Mr. Migdal

Hospitality Law

The Hotel Deed in Lieu

By Nelson Migdal, Real Estate, Shareholder, Greenberg Traurig LLP

The deed in lieu of foreclosure offers lenders and borrowers an alternative to foreclosure when the going gets rough. However, when the subject of foreclosure is an operating hotel, there are many complexities that must be analyzed and understood prior to handing the keys over to the lender.

We all understand the current realities. Opinions and commentary are available from an infinite number of sources. After the commentary is read and the reality is understood, there may still come a time when a lender holding a loan, secured by real estate that is an operating hotel, will ask the borrower or strongly suggest to the borrower that it is time for the borrower to hand the lender the keys. The deed in lieu of foreclosure is relatively straight-forward solution to this sticky situation. Rather than endure the additional cost and trauma of a lender foreclosure and trustee's sale, the borrower and the lender, by mutual agreement and consent, arrive at a settlement whereby, among may other matters, the borrower conveys good and marketable fee simple title to the asset to the lender (or a lender designee).

The conveyance through deed in lieu of foreclosure generally includes all of borrower's right, title and interest in and to the land, all improvements on the land, and all other rights that the borrower may hold. When the land and the improvements are an operating hotel, with amenities like a spa and restaurant, it is a bit more complex than a traditional commercial asset. When the borrower is the owner of the asset, but has a third party manager in place at the hotel and/or restaurant and spa to handle day-to-day operations, the matter requires special care and attention in a manner that is very different from how a lender might approach an apartment building or commercial office building. Each of these management agreements (hotel, restaurant and spa) will have special requirements and complexities that must be considered prior to the conveyance.

Underwrite the Underwriting

Having an underwriting process to make a loan to a borrower which loan is secured by a hotel is one thing. At this point the lender is primarily looking at the value of the asset and whether the operations of the hotel will generate enough revenue to allow the borrower to pay the lender back. Having a lender or lender designee actually become the owner of the hotel is quite another thing. When the loan goes bad and the lender is looking at taking over the operation of the hotel the calculation is very different than the underwriting process. The lender is in the business of lending money - not operating hotels - therefore, the lender really needs to understand how the hotel and its component amenities function, and how the hotel will be operated, even if the lender will own and operate the hotel just long enough to sell it to someone else. The structure of the borrower, the various entities that the borrower may have created to hold licenses and permits, employ the employees, or lease or operate the amenities must be examined with fresh eyes and minds. The lender must be keenly aware of what it is going to take for the lender to step into the shoes of the hotel owner and successfully operate the hotel.

Follow the Paper

Operating hotel assets frequently have separate legal entities that perform the various functions that together become the hotel. For an efficient and effective process, each function and each entity must be peeled back so that the documentation of the deed in lieu transactions includes each necessary piece. Knowing that a deed of conveyance is required for the land and a bill of sale is required for personal property is just the beginning. The lender must assess how to capture the intellectual property through assignment and registrations, the residential elements, the hotel management agreement, liquor licenses, operating permits and approvals, and assignment of the restaurant and spa agreements. It is critical that each detail is analyzed and that each aspect of the operation of the hotel is properly transferred to the lender or its designee. The lender's primary objective continues to be to ensure that the hotel is profitable. Imagine missing a "detail" like transferring the liquor license and the effect that would have on the bottom line. Lenders should expect to have a number of tasks to complete prior to the deed in lieu closing in order to be able to walk in and continue operating the hotel in the manner that will not cause disruption to the operating cash flow of the asset.

