taxable year (other than the first taxable year for which we elect to be taxed as a REIT). Our charter, with certain exceptions, authorizes our directors to take such actions as are necessary and desirable to preserve our qualification as a REIT. Our charter also provides that, unless exempted by our Board, no person may own more than 9.8% in value or in number, whichever is more restrictive, of the outstanding shares of our common stock, or 9.8% in value or in number, whichever is more restrictive, of the outstanding shares of all classes and series of our capital stock. Our Board may, in its sole discretion, subject to such conditions as it may determine and the receipt of certain representations and undertakings, prospectively or retroactively, waive the ownership limit or establish a different limit on ownership, or excepted holder limit, for a particular stockholder if the stockholder's ownership in excess of the ownership limit would not result in us being "closely held" under Section 856(h) of the Internal Revenue Code or otherwise failing to qualify as a REIT. Our Board of Directors has granted waivers to six of our stockholders covering an aggregate of 1,370,799 shares of our common stock. As a result, if we do not issue at least approximately 5.6 million shares to sufficiently diverse holders in this offering to dilute the ownership of our current stockholders so that no individual will own in excess of 9.8% of our common stock under the attribution rules applicable for purposes of applying the five or fewer rule, our Board will be required to reduce our common stock and
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capital stock ownership limitations below 9.8% in order for these ownership limitations to prevent us from failing to satisfy the five or fewer rule. These ownership limits could delay or prevent a transaction or a change in control of our Company that might involve a premium price for shares of our common stock or otherwise be in the best interest of our stockholders.
Certain financing activities may subject us to U.S. federal income tax and increase the tax liability of our stockholders.
We may enter into transactions that could result in us, our Operating Partnership or a portion of our Operating Partnership's assets being treated as a "taxable mortgage pool" for U.S. federal income tax purposes. Specifically, we may securitize residential or commercial real estate loans that we acquire and such securitizations, to the extent structured as other than a REMIC, would likely result in us owning interests in a taxable mortgage pool. We would be precluded from holding equity interests in such a taxable mortgage pool securitization through our Operating Partnership. Accordingly, we would likely enter into such transactions through a qualified REIT subsidiary of one or more subsidiary REITs formed by our Operating Partnership, and will be precluded from selling to outside investors equity interests in such securitizations or from selling any debt securities issued in connection with such securitizations that might be considered equity for U.S. federal income tax purposes. We will be taxed at the highest U.S. federal corporate income tax rate on any "excess inclusion income" arising from a taxable mortgage pool that is allocable to the percentage of our shares held in record name by "disqualified organizations," which are generally certain cooperatives, governmental entities and tax-exempt organizations that are exempt from tax on unrelated business taxable income. To the extent that common stock owned by "disqualified organizations" is held in record name by a broker/dealer or other nominee, the broker/dealer or other nominee would be liable for the U.S. federal corporate income tax on the portion of our excess inclusion income allocable to the common stock held by the broker/dealer or other nominee on behalf of the disqualified organizations. Disqualified organizations may own our stock. Because this tax would be imposed on us, all of our investors, including investors that are not disqualified organizations, will bear a portion of the tax cost associated with the classification of us or a portion of our assets as a taxable mortgage pool. A regulated investment company (or RIC) or other pass-through entity owning our common stock in record name will be subject to tax at the highest corporate tax rate on any excess inclusion income allocated to their owners that are disqualified organizations.
In addition, if we realize excess inclusion income and allocate it to our stockholders, this income cannot be offset by net operating losses of our stockholders. If the stockholder is a tax-exempt entity and not a disqualified organization, then this income is fully taxable as unrelated business taxable income under Section 512 of the Internal Revenue Code. If the stockholder is a foreign person, it would be subject to U.S. federal income tax withholding on this income without reduction or exemption pursuant to any otherwise applicable income tax treaty. If the stockholder is a REIT, a RIC, common trust fund or other pass-through entity, our allocable share of our excess inclusion income could be considered excess inclusion income of such entity. Accordingly, such investors should be aware that a portion of our income may be considered excess inclusion income. Finally, if a subsidiary REIT of our Operating Partnership through which we held taxable mortgage pool securitizations were to fail to qualify as a REIT, our taxable mortgage pool securitizations will be treated as separate taxable corporations for U.S. federal income tax purposes that could not be included in any consolidated U.S. federal corporate income tax return and that could prevent us from meeting the REIT asset tests.
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The tax on prohibited transactions will limit our ability to engage in transactions, including certain methods of securitizing mortgage loans, which would be treated as prohibited transactions for U.S. federal income tax purposes.
Net income that we derive from a prohibited transaction is subject to a 100% tax. The term "prohibited transaction" generally includes a sale or other disposition of property (including mortgage loans, but other than foreclosure property, as discussed below) that is held primarily for sale to customers in the ordinary course of a trade or business by us or by a borrower that has issued a shared appreciation mortgage or similar debt instrument to us. We might be subject to this tax if we were to dispose of or securitize loans, directly or through a subsidiary REIT, in a manner that was treated as a prohibited transaction for U.S. federal income tax purposes. We intend to conduct our operations so that no asset that we or a subsidiary REIT owns (or is treated as owning) will be treated as, or as having been, held for sale to customers, and that a sale of any such asset will not be treated as having been in the ordinary course of our business or the business of a subsidiary REIT. As a result, we may choose not to engage in certain sales of loans at the REIT level, and may limit the structures we utilize for our securitization transactions, even though the sales or structures might otherwise be beneficial to us. In addition, whether property is held "primarily for sale to customers in the ordinary course of a trade or business" depends on the particular facts and circumstances. No assurance can be given that any property that we sell will not be treated as property held for sale to customers, or that we can comply with certain safe-harbor provisions of the Internal Revenue Code that would prevent such treatment. The 100% tax does not apply to gains from the sale of property that is held through a TRS or other taxable corporation, although such income will be subject to tax in the hands of the corporation at regular corporate rates. We intend to structure our activities to avoid prohibited transaction characterization.
Characterization of our repurchase agreements we entered into to finance our investments as sales for tax purposes rather than as secured lending transactions would adversely affect our ability to qualify as a REIT.
We have entered into repurchase agreements with counterparties to achieve our desired amount of leverage for the assets in which we intend to invest. Under our repurchase agreements, we generally sell assets to our counterparty to the agreement and receive cash from the counterparty. The counterparty is obligated to resell the assets back to us at the end of the term of the transaction. We believe that for U.S. federal income tax purposes we will be treated as the owner of the assets that are the subject of repurchase agreements and that the repurchase agreements will be treated as secured lending transactions notwithstanding that such agreements may transfer record ownership of the assets to the counterparty during the term of the agreement. It is possible, however, that the IRS could successfully assert that we did not own these assets during the term of the repurchase agreements, in which case we could fail to qualify as a REIT.
If we were to make a taxable distribution of shares of our stock, stockholders may be required to sell such shares or sell other assets owned by them in order to pay any tax imposed on such distribution.
We may be able to distribute taxable dividends that are payable in shares of our stock. If we were to make such a taxable distribution of shares of our stock, stockholders would be required to include the full amount of such distribution as income. As a result, a stockholder may be required to pay tax with respect to such dividends in excess of cash received. Accordingly, stockholders receiving a distribution of our shares may be required to sell shares received in such distribution or may be required to sell other stock or assets owned by them,
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at a time that may be disadvantageous, in order to satisfy any tax imposed on such distribution. If a stockholder sells the shares it receives as a dividend in order to pay such tax, the sale proceeds may be less than the amount included in income with respect to the dividend. Moreover, in the case of a taxable distribution of shares of our stock with respect to which any withholding tax is imposed on a non-U.S. stockholder, we may have to withhold or dispose of part of the shares in such distribution and use such withheld shares or the proceeds of such disposition to satisfy the withholding tax imposed.
While the IRS in certain private letter rulings has ruled that a distribution of cash or shares at the election of a REIT's stockholders may qualify as a taxable stock dividend if certain requirements are met, it is unclear whether and to what extent we will be able to pay taxable dividends in cash and shares of common stock in any future period.
Complying with REIT requirements may limit our ability to hedge effectively.
The REIT provisions of the Internal Revenue Code may limit our ability to hedge our assets and operations. Under these provisions, any income that we generate from transactions intended to hedge our interest rate and currency risks will generally be excluded from gross income for purposes of the 75% and 95% gross income tests if (i) the instrument hedges interest rate risk or foreign currency exposure on liabilities used to carry or acquire real estate assets or hedges risk of currency fluctuations with respect to any item of income or gain that would be qualifying income under the 75% or 95% gross income tests, and (ii) such instrument is properly identified under applicable regulations promulgated by the U.S. Department of the Treasury (or the Treasury Regulations). In addition, any income from other hedges would generally constitute non-qualifying income for purposes of both the 75% and 95% gross income tests. See "U.S. Federal Income Tax ConsiderationsTaxation of Our CompanyGross Income TestsHedging Transactions." As a result of these rules, we may have to limit our use of hedging techniques that might otherwise be advantageous or implement those hedges through a TRS, which could increase the cost of our hedging activities or result in greater risks associated with interest rate or other changes than we would otherwise incur.
Even if we qualify as a REIT, we may face tax liabilities that reduce our cash flow.
Even if we qualify as a REIT, we may be subject to certain U.S. federal, state and local taxes on our income and assets, including taxes on any undistributed income, tax on income from some activities conducted as a result of a foreclosure, and state or local income, franchise, property and transfer taxes, including mortgage related taxes. See "U.S. Federal Income Tax ConsiderationsTaxation of Our CompanyTaxation of REITs in General." In addition, ZAIS I TRS and any other domestic TRSs we own will be subject to U.S. federal, state, and local corporate taxes. In order to meet the REIT qualification requirements, or to avoid the imposition of a 100% tax that applies to certain gains derived by a REIT from sales of inventory or property held primarily for sale to customers in the ordinary course of business, we may hold some of our assets through taxable subsidiary corporations, including domestic TRSs. Any taxes paid by such subsidiary corporations would decrease the cash available for distribution to our stockholders. Furthermore, if we acquire appreciated assets from a subchapter C corporation in a transaction in which the adjusted tax basis of the assets in our hands is determined by reference to the adjusted tax basis of the assets in the hands of the C corporation, and if we subsequently dispose of any such assets during the 10 year period following the acquisition of the assets from the C corporation, we will be subject to tax at the highest corporate tax rates on any gain from such assets to the extent of the excess of the fair market value of the assets on the date that they were contributed to us over the basis of such assets on such date, which we refer to as built-in gains. A portion of the assets
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contributed to us in connection with our formation may be subject to the built-in gains tax. Although we expect that the built-in gains tax liability arising from any such assets should be de minimis, there is no assurance that this will be the case.
Our qualification as a REIT and exemption from U.S. federal income tax with respect to certain assets may be dependent on the accuracy of legal opinions or advice rendered or given or statements by the issuers of assets that we acquire, and the inaccuracy of any such opinions, advice or statements may adversely affect our REIT qualification and result in significant corporate-level tax.
When purchasing securities, we may rely on opinions or advice of counsel for the issuer of such securities, or statements made in related offering documents, for purposes of determining whether such securities represent debt or equity securities for U.S. federal income tax purposes, and also to what extent those securities constitute REIT real estate assets for purposes of the REIT asset tests and produce income which qualifies under the 75% REIT gross income test. In addition, when purchasing the equity tranche of a securitization, we may rely on opinions or advice of counsel regarding the qualification of the securitization for exemption from U.S. corporate income tax and the qualification of interests in such securitization as debt for U.S. federal income tax purposes. The inaccuracy of any such opinions, advice or statements may adversely affect our REIT qualification and result in significant corporate-level tax.
We may be subject to adverse legislative or regulatory tax changes that could reduce the value of our common stock.
At any time, the U.S. federal income tax laws or regulations governing REITs or the administrative interpretations of those laws or regulations may be amended, possibly with retroactive effect. We cannot predict when or if any new U.S. federal income tax law, regulation or administrative interpretation, or any amendment to any existing U.S. federal income tax law, regulation or administrative interpretation, will be adopted, promulgated or become effective, and any such law, regulation or interpretation may take effect retroactively. We and our stockholders could be adversely affected by any such change in, or any new, U.S. federal income tax law, regulation or administrative interpretation.
Dividends payable by REITs do not qualify for the reduced tax rates on dividend income from regular corporations, which could adversely affect the value of our common stock.
The maximum U.S. federal income tax rate for certain qualified dividends payable to U.S. stockholders that are individuals, trusts and estates is 20%. Dividends payable by REITs, however, are generally not eligible for the reduced rates and therefore may be subject to up to a 39.6% maximum U.S. federal income tax rate on ordinary income. Although the reduced U.S. federal income tax rate applicable to dividend income from regular corporate dividends does not adversely affect the taxation of REITs or dividends paid by REITs, the more favorable rates applicable to regular corporate dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the shares of REITs, including our common stock.
Qualifying as a REIT involves highly technical and complex provisions of the Internal Revenue Code.
Qualification as a REIT involves the application of highly technical and complex Internal Revenue Code provisions for which only limited judicial and administrative authorities exist.
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Even a technical or inadvertent violation could jeopardize our REIT qualification. Our qualification as a REIT will depend on our satisfaction of certain asset, income, organizational, distribution, stockholder ownership and other requirements on a continuing basis. In addition, our ability to satisfy the requirements to qualify as a REIT depends in part on the actions of third parties over which we have no control or only limited influence, including in cases where we own an equity interest in an entity that is classified as a partnership for U.S. federal income tax purposes.
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Some of the statements under "Summary," "Risk Factors," "Use of Proceeds," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business," "The History and Formation of our Company," "Distribution Policy" and elsewhere in this prospectus constitute forward-looking statements. These forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account information currently available to us. In some cases, you can identify forward looking statements by terms such as "anticipate," "believe," "could," "estimate," "expect," "intend," "may," "plan," "potential," "should" and "would" or the negative of these terms or other comparable terminology. Statements regarding the following subjects, among others, are forward-looking by their nature:
Our beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us or are within our control. If any such change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in, or implied by, our forward-looking statements. You should carefully consider these risks before you make an investment decision with respect to our
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common stock, along with, among others, the following factors that could cause actual results to vary from our forward-looking statements:
Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. You should not rely on these forward-looking statements, which apply only as of the date of this prospectus. We are not obligated, and do not intend, to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
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We estimate that our net proceeds from this offering, after deducting estimated offering expenses of $ , will be $ million (based on the offering price of $ per share, which is the anticipated initial public offering price range shown on the cover page of this prospectus). The underwriting fee incurred in this offering will be paid by our Advisor. Our Advisor has also agreed to pay any expenses in connection with this offering in excess of $1.2 million. We will not be obligated to repay our Advisor for any of these costs. We estimate that our net proceeds will be $ million if the underwriters exercise their overallotment option in full.
We plan to use the net proceeds from this offering, together with additional borrowings, to purchase our target assets such that, over time, our equity is allocated 50% to 60% to whole loans, 30% to 40% to non-agency RMBS, 5% to 10% to MSRs, other real-estate related and financial assets and cash, and 0% to 5% to agency RMBS. Until appropriate investments can be identified, our Advisor may invest the net proceeds from this offering in our target asset classes in different allocations than indicated above, and/or interest-bearing, short-term investments, including money market accounts and/or funds, that are consistent with our intention to qualify as a REIT and maintain our exemption from registration under the 1940 Act, or may elect to pay-down outstanding repurchase agreements. These initial investments, if any, are expected to provide a lower net return than we will seek to achieve from investments in non-Agency RMBS, Agency RMBS, residential mortgage loans and our other target assets. In addition, we will use the net proceeds from this offering to redeem 133 shares of our 12.5% Series A Cumulative Non-Voting Preferred Stock outstanding for an aggregate redemption price of $146,300.
Prior to the time we have fully used the proceeds of this offering to acquire non-Agency RMBS, Agency RMBS, residential mortgage loans and our other target assets, we may fund our quarterly distributions out of such proceeds.
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We have elected to be taxed as a REIT for U.S. federal income tax purposes commencing with our taxable year ended December 31, 2011. U.S. federal income tax law requires that a REIT distribute annually at least 90% of its REIT taxable income, excluding net capital gains and determined without regard to the dividends paid deduction, and that it pay tax at regular corporate rates to the extent that it annually distributes less than 100% of its net taxable income.
To satisfy the requirements to qualify as a REIT and generally not be subject to U.S. federal income and excise tax, we intend to make regular quarterly distributions to holders of common stock out of legally available funds.
On May 1, 2012, we declared a dividend in respect of the period from July 29, 2011 (the date of our inception) to December 31, 2011 of $0.51 per share of common stock, payable to stockholders of record on May 1, 2012, which was paid on May 15, 2012.
On June 5, 2012, we declared a dividend in respect of the first quarter of 2012 of $0.57 per share of common stock, payable to stockholders of record on June 5, 2012, which was paid on June 12, 2012.
On October 22, 2012, we declared a dividend in respect of the second quarter of 2012 of $0.89 per share of common stock and OP unit, payable to stockholders and OP unit holders of record on October 22, 2012, which was paid on October 29, 2012.
On November 29, 2012, we declared a dividend in respect of the third quarter of 2012 of $0.98 per share of common stock and OP unit, payable to stockholders and OP unit holders of record on November 29, 2012, which was paid on December 6, 2012.
On December 19, 2012, we declared a dividend in respect of the fourth quarter of 2012 of $1.16 per share of common stock and OP unit, payable to stockholders and OP unit holders of record on December 19, 2012, which is expected to be paid on December 26, 2012.
Our current policy is to pay quarterly distributions which, on an annual basis, will equal all or substantially all of our net taxable income. In certain cases, due to differences in timing between the inclusion of income and the receipt of cash with respect to certain assets, we may be required to borrow or make a taxable stock distribution to our stockholders in order to satisfy the distribution requirement. We intend to declare dividends within 45 days of the end of each quarter. We expect that the first dividend following this offering will be declared on , 2013 in respect of the first quarter of 2013. Any distributions we make will be at the discretion of our Board and will depend upon our earnings and financial condition, maintenance of our REIT qualification, restrictions on making distributions under Maryland law and such other factors as our Board deems relevant. Our earnings and financial condition will be affected by various factors, including the net interest and other income from our portfolio, our operating expenses and any other expenditures. For more information regarding risk factors that could materially adversely affect our earnings and financial condition, see "Risk Factors."
We anticipate that REIT distributions generally will be taxable as ordinary income to our stockholders. A portion of such distributions may be designated by us as qualified dividend income or capital gains or may constitute a return of capital. We will furnish annually to each of our stockholders a statement setting forth distributions paid during the preceding year and their characterization as ordinary income, qualified dividend income, capital gains or return of capital. For more information, see "U.S. Federal Income Tax Considerations."
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Our cash available for distribution may be less than the amount required to meet the distribution requirements for REITs under the Internal Revenue Code, and we may be required to sell assets or borrow funds to make cash distributions, make a portion of the required distribution in the form of a taxable stock distribution or distribution of debt securities. In addition, prior to the time we have fully used the proceeds of this offering to acquire our target assets, we may fund our quarterly distributions out of such proceeds. We will generally not be required to make distributions with respect to activities conducted through ZAIS I TRS and any other domestic TRS that we form following the completion of this offering. For more information, see "U.S. Federal Income Tax ConsiderationsTaxation of Our CompanyTaxation of Taxable U.S. Stockholders."
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The following table sets forth (1) our actual capitalization at September 30, 2012, (2) our pro forma as adjusted capitalization to reflect the issuance of an aggregate of 232,038 shares of common stock and 926,914 OP units on October 11, 2012 and December 13, 2012, and the application of the proceeds of such issuances to repurchase shares of common stock as described under "The History and Formation of Our Company" and (3) our pro forma capitalization as further adjusted to reflect the effects of the sale of our common stock in this offering at an offering price of $ per share, which is the anticipated initial public offering price range shown on the cover page of this prospectus, after deducting the estimated offering expenses payable by us. You should read this table together with "Use of Proceeds" included elsewhere in this prospectus.
|
As of September 30, 2012 | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
Actual |
Pro Forma
As Adjusted (1) |
Pro Forma
As Further Adjusted (1) (2) (3) |
|||||||
|
(unaudited)
(dollars in thousands, except share and per share data) |
|||||||||
Cash |
$ | 15,265 | $ | 20,861 | $ | |||||
Total debt |
$ |
110,129 |
$ |
110,129 |
$ |
|||||
Stockholders' equity: |
||||||||||
12.5% Series A Cumulative Non-Voting Preferred Stock, par value $0.0001 per share; 140 shares authorized; 133 shares outstanding, actual, 133 shares outstanding, pro forma as adjusted, and no shares outstanding, pro forma as further adjusted (4) |
$ | | $ | | $ | |||||
Common stock, par value $0.0001 per share; 500,000,000 shares authorized; 1,839,057 shares outstanding, actual, 2,320,882 shares outstanding, pro forma as adjusted, and shares outstanding, pro forma as further adjusted |
| | ||||||||
Capital in excess of par value |
35,465 | 45,657 | ||||||||
Retained earnings/(accumulated deficit) |
9,209 | 9,209 | ||||||||
Total ZAIS Financial Corp. equity |
$ | 44,674 | (5) | $ | 54,866 | $ | ||||
Non-controlling interests |
| 20,506 | ||||||||
Total equity |
$ | 44,674 | (5) | $ | 75,372 | $ | ||||
Total capitalization |
$ |
154,803 |
$ |
185,501 |
$ |
|||||
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The table below sets forth certain of our historical financial data as of and for the periods indicated. We derived our selected consolidated financial data (i) as of December 31, 2011 and for the period from July 29, 2011 (the date of our inception) to December 31, 2011, from our audited consolidated financial statements appearing in this prospectus and (ii) as of September 30, 2012 and for the nine-month period ended September 30, 2012, from our unaudited consolidated financial statements appearing in this prospectus. The following selected consolidated financial data should be read in conjunction with our consolidated financial statements and related notes and with "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing in this prospectus.
|
For the period from
July 29, 2011 (the date of our inception) to December 31, 2011 |
Nine-month period ended
September 30, 2012 |
|||||
---|---|---|---|---|---|---|---|
|
|
(unaudited)
|
|||||
|
(dollars in thousands, except share and per share data)
|
||||||
Operating Data: |
|||||||
Interest income |
$ | 3,617 | $ | 7,100 | |||
Interest expense |
295 | 1,044 | |||||
Net interest income |
3,322 | 6,056 | |||||
Operating expense |
(779 | ) | (2,007 | ) | |||
Change in unrealized (loss)/gain on real estate securities |
(5,960 | ) | 15,872 | ||||
Realized loss on real estate securities |
(1,482 | ) | (1,097 | ) | |||
Loss on derivative instruments |
(235 | ) | (1,216 | ) | |||
Net (loss)/income applicable to common stockholders |
$ | (5,134 | ) | $ | 17,608 | ||
Net (loss)/income per share applicable to common stockholdersbasic and diluted; based on 3,022,617 weighted average shares outstanding for the year ended December 31, 2011 and 2,930,421 weighted average shares outstanding for the nine-month period ended September 30, 2012. |
$ | (1.70 | ) | $ | 6.01 | ||
Dividends declared per share of common stock; based on 3,022,617 shares of record on December 31, 2011 and 3,022,617 shares of record on September 30, 2012. |
$ | | $ | 1.08 | (1) |
|
As of December 31, 2011 | As of September 30, 2012 | |||||
---|---|---|---|---|---|---|---|
|
|
(unaudited)
|
|||||
|
(dollars in thousands, except per share data)
|
||||||
Balance Sheet Data (at period end): |
|||||||
Total assets |
$ | 154,105 | $ | 182,333 | |||
Total liabilities |
$ | 98,787 | $ | 137,660 | (2) | ||
Total stockholders' equity |
$ | 55,318 | $ | 44,674 | |||
Stockholders' equity per share of common stock |
$ | 18.30 | $ | 24.29 | (3) |
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(2) on June 5, 2012, we declared a dividend in respect of the first quarter of 2012 of $0.57 per share of common stock, payable to stockholders of record on June 5, 2012, which was paid on June 21, 2012. Subsequently, (1) on October 22, 2012, we declared a dividend in respect of the second quarter of 2012 of $0.89 per share of common stock and OP unit, payable to stockholders and OP unit holders of record on October 22, 2012, which was paid on October 29, 2012, (2) on November 29, 2012, we declared a dividend in respect of the third quarter of 2012 of $0.98 per share of common stock and OP unit, payable to stockholders and OP unit holders of record on November 29, 2012, which was paid on December 6, 2012 and (3) on December 19, 2012, we declared a dividend in respect of the fourth quarter of 2012 of $1.16 per share of common stock and OP unit, payable to stockholders and OP unit holders of record on December 19, 2012, which is expected to be paid on December 26, 2012.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We are a Maryland corporation that invests in, finances and manages a diversified portfolio of residential mortgage assets, other real estate-related securities and financial assets. We currently primarily invest in, finance and manage non-Agency RMBS and Agency RMBS. Our RMBS strategy focuses on non-Agency RMBS with an emphasis on securities that, when originally issued, were rated in the highest rating category by one or more of the nationally recognized statistical rating organizations, as well as Agency RMBS. Our strategy will also emphasize the purchase of performing and re-performing residential whole loans. We will also have the discretion to invest in other real estate-related and financial assets, MSRs, IOs, CMBS and ABS.
Our income is generated primarily by the net spread between the income we earn on our assets and the cost of our financing and hedging activities. Our objective is to provide attractive risk-adjusted returns to our stockholders, primarily through quarterly distributions and secondarily through capital appreciation.
We completed our formation transaction and commenced operations on July 29, 2011. The formation transaction involved the exchange by investors in two funds from the Matrix VI Funds of cash and RMBS assets for an aggregate of 3,022,617 shares of our common stock. We received $60.5 million in this transaction, including $8.65 million from the ZAIS Parties and deployed the cash together with additional borrowings to build a diversified portfolio of RMBS assets. As part of the initial formation transactions, we anticipated completing our initial public offering on or prior to August 3, 2012 and viewed our initial public offering as a means for our stockholders to achieve liquidity in their investments. We determined, due to our assessment of market conditions, to delay the initial public offering beyond August 3, 2012. In connection with our delay of the initial public offering, we offered to repurchase shares from our stockholders who desired to achieve liquidity around the time of the original August 3, 2012 time frame. Accordingly, on October 11, 2012, we repurchased 668,525 shares of common stock from our existing stockholders at the per share book value as of July 31, 2012. On January 24, 2013, we also repurchased 265,245 shares of our common stock from one of our institutional stockholders. We paid to such stockholder approximately $5.2 million, which represents 90% of the repurchase amount based on the estimated book value per share as of December 31, 2012, the remaining 10% of the repurchase price will be paid following the completion of our December 31, 2012 year-end audit. In October of 2012, we also completed a private placement in which we sold 195,457 shares of common stock and 22,492 Operating Partnership units (or OP units) at a price per share equal to the per share book value as of August 31, 2012. Subsequently, in December of 2012, we completed another private placement in which we sold 36,581 shares of common stock and 904,422 OP units at a price per share equal to the per share book value as of November 30, 2012. As a consequence of these transactions, we currently have outstanding 2,320,882 shares of common stock and 926,914 OP units. For more information on our history, see "The History and Formation of our Company." From the date of the commencement of our operations through September 30, 2012, we have delivered total returns to stockholders that have held our common stock from inception, taking into account both distributions and capital appreciation (measured by increases in our estimated book value per share), of 26.9%. For more information related to the basis for the calculation of the total return that we have delivered to stockholders, see "BusinessGeneral."
As of September 30, 2012, we held a diversified portfolio of RMBS assets with an estimated fair market value of $163.4 million, consisting primarily of senior tranches of
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non-Agency RMBS that were originally highly rated but subsequently downgraded, and Agency RMBS collateralized by either fixed rate loans or ARMs. The borrowings we used to fund the purchase of our portfolio totaled approximately $110.1 million as of September 30, 2012 under master repurchase agreements with two counterparties. As of September 30, 2012, we had entered into master repurchase agreements with three counterparties and had outstanding borrowings with two of these counterparties. We are also in discussions with other financial institutions in order to potentially provide us with additional repurchase agreement capacity.
We have elected to be taxed as a REIT for U.S. federal income tax purposes commencing with our taxable year ended December 31, 2011. We are organized in a format pursuant to which we serve as the general partner of, and conduct substantially all of our business through, our Operating Partnership subsidiary, ZAIS Financial Partners, L.P., a Delaware limited partnership. We also expect to operate our business so that we are not required to register as an investment company under the 1940 Act.
Results of Operations
Nine Month Period Ended September 30, 2012
The following table sets forth certain information regarding our assets at September 30, 2012:
|
|
|
|
Gross Unrealized (1) |
|
Weighted Average | |||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Current
Principal Balance |
Premium
(Discount) |
Amortized
Cost |
|
|||||||||||||||||||||
(unaudited)
(dollars in thousands) |
Gains | Losses | Fair Value | Coupon | Yield (2) | ||||||||||||||||||||
Real estate securities |
|||||||||||||||||||||||||
Agency RMBS |
|||||||||||||||||||||||||
30-year adjustable rate mortgage |
$ | 3,200 | $ | 282 | $ | 3,482 | $ | | $ | (124 | ) | $ | 3,358 | 2.83 | % | 2.28 | % | ||||||||
30-year fixed rate mortgage |
55,608 | 2,904 | 58,512 | 2,730 | | 61,242 | 3.85 | 3.53 | |||||||||||||||||
Non-Agency RMBS |
|||||||||||||||||||||||||
AlternativeA |
33,441 | (8,240 | ) | 25,201 | 2,342 | (55 | ) | 27,488 | 5.60 | 7.70 | |||||||||||||||
Pay option adjustable rate |
1,626 | (478 | ) | 1,148 | 69 | (7 | ) | 1,210 | 1.05 | 7.84 | |||||||||||||||
Prime |
70,289 | (8,815 | ) | 61,474 | 4,864 | | 66,338 | 5.74 | 6.57 | ||||||||||||||||
Subprime |
4,582 | (934 | ) | 3,648 | 150 | (57 | ) | 3,741 | 1.00 | 7.99 | |||||||||||||||
Real Estate Securities |
$ | 168,746 | $ | (15,281 | ) | $ | 153,465 | $ | 10,155 | $ | (243 | ) | $ | 163,377 | 4.80 | % | 5.57 | % | |||||||
Investment Activity
RMBS. During the nine-month period ended September 30, 2012, we acquired Agency RMBS with a principal balance of $21.7 million for $22.5 million and non-Agency RMBS with principal balance of $69.2 million for $60.6 million. During the same period, we sold non-Agency RMBS for $39.6 million in net proceeds and Agency RMBS for $25.2 million in net proceeds, and recognized a net realized loss of $1.1 million. The fair market values of our Agency RMBS and non-Agency RMBS at September 30, 2012 were $64.6 million and $98.8 million, respectively.
Financing and Other Liabilities. The borrowings we used to fund the purchase of our portfolio totaled approximately $110.1 million as of September 30, 2012 under master repurchase agreements with two counterparties. As of September 30, 2012, we had entered
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into master repurchase agreements with three counterparties and had outstanding borrowings with two of these counterparties. These agreements are secured by a portion of our Agency RMBS and non-Agency RMBS and bear interest at rates that have historically moved in close relationship to LIBOR. We are also in discussions with other financial institutions in order to potentially provide us with additional repurchase agreement capacity.
The following table presents certain information regarding our repurchase agreements as of September 30, 2012 by remaining maturity and collateral type:
|
Agency Securities | Non-Agency Securities | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(unaudited)
(dollars in thousands) |
|
Weighted
Average Rate |
|
Weighted
Average Rate |
|||||||||
Balance | Balance | ||||||||||||
Repurchase agreements maturing within
|
|||||||||||||
30 days or less |
$ | 61,174 | 0.45 | % | $ | 48,955 | 2.15 | % | |||||
31 - 60 days |
| | | | |||||||||
61 - 90 days |
| | | | |||||||||
Greater than 90 days |
| | | | |||||||||
Total/Weighted average |
$ | 61,174 | 0.45 | % | $ | 48,955 | 2.15 | % | |||||
Derivative Instruments. As of September 30, 2012, we had outstanding interest rate swap agreements designed to mitigate the effects of increases in interest rates under a portion of our repurchase agreements. These swap agreements provide for us to pay fixed interest rates and receive floating interest rates indexed off of LIBOR, effectively fixing the floating interest rates on $32.6 million of borrowings under our repurchase agreements as of September 30, 2012.
The following table presents certain information about our interest rate swaps as of September 30, 2012:
(unaudited)
(dollars in thousands) |
Notional
Amount |
Weighted
Average Pay Rate |
Weighted
Average Receive Rate |
Weighted
Average Years to Maturity |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Swap agreements maturing in
|
|||||||||||||
2016 |
$ | 12,102 | 1.21 | % | 0.48 | % | 4.0 | ||||||
2017 |
11,050 | 1.28 | 0.48 | % | 4.5 | ||||||||
2021 |
9,448 | 2.16 | 0.48 | % | 9.0 | ||||||||
Total/Weighted average |
$ | 32,600 | 1.51 | % | 0.48 | % | 5.6 | ||||||
Net Interest Income
We earned interest income of $7.1 million for the nine-month period ended September 30, 2012, representing interest earned on our assets. We incurred interest expense of $1.0 million for this period related to borrowings from repurchase agreements. As of September 30, 2012, the weighted average net interest spread between the yield on our assets and the cost of funds, including the impact of interest rate hedging, was 2.47% for our Agency RMBS and 4.80% for our non-Agency RMBS.
Interest income is subject to interest rate risk. See "Quantitative and Qualitative Disclosures about Market Risk," for more information relating to interest rate risk and its impact on our operating results.
Our net interest income is also impacted by prepayment speeds, as measured by the weighted average Constant Prepayment Rate (or the CPR) on our assets. The three-month average and the six-month average CPR for the periods ended September 30, 2012 of our Agency RMBS were 7.0% and 5.4%, respectively, and were 18.1% and 17.4%, respectively, for
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our non-Agency RMBS. The non-Agency RMBS CPR includes both voluntary and involuntary amounts. For additional information related to the CPR on our assets, see "Factors Impacting Our Operating Results."
Expenses
Advisory Fee Expense (Related Party). Pursuant to the terms of the Investment Advisory Agreement, during this period our Advisor was paid an advisory fee equal to 1.5% per annum of our Net Asset Value (as defined in the Investment Advisory Agreement), calculated and payable (in cash) quarterly in arrears. This fee (which was recorded as an advisory fee expense to a related party) totaled $0.7 million for the nine-month period ended September 30, 2012.
Professional Fees. We incurred professional fees of $1.2 million for the nine-month period ended September 30, 2012, which are primarily related to legal fees, audit fees, consulting fees and insurance.
Realized and Unrealized Gain/(Loss)
During the nine-month period ended September 30, 2012, we sold certain of our RMBS and recognized net loss of $1.1 million. During this period, our change in unrealized gain/loss on our RMBS was $15.9 million primarily due to changes in the fair value of our RMBS.
We have not designated our interest rate swaps as hedging instruments. As a result, we recorded the change in estimated fair value related to interest rate swaps held during the period in earnings as gain or loss on derivative instruments. Included in gain or loss on derivative instruments are the net swap payments for the derivative instruments.
We have elected to record the change in estimated fair value related to our RMBS in earnings by electing the fair value option.
The following amounts related to realized gains and losses as well as changes in estimated fair value of our RMBS portfolio and derivative instruments are included in our unaudited consolidated statement of operations for the nine-month period ended September 30, 2012:
(unaudited)
|
|
|||
---|---|---|---|---|
Other gain/(loss)
(dollars in thousands) |
|
|||
Change in unrealized gain/loss on real estate securities |
$ | 15,872 | ||
Realized loss on real estate securities |
(1,097 | ) | ||
Loss on derivative instruments |
(1,217 | ) | ||
Total other gain |
$ | 13,558 | ||
Series A Preferred Stock
On January 18, 2012, we completed a private placement of 133 shares of $0.0001 par value 12.5% Series A Cumulative Non-Voting Preferred Stock (or Series A Preferred Stock). The Series A Preferred Stock carries a liquidation preference of $1,000 per share. The holders of the Series A Preferred Stock are entitled to receive cumulative cash dividends at the rate of 12.5% per annum of the liquidation preference. Upon completion of this offering, we plan to redeem the 133 outstanding shares of Series A Preferred Stock for an aggregate redemption price of $146,300, plus any accrued and unpaid dividends. The Series A Preferred Stock is not convertible into shares of any other class or series of stock.
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Subsequent Events
On October 11, 2012, we completed the closing of a private offering. We sold 195,457 shares of common stock and 22,492 OP Units in reliance on exemptions from the registration requirements of the Securities Act pursuant to Section 4(2) or Regulation S thereof at an offering price of $22.23 per common share or OP Unit, as applicable. Net proceeds from the closing of this offering, after deducting offering expenses, were $4.4 million, which we used to repurchase shares of common stock.
On October 11, 2012, we repurchased 668,525 shares of common stock for a gross purchase price of $14.2 million and cancelled the shares of common stock. In addition, on January 24, 2013, we repurchased 265,245 shares of our common stock from one of our institutional stockholders. We paid to such stockholder approximately $5.2 million, which represents 90% of the repurchase amount based on the estimated book value per share as of December 31, 2012, the remaining 10% of the repurchase price will be paid following the completion of our December 31, 2012 year-end audit.
On October 22, 2012, we declared a dividend in respect of the second quarter of 2012 of $0.89 per share of common stock and OP unit, payable to stockholders and OP unit holders of record on October 22, 2012, which was paid on October 29, 2012.
On November 29, 2012, we declared a dividend in respect of the third quarter of 2012 of $0.98 per share of common stock and OP unit, payable to stockholders and OP unit holders of record as of November 29, 2012, which was paid on December 6, 2012.
On December 13, 2012, we completed the closing of a private offering. We sold 36,581 shares of common stock and 904,422 OP units in reliance on exemptions from the registration requirements of the Securities Act pursuant to Section 4(2) or Regulation S thereof at an offering price of $22.39 per common share or OP unit, as applicable. Net proceeds from the closing of this offering, after deducting offering expenses, were $20.9 million. See "The History and Formation of our Company."
On December 19, 2012, we declared a dividend in respect of the fourth quarter of 2012 of $1.16 per share of common stock and OP unit, payable to stockholders and OP unit holders of record on December 19, 2012, which is expected to be paid on December 26, 2012.
Period from July 29, 2011 (the Date of our Inception) to December 31, 2011
The following table sets forth certain information regarding our assets at December 31, 2011:
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Gross Unrealized (1) |
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Weighted Average | |||||||||||||||||||
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Current
Principal Balance |
Premium
(Discount) |
Amortized
Cost |
Fair
Value |
|||||||||||||||||||||
(unaudited)
(dollars in thousands) |
Gains | Losses | Coupon | Yield | |||||||||||||||||||||
Real estate securities : |
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Agency RMBS |
|||||||||||||||||||||||||
30-year adjustable rate mortgage |
$ | 12,904 | $ | 551 | $ | 13,455 | $ | 22 | $ | (1 | ) | $ | 13,476 | 3.16 | % | 2.34 | % | ||||||||
30-year fixed rate mortgage |
52,681 | 3,116 | 55,798 | 384 | (159 | ) | 56,022 | 4.20 | % | 3.80 | % | ||||||||||||||
Non-agency RMBS |
|||||||||||||||||||||||||
AlternativeA/B |
51,686 | (14,541 | ) | 37,145 | 71 | (2,149 | ) | 35,067 | 4.92 | % | 7.88 | % | |||||||||||||
Pay option adjustable rate |
24,665 | (9,993 | ) | 14,672 | 34 | (1,915 | ) | 12,791 | 0.84 | % | 7.68 | % | |||||||||||||
Prime |
24,633 | (4,361 | ) | 20,271 | 244 | (856 | ) | 19,660 | 4.55 | % | 7.22 | % | |||||||||||||
Subprime |
20,624 | (10,034 | ) | 10,590 | | (1,635 | ) | 8,955 | 0.87 | % | 15.04 | % | |||||||||||||
Real Estate Securities |
$ | 187,193 | $ | (35,262 | ) | $ | 151,931 | $ | 755 | $ | (6,715 | ) | $ | 145,971 | 3.76 | % | 6.14 | % | |||||||
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Investment Activity
RMBS. During the period from July 29, 2011 (the date of our inception) to December 31, 2011, we acquired Agency RMBS with a principal balance of $66.6 million for $70.4 million. During the same period, we acquired non-Agency RMBS with principal balance of $120.1 million for $101.5 million, which includes the non-Agency RMBS we received in connection with our formation transactions. During the same period, we sold non-Agency RMBS for $7.2 million in net proceeds, and recognized a net realized loss of $1.5 million. We did not sell any Agency RMBS during the period from July 29, 2011 (the date of our inception) to December 31, 2011. The fair market values of our Agency RMBS and non-Agency RMBS at December 31, 2011 were $69.5 million and $76.5 million, respectively.
Financing and Other Liabilities. As of December 31, 2011, we had 65 repurchase agreements outstanding with one counterparty totaling $97.6 million, which was used to finance Agency RMBS and non-Agency RMBS. This agreement is secured by a portion of our Agency RMBS and non-Agency RMBS and bears interest at rates that have historically moved in close relationship to LIBOR.
The following table presents certain information regarding our repurchase agreements as of December 31, 2011 by remaining maturity and collateral type:
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Agency Securities | Non-Agency Securities | |||||||||||
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Weighted
Average Rate |
|
Weighted
Average Rate |
|||||||||
(dollars in thousands)
|
Balance | Balance | |||||||||||
Repurchase agreements maturing within
|
|||||||||||||
30 days or less |
$ | 25,733 | 0.60 | % | $ | 30,958 | 2.28 | % | |||||
31 - 60 days |
37,475 | 0.50 | | | |||||||||
61 - 90 days |
3,431 | 0.50 | | | |||||||||
Greater than 90 days |
| | | | |||||||||
Total/Weighted average |
$ | 66,639 | 0.54 | % | $ | 30,958 | 2.28 | % | |||||
Derivative Instruments. As of December 31, 2011, we had outstanding interest rate swap agreements designed to mitigate the effects of increases in interest rates under a portion of our repurchase agreements. These swap agreements provide for us to pay fixed interest rates and receive floating interest rates indexed off of LIBOR, effectively fixing the floating interest rates on $21.6 million of borrowings under our repurchase agreements as of December 31, 2011.
The following table presents certain information about our interest rate swaps as of December 31, 2011:
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|
|
Weighted
Average Receive Rate |
Weighted
Average Years to Maturity |
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|
Notional Amount |
Weighted
Average Pay Rate |
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(dollars in thousands)
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|||||||||||||
Swap agreements maturing in
|
|||||||||||||
2016 |
$ | 12,102 | 1.21 | % | 0.38 | % | 4.7 | ||||||
2021 |
9,448 | 2.16 | 0.38 | 9.7 | |||||||||
Total/Weighted average |
$ | 21,550 | 1.62 | % | 0.38 | % | 6.9 | ||||||
Net Interest Income
We earned interest income of $3.6 million from July 29, 2011 (the date of our inception) to December 31, 2011, representing interest earned on our assets. We incurred interest expense of $0.3 million for this period related to borrowings from our repurchase agreement. As of December 31, 2011, the weighted average net interest spread between the yield on our
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assets and the cost of funds, including the impact of interest rate hedging, was 2.59% for our Agency RMBS and 6.32% for our non-Agency RMBS.
Interest income is subject to interest rate risk. See "Quantitative and Qualitative Disclosures about Market Risk," for more information relating to interest rate risk and its impact on our operating results.
Our net interest income is also impacted by prepayment speeds, as measured by the CPR on our assets. The three-month CPR for the period ended December 31, 2011 was 4.2% for our Agency RMBS. The six-month average CPR for the period ended December 31, 2011 for our Agency RMBS could not be calculated due to the age of our loan pools. The three-month average and the six-month average CPR for the periods ended December 31, 2011 were 14.3% and 13.9%, respectively, for our non-Agency RMBS. The non-Agency RMBS CPR includes both voluntary and involuntary amounts. For additional information related to the CPR on our assets, see "Factors Impacting Our Operating Results."
Expenses
Advisory Fee Expense (Related Party). Pursuant to the terms of the Investment Advisory Agreement, our Advisor is paid an advisory fee equal to 1.5% per annum of our Net Asset Value (as defined in the Investment Advisory Agreement), calculated and payable (in cash) quarterly in arrears. This fee (which was recorded as an advisory fee expense to a related party) totaled $0.4 million for the period from July 29, 2011 (the date of our inception) to December 31, 2011.
Professional Fees. We incurred professional fees of $0.4 million for the period from July 29, 2011 (the date of our inception) to December 31, 2011, which primarily represents consulting fees and insurance.
General and Administrative Expenses. We incurred general and administrative expenses of $0.1 million for the period from July 29, 2011 (the date of our inception) to December 31, 2011, which represents accrued excise taxes.
Realized and Unrealized Gain/(Loss)
During the period from July 29, 2011 (the date of our inception) to December 31, 2011, we sold certain of our RMBS and recognized net loss of $1.5 million. During this period, our change in unrealized loss on our RMBS was $6.0 million primarily due to changes in the fair value of our RMBS.
We have not designated our interest rate swaps as hedging instruments. As a result, we recorded the change in estimated fair value related to interest rate swaps held during the period in earnings as gain or loss on derivative instruments. Included in gain or loss on derivative instruments are the net swap payments for the derivative instruments.
We have elected to record the change in estimated fair value related to our RMBS in earnings by electing the fair value option.
The following amounts related to realized gains and losses as well as changes in estimated fair value of our RMBS portfolio and derivative instruments are included in our
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consolidated statement of operations for the period from July 29, 2011 (the date of our inception) to December 31, 2011:
Other gain/(loss)
(dollars in thousands) |
|
|||
---|---|---|---|---|
Change in unrealized loss on real estate securities |
$ | (5,960 | ) | |
Realized loss on real estate securities |
(1,482 | ) | ||
Loss on derivative instruments |
(236 | ) | ||
Total other loss |
$ | (7,678 | ) | |
Factors Impacting Our Operating Results
We held a diversified portfolio of RMBS assets with a fair market value of $163.4 million as of September 30, 2012, and $146.0 million as of December 31, 2011. For more information about our mix of assets, see "BusinessOur Investment StrategyOur Portfolio." In addition, we anticipate having substantial available borrowing capacity from which we expect to be able to acquire additional assets. Our operating results will be impacted by our actual available borrowing capacity.
We expect that the results of our operations will also be affected by a number of other factors, including the level of our net interest income, the fair market value of our assets and the supply of, and demand for, the target assets in which we may invest. Our net interest income, which includes the amortization of purchase premiums and accretion of purchase discounts, varies primarily as a result of changes in market interest rates and prepayment speeds, as measured by CPR on our target assets. Interest rates and prepayment speeds vary according to the type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any certainty. Our operating results may also be impacted by credit losses in excess of initial anticipations or unanticipated credit events experienced by borrowers whose mortgage loans are held directly by us or included in our non-Agency RMBS or in other assets we may acquire in the future.
Changes in Fair Value of Our Assets
Our RMBS are carried at fair value and future mortgage related assets may also be carried at fair value. Accordingly, changes in the fair value of our assets may impact the results of our operations for the period in which such change in value occurs. The expectation of changes in real estate prices is a major determinant of the value of mortgage loans and, therefore, of RMBS. This factor is beyond our control. For additional information relating to the determination of fair value, see "Determination of Fair Value and Market Value Measurement."
Changes in Market Interest Rates
With respect to our business operations, increases in interest rates, in general, may over time cause: (i) the interest expense associated with our borrowings to increase; (ii) the value of our investment portfolio to decline; (iii) coupons on our ARMs and hybrid ARMs (including RMBS secured by such collateral) and on our other floating rate securities to reset, although on a delayed basis, to higher interest rates; (iv) prepayments on our RMBS to slow, thereby slowing the amortization of our purchase premiums and the accretion of our purchase discounts; and (v) the value of our interest rate swap agreements to increase. Conversely, decreases in interest rates, in general, may over time cause: (i) prepayments on our RMBS to increase, thereby accelerating the amortization of our purchase premiums and the accretion of our purchase discounts; (ii) the interest expense associated with our borrowings to decrease;
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(iii) the value of our investment portfolio to increase; (iv) the value of our interest rate swap agreements to decrease; and (v) coupons on our ARMs and hybrid ARMs (including RMBS secured by such collateral) and on our other floating rate securities to reset, although on a delayed basis, to lower interest rates. As of September 30, 2012 and December 31, 2011, 21.5% and 40.2% of our assets, respectively, as measured by fair market value, consisted of RMBS assets with a variable interest rate component, including ARMs and hybrid ARMs. For more information relating to the composition of our assets, including our variable interest rate assets, see "BusinessOur Investment StrategyOur Portfolio."
Prepayment Speeds
Prepayment speeds on residential mortgage loans, and therefore, RMBS vary according to interest rates, the type of investment, conditions in the financial markets, competition, foreclosures and other factors that cannot be predicted with any certainty. In general, when interest rates rise, it is relatively less attractive for borrowers to refinance their mortgage loans and, as a result, prepayment speeds tend to decrease. This can extend the period over which we earn interest income. When interest rates fall, prepayment speeds on residential mortgage loans, and therefore, RMBS tend to increase, thereby decreasing the period over which we earn interest income. Additionally, other factors such as the credit rating of the borrower, the rate of home price appreciation or depreciation, financial market conditions, foreclosures and lender competition, none of which can be predicted with any certainty, may affect prepayment speeds on RMBS. In particular, despite the historically low interest rates, recent severe dislocations in the housing market, including home price depreciation resulting in many borrowers owing more on their mortgage loans than the values of their homes have prevented many such borrowers from refinancing their mortgage loans, which has impacted prepayment rates and the value of RMBS assets. However, mortgage loan modification and refinance programs or future legislative action may make refinancing mortgage loans more accessible or attractive to such borrowers, which could cause the rate of prepayments on RMBS assets to accelerate. For RMBS assets, including some of our RMBS assets, that were purchased or are trading at premium to their par value, higher prepayment rates would adversely affect the value of such assets or cause the holder to incur losses with respect to such assets. For more information related to our assets trading at a premium to their par value as of September 30, 2012, see our asset table set out under "BusinessOur Investment StrategyOur Portfolio."
Spreads on Non-Guaranteed Mortgage Loans and Securities
Since the financial crisis that began in 2007, the spread between swap rates and residential mortgage loans and non-Agency RMBS has been volatile. Spreads on these assets initially moved wider due to the difficult credit conditions and have only recovered a portion of that widening. As the prices of securitized assets declined, a number of investors and a number of structured investment vehicles faced margin calls from dealers and were forced to sell assets in order to reduce leverage. The price volatility of these assets also impacted lending terms in the repurchase market, as counterparties raised margin requirements to reflect the more difficult environment. The spread between the yield on our assets and our funding costs is an important factor in the performance of this aspect of our business. Wider spreads imply greater income on new asset purchases but may have a negative impact on our stated book value. Wider spreads generally negatively impact asset prices. In an environment where spreads are widening, counterparties may require additional collateral to secure borrowings which may require us to reduce leverage by selling assets. Conversely, tighter spreads imply lower income on new asset purchases but may have a positive impact on our stated book value. Tighter spreads generally have a positive impact on asset prices. In this case, we may be able to reduce the amount of collateral required to secure borrowings.
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Mortgage Extension Risk
Our Advisor computes the projected weighted-average life of our investments based on assumptions regarding the rate at which the borrowers will prepay the underlying mortgages. In general, when we acquire a fixed-rate mortgage or hybrid ARM security, we may, but are not required to, enter into an interest rate swap agreement or other hedging instrument that effectively fixes our borrowing costs for a period close to the anticipated average life of the fixed-rate portion of the related assets. This strategy is designed to protect us from rising interest rates, because the borrowing costs are fixed for the duration of the fixed-rate portion of the related RMBS.
However, if prepayment rates decrease in a rising interest rate environment, the life of the fixed-rate portion of the related assets could extend beyond the term of the swap agreement or other hedging instrument. This could have a negative impact on our results of operations, as borrowing costs would no longer be fixed after the end of the hedging instrument while the income earned on the hybrid ARM security would remain fixed. This situation may also cause the fair market value of our hybrid ARM security to decline, with little or no offsetting gain from the related hedging transactions. In extreme situations, we may be forced to sell assets to maintain adequate liquidity, which could cause us to incur losses.
In addition, the use of this swap hedging strategy effectively limits increases in our book value in a declining rate environment, due to the effectively fixed nature of our hedged borrowing costs. In an extreme rate decline, prepayment rates on our assets might actually result in certain of our assets being fully paid off while the corresponding swap or other hedge instrument remains outstanding. In such a situation, we may be forced to liquidate the swap or other hedge instrument at a level that causes us to incur a loss.
Credit Risk
We are subject to credit risk in connection with our investments. Although we do not expect to encounter credit risk in our Agency RMBS, we do expect to encounter credit risk related to our non-Agency RMBS, whole loans and other target assets we may acquire in the future. Increases in defaults and delinquencies will adversely impact our operating results, while declines in rates of default and delinquencies will improve our operating results from this aspect of our business.
Size of Investment Portfolio
The size of our investment portfolio, as measured by the aggregate principal balance of our mortgage related securities and the other assets we own, is also a key revenue driver. Generally, as the size of our investment portfolio grows, the amount of interest income we receive increases. A larger investment portfolio, however, drives increased expenses, as we incur additional interest expense to finance the purchase of our assets.
Critical Accounting Policies and Use of Estimates
Our financial statements are prepared in accordance with U.S. GAAP, which requires the use of estimates and assumptions that involve the exercise of judgment and use of assumptions as to future uncertainties. Our most critical accounting policies involve decisions and assessments that affect our reported assets and liabilities, as well as our reported revenues and expenses. We believe that all of the decisions and assessments upon which our financial statements will be based will be reasonable at the time made and based upon information available to us at that time. Our critical accounting policies and accounting estimates may be expanded over time as we fully implement our strategy. Those accounting
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policies and estimates that we expect to be most critical to an investor's understanding of our financial results and condition are discussed below:
Real Estate SecuritiesFair Value Election
U.S. GAAP permits entities to choose to measure many financial instruments and certain other items at fair value. We have elected the fair value option for each of our RMBS at the date of purchase, including those contributed in connection with our formation, which permits us to measure these securities at estimated fair value with the change in estimated fair value included as changes in unrealized gain/loss on real estate securities. We believe that the election of the fair value option for our RMBS portfolio more appropriately reflects the results of our operations for a particular reporting period as all securities activities are recorded in a similar manner.
Determination of Fair Value and Market Value Measurement
The "Fair Value Measurements and Disclosures" Topic of the Financial Accounting Standards Board (or FASB) Accounting Standards Codification (or ASC) defines fair value, establishes a framework for measuring fair value, and requires certain disclosures about fair value measurements under U.S. GAAP. Specifically, this guidance defines fair value based on exit price, or the price that would be received upon the sale of an asset or the transfer of a liability in an orderly transaction between market participants at the measurement date.
Fair value under U.S. GAAP represents an exit price in the normal course of business, not a forced liquidation price. If we were forced to sell assets in a short period to meet liquidity needs, the prices we receive could be substantially less than their recorded fair values. Furthermore, the analysis of whether it is more likely than not that we will be required to sell securities in an unrealized loss position prior to an expected recovery in value (if any), the amount of such expected required sales, and the projected identification of which securities would be sold is also subject to significant judgment.
Changes to the valuation methodology will be reviewed by our Advisor to ensure the changes are appropriate. The fair value methodology may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, we anticipate the valuation methods will be appropriate and consistent with other market participants, the use of different methodologies, or assumptions, to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.
We categorize our financial instruments in accordance with U.S. GAAP, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the financial instruments fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.
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Financial assets and liabilities recorded on our consolidated balance sheet are categorized based on the inputs to the valuation techniques as follows:
Level 1 | Quoted prices for identical assets or liabilities in an active market. | |
Level 2 |
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Financial assets and liabilities whose values are based on the following: |
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Quoted prices for similar assets or liabilities in active markets. |
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Quoted prices for identical or similar assets or liabilities in nonactive markets. |
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Pricing models whose inputs are observable for substantially the full term of the asset or liability. |
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Pricing models whose inputs are derived principally from or corroborated by observable market data for substantially the full term of the asset or liability. |
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Level 3 |
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Prices or valuation techniques based on inputs that are both unobservable and significant to the overall fair value measurement. |
We may use valuation techniques consistent with the market and income approaches to measure the fair value of our assets and liabilities. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. The income approach uses valuation techniques to convert future projected cash flows to a single discounted present value amount. When applying either approach, we maximize the use of observable inputs and minimize the use of unobservable inputs. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires significant judgment and considers factors specific to the investment. We utilize proprietary modeling analysis to support the independent third party broker quotes selected to determine the fair value of investments and derivative instruments.
The following is a description of the valuation techniques used to measure fair value and the general classification of these instruments pursuant to the fair value hierarchy.
Real Estate Securities
The fair value of our RMBS considers the underlying characteristics of each security including coupon, maturity date and collateral. We estimate the fair value of our Agency RMBS and non-Agency RMBS based upon a combination of observable prices in active markets, multiple indicative quotes from brokers, and executable bids. In evaluating broker quotes we also consider additional observable market data points including recent observed trading activity for identical and similar securities, back-testing, broker challenges and other interactions with market participants, as well as yield levels generated by model-based valuation techniques. In absence of observable quotes, we utilize model-based valuation techniques that may contain unobservable valuation inputs.
When available, the fair value of RMBS is based on quoted prices in active markets. If quoted prices are not available, fair values are obtained from either broker quotes, observed traded levels or model-based valuation techniques using observable inputs such as benchmark yields or issuer spreads. Our Agency RMBS are valued using the market data described above, which includes inputs determined to be observable or whose significant value drivers are observable. Accordingly, Agency RMBS securities are classified as Level 2 in the fair value hierarchy.
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While our non-Agency RMBS are valued using the same process with similar inputs as the Agency RMBS, a significant amount of inputs are unobservable due to relatively low levels of market activity. The fair value of these securities is typically based on broker quotes or our model-based valuation. Accordingly, our non-Agency RMBS are classified as Level 3 in the fair value hierarchy. Model-based valuation consists primarily of discounted cash flow and yield analyses. Significant model inputs and assumptions include market-implied discount rates, default rates, expected loss severity, weighted average life, collateral composition, borrower characteristics and prepayment rates, and may also include general economic conditions, home price index forecasts, servicing data and other relevant information. Where possible, collateral-related assumptions are determined on an individual loan level.
Derivative Instruments
Derivative instruments are valued using counterparty valuations. These valuations are generally based on models with market observable inputs such as interest rates and contractual cash flows, and as such, are classified as Level 2 of the fair value hierarchy. We review these valuations, including consideration of counterparty risk and collateral provisions.
Interest Income Recognition and Impairment
Interest income on Agency RMBS is accrued based on the outstanding principal balance and their contractual terms. Premiums and discounts associated with Agency RMBS at the time of purchase are amortized into interest income over the life of such securities using the effective yield method and adjusted for actual prepayments in accordance with ASC 310-20 "Nonrefundable Fees and Other Costs" or ASC 325-40 "Beneficial Interests in Securitized Financial Assets," as applicable. Total interest income is recorded as Interest incomereal estate securities in the consolidated statement of operations.
Interest income on the non-Agency RMBS that were purchased at a discount to par value and/or were rated below AA at the time of purchase is recognized based on the effective yield method. The effective yield on these securities is based on the projected cash flows from each security, which are estimated based on our observation of current information and events and include assumptions related to interest rates, prepayment rates and the timing and amount of credit losses. On at least a quarterly basis, we review and, if appropriate, make adjustments to our cash flow projections based on input and analysis received from external sources, internal models, and our judgment about interest rates, prepayment rates, the timing and amount of credit losses, and other factors. Changes in cash flows from those originally projected, or from those estimated at the last evaluation, may result in a prospective change in the yield/interest income recognized on such securities. Actual maturities of the securities are affected by the contractual lives of the associated mortgage collateral, periodic payments of principal, and prepayments of principal. Therefore, actual maturities of the securities are generally shorter than stated contractual maturities.
Based on the projected cash flows from our non-Agency RMBS purchased at a discount to par value, a portion of the purchase discount may be designated as credit protection against future credit losses and, therefore, not accreted into interest income. The amount designated as credit discount is determined and may be adjusted over time, based on the actual performance of the security, its underlying collateral, actual and projected cash flow from such collateral, economic conditions and other factors. If the performance of a security with a credit discount is more favorable than forecasted, a portion of the amount designated as credit discount may be accreted into interest income prospectively.
RMBS are periodically evaluated for other-than-temporary impairment (or OTTI). A security where the fair value is less than amortized cost is considered impaired. Impairment of
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a security is considered to be other-than-temporary when: (i) the holder has the intent to sell the impaired security; (ii) it is more likely than not the holder will be required to sell the security; or (iii) the holder does not expect to recover the entire amortized cost of the security. When a security has been deemed to be other-than-temporarily impaired, the amount of OTTI is bifurcated into: (i) the amount related to expected credit losses; and (ii) the amount related to fair value adjustments in excess of expected credit losses. The portion of OTTI related to expected credit losses is recognized in the consolidated statement of operations as a realized loss. The remaining OTTI related to the valuation adjustment is recognized as a component of unrealized loss in the consolidated statement of operations. Realized gains and losses on sale of RMBS are determined using the specific identification method. RMBS transactions are recorded on the trade date.
Repurchase Agreements
The borrowings we used to fund the purchase of our portfolio totaled approximately $110.1 million as of September 30, 2012 under master repurchase agreements with two counterparties. As of September 30, 2012, we had entered into master repurchase agreements with three counterparties and had outstanding borrowings with two of these counterparties. We are also in discussions with other financial institutions in order to potentially provide us with additional repurchase agreement capacity. Repurchase agreements are treated as collateralized financing transactions and are carried at their contractual amounts, including accrued interest, as specified in the respective agreements. Repurchase agreements are recorded on trade date at the contract amount.
We pledge cash and certain of our securities as collateral under these repurchase arrangements. The amounts available to be borrowed are dependent upon the fair value of the securities pledged as collateral, which fluctuates with changes in interest rates, type of security and liquidity conditions within the banking, mortgage finance and real estate industries. In response to declines in fair value of pledged securities, the lenders may require us to post additional collateral or pay down borrowings to re-establish agreed upon collateral requirements, referred to as margin calls. As of September 30, 2012, we met all margin call requirements.
Derivatives and Hedging Activities
We account for our derivative financial instruments in accordance with derivative accounting guidance, which requires an entity to recognize all derivatives as either assets or liabilities on its balance sheet and to measure those instruments at fair value. We have not designated any of our derivative contracts as hedging instruments for accounting purposes. As a result, changes in the fair value of derivatives are recorded through current period earnings.
Our derivative contracts contain provisions that allow for netting or setting off of all individual swap receivables and payables with the counterparty and, therefore, the fair value of those swap contracts are netted. The credit support annex provisions of our interest rate swap contracts allow the parties to mitigate their credit risk by requiring the party which is out of the money to post collateral. At September 30, 2012, all collateral provided under these contracts consists of cash collateral.
Loans Held-for-Investment
Loans, which we may acquire, may be classified as held-for-investment based upon management's intent and ability to hold the loans for the foreseeable future or may be elected to be accounted for under the fair value option of accounting. Loans held-for-investment will
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be recorded at amortized cost, or the outstanding unpaid principal balance of the loan, net of unamortized acquisition premiums or discounts and unamortized costs and fees directly associated with the origination or acquisition of the loan. Net deferred loan fees and origination and acquisition costs will be recognized in interest income over the loan term as a yield adjustment using the interest method or a method that approximates a level rate of return over the loan term. The accounting guidance provides for the recognition of an allowance for loan losses for groups of homogeneous loans. We will record a reserve for loan losses reflecting management's estimate of loan losses inherent in the loan portfolio as of the balance sheet date. The allowance for loan losses will be management's best estimate of probable credit losses inherent in the loan portfolio at the balance sheet date. We will record a reserve for performing loans when (i) available information as of each balance sheet date indicates that it is probable a loss has occurred in the portfolio and (ii) the amount of the loss can be reasonably estimated. The reserve will be decreased by charge offs when losses are confirmed.
We may also purchase loans held-for-investment at a discount to face value where there has been a deterioration in credit quality since origination and, at the acquisition date, we expect to collect less than the contractual amounts due under the terms of the loan based, at least in part, on our assessment of the credit quality of the borrower. Loans acquired in a transfer will be initially measured at fair value (in the aggregate, presumptively the price paid or advanced to the borrower if originated by us).
Interest IncomeLoans Held-For-Investment
We expect that interest income on performing held-for-investment mortgage loans, which we may acquire, will be accrued based on the actual coupon rate and the outstanding principal balance of such assets without estimating prepayments. Premiums and discounts will be amortized or accreted into interest income over the lives of the assets using the effective yield method, as adjusted for actual prepayments. Actual prepayments accelerate the rate at which premiums and discounts are amortized or accreted into interest income in order to maintain the original effective interest rate, based on contractual cash flows.
We will place mortgage loans on nonaccrual status when any portion of principal or interest is more than 90 days past due, or earlier when concern exists as to the ultimate collection of principal or interest. When a mortgage loan is placed on nonaccrual status, we will reverse the accrual for unpaid interest and will not recognize interest income until the cash is received or the mortgage loan returns to accrual status. A mortgage loan may be returned to accrual status when all delinquent principal and interest payments are brought current in accordance with the terms of the loan agreement and certain performance criteria have been met by the borrower.
Interest IncomeLoans Held-For-Investment with Deteriorated Credit Quality
For whole loans purchased that show evidence of a deterioration in credit quality since origination where it is probable we will not collect all contractual cash flows, we will apply the guidance which addresses accounting for differences between contractual cash flows and cash flows expected to be collected from our initial investment in loans or debt securities (loans) acquired in a transfer. The yield that may be accreted (accretable yield) will be limited to the excess of our initial estimate of undiscounted expected principal, interest, and other cash flows (cash flows expected at acquisition to be collected) over our initial investment in the loan. Interest income will be recognized using the accretable yield on a level-yield basis over the life of the loan as long as cash flows can be reasonably estimated. On a quarterly basis, we update our estimate of the cash flows expected to be collected. The excess of contractual
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cash flows over cash flows expected to be collected (nonaccretable difference) will not be recognized as an adjustment of yield, loss accrual or valuation allowance. Subsequent significant increases in cash flows expected to be collected generally will be recognized first to reduce any previously recorded allowance and any remaining increase will be recognized prospectively through adjustment of the loan's accretable yield over its remaining life. The amount of interest income to be recognized cannot result in a carrying amount that exceeds the payoff amount of the loan. Decreases in cash flows expected to be collected will be recognized as an impairment when it is probable that we will no longer be able to collect all amounts estimated to be collected at the time of acquisition plus additional cash flows expected to be collected arising from changes in estimate after acquisition and recognized in prior periods.
Loan Impairment
Loans classified as held-for-investment will be evaluated for impairment on a quarterly basis. Loans held-for-investment will be considered impaired when (i) it is deemed probable that we will not be able to collect all amounts due according to the contractual terms of the loan or, (ii) for loans acquired at a discount to face value, when it is probable that we will no longer be able to collect all amounts estimated to be collected at the time of acquisition plus additional cash flows expected to be collected arising from changes in estimate after acquisition and recognized in prior periods. Impairment will be measured by comparing the recorded amount of the loan to the present value of expected future cash flows discounted at the loan's effective rate, or at the loan's market price or the fair value of the collateral, if the loan is collateral dependent. Upon measurement of impairment, we will record an allowance to reduce the carrying value of the loan and record a corresponding charge to net income. Significant judgments will be required in determining impairment, including estimating future cash flows, making assumptions regarding the value of the loan, the value of the underlying collateral and other provisions such as guarantees.
A loan is also considered impaired if its terms are modified in a troubled debt restructuring (or TDR). A TDR occurs when a company grants a concession to a borrower in financial difficulty by modifying the original terms of the loan. Impairments on TDR loans are measured based on the present value of expected future cash flows discounted at the effective interest rate of the original loan.
Loans Held-for-Sale
Loans classified as held-for-sale will be recorded at the lower of amortized cost and fair value. We will determine fair value of loans held-for-sale by using current secondary market information for loans with similar terms and credit quality. If current secondary market information is not available, we will consider other factors in estimating fair value, including modeled valuations using assumptions management believes a reasonable market participant would use in valuing similar assets (assumptions may include loss rates, prepayment rates, interest rates and credit spreads). If fair value is lower than the amortized cost basis of a loan classified as held-for-sale, we will record a valuation allowance to write the loan down to fair value, with a corresponding charge to net income.
Interest IncomeLoans Held-For-Sale
Interest income on loans held-for-sale is accrued and recognized based on the contractual rate of interest. Purchase price discounts or premiums are an adjustment to the basis of the loan and are deferred until the related loan is sold. We do not apply reserves to these loans as they are recognized at the lower of cost or fair value.
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Securitizations
We may periodically enter into transactions in which we sell financial assets, such as RMBS, CMBS, residential mortgage loans and other assets or we may securitize mortgage loans we hold if such financing is available. These transactions will be accounted for as either a sale and the assets will be removed from our balance sheet or as a financing and will be classified as securitized assets on our balance sheet, depending upon the structure of the securitization transaction. The accounting guidance is complex and may require us to exercise significant judgment in determining whether a transaction should be recorded as a sale or a financing.
To the extent such transfers qualify as sales to non-consolidated entities, gains and losses on such transactions will be recognized based on a financial components approach that focuses on control. Under this approach, after a transfer of financial assets that meets the criteria for treatment as a sale to a non-consolidated entitylegal isolation, ability of transferee to pledge or exchange the transferred assets without constraint, and transferred controlan entity recognizes the financial and servicing assets it acquired or retained and the liabilities it has incurred, derecognizes financial assets it has sold, and derecognizes liabilities when extinguished. We will determine the gain or loss by allocating the carrying value between securities or loans sold and the interests retained based on their fair values. The gain or loss on sale is the difference between the cash proceeds from the sale and the amount allocated to the securities or loans sold.
Upon a transfer of financial assets, we will sometimes retain or acquire senior or subordinated interests in securitization entities created in connection with the sale. Such securitization entities will be evaluated to determine whether they should be consolidated. Generally, a securitization entity will be consolidated by the party that has the power to direct matters that most significantly impact the activities of the entity and has an obligation to absorb losses or a right to receive benefits of the entity that could potentially be significant to the entity. This overall consolidation assessment includes a review of, among other factors, which interests create or absorb variability, contractual terms, key decision making powers, their impact on the vehicle's economic performance, and related party relationships both at inception and on an ongoing basis.
Income Taxes
We have elected to be taxed as a REIT under the Internal Revenue Code commencing with our taxable year ended December 31, 2011. To qualify as a REIT, we must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of our annual REIT taxable income to our stockholders (which is computed without regard to the dividends paid deduction or net capital gain and which does not necessarily equal net income as calculated in accordance with U.S. GAAP). As a REIT, we will not be subject to federal income tax on our taxable income that we distribute to our stockholders. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax on our taxable income at regular corporate income tax rates and generally will not be permitted to qualify for treatment as a REIT for federal income tax purposes for the four taxable years following the year during which qualification is lost unless the Internal Revenue Service grants us relief under certain statutory provisions. Such an event could materially adversely affect our net income and net cash available for distribution to stockholders. However, we intend to organize and operate in such a manner as to qualify for treatment as a REIT.
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Accounting Standards Applicable To Emerging Growth Companies
The JOBS Act contains provisions that relax certain requirements for "emerging growth companies," which includes us. For as long as we are an emerging growth company, which may be up to five full fiscal years, unlike other public companies, we will not be required to (i) comply with any new or revised financial accounting standards applicable to public companies until such standards are also applicable to private companies under Section 102(b)(1) of the JOBS Act, (ii) provide an auditor's attestation report on management's assessment of the effectiveness of our system of internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act, (iii) comply with any new requirements adopted by the PCAOB requiring mandatory audit firm rotation or a supplement to the auditor's report in which the auditor would be required to provide additional information about the audit and the financial statements of the issuer, or (iv) comply with any new audit rules adopted by the PCAOB after April 5, 2012 unless the SEC determines otherwise. We have irrevocably opted-out of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. As a result, we will comply with new or revised accounting standards on the same time frames as other public companies that are not "emerging growth companies."
Recent Accounting Pronouncements
In December 2011, FASB issued ASU No. 2011-11: Disclosures about Offsetting Assets and Liabilities ( or ASU 2011-11) which requires new disclosures about balance sheet offsetting and related arrangements. For derivatives and financial assets and liabilities, the amendment requires disclosure of gross asset and liability amounts, amounts offset on the balance sheet, and amounts subject to the offsetting requirements but not offset on the balance sheet. The guidance is effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods and is to be applied retrospectively for all comparative periods presented. We do not believe the adoption of ASU 2011-11 will have a material impact on our consolidated financial statements.
Liquidity and Capital Resources
Liquidity is a measure of our ability to turn non-cash assets into cash and to meet potential cash requirements. We use significant cash to purchase securities, pay dividends, repay principal and interest on our borrowings, fund our operations and meet other general business needs. Our primary sources of liquidity of our existing cash balances, borrowings under our repurchase agreements, the net proceeds of this offering (as well as future offerings of equity and debt securities) and net cash provided by operating activities, private funding sources, including other borrowings structured as repurchase agreements, securitizations, term financings and derivative contracts, and future issuances of common equity, preferred equity, convertible securities, trust preferred and/or debt securities. We do not currently have any committed borrowing capacity, other than pursuant to the repurchase agreements discussed below.
The borrowings we used to fund the purchase of our portfolio totaled approximately $110.1 million as of September 30, 2012 under master repurchase agreements with two counterparties. As of September 30, 2012, we had entered into master repurchase agreements with three counterparties and had outstanding borrowings with two of these counterparties. We are also in discussions with other financial institutions in order to potentially provide us with additional repurchase agreement capacity.
As of September 30, 2012, we had a total of $137.5 million in fair market value of RMBS pledged against our repurchase agreement borrowings.
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Under repurchase agreements, we may be required to pledge additional assets to our repurchase agreement counterparties (lenders) in the event that the estimated fair value of the existing pledged collateral under such agreements declines and such lenders demand additional collateral which may take the form of additional securities or cash. Generally, our repurchase agreements contain a LIBOR-based financing rate, term and haircuts depending on the types of collateral and the counterparties involved. Further, as of September 30, 2012, the range of haircut provisions associated with our repurchase agreements was between 3% and 5% for Agency RMBS and between 20% and 40% for non-Agency RMBS.
If the estimated fair value of the investment securities increases due to changes in market interest rates or market factors, lenders may release collateral back to us. Specifically, margin calls may result from a decline in the value of the investments securing our repurchase agreements, prepayments on the mortgages securing such investments and from changes in the estimated fair value of such investments generally due to principal reduction of such investments from scheduled amortization and resulting from changes in market interest rates and other market factors. Counterparties also may choose to increase haircuts based on credit evaluations of our company and/or the performance of the bonds in question. The recent disruptions in the financial and credit markets have resulted in increased volatility in these levels, and this volatility could persist as market conditions continue to change rapidly. Should prepayment speeds on the mortgages underlying our investments or market interest rates suddenly increase, margin calls on our repurchase agreements could result, causing an adverse change in our liquidity position. To date, we have satisfied all of our margin calls and have never sold assets in response to any margin call under our repurchase agreement borrowings.
Our borrowings under repurchase agreements are renewable at the discretion of our lenders and, as such, our ability to roll-over such borrowings is not guaranteed. The terms of the repurchase transaction borrowings under our repurchase agreements generally conform to the terms in the standard master repurchase agreement as published by the Securities Industry and Financial Markets Association, or SIFMA, as to repayment, margin requirements and the segregation of all securities we have initially sold under the repurchase transaction. In addition, each lender typically requires that we include supplemental terms and conditions to the standard master repurchase agreement. Typical supplemental terms and conditions, which differ by lender, may include changes to the margin maintenance requirements, required haircuts, and purchase price maintenance requirements, requirements that all controversies related to the repurchase agreement be litigated in a particular jurisdiction and cross default and setoff provisions.
We maintain cash, unpledged Agency RMBS and non-Agency RMBS (which may be subject to various haircuts if pledged as collateral to meet margin requirements) and collateral in excess of margin requirements held by our counterparties (or, collectively, our Cushion) to meet routine margin calls and protect against unforeseen reductions in our borrowing capabilities. Our ability to meet future margin calls will be impacted by our Cushion, which varies based on the fair market value of our securities, our cash position and margin requirements. Our cash position fluctuates based on the timing of our operating, investing and financing activities and is managed based on our anticipated cash needs. As of September 30, 2012, we had a Cushion of $26.5 million.
As of September 30, 2012, we had a total of $3.1 million of restricted cash pledged against our swaps and repurchase agreements. As described elsewhere in this prospectus, we repurchased 265,245 shares of our common stock from one of our institutional stockholders in January 2013 at a purchase price per share equal to our book value per share as of December 31, 2012, which will reduce our available liquidity by approximately $5.7 million
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(based on a purchase price of $21.61 per share, which is our estimated book value per share as of December 31, 2012).
We believe these identified sources of liquidity will be adequate for purposes of meeting our short-term (within one year) liquidity and long-term liquidity needs. However, our ability to meet our long-term liquidity and capital resource requirements may require additional financing. Our short-term and long-term liquidity needs include funding future investments, operating costs and distributions to our stockholders and OP unit holders.
To qualify as a REIT, we must distribute annually at least 90% of our net taxable income. These distribution requirements limit our ability to retain earnings and thereby replenish or increase capital for operations. For more information, see "Distribution Policy."
Cash Generated from Operating Activities
Our operating activities provided net cash of $2.9 million for the nine-month period ended September 30, 2012. The cash provided by operating activities is primarily a result of income earned on our assets.
Our operating activities provided net cash of $1.5 million for the period from July 29, 2011 (the date of our inception) to December 31, 2011. The cash provided by operating activities is primarily a result of income earned on our assets.
Cash Used in Investing Activities
Our investing activities used net cash of $3.3 million for the nine-month period ended September 30, 2012. During the nine-month period ended September 30, 2012, we utilized cash to purchase $83.1 million in RMBS and increased restricted cash by $1.4 million in connection with swap agreements, which was offset by proceeds from the sale of real estate securities of $64.8 million and principal repayments on real estate securities of $16.5 million.
Our investing activities used net cash of $95.8 million for the period from July 29, 2011 (the date of our inception) to December 31, 2011. During the period from July 29, 2011 (the date of our inception) to December 31, 2011, we utilized cash to purchase $107.2 million in RMBS, and $1.7 million became restricted cash in connection with swap agreements, which was offset by proceeds from the sale of real estate securities of $7.2 million and principal repayments of $5.7 million.
Cash Generated from Financing Activities
Our financing activities provided cash of $9.4 million for the nine-month period ended September 30, 2012, which was primarily a result of borrowings from repurchase agreements of $61.9 million, partially offset by repayments of repurchase agreements of $49.4 million and dividend payments of $3.3 million.
Our financing activities provided cash of $100.6 million from the period from July 29, 2011 (the date of our inception) to December 31, 2011, which was primarily a result of borrowings from repurchase agreements of $108.0 million and cash received pursuant to our formation transactions of $3.0 million, which were partially offset by repayments of purchase agreements of $10.4 million.
Contractual Obligations
We have entered into an Investment Advisory Agreement with our Advisor. Our Advisor is entitled to receive a quarterly advisory fee and the reimbursement of certain expenses; however, those obligations do not have fixed and determinable payments. See "Our Advisor
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and the Investment Advisory AgreementAdvisory Fees, Expense Reimbursements and Termination Fee." Additionally, as discussed above under "Liquidity and Capital Resources," the borrowings we used to fund the purchase of our portfolio totaled approximately $110.1 million as of September 30, 2012 under master repurchase agreements with two counterparties. As of September 30, 2012, we had entered into master repurchase agreements with three counterparties and had outstanding borrowings with two of these counterparties. We are also in discussions with other financial institutions in order to potentially provide us with additional repurchase agreement capacity. These borrowings were all due within one year. For more information relating to our borrowings, see "BusinessOur Financing Strategy."
On October 11, 2012, we repurchased 668,525 shares of common stock from our existing stockholders for $14.2 million at a purchase price per share of $21.21 per share which was equal to the per share book value as of July 31, 2012.
On January 24, 2013, we repurchased 265,245 shares of our common stock from one of our institutional stockholders. We paid to such stockholder approximately $5.2 million, which represents 90% of the repurchase amount based on the estimated book value per share as of December 31, 2012, the remaining 10% of the repurchase price will be paid following the completion of our December 31, 2012 year-end audit. This will reduce our available liquidity by approximately $5.7 million (based on a purchase price of $21.61 per share, which is our estimated book value per share as of December 31, 2012).
Off-Balance Sheet Arrangements
As of the date of this prospectus, we had no off-balance sheet arrangements.
Inflation
Virtually all of our assets and liabilities are and will be interest rate sensitive in nature. As a result, interest rates and other factors influence our performance far more so than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Our financial statements are prepared in accordance with U.S. GAAP and our activities and balance sheet shall be measured with reference to historical cost and/or fair market value without considering inflation.
Quantitative and Qualitative Disclosures about Market Risk
The primary components of our market risk are related to interest rate risk, prepayment risk, credit risk and fair market value risk. While we do not seek to avoid risk completely, we believe that risk can be quantified from historical experience and we will seek to actively manage that risk, to earn sufficient compensation to justify taking risk and to maintain capital levels consistent with the risks we undertake.
Interest Rate Risk
Interest rate risk is highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control.
We are subject to interest rate risk in connection with any floating or inverse floating rate investments and our repurchase agreements. Our repurchase agreements may be of limited duration and are periodically refinanced at current market rates. We intend to manage this risk using interest rate derivative contracts. These instruments are intended to serve as a hedge against future interest rate increases on our borrowings.
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We primarily assess our interest rate risk by estimating and managing the duration of our assets relative to the duration of our liabilities. Duration measures the change in the fair market value of an asset based on a change in an interest rate. We generally calculate duration using various financial models and empirical data. Different models and methodologies can produce different duration numbers for the same securities.
The borrowings we used to fund the purchase of our portfolio totaled approximately $110.1 million as of September 30, 2012 under master repurchase agreements with two counterparties. As of September 30, 2012, we had entered into master repurchase agreements with three counterparties and had outstanding borrowings with two of these counterparties. We are also in discussions with other financial institutions in order to potentially provide us with additional repurchase agreement capacity. At September 30, 2012, we also had interest rate swaps with an outstanding notional amount of $32.6 million, resulting in variable rate debt of $77.5 million. A 50 basis point increase in LIBOR would increase the quarterly interest expense related to the $77.5 million in variable rate debt by $0.1 million. Such hypothetical impact of interest rates on our variable rate debt does not consider the effect of any change in overall economic activity that could occur in a rising interest rate environment. Further, in the event of such a change in interest rates, we may take actions to further mitigate our exposure to such a change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, this analysis assumes no changes in our financial structure.
Net Interest Income
Our operating results will depend in large part on differences between the income from our investments and our borrowing costs. Most of our repurchase agreements provide financing based on a floating rate of interest calculated on a fixed spread over LIBOR. During periods of rising interest rates, the borrowing costs associated with our investments tend to increase while the income earned on our fixed interest rate investments may remain substantially unchanged. This will result in a narrowing of the net interest spread between the related assets and borrowings and may result in losses.
Hedging techniques are partly based on assumed levels of prepayments of our RMBS. If prepayments are slower or faster than assumed the effectiveness of any hedging strategies we use will be reduced and may cause losses on such transactions. Hedging strategies involving the use of derivative securities are complex and may produce volatile returns. For more information, see "BusinessOur Hedging Strategy."
Fair Value
Changes in interest rates may also have an impact on the fair market value of the assets we acquire. For more information, see "Factors Impacting Our Operating ResultsChanges in Fair Value of Our Assets."
Prepayment Risk
As we receive prepayments of principal on our investments, premiums paid on such investments will be amortized against interest income. In general, an increase in prepayment rates will accelerate the amortization of purchase premiums, thereby reducing the interest income earned on the investments. Conversely, discounts on such investments are accreted into interest income. In general, an increase in prepayment rates will accelerate the accretion of purchase discounts, thereby increasing the interest income earned on the investments.
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Credit Risk
We are subject to credit risk in connection with our investments. Although we do not expect to encounter credit risk in our Agency RMBS, we do expect to encounter credit risk related to our non-Agency RMBS and other target assets we may acquire in the future. We anticipate that a portion of our assets will be comprised of residential mortgage loans that are unrated. The credit risk related to these investments pertains to the ability and willingness of the borrowers to pay, which is assessed before credit is granted or renewed and periodically reviewed throughout the loan or security term. We believe that residual loan credit quality is primarily determined by the borrowers' credit profiles and loan characteristics.
Extension Risk
If prepayment rates decrease in a rising interest rate environment, the life of the fixed-rate portion of the related assets could extend beyond the term of the swap agreement or other hedging instrument. This could have a negative impact on our results from operations, as borrowing costs would no longer be fixed after the end of the hedging instrument, while the income earned on the hybrid adjustable-rate assets would remain fixed. This situation may also cause the fair market value of our hybrid adjustable-rate assets to decline, with little or no offsetting gain from the related hedging transactions. In extreme situations, we may be forced to sell assets to maintain adequate liquidity, which could cause us to incur losses.
Fair Market Value Risk
We intend to elect the fair value option of accounting on most of our securities investments and account for them at their estimated fair value with unrealized gains and losses included in earnings pursuant to accounting guidance. The estimated fair value of these securities fluctuates primarily due to changes in interest rates and other factors. Generally, in a rising interest rate environment, the estimated fair value of these securities would be expected to decrease; conversely, in a decreasing interest rate environment, the estimated fair value of these securities would be expected to increase.
Risk Management
To the extent consistent with maintaining our REIT qualification, we may seek to manage our risk to protect our stockholders' equity from adverse changes in the fair market value of our investment portfolio and our net interest income from the impact of changing interest rates and prepayment rates. When our Advisor deems appropriate we may incorporate a variety of risk management techniques, including the following:
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General
We are a Maryland corporation that invests in, finances and manages a diversified portfolio of residential mortgage assets, other real estate-related securities and financial assets. We currently primarily invest in, finance and manage non-Agency RMBS and Agency RMBS. Our RMBS strategy focuses on non-Agency RMBS with an emphasis on securities that, when originally issued, were rated in the highest rating category by one or more of the nationally recognized statistical rating organizations, as well as Agency RMBS. Our strategy will also emphasize the purchase of performing and re-performing residential whole loans. We will also have the discretion to invest in other real estate-related and financial assets, MSRs, IOs, CMBS and ABS.
Our income is generated primarily by the net spread between the income we earn on our assets and the cost of our financing and hedging activities. Our objective is to provide attractive risk-adjusted returns to our stockholders, primarily through quarterly distributions and secondarily through capital appreciation.
We completed our formation transaction and commenced operations on July 29, 2011. The formation transaction involved the exchange by investors in two funds from the Matrix VI Funds of cash and RMBS assets for an aggregate of 3,022,617 shares of our common stock. We received $60.5 million in this transaction, including $8.65 million from the ZAIS Parties and deployed the cash together with additional borrowings to build a diversified portfolio of RMBS assets. As part of the initial formation transactions, we anticipated completing our initial public offering on or prior to August 3, 2012 and viewed our initial public offering as a means for our stockholders to achieve liquidity in their investments. We determined, due to our assessment of market conditions, to delay the initial public offering beyond August 3, 2012. In connection with our delay of the initial public offering, we offered to repurchase shares from our stockholders who desired to achieve liquidity around the time of the original August 3, 2012 time frame. Accordingly, on October 11, 2012, we repurchased 668,525 shares of common stock from our existing stockholders at the per share book value as of July 31, 2012. On January 24, 2013, we also repurchased 265,245 shares of our common stock from one of our institutional stockholders. We paid to such stockholder approximately $5.2 million, which represents 90% of the repurchase amount based on the estimated book value per share as of December 31, 2012, the remaining 10% of the repurchase price will be paid following the completion of our December 31, 2012 year-end audit. In October of 2012, we also completed a private placement in which we sold 195,457 shares of common stock and 22,492 OP units at a price per share equal to the per share book value as of August 31, 2012. Subsequently, in December of 2012, we completed another private placement in which we sold 36,581 shares of common stock and 904,422 OP units at a price per share equal to the per share book value as of November 30, 2012. As a consequence of these transactions, we currently have outstanding 2,320,882 shares of common stock and 926,914 OP units. For more information on our history, see "The History and Formation of our Company."
As illustrated by the following table, from the date of the commencement of our operations through September 30, 2012, we have delivered total returns to stockholders that have held our common stock from inception, taking into account both distributions and capital appreciation (measured by increases in our book value per share), of 26.9%. The following table shows our book value per outstanding share of common stock as of our inception date and as of the end of each completed fiscal quarter thereafter, the dividends per share we paid
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with respect to each such quarter, the quarterly total return for each such quarter and the cumulative total return as of the end of each such quarter:
ZAIS Financial Corp. Book Value and Total
|
Book Value
Per Share |
Dividends
Paid |
Quarterly
Total Return (2) |
Cumulative
Total Return (2) |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Commenced operations (July 29, 2011) (1) |
$ | 20.00 | N/A | N/A | N/A | ||||||||
July 29, 2011 through September 30, 2011 |
$ | 18.73 | $ | 0.00 | (6.4 | )% | (6.4 | )% | |||||
Three-month period ended December 31, 2011 |
$ | 18.30 | $ | 0.00 | (2.3 | )% | (8.5 | )% | |||||
Three-month period ended March 31, 2012 |
$ | 20.40 | $ | 0.00 | 11.5 | % | 2.0 | % | |||||
Three-month period ended June 30, 2012 (3) |
$ | 20.42 | $ | 1.08 | 5.4 | % | 7.5 | % | |||||
Three-month period ended September 30, 2012 |
$ | 24.29 | $ | 0.00 | 19.0 | % | 26.9 | % |
All performance data presented above is historical in nature and not indicative of our future results of operations or financial condition. We cannot provide any assurance as to our future results of operations or financial condition, or that our future results of operations or financial condition will be comparable to those presented above.
As of September 30, 2012, we held a diversified portfolio of RMBS assets with an estimated fair market value of $163.4 million, consisting primarily of senior tranches of non-Agency RMBS that were originally highly rated but subsequently downgraded, and Agency RMBS collateralized by either fixed rate loans ARMs. The borrowings we used to fund the purchase of our portfolio totaled approximately $110.1 million as of September 30, 2012 under master repurchase agreements with two counterparties. As of September 30, 2012, we had entered into master repurchase agreements with three counterparties and had outstanding borrowings with two of these counterparties. We are also in discussions with other financial institutions in order to potentially provide us with additional repurchase agreement capacity.
We have elected to be taxed as a REIT for U.S. federal income tax purposes commencing with our taxable year ended December 31, 2011. We are organized in an UpREIT format pursuant to which we serve as the general partner of, and conduct substantially all of our business through, our Operating Partnership subsidiary, ZAIS Financial Partners, L.P., a Delaware limited partnership. We also expect to operate our business so that we are not required to register as an investment company under the 1940 Act.
Current Market Opportunities
Residential Mortgage Market Opportunities
While U.S. financial markets have recovered significantly since the financial crisis that began in 2007, much of the residential mortgage market remains under a great deal of
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distress. The unprecedented liquidity injections into the U.S. financial system have restored stability in the financial sector and supported the flow of capital and credit into the broader economy. At the same time, the U.S. housing market recovery remains tepid, and bank holdings of delinquent mortgage loans remain high. We believe that the slow resolution of mortgage foreclosures has constrained the volume of distressed home sales and may have provided a floor to home prices. This floor has also been supported in some local markets by bulk buyers of foreclosed homes targeting the single family rental market. Continued high levels of "shadow inventory" will likely increase the volume of distressed sales in the future and slow the pace of recovery. While yield levels in the RMBS market have recovered from the depths of the financial crisis and we expect to see further credit spread tightening, we believe the volatility of expected credit performance across the RMBS market presents many opportunities based on individual sector and security selection. In addition, we expect the opportunity to acquire mortgage loans from legacy portfolios to continue for some time as economic risk factors persist.
Reduced Exposure of Banks and Traditional Lenders
Despite generally higher capital levels, many financial institutions continue to reduce their exposure to residential mortgage-related assets including whole loans and MSRs. This is, in part, because the servicing of legacy loan portfolios has become a significant operational risk and resource drain for banks and regulatory changes related to capital requirements have made it more costly for traditional lenders, such as banks, to hold MSRs on their balance sheets. Additionally, we believe that the state of the housing market along with subsequent legislative and regulatory initiatives have permanently altered the mortgage landscape. Banks and traditional lenders face ongoing uncertainties related to the Dodd-Frank Act and other such legislative initiatives. In particular, the Dodd-Frank Act seeks to reform the mortgage-backed securities market by requiring the retention of a portion of the credit risk inherent in the pool of securitized assets and it also imposes significant regulatory restrictions on the origination and securitization of residential mortgage loans. We believe that the requirements imposed by the Dodd-Frank Act and other such legislative initiatives have had an effect on the willingness of some banks and traditional lenders to participate in mortgage loan origination on terms attractive to borrowers, which should lead to attractive risk-adjusted return opportunities for us.
Opportunities Created by Housing Finance Reform
We believe the U.S. housing finance system will evolve at an increasingly rapid pace in the coming years, although the pace of mortgage market restructuring has been slow to date. Currently, the primary mortgage market is being supported by the government's deep involvement through its receivership relationship with Fannie Mae and Freddie Mac, and an indirect subsidization of the FHA. The housing finance reform report issued by the U.S. Department of Treasury and the Department of Housing and Urban Development in February 2011 indicates an intent to reduce the government's role in the residential mortgage market from current levels. The options outlined in the report all share a common objective of significantly increasing the role of private sector capital in bearing credit risk in the residential mortgage market. The October 2011 proposal by the Obama administration to have Fannie Mae and Freddie Mac sell tranches of RMBS that would not carry such entities' guaranty is another example of this trend. It is not yet possible to determine whether or when any of such proposals may be enacted, what form any final legislation or policies might take and how proposals, legislation or policies emanating from this report may impact our business, operations and financial condition. We expect this process of privatizing mortgage credit risk will create attractive investment opportunities consistent with our investment objectives. We believe ZAIS's capabilities in evaluating, acquiring and risk managing residential mortgage
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whole loans will provide us with an important advantage as this new market opportunity evolves.
Credit Constraints and Mortgage Gap
Since 2008, credit availability in the residential mortgage market has been highly constrained, despite the Federal Reserve's monetary policies and other efforts to maintain short term interest rates at relatively low levels. Large segments of potential borrowers have limited access to credit due to tightening credit standards for loans eligible for Fannie Mae, Freddie Mac, or FHA programs. As a result, the average FICO credit scores of borrowers obtaining mortgages eligible for Agency RMBS or for the FHA pools significantly increased since the onset of the financial crisis in 2007. Additionally, non-agency origination programs have contracted significantly, with mortgages eligible for Agency RMBS or FHA pools representing the vast majority of new originations. Many of these changes may be warranted. For example, "low documentation loans," which refer to loans in which the underlying documentation or application process requires little information with respect to the employment, income or assets of the proposed borrower, as a percentage of all mortgage loans originated, fell sharply beginning in 2008 and these types of mortgages are, for the most part, no longer being originated. However, the impact of the mortgage crisis has gone beyond just increasing the requisite credit standards of lenders, as it has, in our view, created a mortgage gap for many qualified borrowers. We believe that credit availability in the residential mortgage market will remain highly constrained over the next several years, which will present an opportunity for new providers of mortgage credit to emerge as the government's share of mortgage origination declines.
ZAIS's Investment Platform
We believe that ZAIS's investment platform is well positioned to take advantage of the current investment environment. ZAIS currently invests in both residential mortgage loans and RMBS, which allows it to seek risk-adjusted returns regardless of the investment form. We believe that ZAIS's capability to model, analyze, diligence, acquire, structure and manage risk across both residential mortgage loans and RMBS is an important part of our value proposition. As market conditions change over time, ZAIS intends to adjust its strategy by shifting its asset allocations across our target asset classes to take advantage of changes in interest rates and credit spreads as well as economic and credit conditions. Furthermore, the robustness of ZAIS's credit modeling and analytics framework is enhanced by its access to various loan level data. ZAIS's existing loan platform has servicing oversight and asset management capabilities at the individual loan level that we believe will enable us to acquire and manage loan risk prudently. ZAIS's existing loan platform, and corresponding relationships, also provides a sourcing advantage for acquiring risk in unsecuritized assets such as mortgage loans and MSRs. For more information, see "General."
Our Advisor
We are externally managed and advised by our Advisor, a subsidiary of ZAIS, pursuant to an Investment Advisory Agreement. Our Advisor has entered into a shared facilities and services agreement with ZAIS, pursuant to which ZAIS provides our Advisor with the personnel, systems and services needed to run our business. Our Advisor may, without our consent, assign the Investment Advisory Agreement to a majority-owned and controlled affiliate of ZAIS. It is expected that, in the event of such an assignment, ZAIS employees will support the affiliate in providing services to us.
ZAIS was established in 1997 as a Delaware limited liability company and is an SEC registered investment adviser specializing in structured credit, including residential whole
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loans, RMBS and ABS. As of September 30, 2012, ZAIS estimates that it had approximately $5.5 billion of assets under management (comprised of the net asset value of ZAIS-managed funds, and the aggregate principal balance of CDO vehicles and other entities, which do not mark their securities to fair market value under U.S. GAAP) and has built long-term relationships with a global investor base, including public and private pension funds, endowment/foundations, insurance companies, family offices, fund of funds, sovereign wealth funds and investment advisors. As of September 30, 2012, ZAIS's team included 123 professionals in the United States, Europe and Asia.
ZAIS has been an active investor across the structured finance and credit markets since 1997. ZAIS established its first strategy dedicated exclusively to the mortgage sector in 2006 with the formation of the Scepticus Funds. The Scepticus Funds consisted of predominantly short investments and sought to capitalize by selectively shorting credits that were structurally inferior based on certain collateral. In 2006, ZAIS formed the Matrix V Funds, which are primarily focused on investing in collateral loan obligations, CDOs and RMBS assets, including subordinate and distressed credits. Beginning in late 2007, ZAIS formed the Matrix VI Funds, which deployed a long only, unlevered strategy seeking to capitalize on the market dislocation and leverage unwind in the mortgage securities sector. In August 2008, ZAIS formed the SerVertis Fund which is focused on acquiring distressed residential loan portfolios (whether through loan acquisitions or structured securities backed by residential loans) and controlling the loans by utilizing the mortgage servicing and collections platform of a mortgage servicer with which ZAIS has formed a strategic relationship. ZAIS manages the SerVertis Fund and has engaged a sub-advisor to assist ZAIS in asset selection and disposition decisions. ZAIS also formed the 2009-2010 Managed Accounts, which are accounts for certain institutional investors seeking to capitalize on a strategy similar to the Matrix VI Funds through a separate managed account format. In 2012, ZAIS formed the ZAIS Mortgage Securities Fund and the INARI Fund. Additionally, ZAIS entered into an investment advisory agreement to serve as the investment advisor to the 2012 Managed Account. ZAIS serves as the investment advisor to each of these funds formed in 2012 and the 2012 Managed Account, which deploy predominantly long strategies focused on opportunities in the RMBS sector and, in some instances, utilize explicit leverage and utilize derivative financial instruments to mitigate mark-to-market risk on the predominantly long positions held by each fund.
In addition to RMBS and residential mortgage loan focused funds, in 2003, ZAIS established the ZAIS Opportunity Fund with a focus on investing in various structured finance securities, including a permitted investment in certain of our target assets. Unlike the Matrix Funds and the SerVertis Fund, the ZAIS Opportunity Fund has no defined reinvestment period and the ability to accept new subscriptions of capital. Accordingly, we may compete with the ZAIS Opportunity Fund for both our target assets and for ZAIS's resources. ZAIS has also served as the collateral manager of a number of CDO vehicles, some of which encountered events of default as a result of ratings downgrades during the recent financial crisis.
Our Advisor provides us with valuable market insights, through ZAIS's research and surveillance capabilities. ZAIS possesses a comprehensive analytics and data infrastructure, credit modeling, loan and securities valuation, loan data management and servicing oversight capabilities, as well as significant structuring and securitization experience. We also benefit from ZAIS's operational support in areas such as finance and accounting, administration, compliance, investor relations, trade execution, securities valuation, risk management and information technology in connection with the performance of its duties.
Pursuant to the terms of its Investment Advisory Agreement with us, and its shared facilities and services agreement with ZAIS, our Advisor and its affiliates provide us with our management team, including our chief executive officer and chief financial officer, along with appropriate support personnel. Each of our officers and directors is also an employee of ZAIS
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or its affiliates. We do not have any employees. Our Advisor and its affiliates are not obligated to dedicate any of their respective employees exclusively to us, nor are our Advisor, its affiliates or any of their employees obligated to dedicate any specific portion of its or their time to our business. Our Advisor is at all times subject to the supervision and oversight of our Board.
Our Competitive Advantages
Significant Experience of ZAIS
Founded in 1997, ZAIS focuses on alternative investment strategies in the credit markets. ZAIS has been an active investor in residential mortgage loans, non-Agency RMBS and ABS. Additionally, ZAIS's senior management team has previous experience investing in a wide array of other asset classes, including Agency RMBS and MSRs. As the mortgage market deteriorated in 2007, ZAIS began to raise capital to invest in distressed residential mortgage securities and loans. Since September 2007, ZAIS attracted approximately $2.6 billion (as of September 30, 2012) in capital commitments from investors for distressed mortgage investment mandates. ZAIS has built long-term relationships with a global investor base, including public and private pension funds, endowment/foundations, insurance companies, family offices, fund of funds, sovereign wealth funds and investment advisors. ZAIS manages assets using a range of strategies and investment vehicles, including private equity-style funds, hedge funds and separately managed accounts. Most recently, ZAIS has established managed accounts and dedicated funds on behalf of individual investors that focus on opportunities in the RMBS sector and, in some instances, utilize derivative financial instruments to hedge against changes in the fair value of RMBS in periods of general market risk aversion. We believe that ZAIS's senior management team, which has a long track record and broad experience in managing mortgage loan and RMBS assets through a variety of credit and interest rate environments, will provide us with a competitive advantage. For a description of ZAIS's historical performance, see "Our Advisor And The Investment Advisory AgreementHistorical Performance of Certain Funds and Managed Accounts Managed by ZAIS."
Whole Loan Investment Platform
We believe ZAIS's capabilities in managing residential whole loan investments will provide us with a competitive advantage in acquiring loans that offer relative value advantages to non-Agency RMBS assets backed by similar loan collateral. In addition, ZAIS's whole loan investment capabilities will provide us with the capability to invest in newly originated loans as the mortgage market is restructured to significantly increase the role of private sector capital in bearing mortgage credit risk. See "Current Market Opportunities." Since inception through September 30, 2012, the SerVertis Fund, which is managed by ZAIS, has purchased 9,374 loans, totaling $2.2 billion in unpaid principal balance. Over the same period, the SerVertis Fund has liquidated 1,560 loans, totaling $384.4 million in unpaid principal balance, and modified 776 loans, totaling $198.1 million in unpaid principal balance. Over the last two years, ZAIS, working with investment banking intermediaries, has securitized performing, re-performing and non-performing loans totaling $1.2 billion in unpaid principal balance in both rated and unrated transactions. ZAIS's modelling, analytics and risk management platforms have been developed and are currently utilized across the whole loan and RMBS sectors, providing a disciplined, consistent investment approach across markets. Proprietary database and analytics applications provide the infrastructure for fully developed loan level due diligence, servicing oversight and loss mitigation capabilities. We believe ZAIS's servicing relationships and its ability to provide loan level loss mitigation decisions can enhance the performance of a distressed mortgage loan portfolio. Core to the ZAIS asset management framework is an integrated process for managing asset selection, due diligence,
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securitization and servicing strategy in order to achieve our targeted returns. We believe these well-developed capabilities and the scalable technology on which they are built, will provide us with the ability to move and adapt quickly as the mortgage whole loan market evolves.
Access to ZAIS Infrastructure
ZAIS maintains a proprietary database, analytics and modeling infrastructure. This infrastructure is focused on loan level data aggregation, evaluation and modeling, allowing ZAIS to apply a common analytics platform across the residential mortgage loan and securities markets. It integrates the analysis of borrower credit, collateral (property) value and economic variables to forecast loan prepayment, delinquency, default, and recovery rates. Utilizing a common analytics platform for both securities and loans enables ZAIS to make relative value allocations across these sectors. We expect to benefit from these systems and tools, as well as an established qualitative approach to originator, issuer and servicer due diligence, for our benefit in evaluating, acquiring and managing our investment portfolio. We believe that ZAIS's rigorous approach will support us in a variety of market conditions.
Extensive Strategic Relationships
ZAIS maintains extensive long-term relationships with other financial intermediaries, including primary dealers, leading investment banks, brokerage firms, leading mortgage originators, mortgage servicers and commercial banks. ZAIS-managed funds actively source investments, finance positions, hedge exposures, and securitize assets with these counterparties currently. We believe these relationships enhance our ability to source, finance and hedge investment opportunities and, thus, enable us to grow in various credit and interest rate environments.
Alignment of Interests
We have taken steps to structure our relationship with ZAIS and our Advisor so that our interests and those of ZAIS and our Advisor are closely aligned. Upon completion of this offering, the ZAIS Parties will beneficially own 543,705 shares and OP units, or %, of our outstanding common stock (or % if the underwriters fully exercise their overallotment option). These shares will be subject to a 270-day lock-up following this offering. We believe that the investment in us by the ZAIS Parties has aligned ZAIS and our Advisor's interests with our interests and creates an incentive to maximize returns, while prudently managing risks, for our stockholders.
Our Investment Strategy
Our objective is to provide attractive risk-adjusted returns to our stockholders over the long-term, primarily through quarterly distributions and secondarily through capital appreciation. We intend to achieve this objective by selectively constructing a portfolio of our target assets. We may utilize ZAIS's existing whole loan investment platform to purchase loans originated prior to the financial crisis that began in 2007 at prices below the par amount of unpaid principal. We believe that our target assets currently present attractive risk-adjusted return profiles and that current market conditions present opportunities for us to selectively acquire our target assets at attractive trading prices. As market conditions change over time, we intend to adjust our strategy by shifting our asset allocations across our target asset classes to take advantage of changes in interest rates and credit spreads as well as economic and credit conditions. For example, our Advisor is actively reviewing for us a pipeline of multiple whole loan portfolio transactions totaling approximately $680 million in unpaid principal balance. Although there can be no assurance that any such transactions will be completed, the pipeline is reflective of the type and size of opportunities that may be available
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for us in this asset class. We believe that the diversification of our portfolio of assets, our expertise among mortgage loans and securities and the flexibility of our strategy will position us to generate attractive risk-adjusted returns for our stockholders over the long-term.
We rely on our Advisor's investment expertise in identifying assets within our target assets and efficiently financing those assets. Our Advisor makes investment decisions based on a variety of factors, including expected risk-adjusted returns, credit fundamentals, liquidity, availability of adequate financing, borrowing costs and macroeconomic conditions, as well as maintaining our REIT qualification and our exemption from registration under the 1940 Act. We intend to follow a predominantly long-term buy and hold strategy with respect to the assets that we acquire.
We have elected to be taxed as a REIT for U.S. federal income tax purposes commencing with our taxable year ended December 31, 2011 and to operate our business so as to be exempt from registration under the 1940 Act. See "Operating and Regulatory Structure." Subject to maintaining our REIT qualification and our 1940 Act exemption, we do not have any limitations on the amounts we may acquire of our targeted asset class.
Our Portfolio
The following diagram and table illustrate our asset types and set out certain information with respect to our RMBS assets as of September 30, 2012.
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The following diagrams illustrate the seniority and vintage of our non-Agency RMBS as of September 30, 2012.
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As of September 30, 2012, the five states that represented the largest portion of mortgage loans underlying our non-agency RMBS assets (measured by outstanding principal balance) were: California (44.3%); Florida (7.6%); New York (6.7%); Virginia (4.6%); and New Jersey (4.3%).
Non-Agency RMBS Additions
Our strategy includes a focus on non-Agency RMBS assets. We rely on ZAIS's capabilities to select non-Agency RMBS that meet our investment objectives and offer attractive return characteristics, and monitor their performance on an ongoing basis. The above diagrams illustrate the underlying collateral, seniority and vintage of our non-Agency RMBS assets as of September 30, 2012.
Agency RMBS Additions
Our strategy includes the acquisition of Agency RMBS which represent attractive investment opportunities and will help us to manage liquidity risk within our investment portfolio. We rely on ZAIS's capabilities to evaluate and manage our exposure to product
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sectors within Agency RMBS, evaluate and execute hedging strategies, and efficiently finance these positions. As prepayment rates have been increasingly dependent upon borrowers' credit characteristics and performance, we believe ZAIS's extensive experience in analyzing and forecasting mortgage credit performance will provide strong insight into the Agency RMBS market.
Legacy Loan Acquisitions
We may utilize ZAIS's existing whole loan investment platform to purchase loans originated prior to the financial crisis that began in 2007 at prices below the par amount of unpaid principal. We expect these loans will be primarily, but not exclusively, performing and re-performing loans at the time of acquisition. Generally, these loans are deemed by the seller to carry an elevated risk of default, and are sold in an effort to manage portfolio credit risk at the institution. ZAIS's whole loan investment platform, principally through the SerVertis Fund, has been active in sourcing, evaluating, purchasing, financing, securitizing and risk managing loans of similar characteristics. We believe ZAIS's capabilities in forecasting credit performance, pricing mortgage loan risk and performing collateral due diligence will enable ZAIS and us to identify and invest in loans that offer relative value advantages to non-Agency RMBS securities backed by similar loan collateral. Importantly, we also believe ZAIS's loan level asset management skills and experience, including servicing and loan modification oversight, and loss mitigation efforts will enable us to achieve our expected returns while minimizing the operational risk of investing in mortgage whole loans.
Newly Originated Mortgage Loans
Over time, we expect to evolve our whole loan investment strategy to one that may be focused primarily on newly originated loans. The timing and pace of this shift will be dictated by a number of factors including the restructuring of the government's role in the mortgage market, the stability and recovery of the housing market, overall economic conditions and transparency of regulatory changes affecting the mortgage origination market. See "Current Market OpportunitiesOpportunities Created by Housing Finance Reform." Over the long-term, we expect investments in newly originated loans to be a core component of our investment strategy and a key differentiator of our performance. We believe ZAIS's existing whole loan investment platform will enable us to transition into this phase of our investment strategy in a timely, yet controlled, manner. We believe ZAIS's mortgage credit expertise will provide us with important insight into the selection and pricing of newly originated loans. In addition, we believe ZAIS's whole loan asset management capabilities, including its ability to perform due diligence, risk management and servicing oversight, will enable us to grow the new origination investment strategy quickly, without taking on the undue operational risk often associated with such growth.
Our Target Assets
Our target assets are as follows:
Non-Agency RMBS
Non-Agency RMBS are RMBS that are not issued or guaranteed by a U.S. Government agency or federally chartered corporation. Non-Agency RMBS represent securitized interests in "pools" of mortgage loans secured by residential real property. Non-Agency RMBS may be rated as high as AAA through unrated, although we expect to acquire primarily senior tranches that were originally highly rated but may have been subsequently downgraded. The rating, as determined by one or more of the rating agencies, including Fitch, Moody's and Standard & Poor's, indicates the creditworthiness of the investment (which is the obligor's ability to meet its
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financial commitment on the obligation). The mortgage loan collateral for non-Agency RMBS consists of residential mortgage loans that do not generally conform to underwriting guidelines issued by a federally chartered corporation, such as Fannie Mae or Freddie Mac, or an agency of the U.S. Government, such as Ginnie Mae, due to certain factors, including mortgage balances in excess of agency underwriting guidelines, borrower characteristics, loan characteristics and level of documentation, and therefore are not issued or guaranteed by an agency. The mortgage loan collateral may be classified as prime, subprime and alternative-A and alternative-B mortgage loans, which may be adjustable-rate, hybrid and/or fixed-rate residential mortgage loans and pay option adjustable-rate mortgage loans.
Agency RMBS
Agency RMBS are RMBS that are issued or guaranteed by a U.S. Government agency, such as Ginnie Mae, or federally chartered corporation, such as Fannie Mae or Freddie Mac. Payments of principal and interest on Agency RMBS, not the fair market value of the securities themselves, are guaranteed. Agency RMBS are collateralized by either fixed rate loans, ARMs or hybrid ARMs.
Residential Mortgage Loans
Residential mortgage loans are prime, subprime and alternative-A and alternative-B mortgage loans, which may be adjustable-rate, hybrid and/or fixed-rate residential mortgage loans and pay option adjustable-rate mortgage loans. We expect that the residential mortgage loans that we may acquire will be primarily, but not exclusively, performing and re-performing loans at the time of acquisition. We will acquire residential mortgage loans primarily through direct purchases from selected sellers. We intend to enter into mortgage loan purchase agreements with a number of sellers, including investment banks, commercial banks, savings and loan associations, loan originators, home builders, credit unions and mortgage conduits. We may purchase mortgage loans on both the primary and secondary markets. We expect these loans to be secured primarily by residential properties in the United States.
We will seek to obtain various representations and warranties from each seller although such representations and warranties may be limited, or in some cases, non-existent. A seller who breaches these representations and warranties may be obligated to repurchase the loan from us. As added security, we will use the services of a third-party document custodian to insure the quality and accuracy of all individual mortgage loan closing documents and to hold the documents in safekeeping. As a result, to the extent available, all of the original loan collateral documents that are signed by the borrower, other than the original credit verification documents, are examined, verified and held by the third-party document custodian.
We expect over time to evolve our whole loan strategy to include newly originated loans, which may also become a core component of our strategy and a key differentiator of our performance. We initially expect to retain rated servicers to service our mortgage loan portfolio. We may also purchase certain residential mortgage loans on a servicing-retained basis.
We may acquire residential mortgage loans for our portfolio with the intention of either holding them in our residential mortgage loan portfolio or securitizing and retaining them in our portfolio as securitized mortgage loans. RMBS are typically issued in multiple tranches whereby the more senior classes are entitled to priority distributions from the trust's income to make specified interest and principal payments on such tranches. Losses and other shortfalls from expected amounts to be received on the mortgage pool are borne by the most junior classes, which receive principal payments only after the more senior classes have received all principal payments to which they are entitled. We may sell the most senior notes or certificates and retain the junior notes or certificates associated with a securitization. We may also finance our residential mortgage loan portfolio through the use of repurchase agreements.
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Once a potential residential loan pool has been identified for purchase, our Advisor and the third parties it engages will analyze the loan pool and conduct due diligence as part of the underwriting process. As part of this process, the key factors which underwriters or our Advisor will consider include documentation, borrower credit, debt-to-income ratio, property valuation and loan-to-value ratios. This diligence may be done by an affiliated entity, or an unrelated third party. The diligence findings are then measured along with other key factors such as price of the pool, geographic concentrations and type of product to determine the pool's relative attractiveness. Our Advisor will refine its asset selection criteria based upon actual loan portfolio experience and as market conditions and investor requirements evolve.
Agency CMOs
Our Agency RMBS assets may include collateralized mortgage obligations (or CMOs) which are securities that are structured from U.S. Government agency or federally chartered corporation-backed mortgage pass-through certificates. CMOs divide the cash flows which come from the underlying mortgage pass-through certificates into different classes of securities, and can have different maturities and different weighted average lives than the underlying mortgage pass-through certificates. CMOs can re-distribute the risk characteristics of mortgage pass-through certificates to better satisfy the demands of various investor types. These risk characteristics would include average life variability, prepayments, volatility, floating versus fixed interest rate and payment and interest rate risk.
Other Real Estate-Related and Financial Assets
Subject to maintaining our qualification as a REIT, over time, we may acquire securities, including MSRs, IOs, CMBS, ABS, as well as common stock, preferred stock and debt, of other real estate-related entities.
MSRs
An MSR provides a mortgage servicer with the right to service a pool of mortgages in exchange for a portion of the interest payments made on the underlying mortgages. As MSRs are a combination of rate-sensitive, rate insensitive and intangible assets, they are difficult to hedge and introduce substantial amounts of volatility to financial reporting. GSE reform, the Dodd-Frank Act, and most importantly, Basel III, developed by the Basel Committee on Banking Regulations and Supervisory Practices, are expected to increase the costs for banks to hold MSRs. Moreover, we expect that Basel III, in particular, will likely impact the largest bank servicers, as they have the largest MSRs as a percentage of Tier 1 Capital (as defined in Basel III). Basel III will require banks to hold 100% capital against MSRs in excess of 10% of Tier 1 Capital. The banking regulators have not yet adopted Basel III or issued the new capital rules required by the Dodd-Frank Act, and as such it is not possible to predict the extent to which it will be more costly for banks to hold MSRs.
IOs
"Interest only" securities are mortgage-backed securities structured with two or more classes that receive different distributions of principal or interest on a pool of Agency RMBS or non-Agency RMBS or whole loans. IOs receive only interest. The yield to maturity on IOs is extremely sensitive to the rate of principal payments (including prepayments) on the related underlying assets.
CMBS
CMBS are securities backed by obligations (including certificates of participation in obligations) that are principally secured by commercial mortgages on real property or
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interests therein having a multifamily or commercial use, such as regional malls, other retail space, office buildings, industrial or warehouse properties, hotels, apartments, nursing homes and senior living facilities. The underlying mortgage collateral may be fixed or floating-rate mortgage loans.
CMBS are typically issued in multiple tranches whereby the more senior classes are entitled to priority distributions from the trust's income to make specified interest and principal payments on such tranches. Losses and other shortfalls from expected amounts to be received on the mortgage pool are borne by the most subordinate classes, which receive principal payments only after the more senior classes have received all principal payments to which they are entitled. The credit quality of CMBS depends on the credit quality of the underlying mortgage loans, which is a function of factors such as the principal amount of loans relative to the value of the related properties; the cash flow produced by the property; the mortgage loan terms, such as amortization; market assessment and geographic location; construction quality of the property; and the creditworthiness of the borrowers.
ABS
Subject to maintaining our qualification as a REIT, we may acquire debt and equity tranches of securitizations backed by various asset classes, including small balance commercial mortgages, manufactured housing, aircraft, automobiles, credit cards, equipment, manufactured housing, franchises, recreational vehicles and student loans. To the extent such securities are treated as debt of the issuer of the securitization vehicle for U.S. federal income tax purposes, we will hold the securities directly, subject to the requirements of our continued qualification as a REIT as described in "U.S. Federal Income Tax ConsiderationsTaxation of Our CompanyAsset Tests." To the extent the securities represent equity interests in the issuer of the securitization for U.S. federal income tax purposes, we may hold such securities through a TRS, which may cause the income recognized with respect to such securities to be subject to U.S. federal (and applicable state and local) corporate income tax. Investments in ABS generally are not qualifying assets for purposes of the 75% asset test applicable to REITs and generally do not generate qualifying income for purposes of the 75% gross income test applicable to REITs. As a result, we may be limited in our ability to invest in such assets. See "U.S. Federal Income Tax Considerations."
Asset Allocations
Based on current market conditions, over time, we expect to allocate an estimated: 50% to 60% of our equity to whole loans; 30% to 40% of our equity to non-Agency RMBS; 5% to 10% of our equity to MSRs, other real estate-related and financial assets and cash; and 0% to 5% of our equity to Agency RMBS. As market conditions change, we intend to adjust our strategy by shifting our asset allocations across our target asset classes. We believe that the diversification of our portfolio of assets, our expertise among our target assets and the flexibility of our strategy will position us to generate attractive risk-adjusted returns for our stockholders in a variety of assets and market conditions. We will rely on our Advisor's expertise in identifying assets within the target assets described above and, to the extent that leverage is employed, efficiently financing those assets. We expect allocation decisions will be based on a variety of factors, including expected risk-adjusted returns, credit fundamentals, and liquidity.
Investment Guidelines
Our Board, which includes our Chief Executive Officer and President, Michael Szymanski, has adopted a set of investment guidelines that sets forth our target assets and other criteria used to evaluate specific assets as well as the overall portfolio composition. Our Advisor
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makes determinations as to the percentage of assets that will be invested in each of the target asset classes, consistent with the investment guidelines adopted by our Board. Our Advisor's investment decisions will depend on prevailing market conditions and may change over time in response to opportunities available in different interest rate, economic and credit environments. As a result, we cannot predict the percentage of assets that will be invested in any of the target asset classes at any given time, and such allocations may differ from the allocations provided above. In addition, our investment guidelines may be changed from time to time by our Board without the approval of our stockholders. Changes to our investment guidelines may include, without limitation, modification or expansion of the types of assets in which we may invest. To the extent that our Board approves material changes to our investment guidelines, we will inform stockholders of such changes through disclosure in our periodic reports and other filings required under the Exchange Act.
Our Advisor's investment committee reviews our compliance with our guidelines periodically and our Board will receive a report at each quarter end in conjunction with its review of our quarterly results. Our Board also will review our portfolio of assets and related compliance with our policies and procedures and guidelines at each regularly scheduled Board meeting.
Our Board has adopted the following guidelines for our assets and borrowings:
These guidelines may be changed from time to time by a majority of our Board without the approval of our stockholders.
Asset Sourcing
ZAIS and its affiliates have extensive long-term relationships with financial intermediaries, including primary dealers, investment banks, brokerage firms, repurchase agreement counterparties, leading mortgage originators and commercial banks. Funds currently managed by ZAIS actively utilize these relationships to source, finance and securitize both RMBS and whole loan assets. We expect our Advisor and its affiliates to take advantage of their broad network of relationships to identify opportunities for us to acquire our target assets.
Acquiring, and sourcing financing for, our target assets is highly competitive. Our Advisor and its affiliates compete with many other investment managers for profitable acquisition opportunities in fixed income asset classes and related acquisition opportunities and sources of financing.
Asset Acquisition Process
We expect that our asset acquisition process will benefit from the resources and professionals of our Advisor and its affiliates. Our Advisor's initial investment committee, which is comprised of Christian Zugel, Denise Crowley, Michael Szymanski, Rick Nicklas, Brian Hargrave and Glenn Boyd, oversees our asset acquisition and financing strategies as well as
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compliance with our guidelines and meets periodically to discuss our strategies. For biographical information of members of our Advisor's investment committee, please see "Our Advisor and the Investment Advisory AgreementBiographical Information."
Our asset acquisition process is an integrated approach that combines the work of experienced real estate professionals and dedicated analytical modeling teams. The process begins with the development of a broad based macro view which includes detailed analysis of fundamental housing, mortgage and fixed income market trends, and our Advisor's assessment of how prevailing conditions will impact general credit performance, prepayment rates and interest rates. Our Advisor then conducts a rigorous review of the market in order to determine which sectors offer relative value.
ZAIS has maintained a philosophy that the key to successful risk management is proper asset selection and appropriate compensation for the risks inherent in its portfolio loans and securities. As such, ZAIS's analytical approach incorporates multiple scenario analysis, both in static and simulation based frameworks, to assess the risk component of assets. In particular, ZAIS's loan level default and loss severity models include (i) a roll rate model which incorporates over 30 collateral characteristics, (ii) credit bureau information which includes updated credit scores, lien analysis and fraud indicators, (iii) credit availability variables, (iv) separate models for legacy and newly originated loans, (v) servicing advance and geographic specific cost and timeline analysis and (vi) a proprietary based home price model. ZAIS emphasizes transparency in its modeling, in various ways, including: (i) monthly reconciliation of actual vs. projected performance and (ii) attribution tools that display incremental impacts of changes in variables.
The analytics platform allows our Advisor's portfolio managers to benchmark the loans, or loans backing an RMBS security, against similar collateral cohorts across the non-Agency RMBS universe. This analysis, which is an integrated approach to both RMBS assets and whole loan packages, shows the risk profile of returns across a variety of macroeconomic environments. Portfolio managers can conduct this analysis across a broad range of assets available in the market, effectively creating an "efficient frontier" of available investments. Our Advisor also has an extensive database of trading price history on loans and RMBS that enables portfolio managers to see where various assets have traded over time.
Our Advisor monitors our RMBS assets, and expects to monitor our loans, through a variety of credit surveillance techniques and models which include severity attribution analysis detailing the impact of timeline extension and changes in home prices. Additionally, the models analyze the performance differentials between the securitized loans and whole loans, providing insight into servicer performance and other idiosyncratic measures.
Asset Monitoring
We do not utilize a ranking or classification methodology for evaluating or categorizing investment risk. Rather, our approach is scenario based and attempts to establish a range of expected outcomes based on changes to various macroeconomic and idiosyncratic risk factors. Each investment is then evaluated based upon its expected returns across this range of outcomes. The resulting investment return profile can then be compared to other assets to assess relative value and risk. This methodology is used both to evaluate potential asset purchases, as well as on an ongoing basis to monitor portfolio investments.
Our Financing Strategy
We fund the acquisition of our target assets through the use of prudent amounts of leverage. The borrowings we used to fund the purchase of our portfolio totaled approximately $110.1 million as of September 30, 2012 under master repurchase agreements with two
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counterparties. As of September 30, 2012, we had entered into master repurchase agreements with three counterparties and had outstanding borrowings with two of these counterparties. We are also in discussions with other financial institutions in order to potentially provide us with additional repurchase agreement capacity. We may also, in the future, finance investments in our target assets through other private funding sources, including borrowings structured as securitizations and term financings.
Our income is generated primarily by the net spread between the income we earn on our assets and the cost of our financing and hedging activities. Although we are not required to maintain any particular leverage ratio, the amount of leverage we deploy for particular investments in our target assets depends upon our Advisor's assessment of a variety of factors, which may include the anticipated liquidity and price volatility of the assets in our investment portfolio, the gap between the duration of our assets and liabilities, including hedges, the availability and cost of financing the assets, our opinion of the creditworthiness of our financing counterparties, the health of the U.S. economy and residential and commercial mortgage-related markets, our outlook for the level, slope, and volatility of interest rates, the credit quality of collateral underlying our non-Agency RMBS, Agency RMBS, residential mortgage loans and other target assets, our outlook for asset spreads relative to the LIBOR curve and regulatory requirements limiting the permissible amount of leverage to be utilized. Based on current market conditions, we expect that we may deploy, on a debt-to-equity basis, up to nine to one leverage on our Agency RMBS assets. In addition, we expect that we may deploy, on a debt-to-equity basis, up to three to one leverage on our non-Agency RMBS assets and up to four to one leverage on our residential whole loans. To the extent we securitize any residential mortgage loans in the future, we expect that the leverage obtained through such structures will vary considerably depending on the characteristics of the underlying loans.
We intend to use leverage for the primary purpose of financing our portfolio and not for the purpose of speculating on changes in interest rates. We are, however, limited or restricted in the amount of leverage we may employ by the terms and provisions of our existing repurchase agreement borrowings as well as other financing agreements that we may enter into in the future. We may also be subject to margin calls as a result of our financing activity. In addition, we intend to rely on short-term financing such as repurchase transactions under master repurchase agreements, the duration of which is typically 30 to 90 days but in some cases may be longer.
Our Hedging Strategy
We utilize derivative financial instruments to hedge the interest rate risk associated with our borrowings. Under the U.S. federal income tax laws applicable to REITs, we generally will be able to enter into certain transactions to hedge indebtedness that we may incur, or plan to incur, to acquire or carry real estate assets, although our total gross income from interest rate hedges that do not meet this requirement and other non-qualifying sources generally must not exceed 5% of our gross income.
Subject to maintaining our qualification as a REIT and exemption from registration under the 1940 Act, we may also engage in a variety of interest rate management techniques that seek on the one hand to mitigate the influence of interest rate changes on the values of some of our assets and on the other hand help us achieve our risk management objectives. The U.S. federal income tax rules applicable to REITs may require us to implement certain of these
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techniques through ZAIS I TRS or another domestic TRS, either of which will be fully subject to federal corporate income taxation. Our interest rate management techniques may include:
We may attempt to reduce interest rate risks and to minimize exposure to interest rate fluctuations through the use of match funded financing structures, when appropriate, whereby we may seek (i) to match the maturities of our debt obligations with the maturities of our assets and (ii) to match the interest rates on our assets with like-kind debt (i.e., we may finance floating rate assets with floating rate debt and fixed-rate assets with fixed-rate debt), directly or through the use of interest rate swap agreements, interest rate cap agreements, or other financial instruments, or through a combination of these strategies. We expect these instruments will allow us to minimize, but not eliminate, the risk that we have to refinance our liabilities before the maturities of our assets and to reduce the impact of changing interest rates on our earnings. As of September 30, 2012, we had outstanding interest rate swap agreements designed to mitigate the effects of increases in interest rates under a portion of our repurchase agreements. These swap agreements provide for us to pay fixed interest rates and receive floating interest rates indexed off of LIBOR, effectively fixing the floating interest rates on $32.6 million of borrowings under our repurchase agreements as of September 30, 2012. See "Management's Discussion and Analysis of Financial Condition and Results of OperationsResults of OperationsDerivative Instruments" for a further discussion of our hedging instruments as of September 30, 2012.
Risk management is an important component of our strategy to deliver consistent risk-adjusted returns to our stockholders. Because we hold and intend to acquire primarily RMBS and mortgage loans, losses from credit defaults, interest rate volatility or other risks can meaningfully reduce or eliminate our distributions to stockholders. In addition, because we employ financial leverage in funding our portfolio, mismatches in the maturities of our assets and liabilities may create the need to renew or otherwise refinance our liabilities. Our net interest margins are dependent upon a positive spread between the returns on our asset portfolio and our overall cost of funding. In order to minimize the risks to us, we employ loan and security-specific risk measurement and management processes. Our risk management tools include proprietary systems and analytical methods developed by ZAIS, in addition to software and services licensed or purchased from third parties. There can be no guarantee that these tools and the other risk management techniques described above will protect us from market risks.
Our Policies with Respect to Certain Other Activities
If our Board determines that additional funding is required, we may raise such funds through additional offerings of equity or debt securities or the retention of cash flow (subject to provisions in the Internal Revenue Code concerning distribution requirements and the taxability of undistributed REIT taxable income) or a combination of these methods. In the event that our Board determines to raise additional equity capital, it has the authority, without stockholder approval, to issue additional common stock or preferred stock in any manner and on such terms and for such consideration as it deems appropriate, at any time.
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We may offer equity or debt securities in exchange for property and to repurchase or otherwise reacquire our shares and may engage in such activities in the future. We may also make loans to third parties. We may also invest in the securities of other issuers for the purpose of exercising control.
In addition, we finance the acquisition of assets with traditional forms of private funding, such as borrowings structured as repurchase agreements, term financings and derivative contracts. Our Board will receive a report and review our portfolio and related compliance with our guidelines on at least a quarterly basis.
We intend to engage in the purchase and sale of assets.
Our Board may change any of these policies without prior notice or a vote of our stockholders.
Operating and Regulatory Structure
REIT Qualification
We have elected to qualify as a REIT under the Internal Revenue Code, commencing with our taxable year ended December 31, 2011. We believe that we have been organized and have operated in conformity with the requirements for qualification and taxation as a REIT under the Internal Revenue Code. In addition, we believe that our intended manner of operation will enable us to continue to meet the requirements for qualification and taxation as a REIT. However, as described elsewhere in this prospectus, we repurchased 265,245 shares of our common stock from one of our institutional stockholders in January 2013 at a price per share equal to our book value per share as of December 31, 2012. If on or prior to June 30, 2013 we are not able to raise additional capital from sufficiently diverse sources to satisfy the five or fewer rule, including by issuing at least approximately 320,000 shares to sufficiently diverse holders in this offering, we would fail to qualify as a REIT for the 2013 taxable year and would likely proceed with an early orderly liquidation of our business. Although we believe that we have satisfied this requirement for prior taxable years, following the repurchase of 265,245 shares of our common stock on January 24, 2013, five individuals own in excess of 54% by value of our outstanding common stock, and one of these individuals owns approximately 31.2% by value of our outstanding common stock, under the attribution rules applicable for purposes of applying the five or fewer rule. To qualify as a REIT, we must meet on a continuing basis, through organizational and actual investment and operating results, various requirements under the Internal Revenue Code relating to, among other items, the sources of our gross income, the composition and values of our assets, our distribution levels and the diversity of ownership of our shares. If we fail to qualify as a REIT in any taxable year and do not qualify for certain statutory relief provisions, we will be subject to U.S. federal income tax at regular corporate rates and may be precluded from qualifying as a REIT for the subsequent four taxable years following the year during which we failed to qualify as a REIT. Even if we qualify for taxation as a REIT, we may be subject to some U.S. federal, state and local taxes on our income or property. Distributions paid by us generally will not be eligible for taxation at the preferred U.S. federal income tax rates that apply to certain distributions received by individuals from taxable corporations.
1940 Act Exemption
We intend to conduct our operations so that we are not required to register as an investment company under the 1940 Act. Section 3(a)(1)(A) of the 1940 Act defines an investment company as any issuer that is or holds itself out as being engaged primarily in the business of investing, reinvesting or trading in securities. Section 3(a)(1)(C) of the 1940 Act defines an investment company as any issuer that is engaged or proposes to engage in the
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business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40% of the value of the issuer's total assets (exclusive of U.S. Government securities and cash items) on an unconsolidated basis. Excluded from the term "investment securities," among other things, are U.S. Government securities and securities issued by majority-owned subsidiaries that are not themselves investment companies and are not relying on the exception from the definition of investment company set forth in Section 3(c)(1) or Section 3(c)(7) of the 1940 Act.
We are organized as a holding company and conduct our businesses primarily through our wholly-owned or majority-owned subsidiaries. We intend to conduct our operations so that we do not come within the definition of an investment company because fewer than 40% of our total assets on an unconsolidated basis will consist of "investment securities." The securities issued to us by any wholly-owned or majority-owned subsidiary that we may form in the future that is excepted from the definition of "investment company" by Section 3(c)(1) or 3(c)(7) of the 1940 Act, together with any other investment securities we may own, may not have a value in excess of 40% of the value of our total assets on an unconsolidated basis. We will monitor our holdings to ensure continuing and ongoing compliance with this test. In addition, we believe we will not be considered an investment company under Section 3(a)(1)(A) of the 1940 Act because we will not engage primarily or hold ourselves out as being engaged primarily in the business of investing, reinvesting or trading in securities. Rather, through our wholly-owned and majority-owned subsidiaries, we will be primarily engaged in the non-investment company businesses of our subsidiaries.
If the value of our investments in our subsidiaries that are excepted from the definition of "investment company" by Section 3(c)(1) or 3(c)(7) of the 1940 Act, together with any other investment securities we own, exceeds 40% of our total assets on an unconsolidated basis, or if one or more of such subsidiaries fail to maintain their exceptions or exemptions from the 1940 Act, we may have to register under the 1940 Act and would become subject to substantial regulation with respect to our capital structure (including our ability to use leverage), management, operations, transactions with affiliated persons (as defined in the 1940 Act), portfolio composition, including restrictions with respect to diversification and industry concentration, and other matters.
The determination of whether an entity is a majority-owned subsidiary of our company is made by us. The 1940 Act defines a majority-owned subsidiary of a person as a company 50% or more of the outstanding voting securities of which are owned by such person, or by another company which is a majority-owned subsidiary of such person. The 1940 Act further defines voting securities as any security presently entitling the owner or holder thereof to vote for the election of directors of a company. We treat companies in which we own at least a majority of the outstanding voting securities as majority-owned subsidiaries for purposes of the 40% test. We have not requested the SEC to approve our treatment of any company as a majority-owned subsidiary and the SEC has not done so. If the SEC, or its staff, were to disagree with our treatment of one or more companies as majority-owned subsidiaries, we would need to adjust our strategy and our assets in order to continue to pass the 40% test. Any such adjustment in our strategy could have a material adverse effect on us.
We believe that certain of our subsidiaries qualify for an exemption from registration under the 1940 Act as an investment company pursuant to Section 3(c)(5)(C) of the 1940 Act, which is available for entities "primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate." This exemption generally requires that at least 55% of such subsidiaries' assets must be comprised of qualifying assets and at least 80% of their total assets must be comprised of qualifying assets and real estate-related assets under the 1940 Act. We will treat as qualifying assets for this purpose mortgage loans, Agency RMBS in which we hold all the certificates issued by the pool and other
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interests in real estate, in each case meeting certain other qualifications based upon SEC staff no-action letters. Although SEC staff no-action letters have not specifically addressed the categorization of these types of assets, we will also treat as qualifying assets for this purpose bridge loans wholly secured by first priority liens on real estate that provide interim financing to borrowers seeking short-term capital (with terms of generally up to three years), non-Agency RMBS representing ownership of an entire pool of mortgage loans, and real estate owned properties. We expect each of our subsidiaries relying on Section 3(c)(5)(C) to invest an additional 25% of its assets in other types of mortgages, MBS, CMBS, securities of REITs and other real estate-related assets. We expect each of our subsidiaries relying on Section 3(c)(5)(C) to rely on guidance published by the SEC, or its staff, or on our analyses of guidance published with respect to other types of assets to determine which assets are qualifying real estate assets and real estate-related assets. The SEC staff has not, however, published guidance with respect to the treatment of some of these assets under Section 3(c)(5)(C). To the extent that the SEC, or its staff, publishes new or different guidance with respect to these matters, we may be required to adjust our strategy accordingly. Although we intend to monitor our portfolio periodically and prior to each investment acquisition, there can be no assurance that we will be able to maintain an exemption from registration for these subsidiaries. In addition, we may be limited in our ability to make certain investments and these limitations could result in the subsidiary holding assets we might wish to sell or selling assets we might wish to hold.
In 2011, the SEC solicited public comment on a wide range of issues relating to Section 3(c)(5)(C) of the 1940 Act, including the nature of the assets that qualify for purposes of the exemption and whether mortgage REITs should be regulated in a manner similar to registered investment companies. There can be no assurance that the laws and regulations governing the 1940 Act status of REITs, including the SEC, or its staff, providing more specific or different guidance regarding these exemptions, will not change in a manner that adversely affects our operations. If we or our subsidiaries fail to maintain an exception or exemption from the 1940 Act, we could, among other things, be required either to (i) change the manner in which we conduct our operations to avoid being required to register as an investment company, (ii) effect sales of our assets in a manner that, or at a time when, we would not otherwise choose to do so, or (iii) register as an investment company, any of which would negatively affect the value of our shares of common stock, the sustainability of our business model, and our ability to make distributions which would have an adverse effect on our business and the value of our shares of common stock.
We and our subsidiaries may also purchase ABS. If we purchase ABS directly, we will treat them as "investment securities" for purposes of the 1940 Act. If ABS are purchased by one of our subsidiaries relying on Rule 3(c)(5)(C), we will treat them as miscellaneous investments, which may not comprise more than 20% of such subsidiary's total assets. We may form subsidiaries to purchase ABS that rely on Rule 3a-7 promulgated under the 1940 Act (as discussed below) or that rely on Section 3(c)(5)(A) or 3(c)(5)(B) in accordance with SEC staff guidance published with respect to such sections.
It is possible that some of these subsidiaries may seek to rely on the 1940 Act exemption provided to certain structured financing vehicles by Rule 3a-7. Any such subsidiary would need to be structured to comply with any guidance that may be issued by the SEC, or its staff, on the restrictions contained in Rule 3a-7. In certain circumstances, compliance with Rule 3a-7 may require, among other things, that the indenture governing the subsidiary include limitations on the types of assets the subsidiary may sell or acquire out of the proceeds of assets that mature, are refinanced or otherwise sold, on the period of time during which such transactions may occur, and on the level of transactions that may occur. We expect that the
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aggregate value of our interests in subsidiaries that may in the future seek to rely on Rule 3a-7, if any, will comprise less than 20% of our total assets on an unconsolidated basis.
In August 2011, the SEC solicited public comment on a wide range of issues relating to Rule 3a-7, including potential amendments to Rule 3a-7 to reflect market developments since its adoption, recent developments affecting asset-backed issuers and ABS markets and the passage of the Dodd-Frank Act. In soliciting public comment, the SEC requested comment on whether additional conditions should be added to Rule 3a-7 to better address investor protection matters. Consequently, it is possible that the laws and regulations relating to Rule 3a-7 may be changed and additional conditions for the use and availability of Rule 3a-7 may be added that may make reliance on Rule 3a-7 less advantageous to us which could in turn impact the manner in which we conduct our operations and the types of assets we hold.
Qualification for exemption from registration under the 1940 Act will limit our ability to make certain investments. For example, these restrictions will limit the ability of our subsidiaries to invest directly in MBS that represent less than the entire ownership in a pool of mortgage loans, debt and equity tranches of securitizations and ABS, and real estate companies or in assets not related to real estate.
Certain of our subsidiaries may rely on the exemption provided by Section 3(c)(6) to the extent that they hold mortgage assets through majority-owned subsidiaries that rely on Section 3(c)(5)(C). The SEC staff has issued little interpretive guidance with respect to Section 3(c)(6) and any guidance published by the staff could require us to adjust our strategy accordingly. Although the SEC staff has issued little interpretive guidance with respect to Section 3(c)(6), we believe that our subsidiaries may rely on Section 3(c)(6) if, among other things, 55% of the assets of such subsidiaries consist of, and at least 55% of the income of such subsidiaries are derived from, qualifying real estate investment assets owned by wholly-owned or majority-owned subsidiaries of such subsidiaries.
The mortgage-related investments that we acquire are limited by the provisions of the 1940 Act and the rules and regulations promulgated thereunder. We also may be required at times to adopt less efficient methods of financing certain of our mortgage-related investments and we may be precluded from acquiring certain types of mortgage-related investments. This exemption also prohibits us from issuing redeemable securities. If we fail to qualify for an exemption from registration as an investment company under the 1940 Act or an exclusion from the definition of an investment company, our ability to use leverage would be substantially reduced, and we would not be able to conduct our business as described in this prospectus.
No assurance can be given that the SEC, or its staff, will concur with our classification of our or our subsidiaries' assets or that the SEC, or its staff, will not, in the future, issue further guidance that may require us to reclassify those assets for purposes of qualifying for an exclusion from regulation under the 1940 Act. To the extent that the SEC, or its staff, provides more specific guidance regarding any of the matters bearing upon the definition of investment company and the exceptions to that definition, we may be required to adjust our investment strategy accordingly. Additional guidance from the SEC, or its staff, could provide additional flexibility to us, or it could further inhibit our ability to pursue the investment strategy we have chosen. If the SEC or its staff take a position contrary to our analysis with respect to the characterization of any of the assets or securities we invest in, we may be deemed an unregistered investment company. Therefore, in order not to be required to register as an investment company, we may need to dispose of a significant portion of our assets or securities or acquire significant other additional assets which may have lower returns than our expected portfolio, or we may need to modify our investment strategy to register as an investment company, which would result in significantly increased operating
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expenses and would likely entail significantly reducing our indebtedness, which could also require us to sell a significant portion of our assets. We cannot assure you that we would be able to complete these dispositions or acquisitions of assets, or deleveraging, on favorable terms, or at all. Consequently, any modification of our investment strategy could have a material adverse effect on us. Further, if the SEC determined that we were an unregistered investment company, we would be subject to monetary penalties and injunctive relief in an action brought by the SEC, we would potentially be unable to enforce contracts with third parties and third parties could seek to obtain rescission of transactions undertaken during the period for which it was established that we were an unregistered investment company. Any of these results would have a material adverse effect on us.
Since we will not be subject to the 1940 Act, we will not be subject to its substantive provisions, including provisions requiring diversification of investments, limiting leverage and restricting investments in illiquid assets.
Dividend Reinvestment Plan
In the future, we intend to adopt a dividend reinvestment plan that will permit stockholders who elect to participate in the plan to have their cash dividends reinvested in additional shares of our common stock. As a result, if our Board authorizes, and we declare, a cash dividend or other distribution, then our stockholders who have elected to participate in our dividend reinvestment plan will have their cash distribution reinvested in additional shares of common stock, rather than receiving the cash distribution.
Licensing
We may be required to be licensed to purchase and sell previously originated residential mortgage loans in certain jurisdictions in which we will conduct our business. Our failure to obtain or maintain licenses will restrict our investment options with respect to residential mortgage loans. We may consummate this offering even if we have not yet obtained such licenses. Once we are fully licensed to purchase and sell mortgage loans in each of the states in which we become licensed, we may acquire previously originated residential loans in those states. The State of New Jersey, which is the jurisdiction in which our principal place of business is located, does not require us to be licensed to purchase and sell residential mortgage loans, and we believe that, in the jurisdictions that require us to be licensed, most of such licenses are generally easily and inexpensively obtainable within a few months following application for the license.
Implications of being an Emerging Growth Company
We are an "emerging growth company" as defined in the JOBS Act and we intend to take advantage of certain exemptions from various disclosure and reporting requirements that are otherwise generally applicable to public companies including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. We may take advantage of these exemptions for up to five years or such earlier time that we are no longer an "emerging growth company." We will cease to be an "emerging growth company" on the earliest of (i) the last day of the first fiscal year in which our annual gross revenues exceed $1.0 billion, (ii) December 31 of the fiscal year that we become a "large accelerated filer" as defined in Rule 12b-2 under the Exchange Act which would occur if the fair market value of our common stock that is held by non-affiliates exceeds $700.0 million as of the last business day of our
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most recently completed second fiscal quarter and we have been publicly reporting for at least 12 months, (iii) the date on which we have issued more than $1.0 billion in non-convertible debt securities during the preceding three-year period, or (iv) the end of the fiscal year following the fifth anniversary of our initial public offering. We have irrevocably opted-out of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. As a result, we will comply with new or revised accounting standards on the same time frames as other public companies that are not "emerging growth companies." If we take advantage of one or more of these exemptions, we do not know if investors will find our common stock less attractive as a result. If they do, there would likely be a less active trading market for our securities than would otherwise be the case.
Competition
Our success depends, in large part, on our ability to acquire assets at favorable spreads over our borrowing costs and our ability to efficiently manage our portfolio risks. In acquiring our target assets and establishing hedge positions, we compete with other existing mortgage REITs (both internally and externally managed), government sponsored enterprises, mortgage finance and specialty finance companies, savings and loan associations, banks, mortgage bankers, insurance companies, hedge funds (including those managed by ZAIS), mutual funds, institutional investors, investment banking firms, governmental bodies and other companies with similar asset acquisition objectives, and others which may be organized in the future. See "ManagementConflicts of Interest." Some of our competitors may have greater financial resources and access to lower cost of capital than we have, including the U.S. Department of the Treasury and the Federal Reserve both of which have recently become dominant players in the RMBS markets. These competitors may not be subject to the same regulatory constraints (such as REIT compliance or maintaining an exemption under the 1940 Act) as we are. The effect of the existence of additional REITs and other market participants may be to increase competition for the available supply of mortgage assets suitable for purchase, as well as the amount of financing available to us in the repurchase agreement market.
In the face of this competition, we have access to our Advisor's professionals and their industry expertise, which may provide us with a competitive advantage to help us assess risks and determine appropriate pricing for certain potential asset acquisitions. We expect that these relationships will enable us to compete more effectively for attractive asset acquisition opportunities. In addition, we believe that current market conditions may have adversely affected the financial condition of certain competitors. However, we may not be able to achieve our business goals or expectations due to the competitive risks that we face. See "Risk Factors."
Staffing
We are managed by our Advisor pursuant to the Investment Advisory Agreement between our Advisor and us. All of our officers and directors are also employees of our Advisor or its affiliates. We will have no employees upon completion of this offering. See "Our Advisor and the Investment Advisory AgreementInvestment Advisory Agreement."
Legal Proceedings
Neither we nor our Advisor is currently subject to any legal proceedings which it considers to be material.
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OUR ADVISOR AND THE INVESTMENT ADVISORY AGREEMENT
General
Our Advisor is responsible for our investment strategies and decisions and our day-to-day operations, subject to the supervision and oversight of our Board. ZAIS is the Managing Member of our Advisor and ZAIS and its employees support our Advisor in providing services to us pursuant to the terms of a shared facilities and services agreement between ZAIS and our Advisor. We rely on our Advisor and ZAIS to provide or obtain on our behalf the personnel and services necessary for us to conduct our business, and we have no employees of our own. All of our officers and directors are also employees of ZAIS and its affiliates. The executive offices of our Advisor are located at Two Bridge Avenue, Suite 322, Red Bank, New Jersey 07701-1106, and the telephone number of our Advisor's executive offices is (732) 978-7518.
Key Personnel of ZAIS and Our Advisor
The following table sets forth certain information with respect to each of the key personnel of ZAIS and our Advisor who are primarily responsible for making investments in our target assets and operating our company:
Name
|
Age | Position Held with Our Advisor | Position Held with ZAIS | ||||
---|---|---|---|---|---|---|---|
Christian Zugel |
52 | Chairman of Investment Committee | Founder, Managing Member and Chief Investment Officer | ||||
Michael Szymanski |
46 |
Chief Executive Officer, Investment Committee member |
President |
||||
Brian Hargrave |
43 |
Chief Investment Officer, Investment Committee member |
Senior Portfolio Manager |
||||
Paul McDade |
48 |
Chief Financial Officer |
Chief Financial Officer |
||||
Denise Crowley |
39 |
Senior Portfolio Manager, Investment Committee member |
Senior Portfolio Manager |
||||
Rick Nicklas |
49 |
Senior Portfolio Manager, Investment Committee member |
Senior Portfolio Manager and Head of Relative Value |
||||
Glenn Boyd |
51 |
Chief Investment Strategist, Investment Committee member |
Chief Investment Strategist |
||||
Steven Haber |
35 |
None |
Counsel |
Biographical Information
Set forth below is biographical information for the key personnel of ZAIS.
Christian Zugel
Mr. Zugel currently serves as Chairman of our Board. Mr. Zugel currently serves as Managing Member and Chief Investment Officer (CIO) of ZAIS and is also Chairman of our Advisor's investment committee. Mr. Zugel is Chairman of the ZAIS Management Committee. Prior to founding ZAIS in 1997, Mr. Zugel was a senior executive with J.P. Morgan Securities Inc., where he led J.P. Morgan's entry into many new trading initiatives. At J.P. Morgan, Mr. Zugel also served on the Asia Pacific management-wide and firm-wide market risk committees. Mr. Zugel received a Masters in Economics from the University of
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Mannheim, Germany. Mr. Zugel was selected to serve as Chairman of our Board because of his business acumen and real estate investment experience.
Michael Szymanski
Mr. Szymanski currently serves as our Chief Executive Officer, President and Director. Mr. Szymanski currently serves as President of ZAIS and member of the ZAIS Management Committee, and as Chief Executive Officer of our Advisor and a member of our Advisor's investment committee. Prior to joining ZAIS, Mr. Szymanski was Chief Executive Officer of XE Capital Management, LLC, an investment management firm specializing in structured products, from 2003 to 2008. Prior to that, Mr. Szymanski was Chief Financial Officer of Zurich Capital Markets (or ZCM), a subsidiary of Zurich Financial Group, from 2000 to 2002. At ZCM, Mr. Szymanski managed global finance, accounting, tax, treasury, and risk management for a business specializing in structured products, including hedge fund linked derivatives and principal investments. Prior to that, Mr. Szymanski was a Vice President in the Bank and Insurance Strategies Group of Lehman Brothers from 1997 to 2000, providing capital markets structuring and advisory services to financial institutions and corporations. Prior to that, Mr. Szymanski spent nine years at Ernst & Young LLP advising financial services clients, leaving as a Senior Manager in the Capital Markets/M&A Advisory Group in New York. Mr. Szymanski served in E&Y's National Office-Financial Services Industries Group, providing internal consultation services to resolve clients' accounting and regulatory issues, specializing in financial instruments. Mr. Szymanski is a CPA and received a B.A. in Business Administration with a concentration in Accountancy from the University of Notre Dame and an Executive M.B.A. with a concentration in Finance from New York University's Stern School of Business. Mr. Szymanski serves on the Board of Directors of the National Stock Exchange as Chairman of the Audit Committee. We believe that Mr. Szymanski's industry experience will enhance the breadth of experience of our Board.
Brian Hargrave
Mr. Hargrave currently serves as our Chief Investment Officer. Mr. Hargrave currently serves as Senior Portfolio Manager of ZAIS and is responsible for whole loan investment and REIT platforms. Mr. Hargrave also serves as Chief Investment Officer of our Advisor and a member of our Advisor's investment committee. He was previously responsible for Lehman Brothers' whole loan trading businesses including small balance commercial mortgages, student loans and residential mortgages. Prior to that, Mr. Hargrave ran Lehman Brothers' adjustable rate mortgage trading desk, with responsibility for whole loan acquisition, securitization and the firm's agency and non-Agency secondary trading activities. He joined Lehman Brothers' in the mortgage research group and has held several positions in research, structuring and trading. Mr. Hargrave received an M.B.A. from Harvard Business School and a B.S. from Indiana University.
Paul McDade
Mr. McDade currently serves as our Chief Financial Officer and Treasurer. Mr. McDade currently serves as Chief Financial Officer of ZAIS and is also a member of the ZAIS Management Committee. Mr. McDade also serves as Chief Financial Officer of our Advisor. Prior to joining ZAIS in 2010, Mr. McDade was the Chief Financial Officer and Chief Operating Officer for XE Capital Management, LLC, an investment management firm specializing in structured products, from 2004 to 2008. During his 25 year career, Mr. McDade has held various financial roles at Zurich Capital Markets, J.P. Morgan Chase & Co., Reliance Group Holdings, Inc., and PricewaterhouseCoopers LLP. Mr. McDade is a CPA and received a B.S. in Accounting from the University of Scranton.
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Denise Crowley
Ms. Crowley currently serves on our Board. Ms. Crowley currently serves as Senior Portfolio Manager of ZAIS and is responsible for custom/benchmark portfolios and funds. Ms. Crowley currently serves as a member of the ZAIS Management Committee, and as a Senior Portfolio Manager of our Advisor and a member of our Advisor's investment committee. Ms. Crowley joined ZAIS in 1997 and has been actively involved in the ABS and CDO security market since 1999. Prior to that, Ms. Crowley managed a credit fund for ZAIS. Prior to joining ZAIS, Ms. Crowley worked at J.P. Morgan in the High Yield Trading Group. Prior to that, she worked for the Honorable Daniel P. Moynihan as an economic research analyst. Ms. Crowley received a B.A. from Boston College and an M.B.A. from New York University's Stern School of Business. Due to her experience in the mortgage securities sector, we believe Ms. Crowley should serve as a member of our Board.
Rick Nicklas
Mr. Nicklas currently serves as Senior Portfolio Manager and Head of Relative Value at ZAIS. Mr. Nicklas also serves as Senior Portfolio Manager of our Advisor and a member of our Advisor's investment committee. Mr. Nicklas has over 15 years of experience in the U.S. Structured Securities market. Prior to joining ZAIS in August of 2008, Mr. Nicklas spent eight years with Lehman Brothers where he was a Senior Vice President trading non-Agency mortgage-backed securities with a particular focus on credit. Prior to Lehman, Mr. Nicklas spent seven years at Donaldson, Lufkin & Jenrette trading both the senior and subordinate parts of the capital structure in the residential mortgage space. Mr. Nicklas received an M.B.A. from The Wharton School at The University of Pennsylvania and a B.S. from the University of Virginia.
Glenn Boyd
Mr. Boyd currently serves as Chief Investment Strategist of ZAIS. Mr. Boyd is responsible for mortgage, consumer, and corporate credit research, ranging from modeling to investment strategies. Mr. Boyd also serves as Chief Investment Strategist at our Advisor and a member of our Advisor's investment committee. He joined ZAIS in June of 2010, following five years at Barclays Capital. His roles at Barclays Capital included Co-Head of Fixed Income Research and Head of Securitized Products Strategy, encompassing products such as non-agency RMBS, CMBS, consumer ABS, agency RMBS, and interest rates. Previously, Mr. Boyd worked in agency and non-agency MBS research roles at Paine Webber/UBS and Credit Suisse. He holds a B.S. from SUNY Stony Brook, and a Ph.D. in physics from the California Institute of Technology.
Steven Haber
Mr. Haber currently serves as our Secretary. Mr. Haber also currently serves as Counsel of ZAIS. Prior to joining ZAIS in 2012, Mr. Haber was associated with several firms, including SNR Denton US LLP and Thacher Proffitt & Wood LLP where he practiced in the capital markets and structured finance groups. Mr. Haber received a B.A. from Brandeis University and a J.D. from Brooklyn Law School.
Investment Committee
Our Advisor has an investment committee whose role will be to oversee our asset acquisition and financing strategies as well as compliance with our guidelines. The initial investment committee is comprised of Christian Zugel, Denise Crowley, Michael Szymanski,
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Rick Nicklas, Brian Hargrave and Glenn Boyd. The investment committee will meet as frequently as it believes is necessary but at least quarterly.
Investment Advisory Agreement
We have entered into an Investment Advisory Agreement with our Advisor pursuant to which it provides for the day-to-day management of our operations.
The Investment Advisory Agreement requires our Advisor to manage our business affairs in conformity with the policies and the guidelines that are approved and monitored by our Board. Our Advisor's role as manager is under the supervision and direction of our Board. Our Advisor is responsible for, among other responsibilities, (i) the selection, purchase and sale of our portfolio of assets, (ii) our financing activities, and (iii) providing us with advisory services. Our Advisor is responsible for our day-to-day operations and performs (or causes to be performed) such services and activities relating to our and our subsidiaries' assets and operations as may be appropriate, which may include, without limitation, the following:
(i) forming the investment committee, which will propose guidelines to be approved by a majority of our independent directors;
(ii) serving as our consultant with respect to the periodic review of the guidelines and other parameters for our assets, financing activities and operations, any modifications to which will be approved by a majority of our independent directors, and other policies for approval by our Board;
(iii) providing us with portfolio management;
(iv) investigating, analyzing and selecting possible opportunities and acquiring, financing, retaining, selling, restructuring or disposing of assets consistent with our guidelines;
(v) with respect to prospective purchases, sales or exchanges of assets, conducting negotiations on our behalf with sellers, purchasers and brokers and, if applicable, their respective agents and representatives;
(vi) advising us on and negotiating and entering into, on our behalf, repurchase agreements, interest rate swap agreements and other hedging instruments, and all other agreements and instruments required for us to conduct our business;
(vii) engaging and supervising, on our behalf and at our expense, independent contractors which provide investment banking, mortgage brokerage, securities brokerage, other financial services, due diligence services, underwriting review services, legal and accounting services, and all other services (including transfer agent and registrar services) as may be required relating to our assets (or potential assets);
(viii) coordinating and managing operations of any co-investment interests or joint venture held by us and conducting all matters with the co-investment partners or joint venture;
(ix) providing executive and administrative personnel, office space and office services required in rendering services to us;
(x) administering the day-to-day operations and performing and supervising the performance of such other administrative functions necessary to our management as may be agreed upon by our Advisor and our Board, including, without limitation, the collection of revenues and the payment of our debts and obligations and maintenance of appropriate computer services to perform such administrative functions;
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(xi) communicating on our behalf with the holders of any of our equity or debt securities as required to satisfy any reporting and other requirements of any governmental bodies or agencies or trading markets and to maintain effective relations with such holders;
(xii) counseling us in connection with policy decisions to be made by our Board;
(xiii) evaluating and recommending to our Board hedging strategies and engaging in hedging activities on our behalf, consistent with such strategies as so modified from time to time, with our qualification as a REIT and with our guidelines;
(xiv) counseling us regarding the maintenance of our qualification as a REIT and monitoring compliance with the various REIT qualification tests and other rules set out in the Internal Revenue Code and Treasury Regulations thereunder and using commercially reasonable efforts to cause us to qualify for taxation as a REIT;
(xv) counseling us regarding the maintenance of our exemption and our subsidiaries' exemptions from the status of an investment company required to register under the 1940 Act, monitoring compliance with the requirements for maintaining such exemptions and using commercially reasonable efforts to cause us and our subsidiaries to maintain such exemptions from such status;
(xvi) assisting us in developing criteria for asset purchase commitments that are specifically tailored to our objectives and strategies and making available to us its knowledge and experience with respect to our target assets, other real estate-related assets and non-real estate-related assets;
(xvii) furnishing reports and statistical and economic research to us regarding our activities and services performed for us by our Advisor;
(xviii) monitoring the operating performance of our assets and providing periodic reports with respect thereto to our Board, including comparative information with respect to such operating performance and budgeted or projected operating results;
(xix) deploying and redeploying any moneys and securities of ours (including acquiring short-term assets pending the acquisition of other assets, payment of fees, costs and expenses, or payments of dividends to our stockholders) and advising us as to our capital structure and capital raising;
(xx) assisting us in retaining qualified accountants and legal counsel, as applicable, to assist in developing appropriate accounting systems and procedures, internal controls and other compliance procedures and testing systems with respect to financial reporting obligations and compliance with the provisions of the Internal Revenue Code applicable to REITs and to conduct quarterly compliance reviews with respect thereto;
(xxi) assisting us to qualify to do business in all applicable jurisdictions and to obtain and maintain all appropriate licenses;
(xxii) assisting us in complying with all regulatory requirements applicable to us in respect of our business activities, including preparing or causing to be prepared all financial statements required under applicable regulations and contractual undertakings and all reports and documents, if any, required under the Exchange Act or the Securities Act, or by any securities exchange requirements;
(xxiii) assisting us in taking all necessary actions to enable us to make required tax filings and reports, including soliciting stockholders for required information to the extent required by the provisions of the Internal Revenue Code applicable to REITs;
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(xxiv) placing, or arranging for the placement of, all orders pursuant to our Advisor's investment determinations for us either directly with the issuer or with a broker or dealer (including any affiliated broker or dealer);
(xxv) handling and resolving all claims, disputes or controversies (including all litigation, arbitration, settlement or other proceedings or negotiations) on our behalf in which we may be involved or to which we may be subject arising out of our day-to-day operations (other than with our Advisor or its affiliates), subject to such limitations or parameters as may be imposed from time to time by our Board;
(xxvi) using commercially reasonable efforts to cause expenses incurred by us or on our behalf to be commercially reasonable or commercially customary and within any budgeted parameters or expense guidelines set by our Board from time to time;
(xxvii) arranging marketing materials, advertising, industry group activities (such as conference participations and industry organization memberships) and other promotional efforts designed to promote our business;
(xxviii) advising us with respect to and structuring long-term financing vehicles for our portfolio of assets, and offering and selling securities publicly or privately in connection with any such structured financing;
(xxix) performing such other services as may be required from time to time for management and other activities relating to our assets and business as our Board shall reasonably request or our Advisor shall deem appropriate under the particular circumstances; and
(xxx) using commercially reasonable efforts to cause us to comply with all applicable laws.
