26 October 2008
Hotel Operating Agreement, HOA, Hotel Management Agreement, HMA, Hotel Management Contract, Management Contract. Hotel Operator, Hotel Manager, Hotel Owner. RFP for Hotel Manager. RFP for Hotel Operator, How to get a great hotel operator.
Contracts between hotel owners and managers (or operators) controlling the management of a hotel go by various names. They are called hotel management agreements, HMAs, hotel management contracts or hotel operating agreements. For convenient reference, this article will generally use the term “Hotel Management Agreement” or “HMA.” However all these terms can be used interchangeably and mean the same thing, just as with hotel operator or hotel manager.
Whatever they are called, Hotel Management Agreements allocate risk between the hotel manager and the hotel owner. They are critical in determining the profitability and value of a hotel.
Hospitality Lawyer on how SNDAs or Subordination Agreements affect the value, financeability, and collateral value of a hotel.
As we mentioned recently, Bob Braun and I decided to create a series of articles about Hotel Management Agreements or HMAs as hospitality industry veterans often call them. (See “Hotel Management Agreements 201 by Hospitality Lawyer – Indemnification Provisions“). The successful matching of the brand and operator with your hotel can be one of the most important factors controlling your hotel’s value, liquidity, financeability and operational success. Many owners do not realize how important the HMA is until it is too late. That’s why the Hospitality Attorneys at JMBM’s Global Hospitality Group® — who focus on representing hotel owners, developers and lenders — decided to share some important lessons we have learned over the years in working on many hundreds of Hotel Management Agreements — probably more than 1,000.
If you are about to explore looking for a hotel operator for your hotel project, have a new hotel management agreement in your future, or have issues with an existing HMA, you will find important information under the “Hotel Management Agreements” TOPIC — one of the tabs at the top — at www.HotelLawBlog.com. You might also check out the resources listed at the end of this article.
The SNDA will strongly affect the Owner’s ability to finance or refinance the property, and possible liability on loan default
Hotel Management Agreements — Subordination Agreements and SNDAs.
Hotel Management Agreements allocate risk between the hotel manager and the hotel owner. There are many provisions in the HMA that do this, including reimbursement obligations, termination rights, performance standards and indemnifications. The subordination provisions in hotel management agreements — often referred to as SNDAs or Subordination Agreements — are particularly important, usually negotiable, and little understood by most business people outside the hospitality industry.
What does subordination mean in an HMA?
For our purposes the following three terms are identical in meaning and fully interchangeable in the context of hotel operating agreements:
- Subordination Agreement
- Subordination, Non- Disturbance and Attornment Agreement
Subordination Agreements are frequently used with various types of real property when someone other than the owner is occupying or using the property secured by the lender’s loan. So in the hotel industry, this arrangement involves the hotel owner, the hotel operator and the hotel lender. And because the lender’s joint agreement is required, typically the HMA will specify that these three parties will execute an SNDA (as a free standing agreement) prior to placing any lien on the hotel. The terms of the SNDA may be specified in the HMA, set forth in an attached exhibit, or required to conform to the requirements of the hotel operator.
What are the 3 prongs of a typical SNDA?
An SNDA typically has 3 prongs, as follows:
Subordination (the “S” in SNDA) — The hotel manager agrees to subordinate its hotel management agreement and any other interests in certain respects to the lender’s lien. Most lenders insist on having some kind of subordination from a hotel operator as a condition to making a loan, and the inability of an owner to compel the delivery of subordination in a form satisfactory to the lender may jeopardize the financing.
Non-Disturbance (the “ND” in SNDA) — The lender typically agrees not to disturb the manager’s enjoyment and control of the property, and not to attempt to terminate the hotel management agreement executed by the owner/borrower or to remove the manager. While this makes sense as long as a loan is performing, it can seriously diminish asset value and flexibility after a loan default by the owner/borrower.
Attornment (the “A” in SNDA) — The manager agrees to recognize the lender, or its successor in interest, as the new owner after the lender forecloses or acquires the hotel by deed in lieu of foreclosure.
What does a subordination provision look like?
While the terms of an SNDA will undoubtedly depend upon the operator’s and owner’s relative sophistication and bargaining strength, a typical hotel management agreement is likely to have something like the following provision:
Subordination. Owner shall ensure that all existing and future Mortgagees and lessors provide Operator with non-disturbance agreements in form and content reasonably acceptable to Operator, which agreements shall preclude the termination of this Agreement absent the uncured breach of this Agreement by Operator, and shall further preclude the conveyance or leasing of the Hotel (whether on foreclosure, deed in lieu thereof or otherwise) to any Person to which Owner could not assign this Agreement without Operator’s consent.
