Most hotel buyers will want financing. Some of the big REITs or other cash-rich players will buy for all cash and then find financing at their leisure. That gives them an advantage in bidding on hot properties. But most buyers will want financing to pay for their acquisition.
Either way, there are some things your mother may not have told you, but as a buyer (and a borrower) in a hotel purchase, you really should know these 10 things that my partner, hotel lawyer Jeffrey Steiner, lays out for us in his article.
(Because of the length of this article, it is presented in two parts. Here is part two; to read part one, click here.)
Buying a hotel and financing a hotel purchase: 10 things every borrower should know, part 2
6. Limits on other indebtedness
The loan documents may restrict the borrower from having any indebtedness other than the mortgage loan, with an exception for a limited amount of accounts payable that may be outstanding for a short time (consistent with the normal payment cycle — such as 60 days), as long as the indebtedness is not evidenced by a promissory note. The aggregate amount of other indebtedness that may be outstanding at any time will ordinarily be expressed as a percentage of the mortgage loan amount (such as 2%). The borrower should review the historical accounts payable levels and payment cycle to make sure it can comply with the loan document limits. Also, equipment leases are considered to be other indebtedness, so the amount and time limits may need to be adjusted to take them into account. For instance, an additional 1% or 2% may be permitted (or the total other indebtedness cap increased) for leases of equipment that are normally leased in the hospitality industry, such as airport shuttles, other vehicles, and office equipment.
A trademark or service mark is a word, symbol, or design that identifies and distinguishes a source of goods or services. If a hotel is not using branded names licensed from others, the hotel name and names of facilities within the hotel, such as restaurants, bars, and spas may be trade marks or service marks, the rights to which the hotel owner may protect by registration in the United States Patent and Trademark Office. If in its underwriting, a lender determines that the trademarks or service marks add value to the hotel, it may require that the trademarks or service marks be registered to protect the hotel owner’s interest (unless already registered), so that the lender can have the registration protection benefits following a foreclosure. The pledge of the trademarks and service marks may also then be registered in the Patent Office. Based upon the pledge, the trademark and service mark rights can be foreclosed upon in the case of a default, so that the lender or other successor owner has the protected use rights afforded by the registration. In granting such a pledge, a hotel owner has to be careful if it uses, or may use in the future, its trademarks or service marks at other locations. If unlimited rights are pledged to its lender on one hotel, the lender could receive the rights to the tradenames and service marks for all locations in which they are or may be used, and that may not be the hotel owner’s intention. In such a case, the hotel owner should establish a licensing arrangement and only grant the lender a security interest in the relevant license (for the property being financed), so that upon a foreclosure the lender does not receive by foreclosing ownership of the trademarks or service marks in use at other hotels or potential use rights at other locations.
8. Liquor licenses
If alcoholic beverage sales represent an important part of a hotel’s business, a hotel lender will want to ensure the orderly transfer of the rights to sell alcoholic beverages following a foreclosure. State laws generally have strict qualifications for persons permitted to be issued liquor licenses or to acquire through a transfer existing liquor licenses. Also, the number of liquor licenses available in a particular jurisdiction may be limited. Under California law, a lender cannot take a security interest in a liquor license, and agreements to sell liquor licenses made more than 6 months in advance of the transfer date will not be accepted by the state authorities. Lenders will evaluate the applicable state law requirements and limits to determine what viable steps must be taken to assure that the lender or other successor owner following a foreclosure may take control of the liquor license and continue alcoholic beverage sales at the hotel. As an example, assuming the hotel loan is nonrecourse to the borrower, the lender may require that the borrower’s failure to effect the orderly transfer of the liquor license and alcoholic beverage operations upon a foreclosure be a carve-out for which the borrower and guarantor would be liable either for losses attributable to the failure or for the entire loan deficiency. Another way to allow the hotel lender to gain control of the liquor license following foreclosure is to have the license held by a separate entity initially controlled by the borrower in which a party friendly to the lender has a minority interest. Upon a foreclosure, the minority interest is granted control rights over the liquor license. Borrowers should expect to encounter these and other creative means from their lenders to gain control over liquor licenses following a foreclosure, depending upon the restrictions on liquor license transfers in the applicable state laws.
9. Timing of lender remedies
Under California law and typically under other state laws, the timing and procedures for a lender to foreclose on the real property collateral securing a hotel loan may be different than those under the Uniform Commercial Code for foreclosing on personal property. The collateral assignment of the hotel management agreement may provide for the immediate exercise of lender remedies respecting that agreement following a loan default. Also, under California law, in the case of periodic payment defaults, the borrower has reinstatement rights that give it an extended cure period by law before the lender may complete a real property foreclosure. This law does not restrict the lender’s remedies against personal property collateral, even though the borrower’s reinstatement period is still pending.
Although the hotel lender will ordinarily conduct a unified foreclosure sale of real and personal property and not have an incentive to exercise its remedies against the personal property or hotel management agreement before completing the real property foreclosure, it might do so to place maximum pressure on the borrower. Consequently, the borrower may want to negotiate a requirement that the lender use the unified sale procedure to foreclose on real and personal property collateral concurrently.
10. Lender approval mechanism
As noted in a number of the points above, the issue of timing of a lender response to borrower requests for its approval is important in many contexts given the immediate impact on hotel operations that a delay in obtaining lender approval may have. Loan document provisions are sometimes written in a way that suggests the lender is committed to communicating its decision within a specified time period while it actually is not. For instance, a loan document provision might say the borrower must request the lender’s approval of a change in management at least 30 days before the borrower wants the change to take effect. That provision does not commit the lender to act in 30 days. Also, borrowers have become more sensitive to timing issues in connection with securitized loans because the loan will be administered by a servicer with which the borrower does not have a prior lending relationship. For these reasons, the borrower should negotiate loan document provisions applicable to all lender approval rights concerning important hotel operational issues requiring the lender to respond with its approval or disapproval within a specified reasonable period and addressing the effect of the lender’s failure to give or withhold its approval in the stated time. Ideally, the borrower would like a provision stating that the lender’s approval is deemed to be given if the lender does not respond on a timely basis. However, lenders are reluctant to allow the borrower to proceed with what may be a significant change affecting the hotel based upon a lender failure to respond to a notice, which may have been overlooked inadvertently. The compromise is known as the second notice provision. If the lender does not respond to the first notice, before “deemed approval” applies, the borrower has to deliver a second notice containing language warning the lender that the failure to respond within the time specified after the second notice will be a “deemed approval.” Ordinarily, the time period for the lender to respond to the second notice will be shorter than the time period for responding to the first notice.