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Notice of Proposed Individual Exemption Involving the ARINC Incorporated Retirement Income Plan (the Plan); Located in Annapolis, MD
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[Federal Register: September 13, 2004 (Volume 69, Number 176)]
[Notices]
[Page 55179-55198]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr13se04-76]
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DEPARTMENT OF LABOR
Employee Benefits Security Administration
[Application No. D-11220]
Notice of Proposed Individual Exemption Involving the ARINC
Incorporated Retirement Income Plan (the Plan); Located in Annapolis,
MD
AGENCY: Employee Benefits Security Administration, Department of Labor.
ACTION: Notice of proposed individual exemption.
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SUMMARY: This document contains a notice of pendency before the
Department of Labor (the Department) of a proposed exemption from
certain prohibited transaction restrictions of the Employee Retirement
Income Security Act of 1974 (ERISA or the Act) and from certain taxes
imposed by the Internal Revenue Code of 1986 (the Code). If granted,
the proposed exemption would permit: (1) The in-kind contribution of
the property described as the 27.5 acre headquarters of ARINC
Incorporated (ARINC or the Applicant) situated in Annapolis, MD or the
ownership interests of a special purpose entity (SPE) whose only asset
is this property (collectively, the Property) to the Plan by ARINC, the
plan sponsor and a party in interest with respect to the Plan (the
Contribution); (2) the holding of the Property by the Plan; (3) the
leaseback of the Property by the Plan to ARINC (the Lease or
Leaseback); (4) the repurchase of the Property by ARINC (the
Repurchase) pursuant to (a) a right of first offer to ARINC should the
Plan wish to sell the Property to a third party or (b) a voluntary
agreement under which the Plan agrees to sell the Property to ARINC at
any time during the Lease; and (5) any payments to the Plan by ARINC
made pursuant to a make whole obligation as specified below (the Make
Whole Payment or Obligation) (collectively, the Exemption
Transactions). If granted, the proposed exemption would affect
participants and beneficiaries of, and fiduciaries with respect to, the
Plan.
DATES: Written comments and requests for a public hearing should be
received by the Department on or before October 20, 2004.
Effective Date: This proposed exemption, if granted, will be
effective as of September 7, 2004.
ADDRESSES: All written comments and requests for a public hearing
(preferably, three copies) should be sent to the Office of Exemption
Determinations, Employee Benefits Security Administration, Room N-5649,
U.S. Department of Labor, 200 Constitution Avenue, NW., Washington, DC
20210, (Attention: Exemption Application Number D-11220).
Interested persons are also invited to submit comments and/or
hearing requests to the Department by the end of the scheduled comment
period either by facsimile to (202) 219-0204 or by electronic mail to
moffitt.betty@dol.gov. The application pertaining to the proposed
exemption (Application) and the comments received will be available for
public inspection in the Public Disclosure Room of the Employee
Benefits Security Administration, U.S. Department of Labor, Room N-
1513, 200 Constitution Avenue, NW., Washington, DC 20210.
SUPPLEMENTARY INFORMATION: This document contains a notice of pendency
before the Department of a proposed individual exemption from the
restrictions of sections 406(a), 406(b)(1) and (b)(2), and 407(a) of
the Act, and from the sanctions resulting from the application of
section 4975(a) and (b) of the Code, by reason of section 4975(c)(1)(A)
through (E) of the Code.
FOR FURTHER INFORMATION CONTACT: Wendy M. McColough of the Office of
Exemption Determinations, Employee Benefits Security Administration,
U.S. Department of Labor, telephone (202) 693-8540. (This is not a
toll-free number.)
Summary of Facts and Representations
1. The Applicant. ARINC represents that it was founded in 1929 and
provides transportation communications and systems engineering
solutions to the defense industry and the airline industry. ARINC
maintains 84 offices worldwide and serves more than 3,000 customers in
more than 140 countries. ARINC confirms that its products and services
generated approximately $636 million in annual revenues in 2003.
Ninety-six percent of the voting shares of ARINC are owned by the six
major United States airlines: American Airlines, Delta Airlines,
Continental Airlines, Northwest Airlines, United Airlines, and U.S.
Airways.
The Independent Fiduciary retained to represent the Plan in
connection with the exemption request, Independent Fiduciary Services,
Inc. (IFS), submitted a report to the Department on June 18, 2004 (the
IFS Report). The IFS Report provides that ARINC is a leading provider
of mission-critical communications and IT services to the global
aviation industry (45% of revenues) and engineering services to the
U.S. military and other government agencies (55%). The Federal
Communications Commission has granted ARINC the exclusive right to
manage and license the radio frequencies used by the airlines, and
ARINC networks carry more than half of all air-ground messages in the
world between commercial aircraft and airline operation centers. Other
commercial transportation products include airport check-in and
boarding systems, flight display and information systems, commuter rail
control and information systems, and mobile private digital networks
and ground communications systems. ARINC also provides engineering
services such as systems engineering, acquisition and program
management, operational support, and life-cycle support for defense
aviation systems, with offices located at every U.S. Air Force base.
ARINC also provides onsite technical and training support for complex
electronic systems for all branches of the military, and provides
integration of new navigational, communications, and command and
control systems for defense and other government agencies.
2. The Property and the Qualified Independent Appraiser. ARINC has
its headquarters in Annapolis, Maryland, where it occupies a six
building office complex situated on 27.6 acres. The Applicant
represents that this Property will be unencumbered at the time of the
transaction and is a marketable and substantial asset appraised by
Deloitte & Touche LLP (Deloitte) at $49,000,000 as of June 30, 2004
(The Appraisal). IFS appointed Deloitte, a nationally recognized,
qualified, independent appraiser to appraise the Property. The
Appraisal also estimated the prospective market value of the leased fee
interest in the Property at the end of a 23-year lease to be
$83,000,000. In a June 17, 2004 letter to IFS, Deloitte represents
that, in accordance with the guidelines set out
[[Page 55180]]
by the Appraisal Institute, Deloitte is independent of IFS, ARINC and
the Plan. Deloitte represents that it has no current or prospective
financial interest in the appraised asset (the Property) and that the
fee for the Appraisal is in no way dependent upon or influenced by the
result of Deloitte's analysis.
Deloitte is an international accounting and consulting firm that
provides, among other things, real estate financial advisory services,
with personnel who have extensive experience providing valuation and
appraisal services for real estate similar to the Property (office and
industrial space) in the relevant geographic area (central Atlantic
coastal region, including Maryland). Its personnel have earned
professional designations from the organizations that accredit
appraisers. For a more detailed description of the Property and the
Appraisal, see the IFS Report paragraph below.
3. The Plan. ARINC sponsors and maintains a defined benefit pension
plan. The formal name of the Plan is the ``ARINC Incorporated
Retirement Income Plan.'' The number of participants and beneficiaries
in the Plan as of December 31, 2003, is 3,975. The plan administrator
for the Plan is a Committee designated by the ARINC Board of Directors
(the Committee or the Pension Committee). ARINC, through either its
Board of Directors or through the Committee, has the power to appoint
and remove Plan trustees, investment managers, and other service
providers. Under the terms of the Plan, the Committee is the named
fiduciary and has discretion with respect to the investment of the
Plan's assets. Pursuant to its authority under the Plan, the Committee
has appointed investment managers to manage plan assets. ARINC
represents that with respect to the proposed transactions and the
possible Monetization, the Committee will appoint an independent
fiduciary to act as an investment manager with the authority and
discretion to acquire, hold, lease, monetize, and dispose of the
Property. No other Plan fiduciary will exercise investment discretion
over the assets involved in the proposed transactions.
4. Plan Contributions. Contributions required to fund the Plan are
made to and held under a single master trust, the ARINC Incorporated
Defined Benefit Master Trust (the Master Trust). The Master Trust holds
the assets of the Plan in separate sub-accounts, a non-union employee
sub-account and a union employee sub-account. The Trustee of the Master
Trust is Mellon Bank, N.A. The IFS Report states that as of December
31, 2003, the Plan was approximately 82% funded, with $252 million in
assets and $308 million in liabilities measured on an accumulated
benefit obligation basis (ABO) under Financial Accounting Standard
(FAS) No. 87, Employers' Accounting for Pensions.\1\ ARINC notes that,
as recently as 2000, the Plan was overfunded and that the Plan has
become underfunded due to three consecutive years of negative
investment returns (2000 through 2002) and record low interest rates.
Despite these conditions, ARINC states that it is committed to fully
funding the Plan. Toward that goal, the company plans to make cash
contributions for Plan Year 2003 totaling $18 million, well above its
$8 million required contribution for Plan Year 2003. In addition, ARINC
also plans to make a cash contribution in excess of the minimum
requirement for Plan Year 2004. ARINC expects that, when combined with
the contribution of the Property, its cash contribution for Plan Year
2004 will accomplish the goal of fully funding the Plan to the ABO
level.
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\1\ The ABO is based on a 6.75% discount rate.
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ARINC represents that the proposed contribution would be a
voluntary contribution in excess of ARINC's minimum funding obligations
under section 412 of the Code. Absent the contribution of the Property,
ARINC will continue to make the required minimum contributions, but the
Plan probably will not be fully funded in the near future. Thus, ARINC
concludes that the contribution is very much in the interest of the
Plan and its participants.
5. The Transfer Agreement and the Contribution. On March 25, 2004,
ARINC submitted a draft transfer agreement dated March 24, 2004 (Draft
Transfer Agreement). The Draft Transfer Agreement governs the terms
upon which the Property will be contributed to and held by the Plan and
is between ARINC (the Transferor), Aeronautical Radio, Inc. (ARI), a
wholly-owned subsidiary of ARINC, and the Plan through its agent, IFS
(the Transfer Agreement).
The Draft Transfer Agreement states that ARI is the owner of fee
simple title in the Property. Subject to the terms and conditions set
forth in the Draft Transfer Agreement, ARINC and ARI agree to transfer
to the Plan, and the Plan agrees to acquire and assume, the Property.
ARINC (and, to the extent applicable, ARI) shall retain all of its
rights and obligations under and pursuant to any and all contracts (and
amendments thereto) relating to the ownership, management, leasing,
parking, operation, maintenance and/or repair of the Property
(collectively, the Contracts). The Draft Transfer Agreement notes that
consideration for the transfer of the Property by ARINC to the Plan, a
voluntary contribution in excess of ARINC's minimum funding
requirements under ERISA Section 302 and Code Section 412, is the
improvement of the funded status of the Plan. As a result, ARINC's
future required contributions will be reduced. Furthermore, the
transfer of the Property by ARINC to the Plan will resolve or
substantially resolve the underfunded status of the Plan.
The Plan shall have a period (the Review Period) commencing on the
date of execution of the Transfer Agreement (Effective Date) and ending
at 5 p.m. Eastern Standard Time on the date that is sixty (60) days
after the Effective Date (the Review Period Expiration Date), to
undertake a review and examination of all aspects of the Property,
including the use and operation thereof. ARINC and ARI shall permit the
Plan and IFS, and their respective agents, employees and contractors to
enter upon the Property at any time and from time to time upon
reasonable prior notice to Transferor to examine and/or test any aspect
thereof.
If the Plan, in the Plan's sole discretion, is dissatisfied with
the results of any examination of the Property or any studies or
investigations as permitted herein or any matter set forth in the
Property documents or for any other reason, the Plan shall have the
right to terminate the Transfer Agreement at any time prior to the
Review Period Expiration Date by providing written notice thereof to
ARINC. Upon the giving of such notice, the Transfer Agreement shall
terminate and all rights, obligations and liabilities of the parties
hereunder shall be released and discharged, except under those
provisions that expressly survive termination of the Transfer
Agreement.
The Draft Transfer Agreement provides that all transactions
involving the Plan in connection with the contribution of the Property
to the Plan will be conducted and completed on terms no less favorable
to the Plan than similar terms in arms length transactions involving
unrelated parties. No commissions, fees, costs, charges or other
expenses will be borne by the Plan in connection with the transfer of
the Property to the Plan.
The Form of Property Transfer
Although the Application originally requested relief for the
transfer of the fee interest in the Property directly from ARINC to the
Plan, ARINC subsequently determined that a direct transfer of the fee
interest to the Plan may subject
[[Page 55181]]
ARINC to a substantial Maryland state recordation tax. ARINC believes
that this tax can be avoided if the fee interest is first transferred
to a newly created single purpose entity (SPE) (which could be a
Delaware corporation, an unincorporated business trust or a limited
liability company), which would be a wholly owned subsidiary of ARINC
or ARI, and then the interests in that SPE are transferred to the Plan.
As a result, the Transfer Agreement provides that ARINC will cause ARI
to either contribute the property directly to the Plan or first
transfer the property to a newly created SPE one hundred percent (100%)
owned by ARINC or ARI and then ARINC or ARI, as the case may be, will
transfer one hundred percent (100%) of the interests in the SPE to the
Plan.
ARINC asserts that the Exemption Transactions remain identical in
economic substance to the transactions described in the Application,
notwithstanding that it may take the form of a transfer of the
ownership interests in the SPE. The Plan would hold one hundred percent
(100%) of the ownership interest in the Property and the Plan would
have the ordinary rights of the owner (subject to the terms of the
Lease). ARINC adds that the Transfer Agreement includes specific
provisions to protect the Plan's interests in connection with this
change, including ARINC's representation that the SPE will have no
obligations or liability unrelated to the property at the time of
transfer. In addition, IFS, on behalf of the Plan, will review and
approve the form of entity which is created and whose interests are
transferred to the Plan. Finally, ARINC intends to establish the
subsidiary entity just prior to closing so as to limit any possibility
that the new entity would have any liability unrelated to the property.
BearingPoint Lease
ARINC informed the Department that on January 26, 2004, ARINC
entered into a 1-year lease with BearingPoint Inc., a global business
consulting firm (BearingPoint). The lease is renewable at
BearingPoint's option for one subsequent 1-year term. Under the lease,
BearingPoint leases 27,360 square feet, all of it on one floor of
Building One on the Property. ARINC decided to lease this space since
it is currently not needed by ARINC and it provides ARINC with a source
of additional revenue. With the involvement and approval of IFS, the
lease between ARINC and BearingPoint specifically provides that the
BearingPoint lease will convert to a sublease if the Property is
contributed to the Plan and leased back to ARINC. Thus, ARINC will
lease all of the Property from the Plan and will sublease the current
space occupied by BearingPoint to BearingPoint.