Pursuant to the Investment Advisory Agreement, our Advisor does not assume any responsibility other than to render the services called for thereunder and will not be responsible for any action of our Board in following or declining to follow its advice or recommendations. Our Advisor, its officers, stockholders, members, managers, partners, directors and personnel, any person controlling or controlled by our Advisor, including ZAIS, and any person providing sub-advisory services to our Advisor are not liable to us, any subsidiary of ours, our directors, our stockholders or any subsidiary's stockholders or partners for acts or omissions performed in accordance with and pursuant to the Investment Advisory Agreement, except because of acts constituting bad faith, willful misconduct, gross negligence, or reckless disregard of their duties under the Investment Advisory Agreement, as determined by a final non-appealable order of a court of competent jurisdiction. We have agreed to indemnify our Advisor, its officers, stockholders, members, managers, partners, directors and personnel, any person controlling or controlled by our Advisor, including ZAIS, and any person providing sub-advisory services to our Advisor with respect to all expenses, losses, damages, liabilities, demands, charges and claims arising from acts or omissions of our Advisor not constituting bad faith, willful misconduct, gross negligence, or reckless disregard of duties, performed in good faith in accordance with and pursuant to the Investment Advisory Agreement. Our Advisor has agreed to indemnify us and our directors and officers with respect to all expenses, losses, damages, liabilities, demands, charges and claims arising from acts or omissions of our Advisor constituting bad faith, willful misconduct, gross negligence or reckless disregard of its duties under the Investment Advisory Agreement. Our Advisor is not liable for trade errors that may result from ordinary negligence, such as errors in the investment decision making process (for example, a transaction was effected in violation of our guidelines) or in the trade process (for example, a buy order was entered instead of a sell order, or the wrong security was purchased or sold, or a security was
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purchased or sold in an amount or at a price other than the correct amount or price). Notwithstanding the foregoing, our Advisor carries "errors and omissions" insurance.
Pursuant to the terms of our Investment Advisory Agreement, our Advisor and its affiliates provide us with our management team, including our chief executive officer and chief financial officer, along with appropriate support personnel. Each of our officers and directors is also an employee of our Advisor or its affiliates. We do not have any employees. Our Advisor and its affiliates are not obligated to dedicate any of their respective employees exclusively to us, nor are our Advisor, its affiliates or any of their employees obligated to dedicate any specific portion of its or their time to our business. Our Advisor is at all times subject to the supervision and oversight of our Board.
The Investment Advisory Agreement may be amended or modified by agreement between us and our Advisor. The initial term of our Investment Advisory Agreement with our Advisor only extends until the third anniversary of our listing, with automatic one-year renewal terms on each anniversary date thereafter unless previously terminated as described below. Our Board will review our Advisor's performance and the management fees annually and, following the three-year initial term, the Investment Advisory Agreement may be terminated annually upon the affirmative vote of at least two-thirds of our independent directors or by a vote of the holders of at least two-thirds of the outstanding shares of our common stock (other than those shares held by certain parties related to us, including our members, principals, employees and affiliates), based upon (i) unsatisfactory performance that is materially detrimental to us or (ii) our determination that the management fees payable to our Advisor are not fair, subject to our Advisor's right to prevent such termination due to unfair fees by accepting a reduction of management fees agreed to by at least two-thirds of our independent directors. We must provide 180 days' prior notice of any such termination. Unless terminated for cause, our Advisor will be paid a termination fee equal to three times the average annual advisory fee earned by our Advisor during the 24-month period immediately preceding such termination, calculated as of the end of the most recently completed fiscal year before the date of termination.
We may also terminate the Investment Advisory Agreement at any time, including during the three-year initial term, without the payment of any termination fee, with 30 days' prior written notice from our Board for cause, which is defined as:
Our Advisor may generally only assign the Investment Advisory Agreement or any of its duties thereunder with the written approval of a majority of our directors. Our Advisor, however, may assign the Investment Advisory Agreement or any of its duties thereunder to any majority-owned and controlled affiliates of ZAIS without the approval of our directors if such assignment does not require our approval under the Investment Advisers Act of 1940. It
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is expected that, in the event of such an assignment, ZAIS employees will support the affiliate in providing services to us.
Our Advisor may terminate the Investment Advisory Agreement if we become required to register as an investment company under the 1940 Act, with such termination deemed to occur immediately before such event, in which case we would not be required to pay a termination fee. Our Advisor may also decline to renew the Investment Advisory Agreement following the three-year initial term by providing us with 180 days written notice, in which case we would not be required to pay a termination fee. In addition, if we default in the performance of any material term of the agreement and the default continues for a period of 30 days after written notice to us, our Advisor may terminate the Investment Advisory Agreement upon 60 days written notice. If the Investment Advisory Agreement is terminated by our Advisor upon our breach, we would be required to pay our Advisor the termination fee described above.
Advisory Fees, Expense Reimbursements and Termination Fee
We do not maintain an office or employ personnel. Instead we rely on the facilities and resources of our Advisor and its affiliates to conduct our day-to-day operations. Expense reimbursements to our Advisor are made in cash on a quarterly basis following the end of each quarter.
Advisory Fee
Our Operating Partnership will pay to our Advisor an advisory fee, calculated and payable quarterly in arrears, equal to 1.5%, calculated and payable (in cash) quarterly in arrears, per annum of our Stockholders' Equity (as defined below). The fee totaled $0.7 million for the nine-month period ended September 30, 2012. However, prior to the completion of this offering, the fee was calculated based on our Net Asset Value as defined in the Investment Advisory Agreement (not our Stockholders' Equity).
"Stockholders' Equity" means our net asset value of our Operating Partnership at completion of this offering, plus the sum of the net proceeds from all issuances of our capital stock and our Operating Partnership's equity securities (exclusive of Operating Partnership equity securities held by us or our controlled subsidiaries) following the completion of this offering (allocated on a pro rata basis for such issuances during the fiscal quarter of any such issuance), plus our retained earnings at the end of the most recently completed calendar quarter (without taking into account any non-cash equity compensation expense incurred in current or prior periods), less any amount that we pay to repurchase common stock following the closing of this offering, and excluding any unrealized gains, losses or other items that do not affect realized net income (regardless of whether such items are included in other comprehensive income or loss, or in net income). This amount is adjusted to exclude one-time events pursuant to changes in U.S. generally accepted accounting principles (or U.S. GAAP) and certain other non-cash items after discussions between our Advisor and our independent directors and approved by a majority of our independent directors. For purposes of calculating Stockholders' Equity, outstanding OP units (other than OP units held by us) are treated as outstanding shares of our capital stock. The definition of Stockholders' Equity for purposes of determining the advisory fee that we will pay our Advisor is different than the determination of stockholders' equity under U.S. GAAP. Our Advisor uses the proceeds from its advisory fee in part to pay compensation to its officers and personnel who, notwithstanding that certain of them also are our officers, receive no cash compensation directly from us.
Our Advisor's advisory fee shall be calculated within 30 days after the end of each quarter and such calculation shall be promptly delivered to us. Our Operating Partnership is obligated to pay the advisory fee in cash within five business days after delivery to us of the written statement of our Advisor setting forth the computation of the advisory fee for such quarter.
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Reimbursement of Expenses
Because our Advisor's personnel perform certain services, which may include accounting, due diligence tasks and other services, that outside professionals or outside consultants otherwise would perform, our Advisor is paid or reimbursed for the documented cost of performing such tasks, provided that such costs and reimbursements are in amounts which are no greater than those which would be payable to outside professionals or consultants engaged to perform such services pursuant to agreements negotiated on an arm's-length basis.
We also pay all operating expenses, except those specifically required to be borne by our Advisor under the Investment Advisory Agreement. The underwriting fee incurred in this offering will be paid by our Advisor. Our Advisor has also agreed to pay any expenses in connection with this offering in excess of $1.2 million. We will not be obligated to repay our Advisor for any of these costs. The expenses required to be paid by us include:
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fees and expenses, including any research services utilized by our Advisor on our behalf;
In addition, we may be required to pay our pro rata portion of rent, telephone, utilities, office furniture, equipment, machinery and other office, internal and overhead expenses of our Advisor and its affiliates required for our operations. These expenses will be allocated between our Advisor and us based on the ratio of our proportion of gross assets compared to all remaining gross assets managed or held by our Advisor as calculated at each quarter end. We and our Advisor will modify this allocation methodology, subject to the approval of our independent directors if the allocation becomes inequitable based on, among other things, significant leverage differences between us and our Advisor's other clients.
Termination Fee
A termination fee will be payable in the event that the Investment Advisory Agreement is terminated without cause upon the affirmative vote of at least two-thirds of our independent
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directors or the holders of at least two-thirds of our outstanding common stock (other than those shares held by certain parties related to us, including our members, principals, employees and affiliates), based upon unsatisfactory performance by our Advisor that is materially detrimental to us or a determination that the compensation payable to our Advisor under the Investment Advisory Agreement is not fair, unless our Advisor agrees to compensation that at least two-thirds of our independent directors determine is fair. The termination fee will be equal to three times the average annual advisory fee earned by our Advisor during the prior 24-month period immediately preceding the date of termination, calculated as of the end of the most recently completed fiscal year prior to the date of termination.
Grants of Equity Compensation to Our Officers and Directors and Officers and Employees of Our Advisor and Its Affiliates
We have adopted a 2012 equity incentive plan whereby the compensation committee of our Board is authorized to approve grants of equity-based awards to our officers and directors and officers and employees of our Advisor and its affiliates. Our equity incentive plan provides for grants of equity awards up to, in the aggregate, the equivalent of 5% of the shares of common stock issued and outstanding from time to time following the completion of this offering. No awards will be issued in connection with this offering.
Shared Facilities and Services Agreement
Pursuant to the terms of the Investment Advisory Agreement, our Advisor and its affiliates provide us with our executive officers. Our Advisor is at all times subject to the supervision and oversight of our Board and has only such functions and authority as we delegate to it. Our Advisor has entered into a shared facilities and services agreement with ZAIS, pursuant to which ZAIS provides our Advisor with the personnel needed for our Advisor to provide us with our executive officers and access to, among other things, ZAIS's information technology, office space, personnel and other resources necessary to enable our Advisor to perform its obligations under the Investment Advisory Agreement. Our Advisor also benefits from ZAIS's finance and administration functions, which address compliance, investor relations and operational matters, including portfolio management, trade allocation and execution, securities valuation, risk management and information technologies in connection with the performance of our Advisor's duties.
Historical Performance of Certain Funds and Managed Accounts Managed by ZAIS
ZAIS was established in 1997 and is an SEC-registered investment adviser specializing in structured credit, including residential whole loans, RMBS and ABS. As of September 30, 2012, ZAIS estimates that it had approximately $5.5 billion of assets under management (comprised of the net asset value of ZAIS-managed funds, and the aggregate principal balance of CDO vehicles and other entities, which do not mark their securities to fair market value under U.S. GAAP) and has built long-term relationships with a global investor base, including public and private pension funds, endowment/foundations, insurance companies, family offices, fund of funds, sovereign wealth funds and investment advisors. ZAIS manages these assets using a range of strategies and investment vehicles, including private equity-style funds and separately managed accounts.
Matrix V Funds
In 2006, ZAIS formed the Matrix V Funds, which are private investment vehicles with finite investment periods that primarily focused on investing in collateral loan obligations, CDO
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securities and RMBS assets, primarily subordinate and distressed credits. These funds were formed to take advantage of ZAIS's view, at the time, that well structured CLOs and select subordinate ABS CDO tranches offered attractive risk and return characteristics and that over time, the U.S. RMBS market could become distressed and offer investment opportunities. The reinvestment period for Matrix V-A and V-B ended in 2008 and for Matrix V-C, in 2010. The Matrix V Funds did not employ explicit leverage. The Matrix V Funds had been returning capital to investors periodically since the end of their respective reinvestment periods from interest, amortizations and sales of assets in the portfolio and, as of December 31, 2012, all of the Matrix V Funds' securities have been liquidated and the only remaining asset is cash.
The economic downturn and the disruption of financial markets which started in 2007 had a negative impact on the prices of structured products, particularly non-Agency RMBS. A decrease in home prices and an increase in unemployment rates caused default and loss rates of collateral backing non-Agency RMBS to rise to levels much higher than projected at the time of issuance of these securities. A number of factors, including reduced liquidity, the unavailability of financing in the capital markets, downgrades of RMBS by credit agencies and general risk aversion by investors caused many holders to sell these securities at distressed levels, putting additional pressure on prices. These market conditions adversely affected the prices of non-Agency RMBS from the middle of 2007 until early 2009. As the economic recovery progressed, prices of these securities have improved. The impact of the economic downturn on the Matrix V Funds was mixed. Matrix V-A and Matrix V-B exited their reinvestment periods in September 2008, just as non-Agency RMBS were rapidly declining in price. As a result, these funds could not deploy capital when the market was at its lowest value and the precipitous declines incurred in non-Agency RMBS and other credit sensitive assets negatively impacted the returns in Matrix V-A and Matrix V-B. Matrix V-C had a reinvestment period that extended well beyond the period of peak distress and it was able to continue to add securities to the portfolio when the market was very distressed. The opportunity to add positions to the Matrix V-C portfolio at very distressed levels helped the performance of the fund. Ultimately, many of these securities recovered a significant portion of their lost value which helped the performance of the Matrix V Funds in the second half of 2009 through 2012.
Matrix VI Funds
Beginning in late 2007, ZAIS formed the Matrix VI Funds, which are private investment vehicles with finite investment periods that deployed a long-only, unlevered strategy that sought to capitalize on the market dislocation and leverage unwind in the mortgage securities sector. These funds were formed to take advantage of ZAIS's view that re-assessment of credit risk would cause a deteriorating and volatile market environment that would lead to numerous distressed investment opportunities. The Matrix VI Funds focused on distressed investment opportunities primarily in the U.S. non-Agency RMBS market. The existing Matrix VI Funds had been periodically returning capital to investors from interest, amortizations and sales of assets in the portfolios and, as of December 31, 2012, all of the Matrix VI Funds' securities have been liquidated and the only remaining asset is cash. In contrast to the Matrix VI Funds, we do not expect to focus our strategy on exclusively distressed assets and we expect to deploy borrowings as part of our business strategy.
The economic downturn and the disruption of financial markets which started in 2007 had a negative impact on the prices of structured products, particularly non-Agency RMBS. A decrease in home prices and an increase in unemployment rates caused default and loss rates of collateral backing non-Agency RMBS to rise to levels much higher than projected at the time of issuance of these securities. A number of factors, including reduced liquidity, the unavailability of financing in the capital markets, downgrades of RMBS by credit agencies and
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general risk aversion by investors caused many holders to sell these securities at distressed levels, putting additional pressure on prices. These market conditions adversely affected the prices of non-Agency RMBS from the middle of 2007 until early 2009. As the economic recovery progressed, prices of these securities have improved. The Matrix VI Funds largely benefitted from the decline in non-Agency RMBS prices that was most pronounced in late 2008 and early 2009 because these funds were in their reinvestment periods and had considerable capital left to deploy for asset purchases. Ultimately, many of these positions rose significantly in value between the second half of 2009 and 2012.
ZAIS Managed Accounts
ZAIS has established various Managed Accounts which are private investment vehicles for individual investors. The 2009-2010 Managed Accounts focus on opportunities in the RMBS sector and utilize a strategy similar to the Matrix VI Fund strategy. More recently, ZAIS formed the 2012 Managed Account, which utilizes a strategy similar to the strategies utilized by the ZAIS Mortgage Securities Fund and the INARI Fund. Pursuant to the management agreements that establish investment guidelines and that govern the relationship between ZAIS and investors participating in the Managed Accounts, ZAIS controls all aspects of asset selection and disposition. As of September 30, 2012, the Managed Accounts had a net asset value of $112.0 million, and the combined investments of the Managed Accounts had a fair market value of $109.1 million, which consisted almost entirely of non-Agency RMBS. In November 2012, one of the 2009 Managed Accounts was liquidated. In contrast to the Managed Accounts, we expect to invest in a broader portfolio of our target assets, including Agency RMBS and whole loans.
Although the investment objectives and strategies of certain of the Matrix V Funds, Matrix VI Funds, ZAIS Funds and Managed Accounts may be considered similar in some aspects to our objectives and strategies, there are, as indicated above, significant differences in both assets mix and use of borrowings.
SerVertis Fund
In August 2008, ZAIS formed the SerVertis Fund. ZAIS manages the SerVertis Fund and has engaged a sub-advisor to assist ZAIS in asset selection and disposition decisions. The SerVertis Fund is a private investment vehicle with an investment strategy focused on acquiring distressed residential loan portfolios (whether through loan acquisitions or structured securities backed by residential loans), consisting primarily of current loans as opposed to delinquent loans, and controlling the loans by utilizing the mortgage servicing and collections platform of a mortgage servicer with which ZAIS has formed a strategic relationship. The SerVertis Fund has also invested, from time to time, in non-Agency RMBS. The SerVertis Fund was formed to capitalize on the need for financial institutions to shed high risk assets to raise capital and improve performance on existing assets through better loan servicing. The SerVertis Fund can employ leverage of up to 100% of its commitments, not including any term, non-recourse specific asset or pool financing, and, as of September 30, 2012, had total debt equal to approximately 34% of its net asset value.
As of September 30, 2012, the SerVertis Fund had a net asset value of $784.2 million. The fund's investments had a fair market value of $1.0 billion which included 6,955 residential whole loans (including RMBS securities backed by such loans for which the SerVertis Fund owns all tranches issued by the related securitization vehicle) with a fair market value of $988.4 million, which represented 94.6% of its total investments, as of such date. Approximately 73% of these loans were current on their contractual obligations, as measured by unpaid principal balance, with the remainder being delinquent. In contrast to the SerVertis
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Fund, we expect to invest in RMBS and we expect to deploy more borrowings as part of our business strategy. See "BusinessFinancing Strategy."
The economic downturn and the disruption of financial markets which started in 2007 had a negative impact on the prices of structured products, particularly non-Agency RMBS. A decrease in home prices and an increase in unemployment rates caused default and loss rates of collateral backing non-Agency RMBS to rise to levels much higher than projected at the time of issuance of these securities. A number of factors, including reduced liquidity, the unavailability of financing in the capital markets, downgrades of RMBS by credit agencies and general risk aversion by investors caused many holders to sell these securities at distressed levels, putting additional pressure on prices. These market conditions adversely affected the prices and availability of residential whole loans. As a result, the SerVertis Fund held a relatively high level of uninvested capital in the form of cash from late 2008 to early 2010 reducing investment returns over that period. As the economic recovery progressed, prices of these assets have improved and the SerVertis fund has been able to deploy this cash into residential whole loan and securities investments.
The ZAIS Mortgage Securities Fund and the INARI Fund
In 2012, ZAIS formed the ZAIS Mortgage Securities Fund and the INARI Fund. ZAIS serves as the investment advisor to both of these funds, which deploy predominantly long strategies focused on opportunities in the RMBS sector and, in some instances, utilize explicit leverage and utilize derivative financial instruments to mitigate mark-to-market risk on the predominantly long positions held by each fund. As of September 30, 2012, the ZAIS Mortgage Securities Fund had a net asset value of $154.2 million, and its investments had a fair market value of $152.1 million, which consisted entirely of non-Agency RMBS. As of September 30, 2012, the INARI Fund had a net asset value of $104.0 million, and its investments had a fair market value of $102.6 million, which consisted entirely of non-Agency RMBS. The ZAIS Mortgage Securities Fund may utilize explicit leverage of up to one times the net asset value of the fund and the INARI Fund may utilize explicit leverage of up to two times the net asset value of the fund; however, these funds had not used leverage through September 30, 2012.
Our Company
We commenced operations on July 29, 2011. ZAIS supported the organization of our company in order to provide investors with the opportunity to invest in a specialty finance company that primarily invests in, finances and manages both non-Agency and Agency RMBS, residential whole loans and other asset classes. Our strategy includes the use of borrowings. ZAIS positioned our company so that it could ultimately be listed on a national securities exchange and thereby provide investors with the opportunity to achieve liquidity in their investments through the sale of their shares of common stock on that exchange.
Summary Performance
The following tables set out certain information for the period ended September 30, 2012 related to our company as well as the Matrix V Funds, the Matrix VI Funds, certain ZAIS Funds and Managed Accounts. The tables include, all of the private equity-style funds and hedge funds managed by ZAIS focused on investing in RMBS and/or whole loans since 2006, other than certain private equity-style funds whose predominant investment thesis was the shorting of RMBS, certain structured vehicles (i.e., CDOs) that contained RMBS exposure for which ZAIS served as the collateral manager and one fund for which ZAIS assumed asset management responsibilities from a prior manager. There are significant differences between
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our investment policies and those of the Matrix V Funds, the Matrix VI Funds, the ZAIS Funds and Managed Accounts specified below. Accordingly, the performance of these portfolios is not necessarily indicative of our potential performance.
Performance of ZAIS RMBS and Whole Loan Funds (Unaudited)
Performance of ZAIS RMBS Managed Accounts (Unaudited)
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Capital Returned |
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Managed Accounts
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Inception Date | Liquidation Date | (in millions) (1) | (in millions) (1)(2) | Net IRR (3) | ||||||||||||
#1 |
March 2010 | June 2012 | $ | 19.50 | $ | 23.21 | 9.90 | % | 9.36 | % | |||||||
#2 |
May 2009 | N/A (9) | $ | 25.00 | $ | 29.55 | 22.24 | % | 18.76 | % | |||||||
#3 |
June 2009 | N/A | $ | 35.00 | $ | 15.00 | 23.80 | % | 19.93 | % | |||||||
#4 |
September 2009 | February 2011 | $ | 50.00 | $ | 61.52 | 24.09 | % | 20.75 | % | |||||||
#5 |
April 2012 | N/A | $ | 67.00 | | 33.28 | % | 27.89 | % |
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advisor to each fund or account validates these fair values using the same techniques discussed above. The fair value of the investments held by the SerVertis Fund is determined by the advisor utilizing a proprietary model. The proprietary model is driven by observable market inputs, and also gives consideration to loan level data, general economic conditions, Home Price Index forecasts and valuations of underlying properties. For existing Matrix V Funds, Matrix VI Funds, ZAIS Funds and Managed Accounts, IRRs have been calculated for the period from inception through September 30, 2012 for investors remaining in the ZAIS Fund or Managed Account as of September 30, 2012 and which are subject to advisory fees and incentive allocation/fees. For liquidated Matrix V Funds, Matrix VI Funds, ZAIS Funds and Managed Accounts, IRRs have been calculated for the period from inception through the liquidation date for all investors which were subject to and not subject to advisory fees and incentive allocation/fees during the period of time that the ZAIS Fund or Managed Account was in existence. "Net" IRR is computed after the deduction of incentive fees paid and/or accrued. "Gross" IRR is computed before deduction of incentive fees paid and/or accrued.
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Our Directors, Director Nominees and Officers
Upon completion of this offering, our Board will be comprised of seven members. Our Board is currently comprised of three members. In connection with the closing of this offering, we expect that our Board will increase its size to seven directors by electing four other individuals to serve on our Board, who our Board expects to determine for these newly appointed directors will satisfy the listing standards for independence of the NYSE. Our bylaws provide that a majority of the entire Board may at any time increase or decrease the number of directors. However, unless our bylaws are amended, the number of directors may never be less than the minimum number required by the MGCL nor more than 15.
The following sets forth certain information with respect to our directors, director nominees and officers and other key personnel:
Name
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Age | Position Held with Our Company | |||
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Christian Zugel |
52 | Chairman of the Board | |||
Michael Szymanski |
46 | Chief Executive Officer, President and Director | |||
Denise Crowley |
39 | Director | |||
Paul McDade |
48 | Chief Financial Officer and Treasurer | |||
Brian Hargrave |
43 | Chief Investment Officer | |||
Steven Haber |
35 | Secretary | |||
Daniel Mudge |
63 | Director Nominee | |||
Marran Ogilvie |
44 | Director Nominee | |||
Eric Reimer |
51 | Director Nominee | |||
James Zinn |
60 | Director Nominee |
Biographical Information
For biographical information on Messrs. Zugel, Szymanski, McDade and Hargrave and Ms. Crowley, see "Our Advisor and the Investment Advisory AgreementKey Personnel of ZAIS and Our Advisor." Additional biographical information of our director nominees is outlined below.
Daniel Mudge
Mr. Mudge is one of our director nominees. Mr. Mudge is currently a Special Adviser to Promontory Financial Group, LLC, a risk management and regulatory compliance consulting firm. From 2008 to 2011, Mr. Mudge served as a founding Partner and the Chief Executive Officer of docGenix L.P., a firm specializing in the conversion of legal documents into text and data. From June 2011 to November 2011, Mr. Mudge served as a Senior Adviser to Innodata docGenix LLC, the successor company to docGenix L.P. Prior to that, from 2005 to 2008, Mr. Mudge served as the Group Managing Director of the Operational Risk and Content Businesses of Algorithmics Inc., a risk advisory and software firm. From 2002 to 2005, Mr. Mudge served as a Group Managing Director of Fitch Risk Management, Inc. (or Fitch Risk), a risk advisory firm that was a predecessor to Algorithmics Inc. At Fitch Risk, Mr. Mudge led a number of acquisitions and integrations of business segments purchased by Fitch Risk and provided management services in the field of operational risk management software. Prior to that, from 1997 to 2002, Mr. Mudge was the Chief Executive Officer of OpVantage LLC and a founding partner of NetRisk Inc., both of which were predecessors to Fitch Risk. Mr. Mudge also served in various roles for Bankers Trust from 1973 to 1997, including Head of Global Risk Management and was responsible for Corporate Risk & Insurance and Corporate Risk Technology. Mr. Mudge received a B.S. in Economics from the University of Pennsylvania
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and an M.B.A. from Harvard Business School. Due to his extensive experience in risk management, we believe Mr. Mudge should serve as a member of our Board.
Marran Ogilvie
Ms. Ogilvie is one of our director nominees. Ms. Ogilvie currently serves as an Advisor to the Creditors Committee for the Lehman Brothers International (Europe) Administration, as a Director, member of the Audit Committee and Chairman of the Governance Committee of Southwest Bankcorp, Inc., a commercial bank with branches in Oklahoma, Texas and Kansas, and as a Director of the Korea Fund, a non-diversified, closed-end investment company which invests in Korean companies. Prior to that, Ms. Ogilvie was a founding member of Ramius, LLC, an alternative investment management firm, where she served in various capacities from 1994 to 2009 before the firm's merger with Cowen Group, Inc., a diversified financial services firm, including Chief Operating Officer from 2007 to 2009 and General Counsel from 1997 to 2007. Following the merger, Ms. Ogilvie became Chief of Staff at Cowen Group, Inc. until 2010. Ms. Ogilvie received a B.A. from the University of Oklahoma and a J.D. from St. John's University. Due to her legal expertise and experience in investment management and financial services industries, we believe Ms. Ogilvie should serve as a member of our Board.
Eric Reimer
Mr. Reimer is one of our director nominees. Mr. Reimer has served as a Partner and the Chairman of the Corporate Finance Group of O'Melveny & Myers LLP since 2010, where he provides strategic and legal counsel to institutions and public and private companies on the structuring and execution of financial transactions and investments. Mr. Reimer has also served as a Vice Chair of the Board of Trustees of Children's Burn Foundation since 2002. Mr. Reimer previously served as a Partner and the Chairman of the Private Equity Finance Group of Goodwin Procter LLP from 2008 to 2010. From 1999 to 2008, Mr. Reimer served as a Partner of McDermott, Will & Emery, LLP, where he served as Chairman of the Global Finance Group and a Member of the Management Committee and was involved in strategic, budgeting and staffing decisions throughout his tenure. Mr. Reimer received a B.S. in Business Administration from the University of Southern California and a J.D. from the University of California, Hastings College of the Law. We believe that Mr. Reimer should be a member of our Board due to his legal expertise and industry experience.
James Zinn
Mr. Zinn is one of our director nominees. Since 2012, Mr. Zinn has been a director of dwinQ, Inc, a company that offers an online social media platform. Since 2010, Mr. Zinn has served as a Director and the Treasurer of a home owners association representing over 5,000 residents. Since 2008, he has also maintained an on-call consultant role with ODIN Technologies, Inc., a radio-frequency identification engineering firm, which he helped organize in 2003. From 2003 to 2009, Mr. Zinn served as a director of Vmeals, LLC, an online food sales organization. During 2008, Mr. Zinn also served on the valuation committee of XE Capital Management, LLC, a hedge fund based in New York City, New York. Prior to that, Mr. Zinn co-founded and served as Chief Financial Officer (until 2002) and a Director of ServerVault, Inc., a secure web-hosting company, from 1999 to 2006. From 1994 to 1999, Mr. Zinn served as the Chief Financial Officer and Senior Vice President of CapitalOne Financial Corporation, where he was responsible for all financial management and related communications. Prior to that, from 1977 to 1994, Mr. Zinn served in various capacities from staff accountant to Regional Partner for Ernst & Young, LLP, providing accounting and consultation advice on technical accounting matters to financial services clients. Mr. Zinn
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received a B.S. in Business Administration from The Ohio State University. We believe that Mr. Zinn should be a member of our Board due to his accounting expertise and industry experience.
Executive and Director Compensation
Executive Compensation
Because our Investment Advisory Agreement provides that our Advisor is responsible for managing our affairs, our officers, who are employees of our Advisor, do not receive cash compensation from us for serving as our officers.
Except for certain equity grants and except as set forth above, our Advisor or one of its affiliates compensates each of our officers. We pay our Advisor an advisory fee and our Advisor uses the proceeds from the advisory fee in part to pay compensation to its personnel. We have adopted a 2012 equity incentive plan to provide incentive compensation to our officers, our non employee directors, our Advisor's personnel and other service providers to encourage their efforts toward our continued success, long-term growth and profitability and to attract, reward and retain key personnel. See "Equity Incentive Plan" for detailed description of our 2012 equity incentive plan.
Compensation of Directors
We will pay a $45,000 annual base director's fee to each of our independent directors. Initially, we will pay this fee in cash, but we may in the future pay all or a portion of this fee in equity-based awards. In addition, the chairs of the audit, compensation and nominating and corporate governance committees will receive an additional annual cash retainer of $10,000, respectively. Each independent director will also receive a fee of $2,000 for attending each committee meeting. We will also reimburse all members of our Board for their travel expenses incurred in connection with their attendance at full Board and committee meetings.
Our independent directors will also generally be eligible to receive restricted common stock, options and other stock based equity awards under our 2012 equity incentive plan.
We will pay directors' fees only to those directors who are independent under the NYSE listing standards.
Corporate GovernanceBoard of Directors and Committees
Our business is managed by our Advisor, subject to the supervision and oversight of our Board, which has established investment guidelines for our Advisor to follow in its day to day management of our business. Upon completion of this offering, a majority of our Board will be "independent," as determined by the requirements of the NYSE. Our directors keep informed about our business by attendance at meetings of our board and its committees and through supplemental reports and communications. Our independent directors meet regularly in executive sessions without the presence of our corporate officers or non independent directors.
Upon completion of this offering, our Board will form an audit committee, a compensation committee and a nominating and corporate governance committee and adopt charters for each of these committees. Each of these committees will be composed exclusively of independent directors, as defined by the listing standards of the NYSE. Moreover, the compensation committee will be composed exclusively of individuals intended to be, to the extent provided by Rule 16b-3 of the Exchange Act, non-employee directors and will, at such times as we are subject to Section 162(m) of the Internal Revenue Code, qualify as outside directors for purposes of Section 162(m) of the Internal Revenue Code.
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Audit Committee
The audit committee will comprise Messrs. Zinn, Ogilvie and Reimer each of whom will be an independent director and "financially literate" under the rules of the NYSE. Mr. Zinn will chair our audit committee and serve as our audit committee financial expert, as that term is defined by the SEC. The audit committee will be responsible for engaging an independent registered public accounting firm, preparing audit committee reports, reviewing with the independent registered public accounting firm the plans and results of the audit engagement, approving professional services provided by the independent registered public accounting firm, reviewing the independence of the independent registered public accounting firm, considering the range of audit and non-audit fees and reviewing the adequacy of our internal accounting controls.
Compensation Committee
The compensation committee will comprise Messrs. Ogilvie, Mudge and Zinn, each of whom will be an independent director. Ms. Ogilvie will chair our compensation committee. The principal functions of the compensation committee will be to (i) evaluate the performance of our officers, (ii) review the compensation payable to our officers, (iii) evaluate the performance of our Advisor, (iv) review the compensation and fees payable to our Advisor under the Investment Advisory Agreement, (v) prepare compensation committee reports and (vi) administer our proposed 2012 equity incentive plan.
Nominating and Corporate Governance Committee
The nominating and corporate governance committee will comprise Messrs. Reimer and Mudge, each of whom will be an independent director. Mr. Reimer will chair our nominating and corporate governance committee. The nominating and corporate governance committee will be responsible for seeking, considering and recommending to the Board qualified candidates for election as directors and will approve and recommend to the full Board the appointment of each of our officers.
The nominating and corporate governance committee will also periodically prepare and submit to the Board for adoption the committee's selection criteria for director nominees. It will review and make recommendations on matters involving general operation of the Board and our corporate governance and will annually recommend to the Board nominees for each committee of the Board. In addition, the committee will annually facilitate the assessment of the Board's performance as a whole and of the individual directors and report thereon to the Board.
Code of Business Conduct and Ethics
Our code of business conduct and ethics applies to our officers and directors and to our Advisor's personnel when such individuals are acting for or on our behalf. Among other matters, our code of business conduct and ethics is designed to deter wrongdoing and to promote:
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Any waiver of the code of business conduct and ethics for our officers or directors may be made only by our Board or one of our Board committees and will be promptly disclosed if and to the extent required by law or stock exchange regulations.
Conflicts of Interest
Asset Allocations
We are dependent on our Advisor for our day-to-day management, and we do not have any independent officers or employees. Each of our officers and directors is also an employee of our Advisor or its affiliates. Our Investment Advisory Agreement with our Advisor was negotiated between related parties and its terms, including fees and other amounts payable, may not be as favorable to us as if they had been negotiated on an arm's-length basis with unaffiliated third parties. In addition, the ability of our Advisor and its officers and personnel to engage in other business activities, including the management of other entities and separate accounts, may reduce the time our Advisor and its officers and personnel spend managing us.
Various potential and actual conflicts of interest may arise from the overall investment activities of our Advisor, its affiliates, investment management clients or investment funds managed by it. ZAIS has in the past served, is currently serving and will in the future serve as the investment adviser to a series of funds, dedicated funds and managed accounts, which also invest in our target assets.
In 2006, ZAIS formed the Matrix V Funds, which are private investment vehicles with finite investment periods that primarily focus on investing in collateral loan obligations, CDO securities and RMBS assets, primarily subordinate and distressed credits. Beginning in late 2007, ZAIS formed the Matrix VI Funds, which are private investment vehicles with finite investment periods that deploy a long-only, unlevered strategy that sought to capitalize on the market dislocation and leverage unwind in the mortgage securities sector. The Matrix Funds have liquidated their investment assets and are in the process of winding down their operations.
In August 2008, ZAIS formed the SerVertis Fund. The SerVertis Fund is a private investment vehicle with an investment strategy focused on acquiring distressed residential loan portfolios (whether through loan acquisitions or structured securities backed by residential loans), consisting primarily of current loans as opposed to delinquent loans, and controlling the loans by utilizing the mortgage servicing and collections platform of a mortgage servicer with which ZAIS has formed a strategic relationship. While the SerVertis Fund has only limited reinvestment capacity since it has exited its commitment period, certain conflicts of interest may still exist with respect to the SerVertis Fund, including, circumstances where we may purchase assets being disposed of by the SerVertis Fund as it begins to liquidate assets. As of September 30, 2012, the SerVertis Fund had a net asset value of $784.2 million.
ZAIS also formed the 2009-2010 Managed Accounts, which are accounts for certain institutional investors seeking to capitalize on a strategy similar to the Matrix VI Funds through a separate managed account format. As of September 30, 2012, the 2009-2010 Managed Accounts had a net asset value of $40.1 million.
In 2012, ZAIS formed the ZAIS Mortgage Securities Fund and the INARI Fund. Additionally, in 2012, ZAIS entered into an investment advisory agreement to serve as the investment advisor to the 2012 Managed Account. ZAIS serves as the investment advisor to each of these funds formed in 2012 and the 2012 Managed Account, which deploy predominantly long strategies focused on opportunities in the RMBS sector and, in some
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instances, utilize explicit leverage and utilize derivative financial instruments to mitigate mark-to-market risk on the predominantly long positions held by each fund. As of September 30, 2012, the ZAIS Mortgage Securities Fund, the INARI Fund and the 2012 Managed Account had net asset values of $154.2 million, $104.0 million and $71.9 million, respectively.
In addition to RMBS and residential mortgage loan focused funds, in 2003, ZAIS established the ZAIS Opportunity Fund with a focus on investing in various structured finance securities, including a permitted investment in certain of our target assets. Unlike the SerVertis Fund, the ZAIS Opportunity Fund has no defined reinvestment period and the ability to accept new subscriptions of capital. Accordingly, we may compete with the ZAIS Opportunity Fund for both our target assets and for ZAIS's resources. As of September 30, 2012, the ZAIS Opportunity Fund had a net asset value of $486.5 million. ZAIS has also served as the collateral manager of a number of CDO vehicles, some of which encountered events of default as a result of ratings downgrades during the recent financial crisis.
Certain of the Other Clients have significant uninvested capital and will likely compete with us. Accordingly, we and the Other Clients may co-invest in many of the same securities and issues. The Other Clients may also invest in target assets that would be appropriate investments for us. Our Advisor intends to allocate investment opportunities to us and the Other Clients in a fair and equitable manner, consistent with our and the Other Clients' investment objectives and approaches. Our Advisor allocates investment opportunities to Other Clients which have a current strategy allocation to a given sector (or the Allocation Accounts). The allocation of individual investments is specifically documented and retained on record. In general, allocations are made on a pro-rata basis taking into account the available cash and capital of the respective Allocation Accounts. Pro-rata allocations may be modified for constraints unique to the Allocation Account such as portfolio concentrations, tax consequences, regulatory restrictions or liquidity requirements, among others. This policy does not require our Advisor to act in a way that is favorable to us, and such investments made on our behalf may be different from those made on behalf of the Other Clients.
Our Advisor, its affiliates and/or the Other Clients may have economic interests in or other relationships with issuers in whose obligations or securities we may invest. In particular, such persons may make and/or hold an investment in an issuer's securities that may be pari passu , senior or junior in ranking to an investment in such issuer's securities made and/or held by us. In particular, we and the Other Clients may also hold different tranches of the same RMBS or CDO securities where the tranche of an RMBS or CDO security held by us may be subordinate or senior to the tranche held by the Other Clients. We may also invest in an issuer's securities in which our Advisor, its affiliates and/or the Other Clients serve on boards of directors, or own an equity interest, have a financial interest or otherwise have ongoing relationships. Each of such ownership and other relationships may result in securities laws restrictions on transactions in such securities by us and otherwise create conflicts of interest for us. In such instances, our Advisor and its affiliates may in their discretion make investment recommendations and decisions that may be the same as or different from those made with respect to us. Additionally, we and the Other Clients may take adverse positions in the same securities and issues and we and the Other Clients may choose to liquidate positions at different times.
In addition to the existing funds for which ZAIS acts as investment advisor, ZAIS may, in the future, establish new funds or enter into new managed account arrangements with investment strategies that are substantially similar to our strategy, including funds and accounts investing primarily in our target assets, including RMBS and residential mortgage
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loans. ZAIS will allocate investments between us and such other funds in a fair and equitable manner, taking into account any capacity or liquidity constraints.
Although the officers and employees of our Advisor and its affiliates devote as much time to us as each of them deems appropriate, they may have conflicts in allocating their time and services among us, their affiliates, and the Other Clients. In the course of performing its duties to us, our Advisor may consider its relationships with its affiliates and their respective clients. Our Advisor may decline to pursue a particular investment opportunity on our behalf in view of such relationships. In providing services to Other Clients, our Advisor and its affiliates may recommend activities that would compete with or otherwise adversely affect us.
In addition, our Advisor, its affiliates, its investment management clients and investment funds managed by it in connection with their other business activities, may acquire material non-public confidential information that may restrict them from purchasing securities or selling securities (or recommending purchases or sales) for itself or its clients or otherwise using such information for the benefit of their clients or themselves. Accordingly, during certain periods or in certain circumstances, our Advisor may be unable as a result of such restrictions to buy or sell securities or to take other actions that it might consider to be in our best interests.
Our Advisor and one or more of its affiliates may hold equity or other interests in the collateral managers of issuers in whose securities we have invested or may invest, or any reference entities referred to in CDS contracts or ABS indices, and receives and may continue to receive such equity interests or distributions in respect thereof from such collateral managers as a result of our investment or other funds or issuers for which our Advisor acts as investment advisor. Receipt of any such interests or amounts will be solely the property of our Advisor or such affiliate(s), as the case may be, without any credit to us or any reduction in the fees payable by us to our Advisor. In addition, our Advisor may take a long (or short) position for one or more Other Clients in an investment in which we are short (or long). More particularly, our Advisor or its affiliates may serve as collateral manager or investment adviser for an Other Client (including a CDO) whose reference portfolio contains long positions in the same reference obligation that we are short, or, alternatively, an Other Client (including a CDO) whose reference portfolio contains short positions in the same reference obligation that we are long.
Additionally, some of the target assets purchased by us may be purchased from portfolios of investments held for the account(s) of one or more of the Other Clients. We may purchase target assets from our Advisor, its affiliates or any such Other Client only to the extent (i) such purchases are made at fair market value (as determined in good faith by our Advisor) and otherwise on arm's-length terms and (ii) our Advisor determines that such purchases are consistent with our investment guidelines and objectives, the restrictions contained in our Investment Advisory Agreement and applicable law. We may also invest in other companies or pooled investment vehicles focused on investing in Agency RMBS and/or any class of our targeted assets. We may make investments in such vehicles which are managed by our Advisor or one of its affiliates. Our Advisor and its affiliates also may sell target assets initially purchased for us to Other Clients.
We will not, however, purchase any assets from, or issued by, any Other Client or any entity managed by our Advisor or its affiliates, or sell any asset to any Other Client or any such other entity without the consent of a majority of our Board, including a majority of our independent directors. A majority of our independent directors may amend this affiliated investment policy at any time without stockholder consent.
Further, our Advisor may purchase on our behalf securities in one or more ZAIS Funds so long as the underlying investments of such ZAIS Funds primarily consist of our target assets.
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Our investments in such ZAIS Funds may include debt or equity interests that are subordinate in right of payment to other securities or interests issued by such ZAIS Funds and generally will not be readily marketable. In certain cases, we may sell assets to a ZAIS Fund but repurchase a portion of the credit risk of the assets through ownership of a subordinated debt or equity interest in the ZAIS Fund. ZAIS, or its affiliates, as applicable, shall either cause the documentation for any such ZAIS Fund to, or shall itself, waive or rebate any applicable senior management fees, subordinated management fees, incentive fees or residual interests of such ZAIS Fund that would otherwise payable by us. Instances may arise wherein funds sponsored or managed by ZAIS and from which ZAIS receives substantial compensation could not have been formed without our participation as a seller of assets to or a purchaser of securities issued by such ZAIS Fund. Our Advisor may have a conflict of interest in causing us to participate in, as well as in using our assets to help form, such funds.
Advisory Fee
We have agreed to pay our Advisor an advisory fee that is not tied to our performance. Because of this, the advisory fee may not sufficiently incentivize our Advisor to generate attractive risk adjusted returns for us.
Code of Business Conduct and Ethics
We do not have a policy that expressly prohibits our directors, officers, security holders and affiliates from engaging for their own account in business activities of the types conducted by us. However, our code of business conduct and ethics contains a conflicts of interest policy that prohibits our directors, officers and employees, to the extent we have employees in the future, from engaging in any transaction that involves an actual conflict of interest with us as determined by a majority of our directors.
Equity Incentive Plan
We have adopted a 2012 equity incentive plan to provide incentive compensation to attract and retain qualified directors, officers, advisors, consultants and other personnel, including our Advisor and affiliates and personnel of our Advisor or its affiliates, and any joint venture affiliates of ours. The 2012 equity incentive plan will be administered by a committee (which may be the compensation committee) appointed by our Board. The 2012 equity incentive plan permits the granting of stock options, restricted shares of common stock, phantom shares, dividend equivalent rights, restricted limited partner profit interests (or LTIP units) and other restricted limited partnership units issued by our Operating Partnership and other equity-based awards.
Administration
The committee appointed by our Board to administer the 2012 equity incentive plan has the full authority to administer and interpret the 2012 equity incentive plan, to authorize the granting of awards, to determine the eligibility of directors, officers, advisors, consultants and other personnel, including our Advisor and affiliates and personnel of our Advisor or its affiliates, and any joint venture affiliates of ours to receive an award, to determine the number of shares of common stock to be covered by each award (subject to the individual participant limitations provided in the 2012 equity incentive plan), to determine the terms, provisions and conditions of each award (which may not be inconsistent with the terms of the 2012 equity incentive plan), to prescribe the form of instruments evidencing awards and to take any other actions and make all other determinations that it deems necessary or appropriate in connection with the 2012 equity incentive plan or the administration or interpretation thereof. In connection with this authority, the committee may, among other things, establish
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performance goals that must be met in order for awards to be granted or to vest, or for the restrictions on any such awards to lapse. From and after the consummation of this offering, the 2012 equity incentive plan will be administered by a committee consisting of two or more non employee directors, each of whom is intended to be, to the extent required by Rule 16b-3 under the Exchange Act, a non-employee director and will, at such times as we are subject to Section 162(m) of the Internal Revenue Code and intend that grant be exempt from the restriction of Section 162(m), qualify as an outside director for purposes of Section 162(m) of the Internal Revenue Code, or, if no committee exists, our Board. References below to the committee include a reference to the board for those periods in which the board is acting.
Available Shares
Our 2012 equity incentive plan provides for grants of stock options, restricted shares of common stock, phantom shares dividend equivalent rights, LTIP units and other restricted limited partnership units issued by our Operating Partnership and other equity based awards up to, in the aggregate, the equivalent of 5% of the issued and outstanding shares of our common stock from time to time following the completion of this offering (on a fully diluted basis (assuming, if applicable, the exercise of all outstanding options and the conversion of all warrants and convertible securities into shares of common stock) and excluding shares to be sold pursuant to the underwriters' exercise of their overallotment option) at the time of the award. If an option or other award granted under the 2012 equity incentive plan expires or terminates, the shares subject to any portion of the award that expires, forfeits or terminates without having been exercised or paid, as the case may be, will again become available for the issuance of additional awards. Unless previously terminated by our Board, no new award may be granted under the 2012 equity incentive plan after the tenth anniversary of the earlier of the date that such plan was initially approved by (i) our Board or (ii) our stockholders. No award may be granted under our 2012 equity incentive plan to any person who, assuming exercise of all options and payment of all awards held by such person would own or be deemed to own more than 9.8% of the outstanding shares of our common stock.
Awards Under the Plan
Stock Options. The terms of specific options, including whether options shall constitute "incentive stock options" for purposes of Section 422(b) of the Internal Revenue Code, shall be determined by the committee. The exercise price of an option shall be determined by the committee and reflected in the applicable award agreement. The exercise price with respect to incentive stock options may not be lower than 100% (110% in the case of an incentive stock option granted to a 10% stockholder, if permitted under the plan) of the fair market value of our common stock on the date of grant. Each option will be exercisable after the period or periods specified in the award agreement, which will generally not exceed ten years from the date of grant (or five years in the case of an incentive stock option granted to a 10% stockholder, if permitted under the plan). Options will be exercisable at such times and subject to such terms as determined by the committee.
Restricted Shares of Common Stock. A restricted share award is an award of shares of common stock that is subject to restrictions on transferability and such other restrictions, if any, as the committee may impose at the date of grant. Grants of restricted shares of common stock will be subject to vesting schedules as determined by the committee. The restrictions may lapse separately or in combination at such times, under such circumstances, including, without limitation, a specified period of employment or the satisfaction of pre established criteria, in such installments or otherwise, as the committee may determine. A participant granted restricted shares of common stock has all of the rights of a stockholder,
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including, without limitation, the right to vote and the right to receive dividends on the restricted shares of common stock.
Although dividends will be paid on restricted shares of common stock, whether or not vested, at the same rate and on the same date as on shares of our common stock, holders of restricted shares of common stock are prohibited from selling such shares until they vest.
Phantom Shares. Phantom shares, when issued, will reduce the number of shares available for grant under the 2012 equity incentive plan and will vest as provided in the applicable award agreement. A phantom share represents a right to receive the fair market value of a share of common stock, or, if provided by the committee, the right to receive the fair market value of a share of common stock in excess of a base value established by the committee at the time of grant. Phantom shares may generally be settled in cash or by transfer of shares of common stock (as may be elected by the participant or the committee, as may be provided by the committee at grant). The committee may, in its discretion and under certain circumstances, permit a participant to receive as settlement of the phantom shares installments over a period not to exceed ten years.
Dividend Equivalents. A dividend equivalent is a right to receive (or have credited) the equivalent value (in cash or shares of common stock) of dividends paid on shares of common stock otherwise subject to an award. The committee may provide that amounts payable with respect to dividend equivalents shall be converted into cash or additional shares of common stock. The committee will establish all other limitations and conditions of awards of dividend equivalents as it deems appropriate.
Restricted Limited Partnership Units. A restricted limited partnership unit represents OP units or may include LTIP units that are structured as profit interests in our Operating Partnership, providing distributions to the holder of the award based on the achievement of specified levels of profitability by our Operating Partnership or the achievement of certain goals or events. The restricted OP units may be convertible into or exchangeable for other securities of our Operating Partnership or into shares of our capital stock. The compensation committee will establish all other limitations and conditions of awards of restricted OP units as it deems appropriate.
Other Share Based Awards. The 2012 equity incentive plan authorizes the granting of other awards based upon shares of our common stock (including the grant of securities convertible into shares of common stock and share appreciation rights), subject to terms and conditions established at the time of grant.
Change in Control
Upon a change in control (as defined in the 2012 equity incentive plan), the committee may make such adjustments as it, in its discretion, determines are necessary or appropriate in light of the change in control, but only if the committee determines that the adjustments do not have a substantial adverse economic impact on the participants (as determined at the time of the adjustments) and provided that any discretionary increase in the aggregate number of shares issuable under the 2012 equity incentive plan must be approved by our Board.
Other Changes
Our Board may amend, alter, suspend or discontinue the 2012 equity incentive plan but cannot take any action that would impair the rights of a participant's existing grants. To the extent necessary and desirable (including, as required by law or any stock exchange rules),
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the board of directors must obtain approval of our stockholders for any amendment that would:
The committee or our Board may amend the terms of any award granted under the 2012 equity incentive plan, prospectively or retroactively, but, generally may not impair the rights of any participant without his or her consent.
Limitation of Liability and Indemnification
Maryland law permits a Maryland corporation to include in its charter a provision limiting the liability of its directors and officers to the corporation and its stockholders for money damages except for liability resulting from (1) actual receipt of an improper benefit or profit in money, property or services or (2) active and deliberate dishonesty established by a final judgment as being material to the cause of action. Our charter contains such a provision which eliminates the liability of our directors and officers to the maximum extent permitted by Maryland law.
Our charter authorizes us to obligate ourselves, and our bylaws obligate us, to the maximum extent permitted by Maryland law, to indemnify and pay or reimburse reasonable expenses in advance of final disposition of a proceeding to (1) any present or former director or officer of our company or (2) any individual who, while serving as our director or officer and at our request, serves or has served another corporation, REIT, limited liability company, partnership, joint venture, trust, employee benefit plan or any other enterprise as a director, officer, partner, trustee, member or manager of such corporation, REIT, limited liability company, partnership, joint venture, trust, employee benefit plan or other enterprise, and who is made or threatened to be made a party to the proceeding from and against any claim or liability to which he or she may become subject or which he or she may incur by reason of his or her service in such capacity or capacities. The rights to indemnification and advance of expenses provided by our charter and bylaws vest immediately upon election of a director or officer. Our charter and bylaws also permit us to indemnify and advance expenses to any person who served any predecessor of our company in any of the capacities described above and to any employee or agent of our company or of any predecessor.
The MGCL requires a Maryland corporation (unless its charter provides otherwise, which our charter does not) to indemnify a director or officer who has been successful, on the merits or otherwise, in the defense of any proceeding to which he or she is made or threatened to be made a party by reason of his or her service in that capacity. The MGCL permits a Maryland corporation to indemnify its present and former directors and officers, among others, against judgments, penalties, fines, settlements and reasonable expenses actually incurred by them in connection with any proceeding to which they may be made or threatened to be made a party by reason of their service in those or other capacities unless it is established that (1) the act or omission of the director or officer was material to the matter giving rise to the proceeding and (A) was committed in bad faith or (B) was the result of active and deliberate dishonesty, (2) the director or officer actually received an improper personal benefit in money, property or services or (3) in the case of any criminal proceeding, the director or officer had reasonable cause to believe that the act or omission was unlawful. Under the MGCL, a Maryland corporation may not indemnify a director or officer in a suit by or in the right of the corporation in which the director or officer was adjudged to be liable to
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the corporation or in a proceeding in which the director or officer was adjudged to be liable on the basis that personal benefit was improperly received, unless in either case a court orders indemnification and then only for expenses. In addition, the MGCL permits a corporation to advance reasonable expenses to a director or officer upon the corporation's receipt of (1) a written affirmation by the director or officer of his or her good faith belief that he or she has met the standard of conduct necessary for indemnification by the corporation and (2) a written undertaking by him or her or on his or her behalf to repay the amount paid or reimbursed by the corporation if it is ultimately determined that the standard of conduct was not met.
In addition, we have entered into indemnification agreements with each of our directors and executive officers that provide for indemnification to the maximum extent permitted by Maryland law.
"ZAIS" License Agreement
Prior to the completion of the offering, we will enter into a license agreement with ZAIS pursuant to which ZAIS will grant us a revocable, non exclusive, royalty free license to use the name "ZAIS." Under this agreement, we have a right to use this name and trademark for so long as ZAIS REIT Management, LLC or another affiliate of ZAIS Group, LLC serves as our Advisor pursuant to the Investment Advisory Agreement. In the event the investment advisory agreement is terminated, we would be required to change our name to eliminate the use of "ZAIS."
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The following table sets forth certain information following the closing of this offering, regarding the ownership of each class of our capital stock by:
Each listed person's beneficial ownership includes:
Unless otherwise indicated, all shares are owned directly, and the indicated person has sole voting and investment power. Except as indicated in the footnotes to the table below, the business address of the stockholders listed below is the address of our principal executive office, Two Bridge Avenue, Suite 322, Red Bank, New Jersey 07701.
Name and Address
(1)
)
|
Number of Shares
Beneficially Owned |
Percentage of
All Shares Immediately After Offering (2) |
|||||
---|---|---|---|---|---|---|---|
Christian Zugel (3) |
119,481 | ||||||
Michael Szymanski |
11,246 | ||||||
Denise Crowley (4) |
6,437 | ||||||
Paul McDade |
900 | ||||||
Brian Hargrave |
4,498 | ||||||
Steven Haber |
0 | ||||||
All directors, executive officers as a group (6 persons) |
142,562 |
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THE HISTORY AND FORMATION OF OUR COMPANY
We completed our formation transaction and commenced operations on July 29, 2011. The formation transaction involved the exchange by investors in Matrix VI-A and VI-B of cash and RMBS assets for an aggregate of 3,022,617 shares of our common stock. We received $60.5 million in this transaction, including $8.65 million from the ZAIS Parties. The amounts contributed represented approximately 22.4% of the aggregate equity value of Matrix VI-A and Matrix V-B as of the date of the closing of the formation transaction. Upon completion of the formation transaction, the Matrix Funds continued their operations, while we deployed the contributed assets together with additional borrowings to build a diversified portfolio of RMBS assets. In connection with the formation transaction, Matrix VI-A and VI-B made customary representations and warranties to us and agreed to indemnify us, subject to certain conditions and limitations, for breach of these representations and warranties, provided claims were brought within one year following the closing of these transactions.
As part of the initial formation transactions, we anticipated completing our initial public offering on or prior to August 3, 2012 and viewed our initial public offering as a means for our stockholders to achieve liquidity in their investments. We determined, due to our assessment of market conditions, to delay the initial public offering beyond August 3, 2012. In connection with our delay of the initial public offering, we offered to repurchase shares from our stockholders who desired to achieve liquidity around the time of the original August 3, 2012 time frame. Accordingly, on October 11, 2012 we repurchased 668,525 shares of common stock from our existing stockholders at the per share book value as of July 31, 2012. On January 24, 2013, we also repurchased 265,245 shares of our common stock from one of our institutional stockholders. We paid to such stockholder approximately $5.2 million, which represents 90% of the repurchase amount based on the estimated book value per share as of December 31, 2012, the remaining 10% of the repurchase price will be paid following the completion of our December 31, 2012 year-end audit. In October of 2012, we also completed a private placement in which we sold 195,457 shares of common stock and 22,492 OP units at a price per share equal to the per share book value as of August 31, 2012. Subsequently, in December of 2012, we completed another private placement in which we sold 36,581 shares of common stock and 904,422 OP units at a price per share equal to the per share book value as of November 30, 2012. As a consequence of these transactions, we currently have outstanding 2,320,882 shares of common stock and 926,914 OP units.
As part of the capital raising and other transactions we have completed in connection with our formation, we committed to commence the orderly liquidation of our assets, taking into account market conditions, unless, at any time prior to February 28, 2014, we succeed in listing our shares of common stock on a national securities exchange and achieving Stockholders' Equity of at least $100 million. We expect that the closing of this offering would relieve us of any requirement relating to the orderly liquidation of our assets.
Class B Interests in our Advisor
As part of the capital raising and other transactions we have completed in connection with our formation, we granted Class B non-voting and non-transferable membership interests in our Advisor (or the Class B Interests) to our stockholders and OP unitholders. The Class B Interests entitle the holders thereof, subject to the legal availability of funds, to participate in distributions paid by our Advisor in (i) 20% of the advisory fees received by our Advisor pursuant to the Investment Advisory Agreement with respect to the first $1.0 billion of our Stockholders' Equity (as defined in Investment Advisory Agreement) and (ii) 10% of the advisory fees received by our Advisor pursuant to the Investment Advisory Agreement with respect to our Stockholders Equity in excess of $1 billion. The Class B Interests are subject to
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repurchase by our Advisor at any time after September 30, 2017 in exchange for the formula based cash payment specified in the Class B Interest grant agreements.
Registration Rights Agreement
In connection with the capital raising and other transactions we have completed in connection with our formation and the other private placements of our shares of common stock and OP units, we entered into registration rights agreements with our existing stockholders and OP unitholders. Pursuant to these agreements, we have agreed for the benefit of such holders that we will, at our expense (i) use our reasonable efforts to file with the SEC a resale shelf registration statement (providing for the resale of the shares of common stock issued in or in exchange for shares of common stock or OP units), no later than 270 days after the listing of shares of common stock on a national securities exchange, subject to extension if we are bound by a lock-up agreement which restricts the filing of the registration statement in which event we will be required to use our reasonable efforts to file the registration statement within 30 days after the expiration of the lock-up period, (ii) use our commercially reasonable efforts to cause the resale shelf registration statement to be declared effective by the SEC under the Securities Act as promptly as practicable after the filing, (iii) use our commercially reasonable efforts to maintain a listing for such shares of common stock registered on such resale shelf registration statement for trading on a national securities exchange and (iv) use our commercially reasonable efforts to maintain the resale shelf registration statement's effectiveness under the Securities Act until the first to occur of (A) such time as all of such shares of common stock covered by the resale shelf registration statement have been sold pursuant to the resale shelf registration statement or pursuant to Rule 144 under the Securities Act and (B) the second anniversary after the completion of our listing.
Lock-Up Agreements
Holders of 92.3% of our outstanding shares of common stock and OP units, after giving effect to the 2013 repurchase described elsewhere in this prospectus, have agreed with ZAIS, as the managing member of our Advisor, not to, directly or indirectly, sell, transfer, assign, mortgage, hypothecate, pledge or otherwise dispose of or encumber or permit or suffer any encumbrance of all or any part of the shares of our common stock or OP units acquired as part of the above formation transactions or subsequent purchases of such common stock or OP units, until 270 days following the completion of our listing without the prior written consent of ZAIS, subject to certain exceptions relating to private resales where the transferee continues to be bound by the lock-up agreement.
Additionally, each of our directors and executive officers and the ZAIS Parties who collectively own an aggregate of 510,047 shares of common stock and 33,658 OP units have agreed not to offer, sell, contract to sell or otherwise dispose of, or enter into any transaction that is designed to, or could be expected to, result in the disposition of any shares of our common stock that they may own or have the right to acquire or other securities convertible into or exchangeable or exercisable for our common stock (including OP units) prior to this offering for a period of 270 days after the effective date of the registration statement of which this prospectus is a part without the prior written consent of the representatives of the underwriters. This consent may be given at any time without public notice. Transfers or dispositions may be made during the lock-up period if any such transfer or disposition does not trigger any filing or reporting requirement or obligation or result in any other voluntary or mandatory public disclosure, including but not limited to Form 4 of Section 16 of the Exchange Act, and is by gift, will or intestacy, or distribution to partners, members or shareholders of the transferor, provided that the transferee agrees in writing to be bound by the restrictions set forth in the lock-up agreement. There are no agreements between the representatives and any of our stockholders or affiliates releasing them from these lock-up agreements prior to the expiration of the 270-day period. We and our Advisor have also entered into a similar agreement with the representatives of the underwriters.
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CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Investment Advisory Agreement
We have entered into an Investment Advisory Agreement with our Advisor, pursuant to which our Advisor provides the day-to-day management of our operations. The Investment Advisory Agreement requires our Advisor to manage our business affairs in conformity with the policies and the guidelines that are approved and monitored by our Board. The Investment Advisory Agreement has an initial three-year term and will be renewed for one-year terms thereafter unless terminated by either us or our Advisor. Our Advisor is entitled to receive a termination fee from us, under certain circumstances. We are also obligated to reimburse certain expenses incurred by our Advisor. Our Advisor is entitled to receive from us an advisory fee. See "Our Advisor and the Investment Advisory AgreementInvestment Advisory Agreement." During the period from July 29, 2011 (the date of our inception) to September 30, 2012, we incurred $1.1 million in advisory fees to our Advisor under our Investor Advisory Agreement.
Our officers and directors are also employees of our Advisor or its affiliates. As a result, the Investment Advisory Agreement between us and our Advisor was negotiated between related parties, and its terms, including fees and other amounts payable, may not be as favorable to us as if they had been negotiated with unaffiliated third parties. See "ManagementConflicts of Interest" and "Risk FactorsRisks Associated With Our Management and Our Relationship With Our AdvisorThere are conflicts of interest in our relationship with ZAIS and its affiliates, which could result in decisions that are not in the best interests of our stockholders."
ZAIS License Agreement
Prior to the completion of the offering, we will enter into a license agreement with ZAIS pursuant to which ZAIS will grant us a revocable, non exclusive, royalty free license to use the name "ZAIS." Under this agreement, we have a right to use this name and trademark for so long as ZAIS REIT Management, LLC or another affiliate of ZAIS Group, LLC serves as our Advisor pursuant to the Investment Advisory Agreement. In the event the investment advisory agreement is terminated, we would be required to change our name to eliminate the use of "ZAIS." See "Our Management"ZAIS" License Agreement."
Restricted Common Stock and Other Equity Based Awards
Our 2012 equity incentive plan provides for grants of restricted common stock and other equity based awards up to, in the aggregate, the equivalent of 5% of the issued and outstanding shares of our common stock from time to time following the completion of this offering (on a fully diluted basis (assuming, if applicable, the exercise of all outstanding options and the conversion of all warrants and convertible securities into shares of common stock) and excluding shares to be sold pursuant to the underwriters' exercise of their overallotment option) at the time of the award.
Purchases of Common Stock by Affiliates
In connection with the capital raising and other transactions we have completed in connection with our formation, the ZAIS Parties (which consist of certain current and former employees of ZAIS and relatives of such persons as well as current and former members and owners of ZAIS) acquired 510,047 net shares of our common stock and 33,658 OP units for a weighted average purchase price of $20.47 per share/OP unit. All of these shares were acquired at a book value per share as of a month end prior to the purchase. The ZAIS Parties
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are entitled to the benefits of a registration rights agreement with respect to these shares of common stock and OP units. See "Stock Eligible for Future SaleRegistration Rights Agreement."
Indemnification and Limitation of Directors' and Officers' Liability
Maryland law permits a Maryland corporation to include in its charter a provision limiting the liability of its directors and officers to the corporation and its stockholders for money damages except for liability resulting from (1) actual receipt of an improper benefit or profit in money, property or services or (2) active and deliberate dishonesty established by a final judgment as being material to the cause of action. Our charter contains such a provision which eliminates the liability of our directors and officers to the maximum extent permitted by Maryland law.
We have entered into indemnification agreements with each of our directors and executive officers that provide for indemnification to the maximum extent permitted by Maryland law. For more information, see "ManagementLimitation of Liability and Indemnification."
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The following summary description of our capital stock does not purport to be complete and is subject to and qualified in its entirety by reference to the MGCL and to our charter and bylaws, each as amended and restated in connection with this offering. For a more complete understanding of our capital stock, we encourage you to read carefully this entire prospectus, as well as our amended and restated charter and our amended and restated bylaws, the forms of which are filed as exhibits to the registration statement of which this prospectus forms a part.
General
Our charter provides that we may issue up to 500,000,000 shares of common stock, $0.0001 par value per share, and up to 50,000,000 shares of preferred stock, $0.0001 par value per share. Our charter authorizes our Board to amend our charter to increase or decrease the aggregate number of authorized shares of stock or the number of shares of stock of any class or series without stockholder approval. After giving effect to this offering, shares of common stock will be issued and outstanding ( if the underwriters' overallotment option is exercised in full), and 133 shares of our Series A Preferred Stock (as defined below) will be issued and outstanding. If the underwriters exercise their overallotment option in full, shares of our common stock will be outstanding after the completion of this offering. We intend to redeem all shares of our Series A Preferred Stock for an aggregate redemption price of $146,300, plus any accrued and unpaid dividends, shortly after the completion of this offering so that there will be no shares of our preferred stock issued and outstanding. Under Maryland law, our stockholders are not generally liable for our debts or obligations.
Shares of Common Stock
All of the shares of our common stock offered by this prospectus will be duly authorized, validly issued, fully paid and nonassessable. Subject to the preferential rights, if any, of holders of any other class or series of our stock and to the provisions of our charter regarding the restrictions on the ownership and transfer of our stock, holders of outstanding shares of our common stock are entitled to receive dividends on such shares of common stock out of assets legally available therefor if, as and when authorized by our Board and declared by us, and the holders of outstanding shares of our common stock are entitled to share ratably in our assets legally available for distribution to our stockholders in the event of our liquidation, dissolution or winding up after payment of or adequate provision for all of our known debts and liabilities.
The shares of common stock that we are offering will be issued by us and do not represent any interest in or obligation of ZAIS or any of its affiliates. Further, the shares are not a deposit or other obligation of any bank, are not an insurance policy of any insurance company and are not insured or guaranteed by the FDIC, any other governmental agency or any insurance company. The shares of common stock will not benefit from any insurance guaranty association coverage or any similar protection.
Holders of shares of our common stock have no preference, conversion, exchange, redemption or sinking fund rights, have no preemptive rights to subscribe for any securities of our company and have no appraisal rights unless our Board determines that appraisal rights apply, with respect to all or any classes or series of stock, to one or more transactions occurring after the date of such determination in connection with which stockholders would otherwise be entitled to exercise appraisal rights. Subject to the provisions of our charter regarding the restrictions relating to the ownership and transfer of our stock, and to the rights
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of any outstanding shares of our preferred stock, shares of our common stock will have equal dividend, liquidation and other rights.
Subject to the provisions of our charter regarding the restrictions on ownership and transfer of our stock and except as may otherwise be specified in the terms of any class or series of common stock, each outstanding share of common stock entitles the holder to one vote on all matters submitted to a vote of stockholders, including the election of directors and, except as provided with respect to any other class or series of stock, the holders of shares of common stock will possess the exclusive voting power. A plurality of the votes cast in the election of directors is sufficient to elect a director and there is no cumulative voting in the election of directors, which means that the holders of a majority of the outstanding shares of common stock can elect all of the directors then standing for election, and the holders of the remaining shares will not be able to elect any directors.
Under the MGCL, a Maryland corporation generally cannot dissolve, amend its charter, merge or consolidate with another entity, sell all or substantially all of its assets or engage in a statutory share exchange unless the action is advised by its board of directors and approved by the affirmative vote of stockholders entitled to cast at least two-thirds of the votes entitled to be cast on the matter, unless a lesser percentage (but not less than a majority of all of the votes entitled to be cast on the matter) is specified in the corporation's charter. Our charter provides that these actions (other than amendments to the provisions of our charter related to the vote required to remove a director and the restrictions relating to the ownership and transfer of our stock, which must be declared advisable by our Board and approved by at least two-thirds of the votes entitled to be cast on the amendment) must be approved by a majority of all of the votes entitled to be cast on the matter.
Preferred Stock
Our charter authorizes our Board to classify any unissued shares of our preferred stock and to reclassify any previously classified but unissued shares of preferred stock into other classes or series of stock. Before the issuance of shares of each class or series, our Board is required by Maryland law and by our charter to set, subject to our charter restrictions on ownership and transfer of stock, the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications or terms or conditions of redemption for each class or series.
Series A Preferred Stock
As of September 30, 2012, we had outstanding 133 shares of $0.0001 par value 12.5% Series A Cumulative Non-Voting Preferred Stock (or Series A Preferred Stock). The holders of the Series A Preferred Stock are entitled to receive cumulative cash dividends at the rate of 12.5% per annum of the liquidation preference. At our election, the Series A Preferred Stock is redeemable, in whole or in part, for an amount equal to its liquidation preference, plus any accrued and unpaid dividends, plus a redemption premium which declines over time. The Series A Preferred Stock is not convertible into shares of any other class or series of stock. The Series A Preferred Stock is entitled to a liquidation preference of $1,000 per share. After we repurchase our Series A Preferred Stock shortly after the completion of this offering for an aggregate redemption price of $146,300, plus any accrued and unpaid dividends, no shares of our preferred stock will be outstanding.
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Power to Reclassify Our Unissued Shares of Stock
Our charter authorizes our Board to classify and reclassify any unissued shares of our common or preferred stock into other classes or series of stock, including one or more classes or series of stock that have priority with respect to voting rights or dividends or upon liquidation over our common stock, and authorizes us to issue the newly-classified shares. Prior to issuance of shares of each class or series, our Board is required by Maryland law and by our charter to set, subject to the provisions of our charter regarding the restrictions relating to the ownership and transfer of our stock and, subject to the express terms of any class or series of our stock outstanding at the time, the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms or conditions of redemption for each class or series. Our Board may take these actions without stockholder approval unless stockholder approval is required by the rules of any stock exchange or automated quotation system on which our securities may be listed or traded. Therefore, our Board could authorize the issuance of shares of common or preferred stock with terms and conditions that could have the effect of delaying, deferring or preventing a change in control or other transaction that might involve a premium price for shares of our common stock or otherwise be in the best interest of our stockholders.
Power to Increase or Decrease Authorized Shares of Stock and Issue Additional Shares of Common and Preferred Stock
We believe that the power of our Board to approve amendments to our charter to increase or decrease the number of authorized shares of stock, to authorize and to issue additional authorized but unissued shares of common or preferred stock and to classify or reclassify unissued shares of common or preferred stock and thereafter to authorize and to issue such classified or reclassified shares of stock will provide us with increased flexibility in structuring possible future financings and acquisitions and in meeting other needs that might arise. The additional classes or series, as well as the additional shares of common stock, will be available for issuance without further action by our stockholders, unless such approval is required by the rules of any stock exchange or automated quotation system on which our securities may be listed or traded. Although our Board does not intend to do so, it could authorize us to issue a class or series of stock that could, depending upon the terms of the particular class or series, delay, defer or prevent a change in control or other transaction that might involve a premium price for shares of our common stock or otherwise be in the best interest of our stockholders.
Restrictions on Ownership and Transfer
In order for us to qualify as a REIT under the Internal Revenue Code, shares of our stock must be owned by 100 or more persons during at least 335 days of a taxable year of 12 months (other than the first year for which we make an election to be taxed as a REIT) or during a proportionate part of a shorter taxable year. Also, not more than 50% of the value of the outstanding shares of our stock may be owned, directly or indirectly, by five or fewer individuals (as defined in the Internal Revenue Code to include certain entities) during the last half of a taxable year (other than the first year for which we make an election to be taxed as a REIT). As described elsewhere in this prospectus, we repurchased 265,245 shares of our common stock from one of our institutional stockholders in January 2013 at a price per share equal to our book value per share as of December 31, 2012. If on or prior to June 30, 2013 we are not able to raise additional capital from sufficiently diverse sources to satisfy the five or fewer rule, including by issuing at least approximately 320,000 shares to sufficiently diverse holders in this offering, we would fail to qualify as a REIT for the 2013 taxable year and would
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likely proceed with an early orderly liquidation of our business. Although we believe that we have satisfied this requirement for prior taxable years, following the repurchase of 265,245 shares of our common stock on January 24, 2013, five individuals own in excess of 54% by value of our outstanding common stock, and one of these individuals owns approximately 31.2% by value of our outstanding common stock, under the attribution rules applicable for purposes of applying the five or fewer rule. See "Risk FactorsOur failure to qualify as a REIT would subject us to U.S. federal income tax and applicable state and local taxes, which would reduce the amount of cash available for distribution to our stockholders." To qualify as a REIT, our company must satisfy other requirements as well. See "U.S. Federal Income Tax ConsiderationsTaxation of Our CompanyRequirements for Qualification as a REIT."
Our charter contains restrictions relating to the ownership and transfer of our stock. The relevant sections of our charter provide that, subject to the exceptions described below, no person or entity may own, or be deemed to own, by virtue of the applicable constructive ownership provisions of the Internal Revenue Code, more than 9.8% in value or in number, whichever is more restrictive, of the outstanding shares of our common stock (or the common share ownership limit), or 9.8% in value or in number, whichever is more restrictive, of the outstanding shares of all classes and series of our capital stock (or the aggregate share ownership limit). We refer to the common share ownership limit and the aggregate share ownership limit collectively as the "ownership limit." A person or entity that becomes subject to the ownership limit by virtue of a violative transfer that results in a transfer to a trust, as described below, is referred to as a "purported transferee" if, had the violative transfer been effective, the person or entity would have been a record owner and beneficial owner or solely a beneficial owner of shares of our stock.
The constructive ownership rules under the Internal Revenue Code are complex and may cause shares of stock owned actually or constructively by a group of related individuals and/or entities to be owned constructively by one individual or entity. As a result, the acquisition of less than 9.8% in value or in number, whichever is more restrictive, of the outstanding shares of our common stock, or 9.8% in value or in number, whichever is more restrictive, of the outstanding shares of all classes and series of our capital stock (or the acquisition of an interest in an entity that owns, actually or constructively, shares of our stock by an individual or entity), could, nevertheless, cause that individual or entity, or another individual or entity, to own constructively in excess of the ownership limit. In addition, if we do not issue at least approximately 5.6 million shares to sufficiently diverse holders in this offering to dilute the ownership of our current stockholders so that no individual will own in excess of 9.8% of our common stock under such attribution rules, our Board will be required to reduce our ownership limit below 9.8% in order for the ownership limits to prevent us from failing to satisfy the five or fewer rule.
Our Board may, in its sole discretion, subject to such conditions as it may determine and the receipt of certain representations and undertakings, prospectively or retroactively, waive the ownership limit or establish a different limit on ownership, or excepted holder limit, for a particular stockholder if the stockholder's ownership in excess of the ownership limit would not result in our company being "closely held" within the meaning of Section 856(h) of the Internal Revenue Code or otherwise would result in our company failing to qualify as a REIT (without regard to whether the ownership interest is held during the last half of a taxable year). As a condition of its waiver, our Board may, but is not required to, require an opinion of counsel or IRS ruling satisfactory to the Board with respect to its qualification as a REIT.
In connection with granting a waiver of the ownership limit or creating an excepted holder limit or at any other time, our Board may from time to time increase or decrease the ownership limit for all other persons and entities unless, after giving effect to such increase,
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five or fewer individuals could own or constructively own in the aggregate, more than 49.9% in value of the shares then outstanding or our company would otherwise fail to qualify as a REIT. Prior to the modification of the ownership limit, our Board may require such opinions of counsel, IRS rulings, representations or undertakings as it may deem necessary or advisable in order to determine or ensure our qualification as a REIT. A reduced ownership limit will not apply to any person or entity whose percentage ownership of our common stock or stock of all classes and series, as applicable, is in excess of such decreased ownership limit until such time as such person's or entity's percentage ownership of our common stock or stock of all classes and series, as applicable, equals or falls below the decreased ownership limit, but any further acquisition of shares of our common stock or stock of any other class or series, as applicable, in excess of such percentage ownership of our common stock or stock of all classes and series will be in violation of the ownership limit.
Our Board has granted waivers of these ownership limits to certain of our stockholders, which allow (1) one individual to beneficially or constructively own 723,969 shares of our common stock, or 31.2% of our outstanding common stock; (2) a second individual to beneficially or constructively own 321,830 shares of our common stock, or 13.9% of our outstanding common stock; and (3) an institutional investor to beneficially or constructively own 325,000 shares of our common stock, or 14.0% of our outstanding common stock. As a result, if we do not issue at least approximately 5.6 million shares to sufficiently diverse holders in this offering to sufficiently dilute the ownership of these persons, our Board will be required to reduce our common stock and capital stock ownership limitations below 9.8% in order for the ownership limits to prevent us from failing to satisfy the five or fewer rule.
Our charter further prohibits:
Any person who acquires or attempts or intends to acquire beneficial or constructive ownership of shares of our stock that will or may violate the ownership limit or any of the foregoing restrictions relating to transferability and ownership must immediately give written notice to our company or, in the case of a proposed or attempted transaction, give at least 15 days' prior written notice and provide our company with such other information as our company may request in order to determine the effect of such transfer on our qualification as a REIT. The foregoing provisions on transferability and ownership will not apply if our Board determines that it is no longer in our best interests to attempt to qualify, or to continue to qualify, as a REIT.
If any transfer of shares of our stock would result in shares of our stock being beneficially owned by fewer than 100 persons, such transfer will be null and void and the intended transferee will acquire no rights in such shares. In addition, if any purported transfer of shares of our stock or any other event would otherwise result in any person violating the ownership limit or an excepted holder limit established by our Board or in our company being "closely held" under Section 856(h) of the Internal Revenue Code or otherwise failing to qualify as a REIT, then that number of shares (rounded up to the nearest whole share) that would cause our company to violate such restrictions will be automatically transferred to, and held by, a trust for the exclusive benefit of one or more charitable organizations selected by our
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company and the intended transferee will acquire no rights in such shares. The automatic transfer will be effective as of the close of business on the business day prior to the date of the violative transfer or other event that results in a transfer to the trust. Any dividend or other distribution paid to the purported transferee, prior to our discovery that the shares had been automatically transferred to a trust as described above, must be repaid to the trustee upon demand for distribution to the beneficiary by the trust. If the transfer to the trust as described above is not automatically effective, for any reason, to prevent violation of the applicable ownership limit or our company being "closely held" under Section 856(h) of the Internal Revenue Code or otherwise failing to qualify as a REIT, then our charter provides that the transfer of the shares will be null and void.
Shares of stock transferred to the trustee are deemed offered for sale to us, or our designee, at a price per share equal to the lesser of (1) the price paid by the purported transferee for the shares (or, if the event that resulted in the transfer to the trust did not involve a purchase of such shares of stock at market price, the last reported sales price reported on the NYSE (or other applicable exchange) on the day of the event which resulted in the transfer of such shares of stock to the trust and (2) the market price on the date we, or our designee, accepts such offer. We have the right to accept such offer until the trustee has sold the shares of our stock held in the trust pursuant to the clauses discussed below. Upon a sale to us, the interest of the charitable beneficiary in the shares sold terminates, the trustee must distribute the net proceeds of the sale to the purported transferee and any dividends or other distributions held by the trustee with respect to such shares of stock will be paid to the charitable beneficiary.
If we do not buy the shares, the trustee must, within 20 days of receiving notice from us of the transfer of shares to the trust, sell the shares to a person or entity designated by the trustee who could own the shares without violating the ownership limit or the other restrictions relating to the ownership and transfer of our stock. After the sale of the shares, the interest of the charitable beneficiary in the shares transferred to the trust will terminate and the trustee must distribute to the purported transferee an amount equal to the lesser of (1) the price paid by the purported transferee for the shares (or, if the event which resulted in the transfer to the trust did not involve a purchase of such shares at market price, the last reported sales price reported on the NYSE (or other applicable exchange) on the day of the event which resulted in the transfer of such shares of stock to the trust) and (2) the sales proceeds (net of commissions and other expenses of sale) received by the trust for the shares. Any net sales proceeds in excess of the amount payable to the purported transferee will be immediately paid to the beneficiary of the trust, together with any dividends or other distributions thereon. In addition, if, prior to discovery by our company that shares of stock have been transferred to a trust, such shares of stock are sold by a purported transferee, then such shares will be deemed to have been sold on behalf of the trust and to the extent that the purported transferee received an amount for such shares that exceeds the amount that such purported transferee was entitled to receive, such excess amount will be paid to the trustee upon demand. The purported transferee has no rights in the shares held by the trustee.
The trustee will be designated by our company and will be unaffiliated with our company and with any purported transferee. Prior to the sale of any shares by the trust, the trustee will receive, in trust for the beneficiary of the trust, all dividends and other distributions paid by our company with respect to the shares held in trust and may also exercise all voting rights with respect to the shares held in trust. These rights will be exercised for the exclusive benefit of the beneficiary of the trust. Any dividend or other distribution paid prior to our discovery that shares of stock have been transferred to the trust will be paid by the recipient to the
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trustee upon demand. Any dividend or other distribution authorized but unpaid will be paid when due to the trustee.
Subject to Maryland law, effective as of the date that the shares have been transferred to the trust, the trustee will have the authority, at the trustee's sole discretion:
However, if our company has already taken irreversible corporate action, then the trustee may not rescind and recast the vote.
In addition, if our Board determines in good faith that a proposed transfer or other event has taken place that would violate the restrictions relating to the ownership and transfer of our stock, our Board will take such action as it deems advisable to refuse to give effect to or to prevent such transfer, including causing our company to redeem the shares of stock, refusing to give effect to the transfer on its books or instituting proceedings to enjoin the transfer.
Every owner of 5% or more (or such lower percentage as required by the Internal Revenue Code or the regulations promulgated thereunder) of our stock, within 30 days after the end of each taxable year, must give our company written notice, stating the stockholder's name and address, the number of shares of each class and series of our stock that the stockholder beneficially owns and a description of the manner in which the shares are held. Each such owner must provide our company with such additional information as our company may request in order to determine the effect, if any, of the stockholder's beneficial ownership on our qualification as a REIT and to ensure compliance with the ownership limit. In addition, each stockholder must provide our company with such information as our company may request in good faith in order to determine its qualification as a REIT and to comply with the requirements of any taxing authority or governmental authority or to determine such compliance.
Any certificates representing shares of our stock will bear a legend referring to the restrictions described above.
These restrictions relating to ownership and transfer will not apply if our Board determines that it is no longer in our best interests to continue to qualify as a REIT.
These ownership limits could delay, defer or prevent a transaction or a change in control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.
Transfer Agent and Registrar
American Stock Transfer & Trust Company, LLC acts as our transfer agent and registrar for our shares of common stock and OP units.
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STOCK ELIGIBLE FOR FUTURE SALE
After giving effect to this offering, we will have shares of common stock outstanding on a fully diluted basis and 926,914 OP units, which are exchangeable on a one-for-one basis into shares of our common stock. No prediction can be made as to the effect, if any, that future sales of such shares or the availability of shares for future sale will have on the market price prevailing from time to time. Sales of substantial amounts of shares of common stock, or the perception that such sales could occur, may affect adversely prevailing market prices of the shares of common stock. See "Risk FactorsRisks Related to Owning Our Common Stock."
For a description of certain restrictions on ownership and transfer of shares of our common stock, see "Description of Capital StockRestrictions on Ownership and Transfer."
Issuance of Shares of Common Stock
Our 2012 equity incentive plan provides for grants of restricted common stock and other equity based awards up to, in the aggregate, the equivalent of 5% of the issued and outstanding shares of our common stock from time to time following the completion of this offering (on a fully diluted basis (assuming, if applicable, the exercise of all outstanding options and the conversion of all warrants and convertible securities into shares of common stock) and excluding shares to be sold pursuant to the underwriters' exercise of their overallotment option) at the time of the award.
Rule 144
The outstanding shares of common stock and any additional shares of common stock that may be issued upon exchange of OP units are or will be, when issued, "restricted" securities under the meaning of Rule 144 under the Securities Act, and may not be sold in the absence of registration under the Securities Act unless an exemption from registration is available, including the exemption provided by Rule 144.
In general, under Rule 144 under the Securities Act, a person (or persons whose shares are aggregated) who is not deemed to have been an "affiliate" of ours at any time during the three months preceding a sale, and who has beneficially owned restricted securities within the meaning of Rule 144 for at least six months (including any period of consecutive ownership of preceding non-affiliated holders) would be entitled to sell those securities, subject only to the availability of current public information about us. As defined in Rule 144, an "affiliate" of an issuer is a person that directly, or indirectly, through one or more intermediaries, controls, or is under common control with the issuer. A non-affiliated person who has beneficially owned restricted securities within the meaning of Rule 144 for at least one year would be entitled to sell those securities without regard to the provisions of Rule 144.
A person (or persons whose securities are aggregated) who is deemed to be an affiliate of ours and who has beneficially owned restricted securities within the meaning of Rule 144 for at least six months would be entitled to sell within any nine-month period a number of securities that does not exceed the greater of one percent of the then outstanding shares of securities of such class or the average weekly trading volume of securities of such class during the four calendar weeks preceding such sale. Such sales are also subject to certain manner of sale provisions, notice requirements and the availability of current public information about us (which requires that we are current in our periodic reports under the Exchange Act).
For a description of certain restrictions relating to the transfers of shares of our common stock held by certain of our stockholders, see "Description of Capital StockRestrictions on Ownership and Transfer."
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Registration Rights
In connection with the capital raising and other transactions we have completed in connection with our formation and the other private placements of our shares of common stock and OP units, we entered into registration rights agreements with our existing stockholders and OP unitholders. Pursuant to these agreements, we have agreed for the benefit of such holders that we will, at our expense (i) use our reasonable efforts to file with the SEC a resale shelf registration statement (providing for the resale of the shares of common stock issued in or in exchange for shares of common stock or OP units), no later than 270 days after the listing of shares of common stock on a national securities exchange, subject to extension if we are bound by a lock-up agreement which restricts the filing of the registration statement in which event we will be required to use our reasonable efforts to file the registration statement within 30 days after the expiration of the lock-up period, (ii) use our commercially reasonable efforts to cause the resale shelf registration statement to be declared effective by the SEC under the Securities Act as promptly as practicable after the filing, (iii) use our commercially reasonable efforts to maintain a listing for such shares of common stock registered on such resale shelf registration statement for trading on a national securities exchange and (iv) use our commercially reasonable efforts to maintain the resale shelf registration statement's effectiveness under the Securities Act until the first to occur of (A) such time as all of such shares of common stock covered by the resale shelf registration statement have been sold pursuant to the resale shelf registration statement or pursuant to Rule 144 under the Securities Act and (B) the second anniversary after the completion of our listing.
Lock-Up Agreements
Holders of 92.3% of our outstanding shares of common stock and OP units, after giving effect to the 2013 repurchase described elsewhere in this prospectus, have agreed with ZAIS, as the managing member of our Advisor, not to, directly or indirectly, sell, transfer, assign, mortgage, hypothecate, pledge or otherwise dispose of or encumber or permit or suffer any encumbrance of all or any part of the shares of our common stock or OP units acquired as part of the above formation transactions or subsequent purchases of such common stock or OP units, until 270 days following the completion of our listing without the prior written consent of ZAIS, subject to certain exceptions relating to private resales where the transferee continues to be bound by the lock-up agreement.
Additionally, each of our directors and executive officers and the ZAIS Parties who collectively own an aggregate of 510,047 shares of common stock and 33,658 OP units have agreed not to offer, sell, contract to sell or otherwise dispose of, or enter into any transaction that is designed to, or could be expected to, result in the disposition of any shares of our common stock that they may own or have the right to acquire or other securities convertible into or exchangeable or exercisable for our common stock (including OP units) prior to this offering for a period of 270 days after the effective date of the registration statement of which this prospectus is a part without the prior written consent of the representatives of the underwriters. This consent may be given at any time without public notice. Transfers or dispositions may be made during the lock-up period if any such transfer or disposition does not trigger any filing or reporting requirement or obligation or result in any other voluntary or mandatory public disclosure, including but not limited to Form 4 of Section 16 of the Exchange Act, and is by gift, will or intestacy, or distribution to partners, members or shareholders of the transferor, provided that the transferee agrees in writing to be bound by the restrictions set forth in the lock-up agreement. There are no agreements between the representatives and any of our stockholders or affiliates releasing them from these lock-up agreements prior to the expiration of the 270-day period. We and our Advisor have also entered into a similar agreement with representatives of the underwriters.
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CERTAIN PROVISIONS OF THE MARYLAND GENERAL CORPORATION LAW
AND OUR CHARTER AND BYLAWS
The following description of the terms of our stock and of certain provisions of Maryland law is only a summary. For a complete description, we refer you to the MGCL and to our charter and bylaws, each as amended and restated in connection with this offering. For a more complete understanding of our capital stock, we encourage you to read carefully this entire prospectus, as well as our amended and restated charter and our amended and restated bylaws, the forms of which are filed as exhibits to the registration statement of which this prospectus forms a part.
Our Board of Directors
Our charter and bylaws provide that the number of directors we have may be established by our Board but may not be less than the minimum number required by law and no more than 15. Our bylaws provide that any vacancy may be filled by a majority of the remaining directors or, if the vacancy resulted from an increase in the number of directors and until we are able to make an election under Subtitle 8 of Title 3 of the MGCL, by a majority of the entire Board. Any individual elected to fill such vacancy will serve until the next annual meeting of stockholders and until a successor is duly elected and qualifies.
Each of our directors will be elected by our stockholders to serve until the next annual meeting of our stockholders and until his or her successor is duly elected and qualifies. Holders of shares of our common stock will have no right to cumulative voting in the election of directors, and directors will be elected by a plurality of the votes cast in the election of directors. Consequently, at each annual meeting of stockholders, the holders of a majority of the shares of our common stock entitled to vote will be able to elect all of our directors.
Removal of Directors
Our charter provides that, subject to any rights of holders of one or more classes or series of preferred stock to elect or remove one or more directors, a director may be removed with or without cause but only by the affirmative vote of stockholders entitled to cast at least two-thirds of all the votes entitled to be cast generally in the election of directors. This provision, when coupled with the exclusive power of our Board to fill vacancies on our Board, precludes stockholders from (i) removing incumbent directors except upon a substantial affirmative vote and (ii) filling the vacancies created by such removal with their own nominees.
Business Combinations
Under the MGCL, certain "business combinations" (including a merger, consolidation, statutory share exchange or, in certain circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities) between a Maryland corporation and an interested stockholder (defined generally as any person who beneficially owns, directly or indirectly, 10% or more of the voting power of the corporation's outstanding voting stock or an affiliate or associate of the corporation who, at any time within the two-year period immediately prior to the date in question, was the beneficial owner of 10% or more of the voting power of the then outstanding stock of the corporation) and any an affiliate of such an interested stockholder are prohibited for five years after the most recent date on which the interested stockholder becomes an interested stockholder. Thereafter, any such business combination must generally be recommended by the board of directors of such corporation and approved by the affirmative vote of at least (a) 80% of the votes entitled to be cast by
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holders of outstanding shares of voting stock of the corporation and (b) two-thirds of the votes entitled to be cast by holders of voting stock of the corporation other than shares held by the interested stockholder with whom (or with whose affiliate) the business combination is to be effected or held by an affiliate or associate of the interested stockholder, unless, among other conditions, the corporation's common stockholders receive a minimum price (as defined in the MGCL) for their shares and the consideration is received in cash or in the same form as previously paid by the interested stockholder for its shares. A person is not an interested stockholder under the statute if the board of directors approved in advance the transaction by which the person otherwise would have become an interested stockholder. Our Board may provide that its approval is subject to compliance, at or after the time of approval, with any terms and conditions determined by it.
These provisions of the MGCL do not apply, however, to business combinations that are approved or exempted by a board of directors prior to the time that the interested stockholder becomes an interested stockholder. Pursuant to the statute, our Board will by resolution exempt business combinations (i) between us and ZAIS or its affiliates and (ii) between us and any other person, provided that such business combination is first approved by our Board (including a majority of our directors who are not affiliates or associates of such person). Consequently, the five-year prohibition and the supermajority vote requirements will not apply to business combinations between us and any person described above. As a result, any person described above may be able to enter into business combinations with us that may not be in the best interest of our stockholders, without compliance by our company with the supermajority vote requirements and other provisions of the statute.
If our Board opted back in to the business combination statute or failed to first approve a business combination, the business combination statute may discourage others from trying to acquire control of our Company and increase the difficulty of consummating any offer.
Control Share Acquisitions
The MGCL provides that holders of "control shares" of a Maryland corporation acquired in a "control share acquisition" have no voting rights with respect to such shares except to the extent approved by the affirmative vote of two-thirds of the votes entitled to be cast on the matter, excluding shares of stock in a corporation in respect of which any of the following persons is entitled to exercise or direct the exercise of the voting power of such shares in the election of directors: (i) a person who makes or proposes to make a control share acquisition, (ii) an officer of the corporation or (iii) an employee of the corporation who is also a director of the corporation. "Control shares" are voting shares of stock which, if aggregated with all other shares of stock owned by the acquirer, or in respect of which the acquirer is able to exercise or direct the exercise of voting power (except solely by virtue of a revocable proxy), would entitle the acquirer to exercise voting power in electing directors within one of the following ranges of voting power: (A) one-tenth or more but less than one-third; (B) one-third or more but less than a majority; or (C) a majority or more of all voting power. Control shares do not include shares that the acquiring person is then entitled to vote as a result of having previously obtained stockholder approval or shares acquired directly from the corporation. A "control share acquisition" means the acquisition of issued and outstanding control shares, subject to certain exceptions.
A person who has made or proposes to make a control share acquisition, upon satisfaction of certain conditions (including an undertaking to pay expenses and making an "acquiring person statement" as described in the MGCL), may compel our Board to call a special meeting of stockholders to be held within 50 days of demand to consider the voting
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rights of the shares. If no request for a meeting is made, the corporation may itself present the question at any stockholders meeting.
If voting rights are not approved at the meeting or if the acquiring person does not deliver an "acquiring person statement" as required by the statute, then, subject to certain conditions and limitations, the corporation may redeem any or all of the control shares (except those for which voting rights have previously been approved) for fair value determined, without regard to the absence of voting rights for the control shares, as of the date of the last control share acquisition by the acquirer or as of any meeting of stockholders at which the voting rights of such shares are considered and not approved. If voting rights for control shares are approved at a stockholders meeting and the acquirer becomes entitled to vote a majority of the shares entitled to vote, all other stockholders may exercise appraisal rights. The fair value of the shares as determined for purposes of such appraisal rights may not be less than the highest price per share paid by the acquirer in the control share acquisition.
The control share acquisition statute does not apply to (a) shares acquired in a merger, consolidation or statutory share exchange if the corporation is a party to the transaction or (b) acquisitions approved or exempted by the charter or bylaws of the corporation.
Our bylaws contain a provision exempting from the control share acquisition statute any and all acquisitions by any person of shares of our stock. There can be no assurance that such provision will not be amended or eliminated at any time in the future.
Subtitle 8
Subtitle 8 of Title 3 of the MGCL permits a Maryland corporation with a class of equity securities registered under the Exchange Act and at least three independent directors to elect to be subject, by provision in its charter or bylaws or a resolution of its Board and notwithstanding any contrary provision in the charter or bylaws, to any or all of the following five provisions:
Our charter provides that, at such time as we are able to make a Subtitle 8 election, vacancies on our Board may be filled only by the remaining directors and for the remainder of the full term of the directorship in which the vacancy occurred. Through provisions in our charter and bylaws unrelated to Subtitle 8, we already (i) require the affirmative vote of holders of shares entitled to cast at least two-thirds of all of the votes entitled to be cast generally in the election of directors for the removal of any director from the Board, with or without cause, (ii) vest in the Board the exclusive power to fix the number of directorships and (iii) require, unless called by our chairman of the Board, our chief executive officer, our president or the Board, the written request of stockholders entitled to cast not less than a majority of all the votes entitled to be cast at such a meeting to call a special meeting of stockholders.
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Meetings of Stockholders
Pursuant to our bylaws, a meeting of our stockholders for the election of directors and the transaction of any business will be held annually on a date and at the time set by our Board. The chairman of our Board, our chief executive officer, our president or our Board may call a special meeting of our stockholders. Subject to the provisions of our bylaws, a special meeting of our stockholders to act on any matter that may properly be brought before a meeting of the stockholders will also be called by our secretary upon the written request of the stockholders entitled to cast a majority of all the votes entitled to be cast on such matter at the meeting and containing the information required by our bylaws. Our secretary will inform the requesting stockholders of the reasonably estimated cost of preparing and mailing or delivering the notice of meeting (including our proxy materials), and the requesting stockholder must pay such estimated cost before our secretary is required to prepare and deliver the notice of the special meeting.
Amendment to Our Charter and Bylaws
Except for amendments to the provisions of our charter relating to the vote required to remove a director and the restrictions relating to the ownership and transfer of our shares of stock (each of which requires the affirmative vote of stockholders entitled to cast at least two-thirds of all the votes entitled to be cast on the matter) and amendments requiring the approval only of our Board, our charter generally may be amended only if declared advisable by our Board and approved by the affirmative vote of the holders of not less than a majority of all of the votes entitled to be cast on the matter.
Our Board has the exclusive power to adopt, alter or repeal any provision of our bylaws and to make new bylaws.
Dissolution of Our Company
The dissolution of our company must be approved by a majority of our entire Board and the affirmative vote of stockholders entitled to cast not less than a majority of all of the votes entitled to be cast on the matter.
Advance Notice of Director Nominations and New Business
Our bylaws provide that, with respect to an annual meeting of stockholders, nominations of individuals for election to our Board and the proposal of other business to be considered by stockholders may be made only (i) pursuant to our notice of the meeting, (ii) by or at the direction of our Board or (iii) by a stockholder who is a stockholder of record both at the time of giving advance notice required by our bylaws and at the time of the meeting, who is entitled to vote at the meeting and who has complied with the advance notice provisions set forth in our bylaws.
With respect to special meetings of stockholders, only the business specified in our notice of meeting may be brought before the meeting. Nominations of individuals for election to our Board may be made only (i) by or at the direction of our Board or (ii) provided that the meeting has been called for the purpose of electing directors, by a stockholder who is a stockholder of record both at the time of giving advance notice required by our bylaws and at the time of the meeting, who is entitled to vote at the meeting in the election of such nominee and who has complied with the advance notice provisions set forth in our bylaws.
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Anti-takeover Effect of Certain Provisions of Maryland Law and of Our Charter and Bylaws
Our charter and bylaws and Maryland law contain provisions that may delay, defer or prevent a change in control or other transaction that might involve a premium price for shares of our common stock or otherwise be in the best interests of our stockholders, including business combination provisions, supermajority vote requirements and advance notice requirements for director nominations and stockholder proposals. Likewise, if the provision in the bylaws opting out of the control share acquisition provisions of the MGCL were rescinded or if we were to opt in to the classified board or other provisions of Subtitle 8, these provisions of the MGCL could have similar anti-takeover effects.
Indemnification and Limitation of Directors' and Officers' Liability
Maryland law permits a Maryland corporation to include in its charter a provision limiting the liability of its directors and officers to the corporation and its stockholders for money damages, except for liability resulting from (1) actual receipt of an improper benefit or profit in money, property or services or (2) active and deliberate dishonesty established by a final judgment as being material to the cause of action. Our charter contains such a provision which eliminates the liability of our directors and officers to the maximum extent permitted by Maryland law.
We have entered into indemnification agreements with each of our directors and executive officers that provide for indemnification to the maximum extent permitted by Maryland law. For more information, see "ManagementLimitation of Liability and Indemnification."
Insofar as the foregoing provisions permit indemnification of directors, officers or persons controlling us for liability arising under the Securities Act, we have been informed that, in the opinion of the SEC, this indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable.
REIT Qualification
Our charter provides that our Board may revoke or otherwise terminate our REIT election, without approval of our stockholders, if it determines that it is no longer in our best interests to continue to qualify as a REIT.
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THE OPERATING PARTNERSHIP AGREEMENT
The following is a summary of material provisions in the partnership agreement of our Operating Partnership, a copy of which is filed as an exhibit to the registration statement of which this prospectus forms a part.
General
We conduct substantially all of our business through ZAIS Financial Partners, L.P., a Delaware limited partnership that was formed on May 24, 2011, which we refer to as our Operating Partnership. We are the general partner of our Operating Partnership and we own 2,551,000 OP units, which are comprised of 35,130 general partnership OP units and 2,515,870 OP units. ZAIS Financial, LLC, one of our wholly-owned subsidiaries, owns 35,130 OP units, ZAIS Parties own 33,658 OP units and an institutional stockholder owns the remaining 893,256 OP units.
Although all of our assets are currently held through the Operating Partnership, we may in the future elect for various reasons to hold certain of our assets directly rather than through our Operating Partnership.
Our Operating Partnership is structured to make distributions with respect to OP units that will be equivalent to the distributions made to our common stockholders. Finally, our Operating Partnership is structured to permit limited partners in the Operating Partnership, through the exercise of their redemption rights, to exchange their OP units for shares of our common stock on a one-for-one basis (in a taxable transaction) and achieve liquidity for their investment.
Management
We are the sole general partner of the Operating Partnership and are liable for its obligations. As the sole general partner, we have full, exclusive and complete responsibility and discretion in the management and control of our Operating Partnership, including the ability to cause our Operating Partnership to enter into certain major transactions, including a merger of our Operating Partnership or a sale of substantially all of its assets. The OP units will have no voting rights. Our Operating Partnership is under no obligation to give priority to the separate interests of the limited partners or our stockholders in deciding whether to cause our Operating Partnership to take or decline to take any actions. As the sole general partner of the Operating Partnership, our consent is required for any amendment to the partnership agreement of our Operating Partnership. Additionally, without the consent of the limited partners, we may amend the partnership agreement of our Operating Partnership in any respect, implement mergers involving our Operating Partnership or sales of all or substantially all of its assets. Through the exercise of these powers, we would be authorized, without the consent of limited partners, to implement a transaction such as a merger involving our Operating Partnership that could result in the conversion of outstanding OP units into cash, shares of our common stock or other securities. The partnership agreement of our Operating Partnership only requires that, in such circumstances, limited partners receive cash, shares of our common stock or other securities having a fair market or net asset value, as the case may be, equal to the net asset value of the OP units being converted as of the month end period immediately prior to such conversion. The limited partners have no power to remove the general partner without the general partner's consent.
Capital Contributions
If our Operating Partnership requires additional funds at any time in excess of capital contributions made by us, we may borrow funds from a financial institution or other lender
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and lend such funds to our Operating Partnership on the same terms and conditions as are applicable to our borrowing of such funds. In addition, we are authorized to cause our Operating Partnership to issue partnership interests for less than fair market value if we conclude in good faith that such issuance is in the best interest of our Operating Partnership and our stockholders.
Operations
The partnership agreement of our Operating Partnership provides that our Operating Partnership is to be operated in a manner that will (1) enable us to satisfy the requirements for qualification as a REIT for U.S. federal income tax purposes, (2) avoid any U.S. federal income or excise tax liability and (3) ensure that our Operating Partnership will not be classified as a "publicly traded partnership" taxable as a corporation for purposes of Section 7704 of the Internal Revenue Code.
The partnership agreement of our Operating Partnership provides that our Operating Partnership will distribute cash flow from operations to the partners of our Operating Partnership in accordance with its relative percentage interests on at least a quarterly basis in amounts determined by us as the general partner such that a holder of one OP unit will receive the same amount of annual cash flow distributions from our Operating Partnership as the amount of annual distributions paid to the holder of one share of our common stock.
Similarly, the partnership agreement of our Operating Partnership provides that taxable income is allocated to the partners of our Operating Partnership in accordance with their relative percentage interests such that a holder of one OP unit will be allocated taxable income for each taxable year in an amount equal to the amount of taxable income to be recognized by a holder of one share of our common stock, subject to compliance with the provisions of Sections 704(b) and 704(c) of the Internal Revenue Code and corresponding Treasury Regulations. Losses, if any, will generally be allocated among the partners in accordance with their respective percentage interests in our Operating Partnership.
Upon the liquidation of our Operating Partnership, after payment of debts and obligations, any remaining assets of our Operating Partnership will be distributed to partners with positive capital accounts in accordance with their respective positive capital account balances.
Reimbursement of Expenses
We will not receive any compensation for our services as general partner of our Operating Partnership. In addition to the administrative and operating costs and expenses incurred by our Operating Partnership in acquiring and holding our assets, our Operating Partnership will pay all of our administrative costs and expenses and such expenses will be treated as expenses of our Operating Partnership. Such expenses will include:
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See also "Our Advisor and the Investment Advisory AgreementAdvisory Fees, Expense Reimbursements and Termination Fee."
Exchange of OP Units
Limited partners in the Operating Partnership, through the exercise of their redemption rights, are permitted to exchange their OP units for shares of our common stock on a one-for-one basis (in a taxable transaction) and achieve liquidity for their investment. Subject to certain limitations and exceptions, holders of OP units, other than us or our subsidiaries, will have the right to cause our Operating Partnership to purchase their OP units for cash in an amount equal to the fair market value of an equivalent number of shares of our common stock. The fair market value of the common stock for this purpose will be equal to the average of the closing trading price of a share of our common stock on a U.S. national securities exchange for the ten trading days before the day on which the redemption notice is given to our Operating Partnership. In addition, the partnership agreement of our Operating Partnership also provides that we have the right to exchange OP units offered for redemption, on a one-for-one basis, for shares of common stock. We anticipate that, rather than pay cash, we will normally elect to issue common stock in exchange for OP units offered for redemption. Redemption rights of OP unit holders may not be exercised, however, if and to the extent that the delivery of shares upon such exercise would (i) result in any person owning shares in excess of our ownership limits, (ii) result in shares being owned by fewer than 100 persons or (iii) result in us being "closely held" within the meaning of Section 856(h) of the Internal Revenue Code.
Mandatory Redemption Rights
We (and our Operating Partnership) do not have a mandatory redemption policy. However, as the sole general partner of our Operating Partnership, we may, without the consent of the limited partners, amend the partnership agreement of our Operating Partnership in any respect, implement mergers involving our Operating Partnership or sales of all or substantially all of its assets. Through the exercise of these powers, we would be authorized, without the consent of limited partners, to implement a transaction such as a merger involving our Operating Partnership, that could result in the mandatory conversion of outstanding OP units into cash, shares of our common stock or other securities. The partnership agreement of our Operating Partnership only requires that, in such circumstances, limited partners receive cash, shares of our common stock or other securities having a fair market or net asset value, as the case may be, equal to the net asset value of the OP units being converted as of the month end period immediately prior to such conversion. See "General"
Distributions
To satisfy the requirements to qualify as a REIT and generally not be subject to U.S. federal income and excise tax, we and our Operating Partnership's current policy is to pay quarterly distributions which, on an annual basis, will equal all or substantially all of our net taxable income. Any distributions we and our Operating Partnership make will be at the discretion of our Board and will depend upon our earnings and financial condition, maintenance of our REIT qualification, restrictions on making distributions under Maryland law and such other factors as our Board deems relevant. Our earnings and financial condition will be affected by various factors, including the net interest and other income from our portfolio, our operating expenses and any other expenditures. For more information, see "Distribution Policy."
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Allocations of Net Income and Net Loss
Net income and net loss of our Operating Partnership are determined and allocated with respect to each fiscal year of our Operating Partnership as of the end of the year. Except as otherwise provided in the partnership agreement of our Operating Partnership, an allocation of a share of net income or net loss is treated as an allocation of the same share of each item of income, gain, loss or deduction that is taken into account in computing net income or net loss. Except as otherwise provided in the partnership agreement of our Operating Partnership, net income and net loss are allocated to the holders of OP units holding the same class or series of OP units in accordance with their respective percentage interests in the class or series at the end of each fiscal year. The partnership agreement of our Operating Partnership contains provisions for special allocations intended to comply with certain regulatory requirements, including the requirements of Treasury Regulations Sections 1.704-1(b) and 1.704-2. Except as otherwise required by the partnership agreement of our Operating Partnership or the Code and the Treasury Regulations, each operating partnership item of income, gain, loss and deduction is allocated among the limited partners of our Operating Partnership for U.S. federal income tax purposes in the same manner as its correlative item of book income, gain, loss or deduction is allocated pursuant to the partnership agreement of our Operating Partnership. In addition, under Section 704(c) of the Code, items of income, gain, loss and deduction with respect to appreciated or depreciated property which is contributed to a partnership, such as our Operating Partnership, in a tax-free transaction must be specially allocated among the partners in such a manner so as to take into account such variation between tax basis and fair market value. Our Operating Partnership will allocate tax items to the holders of OP units taking into consideration the requirements of Section 704(c). See "U.S. Federal Income Tax Considerations."
Transferability of Interests
We will not be able to (1) voluntarily withdraw as the general partner of our Operating Partnership, or (2) transfer our general partner interest in our Operating Partnership (except to a wholly-owned subsidiary), unless the transaction in which such withdrawal or transfer occurs results in the limited partners receiving or having the right to receive an amount of cash, securities or other property equal in value to the amount they would have received if they had exercised their redemption rights immediately prior to such transaction. Any limited partners will not be able to transfer their OP units, in whole or in part, without our written consent as the general partner of the partnership except where the limited partner becomes incapacitated.
Fiduciary Responsibilities
Our directors and officers have duties under applicable Maryland law to manage us in a manner consistent with our best interests. At the same time, the general partner of our Operating Partnership has fiduciary duties under Delaware law to manage our Operating Partnership in a manner beneficial to our Operating Partnership and its OP unitholders. Our duties, as the general partner of our Operating Partnership, to our Operating Partnership and its OP unitholders, therefore, may come into conflict with the duties of our directors and officers to our stockholders. We will be under no fiduciary obligation to give priority to the OP unitholders of our Operating Partnership or to our stockholders in deciding whether to cause our Operating Partnership to take or decline to take any actions.
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Indemnification and Limitation of Liability
The partnership agreement expressly limits our liability by providing that neither we, as the general partner of our Operating Partnership, nor any of our directors or officers, will be liable or accountable in damages to our Operating Partnership, the OP unitholders or assignees for errors in judgment, mistakes of fact or law or for any act or omission if we, or such director or officer, acted in good faith. In addition, our Operating Partnership is required to indemnify us, and our officers, directors, employees, agents and designees to the fullest extent permitted by applicable law from and against any and all claims arising from operations of our Operating Partnership, except (1) for willful misconduct or a knowing violation of the law, (2) for any transaction for which the indemnified party received an improper personal benefit in violation or breach of any provision of the partnership agreement, or (3) in the case of any criminal proceeding, the indemnified party had reasonable cause to believe that the act or omission was unlawful. Our Operating Partnership also must pay or reimburse the reasonable expenses of any such person upon its receipt of a written affirmation of the person's good faith belief that the standard of conduct necessary for indemnification has been met and a written undertaking to repay any amounts paid or advanced if it is ultimately determined that the person did not meet the standard of conduct for indemnification.
Term
Our Operating Partnership will continue perpetually, unless earlier terminated in the following circumstances:
Tax Matters
Our partnership agreement will provide that we, as the sole general partner of our Operating Partnership, will be the tax matters partner of the Operating Partnership and, as such, will have authority to handle tax audits and to make tax elections under the Code on behalf of our Operating Partnership.
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U.S. FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of the material U.S. federal income tax considerations relating to our qualification and taxation as a REIT and the acquisition, holding, and disposition of our common stock. For purposes of this section, references to "we," "us" or "our company" means only ZAIS Financial Corp. and not its subsidiaries or other lower-tier entities, except as otherwise indicated. This summary is based upon the Internal Revenue Code, the regulations promulgated by the Treasury Regulations, current administrative interpretations and practices of the IRS (including administrative interpretations and practices expressed in private letter rulings which are binding on the IRS only with respect to the particular taxpayers who requested and received those rulings) and judicial decisions, all as currently in effect and all of which are subject to differing interpretations or to change, possibly with retroactive effect. No assurance can be given that the IRS would not assert, or that a court would not sustain, a position contrary to any of the tax consequences described below. No advance ruling has been or will be sought from the IRS regarding any matter discussed in this summary. The summary is also based upon the assumption that the operation of our company, and of our subsidiaries and other lower-tier and affiliated entities, including our Operating Partnership will, in each case, be in accordance with its applicable organizational documents. This summary is for general information only, and does not purport to discuss all aspects of U.S. federal income taxation that may be important to a particular stockholder in light of its investment or tax circumstances or to stockholders subject to special tax rules, such as:
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This summary assumes that stockholders will hold our common stock as capital assets, which generally means as property held for investment.
For the purposes of this summary, a U.S. person is a beneficial owner of our common stock who for U.S. federal income tax purposes is:
For the purposes of this summary, a U.S. stockholder is a beneficial owner of our common stock who is a U.S. person. A tax exempt organization is a U.S. person who is exempt from U.S. federal income tax under Section 401(a) or 501(a) of the Internal Revenue Code.
For the purposes of this summary, a non-U.S. person is a beneficial owner of our common stock who is neither a U.S. stockholder nor an entity that is treated as a partnership for U.S. federal income tax purposes, and a non-U.S. stockholder is a holder of our common stock who is a non-U.S. person.
THE U.S. FEDERAL INCOME TAX TREATMENT OF HOLDERS OF OUR COMMON STOCK DEPENDS IN SOME INSTANCES ON DETERMINATIONS OF FACT AND INTERPRETATIONS OF COMPLEX PROVISIONS OF U.S. FEDERAL INCOME TAX LAW FOR WHICH NO CLEAR PRECEDENT OR AUTHORITY MAY BE AVAILABLE. IN ADDITION, THE TAX CONSEQUENCES OF HOLDING OUR COMMON STOCK TO ANY PARTICULAR STOCKHOLDER WILL DEPEND ON THE STOCKHOLDER'S PARTICULAR TAX CIRCUMSTANCES. YOU ARE URGED TO CONSULT YOUR TAX ADVISOR REGARDING THE U.S. FEDERAL, STATE, LOCAL, AND FOREIGN INCOME AND OTHER TAX CONSEQUENCES TO YOU, IN LIGHT OF YOUR PARTICULAR INVESTMENT OR TAX CIRCUMSTANCES, OF ACQUIRING, HOLDING, AND DISPOSING OF OUR COMMON STOCK.
Taxation of Our Company
We have elected to be taxed as a REIT under the Internal Revenue Code, commencing with its taxable year ended December 31, 2011. We believe that we have been organized and operated, and we intend to continue to operate, in a manner that allows us to qualify for taxation as a REIT under the Internal Revenue Code.
The law firm of Clifford Chance US LLP has acted as our counsel in connection with this offering. We will receive an opinion of Clifford Chance US LLP to the effect that, commencing with our taxable year ended December 31, 2011, we have been organized and operated in conformity with the requirements for qualification and taxation as a REIT under the Internal Revenue Code, and our proposed method of operation, as represented by our management and our Advisor in their certificate of representations supporting the opinion, will enable us to meet the requirements for qualification and taxation as a REIT under the Internal Revenue Code. It must be emphasized that the opinion of Clifford Chance US LLP is based on various assumptions relating to our organization and operation, including that all factual representations and statements set forth in all relevant documents, records and instruments
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are true and correct, all actions described in this prospectus are completed in a timely fashion and that it will at all times operate in accordance with the method of operation described in our organizational documents and this prospectus. Additionally, the opinion of Clifford Chance US LLP is conditioned upon factual representations and covenants made by the Advisor and our management regarding our organization, assets, past, present and future conduct of our business operations and other items regarding our ability to meet the various requirements for qualification as a REIT, and assumes that such representations and covenants are accurate and complete and that we will take no action inconsistent with our qualification as a REIT. In particular, the opinion of Clifford Chance US LLP will rely on the accuracy of a factual representation made by our Advisor and our management that we have satisfied and will continue to satisfy the "five or fewer" requirement described below. In addition, the opinion of Clifford Chance US LLP regarding our REIT qualification will assume that a minimum of approximately 320,000 shares of common stock will be sold in this offering and that the offering will close prior to June 30, 2013, or we will otherwise satisfy the five or fewer rule on or prior to June 30, 2013, as further explained below. While our Advisor believes that we are organized and intend to operate so that we will qualify as a REIT, given the highly complex nature of the rules governing REITs, the ongoing importance of factual determinations and the possibility of future changes in our circumstances or applicable law, no assurance can be given by Clifford Chance US LLP or us that we will so qualify for any particular year. Clifford Chance US LLP will have no obligation to advise us or the holders of shares of our common stock of any subsequent change in the matters stated, represented or assumed or of any subsequent change in the applicable law. You should be aware that opinions of counsel are not binding on the IRS, and no assurance can be given that the IRS will not challenge the conclusions set forth in such opinions. In order to qualify as a REIT, during the last half of each taxable year following our taxable year ended December 31, 2011 (the first year that we elected to qualify as a REIT), not more than 50% in value of our outstanding stock can be owned by five or fewer "individuals" as defined in the Internal Revenue Code to include certain entities (or the five or fewer rule). We believe that we have satisfied the five or fewer rule. However, as described elsewhere in this prospectus, we repurchased 265,245 shares of our common stock from one of our institutional stockholders in January 2013 at a price per share equal to our book value per share as of December 31, 2012. If on or prior to June 30, 2013 we are not able to raise additional capital from sufficiently diverse sources to satisfy the five or fewer rule, including by issuing at least approximately 320,000 shares to sufficiently diverse holders in this offering, we would fail to qualify as a REIT for the 2013 taxable year and would likely proceed with an early orderly liquidation of our business. Although we believe that we have satisfied this requirement for prior taxable years, following the repurchase of 265,245 shares of our common stock on January 24, 2013, five individuals own in excess of 54% by value of our outstanding common stock, and one of these individuals owns approximately 31.2% by value of our outstanding common stock, under the attribution rules applicable for purposes of applying the five or fewer rule. While our charter contains restrictions on transfers of our shares to assist us in meeting the five or fewer rule, our charter does generally permit an individual to acquire up to 9.8% of our common stock subject to our continuing to meet the five or fewer rule. We have monitored and, until the closing of this offering, intend to continue to monitor all purchases and transfers of our common stock to ensure that we have met and will continue to meet the five or fewer rule. However, the attribution rules that apply for purposes of determining the ownership of shares for purposes of applying the five or fewer rule are complex and in some cases dependent on facts that are not always easy to determine. Accordingly, no assurance can be given that we have at all times satisfied or will continue to satisfy the five or fewer rule. In the event we fail to satisfy the five or fewer rule we could fail to qualify as a REIT. See "Failure to Qualify."
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Qualification and taxation as a REIT depends on our ability to meet, on a continuing basis, through actual results of operations, distribution levels, diversity of share ownership and various qualification requirements imposed upon REITs by the Internal Revenue Code, the compliance with which has not been reviewed by Clifford Chance US LLP. In addition, our ability to qualify as a REIT may depend in part upon the operating results, organizational structure and entity classification for U.S. federal income tax purposes of certain entities in which we invest, which entities have not been reviewed by Clifford Chance US LLP. Our ability to qualify as a REIT also requires that we satisfy certain asset and income tests, some of which depend upon the fair market values of assets directly or indirectly owned by us or which serve as security for loans made by us. Such values may not be susceptible to a precise determination. Accordingly, no assurance can be given that the actual results of our operations for any taxable year will satisfy the requirements for qualification and taxation as a REIT.
Taxation of REITs in General
As indicated above, qualification and taxation as a REIT depends upon our ability to meet, on a continuing basis, various qualification requirements imposed upon REITs by the Internal Revenue Code. The material qualification requirements are summarized below, under "Requirements for Qualification as a REIT." While we intend to operate so that we qualify as a REIT, no assurance can be given that the IRS will not challenge our qualification as a REIT or that we will be able to operate in accordance with the REIT requirements in the future. See "Failure to Qualify."
Provided that we qualify as a REIT, we will generally be entitled to a deduction for dividends that we pay and, therefore, will not be subject to U.S. federal corporate income tax on our net taxable income that is currently distributed to our stockholders. This treatment substantially eliminates the "double taxation" at the corporate and stockholder levels that results generally from investment in a corporation. Rather, income generated by a REIT generally is taxed only at the stockholder level, upon a distribution of dividends by the REIT.
U.S. stockholders (as defined above) who are individuals are generally taxed on corporate dividends at a maximum rate of 20% (the same as long term capital gains), thereby substantially reducing, though not completely eliminating, the double taxation that has historically applied to corporate dividends.
With limited exceptions, however, dividends received by individual U.S. stockholders from our company or from other entities that are taxed as REITs will continue to be taxed at rates applicable to ordinary income, which are as high as 39.6%.
Net operating losses, foreign tax credits and other tax attributes of a REIT generally do not pass through to the stockholders of the REIT, subject to special rules for certain items, such as capital gains, recognized by REITs. See "Taxation of Taxable U.S. Stockholders."
Even if we qualify for taxation as a REIT, however, we will be subject to U.S. federal income taxation as follows:
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In addition, we may be subject to a variety of taxes other than U.S. federal income tax, including state, local, and foreign income, franchise property and other taxes. We could also be subject to tax in situations and on transactions not presently contemplated.
Requirements for Qualification as a REIT
The Internal Revenue Code defines a REIT as a corporation, trust or association:
The Internal Revenue Code provides that conditions (1) through (4) must be met during the entire taxable year, and that condition (5) must be met during at least 335 days of a taxable year of 12 months, or during a proportionate part of a shorter taxable year. Conditions (5) and (6) do not need to be satisfied for the first taxable year for which an election to become a REIT has been made. We believe that we have outstanding common stock with sufficient diversity of ownership to satisfy the requirements described in
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conditions (5) and (6). In addition, our charter provides restrictions regarding the ownership and transfer of our shares, which are intended to assist us in satisfying the share ownership requirements described in conditions (5) and (6) above. We believe that we currently satisfy condition (6) and will continue to satisfy condition (6). However, as described elsewhere in this prospectus, we repurchased 265,245 shares of our common stock from one of our institutional stockholders in January 2013 at a price per share equal to our book value per share as of December 31, 2012. If on or prior to June 30, 2013 we are not able to raise additional capital from sufficiently diverse sources to satisfy the five or fewer rule, including by issuing at least approximately 320,000 shares to sufficiently diverse holders in this offering, we would fail to qualify as a REIT for the 2013 taxable year and would likely proceed with an early orderly liquidation of our business. Although we believe that we have satisfied this requirement for prior taxable years, following the repurchase of 265,245 shares of our common stock on January 24, 2013, five individuals own in excess of 54% by value of our outstanding common stock, and one of these individuals owns approximately 31.2% by value of our outstanding common stock, under the attribution rules applicable for purposes of condition (6). While our charter contains restrictions on transfers of our shares to assist us in meeting condition (6), our charter does generally permit an individual to acquire up to 9.8% of our common stock subject to our continuing to meet condition (6). We have monitored and, until the closing of this offering, intend to continue to monitor all purchases and transfers of our common stock to ensure that we have met and will continue to meet the five or fewer rule. However, the attribution rules that apply for purposes of determining the ownership of shares for purposes of condition (6) are complex and in some cases dependent on facts that are not always easy to determine. Accordingly, no assurance can be given that we have at all times satisfied or will continue to satisfy condition (6). In the event we failed to satisfy condition (6) we could fail to qualify as a REIT. See "Failure to Qualify." For purposes of condition (6), an "individual" generally includes a supplemental unemployment compensation benefit plan, a private foundation or a portion of a trust permanently set aside or used exclusively for charitable purposes, but does not include a qualified pension plan or profit sharing trust.
To monitor compliance with the share ownership requirements, we are generally required to maintain records regarding the actual ownership of our shares. To do so, we must demand written statements each year from the record holders of significant percentages of our shares of stock, in which the record holders are to disclose the actual owners of the shares (that is, the persons required to include in gross income the dividends paid by our company). A list of those persons failing or refusing to comply with this demand must be maintained as part of our records. Failure by our company to comply with these record-keeping requirements could subject us to monetary penalties. If we satisfy these requirements and after exercising reasonable diligence would not have known that condition (6) is not satisfied, we will be deemed to have satisfied such condition. A stockholder that fails or refuses to comply with the demand is required by Treasury Regulations to submit a statement with its tax return disclosing the actual ownership of the shares and other information.
With respect to condition (8), we believe that we will not have any non-REIT earnings and profits. With respect to condition (9), we intend that we will adopt December 31 as our taxable year end and thereby satisfy this requirement.
Effect of Subsidiary Entities
Ownership of Partnership Interests
In the case of a REIT that is a partner in an entity that is treated as a partnership for U.S. federal income tax purposes, such as our Operating Partnership at any time that our Operating Partnership has two or more partners for U.S. federal income tax purposes,
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Treasury Regulations provide that the REIT is deemed to own its proportionate share of the partnership's assets and to earn its proportionate share of the partnership's gross income based on its pro rata share of capital interests in the partnership for purposes of the asset and gross income tests applicable to REITs, as described below. However, solely for purposes of the 10% value test, described below, the determination of a REIT's interest in partnership assets will be based on the REIT's proportionate interest in any securities issued by the partnership, excluding for these purposes, certain excluded securities as described in the Internal Revenue Code. In addition, the assets and gross income of the partnership generally are deemed to retain the same character in the hands of the REIT. Thus, our proportionate share of the assets and items of income of partnerships in which we own an equity interest is treated as assets and items of income of our company for purposes of applying the REIT requirements described below. Consequently, to the extent that we directly or indirectly hold a preferred or other equity interest in a partnership, the partnership's assets and operations may affect our ability to qualify as a REIT, even though we may have no control or only limited influence over the partnership.
As discussed in greater detail in "Tax Aspects of Investments in Partnerships" below, an investment in a partnership involves special tax considerations. For example, it is possible that the IRS could treat a subsidiary partnership of ours as a corporation for U.S. federal income tax purposes. In this case, the subsidiary partnership would be subject to entity-level tax and the character of our assets and items of gross income would change, possibly causing us to fail the requirements to qualify as a REIT. See "Tax Aspects of Investments in PartnershipsEntity Classification" and "Failure to Qualify" below. In addition, special rules apply in the case of appreciated or depreciated property that is contributed to a partnership in exchange for an interest in the partnership. In general terms, these rules require that certain items of income, gain, loss and deduction associated with the contributed property be allocated to the contributing partner for U.S. federal income tax purposes. In certain circumstances, these rules could adversely affect us. See "Tax Aspects of Investments in PartnershipsTax Allocations With Respect to Partnership Properties" below.
Disregarded Subsidiaries
If a REIT owns a corporate subsidiary that is a "qualified REIT subsidiary," that subsidiary is disregarded for U.S. federal income tax purposes, and all assets, liabilities and items of income, deduction and credit of the subsidiary are treated as assets, liabilities and items of income, deduction and credit of the REIT itself, including for purposes of the gross income and asset tests applicable to REITs, as summarized below. A qualified REIT subsidiary is any corporation, other than a TRS, that is wholly owned by a REIT, by other disregarded subsidiaries of a REIT or by a combination of the two. Single member limited liability companies that are wholly owned by a REIT are also generally disregarded as separate entities for U.S. federal income tax purposes, including for purposes of the REIT gross income and asset tests. Disregarded subsidiaries, along with partnerships in which we hold an equity interest, are sometimes referred to herein as "pass-through subsidiaries."
In the event that a disregarded subsidiary ceases to be wholly owned by us (for example, if any equity interest in the subsidiary is acquired by a person other than us or another disregarded subsidiary of our company), the subsidiary's separate existence would no longer be disregarded for U.S. federal income tax purposes. Instead, it would have multiple owners and would be treated as either a partnership or a taxable corporation. Such an event could, depending on the circumstances, adversely affect our ability to satisfy the various asset and gross income tests applicable to REITs, including the requirement that REITs generally may not own, directly or indirectly, more than 10% of the value or voting power of the outstanding securities of another corporation. See "Asset Tests" and "Gross Income Tests."
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Taxable REIT Subsidiaries
A REIT, in general, may jointly elect with a subsidiary corporation, whether or not wholly owned, to treat the subsidiary corporation as a TRS. The separate existence of a TRS or other taxable corporation, unlike a disregarded subsidiary as discussed above, is not ignored for U.S. federal income tax purposes. Accordingly, such an entity would generally be subject to corporate income tax on its earnings, which may reduce the cash flow generated by us and our subsidiaries in the aggregate and our ability to make distributions to our stockholders.
We have elected, together with ZAIS I TRS, for ZAIS I TRS to be treated as a TRS, and we may make TRS elections with respect to certain other domestic entities and non-U.S. entities we may form in the future. The Internal Revenue Code and the Treasury Regulations promulgated thereunder provide a specific exemption from U.S. federal income tax that applies to a non-U.S. corporation that restricts its activities in the United States to trading in stock and securities (or any activity closely related thereto) for its own account whether such trading (or such other activity) is conducted by such a non-U.S. corporation or its employees through a resident broker, commission agent, custodian or other agent. Certain U.S. stockholders of such a non-U.S. corporation are required to include in their income currently their proportionate share of the earnings of such a corporation, whether or not such earnings are distributed. We may invest in certain non-U.S. corporations with which we will jointly make a TRS election which will be organized as Cayman Islands companies and will either rely on such exemption or otherwise operate in a manner so that such non-U.S. corporations will not be subject to U.S. federal income tax on their net income. Therefore, despite such contemplated entities' status as TRSs, such entities should generally not be subject to U.S. federal corporate income tax on their earnings. However, we will likely be required to include in our income, on a current basis, the earnings of any such TRSs. This could affect our ability to comply with the REIT income tests and distribution requirement. See "Gross Income Tests" and "Annual Distribution Requirements."
A REIT is not treated as holding the assets of a TRS or other taxable subsidiary corporation or as receiving any income that the subsidiary earns. Rather, the stock issued by the subsidiary is an asset in the hands of the REIT, and the REIT generally recognizes as income the dividends, if any, that it receives from the subsidiary. This treatment can affect the gross income and asset test calculations that apply to the REIT, as described below. Because a parent REIT does not include the assets and income of such subsidiary corporations in determining the parent REIT's compliance with the REIT requirements, such entities may be used by the parent REIT to undertake indirectly activities that the REIT rules might otherwise preclude the parent REIT from doing directly or through pass-through subsidiaries or render commercially unfeasible (for example, activities that give rise to certain categories of income such as non-qualifying fee or hedging income or inventory sales). If dividends are paid to us by one or more domestic TRSs we may own, then a portion of the dividends that we distribute to stockholders who are taxed at individual rates generally will be eligible for taxation at preferential qualified dividend income tax rates rather than at ordinary income rates. See "Taxation of Taxable U.S. Stockholders" and "Annual Distribution Requirements."
Certain restrictions imposed on TRSs are intended to ensure that such entities will be subject to appropriate levels of U.S. federal income taxation. First, a TRS may not deduct interest payments made in any year to an affiliated REIT to the extent that the excess of such payments over the TRS's interest income exceeds, generally, 50% of the TRS's adjusted taxable income for that year (although the TRS may carry forward to, and deduct in, a succeeding year the disallowed interest amount if the 50% test is satisfied in that year). Since this limitation generally only applies to interest expense to the extent it exceeds a TRS's
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interest income, the limitation may not have a significant impact on TRSs that primarily hold debt investments. In addition, if amounts are paid to a REIT or deducted by a TRS due to transactions between a REIT, its tenants and/or the TRS, that exceed the amount that would be paid to or deducted by a party in an arm's-length transaction, the REIT generally will be subject to an excise tax equal to 100% of such excess. We intend to scrutinize all of our transactions with any of our subsidiaries that are treated as TRSs in an effort to ensure that we will not become subject to this excise tax; however, we cannot assure you that we will be successful in avoiding this excise tax.
Taxable Mortgage Pools
An entity, or a portion of an entity, is classified as a taxable mortgage pool under the Internal Revenue Code if:
Under Treasury Regulations, if less than 80% of the assets of an entity (or a portion of an entity) consist of debt obligations, these debt obligations are considered not to comprise "substantially all" of its assets, and therefore the entity would not be treated as a taxable mortgage pool. We may enter into transactions that could result in us, our Operating Partnership or a portion of our assets being treated as a "taxable mortgage pool" for U.S. federal income tax purposes. Specifically, we may securitize RMBS that we acquire and certain securitizations may result in us owning interests in a taxable mortgage pool. We would be precluded from holding equity interests in such a securitization through our Operating Partnership at any time that our Operating Partnership is treated as a partnership for U.S. federal income tax purposes. Accordingly, we would likely enter into such a transaction through a qualified REIT subsidiary of a subsidiary REIT of our Operating Partnership, and will be precluded from selling to outside investors equity interests in such a securitization or from selling any debt securities issued in connection with such a securitization that might be considered to be equity interests for U.S. federal income tax purposes.
A taxable mortgage pool generally is treated as a corporation for U.S. federal income tax purposes. However, special rules apply to a REIT, a portion of a REIT, or a qualified REIT subsidiary that is a taxable mortgage pool. If a REIT, including a subsidiary REIT formed by our Operating Partnership, owns directly, or indirectly through one or more qualified REIT subsidiaries or other entities that are disregarded as a separate entity for U.S. federal income tax purposes, 100% of the equity interests in the taxable mortgage pool, the taxable mortgage pool will be a qualified REIT subsidiary and, therefore, ignored as an entity separate from the REIT for U.S. federal income tax purposes and would not generally affect the tax qualification of the REIT. Rather, the consequences of the taxable mortgage pool classification would generally, except as described below, be limited to the REIT's stockholders. See "Excess Inclusion Income."
If such a subsidiary REIT of our Operating Partnership owns less than 100% of the ownership interests in a subsidiary that is a taxable mortgage pool, the foregoing rules would not apply. Rather, the subsidiary would be treated as a corporation for U.S. federal income tax
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purposes, and would be subject to corporate income tax. In addition, this characterization would alter the REIT income and asset test calculations of such a subsidiary REIT and could adversely affect such REIT's compliance with those requirements, which, in turn, could affect our compliance with the REIT requirements. We do not expect that we, or any subsidiary REIT owned by our Operating Partnership, would form any subsidiary that would become a taxable mortgage pool, in which we own some, but less than all, of the ownership interests, and we intend to monitor the structure of any taxable mortgage pools in which we have an interest to ensure that they will not adversely affect our qualification as a REIT.
Subsidiary REITs
Our Operating Partnership may establish one or more subsidiary REITs to hold certain assets and conduct certain activities. Any such subsidiary REIT will be treated as a separate entity for U.S. federal income tax purposes, and we will not be treated as owning the assets of such subsidiary REIT or recognizing the income recognized by such subsidiary REIT. Any such subsidiary REIT will generally be subject to U.S. federal income tax in the same manner as us and will be subject to the same gross income tests, asset tests and other REIT qualification requirements and considerations as are applicable to us.
The stock of any such subsidiary REIT will be a qualifying asset to us for the purpose of the 75% asset test so long as such subsidiary REIT continues to qualify as a REIT for U.S. federal income tax purposes. See "Asset Tests." Any dividends received by our Operating Partnership from such subsidiary REIT will be qualifying income to us for purposes of both the 75% and 95% gross income tests. See "Gross Income TestsDividend Income." We may capitalize a subsidiary REIT with debt in addition to equity. Such debt will generally not be a qualifying asset for purposes of the 75% asset test. See "Asset Tests." Interest paid to us on such debt will generally be qualifying income for purposes of the 95% gross income test but not the 75% gross income test. See "Gross Income TestsInterest Income."
Gross Income Tests
In order to maintain our qualification as a REIT, we annually must satisfy two gross income tests. First, at least 75% of our gross income for each taxable year, excluding gross income from sales of inventory or dealer property in "prohibited transactions" and certain hedging and foreign currency transactions, must be derived from investments relating to real property or mortgages on real property, including "rents from real property," dividends received from and gains from the disposition of other shares of REITs, interest income derived from mortgage loans secured by real property (including certain types of RMBS), and gains from the sale of real estate assets, as well as income from certain kinds of temporary investments. Second, at least 95% of our gross income in each taxable year, excluding gross income from prohibited transactions and certain hedging and foreign currency transactions, must be derived from some combination of income that qualifies under the 75% income test described above, as well as other dividends, interest, and gain from the sale or disposition of stock or securities, which need not have any relation to real property. We intend to monitor the amount of our non-qualifying income and manage our portfolio of assets to comply with the gross income tests, but we cannot assure you that we will be successful in the effort.
For purposes of the 75% and 95% gross income tests, a REIT is deemed to have earned a proportionate share of the income earned by any partnership, or any limited liability company treated as a partnership for U.S. federal income tax purposes, in which it owns an interest, which share is determined by reference to its capital interest in such entity, and is deemed to have earned the income earned by any qualified REIT subsidiary.
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Interest Income
Interest income constitutes qualifying mortgage interest for purposes of the 75% gross income test to the extent that the obligation upon which such interest is paid is secured by a mortgage on real property. If we receive interest income with respect to a mortgage loan that is secured by both real property and other property and the highest principal amount of the loan outstanding during a taxable year exceeds the fair market value of the real property on the date that we acquired the mortgage loan, the interest income will be apportioned between the real property and the other property, and our home from the arrangement will qualify for purposes of the 75% gross income test only to the extent that the interest is allocable to the real property. Even if a loan is not secured by real property or is undersecured, the income that it generates may nonetheless qualify for purposes of the 95% gross income test.
In the event that we invest in a mortgage that is secured by both real property and other property, we would be required to apportion our annual interest income to the real property security based on a fraction, the numerator of which is the value of the real property securing the loan, determined when we commit to acquire the loan, and the denominator of which is the highest "principal amount" of the loan during the year. The IRS recently issued Revenue Procedure 2011-16, which interprets the "principal amount" of the loan to be the face amount of the loan, despite the Internal Revenue Code requiring taxpayers to treat any market discount, that is the difference between the purchase price of the loan and its face amount, for all purposes (other than certain withholding and information reporting purposes) as interest rather than principal. Any mortgage loan that we invest in that is not fully secured by real property may therefore be subject to the interest apportionment rules and the position taken in IRS Revenue Procedure 2011-16 as described above.
We have and intend to continue to invest in RMBS that are either pass-through certificates or CMOs. We expect that such RMBS are treated either as interests in a grantor trust or as regular interests in a REMIC for U.S. federal income tax purposes and that substantially all of the interest income, OID and market discount from our RMBS will be qualifying income for the 95% gross income test. In the case of RMBS treated as interests in grantor trusts, we would be treated as owning an undivided beneficial ownership interest in the mortgage loans held by the grantor trust. The interest, OID and market discount on such mortgage loans would be qualifying income for purposes of the 75% gross income test to the extent that the obligation is secured by real property, as discussed above. In the case of RMBS treated as interests in a REMIC, income derived from REMIC interests will generally be treated as qualifying income for purposes of the 75% and 95% gross income tests. If less than 95% of the assets of the REMIC are real estate assets, however, then only a proportionate part of its interest in the REMIC and income derived from the interest will qualify for purposes of the 75% gross income test. In addition, some REMIC securitizations include imbedded interest swap or cap contracts or other derivative instruments that potentially could produce non-qualifying income for the holder of the related REMIC securities. In connection with the recently expanded HARP program, the IRS recently issued guidance providing that, among other things, if a REIT holds a regular or residual interest in an "eligible REMIC" that informs the REIT that at least 80% of the REMIC's assets constitute real estate assets, then the REIT may treat 80% of the gross income received with respect to the interest in the REMIC as interest on an obligation secured by a mortgage on real property for the purpose of the 75% REIT gross income test. For this purpose, a REMIC is an "eligible REMIC" if (i) the REMIC has received a guarantee from Fannie Mae or Freddie Mac that will allow the REMIC to make any principal and interest payments on its regular and residual interests and (ii) all of the REMIC's mortgages and pass-through certificates are secured by interests in single-family dwellings. If we were to acquire an interest in an eligible REMIC less than 95% of the assets of which
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constitute real estate assets, the IRS guidance described above may generally allow us to treat 80% of the gross income derived from the interest as qualifying income for the purpose of the 75% REIT gross income test. However, the remaining portion of such income would not generally be qualifying income for the purpose of the 75% REIT gross income test, which could adversely affect our ability to qualify as a REIT. We expect that substantially all of our income from RMBS will be qualifying income for purposes of the REIT gross income tests.
We believe that the interest, OID, and market discount income that we receive from our RMBS generally will be qualifying income for purposes of both the 75% and 95% gross income tests. However, to the extent that we own non-REMIC CMO obligations or other debt instruments secured by mortgage loans (rather than by real property) or secured by non-real estate assets, or debt securities that are not secured by mortgages on real property or interests in real property, the interest income received with respect to such securities generally will be qualifying income for purposes of the 95% gross income test, but not the 75% gross income test. In addition, the loan amount of a mortgage loan that we own may exceed the value of the real property securing the loan. In that case, income from the loan will be qualifying income for purposes of the 95% gross income test, but the interest attributable to the amount of the loan that exceeds the value of the real property securing the loan will not be qualifying income for purposes of the 75% gross income test.
We may acquire excess MSRs, which means the portion of an MSR that exceeds the arm's length fee for services performed by the mortgage servicer. In a recent private letter ruling, the IRS ruled that interest received by a REIT from excess MSRs meeting certain requirements will be considered interest on obligations secured by mortgages on real property for purposes of the 75% REIT gross income test. A private letter ruling may be relied upon only by the taxpayer to whom it is issued, and the IRS may revoke a private letter ruling. Consistent with the analysis adopted by the IRS in that private letter ruling and based on advice of counsel, we intend to treat such income from any excess MSRs we acquire that meet the requirements provided in the private letter ruling as qualifying income for purposes of the 75% and 95% gross income tests. Notwithstanding the IRS's determination in the private letter ruling described above, it is possible that the IRS could successfully assert that such income does not qualify for purposes of the 75% and/or 95% gross income tests, which, if such income together with other income we earn that does not qualify for the 75% or 95% gross income test, as applicable, exceeded 25% or 5% of our gross income, could cause us to be subject to a penalty tax and could impact our ability to qualify as a REIT. See "Failure to Satisfy the Gross Income Tests" and "Failure to Qualify." To the extent we acquire MSRs other than excess MSRs, we expect that we would hold such MSRs in a TRS in order to avoid recognizing non-qualifying income for purposes of the REIT gross income tests.
Phantom Income
Due to the nature of the assets in which we will invest, we may be required to recognize taxable income from certain of our assets in advance of our receipt of cash flow on or proceeds from disposition of such assets, which we refer to as "phantom income," and we may be required to report taxable income in early periods that exceeds the economic income ultimately realized on such assets.
We have and may continue to acquire debt instruments, including RMBS, in the secondary market for less than their face amount. The discount at which such debt instruments are acquired may reflect doubts about their ultimate collectability rather than current market interest rates. The amount of such discount will nevertheless generally be treated as "market discount" for U.S. federal income tax purposes. We expect to accrue market discount on a constant yield to maturity of the debt instrument, based generally on the
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assumption that all future payments on the debt instrument will be made. Accrued market discount is reported as income when, and to the extent that, any payment of principal on the debt instrument is received, unless we elect to include accrued market discount in incomes as it accrues. Principal payments on certain loans are made monthly, and consequently accrued market discount may have to be included in income each month as if the debt instrument would ultimately be collected in full. If we collect less on the debt instrument than our purchase price plus any market discount we had previously reported as income, we may not be able to benefit from any offsetting loss deductions in subsequent years. In certain cases, we may be able to cease accruing interest income with respect to a debt instrument, to the extent there is reasonable doubt as to our ability to collect such interest income. However, if we recognize insufficient interest income, and the IRS were to successfully assert that we did not accrue the appropriate amount of income with respect to such a debt instrument in a given taxable year, we may be required to increase our taxable income with respect to such year, which could cause us to be required to pay a deficiency dividend or a tax on undistributed income, or fail to qualify as a REIT.
Some of the RMBS that we purchase will likely have been issued with OID. We will be required to accrue OID based on a constant yield method and income will accrue on the RMBS based on the assumption that all future payments on such RMBS will be made. If such RMBS turn out not to be fully collectible, an offsetting loss will only become available in a later year when uncollectiblity is provable. Moreover, such loss will likely be treated as a capital loss in the hands of our Operating Partnership, and the utility of that deduction would therefore depend on our having capital gain in that later year or thereafter. We may also be required under the terms of the indebtedness that we incur to use cash received from interest payments to make principal payment on that indebtedness, with the effect that we will recognize income but will not have a corresponding amount of cash available for distribution to our stockholders.
In addition, we may acquire excess MSRs. Based on IRS guidance concerning the classification of excess MSRs, we intend to treat any excess MSRs that we may acquire that meet certain requirements as ownership interests in the interest payments made on the underlying pool of mortgage loans. Under this treatment, each excess MSR is treated as a bond that was issued with OID on the date we acquired such excess MSR. In general, we will be required to accrue OID based on the constant yield to maturity of each excess MSR, and to treat such OID as taxable income in accordance with the applicable U.S. federal income tax rules. The constant yield of an excess MSR will be determined, and we will be taxed based on, a prepayment assumption regarding future payments due on the mortgage loans underlying the excess MSR. If the mortgage loans underlying an excess MSR prepay at a rate different than that under the prepayment assumption, our recognition of OID will be either increased or decreased depending on the circumstances. Thus, in a particular taxable year, we may be required to accrue an amount of income in respect of an excess MSR that exceeds the amount of cash collected in respect of that excess MSR. Furthermore, it is possible that, over the life of the investment in an excess MSR, the total amount we pay for, and accrue with respect to, the excess MSR may exceed the total amount we collect on such excess MSR. No assurance can be given that we will be entitled to an ordinary loss or deduction for such, meaning that we may not be able to use any such loss or deduction to offset OID recognized with respect to our excess MSRs or other ordinary income recognized by us. As a result of this mismatch in character between the income and losses generated by our excess MSRs, our REIT taxable income may be higher than it otherwise would have been in the absence of that mismatch.
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Due to each of these potential differences between income recognition or expense deduction and related cash receipts or disbursements, there is a significant risk that we may have substantial taxable income in excess of cash available for distribution. In that event, we may need to borrow funds or take other actions to satisfy the REIT distribution requirements for the taxable year in which this "phantom income" is recognized. See "Annual Distribution Requirements."
Dividend Income
We may receive distributions from TRSs or other corporations that are not REITs or qualified REIT subsidiaries. These distributions are generally classified as dividend income to the extent of the earnings and profits of the distributing corporation. Such distributions generally constitute qualifying income for purposes of the 95% gross income test, but not the 75% gross income test. Any dividends received by us from a REIT is qualifying income in our hands for purposes of both the 95% and 75% gross income tests.
Income inclusions from certain equity investments in a foreign TRS or other non-U.S. corporation in which we may hold an equity interest are technically neither dividends nor any of the other enumerated categories of income specified in the 95% gross income test for U.S. federal income tax purposes. However, in a recent private letter ruling, the IRS exercised its authority under Internal Revenue Code section 856(c)(5)(J)(ii) to treat such income as qualifying income for purposes of the 95% gross income test. A private letter ruling may be relied upon only by the taxpayer to whom it is issued, and the IRS may revoke a private letter ruling. Consistent with the position adopted by the IRS in those private letter rulings and based on advice of counsel concerning the classification of such income inclusions for purposes of the REIT income tests, we intend to treat such income inclusions that meet certain requirements as qualifying income for purposes of the 95% gross income test. Notwithstanding the IRS's determination in the private letter ruling described above, it is possible that the IRS could successfully assert that such income does not qualify for purposes of the 95% gross income test, which, if such income together with other income we earn that does not qualify for the 95% gross income test exceeded 5% of our gross income, could cause us to be subject to a penalty tax and could impact our ability to qualify as a REIT. See "Failure to Satisfy the Gross Income Tests" and "Failure to Qualify." In addition, if such income was determined not to qualify for the 95% gross income test, we would need to invest in sufficient qualifying assets, or sell some of our interests in any foreign TRSs or other non-U.S. corporations in which we hold an equity interest to ensure that the income recognized by us from our foreign TRSs or such other corporations does not exceed 5% of our gross income.
Hedging Transactions
We may enter into hedging transactions with respect to one or more of our assets or liabilities. Hedging transactions could take a variety of forms, including interest rate swap agreements, interest rate cap agreements, options, forward rate agreements or similar financial instruments. Except to the extent provided by Treasury Regulations, any income from a hedging transaction we enter into (1) in the normal course of business primarily to manage risk of interest rate or price changes or currency fluctuations with respect to borrowings made or to be made, or ordinary obligations incurred or to be incurred, to acquire or carry real estate assets, which is clearly identified as specified in Treasury Regulations before the close of the day on which it was acquired, originated, or entered into, including gain from the sale or disposition of such a transaction, and (2) primarily to manage risk of currency fluctuations with respect to any item of income or gain that would be qualifying income under the 75% or
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95% gross income tests which is clearly identified as such before the close of the day on which it was acquired, originated, or entered into, will not constitute gross income for purposes of the 75% or 95% gross income test. To the extent that we enter into other types of hedging transactions, the income from those transactions is likely to be treated as non-qualifying income for purposes of both of the 75% and 95% gross income tests. We intend to structure any hedging transactions in a manner that does not jeopardize its qualification as a REIT, but there can be no assurance that we will be successful in this regard.
Rents from Real Property
We currently do not intend to acquire real property with the proceeds of this offering. However, to the extent that we own real property or interests therein, rents we receive qualify as "rents from real property" in satisfying the gross income tests described above, only if several conditions are met, including the following. If rent attributable to personal property leased in connection with a lease of real property is greater than 15% of the total rent received under any particular lease, then all of the rent attributable to such personal property will not qualify as rents from real property. The determination of whether an item of personal property constitutes real or personal property under the REIT provisions of the Internal Revenue Code is subject to both legal and factual considerations and is therefore subject to different interpretations.
In addition, in order for rents received by us to qualify as "rents from real property," the rent must not be based in whole or in part on the income or profits of any person. However, an amount will not be excluded from rents from real property solely by reason of being based on a fixed percentage or percentages of sales or if it is based on the net income of a tenant which derives substantially all of its income with respect to such property from subleasing of substantially all of such property, to the extent that the rents paid by the subtenants would qualify as rents from real property, if earned directly by our company. Moreover, for rents received to qualify as "rents from real property," we generally must not operate or manage the property or furnish or render certain services to the tenants of such property, other than through an "independent contractor" who is adequately compensated and from which we derive no income or through a TRS. We are permitted, however, to perform services that are "usually or customarily rendered" in connection with the rental of space for occupancy only and are not otherwise considered rendered to the occupant of the property. In addition, we may directly or indirectly provide non-customary services to tenants of our properties without disqualifying all of the rent from the property if the payment for such services does not exceed 1% of the total gross income from the property. In such a case, only the amounts for non-customary services are not treated as rents from real property and the provision of the services does not disqualify the related rent.
Rental income will qualify as rents from real property only to the extent that we do not directly or constructively own, (1) in the case of any tenant which is a corporation, stock possessing 10% or more of the total combined voting power of all classes of stock entitled to vote, or 10% or more of the total value of shares of all classes of stock of such tenant, or (2) in the case of any tenant which is not a corporation, an interest of 10% or more in the assets or net profits of such tenant.
Failure to Satisfy the Gross Income Tests
We intend to monitor our sources of income, including any non-qualifying income received by us, and manage our assets so as to ensure our compliance with the gross income tests. We cannot assure you, however, that we will be able to satisfy the gross income tests. If we fail to satisfy one or both of the 75% or 95% gross income tests for any taxable year, we
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may still qualify as a REIT for the year if we are entitled to relief under applicable provisions of the Internal Revenue Code. These relief provisions will generally be available if our failure to meet these tests was due to reasonable cause and not due to willful neglect and, following the identification of such failure, we set forth a description of each item of our gross income that satisfies the gross income tests in a schedule for the taxable year filed in accordance with the Treasury Regulation. It is not possible to state whether we would be entitled to the benefit of these relief provisions in all circumstances. If these relief provisions are inapplicable to a particular set of circumstances involving us, it will not qualify as a REIT. As discussed above under "Taxation of REITs in General," even where these relief provisions apply, a tax would be imposed upon the profit attributable to the amount by which we fail to satisfy the particular gross income test.
Asset Tests
We, at the close of each calendar quarter, must also satisfy four tests relating to the nature of our assets. First, at least 75% of the value of our total assets must be represented by some combination of "real estate assets," cash, cash items, U.S. Government securities and, under some circumstances, stock or debt instruments purchased with new capital. For this purpose, real estate assets include interests in real property, such as land, buildings, leasehold interests in real property, stock of other corporations that qualify as REITs and certain kinds of RMBS and mortgage loans. Regular or residual interests in REMICs are generally treated as a real estate asset. If, however, less than 95% of the assets of a REMIC consists of real estate assets (determined as if we held such assets), we will be treated as owning our proportionate share of the assets of the REMIC. As further discussed above under "Gross Income TestsInterest Income," the IRS has recently issued guidance providing that, among other things, if a REIT holds a regular or residual interest in an "eligible REMIC" that informs the REIT that at least 80% of the REMIC's assets constitute real estate assets, then the REIT may treat 80% of the value of the interest in the REMIC as a real estate asset for the purpose of the REIT asset tests. The remaining 20% of the value of the REIT's interest in the REMIC would not qualify as a real estate asset for purposes of the REIT asset tests and could adversely affect our ability to qualify as a REIT. In the case of interests in grantor trusts, we will be treated as owning an undivided beneficial interest in the mortgage loans held by the grantor trust. Assets that do not qualify for purposes of the 75% test are subject to the additional asset tests described below. Second, the value of any one issuer's securities owned by us may not exceed 5% of the value of our gross assets. Third, we may not own more than 10% of any one issuer's outstanding securities, as measured by either voting power or value. Fourth, the aggregate value of all securities of TRSs held by us may not exceed 25% of the value of our gross assets.
The 5% and 10% asset tests do not apply to stock and securities of TRSs and qualified REIT subsidiaries. The 10% value test does not apply to certain "straight debt" and other excluded securities, as described in the Internal Revenue Code, including any loan to an individual or an estate, any obligation to pay rents from real property and any security issued by a REIT. In addition, (1) a REIT's interest as a partner in a partnership is not considered a security for purposes of applying the 10% value test; (2) any debt instrument issued by a partnership (other than straight debt or other excluded security) will not be considered a security issued by the partnership if at least 75% of the partnership's gross income is derived from sources that would qualify for the 75% REIT gross income test; and (3) any debt instrument issued by a partnership (other than straight debt or other excluded security) will not be considered a security issued by the partnership to the extent of the REIT's interest as a partner in the partnership.
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For purposes of the 10% value test, "straight debt" means a written unconditional promise to pay on demand on a specified date a sum certain in money if (1) the debt is not convertible, directly or indirectly, into stock, (2) the interest rate and interest payment dates are not contingent on profits, the borrower's discretion, or similar factors other than certain contingencies relating to the timing and amount of principal and interest payments, as described in the Internal Revenue Code and (3) in the case of an issuer which is a corporation or a partnership, securities that otherwise would be considered straight debt will not be so considered if we, and any of our "controlled taxable REIT subsidiaries" as defined in the Internal Revenue Code, hold any securities of the corporate or partnership issuer which (A) are not straight debt or other excluded securities (prior to the application of this rule), and (B) have an aggregate value greater than 1% of the issuer's outstanding securities (including, for the purposes of a partnership issuer, our interest as a partner in the partnership).
After initially meeting the asset tests at the close of any quarter, we will not lose our qualification as a REIT for failure to satisfy the asset tests at the end of a later quarter solely by reason of changes in asset values. If we fail to satisfy the asset tests because we acquire assets during a quarter, we can cure this failure by disposing of sufficient non-qualifying assets within 30 days after the close of that quarter. If we fail the 5% asset test, or the 10% vote or value asset tests at the end of any quarter and such failure is not cured within 30 days thereafter, we may dispose of sufficient assets (generally within six months after the last day of the quarter in which the identification of the failure to satisfy these asset tests occurred) to cure such a violation that does not exceed the lesser of 1% of our assets at the end of the relevant quarter or $10,000,000. If we fail any of the other asset tests or our failure of the 5% and 10% asset tests is in excess of the de minimis amount described above, as long as such failure was due to reasonable cause and not willful neglect, it is permitted to avoid disqualification as a REIT, after the 30 day cure period, by taking steps, including the disposition of sufficient assets to meet the asset test (generally within six months after the last day of the quarter in which the identification of the failure to satisfy the REIT asset test occurred) and paying a tax equal to the greater of $50,000 or the highest corporate income tax rate (currently 35%) of the net income generated by the non-qualifying assets during the period in which we failed to satisfy the asset test.
We expect that the RMBS that we own generally will be qualifying assets for purposes of the 75% asset test. However, to the extent that we own non-REMIC CMOs or other debt instruments secured by mortgage loans (rather than by real property) or secured by non-real estate assets, or debt securities issued by C corporations or other fixed-income securities that are not secured by mortgages on real property, those securities will generally not be qualifying assets for purposes of the 75% asset test.
A real estate mortgage loan that we own generally will be treated as a real estate asset for purposes of the 75% REIT asset test if, on the date that we acquire or originate the mortgage loan, the value of the real property securing the loan is equal to or greater than the principal amount of the loan. Existing IRS guidance provides that certain rules described above that are applicable to the gross income tests may apply to determine what portion of a mortgage loan will be treated as a real estate asset if the mortgage loan is secured both by real property and other assets. Although the issue is not free from doubt, we may be required to treat a portion of a mortgage loan that is acquired (or modified in a manner that is treated as an acquisition of a new loan for U.S. federal income tax purposes) at a time when the fair market value of the real property securing the loan is less than the loan's face amount and there are other assets securing the loan, as nonqualifying for the 75% REIT asset test even if our acquisition price for the loan (that is, the fair market value of the loan) is less than the value of the real property securing the loan.
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We may acquire excess MSRs. In a recent private letter ruling, the IRS ruled that excess MSRs meeting certain requirements would be treated as an interest in mortgages on real property and thus a real estate asset for purposes of the 75% REIT asset test. A private letter ruling may be relied upon only by the taxpayer to whom it is issued, and the IRS may revoke a private letter ruling. Consistent with the analysis adopted by the IRS in that private letter ruling and based on advice of counsel, we intend to treat any excess MSRs that we acquire that meet the requirements provided in the private letter ruling as qualifying assets for purposes of the 75% REIT gross asset test. Notwithstanding the IRS's determination in the private letter ruling described above, it is possible that the IRS could successfully assert that any excess MSRs that we acquire do not qualify for purposes of the 75% REIT gross asset test, which could cause us to be subject to a penalty tax and could impact our ability to qualify as a REIT. See "Failure to Qualify." To the extent we acquire MSRs other than excess MSRs, we expect that we would hold such MSRs in a TRS in order to avoid recognizing non-qualifying income for purposes of the REIT gross income tests.
We believe that our holdings of securities and other assets will be structured in a manner that will comply with the foregoing REIT asset requirements and we intend to monitor compliance on an ongoing basis. There can be no assurance, however, that we will be successful in this effort. In this regard, to determine compliance with these requirements, we will need to estimate the value of our assets. We may not obtain independent appraisals to support our conclusions concerning the values of our assets, and the values of some of our assets may not be susceptible to a precise determination and are subject to change in the future. Although we will be prudent in making estimates as to the value of our assets, there can be no assurance that the IRS will not disagree with the determinations and assert that a different value is applicable, in which case we might not satisfy the 75% asset test and the other asset tests and could fail to qualify as a REIT. Furthermore, the proper classification of an instrument as debt or equity for U.S. federal income tax purposes may be uncertain in some circumstances, which could affect the application of the REIT asset tests. As an example, if we were to acquire equity securities of a REIT issuer that were determined by the IRS to represent debt securities of such issuer, such securities would also not qualify as real estate assets. Accordingly, there can be no assurance that the IRS will not contend that our interests in subsidiaries or in the securities of other issuers (including REIT issuers) cause a violation of the REIT asset tests.
In addition, we intend to enter into repurchase agreements under which we will nominally sell certain of our assets to a counterparty and simultaneously enter into an agreement to repurchase the sold assets. We believe that we will be treated for U.S. federal income tax purposes as the owner of the assets that are the subject of any such repurchase agreement and the repurchase agreement will be treated as a secured lending transaction notwithstanding that we may transfer record ownership of the assets to the counterparty during the term of the agreement. It is possible, however, that the IRS could successfully assert that we did not own the assets during the term of the repurchase agreement, in which case we could fail to qualify as a REIT.
Annual Distribution Requirements
In order to qualify as a REIT, we are required to distribute dividends, other than capital gain dividends, to our stockholders in an amount at least equal to:
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These distributions must be paid in the taxable year to which they relate or in the following taxable year if such distributions are declared in October, November or December of the taxable year, are payable to stockholders of record on a specified date in any such month and are actually paid before the end of January of the following year. Such distributions are treated as both paid by us and received by each stockholder on December 31 of the year in which they are declared. In addition, at our election, a distribution for a taxable year may be declared before we timely file our tax return for the year and be paid with or before the first regular dividend payment after such declaration, provided that such payment is made during the 12-month period following the close of such taxable year. These distributions are taxable to our stockholders in the year in which paid, even though the distributions relate to our prior taxable year for purposes of the 90% distribution requirement.
