Seller representations and warranties in a hotel purchase agreement — What are the big issues today?

4 November 2012

Hotel Lawyer with some tips on buying a hotel or other hospitality property.

Hotels, restaurants, resorts, vacation ownership projects, spas, golf courses and other similar hospitality properties are different than most real estate. They involve operating businesses that are integrally intertwined with special purpose real estate.

So the documentation to buy or sell such a property (and business) needs to be different than that used for other commercial real estate. One of the areas that is most apparent is in the seller’s representation and warranties.

The article below is by hotel and timeshare lawyer David Sudeck, a senior member of JMBM’s Global Hospitality Group®, and someone very experienced in the purchase and sale of hotels, restaurants, resorts, vacation ownership projects, spas, golf courses and other similar hospitality properties. In this article he talks about representations and warranties — what they are, what areas they cover, and what you want to get in a typical deal.

This article is one of a series of insights that will be published initially as articles on the Hotel Law Blog at www.HotelLawyer.com and then they will be assembled into the HOW TO BUY A HOTEL handbook for our “We wrote the book™” series, much like the HMA Handbook and the Lenders Handbook for Troubled Hotels (see Resource Center at HotelLawyer.com for free copies).

Buying and selling hospitality properties:
What representations and warranties do you want
in your hotel purchase and sale agreement?
by
David Sudeck | Hotel and timeshare lawyer

Purchasing real estate along with an operating business (whether a hotel, resort, vacation ownership project, restaurant, spa, golf course or tennis facility) can be complex and risky. There are practical and financial limitations to the information that can be secured and reviewed during what is typically a short (e.g., 15-60 day) due diligence period. In most traditional sales (as opposed to note or foreclosure sales), the seller of the business and property will have knowledge of the assets, and securing representations and warranties from the seller regarding the subject assets will provide the buyer with some additional information, and comfort that the information the buyer finally receives is comprehensive and accurate.

In this article, we will cover (I.) What are representation and warranties, and what is their purpose? (II.) What areas are typically covered by representations and warranties? and (III.) What are typical representations and warranties in today’s “seller’s market” for a transaction involving a hotel or other hospitality property?

I. What are representations and warranties?
What is their purpose?

The term “representation” is used in reference to a statement made by one party to a contract to another regarding a “particular fact or circumstance that serves to influence the consummation of the deal.” A “warranty” is defined as “a promise that a proposition of fact is true.” (source for definitions: Black’s Law Dictionary)

From the buyer’s perspective, the purpose of the seller’s representations and warranties is to cause the seller to disclose those facts that, together with ordinary due diligence, are sufficient to allow the buyer to make an informed purchasing decision.

Sellers, however, are hesitant to provide meaningful representations and warranties, because ultimately, by providing representations and warranties, the seller is accepting the allocation of risk of inaccuracy. As a basic premise, sellers prefer to sell property “as is” and with no representations and warranties whatsoever. Buyers, on the other hand, would like a comprehensive list of unqualified representations and warranties.

Most buyers ultimately “just want to know what the seller knows.” Therefore, in nearly all circumstances, representations and warranties of the seller of the property that relate to conditions of the property or its operations will be qualified to the actual knowledge of the seller or the actual knowledge of one or two key employees of the seller.

II. What areas are typically covered by representations and warranties?

Representations and warranties in purchase agreements typically cover 3 general areas: (a) the seller, (b) the purchase agreement and (c) the status and condition of the property and the business being sold.

Seller. This will include a statement regarding the existence of the seller entity, that the seller is in good standing, that the seller is not a foreign entity, that the seller is not a debtor in bankruptcy or otherwise the subject of an insolvency proceeding, that all consents have been obtained by the seller, and that the seller has the right and authority to sell. These representations and warranties are important to ensure that the buyer has a claim for damages under contract (and possibly under tort) law if the seller does not have the authority to enter into the agreement. While the title company handling the sale will typically confirm these issues when it insures the transfer of title if the escrow closes, title insurance will not cover a claim for rescission based on claims that the seller did not have the right to enter into the agreement in the first place. As buyer’s counsel, we typically also independently verify the seller’s status and confirm that it is not in bankruptcy.

Note that while the seller itself may not seek to nullify the agreement for lack of corporate capacity, a shareholder of the company and certain other third parties may seek to enjoin the agreement based on a claim that the officers of the corporation exceeded their capacity. These representations and warranties typically do not include a knowledge qualifier (e.g., to seller’s actual knowledge) because they are within the seller’s knowledge.

