Note 10. Related Person Transactions

We have relationships and historical and continuing transactions with Five Star, RMR LLC, RMR Inc., and others related to them, including other companies to which RMR LLC provides management services and which have trustees, directors and officers who are also trustees, directors or officers of us, RMR Inc. or RMR LLC. For information in addition to that presented herein about these and other such relationships and certain other related person transactions, please refer to our Annual Report and our Current Report on Form 8-K filed with the Securities and Exchange Commission, or the SEC, on June 8, 2015.

Five Star:

Five Star was our 100% owned subsidiary until it was spun out to our shareholders as a special distribution in 2001. As of September 30, 2015, we owned 4,235,000 of Five Star’s common shares, representing approximately 8.6% of Five Star’s outstanding common shares, and we are Five Star’s largest shareholder. Five Star is our largest tenant and property operator.

As of September 30, 2015, we leased 178 senior living communities to Five Star. We recognized total rental income from Five Star of $47,828 and $47,717 for the three months ended September 30, 2015 and 2014, respectively, and $143,271 and $142,842 for the nine months ended September 30, 2015 and 2014, respectively. As of October 2015 and 2014, we received estimated percentage rent payments from Five Star of $4,194 and $4,317 for the nine months ended September 30, 2015 and 2014, respectively. We determine actual percentage rent due under our Five Star leases annually and recognize any resulting amount as rental income at year end when all contingencies are met. During the nine months ended September 30, 2015 and 2014, pursuant to the terms of our leases with Five Star, we purchased $16,915 and $23,776, respectively, of improvements made to properties leased to Five Star, and, as a result, the annual rent payable to us by Five Star increased by approximately $1,361 and $1,902, respectively. As of September 30, 2015 and December 31, 2014, our rents receivable from Five Star were $15,937 and $17,310, respectively, and those amounts are included in other assets in our condensed consolidated balance sheets.

In February 2015, we and Five Star sold a vacant senior living community that was leased to Five Star for a sale price of $250; and, as a result of this sale, Five Star’s annual minimum rent payable to us decreased by $23 in accordance with the terms of the applicable lease. In July 2015, we and Five Star sold a senior living community that was leased to Five Star for a sale price of $155; and, as a result of this sale, Five Star’s annual minimum rent payable to us decreased by $16 in accordance with the terms of the applicable lease. In August 2015, we and Five Star sold a senior living community that was leased to Five Star for $850; and, as a result of this sale, Five Star’s annual minimum rent payable to us decreased by $85 in accordance with the terms of the applicable lease.

As of September 30, 2015, Five Star managed 60 senior living communities for our account; as of September 30, 2014, Five Star managed 44 senior living communities for our account. Pursuant to our management agreements with Five Star, we incurred management fees of $2,717 and $2,438 for the three months ended September 30, 2015 and 2014, respectively, and $7,939 and $7,295 for the nine months ended September 30, 2015 and 2014, respectively, with respect to the communities Five Star manages. These amounts are included in property operating expenses in our condensed consolidated statements of comprehensive income.

In connection with our acquisition of 37 senior living communities in May 2015 described in Note 3, we terminated the pre-existing management agreements for 14 of these communities, with 838 living units, and entered into 14 separate management agreements with Five Star for it to manage these communities for our account.

In May 2015, we acquired one senior living community with 40 private pay independent living units for approximately $9,750, excluding closing costs, using a TRS structure. This senior living community is adjacent to another community that we own which is managed by Five Star. The operations of this community and the community already owned are now conducted as a single integrated community under one management agreement.

Pursuant to the sublease agreement between one of our TRSs and D&R Yonkers LLC, D&R Yonkers LLC incurred rent expense of $759 and $737 for the three months ended September 30, 2015 and 2014, respectively, and $2,263 and $2,197 for the nine months ended September 30, 2015 and 2014, respectively. D&R Yonkers LLC is owned by our officers in order to accommodate certain state licensing requirements. Five Star manages the senior living community to which the sublease agreement relates.

Acquisition of Interest in our Manager:

On June 5, 2015, we and three other real estate investment trusts, or REITs, to which RMR LLC provides management services – Government Properties Income Trust, or GOV, Hospitality Properties Trust, or HPT, and SIR, and collectively with GOV and HPT, the Other REITs – participated in a transaction, or the Up-C Transaction, by which we and the Other REITs each acquired an ownership interest in RMR Inc.