In order for distributions to be counted towards our distribution requirement and to give rise to a tax deduction by us, they must not be "preferential dividends." A dividend is not a preferential dividend if it is pro rata among all outstanding shares of stock within a particular class and is in accordance with the preferences among different classes of stock as set forth in the organizational documents.
To the extent that we distribute at least 90%, but less than 100%, of our "REIT taxable income," as adjusted, we will be subject to tax at ordinary U.S. federal corporate tax rates on the retained portion. In addition, we may elect to retain, rather than distribute, our net long-term capital gains and pay tax on such gains. In this case, we could elect to have our stockholders include their proportionate share of such undistributed long-term capital gains in income and receive a corresponding credit or refund, as the case may be, for their proportionate share of the tax paid by us. Our stockholders would then increase the adjusted basis of their stock in us by the difference between the designated amounts included in their long-term capital gains and the tax deemed paid with respect to their proportionate shares.
If we fail to distribute during each calendar year at least the sum of (1) 85% of our REIT ordinary income for such year, (2) 95% of our REIT capital gain net income for such year and (3) any undistributed taxable income from prior periods, we will be subject to a 4% excise tax on the excess of such required distribution over the sum of (x) the amounts actually distributed (taking into account excess distributions from prior periods) and (y) the amounts of income retained on which we have paid corporate income tax. We intend to make timely distributions so that we are not subject to the 4% excise tax.
In addition, if we were to recognize "built-in gain" (as defined below) on the disposition of any assets acquired from a C corporation in a transaction in which our basis in the assets was determined by reference to the C corporation's basis (for instance, if the assets were acquired in a tax-free reorganization or contribution), we would be required to distribute at least 90% of the built-in gain net of the tax we would pay on such gain. See "Tax on Built-In Gains" below.
It is possible that we, from time to time, may not have sufficient cash to meet the distribution requirements due to timing differences between (a) the actual receipt of cash, including receipt of distributions from our subsidiaries and (b) the inclusion of items in income by us for U.S. federal income tax purposes prior to receipt of such income in cash. For example, we may acquire debt instruments or notes whose face value may exceed its
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issue price as determined for U.S. federal income tax purposes, reverse mortgages or market discount bonds such that we will be required to include in our income a portion of income each year that such instrument is held before we receive any corresponding cash. Similarly, income from excess MSRs that we acquire may be treated as debt instruments issued with OID, and as a result we may accrue interest income without receiving corresponding cash payments with respect to such excess MSRs. See "Gross Income TestsPhantom Income" above. In the event that such timing differences occur, to meet our distribution requirements it might be necessary to arrange for short-term, or possibly long-term, borrowings, use cash reserves, liquidate non-cash assets at rates or times that we regard as unfavorable or pay dividends in the form of taxable stock dividends. In the case of a taxable stock dividend, stockholders would be required to include the dividend as income and would be required to satisfy the tax liability associated with the distribution with cash from other sources, including sales of our common stock. Both a taxable stock distribution and sale of common stock resulting from such distribution could adversely affect the value of our common stock.
We may be able to rectify a failure to meet the distribution requirements for a year by paying "deficiency dividends" to stockholders in a later year, which may be included in our deduction for dividends paid for the earlier year. In this case, we may be able to avoid losing our qualification as a REIT or being taxed on amounts distributed as deficiency dividends. However, we will be required to pay interest and a penalty based on the amount of any deduction taken for deficiency dividends.
Tax on Built-In Gains
If we acquire appreciated assets from a subchapter C corporation in a transaction in which the adjusted tax basis of the assets in our hands is determined by reference to the adjusted tax basis of the assets in the hands of the C corporation, and if we subsequently dispose of any such assets during the 10-year period following the acquisition of the assets from the C corporation, we will be subject to tax at the highest corporate tax rates on any gain from such assets to the extent of the excess of the fair market value of the assets on the date that they were contributed to us over the basis of such assets on such date, which we refer to as built-in gains. Similarly, to the extent that any C corporation holds an interest in an entity treated as a partnership for U.S. federal income tax purposes (either directly or through one or more other entities treated as partnerships for U.S. federal income tax purposes) and we acquire appreciated assets from such partnership in a transaction in which the adjusted tax basis of the assets in our hands is determined by reference to the adjusted tax basis of the assets in the hands of the partnership, the underlying C corporation's proportionate share of such assets will be treated as contributed by a C corporation and therefore will be subject to the tax on built-in gains. However, the built-in gains tax will not apply if the C corporation elects to be subject to an immediate tax when the asset is acquired by us.
As part of our formation, certain of the Matrix VI Funds and certain other persons who are treated as C corporations for U.S. federal income tax purposes contributed assets to us in exchange for stock. The Matrix VI Funds that are treated as C corporations for U.S. federal income tax purposes have elected to recognize any gain or loss on such contribution of assets to us pursuant to our formation. We believe that any other person who contributed assets to us in exchange for stock in connection with our formation and who is treated as a C corporation for U.S. federal income tax purposes (including any person treated as a partnership for U.S. federal income tax purposes with one or more direct or indirect C corporation partners) contributed assets with a de minimis amount of built-in gains. As a result, although it is possible that a portion of the assets contributed to us in connection with our formation may be subject to the built-in gains tax, we expect that the built-in gains resulting from such assets should generally be de minimis .
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Recordkeeping Requirements
We are required to maintain records and request on an annual basis information from specified stockholders. These requirements are designed to assist us in determining the actual ownership of our outstanding stock and maintaining our qualifications as a REIT.
Excess Inclusion Income
If we, our Operating Partnership or a subsidiary REIT owned by our Operating Partnership, acquire a residual interest in a REMIC, we may realize excess inclusion income. In addition, if we, our Operating Partnership or a subsidiary REIT owned by our Operating Partnership is deemed to have issued debt obligations having two or more maturities, the payments on which correspond to payments on mortgage loans owned by us, such arrangement will be treated as a taxable mortgage pool for U.S. federal income tax purposes. See "Effect of Subsidiary EntitiesTaxable Mortgage Pools." We may securitize RMBS that we acquire and certain securitizations may result in us owning interests in a taxable mortgage pool. We would be precluded from holding equity interests in such a securitization through our Operating Partnership. Accordingly, we would likely form such securitizations as qualified REIT subsidiaries of a subsidiary REIT of our Operating Partnership, and will be precluded from selling to outside investors equity interests in such securitizations or from selling any debt securities issued in connection with such securitizations that might be considered to be equity interests for U.S. federal income tax purposes. We are taxed at the highest corporate income tax rate on a portion of the income, referred to as "excess inclusion income," arising from a taxable mortgage pool that is allocable to the percentage of our shares held in record name by "disqualified organizations," which are generally certain cooperatives, governmental entities and tax-exempt organizations that are exempt from tax on unrelated business taxable income. To the extent that common stock owned by "disqualified organizations" is held in record name by a broker/dealer or other nominee, the broker/dealer or other nominee would be liable for the corporate level tax on the portion of our excess inclusion income allocable to the common stock held by the broker/dealer or other nominee on behalf of the "disqualified organizations." Disqualified organizations may own our stock. Because this tax would be imposed on our company, all of our investors, including investors that are not disqualified organizations, will bear a portion of the tax cost associated with the classification of our company or a portion of our assets as a taxable mortgage pool. A RIC or other pass-through entity owning our common stock in record name will be subject to tax at the highest corporate tax rate on any excess inclusion income allocated to their owners that are disqualified organizations.
In addition, if we realize excess inclusion income and allocate it to stockholders, this income cannot be offset by net operating losses of our stockholders. If the stockholder is a tax-exempt entity and not a disqualified organization, then this income is fully taxable as unrelated business taxable income under Section 512 of the Internal Revenue Code. If the stockholder is a foreign person, it would be subject to U.S. federal income tax withholding on this income without reduction or exemption pursuant to any otherwise applicable income tax treaty. If the stockholder is a REIT, a RIC, common trust fund or other pass-through entity, the stockholder's allocable share of our excess inclusion income could be considered excess inclusion income of such entity. Accordingly, such investors should be aware that a significant portion of our income may be considered excess inclusion income. Finally, if a subsidiary REIT of our Operating Partnership through which we hold taxable mortgage pool securitizations were to fail to qualify as a REIT, our taxable mortgage pool securitizations will be treated as separate taxable corporations for U.S. federal income tax purposes that could not be included in any consolidated corporate tax return.
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Prohibited Transactions
Net income we derive from a prohibited transaction is subject to a 100% tax. The term "prohibited transaction" generally includes a sale or other disposition of property (other than foreclosure property) that is held as inventory or primarily for sale to customers, in the ordinary course of a trade or business by a REIT, by a lower-tier partnership in which the REIT holds an equity interest or by a borrower that has issued a shared appreciation mortgage or similar debt instrument to the REIT. We intend to conduct our operations so that no asset owned by us or our pass-through subsidiaries will be held as inventory or primarily for sale to customers, and that a sale of any assets owned by us directly or through a pass-through subsidiary will not be in the ordinary course of business. However, whether property is held as inventory or "primarily for sale to customers in the ordinary course of a trade or business" depends on the particular facts and circumstances. No assurance can be given that any particular asset in which we hold a direct or indirect interest will not be treated as property held as inventory or primarily for sale to customers or that certain safe harbor provisions of the Internal Revenue Code that prevent such treatment will apply. The 100% tax will not apply to gains from the sale of property that is held through a TRS or other taxable corporation, although such income will be subject to tax in the hands of the corporation at regular corporate income tax rates.
Foreclosure Property
Foreclosure property is real property and any personal property incident to such real property (1) that is acquired by a REIT as a result of the REIT having bid on the property at foreclosure or having otherwise reduced the property to ownership or possession by agreement or process of law after there was a default (or default was imminent) on a lease of the property or a mortgage loan held by the REIT and secured by the property, (2) for which the related loan or lease was acquired by the REIT at a time when default was not imminent or anticipated and (3) for which such REIT makes a proper election to treat the property as foreclosure property. REITs generally are subject to tax at the maximum U.S. federal corporate rate (currently 35%) on any net income from foreclosure property, including any gain from the disposition of the foreclosure property, other than income that would otherwise be qualifying income for purposes of the 75% gross income test. Any gain from the sale of property for which a foreclosure property election has been made will not be subject to the 100% tax on gains from prohibited transactions described above, even if the property would otherwise constitute inventory or dealer property in the hands of the selling REIT. We do not anticipate that we will receive any income from foreclosure property that is not qualifying income for purposes of the 75% gross income test, but, if we receive any such income, we intend to elect to treat the related property as foreclosure property.
Tax Aspects of Investments in Partnerships
General
We will hold investments through entities that are classified as partnership for U.S. federal income tax purposes, including our interest in our Operating Partnership at any time that our Operating Partnership, and potentially equity interests in lower-tier partnerships. In general, partnerships are "pass-through" entities that are not subject to U.S. federal income tax. Rather, partners are allocated their proportionate shares of the items of income, gain, loss, deduction and credit of a partnership, and are subject to tax on these items without regard to whether the partners receive a distribution from the partnership. We will include in our income our proportionate share of these partnership items for purposes of the various REIT income tests, based on our capital interest in such partnership. Moreover, for purposes of the REIT asset tests, we will include our proportionate share of assets held by subsidiary
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partnerships, based on its capital interest in such partnerships (other than for purposes of the 10% value test, for which the determination of our interest in partnership assets will be based on its proportionate interest in any securities issued by the partnership excluding, for these purposes, certain excluded securities as described in the Internal Revenue Code). Consequently, to the extent that we hold an equity interest in a partnership, the partnership's assets and operations may affect our ability to qualify as a REIT, even though we may have no control, or only limited influence, over the partnership.
Entity Classification
The investment by us in partnerships involves special tax considerations, including the possibility of a challenge by the IRS of the status of any of our subsidiary partnerships as a partnership, as opposed to an association taxable as a corporation, for U.S. federal income tax purposes. If any of these entities were treated as an association for U.S. federal income tax purposes, it would be taxable as a corporation and, therefore, could be subject to an entity-level tax on its income.
Pursuant to Section 7704 of the Internal Revenue Code, a partnership that does not elect to be treated as a corporation nevertheless will be treated as a corporation for U.S. federal income tax purposes if it is a "publicly traded partnership" and it does not receive at least 90% of its gross income from certain specified sources of "qualifying income" within the meaning of that section. A "publicly traded partnership" is any partnership (i) the interests in which are traded on an established securities market or (ii) the interests in which are readily tradable on a "secondary market or the substantial equivalent thereof." Although the OP units will not be traded on an established securities market, there is a significant risk that after this offering the right of a holder of OP units to redeem the units for our common stock could cause the OP units to be considered readily tradable on the substantial equivalent of a secondary market. Under the relevant Treasury Regulations, interests in a partnership will not be considered readily tradable on a secondary market or on the substantial equivalent of a secondary market if the partnership qualifies for specified "safe harbors," which are based on the specific facts and circumstances relating to the partnership. Although our Operating Partnership may, depending on the number of parties in our Operating Partnership and the percentage of interests in our Operating Partnership transferred during a taxable year, qualify for one of these safe harbors in the future, we cannot provide any assurance that our Operating Partnership will, in each of its taxable years, qualify for one of these safe harbors. If our Operating Partnership were a publicly traded partnership, it would be taxed as a corporation unless at least 90% of its gross income consisted of "qualifying income" under Section 7704 of the Internal Revenue Code. Qualifying income is generally real property rents and other types of passive income. We believe that our Operating Partnership will have sufficient qualifying income so that it would be taxed as a partnership even if it were a publicly traded partnership. The income requirements applicable to us to qualify as a REIT under the Internal Revenue Code and the definition of qualifying income under the publicly traded partnership rules are very similar. Although differences exist between these two income tests, we do not believe that these differences would cause our Operating Partnership not to satisfy the 90% gross income test applicable to publicly traded partnerships.
If our Operating Partnership were taxable as a corporation, the character of our assets and items of our gross income would change and could preclude us from satisfying the REIT asset tests (particularly the tests generally preventing a REIT from owning more than 10% of the voting securities, or more than 10% of the value of the securities, of a corporation) or the gross income tests as discussed in "Requirements for Qualification as a REIT," "Asset Tests" and "Gross Income Tests" above, and in turn could prevent us from qualifying as a REIT. See "Failure to Qualify," below, for a discussion of the effect of our failure to meet
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these tests for a taxable year. In addition, any change in the status of any of our subsidiary partnerships for tax purposes might be treated as a taxable event, in which case we could have taxable income that is subject to the REIT distribution requirements without receiving any cash.
Tax Allocations With Respect to Partnership Properties
The partnership agreement of our Operating Partnership generally provides that items of operating income and loss will be allocated to the holders of units in proportion to the number of units held by each holder. If an allocation of partnership income or loss does not comply with the requirements of Section 704(b) of the Internal Revenue Code and the Treasury Regulations thereunder, the time subject to the allocation will be reallocated in accordance with the partners' interests in the partnership. This reallocation will be determined by taking into account all of the facts and circumstances relating to the economic arrangement of the partnership with respect to such item. Our Operating Partnership's allocations of income and loss are intended to comply with the requirements of Section 704(b) of the Internal Revenue Code and the Treasury Regulations promulgated under such section.
Under Section 704(b), income, gain, loss and deduction attributable to appreciated or depreciated property that is contributed to a partnership in exchange for an interest in the partnership must be allocated for tax purposes in a manner such that the contributing partner is charged with, or benefits from, the unrealized gain or unrealized loss associated with the property at the time of the contribution. The amount of the unrealized gain or unrealized loss is generally equal to the difference between the fair market value (or the book value) of the contributed property and the adjusted tax basis of such property at the time of the contribution (or a book-tax difference). Such allocations are solely for U.S. federal income tax purposes and do not affect partnership capital accounts or other economic or legal arrangements among the partners.
The partnership agreement requires that allocations with respect to any property contributed to our Operating Partnership in exchange for OP units in a tax-deferred transaction be made in a manner consistent with Section 704(c) of the Internal Revenue Code. As a result, any gain recognized on the sale of any such properties would generally be allocated to the partner who contributed the property to our Operating Partnership to the extent of the book-tax difference at the time of such contribution. As a result, in the event that any such properties are sold, the partner who contributed such assets to our Operating Partnership or, in certain cases, a successor to such partner, which may include us, could be allocated gain in excess of its corresponding book gain (or taxable loss that is less than such person's corresponding economic or book loss), with a corresponding benefit to the partners who did not contribute such assets to our Operating Partnership.
Prior to this offering, we were treated as contributing assets to our Operating Partnership in exchange for OP units for U.S. federal income tax purposes, and therefore we are subject to the allocation provisions described above to the extent of any book-tax difference in our assets at the time of such contribution. These allocation provisions could result in us having taxable income that is in excess of our economic or book income as well as our cash distributions from our Operating Partnership, which might adversely affect our ability to comply with the REIT distribution requirements or result in a greater portion of our distributions being treated as taxable dividend income.
Failure to Qualify
In the event that we violate a provision of the Internal Revenue Code that would result in our failure to qualify as a REIT, we may nevertheless continue to qualify as a REIT under
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specified relief provisions available to us to avoid such disqualification if (1) the violation is due to reasonable cause and not due to willful neglect, (2) we pay a penalty of $50,000 for each failure to satisfy a requirement for qualification as a REIT and (3) the violation does not include a violation under the gross income or asset tests described above (for which other specified relief provisions are available). This cure provision reduces the instances that could lead to our disqualification as a REIT for violations due to reasonable cause. If we fail to qualify for taxation as a REIT in any taxable year and none of the relief provisions of the Internal Revenue Code apply, we will be subject to tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates. Distributions to our stockholders in any year in which we are not a REIT will not be deductible by us, nor will they be required to be made. In this situation, to the extent of current or accumulated earnings and profits, and, subject to limitations of the Internal Revenue Code, distributions to our stockholders will generally be taxable in the case of U.S. stockholders (as defined above) who are individuals at a maximum rate of 20%, and dividends in the hands of our corporate U.S. stockholders may be eligible for the dividends received deduction. Unless we are entitled to relief under the specific statutory provisions, we will also be disqualified from re-electing to be taxed as a REIT for the four taxable years following a year during which qualification was lost. It is not possible to state whether, in all circumstances, we will be entitled to statutory relief.
Taxation of Taxable U.S. Stockholders
This section summarizes the taxation of U.S. stockholders that are not tax exempt organizations. If an entity or arrangement treated as a partnership for U.S. federal income tax purposes holds our stock, the U.S. federal income tax treatment of a partner generally will depend upon the status of the partner and the activities of the partnership. A partner of a partnership holding our common stock should consult its own tax advisor regarding the U.S. federal income tax consequences to the partner of the acquisition, ownership and disposition of our stock by the partnership.
Distributions
Provided that we qualify as a REIT, distributions made to our taxable U.S. stockholders out of our current or accumulated earnings and profits, and not designated as capital gain dividends, will generally be taken into account by them as ordinary dividend income and will not be eligible for the dividends received deduction for corporations. In determining the extent to which a distribution with respect to our common stock constitutes a dividend for U.S. federal income tax purposes, our earnings and profits will be allocated first to distributions with respect to our preferred stock, if any, and then to our common stock. Dividends received from REITs are generally not eligible to be taxed at the preferential qualified dividend income rates applicable to individual U.S. stockholders who receive dividends from taxable subchapter C corporations. As discussed above, if we realize excess inclusion income and allocate it to a taxable U.S. stockholder, this income cannot be offset by net operating losses of such stockholder.
In addition, distributions from us that are designated as capital gain dividends will be taxed to U.S. stockholders as long-term capital gains, to the extent that they do not exceed the actual net capital gain of our company for the taxable year, without regard to the period for which the U.S. stockholder has held our stock. To the extent that we elect under the applicable provisions of the Internal Revenue Code to retain our net capital gains, U.S. stockholders will be treated as having received, for U.S. federal income tax purposes, our undistributed capital gains as well as a corresponding credit or refund, as the case may be, for taxes paid by us on such retained capital gains. U.S. stockholders will increase their
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adjusted tax basis in our common stock by the difference between their allocable share of such retained capital gain and their share of the tax paid by us. Corporate U.S. stockholders may be required to treat up to 20% of some capital gain dividends as ordinary income. Long-term capital gains are generally taxable at maximum U.S. federal rates of 20% in the case of U.S. stockholders who are individuals for taxable years beginning after December 31, 2012, and 35% for corporations. Capital gains attributable to the sale of depreciable real property held for more than 12 months are subject to a 25% maximum U.S. federal income tax rate for U.S. stockholders who are individuals, to the extent of previously claimed depreciation deductions.
Distributions from us in excess of our current or accumulated earnings and profits will not be taxable to a U.S. stockholder to the extent that they do not exceed the adjusted tax basis of the U.S. stockholder's shares of our common stock in respect of which the distributions were made, but rather will reduce the adjusted tax basis of these shares. To the extent that such distributions exceed the adjusted tax basis of a U.S. stockholder's shares of our common stock, they will be included in income as long-term capital gain, or short-term capital gain if the shares have been held for one year or less. In addition, any dividend declared by us in October, November or December of any year and payable to a U.S. stockholder of record on a specified date in any such month will be treated as both paid by us and received by the U.S. stockholder on December 31 of such year, provided that the dividend is actually paid by us before the end of January of the following calendar year.
With respect to U.S. stockholders who are taxed at the rates applicable to individuals, we may elect to designate a portion of our distributions paid to such U.S. stockholders as "qualified dividend income." A portion of a distribution that is properly designated as qualified dividend income is taxable to non corporate U.S. stockholders as capital gain, provided that the U.S. stockholder has held the common stock with respect to which the distribution is made for more than 60 days during the 121 day period beginning on the date that is 60 days before the date on which such common stock became ex dividend with respect to the relevant distribution. The maximum amount of our distributions eligible to be designated as qualified dividend income for a taxable year is equal to the sum of:
(i) the qualified dividend income received by us during such taxable year from non REIT C corporations (including ZAIS I TRS and any other TRS in which we may own an interest);
(ii) the excess of any "undistributed" REIT taxable income recognized during the immediately preceding year over the U.S. federal income tax paid by us with respect to such undistributed REIT taxable income; and
(iii) the excess of any income recognized during the immediately preceding year attributable to the sale of a built-in gain asset that was acquired in a carry over basis transaction from a non REIT C corporation over the U.S. federal income tax paid by us with respect to such built in gain.
Generally, dividends that we receive will be treated as qualified dividend income for purposes of (i) above if the dividends are received from a domestic C corporation (other than a REIT or a RIC), ZAIS I TRS and any other TRS we may form, or a "qualified foreign corporation" and specified holding period requirements and other requirements are met.
To the extent that we have available net operating losses and capital losses carried forward from prior tax years, such losses may reduce the amount of distributions that must be made in order to comply with the REIT distribution requirements. See "Taxation of Our Company" and "Annual Distribution Requirements." Such losses, however, are not passed through to U.S. stockholders and do not offset income of U.S. stockholders from other
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sources, nor do they affect the character of any distributions that are actually made by us, which are generally subject to tax in the hands of U.S. stockholders to the extent that we have current or accumulated earnings and profits.
Dispositions of Our Common Stock
In general, a U.S. stockholder will realize gain or loss upon the sale, redemption or other taxable disposition of our common stock in an amount equal to the difference between the sum of the fair market value of any property and the amount of cash received in such disposition and the U.S. stockholder's adjusted tax basis in the common stock at the time of the disposition. In general, a U.S. stockholder's adjusted tax basis will equal the U.S. stockholder's acquisition cost, increased by the excess of net capital gains deemed distributed to the U.S. stockholder (discussed above) less tax deemed paid on it and reduced by returns of capital. In general, capital gains recognized by individuals and other non-corporate U.S. stockholders upon the sale or disposition of shares of our common stock will be subject to a maximum U.S. federal income tax rate of 20% for taxable years beginning after December 31, 2012, if such shares were held for more than 12 months, and will be taxed at ordinary income rates (of up to 39.6% with respect to taxable years beginning after December 31, 2012) if such shares were held for 12 months or less. Gains recognized by U.S. stockholders that are corporations are subject to U.S. federal income tax at a maximum rate of 35%, whether or not classified as long-term capital gains. The IRS has the authority to prescribe, but has not yet prescribed, regulations that would apply a capital gain tax rate of 25% (which is generally higher than the long-term capital gain tax rates for non-corporate holders) to a portion of capital gain realized by a non-corporate holder on the sale of REIT stock or depositary shares that would correspond to the REIT's "unrecaptured Section 1250 gain."
Holders are advised to consult with their tax advisors with respect to their capital gain tax liability. Capital losses recognized by a U.S. stockholder upon the disposition of our common stock held for more than one year at the time of disposition will be considered long-term capital losses, and are generally available only to offset capital gain income of the U.S. stockholder but not ordinary income (except in the case of individuals, who may offset up to $3,000 of ordinary income each year). In addition, any loss upon a sale or exchange of shares of our common stock by a U.S. stockholder who has held the shares for six months or less, after applying holding period rules, will be treated as a long-term capital loss to the extent of distributions received from us that were required to be treated by the U.S. stockholder as long-term capital gain.
Passive Activity Losses and Investment Interest Limitations
Distributions made by us and gain arising from the sale or exchange by a U.S. stockholder of our common stock will not be treated as passive activity income. As a result, U.S. stockholders will not be able to apply any "passive losses" against income or gain relating to our common stock. Distributions made by us, to the extent they do not constitute a return of capital, generally will be treated as investment income for purposes of computing the investment interest limitation. A U.S. stockholder that elects to treat capital gain dividends, qualified dividend income or capital gains from the disposition of stock as investment income for purposes of the investment interest limitation will be taxed at ordinary income rates on such amounts.
Medicare tax on unearned income
Recently enacted legislation requires certain U.S. stockholders that are individuals, estates or trusts to pay an additional 3.8% tax on, among other things, dividends on and capital gains from the sale or other disposition of stock for taxable years beginning after December 31,
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2012. U.S. stockholders should consult their tax advisors regarding the effect, if any, of this legislation on their ownership and disposition of our common stock.
Foreign Accounts
Under recently enacted legislation, dividends made after December 31, 2013, and gross proceeds from the sale or other disposition of our common stock paid after December 31, 2016, to "foreign financial institutions" in respect of accounts of U.S. stockholders at such financial institutions may be subject to withholding at a rate of 30%. U.S. stockholders should consult their tax advisors regarding the effect, if any, of this new legislation on their ownership and disposition of our common stock.
Taxation of Tax Exempt U.S. Stockholders
U.S. tax exempt entities, including qualified employee pension and profit sharing trusts and individual retirement accounts, generally are exempt from U.S. federal income taxation. However, they are subject to taxation on their UBTI. While many investments in real estate may generate UBTI, the IRS has ruled that regular distributions from a REIT to a tax exempt entity do not constitute UBTI. Based on that ruling, and provided that (1) a tax exempt U.S. stockholder has not held our common stock as "debt financed property" within the meaning of the Internal Revenue Code (that is, where the acquisition or holding of the property is financed through a borrowing by the tax exempt stockholder), (2) our common stock is not otherwise used in an unrelated trade or business and (3) we do not hold an asset that gives rise to "excess inclusion income," (see "Excess Inclusion Income") distributions from us and income from the sale of our common stock generally should not give rise to UBTI to a tax exempt U.S. stockholder. As previously noted, we may engage in transactions that would result in a portion of our dividend income being considered "excess inclusion income" and, accordingly, it is possible that a portion of our dividends received by a tax-exempt stockholder may be treated as UBTI.
Tax exempt U.S. stockholders that are social clubs, voluntary employee benefit associations, supplemental unemployment benefit trusts, and qualified group legal services plans exempt from U.S. federal income taxation under Sections 501(c)(7), (c)(9), (c)(17) and (c)(20) of the Internal Revenue Code, respectively, are subject to different UBTI rules, which generally will require them to characterize distributions from us as UBTI.
In certain circumstances, a pension trust (1) that is described in Section 401(a) of the Internal Revenue Code, (2) is tax exempt under Section 501(a) of the Internal Revenue Code, and (3) that owns more than 10% of our stock could be required to treat a percentage of the dividends from us as UBTI if it is a "pension-held REIT." We will not be a pension-held REIT unless (1) either (A) one pension trust owns more than 25% of the value of our stock, or (B) a group of pension trusts, each individually holding more than 10% of the value of our stock, collectively owns more than 50% of such stock; and (2) we would not have qualified as a REIT but for the fact that Section 856(h)(3) of the Internal Revenue Code provides that stock owned by such trusts shall be treated, for purposes of the requirement that not more than 50% of the value of the outstanding stock of a REIT is owned, directly or indirectly, by five or fewer "individuals" (as defined in the Internal Revenue Code to include certain entities), as owned by the beneficiaries of such trusts. Certain restrictions relating to the ownership and transfer of our stock should generally prevent a U.S. tax exempt entity from owning more than 10% of the value of our stock, or us from becoming a pension-held REIT.
Tax exempt U.S. stockholders are urged to consult their tax advisors regarding the U.S. federal, state, local and foreign tax consequences of owning our stock.
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Taxation of Non-U.S. Stockholders
The following is a summary of certain U.S. federal income tax consequences of the acquisition, ownership and disposition of our common stock applicable to non-U.S. stockholders of our common stock. The discussion is based on current law and is for general information only. It addresses only selective and not all aspects of U.S. federal income taxation. Non-U.S. Stockholders should consult their tax advisors concerning the U.S. federal estate tax consequences of ownership of our common stock.
For most non-U.S. persons, an investment in a REIT that invests principally in mortgage loans and RMBS is not the most tax-efficient way to invest in such assets. That is because receiving distributions of income derived from such assets in the form of REIT dividends subjects most non-U.S. persons to withholding taxes that direct investment in those asset classes, and the direct receipt of interest and principal payments with respect to them, would not. The principal exceptions are foreign sovereigns and their agencies and instrumentalities, which may be exempt from withholding taxes on REIT dividends under the Internal Revenue Code, and certain foreign pension funds or similar entities able to claim an exemption from withholding taxes on REIT dividends under the terms of a bilateral tax treaty between their country of residence and the United States.
Ordinary Dividends
The portion of dividends received by non-U.S. stockholders payable out of our earnings and profits that are not attributable to gains from sales or exchanges of U.S. real property interests and which are not effectively connected with a U.S. trade or business of the non-U.S. stockholder will generally be subject to U.S. federal withholding tax at the rate of 30%, unless reduced or eliminated by an applicable income tax treaty. Under some treaties, however, lower rates generally applicable to dividends do not apply to dividends from REITs. In addition, any portion of the dividends paid to non-U.S. stockholders that are treated as excess inclusion income will not be eligible for exemption from the 30% withholding tax or a reduced treaty rate. As previously noted, we may engage in transactions that could result in a portion of our dividends being considered excess inclusion income, and accordingly, a portion of our dividend income may not be eligible for exemption from the 30% withholding rate or a reduced treaty rate. In the case of a taxable stock dividend with respect to which any withholding tax is imposed on a non-U.S. stockholder, we may have to withhold or dispose of part of the shares otherwise distributable in such dividend and use such withheld shares or the proceeds of such disposition to satisfy the withholding tax imposed.
In general, non-U.S. stockholders will not be considered to be engaged in a U.S. trade or business solely as a result of their ownership of our stock. In cases where the dividend income from a non-U.S. stockholder's investment in our common stock is, or is treated as, effectively connected with the non-U.S. stockholder's conduct of a U.S. trade or business, the non-U.S. stockholder generally will be subject to U.S. federal income tax at graduated rates, in the same manner as U.S. stockholders are taxed with respect to such dividends, and may also be subject to the 30% branch profits tax on the income after the application of the income tax in the case of a non-U.S. stockholder that is a corporation. In addition, we may have to withhold or dispose of part of the shares otherwise distributable in such dividend and use such withheld shares or the proceeds of such disposition to satisfy the withholding tax imposed.
Non-Dividend Distributions
Unless (1) our common stock constitutes a U.S. real property interest (or USRPI) or (2) either (A) the non-U.S. stockholder's investment in our common stock is effectively
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connected with a U.S. trade or business conducted by such non-U.S. stockholder (in which case the non-U.S. stockholder will be subject to the same treatment as U.S. stockholders with respect to such gain) or (B) the non-U.S. stockholder is a nonresident alien individual who was present in the U.S. for 183 days or more during the taxable year and has a "tax home" in the U.S. (in which case the non-U.S. stockholder will be subject to a 30% tax on the individual's net capital gain for the year), distributions by us which are not dividends out of our earnings and profits will not be subject to U.S. federal income tax. If it cannot be determined at the time at which a distribution is made whether or not the distribution will exceed current or accumulated earnings and profits, the distribution will be subject to withholding at the rate applicable to dividends. However, the non-U.S. stockholder may seek a refund from the IRS of any amounts withheld if it is subsequently determined that the distribution was, in fact, in excess of our current or accumulated earnings and profits. If our common stock constitutes a USRPI, as described below, distributions by us in excess of the sum of our earnings and profits plus the non-U.S. stockholder's adjusted tax basis in our common stock will be taxed under the Foreign Investment in Real Property Tax Act of 1980 (or FIRPTA) at the rate of tax, including any applicable capital gains rates, that would apply to a U.S. stockholder of the same type (such as, an individual or a corporation, as the case may be), and the collection of the tax will be enforced by a refundable withholding at a rate of 10% of the amount by which the distribution exceeds the stockholder's share of our earnings and profits.
Capital Gain Dividends
Under FIRPTA, a distribution made by us to a non-U.S. stockholder, to the extent attributable to gains from dispositions of USRPIs held by us directly or through pass-through subsidiaries (or USRPI capital gains), will be considered effectively connected with a U.S. trade or business of the non-U.S. stockholder and will be subject to U.S. federal income tax at the rates applicable to U.S. stockholders, without regard to whether the distribution is designated as a capital gain dividend. In addition, we will be required to withhold tax equal to 35% of the amount of capital gain dividends to the extent the dividends constitute USRPI capital gains. Distributions subject to FIRPTA may also be subject to a 30% branch profits tax in the hands of a non-U.S. holder that is a corporation. However, the 35% withholding tax will not apply to any capital gain dividend with respect to any class of our stock which is regularly traded on an established securities market located in the U.S. if the non-U.S. stockholder did not own more than 5% of such class of stock at any time during the one year period ending on the date of such dividend. Instead any capital gain dividend will be treated as a distribution subject to the rules discussed above under "Ordinary Dividends." Also, the branch profits tax will not apply to such a distribution. We anticipate that our common stock will be regularly traded on an established securities market in the United States immediately following this offering.
A distribution is not a USRPI capital gain if we held the underlying asset solely as a creditor, although the holding of a shared appreciation mortgage loan would not be solely as a creditor. Capital gain dividends received by a non-U.S. stockholder from a REIT that are not USRPI capital gains are generally not subject to U.S. federal income or withholding tax, unless either (1) the non-U.S. stockholder's investment in our common stock is effectively connected with a U.S. trade or business conducted by such non-U.S. stockholder (in which case the non-U.S. stockholder will be subject to the same treatment as U.S. stockholders with respect to such gain) or (2) the non-U.S. stockholder is a nonresident alien individual who was present in the U.S. for 183 days or more during the taxable year and has a "tax home" in the U.S. (in which case the non-U.S. stockholder will be subject to a 30% tax on the individual's net capital gain for the year).
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Dispositions of Our Common Stock
Unless our common stock constitutes a USRPI, a sale of the stock by a non-U.S. stockholder generally will not be subject to U.S. federal income taxation under FIRPTA. The stock will not be treated as a USRPI if less than 50% of our assets throughout a prescribed testing period consist of interests in real property located within the U.S., excluding, for this purpose, interests in real property solely in a capacity as a creditor. We do not expect that 50% or more of our assets will consist of interests in real property located in the U.S.
Even if our shares of common stock otherwise would be a USRPI under the foregoing test, our shares of common stock will not constitute a USRPI if we are a "domestically controlled REIT." A domestically controlled REIT is a REIT in which, at all times during a specified testing period (generally the lesser of the five year period ending on the date of disposition of the REIT's shares of common stock or the period of the REIT's existence), less than 50% in value of its outstanding shares of common stock is held directly or indirectly by non-U.S. stockholders. We may be a domestically controlled REIT, in which case the sale of our common stock would not be subject to taxation under FIRPTA. However, because our stock is expected to be widely held, we cannot assure investors that we will be a domestically controlled REIT. Even if we do not qualify as a domestically controlled REIT, a non-U.S. stockholder's sale of our common stock nonetheless will generally not be subject to tax under FIRPTA as a sale of a USRPI, provided that (1) our common stock owned is of a class that is "regularly traded," as defined by the applicable Treasury Regulation, on an established securities market, and (2) the selling non-U.S. stockholder owned, actually or constructively, 5% or less of our outstanding stock of that class at all times during a specified testing period. We anticipate that our common stock will be regularly traded on an established securities market in the United States immediately following this offering.
If gain on the sale of our common stock were subject to taxation under FIRPTA, the non-U.S. stockholder would be subject to the same treatment as a U.S. stockholder with respect to such gain, subject to applicable alternative minimum tax and a special alternative minimum tax in the case of non-resident alien individuals, and the purchaser of the stock could be required to withhold 10% of the purchase price and remit such amount to the IRS.
Gain from the sale of our common stock that would not otherwise be subject to FIRPTA will nonetheless be taxable in the U.S. to a non-U.S. stockholder in two cases: (1) if the non-U.S. stockholder's investment in our common stock is effectively connected with a U.S. trade or business conducted by such non-U.S. stockholder, the non-U.S. stockholder will be subject to the same treatment as a U.S. stockholder with respect to such gain, or (2) if the non-U.S. stockholder is a nonresident alien individual who was present in the U.S. for 183 days or more during the taxable year and has a "tax home" in the U.S., the nonresident alien individual will be subject to a 30% tax on the individual's net capital gain.
Backup Withholding and Information Reporting
We will report to our U.S. stockholders and the IRS the amount of dividends paid during each calendar year and the amount of any tax withheld. Under the backup withholding rules, a U.S. stockholder may be subject to backup withholding with respect to dividends paid unless the holder is a corporation or comes within other exempt categories and, when required, demonstrates this fact or provides a taxpayer identification number or social security number, certifies as to no loss of exemption from backup withholding and otherwise complies with applicable requirements of the backup withholding rules. A U.S. stockholder that does not provide his or her correct taxpayer identification number or social security number may also be subject to penalties imposed by the IRS. Backup withholding is not an additional tax.
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In addition, we may be required to withhold a portion of capital gain distribution to any U.S. stockholder who fails to certify their non-foreign status.
We must report annually to the IRS and to each non-U.S. stockholder the amount of dividends paid to such holder and the tax withheld with respect to such dividends, regardless of whether withholding was required. Copies of the information returns reporting such dividends and withholding may also be made available to the tax authorities in the country in which the non-U.S. stockholder resides under the provisions of an applicable income tax treaty. A non-U.S. stockholder may be subject to backup withholding unless applicable certification requirements are met.
Payment of the proceeds of a sale of our common stock within the U.S. is subject to both backup withholding and information reporting unless the beneficial owner certifies under penalties of perjury that it is a non-U.S. stockholder (and the payor does not have actual knowledge or reason to know that the beneficial owner is a U.S. person) or the holder otherwise establishes an exemption. Payment of the proceeds of a sale of our common stock conducted through certain U.S. related financial intermediaries is subject to information reporting (but not backup withholding) unless the financial intermediary has documentary evidence in its records that the beneficial owner is a non-U.S. stockholder and specified conditions are met or an exemption is otherwise established.
Backup withholding is not an additional tax. Any amounts withheld under the backup withholding rules may be allowed as a refund or a credit against such holder's U.S. federal income tax liability provided the required information is timely furnished to the IRS.
Foreign Accounts
Federal legislation may, pursuant to proposed Treasury Regulations and other guidance, impose withholding taxes on U.S. source payments made after December 31, 2013 to "foreign financial institutions" and certain other non-U.S. entities and on disposition proceeds of U.S. securities realized after December 31, 2016. Under this legislation, the failure to comply with additional certification, information reporting and other specified requirements could result in withholding tax being imposed on payments of dividends and sales proceeds to U.S. stockholders (as defined in above) who own shares of our common stock through foreign accounts or foreign intermediaries and certain non-U.S. stockholders. The legislation imposes a 30% withholding tax on dividends on, and gross proceeds from the sale or other disposition of, our common stock paid to a foreign financial institution or to a foreign entity other than a financial institution, unless (i) the foreign financial institution undertakes certain diligence and reporting obligations or (ii) the foreign entity is not a financial institution and either certifies it does not have any substantial United States owners or furnishes identifying information regarding each substantial United States owner. If the payee is a foreign financial institution, it must enter into an agreement with the United States Treasury requiring, among other things, that it undertake to identify accounts held by certain United States persons or United States-owned foreign entities, annually report certain information about such accounts, and withhold 30% on payments to account holders whose actions prevent it from complying with these reporting and other requirements. The proposed regulations and other guidance relating to this legislation will not be effective until reflected in final regulations. There can be no assurance either as to when these final regulations will be issued or as to the particular form that those final regulations might take. Prospective investors should consult their tax advisors regarding this legislation.
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Tax Shelter Regulations
In certain circumstances, a holder of common stock who disposes of an interest in a transaction resulting in the recognition by such common stock of significant losses in excess of certain threshold amounts may be obligated to disclose its participation in such transaction (or a reportable transaction) in accordance with recently issued regulations governing tax shelters and other potentially tax-motivated transactions (or the Tax Shelter Regulations). Holders should consult their tax advisors concerning any possible disclosure obligation under the Tax Shelter Regulations with respect to the disposition of common stock.
State, Local and Foreign Taxes
We and our stockholders may be subject to state, local or foreign taxation in various jurisdictions, including those in which it or they transact business, own property or reside. The state, local or foreign tax treatment of our Company and our stockholders may not conform to the U.S. federal income tax treatment discussed above. Any foreign taxes incurred by us would not pass through to stockholders as a credit against their U.S. federal income tax liability. Prospective stockholders should consult their tax advisors regarding the application and effect of state, local and foreign income and other tax laws on an investment in our common stock.
Legislative or Other Actions Affecting REITs
The rules dealing with U.S. federal income taxation are constantly under review by persons involved in the legislative process and by the IRS and the U.S. Department of the Treasury. No assurance can be given as to whether, when, or in what form, U.S. federal income tax laws applicable to us and our stockholders may be enacted. Changes to the U.S. federal income tax laws and interpretations of U.S. federal income tax laws could adversely affect an investment in our shares of common stock.
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A fiduciary of a pension, profit sharing, retirement or other employee benefit plan (or plan), subject to the Employee Retirement Income Security Act of 1974, as amended (or ERISA), should consider the fiduciary standards under ERISA in the context of the plan's particular circumstances before authorizing an investment of a portion of such plan's assets in the shares of common stock. Accordingly, among other things, such fiduciary should consider (i) whether the investment satisfies the diversification requirements of Section 404(a)(1)(C) of ERISA, (ii) whether the investment is in accordance with the documents and instruments governing the plan as required by Section 404(a)(1)(D) of ERISA, and (iii) whether the investment is prudent under ERISA. In addition to the imposition of general fiduciary standards of investment prudence and diversification, ERISA, and the corresponding provisions of the Internal Revenue Code, prohibit a wide range of transactions involving the assets of the plan and persons who have certain specified relationships to the plan ("parties in interest" within the meaning of ERISA, "disqualified persons" within the meaning of the Internal Revenue Code). A party in interest or disqualified person who engages in a prohibited transaction may be subject to excise taxes and other penalties and liabilities under ERISA and the Code. In addition, the fiduciary of the plan that is engaged in such a non-exempt prohibited transaction may be subject to penalties under ERISA and the Code. Thus, a plan fiduciary considering an investment in the shares of common stock also should consider whether the acquisition or the continued holding of the shares of common stock might constitute or give rise to a direct or indirect prohibited transaction that is not subject to an exemption issued by the Department of Labor (or the DOL).
The DOL has issued final regulations (or the DOL Regulations) as to what constitutes assets of an employee benefit plan under ERISA. Under the DOL Regulations, if a plan acquires an equity interest in an entity, which interest is neither a "publicly offered security" nor a security issued by an investment company registered under the 1940 Act, the plan's assets would include, for example, for purposes of the fiduciary responsibility provision of ERISA, both the equity interest and an undivided interest in each of the entity's underlying assets unless certain specified exceptions apply. The DOL Regulations define a publicly offered security as a security that is "widely held," "freely transferable," and either part of a class of securities registered under the Exchange Act, or sold pursuant to an effective registration statement under the Securities Act (provided the securities are registered under the Exchange Act within 120 days after the end of the fiscal year of the issuer during which the public offering occurred). The shares of common stock are being sold in an offering registered under the Securities Act and will be registered under the Exchange Act.
The DOL Regulations provide that a security is "widely held" only if it is part of a class of securities that is owned by 100 or more investors independent of the issuer and of one another. A security will not fail to be "widely held" because the number of independent investors falls below 100 subsequent to the initial public offering as a result of events beyond the issuer's control. We expect the common stock to be "widely held" upon completion of the initial public offering.
The DOL Regulations provide that whether a security is "freely transferable" is a factual question to be determined on the basis of all relevant facts and circumstances. The DOL Regulations further provide that when a security is part of an offering in which the minimum investment is $10,000 or less, as is the case with this offering, certain restrictions ordinarily will not, alone or in combination, affect the finding that such securities are "freely transferable." We believe that the restrictions imposed under our charter on the transfer of our common stock are limited to the restrictions on transfer generally permitted under the DOL Regulations and are not likely to result in the failure of common stock to be "freely
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transferable." The DOL Regulations only establish a presumption in favor of the finding of free transferability, and, therefore, no assurance can be given that the DOL will not reach a contrary conclusion.
Assuming that the common stock will be "widely held" and "freely transferable," we believe that our common stock will be publicly offered securities for purposes of the DOL Regulations and that our assets will not be deemed to be "plan assets" of any plan that invests in our common stock.
Certain individuals, including us, ZAIS, our Advisor, and any of their respective affiliates may be parties in interest and disqualified persons with respect to plans subject to ERISA or the Code. Prohibited transactions within the meaning of Section 406 of ERISA or Section 4975 of the Code may arise if common stock is acquired or held by a plan with respect to which we, ZAIS, our Advisor or any of their respective affiliates, is a party in interest or a disqualified person. Certain exemptions from the prohibited transaction provisions of Section 406 of ERISA and Section 4975 of the Code may be applicable, however, in certain cases, depending in part on the type of plan fiduciary making the decision to acquire the common stock and the circumstances under which such decision is made. Accordingly, each holder of our common stock will be deemed to have represented and agreed that its purchase and holding of such common stock (or any interest therein) will not constitute or result in a non exempt prohibited transaction under ERISA or Section 4975 of the Internal Revenue Code.
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Subject to the terms and conditions of the underwriting agreement, the underwriters named below, through their representatives Deutsche Bank Securities Inc., Citigroup Global Markets Inc., Barclays Capital Inc. and Credit Suisse Securities (USA) LLC, have severally agreed to purchase from us the following respective number of shares of common stock at a public offering price less the underwriting fee set forth on the cover page of this prospectus:
Underwriters
|
Number of
Shares |
|
---|---|---|
Deutsche Bank Securities Inc. |
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Citigroup Global Markets Inc. |
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Barclays Capital Inc. |
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Credit Suisse Securities (USA) LLC |
||
Stifel, Nicolaus & Company, Incorporated |
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Oppenheimer & Co. |
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Ladenburg Thalmann & Co. Inc. |
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Total |
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The underwriting agreement provides that the obligations of the several underwriters to purchase the shares of common stock offered hereby are subject to certain conditions precedent and that the underwriters will purchase all of the shares of common stock offered by this prospectus, other than those covered by the option to purchase additional shares described below, if any of these shares are purchased. The underwriting agreement also provides that if an underwriter defaults, the purchase commitments of non-defaulting underwriters may also be increased or this offering may be terminated.
We and our Advisor have agreed to indemnify the underwriters against some specified types of liabilities, including liabilities under the Securities Act, and to contribute to payments the underwriters may be required to make in respect of any of these liabilities.
The underwriters are offering the shares, subject to prior sale, when, as and if issued to and accepted by them, subject to approval of legal matters by their counsel, including the validity of the shares, and other conditions contained in the underwriting agreement, such as the receipt by the underwriters of officer's certificates and legal opinions. The underwriters reserve the right to withdraw, cancel or modify offers to the public and to reject orders in whole or in part.
Underwriting Fee
We have been advised by the representatives of the underwriters that the underwriters propose to offer the shares of common stock to the public at the public offering price set forth on the cover of this prospectus and to dealers at a price that represents a concession not in excess of $ per share under the public offering price. The underwriters may allow, and these dealers may re-allow, a concession of not more than $ per share to other dealers. After the initial public offering, the representatives of the underwriters may change the offering price and other selling terms. This offering of the shares of common stock by the underwriters is subject to receipt and acceptance and subject to the underwriters' right to reject any order in whole or in part.
The underwriting fee per share, which will be paid by our Advisor, is equal to $ or % of the initial public offering price. Our Advisor has agreed to pay the underwriters the
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following underwriting fee, assuming either no exercise or full exercise by the underwriters of the underwriters' option to purchase additional shares:
|
|
Total Fees | ||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
Per Share |
Without Exercise of
Option to Purchase Additional Shares |
With Full Exercise of
Option of Purchase Additional Shares |
|||||||
Underwriting fee paid by our Advisor |
$ | $ | $ |
In addition, we estimate that our share of the total expenses of this offering, excluding the underwriting fee, will be $ . We have agreed with the underwriters to pay all fees and expenses related to the review and qualification of this offering by the Financial Industry Regulatory Authority, Inc. and "blue sky" expenses and the cost of any aircraft chartered in connection with the road show for this offering. The underwriting fee incurred in this offering will be paid by our Advisor. Our Advisor has also agreed to pay any expenses in connection with this offering in excess of $1.2 million. We will not be obligated to repay our Advisor for any of these costs.
Option to Purchase Additional Shares
We have granted to the underwriters an option, exercisable not later than 30 days after the date of this prospectus, to purchase up to additional shares of common stock at the public offering price less the underwriting fee set forth on the cover page of this prospectus. To the extent that the underwriters exercise this option, each of the underwriters will become obligated, subject to conditions, to purchase the same percentage of these additional shares of common stock as the number of shares of common stock to be purchased by it in the above table bears to the total number of shares of common stock offered by this prospectus. We will be obligated, pursuant to the option, to sell these additional shares of common stock to the underwriters to the extent the option is exercised. If any additional shares of common stock are purchased, the underwriters will offer the additional shares on the same terms as those on which the initial shares referred to in the above table are being offered.
No Sales of Similar Securities
Holders of 92.3% of our outstanding shares of common stock and OP units, after giving effect to the 2013 repurchase described elsewhere in this prospectus, have agreed with ZAIS, as the managing member of our Advisor, not to, directly or indirectly, sell, transfer, assign, mortgage, hypothecate, pledge or otherwise dispose of or encumber or permit or suffer any encumbrance of all or any part of the shares of our common stock or OP units acquired as part of the above formation transactions or subsequent purchases of such common stock or OP units, until 270 days following the completion of our listing without the prior written consent of ZAIS, subject to certain exceptions relating to private resales where the transferee continues to be bound by the lock-up agreement.
Additionally, each of our directors and executive officers and the ZAIS Parties who collectively own an aggregate of 510,047 shares of common stock and 33,658 OP units have agreed not to offer, sell, contract to sell or otherwise dispose of, or enter into any transaction that is designed to, or could be expected to, result in the disposition of any shares of our common stock that they may own or have the right to acquire or other securities convertible into or exchangeable or exercisable for our common stock (including OP units) prior to this offering for a period of 270 days after the effective date of the registration statement of which this prospectus is a part without the prior written consent of the representatives of the
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underwriters. This consent may be given at any time without public notice. Transfers or dispositions may be made during the lock-up period if any such transfer or disposition does not trigger any filing or reporting requirement or obligation or result in any other voluntary or mandatory public disclosure, including but not limited to Form 4 of Section 16 of the Exchange Act, and is by gift, will or intestacy, or distribution to partners, members or shareholders of the transferor, provided that the transferee agrees in writing to be bound by the restrictions set forth in the lock-up agreement. There are no agreements between the representatives and any of our stockholders or affiliates releasing them from these lock-up agreements prior to the expiration of the 270-day period. We and our Advisor have also entered into a similar agreement with the representatives of the underwriters.
Price Stabilization, Short Positions and Penalty Bids
In connection with this offering, the underwriters may purchase and sell shares of our common stock in the open market. These transactions may include short sales, purchases to cover positions created by short sales and stabilizing transactions. Short sales involve the sale by the underwriters of a greater number of shares than they are required to purchase in this offering. "Covered" short sales are sales made in an amount not greater than the underwriters' option to purchase additional shares of common stock from us in this offering. The underwriters may close out any covered short position by either exercising their option to purchase additional shares or purchasing shares in the open market. In determining the source of shares to close out the covered short position, the underwriters will consider, among other things, the price of shares available for purchase in the open market as compared to the price at which they may purchase additional shares of common stock pursuant to the option granted to them. "Naked" short sales are any sales in excess of such option. The underwriters must close out any naked short position by purchasing shares in the open market. A naked short position is more likely to be created if underwriters are concerned that there may be downward pressure on the price of the shares in the open market prior to the completion of this offering. Stabilizing transactions consist of various bids for or purchases of our common stock made by the underwriters in the open market prior to the completion of this offering.
The underwriters may also impose a penalty bid. This occurs when a particular underwriter repays to the other underwriters a portion of the underwriting discount received by it because the representatives of the underwriters have repurchased shares sold by or for the account of that underwriter in stabilizing or short covering transactions.
Purchases to cover a short position and stabilizing transactions may have the effect of preventing or slowing a decline in the market price of our common stock. Additionally, these purchases, along with the imposition of the penalty bid, may stabilize, maintain or otherwise affect the market price of our common stock. As a result, the price of our common stock may be higher than the price that might otherwise exist in the open market. These transactions may be effected on the NYSE, in the over-the-counter market or otherwise.
New York Stock Exchange Listing
We have applied to list our common stock for trading on the New York Stock Exchange under the symbol "ZFC". In order to meet the requirements for listing on that exchange, the underwriters have undertaken to sell a minimum number of shares to a minimum number of beneficial owners as required by that exchange.
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Pricing of this Offering
Prior to this offering, there has been no public market for our common stock. Consequently, the initial public offering price of our common stock will be determined by negotiation among us and the representatives of the underwriters. Among the primary factors that will be considered in determining the public offering price are:
An active trading market for the shares may not develop. It is also possible that after the offering the shares will not trade in the public market at or above the initial public offering price.
Electronic Offer, Sale and Distribution of Shares
In connection with this offering, certain of the underwriters or securities dealers may distribute prospectuses by electronic means, such as e-mail. In addition, Deutsche Bank Securities Inc. may facilitate Internet distribution for this offering to certain of its Internet subscription customers. Deutsche Bank Securities Inc. may allocate a limited number of shares for sale to its online brokerage customers. A prospectus in electronic format is being made available on Internet web sites maintained by one or more of the lead underwriters of this offering and may be made available on web sites maintained by other underwriters. Other than the prospectus in electronic format, the information on any underwriter's web site and any information contained in any other web site maintained by an underwriter is not part of the prospectus or the registration statement of which the prospectus forms a part.
Other Relationships
Some of the underwriters and their affiliates have engaged in, and may in the future engage in, investment banking and other commercial dealings in the ordinary course of business with us or our affiliates. They have received, or may in the future receive, customary fees and commissions for these transactions.
In addition, in the ordinary course of their business activities, the underwriters and their affiliates may make or hold a broad array of investments and actively trade debt and equity securities (or related derivative securities) and financial instruments (including bank loans) for their own account and for the accounts of their customers. Such investments and securities activities may involve securities and/or instruments of ours or our affiliates. The underwriters and their affiliates may also make investment recommendations and/or publish or express independent research views in respect of such securities or financial instruments and may hold, or recommend to clients that they acquire, long and/or short positions in such securities and instruments.
Barclays Capital Inc. and an affiliate of Credit Suisse Securities (USA) LLC are counterparties to master repurchase agreements with us.
228
Selling Restrictions
Notice to Prospective Investors in the European Economic Area
In relation to each Member State of the European Economic Area which has implemented the Prospectus Directive (each, a Relevant Member State), each underwriter has represented and agreed that with effect from and including the date on which the Prospectus Directive is implemented in that Relevant Member State (or the Relevant Implementation Date) it has not made and will not make an offer of shares to the public in that Relevant Member State prior to the publication of a prospectus in relation to the shares which has been approved by the competent authority in that Relevant Member State or, where appropriate, approved in another Relevant Member State and notified to the competent authority in that Relevant Member State, all in accordance with the Prospectus Directive, except that it may, with effect from and including the Relevant Implementation Date, make an offer of shares to the public in that Relevant Member State at any time:
For the purposes of this provision, the expression an "offer of shares to the public" in relation to any shares in any Relevant Member State means the communication in any form and by any means of sufficient information on the terms for the offer and the shares to be offered so as to enable an investor to decide to purchase or subscribe the shares, as the same may be varied in that Relevant Member State by any measure implementing the Prospectus Directive in that Relevant Member State, the expression Prospectus Directive means Directive 2003/71/EC (and amendments thereto, including the PD 2010 Amending Directive to the extent implemented in the Relevant Member State) and includes any relevant implementing measure in each Relevant Member State, and the expression 2010 PD Amending Directive means Directive 2010/73/EU.
Notice to Prospective Investors in the United Kingdom
This prospectus and any other material in relation to the shares described herein is only being distributed to, and is only directed at, persons in the United Kingdom that are qualified investors within the meaning of Article 2(1)(e) of the Prospective Directive (or qualified investors) that also (i) have professional experience in matters relating to investments falling within Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended, or the Order, (ii) who fall within Article 49(2)(a) to (d) of the Order or (iii) to whom it may otherwise lawfully be communicated (all such persons together being referred to as relevant persons). The shares are only available to, and any invitation, offer or agreement to purchase or otherwise acquire such shares will be engaged in only with, relevant persons. This prospectus and its contents are confidential and should not be distributed, published or reproduced (in whole or in part) or disclosed by recipients to any other person in the United Kingdom. Any person in the United Kingdom that is not a relevant person should not act or rely on this prospectus or any of its contents.
229
Certain legal matters relating to this offering will be passed upon for us by Clifford Chance US LLP, New York, New York. In addition, the description of U.S. federal income tax consequences contained in the section of the prospectus entitled "U.S. Federal Income Tax Considerations" is based on the opinion of Clifford Chance US LLP. Certain legal matters relating to this offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York.
Our consolidated financial statements as of December 31, 2011 and for the period from July 29, 2011 through December 31, 2011, appearing in this prospectus have been so included in reliance on the report (which contains an explanatory paragraph relating to the expected timing of the initial public offering as provided by the Exchange Offer Statement as described in Note 1 to the financial statements) of PricewaterhouseCoopers LLP, an independent registered public accounting firm, given on the authority of said firm as experts in auditing and accounting.
230
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the SEC a registration statement on Form S-11, including exhibits and schedules filed with the registration statement of which this prospectus is a part, under the Securities Act with respect to the shares of common stock to be sold in this offering. This prospectus does not contain all of the information set forth in the registration statement and exhibits and schedules to the registration statement. For further information with respect to us and the shares of common stock to be sold in this offering, reference is made to the registration statement, including the exhibits and schedules to the registration statement. Copies of the registration statement, including the exhibits and schedules to the registration statement, may be examined without charge at the public reference room of the SEC, 100 F Street, N.E., Room 1580, Washington, D.C. 20549. Information about the operation of the public reference room may be obtained by calling the SEC at 1 800 SEC 0300. Copies of all or a portion of the registration statement may be obtained from the public reference room of the SEC upon payment of prescribed fees. Our SEC filings, including our registration statement, are also available to you, free of charge, on the SEC's website at www.sec.gov.
As a result of this offering, we will become subject to the information and reporting requirements of the Exchange Act and will file periodic reports, proxy statements and will make available to our stockholders annual reports containing audited financial information for each year and quarterly reports for the first three quarters of each fiscal year containing unaudited interim financial information.
231
The following terms used in this prospectus have the meanings described below:
" ABS " means asset-backed securities.
" Agency RMBS " means RMBS assets for which a U.S. Government agency or federally chartered corporation guarantees payments of principal and interest on the securities.
" ARMs " means adjustable-rate mortgages.
" Basel III " means the new capital standards for major banking institutions published by the Group of Governors and Heads of Supervisors of the Basel Committee on Banking Supervision, the oversight body of the Basel Committee, which, when fully phased in on January 1, 2019, will require banking institutions to maintain heightened Tier 1 common equity, Tier 1 capital and total capital ratios, as well as maintain a "capital conservation buffer."
" CDO " means collateralized debt obligation.
" CDS " means credit default swap.
" Class B Interests " means Class B non-voting and non-transferable membership interests in our Advisor.
" CMBS " means commercial mortgage-backed securities.
" CMOs " means collateralized mortgage obligations.
" CPO " means a commodity pool operator.
" CPR " means the Constant Prepayment Rate.
" Cushion " means our cash, unpledged Agency RMBS and non-Agency RMBS and collateral in excess of margin requirements held by our counterparties.
" derivative contracts " means derivative contracts governed by the International Swaps and Derivatives Association, Inc.
" ERISA " means the Employee Retirement Income Security Act of 1974, as amended.
" Fannie Mae " means the Federal National Mortgage Association.
" FDIC " means the Federal Deposit Insurance Corporation.
" FHA " means the Federal Housing Authority.
" FHFA " means the U.S. Federal Housing Finance Agency.
" Freddie Mac " means the Federal Home Loan Mortgage Corporation.
" Ginnie Mae " means the Government National Mortgage Association.
" GSE " means a government-sponsored entity.
" HAMP " means the Home Affordable Modification Program.
" HARP " means the Home Affordable Refinance Program.
" HERA " means the Housing and Economic Recovery Act of 2008.
" H4H Program " means the Hope for Homeowners Program.
" IOs " means interest only strips created from residential mortgage-backed securities.
232
" MBS " means mortgage-backed securities.
" MSRs " means mortgage servicing rights.
" non-Agency RMBS " means residential mortgage loans and RMBS assets that are not issued or guaranteed by a U.S. Government agency or federally chartered corporation.
" OID " means original issue discount.
" performing residential whole loan " means a single residential mortgage that a lender has issued to a borrower, that has not been securitized, and that is being paid according to terms.
" plan " means a pension, profit sharing, retirement or other employee benefit plan subject to ERISA.
" REIT " means Real Estate Investment Trust.
" REMIC " means residual real estate mortgage investment conduit.
" re-performing residential whole loans " means a single residential mortgage that a lender has issued to a borrower, that has not been securitized, and on which the borrower was behind on payments (delinquent) by at least 90 days but has resumed making payments.
" RMBS " means residential mortgage-backed securities.
" TDR " means troubled debt restructuring.
" TSR " means taxable REIT subsidiaries.
" U.S. GAAP " means U.S. generally accepted accounting principles.
" UpREIT " means a traditional umbrella partnership real estate investment trust.
233
As of September 30, 2012 and December 31, 2011 and for the Nine Months Ended September 30, 2012 and the Period from July 29, 2011 (Inception) to September 30, 2011 (unaudited)
F-1
ZAIS Financial Corp. and Subsidiaries
Consolidated Balance Sheets
(Expressed in United States Dollars)
|
September 30, 2012 | December 31, 2011 | |||||
---|---|---|---|---|---|---|---|
|
(unaudited)
|
|
|||||
Assets |
|||||||
Cash |
$ | 15,265,259 | $ | 6,326,724 | |||
Restricted cash |
3,122,112 | 1,715,211 | |||||
Real estate securities, at fair value$137,536,229 and $115,589,035 pledged as collateral, respectively |
163,376,777 | 145,971,111 | |||||
Other assets |
569,200 | 92,148 | |||||
Total assets |
$ | 182,333,348 | $ | 154,105,194 | |||
Liabilities |
|||||||
Repurchase agreements |
$ | 110,128,912 | $ | 97,597,010 | |||
Common stock repurchase liability (1,183,560 common shares) |
25,103,308 | | |||||
Accounts payable and other liabilities |
1,242,071 | 871,060 | |||||
Preferred dividends payable |
4,618 | | |||||
Derivative instruments |
1,117,332 | 254,302 | |||||
Accrued interest payable |
63,513 | 64,948 | |||||
Total liabilities |
137,659,754 | 98,787,320 | |||||
Stockholders' Equity |
|||||||
12.5% Series A cumulative non-voting preferred stock, $0.0001 par value; 50,000,000 shares authorized; 133 shares and zero shares issued and outstanding, respectively |
| | |||||
Class A common stock $0.0001 par value; 500,000,000 shares authorized; 3,022,617 shares issued and 1,839,057 outstanding |
184 | 302 | |||||
Additional paid-in capital |
35,464,347 | 60,452,038 | |||||
Retained earnings/(accumulated deficit) |
9,209,063 | (5,134,466 | ) | ||||
Total stockholders' equity |
44,673,594 | 55,317,874 | |||||
Total liabilities and stockholders' equity |
$ | 182,333,348 | $ | 154,105,194 | |||
The accompanying notes are an integral part of these consolidated financial statements.
F-2
ZAIS Financial Corp. and Subsidiaries
Consolidated Statements of Operations
(Expressed in United States Dollars)
|
Nine Months Ended
September 30, 2012 |
Period from
July 29, 2011 (Inception) to September 30, 2011 |
|||||
---|---|---|---|---|---|---|---|
|
(unaudited)
|
(unaudited)
|
|||||
Interest income |
|||||||
Real estate securities |
$ | 7,100,418 | $ | 1,115,130 | |||
Total interest income |
7,100,418 | 1,115,130 | |||||
Interest expense |
|||||||
Repurchase agreements |
1,043,889 | 76,077 | |||||
Total interest expense |
1,043,889 | 76,077 | |||||
Net interest income |
6,056,529 | 1,039,053 | |||||
Other gain/(loss) |
|||||||
Change in unrealized gain/(loss) on real estate securities |
15,871,869 | (4,493,562 | ) | ||||
Realized loss on real estate securities |
(1,097,082 | ) | | ||||
Loss on derivative instruments |
(1,216,498 | ) | (36,739 | ) | |||
Total other gain/(loss) |
13,558,289 | (4,530,301 | ) | ||||
Expenses |
|||||||
Advisory feerelated party |
728,521 | 148,880 | |||||
Professional fees |
1,228,650 | 212,946 | |||||
General and administrative expenses |
37,962 | 725 | |||||
Total expenses |
1,995,133 | 362,551 | |||||
Net income/(loss) |
17,619,685 | (3,853,799 | ) | ||||
Preferred dividends |
11,730 | | |||||
Net income/(loss) applicable to common stockholders |
$ | 17,607,955 | $ | (3,853,799 | ) | ||
Net income/(loss) per share applicable to common stockholdersbasic and diluted |
$ | 6.01 | $ | (1.27 | ) | ||
Weighted average number of shares outstandingbasic and diluted |
2,930,421 | 3,022,617 |
The accompanying notes are an integral part of these consolidated financial statements.
F-3
ZAIS Financial Corp. and Subsidiaries
Consolidated Statements of Stockholders' Equity
(Expressed in United States Dollars)
|
Preferred Stock | Common Stock |
|
|
|
|||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
|
(Accumulated
Deficit)/ Retained Earnings |
Total ZAIS
Financial Corp. Stockholders' Equity |
|||||||||||||||||||
|
Shares of
Preferred Stock |
Preferred
Stock at Par |
Shares of
Common Stock |
Common
Stock at Par |
Additional
Paid-in Capital |
|||||||||||||||||
Balance at July 29, 2011 (Inception) |
| $ | | | $ | | $ | | $ | | $ | | ||||||||||
Exchange offer contribution |
| | 3,022,617 | 302 | 60,452,038 | | 60,452,340 | |||||||||||||||
Net loss applicable to common stockholders |
| | | | | (5,134,466 | ) | (5,134,466 | ) | |||||||||||||
Balance at December 31, 2011 |
| | 3,022,617 | 302 | 60,452,038 | (5,134,466 | ) | 55,317,874 | ||||||||||||||
Net proceeds from offering of preferred stock |
133 |
|
|
|
115,499 |
|
115,499 |
|||||||||||||||
Dividends on common stock |
| | | | | (3,264,426 | ) | (3,264,426 | ) | |||||||||||||
Common stock repurchase liability |
| | (1,183,560 | ) | (118 | ) | (25,103,190 | ) | | (25,103,308 | ) | |||||||||||
Net income applicable to common stockholders |
| | | | | 17,607,955 | 17,607,955 | |||||||||||||||
Balance at September 30, 2012 (unaudited) |
133 | $ | | 1,839,057 | $ | 184 | $ | 35,464,347 | $ | 9,209,063 | $ | 44,673,594 | ||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
F-4
ZAIS Financial Corp. and Subsidiaries
Consolidated Statements of Cash Flows
(Expressed in United States Dollars)
|
Nine Months Ended
September 30, 2012 |
Period from
July 29, 2011 (Inception) to September 30, 2011 |
|||||
---|---|---|---|---|---|---|---|
|
(unaudited)
|
(unaudited)
|
|||||
Cash flows from operating activities |
|||||||
Net income/(loss) |
$ | 17,619,685 | $ | (3,853,799 | ) | ||
Adjustments to reconcile net income/(loss) to net cash provided by operating activities |
|||||||
Net (accretion)/amortization of (discounts)/premiums related to real estate securities |
(721,891 | ) | 250,913 | ||||
Change in unrealized (gain)/loss on real estate securities |
(15,871,869 | ) | 4,493,562 | ||||
Realized loss on real estate securities |
1,097,082 | | |||||
Change in unrealized loss on derivative instruments |
863,030 | 36,739 | |||||
Changes in operating assets and liabilities |
|||||||
Increase in other assets |
(477,052 | ) | (117,383 | ) | |||
Increase in accounts payable and other liabilities |
371,011 | 450,838 | |||||
Decrease/(increase) in accrued interest payable |
(1,435 | ) | 79,554 | ||||
Net cash provided by operating activities |
2,878,561 | 1,340,424 | |||||
Cash flows from investing activities |
|||||||
Acquisitions of real estate securities |
(83,122,058 | ) | (105,928,570 | ) | |||
Proceeds from principal repayments on real estate securities |
16,453,167 | (199,985 | ) | ||||
Proceeds from sale of real estate securities |
64,759,903 | | |||||
Restricted cash used in investment activities |
(1,406,901 | ) | (1,370,041 | ) | |||
Net cash used in investing activities |
(3,315,889 | ) | (107,498,596 | ) | |||
Cash flows from financing activities |
|||||||
Proceeds from issuance of common stock upon exchange offer |
| 3,036,222 | |||||
Proceeds from issuance of preferred stock, net |
115,499 | | |||||
Borrowings from repurchase agreements |
61,890,233 | 104,895,068 | |||||
Repayments of repurchase agreements |
(49,358,331 | ) | (256,130 | ) | |||
Preferred dividends |
(7,112 | ) | | ||||
Dividends on common stock |
(3,264,426 | ) | | ||||
Net cash provided by financing activities |
9,375,863 | 107,675,160 | |||||
Net increase in cash |
8,938,535 | 1,516,988 | |||||
Cash |
|||||||
Beginning of period |
6,326,724 | | |||||
End of period |
$ | 15,265,259 | $ | 1,516,988 | |||
Supplemental disclosure of cash flow information |
|||||||
Interest paid |
$ | 1,016,138 | $ | 25,619 | |||
Taxes paid |
| | |||||
Supplemental disclosure of noncash investing and financing activities |
|||||||
Exchange offer contributiondebt securities |
$ | | $ | 57,416,118 |
The accompanying notes are an integral part of these consolidated financial statements.
F-5
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
1. Formation and Organization
ZAIS Financial Corp. (the "Company") was incorporated in Maryland on May 24, 2011, and has elected to be taxed and to qualify as a real estate investment trust ("REIT") beginning with the taxable year ended December 31, 2011. The Company was initially capitalized and commenced operations on July 29, 2011, when it completed an exchange of a mutually agreed upon portion of the shareholders' and limited partners' interests in the ZAIS Matrix VI-A Ltd. and ZAIS Matrix VI-B L.P. funds (the "Matrix Funds") managed by ZAIS Group, LLC (the "Advisor"), which included cash of $3,036,222 and real estate securities having a fair market value of $57,416,118, for 3,022,617 shares of the Company's common stock or operating partnership units ("OP units"), pursuant to an exchange offer statement dated May 25, 2011 and the related contribution agreements executed on July 29, 2011. All OP units were converted into shares of common stock upon issuance.
The Company was organized primarily to invest in, finance and manage residential mortgage loans and residential mortgage-backed securities ("RMBS") that are not issued or guaranteed by a U.S. Government agency or by a federally chartered corporation ("Non-Agency RMBS"). The Company also initially intends to acquire RMBS for which a U.S. Government agency or federally chartered corporation guarantees payments of principal and interest on the securities ("Agency RMBS") and has the discretion to invest in other real estate-related and financial assets, including, but not limited to, commercial mortgage-backed securities and other asset-backed securities. The Company is externally managed by the Advisor and has no employees. Substantially all of the Company's business is conducted through ZAIS Financial Partners, L.P., the Company's consolidated operating partnership (the "OP"). The Company is the sole general partner of the OP. The Company and a subsidiary are the limited partners of the OP.
The Company's charter authorizes the issuance of up to 500,000,000 shares of common stock with a par value of $0.0001 per share, and 50,000,000 shares of preferred stock, with a par value of $0.0001 per share. The Company's board of directors is authorized to amend its charter, without the approval of the stockholders, to increase the aggregate number of authorized shares of capital stock or the number of shares of any class or series that the Company has authority to issue.
2. Summary of Significant Accounting Policies
Basis of Quarterly Presentation
The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("U.S. GAAP") as contained within the Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") and the rules and regulations of the Securities and Exchange Commission for interim financial reporting. In the opinion of management, all adjustments considered necessary for a fair statement of the Company's financial position, results of operations and cash flows have been included and are of a normal and recurring nature. The operating results presented for the interim period are not necessarily indicative of the results that may be expected for any other interim period or for the entire year.
The Company currently operates as one business segment.
F-6
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) (Continued)
2. Summary of Significant Accounting Policies (Continued)
Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may ultimately differ from those estimates.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company the OP, and five wholly owned subsidiaries of the OP. The Company holds all voting interests in the OP and the OP holds all voting interests of the five subsidiaries. The Company conducts its business through the OP. All significant intercompany balances have been eliminated in consolidation.
Variable Interest Entities
A variable interest entity ("VIE") is an entity that lacks one or more of the characteristics of a voting interest entity. The Company evaluates each of its investments to determine if each is a VIE based on: (1) the sufficiency of the entity's equity investment at risk to finance its activities without additional subordinated financial support provided by any parties, including the equity holders; (2) whether as a group the holders of the equity investment at risk have (a) the power, through voting rights or similar rights, to direct the activities of a legal entity that most significantly impacts the entity's economic performance, (b) the obligation to absorb the expected losses of the legal entity and (c) the right to receive the expected residual returns of the legal entity; and (3) whether the voting rights of these investors are proportional to their obligations to absorb the expected losses of the entity, their rights to receive the expected returns of their equity, or both, and whether substantially all of the entity's activities involve or are conducted on behalf of an investor that has disproportionately fewer voting rights. An investment that lacks one or more of the above three characteristics is considered to be a VIE. The Company reassesses its initial evaluation of an entity as a VIE upon the occurrence of certain reconsideration events.
A VIE is subject to consolidation if the equity investors either do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support, are unable to direct the entity's activities, or are not exposed to the entity's losses or entitled to its residual returns. VIEs are required to be consolidated by their primary beneficiary. The primary beneficiary of a VIE is determined to be the party that has both the power to direct the activities of a VIE that most significantly impact the VIE's economic performance and the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. This determination can sometimes involve complex and subjective analyses.
The Company has evaluated its securities investments to determine if each represents a variable interest in a VIE. The Company monitors these investments and analyzes them for potential consolidation. The Company will continue to analyze future investments pursuant to the VIE requirements. These analyses require considerable judgment in determining the
F-7
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) (Continued)
2. Summary of Significant Accounting Policies (Continued)
primary beneficiary of a VIE. The Company's securities investments represent variable interests in VIEs. At September 30, 2012 and December 31, 2011, no VIEs required consolidation.
Cash
The Company's deposits with financial institutions may exceed federally insurable limits of $250,000 per institution. The Company mitigates this risk by depositing funds with a major financial institution.
Restricted Cash
Restricted cash represents the Company's cash held by counterparties as collateral against the Company's derivatives and/or repurchase agreements. Cash held by counterparties as collateral is not available to the Company for general corporate purposes, but may be applied against amounts due to derivative or repurchase agreement counterparties or returned to the Company when the collateral requirements are exceeded or, at the maturity of the derivatives or repurchase agreements.
Real Estate SecuritiesFair Value Election
U.S. GAAP permits entities to choose to measure many financial instruments and certain other items at fair value. The Company has elected the fair value option for each of its real estate securities at the date of purchase, including those contributed in connection with the initial exchange offer contribution, which permits the Company to measure these securities at estimated fair value with the change in estimated fair value included as changes in unrealized gain/loss on real estate securities in the Company's consolidated statements of operations. The Company believes that the election of the fair value option for its real estate securities portfolio more appropriately reflects the results of the Company's operations for a particular reporting period as all securities activities are recorded in a similar manner.
Determination of Fair Value and Market Value Measurement
The "Fair Value Measurements and Disclosures" Topic of the FASB ASC defines fair value, establishes a framework for measuring fair value, and requires certain disclosures about fair value measurements under U.S. GAAP. Specifically, this guidance defines fair value based on exit price, or the price that would be received upon the sale of an asset or the transfer of a liability in an orderly transaction between market participants at the measurement date.
Fair value under U.S. GAAP represents an exit price in the normal course of business, not a forced liquidation price. If the Company was forced to sell assets in a short period to meet liquidity needs, the prices it receives could be substantially less than their recorded fair values. Furthermore, the analysis of whether it is more likely than not that the Company will be required to sell securities in an unrealized loss position prior to an expected recovery in value (if any), the amount of such expected required sales, and the projected identification of which securities would be sold is also subject to significant judgment.
F-8
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) (Continued)
2. Summary of Significant Accounting Policies (Continued)
Changes to the valuation methodology will be reviewed by the Advisor to ensure the changes are appropriate. The fair value methodology may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while the Company anticipates that the Advisor's valuation methods will be appropriate and consistent with other market participants, the use of different methodologies, or assumptions, to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.
The Company categorizes its financial instruments in accordance with U.S. GAAP, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the financial instruments fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.
Financial assets and liabilities recorded on the consolidated balance sheet are categorized based on the inputs to the valuation techniques as follows:
Level 1 | Quoted prices for identical assets or liabilities in an active market. | |||
|
|
Level 2 |
|
Financial assets and liabilities whose values are based on the following: |
Level 3 | Prices or valuation techniques based on inputs that are both unobservable and significant to the overall fair value measurement. |
The Company may use valuation techniques consistent with the market and income approaches to measure the fair value of its assets and liabilities. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. The income approach uses valuation techniques to convert future projected cash flows to a single discounted present value amount. When applying either approach, the Company maximizes the use of observable inputs and minimizes the use of unobservable inputs. The Company's assessment of the significance of a particular input to the fair value measurement in its entirety requires significant judgment and considers factors specific to the investment. The Company utilizes proprietary modeling analysis to support the independent third party broker quotes selected to determine the fair value of investments and derivative instruments.
The following is a description of the valuation techniques used to measure fair value and the general classification of these instruments pursuant to the fair value hierarchy.
F-9
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) (Continued)
2. Summary of Significant Accounting Policies (Continued)
Real Estate Securities
The fair value of the Company's real estate securities considers the underlying characteristics of each security including coupon, maturity date and collateral. The Company estimates the fair value of its Agency RMBS and Non-Agency RMBS based upon a combination of observable prices in active markets, multiple indicative quotes from brokers, and executable bids. In evaluating broker quotes the Company also considers additional observable market data points including recent observed trading activity for identical and similar securities, back-testing, broker challenges and other interactions with market participants, as well as yield levels generated by model-based valuation techniques. In the absence of observable quotes, the Company utilizes model-based valuation techniques that may contain unobservable valuation inputs.
When available, the fair value of real estate securities is based on quoted prices in active markets. If quoted prices are not available, fair values are obtained from either broker quotes, observed traded levels or model-based valuation techniques using observable inputs such as benchmark yields or issuer spreads. The Company's Agency RMBS are valued using the market data described above, which includes inputs determined to be observable or whose significant value drivers are observable. Accordingly, Agency RMBS securities are classified as Level 2 in the fair value hierarchy.
While the Company's Non-Agency RMBS are valued using the same process with similar inputs as the Agency RMBS, a significant amount of inputs are unobservable due to relativity low levels of market activity. The fair value of these securities is typically based on broker quotes or the Company's model-based valuation. Accordingly, the Company's Non-Agency RMBS are classified as Level 3 in the fair value hierarchy. Model-based valuation consists primarily of discounted cash flow and yield analyses. Significant model inputs and assumptions include market-implied discount rates, default rates, expected loss severity, weighted average life, collateral composition, borrower characteristics and prepayment rates, and may also include general economic conditions, including home price index forecasts, servicing data and other relevant information. Where possible, collateral-related assumptions are determined on an individual loan level basis.
Derivative Instruments
Derivative instruments are valued using counterparty valuations. These valuations are generally based on models with market observable inputs such as interest rates and contractual cash flows, and as such, are classified as Level 2 of the fair value hierarchy. The Company reviews these valuations, including consideration of counterparty risk and collateral provisions. The Company's swap contracts are governed by International Swap and Derivative Association trading agreements, which are separately negotiated agreements with dealer counterparties. As of September 30, 2012 and December 31, 2011, no credit valuation adjustment was made in determining the fair value of derivatives.
Interest Income Recognition and Impairment
Interest income on Agency RMBS is accrued based on the outstanding principal balance and their contractual terms. Premiums and discounts associated with Agency RMBS at the
F-10
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) (Continued)
2. Summary of Significant Accounting Policies (Continued)
time of purchase are amortized into interest income over the life of such securities using the effective yield method and adjusted for actual prepayments in accordance with ASC 310-20 " Nonrefundable Fees and Other Costs " or ASC 325-40 " Beneficial Interests in Securitized Financial Assets ," as applicable. Total interest income is recorded as Interest incomereal estate securities in the consolidated statements of operations.
Interest income on the Non-Agency RMBS that were purchased at a discount to par value and/or were rated below AA at the time of purchase is recognized based on the effective yield method. The effective yield on these securities is based on the projected cash flows from each security, which are estimated based on the Company's observation of current information and events and include assumptions related to interest rates, prepayment rates and the timing and amount of credit losses. On at least a quarterly basis, the Company reviews and, if appropriate, makes adjustments to its cash flow projections based on input and analysis received from external sources, internal models, and its judgment about interest rates, prepayment rates, the timing and amount of credit losses, and other factors. Changes in cash flows from those originally projected, or from those estimated at the last evaluation, may result in a prospective change in the yield/interest income recognized on such securities. Actual maturities of the securities are affected by the contractual lives of the associated mortgage collateral, periodic payments of principal, and prepayments of principal. Therefore, actual maturities of the securities are generally shorter than stated contractual maturities.
Based on the projected cash flows from the Company's Non-Agency RMBS purchased at a discount to par value, a portion of the purchase discount may be designated as credit protection against future credit losses and, therefore, not accreted into interest income. The amount designated as credit discount is determined and may be adjusted over time, based on the actual performance of the security, its underlying collateral, actual and projected cash flow from such collateral, economic conditions and other factors. If the performance of a security with a credit discount is more favorable than forecasted, a portion of the amount designated as credit discount may be accreted into interest income prospectively.
Real estate securities are periodically evaluated for other-than-temporary impairment ("OTTI"). A security where the fair value is less than amortized cost is considered impaired. Impairment of a security is considered to be other-than-temporary when: (i) the holder has the intent to sell the impaired security; (ii) it is more likely than not the holder will be required to sell the security; or (iii) the holder does not expect to recover the entire amortized cost of the security. When a security has been deemed to be other-than-temporarily impaired, the amount of OTTI is bifurcated into: (i) the amount related to expected credit losses; and (ii) the amount related to fair value adjustments in excess of expected credit losses. The portion of OTTI related to expected credit losses is recognized in the consolidated statement of operations as a realized loss. The remaining OTTI related to the valuation adjustment is recognized as a component of change in unrealized gain/loss in the consolidated statement of operations. Realized gains and losses on sale of real estate securities are determined using the specific identification method. Real estate securities transactions are recorded on the trade date.
F-11
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) (Continued)
2. Summary of Significant Accounting Policies (Continued)
Expense Recognition
Expenses are recognized when incurred. Expenses include, but are not limited to, operating expenses related to the Company that are incurred by the Company or the Advisor, which are eligible for reimbursement by the Advisor.
Offering Costs
Offering costs in connection with the Company's initial public offering ("IPO") will be paid out of the proceeds of the IPO. Offering costs will be accounted for as a reduction of additional paid-in-capital. Costs incurred to organize the Company are expensed as incurred. The Company's obligation to pay for organization and offering expenses incurred is capped at $1.2 million and the Advisor will pay for such expenses incurred above the cap.
Repurchase Agreements
The Company finances a portion of its investment portfolio through the use of repurchase agreements entered into under Master Repurchase Agreements with several financial institutions. Repurchase agreements are treated as collateralized financing transactions and are carried at their contractual amounts, including accrued interest, as specified in the respective agreements. Repurchase agreements are recorded on trade date at the contract amount.
The Company pledges cash and certain of its securities as collateral under these repurchase agreements. The amounts available to be borrowed are dependent upon the fair value of the securities pledged as collateral, which fluctuates with changes in interest rates, type of security and liquidity conditions within the banking, mortgage finance and real estate industries. In response to declines in fair value of pledged securities, the lenders may require the Company to post additional collateral or pay down borrowings to re-establish agreed upon collateral requirements, referred to as margin calls. As of September 30, 2012 and December 31, 2011, the Company has met all margin call requirements.
Derivatives and Hedging Activities
The Company accounts for its derivative financial instruments in accordance with derivative accounting guidance, which requires an entity to recognize all derivatives as either assets or liabilities in the balance sheets and to measure those instruments at fair value. The Company has not designated any of its derivative contracts as hedging instruments for accounting purposes. As a result, changes in the fair value of derivatives are recorded through current period earnings.
The Company's derivative contracts contain legally enforceable provisions that allow for netting or setting off of all individual swap receivables and payables with the counterparty and, therefore, the fair value of those swap contracts are netted. The credit support annex provisions of the Company's interest rate swap contracts allow the parties to mitigate their credit risk by requiring the party which is out of the money to post collateral. At September 30, 2012 and December 31, 2011, all collateral provided under these contracts consists of cash collateral.
F-12
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) (Continued)
2. Summary of Significant Accounting Policies (Continued)
Net Income (Loss) Per Share
The Company calculates basic income per share by dividing net income (loss) for the period by the weighted-average shares of the Company's common stock outstanding for that period. The Company has no potentially dilutive instruments at September 30, 2012 and December 31, 2011.
Income Taxes
The Company has elected to be taxed as a REIT for U.S. federal income tax purposes commencing with its taxable year ended December 31, 2011. The Company intends to be organized and operate in a manner that qualifies the Company to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the "Code"). To qualify as a REIT, the Company must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of the Company's annual REIT taxable income to its stockholders (which is computed without regard to the dividends paid deduction or net capital gain and which does not necessarily equal net income as calculated in accordance with U.S. GAAP). As a REIT, the Company will not be subject to federal income tax on its taxable income that it distributes to its stockholders. If the Company fails to qualify as a REIT in any taxable year, it will be subject to federal income tax on its taxable income at regular corporate income tax rates and generally will not be permitted to qualify for treatment as a REIT for federal income tax purposes for the four taxable years following the year during which qualification is lost unless the Internal Revenue Service grants the Company relief under certain statutory provisions. Such an event could materially adversely affect the Company's net income and net cash available for distribution to stockholders. However, the Company intends to organize and operate in such a manner as to qualify for treatment as a REIT.
The Company evaluates uncertain income tax positions, if any, and based its analysis of income tax positions, the Company concluded that it does not have any uncertain tax positions that meet the recognition or measurement criteria as of September 30, 2012 and December 31, 2011.
Repurchase Liability
The Company reflects agreements to repurchase equity shares as liabilities when these agreements require or may require the Company to settle the obligation by transferring assets. Pursuant to a share repurchase agreement dated July 5, 2012, the Company was obligated at September 30, 2012, to repurchase 1,183,560 shares valued at the July 31, 2012 book value per share of $21.21, or $25.1 million which is reflected as common stock repurchase liability on the consolidated balance sheet.
Recent Accounting Pronouncements
In December 2011, FASB issued ASU No. 2011-11: Disclosures about Offsetting Assets and Liabilities ("ASU 2011-11") which requires new disclosures about balance sheet offsetting and related arrangements. For derivatives and financial assets and liabilities, the amendment requires disclosure of gross asset and liability amounts, amounts offset on the balance sheet, and amounts subject to the offsetting requirements but not offset on the balance sheet. The
F-13
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) (Continued)
2. Summary of Significant Accounting Policies (Continued)
guidance is effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods and is to be applied retrospectively for all comparative periods presented. The Company does not believe the adoption of ASU 2011-11 will have a material impact on its consolidated financial statements.
3. Fair Value
Fair Value Measurement
Financial assets and liabilities recorded at fair value on a recurring basis are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
The following table sets forth the Company's financial instruments that were accounted for at fair value on a recurring basis as of September 30, 2012, by level within the fair value hierarchy:
|
Assets and Liabilities at Fair Value | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Level 1 | Level 2 | Level 3 | Total | |||||||||
Assets |
|||||||||||||
Real estate securities |
|||||||||||||
Agency RMBS |
|||||||||||||
30-year adjustable rate mortgage |
$ | | $ | 3,358,214 | $ | | $ | 3,358,214 | |||||
30-year fixed rate mortgage |
| 61,241,564 | | 61,241,564 | |||||||||
Non-Agency RMBS |
| | 98,776,999 | 98,776,999 | |||||||||
Total assets |
$ | | $ | 64,599,778 | $ | 98,776,999 | $ | 163,376,777 | |||||
Liabilities |
|||||||||||||
Derivative instruments |
$ | | $ | 1,117,332 | $ | | $ | 1,117,332 | |||||
Total liabilities |
$ | | $ | 1,117,332 | $ | | $ | 1,117,332 | |||||
F-14
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) (Continued)
3. Fair Value (Continued)
The following table sets forth the Company's financial instruments that were accounted for at fair value on a recurring basis as of December 31, 2011, by level within the fair value hierarchy:
|
Assets and Liabilities at Fair Value | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Level 1 | Level 2 | Level 3 | Total | |||||||||
Assets |
|||||||||||||
Real estate securities |
|||||||||||||
Agency RMBS |
|||||||||||||
30-year adjustable rate mortgage |
$ | | $ | 13,475,942 | $ | | $ | 13,475,942 | |||||
30-year fixed rate mortgage |
| 56,022,077 | | 56,022,077 | |||||||||
Non-Agency RMBS |
| | 76,473,092 | 76,473,092 | |||||||||
Total assets |
$ | | $ | 69,498,019 | $ | 76,473,092 | $ | 145,971,111 | |||||
Liabilities |
|||||||||||||
Derivative instruments |
$ | | $ | 254,302 | $ | | $ | 254,302 | |||||
Total liabilities |
$ | | $ | 254,302 | $ | | $ | 254,302 | |||||
The following table presents additional information about the Company's real estate securities which are measured at fair value on a recurring basis for which the Company has utilized Level 3 inputs to determine fair value:
|
September 30, 2012 | December 31, 2011 | |||||
---|---|---|---|---|---|---|---|
Beginning balance |
$ | 76,473,092 | $ | | |||
Total net transfers into/out of Level 3 |
| | |||||
Exchange offer contributiondebt securities |
| 57,416,118 | |||||
Acquisitions of real estate securities |
60,603,677 | 36,887,261 | |||||
Proceeds from sale of real estate securities |
(39,577,949 | ) | (7,216,183 | ) | |||
Net accretion of discounts related to real estate securities |
1,034,034 | 1,682,296 | |||||
Proceeds from principal repayments on real estate securities |
(11,750,248 | ) | (4,608,855 | ) | |||
Total losses (realized / unrealized) included in earnings |
(2,562,076 | ) | (8,036,628 | ) | |||
Total gains (realized / unrealized) included in earnings |
14,556,469 | 349,083 | |||||
Ending balance |
$ | 98,776,999 | $ | 76,473,092 | |||
The amount of total gains or (losses) for the period included in earnings attributable to the change in unrealized gains or losses relating to assets or liabilities still held at the reporting date |
$ | 8,847,769 | $ | (6,205,624 | ) |
There were no financial assets or liabilities that were accounted for at fair value on a nonrecurring basis at September 30, 2012 or December 31, 2011. There were no transfers into or out of Level 1, Level 2, or Level 3 during the nine months ended September 30, 2012, or for the period from July 29, 2011 (Inception) to September 30, 2011.
F-15
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) (Continued)
3. Fair Value (Continued)
The following table presents quantitative information about the Company's real estate securities which are measured at fair value on a recurring basis for which the Company has utilized Level 3 inputs to determine fair value:
Quantitative Information about Level 3 Fair Value Measurements
|
Fair Value as of
September 30, 2012 |
Valuation
Technique(s) |
Unobservable Input | Min / Max |
Weighted
Average |
||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Non-Agency RMBS (1) |
|||||||||||||||||
AlternativeA |
$ | 27,488,247 | Broker quotes/ | Constant voluntary prepayment | 2.4 | % | 12.8 | % | 5.7 | % | |||||||
|
comparable trades | Constant default rate | 1.8 | % | 12.6 | % | 6.6 | % | |||||||||
|
Loss severity | 0.0 | % | 69.6 | % | 46.4 | % | ||||||||||
|
Delinquency | 5.5 | % | 36.6 | % | 19.1 | % | ||||||||||
Pay option |
1,210,830 |
Broker quotes/ |
Constant voluntary prepayment |
0.8 |
% |
18.6 |
% |
7.0 |
% |
||||||||
adjustable |
comparable trades | Constant default rate | 3.8 | % | 16.2 | % | 8.6 | % | |||||||||
rate |
Loss severity | 1.9 | % | 75.3 | % | 55.8 | % | ||||||||||
|
Delinquency | 14.9 | % | 45.4 | % | 26.1 | % | ||||||||||
Prime |
66,337,929 |
Broker quotes/ |
Constant voluntary prepayment |
1.5 |
% |
25.0 |
% |
9.3 |
% |
||||||||
|
comparable trades | Constant default rate | 1.6 | % | 10.4 | % | 6.4 | % | |||||||||
|
Loss severity | 1.5 | % | 56.9 | % | 42.6 | % | ||||||||||
|
Delinquency | 7.5 | % | 24.5 | % | 16.2 | % | ||||||||||
Subprime |
3,739,993 |
Broker quotes/ |
Constant voluntary prepayment |
1.3 |
% |
9.6 |
% |
4.5 |
% |
||||||||
|
comparable trades | Constant default rate | 4.0 | % | 12.5 | % | 6.1 | % | |||||||||
|
Loss severity | 9.6 | % | 70.8 | % | 52.5 | % | ||||||||||
|
Delinquency | 19.7 | % | 31.2 | % | 24.3 | % | ||||||||||
Total |
$ | 98,776,999 | |||||||||||||||
The fair value measurements of these assets are sensitive to changes in assumptions regarding prepayment, probability of default, loss severity in the event of default, forecasts of home prices, or significant activity or developments in the non-agency securities market. Significant changes in any of those inputs in isolation may result in significantly higher or lower fair value measurements. A change in the assumption used for forecasts of home price changes is accompanied by directionally similar changes in the assumptions used for probability of default and loss severity.
Fair Value Option
Changes in fair value for assets and liabilities for which the fair value election is made are recognized in income as they occur. The fair value option may be elected on an instrument-by-instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument.
F-16
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) (Continued)
3. Fair Value (Continued)
The following table presents the difference between the fair value and the aggregate unpaid principal amount of assets for which the fair value option was elected:
|
September 30, 2012 | December 31, 2011 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Fair Value |
Amount
Due Upon Maturity |
Difference | Fair Value |
Amount
Due Upon Maturity |
Difference | |||||||||||||
Financial instruments, at fair value |
|||||||||||||||||||
Assets |
|||||||||||||||||||
Real estate securities |
|||||||||||||||||||
Agency RMBS |
|||||||||||||||||||
30-year adjustable rate mortgage |
$ | 3,358,214 | $ | 3,199,717 | $ | 158,497 | $ | 13,475,942 | $ | 12,904,151 | $ | 571,791 | |||||||
30-year fixed rate mortgage |
61,241,564 | 55,607,975 | 5,633,589 | 56,022,077 | 52,681,733 | 3,340,344 | |||||||||||||
Non-Agency RMBS |
98,776,999 | 109,938,749 | (11,161,750 | ) | 76,473,092 | 121,607,167 | (45,134,075 | ) | |||||||||||
Total assets |
$ | 163,376,777 | $ | 168,746,441 | $ | (5,369,664 | ) | $ | 145,971,111 | $ | 187,193,051 | $ | (41,221,940 | ) | |||||
Fair Value of Other Financial Instruments
In addition to the above disclosures regarding assets or liabilities which are recorded at fair value, U.S. GAAP requires disclosure about the fair value of all other financial instruments. Estimated fair value of financial instruments was determined by the Company, using available market information and appropriate valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair values. The use of different market assumptions and/or estimation methodologies may have a material effect on estimated fair value.
The following table summarizes the estimated fair value for all other financial instruments:
|
September 30, 2012 | December 31, 2011 | |||||
---|---|---|---|---|---|---|---|
Other financial instruments |
|||||||
Assets |
|||||||
Cash |
$ | 15,265,259 | $ | 6,326,724 | |||
Restricted Cash |
3,122,112 | 1,715,211 | |||||
Liabilities |
|||||||
Repurchase agreements |
$ | 109,902,344 | $ | 97,423,747 | |||
Common stock repurchase liability |
25,103,124 | |
Cash includes cash on hand. Fair value equals carrying value (a Level 1 measurement). Restricted cash represents the Company's cash held by counterparties as collateral against the Company's derivatives and/or repurchase agreements. Due to the short-term nature of the restrictions, fair value approximates carrying value (a Level 1 measurement). The fair value of repurchase agreements is based on an expected present value technique using observable market interest rates. As such, the Company considers the estimated fair value to be a Level 2 measurement. This method discounts future estimated cash flows using rates the Company determined best reflect current market interest rates that would be offered for loans with similar characteristics and credit quality. The fair value of the common stock repurchase liability is equal to the agreed upon purchase price.
F-17
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) (Continued)
4. Real Estate Securities
The following table presents the current principal balance, amortized cost, gross change in unrealized gains, gross change in unrealized losses, and estimated fair market value of the Company's real estate securities portfolio at September 30, 2012. The Company's Agency RMBS are mortgage pass-through certificates representing interests in or obligations backed by pools of residential mortgage loans issued or guaranteed by Fannie Mae or Freddie Mac. The Non-Agency RMBS portfolios are not issued or guaranteed by Fannie Mae, Freddie Mac or any other U.S. Government agency or a federally chartered corporation and are therefore subject to credit risk.
|
|
|
|
|
|
|
Weighted
Average |
||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
|
|
|
Gross Unrealized (1) |
|
||||||||||||||||||||
|
Current
Principal Balance |
Premium
(Discount) |
Amortized
Cost |
Fair
Value |
|||||||||||||||||||||
|
Gains | Losses | Coupon | Yield | |||||||||||||||||||||
Real estate securities |
|||||||||||||||||||||||||
Agency RMBS |
|||||||||||||||||||||||||
30-year adjustable rate mortgage |
$ | 3,199,717 | $ | 282,314 | $ | 3,482,031 | $ | | $ | (123,817 | ) | $ | 3,358,214 | 2.83 | % | 2.28 | % | ||||||||
30-year fixed rate mortgage |
55,607,975 | 2,903,781 | 58,511,756 | 2,729,808 | | 61,241,564 | 3.85 | 3.53 | |||||||||||||||||
Non-Agency RMBS |
|||||||||||||||||||||||||
AlternativeA |
33,442,005 | (8,240,471 | ) | 25,201,534 | 2,342,110 | (55,397 | ) | 27,488,247 | 5.60 | 7.70 | |||||||||||||||
Pay option adjustable rate |
1,625,720 | (477,579 | ) | 1,148,141 | 69,105 | (6,416 | ) | 1,210,830 | 1.05 | 7.84 | |||||||||||||||
Prime |
70,288,657 | (8,814,952 | ) | 61,473,705 | 4,864,224 | | 66,337,929 | 5.74 | 6.57 | ||||||||||||||||
Subprime |
4,582,367 | (934,325 | ) | 3,648,042 | 149,339 | (57,388 | ) | 3,739,993 | 1.00 | 7.99 | |||||||||||||||
Total assets |
$ | 168,746,441 | $ | (15,281,232 | ) | $ | 153,465,209 | $ | 10,154,586 | $ | (243,018 | ) | $ | 163,376,777 | 4.80 | % | 5.57 | % | |||||||
F-18
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) (Continued)
4. Real Estate Securities (Continued)
The following table presents the current principal balance, amortized cost, gross change in unrealized gains, gross change in unrealized losses, and estimated fair market value of the Company's real estate securities portfolio at December 31, 2011:
|
|
|
|
|
|
|
Weighted
Average |
||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
|
|
|
Gross Unrealized (1) |
|
||||||||||||||||||||
|
Current
Principal Balance |
Premium
(Discount) |
Amortized
Cost |
Fair
Value |
|||||||||||||||||||||
|
Gains | Losses | Coupon | Yield | |||||||||||||||||||||
Real estate securities: |
|||||||||||||||||||||||||
Agency RMBS |
|||||||||||||||||||||||||
30-year adjustable rate mortgage |
$ | 12,904,151 | $ | 550,801 | $ | 13,454,952 | $ | 22,150 | $ | (1,160 | ) | $ | 13,475,942 | 3.16 | % | 2.34 | % | ||||||||
30-year fixed rate mortgage |
52,681,733 | 3,116,011 | 55,797,744 | 383,502 | (159,169 | ) | 56,022,077 | 4.20 | % | 3.80 | % | ||||||||||||||
Non-agency RMBS |
|||||||||||||||||||||||||
AlternativeA/B |
51,687,232 | (14,542,076 | ) | 37,145,156 | 70,598 | (2,148,837 | ) | 35,066,916 | 4.92 | % | 7.88 | % | |||||||||||||
Pay option adjustable rate |
24,664,566 | (9,992,595 | ) | 14,671,971 | 34,077 | (1,914,953 | ) | 12,791,094 | 0.84 | % | 7.68 | % | |||||||||||||
Prime |
24,631,709 | (4,360,503 | ) | 20,271,205 | 244,408 | (855,893 | ) | 19,659,722 | 4.55 | % | 7.22 | % | |||||||||||||
Subprime |
20,623,660 | (10,033,276 | ) | 10,590,384 | | (1,635,024 | ) | 8,955,360 | 0.87 | % | 15.04 | % | |||||||||||||
Total assets |
$ | 187,193,051 | $ | (35,261,639 | ) | $ | 151,931,412 | $ | 754,735 | $ | (6,715,036 | ) | $ | 145,971,111 | 3.76 | % | 6.14 | % | |||||||
The following table presents certain information regarding the Company's Agency and Non-Agency securities as of September 30, 2012 by weighted average life and weighted average yield:
|
Agency Securities | Non-Agency Securities | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Fair
Value |
Amortized
Cost |
Weighted
Average Yield |
Fair
Value |
Amortized
Cost |
Weighted
Average Yield |
|||||||||||||
Weighted average life (1) |
|||||||||||||||||||
Greater than 5 years |
$ | 64,599,778 | $ | 61,993,787 | 3.46 | % | $ | 98,776,999 | $ | 91,471,422 | 6.95 | % | |||||||
|
$ | 64,599,778 | $ | 61,993,787 | 3.46 | % | $ | 98,776,999 | $ | 91,471,422 | 6.95 | % | |||||||
At September 30, 2012, the contractual maturities of the real estate securities ranged from 8.9 to 32.7 years, with a weighted average maturity of 26.7 years.
During the nine months ended September 30, 2012, proceeds from the sale of real estate securities were $64,759,903 and realized losses on the sale of real estate securities were $1,097,082.
F-19
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) (Continued)
4. Real Estate Securities (Continued)
The following table presents certain information regarding the Company's Agency and Non-Agency securities as of December 31, 2011 by weighted average life and weighted average yield:
|
Agency Securities | Non-Agency Securities | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Fair
Value |
Amortized
Cost |
Weighted
Average Yield |
Fair
Value |
Amortized
Cost |
Weighted
Average Yield |
|||||||||||||
Weighted average life (1) |
|||||||||||||||||||
Greater than 5 years |
$ | 69,498,019 | $ | 69,252,696 | 3.52 | % | $ | 76,473,092 | $ | 82,678,716 | 8.33 | % | |||||||
|
$ | 69,498,019 | $ | 69,252,696 | 3.52 | % | $ | 76,473,092 | $ | 82,678,716 | 8.33 | % | |||||||
At December 31, 2011, the contractual maturities of the real estate securities ranged from 9.6 to 35.0 years, with a weighted average maturity of 27.1 years.
5. Repurchase Agreements
Repurchase agreements involve the sale and a simultaneous agreement to repurchase the transferred assets or similar assets at a future date. The amount borrowed generally is equal to the fair value of the assets pledged less an agreed-upon discount, referred to as a "haircut." Repurchase agreements entered into by the Company are accounted for as financings and require the repurchase of the transferred securities at the end of each arrangement's term, typically 30 to 90 days. The Company maintains the beneficial interest in the specific securities pledged during the term of the repurchase arrangement and receives the related principal and interest payments. Interest rates on these borrowings are fixed based on prevailing rates corresponding to the terms of the borrowings, and interest is paid at the termination of the repurchase arrangement at which time the Company may enter into a new repurchase arrangement at prevailing market rates with the same counterparty or repay that counterparty and negotiate financing with a different counterparty. In response to declines in fair value of pledged securities due to changes in market conditions or the publishing of monthly security paydown factors, the lender requires the Company to post additional securities as collateral, pay down borrowings or establish cash margin accounts with the counterparty in order to re-establish the agreed-upon collateral requirements, referred to as margin calls. Under the terms of the Company's master repurchase agreements, the counterparty may sell or re-hypothecate the pledged collateral.
F-20
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) (Continued)
5. Repurchase Agreements (Continued)
The following table presents certain information regarding the Company's repurchase agreements as of September 30, 2012 by remaining maturity and collateral type:
|
Agency Securities | Non-Agency Securities | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Balance |
Weighted
Average Rate |
Balance |
Weighted
Average Rate |
|||||||||
Repurchase agreements maturing within |
|||||||||||||
30 days or less |
$ | 61,174,008 | 0.45 | % | $ | 48,954,904 | 2.15 | % | |||||
31-60 days |
| | | | |||||||||
61-90 days |
| | | | |||||||||
Greater than 90 days |
| | | | |||||||||
Total / weighted average |
$ | 61,174,008 | 0.45 | % | $ | 48,954,904 | 2.15 | % | |||||
The following table presents certain information regarding the Company's repurchase agreements as of December 31, 2011 by remaining maturity and collateral type:
|
Agency Securities | Non-Agency Securities | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Balance |
Weighted
Average Rate |
Balance |
Weighted
Average Rate |
|||||||||
Repurchase agreements maturing within |
|||||||||||||
30 days or less |
$ | 25,732,880 | 0.60 | % | $ | 30,958,070 | 2.28 | % | |||||
31-60 days |
37,475,420 | 0.50 | | | |||||||||
61-90 days |
3,430,640 | 0.50 | | | |||||||||
Greater than 90 days |
| | | | |||||||||
Total / weighted average |
$ | 66,638,940 | 0.54 | % | $ | 30,958,070 | 2.28 | % | |||||
Although repurchase agreements are committed borrowings until maturity, the lender retains the right to mark the underlying collateral to fair value. A reduction in the value of pledged assets would require the Company to provide additional collateral or cash to fund margin calls.
The following table presents information with respect to the Company's posting of collateral at September 30, 2012:
Repurchase agreements secured by Agency RMBS |
$ | 61,174,008 | ||
Fair value of Agency RMBS pledged as collateral under repurchase agreements |
64,599,777 | |||
Repurchase agreements secured by Non-Agency RMBS |
48,954,904 | |||
Fair value of Non-Agency RMBS pledged as collateral under repurchase agreements |
72,936,451 | |||
Cash pledged under repurchase agreements |
745,022 |
The following table presents information with respect to the Company's posting of collateral at December 31, 2011:
Fair value of Agency RMBS pledged as collateral under repurchase agreements |
69,498,019 | |||
Repurchase agreements secured by Non-Agency RMBS |
30,958,070 | |||
Fair value of Non-Agency RMBS pledged as collateral under repurchase agreements |
46,091,017 | |||
Cash pledged under repurchase agreements |
585,052 |
F-21
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) (Continued)
6. Derivative Instruments
Interest Rate Swaps
To help mitigate exposure to higher short-term interest rates, the Company uses currently-paying and forward-starting, three-month LIBOR-indexed, pay-fixed, receive-variable, interest rate swap agreements. These agreements establish an economic fixed rate on related borrowings because the variable-rate payments received on the swap agreements largely offset interest accruing on the related borrowings, leaving the fixed-rate payments to be paid on the swap agreements as the Company's effective borrowing rate, subject to certain adjustments including changes in spreads between variable rates on the swap agreements and actual borrowing rates.
The Company's interest rate swap derivatives have not been designated as hedging instruments.
The following table presents information about the Company's interest rate swaps as of September 30, 2012:
Maturity
|
Notional
Amount |
Weighted
Average Pay Rate |
Weighted
Average Receive Rate |
Weighted
Average Years to Maturity |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
2016 |
$ | 12,102,000 | 1.21 | % | 0.48 | % | 4.0 | ||||||
2017 |
11,050,000 | 1.28 | 0.48 | 4.5 | |||||||||
2021 |
9,448,000 | 2.16 | 0.48 | 9.0 | |||||||||
Total/Weighted average |
$ | 32,600,000 | 1.51 | % | 0.48 | % | 5.6 | ||||||
The following table presents information about the Company's interest rate swaps as of December 31, 2011:
Maturity
|
Notional
Amount |
Weighted
Average Pay Rate |
Weighted
Average Receive Rate |
Weighted
Average Years to Maturity |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
2016 |
$ | 12,102,000 | 1.21 | % | 0.38 | % | 4.7 | ||||||
2021 |
9,448,000 | 2.16 | 0.38 | 9.7 | |||||||||
Total/Weighted average |
$ | 21,550,000 | 1.62 | % | 0.38 | % | 6.9 | ||||||
The following table presents the fair value of the Company's derivative instruments and their balance sheet location:
Derivative instruments
|
Designation | Balance Sheet Location |
September 30,
2012 |
December 31,
2011 |
|||||||
---|---|---|---|---|---|---|---|---|---|---|---|
Interest rate swaps, at fair value |
Non-hedge | Derivative instruments | $ | (1,117,332 | ) | $ | (254,302 | ) |
F-22
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) (Continued)
6. Derivative Instruments (Continued)
The following table summarizes losses related to derivatives:
Non-hedge derivative losses
|
Income Statement Location |
Nine Months Ended
September 30, 2012 |
Period from
July 29, 2011 (Inception) to September 30, 2011 |
||||||
---|---|---|---|---|---|---|---|---|---|
Interest rate swaps, at fair value |
Loss on
derivative instruments |
$ | (1,216,498 | ) | $ | (36,739 | ) |
The following table summarizes information related to derivative instruments:
Non-hedge derivatives
|
September 30,
2012 |
December 31,
2011 |
|||||
---|---|---|---|---|---|---|---|
Notional amount of interest rate swaps |
$ | 32,600,000 | $ | 21,550,000 |
Restricted cash at September 30, 2012 includes $2,377,090 of cash pledged as collateral against interest rate swaps. Restricted cash at December 31, 2011 includes $1,130,159 of cash pledged as collateral against interest rate swaps.
7. Earnings Per Share
The following table presents a reconciliation of the earnings and shares used in calculating basic and diluted earnings per share:
|
Nine Months Ended
September 30, 2012 |
Period from
July 29, 2011 (Inception) to September 30, 2011 |
|||||
---|---|---|---|---|---|---|---|
Numerator |
|||||||
Net income/(loss) applicable to common stockholders for basic and diluted earnings per share |
$ | 17,607,955 | $ | (3,853,799 | ) | ||
Denominator |
|||||||
Basic/diluted weighted average shares outstanding |
2,930,421 | 3,022,617 | |||||
Basic/diluted net income/(loss) per share |
$ | 6.01 | $ | (1.27 | ) |
8. Related Party Transactions
ZAIS Group, LLC
The Company was initially capitalized and commenced operations on July 29, 2011, when it completed an exchange of a mutually agreed upon portion of the shareholders' and limited partners' interests in the Matrix Funds, which are managed by the Advisor.
Subject to certain restrictions and limitations, the Advisor is responsible for managing the Company's affairs on a day-to-day basis and for, among other responsibilities, (i) the selection, purchase and sale of the Company's portfolio of assets (ii) the Company's financing activities, and (iii) providing the Company with advisory services.
The Company will pay to its Advisor an advisory fee, calculated and payable quarterly in arrears, equal to 1.5% per annum of (i) prior to an initial public offering of its common stock
F-23
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) (Continued)
8. Related Party Transactions (Continued)
("IPO"), the Company's net asset value and (ii) following the completion of an IPO, the Company's stockholders' equity, as defined in the Company's registration statement on Form S-11.
The Advisor will be paid or reimbursed for the documented cost of performing certain services, which may include legal, accounting, due diligence tasks and other services, that outside professionals or outside consultants otherwise would perform, provided that such costs and reimbursements are in amounts which are no greater than those which would be payable to outside professionals or consultants engaged to perform such services pursuant to agreements negotiated on an arm's-length basis. The Company will also pay or reimburse all operating expenses incurred by the Advisor, except those specifically required to be borne by the Advisor under the Investment Advisory Agreement. In addition, the Company may be required to pay its portion of rent, telephone, utilities, office furniture, equipment, machinery and other office, internal and overhead expenses of the Advisor and its affiliates required for the Company's operations. The Company will not reimburse the Advisor or its affiliates for the salaries and other compensation of the Advisor's personnel. The Advisor cannot be terminated prior to an IPO. Following an IPO and after an initial three-year term, the Advisor may be terminated annually upon the affirmative vote of at least two-thirds of the Company's independent directors or by a vote of the holders of at least two-thirds of the outstanding shares of the Company's common stock.
For the nine months ended September 30, 2012, the Company incurred $728,521 in advisory fee expense, of which $494,167 was included in accounts payable and other liabilities in the consolidated balance sheet at September 30, 2012. For the period from July 29, 2011(Inception) to September 30, 2011 the Company incurred $148,880 in advisory fee expenses.
9. Stockholders' Equity
Common Stock
The holders of shares of the Company's common stock are entitled to one vote per share on all matters voted on by stockholders, including election of the Company's directors. The Company's charter does not provide for cumulative voting in the election of directors. Therefore, the holders of a majority of the outstanding shares of the Company's common stock can elect its entire board of directors. Subject to any preferential rights of any outstanding series of preferred stock, the holders of shares of the Company's common stock are entitled to such distributions as may be authorized from time to time by its board of directors out of legally available funds and declared by the Company and, upon liquidation, are entitled to receive all assets available for distribution to stockholders. Holders of shares of the Company's common stock will not have preemptive rights, which means that stockholders will not have an automatic option to purchase any new shares of common stock that the Company issues, or have appraisal rights, unless the Company's board of directors determines that appraisal rights apply, with respect to all or any classes or series of its common stock, to one or more transactions occurring after the date of such determination in connection with which stockholders would otherwise be entitled to exercise such rights.
F-24
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) (Continued)
9. Stockholders' Equity (Continued)
The Company had 3,022,617 shares of common stock outstanding as of September 30, 2012 and December 31, 2011.
Pursuant to a share repurchase agreement dated July 5, 2012, the Company was obligated at September 30, 2012, to repurchase 1,183,560 shares.
On May 1, 2012, the Company declared a dividend of $0.51 per share of common stock. The common stock dividend was paid on May 15, 2012 to stockholders of record as of the close of business on May 1, 2012.
On June 5, 2012, the Company declared a dividend of $0.57 per share of common stock. The common stock dividend was paid on June 21, 2012 to stockholders of record as of the close of business on June 5, 2012.
Preferred Shares
The Company's charter authorizes its board of directors to classify and reclassify any unissued shares of its common stock and preferred stock into other classes or series of stock. Prior to issuance of shares of each class or series, the board of directors is required by the Company's charter to set, subject to the charter restrictions on transfer of its stock, the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms or conditions of redemption for each class or series. Thus, the board of directors could authorize the issuance of shares of common stock or preferred stock with terms and conditions which could have the effect of delaying, deferring or preventing a transaction or change in control that might involve a premium price for holders of the Company's common stock or otherwise be in their best interest.
On January 18, 2012 the Company completed a private placement of 133 shares of its 12.5% Series A cumulative non-voting preferred stock raising net proceeds of $115,499, net of $17,501 in offering fees.
10. Commitments and Contingencies
Advisor Services
The Company is dependent on the Advisor for certain services that are essential to the Company, including the identification, evaluation, negotiation, origination, acquisition and disposition of investments; management of the daily operations of the Company's investment portfolio; and other general and administrative responsibilities. In the event that the Advisor is unable to provide the respective services, the Company will be required to obtain such services from an alternative source.
Litigation
From time to time, the Company may become involved in various claims and legal actions arising in the ordinary course of business. Management is not aware of any significant contingencies at September 30, 2012 or December 31, 2011.
F-25
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited) (Continued)
11. Subsequent Events
On October 11, 2012, the Company completed the first closing of a private offering. Pursuant to the offering, the Company will offer shares of its common stock or OP Units (or a combination thereof), in one or more offerings of up to an aggregate number of shares of common stock and OP units, which are convertible to shares of the Company's common stock, equal in value to $120 million, in reliance on exemptions from the registration requirements of the Securities Act pursuant to Section 4(2) or Regulation S thereof. The offering price for the Company's shares of common stock and OP Units was $22.23 per common share or OP Unit, as applicable. Approximately $4,345,000 of shares of common stock and $500,000 of OP Units were sold. Net proceeds from the closing of this offering, after deducting offering expenses, were approximately $4.4 million, which the Company used to repurchase shares of common stock.
On October 11, 2012, the Company settled its obligation reflected at September 30, 2012 to repurchase 668,525 shares of common stock for a gross purchase price of $14.2 million and cancelled the shares of common stock. In addition, the Company renegotiated a share repurchase agreement for 515,035 shares of its common stock from one of its existing institutional stockholders to be purchased in January 2013 at a price per share equal to its book value per share as of the month end prior to the repurchase.
On October 22, 2012, the Company declared a dividend in respect of the second quarter of 2012 of $0.89 per share of common stock and OP unit, payable to stockholders and OP Unit holders of record on October 22, 2012, which was paid on October 29, 2012.
Events subsequent to September 30, 2012 were evaluated through the date these financial statements were issued and no additional events were identified requiring further disclosure in these Consolidated Financial Statements.
F-26
Report of Independent Auditors
To the Board of Directors and Stockholders of ZAIS Financial Corp.:
In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations, stockholders' equity and cash flows present fairly, in all material respects, the financial position of ZAIS Financial Corp. and its subsidiaries at December 31, 2011, and the results of their operations and their cash flows for the period from July 29, 2011 (inception) to December 31, 2011 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States) and in accordance with the auditing and attestation standards established by the American Institute of Certified Public Accountants. 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
As discussed in Note 1 to the consolidated financial statements, the Company does not expect to completed an initial public offering within the time provided by the Exchange Offer Statement and is considering its alternatives, including an orderly liquidation of its assets.
April 27, 2012
PricewaterhouseCoopers LLP, PricewaterhouseCoopers Center, 300 Madison Avenue,
New York, NY 10017 T: (646) 471 3000, F: (813) 286 6000
, www.pwc.com/us
F-27
ZAIS Financial Corp. and Subsidiaries
Consolidated Balance Sheet
December 31, 2011
(Expressed in United States Dollars)
Assets |
||||
Cash |
$ | 6,326,724 | ||
Restricted cash |
1,715,211 | |||
Real estate securities, at fair value$115,589,035 pledged as collateral |
145,971,111 | |||
Other assets |
92,148 | |||
Total assets |
$ | 154,105,194 | ||
Liabilities |
||||
Repurchase agreements |
$ | 97,597,010 | ||
Accounts payable and other liabilities |
871,060 | |||
Derivative instruments |
254,302 | |||
Accrued interest payable |
64,948 | |||
Total liabilities |
98,787,320 | |||
Stockholders' Equity |
||||
Class A common stock $0.0001 par value 500,000,000 shares authorized; 3,022,617 shares issued and outstanding |
302 | |||
Series A preferred stock, $0.0001 par value; 50,000,000 shares authorized, zero shares issued and outstanding |
| |||
Additional paid-in capital |
60,452,038 | |||
Accumulated deficit |
(5,134,466 | ) | ||
Total stockholders' equity |
55,317,874 | |||
Total liabilities and stockholders' equity |
$ | 154,105,194 | ||
The accompanying notes are an integral part of these consolidated financial statements.
F-28
ZAIS Financial Corp. and Subsidiaries
Consolidated Statement of Operations
Period from July 29, 2011 (Inception) to December 31, 2011
(Expressed in United States Dollars)
Interest income |
||||
Real estate securities |
$ | 3,617,753 | ||
Total interest income |
3,617,753 | |||
Interest expense |
||||
Repurchase agreements |
295,433 | |||
Total interest expense |
295,433 | |||
Net interest income |
3,322,320 | |||
Other loss |
||||
Unrealized loss on real estate securities |
(5,960,301 | ) | ||
Realized loss on real estate securities |
(1,481,921 | ) | ||
Loss on derivative instruments |
(235,599 | ) | ||
Total other loss |
(7,677,821 | ) | ||
Expenses |
||||
Advisory fee |
361,890 | |||
Professional fees |
363,969 | |||
General and administrative expenses |
53,106 | |||
Total expenses |
778,965 | |||
Net loss applicable to common stockholders |
$ | (5,134,466 | ) | |
Net loss per share applicable to common stockholdersbasic and diluted |
$ | (1.70 | ) | |
Weighted average number of shares outstandingbasic and diluted |
3,022,617 | |||
The accompanying notes are an integral part of these consolidated financial statements.
F-29
ZAIS Financial Corp. and Subsidiaries
Consolidated Statement of Stockholder's Equity
Period from July 29, 2011 (Inception) to December 31, 2011
(Expressed in United States Dollars)
|
Shares of
Common Stock |
Common
Stock at Par |
Additional
Paid-in Capital |
Accumulated
Deficit |
Total ZAIS
Financial Corp. Stockholders' Equity |
|||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Balance at July 29, 2011 (Inception) |
| $ | | $ | | $ | | $ | | |||||||
Exchange offer contribution |
3,022,617 | 302 | 60,452,038 | | 60,452,340 | |||||||||||
Net loss applicable to common stockholders |
| | | (5,134,466 | ) | (5,134,466 | ) | |||||||||
Balance at December 31, 2011 |
3,022,617 | $ | 302 | $ | 60,452,038 | $ | (5,134,466 | ) | $ | 55,317,874 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
F-30
ZAIS Financial Corp. and Subsidiaries
Consolidated Statement of Cash Flows
Period from July 29, 2011 (Inception) to December 31, 2011
(Expressed in United States Dollars)
Cash flows from operating activities |
||||
Net loss applicable to common stockholders |
$ | (5,134,466 | ) | |
Adjustments to reconcile net loss applicable to common stockholders to net cash provided by operating activities |
||||
Net (accretion)/amortization of (discounts)/premiums related to real estate securities |
(1,688,467 | ) | ||
Unrealized loss on real estate securities |
5,960,301 | |||
Realized loss on real estate securities |
1,481,921 | |||
Changes in operating assets and liabilities |
||||
Increase in other assets |
(92,148 | ) | ||
Increase in accounts payable and other liabilities |
871,060 | |||
Increase in accrued interest payable |
64,948 | |||
Net cash provided by operating activities |
1,463,149 | |||
Cash flows from investing activities |
||||
Acquisition of real estate securities |
(107,245,213 | ) | ||
Proceeds from principal repayments on real estate securities |
5,720,282 | |||
Proceeds from sale of real estate securities |
7,216,183 | |||
Restricted cash used in investment activities |
(1,715,211 | ) | ||
Derivative instruments |
254,302 | |||
Net cash used in investing activities |
(95,769,657 | ) | ||
Cash flows from financing activities |
||||
Proceeds from issuance of common stock upon exchange offer |
3,036,222 | |||
Borrowings from repurchase agreements |
108,041,100 | |||
Repayments of repurchase agreements |
(10,444,090 | ) | ||
Net cash provided by financing activities |
100,633,232 | |||
Net increase in cash |
6,326,724 | |||
Cash |
||||
Beginning of period |
| |||
End of period |
$ | 6,326,724 | ||
Supplemental disclosure of non-cash investing and financing activities |
||||
Exchange offer contributiondebt securities, at fair value |
$ | 57,416,118 | ||
Supplemental disclosure of cash flow information |
||||
Interest paid |
$ | (224,475 | ) | |
Taxes paid |
$ | |
The accompanying notes are an integral part of these consolidated financial statements.
F-31
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2011
1. Formation and Organization
ZAIS Financial Corp. (the "Company") was incorporated in Maryland on May 24, 2011, and intends to qualify as a real estate investment trust ("REIT") beginning with the taxable year ended December 31, 2011. The Company was initially capitalized and commenced operations on July 29, 2011, when it completed an exchange of a mutually agreed upon portion of the shareholders' and limited partners' interests in the ZAIS Matrix VI-A Ltd. and ZAIS Matrix VI-B L.P. funds (the "Matrix Funds") managed by ZAIS Group, LLC (the "Advisor"), which included cash of $3,036,222 and real estate securities having a fair market value of $57,416,118, for 3,022,617 shares of the Company's common stock or operating partnership units ("OP units"), pursuant to an exchange offer statement dated May 25, 2011 and the related contribution agreements executed on July 29, 2011. All OP units were converted into shares of common stock upon issuance.
The Company was organized primarily to invest in, finance and manage residential mortgage loans and residential mortgage-backed securities ("RMBS") that are not issued or guaranteed by a U.S. Government agency or by a federally chartered corporation ("non-Agency RMBS"). The Company also initially intends to acquire RMBS for which a U.S. Government agency or federally chartered corporation guarantees payments of principal and interest on the securities ("Agency RMBS") and has the discretion to invest in other real estate-related and financial assets, including, but not limited to, commercial mortgage-backed securities and other asset-backed securities. The Company is externally managed by the Advisor and has no employees. Substantially all of the Company's business is conducted through ZAIS Financial Partners, L.P., the Company's operating partnership (the "OP"). The Company is the sole general partner of the OP. The Company and a subsidiary, are the limited partners of the OP.
The Company's charter authorizes the issuance of up to 500,000,000 shares of common stock with a par value of $0.0001 per share, and 50,000,000 shares of preferred stock, with a par value of $0.0001 per share. The Company's board of directors is authorized to amend its charter, without the approval of the stockholders, to increase the aggregate number of authorized shares of capital stock or the number of shares of any class or series that the Company has authority to issue.
In connection with the exchange of interests described above, the Company committed to complete an initial public offering ("IPO") by August 3, 2012 or, in the event an IPO was not completed by such date, to commence the orderly liquidation of its assets. The Company does not believe that current market conditions would permit an IPO to be completed by August 3, 2012 under terms acceptable to the Company. The Company is currently considering alternatives to an IPO, including raising additional equity capital through one or more private placements, as well as seeking the consents of its existing stockholders to not having their shares redeemed in connection with a liquidation or otherwise. There is no assurance that the Company will be able to raise additional equity capital or obtain consents of its existing stockholders to enable it to defer commencing an orderly liquidation. The Company is not required to, and does not expect to, conclude the liquidation of its assets prior to December 31, 2012.
F-32
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
December 31, 2011
2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("U.S. GAAP") as contained within the Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") and the rules and regulations of the Securities and Exchange Commission.
The Company currently operates as one business segment.
Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may ultimately differ from those estimates.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, which are controlled by the Company. All significant intercompany balances have been eliminated in consolidation.
Variable Interest Entities
A variable interest entity ("VIE") is an entity that lacks one or more of the characteristics of a voting interest entity. The Company evaluates each of its investments to determine if each is a VIE based on: (1) the sufficiency of the entity's equity investment at risk to finance its activities without additional subordinated financial support provided by any parties, including the equity holders; (2) whether as a group the holders of the equity investment at risk have (a) the power, through voting rights or similar rights, to direct the activities of a legal entity that most significantly impacts the entity's economic performance, (b) the obligation to absorb the expected losses of the legal entity and (c) the right to receive the expected residual returns of the legal entity; and (3) whether the voting rights of these investors are proportional to their obligations to absorb the expected losses of the entity, their rights to receive the expected returns of their equity, or both, and whether substantially all of the entity's activities involve or are conducted on behalf of an investor that has disproportionately fewer voting rights. An investment that lacks one or more of the above three characteristics is considered to be a VIE. The Company reassesses its initial evaluation of an entity as a VIE upon the occurrence of certain reconsideration events.
The Company has evaluated its securities investments to determine if each represents a variable interest in a VIE. The Company monitors these investments and analyzes them for potential consolidation. The Company will continue to analyze future investments pursuant to the VIE requirements. These analyses require considerable judgment in determining the primary beneficiary of a VIE. The Company's securities investments represent variable interests in VIEs. At December 31, 2011, no VIEs required consolidation.
F-33
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
December 31, 2011
2. Summary of Significant Accounting Policies (Continued)
Cash
There are no restrictions on the use of the Company's cash as of December 31, 2011. The Company's deposits with financial institutions may exceed federally insurable limits of $250,000 per institution. The Company mitigates this risk by depositing funds with a major financial institution.
Restricted Cash
Restricted cash represents the Company's cash held by counterparties as collateral against the Company's derivatives and/or repurchase agreements. Cash held by counterparties as collateral is not available to the Company for general corporate purposes, but may be applied against amounts due to securities, derivative or repurchase agreement counterparties or returned to the Company when the collateral requirements are exceeded or, at the maturity of the derivatives or repurchase agreements.
Real Estate SecuritiesFair Value Election
U.S. GAAP permits entities to choose to measure many financial instruments and certain other items at fair value. The Company has elected the fair value option for each of its real estate securities at the date of purchase, including those contributed in connection with the initial exchange offer contribution, which permits the Company to measure these securities at estimated fair value with the change in estimated fair value included as a component of earnings. The Company believes that the election of the fair value option for its real estate securities portfolio more appropriately reflects the results of the Company's operations for a particular reporting period as all securities activities are recorded in a similar manner.
Determination of Fair Value and Market Value Measurement
The "Fair Value Measurements and Disclosures" Topic of the FASB ASC defines fair value, establishes a framework for measuring fair value, and requires certain disclosures about fair value measurements under U.S. GAAP. Specifically, this guidance defines fair value based on exit price, or the price that would be received upon the sale of an asset or the transfer of a liability in an orderly transaction between market participants at the measurement date.
Fair value under U.S. GAAP represents an exit price in the normal course of business, not a forced liquidation price. If the Company was forced to sell assets in a short period to meet liquidity needs, the prices it receives could be substantially less than their recorded fair values. Furthermore, the analysis of whether it is more likely than not that the Company will be required to sell securities in an unrealized loss position prior to an expected recovery in value (if any), the amount of such expected required sales, and the projected identification of which securities would be sold is also subject to significant judgment.
Fair value is determined by the Company's Advisor. Any changes to the valuation methodology will be reviewed by the Advisor to ensure the changes are appropriate. The methods used by the Advisor may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while the Company
F-34
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
December 31, 2011
2. Summary of Significant Accounting Policies (Continued)
anticipates that the Advisor's valuation methods will be appropriate and consistent with other market participants, the use of different methodologies, or assumptions, to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.
The Company categorizes its financial instruments in accordance with U.S. GAAP, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the financial instruments fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.
Financial assets and liabilities recorded on the consolidated balance sheet are categorized based on the inputs to the valuation techniques as follows:
Level 1 Quoted prices for identical assets or liabilities in an active market.
Level 2 Financial assets and liabilities whose values are based on the following:
Level 3 Prices or valuation techniques based on inputs that are both unobservable and significant to the overall fair value measurement.
The Company may use valuation techniques consistent with the market and income approaches to measure the fair value of its assets and liabilities. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. The income approach uses valuation techniques to convert future projected cash flows to a single discounted present value amount. When applying either approach, the Company maximizes the use of observable inputs and minimizes the use of unobservable inputs. The Company reviews the fair values determined by the third-party pricing models and dealer quotes and compare the results to internally generated pricing models on each asset or liability to validate reasonableness.
The following is a description of the valuation techniques used to measure fair value and the general classification of these instruments pursuant to the fair value hierarchy.
Real Estate Securities
The fair value of the Company's real estate securities considers the underlying characteristics of each security including coupon, maturity date and collateral. The Company
F-35
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
December 31, 2011
2. Summary of Significant Accounting Policies (Continued)
estimates the fair value of its Agency RMBS and non-Agency RMBS based upon a combination of observable prices in active markets, multiple indicative quotes from brokers, and executable bids. In evaluating broker quotes the Company also considers additional observable market data points including recent observed trading activity for identical and similar securities, back-testing, broker challenges and other interactions with market participants, as well as yield levels generated by model-based valuation techniques. In absence of observable quotes, the Company utilizes model-based valuation techniques that may contain unobservable valuation inputs.
When available, the fair value of real estate securities is based on quoted prices in active markets. If quoted prices are not available, fair values are obtained from either broker quotes, observed traded levels or model-based valuation techniques using observable inputs such as benchmark yields or issuer spreads. The Company's Agency RMBS are valued using the market data described above, which includes inputs determined to be observable or whose significant value drivers are observable. Accordingly, Agency RMBS securities are classified as Level 2 in the fair value hierarchy.
While the Company's non-Agency RMBS are valued using the same process with similar inputs as the Agency RMBS, a significant amount of inputs are unobservable due to relativity low levels of market activity. The fair value of these securities is typically based on broker quotes or the Company's model-based valuation. Accordingly, the Company's non-Agency RMBS are classified as Level 3 in the fair value hierarchy. Model-based valuation consists primarily of discounted cash flow and yield analyses. Significant model inputs and assumptions include market-implied discount rates, default rates, expected loss severity, weighted average life, collateral composition, borrower characteristics and prepayment rates, and may also include general economic conditions, Home Price Index forecasts, servicing data and other relevant information. Where possible, collateral-related assumptions are determined on an individual loan level.
Derivative Instruments
Derivative instruments are valued using counterparty valuations. These valuations are generally based on models with market observable inputs such as interest rates and contractual cash flows, and as such, are classified as Level 2 of the fair value hierarchy. The Company reviews these valuations, including consideration of counterparty risk and collateral provisions.
Interest Income Recognition and Impairment
Interest income on Agency RMBS is accrued based on the outstanding principal balance and their contractual terms. Premiums and discounts associated with Agency RMBS at the time of purchase are amortized into interest income over the life of such securities using the effective yield method and adjusted for actual prepayments in accordance with ASC 310-20 "Nonrefundable Fees and Other Costs" or ASC 325-40 "Beneficial Interests in Securitized Financial Assets," as applicable. Total interest income is recorded as Interest incomereal estate securities in the consolidated statement of operations.
F-36
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
December 31, 2011
2. Summary of Significant Accounting Policies (Continued)
Interest income on the non-Agency RMBS that were purchased at a discount to par value and/or were rated below AA at the time of purchase is recognized based on the effective yield method. The effective yield on these securities is based on the projected cash flows from each security, which are estimated based on the Company's observation of current information and events and include assumptions related to interest rates, prepayment rates and the timing and amount of credit losses. On at least a quarterly basis, the Company reviews and, if appropriate, makes adjustments to its cash flow projections based on input and analysis received from external sources, internal models, and its judgment about interest rates, prepayment rates, the timing and amount of credit losses, and other factors. Changes in cash flows from those originally projected, or from those estimated at the last evaluation, may result in a prospective change in the yield/interest income recognized on such securities. Actual maturities of the securities are affected by the contractual lives of the associated mortgage collateral, periodic payments of principal, and prepayments of principal. Therefore, actual maturities of the securities are generally shorter than stated contractual maturities.
Based on the projected cash flows from the Company's non-Agency RMBS purchased at a discount to par value, a portion of the purchase discount may be designated as credit protection against future credit losses and, therefore, not accreted into interest income. The amount designated as credit discount may be adjusted over time, based on the actual performance of the security, its underlying collateral, actual and projected cash flow from such collateral, economic conditions and other factors. If the performance of a security with a credit discount is more favorable than forecasted, a portion of the amount designated as credit discount may be accreted into interest income prospectively.
Real estate securities are periodically evaluated for other-than-temporary impairment ("OTTI"). A security where the fair value is less than amortized cost is considered impaired. Impairment of a security is considered to be other-than-temporary when: (i) the holder has the intent to sell the impaired security; (ii) it is more likely than not the holder will be required to sell the security; or (iii) the holder does not expect to recover the entire amortized cost of the security. When a security has been deemed to be other-than-temporarily impaired, the amount of OTTI is bifurcated into: (i) the amount related to expected credit losses; and (ii) the amount related to fair value adjustments in excess of expected credit losses. The portion of OTTI related to expected credit losses is recognized in the consolidated statement of operations as a realized loss. The remaining OTTI related to the valuation adjustment is recognized as a component of unrealized loss in the consolidated statement of operations. Realized gains and losses on sale of real estate securities are determined using the specific identification method. Real estate securities transactions are recorded on the trade date.
Repurchase Agreements
The Company finances a portion of its investment portfolio through the use of repurchase agreements entered into under a Master Repurchase Agreement with a financial institution. Repurchase agreements are treated as collateralized financing transactions and are carried at their contractual amounts, including accrued interest, as specified in the respective agreements. Repurchase agreements are recorded on trade date at the contract amount.
F-37
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
December 31, 2011
2. Summary of Significant Accounting Policies (Continued)
The Company pledges cash and certain of its securities as collateral under these repurchase arrangements. The amounts available to be borrowed are dependent upon the fair value of the securities pledged as collateral, which fluctuates with changes in interest rates, type of security and liquidity conditions within the banking, mortgage finance and real estate industries. In response to declines in fair value of pledged securities, the lender may require the Company to post additional collateral or pay down borrowings to re-establish agreed upon collateral requirements, referred to as margin calls. As of December 31, 2011, the Company has met all margin call requirements.
Derivatives and Hedging Activities
The Company accounts for its derivative financial instruments in accordance with derivative accounting guidance, which requires an entity to recognize all derivatives as either assets or liabilities in the balance sheets and to measure those instruments at fair value. The Company has not designated any of its derivative contracts as hedging instruments for accounting purposes. As a result, changes in the fair value of derivatives are recorded through current period earnings.
The Company's derivative contracts contain legally enforceable provisions that allow for netting or setting off of all individual swap receivables and payables with the counterparty and, therefore, the fair value of those swap contracts are netted. The credit support annex provisions of the Company's interest rate swap contracts allow the parties to mitigate their credit risk by requiring the party which is out of the money to post collateral. At December 31, 2011, all collateral provided under these contracts consists of cash collateral.
Net Income (Loss) Per Share
The Company calculates basic income per share by dividing net income (loss) for the period by weighted-average shares of the Company's common stock outstanding for that period. The Company has no potentially dilutive instruments at December 31, 2011.
Income Taxes
The Company intends to elect to be organized and operate in a manner that qualifies the Company to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the "Code"). To qualify as a REIT, the Company must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of the Company's annual REIT taxable income to its stockholders (which is computed without regard to the dividends paid deduction or net capital gain and which does not necessarily equal net income as calculated in accordance with U.S. GAAP). As a REIT, the Company will not be subject to federal income tax on its taxable income that it distributes to its stockholders. If the Company fails to qualify as a REIT in any taxable year, it will be subject to federal income tax on its taxable income at regular corporate income tax rates and generally will not be permitted to qualify for treatment as a REIT for federal income tax purposes for the four taxable years following the year during which qualification is lost unless the Internal Revenue Service grants the Company relief under certain statutory provisions. Such an event could materially adversely affect the
F-38
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
December 31, 2011
2. Summary of Significant Accounting Policies (Continued)
Company's net income and net cash available for distribution to stockholders. However, the Company intends to organize and operate in such a manner as to qualify for treatment as a REIT. At December 31, 2011, general and administrative expenses includes $51,943 in accrued excise taxes related to the declaration and distribution of 2011 dividends.
Recent Accounting Pronouncements
In April 2011, the FASB issued ASU No. 2011-03, Reconsideration of Effective Control for Repurchase Agreements ("ASU 2011-03"), which is intended to improve the accounting for repurchase agreements by removing from the assessment of effective control the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, as well as implementation guidance related to that criterion. ASU 2011-03 is effective for the first interim or annual period beginning on or after December 15, 2011 and the guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. The Company does not believe the adoption of ASU 2011-03 will have a material impact on its consolidated financial statements.
In May 2011, the FASB issued ASU No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs ("ASU 2011-04"), which largely aligns fair value measurement and disclosure requirements between International Financial Reporting Standards and U.S. GAAP. For U.S. GAAP, the update mainly represents clarifications to Topic 820 Fair Value Measurement as well as some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. ASU 2011-04 clarifies that (i) the highest and best use concept only applies to nonfinancial assets, (ii) an instrument classified in stockholders' equity should be measured from the perspective of a market participant holding that instrument as an asset and (iii) quantitative disclosure is required for unobservable inputs used in Level 3 measurements. ASU 2011-04 changes the guidance in Topic 820 so that (i) the fair value of a group of financial assets and financial liabilities with similar risk exposures may be measured on the basis of the entity's net risk exposure, (ii) premiums or discounts may be applied in a fair value measurement under certain circumstances but blockage factors are not permitted and (iii) additional Level 3 disclosures are required, including a narrative description of the sensitivity of the fair value measurement to changes in unobservable inputs. ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011. Early application by public entities is not permitted. The Company does not believe the adoption of ASU 2011-04 will have a material impact on its consolidated financial statements.
In December 2011, FASB issued ASU No. 2011-11: Disclosures about Offsetting Assets and Liabilities ( "ASU 2011-11") which requires new disclosures about balance sheet offsetting and related arrangements. For derivatives and financial assets and liabilities, the amendment requires disclosure of gross asset and liability amounts, amounts offset on the balance sheet, and amounts subject to the offsetting requirements but not offset on the balance sheet. The guidance is effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods and is to be applied retrospectively for all comparative periods presented. The Company does not believe the adoption of ASU 2011-11 will have a material impact on its consolidated financial statements.
F-39
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
December 31, 2011
3. Fair Value
Fair Value Measurement
Financial assets and liabilities recorded at fair value on a recurring basis are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
The following tables set forth the Company's financial instruments that were accounted for at fair value on a recurring basis as of December 31, 2011, by level within the fair value hierarchy:
|
Assets and Liabilities at Fair Value | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Level 1 | Level 2 | Level 3 | Total | |||||||||
Assets |
|||||||||||||
Real estate securities |
|||||||||||||
Agency RMBS |
|||||||||||||
30-year adjustable rate mortgage |
$ | | $ | 13,475,942 | $ | | $ | 13,475,942 | |||||
30-year fixed rate mortgage |
| 56,022,077 | | 56,022,077 | |||||||||
Non-agency RMBS |
| | 76,473,092 | 76,473,092 | |||||||||
Total assets |
$ | | $ | 69,498,019 | $ | 76,473,092 | $ | 145,971,111 | |||||
Liabilities |
|||||||||||||
Derivative instruments |
$ | | $ | 254,302 | $ | | $ | 254,302 | |||||
Total liabilities |
$ | | $ | 254,302 | $ | | $ | 254,302 | |||||
The following table presents additional information about the Company's real estate securities which are measured at fair value on a recurring basis at December 31, 2011, for which the Company has utilized Level 3 inputs to determine fair value:
Beginning balance |
$ | | ||
Total net transfers into/out of Level 3 |
| |||
Exchange offer contribution |
57,416,118 | |||
Purchases |
36,887,261 | |||
Sales |
(7,216,183 | ) | ||
Accretion on real estate securities |
1,682,296 | |||
Principal repayments |
(4,608,855 | ) | ||
Total losses (realized or unrealized) included in earning |
(8,036,628 | ) | ||
Total gains (realized or unrealized) included in earning |
349,082 | |||
Ending balance |
$ | 76,473,092 | ||
The amount of total gains or (losses) for the period included in earnings attributable to the change in unrealized gains or losses relating to assets or liabilities still held at the reporting date |
$ | (6,205,624 | ) |
F-40
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
December 31, 2011
3. Fair Value (Continued)
There were no financial assets or liabilities that were accounted for at fair value on a nonrecurring basis at December 31, 2011. There were no transfers into or out of Level 3 during the period from July 29, 2011 (Inception) to December 31, 2011.
Fair Value Option
Changes in fair value for assets and liabilities for which the fair value election is made are recognized in income as they occur. The fair value option may be elected on an instrument-by-instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument.
The following table presents the difference between the fair value and the aggregate unpaid principal amount of assets for which the fair value option was elected at December 31, 2011:
|
Fair Value at
December 31, 2011 |
Amount
Due Upon Maturity |
Difference | |||||||
---|---|---|---|---|---|---|---|---|---|---|
Financial instruments, at fair value |
||||||||||
Assets |
||||||||||
Real estate securities |
||||||||||
Agency RMBS |
||||||||||
30-year adjustable rate mortgage |
$ | 13,475,942 | $ | 12,904,151 | $ | 571,791 | ||||
30-year fixed rate mortgage |
56,022,077 | 52,681,733 | 3,340,344 | |||||||
Nonagency RMBS |
76,473,092 | 121,607,167 | (45,134,075 | ) | ||||||
Total assets |
$ | 145,971,111 | $ | 187,193,051 | $ | (41,221,940 | ) | |||
For the period from July 29, 2011 (Inception) to December 31, 2011, the Company recognized a net loss of $5,960,301 from the change in fair value of real estate securities for which the fair value option was elected and that were still held at December 31, 2011.
Fair Value of Other Financial Instruments
In addition to the above disclosures regarding assets or liabilities which are recorded at fair value, U.S. GAAP requires disclosure about the fair value of all other financial instruments. Estimated fair value of financial instruments was determined by the Company, using available market information and appropriate valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair values. The use of different market assumptions and/or estimation methodologies may have a material effect on estimated fair value.
F-41
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
December 31, 2011
3. Fair Value (Continued)
The following table summarizes the estimated fair value for all other financial instruments as of December 31, 2011:
Other financial instruments
|
|
|||
---|---|---|---|---|
Liabilities |
||||
Repurchase agreements |
$ | 97,423,747 | ||
|
$ | 97,423,747 | ||
The fair value of repurchase agreements is based on an expected present value technique. This method discounts future estimated cash flows using rates the Company determined best reflect current market interest rates that would be offered for loans with similar characteristics and credit quality.
4. Real Estate Securities
The following table presents the current principal balance, amortized cost, gross unrealized gain, gross unrealized loss, and estimated fair market value of the Company's real estate securities portfolio at December 31, 2011. The Company's Agency RMBS are mortgage pass-through certificates representing interests in or obligations backed by pools of residential mortgage loans issued or guaranteed by Fannie Mae or Freddie Mac. The non-Agency RMBS portfolios are not issued or guaranteed by Fannie Mae, Freddie Mac or any other U.S. Government agency or a federally chartered corporation and are therefore subject to credit risk.
F-42
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
December 31, 2011
4. Real Estate Securities (Continued)
The following table details weighted average life by Agency and non-Agency securities as of December 31, 2011:
|
Agency Securities | Non-Agency Securities | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Fair
Value |
Amortized
Cost |
Weighted
Average Yield |
Fair
Value |
Amortized
Cost |
Weighted
Average Yield |
|||||||||||||
Weighted average life (1) |
|||||||||||||||||||
Greater than 5 years |
$ | 69,498,019 | $ | 69,252,696 | 3.52 | % | $ | 76,473,092 | $ | 82,678,716 | 8.33 | % | |||||||
|
$ | 69,498,019 | $ | 69,252,696 | 3.52 | % | $ | 76,473,092 | $ | 82,678,716 | 8.33 | % | |||||||
At December 31, 2011, the contractual maturities of the real estate securities ranged from 9.6 to 35.0 years, with a weighted average maturity of 27.1 years.
During the period from July 29, 2011 (Inception) to December 31, 2011, proceeds from the sale of real estate securities were $7,216,183, realized losses on the sale of real estate securities were $1,273,761 and realized losses on other-than-temporary impairments were $208,160.
5. Repurchase Agreements
Repurchase arrangements involve the sale and a simultaneous agreement to repurchase the transferred assets or similar assets at a future date. The amount borrowed generally is equal to the fair value of the assets pledged less an agreed-upon discount, referred to as a "haircut." Repurchase arrangements entered into by the Company are accounted for as financings and require the repurchase of the transferred securities at the end of each arrangement's term, typically 30 to 90 days. The Company maintains the beneficial interest in the specific securities pledged during the term of the repurchase arrangement and receives the related principal and interest payments. Interest rates on these borrowings are fixed based on prevailing rates corresponding to the terms of the borrowings, and interest is paid at the termination of the repurchase arrangement at which time the Company may enter into a new repurchase arrangement at prevailing market rates with the same counterparty or repay that counterparty and negotiate financing with a different counterparty. In response to declines in fair value of pledged securities due to changes in market conditions or the publishing of monthly security paydown factors, the lender requires the Company to post additional securities as collateral, pay down borrowings or establish cash margin accounts with the counterparty in order to re-establish the agreed-upon collateral requirements, referred to as margin calls. Under the terms of the Company's master repurchase agreements, the counterparty may sell or re-hypothecate the pledged collateral.
F-43
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
December 31, 2011
5. Repurchase Agreements (Continued)
The following table presents certain information regarding the Company's repurchase agreements as of December 31, 2011 by remaining maturity and collateral type:
|
Agency Securities | Non-Agency Securities | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Balance |
Weighted
Average Rate |
Balance |
Weighted
Average Rate |
|||||||||
Repurchase agreements maturing within |
|||||||||||||
30 days or less |
$ | 25,732,880 | 0.60 | % | $ | 30,958,070 | 2.28 | % | |||||
31-60 days |
37,475,420 | 0.50 | | 0.00 | |||||||||
61-90 days |
3,430,640 | 0.50 | | 0.00 | |||||||||
Greater than 90 days |
| 0.00 | | 0.00 | |||||||||
|
$ | 66,638,940 | 0.54 | % | $ | 30,958,070 | 2.28 | % | |||||
Although repurchase agreements are committed borrowings until maturity, the lender retains the right to mark the underlying collateral to fair value. A reduction in the value of pledged assets would require the Company to provide additional collateral or cash to fund margin calls.
The following table presents information with respect to the Company's posting of collateral at December 31, 2011:
Repurchase agreements secured by Agency RMBS |
$ | 66,638,940 | ||
Fair value of Agency RMBS pledged as collateral under repurchase agreements |
69,498,019 | |||
Repurchase agreements secured by non-Agency RMBS |
30,958,070 | |||
Fair value of non-Agency RMBS pledged as collateral under repurchase agreements |
46,091,017 | |||
Cash pledged (i.e. restricted cash) under repurchase agreements |
585,052 |
6. Derivative Instruments
Interest Rate Swaps
To help mitigate exposure to higher short-term interest rates, the Company uses currently-paying and forward-starting, three-month LIBOR-indexed, pay-fixed, receive-variable, interest rate swap agreements. These arrangements establish an economic fixed rate on related borrowings because the variable-rate payments received on the swap agreements largely offset interest accruing on the related borrowings, leaving the fixed-rate payments to be paid on the swap agreements as the Company's effective borrowing rate, subject to certain adjustments including changes in spreads between variable rates on the swap agreements and actual borrowing rates.
F-44
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
December 31, 2011
6. Derivative Instruments (Continued)
The Company's interest rate swap derivatives have not been designated as hedging instruments.
The following table presents information about the Company's interest rate swaps as of December 31, 2011:
Maturity
|
Notional
Amount |
Weighted
Average Pay Rate |
Weighted
Average Receive Rate |
Weighted
Average Years to Maturity |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
2016 |
$ | 12,102,000 | 1.21 | % | 0.38 | % | 4.7 | ||||||
2021 |
9,448,000 | 2.16 | 0.38 | 9.7 | |||||||||
Total/Weighted average |
$ | 21,550,000 | 1.62 | % | 0.38 | % | 6.9 | ||||||
The following table presents the fair value of the Company's derivative instruments and their balance sheet location:
Derivative Instruments
|
Designation | Balance Sheet Location |
December 31,
2011 |
|||||
---|---|---|---|---|---|---|---|---|
Interest rate swaps, at fair value |
Non-hedge | Derivative instruments | $ | (254,302 | ) |
The following table summarizes gains (losses) related to derivatives:
Non-hedge Derivative Losses
|
Income Statement Location |
December 31,
2011 |
||||
---|---|---|---|---|---|---|
Interest rate swaps, at fair value |
Loss on
derivative instruments |
$ | (235,599 | ) |
The following table summarizes information related to derivative instruments:
Non-hedge Derivatives
|
December 31,
2011 |
|||
---|---|---|---|---|
Notional amount of interest rate swaps |
$ | 21,550,000 |
Restricted cash at December 31, 2011 includes $1,130,159 of cash pledged as collateral against interest rate swaps.
7. Earnings Per Share
The following table presents a reconciliation of the earnings and shares used in calculating basic and diluted earnings per share, or EPS, for the period from July 29, 2011 (Inception) to December 31, 2011:
Numerator |
||||
Net loss applicable to common stockholders for basic and diluted earnings per share |
$ | (5,134,466 | ) | |
Denominator |
||||
Basic/diluted weighted average shares outstanding |
3,022,617 | |||
Basic/diluted net loss per share |
$ | (1.70 | ) |
F-45
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
December 31, 2011
8. Related Party Transactions
ZAIS Group, LLC
The Company was initially capitalized and commenced operations on July 29, 2011, when it completed an exchange of a mutually agreed upon portion of the shareholders' and limited partners' interests in the Matrix Funds, which are managed by the Advisor.
Subject to certain restrictions and limitations, the Advisor is responsible for managing the Company's affairs on a day-to-day basis and for, among other responsibilities, (i) the selection, purchase and sale of the Company's portfolio of assets (ii) the Company's financing activities, and (iii) providing the Company with advisory services.
The Company will pay to its Advisor an advisory fee, calculated and payable quarterly in arrears, equal to 1.5% per annum of (i) prior to an IPO, the Company's net asset value and (ii) following the completion of an IPO, the Company's stockholders' equity.
The Advisor will be paid or reimbursed for the documented cost of performing certain services, which may include legal, accounting, due diligence tasks and other services, that outside professionals or outside consultants otherwise would perform, provided that such costs and reimbursements are in amounts which are no greater than those which would be payable to outside professionals or consultants engaged to perform such services pursuant to agreements negotiated on an arm's-length basis. The Company will also pay or reimburse all operating expenses incurred by the Advisor, except those specifically required to be borne by the Advisor under the Investment Advisory Agreement. In addition, the Company may be required to pay its portion of rent, telephone, utilities, office furniture, equipment, machinery and other office, internal and overhead expenses of the Advisor and its affiliates required for the Company's operations. The Advisor cannot be terminated prior to an IPO. Following an IPO and after an initial three-year term, the Advisor may be terminated annually upon the affirmative vote of at least two-thirds of the Company's independent directors or by a vote of the holders of at least two-thirds of the outstanding shares of the Company's common stock.
For the period from July 29, 2011, (Inception) to December 31, 2011, the Company incurred $361,890 in advisory fee expenses, payable to the Advisor, which are recorded as Accounts payable and other liabilities in the consolidated balance sheet at December 31, 2011. Accounts payable and other liabilities at December 31, 2011 includes $61,801 payable to the Advisor related to the reimbursement of insurance premiums.
9. Stockholders' Equity
Common Stock
The holders of shares of the Company's common stock are entitled to one vote per share on all matters voted on by stockholders, including election of the Company's directors. The Company's charter does not provide for cumulative voting in the election of directors. Therefore, the holders of a majority of the outstanding shares of the Company's common stock can elect its entire board of directors. Subject to any preferential rights of any outstanding series of preferred stock, the holders of shares of the Company's common stock are entitled to such distributions as may be authorized from time to time by its board of directors out of legally available funds and declared by the Company and, upon liquidation, are entitled to receive all assets available for distribution to stockholders. Holders of shares of the Company's common stock will not have preemptive rights, which means that stockholders will not have an automatic option to purchase any new shares of common stock that the
F-46
ZAIS Financial Corp. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
December 31, 2011
9. Stockholders' Equity (Continued)
Company issues, or have appraisal rights, unless the Company's board of directors determines that appraisal rights apply, with respect to all or any classes or series of its common stock, to one or more transactions occurring after the date of such determination in connection with which stockholders would otherwise be entitled to exercise such rights.
The Company had 3,022,617 shares of common stock outstanding as of December 31, 2011.
Preferred Shares
The Company's charter authorizes its board of directors to classify and reclassify any unissued shares of its common stock and preferred stock into other classes or series of stock. Prior to issuance of shares of each class or series, the board of directors is required by the Company's charter to set, subject to the charter restrictions on transfer of its stock, the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms or conditions of redemption for each class or series. Thus, the board of directors could authorize the issuance of shares of common stock or preferred stock with terms and conditions which could have the effect of delaying, deferring or preventing a transaction or change in control that might involve a premium price for holders of the Company's common stock or otherwise be in their best interest.
10. Commitments and Contingencies
Advisor Services
The Company is dependent on the Advisor for certain services that are essential to the Company, including the identification, evaluation, negotiation, origination, acquisition and disposition of investments; management of the daily operations of the Company's investment portfolio; and other general and administrative responsibilities. In the event that the Advisor is unable to provide the respective services, the Company will be required to obtain such services from an alternative source.
Counterparty Concentration
As of December 31, 2011, all repurchase agreements and derivative instruments have been entered into with the same counterparty.
Litigation
From time to time, the Company may become involved in various claims and legal actions arising in the ordinary course of business. Management is not aware of any significant contingencies at December 31, 2011.
11. Subsequent Events
On January 18, 2012 the Company completed a private placement of 133 shares of Series A cumulative non-voting preferred stock having an interest rate of 12.5% and raising net proceeds of $109,250, net of $23,750 in fees.
F-47
You should rely only on the information contained in this prospectus. We have not authorized anyone to provide information different from that contained in this prospectus. We are offering to sell, and seeking offers to buy, shares of common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of our common stock.
TABLE OF CONTENTS
Until , 2013 (25 days after the date of this prospectus), all dealers that effect transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealer's obligation to deliver a prospectus when acting as an underwriter and with respect to unsold allotments or subscriptions.
ZAIS Financial Corp.
Shares
Common Stock
Deutsche Bank Securities
Citigroup
Barclays
Credit Suisse
Stifel Nicolaus Weisel
Oppenheimer & Co.
Ladenburg Thalmann & Co. Inc.
Prospectus
, 2013
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 31. Other expenses of issuance and distribution.
The following table shows the fees and expenses, other than underwriting fee, to be paid by us in connection with the sale and distribution of the securities being registered hereby. All amounts except the SEC registration fee are estimated.
|
(dollars in thousands)
|
|||
---|---|---|---|---|
Securities and Exchange Commission registration fee |
$ | 19,096 | ||
Financial Industry Regulatory Authority, Inc. filing fee |
$ | * | ||
NYSE listing fee |
$ | * | ||
Legal fees and expenses (including Blue Sky fees) |
$ | * | ||
Accounting fees and expenses |
$ | * | ||
Printing and engraving expenses |
$ | * | ||
Transfer agent fees and expenses |
$ | * | ||
Miscellaneous |
$ | * | ||
Total |
$ | * | ||
Item 32. Sales to Special Parties.
None.
Item 33. Recent sales of unregistered securities.
On July 29, 2011, we completed a private placement whereby existing holders of shares and limited partnership interests in two funds from the Matrix VI series of funds of cash and RMBS assets with a net asset value of $60.5 million (calculated as of July 29, 2011) exchanged their shares and limited partnership interests for an aggregate of 3,022,617 shares of our common stock, which equaled a value per share of common stock as of July 29, 2011 of $20.00. We received $60.5 million in the private placement, including $8.65 million from certain current and former employees of ZAIS and relatives of such persons as well as current and former members and owners of ZAIS (or, collectively, the ZAIS Parties) and deployed the cash together with additional borrowings to build a diversified portfolio of RMBS assets. The ZAIS Parties who participated in our formation received 432,328 shares of our common stock in connection therewith. Such issuances were exempt from the registration requirements of the Securities Act pursuant to Section 4(2) or Regulation S thereof.
On January 18, 2012, we sold 133 shares of our Series A Cumulative Non-Voting Preferred Stock, par value $0.0001 per share (or the Series A Preferred Shares), for $1,000 per share to a select group of investors who are "accredited investors" within the meaning of Rule 501(a) of Regulation D promulgated under the Securities Act. Such issuance was exempt from the registration requirements of the Securities Act pursuant to Section 4(2) thereof. The Series A Preferred Shares were sold through H & L Equities, LLC or such other registered broker-dealers as selected by REIT Funding, LLC. In exchange for providing such services, we paid a fee of $15,000 to REIT Funding, LLC (and agreed to reimburse REIT Funding, LLC for certain expenses). From this fee, REIT Funding, LLC was responsible for paying the brokerage or placement fees of $6,650 and advisory fees.
II-1
On October 11, 2012, we completed the closing of a private offering. We sold 195,457 shares of common stock and 22,492 OP Units in reliance on exemptions from the registration requirements of the Securities Act pursuant to Section 4(2) or Regulation S thereof at an offering price of $22.23 per common share or OP Unit, as applicable. Net proceeds from the closing of this offering, after deducting offering expenses, were $4.4 million, which we used to repurchase shares of common stock.
