Legal Overview of Transition Matters in a Hotel Management Company M&A Transaction

By Patricia Mahlstedt Co-Chair Hospitality & Gaming Practice, Eckert Seamans | December 24, 2017

Consent Process

A hotel operator’s management contracts with the hotel owners are the main assets of the operator’s business. Any business combination of two hotel operators needs to keep those assets intact to accomplish a successful combination. Thus, if the contracts require the consent of one or more hotel owners in order to consummate the proposed combination, from both a legal and financial perspective it is imperative to obtain those consents. Attorneys for both parties should review all the management contracts during legal due diligence review, and will draft the necessary documents for obtaining the consents. However, this process isn’t just a review and documentation exercise for the lawyers. The results of the contract review can help the parties strategize on the structure of the transaction, as well as focus resources for the consent-seeking process. 

Further, the executives and upper-level operational personnel of both operators play a key role in obtaining the necessary consents – they will need to satisfy those hotel owners that the combination will not negatively impact their hotels. Even if a contract does not require a hotel owner’s consent for the particular transaction, keeping hotel owners satisfied is a core requirement for any hotel operator ( particularly for contracts without long, non-cancellable terms ). Therefore, whether or not a consent is required, it is also important for the hotel operators to demonstrate that the new, combined company will also have a positive impact on hotel operations.

We can’t talk about obtaining owner consents, without also discussing consents from franchisors and lenders. The acquiring hotel operator needs to become ( or remain ) an operator approved by the owners’ franchisors and lenders. Even if a management contract doesn’t expressly require the owner’s consent to the transaction, most likely the hotel operator is required to remain an approved operator, or at the very least is prohibited from taking any action which could cause a default under the owner’s franchise agreement or loan agreement. While the hotel operators may have existing relationships with the franchisors and lenders, with respect to the specific hotels it is the hotel owners who have the direct contractual relationships with those parties. Therefore, the hotel operators need to have the hotel owners on board ( or at least in the loop ) before contacting the franchisors and lenders for any required consents. The goal is the same as with the owners – satisfy them that the combination of the hotel operators will not hurt hotel operations, and will likely positively impact the hotels. In addition, the hotel owners will not be expecting to bear any cost of obtaining and documenting these consents – the hotel operators need to be prepared to cover approval fees, as well as legal fees, of the franchisors and lenders.

The transaction will likely also require consents from other third parties. Each hotel operator will have corporate-level contracts which impact both their respective internal corporate operations and hotel operations. For example, they may have contracts with a payroll processor for both corporate and hotel employees, licenses/agreements with software vendors and other information technology providers or master purchasing agreements for food and other operating supplies. Depending upon which of the various vendors will “survive” the transaction, the contracts may require consent from the vendors. Alternatively, for those contracts which overlap in services, the parties will need to address the ability to terminate the redundant contracts. Again, counsel for the parties can help identify the contracts which will be impacted, help the parties estimate related transaction costs, and assist in the consent ( or termination ) process.

Employment-Related Matters

Perhaps the largest operational integration matters are employment-related matters. Although management contracts are the main assets of a hotel operator, the employees - both at the hotel level and at the corporate level - are the key to successful operation under those contracts. Any business combination, regardless of the industry involved, needs to address integration and redundancy at the corporate level. For hotel operators, though, there are additional factors to consider at the hotel level. For example:

  1. Are the pay scale and benefit programs of the acquiring hotel operator comparable to those of the outgoing operator ( or outgoing parent company )?
  2. What employment eligibility and background check programs does the outgoing operator follow?
  3. Are there any wage and hour compliance issues at the incoming hotels? 

At the outset of the transaction, due diligence review of employment-related practices and documentation, conducted by human resource personnel and counsel for the acquiring company, will help identify any concerns. Based on the information, the parties need to address whether any programs need to be re-structured from both a legal compliance standpoint ( e.g., I-9 verification, “WARN Act” compliance, exempt/non-exempt classification, etc. ) and an employee integration/morale standpoint, while taking into account the financial impact of such changes. Again, hotel owners will resist any changes which may impact their hotels’ profitability. That being said, if changes are necessary because of the changing demands of legal requirements or industry best practices, the hotel operators can legitimately take the position that those are operational costs to be borne by hotel operations, regardless of what company is the hotel operator.  