Environmental Laws
A Draft Transfer Agreement provision concerning ARINC's
representations and warranties includes a paragraph on environmental
laws and states that to ARINC's knowledge: (A) No portion of the
Property is in violation of any applicable Environmental Law; (B) there
is no presence or release of, nor has there been a release of,
Hazardous Substances on or from the Property or Improvements, except as
disclosed in writing to the Plan in the following reports: (i) Phase
One Environmental Site Assessment for 2551 Riva Road, Annapolis,
Maryland, prepared by Custer Environmental, Inc. (undated), and such
presence or release, if any, has been fully remedied in accordance with
all applicable Environmental Laws to the extent remediation is
required; (C) no investigation, administrative order, consent order and
agreement, litigation, or settlement with respect to any ``Hazardous
Substances'' as defined by the Comprehensive Environmental Response,
Compensation, and Liability Act (42 U.S.C. 9601 et seq.), as amended
(CERCLA) \2\, is pending or threatened in writing with respect to the
Property and Improvements; and (D) no aboveground or underground
storage tanks on the Property are in violation of any applicable
Environmental Law. Neither ARINC nor ARI have received any notice, and
neither have knowledge, of any Hazardous Substances located on any
property adjacent to the Property which could reasonably be expected to
migrate to, or have a material adverse effect on, the Property.
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\2\ For purposes hereof, the term ``Environmental Law'' shall
mean: (i) The Comprehensive Environmental Response, Compensation,
and Liability Act (42 U.S.C. 9601 et seq.), as amended; (ii) the
Solid Waste Disposal Act, as amended by the Resource Conservation
and Recovery Act (42 U.S.C. 6901 et seq.), as amended; (iii) the
Emergency Planning and Community Right to Know Act (42 U.S.C. 11001
et seq.), as amended; (iv) the Clean Air Act (42 U.S.C. 7401 et
seq.), as amended; (v) the Clean Water Act (33 U.S.C. 1251 et seq.),
as amended; (vi) the Toxic Substances Control Act (15 U.S.C. 2601 et
seq.), as amended; (vii) the Hazardous Materials Transportation Act
(49 U.S.C. 1801 et seq.), as amended; (viii) the Federal
Insecticide, Fungicide and Rodenticide Act (7 U.S.C. 136 et seq.),
as amended; (ix) the Safe Drinking Water Act (42 U.S.C. 300f et
seq.), as amended; (x) any state, county, municipal or local
statutes, laws or ordinances similar or analogous to the federal
statutes listed in parts (i)-(ix) of this definition; (xi) any
amendments to the statutes, laws or ordinances listed in parts (i)-
(x) of this definition in effect as of the Effective Date; (xii) any
rules, regulations, guidelines, directives, orders or the like
adopted pursuant to or to implement the statutes, laws, ordinances
and amendments listed in parts (i)-(xi) of this definition; and
(xiii) any other law, statute, ordinance, amendment, rule,
regulation, or order relating to environmental, health or safety
matters.
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6. The Lease Agreement. The Applicant submitted a draft lease term
sheet, as revised on June 11, 2004, that provides the terms and
conditions of the proposed lease agreement between ARINC and the Plan
acting by and through IFS (Lease or Lease Agreement) to the Department
(Draft Lease Term Sheet). On July 9, 2004, ARINC stated that this Draft
Lease Term Sheet was agreed to by IFS and includes the material terms
and conditions of the Lease Agreement. ARINC represents that these
terms and conditions will be reflected in the final Lease Agreement.
According to the Draft Lease Term Sheet, the Plan may form a
limited liability company (LLC) or other entity in which the Plan will
be the sole member or owner and IFS will be the manager, which LLC or
other entity will own the Property and be the lessor under the Lease.
The term ``Lessor'' in the Draft Lease Term Sheet provisions discussed
below refers to the Plan and the LLC or other entity in which the Plan
is the member or owner and IFS is the manager. In an August 4, 2004
letter to the Department, ARINC notes that this is the typical way to
hold interests in commercial real estate and this structure protects
the Plan from potential liability associated with claims involving the
Property. If ARINC, as expected, transfers the Property as interest in
an SPE, the Plan, at its option, could elect to hold the stock in the
SPE in a newly established LLC. Alternatively, the Plan may elect to
convert the SPE to an LLC. Either way, ARINC asserts that prospective
claims would lie against the LLC rather than the Plan.
Transaction Description
The Draft Lease Term Sheet states that ARINC will, or will cause
its wholly owned subsidiary ARI, to contribute its right, title and
interest in and to its headquarters property and all improvements
thereon located at 2551 Riva Road in Annapolis, Maryland (the Property)
to the Plan, acting by and through IFS as independent fiduciary.
Simultaneously, ``the Plan will lease the Property back to ARINC under
a ``true'' tax, operating lease, the structure of which will be
`bondable' until the earlier of (i) the end of the first 10 years of
the lease term or (ii) the date on which the Property is sold to a
third party or transferred to a lender secured by the Property or the
rental stream from the Property'' (the Monetization), at which point
the lease structure will convert to a traditional triple-net, ``non-
[[Page 55182]]
bondable'' lease (the bondable and non-bondable structures are more
particularly detailed below), with an initial term of 20 years and one
3-year extension option. If IFS desires to sell or convey the Property
or any interest therein during the term of the Lease, ARINC shall have
the right of first offer to purchase or otherwise acquire the Property
or such interest therein (Right of First Offer or ROFO).
Lease Term
The Lease provides for an initial term of 20 years with one 3-year
renewal period. ARINC asserts that the longer lease term is favorable
to both parties, providing the Plan with a long-term favorable
investment return (i.e., the lease payments) on the Property and ARINC
with stability and security for its headquarters location. The specific
23-year period was chosen to provide the longest lease term and still
have the lease qualify as a true tax lease, which is necessary to
ensure that the contribution is deductible by ARINC. The Draft Lease
Term Sheet provides that all of the Plan's reasonable and actual out-
of-pocket costs, as well as other reasonable fees and expenses,
associated with the proposed transaction will be paid by ARINC whether
or not the proposed transaction should close.
Bondable/Triple Net Lease Structure
The initial 10-year period of the Lease will be a ``bondable''
lease. ARINC believes that a ``bondable'' lease is even more favorable
to the Plan than a traditional ``triple net'' lease. Under the bondable
lease structure, the rent payable by ARINC to the Plan remains payable
under all circumstances and all costs related to the Property,
including taxes, insurance, utilities and non-capital maintenance,
repair and capital improvements, are the responsibility of ARINC as
lessee. Under a traditional triple-net lease, the Plan, not ARINC,
would bear the responsibility to pay capital expenditures.
Additionally, the Draft Lease Term Sheet specifies that the Lease
shall contain a commercially reasonable standard for determining
whether capital improvements (repair or replacement) are required for
the Property during the bondable period of the Lease. On August 19,
2004, ARINC informed the Department that the Lease Agreement will
specify that in the event the parties disagree as to whether such
capital improvements are required, the determination will be made by a
neutral third-party arbitrator. ARINC asserts that it will not be able
to preclude capital improvements from being made that the Plan desires
if the arbitrator determines the same to be required. ARINC states that
although the parties continue to work out the details in the Lease, the
process and ultimate determination by a neutral third-party in
connection with a dispute will remain in place.
ARINC notes that the purpose of the ``bondable'' lease structure is
to facilitate the Plan's ability to ``monetize'' (sell) the stream of
lease payments that ARINC will make during the first 10 years of the
lease to a third party (as described below). The Lease will remain
``bondable'' until the earlier of (i) the end of the first 10 years of
the lease, or (ii) the date on which the property is sold or
transferred to a third party. The Lease will then convert to a
traditional triple net lease under which ARINC will pay rent, taxes,
insurance, utilities, non-capital maintenance and repair, but the Plan
will be responsible for capital expenditures.
Rental Rate
The Draft Lease Term Sheet provides that the rental rate shall be
fair market value determined in connection with the Appraisal of the
Property. The Draft Lease Term Sheet further provides that the rental
rate shall increase when the Lease shifts from bondable to a
traditional triple net lease to reflect the Plan's obligation to make
capital improvements at that time. ARINC represents that ARINC and IFS
will agree to specific rental rates, including annual increases, for
the entire 20-year period at the time the parties sign the full Lease
Agreement. The rental rate during the 3-year renewal term will be the
then-prevailing fair market rental rate as determined in accordance
with the Lease. ARINC expects that the Lease will generate an estimated
$4 million to $4.5 million in annual lease income for the Plan.
In a June 30, 2004 letter to the Department, ARINC noted that under
the terms of the proposed Lease between the Plan and ARINC, the annual
base rent for the Property as a whole for the first year of the Lease
is expected to be $12.40 per square foot under the bondable structure
and $14.65 per square foot under the non-bondable structure. Both rates
will increase at 2.5% per year, compounded.\3\ Additionally, ARINC
provided the Department a table showing the expected annual rental
amounts for years 1 through 20 of the lease under both the bondable and
non-bondable structure. On July 7, 2004, ARINC informed the Department
that ARINC will pay $4,290,189 in lease payments to the Plan in year 1
of the lease. ARINC's lease payments will increase to $8,103,000 in
year 20 (reflecting the 2.5% per year annual increase and the change
from bondable to non-bondable after year 10). ARINC will make total
lease payments during the 20-year term of the lease equal to
$120,755,549.
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\3\ In an August 4, 2004 letter to the Department, ARINC stated
that under a commercial lease, there generally are two ways to seek
to ensure that rental payments remain fair market value rental
payments over time. The first is by setting a fixed periodic rental
adjustment, and the second is by tying the rental payments to
periodic increases in the consumer price index (CPI). Setting a
fixed periodic rental adjustment is a more customary way to ensure
fair market value rental payments than is a method that ties rental
payments to CPI. ARINC asserts that this is true even for long term
leases, such as the 20-year lease contemplated in this transaction.
The independent appraiser, Deloitte, examined annual rent
escalations used in conventional leases in the relevant market area.
Deloitte concluded that annual rent escalations ranging from 2% to
3% are typical, and concluded on a 2.5% annual growth rate as
representative of market terms. ARINC notes that IFS considered this
conclusion in its assessing the prudence of the proposed transaction
and that IFS expects that this adjustment will ensure that the
rental payments to the Plan over the life of the Lease will account
for a presumed rate of inflation.
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The Right of First Offer
If the Plan desires to sell or convey the Property or its interest
therein during the Lease term, the Draft Lease Term Sheet provides a
Right of First Offer to ARINC. The Plan shall first offer ARINC the
right to purchase or otherwise acquire the Property or such interest
therein (a) on such terms and conditions as the Plan proposes to market
the Property or such interest therein for sale (Soliciting Offer),
which terms and conditions shall reflect the Plan's good faith
determination of market conditions and the fair market value for the
Property; provided, however, that with respect to any right of first
offer hereunder triggered from and after the fifteenth (15th)
anniversary of the commencement date of the Lease, the Plan's offer to
ARINC shall reflect a fair market value (FMV) purchase price that is
determined by a 3-appraiser method (if the parties are unable otherwise
to so agree) or (b) on such terms and conditions as are contained
within an unsolicited bona fide offer from an unaffiliated third party
that the Plan desires to accept (Unsolicited Offer). The parties shall
negotiate in good faith the terms and conditions of any purchase based
on a Soliciting Offer for a period of thirty (30) days following (i)
the Plan's notice to ARINC (if prior to the 15th anniversary of the
Lease commencement date) or (ii) the establishment of the FMV purchase
price (if from or after the 15th
[[Page 55183]]
anniversary of the Lease commencement date). In all events, ARINC shall
exercise such right, if at all, upon notice to the Plan within the
thirty (30) day period described above with respect to a Soliciting
Offer or within thirty (30) days after notice to ARINC of an
Unsolicited Offer. If ARINC fails to exercise such right to purchase,
the Plan is free to sell the Property (i.e., close on the transfer) to
a third party on such terms for the next 360 days, however, the Plan
shall not have the right to sell to a third party at a lower effective
purchase price or on any other materially more favorable term than the
effective purchase price and terms proposed by the Plan to ARINC
without first re-offering the Property to ARINC at such lower effective
purchase price or other more favorable term, nor to sell on any terms
following the expiration of such 360-day period, without first re-
offering the Property to ARINC. The right of first offer shall
terminate upon the commencement of the exercise by the Plan of its
remedies under the Lease as the result of a monetary event of default
by ARINC that continues uncured following notice and the expiration of
applicable cure periods (and a second notice and cure period provided
fifteen (15) days before the loss of such right on account of such
default).
The IFS Report and ARINC note that ARINC will lose the ROFO in the
event of an uncured monetary default under the Lease. In the event that
ARINC is in monetary default under the Lease and the Lease terminates,
the ROFO will terminate and the Plan would be free to sell the Property
without offering the Property to ARINC. In addition, the terms on which
the Property is to be offered to ARINC under the ROFO are to be set by
the value of an Unsolicited Offer that the Plan decides it wishes to
accept or, in the absence of an Unsolicited Offer, at fair market
value. For the first 14 years of the lease, the Plan is authorized to
set that fair market value and beginning with year 15, that value will
be set by agreement of the parties (using an alternate dispute
resolution method if the parties cannot agree on that value). ARINC
will have only 30 days to decide whether to accept the offer on those
terms and, if ARINC declines, the Plan may sell to any third party on
the offered terms or better without giving ARINC any further
opportunity to purchase the Property.
In an August 4, 2004, letter to the Department, ARINC states that
at no time during the Lease will the Soliciting Offer be established by
ARINC. Rather, as described in the Draft Lease Term Sheet, during the
first 14 years of the Lease, the Property will be offered to ARINC on
such terms and conditions as the Independent Fiduciary on behalf of the
Plan proposes to market the Property or the Plan's interests in the
Property for sale. These terms and conditions are set exclusively by
the Plan and will reflect the Independent Fiduciary's good faith
determination of market conditions and the fair market value for the
Property, subject to challenge by ARINC only for lack of good faith.
Beginning in the 15th year of the Lease, the Independent Fiduciary on
behalf of the Plan will propose terms and conditions for the soliciting
offer to ARINC. If the parties do not agree to the terms proposed by
the Independent Fiduciary, the fair market value price will be
determined by a three appraisal method.
ARINC believes the ROFO is only a modest encumbrance on the Plan
since the Plan will establish the fair market value price at which the
Property is offered and ARINC must respond to the Plan's offer
promptly, after which time the Plan can offer the Property to the
public. While a modest restriction, it is important to ARINC to have
this right since the Property is its headquarters campus. ARINC
represents that Deloitte, the Plan's independent appraiser, believes
that the right of first offer will have little, if any, impact on
value. ARINC states that it understands that such rights are common in
commercial, arm's-length sale-leaseback transactions.