Beware the Unique Issues

Unlike an apartment building or an office building, a hotel will have unique challenges such as liquor licensing, employees, a hotel management agreement with a nationally recognized brand or flag, and perhaps even a separate restaurant management agreement and a spa operations agreement. In theory, the loan closing occurred with a subordination, nondisturbance and attornment agreement in place, so there will be some guidance with respect to how the lender and the hotel manager expect to work together. The majority of agreements among the borrower, lender and hotel manager permit the hotel manager to continue to operate the hotel under the management agreement without interference when the only default is by the borrower under the loan without a default by the manager under the hotel management agreement. Nevertheless, the hotel management agreement must be understood by the lender in a way that differs from that of a lender being in the role of lender. Now the lender is the owner and the manager works for the lender. Depending upon what was negotiated in the subordination, nondisturbance and attornment agreement, the lender may have obligations on the way in, when it becomes the owner, such as funding obligations to maintain brand standard, and on the way out, when the asset is being sold by the lender, which the lender, as "seller" will try to pass through to the hotel purchaser under a purchase and sale agreement.

Understand Hotel Management

Generally, hotel management agreements today are independent contractor or agency style agreements. Nevertheless, the flashpoints for the lender, as it becomes the owner, usually include, employment matters, and owner's right to terminate for convenience or upon sale with or without a termination fee. Whether the lender has a right to terminate the management agreement upon a foreclosure or a deed in lieu of foreclosure will have been heavily negotiated in the subordination, nondisturbance and attornment agreement. Because the manager views the management agreement as steady income, almost like an annuity, which is the basis of how the management company is valued for its purposes, and the termination of the management agreement terminates the revenue projections of the management company for that asset, the right to terminate is often unavailable to the lender, other than upon limited areas of a manager default or payment of a termination fee. Prior to conveyance, the lender must understand the cost of termination of the management agreement, if that is an option, and if termination is not an option, the intricacies of the hotel management agreement.

How to Handle Employees

Upon conveyance of the hotel and the lender and borrower must be mindful of how the transfer of ownership of the hotel might trigger the applicability of the Worker Adjustment and Retraining Notification Act (WARN Act). The WARN Act protects workers by requiring employers to provide notice 60 days prior to hotel closings or mass layoffs. Although this issue may have bee adequately addressed in the hotel management agreement, particularly when the current manager is the employer, it is important to warn both the lender and borrower to pay close attention to their responsibilities under the WARN Act.

If the hotel will continue to operate, the manager is the employer and the lender assumes the hotel management agreement upon the hotel conveyance, the employees stay in place. However, upon the transfer of ownership of the hotel, if the hotel employees are employees of the borrower (other than employees who have worked less than 6 months in the last 12 month period or worked an average of less than 20 hours a week), on the date of closing the employees of borrower become the employees of lender.

There are many issues related to employees when transferring ownership of the hotel, for example the allocation of all accrued but unpaid employee salaries, wages, bonuses, profit sharing and other benefits. This can be a hidden cost if not addressed during the conveyance process. Lenders should discuss the issues related to the employment of hotel employees with an experienced employment attorney prior to purchasing a hotel.

Get in and Get Out

The core business of the lender is not the core business of a hotel owner. If the borrower and lender conclude that the lender will take the keys, the fundamental basis for such an action is for the protection of the collateral rather than for the lender to become a hotel owner. The mission for the lender should be to take the asset and make it sale ready as quickly as prudent business practices will allow. However, between conveyance and subsequent sale the lender must be fully prepared to own and operate the hotel in a manner that permits a seamless transition and ensures the profitability of the hotel.

Nelson F. Migdal is a Principal Shareholder at Greenberg Traurig and head of the Mid-Atlantic Real Estate practice group. He has practiced hospitality law for over 25 years. He handled the management agreements for The Echelon Place, in Las Vegas. In Panama, as owner's counsel, he obtained the first "Trump" license in Central America. Nelson is owner's counsel for The Trump Soho Project, and handled the Exclusive License with Trump in Istanbul. Nelson is an officer of the Academy of Hospitality Industry Attorneys and a member of the International Society of Hospitality Consultants. Mr. Migdal can be contacted at 202-331-3180 or migdaln@gtlaw.com Extended Bio...

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