The subordination provisions in hotel management agreements — often referred to SNDAs or Subordination Agreements — are particularly important, usually negotiable, and little understood by most business people outside the hospitality industry.
As an Owner or Lender, do you know why the SNDA so important?
As one critical part of a long-term hotel management agreement that may govern the parties’ rights and liabilities for decades, the SNDA controls how each party’s interests will be served or thwarted. In other words, the SNDA will strongly affect the Owner’s ability to finance or refinance the property, and possible liability on loan default. Similarly, the SNDA will control vital aspects of the lender’s flexibility on loan default and in workouts, receiverships, foreclosures, bankruptcies, or deeds in lieu. It is also likely to have a dramatic impact on the value of the hotel, and how many bidders are interested in buying the distressed property.
What does each stakeholder-party to the SNDA want?
What does the hotel operator want?
The hotel manager typically wants the option to continue to manage the hotel for the full contract term (with extensions) with a solvent owner — even when the hotel fails to produce enough cash flow to service debt and the owner is faced with foreclosure.
The principal motivations of the operator are purely economic. Long-term management contracts are assets for the hotel operator. They are somewhat like bonds or annuities, creating streams of inflation-adjusted income for many years. The present value of these income streams represents a significant asset. Anything that could result in an early termination of this income stream is a problem for the manager. That includes the ability of a lender to terminate the operator on foreclosure (or sale by a receiver, deed in lieu or bankruptcy court).
The hotel operator also wants to control the transfer of the property, even on foreclosure, to be sure that the proposed transferee is suitable from its perspective. For example, the hotel operator wants to know that the new owner will not be a competitor, has adequate resources to meet the owner’s obligations under the HMA, and get appropriate assumption agreements whereby the new owner agrees to the terms of the old HMA, or renegotiates a new one.
Operators would say that they want to protect their “distribution system.” They do not want their brand going up and down on properties, confusing the public. They want the property to continue shouldering its share of system costs (reservation, centralized services, marketing, and support of national and regional offices) and they want to continue managing the property and earning their fees.
A rule of thumb in the hotel industry is that the business and legal terms of the hotel management agreement — wholly apart from the operator’s abilities — can add or subtract 25% of the nominal value of the hotel, or more. That is huge!
What do lenders want?
Initially, most lenders really want their borrowers to perform according to the loan documents and pay off at maturity. That does not always happen.
So lenders need both certainty and flexibility. They would like certainty that a capable, professional hotel operator is running the property to maximize cash flow and preserve the value of the asset securing their loan. Operators initially gained their bargaining power from the insistence of lenders and other investors that the branded operator be “locked down” for 50 or 100 years, so the lenders and investors would not have to worry about the promoter (or managing partner) taking over the property and destroying its value. The brands were happy to accommodate being “locked down” as long as the property met their brand standards” and funded all deficit operating cash flow.
Normally, lenders would like the brand and operator to stay in place even when loans go into default or foreclosure. They do not want the asset to lose professional management, reservation systems, or to suffer the significant cost and disruption of re-branding. But to maximize the value of the hotel collateral, the lenders would like for a potential hotel buyer (or the buyer at any of the distressed sales) to have the right on closing the purchase, or thereafter, to terminate the hotel operator.
Why would the lender want the ability to terminate the hotel management agreement, or give that right to a buyer of the distressed property?
Hint: A review of all the individual hotel purchase and sale transactions over the past 20 years — which transacted for $10 million or more per property — shows that in 80% of the transactions, the buyer was either a hotel management company or a joint venture of a capital source with a branded hotel management company. What happens if the long-term management agreement cannot be terminated on foreclosure or bankruptcy sale or on a deed in lieu sale, and 80% of the typical buyers for the hotel don’t bid because they cannot substitute the
ir management? What is the impact on value?
In fact, when our hotel workouts team worked with major lenders in the late 1980s and early 1990s, including acting as RTC counsel for many bankrupt hotels, the typical lender swore that it would “never again” agree to an SNDA without the option to terminate the operator on loan default or distressed sale. And that determination was strong . . . at least for a few years until people forgot about what happens in the bad times. They are starting to remember “why” again.
[I]n the … early 1990s … the typical lender swore that they would “never again” agree to an SNDA without the option to terminate the operator on loan default or distressed sale…. They are starting to remember “why” again.
What do Owners want?