The Make Whole Obligation (MWO)
The Draft Lease Term Sheet provides that, if on the earlier of the
date of a sale of the Property by the Plan or the date that is five
years from the date of the closing under the Transfer Agreement (the
Make-Whole Date), the Actual Return to the Plan, as defined according
to several specific situations, is less than the sum of the
contribution value plus a return equal to an annual rate of five
percent (5.00%) compounded on the contribution value of the Property
(the Minimum Return), then ARINC will contribute to the Plan, within
180 days of the Make-Whole Date, a cash payment in the amount of any
such difference (Make-Whole Payment). The Draft Lease Term Sheet
provides various situations, whether the rental income is monetized and
whether the Property is sold, that will determine the value of the
Actual Return but in all cases, expenses applicable to the Lease and
the sale shall not include any costs of monetization and prepayment of
monetization.\4\
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\4\ If the Plan does not monetize any portion of the rental
income and the Property is sold, the Actual Return to be compared to
the Minimum Return shall be the sum of (i) the proceeds received
from the fair market value sale net of selling costs plus (ii) the
rental income received by the Plan under the Lease up to the Make-
Whole Date, less expenses incurred by the Plan with respect to the
Property and the Lease.
If the Plan does not monetize any portion of the rental income
and the Property is not sold, the Actual Return to be compared to
the Minimum Return shall be the sum of (i) the fair market value of
the Property on the Make-Whole Date, as determined by a three
appraiser method (if the parties are unable to otherwise agree) plus
(ii) the rental income received by the Plan under the Lease up to
the Make-Whole Date, less expenses incurred by the Plan with respect
to the Property and the Lease.
If the Plan monetizes any portion of the rental income, the
Property is sold, and the monetization is repaid or prepaid in full
prior to or concurrent with the closing on that sale, then the
Actual Return to be compared to the Minimum Return shall be the sum
of (i) the proceeds received from the fair market value sale net of
selling costs, plus (ii) the rental income that the Plan actually
received prior to and/or after monetization, plus (iii) rental
income the Plan would have received under the Lease had monetization
not occurred (Deemed Rent) up to the Make-Whole Date, less expenses
incurred by the Plan with respect to the Property and the Lease.
If the Plan monetizes any portion of the rental income, the
Property is not sold, but the monetization is repaid prior to the
Make-Whole Date, then the Actual Return to be compared to the
Minimum Return shall be the sum of (i) the fair market value of the
Property on the Make-Whole Date, as determined by a three appraiser
method (if the parties are unable to otherwise agree) plus (ii) the
rental income that the Plan actually received prior to and/or after
monetization, plus (iii) Deemed Rent up to the Make-Whole Date, less
expenses incurred by the Plan with respect to the Property and the
Lease.
If the Plan monetizes any portion of the rental income, the
Property is sold, and the monetization continues beyond the Make-
Whole Date, then the Actual Return to be compared to the Minimum
Return shall be the sum of (i) the proceeds received from the fair
market value sale net of selling costs, plus (ii) the present value
of the remaining monetization debt service payments discounted at
the monetization implicit interest rate plus (iii) the rental income
that the Plan actually received prior to monetization, plus (iv)
Deemed Rent up to the Make-Whole Date, less expenses incurred by the
Plan with respect to the Property and the Lease.
If the Plan monetizes any portion of the rental income, the
Property is not sold, and the monetization continues beyond the
Make-Whole Date, then the Actual Return to be compared to the
Minimum Return shall be the sum of (i) the fair market value on the
Make-Whole Date of the Property (giving full recognition to the
effect of the remaining monetization obligation on future rental
income), as determined by a three appraiser method (if the parties
are unable to otherwise agree) subject to the monetization
obligation, plus (ii) the present value of the remaining
monetization debt service payments discounted at the monetization
implicit interest rate, plus (iii) the rental income that the Plan
actually received prior to monetization, plus (iv) Deemed Rent up to
the Make-Whole Date, less expenses incurred by the Plan with respect
to the Property and the Lease.
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ARINC represents that as a result of the negotiations between ARINC
and IFS, the Make Whole Payment provision safeguards the Plan's
interests in significant ways. First, the provision has been modified
such that it provides for a make whole determination not only
[[Page 55184]]
upon a sale of the Property by the Plan within the first five years,
but also at the end of the first five years if the Plan does not sell
during such period. The Plan is also guaranteed a minimum 5% rate of
return on its investment in the Property. Thus, any Make Whole Payment
triggered in the event of either a sale or at the end of the five-year
period ensures a positive minimum annual return to the Plan of 5%.
Finally, the provision will apply whether or not there is a
Monetization.
The IFS Report describes the Make Whole Payment as a ``make whole''
obligation. ARINC will guarantee a minimum return of 5% to the Plan by
agreeing that if (a) the combination of the proceeds from a sale of the
Property (or the change in the value of the Property if the Plan
continues holding it) plus the Plan's net income on the Property under
the Lease prior to the sale (or over the full five years) is less than
(b) the Property's value as of the date of the Contribution plus a 5%
compounded rate of return on that value plus the costs of holding and
maintaining the Property, then (c) ARINC will contribute to the Plan
the difference necessary to provide the 5% return. The calculation of
the Make Whole Payment will take into account the status of any
Monetization of the lease payments as of the time of the sale or five-
year anniversary of the Contribution. For the IFS opinion on the make
whole obligation, see the IFS Report below.
The Draft Lease Term Sheet specifies further that, notwithstanding
the above provision, if a Make-Whole Payment is due and if, for the
taxable year of ARINC in which the Make-Whole Payment is to be made,
such Make-Whole Payment (A) would not be deductible under section
404(a)(1) of the Code or (B) would result in the imposition of an
excise tax under section 4972 of the Code, such Make-Whole Payment
shall not be required to be made until the next taxable year of ARINC
for which the Make-Whole Payment will be deductible under section
404(a)(1) of the Code and will not result in an excise tax under
section 4972 of the Code.
ARINC represents that its tax adviser, PriceWaterhouseCoopers
(PWC), has determined that the five-year time limitation on the Make
Whole Payment provision is necessary to ensure the deductibility of the
contribution of the property. PWC advises that in the event that the
Internal Revenue Service (IRS) questions the deductibility of the
contribution of the Property to the Plan (the deduction available to
ARINC may also be subject to limitation under section 404 of the Code),
one of the key elements they would likely review is whether there was
an actual transfer of the Property.
In a June 3, 2004 memorandum from PWC to ARINC and submitted to the
Department by ARINC, PWC concluded that ``if the IRS were to question
the deductibility of the contribution to the Plan, the inclusion of the
`Make-Whole' provision creates additional risk that the IRS would
assert that no transfer of property had occurred.'' PWC notes that
although a make-whole provision is generally evidence that an actual
transfer has not occurred, all of the facts and circumstances must be
considered before a determination can be made. In this regard, the
longer the term of the make-whole provision, the more negatively it
will be viewed and conversely, the shorter the term of the make-whole
provision, the less detrimental. This consideration is another reason,
PWC continues, that it recommends eliminating or alternatively making
the term of the make-whole provision as short as possible.
The Applicant asserts that because it is an important economic
aspect of the transaction from ARINC's perspective, there is a
substantial likelihood that ARINC would not proceed with the
transaction unless ARINC is assured that the contribution is
deductible. ARINC represents that, if ARINC does not go forward, the
Plan would be denied the benefit of a voluntary, excess contribution
that is being made on top of its minimum funding requirement and is not
in lieu of cash contributions. Moreover, the proposed transaction is
the only means by which the Plan will likely become fully funded in the
near term.
Indemnification
The Draft Lease Term Sheet provides that ARINC will indemnify,
defend and hold harmless the Lessor and their respective officers,
directors, principals, fiduciaries (including officers, directors and
shareholders of such fiduciaries), shareholders, members, partners,
employees, agents and attorneys (each, a Lessor Indemnified Person)
from all losses, claims, liabilities and damages (other than those
caused by the negligence or willful misconduct of any such Lessor
Indemnified Person and other than consequential damages and indirect
losses) related to (i) ARINC's renovation, use, repair, management,
lease, sublease, maintenance, or operation of the Property, (ii) during
the bondable period of the Lease, violation of any environmental laws,
the Americans with Disabilities Act (ADA) and other health/safety laws
applicable to the Property, and during the nonbondable period of the
Lease, violation of the same only to the extent resulting from acts or
omissions of ARINC or any sublessee or assignee during the Lease Term,
and (iii) any default by ARINC under the Lease.
The Lessor will indemnify, defend and hold harmless ARINC and its
officers, directors, principals, shareholders, members, partners,
employees, agents and attorneys (each, a Lessee Indemnified Person)
from all losses, claims, liabilities and damages (other than those
caused by the negligence or willful misconduct of any such Lessee
Indemnified Person and other than consequential damages and indirect
losses) related to (a) the Lessor's acts or omissions in or about the
Property, (b) violation of any environmental laws, the ADA, or other
health/safety laws caused by an act or omission of the Lessor, and (c)
any default by the Lessor under the Lease. The liability of the Lessor
shall be limited to its interest in the Property (and any insurance
proceeds or condemnation awards related thereto).
The foregoing indemnifications shall survive the expiration or
earlier termination of the Lease Term. The Draft Lease Term Sheet notes
that should any terms in these indemnifications conflict with terms in
the IF Agreement (as described below), the terms in the IF Agreement
will control.
Events of Default
The Draft Lease Term Sheet provides the following events of party
default.
ARINC Default
(a) ARINC shall fail to pay any Rentals or other amounts due under
the Lease within 5 business days of its receipt of written notice that
the same is past due;
(b) ARINC shall fail to maintain the insurance specified in the
Lease;
(c) ARINC shall fail to perform any other obligations or covenants
under the Lease and such failure is not cured within 30 days following
receipt of written notice thereof, or if the failure cannot reasonably
be cured within such 30-day period, then such longer time as is
reasonably necessary under the circumstances provided that ARINC
commences the cure within such 30-day period and diligently and
continuously pursues the cure; and
(d) Certain acts of bankruptcy or insolvency occur on the part of
ARINC.
The Lease shall contain commercially reasonable provisions
regarding late fees and default interest, to be reasonably agreed
between the Plan and IFS and ARINC. The Lessor shall have the right,
[[Page 55185]]
following a default by ARINC that remains uncured following notice and
the expiration of applicable cure periods, to cure such failure and
charge ARINC the costs incurred in connection therewith as additional
rent, in which event ARINC's timely payment of 110% of such amounts
shall constitute cure of such failure provided, however, that with
respect to the third (and any succeeding) default in any 12 month
period that costs more than $250,000, as increased by any increases in
the consumer price index from the date of transfer of the Property (or
the ownership interests in the entity owning the Property) to the Plan
and IFS to the date of the applicable default, to cure (singly, and not
in the aggregate), such payment shall not constitute a cure of such
failure, but shall prevent Lessor from terminating the Right of First
Offer in connection with such failure and ARINC's failure to timely pay
such amounts shall constitute a monetary default under the Lease. It is
expressly agreed that disputes concerning the foregoing cure mechanism
shall be subject to the dispute resolution provisions of the Lease.
Lessor Default
(a) Lessor shall fail to pay any amounts due under the Lease within
5 business days of its receipt of written notice that the same is past
due;
(b) Lessor shall fail to perform any other obligations or covenants
under the Lease and such failure is not cured within 30 days following
receipt of written notice thereof, or if the failure cannot reasonably
be cured within such 30-day period, then such longer time as is
reasonably necessary under the circumstances provided that the Plan
commences the cure within such 30-day period and diligently and
continuously pursues the cure; and
(c) Certain acts of bankruptcy or insolvency occur on the part of
the Lessor.
During the non-bondable period of the Lease, in the event of
Lessor's default that continues uncured following notice and the
expiration of applicable cure periods, ARINC shall have rights of self-
help and, following Lessor's failure to pay ARINC therefor and a
judgment against Lessor requiring payment of the same, the right to
offset the costs incurred in connection therewith against the rent
payable under the Lease.
7. The Monetization. In its Application, ARINC noted that if it is
deemed more advantageous to the Plan by the qualified independent
fiduciary and at the qualified independent fiduciary's discretion,
ARINC proposes that the Plan may, at the time of the contribution and
leaseback or soon thereafter, enter into an agreement to sell the
stream of lease income for the initial ten years of the lease to a
third party for cash (the Monetization).\5\ ARINC believes that the
Monetization would provide further protection to the Plan and
participants by reducing the Plan's exposure to investment in a single
parcel of employer real property and by providing the Plan with a large
influx of cash, which may be reinvested immediately. The Monetization
is not a transaction for which the Applicant seeks exemptive relief.
Pursuant to the Monetization, ARINC believes that the Plan could agree
to enter into a transaction to sell to the third party the initial ten-
year stream of lease income, which the Applicant expects to be worth
approximately $28 million to $32 million in cash. Following the
Monetization, ARINC represents that the Plan, instead of holding
employer real property worth approximately $49 million (or 15% of the
Plan's total assets), would hold approximately $28 million to $32
million in cash related to the real estate transaction and employer
real property with a residual value that is substantially less than 10%
of total plan assets.
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\5\ ARINC provides that this transaction could be structured as
a sale of the stream of lease payments to a third party or a loan
from a third party to be repaid by the stream of lease payments.
---------------------------------------------------------------------------
Since the Application was submitted, ARINC has informed the
Department that IFS has conducted significant due diligence in
determining the feasibility of monetizing the stream of lease payments
the Plan will receive from the property. At this point, IFS believes it
is unlikely that it will be able to obtain a monetization arrangement
that is in the Plan's interests. Of chief concern is a significant
unrelated business income tax (UBIT) issue that is created if the Plan
enters into a secured loan arrangement (with the property as
collateral) with a monetization lender. However, absent such a security
interest, monetization is less attractive to potential lenders.
Nevertheless, IFS does not want unnecessarily to constrain the
possibility of achieving in the future a favorable monetization
arrangement.
8. ARINC's Request for Exemptive Relief. ARINC requests exemptive
relief for (a) the in-kind contribution to the Plan of the Property
(the Contribution); (b) the holding of the Property by the Plan; (c)
the Plan's Leaseback of the Property to ARINC (the initial ten-year
period of the lease will be a ``bondable'' lease and will then convert
to a traditional triple net lease); (d) the Repurchase of the Property;
and (e) any payments to the Plan by ARINC made pursuant to the Make
Whole Payment.
ARINC requests exemptive relief because of its belief that the
contribution of the Property by ARINC to the Plan and the Plan's
holding, leasing and potential future sale of the Property to ARINC
would not meet the requirements for the acquisition, lease or sale of
``qualifying employer property'' under section 408(e) of the Act.