The Up-C Transaction was completed pursuant to a transaction agreement by and among us, our manager, RMR LLC, its then sole member, Reit Management & Research Trust, or RMR Trust, and RMR Inc. and similar transaction agreements that each Other REIT entered into with RMR LLC, RMR Trust and RMR Inc. RMR Trust is owned by our Managing Trustees, Barry and Adam Portnoy. Pursuant to these transaction agreements: we contributed to RMR Inc. 2,345,000 of our common shares and $13,967 in cash; GOV contributed to RMR Inc. 700,000 of its common shares and $3,917 in cash; HPT contributed to RMR Inc. 1,490,000 of its common shares and $12,622 in cash; SIR contributed to RMR Inc. 880,000 of its common shares and $15,880 in cash; RMR Trust contributed to RMR Inc. $11,520 in cash, which RMR Inc. contributed to RMR LLC; RMR LLC issued 1,000,000 of its class B membership units to RMR Inc.; RMR Inc. issued 5,272,787 shares of its class A common stock to us, 1,541,201 shares of its class A common stock to GOV, 5,019,121 shares of its class A common stock to HPT, 3,166,891 shares of its class A common stock to SIR and 1,000,000 shares of its class B-1 common stock and 15,000,000 shares of its class B-2 common stock to RMR Trust; RMR Trust delivered 15,000,000 of the 30,000,000 class A membership units of RMR LLC which RMR Trust then owned to RMR Inc.; and RMR Inc. delivered to RMR Trust our common shares, the common shares of the Other REITs and the cash which had been contributed by us and the Other REITs to RMR Inc.

The class A common stock and class B-1 common stock of RMR Inc. share ratably as a single class in dividends and other distributions of RMR Inc. when and if declared by the board of directors of RMR Inc. and have the same rights in a liquidation of RMR Inc. The class B-1 common stock of RMR Inc. is convertible into class A common stock of RMR Inc. on a 1:1 basis. The class A common stock of RMR Inc. has one vote per share. The class B-1 common stock of RMR Inc. has 10 votes per share. The class B-2 common stock of RMR Inc. has no economic interest in RMR Inc., but has 10 votes per share and is paired with the class A membership units of RMR LLC owned by RMR Trust. The class A membership units of RMR LLC owned by RMR Trust are required to be redeemed by RMR LLC upon request by RMR Trust for class A common stock of RMR Inc. on a 1:1 basis, or if RMR Inc. elects, cash. Under the governing documents of RMR Inc., upon the redemption of a class A membership unit of RMR LLC the class B-2 common stock of RMR Inc. “paired” with an equal number of class A membership units are cancelled for no additional consideration.

As part of the Up-C Transaction and concurrently with entering the transaction agreements, on June 5, 2015:

We entered into an amended and restated business management agreement, or the amended business management agreement, with RMR LLC and an amended and restated property management agreement, or the amended property management agreement, with RMR LLC. The amendments made by these agreements are described below in this Note under “Amendment and Restatement of Management Agreements with RMR LLC.” Each Other REIT also entered amended and restated business and property management agreements with RMR LLC which made similar amendments to their management agreements with RMR LLC.

We entered into a registration rights agreement with RMR Inc. covering the class A common stock of RMR Inc. that we received in the Up-C Transaction, pursuant to which we received demand and piggyback registration rights, subject to certain limitations. Each Other REIT entered into a similar registration rights agreement with RMR Inc.

We entered into a lock up and registration rights agreement with RMR Trust and Barry and Adam Portnoy pursuant to which RMR Trust and Barry and Adam Portnoy agreed not to transfer the 2,345,000 of our common shares RMR Trust received in the Up-C Transaction for a period of 10 years and we granted them certain registration rights, subject to certain limited exceptions. Each Other REIT also entered into a similar lock up and registration rights agreement with RMR Trust and Barry and Adam Portnoy.

As a result of the Up-C Transaction: RMR LLC became a subsidiary of RMR Inc.; RMR Inc. became the managing member of RMR LLC; through our ownership of class A common stock of RMR Inc., we currently have an indirect 17.0% economic interest in RMR LLC; through their ownership of class A common stock of RMR Inc., GOV, HPT and SIR currently have an indirect 5.0%, 16.2% and 10.2% economic interest in RMR LLC, respectively; and RMR Trust through its ownership of class B-1 common stock of RMR Inc., class B-2 common stock of RMR Inc. and class A membership units of RMR LLC currently directly and indirectly has a 51.6% economic interest in RMR LLC and controls 91.4% of the voting power of outstanding capital stock of RMR Inc.