On December 13, 2012, we completed the closing of a private offering. We sold 36,581 shares of common stock and 904,422 OP units in reliance on exemptions from the registration requirements of the Securities Act pursuant to Section 4(2) or Regulation S thereof at an offering price of $22.39 per common share or OP Unit, as applicable. Net proceeds from the closing of this offering, after deducting offering expenses, were $20.9 million, which we plan to use to fund the repurchase of shares of common stock in connection with the January 2013 share repurchase and to purchase of our target assets, focusing primarily on Agency RMBS and non-Agency RMBS.
Item 34. Indemnification of directors and officers.
Maryland law permits a Maryland corporation to include in its charter a provision limiting the liability of its directors and officers to the corporation and its stockholders for money damages except for liability resulting from (1) actual receipt of an improper benefit or profit in money, property or services or (2) active and deliberate dishonesty that was established by a final judgment and was material to the cause of action. Our charter contains a provision that eliminates the liability of our directors and officers to the maximum extent permitted by Maryland law.
The MGCL requires us (unless our charter provides otherwise, which our charter does not) to indemnify a director or officer who has been successful, on the merits or otherwise, in the defense of any proceeding to which he or she is made a party by reason of his or her service in that capacity. The MGCL permits us to indemnify our present and former directors and officers, among others, against judgments, penalties, fines, settlements and reasonable expenses actually incurred by them in connection with any proceeding to which they may be made or threatened to be made a party by reason of their service in those or other capacities unless it is established that:
However, under the MGCL, we may not indemnify a director or officer in a suit by us or in our right in which the director or officer was adjudged liable to us or in a suit in which the director or officer was adjudged liable on the basis that personal benefit was improperly received, unless in either case a court orders indemnification and then only for expenses.
II-2
In addition, the MGCL permits us to advance reasonable expenses to a director or officer upon our receipt of:
Our charter authorizes us to obligate ourselves, and our bylaws obligate us, to the fullest extent permitted by Maryland law in effect from time to time, to indemnify and, without requiring a preliminary determination of the ultimate entitlement to indemnification, pay or reimburse reasonable expenses in advance of final disposition of a proceeding to:
Our charter and bylaws also permit us to indemnify and advance expenses to any person who served a predecessor of ours in any of the capacities described above and any employee or agent of our company or a predecessor of our company.
We have entered into indemnification agreements with each of our directors and officers that provide for indemnification to the maximum extent permitted by Maryland law.
Insofar as the foregoing provisions permit indemnification of directors, officers or persons controlling us for liability arising under the Securities Act, we have been informed that, in the opinion of the SEC, this indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable.
Item 35. Treatment of proceeds from stock being registered.
None of the proceeds will be credited to an account other than the appropriate capital share account.
Item 36. Financial statements and exhibits.
Exhibit
number |
Exhibit description | ||
---|---|---|---|
1.1* | Form of Underwriting Agreement among ZAIS Financial Corp. and the underwriters named therein | ||
|
3.1 |
|
Articles of Amendment and Restatement of ZAIS Financial Corp. |
|
3.2 |
|
Articles Supplementary of ZAIS Financial Corp. |
II-3
Exhibit
number |
Exhibit description | ||
---|---|---|---|
3.3 | Bylaws of ZAIS Financial Corp. | ||
|
4.1* |
|
Specimen Common Stock Certificate of ZAIS Financial Corp. |
|
5.1* |
|
Opinion of Clifford Chance US LLP (including consent of such firm) |
|
8.1* |
|
Tax Opinion of Clifford Chance US LLP (including consent of such firm) |
|
10.1 |
|
Second Amended and Restated Investment Advisory Agreement, dated as of December 13, 2012, by and among ZAIS Financial Corp., ZAIS Financial Partners, L.P., ZAIS Asset I, LLC, ZAIS Asset II, LLC, ZAIS Asset III, LLC, ZAIS Asset IV, LLC and ZAIS REIT Management, LLC |
|
10.2 |
|
Agreement of Limited Partnership, dated as of July 29, 2011, of ZAIS Financial Partners, L.P., as amended on August 3, 2011, October 11, 2012, and December 13, 2012. |
|
10.3 |
|
Registration Rights Agreement, dated August 3, 2011, among ZAIS Financial Corp., ZAIS Group, LLC and certain persons listed on Schedule I thereto |
|
10.4 |
|
First Amended and Restated Registration Rights Agreement, dated October 11, 2012, among ZAIS Financial Corp., ZAIS Group, LLC and certain persons listed on Schedule I thereto |
|
10.5 |
|
First Amended and Restated Registration Rights Agreement, dated December 13, 2012, among ZAIS Financial Corp., ZAIS REIT Management, LLC and certain persons listed on Schedule I thereto |
|
10.6 |
|
Indemnification Agreement, dated August 3, 2011, between ZAIS Financial Corp. and Christian Zugel |
|
10.7 |
|
Indemnification Agreement, dated August 3, 2011, between ZAIS Financial Corp. and Michael Szymanski |
|
10.8 |
|
Indemnification Agreement, dated August 3, 2011, between ZAIS Financial Corp. and Denise Crowley |
|
10.9 |
|
Indemnification Agreement, dated August 3, 2011, between ZAIS Financial Corp. and Paul McDade |
|
10.10 |
|
Indemnification Agreement, dated August 3, 2011, between ZAIS Financial Corp. and Brian Hargrave |
|
10.11 |
|
Indemnification Agreement, dated December 13, 2012, between ZAIS Financial Corp. and Steven Haber |
|
10.12* |
|
Form of Indemnification Agreement among ZAIS Financial Corp. and its proposed directors |
|
10.13 |
|
ZAIS Financial Corp. 2012 Equity Incentive Plan |
|
10.14* |
|
Form of Restricted Stock Award Agreement |
|
10.15* |
|
Form of Restricted Stock Unit Award Agreement |
|
10.16* |
|
Form of License Agreement |
|
10.17 |
|
Forms of Irrevocable Exchange and Subscription Agreement between various contributors and ZAIS Financial Corp. (relating to the initial formation transactions) |
II-4
Exhibit
number |
Exhibit description | ||
---|---|---|---|
21.1 | List of Subsidiaries of ZAIS Financial Corp. | ||
|
23.1* |
|
Consent of Clifford Chance US LLP (included in Exhibit 5.1) |
|
23.2* |
|
Consent of Clifford Chance US LLP (included in Exhibit 8.1) |
|
23.3 |
|
Consent of PricewaterhouseCoopers LLP |
|
99.1** |
|
Consent of Daniel Mudge as a director nominee |
|
99.2** |
|
Consent of Marran Ogilvie as a director nominee |
|
99.3** |
|
Consent of Eric Reimer as a director nominee |
|
99.4** |
|
Consent of James Zinn as a director nominee |
II-5
Pursuant to the requirements of the Securities Act of 1933, the registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form S-11 and has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Red Bank, State of New Jersey, on January 28, 2013.
ZAIS Financial Corp. | ||||
|
|
By: |
|
/s/ MICHAEL SZYMANSKI Name: Michael Szymanski Title: Chief Executive Officer and President |
Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed below by the following persons in the capacities and on the date indicated.
Signatures
|
Title
|
Date
|
||||
---|---|---|---|---|---|---|
|
|
|
|
|
|
|
By: |
/s/ CHRISTIAN ZUGEL
Christian Zugel |
Chairman of the Board of Directors
(Co-Principal Executive Officer) |
January 28, 2013 | |||
By: |
|
/s/ MICHAEL SZYMANSKI Michael Szymanski |
|
Chief Executive Officer, President and Director (Co-Principal Executive Officer) |
|
January 28, 2013 |
By: |
|
/s/ PAUL MCDADE Paul McDade |
|
Chief Financial Officer and Treasurer (Principal Financial Officer and Principal Accounting Officer) |
|
January 28, 2013 |
II-6
Exhibit
number |
Exhibit description | ||
---|---|---|---|
1.1* | Form of Underwriting Agreement among ZAIS Financial Corp. and the underwriters named therein | ||
|
3.1 |
|
Articles of Amendment and Restatement of ZAIS Financial Corp. |
|
3.2 |
|
Articles Supplementary of ZAIS Financial Corp. |
|
3.3 |
|
Bylaws of ZAIS Financial Corp. |
|
4.1* |
|
Specimen Common Stock Certificate of ZAIS Financial Corp. |
|
5.1* |
|
Opinion of Clifford Chance US LLP (including consent of such firm) |
|
8.1* |
|
Tax Opinion of Clifford Chance US LLP (including consent of such firm) |
|
10.1 |
|
Second Amended and Restated Investment Advisory Agreement, dated as of December 13, 2012, by and among ZAIS Financial Corp., ZAIS Financial Partners, L.P., ZAIS Asset I, LLC, ZAIS Asset II, LLC, ZAIS Asset III, LLC, ZAIS Asset IV, LLC and ZAIS REIT Management, LLC |
|
10.2 |
|
Agreement of Limited Partnership, dated as of July 29, 2011, of ZAIS Financial Partners, L.P., as amended on August 3, 2011, October 11, 2012, and December 13, 2012. |
|
10.3 |
|
Registration Rights Agreement, dated August 3, 2011, among ZAIS Financial Corp., ZAIS Group, LLC and certain persons listed on Schedule I thereto |
|
10.4 |
|
First Amended and Restated Registration Rights Agreement, dated October 11, 2012, among ZAIS Financial Corp., ZAIS Group, LLC and certain persons listed on Schedule I thereto |
|
10.5 |
|
First Amended and Restated Registration Rights Agreement, dated December 13, 2012, among ZAIS Financial Corp., ZAIS REIT Management, LLC and certain persons listed on Schedule I thereto |
|
10.6 |
|
Indemnification Agreement, dated August 3, 2011, between ZAIS Financial Corp. and Christian Zugel |
|
10.7 |
|
Indemnification Agreement, dated August 3, 2011, between ZAIS Financial Corp. and Michael Szymanski |
|
10.8 |
|
Indemnification Agreement, dated August 3, 2011, between ZAIS Financial Corp. and Denise Crowley |
|
10.9 |
|
Indemnification Agreement, dated August 3, 2011, between ZAIS Financial Corp. and Paul McDade |
|
10.10 |
|
Indemnification Agreement, dated August 3, 2011, between ZAIS Financial Corp. and Brian Hargrave |
|
10.11 |
|
Indemnification Agreement, dated December 13, 2012, between ZAIS Financial Corp. and Steven Haber |
|
10.12* |
|
Form of Indemnification Agreement among ZAIS Financial Corp. and its proposed directors |
|
10.13 |
|
ZAIS Financial Corp. 2012 Equity Incentive Plan |
II-7
Exhibit
number |
Exhibit description | ||
---|---|---|---|
10.14* | Form of Restricted Stock Award Agreement | ||
|
10.15* |
|
Form of Restricted Stock Unit Award Agreement |
|
10.16* |
|
Form of License Agreement |
|
10.17 |
|
Forms of Irrevocable Exchange and Subscription Agreement between various contributors and ZAIS Financial Corp. (relating to the initial formation transactions) |
|
21.1 |
|
List of Subsidiaries of ZAIS Financial Corp. |
|
23.1* |
|
Consent of Clifford Chance US LLP (included in Exhibit 5.1) |
|
23.2* |
|
Consent of Clifford Chance US LLP (included in Exhibit 8.1) |
|
23.3 |
|
Consent of PricewaterhouseCoopers LLP |
|
99.1** |
|
Consent of Daniel Mudge as a director nominee |
|
99.2** |
|
Consent of Marran Ogilvie as a director nominee |
|
99.3** |
|
Consent of Eric Reimer as a director nominee |
|
99.4** |
|
Consent of James Zinn as a director nominee |
II-8
Exhibit 3.1
ZAIS FINANCIAL CORP.
ARTICLES OF AMENDMENT AND RESTATEMENT
FIRST : ZAIS Financial Corp., a Maryland corporation (the Corporation), desires to amend and restate its charter as currently in effect and as hereinafter amended.
SECOND : The following provisions are all the provisions of the charter currently in effect and as hereinafter amended:
ARTICLE I
INCORPORATOR
Monica Clavijo, whose address is c/o Clifford Chance US LLP, 31 West 52 nd Street, New York, New York, 10019, being at least 18 years of age, formed a corporation under the general laws of the State of Maryland on May 24, 2011.
ARTICLE II
NAME
The name of the corporation (the Corporation) is:
ZAIS Financial Corp.
ARTICLE III
PURPOSE
The purposes for which the Corporation is formed are to engage in any lawful act or activity (including, without limitation or obligation, engaging in business as a real estate investment trust under the Internal Revenue Code of 1986, as amended, or any successor statute (the Code)) for which corporations may be organized under the general laws of the State of Maryland as now or hereafter in force. For purposes of the charter of the Corporation (the Charter), REIT means a real estate investment trust under Sections 856 through 860 of the Code.
ARTICLE IV
PRINCIPAL OFFICE IN STATE AND RESIDENT AGENT
The address of the principal office of the Corporation in the State of Maryland is c/o The Corporation Trust Incorporated, 351 West Camden Street, Baltimore, Maryland 21201. The name and address of the resident agent of the Corporation in the State of Maryland are The Corporation Trust Incorporated, 351 West Camden Street, Baltimore, Maryland 21201. The resident agent is a Maryland corporation.
ARTICLE V
PROVISIONS FOR DEFINING, LIMITING
AND REGULATING CERTAIN POWERS OF THE
CORPORATION AND OF THE STOCKHOLDERS AND DIRECTORS
Section 5.1 Number of Directors . The business and affairs of the Corporation shall be managed under the direction of the Board of Directors. The number of directors of the Corporation initially shall be three, which number may be increased or decreased only by the Board of Directors pursuant to the Bylaws of the Corporation (the Bylaws), but shall never be less than the minimum number required by the Maryland General Corporation Law (the MGCL). The names of the directors who shall serve until the first annual meeting of stockholders and until their successors are duly elected and qualify are:
Denise Crowley
Michael Szymanski
Christian Zugel
These directors may increase the number of directors and may fill any vacancy, whether resulting from an increase in the number of directors or otherwise, on the Board of Directors occurring before the first annual meeting of stockholders in the manner provided in the Bylaws.
The Corporation elects, at such time as it becomes eligible to make the election provided for under Section 3-804(c) of the MGCL, that, except as may be provided by the Board of Directors in setting the terms of any class or series of Preferred Stock (as hereinafter defined),
any and all vacancies on the Board of Directors may be filled only by the affirmative vote of a majority of the remaining directors in office, even if the remaining directors do not constitute a quorum, and any director elected to fill a vacancy shall serve for the remainder of the full term of the directorship in which such vacancy occurred and until a successor is elected and qualifies.
Section 5.2 Extraordinary Actions . Except as specifically provided in Section 5.8 (relating to removal of directors) and in the last sentence of Article VIII, notwithstanding any provision of law permitting or requiring any action to be taken or approved by the affirmative vote of the holders of shares entitled to cast a greater number of votes, any such action shall be effective and valid if declared advisable by the Board of Directors and taken or approved by the affirmative vote of holders of shares entitled to cast a majority of all the votes entitled to be cast on the matter.
Section 5.3 Authorization by Board of Stock Issuance . The Board of Directors may authorize the issuance from time to time of shares of stock of the Corporation of any class or series, whether now or hereafter authorized, or securities or rights convertible into shares of its stock of any class or series, whether now or hereafter authorized, for such consideration as the Board of Directors may deem advisable (or without consideration in the case of a stock split or stock dividend), subject to such restrictions or limitations, if any, as may be set forth in the Charter or the Bylaws.
Section 5.4 Preemptive and Appraisal Rights . Except as may be provided by the Board of Directors in setting the terms of classified or reclassified shares of stock pursuant to Section 6.4 or as may otherwise be provided by a contract approved by the Board of Directors, no holder of shares of stock of the Corporation shall, as such holder, have any preemptive right to purchase or subscribe for any additional shares of stock of the Corporation or any other security of the Corporation which it may issue or sell. Holders of shares of stock shall not be entitled to exercise any rights of an objecting stockholder provided for under Title 3, Subtitle 2 of the MGCL or any successor statute unless the Board of Directors, upon the affirmative vote of a majority of the Board of Directors, shall determine that such rights apply, with respect to all or
any classes or series of stock, to one or more transactions occurring after the date of such determination in connection with which holders of such shares would otherwise be entitled to exercise such rights.
Section 5.5 Indemnification . The Corporation shall have the power, to the maximum extent permitted by Maryland law in effect from time to time, to obligate itself to indemnify, and to pay or reimburse reasonable expenses in advance of final disposition of a proceeding to, (a) any individual who is a present or former director or officer of the Corporation or (b) any individual who, while a director or officer of the Corporation and at the request of the Corporation, serves or has served as a director, officer, partner, trustee, member or manager of another corporation, REIT, limited liability company, partnership, joint venture, trust, employee benefit plan or any other enterprise from and against any claim or liability to which such person may become subject or which such person may incur by reason of his or her service in such capacity. The Corporation shall have the power, with the approval of the Board of Directors, to provide such indemnification and advancement of expenses to a person who served a predecessor of the Corporation in any of the capacities described in (a) or (b) above and to any employee or agent of the Corporation or a predecessor of the Corporation.
Section 5.6 Determinations by Board . The determination as to any of the following matters, made in good faith by or pursuant to the direction of the Board of Directors consistent with the Charter, shall be final and conclusive and shall be binding upon the Corporation and every holder of shares of its stock: the amount of the net income of the Corporation for any period and the amount of assets at any time legally available for the payment of dividends, redemption of its stock or the payment of other distributions on its stock; the amount of paid-in surplus, net assets, other surplus, annual or other cash flow, funds from operations, net profit, net assets in excess of capital, undivided profits or excess of profits over losses on sales of assets; the amount, purpose, time of creation, increase or decrease, alteration or cancellation of any reserves or charges and the propriety thereof (whether or not any obligation or liability for which such reserves or charges shall have been created shall have been paid or
discharged); any interpretation of the terms, preferences, conversion or other rights, voting powers or rights, restrictions, limitations as to dividends or other distributions, qualifications or terms or conditions of redemption of any class or series of stock of the Corporation; the fair value, or any sale, bid or asked price to be applied in determining the fair value, of any asset owned or held by the Corporation or of any shares of stock of the Corporation; the net asset value per share of stock of the Corporation; the number of shares of stock of any class or series of the Corporation; any matter relating to the acquisition, holding and disposition of any assets by the Corporation; or any other matter relating to the business and affairs of the Corporation or required or permitted by applicable law, the Charter or Bylaws or otherwise to be determined by the Board of Directors.
Section 5.7 REIT Qualification . If the Corporation elects to qualify for U.S. federal income tax treatment as a REIT, the Board of Directors shall use its reasonable best efforts to take such actions as are necessary or appropriate to preserve the qualification of the Corporation as a REIT; however, if the Board of Directors determines that it is no longer in the best interests of the Corporation to continue to be qualified as a REIT, the Board of Directors may revoke or otherwise terminate the Corporations REIT election pursuant to Section 856(g) of the Code. The Board of Directors also may determine that compliance with any restriction or limitation on stock ownership and transfers set forth in Article VII is no longer required for REIT qualification.
Section 5.8 Removal of Directors . Subject to the rights of holders of one or more classes or series of Preferred Stock to elect or remove one or more directors, any director, or the entire Board of Directors, may be removed from office with or without cause at any time, but only by the affirmative vote of holders of shares entitled to cast at least two-thirds of all the votes entitled to be cast generally in the election of directors.
Section 5.9 Advisor Agreements . Subject to such approval of stockholders and other conditions, if any, as may be required by any applicable statute, rule or regulation, the Board of Directors may authorize the execution and performance by the Corporation of one or
more agreements with any person, corporation, association, company, trust, partnership (limited or general) or other organization whereby, subject to the supervision and control of the Board of Directors, any such other person, corporation, association, company, trust, partnership (limited or general) or other organization shall render or make available to the Corporation managerial, investment, advisory and/or related services, office space and other services and facilities (including, if deemed advisable by the Board of Directors, the management or supervision of the investments of the Corporation) upon such terms and conditions as may be provided in such agreement or agreements (including, if deemed fair and equitable by the Board of Directors, the compensation payable thereunder by the Corporation).
ARTICLE VI
STOCK
Section 6.1 Authorized Shares . The Corporation has authority to issue 550,000,000 shares of stock, consisting of 500,000,000 shares of Common Stock, $.0001 par value per share (Common Stock), and 50,000,000 shares of Preferred Stock, $.0001 par value per share (Preferred Stock). The aggregate par value of all authorized shares of stock having par value is $55,000. If shares of one class of stock are classified or reclassified into shares of another class of stock pursuant to Section 6.2, 6.3 or 6.4 of this Article VI, the number of authorized shares of the former class shall be automatically decreased and the number of shares of the latter class shall be automatically increased, in each case by the number of shares so classified or reclassified, so that the aggregate number of shares of stock of all classes that the Corporation has authority to issue shall not be more than the total number of shares of stock set forth in the first sentence of this paragraph. The Board of Directors, with the approval of a majority of the entire Board and without any action by the stockholders of the Corporation, may amend the Charter from time to time to increase or decrease the aggregate number of shares of stock or the number of shares of stock of any class or series that the Corporation has authority to issue.
Section 6.2 Common Stock . Subject to the provisions of Article VII and except as may otherwise be specified in the Charter, each share of Common Stock shall entitle the holder thereof to one vote. The Board of Directors may reclassify any unissued shares of Common Stock from time to time into one or more classes or series of stock.
Section 6.3 Preferred Stock . The Board of Directors may classify any unissued shares of Preferred Stock and reclassify any previously classified but unissued shares of Preferred Stock of any series from time to time, into one or more classes or series of stock.
Section 6.4 Classified or Reclassified Shares . Prior to issuance of classified or reclassified shares of any class or series, the Board of Directors by resolution shall: (a) designate that class or series to distinguish it from all other classes and series of stock of the Corporation; (b) specify the number of shares to be included in the class or series; (c) set or change, subject to the provisions of Article VII and subject to the express terms of any class or series of stock of the Corporation outstanding at the time, the preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms and conditions of redemption for each class or series; and (d) cause the Corporation to file articles supplementary with the State Department of Assessments and Taxation of Maryland (SDAT). Any of the terms of any class or series of stock set or changed pursuant to clause (c) of this Section 6.4 may be made dependent upon facts or events ascertainable outside the Charter (including determinations by the Board of Directors or other facts or events within the control of the Corporation) and may vary among holders thereof, provided that the manner in which such facts, events or variations shall operate upon the terms of such class or series of stock is clearly and expressly set forth in the articles supplementary or other Charter document.
Section 6.5 Stockholders Consent in Lieu of Meeting . Any action required or permitted to be taken at any meeting of the stockholders may be taken without a meeting by consent, in writing or by electronic transmission, in any manner permitted by the MGCL and set forth in the Bylaws.
Section 6.6 Charter and Bylaws . The rights of all stockholders and the terms of
all stock are subject to the provisions of the Charter and the Bylaws.
ARTICLE VII
RESTRICTIONS ON TRANSFER AND OWNERSHIP OF SHARES
Section 7.1 Definitions . For the purpose of this Article VII, the following terms shall have the following meanings:
Aggregate Stock Ownership Limit . The term Aggregate Stock Ownership Limit shall mean 9.8 percent (in value or in number of shares, whichever is more restrictive) of the aggregate of the outstanding shares of Capital Stock, or such other percentage determined by the Board of Directors in accordance with Section 7.2.8 of the Charter.
Beneficial Ownership . The term Beneficial Ownership shall mean ownership of Capital Stock by a Person, whether the interest in the shares of Capital Stock is held directly or indirectly (including by a nominee), and shall include interests that would be treated as owned through the application of Section 544 of the Code, as modified by Sections 856(h)(1)(B) and 856(h)(3) of the Code. The terms Beneficial Owner, Beneficially Owns and Beneficially Owned shall have the correlative meanings.
Benefit Plan Investor . The term Benefit Plan Investor shall mean any holder of shares of Capital Stock that is (a) an employee benefit plan (as defined in Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended (ERISA)) that is subject to the provisions of Title I of ERISA; (b) a plan as defined in and is subject to Section 4975(e) of the Code (any such employee benefit plan or plan described in clause (a) or this clause (b) being referred to herein as a Plan); (c) an entity whose underlying assets include (or are deemed to include under ERISA or Section 4975(e) of the Code) assets of a Plan by reason of such Plans investment in such entity; or (d) any other entity that otherwise constitutes a benefit plan investor for purposes of the Plan Asset Regulations.
Business Day . The term Business Day shall mean any day, other than a Saturday or Sunday, that is neither a legal holiday nor a day on which banking institutions in New York City are authorized or required by law, regulation or executive order to close.
Capital Stock . The term Capital Stock shall mean all classes or series of stock of the Corporation, including, without limitation, Common Stock and Preferred Stock.
Charitable Beneficiary . The term Charitable Beneficiary shall mean one or more beneficiaries of the Trust as determined pursuant to Section 7.3.6, provided that each such organization must be described in Section 501(c)(3) of the Code and contributions to each such organization must be eligible for deduction under each of Sections 170(b)(1)(A), 2055 and 2522 of the Code.
Common Stock Ownership Limit . The term Common Stock Ownership Limit shall mean 9.8 percent (in value or in number of shares, whichever is more restrictive) of the aggregate of the outstanding shares of Common Stock, or such other percentage determined by the Board of Directors in accordance with Section 7.2.8 of the Charter.
Constructive Ownership . The term Constructive Ownership shall mean ownership of Capital Stock by a Person, whether the interest in the shares of Capital Stock is held directly or indirectly (including by a nominee), and shall include interests that would be treated as owned through the application of Section 318(a) of the Code, as modified by Section 856(d)(5) of the Code. The terms Constructive Owner, Constructively Owns and Constructively Owned shall have the correlative meanings.
Controlling Person . The term Controlling Person shall mean a Person (other than a Benefit Plan Investor) who has discretionary authority or control with respect to the assets of the Corporation or who provides investment advice to the Corporation for a fee (direct or indirect) with respect to such assets, and any affiliate of such Person.
Excepted Holder . The term Excepted Holder shall mean a Person for whom an Excepted Holder Limit is created by the Charter or by the Board of Directors pursuant to Section 7.2.7.
Excepted Holder Limit . The term Excepted Holder Limit shall mean, provided that the affected Excepted Holder agrees to comply with the requirements established by the
Board of Directors pursuant to Section 7.2.7 and subject to adjustment pursuant to Section 7.2.8, the percentage limit established by the Board of Directors pursuant to Section 7.2.7.
Initial Date . The term Initial Date shall mean the date upon which the Articles of Amendment and Restatement containing this Article VII are accepted for record by the SDAT.
Insignificant Participation Exception . The term Insignificant Participation Exception shall mean the exception under the Plan Asset Regulations that provides that an entitys assets will not be deemed to constitute the underlying assets of a Benefit Plan Investor that invests in the entity if at all times less than 25% of the value of each class of equity interests in the entity is held by one or more Benefit Plan Investors (disregarding any investment by a Controlling Person).
Market Price . The term Market Price on any date shall mean, with respect to any class or series of outstanding shares of Capital Stock, the Closing Price for such Capital Stock on such date. The Closing Price on any date shall mean the last sale price for such Capital Stock, regular way, or, in case no such sale takes place on such day, the average of the closing bid and asked prices, regular way, for such Capital Stock, in either case as reported in the principal consolidated transaction reporting system with respect to securities listed or admitted to trading on the NYSE or, if such Capital Stock is not listed or admitted to trading on the NYSE, as reported on the principal consolidated transaction reporting system with respect to securities listed on the principal national securities exchange on which such Capital Stock is listed or admitted to trading or, if such Capital Stock is not 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 principal automated quotation system that may then be in use or, if such Capital Stock is not quoted by any such system, the average of the closing bid and asked prices as furnished by a professional market maker making a market in such Capital Stock selected by the Board of Directors of the Corporation or, in the
event that no trading price is available for such Capital Stock, the fair market value of the Capital Stock, as determined in good faith by the Board of Directors of the Corporation.
NYSE . The term NYSE shall mean the New York Stock Exchange.
Person . The term Person shall mean an individual, corporation, partnership, estate, trust (including a trust qualified under Sections 401(a) or 501(c)(17) of the Code), a portion of a trust permanently set aside for or to be used exclusively for the purposes described in Section 642(c) of the Code, association, private foundation within the meaning of Section 509(a) of the Code, joint stock company or other entity and also includes a group as that term is used for purposes of Section 13(d)(3) of the Securities Exchange Act of 1934, as amended, and a group to which an Excepted Holder Limit applies.
Plan Asset Regulations . The term Plan Asset Regulations shall mean 29 C.F.R. Section 2510.3-101 et seq. issued by the U.S. Department of Labor.
Prohibited Owner . The term Prohibited Owner shall mean, with respect to any purported Transfer, any Person who, but for the provisions of this Article VII, would Beneficially Own or Constructively Own shares of Capital Stock in violation of Section 7.2.1, and if appropriate in the context, shall also mean any Person who would have been the record owner of the shares that the Prohibited Owner would have so owned.
Publicly-Offered Securities . The term Publicly-Offered Securities shall have the meaning provided in Section 2510.3-101(b)(2) of the Plan Asset Regulations, or any successor regulation thereto.
Restriction Termination Date . The term Restriction Termination Date shall mean the first day after the Initial Date on which the Board of Directors determines pursuant to Section 5.7 of the Charter that it is no longer in the best interests of the Corporation to attempt to, or continue to, qualify as a REIT or that compliance with the restrictions and limitations on Beneficial Ownership, Constructive Ownership and Transfers of shares of Capital Stock set forth herein is no longer required in order for the Corporation to qualify as a REIT.
Transfer . The term Transfer shall mean any issuance, sale, transfer, gift, assignment, devise or other disposition, as well as any other event that causes any Person to acquire Beneficial Ownership or Constructive Ownership, or any agreement to take any such actions or cause any such events, of Capital Stock or the right to vote or receive dividends on Capital Stock, including (a) the granting or exercise of any option (or any disposition of any option), (b) any disposition of any securities or rights convertible into or exchangeable for Capital Stock or any interest in Capital Stock or any exercise of any such conversion or exchange right and (c) Transfers of interests in other entities that result in changes in Beneficial Ownership or Constructive Ownership of Capital Stock; in each case, whether voluntary or involuntary, whether owned of record, Constructively Owned or Beneficially Owned and whether by operation of law or otherwise. The terms Transferring and Transferred shall have the correlative meanings.
Trust . The term Trust shall mean any trust provided for in Section 7.3.1.
Trustee . The term Trustee shall mean the Person unaffiliated with the Corporation and a Prohibited Owner, that is appointed by the Corporation to serve as trustee of the Trust.
Section 7.2 Capital Stock .
Section 7.2.1 Ownership Limitations . During the period commencing on the Initial Date and prior to the Restriction Termination Date, but subject to Section 7.4:
(a) Basic Restrictions .
(i) (1) No Person, other than an Excepted Holder, shall Beneficially Own or Constructively Own shares of Capital Stock in excess of the Aggregate Stock Ownership Limit, (2) no Person, other than an Excepted Holder, shall Beneficially Own or Constructively Own shares of Common Stock in excess of the Common Stock Ownership Limit and (3) no Excepted Holder shall Beneficially Own or Constructively Own shares of Capital Stock in excess of the Excepted Holder Limit for such Excepted Holder.
(ii) No Person shall Beneficially Own or Constructively Own shares of Capital Stock to the extent that such Beneficial Ownership or Constructive Ownership of Capital Stock would result in the Corporation being closely held within the meaning of Section 856(h) of the Code (without regard to whether the ownership interest is held during the last half of a taxable year), or otherwise failing to qualify as a REIT (including, but not limited to, Beneficial Ownership or Constructive Ownership that would result in the Corporation owning (actually or Constructively) an interest in a tenant that is described in Section 856(d)(2)(B) of the Code if the income derived by the Corporation from such tenant could cause the Corporation to fail to satisfy any of the gross income requirements of Section 856(c) of the Code).
(iii) Any Transfer of shares of Capital Stock that, if effective, would result in the Capital Stock being beneficially owned by less than 100 Persons (determined under the principles of Section 856(a)(5) of the Code) shall be void ab initio , and the intended transferee shall acquire no rights in such shares of Capital Stock.
(iv) During the period commencing on the Initial Date and prior to the date that either (1) each class or series of Capital Stock qualifies as a class of Publicly-Offered Securities or (2) the Corporation qualifies for another exception to the Plan Asset Regulations (other than the Insignificant Participation Exception), no Person shall Transfer or attempt to Transfer shares of Capital Stock to the extent such Transfer would result in 25% or more of any class or series of Capital Stock (excluding Capital Stock held by Controlling Persons who are not Benefit Plan Investors) being Beneficially Owned by one or more Benefit Plan Investors.
(v) During the period commencing on the Initial Date and prior to the date that either (1) each class or series of Capital Stock qualifies as a class of Publicly-Offered Securities or (2) the Corporation qualifies for another exception to the Plan Asset Regulations (other than the Insignificant Participation Exception), no Person (other than an underwriter that participates in the initial private placement of Capital Stock) shall Transfer or
attempt to Transfer shares of Capital Stock unless such Person obtains from its transferee a representation and agreement that (i) its transferee is not (and will not be), and is not acting on behalf of, a Benefit Plan Investor or Controlling Person and (ii) such transferee will obtain from its transferee the representation and agreement set forth in this sentence (including without limitation clauses (i) and (ii)).
(b) Transfer in Trust . If any Transfer of shares of Capital Stock occurs which, if effective, would result in any Person Beneficially Owning or Constructively Owning shares of Capital Stock in violation of Section 7.2.1(a)(i), (ii), (iv) or (v),
(i) then that number of shares of the Capital Stock the Beneficial Ownership or Constructive Ownership of which otherwise would cause such Person to violate Section 7.2.1(a)(i), (ii), (iv) or (v) (rounded up to the nearest whole share) shall be automatically transferred to a Trust for the benefit of a Charitable Beneficiary, as described in Section 7.3, effective as of the close of business on the Business Day prior to the date of such Transfer, and such Person shall acquire no rights in such shares; or
(ii) if the transfer to the Trust described in clause (i) of this sentence would not be effective for any reason to prevent the violation of Section 7.2.1(a)(i), (ii), (iv) or (v), then the Transfer of that number of shares of Capital Stock that otherwise would cause any Person to violate Section 7.2.1(a)(i), (ii), (iv) or (v), shall be void ab initio , and the intended transferee shall acquire no rights in such shares of Capital Stock.
(iii) To the extent that, upon a transfer of shares of Capital Stock pursuant to this Section 7.2.1(b), a violation of any provision of this Article VII would nonetheless be continuing (for example where the ownership of shares of Capital Stock by a single Trust would violate the 100 stockholder requirement applicable to REITs), then shares of Capital Stock shall be transferred to that number of Trusts, each having a distinct Trustee and a Charitable Beneficiary or Beneficiaries that are distinct from those of each other Trust, such that there is no violation of any provision of this Article VII.
Section 7.2.2 Remedies for Breach . If the Board of Directors or any duly authorized committee thereof shall at any time determine in good faith that a Transfer or other event has taken place that results in a violation of Section 7.2.1 or that a Person intends to acquire or has attempted to acquire Beneficial Ownership or Constructive Ownership of any shares of Capital Stock in violation of Section 7.2.1 (whether or not such violation is intended), the Board of Directors or such committee thereof shall take such action as it deems advisable to refuse to give effect to or to prevent such Transfer or other event, including, without limitation, causing the Corporation to redeem shares, refusing to give effect to such Transfer on the books of the Corporation or instituting proceedings to enjoin such Transfer or other event; provided , however , that any Transfer or attempted Transfer or other event in violation of Section 7.2.1 shall automatically result in the transfer to the Trust described above, and, where applicable, such Transfer (or other event) shall be void ab initio as provided above irrespective of any action (or non-action) by the Board of Directors or such committee thereof.
Section 7.2.3 Notice of Restricted Transfer . Any Person who acquires or attempts or intends to acquire Beneficial Ownership or Constructive Ownership of shares of Capital Stock that will or may violate Section 7.2.1(a) or any Person who would have owned shares of Capital Stock that resulted in a transfer to the Trust pursuant to the provisions of Section 7.2.1(b) shall immediately give written notice to the Corporation of such event or, in the case of such a proposed or attempted transaction, give at least 15 days prior written notice, and shall provide to the Corporation such other information as the Corporation may request in order to determine the effect, if any, of such Transfer on the Corporations qualification as a REIT.
Section 7.2.4 Owners Required To Provide Information . From the Initial Date and prior to the Restriction Termination Date:
(a) every owner of five percent or more (or such lower percentage as required by the Code or the U.S. Treasury Department regulations promulgated thereunder) of the outstanding shares of Capital Stock, within 30 days after the end of each taxable year, shall give written notice to the Corporation stating the name and address of such
owner, the number of shares of each class and series of Capital Stock and other shares of the Capital Stock Beneficially Owned and a description of the manner in which such shares are held. Each such owner shall provide to the Corporation such additional information as the Corporation may request in order to determine the effect, if any, of such Beneficial Ownership on the Corporations qualification as a REIT and to ensure compliance with the Common Stock Ownership Limit and the Aggregate Stock Ownership Limit; and
(b) each Person who is a Beneficial Owner or Constructive Owner of Capital Stock and each Person (including the stockholder of record) who is holding Capital Stock for a Beneficial Owner or Constructive Owner shall provide to the Corporation such information as the Corporation may request, in good faith, in order to determine the Corporations qualification as a REIT and to comply with the requirements of any taxing authority or governmental authority or to determine such compliance.
Section 7.2.5 Remedies Not Limited . Subject to Section 5.7 of the Charter, nothing contained in this Section 7.2 shall limit the authority of the Board of Directors to take such other action as it deems necessary or advisable to (a) protect the Corporation and the interests of its stockholders in preserving the Corporations qualification as a REIT or (b) avoid having the assets of the Corporation being considered to be plan assets (within the meaning of the Plan Asset Regulations) of any stockholder.
Section 7.2.6 Ambiguity . In the case of an ambiguity in the application of any of the provisions of this Section 7.2, Section 7.3, or any definition contained in Section 7.1, the Board of Directors shall have the power to determine the application of the provisions of this Section 7.2 or Section 7.3 or any such definition with respect to any situation based on the facts known to it. In the event Section 7.2 or 7.3 requires an action by the Board of Directors and the Charter fails to provide specific guidance with respect to such action, the Board of Directors shall have the power to determine the action to be taken so long as such action is not contrary to the provisions of Sections 7.1, 7.2 or 7.3. Absent a decision to the contrary by the Board of Directors (which the Board may make in its sole and absolute discretion), if a Person would have
(but for the remedies set forth in Section 7.2.2) acquired Beneficial Ownership or Constructive Ownership of Capital Stock in violation of Section 7.2.1, such remedies (as applicable) shall apply first to the shares of Capital Stock which, but for such remedies, would have been Beneficially Owned or Constructively Owned (but not actually owned) by such Person, pro rata among the Persons who actually own such shares of Capital Stock based upon the relative number of the shares of Capital Stock held by each such Person.
Section 7.2.7 Exceptions .
(a) Subject to Section 7.2.1(a)(ii), the Board of Directors, in its sole discretion, may exempt (prospectively or retroactively) a Person from the Aggregate Stock Ownership Limit and/or the Common Stock Ownership Limit, as the case may be, and may establish or increase an Excepted Holder Limit for such Person if:
(i) the Board of Directors obtains such representations and undertakings from such Person as are reasonably necessary to ascertain that no individuals (as defined in Section 542(a)(2) of the Code) Beneficial Ownership or Constructive Ownership of such shares of Capital Stock will violate Section 7.2.1(a)(ii);
(ii) such Person provides the Board of Directors with information including, to the extent necessary, representations and undertakings satisfactory to the Board of Directors in its reasonable discretion that demonstrate that such Person will not own, actually or Constructively, an interest in a tenant of the Corporation (or a tenant of any entity owned or controlled by the Corporation) that would cause the Corporation to own, actually or Constructively, more than a 9.9% interest (as set forth in Section 856(d)(2)(B) of the Code) in such tenant (for this purpose, a tenant from whom the Corporation (or an entity owned or controlled by the Corporation) derives (and is expected to continue to derive) a sufficiently small amount of revenue such that, in the opinion of the Board of Directors, rent from such tenant would not adversely affect the Corporations ability to qualify as a REIT shall not be treated as a tenant of the Corporation); and
(iii) such Person agrees that any violation or attempted violation of such representations or undertakings (or other action which is contrary to the restrictions contained in Sections 7.2.1 through 7.2.6) may result in such shares of Capital Stock being automatically transferred to a Trust in accordance with Sections 7.2.1(b) and 7.3.
(b) Prior to granting any exception pursuant to Section 7.2.7(a), the Board of Directors may require a ruling from the Internal Revenue Service, or an opinion of counsel, in either case in form and substance satisfactory to the Board of Directors in its sole discretion, as it may deem necessary or advisable in order to determine or ensure the Corporations status as a REIT. Notwithstanding the receipt of any ruling or opinion, the Board of Directors may impose such conditions or restrictions as it deems appropriate in connection with granting such exception.
(c) Subject to Section 7.2.1(a)(ii), an underwriter which participates in a public offering or a private placement of Capital Stock (or securities convertible into or exchangeable for Capital Stock) may Beneficially Own or Constructively Own shares of Capital Stock (or securities convertible into or exchangeable for Capital Stock) in excess of the Aggregate Stock Ownership Limit, the Common Stock Ownership Limit, or both such limits, but only to the extent necessary to facilitate such public offering or private placement.
(d) The Board of Directors may only reduce the Excepted Holder Limit for an Excepted Holder: (1) with the written consent of such Excepted Holder at any time, or (2) pursuant to the terms and conditions of the agreements and undertakings entered into with such Excepted Holder in connection with the establishment of the Excepted Holder Limit for that Excepted Holder. No Excepted Holder Limit shall be reduced to a percentage that is less than the Common Stock Ownership Limit.
Section 7.2.8 Increase in Aggregate Stock Ownership and Common Stock Ownership Limits . Subject to Section 7.2.1(a)(ii), the Board of Directors may from time to time increase the Common Stock Ownership Limit and the Aggregate Stock Ownership Limit for one or more Persons and decrease the Common Stock Ownership Limit and the Aggregate Stock
Ownership Limit for all other Persons; provided, however, that the decreased Common Stock Ownership Limit and/or Aggregate Stock Ownership Limit will not be effective for any Person whose percentage ownership in Common Stock is in excess of such decreased Common Stock Ownership Limit and/or whose percentage ownership in Capital Stock is in excess of such decreased Aggregate Stock Ownership Limit, as applicable, until such time as such Persons percentage of Common Stock equals or falls below the decreased Common Stock Ownership Limit and/or such Persons percentage of Capital Stock equals or falls below the decreased Aggregate Stock Ownership Limit, as applicable, but any further acquisition of Capital Stock in excess of such percentage ownership of Common Stock and/or Capital Stock will be in violation of the Common Stock Ownership Limit and/or Aggregate Stock Ownership Limit, as applicable, and, provided further, that the new Common Stock Ownership Limit and/or Aggregate Stock Ownership Limit would not allow five or fewer Persons to Beneficially Own more than 49.9% in value of the outstanding Capital Stock.
Section 7.2.9 Legend . Each certificate for shares of Capital Stock, if certificated, or any written statement of information in lieu of a certificate, if shares of Capital Stock are uncertificated, shall bear substantially the following legend:
The shares represented by this certificate are subject to restrictions on Beneficial Ownership and Constructive Ownership and Transfer for the purpose, among others, of the Corporations maintenance of its qualification as a real estate investment trust under the Internal Revenue Code of 1986, as amended (the Code). Subject to certain further restrictions and except as expressly provided in the Corporations charter, (i) no Person may Beneficially Own or Constructively Own shares of Common Stock in excess of 9.8 percent (in value or number of shares) of the outstanding shares of Common Stock unless such Person is an Excepted Holder (in which case the Excepted Holder Limit shall be applicable); (ii) no Person may Beneficially Own or Constructively Own shares of Capital Stock in excess of 9.8 percent (in value or number of shares) of the total outstanding shares of Capital Stock, unless such Person is an Excepted Holder (in which case the Excepted Holder Limit shall be applicable); (iii) no Person may Beneficially Own or Constructively Own Capital Stock that would result in the Corporation being closely held
under Section 856(h) of the Code or otherwise cause the Corporation to fail to qualify as a REIT; (iv) no Person may Transfer shares of Capital Stock if such Transfer would result in the Capital Stock being beneficially owned by fewer than 100 Persons, (v) prior to the date that either each class or series of Capital Stock qualifies as a class of Publicly-Offered Securities or the Corporation qualifies for another exception to the Plan Asset Regulations (other than the Insignificant Participation Exception), no Person shall Transfer or attempt to Transfer shares of Capital Stock to the extent such Transfer would result in holding of any class or series of Capital Stock by Benefit Plan Investors being deemed to be significant for purposes of the Employee Retirement Income Security Act of 1974, as amended (ERISA); and (vi) prior to the date that either each class or series of Capital Stock qualifies as a class of Publicly-Offered Securities or the Corporation qualifies for another exception to the Plan Asset Regulations (other than the Insignificant Participation Exception), no Person (other than an underwriter that participates in the initial private placement of Capital Stock of the Corporation) shall Transfer or attempt to Transfer shares of Capital Stock unless such Person obtains from its transferee a representation and agreement that (1) its transferee is not (and will not be), and is not acting on behalf of, a Benefit Plan Investor or Controlling Person and (2) such transferee will obtain from its transferee the representation and agreement set forth in this sentence (including without limitation clauses (1) and (2)). Any Person who Beneficially Owns or Constructively Owns or attempts to Beneficially Own or Constructively Own shares of Capital Stock which causes or will cause a Person to Beneficially Own or Constructively Own shares of Capital Stock in excess or in violation of the above limitations must immediately notify the Corporation. If any of the restrictions on transfer or ownership are violated, the shares of Capital Stock in excess or in violation of the above limitations will be automatically transferred to a Trustee of a Trust for the benefit of one or more Charitable Beneficiaries. In addition, the Corporation may redeem shares upon the terms and conditions specified by the Board of Directors in its sole discretion if the Board of Directors determines that ownership or a Transfer or other event may violate the restrictions described above. Furthermore, upon the occurrence of certain events, attempted Transfers in violation of the restrictions described above may be void ab initio . All capitalized terms in this legend have the meanings defined in the charter of the Corporation, as the same may be amended from time to time, a copy of which, including the restrictions on transfer and ownership, will be furnished to each holder of Capital Stock on
request and without charge. Requests for such a copy may be directed to the Secretary of the Corporation at its principal office.
Instead of the foregoing legend, the certificate or written statement of information in lieu of a certificate may state that the Corporation will furnish a full statement about certain restrictions on transferability to a stockholder on request and without charge.
Section 7.3 Transfer of Capital Stock in Trust .
Section 7.3.1 Ownership in Trust . Upon any purported Transfer or other event described in Section 7.2.1(b) that would result in a transfer of shares of Capital Stock to a Trust, such shares of Capital Stock shall be deemed to have been transferred to the Trustee as trustee of a Trust for the exclusive benefit of one or more Charitable Beneficiaries. Such transfer to the Trustee shall be deemed to be effective as of the close of business on the Business Day prior to the purported Transfer or other event that results in the transfer to the Trust pursuant to Section 7.2.1(b). The Trustee shall be appointed by the Corporation and shall be a Person unaffiliated with the Corporation and any Prohibited Owner. Each Charitable Beneficiary shall be designated by the Corporation as provided in Section 7.3.6.
Section 7.3.2 Status of Shares Held by the Trustee . Shares of Capital Stock held by the Trustee shall be issued and outstanding shares of Capital Stock. The Prohibited Owner shall have no rights in the shares held by the Trustee. The Prohibited Owner shall not benefit economically from ownership of any shares held in trust by the Trustee, shall have no rights to dividends or other distributions and shall not possess any rights to vote or other rights attributable to the shares held in the Trust.
Section 7.3.3 Dividend and Voting Rights . The Trustee shall have all voting rights and rights to dividends or other distributions with respect to shares of Capital Stock held in the Trust, which rights shall be exercised for the exclusive benefit of the Charitable Beneficiary. Any dividend or other distribution paid prior to the discovery by the Corporation that the shares of Capital Stock have been transferred to the Trustee shall be paid by the recipient of such dividend or distribution to the Trustee upon demand and any dividend or other
distribution authorized but unpaid shall be paid when due to the Trustee. Any dividend or other distribution so paid to the Trustee shall be held in trust for the Charitable Beneficiary. The Prohibited Owner shall have no voting rights with respect to shares held in the Trust and, subject to Maryland law, effective as of the date that the shares of Capital Stock have been transferred to the Trust, the Trustee shall have the authority (at the Trustees sole discretion) (i) to rescind as void any vote cast by a Prohibited Owner prior to the discovery by the Corporation that the shares of Capital Stock have been transferred to the Trustee and (ii) to recast such vote in accordance with the desires of the Trustee acting for the benefit of the Charitable Beneficiary; provided, however, that if the Corporation has already taken irreversible corporate action, then the Trustee shall not have the authority to rescind and recast such vote. Notwithstanding the provisions of this Article VII, until the Corporation has received notification that shares of Capital Stock have been transferred into a Trust, the Corporation shall be entitled to rely on its share transfer and other stockholder records for purposes of preparing lists of stockholders entitled to vote at meetings, determining the validity and authority of proxies and otherwise conducting votes of stockholders.
Section 7.3.4 Sale of Shares by Trustee . Within 20 days of receiving notice from the Corporation that shares of Capital Stock have been transferred to the Trust, the Trustee of the Trust shall sell the shares held in the Trust to a person, designated by the Trustee, whose ownership of the shares will not violate the ownership limitations set forth in Section 7.2.1(a). Upon such sale, the interest of the Charitable Beneficiary in the shares sold shall terminate and the Trustee shall distribute the net proceeds of the sale to the Prohibited Owner and to the Charitable Beneficiary as provided in this Section 7.3.4. The Prohibited Owner shall receive the lesser of (1) the price paid by the Prohibited Owner for the shares or, if the Prohibited Owner did not give value for the shares in connection with the event causing the shares to be held in the Trust ( e.g. , in the case of a gift, devise or other such transaction), the Market Price of the shares on the day of the event causing the shares to be held in the Trust and (2) the price per share received by the Trustee (net of any commissions and other expenses of sale) from the sale
or other disposition of the shares held in the Trust. The Trustee may reduce the amount payable to the Prohibited Owner by the amount of dividends and other distributions which have been paid to the Prohibited Owner and are owed by the Prohibited Owner to the Trustee pursuant to Section 7.3.3 of this Article VII. Any net sales proceeds in excess of the amount payable to the Prohibited Owner shall be immediately paid to the Charitable Beneficiary. If, prior to the discovery by the Corporation that shares of Capital Stock have been transferred to the Trustee, such shares are sold by a Prohibited Owner, then (i) such shares shall be deemed to have been sold on behalf of the Trust and (ii) to the extent that the Prohibited Owner received an amount for such shares that exceeds the amount that such Prohibited Owner was entitled to receive pursuant to this Section 7.3.4, such excess shall be paid to the Trustee upon demand.
Section 7.3.5 Purchase Right in Stock Transferred to the Trustee . Shares of Capital Stock transferred to the Trustee shall be deemed to have been offered for sale to the Corporation, or its designee, at a price per share equal to the lesser of (i) the price per share in the transaction that resulted in such transfer to the Trust (or, in the case of a devise or gift, the Market Price at the time of such devise or gift) and (ii) the Market Price on the date the Corporation, or its designee, accepts such offer. The Corporation may reduce the amount payable to the Prohibited Owner by the amount of dividends and other distributions which has been paid to the Prohibited Owner and is owed by the Prohibited Owner to the Trustee pursuant to Section 7.3.3 of this Article VII. The Corporation may pay the amount of such reduction to the Trustee for the benefit of the Charitable Beneficiary. The Corporation shall have the right to accept such offer until the Trustee has sold the shares held in the Trust pursuant to Section 7.3.4. Upon such a sale to the Corporation, the interest of the Charitable Beneficiary in the shares sold shall terminate and the Trustee shall distribute the net proceeds of the sale to the Prohibited Owner.
Section 7.3.6 Designation of Charitable Beneficiaries . By written notice to the Trustee, the Corporation shall designate one or more nonprofit organizations to be the Charitable Beneficiary of the interest in the Trust such that the shares of Capital Stock held in the
Trust would not violate the restrictions set forth in Section 7.2.1(a) in the hands of such Charitable Beneficiary.
Section 7.4 NYSE Transactions . Nothing in this Article VII shall preclude the settlement of any transaction entered into through the facilities of the NYSE or any other national securities exchange or automated inter-dealer quotation system. The fact that the settlement of any transaction occurs shall not negate the effect of any other provision of this Article VII and any transferee in such a transaction shall be subject to all of the provisions and limitations set forth in this Article VII.
Section 7.5 Deemed ERISA Representations . From and after the date upon which a registration statement with respect to the Common Stock becomes effective, each purchaser and subsequent transferee of Common Stock will be deemed to have represented, warranted, and agreed that its purchase and holding of Common Stock will not constitute or result in (i) a non-exempt prohibited transaction under Section 406 of ERISA or Section 4975 of the Code or (ii) a violation of any applicable other federal, state, local, non-U.S. or other laws or regulations that contain one or more provisions that are similar to the provisions of Title I of ERISA or Section 4975 of the Code.
Section 7.6 Enforcement . The Corporation is authorized specifically to seek equitable relief, including injunctive relief, to enforce the provisions of this Article VII.
Section 7.7 Non-Waiver . No delay or failure on the part of the Corporation or the Board of Directors in exercising any right hereunder shall operate as a waiver of any right of the Corporation or the Board of Directors, as the case may be, except to the extent specifically waived in writing.
Section 7.8 Severability . If any provision of this Article VII or any application of any such provision is determined to be invalid by any federal or state court having jurisdiction over the issues, the validity of the remaining provisions shall not be affected and other applications of such provisions shall be affected only to the extent necessary to comply with the determination of such court.
ARTICLE VIII
AMENDMENTS
The Corporation reserves the right from time to time to make any amendment to the Charter, now or hereafter authorized by law, including any amendment altering the terms or contract rights, as expressly set forth in the Charter, of any shares of outstanding stock. All rights and powers conferred by the Charter on stockholders, directors and officers are granted subject to this reservation. Except as set forth below and except for those amendments permitted to be made without stockholder approval under Maryland law or by specific provision in the Charter, any amendment to the Charter shall be valid only if declared advisable by the Board of Directors and approved by the affirmative vote of holders of shares entitled to cast a majority of all the votes entitled to be cast on the matter. Any amendment to Section 5.8, Article VII or to this sentence of the Charter shall be valid only if declared advisable by the Board of Directors and approved by the affirmative vote of holders of shares entitled to cast at least two-thirds of all the votes entitled to be cast on the matter.
ARTICLE IX
LIMITATION OF LIABILITY
To the maximum extent that Maryland law in effect from time to time permits limitation of the liability of directors and officers of a corporation, no present or former director or officer of the Corporation shall be liable to the Corporation or its stockholders for money damages. Neither the amendment nor repeal of this Article IX, nor the adoption or amendment of any other provision of the Charter or Bylaws inconsistent with this Article IX, shall apply to or affect in any respect the applicability of the preceding sentence with respect to any act or failure to act which occurred prior to such amendment, repeal or adoption.
THIRD : The amendment to and restatement of the charter as hereinabove set forth have been approved by the Board of Directors of the Corporation as required by law. The Corporation has no stockholders.
FOURTH : The current address of the principal office of the Corporation is as set forth in Article IV of the foregoing amendment and restatement of the charter.
FIFTH : The name and address of the Corporations current resident agent are as set forth in Article IV of the foregoing amendment and restatement of the charter.
SIXTH : The number of directors of the Corporation and the names of those currently in office are as set forth in Article V of the foregoing amendment and restatement of the charter.
SEVENTH : The total number of shares of stock which the Corporation had authority to issue immediately prior to the foregoing amendment and restatement of the charter was 1,000 shares, $.01 par value per share, all of one class. The aggregate par value of all shares of stock having par value was $10.
EIGHTH : The total number of shares of stock which the Corporation has authority to issue pursuant to the foregoing amendment and restatement of the charter is 550,000,000, consisting of 500,000,000 shares of Common Stock, $.0001 par value per share, and 50,000,000 shares of Preferred Stock, $.0001 par value per share. The aggregate par value of all authorized shares of stock having par value is $55,000.
NINTH : The undersigned acknowledges these Articles of Amendment and Restatement to be the corporate act of the Corporation and as to all matters or facts required to be verified under oath, the undersigned 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 for perjury.
IN WITNESS WHEREOF, the Corporation has caused these Articles of Amendment and Restatement to be signed in its name and on its behalf by its Chief Executive Officer and President and attested to by its Secretary on this 3rd day of August, 2011.
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/s/ Paul McDade |
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Paul McDade |
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Michael Szymanski |
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Chief Executive Officer and President |
Exhibit 3.2
ZAIS FINANCIAL CORP.
Articles Supplementary
140 Shares
12.5% Series A Cumulative Non-Voting Preferred Stock
ZAIS Financial Corp. , a Maryland corporation (the Corporation), hereby certifies to the State Department of Assessments and Taxation of Maryland that:
FIRST: Under a power contained in Article VI of the charter of the Corporation (the Charter), the Board of Directors of the Corporation (the Board of Directors), by duly adopted resolutions, reclassified and designated One Hundred and Forty (140) authorized but unissued shares of preferred stock, par value $0.0001 per share, of the Corporation (the Preferred Stock) as shares of 12.5% Series A Cumulative Non-Voting Preferred Stock, par value $0.0001 per share, with the following preferences, conversion and other rights, voting powers, restrictions, limitations as to dividends and other distributions, qualifications, and terms and conditions of redemption, which, upon any restatement of the Charter, shall become part of Article VI of the Charter, with any necessary or appropriate renumbering or relettering of the sections or subsections hereof:
12.5% Series A Cumulative Non-Voting Preferred Stock
(1) DESIGNATION AND NUMBER . A series of Preferred Stock, designated as 12.5% Series A Cumulative Non-Voting Preferred Stock (the Series A Preferred Stock), is hereby established. The total number of shares of Series A Preferred Stock shall be One Hundred and Forty (140) .
(2) RANK . The Series A Preferred Stock shall, with respect to dividend and redemption rights and rights upon liquidation, dissolution or winding up of the Corporation, rank senior to all classes or series of shares of common stock, par value $0.0001 per share, of the Corporation (the Common Stock) and to all other equity securities issued by the Corporation from time to time (together with the Common Stock, the Junior Securities). The term equity securities shall not include convertible debt securities unless and until such securities are converted into equity securities of the Corporation.
(3) DIVIDENDS .
(a) Each holder of the then outstanding shares of Series A Preferred Stock shall be entitled to receive, when and as authorized by the Board of Directors and declared by the Corporation, out of funds legally available for the payment of dividends, cumulative preferential cash dividends per share of Series A Preferred Stock at the rate of 12.5% per annum of the total of $1,000.00 plus all accumulated and unpaid dividends thereon. Such dividends shall accrue on outstanding shares of Series A Preferred Stock on a daily basis and be cumulative from the first date on which such share of Series A Preferred Stock is issued, such issue date to be contemporaneous with the receipt by the Corporation of subscription funds for the Series A Preferred Stock (the Original Issue Date), and shall be payable semi-annually in arrears on or before June 30 and December 31 of each year (each a Dividend Payment Date); provided, however, that if any Dividend Payment Date is not a Business Day, then the dividend which would otherwise have been payable on such Dividend Payment Date may be paid on the
preceding Business Day (as defined in Article VII of the Charter) or the following Business Day with the same force and effect as if paid on such Dividend Payment Date. Any dividend payable on the Series A Preferred Stock for any partial dividend period will be computed on the basis of a 360-day year consisting of twelve 30-day months (it being understood that the dividend payable on June 30, 2012 will be for less than a full dividend period). A dividend period shall mean, with respect to the first dividend period, the period from and including the Original Issue Date to and including the first Dividend Payment Date, and with respect to each subsequent dividend period, the period from but excluding a Dividend Payment Date to and including the next succeeding Dividend Payment Date or other date as of which accrued dividends are to be calculated. Dividends will be payable to holders of record as they appear in the stock transfer records of the Corporation at the close of business on the applicable record date, which shall be the fifteenth day of the calendar month in which the applicable Dividend Payment Date falls or on such other date designated by the Board of Directors for the payment of dividends that is not more than 30 nor less than 10 days prior to such Dividend Payment Date (each, a Dividend Record Date).
(b) No dividends on shares of Series A Preferred Stock shall be declared by the Corporation or paid or set apart for payment by the Corporation at such time as the terms and provisions of any written agreement between the Corporation and any party that is not an affiliate of the Corporation, including any agreement relating to its indebtedness, prohibit such declaration, payment or setting apart for payment or provide that such declaration, payment or setting apart for payment would constitute a breach thereof or a default thereunder, or if such declaration or payment shall be restricted or prohibited by law. For purposes of these Articles Supplementary, affiliate shall mean any party that controls, is controlled by or is under common control with the Corporation.
(c) Notwithstanding the foregoing, dividends on the Series A Preferred Stock shall accrue whether or not the terms and provisions set forth in Section 3(b) hereof at any time prohibit the current payment of dividends, whether or not the Corporation has earnings, whether or not there are funds legally available for the payment of such dividends and whether or not such dividends are authorized or declared. Furthermore, dividends will be declared and paid when due in all events to the fullest extent permitted by law and except as provided in Section 3(b) above. Accrued but unpaid dividends on the Series A Preferred Stock will accumulate as of the Dividend Payment Date on which they first become payable.
(d) Unless full cumulative dividends on all of the outstanding shares of Series A Preferred Stock have been or contemporaneously are declared and paid or declared and a sum sufficient for the payment thereof is set apart for payment for all past dividend periods, no dividends (other than in Junior Securities) shall be declared or paid or set apart for payment nor shall any other distribution be declared or made upon any Junior Securities, nor shall any Junior Securities be redeemed, purchased or otherwise acquired for any consideration (or any moneys be paid to or made available for a sinking fund for the redemption of any such Junior Securities) by the Corporation (except by conversion into or exchange for other Junior Securities and except for transfers, redemptions or purchases made pursuant to the provisions of Article VII of the Charter).
(e) When dividends are not paid in full (or a sum sufficient for such full payment is not set apart) on the Series A Preferred Stock, all dividends declared upon the Series A Preferred Stock shall be declared and paid pro rata based on the number of shares of Series A Preferred Stock then outstanding.
(f) Any dividend payment made on shares of the Series A Preferred Stock shall first be credited against the earliest accrued but unpaid dividend due with respect to such shares which remains payable. Holders of the Series A Preferred Stock shall not be entitled to any dividend, whether payable in cash, property or shares, in excess of full cumulative dividends on the Series A Preferred Stock as described above.
(4) LIQUIDATION PREFERENCE .
(a) Upon any voluntary or involuntary liquidation, dissolution or winding up of the affairs of the Corporation, the holders of shares of Series A Preferred Stock then outstanding will be entitled to be paid, or have the Corporation declare and set apart for payment, out of the assets of the Corporation legally available for distribution to its stockholders, before any distribution of assets is made to holders of any Junior Securities, a liquidation preference per share of Series A Preferred Stock equal to the sum of the following (collectively, the Liquidation Preference): (i) $1,000.00, (ii) all accrued and unpaid dividends thereon through and including the date of payment, and (iii) if the Redemption Premium (as defined below) would then be payable upon the redemption of shares of Series A Preferred Stock in accordance with Section 5(a) below, the per share Redemption Premium. In the event that the Corporation elects to set apart the Liquidation Preference for payment, the Series A Preferred Stock shall remain outstanding until the holders thereof are paid the full Liquidation Preference therefor, which payment shall be made no later than immediately prior to the Corporation making its final liquidating distribution on shares of Common Stock. In the event that the Redemption Premium would be payable on the date that the Liquidation Preference was set apart for payment but no Redemption Premium would be payable on the payment date, the Corporation may make a corresponding reduction to the funds set apart for payment of the Liquidation Preference.
(b) In the event that, upon any such voluntary or involuntary liquidation, dissolution or winding up, the available assets of the Corporation are insufficient to pay the full amount of the Liquidation Preference on all outstanding shares of Series A Preferred Stock, then the holders of the Series A Preferred Stock shall share ratably in any such distribution of assets in proportion to the full Liquidation Preference to which they would otherwise be respectively entitled.
(c) After payment of the full amount of the Liquidation Preference to which they are entitled, the holders of Series A Preferred Stock will have no right or claim to any of the remaining assets of the Corporation.
(d) Upon the Corporations provision of written notice as to the effective date of any such liquidation, dissolution or winding up of the Corporation, accompanied by a check in the amount of the full Liquidation Preference to which each record holder of the Series A Preferred Stock is entitled, the Series A Preferred Stock shall no longer be outstanding shares of stock of the Corporation and all rights of the holders of such shares will terminate. Such notice shall be given by first class mail, postage pre-paid, to each record holder of the Series A Preferred Stock at the respective mailing addresses of such holders as the same shall appear on the stock transfer records of the Corporation.
(e) The consolidation or merger of the Corporation with or into any other business enterprise or of any other business enterprise with or into the Corporation, the sale, transfer, lease or conveyance of all or substantially all of the assets or business of the Corporation, or a statutory share exchange shall not be deemed to constitute a liquidation, dissolution or winding up of the Corporation.
(5) REDEMPTION .
(a) Right of Optional Redemption . The Corporation, at its option, may redeem shares of the Series A Preferred Stock, in whole or in part, at any time or from time to time, for cash at a redemption price per share of Series A Preferred Stock (the Redemption Price) equal to $1,000.00 plus all accrued and unpaid dividends thereon to and including the date fixed for redemption (except as provided in Section 5(c) below), plus a redemption premium per share (the Redemption Premium) calculated as follows based on the date fixed for redemption:
(1) until December 31, 2013, $100.00, and
(2) thereafter, no Redemption Premium.
If less than all of the outstanding shares of Series A Preferred Stock are to be redeemed, the shares of Series A Preferred Stock to be redeemed may be selected by any equitable method determined by the Corporation provided that such method does not result in the creation of fractional shares.
(b) Limitations on Redemption . Unless full cumulative dividends on all shares of Series A Preferred Stock shall have been, or contemporaneously are, declared and paid or declared and a sum sufficient for the payment thereof is set apart for payment for all past dividend periods, no shares of Series A Preferred Stock shall be redeemed or otherwise acquired, directly or indirectly, by the Corporation unless all outstanding shares of Series A Preferred Stock are simultaneously redeemed or acquired, and the Corporation shall not purchase or otherwise acquire, directly or indirectly, any Junior Securities of the Corporation (except by exchange for Junior Securities); provided, however, that the foregoing shall not prevent the purchase by the Corporation of shares transferred to a Trustee (as defined in the Charter) pursuant to Article VII of the Charter or the purchase or acquisition of shares of Series A Preferred Stock pursuant to a purchase or exchange offer made on the same terms to holders of all outstanding shares of Series A Preferred Stock.
(c) Rights to Dividends on Shares Called for Redemption . Immediately prior to or upon any redemption of Series A Preferred Stock, the Corporation shall pay, in cash, any accrued and unpaid dividends to and including the redemption date, unless a redemption date falls after a Dividend Record Date and prior to the corresponding Dividend Payment Date, in which case each holder of Series A Preferred Stock at the close of business on such Dividend Record Date shall be entitled to the dividend payable on such shares on the corresponding Dividend Payment Date notwithstanding the redemption of such shares before such Dividend Payment Date.
(d) Procedures for Redemption .
(i) Upon the Corporations provision of written notice as to the effective date of the redemption, accompanied by a check in the amount of the full Redemption Price through such effective date to which each record holder of shares of Series A Preferred Stock to be redeemed is entitled or, if the shares of Series A Preferred Stock to be redeemed are represented by certificates, the setting apart of such amount pursuant to Section 5(d)(iii) below, shares of the Series A Preferred Stock shall be redeemed and shall no longer be deemed outstanding shares of stock of the Corporation and all rights of the holders of such shares will terminate. Such notice shall be given by first class mail, postage pre-paid, to each record holder of shares of Series A Preferred Stock to be
redeemed at the respective mailing addresses of such holders as the same shall appear on the stock transfer records of the Corporation. No failure to give such notice or any defect therein or in the mailing thereof shall affect the validity of the proceedings for the redemption of any shares of Series A Preferred Stock except as to the holder to whom notice was defective or not given.
(ii) In addition to any information required by law or by the applicable rules of any exchange upon which Series A Preferred Stock may be listed or admitted to trading, such notice shall state: (A) the redemption date; (B) the Redemption Price; (C) the number of shares of Series A Preferred Stock to be redeemed; (D) the place or places where the Series A Preferred Stock are to be surrendered (if so required in the notice) for payment of the Redemption Price (if not otherwise included with the notice); and (E) that dividends on the shares to be redeemed will cease to accrue on such redemption date. If less than all of the shares of Series A Preferred Stock held by any holder are to be redeemed, the notice mailed to such holder shall also specify the number of shares of Series A Preferred Stock held by such holder to be redeemed.
(iii) If notice of redemption of any shares of Series A Preferred Stock has been given and if the funds necessary for such redemption have been set apart by the Corporation for the benefit of the holders of any shares of Series A Preferred Stock so called for redemption, then, from and after the redemption date, dividends will cease to accrue on such shares of Series A Preferred Stock, such shares of Series A Preferred Stock shall no longer be deemed outstanding and all rights of the holders of such shares will terminate, except the right to receive the Redemption Price therefor. If the Corporation shall so require and the notice of redemption shall so state, holders of Series A Preferred Stock to be redeemed shall surrender the certificates representing such Series A Preferred Stock, to the extent that such shares are certificated, at the place designated in such notice and, upon surrender in accordance with said notice of the certificates representing shares of Series A Preferred Stock so redeemed (properly endorsed or assigned for transfer, if the Corporation shall so require and the notice shall so state), such shares of Series A Preferred Stock shall be redeemed by the Corporation at the Redemption Price. In case less than all of the shares of Series A Preferred Stock represented by any such certificate are redeemed, a new certificate or certificates shall be issued representing the unredeemed shares of Series A Preferred Stock without cost to the holder thereof. In the event that the shares of Series A Preferred Stock to be redeemed are uncertificated, such shares shall be redeemed in accordance with the notice and no further action on the part of the holders of such shares shall be required.
(iv) The deposit of funds with a bank or trust company for the purpose of redeeming Series A Preferred Stock shall be irrevocable except that:
(A) the Corporation shall be entitled to receive from such bank or trust company the interest or other earnings, if any, earned on any money so deposited in trust, and the holders of any shares redeemed shall have no claim to such interest or other earnings; and
(B) any balance of monies so deposited by the Corporation and unclaimed by the holders of the Series A Preferred Stock entitled thereto at the
expiration of two years from the applicable redemption dates shall be repaid, together with any interest or other earnings thereon, to the Corporation, and, after any such repayment, the holders of the shares of Series A Preferred Stock entitled to the funds so repaid to the Corporation shall look only to the Corporation for payment of the Redemption Price without interest or other earnings.
(e) Application of Article VII . The shares of Series A Preferred Stock are subject to the provisions of Article VII of the Charter, including, without limitation, the provision for the redemption of shares transferred to the Trustee.
(f) Status of Redeemed Shares . Any shares of Series A Preferred Stock that shall at any time have been redeemed or otherwise acquired by the Corporation shall, after such redemption or acquisition, have the status of authorized but unissued shares of Series A Preferred Stock which may be issued by the Board of Directors from time to time at its discretion.
(6) VOTING RIGHTS . Except as provided in this Section, the holders of Series A Preferred Stock shall not be entitled to vote on any matter submitted to the stockholders of the Corporation for a vote. Notwithstanding the foregoing, the consent of the holders of a majority of the outstanding shares of Series A Preferred Stock, voting as a separate class, shall be required for (a) authorization or issuance of any equity security of the Corporation senior to or on a parity with the Series A Preferred Stock, (b) any reclassification of the Series A Preferred Stock or (c) any amendment to the Charter or the terms of the Series A Preferred Stock, whether by merger, consolidation, transfer or conveyance of all or substantially all of the assets of the Corporation or otherwise (an Event), which amendment materially and adversely affects any right, preference, privilege or voting power of the Series A Preferred Stock or which increases the number of authorized shares of Series A Preferred Stock to a number greater than 140 ; provided, however, with respect to the occurrence of any of the Events set forth in subsection (c) above, so long as the Series A Preferred Stock remains outstanding with the terms thereof materially unchanged or the holders of shares of Series A Preferred Stock receive equity securities of the successor or survivor of such Event with substantially identical rights as the Series A Preferred Stock, taking into account that, upon the occurrence of an Event, the Corporation may not be the surviving entity or the surviving entity may not be a corporation, the occurrence of such Event shall not be deemed to materially and adversely affect such rights, preferences, privileges or voting powers of the Series A Preferred Stock, and in such case the holders of shares of Series A Preferred Stock shall not have any voting rights with respect to the occurrence of any of the Events set forth in subsection (c) above unless the number of authorized shares of Series A Preferred Stock is increased to a number greater than 140 .
(7) CONVERSION . The shares of Series A Preferred Stock are not convertible into or exchangeable for any other property or securities of the Corporation.
SECOND: The Series A Preferred Stock has been classified and designated by the Board of Directors under the authority contained in the Charter.
THIRD: These Articles Supplementary have been approved by the Board of Directors in the manner and by the vote required by law.
FOURTH: The undersigned Chief Executive Officer and President of the Corporation acknowledges these Articles Supplementary to be the corporate act of the Corporation and, as to all matters or facts required to be verified under oath, the undersigned Chief Executive Officer and President 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.
[SIGNATURE PAGE FOLLOWS]
IN WITNESS WHEREOF, the Corporation has caused these Articles Supplementary to be signed in its name and on its behalf by its Chief Executive Officer and President and attested to by its Secretary on this 18th day of January, 2012.
ATTEST: |
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/s/ Michael Szymanski |
(SEAL) |
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Paul McDade |
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Michael Szymanski |
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Exhibit 3.3
ZAIS FINANCIAL CORP.
BYLAWS
ARTICLE I
OFFICES
Section 1. PRINCIPAL OFFICE. The principal office of the Corporation in the State of Maryland shall be located at such place as the Board of Directors may designate.
Section 2. ADDITIONAL OFFICES. The Corporation may have additional offices, including a principal executive office, at such places as the Board of Directors may from time to time determine or the business of the Corporation may require.
ARTICLE II
MEETINGS OF STOCKHOLDERS
Section 1. PLACE. All meetings of stockholders shall be held at the principal executive office of the Corporation or at such other place as shall be set in accordance with these Bylaws and stated in the notice of the meeting.
Section 2. ANNUAL MEETING. An annual meeting of stockholders for the election of directors and the transaction of any business within the powers of the Corporation shall be held on the date and at the time and place set by the Board of Directors. The Corporation shall hold its first annual meeting of stockholders beginning with the year 2012.
Section 3. SPECIAL MEETINGS.
(a) General. Each of the chairman of the board, chief executive officer, president and Board of Directors may call a special meeting of stockholders. Except as provided in subsection (b)(4) of this Section 3, a special meeting of stockholders shall be held on the date and at the time and place set by the chairman of the board, chief executive officer, president or Board of Directors, whoever has called the meeting. Subject to subsection (b) of this Section 3, a special meeting of stockholders shall also be called by the secretary of the Corporation to act on any matter that may properly be considered at a meeting of stockholders upon the written request of stockholders entitled to cast not less than a majority of all the votes entitled to be cast on such matter at such meeting.
(b) Stockholder-Requested Special Meetings. (1) Any stockholder of record seeking to have stockholders request a special meeting shall, by sending written notice to the secretary (the Record Date Request Notice) by registered mail, return receipt requested, request the Board of Directors to fix a record date to determine the stockholders entitled to request a special meeting (the Request Record Date). The Record Date Request Notice shall set forth the purpose of the meeting and the matters proposed to be acted on at it, shall be signed by one or more stockholders of record as of the date of signature (or their agents duly authorized in a writing accompanying the Record Date Request Notice), shall bear the date of signature of each such stockholder (or such agent) and shall set forth all information relating to each such
stockholder and each matter proposed to be acted on at the meeting that would be required to be disclosed in connection with the solicitation of proxies for the election of directors in an election contest (even if an election contest is not involved), or would otherwise be required in connection with such a solicitation, in each case pursuant to Regulation 14A (or any successor provision) under the Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder (the Exchange Act). Upon receiving the Record Date Request Notice, the Board of Directors may fix a Request Record Date. The Request Record Date shall not precede and shall not be more than ten days after the close of business on the date on which the resolution fixing the Request Record Date is adopted by the Board of Directors. If the Board of Directors, within ten days after the date on which a valid Record Date Request Notice is received, fails to adopt a resolution fixing the Request Record Date, the Request Record Date shall be the close of business on the tenth day after the first date on which a Record Date Request Notice is received by the secretary.
(2) In order for any stockholder to request a special meeting to act on any matter that may properly be considered at a meeting of stockholders, one or more written requests for a special meeting (collectively, the Special Meeting Request) signed by stockholders of record (or their agents duly authorized in a writing accompanying the request) as of the Request Record Date entitled to cast not less than a majority of all of the votes entitled to be cast on such matter at such meeting (the Special Meeting Percentage) shall be delivered to the secretary. In addition, the Special Meeting Request shall (a) set forth the purpose of the meeting and the matters proposed to be acted on at it (which shall be limited to those lawful matters set forth in the Record Date Request Notice received by the secretary), (b) bear the date of signature of each such stockholder (or such agent) signing the Special Meeting Request, (c) set forth (i) the name and address, as they appear in the Corporations books, of each stockholder signing such request (or on whose behalf the Special Meeting Request is signed), (ii) the class, series and number of all shares of stock of the Corporation which are owned (beneficially or of record) by each such stockholder and (iii) the nominee holder for, and number of, shares of stock of the Corporation owned beneficially but not of record by such stockholder, (d) be sent to the secretary by registered mail, return receipt requested, and (e) be received by the secretary within 60 days after the Request Record Date. Any requesting stockholder (or agent duly authorized in a writing accompanying the revocation of the Special Meeting Request) may revoke his, her or its request for a special meeting at any time by written revocation delivered to the secretary.
(3) The secretary shall inform the requesting stockholders of the reasonably estimated cost of preparing and mailing or delivering the notice of the meeting (including the Corporations proxy materials). The secretary shall not be required to call a special meeting upon stockholder request and such meeting shall not be held unless, in addition to the documents required by paragraph (2) of this Section 3(b), the secretary receives payment of such reasonably estimated cost prior to the preparation and mailing or delivery of such notice of the meeting.
(4) In the case of any special meeting called by the secretary upon the request of stockholders (a Stockholder-Requested Meeting), such meeting shall be held at such place, date and time as may be designated by the Board of Directors; provided, however, that the date of any Stockholder-Requested Meeting shall be not more than 90 days after the record date for such meeting (the Meeting Record Date); and provided further that if
the Board of Directors fails to designate, within ten days after the date that a valid Special Meeting Request is actually received by the secretary (the Delivery Date), a date and time for a Stockholder-Requested Meeting, then such meeting shall be held at 2:00 p.m., local time, on the 90 th day after the Meeting Record Date or, if such 90 th day is not a Business Day (as defined below), on the first preceding Business Day; and provided further that in the event that the Board of Directors fails to designate a place for a Stockholder-Requested Meeting within ten days after the Delivery Date, then such meeting shall be held at the principal executive office of the Corporation. In fixing a date for any special meeting, the chairman of the board, chief executive officer, president or Board of Directors may consider such factors as he, she or it deems relevant, including, without limitation, the nature of the matters to be considered, the facts and circumstances surrounding any request for the meeting and any plan of the Board of Directors to call an annual meeting or a special meeting. In the case of any Stockholder-Requested Meeting, if the Board of Directors fails to fix a Meeting Record Date that is a date within 30 days after the Delivery Date, then the close of business on the 30 th day after the Delivery Date shall be the Meeting Record Date. The Board of Directors may revoke the notice for any Stockholder-Requested Meeting in the event that the requesting stockholders fail to comply with the provisions of paragraph (3) of this Section 3(b).
(5) If written revocations of the Special Meeting Request have been delivered to the secretary and the result is that stockholders of record (or their agents duly authorized in writing), as of the Request Record Date, entitled to cast less than the Special Meeting Percentage have delivered, and not revoked, requests for a special meeting on the matter to the secretary: (i) if the notice of meeting has not already been delivered, the secretary shall refrain from delivering the notice of the meeting and send to all requesting stockholders who have not revoked such requests written notice of any revocation of a request for a special meeting on the matter, or (ii) if the notice of meeting has been delivered and if the secretary first sends to all requesting stockholders who have not revoked requests for a special meeting on the matter written notice of any revocation of a request for the special meeting and written notice of the Corporations intention to revoke the notice of the meeting or for the chairman of the meeting to adjourn the meeting without action on the matter, (A) the secretary may revoke the notice of the meeting at any time before ten days before the commencement of the meeting or (B) the chairman of the meeting may call the meeting to order and adjourn the meeting without acting on the matter. Any request for a special meeting received after a revocation by the secretary of a notice of a meeting shall be considered a request for a new special meeting.
(6) The chairman of the board, chief executive officer, president or Board of Directors may appoint regionally or nationally recognized independent inspectors of elections to act as the agent of the Corporation for the purpose of promptly performing a ministerial review of the validity of any purported Special Meeting Request received by the secretary. For the purpose of permitting the inspectors to perform such review, no such purported Special Meeting Request shall be deemed to have been delivered to the secretary until the earlier of (i) five Business Days after receipt by the secretary of such purported request and (ii) such date as the independent inspectors certify to the Corporation that the valid requests received by the secretary represent, as of the Request Record Date, stockholders of record entitled to cast not less than the Special Meeting Percentage. Nothing contained in this paragraph (6) shall in any way be construed to suggest or imply that the Corporation or any stockholder shall not be entitled to contest the validity of any request, whether during or after such five Business Day period, or to take any other action (including,
without limitation, the commencement, prosecution or defense of any litigation with respect thereto, and the seeking of injunctive relief in such litigation).
(7) For purposes of these Bylaws, Business Day 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.
Section 4. NOTICE. Not less than ten nor more than 90 days before each meeting of stockholders, the secretary shall give to each stockholder entitled to vote at such meeting and to each stockholder not entitled to vote who is entitled to notice of the meeting notice in writing or by electronic transmission stating the time and place of the meeting and, in the case of a special meeting or as otherwise may be required by any statute, the purpose for which the meeting is called, by mail, by presenting it to such stockholder personally, by leaving it at the stockholders residence or usual place of business or by any other means permitted by Maryland law. If mailed, such notice shall be deemed to be given when deposited in the United States mail addressed to the stockholder at the stockholders address as it appears on the records of the Corporation, with postage thereon prepaid. If transmitted electronically, such notice shall be deemed to be given when transmitted to the stockholder by an electronic transmission to any address or number of the stockholder at which the stockholder receives electronic transmissions. The Corporation may give a single notice to all stockholders who share an address, which single notice shall be effective as to any stockholder at such address, unless such stockholder objects to receiving such single notice or revokes a prior consent to receiving such single notice. Failure to give notice of any meeting to one or more stockholders, or any irregularity in such notice, shall not affect the validity of any meeting fixed in accordance with this Article II or the validity of any proceedings at any such meeting.
Subject to Section 11(a) of this Article II, any business of the Corporation may be transacted at an annual meeting of stockholders without being specifically designated in the notice, except such business as is required by any statute to be stated in such notice. No business shall be transacted at a special meeting of stockholders except as specifically designated in the notice. The Corporation may postpone or cancel a meeting of stockholders by making a public announcement (as defined in Section 11(c)(3) of this Article II) of such postponement or cancellation prior to the meeting. Notice of the date, time and place to which the meeting is postponed shall be given not less than ten days prior to such date and otherwise in the manner set forth in this section.
Section 5. ORGANIZATION AND CONDUCT. Every meeting of stockholders shall be conducted by an individual appointed by the Board of Directors to be chairman of the meeting or, in the absence of such appointment or appointed individual, by the chairman of the board or, in the case of a vacancy in the office or absence of the chairman of the board, by one of the following officers present at the meeting in the following order: the vice chairman of the board, if there is one, the chief executive officer, the president, the vice presidents in their order of rank and seniority, the secretary, or, in the absence of such officers, a chairman chosen by the stockholders by the vote of a majority of the votes cast by stockholders present in person or by proxy. The secretary, or, in the secretarys absence, an assistant secretary, or, in the absence of both the secretary and assistant secretaries, an individual appointed by the Board of Directors or, in the absence of such appointment, an individual appointed by the chairman of the meeting shall act as secretary. In the event that the secretary
presides at a meeting of stockholders, an assistant secretary, or, in the absence of all assistant secretaries, an individual appointed by the Board of Directors or the chairman of the meeting, shall record the minutes of the meeting. The order of business and all other matters of procedure at any meeting of stockholders shall be determined by the chairman of the meeting. The chairman of the meeting may prescribe such rules, regulations and procedures and take such action as, in the discretion of the chairman and without any action by the stockholders, are appropriate for the proper conduct of the meeting, including, without limitation, (a) restricting admission to the time set for the commencement of the meeting; (b) limiting attendance at the meeting to stockholders of record of the Corporation, their duly authorized proxies and such other individuals as the chairman of the meeting may determine; (c) limiting participation at the meeting on any matter to stockholders of record of the Corporation entitled to vote on such matter, their duly authorized proxies and other such individuals as the chairman of the meeting may determine; (d) limiting the time allotted to questions or comments; (e) determining when and for how long the polls should be opened and when the polls should be closed; (f) maintaining order and security at the meeting; (g) removing any stockholder or any other individual who refuses to comply with meeting procedures, rules or guidelines as set forth by the chairman of the meeting; (h) concluding a meeting or recessing or adjourning the meeting to a later date and time and at a place announced at the meeting; and (i) complying with any state and local laws and regulations concerning safety and security. Unless otherwise determined by the chairman of the meeting, meetings of stockholders shall not be required to be held in accordance with the rules of parliamentary procedure.
Section 6. QUORUM. At any meeting of stockholders, the presence in person or by proxy of stockholders entitled to cast a majority of all the votes entitled to be cast at such meeting on any matter shall constitute a quorum; but this section shall not affect any requirement under any statute or the charter of the Corporation for the vote necessary for the approval of any matter. If such quorum is not established at any meeting of the stockholders, the chairman of the meeting may adjourn the meeting sine die or from time to time to a date not more than 120 days after the original record date without notice other than announcement at the meeting. At such adjourned meeting at which a quorum shall be present, any business may be transacted which might have been transacted at the meeting as originally notified.
The stockholders present either in person or by proxy, at a meeting which has been duly called and at which a quorum has been established, may continue to transact business until adjournment, notwithstanding the withdrawal from the meeting of enough stockholders to leave fewer than would be required to establish a quorum.
Section 7. VOTING. A plurality of all the votes cast at a meeting of stockholders duly called and at which a quorum is present shall be sufficient to elect a director. Each share may be voted for as many individuals as there are directors to be elected and for whose election the share is entitled to be voted. A majority of the votes cast at a meeting of stockholders duly called and at which a quorum is present shall be sufficient to approve any other matter which may properly come before the meeting, unless more than a majority of the votes cast is required by statute or by the charter of the Corporation. Unless otherwise provided by statute or by the charter, each outstanding share, regardless of class, shall be entitled to one vote on each matter submitted to a vote at a meeting of stockholders. Voting on any question or in any election may be viva voce unless the chairman of the meeting shall order that voting be by ballot or otherwise.
Section 8. PROXIES. A holder of record of shares of stock of the Corporation may cast votes in person or by proxy executed by the stockholder or by the stockholders duly authorized agent in any manner permitted by law. Such proxy or evidence of authorization of such proxy shall be filed with the secretary of the Corporation before or at the meeting. No proxy shall be valid more than eleven months after its date unless otherwise provided in the proxy.
Section 9. VOTING OF STOCK BY CERTAIN HOLDERS. Stock of the Corporation registered in the name of a corporation, partnership, trust, limited liability company or other entity, if entitled to be voted, may be voted by the president or a vice president, general partner, trustee or managing member thereof, as the case may be, or a proxy appointed by any of the foregoing individuals, unless some other person who has been appointed to vote such stock pursuant to a bylaw or a resolution of the governing body of such corporation or other entity or agreement of the partners of a partnership presents a certified copy of such bylaw, resolution or agreement, in which case such person may vote such stock. Any director or fiduciary may vote stock registered in the name of such person in the capacity of such director or fiduciary, either in person or by proxy.
Shares of stock of the Corporation directly or indirectly owned by it shall not be voted at any meeting and shall not be counted in determining the total number of outstanding shares entitled to be voted at any given time, unless they are held by it in a fiduciary capacity, in which case they may be voted and shall be counted in determining the total number of outstanding shares at any given time.
The Board of Directors may adopt by resolution a procedure by which a stockholder may certify in writing to the Corporation that any shares of stock registered in the name of the stockholder are held for the account of a specified person other than the stockholder. The resolution shall set forth the class of stockholders who may make the certification, the purpose for which the certification may be made, the form of certification and the information to be contained in it; if the certification is with respect to a record date, the time after the record date 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 by the Corporation of such certification, the person specified in the certification shall be regarded as, for the purposes set forth in the certification, the holder of record of the specified stock in place of the stockholder who makes the certification.
Section 10. INSPECTORS. The Board of Directors or the chairman of the meeting may appoint, before or at the meeting, one or more inspectors for the meeting and any successor to the inspector. Except as otherwise provided by the chairman of the meeting, the inspectors, if any, shall (i) determine the number of shares of stock represented at the meeting, in person or by proxy, and the validity and effect of proxies, (ii) receive and tabulate all votes, ballots or consents, (iii) report such tabulation to the chairman of the meeting, (iv) hear and determine all challenges and questions arising in connection with the right to vote, and (v) do such acts as are proper to fairly conduct the election or vote. Each such report shall be in writing and signed by the inspector 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. ADVANCE NOTICE OF STOCKHOLDER NOMINEES FOR DIRECTOR AND OTHER STOCKHOLDER PROPOSALS.
(a) Annual Meetings of Stockholders. (1) Nominations of individuals for election to the Board of Directors and the proposal of other business to be considered by the stockholders may be made at an annual meeting of stockholders (i) pursuant to the Corporations notice of meeting, (ii) by or at the direction of the Board of Directors or (iii) by any stockholder of the Corporation who was a stockholder of record both at the time of giving of notice by the stockholder as provided for in this Section 11(a) and at the time of the annual meeting, who is entitled to vote at the meeting in the election of each individual so nominated or on any such other business and who has complied with this Section 11(a).
(2) For any nomination or other business to be properly brought before an annual meeting by a stockholder pursuant to clause (iii) of paragraph (a)(1) of this Section 11, the stockholder must have given timely notice thereof in writing to the secretary of the Corporation and any such other business must otherwise be a proper matter for action by the stockholders. To be timely, a stockholders notice shall set forth all information required under this Section 11 and shall be delivered to the secretary at the principal executive office of the Corporation not earlier than the 150 th day nor later than 5:00 p.m., Eastern Time, on the 120 th day prior to the first anniversary of the date of the proxy statement (as defined in Section 11(c)(3) of this Article II) for the preceding years annual meeting; provided, however, that in connection with the Corporations first annual meeting or in the event that the date of the annual meeting is advanced or delayed by more than 30 days from the first anniversary of the date of the preceding years annual meeting, notice by the stockholder to be timely must be so delivered not earlier than the 150 th day prior to the date of such annual meeting and not later than 5:00 p.m., Eastern Time, on the later of the 120 th day prior to the date of such annual meeting, as originally convened, or the tenth day following the day on which public announcement of the date of such meeting is first made. The public announcement of a postponement or adjournment of an annual meeting shall not commence a new time period for the giving of a stockholders notice as described above.
(3) Such stockholders notice shall set forth:
(i) as to each individual whom the stockholder proposes to nominate for election or reelection as a director (each, a Proposed Nominee), all information relating to the Proposed Nominee that would be required to be disclosed in connection with the solicitation of proxies for the election of the Proposed Nominee as a director in an election contest (even if an election contest is not involved), or would otherwise be required in connection with such solicitation, in each case pursuant to Regulation 14A (or any successor provision) under the Exchange Act;
(ii) as to any other business that the stockholder proposes to bring before the meeting, a description of such business, the stockholders reasons for proposing such business at the meeting and any material interest in such business of such stockholder or any Stockholder Associated Person (as defined below), individually or in the aggregate, including any anticipated benefit to the stockholder or the Stockholder Associated Person therefrom;
(iii) as to the stockholder giving the notice, any Proposed Nominee and any Stockholder Associated Person,
(A) the class, series and number of all shares of stock or other securities of the Corporation or any affiliate thereof (collectively, the Company Securities), if any, which are owned (beneficially or of record) by such stockholder, Proposed Nominee or Stockholder Associated Person, the date on which each such Company Security was acquired and the investment intent of such acquisition, and any short interest (including any opportunity to profit or share in any benefit from any decrease in the price of such stock or other security) in any Company Securities of any such person,
(B) the nominee holder for, and number of, any Company Securities owned beneficially but not of record by such stockholder, Proposed Nominee or Stockholder Associated Person,
(C) whether and the extent to which such stockholder, Proposed Nominee or Stockholder Associated Person, directly or indirectly (through brokers, nominees or otherwise), is subject to or during the last six months has engaged in any hedging, derivative or other transaction or series of transactions or entered into any other agreement, arrangement or understanding (including any short interest, any borrowing or lending of securities or any proxy or voting agreement), the effect or intent of which is to (I) manage risk or benefit of changes in the price of Company Securities for such stockholder, Proposed Nominee or Stockholder Associated Person or (II) increase or decrease the voting power of such stockholder, Proposed Nominee or Stockholder Associated Person in the Corporation or any affiliate thereof disproportionately to such persons economic interest in the Company Securities and
(D) any substantial interest, direct or indirect (including, without limitation, any existing or prospective commercial, business or contractual relationship with the Corporation), by security holdings or otherwise, of such stockholder, Proposed Nominee or Stockholder Associated Person, in the Corporation or any affiliate thereof, other than an interest arising from the ownership of Company Securities where such stockholder, Proposed Nominee or Stockholder Associated Person receives no extra or special benefit not shared on a pro rata basis by all other holders of the same class or series;
(iv) as to the stockholder giving the notice, any Stockholder Associated Person with an interest or ownership referred to in clauses (ii) or (iii) of this paragraph (3) of this Section 11(a) and any Proposed Nominee,
(A) the name and address of such stockholder, as they appear on the Corporations stock ledger, and the current name and business address, if different, of each such Stockholder Associated Person and any Proposed Nominee and
(B) the investment strategy or objective, if any, of such stockholder and each such Stockholder Associated Person who is not an individual and a copy of the prospectus, offering memorandum or similar document, if any, provided to investors or potential investors in such stockholder and each such Stockholder Associated Person;
(v) the name and address of any person who contacted or was contacted by the stockholder giving the notice or any Stockholder Associated Person about the Proposed Nominee or other business proposal prior to the date of such stockholders notice; and
(vi) to the extent known by the stockholder giving the notice, the name and address of any other stockholder supporting the nominee for election or reelection as a director or the proposal of other business on the date of such stockholders notice.
(4) Such stockholders notice shall, with respect to any Proposed Nominee, be accompanied by a certificate executed by the Proposed Nominee (i) certifying that such Proposed Nominee (a) is not, and will not become a party to, any agreement, arrangement or understanding with any person or entity other than the Corporation in connection with service or action as a director that has not been disclosed to the Corporation and (b) will serve as a director of the Corporation if elected; and (ii) attaching a completed Proposed Nominee questionnaire (which questionnaire shall be provided by the Corporation, upon request, to the stockholder providing the notice and shall include all information relating to the Proposed Nominee that would be required to be disclosed in connection with the solicitation of proxies for the election of the Proposed Nominee as a director in an election contest (even if an election contest is not involved), or would otherwise be required in connection with such solicitation, in each case pursuant to Regulation 14A (or any successor provision) under the Exchange Act and the rules thereunder, or would be required pursuant to the rules of any national securities exchange on which any securities of the Corporation are listed or over-the-counter market on which any securities of the Corporation are traded).
(5) Notwithstanding anything in this subsection (a) of this Section 11 to the contrary, in the event that the number of directors to be elected to the Board of Directors is increased, and there is no public announcement of such action at least 130 days prior to the first anniversary of the date of the proxy statement (as defined in Section 11(c)(3) of this Article II) for the preceding years annual meeting, a stockholders notice required by this Section 11(a) shall also be considered timely, but only with respect to nominees for any new positions created by such increase, if it shall be delivered to the secretary at the principal executive office of the Corporation not later than 5:00 p.m., Eastern Time, on the tenth day following the day on which such public announcement is first made by the Corporation.
(6) For purposes of this Section 11, Stockholder Associated Person of any stockholder shall mean (i) any person acting in concert with such stockholder, (ii) any beneficial owner of shares of stock of the Corporation owned of record or beneficially by such stockholder (other than a stockholder that is a depositary) and (iii) any person that directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, such stockholder or such Stockholder Associated Person.
(b) Special Meetings of Stockholders. Only such business shall be conducted at a special meeting of stockholders as shall have been brought before the meeting pursuant to the Corporations notice of meeting. Nominations of individuals for election to the Board of Directors may be made at a special meeting of stockholders at which directors are to be elected only (i) by or at the direction of the Board of Directors or (ii) provided that the special meeting has been called in accordance with Section 3(a) of this Article II for the purpose of
electing directors, by any stockholder of the Corporation who is a stockholder of record both at the time of giving of notice provided for in this Section 11 and at the time of the special meeting, who is entitled to vote at the meeting in the election of each individual so nominated and who has complied with the notice procedures set forth in this Section 11. In the event the Corporation calls a special meeting of stockholders for the purpose of electing one or more individuals to the Board of Directors, any stockholder may nominate an individual or individuals (as the case may be) for election as a director as specified in the Corporations notice of meeting, if the stockholders notice, containing the information required by paragraph (a)(3) of this Section 11, is delivered to the secretary at the principal executive office of the Corporation not earlier than the 120 th day prior to such special meeting and not later than 5:00 p.m., Eastern Time, on the later of the 90 th day prior to such special meeting or the tenth day following the day on which public announcement is first made of the date of the special meeting and of the nominees proposed by the Board of Directors to be elected at such meeting. The public announcement of a postponement or adjournment of a special meeting shall not commence a new time period for the giving of a stockholders notice as described above.
(c) General. (1) If information submitted pursuant to this Section 11 by any stockholder proposing a nominee for election as a director or any proposal for other business at a meeting of stockholders shall be inaccurate in any material respect, such information may be deemed not to have been provided in accordance with this Section 11. Any such stockholder shall notify the Corporation of any inaccuracy or change (within two Business Days of becoming aware of such inaccuracy or change) in any such information. Upon written request by the secretary or the Board of Directors, any such stockholder shall provide, within five Business Days of delivery of such request (or such other period as may be specified in such request), (A) written verification, satisfactory, in the discretion of the Board of Directors or any authorized officer of the Corporation, to demonstrate the accuracy of any information submitted by the stockholder pursuant to this Section 11, and (B) a written update of any information (including, if requested by the Corporation, written confirmation by such stockholder that it continues to intend to bring such nomination or other business proposal before the meeting) submitted by the stockholder pursuant to this Section 11 as of an earlier date. If a stockholder fails to provide such written verification or written update within such period, the information as to which written verification or a written update was requested may be deemed not to have been provided in accordance with this Section 11.
(2) Only such individuals who are nominated in accordance with this Section 11 shall be eligible for election by stockholders as directors, and only such business shall be conducted at a meeting of stockholders as shall have been brought before the meeting in accordance with this Section 11. The chairman of the meeting shall have the power to determine whether a nomination or any other business proposed to be brought before the meeting was made or proposed, as the case may be, in accordance with this Section 11.
(3) For purposes of this Section 11, the date of the proxy statement shall have the same meaning as the date of the companys proxy statement released to shareholders as used in Rule 14a-8(e) promulgated under the Exchange Act, as interpreted by the Securities and Exchange Commission from time to time. Public announcement shall mean disclosure (A) in a press release reported by the Dow Jones News Service, Associated Press, Business Wire, PR Newswire or other widely circulated news or wire service or (B) in a
document publicly filed by the Corporation with the Securities and Exchange Commission pursuant to the Exchange Act.
(4) Notwithstanding the foregoing provisions of this Section 11, a stockholder shall also comply with all applicable requirements of state law and of the Exchange Act and the rules and regulations thereunder with respect to the matters set forth in this Section 11. Nothing in this Section 11 shall be deemed to affect any right of a stockholder to request inclusion of a proposal in, or the right of the Corporation to omit a proposal from, the Corporations proxy statement pursuant to Rule 14a-8 (or any successor provision) under the Exchange Act. Nothing in this Section 11 shall require disclosure of revocable proxies received by the stockholder or Stockholder Associated Person pursuant to a solicitation from substantially all of the holders of any class of securities conducted in accordance with applicable state and federal securities laws.
Section 12. CONTROL SHARE ACQUISITION ACT. Notwithstanding any other provision of the charter of the Corporation or these Bylaws, Title 3, Subtitle 7 of the Maryland General Corporation Law, or any successor statute (the MGCL), shall not apply to any acquisition by any person of shares of stock of the Corporation. This section may be repealed, in whole or in part, at any time, whether before or after an acquisition of control shares and, upon such repeal, may, to the extent provided by any successor bylaw, apply to any prior or subsequent control share acquisition.
Section 13. TELEPHONE MEETINGS. The Board of Directors or chairman of the meeting may permit one or more stockholders to participate in a meeting by means of a conference telephone or other communications equipment if all persons participating in the meeting can hear each other at the same time. Participation in a meeting by these means constitutes presence in person at the meeting.
Section 14. STOCKHOLDERS CONSENT IN LIEU OF MEETING. Any action required or permitted to be taken at any meeting of stockholders may be taken without a meeting (a) if a unanimous consent setting forth the action is given in writing or by electronic transmission by each stockholder entitled to vote on the matter and filed with the minutes of proceedings of the stockholders or (b) if the action is advised, and submitted to the stockholders for approval, by the Board of Directors and a consent in writing or by electronic transmission of stockholders entitled to cast not less than the minimum number of votes that would be necessary to authorize or take the action at a meeting of stockholders is delivered to the Corporation in accordance with the MGCL. The Corporation shall give notice of any action taken by less than unanimous consent to each stockholder not later than ten days after the effective time of such action.
ARTICLE III
DIRECTORS
Section 1. GENERAL POWERS. The business and affairs of the Corporation shall be managed under the direction of its Board of Directors.
Section 2. NUMBER, TENURE AND RESIGNATION. At any regular meeting or at any special meeting called for that purpose, a majority of the entire Board of Directors may establish, increase or decrease the number of directors, provided that the number thereof shall never be less than the minimum number required by the MGCL, nor more than 15, and further provided that the tenure of office of a director shall not be affected by any decrease in the number of directors. Any director of the Corporation may resign at any time by delivering his or her resignation to the Board of Directors, the chairman of the board or the secretary. Any resignation shall take effect immediately upon its receipt or at such later time specified in the resignation. The acceptance of a resignation shall not be necessary to make it effective unless otherwise stated in the resignation.
Section 3. ANNUAL AND REGULAR MEETINGS. An annual meeting of the Board of Directors shall be held immediately after and at the same place as the annual meeting of stockholders, no notice other than this Bylaw being necessary. In the event such meeting is not so held, the meeting may be held at such time and place as shall be specified in a notice given as hereinafter provided for special meetings of the Board of Directors. The Board of Directors may provide, by resolution, the time and place for the holding of regular meetings of the Board of Directors without other notice than such resolution.
Section 4. SPECIAL MEETINGS. Special meetings of the Board of Directors may be called by or at the request of the chairman of the board, the chief executive officer, the president or a majority of the directors then in office. The person or persons authorized to call special meetings of the Board of Directors may fix any place as the place for holding any special meeting of the Board of Directors called by them. The Board of Directors may provide, by resolution, the time and place for the holding of special meetings of the Board of Directors without other notice than such resolution.
Section 5. NOTICE. Notice of any special meeting of the Board of Directors shall be delivered personally or by telephone, electronic mail, facsimile transmission, courier or United States mail to each director at his or her business or residence address. Notice by personal delivery, telephone, electronic mail or facsimile transmission shall be given at least 24 hours prior to the meeting. Notice by United States mail shall be given at least three days prior to the meeting. Notice by courier shall be given at least two days prior to the meeting. Telephone notice shall be deemed to be given when the director or his or her agent is personally given such notice in a telephone call to which the director or his or her agent is a party. Electronic mail notice shall be deemed to be given upon transmission of the message to the electronic mail address given to the Corporation by the director. Facsimile transmission notice shall be deemed to be given upon completion of the transmission of the message to the number given to the Corporation by the director and receipt of a completed answer-back indicating receipt. Notice by United States mail shall be deemed to be given when deposited in the United States mail properly addressed, with postage thereon prepaid. Notice by courier shall be deemed to be given when deposited with or delivered to a courier properly addressed. Neither the business to be transacted at, nor the purpose of, any annual, regular or special meeting of the Board of Directors need be stated in the notice, unless specifically required by statute or these Bylaws.
Section 6. QUORUM. A majority of the directors shall constitute a quorum for transaction of business at any meeting of the Board of Directors, provided that, if less than a
majority of such directors is present at such meeting, a majority of the directors present may adjourn the meeting from time to time without further notice, and provided further that if, pursuant to applicable law, the charter of the Corporation or these Bylaws, the vote of a majority or other percentage of a particular group of directors is required for action, a quorum must also include a majority or such other percentage of such group.
The directors present at a meeting which has been duly called and at which a quorum has been established may continue to transact business until adjournment, notwithstanding the withdrawal from the meeting of enough directors to leave fewer than required to establish a quorum.
Section 7. VOTING. The action of a majority of the directors present at a meeting at which a quorum is present shall be the action of the Board of Directors, unless the concurrence of a greater proportion is required for such action by applicable law, the charter or these Bylaws. If enough directors have withdrawn from a meeting to leave fewer than required to establish a quorum, but the meeting is not adjourned, the action of the majority of that number of directors necessary to constitute a quorum at such meeting shall be the action of the Board of Directors, unless the concurrence of a greater proportion is required for such action by applicable law, the charter of the Corporation or these Bylaws.
Section 8. ORGANIZATION. At each meeting of the Board of Directors, the chairman of the board or, in the absence of the chairman, the vice chairman of the board, if any, shall act as chairman of the meeting. In the absence of both the chairman and vice chairman of the board, the chief executive officer or, in the absence of the chief executive officer, the president or, in the absence of the president, a director chosen by a majority of the directors present, shall act as chairman of the meeting. The secretary or, in his or her absence, an assistant secretary of the Corporation, or, in the absence of the secretary and all assistant secretaries, an individual appointed by the chairman of the meeting, shall act as secretary of the meeting.
Section 9. TELEPHONE MEETINGS. Directors may participate in a meeting by means of a conference telephone or other communications equipment if all persons participating in the meeting can hear each other at the same time. Participation in a meeting by these means shall constitute presence in person at the meeting.
Section 10. CONSENT BY DIRECTORS 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 or by electronic transmission to such action is given by each director and is filed with the minutes of proceedings of the Board of Directors.
Section 11. VACANCIES. If for any reason any or all of the directors cease to be directors, such event shall not terminate the Corporation or affect these Bylaws or the powers of the remaining directors hereunder. Until such time as the Corporation becomes subject to Section 3-804(c) of the MGCL, any vacancy on the Board of Directors for any cause other than an increase in the number of directors may be filled by a majority of the remaining directors, even if such majority is less than a quorum; any vacancy in the number of directors created by an increase in the number of directors may be filled by a majority vote of the entire Board of Directors; and any individual so elected as director shall serve until the next annual meeting of stockholders and until his or her successor is elected and qualifies. At such time as the
Corporation becomes subject to Section 3-804(c) of the MGCL and except as may be provided by the Board of Directors in setting the terms of any class or series of preferred stock, any vacancy on the Board of Directors may be filled only by a majority of the remaining directors, even if the remaining directors do not constitute a quorum, and any director elected to fill a vacancy shall serve for the remainder of the full term of the directorship in which the vacancy occurred and until a successor is elected and qualifies.
Section 12. COMPENSATION. Directors shall not receive any stated salary for their services as directors but, by resolution of the Board of Directors, may receive compensation per year and/or per meeting and/or per visit to real property or other facilities owned or leased by the Corporation and for any service or activity they performed or engaged in as directors. Directors may be reimbursed for expenses of attendance, if any, at each annual, regular or special meeting of the Board of Directors or of any committee thereof and for their expenses, if any, in connection with each property visit and any other service or activity they perform or engage in as directors; but nothing herein contained shall be construed to preclude any directors from serving the Corporation in any other capacity and receiving compensation therefor.
Section 13. RELIANCE. Each director and officer of the Corporation shall, in the performance of his or her duties with respect to the Corporation, be entitled to rely on any information, opinion, report or statement, including any financial statement or other financial data, prepared or presented by an officer or employee of the Corporation whom the director or officer reasonably believes to be reliable and competent in the matters presented, by a lawyer, certified public accountant or other person, as to a matter which the director or officer reasonably believes to be within the persons professional or expert competence, or, with respect to a director, by a committee of the Board of Directors on which the director does not serve, as to a matter within its designated authority, if the director reasonably believes the committee to merit confidence.
Section 14. RATIFICATION. The Board of Directors or the stockholders may ratify and make binding on the Corporation any action or inaction by the Corporation or its officers to the extent that the Board of Directors or the stockholders could have originally authorized the matter. Moreover, any action or inaction questioned in any stockholders derivative proceeding or any other proceeding on the ground of lack of authority, defective or irregular execution, adverse interest of a director, officer or stockholder, non-disclosure, miscomputation, the application of improper principles or practices of accounting or otherwise, may be ratified, before or after judgment, by the Board of Directors or by the stockholders, and if so ratified, shall have the same force and effect as if the questioned action or inaction had been originally duly authorized, and such ratification shall be binding upon the Corporation and its stockholders and shall constitute a bar to any claim or execution of any judgment in respect of such questioned action or inaction.
Section 15. CERTAIN RIGHTS OF DIRECTORS AND OFFICERS. Any director or officer, in his or her personal capacity or in a capacity as an affiliate, employee, or agent of any other person, or otherwise, may have business interests and engage in business activities similar to, in addition to or in competition with those of or relating to the Corporation.
Section 16. EMERGENCY PROVISIONS. Notwithstanding any other provision in the charter or these Bylaws, this Section 16 shall apply during the existence of any catastrophe, or other similar emergency condition, as a result of which a quorum of the Board of Directors under Article III of these Bylaws cannot readily be obtained (an Emergency). During any Emergency, unless otherwise provided by the Board of Directors, (i) a meeting of the Board of Directors or a committee thereof may be called by any director or officer by any means feasible under the circumstances; (ii) notice of any meeting of the Board of Directors during such an Emergency may be given less than 24 hours prior to the meeting to as many directors and by such means as may be feasible at the time, including publication, television or radio; and (iii) the number of directors necessary to constitute a quorum shall be one-third of the entire Board of Directors.
ARTICLE IV
COMMITTEES
Section 1. NUMBER, TENURE AND QUALIFICATIONS. The Board of Directors may appoint from among its members an Executive Committee, an Audit Committee, a Compensation Committee, a Nominating and Corporate Governance Committee and one or more other committees, composed of one or more directors, to serve at the pleasure of the Board of Directors.
Section 2. POWERS. The Board of Directors may delegate to committees appointed under Section 1 of this Article any of the powers of the Board of Directors, except as prohibited by law.
Section 3. MEETINGS. Notice of committee meetings shall be given in the same manner as notice for special meetings of the Board of Directors. A majority of the members of the committee shall constitute a quorum for the transaction of business at any meeting of the committee. The act of a majority of the committee members present at a meeting shall be the act of such committee. The Board of Directors may designate a chairman of any committee, and such chairman or, in the absence of a chairman, any two members of any committee (if there are at least two members of the committee) may fix the time and place of its meeting unless the Board shall otherwise provide. In the absence of any member of any such committee, the members thereof present at any meeting, whether or not they constitute a quorum, may appoint another director to act in the place of such absent member.
Section 4. TELEPHONE MEETINGS. Members of a committee of the Board of Directors may participate in a meeting by means of a conference telephone or other communications equipment if all persons participating in the meeting can hear each other at the same time. Participation in a meeting by these means shall constitute presence in person at the meeting.
Section 5. CONSENT 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 or by electronic transmission to such action is given by each member of the committee and is filed with the minutes of proceedings of such committee.
Section 6. VACANCIES. Subject to the provisions hereof, the Board of Directors shall have the power at any time to change the membership of any committee, to fill any vacancy, to designate an alternate member to replace any absent or disqualified member or to dissolve any such committee.
ARTICLE V
OFFICERS
Section 1. GENERAL PROVISIONS. The officers of the Corporation shall include a president, a secretary and a treasurer and may include a chairman of the board, a vice chairman of the board, a chief executive officer, one or more vice presidents, a chief operating officer, a chief financial officer, a chief investment officer, one or more assistant secretaries and one or more assistant treasurers. In addition, the Board of Directors may from time to time elect such other officers with such powers and duties as it shall deem necessary or desirable. The officers of the Corporation shall be elected annually by the Board of Directors, except that the chief executive officer or president may from time to time appoint one or more vice presidents, assistant secretaries and assistant treasurers or other officers. Each officer shall serve until his or her successor is elected and qualifies or until his or her death, or his or her resignation or removal in the manner hereinafter provided. Any two or more offices except president and vice president may be held by the same person. Election of an officer or agent shall not of itself create contract rights between the Corporation and such officer or agent.
Section 2. REMOVAL AND RESIGNATION. Any officer or agent of the Corporation may be removed, with or without cause, by the Board of Directors, 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 delivering his or her resignation to the Board of Directors, the chairman of the board, the chief executive officer, the president or the secretary. Any resignation shall take effect immediately upon its receipt or at such later time specified in the resignation. The acceptance of a resignation shall not be necessary to make it effective unless otherwise stated in the resignation. Such resignation shall be without prejudice to the contract rights, if any, of the Corporation.
Section 3. VACANCIES. A vacancy in any office may be filled by the Board of Directors for the balance of the term.
Section 4. CHAIRMAN OF THE BOARD. The Board of Directors may designate from among its members a chairman of the board, who shall not, solely by reason of these Bylaws, be an officer of the Corporation. The Board of Directors may designate the chairman of the board as an executive or non-executive chairman. The chairman of the board shall preside over the meetings of the Board of Directors. The chairman of the board shall perform such other duties as may be assigned to him or her by these Bylaws or the Board of Directors.
Section 5. CHIEF EXECUTIVE OFFICER. The Board of Directors may designate a chief executive officer. In the absence of such designation, the chairman of the board shall be the chief executive officer of the Corporation. The chief executive officer shall have general responsibility for implementation of the policies of the Corporation, as determined by the
Board of Directors, and for the management of the business and affairs of the Corporation. He or she may execute any deed, mortgage, bond, contract or other instrument, except in cases where the execution thereof shall be expressly delegated by the Board of Directors or by these Bylaws to some other officer or agent of the Corporation or shall be required by law to be otherwise executed; and in general shall perform all duties incident to the office of chief executive officer and such other duties as may be prescribed by the Board of Directors from time to time.
Section 6. CHIEF OPERATING OFFICER. The Board of Directors may designate a chief operating officer. The chief operating officer shall have the responsibilities and duties as determined by the Board of Directors or the chief executive officer.
Section 7. CHIEF FINANCIAL OFFICER. The Board of Directors may designate a chief financial officer. The chief financial officer shall have the responsibilities and duties as determined by the Board of Directors or the chief executive officer.
Section 8. PRESIDENT. In the absence of a chief executive officer, the president shall in general supervise and control all of the business and affairs of the Corporation. In the absence of a designation of a chief operating officer by the Board of Directors, the president shall be the chief operating officer. He or she may execute any deed, mortgage, bond, contract or other instrument, except in cases where the execution thereof shall be expressly delegated by the Board of Directors or by these Bylaws to some other officer or agent of the Corporation or shall be required by law to be otherwise executed; and in general shall perform all duties incident to the office of president and such other duties as may be prescribed by the Board of Directors from time to time.
Section 9. VICE PRESIDENTS. In the absence of the president or in the event of a vacancy in such office, the vice president (or in the event there be more than one vice president, the vice presidents in the order designated at the time of their election or, in the absence of any designation, then in the order of their election) shall perform the duties of the president and when so acting shall have all the powers of and be subject to all the restrictions upon the president; and shall perform such other duties as from time to time may be assigned to such vice president by the chief executive officer, the president or the Board of Directors. The Board of Directors may designate one or more vice presidents as executive vice president, senior vice president, or vice president for particular areas of responsibility.
Section 10. SECRETARY. The secretary shall (a) keep the minutes of the proceedings of the stockholders, the Board of Directors and committees of the Board of Directors in one or more books provided for that purpose; (b) see that all notices are duly given in accordance with the provisions of these Bylaws or as required by law; (c) be custodian of the corporate records and of the seal of the Corporation; (d) keep a register of the post office address of each stockholder which shall be furnished to the secretary by such stockholder; (e) have general charge of the stock transfer books of the Corporation; and (f) in general perform such other duties as from time to time may be assigned to him or her by the chief executive officer, the president or the Board of Directors.
Section 11. TREASURER. The treasurer shall have the custody of the funds and securities of the Corporation, shall keep full and accurate accounts of receipts and
disbursements in books belonging to the Corporation, 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 and in general perform such other duties as from time to time may be assigned to him or her by the chief executive officer, the president or the Board of Directors. In the absence of a designation of a chief financial officer by the Board of Directors, the treasurer shall be the chief financial officer of the Corporation.
The treasurer shall disburse the funds of the Corporation as may be ordered by the Board of Directors, taking proper vouchers for such disbursements, and shall render to the president and Board of Directors, at the regular meetings of the Board of Directors or whenever it may so require, an account of all his or her transactions as treasurer and of the financial condition of the Corporation.
Section 12. ASSISTANT SECRETARIES AND ASSISTANT TREASURERS. The assistant secretaries and assistant treasurers, in general, shall perform such duties as shall be assigned to them by the secretary or treasurer, respectively, or by the chief executive officer, the president or the Board of Directors.
Section 13. COMPENSATION. The compensation of the officers shall be fixed from time to time by or under the authority of the Board of Directors and no officer shall be prevented from receiving such compensation by reason of the fact that he or she is also a director.
ARTICLE VI
CONTRACTS, CHECKS AND DEPOSITS
Section 1. CONTRACTS. The Board of Directors may authorize any officer or agent to enter into any contract or to execute and deliver any instrument in the name of and on behalf of the Corporation and such authority may be general or confined to specific instances. Any agreement, deed, mortgage, lease or other document shall be valid and binding upon the Corporation when duly authorized or ratified by action of the Board of Directors and executed by an authorized person.
Section 2. CHECKS AND DRAFTS. All checks, drafts or other orders for the payment of money, notes or other evidences of indebtedness issued in the name of the Corporation shall be signed by such officer or agent of the Corporation in such manner as shall from time to time be determined by the Board of Directors.
Section 3. DEPOSITS. All funds of the Corporation not otherwise employed shall be deposited or invested from time to time to the credit of the Corporation as the Board of Directors, the chief executive officer, the president, the chief financial officer, or any other officer designated by the Board of Directors may determine.
ARTICLE VII
STOCK
Section 1. CERTIFICATES. Except as may be otherwise provided by the Board of Directors, stockholders of the Corporation are not entitled to certificates representing the shares of stock held by them. In the event that the Corporation issues shares of stock represented by certificates, such certificates shall be in such form as prescribed by the Board of Directors or a duly authorized officer, shall contain the statements and information required by the MGCL and shall be signed by the officers of the Corporation in the manner permitted by the MGCL. In the event that the Corporation issues shares of stock without certificates, to the extent then required by the MGCL, the Corporation shall provide to the record holders of such shares a written statement of the information required by the MGCL to be included on stock certificates. There shall be no differences in the rights and obligations of stockholders based on whether or not their shares are represented by certificates.
Section 2. TRANSFERS. All transfers of shares of stock shall be made on the books of the Corporation, by the holder of the shares, in person or by his or her attorney, in such manner as the Board of Directors or any officer of the Corporation may prescribe and, if such shares are certificated, upon surrender of certificates duly endorsed. The issuance of a new certificate upon the transfer of certificated shares is subject to the determination of the Board of Directors that such shares shall no longer be represented by certificates. Upon the transfer of any uncertificated shares, to the extent then required by the MGCL, the Corporation shall provide to the record holders of such shares a written statement of the information required by the MGCL to be included on stock certificates.
The Corporation shall be entitled to treat the holder of record of any share of stock as the holder in fact thereof and, accordingly, shall not be bound to recognize any equitable or other claim to or interest in such share or on the part of any other person, whether or not it shall have express or other notice thereof, except as otherwise expressly provided by the laws of the State of Maryland.
Notwithstanding the foregoing, transfers of shares of any class or series of stock will be subject in all respects to the charter of the Corporation and all of the terms and conditions contained therein.
Section 3. REPLACEMENT CERTIFICATE. Any officer of the Corporation may direct a new certificate or certificates to be issued in place of any certificate or certificates theretofore issued by the Corporation alleged to have been lost, destroyed, stolen or mutilated, upon the making of an affidavit of that fact by the person claiming the certificate to be lost, destroyed, stolen or mutilated; provided, however, if such shares have ceased to be certificated, no new certificate shall be issued unless requested in writing by such stockholder and the Board of Directors has determined that such certificates may be issued. Unless otherwise determined by an officer of the Corporation, the owner of such lost, destroyed, stolen or mutilated certificate or certificates, or his or her legal representative, shall be required, as a condition precedent to the issuance of a new certificate or certificates, to give the Corporation a bond in such sums as it may direct as indemnity against any claim that may be made against the Corporation.
Section 4. FIXING OF RECORD DATE. The Board of Directors may set, in advance, a record date for the purpose of determining stockholders entitled to notice of or to vote at any meeting of stockholders or determining stockholders entitled to receive payment of any dividend or the allotment of any other rights, or in order to make a determination of stockholders for any other proper purpose. Such date, in any case, shall not be prior to the close of business on the day the record date is fixed and shall be not more than 90 days and, in the case of a meeting of stockholders, not less than ten days, before the date on which the meeting or particular action requiring such determination of stockholders of record is to be held or taken.
When a record date for the determination of stockholders entitled to notice of and to vote at any meeting of stockholders has been set as provided in this section, such record date shall continue to apply to the meeting if adjourned or postponed, except if the meeting is adjourned or postponed to a date more than 120 days after the record date originally fixed for the meeting, in which case a new record date for such meeting may be determined as set forth herein.
Section 5. STOCK LEDGER. The Corporation shall maintain at its principal office or at the office of its counsel, accountants or transfer agent, an original or duplicate stock ledger containing the name and address of each stockholder and the number of shares of each class held by such stockholder.
Section 6. FRACTIONAL STOCK; ISSUANCE OF UNITS. The Board of Directors may authorize the Corporation to issue fractional stock or authorize the issuance of scrip, all on such terms and under such conditions as it may determine. Notwithstanding any other provision of the charter or these Bylaws, the Board of Directors may issue units consisting of different securities of the Corporation. Any security issued in a unit shall have the same characteristics as any identical securities issued by the Corporation, except that the Board of Directors may provide that for a specified period securities of the Corporation issued in such unit may be transferred on the books of the Corporation only in such unit.
ARTICLE VIII
ACCOUNTING YEAR
The Board of Directors shall have the power, from time to time, to fix the fiscal year of the Corporation by a duly adopted resolution.
ARTICLE IX
DISTRIBUTIONS
Section 1. AUTHORIZATION. Dividends and other distributions upon the stock of the Corporation may be authorized by the Board of Directors, subject to the provisions of law and the charter of the Corporation. Dividends and other distributions may be paid in cash, property or stock of the Corporation, subject to the provisions of law and the charter.
Section 2. CONTINGENCIES. Before payment of any dividends or other distributions, there may be set aside out of any assets of the Corporation available for dividends or other distributions such sum or sums as the Board of Directors may from time to time, in its
absolute discretion, think proper as a reserve fund for contingencies, for equalizing dividends, for repairing or maintaining any property of the Corporation or for such other purpose as the Board of Directors shall determine, and the Board of Directors may modify or abolish any such reserve.
ARTICLE X
INVESTMENT POLICY
Subject to the provisions of the charter of the Corporation, the Board of Directors may from time to time adopt, amend, revise or terminate any policy or policies with respect to investments by the Corporation as it shall deem appropriate in its sole discretion.
ARTICLE XI
SEAL
Section 1. SEAL. The Board of Directors may authorize the adoption of a seal by the Corporation. The seal shall contain the name of the Corporation and the year of its incorporation and the words Incorporated Maryland. The Board of Directors may authorize one or more duplicate seals and provide for the custody thereof.
Section 2. AFFIXING SEAL. Whenever the Corporation is permitted or required to affix its seal to a document, it shall be sufficient to meet the requirements of any law, rule or regulation relating to a seal to place the word (SEAL) adjacent to the signature of the person authorized to execute the document on behalf of the Corporation.
ARTICLE XII
INDEMNIFICATION AND ADVANCE OF EXPENSES
To the maximum extent permitted by Maryland law in effect from time to time, the Corporation shall indemnify and, without requiring a preliminary determination of the ultimate entitlement to indemnification, shall pay or reimburse reasonable expenses in advance of final disposition of a proceeding to (a) any individual who is a present or former director or officer of the Corporation and who is made or threatened to be made a party to the proceeding by reason of his or her service in that capacity or (b) any individual who, while a director or officer of the Corporation and at the request of the Corporation, serves or has served as a director, officer, partner, trustee, member or manager of another corporation, real estate investment trust, limited liability company, partnership, joint venture, trust, employee benefit plan or other enterprise and who is made or threatened to be made a party to the proceeding by reason of his or her service in that capacity. The rights to indemnification and advance of expenses provided by the charter of the Corporation and these Bylaws shall vest immediately upon election of a director or officer. The Corporation may, with the approval of its Board of Directors, provide such indemnification and advance for expenses to an individual who served a predecessor of the Corporation in any of the capacities described in (a) or (b) above and to any employee or agent of the Corporation or a predecessor of the Corporation. The indemnification and payment or reimbursement of expenses provided in these Bylaws shall not be deemed exclusive of or limit in any way other rights to which any person seeking indemnification or payment or reimbursement
of expenses may be or may become entitled under any bylaw, resolution, insurance, agreement or otherwise.
Neither the amendment nor repeal of this Article, nor the adoption or amendment of any other provision of the charter of the Corporation or these Bylaws inconsistent with this Article, shall apply to or affect in any respect the applicability of the preceding paragraph with respect to any act or failure to act which occurred prior to such amendment, repeal or adoption.
ARTICLE XIII
WAIVER OF NOTICE
Whenever any notice of a meeting is required to be given pursuant to the charter of the Corporation or these Bylaws or pursuant to applicable law, a waiver thereof in writing or by electronic transmission, given 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 of such meeting, 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 has not been lawfully called or convened.
ARTICLE XIV
AMENDMENT OF BYLAWS
The Board of Directors shall have the exclusive power to adopt, alter or repeal any provision of these Bylaws and to make new Bylaws.
Exhibit 10.1
SECOND AMENDED AND RESTATED INVESTMENT ADVISORY AGREEMENT
THIS SECOND AMENDED AND RESTATED INVESTMENT ADVISORY AGREEMENT is made as of December 13, 2012 by and among ZAIS FINANCIAL CORP., a Maryland corporation (the Company ), ZAIS Financial Partners, L.P., a Delaware partnership (the Operating Partnership ), ZAIS Asset I, LLC, a Delaware limited liability company ( Asset I ), ZAIS Asset II, LLC, a Delaware limited liability company ( Asset II ), ZAIS Asset III, LLC, a Delaware limited liability company ( Asset III ), ZAIS Asset IV, LLC, a Delaware limited liability company and ZAIS REIT Management, LLC, a Delaware limited liability company (together with its permitted assignees, the Advisor ).
WHEREAS, the Company is a corporation that has elected to be taxed as a REIT for U.S. federal income tax purposes commencing with its taxable year ended December 31, 2011;
WHEREAS, the Company, the Operating Partnership and each of the Subsidiaries (defined below) retained ZAIS Group, LLC (the ZAIS ) to provide investment advisory services to them on the terms and conditions set forth in the Investment Advisory Agreement, dated August 3, 2011 (the Investment Advisory Agreement );
WHEREAS, the parties to the Investment Advisory Agreement amended such agreement as of October 11, 2012 to reflect the assignment of such agreement from ZAIS to the Advisor (the First Amended and Restated Investment Advisory Agreement ), pursuant to that certain Assignment of Investment Advisory Agreement, dated October 11, 2012, by and among ZAIS and the Advisor, and to make certain other amendments; and
WHEREAS, the parties to the First Amended and Restated Investment Advisory Agreement desire to amend such agreement to revise the definition of the defined term Stockholders Equity, to add additional subsidiaries of the Operating Partnership as parties and to make certain other amendments;
NOW THEREFORE, in consideration of the mutual agreements herein set forth, the parties hereto agree as follows:
Section 1. Definitions . The following terms have the following meanings assigned to them:
(a) ABS means asset-backed securities.
(b) Advisor Indemnified Party shall have the meaning set forth in Section 11(a) of this Agreement.
(c) Affiliate means, when used with reference to a specified Person, any Person that directly, or indirectly through one or more intermediaries, Controls or is Controlled by, or is under common Control with the specified Person.
(d) Agency RMBS means residential mortgage-backed securities for which a U.S. government entity guarantees payment of principal and interest to holders of the securities.
(e) Agreement means this Second Amended and Restated Investment Advisory Agreement, as amended from time to time.
(f) Asset I means ZAIS Asset I, LLC, a Delaware limited liability company.
(g) Asset II means ZAIS Asset II, LLC, a Delaware limited liability company.
(h) Asset III means ZAIS Asset III, LLC, a Delaware limited liability company.
(i) Assets means the assets of the Company and the Subsidiaries.
(j) Bankruptcy means, with respect to any Person, (a) the filing by such Person of a voluntary petition seeking liquidation, reorganization, arrangement or readjustment, in any form, of its debts under Title 11 of the United States Code or any other federal, state or foreign insolvency law, or such Persons filing an answer consenting to or acquiescing in any such petition, (b) the making by such Person of any assignment for the benefit of its creditors, (c) the expiration of 60 days after the filing of an involuntary petition under Title 11 of the Unites States Code, an application for the appointment of a receiver for a material portion of the assets of such Person, or an involuntary petition seeking liquidation, reorganization, arrangement or readjustment of its debts under any other federal, state or foreign insolvency law, provided that the same shall not have been vacated, set aside or stayed within such 60-day period or (d) the entry against it of a final and non-appealable order for relief under any bankruptcy, insolvency or similar law now or hereinafter in effect.
(k) Base Advisory Fee means a base advisory fee equal to 1.5% per annum, calculated and paid quarterly in arrears, of (i) prior to the Listing, Net Asset Value, (ii) after the Listing, the Stockholders Equity.
(l) Board of Directors means the Board of Directors of the Company.
(m) CMBS means commercial mortgage-backed securities.
(n) Code means the Internal Revenue Code of 1986, as amended.
(o) Common Stock means shares of the Companys common stock, par value $0.0001 per share.
(p) Company Account shall have the meaning set forth in Section 5 of this Agreement.
(q) Company Indemnified Party shall have the meaning set forth in Section 11(b) of this Agreement.
(r) Control (including the correlative meanings of the terms Controls, Controlled by and under common Control with), as used with respect to any Person, means 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.
(s) Effective Termination Date shall have the meaning set forth in Section 13(a) of this Agreement.
(t) Excess Funds shall have the meaning set forth in Section 2(m) of this Agreement.
(u) Exchange Act means the Securities Exchange Act of 1934, as amended.
(v) Expenses shall have the meaning set forth in Section 9 of this Agreement.
(w) First Amended and Restated Investment Advisory Agreement means the First Amended and Restated Investment Advisory Agreement, dated October 11, 2012, by and among the Company, the Operating Partnership and each of the Subsidiaries.
(x) GAAP means generally accepted accounting principles, as applied in the United States.
(y) Governing Instruments means, with regard to any entity, the articles of incorporation and bylaws in the case of a corporation, certificate of limited partnership and the partnership agreement in the case of a general or limited partnership, the articles of formation and the operating agreement in the case of a limited liability company, the trust instrument in the case of a trust, or similar governing documents, in each case as amended from time to time.
(z) Guidelines shall have the meaning set forth in Section 2(b)(ii) of this Agreement.
(aa) Indemnitee shall have the meaning set forth in Section 11(b) of this Agreement.
(bb) Indemnitor shall have the meaning set forth in Section 11(c) of this Agreement.
(cc) Independent Directors means the members of the Board of Directors who are not officers or employees of the Advisor or any Person directly or indirectly controlling or controlled by the Advisor or its Affiliates, and who are otherwise independent in accordance with the Companys Governing Instruments and, if applicable, the rules of any national securities exchange on which the Common Stock is listed.
(dd) Initial Term shall have the meaning set forth in Section 13 of this Agreement.
(ee) Investment Advisory Agreement means the Investment Advisory Agreement, dated August 3, 2011, by and among the Company, the Operating Partnership and each of the Subsidiaries.
(ff) Investment Committee means the Advisors investment committee that will oversee the Companys acquisition and financing strategies as well as compliance with the Companys investment guidelines.
(gg) Investment Company Act means the Investment Company Act of 1940, as amended.
(hh) Liabilities means the liabilities of the Company and the Subsidiaries.
(ii) LIBOR means London Interbank Offered Rate.
(jj) Listing means the listing of shares of Common Stock on the NASDAQ Capital Market or another U.S. national securities exchange.
(kk) Monitoring Services shall have the meaning set forth in Section 2(b) of this Agreement.
(ll) Net Asset Value means the value of all of the Assets determined by the Advisor as of the close of business on the day on which the Assets are being valued less all of the Companys
Liabilities. In each case, the Companys net Assets will be determined on the accrual basis of accounting utilizing GAAP as a guideline.
(mm) Non-Agency RMBS means residential mortgage-backed securities that are not issued or guaranteed by a U.S. government agency or federally chartered corporation.
(nn) Notice of Proposal to Negotiate shall have the meaning set forth in Section 13(a) of this Agreement.
(oo) Offering means the Companys offering of Common Stock and OP units pursuant to a confidential exchange offer statement, dated May 25, 2011, and the supplement thereto dated July 14, 2011, which closed on August 3, 2011.
(pp) Operating Partnership means ZAIS Financial Partners, L.P.
(qq) Person means any individual, corporation, partnership, joint venture, limited liability company, estate, trust, unincorporated association, any federal, state, county or municipal government or any bureau, department or agency thereof and any fiduciary acting in such capacity on behalf of any of the foregoing.
(rr) Portfolio Management Services shall have the meaning set forth in Section 2(b) of this Agreement.
(ss) REIT means a real estate investment trust as defined under the Code.
(tt) Renewal Term shall have the meaning set forth in Section 13(a) of this Agreement.
(uu) Securities Act means the Securities Act of 1933, as amended.
(vv) Stockholders Equity means:
(i) The Net Asset Value of the Operating Partnership at completion of the Listing, plus
(ii) the sum of the net proceeds from any issuances of the Companys capital stock and the Operating Partnerships equity securities (exclusive of Operating Partnership equity securities held by the Company or its controlled subsidiaries) following the completion of the Listing (allocated on a pro rata daily basis for such issuances during the fiscal quarter of any such issuance), plus
(iii) the Companys retained earnings at the end of the most recently completed quarter (without taking into account any non-cash equity compensation expense incurred in current or prior periods), less
(iv) any amount that the Company pays for repurchases of the Common Stock since inception, any unrealized gains, losses or other items that do not affect realized net income (regardless of whether such items are included in other comprehensive income or loss, or in net income), as adjusted to exclude
(v) one-time events pursuant to changes in GAAP and certain non-cash items after discussions between the Advisor and the Companys Independent Directors and approved by a majority of the Companys Independent Directors.
For purposes of calculating Stockholders Equity, outstanding OP Units (other than OP Units held by the Company) shall be treated as outstanding shares of capital stock of the Company.
(ww) Subsidiary means any subsidiary of the Company; any partnership, the general partner of which is the Company or any subsidiary of the Company; any limited liability company, the managing member of which is the Company or any subsidiary of the Company; and 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 the Company or any subsidiary of the Company. Initially, the Subsidiaries shall be Asset I, Asset II and Asset III.
(xx) Target Assets means residential mortgage loans, Non-Agency RMBS, Agency RMBS and other real estate-related and financial assets, including, but not limited to, CMBS and ABS.
(yy) Termination Fee shall have the meaning set forth in Section 13(b) of this Agreement.
(zz) Termination Notice shall have the meaning set forth in Section 13(a) of this Agreement.
(aaa) Treasury Regulations means the regulations promulgated under the Code as amended from time to time.
(bbb) ZAIS means ZAIS Group, LLC.
Section 2. Appointment and Duties of the Advisor .
(a) The Company and each of the Subsidiaries hereby appoints the Advisor to manage the assets of the Company and the Subsidiaries subject to the further terms and conditions set forth in this Agreement and the Advisor hereby agrees to use its commercially reasonable efforts to perform each of the duties set forth herein. The appointment of the Advisor shall be exclusive to the Advisor except to the extent that the Advisor otherwise agrees, in its sole and absolute discretion, and except to the extent that the Advisor elects, pursuant to the terms of this Agreement, to cause the duties of the Advisor hereunder to be provided by third parties.
(b) The Advisor, in its capacity as manager of the assets and the day-to-day operations of the Company and the Subsidiaries, at all times will be subject to the supervision of the Companys Board of Directors and will have only such functions and authority as the Company may delegate to it including, without limitation, the functions and authority identified herein and delegated to the Advisor hereby. The Advisor will be responsible for the day-to-day operations of the Company and the Subsidiaries and will perform (or cause to be performed) such services and activities relating to the assets and operations of the Company and the Subsidiaries as may be appropriate, including, without limitation:
(i) forming the Investment Committee, which will propose guidelines to be approved by a majority of the members of the Board of Directors prior to the Listing and a majority of the Companys Independent Directors after the Listing;
(ii) serving as the Companys and the Subsidiaries consultant with respect to the periodic review of the guidelines and other parameters for the Assets, financing activities and operations, any modifications to which shall be approved by a majority of the members of the Board of Directors prior to the Listing and a majority of the Independent Directors after the Listing (such guidelines as initially approved and attached hereto as Exhibit A , as the same may be modified with such approval, the Guidelines ), and other policies for approval by the Board of Directors;
(iii) providing the Company with portfolio management;
(iv) investigating, analyzing and selecting possible opportunities and acquiring, financing, retaining, selling, restructuring or disposing of Assets consistent with the Guidelines;
(v) with respect to prospective purchases, sales or exchanges of Assets, conducting negotiations on behalf of the Company and the Subsidiaries with sellers, purchasers and brokers and, if applicable, their respective agents and representatives;
(vi) advising the Company on and negotiating and entering into, on behalf of the Company and the Subsidiaries, repurchase agreements, interest rate swap agreements and other hedging instruments, and all other agreements and instruments required for the Company and the Subsidiaries to conduct their business;
(vii) engaging and supervising, on behalf of the Company and the Subsidiaries and at the Companys expense, independent contractors which provide investment banking, mortgage brokerage, securities brokerage, other financial services, due diligence services, underwriting review services, legal and accounting services, and all other services (including transfer agent and registrar services) as may be required relating to Assets (or potential Assets);
(viii) coordinating and managing operations of any co-investment interests or joint venture held by the Company and the Subsidiaries and conducting all matters with the co-investment partners or joint venture;
(ix) providing executive and administrative personnel, office space and office services required in rendering services to the Company and the Subsidiaries;
(x) administering the day-to-day operations and performing and supervising the performance of such other administrative functions necessary to the management of the Company and the Subsidiaries as may be agreed upon by the Advisor and the Board of Directors, including, without limitation, the collection of revenues and the payment of the debts and obligations of the Company and the Subsidiaries and maintenance of appropriate computer services to perform such administrative functions;
(xi) communicating on behalf of the Company and the Subsidiaries with the holders of any of their equity or debt securities as required to satisfy any reporting and other requirements of any governmental bodies or agencies or trading markets and to maintain effective relations with such holders;
(xii) counseling the Company in connection with policy decisions to be made by the Board of Directors;
(xiii) evaluating and recommending to the Board of Directors hedging strategies and engaging in hedging activities on behalf of the Company and the Subsidiaries, consistent with such strategies as so modified from time to time, with the Companys qualification as a REIT and with the Guidelines;
(xiv) counseling the Company regarding the maintenance of its qualification as a REIT and monitoring compliance with the various REIT qualification tests and other rules set out in the Code and Treasury Regulations thereunder and using commercially reasonable efforts to cause the Company to qualify for taxation as a REIT;
(xv) counseling the Company and the Subsidiaries regarding the maintenance of their exemptions from the status of an investment company required to register under the Investment Company Act, monitoring compliance with the requirements for maintaining such exemptions and using commercially reasonable efforts to cause them to maintain such exemptions from such status;
(xvi) assisting the Company and the Subsidiaries in developing criteria for asset purchase commitments that are specifically tailored to the Companys objectives and strategies and making available to the Company and the Subsidiaries its knowledge and experience with respect to the Target Assets, other real estate-related assets and non-real estate-related assets;
(xvii) furnishing reports and statistical and economic research to the Company and the Subsidiaries regarding their activities and services performed for the Company and the Subsidiaries by the Advisor;
(xviii) monitoring the operating performance of Assets and providing periodic reports with respect thereto to the Board of Directors, including comparative information with respect to such operating performance and budgeted or projected operating results;
(xix) deploying and redeploying any moneys and securities of the Company and the Subsidiaries (including acquiring short-term Assets pending the acquisition of other Assets, payment of fees, costs and expenses, or payments of dividends to stockholders of the Company and the Subsidiaries) and advising the Company and the Subsidiaries as to their capital structure and capital raising;
(xx) assisting the Company and the Subsidiaries in retaining qualified accountants and legal counsel, as applicable, to assist in developing appropriate accounting systems and procedures, internal controls and other compliance procedures and testing systems with respect to financial reporting obligations and compliance with the provisions of the Code applicable to REITs and to conduct quarterly compliance reviews with respect thereto;
(xxi) assisting the Company and the Subsidiaries to qualify to do business in all applicable jurisdictions and to obtain and maintain all appropriate licenses;
(xxii) assisting the Company and the Subsidiaries in complying with all regulatory requirements applicable to them in respect of their business activities, including preparing or causing to be prepared all financial statements required under applicable regulations and contractual undertakings and all reports and documents, if any, required under the Exchange Act, the Securities Act, or by any securities exchange requirements;
(xxiii) assisting the Company and the Subsidiaries in taking all necessary actions to enable them to make required tax filings and reports, including soliciting stockholders for required information to the extent required by the provisions of the Code applicable to REITs;
(xxiv) placing, or arranging for the placement of, all orders pursuant to the Advisors investment determinations for the Company and the Subsidiaries, either directly with the issuer or with a broker or dealer (including any affiliated broker or dealer);
(xxv) handling and resolving all claims, disputes or controversies (including all litigation, arbitration, settlement or other proceedings or negotiations) on the Companys and/or the Subsidiaries behalf in which the Company and/or the Subsidiaries may be involved or to which they may be subject arising out of their day-to-day operations (other than with the Advisor or its affiliates), subject to such limitations or parameters as may be imposed from time to time by the Board of Directors;
(xxvi) using commercially reasonable efforts to cause expenses incurred by the Company and the Subsidiaries or on their behalf to be commercially reasonable or commercially customary and within any budgeted parameters or expense guidelines set by the Board of Directors from time to time;
(xxvii) arranging marketing materials, advertising, industry group activities (such as conference participations and industry organization memberships) and other promotional efforts designed to promote the business of the Company and the Subsidiaries;
(xxviii) advising the Company and the Subsidiaries with respect to and structuring long term financing vehicles for their portfolio of assets, and offering and selling securities publicly or privately in connection with any such structured financing;
(xxix) performing such other services as may be required from time to time for management and other activities relating to the assets and business of the Company and the Subsidiaries as the Board of Directors shall reasonably request or the Advisor shall deem appropriate under the particular circumstances; and
(xxx) using commercially reasonable efforts to cause the Company and the Subsidiaries to comply with all applicable laws.
Without limiting the foregoing, the Advisor will perform portfolio management services (the Portfolio Management Services ) on behalf of the Company and the Subsidiaries with respect to the Assets. Such services will include, but not be limited to, consulting with the Company and the Subsidiaries on the purchase and sale of, and other opportunities in connection with, the Companys portfolio of assets; the collection of information and the submission of reports pertaining to the Companys assets, interest rates and general economic conditions; periodic review and evaluation of the performance of the Companys portfolio of assets; acting as liaison between the Company and the Subsidiaries and banking, mortgage banking, investment banking and other parties with respect to the purchase, financing and disposition of assets; and other customary functions related to portfolio management. Additionally, the Advisor will perform monitoring services (the Monitoring Services ) on behalf of the Company and the Subsidiaries with respect to any loan servicing activities provided by third parties. Such Monitoring Services will include, but not be limited to, negotiating servicing agreements; acting as a liaison between the servicers of the assets and the Company and the Subsidiaries; review of servicers delinquency, foreclosure and other reports on assets; supervising claims filed under any insurance policies; and enforcing the obligation of any servicer to repurchase assets.
(c) For the period and on the terms and conditions set forth in this Agreement, the Company and each of the Subsidiaries hereby constitutes, appoints and authorizes the Advisor as its true and lawful agent and attorney-in-fact, in its name, place and stead, to negotiate, execute, deliver and enter into such securities repurchase and reverse repurchase agreements and arrangements, brokerage agreements, interest rate swap agreements, custodial agreements and such other agreements, instruments and authorizations on their behalf, on such terms and conditions as the Advisor, acting in its sole and absolute discretion, deems necessary or appropriate. This power of attorney is deemed to be coupled with an interest.
(d) The Advisor may enter into agreements with other parties, including its affiliates, for the purpose of engaging one or more parties for and on behalf, and at the sole cost and expense, of the Company and the Subsidiaries to provide property management, asset management, leasing, development and/or other services to the Company and the Subsidiaries (including, without limitation, Portfolio Management Services and Monitoring Services) pursuant to agreement(s) with terms which are then customary for agreements regarding the provision of services to companies that have assets similar in type, quality and value to the assets of the Company and the Subsidiaries; provided that (i) any such agreements entered into with affiliates of the Advisor shall be (A) on terms no more favorable to such affiliate than would be obtained from a third party on an arms-length basis and (B) to the extent the same do not fall within the provisions of the Guidelines, approved by a majority of the members of the Board of Directors prior to the Listing and a majority of the Independent Directors after the Listing, (ii) with respect to Portfolio Management Services, (A) any such agreements shall be subject to the Companys prior written approval and (B) the Advisor shall remain liable for the performance of such Portfolio Management Services, and (iii) with respect to Monitoring Services, any such agreements shall be subject to the Companys prior written approval.
(e) To the extent that the Advisor deems necessary or advisable, the Advisor may, from time to time, propose to retain one or more additional entities for the provision of sub-advisory services to the Advisor, or enter into a shared facilities and services agreement with its affiliates, in order to enable the Advisor to provide the services to the Company and the Subsidiaries specified by this Agreement; provided that any such agreement (i) shall be on terms and conditions substantially identical to the terms and conditions of this Agreement or otherwise not adverse to the Company and the Subsidiaries, and (ii) shall be approved by the Board of Directors prior to the Listing and the Independent Directors of the Company after the Listing.
(f) The Advisor may retain, for and on behalf and at the sole cost and expense of the Company and the Subsidiaries, such services of accountants, legal counsel, appraisers, insurers, brokers, transfer agents, registrars, developers, investment banks, financial advisors, due diligence firms, underwriting review firms, banks and other lenders and others as the Advisor deems necessary or advisable in connection with the management and operations of the Company and the Subsidiaries. Notwithstanding anything contained herein to the contrary, the Advisor shall have the right to cause any such services to be rendered by its employees or affiliates. Except as otherwise provided herein, the Company and the Subsidiaries shall pay or reimburse the Advisor or its affiliates performing such services for the cost thereof; provided that such costs and reimbursements are no greater than those which would be payable to outside professionals or consultants engaged to perform such services pursuant to agreements negotiated on an arms-length basis.
(g) The Advisor may effect transactions by or through the agency of another person with it or its affiliates which have an arrangement under which that party or its affiliates will from time to time provide to or procure for the Advisor and/or its affiliates goods, services or other benefits (including, but not limited to, research and advisory services; economic and political analysis, including valuation and performance measurement; market analysis, data and quotation services; computer hardware and
software incidental to the above goods and services; clearing and custodian services and investment related publications), the nature of which is such that provision can reasonably be expected to benefit the Company and the Subsidiaries as a whole and may contribute to an improvement in the performance of the Company and the Subsidiaries or the Advisor or its affiliates in providing services to the Company and the Subsidiaries on terms that no direct payment is made but instead the Advisor and/or its affiliates undertake to place business with that party.
(h) In executing portfolio transactions and selecting brokers or dealers, the Advisor will use its best efforts to seek on behalf of the Company and the Subsidiaries the best overall terms available. In assessing the best overall terms available for any transaction, the Advisor shall consider all factors that it deems relevant, including, without limitation, the breadth of the market in the security, the price of the security, the financial condition and execution capability of the broker or dealer, and the reasonableness of the commission, if any, both for the specific transaction and on a continuing basis. In evaluating the best overall terms available, and in selecting the broker or dealer to execute a particular transaction, the Advisor may also consider whether such broker or dealer furnishes research and other information or services to the Advisor.
(i) The Advisor has no duty or obligation to seek in advance competitive bidding for the most favorable commission rate applicable to any particular purchase, sale or other transaction, or to select any broker-dealer on the basis of its purported or posted commission rate, but will endeavor to be aware of the current level of charges of eligible broker-dealers and to minimize the expense incurred for effecting purchases, sales and other transactions to the extent consistent with the interests and policies of the Company and the Subsidiaries. Although the Advisor will generally seek competitive commission rates, it is not required to pay the lowest commission or commission equivalent, provided that such decision is made in good faith to promote the best interests of the Company and the Subsidiaries.
(j) As frequently as the Advisor may deem necessary or advisable, or at the direction of the Board of Directors, the Advisor shall, at the sole cost and expense of the Company and the Subsidiaries, prepare, or cause to be prepared, with respect to any Asset, reports and other information with respect to such Asset as may be reasonably requested by the Company.
(k) The Advisor shall prepare, or cause to be prepared, at the sole cost and expense of the Company and the Subsidiaries, all reports, financial or otherwise, with respect to the Company and the Subsidiaries reasonably required by the Board of Directors in order for the Company and the Subsidiaries to comply with their Governing Instruments or any other materials required to be filed with any governmental body or agency, and shall prepare, or cause to be prepared, all materials and data necessary to complete such reports and other materials including, without limitation, an annual audit of the Companys and the Subsidiaries books of account by a nationally recognized registered independent public accounting firm.
(l) The Advisor shall prepare regular reports for the Board of Directors to enable the Board of Directors to review the Companys and the Subsidiaries acquisitions, portfolio composition and characteristics, credit quality, performance and compliance with the Guidelines and policies approved by the Board of Directors.
(m) Notwithstanding anything contained in this Agreement to the contrary, except to the extent that the payment of additional moneys is proven by the Company to have been required as a direct result of the Advisors acts or omissions which result in the right of the Company and the Subsidiaries to terminate this Agreement pursuant to Section 15 of this Agreement, the Advisor shall not be required to expend money ( Excess Funds ) in connection with any expenses that are required to be paid for or reimbursed by the Company and the Subsidiaries pursuant to Section 9 in excess of that
contained in any applicable Company Account (as herein defined) or otherwise made available by the Company and the Subsidiaries to be expended by the Advisor hereunder. Failure of the Advisor to expend Excess Funds out-of-pocket shall not give rise or be a contributing factor to the right of the Company and the Subsidiaries under Section 13(a) of this Agreement to terminate this Agreement due to the Advisors unsatisfactory performance.
(n) In performing its duties under this Section 2 , the Advisor shall be entitled to rely reasonably on qualified experts and professionals (including, without limitation, accountants, legal counsel and other service providers) hired by the Advisor at the Companys and the Subsidiaries sole cost and expense.
Section 3. Devotion of Time; Additional Activities .
(a) The Advisor and its affiliates will provide the Company and the Subsidiaries with a management team, including a Chief Executive Officer, a Chief Financial Officer, and other appropriate support personnel. The Advisor is not obligated to dedicate any of its employees exclusively to the Company, nor is the Advisor or its employees obligated to dedicate any specific portion of its or their time to the Company.
(b) The Advisor agrees to offer the Company and the Subsidiaries the right to participate in all opportunities that the Advisor determines are appropriate for the Company and the Subsidiaries in view of their objectives, policies and strategies, and other relevant factors, subject to the exception that the Company and the Subsidiaries might not participate in each such opportunity but will on an overall basis equitably participate with the Advisors other funds in relevant opportunities. Nothing in this Agreement shall (i) prevent the Advisor or any of its affiliates, officers, directors, employees or personnel, from engaging in other businesses or from rendering services of any kind to any other Person, including, without limitation, investing in, or rendering advisory services to others investing in, any type of business (including, without limitation, acquisitions of assets that meet the principal objectives of the Company), whether or not the objectives or policies of any such other Person or entity are similar to those of the Company or (ii) in any way bind or restrict the Advisor or any of its affiliates, officers, directors, employees or personnel from buying, selling or trading any securities or assets for their own accounts or for the account of others for whom the Advisor or any of its affiliates, officers, directors, employees or personnel may be acting. When making decisions where a conflict of interest may arise, the Advisor will endeavor to allocate acquisition and financing opportunities in a fair and equitable manner over time as between the Company and the Subsidiaries and the Advisors other clients.
(c) Advisors, partners, officers, employees, personnel and agents of the Advisor or affiliates of the Advisor may serve as directors, officers, employees, personnel, agents, nominees or signatories for the Company and/or any Subsidiary, to the extent permitted by their Governing Instruments or by any resolutions duly adopted by the Board of Directors pursuant to the Companys Governing Instruments. When executing documents or otherwise acting in such capacities for the Company or the Subsidiaries, such persons shall use their respective titles in the Company or the Subsidiaries.
Section 4. Agency . The Advisor shall act as agent of the Company and the Subsidiaries in making, acquiring, financing and disposing of Assets, disbursing and collecting the funds of the Company and the Subsidiaries, paying the debts and fulfilling the obligations of the Company and the Subsidiaries, supervising the performance of professionals engaged by or on behalf of the Company and the Subsidiaries and handling, prosecuting and settling any claims of or against the Company and the Subsidiaries, the Board of Directors, holders of the Companys securities or representatives or properties of the Company and the Subsidiaries.
Section 5. Bank Accounts . At the direction of the Board of Directors, the Advisor may establish and maintain one or more bank accounts in the name of the Company or any Subsidiary (any such account, a Company Account ), and may collect and deposit funds into any such Company Account or Company Accounts, and disburse funds from any such Company Account or Company Accounts, under such terms and conditions as the Board of Directors may approve; and the Advisor shall from time to time render appropriate accountings of such collections and payments to the Board of Directors and, upon request, to the auditors of the Company or any Subsidiary.
Section 6. Records; Confidentiality . The Advisor shall maintain appropriate books of accounts and records relating to services performed under this Agreement, and such books of account and records shall be accessible for inspection by representatives of the Company or any Subsidiary at any time during normal business hours upon reasonable advance notice. The Advisor shall keep confidential any and all information obtained in connection with the services rendered under this Agreement and shall not disclose any such information (or use the same except in furtherance of its duties under this Agreement) to unaffiliated third parties except (i) with the prior written consent of the Board of Directors; (ii) to legal counsel, accountants and other professional advisors; (iii) to appraisers, financing sources and others in the ordinary course of the Companys business; (iv) to governmental officials having jurisdiction over the Company or any Subsidiary; (v) in connection with any governmental or regulatory filings of the Company or any Subsidiary or disclosure or presentations to Company investors; (vi) as required by law or legal process to which the Advisor or any Person to whom disclosure is permitted hereunder is a party; or (vii) to the extent such information is otherwise publicly available. The foregoing shall not apply to information which has previously become publicly available through the actions of a Person other than the Advisor not resulting from the Advisors violation of this Section 6 . The provisions of this Section 6 shall survive the expiration or earlier termination of this Agreement for a period of one year.
Section 7. Obligations of Advisor; Restrictions .
(a) The Advisor shall require each seller or transferor of investment assets to the Company and the Subsidiaries to make such representations and warranties regarding such assets as may, in the judgment of the Advisor, be necessary and appropriate. In addition, the Advisor shall take such other action as it deems necessary or appropriate with regard to the protection of the Assets.
(b) The Advisor shall refrain from any action that, in its sole judgment made in good faith, (i) is not in compliance with the Guidelines, (ii) would adversely and materially affect the status of the Company as a REIT under the Code, (iii) would adversely and materially affect the Companys or any Subsidiarys status as an entity intended to be exempted or excluded from investment company status under the Investment Company Act or (iv) would violate any law, rule or regulation of any governmental body or agency having jurisdiction over the Company or any Subsidiary or that would otherwise not be permitted by the Companys Governing Instruments. If the Advisor is ordered to take any such action by the Board of Directors, the Advisor shall promptly notify the Board of Directors of the Advisors judgment that such action would adversely and materially affect such status or violate any such law, rule or regulation or the Governing Instruments. Notwithstanding the foregoing, the Advisor, its directors, members, officers, stockholders, managers, personnel, employees and any Person controlling or controlled by the Advisor and any Person providing sub-advisory or shared facilities services to the Advisor shall not be liable to the Company or any Subsidiary, the Board of Directors, or the Companys or any Subsidiarys stockholders, members or partners, for any act or omission by the Advisor, its directors, officers, stockholders or employees except as provided in Section 11 of this Agreement.
(c) The Board of Directors shall periodically review the Guidelines and the Companys portfolio of Assets but will not review each proposed Asset, except as otherwise provided herein. If, prior to the Listing, a majority of the members of the Board of Directors or, after the Listing, a
majority of the Independent Directors determines in their periodic review of transactions that a particular transaction does not comply with the Guidelines, then a majority of the members of the Board of Directors or a majority of the Independent Directors, as applicable, will consider what corrective action, if any, can be taken. The Advisor shall be permitted to rely upon the direction of the Secretary of the Company to evidence the approval of the Board of Directors or the Independent Directors with respect to a proposed acquisition.
(d) Other than the exchange offer and related transactions related to the Offering, neither the Company nor the Subsidiaries shall acquire any security structured or issued by an entity managed by the Advisor or any affiliate thereof, unless (i) the acquisition is made in accordance with the Guidelines; (ii) such acquisition, if prior to the Listing, is approved in advance by a majority of the members of the Board of Directors and, if after the Listing, is approved in advance by a majority of the Independent Directors; and (iii) the acquisition is made in accordance with applicable laws.
(e) The Advisor shall at all times during the term of this Agreement maintain errors and omissions insurance coverage and other insurance coverage which is customarily carried by property, asset and investment managers performing functions similar to those of the Advisor under this Agreement with respect to assets similar to the assets of the Company and the Subsidiaries, in an amount which is comparable to that customarily maintained by other managers or servicers of similar assets.
Section 8. Compensation .
(a) During the Initial Term and any Renewal Term (each as defined below), the Company shall pay the Advisor the Base Advisory Fee quarterly in arrears commencing with the quarter in which the Investment Advisory Agreement was executed (with such initial payment pro-rated based on the number of days during such quarter that the Investment Advisory Agreement was in effect).
(b) The Advisor shall compute each installment of the Base Advisory Fee within 30 days after the end of the fiscal quarter with respect to which such installment is payable. A copy of the computations made by the Advisor to calculate such installment shall thereafter, for informational purposes only and subject in any event to Section 13(a) of this Agreement, promptly be delivered to the Board of Directors and, upon such delivery, payment of such installment of the Base Advisory Fee shown therein shall be due and payable in cash no later than the date which is five business days after the date of delivery to the Board of Directors of such computations.
(c) The Base Advisory Fee is subject to adjustment pursuant to and in accordance with the provisions of Section 13(a) of this Agreement.