Similarly, the Department notes that if the fee interest in the
Property is first transferred to a newly created SPE and then the
interests in that SPE are transferred to the Plan, this would also
raise issues regarding the requirements for the acquisition or sale of
``qualifying employer securities'' under section 408(e).
ARINC believes that the contribution of ARINC's headquarters
property may violate sections 406 and 407(a) because it would not
constitute ``qualifying employer real property'' since the Property is
a single parcel and since the fair market of the Property immediately
after acquisition would constitute greater than 10% (percent) of the
fair market value of the Plan's assets. ARINC expects that the fair
market value of the Property immediately after the contribution will
constitute approximately 16% of the Plan's assets, based upon the
Plan's current assets. In this regard, the Department believes that for
purposes of the proposed exemption, it would not be practical to
develop a maximum percentage limitation that would continue to apply to
the Contribution of the Property to the Plan over time in view of the
potential changes in value of the real property and the other
investment of the Plan's assets over the possible twenty-three year
period of the Lease. The Department notes that section 404(a) of the
Act requires, among other things, that a fiduciary discharge his duties
with respect to a plan solely in the interest of the plan's
participants and beneficiaries and in a prudent fashion. Section
404(a)(1)(C) further requires that a fiduciary diversify the
investments of the plan so as to minimize the risk of large losses,
unless under the circumstances it is clearly prudent not to do so.
Accordingly, it is the responsibility of the Independent Fiduciary of
the Plan to determine the continued appropriateness of the Plan's
investment in the Property, based on the particular facts and
circumstances, consistent with its responsibilities under section 404
of the Act.
If the proposed exemption is granted, ARINC requests that September
7, 2004
[[Page 55186]]
be the effective date of the exemption since this will allow ARINC
about a one-week period to close the Contribution of the Property prior
to September 15, 2004. The Department agrees and has determined to
propose a September 7, 2004 effective date. If this is done, a Pension
Benefit Guaranty Corporation (PBGC) variable-rate premium payment of
approximately $910,000 will be avoided since no payment is required
under the Act if by September 15, 2004, ARINC contributes to the Plan
the Property whose value is greater than the amount necessary for the
Plan's full funding limit that is due for the 2003 plan year.
9. Reasons for Entering Into the Exemption Transactions. ARINC
believes that the relief requested in its Application offers
significant potential benefits both to the Plan and to ARINC. ARINC
asserts that the Exemption Transactions are in the interest of the Plan
and its participants and beneficiaries because: (a) The contributions
represent a voluntary excess contribution which will be made in
addition to all required cash contributions, (b) the Plan is expected
to be fully funded after the planned cash contributions and the
contribution of the Property, (c) the Plan will receive a valuable
investment property that is likely to appreciate over time, and (d) the
Plan will receive an estimated $4 million to $4.5 million a year in
lease income for the ten years of the initial lease, or if the
qualified independent fiduciary approves the Monetization, the Plan
will immediately receive approximately $28 million to $32 million in
cash and the Plan's exposure to a single parcel of employer real
property will be reduced to less than 10% of the fair market value of
the Plan's assets.
ARINC adds that the transactions will have additional benefits to
ARINC's employees and the company. First, ARINC depends on a highly
skilled workforce and knows that sound pension funding is important in
attracting and retaining a quality workforce. Second, due to accounting
disclosures of other comprehensive income (OCI) required by FAS No.
132, Employers' Disclosures about Pensions and Other Retirement
Benefits, the underfunded status of the Plan lowers ARINC's reported
net worth. Similarly, under the requirements of FAS No. 87, the
underfunded status of the Plan creates a significant added annual
expense. By fully funding the Plan, such FAS No. 132 and FAS No. 87
issues will be mitigated, and the Plan and its participants will
benefit from ARINC's strengthened financial position.
ARINC believes the proposed exemption is administratively feasible
because the transactions would be carried out under the supervision and
direction of a qualified independent fiduciary and would be similar to
other exemptions previously granted by the Department. ARINC asserts
that the proposed transactions would be protective of the rights of the
Plan and its participants and beneficiaries since they would be entered
into at the discretion of a qualified independent fiduciary and the
contribution value would be established with the assistance of a
qualified independent appraiser.
10. The Independent Fiduciary.\6\ For purposes of the proposed
Exemption Transactions and the possible Monetization, IFS has been
retained as the qualified independent fiduciary. ARINC represents that
the Plan shall enter into each of the Exemption Transactions only at
the discretion of the qualified independent fiduciary. The valuation of
the Property as an asset of the Plan, if the contribution of the
Property is accepted, will be determined by the qualified independent
fiduciary based on an appraisal by a qualified independent appraiser.
The qualified independent fiduciary will also be responsible for
enforcing the Plan's rights and interests with respect to the Lease and
any sale of the Property and performing other fiduciary functions on
behalf of the Plan as owner of the Property.
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\6\ The Department notes that the Act's general standards of
fiduciary conduct would apply to the transactions permitted by this
proposed exemption, if granted. In this regard, section 404 of the
Act requires, among other things, a fiduciary to discharge his
duties respecting a plan solely in the interest of the plan's
participants and beneficiaries and in a prudent manner. Accordingly,
an independent plan fiduciary must act prudently with respect to:
(1) The decision to enter into the transactions described herein;
and (2) the negotiation of the terms of such a transaction,
including, among other things, the specific terms by which the Plan
will acquire, hold, lease and sell the Property. The Department
further emphasizes that it expects the independent plan fiduciary,
prior to authorizing the acquisition and leaseback of the Property
and any sale of such Property, to fully understand the benefits and
risks associated with such transactions. In addition, the Department
notes that such plan fiduciary must periodically monitor, and have
the ability to so monitor the Property.
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The qualifications of IFS to serve as the Independent Fiduciary for
these transactions are set forth in the IFS Proposal to ARINC for
serving as independent fiduciary dated November 7, 2003 (IFS Proposal).
The IFS Proposal states that from its formation in January 1987 until
October 1, 1996, IFS was a wholly owned subsidiary of The Bear Sterns
Companies Inc. and an affiliate of Bear, Sterns & Co. Inc. On that
date, ownership transferred to officers of the firm and the name
changed to Independent Fiduciary Services, Inc. IFS believes it is
qualified to perform the evaluations and make the decisions involved
with the ARINC transaction because of its staff's corporate, financial,
investment management, analytical, and ERISA regulatory expertise. IFS
states that it has acted as independent fiduciary on many transactions
involving prohibited transaction applications, including several for
real property transfers and it has longstanding expertise in leaseback
transactions between companies and their pension plans. IFS also states
that it has experience with employers and benefit plans involved in the
aviation industry.
The IFS Report further state that IFS specializes in acting as an
independent fiduciary to ERISA-covered plans. The firm is highly
experienced as a fiduciary in making and evaluating investment
decisions. IFS has served and continues to serve as an independent
fiduciary in connection with numerous pension funds and investment
transactions, involving substantial issues under the fiduciary
responsibility provisions of ERISA. An SEC-registered investment
adviser, IFS has acted in a variety of independent fiduciary roles,
including independent fiduciary, named fiduciary, investment manager
and adviser or special consultant.
IFS also serves as an ongoing investment consultant to ERISA plans
with assets valued at approximately $15 billion. In that part of its
business, IFS routinely evaluates matters of investment policy,
diversification across asset classes and expected risk and return.
The staff of IFS includes professionals experienced with the
management and disposition of portfolio assets, as well as ERISA
lawyers sensitive to fiduciary responsibilities involving investment
activities. With offices in Washington, DC and Newark, New Jersey, IFS
has coordinated and deployed a wide variety of specialized
professionals on prior projects involving real estate sale-leasebacks,
mergers and acquisitions, ERISA assets managed by banks and insurance
companies, publicly-traded securities and private assets, valuation and
financial restructuring.
In a July 20, 2004 letter to the Department, IFS represents that it
does not control ARINC and is not controlled by or under common control
with ARINC. IFS represents that the fees it will receive from ARINC in
connection with its engagement as Independent Fiduciary to the Plan for
any year of its
[[Page 55187]]
engagement, when aggregated with any other fees or compensation it
receives from ARINC or any affiliate of ARINC for that same year, will
comprise less than 5% of its annual gross revenue from all sources for
its prior tax year.
The IF Agreement
In a December 8, 2003 letter agreement between IFS, ARINC, and the
Pension Committee of the Plan, the Committee, in its role as named
fiduciary to the Plan, agreed to the engagement of IFS as the
Independent Fiduciary (The IF Agreement). The IF Agreement describes
the initial function of IFS to decide on behalf of the Plan whether and
on what terms to agree on behalf of the Plan to the Contribution/
Leaseback and, if applicable, the Monetization Transaction. In making
such decisions, IFS will review the Plan's financial and actuarial
condition, asset allocation, investment portfolio, investment policy
statement and other material relevant to a determination as to the
suitability of engaging in the transactions within the context of the
Plan's overall assets.
The IF Agreement provides that, if IFS decides to agree to the
Contribution/Leaseback, IFS will provide a written report (IFS Report)
to the Department outlining its conclusions and summarizing the
analysis and considerations it took into account in reaching such
conclusions. The IFS Report's conclusions shall include IFS's views as
to whether the Contribution/Leaseback satisfies the criteria set forth
in sections 404 and 408(a) of ERISA.
The IF Agreement states that if the proposed exemption is granted
and the transactions entered into, the IFS will negotiate the specific
terms of and closing of the Contribution/Leaseback and, if applicable,
the Monetization Transaction; and determine on behalf of the Plan the
value of the assets obtained by the Plan by virtue of the consummation
of the Contribution/Leaseback and, if applicable, the Monetization. The
ongoing functions of IFS are to: (a) Monitor and enforce the Plan's
rights and interests with respect to the Property and any lease or
other agreements with ARINC regarding use of such Property; (b)
propose, negotiate and decide whether to enter into any agreements to
amend the Lease; (c) evaluate and decide whether to grant requests for
waivers of lease terms; (d) arrange for such appraisals of the Property
as may be necessary to satisfy the Plan's responsibilities under ERISA
and the exemption to establish and report the Property's value; (e)
report annually to the Committee concerning the physical and financial
condition of the Property; (f) determine whether continued ownership of
the Property is in the interests of the Plan's participants and
beneficiaries and whether, when and on what terms to seek prudently to
sell the Property in accordance with provisions of any contract between
the Plan and ARINC; and (g) in the event IFS determines to sell or
otherwise dispose of the Property, negotiating the terms and conditions
of, and consummating the sale or disposition.
The IF Agreement notes that in performing these functions, IFS
agrees that it shall act for the exclusive benefit and in the sole
interest of the Plan and its participants and beneficiaries; with the
care, skill, prudence and diligence that a prudent person acting in a
like capacity and in similar circumstances and familiar with such
matters would exercise; and otherwise in accordance with the applicable
fiduciary responsibility provisions of ERISA. IFS represents that it
will act as a qualified professional asset manager (QPAM) as defined in
PTE 84-14 with respect to the Monetization or a sale of the Property to
a third party if relief from ERISA section 406(a) is necessary.
Amendment and Addendum to the IF Agreement
On July 30, 2004, the Department was informed that the ARINC
Pension Committee, ARINC and IFS agreed to an amendment and addendum to
the IF Agreement that expands the role of IFS to include the ongoing
review of the Plan for any diversification issue that may be presented
by the Plan's investment in the Property. As part of IFS's ongoing duty
to determine whether continued ownership of the Property is in the
Plan's interest, IFS will specifically consider the nature and
diversification of the Plan's overall investment portfolio, cash flow
and liquidity needs and actuarial condition. ARINC will supply IFS with
added information so that it can appropriately carry out this function.
The purpose of these expanded duties will be to ensure that IFS
determines on an ongoing basis that the Plan's holding of the Property
does not pose an undue risk to the Plan of an over concentration of
Plan assets in the Property. The following changes were added to the IF
Agreement:
? In considering whether and on what terms to seek prudently
to sell the Property, IFS shall consider the nature, value and other
relevant aspects of the Property in isolation, as well as the nature
and diversification of the Plan's overall investment portfolio. Insofar
as IFS determines that continued ownership of the Property poses undue
risk to the Plan of over concentration from an investment perspective,
IFS shall determine and take appropriate action to seek prudently to
reduce such risk.
? The initial and ongoing functions of IFS shall not include
any Plan assets other than Property assets, provided that IFS shall
consider the nature and diversification of the Plan's overall
investment portfolio pursuant to its function to determine whether
continued ownership of the Property is in the interests of the Plan's
participants and beneficiaries and whether and on what terms to sell
the Property.
? At the request of IFS, the Committee and/or ARINC shall
specifically provide information regarding the nature and
diversification of the Plan's overall investment portfolio, its cash
flow and liquidity needs, and its actuarial condition.
? ARINC acknowledges that it is a party to the IF Agreement
and is subject to the obligations imposed on ARINC therein.
Termination of the IF Agreement
The parties to the IF Agreement are ARINC, the Plan Committee and
IFS. The IF Agreement provides that any party to the IF Agreement may
terminate it at any time by giving written notice to that effect to the
other parties, and such termination shall become effective no less than
30 days thereafter, provided, however, that ARINC pays IFS and its
agents all of their respective fees and expenses through the effective
date of termination. In the event of termination, IFS shall cooperate
with any successor independent fiduciary and shall promptly deliver all
relevant documents and information in connection with the transactions
to such successor independent fiduciary. IFS will not assign its
obligations to perform services hereunder to any other party without
the prior written consent of the Committee.
The Department notes that if any party to the IF Agreement
terminates the IF Agreement or if IFS decides to assign its obligations
to perform services, the parties to the IF Agreement shall notify the
Department within 15 days of any decision regarding the resignation,
termination or change in control of the Independent Fiduciary. Any
replacement or successor Independent Fiduciary must be acceptable to
the Department and must assume its responsibility prior to the
effective date of the removal of the predecessor Independent Fiduciary.
11. The IFS Report. IFS provided the IFS Report to the Department
on June 18, 2004. The IFS Report states that ARINC has advised IFS that
the
[[Page 55188]]
Contribution and Leaseback (the Proposed Transaction) is the only
funding strategy under formal consideration by ARINC that would render
the Plan fully funded on an ABO basis in the near term, and that if the
Proposed Transaction proceeds, ARINC intends to make an additional cash
contribution to the Plan in 2004 in an amount (estimated at $9 million)
sufficient to achieve that objective, absent unexpected deterioration
in the Plan's funded status due to unforeseen investment losses.
