TAX PROTECTION AGREEMENT
by and among
HARBOR POINT DEVELOPMENT JV, LLC
a Delaware limited liability company
FAIRWATER HP MANAGER, LLC
a Maryland limited liability company
and
PRESCOTT HP INVESTOR, LLC
a Delaware limited liability company
Dated as of January 12, 2026
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TAX PROTECTION AGREEMENT
This TAX PROTECTION AGREEMENT (this "Agreement") is entered into as of January 12, 2026 (the "Effective Date"), by and among:
HARBOR POINT DEVELOPMENT JV, LLC, a Delaware limited liability company (the "Company" or "HP JV"), with its registered agent at Incorporators & Associates, Inc., 1209 Orange Street, Wilmington, Delaware 19801, Employer Identification Number: 84-6213950 (applied for);
FAIRWATER HP MANAGER, LLC, a Maryland limited liability company (the "Fairwater Member"), whose sole member is Fairwater Real Estate Investment Trust, a Maryland real estate investment trust (NYSE: FWT), Employer Identification Number: 52-2201889; and
PRESCOTT HP INVESTOR, LLC, a Delaware limited liability company (the "Prescott Member"), whose sole member is Prescott Capital Partners, LP, a Delaware limited partnership, Employer Identification Number: 13-4603217.
Each of the Company, the Fairwater Member, and the Prescott Member is sometimes referred to herein individually as a "Party" and collectively as the "Parties."
RECITALS
A. Fairwater HP Manager, LLC (as a 30% member) and Prescott HP Investor, LLC (as a 70% member) have entered into that certain Amended and Restated Operating Agreement of Harbor Point Development JV, LLC, dated as of January 12, 2026 (as the same may be amended, restated, supplemented, or otherwise modified from time to time, the "Operating Agreement"), governing the management, operations, and affairs of the Company.
B. HP JV is a Delaware limited liability company formed for the purpose of developing a Class A mixed-use project known as "Harbor Point Towers," consisting of two twenty-eight (28)-story residential towers encompassing approximately six hundred ten (610) residential units and approximately forty-five thousand (45,000) square feet of ground-floor retail space, to be constructed on an approximately 8.2-acre waterfront site located at 1500–1580 Wills Street, Baltimore, Maryland 21231 (Block 7419, Lots 1–6, Baltimore City) (the "Property").
C. The total project cost for Harbor Point Towers is estimated at Five Hundred Seventy-Six Million Dollars ($576,000,000), consisting of: (i) land acquisition costs of Fifty-Four Million Dollars ($54,000,000), to be acquired from Harbor East Land Holdings, LLC; (ii) hard construction costs of approximately Four Hundred Thirty-Two Million Dollars ($432,000,000); and (iii) soft costs of approximately Ninety Million Dollars ($90,000,000). The total project cost is expected to be funded by (a) total joint venture equity of Two Hundred Forty Million Dollars ($240,000,000), of which Seventy-Two Million Dollars ($72,000,000) (30%) is to be contributed by the Fairwater Member and One Hundred Sixty-Eight Million Dollars ($168,000,000) (70%) is to be contributed by the Prescott Member, and (b) a construction loan in the amount of Three Hundred Thirty-Six Million Dollars ($336,000,000) from Meridian National Bank, N.A.
D. HP JV is classified as a partnership for federal income tax purposes and intends to maintain such classification for the duration of its existence. The Parties intend that the Company shall comply with the requirements of Sections 704(b) and 704(c) of the Internal Revenue Code of 1986, as amended (the "Code"), and the Treasury Regulations promulgated thereunder, in the allocation of income, gain, loss, deduction, and credit among the Members.
E. Fairwater HP Manager, LLC's sole member, Fairwater Real Estate Investment Trust, is a publicly traded real estate investment trust listed on the New York Stock Exchange under the ticker symbol "FWT." As a REIT, Fairwater Real Estate Investment Trust is subject to specific requirements under the Code regarding income testing, asset testing, distribution requirements, and the prohibition on certain transactions. Fairwater Member requires protections under this Agreement to preserve the REIT qualification of Fairwater Real Estate Investment Trust, including protections with respect to the REIT income tests under Section 856(c) of the Code and the prohibited transaction rules under Section 857(b)(6) of the Code.
F. The Parties desire to set forth their agreements regarding (i) the allocation of tax items attributable to Built-In Gain and Built-In Loss in Company property under Section 704(c) of the Code, (ii) protections against the recognition of taxable gain by the Members during specified protection periods, and (iii) limitations on Company actions that could trigger disproportionate or unanticipated tax liabilities to either Member, all as more particularly set forth herein.
G. Contemporaneously with the execution of this Agreement, the Parties have entered into or will enter into (i) that certain REIT Compliance Side Letter, dated as of even date herewith, by and between Fairwater Member and Prescott Member (the "REIT Compliance Side Letter"), and (ii) that certain Capital Contribution Agreement, dated as of even date herewith, by and among the Company, Fairwater Member, and Prescott Member (the "Capital Contribution Agreement"), each of which is incorporated herein by reference as a related transaction document.
H. Fairwater HP Manager, LLC has been designated as the Partnership Representative (formerly known as the "Tax Matters Partner") of the Company under Section 6223 of the Code, as set forth in Article [●] of the Operating Agreement, and shall serve in such capacity in connection with all federal income tax audits, examinations, and proceedings relating to the Company.
NOW, THEREFORE, in consideration of the mutual covenants and agreements hereinafter set forth, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Parties agree as follows:
ARTICLE I — DEFINITIONS
Section 1.1 — Defined Terms
As used in this Agreement, the following terms shall have the meanings set forth below:
"Adjusted Tax Basis" means, with respect to any Company property, the adjusted basis of such property for federal income tax purposes, as determined under Section 1011 of the Code, taking into account all adjustments to basis required or permitted under the Code and the Treasury Regulations, including adjustments for depreciation, amortization, capital improvements, and any other items affecting basis.
