Transferring Franchise Agreements: The Deal You Save May Be Your Own
November 13, 2000
Michelle M. DeRosa- Ft Lauderdale
Your hotel’s flag is a very important asset to you. It is probably going to be just as valuable to your buyer. It means everything to the franchisor. You may have a great relationship with your franchisor, but have you even stopped to consider what will happen when you ask that franchisor to approve an assignment of that valuable franchise to your buyer? Maybe you’re very familiar with what your franchise agreement clearly provides. You may not be quite as familiar with what is not so obvious—powers the franchisor actually and practically has under the franchise agreement and what affect these powers can have on your ability to sell or even mortgage your hotel property, if you want that branding to be included in your deal.
You must be aware of the hidden powers that are not revealed from even a careful review of the franchise agreement. These hidden powers typically remain unrecognized and are only exposed at a time when they could cause the most harm: when an owner attempts to sell or mortgage its property.
Effectively, a franchisor has the power and ability to introduce unexpected issues that could cause delays in a sale or loan transaction relating to the hotel. Is there anything a franchisee/seller can do to avoid these potentially deal-killing hurdles? Fortunately, the answer is a clear YES.
Just What Are These Problems?
Why can’t I get the franchisor to make a decision? The turnaround time to obtain the consent of the franchisor does not happen in the timeframe we need or want—before the end of the buyer’s due diligence period, for example. More often than not, your request for the franchisor’s consent to the transfer must go through numerous levels of review and be processed by several departments prior to it being finally considered by the appropriate party. Each of these levels and departments (the legal department being just one) has its own guidelines and requirements that are reviewed by a staff person, without any authority to compromise or deviate from strict requirements of the franchise agreement or franchisor policy. Try asking a staff person to make your request a priority. Their response will probably be, “Your request will be processed in the order in which it is received.” You expect the next statement to be “This is a recording.”
Where Is the Operator In All This?
Franchisors are generally less concerned with the entity that will own the hotel property than in the entity that will be responsible for the management of the hotel property once it is conveyed. The key point here is less concerned. Financial strength of the new owner virtually always will be important. As a result, in a sale, the franchisor will want to know the status of the approved existing operator, and, if change is in the air, you should expect a firm requirement that it be provided with extensive information relating to the proposed new operator. The franchisor will undoubtedly hold up providing its consent to the transfer of the franchise agreement until it has been provided with the requested information and has approved the new owner and operator. Has the purchaser finally resolved a potential operator at this stage of the transaction? Maybe not. This situation should remind you of those highway construction-warning signs: “Expect Delays.” At this stage of the transaction, the buyer is focusing on other important matters such as reviewing the books and records of the property, performing its due diligence, and dealing with the requirements of its lender. It may not be focused on (or even considered) finding and hiring an operator for the hotel. The seller generally pays little attention to this issue as “It’s not my problem.” Perhaps not at this moment, but it will quickly become the seller’s problem as well as the buyer’s.
They Want Me to Spend How Much On Renovations Now?
One of the most potentially problematic and expensive issues to deal with relates to the Property Improvement Program or similar name assigned by franchisors. Whenever a notice of change in the ownership of the hotel is given, the franchisor generally performs an inspection of the property to decide what repairs and/or improvements must be made to the property in order to bring it up to the franchisor’s current standards for that hotel brand. Typically, the franchisor provides the owner with a laundry list of improvements (possibly even including the laundry facility at the hotel) that must be completed, or at a minimum, committed to, prior to the franchisor granting its consent to the transfer of the franchise. It is not uncommon for the expense of the required improvements to total several million dollars. Although it is possible to negotiate these improvements with the franchisor, these negotiations will take time—real time that may not accommodate deadlines like the closing date. Moreover, if there are certain improvements required prior to approval, there might not be sufficient time under the contract to cause these improvements to be completed prior to the agreed closing date.
Why Can’t We Even Get an Estoppel Letter?
Lenders want their own form of estoppel letter. The lender form seeks everything under the sun, from unconditional representations and warranties to a blind commitment to approve the lender and its successor as a franchisee after foreclosure or bankruptcy, even if a terrorist organization is going to operate the hotel. The franchisor, of course, has its own form of estoppel certificate that is as binding as a politician’s promise—it provides only modest lender comfort. The lender’s right to take over and assume the franchise agreement and being granted the right to encumber the franchise with a mortgage are the big sticking points. As a result, negotiation of the estoppel letter, while nominally between franchisor and lender, takes almost as long as a major league baseball season. This can wreak havoc in a loan transaction where a lender and franchisor dig in their heels.
What’s a Seller or Borrower to Do?
Knowledge is the key. In any sale or loan transaction, you need to fully understand the stated and practical powers the franchisor has that may impact your transaction. Be aware of the procedures that must be followed in order to obtain the consent of the franchisor to the transaction. All internal procedures and time frames of the franchisor must be considered before you finish your purchase contract or loan commitment. Anticipate the possibility of delays and interim rejection of submittals for minor things from very busy franchisor staff, who aren’t making money for the company processing transfer requests.
Make sure that you provide sufficient (and then some) time in your contract or loan commitment (or contingencies): (i) to obtain any necessary consents of the franchisor; (ii) to address and negotiate any estoppel certificate forms; and (iii) to negotiate any required property improvements that may be required by the franchisor. Don’t wait until you have a signed contract or loan commitment; find out right after you decide to sell or refinance. Take out that franchise agreement and review it thoroughly; or have a lawyer experienced in hotel franchise transfers get involved. Then, contact the franchisor immediately to discuss requirements and timeframes. If there’s going to be a problem, right now is the best time to know about it.
If you are lucky, someone on your team or someone involved in the transaction has a friendly relationship with the franchisor. This may be your buyer, who might have several other properties, presently or in the past, with the same franchisor. A telephone call or two from these parties to the key people within the franchisor’s organization could be just what is needed to help negotiate any issues and push the approvals along. Don’t underestimate the value of these contacts and relationships. Understand the legitimate interest of the franchisor in protecting the integrity of the brand. That’s what created the value of the franchise in the first place.
Forewarned is forearmed. The lesson to bear in mind is that it’s never too early to deal with a franchise agreement that is to be transferred as part of a sale or encumbered with a mortgage in a loan transaction. Getting that early start may be the difference between a closed deal and a lost deal.
Michelle DeRosa is an Associate in the Fort Lauderdale office. Ms DeRosa can be reached at 954-468-7934 and at mderosa@hklaw.com.