WAIVERS OF OWNERSHIP LIMITATION PROVISIONS IN REIT CHARTERS 48 the ownership limit. If yes, then, as discussed above, the implication is either that a waiver has been granted or that one is unnecessary under the particular REIT’s charter. Conversely, waivers granted by the board not in the ordinary course of business and/or to investors that are (or would be required to be) Schedule 13D filers would generally be disclosable events to be reported in the appropriate periodic report under the Exchange Act and/or in an amendment the relevant Schedule 13D. 6. RELATED PARTY TENANT OWNERSHIP LIMITATIONS As noted above, the ownership limitation provisions in a REIT’s charter are also designed to protect the REIT from running afoul of another potential REIT qualification pitfall, receiving “bad” REIT income in the form of related party rent. If a single person or entity owns (including under certain constructive ownership rules that attribute the ownership of shares owned by one person to another29 ) 10% or more of both the REIT and one of its tenants, then the rent received by the REIT from that tenant will be considered “bad” REIT income and not “rent from real property” for purposes of satisfying the minimum percentage threshold requirements under the REIT gross income tests.30 By providing that no one can own shares, actually and/or constructively, in excess of the specified ownership limit — which to be safe should always be less than 10.0% — the REIT protects itself from ever incurring a related party tenant income problem. This is particularly important for REITs with assets in a sector (such as office, retail and industrial) where large institutional stockholders of the REIT may also own 10% or more of the REIT’s tenants. These stockholders rarely present a true 5/50 test concern but often can potentially raise a related party tenant income issue. Unlike the 5/50 test, the relevant tax rules and definitions relating to related party rent determinations generally treat legal entities as single persons.31 So a single mutual fund that owns 10% or more of the REIT’s outstanding stock and also owns 10% or more of a tenant of the REIT would cause all of the rent received from that tenant to fail to qualify as “rents from real property” for purposes of the REIT’s gross income tests, which, in turn, could cause the REIT to fail to qualify as a REIT for U.S. federal income tax purposes. This is true irrespective of the fact that the mutual fund’s ownership would not cause a 5/50 test concern. This means that a REIT must proceed with caution when considering a waiver request from the related party tenant ownership limit for a single entity, even if the entity is, say, a widely held mutual fund. If the REIT grants a related party tenant ownership limit waiver to a single entity, the REIT would first be required to obtain extensive representations from the investor that it does not own (including constructively) 10% or more of any tenant of the REIT and the REIT should then also endeavor to monitor, including by way of undertakings from the investor, the investor’s direct and indirect ownership percentages in the REIT’s tenants. Otherwise, the REIT runs the risk of receiving related party rent, which could jeopardize its REIT status.32 Accordingly, many forms of ownership limit waivers and/or related Excepted Holder Certificates place the affirmative covenant on the Excepted Holder to notify the REIT of any acquisitions by the Excepted Holder of actual or constructive interests in tenants of the REIT. Similarly, large stockholders who may also be 29 In a typical REIT charter, the constructive ownership rules that apply to the related-party tenant income rules are generally incorporated through the use of the defined term “Constructive Ownership” whereas the constructive ownership rules that apply to the 5/50 ownership test are commonly referred to in a REIT charter as “Beneficial Ownership,” as noted above in footnote 8. 30 Under Section 856(c)(2) and 856(c)(3) of the Internal Revenue Code, a REIT must generally derive (i) at least 75 percent of its gross income from rents from real property, interest on obligations secured by mortgages on real property, gain from the sale or disposition of real property (other than the sale of dealer property), and certain other income related to real property and (ii) 95 percent of its gross income from real property related income meeting the 75% gross income test and certain other passive sources, e.g., dividends, interest and other capital gains. Related party rent will not qualify as income meeting either of these tests, though certain exceptions apply. A REIT has only a 5% basket for “bad” REIT income that does not qualify for the 95% gross income test (which would include related party rent as well as certain other sources of income). While beyond the scope of this article, we note that in addition to the fact pattern described above in which a stockholder holds both 10% or more of the REIT and 10% or more of a tenant, there are other more circuitous and complicated paths of ownership attribution that can apply under the relevant constructive ownership rules which would also result in related party rent to the REIT. 31 Section 856(d)(2)(B) and 856(d)(5) of the Internal Revenue Code. 32 Even though the REIT’s charter will typically include a provision that would result in the transfer of a stockholder’s shares to a charitable trust to the extent the person’s ownership caused the REIT to have related party tenant income or otherwise caused the REIT to fail to qualify as a REIT, the board will nonetheless want to review any potential related party tenant issues that could arise with respect to a waiver recipient’s ownership of 10% or more of the REIT’s stock rather than rely solely on the charter provisions to protect the REIT’s status as a REIT. In some isolated cases, the board may even require that a recipient of an ownership limit waiver (i) review tenant lists and make representations with respect to its lack of actual or constructive ownership in tenants, and (ii) agree to review revised tenant lists and update its representations on a periodic basis, subject in each case to appropriate agreements relating to preserving the confidentiality.