"Book Value" means, with respect to any Company property, (a) in the case of contributed property, the fair market value of such property at the date of contribution to the Company, or (b) in the case of revalued property, the fair market value of such property at the date of revaluation, in each case as adjusted from time to time in accordance with Treasury Regulation Section 1.704-1(b)(2)(iv) to reflect depreciation, amortization, capital expenditures, and other adjustments as provided in the Operating Agreement and applicable Treasury Regulations.
"Built-In Gain" means, with respect to any Company property, the excess, if any, of the Book Value of such property over the Adjusted Tax Basis of such property at the time of contribution to the Company or at the time of a revaluation event, as the case may be.
"Built-In Loss" means, with respect to any Company property, the excess, if any, of the Adjusted Tax Basis of such property over the Book Value of such property at the time of contribution to the Company or at the time of a revaluation event, as the case may be.
"Capital Account" means, with respect to each Member, the capital account maintained for such Member in accordance with the Operating Agreement and Treasury Regulation Section 1.704-1(b)(2)(iv), as adjusted from time to time to reflect capital contributions, allocations of income, gain, loss, and deduction, distributions, and other items as required under the Treasury Regulations.
"Code" means the Internal Revenue Code of 1986, as amended from time to time (or any corresponding provision or provisions of any succeeding law).
"Company" means Harbor Point Development JV, LLC, a Delaware limited liability company.
"Company Minimum Gain" has the meaning set forth in Treasury Regulation Section 1.704-2(b)(2), and shall be computed in accordance with Treasury Regulation Section 1.704-2(d).
"Disposition" means any sale, exchange, transfer, conveyance, or other taxable disposition of all or any portion of the Property or any other Company property, whether voluntary or involuntary, including any foreclosure, deed in lieu of foreclosure, condemnation (whether by eminent domain or otherwise), abandonment, or other event treated as a taxable disposition for federal income tax purposes. For the avoidance of doubt, a Disposition shall include any transaction structured as a contribution to another entity if such contribution is treated as a taxable exchange for federal income tax purposes.
"Fairwater Member" means Fairwater HP Manager, LLC, a Maryland limited liability company.
"Guaranteed Debt" means any Company indebtedness for which a Member bears the economic risk of loss within the meaning of Treasury Regulation Section 1.752-2, whether by reason of a guaranty, indemnification, pledge, deficit restoration obligation, or other arrangement.
"Liability Allocation" means the allocation of Company liabilities among the Members in accordance with Section 752 of the Code and the Treasury Regulations promulgated thereunder, including Treasury Regulation Sections 1.752-1 through 1.752-5.
"Member Nonrecourse Debt" has the meaning set forth in Treasury Regulation Section 1.704-2(b)(4), and includes any Company liability to the extent that a Member (or a related person within the meaning of Treasury Regulation Section 1.752-4(b)) bears the economic risk of loss with respect to such liability under Treasury Regulation Section 1.752-2.
"Minimum Gain Chargeback" has the meaning set forth in Treasury Regulation Section 1.704-2(f), and refers to the allocation of items of income and gain required when there is a net decrease in Company Minimum Gain during a taxable year.
"Nonrecourse Deductions" has the meaning set forth in Treasury Regulation Section 1.704-2(b)(1), and means the amount of deductions attributable to increases in Company Minimum Gain during a given taxable year, as determined in accordance with Treasury Regulation Section 1.704-2(c).
"Operating Agreement" means the Amended and Restated Operating Agreement of Harbor Point Development JV, LLC, dated as of January 12, 2026, by and between Fairwater Member and Prescott Member, as the same may be amended, restated, supplemented, or otherwise modified from time to time in accordance with its terms.
"Partnership Representative" means Fairwater HP Manager, LLC, in its capacity as the "partnership representative" of the Company under Section 6223 of the Code, as designated in the Operating Agreement.
"Prescott Member" means Prescott HP Investor, LLC, a Delaware limited liability company.
"Property" means the real property and all improvements thereon (whether now existing or hereafter constructed) located at 1500–1580 Wills Street, Baltimore, Maryland 21231 (Block 7419, Lots 1–6, Baltimore City), together with all fixtures, appurtenances, easements, and rights pertaining thereto.
"Protected Gain" has the meaning set forth in Section 2.1 of this Agreement.
"Protected Member" means each of the Fairwater Member and the Prescott Member, to the extent such Member has Protected Gain with respect to any Section 704(c) Property.
"Protected Period" has the meaning set forth in Section 2.2 of this Agreement.
"Qualified Income Offset" has the meaning set forth in Treasury Regulation Section 1.704-1(b)(2)(ii)(d), and refers to the provision requiring that a Member who unexpectedly receives an adjustment, allocation, or distribution described in Treasury Regulation Section 1.704-1(b)(2)(ii)(d)(4), (5), or (6) that causes or increases a deficit balance in such Member's Capital Account shall be allocated items of income and gain in an amount and manner sufficient to eliminate such deficit balance as quickly as possible.
"Refinancing" means any refinancing, extension, modification, renewal, replacement, assumption, or restructuring of the construction loan from Meridian National Bank, N.A. (or any successor lender) or any other Company indebtedness, whether involving the same or a different lender, and whether or not the terms of such indebtedness are materially changed.
"REIT" means a real estate investment trust within the meaning of Section 856 of the Code.
"Section 704(c) Allocation" means any allocation of tax items (including depreciation, amortization, gain, loss, and deduction) made pursuant to Section 704(c) of the Code and Treasury Regulation Section 1.704-3, including curative and remedial allocations to the extent applicable.
"Section 704(c) Property" means any Company property that is subject to the allocation requirements of Section 704(c) of the Code, including (a) property contributed to the Company with an Adjusted Tax Basis that differs from its Book Value at the time of contribution, and (b) property that has been revalued on the Company's books in connection with a capital event, creating a "reverse 704(c) layer."
