The State of the Hospitality Industry: The Legal Perspective
 
March 15, 2002
 
James M. "Jim" Norman- Ft Lauderdale

The current economic good news and positive trends in the industry should not be mistaken for a post-recession boom. Vigilance and careful planning for problems remain essential business and legal strategies.

The events of 2001 changed the world and the hospitality industry was not immune. September 11 served to accelerate what had already begun. However, this tragedy was not the single source, by any means, of the current state of the hospitality industry. When times are good, every element of the hospitality industry takes certain things for granted. The focus is on the upside, not the downside. Now is the time when all industry players need to stop, take stock of their current situation, and employ steps to deal not only with the projected and hoped-for turnaround, but a potential continuation of the current situation and a potential that an extended down period or period of market uncertainty will demand defensive strategies.

Much of the industry press deals with business aspects, such as ADR, RevPar and occupancy rates. This bulletin is intended to present the legal point of view. Our basic recommendation is to follow Benjamin Franklin's guidance: "An ounce of prevention is worth a pound of cure." Problems are not wine; they do not get better with age.

Considerations for Owners

• Analyze security issues, review insurance coverages, requirements in loan documents and requirements in management agreements. Acts of terrorism may or may not be covered. Seek professional advice with respect to what screening of guests may be permissible or required under post-September 11 laws and regulations.

• Review loan documents with respect to financial covenants that may be affected by sudden down turns in RevPar, occupancy rates and required debt service ratio coverages. Create a plan for dealing with potential loan defaults by communicating with the interested parties proactively.

• Review your management agreement with respect to the manager's performance standard obligations, force majeure provisions and possible rights relating to termination. You will want to know where you stand in relation to these issues when times get tough or disputes arise.

• If a sale of the hotel is, or may be, necessary, review loan documents and management agreements with respect to rights and obligations.

• Plan new projects and acquisitions with new, stricter equity requirements and possible mezzanine financing costs in the proforma. In particularly desirable projects, consider requiring the manager to contribute equity, mezzanine equity or a guaranteed minimum return on owner's equity to the project.

Considerations for Operators

• Review performance standards and termination provisions of your management agreement.

• Address issues currently rather than risk a potential waiver of certain rights.

• Consider, if other items are to be renegotiated, renegotiating how the performance standard will operate and the interplay of events, such as force majeure or industrywide downturns.

• Review merger and assignment provisions. Most experts believe that further consolidation in the industry will occur. What will happen to your management agreements in the event of a merger? The legal tide may be running against operators. After about two years of waiting for a decision on post-trial motions, the judge in 2660 Woodley Road Joint Venture et al., v. ITT Sheraton Corporation, et al., Civil Action No. 97-450-JJF decided all post-trial motions in favor of the owner and against Sheraton, with the exception of the reduction of the punitive damages award from $31.7 million to $17.5 million. In addition, a very similar type of suit has been filed against Ritz Carlton and Marriott entities in the Green Isle case now pending in Puerto Rico. Analyze your base agreement provisions and consider modifying the terms of your agreements to maximize protection against this type of claim. Obtain legal advice to analyze your current practices and procedures in light of the Woodley Road and Green Isle-type claims.

• Look for situations in which management agreements morph into master leases. Here, operators have certain minimum payment obligations to owners. Watch these trends carefully. There are significant tax and legal issues as these two separate deal structures become one.

• Separate your proposal from the field through creative measures on risk sharing and financing as conditions to a long-term agreement. Be sure that your management agreement takes into account court decisions that may unintentionally allow early termination by the owner.

Considerations for Lenders

• Review loan performance and compliance with financial covenants, specifically including insurance coverage for terrorist acts.

• Review lender rights in connection with a sale of the hotel, termination of the existing management agreement and management agreement lender protection provisions. Conduct the review or have your attorney do so as though a material loan default is imminent.

The downward slope of the business cycle became suddenly steeper as a result of the events of September 11, 2001. This "double-whammy" profoundly affected the hospitality industry. An economic truism is that tough times make opportunities for those who avoid the herd mentality and believe that the future will be brighter. Careful and thorough preparation before problems arise is critical and will determine who survives, who perishes and who prospers in the upmarket to come.

For more information, contact Mr. Norman or Mr. Migdal at 888-688-8500 or via e-mail at jnormanhklakw.com or nmigdal@hklaw.com, respectively.

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