Without the Proposed Transaction, minimum required contributions
totaling more than $97 million would leave the Plan underfunded by
between $52 million and $77 million on an ABO basis through 2008. With
the Proposed Transaction and accompanying additional cash contribution
in 2004, no minimum funding contributions would be required until 2008,
and the underfunding would range from only $12 million to $41 million.
The IF Report summarizes that the Proposed Transaction includes the
following features, which are protective of the interests of the Plan's
participants and beneficiaries:
? The bondable nature of the triple net lease during its
first ten years means that ARINC, not the Plan, will bear during that
time not only the ordinary maintenance, tax and insurance expenses
associated with a triple net lease but also all capital expenses
associated with the Property. In addition, during the bondable portion
of the lease, ARINC will not have a tenant's typical right to rent
abatement in the event the Property suffers a casualty and cannot be
occupied.
? ARINC relinquished its demand for an option to purchase
the Property at the end of the lease, so the Plan will have an
unencumbered right to sell or lease the Property to anyone when ARINC's
lease expires.
? ARINC relinquished its demand for a right of first refusal
during the term of the lease, and has now accepted a far less
restrictive right of first offer (ROFO). That right is subject to
forfeiture in the event of ARINC's uncured monetary default.
? ARINC relinquished its demand that the ROFO ``run with the
land,'' so it will be extinguished if ARINC declines to exercise the
right and the Plan sells the Property to a third party
? ARINC has agreed to provide the Plan a minimum rate of
return on the Property as of the fifth anniversary of the contribution
or an earlier sale of the Property by the Plan. This will take the form
of ARINC's payment of an additional ``make-whole'' contribution to the
Plan in the amount of the shortfall, if any, in the Plan's actual
return on the Property against a minimum return of five percent
compounded. The calculation of the make-whole contribution will take
into consideration any monetization of the lease payments.
? The Property the Plan would receive is an attractive,
well-maintained corporate campus in the desirable real estate market of
Annapolis, Maryland. The Property's configuration, combined with its
location, renders it readily marketable to parties other than ARINC in
the event the lease is terminated. Indeed, ARINC recently leased a
portion of the Property to a third party (BearingPoint), which confirms
the Property's attractiveness to users other than ARINC.
? In addition to improving the Plan's actuarial condition,
both immediately and into the future, the Proposed Transaction will
render the Plan less dependent on ARINC's cash flow in view of the
substantial reduction in the Plan's minimum funding requirements if the
Proposed Transaction occurs. Moreover, since the Plan does not
currently own any real estate, the Proposed Transaction should improve
the overall diversification of the Plan's portfolio in view of the low
expected correlation of the investment returns on the Property with the
publicly traded equity and fixed income securities in which the Plan's
assets are currently invested. Applying its capital market assumptions
to the Plan's portfolio both with and without the Property included,
IFS has determined that the expected risk-adjusted return on the Plan's
assets will increase significantly if the Proposed Transaction takes
place.
The IFS report concludes that the Proposed Transaction is
appropriate and in the interest of the Plan's participants and
beneficiaries. IFS reaches this conclusion based upon the
considerations summarized above and explained more thoroughly below,
and its significant due diligence as also described more completely
below. Based on IFS' experience and due diligence in reviewing the
Proposed Transaction, IFS believes that the terms of the Proposed
Transaction, taken as a whole, are consistent with an arm's length
negotiation between a Seller and Buyer with the respective goals of
ARINC and the Plan. This conclusion reflects, inter alia, IFS'
consideration of the likely effect of the ROFO provisions in the
context of the overall Proposed Transaction. ARINC has made it clear to
IFS that, as a business judgment, ARINC simply will not contribute the
Property to the Plan without the ROFO, which preserves for ARINC a
limited right to buy its corporate headquarters back if the Plan were
to decide to sell it during the term of the lease. Given the
significant and beneficial impact of the Proposed Transaction on the
Plan's funded status, the limitations on the ROFO that ARINC has
accepted, its withdrawal of its earlier demands for far more
restrictive right of first refusal and purchase option provisions, the
``make-whole'' obligation and the other aspects of the transaction, IFS
concludes that the Plan would be in a better overall position with the
Property on the terms of the Proposed Transaction than without it. The
Proposed Transaction is designed to produce significant value for the
Plan, even with a limited ROFO, so that proceeding with the Proposed
Transaction is in the Plan's interest.
Although IFS has attorneys with extensive experience counseling
ERISA-governed benefit plans in issues related to plan investments in
general, and real estate and employer asset transactions in particular,
IFS has engaged the firm of Reed Smith, at ARINC's expense, to advise
it with respect to the legal issues raised by the Proposed Transaction.
Reed Smith attorneys have participated actively in the negotiation of
the terms of the Proposed Transaction and assisted in the analysis of
the Proposed Transaction for purposes of the IFS report. IFS has also
identified other independent professionals to assist it (also at
ARINC's expense), including an engineering firm and an environmental
testing firm, all as detailed below.
The Property and Appraisal
The IFS Report states that Deloitte was well qualified to conduct
the appraisal, and that the firm's knowledge of the Property (by virtue
of a preliminary appraisal of the Property for the Plan which Deloitte
conducted at ARINC's request in the fall of 2003) would facilitate the
process for completing the appraisal. IFS requested proposals from five
other firms it considered likely also to have the qualifications and
experience to conduct the appraisal, but only one of these responded;
the others declined. IFS determined that Deloitte was in a better
position to conduct the appraisal due to its equal or superior
qualifications and its familiarity with the Property.
Although Deloitte had previously entered into a contract with ARINC
to appraise the Property for the benefit of the Plan, IFS required that
Deloitte enter into a new agreement with the Plan on significantly
different terms. IFS obtained changes to the engagement letter document
proposed by Deloitte
[[Page 55189]]
with regard to the scope of the engagement, specifying additional
issues regarding the Property to address in the appraisal report that
would be relevant to IFS' analysis of the Proposed Transaction. There
were extensive negotiations over several other key points. First, IFS
successfully demanded that the agreement with Deloitte contain no
indemnification obligation on the part of the Plan. Next, IFS persuaded
Deloitte to restrict the limitations on Deloitte's liability typically
included in Deloitte's agreements with appraisal clients. Third, IFS
required that Deloitte agree to an exception to Deloitte's standard
confidentiality provisions to allow IFS to disclose and use the
Deloitte appraisal report as necessary and appropriate in connection
with the Application. A final engagement letter was executed in late
March 2004. Under its terms, ARINC, not the Plan, is to pay the costs
of the Deloitte appraisal.
The IFS Report states that the information about the Property is
derived largely from Deloitte's Appraisal. In addition, two IFS
employees (including IFS's Chief Financial Officer) visited the
Property on May 5, 2004 and toured the grounds and the various
buildings accompanied by two representatives from Deloitte's appraisal
staff and three ARINC employees. The Property is located at 2551 Riva
Road, Anne Arundel County, Maryland, just outside the city of
Annapolis, the capital of Maryland and the county seat. The site,
identified as Parcel 2000-9003-8018, consists of approximately 27.595
acres, between Riva Road and Spruill Road and divided by Admiral
Cochrane Drive. It is zoned W-1, Parole Town Growth Management Area.
This zoning allows a diverse mix of office, retail, hotel, services,
R&D, light industrial and similar uses. The Property reportedly
conforms to minimum zoning requirements.
Site improvements consist of six buildings, five configured for
office use and one as office and light industrial, plus several small
support structures. Total gross area is approximately 359,283 square
feet, with 345,983 net rentable square feet. The oldest two buildings
were constructed in 1964; the newest in 1989 and expanded in 2001. In
addition, buildings were renovated between 1996 and 2002, with a
capital plan in place for additional renovations over the next several
years. Buildings on either side of Admiral Cochrane Drive are
interconnected by covered surface passageways, permitting movement
among sets of buildings in a weatherproof environment. There are
currently 1,367 paved surface parking spaces. ARINC reported that the
site is zoned and situated to permit the construction of an additional
approximately 140,000 square feet.
The Property's overall arrangement and appearance presents a well-
maintained office campus environment. The buildings are attractive and
appear to be in good condition and well maintained. As Deloitte
reported, grounds were well landscaped and maintained. Parking lots
appeared in good condition and clearly marked. The public road (Admiral
Cochrane Drive) bisecting the Property allows easy access, yet security
at the buildings was thorough. Generally, the Property appeared to be
fully occupied and actively used in ARINC's business.
One floor of Building One, consisting of 27,630 square feet, is
currently leased on a short-term basis to BearingPoint. BearingPoint
has its own separate access and security. BearingPoint's willingness to
rent the Property supports the proposition that the Property is
attractive and marketable to users other than ARINC.\7\
---------------------------------------------------------------------------
\7\ At IFS' insistence on behalf of the Plan, the lease between
ARINC and BearingPoint explicitly provides that it will convert into
a sublease if the Proposed Transaction occurs. In the event that
ARINC defaults under the lease with the Plan while the BearingPoint
sublease remains in effect, and the building occupied by
BearingPoint requires capital repairs, the Plan can avoid that
expense by relocating BearingPoint to a different building on the
Property. The sublease contains other provisions protective of the
Plan in contemplation of the Proposed Transaction.
---------------------------------------------------------------------------
The neighborhood surrounding the Property consists of a mix of
similar use structures, retail, and hotel properties. Many structures
appear of recent construction or renovation, and at least one hotel is
currently under construction. The Property is convenient to major
highways providing connections to Annapolis, Baltimore and Washington;
it is easily accessible from Route 50 and Aris T. Allen Boulevard
(Route 665).
Valuation of the Property
Deloitte was engaged to determine the market value of the Property
and its fair rental value using the definitions and methods generally
accepted in such appraisals. Standard practice in appraising real
estate similar to the Property is to establish value using each of
three approaches (cost, sales comparison and income) to the extent that
each approach is applicable, and to apply appropriate weightings to the
three resulting values to reach a single conclusion. The cost approach
estimates the market value of the land as if vacant and the cost to
replace the improvements less depreciation to their current conditions.
The sales comparison approach estimates the market value based on sales
and listings of similar properties. The income approach estimates value
by capitalizing the net income the property is capable of generating at
market rates. Deloitte determined that all three approaches were
applicable to the Property.
IFS reviewed a preliminary draft of the appraisal, which Deloitte
delivered on April 19, 2004. The IFS team identified several key issues
requiring further analysis and explanation. For example, IFS questioned
the draft's assumptions regarding the capital expense reserves, the key
element in calculating the differential in fair market rent as between
the bondable and non-bondable structures. IFS also requested that
Deloitte further review and explain the suitability of the comparable
transactions relied upon in the draft, as well as the market and
economic considerations underlying the capitalization rate and other
variables. IFS also sought input from ARINC, which resulted in
corrections of the draft's property measurements and descriptions of
the equipment and facilities located on the Property. ARINC staff also
contributed to the clarification of Deloitte's assumptions and inputs.
These and other issues were discussed with Deloitte on May 5 at the
conclusion of the tour of the Property described above.
Deloitte submitted a second draft dated May 25, 2004. This draft
addressed a number of the issues IFS had raised in response to the
first draft. The second draft also added a valuation using a
modification of the income approach to reflect the evolving terms of
the Proposed Transaction, including the ten-year bondable lease period
and the parties' respective responsibilities and cash flow obligations
under the proposed lease. The May 25 draft presented the following
estimates of value:
------------------------------------------------------------------------
------------------------------------------------------------------------
Cost Approach............................................. $46,500,000
Sales Comparison Approach................................. 46,000,000
Income Approach, NNN Direct Cap........................... 45,300,000
Income Approach, NNN DCF.................................. 45,000,000
Income Approach, Bondable DCF............................. 52,000,000
Overall Conclusion........................................ 52,000,000
Initial Rent, NNN......................................... 14.65
Initial Rent, Bondable.................................... 13.35
------------------------------------------------------------------------
IFS evaluated the May 25 draft and discussed with Deloitte the cash
flow and other assumptions and concluded that the differentials in
value and fair rent between the NNN market rate and the bondable/NNN
structure overstated the differentiating factors of responsibility for
capital expenditures
[[Page 55190]]
and risk of casualty or other rent abatement.
Deloitte's final report sets forth the values listed below. IFS is
satisfied that the Deloitte report satisfactorily addresses the
concerns IFS raised in response to all of the earlier drafts and may be
relied upon as the basis for IFS' conclusions regarding the Proposed
Transaction as set forth in this Report. The values determined by
Deloitte are:
------------------------------------------------------------------------
------------------------------------------------------------------------
Cost Approach............................................. $46,900,000
Sales Comparison Approach................................. 46,000,000
Income Approach--Capitalization........................... 46,600,000
Income Approach--DCF...................................... 46,800,000
Reconciled Market Value................................... 46,500,000
Bondable/NNN Lease Structure.............................. 49,000,000
Final Reconciled Value.................................... 49,000,000
------------------------------------------------------------------------
Deloitte concluded that the final reconciled value should be the
fair value based on the actual terms of the proposed lease, including
the actual distribution of responsibility and cost for capital
maintenance, and not on a more generalized market value based on market
standard lease terms. IFS agrees with this view.
As a component of determining value under the income approach, as
well as a requirement of the engagement, Deloitte developed an estimate
of the fair rent for the Property, given the substantive terms of the
Lease, including the bondable and non-bondable character of the rent
obligation, as described in II(C), above.
Deloitte determined the fair rent based on competitive gross rents
for similar properties in the area, reduced for reasonable costs and
allowances that a landlord would incur in managing such a property and
renting it under a similar lease structure to an unrelated tenant. This
resulted in a triple net lease fair rental rate of $14.65 per rentable
square foot. Deloitte then estimated the cost reserve applicable to the
capital maintenance of the Property, the vacancy risk and other factors
in order to determine the difference between the triple net and the
bondable lease rental rates, and arrived at a bondable fair rental
value rate of $12.40 per rentable square foot. Finally, Deloitte
determined that fair market leases contain annual escalation in base
rent of 2.50 percent.
IFS concluded that the final values Deloitte has calculated benefit
the Plan in several ways, relative to their earlier draft values. The
reduction in value from $52 million to $49 million reduces the amount
of the contribution to the Plan that the Property will constitute. This
will be offset, however, by an increase in the additional cash
contribution ARINC intends to make to fully fund the Plan on an ABO
basis if the Proposed Transaction proceeds. The lower property value
also reduces the extent to which the Plan's overall portfolio is
concentrated in a single asset, the Property. Additionally, because the
contribution value is closer to the value under more typical terms
(i.e., a non-bondable triple-net lease), the risk of a value reduction
if the Property is sold or leased to a different tenant is reduced. IFS
notes that although the rent on the Property per square foot and,
therefore, the total annual rent the Plan will receive are lower in the
final appraisal than in the earlier draft, the value of the Property
and thus the value of the contribution, are also lower. Accordingly,
the resulting cash on contribution yield (i.e., rent divided by
contribution value) in the final appraisal is essentially the same as
in the draft appraisal since both the numerator and the denominator in
the yield calculation are lower. In other words, the income yield on
the property, measured by rental income as a percentage of property
value, is essentially unchanged.