"Tax Gain" means gain recognized for federal income tax purposes, including gain arising from a Disposition of Company property, a deemed distribution under Section 752(b) of the Code, or any other transaction or event giving rise to taxable income or gain.
"Tax Protection Amount" has the meaning set forth in Section 3.1 of this Agreement.
"Treasury Regulations" means the regulations promulgated under the Code by the United States Department of the Treasury, as such regulations may be amended from time to time (including corresponding provisions of succeeding regulations).
Section 1.2 — Cross-References to Operating Agreement
Capitalized terms used but not otherwise defined in this Agreement shall have the respective meanings ascribed to such terms in the Operating Agreement. In the event of any inconsistency between the definition of a term in this Agreement and the definition of such term in the Operating Agreement, the definition in this Agreement shall control for purposes of this Agreement.
Section 1.3 — Construction
Unless the context otherwise requires: (a) references to "Sections" and "Articles" are to sections and articles of this Agreement; (b) references to any statute, regulation, or other law include all statutory and regulatory provisions consolidating, amending, replacing, or interpreting such statute, regulation, or law and any reference to any statute, regulation, or law shall also be deemed to refer to all rules and regulations promulgated thereunder, in each case as amended from time to time; (c) the words "include," "includes," and "including" shall be deemed to be followed by the words "without limitation"; (d) the word "or" is not exclusive; (e) the headings in this Agreement are for convenience of reference only and shall not affect the interpretation or construction of this Agreement; (f) references to the singular include the plural and vice versa; and (g) references to "dollars" or "$" are to United States dollars.
ARTICLE II — SECTION 704(c) ALLOCATIONS
Section 2.1 — Identification of Protected Gain
(a) Upon the acquisition of the Property by the Company from Harbor East Land Holdings, LLC at a purchase price of Fifty-Four Million Dollars ($54,000,000) (with the land closing targeted for January 30, 2026), the Property's initial Book Value shall equal Fifty-Four Million Dollars ($54,000,000) for purposes of the Company's books and Capital Account maintenance under Treasury Regulation Section 1.704-1(b)(2)(iv).
(b) To the extent that any Member contributes property to the Company (or is treated as contributing property to the Company for federal income tax purposes) with a Book Value that differs from the Adjusted Tax Basis of such property, the difference between such Book Value and Adjusted Tax Basis shall constitute Built-In Gain (if Book Value exceeds Adjusted Tax Basis) or Built-In Loss (if Adjusted Tax Basis exceeds Book Value) for purposes of Section 704(c) of the Code. All such property shall constitute Section 704(c) Property.
(c) "Protected Gain" means, with respect to each Protected Member, the amount of Built-In Gain in any Section 704(c) Property that is attributable to such Protected Member at the time of the initial contribution of such property to the Company (or at the time of a revaluation event creating a reverse 704(c) layer), as reduced from time to time by (i) Section 704(c) Allocations of depreciation, amortization, or other items previously allocated to such Protected Member that reduce the Built-In Gain attributable to such Member, and (ii) any Tax Gain actually recognized and allocated to such Protected Member with respect to such Section 704(c) Property. The Protected Gain for each Protected Member shall be tracked separately for each item or layer of Section 704(c) Property.
(d) The initial Built-In Gain or Built-In Loss in the Property, as well as the initial Protected Gain attributable to each Member, shall be determined by the Company's tax advisor, Alderman & Fields, CPAs, LLP (engagement partner: Robert E. Alderman), based upon the actual Adjusted Tax Basis of the Property as established at the land closing and the fair market value of the Property as of such date. The initial schedule of Section 704(c) Property is attached hereto as Exhibit A and shall be updated promptly following the land closing.
(e) Any revaluation of Company property on the Company's books (for example, upon the admission of a new member, a distribution in connection with a capital event, or any other event requiring a revaluation under Treasury Regulation Section 1.704-1(b)(2)(iv)(f)) shall create additional Section 704(c) layers (commonly referred to as "reverse 704(c) layers"), and the resulting Built-In Gain or Built-In Loss in each such layer shall be treated as Protected Gain or Protected Loss, as applicable, for purposes of this Agreement. Each reverse 704(c) layer shall be tracked separately in accordance with the requirements of Treasury Regulation Section 1.704-3(a)(6).
Section 2.2 — Protected Period
(a) The "Protected Period" with respect to each item or layer of Section 704(c) Property shall begin on the date of the initial contribution of such property to the Company (or, in the case of a reverse 704(c) layer, the date of the revaluation event creating such layer) and shall continue for a period of ten (10) years thereafter, unless earlier terminated by the mutual written consent of all Members.
(b) Upon the expiration of the Protected Period with respect to any particular item or layer of Section 704(c) Property, the obligations of the Parties under this Article II and Article III with respect to such item or layer shall terminate, except that (i) any obligations that accrued during the Protected Period but remain unperformed or unsatisfied shall survive such expiration until fully performed or satisfied, and (ii) the indemnification obligations set forth in Article V shall survive in accordance with their terms.
Section 2.3 — Method of Allocation
(a) The Company shall apply the "traditional method with curative allocations" as described in Treasury Regulation Section 1.704-3(c) for all Section 704(c) Allocations with respect to Section 704(c) Property, unless the Members unanimously agree in writing to adopt a different reasonable method permitted under Treasury Regulation Section 1.704-3 (including, without limitation, the remedial allocation method under Treasury Regulation Section 1.704-3(d)).
(b) The Company shall not change the Section 704(c) allocation method applicable to any item or layer of Section 704(c) Property without the prior written consent of both Members. Any change in method shall be prospective only and shall not affect allocations made in prior taxable years.
