1 November 2009
How Expedia, Orbitz, Travelocity and other online travel companies (OTCs) create huge headaches for owners and operators on their suits over hotel occupancy taxes.
Billions of dollars of hotel rooms have been sold through the online travel companies or OTCs. Generally speaking, no transient occupancy taxes (TOT) or bed taxes, have been paid on the portion of these sales kept by the OTCs when they resell the rooms to hotel guests. The exposure on these unpaid hotel bed taxes easily exceeds $100 million — before interest and penalties.
Until now, most of the press has focused on the lawsuits brought by more than 200 local governments against Expedia, Orbitz, Travelocity and the other third party internet hotel booking companies. As many of these lawsuits now reach final resolution, some cities have announced that if they don’t win against the OTCs, they will take aggressive action to collect these lost bed taxes from the hotels themselves. And OTCs have said that if they lose, they may come back against the hotels.
Who will be the biggest loser in this high-stakes poker game, and how did we get here? If you think you already know that, then skip to end of this article to see if you also have a firm grip on the “5 things every hotel owner and operator needs to know.”
What is the TOT problem all about?
On October 31, 2009, the City of San Antonio won a $20.6 million verdict against 11 online travel companies
Problem starts with the merchant model
For the past decade, hotels have used a “merchant-model” to sell unused room inventory at discounted rates to online travel companies which, in turn, mark up the cost of the rooms and resell them to individual consumers. The mark-up typically consists of items characterized by the OTC as “service fees,” “taxes,” and/or “tax recovery charges.”
It is important to understand that the online travel company, not the hotel, enters into a contractual relationship with each paying consumer.
The issue that local governments have with the OTC scenario, is that the OTC pays bed taxes on the discounted rate purchased from hotels — not on the rate the OTC ultimately charges the consumer for the room. Assuming a 10% TOT, a guest that pays $100 to the hotel directly, would contribute a $10 bed tax to the local government’s coffers. But if the OTC buys the room at discount from the hotel for $70, then sells it to the guest for $100, the local government gets only $7.00, and the $3.00 difference is “lost”. Multiply this “lost” TOT by thousands of rooms over thousands of stays — that is what local governments are seeking to recover from the OTCS, (and some are asking for punitive damages, as well.)
Impact on local governments is big
By our rough calculations, local governments have arguably “lost” more than $100 million in transient occupancy taxes on these internet channel sales — perhaps several hundred million.
The hotel tax problem first emerges with OTCs
As early as 2000, SEC filings by OTCs began to acknowledge the discrepancy that soon led to the issue now at hand (and explained below). Hotels began flocking to OTCs when people stopped traveling after 9/11. Online booking of hotel rooms soared and by 2002 many cities and local governments began to focus on the problem.
The City of Los Angeles was one of the first to file suit against the OTCs in late 2004, and was soon joined by San Diego, San Francisco and Anaheim. But this is not just a California problem. It is national.
One source recently estimated that more than 200 local governments have filed suits or levied assessments. They range from Chicago, Atlanta, Orlando and Louisville to tourist destinations like Branson, Missouri and Charleston, South Carolina. San Antonio filed suit and was joined by 176 cities. But a lot of counties have also joined the action, including Nassau County in New York; Broward, Miami-Dade and Orange Counties in Florida and Pitt County in North Carolina.
And more local governments get on the band wagon every day. On October 25, 2009, The Bradenton Herald announced that 5 more Florida counties were expected to file lawsuits against the OTCs within a week, seeking to recoup back bed taxes.
Mixed results on cases so far — but the stakes are already huge
To date, the record has been mixed. The online travel companies won a few early victories such as dismissal of suits filed by Louisville and Lexington, Kentucky. They also won a favorable decision in the fourth circuit dismissing a class action by Pitt County, North Carolina against OTCs.
But the online travel companies have also lost some big cases, either in court litigation or in tax administrative proceedings. For example, earlier this year, the City of Anaheim assessed more than $21 million against eleven online travel companies, including Expedia, Hotel.com, Hotwire, Travelocity, Orbitz, and Priceline, among others. San Francisco assessed more than $30 million against various online travel companies.
On October 31, 2009, the City of San Antonio won a $20.6 million verdict against 11 online travel companies. In this case, the OTCs escaped being hit with an additional $40 million in punitive damages.
Also in October 2009, the Georgia Supreme Court ruled 6-1 for the City of Columbus that OTCs must pay TOT on the rate paid by the retail customer, not the amount paid to the hotel by the OTCs.
And earlier this year in June, a Washington State Court awarded $184 million against Expedia — the largest consumer class action judgment in the State’s history. This was actually a different kind of case finding that the way Expedia described its charges was a fraudulent scheme that deceived consumers and made Expedia liable for everything over the amount paid by Expedia to the hotels.
Unless reversed, the present awards and assessments in just a few cases look to exceed $300 million. If one looks at all of the hotel rooms sold through the OTCs, it is obvious that there is a tremendous amount of money at stake.