Deloitte also evaluated the marketability of the Property and its
fitness for multiple uses within the overall area and market in which
it is located. Factors affecting this include the strength and growth
patterns of the region and the physical structure as well as the
permitted uses of the Property.
The Contribution
IFS notes that the Transfer Agreement provides for a 60-day Review
Period during which the Plan may conduct final due diligence concerning
the Property. The Plan, by IFS as independent fiduciary, may terminate
the Transfer Agreement at any time during the Review Period, in which
event the Proposed Transaction will not be consummated and the
Contribution will not take place. During the Review Period, IFS may, on
behalf of the Plan, conduct such inspections and surveys as to title,
zoning, insurance, engineering, environmental and other matters as it
sees fit. ARINC is obligated to pay all of the costs, including
attorneys' fees, which IFS incurs on behalf of the Plan in connection
with the Proposed Transaction, including the fees of the consultants
and experts IFS retains on behalf of the Plan to assist it in the due
diligence process. IFS engaged Deloitte and is prepared to contract
with environmental, engineering and insurance experts to advise it.
ARINC, not the Plan, is paying their fees, as well as Reed Smith's
fees.
The closing is contingent upon, in addition to standard conditions,
the Department's issuance of a prohibited transaction exemption. In
addition, ARINC and ARI are required under the Transfer Agreement to
certify at closing that their representations and warranties concerning
the Property and other matters made in the Transfer Agreement are still
accurate. If the Contribution is consummated, IFS will determine the
value of the Property to be recorded on the Plan's books, taking into
account the results of the appraisal performed by Deloitte.
The Lease
The IFS Report states that upon the Contribution, the Plan will
lease the Property back to ARINC; indeed, execution of a lease between
the Plan (or the SPE) and ARINC is a condition to a closing of the
Contribution. The terms of the proposed lease (the Lease) are set forth
in a detailed term sheet (the Draft Lease Term Sheet). As explained
below, the Lease will be a triple net lease (i.e., the base rental
shall not include real estate taxes, utilities and insurance, as well
as certain costs for the operation, maintenance, management, repair and
replacement of the Property, all of which costs shall be paid by ARINC
as tenant) throughout its term, and will be ``bondable'' for the first
ten years unless the Property is sold during that time.
The Lease shall start as a ``bondable'' lease, in which ARINC's
obligation to pay rent to the Plan will be absolute and unconditional
and the rental payments will be exclusive of all costs related to the
Property, including real estate taxes, utilities and insurance, which
ARINC will pay. ARINC will bear the costs of capital improvements and
all other costs to operate, maintain, repair and replace in good
condition the systems and structural and non-structural components of
the buildings on the Property, all in a manner befitting office
buildings in Annapolis, Maryland that are comparable to the buildings
on the Property and in accordance with all applicable laws. The Lease
shall contain a commercially reasonable standard for determining
whether repair or replacement is necessitated. All such maintenance,
repair and replacement work shall be performed by ARINC. This bondable
character of the Lease remains in effect until the earlier of (i) the
end of the first 10 years of the Lease Term or (ii) the date on which
the Property is sold to a third party or transferred to a Lender, at
which time the Lease shall convert to a ``non-bondable'' lease (as more
particularly described immediately below).
During the ``non-bondable'' term of the Lease, ARINC will continue
to be
[[Page 55191]]
responsible for real estate taxes, utilities and insurance, and all
ordinary, commercially reasonable, non-capital costs of operating,
repairing and maintaining the Property. (This type of arrangement is
commonly called a ``triple net'' lease, or--in shorthand--``NNN''). The
Plan shall be responsible only for all capital repairs and replacements
and other costs incurred in connection with the Property that
customarily are the responsibility of owners of real property leased
under triple net, non-bondable leases, all in a manner befitting office
buildings in Annapolis, Maryland that are comparable to the buildings
on the Property, and in accordance with all applicable laws. The Lease
will reallocate responsibility for various obligations effective upon
the conversion to a non-bondable structure, including all such capital
maintenance, repair and replacement work. ARINC shall continue to
perform such work upon the Plan's approval, subject to reimbursement,
as applicable, by the Plan. In addition, ARINC will have rights of
abatement and termination for casualty, condemnation and failure of
utilities and services, as described in the Draft Lease Term Sheet and
to be defined more precisely in the Lease.
IFS states that the rental payments under the Lease are to be set
at fair market rates. Subject to final due diligence and the approval
of the Independent Fiduciary, the annual base rent for the Property as
a whole is expected to be based on the current fair market rental value
identified in the Appraisal, $14.65 per square foot under the non-
bondable structure and $12.40 under the bondable structure. Both rates
will increase at 2.50 percent per year, compounded. ARINC will pay the
bondable rate as long as the Property is leased under the bondable
conditions, after which the rent will increase to the non-bondable
triple net rate then in effect (i.e., reflecting the annual increases).
Any subletting profits during the bondable period will be retained by
ARINC, but the Plan will receive 50% of such profits during the non-
bondable term.
If ARINC exercises the option to renew the Lease for three years,
the rent for that additional term will be equal to the then prevailing
fair market rental, and no lower than the rent paid during the last
year before the renewal period starts, with disputes concerning the
rent for the renewal period to be resolved by a three-appraiser method.
During negotiations, IFS obtained ARINC's agreement that the renewal
right cannot be exercised if there have occurred during the 18-month
period preceding the election date more than three material monetary
defaults that continued uncured following notice and the expiration of
applicable cure periods.
The Make Whole Obligation
The IFS Report concludes that the fact that the Make Whole
Obligation will not extend beyond the first five years will not
adversely affect the Plan absent a catastrophic decline in the
Property's value. This is because the rental income under the Lease
significantly exceeds the 5% threshold. The IFS Report presents an
analysis of the make whole provision on a break-even basis. The actual
accumulated rental income is compared to the guaranteed value at the
end of each year (i.e., the initial contribution value of $49 million
plus five percent minimum return). The difference is the minimum
property value (sale price or appraised value) necessary for the actual
return to equal the guaranteed 5% return. The value of the Property at
the end of year five (when the make whole will be calculated assuming
the Property has not been previously sold) can be as low as $39,987,251
to achieve the guaranteed five percent return. This value is 81.6
percent of the initial contribution value, meaning that the Property
would have to lose at least 18.4 percent of its value over the first
five years in order to trigger a make whole contribution at the end of
the five years to provide the Plan with the guaranteed five percent
return, and the loss would have to increase thereafter for the Plan to
fail to achieve the 5%.
The Monetization
The IFS Report states that IFS has been exploring various proposals
to monetize the stream of lease payments in order to convert them into
an immediate cash payment and reduce the Plan's allocation of assets to
the Property. IFS has held extensive discussions with several
prospective counterparties and investment bankers about alternative
proposals that would enable the Plan to receive a lump sum payment in
exchange for a counterparty receiving the cash flow associated with the
lease payment stream. IFS notes that in general, structuring the
transaction as a financing creates the risk that the transaction will
subject the Plan to unrelated business income taxes. Conversely,
structuring the transaction as an outright sale raises more credit risk
issues and costs with the counterparties, and effectively reduces the
value to the Plan. At present, no counterparty appears willing to
proceed with an outright purchase of the lease stream. IFS notes that
while they continue to engage financial institutions in discussions of
various proposals, they do not expect that a monetization transaction
will occur.
Analysis and Determination by IFS
The Impact of the Proposed Transaction on the Plan's Funding Status
In order to evaluate the impact of the Proposed Transaction on the
Plan's financial and actuarial condition over the next five years, IFS
reviewed the Plan's asset allocation target, as well as actuarial
projections provided by ARINC's actuary, Watson Wyatt. The IFS Report
tables below compare the status of the Plan under two scenarios: (1)
The Proposed Transaction proceeds and ARINC makes an additional $9
million cash contribution to the Plan in 2004 and minimum contributions
after that; (2) the Proposed Transaction does not proceed and ARINC
makes only the minimum required contributions.
----------------------------------------------------------------------------------------------------------------
2004 2005 2006 2007 2008
----------------------------------------------------------------------------------------------------------------
Plan Assets at November 30 of prior year ($ millions)
----------------------------------------------------------------------------------------------------------------
With transaction and minimum 243.6 305.8 307.4 308.5 309
future cash contributions.....
Without transaction (minimum 243.6 244.3 242.3 269.2 298.2
cash contributions only)......
--------------------------------
Funded Status \8\ ($ millions) at November 30 of prior year
----------------------------------------------------------------------------------------------------------------
With transaction and minimum (64) 0.4 (11.6) (25.4) (41)
future contributions..........
Without transaction (minimum (64) (61.1) (76.7) (64.7) (51.8)
contributions only)...........
--------------------------------
[[Page 55192]]
Funding Standard Account credit balance at January 1 ($ millions)
----------------------------------------------------------------------------------------------------------------
With transaction and minimum 19.5 56.1 33.9 3.0 0
future cash contributions.....
Without transaction (minimum 10.5 0 0 0 0
cash contributions only)......
--------------------------------
Plan Funding Contributions, Property and Cash ($ millions)
----------------------------------------------------------------------------------------------------------------
With transaction and minimum 62.5 0 0 0 27.4
future cash contributions.....
Without transaction (minimum 4.5 2.5 30.4 31.1 29.1
cash contributions only)......
--------------------------------
Cash flow from ARINC to the Plan ($ millions)
----------------------------------------------------------------------------------------------------------------
With transaction (minimum 11.1 4.3 4.5 4.6 32.1
contribution plus rent).......
Without transaction (minimum 4.5 2.5 30.4 31.1 29.1
cash contributions only)......
----------------------------------------------------------------------------------------------------------------
\8\ Market value of plan assets less Accumulated Benefit Obligation.
Based on this analysis, IFS believes that the Proposed Transaction
would place the Plan in a better actuarial and financial position over
the five years, with a higher funding percentage and a larger funding
standard account credit balance, with lower cash contributions from
ARINC. The last chart shows that even when ARINC's rent is taken into
account, the Plan will be less reliant on ARINC's ability to generate
cash for payments to the Plan. IFS adds that more generally, since the
Property is a marketable asset with value independent of ARINC as the
lessee, the Proposed Transaction would reduce the Plan's reliance on
ARINC's creditworthiness.
The Plan's Investment Portfolio
Investment Policy
IFS notes that the Plan's investment policy statement currently
permits investments in equities (domestic and international), fixed
income, real estate, immediate participation guarantee contracts issued
by insurers and cash equivalents. The Plan's current target asset
allocation is:
30% large cap domestic equity
30% small cap domestic equity
10% international equity
27.5% domestic fixed income
2.5% cash
The actual asset allocation as of March 31, 2004 was 64% U.S.
stocks, 11% international stocks, 24% U.S. fixed income, and 1% cash.
The Plan currently owns no real estate, and owns no employer
securities.
Asset Allocation Analysis/Expected Risk and Return
The IFS Report states that if the Proposed Transaction proceeds and
the Property becomes an asset of the Plan valued at $49 million, and if
ARINC makes the additional cash contribution of $9 million to achieve
ABO full funding, the Property will represent approximately 16% of the
Plan's assets. Assuming no reallocation of the Plan's other assets
after the Contribution, the Plan's target asset allocation would
become:
25% large cap domestic equity
25% small cap domestic equity
16% real estate
9% international equity
23% domestic fixed income
2% cash
IFS expects that adding a real estate asset like the Property to a
portfolio of publicly traded securities should enhance overall
portfolio diversification. The expected correlation of returns of
institutional quality real estate relative to public equities is only
approximately 0.20, and relative to publicly traded fixed income, it is
also only approximately 0.20.
ERISA Section 404(a)(1)(C)
In light of the diversification requirement set forth in ERISA
Section 404, IFS has considered the fact that if the Proposed
Transaction proceeds, approximately 15% of the Plan's assets would be
invested in a single asset, the Property. As a preliminary matter,
IFS's diversification analysis recognizes that the Plan currently holds
no real estate assets--its other assets consist entirely of marketable
equity and fixed income securities. Less than 25% of the current assets
of the Plan are fixed income investments. IFS notes that it is well
recognized that real estate leased to a creditworthy tenant enhances an
institutional investor's portfolio diversification in view of the low
correlation of returns (0.20 as discussed above) as between real estate
and other asset classes such as the equity and fixed income securities
in which the Plan's assets are currently invested and that
diversification can be expected to improve the Plan's risk adjusted
returns.
Attorneys from Reed Smith, led by Donald J. Myers and Michael B.
Richman, experienced practitioners in matters requiring prohibited
transaction exemptions, have assisted IFS in the analysis of this
important issue. Based on the advice IFS received from Reed Smith, IFS
is satisfied that the Proposed Transaction would not cause the Plan to
fail to satisfy the statute's diversification requirement.
Due Diligence Regarding the Property
As indicated above, IFS representatives have physically inspected
the Property. In addition, IFS represents that it intends to use the
Review Period under the Transfer Agreement to analyze thoroughly the
condition of the Property and the safeguards available to protect the
Plan if the Proposed Transaction proceeds. In anticipation of the
commencement of the Review Period, IFS has identified experts to assist
in the due diligence process.
IFS sent requests for proposals to two consulting firms, URS Corp.
and EBI Consulting, to perform a property condition assessment (PCA).
The purpose of this PCA will be to assess the physical condition of the
Property and to document any defects. The building components and
systems evaluated will include site development; building structure and
envelope; building exteriors; roofs and facades; building interiors;
vertical transportation systems; mechanical, HVAC, electrical,
plumbing, conveyance, and life safety
[[Page 55193]]
and fire protection systems; and accessibility for disabled persons.
While both firms appeared qualified to perform the work, URS was
selected because of favorable recommendations from firms active in the
real estate business. IFS is finalizing a formal contract with URS. The
firm has agreed to conduct its PCA in general conformance with the
American Society of Testing and Materials (ASTM) guidelines for
property condition assessments.
