A Hospitality Lawyer's Guide to M&A Deals
By Todd Soloway Partner, Pryor Cashman LLP | February 24, 2019
Co-authored by Michelle Pham, Associate, Pryor Cashman LLP
Corporate M&A activity has increased significantly in recent years. In the first nine months of 2018 alone, approximately $3.3 trillion in mergers and acquisitions were announced globally. Although global M&A deal volume fell in Q3, 2018 remains on track to surpass the record-setting $4.1 trillion in M&A activity in 2007.
In keeping with this overall trend, hospitality has seen a surge in mega-deals and consolidations over the last several years, including Marriott International's $13.3 billion acquisition of Starwood Hotels & Resorts in 2016; the $1.95 billion acquisition of La Quinta Holdings by Wyndham Hotels & Resorts earlier this year; AccorHotels' $319 million acquisition of a 50% stake in sbe Entertainment Group in October 2018; and the recent acquisition of Two Roads Hospitality by Hyatt Hotels for $405 million (with potential additional consideration of $96 million).
To be sure, economic factors - including changes to the federal tax code and rising profits stemming from a robust, post-recession economy - play a role in the increase in M&A activity. But, to an even greater extent, hospitality has been shaped by industry-specific influences that are driving companies to acquire and consolidate with others.
The hospitality sector is, at present, highly fragmented, with no single entity dominating global market share. Additionally, owners, proprietors and brands are facing rising competition from online booking sites and ever-popular, ever-proliferating home-sharing platforms like Airbnb, VRBO, HomeAway and Onefinestay (which was ultimately acquired by AccorHotels for nearly $170 million). Opting to accelerate growth, rather than relying solely on organic growth, to remain competitive, hospitality companies are fervently eyeing other brands for acquisitions, hoping to broaden their portfolios, strengthen loyalty programs and increase leverage against online booking sites and alternative lodging platforms while expanding into new geographic and demographic markets.
As numerous hospitality companies have determined to leverage favorable economic conditions to grow their respective businesses through mergers and acquisitions, legal counsel to these companies have had to acquaint themselves with the wide spectrum of issues that come into play in these deals. This article will examine common issues that arise during M&A transactions involving hospitality companies and will offer guidance on how parties on both sides of a deal should address the risks and liabilities. As we will see, a complete grasp of one's obligations and risk exposure is essential.
Key Legal Issues Affecting Hospitality M&A Deals
Ownership of intellectual property, liability for data breaches and withdrawal liability are three particularly important legal issues that any buyer or seller of a hospitality enterprise should be prepared to confront during a merger or acquisition transaction. Of course, all three of these legal issues may not present significant barriers in a given deal, and there will of course be others; however, it is incumbent on parties to fully appreciate the potential economic impact of these issues.
Valuing Intellectual Property Assets
A key objective of many hospitality M&A deals is the acquisition of additional brands for the purpose of expanding a purchaser's brand portfolio. For this reason, the target company's verifiable and complete ownership of the intellectual property relating to its brands is of the utmost importance to the purchaser. While third party claims of ownership of a target company's hotel brands arise less frequently because hospitality companies tend to perform the requisite diligence to confirm such brands are available before use, hospitality companies with restaurant or other food and beverage brands should be cautious when developing new brands in partnership with chefs or other third party partners. When unclearly or hastily documented, an otherwise valuable restaurant or food and beverage brand in a target's portfolio can present significant challenges if there is any indication that a third party has asserted, intends to assert or could assert a claim of ownership of any interest in the brand. These claims can substantially undercut the value of the brand and the target company.
It is strongly recommended that, prior to entering into a M&A transaction, target companies carefully scrutinize their brand portfolios to determine whether any brands – hotel, restaurant, food and beverage, nightlife, etc. – have been developed jointly with a third party and, if so, whether the ownership (or fee arrangements) have been properly documented between the parties. This holds true even if a target company has consistently operated over a period of time as if it fully owns all rights to the underlying intellectual property or if the third party has made reference to an ownership claim but has not yet formally asserted any claim.
In all cases, the goal should be to ensure a clear, documented understanding of the target company's ownership of its brands so that a potential buyer can accurately value the brand portfolio.