Why hotels should be concerned
Some OTCs are presently refusing to accept responsibility for the bed taxes on a prospective basis. For now, the OTCs are saying “take-it-or-leave-it.”
Someone will go after the hotels.
Why should hotels be concerned about the outcome of the dispute between cities and OTCs? There are hundreds of millions of dollars at stake. Whether local governments prevail or the OTCs prevail, we can be pretty sure whichever is the loser will go after hotels.
If courts determine that the cities cannot collect the lost TOT revenue from the OTCs, there is little doubt that the cities will come after the hotels for this money. For example, the City of Los Angeles amended its TOT ordinance in 2004 to allow it to collect this lost revenue from its hotels if it cannot collect it from the OTCs. Similarly, Anaheim has said that it will ultimately seek to hold its hotels liable if the OTCs win, and San Francisco has made similar indications.
If, on the other hand, the OTCs are ultimately held liable to the cities and counties for the TOT revenue that is in dispute, it is anticipated that the OTCs will do everything they can to seek indemnification or reimbursement from the hotels.
Simply put: When this kind of money is at stake, no one is going to give up easily.
Are the hotels really exposed to liability?
Whether a particular hotel has exposure will depend, of course, on who is making the claim and the specific circumstances involved.
If the cities lose against the relevant OTCs and then pursue claims against the hotel, the hotel’s liability will hinge on the specific wording of the applicable tax law, entitlements and contracts as well as the legal theories asserted by the local governments. But the hotels would have a number of due process and other legal defenses that will have great merit in many situations.
Among other things, and while this involves uncharted legal waters, hotels should certainly argue that by changing its TOT mechanism — either by formally amending its ordinance as Los Angeles did or by simply by administrative fiat — to hold hotels liable for the TOT on the marked-up prices charged to guests by the OTCs, a local governmental entity has either created a new tax or increased an existing tax, thereby requiring voter approval. To our knowledge, no local government in California has obtained this voter approval.
On the other hand, where the OTCs lose to the local governments and the OTCs seek reimbursement from the hotels, a hotel’s exposure to the OTCs will depend, in large part, on the terms of the transient occupancy tax provision and the specific language contained in the agreement between each hotel and each online travel company.
And that is also why it is so important now that lodging operators focus on this issue as they negotiate their new contracts with the OTCs — something that is underway right now. Liability and indemnification for the exposure discussed in this article should be covered in these agreements. But beware.
Some OTCs are presently refusing to accept responsibility for the bed taxes on a prospective basis. For now, the OTCs are saying “take-it-or-leave-it.”
5 things every hotel owner and operator needs to know
Why should hotels be concerned about the outcome of a dispute between cities and OTCs? There are hundreds of millions of dollars at stake. Whether local governments prevail or the OTCs prevail, we can be pretty sure whichever is the loser will go after hotels
Given the enormous potential liability hotels are facing in this dispute, Jim Abrams and the hotel lawyers of JMBM’s Global Hospitality Group® formed a task force working on these issues. We are working with hotels to formulate specific approaches and responses.
5 things every hotel owner and operator needs to know
- Review and analyze your applicable TOT law
- Oppose any effort by the local government to amend the TOT law to make you and your hotel liable for the TOT on the gross amount charged by the OTC to your hotel guest (i.e. the retail rate)
- Watch all communications from local tax authorities to avoid inadvertent agreement or acknowledgement that you are liable for TOT on the incremental amounts received only the OTCs.
- Review agreements with each OTC to sort out potential liability for any TOT (or related obligation) due to incremental amounts above the wholesale rate your hotel actually receives from the OTC
- Don’t make any new agreement with an OTC before you understand all the ramifications of new provisions
In other words, each hotel needs to quickly analyze its specific situation and exposure to relevant taxing authorities and OTCs. Prudent hotel owners and operators will consult counsel now and be prepared. This one of the biggest tax threats to face the hotel industry in a long time. A lot is at stake here.
This is Jim Butler, author of www.HotelLawBlog.com and hotel lawyer, signing off. We’ve done more than $87 billion of hotel transactions and have developed innovative solutions to unlock value from troubled hotel transactions. Who’s your hotel lawyer?
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Jim Abrams is a senior member of the JMBM Global Hospitality Group® and the former President and CEO of the California Hotel & Lodging Association. Jim has served the hospitality industry for 40 years and specializes in lodging and hospitality law and in representing and advising trade associations and other non-profit entities. Jim has significant experience in government affairs at the national level, the state level – including the California Legislature and scores of state agencies – and with local governments and agencies. He has authored successful ballot measures and scores of bills for his clients. For more information, contact Jim at jabrams@jmbm.com or 415.398.8080.
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Our Perspective. We represent hotel lenders, owners and investors. We have helped our clients find business and legal solutions for more than $125 billion of hotel transactions, involving more than 4,700 properties all over the world. For more information, please contact Jim Butler at jbutler@jmbm.com or 310.201.3526.
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