Section 9. Expenses of the Company . The Company shall pay all of its expenses and shall reimburse the Advisor for documented expenses of the Advisor incurred on its behalf (collectively, the Expenses ) excepting those expenses that are specifically the responsibility of the Advisor as set forth herein. Such costs and reimbursements shall not be in amounts which are greater than those which would be payable to outside professionals or consultants engaged to perform such services pursuant to agreements negotiated on an arms-length basis. Expenses include all costs and expenses which are expressly designated elsewhere in this Agreement as the Companys, together with the following:
(i) expenses in connection with the issuance and transaction costs incident to the acquisition, disposition and financing of Assets;
(ii) costs of legal, tax, accounting, third party administrators for the establishment and maintenance of the books and records, consulting, auditing, administrative and other
similar services rendered for the Company and the Subsidiaries by providers retained by the Advisor or, if provided by the Advisors personnel, in amounts which are no greater than those which would be payable to outside professionals or consultants engaged to perform such services pursuant to agreements negotiated on an arms-length basis;
(iii) the compensation and expenses of the Companys directors and the cost of liability insurance to indemnify the Companys directors and officers;
(iv) costs associated with the establishment and maintenance of any of the Companys repurchase agreements or other indebtedness of the Company (including commitment fees, accounting fees, legal fees, closing and other similar costs) or any of the Companys or any Subsidiarys securities offerings;
(v) expenses connected with communications to holders of the Companys or our Subsidiarys securities and other bookkeeping and clerical work necessary in maintaining relations with holders of such securities and in complying with any applicable reporting and other requirements of governmental bodies or agencies, including, without limitation, all costs of preparing and filing required reports with the Securities and Exchange Commission, the costs payable by the Company to any transfer agent and registrar in connection with the listing and/or trading of the Companys stock on any exchange, the fees payable by the Company to any such exchange in connection with its listing, and the costs of preparing, printing and mailing the Companys annual report to its stockholders and proxy materials with respect to any meeting of the Companys stockholders;
(vi) costs associated with any computer software or hardware, electronic equipment or purchased information technology services from third party vendors that is used for the Company and the Subsidiaries;
(vii) expenses incurred by managers, officers, personnel and agents of the Advisor for travel on the Companys behalf and other out-of-pocket expenses incurred by managers, officers, personnel and agents of the Advisor in connection with the purchase, financing, refinancing, sale or other disposition of an Asset or establishment and maintenance of any repurchase agreements, or other financings or any of the Companys or any of the Subsidiarys securities offerings or exchange offerings;
(viii) costs and expenses incurred with respect to market information systems and publications, research publications and materials, and settlement, clearing and custodial fees and expenses including any research services utilized by the Advisor on the Companys behalf;
(ix) compensation and expenses of the Companys custodian and transfer agent, if any;
(x) the costs of maintaining compliance with all federal, state and local rules and regulations or any other regulatory agency;
(xi) all taxes and license fees;
(xii) all insurance costs incurred in connection with the operation of the Companys business;
(xiii) costs and expenses incurred in contracting with third parties, including affiliates of the Advisor, for the servicing and special servicing of the assets of the Company and the Subsidiaries;
(xiv) all other costs and expenses relating to the business operations of the Company and the Subsidiaries, including, without limitation, the costs and expenses of acquiring, owning, protecting, maintaining, developing and disposing of Assets, including appraisal, reporting, audit and legal fees;
(xv) expenses relating to any office(s) or office facilities, including disaster backup recovery sites and facilities, maintained for the Company and the Subsidiaries or Assets separate from the office or offices of the Advisor;
(xvi) expenses connected with the payments of interest, dividends or distributions in cash or any other form authorized or caused to be made by the Board of Directors to or on account of holders of the Companys or any Subsidiarys securities, including, without limitation, in connection with any dividend reinvestment plan;
(xvii) any judgment or settlement of pending or threatened proceedings (whether civil, criminal or otherwise) against the Company or any Subsidiary, or against any trustee, director or officer of the Company or of any Subsidiary in his capacity as such for which the Company or any Subsidiary is required to indemnify such trustee, director or officer by any court or governmental agency;
(xviii) expenses incurred in connection with obtaining and maintaining the insurance coverage referred to in Section 7(e) above; and
(xix) all other expenses actually incurred by the Advisor (except as described below) which are reasonably necessary for the performance by the Advisor of its duties and functions under this Agreement.
In addition, the Company will be required to pay the Companys pro rata portion of rent, telephone, utilities, office furniture, equipment, machinery and other office, internal and overhead expenses of the Advisor and its affiliates required for the operations of the Company and the Subsidiaries. These expenses will be allocated between the Advisor and the Company based on the ratio of the Companys proportion of gross assets compared to all remaining gross assets managed or held by the Advisor as calculated at each quarter end. The Advisor and the Company will modify this allocation methodology, subject to the approval of the Board of Directors prior to the Listing and subject to the Independent Directors approval after the Listing, if the allocation becomes inequitable, based on significant leverage differences between the Company and the Advisors other clients.
The Advisor may, at its option, elect not to seek reimbursement for certain expenses during a given quarterly period, which determination shall not be deemed to construe a waiver of reimbursement for similar expenses in future periods. The Company will reimburse the Advisor for all organizational, formation and offering costs it has incurred on behalf of the Company in connection with the Offering.
The provisions of this Section 9 shall survive the expiration or earlier termination of this Agreement to the extent such expenses have previously been incurred or are incurred in connection with such expiration or termination.
Section 10. Calculations of Expenses . The Advisor shall prepare a statement documenting the Expenses of the Company and the Subsidiaries and the Expenses incurred by the Advisor on behalf of the Company and the Subsidiaries during each fiscal quarter, and shall deliver such statement to the Company within 30 days after the end of each fiscal quarter. Expenses incurred by the Advisor on behalf of the Company and the Subsidiaries shall be reimbursed by the Company to the Advisor on the fifth
business day immediately following the date of delivery of such statement; provided , however , that such reimbursements may be offset by the Advisor against amounts due to the Company and the Subsidiaries. The provisions of this Section 10 shall survive the expiration or earlier termination of this Agreement.
Section 11. Limits of Advisor Responsibility; Indemnification .
(a) The Advisor assumes no responsibility under this Agreement other than to render the services called for under this Agreement and shall not be responsible for any action of the Board of Directors in following or declining to follow any advice or recommendations of the Advisor, including as set forth in Section 7(b) of this Agreement. The Advisor, its officers, stockholders, members, managers, directors, personnel, any Person controlling or controlled by the Advisor and any Person providing sub-advisory or shared facilities services to the Advisor will not be liable to the Company or any Subsidiary, to the Board of Directors, or the Companys or any Subsidiarys stockholders, members or partners for any acts or omissions by any such Person (including, without limitation, trade errors that may result from ordinary negligence, such as errors in the investment decision making process or in the trade process), pursuant to or in accordance with this Agreement, except by reason of acts or omissions constituting bad faith, willful misconduct, gross negligence or reckless disregard of the Advisors duties under this Agreement, as determined by a final non-appealable order of a court of competent jurisdiction. The Company shall, to the full extent lawful, reimburse, indemnify and hold the Advisor, its officers, stockholders, members, managers, directors, personnel, any Person controlling or controlled by the Advisor and any Person providing sub-advisory or shared facilities services to the Advisor, together with such Persons officers, stockholders, members, managers, directors and personnel (each a Advisor Indemnified Party ), harmless of and from any and all expenses, losses, damages, liabilities, demands, charges and claims of any nature whatsoever (including attorneys fees) in respect of or arising from any acts or omissions of such Advisor Indemnified Party made in good faith in the performance of the Advisors duties under this Agreement and not constituting such Advisor Indemnified Partys bad faith, willful misconduct, gross negligence or reckless disregard of the Advisors duties under this Agreement.
(b) The Advisor shall, to the full extent lawful, reimburse, indemnify and hold the Company (or any Subsidiary), its stockholders, directors and officers and each other Person, if any, controlling the Company (each, a Company Indemnified Party and together with a Advisor Indemnified Party, the Indemnitee ), harmless of and from any and all expenses, losses, damages, liabilities, demands, charges and claims of any nature whatsoever (including attorneys fees) in respect of or arising from the Advisors bad faith, willful misconduct, gross negligence or reckless disregard of its duties under this Agreement.
(c) The Indemnitee will promptly notify the party against whom indemnity is claimed (the Indemnitor ) of any claim for which it seeks indemnification; provided , however , that the failure to so notify the Indemnitor will not relieve the Indemnitor from any liability which it may have hereunder, except to the extent such failure actually prejudices the Indemnitor. The Indemnitor shall have the right to assume the defense and settlement of such claim; provided , that the Indemnitor notifies the Indemnitee of its election to assume such defense and settlement within 30 days after the Indemnitee gives the Indemnitor notice of the claim. In such case, the Indemnitee will not settle or compromise such claim, and the Indemnitor will not be liable for any such settlement made without its prior written consent. If the Indemnitor is entitled to, and does, assume such defense by delivering the aforementioned notice to the Indemnitee, the Indemnitee will (i) have the right to approve the Indemnitors counsel (which approval will not be unreasonably withheld, delayed or conditioned), (ii) be obligated to cooperate in furnishing evidence and testimony and in any other manner in which the Indemnitor may reasonably request and (iii) be entitled to participate in (but not control) the defense of any such action, with its own counsel and at its own expense.
Section 12. No Joint Venture . Nothing in this Agreement shall be construed to make the Company and the Advisor partners or joint venturers or impose any liability as such on either of them.
Section 13. Term; Termination .
(a) Until this Agreement is terminated in accordance with its terms, this Agreement shall be in effect until the third anniversary of completion of the Listing (the Initial Term ) and shall be automatically renewed for a one-year term each anniversary date thereafter (a Renewal Term ) unless at least two-thirds of the Independent Directors or the holders of at least two-thirds of the outstanding shares of Common Stock (other than those shares held by certain parties related to the Company, including the Companys members, principals, employees and affiliates) agree that (i) there has been unsatisfactory performance by the Advisor that is materially detrimental to the Company and the Subsidiaries or (ii) the compensation payable to the Advisor hereunder is unfair; provided that the Company shall not have the right to terminate this Agreement under clause (ii) above if the Advisor agrees to continue to provide the services under this Agreement at a reduced fee that at least two-thirds of the Independent Directors determines to be fair pursuant to the procedure set forth below. If the Company elects not to renew this Agreement at the expiration of the Initial Term or any Renewal Term as set forth above, the Company shall deliver to the Advisor prior written notice (the Termination Notice ) of the Companys intention not to renew this Agreement based upon the terms set forth in this Section 13(a) not less than 180 days prior to the expiration of the then existing term. If the Company so elects not to renew this Agreement, the Company shall designate the date (the Effective Termination Date ), not less than 180 days from the date of the notice, on which the Advisor shall cease to provide services under this Agreement, and this Agreement shall terminate on such date; provided , however , that in the event that such Termination Notice is given in connection with a determination that the compensation payable to the Advisor is unfair, the Advisor shall have the right to renegotiate such compensation by delivering to the Company, no fewer than 45 days prior to the prospective Effective Termination Date, written notice (any such notice, a Notice of Proposal to Negotiate ) of its intention to renegotiate its compensation under this Agreement. Thereupon, the Company (represented by the Independent Directors) and the Advisor shall endeavor to negotiate in good faith the revised compensation payable to the Advisor under this Agreement, provided that the Advisor and at least two-thirds of the Independent Directors agree to the terms of the revised compensation to be payable to the Advisor within 45 days following the receipt of the Notice of Proposal to Negotiate, the Termination Notice shall be deemed of no force and effect and this Agreement shall continue in full force and effect on the terms stated in this Agreement, except that the compensation payable to the Advisor hereunder shall be the revised compensation then agreed upon by the parties to this Agreement. The Company and the Advisor agree to execute and deliver an amendment to this Agreement setting forth such revised compensation promptly upon reaching an agreement regarding same. In the event that the Company and the Advisor are unable to agree to the terms of the revised compensation to be payable to the Advisor during such 45-day period, this Agreement shall terminate, such termination to be effective on the date which is the later of (A) 10 days following the end of such 45-day period and (B) the Effective Termination Date originally set forth in the Termination Notice.
(b) In recognition of the level of the upfront effort required by the Advisor to structure and acquire the assets of the Company and the Subsidiaries and the commitment of resources by the Advisor, in the event that this Agreement is terminated in accordance with the provisions of Section 13(a) of this Agreement, the Company shall pay to the Advisor, on the date on which such termination is effective, a termination fee (the Termination Fee ) equal to three times the average annual Base Advisory Fee earned by the Advisor during the 24-month period immediately preceding the date of such termination, calculated as of the end of the most recently completed fiscal year prior to the date of termination.
(c) No later than 180 days prior to the anniversary date of this Agreement of any year during a Renewal Term, the Advisor may deliver written notice to the Company informing it of the Advisors intention to decline to renew this Agreement, whereupon this Agreement shall not be renewed and extended and this Agreement shall terminate effective on the anniversary date of this Agreement next following the delivery of such notice. The Company is not required to pay to the Advisor the Termination Fee if the Advisor terminates this Agreement pursuant to this Section 13(c) .
(d) If this Agreement is terminated pursuant to Section 13 , such termination shall be without any further liability or obligation of either party to the other, except as provided in Sections 6, 9, 10, 13(b), 15(b) , and 16 of this Agreement. In addition, Sections 11 and 20 of this Agreement shall survive termination of this Agreement.
Section 14. Assignment .
(a) Except as set forth in Section 14(b) of this Agreement, this Agreement shall terminate automatically in the event of its assignment, in whole or in part, by the Advisor, unless such assignment is consented to in writing by the Company with the approval of a majority of the directors; provided , however , that no such approval shall be required in the case of an assignment by the Advisor to a majority-owned and controlled affiliate of ZAIS if such assignment does not require the Companys approval under the Investment Advisers Act of 1940. Any such permitted assignment shall bind the assignee under this Agreement in the same manner as the Advisor is bound, and the Advisor shall be liable to the Company for all errors or omissions of the assignee under any such assignment. In addition, the assignee shall execute and deliver to the Company a counterpart of this Agreement naming such assignee as Advisor. This Agreement shall not be assigned by the Company without the prior written consent of the Advisor, except in the case of assignment by the Company to another REIT or other organization which is a successor (by merger, consolidation, purchase of assets, or similar transaction) to the Company, in which case such successor organization shall be bound under this Agreement and by the terms of such assignment in the same manner as the Company is bound under this Agreement.
(b) Notwithstanding any provision of this Agreement, the Advisor may subcontract and assign any or all of its responsibilities under Sections 2(b), 2(c) and 2(d) of this Agreement to any of its affiliates in accordance with the terms of this Agreement applicable to any such subcontract or assignment, and the Company hereby consents to any such assignment and subcontracting. In addition, provided that the Advisor provides prior written notice to the Company for informational purposes only, nothing contained in this Agreement shall preclude any pledge, hypothecation or other transfer of any amounts payable to the Advisor under this Agreement. In addition, the Advisor may assign this Agreement to any of its affiliates without the approval of the Independent Directors.
Section 15. Termination for Cause .
(a) The Company may terminate this Agreement effective upon 30 days prior written notice of termination from the Board of Directors of the Company to the Advisor, without payment of any Termination Fee, if (i) the Advisor, its agents or its assignees materially breaches any provision of this Agreement and such breach shall continue for a period of 30 days after written notice thereof specifying such breach and requesting that the same be remedied in such 30-day period (or 45 days after written notice of such breach if the Advisor takes steps to cure such breach within 30 days of the written notice), (ii) the Advisor engages in any act of fraud, misappropriation of funds, or embezzlement against the Company or any Subsidiary, (iii) there is an event of any gross negligence on the part of the Advisor in the performance of its duties under this Agreement, (iv) there is a commencement of any proceeding relating to the Advisors Bankruptcy or insolvency, including an order for relief in an involuntary bankruptcy case or the Advisor authorizing or filing a voluntary bankruptcy
petition, (v) the Advisor is convicted of (including a plea of nolo contendere ) a felony or (vi) there is a dissolution of the Advisor.
(b) The Advisor may terminate this Agreement effective upon 60 days prior written notice of termination to the Company in the event that the Company shall default in the performance or observance of any material term, condition or covenant contained in this Agreement and such default shall continue for a period of 30 days after written notice thereof specifying such default and requesting that the same be remedied in such 30-day period. The Company is required to pay to the Advisor the Termination Fee if the termination of this Agreement is made pursuant to this Section 15(b) .
(c) The Advisor may terminate this Agreement, without payment of any Termination Fee, in the event the Company becomes regulated as an investment company under the Investment Company Act, with such termination deemed to have occurred immediately prior to such event.
Section 16. Action Upon Termination . From and after the effective date of termination of this Agreement, pursuant to Sections 13 or 15 of this Agreement, the Advisor shall not be entitled to compensation for further services under this Agreement, but shall be paid all compensation accruing to the date of termination and, if terminated pursuant to Section 13(a) or Section 15(b) , the applicable Termination Fee. Upon such termination, the Advisor shall forthwith:
(i) after deducting any accrued compensation and reimbursement for its expenses to which it is then entitled, pay over to the Company or a Subsidiary all money collected and held for the account of the Company or a Subsidiary pursuant to this Agreement;
(ii) deliver to the Board of Directors a full accounting, including a statement showing all payments collected by it and a statement of all money held by it, covering the period following the date of the last accounting furnished to the Board of Directors with respect to the Company or a Subsidiary; and
(iii) deliver to the Board of Directors all property and documents of the Company or any Subsidiary then in the custody of the Advisor.
Section 17. Notices . Unless expressly provided otherwise in this Agreement, all notices, requests, demands and other communications required or permitted under this Agreement shall be in writing and shall be deemed to have been duly given, made and received when delivered against receipt or upon actual receipt of (i) personal delivery, (ii) delivery by reputable overnight courier, (iii) delivery by facsimile transmission with telephonic confirmation or (iv) delivery by registered or certified mail, postage prepaid, return receipt requested, addressed as set forth below:
(a) If to the Company:
ZAIS Financial Corp.
Two Bridge Avenue, Suite 322
Red Bank, New Jersey 07701-1106
Attention: General Counsel
Facsimile: (732) 978-7507
(b) If to the Advisor:
ZAIS REIT Management, LLC
c/o ZAIS Group, LLC
Two Bridge Avenue, Suite 322
Red Bank, New Jersey 07701-1106
Attention: General Counsel
Facsimile: (732) 978-7507
Either party may alter the address to which communications or copies are to be sent by giving notice of such change of address in conformity with the provisions of this Section 17 for the giving of notice.
Section 18. Binding Nature of Agreement; Successors and Assigns . This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective heirs, personal representatives, successors and permitted assigns as provided in this Agreement.
Section 19. Entire Agreement . This Agreement contains the entire agreement and understanding among the parties hereto with respect to the subject matter of this Agreement, and supersedes all prior and contemporaneous agreements, understandings, inducements and conditions, express or implied, oral or written, of any nature whatsoever with respect to the subject matter of this Agreement. The express terms of this Agreement control and supersede any course of performance and/or usage of the trade inconsistent with any of the terms of this Agreement. This Agreement may not be modified or amended other than by an agreement in writing signed by the parties hereto.
Section 20. GOVERNING LAW . THIS AGREEMENT AND THE RIGHTS AND OBLIGATIONS OF THE PARTIES UNDER THIS AGREEMENT SHALL BE GOVERNED BY, AND CONSTRUED AND INTERPRETED IN ACCORDANCE WITH, THE LAW OF THE STATE OF NEW YORK WITHOUT REGARD TO CONFLICTS OF LAW PRINCIPLES TO THE CONTRARY.
Section 21. No Waiver; Cumulative Remedies . No failure to exercise and no delay in exercising, on the part of any party hereto, any right, remedy, power or privilege hereunder shall operate as a waiver thereof; nor shall any single or partial exercise of any right, remedy, power or privilege hereunder preclude any other or further exercise thereof or the exercise of any other right, remedy, power or privilege. The rights, remedies, powers and privileges herein provided are cumulative and not exclusive of any rights, remedies, powers and privileges provided by law. No waiver of any provision hereunder shall be effective unless it is in writing and is signed by the party asserted to have granted such waiver.
Section 22. Headings . The headings of the sections of this Agreement have been inserted for convenience of reference only and shall not be deemed part of this Agreement.
Section 23. Counterparts . This Agreement may be executed in any number of counterparts, each of which shall be deemed to be an original as against any party whose signature appears thereon, and all of which shall together constitute one and the same instrument. This Agreement shall become binding when one or more counterparts of this Agreement, individually or taken together, shall bear the signatures of all of the parties reflected hereon as the signatories.
Section 24. Severability . Any provision of this Agreement that is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such
prohibition or unenforceability without invalidating the remaining provisions hereof, and any such prohibition or unenforceability in any jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction.
Section 25. Gender . Words used herein regardless of the number and gender specifically used, shall be deemed and construed to include any other number, singular or plural, and any other gender, masculine, feminine or neuter, as the context requires.
[SIGNATURE PAGES FOLLOW]
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first written above.
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ZAIS FINANCIAL CORP. |
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By: |
/s/ Michael Szymanski |
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Name: Michael Szymanski |
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Title: Chief Executive Officer and President |
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ZAIS REIT MANAGEMENT, LLC |
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By: |
/s/ Michael Szymanski |
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Name: Michael Szymanski |
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Title: Chief Executive Officer |
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ZAIS FINANCIAL PARTNERS, L.P. |
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By: |
ZAIS Financial Corp., its General Partner |
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By: |
/s/ Michael Szymanski |
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Name: Michael Szymanski |
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Title: Chief Executive Officer and President |
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ZAIS ASSET I, LLC |
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By: |
ZAIS Financial Partners, L.P., its Managing Member |
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By: |
ZAIS Financial Corp., its General Partner |
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By: |
/s/ Michael Szymanski |
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Name: Michael Szymanski |
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Title: Chief Executive Officer and President |
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ZAIS ASSET II, LLC |
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By: |
ZAIS Financial Partners, L.P., its Managing Member |
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By: |
ZAIS Financial Corp., its General Partner |
[ Signature Page 1 of 2 to Investment Advisory Agreement ]
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By: |
/s/ Michael Szymanski |
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Name: Michael Szymanski |
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Title: Chief Executive Officer and President |
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ZAIS ASSET III, LLC |
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By: |
ZAIS Financial Partners, L.P., its Managing Member |
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By: |
ZAIS Financial Corp., its General Partner |
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By: |
/s/ Michael Szymanski |
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Name: Michael Szymanski |
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Title: Chief Executive Officer and President |
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ZAIS ASSET IV, LLC |
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By: |
ZAIS Financial Partners, L.P., its Managing Member |
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By: |
ZAIS Financial Corp., its General Partner |
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By: |
/s/ Michael Szymanski |
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Name: Michael Szymanski |
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Title: Chief Executive Officer and President |
[ Signature Page 1 of 2 to Investment Advisory Agreement ]
Exhibit A
· No acquisition shall be made that would cause the Company to fail to qualify as a REIT for U.S. federal income tax purposes;
· No acquisition shall be made that would cause the Company to be required to register as an investment company under the Investment Company Act; and
· The Companys Assets will be predominantly in residential mortgage loans, Non-Agency RMBS, Agency RMBS, and other real estate-related and financial assets, including, but not limited to, CMBS and ABS.
· Until appropriate assets can be identified, the Advisor may deploy the proceeds of the Companys or any Subsidiarys securities offerings in interest bearing, short term investments, including money market accounts and/or funds that are consistent with the Companys intention to maintain its qualification as a REIT.
Exhibit 10.2
EXECUTION VERSION
AGREEMENT OF LIMITED PARTNERSHIP
OF
ZAIS FINANCIAL PARTNERS, L.P.
a Delaware limited partnership
CONTENTS
Clause |
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Article I DEFINED TERMS |
1 |
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Article II ORGANIZATIONAL MATTERS |
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Section 2.01. |
Organization |
15 |
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Section 2.02. |
Name |
15 |
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Section 2.03. |
Registered Office and Agent; Principal Office |
15 |
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Section 2.04. |
Power of Attorney |
15 |
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Section 2.05. |
Term |
16 |
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Section 2.06. |
Partnership Interests as Securities |
17 |
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Article III PURPOSE |
17 |
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Section 3.01. |
Purpose and Business |
17 |
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Section 3.02. |
Powers |
17 |
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Section 3.03. |
Partnership Only for Partnership Purposes Specified |
17 |
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Section 3.04. |
Representations and Warranties by the Parties |
18 |
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Article IV CAPITAL CONTRIBUTIONS |
19 |
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Section 4.01. |
Capital Contributions of the Partners |
19 |
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Section 4.02. |
Issuances of Additional Partnership Interests |
20 |
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Section 4.03. |
Additional Funds and Capital Contributions |
21 |
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Section 4.04. |
Equity Incentive Plan |
22 |
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Section 4.05. |
No Interest; No Return |
23 |
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Section 4.06. |
Other Contribution Provisions |
23 |
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Section 4.07. |
Not Publicly Traded |
23 |
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Section 4.08. |
No Third Party Beneficiary |
24 |
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Article V DISTRIBUTIONS |
24 |
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Section 5.01. |
Requirement and Characterization of Distributions |
24 |
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Section 5.02. |
Interests in Property Not Held Through the Partnership |
25 |
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Section 5.03. |
Distributions In-Kind |
25 |
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Section 5.04. |
Amounts Withheld |
25 |
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Section 5.05. |
Distributions Upon Liquidation |
25 |
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Section 5.06. |
Distributions to Reflect Issuance of Additional Partnership Units |
25 |
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Section 5.07. |
Restricted Distributions |
25 |
Article VI ALLOCATIONS |
26 |
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Section 6.01. |
Timing and Amount of Allocations of Net Income and Net Loss |
26 |
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Section 6.02. |
General Allocations |
26 |
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Section 6.03. |
Additional Allocation Provisions |
27 |
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Section 6.04. |
Tax Allocations |
29 |
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Article VII MANAGEMENT AND OPERATIONS OF BUSINESS |
30 |
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Section 7.01. |
Management |
30 |
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Section 7.02. |
Certificate of Limited Partnership |
34 |
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Section 7.03. |
Restrictions on General Partners Authority |
35 |
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Section 7.04. |
Reimbursement of the General Partner |
36 |
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Section 7.05. |
Outside Activities of the General Partner |
38 |
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Section 7.06. |
Contracts with Affiliates |
38 |
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Section 7.07. |
Indemnification |
38 |
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Section 7.08. |
Liability of the General Partner |
40 |
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Section 7.09. |
Other Matters Concerning the General Partner |
42 |
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Section 7.10. |
Title to Partnership Assets |
42 |
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Section 7.11. |
Reliance by Third Parties |
43 |
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Article VIII RIGHTS AND OBLIGATIONS OF LIMITED PARTNERS |
43 |
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Section 8.01. |
Limitation of Liability |
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Section 8.02. |
Management of Business |
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Section 8.03. |
Outside Activities of Limited Partners |
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Section 8.04. |
Return of Capital |
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Section 8.05. |
Adjustment Factor |
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Section 8.06. |
Redemption Rights |
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Article IX BOOKS, RECORDS, ACCOUNTING AND REPORTS |
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Section 9.01. |
Records and Accounting |
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Section 9.02. |
Partnership Year |
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Section 9.03. |
Reports |
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Article X TAX MATTERS |
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Section 10.01. |
Preparation of Tax Returns |
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Section 10.02. |
Tax Elections |
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Section 10.03. |
Tax Matters Partner |
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Section 10.04. |
Withholding |
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Section 10.05. |
Organizational Expenses |
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Article XI TRANSFERS AND WITHDRAWALS |
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Section 11.01. |
Transfer |
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Section 11.02. |
Transfer of General Partners Partnership Interest |
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Section 11.03. |
Transfer of Limited Partners Partnership Interests |
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Section 11.04. |
Substituted Limited Partners |
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Section 11.05. |
Assignees |
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Section 11.06. |
General Provisions |
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Article XII ADMISSION OF PARTNERS |
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Section 12.01. |
Admission of Successor General Partner |
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Section 12.02. |
Admission of Additional Limited Partners |
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Section 12.03. |
Amendment of Agreement and Certificate of Limited Partnership |
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Section 12.04. |
Limit on Number of Partners |
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Section 12.05. |
Admission |
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Article XIII DISSOLUTION, LIQUIDATION AND TERMINATION |
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Section 13.01. |
Dissolution |
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Section 13.02. |
Winding Up |
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Section 13.03. |
Deemed Distribution and Recontribution |
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Section 13.04. |
Rights of Limited Partners |
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Section 13.05. |
Notice of Dissolution |
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Section 13.06. |
Cancellation of Certificate of Limited Partnership |
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Section 13.07. |
Reasonable Time for Winding-Up |
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Article XIV PROCEDURES FOR ACTIONS AND CONSENTS OF PARTNERS; AMENDMENTS; MEETINGS |
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Section 14.01. |
Procedures for Actions and Consents of Partners |
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Section 14.02. |
Amendments |
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Section 14.03. |
Meetings of the Partners |
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Article XV GENERAL PROVISIONS |
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Section 15.01. |
Addresses and Notice |
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Section 15.02. |
Titles and Captions |
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Section 15.03. |
Pronouns and Plurals |
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Section 15.04. |
Further Action |
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Section 15.05. |
Binding Effect |
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Section 15.06. |
Waiver |
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Section 15.07. |
Counterparts |
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Section 15.08. |
Applicable Law |
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THIS AGREEMENT OF LIMITED PARTNERSHIP OF ZAIS FINANCIAL PARTNERS, L.P., dated as of July 29, 2011 is entered into by and among ZAIS FINANCIAL CORP., a Maryland corporation (the General Partner ), and the limited partner(s) listed on Exhibit A hereto (each a Limited Partner ).
WHEREAS, the Certificate of Limited Partnership of the Partnership was filed in the office of the Secretary of State of the State of Delaware on May 24, 2011;
NOW, THEREFORE, in consideration of the mutual covenants and agreements contained herein and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows:
ARTICLE I
DEFINED TERMS
The following definitions shall be for all purposes, unless otherwise clearly indicated to the contrary, applied to the terms used in this Agreement.
Act means the Delaware Revised Uniform Limited Partnership Act (6 Del. C. § 17-101 et seq. ), as it may be amended from time to time, and any successor to such statute.
Actions has the meaning set forth in Section 7.07 hereof.
Additional Funds has the meaning set forth in Section 4.03(a) hereof.
Additional Limited Partner means a Person who is admitted to the Partnership as a Limited Partner pursuant to Section 4.02 and Section 12.02 hereof and who is shown as such on the books and records of the Partnership.
Adjusted Capital Account means the Capital Account maintained for each Partner as of the end of each Fiscal Year (i) increased by any amounts which such Partner is obligated to restore pursuant to any provision of this Agreement or is deemed to be obligated to restore pursuant to the penultimate sentences of Regulations Sections 1.704-2(g)(1) and 1.704-2(i)(5) and (ii) decreased by the items described in Regulations Sections 1.704-1(b)(2)(ii)(d)(4), 1.704-1(b)(2)(ii)(d)(5) and 1.704-1(b)(2)(ii)(d)(6). The foregoing definition of Adjusted Capital Account is intended to comply with the provisions of Regulations Section 1.704-1(b)(2)(ii)(d) and shall be interpreted consistently therewith.
Adjusted Capital Account Deficit means, with respect to any Partner, the deficit balance, if any, in such Partners Adjusted Capital Account as of the end of the relevant Partnership Year.
Adjustment Factor means 1.0; provided , however , that in the event that:
(i) the General Partner (a) declares or pays a dividend on its outstanding REIT Shares wholly or partly in REIT Shares or makes a distribution to all holders of its outstanding REIT Shares wholly or partly in REIT Shares, (b) splits or subdivides its outstanding REIT
Shares or (c) effects a reverse stock split or otherwise combines its outstanding REIT Shares into a smaller number of REIT Shares, the Adjustment Factor shall be adjusted by multiplying the Adjustment Factor previously in effect by a fraction, (i) the numerator of which shall be the number of REIT Shares issued and outstanding on the record date for such dividend, distribution, split, subdivision, reverse split or combination (assuming for such purposes that such dividend, distribution, split, subdivision, reverse split or combination has occurred as of such time) and (ii) the denominator of which shall be the actual number of REIT Shares (determined without the above assumption) issued and outstanding on the record date for such dividend, distribution, split, subdivision, reverse split or combination;
(ii) the General Partner distributes any rights, options or warrants to all holders of its REIT Shares to subscribe for or to purchase or to otherwise acquire REIT Shares (or other securities or rights convertible into, exchangeable for or exercisable for REIT Shares) at a price per share less than the Value of a REIT Share on the record date for such distribution (each a Distributed Right ), then the Adjustment Factor shall be adjusted by multiplying the Adjustment Factor previously in effect by a fraction (a) the numerator of which shall be the number of REIT Shares issued and outstanding on the record date plus the maximum number of REIT Shares purchasable under such Distributed Rights and (b) the denominator of which shall be the number of REIT Shares issued and outstanding on the record date plus a fraction (1) the numerator of which is the maximum number of REIT Shares purchasable under such Distributed Rights times the minimum purchase price per REIT Share under such Distributed Rights and (2) the denominator of which is the Value of a REIT Share as of the record date; provided , however , that if any such Distributed Rights expire or become no longer exercisable, then the Adjustment Factor shall be adjusted, effective retroactive to the date of distribution of the Distributed Rights, to reflect a reduced maximum number of REIT Shares or any change in the minimum purchase price for the purposes of the above fraction;
(iii) the General Partner shall, by dividend or otherwise, distribute to all holders of its REIT Shares evidences of its indebtedness or assets (including securities, but excluding any dividend or distribution referred to in subsection (i) above), which evidences of indebtedness or assets relate to assets not received by the General Partner or its Subsidiaries pursuant to a pro rata distribution by the Partnership, then the Adjustment Factor shall be adjusted to equal the amount determined by multiplying the Adjustment Factor in effect immediately prior to the close of business on the date fixed for determination of stockholders of the General Partner entitled to receive such distribution by a fraction (i) the numerator of which shall be such Value of a REIT Share on the date fixed for such determination and (ii) the denominator of which shall be the Value of a REIT Share on the dates fixed for such determination less the then fair market value (as determined by the REIT, whose determination shall be conclusive) of the portion of the evidences of indebtedness or assets so distributed applicable to one REIT Share; and
(iv) an entity other than an Affiliate of the General Partner shall become General Partner pursuant to any merger, consolidation or combination of the General Partner with or into another entity (the Successor Entity ), the Adjustment Factor shall be adjusted by multiplying the Adjustment Factor by the number of shares of the Successor Entity into which one REIT Share is converted pursuant to such merger, consolidation or combination, determined as of the date of such merger, consolidation or combination.
Any adjustments to the Adjustment Factor shall become effective immediately after the effective date of such event, retroactive to the record date, if any, for such event. Notwithstanding the foregoing, the Adjustment Factor shall not be adjusted in connection with an event described in clauses (i) or (ii) above if, in connection with such event, the Partnership makes a distribution of cash, Partnership Units, REIT Shares and/or rights, options or warrants to acquire Partnership Units and/or REIT Shares with respect to all applicable OP Units or effects a reverse split of, or otherwise combines, the OP Units, as applicable, that is comparable as a whole in all material respects with such an event, or if in connection with an event described in clause (iv) above, the consideration in Section 11.02 hereof is paid.
Affiliate means, with respect to any Person, (i) any Person directly or indirectly controlling or controlled by or under common control with such Person, (ii) any Person owning or controlling ten percent (10%) or more of the outstanding voting interests of such Person, (iii) any Person of which such Person owns or controls ten percent (10%) or more of the voting interests or (iv) any officer, director, general partner or trustee of such Person or any Person referred to in clauses (i), (ii), and (iii) above. For the purposes of this definition, control when used with respect to any Person means the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of such Person, whether through the ownership of voting securities, by contract or otherwise, and the terms controlling and controlled have meanings correlative to the foregoing.
Agreement means this Agreement of Limited Partnership of ZAIS Financial Partners, L.P., as it may be amended, supplemented or restated from time to time.
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, and who has the rights set forth in Section 11.05 hereof.
Available Cash means, with respect to any period for which such calculation is being made, the amount of cash flow from operations available for distribution by the Partnership as determined by the General Partner in its sole and absolute discretion.
Business Day means any day except a Saturday, Sunday or other day on which commercial banks in New York, New York are authorized or required by law to close.
Bylaws means the Bylaws of the General Partner, as amended, supplemented or restated from time to time.
Capital Account means, with respect to any Partner, the Capital Account maintained by the General Partner for such Partner on the Partnerships books and records in accordance with the following provisions:
A. To each Partners Capital Account, there shall be added such Partners Capital Contributions, such Partners distributive share of Net Income and any items in the nature of income or gain that are specially allocated pursuant to Section 6.03 hereof, and the principal amount of any Partnership liabilities assumed by such Partner or that are secured by any property distributed to such Partner.
B. From each Partners Capital Account, there shall be subtracted the amount of cash and the Gross Asset Value of any property distributed to such Partner pursuant to any provision of this Agreement, such Partners distributive share of Net Losses and any items in the nature of expenses or losses that are specially allocated pursuant to Section 6.03 hereof, and the principal amount of any liabilities of such Partner assumed by the Partnership or that are secured by any property contributed by such Partner to the Partnership.
C. In the event any interest in the Partnership is Transferred in accordance with the terms of this Agreement, the transferee shall succeed to the Capital Account of the transferor to the extent that it relates to the Transferred interest.
D. In determining the principal amount of any liability for purposes of subsections (a) and (b) hereof, there shall be taken into account Code Section 752(c) and any other applicable provisions of the Code and Regulations.
E. The provisions of this Agreement relating to the maintenance of Capital Accounts are intended to comply with Regulations Sections 1.704-1(b) and 1.704-2, and shall be interpreted and applied in a manner consistent with such Regulations. If the General Partner shall determine that it is prudent to modify the manner in which the Capital Accounts are maintained in order to comply with such Regulations, the General Partner may make such modification provided , that such modification will not have a material effect on the amounts distributable to any Partner without such Partners Consent. The General Partner also shall (i) make any adjustments that are necessary or appropriate to maintain equality between the Capital Accounts of the Partners and the amount of Partnership capital reflected on the Partnerships balance sheet, as computed for book purposes, in accordance with Regulations Section 1.704-1(b)(2)(iv)(q) and (ii) make any appropriate modifications in the event that unanticipated events might otherwise cause this Agreement not to comply with Regulations Section 1.704-1(b) or Section 1.704-2.
Capital Account Deficit has the meaning set forth in Section 13.02(c) hereof.
Capital Contribution means, with respect to any Partner, the amount of money and the initial Gross Asset Value of any Contributed Property that such Partner contributes to the Partnership or is deemed to contribute pursuant to Section 4.03 hereof.
Cash Amount means, with respect to a Tendering Party, an amount of cash equal to the product of (A) the Value of a REIT Share and (B) such Tendering Partys REIT Shares Amount determined as of the date of receipt by the General Partner of such Tendering Partys Notice of Redemption or, if such date is not a Business Day, the immediately preceding Business Day.
Certificate means the Certificate of Limited Partnership of the Partnership filed in the office of the Secretary of State of the State of Delaware on May 24, 2011, as amended from time to time in accordance with the terms hereof and the Act.
Charter means the Amended and Restated Charter of the General Partner as filed with the Maryland State Department of Assessment and Taxation, as amended, supplemented or restated from time to time.
Closing Price has the meaning set forth in the definition of Value.
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.
Consent means the consent to, approval of, or vote in favor of a proposed action by a Partner given in accordance with Article XIV hereof.
Contributed Property means each item of Property or other asset, in such form as may be permitted by the Act, but excluding cash, contributed or deemed contributed to the Partnership (or deemed contributed by the Partnership to a new partnership pursuant to Code Section 708) net of any liabilities assumed by the Partnership relating to such Contributed Property and any liability to which such Contributed Property is subject.
Debt means, as to any Person, as of any date of determination, (i) all indebtedness of such Person for borrowed money or for the deferred purchase price of property or services; (ii) all amounts owed by such Person to banks or other Persons in respect of reimbursement obligations under letters of credit, surety bonds and other similar instruments guaranteeing payment or other performance of obligations by such Person; (iii) all indebtedness for borrowed money or for the deferred purchase price of property or services secured by any lien on any property owned by such Person, to the extent attributable to such Persons interest in such property, even though such Person has not assumed or become liable for the payment thereof; and (iv) lease obligations of such Person that, in accordance with generally accepted accounting principles, should be capitalized.
Depreciation means, for each Partnership Year or other applicable period, an amount equal to the federal income tax depreciation, amortization or other cost recovery deduction allowable with respect to an asset for such year or other period, except that if the Gross Asset Value of an asset differs from its adjusted basis for federal income tax purposes at the beginning of such year or period, Depreciation shall be in an amount that bears the same ratio to such beginning Gross Asset Value as the federal income tax depreciation, amortization or other cost recovery deduction for such year or other period bears to such beginning adjusted tax basis; provided , however , that if the federal income tax depreciation, amortization or other cost recovery deduction for such year or period is zero, Depreciation shall be determined with reference to such beginning Gross Asset Value using any reasonable method selected by the General Partner.
Distributed Right has the meaning set forth in the definition of Adjustment Factor.
Equity Incentive Plan means any equity incentive plan hereafter adopted by the Partnership or the General Partner.
ERISA means the Employee Retirement Income Security Act of 1974, as amended.
Exchange Act means the Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder.
Funding Debt means the incurrence of any Debt for the purpose of providing funds to the Partnership by or on behalf of the General Partner or any wholly owned subsidiary of the General Partner.
General Partner means ZAIS Financial Corp., a Maryland corporation, and its successors and assigns, as the general partner of the Partnership.
General Partner Employees means an employee of the Partnership, the General Partner or any of their subsidiaries.
General Partner Interest means the Partnership Interest held by the General Partner, which Partnership Interest is an interest as a general partner under the Act. A General Partner Interest may be expressed as a number of Partnership Units.
General Partner Loan has the meaning set forth in Section 4.03(d) hereof.
Gross Asset Value means, with respect to any asset, the assets adjusted basis for federal income tax purposes, except as follows:
(a) The initial Gross Asset Value of any asset contributed by a Partner to the Partnership shall be the gross fair market value of such asset as determined by the General Partner in its sole discretion.
(b) The Gross Asset Values of all Partnership assets immediately prior to the occurrence of any event described in clause (i), clause (ii), clause (iii) or clause (iv) hereof shall be adjusted to equal their respective gross fair market values, as determined by the General Partner in its sole discretion using such reasonable method of valuation as it may adopt, as of the following times:
(i) the acquisition of an additional interest in the Partnership (other than in connection with the execution of this Agreement) by a new or existing Partner in exchange for more than a de minimis Capital Contribution, if the General Partner reasonably determines that such adjustment is necessary or appropriate to reflect the relative economic interests of the Partners in the Partnership;
(ii) the distribution by the Partnership to a Partner of more than a de minimis amount of Property as consideration for an interest in the Partnership, if the General Partner reasonably determines that such adjustment is necessary or appropriate to reflect the relative economic interests of the Partners in the Partnership;
(iii) the liquidation of the Partnership within the meaning of Regulations Section 1.704-1(b)(2)(ii)(g); and
(iv) at such other times as the General Partner shall reasonably determine necessary or advisable in order to comply with Regulations Sections 1.704-1(b) and 1.704-2.
(c) The Gross Asset Value of any Partnership asset distributed to a Partner shall be the gross fair market value of such asset on the date of distribution as determined by the distributee and the General Partner provided , that , if the distributee is the General Partner or if the distributee and the General Partner cannot agree on such a determination, such gross fair market value shall be determined by an independent third party experienced in the valuation of similar assets, selected by the General Partner in good faith.
(d) The Gross Asset Values of Partnership assets shall be increased (or decreased) to reflect any adjustments to the adjusted basis of such assets pursuant to Code Section 734(b) or Code Section 743(b), but only to the extent that such adjustments are taken into account in determining Capital Accounts pursuant to Regulations Section 1.704-1(b)(2)(iv)(m); provided , however , that Gross Asset Values shall not be adjusted pursuant to this subsection (d) to the extent that the General Partner reasonably determines that an adjustment pursuant to subsection (b) above is necessary or appropriate in connection with a transaction that would otherwise result in an adjustment pursuant to this subsection (d).
(e) If the Gross Asset Value of a Partnership asset has been determined or adjusted pursuant to subsection (a), subsection (b) or subsection (d) above, such Gross Asset Value shall thereafter be adjusted by the Depreciation taken into account with respect to such asset for purposes of computing Net Income and Net Losses.
Holder means either (a) a Partner or (b) an Assignee, owning a Partnership Unit, that is treated as a member of the Partnership for federal income tax purposes.
Incapacity or Incapacitated means, (i) as to any Partner who is an individual, death, total physical disability or entry by a court of competent jurisdiction adjudicating such Partner incompetent to manage his or her person or his or her estate; (ii) as to any Partner that is a corporation or limited liability company, the filing of a certificate of dissolution, or its equivalent, or the revocation of the corporations charter; (iii) as to any Partner that is a partnership, the dissolution and commencement of winding up of the partnership; (iv) as to any Partner that is an estate, the distribution by the fiduciary of the estates entire interest in the Partnership; (v) as to any trustee of a trust that is a Partner, the termination of the trust (but not the substitution of a new trustee); or (vi) as to any Partner, the bankruptcy of such Partner. For purposes of this definition, bankruptcy of a Partner shall be deemed to have occurred when (a) the Partner commences a voluntary proceeding seeking liquidation, reorganization or other relief of or against such Partner under any bankruptcy, insolvency or other similar law now or hereafter in effect, (b) the Partner is adjudged as bankrupt or insolvent, or a final and nonappealable order for relief under any bankruptcy, insolvency or similar law now or hereafter in effect has been entered against the Partner, (c) the Partner executes and delivers a general assignment for the benefit of the Partners creditors, (d) the Partner files an answer or other pleading admitting or failing to contest the material allegations of a petition filed against the Partner in any proceeding of the nature described in clause (b) above, (e) the Partner seeks, consents to or acquiesces in the appointment of a trustee, receiver or liquidator for the Partner or for all or any substantial part of the Partners properties, (f) any proceeding seeking liquidation, reorganization or other relief under any bankruptcy, insolvency or other similar law now or hereafter in effect has not been dismissed within 120 days after the commencement thereof, (g) the appointment without the Partners consent or acquiescence of a trustee, receiver or
liquidator has not been vacated or stayed within 90 days of such appointment, or (h) an appointment referred to in clause (g) above is not vacated within 90 days after the expiration of any such stay.
Indemnitee means (i) any Person made a party to a proceeding by reason of its status as (A) the General Partner or any successor thereto or (B) a member of the General Partner or an officer of the Partnership, the General Partner or a Subsidiary thereof 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 Directors means the independent directors of the Board of Directors of the General Partner as determined by the rules and regulations of the New York Stock Market then in effect.
IRS means the Internal Revenue Service, which administers the internal revenue laws of the United States.
Junior Share means a share of capital stock of the General Partner now or hereafter authorized or reclassified that has dividend rights, or rights upon liquidation, winding up and dissolution, that are junior in rank to the REIT Shares.
Junior Unit means a fractional share of the Partnership Interests that the General Partner has authorized pursuant to Section 4.01 , 4.02 , or 4.03 hereof that has distribution rights, or rights upon liquidation, winding up and dissolution, that are junior in rank to the OP Units.
Limited Partner means any Person named as a Limited Partner in Exhibit A attached hereto, as such Exhibit A may be amended from time to time, or any Substituted Limited Partner or Additional Limited Partner, in such Persons capacity as a Limited Partner in the Partnership.
Limited Partner Interest means a Partnership Interest of a Limited Partner in the Partnership representing a fractional part of the Partnership Interests of all Limited Partners 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. A Limited Partner Interest may be expressed as a number of OP Units, Preferred Units, Junior Units or other Partnership Units.
Liquidating Event has the meaning set forth in Section 13.01 hereof.
Liquidator has the meaning set forth in Section 13.02(a) hereof.
Majority in Interest of the Outside Limited Partners means Limited Partners (excluding for this purpose (i) any Limited Partnership Interests held by the General Partner or its Subsidiaries, (ii) any Person of which the General Partner or its Subsidiaries directly or indirectly owns or controls more than 50% of the voting interests and (iii) any Person directly or indirectly owning or controlling more than 50% of the outstanding interests of the General Partner) holding more than 50% of the outstanding OP Units and any other Partnership Units
voting as single class that are held by all Limited Partners who are not excluded for the purposes hereof.
Market Price has the meaning set forth in the definition of Value.
Net Income or Net Loss means, for each Partnership Year of the Partnership, an amount equal to the Partnerships taxable income or loss for such year, determined in accordance with Code Section 703(a) (for this purpose, all items of income, gain, loss or deduction required to be stated separately pursuant to Code Section 703(a)(1) shall be included in taxable income or loss), with the following adjustments:
(a) Any income of the Partnership that is exempt from federal income tax and not otherwise taken into account in computing Net Income (or Net Loss) pursuant to this definition of Net Income or Net Loss shall be added to (or subtracted from, as the case may be) such taxable income (or loss);
(b) Any expenditure of the Partnership described in Code Section 705(a)(2)(B) or treated as a Code Section 705(a)(2)(B) expenditure pursuant to Regulations Section 1.704-1(b)(2)(iv)(i), and not otherwise taken into account in computing Net Income (or Net Loss) pursuant to this definition of Net Income or Net Loss, shall be subtracted from (or added to, as the case may be) such taxable income (or loss);
(c) In the event the Gross Asset Value of any Partnership asset is adjusted pursuant to subsection (b) or subsection (c) of the definition of Gross Asset Value, the amount of such adjustment shall be taken into account as gain or loss from the disposition of such asset for purposes of computing Net Income or Net Loss;
(d) Gain or loss resulting from any disposition of property with respect to which gain or loss is recognized for federal income tax purposes shall be computed by reference to the Gross Asset Value of the property disposed of, notwithstanding that the adjusted tax basis of such property differs from its Gross Asset Value;
(e) In lieu of the depreciation, amortization and other cost recovery deductions that would otherwise be taken into account in computing such taxable income or loss, there shall be taken into account Depreciation for such Partnership Year;
(f) To the extent that an adjustment to the adjusted tax basis of any Partnership asset pursuant to Code Section 734(b) or Code Section 743(b) is required pursuant to Regulations Section 1.704-1(b)(2)(iv)(m)(4) to be taken into account in determining Capital Accounts as a result of a distribution other than in liquidation of a Partners interest in the Partnership, the amount of such adjustment shall be treated as an item of gain (if the adjustment increases the basis of the asset) or loss (if the adjustment decreases the basis of the asset) from the disposition of the asset and shall be taken into account for purposes of computing Net Income or Net Loss; and
(g) Notwithstanding any other provision of this definition of Net Income or Net Loss, any item that is specially allocated pursuant to Section 6.03 hereof shall not be taken into account in computing Net Income or Net Loss. The amounts of the items of Partnership income,
gain, loss or deduction available to be specially allocated pursuant to Section 6.03 hereof shall be determined by applying rules analogous to those set forth in this definition of Net Income or Net Loss.
New Securities means (i) any rights, options, warrants or convertible or exchangeable securities having the right to subscribe for or purchase REIT Shares, Preferred Shares or Junior Shares, except that New Securities shall not mean any Preferred Shares, Junior Shares or grants under the Equity Incentive Plans or (ii) any Debt issued by the REIT that provides any of the rights described in clause (i).
Nonrecourse Deductions has the meaning set forth in Regulations Section 1.704-2(b)(1), and the amount of Nonrecourse Deductions for a Partnership Year shall be determined in accordance with the rules of Regulations Section 1.704-2(c).
Nonrecourse Liability has the meaning set forth in Regulations Section 1.752-1(a)(2).
Notice of Redemption means the Notice of Redemption substantially in the form of Exhibit B attached to this Agreement.
OP Unit means a fractional share of the Partnership Interests of all Partners issued pursuant to Section 4.01 hereof, but does not include any LTIP Unit, Preferred Unit, Junior Unit or any other Partnership Unit specified in a Partnership Unit Designation as being other than an OP Unit; provided , however , that the General Partner Interest and the Limited Partner Interests shall have the differences in rights and privileges as specified in this Agreement.
Outside Interest has the meaning set forth in Section 5.02 hereof.
Ownership Limit means the applicable restriction or restrictions on ownership of shares of the General Partner imposed under the Charter.
Partner means the General Partner or a Limited Partner, and Partners means the General Partner and the Limited Partners.
Partner Minimum Gain means an amount, with respect to each Partner Nonrecourse Debt, equal to the Partnership Minimum Gain that would result if such Partner Nonrecourse Debt were treated as a Nonrecourse Liability, determined in accordance with Regulations Section 1.704-2(i)(3).
Partner Nonrecourse Debt has the meaning set forth in Regulations Section 1.704-2(b)(4).
Partner Nonrecourse Deductions has the meaning set forth in Regulations Section 1.704-2(i)(2), and the amount of Partner Nonrecourse Deductions with respect to a Partner Nonrecourse Debt for a Partnership Year shall be determined in accordance with the rules of Regulations Section 1.704-2(i)(2).
Partnership means the limited partnership formed under the Act and pursuant to this Agreement, and any successor thereto.
Partnership Interest means an ownership interest in the Partnership held 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. A Partnership Interest may be expressed as a number of OP Units, Preferred Units, Junior Units or other Partnership Units.
Partnership Minimum Gain has the meaning set forth in Regulations Section 1.704-2(b)(2), and the amount of Partnership Minimum Gain, as well as any net increase or decrease in Partnership Minimum Gain, for a Partnership Year shall be determined in accordance with the rules of Regulations Section 1.704-2(d).
Partnership Record Date means a record date established by the General Partner for the distribution of Available Cash pursuant to Section 5.01 hereof, which record date shall generally 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 shall mean an OP Unit, a Preferred Unit, a Junior Unit or any other fractional share of the Partnership Interests that the General Partner has authorized pursuant to Section 4.01 , 4.02 or 4.03 hereof.
Partnership Unit Designation has the meaning set forth in Section 4.02 hereof.
Partnership Year means the fiscal year of the Partnership and the Partnerships taxable year for federal income tax purposes, each of which shall be the calendar year unless otherwise required under the Code.
Percentage Interest means, as to a Partner holding a class or series of Partnership Interests, its interest in such class or series as determined by dividing the Partnership Units of such class or series owned by such Partner by the total number of Partnership Units of such class then outstanding as specified in Exhibit A attached hereto, as such Exhibit A may be amended from time to time. If the Partnership issues additional classes or series of Partnership Interests other than as contemplated herein, the interest in the Partnership among the classes or series of Partnership Interests shall be determined as set forth in the amendment to the Partnership Agreement setting forth the rights and privileges of such additional classes or series of Partnership Interest, if any, as contemplated by Section 4.02 .
Person means an individual or a corporation, partnership (general or limited), trust, estate, custodian, nominee, unincorporated organization, association, limited liability company or any other individual or entity in its own or any representative capacity.
Preferred Share means a share of capital stock of the General Partner now or hereafter authorized or reclassified that has dividend rights, or rights upon liquidation, winding up and dissolution, that are superior or prior to the REIT Shares.
Preferred Unit means a fractional share of the Partnership Interests that the General Partner has authorized pursuant to Section 4.01 , 4.02 or 4.03 hereof that has distribution rights, or rights upon liquidation, winding up and dissolution, that are superior or prior to the OP Units.
Properties means any assets and property of the Partnership such as, but not limited to, interests in real property and personal property, including, without limitation, fee interests, interests in ground leases, interests in limited liability companies, joint ventures or partnerships, interests in mortgages, and Debt instruments as the Partnership may hold from time to time and Property shall mean any one such asset or property.
Publicly Traded means listed or admitted to trading on the New York Stock Exchange, the American Stock Exchange, the NASDAQ Stock Market or another national securities exchange or any successor to the foregoing.
Qualified Assets means any of the following assets: (i) interests, rights, options, warrants or convertible or exchangeable securities of the Partnership; (ii) Debt issued by the Partnership or any Subsidiary thereof in connection with the incurrence of Funding Debt; (iii) equity interests in Qualified REIT Subsidiaries and limited liability companies (or other entities disregarded from their sole owner for U.S. federal income tax purposes, including wholly owned grantor trusts) whose assets consist solely of Qualified Assets; (iv) up to a one percent (1%) equity interest in any partnership or limited liability company at least ninety-nine percent (99%) of the equity of which is owned, directly or indirectly, by the Partnership; (v) cash held for payment of administrative expenses or pending distribution to security holders of the General Partner or any wholly owned Subsidiary thereof or pending contribution to the Partnership; and (vi) other tangible and intangible assets that, taken as a whole, are de minimis in relation to the net assets of the Partnership and its Subsidiaries.
Qualified REIT Subsidiary means any Subsidiary of the General Partner that is a qualified REIT subsidiary within the meaning of Code Section 856(i).
Qualified Transferee means an Accredited Investor as defined in Rule 501 promulgated under the Securities Act.
Recourse Liabilities means the amount of liabilities owed by the Partnership (other than Nonrecourse Liabilities and liabilities to which Partner Nonrecourse Deductions are attributable in accordance with Section 1.704-(2)(i) of the Regulations).
Redemption has the meaning set forth in Section 8.06(a) hereof.
Regulations means the applicable income tax regulations under the Code, whether such regulations are in proposed, temporary or final form, as such regulations may be amended from time to time (including corresponding provisions of succeeding regulations).
Regulatory Allocations has the meaning set forth in Section 6.03(a)(vii) hereof.
REIT means a real estate investment trust qualifying under Code Section 856.
REIT Payment has the meaning set forth in Section 15.11 hereof.
REIT Requirements has the meaning set forth in Section 5.01 hereof.
REIT Share means a share of the General Partners common stock, par value $0.0001 per share. Where relevant in this Agreement, REIT Share includes shares of the General Partners common stock, par value $0.0001 per share, issued upon conversion of Preferred Shares or Junior Shares.
REIT Shares Amount means a number of REIT Shares equal to the product of (a) the number of Tendered Units and (b) the Adjustment Factor in effect on the Specified Redemption Date with respect to such Tendered Units; provided , however , that in the event that the General Partner issues to all holders of REIT Shares as of a certain record date rights, options, warrants or convertible or exchangeable securities entitling the General Partners stockholders to subscribe for or purchase REIT Shares, or any other securities or property (collectively, the Rights ), with the record date for such Rights issuance falling within the period starting on the date of the Notice of Redemption and ending on the day immediately preceding the Specified Redemption Date, which Rights will not be distributed before the relevant Specified Redemption Date, then the REIT Shares Amount shall also include such Rights that a holder of that number of REIT Shares would be entitled to receive, expressed, where relevant hereunder, in a number of REIT Shares determined by the General Partner in good faith.
Rights has the meaning set forth in the definition of REIT Shares Amount.
Securities Act means the Securities Act of 1933, as amended, and the rules and regulations promulgated thereunder.
Services Agreement means any management, development or advisory agreement with a property and/or asset manager for the provision of property management, asset management, leasing, development and/or similar services with respect to the Properties and any agreement for the provision of services of accountants, legal counsel, appraisers, insurers, brokers, transfer agents, registrars, developers, financial advisors and other professional services.
Specified Redemption Date means the 10th Business Day following receipt by the General Partner of a Notice of Redemption; provided , that , if the REIT Shares are not Publicly Traded, the Specified Redemption Date means the 30th Business Day following receipt by the General Partner of a Notice of Redemption.
Subsidiary means, with respect to any Person, any other Person (which is not an individual) 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.
Substituted Limited Partner means a Person who is admitted as a Limited Partner to the Partnership pursuant to Section 11.04 hereof.
Successor Entity has the meaning set forth in the definition of Adjustment Factor.
Tax Items has the meaning set forth in Section 6.04(a) hereof.
Tendered Units has the meaning set forth in Section 8.06(a) hereof.
Tendering Partner has the meaning set forth in Section 8.06(a) hereof.
Tendering Party has the meaning set forth in Section 8.06(a) hereof.
Terminating Capital Transaction means any sale or other disposition of all or substantially all of the assets of the Partnership or a related series of transactions that, taken together, result in the sale or other disposition of all or substantially all of the assets of the Partnership.
Termination Transaction has the meaning set forth in Section 11.02(b) hereof.
Transfer , when used with respect to a Partnership Unit, or all or any portion of a Partnership Interest, means any sale, assignment, bequest, conveyance, devise, gift (outright or in trust), pledge, encumbrance, hypothecation, mortgage, exchange, transfer or other disposition or act of alienation, whether voluntary or involuntary or by operation of law; provided , however , that when the term is used in Article XI hereof, Transfer does not include (a) any Redemption of Partnership Units by the Partnership or the General Partner, or acquisition of Tendered Units by the General Partner, pursuant to Section 8.06 hereof or (b) any redemption of Partnership Units pursuant to any Partnership Unit Designation. The terms Transferred and Transferring have correlative meanings.
Value means, on any date of determination with respect to a REIT Share, the average of the daily Market Prices for ten consecutive trading days immediately preceding the date of determination except that, as provided in Section 4.04(b) hereof, the Market Price for the trading day immediately preceding the date of exercise of a stock option under any Equity Incentive Plan shall be substituted for such average of daily market prices for purposes of Section 4.04 hereof; provided , however , that for purposes of Section 8.06 , the date of determination shall be the date of receipt by the General Partner of a Notice of Redemption or, if such date is not a Business Day, the immediately preceding Business Day. The term Market Price on any date shall mean, with respect to any class or series of outstanding REIT Shares, the Closing Price for such REIT Shares on such date. The Closing Price on any date shall mean the last sale price for such REIT Shares, regular way, or, in case no such sale takes place on such day, the average of the closing bid and asked prices, regular way, for such REIT Shares, 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 Market or, if such REIT Shares are not listed or admitted to trading on the New York Stock Market, as reported on the principal consolidated transaction reporting system with respect to securities listed on the principal national securities exchange on which such REIT Shares are listed or admitted to trading or, if such REIT Shares are not listed or admitted to trading on any national securities exchange, the last quoted price, or, if not so quoted, the principal other automated quotation system that may then be in use or, if such REIT Shares are not quoted by any such organization, the average of the closing bid and asked prices as furnished by a professional market maker making a market in such REIT Shares selected by the Board of Directors of the General Partner or, in the event that no trading price is available for such REIT Shares, the fair market value of the REIT Shares, as determined in good faith by the Board of Directors of the General Partner.
In the event that the REIT Shares Amount includes Rights that a holder of REIT Shares would be entitled to receive, then the Value of such Rights shall be determined by the General
Partner acting in good faith on the basis of such quotations and other information as it considers, in its reasonable judgment, appropriate.
ARTICLE II
ORGANIZATIONAL MATTERS
Section 2.01. Organization . The Partnership is a limited partnership organized pursuant to the provisions of the Act and upon the terms and subject to the conditions set forth in this Agreement. 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.
Section 2.02. Name . The name of the Partnership is ZAIS Financial Partners, L.P. The Partnerships 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, LP, L.P., Ltd. or similar words or letters shall be included in the Partnerships 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 Partners of such change in the next regular communication to the Partners.
Section 2.03. Registered Office and Agent; Principal Office . The address of the registered office of the Partnership in the State of Delaware is located at Corporation Service Company, 2711 Centerville Road, Wilmington, Delaware 19808, and the registered agent for service of process on the Partnership in the State of Delaware at such registered office is Corporation Service Company. The principal office of the Partnership is located at Two Bridge Avenue, Suite 322, Red Bank, New Jersey 07701-1106 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.
Section 2.04. Power of Attorney .
(a) Each Limited Partner and each Assignee hereby irrevocably constitutes and appoints the General Partner, any Liquidator, and authorized officers and attorneys-in-fact of each, and each of those acting singly, in each case with full power of substitution, 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, seal, 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, supplements or restatements thereof) that the General Partner or 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 to the extent provided by applicable law) in the State of Delaware and in all other jurisdictions in which the Partnership may 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 or the Liquidator 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 conveyances and other instruments or documents that the General Partner or the Liquidator deems appropriate or necessary to reflect the distribution or exchange of assets of the Partnership pursuant to the terms of this Agreement; (e) all instruments relating to the admission, withdrawal, removal or substitution of any Partner pursuant to, or other events described in, Article XI , Article XII or Article XIII hereof or the Capital Contribution of any Partner; and (f) all certificates, documents and other instruments relating to the determination of the rights, preferences and privileges relating to Partnership Interests; and
(ii) execute, swear to, 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 that is made or given by the Partners hereunder or is consistent with the terms of this Agreement or appropriate or necessary, in the sole and absolute discretion of the General Partner or the Liquidator, to effectuate the terms or intent of this Agreement.
Nothing contained herein shall be construed as authorizing the General Partner or the Liquidator to amend this Agreement except in accordance with Article XIV hereof or 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 Limited Partners and Assignees will be relying upon the power of the General Partner or the 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 Partners or Assignees Partnership Units or Partnership Interest and shall extend to such Limited Partners or Assignees 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 the Liquidator, acting in good faith pursuant to such power of attorney; and each such Limited Partner or Assignee hereby waives any and all defenses that may be available to contest, negate or disaffirm the action of the General Partner or the 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 15 days after receipt of the General Partners or the Liquidators 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.
Section 2.05. Term . Pursuant to Sections 17-201(b) and 17-801 of the Act, the term of the Partnership commenced on May 24, 2011 and shall continue perpetually, unless it is dissolved pursuant to the provisions of Article XIII hereof or as otherwise provided by law.
Section 2.06. Partnership Interests as Securities . All Partnership Interests shall be securities within the meaning of, and governed by, (i) Article 8 of the Delaware Uniform Commercial Code and (ii) Article 8 of the Uniform Commercial Code of any other applicable jurisdiction.
ARTICLE III
PURPOSE
Section 3.01. Purpose and Business . The purpose and nature of the Partnership is to conduct any business, enterprise or activity permitted by or under the Act; provided , however , such business and arrangements and interests may be limited to and conducted in such a manner as to permit the General Partner, in its sole and absolute discretion, at all times to be classified as a REIT unless the General Partner, in accordance with its Charter and Bylaws, in its sole discretion has chosen to cease to qualify as a REIT or has chosen not to attempt to qualify as a REIT for any reason or for reasons whether or not related to the business conducted by the Partnership. Without limiting the General Partners right in its sole discretion to cease qualifying as a REIT, the Partners acknowledge that the qualification of the General Partner as a REIT inures to the benefit of all Partners and not solely to the General Partner, the General Partner or its Affiliates. In connection with the foregoing, the Partnership shall have full power and authority to enter into, perform and carry out contracts of any kind, to borrow and lend money and to issue and guarantee evidence of indebtedness, whether or not secured by mortgage, deed of trust, pledge or other lien and, directly or indirectly, to acquire and construct additional Properties necessary, useful or desirable in connection with its business.
Section 3.02. Powers .
(a) The Partnership shall be 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.
(b) The Partnership may contribute from time to time Partnership capital to one or more newly formed entities solely in exchange for equity interests therein (or in a wholly owned subsidiary entity thereof).
(c) Notwithstanding any other provision in this Agreement, the General Partner may cause the Partnership not to take, or to refrain from taking, any action that, in the judgment of the General Partner, in its sole and absolute discretion, (i) could adversely affect the ability of the General Partner to continue to qualify as a REIT, (ii) could subject the General Partner to any additional taxes under Code Section 857 or Code Section 4981 or any other related or successor provision of the Code or (iii) could violate any law or regulation of any governmental body or agency having jurisdiction over the General Partner, its securities or the Partnership.
Section 3.03. Partnership Only for Partnership Purposes Specified . This Agreement shall not be deemed to create a company, venture or partnership between or among the Partners
with respect to any activities whatsoever other than the activities within the purposes of the Partnership as specified in Section 3.01 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, and the Partnership shall not 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.
Section 3.04. Representations and Warranties by the Parties .
(a) Each Partner (including, without limitation, each Additional Limited Partner or Substituted Limited Partner as a condition to becoming an Additional Limited Partner or a Substituted Limited Partner, respectively) represents and warrants to each other Partner that (i) the consummation of the transactions contemplated by this Agreement to be performed by such Partner will not result in a breach or violation of, or a default under, any material agreement by which such Partner or any of such Partners property is bound, or any statute, regulation, order or other law to which such Partner is subject, (ii) subject to the last sentence of this Section 3.04(a) , such Partner is neither a foreign person within the meaning of Code Section 1445(f) nor a foreign partner within the meaning of Code Section 1446(e), (iii) such Partner does not own, directly or indirectly, (a) 9.8% or more of the total combined voting power of all classes of stock entitled to vote, or 9.8% or more of the total number of shares of all classes of stock, of any corporation that is a tenant of either (I) the General Partner or any Qualified REIT Subsidiary, (II) the Partnership or (III) any partnership, venture or limited liability company of which the General Partner, any Qualified REIT Subsidiary or the Partnership is a member or (b) an interest of 9.8% or more in the assets or net profits of any tenant of either (I) the General Partner or any Qualified REIT Subsidiary, (II) the Partnership or (III) any partnership, venture, or limited liability company of which the General Partner, any Qualified REIT Subsidiary or the Partnership is a member and (iv) this Agreement is binding upon, and enforceable against, such Partner in accordance with its terms. Notwithstanding anything contained herein to the contrary, in the event that the representation contained in the foregoing clause (ii) would be inaccurate if given by a Partner, such Partner (w) shall not be required to make and shall not be deemed to have made such representation, if it delivers to the General Partner in connection with or prior to its execution of this Agreement written notice that it may not truthfully make such representation, (x) hereby agrees that it is subject to, and hereby authorizes the General Partner to withhold, all withholdings to which such a foreign person or foreign partner, as applicable, is subject under the Code and (y) hereby agrees to cooperate fully with the General Partner with respect to such withholdings, including by effecting the timely completion and delivery to the General Partner of all governmental forms required in connection therewith.
(b) Each Partner (including, without limitation, each Substituted Limited Partner as a condition to becoming a Substituted Limited Partner) represents, warrants and agrees that it has acquired and continues to hold its interest in the Partnership for its own account for investment purposes only and not for the purpose of, or with a view toward, the resale or
distribution of all or any part thereof, and not with a view toward selling or otherwise distributing such interest or any part thereof at any particular time or under any predetermined circumstances. Each Partner further represents and warrants that it is a sophisticated investor, able and accustomed to handling sophisticated financial and tax matters for itself, particularly real estate investments, and that it has a sufficiently high net worth that it does not anticipate a need for the funds that it has invested in the Partnership in what it understands to be a highly speculative and illiquid investment.
(c) The representations and warranties contained in Sections 3.04(a) and 3.04(b) hereof shall survive the execution and delivery of this Agreement by each Partner (and, in the case of an Additional Limited Partner or a Substituted Limited Partner, the admission of such Additional Limited Partner or Substituted Limited Partner as a Limited Partner in the Partnership) and the dissolution, liquidation and termination of the Partnership.
(d) Each Partner (including, without limitation, each Substituted Limited Partner as a condition to becoming a Substituted Limited Partner) hereby acknowledges that no representations as to potential profit, cash flows, funds from operations or yield, if any, in respect of the Partnership or the General Partner have been made by the General Partner, any Partner or any employee or representative or Affiliate of the General Partner or any Partner, and that projections and any other information, including, without limitation, financial and descriptive information and documentation, that may have been in any manner submitted to such Partner shall not constitute any representation or warranty of any kind or nature, express or implied.
(e) Provision of Information . Each Partner agrees to provide the Partnership with any information and documentation reasonably requested by the Partnership for the purpose of reducing any withholding on payments to the Partnership or otherwise complying with the requirements of any tax laws to which the Partnership is subject.
ARTICLE IV
CAPITAL CONTRIBUTIONS
Section 4.01. Capital Contributions of the Partners .
(a) Capital Contributions . Each Partner has made a Capital Contribution to the Partnership and owns Partnership Units in the amount and designation set forth for such Partner on Exhibit A , as the same may be amended from time to time by the General Partner to the extent necessary to reflect accurately sales, exchanges, conversions or other Transfers, redemptions, Capital Contributions, the issuance of additional Partnership Units, or similar events having an effect on a Partners ownership of Partnership Units. Except as provided by law or in Section 4.03 , 10.04 or 13.02(d) hereof, the Partners shall have no obligation or right to make any additional Capital Contributions or loans to the Partnership.
(b) General Partnership Interest . A number of Partnership Units held by the General Partner equal to one percent (1%) of all outstanding OP Units shall be deemed to be the General Partner Interest of the General Partner. All other Partnership Units held by the
General Partner shall be deemed to be Limited Partner Interests and shall be held by the General Partner in its capacity as a Limited Partner in the Partnership.
Section 4.02. Issuances of Additional Partnership Interests .
(a) General . The General Partner may cause the Partnership to issue 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, and to admit such Persons as Additional Limited Partners, 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. Without limiting the foregoing, the General Partner is expressly authorized to cause the Partnership to issue Partnership Units (i) upon the conversion, redemption or exchange of any Debt, Partnership Units or other securities issued by the Partnership, (ii) for less than fair market value, so long as the General Partner concludes in good faith that such issuance is in the best interest of the General Partners stockholders and the Partnership and (iii) in connection with any merger of any other Person into the Partnership or any Subsidiary of the Partnership if the applicable merger agreement provides that Persons are to receive Partnership Units in exchange for their interests in the Person merging into the Partnership or any Subsidiary of the Partnership. Subject to Delaware law, any additional Partnership Interests 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 as shall be determined by the General Partner, in its sole and absolute discretion without the approval of any Limited Partner, and set forth in a written document thereafter attached to and made an exhibit to this Agreement (each, a Partnership Unit Designation ). Without limiting the generality of the foregoing, the General Partner shall have authority to specify (a) the allocations of items of Partnership income, gain, loss, deduction and credit to each such class or series of Partnership Interests; (b) the right of each such class or series of Partnership Interests to share in Partnership distributions; (c) the rights of each such class or series of Partnership Interests upon dissolution and liquidation of the Partnership; (d) the voting rights, if any, of each such class or series of Partnership Interests; and (e) the conversion, redemption or exchange rights applicable to each such class or series of Partnership Interests. Nothing in this Agreement shall prohibit the General Partner from issuing Partnership Units for less than fair market value if the General Partner concludes in good faith that such issuance is in the best interest of the Partnership and the General Partners stockholders. Upon the issuance of any additional Partnership Interest, the General Partner shall amend Exhibit A as appropriate to reflect such issuance.
(b) Issuances to the General Partner . No additional Partnership Units shall be issued to the General Partner unless (i) the additional Partnership Units are issued to all Partners in proportion to their respective Percentage Interests with respect to the class of Partnership Units so issued, (ii) (a) the additional Partnership Units are (x) OP Units issued in connection with an issuance of REIT Shares or (y) Partnership Units (other than OP Units) issued in connection with an issuance of Preferred Shares, Junior Shares, New Securities or other interests in the General Partner (other than REIT Shares), which Preferred Shares, Junior Shares, New Securities or other interests have designations, preferences and other rights, terms and provisions that are substantially the same as the designations, preferences and other rights, terms and provisions of the additional Partnership Units issued to the General Partner and (b) the
General Partner directly or indirectly contributes or otherwise causes to be transferred to the Partnership the cash proceeds or other consideration, if any, received in connection with the issuance of such REIT Shares, Preferred Shares, Junior Shares, New Securities or other interests in the General Partner or (iii) the additional Partnership Units are issued upon the conversion, redemption or exchange of Debt, Partnership Units or other securities issued by the Partnership. In the event that the Partnership issues additional Partnership Units pursuant to this Section 4.02(b) , the General Partner shall make such revisions to this Agreement (including but not limited to the revisions described in Sections 6.02(b) and 8.06 ) as it determines are necessary to reflect the issuance of such additional Partnership Interests.
(c) No Preemptive Rights . No Person, including, without limitation, any Partner or Assignee, shall have any preemptive, preferential, participation or similar right or rights to subscribe for or acquire any Partnership Interest.
Section 4.03. Additional Funds and Capital Contributions .
(a) General . The General Partner may, at any time and from time to time, determine that the Partnership requires additional funds ( Additional Funds ) for the acquisition or development of additional Properties, for the redemption of Partnership Units or for such other purposes as the General Partner may determine in its sole and absolute discretion. Additional Funds may be obtained by the Partnership, at the election of the General Partner, in any manner provided in, and in accordance with, the terms of this Section 4.03 without the approval of any Limited Partners.
(b) Additional Capital Contributions . The General Partner, on behalf of the Partnership, may obtain any Additional Funds by accepting Capital Contributions from any Partners or other Persons. In connection with any such Capital Contribution (of cash or property), the General Partner is hereby authorized to cause the Partnership from time to time to issue additional Partnership Units (as set forth in Section 4.02 above) in consideration therefor and the Percentage Interests of the General Partner and the Limited Partners shall be adjusted to reflect the issuance of such additional Partnership Units.
(c) Loans by Third Parties . The General Partner, on behalf of the Partnership, may obtain any Additional Funds by causing the Partnership to incur Debt to any Person upon such terms as the General Partner determines appropriate, including making such Debt convertible, redeemable or exchangeable for Partnership Units; provided , however , that the Partnership shall not incur any such Debt if any Partner would be personally liable for the repayment of such Debt (unless such Partner otherwise agrees).
(d) General Partner Loans . The General Partner, on behalf of the Partnership, may obtain any Additional Funds by causing the Partnership to incur Debt with the General Partner (a General Partner Loan ), if (i) such Debt is, to the extent permitted by law, on substantially the same terms and conditions (including interest rate, repayment schedule, and conversion, redemption, repurchase and exchange rights) as Funding Debt incurred by the General Partner, the net proceeds of which are loaned to the Partnership to provide such Additional Funds or (ii) such Debt is on terms and conditions no less favorable to the Partnership than would be available to the Partnership from any third party; provided , however , that the
Partnership shall not incur any such Debt if (a) a breach, violation or default of such Debt would be deemed to occur by virtue of the Transfer by any Limited Partner of any Partnership Interest or (b) such Debt is recourse to any Partner (unless the Partner otherwise agrees).
(e) Issuance of Securities by the General Partner . The General Partner shall not issue any additional REIT Shares, Preferred Shares, Junior Shares or New Securities unless the General Partner contributes directly or indirectly the cash proceeds or other consideration, if any, received from the issuance of such additional REIT Shares, Preferred Shares, Junior Shares or New Securities, as the case may be, and from the exercise of the rights contained in any such additional New Securities, to the Partnership in exchange for (x) in the case of an issuance of REIT Shares, Partnership Units or (y) in the case of an issuance of Preferred Shares, Junior Shares or New Securities, Partnership Units with designations, preferences and other rights, terms and provisions that are substantially the same as the designations, preferences and other rights, terms and provisions of such Preferred Shares, Junior Shares or New Securities; provided , however , that notwithstanding the foregoing, the General Partner may issue REIT Shares, Preferred Shares, Junior Shares or New Securities (a) pursuant to Section 4.04 or 8.06(b) hereof, (b) pursuant to a dividend or distribution (including any stock split) wholly or partly of REIT Shares, Preferred Shares, Junior Shares or New Securities to all of the holders of REIT Shares, Preferred Shares, Junior Shares or New Securities, as the case may be, (c) upon a conversion, redemption or exchange of Preferred Shares, (d) upon a conversion of Junior Shares into REIT Shares, (e) upon a conversion, redemption, exchange or exercise of New Securities or, (f) pursuant to share grants or awards made pursuant to any Equity Incentive Plan of the General Partner. In the event of any issuance of additional REIT Shares, Preferred Shares, Junior Shares or New Securities by the General Partner, and the direct or indirect contribution to the Partnership, by the General Partner, of the cash proceeds or other consideration received from such issuance, if any, the Partnership shall pay the General Partners expenses associated with such issuance, including any underwriting discounts or commissions (it being understood that if the proceeds actually received by the General Partner are less than the gross proceeds of such issuance as a result of any underwriters discount or other expenses paid or incurred by the General Partner in connection with such issuance, then the General Partner shall be deemed to have made a Capital Contribution to the Partnership in the amount of the gross proceeds of such issuance and the Partnership shall be deemed simultaneously to have reimbursed the General Partner pursuant to Section 7.04(b) for the amount of such underwriters discount or other expenses). Nothing in this Agreement shall prohibit the General Partner from issuing Partnership Units for less than fair market value if the General Partner concludes in good faith that such issuance is in the best interest of the Partnership and the General Partners stockholders.
Section 4.04. Equity Incentive Plan .
(a) Options Granted to General Partner Employees and Independent Directors . If at any time or from time to time, in connection with an Equity Incentive Plan, a stock option granted to a General Partner Employee or Independent Director is duly exercised:
(i) the General Partner shall, as soon as practicable after such exercise, make or cause to be made directly or indirectly a Capital Contribution to the Partnership in an
amount equal to the exercise price paid to the General Partner by such exercising party in connection with the exercise of such stock option.
(ii) Notwithstanding the amount of the Capital Contribution actually made pursuant to Section 4.04(a)(i) hereof, the General Partner shall be deemed to have contributed directly or indirectly to the Partnership, as a Capital Contribution, in consideration of an additional Limited Partner Interest (expressed in and as additional Partnership Units), an amount equal to the Value of a REIT Share as of the date of exercise multiplied by the number of REIT Shares then being issued in connection with the exercise of such stock option.
(iii) An equitable Percentage Interest adjustment shall be made in which the General Partner shall be treated as having made a cash contribution equal to the amount described in Section 4.04(a)(ii) hereof.
(b) Special Valuation Rule . For purposes of this Section 4.04 , in determining the Value of a REIT Share, only the trading date immediately preceding the exercise of the relevant stock option under the Equity Incentive Plan shall be considered.
(c) Future Equity Incentive Plans . Nothing in this Agreement shall be construed or applied to preclude or restrain the General Partner from adopting, modifying or terminating any Equity Incentive Plan, for the benefit of employees, directors or other business associates of the General Partner, the Partnership or any of their Affiliates. The Limited Partners acknowledge and agree that, in the event that any such plan is adopted, modified or terminated by the General Partner, amendments to this Section 4.04 may become necessary or advisable and that any approval or consent of the Limited Partners required pursuant to the terms of this Agreement in order to effect any such amendments requested by the General Partner shall not be unreasonably withheld or delayed.
Section 4.05. No Interest; No Return . No Partner shall be entitled to interest on its Capital Contribution or on such Partners Capital Account. Except as provided herein or by law, no Partner shall have any right to demand or receive the return of its Capital Contribution from the Partnership.
Section 4.06. Other Contribution Provisions . In the event that any Partner is admitted to the Partnership and is given a Capital Account in exchange for services rendered to the Partnership, unless otherwise determined by the General Partner in its sole and absolute discretion, such transaction shall be treated by the Partnership and the affected Partner as if the Partnership had compensated such partner in cash and such Partner had contributed the cash to the capital of the Partnership. In addition, with the consent of the General Partner, one or more Limited Partners may enter into contribution agreements with the Partnership which have the effect of providing a guarantee of certain obligations of the Partnership.
Section 4.07. Not Publicly Traded . The General Partner, on behalf of the Partnership, shall use its best efforts not to take any action which would result in the Partnership being a publicly traded partnership under and as such term is defined in Code Section 7704(b), and by reason thereof, taxable as a corporation.
Section 4.08. 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 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. 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.
ARTICLE V
DISTRIBUTIONS
Section 5.01. Requirement and Characterization of Distributions . Subject to the terms of any Partnership Unit Designation, the General Partner may cause the Partnership to distribute at least quarterly all, or such portion as the General Partner may in its sole and absolute discretion determine, of Available Cash generated by the Partnership during such quarter to the Holders of Partnership Units on such Partnership Record Date with respect to such quarter: (1) first, with respect to any Partnership Interests that are entitled to any preference in distribution, in accordance with the rights of such class(es) of Partnership Interests (and, within such class(es), pro rata in proportion to the respective Percentage Interests on such Partnership Record Date) and (2) second, with respect to any Partnership Interests that are not entitled to any preference in distribution, in accordance with the rights of such class of Partnership Interests (and, within such class, pro rata in proportion to the respective Percentage Interests on such Partnership Record Date) such that a holder of one OP Unit will receive the same amount of annual cash flow distributions from the Partnership as the amount of annual distributions paid to the holder of one REIT Share. At the election of the General Partner, distributions payable with respect to any Partnership Units that were not outstanding during the entire quarterly period in respect of which any distribution is made may be prorated based on the portion of the period that such Partnership Units were outstanding.
The General Partner in its sole and absolute discretion may distribute to the Holders Available Cash on a more frequent basis and provide for an appropriate Partnership Record Date. Notwithstanding anything herein to the contrary, the General Partner shall make such reasonable efforts, as determined by it in its sole and absolute discretion and consistent with the General Partners qualification as a REIT, to cause the Partnership to distribute sufficient amounts to enable the General Partner to pay stockholder dividends that will (a) satisfy the requirements for its qualification as a REIT under the Code and Regulations (the REIT Requirements ) and
(b) except to the extent otherwise determined by the General Partner, in its sole and absolute discretion, avoid any federal income or excise tax liability of the General Partner.
Section 5.02. Interests in Property Not Held Through the Partnership . To the extent amounts distributed by the Partnership are attributable to amounts received from a property in which the General Partner or any Affiliate of the General Partner holds a direct or indirect interest (other than through the Partnership) (an Outside Interest ), (i) such amounts distributed to the General Partner will be reduced so as to take into account amounts received pursuant to the Outside Interest and (ii) the amounts distributed to the Limited Partners will be increased to the extent necessary so that the overall effect of the distribution is to distribute what would have been distributed had such Outside Interest been held through the Partnership (treating any distribution made in respect of the Outside Interest as if such distribution had been received by the General Partner).
Section 5.03. Distributions In-Kind . No right is given to any Partner to demand and receive property other than cash as provided in this Agreement. The General Partner may determine, in its sole and absolute discretion, to make a distribution in-kind of Partnership assets to the Holders, and such assets shall be distributed in such a fashion as to ensure that the fair market value is distributed and allocated in accordance with Articles V , VI and X hereof.
Section 5.04. Amounts Withheld . All amounts withheld pursuant to the Code or any provisions of any state or local tax law and Section 10.04 hereof with respect to any allocation, payment or distribution to any Holder shall be treated as amounts paid or distributed to such Holder pursuant to Section 5.01 hereof for all purposes under this Agreement.
Section 5.05. Distributions Upon Liquidation . Notwithstanding the other provisions of this Article V , net proceeds from a Terminating Capital Transaction, and any other cash received or reductions in reserves made after commencement of the liquidation of the Partnership, shall be distributed to the Holders in accordance with Section 13.02 hereof.
Section 5.06. Distributions to Reflect Issuance of Additional Partnership Units . In the event that the Partnership issues additional Partnership Units pursuant to the provisions of Article IV hereof, subject to Section 7.03(d) , the General Partner is may make such revisions to this Article V as it determines are necessary or desirable to reflect the issuance of such additional Partnership Units, including, without limitation, making preferential distributions to certain classes of Partnership Units.
Section 5.07. Restricted Distributions . Notwithstanding any provision to the contrary contained in this Agreement, neither the Partnership nor the General Partner, on behalf of the Partnership, shall make a distribution to any Holder on account of its Partnership Interest or interest in Partnership Units if such distribution would violate Section 17-607 of the Act or other applicable law.
ARTICLE VI
ALLOCATIONS
Section 6.01. Timing and Amount of Allocations of Net Income and Net Loss . Net Income and Net Loss of the Partnership shall be determined and allocated with respect to each Partnership Year of the Partnership as of the end of each such year. Except as otherwise provided in this Article VI , and subject to Section 11.06(c) hereof, an allocation to a Holder of a share of Net Income or Net Loss shall be treated as an allocation of the same share of each item of income, gain, loss or deduction that is taken into account in computing Net Income or Net Loss.
Section 6.02. General Allocations .
(a) Allocations of Net Income and Net Loss .
(i) Net Income . Except as otherwise provided herein, Net Income for any Partnership Year or other applicable period shall be allocated in the following order and priority:
(A) First, to the General Partner until the cumulative Net Income allocated to the General Partner pursuant to this subparagraph (i)(A) equals the cumulative Net Loss allocated to the General Partner pursuant to subparagraph (ii) below;
(B) Second, to the holders of any Partnership Interests that are entitled to any preference in distribution upon liquidation until the cumulative Net Income allocated under this subparagraph equals the cumulative Net Loss allocated to such Partners under subparagraph (ii)(C);
(C) Third, to the holders of any Partnership Units that are entitled to any preference in distribution in accordance with the rights of any other class of Partnership Units until each such Partnership Unit has been allocated, on a cumulative basis pursuant to this subparagraph (i)(C), Net Income equal to the amount of distributions received which are attributable to the preference of such class of Partnership Unit (and, within such class, pro rata in proportion to the respective Percentage Interests as of the last day of the period for which such allocation is made); and
(D) Thereafter, with respect to Partnership Units that are not entitled to any preference in distribution or with respect to which distributions are not limited to any preference in distribution, pro rata to each such class in accordance with the terms of such class (and, within such class, pro rata in proportion to the respective Percentage Interests as of the last day of the period for which such allocation is being made).
(ii) Net Loss . Except as otherwise provided herein, Net Loss for any Partnership Year or other applicable period shall be allocated in the following order and priority:
(A) First, to each holder of Partnership Units in proportion to and to the extent of the amount by which the cumulative Net Income allocated to such Partner pursuant to subparagraph (i)(D) above exceeds, on a cumulative basis, the sum of (a) distributions with respect to such Partnership Units pursuant to clause (2) of Section 5.01 and (b) Net Loss allocated to such Partner pursuant to this subparagraph (ii)(A);
(B) Second, with respect to classes of Partnership Units that are not entitled to any preference in distribution or with respect to which distributions are not limited to any preference in distribution, pro rata to each such class in accordance with the terms of such class (and within such class, pro rata in proportion to the respective Percentage Interests as of the last day of the period for which such allocation is being made); provided , that Net Loss shall not be allocated to any Partner pursuant to this subparagraph (ii)(B) to the extent that such allocation would cause such Partner to have an Adjusted Capital Account Deficit (or increase any existing Adjusted Capital Account Deficit) (determined in each case (1) with respect to a Partner who also holds classes of Partnership Units that are entitled to any preferences in distribution upon liquidation, by subtracting from such Partners Adjusted Capital Account the amount of such preferred distribution to be made upon liquidation and (2) by not including in the Partners Adjusted Capital Accounts any amount that a Partner is obligated to contribute to the Partnership with respect to any deficit in its Capital Account pursuant to Section 13.02(d) ) at the end of such Partnership Year or other applicable period; and
(C) Third, with respect to classes of Partnership Units that are entitled to any preference in distribution upon liquidation, in reverse order of the priorities of each such class (and within each such class, pro rata in proportion to their respective Percentage Interests as of the last day of the period for which such allocation is being made); provided , that Net Loss shall not be allocated to any Partner pursuant to this subparagraph (ii)(C) to the extent that such allocation would cause such Partner to have an Adjusted Capital Account Deficit (or increase any existing Adjusted Capital Account Deficit) (determined in each case by not including in the Partners Adjusted Capital Accounts any amount that a Partner is obligated to contribute to the Partnership with respect to any deficit in its Capital Account pursuant to Section 13.02(d) ) at the end of such Partnership Year or other applicable period;
(D) Thereafter, to the General Partner.
(b) Allocations to Reflect Issuance of Additional Partnership Units . In the event that the Partnership issues additional Partnership Units pursuant to the provisions of Article IV hereof, the General Partner may make such revisions to this Section 6.02 as it determines are necessary or desirable to reflect the terms of the issuance of such additional Partnership Units.
Section 6.03. Additional Allocation Provisions . Notwithstanding the foregoing provisions of this Article VI :
(a) Regulatory Allocations .
(i) Minimum Gain Chargeback . Except as otherwise provided in Regulations Section 1.704-2(f), notwithstanding the provisions of Section 6.02 hereof, or any other provision of this Article VI , if there is a net decrease in Partnership Minimum Gain during any Partnership Year, each Holder shall be specially allocated items of Partnership income and gain for such year (and, if necessary, subsequent years) in an amount equal to such Holders share of the net decrease in Partnership Minimum Gain, as determined under Regulations Section 1.704-2(g). Allocations pursuant to the previous sentence shall be made in proportion to the respective amounts required to be allocated to each Holder pursuant thereto. The items to be allocated shall be determined in accordance with Regulations Sections 1.704-2(f)(6) and 1.704-2(j)(2). This Section 6.03(a)(i) is intended to qualify as a minimum gain chargeback within the meaning of Regulations Section 1.704-2(f) and shall be interpreted consistently therewith.
(ii) Partner Minimum Gain Chargeback . Except as otherwise provided in Regulations Section 1.704-2(i)(4) or in Section 6.03(a)(i) hereof, if there is a net decrease in Partner Minimum Gain attributable to a Partner Nonrecourse Debt during any Partnership Year, each Holder who has a share of the Partner Minimum Gain attributable to such Partner Nonrecourse Debt, determined in accordance with Regulations Section 1.704-2(i)(5), shall be specially allocated items of Partnership income and gain for such year (and, if necessary, subsequent years) in an amount equal to such Holders share of the net decrease in Partner Minimum Gain attributable to such Partner Nonrecourse Debt, determined in accordance with Regulations Section 1.704-2(i)(4). Allocations pursuant to the previous sentence shall be made in proportion to the respective amounts required to be allocated to each General Partner, Limited Partner and other Holder pursuant thereto. The items to be so allocated shall be determined in accordance with Regulations Sections 1.704-2(i)(4) and 1.704-2(j)(2). This Section 6.03(a)(ii) is intended to qualify as a chargeback of partner nonrecourse debt minimum gain within the meaning of Regulations Section 1.704-2(i) and shall be interpreted consistently therewith.
(iii) Nonrecourse Deductions and Partner Nonrecourse Deductions . Any Nonrecourse Deductions for any Partnership Year shall be specially allocated to the Holders of OP Units in accordance with their OP Units. Any Partner Nonrecourse Deductions for any Partnership Year shall be specially allocated to the Holder(s) who bears the economic risk of loss with respect to the Partner Nonrecourse Debt to which such Partner Nonrecourse Deductions are attributable, in accordance with Regulations Section 1.704-2(i).
(iv) Qualified Income Offset . If any Holder unexpectedly receives an adjustment, allocation or distribution described in Regulations Section 1.704-1(b)(2)(ii)(d)(4), (5), or (6), items of Partnership income and gain shall be allocated, in accordance with Regulations Section 1.704-1(b)(2)(ii)(d), to such Holder in an amount and manner sufficient to eliminate, to the extent required by such Regulations, the Adjusted Capital Account Deficit of such Holder as quickly as possible. It is intended that this Section 6.03(a)(iv) qualify and be construed as a qualified income offset within the meaning of Regulations Section 1.704-1(b)(2)(ii)(d) and shall be interpreted consistently therewith.
(v) Gross Income Allocation . In the event that any Holder has an Adjusted Capital Account Deficit at the end of any Partnership Year, each such Holder shall be specially allocated items of Partnership income and gain in the amount of such excess to eliminate such deficit as quickly as possible.
(vi) Section 754 Adjustment . To the extent that an adjustment to the adjusted tax basis of any Partnership asset pursuant to Code Section 734(b) or Code Section 743(b) is required, pursuant to Regulations Section 1.704-1(b)(2)(iv)(m)(2) or Regulations Section 1.704-1(b)(2)(iv)(m)(4), to be taken into account in determining Capital Accounts as the result of a distribution to a Holder in complete liquidation of its interest in the Partnership, the amount of such adjustment to the Capital Accounts shall be treated as an item of gain (if the adjustment increases the basis of the asset) or loss (if the adjustment decreases such basis), and such gain or loss shall be specially allocated to the Holders in accordance with their Partnership Units in the event that Regulations Section 1.704-1(b)(2)(iv)(m)(2) applies, or to the Holders to whom such distribution was made in the event that Regulations Section 1.704-1(b)(2)(iv)(m)(4) applies.
(vii) Curative Allocations . The allocations set forth in Sections 6.03(a)(i) , (ii) , (iii) , (iv) , (v) , and (vi) hereof (the Regulatory Allocations ) are intended to comply with certain regulatory requirements, including the requirements of Regulations Sections 1.704-1(b) and 1.704-2. Notwithstanding the provisions of Section 6.01 hereof, the Regulatory Allocations shall be taken into account in allocating other items of income, gain, loss and deduction among the Holders of Partnership Units so that to the extent possible without violating the requirements giving rise to the Regulatory Allocations, the net amount of such allocations of other items and the Regulatory Allocations to each Holder of a Partnership Unit shall be equal to the net amount that would have been allocated to each such Holder if the Regulatory Allocations had not occurred.
(b) Allocation of Excess Nonrecourse Liabilities . The Partnership shall allocate nonrecourse liabilities (within the meaning of Regulations Section 1.752-1(a)(2)) of the Partnership that are secured by multiple Properties under any reasonable method chosen by the General Partner in accordance with Regulations Section 1.752-3(a)(3) and (b). The Partnership shall allocate excess nonrecourse liabilities of the Partnership under any method approved under Regulations Section 1.752-3(a)(3) as chosen by the General Partner.
(c) Allocations to Reflect Outside Interests . Any income or loss to the Partnership associated with an Outside Interest shall be specially allocated so as to take into account amounts received by, and income or loss allocated to, the General Partner or any Affiliate of the General Partner with respect to such Outside Interest so that the overall effect is to allocate income or loss in the same manner as would have occurred had such Outside Interest been held through the Partnership (treating any allocation in respect of the Outside Interest as if such allocation had been made to the General Partner).
Section 6.04. Tax Allocations .
(a) In General . Except as otherwise provided in this Section 6.04 , for income tax purposes under the Code and the Regulations each Partnership item of income, gain,
loss and deduction (collectively, Tax Items ) shall be allocated among the Holders of Partnership Units in the same manner as its correlative item of book income, gain, loss or deduction is allocated pursuant to Sections 6.02 and 6.03 hereof.
(b) Allocations Respecting Section 704(c) Revaluations . Notwithstanding Section 6.04(a) hereof, Tax Items with respect to Property that is contributed to the Partnership with a Gross Asset Value that varies from its basis in the hands of the contributing Partner immediately preceding the date of contribution shall be allocated among the Holders of Partnership Units for income tax purposes pursuant to Regulations promulgated under Code Section 704(c) so as to take into account such variation. The Partnership shall account for such variation under any method approved under Code Section 704(c) and the applicable Regulations as chosen by the General Partner. In the event that the Gross Asset Value of any partnership asset is adjusted pursuant to subsection (b) of the definition of Gross Asset Value (provided in Article I hereof), subsequent allocations of Tax Items with respect to such asset shall take account of the variation, if any, between the adjusted basis of such asset and its Gross Asset Value in the same manner as under Code Section 704(c) and the applicable Regulations or under any method approved under Code Section 7.04(c) and the applicable Regulations as chosen by the General Partner, including the aggregation methods applicable to securities partnerships, to the extent applicable and to the extent the General Partner decides to apply such methods.
ARTICLE VII
MANAGEMENT AND OPERATIONS OF BUSINESS
Section 7.01. Management .
(a) Except as otherwise expressly provided in this Agreement, all management powers over the business and affairs of the Partnership are and shall be exclusively vested in the General Partner, and no Limited Partner shall have any right to participate in or exercise control or management power over the business and affairs of the Partnership. The General Partner may not be removed by the Limited Partners, except with the consent of the General Partner. In addition to the powers now or hereafter granted to a general partner of a limited partnership under applicable law or that are granted to the General Partner under any other provision of this Agreement, the General Partner, subject to the other provisions hereof including Section 7.03 , 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 3.02 hereof and to effectuate the purposes set forth in Section 3.01 hereof, including, without limitation:
(i) the making of any expenditures, the lending or borrowing of money (including, without limitation, making prepayments on loans and borrowing money or selling assets to permit the Partnership to make distributions to its Partners in such amounts as will permit the General Partner (so long as the General Partner desires to maintain or restore its qualification as a REIT) to avoid the payment of any federal income tax (including, for this purpose, any excise tax pursuant to Code Section 4981) and to make distributions to its stockholders sufficient to permit the General Partner to maintain or restore REIT qualification or otherwise to satisfy the REIT Requirements), the assumption or guarantee of, or other
contracting for, indebtedness and other liabilities, the issuance of evidences of indebtedness (including the securing of same by deed to secure debt, mortgage, deed of trust or other lien or encumbrance on the Partnerships assets) and the incurring of any obligations that it deems necessary for the conduct of the activities of the Partnership;
(ii) the making of tax, regulatory and other filings, or rendering of periodic or other reports to governmental or other agencies having jurisdiction over the business or assets of the Partnership, the registration of any class of securities of the Partnership under the Exchange Act and the listing of any debt securities of the Partnership on any exchange;
(iii) subject to Section 11.02 hereof, the acquisition, sale, lease, transfer, exchange or other disposition of any, all or substantially all of the assets of the Partnership (including, but not limited to, the exercise or grant of any conversion, option, privilege or subscription right or any other right available in connection with any assets at any time held by the Partnership) or the merger, consolidation, reorganization or other combination of the Partnership with or into another entity;
(iv) the mortgage, pledge, encumbrance or hypothecation of any assets of the Partnership, the use of the assets of the Partnership (including, without limitation, cash on hand) for any purpose consistent with the terms of this Agreement and on any terms that it sees fit, including, without limitation, the financing of the operations and activities of the General Partner, the Partnership or any of the Partnerships Subsidiaries, the lending of funds to other Persons (including, without limitation, the Partnerships Subsidiaries) and the repayment of obligations of the Partnership, its Subsidiaries and any other Person in which the Partnership has an equity investment, and the making of capital contributions to and equity investments in the Partnerships Subsidiaries;
(v) the use of the assets of the Partnership (including, without limitation, cash on hand) for any purpose consistent with the terms of this Agreement and on any terms it sees fit, including, without limitation, the financing of the conduct of the operations of the General Partner, the Partnership or any of the Partnerships Subsidiaries, the lending of funds to other Persons (including, without limitation, the General Partner and its Subsidiaries and the Partnerships Subsidiaries) and the repayment of obligations of the Partnership and its Subsidiaries and any other Person in which the Partnership has an equity investment and the making of capital contributions to its Subsidiaries;
(vi) the management, operation, leasing, landscaping, repair, alteration, demolition, replacement or improvement of any Property, including, without limitation, any Contributed Property, or other asset of the Partnership or any Subsidiary, whether pursuant to a Services Agreement or otherwise;
(vii) the negotiation, execution and performance of any contracts, leases, conveyances or other instruments that the General Partner considers useful or necessary to the conduct of the Partnerships operations or the implementation of the General Partners 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 Partnerships assets;
(viii) the distribution of Partnership cash or other Partnership assets in accordance with this Agreement, the holding, management, investment and reinvestment of cash and other assets of the Partnership and the collection and receipt of revenues, rents and income of the Partnership;
(ix) the maintenance of such insurance for the benefit of the Partnership and the Partners as the General Partner deems necessary or appropriate, including, without limitation, (i) casualty, liability and other insurance on the Properties and (ii) liability insurance for the Indemnitees hereunder;
(x) the formation of, or acquisition of an interest in, and the contribution of property to, any further limited or general partnerships, limited liability companies, joint ventures or other relationships that the General Partner deems desirable (including, without limitation, the acquisition of interests in, and the contributions of property to, any Subsidiary and any other Person in which it has an equity investment from time to time); provided , however , that as long as the General Partner has determined to continue to qualify as a REIT, the General Partner may not engage in any such formation, acquisition or contribution that would cause it to fail to qualify as a REIT within the meaning of Code Section 856(a) (so long as the General Partner desires to maintain its qualification as a REIT);
(xi) the filing of applications, communicating and otherwise dealing with any and all governmental agencies having jurisdiction over, or in any way affecting, the Partnerships assets or any other aspect of the Partnership business;
(xii) the control of any matters affecting the rights and obligations of the Partnership, including the settlement, compromise, submission to arbitration or any other form of dispute resolution, or abandonment, of any claim, cause of action, liability, debt or damages, due or owing to or from the Partnership, the commencement or defense of suits, legal proceedings, administrative proceedings, arbitrations or other forms of dispute resolution, and the representation of the Partnership in all suits or legal proceedings, administrative proceedings, arbitrations or other forms of dispute resolution, the incurring of legal expense, and the indemnification of any Person against liabilities and contingencies to the extent permitted by law;
(xiii) the undertaking of any action in connection with the Partnerships direct or indirect investment in any Subsidiary or any other Person (including, without limitation, the contribution or loan of funds by the Partnership to such Persons);
(xiv) except as otherwise specifically set forth in this Agreement, the determination of the fair market value of any Partnership property distributed in-kind using such reasonable method of valuation as it may adopt; provided , that such methods are otherwise consistent with the requirements of this Agreement;
(xv) the enforcement of any rights against any Partner pursuant to representations, warranties, covenants and indemnities relating to such Partners contribution of property or assets to the Partnership;
(xvi) the exercise, directly or indirectly, through any attorney-in-fact acting under a general or limited power-of-attorney, of any right, including the right to vote, appurtenant to any asset or investment held by the Partnership;
(xvii) the exercise of any of the powers of the General Partner enumerated in this Agreement on behalf of or in connection with any Subsidiary of the Partnership or any other Person in which the Partnership has a direct or indirect interest, or jointly with any such Subsidiary or other Person;
(xviii) the exercise of any of the powers of the General Partner enumerated in this Agreement on behalf of any Person in which the Partnership does not have an interest, pursuant to contractual or other arrangements with such Person;
(xix) the making, execution and delivery of any and all deeds, leases, notes, deeds to secure Debt, mortgages, deeds of trust, security agreements, conveyances, contracts, guarantees, warranties, indemnities, waivers, releases or legal instruments or agreements in writing necessary or appropriate in the judgment of the General Partner for the accomplishment of any of the powers of the General Partner enumerated in this Agreement;
(xx) the issuance of additional Partnership Units, as appropriate and in the General Partners sole and absolute discretion, in connection with Capital Contributions by Additional Limited Partners and additional Capital Contributions by Partners pursuant to Article IV hereof;
(xxi) the selection and dismissal of Company Employees (including, without limitation, employees having titles or offices such as president, vice president, secretary and treasurer), and agents, outside attorneys, accountants, consultants and contractors of the Partnership or the General Partner, the determination of their compensation and other terms of employment or hiring and the delegation to any such Company Employee the authority to conduct the business of the Partnership in accordance with the terms of this Agreement;
(xxii) the distribution of cash to acquire Partnership Units held by a Limited Partner in connection with a Limited Partners exercise of its Redemption right under Section 8.06 hereof;
(xxiii) the amendment and restatement of Exhibit A hereto to reflect accurately at all times the Capital Contributions and Percentage Interests of the Partners as the same are adjusted from time to time to the extent necessary to reflect redemptions, Capital Contributions, the issuance of Partnership Units, the admission of any Additional Limited Partner or any Substituted Limited Partner or otherwise, which amendment and restatement, notwithstanding anything in this Agreement to the contrary, shall not be deemed an amendment to this Agreement, as long as the matter or event being reflected in Exhibit A hereto otherwise is authorized by this Agreement;
(xxiv) the determination regarding whether a payment to a Partner who exercises its Redemption Right under Section 8.06 that is assumed by the General Partner will be paid in the form of the Cash Amount or the REIT Shares Amount, except as such determination may be limited by Section 8.06 ;
(xxv) the collection and receipt of revenues and income of the Partnership;
(xxvi) the registration of any class of securities of the Partnership under the Securities Act or the Exchange Act, and the listing of any debt securities of the Partnership on any exchange;
(xxvii) an election to dissolve the Partnership pursuant to Section 13.01(b) hereof; and
(xxviii) the taking of any action necessary or appropriate to enable the General Partner to qualify as a REIT (so long as the General Partner desires to maintain its qualification as a REIT).
(b) Each of the Limited Partners agrees that, except as provided in Section 7.03 hereof, the General Partner is authorized to execute, deliver and perform the above-mentioned agreements and transactions on behalf of the Partnership without any further act, approval or vote of the Partners, notwithstanding any other provision of this Agreement, the Act or any applicable law, rule or regulation.
(c) At all times from and after the date hereof, the General Partner may cause the Partnership to establish and maintain working capital and other reserves in such amounts as the General Partner, in its sole and absolute discretion, deems appropriate and reasonable from time to time.
(d) In exercising its authority under this Agreement, the General Partner may, but shall be under no obligation to, take into account the tax consequences to any Partner (including the General Partner) of any action taken (or not taken) by it. Except as may be provided in a separate written agreement between the Partnership and the Limited Partners, the General Partner and the Partnership shall not have liability to a Limited Partner under any circumstances as a result of an income tax liability incurred by such Limited Partner as a result of an action (or inaction) by the General Partner pursuant to its authority under this Agreement provided , that the General Partner has acted in good faith and pursuant to its authority under this Agreement.
Section 7.02. Certificate of Limited Partnership . To the extent that such action is determined by the General Partner to be reasonable and necessary or appropriate, the General Partner shall file amendments to and restatements of the Certificate and do all the things to maintain the Partnership as a limited partnership (or a partnership in which the limited partners have limited liability) under the laws of the State of Delaware and each other state, the District of Columbia or any other jurisdiction, in which the Partnership may elect to do business or own property. Except as otherwise required under the Act, the General Partner shall not be required, before or after filing, to deliver or mail a copy of the Certificate or any amendment thereto to any Limited Partner. The General Partner shall use all reasonable efforts to cause to be filed such other certificates or documents as may be reasonable and necessary or appropriate for the formation, continuation, qualification and operation of a limited partnership (or a partnership in which the limited partners have limited liability to the extent provided by applicable law) in the
State of Delaware and any other state, or the District of Columbia or other jurisdiction, in which the Partnership may elect to do business or own property.
Section 7.03. Restrictions on General Partners Authority .
(a) The General Partner may not take any action in contravention of an express prohibition or limitation of this Agreement without the written consent of a Majority in Interest of the Outside Limited Partners and may not perform any act that would subject a Limited Partner to liability as a general partner in any jurisdiction or any other liability except as provided herein or under the Act.
(b) The General Partner shall not, without the written consent of a Majority in Interest of the Limited Partners, terminate this Agreement.
(c) The General Partner shall have the exclusive power, without the prior consent of the Limited Partners, to amend this Agreement, including, without limitation, as may be required to facilitate or implement any of the following purposes:
(i) to add to the obligations of the General Partner or surrender any right or power granted to the General Partner or any Affiliate of the General Partner for the benefit of the Limited Partners;
(ii) to reflect the admission, substitution or withdrawal of Partners or the termination of the Partnership in accordance with this Agreement, and to amend Exhibit A in connection with such admission, substitution or withdrawal;
(iii) to reflect a change that is of an inconsequential nature or does not adversely affect the Limited Partners in any material respect, or to cure any ambiguity, correct or supplement any provision in this Agreement not inconsistent with law or with other provisions, or make other changes with respect to matters arising under this Agreement that will not be inconsistent with law or with the provisions of this Agreement;
(iv) to satisfy any requirements, conditions or guidelines contained in any order, directive, opinion, ruling or regulation of a federal or state agency or contained in federal or state law;
(v) set forth in the partnership agreement the designations, rights, powers, duties and preferences of the holders of any additional partnership units issued pursuant to the partnership agreement;
(vi) (a) to reflect such changes as are reasonably necessary for the General Partner to maintain or restore its qualification as a REIT or to satisfy the REIT Requirements; or (b) to reflect the Transfer of all or any part of a Partnership Interest among the General Partner and any Qualified REIT Subsidiary;
(vii) to modify either or both the manner in which items of Net Income or Net Loss are allocated pursuant to Article VI or the manner in which Capital Accounts are
adjusted, computed or maintained (but only to the extent set forth in the definition of Capital Account or contemplated by the Code or the Regulations);
(viii) to issue additional Partnership Interests in accordance with Section 4.02 ; and
(ix) to reflect any other modification to this Agreement as is reasonably necessary for the business or operations of the Partnership or the General Partner.
The General Partner will provide notice to the Limited Partners whenever any action under this Section 7.03(c) is taken.
(d) No action may be taken by the General Partner, without the consent of each Partner adversely affected thereby, if such action would (i) convert a Limited Partner Interest in the Partnership into a General Partner Interest (except as a result of the General Partner acquiring such Partnership Interest), or (ii) modify the limited liability of a Limited Partner.
Section 7.04. Reimbursement of the General Partner .
(a) Except as provided in this Section 7.04 and elsewhere in this Agreement (including the provisions of Articles V and VI regarding distributions, payments and allocations to which it may be entitled), the General Partner shall not be compensated for its services as general partner of the Partnership.
(b) The Partnership shall be responsible for and shall pay all the administrative and operating costs and expenses incurred by the Partnership in acquiring and holding the General Partners assets, and the General Partners administrative costs and expenses, and such expenses will be treated as expenses of the Partnership. Such expenses will include:
(i) all expenses relating to the General Partners formation and continuity of existence;
(ii) all expenses relating to any offerings and registrations of securities;
(iii) all expenses associated with the General Partners preparation and filing of any periodic reports under federal, state or local laws or regulations;
(iv) all expenses associated with the General Partners compliance with applicable laws, rules and regulations; and
(v) all other operating or administrative costs of the General Partners incurred in the ordinary course of its business.
The General Partner is hereby authorized to pay compensation for accounting, administrative, legal, technical, management and other services rendered to the Partnership. Except to the extent provided in this Agreement, the General Partner and its Affiliates shall be reimbursed on a monthly basis, or such other basis as the General Partner may determine in its sole and absolute
discretion, for all expenses that the General Partner and its Affiliates incur relating to the ownership and operation of, or for the benefit of, the Partnership (including, without limitation, administrative expenses); provided , that the amount of any such reimbursement shall be reduced by any interest earned by the General Partner with respect to bank accounts or other instruments or accounts held by it on behalf of the Partnership. The Partners acknowledge that all such expenses of the General Partner are deemed to be for the benefit of the Partnership. Such reimbursement shall be in addition to any reimbursement made as a result of indemnification pursuant to Section 7.07 hereof. In the event that certain expenses are incurred for the benefit of the Partnership and other entities (including the General Partner), such expenses will be allocated to the Partnership and such other entities in such a manner as the General Partner in its sole and absolute discretion deems fair and reasonable. All payments and reimbursements hereunder shall be characterized for federal income tax purposes as expenses of the Partnership incurred on its behalf, and not as expenses of the General Partner.
(c) If the General Partner shall elect to purchase from its stockholders REIT Shares for the purpose of delivering such REIT Shares to satisfy an obligation under any dividend reinvestment program adopted by the General Partner, any employee stock purchase plan adopted by the General Partner or any similar obligation or arrangement undertaken by the General Partner in the future or for the purpose of retiring such REIT Shares, the purchase price paid by the General Partner for such REIT Shares and any other expenses incurred by the General Partner in connection with such purchase shall be considered expenses of the Partnership and shall be advanced to the General Partner or reimbursed to the General Partner, subject to the condition that: (1) if such REIT Shares subsequently are sold by the General Partner, the General Partner shall pay or cause to be paid to the Partnership any proceeds received by the General Partner for such REIT Shares (which sales proceeds shall include the amount of dividends reinvested under any dividend reinvestment or similar program; provided , that a transfer of REIT Shares for Partnership Units pursuant to Section 8.06 would not be considered a sale for such purposes); and (2) if such REIT Shares are not retransferred by the General Partner within 30 days after the purchase thereof, or the General Partner otherwise determines not to retransfer such REIT Shares, the General Partner shall cause the Partnership to redeem a number of Partnership Units held by the General Partner equal to the number of such REIT Shares, as adjusted (x) pursuant to Section 7.07 (in the event the General Partner acquires material assets, other than on behalf of the Partnership) and (y) for stock dividends and distributions, stock splits and subdivisions, reverse stock splits and combinations, distributions of rights, warrants or options, and distributions of evidences of indebtedness or assets relating to assets not received by the General Partner pursuant to a pro rata distribution by the Partnership (in which case such advancement or reimbursement of expenses shall be treated as having been made as a distribution in redemption of such number of Partnership Units held by the General Partner).
(d) As set forth in Section 4.02 , the General Partner shall be treated as having made a Capital Contribution in the amount of all expenses that it incurs relating to its offering of REIT Shares, Preferred Shares, Junior Shares or New Securities.
(e) If and to the extent any reimbursements to the General Partner pursuant to this Section 7.04 constitute gross income of the General Partner (as opposed to the repayment of advances made by the General Partner on behalf of the Partnership), such amounts shall
constitute guaranteed payments with respect to capital within the meaning of Code Section 707(c), shall be treated consistently therewith by the Partnership and all Partners, and shall not be treated as distributions for purposes of computing the Partners Capital Accounts.
Section 7.05. Outside Activities of the General Partner . Without limiting the other powers granted to the General Partner under this Agreement, the General Partner and its officers, directors, employees, agents, trustees, Affiliates and members 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 that are in direct or indirect competition with the Partnership or that are enhanced by the activities of the Partnership. Neither the Partnership nor any Partner shall have any rights by virtue of this Agreement in any business ventures of the General Partner.
Section 7.06. Contracts with Affiliates .
(a) The Partnership may lend or contribute funds or other assets 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.
(b) The Partnership may transfer assets to joint ventures, limited liability companies, partnerships, corporations, business trusts or other business entities in which it is or thereby becomes a participant upon such terms and subject to such conditions consistent with this Agreement and applicable law as the General Partner, in its sole and absolute discretion, believes to be advisable.
(c) Except as expressly permitted by this Agreement, neither the General Partner nor any of its Affiliates shall sell, transfer or convey any property to the Partnership, directly or indirectly, except pursuant to transactions that are determined by the General Partner in good faith to be fair and reasonable.
(d) The General Partner, in its sole and absolute discretion and without the approval of the Limited Partners, may propose and adopt on behalf of the Partnership employee benefit plans funded by the Partnership for the benefit of employees of the General Partner, the Partnership, Subsidiaries of the Partnership or any Affiliate of any of them in respect of services performed, directly or indirectly, for the benefit of the Partnership or any of the Partnerships Subsidiaries.
(e) The General Partner is expressly authorized to enter into, in the name and on behalf of the Partnership, any Services Agreement with Affiliates of any of the Partnership or the General Partner, on such terms as the General Partner, in its sole and absolute discretion, believes are advisable.
Section 7.07. Indemnification .
(a) To the fullest extent permitted by applicable law, the Partnership shall indemnify each Indemnitee from and against any and all losses, claims, damages, liabilities
(whether joint or several), expenses (including, without limitation, attorneys fees and other 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 ( Actions ) as set forth in this Agreement in which such Indemnitee may be involved, or is threatened to be involved, as a party or otherwise; provided , however , that the Partnership shall not indemnify an Indemnitee (1) for willful misconduct or a knowing violation of the law, (2) for any transaction for which such Indemnitee received an improper personal benefit in violation or breach of any provision of this Agreement, or (3) in the case of any criminal proceeding, the Indemnitee had reasonable cause to believe that the act or omission was unlawful. Without limitation, the foregoing indemnity shall extend to any liability of any Indemnitee, pursuant to a loan guaranty 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 subject to), and the General Partner is hereby authorized and empowered, on behalf of the Partnership, to enter into one or more indemnity agreements consistent with the provisions of this Section 7.07 in favor of any Indemnitee having or potentially having liability for any such indebtedness. 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 7.07(a) . The termination of any proceeding by conviction of an Indemnitee or upon a plea of nolo contendere or its equivalent by an Indemnitee, or an entry of an order of probation against an Indemnitee prior to judgment, does not create a presumption that such Indemnitee acted in a manner contrary to that specified in this Section 7.07(a) with respect to the subject matter of such proceeding. Any indemnification pursuant to this Section 7.07 shall be made only out of the assets of the Partnership and any insurance proceeds from the liability policy covering the General Partner and any Indemnitees, and neither the General Partner nor any Limited Partner shall have any obligation to contribute to the capital of the Partnership or otherwise provide funds to enable the Partnership to fund its obligations under this Section 7.07 .
(b) To the fullest extent permitted by law, expenses incurred by an Indemnitee who is a party to a proceeding or otherwise subject to or the focus of or is involved in any Action shall be paid or reimbursed by the Partnership as incurred by the Indemnitee in advance of the final disposition of the Action upon receipt by the Partnership of (1) a written affirmation by the Indemnitee of the Indemnitees good faith belief that the standard of conduct necessary for indemnification by the Partnership as authorized in this Section 7.07(b) has been met and (2) 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 7.07 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 and shall inure to the benefit of the heirs, successors, assigns and administrators of the Indemnitee unless otherwise provided in a written agreement with such Indemnitee or in the writing pursuant to which such Indemnitee is indemnified.
(d) The Partnership may, but shall not be obligated to, purchase and maintain insurance, on behalf of any 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 Partnerships activities, regardless of whether the Partnership would have the power to indemnify such Person against such liability under the provisions of this Agreement.
(e) Any liabilities which an Indemnitee incurs as a result of acting on behalf of the Partnership or the General Partner (whether as a fiduciary or otherwise) in connection with the operation, administration or maintenance of an employee benefit plan or any related trust or funding mechanism (whether such liabilities are in the form of excise taxes assessed by the IRS, penalties assessed by the Department of Labor, restitutions to such a plan or trust or other funding mechanism or to a participant or beneficiary of such plan, trust or other funding mechanism, or otherwise) shall be treated as liabilities or judgments or fines under this Section 7.07 , unless such liabilities arise as a result of (1) such Indemnitees intentional misconduct or knowing violation of the law, (2) any transaction in which such Indemnitee received a personal benefit in violation or breach of any provision of this Agreement or applicable law, or (3) in the case of any criminal proceeding, the Indemnitee had reasonable cause to believe that the act or omission was unlawful.
(f) In no event may an Indemnitee subject any of the 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 7.07 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 7.07 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. Any amendment, modification or repeal of this Section 7.07 or any provision hereof shall be prospective only and shall not in any way affect the obligations of the Partnership or the limitations on the Partnerships liability to any Indemnitee under this Section 7.07 as in effect immediately prior to such amendment, modification or repeal with respect to claims arising from or relating to matters occurring, in whole or in part, prior to such amendment, modification or repeal, regardless of when such claims may arise or be asserted.
(i) If and to the extent any payments to the General Partner pursuant to this Section 7.07 constitute gross income to the General Partner (as opposed to the repayment of advances made on behalf of the Partnership) such amounts shall be treated as guaranteed payments for the use of capital within the meaning of Code Section 707(c), shall be treated consistently therewith by the Partnership and all Partners, and shall not be treated as distributions for purposes of computing the Partners Capital Accounts.
Section 7.08. Liability of the General Partner .
(a) Notwithstanding anything to the contrary set forth in this Agreement, neither the General Partner or any of its members or officers shall be liable or accountable in damages or otherwise to the Partnership, any Partners or any Assignees for losses sustained,
liabilities incurred or benefits not derived as a result of errors in judgment or mistakes of fact or law or of any act or omission if the General Partner or such member, director or officer acted in good faith.
(b) The Limited Partners expressly acknowledge that the General Partner is acting for the benefit of the Partnership, the Limited Partners and its own stockholders collectively and that the General Partner is under no obligation to give priority to the separate interests of the Limited Partners or its own stockholders (including, without limitation, the tax consequences to Limited Partners, Assignees or its own stockholders) in deciding whether to cause the Partnership to take (or decline to take) any actions. If there is a conflict between the interests of the stockholders of the General Partner on one hand and the Limited Partners on the other, the Limited Partners expressly acknowledge that the General Partner will fulfill its fiduciary duties to such Limited Partners by acting in the best interests of the stockholders of the General Partner. The General Partner shall not be liable under this Agreement to the Partnership or to any Partner 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 7.01(a) hereof, the General Partner may exercise any of the powers granted to it by this Agreement and perform any of the duties imposed upon it hereunder either directly or by or through its employees or agents (subject to the supervision and control of the General Partner). 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) To the extent that, at law or in equity, the General Partner has duties (including fiduciary duties) and liabilities relating thereto to the Partnership or the Limited Partners, the General Partner shall not be liable to the Partnership or to any other Partner for its good faith reliance on the provisions of this Agreement.
(e) Notwithstanding anything herein to the contrary, except for fraud, willful misconduct or gross negligence, or pursuant to any express indemnities given to the Partnership by any Partner pursuant to any other written instrument, no Partner shall have any personal liability whatsoever, to the Partnership or to the other Partner(s), for the debts or liabilities of the Partnership or the Partnerships obligations hereunder, and the full recourse of the other Partner(s) shall be limited to the interest of that Partner in the Partnership. To the fullest extent permitted by law, no officer, or member of the General Partner shall be liable to the Partnership for money damages except for (1) active and deliberate dishonesty established by a nonappealable final judgment or (2) actual receipt of an improper benefit or profit in money, property or services. Without limitation of the foregoing, and except for fraud, willful misconduct or gross negligence, or pursuant to any such express indemnity, no property or assets of any Partner, other than its interest in the Partnership, shall be subject to levy, execution or other enforcement procedures for the satisfaction of any judgment (or other judicial process) in favor of any other Partner(s) and arising out of, or in connection with, this Agreement. This Agreement is executed by the members of the General Partner solely as members of the same and not in their own individual capacities.
(f) Any amendment, modification or repeal of this Section 7.08 or any provision hereof shall be prospective only and shall not in any way affect the limitations on the General Partners, and its officers and members, liability to the Partnership and the Limited Partners under this Section 7.08 as in effect immediately prior to such amendment, modification or repeal with respect to claims arising from or relating to matters occurring, in whole or in part, prior to such amendment, modification or repeal, regardless of when such claims may arise or be asserted.
Section 7.09. Other Matters Concerning the General Partner .
(a) The General Partner may rely and shall be protected in acting or refraining from acting upon any resolution, certificate, statement, instrument, opinion, report, notice, request, consent, order, bond, debenture or other paper or document believed by it in good faith to be genuine and to have been signed or presented by the proper party or parties.
(b) The General Partner may consult with legal counsel, accountants, appraisers, management consultants, investment bankers, architects, engineers, environmental consultants and other consultants and advisers selected by it, and any act taken or omitted to be taken in reliance upon the opinion of such Persons as to matters that the General Partner reasonably believe to be within such Persons professional or expert competence shall be conclusively presumed to have been done or omitted in good faith and in accordance with such opinion.
(c) The General Partner shall have the right, in respect of any of its powers or obligations hereunder, to act through any of its duly authorized officers and a duly appointed attorney or attorneys-in-fact. Each such attorney shall, to the extent provided by the General Partner in the power of attorney, have full power and authority to do and perform all and every act and duty that is permitted or required to be done by the General Partner hereunder.
(d) Notwithstanding any other provision 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 (1) to protect the ability of the General Partner to continue to qualify as a REIT, (2) for the General Partner otherwise to satisfy the REIT Requirements, or (3) to avoid the General Partner incurring any taxes under Code Section 857 or Code Section 4981, is expressly authorized under this Agreement and is deemed approved by all of the Limited Partners.
Section 7.10. 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 with other Partners or Persons, 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. 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.
Section 7.11. 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 the 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 it were the Partnerships sole party in interest, both legally and beneficially. Each Limited Partner hereby waives any and all defenses or other remedies that 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 expediency 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 in good faith thereon or claiming thereunder that (1) at the time of the execution and delivery of such certificate, document or instrument, this Agreement was in full force and effect, (2) 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 (3) 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.
ARTICLE VIII
RIGHTS AND OBLIGATIONS OF LIMITED PARTNERS
Section 8.01. Limitation of Liability . The Limited Partners shall have no liability under this Agreement (other than for breach thereof) except as expressly provided in Section 10.04 , 13.02(d) or under the Act.
Section 8.02. Management of Business . No Limited Partner or Assignee (other than the General Partner, any of its Affiliates or any officer, member, employee, partner, agent or director of the General Partner, the Partnership or any of their Affiliates, in their capacity as such) shall take part in the operations, management or control (within the meaning of the Act) of the Partnerships business, transact any business in the Partnerships name or have the power to sign documents for or otherwise bind the Partnership. The transaction of any such business by the General Partner, any of its Affiliates or any officer, director, member, employee, partner, agent, representative, stockholder or trustee of the General Partner, the Partnership or any of their Affiliates, in their capacity as such, shall not affect, impair or eliminate the limitations on the liability of the Limited Partners or Assignees under this Agreement.
Section 8.03. Outside Activities of Limited Partners . Subject to any agreements entered into pursuant to Section 7.06(e) hereof and any other agreements entered into by a Limited Partner or its Affiliates with the General Partner, the Partnership or any Affiliate thereof
(including, without limitation, any employment agreement), any Limited Partner and any Assignee, officer, director, employee, agent, trustee, Affiliate, member or shareholder of any Limited 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 that are in direct or indirect competition with the Partnership or that are enhanced by the activities of the Partnership. Neither the Partnership nor any Partner shall have any rights by virtue of this Agreement in any business ventures of any Limited Partner or Assignee. Subject to such agreements, 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 business ventures of any other Person (other than the General Partner, to the extent expressly provided herein), and such Person shall have no obligation pursuant to this Agreement, subject to Section 7.06(e) hereof and any other agreements entered into by a Limited Partner or its Affiliates with the General Partner, the Partnership or any Affiliate thereof, to offer any interest in any such business ventures to the Partnership, any Limited Partner or any such other Person, even if such opportunity is of a character that, if presented to the Partnership, any Limited Partner or such other Person, could be taken by such Person.
Section 8.04. Return of Capital . Except pursuant to the rights of Redemption set forth in Section 8.06 hereof, no Limited Partner shall be entitled to the withdrawal or return of its Capital Contribution, except to the extent of distributions made pursuant to this Agreement, upon termination of the Partnership as provided herein or upon a merger of the General Partner or a sale by the General Partner of all or substantially all of its assets pursuant to Section 7.01(a)(iii) hereof. Except to the extent provided in Article VI hereof or otherwise expressly provided in this Agreement, no Limited Partner or Assignee shall have priority over any other Limited Partner or Assignee either as to the return of Capital Contributions or as to profits, losses or distributions.
Section 8.05. Adjustment Factor . The Partnership shall notify any Limited Partner, on request, of the then current Adjustment Factor or any change made to the Adjustment Factor.
Section 8.06. Redemption Rights .
(a) On or after the date specified in any agreement to which OP Units are issued, each Limited Partner shall have the right (subject to the terms and conditions set forth herein and in any other such agreement, as applicable) to cause the Partnership to purchase all or a portion of the OP Units held by such Limited Partner (such OP Units being hereafter referred to as Tendered Units ) in exchange for the Cash Amount (a Redemption ) unless the terms of such OP Units or a separate agreement entered into between the Partnership and the holder of such OP Units provide that such OP Units are not entitled to a right of Redemption. The Tendering Partner shall have no right, with respect to any OP Units so redeemed, to receive any distributions paid on or after the Specified Redemption Date. Any Redemption shall be exercised pursuant to a Notice of Redemption delivered to the General Partner by the Limited Partner who is exercising the right (the Tendering Partner ). The Cash Amount shall be payable to the Tendering Partner on the Specified Redemption Date.
(b) Notwithstanding Section 8.06(a) above, if a Limited Partner has delivered to the General Partner a Notice of Redemption then the General Partner may, in its sole and
absolute discretion, (subject to the limitations on ownership and transfer of REIT Shares set forth in the Charter) elect to assume and satisfy the Partnerships Redemption obligation and acquire some or all of the Tendered Units from the Tendering Partner in exchange for the REIT Shares Amount (as of the Specified Redemption Date) and, if the General Partner so elects, the Tendering Partner shall sell the Tendered Units to the General Partner in exchange for the REIT Shares Amount. In such event, the Tendering Partner shall have no right to cause the Partnership to redeem such Tendered Units. The General Partner shall give such Tendering Partner written notice of its election on or before the close of business on the fifth Business Day after the its receipt of the Notice of Redemption.
(c) The REIT Shares Amount, if applicable, shall be delivered as duly authorized, validly issued, fully paid and nonassessable REIT Shares and, if applicable, free of any pledge, lien, encumbrance or restriction, other than those provided in the Charter or the Bylaws of the General Partner, the Securities Act, relevant state securities or blue sky laws and any applicable registration rights agreement with respect to such REIT Shares entered into by the Tendering Partner. Notwithstanding any delay in such delivery (but subject to Section 8.06(e) ), the Tendering Partner shall be deemed the owner of such REIT Shares for all purposes, including without limitation, rights to vote or consent, and receive dividends, as of the Specified Redemption Date. In addition, the REIT Shares for which the Partnership Units might be exchanged shall also bear such restrictive legends that the General Partner determines are appropriate to mark transfer, ownership or other restrictions and limitations applicable to the REIT Shares.
(d) Each Limited Partner covenants and agrees with the General Partner that all Tendered Units shall be delivered to the General Partner free and clear of all liens, claims and encumbrances whatsoever and should any such liens, claims and/or encumbrances exist or arise with respect to such Tendered Units, the General Partner shall be under no obligation to acquire the same. 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 Tendered Units to the General Partner (or its designee), such Limited Partner shall assume and pay such transfer tax.
(e) Notwithstanding the provisions of Section 8.06(a) , 8.06(b) , 8.06(c) or any other provision of this Agreement, a Limited Partner (i) shall not be entitled to effect a Redemption for cash or an exchange for REIT Shares to the extent the ownership or right to acquire REIT Shares pursuant to such exchange by such Partner on the Specified Redemption Date could cause such Partner or any other Person to violate the restrictions on ownership and transfer of REIT Shares set forth in the Charter of the General Partner and (ii) shall have no rights under this Agreement to acquire REIT Shares which would otherwise be prohibited under the Charter. To the extent any attempted Redemption or exchange for REIT Shares would be in violation of this Section 8.06(e) , it shall be null and void ab initio and such Limited Partner shall not acquire any rights or economic interest in the cash otherwise payable upon such Redemption or the REIT Shares otherwise issuable upon such exchange.
(f) Notwithstanding anything herein to the contrary (but subject to Section 8.06(e) ), with respect to any Redemption or exchange for REIT Shares pursuant to this Section 8.06 : (i) a portion of the OP Units acquired by the General Partner pursuant thereto shall automatically, and without further action required, be converted into and deemed to be General
Partner Interests and all other OP Units shall be deemed to be Limited Partner Interests and held by the General Partner in its capacity as a Limited Partner in the Partnership such that, immediately after such Redemption, the requirements of Section 4.01(b) continue to be met; (ii) without the consent of the General Partner, each Limited Partner may effect a Redemption only one time in each fiscal quarter; (iii) without the consent of the General Partner, each Limited Partner may not effect a Redemption for less than 1,000 OP Units or, if the Limited Partner holds less than 1,000 OP Units, all of the OP Units held by such Limited Partner; (iv) without the consent of the General Partner, each Limited Partner may not effect a Redemption during the period after the Partnership Record Date with respect to a distribution and before the record date established by the General Partner for a distribution to its stockholders of some or all of its portion of such distribution; (v) the consummation of any Redemption or exchange for REIT Shares shall be subject to the expiration or termination of the applicable waiting period, if any, under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended; and (vi) each Tendering Partner shall continue to own all OP Units subject to any Redemption or exchange for REIT Shares, and be treated as a Limited Partner with respect to such OP Units for all purposes of this Agreement, until such OP Units are transferred to the General Partner and paid for or exchanged on the Specified Redemption Date. Until a Specified Redemption Date, the Tendering Partner shall have no rights as a stockholder of the General Partner with respect to such Tendering Partners OP Units.
(g) In the event that the Partnership issues additional Partnership Interests to any Additional Limited Partner pursuant to Section 4.03 , the General Partner shall make such revisions to this Section 8.06 as it determines are necessary to reflect the issuance of such additional Partnership Interests.
ARTICLE IX
BOOKS, RECORDS, ACCOUNTING AND REPORTS
Section 9.01. Records and Accounting .
(a) The General Partner shall keep or cause to be kept at the principal office of the Partnership those records and documents required to be maintained by the Act and other books and records deemed by the General Partner to be appropriate with respect to the Partnerships business, including, without limitation, all books and records necessary to provide to the Limited Partners any information, lists and copies of documents required to be provided pursuant to Section 8.05 or 9.03 hereof. Any records maintained by or on behalf of the Partnership in the regular course of its business may be kept on, or be in the form for, magnetic tape, photographs, micrographics or any other information storage device, provided , that the records so maintained are convertible into clearly legible written form within a reasonable period of time. The books of the Partnership shall be maintained, for financial and tax reporting purposes, on an accrual basis in accordance with generally accepted accounting principles.
(b) The books of the Partnership shall be maintained, for financial reporting purposes, on an accrual basis in accordance with generally accepted accounting principles, or on such other basis as the General Partner determines to be necessary or appropriate. To the extent permitted by sound accounting practices and principles, the Partnership and the General Partner
may operate with integrated or consolidated accounting records, operations and principles. The Partnership also shall maintain its tax books on the accrual basis.
Section 9.02. Partnership Year . The Partnership Year of the Partnership shall be the calendar year.
Section 9.03. Reports .
(a) As soon as practicable, but in no event later than the date on which the General Partner mails its annual report to its stockholders, the General Partner shall cause to be mailed to each Limited Partner an annual report, as of the close of the most recently ended Partnership Year, containing financial statements of the Partnership, or of the General Partner if such statements are prepared solely on a consolidated basis with the Partnership, for such Partnership Year, presented in accordance with generally accepted accounting principles, such statements to be audited by a nationally recognized firm of independent public accountants selected by the General Partner.
(b) If and to the extent that the General Partner mails quarterly reports to its stockholders, as soon as practicable, but in no event later than the date on such reports are mailed, the General Partner shall cause to be mailed to each Limited Partner a report containing unaudited financial statements, as of the last day of such fiscal quarter, of the Partnership, or of the General Partner if such statements are prepared solely on a consolidated basis with the Partnership, and such other information as may be required by applicable law or regulations, or as the General Partner determines to be appropriate.
(c) The General Partner shall have satisfied its obligations under Section 9.03(a) and 9.03(b) hereof by posting or making available the reports required by this Section 9.03 on the website maintained from time to time by the Partnership provided that such reports are able to be printed or downloaded from such website.
(d) At the request of any Limited Partner, the General Partner shall provide access to the books, records and work paper upon which the reports required by this Section 9.03 are based, to the extent required by the Act.
ARTICLE X
TAX MATTERS
Section 10.01. Preparation of Tax Returns . The General Partner shall arrange for the preparation and timely filing of all returns with respect to Partnership income, gains, deductions, losses and other items required of the Partnership for federal and state income tax purposes and shall use all reasonable effort to furnish, within 90 days of the close of each taxable year, the tax information reasonably required by Limited Partners for federal and state income tax reporting purposes. The Limited Partners shall promptly provide the General Partner with such information relating to the Contributed Properties, including tax basis and other relevant information, as may be reasonably requested by the General Partner from time to time.
Section 10.02. Tax Elections . Except as otherwise provided herein, the General Partner shall, in its sole and absolute discretion, determine whether to make any available election pursuant to the Code, including, but not limited to, the election under Code Section 754 and the election to use the recurring item method of accounting provided under Code Section 461(h) with respect to property taxes imposed on the Partnerships Properties. The General Partner shall have the right to seek to revoke any such election (including, without limitation, any election under Code Sections 461(h) and 754) upon the General Partners determination in its sole and absolute discretion that such revocation is in the best interests of the Partners.
Section 10.03. Tax Matters Partner .
(a) The General Partner shall be the tax matters partner of the Partnership for federal income tax purposes. The tax matters partner shall receive no compensation for its services. All third-party costs and expenses incurred by the tax matters partner in performing its duties as such (including legal and accounting fees and expenses) shall be borne by the Partnership in addition to any reimbursement pursuant to Section 7.04 hereof. Nothing herein shall be construed to restrict the Partnership from engaging an accounting firm to assist the tax matters partner in discharging its duties hereunder, so long as the compensation paid by the Partnership for such services is reasonable.
(b) The tax matters partner is authorized, but not required:
(i) to enter into any settlement with the IRS with respect to any administrative or judicial proceedings for the adjustment of Partnership items required to be taken into account by a Partner for income tax purposes (such administrative proceedings being referred to as a tax audit and such judicial proceedings being referred to as judicial review), and in the settlement agreement the tax matters partner may expressly state that such agreement shall bind all Partners;
(ii) in the event that a notice of a final administrative adjustment at the Partnership level of any item required to be taken into account by a Partner for tax purposes (a final adjustment ) is mailed to the tax matters partner, to seek judicial review of such final adjustment, including the filing of a petition for readjustment with the United States Tax Court or the United States Claims Court, or the filing of a complaint for refund with the District Court of the United States for the district in which the Partnerships principal place of business is located;
(iii) to intervene in any action brought by any other Partner for judicial review of a final adjustment;
(iv) to file a request for an administrative adjustment with the IRS at any time and, if any part of such request is not allowed by the IRS, to file an appropriate pleading (petition or complaint) for judicial review with respect to such request;
(v) to enter into an agreement with the IRS to extend the period for assessing any tax that is attributable to any item required to be taken into account by a Partner for tax purposes, or an item affected by such item; and
(vi) to take any other action on behalf of the Partners in connection with any tax audit or judicial review proceeding to the extent permitted by applicable law or regulations.
The taking of any action and the incurring of any expense by the tax matters partner in connection with any such proceeding, except to the extent required by law, is a matter in the sole and absolute discretion of the tax matters partner and the provisions relating to indemnification of the General Partner set forth in Section 7.07 hereof shall be fully applicable to the tax matters partner in its capacity as such.
Section 10.04. 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 Code Sections 1441, 1442, 1445 or 1446 and Treasury Regulations thereunder. Any amount paid on behalf of or with respect to a Limited Partner, in excess of any withheld amounts shall constitute a loan by the Partnership to such Limited Partner, which loan shall be repaid by such Limited Partner within 15 days after notice from the General Partner that such payment must be made unless (i) the Partnership withholds such payment from a distribution that would otherwise be made to the Limited Partner or (ii) the General Partner determines, in its sole and absolute discretion, that such payment may be satisfied out of the Available Cash of the Partnership that would, but for such payment, be distributed to the Limited Partner. Each Limited Partner hereby unconditionally and irrevocably grants to the Partnership a security interest in such Limited Partners Partnership Interest to secure such Limited Partners obligation to pay to the Partnership any amounts required to be paid pursuant to this Section 10.04 . In the event that a Limited Partner fails to pay any amounts owed to the Partnership pursuant to this Section 10.04 when due, the General Partner may, in its sole and absolute discretion, elect to make the payment to the Partnership on behalf of such defaulting Limited Partner, and in such event shall be deemed to have loaned such amount to such defaulting Limited Partner and shall succeed to all rights and remedies of the Partnership as against such defaulting Limited Partner (including, without limitation, the right to receive distributions). Any amounts payable by a Limited Partner hereunder shall bear interest at 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 four percentage points (but not higher than the maximum lawful rate) from the date such amount is due ( i.e ., 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.
Section 10.05. Organizational Expenses . The Partnership shall elect to amortize expenses, if any, incurred by it in organizing the Partnership ratably over a 180-month period as provided in Code Section 709.
ARTICLE XI
TRANSFERS AND WITHDRAWALS
Section 11.01. Transfer .
(a) No part of the interest of a Partner shall be subject to the claims of any creditor, to any spouse for alimony or support, or to legal process, and may not be voluntarily or involuntarily alienated or encumbered except as may be specifically provided for in this Agreement.
(b) No Partnership Interest shall be Transferred, in whole or in part, except in accordance with the terms and conditions set forth in this Article XI . Any Transfer or purported Transfer of a Partnership Interest not made in accordance with this Article XI shall be null and void ab initio unless consented to by the General Partner in its sole and absolute discretion.
(c) No Transfer of any Partnership Interest may be made to a lender to the Partnership or any Person who is related (within the meaning of Section 1.752-4(b) of the Regulations) to any lender to the Partnership whose loan constitutes a Nonrecourse Liability, without the consent of the General Partner in its sole and absolute discretion; provided , that as a condition to such consent, the lender will be required to enter into an arrangement with the Partnership and the General Partner to redeem or exchange for REIT Shares any Partnership Units in which a security interest is held by such lender concurrently with such time as such lender would be deemed to be a partner in the Partnership for purposes of allocating liabilities to such lender under Code Section 752.
Section 11.02. Transfer of General Partners Partnership Interest .
(a) The General Partner may not transfer any of its Partnership Interests except in connection with (i) a transaction permitted under Section 11.02(b) , (ii) any merger (including a triangular merger), consolidation or other combination with or into another Person following the consummation of which the equity holders of the surviving entity are substantially identical to the members of the General Partner, (iii) a transfer to a Qualified REIT Subsidiary or (iv) as otherwise expressly permitted under this Agreement, nor shall the General Partner withdraw as General Partner except in connection with a transaction permitted under Section 11.02(b) or any merger, consolidation, or other combination permitted under clause (ii) of this Section 11.02(a) .
(b) The General Partner shall not engage in any merger (including, without limitation, a triangular merger), consolidation or other combination with or into another Person (other than any transaction permitted by Section 11.02(a) ), sale of all or substantially all of its assets or any reclassification, 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 as described in the definition of Adjustment Factor) ( Termination Transaction ), unless (i) following such merger or other consolidation, substantially all of the assets of the surviving entity consist of Partnership Units or (ii) in connection with which all Partners (other than the General Partner) who hold Partnership Units either will receive, or will
have the right to receive, for each Partnership Unit an amount of cash, REIT Shares or other securities having a fair market or net asset value, as the case may be, equal to the net asset value of the Partnership Units being converted as of the month end period immediately prior to such conversion; provided , however , that , if in connection with the Termination Transaction, a purchase, tender or exchange offer shall have been made to and accepted by the holders of the percentage required for the approval of mergers under the organizational documents of the General Partner, each holder of Partnership Units shall receive, or shall have the right to receive without any right of Consent set forth above in this Section 11.02(b) , the amount of cash, REIT Shares or other securities which such holder would have received had it exercised the Redemption Right and received REIT Shares in exchange for its Partnership Units immediately prior to the expiration of such purchase, tender or exchange offer and had thereupon accepted such purchase, tender or exchange offer.
(c) The General Partner shall not enter into an agreement or other arrangement providing for or facilitating the creation of a General Partner other than the General Partner, unless the successor General Partner executes and delivers a counterpart to this Agreement in which such General Partner agrees to be fully bound by all of the terms and conditions contained herein that are applicable to a General Partner.
Section 11.03. Transfer of Limited Partners Partnership Interests .
(a) No Limited Partner shall Transfer all or any portion of its Partnership Interest to any transferee without the written consent of the General Partner, which consent may be withheld in its sole and absolute discretion.
(b) Without limiting the generality of Section 11.03(a) hereof, it is expressly understood and agreed that the General Partner will not consent to any Transfer of all or any portion of any Partnership Interest pursuant to Section 11.03(a) above unless such Transfer meets each of the following conditions:
(i) The transferee in such Transfer assumes by operation of law or express agreement all of the obligations of the transferor Limited Partner under this Agreement with respect to such Transferred Partnership Interest; provided , that no such Transfer (unless made pursuant to a statutory merger or consolidation wherein all obligations and liabilities of the transferor Partner are assumed by a successor corporation by operation of law) shall relieve the transferor Partner of its obligations under this Agreement without the approval of the General Partner, in its sole and absolute discretion. Notwithstanding the foregoing, any transferee of any Transferred Partnership Interest shall be subject to any and all ownership limitations contained in the Charter that may limit or restrict such transferees ability to exercise its Redemption rights, including, without limitation, the Ownership Limit. Any transferee, whether or not admitted as a Substituted Limited Partner, shall take subject to the obligations of the transferor hereunder. Unless admitted as a Substituted Limited Partner, no transferee, whether by a voluntary Transfer, by operation of law or otherwise, shall have any rights hereunder, other than the rights of an Assignee as provided in Section 11.05 hereof.
(ii) Such Transfer is effective as of the first day of a fiscal quarter of the Partnership.
(c) If a Limited Partner is subject to Incapacity, the executor, administrator, trustee, committee, guardian, conservator or receiver of such Limited Partners estate shall have all the rights of a Limited Partner, but not more rights than those enjoyed by other Limited Partners, for the purpose of settling or managing the estate, and such power as the Incapacitated Limited Partner possessed to Transfer all or any part of its interest in the Partnership. The Incapacity of a Limited Partner, in and of itself, shall not dissolve or terminate the Partnership.
(d) In connection with any proposed Transfer of a Limited Partner Interest, the General Partner shall have the right to receive an opinion of counsel reasonably satisfactory to it to the effect that the proposed Transfer may be effected without registration under the Securities Act and will not otherwise violate any federal or state securities laws or regulations applicable to the Partnership or the Partnership Interests Transferred.
(e) No Transfer by a Limited Partner of its Partnership Interests (including any Redemption, any other acquisition of Partnership Units by the Partnership or the General Partner) may be made to or by any person, without the consent of the General Partner in its sole discretion, if (i) in the opinion of legal counsel for the Partnership, there is a significant risk that it would result in the Partnership being treated as an association taxable as a corporation or would result in a termination of the Partnership under Code Section 708, (ii) such Transfer would be effectuated through an established securities market or a secondary market (or the substantial equivalent thereof) within the meaning of Code Section 7704, (iii) such Transfer would result in the Partnership being unable to qualify for one or more of the safe harbors set forth in Regulations Section 1.7704-1 (or such other guidance subsequently published by the IRS setting forth safe harbors under which interests will not be treated as readily tradable on a secondary market (or the substantial equivalent thereof) within the meaning of Section 7704 of the Code) (the Safe Harbors ) or (iv) in the opinion of legal counsel for the Partnership, there is a risk that such transfer would adversely affect the ability of the General Partner to continue to qualify as a REIT or subject the General Partner to any additional taxes under Code Section 857 or Code Section 4981.
Section 11.04. Substituted Limited Partners .
(a) A transferee of the interest of a Limited Partner pursuant to a Transfer consented to by the General Partner pursuant to Section 11.03(a) may be admitted as a Substituted Limited Partner only with the consent of the General Partner, which consent may be given or withheld by the General Partner in its sole and absolute discretion. The failure or refusal by the General Partner to permit a transferee of any such interests to become a Substituted Limited Partner shall not give rise to any cause of action against the Partnership or the General Partner. Subject to the foregoing, an Assignee shall not be admitted as a Substituted Limited Partner until and unless it furnishes to the General Partner (i) evidence of acceptance, in form and substance satisfactory to the General Partner, of all the terms, conditions and applicable obligations of this Agreement, (ii) a counterpart signature page to this Agreement executed by such Assignee, and (iii) such other documents and instruments as may be required or advisable, in the sole and absolute discretion of the General Partner, to effect such Assignees admission as a Substituted Limited Partner.
(b) A transferee who has been admitted as a Substituted Limited Partner in accordance with this Article XI shall have all the rights and powers and be subject to all the restrictions and liabilities of a Limited Partner under this Agreement.
(c) Upon the admission of a Substituted Limited Partner, the General Partner shall amend Exhibit A to reflect the name, address and number of Partnership Units of such Substituted Limited Partner and to eliminate or adjust, if necessary, the name, address and number of Partnership Units of the predecessor of such Substituted Limited Partner.
Section 11.05. Assignees . If the General Partner, in its sole and absolute discretion, does not consent to the admission of any transferee of any Partnership Interest as a Substituted Limited Partner in connection with a transfer permitted by the General Partner pursuant to Section 11.03(a) , such transferee shall be considered an Assignee for purposes of this Agreement. An Assignee shall be entitled to all the rights of an assignee of a limited partnership interest under the Act, including the right to receive distributions from the Partnership and the share of Net Income, Net Losses and other items of income, gain, loss, deduction and credit of the Partnership attributable to the Partnership Units assigned to such transferee and the rights to Transfer the Partnership Units only in accordance with the provisions of this Article XI , but shall not be deemed to be a holder of Partnership Units for any other purpose under this Agreement, and shall not be entitled to effect a Consent or vote or effect a Redemption with respect to such Partnership Units on any matter presented to the Limited Partners for approval (such right to Consent or vote or effect a Redemption, to the extent provided in this Agreement or under the Act, fully remaining with the transferor Limited Partner). In the event that any such transferee desires to make a further assignment of any such Partnership Units, such transferee shall be subject to all the provisions of this Article XI to the same extent and in the same manner as any Limited Partner desiring to make an assignment of Partnership Units.
Section 11.06. General Provisions .
(a) No Limited Partner may withdraw from the Partnership other than as a result of a permitted Transfer of all of such Limited Partners Partnership Units in accordance with this Article XI , with respect to which the transferee becomes a Substituted Limited Partner, or pursuant to a redemption (or acquisition by the General Partner) of all of its Partnership Units pursuant to a Redemption under Section 8.06 hereof and/or pursuant to any Partnership Unit Designation.
(b) Any Limited Partner who shall Transfer all of its Partnership Units in a Transfer (i) consented to by the General Partner pursuant to this Article XI where such transferee was admitted as a Substituted Limited Partner, (ii) pursuant to the exercise of its rights to effect a redemption of all of its Partnership Units pursuant to a Redemption under Section 8.06 hereof and/or pursuant to any Partnership Unit Designation, or (iii) to the General Partner, whether or not pursuant to Section 8.06(b) hereof, shall cease to be a Limited Partner.
(c) If any Partnership Unit is Transferred in compliance with the provisions of this Article XI , or is redeemed by the Partnership, or acquired by the General Partner pursuant to Section 8.06 hereof, on any day other than the first day of a Partnership Year, then Net Income, Net Losses, each item thereof and all other items of income, gain, loss, deduction and credit
attributable to such Partnership Unit for such Partnership Year shall be allocated to the transferor Partner or the Tendering Party, as the case may be, and, in the case of a Transfer or assignment other than a Redemption, to the transferee Partner, by taking into account their varying interests during the Partnership Year in accordance with Code Section 706(d) and the corresponding Regulations, using the interim closing of the books method or another permissible method selected by the General Partner (unless the General Partner in its sole and absolute discretion elects to adopt a daily, weekly or monthly proration period, in which case Net Income or Net Loss shall be allocated based upon the applicable method selected by the General Partner). All distributions of Available Cash attributable to such Partnership Unit with respect to which the Partnership Record Date is before the date of such Transfer, assignment or Redemption shall be made to the transferor Partner or the Tendering Party, as the case may be, and, in the case of a Transfer other than a Redemption, all distributions of Available Cash thereafter attributable to such Partnership Unit shall be made to the transferee Partner.
(d) In no event may any Transfer or assignment of a Partnership Interest by any Partner (including any Redemption, any acquisition of Partnership Units by the General Partner or any other acquisition of Partnership Units by the Partnership) be made (i) to any person or entity who lacks the legal right, power or capacity to own a Partnership Interest; (ii) in violation of applicable law; (iii) of any component portion of a Partnership Interest, such as the Capital Account, or rights to distributions, separate and apart from all other components of a Partnership Interest; (iv) in the event that such Transfer would cause the General Partner to cease to comply with the REIT Requirements; (v) except with the consent of the General Partner, if such Transfer, in the opinion of counsel to the Partnership or the General Partner, would create a significant risk that such transfer would cause a termination of the Partnership for federal or state income tax purposes; (vi) if such Transfer would, in the opinion of legal counsel to the Partnership, cause the Partnership to cease to be classified as a partnership for federal income tax purposes (except as a result of the Redemption (or acquisition by the General Partner) of all Partnership Units held by all Limited Partners); (vii) if 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 ERISA Section 3(14)) or a disqualified person (as defined in Code Section 4975(c)); (viii) without the consent of the General Partner, to any benefit plan investor within the meaning of Department of Labor Regulations Section 2510.3-101(f); (ix) if such Transfer would, in the opinion of legal counsel to the Partnership or the General Partner, cause any portion of the assets of the Partnership to constitute assets of any employee benefit plan pursuant to Department of Labor Regulations Section 2510.3-101; (x) if such Transfer requires the registration of such Partnership Interest pursuant to any applicable federal or state securities laws; (xi) except with the consent of the General Partner, if such transfer would be effectuated through an established securities market or a secondary market (or the substantial equivalent thereof) within the meaning of Code Section 7704, could cause the Partnership to become a publicly traded partnership as such term is defined in Sections 469(k)(2) or 7704(b) of the Code, or could cause the Partnership to fail one or more of the Safe Harbors; (xii) if such Transfer causes the Partnership (as opposed to the General Partner) to become a reporting company under the Exchange Act; or (xiii) if such Transfer subjects the Partnership to regulation under the Investment Company Act of 1940, the Investment Advisors Act of 1940 or ERISA, each as amended.
ARTICLE XII
ADMISSION OF PARTNERS
Section 12.01. Admission of Successor General Partner . A successor to all of the General Partners General Partner Interest pursuant to Section 11.02 hereof who is proposed to be admitted as a successor General Partner shall be admitted to the Partnership as the General Partner, effective immediately prior to such Transfer. Any such successor shall carry on the business of the Partnership without dissolution. In each case, the admission shall be subject to the successor General Partner executing and delivering to the Partnership an acceptance of all of the terms and conditions of this Agreement and such other documents or instruments as may be required to effect the admission. Concurrently with, and as evidence of, the admission of an Additional Limited Partner, the General Partner shall amend Exhibit A and the books and records of the Partnership to reflect the name, address and number of Partnership Units of such Additional Limited Partner.
Section 12.02. Admission of Additional Limited Partners .
(a) After the date hereof, a Person (other than an existing Partner) who makes a Capital Contribution to the Partnership in accordance with this Agreement shall be admitted to the Partnership as an Additional Limited Partner only upon furnishing to the General Partner (i) evidence of acceptance, in form and substance satisfactory to the General Partner, of all of the terms and conditions of this Agreement, including, without limitation, the power of attorney granted in Section 2.04 hereof, (ii) a counterpart signature page to this Agreement executed by such Person, and (iii) such other documents or instruments as may be required in the sole and absolute discretion of the General Partner in order to effect such Persons admission as an Additional Limited Partner and the satisfaction of all the conditions set forth in this Section 12.02.
(b) Notwithstanding anything to the contrary in this Section 12.02 , no Person shall be admitted as an Additional Limited Partner without the consent of the General Partner, which consent may be given or withheld in the General Partners sole and absolute discretion. The admission of any Person as an Additional Limited Partner shall become effective on the date upon which the name of such Person is recorded on the books and records of the Partnership, following the consent of the General Partner to such admission.
(c) If any Additional Limited Partner is admitted to the Partnership on any day other than the first day of a Partnership Year, then Net Income, Net Losses, each item thereof and all other items of income, gain, loss, deduction and credit allocable among Partners and Assignees for such Partnership Year shall be allocated pro rata among such Additional Limited Partner and all other Partners and Assignees by taking into account their varying interests during the Partnership Year in accordance with Code Section 706(d), using the interim closing of the books method or another permissible method selected by the General Partner. Solely for purposes of making such allocations, each of such items for the calendar month in which an admission of any Additional Limited Partner occurs shall be allocated among all the Partners and Assignees including such Additional Limited Partner, in accordance with the principles described in Section 11.06(c) hereof. All distributions of Available Cash with respect
to which the Partnership Record Date is before the date of such admission shall be made solely to Partners and Assignees other than the Additional Limited Partner, and all distributions of Available Cash thereafter shall be made to all the Partners and Assignees including such Additional Limited Partner.
Section 12.03. Amendment of Agreement and Certificate of Limited Partnership . For the admission to the Partnership of any Partner, the General Partner shall take all steps necessary and appropriate under the Act to amend the records of the Partnership and, if necessary, to prepare as soon as practical an amendment of this Agreement (including an amendment of Exhibit A ) and, if required by law, shall prepare and file an amendment to the Certificate and may for this purpose exercise the power of attorney granted pursuant to Section 2.04 hereof.
Section 12.04. Limit on Number of Partners . Unless otherwise permitted by the General Partner, no Person shall be admitted to the Partnership as an Additional Limited Partner if the effect of such admission would be to cause the Partnership to have a number of Partners that would cause the Partnership to become a reporting company under the Exchange Act.
Section 12.05. Admission . A Person shall be admitted to the Partnership as a Limited Partner of the Partnership only upon strict compliance, and not upon substantial compliance, with the requirements set forth in this Agreement for admission to the Partnership as an Additional Limited Partner.
ARTICLE XIII
DISSOLUTION, LIQUIDATION AND TERMINATION
Section 13.01. Dissolution . The Partnership shall not be dissolved by the admission of Additional Limited Partners or by the admission of a successor General Partner in accordance with the terms of this Agreement. Upon the withdrawal of the General Partner, any successor General Partner shall continue the business of the Partnership without dissolution. However, the Partnership shall dissolve, and its affairs shall be wound up, upon the first to occur of any of the following (each a Liquidating Event ):
(a) a final and nonappealable judgment is entered by a court of competent jurisdiction ruling that the General Partner is bankrupt or insolvent, or a final and nonappealable order for relief is entered by a court with appropriate jurisdiction against the General Partner, in each case under any federal or state bankruptcy or insolvency laws as now or hereafter in effect, unless, prior to the entry of such order or judgment, a Majority in Interest of the remaining Outside Limited Partners agree in writing, in their sole and absolute discretion, to continue the business of the Partnership and to the appointment, effective as of a date prior to the date of such order or judgment, of a successor General Partner;
(b) an election to dissolve the Partnership made by the General Partner in its sole and absolute discretion, with or without the Consent of a Majority in Interest of the Outside Limited Partners, including in the event that an initial public offering of REIT Shares is not completed by the first anniversary of August 3, 2011, taking into account market conditions at such time;
(c) entry of a decree of judicial dissolution of the Partnership pursuant to the provisions of the Act;
(d) the occurrence of a Terminating Capital Transaction;
(e) the Redemption (or acquisition by the General Partner) of all Partnership Units other than Partnership Units held by the General Partner; or
(f) the Incapacity or withdrawal of the General Partner, unless all of the remaining Partners in their sole and absolute discretion agree in writing to continue the business of the Partnership and to the appointment, effective as of a date prior to the date of such Incapacity, of a substitute General Partner.
Section 13.02. Winding Up .
(a) Upon the occurrence of a Liquidating Event, the Partnership shall continue solely for the purposes of winding up its affairs in an orderly manner, liquidating its assets and satisfying the claims of its creditors and Partners. After the occurrence of a Liquidating Event, no Partner shall take any action that is inconsistent with, or not necessary to or appropriate for, the winding up of the Partnerships business and affairs. The General Partner or, in the event that there is no remaining General Partner or the General Partner has dissolved, become bankrupt within the meaning of the Act or ceased to operate, any Person elected by a Majority in Interest of the Outside Limited Partners (the General Partner or such other Person being referred to herein as the Liquidator ) shall be responsible for overseeing the winding up and dissolution of the Partnership and shall take full account of the Partnerships liabilities and property, and the Partnership property shall be liquidated as promptly as is consistent with obtaining the fair value thereof, and the proceeds therefrom (which may, to the extent determined by the General Partner, include shares of stock in the General Partner) shall be applied and distributed in the following order:
(i) First, to the satisfaction of all of the Partnerships Debts and liabilities to creditors other than the Partners and their Assignees (whether by payment or the making of reasonable provision for payment thereof);
(ii) Second, to the satisfaction of all of the Partnerships Debts and liabilities to the General Partner (whether by payment or the making of reasonable provision for payment thereof), including, but not limited to, amounts due as reimbursements under Section 7.04 hereof;
(iii) Third, to the satisfaction of all of the Partnerships Debts and liabilities to the other Partners and any Assignees (whether by payment or the making of reasonable provision for payment thereof); and
(iv) The balance, if any, to the Partners in accordance with Section 5.01.
The General Partner shall not receive any additional compensation for any services performed pursuant to this Article XIII .
(b) Notwithstanding the provisions of Section 13.02(a) hereof that require liquidation of the assets of the Partnership, but subject to the order of priorities set forth therein, if prior to or upon dissolution of the Partnership the Liquidator determines that an immediate sale of part or all of the Partnerships assets would be impractical or would cause undue loss to the Partners, the Liquidator may, in its sole and absolute discretion, defer for a reasonable time the liquidation of any assets except those necessary to satisfy liabilities of the Partnership (including to those Partners as creditors) and/or distribute to the Partners, in lieu of cash, as tenants in common and in accordance with the provisions of Section 13.02(a) hereof, undivided interests in such Partnership assets as the Liquidator deems not suitable for liquidation. Any such distributions in kind shall be made only if, in the good faith judgment of the Liquidator, such distributions in kind are in the best interest of the Partners, and shall be subject to such conditions relating to the disposition and management of such properties as the Liquidator deems reasonable and equitable and to any agreements governing the operation of such properties at such time. The Liquidator shall determine the fair market value of any property distributed in kind using such reasonable method of valuation as it may adopt.