Additionally, if any hotels impacted by the transaction have union employees, the hotel operators need to determine whether the transaction requires notice to, and perhaps consent from, the unions. Preserving relationships with the unions is not only important to a hotel operator as the employer, but also part of meeting the expectations of hotel owners. If a hotel is in the middle of a collective bargaining process, this can complicate the process. Another complicating factor could arise if the combined company will result in the acquiring hotel operator managing non-union hotels in the same city as hotels which already have unionized employees. The parties need to be aware of the potential for increased union activity due to proximity and integration of employees ( especially if accretion or neutrality agreements are in place ), and consider both the operational and financial impact.  

Another factor for the acquiring hotel operator to consider is whether the outgoing operator employs contract or temporary labor at the hotels becoming part of the acquirer’s operations. Given the leanings of the courts and the NLRB during the Obama administration regarding joint-employer liability for contract labor, the acquiring hotel operator needs to carefully review the contracts with the labor providers, as well as the actual practices at the hotels in dealing with those contract laborers. While it is uncertain if the relevant rulings will stand with the change in administration, the acquirer should nevertheless be aware of, and take reasonable steps to limit, potential joint-employer liability.

Licenses

The business combination of hotel operators, whether an asset purchase or a merger, can impact hotel-level licenses and permits. Very often the hotel operator holds a hotel’s liquor license. Even if the liquor license is held in the name of the hotel owner, a change with respect to the hotel operator may still impact that license. State law ( and sometimes local law ) will almost certainly require addressing a hotel’s liquor license. Depending upon the applicable law, this could be as simple as a notice filing after the closing of the transaction. As is more often the case, however, the change in hotel operator – and even a change at an upper-tier of the operator’s structure – will require reporting the pending change and obtaining regulatory approval before the transaction closes. Some, but not all, states will permit an interim arrangement to address a timing lag between the closing and obtaining such approval. In any case, it is important to identify the relevant licenses early on in the transaction and work with local liquor counsel in each location to ensure meeting the planned closing timing. If there are liquor licenses in several states, a single point of coordination ( whether in-house at the hotel operator or an outside coordinator ) for communicating with the multiple local liquor attorneys goes a long way in smoothing out this process.

For the most part, other licenses and permits required for the operation of a hotel should be maintained in the names of the relevant hotel owners – such as business operation licenses, elevator permits, pool permits and others. In addition to the liquor licenses described above, however, some locations require the hotel operator entity to maintain its own business operator license. For example, many California municipalities require the hotel operator to hold its own business license, separate and apart from the business license of the hotel. The parties will need to identify any licenses in the hotel operator’s name and address any required changes or approvals.

Again, hotel owners will not expect to bear any cost of obtaining and documenting these license changes or approvals – the hotel operators need to be prepared to pay all filing fees and legal costs involved.

Financial Operations

Financial operations are a key part of any hotel operator’s business – the receipt and use of hotel revenues, and the related financial accounting and reporting process. The management contracts may permit the hotel operator to select the financial institution for hotel bank accounts, but lender requirements may restrict the ability to change accounts. For this reason and in the interest of being less disruptive to hotel operations, assignment of the existing bank accounts to the incoming hotel operator ( along with changing authorized signatories ) may be more acceptable to hotel owners. For those hotels which will be changing accounting systems or providers, in addition to the consents from software and information technology vendors which may be required, additional steps are required to facilitate integration. The parties need to ensure data transfer to a new system is seamless, as well as ensure the new system complies with any requirements set forth in the management contracts. The acquiring hotel operator may need a license agreement from the outgoing operator to continue to use the existing system for an interim period to assist with a smooth transition.  

The matters addressed in this article are not intended to be an exhaustive list of transition items for hotel management company merger or acquisition transactions - each business combination of hotel operators will have its own operational transition items, some of which may be unique to the parties involved. Paying attention to these key transition matters, however, is necessary to accomplish the main goal of the combination – creating a larger, stronger and ( hopefully ) more profitable business, which ultimately continues to serve the needs of the hotel owners. 

Ms. MahlstedtTricia Mahlstedt is Co-Chair of Eckert Seamans’ Hospitality & Gaming practice. Her focus is hospitality law, representing hotel owners, developers, investors, and management companies. Ms. Mahlstedt covers various aspects of hotel-related matters for clients with properties throughout the United States, as well as in internationally. Her practice includes hotel acquisitions and sales, joint venture negotiations, financing matters, leases, management agreements, franchise and food and beverage operating agreements and day-to-day hotel operational matters. She manages Eckert Seamans’ role as outside counsel for negotiation of management agreements for independent hotel management companies in the U.S. and internationally, as well as on-going legal support for their operations. Ms. Mahlstedt can be contacted at 412-566-1914 or pmahlstedt@eckertseamans.com Please visit http://www.eckertseamans.com for more information. Extended Bio...

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