What every hotel lender needs to know about cash controls

What every hotel lender needs to know about cash controls

A lot can go wrong with lender expectations in a hotel loan unless the hotel loan documents are prepared by knowledgeable hotel lending lawyers. In today’s blog, Guy Maisnik highlights the importance of the hotel lender keeping control over revenues post foreclosure and explains why it doesn’t always happen.

In a post-foreclosure scenario, the hotel lender has to take over the hotel and make certain it controls all hotel revenues. There are two major impediments to this goal that must be addressed on the front end, when the loan is made: 

  • If the hotel lender agreed to give non-disturbance rights to the hotel operator (typically with a Subordination, Non-Disturbance and Attornment Agreement, or SNDA), it will find the hotel operator controls all hotel revenues and will have priority over all such funds. 
  • The hotel loan may not encumber or may not adequately cover all the hotel property, and as a result, the hotel lender cannot obtain control over all revenues. 
For example, rights to the liquor licenses and attendant fixtures and equipment may belong to a third party. In this case, the foreclosing lender may have to purchase the rights to use these. Or, the hotel owner may have pre-sold many rooms at a deep discount. Or, much of the personal property may be owned by a third party and leased to the hotel owner or an affiliate of the hotel owner. Or, the hotel owner may have accrued significant trade payables, and the foreclosing hotel lender as a practical matter will have to cover those payables lest it lose an important vendor.
Lenders want to control the cash

Lenders typically demand that hotel revenues first be applied to debt service before the payment on any other expense. However, in reality, unless the lender is willing to permit the hotel to close, basic operating costs must be covered or the hotel will quickly lose value. So, most hotel lenders bite the bullet and permit (if not require) normal operating costs to be paid ahead of debt service. 

However, in exchange for agreeing to cover operating costs, experienced hotel lenders will require that operating costs be covered according to an agreed-upon schedule, budget and waterfall approved by the hotel lender. Further, experienced hotel lenders understand how to arrange this process, even under adverse conditions. 

Of ‘cash traps’ and more

Experienced hotel lenders understand how critical it is that the lender controls hotel cash revenue. One of the primary methods of accomplishing such control is through the use of a deposit account control agreement under Article 9 of the Uniform Commercial Code. One common method for a lender to obtain control of cash flow is for the lender to require the borrower (the hotel owner) to enter into a so-called “control agreement” (often called a “deposit account control agreement”) with the depository bank. These arrangements are also known as “cash control,” “cash trap” and “cash management” agreements. But whatever they are called, the depository bank and the borrower agree that the depository bank will take direction from the hotel lender under the specified conditions. 

Another problem with SNDAs

Unfortunately for the lender, in the typical hotel managed by a major brand, the operator will control the cash flow under the hotel management agreement. And the typical branded operator’s SNDA provides that the hotel lender will not disturb the branded operators’ rights under its hotel management agreement. As a consequence, the lender may be unable to obtain control of the hotel’s cash flow from the hotel operator, even upon a borrower default. 

Without experience as to how to address this circumstance before the loan is made, the lender will likely have no practical ability to control hotel operator expenses and stem the bleeding. Potentially worse, the hotel lender may not have a perfected security interest in the cash deposit account if the hotel manager is able to interfere with the hotel lender’s instructions directing disposition of the funds in the deposit account. Without a perfected security interest, competing creditors may be on equal footing with the hotel lender as to rights to the deposit account funds. Hotel lenders and their legal counsel need to coordinate their efforts to avoid this outcome.