24 August 2011
Hotel Lenders: Will you control the revenues of your hotel after foreclosure? Are you sure? What could go wrong? 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 post, Guy Maisnik highlights the importance of the hotel lender keeping control over revenues post foreclosure, and explains why it doesn’t always happen.
If you would like a refresher as to why hotel lending is different from other kinds of real estate lending, you may want to refer to (see, Why hotel lending is different and 8 pitfalls of hotel lending and how to avoid them).
Please see the links at the end of this article for other articles in the “What every hotel lender needs to know” series.
What every hotel lender needs to know
about hotel cash controls
Guy Maisnik | Hotel Lending Lawyer, JMBM Global Hospitality Group®
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 (i.e. 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
Another article in this “What every hotel lender needs to know” series focused on Subordination, Non-Disturbance and Attornment Agreement or SNDA. The primary focus of attention there was the confounding effect that SNDAs have on the lender’s ability to foreclose out hotel management agreements and the hidden liabilities assumed by lenders on foreclosure, deed-in-lieu of foreclosure and the exercise of other similar remedies.
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 from the hotel operator of the hotel’s cash flow, 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.
Hotel lending lawyer series – What every hotel lender needs to know
There are a lot of hotel-specific issues that hotel loan documents have to deal with. This series is designed to provide the essentials:
Guy Maisnik is a hotel lawyer with nearly three decades in commercial real estate transactions. He is a partner and Vice Chair of JMBM’s Global Hospitality Group®, a member of the JMBM Chinese Investment Group™ and a partner in the JMBM’s real estate department. Guy advises clients on hotel transactions, representing lenders, opportunity funds, banks, special servicers, owners, REITs and developers in hotel transactions, including senior and mezzanine financing, workout and debt restructure, strategic portfolio acquisitions, co-lender, participation and securitization arrangements, joint ventures, management agreements, buying, selling and ground leasing of hotels, complex mixed used resort development, fractional and timeshare. For troubled hotels, Guy develops and executes strategies for CMBS and whole loans, and REOs. He also assists investors with recapitalization of distressed borrowers and purchases of troubled assets. Guy has assisted major lenders in revising and structuring their hotel lending programs and documentation, including their hotel construction lending. Guy’s practice is both domestic and foreign; he has advised on hotel and real estate matters throughout the United States, Canada, Mexico, South America, Middle East, Caribbean, Western and Eastern Europe, Asia and Scandinavia. For more information, please contact Guy Maisnik at 310.201.3588 or email@example.com.
This is Jim Butler, author of www.HotelLawBlog.com and hotel lawyer, signing off. We’ve done more than $60 billion of hotel transactions and have developed innovative solutions to unlock value from hotels. Who’s your hotel lawyer?
Our Perspective. We represent hotel lenders, owners and investors. We have helped our clients find business and legal solutions for more than $60 billion of hotel transactions, involving more than 1,300 properties all over the world. For more information, please contact Jim Butler at firstname.lastname@example.org or +1 (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.