(c) All Section 704(c) Allocations shall be made consistently with the maintenance of Capital Accounts under Section 704(b) of the Code and Treasury Regulation Section 1.704-1(b)(2)(iv). The Company shall ensure that allocations of book items and tax items are properly bifurcated and that the book/tax disparities created by Section 704(c) are accounted for in the Company's books and records in accordance with the applicable Treasury Regulations.
Section 2.4 — Ceiling Rule Limitations
(a) To the extent that the "ceiling rule" under Treasury Regulation Section 1.704-3(b)(1) would limit the amount of tax items that can be allocated to a non-contributing Member with respect to Section 704(c) Property, thereby resulting in a distortion of allocations as compared to the allocations of corresponding book items, the Company shall use curative allocations of other tax items (including, without limitation, depreciation, amortization, and gain or loss from other Company properties) to correct such distortion, consistent with the provisions of Treasury Regulation Section 1.704-3(c).
(b) Curative allocations under this Section 2.4 shall be made using tax items of the same character and type as the item subject to the ceiling rule limitation, to the extent reasonably available. If curative allocations of items of the same character and type are insufficient to fully correct the distortion, the Company shall use curative allocations of other available tax items, subject to the limitations of Treasury Regulation Section 1.704-3(c)(3).
(c) If curative allocations are insufficient to fully correct the distortion caused by the ceiling rule, the Company may, with the prior written consent of both Members, adopt remedial allocations under Treasury Regulation Section 1.704-3(d) with respect to the affected Section 704(c) Property, either prospectively or, to the extent permitted under applicable Treasury Regulations, retroactively.
Section 2.5 — Reverse 704(c) Layers
(a) Upon any revaluation of Company assets in connection with a capital event (including, without limitation, the admission of additional members, the distribution of property to a Member, an adjustment to reflect a change in membership interests, or any other event described in Treasury Regulation Section 1.704-1(b)(2)(iv)(f)), the Company shall create reverse 704(c) layers with respect to each item of Company property that has a fair market value that differs from its book value as of the date of such revaluation.
(b) Each reverse 704(c) layer shall be tracked separately on the Company's books and records and shall be identified on the schedule attached as Exhibit A (as updated from time to time).
(c) Allocations of tax items attributable to reverse 704(c) layers shall follow the same allocation method selected under Section 2.3 of this Agreement (i.e., the traditional method with curative allocations, unless the Members have unanimously agreed in writing to adopt a different method), and shall be subject to all of the same protections and limitations set forth in this Article II and Article III.
ARTICLE III — GAIN PROTECTION PROVISIONS
Section 3.1 — Tax Protection Obligation
(a) During the Protected Period with respect to any Section 704(c) Property, the Company shall not undertake, authorize, or permit any Disposition of such Section 704(c) Property if such Disposition would result in the recognition of Tax Gain to a Protected Member in excess of the Tax Protection Amount, except as expressly provided in Section 3.1(b) below.
(b) The "Tax Protection Amount" means, for each Protected Member, the amount of federal, state, and local income tax (computed at the highest applicable combined federal and Maryland state marginal income tax rate for the relevant character of income, including both ordinary income and capital gain rates, as applicable, and taking into account the net investment income tax under Section 1411 of the Code to the extent applicable) that such Protected Member (or its direct or indirect owners, to the extent such tax liability flows through to such owners) would owe on the Tax Gain allocated to such Protected Member as a result of a Disposition of Section 704(c) Property.
(c) Notwithstanding the foregoing, the restriction set forth in Section 3.1(a) shall not apply if:
(i) the Protected Member whose Tax Gain would exceed the Tax Protection Amount provides its prior written consent to such Disposition, which consent may be given or withheld in such Protected Member's sole and absolute discretion;
(ii) the Disposition is required by (A) a final, non-appealable order of a court of competent jurisdiction, (B) a condemnation by a governmental authority exercising the power of eminent domain, or (C) a foreclosure (whether judicial or non-judicial) by Meridian National Bank, N.A. or any other secured lender holding a lien on the Property or on the applicable Company property, in each case under this clause (ii) only where the Company has exhausted all commercially reasonable efforts to avoid such forced Disposition, including, without limitation, negotiating with the applicable governmental authority or lender to restructure, defer, or otherwise mitigate the impact of such forced Disposition; or
(iii) a Protected Member's remaining Protected Gain with respect to the applicable Section 704(c) Property has been reduced to zero through prior Section 704(c) Allocations and recognized gain allocations.
Section 3.2 — Minimum Debt Maintenance Obligation
(a) During the Protected Period, the Company shall use commercially reasonable efforts to maintain outstanding Company indebtedness (whether the construction loan from Meridian National Bank, N.A. in the original principal amount of Three Hundred Thirty-Six Million Dollars ($336,000,000), or any replacement, substitute, or refinanced indebtedness) in an aggregate principal amount sufficient to enable each Protected Member to include in its share of Company liabilities under Section 752 of the Code and the Treasury Regulations thereunder (taking into account the allocation of both recourse and nonrecourse liabilities) an amount at least equal to such Protected Member's Protected Gain as of the applicable date.
(b) The purpose of this minimum debt maintenance obligation is to avoid a deemed distribution under Section 752(b) of the Code (which treats any decrease in a Member's share of Company liabilities as a distribution of money to such Member) that would reduce a Protected Member's outside basis in its interest in the Company below zero and thereby trigger gain recognition under Section 731(a) of the Code. The Parties acknowledge that a reduction in a Protected Member's share of Company liabilities below the amount of such Protected Member's Protected Gain could result in the recognition of taxable gain to such Protected Member even in the absence of any actual cash distribution.