Purchase Agreement. This will include a statement that the agreement does not conflict with other obligations of the seller and the applicable law and that the agreement is enforceable against the seller under all circumstances, with a carve-out for bankruptcy. These representations and warranties typically do not include a knowledge qualifier as to a conflict with existing agreements because they are within the seller’s knowledge, but a knowledge qualifier is typical for statements regarding compliance with applicable law.

Property and Business. These representations and warranties are intended to cause the seller to disclose those facts that the buyer needs, along with the results of its own due diligence, to make an informed decision as to whether to purchase the property. In the next section we list 13 representations and warranties that we typically see in purchase and sale agreements for hotels, restaurants, resorts, vacation ownership projects, spas, golf courses and other similar hospitality properties.

III. What are typical representations and warranties,
in today’s “seller’s market” for a transaction involving a
hotel or other hospitality property?

In addition to the representations and warranties regarding the seller, and the purchase agreement discussed above, the following are 13 of the subject matters that we typically deal with in a purchase and sale agreement for a hospitality project.

1. No condemnation. The seller typically represents that there are no condemnation proceedings pending or threatened (except as specifically disclosed on a schedule). Typically, “threatened” may be qualified based on actual knowledge and/or receipt of a written notice.
2. No litigation. The seller typically represents that there is no material litigation (as defined) pending or threatened (except as specifically disclosed on a schedule). Again, “threatened” may be qualified based on actual knowledge and/or receipt of a written notice. Consider also including a written disclosure of customer claims that do not rise to the level of litigation (e.g., illness or bed bugs).
3. No violations of law/CC&Rs and other items of record. Usually, the seller will seek to limit its representations and warranties on this subject a statement that seller has not received any written notice of such violation. There should also be a statement as to who bears the risks of violations discovered during escrow.
4. Environmental conditions. The buyer wants to know that it will not be responsible for any costs or expenses relating to environmental conditions or claims relating to the period prior to its ownership. These representations and warranties are often the subject of significant negotiation, because the seller will want a full release of all liabilities once it sells the property. At the same time, most sellers do not want invasive testing to occur, thereby effectively limiting the buyer to perform a Phase I (visual) environmental site assessment. Therefore, it is important for a buyer to secure a representation and warranty (almost always qualified to seller’s knowledge) that there have been no releases of hazardous substances and that no violations of environmental law exist.
5. Ground and space leases. The seller will typically agree to a representation and warranty that no ground leases or space leases exist or a statement that only the scheduled leases do exist, that full and accurate copies have been provided, and that no defaults exist in connection therewith. If there are leases, and if they are material to the value of the property or the operations of the business, then the buyer should also request estoppels from the other parties to the leases.
6. Conveyance free of all liens. The ability of the seller to sell the property free of all liens may be addressed through proper title review along with a covenant on the part of the seller to sell the property free of all liens other than the “permitted exceptions” (as determined during the due diligence period, but typically with an agreement on the part of the seller to extinguish all, or specified, monetary liens and encumbrances.
7. Contracts/management agreement/franchise agreement. The purchase agreement will typically provide that the buyer will assume certain (or all) contracts. If that is the case, then the buyer will want a representation and warranty from the seller that only the scheduled contracts exist and that there is no default in connection with any of them. This statement may also address management and franchise agreements, or those agreements may be addressed separately due to their importance to the value of a hospitality asset. In any event, all material contracts should be reviewed for their terms and assignability. Note: Before assuming all contracts, a buyer should consider whether there are some, such as union contracts, that it may not wish to assume and may not be obligated to assume.
8. Financial and operating statements. Even in this time of limited seller representations and warranties, the seller should represent and warrant at least that full and accurate financial and operating statements have been provided for the periods in question and, if the statements were prepared by the property’s management company, that the statements are all of those that the seller uses in making its decisions with respect to property operations. This representation and warranty is often the subject of significant negotiation because of the importance of this information to the buyer when determining the value of a hospitality property.
9. No right of first refusal/rights to purchase or lease. The rights of third parties to purchase a property may or may not be a matter of public record, making it difficult for a buyer to assess the risk of a third party seeking to enjoin the sale. Therefore, the seller should be willing to represent and warrant that no other party has a right to purchase or lease the property. This is particularly important with a branded hotel, as many franchise and brand management agreements provide for a right of first refusal. Ground leases also often contain such a right and should be carefully reviewed.
10. Taxes. Due to the risk of successor liability and a lien against the property, the buyer should confirm that the seller has paid all taxes and assessments including real property (which should be reflected on an updated title report), transient occupancy, employment, sales, etc.) prior to delinquency. In addition to securing this statement from the seller, the buyer may also want to secure tax clearance certificates (or their equivalents) to ensure that taxes are paid through closing.
11. Maintenance and No Defects. Proper due diligence by a buyer includes a comprehensive physical inspection by a qualified consultant or contractor, but the buyer still wants to know if the seller knows of any defects in the facilities comprising the property (particularly those that may be latent, such as mold not visible through a physical inspection). The seller, however, will typically seek to limit representations and warranties regarding the condition of the property and its improvements, and if provided, they will be heavily negotiated.
12. ERISA. If the buyer or the seller, directly or through a management company, is contributing to a pension plan that is subject to ERISA, then the details of the plan(s) may be provided as part of a tailored representation and warranty.
13. Money Laundering. The buyer should confirm that the seller is not on any governmental list related to money laundering (e.g. OFAC) and is not the subject of a criminal investigation relating to money laundering. Note: This statement is more important with respect to the buyer, as the buyer is providing the funds for the purchase.

