7. Transactions with Sunburst

Effective October 15, 1997, Choice Hotels International, Inc. (“CHI”), which at that point included both the franchising business and owned hotel business, separated the businesses via spin-off of the Company (the “Sunburst Distribution”). CHI changed its name to Sunburst Hospitality Corporation (referred to hereafter as “Sunburst”). As part of the spin-off, Sunburst and the Company entered into a strategic alliance agreement, which was amended in December 1998 and September 2000. Among other things, the strategic alliance agreement provides for (i) certain commitments by Sunburst for the development of MainStay Suites hotels; (ii) special procedures associated with liquidated damages; and (iii) predetermined franchise fee credits based on operating performance. The amended strategic alliance agreement extends through October 15, 2002 as it relates to development commitments. Liquidated damage and franchise fee credit provisions extend through the life of existing franchise agreements.

In connection with the spin-off, the Company borrowed $115 million under its Credit Facility (as defined in Note 10) in order to fund a subordinated term note to Sunburst (the “Note”). The Note of $115 million accrues interest monthly at an initial simple rate of 11% per annum through October 14, 2000. In connection with an amendment of the strategic agreement discussed above, effective October 15, 2000,

interest shall accrue at a rate of 11% per annum compounded daily. On January 1, 1999, the Company began recognizing interest on the outstanding principal and accrued interest amounts at an effective rate of 10.58%. The Note is payable in full, along with accrued interest, on October 15, 2002. Total interest accrued as of December 31, 2000 and 1999 was $42.2 million and $27.0 million, respectively.

On September 1, 2000, Sunburst transferred title to three MainStay properties under a put/ call agreement entered into between the Company and Sunburst in March 2000. The properties were received by the Company as consideration for $16.3 million of the then $149 million amount due under the Note. The fair market value of the MainStay properties was approximately $12.2 million. Accordingly, the Company recognized a $4.1 million pre-tax loss on the Note.

On September 20, 2000, the Company and Sunburst reached agreement on the terms of a proposed restructuring of the then existing $136 million Note. Under the terms of the agreement, the Company would receive cash and a newly issued 11 3/ 8% seven-year subordinated note. On January 5, 2001, the Company received $101.9 million, a parcel of land valued at approximately $1.5 million and a $35 million seven-year senior subordinated note bearing interest at 11 3/ 8% in settlement of the balance of the Note. In 2000, the Company recognized a pre-tax loss of $3.5 million resulting from this transaction.

During the periods presented, Sunburst operated substantially all of its hotels pursuant to franchise agreements with the Company. Total fees paid to the Company included in the accompanying consolidated financial statements for franchising royalty, marketing and reservation fees were $10.3 million, $9.1 million and $11.2 million for the years ended December 31, 2000, 1999 and 1998, respectively.