(c) If maintaining Company indebtedness at the level required by Section 3.2(a) is not commercially feasible (by reason of market conditions, lender requirements, debt-to-equity covenants, or other factors beyond the Company's reasonable control), the Company shall:
(i) provide at least sixty (60) days' prior written notice to the affected Protected Member, specifying the reasons for the anticipated reduction in Company indebtedness and the estimated impact on such Protected Member's share of Company liabilities under Section 752; and
(ii) at the election of the affected Protected Member (to be made in writing within thirty (30) days following receipt of such notice), either:
(A) arrange for the Protected Member to guarantee, or to be treated as bearing the economic risk of loss (within the meaning of Treasury Regulation Section 1.752-2) with respect to, a sufficient portion of Company indebtedness to maintain such Protected Member's share of Company liabilities at or above the required level, with such guarantee or arrangement to be on terms reasonably satisfactory to the Protected Member and the applicable lender; or
(B) provide a deficit restoration obligation or other mechanism (including, without limitation, a bottom-dollar guarantee, an indemnification arrangement, or an environmental compliance guarantee) recognized under Treasury Regulation Section 1.752-2 as creating economic risk of loss, in an amount sufficient to preserve the Protected Member's share of Company liabilities at or above the required level.
(d) All costs, fees, and expenses incurred by the Company in connection with implementing the arrangements described in Section 3.2(c) shall be borne by the Company as an operating expense, except that any premium, fee, or other cost specifically attributable to a Protected Member's individual guarantee or deficit restoration obligation shall be borne by such Protected Member.
Section 3.3 — Limitation on Debt Prepayment
During the Protected Period, the Company shall not voluntarily prepay, defease, retire, or otherwise reduce the outstanding principal balance of any Company indebtedness (whether the construction loan from Meridian National Bank, N.A. or any other Company indebtedness) to the extent that such prepayment, defeasance, retirement, or reduction would cause any Protected Member's share of Company liabilities under Section 752 of the Code to fall below the amount of such Protected Member's Protected Gain as of the date of such prepayment, unless:
(a) the affected Protected Member provides its prior written consent to such prepayment, which consent may be given or withheld in such Protected Member's sole and absolute discretion;
(b) concurrently with such prepayment, the Company incurs substitute indebtedness in a principal amount sufficient to maintain each Protected Member's share of Company liabilities at or above the level required by Section 3.2(a), with such substitute indebtedness being allocated among the Members in a manner that preserves each Protected Member's required share of Company liabilities; or
(c) the affected Protected Member's Built-In Gain (and corresponding Protected Gain) with respect to all Section 704(c) Property has been fully reduced to zero through prior Section 704(c) Allocations and recognized gain allocations.
Section 3.4 — Refinancing Limitations
(a) Any Refinancing of Company indebtedness during the Protected Period shall be structured so that the resulting allocation of Company liabilities under Section 752 of the Code and the Treasury Regulations thereunder does not reduce any Protected Member's share of Company liabilities below the amount of such Protected Member's Protected Gain as of the date of such Refinancing.
(b) Prior to entering into any Refinancing, the Company shall consult with each Protected Member and the Company's tax advisors (Alderman & Fields, CPAs, LLP) to model the anticipated impact of the proposed Refinancing on the Section 752 liability allocation for each Member. The Company shall provide each Protected Member with a written analysis of such impact no later than thirty (30) days prior to the anticipated closing date of the Refinancing.
(c) If the Company's tax advisors determine that a proposed Refinancing would reduce any Protected Member's share of Company liabilities below the required threshold, the Company shall use commercially reasonable efforts to structure the Refinancing in a manner that maintains adequate liability allocations for each Protected Member. Such efforts may include, without limitation:
(i) obtaining guarantees or indemnities from one or more Members (or their affiliates) to allocate a sufficient portion of the refinanced indebtedness to the affected Protected Member as recourse debt under Treasury Regulation Section 1.752-2;
(ii) structuring the Refinancing as a partial refinancing, with a portion of the existing indebtedness remaining outstanding in an amount sufficient to maintain the required liability allocation;
(iii) providing for deficit restoration obligations or other arrangements recognized under Treasury Regulation Section 1.752-2;
(iv) structuring a portion of the refinanced indebtedness as Member Nonrecourse Debt allocated to the affected Protected Member; or
(v) any other arrangement mutually agreed by the Members and their respective tax advisors that achieves the intended result under Section 752 of the Code.
(d) The Company shall not consummate any Refinancing that would reduce a Protected Member's share of Company liabilities below the required threshold unless the Company has first implemented one or more of the measures described in Section 3.4(c) above or has obtained the prior written consent of the affected Protected Member.
Section 3.5 — Like-Kind Exchange and Installment Sale Provisions
(a) If the Company proposes to undertake a Disposition of the Property (or any portion thereof) during the Protected Period, and a Protected Member desires that such Disposition be structured on a tax-deferred or tax-efficient basis, such Protected Member may, within fifteen (15) business days after receiving notice of the proposed Disposition, deliver a written request to the Company requesting that the Company use commercially reasonable efforts to structure the Disposition as:
(i) a tax-deferred exchange under Section 1031 of the Code, to the extent available and applicable to the Company's assets and the character of the property being disposed of (taking into account the limitations on like-kind exchange treatment for personal property, partnership interests, and other excluded property under Section 1031 of the Code, as amended by the Tax Cuts and Jobs Act of 2017); or
(ii) alternatively, an installment sale under Section 453 of the Code, with such terms and conditions (including the amount and timing of installment payments) as may be reasonably satisfactory to the Protected Member and the Company.
(b) The Company shall consider in good faith any such request and shall use commercially reasonable efforts to accommodate the requesting Protected Member's tax-deferral objectives, provided that:
(i) the Company shall not be required to delay a Disposition for more than ninety (90) days to accommodate a Section 1031 exchange identification or closing;
(ii) the Company shall not be required to accept materially less favorable economic terms in connection with a Disposition in order to accommodate a Section 1031 exchange or installment sale structure; and
(iii) the Company shall not be required to undertake any action that would violate the terms of any Company indebtedness, the Operating Agreement, or applicable law.