Hotel Owners usually have the simplest goal. They want reasonable freedom to get attractive financing for the purchase, construction, improvement or equity take-out of the hotel. They don’t want to find that lenders are spooked by their hotel management agreement, or that the terms of financing are adversely affected. They want the hotel operator to give the lender whatever is necessary to facilitate the financing and don’t want to be “held up” by the hotel operator when the lender needs some accommodation.
And lending standards can change dramatically over relatively short periods of time, at least when compared to long-term management agreements.
What are the challenges?
Negotiating the subordination provision in a hotel management agreement is challenging:
- In a new development deal, the hotel owner frequently has to get the operator before meaningful negotiations with the lender take place, and therefore the HMA with the subordination provision is usually in place long before talking to a lender. Also, many owners and their advisors do not understand the importance of this issue or ignore it, until it is too late. Many owners are lulled by the manager’s assurances that the manager has great influence with lenders, that lenders will be attracted to the project because of the manager, and that a deal has never been held up because of this provision. The last might be true, but that’s only because the borrower bears the cost!
- Lenders’ standards are constantly changing. As lenders underwrite loans during times of easy credit, they are more likely to accept some terms from managers that they will not during challenging economic conditions. But since management agreements can have terms of 20, 30, 40, even 50 years or more, owners have to anticipate that they (or their buyers) will need to approach lenders many times over the course of the agreement, not just when the agreement is executed. The burden a subordination provisions places on financing will undoubtedly affect the value of the hotel through many transactions over the life of the property.
What is the answer? How can you resolve the conflicting interests?
There is no simple answer. Each situation is unique. You need to understand how subordination provisions relate to your interests, the entire agreement, the lending environment, and address it as part of the overall relationship between owner and operator in the hotel management contract.
Unless you are handling hundreds of hotel management agreements a year, so that you know all the ins and outs and current market trends, even professional or institutional hotel investors should not start the management agreement process (not even in negotiating the LOI or term sheet) without veteran hotel advisory and legal counsel experienced in these agreements.
Putting it all in context. . .
A rule of thumb in the hotel industry is that the business and legal terms of the hotel management agreement — wholly apart from the operator’s abilities — can add or subtract 25% of the nominal value of the hotel, or more. That is huge! Take a hotel nominally worth $10 million. By this industry rule of thumb, the hotel’s value could easily swing from $7.5 million to $12.5 million depending on the operator and the management contract terms. If you multiply the nominal value by 10 for a $100 million hotel, the same rule applies, but gives you a swing in value from $75 million to $125 million.
The SNDA provisions of an HMA are one critical set of provisions that create, or give up, part of this value.
Research on Hotel Management Agreements? Helpful articles on Hotel Management Contracts.
The Hospitality Lawyers of JMBM’s Global Hospitality Group® recommend the following articles dealing with important aspects of HMAs available for free on www.HotelLawBlog.com. They can help you create millions of dollars of value with your hotel.
Hotel Lawyer: Ritz-Carlton breached contractual and fiduciary duties under hotel management agreement giving rise to free termination, $10.3 million in damages plus attorneys fees. When will hotel operators “get it”?
This is Jim Butler, author of www.HotelLawBlog.com and hotel lawyer, signing off. We’ve done more than $50 billion of hotel transactions and more than 100 hotel mixed-used deals in the last 5 years alone. Who’s your hotel lawyer?
Robert Braun is a partner and senior member in JMBM’s Global Hospitality Group® — a team of 50 seasoned professionals with more than $50 billion of hotel transactional experience, involving more than 1,000 properties located around the globe. The Group represents owners, developers and lenders. Robert represents hospitality industry clients in both transactional and operational issues, including negotiating, implementing and monitoring hotel and resort management and franchise agreements, acquisitions and divestitures; and joint ventures and strategic relationships. He has represented clients in several hundreds of management agreements. You can reach him at 310.785.5331 or at email@example.com.
Our Perspective. We represent developers, owners and lenders. We have helped our clients as business and legal advisors on more than $50 billion of hotel transactions, involving more than 1,000 properties all over the world. For more information, please contact Jim Butler at firstname.lastname@example.org or 310.201.3526.
Jim Butler is one of the top hospitality attorneys in the world. GOOGLE “hotel lawyer” or “hotel mixed-use” or “condo hotel lawyer” and you will see why.
Jim devotes 100% of his practice to hospitality, representing hotel owners, developers and lenders. Jim leads JMBM’s Global Hospitality Group® — a team of 50 seasoned professionals with more than $50 billion of hotel transactional experience, involving more than 1,000 properties located around the globe. In the last 5 years alone, Jim and his team have assisted clients with more than 100 hotel mixed-use projects — frequently integrated with energizing lifestyle elements.
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.