Separately, IFS will contract with Custer Environmental, a
respected environmental consultant, to provide an environmental site
assessment (ESA) of the Property. Custer was selected because the firm
is well qualified for the work and familiar with the Property, having
conducted a Phase I ESA in March 2002. The assessment to be performed
will follow the ASTM standards and provide an update to the 2002 Phase
I ESA. Custer will conduct follow-up interviews with various
governmental agencies that have site-specific knowledge; review
documentation pertaining to soil and groundwater contamination; conduct
an investigation to determine the presence of hazardous materials,
underground storage tanks, and other potential hazards related to
ground water contamination; perform a background investigation of the
site and adjacent property histories; and inspect the buildings for
suspected asbestos-containing materials.
IFS also expects to contract with an expert in insurance issues
pertinent to the ownership of real estate similar to the Property. We
anticipate that this insurance expert will evaluate the adequacy of the
insurance coverages ARINC currently maintains on the Property and, if
appropriate, recommend changes in or additions to those coverages.
ARINC's Creditworthiness and Financial Condition
The IFS Report states that in mid-January 2004, Moody's and
Standard & Poor's issued initial public ratings of ARINC's proposed
$200 million senior secured credit facilities. Moody's assigned a
rating of ``Ba3'' to the proposed credit facility and ``B1'' to ARINC
as the issuer. S&P assigned its ``BB'' corporate credit rating to ARINC
and the proposed credit facility. These ratings place the ARINC debt
one level below what is considered investment-grade quality. IFS not
only reviewed the ratings reports but also discussed them with the
rating agencies' personnel.
IFS notes that a credit rating reflects the rating agency's opinion
of the relative default risk over the life of a debt issue,
incorporating an assessment of all future events to the extent they
reasonably can be anticipated. Such ratings reflect both the likelihood
of default and any financial loss that may reasonably be anticipated in
the event of default. Investment grade obligations are rated Aaa, Aa,
A, and Baa by Moody's and AAA, AA, A, and BAA by S&P. The next two
levels of ratings, Ba and B (Moody's) and BB and B (S&P), imply that
the rating agency believes the obligations to have speculative elements
and are subject to substantial credit risk. Moody's Ba3 rating of the
credit facility placed it at the lowest of three rankings within the
``Ba'' category, while S&P's B1 rating places ARINC at the highest
ranking in the ``B'' category.
S&P also gave ARINC a rating ``outlook'' of ``Stable.'' A rating
outlook assesses potential for change and is assigned as an ongoing
component of all long-term ratings. Outlooks have a long time horizon,
and incorporate trends or risks with less certain implications for
credit quality. Outlooks may be ``positive,'' indicating a rating may
be raised, or ``negative,'' indicating a rating may be lowered.
``Stable'' is the outlook assigned when ratings are not likely to be
changed. The time frame for an outlook generally is up to two years.
S&P's credit rating of ARINC is derived from ARINC's small equity
base, limited financial flexibility, and the weak domestic commercial
aviation market, offset somewhat by ARINC's leading positions in
aviation communications markets and the positive outlook for defense
spending. S&P believes ARINC's leading niche market positions, steady
defense business, and, significantly, its efforts to address its
underfunded pension plan should offset its exposure to the commercial
aviation market and somewhat higher debt levels. Moody's ratings
considered ARINC's relatively stable and diversified revenue base, with
more than 65% represented by contractual revenue from governmental
agencies, its dominant market position in air-to-ground communication
services to airlines worldwide, and its solid track record of revenue
growth and stable margins.
Since ARINC received ratings below investment grade and its outlook
was deemed ``Stable,'' IFS considered the impact on the Property's
value to the Plan if ARINC were to default on its obligations under the
Lease. That analysis is discussed immediately below.
Value of the Property as a Marketable Asset
IFS believes that a critical aspect of the process of determining
whether the Proposed Transaction will be in the interest of the Plan
and its participants and beneficiaries involves consideration of not
just the abstract value of the Property as determined in the Appraisal
but a realistic assessment of the marketability of the Property to
parties other than ARINC in the event the Lease is terminated and ARINC
no longer will occupy the Property, whether by choice or due to a
default under the Lease (which would likely indicate that ARINC is
experiencing financial difficulties). While the Property is currently
occupied almost exclusively (except for ARINC's tenant BearingPoint) by
a single tenant primarily as a corporate headquarters office complex, a
number of factors indicate that it is suitable for use by potential
occupants other than ARINC, so the value of the Property can be
realized independent of ARINC's long range prospects and plans.
The site improvements consist of two sets of buildings, clearly
divided by a public road. This physical separation would allow, at a
minimum, the Property to be leased or sold in two parts. The individual
buildings, although interconnected, can be easily separated for
separate tenant occupancy. For example, IFS understands that
BearingPoint, which occupies one floor of one of the buildings, has a
separate entrance and separate access security. The Property, although
primarily built out for general office use, is adaptable for other uses
as well. One building is designed and currently used for light
industrial purposes, primarily for prototype fabrication.
IFS concludes that, given the economic vibrancy of the Annapolis
region, the attractiveness of the Property's location as described in
the Appraisal, the physical condition and layout of the Property and
its improvements, and the diverse legally permitted uses, there should
be multiple opportunities for sale or rental of the Property to one or
more unrelated users.
The Terms of the Proposed Transaction
The IFS Report represents that the provisions of the Transfer
Agreement, including the Draft Lease Term Sheet setting forth in detail
the key terms of the Lease, were the product of extensive negotiation
between IFS and ARINC. IFS asserts that IFS senior personnel were
directly and intensively active in the negotiations. IFS also was
represented by counsel from Reed Smith
[[Page 55194]]
experienced in both real estate transactions in the Annapolis area and
the representation of benefit plans subject to ERISA engaging in
transactions requiring exemptive relief from the Department. IFS states
that in light of IFS' experience and due diligence, they believe that
the terms of the Proposed Transaction set forth in the documents are
commercially reasonable and consistent with the terms that unrelated
parties bargaining at arms length would agree to in a similar
transaction.
The IFS Report notes that the economic terms of the Proposed
Transaction provide fair value to the Plan. The rental payments are to
be made at rates, including annual escalations, equal to fair market
value as determined by the independent appraiser, Deloitte. IFS
believes that the Proposed Transaction would not appear to place a
financial burden on ARINC that would jeopardize its ability to satisfy
its obligations to the Plan. The anticipated annual rent under the
Lease, $4.3 million, represents only 8.1% of the cash generated by
ARINC's operations in 2003 as reported in its financial statements. And
as shown above, the total of minimum funding contributions and rent
that ARINC will have to pay the Plan if the Proposed Transaction occurs
is less than the contributions the Plan would require if it does not.
IFS states that this reduction in ARINC's Plan-related costs improves
ARINC's financial position, rendering it a more reliable source of
future contributions to the Plan. IFS concludes that the bondable
structure of the Lease's first ten (10) years provides additional
assurance that the rent will be paid and also relieves the Plan during
that period of any obligation to expend Plan assets on the Property for
any purpose, including repairs, administration and capital
improvements, absent a default by ARINC.
IFS asserts that it has carefully considered whether and to what
extent the ROFO will materially impair the Plan's ability to sell the
Property for fair value during the term of the Lease. As described
above, the ROFO is the only restraint on sale that ARINC is requiring
as a condition for contributing the Property to the Plan, despite IFS'
extensive efforts to persuade ARINC to drop its demand for the
provision. (By contrast, after considerable negotiations, ARINC
withdrew its proposals for a purchase option and a right of first
refusal.) As structured, IFS believes that the ROFO will not bar the
Plan from marketing the Property for sale at fair market value since
the ROFO is exercisable only at that value (or the value of an
unsolicited offer), and the Plan may sell to a third party if ARINC
declines to buy at that value. Accepting another of IFS' objections to
the terms as originally proposed, ARINC has agreed that if it declines
to exercise its ROFO and the Plan sells the Property, the purchaser
will not have an ROFO obligation to ARINC because the ROFO will not run
with the land. Moreover, since the ROFO is also extinguished in the
event of an uncured monetary default of ARINC's obligations to the Plan
as tenant, the ROFO serves as an inducement to ARINC to meet its
financial obligations to the Plan under the Lease.
IFS believes that ARINC's Make Whole Obligation significantly
mitigates the effect of the ROFO. If the Property is sold within the
first five years, the Plan will achieve at least a 5% per annum
compounded return on the Property's value as contributed. Even after
the five year guarantee expires, the flow of rental payments at a yield
of more than five percent generates a reduced minimum sale price that
still results in a five percent compound return over the lease term
except under conditions of catastrophic loss of value. IFS notes that
for example, at the end of ten years, the Property could be sold at 65
percent of contribution value ($31.75 million) and still achieve the
five percent minimum return; after 20 years, the minimum price to
achieve the five percent return is below 19 percent of contribution
value ($9.26 million).
IF Report Conclusion
IFS believes that the Proposed Transaction will immediately improve
the Plan's funding, improve the Plan's overall portfolio of assets in
terms of anticipated risk-adjusted return and reduce the Plan's
reliance on future cash contributions from ARINC. The Plan will receive
an attractive, marketable parcel of real estate, fully leased to a
reasonably credit-worthy tenant obligated to pay rent at fair market
value with regular annual increases. The terms of the Lease relieve the
Plan of any exposure to the cost of capital improvements for the first
ten years after the Property is contributed to the Plan, and are
triple-net throughout its term. Accordingly, and for all the reasons
set forth above, IFS concludes, as independent fiduciary to the Plan,
that the Proposed Transaction is prudent and in the interest of the
Plan's participants and beneficiaries.
12. Duties of the Independent Fiduciary. The Department notes that
the appointment of an independent fiduciary to represent the interests
of the Plan with respect to the transactions that are the subject of
the exemption request is a material factor in its determination to
propose exemptive relief. The Department believes that it would be
helpful to provide its views on the responsibilities of an independent
fiduciary in connection with the in-kind contribution, directly or
indirectly, of property to an employee benefit plan.
As noted in the Department's Interpretive Bulletin, 29 CFR 2509.94-
3(d) (59 FR 66736, December 28 1994), apart from consideration of the
prohibited transaction provisions, plan fiduciaries must determine that
acceptance of an in-kind contribution is consistent with ERISA's
general standards of fiduciary conduct. It is the view of the
Department that acceptance of an in-kind contribution is a fiduciary
act subject to section 404 of ERISA. In this regard, section
404(a)(1)(A) and (B) of ERISA requires that fiduciaries discharge their
duties to a plan solely in the interests of the participants and
beneficiaries, for the exclusive purpose of providing benefits to
participants and beneficiaries and defraying reasonable administrative
expenses, and with the care, skill, prudence, and diligence under the
circumstances then prevailing that a prudent person acting in a like
capacity and familiar with such matters would use in the conduct of an
enterprise of a like character and with like aims. In addition, section
404(a)(1)(C) requires that fiduciaries diversify plan investments so as
to minimize the risk of large losses, unless under the circumstances it
is clearly prudent not to do so. Accordingly, the fiduciaries of a plan
must act ``prudently,'' ``solely in the interest'' of the plan's
participants and beneficiaries, and with a view to the need to
diversify plan assets when deciding whether to accept an in-kind
contribution. If accepting an in-kind contribution is not ``prudent,''
not ``solely in the interest'' of the participants and beneficiaries of
the plan, or would result in an improper lack of diversification of
plan assets, the responsible fiduciaries of the plan would be liable
for any losses resulting from such a breach of fiduciary
responsibility, even if a contribution in kind does not constitute a
prohibited transaction under section 406 of ERISA.
The selection of an independent qualified appraiser to determine
the value of an in-kind contribution and the acceptance of the
resulting valuation are fiduciary decisions governed by the provisions
of Part 4 of Title I ERISA. In discharging its obligations under
section 404(a)(1), the independent fiduciary must take steps calculated
to obtain the most accurate valuation available. In
[[Page 55195]]
addition, the fiduciary obligation to act prudently requires, at a
minimum, that the independent fiduciary conduct an objective, thorough,
and analytical critique of the valuation. In conducting such
verification, the independent fiduciary must evaluate a number of
factors relating to the accuracy and methodology of the valuation and
the expertise of the independent qualified appraiser. Reliance solely
on the valuation provided by the appraiser would not be sufficient to
meet this prudence requirement.
In considering whether to accept the Contribution and to engage in
transactions involving the Leaseback of the Property by the Plan to
ARINC and any renewal of the Lease, the Repurchase of the Property, any
Make Whole Payment or Monetization, the Independent Fiduciary's
responsibilities include the following:
1. The Independent Fiduciary must prudently determine the fair
market value of the Property as of the date it is contributed to the
Plan. In determining the fair market value of the Property, the
Independent Fiduciary must obtain an appraisal by a qualified
independent appraiser, and must ensure that the appraisal is consistent
with sound principles of valuation.
2. The Independent Fiduciary must ensure that the appraisal, at a
minimum, includes the following elements:
(a) A summary of the appraiser's qualifications to evaluate the
Property,
(b) A statement that the appraiser is independent of ARINC and that
the appraiser has no interest in the Property.
(c) A statement that the appraisal is being conducted to determine
the fair market value of the Property, which is defined as the price at
which the Property would change hands between a willing buyer and a
willing seller when the former is not under any compulsion to buy and
the latter is not under any compulsion to sell, and both parties are
able, as well as willing, to trade and are well informed about the
Property and the market for the Property,
(d) A statement of the Property's value, the methodologies used in
determining the value, the reasons for the valuation in light of the
methodologies, and the reasons that the appraiser chose to apply
particular valuation methods rather than others,
(e) A statement that the appraisal is being conducted to determine
the fair market rental value of the leased Property, which is defined
as the price at which the Property would change hands between a willing
lessee and a willing lessor when the parties are not under any
compulsion to lease, and both parties are able, as well as willing, to
transact and are well informed about the Property and the market for
the leased Property,
(f) A statement of the Property's rental value, the methodologies
used in determining the value, the reasons for the valuation in light
of the methodologies, and the reasons that the appraiser chose to apply
particular valuation methods rather than others,
(g) A statement of the relevance or significance accorded to the
valuation methodologies taken into account,
(h) The effective date of the valuations,
(i) A description of the nature of ARINC's business and history,
(j) A description of the economic outlook in general, and of the
condition and outlook of the local real property market and rental
market in particular,
(k) An analysis of the Property's condition and future value,
(l) A description of all of the factors taken into account in
making the valuation, including any restrictions, understandings,
agreements or obligations limiting the Plan's ability to dispose of the
Property,
(m) A statement of past transactions involving the Property,
including dates, amounts, price, and whether the transactions were at
arms-length, as well as a description of any attempts to buy or sell
the Property over the last five years, including a description of any
previous plans for such transactions as described in the Application,
(n) An analysis of the market price of similarly situated
properties,
(o) An analysis of the marketability, or lack thereof of the
Property, with specific reference to any restrictions, understandings,
agreements, or obligations limiting the Plan's ability to dispose of
the Property, and
(p) Any other factors necessary for a prudent determination of the
market value of the Property.