(c) All out-of-pocket costs, fees, and expenses (including qualified intermediary fees, escrow fees, legal fees, and accounting fees) directly associated with structuring a Section 1031 exchange or installment sale at the request of a Protected Member shall be borne by the requesting Protected Member and shall not be treated as Company expenses or reduce distributions to the other Member.
(d) The Members acknowledge and agree that Section 1031 exchange treatment may not be available for all Company assets. In particular, the Members acknowledge that certain assets held by the Company (including, without limitation, any personal property, inventory, or other assets that do not qualify as "real property" within the meaning of Section 1031 of the Code and the Treasury Regulations thereunder, as amended) may not be eligible for tax-deferred exchange treatment. Nothing in this Section 3.5 shall be construed as a guarantee or warranty that any particular Disposition can or will qualify for tax-deferred treatment under Section 1031 or Section 453 of the Code.
Section 3.6 — Interaction with Distribution Waterfall
(a) The protections set forth in this Article III are independent of, and shall not modify, supersede, or otherwise affect, the distribution waterfall and promote structure set forth in the Operating Agreement. For reference, the Operating Agreement provides for the following distribution priorities: (i) return of capital contributions to the Members pro rata (30% to Fairwater Member / 70% to Prescott Member); (ii) a 9.0% preferred return, compounded quarterly, to each Member on unreturned capital contributions; (iii) a catch-up distribution split 60% to Fairwater Member / 40% to Prescott Member until Fairwater Member has received its proportionate share of the preferred return and catch-up; (iv) a base residual split of 20% to Fairwater Member and 80% to Prescott Member; and (v) a second promote tier of 30% to Fairwater Member and 70% to Prescott Member on amounts in excess of a 15% project-level internal rate of return.
(b) No distribution or promote payment payable under the Operating Agreement shall be reduced, deferred, or otherwise modified on account of this Agreement. The tax protection obligation requires the Company to refrain from or to structure transactions to avoid triggering the recognition of Tax Gain to a Protected Member in excess of the Tax Protection Amount; it does not require any alteration to the economic distributions otherwise payable under the Operating Agreement.
(c) In the event of a conflict between the distribution provisions of the Operating Agreement and the tax protection obligations set forth in this Article III, the Parties shall negotiate in good faith to reconcile such conflict, giving due weight to both the economic terms of the Operating Agreement (including the distribution waterfall and promote structure) and the tax protections set forth in this Agreement. The Parties acknowledge that the intent of this Agreement is to protect the Members from unanticipated or disproportionate tax consequences, not to alter the agreed-upon economics of the venture.
ARTICLE IV — SPECIAL REIT PROTECTION PROVISIONS
Section 4.1 — Prohibited Transaction Protection
(a) The Company and each Member acknowledge and agree that the Fairwater Member's sole member, Fairwater Real Estate Investment Trust (NYSE: FWT; EIN: 52-2198437; Maryland State Department of Assessments and Taxation ID: D19847321), is a publicly traded real estate investment trust that has elected to be taxed as a REIT under Sections 856 through 860 of the Code, and that the maintenance of such REIT qualification is of critical importance to the Fairwater Member and its affiliates.
(b) The Company shall not engage in, authorize, or permit any Disposition of the Property (or any portion thereof) that would constitute a "prohibited transaction" within the meaning of Section 857(b)(6) of the Code with respect to the Fairwater Member, unless the Fairwater Member provides its prior written consent to such Disposition after consultation with the Fairwater Member's tax advisors. For this purpose, a "prohibited transaction" means a sale or other disposition of property described in Section 1221(a)(1) of the Code that is not described in Section 857(b)(6)(C) of the Code (the "safe harbor") or another applicable exception.
(c) In planning any Disposition of the Property, the Company shall give due consideration to whether the Disposition qualifies for the safe harbor under Section 857(b)(6)(C) of the Code, including without limitation the following requirements:
(i) the Property has been held by the Company for at least two (2) years;
(ii) the aggregate expenditures made by the Company during the two-year period preceding the date of the Disposition that are includable in the basis of the Property equal or exceed 30% of the net selling price of the Property;
(iii) the number of properties sold by the Company during the taxable year does not exceed seven (7) (or, alternatively, the aggregate adjusted bases or fair market values of property sold during the taxable year do not exceed 10% and 20% of the aggregate adjusted bases and fair market values, respectively, of all Company assets as of the beginning of the taxable year); and
(iv) substantially all of the marketing and development expenditures with respect to the Property are made through an independent contractor.
(d) The Company shall use commercially reasonable efforts to satisfy the safe harbor requirements of Section 857(b)(6)(C) of the Code in connection with any proposed Disposition, to the extent that compliance with such requirements is consistent with the economic objectives of the Company and the Operating Agreement.
Section 4.2 — Dealer Status Protections
(a) The Company shall not engage in a pattern of Dispositions or other activities that could reasonably be expected to cause the Company's real property assets (including the Property) to be characterized as property "held primarily for sale to customers in the ordinary course of a trade or business" within the meaning of Section 1221(a)(1) of the Code (i.e., "dealer property"). The characterization of the Property as dealer property could result in the imposition of the 100% prohibited transaction tax under Section 857(b)(6)(A) of the Code on Fairwater Real Estate Investment Trust and could jeopardize the Fairwater Member's REIT qualification.
(b) Any proposed Disposition of the Property (or any portion thereof) shall be reviewed by the Partnership Representative and the Company's tax advisors (Alderman & Fields, CPAs, LLP) for compliance with this Section 4.2 prior to the execution of any agreement of sale or other binding commitment with respect to such Disposition. Such review shall include an analysis of the relevant facts and circumstances (including holding period, number of sales, purpose of acquisition, extent of improvements, frequency and continuity of sales, and the extent of marketing activities) to assess whether the proposed Disposition could give rise to dealer status or prohibited transaction treatment.