(c) In the event that the Partnership is liquidated within the meaning of Regulations Section 1.704-1(b)(2)(ii)(g), distributions shall be made pursuant to this Article XIII to the Partners and Assignees that have positive Capital Accounts in compliance with Regulations Section 1.704-1(b)(2)(ii)(b)(2) to the extent of, and in proportion to, positive Capital Account balances. If any Partner has a deficit balance in its Capital Account (after giving effect to all contributions, distributions and allocations for all taxable years, including the year during which such liquidation occurs) (a Capital Account Deficit ), such Partner shall not be required to make any contribution to the capital of the Partnership with respect to such Capital Account Deficit and such Capital Account Deficit shall not be considered a debt owed to the Partnership or any other person for any purpose whatsoever.
(d) Notwithstanding the foregoing, (i) if the General Partner has a Capital Account Deficit, the General Partner shall contribute to the capital of the Partnership the amount necessary to restore such Capital Account Deficit balance to zero; and (ii) the second sentence of Section 13.02(c) shall not apply with respect to any other Partner to the extent, but only to the extent, that such Partner previously has agreed in writing, with the consent of the General Partner, to undertake an express obligation to restore all or any portion of a deficit that may exist in its Capital Account upon a liquidation of the Partnership.
(e) In the sole and absolute discretion of the General Partner or the Liquidator, a pro rata portion of the distributions that would otherwise be made to the Partners pursuant to this Article XIII may be:
(i) distributed to a trust established for the benefit of the General Partner and the Limited Partners for the purpose of liquidating Partnership assets, collecting amounts owed to the Partnership, and paying any contingent or unforeseen liabilities or obligations of the Partnership or of the General Partner arising out of or in connection with the Partnership and/or Partnership activities. The assets of any such trust shall be distributed to the General Partner and the Limited Partners, from time to time, in the reasonable discretion of the General Partner or the Liquidator, in the same proportions and amounts as would otherwise have been distributed to the General Partner and the Limited Partners pursuant to this Agreement; or
(ii) withheld or escrowed to provide a reasonable reserve for Partnership liabilities (contingent or otherwise) and to reflect the unrealized portion of any installment obligations owed to the Partnership, provided , that such withheld or escrowed amounts shall be distributed to the General Partner and Limited Partners in the manner and order of priority set forth in Section 13.02(a) hereof as soon as practicable.
Section 13.03. Deemed Distribution and Recontribution . Notwithstanding any other provision of this Article XIII , in the event that the Partnership is liquidated within the meaning of Regulations Section 1.704-1(b)(2)(ii)(g), but no Liquidating Event has occurred, the Partnerships Property shall not be liquidated, the Partnerships liabilities shall not be paid or discharged and the Partnerships affairs shall not be wound up. Instead, for federal income tax purposes the Partnership shall be deemed to have contributed all of its assets and liabilities to a new partnership in exchange for an interest in the new partnership; and, immediately thereafter, distributed interests in the new partnership to the Partners in accordance with their respective Capital Accounts in liquidation of the Partnership, and the new partnership is deemed to continue the business of the Partnership. Nothing in this Section 13.03 shall be deemed to have constituted any Assignee as a Substituted Limited Partner without compliance with the provisions of Section 11.04 hereof.
Section 13.04. Rights of Limited Partners . Except as otherwise provided in this Agreement, (a) each Limited Partner shall look solely to the assets of the Partnership for the return of its Capital Contribution, (b) no Limited Partner shall have the right or power to demand or receive property other than cash from the Partnership, and (c) no Limited Partner (other than any Limited Partner who holds Preferred Units, to the extent specifically set forth herein and in the applicable Partnership Unit Designation) shall have priority over any other Limited Partner as to the return of its Capital Contributions, distributions or allocations.
Section 13.05. Notice of Dissolution . In the event that a Liquidating Event occurs or an event occurs that would, but for an election or objection by one or more Partners pursuant to Section 13.01 hereof, result in a dissolution of the Partnership, the General Partner shall, within 30 days thereafter, provide written notice thereof to each of the Partners and, in the General Partners sole and absolute discretion or as required by the Act, to all other parties with whom the Partnership regularly conducts business (as determined in the sole and absolute discretion of the General Partner), and the General Partner may, or, if required by the Act, shall, publish notice thereof in a newspaper of general circulation in each place in which the Partnership regularly conducts business (as determined in the sole and absolute discretion of the General Partner).
Section 13.06. Cancellation of Certificate of Limited Partnership . Upon the completion of the liquidation of the Partnership cash and property as provided in Section 13.02 hereof, the Partnership shall be terminated, a certificate of cancellation shall be filed with the State of Delaware, all qualifications of the Partnership as a foreign limited partnership or association in jurisdictions other than the State of Delaware shall be cancelled, and such other actions as may be necessary to terminate the Partnership shall be taken.
Section 13.07. Reasonable Time for Winding-Up . A reasonable time shall be allowed for the orderly winding-up of the business and affairs of the Partnership and the liquidation of its assets pursuant to Section 13.02 hereof, in order to minimize any losses otherwise attendant
upon such winding-up, and the provisions of this Agreement shall remain in effect between the Partners during the period of liquidation.
ARTICLE XIV
PROCEDURES FOR ACTIONS AND CONSENTS
OF PARTNERS; AMENDMENTS; MEETINGS
Section 14.01. Procedures for Actions and Consents of Partners . The actions requiring consent or approval of Limited Partners pursuant to this Agreement, including Section 7.03 hereof, or otherwise pursuant to applicable law, are subject to the procedures set forth in this Article XIV .
Section 14.02. Amendments . No amendment to this Agreement may be made without the consent of the General Partner. The General Partner may amend this Agreement in any respect without the consent of the Limited Partners.
Section 14.03. 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 a Majority in Interest of the Outside Limited Partners. 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 seven days nor more than 30 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 Partners is permitted or required under this Agreement, such vote or Consent may be given at a meeting of Partners or may be given in accordance with the procedure prescribed in Section 14.03(b) hereof.
(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 for the action in question). Such approvals may be obtained by the General Partner by means of written notice to the Limited Partners requiring them to respond in the negative by a specified time, or to be deemed to have approved of the proposed action. 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 it 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 Partner or its attorney-in-fact. No proxy shall be valid after the expiration of 11 months from the date thereof unless otherwise provided in the proxy (or there is receipt of a proxy authorizing a later date). Every proxy shall be revocable at the pleasure of the Limited Partner executing it, such revocation to be effective upon the Partnerships receipt of written
notice of such revocation from the Limited Partner executing such proxy. The use of proxies will be governed in the same manner as in the case of corporations organized under the Delaware General Corporation Law (including Section 212 thereof).
(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 and absolute discretion. Without limitation, meetings of Partners may be conducted in the same manner as meetings of the General Partners stockholders and may be held at the same time as, and as part of, the meetings of the General Partners stockholders.
(e) On matters on which Limited Partners are entitled to vote, each Limited Partner holding OP Units shall have a vote equal to the number of OP Units held.
(f) Except as otherwise expressly provided in this Agreement, the Consent of Holders of Partnership Interests representing a majority of the Partnership Interests of the Limited Partners shall control.
ARTICLE XV
GENERAL PROVISIONS
Section 15.01. Addresses and Notice . Any notice, demand, request or report required or permitted to be given or made to a Partner or Assignee under this Agreement shall be in writing and shall be deemed given or made when delivered in person or when sent by first class United States mail or by other means of written communication (including by telecopy, facsimile, or commercial courier service) to the Partner or Assignee at the address set forth in Exhibit A or such other address of which the Partner shall notify the General Partner in writing.
Section 15.02. Titles and Captions . All article or section titles or captions in this Agreement are for convenience only. They shall not be deemed part of this Agreement and in no way define, limit, extend or describe the scope or intent of any provisions hereof. Except as specifically provided otherwise, references to Articles or Sections are to Articles and Sections of this Agreement.
Section 15.03. Pronouns and Plurals . Whenever the context may require, any pronouns used in this Agreement shall include the corresponding masculine, feminine or neuter forms, and the singular form of nouns, pronouns and verbs shall include the plural and vice versa .
Section 15.04. Further Action . The parties shall execute and deliver all documents, provide all information and take or refrain from taking action as may be necessary or appropriate to achieve the purposes of this Agreement.
Section 15.05. Binding Effect . This Agreement shall be binding upon and inure to the benefit of the parties hereto and their heirs, executors, administrators, successors, legal representatives and permitted assigns.
Section 15.06. Waiver .
(a) 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.
(b) The restrictions, conditions and other limitations on the rights and benefits of the Limited Partners contained in this Agreement, and the duties, covenants and other requirements of performance or notice by the Limited Partners, are for the benefit of the Partnership and, except for an obligation to pay money to the Partnership, may be waived or relinquished by the General Partner, in its sole and absolute discretion, on behalf of the Partnership in one or more instances from time to time and at any time.
Section 15.07. Counterparts . This Agreement may be executed in counterparts, all of which together shall constitute one agreement binding on all the parties hereto, notwithstanding that all such parties are not signatories to the original or the same counterpart. Each party shall become bound by this Agreement immediately upon affixing its signature hereto.
Section 15.08. Applicable Law . This Agreement shall be construed and enforced in accordance with and governed by the laws of the State of Delaware, without regard to the principles of conflicts of law. In the event of a conflict between any provision of this Agreement and any non-mandatory provision of the Act, the provisions of this Agreement shall control and take precedence.
Section 15.09. Entire Agreement . This Agreement contains all of the understandings and agreements between and among the Partners with respect to the subject matter of this Agreement and the rights, interests and obligations of the Partners with respect to the Partnership.
Section 15.10. 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.
Section 15.11. Limitation to Preserve REIT Qualification . Notwithstanding anything else in this Agreement, to the extent that the amount paid, credited, distributed or reimbursed by the Partnership to the General Partner or its officers, directors, members, employees or agents, whether as a reimbursement, fee, expense or indemnity (a REIT Payment ), would constitute gross income to the General Partner for purposes of Code Section 856(c)(2) or Code Section 856(c)(3), then, notwithstanding any other provision of this Agreement, the amount of such REIT Payments, as selected by the General Partner in its discretion from among items of potential distribution, reimbursement, fees, expenses and indemnities, shall be reduced for any Partnership Year so that the REIT Payments, as so reduced, for or with respect to the General Partner, shall not exceed the lesser of:
(i) an amount equal to the excess, if any, of (a) 4.9% of the General Partners total gross income (but excluding the amount of any REIT Payments) for the Partnership Year that is described in subsections (A) through (H) of Code Section 856(c)(2) over (b) the amount of gross income (within the meaning of Code Section 856(c)(2)) derived by the
General Partner from sources other than those described in subsections (A) through (H) of Code Section 856(c)(2) (but not including the amount of any REIT Payments); or
(ii) an amount equal to the excess, if any, of (a) 24% of the General Partners total gross income (but excluding the amount of any REIT Payments) for the Partnership Year that is described in subsections (A) through (I) of Code Section 856(c)(3) over (b) the amount of gross income (within the meaning of Code Section 856(c)(3)) derived by the General Partner from sources other than those described in subsections (A) through (I) of Code Section 856(c)(3) (but not including the amount of any REIT Payments); provided , however , that REIT Payments in excess of the amounts set forth in clauses (i) and (ii) above may be made if the General Partner, as a condition precedent, obtains an opinion of tax counsel that the receipt of such excess amounts shall not adversely affect the General Partners ability to qualify as a REIT. To the extent that REIT Payments may not be made in a Partnership Year as a consequence of the limitations set forth in this Section 15.11 , such REIT Payments shall carry over and shall be treated as arising in the following Partnership Year. The purpose of the limitations contained in this Section 15.11 is to prevent the General Partner from failing to qualify as a REIT under the Code by reason of the General Partners share of items, including distributions, reimbursements, fees, expenses or indemnities, receivable directly or indirectly from the Partnership, and this Section 15.11 shall be interpreted and applied to effectuate such purpose.
Section 15.12. No 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 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.
Section 15.13. 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. No creditor or other third party having dealings with the Partnership (other than as expressly set forth herein with respect to Indemnitees) shall have the right to enforce the right or obligation of any Partner to make Capital Contributions or loans to the Partnership or to pursue any other right or remedy hereunder or at law or in equity. 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 any 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 any of the Partners.
Section 15.14. No Rights as Members of the General Partner . Nothing contained in this Agreement shall be construed as conferring upon the Holders of Partnership Units any rights
whatsoever as members of the General Partner, including without limitation any right to receive dividends or other distributions made to members of the General Partner, or to vote or to consent or receive notice as stockholders in respect of any meeting of stockholders for the election of directors of the General Partner or any other matter.
Section 15.15. Creditors . Other than as expressly set forth herein with respect to Indemnitees, none of the provisions of this Agreement shall be for the benefit of, or shall be enforceable by, any creditor of the Partnership.
[ signature page follows ]
IN WITNESS WHEREOF, this Agreement of Limited Partnership has been executed as of the date first written above.
GENERAL PARTNER: |
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ZAIS Financial Corp. |
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/s/ Michael Szymanski |
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Name: Michael Szymanski |
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Title: Chief Executive Officer, President and Director |
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LIMITED PARTNERS: |
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ZAIS Financial Corp. |
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By: |
/s/ Michael Szymanski |
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Name: Michael Szymanski |
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Title: Chief Executive Officer, President and Director |
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ZAIS Financial, LLC |
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By: |
ZAIS Financial Corp., |
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as its sole managing member and sole member |
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By: |
/s/ Michael Szymanski |
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Name: Michael Szymanski |
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Title: Chief Executive Officer, President and Director |
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[ Signature Page to OP Agreement ]
Exhibit A
PARTNERS AND PARTNERSHIP UNITS
As of July 29 2011
Name and Address of Partners |
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Partnership Units (Type
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Exhibit B
NOTICE OF REDEMPTION
To:
ZAIS Financial Corp.
Two Bridge Avenue, Suite 322
Red Bank, New Jersey 07701-1106
The undersigned Limited Partner or Assignee hereby irrevocably tenders for Redemption OP Units in ZAIS Financial Partners, L.P. in accordance with the terms of the Agreement of Limited Partnership of ZAIS Financial Partners, L.P., dated as of July 29, 2011 (the Agreement ), and the Redemption rights referred to therein. The undersigned Limited Partner or Assignee:
(a) undertakes (i) to surrender such OP Units and any certificate therefor at the closing of the Redemption and (ii) to furnish to the General Partner, prior to the Specified Redemption Date, the documentation, instruments and information required under Section 8.06(g) of the Agreement;
(b) directs that the certified check representing the Cash Amount, or the REIT Shares Amount, as applicable, deliverable upon the closing of such Redemption be delivered to the address specified below;
(c) represents, warrants, certifies and agrees that:
(i) the undersigned Limited Partner or Assignee is a Qualifying Party,
(ii) the undersigned Limited Partner or Assignee has, and at the closing of the Redemption will have, good, marketable and unencumbered title to such OP Units, free and clear of the rights or interests of any other person or entity,
(iii) the undersigned Limited Partner or Assignee has, and at the closing of the Redemption will have, the full right, power and authority to tender and surrender such Partnership Units as provided herein, and
(iv) the undersigned Limited Partner or Assignee has obtained the consent or approval of all persons and entities, if any, having the right to consent to or approve such tender and surrender; and
(d) acknowledges that he will continue to own such OP Units until and unless either (1) such OP Units are acquired by the General Partner pursuant to Section 8.6.B of the Agreement or (2) such redemption transaction closes.
All capitalized terms used herein and not otherwise defined shall have the same meaning ascribed to them respectively in the Agreement.
Dated: |
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Name of Limited Partner or Assignee: |
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(Signature of Limited Partner or Assignee) |
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(Street Address) |
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(City) (State) (Zip Code) |
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Signature Medallion Guaranteed by: |
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Issue Check Payable/REIT Shares to: |
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Name: |
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Please insert social security or identifying number: |
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AMENDMENT
TO
AGREEMENT OF LIMITED PARTNERSHIP
OF
ZAIS FINANCIAL PARTNERS, L.P.
This amendment to the Agreement of Limited Partnership of ZAIS Financial Partners, L.P. (the Partnership ) is made and entered as of August 3, 2011 (this Amendment ), by ZAIS Financial Corp., a Maryland corporation (the General Partner ).
RECITALS :
A. The General Partner and the Limited Partners entered into that certain Agreement of Limited Partnership of ZAIS Financial Partners, L.P. dated as of July 29, 2011 (the Partnership Agreement ), to set forth their agreements with respect to the business and affairs of the Partnership.
B. Pursuant to Section 7.03(c) of the Partnership Agreement, the General Partner has the exclusive power, without the prior consent of the Limited Partners, to amend the Partnership Agreement to, among other things, modify the manner in which items of Net Income or Net Loss are allocated pursuant to Article VI or the manner in which Capital Accounts are adjusted, computed or maintained, to the extent contemplated by the Code or the Regulations, to reflect any other modification that are reasonably necessary for the business or operations of the Partnership or the General Partner, and to issue additional Partnership Interests, in the form of Partnership Units, on such terms and conditions as shall be established by the General Partner in it sole and absolute discretion, without the approval of any Limited Partners, in accordance with Section 4.02 of the Partnership Agreement and, pursuant to Section 7.03(c) of the Partnership Agreement, the General Partners shall provide notice to the Limited Partners of any such modification or issuance.
C. The General Partner, has offered, pursuant to an Exchange Offer Statement dated May 24, 2011, and the Supplement thereto dated July 14, 2011, to stockholders, limited partners and account owners (collectively, Existing Holders ) of the ZAIS Matrix VI series of funds managed by ZAIS Group, LLC, a Delaware limited liability company, the opportunity to exchange a mutually agreeable portion of each such Existing Holders shares or limited partnership interests in such funds (collectively, the Existing Interests ), for shares of the General Partners common stock, $0.0001 par value per share ( Common Stock ), or operating partnership units ( OP Units ) in the Partnership (such transactions, the Exchange Offer ).
D. Pursuant to the contribution agreement dated, August 3, 2011, by and among ZAIS Matrix VI-B LP (the Contributor ) and the Partnership (the OP Contribution Agreement ), the Contributor will distribute OP Units delivered pursuant to the OP Contribution Agreement to the applicable Existing Holders in redemption of their Existing Interests in the Contributor that will exchanged in the Exchange Offer.
E. All Existing Holders that receive OP Units pursuant to the OP Contribution Agreement have elected to exchange such OP Units for shares of Common Stock.
F. Capitalized terms used but not defined herein shall have the meanings ascribed to them in the Partnership Agreement.
NOW, THEREFORE, the General Partner desires to amend the Partnership Agreement as provided herein:
1. Exhibit . Upon the closing of the transactions contemplated by the OP Contribution Agreement, Exhibit A to the Partnership Agreement is hereby amended and restated in its entirety as set forth in Exhibit A-I attached hereto, which Exhibit shall set forth the official record ownership of the Partnership as of the closing of the transactions contemplated by the OP Contribution Agreement. Upon the exchange of the OP Units issued pursuant to the OP Contribution Agreement for shares of Common Stock, Exhibit A to the Partnership Agreement is hereby further amended and restated in its entirety as set forth in Exhibit A-II attached hereto, which Exhibit shall set forth the official record ownership of the Partnership as of the date hereof.
2. Disregarded Entity Status . At any time that the Partnership has only one partner for U.S. federal income tax purposes, the Partnership shall be treated as disregarded as an entity separate from its owner, rather than a partnership, for U.S. federal income tax purposes. During any such time, the Partnership shall allocate all Tax Items to its sole owner, and shall allocate all Net Income and Net Loss to its sole owner (except to the extent that more than one Person owns an interest in the Partnership, in which case the Partnership shall allocate Net Income and Net Loss between such Persons in a manner consistent with the Partnership Agreement). Furthermore, during any such time, all provisions of the Partnership Agreement that are inconsistent with the U.S. federal income tax status of the Partnership as a disregarded entity shall be without effect.
3. Partnership Agreement . Except as set forth herein, the Partnership Agreement shall remain in full force and effect.
4. Governing Law . This Amendment shall be governed by, and construed in accordance with, the laws of the State of Delaware.
[The remainder of this page has been intentionally left blank]
IN WITNESS WHEREOF, the undersigned, intending to be legally bound hereby, has duly executed this Agreement as of the date first written above.
ZAIS FINANCIAL CORP., |
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General Partner |
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/s/ Michael Szymanski |
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Michael Szymanski |
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CEO, President and Director |
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[Signature Page to Amendment to OP Agreement]
EXHIBIT A-I
Exhibit A
PARTNERS AND PARTNERSHIP UNITS
As of August 3, 2011
Name and Address of Partners |
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SECOND AMENDMENT
TO
AGREEMENT OF LIMITED PARTNERSHIP
OF
ZAIS FINANCIAL PARTNERS, L.P.
This Second Amendment (this Amendment ), to the Agreement of Limited Partnership of ZAIS Financial Partners, L.P. (the Partnership ), as amended, is made and entered as of October 11, 2012 by ZAIS Financial Corp., a Maryland corporation (the General Partner ).
RECITALS:
A. The General Partner and the Limited Partners entered into that certain Agreement of Limited Partnership of ZAIS Financial Partners, L.P. dated as of July 29, 2011 (the Existing Partnership Agreement ), as amended by that certain Amendment to the Agreement of Limited Partnership of ZAIS Financial Partners, L.P. made and entered as of August 3, 2011 (the First Partnership Agreement Amendment and together with the Existing Partnership Agreement, the Partnership Agreement ), to set forth their agreements with respect to the business and affairs of the Partnership.
B. Pursuant to Section 7.03(c) of the Partnership Agreement, the General Partner has the exclusive power, without the prior consent of the Limited Partners, to amend the Partnership Agreement to issue additional Partnership Interests, in the form of Partnership Units, on such terms and conditions as shall be established by the General Partner in it sole and absolute discretion, without the approval of any Limited Partners, in accordance with Section 4.02 of the Partnership Agreement.
C. On October 11, 2012, the General Partner closed the offering of 195,457 shares of its common stock, $0.0001 par value per share ( Common Stock ), and 22,492 OP Units and the repurchase of 668,525 shares of Common Stock (collectively, the Closing ).
D. The General Partner has determined that it is necessary and desirable to amend the Partnership Agreement to amend Exhibit A thereto in connection with the Closing.
E. Capitalized terms used but not defined herein shall have the meanings ascribed to them in the Existing Partnership Agreement.
NOW, THEREFORE, the General Partner desires to effect this Amendment to the Partnership Agreement as provided herein:
1. Exhibit A . Exhibit A is hereby amended as set forth in Exhibit A hereto.
2. Partnership Agreement . Except as set forth herein, the Partnership Agreement shall remain in full force and effect.
3. Governing Law . This Amendment shall be governed by, and construed in accordance with, the laws of the State of Delaware.
[The remainder of this page has been intentionally left blank]
IN WITNESS WHEREOF, the undersigned, intending to be legally bound hereby, has duly executed this Amendment as of the date first written above.
ZAIS Financial Partners, L.P.,
By: ZAIS Financial Corp., its General Partner |
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/s/ Michael Szymanski |
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Chief Executive Officer, President and Director |
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[ Signature Page to Second Amendment to LPA ]
EXHIBIT A
PARTNERS AND PARTNERSHIP UNITS
As of October 11, 2012
Name and Address of Partners |
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THIRD AMENDMENT
TO
AGREEMENT OF LIMITED PARTNERSHIP
OF
ZAIS FINANCIAL PARTNERS, L.P.
This Third Amendment (this Amendment ), to the Agreement of Limited Partnership of ZAIS Financial Partners, L.P. (the Partnership ), as amended, is made and entered as of December 13, 2012 by ZAIS Financial Corp., a Maryland corporation (the General Partner ).
RECITALS:
A. The General Partner and the Limited Partners entered into that certain Agreement of Limited Partnership of ZAIS Financial Partners, L.P. dated as of July 29, 2011 (the Original Partnership Agreement ), as amended by that certain Amendment to the Agreement of Limited Partnership of ZAIS Financial Partners, L.P. made and entered as of August 3, 2011 (the First Partnership Agreement Amendment and together with the Original Partnership Agreement, the Amended Partnership Agreement ) and that certain Second Amendment to the Agreement of Limited Partnership of ZAIS Financial Partners, L.P. made and entered as of October 11, 2012 (the Second Partnership Agreement Amendment and together with the Amended Partnership Agreement, the Partnership Agreement ), to set forth their agreements with respect to the business and affairs of the Partnership.
B. Pursuant to Section 7.03(c) of the Partnership Agreement, the General Partner has the exclusive power, without the prior consent of the Limited Partners, to amend the Partnership Agreement to issue additional Partnership Interests, in the form of Partnership Units, on such terms and conditions as shall be established by the General Partner in it sole and absolute discretion, without the approval of any Limited Partners, in accordance with Section 4.02 of the Partnership Agreement.
C. On December 13, 2012, the General Partner closed the offering of 36,581 shares of its common stock, $0.0001 par value per share ( Common Stock ) and 904,442 OP Units (collectively, the Closing ).
D. The General Partner has determined that it is necessary and desirable to amend the Partnership Agreement to amend Exhibit A thereto in connection with the Closing.
E. Capitalized terms used but not defined herein shall have the meanings ascribed to them in the Partnership Agreement.
NOW, THEREFORE, the General Partner desires to effect this Amendment to the Partnership Agreement as provided herein:
1. Exhibit A . Exhibit A is hereby amended as set forth in Exhibit A hereto.
2. Partnership Agreement . Except as set forth herein, the Partnership Agreement shall remain in full force and effect.
3. Governing Law . This Amendment shall be governed by, and construed in accordance with, the laws of the State of Delaware.
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IN WITNESS WHEREOF, the undersigned, intending to be legally bound hereby, has duly executed this Amendment as of the date first written above.
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ZAIS FINANCIAL PARTNERS, L.P., |
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By: ZAIS Financial Corp., |
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its General Partner |
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By: |
/s/ Michael Szymanski |
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Name: |
Michael Szymanski |
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Title: |
President |
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[ Signature Page to Third Amendment to LPA ]
EXHIBIT A
PARTNERS AND PARTNERSHIP UNITS
As of December 13, 2012
Name and Address of Partners |
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Partnership Units (Type
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Address |
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Exhibit 10.3
REGISTRATION RIGHTS AGREEMENT
This Registration Rights Agreement (this Agreement ) is made and entered into this 3rd day of August, 2011, among ZAIS Financial Corp., a Maryland corporation (the Company ), ZAIS Group, LLC, a Delaware limited liability company ( ZAIS Group ) and certain persons listed on Schedule I hereto (such persons, in their capacities as holders of Registrable Shares (as defined below), the Holders, and each a Holder ).
The Company is offering pursuant to an Exchange Offer Statement stockholders, limited partners or account owners (the Existing Holders ) of the ZAIS Matrix VI series of funds and certain separate accounts managed by ZAIS Group the opportunity to exchange (the Exchange Offer ) a mutually agreeable portion of each such Existing Holders shares, limited partnership interests or separate account holdings (collectively, the Interests ) for shares of the Companys common stock, par value $0.0001 per share (the common stock ) or operating partnership units (the OP units ) in ZAIS Financial Partners, L.P. (the Operating Partnership ).
In order to induce Existing Holders to exchange their Interests for shares of common stock or OP units, the Company has agreed to provide to such Existing Holders and investors and their respective direct and indirect transferees the registration rights set forth in this Agreement.
In consideration of the foregoing and the mutual covenants and agreements herein contained and other good and valid consideration, the receipt and sufficient of which are hereby acknowledged, the parties hereto agree as follows:
1. DEFINITIONS .
As used in this Agreement, the following capitalized defined terms shall have the following meanings:
1933 Act shall mean the Securities Act of 1933, as amended from time to time.
1934 Act shall mean the Securities Exchange Act of 1934, as amended from time to time.
Additional Shares shall mean shares of Common Stock (including the shares of Common Stock that may be issued by the Company upon redemption of the OP units) or other securities of the Company issued in respect of the Shares by reason of or in connection with any stock dividend, stock distribution, stock split, purchase in any rights offering or in connection with any exchange for or replacement of such shares or any combination of shares, recapitalization, merger or consolidation, or any other equity securities issued pursuant to any other pro rata distribution with respect to the shares of Common Stock.
Affiliate shall mean as to any specified Person any other Person directly or indirectly controlling or controlled by or under direct or indirect common control with such specified Person. For the purposes of this definition, control (including, with correlative meanings, the terms controlling, 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 or policies of such Person whether through the ownership of voting securities or by agreement or otherwise.
Business Days shall mean Monday, Tuesday, Wednesday, Thursday, and Friday that is not a day on which banking institutions in New York, New Jersey or other applicable places where such act is to occur are authorized or obligated by applicable law, regulation or executive order to close.
Closing Date shall mean the date of completion of the Exchange Offer.
Common Stock shall mean the shares of common stock, par value $0.0001 per share, of the Company.
Company shall have the meaning set forth in the preamble and shall also include the Companys successors.
Controlling Person shall have the meaning set forth in Section 4(a) of this Agreement.
End of Suspension Notice shall have the meaning set forth in Section 5(b) of this Agreement.
Exchange Offer shall have the meaning set forth in the preamble.
FINRA shall mean the Financial Industry Regulatory Authority.
Holder shall have the meaning set forth in the preamble.
Interests shall have the meaning set forth in the preamble.
IPO shall mean the initial public offering of the shares of Common Stock.
Liabilities shall have the meaning set forth in Section 4(a)(i) of this Agreement.
OP units shall have the meaning set forth in the preamble.
Operating Partnership shall have the meaning set forth in the preamble.
Participating Broker-Dealer shall mean any broker-dealer that makes a market in the Registrable Shares.
Person shall mean an individual, partnership (general or limited), corporation, limited liability company, trust or unincorporated organization, or a government or agency or political subdivision thereof.
Prospectus shall mean the prospectus included in a Registration Statement, including any preliminary prospectus, and any such prospectus as amended or supplemented by any prospectus supplement, including any such prospectus supplement with respect to the terms of the offering of any portion of the Registrable Shares covered by a Registration Statement, and by all other amendments and supplements to a prospectus, including post-effective amendments and free-writing prospectuses and in each case including all material incorporated by reference therein.
Registrable Shares shall mean the Shares and any Additional Shares; provided, however, that Shares and Additional Shares shall cease to be Registrable Shares (i) when a Registration Statement with respect to such Shares and Additional Shares shall have been declared effective under the 1933 Act and such Shares or Additional Shares shall have been disposed of pursuant to such Registration Statement, (ii) when such Shares or Additional Shares have ceased to be outstanding or (iii) on the second anniversary of the initial effective date of the Shelf Registration Statement or, in the case of any Additional Shares not included in the Shelf Registration Statement, until the second anniversary of the issuance of the Additional Shares.
Registration Expenses shall mean any and all expenses incident to the performance of or compliance by the Company with this Agreement, whether or not any Registration Statement contemplated hereby is filed or declared effective by the SEC under the 1933 Act, including without limitation: (i) all SEC, stock exchange or FINRA registration and filing fees, including, if applicable, the fees and expenses of any qualified independent underwriter (and its counsel) that is required to be retained by any Holder in accordance with the rules and regulations of the FINRA, (ii) all fees and expenses incurred in connection with compliance with state securities or blue sky laws and compliance with the rules of the FINRA (including reasonable fees and disbursements of one firm of Selling Holders Counsel for any underwriters or Holders in connection with blue sky qualification of any Registrable Shares and any filings with the FINRA), (iii) all expenses of any Persons in preparing or assisting in preparing, word processing, printing, duplicating, mailing and distributing any Registration Statement, any Prospectus, any amendments or supplements thereto, any underwriting agreements, securities sales agreements and other documents relating to the performance of and compliance with this Agreement, (iv) all fees and expenses incurred in connection with the listing, if any, of any of the Registrable Shares on any securities exchange or exchanges, (v) the fees and disbursements of counsel for the Company and of the independent registered public accounting firm of the Company, including the expenses of any special audits or comfort letters required by or incident to such performance and compliance, (vi) the fees and expenses of the Companys transfer agent, and any
escrow agent or custodian, (vii) the reasonable fees and disbursements of one firm of Selling Holders Counsel representing the Holders of Registrable Shares and (viii) any fees and disbursements of the underwriters customarily required to be paid by issuers or sellers of securities and the fees and expenses of any special experts retained by the Company in connection with any Registration Statement, but excluding underwriting discounts and commissions and transfer taxes, if any, relating to the sale or disposition of Registrable Shares by a Holder and the fees and disbursements of any counsel to the Holders, except as provided in clauses (ii) and (vii).
Registration Statement shall mean any registration statement of the Company which covers any of the Registrable Shares pursuant to the provisions of this Agreement, and all amendments and supplements to any such Registration Statement, including pre- and post-effective amendments, in each case including the Prospectus contained therein, all exhibits thereto and all material incorporated by reference therein.
SEC shall mean the U.S. Securities and Exchange Commission or any successor agency or government body performing the functions currently performed by the U.S. Securities and Exchange Commission.
Selling Holders Counsel shall mean counsel for the Holders that is selected by the Holders holding a majority of the Registrable Shares included in a Registration Statement and that is reasonably acceptable to the Company.
Shares shall mean the shares of the Common Stock that may be issued by the Company upon exchange of common stock or upon redemption of OP units that were issued in the Exchange Offer.
Shelf Registration shall mean a registration effected pursuant to Section 2.1 of this Agreement.
Shelf Registration Statement shall mean a shelf registration which covers Registrable Shares on an appropriate form under the 1933 Act, and all amendments and supplements to such registration statement, including pre- and post-effective amendments, in each case including the Prospectus contained therein, all exhibits thereto and all material incorporated by reference therein.
Subsequent Shelf Registration Statement shall mean an additional shelf registration statement of the Company pursuant to the provisions of Section 2.2 of this Agreement which covers Additional Shares on an appropriate form under the 1933 Act, and all amendments and supplements to such registration statement, including pre- and post-effective amendments, in each case including the Prospectus contained therein, all exhibits thereto and all material incorporated by reference therein.
Suspension Event shall have the meaning set forth in Section 5(b) of this Agreement.
Suspension Notice shall have the meaning set forth in Section 5(a) of this Agreement.
Underwriter shall have the meaning set forth in Section 4(a) of this Agreement.
Underwritten Offering shall mean a sale of securities of the Company to an underwriter or underwriters for reoffering to the public.
ZAIS Group shall have the meaning set forth in the preamble.
2. Registration Under the 1933 Act .
2.1 Mandatory Shelf Registration .
(a) The Company agrees (i) to use its reasonable efforts to file a Shelf Registration Statement with the SEC no later than 60 days after the closing of the Companys IPO, subject to extension if the Company is bound by a lock-up agreement in connection with the Companys IPO which restricts the filing of a Shelf Registration Statement in which event the Company will be required to use its reasonable efforts to file a Shelf Registration Statement within 30 days after the expiration of the lock-up period, (ii) to use its
commercially reasonable efforts to cause such Shelf Registration Statement providing for the resale of the Registrable Shares to be declared effective by the SEC as promptly as practicable after such filing and (iii) to use commercially reasonable efforts to arrange for the Registrable Shares registered in such Shelf Registration Statement to be listed for trading on a national securities exchange as promptly as practicable after such filing.
(b) The Company shall use its commercially reasonable efforts to maintain the Shelf Registration Statement continuously effective in order to permit the Prospectus forming part thereof to be usable by the Holders.
(c) The Company shall use its commercially reasonable efforts to maintain the Shelf Registration Statements effectiveness under the 1933 Act until the first to occur of (i) such time as all of the Registrable Shares covered by the Shelf Registration Statement have been sold pursuant to the Shelf Registration Statement or pursuant to Rule 144 under the 1933 Act and (ii) the second anniversary after the closing of the Companys IPO.
(d) Notwithstanding any other provision hereof, the Company agrees to use its commercially reasonable efforts to ensure that (i) any Shelf Registration Statement and any amendment thereto and any Prospectus forming part thereof and any supplement thereto complies, when filed, in all material respects with the 1933 Act and the rules and regulations thereunder, (ii) any Shelf Registration Statement and any amendment thereto does not, when it becomes effective, contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements, in light of the circumstances under which they were made, not misleading and (iii) any Prospectus forming part of any Shelf Registration Statement, and any supplement to such Prospectus (as amended or supplemented from time to time), does not, when filed, include an untrue statement of a material fact or omit to state a material fact necessary in order to make the statements, in light of the circumstances under which they were made, not misleading.
The Company shall not permit any securities other than Registrable Shares to be included in the Shelf Registration Statement. The Company further agrees, if necessary, to supplement or amend the Shelf Registration Statement, as required by Section 3(b) below, and to furnish to the Holders copies of any such supplement or amendment promptly after its being used or filed with the SEC.
2.2 Subsequent Shelf Registration for Additional Shares . If any Additional Shares are issued or distributed to Holders after the effectiveness of the Shelf Registration Statement, or such Additional Shares were otherwise not included in a prior Shelf Registration Statement, then the Company shall as soon as practicable, but in no event later than 60 days after the issuance of such Additional Shares, file and use its commercially reasonable efforts to cause to be declared effective by the SEC as soon as practicable following such filing a Subsequent Shelf Registration Statement in the same manner, and subject to the same provisions.
2.3 Expenses . The Company shall pay all Registration Expenses in connection with the registration of the Registrable Shares pursuant to Section 2.1 or 2.2 hereof. Each Holder shall pay or otherwise bear such Holders proportionate share (based on the total amount of Registrable Shares sold in the Registration Statement) of all underwriting discounts and commissions and transfer taxes, if any, relating to the sale or disposition of such Holders Registrable Shares pursuant to the Shelf Registration Statement or any Subsequent Shelf Registration Statement.
3. Registration Procedures . In connection with the obligations of the Company with respect to a Registration Statement pursuant to Section 2 hereof, the Company shall:
(a) prepare and file with the SEC the Registration Statement, within the relevant time period specified in Section 2, on the appropriate form under the 1933 Act, which form (i) shall be selected by the Company, (ii) shall be available for the registration and sale of the Registrable Shares by the selling Holders thereof, (iii) shall comply as to form in all material respects with the requirements of the applicable form and include or incorporate by reference all financial statements required by the SEC to be filed
therewith or incorporated by reference therein, and (iv) shall comply in all respects with the requirements of Regulation S-T under the 1933 Act, and otherwise comply with its obligations under Section 2 hereof;
(b) prepare and file with the SEC such amendments and post-effective amendments to each Registration Statement as may be necessary under applicable law to keep such Registration Statement effective for the applicable period; and cause each Prospectus to be supplemented by any required prospectus supplement, and as so supplemented to be filed pursuant to Rule 424 (or any similar provision then in force) under the 1933 Act and comply with the provisions of the 1933 Act, the 1934 Act and the rules and regulations thereunder applicable to them with respect to the disposition of all securities covered by each Registration Statement during the applicable period in accordance with the intended method or methods of distribution by the selling Holders thereof (including sales by any Participating Broker-Dealer);
(c) (i) notify each Holder of Registrable Shares, at least five Business Days after filing, that a Registration Statement with respect to the Registrable Shares has been filed and advising such Holders that the distribution of Registrable Shares will be made in accordance with any method or combination of methods legally available by the Holders of any and all Registrable Shares; (ii) furnish to each Holder of Registrable Shares and to each underwriter of an Underwritten Offering of Registrable Shares, if any, without charge, as many copies of each Prospectus, including each preliminary Prospectus, and any amendment or supplement thereto and such other documents as such Holder or underwriter may reasonably request, including financial statements and schedules in order to facilitate the public sale or other disposition of the Registrable Shares; and (iii) hereby consent to the use of the Prospectus or any amendment or supplement thereto by each of the selling Holders of Registrable Shares in connection with the offering and sale of the Registrable Shares covered by the Prospectus or any amendment or supplement thereto;
(d) use its commercially reasonable efforts to register or qualify the Registrable Shares under all applicable state securities or blue sky laws of such jurisdictions as any Holder of Registrable Shares covered by a Registration Statement and each underwriter of an Underwritten Offering of Registrable Shares shall reasonably request by the time the applicable Registration Statement is declared effective by the SEC, and do any and all other acts and things which may be reasonably necessary or advisable to enable each such Holder and underwriter to consummate the disposition in each such jurisdiction of such Registrable Shares owned by such Holder; provided, however, that the Company shall not be required to (i) qualify as a foreign corporation or as a dealer in securities in any jurisdiction where it would not otherwise be required to qualify but for this Section 3(d), or (ii) take any action which would subject it to general service of process or taxation in any such jurisdiction where it is not then so subject;
(e) notify promptly each Holder of Registrable Shares under a Registration Statement and, if requested by such Holder, confirm such advice in writing promptly at the address determined in accordance with Section 9.4 of this Agreement (i) when a Registration Statement has become effective and when any post-effective amendments and supplements thereto become effective, (ii) of any request by the SEC or any state securities authority for post-effective amendments and supplements to a Registration Statement and Prospectus or for additional information after the Registration Statement has become effective, (iii) of the issuance by the SEC or any state securities authority of any stop order suspending the effectiveness of a Registration Statement or the initiation of any proceedings for that purpose, (iv) in the case of a Shelf Registration, if, between the effective date of a Registration Statement and the closing of any sale of Registrable Shares covered thereby, the representations and warranties of the Company contained in any underwriting agreement, securities sales agreement or other similar agreement, if any, relating to the offering cease to be true and correct in all material respects, (v) of the happening of any event or the discovery of any facts during the period a Registration Statement is effective as a result of which such Registration Statement or the related Prospectus or any document incorporated by reference therein contains any untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein not misleading or, in the case of the Prospectus, contains any untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading (which information shall be accompanied by an instruction to suspend the use of the Registration Statement and the Prospectus (such instruction to be provided in the same manner as a
Suspension Notice) until the requisite changes have been made, at which time notice of the end of suspension shall be delivered in the same manner as an End of Suspension Notice), (vi) of the receipt by the Company of any notification with respect to the suspension of the qualification of the Registrable Shares, for sale in any jurisdiction or the initiation or threatening of any proceeding for such purpose and (vii) of the filing of a post-effective amendment to such Registration Statement;
(f) furnish Selling Holders Counsel, if any, copies of any comment letters relating to the selling Holders received from the SEC or any other request by the SEC or any state securities authority for amendments or supplements to a Registration Statement and Prospectus or for additional information relating to the selling Holders;
(g) make every reasonable effort to obtain the withdrawal of any order suspending the effectiveness of a Registration Statement at the earliest possible moment;
(h) furnish to each Holder of Registrable Shares, and each underwriter, if any, without charge,
at least one conformed copy of each Registration Statement and any post-effective amendment thereto, including financial statements and schedules (without documents incorporated therein by reference and all exhibits thereto, unless requested);
(i) cooperate with the selling Holders to facilitate the timely preparation and delivery of certificates representing Registrable Shares to be sold and not bearing any restrictive legends; and enable such Registrable Shares to be in such denominations and registered in such names as the selling Holders or the underwriters, if any, may reasonably request at least three Business Days prior to the closing of any sale of Registrable Shares;
(j) upon the occurrence of any event or the discovery of any facts, as contemplated by Sections 3(e)(v) and 3(e)(vi) hereof, as promptly as practicable after the occurrence of such an event, use its best efforts to prepare a supplement or post-effective amendment to the Registration Statement or the related Prospectus or any document incorporated therein by reference or file any other required document so that, as thereafter delivered to the purchasers of the Registrable Shares or Participating Broker-Dealers, such Prospectus will not contain at the time of such delivery any untrue statement of a material fact or omit to state a material fact necessary to make the statements therein, in light of the circumstances under which they were made, not misleading, or will remain so qualified, as applicable. At such time as such public disclosure is otherwise made or the Company determines that such disclosure is not necessary, in each case to correct any misstatement of a material fact or to include any omitted material fact, the Company agrees promptly to notify each Holder of such determination and to furnish each Holder such number of copies of the Prospectus as amended or supplemented, as such Holder may reasonably request;
(k) within a reasonable time prior to the filing of any Registration Statement, any Prospectus, any amendment to a Registration Statement or amendment or supplement to a Prospectus, provide copies of such document to Selling Holders Counsel, if any, on behalf of such Holders, and make representatives of the Company as shall be reasonably requested by the Holders of Registrable Shares available for discussion of such document;
(1) obtain a CUSIP number for the Registrable Shares not later than the effective date of a Registration Statement, and provide the Companys transfer agent with printed certificates for the Registrable Shares;
(m) enter into agreements (including underwriting agreements) and take all other customary appropriate actions in order to expedite or facilitate the disposition of such Registrable Shares whether or not an underwriting agreement is entered into and whether or not the registration is an underwritten registration:
(i) make such representations and warranties to the Holders of such Registrable Shares and the underwriters, if any, in form, substance and scope as are customarily made by issuers to underwriters in similar underwritten offerings as may be reasonably requested by them;
(ii) obtain opinions of counsel to the Company and updates thereof (which counsel and opinions (in form, scope and substance) shall be reasonably satisfactory to any managing underwriter(s) and their counsel) addressed to the underwriters, if any (and in the case of an underwritten registration, each selling Holder), covering the matters customarily covered in opinions requested in underwritten offerings and such other matters as may be reasonably requested by the underwriter(s);
(iii) obtain comfort letters and updates thereof from the Companys independent registered public accounting firm (and, if necessary, any other independent certified public accountants of any subsidiary of the Company or of any business acquired by the Company for which financial statements are, or are required to be, included in the Registration Statement) addressed to the underwriter(s), if any, and use reasonable efforts to have such letter addressed to the selling Holders in the case of an underwritten registration (to the extent consistent with Statement on Auditing Standards No. 72 of the American Institute of Certified Public Accounts), such letters to be in customary form and covering matters of the type customarily covered in comfort letters to underwriters in connection with similar underwritten offerings;
(iv) enter into a securities sales agreement with the Holders and an agent of the Holders providing for, among other things, the appointment of such agent for the selling Holders for the purpose of soliciting purchases of Registrable Shares, which agreement shall be in form, substance and scope customary for similar offerings;
(v) if an underwriting agreement is entered into, cause the same to set forth indemnification provisions and procedures substantially equivalent to the indemnification provisions and procedures set forth in Section 4 hereof with respect to the underwriters and all other parties to be indemnified pursuant to said Section or, at the request of any underwriters, in the form customarily provided to such underwriters in similar types of transactions; and
(vi) deliver such documents and certificates as may be reasonably requested and as are customarily delivered in similar offerings to the Holders of a majority in principal amount of the Registrable Shares being sold and the managing underwriters, if any;
(n) make available for inspection by any underwriter participating in any disposition pursuant to a Registration Statement, any Participating Broker-Dealer, Selling Holders Counsel and any accountant retained by a majority in principal amount of the Registrable Shares being sold, all financial and other records, pertinent corporate documents and properties or assets of the Company reasonably requested by any such persons, and cause the respective officers, directors, employees, and any other agents of the Company to supply all information reasonably requested by any such representative, underwriter, counsel or accountant in connection with a Registration Statement, and make such representatives of the Company available for discussion of such documents as shall be reasonably requested by the Selling Holders Counsel; provided, however, that the Selling Holders Counsel, if any, and the representatives of any underwriters will use commercially reasonable efforts, to the extent reasonably practicable, to coordinate the foregoing inspection and information gathering and to not materially disrupt the Companys business operations;
(o) a reasonable time prior to filing any Registration Statement, any Prospectus forming a part thereof, any amendment to such Registration Statement, or amendment or supplement to such Prospectus, provide copies of such document to the underwriter(s) of an Underwritten Offering of Registrable Shares; within five Business Days after the filing of any Registration Statement, provide copies of such Registration Statement to Selling Holders Counsel; make such changes in any of the foregoing documents prior to the filing thereof, or in the case of changes received from Selling Holders Counsel by filing an amendment or supplement thereto, as the underwriter or underwriters, or in the case of changes
received from Selling Holders Counsel relating to the selling Holders or the plan of distribution of Registrable Shares, as Selling Holders Counsel, reasonably requests; not file any such document in a form to which any underwriter shall not have previously been advised and furnished a copy of or to which the Selling Holders Counsel, if any, on behalf of the Holders of Registrable Shares, or any underwriter shall reasonably object; not include in any amendment or supplement to such documents any information about the selling Holders or any change to the plan of distribution of Registrable Shares that would limit the method of distribution of the Registrable Shares unless Selling Holders Counsel has been advised in advance and has approved such information or change; and make the representatives of the Company available for discussion of such document as shall be reasonably requested by the Selling Holders Counsel, if any, on behalf of such Holders, Selling Holders Counsel or any underwriter;
(p) use its best efforts to cause all Registrable Shares to be listed on any national securities exchange;
(q) otherwise comply with all applicable rules and regulations of the SEC and make available to its security holders, as soon as reasonably practicable, an earnings statement covering at least 12 months which shall satisfy the provisions of Section 11(a) of the 1933 Act and Rule 158 thereunder;
(r) cooperate and assist in any filings required to be made with the FINRA and in the performance of any due diligence investigation by any underwriter and its counsel (including any qualified independent underwriter that is required to be retained in accordance with the rules and regulations of the FINRA); and
(s) the Company may (as a condition to a Holders participation in an IPO or Shelf Registration) require each Holder of Registrable Shares to furnish to the Company such information regarding the Holder and the proposed distribution by such Holder of such Registrable Shares as the Company may from time to time reasonably request in writing.
Each Holder agrees that, upon receipt of any notice from the Company of the happening of any event or the discovery of any facts of the type described in Section 3(e)(v) hereof, such Holder will forthwith discontinue disposition of Registrable Shares pursuant to a Registration Statement until such Holders receipt of the copies of the supplemented or amended Prospectus contemplated by Section 3(k) hereof, and, if so directed by the Company, such Holder will deliver to the Company (at the Companys expense) all copies in such Holders possession, other than permanent file copies then in such Holders possession, of the Prospectus covering such Registrable Shares current at the time of receipt of such notice.
If any of the Registrable Shares covered by a Registration Statement, are to be sold in an Underwritten Offering, the Company will select the underwriter(s) and managing underwriter(s) that will manage such offering. No Holder of Registrable Shares may participate in any Underwritten Offering hereunder unless such Holder (a) agrees to sell such Holders Registrable Shares on the basis provided in any underwriting arrangements approved by the persons entitled hereunder to approve such arrangements and (b) completes and executes all questionnaires, powers of attorney, indemnities, underwriting agreements and other documents required under the terms of such underwriting arrangements.
4. Indemnification; Contribution .
(a) The Company agrees to indemnify and hold harmless each Holder, each Participating Broker-Dealer, each Person who participates as an underwriter (any such Person being an Underwriter ) and each Person (a Controlling Person ), if any, who controls (within the meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act) any of the foregoing Persons, as follows:
(i) against any and all loss, liability, claim, damage, judgment, actions, other liabilities and expense whatsoever (the Liabilities ), as incurred, arising out of any untrue statement or alleged untrue statement of a material fact contained in any Registration Statement (or any amendment or supplement thereto) pursuant to which Registrable Shares were registered
under the 1933 Act, including all documents incorporated therein by reference, or the omission or alleged omission therefrom of a material fact required to be stated therein or necessary to make the statements therein not misleading, or arising out of any untrue statement or alleged untrue statement of a material fact contained in any Prospectus (or any amendment or supplement thereto) or the omission or alleged omission therefrom at such date of a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading;
(ii) against any and all Liabilities, as incurred, to the extent of the aggregate amount paid in settlement of any litigation, or any investigation or proceeding by any governmental agency or body, commenced or threatened, or of any claim whatsoever based upon any such untrue statement or omission, or any such alleged untrue statement or omission; provided that (subject to Section 4(d) below) any such settlement is effected with the written consent of the Company; and
(iii) against any and all expense whatsoever, as incurred (including the fees and disbursements of counsel chosen by any indemnified party), reasonably incurred in investigating, preparing or defending against any litigation, or any investigation or proceeding by any governmental agency or body, commenced or threatened, or any claim whatsoever based upon any such untrue statement or omission, or any such alleged untrue statement or omission, to the extent that any such expense is not paid under subparagraph (i) or (ii) above;
provided, however, that this indemnity agreement shall not apply to any Liabilities to the extent arising out of any untrue statement or omission or alleged untrue statement or omission made in reliance upon and in conformity with written information furnished to the Company by the Holder or Underwriter expressly for use in a Registration Statement (or any amendment thereto) or any Prospectus (or any amendment or supplement thereto).
(b) Each Holder severally, but not jointly, agrees to indemnify and hold harmless the Company, each Underwriter and the other selling Holders, and each of their respective officers, directors, partners, employees, representatives and agents, and each of their respective Controlling Persons, against any and all Liabilities described in the indemnity contained in Section 4(a) hereof, as incurred, but only with respect to untrue statements or omissions, or alleged untrue statements or omissions, made in the Registration Statement (or any amendment thereto) or any Prospectus included therein (or any amendment or supplement thereto) in reliance upon and in conformity with written information with respect to such Holder furnished to the Company by such Holder expressly for use in the Registration Statement (or any amendment thereto) or such Prospectus (or any amendment or supplement thereto); provided, however, that no such Holder shall be liable for any claims hereunder in excess of the amount of net proceeds received by such Holder from the sale of Registrable Shares pursuant to such Registration Statement.
(c) Each indemnified party shall give notice as promptly as reasonably practicable to each indemnifying party of any action or proceeding commenced against it in respect of which indemnity may be sought hereunder, but failure so to notify an indemnifying party shall not relieve such indemnifying party from any liability hereunder to the extent it is not materially prejudiced as a result thereof and in any event shall not relieve it from any liability which it may have otherwise than on account of this indemnity agreement. An indemnifying party may participate at its own expense in the defense of such action; provided, however, that counsel to the indemnifying party shall not (except with the consent of the indemnified party) also be counsel to the indemnified party. In no event shall the indemnifying party or parties be liable for the fees and expenses of more than one counsel (in addition to any local counsel) separate from their own counsel for all indemnified parties in connection with any one action or separate but similar or related actions in the same jurisdiction arising out of the same general allegations or circumstances. No indemnifying party shall, without the prior written consent of the indemnified parties, settle or compromise or consent to the entry of any judgment with respect to any litigation, or any investigation or proceeding by any governmental agency or body, commenced or threatened, or any claim whosoever in respect of which indemnification or contribution could be sought under this Section 4 (whether or not the indemnified parties are actual or potential parties thereto), unless such settlement,
compromise or consent (i) includes an unconditional release of each indemnified party from all liability arising out of such litigation, investigation, proceeding or claim and (ii) does not include a statement as to or an admission of fault, culpability or a failure to act by or on behalf of any indemnified party.
(d) If at any time an indemnified party shall have requested an indemnifying party to reimburse the indemnified party for fees and expenses of counsel, such indemnifying party agrees that it shall be liable for any settlement of the nature contemplated by Section 4(a)(ii) effected without its written consent if (i) such settlement is entered into more than 45 days after receipt by such indemnifying party of the aforesaid request, (ii) such indemnifying party shall have received notice of the terms of such settlement at least 30 days prior to such settlement being entered into and (iii) such indemnifying party shall not have reimbursed such indemnified party in accordance with such request prior to the date of such settlement.
(e) If the indemnification provided for in this Section 4 is for any reason unavailable to or insufficient to hold harmless an indemnified party in respect of any Liabilities referred to therein, then each indemnifying party shall contribute to the aggregate amount of such Liabilities incurred by such indemnified party, as incurred, in such proportion as is appropriate to reflect the relative fault of the Company on the one hand and the Holders on the other hand in connection with the statements or omissions which resulted in such Liabilities, as well as any other relevant equitable considerations.
The relative fault of the Company on the one hand and the Holders on the other hand shall be determined by reference to, among other things, whether any such untrue or alleged untrue statement of a material fact or omission or alleged omission to state a material fact relates to information supplied by the Company or the Holders and the parties relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission.
The Company and the Holders agree that it would not be just and equitable if contribution pursuant to this Section 4 were determined by pro rata allocation or by any other method of allocation which does not take account of the equitable considerations referred to above in this Section 4. The aggregate amount of Liabilities incurred by an indemnified party and referred to above in this Section 4 shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in investigating, preparing or defending against any litigation, or any investigation or proceeding by any governmental agency or body, commenced or threatened, or any claim whatsoever based upon any such untrue or alleged untrue statement or omission or alleged omission.
No Person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the 1933 Act) shall be entitled to contribution from any Person who was not guilty of such fraudulent misrepresentation.
For purposes of this Section 4, each Person, if any, who controls a Holder within the meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act shall have the same rights to contribution as the Holder, and each director of the Company, and each Person, if any, who controls the Company within the meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act shall have the same rights to contribution as the Company.
5. Black-Out Period .
(a) Subject to the provisions of this Section 5, the Company shall be permitted, in limited circumstances, to suspend the use, from time to time, of the Prospectus that is part of a Shelf Registration Statement (and therefore suspend sales of the Registrable Shares under such Registration Statement), by providing written notice (a Suspension Notice ) to Selling Holders Counsel, if any, and the Holders and by issuing a press release, making a filing with the SEC or such other means that the Company reasonably believes to be a reliable means of communication, for such times as the Company reasonably may determine is necessary and advisable (but in no event for more than an aggregate of 90 days in any rolling 12-month period commencing on the date of this Agreement or more than 45 consecutive days, except as a result of a refusal by the SEC to declare any post-effective amendment to the Registration Statement effective after the Company has used all commercially reasonable efforts to cause the post-effective amendment to be declared effective by the SEC, in which case, the Company must terminate the black-out period immediately following the effective date of the post-effective amendment) if any of the following events shall occur: (i) the managing underwriter(s) in any Underwritten Offering of primary shares of
Common Stock by the Company has advised the Company that the offer or sale of Registrable Shares pursuant to the Registration Statement would have a material adverse effect on the Companys primary offering; (ii) a majority of the Board of Directors of the Company determines in good faith that (A) the offer or sale of any Registrable Shares would materially impede, delay or interfere with any proposed financing, offer or sale of securities, acquisition, corporate reorganization or other material transaction involving the Company (B) after the advice of counsel, the sale of Registrable Shares pursuant to the Registration Statement would require disclosure of non public material information not otherwise required to be disclosed under applicable law, and (C) (x) the Company has a bona fide business purposes for preserving the confidentiality of such transaction, (y) disclosure would have a material adverse effect on the Company or the Companys ability to consummate such transaction, or (z) such transaction renders the Company unable to comply with SEC requirements, in each case under circumstances that would make it impractical or inadvisable to cause the Registration Statement (or such filings) to become effective or to promptly amend or supplement the Registration Statement on a post effective basis, as applicable; or (iii) a majority of the Board of Directors of the Company determines in good faith, upon the advice of counsel, that it is in our best interest or it is required by law, rule or regulation to supplement the Registration Statement or file a post-effective amendment to the Registration Statement in order to ensure that the Prospectus (1) contains the information required under Section 10(a)(3) of the 1933 Act; (2) discloses any facts or events arising after the effective date of the Registration Statement (or of the most-recent post-effective amendment) that, individually or in the aggregate, represents a fundamental change in the information set forth therein; or (3) discloses any material information with respect to the plan of distribution that was not disclosed in the Registration Statement or any material change to such information. Upon the occurrence of any such suspension, the Company shall use its commercially reasonable efforts to cause the Registration Statement to become effective or to promptly amend or supplement the Registration Statement on a post-effective basis or to take such action as is necessary to make resumed use of the Registration Statement as soon as possible.
(b) In the case of an event that causes the Company to suspend the use of a Registration Statement as set forth in paragraph (a) above (a Suspension Event ), the Company shall give a Suspension Notice to the Selling Holders Counsel, if any, and the Holders to suspend sales of the Registrable Shares and such notice shall state generally the basis for the notice and that such suspension shall continue only for so long as the Suspension Event or its effect is continuing and the Company is using its commercially reasonable efforts and taking all reasonable steps to terminate suspension of the use of the Registration Statement as promptly as possible. A Holder shall not affect any sales of the Registrable Shares pursuant to such Registration Statement (or such filings) at any time after it has received a Suspension Notice from the Company and prior to receipt of an End of Suspension Notice (as defined below). If so directed by the Company, each Holder will deliver to the Company (at the expense of the Company) all copies other than permanent file copies then in such Holders possession of the Prospectus covering the Registrable Shares at the time of receipt of the Suspension Notice. The Holders may recommence effecting sales of the Registrable Shares pursuant to the Registration Statement (or such filings) following further written notice to such effect (an End of Suspension Notice ) from the Company, which End of Suspension Notice shall be given by the Company to the Holders and Selling Holders Counsel, if any, promptly following the conclusion of any Suspension Event and its effect.
(c) Notwithstanding any provision herein to the contrary, if the Company shall give a Suspension Notice with respect to any Registration Statement pursuant to this Section 5, the Company agrees that it shall extend the period of time during which such Registration Statement shall be maintained effective pursuant to this Agreement by the number of days during the period from the date of receipt by the Holders of the Suspension Notice to and including the date of receipt by the Holders of the End of Suspension Notice and provide copies of the supplemented or amended Prospectus necessary to resume sales, with respect to each Suspension Event; provided that such period of time shall not be extended beyond the date that Common Stock covered by such Registration Statement are no longer Registrable Shares.
6. Market Stand-Off Agreement . Each Holder hereby agrees that it shall not, directly or indirectly sell, offer to sell (including without limitation any short sale), pledge, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant for the sale of or otherwise
dispose of or transfer any Registrable Shares or other Common Stock or any securities convertible into or exchangeable or exercisable for Common Stock then owned by such Holder (other than to donees or partners of the Holder who agree to be similarly bound) for a period commencing on the effective date of the IPO registration statement and ending 60 days following such effective date; provided, however, that:
(a) all officers and directors of the Company then holding Common Stock or securities convertible into or exchangeable or exercisable for Common Stock enter into similar agreements for not less than the entire time period required of the Holders hereunder; and
(b) the Holders shall be allowed any concession or proportionate release allowed to any officer or director of the Company that entered into similar agreements (with such proportion being determined by dividing the number of shares being released with respect to such officer or director by the total number of issued and outstanding shares held by such Holder, officer or director); provided, that nothing in this Section 6(c) shall be construed as a right to proportionate release for the officers and directors of the Company upon the expiration of the 60 day period applicable to all Holders, officers and directors of the Company.
In order to enforce the foregoing covenant, the Company shall have the right to place restrictive legends on the certificates representing the securities subject to this Section 6 and to impose stop transfer instructions with respect to the Registrable Shares and such other securities of each Holder (and the securities of every other Person subject to the foregoing restriction) until the end of such period.
7. Termination of the Companys Obligations . The Company shall have no further obligations pursuant to this Agreement at such time as no Registrable Shares are outstanding, provided, however, that the Companys obligations under Sections 4 and 9 of this Agreement shall remain in full force and effect following such time.
8. Limitations on Subsequent Registration Rights . From and after the date of this Agreement, the Company shall not, without the prior written consent of the Holders (other than Affiliates of the Company) of a majority of the then outstanding Registrable Shares, enter into any agreement with any holder or prospective holder of any securities of the Company that would provide such holder or prospective holder with registration rights that are superior in any material respect to the registration rights of the Holders set forth herein; provided that the Company may provide any such registration rights that are not superior in any respect to the registration rights of the Holders set forth herein to any Affiliates of the Company or ZAIS Group.
9. Miscellaneous .
9.1 Rule 144 and Rule 144A . For so long as the Company is subject to the reporting requirements of Section 13 or 15 of the 1934 Act, the Company covenants that it will file the reports required to be filed by it under the 1933 Act and Section 13(a) or 15(d) of the 1934 Act and the rules and regulations adopted by the SEC thereunder. If the Company ceases to be so required to file such reports, the Company covenants that it will upon the request of any Holder of Registrable Shares (a) make publicly available such information as is necessary to permit sales pursuant to Rule 144 under the 1933 Act, (b) deliver such information to a prospective purchaser as is necessary to permit sales pursuant to Rule 144A under the 1933 Act and it will take such further action as any Holder of Registrable Shares may reasonably request, and (c) take such further action that is reasonable in the circumstances, in each case to the extent required from time to time to enable such Holder to sell its Registrable Shares without registration under the 1933 Act within the limitation of the exemptions provided by (i) Rule 144 under the 1933 Act, as such Rule may be amended from time to time, (ii) Rule 144A under the 1933 Act, as such rule may be amended from time to time, or (iii) any similar rules or regulations hereafter adopted by the SEC. Upon the request of any Holder of Registrable Shares, the Company will deliver to such Holder a written statement as to whether it has complied with such requirements (at any time after 90 days after the effective date of the first Registration Statement filed by the Company for an offering of its Common Stock to the general public) and of the 1933 Act and the 1934 Act (at any time after it has become subject to the reporting requirements of the 1934 Act), a copy of the most recent annual and quarterly report(s) of the Company, and such other reports, documents or stockholder communications of the Company, and take
such further actions consistent with this Section 9.1, as a Holder may reasonably request in availing itself of
any rule or regulation of the SEC allowing a Holder to sell any such Registrable Shares without registration.
9.2 No Inconsistent Agreements . The Company has not entered into and the Company will not after the date of this Agreement enter into any agreement which is inconsistent with the rights granted to the Holders of Registrable Shares pursuant to this Agreement or otherwise conflicts with the provisions of this Agreement. The rights granted to the Holders hereunder do not and will not for the term of this Agreement in any way conflict with the rights granted to the holders of the Companys other issued and outstanding securities under any such agreements.
9.3 Amendments and Waivers . The provisions of this Agreement, including the provisions of this sentence, may not be amended, modified or supplemented, and waivers or consents to departures from the provisions hereof may not be given unless the Company has obtained the written consent of the Holders (other than Affiliates of the Company) of at least a majority of the outstanding Registrable Shares affected by such amendment, modification, supplement, waiver or departure.
9.4 Notices . All notices and other communications provided for or permitted hereunder shall be made in writing by hand delivery, registered first-class mail, facsimile or any courier guaranteeing overnight delivery (a) if to a Holder, at the most current address given by such Holder to the Company by means of a notice given in accordance with the provisions of this Section 9.4 and (b) if to the Company, ZAIS Financial Corp., Two Bridge Avenue, Suite 322, Red Bank, New Jersey 07701-1106, Attention: General Counsel (facsimile: (732) 978-7507).
All such notices and communications shall be deemed to have been duly given: at the time delivered by hand, if personally delivered; two Business Days after being deposited in the mail, postage prepaid, if mailed; when receipt is acknowledged, if sent by facsimile (provided confirmation of transmission is mechanically or electronically generated and kept on file by the sending party) and on the next Business Day if timely delivered to an air courier guaranteeing overnight delivery.
9.5 Successor and Assigns . This Agreement shall inure to the benefit of and be binding upon the successors, assigns and transferees of each of the parties hereto, including, without limitation and without the need for an express assignment, subsequent Holders.
9.6 Specific Enforcement . Without limiting the remedies available to the Holders, the Company acknowledges that any failure by the Company to comply with its obligations under Sections 2.1 through 2.3 hereof may result in material irreparable injury to the Holders for which there is no adequate remedy at law, that it would not be possible to measure damages for such injuries precisely and that, in the event of any such failure, any Holder may obtain such relief as may be required to specifically enforce the Companys obligations under Sections 2.1 through 2.3 hereof.
9.7 Counterparts . This Agreement may be executed in any number of counterparts and by the 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.
9.8 Headings . The headings in this Agreement are for convenience of reference only and shall not limit or otherwise affect the meaning hereof.
9.9 GOVERNING LAW . THIS AGREEMENT SHALL BE GOVERNED BY, AND CONSTRUED AND INTERPRETED IN ACCORDANCE WITH, THE LAW OF THE STATE OF NEW YORK.
9.10 Severability . In the event that any one or more of the provisions contained herein, or the application thereof in any circumstance, is held invalid, illegal or unenforceable, the validity, legality and enforceability of any such provision in every other respect and of the remaining provisions contained herein shall not be affected or impaired thereby.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first written above.
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ZAIS FINANCIAL CORP. |
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/s/ Michael Szymanski |
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Name: Michael Szymanski |
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Title: Chief Executive Officer |
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ZAIS GROUP, LLC |
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By: |
/s/ Michael Szymanski |
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Name: Michael Szymanski |
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Title: Chief Operating Officer |
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HOLDERS, as shown on Schedule I attached hereto |
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By: |
ZAIS, GROUP, LLC, as attorney-in-fact |
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By: |
/s/ Michael Szymanski |
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Name: Michael Szymanski |
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Title: Chief Operating Officer |
[ Signature Page to Registration Rights Agreement ]
SCHEDULE I
Holders
Exhibit 10.4
FIRST AMENEDED AND RESTATED REGISTRATION RIGHTS AGREEMENT
This First Amended and Restated Registration Rights Agreement (this Agreement ) is made and entered into this 11 th day of October, 2012, among ZAIS Financial Corp., a Maryland corporation (the Company ), ZAIS Group, LLC, a Delaware limited liability company ( ZAIS Group ) and certain persons listed on Schedule I hereto (such persons, in their capacities as holders of Registrable Shares (as defined below), the Holders , and each a Holder ).
The Company offered pursuant to an Exchange Offer Statement stockholders, limited partners or account owners (the Existing Holders ) of the ZAIS Matrix VI series of funds (the Matrix VI Funds ) and certain separate accounts managed by ZAIS Group the opportunity to exchange (the Exchange Offer ) a mutually agreeable portion of each such Existing Holders shares, limited partnership interests or separate account holdings (collectively, the Interests ) for shares of the Companys common stock, par value $0.0001 per share (the Common Stock ) or operating partnership units (the OP units ) in ZAIS Financial Partners, L.P. (the Operating Partnership ).
On August 3, 2011, Existing Holders of the Matrix VI Funds with a net asset value of approximately $60.5 million (calculated as of July 29, 2011) participated in the Exchange Offer receiving, in exchange for their Interests, an aggregate of 3,022,617 shares of Common Stock.
In order to induce Existing Holders to exchange their Interests for shares of common stock or OP units, the Company agreed to provide to such Existing Holders and investors and their respective direct and indirect transferees certain registration rights pursuant to that certain registration rights agreement, dated August 3, 2011, among the Company, ZAIS Group and the Holders (the Registration Rights Agreement ).
The parties hereto desire to amend the Registration Rights Agreement to make the registration rights contained therein consistent with the registration rights granted to investors in an additional private offering of shares of Common Stock and OP units and to make certain other amendments.
In consideration of the foregoing and the mutual covenants and agreements herein contained and other good and valid consideration, the receipt and sufficient of which are hereby acknowledged, the parties hereto agree as follows:
1. DEFINITIONS .
As used in this Agreement, the following capitalized defined terms shall have the following meanings:
1933 Act shall mean the Securities Act of 1933, as amended from time to time.
1934 Act shall mean the Securities Exchange Act of 1934, as amended from time to time.
Additional Shares shall mean shares of Common Stock (including the shares of Common Stock that may be issued by the Company upon redemption of the OP units) or other securities of the Company issued in respect of the Shares by reason of or in connection with any stock dividend, stock distribution, stock split, purchase in any rights offering or in connection with any exchange for or replacement of such shares or any combination of shares, recapitalization, merger or consolidation, or any other equity securities issued pursuant to any other pro rata distribution with respect to the shares of Common Stock.
Affiliate shall mean as to any specified Person any other Person directly or indirectly controlling or controlled by or under direct or indirect common control with such specified Person. For the purposes of this definition, control (including, with correlative meanings, the terms controlling, 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 or policies of such Person whether through the ownership of voting securities or by agreement or otherwise.
Business Days shall mean Monday, Tuesday, Wednesday, Thursday, and Friday that is not a day on which banking institutions in New York, New Jersey or other applicable places where such act is to occur are authorized or obligated by applicable law, regulation or executive order to close.
Common Stock shall have the meaning set forth in the preamble.
Company shall have the meaning set forth in the preamble and shall also include the Companys successors.
Controlling Person shall have the meaning set forth in Section 4(a) of this Agreement.
End of Suspension Notice shall have the meaning set forth in Section 5(b) of this Agreement.
Exchange Offer shall have the meaning set forth in the preamble.
FINRA shall mean the Financial Industry Regulatory Authority.
Holder shall have the meaning set forth in the preamble.
Interests shall have the meaning set forth in the preamble.
Liabilities shall have the meaning set forth in Section 4(a)(i) of this Agreement.
Listing shall mean the listing of shares of Common Stock on the NASDAQ Capital Market or another U.S. national securities exchange.
Matrix VI Funds shall have the meaning set forth in the preamble.
OP units shall have the meaning set forth in the preamble.
Operating Partnership shall have the meaning set forth in the preamble.
Participating Broker-Dealer shall mean any broker-dealer that makes a market in the Registrable Shares.
Person shall mean an individual, partnership (general or limited), corporation, limited liability company, trust or unincorporated organization, or a government or agency or political subdivision thereof.
Prospectus shall mean the prospectus included in a Registration Statement, including any preliminary prospectus, and any such prospectus as amended or supplemented by any prospectus supplement, including any such prospectus supplement with respect to the terms of the offering of any portion of the Registrable Shares covered by a Registration Statement, and by all other amendments and supplements to a prospectus, including post-effective amendments and free-writing prospectuses and in each case including all material incorporated by reference therein.
Registrable Shares shall mean the Shares and any Additional Shares; provided , however , that Shares and Additional Shares shall cease to be Registrable Shares (i) when a Registration Statement with respect to such Shares and Additional Shares shall have been declared effective under the 1933 Act and such Shares or Additional Shares shall have been disposed of pursuant to such Registration Statement, (ii) when such Shares or Additional Shares have ceased to be outstanding, (iii) on the second anniversary of the initial effective date of the Shelf Registration Statement or, in the case of any Additional Shares not included in the Shelf Registration Statement, until the second anniversary of the issuance of the Additional Shares or (iv) when, following the Listing, such Shares or Additional Shares are sold, transferred or otherwise disposed of pursuant to Rule 144 under the 1933 Act.
Registration Expenses shall mean any and all expenses incident to the performance of or compliance by the Company with this Agreement, whether or not any Registration Statement contemplated hereby is filed or declared effective by the SEC under the 1933 Act, including without limitation: (i) all SEC, stock exchange or FINRA registration and filing fees, including, if applicable, the fees and expenses of any qualified independent underwriter (and its counsel) that is required to be retained by any Holder in accordance with the rules and regulations of the FINRA, (ii) all fees and expenses incurred in connection with compliance with state securities or blue sky laws and compliance with the rules of the FINRA (including reasonable fees and disbursements of one firm of Selling Holders Counsel for any underwriters or Holders in connection with blue sky qualification of any Registrable Shares and any filings with the FINRA), (iii) all expenses of any Persons in preparing or assisting in preparing, word processing, printing, duplicating, mailing and distributing any Registration Statement, any Prospectus, any amendments or supplements thereto, any underwriting agreements, securities sales agreements and other documents relating to the performance of and compliance with this Agreement, (iv) all fees and expenses incurred in connection with the Listing, if any, of any of the Registrable Shares, (v) the fees and disbursements of counsel for the Company and of the independent registered public accounting firm of the Company, including the expenses of any special audits or comfort letters required by or incident to such performance and compliance, (vi) the fees
and expenses of the Companys transfer agent, and any escrow agent or custodian, (vii) the reasonable fees and disbursements of one firm of Selling Holders Counsel representing the Holders of Registrable Shares and (viii) any fees and disbursements of the underwriters customarily required to be paid by issuers or sellers of securities and the fees and expenses of any special experts retained by the Company in connection with any Registration Statement, but excluding underwriting discounts and commissions and transfer taxes, if any, relating to the sale or disposition of Registrable Shares by a Holder and the fees and disbursements of any counsel to the Holders, except as provided in clauses (ii) and (vii).
Registration Rights Agreement shall have the meaning set forth in the preamble.
Registration Statement shall mean any registration statement of the Company which covers any of the Registrable Shares and may include securities other than Registrable Shares pursuant to the provisions of this Agreement, and all amendments and supplements to any such Registration Statement, including pre- and post-effective amendments, in each case including the Prospectus contained therein, all exhibits thereto and all material incorporated by reference therein.
SEC shall mean the U.S. Securities and Exchange Commission or any successor agency or government body performing the functions currently performed by the U.S. Securities and Exchange Commission.
Selling Holders Counsel shall mean counsel for the Holders that is selected by the Holders holding a majority of the Registrable Shares included in a Registration Statement and that is reasonably acceptable to the Company.
Shares shall mean the shares of the Common Stock issued by the Company in the Exchange Offer.
Shelf Registration shall mean a registration effected pursuant to Section 2.1 of this Agreement.
Shelf Registration Statement shall mean a shelf registration which covers Registrable Shares and may include securities other than Registrable Shares on an appropriate form under the 1933 Act, and all amendments and supplements to such registration statement, including pre- and post-effective amendments, in each case including the Prospectus contained therein, all exhibits thereto and all material incorporated by reference therein.
Subsequent Shelf Registration Statement shall mean an additional shelf registration statement of the Company pursuant to the provisions of Section 2.2 of this Agreement which covers Additional Shares on an appropriate form under the 1933 Act, and all amendments and supplements to such registration statement, including pre- and post-effective amendments, in each case including the Prospectus contained therein, all exhibits thereto and all material incorporated by reference therein.
Suspension Event shall have the meaning set forth in Section 5(b) of this Agreement.
Suspension Notice shall have the meaning set forth in Section 5(a) of this Agreement.
Underwriter shall have the meaning set forth in Section 4(a) of this Agreement.
Underwritten Offering shall mean a sale of securities of the Company to an underwriter or underwriters for reoffering to the public.
ZAIS Group shall have the meaning set forth in the preamble.
2. Registration Under the 1933 Act .
2.1 Mandatory Shelf Registration .
(a) The Company agrees (i) to use its reasonable efforts to file a Shelf Registration Statement with the SEC no later than 270 days after the closing of the Companys Listing, subject to extension if the Company is bound by a lock-up agreement in connection with the Companys Listing which restricts the filing of a Shelf Registration Statement in which event the Company will be required to use its reasonable efforts to file a Shelf Registration Statement within 30 days after the expiration of the lock-up period, (ii) to use its commercially reasonable efforts to cause such Shelf Registration Statement providing for the resale of the Registrable Shares to be declared effective by the SEC as promptly as practicable after such filing and (iii) to use commercially reasonable efforts to maintain the Listing for the Registrable Shares registered in such Shelf Registration Statement .
(b) The Company shall use its commercially reasonable efforts to maintain the Shelf Registration Statement continuously effective in order to permit the Prospectus forming part thereof to be usable by the Holders.
(c) The Company shall use its commercially reasonable efforts to maintain the Shelf Registration Statements effectiveness under the 1933 Act until the first to occur of (i) such time as all of the Registrable Shares covered by the Shelf Registration Statement have been sold pursuant to the Shelf Registration Statement or pursuant to Rule 144 under the 1933 Act and (ii) the second anniversary after the closing of the Companys Listing.
(d) Notwithstanding any other provision hereof, the Company agrees to use its commercially reasonable efforts to ensure that (i) any Shelf Registration Statement and any amendment thereto and any Prospectus forming part thereof and any supplement thereto complies, when filed, in all material respects with the 1933 Act and the rules and regulations thereunder, (ii) any Shelf Registration Statement and any amendment thereto does not, when it becomes effective, contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements, in light of the circumstances under which they were made, not misleading and (iii) any Prospectus forming part of any Shelf Registration Statement, and any supplement to such Prospectus (as amended or supplemented from time to time), does not,
when filed, include an untrue statement of a material fact or omit to state a material fact necessary in order to make the statements, in light of the circumstances under which they were made, not misleading.
The Company may permit securities other than Registrable Shares to be included in the Shelf Registration Statement. The Company further agrees, if necessary, to supplement or amend the Shelf Registration Statement, as required by Section 3(b) below, and to furnish to the Holders copies of any such supplement or amendment promptly after its being used or filed with the SEC.
2.2 Subsequent Shelf Registration for Additional Shares . If any Additional Shares are issued or distributed to Holders after the effectiveness of the Shelf Registration Statement, or such Additional Shares were otherwise not included in a prior Shelf Registration Statement, then the Company shall as soon as practicable, but in no event later than 60 days after the issuance of such Additional Shares, file and use its commercially reasonable efforts to cause to be declared effective by the SEC as soon as practicable following such filing a Subsequent Shelf Registration Statement in the same manner, and subject to the same provisions.
2.3 Expenses . The Company shall pay all Registration Expenses in connection with the registration of the Registrable Shares pursuant to Section 2.1 or 2.2 hereof. Each Holder shall pay or otherwise bear such Holders proportionate share (based on the total amount of Registrable Shares sold in the Registration Statement) of all underwriting discounts and commissions and transfer taxes, if any, relating to the sale or disposition of such Holders Registrable Shares pursuant to the Shelf Registration Statement or any Subsequent Shelf Registration Statement.
3. Registration Procedures . In connection with the obligations of the Company with respect to a Registration Statement pursuant to Section 2 hereof, the Company shall:
(a) prepare and file with the SEC the Registration Statement, within the relevant time period specified in Section 2, on the appropriate form under the 1933 Act, which form (i) shall be selected by the Company, (ii) shall be available for the registration and sale of the Registrable Shares by the selling Holders thereof, (iii) shall comply as to form in all material respects with the requirements of the applicable form and include or incorporate by reference all financial statements required by the SEC to be filed therewith or incorporated by reference therein, and (iv) shall comply in all respects with the requirements of Regulation S-T under the 1933 Act, and otherwise comply with its obligations under Section 2 hereof;
(b) prepare and file with the SEC such amendments and post-effective amendments to each Registration Statement as may be necessary under applicable law to keep such Registration Statement effective for the applicable period; and cause each Prospectus to be supplemented by any required prospectus supplement, and as so supplemented to be filed pursuant to Rule 424 (or any similar provision then in force) under the 1933 Act and comply with the provisions of the 1933 Act, the 1934 Act and the
rules and regulations thereunder applicable to them with respect to the disposition of all securities covered by each Registration Statement during the applicable period in accordance with the intended method or methods of distribution by the selling Holders thereof (including sales by any Participating Broker-Dealer);
(c) (i) notify each Holder of Registrable Shares, at least five Business Days after filing, that a Registration Statement with respect to the Registrable Shares has been filed and advising such Holders that the distribution of Registrable Shares will be made in accordance with any method or combination of methods legally available by the Holders of any and all Registrable Shares; (ii) furnish to each Holder of Registrable Shares and to each underwriter of an Underwritten Offering of Registrable Shares, if any, without charge, as many copies of each Prospectus, including each preliminary Prospectus, and any amendment or supplement thereto and such other documents as such Holder or underwriter may reasonably request, including financial statements and schedules in order to facilitate the public sale or other disposition of the Registrable Shares; and (iii) hereby consent to the use of the Prospectus or any amendment or supplement thereto by each of the selling Holders of Registrable Shares in connection with the offering and sale of the Registrable Shares covered by the Prospectus or any amendment or supplement thereto;
(d) use its commercially reasonable efforts to register or qualify the Registrable Shares under all applicable state securities or blue sky laws of such jurisdictions as any Holder of Registrable Shares covered by a Registration Statement and each underwriter of an Underwritten Offering of Registrable Shares shall reasonably request by the time the applicable Registration Statement is declared effective by the SEC, and do any and all other acts and things which may be reasonably necessary or advisable to enable each such Holder and underwriter to consummate the disposition in each such jurisdiction of such Registrable Shares owned by such Holder; provided , however , that the Company shall not be required to (i) qualify as a foreign corporation or as a dealer in securities in any jurisdiction where it would not otherwise be required to qualify but for this Section 3(d), or (ii) take any action which would subject it to general service of process or taxation in any such jurisdiction where it is not then so subject;
(e) notify promptly each Holder of Registrable Shares under a Registration Statement and, if requested by such Holder, confirm such advice in writing promptly at the address determined in accordance with Section 9.4 of this Agreement (i) when a Registration Statement has become effective and when any post-effective amendments and supplements thereto become effective, (ii) of any request by the SEC or any state securities authority for post-effective amendments and supplements to a Registration Statement and Prospectus or for additional information after the Registration Statement has become effective, (iii) of the issuance by the SEC or any state securities authority of any stop order suspending the effectiveness of a Registration Statement or the initiation of any proceedings for that purpose, (iv) in the case of a Shelf Registration, if, between the effective date of a Registration Statement and the closing of any sale of Registrable Shares covered thereby, the representations and warranties of the Company contained in any underwriting agreement, securities sales agreement or other similar agreement, if any,
relating to the offering cease to be true and correct in all material respects, (v) of the happening of any event or the discovery of any facts during the period a Registration Statement is effective as a result of which such Registration Statement or the related Prospectus or any document incorporated by reference therein contains any untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein not misleading or, in the case of the Prospectus, contains any untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading (which information shall be accompanied by an instruction to suspend the use of the Registration Statement and the Prospectus (such instruction to be provided in the same manner as a Suspension Notice) until the requisite changes have been made, at which time notice of the end of suspension shall be delivered in the same manner as an End of Suspension Notice), (vi) of the receipt by the Company of any notification with respect to the suspension of the qualification of the Registrable Shares, for sale in any jurisdiction or the initiation or threatening of any proceeding for such purpose and (vii) of the filing of a post-effective amendment to such Registration Statement;
(f) furnish Selling Holders Counsel, if any, copies of any comment letters relating to the selling Holders received from the SEC or any other request by the SEC or any state securities authority for amendments or supplements to a Registration Statement and Prospectus or for additional information relating to the selling Holders;
(g) make every reasonable effort to obtain the withdrawal of any order suspending the effectiveness of a Registration Statement at the earliest possible moment;
(h) furnish to each Holder of Registrable Shares, and each underwriter, if any, without charge, at least one conformed copy of each Registration Statement and any post-effective amendment thereto, including financial statements and schedules (without documents incorporated therein by reference and all exhibits thereto, unless requested);
(i) cooperate with the selling Holders to facilitate the timely preparation and delivery of certificates representing Registrable Shares to be sold and not bearing any restrictive legends; and enable such Registrable Shares to be in such denominations and registered in such names as the selling Holders or the underwriters, if any, may reasonably request at least three Business Days prior to the closing of any sale of Registrable Shares;
(j) upon the occurrence of any event or the discovery of any facts, as contemplated by Sections 3(e)(v) and 3(e)(vi) hereof, as promptly as practicable after the occurrence of such an event, use its best efforts to prepare a supplement or post-effective amendment to the Registration Statement or the related Prospectus or any document incorporated therein by reference or file any other required document so that, as thereafter delivered to the purchasers of the Registrable Shares or Participating Broker-Dealers, such Prospectus will not contain at the time of such delivery any untrue statement of a material fact or omit to state a material fact necessary to make the
statements therein, in light of the circumstances under which they were made, not misleading, or will remain so qualified, as applicable. At such time as such public disclosure is otherwise made or the Company determines that such disclosure is not necessary, in each case to correct any misstatement of a material fact or to include any omitted material fact, the Company agrees promptly to notify each Holder of such determination and to furnish each Holder such number of copies of the Prospectus as amended or supplemented, as such Holder may reasonably request;
(k) within a reasonable time prior to the filing of any Registration Statement, any Prospectus, any amendment to a Registration Statement or amendment or supplement to a Prospectus, provide copies of such document to Selling Holders Counsel, if any, on behalf of such Holders, and make representatives of the Company as shall be reasonably requested by the Holders of Registrable Shares available for discussion of such document;
(l) obtain a CUSIP number for the Registrable Shares not later than the effective date of a Registration Statement, and provide the Companys transfer agent with printed certificates for the Registrable Shares;
(m) enter into agreements (including underwriting agreements) and take all other customary appropriate actions in order to expedite or facilitate the disposition of such Registrable Shares whether or not an underwriting agreement is entered into and whether or not the registration is an underwritten registration:
(i) make such representations and warranties to the Holders of such Registrable Shares and the underwriters, if any, in form, substance and scope as are customarily made by issuers to underwriters in similar underwritten offerings as may be reasonably requested by them;
(ii) obtain opinions of counsel to the Company and updates thereof (which counsel and opinions (in form, scope and substance) shall be reasonably satisfactory to any managing underwriter(s) and their counsel) addressed to the underwriters, if any (and in the case of an underwritten registration, each selling Holder), covering the matters customarily covered in opinions requested in underwritten offerings and such other matters as may be reasonably requested by the underwriter(s);
(iii) obtain comfort letters and updates thereof from the Companys independent registered public accounting firm (and, if necessary, any other independent certified public accountants of any subsidiary of the Company or of any business acquired by the Company for which financial statements are, or are required to be, included in the Registration Statement) addressed to the underwriter(s), if any, and use reasonable efforts to have such letter addressed to the selling Holders in the case of an underwritten registration (to the extent consistent with Statement on Auditing Standards No. 72 of the American Institute of Certified Public Accounts), such letters to be in customary form and covering
matters of the type customarily covered in comfort letters to underwriters in connection with similar underwritten offerings;
(iv) enter into a securities sales agreement with the Holders and an agent of the Holders providing for, among other things, the appointment of such agent for the selling Holders for the purpose of soliciting purchases of Registrable Shares, which agreement shall be in form, substance and scope customary for similar offerings;
(v) if an underwriting agreement is entered into, cause the same to set forth indemnification provisions and procedures substantially equivalent to the indemnification provisions and procedures set forth in Section 4 hereof with respect to the underwriters and all other parties to be indemnified pursuant to said Section or, at the request of any underwriters, in the form customarily provided to such underwriters in similar types of transactions; and
(vi) deliver such documents and certificates as may be reasonably requested and as are customarily delivered in similar offerings to the Holders holding a majority of the Registrable Shares being sold and the managing underwriters, if any;
(n) make available for inspection by any underwriter participating in any disposition pursuant to a Registration Statement, any Participating Broker-Dealer, Selling Holders Counsel and any accountant retained by Holders holding a majority of the Registrable Shares being sold, all financial and other records, pertinent corporate documents and properties or assets of the Company reasonably requested by any such persons, and cause the respective officers, directors, employees, and any other agents of the Company to supply all information reasonably requested by any such representative, underwriter, counsel or accountant in connection with a Registration Statement, and make such representatives of the Company available for discussion of such documents as shall be reasonably requested by the Selling Holders Counsel; provided , however , that the Selling Holders Counsel, if any, and the representatives of any underwriters will use commercially reasonable efforts, to the extent reasonably practicable, to coordinate the foregoing inspection and information gathering and to not materially disrupt the Companys business operations;
(o) a reasonable time prior to filing any Registration Statement, any Prospectus forming a part thereof, any amendment to such Registration Statement, or amendment or supplement to such Prospectus, provide copies of such document to the underwriter(s) of an Underwritten Offering of Registrable Shares; within five Business Days after the filing of any Registration Statement, provide copies of such Registration Statement to Selling Holders Counsel; make such changes in any of the foregoing documents prior to the filing thereof, or in the case of changes received from Selling Holders Counsel by filing an amendment or supplement thereto, as the underwriter or underwriters, or in the case of changes received from Selling Holders Counsel relating to the selling Holders or the plan of distribution of Registrable Shares, as Selling Holders
Counsel, reasonably requests; not file any such document in a form to which any underwriter shall not have previously been advised and furnished a copy of or to which the Selling Holders Counsel, if any, on behalf of the Holders of Registrable Shares, or any underwriter shall reasonably object; not include in any amendment or supplement to such documents any information about the selling Holders or any change to the plan of distribution of Registrable Shares that would limit the method of distribution of the Registrable Shares unless Selling Holders Counsel has been advised in advance and has approved such information or change; and make the representatives of the Company available for discussion of such document as shall be reasonably requested by the Selling Holders Counsel, if any, on behalf of such Holders, Selling Holders Counsel or any underwriter;
(p) use its best efforts to maintain the listing of all the Registrable Shares on the NASDAQ Capital Market or another U.S. national securities exchange;
(q) otherwise comply with all applicable rules and regulations of the SEC and make available to its security holders, as soon as reasonably practicable, an earnings statement covering at least 12 months which shall satisfy the provisions of Section 11(a) of the 1933 Act and Rule 158 thereunder;
(r) cooperate and assist in any filings required to be made with the FINRA and in the performance of any due diligence investigation by any underwriter and its counsel (including any qualified independent underwriter that is required to be retained in accordance with the rules and regulations of the FINRA); and
(s) the Company may (as a condition to a Holders participation in the Shelf Registration) require each Holder of Registrable Shares to furnish to the Company such information regarding the Holder and the proposed distribution by such Holder of such Registrable Shares as the Company may from time to time reasonably request in writing.
Each Holder agrees that, upon receipt of any notice from the Company of the happening of any event or the discovery of any facts of the type described in Section 3(e)(v) hereof, such Holder will forthwith discontinue disposition of Registrable Shares pursuant to a Registration Statement until such Holders receipt of the copies of the supplemented or amended Prospectus contemplated by Section 3(k) hereof, and, if so directed by the Company, such Holder will deliver to the Company (at the Companys expense) all copies in such Holders possession, other than permanent file copies then in such Holders possession, of the Prospectus covering such Registrable Shares current at the time of receipt of such notice.
If any of the Registrable Shares covered by a Registration Statement, are to be sold in an Underwritten Offering, the Company will select the underwriter(s) and managing underwriter(s) that will manage such offering. No Holder of Registrable Shares may participate in any Underwritten Offering hereunder unless such Holder (a) agrees to sell such Holders Registrable Shares on the basis provided in any underwriting arrangements approved by the persons entitled hereunder to approve such arrangements and (b) completes and executes all questionnaires,
powers of attorney, indemnities, underwriting agreements and other documents required under the terms of such underwriting arrangements.
4. Indemnification; Contribution .
(a) The Company agrees to indemnify and hold harmless each Holder, each Participating Broker-Dealer, each Person who participates as an underwriter (any such Person being an Underwriter ) and each Person (a Controlling Person ), if any, who controls (within the meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act) any of the foregoing Persons, as follows:
(i) against any and all loss, liability, claim, damage, judgment, actions, other liabilities and expense whatsoever (the Liabilities ), as incurred, arising out of any untrue statement or alleged untrue statement of a material fact contained in any Registration Statement (or any amendment or supplement thereto) pursuant to which Registrable Shares were registered under the 1933 Act, including all documents incorporated therein by reference, or the omission or alleged omission therefrom of a material fact required to be stated therein or necessary to make the statements therein not misleading, or arising out of any untrue statement or alleged untrue statement of a material fact contained in any Prospectus (or any amendment or supplement thereto) or the omission or alleged omission therefrom at such date of a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading;
(ii) against any and all Liabilities, as incurred, to the extent of the aggregate amount paid in settlement of any litigation, or any investigation or proceeding by any governmental agency or body, commenced or threatened, or of any claim whatsoever based upon any such untrue statement or omission, or any such alleged untrue statement or omission; provided that (subject to Section 4(d) below) any such settlement is effected with the written consent of the Company; and
(iii) against any and all expense whatsoever, as incurred (including the fees and disbursements of counsel chosen by any indemnified party), reasonably incurred in investigating, preparing or defending against any litigation, or any investigation or proceeding by any governmental agency or body, commenced or threatened, or any claim whatsoever based upon any such untrue statement or omission, or any such alleged untrue statement or omission, to the extent that any such expense is not paid under subparagraph (i) or (ii) above;
provided , however , that this indemnity agreement shall not apply to any Liabilities to the extent arising out of any untrue statement or omission or alleged untrue statement or omission made in reliance upon and in conformity with written information furnished to the Company by the Holder or Underwriter expressly for use in a Registration Statement (or any amendment thereto) or any Prospectus (or any amendment or supplement thereto).
(b) Each Holder severally, but not jointly, agrees to indemnify and hold harmless the Company, each Underwriter and the other selling Holders, and each of their respective officers, directors, partners, employees, representatives and agents, and each of their respective Controlling Persons, against any and all Liabilities described in the indemnity contained in Section 4(a) hereof, as incurred, but only with respect to untrue statements or omissions, or alleged untrue statements or omissions, made in the Registration Statement (or any amendment thereto) or any Prospectus included therein (or any amendment or supplement thereto) in reliance upon and in conformity with written information with respect to such Holder furnished to the Company by such Holder expressly for use in the Registration Statement (or any amendment thereto) or such Prospectus (or any amendment or supplement thereto); provided , however , that no such Holder shall be liable for any claims hereunder in excess of the amount of net proceeds received by such Holder from the sale of Registrable Shares pursuant to such Registration Statement.
(c) Each indemnified party shall give notice as promptly as reasonably practicable to each indemnifying party of any action or proceeding commenced against it in respect of which indemnity may be sought hereunder, but failure so to notify an indemnifying party shall not relieve such indemnifying party from any liability hereunder to the extent it is not materially prejudiced as a result thereof and in any event shall not relieve it from any liability which it may have otherwise than on account of this indemnity agreement. An indemnifying party may participate at its own expense in the defense of such action; provided , however , that counsel to the indemnifying party shall not (except with the consent of the indemnified party) also be counsel to the indemnified party. In no event shall the indemnifying party or parties be liable for the fees and expenses of more than one counsel (in addition to any local counsel) separate from their own counsel for all indemnified parties in connection with any one action or separate but similar or related actions in the same jurisdiction arising out of the same general allegations or circumstances. No indemnifying party shall, without the prior written consent of the indemnified parties, settle or compromise or consent to the entry of any judgment with respect to any litigation, or any investigation or proceeding by any governmental agency or body, commenced or threatened, or any claim whosoever in respect of which indemnification or contribution could be sought under this Section 4 (whether or not the indemnified parties are actual or potential parties thereto), unless such settlement, compromise or consent (i) includes an unconditional release of each indemnified party from all liability arising out of such litigation, investigation, proceeding or claim and (ii) does not include a statement as to or an admission of fault, culpability or a failure to act by or on behalf of any indemnified party.
(d) If at any time an indemnified party shall have requested an indemnifying party to reimburse the indemnified party for fees and expenses of counsel, such indemnifying party agrees that it shall be liable for any settlement of the nature contemplated by Section 4(a)(ii) effected without its written consent if (i) such settlement is entered into more than 45 days after receipt by such indemnifying party of the aforesaid request, (ii) such indemnifying party shall have received notice of the terms of such settlement at least 30 days prior to such settlement being entered into and (iii) such
indemnifying party shall not have reimbursed such indemnified party in accordance with such request prior to the date of such settlement.
(e) If the indemnification provided for in this Section 4 is for any reason unavailable to or insufficient to hold harmless an indemnified party in respect of any Liabilities referred to therein, then each indemnifying party shall contribute to the aggregate amount of such Liabilities incurred by such indemnified party, as incurred, in such proportion as is appropriate to reflect the relative fault of the Company on the one hand and the Holders on the other hand in connection with the statements or omissions which resulted in such Liabilities, as well as any other relevant equitable considerations.
The relative fault of the Company on the one hand and the Holders on the other hand shall be determined by reference to, among other things, whether any such untrue or alleged untrue statement of a material fact or omission or alleged omission to state a material fact relates to information supplied by the Company or the Holders and the parties relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission.
The Company and the Holders agree that it would not be just and equitable if contribution pursuant to this Section 4 were determined by pro rata allocation or by any other method of allocation which does not take account of the equitable considerations referred to above in this Section 4. The aggregate amount of Liabilities incurred by an indemnified party and referred to above in this Section 4 shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in investigating, preparing or defending against any litigation, or any investigation or proceeding by any governmental agency or body, commenced or threatened, or any claim whatsoever based upon any such untrue or alleged untrue statement or omission or alleged omission.
No Person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the 1933 Act) shall be entitled to contribution from any Person who was not guilty of such fraudulent misrepresentation.
For purposes of this Section 4, each Person, if any, who controls a Holder within the meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act shall have the same rights to contribution as the Holder, and each director of the Company, and each Person, if any, who controls the Company within the meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act shall have the same rights to contribution as the Company.
5. Black-Out Period .
(a) Subject to the provisions of this Section 5, the Company shall be permitted, in limited circumstances, to suspend the use, from time to time, of the Prospectus that is part of a Shelf Registration Statement (and therefore suspend sales of the Registrable Shares under such Registration Statement), by providing written notice (a Suspension Notice ) to Selling Holders Counsel, if any, and the Holders and by issuing a press release, making a filing with the SEC or such other means that the Company reasonably
believes to be a reliable means of communication, for such times as the Company reasonably may determine is necessary and advisable (but in no event for more than an aggregate of 90 days in any rolling 12-month period commencing on the date of this Agreement or more than 45 consecutive days, except as a result of a refusal by the SEC to declare any post-effective amendment to the Registration Statement effective after the Company has used all commercially reasonable efforts to cause the post-effective amendment to be declared effective by the SEC, in which case, the Company must terminate the black-out period immediately following the effective date of the post-effective amendment) if any of the following events shall occur: (i) the managing underwriter(s) in any Underwritten Offering of primary shares of Common Stock by the Company has advised the Company that the offer or sale of Registrable Shares pursuant to the Registration Statement would have a material adverse effect on the Companys primary offering; (ii) a majority of the Board of Directors of the Company determines in good faith that (A) the offer or sale of any Registrable Shares would materially impede, delay or interfere with any proposed financing, offer or sale of securities, acquisition, corporate reorganization or other material transaction involving the Company (B) after the advice of counsel, the sale of Registrable Shares pursuant to the Registration Statement would require disclosure of non public material information not otherwise required to be disclosed under applicable law, and (C) (x) the Company has a bona fide business purposes for preserving the confidentiality of such transaction, (y) disclosure would have a material adverse effect on the Company or the Companys ability to consummate such transaction, or (z) such transaction renders the Company unable to comply with SEC requirements, in each case under circumstances that would make it impractical or inadvisable to cause the Registration Statement (or such filings) to become effective or to promptly amend or supplement the Registration Statement on a post effective basis, as applicable; or (iii) a majority of the Board of Directors of the Company determines in good faith, upon the advice of counsel, that it is in the Companys best interest or it is required by law, rule or regulation to supplement the Registration Statement or file a post-effective amendment to the Registration Statement in order to ensure that the Prospectus (1) contains the information required under Section 10(a)(3) of the 1933 Act; (2) discloses any facts or events arising after the effective date of the Registration Statement (or of the most-recent post-effective amendment) that, individually or in the aggregate, represents a fundamental change in the information set forth therein; or (3) discloses any material information with respect to the plan of distribution that was not disclosed in the Registration Statement or any material change to such information. Upon the occurrence of any such suspension, the Company shall use its commercially reasonable efforts to cause the Registration Statement to become effective or to promptly amend or supplement the Registration Statement on a post-effective basis or to take such action as is necessary to make resumed use of the Registration Statement as soon as possible.
(b) In the case of an event that causes the Company to suspend the use of a Registration Statement as set forth in paragraph (a) above (a Suspension Event ), the Company shall give a Suspension Notice to the Selling Holders Counsel, if any, and the Holders to suspend sales of the Registrable Shares and such notice shall state generally
the basis for the notice and that such suspension shall continue only for so long as the Suspension Event or its effect is continuing and the Company is using its commercially reasonable efforts and taking all reasonable steps to terminate suspension of the use of the Registration Statement as promptly as possible. A Holder shall not affect any sales of the Registrable Shares pursuant to such Registration Statement (or such filings) at any time after it has received a Suspension Notice from the Company and prior to receipt of an End of Suspension Notice (as defined below). If so directed by the Company, each Holder will deliver to the Company (at the expense of the Company) all copies other than permanent file copies then in such Holders possession of the Prospectus covering the Registrable Shares at the time of receipt of the Suspension Notice. The Holders may recommence effecting sales of the Registrable Shares pursuant to the Registration Statement (or such filings) following further written notice to such effect (an End of Suspension Notice ) from the Company, which End of Suspension Notice shall be given by the Company to the Holders and Selling Holders Counsel, if any, promptly following the conclusion of any Suspension Event and its effect.
(c) Notwithstanding any provision herein to the contrary, if the Company shall give a Suspension Notice with respect to any Registration Statement pursuant to this Section 5, the Company agrees that it shall extend the period of time during which such Registration Statement shall be maintained effective pursuant to this Agreement by the number of days during the period from the date of receipt by the Holders of the Suspension Notice to and including the date of receipt by the Holders of the End of Suspension Notice and provide copies of the supplemented or amended Prospectus necessary to resume sales, with respect to each Suspension Event; provided that such period of time shall not be extended beyond the date that Common Stock covered by such Registration Statement are no longer Registrable Shares.
6. Market Stand-Off Agreement . Each Holder hereby agrees that it shall not, directly or indirectly sell, offer to sell (including without limitation any short sale), pledge, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant for the sale of or otherwise dispose of or transfer any Registrable Shares or other Common Stock or any securities convertible into or exchangeable or exercisable for Common Stock then owned by such Holder (other than to donees or partners of the Holder who agree to be similarly bound) for a period commencing on the effective date of the Listing registration statement and ending 60 days following such effective date; provided , however , that:
(a) all officers and directors of the Company then holding Common Stock or securities convertible into or exchangeable or exercisable for Common Stock enter into similar agreements for not less than the entire time period required of the Holders hereunder; and
(b) the Holders shall be allowed any concession or proportionate release allowed to any officer or director of the Company that entered into similar agreements (with such proportion being determined by dividing the number of shares being released with respect to such officer or director by the total number of issued and outstanding
shares held by such Holder, officer or director); provided , that nothing in this Section 6(c) shall be construed as a right to proportionate release for the officers and directors of the Company upon the expiration of the 60 day period applicable to all Holders, officers and directors of the Company.
In order to enforce the foregoing covenant, the Company shall have the right to place restrictive legends on the certificates representing the securities subject to this Section 6 and to impose stop transfer instructions with respect to the Registrable Shares and such other securities of each Holder (and the securities of every other Person subject to the foregoing restriction) until the end of such period.
7. Termination of the Companys Obligations . The Company shall have no further obligations pursuant to this Agreement at such time as no Registrable Shares are outstanding, provided , however , that the Companys obligations under Sections 4 and 9 of this Agreement shall remain in full force and effect following such time.
8. Limitations on Subsequent Registration Rights . From and after the date of this Agreement, the Company shall not, without the prior written consent of the Holders (other than Affiliates of the Company) of a majority of the then outstanding Registrable Shares, enter into any agreement with any holder or prospective holder of any securities of the Company that would provide such holder or prospective holder with registration rights that are superior in any material respect to the registration rights of the Holders set forth herein; provided that the Company may provide any such registration rights that are not superior in any respect to the registration rights of the Holders set forth herein to any Affiliates of the Company or ZAIS Group.
9. Miscellaneous .
9.1 Rule 144 and Rule 144A . For so long as the Company is subject to the reporting requirements of Section 13 or 15 of the 1934 Act, the Company covenants that it will file the reports required to be filed by it under the 1933 Act and Section 13(a) or 15(d) of the 1934 Act and the rules and regulations adopted by the SEC thereunder. If the Company ceases to be so required to file such reports, the Company covenants that it will upon the request of any Holder of Registrable Shares (a) make publicly available such information as is necessary to permit sales pursuant to Rule 144 under the 1933 Act, (b) deliver such information to a prospective purchaser as is necessary to permit sales pursuant to Rule 144A under the 1933 Act and it will take such further action as any Holder of Registrable Shares may reasonably request, and (c) take such further action that is reasonable in the circumstances, in each case to the extent required from time to time to enable such Holder to sell its Registrable Shares without registration under the 1933 Act within the limitation of the exemptions provided by (i) Rule 144 under the 1933 Act, as such Rule may be amended from time to time, (ii) Rule 144A under the 1933 Act, as such rule may be amended from time to time, or (iii) any similar rules or regulations hereafter adopted by the SEC. Upon the request of any Holder of Registrable Shares, the Company will deliver to such Holder a written statement as to whether it has complied with such requirements (at any time after 90 days after the effective date of the
first Registration Statement filed by the Company for an offering of its Common Stock to the general public) and of the 1933 Act and the 1934 Act (at any time after it has become subject to the reporting requirements of the 1934 Act), a copy of the most recent annual and quarterly report(s) of the Company, and such other reports, documents or stockholder communications of the Company, and take such further actions consistent with this Section 9.1, as a Holder may reasonably request in availing itself of any rule or regulation of the SEC allowing a Holder to sell any such Registrable Shares without registration.
9.2 No Inconsistent Agreements . The Company has not entered into and the Company will not after the date of this Agreement enter into any agreement which is inconsistent with the rights granted to the Holders of Registrable Shares pursuant to this Agreement or otherwise conflicts with the provisions of this Agreement. The rights granted to the Holders hereunder do not and will not for the term of this Agreement in any way conflict with the rights granted to the holders of the Companys other issued and outstanding securities under any such agreements.
9.3 Amendments and Waivers . The provisions of this Agreement, including the provisions of this sentence, may not be amended, modified or supplemented, and waivers or consents to departures from the provisions hereof may not be given unless the Company has obtained the written consent of the Holders (other than Affiliates of the Company) of at least a majority of the outstanding Registrable Shares affected by such amendment, modification, supplement, waiver or departure.
9.4 Notices . All notices and other communications provided for or permitted hereunder shall be made in writing by hand delivery, registered first-class mail, facsimile or any courier guaranteeing overnight delivery (a) if to a Holder, at the most current address given by such Holder to the Company by means of a notice given in accordance with the provisions of this Section 9.4 and (b) if to the Company, ZAIS Financial Corp., Two Bridge Avenue, Suite 322, Red Bank, New Jersey 07701-1106, Attention: General Counsel (facsimile: (732) 978-7507).
All such notices and communications shall be deemed to have been duly given: at the time delivered by hand, if personally delivered; two Business Days after being deposited in the mail, postage prepaid, if mailed; when receipt is acknowledged, if sent by facsimile (provided confirmation of transmission is mechanically or electronically generated and kept on file by the sending party) and on the next Business Day if timely delivered to an air courier guaranteeing overnight delivery.
9.5 Successor and Assigns . This Agreement shall inure to the benefit of and be binding upon the successors, assigns and transferees of each of the parties hereto, including, without limitation and without the need for an express assignment, subsequent Holders.
9.6 Specific Enforcement . Without limiting the remedies available to the Holders, the Company acknowledges that any failure by the Company to comply with its obligations under Sections 2.1 through 2.3 hereof may result in material irreparable injury
to the Holders for which there is no adequate remedy at law, that it would not be possible to measure damages for such injuries precisely and that, in the event of any such failure, any Holder may obtain such relief as may be required to specifically enforce the Companys obligations under Sections 2.1 through 2.3 hereof.
9.7 Counterparts . This Agreement may be executed in any number of counterparts and by the 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.
9.8 Headings . The headings in this Agreement are for convenience of reference only and shall not limit or otherwise affect the meaning hereof.
9.9 GOVERNING LAW . THIS AGREEMENT SHALL BE GOVERNED BY, AND CONSTRUED AND INTERPRETED IN ACCORDANCE WITH, THE LAW OF THE STATE OF NEW YORK.
9.10 Severability . In the event that any one or more of the provisions contained herein, or the application thereof in any circumstance, is held invalid, illegal or unenforceable, the validity, legality and enforceability of any such provision in every other respect and of the remaining provisions contained herein shall not be affected or impaired thereby.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first written above.
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ZAIS Financial Corp. |
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/s/ Michael Szymanski |
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Name: Michael Szymanski |
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Title: Chief Executive Officer and President |
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ZAIS GROUP, LLC |
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/s/ Michael Szymanski |
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Name: Michael Szymanski |
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Title: President |
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HOLDERS, as shown on Schedule I attached hereto |
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ZAIS GROUP, LLC, as attorney-in-fact |
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/s/ Michael Szymanski |
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Name: Michael Szymanski |
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Title: President |
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[Signature Page to Registration Rights Agreement]
SCHEDULE I
Holders
Exhibit 10.5
FIRST AMENDED AND RESTATED REGISTRATION RIGHTS AGREEMENT
This First Amended and Restated Registration Rights Agreement (this Agreement ) is made and entered into this 13th day of December, 2012, among ZAIS Financial Corp., a Maryland corporation (the Company ), ZAIS REIT Management, LLC, a Delaware limited liability company (the Advisor ), and certain persons listed on Schedule I hereto (such persons, in their capacities as holders of Registrable Shares (as defined below), the Holders , and each a Holder ).
The Company is offering (the Offering ) shares of the Companys common stock, par value $0.0001 per share (the Common Stock ) or operating partnership units (the OP units ) in ZAIS Financial Partners, L.P. (the Operating Partnership ) (or a combination thereof), in one or more offerings, up to an aggregate number of shares of Common Stock and OP units equal in value to $120 million, subject to increase at the discretion of ZAIS Group, LLC.
In order to induce the Holders to purchase shares of Common Stock or OP units, the Company has agreed to provide to such Holders and their respective direct and indirect transferees the registration rights set forth in this Agreement.
Whereas, the Company may amend Schedule I hereto, without the written consent of any Holders, to add holders that purchase shares of Common Stock or OP units in the Offering, in consideration of the foregoing and the mutual covenants and agreements herein contained and other good and valid consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows:
1. DEFINITIONS .
As used in this Agreement, the following capitalized defined terms shall have the following meanings:
1933 Act shall mean the Securities Act of 1933, as amended from time to time.
1934 Act shall mean the Securities Exchange Act of 1934, as amended from time to time.
Additional Shares shall mean shares of Common Stock (including the shares of Common Stock that may be issued by the Company upon redemption of the OP units) or other securities of the Company issued in respect of the Shares by reason of or in connection with any stock dividend, stock distribution, stock split, purchase in any rights offering or in connection with any exchange for or replacement of such shares or any combination of shares, recapitalization, merger or consolidation, or any other equity securities issued pursuant to any other pro rata distribution with respect to the shares of Common Stock.
Advisor shall have the meaning set forth in the preamble.
Affiliate shall mean as to any specified Person any other Person directly or indirectly controlling or controlled by or under direct or indirect common control with such specified Person. For the purposes of this definition, control (including, with correlative meanings, the terms controlling, 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 or policies of such Person whether through the ownership of voting securities or by agreement or otherwise.
Business Days shall mean Monday, Tuesday, Wednesday, Thursday, and Friday that is not a day on which banking institutions in New York, New Jersey or other applicable places where such act is to occur are authorized or obligated by applicable law, regulation or executive order to close.
Common Stock shall have the meaning set forth in the preamble.
Company shall have the meaning set forth in the preamble and shall also include the Companys successors.
Controlling Person shall have the meaning set forth in Section 4(a) of this Agreement.
End of Suspension Notice shall have the meaning set forth in Section 5(b) of this Agreement.
FINRA shall mean the Financial Industry Regulatory Authority.
Holder shall have the meaning set forth in the preamble.
Liabilities shall have the meaning set forth in Section 4(a)(i) of this Agreement.
Listing shall mean the listing of shares of Common Stock on the NASDAQ Capital Market or another U.S. national securities exchange.
Offering shall have the meaning set forth in the preamble.
OP units shall have the meaning set forth in the preamble.
Operating Partnership shall have the meaning set forth in the preamble.
Participating Broker-Dealer shall mean any broker-dealer that makes a market in the Registrable Shares.
Person shall mean an individual, partnership (general or limited), corporation, limited liability company, trust or unincorporated organization, or a government or agency or political subdivision thereof.
Prospectus shall mean the prospectus included in a Registration Statement, including any preliminary prospectus, and any such prospectus as amended or supplemented by any prospectus supplement, including any such prospectus supplement with respect to the terms of the offering of any portion of the Registrable Shares covered by a Registration Statement, and by all other amendments and supplements to a prospectus, including post-effective amendments and free-writing prospectuses and in each case including all material incorporated by reference therein.
Registrable Shares shall mean the Shares and any Additional Shares; provided , however , that Shares and Additional Shares shall cease to be Registrable Shares (i) when a Registration Statement with respect to such Shares and Additional Shares shall have been declared effective under the 1933 Act and such Shares or Additional Shares shall have been disposed of pursuant to such Registration Statement, (ii) when such Shares or Additional Shares have ceased to be outstanding, (iii) on the second anniversary of the initial effective date of the Shelf Registration Statement or, in the case of any Additional Shares not included in the Shelf Registration Statement, until the second anniversary of the issuance of the Additional Shares or (iv) when, following the Listing, such Shares or Additional Shares are sold, transferred or otherwise disposed of pursuant to Rule 144 under the 1933 Act.
Registration Expenses shall mean any and all expenses incident to the performance of or compliance by the Company with this Agreement, whether or not any Registration Statement contemplated hereby is filed or declared effective by the SEC under the 1933 Act, including without limitation: (i) all SEC, stock exchange or FINRA registration and filing fees, including, if applicable, the fees and expenses of any qualified independent underwriter (and its counsel) that is required to be retained by any Holder in accordance with the rules and regulations of the FINRA, (ii) all fees and expenses incurred in connection with compliance with state securities or blue sky laws and compliance with the rules of the FINRA (including reasonable fees and disbursements of one firm of Selling Holders Counsel for any underwriters or Holders in connection with blue sky qualification of any Registrable Shares and any filings with the FINRA), (iii) all expenses of any Persons in preparing or assisting in preparing, word processing, printing, duplicating, mailing and distributing any Registration Statement, any Prospectus, any amendments or supplements thereto, any underwriting agreements, securities sales agreements and other documents relating to the performance of and compliance with this Agreement, (iv) all fees and expenses incurred in connection with the Listing, if any, of any of the Registrable Shares, (v) the fees and disbursements of
counsel for the Company and of the independent registered public accounting firm of the Company, including the expenses of any special audits or comfort letters required by or incident to such performance and compliance, (vi) the fees and expenses of the Companys transfer agent, and any escrow agent or custodian, (vii) the reasonable fees and disbursements of one firm of Selling Holders Counsel representing the Holders of Registrable Shares and (viii) any fees and disbursements of the underwriters customarily required to be paid by issuers or sellers of securities and the fees and expenses of any special experts retained by the Company in connection with any Registration Statement, but excluding underwriting discounts and commissions and transfer taxes, if any, relating to the sale or disposition of Registrable Shares by a Holder and the fees and disbursements of any counsel to the Holders, except as provided in clauses (ii) and (vii).
Registration Statement shall mean any registration statement of the Company which covers any of the Registrable Shares and may include securities other than Registrable Shares pursuant to the provisions of this Agreement, and all amendments and supplements to any such Registration Statement, including pre- and post-effective amendments, in each case including the Prospectus contained therein, all exhibits thereto and all material incorporated by reference therein.
SEC shall mean the U.S. Securities and Exchange Commission or any successor agency or government body performing the functions currently performed by the U.S. Securities and Exchange Commission.
Selling Holders Counsel shall mean counsel for the Holders that is selected by the Holders holding a majority of the Registrable Shares included in a Registration Statement and that is reasonably acceptable to the Company.
Shares shall mean the shares of Common Stock issued by the Company in the Offering or upon redemption of OP units issued in the Offering, and any shares that may be granted to the Advisor under the Companys equity incentive plan.
Shelf Registration shall mean a registration effected pursuant to Section 2.1 of this Agreement.
Shelf Registration Statement shall mean a shelf registration which covers Registrable Shares and may include securities other than Registrable Shares on an appropriate form under the 1933 Act, and all amendments and supplements to such registration statement, including pre- and post-effective amendments, in each case including the Prospectus contained therein, all exhibits thereto and all material incorporated by reference therein.
Subsequent Shelf Registration Statement shall mean an additional shelf registration statement of the Company pursuant to the provisions of Section 2.2 of this Agreement which covers Additional Shares on an appropriate form under the 1933 Act, and all amendments and supplements to such registration statement, including pre- and post-effective amendments, in each case including the Prospectus contained therein, all exhibits thereto and all material incorporated by reference therein.
Suspension Event shall have the meaning set forth in Section 5(b) of this Agreement.
Suspension Notice shall have the meaning set forth in Section 5(a) of this Agreement.
Underwriter shall have the meaning set forth in Section 4(a) of this Agreement.
Underwritten Offering shall mean a sale of securities of the Company to an underwriter or underwriters for reoffering to the public.
2. Registration Under the 1933 Act .
2.1 Mandatory Shelf Registration .
(a) The Company agrees (i) to use its reasonable efforts to file a Shelf Registration Statement with the SEC no later than 270 days after the closing of the Companys Listing, subject to extension if the
Company is bound by a lock-up agreement in connection with the Companys Listing which restricts the filing of a Shelf Registration Statement in which event the Company will be required to use its reasonable efforts to file a Shelf Registration Statement within 30 days after the expiration of the lock-up period, (ii) to use its commercially reasonable efforts to cause such Shelf Registration Statement providing for the resale of the Registrable Shares to be declared effective by the SEC as promptly as practicable after such filing and (iii) to use commercially reasonable efforts to maintain the Listing for the Registrable Shares registered in such Shelf Registration Statement.
(b) The Company shall use its commercially reasonable efforts to maintain the Shelf Registration Statement continuously effective in order to permit the Prospectus forming part thereof to be usable by the Holders.
(c) The Company shall use its commercially reasonable efforts to maintain the Shelf Registration Statements effectiveness under the 1933 Act until the first to occur of (i) such time as all of the Registrable Shares covered by the Shelf Registration Statement have been sold pursuant to the Shelf Registration Statement or pursuant to Rule 144 under the 1933 Act and (ii) the second anniversary after the closing of the Companys Listing.
(d) Notwithstanding any other provision hereof, the Company agrees to use its commercially reasonable efforts to ensure that (i) any Shelf Registration Statement and any amendment thereto and any Prospectus forming part thereof and any supplement thereto complies, when filed, in all material respects with the 1933 Act and the rules and regulations thereunder, (ii) any Shelf Registration Statement and any amendment thereto does not, when it becomes effective, contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements, in light of the circumstances under which they were made, not misleading and (iii) any Prospectus forming part of any Shelf Registration Statement, and any supplement to such Prospectus (as amended or supplemented from time to time), does not, when filed, include an untrue statement of a material fact or omit to state a material fact necessary in order to make the statements, in light of the circumstances under which they were made, not misleading.
The Company may permit securities other than Registrable Shares to be included in the Shelf Registration Statement. The Company further agrees, if necessary, to supplement or amend the Shelf Registration Statement, as required by Section 3(b) below, and to furnish to the Holders copies of any such supplement or amendment promptly after its being used or filed with the SEC.
2.2 Subsequent Shelf Registration for Additional Shares . If any Additional Shares are issued or distributed to Holders after the effectiveness of the Shelf Registration Statement, or such Additional Shares were otherwise not included in a prior Shelf Registration Statement, then the Company shall as soon as practicable, but in no event later than 60 days after the issuance of such Additional Shares, file and use its commercially reasonable efforts to cause to be declared effective by the SEC as soon as practicable following such filing a Subsequent Shelf Registration Statement in the same manner, and subject to the same provisions.
2.3 Expenses . The Company shall pay all Registration Expenses in connection with the registration of the Registrable Shares pursuant to Section 2.1 or 2.2 hereof , provided, however, that the Holders will use their good faith efforts to coordinate with holders of securities, other than Registrable Shares, that are included on the Shelf Registration Statement to instruct a single counsel to act for all holders of securities covered on the Shelf Registration Statement. Each Holder shall pay or otherwise bear such Holders proportionate share (based on the total amount of Registrable Shares sold in the Registration Statement) of all underwriting discounts and commissions and transfer taxes, if any, relating to the sale or disposition of such Holders Registrable Shares pursuant to the Shelf Registration Statement or any Subsequent Shelf Registration Statement.
3. Registration Procedures . In connection with the obligations of the Company with respect to a Registration Statement pursuant to Section 2 hereof, the Company shall:
(a) prepare and file with the SEC the Registration Statement, within the relevant time period specified in Section 2, on the appropriate form under the 1933 Act, which form (i) shall be selected by the Company, (ii) shall be available for the registration and sale of the Registrable Shares by the selling Holders thereof, (iii) shall comply as to form in all material respects with the requirements of the applicable form and include or incorporate by reference all financial statements required by the SEC to be filed therewith or incorporated by reference therein, and (iv) shall comply in all respects with the requirements of Regulation S-T under the 1933 Act, and otherwise comply with its obligations under Section 2 hereof;
(b) prepare and file with the SEC such amendments and post-effective amendments to each Registration Statement as may be necessary under applicable law to keep such Registration Statement effective for the applicable period; and cause each Prospectus to be supplemented by any required prospectus supplement, and as so supplemented to be filed pursuant to Rule 424 (or any similar provision then in force) under the 1933 Act and comply with the provisions of the 1933 Act, the 1934 Act and the rules and regulations thereunder applicable to them with respect to the disposition of all securities covered by each Registration Statement during the applicable period in accordance with the intended method or methods of distribution by the selling Holders thereof (including sales by any Participating Broker-Dealer);
(c) (i) notify each Holder of Registrable Shares, at least five Business Days after filing, that a Registration Statement with respect to the Registrable Shares has been filed and advising such Holders that the distribution of Registrable Shares will be made in accordance with any method or combination of methods legally available by the Holders of any and all Registrable Shares; (ii) furnish to each Holder of Registrable Shares and to each underwriter of an Underwritten Offering of Registrable Shares, if any, without charge, as many copies of each Prospectus, including each preliminary Prospectus, and any amendment or supplement thereto and such other documents as such Holder or underwriter may reasonably request, including financial statements and schedules in order to facilitate the public sale or other disposition of the Registrable Shares; and (iii) hereby consent to the use of the Prospectus or any amendment or supplement thereto by each of the selling Holders of Registrable Shares in connection with the offering and sale of the Registrable Shares covered by the Prospectus or any amendment or supplement thereto;
(d) use its commercially reasonable efforts to register or qualify the Registrable Shares under all applicable state securities or blue sky laws of such jurisdictions as any Holder of Registrable Shares covered by a Registration Statement and each underwriter of an Underwritten Offering of Registrable Shares shall reasonably request by the time the applicable Registration Statement is declared effective by the SEC, and do any and all other acts and things which may be reasonably necessary or advisable to enable each such Holder and underwriter to consummate the disposition in each such jurisdiction of such Registrable Shares owned by such Holder; provided , however , that the Company shall not be required to (i) qualify as a foreign corporation or as a dealer in securities in any jurisdiction where it would not otherwise be required to qualify but for this Section 3(d), or (ii) take any action which would subject it to general service of process or taxation in any such jurisdiction where it is not then so subject;
(e) notify promptly each Holder of Registrable Shares under a Registration Statement and, if requested by such Holder, confirm such advice in writing promptly at the address determined in accordance with Section 9.4 of this Agreement (i) when a Registration Statement has become effective and when any post-effective amendments and supplements thereto become effective, (ii) of any request by the SEC or any state securities authority for post-effective amendments and supplements to a Registration Statement and Prospectus or for additional information after the Registration Statement has become effective, (iii) of the issuance by the SEC or any state securities authority of any stop order suspending the effectiveness of a Registration Statement or the initiation of any proceedings for that purpose, (iv) in the case of a Shelf Registration, if, between the effective date of a Registration Statement and the closing of any sale of Registrable Shares covered thereby, the representations and warranties of the Company contained in any underwriting agreement, securities sales agreement or other similar agreement, if any, relating to the offering cease to be true and correct in all material respects, (v) of the happening of any event or the
discovery of any facts during the period a Registration Statement is effective as a result of which such Registration Statement or the related Prospectus or any document incorporated by reference therein contains any untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein not misleading or, in the case of the Prospectus, contains any untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading (which information shall be accompanied by an instruction to suspend the use of the Registration Statement and the Prospectus (such instruction to be provided in the same manner as a Suspension Notice) until the requisite changes have been made, at which time notice of the end of suspension shall be delivered in the same manner as an End of Suspension Notice), (vi) of the receipt by the Company of any notification with respect to the suspension of the qualification of the Registrable Shares, for sale in any jurisdiction or the initiation or threatening of any proceeding for such purpose and (vii) of the filing of a post-effective amendment to such Registration Statement;
(f) furnish Selling Holders Counsel, if any, copies of any comment letters relating to the selling Holders received from the SEC or any other request by the SEC or any state securities authority for amendments or supplements to a Registration Statement and Prospectus or for additional information relating to the selling Holders;
(g) make every reasonable effort to obtain the withdrawal of any order suspending the effectiveness of a Registration Statement at the earliest possible moment;
(h)
furnish to each Holder of Registrable Shares, and each underwriter, if any, without charge,
at least one conformed copy of each Registration Statement and any post-effective amendment thereto, including financial statements and schedules (without documents incorporated therein by reference and all exhibits thereto, unless requested);
(i) cooperate with the selling Holders to facilitate the timely preparation and delivery of certificates representing Registrable Shares to be sold and not bearing any restrictive legends; and enable such Registrable Shares to be in such denominations and registered in such names as the selling Holders or the underwriters, if any, may reasonably request at least three Business Days prior to the closing of any sale of Registrable Shares;
(j) upon the occurrence of any event or the discovery of any facts, as contemplated by Sections 3(e)(v) and 3(e)(vi) hereof, as promptly as practicable after the occurrence of such an event, use its best efforts to prepare a supplement or post-effective amendment to the Registration Statement or the related Prospectus or any document incorporated therein by reference or file any other required document so that, as thereafter delivered to the purchasers of the Registrable Shares or Participating Broker-Dealers, such Prospectus will not contain at the time of such delivery any untrue statement of a material fact or omit to state a material fact necessary to make the statements therein, in light of the circumstances under which they were made, not misleading, or will remain so qualified, as applicable. At such time as such public disclosure is otherwise made or the Company determines that such disclosure is not necessary, in each case to correct any misstatement of a material fact or to include any omitted material fact, the Company agrees promptly to notify each Holder of such determination and to furnish each Holder such number of copies of the Prospectus as amended or supplemented, as such Holder may reasonably request;
(k) within a reasonable time prior to the filing of any Registration Statement, any Prospectus, any amendment to a Registration Statement or amendment or supplement to a Prospectus, provide copies of such document to Selling Holders Counsel, if any, on behalf of such Holders, and make representatives of the Company as shall be reasonably requested by the Holders of Registrable Shares available for discussion of such document;
(l) obtain a CUSIP number for the Registrable Shares not later than the effective date of a Registration Statement, and provide the Companys transfer agent with printed certificates for the Registrable Shares;
(m) enter into agreements (including underwriting agreements) and take all other customary appropriate actions in order to expedite or facilitate the disposition of such Registrable Shares whether or not an underwriting agreement is entered into and whether or not the registration is an underwritten registration:
(i) make such representations and warranties to the Holders of such Registrable Shares and the underwriters, if any, in form, substance and scope as are customarily made by issuers to underwriters in similar underwritten offerings as may be reasonably requested by them;
(ii) obtain opinions of counsel to the Company and updates thereof (which counsel and opinions (in form, scope and substance) shall be reasonably satisfactory to any managing underwriter(s) and their counsel) addressed to the underwriters, if any (and in the case of an underwritten registration, each selling Holder), covering the matters customarily covered in opinions requested in underwritten offerings and such other matters as may be reasonably requested by the underwriter(s);
(iii) obtain comfort letters and updates thereof from the Companys independent registered public accounting firm (and, if necessary, any other independent certified public accountants of any subsidiary of the Company or of any business acquired by the Company for which financial statements are, or are required to be, included in the Registration Statement) addressed to the underwriter(s), if any, and use reasonable efforts to have such letter addressed to the selling Holders in the case of an underwritten registration (to the extent consistent with Statement on Auditing Standards No. 72 of the American Institute of Certified Public Accounts), such letters to be in customary form and covering matters of the type customarily covered in comfort letters to underwriters in connection with similar underwritten offerings;
(iv) enter into a securities sales agreement with the Holders and an agent of the Holders providing for, among other things, the appointment of such agent for the selling Holders for the purpose of soliciting purchases of Registrable Shares, which agreement shall be in form, substance and scope customary for similar offerings;
(v) if an underwriting agreement is entered into, cause the same to set forth indemnification provisions and procedures substantially equivalent to the indemnification provisions and procedures set forth in Section 4 hereof with respect to the underwriters and all other parties to be indemnified pursuant to said Section or, at the request of any underwriters, in the form customarily provided to such underwriters in similar types of transactions; and
(vi) deliver such documents and certificates as may be reasonably requested and as are customarily delivered in similar offerings to the Holders holding a majority of the Registrable Shares being sold and the managing underwriters, if any;
(n) make available for inspection by any underwriter participating in any disposition pursuant to a Registration Statement, any Participating Broker-Dealer, Selling Holders Counsel and any accountant retained by Holders holding a majority of the Registrable Shares being sold, all financial and other records, pertinent corporate documents and properties or assets of the Company reasonably requested by any such persons, and cause the respective officers, directors, employees, and any other agents of the Company to supply all information reasonably requested by any such representative, underwriter, counsel or accountant in connection with a Registration Statement, and make such representatives of the Company available for discussion of such documents as shall be reasonably requested by the Selling Holders Counsel; provided , however , that the Selling Holders Counsel, if any, and the representatives of any underwriters will use commercially reasonable efforts, to the extent reasonably practicable, to coordinate the foregoing inspection and information gathering and to not materially disrupt the Companys business operations;
(o) a reasonable time prior to filing any Registration Statement, any Prospectus forming a part thereof, any amendment to such Registration Statement, or amendment or supplement to such
Prospectus, provide copies of such document to the underwriter(s) of an Underwritten Offering of Registrable Shares; within five Business Days after the filing of any Registration Statement, provide copies of such Registration Statement to Selling Holders Counsel; make such changes in any of the foregoing documents prior to the filing thereof, or in the case of changes received from Selling Holders Counsel by filing an amendment or supplement thereto, as the underwriter or underwriters, or in the case of changes received from Selling Holders Counsel relating to the selling Holders or the plan of distribution of Registrable Shares, as Selling Holders Counsel, reasonably requests; not file any such document in a form to which any underwriter shall not have previously been advised and furnished a copy of or to which the Selling Holders Counsel, if any, on behalf of the Holders of Registrable Shares, or any underwriter shall reasonably object; not include in any amendment or supplement to such documents any information about the selling Holders or any change to the plan of distribution of Registrable Shares that would limit the method of distribution of the Registrable Shares unless Selling Holders Counsel has been advised in advance and has approved such information or change; and make the representatives of the Company available for discussion of such document as shall be reasonably requested by the Selling Holders Counsel, if any, on behalf of such Holders, Selling Holders Counsel or any underwriter;
(p) use its best efforts to maintain the listing of all Registrable Shares on the NASDAQ Capital Market or another U.S. national securities exchange;
(q) otherwise comply with all applicable rules and regulations of the SEC and make available to its security holders, as soon as reasonably practicable, an earnings statement covering at least 12 months which shall satisfy the provisions of Section 11(a) of the 1933 Act and Rule 158 thereunder;
(r) cooperate and assist in any filings required to be made with the FINRA and in the performance of any due diligence investigation by any underwriter and its counsel (including any qualified independent underwriter that is required to be retained in accordance with the rules and regulations of the FINRA); and
(s) the Company may (as a condition to a Holders participation in the Shelf Registration) require each Holder of Registrable Shares to furnish to the Company such information regarding the Holder and the proposed distribution by such Holder of such Registrable Shares as the Company may from time to time reasonably request in writing.
Each Holder agrees that, upon receipt of any notice from the Company of the happening of any event or the discovery of any facts of the type described in Section 3(e)(v) hereof, such Holder will forthwith discontinue disposition of Registrable Shares pursuant to a Registration Statement until such Holders receipt of the copies of the supplemented or amended Prospectus contemplated by Section 3(k) hereof, and, if so directed by the Company, such Holder will deliver to the Company (at the Companys expense) all copies in such Holders possession, other than permanent file copies then in such Holders possession, of the Prospectus covering such Registrable Shares current at the time of receipt of such notice.
If any of the Registrable Shares covered by a Registration Statement, are to be sold in an Underwritten Offering, the Company will select the underwriter(s) and managing underwriter(s) that will manage such offering. No Holder of Registrable Shares may participate in any Underwritten Offering hereunder unless such Holder (a) agrees to sell such Holders Registrable Shares on the basis provided in any underwriting arrangements approved by the persons entitled hereunder to approve such arrangements and (b) completes and executes all questionnaires, powers of attorney, indemnities, underwriting agreements and other documents required under the terms of such underwriting arrangements.
4. Indemnification; Contribution .
(a) The Company agrees to indemnify and hold harmless each Holder, each Participating Broker-Dealer, each Person who participates as an underwriter (any such Person being an Underwriter ) and each Person (a Controlling Person ), if any, who controls (within the meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act) any of the foregoing Persons, as follows:
(i) against any and all loss, liability, claim, damage, judgment, actions, other liabilities and expense whatsoever (the Liabilities ), as incurred, arising out of any untrue statement or alleged untrue statement of a material fact contained in any Registration Statement (or any amendment or supplement thereto) pursuant to which Registrable Shares were registered under the 1933 Act, including all documents incorporated therein by reference, or the omission or alleged omission therefrom of a material fact required to be stated therein or necessary to make the statements therein not misleading, or arising out of any untrue statement or alleged untrue statement of a material fact contained in any Prospectus (or any amendment or supplement thereto) or the omission or alleged omission therefrom at such date of a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading;
(ii) against any and all Liabilities, as incurred, to the extent of the aggregate amount paid in settlement of any litigation, or any investigation or proceeding by any governmental agency or body, commenced or threatened, or of any claim whatsoever based upon any such untrue statement or omission, or any such alleged untrue statement or omission; provided that (subject to Section 4(d) below) any such settlement is effected with the written consent of the Company; and
(iii) against any and all expense whatsoever, as incurred (including the fees and disbursements of counsel chosen by any indemnified party), reasonably incurred in investigating, preparing or defending against any litigation, or any investigation or proceeding by any governmental agency or body, commenced or threatened, or any claim whatsoever based upon any such untrue statement or omission, or any such alleged untrue statement or omission, to the extent that any such expense is not paid under subparagraph (i) or (ii) above;
provided , however , that this indemnity agreement shall not apply to any Liabilities to the extent arising out of any untrue statement or omission or alleged untrue statement or omission made in reliance upon and in conformity with written information furnished to the Company by the Holder or Underwriter expressly for use in a Registration Statement (or any amendment thereto) or any Prospectus (or any amendment or supplement thereto).
(b) Each Holder severally, but not jointly, agrees to indemnify and hold harmless the Company, each Underwriter and the other selling Holders, and each of their respective officers, directors, partners, employees, representatives and agents, and each of their respective Controlling Persons, against any and all Liabilities described in the indemnity contained in Section 4(a) hereof, as incurred, but only with respect to untrue statements or omissions, or alleged untrue statements or omissions, made in the Registration Statement (or any amendment thereto) or any Prospectus included therein (or any amendment or supplement thereto) in reliance upon and in conformity with written information with respect to such Holder furnished to the Company by such Holder expressly for use in the Registration Statement (or any amendment thereto) or such Prospectus (or any amendment or supplement thereto); provided , however , that no such Holder shall be liable for any claims hereunder in excess of the amount of net proceeds received by such Holder from the sale of Registrable Shares pursuant to such Registration Statement.
(c) Each indemnified party shall give notice as promptly as reasonably practicable to each indemnifying party of any action or proceeding commenced against it in respect of which indemnity may be sought hereunder, but failure so to notify an indemnifying party shall not relieve such indemnifying party from any liability hereunder to the extent it is not materially prejudiced as a result thereof and in any event shall not relieve it from any liability which it may have otherwise than on account of this indemnity agreement. An indemnifying party may participate at its own expense in the defense of such action; provided , however , that counsel to the indemnifying party shall not (except with the consent of the indemnified party) also be counsel to the indemnified party. In no event shall the indemnifying party or parties be liable for the fees and expenses of more than one counsel (in addition to any local counsel) separate from their own counsel for all indemnified parties in connection with any one action or separate but similar or related actions in the same jurisdiction arising out of the same general allegations or circumstances. No indemnifying party shall, without the prior written consent of the indemnified parties,
settle or compromise or consent to the entry of any judgment with respect to any litigation, or any investigation or proceeding by any governmental agency or body, commenced or threatened, or any claim whosoever in respect of which indemnification or contribution could be sought under this Section 4 (whether or not the indemnified parties are actual or potential parties thereto), unless such settlement, compromise or consent (i) includes an unconditional release of each indemnified party from all liability arising out of such litigation, investigation, proceeding or claim and (ii) does not include a statement as to or an admission of fault, culpability or a failure to act by or on behalf of any indemnified party.
(d) If at any time an indemnified party shall have requested an indemnifying party to reimburse the indemnified party for fees and expenses of counsel, such indemnifying party agrees that it shall be liable for any settlement of the nature contemplated by Section 4(a)(ii) effected without its written consent if (i) such settlement is entered into more than 45 days after receipt by such indemnifying party of the aforesaid request, (ii) such indemnifying party shall have received notice of the terms of such settlement at least 30 days prior to such settlement being entered into and (iii) such indemnifying party shall not have reimbursed such indemnified party in accordance with such request prior to the date of such settlement.
(e) If the indemnification provided for in this Section 4 is for any reason unavailable to or insufficient to hold harmless an indemnified party in respect of any Liabilities referred to therein, then each indemnifying party shall contribute to the aggregate amount of such Liabilities incurred by such indemnified party, as incurred, in such proportion as is appropriate to reflect the relative fault of the Company on the one hand and the Holders on the other hand in connection with the statements or omissions which resulted in such Liabilities, as well as any other relevant equitable considerations.
The relative fault of the Company on the one hand and the Holders on the other hand shall be determined by reference to, among other things, whether any such untrue or alleged untrue statement of a material fact or omission or alleged omission to state a material fact relates to information supplied by the Company or the Holders and the parties relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission.
The Company and the Holders agree that it would not be just and equitable if contribution pursuant to this Section 4 were determined by pro rata allocation or by any other method of allocation which does not take account of the equitable considerations referred to above in this Section 4. The aggregate amount of Liabilities incurred by an indemnified party and referred to above in this Section 4 shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in investigating, preparing or defending against any litigation, or any investigation or proceeding by any governmental agency or body, commenced or threatened, or any claim whatsoever based upon any such untrue or alleged untrue statement or omission or alleged omission.
No Person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the 1933 Act) shall be entitled to contribution from any Person who was not guilty of such fraudulent misrepresentation.
For purposes of this Section 4, each Person, if any, who controls a Holder within the meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act shall have the same rights to contribution as the Holder, and each director of the Company, and each Person, if any, who controls the Company within the meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act shall have the same rights to contribution as the Company.
5. Black-Out Period .
(a) Subject to the provisions of this Section 5, the Company shall be permitted, in limited circumstances, to suspend the use, from time to time, of the Prospectus that is part of a Shelf Registration Statement (and therefore suspend sales of the Registrable Shares under such Registration Statement), by providing written notice (a Suspension Notice ) to Selling Holders Counsel, if any, and the Holders and by issuing a press release, making a filing with the SEC or such other means that the Company reasonably believes to be a reliable means of communication, for such times as the Company reasonably may determine is necessary and advisable (but in no event for more than an aggregate of 90 days in any rolling 12-month period commencing on the date of this Agreement or more than 45 consecutive days, except as a result of a refusal by the SEC to declare any post-effective amendment to the Registration Statement
effective after the Company has used all commercially reasonable efforts to cause the post-effective amendment to be declared effective by the SEC, in which case, the Company must terminate the black-out period immediately following the effective date of the post-effective amendment) if any of the following events shall occur: (i) the managing underwriter(s) in any Underwritten Offering of primary shares of Common Stock by the Company has advised the Company that the offer or sale of Registrable Shares pursuant to the Registration Statement would have a material adverse effect on the Companys primary offering; (ii) a majority of the Board of Directors of the Company determines in good faith that (A) the offer or sale of any Registrable Shares would materially impede, delay or interfere with any proposed financing, offer or sale of securities, acquisition, corporate reorganization or other material transaction involving the Company (B) after the advice of counsel, the sale of Registrable Shares pursuant to the Registration Statement would require disclosure of non public material information not otherwise required to be disclosed under applicable law, and (C) (x) the Company has a bona fide business purposes for preserving the confidentiality of such transaction, (y) disclosure would have a material adverse effect on the Company or the Companys ability to consummate such transaction, or (z) such transaction renders the Company unable to comply with SEC requirements, in each case under circumstances that would make it impractical or inadvisable to cause the Registration Statement (or such filings) to become effective or to promptly amend or supplement the Registration Statement on a post effective basis, as applicable; or (iii) a majority of the Board of Directors of the Company determines in good faith, upon the advice of counsel, that it is in the Companys best interest or it is required by law, rule or regulation to supplement the Registration Statement or file a post-effective amendment to the Registration Statement in order to ensure that the Prospectus (1) contains the information required under Section 10(a)(3) of the 1933 Act; (2) discloses any facts or events arising after the effective date of the Registration Statement (or of the most-recent post-effective amendment) that, individually or in the aggregate, represents a fundamental change in the information set forth therein; or (3) discloses any material information with respect to the plan of distribution that was not disclosed in the Registration Statement or any material change to such information. Upon the occurrence of any such suspension, the Company shall use its commercially reasonable efforts to cause the Registration Statement to become effective or to promptly amend or supplement the Registration Statement on a post-effective basis or to take such action as is necessary to make resumed use of the Registration Statement as soon as possible.
(b) In the case of an event that causes the Company to suspend the use of a Registration Statement as set forth in paragraph (a) above (a Suspension Event ), the Company shall give a Suspension Notice to the Selling Holders Counsel, if any, and the Holders to suspend sales of the Registrable Shares and such notice shall state generally the basis for the notice and that such suspension shall continue only for so long as the Suspension Event or its effect is continuing and the Company is using its commercially reasonable efforts and taking all reasonable steps to terminate suspension of the use of the Registration Statement as promptly as possible. A Holder shall not affect any sales of the Registrable Shares pursuant to such Registration Statement (or such filings) at any time after it has received a Suspension Notice from the Company and prior to receipt of an End of Suspension Notice (as defined below). If so directed by the Company, each Holder will deliver to the Company (at the expense of the Company) all copies other than permanent file copies then in such Holders possession of the Prospectus covering the Registrable Shares at the time of receipt of the Suspension Notice. The Holders may recommence effecting sales of the Registrable Shares pursuant to the Registration Statement (or such filings) following further written notice to such effect (an End of Suspension Notice ) from the Company, which End of Suspension Notice shall be given by the Company to the Holders and Selling Holders Counsel, if any, promptly following the conclusion of any Suspension Event and its effect.
(c) Notwithstanding any provision herein to the contrary, if the Company shall give a Suspension Notice with respect to any Registration Statement pursuant to this Section 5, the Company agrees that it shall extend the period of time during which such Registration Statement shall be maintained effective pursuant to this Agreement by the number of days during the period from the date of receipt by the Holders of the Suspension Notice to and including the date of receipt by the Holders of the End of Suspension Notice and provide copies of the supplemented or amended Prospectus necessary to resume sales, with respect to each Suspension Event; provided that such period of time shall not be extended beyond the date that Common Stock covered by such Registration Statement are no longer Registrable Shares.
6. Market Stand-Off Agreement . Each Holder hereby agrees that it shall not, directly or indirectly sell, offer to sell (including without limitation any short sale), pledge, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant for the sale of or otherwise dispose of or transfer any Registrable Shares or other Common Stock or any securities convertible into or exchangeable or exercisable for Common Stock then owned by such Holder (other than to donees or partners of the Holder who agree to be similarly bound) for a period commencing on the effective date of the Listing registration statement and ending 60 days following such effective date; provided , however , that:
(a) all officers and directors of the Company then holding Common Stock or securities convertible into or exchangeable or exercisable for Common Stock enter into similar agreements for not less than the entire time period required of the Holders hereunder; and
(b) the Holders shall be allowed any concession or proportionate release allowed to any officer or director of the Company that entered into similar agreements (with such proportion being determined by dividing the number of shares being released with respect to such officer or director by the total number of issued and outstanding shares held by such Holder, officer or director); provided , that nothing in this Section 6(c) shall be construed as a right to proportionate release for the officers and directors of the Company upon the expiration of the 60 day period applicable to all Holders, officers and directors of the Company.
In order to enforce the foregoing covenant, the Company shall have the right to place restrictive legends on the certificates representing the securities subject to this Section 6 and to impose stop transfer instructions with respect to the Registrable Shares and such other securities of each Holder (and the securities of every other Person subject to the foregoing restriction) until the end of such period.
7. Termination of the Companys Obligations . The Company shall have no further obligations pursuant to this Agreement at such time as no Registrable Shares are outstanding, provided , however , that the Companys obligations under Sections 4 and 9 of this Agreement shall remain in full force and effect following such time.
8. Limitations on Subsequent Registration Rights . From and after the date of this Agreement, the Company shall not, without the prior written consent of the Holders (other than Affiliates of the Company) of a majority of the then outstanding Registrable Shares, enter into any agreement with any holder or prospective holder of any securities of the Company that would provide such holder or prospective holder with registration rights that are superior in any material respect to the registration rights of the Holders set forth herein; provided that the Company may provide any such registration rights that are not superior in any respect to the registration rights of the Holders set forth herein to any Affiliates of the Company or the Advisor.
9. Miscellaneous .
9.1 Rule 144 and Rule 144A . For so long as the Company is subject to the reporting requirements of Section 13 or 15 of the 1934 Act, the Company covenants that it will file the reports required to be filed by it under the 1933 Act and Section 13(a) or 15(d) of the 1934 Act and the rules and regulations adopted by the SEC thereunder. If the Company ceases to be so required to file such reports, the Company covenants that it will upon the request of any Holder of Registrable Shares (a) make publicly available such information as is necessary to permit sales pursuant to Rule 144 under the 1933 Act, (b) deliver such information to a prospective purchaser as is necessary to permit sales pursuant to Rule 144A under the 1933 Act and it will take such further action as any Holder of Registrable Shares may reasonably request, and (c) take such further action that is reasonable in the circumstances, in each case to the extent required from time to time to enable such Holder to sell its Registrable Shares without registration under the 1933 Act within the limitation of the exemptions provided by (i) Rule 144 under the 1933 Act, as such Rule may be amended from time to time, (ii) Rule 144A under the 1933 Act, as such rule may be amended from time to time, or (iii) any similar rules or regulations hereafter adopted by the SEC. Upon the request of any Holder of Registrable Shares, the Company will deliver to such Holder a written statement as to whether it has complied with such requirements (at any time after 90 days after the effective date of the first Registration Statement filed by the Company for an offering of its Common Stock to the
general public) and of the 1933 Act and the 1934 Act (at any time after it has become subject to the reporting requirements of the 1934 Act), a copy of the most recent annual and quarterly report(s) of the Company, and such other reports, documents or stockholder communications of the Company, and take such further actions consistent with this Section 9.1, as a Holder may reasonably request in availing itself of any rule or regulation of the SEC allowing a Holder to sell any such Registrable Shares without registration.
9.2 No Inconsistent Agreements . The Company has not entered into and the Company will not after the date of this Agreement enter into any agreement which is inconsistent with the rights granted to the Holders of Registrable Shares pursuant to this Agreement or otherwise conflicts with the provisions of this Agreement. The rights granted to the Holders hereunder do not and will not for the term of this Agreement in any way conflict with the rights granted to the holders of the Companys other issued and outstanding securities under any such agreements.
9.3 Amendments and Waivers . The provisions of this Agreement, including the provisions of this sentence, may not be amended, modified or supplemented, and waivers or consents to departures from the provisions hereof may not be given unless the Company has obtained the written consent of the Holders (other than Affiliates of the Company) of at least a majority of the outstanding Registrable Shares affected by such amendment, modification, supplement, waiver or departure; provided, however, that the Company may amend Schedule I hereto, without the written consent of any Holders, to add holders that purchase shares of Common Stock or OP units in the Offering in an offering subsequent to the initial offering of shares of Common Stock or OP units.
9.4 Notices . All notices and other communications provided for or permitted hereunder shall be made in writing by hand delivery, registered first-class mail, facsimile or any courier guaranteeing overnight delivery (a) if to a Holder, at the most current address given by such Holder to the Company by means of a notice given in accordance with the provisions of this Section 9.4 and (b) if to the Company, ZAIS Financial Corp., Two Bridge Avenue, Suite 322, Red Bank, New Jersey 07701-1106, Attention: General Counsel (facsimile: (732) 978-7507).
All such notices and communications shall be deemed to have been duly given: at the time delivered by hand, if personally delivered; two Business Days after being deposited in the mail, postage prepaid, if mailed; when receipt is acknowledged, if sent by facsimile (provided confirmation of transmission is mechanically or electronically generated and kept on file by the sending party) and on the next Business Day if timely delivered to an air courier guaranteeing overnight delivery.
9.5 Successor and Assigns . This Agreement shall inure to the benefit of and be binding upon the successors, assigns and transferees of each of the parties hereto, including, without limitation and without the need for an express assignment, subsequent Holders.
9.6 Specific Enforcement . Without limiting the remedies available to the Holders, the Company acknowledges that any failure by the Company to comply with its obligations under Sections 2.1 through 2.3 hereof may result in material irreparable injury to the Holders for which there is no adequate remedy at law, that it would not be possible to measure damages for such injuries precisely and that, in the event of any such failure, any Holder may obtain such relief as may be required to specifically enforce the Companys obligations under Sections 2.1 through 2.3 hereof.
9.7 Counterparts . This Agreement may be executed in any number of counterparts and by the 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.
9.8 Headings . The headings in this Agreement are for convenience of reference only and shall not limit or otherwise affect the meaning hereof.
9.9 GOVERNING LAW . THIS AGREEMENT SHALL BE GOVERNED BY, AND CONSTRUED AND INTERPRETED IN ACCORDANCE WITH, THE LAW OF THE STATE OF NEW YORK.
9.10 Severability . In the event that any one or more of the provisions contained herein, or the application thereof in any circumstance, is held invalid, illegal or unenforceable, the validity, legality and enforceability of any such provision in every other respect and of the remaining provisions contained herein shall not be affected or impaired thereby.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first written above.
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ZAIS FINANCIAL CORP. |
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/s/ Michael Szymanski |
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Name: Michael Szymanski |
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Title: Chief Executive Officer and President |
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ZAIS REIT MANAGEMENT, LLC |
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By: |
/s/ Michael Szymanski |
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Name: Michael Szymanski |
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Title: Chief Executive Officer |
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HOLDERS, as shown on Schedule I attached hereto |
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By: |
ZAIS FINANCIAL CORP., as attorney-in-fact |
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By: |
/s/ Michael Szymanski |
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Name: Michael Szymanski |
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Title: Chief Executive Officer and President |
[ Signature Page to Registration Rights Agreement ]
SCHEDULE I
Holders
Exhibit 10.6
INDEMNIFICATION AGREEMENT
THIS INDEMNIFICATION AGREEMENT ( Agreement ) is made and entered into as of the 3rd day of August, 2011, by and between ZAIS Financial Corp., a Maryland corporation (the Company ), and Christian Zugel ( Indemnitee ).
WHEREAS, at the request of the Company, Indemnitee currently serves as a director and/or officer of the Company and may, therefore, be subjected to claims, suits or proceedings arising as a result of his service; and
WHEREAS, as an inducement to Indemnitee to continue to serve as such director and/or officer, the Company has agreed to indemnify and to advance expenses and costs incurred by Indemnitee in connection with any such claims, suits or proceedings, to the maximum extent permitted by law; and
WHEREAS, the parties by this Agreement desire to set forth their agreement regarding indemnification and advance of expenses; and
NOW, THEREFORE, in consideration of the premises and the covenants contained herein, the Company and Indemnitee do hereby covenant and agree as follows:
Section 1. Definitions . For purposes of this Agreement:
(a) Change in Control means a change in control of the Company occurring after the Effective Date of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14A (or in response to any similar item on any similar schedule or form) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act ), whether or not the Company is then subject to such reporting requirement; provided, however, that, without limitation, such a Change in Control shall be deemed to have occurred if, after the Effective Date (i) any person (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) is or becomes the beneficial owner (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company representing 15% or more of the combined voting power of all of the Companys then-outstanding securities entitled to vote generally in the election of directors without the prior approval of at least two-thirds of the members of the Board of Directors in office immediately prior to such persons attaining such percentage interest; (ii) the Company is a party to a merger, consolidation, sale of assets, plan of liquidation or other reorganization not approved by at least two-thirds of the members of the Board of Directors then in office, as a consequence of which members of the Board of Directors in office immediately prior to such transaction or event constitute less than a majority of the Board of Directors thereafter; or (iii) at any time, a majority of the members of the Board of Directors are not individuals (A) who were directors as of the Effective Date or (B) whose election by the Board of Directors or nomination for election by the Companys stockholders was approved by the affirmative vote of at least two-thirds of the directors then in office who were directors as of the Effective Date or whose election or nomination for election was previously so approved.
(b) Corporate Status means the status of a person as a present or former director, officer, employee or agent of the Company or as a director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any other foreign or domestic corporation, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise that such person is or was serving in such capacity at the request of the Company. As a clarification and without limiting the circumstances in which Indemnitee may be serving at the request of the Company, service by Indemnitee shall be deemed to be at the request of the Company if Indemnitee serves or served as a director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any corporation, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise (i) of which a majority of the voting power or equity interest is owned directly or indirectly by the Company or (ii) the management of which is controlled directly or indirectly by the Company.
(c) Disinterested Director means a director of the Company who is not and was not a party to the Proceeding in respect of which indemnification and/or advance of Expenses is sought by Indemnitee.
(d) Effective Date means the date set forth in the first paragraph of this Agreement.
(e) Expenses means any and all reasonable and out-of-pocket attorneys fees and costs, retainers, court costs, transcript costs, fees of experts, witness fees, travel expenses, duplicating costs, printing and binding costs, telephone charges, postage, delivery service fees, federal, state, local or foreign taxes imposed on Indemnitee as a result of the actual or deemed receipt of any payments under this Agreement, ERISA excise taxes and penalties and any other disbursements or expenses incurred in connection with prosecuting, defending, preparing to prosecute or defend, investigating, being or preparing to be a witness in or otherwise participating in a Proceeding. Expenses shall also include Expenses incurred in connection with any appeal resulting from any Proceeding including, without limitation, the premium, security for and other costs relating to any cost bond, supersedeas bond or other appeal bond or its equivalent.
(f) Independent Counsel means a law firm, or a member of a law firm, that is experienced in matters of corporation law and neither is, nor in the past five years has been, retained to represent: (i) the Company or Indemnitee in any matter material to either such party (other than with respect to matters concerning Indemnitee under this Agreement or of other indemnitees under similar indemnification agreements), or (ii) any other party to or participant or witness in the Proceeding giving rise to a claim for indemnification or advance of Expenses hereunder. Notwithstanding the foregoing, the term Independent Counsel shall not include any person who, under the applicable standards of professional conduct then prevailing, would have a conflict of interest in representing either the Company or Indemnitee in an action to determine Indemnitees rights under this Agreement.
(g) Proceeding means any threatened, pending or completed action, suit, arbitration, alternate dispute resolution mechanism, investigation, inquiry, administrative hearing or any other proceeding, whether brought by or in the right of the Company or otherwise and whether of a civil (including intentional or unintentional tort claims), criminal, administrative or investigative (formal or informal) nature, including any appeal therefrom, except one pending or
completed on or before the Effective Date, unless otherwise specifically agreed in writing by the Company and Indemnitee. If Indemnitee reasonably believes that a given situation may lead to or culminate in the institution of a Proceeding, such situation shall also be considered a Proceeding.
Section 2. Services by Indemnitee . Indemnitee will serve as a director and/or officer of the Company. However, this Agreement shall not impose any independent obligation on Indemnitee or the Company to continue Indemnitees service to the Company. This Agreement shall not be deemed an employment contract between the Company (or any other entity) and Indemnitee.
Section 3. General . The Company shall indemnify, and advance Expenses to, Indemnitee (a) as provided in this Agreement and (b) otherwise to the maximum extent permitted by the laws of the State of Maryland in effect on the Effective Date and as amended from time to time; provided, however, that no change in the laws of the State of Maryland shall have the effect of reducing the benefits available to Indemnitee hereunder based on the laws of the State of Maryland as in effect on the Effective Date. The rights of Indemnitee provided in this Section 3 shall include, without limitation, the rights set forth in the other sections of this Agreement, including any additional indemnification permitted by Section 2-418(g) of the Maryland General Corporation Law (the MGCL ).
Section 4. Standard for Indemnification . If, by reason of Indemnitees Corporate Status, Indemnitee is, or is threatened to be, made a party to any Proceeding, Indemnitee shall be indemnified against all judgments, penalties, fines and amounts paid in settlement and all Expenses actually and reasonably incurred by him or on his behalf in connection with any such Proceeding unless it is established that (a) the act or omission of Indemnitee was material to the matter giving rise to the Proceeding and (i) was committed in bad faith or (ii) was the result of active and deliberate dishonesty, (b) Indemnitee actually received an improper personal benefit in money, property or services or (c) in the case of any criminal Proceeding, Indemnitee had reasonable cause to believe that his conduct was unlawful.
Section 5. Certain Limits on Indemnification . Notwithstanding any other provision of this Agreement (other than Section 6), Indemnitee shall not be entitled to:
(a) indemnification hereunder if the Proceeding was one by or in the right of the Company and Indemnitee is adjudged to be liable to the Company;
(b) indemnification hereunder if Indemnitee is adjudged to be liable on the basis that personal benefit was improperly received in any Proceeding charging improper personal benefit to Indemnitee, whether or not involving action in the Indemnitees Corporate Status; or
(c) indemnification or advance of Expenses hereunder if the Proceeding was brought by Indemnitee unless: (i) the Proceeding was brought to enforce indemnification under this Agreement, and then only to the extent in accordance with and as authorized by Section 12 of this Agreement, or (ii) the Companys charter or Bylaws, a resolution of the stockholders entitled to vote generally in the election of directors or of the Board of Directors or an agreement
approved by the Board of Directors to which the Company is a party expressly provide otherwise.
Section 6. Court-Ordered Indemnification . Notwithstanding any other provision of this Agreement, a court of appropriate jurisdiction, upon application of Indemnitee and such notice as the court shall require, may order indemnification in the following circumstances:
(a) if it determines Indemnitee is entitled to reimbursement under Section 2-418(d)(1) of the MGCL, the court shall order indemnification, in which case Indemnitee shall be entitled to recover the Expenses of securing such reimbursement; or
(b) if it determines that Indemnitee is fairly and reasonably entitled to indemnification in view of all the relevant circumstances, whether or not Indemnitee (i) has met the standards of conduct set forth in Section 2-418(b) of the MGCL or (ii) has been adjudged liable for receipt of an improper personal benefit under Section 2-418(c) of the MGCL, the court may order such indemnification as the court shall deem proper. However, indemnification with respect to any Proceeding by or in the right of the Company or in which liability shall have been adjudged in the circumstances described in Section 2-418(c) of the MGCL shall be limited to Expenses.