Pursuant to the transaction agreements, we and each Other REIT agreed to distribute approximately half of the shares of class A common stock of RMR Inc. received in the Up-C Transaction to our respective shareholders as a special distribution, and RMR Inc. agreed to facilitate this distribution by filing a registration statement with the SEC to register the shares of class A common stock of RMR Inc. to be distributed and by seeking a listing of those shares on a national stock exchange upon the registration statement being declared effective by the SEC. The distribution of class A common stock of RMR Inc. that we and the Other REITs have agreed to make to our and the Other REITs’ shareholders will be made only after a registration statement, including a prospectus, is declared effective by the SEC.

Amendment and Restatement of Management Agreements with RMR LLC:

As part of the Up-C Transaction, on June 5, 2015, we and RMR LLC entered into the amended business management agreement, which amended and restated our previous business management agreement with RMR LLC, and the amended property management agreement, which amended and restated our previous property management agreement with RMR LLC. Our amended business management agreement and amended property management agreement are referred to together in this Note as our amended management agreements. Our amended management agreements were effective as of June 5, 2015.

Our amended management agreements have terms that end on December 31, 2035, and automatically extend on December 31st of each year for an additional year, so that the terms of the agreements thereafter end on the 20th anniversary of the date of the extension. We have the right to terminate each amended management agreement: (i) at any time on 60 days’ written notice for convenience, (ii) immediately upon written notice for cause, as defined therein, (iii) on 60 days’ written notice given within 60 days after the end of any calendar year for a performance reason, as defined therein, and (iv) by written notice during the 12 months following a change of control of RMR LLC, as defined therein. RMR LLC has the right to terminate the amended management agreements for good reason, as defined therein.

If we terminate one or both of our amended management agreements for convenience, or if RMR LLC terminates one or both of our amended management agreements for good reason, we have agreed to pay RMR LLC a termination fee in an amount equal to the sum of the present values of the monthly future fees, as defined therein, for the terminated amended management agreement(s) for the remaining term. If we terminate one or both of our amended management agreements for a performance reason, as defined therein, we have agreed to pay RMR LLC the termination fee calculated as described above, but assuming a remaining term of 10 years. We are not required to pay any termination fee if we terminate our amended management agreements for cause or as a result of a change of control of RMR LLC.

Accounting for Investment in RMR Inc.:

On June, 5, 2015, we acquired 5,272,787 shares of class A common stock of RMR Inc. for $60,700, excluding transaction costs. We have concluded, for accounting purposes, that the consideration paid for this investment in RMR Inc.’s shares of class A common stock represented a discount to the fair value of these shares. We account for this investment under the cost method of accounting and have recorded this investment at its estimated fair value of $136,278 as of June 5, 2015 using Level 3 inputs as defined in the fair value hierarchy under GAAP. As a result, we recorded a liability for the amount by which the estimated fair value exceeded the price we paid for these shares and which amount we are amortizing as described below. As of September 30, 2015 the unamortized balance of this liability was $76,648 and it is included in other liabilities in our condensed consolidated balance sheet. Our investment is included in other assets in our condensed consolidated balance sheet and the carrying value of our investment was $138,839, including transaction costs, as of September 30, 2015. We believe the carrying value of our investment in RMR Inc. as of September 30, 2015 approximates its estimated fair value for accounting purposes. The liability related to the acquisition of these shares is being amortized on a straight line basis over the 20 year life of the business and property management agreements with RMR LLC as a reduction to business management fees and property management fees, which are included in general and administrative and property operating expenses, respectively, in our condensed consolidated statements of comprehensive income. Amortization of the liability included in general and administrative expense and property operating expenses for the three and nine months ended September 30, 2015 totaled $959 and $1,202, respectively.

RMR LLC Management Fees and Reimbursements:

Pursuant to our business management agreement with RMR LLC, the business management fees we recognized were $8,682 and $8,077 for the three months ended September 30, 2015 and 2014, respectively, and $26,644 and $22,492 for the nine months ended September 30, 2015 and 2014, respectively. As of September 30, 2015 and 2014, no incentive fees were estimated to be payable to RMR LLC for 2015 and 2014, respectively.

The business management fees we recognized for the 2015 and 2014 periods are included in general and administrative expenses in our condensed consolidated financial statements. In accordance with the terms of our pre-existing business management agreement, we issued 68,983 and 98,449 of our common shares to RMR LLC for the nine months ended September 30, 2015 and 2014, respectively, as payment for portions of the base business management fees we recognized for those periods. Our amended business management agreement requires that 100% of the management fee due to RMR LLC be paid by us in cash.