(c) The Company shall maintain records and documentation sufficient to demonstrate the Company's investment intent with respect to the Property and to support the conclusion that the Property is held for investment or for use in a trade or business (and not primarily for sale to customers in the ordinary course), including board or member resolutions, business plans, and correspondence with lenders and investors reflecting such intent.
Section 4.3 — REIT Income and Asset Testing Coordination
(a) The obligations of this Section 4.3 are in addition to, and are intended to complement, the provisions set forth in the REIT Compliance Side Letter of even date herewith between the Fairwater Member and the Prescott Member.
(b) The Company shall cooperate with the Fairwater Member to ensure that the Company's income, assets, and operations do not cause Fairwater Real Estate Investment Trust to fail:
(i) the 75% gross income test under Section 856(c)(3) of the Code (requiring that at least 75% of a REIT's gross income be derived from rents from real property and other qualifying sources);
(ii) the 95% gross income test under Section 856(c)(2) of the Code (requiring that at least 95% of a REIT's gross income be derived from qualifying real estate sources, dividends, interest, and gain from the sale of certain assets);
(iii) the REIT asset tests under Section 856(c)(4) of the Code (including the requirement that at least 75% of the value of a REIT's total assets be represented by real estate assets, cash and cash items, and government securities); and
(iv) any other REIT qualification requirements under Sections 856 through 860 of the Code that may be affected by the Company's activities.
(c) The Company shall provide to the Fairwater Member, no later than thirty (30) days following the end of each fiscal quarter (and within fifteen (15) days following a reasonable request by the Fairwater Member at any other time), tax information in sufficient detail to enable Fairwater Real Estate Investment Trust to perform the REIT income tests and REIT asset tests under Section 856(c) of the Code, including, without limitation:
(i) a breakdown of the Company's gross income by category (rents from real property, interest income, gain from disposition of real property, other qualifying income, and non-qualifying income);
(ii) a schedule of the Company's assets, including the fair market value and adjusted basis of each material asset; and
(iii) such other information as the Fairwater Member may reasonably request in connection with its REIT compliance obligations.
Section 4.4 — Required REIT Distributions
(a) Consistent with the Operating Agreement and the REIT Compliance Side Letter, the Company shall distribute to the Fairwater Member, upon the Fairwater Member's written request, at least one hundred percent (100%) of the Fairwater Member's allocable share of "REIT taxable income" (within the meaning of Section 857(b)(2) of the Code, determined without regard to the dividends-paid deduction and excluding any net capital gain), in such amounts and at such times as are sufficient for Fairwater Real Estate Investment Trust to satisfy the REIT distribution requirements under Section 857(a) of the Code (which generally requires the distribution of at least 90% of REIT taxable income).
(b) Any distributions made to the Fairwater Member pursuant to this Section 4.4 shall be treated as advances on, and shall reduce, distributions otherwise payable to the Fairwater Member under the distribution waterfall set forth in the Operating Agreement. Such distributions shall not increase the Fairwater Member's aggregate entitlement to distributions under the Operating Agreement beyond the amounts to which it would otherwise be entitled. To the extent that distributions made pursuant to this Section 4.4 exceed the amounts then distributable to the Fairwater Member under the Operating Agreement waterfall, such excess shall be treated as an advance distribution that shall be recouped from future distributions otherwise payable to the Fairwater Member.
(c) The Fairwater Member shall provide the Company with reasonable advance notice (not less than twenty (20) business days) of any request for a REIT distribution under this Section 4.4, together with a computation (prepared by the Fairwater Member's tax advisors) of the amount of REIT taxable income allocable to the Fairwater Member and the minimum distribution required.
ARTICLE V — INDEMNIFICATION
Section 5.1 — Indemnification for Breach
(a) If the Company or any Member breaches any of its obligations under this Agreement and such breach results in the recognition of Tax Gain by a Protected Member (or such Protected Member's direct or indirect owners) during the Protected Period, the breaching Party shall indemnify, defend, and hold harmless the affected Protected Member and its direct and indirect owners from and against:
(i) the incremental federal, state (including the State of Maryland and any other applicable jurisdiction, including any state in which the Protected Member or its direct or indirect owners are subject to income tax as a result of the Company's activities), and local income taxes actually incurred by the Protected Member (or its direct or indirect owners) as a result of such breach, computed at the highest applicable marginal income tax rates for the relevant character of income (including ordinary income rates, capital gain rates, and the net investment income tax rate under Section 1411 of the Code, as applicable);
(ii) any interest and penalties imposed by any taxing authority in connection with the Tax Gain resulting from such breach; and
(iii) an additional amount (the "gross-up amount") sufficient to compensate the Protected Member for the federal, state, and local income taxes payable by the Protected Member (or its direct or indirect owners) on the receipt of the indemnity payment itself (including the gross-up amount), so that the Protected Member is made whole on an after-tax basis.
(b) For purposes of computing the indemnification amounts under this Section 5.1, the applicable tax rates shall include (i) the highest marginal federal income tax rate applicable to the relevant character of income (currently 37% for ordinary income and 20% for long-term capital gains, plus the 3.8% net investment income tax under Section 1411 of the Code, where applicable), (ii) the highest marginal Maryland state income tax rate (currently 5.75% for individual taxpayers, plus any applicable county income tax surcharge, or the applicable rate for corporate or trust taxpayers), and (iii) the Maryland pass-through entity tax, to the extent applicable. The parties acknowledge that the applicable tax rates may change from time to time and that the rates in effect at the time of the breach shall govern.
(c) The indemnification obligations under this Section 5.1 shall survive the expiration or termination of this Agreement for a period of three (3) years following the expiration of the applicable statute of limitations (including all extensions thereof) for the tax year in which the Tax Gain was recognized, and any claim for indemnification may be brought at any time during such survival period.