Section 7. Indemnification for Expenses of a Party Who is Wholly or Partly Successful . Notwithstanding any other provision of this Agreement, and without limiting any such provision, to the extent that Indemnitee was or is, by reason of his Corporate Status, made a party to (or otherwise becomes a participant in) any Proceeding and is successful, on the merits or otherwise, in the defense of such Proceeding, Indemnitee shall be indemnified for all Expenses actually and reasonably incurred by him or on his behalf in connection therewith. If Indemnitee is not wholly successful in such Proceeding but is successful, on the merits or otherwise, as to one or more but less than all claims, issues or matters in such Proceeding, the Company shall indemnify Indemnitee under this Section 7 for all Expenses actually and reasonably incurred by him or on his behalf in connection with each such claim, issue or matter, allocated on a reasonable and proportionate basis. For purposes of this Section 7 and, without limitation, the termination of any claim, issue or matter in such a Proceeding by dismissal, with or without prejudice, shall be deemed to be a successful result as to such claim, issue or matter.
Section 8. Advance of Expenses for a Party . If, by reason of Indemnitees Corporate Status, Indemnitee is, or is threatened to be, made a party to any Proceeding, the Company shall, without requiring a preliminary determination of Indemnitees ultimate entitlement to indemnification hereunder, advance all reasonable Expenses incurred by or on behalf of Indemnitee in connection with such Proceeding within ten days after the receipt by the Company of a statement or statements requesting such advance or advances from time to time, whether prior to or after final disposition of such Proceeding. Such statement or statements shall reasonably evidence the Expenses incurred by Indemnitee and shall include or be preceded or accompanied by a written affirmation by Indemnitee of Indemnitees good faith belief that the standard of conduct necessary for indemnification by the Company as authorized by law and by this Agreement has been met and a written undertaking by or on behalf of Indemnitee, in substantially the form attached hereto as Exhibit A or in such form as may be required under applicable law as in effect at the time of the execution thereof, to reimburse the portion of any
Expenses advanced to Indemnitee relating to claims, issues or matters in the Proceeding as to which it shall ultimately be established that the standard of conduct has not been met by Indemnitee and which have not been successfully resolved as described in Section 7 of this Agreement. To the extent that Expenses advanced to Indemnitee do not relate to a specific claim, issue or matter in the Proceeding, such Expenses shall be allocated on a reasonable and proportionate basis. The undertaking required by this Section 8 shall be an unlimited general obligation by or on behalf of Indemnitee and shall be accepted without reference to Indemnitees financial ability to repay such advanced Expenses and without any requirement to post security therefor.
Section 9. Indemnification and Advance of Expenses of a Witness . Notwithstanding any other provision of this Agreement, to the extent that Indemnitee is or may be, by reason of his Corporate Status, made a witness or otherwise asked to participate in any Proceeding, whether instituted by the Company or any other party, and to which Indemnitee is not a party, he shall be advanced all reasonable Expenses and indemnified against all Expenses actually and reasonably incurred by him or on his behalf in connection therewith within ten days after the receipt by the Company of a statement or statements requesting such advance or advances from time to time, whether prior to or after final disposition of such Proceeding. Such statement or statements shall reasonably evidence the Expenses incurred by Indemnitee.
Section 10. Procedure for Determination of Entitlement to Indemnification .
(a) To obtain indemnification under this Agreement, Indemnitee shall submit to the Company a written request, including therein or therewith such documentation and information as is reasonably available to Indemnitee and is reasonably necessary to determine whether and to what extent Indemnitee is entitled to indemnification. Indemnitee may submit one or more such requests from time to time and at such time(s) as Indemnitee deems appropriate in his sole discretion. The officer of the Company receiving any such request from Indemnitee shall, promptly upon receipt of such a request for indemnification, advise the Board of Directors in writing that Indemnitee has requested indemnification.
(b) Upon written request by Indemnitee for indemnification pursuant to Section 10(a) above, a determination, if required by applicable law, with respect to Indemnitees entitlement thereto shall promptly be made in the specific case: (i) if a Change in Control shall have occurred, by Independent Counsel, in a written opinion to the Board of Directors, a copy of which shall be delivered to Indemnitee, which Independent Counsel shall be selected by the Indemnitee and approved by the Board of Directors in accordance with Section 2-418(e)(2)(ii) of the MGCL, which approval will not be unreasonably withheld; or (ii) if a Change in Control shall not have occurred, (A) by the Board of Directors by a majority vote of a quorum consisting of Disinterested Directors or, if such a quorum cannot be obtained, then by a majority vote of a duly authorized committee of the Board of Directors consisting solely of one or more Disinterested Directors, (B) if Independent Counsel has been selected by the Board of Directors in accordance with Section 2-418(e)(2)(ii) of the MGCL and approved by the Indemnitee, which approval shall not be unreasonably withheld, by Independent Counsel, in a written opinion to the Board of Directors, a copy of which shall be delivered to Indemnitee or (C) if so directed by a majority of the members of the Board of Directors, by the stockholders of the Company. If it is so determined that Indemnitee is entitled to indemnification, payment to Indemnitee shall be
made within ten days after such determination. Indemnitee shall cooperate with the person, persons or entity making such determination with respect to Indemnitees entitlement to indemnification, including providing to such person, persons or entity upon reasonable advance request any documentation or information which is not privileged or otherwise protected from disclosure and which is reasonably available to Indemnitee and reasonably necessary to such determination in the discretion of the Board of Directors or Independent Counsel if retained pursuant to clause (ii)(B) of this Section 10(b). Any Expenses incurred by Indemnitee in so cooperating with the person, persons or entity making such determination shall be borne by the Company (irrespective of the determination as to Indemnitees entitlement to indemnification) and the Company shall indemnify and hold Indemnitee harmless therefrom.
(c) The Company shall pay the reasonable fees and expenses of Independent Counsel, if one is appointed.
Section 11. Presumptions and Effect of Certain Proceedings .
(a) In making any determination with respect to entitlement to indemnification hereunder, the person or persons or entity making such determination shall presume that Indemnitee is entitled to indemnification under this Agreement if Indemnitee has submitted a request for indemnification in accordance with Section 10(a) of this Agreement, and the Company shall have the burden of proof to overcome that presumption in connection with the making of any determination contrary to that presumption.
(b) The termination of any Proceeding or of any claim, issue or matter therein, by judgment, order, settlement or conviction, upon a plea of nolo contendere or its equivalent, or entry of an order of probation prior to judgment, does not create a presumption that Indemnitee did not meet the requisite standard of conduct described herein for indemnification.
(c) The knowledge and/or actions, or failure to act, of any other director, officer, employee or agent of the Company or any other director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any other foreign or domestic corporation, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise shall not be imputed to Indemnitee for purposes of determining any other right to indemnification under this Agreement.
Section 12. Remedies of Indemnitee .
(a) If (i) a determination is made pursuant to Section 10(b) of this Agreement that Indemnitee is not entitled to indemnification under this Agreement, (ii) advance of Expenses is not timely made pursuant to Section 8 of this Agreement, (iii) no determination of entitlement to indemnification shall have been made pursuant to Section 10(b) of this Agreement within 60 days after receipt by the Company of the request for indemnification, (iv) payment of indemnification is not made pursuant to Section 7 of this Agreement within ten days after receipt by the Company of a written request therefor, or (v) payment of indemnification pursuant to any other section of this Agreement or the charter or Bylaws of the Company is not made within ten days after a determination has been made that Indemnitee is entitled to indemnification, Indemnitee shall be entitled to an adjudication in an appropriate court located in the State of
Maryland, or in any other court of competent jurisdiction, of his entitlement to such indemnification or advance of Expenses. Alternatively, Indemnitee, at his option, may seek an award in arbitration to be conducted by a single arbitrator pursuant to the Commercial Arbitration Rules of the American Arbitration Association. Indemnitee shall commence a proceeding seeking an adjudication or an award in arbitration within 180 days following the date on which Indemnitee first has the right to commence such proceeding pursuant to this Section 12(a); provided, however, that the foregoing clause shall not apply to a proceeding brought by Indemnitee to enforce his rights under Section 7 of this Agreement. Except as set forth herein, the provisions of the laws of the State of Maryland (without regard to its conflicts of laws rules) shall apply to any such arbitration. The Company shall not oppose Indemnitees right to seek any such adjudication or award in arbitration.
(b) In any judicial proceeding or arbitration commenced pursuant to this Section 12, Indemnitee shall be presumed to be entitled to indemnification or advance of Expenses, as the case may be, under this Agreement and the Company shall have the burden of proving that Indemnitee is not entitled to indemnification or advance of Expenses, as the case may be. If Indemnitee commences a judicial proceeding or arbitration pursuant to this Section 12, Indemnitee shall not be required to reimburse the Company for any advances pursuant to Section 8 of this Agreement until a final determination is made with respect to Indemnitees entitlement to indemnification (as to which all rights of appeal have been exhausted or lapsed). The Company shall, to the fullest extent not prohibited by law, be precluded from asserting in any judicial proceeding or arbitration commenced pursuant to this Section 12 that the procedures and presumptions of this Agreement are not valid, binding and enforceable and shall stipulate in any such court or before any such arbitrator that the Company is bound by all of the provisions of this Agreement.
(c) If a determination shall have been made pursuant to Section 10(b) of this Agreement that Indemnitee is entitled to indemnification, the Company shall be bound by such determination in any judicial proceeding or arbitration commenced pursuant to this Section 12, absent a misstatement by Indemnitee of a material fact, or an omission of a material fact necessary to make Indemnitees statement not materially misleading, in connection with the request for indemnification.
(d) In the event that Indemnitee, pursuant to this Section 12, seeks a judicial adjudication of or an award in arbitration to enforce his rights under, or to recover damages for breach of, this Agreement, Indemnitee shall be entitled to recover from the Company, and shall be indemnified by the Company for, any and all Expenses actually and reasonably incurred by him in such judicial adjudication or arbitration. If it shall be determined in such judicial adjudication or arbitration that Indemnitee is entitled to receive part but not all of the indemnification or advance of Expenses sought, the Expenses incurred by Indemnitee in connection with such judicial adjudication or arbitration shall be appropriately prorated.
(e) Interest shall be paid by the Company to Indemnitee at the maximum rate allowed to be charged for judgments under the Courts and Judicial Proceedings Article of the Annotated Code of Maryland for amounts which the Company pays or is obligated to pay for the period commencing with the date on which the Company was requested to advance expenses in accordance with Section 8 of this Agreement or to make the determination of entitlement to
indemnification under Section 12(a) above. Indemnitee requests indemnification, reimbursement or advance of any Expenses and ending on the date such payment is made to Indemnitee by the Company.
Section 13. Defense of the Underlying Proceeding .
(a) Indemnitee shall notify the Company promptly in writing upon being served with any summons, citation, subpoena, complaint, indictment, request or other document relating to any Proceeding which may result in the right to indemnification or the advance of Expenses hereunder and shall include with such notice a description of the nature of the Proceeding and a summary of the facts underlying the Proceeding. The failure to give any such notice shall not disqualify Indemnitee from the right, or otherwise affect in any manner any right of Indemnitee, to indemnification or the advance of Expenses under this Agreement unless the Companys ability to defend in such Proceeding or to obtain proceeds under any insurance policy is materially and adversely prejudiced thereby, and then only to the extent the Company is thereby actually so prejudiced.
(b) Subject to the provisions of the last sentence of this Section 13(b) and of Section 13(c) below, the Company shall have the right to defend Indemnitee in any Proceeding which may give rise to indemnification hereunder; provided, however, that the Company shall notify Indemnitee of any such decision to defend within 15 calendar days following receipt of notice of any such Proceeding under Section 13(a) above. The Company shall not, without the prior written consent of Indemnitee, which shall not be unreasonably withheld or delayed, consent to the entry of any judgment against Indemnitee or enter into any settlement or compromise which (i) includes an admission of fault of Indemnitee, (ii) does not include, as an unconditional term thereof, the full release of Indemnitee from all liability in respect of such Proceeding, which release shall be in form and substance reasonably satisfactory to Indemnitee or (iii) would impose any Expense, judgment, fine, penalty or limitation on Indemnitee. This Section 13(b) shall not apply to a Proceeding brought by Indemnitee under Section 12 of this Agreement.
(c) Notwithstanding the provisions of Section 13(b) above, if in a Proceeding to which Indemnitee is a party by reason of Indemnitees Corporate Status, (i) Indemnitee reasonably concludes, based upon an opinion of counsel approved by the Company, which approval shall not be unreasonably withheld, that he may have separate defenses or counterclaims to assert with respect to any issue which may not be consistent with other defendants in such Proceeding, (ii) Indemnitee reasonably concludes, based upon an opinion of counsel approved by the Company, which approval shall not be unreasonably withheld, that an actual or apparent conflict of interest or potential conflict of interest exists between Indemnitee and the Company, or (iii) if the Company fails to assume the defense of such Proceeding in a timely manner, Indemnitee shall be entitled to be represented by separate legal counsel of Indemnitees choice, subject to the prior approval of the Company, which shall not be unreasonably withheld, at the expense of the Company. In addition, if the Company fails to comply with any of its obligations under this Agreement or in the event that the Company or any other person takes any action to declare this Agreement void or unenforceable, or institutes any Proceeding to deny or to recover from Indemnitee the benefits intended to be provided to Indemnitee hereunder, Indemnitee shall have the right to retain counsel of Indemnitees choice,
subject to the prior approval of the Company, which shall not be unreasonably withheld, at the expense of the Company (subject to Section 12(d) of this Agreement), to represent Indemnitee in connection with any such matter.
Section 14. Non-Exclusivity; Survival of Rights; Subrogation .
(a) The rights of indemnification and advance of Expenses as provided by this Agreement shall not be deemed exclusive of any other rights to which Indemnitee may at any time be entitled under applicable law, the charter or Bylaws of the Company, any agreement or a resolution of the stockholders entitled to vote generally in the election of directors or of the Board of Directors, or otherwise. Unless consented to in writing by Indemnitee, no amendment, alteration or repeal of this Agreement or of any provision hereof shall limit or restrict any right of Indemnitee under this Agreement in respect of any action taken or omitted by such Indemnitee in his Corporate Status prior to such amendment, alteration or repeal, regardless of whether a claim with respect to such action or inaction is raised prior or subsequent to such amendment, alteration or repeal. No right or remedy herein conferred is intended to be exclusive of any other right or remedy, and every other right or remedy shall be cumulative and in addition to every other right or remedy given hereunder or now or hereafter existing at law or in equity or otherwise. The assertion of any right or remedy hereunder, or otherwise, shall not prohibit the concurrent assertion or employment of any other right or remedy.
(b) In the event of any payment under this Agreement, the Company shall be subrogated to the extent of such payment to all of the rights of recovery of Indemnitee, who shall execute all papers required and take all action necessary to secure such rights, including execution of such documents as are necessary to enable the Company to bring suit to enforce such rights.
Section 15. Insurance . The Company will use its reasonable best efforts to acquire directors and officers liability insurance, on terms and conditions deemed appropriate by the Board of Directors, with the advice of counsel, covering Indemnitee or any claim made against Indemnitee by reason of his Corporate Status and covering the Company for any indemnification or advance of Expenses made by the Company to Indemnitee for any claims made against Indemnitee by reason of his Corporate Status. Without in any way limiting any other obligation under this Agreement, the Company shall indemnify Indemnitee for any payment by Indemnitee arising out of the amount of any deductible or retention and the amount of any excess of the aggregate of all judgments, penalties, fines, settlements and Expenses incurred by Indemnitee in connection with a Proceeding over the coverage of any insurance referred to in the previous sentence. The purchase, establishment and maintenance of any such insurance shall not in any way limit or affect the rights or obligations of the Company or Indemnitee under this Agreement except as expressly provided herein, and the execution and delivery of this Agreement by the Company and the Indemnitee shall not in any way limit or affect the rights or obligations of the Company under any such insurance policies. If, at the time the Company receives notice from any source of a Proceeding to which Indemnitee is a party or a participant (as a witness or otherwise) the Company has director and officer liability insurance in effect, the Company shall give prompt notice of such Proceeding to the insurers in accordance with the procedures set forth in the respective policies.
Section 16. Coordination of Payments . The Company shall not be liable under this Agreement to make any payment of amounts otherwise indemnifiable or payable or reimbursable as Expenses hereunder if and to the extent that Indemnitee has otherwise actually received such payment under any insurance policy, contract, agreement or otherwise.
Section 17. Reports to Stockholders . To the extent required by the MGCL, the Company shall report in writing to its stockholders the payment of any amounts for indemnification of, or advance of Expenses to, Indemnitee under this Agreement arising out of a Proceeding by or in the right of the Company with the notice of the meeting of stockholders of the Company next following the date of the payment of any such indemnification or advance of Expenses or prior to such meeting.
Section 18. Duration of Agreement; Binding Effect .
(a) This Agreement shall continue until and terminate on the later of (i) ten years after the date that Indemnitee shall have ceased to serve as a director, officer, employee or agent of the Company or as a director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any other foreign or domestic corporation, real estate investment trust, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise that such person is or was serving in such capacity at the request of the Company and (ii) the date that Indemnitee is no longer subject to any actual or possible Proceeding due to the lapse of all applicable statutes of limitations or otherwise (including any rights of appeal thereto and any Proceeding commenced by Indemnitee pursuant to Section 12 of this Agreement).
(b) The indemnification and advance of Expenses provided by, or granted pursuant to, this Agreement shall be binding upon and be enforceable by the parties hereto and their respective successors and assigns (including any direct or indirect successor by purchase, merger, consolidation or otherwise to all or substantially all of the business or assets of the Company), shall continue as to an Indemnitee who has ceased to be a director, officer, employee or agent of the Company or a director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any other foreign or domestic corporation, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise that such person is or was serving in such capacity at the request of the Company, and shall inure to the benefit of Indemnitee and his spouse, assigns, heirs, devisees, executors and administrators and other legal representatives.
(c) The Company shall require and cause any successor (whether direct or indirect by purchase, merger, consolidation or otherwise) to all, substantially all or a substantial part, of the business and/or assets of the Company, by written agreement in form and substance satisfactory to Indemnitee, expressly to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform if no such succession had taken place.
(d) The Company and Indemnitee agree herein that a monetary remedy for breach of this Agreement, at some later date, may be inadequate, impracticable and difficult of proof, and further agree that such breach may cause Indemnitee irreparable harm. Accordingly, the parties hereto agree that Indemnitee may enforce this Agreement by seeking injunctive relief and/or
specific performance hereof, without any necessity of showing actual damage or irreparable harm and that by seeking injunctive relief and/or specific performance, Indemnitee shall not be precluded from seeking or obtaining any other relief to which he may be entitled. Indemnitee shall further be entitled to such specific performance and injunctive relief, including temporary restraining orders, preliminary injunctions and permanent injunctions, without the necessity of posting bonds or other undertakings in connection therewith. The Company acknowledges that, in the absence of a waiver, a bond or undertaking may be required of Indemnitee by a court, and the Company hereby waives any such requirement of such a bond or undertaking.
Section 19. Severability . If any provision or provisions of this Agreement shall be held to be invalid, illegal or unenforceable for any reason whatsoever: (a) the validity, legality and enforceability of the remaining provisions of this Agreement (including, without limitation, each portion of any Section, paragraph or sentence of this Agreement containing any such provision held to be invalid, illegal or unenforceable that is not itself invalid, illegal or unenforceable) shall not in any way be affected or impaired thereby and shall remain enforceable to the fullest extent permitted by law; (b) such provision or provisions shall be deemed reformed to the extent necessary to conform to applicable law and to give the maximum effect to the intent of the parties hereto; and (c) to the fullest extent possible, the provisions of this Agreement (including, without limitation, each portion of any Section, paragraph or sentence of this Agreement containing any such provision held to be invalid, illegal or unenforceable, that is not itself invalid, illegal or unenforceable) shall be construed so as to give effect to the intent manifested thereby.
Section 20. Identical Counterparts . This Agreement may be executed in one or more counterparts, each of which shall for all purposes be deemed to be an original but all of which together shall constitute one and the same Agreement. One such counterpart signed by the party against whom enforceability is sought shall be sufficient to evidence the existence of this Agreement.
Section 21. Headings . The headings of the paragraphs of this Agreement are inserted for convenience only and shall not be deemed to constitute part of this Agreement or to affect the construction thereof.
Section 22. Modification and Waiver . No supplement, modification or amendment of this Agreement shall be binding unless executed in writing by both of the parties hereto. No waiver of any of the provisions of this Agreement shall be deemed or shall constitute a waiver of any other provisions hereof (whether or not similar) nor shall such waiver constitute a continuing waiver.
Section 23. Notices . All notices, requests, demands and other communications hereunder shall be in writing and shall be deemed to have been duly given if (i) delivered by hand and receipted for by the party to whom said notice or other communication shall have been directed or (ii) mailed by certified or registered mail with postage prepaid, on the third business day after the date on which it is so mailed:
(a) If to Indemnitee, to the address set forth on the signature page hereto.
(b) If to the Company, to:
General Counsel
Two Bridge Avenue, Suite 322
Red Bank, New Jersey 07701-1106
Facsimile: (732) 978-7507
or to such other address as may have been furnished in writing to Indemnitee by the Company or to the Company by Indemnitee, as the case may be.
Section 24. Governing Law . The parties agree that this Agreement shall be governed by, and construed and enforced in accordance with, the laws of the State of Maryland, without regard to its conflicts of laws rules.
Section 25. Miscellaneous . Use of the masculine pronoun shall be deemed to include usage of the feminine pronoun where appropriate.
[SIGNATURE PAGE FOLLOWS]
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above written.
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ZAIS FINANCIAL CORP. |
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/s/ Michael Szymanski |
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Name: |
Michael Szymanski |
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Title: |
Chief Executive Officer, President and Director |
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INDEMNITEE |
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/s/ Christian Zugel |
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Name: |
Christian Zugel |
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Address: |
Two Bridge Avenue, Suite 322 |
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Red Bank, New Jersey 07701-1106 |
[ Signature Page to Christian Zugel Indemnification Agreement ]
EXHIBIT A
FORM OF UNDERTAKING TO REPAY EXPENSES ADVANCED
The Board of Directors of ZAIS Financial Corp.
Re: Undertaking to Repay Expenses Advanced
Ladies and Gentlemen:
This undertaking is being provided pursuant to that certain Indemnification Agreement dated the day of July, 2011, by and between ZAIS Financial Corp., a Maryland corporation (the Company), and the undersigned Indemnitee (the Indemnification Agreement ), pursuant to which I am entitled to advance of Expenses in connection with [Description of Proceeding] (the Proceeding ).
Terms used herein and not otherwise defined shall have the meanings specified in the Indemnification Agreement.
I am subject to the Proceeding by reason of my Corporate Status or by reason of alleged actions or omissions by me in such capacity. I hereby affirm my good belief that at all times, insofar as I was involved as [a director] [an officer] of the Company, in any of the facts or events giving rise to the Proceeding, I (1) did not act with bad faith or active or deliberate dishonesty, (2) did not receive any improper personal benefit in money, property or services and (3) in the case of any criminal proceeding, had no reasonable cause to believe that any act or omission by me was unlawful.
In consideration of the advance of Expenses by the Company for reasonable attorneys fees and related Expenses incurred by me in connection with the Proceeding (the Advanced Expenses ), I hereby agree that if, in connection with the Proceeding, it is established that (1) an act or omission by me was material to the matter giving rise to the Proceeding and (a) was committed in bad faith or (b) was the result of active and deliberate dishonesty or (2) I actually received an improper personal benefit in money, property or services or (3) in the case of any criminal proceeding, I had reasonable cause to believe that the act or omission was unlawful, then I shall promptly reimburse the portion of the Advanced Expenses relating to the claims, issues or matters in the Proceeding as to which the foregoing findings have been established.
IN WITNESS WHEREOF, I have executed this Affirmation and Undertaking on this day of , 20 .
Exhibit 10.7
INDEMNIFICATION AGREEMENT
THIS INDEMNIFICATION AGREEMENT ( Agreement ) is made and entered into as of the 3rd day of August, 2011, by and between ZAIS Financial Corp., a Maryland corporation (the Company ), and Michael Szymanski ( Indemnitee ).
WHEREAS, at the request of the Company, Indemnitee currently serves as a director and/or officer of the Company and may, therefore, be subjected to claims, suits or proceedings arising as a result of his service; and
WHEREAS, as an inducement to Indemnitee to continue to serve as such director and/or officer, the Company has agreed to indemnify and to advance expenses and costs incurred by Indemnitee in connection with any such claims, suits or proceedings, to the maximum extent permitted by law; and
WHEREAS, the parties by this Agreement desire to set forth their agreement regarding indemnification and advance of expenses; and
NOW, THEREFORE, in consideration of the premises and the covenants contained herein, the Company and Indemnitee do hereby covenant and agree as follows:
Section 1. Definitions . For purposes of this Agreement:
(a) Change in Control means a change in control of the Company occurring after the Effective Date of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14A (or in response to any similar item on any similar schedule or form) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act ), whether or not the Company is then subject to such reporting requirement; provided, however, that, without limitation, such a Change in Control shall be deemed to have occurred if, after the Effective Date (i) any person (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) is or becomes the beneficial owner (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company representing 15% or more of the combined voting power of all of the Companys then-outstanding securities entitled to vote generally in the election of directors without the prior approval of at least two-thirds of the members of the Board of Directors in office immediately prior to such persons attaining such percentage interest; (ii) the Company is a party to a merger, consolidation, sale of assets, plan of liquidation or other reorganization not approved by at least two-thirds of the members of the Board of Directors then in office, as a consequence of which members of the Board of Directors in office immediately prior to such transaction or event constitute less than a majority of the Board of Directors thereafter; or (iii) at any time, a majority of the members of the Board of Directors are not individuals (A) who were directors as of the Effective Date or (B) whose election by the Board of Directors or nomination for election by the Companys stockholders was approved by the affirmative vote of at least two-thirds of the directors then in office who were directors as of the Effective Date or whose election or nomination for election was previously so approved.
(b) Corporate Status means the status of a person as a present or former director, officer, employee or agent of the Company or as a director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any other foreign or domestic corporation, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise that such person is or was serving in such capacity at the request of the Company. As a clarification and without limiting the circumstances in which Indemnitee may be serving at the request of the Company, service by Indemnitee shall be deemed to be at the request of the Company if Indemnitee serves or served as a director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any corporation, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise (i) of which a majority of the voting power or equity interest is owned directly or indirectly by the Company or (ii) the management of which is controlled directly or indirectly by the Company.
(c) Disinterested Director means a director of the Company who is not and was not a party to the Proceeding in respect of which indemnification and/or advance of Expenses is sought by Indemnitee.
(d) Effective Date means the date set forth in the first paragraph of this Agreement.
(e) Expenses means any and all reasonable and out-of-pocket attorneys fees and costs, retainers, court costs, transcript costs, fees of experts, witness fees, travel expenses, duplicating costs, printing and binding costs, telephone charges, postage, delivery service fees, federal, state, local or foreign taxes imposed on Indemnitee as a result of the actual or deemed receipt of any payments under this Agreement, ERISA excise taxes and penalties and any other disbursements or expenses incurred in connection with prosecuting, defending, preparing to prosecute or defend, investigating, being or preparing to be a witness in or otherwise participating in a Proceeding. Expenses shall also include Expenses incurred in connection with any appeal resulting from any Proceeding including, without limitation, the premium, security for and other costs relating to any cost bond, supersedeas bond or other appeal bond or its equivalent.
(f) Independent Counsel means a law firm, or a member of a law firm, that is experienced in matters of corporation law and neither is, nor in the past five years has been, retained to represent: (i) the Company or Indemnitee in any matter material to either such party (other than with respect to matters concerning Indemnitee under this Agreement or of other indemnitees under similar indemnification agreements), or (ii) any other party to or participant or witness in the Proceeding giving rise to a claim for indemnification or advance of Expenses hereunder. Notwithstanding the foregoing, the term Independent Counsel shall not include any person who, under the applicable standards of professional conduct then prevailing, would have a conflict of interest in representing either the Company or Indemnitee in an action to determine Indemnitees rights under this Agreement.
(g) Proceeding means any threatened, pending or completed action, suit, arbitration, alternate dispute resolution mechanism, investigation, inquiry, administrative hearing or any other proceeding, whether brought by or in the right of the Company or otherwise and whether of a civil (including intentional or unintentional tort claims), criminal, administrative or investigative (formal or informal) nature, including any appeal therefrom, except one pending or
completed on or before the Effective Date, unless otherwise specifically agreed in writing by the Company and Indemnitee. If Indemnitee reasonably believes that a given situation may lead to or culminate in the institution of a Proceeding, such situation shall also be considered a Proceeding.
Section 2. Services by Indemnitee . Indemnitee will serve as a director and/or officer of the Company. However, this Agreement shall not impose any independent obligation on Indemnitee or the Company to continue Indemnitees service to the Company. This Agreement shall not be deemed an employment contract between the Company (or any other entity) and Indemnitee.
Section 3. General . The Company shall indemnify, and advance Expenses to, Indemnitee (a) as provided in this Agreement and (b) otherwise to the maximum extent permitted by the laws of the State of Maryland in effect on the Effective Date and as amended from time to time; provided, however, that no change in the laws of the State of Maryland shall have the effect of reducing the benefits available to Indemnitee hereunder based on the laws of the State of Maryland as in effect on the Effective Date. The rights of Indemnitee provided in this Section 3 shall include, without limitation, the rights set forth in the other sections of this Agreement, including any additional indemnification permitted by Section 2-418(g) of the Maryland General Corporation Law (the MGCL ).
Section 4. Standard for Indemnification . If, by reason of Indemnitees Corporate Status, Indemnitee is, or is threatened to be, made a party to any Proceeding, Indemnitee shall be indemnified against all judgments, penalties, fines and amounts paid in settlement and all Expenses actually and reasonably incurred by him or on his behalf in connection with any such Proceeding unless it is established that (a) the act or omission of Indemnitee was material to the matter giving rise to the Proceeding and (i) was committed in bad faith or (ii) was the result of active and deliberate dishonesty, (b) Indemnitee actually received an improper personal benefit in money, property or services or (c) in the case of any criminal Proceeding, Indemnitee had reasonable cause to believe that his conduct was unlawful.
Section 5. Certain Limits on Indemnification . Notwithstanding any other provision of this Agreement (other than Section 6), Indemnitee shall not be entitled to:
(a) indemnification hereunder if the Proceeding was one by or in the right of the Company and Indemnitee is adjudged to be liable to the Company;
(b) indemnification hereunder if Indemnitee is adjudged to be liable on the basis that personal benefit was improperly received in any Proceeding charging improper personal benefit to Indemnitee, whether or not involving action in the Indemnitees Corporate Status; or
(c) indemnification or advance of Expenses hereunder if the Proceeding was brought by Indemnitee unless: (i) the Proceeding was brought to enforce indemnification under this Agreement, and then only to the extent in accordance with and as authorized by Section 12 of this Agreement, or (ii) the Companys charter or Bylaws, a resolution of the stockholders entitled to vote generally in the election of directors or of the Board of Directors or an agreement
approved by the Board of Directors to which the Company is a party expressly provide otherwise.
Section 6. Court-Ordered Indemnification . Notwithstanding any other provision of this Agreement, a court of appropriate jurisdiction, upon application of Indemnitee and such notice as the court shall require, may order indemnification in the following circumstances:
(a) if it determines Indemnitee is entitled to reimbursement under Section 2-418(d)(1) of the MGCL, the court shall order indemnification, in which case Indemnitee shall be entitled to recover the Expenses of securing such reimbursement; or
(b) if it determines that Indemnitee is fairly and reasonably entitled to indemnification in view of all the relevant circumstances, whether or not Indemnitee (i) has met the standards of conduct set forth in Section 2-418(b) of the MGCL or (ii) has been adjudged liable for receipt of an improper personal benefit under Section 2-418(c) of the MGCL, the court may order such indemnification as the court shall deem proper. However, indemnification with respect to any Proceeding by or in the right of the Company or in which liability shall have been adjudged in the circumstances described in Section 2-418(c) of the MGCL shall be limited to Expenses.
Section 7. Indemnification for Expenses of a Party Who is Wholly or Partly Successful . Notwithstanding any other provision of this Agreement, and without limiting any such provision, to the extent that Indemnitee was or is, by reason of his Corporate Status, made a party to (or otherwise becomes a participant in) any Proceeding and is successful, on the merits or otherwise, in the defense of such Proceeding, Indemnitee shall be indemnified for all Expenses actually and reasonably incurred by him or on his behalf in connection therewith. If Indemnitee is not wholly successful in such Proceeding but is successful, on the merits or otherwise, as to one or more but less than all claims, issues or matters in such Proceeding, the Company shall indemnify Indemnitee under this Section 7 for all Expenses actually and reasonably incurred by him or on his behalf in connection with each such claim, issue or matter, allocated on a reasonable and proportionate basis. For purposes of this Section 7 and, without limitation, the termination of any claim, issue or matter in such a Proceeding by dismissal, with or without prejudice, shall be deemed to be a successful result as to such claim, issue or matter.
Section 8. Advance of Expenses for a Party . If, by reason of Indemnitees Corporate Status, Indemnitee is, or is threatened to be, made a party to any Proceeding, the Company shall, without requiring a preliminary determination of Indemnitees ultimate entitlement to indemnification hereunder, advance all reasonable Expenses incurred by or on behalf of Indemnitee in connection with such Proceeding within ten days after the receipt by the Company of a statement or statements requesting such advance or advances from time to time, whether prior to or after final disposition of such Proceeding. Such statement or statements shall reasonably evidence the Expenses incurred by Indemnitee and shall include or be preceded or accompanied by a written affirmation by Indemnitee of Indemnitees good faith belief that the standard of conduct necessary for indemnification by the Company as authorized by law and by this Agreement has been met and a written undertaking by or on behalf of Indemnitee, in substantially the form attached hereto as Exhibit A or in such form as may be required under applicable law as in effect at the time of the execution thereof, to reimburse the portion of any
Expenses advanced to Indemnitee relating to claims, issues or matters in the Proceeding as to which it shall ultimately be established that the standard of conduct has not been met by Indemnitee and which have not been successfully resolved as described in Section 7 of this Agreement. To the extent that Expenses advanced to Indemnitee do not relate to a specific claim, issue or matter in the Proceeding, such Expenses shall be allocated on a reasonable and proportionate basis. The undertaking required by this Section 8 shall be an unlimited general obligation by or on behalf of Indemnitee and shall be accepted without reference to Indemnitees financial ability to repay such advanced Expenses and without any requirement to post security therefor.
Section 9. Indemnification and Advance of Expenses of a Witness . Notwithstanding any other provision of this Agreement, to the extent that Indemnitee is or may be, by reason of his Corporate Status, made a witness or otherwise asked to participate in any Proceeding, whether instituted by the Company or any other party, and to which Indemnitee is not a party, he shall be advanced all reasonable Expenses and indemnified against all Expenses actually and reasonably incurred by him or on his behalf in connection therewith within ten days after the receipt by the Company of a statement or statements requesting such advance or advances from time to time, whether prior to or after final disposition of such Proceeding. Such statement or statements shall reasonably evidence the Expenses incurred by Indemnitee.
Section 10. Procedure for Determination of Entitlement to Indemnification .
(a) To obtain indemnification under this Agreement, Indemnitee shall submit to the Company a written request, including therein or therewith such documentation and information as is reasonably available to Indemnitee and is reasonably necessary to determine whether and to what extent Indemnitee is entitled to indemnification. Indemnitee may submit one or more such requests from time to time and at such time(s) as Indemnitee deems appropriate in his sole discretion. The officer of the Company receiving any such request from Indemnitee shall, promptly upon receipt of such a request for indemnification, advise the Board of Directors in writing that Indemnitee has requested indemnification.
(b) Upon written request by Indemnitee for indemnification pursuant to Section 10(a) above, a determination, if required by applicable law, with respect to Indemnitees entitlement thereto shall promptly be made in the specific case: (i) if a Change in Control shall have occurred, by Independent Counsel, in a written opinion to the Board of Directors, a copy of which shall be delivered to Indemnitee, which Independent Counsel shall be selected by the Indemnitee and approved by the Board of Directors in accordance with Section 2-418(e)(2)(ii) of the MGCL, which approval will not be unreasonably withheld; or (ii) if a Change in Control shall not have occurred, (A) by the Board of Directors by a majority vote of a quorum consisting of Disinterested Directors or, if such a quorum cannot be obtained, then by a majority vote of a duly authorized committee of the Board of Directors consisting solely of one or more Disinterested Directors, (B) if Independent Counsel has been selected by the Board of Directors in accordance with Section 2-418(e)(2)(ii) of the MGCL and approved by the Indemnitee, which approval shall not be unreasonably withheld, by Independent Counsel, in a written opinion to the Board of Directors, a copy of which shall be delivered to Indemnitee or (C) if so directed by a majority of the members of the Board of Directors, by the stockholders of the Company. If it is so determined that Indemnitee is entitled to indemnification, payment to Indemnitee shall be
made within ten days after such determination. Indemnitee shall cooperate with the person, persons or entity making such determination with respect to Indemnitees entitlement to indemnification, including providing to such person, persons or entity upon reasonable advance request any documentation or information which is not privileged or otherwise protected from disclosure and which is reasonably available to Indemnitee and reasonably necessary to such determination in the discretion of the Board of Directors or Independent Counsel if retained pursuant to clause (ii)(B) of this Section 10(b). Any Expenses incurred by Indemnitee in so cooperating with the person, persons or entity making such determination shall be borne by the Company (irrespective of the determination as to Indemnitees entitlement to indemnification) and the Company shall indemnify and hold Indemnitee harmless therefrom.
(c) The Company shall pay the reasonable fees and expenses of Independent Counsel, if one is appointed.
Section 11. Presumptions and Effect of Certain Proceedings .
(a) In making any determination with respect to entitlement to indemnification hereunder, the person or persons or entity making such determination shall presume that Indemnitee is entitled to indemnification under this Agreement if Indemnitee has submitted a request for indemnification in accordance with Section 10(a) of this Agreement, and the Company shall have the burden of proof to overcome that presumption in connection with the making of any determination contrary to that presumption.
(b) The termination of any Proceeding or of any claim, issue or matter therein, by judgment, order, settlement or conviction, upon a plea of nolo contendere or its equivalent, or entry of an order of probation prior to judgment, does not create a presumption that Indemnitee did not meet the requisite standard of conduct described herein for indemnification.
(c) The knowledge and/or actions, or failure to act, of any other director, officer, employee or agent of the Company or any other director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any other foreign or domestic corporation, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise shall not be imputed to Indemnitee for purposes of determining any other right to indemnification under this Agreement.
Section 12. Remedies of Indemnitee .
(a) If (i) a determination is made pursuant to Section 10(b) of this Agreement that Indemnitee is not entitled to indemnification under this Agreement, (ii) advance of Expenses is not timely made pursuant to Section 8 of this Agreement, (iii) no determination of entitlement to indemnification shall have been made pursuant to Section 10(b) of this Agreement within 60 days after receipt by the Company of the request for indemnification, (iv) payment of indemnification is not made pursuant to Section 7 of this Agreement within ten days after receipt by the Company of a written request therefor, or (v) payment of indemnification pursuant to any other section of this Agreement or the charter or Bylaws of the Company is not made within ten days after a determination has been made that Indemnitee is entitled to indemnification, Indemnitee shall be entitled to an adjudication in an appropriate court located in the State of
Maryland, or in any other court of competent jurisdiction, of his entitlement to such indemnification or advance of Expenses. Alternatively, Indemnitee, at his option, may seek an award in arbitration to be conducted by a single arbitrator pursuant to the Commercial Arbitration Rules of the American Arbitration Association. Indemnitee shall commence a proceeding seeking an adjudication or an award in arbitration within 180 days following the date on which Indemnitee first has the right to commence such proceeding pursuant to this Section 12(a); provided, however, that the foregoing clause shall not apply to a proceeding brought by Indemnitee to enforce his rights under Section 7 of this Agreement. Except as set forth herein, the provisions of the laws of the State of Maryland (without regard to its conflicts of laws rules) shall apply to any such arbitration. The Company shall not oppose Indemnitees right to seek any such adjudication or award in arbitration.
(b) In any judicial proceeding or arbitration commenced pursuant to this Section 12, Indemnitee shall be presumed to be entitled to indemnification or advance of Expenses, as the case may be, under this Agreement and the Company shall have the burden of proving that Indemnitee is not entitled to indemnification or advance of Expenses, as the case may be. If Indemnitee commences a judicial proceeding or arbitration pursuant to this Section 12, Indemnitee shall not be required to reimburse the Company for any advances pursuant to Section 8 of this Agreement until a final determination is made with respect to Indemnitees entitlement to indemnification (as to which all rights of appeal have been exhausted or lapsed). The Company shall, to the fullest extent not prohibited by law, be precluded from asserting in any judicial proceeding or arbitration commenced pursuant to this Section 12 that the procedures and presumptions of this Agreement are not valid, binding and enforceable and shall stipulate in any such court or before any such arbitrator that the Company is bound by all of the provisions of this Agreement.
(c) If a determination shall have been made pursuant to Section 10(b) of this Agreement that Indemnitee is entitled to indemnification, the Company shall be bound by such determination in any judicial proceeding or arbitration commenced pursuant to this Section 12, absent a misstatement by Indemnitee of a material fact, or an omission of a material fact necessary to make Indemnitees statement not materially misleading, in connection with the request for indemnification.
(d) In the event that Indemnitee, pursuant to this Section 12, seeks a judicial adjudication of or an award in arbitration to enforce his rights under, or to recover damages for breach of, this Agreement, Indemnitee shall be entitled to recover from the Company, and shall be indemnified by the Company for, any and all Expenses actually and reasonably incurred by him in such judicial adjudication or arbitration. If it shall be determined in such judicial adjudication or arbitration that Indemnitee is entitled to receive part but not all of the indemnification or advance of Expenses sought, the Expenses incurred by Indemnitee in connection with such judicial adjudication or arbitration shall be appropriately prorated.
(e) Interest shall be paid by the Company to Indemnitee at the maximum rate allowed to be charged for judgments under the Courts and Judicial Proceedings Article of the Annotated Code of Maryland for amounts which the Company pays or is obligated to pay for the period commencing with the date on which the Company was requested to advance expenses in accordance with Section 8 of this Agreement or to make the determination of entitlement to
indemnification under Section 12(a) above. Indemnitee requests indemnification, reimbursement or advance of any Expenses and ending on the date such payment is made to Indemnitee by the Company.
Section 13. Defense of the Underlying Proceeding .
(a) Indemnitee shall notify the Company promptly in writing upon being served with any summons, citation, subpoena, complaint, indictment, request or other document relating to any Proceeding which may result in the right to indemnification or the advance of Expenses hereunder and shall include with such notice a description of the nature of the Proceeding and a summary of the facts underlying the Proceeding. The failure to give any such notice shall not disqualify Indemnitee from the right, or otherwise affect in any manner any right of Indemnitee, to indemnification or the advance of Expenses under this Agreement unless the Companys ability to defend in such Proceeding or to obtain proceeds under any insurance policy is materially and adversely prejudiced thereby, and then only to the extent the Company is thereby actually so prejudiced.
(b) Subject to the provisions of the last sentence of this Section 13(b) and of Section 13(c) below, the Company shall have the right to defend Indemnitee in any Proceeding which may give rise to indemnification hereunder; provided, however, that the Company shall notify Indemnitee of any such decision to defend within 15 calendar days following receipt of notice of any such Proceeding under Section 13(a) above. The Company shall not, without the prior written consent of Indemnitee, which shall not be unreasonably withheld or delayed, consent to the entry of any judgment against Indemnitee or enter into any settlement or compromise which (i) includes an admission of fault of Indemnitee, (ii) does not include, as an unconditional term thereof, the full release of Indemnitee from all liability in respect of such Proceeding, which release shall be in form and substance reasonably satisfactory to Indemnitee or (iii) would impose any Expense, judgment, fine, penalty or limitation on Indemnitee. This Section 13(b) shall not apply to a Proceeding brought by Indemnitee under Section 12 of this Agreement.
(c) Notwithstanding the provisions of Section 13(b) above, if in a Proceeding to which Indemnitee is a party by reason of Indemnitees Corporate Status, (i) Indemnitee reasonably concludes, based upon an opinion of counsel approved by the Company, which approval shall not be unreasonably withheld, that he may have separate defenses or counterclaims to assert with respect to any issue which may not be consistent with other defendants in such Proceeding, (ii) Indemnitee reasonably concludes, based upon an opinion of counsel approved by the Company, which approval shall not be unreasonably withheld, that an actual or apparent conflict of interest or potential conflict of interest exists between Indemnitee and the Company, or (iii) if the Company fails to assume the defense of such Proceeding in a timely manner, Indemnitee shall be entitled to be represented by separate legal counsel of Indemnitees choice, subject to the prior approval of the Company, which shall not be unreasonably withheld, at the expense of the Company. In addition, if the Company fails to comply with any of its obligations under this Agreement or in the event that the Company or any other person takes any action to declare this Agreement void or unenforceable, or institutes any Proceeding to deny or to recover from Indemnitee the benefits intended to be provided to Indemnitee hereunder, Indemnitee shall have the right to retain counsel of Indemnitees choice,
subject to the prior approval of the Company, which shall not be unreasonably withheld, at the expense of the Company (subject to Section 12(d) of this Agreement), to represent Indemnitee in connection with any such matter.
Section 14. Non-Exclusivity; Survival of Rights; Subrogation .
(a) The rights of indemnification and advance of Expenses as provided by this Agreement shall not be deemed exclusive of any other rights to which Indemnitee may at any time be entitled under applicable law, the charter or Bylaws of the Company, any agreement or a resolution of the stockholders entitled to vote generally in the election of directors or of the Board of Directors, or otherwise. Unless consented to in writing by Indemnitee, no amendment, alteration or repeal of this Agreement or of any provision hereof shall limit or restrict any right of Indemnitee under this Agreement in respect of any action taken or omitted by such Indemnitee in his Corporate Status prior to such amendment, alteration or repeal, regardless of whether a claim with respect to such action or inaction is raised prior or subsequent to such amendment, alteration or repeal. No right or remedy herein conferred is intended to be exclusive of any other right or remedy, and every other right or remedy shall be cumulative and in addition to every other right or remedy given hereunder or now or hereafter existing at law or in equity or otherwise. The assertion of any right or remedy hereunder, or otherwise, shall not prohibit the concurrent assertion or employment of any other right or remedy.
(b) In the event of any payment under this Agreement, the Company shall be subrogated to the extent of such payment to all of the rights of recovery of Indemnitee, who shall execute all papers required and take all action necessary to secure such rights, including execution of such documents as are necessary to enable the Company to bring suit to enforce such rights.
Section 15. Insurance . The Company will use its reasonable best efforts to acquire directors and officers liability insurance, on terms and conditions deemed appropriate by the Board of Directors, with the advice of counsel, covering Indemnitee or any claim made against Indemnitee by reason of his Corporate Status and covering the Company for any indemnification or advance of Expenses made by the Company to Indemnitee for any claims made against Indemnitee by reason of his Corporate Status. Without in any way limiting any other obligation under this Agreement, the Company shall indemnify Indemnitee for any payment by Indemnitee arising out of the amount of any deductible or retention and the amount of any excess of the aggregate of all judgments, penalties, fines, settlements and Expenses incurred by Indemnitee in connection with a Proceeding over the coverage of any insurance referred to in the previous sentence. The purchase, establishment and maintenance of any such insurance shall not in any way limit or affect the rights or obligations of the Company or Indemnitee under this Agreement except as expressly provided herein, and the execution and delivery of this Agreement by the Company and the Indemnitee shall not in any way limit or affect the rights or obligations of the Company under any such insurance policies. If, at the time the Company receives notice from any source of a Proceeding to which Indemnitee is a party or a participant (as a witness or otherwise) the Company has director and officer liability insurance in effect, the Company shall give prompt notice of such Proceeding to the insurers in accordance with the procedures set forth in the respective policies.
Section 16. Coordination of Payments . The Company shall not be liable under this Agreement to make any payment of amounts otherwise indemnifiable or payable or reimbursable as Expenses hereunder if and to the extent that Indemnitee has otherwise actually received such payment under any insurance policy, contract, agreement or otherwise.
Section 17. Reports to Stockholders . To the extent required by the MGCL, the Company shall report in writing to its stockholders the payment of any amounts for indemnification of, or advance of Expenses to, Indemnitee under this Agreement arising out of a Proceeding by or in the right of the Company with the notice of the meeting of stockholders of the Company next following the date of the payment of any such indemnification or advance of Expenses or prior to such meeting.
Section 18. Duration of Agreement; Binding Effect .
(a) This Agreement shall continue until and terminate on the later of (i) ten years after the date that Indemnitee shall have ceased to serve as a director, officer, employee or agent of the Company or as a director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any other foreign or domestic corporation, real estate investment trust, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise that such person is or was serving in such capacity at the request of the Company and (ii) the date that Indemnitee is no longer subject to any actual or possible Proceeding due to the lapse of all applicable statutes of limitations or otherwise (including any rights of appeal thereto and any Proceeding commenced by Indemnitee pursuant to Section 12 of this Agreement).
(b) The indemnification and advance of Expenses provided by, or granted pursuant to, this Agreement shall be binding upon and be enforceable by the parties hereto and their respective successors and assigns (including any direct or indirect successor by purchase, merger, consolidation or otherwise to all or substantially all of the business or assets of the Company), shall continue as to an Indemnitee who has ceased to be a director, officer, employee or agent of the Company or a director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any other foreign or domestic corporation, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise that such person is or was serving in such capacity at the request of the Company, and shall inure to the benefit of Indemnitee and his spouse, assigns, heirs, devisees, executors and administrators and other legal representatives.
(c) The Company shall require and cause any successor (whether direct or indirect by purchase, merger, consolidation or otherwise) to all, substantially all or a substantial part, of the business and/or assets of the Company, by written agreement in form and substance satisfactory to Indemnitee, expressly to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform if no such succession had taken place.
(d) The Company and Indemnitee agree herein that a monetary remedy for breach of this Agreement, at some later date, may be inadequate, impracticable and difficult of proof, and further agree that such breach may cause Indemnitee irreparable harm. Accordingly, the parties hereto agree that Indemnitee may enforce this Agreement by seeking injunctive relief and/or
specific performance hereof, without any necessity of showing actual damage or irreparable harm and that by seeking injunctive relief and/or specific performance, Indemnitee shall not be precluded from seeking or obtaining any other relief to which he may be entitled. Indemnitee shall further be entitled to such specific performance and injunctive relief, including temporary restraining orders, preliminary injunctions and permanent injunctions, without the necessity of posting bonds or other undertakings in connection therewith. The Company acknowledges that, in the absence of a waiver, a bond or undertaking may be required of Indemnitee by a court, and the Company hereby waives any such requirement of such a bond or undertaking.
Section 19. Severability . If any provision or provisions of this Agreement shall be held to be invalid, illegal or unenforceable for any reason whatsoever: (a) the validity, legality and enforceability of the remaining provisions of this Agreement (including, without limitation, each portion of any Section, paragraph or sentence of this Agreement containing any such provision held to be invalid, illegal or unenforceable that is not itself invalid, illegal or unenforceable) shall not in any way be affected or impaired thereby and shall remain enforceable to the fullest extent permitted by law; (b) such provision or provisions shall be deemed reformed to the extent necessary to conform to applicable law and to give the maximum effect to the intent of the parties hereto; and (c) to the fullest extent possible, the provisions of this Agreement (including, without limitation, each portion of any Section, paragraph or sentence of this Agreement containing any such provision held to be invalid, illegal or unenforceable, that is not itself invalid, illegal or unenforceable) shall be construed so as to give effect to the intent manifested thereby.
Section 20. Identical Counterparts . This Agreement may be executed in one or more counterparts, each of which shall for all purposes be deemed to be an original but all of which together shall constitute one and the same Agreement. One such counterpart signed by the party against whom enforceability is sought shall be sufficient to evidence the existence of this Agreement.
Section 21. Headings . The headings of the paragraphs of this Agreement are inserted for convenience only and shall not be deemed to constitute part of this Agreement or to affect the construction thereof.
Section 22. Modification and Waiver . No supplement, modification or amendment of this Agreement shall be binding unless executed in writing by both of the parties hereto. No waiver of any of the provisions of this Agreement shall be deemed or shall constitute a waiver of any other provisions hereof (whether or not similar) nor shall such waiver constitute a continuing waiver.
Section 23. Notices . All notices, requests, demands and other communications hereunder shall be in writing and shall be deemed to have been duly given if (i) delivered by hand and receipted for by the party to whom said notice or other communication shall have been directed or (ii) mailed by certified or registered mail with postage prepaid, on the third business day after the date on which it is so mailed:
(a) If to Indemnitee, to the address set forth on the signature page hereto.
(b) If to the Company, to:
General Counsel
Two Bridge Avenue, Suite 322
Red Bank, New Jersey 07701-1106
Facsimile: (732) 978-7507
or to such other address as may have been furnished in writing to Indemnitee by the Company or to the Company by Indemnitee, as the case may be.
Section 24. Governing Law . The parties agree that this Agreement shall be governed by, and construed and enforced in accordance with, the laws of the State of Maryland, without regard to its conflicts of laws rules.
Section 25. Miscellaneous . Use of the masculine pronoun shall be deemed to include usage of the feminine pronoun where appropriate.
[SIGNATURE PAGE FOLLOWS]
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above written.
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ZAIS FINANCIAL CORP. |
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/s/ Paul McDade |
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Paul McDade |
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Chief Financial Officer, |
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Secretary and Treasurer |
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INDEMNITEE |
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/s/ Michael Szymanski |
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Name: |
Michael Szymanski |
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Two Bridge Avenue, Suite 332 |
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Red Bank, New Jersey 07701-1106 |
[ Signature Page to Michael Szymanski Indemnification Agreement ]
EXHIBIT A
FORM OF UNDERTAKING TO REPAY EXPENSES ADVANCED
The Board of Directors of ZAIS Financial Corp.
Re: Undertaking to Repay Expenses Advanced
Ladies and Gentlemen:
This undertaking is being provided pursuant to that certain Indemnification Agreement dated the day of July, 2011, by and between ZAIS Financial Corp., a Maryland corporation (the Company), and the undersigned Indemnitee (the Indemnification Agreement ), pursuant to which I am entitled to advance of Expenses in connection with [Description of Proceeding] (the Proceeding ).
Terms used herein and not otherwise defined shall have the meanings specified in the Indemnification Agreement.
I am subject to the Proceeding by reason of my Corporate Status or by reason of alleged actions or omissions by me in such capacity. I hereby affirm my good belief that at all times, insofar as I was involved as [a director] [an officer] of the Company, in any of the facts or events giving rise to the Proceeding, I (1) did not act with bad faith or active or deliberate dishonesty, (2) did not receive any improper personal benefit in money, property or services and (3) in the case of any criminal proceeding, had no reasonable cause to believe that any act or omission by me was unlawful.
In consideration of the advance of Expenses by the Company for reasonable attorneys fees and related Expenses incurred by me in connection with the Proceeding (the Advanced Expenses ), I hereby agree that if, in connection with the Proceeding, it is established that (1) an act or omission by me was material to the matter giving rise to the Proceeding and (a) was committed in bad faith or (b) was the result of active and deliberate dishonesty or (2) I actually received an improper personal benefit in money, property or services or (3) in the case of any criminal proceeding, I had reasonable cause to believe that the act or omission was unlawful, then I shall promptly reimburse the portion of the Advanced Expenses relating to the claims, issues or matters in the Proceeding as to which the foregoing findings have been established.
IN WITNESS WHEREOF, I have executed this Affirmation and Undertaking on this day of , 20 .
Exhibit 10.8
INDEMNIFICATION AGREEMENT
THIS INDEMNIFICATION AGREEMENT ( Agreement ) is made and entered into as of the 3rd day of August, 2011, by and between ZAIS Financial Corp., a Maryland corporation (the Company ), and Denise Crowley ( Indemnitee ).
WHEREAS, at the request of the Company, Indemnitee currently serves as a director and/or officer of the Company and may, therefore, be subjected to claims, suits or proceedings arising as a result of his service; and
WHEREAS, as an inducement to Indemnitee to continue to serve as such director and/or officer, the Company has agreed to indemnify and to advance expenses and costs incurred by Indemnitee in connection with any such claims, suits or proceedings, to the maximum extent permitted by law; and
WHEREAS, the parties by this Agreement desire to set forth their agreement regarding indemnification and advance of expenses; and
NOW, THEREFORE, in consideration of the premises and the covenants contained herein, the Company and Indemnitee do hereby covenant and agree as follows:
Section 1. Definitions . For purposes of this Agreement:
(a) Change in Control means a change in control of the Company occurring after the Effective Date of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14A (or in response to any similar item on any similar schedule or form) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act ), whether or not the Company is then subject to such reporting requirement; provided, however, that, without limitation, such a Change in Control shall be deemed to have occurred if, after the Effective Date (i) any person (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) is or becomes the beneficial owner (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company representing 15% or more of the combined voting power of all of the Companys then-outstanding securities entitled to vote generally in the election of directors without the prior approval of at least two-thirds of the members of the Board of Directors in office immediately prior to such persons attaining such percentage interest; (ii) the Company is a party to a merger, consolidation, sale of assets, plan of liquidation or other reorganization not approved by at least two-thirds of the members of the Board of Directors then in office, as a consequence of which members of the Board of Directors in office immediately prior to such transaction or event constitute less than a majority of the Board of Directors thereafter; or (iii) at any time, a majority of the members of the Board of Directors are not individuals (A) who were directors as of the Effective Date or (B) whose election by the Board of Directors or nomination for election by the Companys stockholders was approved by the affirmative vote of at least two-thirds of the directors then in office who were directors as of the Effective Date or whose election or nomination for election was previously so approved.
(b) Corporate Status means the status of a person as a present or former director, officer, employee or agent of the Company or as a director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any other foreign or domestic corporation, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise that such person is or was serving in such capacity at the request of the Company. As a clarification and without limiting the circumstances in which Indemnitee may be serving at the request of the Company, service by Indemnitee shall be deemed to be at the request of the Company if Indemnitee serves or served as a director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any corporation, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise (i) of which a majority of the voting power or equity interest is owned directly or indirectly by the Company or (ii) the management of which is controlled directly or indirectly by the Company.
(c) Disinterested Director means a director of the Company who is not and was not a party to the Proceeding in respect of which indemnification and/or advance of Expenses is sought by Indemnitee.
(d) Effective Date means the date set forth in the first paragraph of this Agreement.
(e) Expenses means any and all reasonable and out-of-pocket attorneys fees and costs, retainers, court costs, transcript costs, fees of experts, witness fees, travel expenses, duplicating costs, printing and binding costs, telephone charges, postage, delivery service fees, federal, state, local or foreign taxes imposed on Indemnitee as a result of the actual or deemed receipt of any payments under this Agreement, ERISA excise taxes and penalties and any other disbursements or expenses incurred in connection with prosecuting, defending, preparing to prosecute or defend, investigating, being or preparing to be a witness in or otherwise participating in a Proceeding. Expenses shall also include Expenses incurred in connection with any appeal resulting from any Proceeding including, without limitation, the premium, security for and other costs relating to any cost bond, supersedeas bond or other appeal bond or its equivalent.
(f) Independent Counsel means a law firm, or a member of a law firm, that is experienced in matters of corporation law and neither is, nor in the past five years has been, retained to represent: (i) the Company or Indemnitee in any matter material to either such party (other than with respect to matters concerning Indemnitee under this Agreement or of other indemnitees under similar indemnification agreements), or (ii) any other party to or participant or witness in the Proceeding giving rise to a claim for indemnification or advance of Expenses hereunder. Notwithstanding the foregoing, the term Independent Counsel shall not include any person who, under the applicable standards of professional conduct then prevailing, would have a conflict of interest in representing either the Company or Indemnitee in an action to determine Indemnitees rights under this Agreement.
(g) Proceeding means any threatened, pending or completed action, suit, arbitration, alternate dispute resolution mechanism, investigation, inquiry, administrative hearing or any other proceeding, whether brought by or in the right of the Company or otherwise and whether of a civil (including intentional or unintentional tort claims), criminal, administrative or investigative (formal or informal) nature, including any appeal therefrom, except one pending or
completed on or before the Effective Date, unless otherwise specifically agreed in writing by the Company and Indemnitee. If Indemnitee reasonably believes that a given situation may lead to or culminate in the institution of a Proceeding, such situation shall also be considered a Proceeding.
Section 2. Services by Indemnitee . Indemnitee will serve as a director and/or officer of the Company. However, this Agreement shall not impose any independent obligation on Indemnitee or the Company to continue Indemnitees service to the Company. This Agreement shall not be deemed an employment contract between the Company (or any other entity) and Indemnitee.
Section 3. General . The Company shall indemnify, and advance Expenses to, Indemnitee (a) as provided in this Agreement and (b) otherwise to the maximum extent permitted by the laws of the State of Maryland in effect on the Effective Date and as amended from time to time; provided, however, that no change in the laws of the State of Maryland shall have the effect of reducing the benefits available to Indemnitee hereunder based on the laws of the State of Maryland as in effect on the Effective Date. The rights of Indemnitee provided in this Section 3 shall include, without limitation, the rights set forth in the other sections of this Agreement, including any additional indemnification permitted by Section 2-418(g) of the Maryland General Corporation Law (the MGCL ).
Section 4. Standard for Indemnification . If, by reason of Indemnitees Corporate Status, Indemnitee is, or is threatened to be, made a party to any Proceeding, Indemnitee shall be indemnified against all judgments, penalties, fines and amounts paid in settlement and all Expenses actually and reasonably incurred by him or on his behalf in connection with any such Proceeding unless it is established that (a) the act or omission of Indemnitee was material to the matter giving rise to the Proceeding and (i) was committed in bad faith or (ii) was the result of active and deliberate dishonesty, (b) Indemnitee actually received an improper personal benefit in money, property or services or (c) in the case of any criminal Proceeding, Indemnitee had reasonable cause to believe that his conduct was unlawful.
Section 5. Certain Limits on Indemnification . Notwithstanding any other provision of this Agreement (other than Section 6), Indemnitee shall not be entitled to:
(a) indemnification hereunder if the Proceeding was one by or in the right of the Company and Indemnitee is adjudged to be liable to the Company;
(b) indemnification hereunder if Indemnitee is adjudged to be liable on the basis that personal benefit was improperly received in any Proceeding charging improper personal benefit to Indemnitee, whether or not involving action in the Indemnitees Corporate Status; or
(c) indemnification or advance of Expenses hereunder if the Proceeding was brought by Indemnitee unless: (i) the Proceeding was brought to enforce indemnification under this Agreement, and then only to the extent in accordance with and as authorized by Section 12 of this Agreement, or (ii) the Companys charter or Bylaws, a resolution of the stockholders entitled to vote generally in the election of directors or of the Board of Directors or an agreement
approved by the Board of Directors to which the Company is a party expressly provide otherwise.
Section 6. Court-Ordered Indemnification . Notwithstanding any other provision of this Agreement, a court of appropriate jurisdiction, upon application of Indemnitee and such notice as the court shall require, may order indemnification in the following circumstances:
(a) if it determines Indemnitee is entitled to reimbursement under Section 2-418(d)(1) of the MGCL, the court shall order indemnification, in which case Indemnitee shall be entitled to recover the Expenses of securing such reimbursement; or
(b) if it determines that Indemnitee is fairly and reasonably entitled to indemnification in view of all the relevant circumstances, whether or not Indemnitee (i) has met the standards of conduct set forth in Section 2-418(b) of the MGCL or (ii) has been adjudged liable for receipt of an improper personal benefit under Section 2-418(c) of the MGCL, the court may order such indemnification as the court shall deem proper. However, indemnification with respect to any Proceeding by or in the right of the Company or in which liability shall have been adjudged in the circumstances described in Section 2-418(c) of the MGCL shall be limited to Expenses.
Section 7. Indemnification for Expenses of a Party Who is Wholly or Partly Successful . Notwithstanding any other provision of this Agreement, and without limiting any such provision, to the extent that Indemnitee was or is, by reason of his Corporate Status, made a party to (or otherwise becomes a participant in) any Proceeding and is successful, on the merits or otherwise, in the defense of such Proceeding, Indemnitee shall be indemnified for all Expenses actually and reasonably incurred by him or on his behalf in connection therewith. If Indemnitee is not wholly successful in such Proceeding but is successful, on the merits or otherwise, as to one or more but less than all claims, issues or matters in such Proceeding, the Company shall indemnify Indemnitee under this Section 7 for all Expenses actually and reasonably incurred by him or on his behalf in connection with each such claim, issue or matter, allocated on a reasonable and proportionate basis. For purposes of this Section 7 and, without limitation, the termination of any claim, issue or matter in such a Proceeding by dismissal, with or without prejudice, shall be deemed to be a successful result as to such claim, issue or matter.
Section 8. Advance of Expenses for a Party . If, by reason of Indemnitees Corporate Status, Indemnitee is, or is threatened to be, made a party to any Proceeding, the Company shall, without requiring a preliminary determination of Indemnitees ultimate entitlement to indemnification hereunder, advance all reasonable Expenses incurred by or on behalf of Indemnitee in connection with such Proceeding within ten days after the receipt by the Company of a statement or statements requesting such advance or advances from time to time, whether prior to or after final disposition of such Proceeding. Such statement or statements shall reasonably evidence the Expenses incurred by Indemnitee and shall include or be preceded or accompanied by a written affirmation by Indemnitee of Indemnitees good faith belief that the standard of conduct necessary for indemnification by the Company as authorized by law and by this Agreement has been met and a written undertaking by or on behalf of Indemnitee, in substantially the form attached hereto as Exhibit A or in such form as may be required under applicable law as in effect at the time of the execution thereof, to reimburse the portion of any
Expenses advanced to Indemnitee relating to claims, issues or matters in the Proceeding as to which it shall ultimately be established that the standard of conduct has not been met by Indemnitee and which have not been successfully resolved as described in Section 7 of this Agreement. To the extent that Expenses advanced to Indemnitee do not relate to a specific claim, issue or matter in the Proceeding, such Expenses shall be allocated on a reasonable and proportionate basis. The undertaking required by this Section 8 shall be an unlimited general obligation by or on behalf of Indemnitee and shall be accepted without reference to Indemnitees financial ability to repay such advanced Expenses and without any requirement to post security therefor.
Section 9. Indemnification and Advance of Expenses of a Witness . Notwithstanding any other provision of this Agreement, to the extent that Indemnitee is or may be, by reason of his Corporate Status, made a witness or otherwise asked to participate in any Proceeding, whether instituted by the Company or any other party, and to which Indemnitee is not a party, he shall be advanced all reasonable Expenses and indemnified against all Expenses actually and reasonably incurred by him or on his behalf in connection therewith within ten days after the receipt by the Company of a statement or statements requesting such advance or advances from time to time, whether prior to or after final disposition of such Proceeding. Such statement or statements shall reasonably evidence the Expenses incurred by Indemnitee.
Section 10. Procedure for Determination of Entitlement to Indemnification .
(a) To obtain indemnification under this Agreement, Indemnitee shall submit to the Company a written request, including therein or therewith such documentation and information as is reasonably available to Indemnitee and is reasonably necessary to determine whether and to what extent Indemnitee is entitled to indemnification. Indemnitee may submit one or more such requests from time to time and at such time(s) as Indemnitee deems appropriate in his sole discretion. The officer of the Company receiving any such request from Indemnitee shall, promptly upon receipt of such a request for indemnification, advise the Board of Directors in writing that Indemnitee has requested indemnification.
(b) Upon written request by Indemnitee for indemnification pursuant to Section 10(a) above, a determination, if required by applicable law, with respect to Indemnitees entitlement thereto shall promptly be made in the specific case: (i) if a Change in Control shall have occurred, by Independent Counsel, in a written opinion to the Board of Directors, a copy of which shall be delivered to Indemnitee, which Independent Counsel shall be selected by the Indemnitee and approved by the Board of Directors in accordance with Section 2-418(e)(2)(ii) of the MGCL, which approval will not be unreasonably withheld; or (ii) if a Change in Control shall not have occurred, (A) by the Board of Directors by a majority vote of a quorum consisting of Disinterested Directors or, if such a quorum cannot be obtained, then by a majority vote of a duly authorized committee of the Board of Directors consisting solely of one or more Disinterested Directors, (B) if Independent Counsel has been selected by the Board of Directors in accordance with Section 2-418(e)(2)(ii) of the MGCL and approved by the Indemnitee, which approval shall not be unreasonably withheld, by Independent Counsel, in a written opinion to the Board of Directors, a copy of which shall be delivered to Indemnitee or (C) if so directed by a majority of the members of the Board of Directors, by the stockholders of the Company. If it is so determined that Indemnitee is entitled to indemnification, payment to Indemnitee shall be
made within ten days after such determination. Indemnitee shall cooperate with the person, persons or entity making such determination with respect to Indemnitees entitlement to indemnification, including providing to such person, persons or entity upon reasonable advance request any documentation or information which is not privileged or otherwise protected from disclosure and which is reasonably available to Indemnitee and reasonably necessary to such determination in the discretion of the Board of Directors or Independent Counsel if retained pursuant to clause (ii)(B) of this Section 10(b). Any Expenses incurred by Indemnitee in so cooperating with the person, persons or entity making such determination shall be borne by the Company (irrespective of the determination as to Indemnitees entitlement to indemnification) and the Company shall indemnify and hold Indemnitee harmless therefrom.
(c) The Company shall pay the reasonable fees and expenses of Independent Counsel, if one is appointed.
Section 11. Presumptions and Effect of Certain Proceedings .
(a) In making any determination with respect to entitlement to indemnification hereunder, the person or persons or entity making such determination shall presume that Indemnitee is entitled to indemnification under this Agreement if Indemnitee has submitted a request for indemnification in accordance with Section 10(a) of this Agreement, and the Company shall have the burden of proof to overcome that presumption in connection with the making of any determination contrary to that presumption.
(b) The termination of any Proceeding or of any claim, issue or matter therein, by judgment, order, settlement or conviction, upon a plea of nolo contendere or its equivalent, or entry of an order of probation prior to judgment, does not create a presumption that Indemnitee did not meet the requisite standard of conduct described herein for indemnification.
(c) The knowledge and/or actions, or failure to act, of any other director, officer, employee or agent of the Company or any other director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any other foreign or domestic corporation, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise shall not be imputed to Indemnitee for purposes of determining any other right to indemnification under this Agreement.
Section 12. Remedies of Indemnitee .
(a) If (i) a determination is made pursuant to Section 10(b) of this Agreement that Indemnitee is not entitled to indemnification under this Agreement, (ii) advance of Expenses is not timely made pursuant to Section 8 of this Agreement, (iii) no determination of entitlement to indemnification shall have been made pursuant to Section 10(b) of this Agreement within 60 days after receipt by the Company of the request for indemnification, (iv) payment of indemnification is not made pursuant to Section 7 of this Agreement within ten days after receipt by the Company of a written request therefor, or (v) payment of indemnification pursuant to any other section of this Agreement or the charter or Bylaws of the Company is not made within ten days after a determination has been made that Indemnitee is entitled to indemnification, Indemnitee shall be entitled to an adjudication in an appropriate court located in the State of
Maryland, or in any other court of competent jurisdiction, of his entitlement to such indemnification or advance of Expenses. Alternatively, Indemnitee, at his option, may seek an award in arbitration to be conducted by a single arbitrator pursuant to the Commercial Arbitration Rules of the American Arbitration Association. Indemnitee shall commence a proceeding seeking an adjudication or an award in arbitration within 180 days following the date on which Indemnitee first has the right to commence such proceeding pursuant to this Section 12(a); provided, however, that the foregoing clause shall not apply to a proceeding brought by Indemnitee to enforce his rights under Section 7 of this Agreement. Except as set forth herein, the provisions of the laws of the State of Maryland (without regard to its conflicts of laws rules) shall apply to any such arbitration. The Company shall not oppose Indemnitees right to seek any such adjudication or award in arbitration.
(b) In any judicial proceeding or arbitration commenced pursuant to this Section 12, Indemnitee shall be presumed to be entitled to indemnification or advance of Expenses, as the case may be, under this Agreement and the Company shall have the burden of proving that Indemnitee is not entitled to indemnification or advance of Expenses, as the case may be. If Indemnitee commences a judicial proceeding or arbitration pursuant to this Section 12, Indemnitee shall not be required to reimburse the Company for any advances pursuant to Section 8 of this Agreement until a final determination is made with respect to Indemnitees entitlement to indemnification (as to which all rights of appeal have been exhausted or lapsed). The Company shall, to the fullest extent not prohibited by law, be precluded from asserting in any judicial proceeding or arbitration commenced pursuant to this Section 12 that the procedures and presumptions of this Agreement are not valid, binding and enforceable and shall stipulate in any such court or before any such arbitrator that the Company is bound by all of the provisions of this Agreement.
(c) If a determination shall have been made pursuant to Section 10(b) of this Agreement that Indemnitee is entitled to indemnification, the Company shall be bound by such determination in any judicial proceeding or arbitration commenced pursuant to this Section 12, absent a misstatement by Indemnitee of a material fact, or an omission of a material fact necessary to make Indemnitees statement not materially misleading, in connection with the request for indemnification.
(d) In the event that Indemnitee, pursuant to this Section 12, seeks a judicial adjudication of or an award in arbitration to enforce his rights under, or to recover damages for breach of, this Agreement, Indemnitee shall be entitled to recover from the Company, and shall be indemnified by the Company for, any and all Expenses actually and reasonably incurred by him in such judicial adjudication or arbitration. If it shall be determined in such judicial adjudication or arbitration that Indemnitee is entitled to receive part but not all of the indemnification or advance of Expenses sought, the Expenses incurred by Indemnitee in connection with such judicial adjudication or arbitration shall be appropriately prorated.
(e) Interest shall be paid by the Company to Indemnitee at the maximum rate allowed to be charged for judgments under the Courts and Judicial Proceedings Article of the Annotated Code of Maryland for amounts which the Company pays or is obligated to pay for the period commencing with the date on which the Company was requested to advance expenses in accordance with Section 8 of this Agreement or to make the determination of entitlement to
indemnification under Section 12(a) above. Indemnitee requests indemnification, reimbursement or advance of any Expenses and ending on the date such payment is made to Indemnitee by the Company.
Section 13. Defense of the Underlying Proceeding .
(a) Indemnitee shall notify the Company promptly in writing upon being served with any summons, citation, subpoena, complaint, indictment, request or other document relating to any Proceeding which may result in the right to indemnification or the advance of Expenses hereunder and shall include with such notice a description of the nature of the Proceeding and a summary of the facts underlying the Proceeding. The failure to give any such notice shall not disqualify Indemnitee from the right, or otherwise affect in any manner any right of Indemnitee, to indemnification or the advance of Expenses under this Agreement unless the Companys ability to defend in such Proceeding or to obtain proceeds under any insurance policy is materially and adversely prejudiced thereby, and then only to the extent the Company is thereby actually so prejudiced.
(b) Subject to the provisions of the last sentence of this Section 13(b) and of Section 13(c) below, the Company shall have the right to defend Indemnitee in any Proceeding which may give rise to indemnification hereunder; provided, however, that the Company shall notify Indemnitee of any such decision to defend within 15 calendar days following receipt of notice of any such Proceeding under Section 13(a) above. The Company shall not, without the prior written consent of Indemnitee, which shall not be unreasonably withheld or delayed, consent to the entry of any judgment against Indemnitee or enter into any settlement or compromise which (i) includes an admission of fault of Indemnitee, (ii) does not include, as an unconditional term thereof, the full release of Indemnitee from all liability in respect of such Proceeding, which release shall be in form and substance reasonably satisfactory to Indemnitee or (iii) would impose any Expense, judgment, fine, penalty or limitation on Indemnitee. This Section 13(b) shall not apply to a Proceeding brought by Indemnitee under Section 12 of this Agreement.
(c) Notwithstanding the provisions of Section 13(b) above, if in a Proceeding to which Indemnitee is a party by reason of Indemnitees Corporate Status, (i) Indemnitee reasonably concludes, based upon an opinion of counsel approved by the Company, which approval shall not be unreasonably withheld, that he may have separate defenses or counterclaims to assert with respect to any issue which may not be consistent with other defendants in such Proceeding, (ii) Indemnitee reasonably concludes, based upon an opinion of counsel approved by the Company, which approval shall not be unreasonably withheld, that an actual or apparent conflict of interest or potential conflict of interest exists between Indemnitee and the Company, or (iii) if the Company fails to assume the defense of such Proceeding in a timely manner, Indemnitee shall be entitled to be represented by separate legal counsel of Indemnitees choice, subject to the prior approval of the Company, which shall not be unreasonably withheld, at the expense of the Company. In addition, if the Company fails to comply with any of its obligations under this Agreement or in the event that the Company or any other person takes any action to declare this Agreement void or unenforceable, or institutes any Proceeding to deny or to recover from Indemnitee the benefits intended to be provided to Indemnitee hereunder, Indemnitee shall have the right to retain counsel of Indemnitees choice,
subject to the prior approval of the Company, which shall not be unreasonably withheld, at the expense of the Company (subject to Section 12(d) of this Agreement), to represent Indemnitee in connection with any such matter.
Section 14. Non-Exclusivity; Survival of Rights; Subrogation .
(a) The rights of indemnification and advance of Expenses as provided by this Agreement shall not be deemed exclusive of any other rights to which Indemnitee may at any time be entitled under applicable law, the charter or Bylaws of the Company, any agreement or a resolution of the stockholders entitled to vote generally in the election of directors or of the Board of Directors, or otherwise. Unless consented to in writing by Indemnitee, no amendment, alteration or repeal of this Agreement or of any provision hereof shall limit or restrict any right of Indemnitee under this Agreement in respect of any action taken or omitted by such Indemnitee in his Corporate Status prior to such amendment, alteration or repeal, regardless of whether a claim with respect to such action or inaction is raised prior or subsequent to such amendment, alteration or repeal. No right or remedy herein conferred is intended to be exclusive of any other right or remedy, and every other right or remedy shall be cumulative and in addition to every other right or remedy given hereunder or now or hereafter existing at law or in equity or otherwise. The assertion of any right or remedy hereunder, or otherwise, shall not prohibit the concurrent assertion or employment of any other right or remedy.
(b) In the event of any payment under this Agreement, the Company shall be subrogated to the extent of such payment to all of the rights of recovery of Indemnitee, who shall execute all papers required and take all action necessary to secure such rights, including execution of such documents as are necessary to enable the Company to bring suit to enforce such rights.
Section 15. Insurance . The Company will use its reasonable best efforts to acquire directors and officers liability insurance, on terms and conditions deemed appropriate by the Board of Directors, with the advice of counsel, covering Indemnitee or any claim made against Indemnitee by reason of his Corporate Status and covering the Company for any indemnification or advance of Expenses made by the Company to Indemnitee for any claims made against Indemnitee by reason of his Corporate Status. Without in any way limiting any other obligation under this Agreement, the Company shall indemnify Indemnitee for any payment by Indemnitee arising out of the amount of any deductible or retention and the amount of any excess of the aggregate of all judgments, penalties, fines, settlements and Expenses incurred by Indemnitee in connection with a Proceeding over the coverage of any insurance referred to in the previous sentence. The purchase, establishment and maintenance of any such insurance shall not in any way limit or affect the rights or obligations of the Company or Indemnitee under this Agreement except as expressly provided herein, and the execution and delivery of this Agreement by the Company and the Indemnitee shall not in any way limit or affect the rights or obligations of the Company under any such insurance policies. If, at the time the Company receives notice from any source of a Proceeding to which Indemnitee is a party or a participant (as a witness or otherwise) the Company has director and officer liability insurance in effect, the Company shall give prompt notice of such Proceeding to the insurers in accordance with the procedures set forth in the respective policies.
Section 16. Coordination of Payments . The Company shall not be liable under this Agreement to make any payment of amounts otherwise indemnifiable or payable or reimbursable as Expenses hereunder if and to the extent that Indemnitee has otherwise actually received such payment under any insurance policy, contract, agreement or otherwise.
Section 17. Reports to Stockholders . To the extent required by the MGCL, the Company shall report in writing to its stockholders the payment of any amounts for indemnification of, or advance of Expenses to, Indemnitee under this Agreement arising out of a Proceeding by or in the right of the Company with the notice of the meeting of stockholders of the Company next following the date of the payment of any such indemnification or advance of Expenses or prior to such meeting.
Section 18. Duration of Agreement; Binding Effect .
(a) This Agreement shall continue until and terminate on the later of (i) ten years after the date that Indemnitee shall have ceased to serve as a director, officer, employee or agent of the Company or as a director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any other foreign or domestic corporation, real estate investment trust, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise that such person is or was serving in such capacity at the request of the Company and (ii) the date that Indemnitee is no longer subject to any actual or possible Proceeding due to the lapse of all applicable statutes of limitations or otherwise (including any rights of appeal thereto and any Proceeding commenced by Indemnitee pursuant to Section 12 of this Agreement).
(b) The indemnification and advance of Expenses provided by, or granted pursuant to, this Agreement shall be binding upon and be enforceable by the parties hereto and their respective successors and assigns (including any direct or indirect successor by purchase, merger, consolidation or otherwise to all or substantially all of the business or assets of the Company), shall continue as to an Indemnitee who has ceased to be a director, officer, employee or agent of the Company or a director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any other foreign or domestic corporation, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise that such person is or was serving in such capacity at the request of the Company, and shall inure to the benefit of Indemnitee and his spouse, assigns, heirs, devisees, executors and administrators and other legal representatives.
(c) The Company shall require and cause any successor (whether direct or indirect by purchase, merger, consolidation or otherwise) to all, substantially all or a substantial part, of the business and/or assets of the Company, by written agreement in form and substance satisfactory to Indemnitee, expressly to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform if no such succession had taken place.
(d) The Company and Indemnitee agree herein that a monetary remedy for breach of this Agreement, at some later date, may be inadequate, impracticable and difficult of proof, and further agree that such breach may cause Indemnitee irreparable harm. Accordingly, the parties hereto agree that Indemnitee may enforce this Agreement by seeking injunctive relief and/or
specific performance hereof, without any necessity of showing actual damage or irreparable harm and that by seeking injunctive relief and/or specific performance, Indemnitee shall not be precluded from seeking or obtaining any other relief to which he may be entitled. Indemnitee shall further be entitled to such specific performance and injunctive relief, including temporary restraining orders, preliminary injunctions and permanent injunctions, without the necessity of posting bonds or other undertakings in connection therewith. The Company acknowledges that, in the absence of a waiver, a bond or undertaking may be required of Indemnitee by a court, and the Company hereby waives any such requirement of such a bond or undertaking.
Section 19. Severability . If any provision or provisions of this Agreement shall be held to be invalid, illegal or unenforceable for any reason whatsoever: (a) the validity, legality and enforceability of the remaining provisions of this Agreement (including, without limitation, each portion of any Section, paragraph or sentence of this Agreement containing any such provision held to be invalid, illegal or unenforceable that is not itself invalid, illegal or unenforceable) shall not in any way be affected or impaired thereby and shall remain enforceable to the fullest extent permitted by law; (b) such provision or provisions shall be deemed reformed to the extent necessary to conform to applicable law and to give the maximum effect to the intent of the parties hereto; and (c) to the fullest extent possible, the provisions of this Agreement (including, without limitation, each portion of any Section, paragraph or sentence of this Agreement containing any such provision held to be invalid, illegal or unenforceable, that is not itself invalid, illegal or unenforceable) shall be construed so as to give effect to the intent manifested thereby.
Section 20. Identical Counterparts . This Agreement may be executed in one or more counterparts, each of which shall for all purposes be deemed to be an original but all of which together shall constitute one and the same Agreement. One such counterpart signed by the party against whom enforceability is sought shall be sufficient to evidence the existence of this Agreement.
Section 21. Headings . The headings of the paragraphs of this Agreement are inserted for convenience only and shall not be deemed to constitute part of this Agreement or to affect the construction thereof.
Section 22. Modification and Waiver . No supplement, modification or amendment of this Agreement shall be binding unless executed in writing by both of the parties hereto. No waiver of any of the provisions of this Agreement shall be deemed or shall constitute a waiver of any other provisions hereof (whether or not similar) nor shall such waiver constitute a continuing waiver.
Section 23. Notices . All notices, requests, demands and other communications hereunder shall be in writing and shall be deemed to have been duly given if (i) delivered by hand and receipted for by the party to whom said notice or other communication shall have been directed or (ii) mailed by certified or registered mail with postage prepaid, on the third business day after the date on which it is so mailed:
(a) If to Indemnitee, to the address set forth on the signature page hereto.
(b) If to the Company, to:
General Counsel
Two Bridge Avenue, Suite 322
Red Bank, New Jersey 07701-1106
Facsimile: (732) 978-7507
or to such other address as may have been furnished in writing to Indemnitee by the Company or to the Company by Indemnitee, as the case may be.
Section 24. Governing Law . The parties agree that this Agreement shall be governed by, and construed and enforced in accordance with, the laws of the State of Maryland, without regard to its conflicts of laws rules.
Section 25. Miscellaneous . Use of the masculine pronoun shall be deemed to include usage of the feminine pronoun where appropriate.
[SIGNATURE PAGE FOLLOWS]
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above written.
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ZAIS FINANCIAL CORP. |
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/s/ Michael Szymanski |
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Michael Szymanski |
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Chief Executive Officer, President and Director |
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INDEMNITEE |
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/s/ Denise Crowley |
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Name: |
Denise Crowley |
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Address: |
Two Bridge Avenue, Suite 322 |
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Red Bank, New Jersey 0770-1106 |
[ Signature Page to Denise Crowley Indemnification Agreement ]
EXHIBIT A
FORM OF UNDERTAKING TO REPAY EXPENSES ADVANCED
The Board of Directors of ZAIS Financial Corp.
Re: Undertaking to Repay Expenses Advanced
Ladies and Gentlemen:
This undertaking is being provided pursuant to that certain Indemnification Agreement dated the day of July, 2011, by and between ZAIS Financial Corp., a Maryland corporation (the Company), and the undersigned Indemnitee (the Indemnification Agreement ), pursuant to which I am entitled to advance of Expenses in connection with [Description of Proceeding] (the Proceeding ).
Terms used herein and not otherwise defined shall have the meanings specified in the Indemnification Agreement.
I am subject to the Proceeding by reason of my Corporate Status or by reason of alleged actions or omissions by me in such capacity. I hereby affirm my good belief that at all times, insofar as I was involved as [a director] [an officer] of the Company, in any of the facts or events giving rise to the Proceeding, I (1) did not act with bad faith or active or deliberate dishonesty, (2) did not receive any improper personal benefit in money, property or services and (3) in the case of any criminal proceeding, had no reasonable cause to believe that any act or omission by me was unlawful.
In consideration of the advance of Expenses by the Company for reasonable attorneys fees and related Expenses incurred by me in connection with the Proceeding (the Advanced Expenses ), I hereby agree that if, in connection with the Proceeding, it is established that (1) an act or omission by me was material to the matter giving rise to the Proceeding and (a) was committed in bad faith or (b) was the result of active and deliberate dishonesty or (2) I actually received an improper personal benefit in money, property or services or (3) in the case of any criminal proceeding, I had reasonable cause to believe that the act or omission was unlawful, then I shall promptly reimburse the portion of the Advanced Expenses relating to the claims, issues or matters in the Proceeding as to which the foregoing findings have been established.
IN WITNESS WHEREOF, I have executed this Affirmation and Undertaking on this day of , 20 .
Exhibit 10.9
INDEMNIFICATION AGREEMENT
THIS INDEMNIFICATION AGREEMENT ( Agreement ) is made and entered into as of the 3rd day of August, 2011, by and between ZAIS Financial Corp., a Maryland corporation (the Company ), and Paul McDade ( Indemnitee ).
WHEREAS, at the request of the Company, Indemnitee currently serves as a director and/or officer of the Company and may, therefore, be subjected to claims, suits or proceedings arising as a result of his service; and
WHEREAS, as an inducement to Indemnitee to continue to serve as such director and/or officer, the Company has agreed to indemnify and to advance expenses and costs incurred by Indemnitee in connection with any such claims, suits or proceedings, to the maximum extent permitted by law; and
WHEREAS, the parties by this Agreement desire to set forth their agreement regarding indemnification and advance of expenses; and
NOW, THEREFORE, in consideration of the premises and the covenants contained herein, the Company and Indemnitee do hereby covenant and agree as follows:
Section 1. Definitions . For purposes of this Agreement:
(a) Change in Control means a change in control of the Company occurring after the Effective Date of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14A (or in response to any similar item on any similar schedule or form) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act ), whether or not the Company is then subject to such reporting requirement; provided, however, that, without limitation, such a Change in Control shall be deemed to have occurred if, after the Effective Date (i) any person (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) is or becomes the beneficial owner (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company representing 15% or more of the combined voting power of all of the Companys then-outstanding securities entitled to vote generally in the election of directors without the prior approval of at least two-thirds of the members of the Board of Directors in office immediately prior to such persons attaining such percentage interest; (ii) the Company is a party to a merger, consolidation, sale of assets, plan of liquidation or other reorganization not approved by at least two-thirds of the members of the Board of Directors then in office, as a consequence of which members of the Board of Directors in office immediately prior to such transaction or event constitute less than a majority of the Board of Directors thereafter; or (iii) at any time, a majority of the members of the Board of Directors are not individuals (A) who were directors as of the Effective Date or (B) whose election by the Board of Directors or nomination for election by the Companys stockholders was approved by the affirmative vote of at least two-thirds of the directors then in office who were directors as of the Effective Date or whose election or nomination for election was previously so approved.
(b) Corporate Status means the status of a person as a present or former director, officer, employee or agent of the Company or as a director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any other foreign or domestic corporation, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise that such person is or was serving in such capacity at the request of the Company. As a clarification and without limiting the circumstances in which Indemnitee may be serving at the request of the Company, service by Indemnitee shall be deemed to be at the request of the Company if Indemnitee serves or served as a director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any corporation, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise (i) of which a majority of the voting power or equity interest is owned directly or indirectly by the Company or (ii) the management of which is controlled directly or indirectly by the Company.
(c) Disinterested Director means a director of the Company who is not and was not a party to the Proceeding in respect of which indemnification and/or advance of Expenses is sought by Indemnitee.
(d) Effective Date means the date set forth in the first paragraph of this Agreement.
(e) Expenses means any and all reasonable and out-of-pocket attorneys fees and costs, retainers, court costs, transcript costs, fees of experts, witness fees, travel expenses, duplicating costs, printing and binding costs, telephone charges, postage, delivery service fees, federal, state, local or foreign taxes imposed on Indemnitee as a result of the actual or deemed receipt of any payments under this Agreement, ERISA excise taxes and penalties and any other disbursements or expenses incurred in connection with prosecuting, defending, preparing to prosecute or defend, investigating, being or preparing to be a witness in or otherwise participating in a Proceeding. Expenses shall also include Expenses incurred in connection with any appeal resulting from any Proceeding including, without limitation, the premium, security for and other costs relating to any cost bond, supersedeas bond or other appeal bond or its equivalent.
(f) Independent Counsel means a law firm, or a member of a law firm, that is experienced in matters of corporation law and neither is, nor in the past five years has been, retained to represent: (i) the Company or Indemnitee in any matter material to either such party (other than with respect to matters concerning Indemnitee under this Agreement or of other indemnitees under similar indemnification agreements), or (ii) any other party to or participant or witness in the Proceeding giving rise to a claim for indemnification or advance of Expenses hereunder. Notwithstanding the foregoing, the term Independent Counsel shall not include any person who, under the applicable standards of professional conduct then prevailing, would have a conflict of interest in representing either the Company or Indemnitee in an action to determine Indemnitees rights under this Agreement.
(g) Proceeding means any threatened, pending or completed action, suit, arbitration, alternate dispute resolution mechanism, investigation, inquiry, administrative hearing or any other proceeding, whether brought by or in the right of the Company or otherwise and whether of a civil (including intentional or unintentional tort claims), criminal, administrative or investigative (formal or informal) nature, including any appeal therefrom, except one pending or
completed on or before the Effective Date, unless otherwise specifically agreed in writing by the Company and Indemnitee. If Indemnitee reasonably believes that a given situation may lead to or culminate in the institution of a Proceeding, such situation shall also be considered a Proceeding.
Section 2. Services by Indemnitee . Indemnitee will serve as a director and/or officer of the Company. However, this Agreement shall not impose any independent obligation on Indemnitee or the Company to continue Indemnitees service to the Company. This Agreement shall not be deemed an employment contract between the Company (or any other entity) and Indemnitee.
Section 3. General . The Company shall indemnify, and advance Expenses to, Indemnitee (a) as provided in this Agreement and (b) otherwise to the maximum extent permitted by the laws of the State of Maryland in effect on the Effective Date and as amended from time to time; provided, however, that no change in the laws of the State of Maryland shall have the effect of reducing the benefits available to Indemnitee hereunder based on the laws of the State of Maryland as in effect on the Effective Date. The rights of Indemnitee provided in this Section 3 shall include, without limitation, the rights set forth in the other sections of this Agreement, including any additional indemnification permitted by Section 2-418(g) of the Maryland General Corporation Law (the MGCL ).
Section 4. Standard for Indemnification . If, by reason of Indemnitees Corporate Status, Indemnitee is, or is threatened to be, made a party to any Proceeding, Indemnitee shall be indemnified against all judgments, penalties, fines and amounts paid in settlement and all Expenses actually and reasonably incurred by him or on his behalf in connection with any such Proceeding unless it is established that (a) the act or omission of Indemnitee was material to the matter giving rise to the Proceeding and (i) was committed in bad faith or (ii) was the result of active and deliberate dishonesty, (b) Indemnitee actually received an improper personal benefit in money, property or services or (c) in the case of any criminal Proceeding, Indemnitee had reasonable cause to believe that his conduct was unlawful.
Section 5. Certain Limits on Indemnification . Notwithstanding any other provision of this Agreement (other than Section 6), Indemnitee shall not be entitled to:
(a) indemnification hereunder if the Proceeding was one by or in the right of the Company and Indemnitee is adjudged to be liable to the Company;
(b) indemnification hereunder if Indemnitee is adjudged to be liable on the basis that personal benefit was improperly received in any Proceeding charging improper personal benefit to Indemnitee, whether or not involving action in the Indemnitees Corporate Status; or
(c) indemnification or advance of Expenses hereunder if the Proceeding was brought by Indemnitee unless: (i) the Proceeding was brought to enforce indemnification under this Agreement, and then only to the extent in accordance with and as authorized by Section 12 of this Agreement, or (ii) the Companys charter or Bylaws, a resolution of the stockholders entitled to vote generally in the election of directors or of the Board of Directors or an agreement
approved by the Board of Directors to which the Company is a party expressly provide otherwise.
Section 6. Court-Ordered Indemnification . Notwithstanding any other provision of this Agreement, a court of appropriate jurisdiction, upon application of Indemnitee and such notice as the court shall require, may order indemnification in the following circumstances:
(a) if it determines Indemnitee is entitled to reimbursement under Section 2-418(d)(1) of the MGCL, the court shall order indemnification, in which case Indemnitee shall be entitled to recover the Expenses of securing such reimbursement; or
(b) if it determines that Indemnitee is fairly and reasonably entitled to indemnification in view of all the relevant circumstances, whether or not Indemnitee (i) has met the standards of conduct set forth in Section 2-418(b) of the MGCL or (ii) has been adjudged liable for receipt of an improper personal benefit under Section 2-418(c) of the MGCL, the court may order such indemnification as the court shall deem proper. However, indemnification with respect to any Proceeding by or in the right of the Company or in which liability shall have been adjudged in the circumstances described in Section 2-418(c) of the MGCL shall be limited to Expenses.
Section 7. Indemnification for Expenses of a Party Who is Wholly or Partly Successful . Notwithstanding any other provision of this Agreement, and without limiting any such provision, to the extent that Indemnitee was or is, by reason of his Corporate Status, made a party to (or otherwise becomes a participant in) any Proceeding and is successful, on the merits or otherwise, in the defense of such Proceeding, Indemnitee shall be indemnified for all Expenses actually and reasonably incurred by him or on his behalf in connection therewith. If Indemnitee is not wholly successful in such Proceeding but is successful, on the merits or otherwise, as to one or more but less than all claims, issues or matters in such Proceeding, the Company shall indemnify Indemnitee under this Section 7 for all Expenses actually and reasonably incurred by him or on his behalf in connection with each such claim, issue or matter, allocated on a reasonable and proportionate basis. For purposes of this Section 7 and, without limitation, the termination of any claim, issue or matter in such a Proceeding by dismissal, with or without prejudice, shall be deemed to be a successful result as to such claim, issue or matter.
Section 8. Advance of Expenses for a Party . If, by reason of Indemnitees Corporate Status, Indemnitee is, or is threatened to be, made a party to any Proceeding, the Company shall, without requiring a preliminary determination of Indemnitees ultimate entitlement to indemnification hereunder, advance all reasonable Expenses incurred by or on behalf of Indemnitee in connection with such Proceeding within ten days after the receipt by the Company of a statement or statements requesting such advance or advances from time to time, whether prior to or after final disposition of such Proceeding. Such statement or statements shall reasonably evidence the Expenses incurred by Indemnitee and shall include or be preceded or accompanied by a written affirmation by Indemnitee of Indemnitees good faith belief that the standard of conduct necessary for indemnification by the Company as authorized by law and by this Agreement has been met and a written undertaking by or on behalf of Indemnitee, in substantially the form attached hereto as Exhibit A or in such form as may be required under applicable law as in effect at the time of the execution thereof, to reimburse the portion of any
Expenses advanced to Indemnitee relating to claims, issues or matters in the Proceeding as to which it shall ultimately be established that the standard of conduct has not been met by Indemnitee and which have not been successfully resolved as described in Section 7 of this Agreement. To the extent that Expenses advanced to Indemnitee do not relate to a specific claim, issue or matter in the Proceeding, such Expenses shall be allocated on a reasonable and proportionate basis. The undertaking required by this Section 8 shall be an unlimited general obligation by or on behalf of Indemnitee and shall be accepted without reference to Indemnitees financial ability to repay such advanced Expenses and without any requirement to post security therefor.
Section 9. Indemnification and Advance of Expenses of a Witness . Notwithstanding any other provision of this Agreement, to the extent that Indemnitee is or may be, by reason of his Corporate Status, made a witness or otherwise asked to participate in any Proceeding, whether instituted by the Company or any other party, and to which Indemnitee is not a party, he shall be advanced all reasonable Expenses and indemnified against all Expenses actually and reasonably incurred by him or on his behalf in connection therewith within ten days after the receipt by the Company of a statement or statements requesting such advance or advances from time to time, whether prior to or after final disposition of such Proceeding. Such statement or statements shall reasonably evidence the Expenses incurred by Indemnitee.
Section 10. Procedure for Determination of Entitlement to Indemnification .
(a) To obtain indemnification under this Agreement, Indemnitee shall submit to the Company a written request, including therein or therewith such documentation and information as is reasonably available to Indemnitee and is reasonably necessary to determine whether and to what extent Indemnitee is entitled to indemnification. Indemnitee may submit one or more such requests from time to time and at such time(s) as Indemnitee deems appropriate in his sole discretion. The officer of the Company receiving any such request from Indemnitee shall, promptly upon receipt of such a request for indemnification, advise the Board of Directors in writing that Indemnitee has requested indemnification.
(b) Upon written request by Indemnitee for indemnification pursuant to Section 10(a) above, a determination, if required by applicable law, with respect to Indemnitees entitlement thereto shall promptly be made in the specific case: (i) if a Change in Control shall have occurred, by Independent Counsel, in a written opinion to the Board of Directors, a copy of which shall be delivered to Indemnitee, which Independent Counsel shall be selected by the Indemnitee and approved by the Board of Directors in accordance with Section 2-418(e)(2)(ii) of the MGCL, which approval will not be unreasonably withheld; or (ii) if a Change in Control shall not have occurred, (A) by the Board of Directors by a majority vote of a quorum consisting of Disinterested Directors or, if such a quorum cannot be obtained, then by a majority vote of a duly authorized committee of the Board of Directors consisting solely of one or more Disinterested Directors, (B) if Independent Counsel has been selected by the Board of Directors in accordance with Section 2-418(e)(2)(ii) of the MGCL and approved by the Indemnitee, which approval shall not be unreasonably withheld, by Independent Counsel, in a written opinion to the Board of Directors, a copy of which shall be delivered to Indemnitee or (C) if so directed by a majority of the members of the Board of Directors, by the stockholders of the Company. If it is so determined that Indemnitee is entitled to indemnification, payment to Indemnitee shall be
made within ten days after such determination. Indemnitee shall cooperate with the person, persons or entity making such determination with respect to Indemnitees entitlement to indemnification, including providing to such person, persons or entity upon reasonable advance request any documentation or information which is not privileged or otherwise protected from disclosure and which is reasonably available to Indemnitee and reasonably necessary to such determination in the discretion of the Board of Directors or Independent Counsel if retained pursuant to clause (ii)(B) of this Section 10(b). Any Expenses incurred by Indemnitee in so cooperating with the person, persons or entity making such determination shall be borne by the Company (irrespective of the determination as to Indemnitees entitlement to indemnification) and the Company shall indemnify and hold Indemnitee harmless therefrom.
(c) The Company shall pay the reasonable fees and expenses of Independent Counsel, if one is appointed.
Section 11. Presumptions and Effect of Certain Proceedings .
(a) In making any determination with respect to entitlement to indemnification hereunder, the person or persons or entity making such determination shall presume that Indemnitee is entitled to indemnification under this Agreement if Indemnitee has submitted a request for indemnification in accordance with Section 10(a) of this Agreement, and the Company shall have the burden of proof to overcome that presumption in connection with the making of any determination contrary to that presumption.
(b) The termination of any Proceeding or of any claim, issue or matter therein, by judgment, order, settlement or conviction, upon a plea of nolo contendere or its equivalent, or entry of an order of probation prior to judgment, does not create a presumption that Indemnitee did not meet the requisite standard of conduct described herein for indemnification.
(c) The knowledge and/or actions, or failure to act, of any other director, officer, employee or agent of the Company or any other director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any other foreign or domestic corporation, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise shall not be imputed to Indemnitee for purposes of determining any other right to indemnification under this Agreement.
Section 12. Remedies of Indemnitee .
(a) If (i) a determination is made pursuant to Section 10(b) of this Agreement that Indemnitee is not entitled to indemnification under this Agreement, (ii) advance of Expenses is not timely made pursuant to Section 8 of this Agreement, (iii) no determination of entitlement to indemnification shall have been made pursuant to Section 10(b) of this Agreement within 60 days after receipt by the Company of the request for indemnification, (iv) payment of indemnification is not made pursuant to Section 7 of this Agreement within ten days after receipt by the Company of a written request therefor, or (v) payment of indemnification pursuant to any other section of this Agreement or the charter or Bylaws of the Company is not made within ten days after a determination has been made that Indemnitee is entitled to indemnification, Indemnitee shall be entitled to an adjudication in an appropriate court located in the State of
Maryland, or in any other court of competent jurisdiction, of his entitlement to such indemnification or advance of Expenses. Alternatively, Indemnitee, at his option, may seek an award in arbitration to be conducted by a single arbitrator pursuant to the Commercial Arbitration Rules of the American Arbitration Association. Indemnitee shall commence a proceeding seeking an adjudication or an award in arbitration within 180 days following the date on which Indemnitee first has the right to commence such proceeding pursuant to this Section 12(a); provided, however, that the foregoing clause shall not apply to a proceeding brought by Indemnitee to enforce his rights under Section 7 of this Agreement. Except as set forth herein, the provisions of the laws of the State of Maryland (without regard to its conflicts of laws rules) shall apply to any such arbitration. The Company shall not oppose Indemnitees right to seek any such adjudication or award in arbitration.
(b) In any judicial proceeding or arbitration commenced pursuant to this Section 12, Indemnitee shall be presumed to be entitled to indemnification or advance of Expenses, as the case may be, under this Agreement and the Company shall have the burden of proving that Indemnitee is not entitled to indemnification or advance of Expenses, as the case may be. If Indemnitee commences a judicial proceeding or arbitration pursuant to this Section 12, Indemnitee shall not be required to reimburse the Company for any advances pursuant to Section 8 of this Agreement until a final determination is made with respect to Indemnitees entitlement to indemnification (as to which all rights of appeal have been exhausted or lapsed). The Company shall, to the fullest extent not prohibited by law, be precluded from asserting in any judicial proceeding or arbitration commenced pursuant to this Section 12 that the procedures and presumptions of this Agreement are not valid, binding and enforceable and shall stipulate in any such court or before any such arbitrator that the Company is bound by all of the provisions of this Agreement.
(c) If a determination shall have been made pursuant to Section 10(b) of this Agreement that Indemnitee is entitled to indemnification, the Company shall be bound by such determination in any judicial proceeding or arbitration commenced pursuant to this Section 12, absent a misstatement by Indemnitee of a material fact, or an omission of a material fact necessary to make Indemnitees statement not materially misleading, in connection with the request for indemnification.
(d) In the event that Indemnitee, pursuant to this Section 12, seeks a judicial adjudication of or an award in arbitration to enforce his rights under, or to recover damages for breach of, this Agreement, Indemnitee shall be entitled to recover from the Company, and shall be indemnified by the Company for, any and all Expenses actually and reasonably incurred by him in such judicial adjudication or arbitration. If it shall be determined in such judicial adjudication or arbitration that Indemnitee is entitled to receive part but not all of the indemnification or advance of Expenses sought, the Expenses incurred by Indemnitee in connection with such judicial adjudication or arbitration shall be appropriately prorated.
(e) Interest shall be paid by the Company to Indemnitee at the maximum rate allowed to be charged for judgments under the Courts and Judicial Proceedings Article of the Annotated Code of Maryland for amounts which the Company pays or is obligated to pay for the period commencing with the date on which the Company was requested to advance expenses in accordance with Section 8 of this Agreement or to make the determination of entitlement to
indemnification under Section 12(a) above. Indemnitee requests indemnification, reimbursement or advance of any Expenses and ending on the date such payment is made to Indemnitee by the Company.
Section 13. Defense of the Underlying Proceeding .
(a) Indemnitee shall notify the Company promptly in writing upon being served with any summons, citation, subpoena, complaint, indictment, request or other document relating to any Proceeding which may result in the right to indemnification or the advance of Expenses hereunder and shall include with such notice a description of the nature of the Proceeding and a summary of the facts underlying the Proceeding. The failure to give any such notice shall not disqualify Indemnitee from the right, or otherwise affect in any manner any right of Indemnitee, to indemnification or the advance of Expenses under this Agreement unless the Companys ability to defend in such Proceeding or to obtain proceeds under any insurance policy is materially and adversely prejudiced thereby, and then only to the extent the Company is thereby actually so prejudiced.
(b) Subject to the provisions of the last sentence of this Section 13(b) and of Section 13(c) below, the Company shall have the right to defend Indemnitee in any Proceeding which may give rise to indemnification hereunder; provided, however, that the Company shall notify Indemnitee of any such decision to defend within 15 calendar days following receipt of notice of any such Proceeding under Section 13(a) above. The Company shall not, without the prior written consent of Indemnitee, which shall not be unreasonably withheld or delayed, consent to the entry of any judgment against Indemnitee or enter into any settlement or compromise which (i) includes an admission of fault of Indemnitee, (ii) does not include, as an unconditional term thereof, the full release of Indemnitee from all liability in respect of such Proceeding, which release shall be in form and substance reasonably satisfactory to Indemnitee or (iii) would impose any Expense, judgment, fine, penalty or limitation on Indemnitee. This Section 13(b) shall not apply to a Proceeding brought by Indemnitee under Section 12 of this Agreement.
(c) Notwithstanding the provisions of Section 13(b) above, if in a Proceeding to which Indemnitee is a party by reason of Indemnitees Corporate Status, (i) Indemnitee reasonably concludes, based upon an opinion of counsel approved by the Company, which approval shall not be unreasonably withheld, that he may have separate defenses or counterclaims to assert with respect to any issue which may not be consistent with other defendants in such Proceeding, (ii) Indemnitee reasonably concludes, based upon an opinion of counsel approved by the Company, which approval shall not be unreasonably withheld, that an actual or apparent conflict of interest or potential conflict of interest exists between Indemnitee and the Company, or (iii) if the Company fails to assume the defense of such Proceeding in a timely manner, Indemnitee shall be entitled to be represented by separate legal counsel of Indemnitees choice, subject to the prior approval of the Company, which shall not be unreasonably withheld, at the expense of the Company. In addition, if the Company fails to comply with any of its obligations under this Agreement or in the event that the Company or any other person takes any action to declare this Agreement void or unenforceable, or institutes any Proceeding to deny or to recover from Indemnitee the benefits intended to be provided to Indemnitee hereunder, Indemnitee shall have the right to retain counsel of Indemnitees choice,
subject to the prior approval of the Company, which shall not be unreasonably withheld, at the expense of the Company (subject to Section 12(d) of this Agreement), to represent Indemnitee in connection with any such matter.
Section 14. Non-Exclusivity; Survival of Rights; Subrogation .
(a) The rights of indemnification and advance of Expenses as provided by this Agreement shall not be deemed exclusive of any other rights to which Indemnitee may at any time be entitled under applicable law, the charter or Bylaws of the Company, any agreement or a resolution of the stockholders entitled to vote generally in the election of directors or of the Board of Directors, or otherwise. Unless consented to in writing by Indemnitee, no amendment, alteration or repeal of this Agreement or of any provision hereof shall limit or restrict any right of Indemnitee under this Agreement in respect of any action taken or omitted by such Indemnitee in his Corporate Status prior to such amendment, alteration or repeal, regardless of whether a claim with respect to such action or inaction is raised prior or subsequent to such amendment, alteration or repeal. No right or remedy herein conferred is intended to be exclusive of any other right or remedy, and every other right or remedy shall be cumulative and in addition to every other right or remedy given hereunder or now or hereafter existing at law or in equity or otherwise. The assertion of any right or remedy hereunder, or otherwise, shall not prohibit the concurrent assertion or employment of any other right or remedy.
(b) In the event of any payment under this Agreement, the Company shall be subrogated to the extent of such payment to all of the rights of recovery of Indemnitee, who shall execute all papers required and take all action necessary to secure such rights, including execution of such documents as are necessary to enable the Company to bring suit to enforce such rights.
Section 15. Insurance . The Company will use its reasonable best efforts to acquire directors and officers liability insurance, on terms and conditions deemed appropriate by the Board of Directors, with the advice of counsel, covering Indemnitee or any claim made against Indemnitee by reason of his Corporate Status and covering the Company for any indemnification or advance of Expenses made by the Company to Indemnitee for any claims made against Indemnitee by reason of his Corporate Status. Without in any way limiting any other obligation under this Agreement, the Company shall indemnify Indemnitee for any payment by Indemnitee arising out of the amount of any deductible or retention and the amount of any excess of the aggregate of all judgments, penalties, fines, settlements and Expenses incurred by Indemnitee in connection with a Proceeding over the coverage of any insurance referred to in the previous sentence. The purchase, establishment and maintenance of any such insurance shall not in any way limit or affect the rights or obligations of the Company or Indemnitee under this Agreement except as expressly provided herein, and the execution and delivery of this Agreement by the Company and the Indemnitee shall not in any way limit or affect the rights or obligations of the Company under any such insurance policies. If, at the time the Company receives notice from any source of a Proceeding to which Indemnitee is a party or a participant (as a witness or otherwise) the Company has director and officer liability insurance in effect, the Company shall give prompt notice of such Proceeding to the insurers in accordance with the procedures set forth in the respective policies.
Section 16. Coordination of Payments . The Company shall not be liable under this Agreement to make any payment of amounts otherwise indemnifiable or payable or reimbursable as Expenses hereunder if and to the extent that Indemnitee has otherwise actually received such payment under any insurance policy, contract, agreement or otherwise.
Section 17. Reports to Stockholders . To the extent required by the MGCL, the Company shall report in writing to its stockholders the payment of any amounts for indemnification of, or advance of Expenses to, Indemnitee under this Agreement arising out of a Proceeding by or in the right of the Company with the notice of the meeting of stockholders of the Company next following the date of the payment of any such indemnification or advance of Expenses or prior to such meeting.
Section 18. Duration of Agreement; Binding Effect .
(a) This Agreement shall continue until and terminate on the later of ten years after (i) the date that Indemnitee shall have ceased to serve as a director, officer, employee or agent of the Company or as a director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any other foreign or domestic corporation, real estate investment trust, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise that such person is or was serving in such capacity at the request of the Company and (ii) the date that Indemnitee is no longer subject to any actual or possible Proceeding due to the lapse of all applicable statutes of limitations or otherwise (including any rights of appeal thereto and any Proceeding commenced by Indemnitee pursuant to Section 12 of this Agreement).
(b) The indemnification and advance of Expenses provided by, or granted pursuant to, this Agreement shall be binding upon and be enforceable by the parties hereto and their respective successors and assigns (including any direct or indirect successor by purchase, merger, consolidation or otherwise to all or substantially all of the business or assets of the Company), shall continue as to an Indemnitee who has ceased to be a director, officer, employee or agent of the Company or a director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any other foreign or domestic corporation, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise that such person is or was serving in such capacity at the request of the Company, and shall inure to the benefit of Indemnitee and his spouse, assigns, heirs, devisees, executors and administrators and other legal representatives.
(c) The Company shall require and cause any successor (whether direct or indirect by purchase, merger, consolidation or otherwise) to all, substantially all or a substantial part, of the business and/or assets of the Company, by written agreement in form and substance satisfactory to Indemnitee, expressly to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform if no such succession had taken place.
(d) The Company and Indemnitee agree herein that a monetary remedy for breach of this Agreement, at some later date, may be inadequate, impracticable and difficult of proof, and further agree that such breach may cause Indemnitee irreparable harm. Accordingly, the parties
hereto agree that Indemnitee may enforce this Agreement by seeking injunctive relief and/or specific performance hereof, without any necessity of showing actual damage or irreparable harm and that by seeking injunctive relief and/or specific performance, Indemnitee shall not be precluded from seeking or obtaining any other relief to which he may be entitled. Indemnitee shall further be entitled to such specific performance and injunctive relief, including temporary restraining orders, preliminary injunctions and permanent injunctions, without the necessity of posting bonds or other undertakings in connection therewith. The Company acknowledges that, in the absence of a waiver, a bond or undertaking may be required of Indemnitee by a court, and the Company hereby waives any such requirement of such a bond or undertaking.
Section 19. Severability . If any provision or provisions of this Agreement shall be held to be invalid, illegal or unenforceable for any reason whatsoever: (a) the validity, legality and enforceability of the remaining provisions of this Agreement (including, without limitation, each portion of any Section, paragraph or sentence of this Agreement containing any such provision held to be invalid, illegal or unenforceable that is not itself invalid, illegal or unenforceable) shall not in any way be affected or impaired thereby and shall remain enforceable to the fullest extent permitted by law; (b) such provision or provisions shall be deemed reformed to the extent necessary to conform to applicable law and to give the maximum effect to the intent of the parties hereto; and (c) to the fullest extent possible, the provisions of this Agreement (including, without limitation, each portion of any Section, paragraph or sentence of this Agreement containing any such provision held to be invalid, illegal or unenforceable, that is not itself invalid, illegal or unenforceable) shall be construed so as to give effect to the intent manifested thereby.
Section 20. Identical Counterparts . This Agreement may be executed in one or more counterparts, each of which shall for all purposes be deemed to be an original but all of which together shall constitute one and the same Agreement. One such counterpart signed by the party against whom enforceability is sought shall be sufficient to evidence the existence of this Agreement.
Section 21. Headings . The headings of the paragraphs of this Agreement are inserted for convenience only and shall not be deemed to constitute part of this Agreement or to affect the construction thereof.
Section 22. Modification and Waiver . No supplement, modification or amendment of this Agreement shall be binding unless executed in writing by both of the parties hereto. No waiver of any of the provisions of this Agreement shall be deemed or shall constitute a waiver of any other provisions hereof (whether or not similar) nor shall such waiver constitute a continuing waiver.
Section 23. Notices . All notices, requests, demands and other communications hereunder shall be in writing and shall be deemed to have been duly given if (i) delivered by hand and receipted for by the party to whom said notice or other communication shall have been directed or (ii) mailed by certified or registered mail with postage prepaid, on the third business day after the date on which it is so mailed:
(a) If to Indemnitee, to the address set forth on the signature page hereto.
(b) If to the Company, to:
General Counsel
Two Bridge Avenue, Suite 322
Red Bank, New Jersey 07701-1106
Facsimile: (732) 978-7507
or to such other address as may have been furnished in writing to Indemnitee by the Company or to the Company by Indemnitee, as the case may be.
Section 24. Governing Law . The parties agree that this Agreement shall be governed by, and construed and enforced in accordance with, the laws of the State of Maryland, without regard to its conflicts of laws rules.
Section 25. Miscellaneous . Use of the masculine pronoun shall be deemed to include usage of the feminine pronoun where appropriate.
[SIGNATURE PAGE FOLLOWS]
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above written.
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ZAIS FINANCIAL CORP. |
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By: |
/s/ Michael Szymanski |
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Name: |
Michael Szymanski |
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Title: |
Chief Executive Officer, President and Director |
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INDEMNITEE |
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/s/ Paul McDade |
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Name: |
Paul McDade |
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Two Bridge Avenue, Suite 332 |
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Red Bank, New Jersey 07701-1106 |
[ Signature Page to Paul McDade Indemnification Agreement ]
EXHIBIT A
FORM OF UNDERTAKING TO REPAY EXPENSES ADVANCED
The Board of Directors of ZAIS Financial Corp.
Re: Undertaking to Repay Expenses Advanced
Ladies and Gentlemen:
This undertaking is being provided pursuant to that certain Indemnification Agreement dated the day of July, 2011, by and between ZAIS Financial Corp., a Maryland corporation (the Company), and the undersigned Indemnitee (the Indemnification Agreement ), pursuant to which I am entitled to advance of Expenses in connection with [Description of Proceeding] (the Proceeding ).
Terms used herein and not otherwise defined shall have the meanings specified in the Indemnification Agreement.
I am subject to the Proceeding by reason of my Corporate Status or by reason of alleged actions or omissions by me in such capacity. I hereby affirm my good belief that at all times, insofar as I was involved as [a director] [an officer] of the Company, in any of the facts or events giving rise to the Proceeding, I (1) did not act with bad faith or active or deliberate dishonesty, (2) did not receive any improper personal benefit in money, property or services and (3) in the case of any criminal proceeding, had no reasonable cause to believe that any act or omission by me was unlawful.
In consideration of the advance of Expenses by the Company for reasonable attorneys fees and related Expenses incurred by me in connection with the Proceeding (the Advanced Expenses ), I hereby agree that if, in connection with the Proceeding, it is established that (1) an act or omission by me was material to the matter giving rise to the Proceeding and (a) was committed in bad faith or (b) was the result of active and deliberate dishonesty or (2) I actually received an improper personal benefit in money, property or services or (3) in the case of any criminal proceeding, I had reasonable cause to believe that the act or omission was unlawful, then I shall promptly reimburse the portion of the Advanced Expenses relating to the claims, issues or matters in the Proceeding as to which the foregoing findings have been established.
IN WITNESS WHEREOF, I have executed this Affirmation and Undertaking on this day of , 20 .
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Exhibit 10.10
INDEMNIFICATION AGREEMENT
THIS INDEMNIFICATION AGREEMENT ( Agreement ) is made and entered into as of the 3rd day of August, 2011, by and between ZAIS Financial Corp., a Maryland corporation (the Company ), and Brian Hargrave ( Indemnitee ).
WHEREAS, at the request of the Company, Indemnitee currently serves as a director and/or officer of the Company and may, therefore, be subjected to claims, suits or proceedings arising as a result of his service; and
WHEREAS, as an inducement to Indemnitee to continue to serve as such director and/or officer, the Company has agreed to indemnify and to advance expenses and costs incurred by Indemnitee in connection with any such claims, suits or proceedings, to the maximum extent permitted by law; and
WHEREAS, the parties by this Agreement desire to set forth their agreement regarding indemnification and advance of expenses; and
NOW, THEREFORE, in consideration of the premises and the covenants contained herein, the Company and Indemnitee do hereby covenant and agree as follows:
Section 1. Definitions . For purposes of this Agreement:
(a) Change in Control means a change in control of the Company occurring after the Effective Date of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14A (or in response to any similar item on any similar schedule or form) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act ), whether or not the Company is then subject to such reporting requirement; provided, however, that, without limitation, such a Change in Control shall be deemed to have occurred if, after the Effective Date (i) any person (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) is or becomes the beneficial owner (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company representing 15% or more of the combined voting power of all of the Companys then-outstanding securities entitled to vote generally in the election of directors without the prior approval of at least two-thirds of the members of the Board of Directors in office immediately prior to such persons attaining such percentage interest; (ii) the Company is a party to a merger, consolidation, sale of assets, plan of liquidation or other reorganization not approved by at least two-thirds of the members of the Board of Directors then in office, as a consequence of which members of the Board of Directors in office immediately prior to such transaction or event constitute less than a majority of the Board of Directors thereafter; or (iii) at any time, a majority of the members of the Board of Directors are not individuals (A) who were directors as of the Effective Date or (B) whose election by the Board of Directors or nomination for election by the Companys stockholders was approved by the affirmative vote of at least two-thirds of the directors then in office who were directors as of the Effective Date or whose election or nomination for election was previously so approved.
(b) Corporate Status means the status of a person as a present or former director, officer, employee or agent of the Company or as a director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any other foreign or domestic corporation, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise that such person is or was serving in such capacity at the request of the Company. As a clarification and without limiting the circumstances in which Indemnitee may be serving at the request of the Company, service by Indemnitee shall be deemed to be at the request of the Company if Indemnitee serves or served as a director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any corporation, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise (i) of which a majority of the voting power or equity interest is owned directly or indirectly by the Company or (ii) the management of which is controlled directly or indirectly by the Company.
(c) Disinterested Director means a director of the Company who is not and was not a party to the Proceeding in respect of which indemnification and/or advance of Expenses is sought by Indemnitee.
(d) Effective Date means the date set forth in the first paragraph of this Agreement.
(e) Expenses means any and all reasonable and out-of-pocket attorneys fees and costs, retainers, court costs, transcript costs, fees of experts, witness fees, travel expenses, duplicating costs, printing and binding costs, telephone charges, postage, delivery service fees, federal, state, local or foreign taxes imposed on Indemnitee as a result of the actual or deemed receipt of any payments under this Agreement, ERISA excise taxes and penalties and any other disbursements or expenses incurred in connection with prosecuting, defending, preparing to prosecute or defend, investigating, being or preparing to be a witness in or otherwise participating in a Proceeding. Expenses shall also include Expenses incurred in connection with any appeal resulting from any Proceeding including, without limitation, the premium, security for and other costs relating to any cost bond, supersedeas bond or other appeal bond or its equivalent.
(f) Independent Counsel means a law firm, or a member of a law firm, that is experienced in matters of corporation law and neither is, nor in the past five years has been, retained to represent: (i) the Company or Indemnitee in any matter material to either such party (other than with respect to matters concerning Indemnitee under this Agreement or of other indemnitees under similar indemnification agreements), or (ii) any other party to or participant or witness in the Proceeding giving rise to a claim for indemnification or advance of Expenses hereunder. Notwithstanding the foregoing, the term Independent Counsel shall not include any person who, under the applicable standards of professional conduct then prevailing, would have a conflict of interest in representing either the Company or Indemnitee in an action to determine Indemnitees rights under this Agreement.
(g) Proceeding means any threatened, pending or completed action, suit, arbitration, alternate dispute resolution mechanism, investigation, inquiry, administrative hearing or any other proceeding, whether brought by or in the right of the Company or otherwise and whether of a civil (including intentional or unintentional tort claims), criminal, administrative or investigative (formal or informal) nature, including any appeal therefrom, except one pending or
completed on or before the Effective Date, unless otherwise specifically agreed in writing by the Company and Indemnitee. If Indemnitee reasonably believes that a given situation may lead to or culminate in the institution of a Proceeding, such situation shall also be considered a Proceeding.
Section 2. Services by Indemnitee . Indemnitee will serve as a director and/or officer of the Company. However, this Agreement shall not impose any independent obligation on Indemnitee or the Company to continue Indemnitees service to the Company. This Agreement shall not be deemed an employment contract between the Company (or any other entity) and Indemnitee.
Section 3. General . The Company shall indemnify, and advance Expenses to, Indemnitee (a) as provided in this Agreement and (b) otherwise to the maximum extent permitted by the laws of the State of Maryland in effect on the Effective Date and as amended from time to time; provided, however, that no change in the laws of the State of Maryland shall have the effect of reducing the benefits available to Indemnitee hereunder based on the laws of the State of Maryland as in effect on the Effective Date. The rights of Indemnitee provided in this Section 3 shall include, without limitation, the rights set forth in the other sections of this Agreement, including any additional indemnification permitted by Section 2-418(g) of the Maryland General Corporation Law (the MGCL ).
Section 4. Standard for Indemnification . If, by reason of Indemnitees Corporate Status, Indemnitee is, or is threatened to be, made a party to any Proceeding, Indemnitee shall be indemnified against all judgments, penalties, fines and amounts paid in settlement and all Expenses actually and reasonably incurred by him or on his behalf in connection with any such Proceeding unless it is established that (a) the act or omission of Indemnitee was material to the matter giving rise to the Proceeding and (i) was committed in bad faith or (ii) was the result of active and deliberate dishonesty, (b) Indemnitee actually received an improper personal benefit in money, property or services or (c) in the case of any criminal Proceeding, Indemnitee had reasonable cause to believe that his conduct was unlawful.
Section 5. Certain Limits on Indemnification . Notwithstanding any other provision of this Agreement (other than Section 6), Indemnitee shall not be entitled to:
(a) indemnification hereunder if the Proceeding was one by or in the right of the Company and Indemnitee is adjudged to be liable to the Company;
(b) indemnification hereunder if Indemnitee is adjudged to be liable on the basis that personal benefit was improperly received in any Proceeding charging improper personal benefit to Indemnitee, whether or not involving action in the Indemnitees Corporate Status; or
(c) indemnification or advance of Expenses hereunder if the Proceeding was brought by Indemnitee unless: (i) the Proceeding was brought to enforce indemnification under this Agreement, and then only to the extent in accordance with and as authorized by Section 12 of this Agreement, or (ii) the Companys charter or Bylaws, a resolution of the stockholders entitled to vote generally in the election of directors or of the Board of Directors or an agreement
approved by the Board of Directors to which the Company is a party expressly provide otherwise.
Section 6. Court-Ordered Indemnification . Notwithstanding any other provision of this Agreement, a court of appropriate jurisdiction, upon application of Indemnitee and such notice as the court shall require, may order indemnification in the following circumstances:
(a) if it determines Indemnitee is entitled to reimbursement under Section 2-418(d)(1) of the MGCL, the court shall order indemnification, in which case Indemnitee shall be entitled to recover the Expenses of securing such reimbursement; or
(b) if it determines that Indemnitee is fairly and reasonably entitled to indemnification in view of all the relevant circumstances, whether or not Indemnitee (i) has met the standards of conduct set forth in Section 2-418(b) of the MGCL or (ii) has been adjudged liable for receipt of an improper personal benefit under Section 2-418(c) of the MGCL, the court may order such indemnification as the court shall deem proper. However, indemnification with respect to any Proceeding by or in the right of the Company or in which liability shall have been adjudged in the circumstances described in Section 2-418(c) of the MGCL shall be limited to Expenses.
Section 7. Indemnification for Expenses of a Party Who is Wholly or Partly Successful . Notwithstanding any other provision of this Agreement, and without limiting any such provision, to the extent that Indemnitee was or is, by reason of his Corporate Status, made a party to (or otherwise becomes a participant in) any Proceeding and is successful, on the merits or otherwise, in the defense of such Proceeding, Indemnitee shall be indemnified for all Expenses actually and reasonably incurred by him or on his behalf in connection therewith. If Indemnitee is not wholly successful in such Proceeding but is successful, on the merits or otherwise, as to one or more but less than all claims, issues or matters in such Proceeding, the Company shall indemnify Indemnitee under this Section 7 for all Expenses actually and reasonably incurred by him or on his behalf in connection with each such claim, issue or matter, allocated on a reasonable and proportionate basis. For purposes of this Section 7 and, without limitation, the termination of any claim, issue or matter in such a Proceeding by dismissal, with or without prejudice, shall be deemed to be a successful result as to such claim, issue or matter.
Section 8. Advance of Expenses for a Party . If, by reason of Indemnitees Corporate Status, Indemnitee is, or is threatened to be, made a party to any Proceeding, the Company shall, without requiring a preliminary determination of Indemnitees ultimate entitlement to indemnification hereunder, advance all reasonable Expenses incurred by or on behalf of Indemnitee in connection with such Proceeding within ten days after the receipt by the Company of a statement or statements requesting such advance or advances from time to time, whether prior to or after final disposition of such Proceeding. Such statement or statements shall reasonably evidence the Expenses incurred by Indemnitee and shall include or be preceded or accompanied by a written affirmation by Indemnitee of Indemnitees good faith belief that the standard of conduct necessary for indemnification by the Company as authorized by law and by this Agreement has been met and a written undertaking by or on behalf of Indemnitee, in substantially the form attached hereto as Exhibit A or in such form as may be required under applicable law as in effect at the time of the execution thereof, to reimburse the portion of any
Expenses advanced to Indemnitee relating to claims, issues or matters in the Proceeding as to which it shall ultimately be established that the standard of conduct has not been met by Indemnitee and which have not been successfully resolved as described in Section 7 of this Agreement. To the extent that Expenses advanced to Indemnitee do not relate to a specific claim, issue or matter in the Proceeding, such Expenses shall be allocated on a reasonable and proportionate basis. The undertaking required by this Section 8 shall be an unlimited general obligation by or on behalf of Indemnitee and shall be accepted without reference to Indemnitees financial ability to repay such advanced Expenses and without any requirement to post security therefor.
Section 9. Indemnification and Advance of Expenses of a Witness . Notwithstanding any other provision of this Agreement, to the extent that Indemnitee is or may be, by reason of his Corporate Status, made a witness or otherwise asked to participate in any Proceeding, whether instituted by the Company or any other party, and to which Indemnitee is not a party, he shall be advanced all reasonable Expenses and indemnified against all Expenses actually and reasonably incurred by him or on his behalf in connection therewith within ten days after the receipt by the Company of a statement or statements requesting such advance or advances from time to time, whether prior to or after final disposition of such Proceeding. Such statement or statements shall reasonably evidence the Expenses incurred by Indemnitee.
Section 10. Procedure for Determination of Entitlement to Indemnification .
(a) To obtain indemnification under this Agreement, Indemnitee shall submit to the Company a written request, including therein or therewith such documentation and information as is reasonably available to Indemnitee and is reasonably necessary to determine whether and to what extent Indemnitee is entitled to indemnification. Indemnitee may submit one or more such requests from time to time and at such time(s) as Indemnitee deems appropriate in his sole discretion. The officer of the Company receiving any such request from Indemnitee shall, promptly upon receipt of such a request for indemnification, advise the Board of Directors in writing that Indemnitee has requested indemnification.
(b) Upon written request by Indemnitee for indemnification pursuant to Section 10(a) above, a determination, if required by applicable law, with respect to Indemnitees entitlement thereto shall promptly be made in the specific case: (i) if a Change in Control shall have occurred, by Independent Counsel, in a written opinion to the Board of Directors, a copy of which shall be delivered to Indemnitee, which Independent Counsel shall be selected by the Indemnitee and approved by the Board of Directors in accordance with Section 2-418(e)(2)(ii) of the MGCL, which approval will not be unreasonably withheld; or (ii) if a Change in Control shall not have occurred, (A) by the Board of Directors by a majority vote of a quorum consisting of Disinterested Directors or, if such a quorum cannot be obtained, then by a majority vote of a duly authorized committee of the Board of Directors consisting solely of one or more Disinterested Directors, (B) if Independent Counsel has been selected by the Board of Directors in accordance with Section 2-418(e)(2)(ii) of the MGCL and approved by the Indemnitee, which approval shall not be unreasonably withheld, by Independent Counsel, in a written opinion to the Board of Directors, a copy of which shall be delivered to Indemnitee or (C) if so directed by a majority of the members of the Board of Directors, by the stockholders of the Company. If it is so determined that Indemnitee is entitled to indemnification, payment to Indemnitee shall be
made within ten days after such determination. Indemnitee shall cooperate with the person, persons or entity making such determination with respect to Indemnitees entitlement to indemnification, including providing to such person, persons or entity upon reasonable advance request any documentation or information which is not privileged or otherwise protected from disclosure and which is reasonably available to Indemnitee and reasonably necessary to such determination in the discretion of the Board of Directors or Independent Counsel if retained pursuant to clause (ii)(B) of this Section 10(b). Any Expenses incurred by Indemnitee in so cooperating with the person, persons or entity making such determination shall be borne by the Company (irrespective of the determination as to Indemnitees entitlement to indemnification) and the Company shall indemnify and hold Indemnitee harmless therefrom.
(c) The Company shall pay the reasonable fees and expenses of Independent Counsel, if one is appointed.
Section 11. Presumptions and Effect of Certain Proceedings .
(a) In making any determination with respect to entitlement to indemnification hereunder, the person or persons or entity making such determination shall presume that Indemnitee is entitled to indemnification under this Agreement if Indemnitee has submitted a request for indemnification in accordance with Section 10(a) of this Agreement, and the Company shall have the burden of proof to overcome that presumption in connection with the making of any determination contrary to that presumption.
(b) The termination of any Proceeding or of any claim, issue or matter therein, by judgment, order, settlement or conviction, upon a plea of nolo contendere or its equivalent, or entry of an order of probation prior to judgment, does not create a presumption that Indemnitee did not meet the requisite standard of conduct described herein for indemnification.
(c) The knowledge and/or actions, or failure to act, of any other director, officer, employee or agent of the Company or any other director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any other foreign or domestic corporation, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise shall not be imputed to Indemnitee for purposes of determining any other right to indemnification under this Agreement.
Section 12. Remedies of Indemnitee .
(a) If (i) a determination is made pursuant to Section 10(b) of this Agreement that Indemnitee is not entitled to indemnification under this Agreement, (ii) advance of Expenses is not timely made pursuant to Section 8 of this Agreement, (iii) no determination of entitlement to indemnification shall have been made pursuant to Section 10(b) of this Agreement within 60 days after receipt by the Company of the request for indemnification, (iv) payment of indemnification is not made pursuant to Section 7 of this Agreement within ten days after receipt by the Company of a written request therefor, or (v) payment of indemnification pursuant to any other section of this Agreement or the charter or Bylaws of the Company is not made within ten days after a determination has been made that Indemnitee is entitled to indemnification, Indemnitee shall be entitled to an adjudication in an appropriate court located in the State of
Maryland, or in any other court of competent jurisdiction, of his entitlement to such indemnification or advance of Expenses. Alternatively, Indemnitee, at his option, may seek an award in arbitration to be conducted by a single arbitrator pursuant to the Commercial Arbitration Rules of the American Arbitration Association. Indemnitee shall commence a proceeding seeking an adjudication or an award in arbitration within 180 days following the date on which Indemnitee first has the right to commence such proceeding pursuant to this Section 12(a); provided, however, that the foregoing clause shall not apply to a proceeding brought by Indemnitee to enforce his rights under Section 7 of this Agreement. Except as set forth herein, the provisions of the laws of the State of Maryland (without regard to its conflicts of laws rules) shall apply to any such arbitration. The Company shall not oppose Indemnitees right to seek any such adjudication or award in arbitration.
(b) In any judicial proceeding or arbitration commenced pursuant to this Section 12, Indemnitee shall be presumed to be entitled to indemnification or advance of Expenses, as the case may be, under this Agreement and the Company shall have the burden of proving that Indemnitee is not entitled to indemnification or advance of Expenses, as the case may be. If Indemnitee commences a judicial proceeding or arbitration pursuant to this Section 12, Indemnitee shall not be required to reimburse the Company for any advances pursuant to Section 8 of this Agreement until a final determination is made with respect to Indemnitees entitlement to indemnification (as to which all rights of appeal have been exhausted or lapsed). The Company shall, to the fullest extent not prohibited by law, be precluded from asserting in any judicial proceeding or arbitration commenced pursuant to this Section 12 that the procedures and presumptions of this Agreement are not valid, binding and enforceable and shall stipulate in any such court or before any such arbitrator that the Company is bound by all of the provisions of this Agreement.
(c) If a determination shall have been made pursuant to Section 10(b) of this Agreement that Indemnitee is entitled to indemnification, the Company shall be bound by such determination in any judicial proceeding or arbitration commenced pursuant to this Section 12, absent a misstatement by Indemnitee of a material fact, or an omission of a material fact necessary to make Indemnitees statement not materially misleading, in connection with the request for indemnification.
(d) In the event that Indemnitee, pursuant to this Section 12, seeks a judicial adjudication of or an award in arbitration to enforce his rights under, or to recover damages for breach of, this Agreement, Indemnitee shall be entitled to recover from the Company, and shall be indemnified by the Company for, any and all Expenses actually and reasonably incurred by him in such judicial adjudication or arbitration. If it shall be determined in such judicial adjudication or arbitration that Indemnitee is entitled to receive part but not all of the indemnification or advance of Expenses sought, the Expenses incurred by Indemnitee in connection with such judicial adjudication or arbitration shall be appropriately prorated.
(e) Interest shall be paid by the Company to Indemnitee at the maximum rate allowed to be charged for judgments under the Courts and Judicial Proceedings Article of the Annotated Code of Maryland for amounts which the Company pays or is obligated to pay for the period commencing with the date on which the Company was requested to advance expenses in accordance with Section 8 of this Agreement or to make the determination of entitlement to
indemnification under Section 12(a) above. Indemnitee requests indemnification, reimbursement or advance of any Expenses and ending on the date such payment is made to Indemnitee by the Company.
Section 13. Defense of the Underlying Proceeding .
(a) Indemnitee shall notify the Company promptly in writing upon being served with any summons, citation, subpoena, complaint, indictment, request or other document relating to any Proceeding which may result in the right to indemnification or the advance of Expenses hereunder and shall include with such notice a description of the nature of the Proceeding and a summary of the facts underlying the Proceeding. The failure to give any such notice shall not disqualify Indemnitee from the right, or otherwise affect in any manner any right of Indemnitee, to indemnification or the advance of Expenses under this Agreement unless the Companys ability to defend in such Proceeding or to obtain proceeds under any insurance policy is materially and adversely prejudiced thereby, and then only to the extent the Company is thereby actually so prejudiced.
(b) Subject to the provisions of the last sentence of this Section 13(b) and of Section 13(c) below, the Company shall have the right to defend Indemnitee in any Proceeding which may give rise to indemnification hereunder; provided, however, that the Company shall notify Indemnitee of any such decision to defend within 15 calendar days following receipt of notice of any such Proceeding under Section 13(a) above. The Company shall not, without the prior written consent of Indemnitee, which shall not be unreasonably withheld or delayed, consent to the entry of any judgment against Indemnitee or enter into any settlement or compromise which (i) includes an admission of fault of Indemnitee, (ii) does not include, as an unconditional term thereof, the full release of Indemnitee from all liability in respect of such Proceeding, which release shall be in form and substance reasonably satisfactory to Indemnitee or (iii) would impose any Expense, judgment, fine, penalty or limitation on Indemnitee. This Section 13(b) shall not apply to a Proceeding brought by Indemnitee under Section 12 of this Agreement.
(c) Notwithstanding the provisions of Section 13(b) above, if in a Proceeding to which Indemnitee is a party by reason of Indemnitees Corporate Status, (i) Indemnitee reasonably concludes, based upon an opinion of counsel approved by the Company, which approval shall not be unreasonably withheld, that he may have separate defenses or counterclaims to assert with respect to any issue which may not be consistent with other defendants in such Proceeding, (ii) Indemnitee reasonably concludes, based upon an opinion of counsel approved by the Company, which approval shall not be unreasonably withheld, that an actual or apparent conflict of interest or potential conflict of interest exists between Indemnitee and the Company, or (iii) if the Company fails to assume the defense of such Proceeding in a timely manner, Indemnitee shall be entitled to be represented by separate legal counsel of Indemnitees choice, subject to the prior approval of the Company, which shall not be unreasonably withheld, at the expense of the Company. In addition, if the Company fails to comply with any of its obligations under this Agreement or in the event that the Company or any other person takes any action to declare this Agreement void or unenforceable, or institutes any Proceeding to deny or to recover from Indemnitee the benefits intended to be provided to Indemnitee hereunder, Indemnitee shall have the right to retain counsel of Indemnitees choice,
subject to the prior approval of the Company, which shall not be unreasonably withheld, at the expense of the Company (subject to Section 12(d) of this Agreement), to represent Indemnitee in connection with any such matter.
Section 14. Non-Exclusivity; Survival of Rights; Subrogation .
(a) The rights of indemnification and advance of Expenses as provided by this Agreement shall not be deemed exclusive of any other rights to which Indemnitee may at any time be entitled under applicable law, the charter or Bylaws of the Company, any agreement or a resolution of the stockholders entitled to vote generally in the election of directors or of the Board of Directors, or otherwise. Unless consented to in writing by Indemnitee, no amendment, alteration or repeal of this Agreement or of any provision hereof shall limit or restrict any right of Indemnitee under this Agreement in respect of any action taken or omitted by such Indemnitee in his Corporate Status prior to such amendment, alteration or repeal, regardless of whether a claim with respect to such action or inaction is raised prior or subsequent to such amendment, alteration or repeal. No right or remedy herein conferred is intended to be exclusive of any other right or remedy, and every other right or remedy shall be cumulative and in addition to every other right or remedy given hereunder or now or hereafter existing at law or in equity or otherwise. The assertion of any right or remedy hereunder, or otherwise, shall not prohibit the concurrent assertion or employment of any other right or remedy.
(b) In the event of any payment under this Agreement, the Company shall be subrogated to the extent of such payment to all of the rights of recovery of Indemnitee, who shall execute all papers required and take all action necessary to secure such rights, including execution of such documents as are necessary to enable the Company to bring suit to enforce such rights.
Section 15. Insurance . The Company will use its reasonable best efforts to acquire directors and officers liability insurance, on terms and conditions deemed appropriate by the Board of Directors, with the advice of counsel, covering Indemnitee or any claim made against Indemnitee by reason of his Corporate Status and covering the Company for any indemnification or advance of Expenses made by the Company to Indemnitee for any claims made against Indemnitee by reason of his Corporate Status. Without in any way limiting any other obligation under this Agreement, the Company shall indemnify Indemnitee for any payment by Indemnitee arising out of the amount of any deductible or retention and the amount of any excess of the aggregate of all judgments, penalties, fines, settlements and Expenses incurred by Indemnitee in connection with a Proceeding over the coverage of any insurance referred to in the previous sentence. The purchase, establishment and maintenance of any such insurance shall not in any way limit or affect the rights or obligations of the Company or Indemnitee under this Agreement except as expressly provided herein, and the execution and delivery of this Agreement by the Company and the Indemnitee shall not in any way limit or affect the rights or obligations of the Company under any such insurance policies. If, at the time the Company receives notice from any source of a Proceeding to which Indemnitee is a party or a participant (as a witness or otherwise) the Company has director and officer liability insurance in effect, the Company shall give prompt notice of such Proceeding to the insurers in accordance with the procedures set forth in the respective policies.
Section 16. Coordination of Payments . The Company shall not be liable under this Agreement to make any payment of amounts otherwise indemnifiable or payable or reimbursable as Expenses hereunder if and to the extent that Indemnitee has otherwise actually received such payment under any insurance policy, contract, agreement or otherwise.
Section 17. Reports to Stockholders . To the extent required by the MGCL, the Company shall report in writing to its stockholders the payment of any amounts for indemnification of, or advance of Expenses to, Indemnitee under this Agreement arising out of a Proceeding by or in the right of the Company with the notice of the meeting of stockholders of the Company next following the date of the payment of any such indemnification or advance of Expenses or prior to such meeting.
Section 18. Duration of Agreement; Binding Effect .
(a) This Agreement shall continue until and terminate on the later of (i) ten years after the date that Indemnitee shall have ceased to serve as a director, officer, employee or agent of the Company or as a director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any other foreign or domestic corporation, real estate investment trust, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise that such person is or was serving in such capacity at the request of the Company and (ii) the date that Indemnitee is no longer subject to any actual or possible Proceeding due to the lapse of all applicable statutes of limitations or otherwise (including any rights of appeal thereto and any Proceeding commenced by Indemnitee pursuant to Section 12 of this Agreement).
(b) The indemnification and advance of Expenses provided by, or granted pursuant to, this Agreement shall be binding upon and be enforceable by the parties hereto and their respective successors and assigns (including any direct or indirect successor by purchase, merger, consolidation or otherwise to all or substantially all of the business or assets of the Company), shall continue as to an Indemnitee who has ceased to be a director, officer, employee or agent of the Company or a director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any other foreign or domestic corporation, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise that such person is or was serving in such capacity at the request of the Company, and shall inure to the benefit of Indemnitee and his spouse, assigns, heirs, devisees, executors and administrators and other legal representatives.
(c) The Company shall require and cause any successor (whether direct or indirect by purchase, merger, consolidation or otherwise) to all, substantially all or a substantial part, of the business and/or assets of the Company, by written agreement in form and substance satisfactory to Indemnitee, expressly to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform if no such succession had taken place.
(d) The Company and Indemnitee agree herein that a monetary remedy for breach of this Agreement, at some later date, may be inadequate, impracticable and difficult of proof, and further agree that such breach may cause Indemnitee irreparable harm. Accordingly, the parties hereto agree that Indemnitee may enforce this Agreement by seeking injunctive relief and/or
specific performance hereof, without any necessity of showing actual damage or irreparable harm and that by seeking injunctive relief and/or specific performance, Indemnitee shall not be precluded from seeking or obtaining any other relief to which he may be entitled. Indemnitee shall further be entitled to such specific performance and injunctive relief, including temporary restraining orders, preliminary injunctions and permanent injunctions, without the necessity of posting bonds or other undertakings in connection therewith. The Company acknowledges that, in the absence of a waiver, a bond or undertaking may be required of Indemnitee by a court, and the Company hereby waives any such requirement of such a bond or undertaking.
Section 19. Severability . If any provision or provisions of this Agreement shall be held to be invalid, illegal or unenforceable for any reason whatsoever: (a) the validity, legality and enforceability of the remaining provisions of this Agreement (including, without limitation, each portion of any Section, paragraph or sentence of this Agreement containing any such provision held to be invalid, illegal or unenforceable that is not itself invalid, illegal or unenforceable) shall not in any way be affected or impaired thereby and shall remain enforceable to the fullest extent permitted by law; (b) such provision or provisions shall be deemed reformed to the extent necessary to conform to applicable law and to give the maximum effect to the intent of the parties hereto; and (c) to the fullest extent possible, the provisions of this Agreement (including, without limitation, each portion of any Section, paragraph or sentence of this Agreement containing any such provision held to be invalid, illegal or unenforceable, that is not itself invalid, illegal or unenforceable) shall be construed so as to give effect to the intent manifested thereby.
Section 20. Identical Counterparts . This Agreement may be executed in one or more counterparts, each of which shall for all purposes be deemed to be an original but all of which together shall constitute one and the same Agreement. One such counterpart signed by the party against whom enforceability is sought shall be sufficient to evidence the existence of this Agreement.
Section 21. Headings . The headings of the paragraphs of this Agreement are inserted for convenience only and shall not be deemed to constitute part of this Agreement or to affect the construction thereof.
Section 22. Modification and Waiver . No supplement, modification or amendment of this Agreement shall be binding unless executed in writing by both of the parties hereto. No waiver of any of the provisions of this Agreement shall be deemed or shall constitute a waiver of any other provisions hereof (whether or not similar) nor shall such waiver constitute a continuing waiver.
Section 23. Notices . All notices, requests, demands and other communications hereunder shall be in writing and shall be deemed to have been duly given if (i) delivered by hand and receipted for by the party to whom said notice or other communication shall have been directed or (ii) mailed by certified or registered mail with postage prepaid, on the third business day after the date on which it is so mailed:
(a) If to Indemnitee, to the address set forth on the signature page hereto.
(b) If to the Company, to:
General Counsel
Two Bridge Avenue, Suite 322
Red Bank, New Jersey 07701-1106
Facsimile: (732) 978-7507
or to such other address as may have been furnished in writing to Indemnitee by the Company or to the Company by Indemnitee, as the case may be.
Section 24. Governing Law . The parties agree that this Agreement shall be governed by, and construed and enforced in accordance with, the laws of the State of Maryland, without regard to its conflicts of laws rules.
Section 25. Miscellaneous . Use of the masculine pronoun shall be deemed to include usage of the feminine pronoun where appropriate.
[SIGNATURE PAGE FOLLOWS]
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above written.
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ZAIS FINANCIAL CORP. |
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By: |
/s/ Michael Szymanski |
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Name: |
Michael Szymanski |
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Title: |
Chief Executive Officer, President and Director |
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INDEMNITEE |
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/s/ Brian Hargrave |
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Name: |
Brian Hargrave |
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Two Bridge Avenue, Suite 322 |
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Red Bank, New Jersey 07701-1106 |
[ Signature Page to Brian Hargrave Indemnification Agreement ]
EXHIBIT A
FORM OF UNDERTAKING TO REPAY EXPENSES ADVANCED
The Board of Directors of ZAIS Financial Corp.
Re: Undertaking to Repay Expenses Advanced
Ladies and Gentlemen:
This undertaking is being provided pursuant to that certain Indemnification Agreement dated the day of July, 2011, by and between ZAIS Financial Corp., a Maryland corporation (the Company), and the undersigned Indemnitee (the Indemnification Agreement ), pursuant to which I am entitled to advance of Expenses in connection with [Description of Proceeding] (the Proceeding ).
Terms used herein and not otherwise defined shall have the meanings specified in the Indemnification Agreement.
I am subject to the Proceeding by reason of my Corporate Status or by reason of alleged actions or omissions by me in such capacity. I hereby affirm my good belief that at all times, insofar as I was involved as [a director] [an officer] of the Company, in any of the facts or events giving rise to the Proceeding, I (1) did not act with bad faith or active or deliberate dishonesty, (2) did not receive any improper personal benefit in money, property or services and (3) in the case of any criminal proceeding, had no reasonable cause to believe that any act or omission by me was unlawful.
In consideration of the advance of Expenses by the Company for reasonable attorneys fees and related Expenses incurred by me in connection with the Proceeding (the Advanced Expenses ), I hereby agree that if, in connection with the Proceeding, it is established that (1) an act or omission by me was material to the matter giving rise to the Proceeding and (a) was committed in bad faith or (b) was the result of active and deliberate dishonesty or (2) I actually received an improper personal benefit in money, property or services or (3) in the case of any criminal proceeding, I had reasonable cause to believe that the act or omission was unlawful, then I shall promptly reimburse the portion of the Advanced Expenses relating to the claims, issues or matters in the Proceeding as to which the foregoing findings have been established.
IN WITNESS WHEREOF, I have executed this Affirmation and Undertaking on this day of , 20 .
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Exhibit 10.11
INDEMNIFICATION AGREEMENT
THIS INDEMNIFICATION AGREEMENT ( Agreement ) is made and entered into as of the 13th day of December, 2012, by and between ZAIS Financial Corp., a Maryland corporation (the Company ), and Steven Haber ( Indemnitee ).
WHEREAS, at the request of the Company, Indemnitee currently serves as a director and/or officer of the Company and may, therefore, be subjected to claims, suits or proceedings arising as a result of his service; and
WHEREAS, as an inducement to Indemnitee to continue to serve as such director and/or officer, the Company has agreed to indemnify and to advance expenses and costs incurred by Indemnitee in connection with any such claims, suits or proceedings, to the maximum extent permitted by law; and
WHEREAS, the parties by this Agreement desire to set forth their agreement regarding indemnification and advance of expenses; and
NOW, THEREFORE, in consideration of the premises and the covenants contained herein, the Company and Indemnitee do hereby covenant and agree as follows:
Section 1. Definitions . For purposes of this Agreement:
(a) Change in Control means a change in control of the Company occurring after the Effective Date of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14A (or in response to any similar item on any similar schedule or form) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act ), whether or not the Company is then subject to such reporting requirement; provided, however, that, without limitation, such a Change in Control shall be deemed to have occurred if, after the Effective Date (i) any person (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) is or becomes the beneficial owner (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company representing 15% or more of the combined voting power of all of the Companys then-outstanding securities entitled to vote generally in the election of directors without the prior approval of at least two-thirds of the members of the Board of Directors in office immediately prior to such persons attaining such percentage interest; (ii) the Company is a party to a merger, consolidation, sale of assets, plan of liquidation or other reorganization not approved by at least two-thirds of the members of the Board of Directors then in office, as a consequence of which members of the Board of Directors in office immediately prior to such transaction or event constitute less than a majority of the Board of Directors thereafter; or (iii) at any time, a majority of the members of the Board of Directors are not individuals (A) who were directors as of the Effective Date or (B) whose election by the Board of Directors or nomination for election by the Companys stockholders was approved by the affirmative vote of at least two-thirds of the directors then in office who were directors as of the Effective Date or whose election or nomination for election was previously so approved.
(b) Corporate Status means the status of a person as a present or former director, officer, employee or agent of the Company or as a director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any other foreign or domestic corporation, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise that such person is or was serving in such capacity at the request of the Company. As a clarification and without limiting the circumstances in which Indemnitee may be serving at the request of the Company, service by Indemnitee shall be deemed to be at the request of the Company if Indemnitee serves or served as a director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any corporation, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise (i) of which a majority of the voting power or equity interest is owned directly or indirectly by the Company or (ii) the management of which is controlled directly or indirectly by the Company.
(c) Disinterested Director means a director of the Company who is not and was not a party to the Proceeding in respect of which indemnification and/or advance of Expenses is sought by Indemnitee.
(d) Effective Date means the date set forth in the first paragraph of this Agreement.
(e) Expenses means any and all reasonable and out-of-pocket attorneys fees and costs, retainers, court costs, transcript costs, fees of experts, witness fees, travel expenses, duplicating costs, printing and binding costs, telephone charges, postage, delivery service fees, federal, state, local or foreign taxes imposed on Indemnitee as a result of the actual or deemed receipt of any payments under this Agreement, ERISA excise taxes and penalties and any other disbursements or expenses incurred in connection with prosecuting, defending, preparing to prosecute or defend, investigating, being or preparing to be a witness in or otherwise participating in a Proceeding. Expenses shall also include Expenses incurred in connection with any appeal resulting from any Proceeding including, without limitation, the premium, security for and other costs relating to any cost bond, supersedeas bond or other appeal bond or its equivalent.
(f) Independent Counsel means a law firm, or a member of a law firm, that is experienced in matters of corporation law and neither is, nor in the past five years has been, retained to represent: (i) the Company or Indemnitee in any matter material to either such party (other than with respect to matters concerning Indemnitee under this Agreement or of other indemnitees under similar indemnification agreements), or (ii) any other party to or participant or witness in the Proceeding giving rise to a claim for indemnification or advance of Expenses hereunder. Notwithstanding the foregoing, the term Independent Counsel shall not include any person who, under the applicable standards of professional conduct then prevailing, would have a conflict of interest in representing either the Company or Indemnitee in an action to determine Indemnitees rights under this Agreement.
(g) Proceeding means any threatened, pending or completed action, suit, arbitration, alternate dispute resolution mechanism, investigation, inquiry, administrative hearing or any other proceeding, whether brought by or in the right of the Company or otherwise and whether of a civil (including intentional or unintentional tort claims), criminal, administrative or investigative (formal or informal) nature, including any appeal therefrom, except one pending or
completed on or before the Effective Date, unless otherwise specifically agreed in writing by the Company and Indemnitee. If Indemnitee reasonably believes that a given situation may lead to or culminate in the institution of a Proceeding, such situation shall also be considered a Proceeding.
Section 2. Services by Indemnitee . Indemnitee will serve as a director and/or officer of the Company. However, this Agreement shall not impose any independent obligation on Indemnitee or the Company to continue Indemnitees service to the Company. This Agreement shall not be deemed an employment contract between the Company (or any other entity) and Indemnitee.
Section 3. General . The Company shall indemnify, and advance Expenses to, Indemnitee (a) as provided in this Agreement and (b) otherwise to the maximum extent permitted by the laws of the State of Maryland in effect on the Effective Date and as amended from time to time; provided, however, that no change in the laws of the State of Maryland shall have the effect of reducing the benefits available to Indemnitee hereunder based on the laws of the State of Maryland as in effect on the Effective Date. The rights of Indemnitee provided in this Section 3 shall include, without limitation, the rights set forth in the other sections of this Agreement, including any additional indemnification permitted by Section 2-418(g) of the Maryland General Corporation Law (the MGCL ).
Section 4. Standard for Indemnification . If, by reason of Indemnitees Corporate Status, Indemnitee is, or is threatened to be, made a party to any Proceeding, Indemnitee shall be indemnified against all judgments, penalties, fines and amounts paid in settlement and all Expenses actually and reasonably incurred by him or on his behalf in connection with any such Proceeding unless it is established that (a) the act or omission of Indemnitee was material to the matter giving rise to the Proceeding and (i) was committed in bad faith or (ii) was the result of active and deliberate dishonesty, (b) Indemnitee actually received an improper personal benefit in money, property or services or (c) in the case of any criminal Proceeding, Indemnitee had reasonable cause to believe that his conduct was unlawful.
Section 5. Certain Limits on Indemnification . Notwithstanding any other provision of this Agreement (other than Section 6), Indemnitee shall not be entitled to:
(a) indemnification hereunder if the Proceeding was one by or in the right of the Company and Indemnitee is adjudged to be liable to the Company;
(b) indemnification hereunder if Indemnitee is adjudged to be liable on the basis that personal benefit was improperly received in any Proceeding charging improper personal benefit to Indemnitee, whether or not involving action in the Indemnitees Corporate Status; or
(c) indemnification or advance of Expenses hereunder if the Proceeding was brought by Indemnitee unless: (i) the Proceeding was brought to enforce indemnification under this Agreement, and then only to the extent in accordance with and as authorized by Section 12 of this Agreement, or (ii) the Companys charter or Bylaws, a resolution of the stockholders entitled to vote generally in the election of directors or of the Board of Directors or an agreement
approved by the Board of Directors to which the Company is a party expressly provide otherwise.
Section 6. Court-Ordered Indemnification . Notwithstanding any other provision of this Agreement, a court of appropriate jurisdiction, upon application of Indemnitee and such notice as the court shall require, may order indemnification in the following circumstances:
(a) if it determines Indemnitee is entitled to reimbursement under Section 2-418(d)(1) of the MGCL, the court shall order indemnification, in which case Indemnitee shall be entitled to recover the Expenses of securing such reimbursement; or
(b) if it determines that Indemnitee is fairly and reasonably entitled to indemnification in view of all the relevant circumstances, whether or not Indemnitee (i) has met the standards of conduct set forth in Section 2-418(b) of the MGCL or (ii) has been adjudged liable for receipt of an improper personal benefit under Section 2-418(c) of the MGCL, the court may order such indemnification as the court shall deem proper. However, indemnification with respect to any Proceeding by or in the right of the Company or in which liability shall have been adjudged in the circumstances described in Section 2-418(c) of the MGCL shall be limited to Expenses.
Section 7. Indemnification for Expenses of a Party Who is Wholly or Partly Successful . Notwithstanding any other provision of this Agreement, and without limiting any such provision, to the extent that Indemnitee was or is, by reason of his Corporate Status, made a party to (or otherwise becomes a participant in) any Proceeding and is successful, on the merits or otherwise, in the defense of such Proceeding, Indemnitee shall be indemnified for all Expenses actually and reasonably incurred by him or on his behalf in connection therewith. If Indemnitee is not wholly successful in such Proceeding but is successful, on the merits or otherwise, as to one or more but less than all claims, issues or matters in such Proceeding, the Company shall indemnify Indemnitee under this Section 7 for all Expenses actually and reasonably incurred by him or on his behalf in connection with each such claim, issue or matter, allocated on a reasonable and proportionate basis. For purposes of this Section 7 and, without limitation, the termination of any claim, issue or matter in such a Proceeding by dismissal, with or without prejudice, shall be deemed to be a successful result as to such claim, issue or matter.
Section 8. Advance of Expenses for a Party . If, by reason of Indemnitees Corporate Status, Indemnitee is, or is threatened to be, made a party to any Proceeding, the Company shall, without requiring a preliminary determination of Indemnitees ultimate entitlement to indemnification hereunder, advance all reasonable Expenses incurred by or on behalf of Indemnitee in connection with such Proceeding within ten days after the receipt by the Company of a statement or statements requesting such advance or advances from time to time, whether prior to or after final disposition of such Proceeding. Such statement or statements shall reasonably evidence the Expenses incurred by Indemnitee and shall include or be preceded or accompanied by a written affirmation by Indemnitee of Indemnitees good faith belief that the standard of conduct necessary for indemnification by the Company as authorized by law and by this Agreement has been met and a written undertaking by or on behalf of Indemnitee, in substantially the form attached hereto as Exhibit A or in such form as may be required under applicable law as in effect at the time of the execution thereof, to reimburse the portion of any
Expenses advanced to Indemnitee relating to claims, issues or matters in the Proceeding as to which it shall ultimately be established that the standard of conduct has not been met by Indemnitee and which have not been successfully resolved as described in Section 7 of this Agreement. To the extent that Expenses advanced to Indemnitee do not relate to a specific claim, issue or matter in the Proceeding, such Expenses shall be allocated on a reasonable and proportionate basis. The undertaking required by this Section 8 shall be an unlimited general obligation by or on behalf of Indemnitee and shall be accepted without reference to Indemnitees financial ability to repay such advanced Expenses and without any requirement to post security therefor.