3. The Independent Fiduciary must investigate the facts and
assumptions underlying the appraisal to ensure that the Property
contribution is not valued at more than fair market value. The
Independent Fiduciary must not simply defer to the conclusions reached
by the appraiser, but rather will take appropriate action to ensure:
(a) That the appraisal is based upon complete, accurate, and
current data;
(b) That the appraiser is appropriately qualified to conduct the
valuation;
(c) That the valuation methodologies are appropriate and adequately
explained and that the appraiser has adequately justified its decision
not to use alternative methodologies;
(d) That the property's value is calculated with appropriate
discounts for any transfer restrictions;
(e) That the appraisal's reasoning and assumptions are consistent,
logical, and supported by appropriate financial and economic data and
that any calculations are accurate;
(f) That the valuation is based on complete and accurate
appraisals, which have been properly analyzed;
(g) That the assumptions underpinning the valuation are properly
identified, and a careful analysis is performed of the impact of
changes in those assumptions on the value of the Property;
(h) That the valuation has appropriately considered ARINC's
financial condition in valuing the Property, as well as the impact of
an ARINC bankruptcy or a decision to move the headquarters to a
different location on the value of the Property; and
(i) That the fair market value of the Property has been determined
by way of a prudent investigation.
Lastly, the Department notes that the above described
responsibilities to be undertaken by the Independent Fiduciary will be
material factors in whether the Department determines to grant a final
exemption.
13. Summary of Conditions. ARINC represents that the requested
exemption would be subject to the following general terms and
conditions:
? With respect to the Contribution, the Leaseback, the
Repurchase, the sale of the Property, as well as any future Plan
transactions involving the Property, the Plan will be represented by a
qualified independent fiduciary who will determine that the
Contribution, Leaseback (and any renewal of the Lease), and sale/
Repurchase transactions are appropriate for and in the interests of the
Plan and its participants;
? The contribution value of the Property is the fair market
value of the Property as determined by a qualified independent
fiduciary in conjunction with a qualified independent appraiser;
? The initial 10-year period of the twenty-year Lease with
one 3-year renewal period is a bondable lease (ARINC pays for capital
expenditure) with the remainder of the lease term as a triple net lease
under which ARINC, as lessee, pays, in addition to the base rent, all
normal operating expenses of the Property, including taxes, insurance,
maintenance, repairs, and utilities;
? If approved by the qualified independent fiduciary upon
its determination that it is in the interest of, and protective of, the
Plan and its
[[Page 55196]]
participants, the Plan's agreement to enter into a transaction to sell
the initial ten-year stream of lease income on the Property to a third
party for cash (the Monetization);
? IFS has ongoing responsibilities with respect to the
Plan's holding of the Property. As part of its ongoing duty to
determine whether continued ownership of the Property is in the Plan's
interest, IFS will specifically consider the nature and diversification
of the Plan's overall investment portfolio, cash flow and liquidity
needs and actuarial condition. ARINC will supply IFS with any necessary
information so that it can appropriately carry out this function. The
purpose of these ongoing duties will be to ensure that IFS determines
on an ongoing basis that the Plan's holding of the Property does not
pose an undue risk to the Plan of an overconcentration of Plan assets
in the Property;
? All terms and conditions of the Contribution, Lease (and
the one 3-year renewal period), and potential Repurchase or sale
transactions involving the Plan will be at least as favorable to the
Plan as those the Plan could obtain in an arm's-length transaction with
an unrelated party;
? No commissions, fees, costs, charges or other expenses
will be paid by the Plan in connection with the acquisition of the
Property, including expenses associated with the contribution, leasing,
or monetizing transactions. This condition does not preclude the Plan
from paying the ongoing costs attributable to the holding of the
Property once the Contribution has been approved and accepted;
? Subject to ARINC's Right of First Offer, the Plan retains
the right to sell or assign, in whole or in part, any of its Property
interests to any third party purchaser; and
? ARINC indemnifies the Plan with respect to all liability
for hazardous substances released on the Property prior to the
execution and closing of the Contribution.
General Information
The attention of interested persons is directed to the following:
(1) The fact that a transaction is the subject of an exemption
under section 408(a) of the Act and section 4975(c)(2) of the Code does
not relieve a fiduciary or other party in interest or disqualified
person from certain other provisions of the Act and the Code, including
any prohibited transaction provisions to which the exemption does not
apply and the general fiduciary responsibility provisions of section
404 of the Act, which require, among other things, that a fiduciary
discharge his or her duties respecting the plan solely in the interest
of the participants and beneficiaries of the plan and in a prudent
fashion in accordance with section 404(a)(1)(B) of the Act; nor does it
affect the requirements of section 401(a) of the Code that the plan
operate for the exclusive benefit of the employees of the employer
maintaining the plan and their beneficiaries;
(2) Before an exemption may be granted under section 408(a) of the
Act and section 4975(c)(2) of the Code, the Department must find that
the exemption is administratively feasible, in the interest of the plan
and of its participants and beneficiaries and protective of the rights
of participants and beneficiaries of the plan;
(3) This proposed exemption, if granted, will be supplemental to,
and not in derogation of, any other provisions of the Act and the Code,
including statutory or administrative exemptions. Furthermore, the fact
that a transaction is subject to an administrative or statutory
exemption is not dispositive of whether the transaction is in fact a
prohibited transaction; and
(4) This proposed exemption, if granted, will be subject to the
express condition that the material facts and representations set forth
in the Application are true and complete, and that the Application
accurately describes all material terms of the transactions that are
the subject of the proposed exemption.
Written Comments and Hearing Requests
All interested persons are invited to submit written comments or
requests for a hearing on the pending exemption to the address above,
within the time frame set forth above, after the publication of this
proposed exemption in the Federal Register. All comments will be made a
part of the record. Comments received will be available for public
inspection with the Application at the address set forth above.
Notice to Interested Persons
Within seven (7) calendar days of publication of the Notice of
Proposed Exemption (the Notice) in the Federal Register, ARINC shall
provide notice to all participants of the Plan (including active
employees, separated vested participants and retirees) by mailing first
class a photocopy of the Notice, plus a copy of the supplemental
statement (Supplemental Statement), as required, pursuant to 29 CFR
2570.43(b) (2). ARINC shall also provide the same notice by first class
mailing to the representatives of the unions that represent employees
of ARINC who currently participate in the Plan.
Proposed Exemption
Based on the facts and representations set forth in the
Application, the Department is considering granting an exemption under
the authority of section 408(a) of the Act and section 4975(c) (2) of
the Code and in accordance with the procedures set forth in 29 CFR Part
2570, Subpart B (55 FR 32836, 32847, August 10, 1990).
Section I. Covered Transactions
If the exemption is granted, the restrictions of sections 406(a),
406(b)(1) and (b)(2), and 407(a) of the Act, and the sanctions
resulting from the application of section 4975(a) and (b) of the Code,
by reason of section 4975(c)(1)(A) through (E) of the Code, shall not
apply to:
(a) The transfer of the property described as the 27.5 acre
headquarters of ARINC Incorporated (ARINC) situated in Annapolis, MD or
the ownership interests of a special purpose entity (SPE) whose sole
asset is this property (collectively, the Property) to the Plan through
the in-kind contribution of such Property by ARINC, the plan sponsor
and a party in interest with respect to the Plan (the Contribution);
(b) The holding of the Property by the Plan;
(c) The leaseback of the Property by the Plan to ARINC (the Lease
or Leaseback);
(d) The repurchase of the Property, by ARINC (the Repurchase)
pursuant to (1) a right of first offer as specified in the Lease should
the Plan wish to sell the Property to a third party or (2) a voluntary
agreement under which the Plan agrees to sell the Property to ARINC at
any time during the Lease; and
(e) Any payments to the Plan by ARINC made pursuant to the make
whole obligation as specified in the Lease (Make Whole Payment)
(collectively, the Exemption Transactions).
Section II. Conditions
This proposed exemption is conditioned upon adherence to the
material facts and representations described herein and upon
satisfaction of the following requirements:
(a) A qualified independent fiduciary (the Independent Fiduciary)
acting on behalf of the Plan, represents the Plan's interests for all
purposes with respect to the Contribution and determines, prior to
entering into any of the Exemption Transactions described herein, that
each
[[Page 55197]]
such transaction is in the interests of the Plan;
(b) The Independent Fiduciary negotiates and approves the terms of
any of the transactions between the Plan and ARINC that relate to the
Property;
(c) The Independent Fiduciary manages the holding, leasing, and
disposition of the Property and takes whatever actions it deems
necessary to protect the rights of the Plan with respect to the
Property;
(d) The terms and conditions of any transactions between the Plan
and ARINC concerning the Property are no less favorable to the Plan
than terms negotiated at arm's length under similar circumstances
between unrelated third parties;
(e) The contribution value of the Property is the fair market value
of the Property as determined by the Independent Fiduciary on the date
the Property is contributed to the Plan. In determining the fair market
value of the Property, the Independent Fiduciary obtains an updated
appraisal from a qualified, independent appraiser selected by the
Independent Fiduciary, and ensures that the appraisal is consistent
with sound principles of valuation;
(f) The Lease has an initial term of twenty years, with a three-
year renewal term. The Lease is a bondable lease for the first ten
years of the Lease (or such earlier date specified in the Lease as
agreed to between the Lessor and ARINC). During the bondable period
ARINC, as lessee, pays, in addition to the base rent, all costs
associated with the Property, including capital expenditures. After the
bondable period expires, the Lease shall convert to a traditional
triple net lease under which ARINC, as lessee, pays, in addition to the
base rent, all normal operating expenses of the Property, including
taxes, insurance, maintenance, repairs, and utilities, but does not pay
capital expenditures;
(g) The Independent Fiduciary has sole authority to determine if it
is in the interest of the Plan to enter into a transaction to sell the
stream of lease income on the Property to a third party for cash (the
Monetization);
(h) The Independent Fiduciary determines on an ongoing basis that
the amount of plan assets invested in employer real property and
employer securities, including its interests in the Property, complies
with ERISA;
(i) At the earlier of: (i) The date the Plan sells the Property for
fair market value or (ii) the date five years from the date of the
Contribution, ARINC will transfer to the Plan a Make Whole Payment, as
described below, in order to guarantee the Plan a minimum rate of
return of 5% compounded per annum on the initial contributed value of
the Property; provided that, if a Make Whole Payment is due and if, for
the taxable year of ARINC in which the Make Whole Payment is to be
made, such Make Whole Payment (i) would not be deductible under section
404(a)(1) of the Code or (ii) would result in the imposition of an
excise tax under section 4972 of the Code, such Make Whole Payment
would not be made until the next taxable year of ARINC for which the
Make Whole Payment is deductible under section 404(a)(1) of the Code
and does not result in an excise tax under section 4972 of the Code;
ARINC will guarantee a minimum return of 5% to the Plan by agreeing
that if (i) the combination of the proceeds from a sale of the Property
(or the change in the value of the Property if the Plan continues
holding it over the full five years) plus the Plan's net income on the
Property under the Lease prior to the sale (or over the full five
years) is less than (ii) the Property's value as of the date of the
Contribution plus a 5% compounded rate of return on that value plus the
costs of holding and maintaining the Property, then (iii) ARINC will
contribute to the Plan the difference necessary to provide the 5%
return. The calculation of the Make Whole Payment will take into
account the status of any Monetization of the lease payments as of the
time of sale or five-year anniversary of the Contribution.
(j) If the Plan desires to sell or convey the Property or its
interest therein during the Lease Term, the Plan must first offer ARINC
the right to purchase or otherwise acquire the Property or such
interest therein on such terms and conditions as the Plan proposes to
market the Property or such interest therein for sale (the Right of
First Offer). If ARINC fails to exercise such right to purchase, the
Plan generally is free to sell the Property to a third party. The right
of first offer shall terminate upon the commencement of the exercise by
the Plan of its remedies under the Lease as the result of a monetary
event of default by ARINC as described in the Lease that continues
uncured following notice and the expiration of applicable cure periods
(and a second notice and cure period provided fifteen (15) days before
the loss of such right on account of such default);
(k) The Plan pays no commissions or fees in connection with the
Contribution, the Lease, the Repurchase, or the Monetization of the
Property. This condition does not preclude the Plan from paying the
ongoing costs associated with the holding of the Property that are not
the responsibility of ARINC under the Lease;
(l) Subject to ARINC's Right of First Offer, the Plan retains the
right to sell or assign, in whole or in part, any of its Property
interests to any third party purchaser; and
(m) ARINC indemnifies the Plan with respect to all liability for
hazardous substances released on the Property prior to the execution
and closing of the Contribution of the Property.
Section III. Definitions
(a) The term ``Independent Fiduciary'' means a fiduciary who is:
(1) Independent of and unrelated to ARINC or its affiliates, and
(2) Appointed to act on behalf of the Plan for all purposes related
to, but not limited to (i) the in-kind contribution of the Property by
ARINC to the Plan, and (ii) other transactions between the Plan and
ARINC related to the Property.
For purposes of this proposed exemption, a fiduciary will not be
deemed to be independent of and unrelated to ARINC if:
(1) Such fiduciary directly or indirectly controls, is controlled
by or is under common control with ARINC,
(2) Such fiduciary directly or indirectly receives any compensation
or other consideration in connection with any transaction described in
this proposed exemption; except that an Independent Fiduciary may
receive compensation for acting as an Independent Fiduciary from ARINC
in connection with the transactions contemplated herein if the amount
or payment of such compensation is not contingent upon or in any way
affected by the Independent Fiduciary's ultimate decision, and
(3) The annual gross revenue received by such fiduciary, during any
year of its engagement, from ARINC and its affiliates exceeds 5 percent
(5%) of the fiduciary's annual gross revenue from all sources for its
prior tax year.
(b) The term ``affiliate'' means:
(1) Any person directly or indirectly through one or more
intermediaries, controlling, controlled by, or under common control
with the person;
(2) Any officer, director, employee, relative, or partner of any
such person; and
(3) Any corporation or partnership of which such person is an
officer, director, partner, or employee.
(c) The term ``control'' means the power to exercise a controlling
influence over the management or policies of a person other than an
individual.
[[Page 55198]]
Signed at Washington, DC, this 7th day of September 2004.
Ivan L. Strasfeld,
Director, Office of Exemption Determinations, Employee Benefits
Security Administration, Department of Labor.
[FR Doc. 04-20538 Filed 9-10-04; 8:45 am]
BILLING CODE 4510-29-P