Section 5.2 — Limitation on Indemnification
Notwithstanding anything to the contrary in Section 5.1, no indemnification shall be owed by any Party under this Article V with respect to:
(a) Tax Gain resulting from actions taken with the prior written consent of the affected Protected Member, provided that such consent was given after the Protected Member was informed in writing of the potential tax consequences of such action;
(b) Tax Gain resulting from involuntary events (including condemnation by a governmental authority or foreclosure by a secured lender) where the Company has complied with the requirements of Section 3.1(c)(ii) of this Agreement, including the exhaustion of commercially reasonable efforts to avoid or mitigate such forced Disposition; or
(c) Tax Gain resulting from changes in applicable law (including changes in the Code, Treasury Regulations, or the interpretation thereof by the Internal Revenue Service or any court of competent jurisdiction) that are enacted or become effective after the date of this Agreement and that could not have been reasonably anticipated by the Parties as of the date hereof.
In addition, the aggregate indemnification obligation of any Party under this Article V shall not exceed the Tax Protection Amount applicable to the affected Protected Member, as calculated pursuant to Section 3.1(b), as of the date of the breach giving rise to the indemnification claim. This limitation shall apply separately to each Protected Member and separately to each item or layer of Section 704(c) Property.
Section 5.3 — Dispute Resolution for Tax Indemnification Claims
(a) Any dispute between the Parties regarding the amount of Tax Gain recognized, the applicable tax rate, the computation of the indemnification amount (including the gross-up amount), or any other matter arising under this Article V shall be submitted for resolution to an independent nationally recognized accounting firm mutually selected by the disputing Members within thirty (30) days after the dispute arises (which firm shall not be Alderman & Fields, CPAs, LLP or any other firm serving as the Company's regular tax advisor).
(b) If the Members are unable to agree on the selection of an independent accounting firm within such thirty (30) day period, each Member shall select one nationally recognized accounting firm, and the two firms so selected shall together select a third nationally recognized accounting firm, which third firm shall serve as the independent accounting firm for purposes of this Section 5.3.
(c) The determination of the independent accounting firm selected pursuant to this Section 5.3 shall be binding on all Parties, absent manifest error. "Manifest error" for purposes of this Section 5.3 means an error that is apparent on the face of the independent accounting firm's written determination, without the need for further analysis or investigation.
(d) The costs and expenses of the independent accounting firm shall be borne equally by the disputing Parties.
ARTICLE VI — PARTNERSHIP REPRESENTATIVE AND TAX MATTERS
Section 6.1 — Partnership Representative
(a) Fairwater HP Manager, LLC shall serve as the Partnership Representative of the Company under Section 6223 of the Code (as amended by the Bipartisan Budget Act of 2015), as provided in the Operating Agreement. Fairwater HP Manager, LLC shall have the authority and responsibility to act on behalf of the Company in connection with all federal income tax audits, examinations, administrative appeals, and judicial proceedings relating to the Company.
(b) The Partnership Representative shall consult with the Prescott Member, and shall provide the Prescott Member with reasonable advance notice, before taking any material action in connection with a federal income tax audit, examination, or proceeding that could materially affect the Prescott Member's tax liability, including without limitation:
(i) agreeing to, or challenging, any proposed adjustment to the Company's items of income, gain, loss, deduction, or credit;
(ii) entering into any settlement or closing agreement with the Internal Revenue Service;
(iii) filing any administrative adjustment request under Section 6227 of the Code; and
(iv) making or refraining from making any election under the centralized partnership audit rules (Sections 6221–6241 of the Code).
(c) The Partnership Representative shall not settle or agree to any federal tax adjustment, or take any action in connection with a federal tax proceeding, that would disproportionately and adversely affect the Prescott Member (relative to the Prescott Member's share of Company income and loss) without the prior written consent of the Prescott Member, which consent shall not be unreasonably withheld, conditioned, or delayed.
Section 6.2 — Tax Returns and Reporting
(a) The Company's federal, state, and local income tax returns shall be prepared by Alderman & Fields, CPAs, LLP (engagement partner: Robert E. Alderman; principal office: 1 South Street, Suite 1800, Baltimore, Maryland 21202) in accordance with this Agreement, the Operating Agreement, and applicable law.
(b) Draft tax returns shall be provided to each Member for review and comment no later than August 15 of the year following the close of the applicable tax year. Final tax returns (including IRS Form 1065 and all applicable Schedules K-1) shall be provided to each Member no later than September 15 of the year following the close of the applicable tax year, or such earlier date as may be required for the Fairwater Member's REIT compliance purposes (including the filing of Fairwater Real Estate Investment Trust's annual federal income tax return on IRS Form 1120-REIT).
(c) Section 704(c) Allocations, Built-In Gain tracking, Protected Gain calculations, and the Liability Allocation under Section 752 of the Code shall be reflected on the Company's tax returns and supporting schedules, including IRS Schedules K-1 delivered to each Member, and shall be accompanied by a supplemental statement setting forth the following information for each Section 704(c) Property:
(i) the initial Book Value and Adjusted Tax Basis of such property;
(ii) the Built-In Gain or Built-In Loss as of the beginning and end of the taxable year;
(iii) the amount of Section 704(c) Allocations (including curative or remedial allocations) made during the taxable year;
(iv) the remaining Protected Gain attributable to each Protected Member as of the end of the taxable year; and
(v) a reconciliation of the Liability Allocation under Section 752, including the classification of Company liabilities as recourse or nonrecourse and the share allocated to each Member.
Section 6.3 — Push-Out Election
(a) In the event of a federal income tax adjustment under the centralized partnership audit rules (Sections 6221–6241 of the Code) with respect to the Company, the Partnership Representative shall, upon the written request of either Member (delivered within thirty (30) days after the Partnership Representative notifies the Members of such adjustment), make an election under Section 6226 of the Code to "push out" the adjustment to the Members (the "Push-Out Election"), so that each Member (including former members for the applicable "reviewed year") takes into account its share of the adjustment on its own income tax return, rather than the Company paying the imputed underpayment at the partnership level under Section 6225 of the Code.