Section 9. Indemnification and Advance of Expenses of a Witness . Notwithstanding any other provision of this Agreement, to the extent that Indemnitee is or may be, by reason of his Corporate Status, made a witness or otherwise asked to participate in any Proceeding, whether instituted by the Company or any other party, and to which Indemnitee is not a party, he shall be advanced all reasonable Expenses and indemnified against all Expenses actually and reasonably incurred by him or on his behalf in connection therewith within ten days after the receipt by the Company of a statement or statements requesting such advance or advances from time to time, whether prior to or after final disposition of such Proceeding. Such statement or statements shall reasonably evidence the Expenses incurred by Indemnitee.
Section 10. Procedure for Determination of Entitlement to Indemnification .
(a) To obtain indemnification under this Agreement, Indemnitee shall submit to the Company a written request, including therein or therewith such documentation and information as is reasonably available to Indemnitee and is reasonably necessary to determine whether and to what extent Indemnitee is entitled to indemnification. Indemnitee may submit one or more such requests from time to time and at such time(s) as Indemnitee deems appropriate in his sole discretion. The officer of the Company receiving any such request from Indemnitee shall, promptly upon receipt of such a request for indemnification, advise the Board of Directors in writing that Indemnitee has requested indemnification.
(b) Upon written request by Indemnitee for indemnification pursuant to Section 10(a) above, a determination, if required by applicable law, with respect to Indemnitees entitlement thereto shall promptly be made in the specific case: (i) if a Change in Control shall have occurred, by Independent Counsel, in a written opinion to the Board of Directors, a copy of which shall be delivered to Indemnitee, which Independent Counsel shall be selected by the Indemnitee and approved by the Board of Directors in accordance with Section 2-418(e)(2)(ii) of the MGCL, which approval will not be unreasonably withheld; or (ii) if a Change in Control shall not have occurred, (A) by the Board of Directors by a majority vote of a quorum consisting of Disinterested Directors or, if such a quorum cannot be obtained, then by a majority vote of a duly authorized committee of the Board of Directors consisting solely of one or more Disinterested Directors, (B) if Independent Counsel has been selected by the Board of Directors in accordance with Section 2-418(e)(2)(ii) of the MGCL and approved by the Indemnitee, which approval shall not be unreasonably withheld, by Independent Counsel, in a written opinion to the Board of Directors, a copy of which shall be delivered to Indemnitee or (C) if so directed by a majority of the members of the Board of Directors, by the stockholders of the Company. If it is so determined that Indemnitee is entitled to indemnification, payment to Indemnitee shall be
made within ten days after such determination. Indemnitee shall cooperate with the person, persons or entity making such determination with respect to Indemnitees entitlement to indemnification, including providing to such person, persons or entity upon reasonable advance request any documentation or information which is not privileged or otherwise protected from disclosure and which is reasonably available to Indemnitee and reasonably necessary to such determination in the discretion of the Board of Directors or Independent Counsel if retained pursuant to clause (ii)(B) of this Section 10(b). Any Expenses incurred by Indemnitee in so cooperating with the person, persons or entity making such determination shall be borne by the Company (irrespective of the determination as to Indemnitees entitlement to indemnification) and the Company shall indemnify and hold Indemnitee harmless therefrom.
(c) The Company shall pay the reasonable fees and expenses of Independent Counsel, if one is appointed.
Section 11. Presumptions and Effect of Certain Proceedings .
(a) In making any determination with respect to entitlement to indemnification hereunder, the person or persons or entity making such determination shall presume that Indemnitee is entitled to indemnification under this Agreement if Indemnitee has submitted a request for indemnification in accordance with Section 10(a) of this Agreement, and the Company shall have the burden of proof to overcome that presumption in connection with the making of any determination contrary to that presumption.
(b) The termination of any Proceeding or of any claim, issue or matter therein, by judgment, order, settlement or conviction, upon a plea of nolo contendere or its equivalent, or entry of an order of probation prior to judgment, does not create a presumption that Indemnitee did not meet the requisite standard of conduct described herein for indemnification.
(c) The knowledge and/or actions, or failure to act, of any other director, officer, employee or agent of the Company or any other director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any other foreign or domestic corporation, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise shall not be imputed to Indemnitee for purposes of determining any other right to indemnification under this Agreement.
Section 12. Remedies of Indemnitee .
(a) If (i) a determination is made pursuant to Section 10(b) of this Agreement that Indemnitee is not entitled to indemnification under this Agreement, (ii) advance of Expenses is not timely made pursuant to Section 8 of this Agreement, (iii) no determination of entitlement to indemnification shall have been made pursuant to Section 10(b) of this Agreement within 60 days after receipt by the Company of the request for indemnification, (iv) payment of indemnification is not made pursuant to Section 7 of this Agreement within ten days after receipt by the Company of a written request therefor, or (v) payment of indemnification pursuant to any other section of this Agreement or the charter or Bylaws of the Company is not made within ten days after a determination has been made that Indemnitee is entitled to indemnification, Indemnitee shall be entitled to an adjudication in an appropriate court located in the State of
Maryland, or in any other court of competent jurisdiction, of his entitlement to such indemnification or advance of Expenses. Alternatively, Indemnitee, at his option, may seek an award in arbitration to be conducted by a single arbitrator pursuant to the Commercial Arbitration Rules of the American Arbitration Association. Indemnitee shall commence a proceeding seeking an adjudication or an award in arbitration within 180 days following the date on which Indemnitee first has the right to commence such proceeding pursuant to this Section 12(a); provided, however, that the foregoing clause shall not apply to a proceeding brought by Indemnitee to enforce his rights under Section 7 of this Agreement. Except as set forth herein, the provisions of the laws of the State of Maryland (without regard to its conflicts of laws rules) shall apply to any such arbitration. The Company shall not oppose Indemnitees right to seek any such adjudication or award in arbitration.
(b) In any judicial proceeding or arbitration commenced pursuant to this Section 12, Indemnitee shall be presumed to be entitled to indemnification or advance of Expenses, as the case may be, under this Agreement and the Company shall have the burden of proving that Indemnitee is not entitled to indemnification or advance of Expenses, as the case may be. If Indemnitee commences a judicial proceeding or arbitration pursuant to this Section 12, Indemnitee shall not be required to reimburse the Company for any advances pursuant to Section 8 of this Agreement until a final determination is made with respect to Indemnitees entitlement to indemnification (as to which all rights of appeal have been exhausted or lapsed). The Company shall, to the fullest extent not prohibited by law, be precluded from asserting in any judicial proceeding or arbitration commenced pursuant to this Section 12 that the procedures and presumptions of this Agreement are not valid, binding and enforceable and shall stipulate in any such court or before any such arbitrator that the Company is bound by all of the provisions of this Agreement.
(c) If a determination shall have been made pursuant to Section 10(b) of this Agreement that Indemnitee is entitled to indemnification, the Company shall be bound by such determination in any judicial proceeding or arbitration commenced pursuant to this Section 12, absent a misstatement by Indemnitee of a material fact, or an omission of a material fact necessary to make Indemnitees statement not materially misleading, in connection with the request for indemnification.
(d) In the event that Indemnitee, pursuant to this Section 12, seeks a judicial adjudication of or an award in arbitration to enforce his rights under, or to recover damages for breach of, this Agreement, Indemnitee shall be entitled to recover from the Company, and shall be indemnified by the Company for, any and all Expenses actually and reasonably incurred by him in such judicial adjudication or arbitration. If it shall be determined in such judicial adjudication or arbitration that Indemnitee is entitled to receive part but not all of the indemnification or advance of Expenses sought, the Expenses incurred by Indemnitee in connection with such judicial adjudication or arbitration shall be appropriately prorated.
(e) Interest shall be paid by the Company to Indemnitee at the maximum rate allowed to be charged for judgments under the Courts and Judicial Proceedings Article of the Annotated Code of Maryland for amounts which the Company pays or is obligated to pay for the period commencing with the date on which the Company was requested to advance expenses in accordance with Section 8 of this Agreement or to make the determination of entitlement to
indemnification under Section 12(a) above. Indemnitee requests indemnification, reimbursement or advance of any Expenses and ending on the date such payment is made to Indemnitee by the Company.
Section 13. Defense of the Underlying Proceeding .
(a) Indemnitee shall notify the Company promptly in writing upon being served with any summons, citation, subpoena, complaint, indictment, request or other document relating to any Proceeding which may result in the right to indemnification or the advance of Expenses hereunder and shall include with such notice a description of the nature of the Proceeding and a summary of the facts underlying the Proceeding. The failure to give any such notice shall not disqualify Indemnitee from the right, or otherwise affect in any manner any right of Indemnitee, to indemnification or the advance of Expenses under this Agreement unless the Companys ability to defend in such Proceeding or to obtain proceeds under any insurance policy is materially and adversely prejudiced thereby, and then only to the extent the Company is thereby actually so prejudiced.
(b) Subject to the provisions of the last sentence of this Section 13(b) and of Section 13(c) below, the Company shall have the right to defend Indemnitee in any Proceeding which may give rise to indemnification hereunder; provided, however, that the Company shall notify Indemnitee of any such decision to defend within 15 calendar days following receipt of notice of any such Proceeding under Section 13(a) above. The Company shall not, without the prior written consent of Indemnitee, which shall not be unreasonably withheld or delayed, consent to the entry of any judgment against Indemnitee or enter into any settlement or compromise which (i) includes an admission of fault of Indemnitee, (ii) does not include, as an unconditional term thereof, the full release of Indemnitee from all liability in respect of such Proceeding, which release shall be in form and substance reasonably satisfactory to Indemnitee or (iii) would impose any Expense, judgment, fine, penalty or limitation on Indemnitee. This Section 13(b) shall not apply to a Proceeding brought by Indemnitee under Section 12 of this Agreement.
(c) Notwithstanding the provisions of Section 13(b) above, if in a Proceeding to which Indemnitee is a party by reason of Indemnitees Corporate Status, (i) Indemnitee reasonably concludes, based upon an opinion of counsel approved by the Company, which approval shall not be unreasonably withheld, that he may have separate defenses or counterclaims to assert with respect to any issue which may not be consistent with other defendants in such Proceeding, (ii) Indemnitee reasonably concludes, based upon an opinion of counsel approved by the Company, which approval shall not be unreasonably withheld, that an actual or apparent conflict of interest or potential conflict of interest exists between Indemnitee and the Company, or (iii) if the Company fails to assume the defense of such Proceeding in a timely manner, Indemnitee shall be entitled to be represented by separate legal counsel of Indemnitees choice, subject to the prior approval of the Company, which shall not be unreasonably withheld, at the expense of the Company. In addition, if the Company fails to comply with any of its obligations under this Agreement or in the event that the Company or any other person takes any action to declare this Agreement void or unenforceable, or institutes any Proceeding to deny or to recover from Indemnitee the benefits intended to be provided to Indemnitee hereunder, Indemnitee shall have the right to retain counsel of Indemnitees choice,
subject to the prior approval of the Company, which shall not be unreasonably withheld, at the expense of the Company (subject to Section 12(d) of this Agreement), to represent Indemnitee in connection with any such matter.
Section 14. Non-Exclusivity; Survival of Rights; Subrogation .
(a) The rights of indemnification and advance of Expenses as provided by this Agreement shall not be deemed exclusive of any other rights to which Indemnitee may at any time be entitled under applicable law, the charter or Bylaws of the Company, any agreement or a resolution of the stockholders entitled to vote generally in the election of directors or of the Board of Directors, or otherwise. Unless consented to in writing by Indemnitee, no amendment, alteration or repeal of this Agreement or of any provision hereof shall limit or restrict any right of Indemnitee under this Agreement in respect of any action taken or omitted by such Indemnitee in his Corporate Status prior to such amendment, alteration or repeal, regardless of whether a claim with respect to such action or inaction is raised prior or subsequent to such amendment, alteration or repeal. No right or remedy herein conferred is intended to be exclusive of any other right or remedy, and every other right or remedy shall be cumulative and in addition to every other right or remedy given hereunder or now or hereafter existing at law or in equity or otherwise. The assertion of any right or remedy hereunder, or otherwise, shall not prohibit the concurrent assertion or employment of any other right or remedy.
(b) In the event of any payment under this Agreement, the Company shall be subrogated to the extent of such payment to all of the rights of recovery of Indemnitee, who shall execute all papers required and take all action necessary to secure such rights, including execution of such documents as are necessary to enable the Company to bring suit to enforce such rights.
Section 15. Insurance . The Company will use its reasonable best efforts to acquire directors and officers liability insurance, on terms and conditions deemed appropriate by the Board of Directors, with the advice of counsel, covering Indemnitee or any claim made against Indemnitee by reason of his Corporate Status and covering the Company for any indemnification or advance of Expenses made by the Company to Indemnitee for any claims made against Indemnitee by reason of his Corporate Status. Without in any way limiting any other obligation under this Agreement, the Company shall indemnify Indemnitee for any payment by Indemnitee arising out of the amount of any deductible or retention and the amount of any excess of the aggregate of all judgments, penalties, fines, settlements and Expenses incurred by Indemnitee in connection with a Proceeding over the coverage of any insurance referred to in the previous sentence. The purchase, establishment and maintenance of any such insurance shall not in any way limit or affect the rights or obligations of the Company or Indemnitee under this Agreement except as expressly provided herein, and the execution and delivery of this Agreement by the Company and the Indemnitee shall not in any way limit or affect the rights or obligations of the Company under any such insurance policies. If, at the time the Company receives notice from any source of a Proceeding to which Indemnitee is a party or a participant (as a witness or otherwise) the Company has director and officer liability insurance in effect, the Company shall give prompt notice of such Proceeding to the insurers in accordance with the procedures set forth in the respective policies.
Section 16. Coordination of Payments . The Company shall not be liable under this Agreement to make any payment of amounts otherwise indemnifiable or payable or reimbursable as Expenses hereunder if and to the extent that Indemnitee has otherwise actually received such payment under any insurance policy, contract, agreement or otherwise.
Section 17. Reports to Stockholders . To the extent required by the MGCL, the Company shall report in writing to its stockholders the payment of any amounts for indemnification of, or advance of Expenses to, Indemnitee under this Agreement arising out of a Proceeding by or in the right of the Company with the notice of the meeting of stockholders of the Company next following the date of the payment of any such indemnification or advance of Expenses or prior to such meeting.
Section 18. Duration of Agreement; Binding Effect .
(a) This Agreement shall continue until and terminate on the later of (i) ten years after the date that Indemnitee shall have ceased to serve as a director, officer, employee or agent of the Company or as a director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any other foreign or domestic corporation, real estate investment trust, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise that such person is or was serving in such capacity at the request of the Company and (ii) the date that Indemnitee is no longer subject to any actual or possible Proceeding due to the lapse of all applicable statutes of limitations or otherwise (including any rights of appeal thereto and any Proceeding commenced by Indemnitee pursuant to Section 12 of this Agreement).
(b) The indemnification and advance of Expenses provided by, or granted pursuant to, this Agreement shall be binding upon and be enforceable by the parties hereto and their respective successors and assigns (including any direct or indirect successor by purchase, merger, consolidation or otherwise to all or substantially all of the business or assets of the Company), shall continue as to an Indemnitee who has ceased to be a director, officer, employee or agent of the Company or a director, trustee, officer, partner, manager, managing member, fiduciary, employee or agent of any other foreign or domestic corporation, partnership, limited liability company, joint venture, trust, employee benefit plan or other enterprise that such person is or was serving in such capacity at the request of the Company, and shall inure to the benefit of Indemnitee and his spouse, assigns, heirs, devisees, executors and administrators and other legal representatives.
(c) The Company shall require and cause any successor (whether direct or indirect by purchase, merger, consolidation or otherwise) to all, substantially all or a substantial part, of the business and/or assets of the Company, by written agreement in form and substance satisfactory to Indemnitee, expressly to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform if no such succession had taken place.
(d) The Company and Indemnitee agree herein that a monetary remedy for breach of this Agreement, at some later date, may be inadequate, impracticable and difficult of proof, and further agree that such breach may cause Indemnitee irreparable harm. Accordingly, the parties hereto agree that Indemnitee may enforce this Agreement by seeking injunctive relief and/or
specific performance hereof, without any necessity of showing actual damage or irreparable harm and that by seeking injunctive relief and/or specific performance, Indemnitee shall not be precluded from seeking or obtaining any other relief to which he may be entitled. Indemnitee shall further be entitled to such specific performance and injunctive relief, including temporary restraining orders, preliminary injunctions and permanent injunctions, without the necessity of posting bonds or other undertakings in connection therewith. The Company acknowledges that, in the absence of a waiver, a bond or undertaking may be required of Indemnitee by a court, and the Company hereby waives any such requirement of such a bond or undertaking.
Section 19. Severability . If any provision or provisions of this Agreement shall be held to be invalid, illegal or unenforceable for any reason whatsoever: (a) the validity, legality and enforceability of the remaining provisions of this Agreement (including, without limitation, each portion of any Section, paragraph or sentence of this Agreement containing any such provision held to be invalid, illegal or unenforceable that is not itself invalid, illegal or unenforceable) shall not in any way be affected or impaired thereby and shall remain enforceable to the fullest extent permitted by law; (b) such provision or provisions shall be deemed reformed to the extent necessary to conform to applicable law and to give the maximum effect to the intent of the parties hereto; and (c) to the fullest extent possible, the provisions of this Agreement (including, without limitation, each portion of any Section, paragraph or sentence of this Agreement containing any such provision held to be invalid, illegal or unenforceable, that is not itself invalid, illegal or unenforceable) shall be construed so as to give effect to the intent manifested thereby.
Section 20. Identical Counterparts . This Agreement may be executed in one or more counterparts, each of which shall for all purposes be deemed to be an original but all of which together shall constitute one and the same Agreement. One such counterpart signed by the party against whom enforceability is sought shall be sufficient to evidence the existence of this Agreement.
Section 21. Headings . The headings of the paragraphs of this Agreement are inserted for convenience only and shall not be deemed to constitute part of this Agreement or to affect the construction thereof.
Section 22. Modification and Waiver . No supplement, modification or amendment of this Agreement shall be binding unless executed in writing by both of the parties hereto. No waiver of any of the provisions of this Agreement shall be deemed or shall constitute a waiver of any other provisions hereof (whether or not similar) nor shall such waiver constitute a continuing waiver.
Section 23. Notices . All notices, requests, demands and other communications hereunder shall be in writing and shall be deemed to have been duly given if (i) delivered by hand and receipted for by the party to whom said notice or other communication shall have been directed or (ii) mailed by certified or registered mail with postage prepaid, on the third business day after the date on which it is so mailed:
(a) If to Indemnitee, to the address set forth on the signature page hereto.
(b) If to the Company, to:
General Counsel
Two Bridge Avenue, Suite 322
Red Bank, New Jersey 07701-1106
Facsimile: (732) 978-7507
or to such other address as may have been furnished in writing to Indemnitee by the Company or to the Company by Indemnitee, as the case may be.
Section 24. Governing Law . The parties agree that this Agreement shall be governed by, and construed and enforced in accordance with, the laws of the State of Maryland, without regard to its conflicts of laws rules.
Section 25. Miscellaneous . Use of the masculine pronoun shall be deemed to include usage of the feminine pronoun where appropriate.
[SIGNATURE PAGE FOLLOWS]
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above written.
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ZAIS FINANCIAL CORP. |
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By: |
/s/ Michael Szymanski |
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Name: |
Michael Szymanski |
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Title: |
Chief Executive Officer, President and Director |
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INDEMNITEE |
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/s/ Steven Haber |
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Name: |
Steven Haber |
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Address: |
c/o Zais Group LLC |
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2 Bridge Ave, Suite 322 |
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Red Bank, NJ 07701 |
[ Signature Page to Steven Haber Indemnification Agreement ]
EXHIBIT A
FORM OF UNDERTAKING TO REPAY EXPENSES ADVANCED
The Board of Directors of ZAIS Financial Corp.
Re: Undertaking to Repay Expenses Advanced
Ladies and Gentlemen:
This undertaking is being provided pursuant to that certain Indemnification Agreement dated the 13th day of December, 2012, by and between ZAIS Financial Corp., a Maryland corporation (the Company), and the undersigned Indemnitee (the Indemnification Agreement ), pursuant to which I am entitled to advance of Expenses in connection with [Description of Proceeding] (the Proceeding ).
Terms used herein and not otherwise defined shall have the meanings specified in the Indemnification Agreement.
I am subject to the Proceeding by reason of my Corporate Status or by reason of alleged actions or omissions by me in such capacity. I hereby affirm my good belief that at all times, insofar as I was involved as [a director] [an officer] of the Company, in any of the facts or events giving rise to the Proceeding, I (1) did not act with bad faith or active or deliberate dishonesty, (2) did not receive any improper personal benefit in money, property or services and (3) in the case of any criminal proceeding, had no reasonable cause to believe that any act or omission by me was unlawful.
In consideration of the advance of Expenses by the Company for reasonable attorneys fees and related Expenses incurred by me in connection with the Proceeding (the Advanced Expenses ), I hereby agree that if, in connection with the Proceeding, it is established that (1) an act or omission by me was material to the matter giving rise to the Proceeding and (a) was committed in bad faith or (b) was the result of active and deliberate dishonesty or (2) I actually received an improper personal benefit in money, property or services or (3) in the case of any criminal proceeding, I had reasonable cause to believe that the act or omission was unlawful, then I shall promptly reimburse the portion of the Advanced Expenses relating to the claims, issues or matters in the Proceeding as to which the foregoing findings have been established.
IN WITNESS WHEREOF, I have executed this Affirmation and Undertaking on this day of , 20 .
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Exhibit 10.13
ZAIS FINANCIAL CORP.
2012 EQUITY INCENTIVE PLAN
1. Purpose . The Plan is intended to provide incentives to directors, officers, advisors, consultants, key employees, and others expected to provide significant services to the Company and its Subsidiaries, including the Advisor and personnel, employees, officers and directors of the other Participating Companies (as defined herein), to encourage a proprietary interest in the Company, to encourage the Advisor and such key personnel to remain in the service of the Company and the other Participating Companies, to attract new personnel with outstanding qualifications, and to afford additional incentive to others to increase their efforts in providing significant services to the Company and the other Participating Companies, in each case, as may be necessary from time to time. In furtherance thereof, the Plan permits awards of equity-based incentives to the Advisor and key personnel, employees, officers and directors of, and certain other providers of services to, the Company or any other Participating Company.
2. Definitions . As used in this Plan, the following definitions apply:
Act shall mean the Securities Act of 1933, as amended.
Advisor shall mean ZAIS REIT Management, LLC, the Companys manager.
Award Agreement shall mean a written agreement evidencing a Grant pursuant to the Plan.
Board shall mean the Board of Directors of the Company.
Cause shall mean, unless otherwise provided in an applicable Award Agreement, a termination of employment or service, based upon a finding by the Company, acting in good faith, after the occurrence of any of the following: (i) the Grantee has engaged in any criminal offense which involves a violation of federal or state securities laws or regulations, embezzlement, fraud, wrongful taking or misappropriation of property, theft, or any other crime involving dishonesty, or has committed gross negligence ; (ii) any Grantee has persistently and willfully neglected his or her duties in respect of the Company, the Advisor or any other Participating Company or failed to devote substantially all of his or her working time, attention, energy and skills to the faithful and diligent performance of such duties, after the Company or the applicable Participating Company has given written notice specifying such conduct and giving the Grantee a reasonable period of time (not less than thirty (30) days), to conform his or her conduct to such duties ; (iii) a ny Grantee that becomes ineligible pursuant to Section 9(a) or (b) of the Investment Company Act of 1940 to serve as an investment advisor (or in any other capacity affected by such Section) to a registered investment company or is or becomes ineligible pursuant to Section 203 of the Investment Advisors Act of 1940 to serve as a registered investment advisor, or has been determined by an appropriate body to have engaged in conduct that would permit the U.S. Securities and Exchange Commission to bar him or her from any such services ; (iv) any Grantee has engaged in conduct which may have a material adverse effect on, or cause reputational damage to, the Company or any Participating Company (as determined by the Company in its sole and absolute discretion); or (v) the Grantees intentional breach of any material provision of an Award Agreement or any other agreements of the Company, the Advisor or any of their respective affiliates. As used in this definition, material means more than de minimis .
Change in Control means unless otherwise provided in an Award Agreement the happening of any of the following:
(i) any person, including a group (as such terms are used in Sections 13(d) and 14(d) of the Exchange Act, but excluding the Company, any entity controlling, controlled by or under common control with the Company, any trustee, fiduciary or other person or entity holding securities under any employee benefit plan or trust of the Company or any such entity, and, with respect to any particular Grantee, the Grantee and any group (as such term is used in Section 13(d)(3) of the Exchange Act) of which the Grantee is a member), is or becomes the beneficial owner (as defined in Rule 13(d)(3) under the Exchange Act), directly or indirectly, of securities of the Company representing 50% or more of either (A) the combined voting power of the Companys then outstanding securities or (B) the then outstanding Shares (in either such case other than as a result of an acquisition of securities directly from the Company);
(ii) any consolidation or merger of the Company where the shareholders of the Company, immediately prior to the consolidation or merger, would not, immediately after the consolidation or merger, beneficially own (as such term is defined in Rule 13d-3 under the Exchange Act), directly or indirectly, shares representing in the aggregate 50% or more of the combined voting power of the securities of the corporation issuing cash or securities in the consolidation or merger (or of its ultimate parent corporation, if any);
(iii) there shall occur (A) any sale, lease, exchange or other transfer (in one transaction or a series of transactions contemplated or arranged by any party as a single plan) of all or substantially all of the assets of the Company, other than a sale or disposition by the Company of all or substantially all of the Companys assets to an entity, at least 50% of the combined voting power of the voting securities of which are owned by persons (as defined above) in substantially the same proportion as their ownership of the Company immediately prior to such sale or (B) the approval by shareholders of the Company of any plan or proposal for the liquidation or dissolution of the Company; or
(iv) the members of the Board at the beginning of any consecutive 24-calendar-month period (the Incumbent Directors ) cease for any reason other than due to death to constitute at least a majority of the members of the Board; provided that any director whose election, or nomination for election by the Companys shareholders, was approved or ratified by a vote of at least a majority of the members of the Board then still in office who were members of the Board at the beginning of such 24-calendar-month period, shall be deemed to be an Incumbent Director.
Notwithstanding the foregoing, no event or condition shall constitute a Change in Control to the extent that, if it were, a 20% tax would be imposed under Section 409A of the Code; provided that , in such a case, the event or condition shall continue to constitute a Change in Control to the maximum extent possible ( e . g ., if applicable, in respect of vesting without an acceleration of distribution) without causing the imposition of such 20% tax.
Code shall mean the Internal Revenue Code of 1986, as amended.
Committee shall mean the Compensation Committee of the Company or any subcommittee of the Board as appointed by the Board in accordance with Section 4 of the Plan; provided , however , that the Committee shall at all times consist of two or more persons who, at the time of their appointment, each qualified as a Non-Employee Director
under Rule 16b-3(b)(3)(i) promulgated under the Exchange Act and, to the extent that relief from the limitation of Section 162(m) of the Code is sought, as an Outside Director under Section 1.162-27(e)(3)(i) of the Treasury Regulations.
Common Stock shall mean the Companys common stock, par value $0.0001 per share, either currently existing or authorized hereafter.
Company shall mean ZAIS Financial Corp., a Maryland corporation.
DER shall mean a right awarded under Section 11 of the Plan to receive (or have credited) the equivalent value (in cash or Shares) of dividends paid on Common Stock.
Disability shall mean, unless otherwise provided by the Committee in the Grantees Award Agreement, a finding by the Committee, based on the basis of medical evidence satisfactory to the Committee in its sole and absolute judgment, that a Grantee is disabled, mentally or physically, within the meaning of Section 409A(a)(2)(C) of the Code. Notwithstanding the foregoing, no circumstances or condition shall constitute a Disability to the extent that, if it were, a 20% tax would be imposed under Section 409A of the Code; provided that , in such a case, the event or condition shall continue to constitute a Disability to the maximum extent possible ( e . g ., if applicable, in respect of vesting without an acceleration of distribution) without causing the imposition of such 20% tax.
Eligible Persons shall mean the Advisor and officers, directors, advisors, personnel and employees of the Participating Companies and other persons expected to provide significant services (of a type expressly approved by the Committee as covered services for these purposes) to one or more of the Participating Companies. For purposes of the Plan and to the extent consistent with applicable securities law, a provider of significant services (such as a consultant or advisor) to the Company or any other Participating Company shall be deemed to be an Eligible Person, but will be eligible to receive Grants (but in no event Incentive Stock Options), only after a finding by the Committee in its discretion that the value of the services rendered or to be rendered to the Participating Company is at least equal to the value of the Grants being awarded.
Employee shall mean an individual, including an officer of a Participating Company, who is employed (within the meaning of Code Section 3401 and the regulations thereunder) by a Participating Company.
Exchange Act shall mean the Securities Exchange Act of 1934, as amended.
Exercise Price shall mean the price per share of Common Stock, determined by the Board or the Committee, at which an Option may be exercised.
Fair Market Value shall mean the value of one share of Common Stock, determined as follows:
(i) If the Shares are then listed on a national stock exchange, the closing sales price per Share on the exchange on the date in question (or, if no such price is available for such date, for the last preceding date on which there was a sale of Shares on such exchange), as determined by the Committee.
(ii) If the Shares are not then listed on a national stock exchange but are then traded on an over-the-counter market, the average of the closing bid and asked prices on
the date in question for the Shares in such over-the-counter market (or, if no such average is available for such date, for the last preceding date on which there was a sale of Shares in such market), as determined by the Committee.
(iii) If neither (i) nor (ii) applies, such value as the Committee in its discretion may in good faith determine. Notwithstanding the foregoing, where the Shares are listed or traded, the Committee may make discretionary determinations in good faith where the Shares have not been traded for 10 trading days.
Notwithstanding the foregoing, with respect to any stock right within the meaning of Section 409A of the Code, Fair Market Value shall not be less than the fair market value of the Shares determined in accordance with the final regulations promulgated under Section 409A of the Code.
Grant shall mean the issuance of an Incentive Stock Option, Non-qualified Stock Option, Restricted Stock, Phantom Share, DER, Restricted Limited Partnership Units, or other equity-based grant as contemplated herein or any combination thereof as applicable to an Eligible Person. The Committee will determine the eligibility of personnel, employees, officers, directors and others expected to provide significant services to any Participating Company based on, among other factors, the position and responsibilities of such individuals, the nature and value to such Participating Company of such individuals accomplishments and potential contribution to the success of such Participating Company whether directly or through its subsidiaries.
Grantee shall mean an Eligible Person to whom Options, Restricted Stock, Phantom Shares, DERs, Restricted Limited Partnership Units or other equity-based awards are granted hereunder.
Incentive Stock Option shall mean an Option of the type described in Section 422(b) of the Code issued to an Employee of (i) the Company, or (ii) a subsidiary corporation or a parent corporation as defined in Section 424(f) of the Code.
Non - qualified Stock Option shall mean an Option not described in Section 422(b) of the Code.
Operating Partnership shall mean ZAIS Financial Partners, L.P., a Delaware limited partnership.
Option shall mean any option, whether an Incentive Stock Option or a Non-qualified Stock Option, to purchase, at a price and for the term fixed by the Committee in accordance with the Plan, and subject to such other limitations and restrictions in the Plan and the applicable Award Agreement, a number of Shares determined by the Committee.
Optionee shall mean any Eligible Person to whom an Option is granted, or the Successors of the Optionee, as the context so requires.
Participating Companies shall mean the Company, the Subsidiaries, the Advisor, the Advisors managing member, ZAIS Group, LLC and, with the consent of the Committee, any of their respective affiliates and any joint venture affiliate of the Company.
Performance-Based Grants shall have the meaning set forth in Section 14.
Performance Criteria shall have the meaning set forth in Exhibit A .
Performance Goals shall have the meaning set forth in Section 14.
Phantom Share shall mean a right, pursuant to the Plan, of the Grantee to payment of the Phantom Share Value.
Phantom Share Value , per Phantom Share, shall mean the Fair Market Value of a Share or, if so provided by the Committee, such Fair Market Value to the extent in excess of a base value established by the Committee at the time of grant.
Plan shall mean the Companys 2012 Equity Incentive Plan, as set forth herein, and as the same may from time to time be amended.
Purchase Price shall mean the Exercise Price multiplied by the number of Shares with respect to which an Option is exercised.
Restricted Stock shall mean an award of Shares that are subject to restrictions hereunder.
Restricted Limited Partnership Units shall mean restricted limited partner profits interests in the Operating Partnership and other restricted limited partnership units in the Operating Partnership , providing distributions to the holder of the award based on the achievement of specified levels of profitability by the Operating Partnership or the achievement of certain goals or events, which may be convertible into or exchangeable for other securities of the Operating Partnership or into shares of the Companys capital stock, including the Shares.
Settlement Date shall have the meaning set forth in Section 10(d)(iii)(A) hereof.
Shares shall mean shares of Common Stock of the Company, adjusted in accordance with Section 16 of the Plan (if applicable).
Subsidiary shall mean any corporation, partnership, limited liability company or other entity at least 50% of the economic interest in the equity of which is owned, directly or indirectly, by the Company or by another Subsidiary.
Successors of the Optionee shall mean the legal representative of the estate of a deceased Optionee or the person or persons who shall acquire the right to exercise an Option by bequest or inheritance or by reason of the death of the Optionee.
Termination of Service shall mean the time when the employee-employer relationship or directorship, or other service relationship (sufficient to constitute service as an Eligible Person), between the Grantee and any Participating Company is terminated for any reason, with or without Cause, including, but not limited to, any termination by resignation, discharge, death or retirement; provided , however , Termination of Service shall not include a termination where there is a simultaneous continuation of service of the Grantee (sufficient to constitute service as an Eligible Person) for another Participating Company. The Committee, in its absolute discretion, shall determine the effects of all matters and questions relating to Termination of Service, including, but not limited to, the question of whether any Termination of Service was for Cause and all questions of whether particular leaves of absence constitute Terminations of Service. For this purpose, the service relationship shall be
treated as continuing intact while the Grantee is on military leave, sick leave or other bona fide leave of absence (to be determined in the discretion of the Committee).
ZAIS shall mean ZAIS Group, LLC.
3. Effective Date . The effective date of the Plan is December 21, 2012. The Plan shall terminate on, and no award shall be granted hereunder on or after, the 10-year anniversary of the earlier of the approval of the Plan by (i) the Board or (ii) the shareholders of the Company; provided , however , that the Board may at any time prior to that date terminate the Plan.
4. Administration .
(a) Membership on Committee . The Plan shall be administered by the Committee. If no Committee is appointed by the Board to act for those purposes or the Board otherwise so elects, the full Board shall have the rights and responsibilities of the Committee hereunder and under the Award Agreements.
(b) Committee Meetings . The acts of a majority of the members present at any meeting of the Committee at which a quorum is present, or acts approved in writing by a majority of the entire Committee, shall be the acts of the Committee for purposes of the Plan. If and to the extent applicable, no member of the Committee may act as to matters under the Plan specifically relating to such member.
(c) Grant of Awards .
(i) The Committee shall from time to time at its discretion select the Eligible Persons who are to be issued Grants and determine the number and type of Grants to be issued under any Award Agreement to an Eligible Person. In particular, the Committee shall (A) determine the terms and conditions, not inconsistent with the terms of the Plan, of any Grants awarded hereunder (including, but not limited to the performance goals and periods applicable to the award of Grants); (B) determine the time or times when and the manner and condition in which each Option shall be exercisable and the duration of the exercise period; and (C) determine or impose other conditions to the Grant or exercise of Options under the Plan as it may deem appropriate. The Committee may establish such rules, regulations and procedures for the administration of the Plan as it deems appropriate, determine the extent, if any, to which Options, Phantom Shares, Shares (whether or not Shares of Restricted Stock), DERs, Restricted Limited Partnership Units or other equity-based awards shall be forfeited (whether or not such forfeiture is expressly contemplated hereunder), and take any other actions and make any other determinations or decisions that it deems necessary or appropriate in connection with the Plan or the administration or interpretation thereof. The Committee shall also cause each Incentive Stock Option to be designated as such, except that no Incentive Stock Options may be granted to an Eligible Person who is not an Employee of the Company or a subsidiary corporation or a parent corporation as defined in Section 424(f) of the Code. The Grantee shall take whatever additional actions and execute whatever additional documents the Committee may in its reasonable judgment deem necessary or advisable in order to carry or effect one or more of the obligations or restrictions imposed on the Grantee pursuant to the express provisions of the Plan and the Award Agreement. DERs will be exercisable separately or together with Options, and paid in cash or other consideration at such times and in accordance with such rules, as the Committee shall determine in its discretion. Unless expressly provided hereunder, the Committee, with respect to any Grant, may exercise its discretion hereunder at
the time of the award or thereafter. The Committee shall have the right and responsibility to interpret the Plan and the interpretation and construction by the Committee of any provision of the Plan or of any Grant thereunder, including, without limitation, in the event of a dispute, shall be final and binding on all Grantees and other persons to the maximum extent permitted by law. Without limiting the generality of Section 25 hereof, no member of the Committee shall be liable for any action or determination made in good faith with respect to the Plan or any Grant hereunder.
(ii) Notwithstanding clause (i) of this Section 4(c), unless otherwise required by law or exchange listing rules, any award under the Plan to an Eligible Person who is a member of the Committee shall be made by the full Board, but for these purposes the directors of the Company who are on the Committee shall be required to be recused in respect of such awards and shall not be permitted to vote.
(d) Awards .
(i) Agreements . Grants to Eligible Persons shall be evidenced by written Award Agreements in such form as the Committee shall from time to time determine (which Award Agreements need not be in the same form as any other Award Agreement evidencing Grants under the Plan and need not contain terms and conditions identical to those applicable to any other Grant under the Plan or to those applicable to any other Eligible Persons). Such Award Agreements shall comply with and be subject to the terms and conditions set forth below.
(ii) Number of Shares . Each Grant issued to an Eligible Person shall state the number of Shares to which it pertains or which otherwise underlie the Grant and shall provide for the adjustment thereof in accordance with the provisions of Section 16 hereof.
(iii) Grants . Subject to the terms and conditions of the Plan and consistent with the Companys intention for the Committee to exercise the greatest permissible flexibility under Rule 16b-3 under the Exchange Act in awarding Grants, the Committee shall have the power:
(A) to determine from time to time the Grants to be issued to Eligible Persons under the Plan and to prescribe the terms and provisions (which need not be identical) of Grants issued under the Plan to such persons;
(B) to construe and interpret the Plan and the Grants thereunder and to establish, amend and revoke the rules, regulations and procedures established for the administration of the Plan. In this connection, the Committee may correct any defect or supply any omission, or reconcile any inconsistency in the Plan, in any Award Agreement, or in any related agreements, in the manner and to the extent it shall deem necessary or expedient to make the Plan fully effective. All decisions and determinations by the Committee in the exercise of this power shall be final and binding upon the Participating Companies and the Grantees;
(C) to amend any outstanding Grant, subject to Section 18 hereof, and to accelerate or extend the vesting or exercisability of any Grant (in compliance with Section 409A of the Code, if applicable) and to waive conditions or restrictions on any Grants, to the extent it shall deem appropriate;
(D) to determine the circumstances, if any, upon which an award made under the Plan shall be subject to forfeiture in whole or in part as a result of a breach by the Grantee of a provision or covenant to which the Grantee is subject; and
(E) generally to exercise such powers and to perform such acts as are deemed necessary or expedient to promote the best interests of the Company with respect to the Plan.
(iv) Any Grant awarded after the effective date of the Plan is subject to mandatory repayment by the Grantee to the Company to the extent the Grantee is or in the future becomes subject to any Company clawback or recoupment policy or as otherwise required by applicable law.
5. Participation .
(a) Eligibility . Only Eligible Persons shall be eligible to receive Grants under the Plan.
(b) Limitation of Ownership . No Grants shall be issued under the Plan to any person who after such Grant would beneficially own more than 9.8% of the outstanding Shares, unless the foregoing restriction is expressly and specifically waived by action of the independent directors of the Board.
(c) Share Ownership . For purposes of Section 5(b) above, in determining Share ownership, a Grantee shall be considered as owning the Shares owned, directly or indirectly, by or for his or her brothers, sisters, spouses, ancestors and lineal descendants. Shares owned, directly or indirectly, by or for a corporation, partnership, estate or trust shall be considered as being owned proportionately by or for its stockholders, partners or beneficiaries. Shares with respect to which any person holds an Option shall be considered to be owned by such person.
(d) Outstanding Shares . For purposes of Section 5(b) above, outstanding Shares shall include all Shares actually issued and outstanding immediately after the issue of the Grant to the Grantee. With respect to the Share ownership of any Grantee, outstanding Shares shall include Shares authorized for issue under outstanding Options held by such Grantee, but not options held by any other person.
6. Shares . Subject to adjustments pursuant to Section 16 hereof, no Grant may cause the total number of Shares subject to all outstanding awards to exceed 5.0% of the issued and outstanding Shares on a fully diluted basis (assuming, if applicable, the exercise of all outstanding Options and the conversion of all warrants and convertible securities into Shares). Notwithstanding the first sentence of this Section 6, (x) Shares that have been granted as Restricted Stock or that have been reserved for distribution in payment for Options or Phantom Shares but are later forfeited or for any other reason are not payable under the Plan; and (y) Shares as to which an Option is granted under the Plan that remains unexercised at the expiration, forfeiture or other termination of such Option, may be the subject of the issue of further Grants. Shares of Common Stock issued hereunder may consist, in whole or in part, of authorized and unissued shares, treasury shares or previously issued Shares under the Plan. The certificates for Shares issued hereunder may include any legend which the Committee deems appropriate to reflect any restrictions on transfer hereunder or under the Award Agreement, or as the Committee may otherwise deem appropriate. Shares subject to DERs,
other than DERs based directly on the dividends payable with respect to Shares subject to Options or the dividends payable on a number of Shares corresponding to the number of Phantom Shares awarded, shall be subject to the limitation of this Section 6. Notwithstanding the limitations above in this Section 6, except in the case of Grants intended to qualify for relief from the limitations of Section 162(m) of the Code, there shall be no limit on the number of Phantom Shares or DERs to the extent they are paid out in cash that may be granted under the Plan. If any Phantom Shares or DERs are paid out in cash, the underlying Shares may again be made the subject of Grants under the Plan, notwithstanding the first sentence of this Section 6.
7. Terms and Conditions of Options .
(a) Each Award Agreement with an Eligible Person shall state the Exercise Price. The Exercise Price for any Option shall not be less than the Fair Market Value on the date of Grant.
(b) Medium and Time of Payment. Except as may otherwise be provided below, the Purchase Price for each Option granted to an Eligible Person shall be payable in full in United States dollars upon the exercise of the Option. In the event the Company determines that it is required to withhold taxes as a result of the exercise of an Option, as a condition to the exercise thereof, an Employee may be required to make arrangements satisfactory to the Company to enable it to satisfy such withholding requirements in accordance with Section 22 hereof. If the applicable Award Agreement so provides, or the Committee otherwise so permits, the Purchase Price may be paid in one or a combination of the following, taking into account the desired accounting treatment and compliance with applicable law:
(i) by a certified or bank cashiers check;
(ii) by the surrender of Shares in good form for transfer, owned by the person exercising the Option and having a Fair Market Value on the date of exercise equal to the Purchase Price, or in any combination of cash and Shares, as long as the sum of the cash so paid and the Fair Market Value of the Shares so surrendered equals the Purchase Price;
(iii) by reduction of the Shares issuable upon exercise of the Option;
(iv) by cancellation of indebtedness owed by the Company to the Grantee;
(v) subject to Section 19(e) hereof, by broker-assisted cashless exercise using a broker reasonably acceptable to the Company, pursuant to which the Grantee delivers to the Company, on or prior to the exercise date, the Grantees instruction directing and obligating the broker to (a) sell Shares (or a sufficient portion of the Shares) acquired upon exercise of the Option and (b) remit to the Company a sufficient portion of the sale proceeds to pay the aggregate purchase price, no later than the third trading day after the exercise date;
(vi) subject to Section 18(e) hereof, by a loan or extension of credit from the Company evidenced by a full recourse promissory note executed by the Grantee. The interest rate and other terms and conditions of such note shall be determined by the Committee (in which case the Committee may require that the Grantee pledge his or her Shares to the Company for the purpose of securing the payment of such note, and in no event shall the stock certificate(s) representing such Shares be released to the Grantee until such note shall have been paid in full); or
(vii) by any combination of such methods of payment or any other method acceptable to the Committee in its discretion.
Except in the case of Options exercised by certified or bank cashiers check, the Committee may impose such limitations and prohibitions on the exercise of Options as it deems appropriate, including, without limitation, any limitation or prohibition designed to avoid accounting consequences which may result from the use of Shares as payment upon exercise of an Option. Any fractional Shares resulting from a Grantees election that are accepted by the Company shall in the discretion of the Committee be paid in cash.
(c) Term and Nontransferability of Grants and Options .
(i) Each Option under this Section 7 shall state the time or times which all or part thereof becomes exercisable, subject to the restrictions set forth in clauses (ii) through (v) below.
(ii) No Option shall be exercisable except by the Grantee or a transferee permitted hereunder.
(iii) No Option shall be assignable or transferable, except by will or the laws of descent and distribution of the state wherein the Grantee is domiciled at the time of his or her death; provided , however , that the Committee may (but need not) permit other transfers, where the Committee concludes that such transferability (A) does not result in accelerated taxation, (B) does not cause any Option intended to be an Incentive Stock Option to fail to be described in Section 422(b) of the Code and (C) is otherwise appropriate and desirable.
(iv) Notwithstanding Section 7(c)(iii) above, if the Award Agreement provides, an Option that is not an Incentive Stock Option may be transferred by an Optionee to the Optionees children, grandchildren, spouse, one or more trusts for the benefit of such family members or a partnership in which such family members are the only partners, on such terms and conditions as may be permitted under Rule 16b-3 under the Exchange Act as in effect from time to time. The holder of an Option transferred pursuant to this clause shall be bound by the same terms and conditions that governed the Option during the period that it was held by the Optionee; provided, however, that such transferee may not transfer the Option except by will or the laws of descent and distribution. In the event of any transfer of an Option (by the Optionee or his or her transferee), the Option and any corresponding stock appreciation right that relates to such Option must be transferred to the same person or persons or entity or entities.
(v) No Option shall be exercisable until such time as set forth in the applicable Award Agreement (but in no event after the expiration of such Grant).
(vi) No modification of an Option shall, without the consent of the Optionee or as required by applicable law or regulation or to meet the requirements of any accounting standard or to correct an administrative error, materially impair the rights of an Optionee under any Option previously granted.
(d) Termination of Service, other than by Death, Disability, or for Cause . Unless otherwise provided in the applicable Award Agreement, upon any Termination of Service for any reason other than his or her death or Disability, an Optionee shall have the
right, subject to the restrictions of Section 4(c) above, to exercise his or her Option at any time within 90 days after Termination of Service, but only to the extent that, at the date of Termination of Service, the Optionees right to exercise such Option had accrued pursuant to the terms of the applicable Award Agreement and had not previously been exercised or forfeited; provided , however , that , unless otherwise provided in the applicable Award Agreement, if there occurs a Termination of Service by a Participating Company for Cause, any Option not exercised in full prior to such termination shall be cancelled.
(e) Death of Optionee . Unless otherwise provided in the applicable Award Agreement, if the Optionee of an Option dies while an Eligible Person or within 90 days after any Termination of Service other than for Cause, and has not fully exercised such Option, subject to the restrictions of Section 4(c) above, such Option may be exercised at any time within 12 months after the Optionees death (or 12 months after the Optionees Termination of Service, if sooner) by the Successor of the Optionee, but only to the extent that, at the date of death, the Optionees right to exercise such Option had accrued pursuant to the terms of the applicable Award Agreement and had not previously been exercised or forfeited.
(f) Disability of Optionee . Unless otherwise provided in the Award Agreement, upon any Termination of Service for reason of his or her Disability, an Optionee shall have the right, subject to the restrictions of Section 4(c) above, to exercise an Option at any time within 12 months after Termination of Service, but only to the extent that, at the date of Termination of Service, the Optionees right to exercise such Option had accrued pursuant to the terms of the applicable Award Agreement and had not previously been exercised or forfeited.
(g) Rights as a Stockholder . An Optionee, a Successor of the Optionee, or the holder of a DER shall have no rights as a stockholder with respect to any Shares covered by his or her Grant until, in the case of an Optionee, the date of the issuance of a stock certificate for such Shares. No adjustment shall be made for dividends (ordinary or extraordinary, whether in cash, securities or other property), distributions or other rights for which the record date is prior to the date such stock certificate is issued, except as provided in Section 16 hereof.
(h) Modification, Extension and Renewal of Option . Within the limitations of the Plan, and only with respect to Options granted to Eligible Persons, the Committee may modify, extend or renew outstanding Options or accept the cancellation of outstanding Options (to the extent not previously exercised) for the granting of new Options in substitution therefor (but not including repricings, in the absence of stockholder approval). The Committee may modify, extend or renew any Option granted to any Eligible Person, taking into consideration Rule 16b-3 under the Exchange Act and Section 409A of the Code. The foregoing notwithstanding, no modification of an Option shall, without the consent of the Optionee, alter or impair any rights or obligations under any Option previously granted.
(i) Stock Appreciation Rights . The Committee, in its discretion, may (taking into account, without limitation, the application of Section 409A of the Code, as the Committee may deem appropriate), also permit the Optionee to elect to exercise an Option by receiving Shares, cash or a combination thereof, in the discretion of the Committee and as may be set forth in the applicable Award Agreement, with an aggregate Fair Market Value (or, to the extent of payment in cash, in an amount) equal to the excess of the Fair Market Value of the Shares with respect to which the Option is being exercised over the aggregate Purchase Price, as determined as of the day the Option is exercised.
(j) Deferral . The Committee may establish a program (taking into account, without limitation, the application of Section 409A of the Code, as the Committee may deem appropriate) under which Optionees will have Phantom Shares, subject to Section 10 hereof, credited upon their exercise of Options, rather than receiving Shares at that time.
(k) Other Provisions . The Award Agreement authorized under the Plan may contain such other provisions not inconsistent with the terms of the Plan (including, without limitation, restrictions upon the exercise of the Option) as the Committee shall deem advisable.
8. Special Rules for Incentive Stock Options .
(a) In the case of Incentive Stock Options granted hereunder, the aggregate Fair Market Value (determined as of the date of the Grant thereof) of the Shares with respect to which Incentive Stock Options become exercisable by any Optionee for the first time during any calendar year (under the Plan and all other plans) required to be taken into account under Section 422(d) of the Code shall not exceed $100,000.
(b) In the case of an individual described in Section 422(b)(6) of the Code (relating to certain 10% owners), the Exercise Price with respect to an Incentive Stock Option shall not be less than 110% of the Fair Market Value of a Share on the day the Option is granted and the term of an Incentive Stock Option shall be no more than five years from the date of grant.
(c) If Shares acquired upon exercise of an Incentive Stock Option are disposed of in a disqualifying disposition within the meaning of Section 422 of the Code by an Optionee prior to the expiration of either two years from the date of grant of such Option or one year from the transfer of Shares to the Optionee pursuant to the exercise of such Option, or in any other disqualifying disposition within the meaning of Section 422 of the Code, such Optionee shall notify the Company in writing as soon as practicable thereafter of the date and terms of such disposition and, if the Company thereupon has a tax-withholding obligation, shall pay to the Company an amount equal to any withholding tax the Company is required to pay as a result of the disqualifying disposition.
9. Provisions Applicable to Restricted Stock .
(a) Vesting Periods . In connection with the grant of Restricted Stock, whether or not Performance Goals apply thereto, the Committee shall establish one or more vesting periods with respect to the shares of Restricted Stock granted, the length of which shall be determined in the discretion of the Committee and set forth in the applicable Award Agreement. Subject to the provisions of this Section 9, the applicable Award Agreement and the other provisions of the Plan, restrictions on Restricted Stock shall lapse if the Grantee satisfies all applicable employment or other service requirements through the end of the applicable vesting period.
(b) Grant of Restricted Stock . Subject to the other terms of the Plan, the Committee may, in its discretion as reflected by the terms of the applicable Award Agreement: (i) authorize the Grant of Restricted Stock to Eligible Persons; (ii) provide a specified purchase price for the Restricted Stock (whether or not the payment of a purchase price is required by any state law applicable to the Company); (iii) determine the restrictions
applicable to Restricted Stock and (iv) determine or impose other conditions to the Grant of Restricted Stock under the Plan as it may deem appropriate.
(c) Certificates .
(i) Each Grantee of Restricted Stock may be issued a stock certificate in respect of Shares of Restricted Stock awarded under the Plan. Any such certificate shall be registered in the name of the Grantee. Without limiting the generality of Section 6 hereof, in addition to any legend that might otherwise be required by the Board or the Companys charter, bylaws or other applicable documents, the certificates for Shares of Restricted Stock issued hereunder may include any legend which the Committee deems appropriate to reflect any restrictions on transfer hereunder or under the applicable Award Agreement, or as the Committee may otherwise deem appropriate, and, without limiting the generality of the foregoing, shall bear a legend referring to the terms, conditions, and restrictions applicable to such Grant, substantially in the following form:
THE TRANSFERABILITY OF THIS CERTIFICATE AND THE SHARES OF STOCK REPRESENTED HEREBY ARE SUBJECT TO THE TERMS AND CONDITIONS (INCLUDING FORFEITURE) OF THE ZAIS FINANCIAL CORP. 2012 EQUITY INCENTIVE PLAN, AND AN AWARD AGREEMENT ENTERED INTO BETWEEN THE REGISTERED OWNER AND ZAIS FINANCIAL CORP. COPIES OF SUCH PLAN AND AWARD AGREEMENT ARE ON FILE IN THE OFFICES OF ZAIS FINANCIAL CORP. AT TWO BRIDGE AVENUE, SUITE 322 RED BANK, NEW JERSEY 07701-1106.
(ii) The Committee may require that any stock certificates evidencing such Shares be held in custody by the Company until the restrictions hereunder shall have lapsed and that, as a condition of any grant of Restricted Stock, the Grantee shall have delivered a stock power, endorsed in blank, relating to the stock covered by such Grant. If and when such restrictions so lapse, the stock certificates shall be delivered by the Company to the Grantee or his or her designee as provided in Section 9(d) hereof.
(iii) For purposes of clarity, nothing contained in the Plan shall preclude the use of non-certficated evidence of ownership that the Committee determines to be appropriate, including book entry.
(d) Restrictions and Conditions . Unless otherwise provided by the Committee in an Award Agreement, the Shares of Restricted Stock awarded pursuant to the Plan shall be subject to the following restrictions and conditions:
(i) Subject to the provisions of the Plan and the applicable Award Agreement, during a period commencing with the date of such Grant and ending on the date the period of forfeiture with respect to which such Shares lapses, the Grantee shall not be permitted voluntarily or involuntarily to sell, transfer, pledge, anticipate, alienate, encumber or assign Shares of Restricted Stock awarded under the Plan (or have such Shares attached or garnished). Subject to the provisions of the applicable Award Agreement, the period of forfeiture with respect to Shares granted hereunder shall lapse as provided in the applicable Award Agreement. Notwithstanding the foregoing, unless otherwise expressly provided by the Committee, the period of forfeiture with respect to such Shares shall only lapse as to whole Shares.
(ii) Except as provided in the foregoing clause (i), or in Section 16 hereof, the Grantee shall have, in respect of the shares of Restricted Stock, all of the rights of a stockholder of the Company, including the right to vote the underlying Shares and receive dividends. Certificates for Shares underlying Restricted Stock (not subject to restrictions hereunder) shall be delivered to the Grantee or his or her designee (or where permitted, transferee) promptly after, and only after, the period of forfeiture shall lapse without forfeiture in respect of such shares of Restricted Stock.
(iii) Termination of service. Unless otherwise provided in the applicable Award Agreement, if the Grantee has a Termination of Service for any reason, then (A) all shares of Restricted Stock still subject to restriction shall thereupon, and with no further action, be forfeited by the Grantee, and (B) the Company shall pay to the Grantee as soon as practicable (and in no event more than 30 days) after such termination an amount equal to the lesser of (X) the amount paid by the Grantee, if any, for such forfeited Restricted Stock as contemplated by Section 9(b) hereof, and (Y) the Fair Market Value on the date of termination of the forfeited Restricted Stock.
10. Provisions Applicable to Phantom Shares .
(a) Grant of Phantom Shares . Subject to the other terms of the Plan, the Committee shall, in its discretion as reflected by the terms of the applicable Award Agreement: (i) authorize the Granting of Phantom Shares to Eligible Persons and (ii) determine or impose other conditions to the grant of Phantom Shares under the Plan as it may deem appropriate.
(b) Term . The Committee may provide in an Award Agreement that any particular Phantom Share shall expire at the end of a specified term.
(c) Vesting .
(i) Subject to the provisions of the applicable Award Agreement and Section 10(c)(ii) below, Phantom Shares shall vest as provided in the applicable Award Agreement.
(ii) Unless otherwise determined by the Committee in an applicable Award Agreement, in the event that a Grantee has a Termination of Service, any and all of the Grantees Phantom Shares which have not vested prior to or as of such termination shall thereupon, and with no further action, be forfeited and cease to be outstanding, and the Grantees vested Phantom Shares shall be settled as set forth in Section 10(d) below.
(d) Settlement of Phantom Shares .
(i) Except as otherwise provided by the Committee, each vested and outstanding Phantom Share shall be settled by the transfer to the Grantee of one Share; provided , however , that , the Committee at the time of grant (or, in the appropriate case, as determined by the Committee, thereafter) may provide that a Phantom Share may be settled (A) in cash at the applicable Phantom Share Value, (B) in cash or by transfer of Shares as elected by the Grantee in accordance with procedures established by the Committee (if any) or (C) in cash or by transfer of Shares as elected by the Company.
(ii) Each Phantom Share shall be settled with a single-sum payment by the Company; provided , however , that , with respect to Phantom Shares of a Grantee which have a common Settlement Date, the Committee may permit the Grantee to elect in accordance with procedures established by the Committee (taking into account, without limitation, Section 409A of the Code, as the Committee may deem appropriate) to receive installment payments over a period not to exceed 10 years.
(iii) (A) Except as otherwise provided by the Committee, the settlement date with respect to a Grantee is the first day of the month to follow the Grantees Termination of Service (the Settlement Date ).
(B) Notwithstanding Section 10(d)(iii)(A), the Committee may provide that distributions of Phantom Shares can be elected at any time in those cases in which the Phantom Share Value is determined by reference to Fair Market Value to the extent in excess of a base value, rather than by reference to unreduced Fair Market Value.
(C) Notwithstanding the foregoing, the Settlement Date, if not earlier pursuant to this Section 10(d)(iii), is the date of the Grantees death.
(iv) Notwithstanding any other provision of the Plan (taking into account, without limitation, Section 409A of the Code, as the Committee may deem appropriate), a Grantee may receive any amounts to be paid in installments as provided in Section 10(d)(ii) or deferred by the Grantee as provided in Section 10(d)(iii) in the event of an Unforeseeable Emergency. For these purposes, an Unforeseeable Emergency shall have the meaning provided in Section 409A of the Code and the regulations thereunder, as determined by the Committee in its sole discretion, provided that such Unforeseeable Emergency must cause a severe financial hardship to the Grantee resulting from (A) a sudden and unexpected illness or accident of the Grantee or dependent, as defined in Section 152(a) of the Code, of the Grantee, (B) loss of the Grantees property due to casualty, or (C) other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the Grantee. The circumstances that will constitute an Unforeseeable Emergency will depend upon the facts of each case, but, in any case, payment may not be made to the extent that such hardship is or may be relieved:
(X) through reimbursement or compensation by insurance or otherwise;
(Y) by liquidation of the Grantees assets, to the extent the liquidation of such assets would not itself cause severe financial hardship; or
(Z) by future cessation of the making of additional deferrals with respect to Phantom Shares.
Without limitation, the need to send a Grantees child to college or the desire to purchase a home shall not constitute an Unforeseeable Emergency. Distributions of amounts because of an Unforeseeable Emergency shall be permitted to the extent reasonably needed to satisfy the emergency need.
(e) Other Phantom Share Provisions .
(i) Except as permitted by the Committee, rights to payments with respect to Phantom Shares granted under the Plan shall not be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, attachment, garnishment, levy, execution, or other legal or equitable process, either voluntary or involuntary; and any attempt to anticipate, alienate, sell, transfer, assign, pledge, encumber, attach or garnish, or levy or execute on any right to payments or other benefits payable hereunder, shall be void.
(ii) A Grantee may designate in writing, on forms to be prescribed by the Committee, a beneficiary or beneficiaries to receive any payments payable after his or her death and may amend or revoke such designation at any time. If no beneficiary designation is in effect at the time of a Grantees death, payments hereunder shall be made to the Grantees estate. If a Grantee with a vested Phantom Share dies, such Phantom Share shall be settled and the Phantom Share Value in respect of such Phantom Shares paid, and any payments deferred pursuant to an election under Section 10(d)(iii) shall be accelerated and paid, as soon as practicable (but no later than 60 days) after the date of death to such Grantees beneficiary or estate, as applicable.
(iii) The Committee may (taking into account, without limitation, Section 409A of the Code, as the Committee may deem appropriate) establish a program under which distributions with respect to Phantom Shares may be deferred for periods in addition to those otherwise contemplated by the foregoing provisions of this Section 10. Such program may include, without limitation, provisions for the crediting of earnings and losses on unpaid amounts and, if permitted by the Committee, provisions under which Grantees may select from among hypothetical investment alternatives for such deferred amounts in accordance with procedures established by the Committee.
(iv) Notwithstanding any other provision of this Section 10, any fractional Phantom Share will be paid out in cash at the Phantom Share Value as of the Settlement Date.
(v) No Phantom Share shall give any Grantee any rights with respect to Shares or any ownership interest in the Company. Except as may be provided in accordance with Section 11 hereof, no provision of the Plan shall be interpreted to confer upon any Grantee of a Phantom Share any voting, dividend or derivative or other similar rights with respect to any Phantom Share.
(f) Claims Procedures .
(i) The Grantee, or his or her beneficiary hereunder or authorized representative, may file a claim for payments with respect to Phantom Shares under the Plan by written communication to the Secretary of the Company or his or her designee. A claim is not considered filed until such communication is actually received. Within 90 days (or, if special circumstances require an extension of time for processing, 180 days, in which case notice of such special circumstances should be provided to the Secretary of the Company or his or her designee within the initial 90-day period) after the filing of the claim, the Committee will either:
(A) approve the claim and take appropriate steps for satisfaction of the claim; or
(B) if the claim is wholly or partially denied, advise the claimant of such denial by furnishing to him or her a written notice of such denial setting forth (1) the specific reason or reasons for the denial; (2) specific reference to pertinent provisions of the Plan on which the denial is based and, if the denial is based in whole or in part on any rule of construction or interpretation adopted by the Committee, a reference to such rule, a copy of which shall be provided to the claimant; (3) a description of any additional material or information necessary for the claimant to perfect the claim and an explanation of the reasons why such material or information is necessary; and (4) a reference to this Section 10(f) as the provision setting forth the claims procedure under the Plan.
(ii) The claimant may request a review of any denial of his or her claim by written application to the Committee within 60 days after receipt of the notice of denial of such claim. Within 60 days (or, if special circumstances require an extension of time for processing, 120 days, in which case notice of such special circumstances should be provided within the initial 60-day period) after receipt of written application for review, the Committee will provide the claimant with its decision in writing, including, if the claimants claim is not approved, specific reasons for the decision and specific references to the Plan provisions on which the decision is based.
11. Provisions Applicable to Dividend Equivalent Rights .
(a) Grant of DERs . Subject to the other terms of the Plan, the Committee shall, in its discretion as reflected by the terms of the Award Agreements, authorize the granting of DERs to Eligible Persons based on the dividends declared on Common Stock, to be credited as of the dividend payment dates, during a specified period determined by the Committee, which may be, for example, between the date a Grant is issued or vests, and the date such Grant is exercised, vests or expires. Such DERs shall be converted to cash or additional Shares by such formula and at such time and subject to such limitation as may be determined by the Committee. With respect to DERs granted with respect to Options intended to be qualified performance-based compensation for purposes of Section 162(m) of the Code, such DERs shall be payable regardless of whether such Option is exercised. If a DER is granted in respect of another Grant hereunder, then, unless otherwise stated in the Award Agreement, or, in the appropriate case, as determined by the Committee, in no event shall the DER be in effect for a period beyond the time during which the applicable related portion of the underlying Grant has been exercised or otherwise settled, or has expired, been forfeited or otherwise lapsed, as applicable.
(b) Certain Terms .
(i) The term of a DER shall be set by the Committee in its discretion.
(ii) Payment of the amount determined in accordance with Section 11(a) shall be in cash, in Common Stock or a combination of the both, as determined by the Committee at the time of grant.
(c) Other Types of DERs . The Committee may establish a program under which DERs of a type whether or not described in the foregoing provisions of this Section 11 may be granted to Eligible Persons. For example, without limitation, the Committee may grant a DER in respect of each Share subject to an Option or with respect to a Phantom Share, which right would consist of the right (subject to Section 11(d)) to receive a cash payment in an amount equal to the dividend distributions paid on a Share from time to time.
(d) Deferral .
(i) The Committee may (taking into account, without limitation, Section 409A of the Code, as the Committee may deem appropriate) establish a program under which Grantees (A) will have Phantom Shares credited, subject to the terms of Sections 10(d) and 10(e) hereof as though directly applicable with respect thereto, upon the granting of DERs, or (B) will have payments with respect to DERs deferred.
(ii) The Committee may establish a program under which distributions with respect to DERs may be deferred. Such program may include, without limitation, provisions for the crediting of earnings and losses on unpaid amounts, and, if permitted by the Committee, provisions under which Grantees may select from among hypothetical investment alternatives for such deferred amounts in accordance with procedures established by the Committee.
12. Provisions Applicable to Restricted Limited Partnership Units .
(a) Vesting Periods . In connection with the grant of Restricted Limited Partnership Units , whether or not Performance Goals apply thereto, the Committee shall establish one or more vesting periods with respect to the Restricted Limited Partnership Units granted, the length of which shall be determined in the discretion of the Committee and set forth in the applicable Award Agreement. Subject to the provisions of this Section 9, the applicable Award Agreement and the other provisions of the Plan, restrictions on Restricted Limited Partnership Units shall lapse if the Grantee satisfies all applicable employment or other service requirements through the end of the applicable vesting period.
(b) Grant of Restricted Limited Partnership Units . Subject to the other terms of the Plan, the Committee may, in its discretion as reflected by the terms of the applicable Award Agreement: (i) authorize the Grant of Restricted Limited Partnership Units to Eligible Persons; (ii) provide a specified purchase price for the Restricted Limited Partnership Units (whether or not the payment of a purchase price is required by any state law applicable to the Company); (iii) determine the restrictions applicable to Restricted Limited Partnership Units and (iv) determine or impose other conditions to the Grant of Restricted Limited Partnership Units under the Plan as it may deem appropriate.
(c) Restrictions and Conditions . Unless otherwise provided by the Committee in an Award Agreement, the Restricted Limited Partnership Units awarded pursuant to the Plan shall be subject to the following restrictions and conditions: subject to the provisions of the Plan and the applicable Award Agreement, during a period commencing with the date of such Grant and ending on the date the period of forfeiture with respect to such Restricted Limited Partnership Units lapses, the Grantee shall not be permitted voluntarily or involuntarily to sell, transfer, pledge, anticipate, alienate, encumber or assign Restricted Limited Partnership Units awarded under the Plan (or have such units attached or garnished). Subject to the provisions of the applicable Award Agreement, the period of forfeiture with respect to Restricted Limited Partnership Units granted hereunder shall lapse as provided in the applicable Award Agreement. Notwithstanding the foregoing, unless otherwise expressly provided by the Committee, the period of forfeiture with respect to such Restricted Limited Partnership Units shall only lapse as to whole units .
(d) Termination of service . Unless otherwise provided in the applicable Award Agreement, if the Grantee has a Termination of Service for any reason, then (A) all
Restricted Limited Partnership Units still subject to restriction shall thereupon, and with no further action, be forfeited by the Grantee, and (B) the Company shall pay to the Grantee as soon as practicable (and in no event more than 30 days) after such termination an amount equal to the lesser of (X) the amount paid by the Grantee, if any, for such forfeited Restricted Limited Partnership Units as contemplated by Section 9(b) hereof, and (Y) the Fair Market Value on the date of termination of the forfeited Restricted Limited Partnership Units .
13. Other Equity-Based Awards . The Board shall have the right to grant other awards based upon the Common Stock having such terms and conditions as the Board may determine, including, without limitation, the grant of Shares based upon certain conditions, the grant of securities convertible into Common Stock, and the grant of restricted stock units.
14. Performance Goals . The Committee, in its discretion, shall in the case of Grants (including, in particular, Grants other than Options) intended to qualify for an exception from the limitation imposed by Section 162(m) of the Code ( Performance-Based Grants ) (i) establish one or more performance goals ( Performance Goals ) as a precondition to the issuance or vesting of Grants, and (ii) provide, in connection with the establishment of the Performance Goals, for predetermined Grants to those Grantees (who continue to meet all applicable eligibility requirements) with respect to whom the applicable Performance Goals are satisfied. The Performance Goals shall be based upon the Performance Criteria set forth in Exhibit A hereto which is hereby incorporated herein by reference as though set forth in full. The Performance Goals shall be established in a timely fashion such that they are considered preestablished for purposes of the rules governing performance-based compensation under Section 162(m) of the Code. Prior to the award of Restricted Stock intended to qualify for an exception from the limitation imposed by Section 162(m) of the Code, the Committee shall have certified that any applicable Performance Goals, and other material terms of the Grant, have been satisfied. Performance Goals which do not satisfy the foregoing provisions of this Section 14 may be established by the Committee with respect to Grants not intended to qualify for an exception from the limitations imposed by Section 162(m) of the Code.
15. Term of Plan . Grants may be granted pursuant to the Plan until the expiration of 10 years from the effective date of the Plan.
16. Recapitalization and Changes of Control .
(a) Subject to any required action by stockholders and to the specific provisions of Section 17 hereof, if (i) the Company shall at any time be involved in a merger, consolidation, dissolution, liquidation, reorganization, exchange of shares, sale of all or substantially all of the assets or stock of the Company or a transaction similar thereto, (ii) any stock dividend, stock split, reverse stock split, stock combination, reclassification, recapitalization or other similar change in the capital structure of the Company, or any distribution to holders of Common Stock other than cash dividends, shall occur or (iii) any other event shall occur which in the judgment of the Committee necessitates action by way of adjusting the terms of the outstanding Grants, then:
(i) the maximum aggregate number of Shares which may be made subject to Options and DERs under the Plan, the maximum aggregate number and kind of Shares of Restricted Stock that may be granted under the Plan, the maximum aggregate number of Phantom Shares and other Grants which may be granted under the Plan shall be appropriately adjusted by the Committee in its discretion; and
(ii) the Committee shall take any such action as in its discretion shall be necessary to maintain each Grantees rights hereunder (including under their applicable Award Agreements) so that they are, in their respective Options, Phantom Shares and DERs (and, as appropriate, other Grants under Section 13 hereof), substantially proportionate to the rights existing in such Options, Phantom Shares and DERs (and other Grants under Section 13 hereof) prior to such event, including, without limitation, adjustments in (A) the number of Options, Phantom Shares and DERs (and other Grants under Section 13) granted, (B) the number and kind of shares or other property to be distributed in respect of Options, Phantom Shares and DERs (and other Grants under Section 13, as applicable, (C) the Exercise Price, Purchase Price and Phantom Share Value, and (D) performance-based criteria established in connection with Grants (to the extent consistent with Section 162(m) of the Code, as applicable); provided that , in the discretion of the Committee, the foregoing clause (D) may also be applied in the case of any event relating to a Subsidiary if the event would have been covered under this Section 16(a) had the event related to the Company.
To the extent that such action shall include an increase or decrease in the number of Shares (or units of other property then available) subject to all outstanding Grants, the number of Shares (or units) available under Section 6 above shall be increased or decreased, as the case may be, proportionately.
(b) Any Shares or other securities distributed to a Grantee with respect to Restricted Stock or otherwise issued in substitution of Restricted Stock pursuant to this Section 16 shall be subject to the applicable restrictions and requirements imposed by Section 9 hereof, including depositing the certificates therefor with the Company together with a stock power and bearing a legend as provided in Section 9(c)(i) hereof.
(c) If the Company shall be consolidated or merged with another corporation or other entity, each Grantee who has received Restricted Stock that is then subject to restrictions imposed by Section 9(d) hereof may be required to deposit with the successor corporation the certificates for the stock or securities or the other property that the Grantee is entitled to receive by reason of ownership of Restricted Stock in a manner consistent with Section 9(c)(ii) hereof, and such stock, securities or other property shall become subject to the restrictions and requirements imposed by Section 9(d) hereof, and the certificates therefor or other evidence thereof shall bear a legend similar in form and substance to the legend set forth in Section 9(c)(i) hereof.
(d) The judgment of the Committee with respect to any matter referred to in this Section 16 shall be conclusive and binding upon each Grantee without the need for any amendment to the Plan.
(e) Subject to any required action by stockholders, if the Company is the surviving corporation in any merger or consolidation, the rights under any outstanding Grant shall pertain and apply to the securities to which a holder of the number of Shares subject to the Grant would have been entitled. Subject to the terms of any applicable Award Agreement, in the event of a merger or consolidation in which the Company is not the surviving corporation, the date of exercisability of each outstanding Option and settling of each Phantom Share or, as applicable, other Grant under Section 13 hereof (in each case whether or not vested), shall be accelerated to a date prior to such merger or consolidation, unless the agreement of merger or consolidation provides for the assumption of the Grant by the successor to the Company.
(f) To the extent that the foregoing adjustment related to securities of the Company, such adjustments shall be made by the Committee, whose determination shall be conclusive and binding on all persons.
(g) Except as expressly provided in this Section 16, a Grantee shall have no rights by reason of subdivision or consolidation of shares of stock of any class, the payment of any stock dividend or any other increase or decrease in the number of shares of stock of any class or by reason of any dissolution, liquidation, merger or consolidation or spin-off of assets or stock of another corporation, and any issue by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall not affect, and no adjustment by reason thereof shall be made with respect to, the number of Shares subject to a Grant or the Exercise Price of Shares subject to an Option.
(h) Grants made pursuant to the Plan shall not affect in any way the right or power of the Company to make adjustments, reclassifications, reorganizations or changes of its capital or business structure, to merge or consolidate or to dissolve, liquidate, sell or transfer all or any part of its business assets.
(i) Upon the occurrence of a Change in Control:
(i) The Committee as constituted immediately before such Change in Control may make such adjustments as it, in its discretion, determines are necessary or appropriate in light of such Change in Control (including, without limitation, the substitution of stock other than stock of the Company as the stock optioned hereunder, and the acceleration of the exercisability or vesting of awards granted under the Plan, cancellation of any Options or stock appreciation rights in return for payment equal to the Fair Market Value of Shares subject to an Option or stock appreciation right as of the date of such Change in Control less the Exercise Price applicable thereto (which amount may be zero) and settling of each vested Phantom Share or, as applicable, other Grant under Section 13 hereof (in each case whether or not vested)), if any, provided that the Committee determines that such adjustments do not have a substantial adverse economic impact on the Grantee as determined at the time of the adjustments.
(ii) Notwithstanding the provisions of Section 10 hereof, the Settlement Date for Phantom Shares shall be the date of such Change in Control and all amounts due with respect to Phantom Shares to a Grantee hereunder shall be paid as soon as practicable (but in no event more than 30 days) after such Change in Control, unless such Grantee elects otherwise in accordance with procedures established by the Committee.
17. Effect of Certain Transactions . In the case of (a) the dissolution or liquidation of the Company, (b) a merger, consolidation, reorganization or other business combination in which the Company is acquired by another entity or in which the Company is not the surviving entity, or (c) any sale, lease, exchange or other transfer (in one transaction or a series of transactions contemplated or arranged by any party as a single plan) of all or substantially all of the assets of the Company, the Plan and the Grants issued hereunder shall terminate upon the effectiveness of any such transaction or event, unless provision is made in connection with such transaction for the assumption of Grants theretofore granted, or the substitution for such Grants of new Grants, by the successor entity or parent thereof, with appropriate adjustment as to the number and kind of shares and the per share exercise prices, as provided in Section 16 hereof. In the event of such termination, all outstanding Options
and Grants shall be exercisable to the extent then vested (taking into account any accelerated vesting provided by the Committee) for at least ten days prior to the date of such termination.
18. Securities Law Requirements .
(a) Legality of Issuance . The issuance of any Shares pursuant to Grants under the Plan and the issuance of any Grant shall be contingent upon the following:
(i) the obligation of the Company to sell Shares with respect to Grants issued under the Plan shall be subject to all applicable laws, rules and regulations, including all applicable federal and state securities laws, and the obtaining of all such approvals by governmental agencies as may be deemed necessary or appropriate by the Committee;
(ii) the Committee may make such changes to the Plan as may be necessary or appropriate to comply with the rules and regulations of any government authority or to obtain tax benefits applicable to stock options; and
(iii) each grant of Options, Restricted Stock, Phantom Shares (or issuance of Shares in respect thereof), DERs (or issuance of Shares in respect thereof), Restricted Limited Partnership Units or other Grant under Section 13 hereof (or issuance of Shares in respect thereof), is subject to the requirement that, if at any time the Committee determines, in its discretion, that the listing, registration or qualification of Shares or other awards issuable pursuant to the Plan is required by any securities exchange or under any state or federal law, or the consent or approval of any governmental regulatory body is necessary or desirable as a condition of, or in connection with, the issuance of Options, Shares of Restricted Stock, Phantom Shares, DERs, Restricted Limited Partnership Units, other Grants or other Shares, no payment shall be made, or Phantom Shares or Shares issued or grant of Restricted Stock, Restricted Limited Partnership Units or other Grant made, in whole or in part, unless listing, registration, qualification, consent or approval has been effected or obtained free of any conditions in a manner acceptable to the Committee.
(b) Restrictions on Transfer . Regardless of whether the offering and sale of Shares under the Plan has been registered under the Act or has been registered or qualified under the securities laws of any state, the Company may impose restrictions on the sale, pledge or other transfer of such Shares (including the placement of appropriate legends on stock certificates) if, in the judgment of the Company and its counsel, such restrictions are necessary or desirable in order to achieve compliance with the provisions of the Act, the securities laws of any state or any other law. In the event that the sale of Shares under the Plan is not registered under the Act but an exemption is available which requires an investment representation or other representation, each Grantee shall be required to represent that such Shares are being acquired for investment, and not with a view to the sale or distribution thereof, and to make such other representations as are deemed necessary or appropriate by the Company and its counsel. Any determination by the Company and its counsel in connection with any of the matters set forth in this Section 18 shall be conclusive and binding on all persons. Without limiting the generality of Section 6 hereof, stock certificates evidencing Shares acquired under the Plan pursuant to an unregistered transaction shall bear a restrictive legend, substantially in the following form, and such other restrictive legends as are required or deemed advisable under the provisions of any applicable law:
THE SALE OF THE SECURITIES REPRESENTED HEREBY HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE
ACT ). ANY TRANSFER OF SUCH SECURITIES WILL BE INVALID UNLESS A REGISTRATION STATEMENT UNDER THE ACT IS IN EFFECT AS TO SUCH TRANSFER OR IN THE OPINION OF COUNSEL FOR THE ISSUER SUCH REGISTRATION IS UNNECESSARY IN ORDER FOR SUCH TRANSFER TO COMPLY WITH THE ACT.
(c) Registration or Qualification of Securities . The Company may, but shall not be obligated to, register or qualify the issuance of Grants and/or the sale of Shares under the Act or any other applicable law. The Company shall not be obligated to take any affirmative action in order to cause the issuance of Grants or the sale of Shares under the Plan to comply with any law.
(d) Exchange of Certificates . If, in the opinion of the Company and its counsel, any legend placed on a stock certificate representing Shares sold under the Plan is no longer required, the holder of such certificate shall, with the permission of the Committee, be entitled to exchange such certificate for a certificate representing the same number of Shares but lacking such legend.
(e) Certain Loans . Notwithstanding any other provision of the Plan, the Company shall not be required to take or permit any action under the Plan or any Award Agreement which, in the good-faith determination of the Company, would result in a material risk of a violation by the Company of Section 13(k) of the Exchange Act.
19. Compliance with Section 409a of the Code .
(a) Any Award Agreement issued under the Plan that is subject to Section 409A of the Code shall include such additional terms and conditions as may be required to satisfy the requirements of Section 409A of the Code.
(b) With respect to any Grant issued under the Plan that is subject to Section 409A of the Code, and with respect to which a payment or distribution is to be made upon a Termination of Service, if the Grantee is determined by the Company to be a specified employee within the meaning of Section 409A(a)(2)(B)(i) of the Code and any of the Companys stock is publicly traded on an established securities market or otherwise, such payment or distribution, to the extent it would constitute a payment of nonqualified deferred compensation within the meaning of Section 409A of the Code that is ineligible for an exemption from treatment as such, may not be made before the date which is six months after the date of Termination of Service (to the extent required under Section 409A of the Code).
(c) Notwithstanding any other provision of the Plan, the Board and the Committee shall administer the Plan, and exercise authority and discretion under the Plan, to satisfy the requirements of Section 409A of the Code or any exemption thereto. Nothing contained herein is intended to provide assurances or an indemnity to any Grantee regarding his or her personal tax treatment.
20. Amendment of the Plan . The Board may from time to time, with respect to any Shares at the time not subject to Grants, suspend or discontinue the Plan or revise or amend it in any respect whatsoever, taking into account applicable laws, regulations, exchange and accounting rules. The Board may otherwise amend the Plan as it shall deem advisable, except that no amendment may materially impair the rights of a Grantee under an award previously granted without the Grantees consent, unless effected to comply with applicable
law or regulation or to meet the requirements of any accounting standard or to correct an administrative error.
21. Application of Funds . The proceeds received by the Company from the sale of Common Stock pursuant to the exercise of an Option, the sale of Restricted Stock or in connection with other Grants under the Plan will be used for general corporate purposes.
22. Tax Withholding . Each Grantee shall, no later than the date as of which the value of any Grant first becomes includable in the gross income of the Grantee for federal income tax purposes, pay to the Company, or make arrangements satisfactory to the Company regarding payment of any federal, state or local taxes of any kind that are required by law to be withheld with respect to such income. To the extent permitted by the Committee from time to time, a Grantee may elect to have such tax withholding satisfied, in whole or in part, by (a) authorizing the Company to withhold a number of Shares to be issued pursuant to a Grant equal to the Fair Market Value as of the date withholding is effected that would satisfy the withholding amount due, (b) transferring to the Company Shares owned by the Grantee with a Fair Market Value equal to the amount of the required withholding tax, or (c) in the case of a Grantee who is an Employee of the Company at the time such withholding is effected, by withholding from the Grantees cash compensation. Notwithstanding anything contained in the Plan to the contrary, the Grantees satisfaction of any tax-withholding requirements imposed by the Committee shall be a condition precedent to the Companys obligation as may otherwise by provided hereunder to provide Shares to the Grantee, and the failure of the Grantee to satisfy such requirements with respect to a Grant shall cause such Grant to be forfeited.
23. Notices . All notices under the Plan shall be in writing, and if to the Company, shall be delivered to the Secretary of the Company or his or her designee or mailed to its principal office, addressed to the attention of the Secretary of the Company or to his or her designee; and if to the Grantee, shall be delivered personally or mailed to the Grantee at the address appearing in the records of the applicable Participating Company. Such addresses may be changed at any time by written notice to the other party given in accordance with this Section 23.
24. Rights to Employment or Other Service . Nothing in the Plan or in any Grant issued pursuant to the Plan shall confer on any individual any right to continue in the employ or other service of any Participating Company (if applicable) or interfere in any way with the right of such Participating Company and its stockholders to terminate the individuals employment or other service at any time.
25. Exculpation and Indemnification . To the maximum extent permitted by law, the Company shall indemnify and hold harmless the members of the Board and the members of the Committee, in each case as constituted from time to time, from and against any and all liabilities, costs and expenses incurred by such persons as a result of any act or omission to act in connection with the performance of such persons duties, responsibilities and obligations under the Plan, other than such liabilities, costs and expenses as may result from the gross negligence, bad faith, willful misconduct or criminal acts of such persons.
26. No Fund Created . Any and all payments hereunder to any Grantee under the Plan shall be made from the general funds of the Company (or, if applicable, a Participating Company), no special or separate fund shall be established or other segregation of assets made to assure such payments, and the Phantom Shares (including for purposes of this
Section 26 any accounts established to facilitate the implementation of Section 10(d)(iii) hereof) and any other similar devices issued hereunder to account for Plan obligations do not constitute Common Stock and shall not be treated as (or as giving rise to) property or as a trust fund of any kind; provided , however , that the Company (or a Participating Company) may establish a mere bookkeeping reserve to meet its obligations hereunder or a trust or other funding vehicle that would not cause the Plan to be deemed to be funded for tax purposes or for purposes of Title I of the Employee Retirement Income Security Act of 1974, as amended. The obligations of the Company (or, if applicable, a Participating Company) under the Plan are unsecured and constitute a mere promise by the Company (or, if applicable, a Participating Company) to make benefit payments in the future and, to the extent that any person acquires a right to receive payments under the Plan from the Company (or, if applicable, a Participating Company), such right shall be no greater than the right of a general unsecured creditor of the Company (or, if applicable, a Participating Company). Without limiting the foregoing, Phantom Shares and any other similar devices issued hereunder to account for Plan obligations are solely a device for the measurement and determination of the amounts to be paid to a Grantee under the Plan, and each Grantees right in the Phantom Shares and any such other devices is limited to the right to receive payment, if any, as may herein be provided.
27. No Fiduciary Relationship . Nothing contained in the Plan (including without limitation Section 10(e)(iii) hereof), and no action taken pursuant to the provisions of the Plan, shall create or shall be construed to create a trust of any kind, or a fiduciary relationship between the Company, the Participating Companies, their respective officers or the Committee, on the one hand, and the Grantee, the Company, the Participating Companies or any other person or entity, on the other.
28. Captions . The use of captions in the Plan is for convenience. The captions are not intended to provide substantive rights.
29. GOVERNING LAW . THE PLAN SHALL BE GOVERNED BY THE LAWS OF MARYLAND, WITHOUT REFERENCE TO PRINCIPLES OF CONFLICT OF LAWS.
30. Regional Variation . The Committee reserves the right to authorize the establishment of, and to grant Awards pursuant to, annexes, sub-plans or other supplementary documentation as the Committee deems appropriate in light of local law, rules and customs.
EXHIBIT A
PERFORMANCE CRITERIA
Performance Based Grants intended to qualify as performance based compensation under Section 162(m) of the Code, may be payable upon the attainment of objective performance goals that are established by the Committee and relate to one or more Performance Criteria (as defined below), in each case on a specified date or over any period, up to 10 years, as determined by the Committee. Performance Criteria may be based on the achievement of the specified levels of performance under one or more of the measures set out below relative to the performance of one or more other corporations or indices.
Performance Criteria means the following business criteria (or any combination thereof) with respect to one or more of the Company, any Participating Company or any division or operating unit thereof:
(i) pre-tax income,
(ii) after-tax income,
(iii) net income (meaning net income as reflected in the Companys financial reports for the applicable period, on an aggregate, diluted and/or per share basis, or economic net income),
(iv) operating income or profit,
(v) cash flow, free cash flow, cash flow return on investment (discounted or otherwise), net cash provided by operations, or cash flow in excess of cost of capital,
(vi) earnings per share (basic or diluted),
(vii) return on equity,
(viii) returns on revenues,
(ix) return on invested capital or assets (gross or net),
(x) cash, funds or earnings available for distribution,
(xi) appreciation in the fair market value of the Common Stock,
(xii) operating expenses,
(xiii) implementation or completion of critical projects or processes,
(xiv) return on investment,
(xv) total return to stockholders (meaning the aggregate Common Stock price appreciation and dividends paid (assuming full reinvestment of dividends) during the applicable period),
(xvi) net earnings growth,
(xvii) stock appreciation (meaning an increase in the price or value of the Common Stock after the date of grant of an award and during the applicable period),
(xviii) related return ratios,
(xix) increase in revenues,
(xx) the Companys published ranking against its peer group of real estate investment trusts based on total stockholder return,
(xxi) net earnings,
(xxii) changes (or the absence of changes) in the per share or aggregate market price of the Companys Common Stock,
(xxiii) number of securities sold,
(xxiv) earnings before or after any one or more of the following items: interest, taxes, depreciation or amortization, as reflected in the Companys financial reports for the applicable period,
(xxv) total revenue growth (meaning the increase in total revenues after the date of grant of an award and during the applicable period, as reflected in the Companys financial reports for the applicable period),
(xxvi) economic value created,
(xxvii) operating margin or profit margin,
(xxviii) Share price or total shareholder return,
(xxix) cost targets, reductions and savings, productivity and efficiencies,
(xxx) strategic business criteria, consisting of one or more objectives based on meeting objectively determinable specified market penetration, geographic business expansion, investor satisfaction, employee satisfaction, human resources management, supervision of litigation, information technology, and goals relating to acquisitions, divestitures, joint ventures and similar transactions, and budget comparisons,
(xxxi) objectively determinable personal professional objectives, including any of the foregoing performance goals, the implementation of policies and plans, the negotiation of transactions, the development of long term business goals, formation of joint ventures, research or development collaborations, and the completion of other corporate transactions, and
(xxxii) any combination of, or a specified increase or improvement in, any of the foregoing.
Where applicable, the Performance Goals may be expressed in terms of attaining a specified level of a particular Performance Criteria or the attainment of a percentage increase or decrease in a particular Performance Criteria, and may be applied to one or more of the
Company, a Subsidiary or affiliate, or a division or strategic business unit of the Company, or may be applied to the performance of the Company relative to a market index, a group of other companies or a combination thereof, all as determined by the Committee.
The Performance Goals may include a threshold level of performance below which no payment shall be made (or no vesting shall occur), levels of performance at which specified payments shall be made (or specified vesting shall occur), and a maximum level of performance above which no additional payment shall be made (or at which full vesting shall occur).
Except as otherwise expressly provided, all financial terms are used as defined under Generally Accepted Accounting Principles ( GAAP ) and all determinations shall be made in accordance with GAAP, as applied by the Company in the preparation of its periodic reports to stockholders.
To the extent permitted by Section 162(m) of the Code, unless the Committee provides otherwise at the time of establishing the performance goals, for each fiscal year of the Company, the Committee shall have the authority to make equitable adjustments to the Performance Goals in recognition of unusual or non-recurring events affecting the Company or any Subsidiary or affiliate or the financial statements of the Company or any Subsidiary or affiliate and may provide for objectively determinable adjustments, as determined in accordance with GAAP, to any of the Performance Criteria described above for one or more of the items of gain, loss, profit or expense: (A) determined to be extraordinary or unusual in nature or infrequent in occurrence, (B) related to the disposal of a segment of a business, (C) related to a change in accounting principle under GAAP or a change in applicable laws or regulations, (D) related to discontinued operations that do not qualify as a segment of a business under GAAP, and (E) attributable to the business operations of any entity acquired by the Company during the fiscal year.
Exhibit 10.17
FORM OF CORPORATE FUND/MANAGED ACCOUNTS IRREVOCABLE EXCHANGE AND SUBSCRIPTION FORM
ZAIS Financial Corp.
Two Bridge Avenue, Suite 322
Red Bank, New Jersey 07701-1106
Dear Sirs:
Reference is made to the Confidential Exchange Offer Statement, dated May 25, 2011 (the Exchange Offer Statement) relating to, among other matters, the offer by ZAIS Financial Corp. (the Company) to stockholders or account holders (collectively, the Existing Holders) of the Corporate Funds or Managed Accounts to exchange (the exchange offer) all of each such Existing Holders shares or separate account holdings in the Corporate Funds or Managed Accounts (collectively, the Interests) for shares of the Companys common stock (the common stock) or operating partnership units (the OP units) in ZAIS Financial Partners, L.P. (the Operating Partnership), a copy of which the undersigned has received and reviewed. Capitalized terms used but not otherwise defined in this Corporate Fund/Managed Accounts Irrevocable Exchange and Subscription Form (the Form) shall have the respective meanings ascribed to them in the Exchange Offer Statement.
The undersigned hereby agrees, confirms and certifies as follows:
1. The undersigned is a holder of Interests in the Corporate Funds or Managed Accounts as described on the attached signature page (the Existing Holders Interests). By executing this Form the undersigned irrevocably elects to exchange a percentage of the Existing Holders Interest shown on the attached signature page (the Designated Interest) for either common stock or OP units as further reflected on the attached signature page.
2. (i) The undersigned understands that if it elects hereunder to exchange such Designated Interests for shares of common stock, the Company will enter into a Contribution Agreement with such Corporate Fund or Managed Account pursuant to which such Corporate Fund or Managed Account will contribute assets to the Company based on the Designated Interests which the undersigned is seeking to exchange and the relative fair market value and adjusted tax basis of such assets and the Company will issue shares of common stock (having a net asset value as of June 30, 2011 or another date selected by the Company upon notice to the undersigned (the Valuation Date) equal to the net asset value of the Designated Interests as of such date) to the Corporate Fund or Managed Account in exchange for such contribution. The undersigned consents to and agrees that in such event the Corporate Fund is authorized to distribute such shares of common stock to the undersigned in redemption of its Designated Interests. The undersigned also understands that the Company will then contribute assets received from the Corporate Funds or Managed Accounts, if any, to the Operating Partnership immediately after receipt of such assets in exchange for OP units.
(ii) The undersigned understands that to the extent that it elects hereunder to exchange such Designated Interests for OP units in the Operating Partnership, the Operating Partnership will enter into a contribution agreement with such Corporate Fund or Managed Account pursuant to which such Corporate Fund or Managed Account will contribute assets to the Operating Partnership based on the Designated Interests which the undersigned is seeking to exchange and the relative fair market value and adjusted tax basis of such assets. The Operating Partnership will issue OP units (having a net asset value as of the Valuation Date equal to the net asset value of the Designated Interests as of such date) to the Corporate Fund or Managed Account in exchange for such contribution. The undersigned consents to and agrees that such Corporate Fund is authorized to distribute such OP units to the undersigned in redemption of its Designated Interests.
(iii) Notwithstanding anything to the contrary in the applicable Corporate Fund or Managed Account materials and/or subscription documents, the undersigned understands and consents that (A) it will be obligated to pay two-thirds of ZAISs incentive fee (or similar incentive compensation) as described in the applicable Corporate Fund or Managed Account materials and/or subscription documents (the Incentive Fee) upon completion of the exchange offer with regard to the undersigneds Designated Interest as if such Designated Interest was the only Interest held by the undersigned in the Corporate Fund or Managed Account from the initial date of investment in the Corporate Fund or Managed Account and (B) the Incentive Fee for the Designated Interest will be calculated as if such Designated Interest were redeemed for cash at a redemption price equal to the net asset value attributable to
such Interest as of the Valuation Date. The undersigned consents to ZAISs calculation of net asset value for this purpose in accordance with ZAISs existing cross trade policy as described in the Exchange Offer Statement. The undersigned further understands that, notwithstanding anything to the contrary in the applicable Corporate Fund or Managed Account materials and/or subscription documents, for the purpose of calculating the Incentive Fee for the Designated Interest, a percentage (equal to the Designated Interest percentage shown on the attached signature page) of any prior distributions made by any Corporate Fund or Managed Account in respect of the undersigneds Interest, will be deemed to have been paid in respect of the Designated Interest.
(iv) Notwithstanding anything to the contrary in the applicable Corporate Fund or Managed Account materials and/or subscription documents, the undersigned understands that with respect to any Interest remaining in a Corporate Fund or Managed Account (the Retained Interest), any Incentive Fees due with respect to such Retained Interest will be calculated over the life of such Corporate Fund or Managed Account on a standalone basis for such Retained Interest as if such Retained Interest had been a separate investment held by the undersigned in the Corporate Fund or Managed Account from the initial date of investment in the Corporate Fund or Managed Account.
(v) The undersigned further understands that, notwithstanding anything to the contrary in the applicable Corporate Fund or Managed Account materials and/or subscription documents, for the purpose of calculating the Incentive Fee for the Retained Interest, a percentage (equal to one (1) minus the Designated Interest percentage shown on the attached signature page) of any prior distributions made by any Corporate Fund or Managed Account in respect of the undersigneds Interest, will be deemed to have been paid in respect of the Retained Interest.
(vi) The undersigned hereby consents to all of the above transactions and all such transactions that may be required to implement the exchange offer, including any amendments to existing Fund materials and/or subscription documents that ZAIS determines are reasonably necessary to effectuate above transactions and the exchange offer.
3. The undersigned, to enable the Company to make offers and sales of the Shares and OP units pursuant to Rule 144A under the Securities Act of 1933 (the Securities Act), hereby certifies that:
The undersigned is a qualified institutional buyer under Rule 144A (QIB) in that the undersigned satisfies the requirement of one or more of sub-paragraphs (i) through (vi) hereof (check applicable box(es)):
o (i) The undersigned is an entity referred to in sub-paragraphs (A) through (G) hereof and in the aggregate owned and invested on a discretionary basis, for its own account and the accounts of other QIBs, at least $100 million in securities of issuers that are not affiliated with the Company (Unaffiliated Securities), calculated as provided in Rule 144A as of the date specified on the signature page hereto.
o (A) Corporation, etc. A corporation (other than a bank, savings and loan or similar institution referred to in (ii) below), partnership, Massachusetts or similar business trust, limited liability company, an organization described in Section 501(c)(3) of the Internal Revenue Code of 1986 (the Code), a small business investment company licensed by the U.S. Small Business Administration under Section 301(c) or (d) of the Small Business Investment Act of 1958 or a business development company as defined in Section 202(a)(22) of the Investment Advisers Act of 1940 (the Advisers Act).
o (B) Insurance Company. An insurance company as defined in Section 2(13) of the Securities Act.
o (C) ERISA Plan. An employee benefits plan within the meaning of Title I of the Employee Retirement Income Security Act of 1974 (ERISA).
o (D) State or Local Plan. A plan established and maintained by a state, its political subdivisions, or any agency or instrumentality of a state or its political subdivisions, for the benefit of its employees.
q (E) Investment Company. An investment company registered under the Investment Company Act of 1940 (the Investment Company Act) or any business development company as defined in Section 2(a)(48) of the Investment Company Act.
q (F) Investment Adviser. An investment adviser registered under the Advisers Act.
q (G) Trust Fund. A trust fund whose trustee is a bank or trust company and whose participants are exclusively plans of the types identified in paragraphs (i)(C) and (i)(D) above, except trust funds that include as participants individual retirement accounts or H.R. 10 plans.
o (ii) Bank or Savings and Loan. The undersigned is a bank as defined in Section 3(a)(2) of the Securities Act; a savings and loan association or other institution referenced in Section 3(a)(5)(A) of the Securities Act; or a foreign bank or savings and loan association or equivalent institution, acting for its own account and the accounts of other QIBs, that in the aggregate owned and invested on a discretionary basis at least $100 million of Unaffiliated Securities, calculated as provided in Rule 144A, as of the date specified on the signature page hereto, and that had an audited net worth of at least $25 million as of the end of its most recent fiscal year. (This paragraph does not include bank commingled funds.)
o (iii) One of a Family of Investment Companies. The undersigned is an investment company registered under the Investment Company Act, acting for its own account or for the accounts of other QIBs, that is part of a family of investment companies, as defined in Rule 144A, that owned in the aggregate at least $100 million of Unaffiliated Securities, calculated as provided in Rule 144A, as of the date specified on the signature page hereto.
o (iv) Dealer. The undersigned is a dealer registered under Section 15 of the Securities Exchange Act of 1934 (the Exchange Act), acting for its own account and the accounts of other QIBs, that in the aggregate owned and invested on a discretionary basis at least $10 million of Unaffiliated Securities, calculated as provided in Rule 144A, as of the date specified on the signature page hereto.
o (v) Dealer. (Riskless Principal Transaction). The undersigned is a dealer registered under Section 15 of the Exchange Act acting in a riskless principal transaction (as defined in Rule 144A) on behalf of a QIB.
o (vi) Entity Owned by Qualified Buyers. The undersigned is an entity, all of the equity owners of which are QIBs (each satisfying one or more of (i) through (v) above or this clause (vi), including, as applicable, the $100 million test), acting for its own account or for the accounts of other QIBs.
For purposes of paragraphs (i) through (vi) of paragraph 3 above, the amount of Unaffiliated Securities owned and invested, and related information, is as follows:
Amount of Unaffiliated Securities:
(State specific amount owned/investedmay be approximate, but not range or minimum)
Most Recent Fiscal Year End:
Date Owned/Invested:
(Complete only if this date is after most recent fiscal year end)
In calculating the aggregate amount of securities owned or invested on a discretionary basis by an entity, as provided in Rule 144A: (a) repurchase agreements, securities owned but subject to repurchase agreements, currency, interest rate and commodity swaps, bank deposit notes and certificates of deposit, loan participation, securities of affiliates and dealers unsold allotments are excluded; and (b) securities are valued at cost, except they may be valued at market if they are reported in financial statements at market and no current cost information is published.
Each entity, including a parent or subsidiary, must separately meet the requirements to be a QIB under Rule 144A. Shares or OP units owned by any subsidiary are included as owned or invested by its parent entity for purposes of Rule 144A only if (1) the subsidiary is consolidated in the parent entitys financial statements prepared in accordance with generally accepted accounting principles and (2) the subsidiarys investments are managed under the parent entitys direction (except that a subsidiarys securities are not included if the parent entity is itself a majority-owned consolidated subsidiary of another enterprise and is not a reporting company under the Exchange Act).
4. The undersigned (check all boxes that are applicable):
o is an accredited investor within the meaning of Rule 501(a) under the Securities Act (an Accredited Investor) in that the undersigned satisfies the requirements of one or more of sub-paragraphs (A) through (C) below (check applicable box(es)):
o (A) is an organization described in Section 501(c)(3) of the Internal Revenue Code of 1986 (the Code), a corporation, a business trust, or a partnership, not formed for the specific purpose of acquiring Shares or OP units, with total assets in excess of $5,000,000,
o (B) is a trust with total assets in excess of $5,000,000, that was not formed for the specific purpose of purchasing Shares or OP units and whose purchase is directed by a person who has such knowledge and experience in financial and business matters that he is capable of evaluating the merits and risks of investing in the Company, or
o (C) is an entity in which all of the equity owners are entities described in (A) or (B) above or this sub-paragraph (C).
5. The undersigned has such knowledge and experience in financial and business matters as to be capable of evaluating the merits and risks of an investment in the common stock or OP units, and each of the undersigned is able to bear the economic risk of such investment and can afford the complete loss of such investment. The undersigned is aware that there are substantial risks incident to the exchange offer, including those summarized under Risk Factors in the Exchange Offer Statement.
6. The undersigned represents and warrants that (a) the undersigned is participating in the exchange offer on its own account (and not for the account of others) for investment purposes and not with a view to, or for offer or sale in connection with, any distribution in violation of the Securities Act of 1933 (the Securities Act), (b) the undersigned was not formed for the specific purpose of participating in the exchange offer, (c) the undersigned understands that there is no established market for the common stock or OP units, that a public market for the common stock may not develop, that a public market for the OP units will not develop and that no U.S. federal or state agency has passed upon the common stock or OP units or the Exchange Offer Statement, or made any findings or determination as to the fairness of an investment in the common stock or OP units, and (d) the undersigned is aware of the restrictions relating to ownership and transfer contained in the Companys charter, the Operating Partnerships partnership agreement and the registration rights agreement relating to the common stock and OP units. The undersigned acknowledges and agrees that the Company did not make any representations, declarations or warranties to the undersigned regarding the common stock or OP units, the Company or the Companys offering of the common stock or OP units.
7. The undersigned (check applicable box):
o is:
o is not and, for so long as it owns the common stock or OP units, will not be:
acting on behalf of or using the plan assets of (i) an employee benefit plan (as defined in Section 3(3) of the Employee Retirement Income Security Act of 1974 (ERISA)), whether or not it is subject to Title I of ERISA (for example, a pension plan, profit sharing plan, 401(k) plan or other plan subject to ERISA, or any employee benefit plan that is exempt from ERISA because, e.g., it is maintained by a governmental employer or is a church or a
foreign plan), (ii) a plan described in Section 4975 of the Internal Revenue Code of 1986 (the Code) (for example a qualified plan, a qualified annuity plan, an individual retirement account or arrangement, an Archer MSA, a health savings account or a Coverdell Education Savings Account), (iii) an entity whose underlying assets include plan assets of a plan described in clause (i) or (ii) by reason of such plans investment in such entity (including an insurance company general account), or (iv) an entity that otherwise constitutes a benefit plan investor within the meaning of the DOL Regulation Section 2510.3-101 (29 C.F.R. Sections 2510.3-101) (for example a fund, and the assets of that fund, are deemed to be plan assets under DOL Regulation Section 2510.3-101, 29 C.F.R. Section 2510.3-101, by application of the look through rule under the regulation) (each, a Covered Plan).
If the undersigned checked the first box above, the undersigned represents, warrants and agrees that its acquisition and holding of the common stock or OP units (i) will not constitute or result in a non-exempt prohibited transaction under Section 406 of ERISA or Section 4975 of the Code or a violation of any applicable other U.S. federal, state, local, non-U.S. or other laws or regulations that contain one or more provisions that are similar to the provisions of Section 406 of ERISA or Section 4975 of the Code, and (ii) is prudent and complies with the fiduciary standards under Title I of ERISA for investments by the undersigned.
8. The undersigned (check applicable box):
o is:
o is not and, for so long as it owns the common stock or OP units, will not be:
a person (other than a Covered Plan) who has discretionary authority or control with respect to the assets of the Company or a person who provides investment advice for a fee (direct or indirect) with respect to such assets or an affiliate of such person (within the meaning of DOL Regulation Section 2510.3-101, 29 C.F.R. Section 2510.3-101, a Controlling Person).
9. The undersigned represents, warrants and agrees that it will not transfer or assign its interest in the common stock or OP units to any transferee (including any change in the source of funds that is a result of a transfer to an affiliate or a different account) unless such transferee represents, warrants and agrees that (i) the transferee is not (and will not be), and is not acting on behalf of a person who is (or will be), a Covered Plan or a Controlling Person and (ii) such transferee will make the representations and agreement set forth above as the transferor (including, without limitation, clauses (i) and (ii)).
10. For holders of Managed Accounts electing to receive common stock only: the undersigned represents 100% of the Designated Interests are being exchanged on behalf of persons that are not C corporations, as defined in United States Treasury Regulation section 1.337(d)-7(a)(2)(i), and that are not entities treated as partnerships or disregarded entities for U.S. federal income tax purposes that are owned, directly or indirectly, in whole or in part, by one or more C corporations. Holders of Managed Accounts that are unable to represent to the preceding sentence and that desire to receive common stock in the Exchange Offer should contact the Company regarding additional representations that are required.
11. The undersigned has received a copy of the Confidential Exchange Offer Statement, dated May 25, 2011 (the Exchange Offer Statement), and the undersigned understands and agrees that the Exchange Offer Statement speaks only as of its date and that the information contained in the Exchange Offer Statement may not be correct or complete as of any time subsequent to that date.
12. The undersigned, on the undersigneds own behalf and on behalf of each Account, if any, understands that the Shares or OP units were sold in a transaction not involving any public offering within the United States within the meaning of the Securities Act and the Shares or OP units have not been registered under the Securities Act or the securities laws of any jurisdiction and, unless so registered, may not be sold except as permitted in the following sentence. The undersigned, on the undersigneds own behalf and on behalf of each Account, if any, agrees that, if in the future the undersigned or any Account decides to offer, resell, pledge or otherwise transfer such Shares or OP units prior to the time such Shares or OP units would no longer be deemed to be restricted securities for purposes of the Securities Act (the Resale Restriction Termination Date), such common stock or OP units may be offered, resold, pledged or otherwise transferred only (a) to the Company or a subsidiary thereof, (b) pursuant to a registration statement that has been declared effective under the Securities Act, (c) for so long as the Shares or OP units are eligible for resale pursuant to Rule 144A, in a transaction complying with the requirements of Rule 144A
to a person or entity who the undersigned or such Account reasonably believes is a QIB that purchases for its own account or for the account of a QIB and to whom notice is given that the offer, resale, pledge or transfer is being made in reliance on Rule 144A, (d) pursuant to offers and sales to non-U.S. persons(l) that occur outside the United States in accordance with and within the meaning of Regulation S under the Securities Act or (e) pursuant to any other available exemption from the registration requirements of the Securities Act, subject in each of the foregoing cases to any requirement of law that the disposition of the undersigneds property or the property of any such Account be at all times within the undersigneds or such Accounts control and subject to compliance with any applicable securities laws of any jurisdiction. Subject to compliance with all applicable laws, the foregoing restrictions on resale will not apply subsequent to the Resale Restriction Termination Date. The undersigned, on the undersigneds own behalf and on behalf of each Account, if any, acknowledges and agrees that in order for any resale or other transfer of the Shares or OP units proposed to be made pursuant to clauses (c), (d) or (e) above to be valid, the transferor must deliver to the Company and to the transfer agent of the Shares or OP units, as applicable, a completed and duly executed letter from the transferee substantially in the form of Annex I to the Exchange Offer Statement. The undersigned, on the undersigneds own behalf and on behalf of each Account, if any, understands that the transfer agent for the Shares or OP units, as applicable, will not be required to accept for registration of transfer any Shares or OP units, as applicable, acquired by the undersigned or any Account, except upon presentation of evidence satisfactory to the Company and the transfer agent that an exemption to the registration requirement under the Securities Act and the rules and regulations thereunder have been complied with. The undersigned, on the undersigneds own behalf and on behalf of each Account, if any, further understands that any certificates, if any, representing Shares or OP units acquired by the undersigned or any Account will bear a legend reflecting the substance of this paragraph. The undersigned, on the undersigneds own behalf and on behalf of each Account, if any, acknowledges that the Company reserves the right to restrict any offer, sale or other transfer of the Shares or OP units (i) pursuant to clauses (c), (d) or (e) above prior to the Resale Restriction Termination Date or (ii) prior to the end of the one-year restricted period within the meaning of Rule 903(b)(3) of Regulation S under the Securities Act, and to require the completion, execution and delivery of certifications and other information satisfactory to the Company and the transfer agent, if applicable, and an opinion of counsel approved by the Company and the transfer agent, if applicable, to ensure compliance with the Securities Act and the rules and regulations thereunder. The undersigned, on the undersigneds own behalf and on behalf of each Account, if any, agrees to notify any transferee of the Shares or OP units of the restrictions on resale set forth herein and in the section of the Exchange Offer Statement entitled Notice to InvestorsTransfer Restrictions.
13. The undersigned hereby makes the representations, warranties, covenants and agreements deemed to have been made by each investor under the sections of the Exchange Offer Statement relating to the Shares entitled Notice to Investors, Description of Capital Stock, The Operating Partnership Agreement and Registration Rights, and agrees to be bound by the restrictions set forth in each such section.
14. The undersigned has received such information as the undersigned deems necessary in order to make an investment decision with respect to the common stock or OP units. The undersigned acknowledges that the undersigned and its professional advisor(s), if any, have the right to ask questions of and receive answers from the Company and its officers and directors, and to obtain such information concerning the terms and conditions of the offering of the common stock or OP units to the extent that the Company possesses the same or could acquire it without unreasonable effort or expense, as the undersigned and any professional advisor(s), if any, deem necessary to verify the accuracy of (1) the information referred to in the Exchange Offer Statement pursuant to which the common stock or OP units are being offered and (2) of any other information that the undersigned and any professional advisor(s), if any, deem relevant to making an investment decision with respect to the common stock or OP units. The undersigned represents and agrees that prior to the undersigneds agreement to purchase the common stock or OP units the undersigned and its professional advisor(s), if any, have asked such questions, received such answers and obtained such information as the undersigned and any professional advisor(s), if any, deem necessary to verify the accuracy (1) of the information referred to in the Exchange Offer Statement and (2) of any other information that the undersigned and any professional advisor(s), if any, deem relevant to making an investment decision with respect to the common stock or OP units.
15. In making the decision to exchange the Designated Interests, the undersigned has relied solely upon the Exchange Offer Statement and independent investigation made by the undersigned. The undersigned
(1) In order to qualify as a non-U.S. person under Regulation S, the proposed transferee must (a) have his, her or its principal address outside the United States, (b) be located outside the United States at the time any offer to buy the Shares was made to the proposed transferee and at the time that the buy order was originated by the proposed transferee, and (c) not be a U.S. person (as defined in Rule 902(k) under the Securities Act).
became aware of the exchange offer and the common stock or OP units were offered to the undersigned solely by means of the Exchange Offer Statement and by direct contact between the undersigned and the Company. The undersigned did not become aware of exchange offer, nor were the common stock or OP units offered to the undersigned by any other means, including, in each case, by any form of general solicitation or general advertising. The undersigned understands and agrees that the common stock or OP units offered pursuant to the Exchange Offer Statement are not being offered in a manner involving a public offering under, or in a distribution in violation of, the Securities Act, or any state securities laws.
16. The undersigned is aware that there are substantial risks incident to the exchange offer, including those summarized under Risk Factors in the Exchange Offer Statement.
17. Alone, or together with any professional advisor(s), the undersigned has adequately analyzed the risks of the exchange offer and determined that the common stock or OP units are a suitable investment for the undersigned. The undersigned has such knowledge in financial and business matters as to be capable of evaluating the merits and risks of an investment in the common stock or OP units, and the undersigned has sought such accounting, legal and tax advice as the undersigned has considered necessary to make an informed investment decision, and the undersigned and any account for which the undersigned is acting is able to bear the economic risk of such investment and can afford a complete loss of such investment.
18. The execution, delivery and performance by the undersigned of this Form is within the powers of the undersigned, have been duly authorized and will not constitute or result in a breach or default under or conflict with any order, ruling or regulation of any court or other tribunal or of any governmental commission or agency, or any agreement or other undertaking, to which the undersigned is bound, and, if the undersigned is not an individual, will not violate any provisions of the undersigneds charter documents, including, without limitation, its incorporation or formation papers, bylaws, indenture of trust or partnership or operating agreement, as may be applicable. The signature on this Form is genuine, and the signatory, if the undersigned is an individual, has legal competence and capacity to execute the same, or, if the undersigned is not an individual, the signatory has been duly authorized to execute the same, and this Form constitutes a legal, valid and binding obligation of the undersigned, enforceable in accordance with its terms.
19. The undersigned (if a natural person), is at least 21 years of age and the undersigned and has adequate means of providing for all his or her current and foreseeable needs and personal contingencies and has no need for liquidity in this investment, and if the undersigned is an unincorporated association, all of its members who are U.S. persons within the meaning of Regulation S under the Securities Act are at least 21 years of age.
20. The undersigned (check applicable box):
o is:
o is not:
an affiliate (as defined in Rule 144 under the Securities Act) of the Company or acting on behalf of an affiliate of the Company.
21. The undersigned represents and warrants that no person or entity controlling, controlled by or under common control with the undersigned, nor any person or entity having a beneficial interest in the undersigned, nor any other person or entity on whose behalf the undersigned is acting: (i) is a person or entity listed in the annex to Executive Order No. 13224 (2001) issued by the President of the United States (Executive Order Blocking Property and Prohibiting Transactions with Persons Who Commit, Threaten to Commit, or Support Terrorism); (ii) is named on the List of Specially Designated Nationals and Blocked Persons maintained by the U.S. Office of Foreign Assets Control (OFAC); (iii) is a non-U.S. shell bank or is providing banking services indirectly to a non-U.S. shell bank; (iv) is a senior non-U.S. political figure or an immediate family member or close associate of such figure; or (v) is otherwise prohibited from investing in the Company pursuant to applicable U.S. anti-money laundering, antiterrorist and asset control laws, regulations, rules or orders (categories (i) through (v) collectively, a Prohibited Investor). The undersigned agrees to provide the Company, promptly upon request, all information that the Company reasonably deems necessary or appropriate to comply with applicable U.S. anti-money laundering, antiterrorist and asset control laws, regulations, rules and orders. The undersigned consents to the disclosure to U.S. regulators and law enforcement authorities by the Company and its affiliates and agents of such information about
the undersigned as the Company reasonably deems necessary or appropriate to comply with applicable U.S. anti-money laundering, antiterrorist and asset control laws, regulations, rules and orders. If the undersigned is a financial institution that is subject to the PATRIOT Act, Public Law No. 107-56 (Oct. 26, 2001) (the Patriot Act), the undersigned represents that the undersigned has met all of the undersigneds obligations under the Patriot Act. The undersigned acknowledges that if, following the investment in the Company by the undersigned, the Company reasonably believes that the undersigned is a Prohibited Investor or is otherwise engaged in suspicious activity or refuses to provide promptly information that the Company requests, the Company has the right or may be obligated to prohibit additional investments, segregate the assets constituting the investment in accordance with applicable regulations or immediately require the undersigned to transfer the common stock or OP units. The undersigned further acknowledges that the undersigned will have no claim against the Company or any of its affiliates or agents for any form of damages as a result of any of the foregoing actions.
22. Effective as of the date that this Form is executed, the undersigned hereby irrevocably (i) appoints ZAIS Group, LLC (for purposes of this Section 20, the Agent) as the undersigneds attorney-in-fact and proxy of the undersigned, with full power of substitution, to execute the registration rights agreement, the partnership agreement of ZAIS Financial Partners, L.P. and all or any other instruments of transfer and/or other documents in the Agents discretion in relation to the Shares, OP units, Designated Interests, and the exchange offer and to do all such other acts and things as may in the opinion of the Agent be necessary or expedient for the purpose of, or in connection with, the undersigneds participation in the exchange offer. The foregoing proxy and power may be exercised by the Agent or its designees acting alone.
23. The undersigned agrees to indemnify and hold harmless the Company, its respective directors, executive officers and each other person, if any, who controls or is controlled by the Company, within the meaning of Section 15 of the Securities Act or Section 20 of the Securities Exchange Act of 1934, from and against any and all loss, liability, claim, damage and expense whatsoever (including, without limitation, any and all expenses whatsoever reasonably incurred in investigating, preparing or defending against any litigation commenced or threatened or any claim whatsoever) arising out of or based upon (a) any false, misleading or incomplete representation, declaration or warranty or breach or failure by the undersigned to comply with any covenant or agreement made by the undersigned in this Form or in any other document furnished by the undersigned to any of the foregoing in connection with this transaction or (b) any action for securities law violations by the undersigned.
24. Neither this Form nor any rights that may accrue to the undersigned hereunder may be transferred or assigned.
25. The undersigned is aware and agrees that the Company did not make any representations, declarations or warranties to the undersigned regarding the Company the exchange offer.
26. The undersigned, on the undersigneds own behalf and on behalf of each Account, if any, acknowledges and agrees that the Company may, in its sole discretion, require the undersigned, on the undersigneds own behalf and on behalf of each Account, if any, to redeem all or any of the Shares or OP units on not less than ten days prior notice.
27. If the undersigned is a U.S. person for U.S. federal income tax purposes, the undersigned has completed, signed, dated and returned to the Company an Internal Revenue Service (IRS) Form W-9 Request for Taxpayer Identification Number and Certification in accordance with the instructions accompanying such form. If the undersigned is not a U.S. person for U.S. federal income tax purposes, the undersigned has completed, signed, dated and returned to the Company an (i) IRS Form W-8BEN Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding, (ii) IRS Form W-8ECI Certificate of Foreign Persons Claim for Exemption from Withholding on Income Effectively Connected With the Conduct of a Trade or Business in the United States, (iii) IRS Form W-8EXP Certificate of Foreign Government or Other Foreign Organization for United States Tax Withholding or (iv) IRS Form W-8IMY Certificate of Foreign Intermediary, Foreign Partnership, or Certain U.S. Branches for United States Tax Withholding, as applicable, in accordance with the instructions accompanying the appropriate IRS Form.
28. If the undersigned will receive OP units in the Exchange Offer, either (i) the undersigned is not a partnership, grantor trust or S corporation for U.S. federal income tax purposes (a flow-through entity); or (ii) the undersigned is such a flow-through entity and either: (A) more than 50% of the value of the undersigned is, and at all times will be, attributable to property other than the OP units; or (B) the undersigned was not formed for the
principal purpose or as one of its principal purposes to permit the Operating Partnership to satisfy the 100 partner limitation of U.S. Treasury Regulation Section 1.7704-1(h)(1)(ii).
29. The undersigned agrees to provide, and periodically update, at any time requested by the Company or the Operating Partnership, any information the Company or the Operating Partnership deem necessary to comply with any requirement imposed by Internal Revenue Code Sections 1471 1474 and the Treasury Regulations and other guidance issued thereunder, and take any other actions required by such provisions, in order to reduce or eliminate withholding taxes. The undersigned Subscriber agrees to promptly notify the Company and the Operating Partnership, as applicable, of any changes in the information described above. The undersigned acknowledges that if it fails to comply with the above requirements on a timely basis, it may be subject to a 30% U.S. federal withholding tax on (1) U.S. source dividends, interest and certain other income and (2) gross proceeds from the sale or other disposition of U.S. stocks, debt instruments and certain other assets.
30. The Company may request from the undersigned such additional information as the Company may deem necessary to evaluate the eligibility of the undersigned to participate in the exchange offer, and may request from time to time such information as the Company may deem necessary to determine the eligibility of the undersigned to hold the common stock or OP units or to enable the Company to determine the Companys compliance with applicable regulatory requirements or tax status, and the undersigned shall provide such information as may reasonably be requested.
31. The undersigned acknowledges that the Company and others will rely on the certifications, acknowledgments, understandings, agreements, representations and warranties contained in this Form. The undersigned agrees to promptly notify the Company of any change in the certifications, acknowledgments, understandings, agreements, representations and warranties set forth herein. The undersigned agrees that each purchase by the undersigned of securities of the Company from or through the Company will constitute a reaffirmation of the acknowledgments, understandings, agreements, representations and warranties herein (as modified by any such notice) by the undersigned as of the time of such purchase.
32. The Company is entitled to rely upon this Form and is irrevocably authorized to produce this Form or a copy hereof to any interested party in any administrative or legal proceeding or official inquiry with respect to the matters covered hereby.
33. If any provision of this Form is invalid or unenforceable under any applicable law, then such provision shall be deemed inoperative to the extent that it may conflict therewith. Any provision hereof which may be held invalid or unenforceable under any applicable law shall not affect the validity or enforceability of any other provision hereof, and to this extent the provisions hereof, shall be severable.
34. This Form shall be binding upon the undersigned and the heirs, personal representatives, successors and assigns of the undersigned.
THIS FORM SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF DELAWARE, WITHOUT REGARD TO THE PRINCIPLES OF CONFLICTS OF LAWS THAT WOULD OTHERWISE REQUIRE THE APPLICATION OF THE LAW OF ANY OTHER STATE.
PLEASE CONFIRM THAT YOU HAVE COMPLETED RESPONSES TO QUESTIONS 3, 4, 7, 8 AND 20.
o YES o NO
IRREVOCABLE EXCHANGE AND SUBSCRIPTION AGREEMENT
COUNTERPART SIGNATURE PAGE
(This signature page must be signed in duplicate by the Existing Holder)
The undersigned Existing Holder, desiring to participate in the exchange offer hereby agrees to all of the terms and provisions of this Form and agrees that such Existing Holder is bound by all such terms and provisions.
Please sign your name below exactly in the same manner as the name(s) in which ownership of the Existing Holders Interest is registered. When the Existing Holders Interest is held by two or more joint holders, all such holders must sign. When signing as attorney-in-fact, executor, administrator, trustee or guardian, please give full title as such. If a corporation, please sign in full corporate name by the President or other authorized officer. If a partnership or limited liability company, please sign in partnership or limited liability company name by an authorized person.
The Existing Holder has executed this Form as of this day of , 2011.
EXISTING HOLDER:
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Original contributed capital $ . (Please insert the original contributed capital)
Existing Holders Interests currently held in the Corporate Funds or Managed Accounts $ . (Please insert the existing Interests held in the Corporate Funds or Managed Accounts)
Distributions received $ since the initial date of investment in the Corporate Fund or Managed Account. (Please insert the distributions received to date)
Designated Interests % . (Please insert the percentage of your existing Interests that you wish to exchange)
I would like to receive (check applicable box):
o common stock
o OP units
in exchange for my Designated Interests.
* With respect to an Existing Holder who is a natural person, please provide the address of your residence. With respect to an Existing Holder which is an entity, please provide the address of your place of business (or, if there is more than one place of business, the chief executive office). With respect to each natural person who is the trustee of an Existing Holder that is a trust, please provide the address of your residence and place of business (or, if there is more than one place of business, the chief executive office). With respect to the Existing Holder that is a trust with an Entity trustee, please provide the information requested of an Entity.
SECOND COPY
IRREVOCABLE EXCHANGE AND SUBSCRIPTION AGREEMENT
COUNTERPART SIGNATURE PAGE
(This signature page must be signed in duplicate by the Existing Holder)
The undersigned Existing Holder, desiring to participate in the exchange offer hereby agrees to all of the terms and provisions of this Form and agrees that such Existing Holder is bound by all such terms and provisions.
Please sign your name below exactly in the same manner as the name(s) in which ownership of the Existing Holders Interest is registered. When the Existing Holders Interest is held by two or more joint holders, all such holders must sign. When signing as attorney-in-fact, executor, administrator, trustee or guardian, please give full title as such. If a corporation, please sign in full corporate name by the President or other authorized officer. If a partnership or limited liability company, please sign in partnership or limited liability company name by an authorized person.
The Existing Holder has executed this Form as of this day of , 2011.
EXISTING HOLDER:
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Original contributed capital $ . (Please insert the original contributed capital)
Existing Holders Interests currently held in the Corporate Funds or Managed Accounts $ . (Please insert the existing Interests held in the Corporate Funds or Managed Accounts)
Distributions received $ since the initial date of investment in the Corporate Fund or Managed Account. (Please insert the distributions received to date)
Designated Interests %. (Please insert the percentage of your existing Interests that you wish to exchange)
I would like to receive (check applicable box):
o common stock
o OP units
in exchange for my Designated Interests.
* With respect to an Existing Holder who is a natural person, please provide the address of your residence. With respect to an Existing Holder which is an entity, please provide the address of your place of business (or, if there is more than one place of business, the chief executive office). With respect to each natural person who is the trustee of an Existing Holder that is a trust, please provide the address of your residence and place of business (or, if there is more than one place of business, the chief executive office). With respect to the Existing Holder that is a trust with an Entity trustee, please provide the information requested of an Entity.
Agreed and Accepted as of this day of , 2011.
ZAIS Financial Corp.,
a Maryland corporation
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FORM OF PARTNERSHIP FUND IRREVOCABLE EXCHANGE AND SUBSCRIPTION FORM
ZAIS Financial Corp.
Two Bridge Avenue, Suite 322
Red Bank, New Jersey 07701-1106
Dear Sirs:
Reference is made to the Confidential Exchange Offer Statement, dated May 25, 2011 (the Exchange Offer Statement) relating to, among other matters, the offer by ZAIS Financial Corp. (the Company) to stockholders or account holders (collectively, the Existing Holders) of the Partnership Funds to exchange (the exchange offer) all of each such Existing Holders limited partnership interests in the Partnership Funds (collectively, the Interests) for shares of the Companys common stock (the common stock) or operating partnership units (the OP units) in ZAIS Financial Partners, L.P. (the Operating Partnership), a copy of which the undersigned has received and reviewed. Capitalized terms used but not otherwise defined in this Corporate Fund/Managed Accounts Irrevocable Exchange and Subscription Form (the Form) shall have the respective meanings ascribed to them in the Exchange Offer Statement.
The undersigned hereby agrees, confirms and certifies as follows:
1. The undersigned is a holder of Interests in the Partnership Funds as set forth on the attached signature page (the Existing Holders Interests). By executing this Form the Existing Holder irrevocably elects to exchange a percentage of the Existing Holders Interest shown on the attached signature page (the Designated Interest) for either common stock or OP units as further reflected on such signature page.
2. (i) The undersigned understands that the Partnership Funds will contribute assets only to the Operating Partnership and if the undersigned elects hereunder to exchange such Designated Interests for OP units in the Operating Partnership or shares of common stock, the Operating Partnership will enter into a Contribution Agreement with such Partnership Fund pursuant to which such Partnership Fund will contribute assets to the Operating Partnership based on the Designated Interests which the undersigned is seeking to exchange and the relative fair market value and adjusted tax basis of such assets and the Operating Partnership will issue OP units (having a net asset value as of June 30, 2011 or another date selected by the Company upon notice to the undersigned (the Valuation Date) equal to the net asset value of the Designated Interests as of such date) to the Partnership Fund in exchange for such contribution. The undersigned consents to and agrees that in such event the Partnership Fund is authorized to distribute such OP units to the undersigned in redemption of its Designated Interests. If the undersigned has elected to receive shares of common stock, the undersigned will, by virtue of making such election, have consented to the contribution of such OP units to the Company in exchange for shares of common stock following the receipt of OP units from the Operating Partnership as part of the exchange offer.
(ii) Notwithstanding anything to the contrary in the applicable Partnership Fund materials and/or subscription documents, the undersigned understands and consents that (A) it will be obligated to pay two-thirds of ZAISs incentive fee (or similar incentive compensation) as described in the applicable Partnership Fund materials and/or subscription documents (the Incentive Fee) upon completion of the exchange offer with regard to the undersigneds Designated Interest as if such Designated Interest was the only Interest held by the undersigned in the Partnership Fund from the initial date of investment in the Partnership Fund and (B) the Incentive Fee for the Designated Interest will be calculated as if such Designated Interest were redeemed for cash at a redemption price equal to the net asset value attributable to such Interest as of the Valuation Date. The undersigned consents to ZAISs calculation of net asset value for this purpose in accordance with ZAISs existing cross trade policy as described in the Exchange Offer Statement. The undersigned further understands that, notwithstanding anything to the contrary in the applicable Partnership Fund materials and/or subscription documents, for the purpose of calculating the Incentive Fee for the Designated Interest, a percentage (equal to the Designated Interest percentage shown on the attached signature page) of any prior distributions made by any Partnership Fund in respect of the undersigneds Interest, will be deemed to have been paid in respect of the Designated Interest.
(iii) Notwithstanding anything to the contrary in the applicable Partnership Fund materials and/or subscription documents, the undersigned understands that with respect to any Interest remaining in a Partnership Fund (the Retained Interest), any Incentive Fees due with respect to such Retained Interest will be calculated over the life of such Partnership Fund on a standalone basis for such Retained Interest as if such Retained Interest had
been a separate investment held by the undersigned in the Partnership Fund from the initial date of investment in the Partnership Fund.
(iv) The undersigned further understands that, notwithstanding anything to the contrary in the applicable Partnership Fund materials and/or subscription documents, for the purpose of calculating the Incentive Fee for the Retained Interest, a percentage (equal to one (1) minus the Designated Interest percentage shown on the attached signature page) of any prior distributions made by any Partnership Fund in respect of the undersigneds Interest, will be deemed to have been paid in respect of the Retained Interest.
(v) The undersigned hereby consents to all of the above transactions and all such transactions that may be required to implement the exchange offer, including any amendments to existing Fund materials and/or subscription documents that ZAIS determines are reasonably necessary to effectuate above transactions and the exchange offer.
3. The undersigned, to enable the Company to make offers and sales of the Shares and OP units pursuant to Rule 144A under the Securities Act of 1933 (the Securities Act), hereby certifies that:
The undersigned is a qualified institutional buyer under Rule 144A (QIB) in that the undersigned satisfies the requirement of one or more of sub-paragraphs (i) through (vi) hereof (check applicable box(es)):
o (i) The undersigned is an entity referred to in sub-paragraphs (A) through (G) hereof and in the aggregate owned and invested on a discretionary basis, for its own account and the accounts of other QIBs, at least $100 million in securities of issuers that are not affiliated with the Company (Unaffiliated Securities), calculated as provided in Rule 144A as of the date specified on the signature page hereto.
o (A) Corporation, etc. A corporation (other than a bank, savings and loan or similar institution referred to in (ii) below), partnership, Massachusetts or similar business trust, limited liability company, an organization described in Section 501(c)(3) of the Internal Revenue Code of 1986 (the Code), a small business investment company licensed by the U.S. Small Business Administration under Section 301(c) or (d) of the Small Business Investment Act of 1958 or a business development company as defined in Section 202(a)(22) of the Investment Advisers Act of 1940 (the Advisers Act).
o (B) Insurance Company. An insurance company as defined in Section 2(13) of the Securities Act.
o (C) ERISA Plan. An employee benefits plan within the meaning of Title 1 of the Employee Retirement Income Security Act of 1974 (ERISA).
o (D) State or Local Plan. A plan established and maintained by a state, its political subdivisions, or any agency or instrumentality of a state or its political subdivisions, for the benefit of its employees.
o (E) Investment Company. An investment company registered under the Investment Company Act of 1940 (the Investment Company Act) or any business development company as defined in Section 2(a)(48) of the Investment Company Act.
o (F) Investment Adviser. An investment adviser registered under the Advisers Act.
o (G) Trust Fund. A trust fund whose trustee is a bank or trust company and whose participants are exclusively plans of the types identified in paragraphs (i)(C) and (i)(D) above, except trust funds that include as participants individual retirement accounts or H.R. 10 plans.
q (ii) Bank or Savings and Loan. The undersigned is a bank as defined in Section 3(a)(2) of the Securities Act; a savings and loan association or other institution referenced in Section 3(a)(5)(A) of the Securities Act; or a foreign bank or savings and loan association or equivalent institution, acting for its own account and the accounts of other QIBs, that in the aggregate owned and invested on a discretionary basis at least $100 million of Unaffiliated Securities, calculated as provided in Rule 144A, as of the date specified on the signature page hereto, and that had an audited net worth of at least $25 million as of the end of its most recent fiscal year. (This paragraph does not include bank commingled funds.)
o (iii) One of a Family of Investment Companies. The undersigned is an investment company registered under the Investment Company Act, acting for its own account or for the accounts of other QIBs, that is part of a family of investment companies, as defined in Rule 144A, that owned in the aggregate at least $100 million of Unaffiliated Securities, calculated as provided in Rule 144A, as of the date specified on the signature page hereto.
o (iv) Dealer. The undersigned is a dealer registered under Section 15 of the Securities Exchange Act of 1934 (the Exchange Act), acting for its own account and the accounts of other QIBs, that in the aggregate owned and invested on a discretionary basis at least $10 million of Unaffiliated Securities, calculated as provided in Rule 144A, as of the date specified on the signature page hereto.
o (v) Dealer. (Riskless Principal Transaction). The undersigned is a dealer registered under Section 15 of the Exchange Act acting in a riskless principal transaction (as defined in Rule 144A) on behalf of a QIB.
o (vi) Entity Owned by Qualified Buyers. The undersigned is an entity, all of the equity owners of which are QIBs (each satisfying one or more of (i) through (v) above or this clause (vi), including, as applicable, the $100 million test), acting for its own account or for the accounts of other QIBs.
For purposes of paragraphs (i) through (vi) of paragraph 3 above, the amount of Unaffiliated Securities owned and invested, and related information, is as follows:
Amount of Unaffiliated Securities:
(State specific amount owned/investedmay be approximate, but not range or minimum)
Most Recent Fiscal Year End:
Date Owned/Invested:
(Complete only if this date is after most recent fiscal year end)
In calculating the aggregate amount of securities owned or invested on a discretionary basis by an entity, as provided in Rule 144A: (a) repurchase agreements, securities owned but subject to repurchase agreements, currency, interest rate and commodity swaps, bank deposit notes and certificates of deposit, loan participation, securities of affiliates and dealers unsold allotments are excluded; and (b) securities are valued at cost, except they may be valued at market if they are reported in financial statements at market and no current cost information is published.
Each entity, including a parent or subsidiary, must separately meet the requirements to be a QIB under Rule 144A. Shares or OP units owned by any subsidiary are included as owned or invested by its parent entity for purposes of Rule 144A only if (1) the subsidiary is consolidated in the parent entitys financial statements prepared in accordance with generally accepted accounting principles and (2) the subsidiarys investments are managed under the parent entitys direction (except that a subsidiarys securities are not included if the parent entity is itself a majority-owned consolidated subsidiary of another enterprise and is not a reporting company under the Exchange Act).
o (ii) The undersigned is not a QIB under Rule 144A.
4. The undersigned (check all boxes that are applicable):
o is an accredited investor within the meaning of Rule 501(a) under the Securities Act (an Accredited Investor) in that the undersigned satisfies the requirements of one or more of sub-paragraphs (A) through (E) below (check applicable box(es)):
o (A) is a natural person and has a net worth, either alone or with the undersigneds spouse, of more than $1,000,000,
o (B) is a natural person and had income in excess of $200,000 during each of the previous two years and reasonably expects to have income in excess of $200,000 during the current year, or joint income with the undersigned spouse in excess of $300,000 during each of the previous two years and reasonably expect to have joint income in excess of $300,000 during the current year,
o (C) is an organization described in Section 501(c)(3) of the Internal Revenue Code of 1986 (the Code), a corporation, a business trust, or a partnership, not formed for the specific purpose of acquiring Shares or OP units, with total assets in excess of $5,000,000,
o (D) is a trust with total assets in excess of $5,000,000, that was not formed for the specific purpose of purchasing Shares or OP units and whose purchase is directed by a person who has such knowledge and experience in financial and business matters that he is capable of evaluating the merits and risks of investing in the Company, or
o (E) is an entity in which all of the equity owners are entities described in (A) through (D) above or this sub-paragraph (E).
5. The undersigned has such knowledge and experience in financial and business matters as to be capable of evaluating the merits and risks of an investment in the common stock or OP units, and each of the undersigned is able to bear the economic risk of such investment and can afford the complete loss of such investment. The undersigned is aware that there are substantial risks incident to the exchange offer, including those summarized under Risk Factors in the Exchange Offer Statement.
6. The undersigned represents and warrants that (a) the undersigned is participating in the exchange offer on its own account (and not for the account of others) for investment purposes and not with a view to, or for offer or sale in connection with, any distribution in violation of the Securities Act of 1933 (the Securities Act), (b) the undersigned was not formed for the specific purpose of participating in the exchange offer, (c) the undersigned understands that there is no established market for the common stock or OP units, that a public market for the common stock may not develop, that a public market for the OP units will not develop and that no U.S. federal or state agency has passed upon the common stock or OP units or the Exchange Offer Statement, or made any findings or determination as to the fairness of an investment in the common stock or OP units, and (d) the undersigned is aware of the restrictions relating to ownership and transfer contained in the Companys charter, the Operating Partnerships partnership agreement and the registration rights agreement relating to the common stock and OP units. The undersigned acknowledges and agrees that the Company did not make any representations, declarations or warranties to the undersigned regarding the common stock or OP units, the Company or the Companys offering of the common stock or OP units.
7. The undersigned (check applicable box):
o is:
o is not and, for so long as it owns the common stock or OP units, will not be:
acting on behalf of or using the plan assets of (i) an employee benefit plan (as defined in Section 3(3) of the Employee Retirement Income Security Act of 1974 (ERISA)), whether or not it is subject to Title I of ERISA (for example, a pension plan, profit sharing plan, 401(k) plan or other plan subject to ERISA, or any employee benefit plan that is exempt from ERISA because, e.g., it is maintained by a governmental employer or is a church or a foreign plan), (ii) a plan described in Section 4975 of the Internal Revenue Code of 1986 (the Code) (for example a qualified plan, a qualified annuity plan, an individual retirement account or arrangement, an Archer MSA, a health savings account or a Coverdell Education Savings Account), (iii) an entity whose underlying assets include plan assets of a plan described in clause (i) or (ii) by reason of such plans investment in such entity (including an insurance company general account), or (iv) an entity that otherwise constitutes a benefit plan investor within the meaning of the DOL Regulation Section 2510.3-101 (29 C.F.R. Sections 2510.3-101) (for example a fund, and the assets of that fund, are deemed to be plan assets under DOL Regulation Section 2510.3-101, 29 C.F.R. Section 2510.3-101, by application of the look through rule under the regulation) (each, a Covered Plan).
If the undersigned checked the first box above, the undersigned represents, warrants and agrees that its acquisition and holding of the common stock or OP units (i) will not constitute or result in a non-exempt prohibited transaction under Section 406 of ERISA or Section 4975 of the Code or a violation of any applicable other U.S. federal, state, local, non-U.S. or other laws or regulations that contain one or more provisions that are similar to the provisions of Section 406 of ERISA or Section 4975 of the Code, and (ii) is prudent and complies with the fiduciary standards under Title I of ERISA for investments by the undersigned.
8. The undersigned (check applicable box):
o is:
o is not and, for so long as it owns the common stock or OP units, will not be:
a person (other than a Covered Plan) who has discretionary authority or control with respect to the assets of the Company or a person who provides investment advice for a fee (direct or indirect) with respect to such assets or an affiliate of such person (within the meaning of DOL Regulation Section 2510.3-101, 29 C.F.R. Section 2510.3-101, a Controlling Person).
9. The undersigned represents, warrants and agrees that it will not transfer or assign its interest in the common stock or OP units to any transferee (including any change in the source of funds that is a result of a transfer to an affiliate or a different account) unless such transferee represents, warrants and agrees that (i) the transferee is not (and will not be), and is not acting on behalf of a person who is (or will be), a Covered Plan or a Controlling Person and (ii) such transferee will make the representations and agreement set forth above as the transferor (including, without limitation, clauses (i) and (ii)).
10. For holders electing to receive common stock only: the undersigned represents 100% of the Designated Interests are being exchanged on behalf of persons that are not C corporations, as defined in United States Treasury Regulation section 1.337(d)-7(a)(2)(i), and that are not entities treated as partnerships or disregarded entities for U.S. federal income tax purposes that are owned, directly or indirectly, in whole or in part, by one or more C corporations. Holders that are unable to represent to the preceding sentence and that desire to receive common stock in the exchange offer should contact the Company regarding additional information that may be required.
11. The undersigned has received a copy of the Confidential Exchange Offer Statement, dated May 25, 2011 (the Exchange Offer Statement), and the undersigned understands and agrees that the Exchange Offer Statement speaks only as of its date and that the information contained in the Exchange Offer Statement may not be correct or complete as of any time subsequent to that date.
12. The undersigned, on the undersigneds own behalf and on behalf of each Account, if any, understands that the Shares or OP units were sold in a transaction not involving any public offering within the United States within the meaning of the Securities Act and the Shares or OP units have not been registered under the Securities Act or the securities laws of any jurisdiction and, unless so registered, may not be sold except as permitted in the following sentence. The undersigned, on the undersigneds own behalf and on behalf of each Account, if any, agrees that, if in the future the undersigned or any Account decides to offer, resell, pledge or otherwise transfer such Shares or OP units prior to the time such Shares or OP units would no longer be deemed to be restricted securities for purposes of the Securities Act (the Resale Restriction Termination Date), such common stock or OP units may be offered, resold, pledged or otherwise transferred only (a) to the Company or a subsidiary thereof, (b) pursuant to a registration statement that has been declared effective under the Securities Act, (c) for so long as the Shares or OP units are eligible for resale pursuant to Rule 144A, in a transaction complying with the requirements of Rule 144A to a person or entity who the undersigned or such Account reasonably believes is a QIB that purchases for its own account or for the account of a QIB and to whom notice is given that the offer, resale, pledge or transfer is being made in reliance on Rule 144A, (d) pursuant to offers and sales to non-U.S. persons (1) that occur outside the United States in accordance with and within the meaning of Regulation S under the Securities Act or (e) pursuant to any other available exemption from the registration requirements of the Securities Act, subject in each of the foregoing
(1) In order to qualify as a non-U.S. person under Regulation S, the proposed transferee must (a) have his, her or its principal address outside the United States, (b) be located outside the United States at the time any offer to buy the Shares was made to the proposed transferee and at the time that the buy order was originated by the proposed transferee, and (c) not be a U.S. person (as defined in Rule 902(k) under the Securities Act).
cases to any requirement of law that the disposition of the undersigneds property or the property of any such Account be at all times within the undersigneds or such Accounts control and subject to compliance with any applicable securities laws of any jurisdiction. Subject to compliance with all applicable laws, the foregoing restrictions on resale will not apply subsequent to the Resale Restriction Termination Date. The undersigned, on the undersigneds own behalf and on behalf of each Account, if any, acknowledges and agrees that in order for any resale or other transfer of the Shares or OP units proposed to be made pursuant to clauses (c), (d) or (e) above to be valid, the transferor must deliver to the Company and to the transfer agent of the Shares or OP units, as applicable, a completed and duly executed letter from the transferee substantially in the form of Annex I to the Exchange Offer Statement. The undersigned, on the undersigneds own behalf and on behalf of each Account, if any, understands that the transfer agent for the Shares or OP units, as applicable, will not be required to accept for registration of transfer any Shares or OP units, as applicable, acquired by the undersigned or any Account, except upon presentation of evidence satisfactory to the Company and the transfer agent that an exemption to the registration requirement under the Securities Act and the rules and regulations thereunder have been complied with. The undersigned, on the undersigneds own behalf and on behalf of each Account, if any, further understands that any certificates, if any, representing Shares or OP units acquired by the undersigned or any Account will bear a legend reflecting the substance of this paragraph. The undersigned, on the undersigneds own behalf and on behalf of each Account, if any, acknowledges that the Company reserves the right to restrict any offer, sale or other transfer of the Shares or OP units (i) pursuant to clauses (c), (d) or (e) above prior to the Resale Restriction Termination Date or (ii) prior to the end of the one-year restricted period within the meaning of Rule 903(b)(3) of Regulation S under the Securities Act, and to require the completion, execution and delivery of certifications and other information satisfactory to the Company and the transfer agent, if applicable, and an opinion of counsel approved by the Company and the transfer agent, if applicable, to ensure compliance with the Securities Act and the rules and regulations thereunder. The undersigned, on the undersigneds own behalf and on behalf of each Account, if any, agrees to notify any transferee of the Shares or OP units of the restrictions on resale set forth herein and in the section of the Exchange Offer Statement entitled Notice to InvestorsTransfer Restrictions.
13. The undersigned hereby makes the representations, warranties, covenants and agreements deemed to have been made by each investor under the sections of the Exchange Offer Statement relating to the Shares entitled Notice to Investors, Description of Capital Stock, The Operating Partnership Agreement and Registration Rights, and agrees to be bound by the restrictions set forth in each such section.
14. The undersigned has received such information as the undersigned deems necessary in order to make an investment decision with respect to the common stock or OP units. The undersigned acknowledges that the undersigned and its professional advisor(s), if any, have the right to ask questions of and receive answers from the Company and its officers and directors, and to obtain such information concerning the terms and conditions of the offering of the common stock or OP units to the extent that the Company possesses the same or could acquire it without unreasonable effort or expense, as the undersigned and any professional advisor(s), if any, deem necessary to verify the accuracy of (1) the information referred to in the Exchange Offer Statement pursuant to which the common stock or OP units are being offered and (2) of any other information that the undersigned and any professional advisor(s), if any, deem relevant to making an investment decision with respect to the common stock or OP units. The undersigned represents and agrees that prior to the undersigneds agreement to purchase the common stock or OP units the undersigned and its professional advisor(s), if any, have asked such questions, received such answers and obtained such information as the undersigned and any professional advisor(s), if any, deem necessary to verify the accuracy (1) of the information referred to in the Exchange Offer Statement and (2) of any other information that the undersigned and any professional advisor(s), if any, deem relevant to making an investment decision with respect to the common stock or OP units.
15. In making the decision to exchange the Designated Interests, the undersigned has relied solely upon the Exchange Offer Statement and independent investigation made by the undersigned. The undersigned became aware of the exchange offer and the common stock or OP units were offered to the undersigned solely by means of the Exchange Offer Statement and by direct contact between the undersigned and the Company. The undersigned did not become aware of exchange offer, nor were the common stock or OP units offered to the undersigned by any other means, including, in each case, by any form of general solicitation or general advertising. The undersigned understands and agrees that the common stock or OP units offered pursuant to the Exchange Offer Statement are not being offered in a manner involving a public offering under, or in a distribution in violation of, the Securities Act, or any state securities laws.
16. The undersigned is aware that there are substantial risks incident to the exchange offer, including those summarized under Risk Factors in the Exchange Offer Statement.
17. Alone, or together with any professional advisor(s), the undersigned has adequately analyzed the risks of the exchange offer and determined that the common stock or OP units are a suitable investment for the undersigned. The undersigned has such knowledge in financial and business matters as to be capable of evaluating the merits and risks of an investment in the common stock or OP units, and the undersigned has sought such accounting, legal and tax advice as the undersigned has considered necessary to make an informed investment decision, and the undersigned and any account for which the undersigned is acting is able to bear the economic risk of such investment and can afford a complete loss of such investment.
18. The execution, delivery and performance by the undersigned of this Form is within the powers of the undersigned, have been duly authorized and will not constitute or result in a breach or default under or conflict with any order, ruling or regulation of any court or other tribunal or of any governmental commission or agency, or any agreement or other undertaking, to which the undersigned is bound, and, if the undersigned is not an individual, will not violate any provisions of the undersigneds charter documents, including, without limitation, its incorporation or formation papers, bylaws, indenture of trust or partnership or operating agreement, as may be applicable. The signature on this Form is genuine, and the signatory, if the undersigned is an individual, has legal competence and capacity to execute the same, or, if the undersigned is not an individual, the signatory has been duly authorized to execute the same, and this Form constitutes a legal, valid and binding obligation of the undersigned, enforceable in accordance with its terms.
19. The undersigned (if a natural person), is at least 21 years of age and the undersigned and has adequate means of providing for all his or her current and foreseeable needs and personal contingencies and has no need for liquidity in this investment, and if the undersigned is an unincorporated association, all of its members who are U.S. persons within the meaning of Regulation S under the Securities Act are at least 21 years of age.
20. The undersigned (check applicable box):
o is:
o is not:
an affiliate (as defined in Rule 144 under the Securities Act) of the Company or acting on behalf of an affiliate of the Company.
21. The undersigned represents and warrants that no person or entity controlling, controlled by or under common control with the undersigned, nor any person or entity having a beneficial interest in the undersigned, nor any other person or entity on whose behalf the undersigned is acting: (i) is a person or entity listed in the annex to Executive Order No. 13224 (2001) issued by the President of the United States (Executive Order Blocking Property and Prohibiting Transactions with Persons Who Commit, Threaten to Commit, or Support Terrorism); (ii) is named on the List of Specially Designated Nationals and Blocked Persons maintained by the U.S. Office of Foreign Assets Control (OFAC); (iii) is a non-U.S. shell bank or is providing banking services indirectly to a non-U.S. shell bank; (iv) is a senior non-U.S. political figure or an immediate family member or close associate of such figure; or (v) is otherwise prohibited from investing in the Company pursuant to applicable U.S. anti-money laundering, antiterrorist and asset control laws, regulations, rules or orders (categories (i) through (v) collectively, a Prohibited Investor). The undersigned agrees to provide the Company, promptly upon request, all information that the Company reasonably deems necessary or appropriate to comply with applicable U.S. anti-money laundering, antiterrorist and asset control laws, regulations, rules and orders. The undersigned consents to the disclosure to U.S. regulators and law enforcement authorities by the Company and its affiliates and agents of such information about the undersigned as the Company reasonably deems necessary or appropriate to comply with applicable U.S. anti-money laundering, antiterrorist and asset control laws, regulations, rules and orders. If the undersigned is a financial institution that is subject to the PATRIOT Act, Public Law No. 107-56 (Oct. 26, 2001) (the Patriot Act), the undersigned represents that the undersigned has met all of the undersigneds obligations under the Patriot Act. The undersigned acknowledges that if, following the investment in the Company by the undersigned, the Company reasonably believes that the undersigned is a Prohibited Investor or is otherwise engaged in suspicious activity or refuses to provide promptly information that the Company requests, the Company has the right or may be obligated to prohibit additional investments, segregate the assets constituting the investment in accordance with applicable regulations or immediately require the undersigned to transfer the common stock or OP units. The undersigned further acknowledges that the undersigned will have no claim against the Company or any of its affiliates or agents for any form of damages as a result of any of the foregoing actions.
22. Effective as of the date that this Form is executed, the undersigned hereby irrevocably (i) appoints ZAIS Group, LLC (for purposes of this Section 21, the Agent) as the undersigneds attorney-in-fact and proxy of the undersigned, with full power of substitution, to execute the registration rights agreement, the partnership agreement of ZAIS Financial Partners, L.P. and all or any other instruments of transfer and/or other documents in the Agents discretion in relation to the Shares, OP units, Designated Interests and the exchange offer and to do all such other acts and things as may in the opinion of the Agent be necessary or expedient for the purpose of or in connection with, the undersigneds participation in the exchange offer. The foregoing proxy and power may be exercised by the Agent or its designees acting alone.
23. The undersigned agrees to indemnify and hold harmless the Company, its respective directors, executive officers and each other person, if any, who controls or is controlled by the Company, within the meaning of Section 15 of the Securities Act or Section 20 of the Securities Exchange Act of 1934, from and against any and all loss, liability, claim, damage and expense whatsoever (including, without limitation, any and all expenses whatsoever reasonably incurred in investigating, preparing or defending against any litigation commenced or threatened or any claim whatsoever) arising out of or based upon (a) any false, misleading or incomplete representation, declaration or warranty or breach or failure by the undersigned to comply with any covenant or agreement made by the undersigned in this Form or in any other document furnished by the undersigned to any of the foregoing in connection with this transaction or (b) any action for securities law violations by the undersigned.
24. Neither this Form nor any rights that may accrue to the undersigned hereunder may be transferred or assigned.
25. The undersigned is aware and agrees that the Company did not make any representations, declarations or warranties to the undersigned regarding the Company the exchange offer.
26. The undersigned, on the undersigneds own behalf and on behalf of each Account, if any, acknowledges and agrees that the Company may, in its sole discretion, require the undersigned, on the undersigneds own behalf and on behalf of each Account, if any, to redeem all or any of the Shares or OP units on not less than ten days prior notice.
27. If the undersigned is a U.S. person for U.S. federal income tax purposes, the undersigned has completed, signed, dated and returned to the Company an Internal Revenue Service (IRS) Form W-9 Request for Taxpayer Identification Number and Certification in accordance with the instructions accompanying such form. If the undersigned is not a U.S. person for U.S. federal income tax purposes, the undersigned has completed, signed, dated and returned to the Company an (i) IRS Form W-8BEN Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding, (ii) IRS Form W-8EC1 Certificate of Foreign Persons Claim for Exemption from Withholding on Income Effectively Connected With the Conduct of a Trade or Business in the United States, (iii) IRS Form W-8EXP Certificate of Foreign Government or Other Foreign Organization for United States Tax Withholding or (iv) IRS Form W-8IMY Certificate of Foreign Intermediary, Foreign Partnership, or Certain U.S. Branches for United States Tax Withholding, as applicable, in accordance with the instructions accompanying the appropriate IRS Form.
28. If the undersigned will retain OP units in the exchange offer (as opposed to exchanging such OP units for common stock), either (i) the undersigned is not a partnership, grantor trust or S corporation for U.S. federal income tax purposes (a flow-through entity); or (ii) the undersigned is such a flow-through entity and either: (A) more than 50% of the value of the undersigned is, and at all times will be, attributable to property other than the OP units; or (B) the undersigned was not formed for the principal purpose or as one of its principal purposes to permit the Operating Partnership to satisfy the 100 partner limitation of U.S. Treasury Regulation Section 1.7704-1(h)(1)(ii).
29. The undersigned agrees to provide, and periodically update, at any time requested by the Company or the Operating Partnership, any information the Company or the Operating Partnership deem necessary to comply with any requirement imposed by Internal Revenue Code Sections 1471 1474 and the Treasury Regulations and other guidance issued thereunder, and take any other actions required by such provisions, in order to reduce or eliminate withholding taxes. The undersigned Subscriber agrees to promptly notify the Company and the Operating Partnership, as applicable, of any changes in the information described above. The undersigned acknowledges that if it fails to comply with the above requirements on a timely basis, it may be subject to a 30% U.S. federal
withholding tax on (1) U.S. source dividends, interest and certain other income and (2) gross proceeds from the sale or other disposition of U.S. stocks, debt instruments and certain other assets.
30. The Company may request from the undersigned such additional information as the Company may deem necessary to evaluate the eligibility of the undersigned to participate in the exchange offer, and may request from time to time such information as the Company may deem necessary to determine the eligibility of the undersigned to hold the common stock or OP units or to enable the Company to determine the Companys compliance with applicable regulatory requirements or tax status, and the undersigned shall provide such information as may reasonably be requested.
31. The undersigned acknowledges that the Company and others will rely on the certifications, acknowledgments, understandings, agreements, representations and warranties contained in this Form. The undersigned agrees to promptly notify the Company of any change in the certifications, acknowledgments, understandings, agreements, representations and warranties set forth herein. The undersigned agrees that each purchase by the undersigned of securities of the Company from or through the Company will constitute a reaffirmation of the acknowledgments, understandings, agreements, representations and warranties herein (as modified by any such notice) by the undersigned as of the time of such purchase.
32. The Company is entitled to rely upon this Form and is irrevocably authorized to produce this Form or a copy hereof to any interested party in any administrative or legal proceeding or official inquiry with respect to the matters covered hereby.
33. If any provision of this Form is invalid or unenforceable under any applicable law, then such provision shall be deemed inoperative to the extent that it may conflict therewith. Any provision hereof which may be held invalid or unenforceable under any applicable law shall not affect the validity or enforceability of any other provision hereof, and to this extent the provisions hereof, shall be severable.
34. This Form shall be binding upon the undersigned and the heirs, personal representatives, successors and assigns of the undersigned.
THIS FORM SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF DELAWARE, WITHOUT REGARD TO THE PRINCIPLES OF CONFLICTS OF LAWS THAT WOULD OTHERWISE REQUIRE THE APPLICATION OF THE LAW OF ANY OTHER STATE.
PLEASE CONFIRM THAT YOU HAVE COMPLETED RESPONSES TO QUESTIONS 3, 4, 7, 8 AND 20.
o YES o NO
IRREVOCABLE EXCHANGE AND SUBSCRIPTION AGREEMENT
COUNTERPART SIGNATURE PAGE
(This signature page must be signed in duplicate by the Existing Holder)
The undersigned Existing Holder, desiring to participate in the exchange offer hereby agrees to all of the terms and provisions of this Form and agrees that such Existing Holder is bound by all such terms and provisions.
Please sign your name below exactly in the same manner as the name(s) in which ownership of the Existing Holders Interest is registered. When the Existing Holders interest is held by two or more joint holders, all such holders must sign. When signing as attorney-in-fact, executor, administrator, trustee or guardian, please give full title as such. If a corporation, please sign in full corporate name by the President or other authorized officer. If a partnership or limited liability company, please sign in partnership or limited liability company name by an authorized person.
The Existing Holder has executed this Form as of this day of , 2011.
EXISTING HOLDER:
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Original contributed capital $ . (Please insert the original contributed capital)
Existing Holders Interests currently held in the Partnership Funds $ . (Please insert the existing Interests held in the Partnership Funds)
Distributions received $ since the initial date of investment in the Partnership Fund. (Please insert the distributions received to date)
Designated Interests %. (Please insert the percentage of your existing Interests that you wish to exchange)
I would like to receive (check applicable box):
o common stock
o OP units
in exchange for my Designated Interests.
* With respect to an Existing Holder who is a natural person, please provide the address of your residence. With respect to an Existing Holder which is an entity, please provide the address of your place of business (or, if there is more than one place of business, the chief executive office). With respect to each natural person who is the trustee of an Existing Holder that is a trust, please provide the address of your residence and place of business (or, if there is more than one place of business, the chief executive office). With respect to the Existing Holder that is a trust with an Entity trustee, please provide the information requested of an Entity.
SECOND COPY
IRREVOCABLE EXCHANGE AND SUBSCRIPTION AGREEMENT
COUNTERPART SIGNATURE PAGE
(This signature page must be signed in duplicate by the Existing Holder)
The undersigned Existing Holder, desiring to participate in the exchange offer hereby agrees to all of the terms and provisions of this Form and agrees that such Existing Holder is bound by all such terms and provisions.
Please sign your name below exactly in the same manner as the name(s) in which ownership of the Existing Holders Interest is registered. When the Existing Holders Interest is held by two or more joint holders, all such holders must sign. When signing as attorney-in-fact, executor, administrator, trustee or guardian, please give full title as such. If a corporation, please sign in full corporate name by the President or other authorized officer. If a partnership or limited liability company, please sign in partnership or limited liability company name by an authorized person.
The Existing Holder has executed this Form as of this day of , 2011.
EXISTING HOLDER:
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Address:* |
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City, State, Zip Code (Please Print) |
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Original contributed capital $ . (Please insert the original contributed capital)
Existing Holders Interests currently held in the Partnership Funds $ . (Please insert the existing Interests held in the Partnership Funds)
Distributions received $ since the initial date of investment in the Partnership Fund. (Please insert the distributions received to date)
Designated Interests %. (Please insert the percentage of your existing Interests that you wish to exchange)
I would like to receive (check applicable box):
o common stock
o OP units
in exchange for my Designated Interests.
* With respect to an Existing Holder who is a natural person, please provide the address of your residence. With respect to an Existing Holder which is an entity, please provide the address of your place of business (or, if there is more than one place of business, the chief executive office). With respect to each natural person who is the trustee of an Existing Holder that is a trust, please provide the address of your residence and place of business (or, if there is more than one place of business, the chief executive office). With respect to the Existing Holder that is a trust with an Entity trustee, please provide the information requested of an Entity.
Agreed and Accepted as of this day of , 2011.
ZAIS Financial Corp.,
a Maryland corporation
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Exhibit 21.1
Subsidiaries of the Registrant
Subsidiary |
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Jurisdiction of Formation |
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ZAIS Asset I, LLC |
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Delaware |
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ZAIS Asset II, LLC |
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Delaware |
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ZAIS Asset III, LLC |
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Delaware |
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ZAIS Asset IV, LLC |
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Delaware |
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ZAIS I TRS, Inc. |
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Delaware |
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ZFC Trust |
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CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We hereby consent to the use in the Registration Statement on Amendment No. 1 to Form S-11 of ZAIS Financial Corp. of our report dated April 27, 2012 relating to the financial statements of ZAIS Financial Corp., which appears in such Registration Statement. We also consent to the reference to us under the heading "Experts" in such Registration Statement.
/s/ PricewaterhouseCoopers LLP |
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New York, New York
January 28, 2013