Allocation of Risk Regarding Data Breaches
Today, technology is utilized at every step of the hotel-booking process, from a hotel operator's mobile app permitting online booking and check-in, to consumer review sites like TripAdvisor and Yelp, which allow potential guests to research accommodations before they commit to a reservation. As a result, prospective buyers in M&A transactions must pay close attention to the risks and liabilities surrounding a target company's data protection and cybersecurity practices, particularly those relating to compliance with governmental regulations. Buyers should request detailed data protection and cybersecurity due diligence reports from targets and push aggressively to include exhaustive representations and warranties regarding such matters instead of settling for a seller's "general compliance with law" representation, which representation may not give a purchaser sufficient protection with respect to the liabilities involved in breaches of data protection or cybersecurity laws.
Furthermore, with the passage of new laws addressing data privacy and protection, including the European Union's implementation of the General Data Protection Regulation (GDPR) in May 2018, buyers have become less amenable to the idea that they should bear significant risk, post-closing, for violations of these regulations or claims from third parties arising from data breaches.
Target companies hoping to be acquired through M&A transactions, should - in the interest of maximizing valuation - consider performing thorough audits of their current compliance with existing data protection and cybersecurity regulations, and take steps to ensure that best practices are undertaken to minimize exposure to potential data breaches. Obtaining an insurance policy to cover risks relating to cybersecurity and data breaches is also strongly recommended.
Understanding "Withdrawal Liability"
Hospitality companies that own or manage hotels, particularly in large urban areas, often employ unionized workers covered under collectively bargained agreements, which require contributions to one or more multiemployer plans. In the event of a change in management or sale of a hotel, the terminated manager or seller may experience a complete or partial withdrawal from a multiemployer plan, resulting in what may be significant withdrawal liability.
Generally, labor laws recognize a hotel manager as the "employer" of the unionized hotel employees. However, under the Employee Retirement Income Security Act of 1974, more commonly known as "ERISA," the hotel owner could be deemed the employer (various factors are considered to determine whether the hotel owner or manager is the employer). Critical to note, even if a hotel owner and manager agree on who is the employer of the unionized employees for ERISA purposes, a multiemployer plan can disagree and find withdrawal liability on the party it determines is the employer. Management agreements will typically provide that between a hotel owner and manager, the hotel owner is ultimately accountable for any withdrawal liability.
To guard against the risk of a substantial withdrawal liability, parties should - in advance of any transaction - consider who is the employer for ERISA purposes, and who will bear responsibility for withdrawal liability under the management agreement. Additionally, hospitality companies would be wise to seek annual estimates of withdrawal liability from any multiemployer plans in which they participate, in order to fully understand their exposure.
New Case Law and What it Means for Buyers and Sellers
In October 2018, the Delaware Chancery Court - widely regarded as the nation's preeminent forum for resolving disputes among corporations and other business entities - rendered a precedent-setting decision which carries important consequences for buyers and sellers negotiating M&A deals. In the case, Akorn Inc. v. Fresenius KABI AG, the court released the buyer, Fresenius - a German healthcare company - from its obligation to complete its acquisition of Akorn - a global pharmaceutical company headquartered in the United States - after a material adverse effect (or "MAE") took place. Prior to this case, a Delaware court had never released a buyer from such an obligation based on the occurrence of a MAE.
So, what's the takeaway? Most significantly, companies looking to sell an equity stake or assets should no longer rely on standard contractual definitions of a MAE and related carve-outs. Instead, they should diligently tailor such provisions based on historical and current business operations. This is especially important given the court's finding that a buyer having known or not known of a foreseeable MAE in advance has no impact on the existence thereof.
If any identifiable risks or liabilities are plausibly likely to occur between signing and closing, the seller should negotiate to revise the MAE defined term and related carve-outs so that a MAE will not be triggered by the occurrence of such risks or liabilities. This effectively forces a buyer to acknowledge its awareness of a foreseeable MAE and agree to close in spite of it, should one occur pre-closing.
With M&A activity in the hospitality industry expected to continue on pace for the foreseeable future, it is paramount that potential buyers and sellers understand the legal issues that so frequently arise during these transactions. Given the recent precedent of the Akorn v. Fresenius case, parties need a solid understanding of the risks and liabilities at stake and how they can be addressed to ensure that deals close as desired.
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