Conclusion

This is a seller’s market. Therefore, the representations and warranties in a hotel purchase and sale agreement tend to be lighter than they might be in other market environments.

The seller would ideally like to make no representations and warranties so it never has to “look back” after the closing and worry about buyer claims.

The buyer would like to know that it has all the relevant information and has not missed anything important that might affect the value of the property or the business. Ideally, the buyer would like seller to be financially responsible for any surprises — at least those that were known to the seller prior to
the closing.

Usually, there is a compromise that can work for everyone if the parties are motivated and reasonable. We help buyers and sellers find solutions in these situations.

Our next article in this series will deal with the “so what” of seller representations and warranties — or what do these representations and warranties mean, what are the hurdles to enforcing them, and what are the common terms used today.

David Sudeck, is a senior member of JMBM’s Global Hospitality Group®. He helps clients create value for their hotels and other hospitality properties in the purchase and sale, development, construction, financing, leasing, sale-lease back, and operation of (including management and ADA compliance issues associated with) such properties.

David’s practice primarily involves the complex issues associated with hotels, resorts, vacation ownership properties (including clubs, timeshares, fractionals and private residence clubs), restaurants, golf courses and spas. He represents several financial institutions and private equity funds as special counsel relating to their hospitality interests.

David has a pragmatic approach to practicing law, and he adds value through his business experience and legal expertise, his finance, entitlement and development knowledge, and his extensive relationships with investors, lenders, brokers, developers, and service providers.

Contact David Sudeck at 310.201.3518 or dsudeck@jmbm.com.

HOW TO BUY A HOTEL — Free handbook

Until the free handbook on HOW TO BUY A HOTEL is published (expected soon), you can access all the materials on this subject at www.HotelLawyer.com. Look on the right hand side of the home page and click on “Buying & Selling a Hotel.”

Here are a few of the articles on the subject under this topic:

Buying a hotel? Financing a hotel? 10 things every borrower should know. (part 1)

Buying a hotel? Financing a hotel? 10 things every borrower should know. (part 2)

The hotel purchase and sale agreement — What is the value of the seller’s representations and warranties to a hotel buyer?

Can I use the EB-5 Visa Program for financing hotel acquisition and renovation?

Seller representations and warranties in a hotel purchase agreement — What are the big issues today?

How to buy a hotel — What you don’t know about undocumented workers could really hurt you!

HOW TO BUY A HOTEL Handbook: Franchise issues in hotel purchase and sale transactions

5 Things to remember when buying hotel notes

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 help investors be successful in bidding for hotel acquisitions, and helping investors and lenders to unlock value from troubled hotel transactions. Who’s your hotel lawyer?

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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.

Jim Butler is a founding partner of JMBM, and Chairman of its Global Hospitality Group® and Chinese Investment Group®. Jim is one of the top hospitality attorneys in the world. GOOGLE “hotel lawyer” and you will see why.

Jim and his team are more than “just” great hotel lawyers. They are also hospitality consultants and business advisors. They are deal makers. They can help find the right operator or capital provider. They know who to call and how to reach them.