Pursuant to our property management agreement with RMR LLC, the property management fees, including construction supervision fees, we recognized were $2,533 and $2,211 for the three months ended September 30, 2015 and 2014, respectively, and $7,554 and $5,928 for the nine months ended September 30, 2015 and 2014, respectively. These amounts are included in property operating expenses or have been capitalized, as appropriate, in our condensed consolidated financial statements and are comprised of fees we recognized under both our pre-existing property management agreement and our amended property management agreement.

Pursuant to our previous and amended management agreements with RMR LLC, we are responsible for paying all of the property level operating costs, which costs are generally incorporated into rents charged to our tenants, including certain payroll and related costs incurred by RMR LLC. The total of those property management related reimbursements paid to RMR LLC were $1,954 and $1,714 for the three months ended September 30, 2015 and 2014, respectively, and $5,189 and $4,629 for the nine months ended September 30, 2015 and 2014, respectively, and these amounts are included in property operating expenses in our condensed consolidated financial statements for these periods. In addition, we have historically awarded share grants to certain RMR LLC employees under our equity compensation plan and we accrue estimated amounts for such share grants based upon historical practices throughout the year. In September 2015 and 2014, we made annual share grants to RMR LLC employees of 84,000 and 81,700 of our common shares, respectively. In September 2015, we purchased 13,113 of our common shares, at the closing price for our common shares on the NYSE on the date of purchase, from certain employees of RMR LLC in satisfaction of tax withholding and payment obligations in connection with the vesting of restricted common shares. In addition, under our business management agreement we reimburse RMR LLC for our allocable costs of internal audit services. The amounts accrued for share grants to RMR LLC employees and internal audit costs were $302 and $662 for the three months ended September 30, 2015 and 2014, respectively, and $1,337 and $1,615 for the nine months ended September 30, 2015 and 2014, respectively, and these amounts are included in our general and administrative expenses for these periods.

Leases with RMR LLC:

Pursuant to our lease agreements with RMR LLC, we recognized rental income from RMR LLC for leased office space of approximately $153 for the nine months ended September 30, 2015.

SIR:

On January 29, 2015, we acquired from SIR entities owning 23 MOBs that SIR acquired when its subsidiary merged with CCIT. Our purchase price for these 23 MOBs was approximately $539,000, excluding closing costs and working capital adjustments and including the assumption of approximately $29,955 of mortgage debts. These 23 MOBs contain approximately 2,170,000 leasable square feet and are located in 12 states. In April 2015, SIR paid to us $8,993 to settle certain working capital activity for the 23 MOBs as of the acquisition date.

AIC:

As of September 30, 2015, our investment in Affiliates Insurance Company, or AIC, an Indiana insurance company, had a carrying value of $6,807, which amount is included in other assets on our condensed consolidated balance sheet. We recognized a loss of ($24) and income of $38 related to our investment in AIC for the three months ended September 30, 2015 and 2014, respectively, and income of $70 and $59 for the nine months ended September 30, 2015 and 2014, respectively. Our other comprehensive income includes unrealized (losses) gains on securities available for sale which are owned by AIC of ($72) and ($33) for the three months ended September 30, 2015 and 2014, respectively, and (losses) of ($91) and gains of $17 for the nine months ended September 30, 2015 and 2014, respectively.

In June 2015, we and the other shareholders of AIC renewed our participation in an insurance program arranged by AIC. In connection with that renewal, we purchased a three year combined property insurance policy providing $500,000 of coverage annually with the premium to be paid annually, a one year property insurance policy providing $1,000,000 of coverage for one very large property we own and a one year combined policy providing terrorism coverage of $200,000 for our properties. We paid aggregate annual premiums, including taxes and fees, of approximately $4,222 in connection with these policies for the policy year ending June 30, 2016, and this amount may be adjusted from time to time as we acquire and dispose of properties that are included in this insurance program.

Directors’ and Officers’ Liability Insurance:

In August 2015, we extended through September 2017 our combined directors' and officers' insurance policy with RMR LLC and five other companies managed by RMR LLC that provides $10,000 in aggregate primary coverage. At that time, we also extended through September 2016 our separate additional directors' and officers' liability insurance policies that provide $20,000 of aggregate excess coverage plus $5,000 of excess non-indemnifiable coverage. The total premium payable by us for these extensions was approximately $502.